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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[X]Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange
Act of 1934.
[Fee Required]
For the Fiscal Year Ended: December 31, 1997
or
[_]Transition Report Pursuant to Section 13 or 15(d) of The Securities
Exchange Act of 1934.
[No Fee Required]
For the transition period from to
COMMISSION FILE NUMBER: 0-27558
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CYTYC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 02-0407755
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
85 SWANSON ROAD, BOXBOROUGH, MASSACHUSETTS 01719
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(978) 263-8000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(TITLE OF CLASS)
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 the voting stock held by nonaffiliates of the
registrant as of March 23, 1998 (based on the closing price as quoted by
Nasdaq National Market as of such date) was $429,003,560.
As of March 23, 1998, 17,588,876 shares of the registrant's common stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive proxy statement pursuant to
Regulation 14A within 120 days of the end of the fiscal year ended December
31, 1997. Portions of such proxy statement are incorporated by reference into
Part III of this Form 10-K.
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PART I
ITEM 1. BUSINESS
THE COMPANY
Cytyc Corporation designs, develops, manufactures and markets a sample
preparation system for medical diagnostic applications. The Company's ThinPrep
System allows for the automated preparation of cervical cell specimens on
microscope slides for use in cervical cancer screening, as well as for the
automated preparation of other cell specimens on microscope slides for use in
non-gynecological testing applications. On May 20, 1996, the Company received
premarket approval ("PMA") from the United States Food and Drug Administration
("FDA") to market the ThinPrep System for cervical cancer screening as a
replacement for the conventional Pap smear method. On November 6, 1996, the
FDA cleared expanded product labeling for the ThinPrep System to include the
claim that the ThinPrep System is significantly more effective in detecting
Low Grade Squamous Intraepithelial Lesions ("LGSIL") and more severe lesions
than the conventional Pap smear method in a variety of patient populations.
The expanded labeling also indicates that the specimen quality using the
ThinPrep System is significantly improved over that of the conventional Pap
smear method. The Company believes that the ThinPrep System improves accuracy
in the detection of cervical cancer and precancerous lesions by making the
slide more representative of the patient's clinical condition, improving
preservation of the sample, standardizing the presentation of cells on the
slide, and reducing the presence of mucus, blood and other obscuring debris.
On February 25, 1997, the FDA approved the Company's supplemental PMA
application for use of a combination of an endocervical brush and spatula
sampling devices, a commonly used method of collecting samples for
conventional Pap smears. On September 4, 1997, the FDA approved the Company's
supplemental PMA application for the testing for the human papilloma virus
("HPV") directly from a single vial of patient specimen collected in a
ThinPrep solution using the Hybrid Capture HPV DNA Assay of Digene
Corporation. The Company conducted the full-scale commercial launch of the
ThinPrep System for cervical cancer screening in the United States in 1997.
See "Business--Marketing and Sales."
CERVICAL CANCER
Cervical cancer is one of the most common cancers among women throughout the
world. Cervical cancer is preceded by curable precancerous lesions that
progress without symptoms over a period of years until they become invasive,
penetrating the cervical epithelium (cellular covering) and entering the
bloodstream or lymph system. In order to detect these precancerous lesions,
gynecologists in the United States typically recommend annual screening
examinations. If detected in the precancerous stage, virtually all cervical
cancer cases are preventable. The treatment of cervical cancer after it
reaches the invasive stage may require surgery, including a hysterectomy, and
chemotherapy or radiation treatment, which are difficult, expensive and may
not be successful.
The factors associated with the development of cervical cancer are believed
to include early sexual activity, multiple sexual partners, cigarette smoking
and immunosuppression. In addition, a number of recent studies have concluded
that cervical cancer is strongly correlated to the presence of certain types
of HPV. According to these studies, HPV DNA is present in most cases of
precancerous lesions and in more than 90% of cases of intraepithelial and
invasive cancer. Cervical lesions that are HPV-negative or lacking certain
types of HPV are less likely to progress to cervical cancer.
THE PAP SMEAR
Cervical cancer screening has been conducted since the late 1940s using the
Pap smear, a test developed by Dr. George Papanicolaou. In the United States,
widespread and regular use of the Pap smear as a screening test has
contributed to a greater than 70% decrease in mortality from cervical cancer
in the past. The Pap smear is currently the most widely-used screening test
for the early detection of cancer in the United States.
The Pap Smear Process
The Pap smear process involves the science of cytology, which is the
microscopic interpretation of precancerous, malignant and other changes in
cells. The conventional Pap smear process begins with the collection of a
cervical specimen during a gynecological examination. To obtain a cervical
cell sample, a
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sampling device, such as either a brush and spatula or a "broom-like" device,
is used to scrape cells from the surface of the cervix. The sample is then
manually smeared onto a clean microscope slide by the physician who must then
spray the slide within a few seconds with a fixative agent to prevent damage
to the cell specimen from air drying. The slide is then submitted to a
clinical laboratory for manual microscopic examination.
At the laboratory, a cytotechnologist, a medical professional with special
training in the examination and interpretation of human cells, conducts a
microscopic review of a prepared slide to determine the adequacy of the sample
and the presence of abnormal cells. In determining slide adequacy,
cytotechnologists classify each slide in one of three categories: (i)
satisfactory for evaluation, (ii) satisfactory but limited by ("SBLB") certain
characteristics, or (iii) unsatisfactory for evaluation. The percentage of
unsatisfactory and SBLB slides varies widely from laboratory to laboratory. In
a 1991 study of 600 laboratories, it was reported that up to 20% of slides
were classified as unsatisfactory and up to 40% were classified as SBLB.
Frequent reasons for unsatisfactory or SBLB classifications include excess
blood or mucus that impairs viewing or too few cells per slide.
After determining the adequacy of the slide, the cytotechnologist manually
screens each Pap smear slide with a microscope to differentiate diseased or
abnormal cells from healthy cells based on size, shape and structural details
of the cells and nuclei. Typically, each Pap smear slide is then classified in
accordance with The Bethesda System for Reporting Cervical/Vaginal Cytologic
Diagnoses ("Bethesda System") into one of the following categories: (i)
Negative; (ii) Atypical Squamous Cells of Undetermined Significance/Atypical
Glandular Cells of Undetermined Significance ("ASCUS/AGUS"); (iii) Low Grade
Squamous Intraepithelial Lesions ("LGSIL"); (iv) High Grade Squamous
Intraepithelial Lesion ("HGSIL"); and (v) Carcinoma. Any slide classified as
other than negative is considered abnormal and may be precancerous or
cancerous. All abnormal slides are referred to a senior cytotechnologist and
pathologist for further review and final diagnosis.
Notwithstanding the classifications imposed by the Bethesda System, the
subjective nature of the classification of Pap smear specimens results in
diagnoses that vary widely among cytotechnologists, pathologists and
laboratories. In 1988, to address accuracy and quality control concerns,
Congress adopted the Clinical Laboratory Improvement Amendments of 1988
("CLIA"). CLIA requires cytology laboratories to perform proficiency testing
and quality control by testing cytotechnologists in order to assure a minimum
level of competence and expertise. In addition, the CLIA regulations currently
limit the number of slides screened per day by a cytotechnologist to 100.
Certain states have also adopted regulations further limiting the number of
slides which can be manually examined per day by a cytotechnologist. As a
further quality control measure, the CLIA regulations require that
laboratories manually rescreen at least 10% of the slides that are initially
classified as negative.
Other methods of rescreening are currently available, including computer
imaging technologies that select certain negative slides or portions of
negative slides for reexamination by the cytotechnologist. These computer
imaging technologies are intended to provide an additional quality control
measure to help identify false negative diagnoses.
Follow-Up Treatment of Abnormal Pap Smears
Women with abnormal Pap smears may have to return to their physician's
office for a repeat Pap smear or to undergo costly colposcopy and biopsy
procedures. A colposcopy involves the physician using a device to visually
examine the surface of the cervix, and if necessary, performing a biopsy.
Treatment of early-stage non-invasive cervical cancer may be accomplished by
procedures to remove the abnormal cells. Once the cancer reaches the invasive
stage, the patient's chances for recovery are diminished and more radical
treatment is typically required, such as a hysterectomy and chemotherapy or
radiation therapy. These procedures may expose the patient to risk and cost
and result in significant physical and psychological stress.
PROBLEMS WITH THE CONVENTIONAL PAP SMEAR
In spite of the success of the Pap smear in reducing deaths due to cervical
cancer, the test has significant limitations, including inadequacies in sample
collection and slide preparation, slide interpretation errors and the
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inability to use the specimen for additional diagnostic tests. These
limitations result in a substantial number of inaccurate test results,
including false negative diagnoses.
False Negative Diagnoses
The limitations of the conventional Pap smear method in sample collection,
slide preparation and interpretation result in a substantial number of
inaccurate test results in the form of false negative diagnoses. A false
negative diagnosis may allow the disease to progress to a later-stage of
development before being detected, thereby requiring a more expensive and
invasive course of treatment and diminishing the likelihood of successful
treatment. Reports of the false negative rate of the Pap test vary widely,
between 5% and 55%. Studies suggest that approximately 50% of false negative
diagnoses are attributable to inadequacies in sample collection and slide
preparation and approximately 50% are attributable to slide interpretation
errors.
Inadequacies in Sample Collection and Slide Preparation
There are a variety of difficulties with current methods of cell collection,
cell transfer and slide preparation. These difficulties include cell loss,
improper fixation of the cells (typically, from air drying), thick and uneven
smearing of cells on the slide, and excess blood, mucus and other obscuring
debris on the slide. A study published in the American Journal of Clinical
Pathology in February 1994 reported that as much as 80% of the sample taken
from a patient using the conventional Pap smear method is not transferred to
the microscope slide and remains on the discarded collection device. This
discarded portion of the sample may contain the abnormal cells necessary for
an accurate diagnosis. In addition to the problem of cell transfer, the
conventional Pap smear method produces inconsistent and non-uniform slides
with extreme variability in quality, making examination difficult. The Company
believes that these limitations are responsible for a large percentage of
slides being classified as SBLB. These slides are more difficult to interpret
and increase the uncertainty of an accurate diagnosis. Consequently, patients
are often subjected to the inconvenience and expense of return office visits
for repeat testing and to the anxiety resulting from the inconclusive nature
of the initial test. The Company believes that these repeat visits and
examinations also result in significant costs to the healthcare system.
Slide Interpretation Errors
The process of screening and interpreting a manually prepared Pap smear is
complex and tedious. This process requires constant vigilance, as
approximately 90% to 95% of all Pap smear diagnoses in the United States are
negative. In addition, the process is prone to error as a result of the
complexity of properly evaluating and categorizing subtle and minute changes
in cellular or nuclear detail. The screening process requires intense visual
review through a microscope of a large volume of slides, each of which
typically contains 50,000 to 300,000 cervical cells. The small percentage of
Pap smears that contain any abnormality may, in turn, contain only a small
number of abnormal cells among the vast number of normal cells.
Cytotechnologists generally review each slide for approximately five to 10
minutes and may review up to 100 slides per day. All of these factors
contribute to the incidence of false negative diagnoses.
Lack of Additional Testing Capability
The conventional Pap smear method does not permit additional or adjunct
testing from the original patient sample. The ability to produce multiple
slides from a single sample could be used by clinical laboratories for follow-
up testing, quality control or proficiency testing. Further, the conventional
Pap smear method requires the patient to be called back to the physician's
office to provide a second sample if additional testing, such as HPV testing,
is desired. The Company believes that the ability to test for HPV directly
from the ThinPrep collection vial has the potential for substantial healthcare
cost savings through reduced costly management of borderline cervical
abnormalities.
THE THINPREP SYSTEM
The Company believes that the ThinPrep System offers a number of benefits
which address limitations of the conventional Pap smear method, including
improved accuracy in the detection of cervical cancer and precancerous
lesions, standardization and simplification of the sample preparation process,
the ability to permit
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multiple tests to be conducted from a single sample and improved productivity
in screening by reducing cytotechnologist fatigue and the time required to
examine each slide. In August 1997, Obstetrics & Gynecology, a preeminent,
widely read, peer-reviewed journal on women's healthcare issues, published a
major study describing the effectiveness of the ThinPrep Pap Test in screening
for cervical cancer.
The ThinPrep System, which was cleared for marketing as a replacement for
the conventional Pap smear method for cervical cancer screening by the FDA on
May 20, 1996, consists of the ThinPrep 2000 Processor and related disposable
reagents, filters and other supplies. The ThinPrep System is designed to
reduce the incidence of false negative diagnoses, improve slide quality,
reduce inconclusive SBLBs and enable a single sample to be used for additional
diagnostic testing. On November 6, 1996, the FDA cleared expanded product
labeling for the ThinPrep System to include the claim that the ThinPrep System
is significantly more effective in detecting LGSIL and more severe lesions
than the conventional Pap smear method in a variety of patient populations.
This expanded labeling also indicates that the specimen quality using the
ThinPrep System is significantly improved over that of the conventional Pap
smear method. In February 1997, the Company received FDA approval of the
Company's supplemental PMA application for the use of a combination of an
endocervical brush and spatula sampling devices, a commonly used method of
collecting samples for conventional Pap smears. In September 1997, the FDA
approved the Company's supplemental PMA application for the testing for HPV
directly from a single vial of patient specimen collected in a ThinPrep
solution using the Hybrid Capture HPV DNA Assay of Digene Corporation.
The ThinPrep process begins with the patient's cervical sample being taken
by the physician using a cervical sampling device which, rather than being
smeared on a microscope slide, is rinsed in a vial filled with the Company's
proprietary PreservCyt Solution. This enables virtually all of the patient's
cell sample to be preserved before the cells can be damaged by air drying. The
ThinPrep specimen vial is then labeled and sent to a laboratory equipped with
a ThinPrep 2000 Processor for slide preparation and screening.
