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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NO. 1-9767
INTERNATIONAL REMOTE
IMAGING SYSTEMS, INC.
DELAWARE 94-2579751
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
9162 ETON AVENUE, CHATSWORTH, CALIFORNIA 91311
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
TELEPHONE NUMBER: (818) 709-1244
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
COMMON STOCK (AMERICAN STOCK EXCHANGE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
On March 12, 1999, the aggregate market value of the shares of Common Stock
held by non-affiliates of the Registrant was approximately $4.9 million based
upon the closing price of $ 7/8 per share of Common Stock as reported on the
American Stock Exchange. Solely for the purpose of determining "non-affiliates"
in this context, shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded. This determination of affiliate status is not necessarily a
determination for other purposes.
The Registrant had 6,432,875 shares of Common Stock outstanding on March
12, 1999.
Part III incorporates information by reference from the Proxy Statement for
the Registrant's 1999 Annual Meeting of Stockholders.
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INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
FORM 10-K ANNUAL REPORT
FISCAL YEAR ENDED DECEMBER 31, 1998
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 16
Item 3. Legal Proceedings........................................... 16
Item 4. Submission of Matters to a Vote of Security Holders......... 16
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters......................................... 17
Item 6. Selected Financial Data..................................... 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 18
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 28
Item 8. Financial Statements and Supplementary Data................. 28
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 28
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 29
Item 11. Executive Compensation...................................... 29
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 29
Item 13. Certain Relationships and Related Transactions.............. 29
PART IV
Item 14. Exhibits, Financial Statements Schedules, and Reports on
Form 8-K.................................................... 29
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PART I
ITEM 1. BUSINESS
A glossary of selected technical terms is included at the end of this
section, and stockholders are encouraged to review the glossary before reading
the description of business.
OVERVIEW
International Remote Imaging Systems, Inc. and its subsidiaries ("IRIS" or
the "Company") design, develop, manufacture and market in vitro diagnostic
("IVD") imaging systems based on patented and proprietary automated intelligent
microscopy ("AIM") technology for automating microscopic procedures performed in
clinical laboratories as well as special purpose centrifuges and other small
instruments. AIM combines the Company's capabilities in automated specimen
presentation, including its patented slideless microscope, and proprietary
high-speed digital processing hardware and software to classify and present
images of microscopic particles in easy-to-view displays. The Company's IVD
imaging systems are designed to provide customers with better and more rapid
results and labor cost-savings over manual methods of performing microscopy. The
Company's products are sold directly and through distributors primarily to
hospital and reference clinical laboratories, as well as veterinary, physician
office and research laboratories.
The Company pioneered its first IVD imaging system application in 1983 with
its introduction of The Yellow IRIS family of workstations for urinalysis. The
Company believes that it is still the only supplier of laboratory systems which
fully automate a complete urinalysis, and it introduced its fourth generation
models in 1996 which incorporate significant advancements in speed, utility and
ease of use. In 1996, the Company also received Food and Drug Administration
("FDA") clearance and began to market the Model 900UDx urine pathology system
designed especially for the high-volume testing requirements of larger
laboratories. The Company also provides ongoing sales of supplies and service
necessary for operation of The Yellow IRIS workstations. Most supplies are
purchased under standing orders and, following an initial one-year warranty
period, the majority of customers purchase annual service contracts.
In July 1996, the Company entered the field of genetics with the
acquisition (the "PSI Acquisition") of the digital imaging business of
Perceptive Scientific Instruments, Inc. ("PSI"). PSI's principal product line is
the PowerGene family of genetic analyzers -- IVD imaging systems for
karyotyping, DNA probe analysis and comparative genomic hybridization. The
Company also acquired international operations from PSI.
In February 1996, the Company acquired StatSpin, Inc. ("StatSpin"), in a
pooling-of-interests transaction. Through StatSpin, the Company manufactures and
markets a variety of benchtop centrifuges, small instruments and supplies for
the laboratory market. These products are used primarily for manual specimen
preparation and dedicated applications in cytology, hematology and urinalysis.
They appeal to laboratories and physician offices performing too few tests to
justify the cost of an automated IVD imaging system.
In December 1997, the Company began distributing the IRIS/Sysmex UF-100
urine cell analyzer in the United States under an existing agreement with its
manufacturer, Sysmex Corporation. Sysmex initiated contractual procedures in
September 1998 for terminating the exclusive nature of the Company's
distribution rights to the UF-100 based on allegations of inadequate
performance. The Company disputed these allegations and entered into discussions
with Sysmex about the pricing and marketing of the UF-100. Those discussions did
not resolve the matter. Sysmex is now asserting that it has the right to appoint
additional distributors for the UF-100 in North America. The Company disputes
that Sysmex has this right but expects that Sysmex will attempt to appoint at
least one additional distributor for North America in the near future. The
Company is presently evaluating its alternatives and may take legal action if
Sysmex does in fact appoint an additional distributor. The Company cannot
presently predict the impact of any attempt by Sysmex to appoint an additional
distributor or any resulting legal action taken by the Company.
The Company has had a major program over a number of years to develop The
White IRIS leukocyte differential analyzer. The FDA cleared The White IRIS in
May 1996, but its commercial release was
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subsequently delayed by other priorities such as the introductions of the Model
900UDx urine pathology system and the UF-100 urine cell analyzer. The Company
has elected not to launch The White IRIS at the present time due to limited
resources and the potential impact of product launch costs on near-term
profitability. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
THE INDUSTRY
As a result of cost containment pressures from third-party payors,
healthcare providers are focusing on the most efficient use of their resources.
This goal is driving them to reduce costs while simultaneously improving the
outcome potential of patient care. Meeting this goal depends to a large degree
on reducing the cost and improving the accuracy of medical tests for diagnosing
and monitoring diseases, as well as reporting the results of these tests in
timely and useful ways.
Medical tests are performed either on the patient or on a specimen removed
from the patient. IVD testing refers to analysis of a specimen -- a sample of
blood ("hematology"), urine ("urinalysis"), chromosomes ("genetics") or other
tissue or material removed from the patient -- usually in the clinical
laboratory. Many IVD tests rely on chemical or simple physical measures of
specific characteristics of the specimen. Over the past five decades, the
chemical and particle-counting aspects of these tests have been largely
converted from manual methods to automated instruments, such as clinical
chemistry analyzers and blood cell counters.
However, many other IVD tests require visual examination of the specimen
through a microscope ("microscopy"). Manual microscopy requires numerous steps
from specimen preparation to visual examination, making the method
labor-intensive, cumbersome, biohazardous, inefficient and imprecise. More labor
time is spent in performing manual microscopy, collectively, than in any other
IVD testing procedure in the clinical laboratory. Nonetheless, the vast majority
of microscopic procedures are still performed manually.
The pressure to reduce the costs and improve the accuracy of IVD tests,
together with recent technological developments, have created an opportunity for
automating microscopic procedures. Advances in image processing software,
computer hardware and solid-state cameras have made it possible to capture
digital images of microscopic specimens in a uniform manner and perform
sophisticated analysis and classification of these images. The test results can
then be electronically transmitted to the central computer system of the
hospital or reference laboratory for clinical use and billing. The digital
images of the specimen can also be stored in electronic format for future review
and, theoretically, transmitted to remote locations for review by other
technologists or specialists.
THE COMPANY'S STRATEGY
The Company's objectives are to maintain its technological leadership,
develop new products, continue market penetration of existing products, expand
the geographic markets for existing products and increase sales of supplies and
service. The Company is pursuing these objectives through the following
strategies:
- Adding New IVD Imaging Applications. The Company believes automated
microscopy has a number of potential applications in the clinical
laboratory beyond the field of urinalysis. In July of 1996, the Company
strategically expanded into the field of genetics through the PSI
Acquisition, which included the acquisition of the PowerGene family of
IVD imaging systems. The Company completed development of The White IRIS
leukocyte differential analyzer for hematology in 1997, but it has
elected not to launch The White IRIS at the present time due to limited
resources and the potential impact of product launch costs on near-term
profitability. See "Overview."
- Continuing Market Penetration for Current Applications of IVD Imaging
Technology. The Company plans to continue penetrating the urinalysis
segment of the IVD testing market with additional sales of its newest
generation models of The Yellow IRIS family, including the Model 900UDx
Urine Pathology System which was designed especially for the high-volume
testing requirements of larger laboratories.
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- Expanding in New Geographic Markets. The Company's growth strategy also
calls for the successful penetration of overseas markets, where its
PowerGene systems have already achieved a strong market presence with
sales in more than 40 countries. Until recently, neither The Yellow IRIS
line nor the StatSpin products have been marketed to a significant degree
outside the United States. International markets have witnessed the same
trend toward consolidation and emphasis on labor productivity that has
characterized the US market for the past 15 years. From a strategic
standpoint, management intends to proceed with the introduction of The
Yellow IRIS in selected markets where consolidation has already been a
factor by developing relationships with distributors in those countries
capable of selling both its clinical systems and small instruments.
- Increasing Sales of Supplies and Service. Once an IVD imaging system is
installed, the Company generates significant recurring revenue from sales
of supplies and service for its operation. The Company seeks to enhance
this revenue stream by installing more systems as well as increasing its
product offering of supplies for each system. For example, the Company
began selling the CHEMSTRIP/IRIStrip urine test strips for The Yellow
IRIS systems at the end of 1994. The Company also hopes to introduce
specific DNA probe kits and other consumables for chromosome analysis to
its PowerGene line.
- Maintaining Technological Edge. The Company maintains an active research
and development program to continually enhance its IVD imaging systems
and explore other potential IVD imaging applications for its AIM
technology.
- Adding Complementary Product Lines. In the past, the Company has also
added several complementary lines of small instruments and supplies which
appeal to smaller laboratories and respond to the desire of integrated
healthcare providers to purchase systems and supplies for a variety of
clinical settings from one supplier. The Company also added the UF-100 to
its urinalysis instrument line which appeals more to reference
laboratories which desire to minimize the number of microscopic
examinations. While it continues to consider complementary product line
acquisitions from time to time, the Company does not presently believe
that such acquisitions are likely in the near term.
AIM TECHNOLOGY
An effective system for automated microscopy in most applications requires
technology for fast, consistent and easily discernable presentation of the
specimen to the microscope ("front end processing") and for rapidly capturing,
analyzing, classifying, enhancing, arranging and displaying images of the
specimen ("back end imaging"). The Company has over the past twenty years
created and developed its patented and proprietary AIM technology to address
both of these requirements.
