INTERNATIONAL REMOTE IMAGING SYSTEMS INC /DE/ - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------

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, 1995 Commission File No. 0-9767

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

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._____

The aggregate market value of shares of Common Stock held by non-affiliates
of the Registrant on March 25, 1996 was $39,766,990 based upon the closing price
of the Common Stock on such date, as reported on the American Stock Exchange.
Solely for the purpose of counting "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 number of shares of Common Stock of the Registrant outstanding as of
March 25, 1996 was 6,308,578.

Part III incorporates information by reference from the Proxy Statement for
the Registrant's 1996 Annual Meeting of Stockholders.

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INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.

FORM 10-K ANNUAL REPORT

FISCAL YEAR ENDED DECEMBER 31, 1995

Caption Page
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PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . 1

Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . .13

Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . .13

Item 4. Submission of Matters to a Vote of Security Holders. . . .13

PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters. . . . . . . . . . . . . . . . . . . .13

Item 6. Selected Financial Data. . . . . . . . . . . . . . . . . .14

Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . .15

Item 8. Financial Statements and Supplementary Data. . . . . . . .19

Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure. . . . . . . . . . . .19

PART III
Item 10. Directors and Executive Officers of the Registrant.. . . .20

Item 11. Executive Compensation . . . . . . . . . . . . . . . . . .20

Item 12. Security Ownership of Certain Beneficial Owners and
Management . . . . . . . . . . . . . . . . . . . . . . . .20

Item 13. Certain Relationships and Related Transactions . . . . . .20

PART IV
Item 14. Exhibits, Financial Statements, Schedules, and
Reports on Form 8-K. . . . . . . . . . . . . . . . . . . .21

PART I
ITEM 1. BUSINESS.

(a) GENERAL DEVELOPMENT OF BUSINESS.

International Remote Imaging Systems, Inc. (IRIS) manufactures and
markets The Yellow IRIS-Registered Trademark-, an automated urinalysis
workstation it developed using its patented slideless Automated Intelligent
Microscopy (AIM) technology. IRIS also manufactures and/or markets most of
the disposable reagents and other materials (commonly referred to as
consumables) used in the operation and maintenance of The Yellow
IRIS-Registered Trademark-, including the CHEMSTRIP/IRIStrip-Registered
Trademark- urine test strips, and offers service contracts for its
maintenance and repair. IRIS completed the acquisition of LDA Systems, Inc.
(LDA) in the second quarter of 1995 and with it reacquired all rights to The
White IRIS-Registered Trademark- leukocyte differential analyzer, a major new
product IRIS has been developing, for which IRIS is awaiting clearance from
the Food and Drug Administration (FDA). There can be no assurance, however,
that such clearance will be obtained. See "Narrative Description of Business
- --Future Developments." In 1995, IRIS began implementing a new strategy to
expand its urinalysis business by adding a line of proprietary
cost-effective, outcome-enhancing urinalysis products suitable for
laboratories of all sizes.

(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.

IRIS does business in one industry segment.

(c) NARRATIVE DESCRIPTION OF BUSINESS.

IRIS manufactures and markets The Yellow IRIS-Registered Trademark-, an
automated urinalysis workstation it developed using its patented AIM and
other technology to automate the manipulative steps in routine urinalyses
performed by hospital and reference clinical laboratories, including counting
and classifying microscopic particles found in urine specimens. IRIS also
manufactures and/or markets most of the consumables used in the operation and
maintenance of The Yellow IRIS-Registered Trademark-, including
CHEMSTRIP/IRIStrip-Registered Trademark- urine test strips, and offers
service contracts for its maintenance and repair. See "Strategic Alliance
with Boehringer Mannheim -- Distribution of CHEMSTRIP/IRIStrip-Registered
Trademark- Test Strips and Custom Reader." IRIS had a backlog, including
equipment, consumables, rentals and service contracts of $1,280,668 and
$1,026,242 at December 31, 1995 and 1994, respectively.

IRIS believes its technology can be used to design and develop other
computerized, microscopical image analysis instruments dedicated to specific
tasks in the clinical laboratory. IRIS has completed prototype development of
an automated high-speed instrument to classify white blood cells, The White
IRIS-Registered Trademark- leukocyte differential analyzer, and has filed a
510(k) submission with the FDA requesting clearance of The White IRIS-Registered
Trademark- for interstate commerce. See "Future Developments -- The White IRIS-
Registered Trademark-." IRIS also has undertaken considerable development work
on a slide-based imaging cytometer, The Purple IRIS-Registered Trademark-, a
project which requires further significant work and funding to reach commercial
readiness. IRIS intends to complete this project only if it is able to obtain
additional funding for this purpose.

In 1995, IRIS began implementing a new strategy to expand its urinalysis
business by adding a line of proprietary cost-effective, outcome-enhancing
urinalysis products suitable for laboratories of all sizes. As part of this
strategy, IRIS acquired (i) the digital refractometer product line of Biovation,
Inc. in March 1995, (ii) the complete business of StatSpin Technologies in
February 1996 and (iii) the urinalysis business of UroHealth Systems, Inc. in
March 1996. Biovation's digital refractometer is a patented device used for
determining the specific gravity of urine. StatSpin Technologies is a
manufacturer of special purpose centrifuges and other small laboratory
instruments and devices. The urinalysis business of UroHealth Systems consists
primarily of two proprietary product lines: the Cen-Slide-Registered Trademark-
1500 System for centrifugal urine sediment and manual microscopic examination
and the FloStar-Registered Trademark- specimen collection and dispensing
container. See "Recent Acquisitions" below in this section.

THE YELLOW IRIS-REGISTERED TRADEMARK-

The Yellow IRIS-Registered Trademark- is an automated workstation designed
to perform a complete routine urinalysis. Routine urinalysis is one of the most
commonly performed and labor-intensive procedures in laboratory medicine and
consists of (i) the observation of gross appearance, (ii) the measurement of
specific gravity, pH, and the concentrations of several chemical substances and
(iii) the microscopical examination of urine sediment. In July 1995, IRIS
introduced two new models (the Model 300 and Model 500) to The Yellow IRIS-
Registered Trademark- series of urinalysis workstations. A new and faster
workstation, the Model 500, introduces a series of technology upgrades that make
it the most accurate, fastest and easiest-to-use urine profiling system ever
built, replacing the long-established

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Model 450 version of The Yellow IRIS-Registered Trademark-. A new and faster
low-cost Model 300 workstation also replaces the earlier Model 250 version.
IRIS began marketing the new models late in the third quarter of 1995.

Laboratories which do not use The Yellow IRIS-Registered Trademark- measure
specific gravity using a relatively inexpensive instrument, and pH and chemical
substances through the use of test strips, usually with the aid of an automated
test strip reader. Urine sediment examination (the most time-consuming portion
of a manually-performed urinalysis) requires numerous steps making the method
labor-intensive, cumbersome, biohazardous and frequently inefficient. Workload
standards published by the College of American Pathologists allow six minutes
for a manually-performed urinalysis. Also, preparation and spreading of the
sediment suspension on the microscope slide often lacks uniformity. When
numerous sediments are viewed, prolonged peering into the eyepieces of a
microscope becomes tiring. These and other factors contribute to imprecision.

In contrast, The Yellow IRIS-Registered Trademark- urinalysis
workstation accepts uncentrifuged urine. IRIS utilizes AIM-Registered
Trademark- to rapidly capture, analyze and display microscopic images. AIM
is a combination of the IRIS patented Slideless-Registered Trademark-
Microscope and its high-speed image processing technology, which allows
visual examination of a moving specimen without the need to mount it on a
slide. The specimen is made to flow in a plane precisely positioned (to
within microns) in a larger fluid stream within the focus of a microscope.
The method of ensuring proper alignment, particle orientation, focus and
measurement, called imaging flow cytometry, is patented. See "Patents and
Copyrights." Moreover, by another patented technique, AIM allows images of
the urine sediment particles to be concentrated electronically rather than
through the physical process of centrifugation. These images then are
automatically classified and displayed on a video monitor for review.

The combination of a digital image processor, host computer and software
provides essentially "real time" image analysis. However, IRIS believes that
certain rare or subtle image qualities, as well as the unpredetermined artifacts
that sometimes occur, are best dealt with by the trained human eye. Therefore,
The Yellow IRIS-Registered Trademark- allows an operator to interpret and, if
necessary, edit all classifications. Use of The Yellow IRIS-Registered
Trademark- enables clinical laboratories to perform routine urinalyses in less
than one-fourth the time usually required by the manual method; minimizes the
inconvenience of a multiple-step manual preparation of urine sediment;
eliminates multiple handling of urine specimens for chemistry, specific gravity
and microscopic measurements; reduces the biohazard exposure to potentially
infectious specimens; increases the number of abnormalities detected; and
improves the reliability of the results obtained. The Yellow IRIS-Registered
Trademark- also can be connected to the central computer record system of the
hospital or laboratory, allowing direct electronic information transfer.

IRIS also manufactures and/or markets most of the consumables used in
the operation and maintenance of The Yellow IRIS-Registered Trademark-,
including the CHEMSTRIP/IRIStrip-Registered Trademark- urine test strips, and
offers service contracts for its maintenance and repair. See "Strategic
Alliance with Boehringer Mannheim --Distribution of
CHEMSTRIP/IRIStrip-Registered Trademark- Test Strips and Custom Reader."
During the third quarter of 1995, IRIS introduced two new
enhanced-performance models of The Yellow IRIS-Registered Trademark-.

MARKETS AND COMPETITION

Laboratory medicine in the United States is carried out primarily in
hospital and reference clinical laboratories. IRIS has been marketing The
Yellow IRIS-Registered Trademark- since 1983 to these hospitals and reference
laboratories which perform large numbers of urinalyses. With hospitals
affiliated with more than 75% of U.S. medical schools and other leading
hospitals nationwide using The Yellow IRIS-Registered Trademark-, IRIS believes
that it is the leader in automated microscopic urinalysis instruments in the
U.S.

IRIS knows of no other competitor marketing a complete urinalysis system.
Boehringer Mannheim Corporation (a member of the Corange group of companies),
Behring Diagnostics (a division of Hoechst AG) and Miles (owned by Bayer AG)
sell lines of disposable test strips which are useful in determining the
concentration of various chemical substances often found in urine. Some claims
have been made that the use of screening algorithms based on these test strips
can reduce the number of microscopical examinations required by as much as one-
half. IRIS believes that urine test strips are not adequate replacements for
microscopic examinations of urine and believes its position is supported in
recent medical literature which shows that a significant number of
microscopically abnormal specimens can be missed if reliance is placed on test
strip screening to reduce the need for microscopy. Still, individual preference
for such procedures hampers IRIS sales efforts in some hospitals which affects
the market for The Yellow IRIS-Registered Trademark-.

A number of hospitals conduct manual urine sediment analyses using the Kova
and other systems composed largely of disposable plastic parts. The Kova system
is made by Hycor Biomedical, Inc., These systems

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provide a more standardized method of manually handling and preparing urine
sediment for microscopical examination. While these systems help somewhat to
overcome manipulative imprecision, they do so at the added expense of disposable
parts and offer little in time savings. In 1992, UroHealth Sytems, Inc. (then
known as Davstar Industries) introduced a novel disposable combination
sedimentation tube and microscope slide with better opportunities for easing
manipulation and saving labor. IRIS purchased this product line from UroHealth
in March 1996. See "Recent Acquisitions."

Significant international clinical laboratory markets may also exist, and
IRIS has in the past attempted to introduce The Yellow IRIS-Registered
Trademark- in certain of those markets through distributors. IRIS has not yet
achieved any significant amount of international sales. As part of a 1988
agreement, TOA Medical Electronics Co., Ltd. (TOA), a Japanese company, had the
right to act as the distributor of certain IRIS products, including The Yellow
IRIS-Registered Trademark-, in Japan. TOA has not purchased any systems since
1988. The exclusivity of TOA's distributorship was terminated in 1991 for
failure to submit a plan to remedy its lack of performance, and TOA officially
resigned its distributorship in December of 1995.

In addition to those problems inherent in the marketing of a new, capital-
intensive product, the success of any further international marketing efforts
will depend on a variety of factors unique to each market and the international
trade environment, including the changing political and economic environments of
certain countries. IRIS has been concentrating its efforts mainly in the U.S.
market and is likely to continue to do so in 1996. Late in 1991, IRIS
established two distributorships, one in Italy and another in Taiwan, as
first steps in its intended renewal of international efforts. The Taiwanese
distributorship has been actively demonstrating The Yellow IRIS-Registered
Trademark- to potential customers in its market, but has placed only one unit to
date. The Italian distributorship has not been actively demonstrating The
Yellow IRIS-Registered Trademark- to potential customers, and IRIS is currently
in discussions regarding the future of this distributorship.

Under the 1988 agreement, TOA also has the right to market urine sediment
analyzers using pre-1989 IRIS technology. In exchange, TOA agreed to pay IRIS
royalties on sales of such analyzers and granted IRIS the exclusive right to
distribute in North America any urine sediment analyzer made by TOA. In late
1990, TOA introduced a urine sediment analyzer, the UA-1000 and in mid-1993,
introduced an improved model, the UA-2000 into the Japanese market. Despite the
fact that the UA-2000 performs only the urine sediment analysis portion of a
complete urinalysis, as limited by the agreement, it is currently priced
comparably with the more versatile The Yellow IRIS-Registered Trademark-.
Royalty reports from TOA indicate that TOA sold 28 UA-2000s in 1994, and only 12
in 1995, all in Japan. More recently, IRIS learned that TOA is showing a new
urine sediment analyzer based on TOA's particle counting technology, the UF-100,
to selected prospects in the U.S. IRIS subsequently asserted its rights under
the 1988 agreement to distribute the UF-100 in North America. TOA disputes the
right of IRIS to distribute this product and has requested arbitration of the
issue in accordance with the terms of the 1988 agreement.

In general, there are numerous large and well-financed companies, in
addition to TOA, engaged in active research and development programs within and
outside of the clinical laboratory instrumentation field that have considerable
experience in areas of interest to IRIS. IRIS cannot determine if any such
firms are currently engaged in potentially competitive research. However, any
one or more of these firms could develop and introduce instruments comparable or
superior to The Yellow IRIS-Registered Trademark- or any other product
ultimately developed by IRIS.

STRATEGIC ALLIANCE WITH BOEHRINGER MANNHEIM

During 1994, IRIS developed a strategic alliance with Boehringer Mannheim
Corporation ("BMC"), an Indianapolis-based manufacturer of diagnostic products,
and Boehringer Mannheim GmbH ("BMG"), BMC's German affiliate and a world leader
in clinical chemistry. BMC and BMG are wholly-owned subsidiaries of Corange
Limited ("Corange"), a diversified healthcare company with 1995 worldwide sales
of more than $3.5 billion. Corange's principal lines of business are
diagnostics, therapeutics and orthopedics.

During 1995, all three companies underwent a significant management
restructuring. As a result of the restructuring, together with certain events
which followed the restructuring, IRIS initiated discussions with BMG to address
several concerns. Based on the position of the BMG management to date, IRIS
believes that these concerns can be adequately addressed. Nonetheless, IRIS
cannot predict what changes, if any, in the IRIS/BMG alliance will result from
these discussions.

DISTRIBUTION OF CHEMSTRIP/IRISTRIP-TM- URINE TEST STRIPS AND CUSTOM READER

During the fourth quarter of 1994, IRIS began marketing an improved version
of The Yellow IRIS-Registered Trademark- featuring a new CHEMSTRIP-Registered
Trademark- urine test strip reader and CHEMSTRIP/IRIStrip-TM- urine test strips,
both designed and

3

manufactured by BMC especially for The Yellow IRIS-Registered Trademark-. BMC
is the recognized world leader in clinical chemistry and the second largest
producer and seller of urine test strips in the United States. The combination
of the CHEMSTRIP-Registered Trademark- reader with the CHEMSTRIP/IRIStrip-TM-
urine test strips is expected to provide the fastest, most accurate urine test
strip on the market. BMC has selected IRIS to be the exclusive distributor of
the CHEMSTRIP/IRIStrip-TM- urine test strips. The test strips used by the less
advanced version of The Yellow IRIS-Registered Trademark- are currently supplied
to IRIS customers by various laboratory products distributors. IRIS is offering
its existing customers an opportunity to upgrade their existing workstations
with the new CHEMSTRIP-Registered Trademark- reader for use with the
CHEMSTRIP/IRIStrips-TM-. The addition of CHEMSTRIP/IRIStrips-TM- to its product
line has created a significant new source of revenues, as more than sixty
percent of existing IRIS customers now use the new strips. This collaborative
project also involves a joint effort to promote the advantages of using
microscopy with urine test strips. As part of the promotion, BMC and IRIS have
agreed to cooperate on various marketing initiatives, and BMC has committed to
spend at least $150,000 annually on promotional efforts.

