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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange
Act of 1934
For the Fiscal Year Ended December 31, 1996 or
[_]Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
Commission File Number: 0-21371
APPLIED IMAGING CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-012490
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) (Identification No.)
2380 WALSH AVENUE, 95051
Building B, (Zip Code)
Santa Clara, California
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 562-0250
Securities registered pursuant to Section 12 (b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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None N/A
Securities registered pursuant to Section 12 (g) of the Act:
COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the 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, based upon the closing sale price of the Common Stock on March 14,
1997, as reported on the Nasdaq National Market, was approximately
$21,893,853.
The number of shares of Common Stock outstanding as of March 14, 1997:
6,824,835 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates information by reference from the
Registrant's definitive proxy statement to be filed with the Securities and
Exchange Commission within 120 days after the close of the fiscal year.
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PART I
ITEM 1. BUSINESS
This Report on Form 10-K contains certain forward looking statements
regarding future events with respect to Applied Imaging Corp. Actual events or
results may differ materially as a result of the factors described herein and
in the documents incorporated herein by reference, including, in particular,
those factors described under "Additional Risk Factors."
THE COMPANY
Applied Imaging Corp. ("Applied Imaging" or the "Company") was incorporated
in California in July 1986, and reincorporated in Delaware in October 1996.
Applied Imaging designs, develops, manufactures and markets automated clinical
analysis systems used by cytogenetic laboratories where prenatal and other
genetic testing is performed. The Company's cytogenetic instrumentation
business, which has sold systems to approximately 500 sites in more than 30
countries since its inception, includes systems that enable laboratories to
automate aspects of the detection of chromosomal abnormalities associated with
conditions such as Down's Syndrome. In addition to the Company's core
instrumentation business, the Company is developing proprietary genetic
screening technology designed to enable prenatal screening for genetic
abnormalities by isolating fetal red blood cells ("fetal blood cells") from a
routine maternal blood sample. This new technology is designed to improve
current prenatal screening procedures by providing an accurate, timely and
cost-effective procedure without the risks of miscarriage or fetal damage
associated with invasive prenatal testing.
The Company's prenatal screening products under development are intended to
provide accurate, non-invasive tests by directly analyzing fetal blood cells
isolated from a routine maternal blood sample. The Company's proprietary
screening technology incorporates (i) a patented blood-based procedure to
enrich the concentration of fetal blood cells, (ii) a fetal hemoglobins test
kit, (iii) automated image analysis instrumentation to identify the fetal
blood cells and (iv) the use of third-party DNA probes to identify certain
chromosomal disorders present in fetal blood cells. The prenatal screening
products are expected to be accurate because they evaluate actual fetal cells
while posing no risk to the fetus. The Company's prenatal screening products
are currently in preclinical evaluation.
In December 1996, the Company submitted two 510(k) medical device
applications to the Food and Drug Administration ("FDA"). The first submission
is for a product that enriches the concentration of any one of a number of
cell types from whole blood, including fetal nucleated red blood cells,
nucleated red blood cells, and white blood cell types. The product is based on
the Company's patented hematological techniques. The second submission is for
an automated image analysis instrument which is a general laboratory tool,
able to automatically detect and locate any of a number of cell types on a
microscope slide. The instrument presents these cells for operator review,
further treatments, and eventual use in a diagnostic or screening procedure.
The Company anticipates that sales of its prenatal screening products, if
approved by the FDA, will include its proprietary consumable enrichment kits
used to separate fetal blood cells from maternal blood samples, kits used to
identify fetal hemoglobins and imaging instrumentation used to analyze the
cells. This new image analysis product is contemplated to be compatible with
the Company's existing installed cytogenetic instrument base. The Company
believes that it can leverage its existing infrastructure, worldwide
distribution capabilities and extensive cytogenetic laboratory relationships
to support the worldwide introduction of these prenatal screening products
under development. Furthermore, the Company believes that its new cell
enrichment, identification and image analysis products could have clinical
utility for cancer applications and the prenatal diagnosis of single gene
disorders, and, if the Company obtains additional funding, it intends to
pursue the development of these other potential applications.
GENETIC DISORDERS
All genetic information in an organism is contained in chromosomes, made up
of strands of DNA and associated protein molecules. DNA is comprised of paired
nucleotide bases, and genetic information is encoded by the specific order of
the nucleotide bases within units called genes. Genes are organized linearly
along the
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chromosomes and carry the required information for the synthesis of the
proteins that provide the structural components of cells and tissues, as well
as enzymes for the basic biochemical and physiological functions of the cells.
Chromosomal Disorders
The nuclei of normal human cells (except sperm and egg cells) contain two
sets of 23 different chromosomes, one set provided by each parent. Sperm and
egg cells are formed in a special cell division process called meiosis, and
they each contain only one set of the 23 individual chromosomes. When these
cells unite during fertilization, each contributes its set of 23 chromosomes
to the genetic information for a new human fetus, and the fertilized egg then
has the two sets of 23 chromosomes. Chromosomal disorders may occur when genes
or portions of genes move between chromosomes (chromosomal translocations),
when portions of chromosomes and the genes they contain are missing, or when
an abnormal number of chromosomes are present in the cell. Certain chromosomal
disorders are thought to occur during meiosis when the division of the
chromosomes to form the egg cell or the sperm cell takes place. During this
process the chromosomes may not divide properly resulting in an extra
chromosome being present in the cell, an extra piece of genetic material being
attached to a chromosome, or a piece of chromosome being broken.
Chromosomes can be seen under a light microscope and, when stained with
certain dyes, reveal light and dark bands reflecting regional variations of
certain paired bases comprising the DNA of the cell. Differences in size and
banding pattern allow the chromosomes to be distinguished from each other and
can be used to identify a chromosomal disorder. The most common chromosomal
disorder, Down's Syndrome, also known as Trisomy 21, occurs when there are
three copies of chromosome 21 in the human cell. Syndromes caused by various
chromosomal abnormalities may result in mental retardation, impaired physical
development and abnormal sexual development.
There are approximately four million births in the United States annually.
Of these, approximately 90% are to women under the age of 35. The Company
estimates that there are approximately 11 million births in industrialized
countries where prenatal screening and diagnostic testing is routine.
Approximately 2% of newborns have birth defects, approximately 12% of which
are caused by chromosomal genetic disorders. The risk of bearing a child with
a chromosomal abnormality increases with maternal age and more than doubles
from one in 526 births for mothers of age 20 to more than one in 192 births
for mothers of age 35.
Single Gene Disorders
In addition to chromosomal disorders caused by translocations or an abnormal
number of chromosomes, single gene disorders may occur when the DNA sequences
of individual genes are altered, resulting in incorrect instructions to the
cells and disruption of the normal balance or function of essential proteins.
Single gene disorders are responsible for many inherited diseases such as
cystic fibrosis, sickle cell anemia and Tay-Sachs disease, and may predispose
an individual to cancer, psychiatric illnesses, and other complex diseases.
PRENATAL TESTING
Prenatal testing is the process of detecting certain types of chromosomal
disorders in a fetus at an early stage of pregnancy. Prenatal testing is
currently performed either invasively, by extracting fetal cells or cells
having fetal-cell characteristics and inspecting the chromosomes within such
cells to diagnose chromosomal disorders, or non-invasively, by an analysis of
a maternal blood sample ("serum test").
The invasive diagnostic procedures yield accurate results on a broad range
of chromosomal disorders because actual fetal cells are obtained and analyzed.
However, these procedures involve the risk of spontaneous miscarriage and
other risks. Due to the risk of spontaneous miscarriage, invasive diagnostic
procedures are usually recommended to only those women who are age 35 or
older, at which ages the risk of having a child with a chromosomal disorder is
greater than the risk of spontaneous miscarriage due to the procedure. Those
women younger than 35 may be screened using non-invasive techniques. For this
group, an invasive diagnostic procedure is generally only recommended to
confirm the result of the non-invasive serum test if such test
2
indicates a heightened risk of a chromosomal disorder. The serum tests present
no risk to the fetus, but are less accurate because they do not diagnose
chromosomal genetic disorders by direct analysis of fetal cells. Such tests
have a relatively high false negative rate resulting in the failure to
identify a significant portion of chromosomal disorders.
Women under the age of 35 have a lower risk of giving birth to an infant
with a chromosomal disorder than do women age 35 or older, but because the
number of births to women under the age of 35 is significantly higher, the
total number of newborns with chromosomal disorders born to women in this age
group is higher than that of women age 35 and older. Consequently, women
younger than 35 bear over 75% of infants with Down's Syndrome.
Invasive Diagnostic Procedures
Amniocentesis. Amniocentesis, usually performed between the 14th and 20th
weeks of pregnancy, is the most common procedure used to obtain fetal cell
samples for prenatal genetic testing. In an amniocentesis procedure a small
amount of amniotic fluid is withdrawn from the amniotic sac via a long needle
inserted through the mother's abdominal wall. Simultaneously during the
procedure, the physician uses ultrasound to guide the needle in order to
minimize potential harm to the unborn child. Once the amniotic sample is
extracted, it is forwarded to a cytogenetic laboratory, where the cells are
cultured and deposited on a slide. The slide is then examined under a
microscope in order to locate and analyze a number of fetal cells in metaphase
(undergoing cell division). In metaphase, a cell's chromosomes are
individually visible in its nucleus.
To find a cell in metaphase a laboratory technician scans the slide manually
to locate cells in metaphase. Once metaphase cells are found, they are
photographed using a camera attached to the microscope. This photograph is
printed and each photographed chromosome is manually cut out of the
photograph, arranged in order and pasted on a sheet to show the two sets of 23
chromosomes present in the cell. This presentation of the chromosomes is
called a karyotype. Alternatively, laboratories may eliminate manual
karyotyping by using an automated computer-based karyotyping system to scan
the slides to locate cells in metaphase, classify the chromosomes, present
them in a display and print hard copies.
Once the karyotype is completed it is then visually analyzed by a trained
geneticist or genetic counselor to determine if any chromosomal abnormalities
are present. The processing and analysis of prenatal genetic samples obtained
by amniocentesis generally requires seven to 14 days. A significant portion of
this time is required to culture the fetal cell samples obtained by the
procedure.
Spontaneous miscarriage occurs in approximately one in every 200
amniocentesis procedures. As a result, only pregnant women who are in a high-
risk group are regularly tested using amniocentesis. In the United States,
amniocentesis generally costs approximately $1,000 per procedure. With an
estimated fetal loss rate of approximately 0.5%, (one in every 200) one normal
fetus will be lost by spontaneous miscarriage resulting from amniocentesis for
every one-to-two fetuses with chromosomal disorders detected by this procedure
for women at age 35.
Amniocentesis is the most common and accurate of all prenatal screening
procedures. All principal chromosomal disorders can be detected and the Down's
Syndrome detection rate is greater than 99%.
Chorionic Villus Sampling (CVS). CVS, typically performed between the 9th
and 11th weeks of pregnancy, involves the extraction of placental tissue
samples, generally through the pregnant woman's cervix. The tissue, which is
genetically representative of the fetus, is analyzed in the same manner as the
fetal cells obtained by amniocentesis to determine if chromosomal disorders
are present. CVS is an alternative to amniocentesis and can be performed
earlier in the pregnancy, but poses a risk of miscarriage that is one in every
100 CVS procedures, double that of amniocentesis. CVS is generally as accurate
as amniocentesis for detecting chromosomal abnormalities. The cost of the CVS
procedure is approximately $1,000. With an estimated fetal loss rate of
approximately 1% (one in every 100), two normal fetuses will be lost by
spontaneous miscarriage resulting from CVS for every one-to-two fetuses with
chromosomal disorders detected by this procedure for women at age 35. Due to
its higher associated risk, CVS is used less frequently than amniocentesis.
3
Non-invasive Screening Procedures
In the United States, approximately 2,000,000 pregnant women under the age
of 35 are screened for chromosomal disorders. Of those screened, a majority
are screened using non-invasive serum tests due to the risk associated with
invasive prenatal diagnostic procedures.
Alpha-fetoprotein Test. A common serum prenatal screening test for certain
chromosomal disorders involves the analysis of alpha-fetoprotein ("AFP") in
the maternal blood. This test is performed on a standard blood sample taken
from the mother that is tested for levels of serum AFP. Down's Syndrome and
other similar chromosomal disorders are associated with low levels of AFP.
Although this serum test is relatively accurate in detecting open neural tube
defects (such as spina bifida), studies indicate that the AFP test can detect
only 20-30% of fetuses with Down's Syndrome.
Triple Test. In recent years, the accuracy of the AFP test has been improved
by combining it with additional blood chemistry tests. This combination is
commonly referred to as "triple marker screening" or the "triple test." This
test identifies Down's Syndrome in 60% of the pregnancies where Down's
Syndrome is present. In 40% of the cases where Down's Syndrome is present,
this test inaccurately concludes Down's Syndrome is not present (a false
negative result). And in approximately 5% of the cases, the triple test
indicates the presence of Down's Syndrome where Down's Syndrome is not present
(a false positive result).
Women whose serum screening results indicate a heightened risk of
chromosomal disorder are usually recommended to have an amniocentesis to
confirm these results. Due to the high false positive rate of the triple test,
amniocentesis procedures are performed in many cases where no chromosomal
disorder exists. Assuming two million serum screening tests per year and a 5%
false positive rate, as many as 100,000 unnecessary procedures may be
performed on women with healthy fetuses each year in the U.S. In addition,
assuming an average cost of $1,000 per amniocentesis, the unnecessary cost to
the health care system associated with these false positive results could be
as high as $100 million per year. With an estimated fetal loss rate of 0.5%
approximately 500 normal fetuses could be lost each year due to unnecessary
amniocentesis procedures.
The characteristics of the current prenatal testing procedures are
summarized below:
CURRENT PRENATAL DIAGNOSTIC AND SCREENING PROCEDURES
APPROX.