The Company's AIM technology automates all or most of the front end
processing in its IVD imaging systems. For example, traditional urine sediment
analysis requires manual preparation of a slide from the specimen requiring
several steps, including centrifugation followed by carefully positioning,
staining and coverslipping a sample extracted from the specimen. The slide is
then placed under the microscope and manually manipulated and scanned by a
technologist. This procedure is often time-consuming, imprecise and carries the
potential for human exposure to biohazards. In contrast, the Company's patented
slideless microscope used in The Yellow IRIS allows microscopic examination of a
moving specimen precisely positioned in a stream of fluid and eliminates the
need for manual slide preparation, manipulation and scanning. The slideless
microscope precisely positions the specimen to within microns in a thin layer
for proper focusing as it flows past the microscope at high-speed ensheathed in
a larger stream of fluid. The method of ensuring proper alignment, particle
orientation, focus and measurement, called "imaging flow cytometry," is
patented, and the Company is unaware of any other company which has developed
similar technology. For those IVD tests where imaging flow cytometry is not
optimal or possible, AIM technology automates the slide manipulation and
scanning process.
Once the specimen is located and presented to the microscope, AIM's back
end imaging automatically captures, digitizes, classifies, organizes and
presents the microscopic images displayed on a video monitor for review by the
medical specialist. These digital images of the specimen can then be stored on
magnetic or optical media for later retrieval, even years later.
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PRODUCTS
AIM Systems
The Company currently markets two families of AIM systems -- The Yellow
IRIS and the PowerGene. They require customers to make substantial capital
investments and are designed for sale to clinical laboratories performing a
relatively large number of IVD tests.
The Yellow IRIS family of urinalysis workstations are widely used
nationwide, including hospitals affiliated with over 75% of all United States
medical schools. This family of IVD imaging systems currently consists of three
models. Two models can also perform IVD imaging tests on a number of body fluids
other than urine, including cerebrospinal, peritoneal, pleural, pericardial,
synovial and seminal fluids as well as peritoneal dialyzates and lavages. The
third model, the Model 900UDx, is designed for laboratories testing high numbers
of urine specimens. The Yellow IRIS family of IVD imaging systems currently has
list prices ranging from $100,000 to $195,000.
The PowerGene family of genetic analyzers performs certain chromosome tests
such as karyotyping, DNA probe analysis in FISH and M-FISH procedures and
comparative genomic hybridization. These tests are typically used for analyzing
genetic abnormalities for both clinical uses (e.g. prenatal screening) and
research applications (e.g. cancer studies). The Company purchased this family
of analyzers in July 1996 in conjunction with the PSI Acquisition. The PowerGene
analyzers currently have list prices ranging from $10,000 to over $100,000
depending upon the range of functionality, selected options and configuration.
Other Systems
In the fourth quarter of 1997, the Company began marketing the IRIS/Sysmex
UF-100 urine cell analyzer in the United States. The UF-100, developed in Japan
by Sysmex Corporation, formerly TOA Medical Electronics Co., Ltd. ("Sysmex"),
utilizes flow cytometric laser scanning principles to screen large volumes of
urine specimens for the presence of abnormal sediment compositions. The Company
is the exclusive distributor for the UF-100 in North America and receives
royalties from Sysmex on sales of the UF-100 outside of North America. The
UF-100 currently has a list price in the United States of $125,000. It provides
only the sediment portion of a complete urinalysis.
Sysmex initiated contractual procedures in September 1998 for terminating
the exclusive nature of the Company's distribution rights to the UF-100 based on
allegations of inadequate performance. The Company disputed these allegations
and entered into discussions with Sysmex about the pricing and marketing of the
UF-100. Those discussions did not resolve the matter. Sysmex is now asserting
that it has the right to appoint additional distributors for the UF-100 in North
America. The Company disputes that Sysmex has this right but expects that Sysmex
will attempt to appoint at least one additional distributor for North America in
the near future. The Company is presently evaluating its alternatives and may
take legal action if Sysmex does in fact appoint an additional distributor. The
Company cannot presently predict the impact of any attempt by Sysmex to appoint
an additional distributor or any resulting legal action taken by the Company.
System Supplies and Service
In addition to sales of IVD imaging systems and the UF-100, the Company
obtains significant recurring revenue from sales of supplies used in the
operation of these systems and from their service and repair. Supplies for The
Yellow IRIS family include the sheath fluid used to position the particles and
cleanse the system in slideless microscopy and "controls" used in calibrating
and monitoring the performance quality of the systems. The Company also sells
the CHEMSTRIP/IRIStrip for testing urine chemistry on The Yellow IRIS. The
Company introduced the CHEMSTRIP/IRIStrip urine test strips in late 1994 and has
converted over 95% of the installed base of systems to these new test strips.
CHEMSTRIP/IRIStrips urine test strips are produced through an agreement with the
Boehringer Mannheim Group of companies, recently bought by Hoffman-LaRoche,
reorganized and now operated as Roche Diagnostics. The Company is currently
seeking to add DNA probe kits for chromosome analysis to the PowerGene product
line.
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Small Instruments and Supplies
The Company also manufactures and markets a variety of small instruments
and supplies for the clinical laboratory market. These products complement the
Company's line of IVD imaging systems because they appeal to smaller
laboratories and physician offices performing an insufficient number of tests to
justify the capital cost of an IVD imaging system. StatSpin's
technologically-advanced small benchtop centrifuges are designed to prepare
certain biological specimens for instrumental or microscopic examination in a
fraction of the time required by larger, common laboratory centrifuges. They
have proven ideal for on-demand, point-of-use testing in hospitals, physician's
offices and veterinary laboratories. The basic StatSpin centrifuge unit is
adaptable to a variety of uses by means of application-specific rotors and
consumables. Noted for their compact design and simple, quiet and unobtrusive
operation, they are particularly well-suited to laboratories in which
technicians are located in close proximity to the equipment. These products also
take advantage of the Company's reputation and expertise in urinalysis and
respond to the desire of integrated healthcare providers to purchase systems and
supplies for a variety of clinical settings (both large and small) from one
supplier. This category of products includes special-purpose centrifuges,
digital refractometers for measuring the specific gravity of urine, the CenSlide
System for manual microscopic examination of urine and other supplies intended
primarily for specimen preparation.
Summary of Revenues by Product Line for Each Segment
The following tables present a summary of revenues for each segment by
product line for the three years ended December 31, 1998:
SMALL
GENETIC LABORATORY
URINALYSIS ANALYSIS(1) DEVICES TOTAL
----------- ----------- ---------- -----------
For the Year Ended December 31, 1996
Sales of IVD systems.................... $ 4,189,663 $2,180,683 $ -- $ 6,370,346
Sales of IVD system supplies and
service............................... 8,831,516 285,977 -- 9,117,493
Sales of small instruments and
supplies.............................. -- -- 5,066,292 5,066,292
Royalty and license revenues............ 42,923 -- -- 42,923
----------- ---------- ---------- -----------
Total................................... $13,064,102 $2,466,660 $5,066,292 $20,597,054
=========== ========== ========== ===========
SMALL
GENETIC LABORATORY
URINALYSIS ANALYSIS DEVICES TOTAL
----------- ---------- ---------- -----------
For the Year Ended December 31, 1997
Sales of IVD systems.................... $ 5,612,308 $6,211,135 $ -- $11,823,443
Sales of IVD system supplies and
service............................... 10,061,314 559,897 -- 10,621,211
Sales of small instruments and
supplies.............................. -- -- 4,447,418 4,447,418
Royalty and license revenues............ 510,920 -- 92,156 603,076
----------- ---------- ---------- -----------
Total................................... $16,184,542 $6,771,032 $4,539,574 $27,495,148
=========== ========== ========== ===========
SMALL
GENETIC LABORATORY
URINALYSIS ANALYSIS DEVICES TOTAL
----------- ---------- ---------- -----------
For the Year Ended December 31, 1998
Sales of IVD systems.................... $ 4,985,717 $5,374,212 $ -- $10,359,929
Sales of IVD system supplies and
service............................... 11,785,185 562,089 -- 12,347,274
Sales of small instruments and
supplies.............................. -- -- 4,345,304 4,345,304
Royalty and license revenues............ 229,972 -- 235,000 464,972
----------- ---------- ---------- -----------
Total................................... $17,000,874 $5,936,301 $4,580,304 $27,517,479
=========== ========== ========== ===========
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(1) Includes only revenues from July 31, 1996, the date of acquisition of the
genetic analysis segment.
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In the second quarter of 1998, the Company adopted Statement of Financial
Accounting Standards (SFAS) 131, "Disclosures about Segments of an Enterprise
and Related Information". SFAS 131 supersedes SFAS 14, "Financial Reporting for
Segments of a Business Enterprise", replacing the "industry segment" approach
with the "management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. The
Company operated in one industry segment under SFAS 14. Since the Company is
organized on the basis of products and related services, it operates in three
segments under SFAS 131: (1) urinalysis, (2) genetic analysis and (3) small
laboratory devices. See Note 19 to the Consolidated Financial Statements,
"Segment and Geographic Information".
Backlog
The sales backlog for IVD imaging systems was approximately $700,000 at
December 31, 1997 and $221,000 at December 31, 1998. The Company believes the
amount of backlog at a given date is not necessarily indicative of sales for any
succeeding period.
RESEARCH AND DEVELOPMENT
The Company maintains an active research and development program to
continually enhance its existing IVD imaging systems and explore other IVD
imaging applications for its AIM technology. In 1996, 1997 and 1998, the Company
focused its research and development efforts on the following major projects, as
well as numerous other smaller projects:
- Developing the Model 900UDx. The Company completed development of its
newest model in The Yellow IRIS family, the Model 900UDx, in 1996. The
Model 900UDx is the industry's first and only fully-automated walkaway
system for performing complete macroscopic, chemical and microscopic
urinalysis profiles. During 1998, the Company upgraded the installed base
of Model 900UDx systems to increase reliability and enhance overall
performance.
- Upgrading The Yellow IRIS. The Company conducts an ongoing process of
refining its AIM technology and the cost-effectiveness of its systems.
During 1998, the Company completed work on software updates to make The
Yellow IRIS family of workstations Y2K compliant. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Year 2000 Problem."
- Expanding PowerGene. The Company has dedicated significant research and
development efforts toward fluorescent in-situ hybridization ("FISH")
analysis. FISH is providing new tools for direct and specific evaluation,
and prediction of human genetic disease. Utilizing multi-spectral
fluorescent chemical probes, Multiplex-FISH ("M-FISH") methods enhance
the sensitivity of classical karyotyping and provide easier
interpretation of chromosome abnormalities permitting such procedures to
be performed rapidly on uncultured amniotic or cancer cells. During 1998,
the Company conducted research and development on DNA probe kits for the
PowerGene product line.
- Developing The White IRIS. The Company has had a major program over a
number of years, under sponsorship of the National Institutes of Health
and later in conjunction with a Company-sponsored research and
development entity, to develop The White IRIS leukocyte differential
analyzer. The White IRIS is an automated high-speed workstation used to
classify normal, as well as immature and other abnormal white blood
cells. The White IRIS performs a differential analysis which includes
identifying the five types of normally occurring white blood cells plus a
number of abnormally occurring immature white blood cells, variant
lymphocytes and other cells. The Company also holds an exclusive,
worldwide license to several patents which cover the unique cytoprobe
used by The White IRIS, as well as the multi-colored expression of 2-MPM
in white blood cells. The Company completed development of The White IRIS
leukocyte differential analyzer for hematology in 1997, but it has
elected not to launch The White IRIS at the present time due to limited
resources and the potential impact of product launch costs on near-term
profitability. See "Overview."