JOINT DEVELOPMENT OF REFERENCE LABORATORY SYSTEM

During the first quarter of 1995, IRIS and BMG announced a joint project to
develop an advanced automated urinalysis system for reference laboratories based
on the proprietary technologies of both companies. The new reference laboratory
system is expected to be a high-capacity urinalysis workstation designed to meet
the high volume and other special requirements of reference laboratories.
Following system integration and testing at its facility in Chatsworth,
California, IRIS submitted a 510(k) application to the FDA requesting clearance
of this advanced model of The Yellow IRIS-Registered Trademark- called the
900UDx urine pathology system. Although this project consists primarily of
refining and integrating existing commercially viable technology from both
companies, there can be no assurance that this project will yield a commercially
acceptable product.

IRIS has the exclusive right to distribute the 900UDx urine pathology
system in the United States and Canada. BMG has the exclusive right to
distribute the reference laboratory system in the rest of the world except Italy
and Taiwan. Pending FDA clearance, IRIS intends to review its existing
distributorships in Italy and Taiwan, with a view towards gaining BMG
distribution of the new system in these countries, as well. IRIS will
manufacture the urine pathology systems distributed by both IRIS and BMG, with
BMG supplying some of the components. IRIS will also manufacture all of the
consumables distributed by both parties except the urine test strips which will
be manufactured by BMG.

In connection with this project, IRIS issued to Corange warrants to
purchase 250,000 shares of IRIS Common Stock at an exercise price of $7.375 per
share and granted Corange certain registration rights with respect to the shares
of IRIS Common Stock issuable upon exercise of these warrants. In addition, BMG
appointed IRIS a non-exclusive distributor in the United States of BMG's
CHEMSTRIP Super UA Urine Analyzer and CHEMSTRIP 10 SUA reagents for sales in
connection with the new reference laboratory system. BMG also offered IRIS the
exclusive right to distribute in the United States BMG's new Seditron urinalysis
system along with its related consumables. The Seditron is a slide-based
imaging system for examination of urine sediment. It has not yet been evaluated
and submitted for FDA clearance for sale in the United States, and IRIS will
have 180 days from the receipt of a sample Seditron system to evaluate it and
elect whether to accept the distributorship offer.

CORANGE FUNDING FOR THE WHITE IRIS-REGISTERED TRADEMARK- PROJECT

In April 1994, LDA secured $1.2 million of funding from Corange to help
complete commercialization of The White IRIS-Registered Trademark-. Corange
purchased units consisting of 85,714 shares of LDA Common Stock and warrants to
purchase 248,571 shares of IRIS Common Stock at an exercise price of $3.75 per
share. The LDA common stock was exchanged for approximately 220,840 shares of
IRIS as the result of the acquisition of LDA by IRIS in June of 1995. Corange
exercised its warrants to purchase IRIS common stock in July. As part of the
Corange investment, LDA and Corange agreed to pursue discussions concerning a
possible joint venture to develop a hematology workstation and not to pursue
similar discussions with third parties prior to October 20, 1995. Subject to
certain exceptions, IRIS also granted Corange a right of first refusal to
purchase shares of IRIS Common Stock, or any securities convertible into IRIS
Common Stock, which IRIS may issue or sell prior to April 20, 1996. This right
of first refusal does not apply to, among other things, the issuance of shares
of IRIS Common Stock in connection with any merger, consolidation,
reorganization, restructuring or recapitalization.

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FUTURE COLLABORATION

The projects described above in this section are part of an evolving
strategic alliance between IRIS, BMC and BMG, and IRIS intends from time to time
to explore further opportunities for mutually beneficial collaboration with
them. Consistent with that view, BMC, BMG and IRIS have agreed to negotiate
with each other first regarding their participation in the development by any of
them of any new automated urinalysis microscopy systems.

RECENT ACQUISITIONS

BIOVATION PRODUCT LINE

In March 1995, IRIS acquired the digital refractometer product line of
Biovation for $850,000 in cash and warrants to purchase 75,000 shares of IRIS
Common Stock at an exercise price of $8.125 per share. The average annual
revenues from this product line were approximately $495,000 over Biovation's
last three fiscal years. IRIS granted Biovation certain registration rights
with respect to the shares of IRIS Common Stock issuable upon exercise of these
warrants. The product line consists of manufacturing and marketing a patented
device known as a digital refractometer and the related consumables used in the
operation and maintenance of the refractometer. The digital refractometer is
used by some physicians and smaller laboratories for determining the specific
gravity of urine. Among other things, IRIS acquired the U.S. patent for the
refractometer as well as the proprietary formulas for certain related
consumables. Pursuant to a royalty-free license from Biovation, IRIS is
marketing the refractometer and related consumables under the Biovation-
Registered Trademark- tradename through existing distribution channels.

LDA SYSTEMS, INC.

In June 1995, IRIS completed the acquisition of LDA for approximately
498,000 shares of IRIS Common Stock. Prior to the acquisition, IRIS and LDA had
been engaged in a joint program to complete commercial development of The White
IRIS-Registered Trademark- leukocyte differential analyzer -- an instrument
being developed from technology originally pioneered by IRIS. IRIS acquired LDA
pursuant to the exercise of its call option under the LDA Restated Certificate
of Incorporation to purchase all of the outstanding shares of LDA Common Stock.
For this purpose, the IRIS Common Stock was valued at $7.7625 per share -- the
average closing price of a share of IRIS Common Stock on the American Stock
Exchange for the 20 trading days preceding the call date. Accordingly, IRIS
tendered 2.5765 shares of IRIS Common Stock for each share of LDA Common Stock.
As a result of the acquisition, IRIS incurred a non-recurring, non-cash charge
of $2.9 million against earnings in the second quarter for the acquisition of
in-process research and development (i.e., work in process not yet cleared for
interstate commerce by the FDA). LDA was merged into IRIS in December 1995.

STATSPIN TECHNOLOGIES

In February 1996, IRIS acquired Norwood, Massachusetts based Norfolk
Scientific, Inc. for approximately 340,000 shares of IRIS common stock and the
assumption of options and warrants to purchase an additional 126,000 shares of
IRIS common stock. Norfolk Scientific, which conducts business under the trade
name "StatSpin Technologies" manufactures special purpose centrifuges and other
small laboratory instruments and consumable plastic devices used in their
operation. StatSpin's products are widely used in clinical, veterinary,
physician's office and research laboratories and distributed to those
laboratories through several distribution channels, including the Curtin
Matheson Scientific Division of Fisher Scientific. StatSpin had net sales of
$3.1 million for the twelve months ended December 31, 1995.

The total consideration paid by IRIS (including the immediately
realizable value of the assumed options and warrants) is estimated at
$3,000,000 based on a negotiated price of $7.58 per share of IRIS common
stock in the transaction. The acquisition was accomplished through the merger
of a newly-formed subsidiary of IRIS into StatSpin, with StatSpin being the
surviving corporation and becoming a wholly-owned subsidiary of IRIS. The
acquisition will be accounted for using the pooling-of-interests method.

CEN-SLIDE-REGISTERED TRADEMARK- AND FLO-STAR-REGISTERED TRADEMARK- PRODUCT LINES

In March 1996, IRIS acquired the urinalysis business of UroHealth
Systems, Inc. for $850,000; $788,000 in cash and $62,000 in the assumption of
liabilities. UroHealth Systems generated revenues of approximately $550,000
from this business in 1995. The business consists primarily of manufacturing
and marketing two proprietary product lines: the Cen-Slide-Registered
Trademark- 1500 System for centrifugal urine sedimentation and manual
microscopic examination and the FloStar-Registered Trademark- urine specimen
collection and dispensing container. These

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products are used primarily by hospital and physician office laboratories in
manually performing routine urinalysis. Among other things, IRIS acquired seven
U.S. patents and eight corresponding foreign patents as well as the design for
the unique centrifuge used in the Cen-Slide-Registered Trademark- system. IRIS
intends to transfer production of these products to its StatSpin subsidiary and
market them under the IRIS/StatSpin label through StatSpin's existing
distribution channels.

LABORATORY REGULATIONS

Regulations issued under the Clinical Laboratory Improvement Amendments of
1988 (CLIA) became effective September 1, 1992. CLIA is intended to increase
the quality of laboratory services to Medicare and Medicaid patients. It brings
physician's offices, clinics and reference laboratories under many of the same
exacting compliance programs as required for hospital laboratories. CLIA
requires laboratory licensure and written operational and quality control
procedures for tests that are carried out in the laboratory. It establishes
personnel standards regarding qualification and training of individuals who
carry out the tests. It also mandates periodic inspection and proficiency
evaluation of the performance of these procedures and individuals. CLIA also
requires the more complex procedures such as clinical microscopy to be performed
by more skilled medical technologists who, today, are in short supply. The
portent of the more demanding CLIA requirements already has caused a shift of
testing away from the physician's office and has brought about the consolidation
of many smaller reference laboratories. IRIS believes that The Yellow IRIS-
Registered Trademark- urinalysis workstation adds operational and quality
improvement plus saves the time of the skilled medical technologists that are in
shortest supply. Therefore, IRIS anticipates the CLIA regulations are likely to
help rather than hinder its sales efforts in the longer term.

BIOHAZARD CONTAINMENT

Early in 1993, the Occupational Safety and Health Administration (OSHA)
mandated that all necessary precautions be taken to ensure the safety of
clinical laboratory personnel handling biohazardous materials including bodily
fluid specimens that may contain life-threatening, blood-borne infectious
pathogens such as Hepatitis B (HBV) and human immunodeficiency viruses (HIV).
Urinalysis as most frequently carried out exposes medical technologists,
technicians and laboratory assistants to potentially infectious urine several
times during its procedure, including through (i) possible aerolization during
high-speed centrifugation, (ii) accidental spillage and splashing in the course
of a number of its manipulative steps, and (iii) cuts which may occur from sharp
edges in the handling of microscope slides, cover slips and chipped or broken
glass and plastic ware. IRIS believes The Yellow IRIS-Registered Trademark-
offers the least manipulative and most contained method for performing
urinalysis today.

COST CONTAINMENT

IRIS must convince potential customers that the advantages of its
instruments justify their capital cost. This task requires considerable effort
and has become even more arduous during recent years due to the introduction of
significant cost containment efforts by the federal government and other
third-party payors. Both public and private payors are increasing pressures to
limit increases in healthcare costs.

Regulations for Medicare disbursements to healthcare providers have had a
profound effect on acquisitions of capital equipment by hospital laboratories.
In an attempt to encourage efficiency, these regulations limit Medicare
disbursements paid to hospitals to a fixed amount for treatment of a particular
malady, regardless of the actual cost of treatment. More recently, enrollment
in health maintenance organizations (HMOs) has been growing rapidly.
Individuals who enroll in an HMO receive a comprehensive benefit package, but
services are available only from a prescribed provider network, including
hospitals, with whom the HMO usually has aggressively negotiated fixed-fees
similar to but often less than those paid by Medicare. Sometimes the fees are
even based on a per capita participation.

IRIS believes that these efforts at cost containment have caused some
hospitals to reduce the number and sometimes the quality of urinalyses being
conducted, thus diminishing the relative cost effectiveness of The Yellow IRIS-
Registered Trademark-. Overall, hospitals have become significantly more
cost-conscious and, in some instances, seem less concerned with the medical
benefits associated with the use of The Yellow IRIS-Registered Trademark-.
Perhaps most importantly, hospitals have imposed more intense reviews of capital
acquisitions, particularly for new systems like The Yellow IRIS-Registered
Trademark-, which address areas that traditionally have not required significant
capital investments.

IRIS is continually responding to these pressures with enhancements to The
Yellow IRIS-Registered Trademark- designed to improve its cost-effectiveness.
IRIS believes that, taking into account all the relevant factors, The Yellow
IRIS-Registered Trademark- is an effective means of controlling laboratory costs
while maintaining quality and safety. Furthermore, laboratories are having to
contend with a widespread shortage of medical technologists and with the
aforementioned new OSHA

6

and CLIA regulations. Since IRIS products are designed to reduce the amount of
labor required to perform laboratory tests and the specimen biohazard exposure,
as well as standardize and improve the analytical quality of the urinalysis
procedure, IRIS believes these factors could enhance its competitive position in
the market.

Nonetheless, healthcare is an area of extensive and dynamic change, and
IRIS cannot predict future changes in the healthcare field or their impact on
its business. In recent years, an increasing number of legislative proposals
have been introduced or proposed in Congress and in some state legislatures that
would effect major changes in the healthcare system, either nationally or at the
state level. The costs of certain proposals would be funded in part by
reductions in payments by governmental programs, including Medicare and Medicaid
to healthcare providers. At the present time, IRIS believes that the
effectiveness of The Yellow IRIS-Registered Trademark- should be even more
beneficial to hospitals if their revenues are further controlled. However, if
IRIS is unable to convince potential customers of this fact, these changes could
have a material adverse effect on the Company's business, results of operations
and financial condition.

MANUFACTURING AND MARKETING

The Yellow IRIS-Registered Trademark- is assembled and tested at the IRIS
facility in Chatsworth, California, and marketed and serviced through its own
sales and service forces throughout the United States. The basic list price of
The Yellow IRIS-Registered Trademark- is $135,000 including installation,
training and a one-year warranty. Certain extra-price options are also
available. In early 1991, IRIS introduced a lower-priced version of The Yellow
IRIS-Registered Trademark- which currently lists for $88,000. This version of
The Yellow IRIS-Registered Trademark- is better suited for smaller community
hospitals and other areas of less-intensive use such as emergency room and
outpatient laboratories. IRIS also has a leasing program under which it has
several instruments under lease as of December 31, 1995. Under the terms of the
leases, payments may be based on the number of tests performed using The Yellow
IRIS-Registered Trademark- or other factors, and IRIS is responsible for
servicing the instruments. In addition, some hospitals lease The Yellow IRIS-
Registered Trademark- through medical equipment companies which, in turn,
purchase The Yellow IRIS-Registered Trademark- from IRIS. IRIS sells and rents
its workstations through its own direct sales force.

IRIS manufactures and/or markets most of the disposable reagents and other
materials (commonly referred to as consumables) used in the operation and
maintenance of The Yellow IRIS-Registered Trademark-, including the recently
introduced CHEMSTRIP/IRIStrip-TM- urine test strips which are manufactured by
BMC and distributed exclusively by IRIS. See "Strategic Alliance with
Boehringer Mannheim -- Distribution of CHEMSTRIP/IRIStrip-TM- Test Strips and
Custom Reader." IRIS also provides a one-year warranty for its instruments, and
believes that the reliability of the equipment is within industry standards.
Thereafter, service is generally provided under an annual service contract or
less frequently on a per-call basis, both of which generate additional revenues
for IRIS. All warranty and service is provided nationwide by its own field
service organization.

In 1995, IRIS began implementing a new strategy to expand its urinalysis
business by adding a line of proprietary cost-effective, outcome enhancing
urinalysis products suitable for laboratories of all sizes. As
part of this strategy, IRIS acquired (i) the digital refractometer product
line of Biovation, Inc. in March 1995, (ii) the complete business of StatSpin
Technologies in February 1996 and (iii) the urinalysis business of UroHealth
Systems, Inc. in March 1996. See "Recent Acquisitions." The Biovation
digital refractometers are currently being assembled and tested at the IRIS
facility in Chatsworth, California, and the consumables are being
manufactured by the independent suppliers previously used by Biovation. IRIS
markets the refractometer and related consumables under the Biovation
tradename through previously existing distribution channels. IRIS plans to
continue the StatSpin business using primarily its existing management,
facilities and distributors. Finally, IRIS intends to transfer production of
the UroHealth and Biovation product lines to StatSpin and market these
products under the IRIS/StatSpin label through StatSpin's existing
distribution channels.

IRIS depends on outside suppliers for most of its parts and raw materials
and has not experienced any significant problems to date with respect to
procurement of supplies. In an effort to minimize the potential for disruption
of its sources, IRIS attempts to maintain an adequate inventory of parts and raw
materials not readily available from alternative sources. Occassionally,
suppliers modify or discontinue the production of certain key parts and IRIS is
forced to implement design changes to incorporate a new part from the same or a
different vendor. While IRIS has successfully implemented such design changes
in the past without significant adverse effects (and, in some cases, with
significant cost advantages), there can be no assurance that future
modifications or discontinuances will not have an adverse effect on the cost of
goods for IRIS products.