APPROX. APPROX. APPROX. DOWN'S WEEK OF
ANNUAL DOWN'S RISK OF FALSE TURNAROUND GESTATION APPROXIMATE
ABNORMALITIES U.S. TEST DETECTION FETAL POSITIVE TIME FOR WHEN TEST COST OF
TEST DETECTED VOLUME RATE LOSS RATE RESULTS ADMINISTERED PROCEDURE
---- ------------- --------- --------- ------- -------- ---------- ------------ -----------
Invasive Tests:
Amniocentesis Chromosomal
Disorders 99+% 0.5% 0% 1-2 weeks 14-20 weeks $1,000
300,000
CVS Chromosomal
Disorders 99+% 1.0% 0% 1 week 9-11 weeks $1,000
Non-Invasive Tests: 20% to 35% 0.0% 5% 1-2 days 15-18 weeks $35 to $70
AFP Neural Tube Defects
and certain
Chromosomal Disor-
ders
2,000,000
Triple Test Neural Tube Defects 60% 0.0% 5% 1-2 days 15-18 weeks $60 to $150
and certain
Chromosomal Disor-
ders
The most accurate prenatal testing involves direct analysis of fetal cells,
which contain the chromosomes of the fetus. The only commercially-available
procedures to extract fetal cells in order to examine the fetal chromosomes
are invasive and pose risks of injury to the fetus and spontaneous
miscarriage. The non-invasive serum screening procedures, which do not pose
such risks, are much less accurate because they do not allow
4
direct examination of fetal chromosomes. The Company believes that there is a
significant need for a prenatal testing procedure which would allow direct
analysis of the fetal cells without the risks associated with the currently-
available invasive procedures.
Fetal blood cells exist in minuscule proportions in samples of maternal
blood. In contrast to adult red blood cells, many of these fetal red blood
cells are nucleated, that is they contain a nucleus with chromosomes. A number
of companies are attempting to isolate these fetal blood cells for testing
through a variety of methods, including various combinations of
immunologically based separation techniques that use monoclonal antibodies,
flow cytometry, or magnetic separation techniques. Although the feasibility of
genetic analysis of fetal blood cells isolated from maternal blood has been
demonstrated, obtaining a sufficient number of fetal blood cells for analysis
has been difficult and generally not suitable to routine clinical
applications.
APPLIED IMAGING'S PRENATAL SCREENING PRODUCTS
The Company is developing proprietary prenatal screening products to detect
chromosomal abnormalities by identifying fetal blood cells from a routine
maternal blood sample. The Company's proprietary screening technology
incorporates (i) a patented hematologically-based procedure to enrich the
concentration of fetal blood cells utilizing the Company's consumable
enrichment kit, (ii) a fetal hemoglobin identification kit, (iii) automated
image analysis instrumentation to identify the fetal blood cells and (iv) the
use of third-party DNA probes to identify certain chromosomal disorders
present in fetal blood cells. This new approach is designed to improve current
prenatal screening procedures by providing an accurate, timely and cost-
effective technique without the risks of miscarriage or fetal damage
associated with invasive prenatal screening techniques.
In contrast to immunologically-based procedures to isolate fetal blood cells
from maternal blood, the Company is developing a proprietary hematologically-
based procedure for enriching the concentration of fetal blood cells from
maternal blood samples for prenatal genetic testing. The Company's process for
enriching the concentration of fetal blood cells from a maternal blood sample
involves the following steps: (i) a centrifugation step for bulk separation of
the blood components, utilizing the Company's patented device which removes
the vast majority of the maternal blood cells; (ii) a selective lysis process
that ruptures the remaining maternal red blood cells; and (iii) a second
centrifugation step to remove the majority of maternal white blood cells using
the Company's patented preformed density gradient medium. The enrichment
process is designed to increase the concentration of fetal blood cells in a
maternal sample approximately 10,000 times. The fetal cell enriched sample is
then harvested and deposited on a slide. The fetal hemoglobins in the cell are
stained using the identification kit to facilitate examination through image
analysis. The Company has developed a semi-automated product to rapidly (under
one hour) identify fetal cells on the slide based on adaptations of its image
analysis, pattern recognition, and slide-scanning technologies incorporated in
the Company's current cytogenetic products.
Once fetal cells are located by the automated scanning systems, fluorescent
DNA probes are added that specifically bind to certain DNA sequences within
the fetal cells indicating the presence or absence of chromosomal disorders.
DNA probes can be designed to locate specific chromosomal changes, additions,
or deletions that result in genetic disorders. The results of the DNA probe
analysis are captured and processed using the Company's automated
visualization technology for the detection, analysis, and documentation of the
DNA probe results.
Clinical/Regulatory Matters
The Company believes that a key aspect of its prenatal screening products is
the ability to enrich and identify fetal blood cells so that they can be
directly analyzed using available DNA probe technology. Through 1996, the
Company and its collaborators have used its fetal cell enrichment procedure on
a total of 133 maternal blood samples at sites internationally and in the
United States. The Company's technology has achieved fetal blood cell
identification in 120 of the 133 samples tested or 90% of the cases.
In December 1996, the Company submitted two 510(k) medical device
applications to the Food and Drug Administration ("FDA"). The first submission
is for a product that enriches the concentration of any one of a
5
number of cell types from whole blood, including fetal nucleated red blood
cells, nucleated red blood cells, and white blood cell types. The product is
based on the Company's patented hematological techniques. The second
submission is for an automated image analysis instrument which is a general
laboratory tool, able to automatically detect and locate any of a number of
cell types on a microscope slide. The instrument presents these cells for
operator review, further treatments, and eventual use in a diagnostic or
screening procedure.
The Company intends to apply for an additional 510(k) clearance for the
fetal cell hemoglobin identification kit. The DNA probe components of the
Company's products will require either FDA clearance of a 510(k) with a tier
III level of review or FDA approval of a PMA. In November 1996, the Company
submitted its protocol for FDA review. The Company is in discussion with the
FDA regarding final clearance of its clinical protocol. The Company plans to
market its prenatal screening products internationally upon receipt of
required regulatory clearances or approvals.'
Commercialization Strategy
The Company's prenatal screening techniques under development are currently
expected to be introduced in Europe in late 1997 and subsequently in the
United States and the Pacific Rim, subject to receipt of required clearances
or approvals in such jurisdictions.
The technology is being designed to initially screen for chromosomal
abnormalities resulting in conditions such as Down's Syndrome and certain sex
chromosome abnormalities such as Turner Syndrome, Klinefelter Syndrome, Triple
X Syndrome and certain other conditions. These abnormalities account for
approximately 80% of the incidence of all birth defects which result from
chromosome-based genetic disorders. The proprietary prenatal screening
products under development will consist of (i) a prepackaged kit to enrich the
concentration of nucleated fetal red blood cells in the maternal blood sample,
(ii) a prepackaged kit to identify the hemoglobins in fetal cells, (iii) the
Company's instrumentation to automate the identification of fetal blood cells
and the acquisition and presentation of the DNA probe analysis, and (iv) may
or may not include a DNA probe kit that is comprised of DNA probes available
from third parties. The Company's prenatal screening products under
development are being designed to be compatible with its existing cytogenetic
products so that customers could potentially add the prenatal screening
products to their existing installations.
FUTURE APPLICATIONS OF THE PRENATAL SCREENING PRODUCTS
The Company's prenatal screening products are being designed to accommodate
various chromosome-specific DNA probes, which are currently commercially
available. The Company believes that its fetal cell identification and
enrichment technology developed for prenatal screening could have future
applications for cancer diagnosis via the isolation of tumor cells from
peripheral blood and the genetic analysis of such cells. The Company is also
developing proprietary uses for its fetal cell analysis that may facilitate
the early detection of single gene disorders such as cystic fibrosis,
hemophilia, thalassemia, sickle-cell anemia and Tay-Sachs. If additional
funding is obtained, the Company intends to pursue these potential additional
applications to leverage its proprietary technology. Because evaluations of
future applications are at an early stage, no assurance can be given when, if
ever, the Company's fetal cell identification and enrichment technology may
facilitate the early detection of single gene disorders or cancers.
CURRENT CYTOGENETIC PRODUCTS
In the United States, approximately 500,000 cytogenetic tests are performed
annually. Cytogenetic testing includes prenatal screening for genetic
disorders using amniotic fluid obtained through amniocentesis and fetal tissue
samples obtained through CVS. Other cytogenetic testing includes screening
tests for diagnosis and prognosis of cancer-related conditions using bone
marrow, blood and tumor tissue samples. The Company currently manufactures,
markets and sells a family of automated instruments for cytogenetic
applications based on the Company's prior generation Cytoscan and GeneVision
product families. The Company's primary cytogenetic products are described
below. The Company has sold systems to approximately 500 sites worldwide in
more than 30 countries. The Company's primary cytogenetic products currently
sell for prices ranging from $50,000 to $125,000.
6
CytoVision Metaphase Finder. The CytoVision Metaphase Finder consists of a
computer-controlled scanning microscope with a patented autofocus mechanism,
image processing hardware, and pattern recognition software. This product
continuously scans laboratory slides for cells in metaphase and records their
location for future identification and analysis of the cells' chromosomes. The
Metaphase Finder uses the Company's patented autofocus system for continuous
scanning. Cytogenetic analysis involves identifying and inspecting a number of
relatively rare metaphase cells on a slide containing a large number of cells,
a majority of which are not in metaphase. This analysis can take a
cytogeneticist up to one hour per slide if performed manually. The Metaphase
Finder is designed to save laboratory time and cost by automating this labor-
intensive process and can identify the cells in metaphase in approximately ten
minutes. This product is fully compatible with the Company's other cytogenetic
products, which have the potential to save laboratories the expense of using
trained technicians to perform routine tasks prior to actual cytogenetic
analysis.
CytoVision Karyotyper. The CytoVision Karyotyper consists of a computerized
image capture and analysis system which incorporates pattern recognition,
automated chromosome classification algorithms and a high resolution output
device. This product supplants many otherwise manual processes in the
preparation of the data for cytogenetic analysis. The CytoVision Karyotyper
provides automated karyotyping, automatic separation of touching and
overlapping chromosomes, image enhancement features, chromosome rotation and
straightening, image zooming for band analysis, annotation capabilities, and
full screen karyotyping display. This product replaces manual photographing of
cells in metaphase, printing of the photograph, manual cutting out of each
chromosome, identifying the chromosomes, arranging the chromosomes in order,
and pasting them on a sheet of paper. In contrast to the automated process
which takes approximately 10 minutes, this manual process takes approximately
thirty minutes to one hour.
CytoVision Probe. The CytoVision Probe consists of a computerized image
capture and image enhancement system which detects and analyzes fluorescent
DNA probes applied to cell nuclei. These probes are designed to attach
themselves to specific DNA sequences which may indicate genetic disorders.
Fluorescent DNA probes are often very faint when viewed by the human eye
through a microscope. This system enhances images of DNA probes and provides a
range of analytical tools. The Company also offers a comparative genomic
hybridization software upgrade package to the CytoVision Probe to detect
genetic amplifications and deletions in tumor cells. The CytoVision Probe
system is not dependent on specific fluorescent DNA probes and may be used in
conjunction with probes from different manufacturers. In the United States the
CytoVision probe is sold for research purposes only.
All of the products in the CytoVision family, a product generation evolving
from the Company's former Cytoscan and GeneVision product lines, are
compatible and can be integrated into a network with common data management
protocols. In addition to the primary products, the Company also sells a
number of peripherals including a range of high quality printers and image
capture workstations. A typical installation will include a number of
interconnected CytoVision systems.
SALES, DISTRIBUTION AND MARKETING
The Company currently sells its cytogenetic products to government and
private clinical cytogenetic laboratories, research institutions, universities
and pharmaceutical companies. The Company has sold such systems to
approximately 500 sites in more than 30 countries. These customers utilize the
Company's cytogenetic products for prenatal genetic screening as well as for
certain cancer screening applications. The Company's prenatal screening
products under development are being designed to be compatible with its
existing cytogenetic products so that customers could potentially update their
new or existing installations to accommodate its prenatal screening products.
If regulatory clearance or approval is received, the Company initially plans
to sell and distribute its prenatal screening products directly and through
its established worldwide network of distributors and agents through which it
sells and distributes its current products.
In North America, the Company sells its cytogenetic products directly to its
customers. The North American sales team is comprised of six sales and
application support individuals, four of whom are based in Pittsburgh,
Pennsylvania and two in Santa Clara, California. Outside of North America, the
Company sells its products either directly through local agents who are
remunerated on a commission basis or through independent distributors.
7
The Company manages its international sales and distribution activities from
Applied Imaging International Ltd., the Company's wholly-owned subsidiary
located in the United Kingdom. The international sales team is comprised of
eight sales and application support individuals, all of whom are based in the
United Kingdom. The Applied Imaging International Ltd. sales team supports all
distributors and agents upon request. The Company's distributors are located
in Australia, Hong Kong, Japan, Italy and South Korea. In addition, the
Company has agents selling its cytogenetic products in other countries
primarily within Europe, the Middle East and the Pacific Rim.
Because the Company's products are technically sophisticated the Company's
sales staff is supported by scientifically qualified and highly trained
product specialists. The Company offers an annual maintenance program to its
customers through its own support organization. The Company's marketing
activities include telemarketing, product advertising and participation in
trade shows and product seminars.
MANUFACTURING
The Company assembles and tests components and subassemblies made by outside
vendors to the Company's specifications and manufactures only when it believes
significant value can be added. The Company's current products are assembled
from a combination of (i) commodity technology components such as computers
and monitors, (ii) custom subassemblies, such as special image capture circuit
boards, and (iii) operating system and application software. Any disruption or
delay in the supply of components or custom subassemblies will have a material
adverse effect on the Company. While the Company typically uses components and
subassemblies which are available from alternate sources, any unanticipated
interruption of the supply of these components or subassemblies could require
the Company to redesign its products.
