UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB [X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2005 [ ] 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 0-14210 COMPUMED, INC. --------------------- (Name of Small Business Issuer in Its Charter) DELAWARE 95-2860434 --------------------------------- -------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 5777 WEST CENTURY BLVD., SUITE 1285, LOS ANGELES, CA 90045 ---------------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (310) 258-5000 ------------------------------------------------ (Issuer's Telephone Number) Securities registered under Section 12(b) of the Exchange Act: NONE Securities registered under Section 12(g) of the Exchange Act: COMMON STOCK, $.01 PAR VALUE Check whether the Issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 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. [X] YES [ ]NO Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X] State the issuer's revenues for its most recent fiscal year: $2,284,000. As of November 30, 2005, the issuer had 22,920,609 common shares were outstanding. The aggregate market value of the common shares held by non-affiliates of the issuer (21,366,028 shares) was approximately $15,704,031 based upon the average bid and asked prices ($0.735) on such date. Transitional Small business issuer Format: [ ] YES [X] NO TABLE OF CONTENTS PART I PAGE Item 1 Description of Business 2 Item 2 Description of Property 9 Item 3 Legal Proceedings 9 Item 4 Submission of Matters to a Vote of Security Holders 9 PART II Item 5 Market For Common Equity and Related Stockholder Matters 9 Item 6 Management's Discussion and Analysis or Plan of Operation 10 Item 7 Financial Statements 14 Item 8 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 14 Item 8A Controls and Procedures 14 PART III Item 9 Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act 14 Item 10 Executive Compensation 16 Item 11 Security Ownership of Certain Beneficial Owners and Management And Related Stockholder Matters 17 Item 12 Certain Relationships and Related Transactions 18 Item 13 Exhibits 18 Item 14 Principal Accountant Fees and Services. 20 Signatures. 20 Financial Statements F-1 2 PART I ------ ITEM 1. DESCRIPTION OF BUSINESS GENERAL We are a developer of Computer Aided Diagnostic (CAD) solutions for the healthcare industry that provides medical imaging software and remote, computer-aided interpretation of electrocardiograms. Our two main products are the OsteoGram(R) and CardioGram systems. The OsteoGram(R) is our proprietary image processing software that utilizes either digital or film-based x-rays of the hand to screen, diagnose and monitor osteoporosis, a disease that affects more than 200 million people worldwide. The CardioGram consists of computer-aided telemedicine services that offer on-line interpretation of electrocardiograms to physicians, government and corporate healthcare providers. We incorporated in the State of Delaware on July 21, 1986. RECENT EVENTS Our core business is the remote interpretation of electrocardiograms (ECGs) coupled with a feature that allows customers to have a cardiologist overread abnormal results. We are pleased that the core business grew 27% this fiscal year. Much of this growth came from a one-time purchase of nearly 100 ECG terminals from the New York State Department of Corrections. Prior to the shipment of the New York order, we made a decision to partner with Schiller AG, Schiller is the global market leader in electrocardiogram equipment and the Schiller system is state-of-the-art in remote interpretation servers. We acquired the latest Schiller server system to accept, interpret and handle the billing and data storage of our ECG business, and we now market Schiller ECG terminals to our customers. The Internet-ready capability of the Schiller system will enable us to accept transmission over the Internet. We believe the ability to immediately transmit an electrocardiogram to an American cardiologist is a desirable feature that may expand our market reach outside of the United States. In addition, we expect to collaborate with Schiller in the development of new product offerings and the expansion into new global markets. We believe that the future of our OsteoGram(R) technology is in the development of medical software applications for digital (filmless) imaging equipment, which is a high growth segment of the medical imaging field. As a result, in 2005, we developed the Digital Communications and Imaging in Medicine (DICOM) standards-based version of the OsteoGram(R) which is our first product in this emerging arena. 3 Late in fiscal 2005 we decided to accelerate our efforts with the OsteoGram(R) product by strengthening our management team in the areas of sales and engineering. We recruited an experienced Vice President of Sales and a seasoned Vice President of Engineering. We expect that these two additions to our management team will rapidly ramp up OsteoGram(R) revenue and hasten product development. Our research and development team devoted the majority of their time this fiscal year to integrating our software application into several digital imaging platforms, including the market-leading direct digital x-ray platform from Swissray. In addition, we released the Version 1.03 of the DICOM OsteoGram product with increased functionality and a more robust underlying structure. THE OSTEOGRAM(R) GENERAL The OsteoGram(R) is a medical image processing system that enables healthcare providers to screen, diagnose and monitor osteoporosis using conventional, film-based hand x-rays or digital images from filmless x-ray equipment. Osteoporosis is diagnosed by measuring bone mineral density (BMD). A low BMD is indicative of the disease. The OsteoGram(R) is based on a bone mass measurement technique called radiographic absorptiometry, which was cited in the 2004 Surgeon General's report on bone disease. Radiographic absorptiometry uses a conventional x-ray of the hand, scanned at high resolution, to measure bone density. The radiographic absorptiometry technique not only measures bone mass, but also the cortical thickness of bones. Recent studies affirm the importance of cortical thickness as an additional measure of bone strength and overall fracture risk. Several prominent pharmaceutical manufacturers are developing products that will strengthen cortical bone. Cortical bone is the outer shell that gives bone strength, much like the hollow tubes from which bicycles are constructed. Our technology has the capability to measure BMD in both cortical and trabecular bone, and we believe this is an important feature to add to the OsteoGram(R) system in the future. Dual x-ray absorptiometry (DXA), is considered the "Gold Standard" of BMD measurement, but it cannot differentiate between cortical and trabecular bone. We believe that the OsteoGram(R) could become a key tool for some pharmaceutical manufacturers not only in the clinical trial phase, but also in monitoring therapy once a drug is approved. Our development team is working diligently to add cortical thickness measurement to the existing OsteoGram(R) report, and we plan to launch the preliminary product in China during the first quarter of 2006. In May 1999, we received clearance from the United States Food and Drug Administration to market an automated version of the OsteoGram(R) software for use as a stand-alone product by physicians. We recently launched the Digital Imaging and Communications in Medicine (DICOM) or digital version of the product. Using digital or film-based x-ray equipment, two posterior-anterior views of the left-hand fingers are taken with an aluminum alloy reference wedge in each exposure. The calibration wedge is used to adjust for any differences among x-ray equipment, exposures and other variables. In the case of the film-based version of the OsteoGram(R), the developed film is scanned with a high-resolution desktop scanner, and the OsteoGram(R) software analysis program rapidly produces an accurate and precise bone mineral density report. With a filmless x-ray system the digital image is captured on a workstation for analysis. We originally developed the DICOM-compliant version of the OsteoGram(R) in fiscal 2004 for use on filmless systems, which have become a high growth segment in the medical imaging market. DICOM is the industry-consortium established information standard that allows the new generation of digital medical imaging equipment to interconnect. The foremost market opportunity that we have identified for our OsteoGram(R) is the market for filmless x-ray systems. Our application can reside on a workstation, just like Microsoft(R) Word on a personal computer. There is no need for expensive, dedicated equipment or redundant computers. Clinicians can launch the OsteoGram(R) application and diagnose osteoporosis at the same time an x-ray is taken for a bone fracture, making it far easier to implement and use than expensive dual x-ray absorptiometry equipment that requires a dedicated room and specially trained technicians who are usually not available around the clock. The business model for the OsteoGram(R) is compelling, since the test is reimbursable by Medicare, adding value to the bundled solution manufacturers of digital radiography equipment can offer to their customers. The OsteoGram(R) not only helps to solve the public health problem of lack of convenient osteoporosis testing, but it also increases revenue for the customer. The projected revenue can be positioned as a means to offset the monthly lease costs of the manufacturer's equipment, allowing these manufacturers and their dealers an attractive sales paradigm. STRATEGIC PARTNERSHIPS As a small company, it is difficult to create global demand for our products; therefore we rely on strategic partners to market the OsteoGram(R) to end-users. Our strategy is to establish distribution and product development partnerships with the major manufactures of digital imaging platforms and to launch the integrated solution in a timely manner. Although we are much more adept at integrating the OsteoGram(R) into various digital modalities, the process is gated by our partners' schedules, the timing of product launches and market conditions. Orex Computed Radiography was one of our earliest licensees. The company was acquired by the Health Group of Eastman Kodak Company in early 2005, and the subsequent integration of Orex into the Kodak system slowed our progress in the field. We expect Orex to devote more attention to the OsteoGram(R) bundled solution in the near future, and revenue from the Orex agreement should begin to flow in the first quarter of our new fiscal year. The Orex licensing agreement was transferable upon the sale of the company, and Kodak is a key player in the digital radiography field with platforms in computed radiography (CR), digital radiography (DR) and CAD mammography. The terms of our licensing agreement with Orex allow Kodak to effortlessly license the OsteoGram(R) for their existing digital products. 4 Last year we signed an OsteoGram(R) licensing agreement with market-leading direct digital radiography (DR) manufacturer, Swissray International. After integrating our software with the Swissray platform, sales efforts began and the Swissray sales organization is actively promoting our product. We have achieved early success, and we are looking forward to a steady revenue stream from Swissray. A second leg of our strategy is to utilize experienced imaging distributors both in the domestic and international market. To reach out to these regional distributors, we hired an experienced imaging executive in July as our new Vice President of Sales. Our new VP concluded fiscal year 2005 by signing a number of new distributors, including Merry X-Ray, a market leader in the digital imaging arena. Merry recently announced the acquisition of SourceOne, the largest clinical imaging distributor in the U.S. We expect that there will be a lag phase in which these new distributors must undergo as they become familiar with the OsteoGram(R) and develop a sustainable sales pipeline. Our new sales VP will continue to work with our new distribution partners to help them identify market opportunities that can be replicated nationwide. Our efforts in the international arena continue. We have been shut out of the European market by the lack of a CE Mark, which is a requirement in the European Union (EU). Gaining a CE Mark is an arduous task, and in August 2005 our efforts were rewarded by a simultaneous approval for a CE Mark and ISO 13485, the internationally recognized standard developed to ensure that companies provide medical devices that consistently meet customer and regulatory requirements. ISO certification verifies that we meet strict requirements for quality management systems applicable to medical devices and related services. ISO 13485 is a key accomplishment, since our imaging manufacturing partners require quality standards that are in alignment with their own internal protocols. Our Scientific Director worked diligently with TUV Rhineland to obtain these important approvals. TUV Rhineland is one of the most prestigious notifying bodies in the quality field, and their audit process is highly demanding. With the CE Mark on the OsteoGram(R), we look forward to a full launch of the product in the EU in the coming fiscal year at Medica, the world's largest all medical trade show held annually in Dusseldorf, Germany during November. RESEARCH & DEVELOPMENT Fiscal 2005 was a demanding year for our development team, as they focused on releasing Version 1.03 of the OsteoGram DICOM software with added functionality and a more robust underlying structure. We were able to accomplish a number of R&D goals during fiscal 2005 by adding a new Vice President of engineering that had an excellent track record in the DICOM development field. In addition, the