7

FUTURE DEVELOPMENTS

THE YELLOW IRIS-REGISTERED TRADEMARK- AND URINALYSIS

IRIS continues to work to increase the cost-effectiveness, speed and
reliability of The Yellow IRIS-Registered Trademark-. IRIS has developed
procedures and software for adapting the AIM technology used in The Yellow
IRIS-Registered Trademark- to other uses such as examining cerebrospinal,
peritoneal, pleural, seminal and other body fluids and determining the
necessity of preparing a urine culture when bacterial infection of the
urinary tract is suspected. Regulatory clearance was obtained in 1992 for
blood cell counting in peritoneal and pleural fluids and peritoneal lavage
and dialyzate, and IRIS began marketing testing of these body fluids as an
optional feature on The Yellow IRIS-Registered Trademark-. IRIS obtained
clearance for cerebrospinal and seminal fluids in 1994 and synovial and
pericardial fluids in 1996. Although none of these tests are done with the
frequency of urinalyses, they take longer when performed manually, and thus
the addition of this capability spreads the capital cost of the instrument
over a larger test base, enhancing the utility and financial justification of
The Yellow IRIS-Registered Trademark-. See "Commercial Regulation." IRIS is
also pursuing further demonstration of its urine culture screening in several
other laboratories in order to satisfy a request from the FDA before this
additional capability is cleared for commerce. IRIS also continues to develop
software and other analytical refinements to increase the speed of The Yellow
IRIS-Registered Trademark- and hardware refinements to further improve its
reliability.

IRIS has made numerous improvements in The Yellow IRIS-Registered
Trademark- over the years, including the IRISensor-TM- camera, IRISpeed
Plus-TM-high-performance software, IRIScope-TM- body fluid cell counting
capabilities, the multi-band image processor, and in July of 1995 introduced
new enhanced versions of both of its models of urinalysis workstations. Many
potential additional improvements are available from IRIS work on The White
IRIS-Registered Trademark- and other projects have been adapted in the
reference laboratory system. IRIS believes sustained incorporation of
on-going improvements into The Yellow IRIS-Registered Trademark- will require
a substantial amount of research and development time and financial
resources. While IRIS believes that it has the technical ability and
financial resources for such an undertaking, IRIS has used alternative
sources of funding, such as the joint development program for
commercialization of The White IRIS-Registered Trademark- with LDA, a
collaborative arrangement with Boehringer Mannheim and a joint development
program with Poly U/A Systems Inc. ("PSI"), described in more detail below.

During the first quarter of 1995, IRIS and BMG announced a joint project to
develop an advanced automated urinalysis system for reference laboratories based
on the proprietary technologies of both companies. The new reference laboratory
system, called the 900UDx urine pathology system, designed to the meet the high
volume and other special requirements of reference laboratories, was unveiled at
the Clinical Laboratory Management Association meeting in Minneapolis in August
and is currently awaiting FDA clearance for commercial introduction. See
"Strategic Alliance with Boehringer Mannheim -- Joint Development of Reference
Laboratory System."

In September 1995, IRIS and PSI entered into a joint project to develop
several new products based on IRIS technology (the PSI Products) to further
enhance automation in the urinalysis field. These products are expected to have
dual potential as both stand-alone products and enhancements to the IRIS
flagship products, The Yellow IRIS-Registered Trademark- series of urinalysis
workstations. Under the terms of this project, PSI will have the right to use
the IRIS technology and any newly developed technology for developing,
manufacturing and marketing the new products as stand-alone devices, and IRIS
will have the right to use the newly developed technology for any other purpose
and to incorporate the new products into The Yellow IRIS-Registered Trademark-.
PSI has retained IRIS to conduct research, development, clinical evaluation and
pre-market testing of the proposed new products. IRIS is funding the first
$15,000 per month, up to a maximum of $500,000, of the cost of the project, and
PSI is reimbursing IRIS for the excess.

PSI, a privately-held company based in Los Angeles, California, was
organized by IRIS in June 1995 to undertake the commercial development of the
PSI Products. In order to fund its share of the project, PSI raised net
proceeds of approximately $2.0 million through the sale of 128 units at a price
of $20,000 per unit. Each unit consisted of 2,000 shares of PSI's Callable
Common Stock and a warrant to purchase 4,000 shares of IRIS Common Stock. The
IRIS warrants are exercisable at $6.50 per share during the last two years of
their three-year duration. IRIS also issued warrants to the placement agent and
the finder to purchase an aggregate of 150,000 shares of IRIS Common Stock at
$7.80 per share for a period of five years.

8

IRIS has an option until 121 days after termination of the project with
PSI (which terminates not later than July 31, 1998) to acquire all of the
Common Stock of PSI at prices rising over time from $14.00 to $20.00 per
share of PSI Common Stock or an aggregate of $3.6 million to $5.1 million for
all the outstanding shares of PSI Common Stock. IRIS may pay the option
exercise price in cash or with shares of IRIS Common Stock valued at the
20-day average closing price just prior to exercise. If, at the time of
exercise, PSI has completed product development and obtained FDA clearance to
market any new products, IRIS would likely capitalize that portion of the
purchase price attributable to completed products and amortize it over the
estimated useful life of the completed technology. IRIS would likely
allocate a substantial portion of the balance of the purchase price (plus any
PSI liabilities outstanding at the time of acquisition) to any products which
have not been completed and approved for marketing by the FDA and would
record a nonrecurring, noncash (if purchased with IRIS stock) charge against
earnings in that amount for the acquisition of in-process research and
development (i.e. work-in-process not yet cleared by the FDA).

THE WHITE IRIS-REGISTERED TRADEMARK- AND HEMATOLOGY

In 1990, upon receiving a Small Business Innovative Research (SBIR) grant,
IRIS shifted its new product efforts to development of The White IRIS-Registered
Trademark- leukocyte differential analyzer. See "Research and Development
Expenditures" below in this section. Automated hematology analyzers currently
on the market can identify five types of white blood cells (leukocytes), known
as a five-part differential analysis, but 30% to 50% of the specimens must then
be examined further microscopically for proper diagnosis. Microscopic
examination is labor intensive and hazardous because it requires removing the
stopper on the blood collection tube, transferring a drop of blood to a
microscope slide, carefully smearing the blood across the slide, drying the
smear, fixing the cells in methanol, applying a stain to the fixed cells,
washing and drying the stained slide, mounting it onto the microscope stage and
finding, observing, classifying and counting 100 or more white blood cells. The
White IRIS-Registered Trademark- leukocyte differential analyzer would be
positioned to replace this lengthy manual procedure, thereby attempting to
complement rather than compete with existing hematology analyzers.

In April, 1992, LDA Systems, Inc. ("LDA") was organized to complete
commercial development of The White IRIS-Registered Trademark-. LDA
successfully closed a public offering of Units in October, 1992. Each Unit
consisted of one share of callable LDA Common Stock and ten IRIS Warrants, each
warrant entitling the holder to purchase one share of IRIS Common Stock for
$0.75. On July 12, 1993, the IRIS warrants were automatically adjusted to
reflect the effect of a 1-for-5 reverse split of the IRIS common stock. As a
result, each five warrants entitled these holders to purchase one share of IRIS
common stock for $3.75. After reimbursing IRIS for the costs of the offering,
the net proceeds to LDA amounted to $774,000.

As a result of the success of the offering, LDA and IRIS entered into a
joint development program in October, 1992 to complete commercial development of
The White IRIS-Registered Trademark-. The program consisted of a Technology
License Agreement and a Research and Development Agreement. Under the
Technology License Agreement, IRIS granted LDA an exclusive, worldwide royalty-
free license to use IRIS technology to develop, manufacture and market The White
IRIS-Registered Trademark-. Under the Research and Development Agreement, LDA
retained IRIS to conduct research, development, clinical evaluation and pre-
market testing of The White IRIS-Registered Trademark-. LDA funded the costs of
performing such work up to an aggregate amount equal to the net proceeds of the
offering less certain expenses, and IRIS funded over a three-year period up to
$500,000 of such costs.

By the end of 1993, LDA had exhausted all of its initial funds. IRIS
temporarily increased its research and development funding while LDA sought
additional funding. LDA secured $1.2 million of additional funding from
Corange in April 1994 and subsequently repaid IRIS $206,000 for the interim
funding in excess of its contractual commitment. As part of the Corange
investment, LDA and Corange agreed to pursue discussions concerning a
possible joint venture to develop a hematology workstation. See "Strategic
Alliance with Boehringer Mannheim -- Corange Funding for The White
IRIS-Registered Trademark- Project."

In June 1995, IRIS completed the acquisition of LDA for approximately
498,000 shares of IRIS Common Stock. As a result of the acquisition, IRIS
incurred a non-recurring, non-cash charge of $2.9 million against earnings in
the second quarter for the acquisition of in-process research and development
(i.e., work in process not yet cleared for interstate commerce by the FDA).
LDA was merged into IRIS in December 1995.

The White IRIS-Registered Trademark- uses a patented stain, 2-
methylpolymethine (2-MPM), which was developed by Cytocolor, Inc. and licensed
exclusively to IRIS. White blood cells express unique colors when stained with
2-MPM. These color differences can be discerned automatically by machine
algorithm. Under the terms of the license, IRIS will

9

pay Cytocolor royalties of $1,000 each on the sale of the first 1,000 units of
The White IRIS-Registered Trademark- plus 8% of the net selling price of
consumable products containing 2-MPM, subject to a minimum annual royalty of
$20,000.

To date, IRIS has manufactured six prototype instruments which successfully
incorporate most of the technology considered essential for the commercial
market. Of these, the three most recent instruments were manufactured in
compliance with FDA standards for "good manufacturing practices." Nonetheless,
some additional refinements may be required before The White IRIS-Registered
Trademark- will be ready for the commercial market.

These prototypes can perform 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. Images of any cells not recognized by the analyzer also can be
saved for subsequent technologist review, thus generally eliminating the need
for most manual specimen preparation. The White IRIS-Registered Trademark- uses
multicolored image analysis, a powerful new and proprietary extension of AIM
technology for which IRIS has obtained its first two patents. IRIS has
identified other potential patent applications in the area of specimen
preparation as well as image analysis. IRIS also owns an exclusive worldwide
license to several patents which cover the unique stain used by The White IRIS-
Registered Trademark-, as well as the multicolor expression of the stain in
white blood cells, subject to certain minimum royalty obligations.

IRIS submitted a 510(K) application for FDA clearance to market The White
IRIS-Registered Trademark- in July of 1995. See "Commercial Regulation."
Assuming such clearance is granted, IRIS expects to bring The White IRIS-
Registered Trademark- to market after having completed its commercial
development. However, there can be no assurance that the project will have
produced a commercially feasible or successful product.

THE PURPLE IRIS-REGISTERED TRADEMARK- AND CYTOLOGY

The Purple IRIS-Registered Trademark- is intended to be a semi-automated
slide-based video microscope designed to perform as a cytopathology
workstation in the objective measure of certain qualities found in biopsy
specimens. Examination of biopsy specimens is the single most
labor-intensive professional activity in surgical pathology today. A biopsy
basically consists of the manual microscopic observation of cells and
histological tissue and the subjective assessment, based on intra and
intercellular appearance, of cancer and its severity. IRIS has completed ten
pilot systems, some of which were evaluated in a number of medical
laboratories. Although those trials demonstrated the clinical utility of The
Purple IRIS-Registered Trademark-, IRIS also believes that operation of The
Purple IRIS-Registered Trademark- must be refined and made capable of
performing additional laboratory procedures before it can become commercially
viable. As a consequence, commercial delivery of instruments cannot be
expected until after further development is completed. IRIS does not
currently plan to conduct any further significant development of The Purple
IRIS-Registered Trademark- unless additional outside funding is secured, an
effort which has been subordinated for the time being to that for The White
IRIS-Registered Trademark-.

POSSIBLE FUTURE PRODUCTS

IRIS believes the technology it has developed may have a number of other
potential applications in the clinical laboratory. These include an
immunochemistry workstation and an automated PAP smear reader. However, no
assurance can be given that any such new products will be developed. Moreover,
the regulatory, technical and financial obstacles to the introduction of any
such products are expected to be significant and could prove insurmountable for
a company the size of IRIS.

RESEARCH AND DEVELOPMENT EXPENDITURES

IRIS spent $1,905,000, $1,580,000 and $1,005,000 for research and
development during 1995, 1994 and 1993, respectively. The 1995, 1994 and 1993
figures include $1,495,000, $1,258,000, and $638,000 of costs incurred under
research and development contracts, principally in conjunction with LDA, PSI and
the joint project with BMG.

10

COMMERCIAL REGULATION

The Yellow IRIS-Registered Trademark-, The White IRIS-Registered
Trademark-, and The Purple IRIS-Registered Trademark-, as well as any other
instruments which IRIS may in the future sell to clinical laboratories, are
subject to the provisions of the Federal Food, Drug and Cosmetic Act (FDCA).
However, the requirements imposed on a manufacturer of medical devices, while
exacting, are considerably less burdensome than those imposed on drug
manufacturers. IRIS must advise the Food and Drug Administration (FDA)
through the submission of a 510(k) application that any diagnostic device it
intends to sell to clinical laboratories will provide "substantially
equivalent performance" to a device marketed prior to May 28, 1976, or since
introduced into commerce in compliance with the FDCA. The FDA then must
determine whether or not the information submitted by IRIS justifies
clearance of the product for marketing. The Yellow IRIS-Registered
Trademark- was cleared for marketing as a urinalysis workstation in 1983.
The Purple IRIS-Registered Trademark- was cleared for marketing for general
microscopy in 1988. To date, IRIS has obtained FDA clearance to market The
Yellow IRIS-Registered Trademark- for blood cell counting in eight body
fluids: peritoneal and pleural fluids and peritoneal lavage and dialyzate in
1992, cerebrospinal and seminal fluids in 1994 and synovial and pericardial
fluids in March of 1996. IRIS has also submitted an application for
clearance to market the urine culture screening adaptation of The Yellow
IRIS-Registered Trademark- and is currently collecting additional test data
requested by the FDA for this application. An improved version of The Yellow
IRIS-Registered Trademark- containing a new urine test strip reader for use
with CHEMSTRIP/IRIStrips-TM- was cleared in 1994. In April 1995, the FDA
cleared for marketing by IRIS a new set of urine chemistry controls for use
with a variety of BMC's CHEMSTRIP urine test strips. IRIS submitted
applications for clearance to market The White IRIS-Registered Trademark- in
July of 1995 and the 900UDx urine pathology system in January of 1996.

IRIS has also registered with the FDA as a manufacturer. IRIS must
maintain "Good Manufacturing Practices" involving documentation and
recordkeeping to insure reproductibility and traceability of components and
products as well as "Pre-Production Design Validation" involving product
development procedures ensuring device safety and performance. Noncompliance
with applicable requirements can result in fines, recall or seizure of products,
total or partial suspension of production, refusal of the government to approve
product license applications or to allow the Company to enter into supply
contracts and criminal prosecution. The FDA also has the authority to revoke
product licenses and establishment licenses previously granted. Failure to
comply with present or future regulatory requirements, or new information
reflecting on the safety or effectiveness of an approved product, can lead the
FDA to withdraw its approval to market the product.

Various states have also enacted statutory provisions regulating medical
devices. The impact of such regulations have been minimal on the business of
IRIS. IRIS has been inspected annually by the State of California, and the
results of these inspections have generally been favorable. It has been
inspected twice by the FDA, most recently in March of 1996. During this last
inspection, the company was cited for four minor deficiencies for which remedial
steps are already underway. Although it is IRIS policy to strive for full
compliance and to be prudent in regulatory matters, IRIS cannot predict what
impact, if any, further regulation by the states or the federal government may
have on its business in the future.

PATENTS AND COPYRIGHTS

IRIS is pursuing broad protection of its proprietary technology through
the filing of various patent applications. IRIS has received U.S. patents
relating to (1) its slideless microscope, expiring in 2000; (2) electronic
composition of images, expiring in 2000; (3) the use of image analysis in
measuring the extent of immunochemical reactions carried out on solid
particles, expiring in 2001; (4) optical image modification, expiring in
2002; (5) a logic scheme and artificial intelligence used to perform
microscopic urinalyses and other diagnosis tests, expiring in 2003; (6) a
method for data compression, expiring in 2002; (7) a method for determining
the origin of blood cells and bacteria in urine, expiring in 2003; (8) a
variation of the logic scheme and artificial intelligence patent, expiring in
2003; (9) analyzing particles in dilute fluids, a variation of the electronic
composition of images patent, expiring in 2000; (10) rapid automatic focusing
of microscopic images, expiring in 2009; (11) simultaneous color image
processing, expiring in 2009; (12) novel color descriptors for
differentiating cells, expiring in 2009; (13) differentiating materials based
upon a dynamically changing threshold, expiring in 2010; (14) a method of
extracting quantile measures from cell images, expiring in 2012; (15)
accelerated gravitational separation of whole blood, expiring in 2013; (16) a
broadened version of simultaneous color image processing, expiring in 2012;
(17) a composition of matter of separated phases from whole blood settling by
our accelerated process, expiring in 2013; and (18) a method of
differentiating cells based upon color ratios, expiring in 2009. Five other
U.S. applications and a number of foreign applications corresponding to U.S.
patents and applications have been filed dealing with various areas of IRIS
technology. Numerous additional disclosures of potentially patentable
inventions have been made, some of which may result in additional patent
applications. IRIS has received patents from Great Britain, Australia,
Canada, Germany, France and Japan corresponding to some of its U.S. patents.
In connection with its recent acquisitions,

11

IRIS acquired (i) from Biovation the U.S. patent for the method and apparatus
for automatic flow-through digital refractometer, (ii) from StatSpin
Technologies seven U.S. Patents relating to centrifuges and (iii) from UroHealth
Systems eight U.S. Patents for the CenSlide-Registered Trademark-, FloStar-
Registered Trademark- and related urinalysis devices. See "Business -- Recent
Acquisitions." IRIS claims copyright in its software and other features.
Except for the aforementioned limited application license of its earlier
technology granted to TOA and the license granted to Poly U/A Systems in
connection with its development program, IRIS retains exclusive rights to all
its patents and copyrights. See "Markets and Competition" and "Future
Developments -- The White IRIS-Registered Trademark-."