The Company orders components and subassemblies to forecast and assembles
specific configurations on receipt of firm orders. The Company's research,
investigational and clinical products are subject to regulation by the FDA and
all products are subject to regulation by the U.S. Department of Commerce
export controls, primarily as they relate to the associated computers and
peripherals. The Company has experienced no material difficulties in obtaining
necessary export licenses to date.
The Company plans to initially subcontract third parties to manufacture the
consumable enrichment kit component of its fetal cell screening technology
under development and may ultimately manufacture such components on its own.
For clinical trials, the Company will purchase the consumable enrichment kit
from a third party contracted to manufacture the kit. The Company has no
experience manufacturing such components. The Company may encounter
difficulties in scaling up production of the consumable component of its fetal
cell screening technology under development or in hiring and training
additional personnel to manufacture its consumable enrichment kit products in
commercial quantities.
Under current law, if the Company manufactures finished devices in the
United States, it will be required to comply with the FDA's and the State of
California's current GMP regulations. In addition, the FDA and/or the
California authorities will inspect the Company's manufacturing facilities on
a regular basis to determine such compliance. Failure to comply with
applicable FDA or other regulatory requirements can result in fines,
injunctions, civil penalties, recalls or seizures of products, total or
partial suspensions of production and criminal prosecutions.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts include various research,
product development, clinical evaluation and testing, quality assurance,
regulatory and process development activities. The current focus of the
Company's research and development efforts is the completion of the
development of the Company's prenatal screening products and particularly the
initiation of clinical trials. The Company is using a consultant to assist in
the design of the protocols for the planned clinical trials. In addition, the
Company is analyzing different methods for facilitating image analysis of
fetal cell enriched samples. If the Company obtains additional funding, the
8
Company's future research and development efforts are expected to include
development of additional applications of the Company's current cytogenetic
products and additional applications of the fetal cell screening technology
under development. These potential additional applications may include the use
of technology developed for fetal cell analysis for the diagnosis and screening
for certain cancers and certain single gene disorders. Development of these
applications would require substantial additional funds and will be subject to
technological, clinical, regulatory and other risks associated with new medical
technologies. There can be no assurance that the Company will develop its
prenatal screening products or any other future applications of such
technology.
In 1995, the Company entered into a clinical testing agreement with the
Academic Medical Center in Amsterdam to evaluate the Company's technology
relating to fetal cell enrichment from maternal blood and associated
instrumentation. The Company has an unrestricted right to use the data
resulting from the evaluation. In 1995, the Company established a wholly-owned
subsidiary in Israel to conduct further research and development focused on the
enrichment aspect of the prenatal screening products. These research activities
are being primarily funded by a $543,000 research grant issued by the Israel--
United States Binational Industrial Research and Development Foundation
pursuant to which repayment is required in the form of royalties from the sale
of the prenatal screening products. In 1996, the Company entered into a
collaborative research agreement with Leiden University in the field of
enrichment, isolation and analysis of fetal cells derived from maternal blood.
Also in 1996, the Company entered into an agreement to acquire an invention for
the use of certain antibodies in the identification of fetal cells from
maternal blood. The agreement provides for the Company to pay certain expenses
associated with obtaining a U.S. patent for the invention and a royalty of not
more than 2% of net sales.
Research and development expenses were approximately $3.7 million, $2.9
million, $2.8 million in 1996, 1995, and 1994, respectively.
PATENTS AND PROPRIETARY RIGHTS
The Company actively seeks, when appropriate, protection for its products and
proprietary information by means of United States and foreign patents and
trademarks. The Company has one issued United States patent relating to its
CytoVision Metaphase Finder and has corresponding issued patents in certain
European countries. In addition, the Company has three United States patents
concerning its technology for enriching the concentration of nucleated fetal
red blood cells from maternal blood samples. Corresponding applications were
filed through the Patent Cooperation Treaty and preserve for the Company the
right to file applications in various countries. The Company relies upon trade
secrets, know-how and contractual arrangements to protect certain of its
proprietary information and products.
The fields of life science instrumentation and genetic screening processes
are covered by many issued patents and patent applications. The Company is not
currently aware of any patents which it may be infringing; however, patent
applications in the United States remain confidential until a patent is issued,
and, therefore, the Company's products could infringe patents to be issued in
the future. If the Company's technology is determined to use products,
processes or other subject matter that is claimed under other existing U.S. or
foreign patents, or if other patents claiming subject matter utilized by the
Company are issued, such companies may bring infringement actions against the
Company. The Company may be required to obtain licenses to patents or
proprietary rights of others. There can be no assurance that any such license
would be made available or, if available, would be available on commercially
acceptable terms. Failure to obtain a required license could prevent the
Company from commercializing its products resulting in a material adverse
affect on the Company's business, financial condition and results of
operations.
The Company generally enters into confidentiality agreements with its
employees and consultants designed to both protect the Company's confidential
information and prevent the disclosure of confidential information of prior
employers and other parties. There can, however, be no assurance that the
Company's trade secrets or proprietary technology will not become known or be
independently developed by competitors in such a manner that the Company has no
practical recourse. Certain employees of and consultants to the Company are
subject to the terms of confidentiality agreements with respect to proprietary
information of their former employers. The
9
failure of these persons to comply with the terms of their agreements could
result in assertion of claims against the Company and such persons which, if
successful, might restrict their roles within the Company.
In 1996, the Company entered into a collaborative research agreement with
Leiden University ("Leiden") in the field of enrichment, isolation and
analysis of fetal cells derived from maternal blood. Under the terms of the
agreement, the Company has sole ownership of any jointly developed inventions
and has an exclusive license to any issued patents owned solely by Leiden. The
royalty rate for the exclusive license shall not be more than 5% of associated
sales.
The Company also relies upon trademarks to protect certain of its products,
and holds a United States trademark registration for the mark "CYTOSCAN."
Registration for this mark and the mark "CYTOVISION" are held by the Company
in certain foreign jurisdictions.
The Company also has certain trademark rights in the United States and other
foreign countries. It is possible that third parties may allege superior
rights to one or more of the Company's trademarks, or close variations, for
those countries in which the Company is presently conducting business or may
do so in the future. The Company's rights to use and register its marks in a
given jurisdiction may depend on its rights relative to a third party's rights
as governed by the laws of the pertinent country. Factors utilized to
determine the relevant rights between parties include priority of the use or
registration of the mark, how close the respective marks are in appearance,
sound and/or meaning, as well as the goods to which they are applied. It is
possible that the Company could be prevented from using or registering its
trademarks in certain countries due to a superior third party right.
COMPETITION
The market for the Company's current cytogenetic products is highly
competitive. The Company believes that its primary competitors in this market
include Perceptive Scientific, Inc. (acquired by International Remote Imaging
Systems, Inc.), and Vysis Corp., a biotechnology subsidiary of AMOCO
Technology Company. The principal competitive factors in this market are
product features offered, ease of use, clarity of output, customer service
capabilities, price and installed base. The Company believes it competes
favorably with regard to these factors.
With respect to its prenatal screening products under development, the
Company is aware of a number of companies that are in the process of
developing genetic screening products based on competing technologies designed
to enrich the concentration of fetal blood cells in maternal blood samples.
Many of these companies have greater research and development, marketing and
financial resources than the Company. These companies include Integrated
Genetics, Inc. (a wholly-owned subsidiary of Genzyme Corp.), CellPro,
Incorporated, Aprogenex, Inc., and Centocor, Inc. Integrated Genetics
specializes in providing genetic testing services. CellPro specializes in cell
separation and gene therapy, Aprogenex specializes in providing DNA probes,
and Centocor specializes in providing monoclonal antibodies.
The medical diagnostic and biotechnology industries are subject to intense
competition. The Company's fetal cell screening technology under development,
if commercially marketed, will also be subject to intense competition from
existing procedures such as the maternal AFP test, the triple test, CVS and
amniocentesis. There can be no assurance that the Company's fetal cell
screening technology under development will replace any existing procedures.
The Company expects the principal competitive factors in the fetal cell
screening market to be reliability, accuracy, range of disorders detected,
risk to the fetus and the price of testing.
Many of the Company's competitors have greater financial and technical
resources and production and marketing capabilities than the Company. There
can be no assurance that these competitors will not succeed in developing
technologies and products that are more effective, easier to use or less
expensive than those which are currently offered or being developed by the
Company or that would render the Company's technology and products obsolete
and noncompetitive. In addition, many of the Company's competitors have
significantly greater experience than the Company in conducting clinical
investigations of new diagnostic products and in obtaining FDA and other
regulatory clearances and approvals of products. Accordingly, the Company's
competitors may succeed in developing and obtaining regulatory approvals for
such products more rapidly than the Company.
10
GOVERNMENT REGULATION
The testing, manufacturing, labeling, distribution, sales, and marketing of
the Company's products are subject to government regulation in the United
States and in other countries. The Company believes that its future success
will be significantly dependent upon commercial sales of its prenatal
screening products under development. The Company will not be able to market
these products for commercial use in the United States until the Company
obtains clearance or approval from the FDA and will not be able to market such
products overseas until it meets the safety and quality regulations of each
foreign jurisdiction in which the Company seeks to sell such products. In the
United States, the Company's products are also subject to regulation by state
authorities. The State of California's requirements in this area require
registration with the state and compliance with state GMP regulations.
Noncompliance with applicable FDA requirements can result in, among other
things, fines, injunctions, civil penalties, recall or seizure of products,
total or partial suspension of production, distribution, sales, and marketing,
refusal of the government to grant approval of a PMA or clearance of a 510(k),
withdrawal of marketing approvals or clearances, a recommendation by the FDA
that the manufacturer or distributor not be permitted to enter into government
contracts, and criminal prosecution. In certain circumstances, the FDA also
has the authority to order the manufacturer or distributor of a device to
repair, replace or refund of the cost of the device. Failure to comply with
regulatory requirements in the United States or abroad could have a material
adverse effect on the company's business, financial condition, and results of
operations.
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 PMA,
unless the device is exempt from the requirement of such clearance or
approval. 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 or to a legally marketed Class III device that
does not itself require an approved PMA prior to marketing ("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. Commercial distribution of a device
for which a 510(k) is required may begin only after the FDA issues a finding
that the device is "substantially equivalent" to a predicate device. A 510(k)
for a device incorporating new technology may be given a tier III level of
review, which requires the submission of data from human clinical trials. The
FDA is required to review 510(k) submissions within 90 days, but it generally
takes from five to twelve months from the date of submission to obtain 510(k)
clearance from the FDA; it may take longer and 510(k) clearance may never be
obtained. The FDA may determine that a device is not "substantially
equivalent" to a predicate device, or that additional information is needed
before a substantial equivalence determination can be made.
If a device is not found by the FDA to be substantially equivalent to a
predicate device, the Company may be required to submit a PMA application. A
PMA must be supported by valid scientific evidence that typically includes
data from preclinical testing and human clinical trials to demonstrate the
safety and effectiveness of the device. Upon submission of a PMA, the FDA
makes a threshold determination regarding whether the application is
sufficiently complete to permit filing for a substantive review. An FDA review
of a PMA generally takes one to two years from the date the PMA is accepted
for filing, but may take significantly longer if the FDA requires the Company
to file any major amendment to the PMA. The review time is often significantly
extended by the FDA's asking for additional information. An Advisory Panel,
primarily composed of clinicians, is convened to review and evaluate the
application and provide recommendations to the FDA regarding whether the PMA
should be approved. The FDA is not bound by the recommendations of the
Advisory Panel. The FDA also conducts an inspection of the manufacturer's
facilities to ensure that the facilities are in compliance with GMP
requirements.
The Company submitted a protocol for clinical trials of the DNA probe
product to the FDA in November of 1996. The Company intends to initiate a
multisite, United States and international, clinical trial of the DNA probe
component of its prenatal testing technology to detect chromosomal disorders
in isolated fetal cells during the first half of 1997. There can be no
assurance regarding the timing or nature of the FDA response regarding
11
the DNA probe related protocol or the timing for the commencement of clinical
trials. There can be no assurance that 510(k) clearance for any of the
prenatal screening products under development or any other future product or
modification of an existing product will be granted or that the clearance
process will not be unduly lengthy and subjected to a thorough FDA review. The
FDA has stated that the DNA probe product will require at least a 510(k) tier
III level of review. Further, in its draft guidance for in vitro diagnostic
devices utilizing cytogenetic in situ hybridization technology for the
detection of genetic mutations, the FDA states that when such devices are
intended for use as a "stand-alone" for test reporting based on interphase
analysis, they will require a PMA that must be reviewed and approved by the
FDA prior to sales, distribution and marketing of these products in the United
States. The PMA process is typically more complex, expensive and time
consuming than the 510(k) process. While the Company has made determinations
regarding the appropriate form of approval, if any, required for its products,
there can be no assurance that such determinations are correct, that the FDA
will concur with such determinations or that such determinations may not be
altered due to new interpretations or new data that may become available or
changes in the FDA's policies.
Export sales of investigational devices that are subject to PMA or
investigational device exemption 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 Export Reform and Enhancement Act of 1996. 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 that 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.
In addition to domestic regulation of medical devices, the Company's current
products and its products under development are subject to corresponding
regulations governing safety processes, manufacturing processes and quality in
foreign jurisdictions in which it operates or such products are sold. The sale
of the fetal cell screening products under development may be materially
affected by the policies of regulatory bodies or the domestic politics of the
countries involved. There can be no assurance that an early prenatal screening
test for genetic disorders will not be prohibited or restricted in some
jurisdictions. In addition, FDA export permits may be required for shipment of
the Company's fetal cell screening products under development to certain
foreign countries. Failure to comply with applicable regulatory requirements
can, among other consequences, result in fines, injunctions, civil penalties,
suspensions or loss of regulatory approvals, product recalls, seizure of
products, operating restrictions and criminal prosecution. In addition, future
governmental regulations may be established that could prevent or delay
regulatory approval of the Company's products. The regulation of medical
devices in a number of such jurisdictions continues to develop and there can
be no assurance that new laws or regulations will not have a material adverse
effect on the Company's business. The European Community and its member
countries currently are imposing more substantial regulation on in vitro
diagnostic devices and equipment-like medical devices, and such regulation may
affect the Company's current products and products under development.