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The Company's current research and development efforts include, among other
things:
- Developing the Next Generation Platform for Its IVD Systems. The Company
is pursuing improvements designed to significantly increase speed and
enhance image quality while simultaneously reducing the amount of
technologist time required to operate the system. The Company is
currently conducting feasibility studies on an entirely new platform for
The Yellow IRIS family of workstations.
- Upgrading the PowerGene Cytogenetic Capabilities. Research and
development efforts for this system are focused upon developing improved
karyotyping image classification algorithms, enhanced functionality for
molecular cytogenetic studies and expanded measures in chromosome
analysis using M-FISH methods. The Company is also developing DNA probe
kits for chromosome analysis to enhance the PowerGene revenue stream.
- Developing the Poly Products. During 1998, the Company and Poly satisfied
their funding commitment on this project. The Company decided not to
exercise its option to acquire Poly but entered into ongoing discussions
to acquire Poly at a price below the option price. No further development
work is planned at this time. Regardless of whether the Company acquires
Poly, the Company has the right and expects to use improvements to its
analyte autorecognition technology from the Poly project in the Company's
next generation walkaway urinalysis systems. See discussion below in this
section.
- Identifying Future Applications. The Company also performs market
research to identify customer needs and experiments to determine future
applications of its technology. The Company believes its AIM technology
has potential for improved cost, speed, convenience and utility and may
have a number of other potential IVD imaging applications such as
cytology, microbiology and histology.
The Company invested $4.3 million, $3.7 million and $3.7 million on total
product technology expenditures during the years ended December 31, 1996, 1997
and 1998, respectively. See "Management Discussion and Analysis of Financial
Condition and Results of Operations -- Overview."
The Company has in the past partially funded research and development
programs through (i) grants from NASA and the National Institutes of Health,
(ii) joint development programs with strategic partners and (iii)
Company-sponsored research and development entities. In recent years, the
Company has entered into four significant projects, two joint development
projects with strategic partners -- Boehringer Mannheim Corporation ("BMC") and
Boehringer Mannheim GmbH ("BMG") -- and two projects with Company-sponsored
research and development entities -- LDA Systems, Inc. ("LDA") and Poly U/A
Systems, Inc. ("Poly"). From 1994 to 1996, the Company collaborated with BMC and
BMG in the development of CHEMSTRIP/IRIStrip urine test strips and the Model
900UDx. BMC supplies the Company with CHEMSTRIP/IRIStrip urine test strips and
has agreed to supply the Company with certain raw materials should the Company
elect to manufacture its own urine test strips, subject to royalty payments. The
Company was granted the non-exclusive right to distribute certain other BMC
urinalysis products to hospitals and commercial laboratories in the United
States. The Company manufactures the Model 900UDx with BMG providing certain
components on an OEM basis at cost. The Company has exclusive marketing rights
to the Model 900UDx in the United States, Canada and Taiwan and non-exclusive
rights for the rest of the world outside of Germany and Italy. During 1997,
Hoffman-LaRoche acquired the Boehringer Mannheim Group of companies, and BMC and
BMG are now operated as Roche Diagnostics.
In 1992, the Company entered into a project with LDA for development of The
White IRIS leukocyte differential analyzer and later acquired LDA for
approximately 498,000 shares of the Company's common stock. In 1995, the Company
entered into a similar project with Poly for development of several new products
to enhance automated urinalysis. Poly funded most of the cost of the project
with the net proceeds from a 1995 private placement of units, each unit
consisting of shares of Poly common stock and warrants to purchase common stock
of the Company. The Company contributed $500,000 toward the cost of the project
and has no further funding commitments. Poly has also satisfied its funding
commitment, and no further development work is planned at this time. The Company
had an option until November 29, 1998 to acquire all of the common stock of Poly
for an aggregate price of $5.1 million, payable in cash or shares of the
Company's common stock. The Company decided not to exercise its option but
entered into ongoing discussions to
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acquire Poly at a price below the option price. The Company cannot predict
whether these discussions will lead to mutually acceptable terms for an
acquisition.
MARKETING AND SALES
In the United States, the Company's IVD imaging systems are sold and
serviced through the Company's own sales and service forces. Sales activities
consist of direct sales by field sales representatives, telemarketing to
initiate and aid in pursuing sales opportunities, logistics support of the field
sales representatives and after-sales support to customers in the operation of
their systems. In addition to its sales activities, the Company promotes the
advantages of its products through advertising in trade journals, attendance at
trade shows and direct mail. All sales of IVD imaging systems include
installation, customer training and a one-year warranty. The Company's small
instruments, targeted primarily at smaller customers, are sold through
distributors. The Company has an overseas sales office and staff based in
Chester, England that supports agents and distributors and promotes its
PowerGene and StatSpin products in more than forty foreign countries.
The Company also maintains a rental program under which it has a number of
systems currently in place. Under the terms of the rental agreements, payments
generally are based on the number of tests performed with a guaranteed monthly
minimum payment to the Company. The Company is responsible for supply and
service of the systems. Alternatively, some customers lease the Company's IVD
systems from medical equipment leasing companies which, in turn, purchase the
systems from the Company.
In addition, the Company markets most of the supplies used in the operation
of its IVD systems and maintains these systems through its own national service
organization. Service (after a one-year warranty period) is generally sold under
an annual service contract or, less frequently, on a per-call basis.
COMPETITION
Urinalysis
The Company's primary products for the urinalysis market are The Yellow
IRIS family of urinalysis workstations and the UF-100 urine cell analyzer. The
principal competitive factors in this market are cost-per-test, ease of use, and
quality of result. The Company believes The Yellow IRIS and the UF-100 compete
favorably with regard to these factors in their respective target markets.
A number of hospitals conduct urine sediment examinations using the Kova
system made by Hycor Biomedical, Inc., as well as several other similar
products, all of which are composed largely of disposable plastic parts. These
products provide a more standardized method of preparing urine sediment for
microscopical examination as opposed to traditional means. While these
disposable products help somewhat to overcome manipulative imprecision, most of
them do so at the added expense of an increased number of disposable parts and
offer little in time savings. One exception is the CenSlide System acquired by
the Company in March of 1996. This system uses a combination centrifuge tube and
microscope slide, thereby actually eliminating much of the manipulation required
in preparing the urine specimen for microscopic observation. The Company views
these types of products as better suited for laboratories performing a small
number of urinalysis tests.
Bayer Diagnostics, Roche Diagnostics, and Dade Behring Corporation sell
lines of urine test strips which are useful in determining the concentration of
various chemical substances often found in urine. Some claims have been made
that the absence of certain results determined with these test strips can
preclude the need for microscopic examinations of some specimens. In 1998, IRIS
obtained FDA clearance of its claims of improved performance of The Yellow IRIS
over reagent strip measures in detecting microscopic abnormalities in urine.
Nonetheless, a substantial portion of the urinalysis market has subscribed to
the theory that these test strips can be relied upon to reduce the number of
microscopic examinations. The Company believes that this is largely due to
laboratories' reacting to cost-cutting pressures. The result is significantly
slower growth in the demand for microscopic examinations at certain hospitals
and reference laboratories.
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The Yellow IRIS currently supports only automated test strip readers
supplied by Roche Diagnostics, and some potential customers who have previously
purchased automated test strip readers from Bayer Diagnostics (the dominant
company in the urine test strip business) cannot connect those readers to The
Yellow IRIS. The Company's ability to modify The Yellow IRIS to support a
connection to test strip readers from Bayer Diagnostics and Dade Behring is
subject to significant restrictions under its existing agreements with Roche
Diagnostics.
The Company is also experiencing increased competitive pressures in the
urinalysis market due to the ongoing consolidation of both hospitals and medical
device suppliers. Large hospital chains and groups of affiliated hospitals are
negotiating comprehensive supply contracts with the larger medical device
suppliers. The larger suppliers often equip an entire laboratory and offer
one-stop shopping for laboratory instruments, supplies and service. In addition,
they typically offer the hospitals annual rebates based on the total volume of
business with the suppliers. These rebates create financial incentives against
purchasing instruments or supplies from others and act as a barrier to the
penetration of hospital laboratories covered by the contract. For example, the
Company has encountered significant difficulty in marketing its urinalysis
products to hospitals which are members of Premier Enterprises, a nationwide
buying cooperative of hospitals and healthcare systems. Premier generally
establishes a single vendor for particular product lines and has designated
Bayer Diagnostics as its vendor for urinalysis test strips. The Company's family
of urinalysis workstations, The Yellow IRIS, uses test strips manufactured for
the Company by Roche Diagnostics and thereby has encountered resistance to
purchasing The Yellow IRIS from many Premier affiliated hospitals for this
reason.
Genetics
The Company's products for the genetics market are the PowerGene family of
chromosome analyzers. The principal competitive factors in this market are
comparative product features, such as ease-of-use, software functionality and
user friendliness, clarity of visual output and the quality and responsiveness
of customer service. The Company believes the PowerGene analyzers compete
favorably with regard to these factors.
The Company's primary competitors in this worldwide market are Applied
Imaging and Vysis, Inc. who market IVD imaging systems for prenatal and other
genetic testing. Vysis utilizes a strategy of offering its systems as a vehicle
for selling its DNA probes, a strategy that has made it the fastest growing
competitor. Leica (a German microscope manufacturer), MetaSystems (also based in
Germany) and ASI (an Israeli camera manufacturer) also sell systems for genetic
analysis.
Hematology
The Company's proposed product for the hematology market is The White IRIS
leukocyte differential analyzer. See "Research and Development." Intelligent
Medical Imaging, Inc. ("IMI") is presently manufacturing an IVD imaging system,
called the Micro 21, for performing certain aspects of white blood cell
differential analysis and certain other analyses. Unlike The White IRIS, which
uses imaging flow cytometry, the Micro 21 is a slide-based system. The Company
believes The White IRIS has certain performance advantages over the Micro 21.
For example, The White IRIS (1) uses a closed-tube sampling procedure which is
safer and more convenient because it does not require slide preparation, (2) is
more sensitive and precise because it counts significantly more white blood
cells, (3) allows an easier-to-obtain and more complete answer because it
automatically classifies variant, immature and other abnormal cells, as compared
only to automated classification of normal cells by the Micro 21, and (4) is
more cost effective because it has higher throughput and requires less attended
time. See " -- Overview".
While other automated blood smear reading instruments capable of varying
degrees of white blood cell differential analysis exist, they are relatively
expensive. There is at least one such instrument currently in production (made
by Omron, a Japanese company), but, to the Company's knowledge, it is not
marketed outside of Japan. The Company is not aware of any current plans by
Omron to market its white blood cell slide readers in the United States. Sysmex,
Abbott Laboratories and Beckman Coulter, all manufacturers of blood cell
counters, have begun displaying devices which automate the blood smear
preparation process and are
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attachable to their respective analyzers but do not provide for automation of
white blood cell differential analysis.