At the laboratory, the ThinPrep specimen vial is inserted into a ThinPrep
2000 Processor, a proprietary sample preparation device which automates the
process of preparing cervical specimens. Once the vial is inserted into the
ThinPrep 2000 Processor, a gentle dispersion step breaks up blood, mucus, non-
diagnostic debris and large sheets of cells and homogenizes the cell
population. The cells are then automatically collected on the Company's
proprietary TransCyt Filter, which incorporates an eight micron membrane
specifically designed to collect abnormal and cancerous cells. The ThinPrep
2000 Processor constantly monitors the rate of flow through the TransCyt
Filter during the collection process in order to prevent the cellular
presentation from being too scant or too dense. A thin layer of cells is then
transferred to a glass slide in a 20 mm-diameter circle and the slide is
automatically deposited into a preservative solution. The ThinPrep 2000
Processor allows for the processing of approximately 20 to 25 patient samples
per hour.
The Company's proprietary reagents and supplies include PreservCyt Solution
to collect and transport cervical samples to the laboratory for optimal cell
preservation and TransCyt Filters to collect cells and remove non-diagnostic
debris and mucus. The Company also sells ThinPrep Microscope Slides, high-
quality microscope slides manufactured to the Company's specifications, which
improve cell adhesion to the slide.
CLINICAL TRIAL RESULTS
In October 1995, the Company completed the clinical trial used to support
its PMA application, which was a blinded study performed at six clinical sites
in the United States, including three screening centers and three hospital
sites. The study was designed to rigorously compare the effectiveness of the
ThinPrep System to the conventional Pap smear method for the detection of
precancerous lesions of the cervix. Specimen adequacy was also compared.
Combining the results of all six sites and 6,747 patients, the ThinPrep
System demonstrated a statistically significant 18% improvement in the
detection of disease (LGSIL or higher classification) as compared to the
conventional Pap smear. The results from the three screening centers indicated
a 65% improvement in the
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detection of disease, while in the three hospital sites in which patients had
historically exhibited high prevalence rates of cervical abnormalities, the
ThinPrep method demonstrated a 6% improvement. Based on the clinical trial
results, the FDA cleared expanded product labeling for the ThinPrep System to
include that the ThinPrep System is significantly more effective in detecting
LGSIL and more severe lesions than the conventional Pap smear method in a
variety of patient populations.
Slides from each patient were also evaluated for specimen adequacy.
Combining the results of all six sites, the ThinPrep System reduced the SBLB
classification rate of specimen adequacy by 29%, a statistically significant
reduction. The Company believes, based on data submitted with its PMA
application, that the ThinPrep System may reduce SBLB classifications by as
much as 50% if the immersion of the sampling device in the PreservCyt Solution
occurs directly after the sample is taken rather than after the preparation of
a conventional Pap smear slide. The direct immersion procedure reflects the
intended use of the ThinPrep System in clinical practice. Based on the
clinical trial results, the FDA cleared expanded product labeling for the
ThinPrep System to include that the specimen quality using the ThinPrep System
is significantly improved over that of the conventional Pap smear method.
NON-GYNECOLOGICAL CYTOLOGY
In May 1991, the Company began commercial shipments of the ThinPrep
Processor to cytology laboratories in the United States for use in non-
gynecological testing applications. Non-gynecological specimens include
sputum; voided and catheterized urine; body fluids such as peritoneal fluid,
ascites fluid, or cerebrospinal fluid; brushing of respiratory or
gastrointestinal tracts; and fine needle aspiration specimens obtained from a
variety of sources such as the breast, thyroid, lung or liver. These samples
are evaluated in patients in whom malignancy is strongly suspected or as
follow-up information in patients previously diagnosed and treated for cancer.
MARKETING AND SALES
The Company's marketing and sales strategy is to achieve broad market
acceptance of the ThinPrep System for cervical cancer screening. A critical
element of its strategy is to utilize the results of the Company's 1995
clinical trial and expanded FDA labeling to demonstrate the safety and
efficacy of the ThinPrep System to healthcare providers, third-party payors
and clinical laboratories. The Company believes that coordination of the
activity of these three market segments is necessary to achieve the desired
level of market penetration of the ThinPrep System. In 1997, the Company
implemented a full-scale commercial launch of the ThinPrep System in the
United States with its direct marketing and sales force organization,
complemented by the initiation of strategic marketing relationships with third
parties.
The Company continues to expand its direct marketing and sales organization
in the United States, supported by customer and technical service
representatives. The Company's direct marketing and sales organization focuses
on the clinical and economic benefits of the ThinPrep System for healthcare
providers, third-party payors and clinical laboratories. The Company designs
its marketing programs to establish and reinforce the recognition of its
corporate and product names through investments in medical advertising, direct
mail, focused medical educational symposia, trade shows and other promotional
activities. The Company has also initiated an education and training program
which will be offered to accredited cytology schools across the United States.
In addition to its direct sales efforts, the Company has built strategic
marketing relationships with third parties, including Mead Johnson, a division
of Bristol-Myers Squibb Company. The Company has entered into an agreement
with Mead Johnson Nutritionals ("MJN") to build a joint sales force of
approximately 500 sales representatives to co-promote the ThinPrep Pap Test
directly to over 15,000 obstetricians and gynecologists throughout the United
States. The Company has also entered into agreements with large clinical
laboratory companies with a network of laboratories across the United States.
The clinical laboratory companies have worked with the Company on marketing
and sales programs, which generally involve joint marketing geared toward
promoting the Company's products to physicians and third-party payors.
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Following the initial market launch of the ThinPrep product in the United
States, the Company has more recently expanded its marketing and sales efforts
beyond the United States to Europe and Australia. The Company has established
subsidiaries in Switzerland and Australia in 1997, and most recently in France
and Italy, to handle sales, service, training and distribution to clinical
laboratories. The Company's strategy is to establish a worldwide selling
channel appropriate for developing an international customer-base, taking into
consideration factors such as government regulations, screening cycles and
clinical practices of the particular country or region. The Company is also
evaluating the use of direct and indirect international sales channels,
including contract sales organizations, distributors and marketing partners.
Due to limited market awareness of the ThinPrep System, the Company believes
that both domestic and international sales efforts will continue to involve a
lengthy process, requiring the Company to educate healthcare providers and
third-party payors regarding the clinical benefits and cost-effectiveness of
the ThinPrep System. The Company's success and growth will depend on market
acceptance of the ThinPrep System among healthcare providers, third-party
payors and clinical laboratories. The Company will continue to sell the
ThinPrep 2000 Processor to customers and charge separately for related
disposable reagents, filters and supplies. In the past, the Company has
offered discounts to stimulate demand for the ThinPrep System and may elect to
do so in the future, which discounts could have a material adverse effect on
the Company's business, financial condition and results of operations.
In order to effectively market the ThinPrep System for cervical cancer
screening, the Company will need to continue to increase its marketing and
sales capabilities. No assurance can be given that the Company's direct sales
force or strategic marketing relationships will succeed in promoting the
ThinPrep System to healthcare providers, third-party payors or clinical
laboratories, or that additional marketing and sales channels will be
successfully established. While the Company is currently evaluating marketing
and sales channels abroad, including contract sales organizations,
distributors and marketing partners, the Company has established very limited
foreign sales channels. There can be no assurance that the Company will be
able to recruit and retain skilled marketing, sales, service or support
personnel or foreign distributors, or that the Company's marketing and sales
efforts will be successful. Failure to successfully expand its marketing and
sales capabilities in the United States or establish its international
marketing and sales organization internationally would have a material adverse
effect on the Company's business, financial condition and results of
operations. The Company's marketing success in the United States and abroad
will depend on whether it can obtain required regulatory approvals,
successfully demonstrate the cost-effectiveness of the ThinPrep System,
further develop its direct sales capability and establish arrangements with
contract sales organizations, distributors and marketing partners. Failure by
the Company to successfully market its products would have a material adverse
effect on the Company's business, financial condition and results of
operations.
RESEARCH AND DEVELOPMENT
The Company's research and development strategy is to continue to develop
innovative medical diagnostic applications of the ThinPrep technology and to
continue to enhance the ThinPrep System. The Company has established a program
to further enhance and automate the ThinPrep Processor. The Company's next
generation instrument, the ThinPrep 3000 Processor, is being designed to
provide batch processing and walk-away capability by increasing capacity to 80
sample vials and more fully-automating the slide preparation process. The
Company expects to conduct clinical trials using the automated ThinPrep 3000
Processor in 1998. Although the Company anticipates that the ThinPrep 3000
Processor will be commercially available during early 1999, there can be no
assurance that the ThinPrep 3000 will be successfully developed, receive
necessary regulatory approvals, or be successfully commercialized.
The Company is also evaluating additional diagnostic applications of its
ThinPrep technology in testing for the presence of other types of cancers and
sexually transmitted diseases. The Company has not yet determined which of
these applications, if any, it will seek to develop and commercialize. There
can be no assurance that the Company will be successful in developing or
marketing additional applications. Furthermore, any additional
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applications will require submission of a PMA application or PMA supplement
prior to the marketing of such applications. There can be no assurance that
the FDA would approve such submissions on a timely basis, if at all.
In addition, the Company is evaluating the use of certain automated
rescreening methods in conjunction with the ThinPrep System. Such systems use
imaging technology to identify slides as more likely to contain cellular
abnormalities. On November 8, 1996, the Company and Neopath, Inc. ("Neopath")
announced the completion of a joint study of the feasibility of screening
cervical specimens using the ThinPrep System in conjunction with Neopath's
AutoPap QC. Additional development work would be required prior to application
to the FDA for the use of such systems in combination. There can be no
assurance that either company will conduct further development work with
respect to this study or that the Company will be able to integrate
successfully the ThinPrep technology with any automated rescreening
technology. The Company is also developing imaging technology, which is also
subject to regulatory approvals. There can be no assurance that the Company
will obtain necessary regulatory approvals or successfully develop such
imaging technology.
The Company's expenditures for research and development (which includes
clinical trials, regulatory affairs and engineering) were approximately $3.9
million, $4.7 million, and $6.0 million for the years ended December 31, 1995,
1996 and 1997, respectively.
THIRD-PARTY REIMBURSEMENT
The Company intends to focus on obtaining coverage and reimbursement from
major national and regional managed care organizations and insurance carriers
throughout the United States. Most of the third-party payor organizations
independently evaluate new diagnostic procedures by reviewing the published
literature and the Medicare coverage and reimbursement policy on the specific
diagnostic procedure. To assist the third-party payors in their respective
evaluations of the ThinPrep System, the Company provides scientific and
clinical data to support its claims of the safety and efficacy of the ThinPrep
System. The Company believes that the ThinPrep System will allow for earlier
detection of LGSIL and more severe lesions and result in less aggressive and
costly treatment procedures. In addition, the Company expects that the
ThinPrep System will significantly improve specimen adequacy, thereby reducing
repeat office visits and test procedures and thus overall healthcare
management costs. The Company will focus on earlier disease detection and cost
savings benefits in establishing reimbursement for the ThinPrep method for
cervical cancer screening.
In the United States, the current rate of reimbursement to laboratories from
managed care organizations and other third-party payors to screen conventional
Pap smears ranges from approximately $6.00 to $36.00 per test, with $17.00 as
the most common rate of reimbursement. The Company believes that the cost per
ThinPrep Pap Test, plus a laboratory mark-up, will be billed to third-party
payors and result in a higher cost than the current charge for conventional
Pap tests.
Successful sales of the ThinPrep System for cervical cancer screening in the
United States and other countries will depend on the availability of
reimbursement from third-party payors such as private insurance plans, managed
care organizations, and Medicare and Medicaid. Although United HealthCare has
announced that it will expand its healthcare coverage to include the ThinPrep
Pap Test, the applicable rate of reimbursement is negotiated between United
HealthCare or its various plans and the specific clinical laboratories
servicing such plans. In February 1997, Blue Cross Blue Shield of
Massachusetts announced that it would expand its healthcare coverage to
include the ThinPrep Pap Test and since that announcement, fifteen additional
Blue Cross and Blue Shield plans across the United States have added the
ThinPrep Pap Test to their list of covered benefits. In 1997, the United
States Healthcare Financing Administration ("USHCFA") determined that Medicare
would cover the ThinPrep Pap Test. Because the ThinPrep Pap Test is a new
test, the USHCFA did not assign a reimbursement level for the procedure, but
instead allows Medicare intermediaries at the state level to "gap fill" or
reimburse for the procedure based on the laboratory billing they receive.
Although a number of managed care organizations have added the ThinPrep Pap
Test to their coverage, there can be no assurance that third-party payors will
provide or continue to provide such coverage, that reimbursement levels will
be adequate or that healthcare providers or clinical laboratories will use the
ThinPrep System for cervical cancer screening in lieu of the
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conventional Pap smear method. There is significant uncertainty concerning
third-party reimbursement for the use of any medical device incorporating new
technology. In February 1998, the BlueCross BlueShield Association's
Technology Evaluation Center announced results of a recent review of three new
cervical cancer screening technologies, including the ThinPrep Pap Test, with
respect to cost-effectiveness. Although the review concluded that such
technologies offered only modest improvement, the Company believes that the
study did not consider certain cost advantages inherent in using the ThinPrep
System. The study's conclusions are not binding and do not represent a
national coverage or reimbursement decision by the Blue Cross and Blue Shield
organizations. Although the Company believes that to date the review has not
caused any change in the decision of Blue Cross and Blue Shield plans
currently reimbursing laboratories for the ThinPrep Pap Test, there can be no
assurance that the review will not lead to adverse reimbursement decisions by
Blue Cross, Blue Shield plans or others. Reimbursement by a third-party payor
depends on a number of factors, including the level of demand by healthcare
providers and the payor's determination that the use of the ThinPrep System
represents a clinical advance compared to current technology and is safe and
effective, medically necessary, appropriate for specific patient populations
and cost-effective. Since reimbursement approval is required from each payor
individually, seeking such approvals is a time-consuming and costly process
which requires the Company to provide scientific and clinical data to support
the use of the ThinPrep System to each payor separately. There can be no
assurance that third-party reimbursement will be or remain available for the
ThinPrep System or any other products that may be developed by the Company, or
that such third-party reimbursement will be adequate.
A key component in the reimbursement decision by most private insurers and
the United States Health Care Financing Administration, which administers
Medicare, is the assignment of a CPT code which is used in the submission of
claims to insurers for reimbursement for medical services. CPT codes are
assigned, maintained and revised by the CPT Editorial Board administered by
the American Medical Association. In 1997, the CPT Editorial Board assigned a
new CPT code number 88142 effective as of January 1, 1998, specifically for
liquid-based monolayer cervical cell specimen preparation.