IRIS has an exclusive license from Cytocolor, Inc. for the patented 2-MPM
stain used in The White IRIS-Registered Trademark-. Cytocolor has pursued
patent protection of the 2-MPM stain through the filing of various patent
applications in the U.S. and abroad. Cytocolor has received U.S. patents
relating to (1) differential staining of immature leukocytes, (2) unique
staining properties in both transmitted light and fluorescence microscopy, (3)
staining of major leukocyte subtypes in blood and bone marrow specimens and (4)
differential staining of lymphocyte subpopulations. These patents expire during
the years 2000 to 2003. Corresponding patents have been granted and/or issued
in the United Kingdom, France, Italy, Canada, Germany and Japan.

While IRIS believes it has significant protection based on the above
patents and claims previously made and pending in its other applications
(assuming those claims are also allowed), there can be no assurance that any
additional applications will be approved or that any patents issued will prove
to be of commercial benefit. Although a patent has a statutory presumption of
validity in the United States, both the validity and enforceability of a patent
can be attacked after its issuance. Accordingly, any patents received by IRIS
or Cytocolor may not afford any protection against competitors with similar
products. In addition, the costs of any litigation to enforce patents which may
be obtained by IRIS, or to defend against infringement claims, could be
substantial. IRIS considers the above patents and copyrights to be important to
its business.

Although IRIS knows of no patents which would be infringed by instruments
IRIS may sell, it can give no assurances that such patents have not or will not
be issued. On the other hand, in 1994, IRIS notified Intelligent Medical
Imaging, Inc. (IMI), a new company demonstrating a new slide-based imaging
system at various trade shows, that it believed IMI's system as displayed
infringed at least two of the above mentioned patents. Discussions with IMI
were unsatisfactory, and the companies are now litigating the issues. See
"Legal Proceedings."

IRIS also owns various trademarks for its products, including "IRIS-
Registered Trademark-", "The Yellow IRIS-Registered Trademark-", "The White
IRIS-Registered Trademark-" and "The Purple IRIS-Registered Trademark-" which
have been federally registered. In 1992, IRIS discovered that another company
was using "IRIS" as a trademark for ophthalmic lasers and as part of its trade
name, IRIS Medical Instruments, Inc. IRIS opposed an application by this
company to register the IRIS mark and brought suit for trademark and trade name
infringement. The matter was settled through informal negotiations with IRIS
Medical Instruments agreeing to curtail the use of IRIS in its corporate
identification and limit the use of IRIS as a trademark to only ophthalmic
devices. IRIS more recently opposed an application by Hitachi to use the look-
alike and sound-alike mark "AIRIS" on some of its large body scanners. Through
its recent acquisitions, IRIS acquired rights to the following additional
federally registered trademarks: (i) from Biovation a license to use the
Biovation-Registered Trademark- trademark for sales of clinical laboratory
devices and consumable products, (ii) from StatSpin ownership of the StatSpin-
Registered Trademark-, Safecrit-Registered Trademark-, Lipoclear-Registered
Trademark-, Flagtag-Registered Trademark-, Miniplasma-Registered Trademark-,
MicroMDLC-Registered Trademark-, Microplasma-Registered Trademark-, and
Plasmarotor-Registered Trademark- trademarks, and (iii) from UroHealth Systems
ownership of the CenSlide-Registered Trademark- and FloStar-Registered
Trademark- trademarks. See "Business -- Recent Acquisitions."

EMPLOYEES

At December 31, 1995, IRIS had 83 full-time employees, as compared to 65 at
the end of 1994, including 14 in research and development, 21 in marketing and
sales, 25 in field service, 18 in product reliability and manufacturing and 5 in
corporate management and general administration. IRIS 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 IRIS believes that its employee relations are satisfactory. The
success of IRIS operations depends in large part on its ability to attract and
retain experienced personnel. Such experienced personnel are in great demand,
and IRIS must compete for their services with other firms which, because of
their maturity and resources, might be able to offer more favorable salaries
and/or benefits.

(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES.

IRIS had export sales of $183,000, $199,000, and $0 in 1995, 1994
and 1993, respectively.

12

TOA was an exclusive distributor of The Yellow IRIS-Registered Trademark-
for the Japanese market, but did not purchase any units from IRIS since 1988.
The exclusivity of TOA's distributorship terminated in 1991 for failure to
submit a plan to remedy its lack of performance, and TOA officially resigned its
distributorship in December 1995.

Late in 1991, IRIS established two new distributorships, one in Italy and
another in Taiwan, as first steps in its intended renewal of international
efforts. The Taiwanese distributorship has been actively demonstrating The
Yellow IRIS-Registered Trademark- to potential customers in its market, but has
placed only ONE unit to date. The Italian distributorship has not been actively
demonstrating The Yellow IRIS-Registered Trademark- to potential customers, and
IRIS is currently in discussions regarding the future of this distributorship.

If IRIS and BMG are successful in the development of the new reference
laboratory system, IRIS will have the exclusive right to distribute the system
in the United States and Canada and BMG will have the exclusive right to
distribute the system in the rest of the world except Italy and Taiwan. Pending
FDA clearance, IRIS intends to review its existing distributorships in Italy and
Taiwan, with a view towards gaining BMG distribution of the new reference
laboratory system in these countries.

ITEM 2. PROPERTIES.

IRIS is located at 9162 Eton Avenue, Chatsworth, California, in
approximately 26,000 square feet of leased office, laboratory and
manufacturing space. The total monthly rent for this space is approximately
$13,600, subject to annual adjustments tied to the Consumer Price Index.
Through its StatSpin subsidiary (acquired in March 1996) located at 85 Morse
Street, Norwood, Massachusetts, IRIS leases an additional 10,851 square feet
of office, laboratory and manufacturing space. The monthly rent for this
space is approximately $7,100. While IRIS does not have any material amount
of unused space in its facilities, it has sufficient capacity now and expects
its capacity to be sufficient to meet any reasonable production increases in
the near term.

ITEM 3. LEGAL PROCEEDINGS.

In 1994, IRIS became aware that a company called Intelligent Medical
Imaging, Inc. (IMI), was demonstrating a new slide-based microscopic imaging
system at various trade shows. After further examination of the IMI system,
IRIS notified IMI that its system infringed at least two IRIS patents. The
parties then entered into negotiations regarding the licensing of these and
possibly other IRIS patents to IMI. The parties were unable to reach an
agreement and, on October 19, 1995, IMI filed a complaint in the United States
District Court for the Southern District of Florida. In its complaint, IMI
seeks, among other things, declaratory judgments that (I) IMI's system does not
infringe either of the two IRIS patents in question, (ii) both of such IRIS
patents are invalid and (iii) both of such IRIS patents are unenforceable
against IMI due to misuse of the patents by IRIS. IMI has also alleged in its
complaint that IRIS is in violation of certain U.S. antitrust laws. IRIS is
vigoroulsy defending both patents and pursuing infringement claims against IMI.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.
PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.

The IRIS Common Stock is traded on the American Stock Exchange under the
symbol "IRI." The closing price of the IRIS Common Stock on March 25, 1996 was
$6.75 per share. The following table sets forth the high and low closing prices
reported by the American Stock Exchange for the period January 1, 1994 through
December 31, 1995:

13

1994 1995
-------------- --------------
HIGH LOW HIGH LOW
---- --- ---- ---
FIRST QUARTER 6-1/8 3-7/8 8-7/8 5-3/8

SECOND QUARTER 5-1/2 4-1/16 8-3/8 6-1/8

THIRD QUARTER 5-7/8 4-3/16 7-1/2 6-1/4

FOURTH QUARTER 7-1/8 4-5/8 7-7/8 6-1/2

As of March 25, 1996, IRIS had approximately 4,752 holders of record of its
Common Stock.

IRIS intends to employ all available funds in the development of its
business. Consequently, it has not and does not intend to pay any cash
dividends in the foreseeable future.

ITEM 6. SELECTED FINANCIAL DATA.

This information is derived from, and should be read in conjunction
with, Management's Discussion and Analysis of Financial Condition and Results
of Operations and the Company's Financial Statements, including the Notes
thereto.

For the year ended December 31,
----------------------------------------------------------------------
1991 1992 1993 1994 1995
----------------------------------------------------------------------

Net revenues. . . . . . . . . . . . . . . . . $5,649,052 $7,806,818 $9,481,454 $10,661,943 $12,764,722
Interest and other income . . . . . . . . . 190,140 201,010 143,790 273,352 405,485
Net income . . . . . . . . . . . . . . . . 172,171 772,377 1,280,562 1,472,886 2,091,431
Net income per share. . . . . . . . . . . . $.04 $.16 $.26 $.28 $.35
Working capital . . . . . . . . . . . . . . 4,311,844 4,675,451 6,351,787 7,196,318 10,799,689
Total assets. . . . . . . . . . . . . . . . 6,356,572 7,861,842 9,545,215 12,128,384 21,207,839
Total liabilities . . . . . . . . . . . . . 1,421,364 1,822,449 2,091,175 2,429,356 2,674,669
Shareholders' equity. . . . . . . . . . . . 4,935,208 6,039,393 7,454,040 9,699,028 18,533,170
Net tangible book value per share . . . . . . $1.05 $1.20 $1.43 $1.76 $1.78
Cash dividends per share . . . . . . . . . . $.00 $.00 $.00 $.00 $.00

14

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

OVERVIEW

In 1995, IRIS began implementing a new strategy to expand its urinalysis
business by adding a line of proprietary cost-effective, outcome-enhancing
urinalysis products suitable for laboratories of all sizes. As part of this
strategy, IRIS acquired (i) the digital refractometer product line of Biovation,
Inc. in March 1995, (ii) the complete business of StatSpin Technologies in
February 1996 and (iii) the urinalysis business of UroHealth Systems, Inc. in
March 1996. IRIS may pursue additional acquisitions in the future consistent
with this strategy. See "Business -- Narrative Description of Business --
Recent Acquisitions."

During March 1995, IRIS acquired the digital refractometer product line
from Biovation, Inc. for $850,000 in cash and warrants to purchase 75,000
shares of IRIS Common Stock at an exercise price of $8.125 per share. The
product line consists of manufacturing and marketing a patented device known
as a digital refractometer and the related consumables used in its operation
and maintenance. Revenues from this product line averaged approximately
$495,000 over Biovation's last three fiscal years.

During February 1996, IRIS acquired Norwood, Massachusetts based Norfolk
Scientific, Inc. for approximately 340,000 shares of IRIS common stock and
the assumption of options and warrants to purchase an additional 126,000
shares of IRIS common stock. Norfolk Scientific, which conducts business
under the trade name "StatSpin Technologies", manufactures special purpose
centrifuges and other small laboratory instruments and plastic consummable
items used in their operation. StatSpin had net sales of $3.1 million for the
twelve months ended December 31, 1995. The total consideration paid by IRIS
(including the immediately realizable value of the assumed options and
warrants) is estimated at $3,000,000 based on a negotiated price of $7.58 per
share of IRIS common stock in the transaction. The acquisition was
accomplished through the merger of a newly-formed subsidiary of IRIS into
StatSpin, with StatSpin being the surviving corporation and becoming a
wholly-owned subsidiary of IRIS. The acquisition was accounted for using the
pooling-of-interests method. In response to the exercise of demand
registration rights granted in connection with the acquisition, IRIS filed a
registration statement with the Securities and Exchange Commission on March
27, 1996 to register approximately 466,000 shares of IRIS Common Stock which
may be offered for sale from time to time by the former securityholders of
StatSpin.

During March 1996, IRIS acquired the urinalysis business of UroHealth
Systems, Inc. for $850,000 of which $788,000 was cash and $62,000 the
assumption of liabilities. UroHealth Systems generated revenues of
approximately $550,000 from this business in 1995. The business consists
primarily of manufacturing and marketing two proprietary product lines: the
Cen-Slide-Registered Trademark-1500 System for centrifugal urine
sedimentation and manual microscopic examination and the FloStar-Registered
Trademark- urine specimen collection and dispensing container.

There were also several significant developments in 1995 related to
IRIS' core business of marketing major laboratory instruments and related
consumables. IRIS completed the acquisition of LDA Systems, Inc. (LDA) in
June 1995 for approximately 498,000 shares of IRIS Common Stock and thereby
reacquired all rights to The White IRIS-Registered Trademark- leukocyte
differential analyzer. The White IRIS-Registered Trademark- is a major new
product which IRIS was developing in a joint program with LDA similar to the
current program with PSI (described below). IRIS is currently awaiting FDA
clearance to market The White IRIS-Registered Trademark-. However, there can
be no assurance that IRIS can secure FDA clearance or that The White
IRIS-Registered Trademark- will be a commercially feasible or successful
product. As a result of the LDA acquisition, IRIS incurred a non-recurring,
non-cash charge of $2.9 million against earnings in the second quarter for
the acquisition of in-process research and development (i.e., work in process
not yet cleared for interstate commerce by the FDA). See "Business -- Future
Developments -- The White IRIS-Registered Trademark- and Hematology".

Late in the third quarter of 1995, IRIS began marketing two new models (the
Model 300 and Model 500) of its flagship product line, The Yellow IRIS-
Registered Trademark- series of urinalysis workstations. A new and faster
workstation, the Model 500 introduces a series of technology upgrades that make
it the most accurate, fastest and easiest-to-use urine profiling system ever
built, replacing the long-established Model 450 version of The Yellow IRIS-
Registered Trademark-.

A new and faster low-cost Model 300 workstation also replaces the earlier
Model 250 version of The Yellow IRIS-Registered Trademark-. The Model 250 was
introduced in 1991 as a lower priced alternative to The Yellow IRIS-Registered
Trademark- Model 450. The Model 300 is the lower-priced version of the Model
500. The lower-priced version of The Yellow IRIS-Registered Trademark-
accounted for approximately 33% and 36% of all new systems placed during 1995
and 1994, respectively. The

15

lower-priced version is expected to remain a significant percentage of total
system sales because of its appeal to more numerous community hospitals.
However, the introduction of the new models may change the ratio of sales of
both units as the marketplace determines their relative appeal. While the gross
margin on the lower-priced version is smaller, IRIS believes it contributes
incrementally to the aggregate gross margin earned as it appeals to a market
segment that ordinarily would not buy the more expensive model. Because its
incremental margin exceeds the incremental operational expenses connected with
its sale, it contributes positively to the profitability of IRIS.

In September 1995, IRIS and Poly U/A Systems, Inc. (PSI) entered into a
joint project to develop several new products based on IRIS technology (the PSI
Products) to further enhance automation in the urinalysis field. These products
are expected to have dual potential as both stand-alone products and
enhancements to the IRIS flagship products, The Yellow IRIS-Registered
Trademark- series of urinalysis workstations. Under the terms of this project,
PSI will have the right to use the IRIS technology and any newly developed
technology for developing, manufacturing and marketing the new products as
stand-alone devices, and IRIS will have the right to use the newly developed
technology for any other purpose and to incorporate the new products into The
Yellow IRIS-Registered Trademark-. PSI has retained IRIS to conduct research,
development, clinical evaluation and pre-market testing of the proposed new
products. IRIS will fund the first $15,000 per month (up to a maximum of
$500,000) of the cost of the project, and PSI will reimburse IRIS for the
excess.

PSI, a privately-held company based in Los Angeles, California, was
organized by IRIS in June 1995 to undertake the commercial development of the
PSI Products. In order to fund its share of the project, PSI raised net
proceeds of approximately $2.0 million through the sale of 128 units at a price
of $20,000 per unit. Each unit consisted of 2,000 shares of PSI's Callable
Common Stock and a warrant to purchase 4,000 shares of IRIS Common Stock. The
IRIS warrants are exercisable at $6.50 per share during the last two years of
their three-year duration. IRIS also issued warrants to the placement agent and
the finder to purchase an aggregate of 150,000 shares of IRIS Common Stock at
$7.80 per share for a period of five years.