OsteoGram(R) software was modified to function on the Swissray International dDR platform, and the Swissray sales team began to market the product both in the United States and in Europe. Preliminary orders for trial systems were installed in several Swissray accounts, and a full-scale effort from Swissray will be forthcoming beginning at this year's Annual Meeting of the Radiological Society of North America (RSNA). The OsteoGram software was exhibited at the 2004 RSNA by Fuji Medical Systems USA on both their market leading computed radiography (CR) and CR mammography units (currently awaiting FDA clearance). We believe that there is a strong market for our product on digital and film-based mammography platforms, and we filed a preliminary patent application in November 2004 to protect our intellectual property rights in that regard. As fiscal 2005 progressed, we undertook a small clinical trial to assess the results of utilizing the OsteoGram(R) software with images taken on a full field digital mammography (FFDM) unit. The trial was conducted at a major teaching hospital, and we were encouraged by the strong correlation between the OsteoGram(R) results on digital mammography equipment and the original OsteoGram(R) film-based product. We are actively planning an OsteoGram(R) product around the concept. One of the major issues preventing routine osteoporosis testing is the lack of convenient testing sites. We believe that, by integrating the OsteoGram(R) into FFDM platforms, women can be conveniently tested for osteoporosis at the same time and on the same equipment as their routine mammogram. Recent studies affirm the importance of cortical thickness as an additional measure of bone strength and overall fracture risk. Several well-known pharmaceutical manufacturers are developing products that will selectively strengthen cortical bone. Cortical bone is the outer shell that gives bone strength, much like the hollow tubes that make up a bicycle. Our technology has the capability to measure BMD in either cortical or trabecular bone. DXA, considered the "Gold Standard" of BMD measurement, cannot differentiate between cortical and trabecular bone, and we believe that the OsteoGram(R) could become a key tool for pharmaceutical manufacturers not only in the clinical trial phase, but also in monitoring therapy once a drug is approved. Our development team is working diligently to add cortical thickness measurement to the existing OsteoGram(R) report, and we plan to launch the preliminary product in China during the first quarter of the fiscal year. We continue to invest in research and development efforts for the OsteoGram(R) technology by planning new applications and filing key patents to protect our intellectual property rights. We are actively engaged in the development of potential diagnostic products based on the technologies covered by our first and second patents awarded by the U.S. Patent and Trademark Office in June 2001 and April 2004. Our technical team invested considerable time and effort in selecting Schiller AG as our new electrocardiogram equipment supplier. We intend to be an active partner with our new supplier in the product planning process, and our goal is to offer a number of electrocardiogram terminals with features that will appeal to both cost-conscious customers and those desiring the additional benefits of upgraded systems. The Schiller system will open up the international markets for our services, plus cut transmission costs. Additionally, upgraded systems will enable us to compete in the market for clinical drug trials. 5 In fiscal 2005, we spent $293,000 in research and development, as compared to $217,000 in fiscal 2004. None of these costs were borne by our customers. OSTEOPOROSIS Osteoporosis is a disease characterized by low bone mass and structural deterioration of tissue leading to bone fragility and an increased susceptibility to fractures of the hip, spine and wrist. While there is increased global awareness of osteoporosis, the disease is under-diagnosed and under-treated. According to the International Osteoporosis Foundation, osteoporosis affects more than 200 million people worldwide, 80% of which are women. Osteoporosis is a major public health threat for 44 million Americans, and the disease costs the U.S. healthcare system in excess of $17 billion annually, compared to breast cancer at $6 billion. In fact, more people die as a result of osteoporosis-related fractures each year than die from breast cancer, and one of every two women will suffer an osteoporosis-related fracture in her lifetime. In July 2002, the National Institutes of Health halted a large, in-progress study examining the effects of hormone replacement therapy. The study, which was one of the five major studies that comprise the large clinical trial called the Women's Health Initiative, was discontinued because the hormones appeared to increase a woman's risk of breast cancer as well as heart disease, blood clots and stroke. This news caused the medical community to question one of the long-accepted practices in the treatment of female menopausal symptoms. Hormone replacement therapy is known to protect women against bone loss; however, the negative implications of increased heart disease, stroke and cancer were largely unknown. Subsequently millions of women discontinued hormone replacement therapy, which increased concern about bone loss. As a result, there was an increased awareness of bone mineral density testing and testing methods. Following the Women's Health Initiative announcement, the U.S. Preventative Services Task Force published its own recommendations that women over the age of 65 be tested for osteoporosis. Soon afterwards the National Osteoporosis Foundation reaffirmed their more comprehensive recommendations for osteoporosis testing. In July 2003 the American Association for Orthopaedic Surgeons posted a policy statement on their web site urging their members to test for underlying bone disease when presented with a fragility fracture. In addition, Medicare is now enacting a new measure requiring health care providers to test for osteoporosis when a fracture is diagnosed. Failure to test or treat osteoporosis may have negative implications for a hospital's accreditation. We believe that the global awareness of osteoporosis is increasing, and that there is a resurgence of interest in bone mineral density testing as a result of the increased publicity. We also believe that osteoporosis testing is a significant public health care issue that can best be dealt with in a routine manner at a point-of-care care setting. COMPETITION-OSTEOGRAM(R) Bone mineral density measurements are the primary methods used to assist physicians in detecting osteoporosis. Bone mineral density is measured by passing x-ray beams or ultrasound through bone and determining how much energy the bone absorbs. Dual x-ray absorptiometry (DXA) is currently the mostly widely used osteoporosis detection technology, with a worldwide installed base of approximately 16,000 units according to Lunar News, Summer 2000. The DXA market is divided into "whole-body" machines, which are designed to measure bone mass and density at a variety of skeletal sites (primarily the hip and spine), and "peripheral" machines, which measure bone mass and density at appendicular sites (forearm, hand or heel). The leading manufacturers of whole-body DXA scanners include General Electric's Lunar Division (U.S.) and Hologic, Inc. (U.S.), which together command most of the worldwide DXA market. The leading manufacturers of peripheral DXA machines are General Electric, Hologic, Norland and Osteometer (a subsidiary of OSI Systems, U.S.). Whole body DXA products typically cost from $70,000-$150,000 and require continued maintenance during their lifetime. They also require specially trained technicians, who must be licensed in most states, and who are not available on a 24-hour, 7 days a week basis. We experience extensive competition for the OsteoGram(R) from companies that offer DXA machines, primarily because they are considered the "Gold Standard" for measuring bone mineral density and have a large installed base worldwide. We compete by offering cost effective testing and a product with a unique digital format. The OsteoGram(R) was developed to enhance the use of existing radiological equipment for generating bone mineral density reports comparable to tests performed on the expensive, dedicated DXA equipment generally found in hospitals and specialty practices. Other competition for the OsteoGram(R) comes from less accurate ultrasound and other peripheral devices. Our competition also uses single-energy x-ray absorptiometry, quantitative computed tomography, peripheral quantitative computed tomography, and radiographic absorptiometry(RA). All radiographic techniques in use today have been validated through extensive clinical studies and are currently approved in the U.S. for Medicare reimbursement. We employ radiographic absorptiometry technology because of its accuracy, ease of use and relative low cost. 6 Quantitative Computed Tomography. Quantitative computed tomography (QCT) utilizes existing computed tomography (CT or CAT) scanners that have been upgraded with specialized software, while peripheral quantitative computed tomography (pQCT) utilizes specialized peripheral computed tomography equipment. QCT and pQCT are expensive to perform and require a high degree of expertise to operate properly. In addition, the radiation dose of QCT is remarkably high compared to the OsteoGram(R) process. Quantitative Ultrasound. Quantitative ultrasound (QUS) bone densitometers were introduced in the early 1990s, and they are widely available. General Electric Lunar and Hologic are leaders in the ultrasound market segment; however, the market also includes numerous regional manufacturers such as Myriad and Sunlight (Israel), IGEA (Italy) and McCue (Great Britain). We believe that there are now approximately 10,000 QUS machines installed worldwide. QUS has Food and Drug Administration clearance for screening in the U.S., but unlike the OsteoGram(R), is not recommended for diagnosis by the National Osteoporosis Foundation. To our knowledge, the only manufacturer using radiographic absorptiometry, other than us, is Alara, Inc. (U.S.). In 2000, the Food and Drug Administration approved Alara's self-contained, tabletop system that performs digital radiographic absorptiometry of the hand. We believe Alara is currently focused on developing computed radiography systems. Our existing and potential competitors consist principally of companies that have substantially greater financial, technical, marketing, distribution and other resources, greater current market penetration and longer-standing relationships with customers than us. We believe that our ability to compete successfully depends on a number of factors, both within and outside of our control, including the price, quality and performance our products and those of our competitors. Other factors include the timing and success of our new product introductions and our competitors, the development of technical innovations, the number and nature of our competitors in a given market, and general market and economic conditions. We may not be able to compete successfully in the future. ELECTROCARDIOGRAM SERVICES GENERAL We have been a supplier of telemedicine services, establishing one of the nation's largest telecommunications networks for processing electrocardiograms on a real time basis, for nearly twenty years. Using our customized electrocardiogram terminal, an electrocardiogram is acquired from a patient, telecommunicated to our central computers, analyzed and received back on the electrocardiogram terminal where the electrocardiogram trace and computer interpretation are printed- all within three minutes. If necessary, we can provide an "overread" by a cardiologist and return the results within an hour. We bill for this service on a per-use basis, and we sell a full range of electrocardiogram supplies including electrodes, recording paper, gel, and patient cables. Electrocardiogram analysis services are available to end-users 24 hours a day, seven days a week. Our computer laboratory is staffed or on-call at all times and has been recently upgraded to provide additional features and faster turn around time for "overreads" by replacing telephone requests with electronic notification. We currently provide electrocardiogram equipment and services to more than 500 government and corporate healthcare facilities, clinics, and hospitals nationwide. Our customers include physicians, correctional healthcare facilities, ambulatory surgery centers, clinics, rural hospitals, occupational health facilities, and behavioral health facilities. Electrocardiogram terminals are available for purchase, rental or lease, and transmission fees are charged on a per-use basis. Customers who choose to purchase an electrocardiogram terminal are charged either hardware maintenance fees or repair fees for maintaining and repairing the equipment. MARKETING - ELECTROCARDIOGRAM SERVICES As in fiscal 2004, our goal in fiscal 2005 was to capture 100% of the state correctional contracts up for bid. We are pleased that we accomplished that goal by renewing our contract with the Idaho Department of Corrections and by capturing the state correctional contracts for both Maryland and Wyoming. The successful bids for Wyoming and Maryland were noteworthy, since we participated with Correctional Medical Systems (CMS) and Prison Health Services (PHS) in winning the overall healthcare award for the two state systems. We have not partnered with CMS or PHS in many years, and we look forward to further opportunities in conjunction with the two market leaders in the correctional healthcare services market. During fiscal 2005 we installed more than 150 new Schiller terminals in the New York and Florida State Departments of Corrections. The New York contract called for the outright purchase of nearly 100 new Schiller terminals, which resulted in a short-term revenue increase that helped boost fiscal 2005 ECG revenue by 27%. Older 507 units will be returned to us from New York and Florida correctional facilities for refurbishing and subsequent marketing to customers that are price sensitive in nature. We believe that the Internet compatibility of the Schiller system will enable us to enter the international markets, where the cost of a phone connection previously was a barrier to entry. We look forward to exploring several potential business models for expansion of our business outside of the United States, and we have held preliminary discussions with a major university medical school in China that expresses interest in partnering with us to provide remote interpretation and overreading services in their country. China has recently initiated a countrywide program to stem the increasing number of deaths from heart disease; therefore, there exists growing awareness of preventative measures. 