The Company has limited experience in obtaining reimbursement for its
products in the United States or other countries. In addition, third-party
payors are routinely limiting reimbursement and coverage for medical devices
and in many instances are exerting significant pressure on medical suppliers
to lower their prices. Lack of or inadequate reimbursement by government and
other third-party payors for the Company's products would have a material
adverse effect on the Company's business, financial condition and results of
operations. Further, outside of the United States healthcare reimbursement
systems vary from country to country, and there can be no assurance that
third-party reimbursement will be made available at an adequate level, if at
all, for the ThinPrep System under any other reimbursement system.
MANUFACTURING
The Company manufactures its ThinPrep 2000 Processors and filters and
purchases related disposable reagents and supplies from third parties. In
November, 1997, the Company leased additional space at its current facility
and currently has a lease for a total of approximately 97,000 square feet. The
Company believes that its existing manufacturing equipment is adequate to meet
the full-scale production demands for the ThinPrep System for cervical cancer
screening.
In 1997, the Company installed new custom-built automated manufacturing
equipment, which incorporates new materials handling procedures that increased
production capacity. The Company is committed to expand its manufacturing
capacity by ordering approximately $2.0 million of additional custom-built
automated equipment, which is expected to be installed in late 1998.
The Company's manufacturing process is subject to pervasive and continuing
regulation by the FDA, including the FDA's Good Manufacturing Practices
("GMP") requirements. Failure to comply with such regulations would materially
impair the Company's ability to achieve or maintain commercial-scale
production. Further, any failure of the Company's custom-built equipment to
perform to the Company's specifications could impair the Company's ability to
produce adequate quantities of ThinPrep supplies. Further, the Company has
9
limited manufacturing experience with the ThinPrep System and, accordingly,
there can be no assurance that the Company's ThinPrep System for cervical
cancer screening will perform adequately in the field when subjected to use
under a variety of conditions. As a result, the Company may be subject to
total or partial suspension of production, withdrawal of approval, and recall
or seizure of products by the FDA in the event of product malfunction or
failure.
In October 1997, the Company obtained ISO 9001 registration, an
international quality standard. The Company has also met the applicable
requirements to use the "CE" mark for its ThinPrep System. There can be no
assurance that the Company will be able to maintain compliance with ISO 9001
or CE mark requirements. Failure to maintain compliance with the applicable
manufacturing requirements of various regulatory agencies would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Certain key components of the Company's ThinPrep System are currently
provided to the Company by single sources. In the event that the Company is
unable to obtain sufficient quantities of such components on commercially
reasonable terms, or in a timely manner, the Company would not be able to
manufacture its products on a timely and cost-competitive basis, which would
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company must obtain approval of a PMA
supplement in order to change suppliers or obtain new suppliers.
GOVERNMENT REGULATION
The manufacture and sale of medical diagnostic devices intended for
commercial use are subject to extensive governmental regulation in the United
States and in other countries. The Company's existing products, including the
ThinPrep System, are regulated in the United States as medical devices by the
FDA under the Federal Food, Drug, and Cosmetic Act ("FDC Act") and generally
require premarket clearance or PMA approval prior to commercial distribution.
In addition, certain material changes or modifications to medical devices also
are subject to the FDA review and clearance or approval. Pursuant to the FDC
Act, the FDA regulates the research, testing, manufacture, safety, labeling,
storage, record keeping, advertising, distribution and production of medical
devices in the United States. Noncompliance with applicable requirements can
result in failure of the government to grant premarket approval for devices,
withdrawal of clearances or approvals, total or partial suspension of
production, fines, injunctions, civil penalties, recall or seizure of
products, and criminal prosecution.
The regulatory approval process can be expensive, lengthy and uncertain.
There can be no assurance that the Company will be able to obtain necessary
regulatory approvals for any proposed future products or modifications of
existing products. The failure to obtain approvals, loss of previously
received approvals, or failure to comply with existing or future regulatory
requirements, would have a material adverse effect on the Company's business,
financial condition and results of operations.
The FDA's regulations require agency approval of a PMA supplement for
certain changes if they affect the safety and effectiveness of the device,
including, but not limited to, new indications for use; labeling changes; the
use of a different facility or establishment to manufacture, process, or
package the device; changes in manufacturing facilities, methods, or quality
control systems; and changes in performance or design specifications.
The ThinPrep System for cervical cancer screening received PMA approval in
May 1996. The Company anticipates that other proposed uses for the ThinPrep
System will require approval of a PMA supplement or a new PMA application.
There can be no assurance that such approvals will be obtained on a timely
basis, or at all.
In July 1997, several petitions were filed requesting that the FDA review
the PMA approval granted to the ThinPrep System. The petitions were filed
pursuant to a provision of the FDC Act permitting any interested party to
initiate a process by which the FDA may review an approval order and may issue
an order affirming, reversing or modifying the approval. To the Company's
knowledge, the FDA has conducted a review pursuant
10
to this provision only twice since the enactment of the Medical Device
Amendments of 1976. The Company responded to the petitions by submitting
comments in December 1997 arguing that the FDA should deny them. No assurance
can be given that the FDA will not conduct a review of the PMA approval
granted with respect to the ThinPrep System, nor can assurance be given that
the FDA will not, after such review, issue an order reversing or unfavorably
modifying the original PMA approval. Any such action by the FDA would have a
material adverse effect on the Company.
The ThinPrep System is, and any other products manufactured or distributed
by the Company pursuant to an approved PMA application and supplements will
be, subject to pervasive and continuing regulation by the FDA, including
record-keeping requirements, reporting of adverse experience with the use of
the device, postmarket surveillance, postmarket registry and other actions as
deemed necessary by the FDA. The Company is subject to FDA inspection for
compliance with regulatory requirements. Product labeling and promotional
activities are also subject to scrutiny by the FDA and, in certain instances,
by the Federal Trade Commission. Products may only be promoted by the Company
and any of its distributors for their approved indications. No assurance can
be given that modifications to the labeling which may be required by the FDA
in the future will not adversely affect the Company's ability to market or
sell the ThinPrep Processor.
The Company also is subject to numerous federal, state and local laws
relating to such matters as safe working conditions, manufacturing practices,
environmental protection, fire hazard control and disposal of hazardous or
potentially hazardous substances. There can be no assurance that the Company
will not be required to incur significant costs to comply with such laws and
regulations in the future, or that such laws or regulations will not have a
material adverse effect upon the Company's business, financial condition and
results of operations.
Sales of medical devices outside of the United States are subject to foreign
regulatory requirements that vary widely from country to country. The time
required to obtain approval by a foreign country may be longer or shorter than
that required for FDA approval, and the requirements may differ. No assurance
can be given that such foreign regulatory approvals will be granted on a
timely basis, or at all. In addition, there can be no assurance that the
Company will meet the FDA's export requirements or receive FDA export approval
when such approval is necessary, or that countries to which the devices are to
be exported will approve the devices for import. Failure of the Company to
meet the FDA's export requirements or obtain FDA export approval when required
to do so, or to obtain approval for import, could have a material adverse
effect on the Company's business, financial condition and results of
operations.
In February 1997, the Company received FDA approval of the Company's PMA
supplement for the ThinPrep System using a combination of an endocervical
brush and spatula sampling devices, which is a commonly used method of
collecting samples for conventional Pap smears.
In April 1997, the Company received the FDA's approval of a PMA supplement
of certain manufacturing process and material changes (and other related
changes to the device, including a software modification).
In September 1997, the FDA approved the Company's supplemental PMA
application for the testing for HPV directly from a single vial of patient
specimen collected in a ThinPrep solution using the Hybrid Capture HPV DNA
Assay of Digene Corporation.
The laboratories that would purchase the ThinPrep System are subject to
extensive regulation under the Clinical Laboratory Improvement Amendments of
1988 (CLIA), which requires laboratories to meet specified standards in the
areas of personnel qualifications, administration, participation in
proficiency testing, patient test management, quality control, quality
assurance and inspections. The Company believes that the device operates in a
manner that will allow laboratories purchasing the device to comply with CLIA
requirements. However, there can be no assurance that interpretations of
current CLIA regulations or future changes in CLIA regulations would not make
compliance by the laboratory difficult or impossible and therefore have an
adverse effect on sales of the ThinPrep System.
PATENTS, TRADEMARKS, COPYRIGHTS, LICENSES AND PROPRIETARY RIGHTS
The Company relies on a combination of patents, trademarks, trade secrets,
copyrights and confidentiality agreements to protect its proprietary
technology, rights and know-how. The Company pursues patent protection
11
in the United States and files corresponding patent applications in certain
foreign jurisdictions. The Company holds ten issued United States patents, two
pending United States patent applications, and corresponding foreign patents
or patent applications relating to various aspects of its ThinPrep technology.
There can be no assurance, however, that pending patent applications will
ultimately issue as patents or that the claims allowed in any of the Company's
existing or future patents will provide competitive advantages for the
Company's products or will not be successfully challenged or circumvented by
competitors. Under current law, patent applications in the United States are
maintained in secrecy until patents are issued and patent applications in
foreign countries are maintained in secrecy for a period after filing. The
right to a patent in the United States is attributable to the first to invent,
not the first to file a patent application. The Company cannot be sure that
its products or technologies do not infringe patents that may be granted in
the future pursuant to pending patent applications or that its products do not
infringe any patents or proprietary rights of third parties. In the event that
any relevant claims of third-party patents are upheld as valid and
enforceable, the Company could be prevented from selling its products or could
be required to obtain licenses from the owners of such patents or be required
to redesign its products to avoid infringement. There can be no assurance that
such licenses would be available or, if available, would be on terms
acceptable to the Company or that the Company would be successful in any
attempts to redesign its products or processes to avoid infringement. The
Company's failure to obtain these licenses or to redesign its products would
have a material adverse effect on the Company's business, financial condition
and results of operations. There can be no assurance that the obligations of
employees of the Company and third parties with whom the Company has entered
into confidentiality agreements to maintain the confidentiality of such trade
secrets and proprietary information will effectively prevent disclosure of the
Company's confidential information or provide meaningful protection for the
Company's confidential information if there is unauthorized use or disclosure,
or that the Company's trade secrets or proprietary information will not be
independently developed by the Company's competitors. In addition, the Company
is the exclusive licensee of certain patented technology from DEKA for use in
the field of cytology related to the fluid pumping system used in the ThinPrep
System. The Company is obligated to pay royalties equal to 1% of net sales of
the ThinPrep Processor, filter cylinder disposable products which are used in
the ThinPrep System, and improvements made by the Company relating to such
items. The license provides that it may be terminated (1) by mutual written
consent of both parties or (ii) by DEKA on written notice to the Company in
the event that the license is assigned without the consent of DEKA. Failure by
the Company to maintain rights to such technology could have a material
adverse effect on the Company's business, financial condition and results of
operations. The Company also holds unregistered rights to copyrights on
documentation and operating software developed by it for the ThinPrep System.
There can be no assurance that any copyrights owned by the Company will
provide competitive advantages for the Company's products or will not be
challenged or circumvented by its competitors. Litigation may be necessary to
defend against claims of infringement, to enforce patents and copyrights of
the Company, or to protect trade secrets and could result in substantial cost
to, and diversion of effort by, the Company. There can be no assurance that
the Company would prevail in any such litigation. In addition, the laws of
some foreign countries do not protect the Company's proprietary rights to the
same extent as do the laws of the United States.
COMPETITION
The Company faces direct competition from a number of publicly-traded and
privately-held companies, including other manufacturers of thin layer slide
preparation systems. Many of the Company's existing and potential competitors
have substantially greater financial, marketing, sales, distribution and
technical resources than the Company, and more experience in research and
development, clinical trials, regulatory matters, manufacturing and marketing.
In addition, many of these companies may have established third-party
reimbursement for their products. Several established medical device
manufacturers produce thin layer slide preparation systems for use in non-
gynecological testing applications, at least one of which has achieved brand-
name recognition and significant penetration in the non-gynecological cytology
market. The Company is aware that another potential competitor, AutoCyte,
Inc., has submitted a PMA for a system for the production and automated
analysis of thin-layer slides, a potential alternative to the conventional Pap
smear and the ThinPrep Pap Test. In addition, Neopath, Inc. is seeking FDA
approval of its AutoPap QC product, an automated computer-aided imaging
system, as a primary screening method. On January 28, 1998, the FDA's
Hematology and
12
Pathology Devices panel unanimously recommended that the FDA approve the
AutoPap QC for primary screening. The FDA typically accords substantial weight
to a panel's recommendation but is not bound by it. The development, FDA
approval and commercial marketing of such systems for cervical cancer
screening could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition to direct
competition, the Company faces indirect competition from companies which
currently market imaging systems to reexamine or rescreen conventional Pap
smears previously diagnosed as negative. The Company believes that these
rescreening systems, as currently sold, could not be used with the ThinPrep
System, and, therefore, if either of such systems is installed at or used by
hospitals and reference laboratories, the Company's ability to market its
products to such hospitals and laboratories could be materially adversely
affected. In addition, if any company receives FDA approval of an imaging
system as a primary screening system to replace some or all of the manual
screening of conventional Pap smears, marketing of these systems for such
purpose could have a material adverse effect on the Company's business,
financial condition and results of operations. The medical device industry is
characterized by rapid product development and technological advances. The
Company's products could be rendered obsolete or uneconomical by the
introduction and market acceptance of competing products, by technological
advances of the Company's current or potential competitors or by other
approaches. The Company competes on the basis of a number of factors,
including manufacturing efficiency, marketing and sales capabilities and
customer service and support, areas in which the Company currently has limited
experience. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that competition,
including the development and commercialization of new products and
technology, will not have a material adverse effect on the Company's business,
financial condition or results of operations.
EMPLOYEES
As of December 31, 1997, the Company employed 209 persons. The Company is
not subject to any collective bargaining agreements, has never experienced a
work stoppage and considers its relations with its employees to be good.