IRIS has an option until 121 days after termination of the project with PSI
(which terminates not later than July 31, 1998) to acquire all of the Common
Stock of PSI at prices rising over time from $14.00 to $20.00 per share of PSI
Common Stock or an aggregate of $3.6 million to $5.1 million for all the
outstanding shares of PSI Common Stock. IRIS may pay the option exercise price
in cash or with shares of IRIS Common Stock valued at the 20-day average closing
price just prior to exercise. If, at the time of exercise, PSI has completed
product development and obtained FDA clearance to market any new products, IRIS
would likely capitalize that portion of the purchase price attributable to
completed products and amortize it over the estimated useful life of the
completed technology. IRIS would likely allocate a substantial portion of the
balance of the purchase price (plus any PSI liabilities outstanding at the time
of acquisition) to any products which have not been completed and approved for
marketing by the FDA and would record a nonrecurring, noncash (if purchased with
IRIS stock) charge against earnings in that amount for the acquisition of in-
process research and development (i.e. work-in-process not yet cleared by the
FDA).

In 1994, IRIS developed a strategic alliance with Boehringer Mannheim
Corporation (BMC), an Indianapolis-based manufacturer of diagnostic products,
and Boehringer Mannheim GmbH (BMG), BMC's German affiliate and a world leader in
clinical chemistry. BMC and BMG are wholly-owned subsidiaries of Corange
Limited (Corange), a diversified healthcare company with 1995 worldwide sales of
more than $3.5 billion. All three companies underwent a significant management
restructuring in 1995. As a result of the restructuring, together with certain
events which followed the restructuring, IRIS initiated discussions with BMG to
address several concerns. Based on the position of the BMG management to date,
IRIS believes that these concerns can be adequately addressed. Nonetheless,
IRIS cannot predict what changes, if any, in the IRIS/BMG alliance will result
from these discussions. See "Business -- Strategic Alliance with Boehringer
Mannheim."

The CHEMSTRIP/IRIStrips-TM- became a significant source of revenues in
1995, as more than sixty percent of existing IRIS customers have converted to
the new test strips. IRIS began marketing the new test strips during the fourth
quarter of 1994 concurrently with the introduction of an improved version of The
Yellow IRIS-Registered Trademark- featuring the new CHEMSTRIP-Registered
Trademark- urine test reader. BMC designed and manufactures both the test
strips and the readers especially for The Yellow IRIS-Registered Trademark-.
See "Business -- Strategic Alliance with Boehringer Mannheim -- Distribution of
CHEMSTRIP/IRIStrip-TM- Urine Test Strips and Custom Reader."

In July 1995, IRIS and BMG unveiled a prototype of the new IRIS/BMC 900UDX-
TM- Urine Pathology System, a high-capacity, automated urinalysis system for
reference laboratories based on the proprietary technologies of both companies.
The 900UDX-TM-, part of The Yellow IRIS-Registered Trademark- series of
urinalysis workstations, is being jointly

16

developed by IRIS and BMG. Pending FDA clearance, the 900UDX-TM- will be
manufactured by IRIS in its Chatsworth, California facility and distributed by
IRIS in North America and through BMG and its affiliates overseas. However,
there can be no assurance that IRIS can secure FDA clearance or that 900UDX-TM-
will be a commercially feasible or successful product. See "Business --
Strategic Alliance with Boehringer Mannheim -- Joint Development of Reference
Laboratory System."

IRIS, like many other companies in the clinical laboratory instrumentation
business, is feeling the impact of Medicare reimbursement regulations and
current economic conditions which have intensified the review of capital
expenditures by hospitals. One result has been slower than expected replacement
sales as IRIS customers postpone capital expenditures and continue using The
Yellow IRIS-Registered Trademark- beyond its five-year anticipated life. On the
other hand, IRIS believes a longer instrument life may benefit new customer
sales by providing greater product justification. IRIS also believes the impact
of intensified capital expenditure reviews may be mitigated by the current
widespread shortage of medical technologists since its products reduce the
number of medical technologists needed in the laboratory and by the increased
interest in better outcomes since its products can produce more accurate and
faster results. See "Business -- Cost Containment."

Nonetheless, healthcare is an area of extensive and dynamic change, and
IRIS cannot predict future changes in the healthcare field or their impact on
its business. In recent years, an increasing number of legislative proposals
have been introduced or proposed in Congress and in some state legislatures that
would effect major changes in the healthcare system, either nationally or at the
state level. The costs of certain proposals would be funded in part by
reductions in payments by governmental programs, including Medicare and Medicaid
to healthcare providers. At the present time, IRIS believes that the
effectiveness of The Yellow IRIS-Registered Trademark- should be even more
beneficial to hospitals if their revenues are further controlled. However, if
IRIS is unable to convince potential customers of this fact, these changes could
have a material adverse effect on the Company's business, results of operations
and financial condition.

RESULTS OF OPERATIONS

1995 COMPARED TO 1994

IRIS had net income of $2.1 million for 1995, an increase of $.6 million
(or 42%) from net income of $1.5 million in 1994. An increase of $.3 million
in income from sales was offset by a comparable increase in net costs
associated with research and development contracts. The improvement in income
from sales is primarily attributable to increased sales of workstations,
service contracts and related supplies, including the first full year of
sales of CHEMSTRIP/IRIStrips-TM- and nine months of sales of the recently
acquired Biovation product line, and decreased field service costs. The
$.6 million increase in overall net income was the result of a $3.6 million
non cash deferred tax benefit due to the reduction of the Company's deferred
tax valuation allowance (discussed below), after recognition of a $2.9 million
nonrecurring charge related to the acquisition of LDA. See "Overview" above
regarding the LDA acquisition.

In 1995, IRIS recognized a tax benefit of $3.6 million through a
reduction in the Company's deferred tax asset valuation allowance. This
reduction in the valuation allowance resulted principally from the Company's
assessment of the realizability of its net operating loss carryforwards based
on recent operating history as well as an assessment that operations will
continue to generate taxable income. Realization of the deferred tax assets
are dependent upon continued generation of sufficient taxable income prior to
expiration of the loss carryforwards. Although realization is not assured,
management believes it is more likely than not that the remaining net
deferred tax assets will be realized. The amount of the deferred tax assets
considered realizable, however, could be reduced in the future if estimates
of future taxable income during the carryforward period are reduced.

These results also include interest income from investments of $307,000 for
1995, compared to $162,000 in 1994. The $145,000 increase in interest income is
due largely to the increased amounts of invested cash. "See Liquidity and
Capital Resources."

The above results also include other income consisting of royalties from
TOA of $98,000 for 1995, compared to $111,000 for 1994. The 1995 royalty amount
reflects an agreement with TOA to temporarily increase the amount of the royalty
from 3% to 5% and the scope of the royalty to apply to revenues on consumables
and service contracts, as well as instruments. These changes were made
retroactive to October 1994 and expire in September 1996, at which time the
scope and amount of the royalty will revert to their original term unless TOA
exercises its right under the temporary agreement to negotiate a permanent
change to the license.

Net sales (excluding revenues from research and development contracts)
increased 24% to $11.9 million for 1995 from $9.6 million during 1994. The $2.3
million increase was attributable primarily to an increase in sales of
workstations and related supplies. Cost of goods sold (excluding the cost of
research and development

17

contracts) increased from approximately $4.7 million in 1994 to approximately
$5.5 million in 1995 and decreased as a percentage of sales from 49% to 46% as a
result of improved utilization of service parts and increased sales of
consumables.

Total research and development expenses, including the costs of development
contracts, increased to $1.9 million in 1995 from $1.6 million in 1994, as IRIS
continued to invest in the development of new applications and further
improvements in its technology. Research and development expenses related to
The White IRIS-Registered Trademark- decreased to $782,000 for 1995 from
$1,258,000, in 1994, and were offset by related revenues of $202,000 in 1995 and
$1,078,000 in 1994 from LDA. Research and development expenses on this project
decreased significantly following submission to the FDA of an application for
clearance to market The White IRIS-Registered Trademark-, and the offsetting
revenues ceased when IRIS acquired LDA. Research and development expenses
related to the 900UDX-TM- reference laboratory system were $682,000 for 1995 and
were offset by revenues of $640,000 from BMG. Research and development expenses
related to the PSI Products were $30,000 for 1995. Research and development
expenses unrelated to these three projects increased to $410,000 in 1995 from
$321,000 in 1994 as research and development activity, in general, was
intensified. See "-- Overview", "Business -- Future Developments -- The White
IRIS-Registered Trademark- and Hematology", "Business -- Strategic Alliance with
Boehringer Mannheim -- Joint Development of Reference Laboratory System."

Marketing and selling expenses in 1995 increased by almost $665,000, to
$2.4 million, compared to 1994. The increase is due largely to a greater
emphasis on direct marketing. General and administrative expenses of $1.9
million for 1995 increased by $516,000 from 1994. The increase in these
expenses is due to a variety of factors including increases related to enlarged
business and the installation of a new computer network.

1994 COMPARED TO 1993

Net income in 1994 increased to $1,473,000 from $1,281,000 in 1993.
Operating income increased $85,000 to $1,279,000 in 1994 from $1,194,000 in 1993
due to increased sales of service contracts and consumables. Net sales of
workstations were relatively unchanged but contributed less to operating income
in 1994 because of lower margins on replacement systems sold through an
aggressive trade-in program. Net income included interest income from
investments of $162,000 in 1994 and $105,000 in 1993. The $57,000 increase in
interest income is due to increased amounts of invested cash, generally higher
interest rates and redirecting cash from interest-bearing bank accounts to
short- and long-term investments. See "Liquidity and Capital Resources." Net
income also included other income which consisted of royalties from TOA of
$111,000 in 1994 and $35,000 in 1993.

Net sales (excluding revenues from research and development contracts)
increased to $9.6 million in 1994 from $9.0 million in 1993. This increase was
attributable primarily to a $629,000 increase in revenues from service
contracts. Improved sales of workstations and related supplies in the last
three quarters of 1994 were offset by unusually slow sales of workstations
during the first quarter of the year. Costs of goods sold (excluding costs of
research and development contracts) increased to $4.7 million in 1994 from $4.3
million in 1993 and increased as a percent of sales, 49.0% in 1994 compared to
47.7% in 1993, as the result of a higher cost of service parts.

Total research and development expenses, including costs incurred on
development contracts, increased to $1.6 million in 1994 from $1.0 million in
1993 as IRIS continued its work under the Research and Development Agreement
with LDA. Research and development expenses related to The White IRIS-
Registered Trademark- increased to $1,258,000 in 1994 from $638,000 in 1993, but
were offset by related revenues of $1,078,000 and $457,000 in 1994 and 1993,
respectively, from LDA under the Research and Development Agreement. Research
and development expenses unrelated to The White IRIS-Registered Trademark-
decreased slightly to $321,000 in 1994 from $368,000 in 1993.

Marketing and selling expenses in 1994 increased $116,000 in 1994 to $1.7
million as IRIS continued to expand the coverage of its sales territories and
increase its product promotion and participation at trade shows. General and
administrative expenses of $1.4 million in 1994 remained consistent with amounts
spent on general and administrative expenses in 1993.

LIQUIDITY AND CAPITAL RESOURCES

Working capital increased by $3.6 million since December 31, 1994 to a
total of $10.8 million at December 31, 1995. IRIS generated cash of $112,000
from the sale of stock to employees and $1.6 million from the

18

exercise of warrants issued in connection with LDA offerings. See "Business
- --Future Developments -- The White IRIS-Registered Trademark- and
Hematology". Total accounts receivable increased by approximately $900,000 in
line with the increased sales level in 1995. Inventory increased $804,000 to
accommodate several new products, including the CHEMSTRIP/IRIStrips-TM-.
Total current liabilities were relatively unchanged during the period.

During 1995, IRIS invested approximately $667,000 in new machinery and
equipment, $887,000 in the acquisition of the Biovation product line and
$138,000 in the construction of workstations for rental. During the first
quarter of 1996, IRIS invested $850,000 in the acquisition of the UroHealth
urinalysis business. IRIS currently is considering the purchase of equipment
during 1996 for the manufacture of Cen-Slide-Registered Trademark- and FloStar-
Registered Trademark- products, the principal products of this business. Future
commitments for capital expenditures may also prove necessary to continue IRIS
efforts in research and development and to manufacture and market its existing
products.

IRIS has made numerous improvements in The Yellow IRIS-Registered
Trademark- over the years, and further improvements to The Yellow IRIS-
Registered Trademark- will require a substantial amount of research and
development time and financial resources. While IRIS believes that it has the
technical ability and financial resources for such implementations, IRIS is
currently funding the majority of this work through a collaborative arrangement
with BMG and through a joint development program with PSI. See -- "Overview".

IRIS currently plans to use only modest amounts of its current working
capital for further development of products other than those related to The
Yellow IRIS-Registered Trademark- and The White IRIS-Registered Trademark-.
More vigorous development of The Purple IRIS-Registered Trademark- and other
products depends on securing alternative sources of funding such as the joint
development programs with PSI and BMG. However, there can be no assurance that
IRIS will be successful in more of these kinds of efforts, or any others, to
locate acceptable sources of funding desired for other products.

In an effort to increase interest income on its cash and cash
equivalents, IRIS invests a significant portion of its funds in U.S. Treasury
securities and federally insured certificates of deposit. As a result, short
and long-term investments increased by approximately $1.4 million since
December 31, 1994. IRIS believes that its current cash on hand plus
short-term investments will be sufficient to meet its needs for at least the
next year.

INFLATION

IRIS does not foresee any material impact on its operations from inflation.

NEWLY ISSUED ACCOUNTING STANDARDS:

In March 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 121 ("SFAS No. 121"), "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of". SFAS No. 121 requires the Company to review the carrying amounts of its
long-lived assets and certain identifiable intangible assets for impairment.
If it is determined the carrying amount of the asset is not recoverable, the
company is required to recognize an impairment loss. The accounting standard
will be implemented during the first quarter of 1996; however, the loss, if
any, has not yet been determined.

In December 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"),
"Accounting for Stock Based Compensation." In accordance with SFAS No. 123,
IRIS will adopt the disclosure method as provided for in the statement.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The financial statements included herein are listed in the Index to
Financial Statements in Part IV, Item 14(a)1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.

19

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Incorporated by reference is the information which appears under the
caption "Directors and Executive Officers" in the Proxy Statement to be filed
with the Securities and Exchange Commission relating to the Registrant's 1996
Annual Meeting of Stockholders.

ITEM 11. EXECUTIVE COMPENSATION.

Incorporated by reference is the information which appears under the same
caption in the Proxy Statement to be filed with the Securities and Exchange
Commission relating to the Registrant's 1996 Annual Meeting of Stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

Incorporated by reference is the information which appears under the same
caption in the Proxy Statement to be filed with the Securities and Exchange
Commission relating to the Registrant's 1996 Annual Meeting of Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Incorporated by reference is the information which appears under the same
caption in the Proxy Statement to be filed with the Securities and Exchange
Commission relating to the Registrant's 1996 Annual Meeting of Stockholders.

20

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K.

(a) The following documents are filed as a part of this report:

1. Index to Financial Statements Page

Report of Independent Public Accountants. 23
Balance Sheets at December 31, 1995 and 1994. 24
Statements of Operations for the Years ended December 31,
1995, 1994, and 1993. 25
Statements of Shareholders' Equity for the Years ended
December 31, 1995, 1994, and 1993. 26
Statements of Cash Flows for the Years ended December 31,
1995, 1994 and 1993. 29
Notes to Financial Statements 30

2. Financial Statement Schedules Covered by the Foregoing Report of
Independent Public Accountants.

The financial statement schedules have been omitted since they are not
required, are not applicable, or the required information is shown in
the Financial Statements or Related Notes.