7 We target our sales efforts for electrocardiogram products and services toward physicians, correctional healthcare facilities, ambulatory surgery centers, rural hospitals and occupational health facilities located throughout the U.S. We maintain a long-standing customer base with contracts for services generally extending between one to five years. New customers are generated mostly by our direct sales efforts. We advertise in trade journals and attend national medical conventions as needed to generate leads for selling our services, equipment and supplies. COMPETITION - ELECTROCARDIOGRAM SERVICES Our primary competitors are the Laboratory Corporation of America, Biomedical Systems, Inc. and Covance, Inc. These companies all offer electrocardiogram terminals that provide electrocardiogram interpretation and data storage services at a central location. We estimate that our centralized electrocardiogram analyses constitute less than 1% of the total number of electrocardiograms taken each year in the U.S. The overall domestic electrocardiogram market is mature. However, we believe that the demand for the centralized electrocardiogram services that we provide may increase due to the trend toward decentralized diagnostic testing with central interpretation and data storage, especially in clinical drug trials, where the federal government is likely to approve more automated procedures. The principal methods under which we compete are service, ease-of-use, and price. Our existing and potential competitors consist principally of companies that have substantially greater financial, technical, marketing, distribution and other resources, greater current market penetration and longer-standing relationships with customers than us. We believe that our ability to compete successfully depends on a number of factors, both within and outside of our control, including the price, quality and performance our products and those of our competitors. Other factors include the timing and success of our new product introductions and our competitors, the development of technical innovations, the number and nature of our competitors in a given market, and general market and economic conditions. We may not be able to compete successfully in the future. ASSEMBLY, REPAIR AND CUSTOMER SERVICE We repair and maintain most of the electrocardiographs rented, leased or sold to our customers. All repair and assembly operations are conducted at our headquarters in Los Angeles. Our internal customer service staff handles customer equipment and training problems, and our customer service department handles initial installation and set-up, usually over the telephone. GOVERNMENT REGULATION The Centers for Medicare and Medicaid Services approve diagnostic tests for reimbursement by Medicare. The OsteoGram(R) is approved for reimbursement by Medicare as a centralized laboratory test and as a stand-alone system. Government regulations may change at any time and Medicare reimbursement for the OsteoGram(R) test, as well as for other bone mineral density tests, may be withdrawn or reduced. Furthermore, other forms of testing for bone mineral density as an indicator of osteoporosis have been or may be approved for reimbursement, which may reduce our market share or profit margins for these services. Our OsteoGram(R) test and automated software have been cleared by the Food and Drug Administration for use and sale. In addition, the OsteoGram(R) is approved for use in China, Korea, and a number of other countries. The OsteoGram(R) software is subject to regulation as a medical device. Our electrocardiogram computer interpretation services are also regulated by the Food and Drug Administration and are compliant. PATENTS AND PROPRIETARY RIGHTS The U.S. Patent and Trademark Office awarded us our first OsteoGram(R) patent in June 2001 with a duration of 20 years. The patent covers twenty aspects of method and apparatus for determining bone mineral density. In April 2004 we were awarded a second patent with a duration of 20 years, which includes twenty-four claims covering image processing and bone segmentation technology. In July 2004, we filed final action on a provisional U.S. patent application for our Digital Communications and Imaging in Medicine DICOM version of the OsteoGram(R) product, which we believe will be a key patent in our field. We are unaware of any other patent to utilize standard or digital x-ray equipment and a DICOM image to evaluate bone mineral density and bone degenerative disease. In September 2004, we filed final action on an additional provisional U.S. patent application on a method to determine the percentage cortical versus trabecular bone utilizing a DICOM image. This is important, since many clinicians are turning their attention to bone microstructure for a more precise diagnosis and prediction of fracture risk. Dual x-ray absorptiometry (DXA) technology, which is considered the "Gold Standard" in bone mineral density testing, is unable to distinguish between cortical and trabecular bone. We believe that our ability to assess bone quality and other emerging parameters will help us to compete effectively with DXA, as clinicians become more aware of fracture risk assessment using parameters beyond bone mineral density. In November 2005 we filed an additional preliminary patent application to protect our intellectual property rights relating to the integration of the OsteoGram(R) with mammography equipment. 8 In June 2005 our technical staff presented an abstract on the DICOM OsteoGram at the annual meeting of the Society for Computer Applications in Radiology (SCAR), one of the most prestigious organizations in our field. The abstract validated the strong correlation between the film-based OsteoGram(R) and the DICOM version on the Orex computed radiography platform. The OsteoGram(R) trademark has been our registered trademark since July 2, 2002. We filed and were awarded trademark protection for the OsteoClick, our remote, pay-per-use system utilizing the OsteoGram(R) software positioned on a central server. EMPLOYEES As of September 30, 2005, we had 15 full-time and 2 part-time employees, in addition to our network of independent sales representatives and distributors. None of our employees is represented by a labor union and we have experienced no work stoppages. We consider our relations with our employees to be good. We also retain consultants from time to time when necessary. Independent cardiologists are retained for electrocardiogram "overreads" on a per-diem basis. INSURANCE We maintain liability insurance on our current products and are not aware of any claims based on the use or failure of our products that are expected to have material adverse effect on our operations or financial condition. Claims made in the future with respect to our products may not be successfully defended or our insurance may not be sufficient. Furthermore, liability insurance may not continue to be available to us on acceptable terms. ITEM 2. DESCRIPTION OF PROPERTY Our corporate office, computer center and warehouse facilities are located in 9,496 square feet in an office building located at 5777 West Century Blvd., Los Angeles, CA 90045. This facility is leased through August 2006 at a monthly rental of $11,800. This is a full service lease that includes utilities, maintenance and taxes on the property, janitorial and security service. ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to stockholders during the quarter ended September 30, 2005. PART II ------- ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is currently quoted on the over-the-counter bulletin board under the symbol "CMPD.OB". Prior to December 1, 1999, our common stock was listed on the NASDAQ National Market System. The following table sets forth the range of high and low bid prices for our common stock during the periods indicated. The prices set forth below represent inter-dealer prices, which do not include retail mark-ups and markdowns, or any commission to the broker-dealer, and may not necessarily represent actual transactions. YEAR ENDED SEPTEMBER 30, 2004 QUARTER ENDED: COMMON STOCK ------------------------------ ------------------------- HIGH LOW ------------- ---------- December 31, 2003. . . . . . . $ .32 $ .26 March 31, 2004 . . . . . . . . .23 .20 June 30, 2004. . . . . . . . . .16 .15 September 30, 2004 . . . . . . .22 .18 YEAR ENDED SEPTEMBER 30, 2005 QUARTER ENDED: COMMON STOCK ------------------------------ ------------------------- HIGH LOW ------------- ---------- December 31, 2004. . . . . . . $ .43 $ .34 March 31, 2005 . . . . . . . . .27 .26 June 30, 2005. . . . . . . . . .33 .25 September 30, 2005 . . . . . . .40 .38 9 As of September 30, 2005, there were approximately 548 record holders of our common stock, which does not include common stock held in "nominee" or "street" name. We have not paid cash dividends on our common stock since our inception. At the present time, we intend to follow a policy of retaining any earnings in order to finance the development of our business and do not anticipate paying cash dividends in the foreseeable future. On November 30, 2005 the closing price of our common stock was $0.74. In fiscal 2005, during the first quarter, we issued 121,000 shares to raise of $33,000, during the second quarter, we issued 139,000 shares to raise $42,000, during the third quarter, we issued 437,000 shares to raise $96,000, and during the fourth quarter, we issued 1,597,000 shares to raise $390,000. At September 30, 2005 we issued an aggregate amount of 2,294,000 shares of common stock to Dutchess Private Equities Fund, L.P. and had a net proceeds of $561,000. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The following discussion and analysis compares our results of operations for the year ended September 30, 2005 to the same period in 2004. This discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS This Report on Form 10-KSB contains forward-looking statements, including, without limitation, statements concerning our possible or assumed future results of operations. These statements are preceded by, followed by or include the words "believes," "could," "expects," "intends" "anticipates," or similar expressions. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons including, but not limited to, product and service demand and acceptance, changes in technology, ability to raise capital, the availability of appropriate acquisition candidates and/or business partnerships, economic conditions, the impact of competition and pricing, capacity and supply constraints or difficulties, government regulation and other risks described in this report. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made, and our future results, levels of activity, performance or achievements may not meet these expectations. We do not intend to update any of the forward-looking statements after the date of this document to conform these statements to actual results or to changes in our expectations, except as required by law. RESULTS OF OPERATIONS FISCAL YEAR ENDED SEPTEMBER 30, 2005 AS COMPARED TO 2004 Total revenues for fiscal 2005 were $2,284,000 as compared to $1,856,000 in fiscal 2004, an increase of 23%. Our ECG transmission services revenues during fiscal 2005 increased by 7% to $1,726,000 from $1,619,000, mostly due to increase of ECG Processing and Overread services. ECG product and supplies sales increased by 418% in fiscal 2005 to $440,000 from $85,000 mostly due to a one-time sales of ECG terminals to the New York State Department of Corrections. During fiscal 2005, OsteoGram (R) revenues decreased by 22% to $118,000 from $152,000. The decrease was due to slower than expected implementation by our OEM partners. 10 Cost of ECG services for fiscal 2005 increased by 18% to $602,000 from $512,000 mostly due to higher demand in overrread services. Cost of goods sold of ECG for fiscal 2005 increased by 454% to $327,000 from $59,000 for fiscal 2004, due to higher sales of ECG equipment. Cost of goods sold for OsteoGram (R) increased by 14% during fiscal 2005 to $8,000 from $7,000 for fiscal 2004 due to cost related hardware of the full system sold. Selling expenses increased by 31% for fiscal 2005 to $313,000 from $239,000 for fiscal 2004 mostly due to costs related to the CE mark applications and the hiring of the Vice President of Sales. General and administrative expenses in fiscal 2005 slightly increased to $1,024,000 from $1,022,000 from fiscal 2004, due to increase in Board of Director meetings and investor relations related expenses. Research and development costs increased for fiscal 2005 increased by 35% to $293,000 from $217,000 for fiscal 2004 due to the hiring of the Vice President of Engineering. Other miscellaneous income for fiscal 2005 decreased by 87% to $7,000 from $55,000 in fiscal 2004. The miscellaneous income was higher in fiscal 2004 due to one-time property tax dispute that was settled in our favor. Interest income for fiscal 2005 remained the same as 2004 at $16,000. The net loss for fiscal year 2005 increased by 22% to $336,000 from $275,000 in fiscal 2004 mostly due to increased staffing in the OsteoGram(R) business in the third and fourth quarters of fiscal 2005. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES At September 30, 2005, we had approximately $571,000 in cash and marketable securities, as compared to a balance of $227,000 at September 30, 2004. The net increase of $344,000 in cash and marketable securities is primarily due to fund raised through Dutchess Private Equities Fund, LP. During fiscal year 2005, purchases of property and equipment increased to $176,000 from $82,000 for fiscal 2004, mostly due to the acquisition of the Schiller terminals to provide to our new acquired and renewed contracts with several Departments of Corrections. We have historically used existing cash and readily marketable securities balances to fund operating losses and capital expenditures. We had raised these funds in 1997 through 2000 through the placement of Preferred Stock issuances and proceeds from the exercise of certain stock options and warrants. During 2005 we raised $561,000 through the sale of 2,294,000 shares of common stock through a financial contract with Dutchess Private Equities Fund, LP. We have incurred recurring losses and had net losses aggregating $611,000 in fiscal years ended September 30, 2005 and 2004. However, we anticipate that our cash flow from operations, available cash and marketable securities will be sufficient to meet our anticipated financial needs for at least the next 12 months. We may need to raise additional capital in the future, which might not be available on reasonable terms or at all. Failure to raise capital when needed could adversely impact our business, operating results and liquidity. If additional funds were raised through the issuance of equity securities, the percentage of ownership of existing stockholders would be reduced. Furthermore, these equity securities might have rights, preferences or privileges senior to our common stock. Our common stock is currently quoted on the over-the-counter bulletin board, which will make it more difficult to raise funds through the issuance of equity securities. These additional sources of financing may not be available on acceptable terms, if at all. Our primary capital resource commitments at September 30, 2005 consist of capital and operating lease commitments, primarily for computer equipment, electrocardiogram terminals and for our corporate office facility. We intend to pursue additional research and/or sub-contractor agreements relating to our development projects. Additionally, we may seek partners and acquisition candidates of businesses that are complementary to our own. These investments would be subject to our obtaining financing through issuance of debt or other securities. An acquisition may be dilutive to stockholders. CAPITAL COMMITMENTS On May 1, 2005, we entered into a six-month agreement with Porter, Levay & Rose, Inc. an investor relations company. During the term of this Agreement, we will pay Porter, LeVay & Rose $6,500 per month. On December 1, 2005, the Agreement was extended for another six months with a 5% increase in fees at $6,825 per month. We lease our corporate offices at a monthly rental of $11,822 per month. FINANCING ACTIVITIES On February 25, 2004, we entered into an Investment Agreement and a Registration Rights Agreement with Dutchess Private Equities Fund, L.P., pursuant to which Dutchess agreed to purchase up to $5,000,000 of shares of our common stock over a three-year period. The purchase price of the shares of our common stock equals 95% the three lowest closing best bid prices of our common stock during the 5 days after we deliver a put notice to them. MATERIAL TRENDS AND UNCERTAINITIES We are disappointed by the rate of progress in commercializing the Digital Communications and Imaging in Medicine (DICOM) OsteoGram (R), and we expect that our distribution partners will accelerate their efforts to incorporate our product into their sales training schedules during the first two quarters of fiscal year 2006. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations, including the discussion on liquidity and capital resources, are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we re-evaluate our estimates and judgments, particularly those related to the determination of the estimated recoverable amounts of trade accounts receivable, impairment of long-lived assets and deferred tax valuation allowance. We believe the following critical accounting policies require our more significant judgment and estimates used in the preparation of the financial statements. 11 We maintain an allowance for doubtful accounts for estimated losses that may arise if any of our customers are unable to make required payments. Management specifically analyzes the age of customer balances, historical bad debt experience, customer credit-worthiness, and changes in customer payment terms when making estimates of the uncollectability of our trade accounts receivable balances. If we determine that the financial conditions of any of our customers deteriorated, whether due to customer specific or general economic issues, increases in the allowance may be made. Accounts receivable are written off when all collection attempts have failed. We have a significant amount of property, equipment and intangible assets, including patents. In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, we review our long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of long-lived and amortizable intangible assets to be held and used is measured by a comparison of the carrying amount of an asset to the future operating cash flows expected to be generated by the asset. If these assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds their fair value. We follow the provisions of Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" (SAB 101), for revenue recognition. Under SAB 101, four conditions must be met before revenue can be recognized: (i) there is persuasive evidence that an arrangement exists, (ii) delivery has occurred or service has been rendered, (iii) the price is fixed or determinable and (iv) collection is reasonably assured. In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition" (SAB No. 104), which revises and rescinds certain sections of SAB No. 101, "Revenue Recognition", in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material effect on our results of operations, financial position or cash flows. Income taxes are accounted for under the asset and liability method. Under this method, to the extent that we believe that the deferred tax asset is not likely to be recovered, a valuation allowance is provided. In making this determination, we consider estimated future taxable income and taxable timing differences expected to reverse in the future. Actual results may differ from those estimates. NEW ACCOUNTING PRONOUNCEMENTS In December 2004, the FASB issued Statement of Accounting Standard No. 123R, "Share-Based Payment", a revision of SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS 123R supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and amends Statement of Accounting Standards No. 9, "Statement of Cash Flows." SFAS 123R requires all companies to measure compensation expense for all share-based payments (including employee stock options and options issued pursuant to employee stock purchase plans) based upon the fair value of the stock-based awards at the date of grant. SFAS 123R is effective for the Company for fiscal year beginning after December 15, 2005. Retroactive application of the requirements of FASB Statement No. 123 to the beginning of the fiscal year that includes the effective date is permitted, but not required. Early adoption of Statement 123R is encouraged. A component of SFAS 123R includes one of the following options: 1) modified-prospective method, 2) the modified-retrospective method, restating all prior periods, or 3) the modified-retrospective method, restating only the prior interim periods of 2005. A determination as to which of the three options we will adopt will be made at a later date. As permitted by SFAS 123, we currently account for share-based payments to employees using APB25's intrinsic value method and, as such, we generally recognize no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123R's fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of Statement 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections." This statement applies to all voluntary changes in accounting principles and requires retrospective application to prior periods' financial statements of changes in accounting principles, unless this would be impracticable. This statement also makes a distinction between "retrospective application" of an accounting principle and the "restatement" of financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company is evaluating the effect the adoption of this interpretation will have on its financial position, cash flows and results of operations. ITEM 7. FINANCIAL STATEMENTS The financial statements are included as a separate section following the signature page to this Form 10-KSB. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 8A. CONTROLS AND PROCEDURES 12 We carried out an evaluation required by the 1934 Act, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. It should be noted that the design of any system of controls is based in part upon certain assumptions, and a design may not succeed in achieving its stated goals. During the most recent fiscal quarter, there has not occurred any change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Our chief executive officer and principal financial officer do not expect that our disclosure controls or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, may only reasonably, not absolutely, meet the objectives of the system. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, absolutely all control issues and instances of fraud, if any, within the Company may not be detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based partly on certain assumptions about the likelihood of future events, and a design may not succeed in achieving its stated goals under all potential future conditions. OTHER INFORMATION On October 28, 2005, we declared a dividend of one Common Stock Purchase Right for each outstanding share of common stock. The dividend is payable to holders of record at the close of business on August 1, 2005. Each Right entitles the registered holder to purchase shares of common stock at a purchase price of $0.40, subject to adjustment. Initially, the Rights will not be exercisable, certificates for the Rights will not be issued and the Rights will automatically trade with our common stock. Until the close of business on the earlier of (i) the tenth day following the public announcement that a person or group of affiliated or associated persons ("Acquiring Person") other than us, our subsidiary or any employee benefit plan or employee stock plan ("Exempt Person") has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of our outstanding common stock or (ii) the tenth business day following the commencement by any person (other than an Exempt Person) of, or the announcement of the intention to commence, a tender or exchange offer that would result in the ownership of 15% or more of our outstanding common stock (the earlier of such dates in clauses (i) and (ii) being called the "Distribution Date"), the Rights will be evidenced, with respect to any of the common stock certificates outstanding as of August 1, 2005, by such common stock certificate, together with a copy of the Summary of Rights. The Rights are not exercisable until the Distribution Date. The Rights will expire at the close of business on October 28, 2009, unless redeemed or exchanged. The terms and conditions of the Rights are contained in a Rights Agreement between U.S. Stock Transfer Corporation and us. A copy of the Rights Agreement was filed with the Securities and Exchange Commission as an Exhibit to a Registration Statement on Form 8-A on November 2, 2005. This summary description of the Rights does not purport to be complete and is qualified in its entirety by reference to the Rights Agreement, as amended from time to time, which is incorporated in this summary description by reference. PART III -------- ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth certain information concerning our directors and executive officers as of September 30, 2005: YEAR BECAME NAME POSITION WITH COMPANY DIRECTOR AGE ------------------------- ------------------------ -------- --- Robert Stuckelman . . . . Chairman of the Board 1973 73 John G. McLaughlin. . . . President, CEO 57 Phillip Berman, MD. . . . Director 2004 52 John Minnick. . . . . . . Director 1985 57 John Romm, M.D. . . . . . Director 1997 75 Stuart L. Silverman, M.D. Director 1999 58 Phuong Dang . . . . . . . Controller and Secretary 49 13 The terms of the Board of Directors will expire at the next annual meeting of stockholders. Our officers are elected by the Board of Directors and hold office at the will of the Board. BACKGROUND EXPERIENCE OF DIRECTORS AND OFFICERS Mr. Stuckelman founded our company in 1973 and served as our President until 1982. From 1982 through 1989, Mr. Stuckelman was a business consultant for small and medium size companies. In 1989, he rejoined us as President and Chief Executive Officer, in which capacities he served until October 1994. Mr. Stuckelman has been our director since our incorporation. He became Chairman of the Board in April 2002. From 1994 to present, he has been