ITEM 2. PROPERTIES
The Company's executive offices and manufacturing operations are located in
Boxborough, Massachusetts in a leased facility consisting of approximately
97,000 square feet. The lease of this facility has a term of seven years
beginning November 1997, with an option to extend the term for an additional
five years. The Company believes this facility will satisfy its principal
facilities requirements for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
On April 15, 1997, the Company commenced a lawsuit against Neuromedical
Systems, Inc. ("NSI"), The PIE Mutual Insurance Company ("PIE"), Cytology
West, Inc. ("CWI") and other parties in the United States District Court in
Massachusetts (Civil Action No. 97-10740). The action was voluntarily
dismissed without prejudice as to certain defendants, and dismissed as to the
remaining defendants following the court's determination that personal
jurisdiction was lacking.
The Company refiled its suit against NSI and two of its officers in the
United States District Court for the Southern District of New York on June 24,
1997 (Civil Action No. 97 CIV 4642). The lawsuit includes claims of false and
misleading advertising, unfair and deceptive trade practices, unfair
competition, misappropriation of trade secrets, tortious interference with the
Company's business relationships and defamation. In addition to seeking
preliminary and permanent injunctions to stop NSI and its officers from such
conduct, the Company seeks damages, including treble damages. On July 30,
1997, NSI moved to dismiss the Company's complaint. On September 5, 1997, the
Court denied NSI's motion to dismiss. On September 19, 1997, the defendants
filed answers and affirmative defenses to the Company's claims, denying
liability, and on October 3, 1997, NSI filed counterclaims against the Company
for false and misleading advertising, unfair competition and defamation. On
November 12, 1997, the Company moved to dismiss NSI's counterclaims, and that
motion is currently pending. The case is in the early stages of discovery.
While the outcome of the action cannot be determined, the Company believes
that the counterclaims are without merit, and intends to defend against them
vigorously.
13
The Company also refiled its suit against PIE and its medical director in
the United States District Court for the Northern District of Ohio, Eastern
Division on July 3, 1997 (Civil Action No. 1:97 CV 1779). The complaint
alleges false and misleading description and representation, unfair and
deceptive trade practices, interference with advantageous relationships,
defamation and commercial disparagement. The Company is seeking injunctive
relief as well as damages, including treble damages. On September 2, 1997, the
defendants filed an answer and affirmative defenses to the Company's claims,
denying liability.
On May 14, 1997, CWI, a defendant in the Company's original lawsuit in
Massachusetts, filed suit against the Company in the United States District
Court for the District of Nevada (Civil Action, No. CV-S-97-00594-LDG (LRL)),
alleging false description, false representation and unfair competition. On
June 27, 1997, the Company filed a motion to dismiss the complaint. The Court
has not rendered a decision on the Company's motion. On August 6, 1997, the
Company filed counterclaims against CWI and third party claims against its
President, including claims for false and misleading description and
representation, unfair competition, interference with advantageous
relationships, defamation, commercial disparagement and abuse of process. On
August 26, 1997, CWI and its President filed an answer and affirmative
defenses to the Company's counterclaims, denying liability. On January 23,
1998, the Company voluntarily withdrew its claim for abuse of process. While
the outcome of the action cannot be determined the Company believes the claims
against the Company are without merit, and intends to defend against those
claims vigorously.
Each of the above pending actions are in the early stages of discovery and,
accordingly, the Company is unable to determine the extent of its liability,
if any, or the likelihood of prevailing in such actions.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders of the Company
during the fourth quarter of the fiscal year ended December 31, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER
MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "CYTC." The following table sets forth, for the calendar periods
indicated since the Company's initial public offering in March 1996, the range
of high and low sales prices for the Common Stock of the Company on the Nasdaq
National Market. These prices do not include retail mark-up, mark-down or
commissions and may not represent actual transactions.
HIGH LOW
---- ----
FISCAL YEAR 1996:
First Quarter (from March 8, 1996) ...................... $18 $15 7/8
Second Quarter........................................... 34 1/2 16
Third Quarter............................................ 26 1/8 12
Fourth Quarter........................................... 29 3/4 11 3/4
FISCAL YEAR 1997:
First Quarter............................................ 31 1/2 18 3/4
Second Quarter........................................... 31 14 1/2
Third Quarter............................................ 28 3/4 17 5/16
Fourth Quarter........................................... 30 18 3/4
Fiscal Year 1998 (through March 23, 1998).................. 25 3/8 24 3/4
14
On March 23, 1998, the last reported sales price of the Common Stock on the
Nasdaq National Market was $24 13/16 per share. As of March 23, 1998, there
were approximately 275 holders of record of the Common Stock.
For the year ended December 31, 1997, no shares of Common Stock have been
sold which were not registered under the Securities Act.
The Company has never declared or paid cash dividends. The Company currently
intends to retain any earnings for use in its business and does not anticipate
paying any cash dividends on its capital stock in the foreseeable future.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below for each of the
years ended December 31, 1995, 1996 and 1997 and at December 31, 1996 and 1997
are derived from consolidated financial statements of the Company audited by
Arthur Andersen LLP, independent public accountants, which are included
elsewhere herein. The consolidated selected financial data for the years ended
December 31, 1993 and 1994 and at December 31, 1993, 1994 and 1995 are derived
from consolidated financial statements of the Company audited by Arthur
Andersen LLP which are not included herein. The selected consolidated
financial data set forth below should be read in conjunction with the
Consolidated Financial Statements and related Notes thereto and with
Management's Discussion and Analysis of Financial Condition and Results of
Operations included as Items 7 and 8 in this Form 10-K.
YEAR ENDED DECEMBER 31,
----------------------------------------------
1993 1994 1995 1996 1997
-------- ------- ------- -------- --------
STATEMENT OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales...................... $ 3,441 $ 2,920 $ 4,273 $ 8,198 $ 26,347
Cost of sales.................. 5,088 2,225 2,413 4,354 8,006
-------- ------- ------- -------- --------
Gross profit................... (1,647) 695 1,860 3,844 18,341
-------- ------- ------- -------- --------
Operating expenses:
Research and development..... 3,058 2,175 3,908 4,689 6,048
Marketing, sales and customer
support..................... 3,417 1,418 2,582 9,918 31,761
General and administrative... 2,257 1,256 1,532 3,314 7,746
-------- ------- ------- -------- --------
Total operating expenses.... 8,732 4,849 8,022 17,921 45,555
-------- ------- ------- -------- --------
Income (loss) from operations.. (10,379) (4,154) (6,162) (14,077) (27,214)
Other income (expense), net.... 108 (112) 247 2,158 5,142
-------- ------- ------- -------- --------
Net loss....................... $(10,271) $(4,266) $(5,915) $(11,919) $(22,072)
======== ======= ======= ======== ========
Net loss per common and poten-
tial common share (1):
Basic........................ $ (41.47) $(15.57) $(19.20) $ (1.06) $ (1.31)
Diluted...................... $ (41.47) $(15.57) $(19.20) $ (1.06) $ (1.31)
Pro forma diluted (Note 1)... $ (2.69) $ (0.98) $ (0.71) $ (0.92) $ (1.31)
Weighted average common and po-
tential common shares out-
standing:
Basic........................ 248 274 308 11,192 16,893
Diluted...................... 248 274 308 11,192 16,893
Pro forma diluted............ 3,817 4,363 8,375 12,982 16,893
1993 1994 1995 1996 1997
BALANCE SHEET DATA: -------- ------- ------- -------- --------
Cash, cash equivalents and
short-term investments........ $ 1,662 $ 2,777 $ 7,902 $ 39,057 $ 85,402
Total assets................... 3,217 3,851 11,025 50,183 108,377
Accumulated deficit............ (25,007) (29,273) (35,188) (47,107) (69,179)
Total stockholders' equity
(deficit)..................... (883) (2,112) 8,078 46,681 96,187
- --------
(1) See Note 2 of Notes to Consolidated Financial Statements for an
explanation of the computation of Basic, Diluted and Pro forma diluted per
share data.
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company designs, develops, manufactures and markets a sample preparation
system for medical diagnostic applications. The ThinPrep System consists of
the Thin Prep 2000 Processor, and related disposable reagents, filters and
other supplies. The Company has marketed the ThinPrep System for use in non-
gynecological testing applications since 1991. On May 20, 1996, the Company
received PMA approval from the FDA to market the ThinPrep System for cervical
cancer screening as a replacement for the conventional Pap smear method. On
November 6, 1996, the FDA cleared expanded product labeling for the ThinPrep
System to include the claim that the ThinPrep System is significantly more
effective in detecting LGSIL and more severe lesions than the conventional Pap
smear method in a variety of patient populations. The expanded labeling also
indicates that the specimen quality using the ThinPrep System is significantly
improved over that of the conventional Pap smear method. On February 25, 1997,
the FDA approved the Company's supplemental PMA application for use of a
combination of an endocervical brush and spatula sampling devices, which is a
commonly used method of collecting samples for conventional Pap smears. On
September 4, 1997, the FDA approved the Company's supplemental PMA application
for the testing for HPV directly from a single vial of patient specimen
collected in a ThinPrep solution using the Hybrid Capture HPV DNA Assay of
Digene Corporation. The Company conducted the full-scale commercial launch of
the ThinPrep System for cervical cancer screening in the United States in
1997.
Since inception, the Company has incurred substantial losses, principally
from expenses associated with obtaining FDA approval of the Company's ThinPrep
System for cervical cancer screening, engineering and development efforts
related to the ThinPrep System, expansion of the Company's manufacturing
facilities, and the establishment of a marketing and sales organization. The
Company expects such losses to continue for the foreseeable future as it
expands its domestic and establishes its international marketing and sales
activities, continues its product development efforts, and commences full-
scale manufacturing of the ThinPrep System for cervical cancer screening. The
operating results of the Company have fluctuated significantly in the past on
an annual and a quarterly basis. The Company expects that its operating
results will fluctuate significantly from quarter to quarter in the future and
will depend on a number of factors, including the extent to which the
Company's products gain market acceptance, the rate and size of expenditures
incurred as the Company expands its domestic and establishes its international
sales and distribution networks, the timing of any approvals of the ThinPrep
System for reimbursement by third-party payors, and other factors, many of
which are outside the Company's control.
The Company occupies a 97,000 square foot facility in Boxborough,
Massachusetts. The Company has installed new custom-built automated equipment
for the high-volume manufacture of disposable filters for use in connection
with the ThinPrep System.
16
The Company believes that in the United States, the current rate of
reimbursement of laboratories from managed care organizations and other third-
party payors to screen conventional Pap smears ranges from approximately $6.00
to $36.00 per test, with $17.00 as the most common rate of reimbursement.
The Company believes that the cost per ThinPrep Pap Test, plus a laboratory
mark-up, will be billed to third-party payors and result in a higher cost than
the current charge for conventional Pap tests. In the past, the Company has
offered discounts to stimulate demand for the ThinPrep System and may elect to
do so in the future, which discounts could have a material adverse effect on
the Company's business, financial condition and results of operations.
The Company believes that its expanded FDA labeling supported by clinical
field and trial results may assist in the establishment of increased
reimbursement for the ThinPrep Pap Test. Although United HealthCare has
announced that it will expand its healthcare coverage to include the ThinPrep
Pap Test, the applicable rate of reimbursement is negotiated between United
HealthCare or its various plans and the specific clinical laboratories
servicing such plans. In February 1997, Blue Cross Blue Shield of
Massachusetts announced that it would expand its healthcare coverage to
include the ThinPrep Pap Test and since that announcement, fifteen additional
Blue Cross and Blue Shield plans across the United States have added the
ThinPrep Pap Test to their list of covered benefits. In 1997, the United
States Health Care Financing Administration ("USHCFA") determined that
Medicare would cover the ThinPrep Pap Test. Because the ThinPrep Pap Test is a
new test, the USHCFA did not assign a reimbursement level for the procedure,
but instead allows Medicare intermediaries at the state level to "gap fill" or
reimburse for the procedure based on the laboratory billing they receive.
Although a number of managed care organizations have added the ThinPrep Pap
Test to their coverage, there can be no assurance that third-party payors will
provide or continue to provide such coverage, that reimbursement levels will
be adequate or that healthcare providers or clinical laboratories will use the
ThinPrep System for cervical cancer screening in lieu of the conventional Pap
smear method.
The Company will continue to increase the amount of expenditures for
marketing, sales and customer support activities of the ThinPrep System for
cervical cancer screening. There can be no assurance, however, that such
investments will result in increased net sales or that the Company's direct
sales force will succeed in promoting the ThinPrep System to healthcare
providers, third-party payors or clinical laboratories, or that additional
marketing and sales channels will be successfully established. During 1997,
the Company entered into a number of agreements in connection with its
marketing and sales activities, including a co-promotion agreement with Mead
Johnson & Company, a division of Bristol-Myers Squibb, to promote the ThinPrep
Pap Test to obstetricians in the United States, and an agreement with Quest
Diagnostics Incorporated to provide ThinPrep Pap Testing at its clinical
laboratories in the United States. The Quest Diagnostics agreement is
exclusive in that Quest will only provide other liquid-based mono or thin
layer sample preparation technologies if FDA labeling claims for such products
exceed the FDA labeling claims of the ThinPrep System and will only provide
computer aided rescreening upon customer initiated request. Quest Diagnostics
and the Company agreed to coordinate their efforts in planning and marketing
the ThinPrep Pap Test to medical professionals and third party payors. There
can be no assurance that such marketing, sales and customer support activities
will result in increased net sales, that the agreements with Mead Johnson &
Company, Quest Diagnostics Incorporated or other third parties will be
successful, that the Company's direct sales force will succeed in promoting
the ThinPrep System to health care providers, third-party payors or clinical
laboratories, or that additional marketing and sales channels will be
successfully established.
The Company will continue to increase its expenditures for research and
development to fund development of follow-on products and additional
applications of ThinPrep technology. The Company will also continue to
increase the amount of expenditures for administrative activities, principally
for the employment of additional administrative personnel, increases in
professional fees and the incremental costs associated with being a publicly-
held company.