Delays in receipt of clearances or approvals to market its products, failure
to receive these clearances or approvals, the loss of previously received
clearances or approvals or the determination that 510(k) clearance, pre-market
approval or other approval is required for a product being marketed without
such clearance or approval could have a material adverse effect on the
Company's business, financial condition and results of operations.
In addition, laboratories who purchase the Company's current products and/or
the prenatal screening products under development could be subject to the
Clinical Laboratory Improvement Amendments of 1988 ("CLIA"), which are
intended to ensure the quality and reliability of medical testing conducted in
laboratories in the United States. The Company's products should comply with
CLIA regulations or the Company's ability to market its products could be
negatively affected.
12
Marketed devices are subject to pervasive and continuing regulatory
oversight by the FDA and other agencies, including record-keeping requirements
and reporting of adverse experiences with the use of the device. Device
manufacturers are required to register their establishments and list their
devices with the FDA and certain state agencies. The Federal Food, Drug and
Cosmetic Act and certain state laws require that medical devices be
manufactured in accordance with GMP regulations. Manufacturing facilities are
subject to periodic inspection by the FDA and certain state agencies on a
periodic basis to monitor compliance with GMP and other requirements. If
violations of the applicable regulations are noted during such inspections of
manufacturing facilities, the Company can be prohibited from conducting
further manufacturing, distribution and sale of the devices until the
violations are cured.
The Company is also subject to other federal, state, local and foreign laws,
regulations and recommendations relating to safe working conditions and good
laboratory practices. The extent of government regulation that might result
from any future legislation or administrative action cannot be accurately
predicted. Failure to comply with any federal or state regulatory requirements
could have a material adverse effect on the Company's business, financial
condition and results of operations.
THIRD-PARTY REIMBURSEMENT AND HEALTH CARE REFORM
In the United States, the Company's products are purchased primarily by
medical institutions which then bill various Third-Party Payors, such as
Medicaid, other government programs and private insurance plans, for the
health care services provided to their patients. Third-Party Payors may deny
reimbursement if they determine that the device used in a treatment was
unnecessary, inappropriate, experimental or investigational, used for a non-
approved indication, or not cost-effective and typically do not reimburse for
devices used for research and investigational purposes. Accordingly,
physicians must determine that the clinical benefits of genetic screening
procedures justify additional cost. The market for the Company's current
cytogenetic products could be adversely affected by changes in governmental
and private third-party payors' policies and the market for the Company's
fetal cell screening technology under development could be materially
adversely effected by the failure of governmental and Third-Party Payors
adopting policies to reimburse health care providers for the use of the
Company's fetal cell screening technology under development. The
unavailability of third-party coverage or the inadequacy of the reimbursement
for medical procedures using the Company's products would adversely affect the
Company's business, financial condition and results of operations. In both the
United States and internationally, Third-Party Payors are increasingly
challenging the prices charged for medical products and services. There can be
no assurance that reimbursement for the procedures using the Company's
products will be available or, if currently available, will continue to be
available, or that future reimbursement policies of payors will not adversely
affect the Company's ability to sell its products on a profitable basis. In
addition, there can be no assurance that third-party reimbursement will be
available for diagnostic procedures based on the Company's prenatal screening
products under development.
The levels of revenues and profitability of medical device companies may be
affected by the continuing efforts of governmental and Third-Party Payors to
contain or reduce the costs of health care through various means. In the
United States, there have been, and the Company expects that there will
continue to be, a number of federal and state proposals to implement
government regulation of health care costs. It is uncertain what legislative
proposals will be adopted or what actions federal, state or private payers for
health care goods and services may take in response to any health care reform
proposals or legislation. The Company cannot predict the effect health care
reforms may have on its business, and no assurance can be given that any such
reforms will not have a material adverse effect on the Company's business,
financial condition and results of operations. Further, to the extent that
such proposals or reforms have a material adverse effect on the business,
financial condition and profitability of the clinical and research
laboratories, hospitals and other institutions that comprise the Company's
customer base, the Company's business, financial condition and results of
operations could be adversely affected.
13
PRODUCT LIABILITY AND INSURANCE
The Company's business may involve the risk of product liability claims,
including those relating to inaccurate results from its screening products.
Although the Company has not experienced any product liability claims to date,
any such claims could have a material adverse impact on the Company. The
Company maintains product liability insurance at coverage levels which it deems
commercially reasonable; however, there can be no assurance that product
liability or other claims will not exceed such insurance coverage limits or
that such insurance will continue to be available on commercially acceptable
terms, or at all. The Company intends to evaluate, depending on the
circumstances that exist at the time, whether or not to obtain any additional
product liability insurance coverage prior to the time that the Company engages
in any extensive marketing of its fetal cell screening technology under
development. Even if the Company obtains additional product liability
insurance, there can be no assurance that it would prove adequate or that a
product liability claim, insured or uninsured, would not have a material
adverse effect on the Company's business, financial condition and results of
operations. Even if a product liability claim is not successful, the time and
expense of defending against such a claim may adversely affect the Company's
business, financial condition and results of operations.
EMPLOYEES
As of December 31, 1996, the Company had 90 employees, of whom 37 were
involved in research and development, 8 in manufacturing and manufacturing
engineering, 29 in sales, marketing and customer service and 16 in finance and
administration. As of December 31, 1996, 35 of the employees were based in the
United Kingdom, 47 in the United States, 6 in Israel, and 2 in France. A total
of 12 employees hold Ph.Ds, and 2 employees are M.D.s. The Company's employees
include several cytogeneticists to specify, support and sell its product range.
The Company believes its relationship with its employees to be good.
ADDITIONAL RISK FACTORS
PRENATAL SCREENING PRODUCTS IN EARLY STAGE OF DEVELOPMENT; NO ASSURANCE OF
SUCCESSFUL DEVELOPMENT OR COMMERCIALIZATION
The Company's prenatal screening products are in an early stage of
development and testing. The isolation, identification, enrichment and analysis
of fetal cells from a maternal blood sample is difficult and poses a
significant technical challenge due to their rarity in maternal blood. The
Company has not yet determined how many fetal cells, if any, can be obtained
using its process. There can be no assurance that the Company's prenatal
screening products will be able to detect fetal cells in amounts sufficient to
allow for the detection and analysis of chromosomal abnormalities. In addition,
the Company's preclinical testing in analyzing cells has almost exclusively
been limited to detecting male and female chromosomes and has not yet focused
on chromosomal abnormalities such as Down's Syndrome. There can be no assurance
that the Company's prenatal screening products will be able to effectively and
accurately detect Down's Syndrome or other chromosomal abnormalities. The
development and potential commercialization of the Company's prenatal screening
products will require significant research and development, substantial
investment and clinical testing and regulatory clearances or approvals. The
Company plans to continue to conduct preclinical testing in order to analyze
the feasibility of its prenatal screening products. Such efforts may disclose
significant technical obstacles that need to be overcome prior to pursuing
clinical trials and seeking necessary regulatory approvals. For example, during
1995 preclinical testing the Company discovered that the gel in the preformed
density gradients portion of its prenatal screening products destabilized if
not properly stored at cool temperatures and, in any event, destabilized within
two weeks even if properly stored. There can be no assurance that the modified
gel used in the later 1996 studies will not encounter stability problems or
that other problems will not be detected. Such problems could have the effect
of delaying or preventing the successful development of the Company's prenatal
screening products. There can be no assurance that the Company will be able to
develop this technology into reliable and effective prenatal screening
products, that required regulatory clearances or approvals for
commercialization will be obtained in a timely manner, or at all, or that the
Company's prenatal screening products or other products under development,
14
if introduced commercially, will be successful. If the Company is unable to
successfully develop and market its prenatal screening products, the Company's
business, financial condition and results of operations would be materially and
adversely affected.
LACK OF CLINICAL DATA
The Company has conducted no clinical trials of its prenatal screening
products pursuant to FDA reviewed protocols. There can be no assurance that the
Company will commence such clinical testing, or once commenced, that such
testing can be completed successfully within the Company's expected time frame
and budget, if at all, or that the Company's products will prove to be reliable
and effective in clinical trials. If clinical trials are initiated, such trials
may disclose significant technical obstacles having the effect of delaying or
preventing the development, testing, regulatory approval and commercialization
of the Company's prenatal screening products. There can be no assurance that
the results of such clinical trials will be consistent with the Company's
limited preclinical results to date or would be sufficient to obtain regulatory
clearance or approval or clinical acceptance. If the Company is unable to
initiate and conclude successfully clinical trials of its prenatal screening
products, the Company's business, financial condition and results of operations
would be materially and adversely affected.
NO ASSURANCE OF CLINICAL ACCEPTANCE
The isolation of fetal cells from maternal blood is a new and novel
development. The clinical acceptance of the Company's prenatal screening
products will depend upon its acceptance by the medical community and third-
party payors as clinically useful, reliable, accurate, and cost-effective
compared to existing and future procedures. Clinical acceptance will depend on
numerous factors, including the establishment of the product's ability to
isolate sufficient numbers of fetal cells during the early stages of pregnancy,
to adequately enrich the concentration of nucleated fetal cells, and to
reliably analyze and detect the presence of chromosomal abnormalities. Clinical
acceptance will also depend on the receipt of regulatory clearances in the
United States and internationally, the availability of third-party
reimbursement and the Company's ability to adequately train laboratory
technicians and cytogeneticists on how to use the prenatal screening products.
In addition, there can be no assurance that the Company's prenatal screening
products will be a preferable alternative to existing procedures such as the
maternal AFP test or the triple test which detect neural tube defects in
addition to chromosomal abnormalities, or that the prenatal screening products
will not be rendered obsolete or noncompetitive by products under development
by other companies. The Company's products are intended to initially screen for
Down's Syndrome and may not compete favorably with widely accepted
methodologies such as amniocentesis or CVS that are highly accurate and
diagnose a broader range of abnormalities from one sample of fetal cells.
Patient acceptance of the Company's prenatal testing products will depend in
part upon physician recommendations as well as other factors, including the
effectiveness and reliability of the procedure as compared to amniocentesis,
CVS and serum marker procedures. Even if the Company's prenatal screening
products are clinically adopted, physicians may elect not to recommend the
procedure unless acceptable reimbursement from health care payors is available.
There can be no assurance that the Company's prenatal screening products under
development will be accepted by the medical community or that market demand for
such products will be sufficient to allow the Company to achieve profitable
operations. Failure of the Company's prenatal screening procedure, for whatever
reason, to achieve significant clinical adoption or failure of the Company's
products to achieve any significant market acceptance would have a material
adverse effect on the Company's business, financial condition and results of
operations.
ACCUMULATED DEFICIT; FUTURE LOSSES
From its inception in July 1986 through the end of 1996, the Company has
generated an accumulated deficit of approximately $12.0 million. The Company
expects its operating losses to continue to increase as it continues its
efforts to develop and test its prenatal screening products. There can be no
assurance that its prenatal screening products under development will be
commercially marketed or, if commercially marketed, that the Company will ever
receive sufficient revenue to achieve profitability and failure to do so would
have a material adverse effect on the Company's business, financial condition
and results of operations.
15
QUARTERLY FLUCTUATIONS
The Company has experienced and expects to continue to experience
significant fluctuations in its quarterly operating results. Factors which may
have an influence on the Company's operating results in a particular quarter
include (i) demand for the Company's products, new product introductions by
the Company or its competitors or transitions to new products; (ii) the
results of preclinical or planned clinical trials and, if ever received, the
timing of regulatory and third-party reimbursement approvals; (iii) the timing
of orders and shipments; (iv) the mix of sales between distributors and the
Company's direct sales force; (iv) competition, including pricing pressures;
(v) the timing and amount of research and development expenses, including
clinical trial-related expenditures; (vi) seasonal factors; (vii) foreign
currency fluctuation; and (viii) the delay between incurrence of expenses to
develop new products, including related marketing and service capabilities,
and realization of benefits from such efforts. The Company typically has
experienced increased sales in its first and fourth quarter. The Company
believes this pattern of fluctuating revenues reflects the budgetary spending
practices of the Company's customer base which consists primarily of public
and private cytogenetic laboratories, research organizations and hospitals
operating on annual budgets. There can be no assurance that this trend will
continue. Due to all the foregoing factors, it is likely that in some future
quarter the Company's operating results will be below the expectations of
public market analysts and investors. In such event, the price of the
Company's Common Stock would likely be materially adversely affected.
ADDITIONAL CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE
The Company has expended and will continue to expend substantial funds for
research and development, preclinical testing, planned clinical
investigations, capital expenditures, and manufacturing and marketing of its
products. The timing and amount of spending of such capital resources cannot
be accurately determined at this time and will depend upon several factors,
including the progress of its research and development efforts and planned
clinical investigations, competing technological and market developments,
commercialization of products currently under development, and market
acceptance and demand for the Company's products. To the extent required, the
Company may seek to obtain additional funds through equity or debt financing,
collaborative or other arrangements with other companies and from other
sources. If additional funds are raised by issuing equity securities, further
dilution to stockholders could occur. There can be no assurance that
additional financing will be available when needed or on terms acceptable to
the Company. If adequate funds are not available, the Company could be
required to delay development or commercialization of certain of its products,
to license to third parties the rights to commercialize certain products or
technologies that the Company would otherwise seek to commercialize for
itself, or to reduce the marketing, customer support or other resources
devoted to certain of its products each of which could have a material adverse
effect on the Company's business, financial condition and results of
operations.