President of Technical Management Consultants, which provides business consulting services to many companies. He holds an M.S.E.E. from the University of Southern California and a B.E.E. from Cornell University. Dr. Berman was appointed to CompuMed's Board in July 2004. As a radiologist and entrepreneur, he is well respected throughout the industry as an innovator and successful businessman. He founded and sold several successful companies, and he was formerly a Vice President of Kodak Medical Imaging. Dr. Berman is a cum laude graduate of both Harvard University and the Medical College of Pennsylvania. He completed his residency in radiology at UC San Diego. Mr. McLaughlin joined us in May 2002 as President and Chief Executive Officer. He has thirty years of experience in the medical products arena, most recently as President of the Great Circle Consulting Group, Inc. from May 1998 through May 2002. There he provided strategic and operational guidance to domestic and international firms in the medical device, diagnostic and biotech markets. Mr. McLaughlin's prior experience includes five years as an officer and Vice President of Marketing and Sales at Diagnostic Products Corporation (NYSE:DP), a global leader in the design, manufacture and marketing of clinical laboratory instrumentation. He served in that capacity from February 1993 to February 1998. Prior to that, Mr. McLaughlin was the President of Biometric Imaging, which was subsequently acquired by Becton Dickinson in 1999. He holds a B.S. in Pharmacy from the State University of New York at Buffalo. Mr. Minnick has been the President of Minnick Capital Management, an investment management firm from 1972 to present. Mr. Minnick is a member of the Kansas and Federal Bars. He is a member of the Association for Investment Management and Research. Mr. Minnick is a graduate of Washburn University (B.A.) and the Washburn University School of Law (J.D.). Dr. Romm has practiced internal medicine and gastroenterology in private practice from 1962 to present. He earned his M.D. at Wayne State College of Medicine and also holds a B.S. in biology. He is an associate professor of medicine at the University of California, Los Angeles and is an attending physician at Cedars-Sinai Medical Center. Dr. Silverman has been the Medical Director of the Osteoporosis Medical Center in Beverly Hills, CA, from 1986 to present. The Osteoporosis Medical Center is a nationally recognized clinical research center for osteoporosis and is also a Clinical Professor of Medicine at the UCLA School of Medicine. Dr. Silverman is a graduate of the Johns Hopkins University Medical School (1973) and earned his undergraduate degree from Princeton University (1969) Cum Laude in biology. He is an internationally recognized authority on osteoporosis and related fields and has been principal investigator for six research grants in the field of osteoporosis and has authored numerous published articles in the field. Ms. Dang has a degree in Accounting and been employed by us since 1990. She has served as Controller, Secretary and Principal Financial Officer since 1997. Ms. Dang has 26 years of corporate accounting and finance experience in the healthcare field, mail order and retail stores . Prior to joining to us, she served as Accounting Manager for the Maxicare Medical Center from 1984 to 1990. From 1978 to 1984, she served as Bookkeeper and Senior Staff Accountant for Sunset House/ Gadget Tree a division of Carter Hawley Hale. BOARD MEETINGS AND COMMITTEES Our Board of Directors held a total of nine meetings during the fiscal year ended September 30, 2005. All of our Directors attended each meeting. AUDIT COMMITTEE The Audit Committee is primarily responsible for approving the services performed by our independent auditors and reviewing reports of our external auditors regarding our accounting practices and systems of internal accounting controls. This Committee currently consists of Mr. Stuckelman and Dr. Romm. The Audit Committee met four times during the fiscal year ended September 30, 2005. Mr. Stuckelman has been approved by our Board of Directors as the independent Audit Committee Financial Expert. 14 COMPENSATION COMMITTEE The Compensation Committee reviews and approves our compensation policy and has assumed responsibility for administration of our 2003 Stock Option Plan. This Committee currently consists of Mr. Minnick and Dr. Silverman. The Compensation Committee met four times during the fiscal year ended September 30, 2005. EXECUTIVE COMMITTEE The Executive Committee is comprised of Dr. Silverman and Mr. Stuckelman and meets monthly with the Chief Executive Officer to review company strategy and our financial condition. COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT Based solely on our review of our records, we believe that, during the fiscal year ended September 30, 2005, our officers, directors, and greater than ten-percent beneficial owners complied with all applicable filing requirements under Section 16(a) of the Security Exchange Act of 1934, as amended. CODE OF ETHICS We have adopted a Code of Ethics that applies to our principal executive officer and controller. A copy of the Code of Ethics is available on our website at http://www.compumed.net/info/index.html. We intend to disclose any amendment or waiver to the Code of Ethics on our website at http://www.compumed.net/info/index.html. We will provide to any person without charge, upon written request to our above address, a copy of such code of ethics. ITEM 10. EXECUTIVE COMPENSATION The following table sets forth the compensation for the fiscal years ended September 30, 2005, 2004 and 2003 for our chief executive officer and all executive officers whose compensation exceeded $100,000.00 for such fiscal year. Long Term Compensation Annual Awards Payouts Compensation (a) (b) (c) (d) (e) (f) (g) (h) (i) Name and Principle . Year Salary Bonus Other Annual Restricted Securities LTIP All Other Position ($) ($) Compensation ($) Stock Underlying Payouts Compensation ($) Award(s)($) Options/SARs(#) ($) John G. McLaughlin, 2005 $ 150,000 - - - 45,000 - - President and CEO 2004 $ 150,000 - - - 245,000 - - 2003 $ 150,000 7,200 - - 434,225 - - STOCK OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth the stock options granted to our executive officer named during the fiscal year ended September 30, 2005. INDIVIDUAL GRANTS ------------------------ NUMBER OF SECURITIES % OF TOTAL OPTIONS (SHARES OF COMMON STOCK) GRANTED TO EXERCISE UNDERLYING OPTIONS EMPLOYEES/DIRECTORS PRICE EXPIRATION NAME GRANTED(1) IN FISCAL ($/SHARE) DATE ------------------ ------------------------ -------------------- --------- ---------- John G. McLaughlin 45,000 4% $ 0.32 2014 ------------------ ------------------------ -------------------- --------- ----------(1) The options are vested over a three-year period. EXERCISE OF STOCK OPTIONS AND YEAR-END OPTION VALUES During fiscal year ended September 30, 2005, the Board of Directors exercised 1,006,000 shares of options. The proceeds were $46,000. The following table sets forth certain information regarding options of the named executive officer outstanding as of September 30, 2005. 15 YEAR-END OPTION VALUES --------------------------------------------------------- NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS/WARRANTS AT OPTIONS/WARRANTS AT SEPTEMBER 30, 2005 SEPTEMBER 30, 2005 (1) NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---------------------- ------------------ ------------------ ------------ ------------- John G. McLaughlin 599,225 225,000 156,569 40,433 ---------------------- ------------------ ------------------ ------------ ------------- (1) Based on a fair market value of $ 0.40 per share, the closing price per share of our common stock on September 30, 2005. COMPENSATION OF DIRECTORS Each of the Directors receives an annual Board of Directors fee of $12,000, which is paid to each Director in equal monthly installments. The Chairman receives an additional $4,800. In addition to the Board of Directors fee, Directors receive an additional $1,000 per meeting when they serve as a member of the Executive, Audit or Compensation Committee. This amount is reduced to $350 if the committee meeting is held by teleconference or on the same day as a board meeting. EMPLOYMENT AGREEMENT We entered into a long-term agreement with John McLaughlin effective November 2, 2002 through September 30, 2004. This agreement provides a base salary of $150,000 per year and a bonus up to $150,000 based on performance factors including revenue, profit and accomplishment of certain key milestones. In addition, Mr. McLaughlin received standard employee options to purchase 50,000 shares of Common Stock at an exercise price of $0.20 per share upon acceptance of the agreement . On September 24, 2004, the Board passed a resolution to extend this contract for an additional year to 2005. On September 9, 2005 the Board passed a resolution to continue Mr. McLaughlin at a monthly salary of $14,500 starting October 1, 2005. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS The following table sets forth information as of September 30, 2005 regarding shares of our common stock subject to outstanding options or authorized for issuance under our currently existing equity compensation plan. NUMBER OF SECURITIES REMAINING AND AVAILABLE FOR NUMBER OF FUTURE ISSUANCE SECURITIES TO BE UNDER EQUITY ISSUED UPON WEIGHTED AVERAGE COMPENSATION EXERCISE OF EXERCISE PRICE OF PLANS (EXCLUDING OUTSTANDING OUTSTANDING SECURITIES OPTIONS, WARRANTS OPTIONS, WARRANTS REFLECTED IN AND RIGHTS AND RIGHTS COLUMN (A)) (A) (B) (C) ------------------ ------------------ ----------------- Equity compensation plans approved by security holders . . 1,929,518 .42 -0- Equity compensation plans not approved by security holders 4,642,416 .18 422,145 Total. . . . . . . . . . . . . . . . . . . . . . . . . . . 6,571,934 .25 422,145 16 NARRATIVE DESCRIPTION OF THE 2003 STOCK INCENTIVE PLAN Options generally become exercisable at a rate of 33% of the shares subject to an option one year after its grant. The remaining shares generally become exercisable over an additional 24 months. The duration of options may not exceed ten years. Options are generally non-assignable, except in the case of death and may be exercised only while the optionee is employed by us or, in certain cases, within three months after termination of employment or six months after death or disability. The purchase price and number of shares of common stock that may be purchased upon exercise of options are subject to adjustment in certain cases, including stock splits, recapitalizations and reorganizations. Both the amount of options granted and to whom they are granted, are determined by the Board of Directors with the recommendation of the Compensation Committee, at their discretion. There are no specific criteria, performance formulas or measures applicable to the determination of the amount of options to be granted and to whom these options are to be granted. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS The following table sets forth, to our knowledge, certain information concerning the beneficial ownership of the our common stock as of November 30, 2005 by: (a) each director of the Company; (b) the executive officer named in the Executive Compensation Table; (c) our directors and executive officer as a group; and (d) each person known to us who beneficially owns 5% or more of our common stock. NAME AND ADDRESS* OF BENEFICIAL OWNER AMOUNT AND NATURE BENEFICIAL OWNERSHIP(1) PERCENT OF CLASS (2) ----------------------- ----------------- Phillip Berman... . . . . . . . . . . . . . . . . 233,334 (3) 1% John G. McLaughlin. . . . . . . . . . . . . . . . 645,892 (4) 3% John Minnick. . . . . . . . . . . . . . . . . . . 1,019,603 (5) 4% John Romm, M.D. . . . . . . . . . . . . . . . . . 896,968 (6) 4% Stuart L. Silverman, M.D. . . . . . . . . . . . . 1,093,554 (7) 5% Robert Stuckelman . . . . . . . . . . . . . . . . 1,388,228 (8) 6% All officers and Directors as a group (6 persons) 5,277,579 (9) 22% Except as otherwise indicated, each person named in the table has sole voting and investment power (or such power together with any spouse of such person, if they are joint tenants), with respect to securities beneficially owned by such person as set forth opposite such person's name. (1) Includes options exercisable as of or within 60 days following November 30, 2005. (2) The number of shares of common stock issued and outstanding on November 30, 2005 was 22,920,609 shares. The calculation of percentage ownership for each listed beneficial owner is based upon the number of shares of common stock issued and outstanding on November 30, 2005. (3) Includes 166,887 shares subject to stock options. (4) Includes 645,892 shares subject to stock options. (5) Includes 643,080 shares subject to stock options. (6) Includes 635,800 shares subject to stock options. (7) Includes 764,439 shares subject to stock options. (8) Includes 866,900 shares subject to stock options. (9) See notes (3) through (8) (*) c/o CompuMed, Inc, 5777 West Century Blvd, Suite 1285, Los Angeles, CA 90045 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS We retained the services of an investment advisor, who is also a member of the Board of Directors, to provide advice on the investment portfolio. During each of the fiscal year ended September 30, 2005 and 2004, we incurred $2,000 each, for these services. 17 ITEM 13. EXHIBITS EXHIBIT NUMBER DESCRIPTION OF EXHIBIT 3.1 Certificate of Incorporation (filed as Exhibit 3.1 to the Registrant's Registration Statement of Form S-1 effective May 7, 1992 and incorporated herein by reference). 3.2 Certificate of Amendment of Certificate of Incorporation (filed as Exhibit 3.1a to the Registrant's Registration Statement on Form S-2/A filed on June 28, 1994 and incorporated herein by reference). 