In 1998, IMI introduced an automated blood smear reader which can be
combined with the Micro 21 for enhanced automation. IMI subsequently entered
into distribution arrangements with Bayer Diagnostics and Beckman Coulter for
the IMI blood smear reader. IMI has recently made public statements that it has
now placed over 70 of its Micro 21 systems as "revenue units."
Other Potential Competitors
The Company is aware of at least four other companies that sell IVD imaging
systems, all for cytology and/or histology applications. Neuromedical Systems,
Inc. and NeoPath, Inc. offer IVD imaging systems for PAP smears. Neuromedical
Systems recently filed for Chapter 11 bankruptcy protection due to rising
losses. Auto-Cyte, Inc. and ChromaVision Medical Systems, two newer ventures,
recently obtained significant funding through initial public offerings. AutoCyte
plans to compete in the PAP smear arena and recently announced a collaboration
with NeoPath and the purchase of intellectual property from Neuromedical
Systems. ChromaVision sells a system for rare event finding for applications
similar in concept to the PowerGene prototype automated rare event finder
delivered last year by PSI to NASA's Johnson Space Center.
INTELLECTUAL PROPERTY
The Company's commercial success depends in large part on its ability to
protect and maintain its proprietary rights. As such, the Company pursues broad
protection of its proprietary technology through the filing of various patent
applications. The Company has received numerous United States patents for its
AIM technology and related applications as well as a number of corresponding
foreign patents. These patents also cover developments in image analysis and
blood processing. A number of additional patent applications are pending in the
United States and abroad. These patents also cover image analysis, urine and
blood processing. Also, numerous patents relating to digital refractometers,
centrifuges, automated slide handling and disposable urinalysis products were
acquired in its recent acquisitions.
The Company has an exclusive license from Cytocolor, Inc. for the patented
2-MPM cytoprobe used in the operation of The White IRIS. Cytocolor has pursued
patent protection of this unique reagent through the filing of patent
applications in the United States and abroad. Under the terms of the license,
the Company is required to pay Cytocolor royalties of $1,000 per system for the
first 1,000 sales of The White IRIS plus 8% of the net sales price of all
consumable products containing 2-MPM.
The Company has granted Sysmex a royalty-bearing license to use pre-1989
technology for urine sediment analyzers and non-medical industrial instruments.
The Company has also granted Dade International a royalty-bearing license to use
certain centrifuge technology.
The Company has trade secrets and unpatented technology and proprietary
knowledge related to the sale, promotion, operation, development and
manufacturing of its products. To protect these rights, the Company enters into
confidentiality agreements with its employees and consultants.
The Company claims copyright in its software and the ways in which it
assembles and displays images, and it has filed copyright registrations with the
United States Copyright Office. The Company also owns various federally
registered trademarks, including "IRIS," "The Yellow IRIS," "The White IRIS,"
"PowerGene," and "StatSpin." The Company owns numerous other registered and
unregistered trademarks. The Company also has certain trademark rights in
foreign jurisdictions. The Company intends to aggressively protect its
copyrights and trademarks.
GOVERNMENT REGULATION
Most of the Company's products are subject to stringent government
regulation in the United States and other countries which govern the testing,
manufacture, labeling, storage, record-keeping, distribution, sale, marketing,
advertising and promotion of such products. The regulatory process can be
lengthy, expensive and uncertain, and securing clearances or approvals may
require the submission of extensive official data and other supporting
information. Failure to comply with applicable requirements can result in fines,
recall or seizure of
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products, total or partial suspension of production, withdrawal of existing
product approvals or clearances, refusal to approve or clear new applications or
notices and criminal prosecution.
In the United States, the FDA regulates medical devices under the Food,
Drug, and Cosmetic Act (the "FDC Act"). Before a new medical device can be
commercially introduced in the United States, the manufacturer usually must
obtain FDA clearance by filing a pre-market notification under Section 510(k) of
the FDC Act (a "510(k) Notification") or obtain FDA approval by filing a
pre-market approval application (a "PMA Application"). The 510(k) Notification
process can be lengthy, expensive and uncertain, but the PMA Application process
is significantly more complex, expensive, time-consuming and uncertain. To date,
the Company has cleared all of its regulated products with the FDA through the
510(k) Notification process.
The Company's business strategy includes the development of additional
products for which FDA clearance or approval may be required, and no assurance
can be given that the Company can secure any necessary FDA clearance to market
these products or that the FDA will not require the filing of a PMA Application
for these products. Furthermore, FDA clearance of a 510(k) Notification or
approval of a PMA Application is subject to continual review, and the subsequent
discovery of previously unknown facts may result in restrictions on a product's
marketing or withdrawal of the product from the market.
The Company is also required to register as a medical device manufacturer
with the FDA and comply with FDA regulations concerning good manufacturing
practices for medical devices ("GMP Standards"). In 1997, the FDA expanded the
scope of the GMP Standards with new regulations requiring medical device
manufacturers to maintain control procedures for the design process, component
purchases and instrument servicing. The FDA periodically inspects the Company's
manufacturing facilities for compliance with GMP Standards. The Company believes
that it is in substantial compliance with the expanded GMP Standards.
The FDA also regulates computer software of the type used in the Company's
IVD imaging systems and is currently reevaluating the regulation of such
software. The Company cannot predict the extent to which the FDA will regulate
such software in the future.
Labeling, advertising and promotional activities for medical devices are
subject to scrutiny by the FDA and, in certain instances, by the Federal Trade
Commission. The FDA also enforces statutory and policy prohibitions against
promoting or marketing medical devices for unapproved uses.
Many states have also enacted statutory provisions regulating medical
devices. The State of California's requirements in this area, in particular, are
extensive, and require registration with the state and compliance with
regulations similar to the GMP Standards established by the FDA. While the
impact of such laws and regulations has not been significant to date, there can
be no assurance that future developments in this area will not have a material
adverse effect on the Company.
In addition to domestic regulation of medical devices, many of the
Company's products are subject to regulations in the foreign jurisdictions in
which it operates or sells products. The requirements for the sale of medical
devices in foreign markets vary widely from country to country, ranging from
simple product registrations to detailed submissions similar to those required
by the FDA. Although the Company distributes the PowerGene analyzer in more than
40 foreign countries, it has not yet applied for regulatory clearances or
approvals to market The Yellow IRIS or The White IRIS in most of these foreign
countries. The Company's business strategy includes expanding the geographic
distribution of these and other products, and there can be no assurance that the
Company can secure the necessary clearances and approvals in the relevant
foreign jurisdictions. Furthermore, the regulations in certain foreign
jurisdictions continue to develop and there can be no assurance that new laws or
regulations will not have a material adverse effect on the Company's existing
business or future plans. Among other things, CE Mark certifications are, or may
soon be, required for the sale of many products in certain international markets
such as the European Community. The Company is actively pursuing CE Mark
certification for many of its products, but there can be no assurance that the
Company will be successful in securing such certification.
In addition, the Company's products are subject to regulation by the United
States Department of Commerce export controls, primarily as they relate to the
associated computers and peripherals. The Company has not experienced any
material difficulties in obtaining necessary export licenses to date.
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Any change in existing federal, state or foreign laws or regulations, or in
the interpretation or enforcement thereof, or the discussion or promulgation of
any additional laws or regulations could have a material adverse effect on the
Company.
SEGMENT AND GEOGRAPHIC INFORMATION
See Note 19 to the Consolidated Financial Statements, "Segment and
Geographic Information," for financial information regarding the Company's
operating segments and geographic areas.
EMPLOYEES
At December 31, 1998, the Company had 154 full-time employees, which is
comparable to the number of employees at the end of 1997. The Company also uses
outside consultants and part-time and temporary employees in production,
administration, marketing and engineering. No employees are covered by
collective bargaining agreements, and the Company believes that its employee
relations are satisfactory.
FORWARD-LOOKING STATEMENTS
This Annual Report contains various forward-looking statements which
reflect the Company's current views with respect to future events and financial
results and are subject to the safe harbor created by the Private Securities
Litigation Reform Act of 1995. These forward-looking statements include, but are
not limited to, the Company's views with respect to future financial results,
financing sources, capital requirements, market growth, new product
introductions and the like, and are generally identified by phrases such as
"anticipates," "believes," "estimates," "expects," "intends," "plans" and words
of similar import. The Company reminds stockholders that forward-looking
statements are merely predictions and therefore inherently subject to
uncertainties and other factors which could cause the actual results to differ
materially from the forward-looking statement. Some of these uncertainties and
other factors are discussed later in this Annual Report. See "Management
Discussion and Analysis of Financial Condition and Results of Operations." In
this section of the Annual Report, the Company has attempted to identify
additional uncertainties and other factors which may affect its forward-looking
statements.
Stockholders should understand that the uncertainties and other factors
identified in the Annual Report do not constitute a comprehensive list of all
the uncertainties and other factors which may affect forward-looking statements.
The Company has merely attempted to identity those uncertainties and other
factors which, in its view at the present time, have the highest likelihood of
significantly affecting its forward-looking statements. In addition, the Company
does not undertake any obligation to update or revise any forward-looking
statements or the list of uncertainties and other factors which could affect
such statements.
Potential Impact of Arbitration Proceeding
The Company is presently in arbitration with the former owner of PSI. See
"Legal Proceedings." Although the Company does not presently anticipate any
material adverse effect as a result of this arbitration proceeding, there can be
no assurance that it will not have such an effect on the financial position or
results of operations of the Company or result in additional dilution to holders
of the Common Stock.
Dependence on Instrument Sales
The Company derives most of its revenues from the sale of two families of
high-priced instruments -- The Yellow IRIS urinalysis workstations and the
PowerGene genetic analyzers. These instruments have list prices ranging from
$10,000 to $195,000 depending on model and configuration, and relatively modest
declines in unit sales or gross margins for either product line could have a
material adverse effect on the Company's revenues and profits.
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Reliance on Single Source Suppliers
Certain key components of the Company's instruments are manufactured
according to the Company's specifications or are available only from single
suppliers. For example, Roche Diagnostics is the sole source for the Company's
proprietary CHEMSTRIP/IRIStrip urine test strips and related urine test strip
readers used in The Yellow IRIS Models 300 and 500. From time to time, single
source suppliers have discontinued production of key components or encountered
production problems which potentially could have a material adverse effect on
instrument sales. Although, in the past, the Company has successfully
transitioned to new components to replace discontinued components, there can be
no assurance that the Company can always successfully transition to satisfactory
replacement components or that the Company will always have access to adequate
supplies of discontinued components on satisfactory terms during the transition
period. In the first quarter of 1997, Nikon discontinued production of the
microscope used in The Yellow IRIS. Prior to the end of production, the Company
significantly increased its inventory of these microscopes to facilitate a
two-year period for transitioning to a new microscope. The Company has selected
and placed orders for a new "off-the-shelf" microscope as the replacement. The
Company's inability to transition successfully to replacement components or to
secure adequate supplies of discontinued components on satisfactory terms during
the transition could have a material adverse effect on instrument sales. See
"-- Dependence on Instrument Sales."