DEPENDENCE ON PRENATAL SCREENING PRODUCTS; RAPID TECHNOLOGICAL CHANGE AND RISK
OF TECHNOLOGICAL OBSOLESCENCE
The Company is dependent on the successful development and commercialization
of the Company's prenatal screening products. Unfavorable preclinical or
clinical results, failure to obtain regulatory clearances or approvals in a
timely manner, or at all, or failure to gain widespread market acceptance for
the products would have a material adverse effect on the Company's business,
financial condition and results of operations.
The medical device industry, particularly the prenatal testing, diagnostic,
and screening markets, is characterized by rapid and significant technological
change. The sale of the Company's current products is largely dependent upon
the continued use of prenatal testing methodologies that require the location
of fetal cells in metaphase and the karyotyping of chromosomes identified in
the metaphase cells. In addition, the Company's current products require a
testing laboratory to make a large one-time investment, and the availability
of less expensive automated cytogenetic equipment could have a material
adverse effect on the Company's business financial condition, and results of
operations. The Company's future success will depend in large part on the
Company's ability to continue to respond to such changes. There can be no
assurance that the Company will be
16
able to respond to such changes or that new or improved competing products
will not be developed that render the Company's products obsolete. Product
research and development will require substantial expenditures and will be
subject to inherent risks, and there can be no assurance that the Company will
be successful in developing products that have the characteristics necessary
to screen or diagnose particular indications or that any new product
introduced will receive regulatory clearance or approval or will be
successfully commercialized.
UNCERTAINTY OF FDA OR OTHER REGULATORY CLEARANCES OR APPROVALS
The testing, manufacturing, labeling, distribution, sale, and marketing, of
the Company's products are subject to government regulation in the United
States and other countries. The Company's future success will be significantly
dependent upon commercial sales of its prenatal screening products under
development. The Company will not be able to market these prenatal screening
products for commercial use in the United States until the Company obtains
clearance or approval from the United States Food and Drug Administration
("FDA") for each device and will not be able to market such products overseas
until it meets the safety and quality regulations of each foreign jurisdiction
in which the Company seeks to sell such products. Noncompliance with
applicable FDA requirements can result in severe administrative, civil and
criminal sanctions.
The Company's Cytoscan products were marketed until 1994 in the United
States pursuant to pre-market notifications to the FDA under Section 510(k) of
the Federal Food, Drug and Cosmetic Act ("510(k)"). A 510(k) pre-market
notification must be supported by appropriate data establishing, to the
satisfaction of the FDA, that a newly developed device is "substantially
equivalent" to a legally marketed device that does not itself require FDA
approval of a premarket approval application ("PMA"). The Company's CytoVision
product is the current model of the Cytoscan product, marketed pursuant to the
original 510(k) filing.
The Company has applied for two separate 510(k) clearances for the fetal
cell enrichment and automated scanning products. The Company intends to file a
510(k) for the fetal hemoglobins identification kit during the second quarter
of 1997. The DNA probe product will require either FDA clearance of a 510(k)
with a tier III level of review or a PMA.
The Company submitted a protocol for clinical trials of the DNA probe
product to the FDA in November of 1996. The Company intends to initiate a
multisite, U.S. and international, clinical trial of the DNA probe product to
detect chromosomal disorders in isolated fetal cells during the first half of
1997, based upon the review of the protocol by the FDA. There can be no
assurance regarding the timing or nature of the FDA response regarding the DNA
probe related protocol or the timing for the commencement of clinical trials.
There can be no assurance that 510(k) clearance for any of the Company's
products under development or any other future product or modification of an
existing product will be granted or that the clearance process will not be
unduly lengthy and subjected to a thorough FDA review. The FDA has stated that
the DNA probe product will require at least a 510(k) tier III level of review.
Further, in its draft guidance for in vitro diagnostic devices utilizing
cytogenetic in situ hybridization technology for the detection of genetic
mutations, the FDA states that when such devices are intended for use as a
"stand-alone" for test reporting based on interphase analysis, they will
require a PMA that must be reviewed and approved by the FDA prior to sales,
distribution and marketing of these products in the United States.
The regulation of medical devices continues to develop and there can be no
assurance that new laws or regulations will not have a material adverse effect
on the Company's business, financial condition and results of operations.
Delays in receipt of clearance or approvals to market its products, failure to
receive these clearances or approvals, the loss of previously received
clearances or approvals, the determination that 510(k) clearance, pre-market
approval or other approval is required for a product being marketed without
such clearance or approval, or failure to comply with existing or future
regulatory requirements could have a material adverse effect on the Company's
business, financial condition and results of operations.
17
NEED TO COMPLY WITH INTERNATIONAL GOVERNMENT REGULATION
The regulatory review process varies from country to country. Currently, the
Company's products are subject to pre-market approval in several of the
countries that are members of the European Union ("EU") and subject to other
regulatory requirements in those and other countries. In addition, the
regulation of in vitro diagnostic devices ("IVDs") and other medical devices
continues to change. The Company may rely, in some circumstances, on its
international distributors for compliance with regulatory requirements in those
countries where the Company intends to use distributors. Any enforcement action
by regulatory authorities with respect to regulatory noncompliance may have a
material adverse effect on the Company's business, financial condition and
results of operations.
The time required to obtain approval for sale in foreign countries may be
longer or shorter than that required for FDA clearance, and the requirements
may differ. In addition, there may be foreign regulatory barriers other than
approval for sale.
The Company plans to bring its instruments, when required, into compliance
with the European Parliament's Electromagnetic Compatibility Directive
(89/336/EEC) (the "ECD") and to be entitled to apply the CE mark, with respect
to the ECD, to its instruments. The European Parliament has made a distinction
between Medical Devices ("MDs") and IVDs. The Company's instruments are not now
subject to the requirements or advantages of the Medical Device Directive
(93/42/EEC). There can be no assurance, however, that some or all of the
Company's products will not be redefined as MDs and made subject to this
Directive by the EU or its member states, which may have a material adverse
effect on the Company's business, financial condition, and results of
operations. There can be no assurance, moreover, that member states, or any
other European country, will not adopt other statutes or regulations that
require approval to sale the Company products, or that will otherwise have a
material adverse effect on the Company's business, financial condition, or
results of operations.
DEPENDENCE UPON PATENTS AND PROPRIETARY TECHNOLOGY; RISK OF INFRINGEMENT
The Company relies on trade secret protection and on its unpatented
proprietary know-how in the development and manufacturing of its products.
There can be no assurance that the Company's trade secrets or proprietary
technology will not become known or be independently developed by competitors
in such a manner that the Company has no practical recourse. Nor can there be
any assurance that others will not develop or acquire equivalent expertise or
develop products which render the Company's current or future products
noncompetitive or obsolete. There can be no assurance that the claims allowed
under its patents will be sufficiently broad to protect what the Company
believes to be its proprietary rights. In addition, there can be no assurance
that issued patents will not be disallowed or circumvented by competitors, or
that the rights granted thereunder will provide competitive advantages to the
Company. Companies have filed applications for, or have been issued patents
relating to, products or processes that may be competitive with certain of the
Company's products or processes. The Company is unable to predict how the
courts would resolve issues relating to the validity and scope of such patents.
The validity and breadth of claims in medical technology patents involve
complex legal and factual questions and, therefore, may be highly uncertain. No
assurance can be given that any issued patent or patents based on pending
patent applications or any future patent application will exclude competitors,
that any of the Company's patents in which it has licensed rights will be held
valid if subsequently challenged or that others will not claim rights in or
ownership of the patents and other proprietary rights held or licensed by the
Company. Furthermore, no assurance can be given that others have not developed
or will not develop similar products, duplicate any of the Company's products
or design around any patents issued to or licensed by the Company or that may
be issued in the future to the Company. Since patent applications in the United
States are maintained in secrecy until patents issue, the Company also cannot
be certain that others did not first file applications for inventions covered
by the Company's pending patent applications, nor can the Company be certain
that it will not infringe any patents that may issue to others on such
applications.
18
In addition, patent applications in foreign countries are maintained in
secrecy for a period after filing. Publication of discoveries in the
scientific or patent literature tends to lag behind actual discoveries and the
filing of related patent applications. The Company has not conducted an
extensive search of patents issued to other companies, research or academic
institutions, or others, and no assurances can be given that such patents do
not exist, have not been filed, or could not be filed or issued, which contain
claims relating to the Company's technology, products or processes. Patents
issued and patent applications filed in the United States or internationally
relating to medical devices are numerous and there can be no assurance that
current and potential competitors and other third parties have not filed or in
the future will not file applications for, or have not received or in the
future will not receive, patents or obtain additional proprietary rights
relating to products or processes used or proposed to be used by the Company.
There are pending applications, which if issued with claims in their present
form, might provide proprietary rights to third parties relating to products
or processes used or proposed to be used by the Company. The Company may be
required to obtain licenses to patents or proprietary rights of others.
The medical device industry in general, and the industry segment that
includes products for prenatal diagnostic screening in particular, have been
characterized by substantial competition. Litigation regarding patent and
other intellectual property rights, whether with or without merit, could be
time-consuming and expensive to respond to and could divert the Company's
technical and management personnel. The Company may be involved in litigation
to defend against claims of infringement by the Company, to enforce patents
issued to the Company, or to protect trade secrets of the Company. If any
relevant claims of third-party patents are held as infringed and not invalid
in any litigation or administrative proceeding, the Company could be prevented
from practicing the subject matter claimed in such patents, or would be
required to obtain licenses from the patent owners of each such patent, or to
redesign its products or processes to avoid infringement. In addition, in the
event of any possible infringement, there can be no assurance that the Company
would be successful in any attempt to redesign its products or processes to
avoid such infringement. Accordingly, an adverse determination in a judicial
or administrative proceeding or failure to obtain necessary licenses could
prevent the Company from manufacturing and selling its products, which would
have a material adverse effect on the Company's business, financial condition
and results of operations. Costly and time-consuming litigation brought by the
Company may be necessary to enforce patents issued to the Company, to protect
trade secrets or know-how owned by the Company, or to determine the
enforceability, scope and validity of the proprietary rights of others.
LIMITED MANUFACTURING EXPERIENCE; NO MANUFACTURING EXPERIENCE FOR THE
CONSUMABLE ENRICHMENT KIT
To date, the Company's manufacturing activities have consisted primarily of
the assembly and testing of its cytogenetic products. If the Company obtains
necessary regulatory clearances, registrations and approvals for its prenatal
screening products and such technology is successfully introduced, the Company
will be required to increase its manufacturing capacity. The Company has no
experience in manufacturing the consumable enrichment kit or fetal hemoglobin
identification kit portions of its prenatal screening products. Manufacturers
often encounter difficulties in commencing and increasing production,
including problems involving production yields, adequate supplies of
components, quality control and assurance (including failure to comply with
the FDA's and State of California's GMP regulations, international quality
standards and other regulatory requirements) and shortages of qualified
personnel. Difficulties experienced by the Company in manufacturing could have
a material adverse effect on its business, financial condition and results of
operations. There can be no assurance that the Company will be successful in
commencing manufacture of the prenatal screening products in commercial
quantities, increasing manufacturing capacity or that it will not experience
manufacturing difficulties or product recalls in the future.
NEED TO MANAGE GROWTH
Significant future growth in the Company's sales and expansion in the scope
of its operations, should they occur, may place considerable strain on the
Company's management, financial, manufacturing and other capabilities,
procedures and controls. There can be no assurance that any existing or
additional capabilities, procedures or controls will be adequate to support
the Company's operations or that its capabilities, procedures
19
or controls will be designed, implemented or improved in a timely and cost-
effective manner. Failure to implement, improve and expand such capabilities,
procedures and controls in an efficient manner at an appropriate pace could
have a material adverse effect on the Company's business, financial condition
and results of operations.
SINGLE SOURCE COMPONENTS; DEPENDENCE ON KEY DISTRIBUTORS
Certain components of the Company's prenatal screening products under
development are expected to be in consumable enrichment kit form. The Company
intends to initially subcontract the manufacture of such consumable enrichment
kits; however, given the stage of the product's development, neither internal
nor third-party manufacturing processes have been established. The Company
currently relies on a sole supplier for a certain component of its consumable
enrichment kit. There can be no assurance that reliable, high volume
commercial supplies of such component can be established at commercially
reasonable costs or that a new supplier could be qualified in a timely manner
if the supply of such component were interrupted. There can be no assurance
that reliable high volume manufacturing of such gradients can be established
at commercially reasonable costs or that a new supplier could be qualified in
a timely manner if the supply of such gradients were interrupted. In addition,
the Company proposes to use DNA probes in a prenatal screening kit under
development, which are currently provided by a limited number of vendors. The
Company has an obligation to purchase certain types of DNA probes from a
particular supplier subject to such supplier meeting various performance
standards. Such probes require FDA clearance or approval for marketing for
clinical diagnostic procedures in the United States and may require FDA
approval for export. The DNA probe market is characterized by extensive patent
litigation and any court order with respect to infringement of intellectual
property could adversely affect the supply of available and cost-effective DNA
probes. While the Company believes that other sources for such DNA probes are
available, if there were to be interruptions in obtaining supplies from its
present source, the Company would have to qualify new sources of approved
supply. Outside of North America and the United Kingdom, the Company relies
substantially on independent distributors and sales agents to market and sell
its products. There can be no assurance that distributors and agents will
devote adequate resources to support sales of the Company's products.
Moreover, agreements with a number of its distributors require that the
Company indemnify such distributors against costs, expenses and liabilities
relating to litigation regarding the Company's products and, despite these
obligations of the Company, distributors may decide to reduce or end their
selling efforts until an infringement dispute is resolved or settled.
