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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NUMBER: 0-22885
AUTOCYTE, INC.
(exact name of registrant as specified in its charter)
Delaware 56-1995728
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
112 Orange Drive, Elon College, North Carolina 27244
(Address of principal executive offices including zip code)
Registrant's telephone number, including area code:
(336) 584-0250
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- ----------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 Par Value
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 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 voting stock held by non-affiliates of the
registrant as of March 23, 1998 was: $21,230,993
There were 12,658,710 shares of the registrant's Common Stock outstanding as of
March 23, 1998.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement of the Registrant for the
Registrant's 1998 Annual Meeting of Shareholders to be held on May 28, 1998,
which definitive proxy statement will be filed with the Securities and Exchange
Commission not later than 120 days after the registrant's fiscal year of
December 31, 1997, are incorporated by reference into Part III of this Form
10-K.
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PART I
ITEM 1. BUSINESS
The discussion included in this section as well as elsewhere in the Annual
Report on Form 10-K may contain forward-looking statements based on current
expectations of the Company's management. Such statements are subject to risks
and uncertainties that could cause actual results to differ from those
projected. See "Important Factors Regarding Forward-Looking Statements" attached
hereto as Exhibit 99.1 and incorporated by reference into this Form 10-K.
Readers are cautioned not to place undue reliance on the forward-looking
statements which speak only as the date hereof. The Company undertakes no
obligation to publicly release the result of any revisions to these
forward-looking statements that may be made to reflect events or circumstances
occurring after the date hereof or to reflect the occurrence of unanticipated
events.
THE COMPANY
AutoCyte, Inc. ("AutoCyte" or the "Company") develops, manufactures and
markets the only integrated automated sample preparation and image analysis
system to support cytology professionals in cervical cancer screening. The
Company is currently pursuing regulatory approval of its products for sale in
the United States and has begun sales in several foreign countries. The
Company's integrated system is comprised of the AutoCyte PREP ("PREP") sample
preparation system and the AutoCyte SCREEN ("SCREEN") image analysis system. The
Company's Pathology Workstation product line further integrates AutoCyte's
product offerings into tools for data handling of cytology and pathology images,
and tools for determining prognosis of disease from cytology and pathology
specimens.
PREP is a proprietary automated liquid-based sample preparation system that
produces slides with a homogeneous layer, or "monolayer," of cervical cells. The
Company believes PREP will improve laboratory productivity and significantly
reduce interpretation errors by producing cell samples that are clearer, more
uniform and easier to interpret than conventional Pap smear samples. PREP is
designed to operate both as an independent sample preparation system and in
conjunction with SCREEN as part of an integrated diagnostic system.
SCREEN is an automated image analysis system which combines proprietary
imaging technology and classification software with off-the-shelf computer
hardware to screen slides prepared using PREP. SCREEN is designed to be an
interactive support tool for the cytology professional in the primary screening
of cervical cells and may serve quality control and adjunctive testing purposes.
By designing PREP and SCREEN to function together, AutoCyte has developed a
system which the Company believes will operate with higher throughput and
greater diagnostic sensitivity than the conventional Pap smear test and other
cervical cancer screening systems.
CERVICAL CANCER SCREENING MARKET
Cervical cancer is the second most common form of cancer among women
throughout the world. The World Health Organization estimates that worldwide
there were approximately 525,000 new cases of cervical cancer and approximately
247,000 deaths attributable to the disease in 1996. The American Cancer Society
estimated that, in the United States alone, approximately 14,500 new cases of
cervical cancer would be diagnosed and 4,800 women would die of cervical cancer
in 1997. The factors associated with the development of cervical cancer are
believed to include sexual activity at an early age, multiple sexual partners, a
history of sexually transmitted disease and cigarette smoking. Recent studies
have also indicated that cervical cancer is linked to the presence of certain
strains of Human Papillomavirus ("HPV").
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
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bloodstream or lymph system. Treatment of early-stage noninvasive cervical
cancer may be accomplished through various low-risk and low-cost procedures
designed to remove the abnormal cells. Once the cancer reaches the invasive
stage, however, the patient's chances for recovery are diminished, and more
radical treatment, such as a hysterectomy and chemotherapy or radiation therapy,
is typically required. These procedures are costly and may expose the patient to
substantial physical morbidity and psychological stress.
Because treatment of cervical cancer at an early stage is almost always
successful, early detection is critical to medical management of the disease.
Thus, regular cervical screening examinations are recommended in the United
States and many foreign countries. The conventional Pap smear is currently the
most widely used screening test for cervical cancer. This test was developed in
1943 by Dr. George Papanicolaou and has remained virtually unchanged for the
past 50 years. It is estimated that clinical laboratories in the United States
perform over 50 million conventional Pap smears annually. The Company believes
that annual test volume outside of the United States is in excess of 55 million.
In the United States, although widespread and regular use of the
conventional Pap smear has contributed to a greater than 70% decrease in
mortality, the mortality rate from the disease has remained fairly constant
since 1970. The Company believes that there are practical limitations to the
conventional Pap smear test which contribute to an estimated $5.0 billion of
annual costs associated with the treatment of advanced precancerous and
cancerous cervical disease. Additional costs are also incurred by third-party
payors due to repeat testing and by clinical laboratories due to litigation
associated with inaccurate diagnoses.
THE CONVENTIONAL PAP SMEAR PROCESS
The conventional Pap smear process involves the science of cytology, which
includes the microscopic interpretation of precancerous, malignant and
morphological changes in cells. The conventional Pap smear process begins with
the collection of cervical cells during a gynecological examination. To obtain a
cervical cell sample, a sampling device is used by a clinician to scrape cells
from the surface of the cervix. The sample is then manually smeared onto a clean
microscope slide, and the sampling device is discarded. The clinician 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. At the laboratory, the slides are manually or mechanically stained
in a batch process typically using common reservoirs of staining reagents to
enhance the morphologic presentation of the cells.
Following staining of the slide sample, a cytotechnologist, a medical
professional with special training in the examination and interpretation of
human cells, conducts a microscopic review of the slide to determine the
adequacy of the sample and to assess the presence of abnormal cells. In
determining slide adequacy, cytotechnologists classify each slide into one of
three categories: (i) satisfactory for evaluation, (ii) satisfactory but limited
by certain characteristics ("SBLB") or (iii) unsatisfactory for evaluation. The
percentage of unsatisfactory and SBLB slides varies widely among laboratories.
In the United States, approximately 1% to 2% of all conventional Pap smear
slides are classified as unsatisfactory and as many as 20% to 30% are classified
as SBLB. Frequent reasons for unsatisfactory or SBLB classifications include
excess blood or mucus or the presence of inflammatory cells, all of which
obscure the diagnostic cells of interest, a lack of diagnostic cells and too few
cells per slide.
After assessing sample adequacy, the cytotechnologist manually screens each
usable slide with a microscope to differentiate diseased or abnormal cells from
normal cells based on size, shape and structural details of the cells and their
nuclei. Typically, each conventional Pap smear slide is then classified in
accordance with the Bethesda System for Reporting Cervical/Vaginal Cytological
Diagnoses (the "Bethesda System"). The following table summarizes the Bethesda
System classification and other characteristics of all conventional Pap smear
slides prepared annually in the United States:
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BETHESDA
SYSTEM APPROXIMATE PRECANCEROUS/ CLINICAL
CLASSIFICATION INCIDENCE INTERPRETATION CANCEROUS ACTION
-------------- ---------- -------------- ------------- ---------
NEGATIVE 92% NORMAL NOT CANCEROUS CONTINUED REGULAR
TESTING
ATYPICAL SQUAMOUS CELLS OF
UNDETERMINED
SIGNIFICANCE/ATYPICAL
GLANDULAR CELLS OF UNDETERMINED
SIGNIFICANCE ("ASCUS/AGUS") 5% EQUIVOCAL UNDETERMINED REPEAT TESTING/
COLPOSCOPY/BIOPSY
LOW-GRADE SQUAMOUS
INTRAEPITHELIAL LESION ("LSIL") 2% ABNORMAL PRECANCEROUS COLPOSCOPY/BIOPSY
HIGH-GRADE SQUAMOUS
INTRAEPITHELIAL LESION ("HSIL") <1% ABNORMAL PRECANCEROUS COLPOSCOPY/BIOPSY
CARCINOMA <1% ABNORMAL CANCEROUS COLPOSCOPY/BIOPSY
ASCUS/AGUS slides contain abnormal cells that cannot be fully explained on
the basis of inflammatory or reactive processes, yet lack certain criteria for a
specific abnormal diagnosis. ASCUS/AGUS slides are generally not considered
precancerous. LSIL slides represent the lowest-grade precancerous state, with
cells characterized as exhibiting mild to moderate dysplasia or evidencing signs
of HPV. Dysplasia is a condition characterized by abnormally differentiated
cells that could either progress to a precancerous state or regress to a normal
state. HSIL slides contain precancerous cells characterized as exhibiting more
serious dysplasia or signs of HPV. All ASCUS/AGUS and abnormal slides are
referred to a pathologist for further review and final diagnosis. 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 use of a low magnification device by a physician to visually
examine the surface of the cervix. Based on the colposcopy results, a biopsy may
then be performed for a more definitive diagnosis.
LIMITATIONS OF THE CONVENTIONAL PAP SMEAR PROCESS
In spite of the success of the conventional Pap smear in reducing deaths due
to cervical cancer, the test has several limitations, including inadequacies in
sample collection and slide preparation, detection and interpretation errors,
inability to use the patient sample for additional diagnostic tests, and
productivity constraints on laboratories caused by regulatory compliance.
Inadequacies in the sample collection and slide preparation process cause many
inaccurate test results, including false negative and false positive diagnoses.
A false negative diagnosis -- the failure to detect cancerous or precancerous
cells -- may result in the progression of cervical cancer to a later stage of
development before being detected. As a result, more expensive and invasive
courses of therapy are required, and the likelihood of patient survival is
diminished. False negative rates of the conventional Pap smear vary widely among
laboratories, ranging from 5% to 55%, depending on such factors as the skill and
experience of the practitioner who collects the sample and prepares the slide
and the level of training of the cytotechnologist and pathologist who review the
slide.
Studies suggest that approximately 60% of all false negative diagnoses are
attributable to inadequacies in sample collection and slide preparation;
approximately 40% are attributable to slide detection and interpretation errors.
False negative diagnoses have given rise to increasing levels of litigation in
recent years, resulting in significant additional costs to clinical
laboratories. False positive diagnoses -- the mistaken classification of normal
cells as precancerous -- can result in unnecessary retesting, biopsies or other
procedures which are costly, invasive and often painful and stressful for
patients.
Inadequacies in Sample Collection and Slide Preparation
There are a variety of difficulties with the conventional Pap smear methods
of cell collection, cell transfer
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and slide preparation. A recent study published in the American Journal of
Clinical Pathology reported that, with a conventional Pap smear, as much as 80%
of the sample taken from a patient is not transferred to the slide and remains
on the discarded collection device. Because the sample cells are not randomized
across the collection device, the discarded portion of the sample may contain
abnormal cells necessary for an accurate diagnosis.
In addition to the problem of cell transfer, the conventional Pap smear slide
preparation process produces inconsistent and non-uniform slides with extreme
variability in quality, often making examination difficult. The poor quality of
slides is often a result of the presence of blood, mucus, inflammatory cells or
other obscuring debris, cell clumping and air-drying of the cell sample before
it is suitably preserved or fixed. Air drying can cause an artificial distortion
in cell size and shape, which are critical indicators in determining whether
abnormalities exist. The conventional Pap smear process also includes batch
staining which may result in cross-contamination among slide samples.
The Company believes that these sample collection and slide preparation
limitations are responsible for a large percentage of slides being classified as
unsatisfactory and SBLB. Consequently, patients are often subjected to the
inconvenience of return office visits for repeat testing and to the anxiety
resulting from the inconclusive nature of the initial test. The Company
estimates that annual costs to the United States health care system of repeat
testing due to unsatisfactory and SBLB slides are $50 million and $750 million,
respectively.
Detection and Interpretation Errors
The process of manually screening and interpreting a conventional Pap smear
is complex and tedious, which can lead to detection and interpretation errors.
Cytotechnologists typically review between 50 and 100 Pap smear slides per day.
The review process requires intense visual examination through a microscope of
the slide sample, each of which typically contains 50,000 to 300,000 cervical
cells. This review process is prone to error because of the complexity of
properly evaluating and categorizing subtle changes in the size and/or shape of
cells and their nucleii. The diagnostic cells can often be obscured by cell
clumping and the presence of debris, which increases the possibility that some
percentage of cells, including abnormal cells, will be missed.
Because more than 90% of all conventional Pap smears in the United States
are diagnosed as negative, the process of identifying the abnormal samples
requires constant vigilance. Despite the diligence of cytotechnologists, the
intense level of concentration on such a high volume of cells over long periods
of time results in some risk of fatigue. This fatigue can contribute to the
incidence of false negative and false positive diagnoses.
Lack of Additional Testing Capability
The conventional Pap smear process does not permit additional or adjunctive
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. Recent studies have shown that
HPV DNA is present in most cases of HSIL lesions and in more than 90% of cases
of cervical cancer. These studies may suggest HPV testing is a less expensive
and less invasive follow-up procedure for women with a conventional Pap smear
classification of ASCUS/AGUS or LSIL, since 30% to 75% of these patients will
not have lesions that progress to high grade lesions or cancer.
Using the conventional Pap smear process, because the residual cell sample
is not saved, the patient must return to the physician's office to provide a
second sample if additional testing, such as HPV testing, is indicated. The
Company believes that the ability to access residual cellular material from the
original patient sample would allow more cost effective patient management for
inconclusive Pap smear tests.
Limitations on Clinical Laboratory Productivity
In 1988, to address, in part, accuracy and quality control concerns
associated with conventional Pap smears,
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Congress adopted the Clinical Laboratory Improvement Amendments of 1988
("CLIA"). CLIA regulations require laboratories to rescreen 10% of the slides
that are initially classified as negative. In addition, CLIA regulations
currently limit the number of slides that may be screened per day by a
cytotechnologist to 100. As a further quality control measure, 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. Certain states have also adopted regulations further limiting the
number of slides that may be manually examined per day by a cytotechnologist.
Compliance with the quality control provisions of CLIA has resulted in
substantial additional costs to clinical laboratories that perform conventional
Pap smear screening.
THE AUTOCYTE SOLUTION
AutoCyte is the first company to develop an integrated sample preparation
and screening system for cervical cancer intended to address the limitations
inherent in the conventional Pap smear process. PREP is a proprietary,
automated, liquid-based sample preparation system that produces slides with a
thin and uniform layer of cervical cells. PREP is designed to operate both as an
independent sample preparation system and in conjunction with SCREEN as part of
an integrated diagnostic system. SCREEN is an automated image analysis system
which combines proprietary imaging technology and classification software with
off-the-shelf computer hardware to screen slides prepared using the PREP system.
SCREEN is designed to be an interactive support tool for the cytology
professional in the primary screening of cervical cells, but may also support
quality control and adjunctive testing applications. The Company's Pathology
Workstation product line further integrates AutoCyte's product offerings into
tools for data handling of cytology and pathology images, and tools for
determining prognosis of disease from cytology and pathology specimens.
The AutoCyte PREP System
The Company's PREP system consists of a proprietary preservative fluid and
reagents, plastic disposables and automated equipment for preparing a monolayer
of cervical cells on the microscope slide. The PREP slide process begins with
the clinician taking a patient's cervical sample using a conventional collection
device. The clinician then immediately places the collection device in a vial
containing the Company's proprietary CytoRich preservative fluid, thereby
retaining virtually all of the cells from the collection device. After receiving
the vial from the clinician, the laboratory thoroughly mixes the sample,
generating a randomized cell suspension, which is then removed from the vial
using the Company's patented disaggregation syringe device and layered onto a
proprietary liquid density reagent in a plastic centrifuge tube. Batch
centrifugation is then conducted on the cell suspension to remove excess blood,
inflammatory cells and other debris from the sample.
Once centrifugation is completed, the lab technician places the tube
containing the separated diagnostic cells onto the automated PREP pipetting
station. PREP then distributes the cells in a thin monolayer on the microscope
slide and discretely stains the slide for subsequent analysis. A PREP slide
typically contains approximately 45,000 cells which are distributed uniformly
over a 13 mm diameter circle. PREP is currently capable of preparing and
discretely staining 48 monolayer slides per hour.
PREP Advantages vs. the Conventional Pap Smear Process
The Company believes that PREP will offer the following advantages over the
conventional Pap smear process:
- More Complete Sample Collection. Because the clinician places the
collection device directly into the PREP vial, the entire patient sample
is contained in the Company's proprietary preservative fluid. As a result,
the subsample on the monolayer preparation is more representative of the
entire patient specimen. Using the conventional Pap smear process, as much
as 80% of the cervical sample can be inadvertently discarded after
smearing the sample onto the slide.
- Improved Sample Quality. By eliminating variations in preparation
techniques and the fixative spraying step from the sample collection
process, PREP virtually eliminates air-drying, generates a more complete
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fixation and provides a more standardized preparation process in a
controlled, laboratory environment. The more uniform cell sample
distribution also reduces cell clumping and obscuring by debris. The
Company believes that PREP's monolayer slides provide cytotechnologists
with samples that are clearer, more representative and easier to diagnose
than conventional Pap smear slides.
- Improved Cytotechnologist Productivity. In the Company's clinical studies,
laboratories using PREP have experienced a greater than 50% increase in
cytotechnologist screening productivity. The impact on cytotechnologist
efficiency is important to clinical laboratories because of the growing
shortage of qualified cytotechnologists in recent years and the need to
create and maintain a desirable working environment for cytology
professionals.
- Automated and Discrete Staining Function. PREP includes a discrete, or
individual, slide staining function performed by a computer-controlled
robotic pipetting station. Unlike conventional Pap smear slides that are
often manually stained in a batch process using common reservoirs of
staining reagents, PREP staining reagents are directly applied to
individual slides. As a result, staining reagents are not shared among
slides, which the Company believes should reduce the risk of
cross-contamination among cell samples. Cross-contamination can lead to
inaccurate diagnoses.
- Multiple Testing Capability. Because the Company's proprietary CytoRich
preservative system enables the patient sample to be preserved for several
months, it permits, if necessary, preparation of several slides from a
single sample. The Company believes that the ability to perform additional
slide-based tests using a single sample, together with the improved
quality of the slide itself, will reduce retesting expenses typically
associated with inconclusive Pap smear tests. The residual patient sample
may also be used for other diagnostic protocols such as HPV and infectious
disease testing.
PREP Advantages vs. Other Automated Sample Preparation Processes
The Company believes that PREP will offer the following advantages over
other automated slide preparation processes:
- Improved Sample Quality. The PREP sample is processed through a series of
proprietary liquid-based reagents and centrifuge separation techniques
designed to isolate a high concentration of diagnostic cells. The only
currently FDA approved monolayer slide preparation system relies on
membrane filtration. The Company believes that its cell isolation process
more effectively controls the incidence of infectious agents, inflammatory
cells and other debris that may reduce the performance of membrane
filtration systems. The Company believes that, in populations in which
rates of gynecological infection are high, PREP's separation and isolation
process will result in a more representative slide sample which should
ultimately lead to a reduction in uncertain or incorrect diagnoses.