Dependence on Key Personnel
The Company's success depends in significant part upon the continued
service of certain key personnel, and its continuing ability to attract,
assimilate and retain such personnel. Competition for such personnel is intense
and there can be no assurance that the Company can retain its key personnel or
that it can attract, assimilate or retain other highly qualified personnel in
the future. While the Company generally enters into agreements with its
employees regarding patents, confidentiality and related maters, the Company
does not have employment agreements with most of its key employees. The Company
does not maintain life insurance policies on such employees. The loss of key
personnel, especially without advance notice, or the inability to hire or retain
qualified personnel could have a material adverse effect on the Company.
Dr. Deindoefer, the Company's Chairman, President and Chief Executive
Officer for the past eighteen years, announced during 1998 his desire to retire
before the year 2000. The Company is currently making succession plans, but
there can be no assurance that the transition will not have a material adverse
effect on the Company's business operations.
Difficulties Associated with Introduction of Future Products
The commercial success of the Company's future products and systems depends
upon their acceptance by the medical community. Capital-intensive laboratory
instruments such as The White IRIS and the Company's other future products can
significantly reduce labor costs, improve precision and offer other distinctive
benefits. However, often there is resistance to products which require
significant capital expenditures or which eliminate jobs through automation.
There can be no assurance that the Company's new products and systems will
achieve significant market acceptance in the future or that sales of such future
products and systems will grow at the rates expected by management. Furthermore,
new product introductions or product enhancements by the Company's competitors
or the use of other technologies could cause a decline in sales or gross margins
on sales or loss of market acceptance of the Company's systems.
The Company has elected not to launch The White IRIS at the present time
due to limited resources and the potential impact of product launch costs on
near-term profitability. Commercial release of The White IRIS would also require
external funding and influential testimonials. See "Management Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
Industry Consolidation Creating Barriers to Market Penetration
The continuing consolidation of hospitals and medical device suppliers is
creating barriers to market penetration. Large hospital chains and groups of
affiliated hospitals prefer to negotiate comprehensive supply
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contracts with the larger medical device suppliers. The larger suppliers can
often equip an entire laboratory and offer one-stop shopping for laboratory
instruments, supplies and service . In addition, they typically offer the
hospitals annual rebates based on the total volume of business with the
suppliers. These rebates create financial incentives against purchasing
instruments or supplies from the Company. The Company's plans for further market
penetration of the urinalysis market with The Yellow IRIS family of workstations
will depend in part on its ability to overcome these and any new barriers
resulting from consolidation in the healthcare industry.
Technological Change
The market for the Company's systems is characterized by rapid
technological advances, changes in customer requirements, and frequent new
product introductions and enhancements. The Company's future success depends
upon its ability to enhance its current product lines, to introduce new products
that keep pace with technological developments and to respond to evolving
customer requirements. Any failure by the Company to anticipate or respond
adequately to technological developments by its competitors or to changes in
customer requirements, or significant delays in product introduction, could
result in a loss of competitiveness and revenues. There can be no assurance that
the Company will be successful in developing and marketing new products or
product enhancements on a timely or cost-effective basis, and such failure could
have a material adverse effect on the Company.
Government Regulation
Most of the Company's products are subject to stringent government
regulation in the United States and other countries. The regulatory process can
be lengthy, expensive and uncertain, and securing clearances or approvals may
require the submission of extensive official data and other supporting
information. Failure to comply with applicable requirements can result in fines,
recall or seizure of products, total or partial suspension of production,
withdrawal of existing product approvals or clearances, refusal to approve or
clear new applications or notices, or criminal prosecution, any of which could
have a material adverse effect on the Company. Furthermore, changes in existing
federal, state or foreign laws or regulations, or in the interpretation or
enforcement thereof, or the discussion or promulgation of any additional laws or
regulations could have a material adverse effect on the Company.
Acquisitions and Expansion
As part of the Company's strategy to enhance and maintain its competitive
position, the Company may from time to time consider potential acquisitions of
complementary products, technologies and other businesses. The Company has
completed a number of acquisitions in the past three years. The evaluation,
negotiation and integration of acquisitions may consume significant time and
resources of the Company. There can be no assurance that acquisitions will not
have a material adverse effect upon the Company due to, among other things,
operational disruptions, integration issues, unexpected expenses and accounting
charges associated with such acquisitions.
Healthcare Reform Policies
In recent years, an increasing number of legislative proposals have been
introduced or proposed in Congress and in home state legislatures that would
effect major changes in the healthcare system, nationally, at the state level or
both. Future legislation, regulation or payment policies of Medicare, Medicaid,
private health insurance plans, health maintenance organizations and other
third-party payors could adversely affect the demand for the Company's current
or future products and its ability to sell its products on a profitable basis.
Moreover, healthcare legislation is an area of extensive and dynamic change, and
the Company cannot predict future legislative changes in the healthcare field or
their impact on its business.
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GLOSSARY OF SELECTED TERMS
The following glossary defines certain technical terms used to describe the
Company's business.
AUTOMATED INTELLIGENT MICROSCOPY (AIM). The synthesis of visual microscopy,
digital image processing and automated image interpretation/pattern recognition
to analyze microscopic specimens. The Yellow IRIS, The White IRIS and PowerGene
are all examples of instruments which are based on AIM technology.
AUTOMATIC KARYOTYPING. A procedure to capture and digitize an image of a
spread of chromosomes from a dividing nucleus (metaphase) which may be further
enhanced by image processing. The individual chromosomes in the enhanced image
are then automatically separated, matched and aligned into their respective
pairs (karyotype).
COMPARATIVE GENOMIC HYBRIDIZATION (CGH). A molecular biology method to
globally view DNA for gain or loss (amplifications or deletions) of genetic
material using a FISH procedure.
CYTOPROBE. A chemical reagent which reacts with enzymatic granules within a
cell to produce unique color characteristics which are useful in identifying the
cell.
DNA. Deoxyribonucleic acid, the chemical composition of chromosomes in the
nuclei of living cells, consisting of two long chains of alternating phosphate
and deoxyribose units twisted into a double helix and joined by hydrogen bonds
between the complementary bases adenine and thymine or cytosine and guanine
bound in unique sequences that determine genetic characteristics.
DNA PROBE ANALYSIS. A molecular biology method using synthesized nucleic
acid comprised of unique short sequences of DNA (deoxyribonucleotides) to locate
their exact template along the DNA chain in the nucleus of a cell.
FLUORESCENT IN-SITU HYBRIDIZATION (FISH). A procedure that allows
microscopic observation of the location of a unique sequence of DNA by using a
DNA probe with a molecule attached to it which emits a distinctive color when
illuminated.
IN VITRO DIAGNOSTIC (IVD) TESTING. Testing conducted outside of the body in
a laboratory apparatus using a specimen obtained from the patient (blood, urine,
tissue, etc.) to identify or monitor a disease.
LEUKOCYTE DIFFERENTIAL ANALYZER. An automated, high-speed laboratory
instrument for classifying the white blood cells (or leukocytes) in a blood
specimen into different categories and determining the relative proportion of
each category.
MULTIPLEX FLUORESCENT IN-SITU HYBRIDIZATION (M-FISH). A procedure which
utilizes a multiple combination of unique sequence DNA probes and fluorescent
markers to label all 22 chromosome pairs and 2 sex chromosomes in 24 unique
colors, permitting easy and rapid identification of chromosomal breakage and
rearrangements (translocations) such as often observed in cancer cells.
REFERENCE LABORATORY. A commercial clinical laboratory which performs
general IVD testing of specimens referred from physician offices and more
specialized IVD testing for physician offices and hospitals.
REFRACTOMETER. A device which measures the index of refraction of a
solution, typically to determine its concentration or specific gravity.
SLIDELESS MICROSCOPY. The process of presenting a microscopic specimen to
the optical portion of a microscope without using a conventional microscope
slide. Slideless microscopy is implemented in The Yellow IRIS and The White IRIS
using a patented flowcell through which the specimen literally flows past a
microscope objective.
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ITEM 2. PROPERTIES
The Company leases all of its facilities. The leases expire at various
times over the next three years. The Company's headquarters are located at 9162
Eton Avenue, Chatsworth, California 91311. The table below sets forth certain
information regarding the Company's leaseholds as of December 31, 1998:
APPROXIMATE FLOOR MONTHLY
LOCATION SPACE (SQ. FT.) RENT USE
-------- ----------------- ------- ---
Chatsworth, CA.......... 26,000 $14,300 Sales and Marketing, Research and
Development, Manufacturing and Corporate
Administration
League City, TX......... 7,800 $11,200 Sales and Marketing, Research and
Development and Manufacturing
Norwood, MA............. 11,000 $ 7,800 Sales and Marketing, Research and
Development and Manufacturing
Chester, England........ 5,000 L 4,200 Sales and Marketing and Manufacturing
The Company believes that its facilities are adequate to meet its current
needs. Although it has limited expansion space at its Chatsworth facility, the
Company believes that it can accommodate planned growth at this facility for the
near term by leasing additional office space for certain non-manufacturing
related activities, making modifications to the Chatsworth facility and adding a
second shift to its manufacturing operations. The lease for the League City
facility expires in August 1999. The Company believes that it can negotiate a
new lease for this facility or lease another adequate facility nearby on
suitable terms.
ITEM 3. LEGAL PROCEEDINGS
In July 1996, the Company acquired PSI from Digital Imaging Technologies,
Inc. ("DITI"). As part of the purchase price, the Company issued to DITI a
five-year warrant to purchase 875,000 shares of Common stock at $8.00 per share.
In August 1997, the Company filed a demand for arbitration against DITI with the
American Arbitration Association. The Company's demand for arbitration alleges
material breaches of the representations, warranties and covenants in the
purchase agreement governing the PSI acquisition. DITI subsequently filed a
counterclaim in the arbitration proceeding alleging that the Company
misrepresented or omitted to disclose material facts in connection with the PSI
acquisition. DITI had previously requested a reduction in the exercise price of
the warrant but elected to seek unspecified monetary damages in the
counterclaim. The parties are currently engaged in discovery. Although the
Company does not presently anticipate any material adverse effect as a result of
this arbitration proceeding, there can be no assurance that it will not have
such an effect on the financial position or results of operations of the Company
or result in additional dilution to holders of the Common Stock.