RELIANCE ON INTERNATIONAL SALES AND OPERATIONS
The Company has significant international operations based in the United
Kingdom employing at December 31, 1996, approximately 37 employees. In 1994,
1995 and 1996, approximately 62%, 61% and 60%, respectively, of the Company's
total revenues were derived from customers and distributors outside of the
United States and Canada. Until such time, if ever, as the FDA clears or
approves the Company's fetal cell screening technology for marketing in the
United States, the Company expects that international sales of cytogenetic
products will continue to account for a significant portion of its revenues.
Changes in overseas economic conditions, currency exchange rates, foreign tax
laws, or tariffs or other trade regulations could have a material adverse
effect on the Company's business, financial condition and results of
operations. The international nature of the Company's business subjects it and
its representatives, agents and distributors to laws and regulations of the
foreign jurisdictions in which it operates or in which its products are sold.
The regulation of medical devices in a number of such jurisdictions,
particularly in the European Community, continue to develop and there can be
no assurance that new laws or regulations will not have a material adverse
effect on the Company's business. The laws of certain foreign countries may
not protect the Company's intellectual property rights to the same extent as
do the laws of the United States.
Currently, most of the Company's international sales are denominated in U.S.
dollars or the U.K. pound sterling. The Company has significant operations in
the U.K., and therefore, incurs significant operating expenses denominated in
U.K. pounds. Accordingly, the Company has not historically attempted to reduce
the risk of currency fluctuations by hedging, as changes in exchange rates
between the U.S. dollar and the U.K. pound
20
sterling immaterially affect the Company's results of operations. However,
there can be no assurance that the Company will not be disadvantaged with
respect to its competitors operating in a foreign country by foreign currency
exchange rate fluctuations that make the Company's products more expensive
relative to those of local competitors.
INTERNATIONAL UNCERTAIN AVAILABILITY OF THIRD-PARTY REIMBURSEMENT; HEALTH CARE
REFORM AND RELATED MATTERS
In the United States, hospitals, physicians and other health care providers
that purchase medical devices generally rely on third-party payors,
principally Medicare, Medicaid, private health insurance plans, health
maintenance organizations and other sources of reimbursement for health care
costs ("Third-Party Payors"), to reimburse all or part of the cost of the
procedure in which the medical device is being used. Certain Third-Party
Payors are moving toward a managed care system in which they contract to
provide comprehensive health care for a fixed cost per person. The fixed cost
per person established by these Third-Party Payors may be independent of the
hospital's cost incurred for the specific case and the specific devices used.
Medicare and other Third-Party Payors are increasingly scrutinizing whether to
cover new products and the level of reimbursement for covered products.
Because the Company's fetal cell screening technology is currently under
development and has not received FDA clearance or approval, uncertainty exists
regarding the availability of third-party reimbursement for procedures that
would use the Company's fetal cell screening technology. Failure by
physicians, hospitals and other potential users of the Company's products or
products currently under development to obtain sufficient reimbursement from
Third-Party Payors for the procedures in which the Company's products or
products currently under the development are intended to be used could have a
material adverse effect on the Company's business, financial condition and
results of operation.
Third-Party Payors that do not use prospectively fixed payments increasingly
use other cost-containment processes that may pose administrative hurdles to
the use of the Company's products and products currently under development. In
addition, Third-Party Payors may deny reimbursement if they determine that the
device used in a treatment is unnecessary, inappropriate, experimental, used
for a non-approved indication or is not cost-effective. Potential purchasers
must determine that the clinical benefits of the Company's products justify
the additional cost or the additional effort required to obtain prior
authorization or coverage and the uncertainty of actually obtaining such
authorization or coverage.
If the Company obtains the necessary foreign regulatory registrations or
approvals, market acceptance of the Company's products and products currently
under development in international markets would be dependent, in part, upon
the availability of reimbursement within prevailing health care payment
systems. Reimbursement and health care payment systems in international
markets vary significantly by country, and include both government sponsored
health care and private insurance. There can be no assurance that any
international reimbursement approvals will be obtained in a timely manner, if
at all. Failure to receive international reimbursement approvals could have a
material adverse effect on market acceptance of the Company's products in the
international markets in which such approvals are sought.
The Company believes that in the future reimbursement will be subject to
increased restrictions both in the United States and in international markets.
The Company believes that the overall escalating cost of medical products and
services will continue to lead to increased pressures on the health care
industry, both foreign and domestic, to reduce the cost of products and
services, including the Company's products and products currently under
development. There can be no assurance in either United States or
international markets that third-party reimbursement and coverage will be
available or adequate, that future legislation, regulation or reimbursement
policies of Third-Party Payors will not otherwise adversely affect the demand
for the Company's products or products currently under development or its
ability to sell its products on a profitable basis. The unavailability of
Third-Party Payor coverage or the inadequacy of reimbursement could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, fundamental reforms in the health care
industry in the United States and Europe continue to be considered, and there
can be no assurance that such reform will not materially adversely affect the
Company's business, financial condition and results of operations.
21
DEPENDENCE UPON KEY PERSONNEL
The Company's future success depends in significant part upon the continued
service of certain key scientific, technical and management personnel, and its
continuing ability to attract and retain highly qualified scientific,
technical and managerial personnel. Competition for such personnel is intense
and there can be no assurance that the Company can retain its key scientific,
technical and managerial personnel or that it can attract, assimilate or
retain other highly qualified scientific, technical and managerial personnel
in the future. The loss of key personnel, especially if without advanced
notice, or the inability to hire or retain qualified personnel could have a
material adverse effect upon the Company's business, results of operations and
financial condition.
RISK OF SOFTWARE DEFECTS
The Company's cytogenetic and prenatal screening products currently under
development involve a software component that facilitates the detection of
chromosomal and genetic abnormalities through the interaction of certain
imaging algorithms with the genetic sample under examination. The software,
including any new versions that may be released, may contain undetected errors
or failures. There can be no assurance that, despite testing by the Company
and current and potential customers, errors will not be found in the software
components of the Company's cytogenetic or prenatal screening products,
resulting in loss or delay in market acceptance, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
PRODUCT LIABILITY RISK; POSSIBLE INSUFFICIENCY OF INSURANCE
The manufacture and sale of the Company's products involves the risk of
product liability claims. There can be no assurance that the coverage limits
of the Company's insurance policies will be adequate. The Company intends to
evaluate its coverage on a regular basis and in connection with the
introduction of products currently under development. Such insurance is
expensive and may not be available on acceptable terms, in sufficient amount
of coverage, or at all. A successful claim brought against the Company in
excess of its insurance coverage would have a material adverse effect on the
Company's business, results of operations and financial condition.
CONTROL BY CERTAIN STOCKHOLDERS
Certain stockholders, including certain executive officers and directors of
the Company and their affiliates, own approximately 77.9% of the outstanding
Common Stock. As a result, these stockholders will, to the extent they act
together, continue to have the ability to exert significant influence and
control over matters requiring the approval of the Company's stockholders,
including the election of a majority of the Company's Board of Directors.
POTENTIAL ADVERSE IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE
Sales of Common Stock (including shares issued upon the exercise of
outstanding options) in the public market after the Company's Initial Public
Offering on November 7, 1996 (the "offering" or "IPO") could materially and
adversely affect the market price of the Common Stock. Such sales also might
make it more difficult for the Company to sell equity securities or equity-
related securities in the future at a time and price that the Company deems
appropriate. Upon the completion of its IPO, the Company had 6,823,835 shares
of Common Stock outstanding, of which 1,507,857 shares of the 1,650,000 shares
offered thereby were freely tradeable (unless held by affiliates of the
Company) without restriction. The remaining 5,173,460 shares are restricted
securities within the meaning of the Securities Act of 1933, as amended (the
"Securities Act"). The Company's directors, executive officers and certain of
its stockholders, who in the aggregate held more than 95% of the shares of
Common Stock of the Company outstanding immediately prior to the completion of
the IPO, entered into lock-up agreements under which they agreed not to sell,
directly or indirectly, any shares owned by them for a period of 180 days
after November 7, 1996 without the prior written consent of Montgomery
22
Securities. Montgomery Securities may, in its sole discretion and at any time
without notice, release all or any portion of the shares subject to such lock-
up agreements. Of the shares not subject to lock-up agreements, approximately
260,553 were freely tradeable (unless held by affiliates of the Company)
without restriction. Upon expiration of the 180-day lock-up agreements,
approximately 4,146,294 additional shares of Common Stock (including
approximately 199,811 shares subject to outstanding vested options) will
become eligible for public resale, subject in some cases to volume limitations
pursuant to Rule 144. Effective April 29, 1997, the holding period for stock
sold under Rule 144 will be reduced from two years to one year and the holding
period for stock sold under paragraph (k) of Rule 144, which sales are not
subject to volume limitations, will be reduced from three years to two years.
The remaining approximately 1,617,301 shares held by existing stockholders
(including up to 508,734 shares of Common Stock issuable upon exercise of
certain outstanding warrants) will become eligible for public resale at
various times over a period of less than one year following the Company's IPO,
subject in some cases to vesting provisions and volume limitations. In
addition, 4,105,674 of the shares outstanding immediately following the
completion of the IPO (including up to 508,734 shares of Common Stock issuable
upon exercise of certain outstanding warrants) became entitled to registration
rights with respect to such shares upon termination of lock-up agreements. The
number of shares sold in the public market could increase if registration
rights are exercised and such sales may have an adverse effect on the market
price of the Common Stock.
POSSIBLE VOLATILITY OF STOCK
The market prices for securities of medical diagnostic instrument companies
have historically been highly volatile. Announcements of technological
innovations or new products by the Company or its competitors, developments
concerning proprietary rights, including patents and litigation matters,
publicity regarding actual or potential results with respect to products under
development by the Company or others, regulatory developments in both the
United States and foreign countries and public concern as to the safety of new
technologies, changes in financial estimates by securities analysts or failure
of the Company to meet such estimates and other factors, may have a
significant impact on the market price of the Common Stock. In addition, the
Company believes that fluctuations in its operating results may cause the
market price of its Common Stock to fluctuate, perhaps substantially.
ANTI-TAKEOVER EFFECT OF DELAWARE LAW AND CERTAIN CHARTER AND BYLAWS PROVISIONS
Certain provisions of the Company's Restated Certificate of Incorporation
and Bylaws may have the effect of making it more difficult for a third party
to acquire, or discouraging a third party from attempting to acquire, control
of the Company. Such provisions could limit the price that certain investors
might be willing to pay in the future for shares of the Company's Common
Stock. Certain of these provisions provide for the elimination of the right of
stockholders to act by written consent without a meeting and specify
procedures for director nominations by stockholders and submission of other
proposals for consideration at stockholder meetings. In addition, the
Company's Board of Directors has the authority to issue up to 6,000,000 shares
of Preferred Stock and to determine the price, rights, preferences, privileges
and restrictions of those shares without any further vote or action by the
stockholders. The rights of the holders of Common Stock will be subject to,
and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. The issuance of Preferred Stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult
for a third party to acquire a majority of the outstanding voting stock of the
Company. The Company has no present plans to issue shares of Preferred Stock.
Certain provisions of Delaware law applicable to the Company could also delay
or make more difficult a merger, tender offer or proxy contest involving the
Company, including Section 203 of the Delaware General Corporation Law, which
prohibits a Delaware corporation from engaging in any business combination
with any interested stockholder for a period of three years unless certain
conditions are met. The inability of stockholders to act by written consent
without a meeting, the procedures required for director nominations and
stockholder proposals and Delaware law could have the effect of delaying,
deferring or preventing a change in control of the Company, including without
limitation, discouraging a proxy contest or making more difficult the
acquisition of a substantial block of the Company's Common Stock. These
provisions could also limit the price that investors might be willing to pay
in the future for shares of the Company's Common Stock.
23
ITEM 2. PROPERTIES
In the United States, Applied Imaging leases an approximately 14,000 square
foot facility in Santa Clara, California, under a lease which terminates in
April 1997. The Company has reached an agreement with the lessor to renew such
lease through October, 1998. The Company also leases an approximately 2,700
square foot facility in Pittsburgh, Pennsylvania, under a lease which
terminates in July 1999. In the United Kingdom, Applied Imaging International
Ltd. leases an approximately 10,000 square foot facility in Sunderland, which
lease terminates in June 1998. In Israel, Applied Imaging Ltd. leases an
approximately 1,500 square foot facility near Tel Aviv under a short-term
lease arrangement. The Company believes that its facilities are adequate to
meet its requirements through 1997.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the NASDAQ National Market (ticker
symbol AICX). The number of record holders of the Company's Common Stock at
December 31, 1996 was 180. The Company has not paid any dividends since its
inception and does not intend to pay any dividends in the foreseeable future.
The Company completed an initial public offering of 1,650,000 shares of
Common Stock in November 1996. Prior to the initial public offering, the
Company's Common Stock was not publicly traded.