- Higher Throughput. PREP has the capacity to produce 48 monolayer slide
preparations per hour, which represents higher throughput than other
available automated slide preparation systems. In addition to this
increased throughput, the PREP processing unit requires less oversight
than other automated systems.
- Improved Cytotechnologist Productivity. The cell circle on a PREP slide is
smaller than the cell circle on other available automated slide
preparation systems, yet the number of diagnostic cells is approximately
equal. The Company believes that the smaller cell circle, coupled with a
lower incidence of infectious agents and inflammatory cells and other
debris, should result in faster, more efficient screening by cytology
professionals.
- Familiarity with Sample Preparation Approach. The PREP centrifugation and
robotic liquid handling techniques are similar to procedures already in
use in clinical laboratories.
- Automated and Discrete Staining Function. Unlike other automated sample
preparation systems that rely on batch staining using common reservoirs of
staining reagents, PREP staining reagents are applied
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directly to individual slides. Discrete staining offers several
benefits, including a reduced risk of cross-contamination among cell
samples, less degradation of the staining solution, less staining time
and lower costs.
- Integration with SCREEN. The Company has specifically designed PREP to
function with SCREEN, creating an integrated diagnostic tool which the
Company believes will operate with higher throughput, greater efficiency
and greater diagnostic sensitivity than other systems which do not
integrate the slide preparation and screening functions.
The AutoCyte SCREEN System
SCREEN is an automated image analysis system which combines proprietary
imaging technology and classification software with off-the-shelf computer
hardware to screen slides prepared using the PREP system. SCREEN is designed to
function as an interactive support tool for the cytology professional in the
primary screening of cervical cells, but may also serve quality control and
adjunctive testing purposes. SCREEN is designed to use a series of proprietary
algorithms to independently classify cells and present the cytotechnologist with
120 images of the most suspicious cells on the sample slide.
SCREEN is designed to evaluate all areas of the PREP monolayer and presents
high-resolution, color images of suspicious cells in the sample. The
cytotechnologist is then able to undertake an independent analysis of these
selected cells to interpret each slide. Once the cytotechnologist inputs the
image assessment into the computer, SCREEN displays its interpretation for
comparison. Unless SCREEN and the cytotechnologist agree that the slide is
normal, the slide is referred to a senior cytotechnologist or pathologist for
reevaluation. Combining expert human review with unbiased computer
interpretation is a fundamental component of the Company's patented SCREEN
process.
SCREEN Advantages vs. the Conventional Pap Smear Process
The Company believes that its diagnostic system combining PREP and SCREEN is
designed to offer the following advantages over the conventional Pap smear
process:
- More Complete Slide Examination on a High Throughput Basis. SCREEN is
designed to allow the cytotechnologist to review the monoloyer slide in
less than half the time now required for manual screenings of conventional
Pap smear slides.
- Presentation of High Resolution Computer Images. Using the SCREEN system,
cytotechnologists can control and display high resolution cell images.
SCREEN is designed to enable images of cells and abnormalities to be
enlarged and enhanced for easier examination. The system is designed to
identify and select for presentation only those cells that are most
pertinent to the diagnostic process. This process enables
cytotechnologists to concentrate on the most significant cells and
clusters, thereby reducing the complexity and tedious nature of manual
review. The Company believes that SCREEN will enable cytotechnologists to
reach accurate cell classification decisions more quickly and efficiently.
- Reduced Compliance Costs to Clinical Laboratories. CLIA allows monolayer
slides which result in cell dispersion on one-half or less of the total
available slide area to be screened at levels higher than the current 100
slide-per-day limit applicable to conventional Pap smear slides.
SCREEN Advantages vs. Other Automated Screening Processes
The Company believes that a diagnostic system combining PREP and SCREEN is
designed to offer the following advantages over other screening systems recently
developed to enhance or replace conventional Pap smear testing:
- Integrated Approach. AutoCyte provides the only automated, integrated
cervical cancer screening system
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available today. By designing PREP and SCREEN to work together, the
Company has created a system which it believes will operate with higher
throughput and with greater diagnostic sensitivity than other available
systems or combinations of approaches.
- Interactive Approach. AutoCyte's proprietary approach to cervical cancer
screening combines review of high resolution cell images by a
cytotechnologist with SCREEN's independent computer classification of each
sample, resulting in what the Company believes is a more sensitive
detection of sample abnormalities. The integrated PREP and SCREEN system
is a diagnostic support tool designed to interact with cytotechnologists,
not replace them. By offering a system which supports the cytology
professional, AutoCyte believes its system will more readily receive
positive acceptance by laboratories compared to systems which replace or
create additional tasks for the cytotechnologist.
- Cost-Effective Approach. SCREEN uses an off-the-shelf computer hardware
platform which is more flexible and requires less customization than other
automated screening devices. The Company believes that SCREEN's open
hardware configuration, combined with the utilization of PREP's monolayer
slides, will result in a lower cost per test than other automated
screening processes.
AUTOCYTE PRODUCT SYSTEMS
PREP System
The PREP system consists of the CytoRich line of proprietary preservatives
and reagents, a variety of proprietary plastic disposable components, and the
customized PREP instrument. The CytoRich reagents include the preservative
fluid, density reagent and multiple stains. The plastic disposables include the
preservative vial, a patented disaggregating syringe, a slide settling column
and pipette tip. The PREP instrument is a proprietary, computer-controlled
robotic pipetting station that has been specifically engineered for preparing
and discretely staining PREP slides. The instrument can be programmed to apply a
variety of different stains. A centrifuge can be provided by the Company as part
of the system. The PREP system can prepare up to 48 monolayer slide preparations
per hour. The resulting slides have a 13 mm diameter circle of cells in a
discretely stained monolayer containing an average of 45,000 cells per slide.
The Company holds a number of patents covering certain components of the PREP
system and the PREP slide preparation process. The Company has placed 14
PREP systems for cervical cytology applications in foreign markets which
collectively have produced over 200,000 monolayer slides in the past 24 months.
SCREEN System
The SCREEN system currently consists of a fully automated microscope, a high
capacity slide handler, an ultra high resolution digital color camera, a high
performance UNIX-based multi-processor and a high resolution monitor. The SCREEN
system uses proprietary cell population histogram analysis software. A
mechanical counter built into the SCREEN system allows the Company to monitor
the number of slides screened. The SCREEN system has been specifically designed
to process monolayer slides that have been prepared by the PREP system. The
SCREEN system can process slides and render slide classifications on a
continuous basis and is usually operated overnight. Up to 400 PREP slides may be
placed onto the fully automated SCREEN instrument for unattended slide handling,
identification and screening. SCREEN currently has the capacity to process, in
unattended operation, over 160 slides per 24-hour period. The Company has placed
SCREEN systems in clinical laboratories in Australia which have screened over
70,000 PREP slides in the past 24 months.
AutoCyte Pathology Workstation
AutoCyte's long-term product strategy encompasses an initiative into the
broader clinical laboratory automation market. The Company believes that market
acceptance of SCREEN will lay a foundation for additional future product lines,
including future applications of the Pathology Workstation. The Pathology
Workstation is a flexible computerized microscope which supports a set of
PC-based applications, such as
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image telecommunications, archiving, image and patient data management and other
supplemental testing designed to complement and support the SCREEN system.
Applications currently available from the Company include:
- Medical Information and Image Management. The AutoCyte Image Management
System ("AIMS") is an intelligent user interface which organizes images
and data using electronic folders. Diagnostic quality images can be
acquired and stored with patient information. Folders containing both
images and text can be incorporated into reports, or transmitted to a
specialist at a remote site during a telepathology consultation. This
folder concept combined with sophisticated search functionality provides a
powerful tool for managing medical images.
- Telepathology. AutoCyte LINK provides the ability to interactively capture
and transfer diagnostic quality images during an online telepathology
consultation. The system supports remote consultation, continuing
education and access to opinions from experts in pathology subspecialties.
- Image Titer. AutoCyte Image Titer enables the quantitative assessment of
anti-nuclear antibodies in a patient's blood specimen. This measurement is
essential in the evaluation of diseases such as lupus, rheumatoid
arthritis and other autoimmune disorders. The patented titration emulation
process is applicable to a wide range of fluorescence-based serum antibody
measurements.
The Company is currently marketing Pathology Workstation products through
distributors. The Company's strategy includes the development of additional
applications or modules to run on the proprietary Pathology Workstation platform
which support and integrate a systematic approach to diagnostic cytology and
pathology. These modules include quantitative DNA analysis, quantitative
immunocytochemistry, computer assisted tumor grading, fluorescence measurements,
slide mapping and computer supported manual cytology screenings.
NON-GYNECOLOGICAL PRODUCT APPLICATIONS
The Company began limited sales of PREP for non-gynecological cytology
applications in 1993. Non-gynecological applications relate to cytology
preparation from a wide variety of specimen types, including urine, sputum,
plural fluid, spinal fluid, peritoneal fluid and other body cavity fluids. Cell
preparations from bronchial, gastrointestinal and endometrial brushings and
washings as well as fine needle aspiration of specific organs are also addressed
among these applications. These non-gynecological applications of the PREP
system do not require FDA clearance. The Company has developed proprietary
preservatives that are optimized for these specific non-gynecological cytology
preparations.
At the end of 1997, there were 61 PREP systems installed in clinical
laboratories and hospitals worldwide, 47 of which were for non-gynecological
applications in the United States. These PREP systems being used for
non-gynecological applications can be converted to gynecological usage if the
FDA approves the PMA for the PREP system for cervical cytology.
CLINICAL TRIALS AND REGULATORY STATUS
Status of PREP PMA
Following completion of clinical trials for gynecological applications, the
Company submitted a PMA for PREP to the FDA on May 12, 1997, which was accepted
for substantive review by the FDA on June 11, 1997. Upon accepting the PREP PMA
for substantive review, the FDA informed the Company that the PMA would not be
submitted to its Medical Devices Advisory Panel for review since information in
the PMA substantially duplicated information previously reviewed by the panel in
a PMA submitted by a different company relating to an alternative monolayer
slide preparation product.
After reviewing the PREP PMA and receiving input on it from members of its
advisory panel, the FDA met with representatives from the Company in December
1997 to address certain of the FDA's questions relating to
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the PREP PMA. At the meeting, the Company presented additional analyses of
certain of the data from the PREP PMA. The FDA advised the Company that it would
need to amend the PREP PMA to include this and other information, and indicated
that it would notify the Company in writing as to the scope of the required
response to the agency's questions.
In February 1998 the Company received a letter from the FDA providing detail
on additional information it needed to continue review of the PREP PMA. The FDA
did not request that the Company perform any additional clinical trials. The FDA
requested that the Company's response be in the form of an amendment to the PREP
PMA. After preparing the requested information, the Company submitted the
amendment to the FDA on March 4, 1998.
FDA regulations provide that the FDA may extend the review period for a PMA
by up to 180 days from the date of submission of an amendment requested by the
agency. While the FDA review of the PREP PMA amendment may be shorter than 180
days, there can be no assurance that the FDA's review will not take 180 days or
longer or that the PREP PMA will be approved within that period or at all.
In late October 1997, the Company's manufacturing facility was inspected for
compliance with FDA's Quality System ("QS," formerly Good Manufacturing
Practice, or "GMP") regulations. In early December 1997, the FDA notified the
Company that the facility had no outstanding deficiencies and that it had passed
the inspection. Also in October, the FDA completed a compliance audit of one of
the eight sites that participated in the PREP clinical study and informed the
Company that the site had passed its audit.
PREP Clinical Trials
The PREP clinical trial design followed draft guidelines that had been
prepared by the FDA and the protocol was reviewed by the FDA. The clinical trial
was a double-blinded, matched-pair study in which a conventional Pap smear and a
PREP monolayer slide derived from the same patient sample were reviewed and
compared by different cytotechnologists without knowledge of the other's
interpretation. In the clinical trial, the sample collected from the cervix was
first smeared on a slide to create a conventional Pap smear. The collection
device with residual sample material was then placed in the Company's
proprietary CytoRich preservative fluid for later processing of a PREP slide.
The two slides, prepared from the same sample, were then used to compare PREP to
the conventional Pap smear.
A total of 8,983 patients from eight clinical trial sites were included in
the primary data analysis of the clinical trial. The combined data indicated
improvements in specimen adequacy using PREP relative to the conventional Pap
smear by reducing the number of unsatisfactory and SBLB slides by 39% and 44%,
respectively. The Company believes that PREP would have further reduced
unsatisfactory and SBLB slides if the sampling device had been immersed in the
CytoRich reagent directly, rather than after the preparation of a conventional
Pap smear slide, as was required by the clinical trial protocol.
The PREP clinical data also indicated statistically significant improvements
relative to the conventional Pap smear in (i) screening sensitivity (the
detection of disease classified in the Bethesda System as LSIL or higher), (ii)
reducing false negative diagnoses (the failure to detect cancerous or
precancerous cells) and (iii) reducing inconclusive diagnoses.
In further analysis of the clinical trial data following submission of the
PMA to the FDA, the Company removed from the analysis all cell samples from
patients having a clinical history of abnormality on a previous Pap smear slide.
The Company's approach sought to control for any potential bias that might have
occurred as a result of the reviewing cytotechnologists exercising more than
their usual level of diligence in reviewing slides from patients known by the
cytotechnologist as having a clinical history of abnormality in a previous Pap
smear test. An analysis of the remaining 6,196 cases revealed that, as compared
to the conventional Pap smear, PREP indicated greater screening sensitivity with
a 17% improvement in the detection of disease (LSIL or higher classification in
the Bethesda System) and an improvement in the rate of false negative diagnoses
with a 46% reduction in such errors by the cytotechnologist.
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The Company's analysis of data obtained from clinical studies is subject to
confirmation and interpretation by the FDA, which could delay, limit or prevent
FDA approval of a PMA. The Company excluded approximately 1,350 specimens from
the PREP clinical trial as noncompliant with protocol criteria. Based on its
internal review of these excluded specimens, the Company believes that the
inclusion of these specimens in the trial data would not have materially
affected the data analysis or other information included in the PREP PMA
submission. If, however, the FDA were to determine that these specimens should
be included in the FDA's statistical calculations, the PREP PMA and other claims
may have to be revised.
SCREEN System
In October 1996, the Company began blinded clinical trials for SCREEN. This
clinical trial involves rescreening PREP slides from the PREP clinical trial
sites using the SCREEN system and comparing these results with the results from
a manual review of the PREP slides. The Company expects to complete this
clinical trial for primary screening and adjunctive testing and submit a PMA for
SCREEN to the FDA during the second quarter of 1998. There can be no assurance
that this clinical trial will be completed or that any PMA for SCREEN will be
submitted to the FDA or if submitted will be accepted for substantive review or,
if accepted, will be approved by the FDA in a timely manner, or at all, or for
the claims for which the Company seeks approval.
Pathology Workstation
The Company has received FDA clearance of premarket notification ("510(k)")
covering Image Titer, an application for the Pathology Workstation currently
being sold by the Company. The Company believes that it will need to obtain
clearance of 510(k)s or approval of PMAs in the United States to market certain
additional Pathology Workstation applications currently being developed.
MARKETING AND SALES
Automated slide preparation and screening products have recently been
introduced into the cervical cancer screening market and the Company expects
that it will benefit from the increased awareness and acceptance of these new
technologies. AutoCyte's systems are already in various stages of evaluation and
use in major universities and laboratories in several countries. The Company
began limited commercial sales of PREP in 1993 and at the end of 1997 had
installed 61 PREP systems throughout the world. The first commercial use of both
PREP and SCREEN for cervical cancer screening has begun in laboratories at four
sites in Australia.
The Company generates PREP revenue from both system sales and rentals. For
system sales, customers purchase the instrument and make separate purchases of
related reagents and other disposables. For system rentals, the Company places
the PREP instrument at the customer's site, and customers make monthly payments
that include rent and a minimum monthly quantity of reagents and other
disposables. The term of the PREP rentals ranges from month-to-month to three
years. For SCREEN customers in the United States, the Company intends to place
instruments without charge at customer locations and to charge customers on a
per test, or Fee-Per-Use ("FPU"), basis. In foreign markets, the Company plans
to either sell or license SCREEN. As an important element of its business
strategy, the Company intends to seek third-party financing to support rentals
of PREP and FPU placements of SCREEN. There can be no assurance that the Company
will be able to obtain such financing or, if so, on favorable terms.
The principal market for non-gynecological applications of PREP is clinical
laboratories in the United States and Asia. PREP is currently being marketed for
non-gynecological applications in the United States directly through the
Company's own sales force. Foreign distribution partners are marketing PREP for
non-gynecological applications outside of the US.
The principal markets for the Pathology Workstation are pathology and
immunology laboratories and pathology research laboratories worldwide. The
Company's strategy is to sell Pathology Workstation products
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through distributors and OEM vendors who will integrate certain of the
workstation software into their own products. The Company has entered into an
international distribution agreement with Carl Zeiss Jena Gmbh, a major
European-based international company engaged in microscope manufacturing and
sales, to distribute the Pathology Workstation in the US and Europe. The Company
has also entered into an agreement with Dynamic HealthCare, Inc., a leader in
the sale of integrated pathology and cytology information systems to hospitals,
medical centers and laboratories throughout the US, to supply the AutoCyte Image
Management System ("AIMS") as a key component of its CoPath(R) client/server
solution for anatomic pathology laboratories.
Marketing Strategy
The Company expects to commence marketing PREP and SCREEN in the United
States for cervical cancer screening when and if FDA approval for cervical
cancer screening is obtained. PREP is designed to be sold as either a
stand-alone system or as an integrated system with SCREEN. The Company intends
to achieve market acceptance of PREP alone and then to target its PREP customer
base for its initial marketing efforts of SCREEN. The Company's marketing
strategy is to achieve broad market acceptance for the integrated PREP and
SCREEN system for cervical cancer screening. In implementing this strategy, the
Company will address the needs of the constituencies described below.
Large clinical laboratories. Conventional Pap smear testing has become a
concentrated market in the United States. The Company believes that three major
clinical laboratories, Laboratory Corporation of America Holdings, Quest
Diagnostics, Inc. ("Quest"), formerly known as Corning Clinical Laboratories,
Inc., and SmithKline Beecham Clinical Laboratories, account for almost 18
million conventional Pap smears annually. In June 1997, Cytyc announced that it
had entered into a multi-year agreement for ThinPrep 2000 with Quest. Other
large testing laboratories, which the Company believes perform more than 10
million conventional Pap smears in the United States annually, account for
another 20% of the market, concentrating approximately 55% of cervical cancer
test volume among a relatively small number of large laboratories. AutoCyte
believes that PREP's high throughput and cost-effectiveness will enable the
Company to market PREP successfully to this concentrated market segment and that
pressures associated with rising health care costs, rising litigation costs and
the limited supply of qualified cytotechnologists will facilitate adoption of
PREP and SCREEN by the large laboratory market. Large clinical laboratories have
used centrifuges and liquid-based analytical techniques for a variety of
applications and, accordingly, the Company believes that the familiar nature of
its underlying technologies will enable its products to be more readily accepted
in the market than products based on other technologies. Due to the concentrated
nature of the large clinical laboratory market, the Company believes that a
relatively small number of employees will be able to effectively market the
Company's systems to these customers.