17
The Company is the exclusive licensee of certain patented technology used in
the ThinPrep System. In consideration for this license, the Company has agreed
to pay a royalty equal to 1% of net sales of the ThinPrep Processor, filter
cylinder disposable products that are used with the ThinPrep System, and
improvements made by the Company relating to such items. Royalty payments, in
connection with this license for the years ended 1995, 1996 and 1997 were
$19,000, $53,000 and $135,000, respectively.
RESULTS OF OPERATIONS
Years Ended December 31, 1997 and December 31, 1996
Net sales increased to $26.3 million in 1997 from $8.2 million in 1996, an
increase of 221.4%. This increase in sales was primarily due to an increase in
the number of ThinPrep Processors sold, sales of the Company's ThinPrep Pap
Test for cervical cancer screening, and additional sales of related reagents,
filters and other supplies for non-gynecological testing. Gross profit
increased to $18.3 million in 1997 from $3.8 million in 1996, an increase of
377.1%, and the gross margin increased to 69.6% in 1997 from 46.9% in 1996.
Management attributes the increase in gross margin in 1997 primarily to the
introduction and sales of the ThinPrep Pap Test beginning in the later part of
1996, the subsequent change in product mix, and increased sale prices for
non-gynecological tests and ThinPrep 2000 Processors.
Total operating expenses increased to $45.6 million in 1997 from $17.9
million in 1996, an increase of 154.2%. Research and development costs
increased to $6.0 million in 1997 from $4.7 million in 1996, an increase of
29.0%, as a result of employment of additional research and development
personnel and engineering consulting expenses. Sales, marketing and customer
support increased to $31.8 million in 1997 from $9.9 million in 1996, an
increase of 220.2%. The increase in sales, marketing and customer support
costs reflects the employment of additional sales and customer support
personnel, increased commission expenses, expenses associated with the Mead
Johnson co-promotion agreement, and additional marketing consulting costs
related to the commercial launch of the ThinPrep Pap Test. General and
administrative costs increased to $7.7 million in 1997 from $3.3 million in
1996, an increase of 133.7%, due to the employment of additional
administrative personnel, increased business insurance costs, and legal
expenses. Net interest income increased to $5.1 million in 1997 from $2.2
million in 1996, an increase of 138.3%, due to an increase in the average cash
balance available for investment.
Years Ended December 31, 1996 and December 31, 1995
Net sales increased to $8.2 million in 1996 from $4.3 million in 1995, an
increase of 91.9%. This increase in sales was primarily due to an increase in
the number of ThinPrep Processors sold, initial sales of the Company's new
ThinPrep Pap Test for cervical cancer screening, and additional sales of
related reagents, filters and other supplies for non-gynecological testing.
Gross profit increased to $3.8 million in 1996 from $1.9 million in 1995, an
increase of 106.7%, and the gross margin increased to 46.9% in 1996 from 43.5%
in 1995. Management attributes the increase in gross margin in 1996 to the
introduction of the ThinPrep Pap Test during the later part of 1996 and
increased sale prices for non-gynecological tests and ThinPrep 2000
Processors, offset partially by the lower unit margin for unit sales to
existing customers upgrading to the ThinPrep 2000 Processor.
Total operating expenses increased to $17.9 million in 1996 from $8.0
million in 1995, an increase of 123.4%. Research and development costs
increased to $4.7 million in 1996 from $3.9 million in 1995, an increase of
20.0%, as a result of employment of additional research and development
personnel and engineering consulting expenses. Sales, marketing and customer
support increased to $9.9 million in 1996 from $2.6 million in 1995, an
increase of 284.1%. The increase in sales, marketing and customer support
costs reflects the employment of additional sales and customer support
personnel, increased commission expenses, increased customer training costs
and additional marketing consulting costs related to the commercial launch of
the ThinPrep Pap Test. General and administrative costs increased to $3.3
million in 1996 from $1.5 million in 1995, an increase of 116.3% due to the
employment of additional administrative personnel, increased business
insurance costs and expenses associated with being a publicly-held company.
Net interest income increased to $2.2 million in 1996 from $262,000 in 1995,
an increase of 729.8%, due to an increase in the average cash balance
available for investment.
18
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company's expenses have significantly exceeded its
revenue, resulting in an accumulated deficit of $69.2 million as of December
31, 1997. The Company has funded its operations primarily
through the private placement and public sale of equity securities aggregating
$165.4 million, net of offering expenses. At December 31, 1997, the Company
had cash, cash equivalents and short-term investments of $85.4 million. Cash,
cash equivalents and short-term investments increased during 1997 primarily
due to the issuance of 3,197,500 shares of Common Stock in connection with the
Company's second public offering for aggregate net proceeds of approximately
$70.6 million. Cash used in the Company's operations was $7.0 million, $13.7
million and $22.0 million for 1995, 1996 and 1997 respectively. The increase
in cash used in operations in 1997 was primarily due to a significant loss
from operations of $27.2 million, which included the expansion of the
Company's marketing, sales and customer support organizations, offset by an
increase in current liabilities.
The Company's capital expenditures for the years ended 1995, 1996 and 1997
were $663,000, $4.8 million, and $1.7 million respectively. The decrease in
capital expenditures in 1997 was due primarily to reduced purchases for
customized manufacturing equipment and leasehold improvements for the
Company's new facility. Additionally, as of December 31, 1997, the Company had
commitments for customized manufacturing equipment of approximately $2.0
million.
Accounts receivable increased $7.8 million to approximately $10.5 million
during 1997 as a result of increased sales volume. Inventories increased
approximately $1.8 million to $3.2 million from December 31, 1996 to December
31, 1997 due primarily to the Company's planned sales increase of ThinPrep Pap
Tests, ThinPrep 2000 Processors and reagents, filters and other supplies for
non-gynecological testing in 1998. Stockholders' equity increased
approximately $49.5 million from December 31, 1996 to December 31, 1997
primarily due to the sale of 3,197,500 shares of Common Stock in connection
with the Company's second public offering in February 1997, which was offset
by the net loss of $22.1 million.
The Company's future liquidity and capital requirements will depend upon
numerous factors, including the resources required to further develop its
marketing and sales capabilities, both domestic and international, and the
extent to which such activities generate market acceptance and demand for the
ThinPrep System for cervical cancer screening. The Company's capital
requirements will also depend upon the progress of the Company's research and
development programs including clinical trials, the receipt of and the time
required to obtain regulatory clearances and approvals, and the resources the
Company devotes to developing, manufacturing and marketing its products. In
addition, the Company's capital requirements will depend on the extent of
potential liabilities, if any, and costs associated with, existing or future
litigation. See "Legal Proceedings." There can be no assurance that the
Company will not require additional financing or will not in the future seek
to raise additional funds through bank facilities, debt or equity offerings or
other sources of capital. Additional funding may not be available when needed
or on terms acceptable to the Company, which would have a material adverse
effect on the Company's business, financial condition and results of
operations.
CERTAIN FACTORS WHICH MAY AFFECT FUTURE RESULTS
The Company does not provide financial performance forecasts. The forward
looking statements in this Form 10-K are made under the safe harbor provisions
of Section 21E of the Securities Exchange Act of 1934, as amended. The
Company's operating results and financial condition have varied and may in the
future vary significantly depending on a number of factors. Statements in this
Form 10-K which are not strictly historical statements, including, without
limitation, statements regarding management's plans and objectives for future
operations, domestic and international marketing and sales plans, product
plans and performance, potential savings to the healthcare system,
management's assessment of market factors, as well as statements regarding the
strategy and plans of the Company, constitute forward-looking statements that
involve risks and uncertainties. The following factors, among others, could
cause actual results to differ materially from those contained in forward-
looking statements made in this report and presented elsewhere by management
from time to time. Such
19
factors, among others, may have a material adverse effect upon the Company's
business, results of operations and financial conditions.
The following discussion of the Company's risk factors should be read in
conjunction with the consolidated financial statements and related notes
included herein. Because of these and other factors, past financial
performance should not be considered an indication of future performance.
Dependence on Single Product. Substantially all of the Company's revenues to
date have been derived from sales of its ThinPrep 2000 Processor and
predecessor instruments, and related reagents, filters and other supplies, for
use in gynecological and non-gynecological testing applications. The Company's
inability to successfully commercialize the ThinPrep System for cervical
cancer screening or to obtain adequate third-party reimbursement coverage,
among other factors, would have a material adverse effect on the Company's
business, financial condition and results of operations.
Uncertainty of Market Acceptance and Additional Cost. The Company's success
and growth will depend on market acceptance of the ThinPrep System for
cervical cancer screening by healthcare providers, third-party payors and
clinical laboratories. The laboratory cost of using the ThinPrep System for
cervical cancer screening is higher than that of a conventional Pap smear. Due
in part to increased competitive pressures in the healthcare industry to
reduce costs, the Company's ability to gain market acceptance of the ThinPrep
System for cervical cancer screening will depend on the Company's ability to
demonstrate that the higher cost of using the ThinPrep System will be offset
by a reduction in costs often associated with conventional Pap smears,
including inaccurate diagnoses and the need for repeat Pap tests.
Limited Marketing and Sales Experience. Although the Company received
clearance from the FDA to market its ThinPrep System for cervical cancer
screening on May 20, 1996, the Company initiated full-scale marketing and
sales efforts for the ThinPrep System in United States beginning only in the
first quarter of 1997. The Company depends on strategic marketing
relationships with Mead Johnson and large clinical laboratories to effect
commercial-scale marketing in the United States. There can be no assurance
that such relationships will succeed in promoting the ThinPrep System in the
United States. The Company has limited experience in selling the ThinPrep
System for cervical cancer screening, and no assurance can be given that its
direct marketing and sales organization will succeed in promoting the ThinPrep
System in the United States or internationally.
Dependence on Third-Party Reimbursement. Successful sales of the ThinPrep
System for cervical cancer screening in the United States and other countries
will depend on the availability of adequate reimbursement from third-party
payors such as private insurance plans, managed care organizations, and
Medicare and Medicaid. Although United HealthCare has announced that it will
expand its healthcare coverage to include the ThinPrep Pap Test, the
applicable rate of reimbursement is negotiated between United HealthCare or
its various plans and the specific clinical laboratories servicing such plans.
In February 1997, Blue Cross Blue Shield of Massachusetts announced that it
would expand its healthcare coverage to include the ThinPrep Pap Test and
since that announcement, fifteen additional Blue Cross and Blue Shield plans
across the United States have added the ThinPrep Pap Test to their list of
covered benefits. Although a number of managed care organizations have added
the ThinPrep Pap Test to their coverage, there can be no assurance that
reimbursement will be available, reimbursement levels will be adequate or that
healthcare providers or clinical laboratories will use the ThinPrep System for
cervical cancer screening in lieu of the conventional Pap smear method. In
February 1998, the BlueCross BlueShield Association's Technology Evaluation
Center announced results of a recent review of three new cervical cancer
screening technologies, including the ThinPrep Pap Test, with respect to cost-
effectiveness. Although the review concluded that such technologies offered
only modest improvement, the Company believes that the study did not consider
certain cost advantages inherent in using the ThinPrep System. The study's
conclusions are not binding and do not represent a national coverage or
reimbursement decision by the Blue Cross and Blue Shield organizations.
Although the Company believes that to date the review has not caused any
change in the decision of Blue Cross and Blue Shield plans currently
reimbursing laboratories for the ThinPrep Pap Test, there can be no assurance
that the review will not lead to adverse reimbursement decisions by Blue
Cross, Blue Shield plans or others. There is significant uncertainty
concerning third-party reimbursement for the use of any medical device
incorporating new technology.
20
Limited Number of Customers and Lengthy Sales Process. Due in part to a
recent trend toward consolidation of clinical laboratories, the Company
expects that the number of potential domestic customers for its products will
decrease. Due to the relative size of the largest United States laboratories,
it is likely that a significant portion of ThinPrep System sales will be
concentrated among a relatively small number of large clinical laboratories.
Further, in order to generate demand for the ThinPrep Pap Test among clinical
laboratories, the Company will be required to educate physicians and
healthcare providers regarding the clinical benefits and cost-effectiveness of
the ThinPrep System as well as to demonstrate to such parties that adequate
levels of reimbursement will be available for the ThinPrep Pap Test, a process
which the Company believes will require a lengthy sales effort.
Limited Operating History; Uncertainty of Profitability. The Company has a
limited operating history and, to date, has focused on product development,
clinical trials, obtaining regulatory approvals, the expansion of
manufacturing facilities and the establishment of marketing and sales
capabilities for its ThinPrep System for cervical cancer screening in the
United States and abroad. The Company has limited experience in marketing and
selling the ThinPrep System for cervical cancer screening. The Company's
future revenues and profitability are critically dependent on the Company's
ability to successfully market and sell the ThinPrep System for cervical
cancer screening.
Risks Associated with Commercialization. In connection with the full-scale
commercialization of the ThinPrep System for cervical cancer screening, the
Company has significantly expanded its facilities and intends to continue to
significantly increase the number of its marketing and sales, engineering, and
financial personnel, and enhance or replace its management information
systems. Such activities are likely to place significant strain on the
Company's management, operations and systems.
Intense Competition. The Company faces direct competition from a number of
publicly-traded and privately-held companies, including at least one other
manufacturer of a thin layer slide preparation system which is seeking
approval of its PMA application. In addition, Neopath, Inc. is seeking FDA
approval of its AutoPap QC product, an automated computer-aided imaging
system, as a primary screening method. On January 28, 1998, the FDA's
Hematology and Pathology Devices Panel unanimously recommended that the FDA
approve the AutoPap QC for primary screening. The FDA typically accords
substantial weight to a panel's recommendation but is not bound by it. The
development, FDA approval and commercial marketing of such systems for
cervical cancer screening could have a material adverse effect on the
Company's business, financial condition and results of operations. Many of the
Company's existing and potential competitors have substantially greater
financial, marketing, sales, distribution and technical resources than the
Company, and more experience in research and development, clinical trials,
regulatory matters, manufacturing and marketing.
History of Losses. The Company has incurred substantial losses since
inception. The Company expects such losses to continue for the foreseeable
future due to expansion of its sales and marketing activities, both domestic
and international, its product development efforts, and commencement of full-
scale commercial manufacturing.