3. Exhibits

3.1 Articles of Incorporation.1/
3.2 Bylaws.2/
3.3 Amendment to Bylaws (adopted March 17, 1996).
10.1 Lease of the Registrant's principal facilities.3/
10.2 1980 and 1982 Stock Option Plans, and forms of Stock Option
Agreements for each Plan.4/
10.3 1983 and 1986 Stock Option Plans, and forms of Stock Option
Agreements for each Plan.5/
10.4 Amended and Restated 1986 Stock Option Plan.6/
10.5 1994 Stock Option Plan and forms of Stock Option
Agreements.7/
10.6 Various Agreements with TOA.8/
10.7 Agreement for a Strategic Alliance in Urinalysis dated
January 7, 1994 between IRIS and BMC.9/
10.8 Securities Purchase Agreement dated as of April 20, 1994 by
and among IRIS, LDA and Corange International Limited.10/
10.9 Warrant Certificate dated April 22, 1994 issued to Corange
International Limited.9/
10.10 Research and Development and Distribution Agreement dated
February 6, 1995 by and among IRIS, LDA and Corange
International Limited.9/
10.11 Warrant Certificate dated February 6, 1995 issued to Corange
International Limited.9/
10.12 Asset Purchase Agreement dated as of March 20, 1995 between
IRIS and Biovation, Inc.9/
10.13 Warrant Certificate dated March 20, 1995 issued to
Biovation, Inc.9/
10.14 Technology License Agreement dated as of September 29, 1995
between IRIS and PSI.11/
10.15 Research and Development Agreement dated as of September 29,
1995 between IRIS and PSI.11/
10.16 $100 Class "A" Note dated September 29, 1995 issued by PSI
in favor of IRIS.11/
10.17 Certificate of Incorporation of PSI. (See Article FOUR
regarding the IRIS option.)11/
10.18 Agreement and Plan of Merger date January 31, 1996 by and
among IRIS, StatSpin and StatSpin Acquisition Corporation.
10.19 Registration Rights Agreement dated January 31, 1996 between
IRIS and StatSpin Stockholders.
10.20 Employment Agreement dated January 30, 1996 with Thomas F.
Kelley.
10.21 Lease for the facilities of the Registrant's subsidiary,
StatSpin.
11 Statement re Computation of Per Share Earnings.12/
24 Consent of Coopers & Lybrand L.L.P.12/

21

(b) Reports on Form 8-K

IRIS did not file any Current Reports on Form 8-K during the quarter
ended December 31, 1995. However, IRIS did file a Current Report on Form
8-K on February 16, 1996 with respect to the acquisition of Norfolk
Scientific, Inc., d/b/a StatSpin Technologies, which included certain
financial statements of StatSpin and unauditied pro forma condensed
financial statements reflecting the combination of IRIS and StatSpin using
the pooling of interests accounting method.

(c) See (a)(3) above.

(d) See (a)(1) and (2) above.
- ---------------

1/ Incorporated by reference to the Company's Current Report on Form 8-K dated
August 13, 1987 and its Quarterly Report on Form 10-Q for the quarter ended
September 30, 1993.
2/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1994.
3/ The original lease and all prior amendments are incorporated by reference
to the Company's Annual Report on Form 10-K for the year ended December
31,1989, its quarterly report on Form 10-Q for the quarter ended September
30, 1993 and its Annual Report on Form 10-K for the year ended December 31,
1994.
4/ Incorporated by reference to the Company's Registration Statement on Form
S-2, as filed with the Securities and Exchange Commission on September 4,
1985.
5/ Incorporated by reference to the Company's Registration Statement on Form
S-8, as filed with the Securities and Exchange Commission on May 10, 1982.
6/ Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1992.
7/ Incorporated by reference to the Company's Registration Statement on Form
S-8, as filed with the Securities and Exchange Commission on August 8,
1994.
8/ Incorporated by reference to the Company's Current Report on Form 8-K dated
July 15, 1988 and its Quarterly Report on Form 10-Q for the quarter ended
June 30, 1995.
9/ Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994.
10/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1994.
11/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1995.
12/ Omitted in copy distributed to stockholders in connection with the 1996
Annual Meeting of Stockholders.

22

SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized, in Chatsworth, California, on
March 29, 1996.

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.

By: /s/ Fred H. Deindoerfer
----------------------------------------------
Fred H. Deindoerfer,
Chairman of the Board of Directors, President,
Chief Executive Officer, and Chief Financial
Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

Signature Title Date
- --------------------------------------------------------------------------------

/s/ Fred H. Deindoerfer Chairman of the Board of March 29, 1996
- ------------------------- Directors, President,
Fred H. Deindoerfer Chief Executive Officer, and
Chief Financial Officer

/s/ E. Eduardo Benmaor Secretary, Controller, and March 29, 1996
- ------------------------- Principal Accounting Officer
E. Eduardo Benmaor

/s/ John A. O'Malley Director March 29, 1996
- -------------------------
John A. O'Malley

/s/ Steven M. Besbeck Director March 29, 1996
- -------------------------
Steven M. Besbeck

/s/ Thomas F. Kelley Director and Vice President March 29, 1996
- -------------------------
Thomas F. Kelley

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Shareholders of International Remote Imaging
Systems, Inc.

We have audited the financial statements of International Remote Imaging
Systems, Inc., as listed in the index on page 21 of this Form 10-K. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of International Remote Imaging
Systems, Inc. at December 31, 1995 and 1994, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1995, in conformity with generally accepted accounting principles.

COOPERS & LYBRAND L.L.P.

/s/ Coopers & Lybrand L.L.P.
Los Angeles, California
March 20, 1996

23

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
BALANCE SHEETS

At December 31,
---------------------------
1994 1995
------------ ------------

ASSETS

Current assets:
Cash and cash equivalents $ 2,406,284 $ 1,144,356
Short-term investments 2,256,062 4,736,726
Accounts receivable-trade, net of allowance for doubtful
accounts of $35,443 in 1994 and $34,765 in 1995 2,057,503 2,957,491
Accounts receivable - service contracts 313,144 481,367
Accounts receivable-other 575,657 407,245
Inventories 1,717,805 2,543,692
Prepaid expenses and other current assets 179,306 212,536
Deferred tax asset - 800,900
------------ ------------

Total current assets 9,505,761 13,284,313

Property and equipment, at cost, net of accumulated depreciation 503,334 934,857
Software development costs, net of accumulated amortization of
$625,816 in 1994 and $667,425 in 1995 40,623 298,030
Long-term investments 1,200,000 100,000
Deferred warrant costs 503,145 1,574,780
Deferred tax asset -- 3,594,100
Other assets 375,521 1,421,759
------------ ------------
Total assets $ 12,128,384 $ 21,207,839
------------ ------------
------------ ------------

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 746,142 $ 668,817
Accrued expenses 879,899 1,129,900
Deferred income - service contracts 683,402 685,907
------------ ------------
Total current liabilities 2,309,443 2,484,624
Deferred income - service contracts 119,913 190,045
------------ ------------
Total liabilities 2,429,356 2,674,669
------------ ------------
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value
Authorized: 3,000,000 shares
None issued and outstanding
Common stock, $.01 par value
Authorized: 15,600,000 shares
Shares issued and outstanding:
1994 - 4,990,067, 1995 - 5,952,148 49,901 59,521
Additional paid-in capital 26,619,692 33,355,537
Treasury stock, at cost (96,473 shares) (453,386) (453,386)
Unearned compensation (93,130) (95,884)
Accumulated deficit (16,424,049) (14,332,618)
------------ ------------
Total shareholders' equity 9,699,028 18,533,170
------------ ------------
Total liabilities and shareholders' equity $ 12,128,384 $ 21,207,839
------------ ------------
------------ ------------

The accompanying notes are an integral part of these financial statements.

24

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
STATEMENTS OF OPERATIONS

For the Year Ended December 31,
-----------------------------------------
1993 1994 1995
-----------------------------------------

Sales of workstations and related supplies . . . . . . . . . . . . . . . . . . . $ 7,499,703 $ 7,430,489 $ 9,566,997
Service contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,524,591 2,153,076 2,355,062
Research and development contracts . . . . . . . . . . . . . . . . . . . . . . . 457,160 1,078,378 842,663
----------- ----------- -----------

Net sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,481,454 10,661,943 12,764,722
----------- ----------- -----------

Cost of goods-workstations and supplies. . . . . . . . . . . . . . . . . . . . . 2,976,078 2,922,084 3,865,774
Cost of goods-service contracts. . . . . . . . . . . . . . . . . . . . . . . . . 1,327,318 1,752,031 1,637,896
Cost of research and development contracts . . . . . . . . . . . . . . . . . . . 637,552 1,258,405 1,494,873
----------- ----------- -----------
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,940,948 5,932,520 6,998,543
----------- ----------- -----------

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,540,506 4,729,423 5,766,179

Marketing and selling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,620,441 1,736,713 2,401,885
General and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,358,570 1,392,785 1,909,076
Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . 367,723 321,391 409,842
Acquisition of in-process research and development . . . . . . . . . . . . . . . -- -- 2,900,430
----------- ----------- -----------

Operating income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,193,772 1,278,534 (1,855,054)

Other income:
Interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105,232 162,112 307,108
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,558 111,240 98,377
----------- ----------- -----------

Income (loss) before provision for income taxes. . . . . . . . . . . . . . . . . 1,337,562 1,551,886 (1,449,569)
Provision (benefit) for income taxes . . . . . . . . . . . . . . . . . . . . . . 57,000 79,000 (3,541,000)
----------- ----------- -----------

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,280,562 $ 1,472,886 $ 2,091,431
----------- ----------- -----------
----------- ----------- -----------

Earnings per share. . . . . . . . . . . . . . . . . . . . . . . . . . . . $.26 $.28 $.35
---- ----- ----
---- ----- ----
Weighted average number of common shares and common share equivalents
outstanding for the period . . . . . . . . . . . . . . . . . . . . . . . . . . 4,979,785 5,323,108 6,043,006
----------- ----------- -----------
----------- ----------- -----------

The accompanying notes are an integral part of these financial statements.

25

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY

Common Stock Additional Shareholders' Unearned
--------------- Paid-In Treasury Notes Compen- Accumulated
Shares Amount Capital Stock Receivable sation Deficit Total
------ ------ ----------- -------- ------------- -------- ----------- -----

Balance,
December 31, 1992. . . . . 4,740,011 $47,400 $25,255,612 $ -- $(28,306) $(57,816) $(19,177,497) $6,039,393

Repurchase of
common stock . . . . . . . (26,200) (262) 262 (142,016) -- -- -- (142,016)

Common stock issued
for cash on exercise
of stock options . . . . . 46,533 465 101,282 -- -- -- -- 101,747

Common stock issued
under Employee Stock
Purchase Plan:
for Cash . . . . . . . . . 13,971 140 67,336 -- -- -- -- 67,476
for Services . . . . . . . 13,971 140 67,336 -- -- (67,476) -- --

Common stock issued
for cash on exercise
of warrants. . . . . . . . 9,800 98 36,652 -- -- -- -- 36,750

Principal payments
received on
shareholders' notes
receivable . . . . . . . . -- -- -- -- 21,639 -- -- 21,639

Amortization of unearned
compensation . . . . . . . -- -- -- -- -- 48,489 -- 48,489

Net income . . . . . . . . -- -- -- -- -- -- 1,280,562 1,280,562
--------- ------- ----------- -------- -------- -------- ------------ ----------

Balance,
December 31, 1993. . . . . 4,798,086 47,981 25,528,480 (142,016) (6,667) (76,803) (17,896,935) 7,454,040

26

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
(continued)

Common Stock Additional Shareholders' Unearned
--------------- Paid-In Treasury Notes Compen- Accumulated
Shares Amount Capital Stock Receivable sation Deficit Total
------ ------ ----------- -------- ------------- -------- ----------- -----

Balance,
December 31, 1993 . . . . 4,798,086 47,981 25,528,480 (142,016) (6,667) (76,803) (17,896,935) 7,454,040

Common stock issued
for cash on exercise of
stock options. . . . . . . 200,832 2,008 445,015 -- -- -- -- 447,023

Common stock issued
under Employee Stock
Purchase Plan:
for Cash . . . . . . . . . 22,811 228 100,559 -- -- -- -- 100,787
for Services . . . . . . . 22,811 228 100,559 -- -- (100,787) -- --

Common stock issued
for cash on exercise
of warrants. . . . . . . . 15,800 158 59,092 -- -- -- -- 59,250

Issuance of warrants . . . -- -- 385,285 -- -- -- -- 385,285

Principal payments
received on share-
holders' notes receivable. -- -- -- -- 6,667 -- -- 6,667

Amortization of unearned
compensation . . . . . . . -- -- -- -- -- 84,460 -- 84,460

Repurchase of common
stock. . . . . . . . . . . (70,273) (702) 702 (311,370) -- -- -- (311,370)

Net income . . . . . . . . -- -- -- -- -- -- 1,472,886 1,472,886
--------- ------- ----------- -------- -------- -------- ------------ ----------

Balance,
December 31, 1994 . . . . 4,990,067 49,901 26,619,692 (453,386) -- (93,130) (16,424,049) 9,699,028

27

STATEMENTS OF SHAREHOLDERS' EQUITY
(continued)

Common Stock Additional Shareholders' Unearned
--------------- Paid-In Treasury Notes Compen- Accumulated
Shares Amount Capital Stock Receivable sation Deficit Total
------ ------ ----------- -------- ------------- -------- ----------- -----

Balance,
December 31, 1994. . . . . 4,990,067 49,901 26,619,692 (453,386) -- (93,130) (16,424,049) 9,699,028

Common stock issued
for cash on exercise of
stock options. . . . . . . 21,900 219 44,231 -- -- -- -- 44,450

Common stock issued
under Employee Stock
Purchase Plan:
for Cash . . . . . . . . . 9,997 100 67,141 -- -- -- -- 67,241
for Services . . . . . . . 16,976 170 112,219 -- -- (89,915) -- 22,474

Common stock issued
for cash on exercise
of warrants. . . . . . . . 414,749 4,147 1,551,161 -- -- -- -- 1,555,308

Issuance of warrants . . . -- -- 1,774,733 -- -- -- -- 1,774,733

Common stock issued in
exchange for LDA
Systems, Inc. callable
common stock . . . . . . . 498,459 4,984 2,972,360 -- -- -- -- 2,977,344

Amortization of unearned
compensation . . . . . . . -- -- -- -- -- 87,161 -- 87,161

Income tax benefit
related to exercise of
nonqualified stock
options. . . . . . . . . . -- -- 214,000 -- -- -- -- 214,000

Net income . . . . . . . . -- -- -- -- -- -- 2,091,431 2,091,431
--------- ------- ----------- -------- -------- -------- ------------ ----------

Balance,
December 31, 1995 . . . . 5,952,148 $59,521 $33,355,537 $(453,386) $ -- $(95,884) $(14,332,618) $18,533,170
--------- ------- ----------- --------- -------- -------- ------------ -----------
--------- ------- ----------- --------- -------- -------- ------------ -----------

The accompanying notes are an integral part of these financial statements.

28

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
STATEMENTS OF CASH FLOWS

For the Year Ended December 31,
-----------------------------------------
1993 1994 1995
-----------------------------------------

Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,280,562 $ 1,472,886 $ 2,091,431
Adjustments to reconcile net income to net cash provided by operations:
Deferred tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- -- (3,587,000)
Acquisition of in-process research and development . . . . . . . . . . . . . -- -- 2,882,858
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . . 443,628 474,135 579,091
Common stock compensation. . . . . . . . . . . . . . . . . . . . . . . . . . 48,489 84,460 109,635
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,500) -- --
Changes in assets and liabilities:
Accounts receivable - trade. . . . . . . . . . . . . . . . . . . . . . . . . . (150,883) (651,526) (899,988)
Account receivable - other . . . . . . . . . . . . . . . . . . . . . . . . . . -- -- 168,412
Notes receivable - trade . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,000 13,731 --
Service contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68,991 23,715 (95,586)
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,462 171,422 (804,087)
Prepaid expenses and other current assets. . . . . . . . . . . . . . . . . . . 89,185 (82,251) (33,230)
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (122,926) (96,328) (121,466)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,895) 470,103 (77,325)
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118,823 (93,084) 230,001
----------- ----------- -----------
Net cash provided by operating activities. . . . . . . . . . . . . . . . . . . . 1,898,936 1,787,263 442,746
----------- ----------- -----------

Cash flows from investing activities:
Acquisition of property and equipment. . . . . . . . . . . . . . . . . . . . . (345,411) (264,242) (805,193)
Acquisition of product line. . . . . . . . . . . . . . . . . . . . . . . . . . -- -- (886,800)
Software development costs . . . . . . . . . . . . . . . . . . . . . . . . . . (81,034) (25,411) (299,016)
Maturities of certificates of deposit. . . . . . . . . . . . . . . . . . . . . 625,000 210,000 215,000
Purchases of certificates of deposit . . . . . . . . . . . . . . . . . . . . . (625,000) (100,000) --
Maturities of held-to-maturity debt securities . . . . . . . . . . . . . . . . -- 1,000,000 2,700,000
Purchases of held-to-maturity debt securities. . . . . . . . . . . . . . . . . -- (3,441,062) (4,295,664)
----------- ----------- -----------
Net cash used in investing activities. . . . . . . . . . . . . . . . . . . . . . (426,445) (2,620,715) (3,371,673)
----------- ----------- -----------

Cash flows from financing activities:
Issuance of common stock for cash. . . . . . . . . . . . . . . . . . . . . . . 138,497 254,823 1,599,758
Repurchase of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . (142,016) (59,920) --
Principal payments received on shareholders' notes receivable. . . . . . . . . 21,639 6,667 --
Issuance of common stock for cash under Employee Stock Purchase Plan . . . . . 67,476 100,787 67,241
----------- ----------- -----------
Net cash provided by financing activities. . . . . . . . . . . . . . . . . . . . 85,596 302,357 1,666,999
----------- ----------- -----------

Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . . 1,558,087 (531,095) (1,261,928)
Cash and cash equivalents at beginning of year . . . . . . . . . . . . . . . . . 1,379,292 2,937,379 2,406,284
----------- ----------- -----------
Cash and cash equivalents at end of year . . . . . . . . . . . . . . . . . . . . $ 2,937,379 $ 2,406,284 $ 1,144,356
----------- ----------- -----------
----------- ----------- -----------
Supplemental schedule of non-cash financing activities:
Issuance of common stock in exchange for services. . . . . . . . . . . . . . . $ 67,476 $ 100,787 $ 109,635
Issuance of common stock under a stock for stock exercise. . . . . . . . . . . -- 251,450 --
Issuance of warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 385,285 1,774,733
Issuance of common stock to acquire shares of LDA. . . . . . . . . . . . . . . -- -- 2,977,344
Tax benefit related to exercise of nonqualified stock options. . . . . . . . . -- -- 214,000
Supplemental disclosure of cash flow information:
Cash paid for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 50,740 112,465 11,000

The accompanying notes are an integral part of these financial statements.