Medium and small clinical laboratories. The Company also intends to devote a
substantial portion of its marketing resources to targeting medium and small
clinical laboratories. Hospital consolidation, and particularly the
consolidation of laboratories of the larger hospitals, is creating a new medium
sized customer for the Company's products. The Company expects that the medium
and small clinical laboratory segment of the market generally will utilize the
Company's equipment rental program.
Third-party payors. To achieve market acceptance for its products, the
Company will need to ensure that the use of its products is supported by
third-party payors. The Company will promote the clinical and economic benefits
of its PREP and SCREEN systems to national managed care providers, major private
insurers and other third-party payors. The Company's cervical cancer screening
system will initially be more expensive than conventional Pap smear testing on a
per test variable cost basis. Because the up-front, direct costs of using the
Company's products will be greater than the cost of the Pap smear, the Company
will need to convince third-party payors that the overall cost savings,
resulting from earlier detection of cervical cancer, reduction of unnecessary
biopsies and colposcopies, improved specimen adequacy and otherwise, will more
than offset the cost of the Company's products. At least two of the Company's
competitors have achieved third-party reimbursement for products that are
similar to PREP and SCREEN.
Health care providers. The Company intends to promote the clinical and
economic benefits of PREP and
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SCREEN directly to gynecologists and primary care physicians by marketing with
reference laboratory sales organizations. AutoCyte's sales and marketing program
will include a significant educational effort to communicate the advantages of
its integrated cervical cancer screening system to the medical community.
Marketing and Sales Organization
The Company currently employs 20 persons worldwide to market, sell and
provide after sale support of its products. The Company anticipates that its
worldwide base of employees to market, sell and provide after-sale support of
its products will grow to 25 to 30 persons by the end of 1998.
In the United States, the Company plans to market its cervical cancer
screening system through a direct sales force, if PMA approvals are obtained.
The majority of the direct sales organization will focus on the laboratory
market to achieve appropriate market penetration, acceptance and availability of
the Company's products. This same organization will market to managed care and
other third-party payor organizations to achieve appropriate reimbursement
levels and to create demand for the products. The Company will also consider
co-marketing agreements with sales organizations of major reference laboratories
and pharmaceutical manufacturers (with an emphasis on women's health care
products) to market its products directly to health care providers.
In international markets the Company markets and sells its products
primarily through distributors. To support these efforts, the Company employs
four people, consisting of sales professionals, supporting product managers and
after sales support personnel located in Europe, Japan and Australia. The
Company anticipates that these distributor organizations will ultimately assume
responsibility for all sales and after sales support activities as well as a
portion of the Company's marketing activities. Both large distribution
organizations with products focused on the clinical diagnostic market and
smaller distribution organizations with products focused specifically on the
cytology market are being considered.
After-sale support services, including customer training, product
installation, telephone technical support and repair service will be offered
directly to customers in the United States. Personnel providing these services
will be located both at the Company's headquarters and in select major
metropolitan areas. Internationally, the Company plans to provide these services
through distributor organizations.
MANUFACTURING
The PREP System
The Company currently assembles, tests and packages components of the PREP
system at its manufacturing facility in Burlington, North Carolina. The Company
also manufactures its CytoRich line of reagents and stains for PREP at the
Burlington facility. The Company believes that its existing manufacturing and
assembly processes are adequate to meet the near-term, full-scale production
requirements of its PREP System for cervical cancer screening.
The Company purchases certain of the PREP instrument components from a
single OEM supplier in Europe. The consumable items used with PREP, including
glass slides, centrifuge tubes, pipette tips, settling chambers and other
disposable components, are purchased from a variety of third-party vendors, some
of which are sole source suppliers. The Company has agreed to use a sole
supplier of manufactured plastic components incorporated into its PREP system
for the North American market for a period of at least five years from the first
production shipment date of each component engineered as of July 26, 1993. In
addition, the Company has agreed to allow this supplier to be the sole supplier
for manufactured plastic components for PREP sales beyond the North American
market. The Company's obligation to use this supplier as its sole supplier for
manufactured plastic components is contingent upon this supplier supplying the
Company at prices competitive with those offered by third parties on similar
terms and upon this supplier meeting the Company's quality and production
requirements. The Company believes that this supplier's production will be
sufficient to meet both
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its present and future requirements for manufactured plastic components. The
Company expects to extend its agreement with this supplier in a new four-year
contract that will commence in the second quarter of 1998.
Subject to any contractual limitations upon its ability to do so, the
Company may seek to establish other relationships with additional suppliers or
vendors for components of its products, although there can be no assurance that
it will be successful in doing so. The incorporation of new components, or
replacement components from alternative suppliers, into the Company's products
may require the Company to submit PMA supplements to, and obtain further
regulatory approvals from, the FDA before marketing the products with the new or
replacement components.
The SCREEN System
The Company also intends to assemble, test, and package its SCREEN system at
the Burlington facility. The SCREEN system is composed of a sophisticated
automated microscope, a robotic slide handler, a digital color camera, a
computer and other related components. The Company is also developing a next
generation SCREEN system ("SCREEN II") that utilizes fewer custom parts than the
current system.
For the SCREEN system, the Company is reliant upon certain sole source
vendors for a variety of components. The Company intends to minimize this
reliance in the future by establishing relationships with additional suppliers.
The incorporation of alternative components from new suppliers into the SCREEN
system may require the Company to submit PMA supplements to the FDA. There can
be no assurance that the Company will be successful in gaining approval for
these supplements.
The Company currently has only limited manufacturing and assembly capacity
for the SCREEN system. The Company believes that it will have adequate
manufacturing capacity in place by the time the Company receives a PMA for the
product, if the Company receives a PMA for SCREEN at all.
Pathology Workstation Products
The Company currently integrates and assembles the Pathology Workstation
products at its Burlington facility and believes it has sufficient capacity to
meet anticipated customer demand for this product. To prepare a Workstation for
shipment, a computer is first configured with the proper hardware and software
components, and is then integrated with an automated microscope and other
related components.
The Company's Workstation Products consist primarily of off-the-shelf
components and proprietary software. The components are supplied by a variety of
vendors, some of which are sole-source suppliers. The Company has been
integrating and selling Workstation Products since 1993.
The Company has finalized a distribution agreement with Carl Zeiss Jena Gmbh
for the Workstation Products. In the U.S., the Company has finalized a
distribution agreement with Dynamic Healthcare, Inc. for the AIMS workstation
product. As part of these distribution agreements, the Company expects to
continue to provide integration services.
Manufacturing Standards
The Company's manufacturing process is subject to extensive regulation by
the FDA, including the FDA's Quality System ("QS," formerly Good Manufacturing
Practice, or "GMP") requirements. The Company's facility in Burlington was
inspected by the FDA in October 1997 for compliance with QS requirements. The
Company was notified by the FDA in December 1997 that the facility had no
outstanding deficiencies and that it had passed the inspection. Failure to
comply with the FDA's QS requirements would materially impair the Company's
ability to achieve or maintain commercial-scale production. In addition, if the
Company is unable to maintain full-scale production capability, acceptance by
the market of PREP and SCREEN would be impaired, which in turn would have a
material adverse effect on the Company's business, financial conditions, and
results of operations.
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In addition to QS manufacturing requirements, the Company may be required
to meet certain requirements relating to ISO 9001 certification and other
European regulatory requirements. A European "CE" certification is required in
order to successfully sell PREP and SCREEN in Europe. The OEM supplier of the
PREP instrument components has ISO 9001 certification and has obtained CE
certification for the PREP in Europe. Other components of the PREP system also
have CE certification for sale in Europe. Although the Company does not
currently have ISO 9001 certification, the Company believes it can integrate the
components of the PREP system for resale in Europe in conformance with the CE
certification requirements. In addition, the Company is in the process of
pursuing a CE mark for its SCREEN system.
The company intends to commence its efforts for ISO 9001 certification in
1998. There can be no assurance, however, that it will be successful in
obtaining these certifications. Failure to either attain or maintain compliance
with the applicable manufacturing requirements of regulatory agencies 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 programs are currently focused on (i)
continued enhancement of the PREP instrument, related reagents and disposables
and further automation of the PREP slide preparation and handling process, (ii)
continued development of the next generation SCREEN product ("SCREEN II") and
(iii) development of additional Pathology Workstation applications to address
the needs of the broader pathology automation market.
Enhancements to PREP under development are particularly focused on
increasing the efficiency and cost effectiveness of the system, including the
introduction of a front-end automated slide processor and improved functionality
of its CytoRich line of reagents and preservatives.
SCREEN II is designed to increase throughput, incorporate more off-the-shelf
components and facilitate slide handling. SCREEN II will rely on an enhanced
proprietary algorithm classification technology and will be designed to have
increased information management and storage capabilities. The Company is
developing SCREEN II to include networking and sophisticated database
capabilities.
The Company is continuing to develop additional applications to run on its
Pathology Workstation platform. These applications include quantitative image
analysis, tumor grading and slide management. One image analysis application
performs a quantitative analysis of DNA, nuclear texture and morphology to
assess the aggressiveness of various types of tumors. Another image analysis
application, immunocytochemistry, performs quantitative analysis of hormone
receptors and proliferation markers in histological sections and single cell
preparations. The tumor grading application is designed to evaluate the
arrangement of tumor cells within sections, much the same way that tissue
sections are evaluated and graded by a pathologist. The slide manager module
facilitates slide mapping and computer assisted manual cytology screening and
cell relocation.
There can be no assurance that any product enhancement or development
project undertaken by the Company either currently or in the future will be
successfully completed, receive regulatory approvals or be successfully
commercialized. The failure of any such enhancement or project to be completed,
approved or commercialized could prevent the Company from successfully competing
in its targeted markets and could have a material adverse effect on the
Company's business, financial condition and results of operations.
As of December 31, 1997, the Company had 36 employees engaged in research
and development. The Company's expenditures for research and development were
approximately $5.1 million, $4.4 million and $4.5 million for the years ended
December 31, 1995 (predecessor), 1996 (proforma-combined) and 1997 (AutoCyte),
respectively.
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THIRD-PARTY REIMBURSEMENT
Successful commercialization of PREP and SCREEN 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 insurers
and managed care organizations. Because the up-front, direct costs of using the
Company's products will be greater than the cost of the conventional Pap smear,
the Company will need to convince third-party payors that the overall cost
savings to the health care system, resulting from earlier detection of cervical
cancer, reduction of unnecessary biopsies and colposcopies, improved specimen
adequacy and otherwise, will more than offset the cost of the Company's
products. 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 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 third-party payors in their respective
evaluations of PREP and SCREEN, the Company intends to provide scientific and
clinical data to support its claims of the safety and efficacy of the Company's
products. The Company expects to focus on improved disease detection and cost
savings benefits in seeking to obtain reimbursement for PREP and SCREEN for
cervical cancer screening.
A critical 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 Current Procedural Terminology ("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. The Company is
aware that certain clinical laboratories using other gynecological monolayer
systems have received reimbursement from certain third-party payors using
existing CPT codes. In January, 1998 the CPT Editorial Board established a
separate CPT code (88152) for liquid-based cervical cytology preparations. There
can be no assurance that monetary reimbursement will be established at a level
sufficient to support use of the PREP system on a routine basis. Failure to
secure sufficient reimbursement could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company has very 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, health care 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 PREP
or SCREEN under any other reimbursement system.
Although several of the Company's competitors have already received
reimbursement approval for their products, there is significant uncertainty
concerning third-party reimbursement for the use of any medical device
incorporating new technology. In February 1998, the Medical Advisory Panel
("MAP") of the Blue Cross and Blue Shield Association's Technology Evaluation
Center completed a cost-effectiveness study pertaining to certain of the
Company's competitors. The MAP concluded that Cytyc, Inc.'s ThinPrep(R) process,
NeoPath, Inc.'s AutoPap(R) 300 QC System (for quality control and adjunctive
testing only) and Neuromedical Systems, Inc.'s PAPNET(R) system (for adjunctive
testing only) offer only modest improvements in diagnostic accuracy at a high
cost. While the three companies have stated that they disagree with the MAP
report, and while AutoCyte's products were not included in the study, there can
be no assurance that the report will not have an adverse effect on market
acceptance of the Company's products. Reimbursement by a third-party payor
depends on a number of factors, including the level of demand by health care
providers and the payor's determination that the use of PREP and SCREEN
represents a clinical advance compared to current technology and is safe and
effective, medically necessary, cost-effective and appropriate for specific
patient populations. Since reimbursement approval is required from each payor
individually, seeking such approvals is a time-consuming and costly process that
requires the Company to provide scientific and clinical data to support the use
of PREP and SCREEN to each payor separately. There can be no assurance that
third-party payors will provide such coverage or coverage for any other products
developed by the Company, that reimbursement
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levels will be adequate or that health care providers or clinical laboratories
will use PREP and SCREEN for cervical cancer screening in lieu of the
conventional Pap smear method.
Recent health care cost containment initiatives in the United States that
have focused on reduction in reimbursement levels may effect the Company
negatively. However, emphasis on preventive measures to reduce the overall costs
to the health care system could lead to more frequent testing for cervical
cancer and use of PREP and SCREEN if approved by the FDA. The Company is unable
to predict the outcome or the effect on its business of the current health care
reform debate.
PATENTS, COPYRIGHTS, LICENSES AND PROPRIETARY RIGHTS
The Company relies on a combination of patents, trade secrets, copyrights
and confidentiality agreements to protect its proprietary technology, rights and
know-how. The Company holds four issued United States patents as well as
corresponding foreign patent applications, and has one United States patent
application that has been allowed but not issued, relating to various aspects of
its PREP and SCREEN technologies. These patents cover system components, such as
the disaggregation syringe, as well as the PREP process and the interactivity of
the cytotechnologist with the SCREEN system. The Company has also filed one
patent application which is pending in the United States and numerous patent
applications which are pending abroad. There can be no assurance, however, 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. The Company is aware that several of its competitors
hold several patents relating to automated slide preparation and screening.
There can be no assurance that a court would rule that the Company's products do
not infringe such third-party patents or would invalidate such third-party
patents. The Company may incur substantial legal fees in defending against a
patent infringement claim or in asserting claims of invalidity against 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
attempt 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.
The Company has entered into confidentiality agreements with all of its
employees and several of its consultants and third-party vendors. 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 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. The Company also holds unregistered rights to copyrights on
documentation and operating software developed by it for the PREP and SCREEN
systems. 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.
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COMPETITION
The cervical cancer screening market is comprised of the conventional Pap
smear process and certain technologies which have been introduced in recent
years or are currently under development to provide improvements over the
conventional Pap smear process. The Company's competitors in the development and
commercialization of alternative cervical cancer screening technologies include
both publicly traded and privately held companies. The alternative technologies
known to the Company have focused on improvements in slide sample preparation,
the development of automated, computerized screening systems and adjunctive
testing technologies. To date, the Company knows of no competitor which has
developed an integrated sample preparation and image analysis system, such as
PREP and SCREEN, which have been designed to function together. Nevertheless,
some competitors' products have already received FDA approval and are being
marketed in the United States. In addition, certain of the Company's 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, customer support,
manufacturing and marketing. In addition, some of these companies may have
received third-party reimbursement for their products. The Company believes that
its products will compete on the basis of a number of factors, including slide
specimen adequacy, screening sensitivity, ease of use, efficiency, cost to
customers and nature of claims allowed by the FDA. While the Company believes
that its products will have competitive advantages based on some of these
factors, there can be no assurance that various competitors' products will not
have competitive advantages based on other factors that, when coupled with the
earlier market entry of some products, will adversely effect the market
acceptance of PREP and SCREEN. Moreover, 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 technologies, will not have a material adverse effect on the
Company's business, financial condition and results of operations. The Company's
products could be rendered obsolete or uneconomical by technological advances of
the Company's current or potential competitors, the introduction and market
acceptance of competing products or by other approaches.
The Company's primary competitor in monolayer slide preparation is Cytyc
Corporation ("Cytyc"). Cytyc's system, the ThinPrep(R) 2000, is based on a
membrane-filtration separation system rather than the centrifugation approach
used in PREP. ThinPrep 2000 is the only monolayer sample preparation system
approved by the FDA for cervical cytology applications. It is also used for
non-gynecological applications. The FDA has allowed Cytyc's claim that ThinPrep
2000 sample preparation is "significantly more effective in detecting LSIL and
more severe lesions than the conventional Pap smear in a variety of patient
populations." Cytyc also has FDA-approved claims that specimen quality with the
ThinPrep 2000 system is significantly improved over that of conventional Pap
smear preparation in a variety of patient populations. There can be no assurance
that the FDA will approve the Company's PMA for PREP, or, if approved, that the
FDA will allow desirable claims. In June 1997, Cytyc announced that it had
entered into a multi-year agreement for ThinPrep 2000 with Quest, one of the
three large national chain laboratories. In addition, in October of 1996, Cytyc
announced a non-exclusive co-marketing agreement with Digene Corporation, which
has developed a product that detects the presence or absence of HPV in
precancerous cervical lesions. In September 1997, the FDA approved PMA
supplements submitted by Cytyc and Digene enabling testing for HPV directly from
Cytyc's ThinPrep process cell suspension. The Company anticipates working with
Digene on a PMA supplement for use of PREP's cell suspension with Digene's HPV
test in the United States. The PREP cell suspension is already in routine use
with Digene's HPV test in several clinical laboratories in Europe. Cytyc has
also announced that it is developing a higher throughput version of its ThinPrep
2000 system and that it has entered into a multi-year sales and marketing
agreement with a large pharmaceutical company for the ThinPrep 2000. Cytyc's
successful implementation of any of the foregoing arrangements or marketing
initiatives may make it more difficult for the Company to promote PREP in
markets in which it competes with Cytyc.
In automated screening the Company faces direct competition primarily from
two companies, NeoPath, Inc. ("NeoPath") and Neuromedical Systems, Inc. ("NSI"),
both of which currently market imaging systems to reexamine or rescreen
conventional Pap smears previously diagnosed as negative. NeoPath is marketing
an imaging system designed to enhance quality control in connection with the
rescreening of the 10% of the slides that are initially classified as negative,
as required by CLIA. NeoPath has also developed a primary screening system and
filed a PMA supplement for this system in August 1997. NeoPath's primary
screening system was recommended for approval by the FDA's Pathology and
Hematology Medical Advisory Panel in January 1998.
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The Company believes that NeoPath's primary screening system could receive
premarket approval from the FDA in early to mid 1998. The NeoPath primary
screening system protocol excludes high-risk patient samples, and of the
remaining samples, approximately 25% are designated, based on system analysis,
for no further review. The remaining 75% of non-high-risk patients' samples
undergo full cytotechnologist review. NSI is marketing an adjunctive screening
system to supplement primary slide screening. In February 1998 NSI announced
that it is working toward regulatory approval to sell its screening system as an
interactive primary screener to be located in the clinical laboratory. The
Company believes that these rescreening systems, without further adaptation and
FDA approval, could not be used with PREP 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. If either NeoPath or NSI receives FDA
approval of its current system or any future product 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.