Potential Fluctuations in Future Quarterly Results. The Company expects that
its operating results will fluctuate significantly from quarter to quarter in
the future and will depend on a number of factors, many of which are outside
the Company's control. These factors include: the extent to which the
Company's products gain market acceptance; the rate and size of expenditures
incurred as the Company expands its domestic and establishes its international
sales and distribution networks; the timing of any approvals of the ThinPrep
System for reimbursement by third-party payors; the timing and size of sales;
the likelihood and timing of FDA approval of PMA supplements related to the
ThinPrep System; the timing and size of expenditures incurred in the research
and development of new products; and the introduction and market acceptance of
competing products or technologies.
Extensive Government Regulation. The manufacture and sale of medical
diagnostic devices are subject to extensive government regulation in the
United States and in other countries. The process of obtaining FDA and
21
other required regulatory approvals can be time-consuming, expensive and
uncertain, frequently requiring several years from the commencement of
clinical trials to the receipt of regulatory approval. After approval, the
Company and its medical products remain subject to pervasive regulation and
FDA inspection for compliance with regulatory requirements. In July 1997,
several petitions were filed requesting that the FDA review the PMA approval
granted to the ThinPrep System. The petitions were filed pursuant to a
provision of the FDC Act permitting any interested party to initiate a process
by which the FDA may review an approval order and may issue an order
affirming, reversing or modifying the approval. To the Company's knowledge,
the FDA has conducted a review pursuant to this provision only twice since the
enactment of the Medical Device Amendments of 1976. The Company responded to
the petitions by submitting comments in December 1997 arguing that the FDA
should deny them. No assurance can be given that the FDA will not conduct a
review of the PMA approval granted to the ThinPrep System, nor can assurance
be given that the FDA will not, after such review, issue an order reversing or
unfavorably modifying the original PMA approval. Any such action by the FDA
would have a material adverse effect on the Company.
International Sales and Operations Risks. The Company has commenced sale of
its ThinPrep System and intends to sell any future products to customers both
in the United States and internationally. While the Company is evaluating
marketing and sales channels abroad, including contract sales organizations,
distributors and marketing partners, the Company currently has very limited
foreign sales channels in place at this time. There can be no assurance that
the Company will successfully develop international sales capabilities or
that, if the Company establishes such capabilities, the Company will be
successful in obtaining reimbursement or any regulatory approvals required in
foreign countries.
Uncertainty of Additional Applications. The Company intends to continue to
evaluate additional diagnostic applications of its ThinPrep technology in
testing for the presence of other types of cancers and sexually transmitted
diseases. The Company has not yet determined which of these applications, if
any, it will seek to develop and commercialize.
Dependence on Key Personnel. The Company is highly dependent on the
principal members of its management and scientific staff, the loss of whose
services might impede achievement of its research and development or strategic
objectives. The Company's success will depend on its ability to retain key
employees and to attract additional qualified employees.
Dependence on Patents, Copyrights, Licenses and Proprietary Rights; Risk of
Third-Party Claims of Infringement. The Company relies on a combination of
patents, trade secrets, copyrights and confidentiality agreements to protect
its proprietary technology, rights and know-how. In addition, the Company is
the exclusive licensee of certain patented technology for use in the field of
cytology related to the fluid pumping system used in the ThinPrep System.
Failure by the Company to protect, defend and maintain such intellectual
property rights, or a third party claim of infringement, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Dependence on Single Source Suppliers. Certain key components of the
ThinPrep System, including its proprietary filter, are currently provided to
the Company by single sources. In the event that the Company is unable to
obtain sufficient quantities of such components on commercially reasonable
terms, or in a timely manner, the Company would not be able to manufacture its
products on a timely and cost-competitive basis, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.
Year 2000 Compliance. The Company has taken actions to understand the nature
and extent of work required to make its products, systems and infrastructure
Year 2000 compliant. The Company uses a number of computer software programs
and operating systems in its internal operations, including applications used
in manufacturing, product development, financial business systems and various
administrative functions. To the extent that these software applications
contain source code that is unable to appropriately interpret the upcoming
year "2000," some level of modification or possibly replacement of such source
code or applications will be
22
necessary. While these efforts will involve some additional costs, the Company
believes, based on available information, that it will be able to manage its
total Year 2000 transition without any material adverse effect on its
business, financial condition or operating results.
Impact of Ongoing Litigation. The Company is currently involved in ongoing
commercial litigation. Any such litigation, regardless of the outcome, could
result in substantial cost to the Company and divert management's attention
from the Company's operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item may be found on pages F-1 through F-16
of this Form 10-K.
ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters in the last two fiscal years.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required under this item may be found under the sections
captioned "Election of Directors," "Occupations of Directors and Executive
Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the
Company's Proxy Statement (the "1998 Proxy Statement"), which will be filed
with the Securities and Exchange Commission not later than 120 days after the
close of the Company's fiscal year ended December 31, 1997, and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required under this item may be found under the section
captioned "Compensation and Other Information concerning Directors and
Officers" in the 1998 Proxy Statement, and is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this item may be found under the section
captioned "Securities Ownership of Certain Beneficial Owners and Management"
in the 1998 Proxy Statement, and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this item may be found under the caption
"Certain Relationships and Related Transactions" in the 1998 Proxy Statement,
and is incorporated herein by reference.
23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Consolidated Financial Statements.
For a list of the consolidated financial information included herein, see
Index on page F-1.
(a)(2) Financial Statement Schedules.
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
accompanying Consolidated Financial Statements or notes thereto.
(a)(3) List of Exhibits.
The following exhibits are filed as part of and incorporated by reference
into, this Annual Report on Form 10-K:
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1(2) Third Amended and Restated Certificate of Incorporation of the
Company.
3.2(2) Amended and Restated By-Laws of the Company.
4.1(1) Specimen certificate representing the Common Stock.
4.2(3) Rights Agreement, dated as of August 27, 1997, between Cytyc
Corporation and BankBoston, N.A., which includes as Exhibit A the
Form of Certificate of Designations, as Exhibit B the Form of Rights
Certificate, and as Exhibit C the Summary of Rights to Purchase
Preferred Stock.
10.1(1)* 1988 Stock Plan.
10.2(1)* 1989 Stock Plan.
10.3(1)* 1995 Stock Plan.
10.4(1)* 1995 Non-Employee Director Stock Option Plan.
10.5(1)* 1995 Employee Stock Purchase Plan, as amended.
10.6(1)# License Agreement between the Company and DEKA Products Limited
Partnership dated March 22, 1993.
10.7(1) Form of Indemnification Agreement.
10.8(1) Lease Agreement between the Company and BFA Realty Partnership, L.P.
d/b/a BFA, Limited Partnership of February 1996.
10.9** Amendment No. 1 to Lease Agreement dated as of February 1996 between
the Company and BFA Realty Partnership, L.P. d/b/a BFA, Limited
Partnership.
10.10(4)# Co-Promotion Agreement dated as of May 27, 1997 by and between Mead
Johnson & Company and the Company.
10.11+** Amendment No. 1 to Co-Promotion Agreement dated as of May 27, 1997
by and between Mead Johnson & Company and the Company.
13.1*** The Company's 1997 Annual Report to Stockholders, certain portions
of which have been incorporated herein by reference.
21.1** List of Subsidiaries of the Company.
23.1** Consent of Arthur Andersen LLP.
24.1** Power of Attorney (see signature page hereto).
27.1** Financial Data Schedule.
- --------
(1) Incorporated herein by reference to the exhibits to the Company's
Registration Statement on Form S-1 (File No. 333-00300).
(2) Incorporated by reference to the exhibits to the Company's Registration
Statement on Form S-1 (File No. 333-19367).
(3) Incorporated herein by reference to Exhibit 4.1 to the Company's Current
Report on Form 8-K, filed August 29, 1997 (File No. 000-27558).
(4) Incorporated herein by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q, filed August 8, 1997.
*Indicates a management contract or any compensatory plan, contract or
arrangement
**Filed herewith.
*** Such report, except for those portions thereof which are expressly
incorporated by reference herein, is furnished for the information of the
Commission and is not to be deemed "filed" as part of this Annual Report
on Form 10-K.
24
# Confidential treatment granted as to certain portions.
+ Confidential treatment requested as to omitted portions pursuant to Rule
24b-2 promulgated under the Securities Exchange Act of 1934, as amended.
(b) Reports On Form 8-K
There were no reports on Form 8-K filed by the Company for the quarter
ended December 31, 1997
(c) Exhibits
The Company hereby files as part of this Annual Report on Form 10-K the
exhibits listed in Item 14(a)(3) set forth above. Exhibits which are
incorporated herein by reference may be inspected and copied at the public
reference facilities maintained by the SEC at Room 1024, Washington, D.C.
20549, and at the SEC's regional offices located at Seven World Trade
Center, Suite 1300, New York, New York 10048, and at Citicorp Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60611-2511. Copies of
such material may be obtained by mail from the Public Reference Section of
the SEC at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549,
at prescribed rates. The SEC also maintains a Website that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the SEC at the address
"http://www.sec.gov"
25
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) 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.
Cytyc Corporation
Date: March 30, 1998
/s/ Patrick J. Sullivan
By: _________________________________
PRESIDENT AND CHIEF EXECUTIVE
OFFICER
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers and directors of Cytyc Corporation, hereby
severally constitute and appoint Patrick J. Sullivan and Joseph W. Kelly, and
each of them singly, our true and lawful attorneys, with full power to both of
them and each of them singly, to sign for us and in our names in the
capacities indicated below, any amendments to this Report on Form 10-K, and
generally to do all things in our names and on our behalf in such capacities
to enable Cytyc Corporation to comply with the provisions of the Securities
Exchange Act of 1934, as amended, and all the requirements of the Securities
and Exchange Commission.
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, in the capacities and on the dates indicated.
SIGNATURE TITLE(S)
DATE
/s/ Patrick J. Sullivan President, Chief March 30, 1998
- ------------------------------------- Executive Officer
PATRICK J. SULLIVAN (Principal
Executive Officer)
and Director
/s/ Joseph W. Kelly Vice President, March 30, 1998
- ------------------------------------- Finance and Chief
JOSEPH W. KELLY Financial Officer
(Principal
Financial Officer
and Principal
Accounting Officer)
/s/ Sally W. Crawford Director March 30, 1998
- -------------------------------------
SALLY W. CRAWFORD
/s/ Franklin J. Iris Director March 30, 1998
- -------------------------------------
FRANKLIN J. IRIS
/s/ William G. Little Director March 30, 1998
- -------------------------------------
WILLIAM G. LITTLE
/s/ C. William McDaniel Director March 30, 1998
- -------------------------------------
C. WILLIAM MCDANIEL
/s/ Anna S. Richo Director March 30, 1998
- -------------------------------------
ANNA S. RICHO
/s/ Monroe Trout, M.D. Chairman of the March 30, 1998
- ------------------------------------- Board of Directors
MONROE TROUT, M.D.