3.3 Certificate of Amendment of Certificate of Incorporation (filed as Exhibit 3.1b to the Registrant's Registration Statement on Form S-2/A filed on November 7, 1994 and incorporated herein by reference). 3.4 Certificate of Correction of Certificate of Amendment (filed as Exhibit 3.1c the Registrant's Registration Statement on Form S-2/A filed on November 7, 1995 and incorporated herein by reference). 3.5 By-Laws (filed as Exhibit 3.5 to the Registrant's Quarterly Report on Form 10-QSB filed on February 13, 2004 and incorporated herein by reference). 3.6 Amendment to By-laws (filed as Exhibit 3.6 to the Registrant's Quarterly Report on Form 10-QSB filed on February 13, 2004 and incorporated herein by reference). 4.1 Certificate of Designation of Class A Preferred Stock (filed as Exhibit 4.5 to the Registrant's Annual Report on Form 10-KSB filed on December 29, 1995 and incorporated herein by reference). 4.2 Certificate of Designation of Class B Preferred Stock (filed as Exhibit 4.6 to the Registrant's Annual Report on Form 10-KSB filed on December 29, 1995 and incorporated herein by reference). 4.3 Certificate of Designation of Class C Preferred Stock (filed as Exhibit 3.1 to the Registrant's Current Report on Form 8-K filed on January 9, 1998 and incorporated herein by reference). 4.4 Certificate of Correction for Class C Preferred Stock (filed as Exhibit 3.2 to the Registrant's Current Report on Form 8-K filed on January 9, 1998 and incorporated herein by reference). 4.5 Rights Agreement between the Company and U.S. Stock Transfer Corporation dated October 28, 2005 (filed as Exhibit 4.1 to the Company's Form 8-A filed on November 2, 2005 and incorporated herein by reference). 10.1 Form of Non-Qualified Stock Option Agreement (filed as Exhibit 10 to the Registrant's Registration Statement on Form S-8 filed on October 14, 1995 and incorporated herein by reference). 10.2 Commercial Office Lease between the Registrant and L.A.T. Investment Corporation, dated August 16, 1999 (filed as Exhibit 10.24 to the Registrant's Annual Report on Form 10-KSB filed on December 29, 1999 and incorporated herein by reference). 10.3 Form of Stock Option Agreement (filed as Exhibit 10.5 to the Registrant's Quarterly Report on Form 10-QSB filed on August 14, 2002 and incorporated herein by reference). 10.4 Employment Agreement between the Registrant and John McLaughlin dated November 2, 2002 (filed as Exhibit 10.6 to the Registrant's Quarterly Report on Form 10-QSB filed on February 14, 2003 and incorporated herein by reference). 10.5 2003 Stock Incentive Plan (filed as Exhibit 99.2 to the Registrant's Registration Statement on Form S-8 filed on June 2, 2003 and incorporated herein by reference). 10.6 Amendment to Commercial Office Lease between the Registrant and L.A.T. Investment Corporation 10.7 Investment Agreement between the Registrant and Dutchess Private Equities Fund, LP, dated February 25, 2004 (filed as Exhibit 10.9 to the Registrant's Registration Statement on Form SB-2 filed on February 27, 2004 and incorporated herein by reference). 10.8 Registration Rights Agreement between the Registrant and Dutchess Private Equities Fund, LP, dated February 25, 2004 (filed as Exhibit 10.10 to the Registrant's Registration Statement on Form SB-2 filed on February 27, 2004 and incorporated herein by reference). 18 10.9 Placement Agent Agreement between the Registrant, Charleston Securities and Dutchess Private Equities Fund, LP, dated February 25, 2004 (filed as Exhibit 10.11 to the Registrant's Registration Statement on Form SB-2 filed on February 27, 2004 and incorporated herein by reference). 21.1 Subsidiaries 23.1 Consent of Independent Registered Public Accounting Firm 31.1 Certification Pursuant to 18 U.S.C. Section 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification Pursuant to 18 U.S.C. Section 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Audit Fees. The aggregate fees billed for professional services rendered by our principal accountants for the audit of our annual financial statements and review of our quarterly financial statements were $49,000 and $43,000 for fiscal years 2005 and 2004, respectively. Audit-Related Fees. None. Tax Fees. The aggregate fees billed to us for professional services rendered by our principal accountants for tax related services were $5,375 and $5,340 for fiscal years 2005 and 2004, respectively. All Other Fees. None SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 19 COMPUMED, INC. By: /s/ John G. McLaughlin ---------------------------- John G. McLaughlin, President and Chief Executive Officer Date: December 27, 2005 In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE ---------------------- -------------------------- ------------- President, Chief Executive Officer (principal /s/ John G. McLaughlin executive officer) December 27, 2005 ---------------------- ----------------- John G. McLaughlin Secretary and Controller (principal financial /s/ Phuong Dang officer) December 27, 2005 ---------------------- ----------------- Phuong Dang /s/ Robert Stuckelman Chairman of the Board December 27, 2005 ---------------------- ----------------- Robert Stuckelman /s/ Phillip Berman Director December 27, 2005 ---------------------- ----------------- Phillip Berman /s/ John D. Minnick Director December 27, 2005 ---------------------- ----------------- John D. Minnick /s/ John Romm Director December 27, 2005 ---------------------- ----------------- John Romm /s/ Stuart Silverman Director December 27, 2005 ---------------------- ----------------- Stuart Silverman 20 COMPUMED, INC. INDEX TO FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm Balance Sheet as of September 30, 2005 Statements of Operations for the years ended September 30, 2005 and 2004 Statements of Stockholders' Equity for the years ended September 30, 2005 and 2004 Statements of Cash Flows for the years ended September 30, 2005 and 2004 Notes to Financial Statements F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders CompuMed, Inc. Los Angeles, California We have audited the accompanying balance sheet of CompuMed, Inc. as of September 30, 2005, and the related statements of operations, stockholders' equity, and cash flows for the years ended September 30, 2005 and 2004. 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 the standards established by the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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 financial position of CompuMed, Inc. as of September 30, 2005, and the results of its operations and its cash flows for the years ended September 30, 2005 and 2004, in conformity with accounting principles generally accepted in the United States of America. /s/ Rose, Snyder & Jacobs --------------------------------------------------- A Corporation of Certified Public Accountants Encino, California November 16, 2005 F-2 COMPUMED, INC. BALANCE SHEET ASSETS SEPTEMBER 30, 2005 -------------- CURRENT ASSETS Cash and cash equivalents $281,000 Marketable securities, at fair market value. . . . . 290,000 Accounts receivable, less allowance of $26,000. . . 323,000 Inventory . . . . . . . . . . . . . . . . . . . . . 31,000 Prepaid expenses and other current assets . . . . . 18,000 -------------- TOTAL CURRENT ASSETS. . . . . . . . . . . . . . . . 943,000 PROPERTY AND EQUIPMENT Machinery and equipment . . . . . . . . . . . . . . 1,252,000 Furniture, fixtures and leasehold improvements. . . 78,000 Equipment under capital leases. . . . . . . . . . . 183,000 -------------- 1,513,000 Accumulated depreciation and amortization . . . . . (1,273,000) -------------- 240,000 OTHER ASSETS Patents, net of accumulated amortization of $5,000. 77,000 Other assets. . . . . . . . . . . . . . . . . . . . 13,000 -------------- TOTAL OTHER ASSETS. . . . . . . . . . . . . . . . . 90,000 TOTAL ASSETS $1,273,000 ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable . . . . . . . . . . . . . . . . . $159,000 Accrued liabilities . . . . . . . . . . . . . . . . 148,000 Current portion of capital lease obligations. . . . 33,000 ------------- TOTAL CURRENT LIABILITIES . . . . . . . . . . . . . 340,000 Capital lease obligations, less current portion . . 126,000 Commitments and Contingencies, note E STOCKHOLDERS' EQUITY Preferred Stock, $.10 par value - authorized 1,000,000 shares Class A $3.50 cumulative convertible voting - -issued and outstanding - 8,400 shares. . . . . . . 1,000 Class B $3.50 cumulative convertible voting - -issued and outstanding - 300 shares. . . . . . .. -0- Common stock, $.01 par value-authorized 50,000,000 shares - issued and outstanding- 22,920,609 shares . . . . 230,000 Additional paid in capital. . . . . . . . . . . . . 33,154,000 Accumulated deficit . . . . . . . . . . . . . . . (32,589,000) Accumulated other comprehensive income. . . . . . . 17,000 Deferred stock compensation . . . . . . . . . . . (6,000) ----------- 807,000 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY . . . . $1,273,000 =========== F-3 STATEMENTS OF OPERATIONS YEAR ENDED SEPTEMBER 30, -------------------------- 2005 2004 ------------ ------------ REVENUES ECG services . . . . . . . . . . . . . . . . . . . . 1,726,000 $ 1,619,000 ECG product and supplies sales . . . . . . . . . . . 440,000 85,000 OsteoGram(R) sales and services . . . . . . . . . . 118,000 152,000 ------------ ------------ 2,284,000 1,856,000 COST AND EXPENSES Cost of ECG services . . . . . . . . . . . . . . . . 602,000 512,000 Cost of goods sold - ECG . . . . . . . . . . . . . . 327,000 59,000 Cost of goods sold - OsteoGram(R) . . . . . . . . . 8,000 7,000 Selling expenses . . . . . . . . . . . . . . . . . . 313,000 239,000 Research and development . . . . . . . . . . . . . . 293,000 217,000 General and administrative expenses. . . . . . . . . 1,024,000 1,022,000 Depreciation and amortization. . . . . . . . . . . . 81,000 152,000 ------------ ------------ 2,648,000 2,208,000 OPERATING LOSS . . . . . . . . . . . . . . . . . . . (364,000) (352,000) Interest income and dividends. . . . . . . . . . . . 16,000 16,000 Other miscellaneous income . . . . . . . . . . . . . 7,000 55,000 Realized gains on marketable securities . . . . . . . 19,000 9,000 Interest expense . . . . . . . . . . . . . . . . . . (14,000) (3,000) ------------ ------------ NET LOSS . . . . . . . . . . . . . . . . . . . . . . $ (336,000) $ (275,000) ============ ============ NET LOSS PER SHARE - Basic and Diluted . . . . . . . $ (.02) $ (.02) Weighted average number of common shares outstanding 20,963,081 18,289,279 F-4 COMPUMED, INC. STATEMENTS OF STOCKHOLDERS' EQUITY ACCUMULATED ADDITIONAL OTHER PREFERRED COMMON PAID IN ACCUMULATED COMPREHENSIVE DEFERRED STOCK STOCK STOCK CAPITAL DEFICIT INCOME COMPENSATION TOTAL Balances at September 30, . . . 2003:. . . . . . . $ 1,000 $180,000 $32,296,000 $(31,978,000) $ 27,000 $ (17,000) $ 509,000 Unrealized gain on marketable securities. . . . . - - - - 26,000 - 26,000 Stock options and restricted shares issued for services - 4,000 43,000 - - (8,000) 39,000 Amortization of deferred compensation. . . . - - - - - 25,000 25,000 Issuance of common stock to Dutchess . . . . - 10,000 150,000 - - - 160,000 Exercise of options - 3,000 31,000 - - - 34,000 Net Loss. . . . . . - - - (275,000) - - (275,000) ----------- -------- ----------- ------------ --------------- --------------- ---------- Balances at September 30, . . . 2004:. . . . . . . $ 1,000 $197,000 $32,520,000 $(32,253,000) $ 53,000 $ - $ 518,000 Unrealized loss on marketable securities. . . . . - - - - (36,000) - (36,000) Stock option issued for services . . . . . - - 8,000 - - (8,000) - Amortization of deferred compensation. . . . - - - - - 2,000 2,000 Issuance of common stock to Dutchess . . . . - 23,000 538,000 - - - 561,000 Exercise of options - 10,000 88,000 - - - 98,000 Net Loss. . . . . . - - - (336,000) - - (336,000) ----------- -------- ----------- ------------ --------------- --------------- ---------- Balances at September 30, . . . 2005:. . . . . . . $ 1,000 $230,000 $33,154,000 $(32,589,000) $ 17,000 $ (6,000) $ 807,000 ============ ======== =========== ============ =============== =============== ========== Comprehensive losses for the years ended September 30, 2005 and 2004 were ($372,000) and ($249,000), respectively. F-5 Twelve Months Ended September 30, 2005 2004 ------------- ------------- OPERATING ACTIVITIES: Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (336,000) (275,000) Net adjustments to reconcile net loss to net cash used in operating activities: Realized gain on marketable securities. . . . . . . . . . . . . . . . . . . . . (19,000) (8,000) Amortization of deferred stock compensation . . . . . . . . . . . . . . . . . . 2,000 25,000 Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . 81,000 150,000 Increase in accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . (26,000) (78,000) Decrease in inventory and prepaid expenses. . . . . . . . . . . . . . . . . . . 20,000 15,000 Decrease (Increase) in accounts payable and other liabilities . . . . . . . . . 59,000 (16,000) ------------- ------------- NET CASH USED IN OPERATING ACTIVITIES . . . . . . . . . . . . . . . . . . . . . (219,000) (187,000) CASH FLOW FROM INVESTING ACTIVITIES: Proceeds from selling of marketable securities. . . . . . . . . . . . . . . . . 55,000 54,000 Investments in purchase of marketable securities. . . . . . . . . . . . . . . . (197,000) (4,000) Purchase of other asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . (14,000) (20,000) Purchase of property, plant and equipment . . . . . . . . . . . . . . . . . . . (44,000) (32,000) ------------- ------------- NET CASH USED IN INVESTING ACTIVITIES . . . . . . . . . . . . . . . . . . . . . (200,000) (2,000) CASH FLOW FROM FINANCING ACTIVITIES: Proceeds from exercise of stock option. . . . . . . . . . . . . . . . . . . . . 98,000 35,000 Net offering of the investment agreement with Dutchess Private Equities Fund. . 