In November 1996, Cytyc and NeoPath announced the completion of a joint
study of the feasibility of screening cervical specimens using the ThinPrep 2000
in conjunction with NeoPath's AutoPap(R) QC automated screening device. The
development and commercialization of such a combined product could have a
material adverse affect on the Company's business, financial condition and
results of operations.
GOVERNMENT REGULATION
The manufacture and sale of medical diagnostic devices are subject to
extensive governmental regulation in the United States and in other countries.
PREP and SCREEN are regulated for cervical cytology applications in the United
States as medical devices by the FDA under the Federal Food, Drug and Cosmetic
Act (the "FDC Act") and require premarket approval by the FDA prior to
commercial distribution. In addition, certain modifications to medical devices,
their manufacture or their labeling also are subject to FDA review and approval
before marketing. Pursuant to the FDC Act, the FDA regulates the preclinical and
clinical testing, manufacture, labeling, distribution, sales, marketing,
advertising and promotion of medical devices in the United States. Noncompliance
with applicable requirements, including Good Clinical Practice ("GCP")
requirements, can result in the refusal of the government to grant premarket
approval for devices, suspension or withdrawal of clearances or approvals, total
or partial suspension of production, distribution, sales and marketing, fines,
injunctions, civil penalties, recall or seizure of products, and criminal
prosecution of a company and its officers and employees.
Medical devices are classified into one of three classes, Class I, II or
III, on the basis of the controls deemed by the FDA to be necessary to
reasonably ensure their safety and effectiveness. Class I devices are subject to
general controls (e.g., labeling and adherence to FDA-mandated quality system
(including GMP) requirements and, in some cases, premarket notification). Class
II devices are subject to general controls including, in most cases, premarket
notification, and to special controls (e.g., performance standards, patient
registries and other FDA guidelines). Generally, Class III devices are those
that must receive premarket approval by the FDA to ensure their safety and
effectiveness (e.g., life-sustaining, life-supporting and implantable devices)
and also include most devices that were not on the market before May 28, 1976
("new medical devices") and for which the FDA has not made a finding of
"substantial equivalence" based on a premarket notification ("510(k)"). Class
III devices usually require clinical testing and FDA approval prior to marketing
and distribution. The Company's PREP and SCREEN products, when intended for
gynecological use, are regulated as Class III medical devices.
If human clinical trials of a device are required and the device presents a
"significant risk," the sponsor of the trial (usually the manufacturer or
distributor of the device) is required to file an investigational new device
("IDE") application prior to commencing human clinical trials. The IDE
application must be supported by data, typically including the results of animal
and laboratory testing. If the IDE application is approved by the FDA (or the
FDA does not notify the sponsor 30 days after receipt of the application that
the trials may not begin) and one or more appropriate institutional review
boards ("IRBs") approves the study protocol, clinical trials may begin at a
specified number of investigational sites with a specific number of patients, as
approved by the
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FDA. If the device presents a "nonsignificant risk" to the patient, such as the
Company's PREP and SCREEN products when intended for gynecological use, or is an
exempt diagnostic device, a sponsor may begin the clinical trial after obtaining
approval for the study from one or more appropriate IRBs, but FDA approval is
not required unless the FDA notifies the sponsor that an IDE application is
required. Sponsors of clinical trials are permitted to sell devices distributed
in the course of the study provided the price charged does not exceed recovery
of the cost of manufacture, research, development and handling. An IDE
supplement must be submitted to, and approved by, the FDA (or the FDA does not
notify the sponsor 30 days after receipt of the supplement that the change may
not be implemented) before a sponsor or an investigator may make a change to the
investigational plan that may affect its scientific soundness or the rights,
safety or welfare of human subjects. The FDA has the authority to re-evaluate,
alter, suspend or terminate clinical testing based on its assessment of data
collected throughout the trials.
Generally, before a new medical device can be introduced into the market,
the manufacturer must obtain FDA clearance of a 510(k) or approval of a
premarket approval application, unless the device is exempt from the requirement
of such clearance. A 510(k) clearance will be granted if the submitted
information establishes that the device is "substantially equivalent" to a
legally marketed Class I or II medical device (for a Class I or II device that
is not exempt from the requirement of 510(k) clearance) or to a legally marketed
Class III device that does not itself require an approved PMA prior to marketing
(a "predicate device"). A 510(k) must contain information to support a claim of
substantial equivalence, which may include laboratory test results or the
results of clinical studies of the device in humans. Such studies can take years
to complete, analyze, and prepare for submission to the FDA. Commercial
distribution of a device for which a 510(k) is required may begin only after the
FDA issues an order finding the device to be "substantially equivalent" to a
predicate device. An FDA review of a 510(k) is generally expected to take from
four to five months from the date the 510(k) is accepted for review by the
agency, but it may take far longer, and 510(k) clearance may never be obtained.
An FDA order may declare that the device is "substantially equivalent" to
another legally marketed device and allow the proposed device to be marketed in
the United States. The FDA, however, may determine that the proposed device is
not "substantially equivalent" or require further information, including
clinical data, to make a determination of substantial equivalence. Such
determinations or requests for additional information could prevent or delay
market introduction of the product that is the subject of the 510(k) premarket
notification.
A PMA for a device must be filed with and approved by the FDA before
marketing of the device may begin if the device is not found by the FDA to be
"substantially equivalent" to a predicate device. A PMA must be supported by
valid scientific evidence that typically includes extensive data, including data
from preclinical testing and human clinical trials to demonstrate the safety and
effectiveness of the device. The FDA ordinarily requires the performance of at
least two independent, statistically significant human clinical trails that must
demonstrate the safety and effectiveness of the device in order to obtain FDA
approval of the PMA. The PMA must also contain the results of all relevant bench
tests, laboratory and animal studies, a complete description of the device and
its components, and a detailed description of the methods, facilities and
controls used to manufacture the device. In addition, the submission must
include the proposed labeling and promotional labeling.
Upon receipt of the PMA, the FDA makes a threshold determination as to
whether the application is sufficiently complete to permit a substantive review.
If the FDA so determines, the FDA will accept the PMA for filing and begin an
in-depth review of it. An FDA review of a PMA typically is expected to take
approximately one year from the date the PMA application is accepted for filing,
but may take significantly longer if the FDA requests additional information and
any major amendments to the PMA are filed. The review time is often
significantly extended by requests from the FDA for more information or
clarification of information already provided in the submission. During the
review period, an advisory committee, including clinicians, may be convened to
review and evaluate the application and provide recommendations to the FDA as to
whether the PMA should be approved. The FDA is not bound by the recommendation
of the advisory committee. The FDA will usually inspect the applicant's
manufacturing facility to ensure compliance with QS requirements prior to
approval of a PMA. The FDA also may conduct bioresearch monitoring inspections
of the clinical trial sites and the PMA applicant to ensure data integrity, and
that the studies were conducted in
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compliance with the applicable FDA regulations.
If the FDA's evaluations of the clinical study sites' compliance with the
agency's GCP requirements and the QS compliance of the manufacturing facilities
are acceptable, the FDA will issue either an approval letter (order) or an
"approvable letter" containing a number of conditions that must be met in order
to secure approval of a PMA. When and if those conditions have been fulfilled to
the satisfaction of the FDA, the agency will issue an order approving the PMA,
authorizing commercial marketing of the device for certain indications. If the
FDA's evaluation of the PMA, the clinical study sites or the manufacturing
facilities are not favorable, the FDA will deny approval of the PMA or issue a
"not approvable letter." The FDA may also determine that additional preclinical
testing or human clinical trials are necessary, in which case approval of the
PMA could be delayed for several years while additional testing or trials are
conducted and submitted in an amendment to the PMA. The IDE/PMA process is
expensive, uncertain and lengthy (typically taking five to seven years or more
to complete), and a number of devices for which FDA approval has been sought by
other companies have never been approved for marketing. There can be no
assurance that the Company will be able to obtain necessary regulatory approvals
for any proposed future products in a timely manner or at all. Delays in receipt
of approvals, failure to receive approvals, the 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; the use of a different
facility or establishment to manufacture, process, or package the device;
changes in vendors supplying components for the device; changes in manufacturing
methods or quality control systems; changes in performance or design
specifications; and certain labeling changes. Any such change will require FDA
approval of an PMA supplement before marketing.
The Company submitted a PMA for PREP to the FDA on May 12, 1997, which was
accepted for substantive review by the FDA on June 11, 1997. Upon accepting the
PREP PMA for substantive review, the FDA informed the Company that the PMA would
not be submitted to its Medical Devices Advisory Panel for review since
information in the PMA substantially duplicated information previously reviewed
by the panel in a PMA submitted by a different company relating to an
alternative monolayer slide preparation product.
After reviewing the PREP PMA and receiving input on it from members of its
advisory panel, the FDA met with representatives from the Company in December
1997 to address certain of the FDA's questions relating to the PREP PMA. At the
meeting, the Company presented additional analyses of certain of the data from
the PREP PMA. The FDA advised the Company that it would need to amend the PREP
PMA to include this and other information, and indicated that it would notify
the Company in writing as to the scope of the required response to the agency's
questions.
In February 1998 the Company received a letter from the FDA providing detail
on additional information it needed to continue review of the PREP PMA. The FDA
did not request that the Company perform any additional clinical trials. The FDA
requested that the Company's response be in the form of an amendment to the PREP
PMA. After preparing the requested information, the Company submitted the
amendment to the FDA on March 4, 1998.
FDA regulations provide that the FDA may extend the review period for a PMA
by up to 180 days from the date of submission of an amendment requested by the
agency. While the FDA review of the PREP PMA amendment may be shorter than 180
days, there can be no assurance that the FDA's review will not take 180 days or
longer or that the PREP PMA will be approved within that period or at all.
In late October 1997, the Company's manufacturing facility was inspected for
compliance with FDA's Quality System ("QS," formerly Good Manufacturing
Practice, or "GMP") regulations. In early December 1997, the FDA notified the
Company that the facility had no outstanding deficiencies and that it had passed
the
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inspection. Also in October, the FDA completed a compliance audit of one of the
eight sites that participated in the PREP clinical study and informed the
Company that the site had passed its audit.
The Company is currently conducting clinical trials for SCREEN and
anticipates submitting a PMA to the FDA during the second quarter of 1998. The
Company anticipates that certain other applications for use on its Pathology
Workstation, including diagnostic applications, will require FDA clearance of
510(k)s or approval of PMAs. There can be no assurance that FDA or other
necessary approvals will be obtained on a timely basis or at all or, if
obtained, that desirable claims will be allowed.
PREP and SCREEN and any other products manufactured or distributed by the
Company pursuant to an approved PMA application and supplements (or to 510(k)
clearances) will be subject to pervasive and continuing regulation by the FDA,
including record-keeping requirements and reporting of adverse experience with
the use of the device. Device manufacturers are required to register their
establishments and list their devices with the FDA. The FDC Act requires that
medical devices be manufactured in accordance with the FDA's QS (formerly GMP)
regulation. This regulation requires, among other things, that (i) the
manufacturing process be regulated, controlled and documented by the use of
written procedures, and (ii) the ability to produce devices which meet the
manufacturer's specifications be validated by extensive and detailed testing of
every aspect of the process. The regulation also requires investigation of any
deficiencies in the manufacturing process or in the products produced,
purchasing controls, detailed record keeping, including the maintenance of
service records, and pre-production design controls. Manufacturing facilities
are subject to FDA inspection on a periodic basis to monitor compliance with QS
requirements. If violations of the applicable regulations are noted during FDA
inspections of manufacturing facilities, the FDA can prohibit further
manufacturing, distribution, sale and marketing of the devices until the
violations are cured. The pre-production design control requirements took effect
June 1, 1997, except that the FDA has stated that as long as manufacturers are
taking reasonable steps to come into compliance, the FDA will not initiate
action (including enforcement cases) based on a failure to comply with these
requirements before June 1, 1998. These regulations are expected to increase
the cost of complying with the FDA QS and related requirements. Other
applicable requirements include the FDA's medical device (manufacturer)
reporting regulation, which requires that the device manufacturer provide
information to the FDA on deaths or serious injuries alleged to have been
associated with the use of its marketed devices, as well as product malfunctions
that would likely cause or contribute to a death or serious injury if the
malfunction were to recur. 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 PREP, SCREEN
or other products of the Company.
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. The Company has been advised by various parties, including
consultants engaged by the Company and foreign distributors, that no regulatory
approvals for a device analogous to FDA approval of a PMA are currently required
by any country where the Company currently sells PREP or SCREEN. Such approval
requirements may be imposed in the future. Export sales of investigational
devices that are subject to PMA or IDE application requirements and have not
received FDA marketing approval generally may be subject to FDA export permit
requirements depending upon, among other things, the purpose of the export
(investigational or commercial), the country to which the device is intended for
export, and on whether the device has valid marketing authorization in a country
listed in the FDA
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Export Reform and Enhancement Act of 1996, e.g., any member country of the
European Union and certain other countries including but not limited to
Australia, Canada, Israel, Japan, New Zealand, and South Africa. In order to
obtain such a permit, when one is required, the Company must provide the FDA
with documentation from the medical device regulatory authority of the country
in which the purchaser is located, stating that the device has the approval of
the country. In addition, the FDA must find the exportation of the device is not
contrary to the public health and safety of the country in order for the Company
to obtain the permit. The Company received an FDA permit to export PREP and
SCREEN to all foreign countries in which the Company is currently selling these
products and where such a permit was required. There can be no assurance that
the Company will meet the FDA's export requirements or receive additional 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.
The laboratories that would purchase the Company's PREP and SCREEN products
are subject to extensive regulation under 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
its PREP and SCREEN products operate in a manner that will allow laboratories
using the products 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 Company's
products.
PRODUCT LIABILITY
Commercial use of any Company products may expose the Company to product
liability claims. The Company currently carries $12,000,000, limited to
$11,000,000 per occurrence, in general liability (including product liability)
insurance coverage. The Company believes that this amount is adequate to meet
its present needs. The medical device industry has experienced increasing
difficulty in obtaining and maintaining reasonable product liability coverage,
and substantial increases in insurance premium costs in many cases have rendered
coverage economically impractical. To date, the Company has not experienced
difficulty obtaining an amount of insurance coverage commensurate with its level
of sales. As the Company's sales expand, however, there can be no assurance that
the Company's existing product liability insurance will be adequate or that
additional product liability insurance will be available to the Company at a
reasonable cost, or that any product liability claim would not have a material
adverse effect on the Company's business, financial condition and results of
operations.
EMPLOYEES
As of December 31, 1997 the Company employed 78 persons on a full-time
basis. The Company believes that its relations with its employees are good. None
of the Company's employees is a party to a collective bargaining agreement.
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ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT
The current executive officers of the Company are as follows:
Name Age Position
---- --- --------
James B. Powell, M.D. 59 President, Chief Executive Officer and Director
Ernest A. Knesel 52 Executive Vice President
Thomas Gahm 41 Vice President of Computer Science
James W. Geyer 53 Vice President of Laboratory Science
William O. Green 40 Chief Financial Officer, Vice President of Finance and
Treasurer
Eric W. Linsley 36 Vice President of Operations and Business Development
Steven C. McPhail 44 Vice President of Sales and Marketing
James B. Powell, M.D. has served as a director of the Company since
November 1996 and as its President and Chief Executive Officer since January
1997. Prior to joining AutoCyte, Dr. Powell served as the President and Chief
Executive Officer of Laboratory Corporation of America Holdings ("LabCorp") from
May 1995 until January 1997. From 1982 until May 1995, Dr. Powell served as
President of Biomedical Reference Laboratories/Roche Biomedical Laboratories,
Inc. ("RBL"), the predecessor to both LabCorp and Roche Image Analysis Systems,
Inc. ("RIAS"), the predecessor of AutoCyte and which he co-founded. He continues
to serve on the board of LabCorp, a publicly traded company. Dr. Powell received
a B.A. degree from Virginia Military Institute and an M.D. from Duke University,
and is board certified in anatomical and clinical pathology.
Ernest A. Knesel has served as Executive Vice President of the Company
since November 1996 and served as its interim President from November 1996 until
January 1997. Previously, Mr. Knesel was a founder of RIAS and served as
President of RIAS from May 1989 until joining AutoCyte. Mr. Knesel also was a
co-founder of RBL, for which he served as Senior Vice President and was
responsible for Scientific Affairs from June 1969 until 1993. Mr. Knesel
received a B.S. in medical technology and an M.S. in biochemistry from Fairleigh
Dickinson University.
Thomas Gahm, Ph.D. has served as Vice President of Computer Science of the
Company since November 1996. Previously, he served RIAS and RBL in the same
capacity since August 1993. From 1983 to 1993, Dr. Gahm was a Scientific Advisor
and Project Coordinator of Kontron Electronics, Image Analysis Division, where
he focused on the commercial development of microscopic image analysis. Dr. Gahm
received an engineering degree from the University of Stuttgart (Institute of
Physical Electronics) and a Ph.D. from the Medical and Technical University of
Hannover.
James W. Geyer, Ph.D. has served as Vice President of the Company since
November 1996. From 1991 until November 1996, Dr. Geyer served RIAS in the same
capacity. He also served as Vice President of Product Development for RBL from
1991 until 1994. In September 1986, Dr. Geyer founded Genetic Design Inc.
("GDI"), a genetic testing laboratory, and served as Vice President of
Scientific Affairs of GDI until it was acquired by Genzyme Corporation in 1991.
From 1975 until 1986, Dr. Geyer served as Vice President of Research and
Development at RBL. Dr. Geyer received a Ph.D. in immunology and microbiology
and an M.S. in biochemistry, both from Wayne State University School of
Medicine.
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William O. Green joined the Company as Controller in January 1997 and
became Chief Financial Officer and Vice President of Finance in April 1997.
Prior to joining AutoCyte, Mr. Green served from 1994 to 1996 as Vice President
and Chief Financial Officer of CORPEX Technologies, Inc. ("CORPEX"), a specialty
chemical company. Prior to joining CORPEX, Mr. Green held various positions at
Mann Industries, Inc. ("Mann"), a privately held manufacturer of technical
man-made fibers and yarns from 1989 to 1993, serving most recently as Chief
Operating Officer from 1992 to 1993. On September 16, 1993 Mann filed for
receivership and subsequently was liquidated. From 1981 to 1989, Mr. Green
worked as a certified public accountant at Arthur Andersen & Co. (now Arthur
Andersen LLP). He received a B.S. degree in business administration from the
University of North Carolina, Chapel Hill.
Eric W. Linsley has served as Vice President of Operations and Business
Development of the Company since May 1997. Prior to joining AutoCyte, Mr.
Linsley was a partner with Ampersand Ventures ("Ampersand"), a venture capital
firm, from 1991 to May 1997, and, in connection with such position, served as
interim management in operating and financial roles for various industrial
products and health care companies. From 1989 to 1991, Mr. Linsley was a
management consultant with Bain & Co. In 1988, he served in the same capacity
with McKinsey & Co. He also has worked as a certified public accountant with
Arthur Andersen LLP from 1984 to 1987. He received a B.A. from Trinity College,
an M.S. in accounting from New York University and an M.B.A. from the Wharton
School at the University of Pennsylvania.