26
CYTYC CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants................................. F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997............. F-3
Consolidated Statements of Operations for the Years Ended December 31,
1995, 1996 and 1997..................................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit) for the Years
Ended December 31, 1995, 1996 and 1997.................................. F-5
Consolidated Statements of Cash Flows for the Years Ended December 31,
1995, 1996 and 1997..................................................... F-6
Notes to Consolidated Financial Statements............................... F-7
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of
Cytyc Corporation:
We have audited the accompanying consolidated balance sheets of Cytyc
Corporation (a Delaware corporation) and subsidiaries as of December 31, 1996
and 1997, and the related consolidated statements of operations, stockholders'
equity (deficit) and cash flows for each of the three years in the period
ended December 31, 1997. These consolidated 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Cytyc
Corporation and subsidiaries as of December 31, 1996 and 1997 and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Boston, Massachusetts
January 26, 1998
F-2
CYTYC CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31,
------------------
1996 1997
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................ $ 27,572 $ 47,204
Short-term investments................................... 11,485 38,198
Accounts receivable, net (Note 3)........................ 2,682 10,501
Inventories (Note 4)..................................... 1,463 3,241
Prepaid expenses and other current assets................ 771 905
-------- --------
Total current assets................................... 43,973 100,049
Property and equipment, net (Note 5)....................... 5,251 5,851
Other assets............................................... 959 2,477
-------- --------
Total assets........................................... $ 50,183 $108,377
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 1,034 $ 2,570
Accrued expenses (Note 6)................................ 1,944 8,088
Deferred revenue......................................... 524 1,532
-------- --------
Total current liabilities.............................. 3,502 12,190
-------- --------
Commitments and contingencies (Note 11)
Stockholders' equity (Note 8):
Preferred Stock, $.01 par value--
Authorized--5,000,000 shares
No shares issued or outstanding......................... -- --
Common Stock, $.01 par value--
Authorized--60,000,000 shares
Issued and outstanding 14,013,002 shares in 1996 and
17,454,096 in 1997...................................... 140 175
Additional paid-in capital............................... 93,648 165,191
Accumulated deficit...................................... (47,107) (69,179)
-------- --------
Total stockholders' equity............................. 46,681 96,187
-------- --------
Total liabilities and stockholders' equity............. $ 50,183 $108,377
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
CYTYC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
---------------------------
1995 1996 1997
------- -------- --------
Net sales........................................ $ 4,273 $ 8,198 $ 26,347
Cost of sales.................................... 2,413 4,354 8,006
------- -------- --------
Gross profit................................... 1,860 3,844 18,341
------- -------- --------
Operating expenses:
Research and development....................... 3,908 4,689 6,048
Sales, marketing and customer support.......... 2,582 9,918 31,761
General and administrative..................... 1,532 3,314 7,746
------- -------- --------
Total operating expenses..................... 8,022 17,921 45,555
------- -------- --------
Loss from operations............................. (6,162) (14,077) (27,214)
------- -------- --------
Other income (expense):
Interest income................................ 371 2,175 5,152
Interest expense............................... (109) (1) --
Other, net..................................... (15) (16) (10)
------- -------- --------
Total other income (expense)................. 247 2,158 5,142
------- -------- --------
Net loss......................................... $(5,915) $(11,919) $(22,072)
======= ======== ========
Net loss per common and potential common share:
Basic.......................................... $(19.20) $ (1.06) $ (1.31)
======= ======== ========
Diluted........................................ $(19.20) $ (1.06) $ (1.31)
======= ======== ========
Pro forma diluted.............................. $ (0.71) $ (0.92) $ (1.31)
======= ======== ========
Weighted average common and potential common
shares outstanding:
Basic.......................................... 308 11,192 16,893
Diluted........................................ 308 11,192 16,893
Pro forma diluted.............................. 8,375 12,982 16,893
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
CYTYC CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
CONVERTIBLE
COMMON STOCK PREFERRED STOCK
---------------- ------------------
TOTAL
ADDITIONAL STOCKHOLDERS'
NUMBER OF PAR NUMBER OF PAR PAID IN ACCUMULATED EQUITY
SHARES VALUE SHARES VALUE CAPITAL DEFICIT (DEFICIT)
---------- ----- ----------- ----- ---------- ----------- -------------
Balance, December 31,
1994................... 307,106 $3 16,252,316 $163 $ 26,995 $(29,273) $ (2,112)
Sale of Series C1 Con-
vertible Preferred
Stock, net of issuance
costs of $157.......... -- -- 3,095,238 31 12,812 -- 12,843
Conversion of notes, in-
cluding accrued inter-
est of $262, into Se-
ries C1 Convertible
Preferred Stock........ -- -- 714,145 7 3,254 -- 3,261
Conversion of four prior
series of convertible
preferred stock into
Series B1 Convertible
Preferred Stock........ -- -- (10,283,373) (103) 103 -- --
Exercise of stock op-
tions.................. 1,400 -- -- -- -- -- --
Net loss................ -- -- -- -- -- (5,915) (5,915)
---------- ---- ----------- ---- -------- -------- --------
Balance, December 31,
1995................... 308,506 3 9,778,326 98 43,165 (35,188) 8,078
Conversion of convert-
ible preferred stock
into Common Stock...... 9,778,326 98 (9,778,326) (98) -- -- --
Sale of Common Stock,
net of issuance costs
of $1,350,000.......... 3,450,000 34 -- -- 49,952 -- 49,986
Exercise of stock op-
tions.................. 470,148 5 -- -- 448 -- 453
Issuance of shares under
the Employee Stock Pur-
chase Plan............. 6,022 -- -- -- 83 -- 83
Net loss................ -- -- -- -- -- (11,919) (11,919)
---------- ---- ----------- ---- -------- -------- --------
Balance, December 31,
1996................... 14,013,002 140 -- -- 93,648 (47,107) 46,681
Sale of Common Stock,
net of issuance costs
of $500,000............ 3,197,500 32 -- -- 70,549 -- 70,581
Exercise of stock op-
tions.................. 232,421 3 -- -- 752 -- 755
Issuance of shares under
Employee Stock Purchase
Plan................... 11,173 -- -- -- 242 -- 242
Net loss................ -- -- -- -- -- (22,072) (22,072)
---------- ---- ----------- ---- -------- -------- --------
Balance, December 31,
1997................... 17,454,096 $175 -- $-- $165,191 $(69,179) $ 96,187
========== ==== =========== ==== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements
F-5
CYTYC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
---------------------------
1995 1996 1997
------- -------- --------
Cash flows from operating activities:
Net loss........................................ $(5,915) $(11,919) $(22,072)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization................. 238 520 1,084
Provision for doubtful accounts............... 50 -- 546
Forgiveness of accrued interest............... 109 -- --
Changes in assets and liabilities--
Accounts receivable......................... (920) (1,359) (8,365)
Inventories................................. (690) (710) (1,778)
Prepaid expenses and other current assets... (22) (723) (134)
Accounts payable............................ 669 (220) 1,536
Accrued expenses............................ (642) 527 6,144
Deferred revenue............................ 109 248 1,008
------- -------- --------
Net cash used in operating activities..... (7,014) (13,636) (22,031)
------- -------- --------
Cash flows from investing activities:
Increase in other assets........................ (42) (900) (1,518)
Purchases of property and equipment, (net)...... (663) (4,831) (1,684)
Purchases of short-term investments............. (2,237) (23,084) (66,653)
Proceeds from sale and maturity of short-term
investments.................................... -- 13,836 39,940
------- -------- --------
Net cash used in investing activities..... (2,942) (14,979) (29,915)
------- -------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options......... 1 453 755
Proceeds from issuance of shares under Employee
Stock Purchase Plan -- 83 242
Proceeds from sale of stock..................... 12,843 49,986 70,581
------- -------- --------
Net cash provided by financing activi-
ties..................................... 12,844 50,522 71,578
------- -------- --------
Net increase in cash and cash equivalents......... 2,888 21,907 19,632
Cash and cash equivalents, beginning of period.... 2,777 5,665 27,572
------- -------- --------
Cash and cash equivalents, end of period.......... $ 5,665 $ 27,572 $ 47,204
======= ======== ========
Supplemental disclosure of noncash financing ac-
tivities:
Conversion of notes payable, including accrued
interest, into Series C1
Convertible Preferred Stock.................... $ 3,261 $ -- $ --
======= ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY
Cytyc Corporation and subsidiaries (the Company) design, develop,
manufacture and market sample preparation systems for medical diagnostic
applications. The Company's principal product, the ThinPrep System, is an
automated system for the preparation of non-gynecological samples and cervical
specimens on microscope slides.
In 1991, the Company commenced commercial sales of ThinPrep Processors,
reagents, filters and related supplies for non-gynecological diagnostic
applications to clinical laboratories and hospitals. On May 20, 1996, the
Company received clearance from the U.S. Food and Drug Administration to
market the ThinPrep System for cervical cancer screening.
To date, revenue from sales of products have not generated sufficient cash
to support the Company's operations. Since inception, the Company has incurred
substantial losses, principally from expenses associated with obtaining FDA
approval of the ThinPrep System, engineering and development efforts related
to the ThinPrep System and the establishment of a sales and administrative
organization. The Company has funded its operations primarily through the
private placement and public sale of equity securities, which resulted in
$163.9 million of net proceeds through 1997. The Company continues to be
subject to certain risks common to medical device companies in similar stages
of development, including dependence on a single product, extensive government
regulation, uncertainty of market acceptance, limited manufacturing, marketing
and sales experience and uncertainty of future profitability.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the application
of certain significant accounting policies, as discussed below and elsewhere
in the notes to consolidated financial statements. The preparation of these
consolidated 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 disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates.
(a) Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries, Cytyc SARL (a Swiss
corporation) (including its wholly-owned subsidiaries Cytyc Italia s.r.l. and
Cytyc France s.a.r.l.), Cytyc (Australia) PTY LTD (an Australian Corporation)
and Cytyc Securities Corporation (a Massachusetts securities corporation). All
material intercompany transactions and balances have been eliminated in
consolidation.
(b) Revenue Recognition
The Company recognizes product revenue upon shipment, when customer
acceptance is assured and collection of the resulting receivable is probable.
Deferred revenue represents amounts relating to deferred interest recorded in
connection with sales type finance leases with customers, and amounts related
to product billed but not shipped.
(c) Cash and Cash Equivalents
Cash equivalents consist of money market mutual funds, commercial paper and
U.S. Government securities with original maturities of three months or less.
F-7
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(d) Short-term Investments
The Company follows the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and
Equity Securities.
Short-term investments consist of U.S. Government securities with original
maturities between three and twelve months. The Company classifies these
short-term investments as held-to-maturity, and accordingly, they are carried
at amortized cost, which approximates market. Aggregate fair value, amortized
cost and average maturity for marketable securities held at December 31, 1997
and 1996 are as follows:
GROSS UNREALIZED
AMORTIZED HOLDING GAINS FAIR
COST (LOSSES) VALUE
--------- ----------------- -------
(IN THOUSANDS)
1997: U.S. Government and Agency secu-
rities (average maturity of 3.6
months).............................. $38,198 71 -- $38,269
======= ======== ======== =======
1996: U.S. Government and Agency secu-
rities (average maturity of 5.3
months).............................. $11,485 66 -- $11,551
======= ======== ======== =======
(e) Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations
of credit risk are principally cash, cash equivalents, short-term investments
and accounts receivable. The Company places its investments in rated financial
institutions. Concentration of credit risk with respect to accounts receivable
is limited to certain customers to whom the Company makes substantial sales.
To reduce risk, the Company routinely assesses the financial strength of its
customers and, as a consequence, believes that its accounts receivable credit
risk exposure is limited. The Company maintains an allowance for potential
credit losses but historically has not experienced any significant credit
losses related to an individual customer or groups of customers in any
particular industry or geographic area.
(f) Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market.
(g) Depreciation and Amortization
The Company provides for depreciation and amortization by charges to
operations, on a straight-line basis, in amounts estimated to allocate the
cost of the assets over their estimated useful lives as follows:
ESTIMATED
ASSET CLASSIFICATION USEFUL LIFE
-------------------- -------------
Production equipment.......................................... 3-7 Years
Research equipment............................................ 5-7 Years
Furniture and fixtures........................................ 5-7 Years
Computer equipment............................................ 3-5 Years
Leasehold improvements........................................ Life of lease
(h) Other Assets
Other assets consist of long-term lease receivables from the sale of
ThinPrep Processors, long-term deposits and the cost of obtaining patents.
Through 1996, patent costs were amortized over their estimated useful lives on
a straight-line basis. The Company chose to fully amortize these costs in
1997.
F-8
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(i) Research and Development Costs
The Company charges research and development costs to operations as
incurred.
(j) Net Loss Per Common Share
The Company adopted SFAS No. 128, Earnings Per Share, effective December 15,
1997. SFAS No. 128 establishes standards for computing and presenting earnings
per share and applies to entities with publicly held common stock or potential
common stock. The Company has applied the provisions of SFAS No. 128
retroactively to all periods presented. In accordance with Staff Accounting
Bulletin (SAB) No. 98, the Company has determined that there were no nominal
issuances of common stock or potential common stock in the period prior to the
Company's initial public offering (IPO). Diluted weighted average shares
outstanding for 1995, 1996 and 1997 exclude the potential common shares from
stock options and convertible preferred stock outstanding because to do so
would have been antidilutive for the years presented. Pro forma diluted net
loss per common and potential common share assumes that all series of
convertible preferred stock had been converted to common stock as of the
original issuance dates. Calculations of basic, diluted and pro forma diluted
net loss per common share and potential common share are as follows:
YEARS ENDED DECEMBER 31,
1997
---------------------------
1995 1996 1997
------- -------- --------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
Net loss...................................... $(5,915) $(11,919) $(22,072)
Weighted average common shares outstanding.... 308 11,192 16,893
======= ======== ========
Diluted weighted average shares outstanding 308 11,192 16,893
======= ======== ========
Pro forma conversion of convertible preferred
stock........................................ 8,067 1,790 --
------- -------- --------
Pro forma diluted weighted average shares
outstanding.................................. 8,375 12,982 16,893
======= ======== ========
Basic net loss per common share............... $(19.20) $ (1.06) $ (1.31)
======= ======== ========
Diluted net loss per common and potential
common share................................. $(19.20) $ (1.06) $ (1.31)
======= ======== ========
Pro forma diluted net loss per common and
potential common share....................... $ (0.71) $ (0.92) $ (1.31)
======= ======== ========
(k) Postretirement and Postemployment Benefits
The Company has no obligations for postretirement or postemployment
benefits.
(l) New Accounting Standards
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No.130, Reporting Comprehensive Income. SFAS No. 130 requires disclosure of
all components of comprehensive income on an annual and interim basis.
Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from nonowner sources. SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997.
In July 1997, the FASB issued SFAS No. 131 Disclosures About Segments of an
Enterprise and Related Information. SFAS No. 131 requires certain financial
and supplemental information to be disclosed on an annual and interim basis
for each reportable segment of an enterprise. SFAS No. 131 is effective for
fiscal years beginning after December 15, 1997.
F-9
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(3) ALLOWANCE FOR DOUBTFUL ACCOUNTS
A summary of the allowance for doubtful accounts activity is as follows:
DECEMBER 31,
----------------
1995 1996 1997
---- ---- ----
(IN THOUSANDS)
Balance, beginning of year................................. $158 $148 $135
Amounts charged off to expense............................. 50 -- 546
Amounts written off........................................ (60) (13) (9)
---- ---- ----
Balance, end of year....................................... $148 $135 $672
==== ==== ====
(4) INVENTORIES
Inventories consist of the following:
DECEMBER 31,
-------------
1996 1997
------ ------
(IN
THOUSANDS)
Raw material and work-in-process.............................. $ 880 $1,374
Finished goods................................................ 583 1,867
------ ------
$1,463 $3,241
====== ======
(5) PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and consists of the following:
DECEMBER 31,
-------------
1996 1997
------ ------
(IN
THOUSANDS)
Production equipment.......................................... $ 650 $3,140
Research equipment............................................ 712 843
Furniture, fixtures and computer equipment.................... 1,256 1,985
Deposits on equipment......................................... 2,248 321
Leasehold improvements........................................ 1,740 2,001
------ ------
6,606 8,290
Less accumulated depreciation and amortization................ 1,355 2,439
------ ------
$5,251 $5,851
====== ======
F-10
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(6) ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31,
-------------
1996 1997
------ ------
(IN
THOUSANDS)
Accrued warranty costs........................................ $ 251 $ 422
Accrued product upgrade costs................................. 378 906
Accrued compensation.......................................... 335 2,865
Accrued taxes................................................. 153 373
Accrued consulting fees....................................... 205 981
Other accruals................................................ 622 2,541
------ ------
$1,944 $8,088
====== ======
(7) INCOME TAXES
The Company records a deferred tax asset or liability based on the
difference between the financial statement and tax bases of assets and
liabilities, as measured by the enacted tax rates assumed to be in effect when
these differences reverse.
As of December 31, 1997, the Company has available net operating loss
carryforwards for federal tax purposes of approximately $60,000,000 and
research and development credit carryforwards of approximately $969,000 to
reduce future income taxes, if any. In addition, the Company has net operating
loss carryforwards for state tax purposes of approximately $54,000,000 and
other credit carryforwards of $897,000. These carryforwards expire at various
dates from 2002 to 2017, and are subject to review and possible adjustment by
the Internal Revenue Service.