The Company is involved in routine litigation arising in the ordinary
course of its business, and, while the results of the proceedings cannot be
predicted with certainty, the Company believes that the final outcome of such
matters will not have a material adverse effect on the financial position or
results of operation of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the American Stock Exchange
("Amex") under the symbol "IRI." The closing price of the Common Stock on March
12, 1999 was $ 7/8 per share. The table below sets forth high and low closing
prices reported by Amex for the period January 1, 1997 through December 31,
1998:
PRICE PER SHARE
-------------------
HIGH LOW
---- ---
FISCAL 1997
First Quarter............................................. $ 5 1/4 $ 3 5/8
Second Quarter............................................ 4 1/4 3 3/8
Third Quarter............................................. 5 3 11/16
Fourth Quarter............................................ 5 1/8 3 1/4
FISCAL 1998
First Quarter............................................. $ 4 11/16 $ 3 1/4
Second Quarter............................................ 4 1/8 2
Third Quarter............................................. 2 3/8 1 1/16
Fourth Quarter............................................ 1 1/2 3/4
As of March 12, 1999, IRIS had approximately 4,100 holders of record of its
Common Stock.
The Company intends to employ all available funds in the development of its
business and the repayment of indebtedness and, as a result, does not expect to
pay any cash dividends for the foreseeable future. Furthermore, the Company may
not pay any cash dividends on the Common Stock, or repurchase any shares of the
Common Stock, without the written consent of the Company's lender, Foothill
Capital Corporation, and the holders of a majority of the outstanding shares of
Series A Preferred Stock.
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ITEM 6. SELECTED FINANCIAL DATA
This information as of December 31, 1997 and 1998 and for the years ended
December 31, 1996, 1997 and 1998, is derived in part from, and should be read in
conjunction with, the Company's Financial Statements, including the Notes
thereto, as included elsewhere in this Annual Report.
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1994 1995(1) 1996(1) 1997(1) 1998(1)
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FINANCIAL STATEMENT DATA
Net revenues............................. $12,580 $14,488 $20,597 $27,495 $27,517
Operating income (loss).................. 1,495 (1,802) (10,434) 246 556
Interest and other income (expense),
net.................................... 95 282 (452) (1,042) (1,061)
Net income (loss)........................ 1,622 2,126 (7,428) (503) (385)
Net income (loss) per share -- basic..... .30 .35 (1.21) (.16) (.06)
Net income (loss) per share -- diluted... .28 .34 (1.21) (.16) (.06)
Working capital.......................... 7,779 11,234 1,914 1,650 3,570
Total assets............................. 13,282 22,203 37,860 32,735 32,107
Long term debt, including current
portion................................ 367 311 13,000 11,442 10,442
Total liabilities........................ 3,122 3,261 24,096 17,942 17,108
Shareholders' equity..................... 10,160 18,942 13,765 14,792 14,999
Cash dividends per share................. -- -- -- -- --
OTHER FINANCIAL DATA
Operating income (loss) as adjusted(2)... 1,495 1,098 (1,292) 1,584 749
EBITDA(3)................................ 2,407 2,150 (849) 4,050 3,407
- ---------------
(1) The years ended December 31, 1995 and 1996 include write-offs of acquired in
process research and development totaling $2.9 million and $7.3 million,
respectively. The year ended December 31, 1996 also includes unusual charges
totaling $1.9 million relating primarily to pooling-of-interest expenses,
the write-off of deferred public offering costs, expenses relating to
litigation and arbitration matters, severance and other incremental costs
associated with a restructuring of the Company's personnel. The year ended
December 31, 1997 includes unusual charges totaling $1.3 million relating to
expenses for litigation and arbitration matters, the write-down of deferred
private offering costs and the write-off of goodwill no longer considered
recoverable. The year ended December 31, 1998 includes unusual charges
totaling $193,000 primarily for legal expenses associated with the pending
arbitration matter.
(2) Operating income (loss) as adjusted represents operating income (loss)
before the write-off of acquired in-process research and development
totaling $2.9 million and $7.3 million in the years ended December 31, 1995
and 1996, respectively, and before unusual charges of $1.9 million, $1.3
million and $193,000 in the years ended December 31, 1996, 1997 and 1998,
respectively.
(3) EBITDA represents earnings before taxes, interest expense, write-off of
acquired in-process research and development, depreciation and amortization,
including amortization of common stock and stock option compensation. The
Company believes that EBITDA serves as a financial analysis tool for
measuring financial information such as operating performance leverage
ratios. EBITDA should not be considered by the reader as an alternative to
net income as an indicator of the Company's performance or as an alternative
to cash flows as a measure of liquidity.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company generates revenues primarily from sales of IVD imaging systems
based on its patented and proprietary AIM technology. Following the initial
sale, these systems become part of the "installed base" and generate follow-on
sales of supplies and service necessary for their operation. The Company also
generates revenues from sales of ancillary lines of small laboratory instruments
and supplies.
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Until 1996, the Company generated most of its revenues from sales of just
two models of The Yellow IRIS urinalysis workstation and related supplies and
services. These two models differ mainly by their speed and price. In 1996, the
Company introduced a third model of The Yellow IRIS, the Model 900UDx urine
pathology system, which is a higher capacity automated urinalysis workstation
designed especially for the high-volume testing requirements of large hospitals
and reference laboratories. The Company also began selling the PowerGene family
of genetic analyzers in August 1996 after completing the acquisition (the "PSI
acquisition") of the digital imaging business of Perceptive Scientific
Instruments, Inc. ("PSI"). The Company is currently seeking to enhance PSI's
revenue stream by adding DNA probe kits for chromosome analysis to the PowerGene
product line and may pursue this goal through internal research and development
efforts or a strategic transaction with another company. Finally, in December
1997, the Company began distributing the IRIS/Sysmex UF-100 urine cell analyzer
in the United States under an existing agreement with Sysmex Corporation, its
manufacturer. Sysmex has initiated contractual procedures in September 1998 for
terminating the exclusive nature of the Company's distribution rights to the
UF-100 based on allegations of inadequate performance. The Company disputed
these allegations and entered into discussions with Sysmex about the pricing and
marketing of the UF-100. Those discussions did not resolve the matter. Sysmex is
now asserting that it has the right to appoint additional distributors for the
UF-100 in North America. The Company disputes that Sysmex has this right but
expects that Sysmex will attempt to appoint at least one additional distributor
for North America in the near future. The Company is presently evaluating its
alternatives and may take legal action if Sysmex does in fact appoint an
additional distributor. The Company cannot presently predict the impact of any
attempt by Sysmex to appoint an additional distributor or any resulting legal
action taken by the Company. See "Business -- Overview."
The Company invests significant amounts in research and development for new
products and enhancements to existing products. The following table summarizes
total product technology expenditures for the periods indicated:
YEAR ENDED DECEMBER 31,
--------------------------
1996 1997 1998
------ ------ ------
(IN THOUSANDS)
Research and development expense, net....................... $1,978 $2,125 $2,421
Capitalized software development costs...................... 577 535 353
Reimbursed costs for research and development grants and
contracts................................................. 1,780 1,015 921
------ ------ ------
Total product technology expenditures............. $4,335 $3,675 $3,695
====== ====== ======
The Company has in the past partially funded its research and development
programs through (i) grants from NASA and the National Institutes of Health,
(ii) joint development programs with strategic partners and (iii)
Company-sponsored research and development entities. See "Business -- Research
and Development."
In the quarter ended June 30, 1998, the Company adopted SFAS 131, replacing
SFAS 14. The Company operated in one industry segment under SFAS 14. The Company
is organized on the basis of products and related services and operates in three
segments under SFAS 131: (1) urinalysis, (2) genetic analysis and (3) small
laboratory devices. See Note 19 to the Consolidated Financial Statements,
"Segment and Geographic Information."
RESULTS OF OPERATIONS
Comparison of Year Ended December 31, 1998 to Year Ended December 31, 1997
Net revenues for the year ended December 31, 1998 totaled $27.5 million
which is comparable to the prior year. Sales of IVD systems decreased to $10.4
million from $11.8 million, a decrease of $1.4 million or 12% from the prior
year. Revenues from sales of urinalysis systems decreased to $5.0 million from
$5.6 million, a decrease of $627,000 or 11%. The decrease is due to a decline in
domestic sales, partially offset by increased sales to an international
distributor. Revenues from sales of the PowerGene line of genetic analyzers
decreased to $5.4 million from $6.2 million, a decrease of $837,000 or 13%. The
decrease relates
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primarily to the non-recurrence of a record $1.25 million multi-system sale of
genetic analyzers during the second, third and fourth quarters of last year,
lower average selling prices in response to increased competition, partially
offset by increased unit volumes. Sales of IVD system supplies and services
increased to $12.3 million from $10.6 million, an increase of $1.7 million or
16% over the comparable period last year, primarily due to the larger installed
base of The Yellow IRIS IVD imaging systems. Sales of small instruments and
supplies decreased to $4.3 million from $4.4 million, a decrease of $102,000.
Royalty and licensing revenue decreased to $465,000 for the year ended
December 31, 1998 as compared to $603,000 in the prior year. The decrease is
primarily due to differences in non-recurring licensing fees received in the two
years. Royalty and licensing revenue is expected to decrease in 1999.
Revenues from the urinalysis segment totaled $17.0 million for the year
ended December 31, 1998 as compared to $16.2 million in the prior year, an
increase of $816,000. The net increase is due to increased revenues from
supplies and service for The Yellow IRIS which more than offset a decline in
sales of The Yellow IRIS instruments and a decline in licensing revenues.
Revenues from the genetic analysis segment declined to $5.9 million in 1998 as
compared to $6.8 million in the prior year for the reasons described above.
Revenues from the small laboratory devices segment were essentially comparable
as increased licensing revenues were substantially offset by reduced purchases
by a major distributor.
Cost of goods for IVD systems increased as a percentage of their sales to
56% for the year ended December 31, 1998 from 51% for the prior year. The
increase is primarily due to lower average selling prices of The Yellow IRIS
urinalysis workstations caused by an increased proportion of international sales
and lower average sales prices relating to the PowerGene genetic analyzer. Cost
of goods for IVD system supplies and services as a percentage of sales of such
products decreased to 48% for the current period as compared to 50% for the
prior year. The decrease is primarily due to decreased costs and increased
selling prices. Cost of goods for small instruments and supplies as a percentage
of sales of small instruments and supplies totaled 55% for 1998 compared to 53%
for the prior year. The increase is primarily due to a change in the sales mix.
The net result of these changes was a decrease in aggregate gross margin to 49%
for 1998, as compared to 50% in the prior year.
Cost of goods sold as a percentage of revenues from the urinalysis segment
totaled 68% in 1998, as compared to 51% in 1997. Lower average selling prices
for The Yellow IRIS workstation to an international distributor were partially
offset by improved pricing and decreased costs on supplies and service. Cost of
goods sold as a percentage of revenues from the genetic analysis segment totaled
52% in 1998, as compared to 47% in the prior year. This increase is primarily
the result of lower average selling prices due to the non-recurrence of the
multi-system order discussed above and price pressures from increased
competition. Cost of goods for the small instrument devices segment as a
percentage of revenues totaled 52% in 1998 and 1997.