Quarterly high and low stock prices are as follows:
QUARTER ENDED HIGH LOW
----------------------------------------- ------- -------
December 31, 1996 (from November 7, 1996) $ 9 1/8 $ 6 1/4
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues:
Product sales..................... $ 9,259 $ 8,106 $ 7,021 $ 6,189 $9,215
Software maintenance and service.. 2,663 2,692 2,550 2,499 2,496
------- ------- ------- ------- ------
Total revenues................... 11,922 10,798 9,571 8,681 11,711
Cost of revenues................... 5,974 5,484 5,350 4,965 6,184
------- ------- ------- ------- ------
Gross profit..................... 5,948 5,314 4,221 3,716 5,527
Operating Expenses:
Research and development.......... 3,667 2,919 2,821 1,756 1,316
Sales and marketing............... 3,088 2,918 2,524 2,543 3,279
General and administrative........ 2,088 2,094 1,898 1,229 1,642
------- ------- ------- ------- ------
Total operating expenses......... 8,843 7,931 7,243 5,528 6,237
------- ------- ------- ------- ------
Operating loss................... (2,895) (2,617) (3,022) (1,812) (710)
Other (expense) income............. 14 71 52 39 (23)
------- ------- ------- ------- ------
Loss before income taxes......... (2,881) (2,546) (2,970) (1,773) (733)
Income tax benefit................. -- -- -- -- 253
------- ------- ------- ------- ------
Net loss......................... $(2,881) $(2,546) $(2,970) $(1,773) $ (480)
======= ======= ======= ======= ======
Pro forma net loss per share....... $ (0.48) $ (0.45)
======= =======
Shares used in cacluation of pro
forma net loss per share.......... 5,942 5,635
======= =======
25
DECEMBER 31,
---------------------------------------
1996 1995 1994 1993 1992
------- ------ ------ ------ ------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments......................... $12,318 $5,156 $2,503 $4,461 $1,151
Working capital...................... 10,700 3,249 1,712 4,756 1,715
Total assets......................... 16,473 9,373 7,441 9,666 6,567
Long-term debt....................... 229 231 336 173 263
Accumulated deficit.................. (12,021) (9,140) (6,594) (3,625) (1,852)
Total stockholders' equity(1)........ 12,005 4,714 2,811 5,813 2,595
(1) No cash dividends have been declared with respect to the Company's Common
and Preferred Stock.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Since its inception in 1986, the Company has principally been engaged in the
design, development, manufacture and marketing of automated clinical analysis
systems used by cytogenetic laboratories for prenatal and other genetic
screening. The Company's cytogenetic instrumentation products include systems
that enable laboratories to automate aspects of the detection of chromosomal
abnormalities associated with conditions such as Down's Syndrome. The
Company's CytoVision family of products includes an automated metaphase finder
which identifies cells in metaphase, a karyotyper which automates the
classification and presentation of chromosomes within cells and a DNA probe
analysis system which detects DNA probes within cell nuclei. The Company sells
its cytogenetic systems to government and private clinical cytogenetic
laboratories, research institutions, universities and pharmaceutical
companies, and has sold such systems to approximately 500 sites in over 30
countries.
Historically, the Company has grown through both internal expansion and
acquisitions. In 1989 and 1991, the Company acquired two separate companies
based in the United Kingdom with complementary technologies and worldwide
market presence. In 1991, the Company restructured its U.K. operations to
combine the two acquired companies. In 1993, the Company eliminated certain
unprofitable product lines in order to focus its efforts on the cytogenetic
screening market.
In 1993, the Company established a research project to develop proprietary
prenatal screening products to detect chromosomal genetic disorders through
the enrichment and analysis of fetal blood cells from a routine maternal blood
sample. Since that time, the Company has devoted substantial resources to the
development of these prenatal screening products. The Company's prenatal
screening products, which the Company is developing, incorporate (i) a
patented hematologically-based procedure to enrich and separate the fetal
blood cells, (ii) automated image analysis instrumentation to identify the
fetal cells and (iii) the use of third-party DNA probes to identify certain
chromosomal disorders present in fetal cells. The prenatal screening products
under development are currently in preclinical evaluations, and the Company
intends to continue preclinical and clinical evaluations of the products to
establish them as a broadly applicable prenatal screening procedure. The
Company anticipates that sales of the products, if cleared or approved by the
FDA, will include both a consumable enrichment kit used to separate fetal
blood cells from maternal blood and imaging instrumentation used to analyze
these cells. The implementation of the Company's strategy is dependent upon
the successful development and commercialization of the Company's prenatal
screening products.
The operating results of the Company have fluctuated significantly in the
past on an annual and quarterly basis. The Company expects that its operating
results will fluctuate significantly from quarter to quarter and year to year
in the future and will depend on a number of factors, some of which may affect
future sales of the Company's cytogenetic products. These factors include, but
are not limited to, demand for the Company's
26
products, timing of orders and shipments, competition and its related pricing
pressures, and seasonal factors, many of which are outside the Company's
control. If FDA clearance or approval is received, the Company intends to
increase the amount of expenditures for research and development and sales and
marketing activities, principally for the commercial launch of its prenatal
screening system. If additional funding is obtained, the Company intends to
increase its research and development expenses related to follow-on products
and additional applications of its prenatal screening technology. The Company
also intends to increase the amount of expenditures related to marketing and
administrative activities.
RESULTS OF OPERATIONS
Years Ended December 31, 1996, 1995 and 1994
Revenues. Revenues increased to $11.9 million in 1996 from $10.8 million in
1995, and from $9.6 million in 1994, or annual increases of 10% and 13%,
respectively. The 1996 and 1995 increases in revenues were primarily
attributable to continued demand by cytogenetic laboratories to automate
aspects of otherwise labor-intensive analyses, to increase capacity of
existing systems, or to replace older generation systems with the Company's
CytoVision products. Software and service contract revenues have remained
relatively flat at $2.7 million for 1996 and 1995 and $2.6 million in 1994,
and as a percentage of total revenues, decreased to 22% in 1996 from 25% in
1995 and 27% in 1994. Software and service contract pricing is derived from
product pricing, and with unit selling prices of the Company's CytoVision
products, sold since 1994, significantly lower than earlier generation
products, software and service contract pricing has decreased accordingly. For
the years ended 1996, 1995 and 1994, revenues derived outside of North America
has remained relatively consistent at approximately 60%, 61% and 62% of total
revenues, respectively.
Cost of Revenues. Cost of revenues increased to $6.0 million in 1996 from
$5.5 million in 1995 and from $5.4 million in 1994, or 50%, 51% and 56% as a
percentage of total revenues, respectively. This decrease in cost of revenues
as a percentage of total revenues from year to year was attributable to
increased product shipment volume, engineering design changes to reduce direct
material and production costs.
Research and Development Expenses. Research and development expenses
increased to approximately $3.7 million in 1996 from $2.9 million in 1995 and
from $2.8 million in 1994. These year to year increases were due to increasing
expenditures on the development of the prenatal screening products.
Sales and Marketing Expenses. Sales and marketing expenses increased to $3.1
million in 1996 from $2.9 million in 1995 and from $2.5 million in 1994. In
1996, 1995 and 1994, sales and marketing expenses as a percentage of total
revenues remained relatively consistent ranging from 26% to 27%.
General and Administrative Expenses. General and administrative expenses
remained relatively unchanged at $2.1 million in 1996 and 1995, an increase
from $1.9 million in 1994. In 1996, 1995 and 1994, general and administrative
expenses were 18%, 19% and 20% of total revenues, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception in July 1986 through December 1996, the Company has
generated an accumulated deficit of approximately $12.0 million. The Company
has financed its operations primarily through the private placement of
Preferred Stock for net aggregate proceeds of $14.8 million and its November
1996 initial public offering of Common Stock, which resulted in proceeds to
the Company of $10.7 million, net of underwriter discounts, but exclusive of
approximately $1.0 million in offering expenses. As of December 31, 1996, the
Company had approximately $12.3 million in cash and cash equivalents. The
Company's primary uses of cash have been to fund working capital requirements,
for capital expenditures, to consummate acquisitions of companies with
complementary products, technology, and marketing and sales organizations, and
to fund the Company's fetal cell screening products research and development
costs.
27
The Company has not renewed its credit facility with a U.S. bank, all
borrowings from which were retired using part of the proceeds from the
Company's initial public offering. The Company's wholly-owned subsidiary,
Applied Imaging International, Ltd. has a (Pounds)500,000 ($800,000) unsecured
line of credit with a United Kingdom bank guaranteed by the Company. No
amounts were outstanding under this facility as of December 31, 1996.
The Company expects negative cash flow from operations to continue into at
least 1999, as it continues the development of its fetal cell screening
technology, conducts clinical trials required for FDA clearance of the DNA
probe portion of that technology, expands its marketing, sales and customer
support capabilities and adds administrative infrastructure.. The Company
currently estimates that its existing capital resources will enable it to
sustain operations until approximately the end of 1998. There can be no
assurance, however, that the Company will not be required to seek capital at
an earlier date. The timing and amount of spending of such capital resources
cannot be accurately determined at this time and will depend on several
factors, including, but not limited to, the progress of its research and
development efforts and clinical investigations, the timing of regulatory
approvals or clearances, competing technological and market developments,
commercialization of products currently under development, and market
acceptance and demand for the Company's products. In addition, as
opportunities arise, proceeds may also be used to acquire businesses,
technologies or products that complement the business of the Company, although
the Company is not currently in negotiations regarding any such acquisitions.
The Company may seek to obtain additional funds through equity or debt
financing, collaborative or other arrangements with other companies and from
other sources. After December 1998, the Company will likely need to raise
additional funds through public or private financings. No assurance can be
given that additional financing will be available when needed or on terms
acceptable to the Company. If adequate funds are not available, the Company
could be required to delay development or commercialization of certain of its
products, to license to third parties the rights to commercialize certain
products or technologies that the Company would otherwise seek to
commercialize itself, or to reduce the marketing, customer support or other
resources devoted to certain of its products.
The Internal Revenue Code of 1986 and the California Conformity Act of 1987
substantially restrict the ability of a corporation to utilize existing net
operating losses, carryforwards, and credits in the event of an "ownership
change." The several issuances of preferred stock and the initial public
offering have resulted in multiple ownership changes since the inception of
the Company. Approximately $9,800,000 of the federal net operating loss
carryforward will be subject to an annual limitation in the aggregate of
$800,000. Any unused annual limitation can be carried over and added to the
succeeding year's annual limitation within the allowable carryforward period.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Applied Imaging Corp.:
We have audited the accompanying consolidated balance sheets of Applied
Imaging Corp. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1996.
In connection with our audits of the consolidated financial statements for the
periods indicated above, we have also audited the financial statement schedule
of valuation and qualifying accounts. These consolidated financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Applied
Imaging Corp. and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996, in conformity with generally
accepted accounting principles. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all materials
respects, the information set forth therein.
KPMG Peat Marwick LLP
San Jose, California
February 18, 1997
29
APPLIED IMAGING CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
1996 1995
----------- ----------
ASSETS
Current Assets:
Cash and cash equivalents........................... $12,318,000 $2,159,000
Short-term investments.............................. -- 2,997,000
Trade accounts receivable (less allowance for
doubtful accounts of $228,000 and $166,000)........ 1,454,00 1,501,000
Inventories......................................... 831,000 880,000
Prepaid expenses and other assets................... 336,000 140,000
----------- ----------
Total current assets.............................. 14,939,000 7,677,000
Property and equipment................................ 1,234,000 1,319,000
Other assets.......................................... 300,000 377,000
----------- ----------
$16,473,000 $9,373,000
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of bank debt........................ $ 33,000 $ 471,000
Accounts payable.................................... 1,679,000 1,141,000
Accrued expenses.................................... 1,304,000 1,430,000
Deferred revenue.................................... 1,223,000 1,386,000
----------- ----------
Total current liabilities......................... 4,239,000 4,428,000
Bank debt, less current portion....................... 229,000 231,000
Commitments
Stockholders' equity:
Preferred stock; $0.001 par value; 6,000,000 shares
authorized; 3,919,179 shares issued and outstanding
in 1995............................................ -- 4,000
Common stock; $0.001 par value; 20,000,000 shares
authorized; 6,823,835 and 1,067,785 shares issued
and outstanding.................................... 7,000 1,000
Additional paid-in capital.......................... 25,569,000 14,216,000
Accumulated deficit................................. (12,021,000) (9,140,000)
Deferred stock compensation......................... (1,183,000) --
Cumulative translation adjustment................... (367,000) (367,000)
----------- ----------
Total stockholders' equity........................ 12,005,000 4,714,000
----------- ----------
$16,473,000 $9,373,000
=========== ==========
See accompanying notes to consolidated financial statements.
30
APPLIED IMAGING CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------
Revenues:
Product sales......................... $ 9,259,000 $ 8,106,000 $ 7,021,000
Software maintenance and service...... 2,663,000 2,692,000 2,550,000
----------- ----------- -----------
Total revenues...................... 11,922,000 10,798,000 9,571,000
----------- ----------- -----------
Cost of revenues:
Product sales......................... 4,501,000 4,171,000 3,937,000
Software maintenance and service...... 1,473,000 1,313,000 1,413,000
----------- ----------- -----------
Total cost of revenues.............. 5,974,000 5,484,000 5,350,000
----------- ----------- -----------
Gross profit........................ 5,948,000 5,314,000 4,221,000
----------- ----------- -----------
Operating expenses:
Research and development.............. 3,667,000 2,919,000 2,821,000
Sales and marketing................... 3,088,000 2,918,000 2,524,000
General and administrative............ 2,088,000 2,094,000 1,898,000
----------- ----------- -----------
Total operating expenses............ 8,843,000 7,931,000 7,243,000
----------- ----------- -----------
Operating loss...................... (2,895,000) (2,617,000) (3,022,000)
Other income............................ 14,000 71,000 52,000
----------- ----------- -----------
Net loss............................ $(2,881,000) $(2,546,000) $(2,970,000)
=========== =========== ===========
Pro forma net loss per common share..... $ (0.48) $ (0.45)
=========== ===========
Shares used in computing pro forma net
loss per common share.................. 5,941,842 5,635,393
=========== ===========
See accompanying notes to consolidated financial statements.