The Internal Revenue Code ("IRC") contains provisions that may limit the
amount of net federal operating loss and credit carryforwards that the Company
may utilize in any one year in the event of certain cumulative changes in
ownership over a three-year period. In the event the Company has had a change
of ownership, as defined in IRC Section 382, utilization of the carryforwards
may be restricted.
The approximate income tax effect of each type of temporary difference and
carryforward is as follows:
DECEMBER 31,
----------------
1996 1997
------- -------
(IN THOUSANDS)
Net operating loss carryforwards......................... $15,638 $22,657
Research and development and other tax credit
carryforwards........................................... 909 1,866
Capitalized research and development expenses............ 3,037 3,478
Nondeductible accruals................................... 733 1,322
Other temporary differences.............................. 303 1,832
------- -------
Deferred tax asset....................................... 20,620 31,155
Valuation allowance...................................... (20,620) (31,155)
------- -------
Net deferred tax asset................................... $ -- $ --
======= =======
Due to the uncertainty surrounding the realization of the deferred tax
asset, the Company has provided a full valuation allowance against this
amount.
F-11
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(8) STOCKHOLDERS' EQUITY
(a) Common Stock Reserved
As of December 31, 1997, the Company has reserved 2,440,260 shares of Common
Stock for issuance as follows:
AMOUNT
---------
Exercise of stock options.......................................... 2,315,455
Exercise of warrant................................................ 2,000
Employee stock purchase plan....................................... 122,805
---------
2,440,260
=========
(b) Preferred Stock
The Board of Directors and stockholders authorized 5,000,000 shares of $.01
par value Preferred Stock. The Board of Directors has the authority to issue
such shares in one or more series and to fix the relative rights and
preferences without further vote or action by the stockholders. The Board of
Directors has no present plans to issue any shares of Preferred Stock.
(c) Stockholders' Rights Plan
On August 6, 1997 the Board of Directors declared a dividend of one
Preferred Stock purchase right for each outstanding share of the Company's
Common Stock to stockholders of record at the close of business on September
5, 1997. Each right entitles the holder to purchase from the Company a unit
consisting of one one-hundredth of a share of Series A Junior Participating
Preferred Stock, $.01 par value, at a purchase price of $110 per Unit, subject
to adjustment.
(9) STOCK OPTION PLANS AND WARRANT
(a) 1995 Stock Option Plan
During 1995, the Board of Directors and stockholders approved, effective
upon the closing of the initial public offering of the Company's Common Stock
described in Note (10), the 1995 Stock Option Plan. The aggregate number of
shares of Common Stock that may be issued pursuant to this Plan is 1,000,000
plus, effective as of January 1, 1997 and each year thereafter, the excess, if
any, of (i) five percent of the total number of shares of Common Stock issued
and outstanding as of December 31 of the preceding year or then reserved for
issuance upon the exercise or conversion of outstanding options, warrants or
convertible securities, over (ii) the number of shares then remaining reserved
and available for grant under the 1995 Plan, subject to certain adjustments,
provided, however, that in no event shall more than 2,000,000 shares of Common
Stock be issued pursuant to incentive stock options under the 1995 Plan. At
January 1, 1998, 454,115 additional shares were made available for grant under
this provision.
(b) 1989 Stock Option Plan
As of December 31, 1997, options to purchase 915,726 shares of common were
outstanding under the 1989 Stock Plan. Upon the closing of the initial public
offering of the Company's Common Stock described in Note (10), no further
grants may be issued under the 1989 Stock Option Plan.
(c) 1995 Director Option Plan
The Board of Directors and stockholders approved the 1995 Non-Employee
Director Stock Option Plan pursuant to which options to purchase up to 250,000
shares of Common Stock were authorized for future issuance. In January 1996,
the Company granted options to purchase 105,000 shares of Common Stock to
seven directors under this plan at an exercise price equal to $16.00 per
share.
F-12
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
At December 31, 1997, the Company had 598,823 options available for future
grants under the 1995 Stock Option Plan and the 1995 Director Option Plan. In
October 1997, the Company approved for grant 3,500 shares of Common Stock to
seven directors under the 1995 Director Option Plan at a market value of
approximately $87,500. Also in October 1997, the Company approved for grant
3,500 shares of Common Stock to seven directors (500 shares each, vesting
equally each month during 1998).
The following schedule summarizes the activity under the Company's stock
option plans for the three years ended December 31, 1997.
WEIGHTED
NUMBER AVERAGE
OF SHARES OPTION PRICE OPTION PRICE
--------- ---------------- ------------
Outstanding, December 31, 1994.... 720,447 $0.50 -- 1.25 $ 0.68
Granted......................... 876,877 0.625 -- 10.00 1.96
Exercised....................... (1,400) 0.50 -- 1.25 0.66
Canceled........................ (22,800) 0.50 -- 1.25 0.77
--------- ---------------- ------
Outstanding, December 31, 1995.... 1,573,124 0.50 -- 10.00 1.39
Granted......................... 641,400 10.00 -- 33.50 18.97
Exercised....................... (470,148) 0.50 -- 5.00 0.96
Canceled........................ (34,850) 0.625 -- 32.00 8.75
--------- ---------------- ------
Outstanding, December 31, 1996.... 1,709,526 0.50 -- 33.50 $ 7.96
Granted......................... 262,110 17.50 -- 31.13 23.89
Exercised....................... (232,421) .50 -- 22.00 3.25
Canceled........................ (22,583) 0.84 -- 32.00 15.15
--------- ---------------- ------
Outstanding, December 31, 1997.... 1,716,632 $0.50 -- $33.50 $10.94
--------- ---------------- ------
Exercisable, December 31, 1997.... 348,042 $0.50 -- $33.50 $ 9.75
========= ================ ======
In October 1995, the FASB issued SFAS No. 123, which requires the
measurement of the fair value of stock-based compensation to be included in
the statement of operations or disclosed in the notes to the financial
statements. The Company has determined that it will continue to account for
stock-based compensation for employees under Accounting Principles Board
Opinion No. 25 and elect the disclosure-only alternative under SFAS No. 123
for stock-based compensation awarded in 1995, 1996 and 1997 using the Black-
Scholes option pricing model prescribed by SFAS No. 123. The underlying
assumptions used are as follows:
DECEMBER 31,
---------------------
1995 1996 1997
----- ------ ------
Risk-free interest rate............................. 6.38% 6.18% 6.22%
Expected dividend yield............................. -- -- --
Expected lives...................................... 5.95 5.99 4.59
Expected volatility................................. 90% 90% 80%
Weighted average value of grants.................... $1.52 $13.85 $15.53
Weighted average remaining contractual life of
options outstanding (years)........................ 8.95 8.31 8.29
F-13
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Had compensation cost for the Company's stock option plans and Employee
stock purchase plan been determined consistent with SFAS No. 123, pro forma
net loss and net loss per share would have been:
DECEMBER 31,
---------------------------
1995 1996 1997
------- -------- --------
Net loss--
As reported.................................. $(5,915) $(11,919) $(22,072)
Pro forma.................................... (5,951) (13,079) (24,975)
Net loss per share, as reported--
Basic ....................................... $(19.20) $ (1.06) $ (1.31)
Diluted...................................... $(19.20) $ (1.06) $ (1.31)
Pro forma diluted............................ $ (0.71) $ (0.92) $ (1.31)
Net loss per share, pro forma--
Basic........................................ $(19.32) $ (1.17) $ (1.48)
Diluted...................................... $(19.32) $ (1.17) $ (1.48)
Pro forma diluted............................ $ (0.71) $ (1.01) $ (1.48)
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
(d) 1995 Employee Stock Purchase Plan
During 1995, the Board of Directors and stockholders approved, effective
upon the closing of the initial public offering of the Company's Common Stock
described in Note (10), the 1995 Employee Stock Purchase Plan pursuant to
which 140,000 shares of Common Stock could be issued. Purchase price is
determined by taking the lesser of 85% of the closing price on the first or
last day of the period. During 1997, 11,173 shares of common stock were issued
at the purchase prices of $22.53 and $21.14 per share. As of December 31,
1997, 122,805 shares were available for future issuance under the 1995
Employee Stock Purchase Plan.
(e) Warrant
In June 1994, the Company issued to a stockholder a warrant to purchase
shares of Common Stock at an exercise price equal to the fair market value of
Common Stock at the time of vesting but not less than $5.00 per share. The
warrant expires ten years from the date of issuance. Vesting of the warrant
was contingent upon achievement of certain performance objectives in
connection with a purchasing agreement between the Company and the
stockholder, which was canceled on July 22, 1996. At December 31, 1997, such
warrant was exercisable to purchase 2,000 shares of Common Stock at an
exercise price of $10.00 per share.
(10) PUBLIC STOCK OFFERINGS
On March 8, 1996, the Company sold through an underwritten initial public
offering, 3,000,000 shares of its Common Stock at $16.00 per share. Upon the
closing of the Company's initial public offering, all outstanding shares of
the Convertible Preferred Stock were converted into 9,778,326 shares of Common
Stock. On April 4, 1996, the Underwriters of the Company's initial public
offering exercised their over-allotment option in full to purchase an
additional 450,000 shares of the Company's Common Stock at $16.00 per share.
On February 6, 1997, the Company sold through an underwritten follow-on
offering 2,650,000 shares of Common Stock at $ 23.50 per share, while existing
shareholders sold 1,000,000 shares of common stock. On February 20, 1997, the
Underwriters of the follow-on public offering exercised their over-allotment
option in full to purchase an additional 547,500 shares of the Company's
Common Stock at $ 23.50 per share.
F-14
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(11) COMMITMENTS AND CONTINGENCIES
(a) Lease Commitments
The Company rents a manufacturing and administrative facility under an
operating lease expiring in February 2005.
At December 31, 1997, future minimum annual lease payments under this lease
are as follows:
AMOUNT
--------------
(IN THOUSANDS)
--------------
1998.......................................................... $1,076
1999.......................................................... 1,076
2000.......................................................... 1,100
2001.......................................................... 1,100
2002.......................................................... 1,149
Thereafter.................................................... 2,346
------
$7,847
======
Rent expense under operating leases totaled approximately $270,000, $513,000
and $709,000 in 1995, 1996 and 1997 respectively.
(b) Litigation
The Company is involved in various commercial lawsuits involving
Neuromedical Systems, Inc. and others. As of December 31, 1997, there were
several pending actions that are in the early stages of discovery and,
accordingly, the Company is unable to determine the extent of its liability,
if any, or the likelihood of prevailing in such actions.
(c) Royalties
The Company is the exclusive licensee of certain patented technology used in
the ThinPrep System. In consideration for this license, the Company has agreed
to pay a royalty equal to 1% of net sales of the ThinPrep Processor, filter
cylinder disposable products that are used with the ThinPrep System, and
improvements made by the Company relating to such items. Royalty payments, in
connection with this license, for the years ended December 31, 1995, 1996 and
1997 were $19,000, $53,000 and $135,000 respectively.
At December 31, 1997, the Company has commitments for the purchase of
capital equipment costing approximately $2,023,000.
F-15
CYTYC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(12) EMPLOYEE BENEFIT PLAN
The Company maintains an employee benefit plan under Section 401(k) of the
Internal Revenue Code. The Plan allows for employees to defer a portion of
their salary up to the maximum allowed under IRS rules. The Company made
contributions to the Plan during 1997 totaling $89,635.
F-16
CYTYC CORPORATION
INDEX TO EXHIBITS FILED WITH FORM 10-K
YEAR ENDED DECEMBER 31, 1997
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1(2) Third Amended and Restated Certificate of Incorporation of the
Company.
3.2(2) Amended and Restated By-Laws of the Company.
4.1(1) Specimen certificate representing the Common Stock.
4.2(3) Rights Agreement, dated as of August 27, 1997, between Cytyc
Corporation and BankBoston, N.A., which includes as Exhibit A the
Form of Certificate of Designations, as Exhibit B the Form of Rights
Certificate, and as Exhibit C the Summary of Rights to Purchase
Preferred Stock.
10.1(1)* 1988 Stock Plan.
10.2(1)* 1989 Stock Plan.
10.3(1)* 1995 Stock Plan.
10.4(1)* 1995 Non-Employee Director Stock Option Plan.
10.5(1)* 1995 Employee Stock Purchase Plan, as amended.
10.6(1)# License Agreement between the Company and DEKA Products Limited
Partnership dated March 22, 1993.
10.7(1) Form of Indemnification Agreement.
10.8(1) Lease Agreement between the Company and BFA Realty Partnership, L.P.
d/b/a BFA, Limited Partnership of February 1996.
10.9** Amendment No. 1 to Lease Agreement dated as of February 1996 between
the Company and BFA Realty Partnership, L.P. d/b/a BFA, Limited
Partnership.
10.10(4)# Co-Promotion Agreement dated as of May 27, 1997 by and between Mead
Johnson & Company and the Company.
10.11+** Amendment No. 1 to Co-Promotion Agreement dated as of May 27, 1997
by and between Mead Johnson & Company and the Company.
13.1*** The Company's 1997 Annual Report to Stockholders, certain portions
of which have been incorporated herein by reference.
21.1** List of Subsidiaries of the Company.
23.1** Consent of Arthur Andersen LLP.
24.1** Power of Attorney (see signature page hereto).
27.1** Financial Data Schedule.
- --------
(1) Incorporated herein by reference to the exhibits to the Company's
Registration Statement on Form S-1 (File No. 333-00300).
(2) Incorporated by reference to the exhibits to the Company's Registration
Statement on Form S-1 (File No. 333-19367).
(3) Incorporated herein by reference to Exhibit 4.1 to the Company's Current
Report on Form 8-K, filed August 29, 1997 (File No. 000-27558).
(4) Incorporated herein by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q, filed August 8, 1997.
* Indicates a management contract or any compensatory plan, contract or
arrangement
** Filed herewith.
*** Such report, except for those portions thereof which are expressly
incorporated by reference herein, is furnished for the information of the
Commission and is not to be deemed "filed" as part of this Annual Report
on Form 10-K.
# Confidential treatment granted as to certain portions.
+ Confidential treatment requested as to omitted portions pursuant to Rule
24b-2 promulgated under the Securities Exchange Act of 1934, as amended.