Marketing and selling expenses consist primarily of salaries, commissions
and related travel expenses of the Company's direct sales force, as well as
salaries for the marketing and distributor relations departments. Marketing and
selling expenses totaled $5.4 million for the year ended December 31, 1998, as
compared to $5.2 million for the prior year, an increase of $149,000 or 3%. The
increase is primarily due to increased promotion of the PowerGene genetic
analyzers. Marketing and selling expenses as a percentage of net revenues
amounted to 20% in 1998 and 19% in 1997.
General and administrative expenses consist primarily of payroll costs
associated with the Company's management and support personnel, facilities
related costs and legal and accounting fees. General and administrative expenses
increased to $3.7 million for the year ended December 31, 1998 from $3.5
million, an increase of $162,000 or 5% over the prior year primarily due to
expansion of the Office of the Chief Executive, severance expenses and charges
associated with the repricing of options held by consultants. These increases
were partially offset by lower legal and accounting expenses. General and
administrative expenses as a percentage of net revenues totaled 13% in 1998 and
1997.
Net research and development expenses consist of costs incurred for the
development of new products and improvements to existing products less
third-party reimbursements under joint development programs, grants and research
and development contracts. Net research and development expenses increased to
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23
$2.4 million for the year ended December 31, 1998 from $2.1 million in the prior
year, an increase of $296,000 or 14%, due to increased expenditures and
decreased external funding under joint development programs. Net research and
development expenses as a percentage of net revenues amounted to 9% in 1998 and
8% in 1997. Reimbursements under joint development programs decreased to
$921,000 from $1.0 million. Total product technology expenditures, including
capitalized software development costs and reimbursed costs under research and
development grants and contracts, totaled to $3.7 million which is comparable to
the prior year.
Amortization of intangible assets reflects the amortization of deferred
expenses for warrants issued in connection with joint development projects and
intangible assets arising from acquisitions and patents. Amortization of
intangible assets for the year ended December 31, 1998 decreased to $1.2 million
from $1.3 million, a decrease of $148,000 or 11% from the prior period. The
decline is primarily the result of the write-off in the fourth quarter of 1997
of goodwill from the digital refractometer product line acquired in 1995.
The results of operations for the year ended December 31, 1998 include
unusual charges of $193,000 relating primarily to legal expenses for a pending
arbitration matter. See "Legal Proceedings." The unusual charges in the prior
year totaled $1.3 million and related primarily to the write-off of deferred
private offering expenses, goodwill no longer considered recoverable associated
with the digital refractometer product line and legal expenses.
The net result of the above described changes was an increase in operating
income to $556,000 in 1998 as compared to $246,000 in the prior year.
For the year ended December 31, 1998, urinalysis segment profits increased
to $2.9 million as compared to $2.7 million in the prior year, an increase of
$147,000 or 5%. This increase is largely attributable to increased sales of
related supplies and service described above, partially offset by a small
increase in operating expenses and lower system margins. Losses for the genetic
analysis segment totaled $2.7 million in 1998 as compared to losses of $1.9
million in the prior year, an increase of $837,000. The increased loss is due
primarily to the decrease in sales related to the non-recurrence of the
multi-system sale discussed above and gross margins for this segment, as well as
a modest increase in operating expenses. Segment profits from the small
laboratory devices segment totaled $1.1 million in 1998 as compared to $372,000
in 1997. The improvement is due to the increase in this segment's licensing
revenues and the write-off in 1997 of goodwill associated with the digital
refractometer product line. Unallocated corporate expenses totaled $1.7 million
in 1998 as compared to $2.0 million in the prior year, a decrease, of $275,000.
This is due to decreased unusual charges for deferred offering costs and legal
expenses as described above.
The income tax benefit for the year ended December 31, 1998 totaled
$120,000 as compared to an income tax benefit of $293,000 for 1997. The income
tax benefit for the year ended December 31, 1998 differs from the federal
statutory rate due to state, local and foreign income taxes and permanent
differences between income reported for financial statement and income tax
purposes.
The above factors contributed to a net loss of $385,000 or $0.06 per
diluted share for the year ended December 31, 1998 as compared to a net loss of
$503,000 or $0.16 per diluted share for the year ended December 31, 1997. The
decrease in the net loss per diluted share is due primarily to an imputed
dividend on the Series A Preferred Stock in 1997. In early 1997 the staff of the
Securities and Exchange Commission ("SEC staff") announced a new position on
accounting for convertible preferred stock which is potentially convertible at a
discount to the market price of the common stock, even if the potential for a
discount is only a possibility. The SEC staff has taken the position, that
solely for purposes of calculating earnings per share the potential discount is
an imputed dividend to the preferred stockholders, which reduces the amount of
earnings available to common stockholders. Accordingly, the issuance of the
Series A Preferred Stock resulted in a one-time reduction in earnings available
to common shareholders of $450,000 or $0.08 per share in first quarter of 1997.
The staff's position is limited to the calculation of earnings per share and did
not have any effect on the Company's net income or cash flow. See "-- Liquidity
and Capital Resources."
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Comparison of Year Ended December 31, 1997 to Year Ended December 31, 1996
The consolidated financial statements for 1996 reflect the consummation of
the PSI Acquisition on July 31, 1996 which was accounted for using the purchase
method of accounting. Accordingly, the consolidated statements of operations
include the financial results of PSI for the entire 1997 fiscal year, but only
for the period from August 1 to December 31 for fiscal 1996.
Net revenues for the year ended December 31, 1997 increased to $27.5
million from $20.6 million, an increase of $6.9 million or 33% over the prior
year. Sales of IVD systems increased to $11.8 million from $6.4 million, an
increase of $5.4 million or 86% over the prior year. The Company added the
PowerGene family of genetic analyzers to its product line in August 1996 as a
result of the PSI Acquisition. Of the 1997 increase in sales of IVD systems,
$4.0 million of the increase reflects the first full year of sales of the
PowerGene analyzer, which included a record $1.25 million multi-system sale, and
$1.4 million reflects increased sales of The Yellow IRIS. Sales of IVD imaging
system supplies and services increased to $10.6 million from $9.1 million, an
increase of $1.5 million or 16% over the prior year, due to the larger installed
base of IVD imaging systems and the conversion of The Yellow IRIS installed base
to the new CHEMSTRIP/IRIStrip urine test strips marketed exclusively by the
Company. Sales of small instruments and supplies decreased to $4.4 million from
$5.1 million, a decrease of $619,000 or 12%, over the prior year. The decrease
reflects lower sales levels of the StatSpin products to one of its distributors.
Royalty and licensing revenue for the year ended December 31, 1997
increased to $603,000 from $43,000, an increase of $560,000 over the prior year.
The increase is primarily the result of increased royalties received, the
receipt of previously disputed royalties relating to the fourth quarter of 1996
and initial fees earned for the license of certain technology.
Revenues from the urinalysis segment totaled $16.2 million for the year
ended December 31, 1997 as compared to $13.1 million in the prior year, an
increase of $3.1 million. This growth is due to the reasons noted above, as well
as improved licensing revenue for this segment. Revenues from the genetic
analysis segment increased to $6.8 million in 1997 as compared to $2.5 million
in the prior year for the reasons described above. Revenues from the small
laboratory devices segment decreased to $4.5 million from $5.1 million due to
lower sales to one distributor.
Cost of goods for IVD systems as a percentage of their sales decreased to
51% for the year ended December 31, 1997 as compared to 54% in the prior year.
The decrease is primarily due to fixed costs being absorbed by increased sales
of The Yellow IRIS, partially offset by increased costs of goods sold relating
to the PowerGene analyzer sales. Cost of goods for IVD system supplies and
services decreased as a percentage of sales of such products to 50% for the year
ended December 31, 1997 from 56% for the prior year. This decrease is
principally due to decreased costs and increased sales prices. Cost of goods for
small instruments and supplies as a percentage of sales of small instruments and
supplies totaled 53% for the year ended December 31, 1997, and is comparable to
the prior year. The net result of these changes and increased royalties and
licensing revenues was an increase in gross margin for the year ended December
31, 1997 to 50%, as compared to 45% for the year ended December 31, 1996.
Cost of goods sold as a percentage of revenues from the urinalysis segment
totaled 51% in 1997, as compared to 55% in 1996, primarily due to the
combination of increased sales of The Yellow IRIS and its related supplies and
services with a decrease in the cost of goods for the related supplies and
services. Cost of goods sold as a percentage of revenues from the genetic
analysis segment totaled 47% in 1997, as compared to 49% in the prior year. This
decrease is due to improved profit margins on service which were partially
offset by a decline in profit margins on the PowerGene instruments. Cost of
goods for the small instrument devices segment as a percentage of revenues
totaled 52% in 1997 and 53% in 1996.
Marketing and selling expenses increased to $5.2 million for the year ended
December 31, 1997 from $4.6 million, an increase of $597,000 or 13% over the
prior year, primarily due to the addition of the sales force from the PSI
Acquisition partially offset by decreased marketing and selling expenses related
to The Yellow IRIS. Marketing and selling expenses as a percentage of net
revenues decreased from 22% in the prior year to 19% in the current year.
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General and administrative expenses increased to $3.5 million for the year
ended December 31, 1997 from $3.3 million, an increase of $243,000 or 7% over
the comparable period in the prior year. This increase is the result of the
addition of administrative functions following the PSI Acquisition, partially
offset by decreased expenses resulting from the restructuring implemented in the
fourth quarter of 1996 and decreased acquisition activities in the current year.
General and administrative expenses as a percentage of net revenues decreased
from 16% for 1996 to 13% for the current year.
Net research and development expenses increased to $2.1 million for the
year ended December 31, 1997 from $2.0 million, an increase of $147,000 or 7%
over the prior year, and decreased as a percentage of net revenues from 10% to
8%. Reimbursements under joint development programs decreased to $1.0 million in
1997 from $1.8 million in 1996. Total product technology expenditures decreased
to $3.7 million from $4.3 million, a decrease of $660,000 or 15% over the prior
year, due primarily to reduced spending on the development of The White IRIS and
decreased expenditures on the products under joint development with Poly UA
Systems, Inc., partially offset by the addition of research and development
staff from the PSI Acquisition.
Amortization of intangible assets for the year ended December 31, 1997
increased to $1.3 million from $794,000, an increase of $515,000 or 65% over the
prior year, primarily as a result of the acquisition of intangible assets in the
PSI Acquisition and a small product line acquisition.
The results of operations for the year ended December 31, 1997 include
certain unusual charges to earnings of $1.3 million, primarily for the write-off
in the fourth quarter of deferred private offering expenses ($481,000), goodwill
no longer considered recoverable associated with the digital refractometer line
of business ($705,000) and legal expenses ($152,000) relating to a completed
patent litigation matter and the pending arbitration matter against Digital
Imaging Technologies, Inc. See "Legal Proceedings." The unusual charges in the
prior year totaled $1.9 million and related primarily to the write-off of
deferred public offering costs ($686,000), litigation expense ($617,000),
restructuring charges ($298,000) and merger related expenses ($244,000).