Steven C. McPhail has served as Vice President of Sales and Marketing of
the Company since May 1997. Prior to joining AutoCyte, Mr. McPhail served as
Vice President of Sales and Marketing from January 1992 to May 1997 for DYNEX
Technologies, Inc. ("DYNEX"), a division of Thermo BioAnalysis Corporation and a
manufacturer of microtiter technology products serving both clinical and
research laboratory customers. Prior to joining DYNEX, Mr. McPhail served in
sales and marketing positions from 1981 to 1992 with Abbott Laboratories
Diagnostics Division. He received a B.S. in biology from San Diego State
University.
ITEM 2. PROPERTIES
The Company currently leases a total of 13,500 square feet of space, devoted
to administrative, research and development and engineering functions, at 112
Orange Drive, Elon College, North Carolina under a month-to-month lease
renewable until April 24, 2000. The Company also currently leases a 20,000
square foot manufacturing facility at 780 Plantation Drive in Burlington, North
Carolina. In addition to manufacturing, the Burlington facility houses the
Company's systems integration support, product warehousing and shipping and
receiving operations. In July 1997, the Company entered into an extension of the
Burlington lease through July 2004. The new lease includes a 23,000 square foot
addition to the Burlington facility which will permit the Company to consolidate
all of its operations in a single facility. The Company anticipates that the
addition will be ready for occupancy in the second quarter of 1998.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any legal proceedings.
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.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock, $0.01 par value per share (the "Common Stock"),
is traded on the Nasdaq National Market under the symbol "ACYT". The following
table sets forth, for the calendar periods indicated since the Company's initial
public offering in September 1997 (the "Offering"), 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 1997:
Third Quarter (from September 5, 1997) $10.125 $8.500
Fourth Quarter $13.125 $7.000
On March 23, 1998, the last reported sales price of the Common Stock on the
Nasdaq National Market was $7.75 per share. As of March 23, 1998, there were
approximately 72 holders of record of the Common Stock.
On May 19, 1997 AutoCyte sold an aggregate of 99,250 shares of Series A
Convertible Preferred Stock, $0.01 par value per share (the "Series A Preferred
Stock"), at an aggregate price of $100,000 to certain purchasers affiliated with
the Company. All of such shares of Series A Preferred Stock converted to Common
Stock on a 1-for-2.033 basis upon the closing of the Offering.
During 1997, AutoCyte issued options to purchase an aggregate of 349,962
shares of Common Stock under the AutoCyte, Inc. 1996 Amended and Restated Equity
Incentive Plan, exercisable at a weighted-average price of $1.47 per share.
No underwriter was engaged in connection with the foregoing issuance of
securities. The above described issuances of Common Stock, Series A Preferred
Stock and options to purchase Common Stock were made in reliance upon Section
4(2) of the Securities Act of 1933, as amended (the "Act"), as transactions not
involving any public offering and Rule 701 promulgated thereunder. The Company
has reason to believe that all of the foregoing purchasers were familiar with or
had access to information concerning the operations and financial condition of
the Company, and all of those individuals were acquiring the shares for
investment and not with a view to the distribution thereof. At the time of
issuance, all of the foregoing shares of Common Stock and Series A Preferred
Stock were deemed to be restricted securities for purposes of the Act and the
certificates representing such securities bore legends to that effect.
Use of proceeds information is provided herewith in connection with the
Offering. The Company's Registration Statement on Form S-1 was declared
effective by the Securities and Exchange Commission on September 4, 1997. The
first closing for the Offering was held on September 10, 1997 and a second
overallotment closing was held on October 10, 1997. The Offering has terminated.
In the aggregate the Company sold in its two closings 3,125,000 shares (with
an aggregate offering price to the public of $31,250,000) out of the 3,565,000
shares of Common Stock (with an aggregate offering price of $35,650,000)
registered in the Offering. The managing underwriters of the Offering were SBC
Warburg Dillon Read Inc. and UBS Securities.
In connection with the Offering, the Company incurred the following expenses
through December 31, 1997: underwriting discounts and commissions of $2,187,000
and other expenses of $1,169,339. After expenses incurred through December 31,
1997, the Company's net proceeds from the Offering were $27,893,661 as of
December 31, 1997. From September 5, 1997 (the effective date of the Company's
Registration Statement on
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Form S-1) through December 31, 1997, the amount of net offering proceeds used by
the Company was as follows: $655,065 for purchases of machinery and equipment,
$2,409,792 to fund current operations (of which $596,533 was paid to officers of
the Company), $141,925 for working capital purposes, and the remaining
$24,686,879 was invested in short-term securities.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its capital stock.
The Company currently intends to retain its future earnings, if any, for use in
its business and therefore does not anticipate paying cash dividends in the
foreseeable future. Payment of future dividends, if any, will be at the
discretion of the Company's Board of Directors after taking into account various
factors, including the Company's financial condition, operating results, current
and anticipated cash needs and plans for expansion.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented below as of December 31,
1994 and 1995 and for the years ended December 31, 1994 and 1995 and for the
period from January 1, 1996 through November 21, 1996 are derived from Financial
Statements of the Company's predecessor, the cytology and pathology automation
business of Roche Image Analysis Systems, Inc. ("RIAS"), included elsewhere
herein, which have been audited by Ernst & Young LLP, independent auditors. The
selected financial data presented below as of December 31, 1996 and 1997 and for
the period from November 22, 1996 through December 31, 1996 and the year ended
December 31, 1997 are derived from Financial Statements of the Company, included
elsewhere herein, which have been audited by Ernst & Young LLP, independent
auditors. The selected consolidated financial data set forth below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Financial Statements and related
Notes thereto included in this Form 10-K.
PREDECESSOR(1) AUTOCYTE PRO FORMA
----------------------------------------- PERIOD FROM COMBINED
PERIOD FROM NOVEMBER 22, PREDECESSOR AND
JANUARY 1, 1996 AUTOCYTE AUTOCYTE
YEARS ENDED 1996 THROUGH THROUGH YEAR ENDED YEAR ENDED
DECEMBER 31, NOVEMBER 21, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1994 1995 1996 1996 1996(2) 1997
--------- --------- ------------- ------------- --------------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF
OPERATIONS DATA:
Net sales........... $ 3,396 $ 3,396 $ 1,747 $ 129 $ 1,876 $ 2,668
Gross profit
(loss)............ 796 982 (1,049) 17 (1,032) 715
Research and
development....... 3,605 5,074 3,908 458 4,366 4,462
Selling, general
and administrative.. 8,479 7,895 11,966 525 12,491 6,532
Operating loss...... (11,288) (11,987) (16,923) (966) (17,889) (10,279)
Net loss............ $ (11,288) $ (11,987) $ (16,923) $ (923) $ (17,846) $ (10,985)
========= ========= ============ ============ ============= ==========
Net loss per
Share(basic
and diluted (3)... $ (0.22) $ (1.59)
============ ==========
Weighted-average
shares
outstanding(3)...... 4,279 6,903
============ ==========
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PREDECESSOR(1) AUTOCYTE
----------------------- ----------------------------
DECEMBER 31, DECEMBER 31,
----------------------- ----------------------------
1994 1995 1996 1997
-------- --------- ------------- ------------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents......... $ 8 $ 10 $ 9,517 $ 28,655
Working capital................... 1,600 3,585 10,673 30,223
Total assets...................... 10,544 10,714 16,683 37,021
Redeemable convertible preferred stock -- -- 9,882 ---
Total stockholders' equity........ 8,966 10,002 5,235 35,027
- ----------
(1) Reflects the operations of the cytology and pathology automation
business as conducted by RIAS.
(2) Reflects the operations of the cytology and pathology automation
business as conducted by RIAS from January 1, 1996 through November 21,
1996 and the operations of the Company from November 22, 1996 through
December 31, 1996.
(3) See Note 2 of Notes to the Company's Financial Statements for
information concerning the computation of net loss per share and shares
used in computing net loss per share. Net loss per share is not
disclosed for periods prior to November 22, 1996 since RIAS operated as
a wholly owned subsidiary of Roche Holding Ltd. prior to the formation
of AutoCyte.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Financial
Statements and Notes thereto included elsewhere in this Form 10-K. The financial
results for the years ended December 31, 1994 and 1995 and for the period from
January 1, 1996 through November 21, 1996 are for the business of the Company as
conducted by the Company's predecessor, the cytology and pathology automation
business of Roche Image Analysis Systems, Inc. ("RIAS"). For purposes of this
discussion, information for the year ended December 31, 1996 combines financial
results of the Company's predecessor and AutoCyte.
Background
AutoCyte was formed in October 1996 to acquire the cytology and pathology
automation business then owned by RIAS, a wholly-owned subsidiary of Roche
Holding Ltd. ("Roche"). Roche had previously operated such business as part of
Roche Biomedical Reference Laboratories, Inc., ("RBL"), a predecessor company to
Laboratory Corporation of America, Inc. ("LabCorp"), the largest clinical
laboratory chain in the United States and formerly a wholly-owned subsidiary of
Roche. The business was acquired from RIAS in November 1996 in exchange for 3.7
million shares of the Company's Common Stock. Contemporaneously with this
acquisition, Ampersand Ventures and the Sprout Group, together with certain
members of the Company's management and other investors, purchased $9.8 million
of redeemable convertible preferred stock of the Company. Included in the
management group making an equity investment in the Company was Dr. James B.
Powell, the Company's Chief Executive Officer and a former President and Chief
Executive Officer of LabCorp and RBL.
The PREP, SCREEN and Pathology Workstation technologies had been under
development by RIAS or other Roche affiliates for several years prior to the
acquisition. From 1990 to 1996, Roche invested more than $50 million in the
cytology and pathology automation business, including over $30 million since the
beginning of 1994. At the time of the acquisition in November 1996, clinical
trials for PREP were in progress and had
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only recently begun for SCREEN.
Following completion of clinical trials for gynecological applications, the
Company submitted a PMA for PREP to the FDA on May 12, 1997, which was accepted
for substantive review by the FDA on June 11, 1997. Upon accepting the PREP PMA
for substantive review, the FDA informed the Company that the PMA would not be
submitted to its Medical Devices Advisory Panel for review since information in
the PMA substantially duplicated information previously reviewed by the panel in
a PMA submitted by a different company relating to an alternative monolayer
slide preparation product.
After reviewing the PREP PMA and receiving input on it from members of its
advisory panel, the FDA met with representatives from the Company in December
1997 to address certain of the FDA's questions relating to the PREP PMA. At the
meeting, the Company presented additional analyses of certain of the data from
the PREP PMA. The FDA advised the Company that it would need to amend the PREP
PMA to include this and other information, and indicated that it would notify
the Company in writing as to the scope of the required response to the agency's
questions.
In February 1998 the Company received a letter from the FDA providing detail
on additional information it needed to continue review of the PREP PMA. The FDA
did not request that the Company perform any additional clinical trials. The FDA
requested that the Company's response be in the form of an amendment to the PREP
PMA. After preparing the requested information, the Company submitted the
amendment to the FDA on March 4, 1998.
FDA regulations provide that the FDA may extend the review period for a PMA
by up to 180 days from the date of submission of an amendment requested by the
agency. While the FDA review of the PREP PMA amendment may be shorter than 180
days, there can be no assurance that the FDA's review will not take 180 days or
longer or that the PREP PMA will be approved within that period or at all.
RIAS began commercial sales of the Pathology Workstation in 1993, and, to
date, the substantial majority of the Company's revenues have been generated by
Pathology Workstation products. RIAS also began commercial sales of PREP in 1993
for non-cervical cytology applications and currently has an installed base of 47
PREP instruments for such applications. As of December 31, 1997, the Company had
placed 14 PREP systems for cervical cytology applications in foreign markets
that collectively have produced over 200,000 monolayer slides in the past 24
months. The Company has placed SCREEN systems in clinical laboratories in
Australia which have screened over 70,000 PREP slides in the past 24 months. The
Company's current sales and marketing efforts are primarily focused on the
placement of PREP systems for non-cervical cytology applications in the United
States and cervical cytology applications outside of the United States and, to a
lesser extent, on sales of the Pathology Workstation.
The Company cannot market the PREP or SCREEN systems in the United States
for use in preparing or screening monolayer slides for cervical cancer until PMA
approvals are received from the FDA. If such approvals are obtained, the Company
intends to focus its marketing efforts on such products for cervical cytology
applications. The Company expects to generate a substantial majority of its
future revenues from the PREP and SCREEN systems. The Company's long-term
revenues and future success are substantially dependent upon its ability to
obtain regulatory approval for, and market and commercialize the PREP and SCREEN
systems for, cervical cancer screening in the United States and abroad.
The Company generates PREP revenue from both system sales and rentals. For
system sales, customers purchase the PREP instrument and make separate purchases
of related reagents and other disposables. For system rentals, the Company
places the PREP instrument at the customer's site, and customers make monthly
payments that include rent and the purchase of a minimum monthly quantity of
reagents and other disposables. The term of the PREP rentals ranges from
month-to-month to three years. For SCREEN customers in the United States, the
Company intends to place instruments without charge at customer locations and to
charge customers on a per test, or Fee-Per-Use ("FPU"), basis. In foreign
markets, the Company plans to either sell or
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license SCREEN. As an important element of its business strategy, the Company
intends to seek third-party financing to support rentals of PREP and FPU
placements of SCREEN. There can be no assurance that the Company will be able to
obtain such financing or, if so, on favorable terms. Failure to obtain such
financing could have a material adverse effect on the Company's business,
financial condition and results of operations.
Future revenues and results of operations may fluctuate significantly from
quarter to quarter and will depend upon, among other factors, the timing and
outcome of the FDA review of the PREP PMA submission, the extent to which the
Company's products gain market acceptance, the timing and volume of sales and
rental orders, regulatory and reimbursement matters, progress of the SCREEN
clinical trials, introduction of alternative technologies by competitors,
pricing of competitive products, the cost and effect of promotional discounts
and marketing programs adopted by the Company.
The Company anticipates that if FDA approval is received to market PREP for
gynecological uses, its marketing and sales expenditures will increase
significantly. The Company also anticipates that research and development
expenses, both in the areas of product enhancement and new product development,
and manufacturing expenses will also increase as product commercialization
increases. The Company additionally expects to incur compensation expense of
$2.7 million as its deferred compensation balance is amortized.
RESULTS OF OPERATIONS
Years ended December 31, 1997 (AutoCyte) and December 31, 1996 (Pro Forma
Combined)
Net sales and gross profit. Net sales increased by 42% from $1.9 million in
1996 to $2.7 million in 1997. The increase was primarily attributable to a $1.1
million increase in PREP revenue from $65,000 in 1996 to $1.2 million in 1997 as
the Company increased the number of PREP placements in the United States and
international markets. This increase was partially offset by a $512,000 decrease
in sales of Pathology Workstation products from $1.8 million in 1996 to $1.3
million in 1997. This decrease was a result of management's decision to focus on
development and sales of PREP and SCREEN products. Additionally, SCREEN revenues
increased to $220,000 in 1997 from $0 in 1996, resulting from foreign
placements. Gross profit increased by $1.7 million from a loss of $1.0 million
in 1996 to gross profit of $715,000. The loss in 1996 was due primarily to the
write-off of obsolete inventory by the Company's predecessor of $1.4 million in
the fourth quarter of 1996 as a result of management's decision to focus on
development and sales of PREP and SCREEN products.
Total operating expenses. Operating expenses decreased by 35% from $16.9
million in 1996 to $11.0 in 1997. Research and development costs remained
relatively flat, increasing from $4.4 million in 1996 to $4.5 million in 1997.
Selling, general and administrative costs decreased by 48% from $12.5 million in
1996 to $6.5 million in 1997 due primarily to the write-down of property and
equipment by the Company's predecessor of $3.9 million in the fourth quarter of
1996, and other acquisition-related one-time charges in the fourth quarter of
1996 of $1.5 million.
During 1997 the Company granted options under the 1996 Equity Incentive Plan
to acquire 304,962 shares of Common Stock at an exercise price of $0.2033 per
share. The Company also sold to certain members of management 48,819 shares of
Series A Preferred Stock at a price of $2.048 per share. The Company recorded
$1.7 million of deferred compensation expense and $432,000 of compensation
expense with respect to these transactions. The Company also recorded $705,000
of amortization of deferred compensation expense during 1997.
Interest income and interest expense, including credit agreement commitment
fee. On June 27, 1997 the Company issued warrants to acquire 207,291 shares of
Common Stock at an exercise price of $2.033 per share as a commitment fee for a
credit agreement among the Company and certain of its principal stockholders.
The Company recorded $1.5 million of commitment fee expense with respect to this
transaction, all of which was expensed in June 1997. This increase in interest
expense was partially offset by an increase in interest income of $730,000 which
was primarily attributable to the investment of the proceeds from the Company's
initial
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public offering.
Years Ended December 31, 1996 (Pro Forma Combined) and December 31, 1995
(Predecessor)
Net sales and gross profit. Net sales decreased by 45% from $3.4 million in
1995 to $1.9 million in 1996. This decrease was primarily due to lower sales of
Pathology Workstation related products, including a decrease in such sales to
LabCorp from $598,000 in 1995 to $299,000 in 1996 resulting primarily from a
decrease in sales activity by the Company's predecessor in anticipation of the
acquisition of the cytology and pathology automation business by the Company.
Gross profit decreased by 205% from $982,000 in 1995 to a loss of $1.0 million
in 1996, and gross margin decreased from 29% in 1995 to negative 55% in 1996.
The decrease in gross margin was attributable to the write-off of obsolete
inventory of $1.4 million and the effect of lower manufacturing volumes on
absorption of fixed costs. During 1996, the Company decided to focus on
development and sales of PREP and SCREEN systems. As a result, certain inventory
items were written-down by approximately $1.4 million to their estimated net
realizable values.
Total operating expenses. Total operating expenses increased by 30% from
$13.0 million in 1995 to $16.9 million in 1996. Research and development costs
decreased by 14% from $5.1 million in 1995 to $4.4 million in 1996, as a result
of the purchase of Pathology Workstation product rights for $687,000 which were
expensed as purchased research and development costs in 1995. Selling, general
and administrative costs increased by 58% from $7.9 million in 1995 to $12.5
million in 1996, primarily as a result of a write-down of impaired assets in
1996. During 1996, the Company evaluated the ongoing value of its older model
systems and equipment and determined that assets were impaired and wrote them
down to their estimated fair value. Approximately $2.7 million of equipment,
primarily computer hardware, and $1.2 million of demonstration equipment were
written-down.
INCOME TAXES
The Company has not generated any taxable income to date and, therefore, has
not paid any federal income taxes since its inception. Realization of deferred
tax assets is dependent on future earnings, if any, the timing and amount of
which are uncertain. Accordingly, valuation allowances, in amounts equal to the
net deferred tax assets as of December 31, 1997 and December 31, 1996, have been
established in each period to reflect these uncertainties.