561,000 160,000 Payments on capital lease obligations . . . . . . . . . . . . . . . . . . . . . (21,000) (10,000) ------------ ------------- NET CASH PROVIDED BY FINANCING ACTIVITIES . . . . . . . . . . . . . . . . . . . 638,000 185,000 NET DECREASE [INCREASE] IN CASH AND CASH EQUIVALENTS. . . . . . . . . . . . . . 219,000 (4,000) CASH AT BEGINNING OF PERIOD . . . . . . . . . . . . . . . . . . . . . . . . . . 62,000 66,000 ------------ ------------- CASH AT END OF PERIOD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 281,000 62,000 SUPPLEMENTAL DISCLOSURES: Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,000 3,000 Equipment acquired under capital lease. . . . . . . . . . . . . . . . . . . . . 133,000 50,000 Disposal of fixed assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . 99,000 0 See notes to financial statements and report of Independent Registered Public Accounting Firm F-6 COMPUMED, INC. NOTES TO FINANCIAL STATEMENTS NOTE A - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business: CompuMed, Inc. (CompuMed or the Company) is a medical diagnostic product and services company focusing on the diagnosis, monitoring and management of several costly, high incidence diseases, particularly cardiovascular disease and osteoporosis. The Company's primary business is the development and marketing of our osteoporosis testing technology OsteoGram (R) and the computer interpretation of electrocardiograms ("ECGs"). CompuMed applies advanced computing, medical imaging, telecommunications and networking technologies to provide medical professionals and patients with affordable, point-of-care solutions for disease risk assessment and decision support. The Company generated negative cash flows from operations and had net losses aggregating $611,000 in fiscal years ended September 30, 2005 and 2004. The Company's business strategy includes an increase in OsteoGram (R) sales through domestic and international marketing and distribution efforts. The Company intends to finance this business strategy by using its current working capital resources and cash flows from existing operations. There can be no assurance that the OsteoGram (R) sales will be sufficient to offset related expenses. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. This basis of accounting contemplates the recovery of the Company's assets and the satisfaction of its liabilities in the normal course of conducting its business. The Company's ability to continue as a going concern is dependent upon various factors including, among others, its ability to generate profits and reduce its operating losses and negative cash flows. No assurance can be given that the Company will be able to accomplish these objectives. The Company uses existing cash and readily available marketable securities balances to fund operating losses and capital expenditures. The Company had raised these funds in 1997 through 2000 through the placement of Preferred Stock issuances and proceeds from the exercise of certain stock options and warrants. Currently, the Company raises fund through the Investment Agreement with Dutchess Private Equities Fund. Management believes the Company will be able to generate sufficient revenue, reduce operating expenses or obtain sources of financing in order to fund ongoing operations through at least September 30, 2006. Accordingly, the financial statements do not include any adjustments to reflect the possible future effects on the recoverability or classifications of liabilities that may result from the outcome of this uncertainty. CASH EQUIVALENTS: ------------------ The Company considers investments in all highly liquid debt instruments with maturity of three months or less when purchased, and investments in money market accounts to be cash equivalents. Cash and cash equivalents also consist of cash on hand and demand deposit accounts. MARKETABLE SECURITIES: ----------------------- Marketable securities consist of common stock of publicly traded domestic companies and are stated at market value based on the most recently traded price of these securities at September 30, 2005. All marketable securities are classified as available for sale at September 30, 2005 and 2004. Unrealized gains and losses, determined by the difference between historical purchase price and the market value at each balance sheet date, are recorded as a component of Accumulated Other Comprehensive Income in Stockholders' Equity. Realized gains and losses are determined by the difference between historical purchase price and gross proceeds received when the marketable securities are sold. As of September 30, 2005, the Company's investments in marketable securities were valued at $290,000. The Company recorded a realized gain of $19,000 and $8,000 for the years ended September 30, 2005 and 2004, respectively, and $17,000 and $53,000 of unrealized gains as other comprehensive income (net of reclassifications adjustments of $19,000 and $8,000 of realized gains above), net of income taxes of $0 for the years ended September 30, 2005 and 2004, respectively. F-7 ACCOUNTS RECEIVABLE: --------------------- The Company maintains an allowance for doubtful accounts for estimated losses that may arise if any of its customers are unable to make required payments. Management specifically analyzes the age of customer balances, historical bad debt experience, customer credit-worthiness, and changes in customer payment terms when making estimates of the uncollectability of the Company's trade accounts receivable balances. If the Company determines that the financial conditions of any of its customers deteriorated, whether due to customer specific or general economic issues, increases in the allowance may be made. Accounts receivable are written off when all collection attempts have failed. INVENTORY: ---------- Inventory consists of ECG terminals, component parts and ECG medical supplies and OsteoGram (R) hardware. Inventory, primarily finished goods, is stated at the lower of cost (first-in first-out method) or market. PROPERTY AND EQUIPMENT: ------------------------- Property and equipment are stated at cost. Depreciation and amortization are computed on the straight-line basis over 3 to 5 years. As of September 30, 2005, the property and equipment being leased to customers had a historical cost of $1,089,000. Amortization of assets leased under capital leases is included in Depreciation and Amortization Expenses. REVENUE RECOGNITION: --------------------- ECG and OsteoGram (R) services are recorded as revenue when billed to the customer in conjunction with services performed. The Company leases ECG equipment under operating leases. Accordingly, revenue from operating leases is recognized over the life of the non-cancelable lease terms under the straight-line method and is recorded as ECG service and supply revenue in the statement of operations. ECG and OsteoGram (R) product and supplies sales are recorded upon shipment of product and passage of title to the customer. PATENTS: -------- Patents are amortized over 15 years, starting from their approval date. INCOME TAXES: -------------- The Company utilizes the liability method to determine the provision for income taxes, whereby deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. PER SHARE DATA: ----------------- The Company reports its earnings (loss) per share in accordance with Statement of Financial Accounting Standards No.128, "Accounting for Earnings Per Share" ("FAS 128"). Basic loss per share is calculated using the net loss divided by the weighted average common shares outstanding. Shares from the assumed conversion of outstanding warrants, options and the effect of the conversion of the Class A Preferred Stock and Class B Preferred Stock are omitted from the computations of diluted loss per share because the effect would be antidilutive. FINANCIAL INSTRUMENTS: ----------------------- The carrying value of short-term financial instruments such as cash equivalents, accounts receivable, accounts payable, accrued liabilities and capital leases approximates their fair value based on the short-term maturities of these instruments. LONG-LIVED ASSETS: ------------------- Long-lived assets used in operations are reviewed periodically to determine whether the carrying values are not impaired and, if indications of impairment are present or if long-lived assets are expected to be disposed of, impairment losses are recorded. Any impairment is charged to expense in the period in which the impairment is determined. The Company has not recorded impairment charges during the years ended September 30, 2005 and 2004. 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 affecting the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-8 STOCK BASED COMPENSATION: --------------------------- The Company accounts for employee and director's stock option grants using the intrinsic method. Generally, the exercise price of the employee stock options equal or exceeds the market price of the underlying stock on the date of grant and no compensation expense is recognized. If the option price is less than market value, the Company records compensation expense over the vesting period of the option. The Company accounts for equity instruments issued to non-employees in exchange for goods or services using the fair value method and records expense based on the values determined. CONCENTRATION OF CREDIT RISK: -------------------------------- The Company sells its products throughout the United States and in the international markets. The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. Credit losses have been within management's expectations. For the year ended September 30, 2005 two customers accounted for approximately 22% of the Company total revenue and 45% of total accounts receivable at September 30, 2005. The Company maintains cash balance at a financial institution which accounts are insured by the Federal Deposit Insurance Corporation of $100,000. The portion in excess of the federally insured limit amounted to approximately $106,000 at September 30, 2005 NOTE B - INCOME TAXES At September 30, 2005, the Company has available for federal income tax purposes, net operating loss carry forwards of approximately $6.3 millions, which expire between 2006 and 2025. The utilization of the above net operating loss carry forwards are subject to significant limitations under the tax codes due to changes in ownership and portions may expire prior to utilization. The difference between the Company's effective income tax rate and the statutory federal rate for the years ended September 30, 2005 and 2004 relates primarily to losses incurred for which no tax benefit was recognized, due to the uncertainty of its realization. The valuation allowance was $2,451,000 and $2,343,000 at September 30, 2005 and 2004, respectively, representing an increase of $108,000 for the year ended September 30, 2005. This increase is mainly explained by loss carry forwards for which no tax effect was recognized due to the uncertainty of its realization, offset by loss carry forwards that expired at September 30, 2005. Significant components of the deferred tax liabilities and assets as of September 30, 2005 are as follows: 2005 2004 ----------- ------------ Deferred tax liabilities: : . . . . . . . . 0 0 Deferred tax assets: Net operating loss carry forwards . . . . . 2,400,000 2,318,000 Other asset and liabilities . . . . . . . . 51,000 25,000 ----------- ----------- Total deferred tax assets 2,451,000 2,343,000 Valuation allowance for Deferred tax assets (2,451,000) (2,343,000) ----------- ----------- Net deferred tax assets . . . . . . . . . . 0 0 Total . . . . . . . . . . . . . . . . . . . $ 0 $ 0 =========== =========== NOTE C - STOCKHOLDERS' EQUITY CLASS A $3.50 CUMULATIVE CONVERTIBLE VOTING PREFERRED STOCK: ------------------------------------------------------------------- The holders of Class A Preferred Stock are entitled to receive, when and as declared by the Board of Directors, dividends at an annual rate of $.35 per share, payable quarterly. Dividends are cumulative from the date of issuance. Total cumulated dividends not declared at September 30, 2005 amounted to $19,000. Every two shares of the Class A Preferred Stock are presently convertible, subject to adjustment, into one share of Common Stock. In the event of any liquidation, the holders of the Class A Preferred Stock are entitled to receive $2.00 in cash per share plus accumulated and unpaid dividends out of assets available for distribution to stockholders, prior to any distribution to holders of Common Stock or any other stock ranking junior to the Class A Preferred Stock. The Class A Preferred Stock may be redeemed by the Company, upon 30-days' written notice, at a redemption price of $3.85 per share. Class A Preferred Stock stockholders have the right to convert their shares into Common Stock during such 30-day period. F-9 Shares of Class A Preferred Stock have one vote each. Shares of Class A Preferred Stock vote along with shares of Common Stock and shares of Class B Preferred Stock as a single class on all matters presented to the stockholders for action except as follows: Without the affirmative vote of the holder of a majority of the Class A Preferred Stock then outstanding, voting as a separate class, the Company may not (i) amend, alter or repeal any of the preferences or rights of the Class A Preferred Stock, (ii) authorize any reclassification of the Class A Preferred Stock, (iii) increase the authorized number of shares of Class A Preferred Stock or (iv) create any class or series of shares ranking prior to the Class A Preferred Stock as to dividends or upon liquidation. A total of 4,200 shares of Common Stock are currently issuable upon conversion of the remaining 8,400 shares of the Class A Preferred Stock. CLASS B $3.50 CONVERTIBLE VOTING PREFERRED STOCK: ------------------------------------------------------- In