Acquisition of in-process research and development charges for the year
ended December 31, 1996 amounted to $7.3 million. No similar charge was incurred
in 1997.
The net result of the above described changes was an increase in operating
income in fiscal 1997 to $246,000 as compared to an operating loss of $10.4
million in the prior year.
Interest income decreased to $57,000 for the year ended December 31, 1997
from $222,000 for the prior year, primarily as the result of decreased amounts
of invested cash in 1997.
Interest expense increased to $1.2 million for the year ended December 31,
1997 from $681,000 for the prior year due to the indebtedness incurred to
finance the PSI Acquisition and increased interest rates on bank debt.
Other income increased primarily due to the receipt of government grant
funds for reimbursement of expenses incurred in prior periods.
For the year ended December 31, 1997, urinalysis segment profits increased
to $2.7 million as compared to a loss of $717,000 in the prior year, an increase
of $3.4 million or 479%. This increase is attributable to increased revenues, a
decline in unusual charges and lower operating costs following a restructuring
in the fourth quarter of 1996. Losses for the genetic analysis segment totaled
$1.9 million in 1997 as compared to losses of $8.7 million in the prior year, an
improvement of $6.8 million or 78%. The improvement is due primarily to
write-off in 1996 of in-process research and development in connection with the
PSI Acquisition. Segment profits from the small laboratory devices segment
totaled $372,000 in 1998 as compared to $985,000 in 1997, a decline of $613,000
or 62%. The change is due to the write-off in 1997 of goodwill associated with
the digital refractometer product line. Unallocated corporate expenses totaled
$2.0 million in 1997 as compared to $2.4 million in the prior year, a decrease
of $469,000 or 19%. This is due primarily to decreased unusual charges.
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The income tax benefit for the year ended December 31, 1997 was $293,000,
as compared to an income tax benefit of $3.5 million for 1996. The income tax
benefit for the year ended December 31, 1997 differs from the federal statutory
rate due to state, local and foreign income taxes and permanent differences
between income reported for the financial statement and income tax purposes.
The above factors contributed to a net loss of $503,000. However, due to
the imputed dividend resulting from the issuance of the Series A Preferred Stock
discussed above, the loss per common share based upon the net loss attributable
to common stockholders of $953,000 amounted to $0.16 per share for the year
ended December 31, 1997 as compared to a net loss of $7.4 million or $1.21 per
share for the year ended December 31, 1996. Excluding the effect of unusual
charges, adjustment to the deferred tax valuation allowance and charges for the
acquisition of in-process research and development from the PSI Acquisition, the
Company would have had net loss attributable to common stockholders of $108,000
or $0.02 per share for the year ended December 31, 1997, as compared to a net
loss of $1.5 million, or $0.24 per share, for the year ended December 31, 1996.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased to $389,000 at December 31, 1998 from
$1.5 million at December 31, 1997. The decrease is due to a decline in cash
provided by operations and increased cash used by investing activities.
Cash provided by operations for the year ended December 31, 1998 decreased
to $960,000 from $2.0 million for the prior year. This decline is primarily due
to an increase in cash operating expenses, a decrease in gross margins,
increases in accounts receivable caused by a shift in the timing of system
sales, an increase in inventories and an increase in long-term sales-type leases
not sold to a third party. These increases were partially offset by increases in
accounts payable.
Cash used by investing activities totaled $1.2 million for the year ended
December 31, 1998, as compared to $872,000 in the prior year. The increase is
primarily due to the conversion of short-term investments into cash during 1997.
Expenditures for property and equipment, including the cost of equipment leased
under short term rental agreements, totaled $1.0 million in 1998 as compared to
$950,000 in 1997. Expenditures for capitalized software development totaled
$353,000 in 1998 as compared to $535,000 in 1997. The Company does not presently
have any material commitments for capital expenditures, and it anticipates that
expenditures for property and equipment will decline in 1999.
On May 8, 1998, the Company refinanced its bank loans with the proceeds of
a new credit facility from Foothill Capital Corporation. The credit facility
consists of a $3.6 million term loan and a $4.0 million revolving line of
credit. Borrowings under the revolving line of credit are limited to a
percentage of eligible accounts receivable, and the credit facility has a
combined limit of $7.0 million for the term loan and revolving line of credit.
The term loan bears interest at the lender's prime rate (7.75% on December 31,
1998) plus 3.0% and is payable in 36 equal monthly installments. The revolving
line of credit bears interest at the lender's prime rate plus 1.0%. The credit
facility matures in 2001 and is collateralized by a first priority lien on all
the assets of the Company. The credit facility is subject to minimum interest
charges, prepayment penalties and customary fees and imposes restrictions on
acquisitions, capital expenditures and cash dividends. It also contains
financial covenants based primarily on tangible net worth and cash flow. The
Company was not in compliance with one of the financial covenants at year end,
and the credit facility was subsequently amended to waive the non-compliance and
modify the financial covenants for future periods.
Net cash used by financing activities totaled $880,000 and consisted
primarily of principal payments made in connection with the refinanced bank
loan, partially offset by proceeds from the new credit facility and proceeds
from the issuance of common stock. As of December 31, 1998, the Company had $2.9
million outstanding under the term loan and $465,000 outstanding under the
revolving line of credit. The Company had $1.2 million available under the
revolving credit line as of that date.
As of December 31, 1998, the Company had outstanding (1) a $7.0 million
senior subordinated note issued to DITI in connection with the PSI Acquisition
and (2) notes payable in the aggregate amount of $542,000 from the repurchase of
common stock and warrants from a former strategic partner in 1996. The senior
subordinated note issued to DITI bears interest at the rate of 8.5%, and the
principal is all due upon
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maturity on July 31, 2001. The notes issued to the former strategic partner bear
interest at the rate of 8.0%, and principal is due in bi-monthly installments of
$100,000.
Assuming constant interest rates, the Company has minimum payments for
principal and interest on outstanding debt obligations totaling $2.8 million in
1999, $2.0 million in 2000 and $7.9 million in 2001. The Company believes that
its current cash on hand, together with cash expected from operations and cash
available under the credit facility, will be sufficient to fund normal
operations and pay principal and interest on outstanding debt obligations
through 2000. The Company will require additional outside capital to pay all or
a portion of the $7.0 principal payment due in July 2001 under the subordinated
note delivered to DITI as partial payment for the PSI Acquisition. The Company
has postponed its fundraising efforts pending resolution of its claims against
DITI through arbitration. See "Legal Proceedings."
The FDA cleared The White IRIS leukocyte differential analyzer in May 1996,
but its commercial release was subsequently delayed by other priorities such as
the introductions of the Model 900UDx urine pathology system and the UF-100
urine cell analyzer. The Company has elected not to launch The White IRIS at the
present time due to limited resources and the potential impact of product launch
costs on near-term profitability. The Company plans to explore strategic
alternatives for The White IRIS program and therefore cannot reasonably estimate
any impact on the recoverability of the capitalized costs associated with the
product line, principally capitalized software and inventory. If the Company is
unable to develop a viable strategic alternative for the program and as a result
abandons the product line, it would incur a charge against future earnings of up
to $1.2 million for the related amounts capitalized.
In September 1995, the Company and Poly U/A Systems Inc., a
Company-sponsored research and development entity, entered into a joint
development project for the development of several new products to enhance
automated urinalysis using the Company's technology. Poly UA funded most of the
cost of the project with the net proceeds from a 1995 private placement of
units, each unit consisting of shares of Poly UA common stock and warrants to
purchase common stock of the Company. The Company contributed $500,000 toward
the cost of the project. During 1998, the Company and Poly UA satisfied their
funding commitment on this project, and no further development work is planned
at this time. The Company had an option until November 29, 1998 to acquire all
of the common stock of Poly UA for an aggregate price of $5.1 million, payable
in cash or shares of the Company's common stock.
The Company decided not to exercise its option but entered into ongoing
discussions to acquire Poly UA at a price below the option price. The Company
cannot predict whether these discussions will lead to mutually acceptable terms
for an acquisition. If the Company acquires Poly in a negotiated transaction, it
may result in a charge against then current earnings and additional dilution to
common stockholders.
The Company has outstanding 3,000 shares of Series A Convertible Preferred
Stock ("Preferred Stock"). Each share of Preferred Stock is convertible into a
number of shares of common stock equal to (i) its $1,000 liquidation value
divided by (ii) a variable conversion price. The conversion price equals the
lower of (a) $3.56 per share or (b) 85% of the average closing bid price of the
common stock for the five consecutive trading days preceding the conversion (but
in no event less than $1.50). Assuming conversion prices of $3.56 and $1.50 per
share, the Preferred Stock is convertible into approximately 843,000 and
2,000,000 shares of Common Stock, respectively. Based on the average closing
price of $0.73 for the five-day period ending March 19, 1999, the conversion
price would be the minimum of $1.50, and the Preferred Stock would convert into
2,000,000 shares of common stock. Any unconverted shares of Preferred Stock will
automatically be converted into Common Stock on December 31, 1999. The Preferred
Stock is non-voting, is not entitled to any preferred dividends and is not
subject to any mandatory or optional redemption provisions. The Company may not
pay cash dividends on the Common Stock or repurchase any shares of the Common
Stock without the written consent of the holder of the Preferred Stock.
YEAR 2000 PROBLEM
The Year 2000 ("Y2K") problem arose because many existing computer programs
use only the last two digits to recognize a year. Therefore, when the year 2000
arrives, these programs may not properly recognize a year beginning with "2000"
instead of the familiar "1900". The Y2K problem may result in the improper
processing of dates and date-sensitive calculations by computers and other
microprocessor-controlled equipment as the year 2000 is approached and reached.
25
28
State of Readiness
The Company has divided its review of Y2K problems into three major areas:
(1) internal systems, (2) Company products, including components supplied by
outside vendors, and (3) potential Y2K problems associated with outside vendors.
The Company has focused most of its Y2K efforts on internal systems because
it believes this area could be its primary source of Y2K problems. The Company's
internal computer systems are the foundation for its business operations and
include such critical functions as order entry, shipping, purchasing, inventory
control, manufacturing, accounts receivable, accounts payable and the general
ledger. The Company has completed a review of these critical systems and has
determined that they are not Y2K compliant. These systems are supported by third
parties who currently have software updates available at reasonable prices. The
Company has purchased and installed these updates. Although the vendors have
certified the updates as Y2K compliant, the Company plans to test the updates on
its systems by June 30, 1999. The Company is also in the process of reviewing
other equipment that contains date-sensitive information. The Company expects to
complete its review of all other internal systems by June 30, 1999 and does not
expect this review to uncover a risk of a material adverse effect on its
operations from Y2K problems in this area.
The Company has reviewed its products and has determined that the IVD
imaging systems produced by the urinalysis and genetics segments have date
sensitive fields or components that have date sensitive fields. Based on
completed verification and validation testing and, if applicable, certificates
received from third party vendors, the Company has concluded that all the
genetic segment IVD imaging systems, the unattended urinalysis IVD imaging