At December 31, 1997, the Company had net operating losses, for tax
purposes, of approximately $11.3 million that may be carried forward to offset
future taxable income. This amount expires in 2011 and 2012 for federal
purposes, and beginning in 2001 for state purposes. Utilization of net operating
losses and any tax credit carryforwards are subject to complex treatment under
the Internal Revenue Code of 1986, as amended (the "Code"). Pursuant to Section
382 of the Code, the change in ownership resulting from the Company's initial
public offering in September 1997 and any other future sale of stock may limit
utilization of future losses in any one year. The Company believes that the sale
of Common Stock in the Offering did not create any immediate limitations on the
Company's utilization of net operating losses.
YEAR 2000
The Company has established a task force to determine the impact the "Year
2000" problem will have on its operations. The Year 2000 problem arises from
certain computer programs utilizing two rather than four digits to define the
applicable year, which could result in a miscalculation of date-sensitive data
or even system failure. This task force is comprised of operations, research and
development and finance personnel, and includes members of senior management.
The task force's activities are designed to ensure that there is no adverse
effect on the Company's core business operations and that transactions with
customers and suppliers are fully supported. The Company is well underway with
these efforts, which are scheduled to be completed in late 1998. The Company
believes that the majority of its internal systems are Year 2000 compliant, and
is currently initiating discussions with significant suppliers, large customers
and financial institutions to ensure that those parties have appropriate plans
to remediate Year 2000 issues where their systems could affect the Company's
operations. The Company is also evaluating the effect the Year 2000 issue may
have on its older generation products. While the Company believes its planning
efforts are adequate to address its Year 2000 concerns, there can be no
guarantee that systems of other companies on which the Company relies will be
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made year 2000 compliant on a timely basis and will not have a material effect
on the Company. The cost of the Year 2000 initiatives is not expected to be
material to the Company's results of operation or financial position.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, FASB issued Statement No. 130, "Reporting Comprehensive
Income" ("SFAS 130") which is effective for fiscal years beginning after
December 15, 1997. SFAS 130 establishes standards for reporting and display of
comprehensive income and its components in financial statements. The Company
will adopt SFAS 130 in the first quarter of 1998 and will provide the required
financial statement disclosures. The application of the new rules will not have
an impact on the Company's financial position or results from operations.
In June 1997, FASB issued Statement No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("SFAS 131") which is effective for
fiscal years beginning after December 15, 1997. SFAS 131 changes the way public
companies report segment information in annual financial statements and also
requires those companies to report selected segment information in interim
financial statements to shareholders. SFAS 131 also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. The Company will adopt SFAS 131 in 1998 that may result in additional
disclosures. The application of the new rules will not have an impact on the
Company's financial position or results from operations.
LIQUIDITY AND CAPITAL RESOURCES
Since its formation on October 24, 1996, the Company's expenses have
significantly exceeded its revenues, resulting in an accumulated deficit of
$11.9 million as of December 31, 1997. The Company has funded its operations
primarily through the private placement and public sale of equity securities,
resulting in net proceeds of $38.0 million, and limited product sales. As of
December 31, 1997, the Company had cash and cash equivalents of $28.7 million.
Cash and cash equivalents increased during the year primarily due to the
issuance of 3.1 million shares of common stock in connection with the Company's
initial public offering raising aggregate net proceeds of $27.9 million.
Cash used in the Company's operations was $8.2 million during 1997 and $10.0
million on a pro forma combined basis during 1996. Negative operating cash flow
during 1997 and 1996 was caused primarily by operating losses. The Company's
capital expenditures were $1.0 million during 1997 and $377,000 on a pro forma
combined basis during 1996 with the increase primarily attributable to the
purchase of PREP units for rental and demonstration purposes. The Company has no
material commitments for capital expenditures.
The Company believes that existing cash and anticipated additional debt
and lease financing for rental placements of PREP and FPU placements of SCREEN
(if and when FDA approval is received) will be sufficient to enable the Company
to meet its future cash obligations through 1999. The Company's future liquidity
and capital requirements will depend upon numerous factors, including the timing
of the Company's receipt of FDA approval of its PMA for PREP, the availability
of financing for the Company's anticipated equipment lease and rental programs,
the level of placements of rental PREP systems and FPU SCREEN systems, the
resources required to further develop its marketing and sales capabilities
domestically and internationally, the resources required to expand manufacturing
capacity and the extent to which the Company's products generate market
acceptance and demand. In particular, if the FDA approves the PREP PMA, the
Company anticipates that marketing and sales expenditures for the PREP market
launch for gynecological uses in the United States, capital expenditures
associated with placements of PREP rental units, and expenditures related to
manufacturing and other administrative costs will increase significantly. 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
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Company's business, financial condition and results of operations.
The discussion included in this section as well as elsewhere in the Annual
Report on Form 10-K may contain forward-looking statements based on current
expectations of the Company's management. Such statements are subject to risks
and uncertainties that could cause actual results to differ from those
projected. See "Important Factors Regarding Forward-Looking Statements" attached
hereto as Exhibit 99.1 and incorporated by reference into this Form 10-K.
Readers are cautioned not to place undue reliance on the forward-looking
statements which speak only as the date hereof. The Company undertakes no
obligation to publicly release the result of any revisions to these
forward-looking statements that may be made to reflect events or circumstances
occurring after the date hereof or to reflect the occurrence of unanticipated
events.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item may be found on pages F-1 through
F-28 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 fiscal year.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The response to this item is contained in part under the caption "Executive
Officers of the Registrant" in Part I, Item 1A hereof and the remainder is
incorporated herein by reference from the discussion responsive thereto under
the captions "Election of Directors" and "Section 16(a) Beneficial Reporting
Compliance" in the Company's Proxy Statement relating to its Annual Meeting of
Stockholders scheduled for May 28, 1998 (the "Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The response to this item is incorporated herein by reference from the
discussion responsive thereto under the captions "Election of Directors,"
Director Compensation," "Executive Compensation" and "Compensation Committee
Interlocks and Insider Participation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this item is incorporated herein by reference from the
discussion responsive thereto under the caption "Share Ownership" in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this item is incorporated herein by reference from the
discussion responsive thereto under the caption "Certain Transactions" in the
Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The financial statements are listed under Part II, Item 8 of this
report.
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.
3. Exhibits
The exhibits are listed under Part IV, Item 14(c) of this report.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the fourth quarter of 1997.
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(c) Exhibits
3.1 Restated Certificate of Incorporation of the Company. Filed as
Exhibit 3.5 to the Company's Registration Statement on Form S-1
(File No. 333-30227) and incorporated herein by reference.
3.2 Amended and Restated By-laws of the Company. Filed as Exhibit
3.7 to the Company's Registration Statement on Form S-1 (File
No. 333-30227) and incorporated herein by reference.
4.1 Specimen of Common Stock Certificate. Filed as Exhibit 4.1 to the
Company's Registration Statement on Form S-1 (File No. 333-30227)
and incorporated herein by reference.
10.1* Amended and Restated 1996 Equity Incentive Plan (including forms
of incentive stock option certificate and nonstatutory stock
option certificate). Filed as Exhibit 10.1 to the Company's
Registration Statement on Form S-1 (File No. 333-30227) and
incorporated herein by reference.
10.2* 1997 Director Stock Option Plan (including form of director
nonstatutory stock option certificate). Filed as Exhibit 10.2 to
the Company's Registration Statement on Form S-1 (File No.
333-30227) and incorporated herein by reference.
10.3 Lease Agreement dated as of March 10, 1993 by and between Carolina
Hosiery Mills, Inc. and Roche Biomedical Laboratories, Inc.
("RBL"), the predecessor of the Company's predecessor (including
notices of renewal thereof dated December 27, 1995 and March 24,
1997). Filed as Exhibit 10.3 to the Company's Registration
Statement on Form S-1 (File No. 333-30227) and incorporated herein
by reference.
10.4 Lease Agreement dated as of April 25, 1995 by and between RBL, the
predecessor of the Company's predecessor, and Roche Image Analysis
Systems, Inc. ("RIAS"), the Company's predecessor (including
notices of renewal thereof dated January 10, 1996 and March 18,
1997). Filed as Exhibit 10.4 to the Company's Registration
Statement on Form S-1 (File No. 333-30227) and incorporated herein
by reference.
10.5+ OEM Supply Agreement dated January 13, 1995 between Tecan AG and
RIAS, the Company's predecessor. Filed as Exhibit 10.6 to the
Company's Registration Statement on Form S-1 (File No. 333-30227)
and incorporated herein by reference.
10.6+ Amendment to the OEM Supply Agreement dated October 14, 1996
between Tecan AG and RIAS, the Company's predecessor. Filed as
Exhibit 10.7 to the Company's Registration Statement on Form S-1
(File No. 333-30227) and incorporated herein by reference.
10.7 Agreement dated July 26, 1993 by and between Technical Precision
Plastics, Inc. and RIAS, the Company's predecessor. Filed as
Exhibit 10.8 to the Company's Registration Statement on Form S-1
(File No. 333-30227) and incorporated herein by reference.
10.8 Registration Rights Agreement dated as of November 22, 1996 by and
among the Company and the individuals and entities listed on
Exhibit A thereto (including amendment thereof dated June 26,
1997). Filed as Exhibit 10.9 to the Company's Registration
Statement on Form S-1 (File No. 333-30227) and incorporated herein
by reference.
10.9 Contribution Agreement dated as of November 22, 1996 by and among
HLR Holdings Inc., RIAS and the Company. Filed as Exhibit 10.10 to
the Company's Registration Statement on Form S-1 (File No.
333-30227) and incorporated herein by reference.
36
37
10.10 Form of Indemnification Agreement between the Company and its
Directors and Executive Officers. Filed as Exhibit 10.11 to the
Company's Registration Statement on Form S-1 (File No.
333-30227) and incorporated herein by reference.
10.11 Lease Agreement dated as of July 28, 1997 by and between Carolina
Hosiery Mills, Inc. and the Company. Filed as Exhibit 10.12 to the
Company's Registration Statement on Form S-1 (File No. 333-30227)
and incorporated herein by reference.
10.12 Renewal dated January 6, 1998 of Lease Agreement dated as of
April 25, 1995 by and between RBL, the predecessor of the
Company's predecessor, and RIAS, the Company's predecessor.
Filed herewith.
23.1 Consent of Ernst & Young LLP, independent auditors to the Company.
Filed herewith.
27.1 December 31, 1997 Financial Data Schedule. Filed herewith.
27.2 December 31, 1996 Financial Data Schedule. Filed herewith.
99.1 Important Factors Regarding Forward-Looking Statements.
Filed herewith.
- ----------
* Indicates a management contract or compensatory plan.
+ Certain confidential material contained in the document has been omitted
and filed separately with the Securities and Exchange Commission pursuant
to Rule 406 of the Securities Act of 1933, as amended. Omitted information
is identified with asterisks in the appropriate places in the agreement.
37
38
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, in the City of Elon
College, State of North Carolina, on March 30, 1998.
AUTOCYTE, INC.
By: /s/ James B. Powell, M.D.
-------------------------------------
James B. Powell, M.D.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on this 30th day of March, 1998.
SIGNATURE TITLE
- --------- -----
/s/ James B. Powell, M.D. President, Chief Executive Officer and Director
- ------------------------ (Principal Executive Officer)
James B. Powell, M.D.
/s/ William O. Green Chief Financial Officer, Vice President of Finance
- ------------------------- and Treasurer (Principal Financial Officer and
William O. Green Principal Accounting Officer)
/s/ Richard A. Charpie Director
- ------------------------
Richard A. Charpie
/s/ Robert E. Curry Director
- ------------------------
Robert E. Curry
/s/ Thomas P. Mac Mahon Director
- ------------------------
Thomas P. Mac Mahon
/s/ Susan E. Whitehead Director
- ------------------------
Susan E. Whitehead
38
39
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
AutoCyte, Inc.
Year ended December 31, 1997 and period from November 22, 1996 (inception)
through December 31, 1996
Report of Independent Auditors............................................. F-2
Audited Consolidated Financial Statements
Consolidated Balance Sheets................................................ F-3
Consolidated Statements of Operations...................................... F-4
Consolidated Statements of Redeemable Convertible Preferred Stock and
Stockholders' Equity.................................................. F-5
Consolidated Statements of Cash Flows...................................... F-6
Notes to Consolidated Financial Statements................................. F-7
Cytology and Pathology Automation Business of Roche Image Analysis Systems, Inc.
Years ended December 31, 1994 and 1995, and the period from January 1, 1996
through November 21, 1996
Report of Independent Auditors............................................. F-21
Audited Financial Statements
Balance Sheets............................................................. F-22
Statements of Operations................................................... F-23
Statements of Cash Flows................................................... F-24
Notes to Financial Statements.............................................. F-25
F-1
40
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
AutoCyte, Inc.
We have audited the accompanying consolidated balance sheets of AutoCyte, Inc.
and subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, redeemable convertible preferred stock and
stockholders' equity and cash flows for the year ended December 31, 1997 and for
the period from November 22, 1996 (inception) through December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of AutoCyte, Inc. and
subsidiaries at December 31, 1997 and 1996, and the consolidated results of
their operations and their cash flows for the year ended December 31, 1997 and
for the period from November 22, 1996 (inception) through December 31, 1996 in
conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Raleigh, North Carolina
February 13, 1998
F-2
41
AUTOCYTE, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
1997 1996
----------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 28,655,082 $ 9,517,274
Accounts receivable, less allowance for doubtful accounts of
$85,000 and $17,500 at December 31, 1997 and 1996,
respectively 906,154 761,117
Inventory 2,191,995 1,911,406
Other current assets 415,248 49,208
----------------------------------
Total current assets 32,168,479 12,239,005
Property and equipment 2,018,142 1,459,932
Goodwill 2,834,375 2,984,375
----------------------------------
Total assets $ 37,020,996 $ 16,683,312
==================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,129,016 $ 1,072,926
Accrued expenses 815,998 493,568
----------------------------------
Total current liabilities 1,945,014 1,566,494
Long-term liabilities 48,768 -
Redeemable convertible preferred stock - 9,882,000
Stockholders' equity:
Common stock, $0.01 par value; 20,650,000 and 20,500,000
shares authorized; 12,505,412 and 4,279,389 shares issued
and outstanding at December 31, 1997 and 1996, respectively 125,054 42,794
Additional paid-in capital 49,553,302 7,898,956
Deferred compensation (2,743,280) (1,783,943)
Accumulated deficit (11,907,862) (922,989)
----------------------------------
Total stockholders' equity 35,027,214 5,234,818
----------------------------------
Total liabilities and stockholders' equity $ 37,020,996 $ 16,683,312
==================================
See accompanying notes.
F-3
42
AUTOCYTE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
PERIOD FROM
NOVEMBER 22, 1996
DECEMBER 31, (INCEPTION) THROUGH
1997 DECEMBER 31, 1996
----------------------------------------------
Sales $ 2,667,837 $ 129,189
Cost of sales 1,952,691 112,022
----------------------------------------------
Gross profit 715,146 17,167
Operating expenses:
Research and development 4,461,881 457,918
Selling, general and administrative 6,532,551 524,669
----------------------------------------------
10,994,432 982,587
----------------------------------------------
Operating loss (10,279,286) (965,420)
Interest income 772,563 42,431
Interest expense, including credit agreement commitment fee (1,478,150) -
----------------------------------------------
Net loss $ (10,984,873) $ (922,989)
==============================================
Net loss per common share (basic and diluted) $ (1.59) $ (0.22)
==============================================
Weighted-average common shares outstanding 6,903,290 4,279,389
==============================================
See accompanying notes.
F-4
43
AUTOCYTE, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
REDEEMABLE
CONVERTIBLE ADDITIONAL TOTAL
PREFERRED COMMON PAID-IN DEFERRED ACCUMULATED STOCKHOLDERS'
STOCK STOCK CAPITAL COMPENSATION DEFICIT EQUITY
-------------------------------------------------------------------------------------
Balance at Inception $ - $ - $ - $ - $ - $ -
Net assets acquired in exchange
for common stock - 36,891 5,963,109 - - 6,000,000
Issuance of common stock - 5,903 114,097 - - 120,000
Issuance of redeemable convertible
preferred stock 9,882,000 - - - - -
Deferred compensation related to
issuance of restricted stock and
grant of stock options - - 1,821,750 (1,821,750) - -
Amortization of deferred compensation - - - 37,807 - 37,807
Net loss - - - - (922,989) (922,989)
-------------------------------------------------------------------------------------
Balance at December 31, 1996 9,882,000 42,794 7,898,956 (1,783,943) (922,989) 5,234,818
Issuance of redeemable convertible
preferred stock and stock options 100,000 - 432,000 - - 432,000
Issuance of warrants - - 1,475,002 - - 1,475,002
Exercise of warrants - 1,936 282,121 - - 284,057
Issuance of common stock - 31,250 27,862,411 - - 27,893,661
Conversion of preferred stock (9,982,000) 48,819 9,933,181 - - 9,982,000
Exercise of stock options - 255 4,937 - - 5,192
Deferred compensation related to
grant of stock options - - 1,664,694 (1,664,694) - -
Amortization of deferred compensation - - - 705,357 - 705,357
Net loss - - - - (10,984,873) (10,984,873)
------------------------------------------------------------------------------------
Balance at December 31, 1997 $ - $125,054 $49,553,302 $(2,743,280) $(11,907,862) $ 35,027,214
====================================================================================
See accompanying notes.
F-5
44
AUTOCYTE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIOD FROM
NOVEMBER 22, 1996
YEAR ENDED (INCEPTION) THROUGH
DECEMBER 31, 1997 DECEMBER 31, 1996
-----------------------------------------------
OPERATING ACTIVITIES
Net loss $ (10,984,873) $ (922,989)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 477,686 39,797
Amortization of goodwill 150,000 15,625
Amortization of deferred compensation 705,357 37,807
Issuance of preferred stock and stock options for services
rendered 432,000 -
Issuance of warrants as consideration for credit agreement
commitment fee 1,475,002 -
Changes in operating assets and liabilities:
Accounts receivable (145,037) (48,792)
Inventory (280,589) (128,674)
Other current assets (366,040) 65
Accounts payable 56,090 225,511
Accrued expenses 322,430 334,785
-----------------------------------------------
Net cash used in operating activities (8,157,974) (446,865)
INVESTING ACTIVITIES
Purchases of property and equipment (1,035,896) (47,889)
Net cash acquired in acquisition of business - 10,028
-----------------------------------------------
Net cash used in investing activities (1,035,896) (37,861)
FINANCING ACTIVITIES
Net proceeds from issuance of common stock 27,893,661 120,000
Net proceeds from issuance of redeemable convertible preferred
stock 100,000 9,882,000
Proceeds from exercise of warrants 284,057 -
Proceeds from exercise of stock options 5,192 -
Increase in long-term liabilities 48,768 -
-----------------------------------------------
Net cash provided by financing activities 28,331,678 10,002,000
-----------------------------------------------
Net increase in cash and cash equivalents 19,137,808 9,517,274
Cash and cash equivalents at beginning of period 9,517,274 -
-----------------------------------------------
Cash and cash equivalents at end of period $ 28,655,082 $ 9,517,274
===============================================
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest $ 3,148 $ -
===============================================
See accompanying notes.