August 1994, the Company issued 52,333 shares of Class B $3.50 Convertible Preferred Stock ("Class B Preferred Stock") in connection with the acquisition of certain property. The holders of Class B Preferred Stock are entitled to receive dividends only, when and as declared by the Board of Directors. Each share of Class B Preferred Stock is convertible, subject to adjustment, into ten shares of Common Stock. In the event of any liquidation, the holders of the Class B Preferred Stock are entitled to receive $3.50 in cash per share plus accumulated and unpaid dividends out of assets available for distribution to stockholders, prior to any distribution to holders of Common Stock or any other stock ranking junior to the Class B Preferred Stock. Each share of Class B Preferred Stock may be redeemed by the Company, upon 30-days' written notice, at a redemption price of $3.85 per share. Class B Preferred Stock stockholders have the right to convert their shares into Common Stock during this 30-day period. Shares of Class B Preferred Stock are entitled to one vote each. Shares of Class B Preferred Stock vote as a single class on all matters presented to the stockholders for action except as follows: Without the affirmative vote of the holder of a majority of the Class B Preferred Stock then outstanding, voting as a separate class, the Company may not (i) amend, alter or repeal any of the preferences or rights of the Class B Preferred Stock, (ii) authorize any reclassification of the Class B Preferred Stock, (iii) increase the authorized number of shares of Class B Preferred Stock or (iv) create any class or series of shares ranking prior to the Class B Preferred Stock as to dividends or upon liquidation. A total of 3,000 shares of Common Stock are currently issuable upon conversion of the remaining 300 shares of Class B Preferred Stock. ISSUANCE OF COMMON STOCK - EQUITY LINE OF CREDIT -------------------------------------------------------- We have entered into an Investment Agreement with Dutchess Private Equities Fund, also referred to as an Equity Line of Credit. That agreement provides that, following notice to Dutchess, we may put to Dutchess up to $5 million in shares of our common stock for a purchase price equal to 95% of the average of the three lowest closing bid prices on the Over-the-Counter Bulletin Board of our common stock during the five day period following that notice. The number of shares that we will be permitted to put pursuant to the Investment Agreement will be either: (A) two hundred percent of the average daily volume of our common stock for the ten trading days prior to the applicable put notice, multiplied by the average of the three daily closing best bid prices immediately preceding the day we issue the put, or (B) $25,000; provided that in no event will the put amount be more than $1,000,000 with respect to any single Put. In turn, Dutchess has indicated that it will resell our shares in the open market, resell our shares to other investors through negotiated transactions or hold our shares in its portfolio. This prospectus covers the resale of our stock by Dutchess either in the open market or to other investors through negotiated transactions. During fiscal year 2005, we issued 2,294,000 shares of common stock to Dutchess and had a net proceeds of $561,000. NOTE D - STOCK OPTIONS AND WARRANTS STOCK OPTIONS: --------------- The Company has adopted one non-stockholder approved stock incentive plan, the 2003 Stock Incentive Plan (the "2003 Plan"), and two stockholder approved stock options plans, the 1992 Stock Option Plan ("1992 Plan") and the 2002 Stock Option Plan (the "2002 Plan") (collectively, the "Plans"). The 1992 Plan expired in March 2002 and the 2002 Plan was suspended on the effective date of the 2003 Plan in June 2003. Awards are outstanding under the Plans, but awards may be granted in the future only under the 2003 Plan. The 2003 Plan provides for the granting of options, stock awards and other forms of equity compensation to key employees, officers and certain individuals. Only nonqualified options may be granted under the 2003 Plan. Options granted under the Plans generally become exercisable at a rate of 33% of the shares subject to an option one year after the date of grant and the remaining shares generally become exercisable over an additional 24 months. The duration of options may not exceed ten years beyond the date of grant. In addition to options issued pursuant to these Plans, the Company has granted non-qualified stock options to certain members of the Board of Directors, management and consultants. Such options have been granted with exercise prices equal to the market prices of the common stock at the date of grant and are for a term of ten years. F-10 During 2001, the Company issued options to purchase 50,000 shares of common stock in exchange for services provided over a period of three years. The Company valued these options using the fair value method, at $7,000 of which $1,000 was expensed in 2001, $3,000 was expensed in 2002, $2,000 was expensed in fiscal 2003 and $1,000 was expensed in fiscal 2004. During 2003, the Company granted options to purchase 50,000 shares of common stock to an officer for compensation, vested upon the grant date. These options were recorded at $0, using the intrinsic method. The Company also issued options to purchase 2,971,768 shares of common stock to directors and employees in 2003, under the 2003 Plan. These options were recorded at $42,000, also using the intrinsic method. $30,000 and $12,000 of these options were expensed in fiscal 2003 and fiscal 2004, respectively. The Company also issued options to purchase 120,000 shares of common stock to a consultant over a 6 month-period. These options were accounted using the fair value method, in accordance with SFAS 123, $7,000, of which $3,000 was expensed during fiscal 2003 and $4,000 in fiscal 2004. During 2004, the Company issued options to purchase 26,087 shares of common stock to a consultant in exchange for services over three-month period. These options were valued according to SFAS 123 at $8,000 of which $8,000 was expensed in fiscal 2004. The Company also granted options to purchase 1,785,000 shares of common stock to directors and employees. These options were recorded at $0 using the intrinsic method and they were valued at $188,000 in accordance with SFAS 123. During 2005, the Company issued options to purchase 35,000 shares of common stock to a consultant. These options were valued according to SFAS 123 at $8,000 of which $2,000 was expensed in 2005. The Company also granted options to purchase 1,160,000 shares of common stock to directors and employees. These options were recorded at $0 using the intrinsic method and they were valued at $124,000 in accordance with SFAS 123. SFAS 123 "Accounting for Stock-Based Compensation", amended by SFAS 148 requires pro forma information regarding net income (loss) using compensation that would have been incurred if the Company had accounted for its employee stock options under the fair value method. Options to purchase 1,195,000 and 1,811,087 shares of common stock were granted during the year ended September 30, 2005 and 2004, respectively. The fair value of these options has been estimated at $132,000 and $196,000 using the Black-Scholes Option pricing model, with the following assumptions: 2005 2004 --------------- --------------- Risk free interest rate. . . . . . . . 4.00% to 4.50% 4.27% to 4.73% Stock volatility factor . . . . . . . . 18% to 33% 21% to 65% Weighted average expected option life 10 years 10 years Expected dividend yield . . . . . . . . None None A summary of the stock option activity, and related information for the years ended September 30 follows: 2005 2004 ------------------- ------------------ WEIGHTED- WEIGHTED- AVERAGE AVERAGE EXERCISE EXERCISE SHARES PRICE SHARES PRICE ----------- ------ --------- ------- Options outstanding, beginning of year 6,437,217 .22 5,027,025 .21 Options exercised. . . . . . . . . . . (1,026,354) .10 (394,227) .09 Options granted. . . . . . . . . . . . 1,195,000 .25 1,811,087 .21 Options forfeited/canceled . . . . . . (33,929) .46 (6,868) .75 ----------- ------ ---------- ------- Options outstanding, end of year . . . 6,571,934 .25 6,437,217 .22 =========== ====== ========== ======= Exercisable at end of year . . . . . . 4,353,609 .26 4,535,551 .23 =========== ====== ========== ======= F-11 The pro forma net loss and loss per share had the Company accounted for its options using FAS 123 would have been as follows: Twelve Months Ended September 30, 2005 2004 ---------- ---------- Net loss as reported $(336,000) $(275,000) Basic and diluted loss per share as reported $(0.02) $(0.02) Stock based employee compensation cost net of related tax effect included in the determination of net loss as reported 2,000 $25,000 Total Stock based employee compensation net of related tax effect, that would have been included in the determination of net loss if the fair value based method would have been applied to all awards $(79,000) $(80,000) Pro forma net loss as if the fair value based method had been applied to all awards $(413,000) $(330,000) Pro forma basic and diluted loss per share as if the fair value method had been applied applied to all awards $(0.02) $(0.02) The following summarizes information concerning stock options outstanding at September 30, 2005: <>C WEIGHTED AVERAGE WEIGHTED WEIGHTED WEIGHTED RANGE OF . . . . . . . . . . . . . . . . . . . . NUMBER REMAINING AVERAGE SUBJECT TO AVERAGE EXERCISE PRICES. . . . . . . . . . . . . . . . . OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISE EXERCISE PRICE $0.0000 - $0.425 . . . . . . . . . . . . . . . . 5,709,249 8.1092 $ 0.1818 3,490,924 0.1520 $0.4251 - $0.850. . . . . . . . . . . . . . . . . 831,435 3.7117 $ 0.6735 831,435 0.6735 $0.8501 - $1.275. . . . . . . . . . . . . . . . . 31,250 2.1368 $ 1.1540 31,250 1.1540 Total. . . . . . . . . . . . . . . . . . . . . . 6,571,934 7.5245 $ 0.2486 4,353,609 0.2588 NOTE E - COMMITMENTS AND CONTINGENCIES The Company has capital leases for machinery and equipment that expire in 2009 and has operating lease for a facility that expired in August 2004, with an option to extend the term of this lease for an additional five years. The Company exercised the option to extend the lease to August 2006The following is a summary as of September 30, 2005 of future minimum lease payments together with the present value of the net minimum lease payments on capital leases: CAPITAL OPERATING YEAR ENDING SEPTEMBER 30 LEASES LEASES ----------------------------------------------------------- -------- ---------- 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . 52,000 129,000 2007. . . . . . . . . . . . . . . . . . . . . . . . . . . . 51,000 4,000 2008. . . . . . . . . . . . . . . . . . . . . . . . . . . . 51,000 4,000 2009. . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,000 2,000 2010. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 - ---------- ---------- Total minimum lease payments. . . . . . . . . . . . . . . . $ 202,000 $ 139,000 ========== ========== Less amount representing interest . . . . . . . . . . . . . 43,000 ---------- Net minimum lease payments. . . . . . . . . . . . . . . . . $159,000 Less current portion. . . . . . . . . . . . . . . . . . . . 33,000 ---------- Present value of net minimum payments, less current portion $126,000 ========== F-12 During the year ended September 30, 2005, the Company entered a capital lease obligation for equipment at the cost of $133,000. This obligation bears an average interest of 12.16 % and a monthly payment of $3,000 and mature in October 2009. Rental expense under operating leases was $144,000 and 129,000 in fiscal years 2005 and 2004. LITIGATION ---------- From time to time the Company is involved in litigation and threatened litigation arising in the ordinary course of business. The Company is not aware of any material unsettled litigation. EMPLOYMENT AGREEMENT --------------------- We entered into a long-term agreement with John McLaughlin effective November 2, 2002 through September 30, 2004. This agreement provided a base salary of $150,000 per year and a bonus up to $150,000 based on performance factors including revenue, profit and accomplishment of certain key milestones. In addition, Mr. McLaughlin received standard employee options to purchase 50,000 shares of Common Stock at an exercise price of $0.20 per share upon acceptance of the agreement. On September 24, 2004, the Board passed a resolution to extend this contract for an additional year to 2005. On September 9, 2005 the Board passed a resolution to continue Mr. McLaughlin at a monthly salary of $14,500 starting October 1, 2005. NOTE F - SAVINGS AND RETIREMENT PLANS The Company has a Savings and Retirement Plan (the "Plan") under which every full-time salaried employee who is 18 years of age or older may contribute up to 100 percent of his or her eligible annual salary to our Plan. For an employee contribution of up to but not exceeding 6 percent of the employee's annual salary the Company makes a matching contribution of $.25 for every $1.00 of the employee's contribution. The Company's contributions are 100% vested after 36 months of contributions to the Plan. Benefits are payable under the Plan upon termination of a participant's employment with us or at retirement. The Plan meets the requirements of Section 401(k) of the Internal Revenue Code. The Company's matching contribution, which was charged to expense, was $16,000 and $15,000 for fiscal 2005 and 2004, respectively. NOTE G - RELATED PARTY TRANSACTIONS The Company has retained the services of an investment advisor, who is also a member of the Board of Directors, to provide advice on the investment portfolio. During each of the fiscal year ended September 30, 2005 and 2004, the Company incurred $2,000 each, for these services.