29

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS

1. FORMATION AND BUSINESS OF THE COMPANY.

IRIS was incorporated in California in 1979 and reincorporated during 1987
in Delaware. IRIS engages in the business of developing, manufacturing and
selling microscopical image analyzing systems based on proprietary technology.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.

Use of Estimates and Assumptions:

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.

Cash Equivalents, Short-term Investments, and Long-term Investments:

Short-term investments principally include certificates of deposit and debt
instruments of the United States Government with maturities greater than three
months and less than one year. Long-term investments represent certificates of
deposit and debt instruments of the United States Government with maturities
greater than one year. For purposes of the statement of cash flows, IRIS
considers all highly liquid debt instruments purchased with a remaining maturity
of three months or less when purchased to be cash equivalents. IRIS places its
cash and investments with high credit quality financial institutions. At times,
these deposits may be in excess of the federally insured limit.

Accounts Receivable:

IRIS sells predominantly to entities in the healthcare industry and
generally grants uncollateralized credit to its customers, primarily domestic
hospitals. IRIS performs ongoing credit evaluations of its customers before
granting uncollateralized credit and, to date, has not experienced any material
credit related losses.

At December 31, 1995, the Company had accounts receivable from one customer
representing 13% of total trade accounts receivable.

Property and Equipment and Depreciation:

Property and equipment are recorded at cost, less accumulated depreciation
and amortization. Depreciation is computed using the straight-line method over
three to five years, the estimated useful lives of the assets. Leasehold
improvements are amortized over the lesser of their useful life or the remaining
term of the lease.

Costs of maintenance and repairs are charged to expense when incurred;
costs of renewals and betterments are capitalized. Upon sale or retirement, the
cost and related accumulated depreciation are eliminated from the respective
accounts, and the resulting gain or loss is included in current income.

Software Development Costs:

IRIS capitalizes certain software development costs in accordance with
Statement of Financial Accounting Standards No. 86 -- "Accounting for the Costs
of Computer Software to be Sold, Leased, or Otherwise Marketed", for new
products and product enhancements once technological feasibility has been
established. IRIS amortizes capitalized software costs using the greater of the
straight line method over the estimated product life, or a percentage of total
units sold over the projected unit sales. Amortization expense of software
development costs was $132,000, $108,000 and $41,600 for 1993, 1994, and 1995,
respectively.

30

Deferred Warrant Costs:

Deferred warrant costs are the result of the issuance of warrants in
conjunction with various development agreements and a product line acquisition.
These costs are being amortized on a straight line basis over the expected life
of the related technology of, generally, ten years.

Revenue Recognition:

IRIS derives revenue from the sale of workstations and related supplies,
the sale of service contracts, and research and development contracts. IRIS
generally recognizes product revenues once all of the following conditions have
been met: a) an authorized purchase order has been received in writing,
b) customer credit worthiness has been established, and c) shipment of the
product to the customer designated location has occurred. Estimated
installation expense is recognized as part of the accrual for warranty expense
at the time of shipment.

IRIS recognizes service revenues ratably over the term of the service
period, which typically ranges from twelve to sixty months. Payments for
service contracts are generally made in advance. Deferred income represents
the revenues to be recognized over the remaining term of the service
contracts.

Revenues are recognized under research and development contracts in
amounts equivalent to reimbursable research and development costs incurred on
the related project plus, where contractually provided for, an amount to
cover general and administrative costs of the project.

Warranties:

IRIS recognizes the full estimated cost of warranty expense at the time
of product shipment.

Research and Development Expenditures:

Except for certain software development costs required to be capitalized as
described above (see Software Development Costs), research and development
expenditures are charged to operations as incurred.

Income Taxes:

In 1993, IRIS changed its method of accounting for income taxes by adopting
Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting
for Income Taxes," which requires recognition of deferred tax liabilities and
assets for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Under this method,
deferred tax liabilities and assets are determined based on the differences
between the financial statement and the tax bases of assets and liabilities
using enacted tax rates in effect for the year in which the differences are
expected to reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized. Income tax
expense represents the tax payable for the period and the change during the
period in deferred tax assets and liabilities.

SFAS 109 was applied retroactively to January 1, 1991.

Reclassifications:

Certain reclassifications have been made to the 1993 and 1994 financial
statements to conform with the 1995 presentation.

Newly Issued Accounting Standards:

In March 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 121 ("SFAS No. 121"), "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
SFAS No. 121 requires the Company to review the carrying amounts of its
long-lived assets and certain identifiable intangible assets for impairment.
If it is determined the carrying amount of the asset is not recoverable, the
company is required to recognize an impairment loss. The accounting standard
will be implemented during the first quarter of 1996; however, the loss, if
any, has not yet been determined.

31

In December 1995, the Financial Accounting Standard Board issued Statement
of Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for
Stock Based Compensation." In accordance with SFAS No. 123, IRIS will adopt the
disclosure method as provided for in the statement.

3. MARKETABLE DEBT SECURITIES.

On January 1, 1994, IRIS adopted Statement of Financial Accounting
Standards No. 115, ("SFAS 115") "Accounting for Certain Investments in Debt and
Equity Securities" and determined that all its debt securities should be
classified as "held-to-maturity" based on the Company's intent and ability to
hold those securities to maturity. Under SFAS 115, debt securities classified
as "held-to-maturity" are carried at amortized cost.

At December 31, 1994 and 1995, the carrying value of marketable debt
securities approximated fair value and is included in short-term and long-term
investments:

December 31, 1994 Expected Maturity Value and Date
----------------- ----------------------------------
Amortized Cost Within One Year One to Five Years
-------------- --------------- -----------------
U.S. Treasury Bills $1,641,062 $1,700,000
U.S. Treasury Notes 802,028 $800,000

December 31, 1995 Expected Maturity Value and Date
----------------- ----------------------------------
Amortized Cost Within One Year One to Five Years
-------------- --------------- -----------------
U.S. Treasury Bills $3,236,725 $3,318,000 $ --
U.S. Treasury Notes 803,376 800,000 --

4. INVENTORIES.

Inventories are carried at the lower of cost or market on a first-in,
first-out basis and are composed of the following:

December 31,
-------------------------
1994 1995
-------------------------

Finished goods . . . . . . . . . . $ 471,318 $ 316,218
Work-in-process. . . . . . . . . . 351,682 195,266
Raw materials, parts and
sub-assemblies. . . . . . . . . . 894,805 2,032,208
---------- ----------
$1,717,805 $2,543,692
---------- ----------
---------- ----------

32

5. PROPERTY AND EQUIPMENT.

Property and equipment is composed of the following:

December 31,
-------------------------
1994 1995
-------------------------

Leasehold improvements . . . . . . $ 257,534 $ 327,178
Furniture and fixtures . . . . . . 80,532 108,018
Machinery and equipment. . . . . . 1,736,869 2,221,612
Tooling, dies and molds. . . . . . 135,859 236,694
Rental units . . . . . . . . . . . 56,084 166,268
----------- -----------
2,266,878 3,059,770
Less accumulated depreciation. . . (1,763,544) (2,124,913)
----------- -----------
$ 503,334 $ 934,857
----------- -----------
----------- -----------

Property and equipment includes $1,270,363 and $1,284,488 respectively, in
1994 and 1995 of fully depreciated assets which remain in service. Depreciation
expense was $246,000, $259,000, and $390,000 for 1993, 1994, and 1995,
respectively. Maintenance and repairs expense for 1993, 1994 and 1995 was
$40,644, $61,643, and $53,450, respectively.

Rental units are carried at cost less accumulated depreciation ($136,136 at
December 31, 1994 and $163,952 at December 31, 1995). Future minimum rental
revenue on noncancellable leases as of December 31, 1995 is approximately
$306,000, due during 1996.

6. ACCRUED EXPENSES.

Accrued expenses are composed of the following:

December 31,
------------------------
1994 1995
------------------------

Accrued bonuses. . . . . . . . . . $ 206,451 $ 366,372
Accrued commissions. . . . . . . . 55,133 76,079
Accrued payroll. . . . . . . . . . 56,074 66,327
Accrued vacation . . . . . . . . . 109,999 135,832
Accrued taxes and other. . . . . . 19,159 64,564
Accrued professional fees. . . . . 88,261 113,403
Accrued warranty expense . . . . . 344,822 307,323
--------- ----------
$ 879,899 $1,129,900
--------- ----------
--------- ----------

33

7. INCOME TAXES.

The provision (benefit) for income taxes consisted of the following:

1993 1994 1995
-------------------------------------

Currently payable:
Federal. . . . . . $26,000 $30,000 $ 26,000
State. . . . . . . 31,000 49,000 20,000
------- ------- -----------
57,000 79,000 46,000
------- ------- -----------

Deferred:
Federal. . . . . . -- -- (3,537,000)
State. . . . . . . -- -- (50,000)
------- ------- -----------
-- -- (3,587,000)
------- ------- -----------

$57,000 $79,000 $(3,541,000)
------- ------- -----------
------- ------- -----------

The provision (benefit) for income taxes differs from the amount obtained
by applying the federal statutory income tax rate to income before income taxes
for the years ended December 31, 1993 and 1994 and 1995 as follows:

1993 1994 1995
---------------------------------------

Tax provision (benefit)
computed at Federal
statutory rate. . . . . . . $ 454,771 $ 527,641 ($492,853)
Increase (decrease) in
taxes due to:
Reinstatement of fully
reserved deferred tax
assets. . . . . . . . . . -- -- (3,587,000)
Utilization of net
operating loss
carryforward. . . . . . . (507,379) (532,610) (568,252)
Write-off of purchased
research and
development . . . . . . . -- -- 1,089,962
State taxes, net
of federal benefit. . . . 17,737 36,523 13,200
Nondeductible expenses. . . 37,214 21,952 (22,057)
Other . . . . . . . . . . . 54,657 25,494 26,000
--------- --------- -----------
$ 57,000 $ 79,000 ($3,541,000)
--------- --------- -----------
--------- --------- -----------

In 1995, IRIS recognized a tax benefit of $3,587,000 through a reduction in
the Company's deferred tax asset valuation allowance. This reduction in the
valuation allowance resulted principally from the Company's assessment of the
realizability of its net operating loss carryforwards based on recent operating
history as well as an assessment that operations will continue to generate
taxable income. Realization of the deferred tax assets are dependent upon
continued generation of sufficient taxable income prior to expiration of the
loss carryforwards. Although realization is not assured, management believes it
is more likely than not that the remaining net deferred tax assets will be
realized. The amount of the deferred tax assets considered realizable, however,
could be reduced in the future if estimates of future taxable income during the
carryforward period are reduced.

At December 31, 1995, the Company had federal net operating loss carryforwards
of approximately $14.2 million and state net operating loss carryforwards of
approximately $740,000 which expire in fiscal years ending in 2000 through 2010.
As of December 31, 1995, IRIS had investment tax and R&D credit carryforwards of
$71,719 expiring in fiscal years through 2003.

34

The primary components of temporary differences which give rise to the
Company's net deferred tax asset at December 31, 1993, 1994 and 1995 are as
follows:

December 31,
------------------------------------
1993 1994 1995
------------------------------------

Depreciation and
amortization. . . . . . . . $ 115,598 $ 129,162 $ 146,200
Allowance for doubtful
accounts. . . . . . . . . . 14,038 14,177 12,900

Accrued liabilities. . . . . 234,718 189,129 213,100

Deferred revenue-service
contracts . . . . . . . . . 186,582 202,164 145,800

Deferred research and
development . . . . . . . . -- -- 537,000

Net operating loss
carryforwards . . . . . . . 5,665,640 5,081,225 4,840,000

Valuation allowance. . . . . (6,216,576) (5,615,857) (1,500,000)
----------- ----------- ----------

$ 0 $ 0 $4,395,000
----------- ----------- ----------
----------- ----------- ----------

8. LDA AND WARRANTS.

In October, 1992 LDA Systems, Inc. ("LDA"), completed an initial public
offering of 107,750 units, each unit consisting of one share of callable LDA
Common Stock and ten IRIS Warrants, each five warrants entitling the holder to
purchase one share of IRIS Common Stock for $3.75, exercisable at any time from
November 16, 1992 through July 31, 1995. LDA received net proceeds of $774,000
from the unit offering. These funds were used throughout 1993 to engage IRIS to
conduct research and development, clinical evaluations and pre-market testing of
The White IRIS-Registered Trademark-, a proposed new product, in accordance with
a research and development contract. In addition, IRIS committed to fund
$500,000 of the development costs over a three year period commencing in October
1992.

On April 25, 1994, LDA completed the sale of additional units to Corange
Limited consisting of 85,714 shares of callable LDA common stock and warrants to
purchase an aggregate of 248,571 shares of IRIS common stock at an exercise
price of $3.75 per share. As part of the investment agreement, Corange was
granted the option to participate with LDA in the joint development,
manufacture, and marketing of certain future hematology instruments. This
option expired October 30, 1995.

IRIS had the option to purchase for cash or shares of IRIS common stock all
of the outstanding shares of LDA common stock at $20 per share. The option
expired 121 days after termination of the research and development agreement,
which was to conclude no later than July 31, 1995. In June 1995, IRIS completed
the acquisition of LDA for approximately 498,000 shares of IRIS Common Stock.
IRIS acquired LDA pursuant to the exercise of its call option under the LDA
Restated Certificate of Incorporation to purchase all the outstanding shares of
LDA Common Stock. Accordingly, IRIS tendered 2.5765 shares of IRIS Common Stock
for each share of LDA Common Stock. As a result of the acquisition, IRIS
incurred a non-recurring charge of approximately $2.9 million against earnings
for the acquisition of in-process research and development (i.e. work in process
not yet cleared for interstate commerce by the Food and Drug Administration).

The following unadutied pro forma combined financial information gives
effect to the acquisition of LDA by IRIS under the purchase method of accounting
as though the acquisition had occurred on January 1, 1994. Substantially all of
the purchase price for the acquisition of LDA by IRIS, including amounts for
liabilities of LDA to be assumed by IRIS has been allocated to in-process
research and development. Under the purchase method of accounting, the
purchased research and development has been written off as of the purchase date.
The one time write-off of in-process research and development of approximately
$2.9 million is excluded from the pro forma information as it represents a non-
recurring item.

35

1994 1995
--------------------------

Net revenues . . . . . . . . . . . $10,661,943 $12,644,655
Net income . . . . . . . . . . . . $ 331,767 $ 4,812,003
Primary and fully diluted
earnings per share . . . . . . . $ 0.06 $ 0.79

The pro forma combined financial information is presented for informational
purposes only and is not necessarily indicative of the operating results that
would have occurred had the merger been consummated as of the above dates. In
addition, the pro forma results are not intended to be a projection of future
results.

9. PSI DEVELOPMENT AGREEMENT.

On September 29, 1995, Poly U/A Systems, Inc. (PSI) engaged IRIS to develop
several new products based on IRIS and other technology to further enhance
automation in the urinalysis field. Under the terms of the project, PSI will
have the right to use the IRIS technology and any newly developed technology for
developing, manufacturing and marketing the new products as stand-alone devices,
and IRIS will have the right to use any newly developed technology for any other
purpose and to incorporate the new products into The Yellow IRIS-Registered
Trademark-. PSI has retained IRIS to conduct the research, development,
clinical evaluation and pre-market testing of the proposed new products. IRIS
will fund the first $15,000 per month (up to a maximum of $500,000) of the cost
of the project, and PSI will reimburse IRIS for the excess. IRIS has an option
until 121 days after termination of the project (which terminates no later than
July 31, 1998) to acquire all of the Common Stock of PSI at prices rising over
time from $14 to $20 per share of PSI Common Stock. IRIS may pay the option
exercise price in cash or with shares of IRIS Common Stock. IRIS is also
providing financial and administrative services to PSI at cost.