F-6
45
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
AutoCyte, Inc. ("AutoCyte" or the "Company"), a Delaware Corporation, was formed
on October 24, 1996 to acquire the cytology and pathology automation business
(the "Business") then owned by Roche Image Analysis Systems, Inc. ("RIAS"), a
wholly-owned subsidiary of Roche Holding Ltd. ("Roche"). The Company develops,
manufactures and markets the only integrated automated sample preparation and
image analysis system to support cytology professionals in cervical cancer
screening. The Company's integrated system is comprised of the AutoCyte PREP
("PREP") sample preparation system and the AutoCyte SCREEN ("SCREEN") image
analysis system. The Company also continues to market and further develop other
pathology automation products previously commercialized by RIAS.
On November 22, 1996, the Company entered into a Contribution Agreement (the
"Agreement") with Roche and RIAS whereby the Company acquired the net assets and
liabilities of the cytology and pathology automation business of RIAS in
exchange for 3,689,129 shares of Common Stock valued at $6.0 million. The
transaction was accounted for as a purchase transaction in accordance with APB
16.
On September 5, 1997, the Company completed an initial public offering of
3,100,000 shares of $0.01 par value Common Stock (the "Offering"). The Offering
price was $10 per common share resulting in gross offering proceeds of
$31,000,000. Proceeds to the Company, net of underwriters discount and offering
expenses were $27,661,161. Simultaneously with the Offering, the redeemable
convertible preferred stock of the Company was automatically converted into
4,881,936 shares of Common Stock. On October 10, 1997, the underwriters
exercised a portion of their over-allotment option and purchased an additional
25,000 shares of Common Stock at $10 per share resulting in additional net
proceeds of $232,500.
Revenues from sales of products have not generated sufficient cash to support
the Company's operations. Both the Company and its predecessor have incurred
substantial losses. The Company has funded its operations primarily through the
private sale of equity securities and its September 1997 initial public
offering. The Company continues to be subject to certain risks and uncertainties
common to early stage medical device companies including the uncertainty of
availability of additional financing, extensive government regulation,
uncertainty of market acceptance of its products, limited manufacturing,
marketing and sales experience, uncertainty of future profitability and the
uncertainty of United States Food and Drug Administration ("FDA") approval of
its products.
F-7
46
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. THE COMPANY (CONTINUED)
The Company must obtain FDA approval in order to market its products in the
United States for their principal intended use. Generally, before a new medical
device can be introduced into the market in the United States, the manufacturer
must obtain FDA approval of a premarket approval application ("PMA") or FDA
clearance of a 501(k) premarket notification. Each of the Company's two
principal products, PREP and SCREEN, are subject to the PMA process; however,
neither has yet received such approval. The Company's failure to obtain or
maintain FDA regulatory approval for its products would have a material adverse
effect on the Company's business, financial condition and results of operations.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of AutoCyte, Inc. and
its subsidiaries, AutoCyte Europe b.v.b.a. and AutoCyte Australia Pty Ltd. All
significant intercompany balances and transactions have been eliminated in
consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK
The Company's principal financial instruments subject to potential concentration
of credit risk are cash, cash equivalents and unsecured accounts receivable. The
Company invests its funds in highly rated institutions, and limits its
investment in any individual debtor to $5 million. The Company provides an
allowance for doubtful accounts equal to the estimated losses to be incurred in
the collection of accounts receivable, which have historically been minimal and
within management's expectations.
F-8
47
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
Revenue is recognized from product sales and rentals. Product sales revenue is
recognized when products are shipped, and product rental revenue is recognized
as earned.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
INVENTORY
Inventory is stated at the lower of cost or net realizable value. Cost is
determined using the average cost method. Net realizable value of inventory is
reviewed in detail on an on-going basis, with consideration given to
deterioration, obsolescence and other factors.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives (three to five years) of
the individual assets. Depreciation expense amounted to $477,686 during 1997 and
$39,797 during the period from November 22, 1996 (inception) through December
31, 1996.
Included in property and equipment is demonstration equipment, which consists of
units being used for demonstration purposes by salespeople; being evaluated by
clinics, laboratories, hospitals, doctors offices or universities; or being used
in clinical trials. A listing of all demonstration equipment is reviewed
quarterly by the Company, and, based on various factors, including whether or
not the Company continues to market the products being demonstrated, asset
impairment reserves are established as necessary.
F-9
48
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GOODWILL
The excess cost over the fair value of net assets acquired ("goodwill") is being
amortized using the straight-line method over 20 years. Accumulated amortization
was $165,625 and $15,625 at December 31, 1997 and 1996, respectively. The
Company periodically reviews the value of its goodwill to determine if an
impairment has occurred. In accordance with SFAS 121, if this review indicates
that goodwill will not be recoverable, as determined based on an analysis of
undiscounted cash flows over the remaining amortization period, the Company
would reduce the carrying value of its goodwill accordingly.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to operations as incurred.
INCOME TAXES
The Company accounts for income taxes using the liability method. Under the
liability method, deferred tax assets and liabilities are determined based on
differences between the financial reporting and tax bases of assets and
liabilities.
NET LOSS PER COMMON SHARE
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement No.
128, "Earnings Per Share" ("SFAS 128"). SFAS 128 is effective for fiscal years
ending after December 15, 1997 and replaces the calculation of primary and fully
diluted earnings per share with basic and diluted earnings per share. Upon
adoption, all prior period earnings per share amounts (including quarterly
information) are required to be restated. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities, and only reflects actual common shares outstanding. The
Company's calculation of earnings (loss) per share reflects the completion of
its initial public offering and the simultaneous conversion of its convertible
preferred stock into common stock in September 1997. Prior to the adoption of
SFAS 128, approximately 4.9 million shares of convertible preferred stock were
assumed to be outstanding in calculating previously reported loss per share
amounts. Under SFAS 128, these shares are not included as
F-10
49
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
shares outstanding until their conversion at the time of the Offering. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. As the Company incurred losses during all periods presented,
the effect of options, warrants and convertible preferred stock is anti-dilutive
and accordingly, there is no difference between basic and diluted loss per
share.
STOCK BASED COMPENSATION
The Company accounts for stock options in accordance with Accounting Principles
Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25").
Under APB 25, no compensation expense is recognized for stock or stock options
issued with an exercise price equivalent to the fair value of the Company's
Common Stock. For stock options granted at exercise prices below the deemed fair
value, the Company records deferred compensation expense for the difference
between the exercise price of the shares and the deemed fair value. Any
resulting deferred compensation expense is amortized ratably over the vesting
period of the individual options.
In October 1995, the FASB issued Statement of Financial Accounting Standards No.
123, "Accounting for Stock Based Compensation" ("SFAS 123"). For companies that
continue to account for stock based compensation arrangements under APB 25, SFAS
123 requires disclosure of the pro forma effect on net income (loss) and
earnings (loss) per share as if the fair value based method prescribed by SFAS
123 had been applied. The Company has adopted the pro forma disclosure
requirements of SFAS 123 (see Note 11).
ADVERTISING EXPENSE
The cost of advertising is expensed as incurred. Advertising and marketing
expense, including trade show expense, amounted to $157,095 during 1997 and
$3,900 during the period from November 22, 1996 (inception) through December 31,
1996.
RECLASSIFICATION
Certain amounts in the 1996 financial statements have been reclassified to
conform with 1997 classifications. These reclassifications had no impact on net
loss or stockholders' equity amounts previously reported.
F-11
50
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, FASB issued Statement No. 130, "Reporting Comprehensive Income"
("SFAS 130") which is effective for fiscal years beginning after December 15,
1997. SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in financial statements. The Company will adopt SFAS
130 in the first quarter of 1998 and will provide the required financial
statement disclosures. The application of the new rules will not have an impact
on the Company's financial position or results from operations.
In June 1997, FASB issued Statement No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131") which is effective for fiscal
years beginning after December 15, 1997. SFAS 131 changes the way public
companies report segment information in annual financial statements and also
requires those companies to report selected segment information in interim
financial statements to shareholders. SFAS 131 also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. The Company will adopt SFAS 131 in 1998 that may result in additional
disclosures. The application of the new rules will not have an impact on the
Company's financial position or results from operations.
3. BUSINESS SEGMENTS
The Company operates in a single industry and is engaged in the development and
sale of cytology and pathology automation systems for use in clinical laboratory
applications. Revenues from significant customers, those representing 10% or
more of total revenues for the respective periods, are summarized as follows:
PERIOD FROM
NOVEMBER 22, 1996
YEAR ENDED (INCEPTION) THROUGH
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------------------------------------
Customer 1 17.0% -
Customer 2 - 70.4%
Sales by geographic region during 1997 were as follows: United States - 59%,
Europe - 19%, Asia and Australia - 18%, other international sales - 4%. There
were no international sales during the period from November 22, 1996 (inception)
through December 31, 1996.
F-12
51
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ALLOWANCE FOR DOUBTFUL ACCOUNTS
A summary of the allowance for doubtful accounts activity is as follows:
DECEMBER 31,
1997 1996
-----------------------------------------
Balance, beginning of year $ 17,500 $ 7,500
Amounts charged to expense 67,500 10,000
Amounts written off - -
-----------------------------------------
Balance, end of year $ 85,000 $ 17,500
=========================================
5. INVENTORY
Inventory consists of the following:
DECEMBER 31,
1997 1996
-----------------------------------------
Raw materials $ 560,297 $ 787,050
Finished goods 1,631,698 1,124,356
-----------------------------------------
$ 2,191,995 $ 1,911,406
=========================================
6. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
1997 1996
-----------------------------------------
Demonstration equipment $ 1,236,161 $ 975,000
Rental units 320,607 -
Machinery and equipment 457,228 299,097
Furniture, fixtures and improvements 87,859 75,000
Computer equipment and software 424,278 150,632
-----------------------------------------
$ 2,526,133 $ 1,499,729
Less accumulated depreciation (507,991) (39,797)
-----------------------------------------
$ 2,018,142 $ 1,459,932
=========================================
F-13
52
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31,
1997 1996
----------------------------------------
Accrued payroll and related benefits $ 213,443 $ 117,615
Accrued warranty costs 196,709 198,813
Customer deposits 130,000 -
Other accrued expenses 275,846 177,140
----------------------------------------
$ 815,998 $ 493,568
========================================
8. CREDIT AGREEMENT
On June 27, 1997, the Company entered into a credit agreement with certain of
its institutional stockholders and the Company's Chief Executive Officer. The
agreement provided the Company with access to a credit line of up to $8,000,000
at an interest rate of prime plus 1%. As consideration for this agreement, the
Company issued warrants to purchase 207,291 shares of its Common Stock at an
exercise price of $2.033 per share. The warrants were immediately exercisable,
with an expiration date ten years from the date of issuance. The Company
estimated the expense associated with the warrant issuance to be approximately
$1,475,000, all of which was expensed at the time of issuance as a credit
agreement commitment fee. No borrowings were made under this credit arrangement,
which expired upon the completion of the Offering in September 1997. On October
24, 1997, all these outstanding warrants were exercised.
9. LEASES
The Company leases its office and manufacturing facilities and certain office
equipment under operating leases expiring at various times through July 2004.
At December 31, 1997, future minimum lease payments under these leases are as
follows:
1998 $ 284,533
1999 310,860
2000 310,860
2001 310,860
2002 309,540
Thereafter 490,105
----------------
$ 2,016,758
================
F-14
53
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. LEASES (CONTINUED)
Rent expense amounted to $281,424 during 1997 and $25,245 during the period from
November 22, 1996 (inception) to December 31, 1996.
10. INCOME TAXES
The Company has cumulative net operating loss carryforwards available to offset
future taxable income of approximately $11,314,000, $10,293,000 of which expires
for federal purposes in 2012 and $1,021,000 of which expires for federal
purposes in 2011. State tax loss carryforwards begin to expire in 2001. Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes.
Components of deferred taxes are as follows:
DECEMBER 31,
1997 1996
----------------------------------
Deferred tax assets:
Inventory $ 1,027,000 $ 1,232,000
Property and equipment 1,408,000 1,992,000
Intangible assets 626,000 690,000
Net operating loss carryforwards 4,412,000 390,000
Other 110,000 84,000
----------------------------------
Total deferred tax asset 7,583,000 4,388,000
Valuation allowance for deferred tax asset (7,583,000) (4,388,000)
----------------------------------
Net deferred taxes $ - $ -
==================================
11. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
REDEEMABLE CONVERTIBLE PREFERRED STOCK
The 9,925,000 shares of Series A Convertible Preferred Stock automatically
converted into 4,881,936 shares of Common Stock upon completion of the Offering
in September 1997.
F-15
54
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (CONTINUED)
Pursuant to the Company's amended and restated Certificate of Incorporation, the
Board of Directors has the authority, without further vote or action by the
stockholders, to issue up to 1,000,000 shares of Preferred Stock in one or more
series and to fix the relative rights, preferences, privileges, qualifications,
limitations and restrictions thereof, including dividend rights, dividend rates,
conversion rights, voting rights, terms of redemption, redemption prices,
liquidation preferences, sinking fund terms and the number of shares
constituting any series or the designation of such series, any or all of which
may be greater that the rights of Common Stock. At December 31, 1997 there are
no shares of Preferred Stock outstanding.
REVERSE STOCK SPLIT
On June 24, 1997, the Company's Board of Directors approved a 1-for-2.033
reverse stock split of the Company's Common Stock effective on June 27, 1997,
the date of the stockholder approval of an amendment to the Company's
Certificate of Incorporation to effect the reverse stock split. All common
share, option and warrant data have been restated for all periods presented to
reflect the split.
EQUITY INCENTIVE PLANS
At inception, the Company adopted the 1996 Equity Incentive Plan (the "Plan")
under which incentive and nonstatutory stock options, stock appreciation rights
and restricted stock may be granted to employees or consultants of the Company.
Generally, options and restricted stock grants vest ratably over a 48 month
term. Stock options expire ten years from the date of grant.
During 1997, the Board of Directors approved the adoption of the 1997 Director
Stock Option Plan and reserved 100,000 shares of common stock for issuance under
the plan. As of December 31, 1997, no options had been granted pursuant to this
plan.
F-16
55
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (CONTINUED)
A summary of activity under the Plans is as follows:
OPTIONS OUTSTANDING
---------------------------------------------------------
SHARES WEIGHTED
AVAILABLE FOR NUMBER OF EXERCISE AVERAGE
GRANT SHARES PRICE RANGE EXERCISE PRICE
-------------------------------------------------------------------------------
Shares reserved 1,512,543 - $ - $ -
Restricted stock granted (590,260) - - -
Options granted (689,836) 689,836 0.20 0.20
-------------------------------------------------------------------------------
Balance at December 31, 1996 232,447 689,836 0.20 0.20
Shares reserved 673,782 - - -
Options granted (349,962) 349,962 $0.20 - $10.50 1.47
Options exercised - (25,535) 0.20 0.20
Options canceled 8,353 (8,353) 0.20 0.20
-------------------------------------------------------------------------------
Balance at December 31, 1997 564,620 1,005,910 $0.20 - $10.50 $ 0.64
===============================================================================
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------- -----------------------------------------
NUMBER WEIGHTED-AVERAGE
OUTSTANDING AT REMAINING WEIGHTED NUMBER
DECEMBER 31, CONTRACTUAL -AVERAGE EXERCISABLE AT WEIGHTED-AVERAGE
PRICE RANGE 1997 LIFE (YEARS) EXERCISE PRICE DECEMBER 31, 1997 EXERCISE PRICE
- -----------------------------------------------------------------------------------------------------------------------
$0.20 960,910 9.0 $0.20 205,294 $0.20
$9.75 - $10.50 45,000 9.9 $10.04 811 $9.82
- -----------------------------------------------------------------------------------------------------------------------
$0.20 - $10.50 1,005,910 9.1 $0.64 206,105 $0.24
=======================================================================================================================
At December 31, 1996, no options were exercisable.
At inception, the Company sold 590,260 shares of restricted Common Stock with a
deemed fair value of $1.6264 per share to the Company's Chief Executive Officer
at a price of $0.2033 per share. Under the terms of the restricted stock
purchase agreement, the shares vest ratably over a 48-month term and are subject
to repurchase by the Company at the issuance price if the CEO ceases to be
employed by the Company.
F-17
56
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (CONTINUED)
SFAS 123
The Company has adopted the disclosure-only provisions of SFAS 123. In
accordance with SFAS 123, the fair value of each option grant was determined by
using the Black-Scholes option-pricing model with the following weighted average
assumptions for 1997 and for the period from November 22, 1996 (inception)
through December 31, 1996, respectively; dividend yield of 0.00%; risk free
interest rate of 6.32% and 6.56%; volatility factor of the expected market price
of the Company's Common Stock of 0.71 and 0.60; and an expected option life of
48 months. The weighted-average fair value of options granted in 1997 and 1996
was $5.64 and $0.72, respectively. Had compensation cost for the Company's stock
options been determined based on the fair value at the date of grant consistent
with the provisions of SFAS 123, the Company's net loss and net loss per share
would not have differed materially from those amounts reported in the
consolidated statements of operations; therefore, supplemental pro forma
information has not been separately disclosed, as permitted by SFAS 123.
COMMON STOCK RESERVED FOR FUTURE ISSUANCE
The Company has reserved authorized shares of Common Stock for future issuance
as follows:
DECEMBER 31,
1997 1996
-------------------------------------
Outstanding stock options 1,005,910 689,836
Possible future issuance under equity incentive plans 564,620 232,447
Redeemable convertible preferred stock - 4,881,936
-------------------------------------
Total shares reserved 1,570,530 5,804,219
=====================================
F-18
57
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (CONTINUED)
DEFERRED COMPENSATION
The Company recorded deferred compensation of $1,664,694 during 1997 and
$1,821,750 during the period from November 22, 1996 (inception) through December
31, 1996 for the difference between the exercise price and the deemed fair value
of the Company's common stock option and restricted stock grants. The amount is
being amortized over the vesting period of the individual options, generally 48
months. Amortization of deferred compensation totaled $705,357 during 1997 and
$37,807 during the period from November 22, 1996 (inception) through December
31, 1996, respectively.
12. RELATED PARTY TRANSACTIONS
The Company rents its office facilities from Laboratory Corporation of America
Holdings, Inc. ("LabCorp"), a public company partially owned by Roche. Roche is
a shareholder of the Company and the Company's Chief Executive Officer is a
Director of LabCorp. Total rent paid to LabCorp amounted to $111,375 during 1997
and $11,600 during the period from November 22, 1996 (inception) through
December 31, 1996. Additionally, the Company owed approximately $348,000 and
$140,000 at December 31, 1997 and 1996, respectively, to Roche or its affiliates
for services provided.
13. RETIREMENT PLAN
The Company has a qualified 401(k) Retirement Plan (the "Plan"). Substantially
all full-time employees are eligible to participate and participants may
contribute from 1% to 15% of their compensation to the Plan. The Company matches
50% of each participant's contribution up to 6% of the employee's compensation,
and may make additional matching contributions at the discretion of management,
not to exceed 15% of the employee's compensation. Total expense for the plan was
$82,198 during 1997 and $5,572 during the period from November 22, 1996
(inception) through December 31, 1996.