PSI, a privately-held company based in Los Angeles, California, was
organized in June 1995 to undertake the commercial development of several
potential products based on technology developed or licensed by IRIS. In
order to fund its share of the project, PSI, in 1995, raised net proceeds of
$2.0 million through the sale of 128 units at a price of $20,000 per unit.
Each unit consists of 2,000 shares of PSI's Callable Common Stock and a
warrant to purchase 4,000 shares of IRIS Common Stock. In the aggregate,
investors purchased 256,000 shares of PSI's callable Common Stock and
warrants to purchase 512,000 shares of IRIS Common Stock. The IRIS warrants
are exercisable at $6.50 per share during the last two years of their
three-year duration. In connection with PSI's sale of units, IRIS also
issued warrants to the placement agent and the finder to purchase an
aggregate of 150,000 shares of IRIS Common Stock. These warrants are
exercisable at $7.80 per share for a five year period and include certain
registration rights.

10. REFERENCE LAB AGREEMENT.

During the first quarter of 1995, IRIS and Boehringer Mannheim Corporation
("BMC") and Boehringer Mannheim GmbH ("BMG"), BMC's German affiliate announced a
joint project to develop a high capacity automated urinalysis system primarily
for reference laboratories based on the proprietary technologies of both
companies. The program is jointly funded by both companies. In addition to
designing specific components of the new system, BMG has agreed to pay IRIS a
fixed amount of $640,000 for its research and development of the project. In
connection with this project and certain distribution considerations, IRIS
issued Corange (an affiliate of BMG) warrants to purchase 250,000 shares of
IRIS Common Stock at an exercise price of $7.375 per share and granted Corange
certain registration rights with respect to the shares of IRIS Common Stock
issuable upon exercise of these warrants.

11. PRODUCT LINE ACQUISITION.

During the first quarter of 1995, IRIS acquired the digital refractometer
product line of Biovation, Inc. for $850,000 in cash and warrants to purchase
75,000 shares of IRIS Common Stcok at an exercise price of $8.125 per share.
IRIS granted Biovation certain registration rights with respect to the shares of
IRIS Common Stock issuable upon exercise of these warrants. The product line
consists of a patented device known as a digital refractometer and the related
consumables used in the operation and maintenance of the refractometer.

36

12. CAPITAL STOCK.

STOCK ISSUANCES:

During 1990, the IRIS Board of Directors adopted an Employee Stock Purchase
Plan designed to allow employees of the Company to buy its shares at 50% of the
then current market price, provided that the employee agrees to hold the shares
purchased for a minimum of 2 years. Payment for the 50% portion may be made at
the option of the employee either by payroll deduction or by lump sum payment,
but in no event may it exceed more than 15% of the employee's salary during any
year. The remaining 50% portion is recorded as deferred compensation and
amortized over the vesting period. The shares purchased pursuant to the Plan
may not be transferred, except following the death of the employee or a change
in control, for a period of 2 years following the date of purchase. During the
period of the limitation on transfer, the Company has the option to repurchase
the shares at the employee's purchase price if the employee terminates
employment with the Company either voluntarily or as a result of termination for
cause. During 1993, 1994 and 1995, IRIS issued 27,942, 45,622, and 26,973
shares of common stock, respectively, in exchange for $134,952, $201,574, and
$179,630 in cash and services, respectively, under the Plan.

Stock Option Plans:

The following tables set forth information on the Company's five stock
option plans as of December 31, 1995:

Options
Options Options Options Available
Plan Authorized Exercised Outstanding for Grant
-----------------------------------------------------------------

1980 200,000 174,468 0 0

1982 84,000 75,034 4,000 0

1983 100,000 74,035 17,400 0

1986 360,000 135,932 223,801 267

1994 700,000 0 368,600 331,400
--------- ------- ------- -------
1,444,000 459,469 613,801 331,667
--------- ------- ------- -------
--------- ------- ------- -------

37

Exercise Price
----------------------------------------------------------
Shares $ Per Share Total
----------------------------------------------------------

Balance outstanding at December 31, 1992 . . . . . . . 443,300 1.10 to 4.25 $1,004,478
Options issued . . . . . . . . . . . . . . . . . . . . 91,000 4.00 to 4.04 364,525
Options cancelled. . . . . . . . . . . . . . . . . . . (15,400) 2.59 to 4.00 (59,814)
Options exercised. . . . . . . . . . . . . . . . . . . (46,533) 1.10 to 3.75 (101,746)
-------- ----------

Balance outstanding at December 31, 1993 . . . . . . . 472,367 1.10 to 5.00 1,207,443
Options issued . . . . . . . . . . . . . . . . . . . . 192,600 3.72 to 5.42 797,028
Options cancelled. . . . . . . . . . . . . . . . . . . (28,234) 1.55 to 4.25 (67,470)
Options exercised. . . . . . . . . . . . . . . . . . . (200,832) 1.10 to 3.75 (447,022)
-------- ----------

Balances outstanding at December 31, 1994. . . . . . . 435,901 1.10 to 5.42 1,489,979
Options issued . . . . . . . . . . . . . . . . . . . . 209,500 4.25 to 7.37 1,195,530
Options cancelled. . . . . . . . . . . . . . . . . . . (9,700) 1.57 to 4.00 (26,782)
Options exercised. . . . . . . . . . . . . . . . . . . (21,900) 1.10 to 4.00 (44,450)
-------- ----------
Balances outstanding at December 31, 1995. . . . . . . 613,801 $2,614,277
-------- ----------
-------- ----------

Options exercisable at December 31, 1995 . . . . . . . 280,386 1.10 to 7.37 $ 894,603
-------- ----------
-------- ----------

Warrants:

At December 31, 1995, there were warrants outstanding and exercisable to
purchase 250,000 shares of common stock at $7.375 per share until February 6,
1998, 75,000 shares at $8.125 per share until March 30, 1998, 512,000 shares at
$6.50 per share until September 29, 1998 and 150,000 shares at $7.80 per share
until September 28, 2000.

Preferred Stock:

IRIS is authorized to issue 3,000,000 shares of preferred stock in one or
more series with such terms as may be designated by the Board of Directors.
There are no issued and outstanding preferred shares at December 31, 1995.

13. COMMITMENTS.

Leases:

IRIS leases its primary business location at a monthly rent of $13,623,
subject to increases based on the Consumer Price Index. IRIS has the option to
renew the lease for two additional three-year periods commencing July 31, 1997.

At December 31, 1995, the minimum lease payments due over the remaining
life of this lease and three automobile leases were:

Year ended December 31, Amount
------------------------------------------------------------

1996 $173,028
1997 100,137
--------
$273,165
--------
--------

Rent expense under all operating leases during 1993, 1994 and 1995 was
$210,269, $194,591,and $358,469 respectively.

38

Other:

Effective September 1, 1988, IRIS entered into consulting and licensing
agreements with Cytocolor, Inc. relating to the use of its patented leukocyte
stain in The White IRIS-Registered Trademark-, a product currently under
development by IRIS. Under the terms of the agreements, IRIS is subject to the
following future minimum royalty payments:

Year ended December 31, Amount
------------------------------------------------------------

1996 $ 20,000
1997 20,000
1998 20,000
1999 20,000
Years thereafter 280,000
--------
$360,000
--------
--------

In connection with the development agreement with PSI, IRIS has agreed to
fund $15,000 per month (up to a maximum of $500,000) of the cost of the
development project (see Note 9).

14. EARNINGS PER SHARE.

The computation of per share amounts for 1993, 1994 and 1995, is based on
the weighted average number of common shares and common share equivalents
outstanding for the period. Fully diluted and primary earnings per share were
$.26, $.28, and $.35 for the years ended December 31, 1993, 1994 and 1995,
respectively.

15. LICENSE.

Pursuant to earlier payments and certain agreements with TOA Medical
Electronics Co., Ltd. (TOA), TOA has developed a urine sediment analyzer under
license from IRIS using pre-1989 IRIS technology in exchange for 3% royalty on
sales. IRIS received royalties of $35,000, $111,000, and $98,000 in 1993, 1994,
and 1995 respectively.

16. EXPORT SALES.

During 1993, 1994 and 1995, IRIS had export equipment sales of $0,
$199,000 and $183,000 respectively.

17. SUBSEQUENT EVENTS.

StatSpin Merger:

On February 1, 1996, a newly formed subsidiary of IRIS completed its
merger with Norfolk Scientific, Inc., d/b/a StatSpin Technologies,
("StatSpin"), which became a wholly owned subsidiary of IRIS. StatSpin
manufactures special purpose centrifuges and other small instruments widely
used in clinical, veterinary, physicians offices and research laboratories
and sells its products primarily through leading distributors to the
physician office and veterinary laboratory markets. IRIS issued
approximately 340,000 shares of common stock for all the outstanding common
stock and stock appreciation rights of StatSpin and assumed options and
warrants to purchase an additional 126,000 shares of IRIS common stock. This
represents an exchange ratio of 4.095 shares of IRIS for each common share
and each stock appreciation right of StatSpin. This transaction will be
accounted for as a pooling-of-interests.

Pro forma unaudited results of operations assuming the merger has occurred
on January 1, 1993 are as follows:

1993 1994 1995
---- ---- ----

Net revenues $10,930,047 $12,931,705 $15,864,320
Net income $ 929,457 $ 1,322,637 $ 2,356,615
Primary and fully diluted
earnings per share $0.18 $0.25 $0.37

39

Product Line Acquisition:

In March 1996, IRIS acquired the CenSlide and FloStar urinalysis devices
product line of UroHealth Sciences, Inc., for $850,000 in cash and the
assumption of certain liabilities.

18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

The following table summarizes certain financial information by quarter for
1994 and 1995:

1994
----------------------------------------------------------------------
March 31 June 30 September 30 December 31
----------------------------------------------------------------------

Net revenues $1,857,275 $2,656,315 $2,821,034 $3,327,319
Gross margin on net revenues 761,818 1,130,349 1,267,267 1,569,989

Interest and other income 92,577 53,123 68,602 59,050
Net income 94,819 356,128 441,532 580,407

Net income per share 0.02 0.07 0.08 0.11

1995
----------------------------------------------------------------------
March 31 June 30 September 30 December 31
----------------------------------------------------------------------

Net revenues $2,731,601 $3,354,727 $3,109,320 $3,569,074
Gross margin on net revenues 1,118,496 1,547,607 1,549,858 1,855,560

Interest and other income 113,558 91,786 85,654 114,487
Net income 309,975 (2,969,089) 501,021 4,249,524

Net income per share 0.06 (0.57) 0.08 0.67

40

EXHIBIT 11

STATEMENT RE COMPUTATION OF PER SHARE EARNINGS

Year Ended December 31,
----------------------------------------
1993 1994 1995
----------------------------------------

Actual Weighted Average Shares Outstanding for the Period. . . . . . . . . . . . 4,783,405 5,043,589 5,654,479
Dilutive Effects of Stock Options and Warrants Using Average
Market Price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 196,380 257,489 320,814
---------- ---------- ----------
Total Shares Based on Shares Outstanding and the Assumption
that All Share Equivalents Are Exercised at Average Stock
Market Price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,979,785 5,301,078 5,975,293
Additional dilutive effect of Stock Options and Warrants Being
Exercised Using Ending Market Price . . . . . . . . . . . . . . . . . . . . . . -- 22,030 67,713
---------- ---------- ----------
Total Shares Based on Shares Outstanding and the Assumption
That All Stock Options and Warrants are Exercised At Ending
Market Price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,979,785 5,323,108 6,043,006
---------- ---------- ----------
---------- ---------- ----------

Net Income Applicable to Fully Diluted Earnings Per Share. . . . . . . . . . . . $1,280,562 $1,472,886 $2,091,431
---------- ---------- ----------
---------- ---------- ----------

Fully Diluted Net Income Per Share . . . . . . . . . . . . . . . . . . . . . . . $ 0.26 $ 0.28 $ 0.35
---------- ---------- ----------
---------- ---------- ----------

41

EXHIBIT 24

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

We consent to the incorporation by reference in the registration statements
of International Remote Imaging Systems, Inc. on Forms S-8 (File Nos. 2-77496
and 33-10631) and on Form S-3 (File No. 33-02001) of our report dated March 20,
1996, on our audits of the financial statements of International Remote Imaging
Systems, Inc. as of December 31, 1995 and 1994, and for the years ended
December 31, 1995, 1994 and 1993, which report is included in this Annual Report
on Form 10-K.

COOPERS & LYBRAND L.L.P.

/s/ Coopers & Lybrand L.L.P.

Los Angeles, California
March 28, 1996

42

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

_______________________

EXHIBITS

TO

FORM 10-K

_______________________

For the fiscal year ended December 31, 1995 Commission File No. 0-9767

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.

43

EXHIBIT INDEX

The following exhibits are included herewith or the Form 10-K or are
incorporated by reference to documents which have been previously filed with the
Securities and Exchange Commission.

Exhibit
Number Description
------- -----------

3.1 Articles of Incorporation.1/
3.2 Bylaws.2/
3.3 Amendment to Bylaws (adopted March 17, 1996).
10.1 Lease of the Registrant's facilities.3/
10.2 1980 and 1982 Stock Option Plans, and forms of Stock Option
Agreements for each Plan.4/
10.3 1983 and 1986 Stock Option Plans, and forms of Stock Option
Agreements for each Plan.5/
10.4 Amended and Restated 1986 Stock Option Plan.6/
10.5 1994 Stock Option Plan and forms of Stock Option Agreements.7/
10.6 Various Agreements with TOA.8/
10.7 Agreement for a Strategic Alliance in Urinalysis dated January 7,
1994 between IRIS and BMC.9/
10.8 Securities Purchase Agreement dated as of April 20, 1994 by and
among IRIS, LDA and Corange International Limited.10/
10.9 Warrant Certificate dated April 22, 1994 issued to Corange
International Limited.9/
10.10 Research and Development and Distribution Agreement dated
February 6, 1995 by and among IRIS, LDA and Corange International
Limited.9/
10.11 Warrant Certificate dated February 6, 1995 issued to Corange
International Limited.9/
10.12 Asset Purchase Agreement dated as of March 20, 1995 between IRIS
and Biovation, Inc.9/
10.13 Warrant Certificate dated March 20, 1995 issued to Biovation,
Inc.9/
10.14 Technology License Agreement dated as of September 29, 1995
between IRIS and PSI.11/
10.15 Research and Development Agreement dated as of September 29, 1995
between IRIS and PSI.11/
10.16 $100 Class "A" Note dated September 29, 1995 issued by PSI in
favor of IRIS.11/
10.17 Certificate of Incorporation of PSI. (See Article FOUR regarding
the IRIS option.)11/
10.18 Agreement and Plan of Merger date January 31, 1996 by and among
IRIS, StatSpin and StatSpin Acquisition Corporation.
10.19 Registration Rights Agreement dated January 31, 1996 between IRIS
and StatSpin Stockholders.
10.20 Employment Agreement dated January 30, 1996 with Thomas F.
Kelley.
10.21 Lease for the facilities of the Registrant's subsidiary,
StatSpin.
11 Statement re Computation of Per Share Earnings.12/
24 Consent of Coopers & Lybrand L.L.P.12/

_______________

1/ Incorporated by reference to the Company's Current Report on Form 8-K dated
August 13, 1987 and its Quarterly Report on Form 10-Q for the quarter ended
September 30, 1993.
2/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1994.
3/ The most recent amendment of the lease is included herewith. The original
lease and all prior amendments are incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31, 1989,
its Quarterly Report on Form 10-Q for the quarter ended September 30, 1993
and its Annual Report on Form 10-K for the year ended December 31, 1994.
4/ Incorporated by reference to the Company's Registration Statement on Form
S-2, as filed with the Securities and Exchange Commission on September 4,
1985.
5/ Incorporated by reference to the Company's Registration Statement on Form
S-8, as filed with the Securities and Exchange Commission on May 10, 1982.
6/ Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1992.
7/ Incorporated by reference to the Company's Registration Statement on Form
S-8, as filed with the Securities and Exchange Commission on August 8,
1994.
8/ Incorporated by reference to the Company's Current Report on Form 8-K dated
July 15, 1988 and its Quarterly Report on Form 10-Q for the quarter ended
June 30, 1995.
9/ Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994.

44

10/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1994.
11/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1995.
12/ Omitted in copy distributed to stockholders in connection with the 1996
Annual Meeting of Stockholders.

45