F-19
58
AUTOCYTE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. PRO FORMA COMBINED RESULTS OF OPERATIONS
The pro forma combined results of operations as if AutoCyte had acquired the
predecessor entity on January 1, 1996 and had been in operation for the entire
year as a combined entity would have been as follows:
PERIOD FROM PERIOD FROM
JANUARY 1, 1996 NOVEMBER 22, 1996
THROUGH THROUGH YEAR ENDED
NOVEMBER 21, 1996 DECEMBER 31, 1996 DECEMBER 31, 1996
(PREDECESSOR) (AUTOCYTE) (PRO FORMA COMBINED)
-----------------------------------------------------------------------------
Sales $ 1,747,209 $ 129,189 $ 1,876,398
Cost of goods sold 2,796,802 112,022 2,908,824
-----------------------------------------------------------------------------
Gross profit (loss) (1,049,593) 17,167 (1,032,426)
Operating expenses:
Research and development 3,907,682 457,918 4,365,600
Selling, general and administrative 11,965,813 524,669 12,490,482
-----------------------------------------------------------------------------
15,873,495 982,587 16,856,082
-----------------------------------------------------------------------------
Operating loss (16,923,088) (965,420) (17,888,508)
Interest income - 42,431 42,431
-----------------------------------------------------------------------------
Net loss $ (16,923,088) $ (922,989) $ (17,846,077)
=============================================================================
Net loss per share is not disclosed for 1996 since RIAS operated as a
wholly-owned subsidiary of Roche Holding Ltd. prior to the formation of AutoCyte
on November 22, 1996.
F-20
59
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
AutoCyte, Inc.
We have audited the accompanying balance sheets of the Cytology and
Pathology Automation Business of Roche Image Analysis Systems, Inc. (the
"Business") as of December 31, 1995 and November 21, 1996, and the related
statements of operations and cash flows for the years ended December 31, 1994
and 1995 and for the period from January 1, 1996 to November 21, 1996. These
financial statements are the responsibility of the Business's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Cytology and Pathology
Automation Business of Roche Image Analysis Systems, Inc. at December 31, 1995
and November 21, 1996, and the results of its operations and its cash flows for
the years ended December 31, 1994 and 1995 and for the period from January 1,
1996 to November 21, 1996 in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Raleigh, North Carolina
June 13, 1997
F-21
60
CYTOLOGY AND PATHOLOGY AUTOMATION BUSINESS
OF ROCHE IMAGE ANALYSIS SYSTEMS, INC.
BALANCE SHEETS
DECEMBER 31, NOVEMBER 21,
1995 1996
------------ ------------
ASSETS
Current assets:
Cash........................................................... $ 9,530 $ 10,028
Accounts receivable, net....................................... 744,288 712,325
Inventory...................................................... 3,508,756 1,782,732
Other current assets........................................... 34,575 49,273
----------- ----------
Total current assets........................................ 4,297,149 2,554,358
Property and equipment, net of accumulated depreciation of
$4,448,000 and $5,732,000 at December 31, 1995 and November 21,
1996, respectively............................................. 6,416,967 1,451,840
----------- ----------
Total assets................................................ $10,714,116 $4,006,198
=========== ==========
LIABILITIES AND BUSINESS EQUITY
Current liabilities:
Accounts payable............................................... $ 411,647 $ 2,010
Accrued expenses............................................... 300,231 1,004,188
----------- ----------
Total current liabilities................................... 711,878 1,006,198
Business equity............................................. 10,002,238 3,000,000
----------- ----------
Total liabilities and business equity....................... $10,714,116 $4,006,198
=========== ==========
See accompanying notes.
F-22
61
CYTOLOGY AND PATHOLOGY AUTOMATION BUSINESS
OF ROCHE IMAGE ANALYSIS SYSTEMS, INC.
STATEMENTS OF OPERATIONS
PERIOD FROM
JANUARY 1,
YEAR ENDED DECEMBER 31, 1996 TO
----------------------------- NOVEMBER 21,
1994 1995 1996
------------ ------------ ------------
Net sales to LabCorp and its predecessor....... $ 844,593 $ 598,174 $ 297,047
Net sales to third parties..................... 2,551,717 2,797,656 1,450,162
------------ ------------ ------------
3,396,310 3,395,830 1,747,209
Cost of goods sold............................. 2,599,859 2,413,886 2,796,802
------------ ------------ ------------
Gross profit (loss)....................... 796,451 981,944 (1,049,593)
Operating expenses:
Research and development..................... 3,604,898 5,073,764 3,907,682
Selling, general and administrative.......... 8,479,057 7,895,394 11,965,813
------------ ------------ ------------
12,083,955 12,969,158 15,873,495
------------ ------------ ------------
Net loss.................................. $(11,287,504) $(11,987,214) $(16,923,088)
============ ============ ============
See accompanying notes.
F-23
62
CYTOLOGY AND PATHOLOGY AUTOMATION BUSINESS
OF ROCHE IMAGE ANALYSIS SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
PERIOD FROM
JANUARY 1,
YEAR ENDED DECEMBER 31, 1996 TO
----------------------------- NOVEMBER 21,
1994 1995 1996
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................. $(11,287,504) $(11,987,214) $(16,923,088)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation........................... 1,915,481 2,242,320 1,359,527
Asset impairment write-down............ 1,980,596 506,241 5,256,680
Changes in operating assets and
liabilities:
Accounts receivable.................... 1,916,368 105,938 31,963
Inventory.............................. (162,485) (1,208,216) 403,810
Other current assets................... 105,086 (15,150) (14,698)
Accounts payable....................... (477,270) 157,953 417
Accrued expenses....................... 384,384 (1,024,112) 293,903
------------ ------------ ------------
Net cash used in operating
activities........................ (5,625,344) (11,222,240) (9,591,486)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment...... (1,702,032) (1,800,295) (328,866)
------------ ------------ ------------
Net cash used in investing
activities........................ (1,702,032) (1,800,295) (328,866)
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances from Roche...................... 7,329,932 13,023,796 9,920,850
------------ ------------ ------------
Net cash provided by financing
activities........................ 7,329,932 13,023,796 9,920,850
------------ ------------ ------------
Net increase in cash and cash equivalents..... 2,556 1,261 498
Cash and cash equivalents at beginning of
period...................................... 5,713 8,269 9,530
------------ ------------ ------------
Cash and cash equivalents at end of period.... $ 8,269 $ 9,530 $ 10,028
============ ============ ============
See accompanying notes.
F-24
63
CYTOLOGY AND PATHOLOGY AUTOMATION BUSINESS
OF ROCHE IMAGE ANALYSIS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
NOVEMBER 21, 1996
1. DESCRIPTION OF THE BUSINESS
The Cytology and Pathology Automation Business (the "Business") of Roche
Image Analysis Systems, Inc. ("RIAS") was engaged in the manufacturing and
marketing of automated pathology workstations, and in the development and
marketing of an integrated sample preparation and automated image analysis
system to support cytologists in cervical cancer screening. The Business
represents the predecessor entity of AutoCyte, Inc. ("AutoCyte"), a company
formed in October 1996 to acquire the Business including its two principal
product candidates, the AutoCyte PREP ("PREP") sample preparation system and the
AutoCyte SCREEN ("SCREEN") automated image analysis system. In addition to this
Business, RIAS, a wholly-owned subsidiary of Roche Holding Ltd ("Roche"), was
also engaged in the sale of human leukocyte antigen ("HLA") kits used for
paternity testing. The HLA business was not acquired by AutoCyte and is thus not
included in these predecessor entity financial statements.
On November 22, 1996, RIAS entered into a Contribution Agreement with
AutoCyte and Roche whereby AutoCyte acquired the net assets and liabilities of
the Business for 3,689,129 shares of AutoCyte common stock.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying financial statements have been prepared as if the Business
had existed as a separate, stand-alone entity during the periods presented and
include the historical assets, liabilities, revenues and expenses that are
directly related to the Business's operations. However, these financial
statements are not necessarily indicative of the financial position and results
of operations which would have occurred had the Business been an independent
company.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Concentrations of Credit Risk
The Business's principal financial instrument subject to potential
concentration of credit risk is unsecured accounts receivable. The Business
provides an allowance for doubtful accounts equal to the estimated losses to be
incurred in the collection of accounts receivable.
Revenue Recognition
Revenue from product sales is recognized when products are shipped.
Cash and Cash Equivalents
The Business considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
Product Warranty
The Business's products generally carry a one year warranty against
defects. The Business provides for estimated warranty costs in the period the
related sales are made.
F-25
64
CYTOLOGY AND PATHOLOGY AUTOMATION BUSINESS
OF ROCHE IMAGE ANALYSIS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Impairment of Long-Lived Assets
The Business adopted the Financial Accounting Standards Board Statement No
121, "Accounting for the Impairment of Long-Lived Assets to be Disposed Of"
("SFAS 121") in the first quarter of 1996. During 1996, the Business decided to
focus on its newer generation PREP and SCREEN systems. Accordingly, the Business
evaluated the ongoing value of the older model systems and other equipment
included in property and equipment. Based on this evaluation, the Business
determined that assets with a carrying amount of approximately $5.4 million were
impaired and wrote them down by $3.9 million to their estimated fair value. Fair
value was based on the estimated price at which the assets could be sold.
Additionally, the Business performed similar evaluations of fair values in 1995
and 1994 and wrote-down certain demonstration equipment and other equipment by
approximately $500,000 and approximately $2 million, respectively.
Income Taxes
The results of the Business's operations were included in the consolidated
income tax returns of its parent company. No provision for income taxes has been
included in these financial statements since the Business's significant
operating losses would have precluded recording any deferred tax assets if the
Business was a stand-alone taxpayer.
Business Equity
Because the Business operated as part of a wholly-owned subsidiary of
Roche, its equity accounts have been combined and presented as "Business Equity"
which includes net amounts advanced to the Business by Roche (Note 7).
Inventory
Inventory is stated at the lower of cost or net realizable value. Cost is
determined using the average cost method. Consideration is given to
deterioration, obsolescence and other factors in evaluating net realizable
value.
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives (three to five years)
of the individual assets. Depreciation expense amounted to $1,915,481,
$2,242,320 and $1,359,527 during 1994, 1995 and the period from January 1, 1996
to November 21, 1996, respectively.
Included in property and equipment is demonstration equipment, which
consists of units being used for demonstration purposes by salespeople; being
evaluated by clinics, laboratories, hospitals, doctors offices or universities;
or being used in clinical trials. As this equipment will likely not be sold
within the next year, the amounts are recorded as a component of property and
equipment rather than inventory, and are being depreciated over their estimated
useful life of four years.
Research and Development Costs
Research and development costs are charged to operations as incurred.
Advertising Expense
The cost of advertising is expensed as incurred. Advertising expense
amounted to $302,444, $478,662 and $405,572 during 1994, 1995 and the period
from January 1, 1996 to November 21, 1996, respectively.
F-26
65
CYTOLOGY AND PATHOLOGY AUTOMATION BUSINESS
OF ROCHE IMAGE ANALYSIS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. SALES AND ACCOUNTS RECEIVABLE
The Business operates in a single industry and is engaged in the development and
sale of cytology and pathology automation systems for use in clinical laboratory
testing. Revenues from significant customers, those representing 10% or more of
total revenues for the respective periods, are summarized as follows:
PERIOD FROM
YEARS ENDED JANUARY 1,
DECEMBER 31, 1996 TO
--------------------------- NOVEMBER 21,
1994 1995 1996
---------- ---------- ------------
Customer 1............................... 24.9% 17.6% 17.0%
Customer 2............................... 19.5 -- --
Customer 3............................... -- -- 13.7
The Business sells its products to international customers, however, these
sales accounted for less than 10% of total sales during all periods presented.
4. INVENTORY
Inventory consists of the following:
DECEMBER 31, NOVEMBER 21,
1995 1996
------------ ------------
Raw materials................................. $1,119,173 $ 802,580
Finished goods................................ 2,389,583 980,152
---------- ----------
$3,508,756 $1,782,732
========== ==========
During 1996, the Business decided to focus on PREP and SCREEN systems. As a
result, certain inventory items were written down by approximately $1.4 million
to their estimated net realizable values.
5. LEASES
The Business leases its office and manufacturing facilities and certain
equipment under operating leases. Rent expense amounted to $391,684, $480,725
and $421,812 during 1994, 1995 and during the period from January 1, 1996 to
November 21, 1996, respectively.
6. CORPORATE ALLOCATIONS
Roche provided substantial services to the Business, including, but not
limited to, general administration, treasury, tax, financial reporting, payroll
administration, insurance, human resources and legal functions. Roche has
traditionally charged the Business for certain of these services through
corporate allocations which were generally based on a percent of sales. The
amount of corporate allocations was dependent upon the total amount of
anticipated allocable costs incurred by Roche, less amounts charged as a
specific cost or expense rather than by allocation. The amounts allocated are
not necessarily indicative of amounts that would have been incurred by the
Business had it operated on a stand-alone basis. Management believes that the
method of expense allocation is reasonable.
F-27
66
CYTOLOGY AND PATHOLOGY AUTOMATION BUSINESS
OF ROCHE IMAGE ANALYSIS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. BUSINESS EQUITY
A summary of the Business equity account activity is as follows:
ADVANCES ACCUMULATED
FROM ROCHE DEFICIT TOTAL
------------- ------------ ------------
Balance at December 31, 1993.......... $ 22,044,244 $ (9,121,016) $ 12,923,228
Advances from Roche.............. 7,329,932 -- 7,329,932
Net loss for year................ -- (11,287,504) (11,287,504)
----------- ------------ ------------
Balance at December 31, 1994.......... 29,374,176 (20,408,520) 8,965,656
Advances from Roche.............. 13,023,796 -- 13,023,796
Net loss for year................ -- (11,987,214) (11,987,214)
----------- ------------ ------------
Balance at December 31, 1995.......... 42,397,972 (32,395,734) 10,002,238
Advances from Roche.............. 9,920,850 -- 9,920,850
Net loss for period.............. -- (16,923,088) (16,923,088)
----------- ------------ ------------
Balance at November 21, 1996.......... $ 52,318,822 $(49,318,822) $ 3,000,000
=========== ============ ============
8. RELATED PARTY TRANSACTIONS
The Business entered into certain product sale arrangements with Laboratory
Corporation of America Holdings or its predecessor ("LabCorp"), a public company
partially owned by Roche. Sales to LabCorp amounted to $844,593, $598,174 and
$297,047 during 1994, 1995 and during the period from January 1, 1996 to
November 21, 1996, respectively.
Additionally, the Business rented its office facility from LabCorp. Rent
paid to LabCorp amounted to $96,000, $102,500 and $100,000 during 1994, 1995 and
during the period from January 1, 1996 to November 21, 1996, respectively.
F-28
67
EXHIBIT INDEX
3.1 Restated Certificate of Incorporation of the Company. Filed as Exhibit 3.5 to the Company's
Registration Statement on Form S-1 (File No. 333-30227) and incorporated herein by reference.
3.2 Amended and Restated By-laws of the Company. Filed as Exhibit 3.7 to the Company's Registration
Statement on Form S-1 (File No. 333-30227) and incorporated herein by reference.
4.1 Specimen of Common Stock Certificate. Filed as Exhibit 4.1 to the Company's Registration
Statement on Form S-1 (File No. 333-30227) and incorporated herein by reference.
10.1* Amended and Restated 1996 Equity Incentive Plan (including forms of incentive stock option
certificate and nonstatutory stock option certificate). Filed as Exhibit 10.1 to the Company's
Registration Statement on Form S-1 (File No. 333-30227) and incorporated herein by reference.
10.2* 1997 Director Stock Option Plan (including form of director nonstatutory stock option certificate).
Filed as Exhibit 10.2 to the Company's Registration Statement on Form S-1 (File No. 333-30227)
and incorporated herein by reference.
10.3 Lease Agreement dated as of March 10, 1993 by and between Carolina Hosiery Mills, Inc. and
Roche Biomedical Laboratories, Inc. ("RBL"), the predecessor of the Company's predecessor
(including notices of renewal thereof dated December 27, 1995 and March 24, 1997). Filed as
Exhibit 10.3 to the Company's Registration Statement on Form S-1 (File No. 333-30227) and
incorporated herein by reference.
10.4 Lease Agreement dated as of April 25, 1995 by and between RBL, the predecessor of the Company's
predecessor, and Roche Image Analysis Systems, Inc. ("RIAS"), the Company's predecessor
(including notices of renewal thereof dated January 10, 1996 and March 18, 1997). Filed as Exhibit
10.4 to the Company's Registration Statement on Form S-1 (File No. 333-30227) and incorporated
herein by reference.
10.5+ OEM Supply Agreement dated January 13, 1995 between Tecan AG and RIAS, the Company's
predecessor. Filed as Exhibit 10.6 to the Company's Registration Statement on Form S-1 (File No.
333-30227) and incorporated herein by reference.
10.6+ Amendment to the OEM Supply Agreement dated October 14, 1996 between Tecan AG and RIAS,
the Company's predecessor. Filed as Exhibit 10.7 to the Company's Registration Statement on Form
S-1 (File No. 333-30227) and incorporated herein by reference.
10.7 Agreement dated July 26, 1993 by and between Technical Precision Plastics, Inc. and RIAS, the
Company's predecessor. Filed as Exhibit 10.8 to the Company's Registration Statement on Form S-1
(File No. 333-30227) and incorporated herein by reference.
10.8 Registration Rights Agreement dated as of November 22, 1996 by and among the Company and the
individuals and entities listed on Exhibit A thereto (including amendment thereof dated June 26,
1997). Filed as Exhibit 10.9 to the Company's Registration Statement on Form S-1 (File No. 333-
30227) and incorporated herein by reference.
10.9 Contribution Agreement dated as of November 22, 1996 by and among HLR Holdings Inc., RIAS
and the Company. Filed as Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File
No. 333-30227) and incorporated herein by reference.
68
10.10 Form of Indemnification Agreement between the Company and its Directors and Executive Officers.
Filed as Exhibit 10.11 to the Company's Registration Statement on Form S-1 (File No. 333-30227)
and incorporated herein by reference.
10.11 Lease Agreement dated as of July 28, 1997 by and between Carolina Hosiery Mills, Inc. and the
Company. Filed as Exhibit 10.12 to the Company's Registration Statement on Form S-1 (File No.
333-30227) and incorporated herein by reference.
10.12 Renewal dated January 6, 1998 of Lease Agreement dated as of April 25, 1995 by and between RBL,
the predecessor of the Company's predecessor, and RIAS, the Company's predecessor. Filed
herewith.
23.1 Consent of Ernst & Young LLP, independent auditors to the Company. Filed herewith.
27.1 December 31, 1997 Financial Data Schedule. Filed herewith.
27.2 December 31, 1996 Financial Data Schedule. Filed herewith.
99.1 Important Factors Regarding Forward-Looking Statements. Filed herewith.
- ----------
* Indicates a management contract or compensatory plan.
+ Certain confidential material contained in the document has been omitted
and filed separately with the Securities and Exchange Commission pursuant
to Rule 406 of the Securities Act of 1933, as amended. Omitted information
is identified with asterisks in the appropriate places in the agreement.