31
APPLIED IMAGING CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
PREFERRED STOCK COMMON STOCK
------------------ ----------------
ADDITIONAL DEFERRED CUMULATIVE TOTAL
PAID-IN ACCUMULATED STOCK TRANSLATION STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT COMPENSATION ADJUSTMENT EQUITY
---------- ------ --------- ------ ----------- ------------ ------------ ----------- -------------
Balances as of
December 31,
1993............. 2,812,962 $3,000 947,573 $1,000 $ 9,758,000 $ (3,624,000) $ -- $(325,000) $ 5,813,000
Exercise of
common stock
options......... -- -- 25,937 -- 10,000 -- -- -- 10,000
Cumulative
translation
adjustment...... -- -- -- -- -- -- -- (42,000) (42,000)
Net loss......... -- -- -- -- -- (2,970,000) -- -- (2,970,000)
---------- ------ --------- ------ ----------- ------------ ----------- --------- -----------
Balances as of
December 31,
1994............. 2,812,962 3,000 973,510 1,000 9,768,000 (6,594,000) -- (367,000) 2,811,000
Exercise of
common stock
options -- -- 94,275 -- 44,000 -- -- -- 44,000
Compensation
expense related
to employee
stock options... -- -- -- -- 59,000 -- -- -- 59,000
Issuances of
Series J
preferred stock,
net of $356,000
offering costs.. 1,106,217 1,000 -- -- 4,345,000 -- -- -- 4,346,000
Net loss......... -- -- -- -- -- (2,546,000) -- -- (2,546,000)
---------- ------ --------- ------ ----------- ------------ ----------- --------- -----------
Balances as of
December 31,
1995............. 3,919,179 4,000 1,067,785 1,000 14,216,000 (9,140,000) -- (367,000) 4,714,000
Exercise of
common stock
options......... -- -- 89,250 -- 161,000 -- -- -- 161,000
Initial public
offering (IPO)
of common stock,
net of
$1,829,000
offering costs.. -- -- 1,650,000 2,000 9,719,000 -- -- -- 9,721,000
Preferred stock
converted to
common stock in
connection with
IPO............. (3,919,179) (4,000) 3,960,017 4,000 -- -- -- -- --
Net exercise of
110,416 Series F
preferred stock
warrants in
connection with
IPO............. -- -- 56,783 -- -- -- -- -- --
Deferred employee
stock option
compensation.... -- -- -- -- 1,473,000 -- (1,473,000) -- --
Amortization of
deferred stock
compensation.... -- -- -- -- -- -- 290,000 -- 290,000
Net loss......... -- -- -- -- -- (2,881,000) -- -- (2,881,000)
---------- ------ --------- ------ ----------- ------------ ----------- --------- -----------
Balances as of
December 31,
1996............. -- $ -- 6,823,835 $7,000 $25,569,000 $(12,021,000) $(1,183,000) $(367,000) $12,005,000
========== ====== ========= ====== =========== ============ =========== ========= ===========
See accompanying notes to consolidated financial statements.
32
APPLIED IMAGING CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
DECEMBER 31,
-----------------------------------
1996 1995 1994
----------- ---------- ----------
Cash flows from operating activities:
Net loss................................. $ 2,881,000 $2,546,000 $2,970,000
Adjustments to reconcile net loss to net
cash used for operating activities
Depreciation and amortization........... 583,000 556,000 602,000
Unrealized exchange (gain) loss......... 33,000 (17,000) 140,000
Compensation expense related to employee
stock options.......................... 290,000 153,000 --
Changes in operating assets and
liabilities:
Trade accounts receivable.............. 47,000 439,000 1,025,000
Inventories............................ 49,000 253,000 (153,000)
Prepaid expenses and other assets...... (196,000) 290,000 (185,000)
Accounts payable....................... 538,000 (309,000) 187,000
Accrued expenses....................... (126,000) 497,000 127,000
Deferred revenue....................... (163,000) 91,000 8,000
----------- ---------- ----------
Net cash used for operating activities (1,826,000) (593,000) (1,219,000)
----------- ---------- ----------
Cash flows from investing activities
Sale of short-term investments........... 2,997,000 -- 3,439,000
Purchase of short-term investments....... -- (2,997,000) --
Purchase of equipment.................... (498,000) (808,000) (653,000)
Other assets............................. 71,000 9,000 (259,000)
----------- ---------- ----------
Net cash provided by (used for)
investing activities 2,570,000 (3,796,000) 2,527,000
----------- ---------- ----------
Cash flows from financing activities
Proceeds from issuance of preferred
stock................................... -- 4,346,000 --
Net proceeds from issuance of common
stock................................... 9,882,000 44,000 10,000
Bank borrowings.......................... -- -- 469,000
Payment of bank debt..................... (467,000) (345,000) (90,000)
----------- ---------- ----------
Net cash provided by financing
activities 9,415,000 4,045,000 389,000
----------- ---------- ----------
Effect of exchange rate changes on cash
and cash equivalents..................... -- -- (216,000)
----------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents.............................. 10,159,000 (344,000) 1,481,000
Cash and cash equivalents at beginning of
period................................... 2,159,000 2,503,000 1,022,000
----------- ---------- ----------
Cash and cash equivalents at end of
period................................... $12,318,000 $2,159,000 $2,503,000
=========== ========== ==========
Supplemental disclosure of cash paid for
interest $ 86,000 $ 110,000 $ 86,000
=========== ========== ==========
Supplemental disclosure of non-cash
financing activities
Deferred compensation relating to
employee stock options................. $ 1,473,000 -- --
=========== ========== ==========
Conversion of preferred stock and
preferred stock warrants into common
stock.................................. $ 4,000 -- --
=========== ========== ==========
See accompanying notes to consolidated financial statements.
33
APPLIED IMAGING CORP.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
The Company
Applied Imaging Corp. (the Company) was incorporated in 1986 to develop,
manufacture, and market automated clinical analysis systems used by
cytogenetic laboratories in prenatal genetic screening. The Company sells its
products to government and private clinical cytogenetic laboratories, research
institutions, universities, and pharmaceutical companies located primarily in
the United States, Canada, Europe, and the Pacific Rim. The Company is
currently devoting significant resources to the development of a new prenatal
screening designed to enable the detection of prenatal chromosomal disorders
through the analysis of fetal blood cells drawn from maternal blood. There
have been no revenues earned in relation to this new prenatal screening
system.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries, Applied Imaging International,
Limited (United Kingdom) and Applied Imaging, Limited (Israel). All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Foreign Exchange
The Company accounts for its foreign operations in accordance with Statement
of Financial Accounting Standards (SFAS) No. 52, Foreign Currency Translation.
Prior to April 1994, the functional currency for Applied Imaging
International, Limited was the British pound and, accordingly, translation
adjustments resulting from the conversion of the subsidiary's financial
statements into U.S. dollars were accumulated and reported as a separate
component of stockholders' equity. Beginning in April 1994, certain
operational and organizational changes within the Company caused the
functional currency for the Company's subsidiary to become the U.S. dollar.
Therefore, monetary assets and liabilities of the subsidiary are remeasured at
year-end exchange rates while nonmonetary items are remeasured at historical
rates. Most income and expense accounts are remeasured at the average rates in
effect during the year. Translation adjustments resulting from the conversion
of the subsidiary's financial statements into U.S. dollars are currently
recognized in the consolidated statement of operations in the year of
occurrence. The functional currency of Applied Imaging, Limited is also the
U.S. dollar.
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 reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Initial Public Offering
The Company completed its initial public offering on November 7, 1996,
whereby 1,650,000 shares of common stock were issued for approximately
$9,721,000 in proceeds, net of underwriters' discounts and issuance costs of
$1,829,000. Amounts included in the accompanying balance sheet as of December
31, 1996, reflect the conversion of all outstanding shares of preferred stock
into 3,960,017 shares of common stock and the net exercise of the Series F
warrants into 56,783 shares of common stock.
34
APPLIED IMAGING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Revenue Recognition
The Company recognizes revenue on product sales upon shipment and
concurrently accrues for expected hardware warranty expenses, and product
returns. Revenue on renewed maintenance contracts, including amounts
attributable to software maintenance bundled in original product sale
agreements, is deferred and recognized ratably over the period of the
contract, generally one year.
Research and Development Expenditures
Research and development expenditures are charged to expense as incurred
unless they are reimbursed under a specific contract.
Pro Forma Net Loss Per Common Share
Pro forma net loss per share data has been computed using the weighted
average number of shares of common stock, including common equivalent shares
from stock options and warrants outstanding (when dilutive using the treasury
stock method) and the shares resulting from the conversion of all outstanding
shares of preferred stock at the closing of the IPO. Pursuant to SEC Staff
Accounting Bulletins, common equivalent shares issued during the 12-month
period prior to the initial filing of the Company's proposed IPO have been
included in the calculation as if they were outstanding for all periods
presented (even if antidilutive), using the treasury stock method and the
anticipated initial public offering price. Due to the significant impact of
the conversion of preferred shares into common shares at the closing of the
IPO, net loss per common share is not meaningful and is therefore not
presented.
Cash Equivalents and Investments
All investments with original maturities of three months or less are
considered by the Company to be cash equivalents.
The Company has accounted for investments in debt securities, consisting of
U.S. Treasury instruments, as "available-for-sale" and has stated applicable
investments at fair value, which approximates cost. Approximately $1,030,000
of investments as of December 31, 1995 consisted of a U.S. Treasury Note
maturing in January 1997. There were no short-term investments as of December
31, 1996.
Inventories
Inventories are stated at the lower of cost (first in, first out) or market.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is provided using the straight-line method over the estimated
useful lives of the respective assets, generally three to five years.
Capitalized Software Costs
Computer software development costs incurred subsequent to the determination
of product technological feasibility are capitalized in accordance with the
provisions of SFAS No. 86, Accounting for the Cost of Computer Software to be
Sold, Leased or Otherwise Marketed. Amortization of these capitalized costs is
provided using the greater of the ratio of revenues generated in the period
over total future revenues of the
35
APPLIED IMAGING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
product, or the straight-line method over the estimated market life of the
related products, generally three years, commencing when the product becomes
generally available to customers. For the years ended December 31, 1996, 1995
and 1994, software development costs incurred subsequent to the establishment
of technological feasibility have not been material. The net book value of
capitalized costs is not significant and is included in other assets on the
consolidated balance sheets.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes, which prescribes an asset and liability approach
that results in the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in the
Company's consolidated financial statements or tax returns. In estimating
future tax consequences, SFAS No. 109 generally considers all expected future
events other than enactment of changes in tax laws or rates.
Fair Value of Financial Instruments
Financial instruments consist principally of cash equivalents, short-term
investments, trade receivables, notes receivable, accounts payable, and bank
debt. The carrying amounts of these financial instruments approximate fair
value.
Financial instruments that potentially subject the Company to concentrations
of credit risk are cash equivalents and short-term investments which the
Company places with high-credit qualified financial institutions and, by
policy, limits the amount of credit exposure to any one financial institution.
The Company sells its products to government and private clinical cytogenetic
laboratories, research institutions, universities, and pharmaceutical
companies located primarily in the United States, Canada, Europe, and the
Pacific Rim. The Company's credit risk is concentrated primarily in the United
States and Europe. The Company does not have a significant concentration of
credit risk with any single customer. The Company performs on-going credit
evaluations of its customer's financial condition and, generally requires no
collateral from its customers. The Company maintains an allowance for doubtful
accounts to cover potential credit losses.
Adoption of New Accounting Standard
The Financial Accounting Standards Board issued SFAS No. 123, Accounting for
Stock-Based Compensation in October 1995. This statement requires that the
Company either recognize in its consolidated financial statements costs
related to its stock-based employee compensation plans, including employee
stock purchase plans and stock option plans, or make pro forma disclosures of
such costs in a footnote to the consolidated financial statements using the
fair-value method. The Company has adopted SFAS No. 123 effective January 1,
1996. Management plans to remain on APB No. 25, Accounting for Stock Issued to
Employees, as allowed under SFAS No. 123, for purposes of measurement of
compensation expense.
36
APPLIED IMAGING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(2) INVENTORIES
A summary of inventories follows:
DECEMBER 31,
-----------------
1996 1995
-------- --------
Raw materials................................................. $759,000 $734,000
Work in process............................................... 46,000 88,000
Finished goods................................................ 26,000 58,000
-------- --------
$831,000 $880,000
======== ========
(3) PROPERTY AND EQUIPMENT
A summary of property and equipment follows:
DECEMBER 31,
---------------------
1996 1995
---------- ----------
Equipment................................................ $2,187,000 $1,873,000
Demonstration equipment.................................. 875,000 760,000
Furniture and fixtures................................... 242,000 173,000
---------- ----------
3,304,000 2,806,000
2,070,000 1,487,000
---------- ----------
Less accumulated depreciation............................ $1,234,000 $1,319,000
========== ==========
(4) ACCRUED EXPENSES
A summary of accrued expenses follows:
DECEMBER 31,
---------------------
1996 1995
---------- ----------
Compensation and related costs........................... 625,000 641,000
Other.................................................... 679,000 789,000
---------- ----------
$1,304,000 $1,430,000
========== ==========
37
APPLIED IMAGING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(5) BANK DEBT
A summary of bank debt follows:
DECEMBER 31,
-----------------
1996 1995
-------- --------
Applied Imaging International, Limited:
Bank note payable in monthly installments through June 2004;
bearing interest at the bank's base rate plus 3% (9.00% and
6.57% as of December 31, 1996 and 1995, respectively)...... $262,000 $261,000
Bank note payable in monthly installments of $7,500 through
October 1996, bearing interest of 9.75% as of December 31,
1995........................................................ -- 83,000
Applied Imaging Corp.:
Advances on bank line of credit; bearing interest at 10.25%
as of 1995................................................. -- 358,000
-------- --------
262,000 702,000
Less current portion......................................... 33,000 471,000
-------- --------
$229,000 $231,000
======== ========
The bank note relating to Applied Imaging International, Limited is
denominated in British pounds and relates to the purchase of real property
from a related party in March 1994. The real property is recorded at cost,
which approximates market value, and is included in other assets in the
accompanying consolidated balance sheet. This note is secured by such real
property.
Applied Imaging International, Limited has a (Pounds)500,000 unsecured line
of credit with an international bank which is guaranteed by the Company. No
amounts were outstanding under this facility as of December 31, 1996.
(6) STOCKHOLDERS' EQUITY
Preferred Stock
As of December 31, 1996 and 1995, the Company is authorized to issue
6,000,000 shares of preferred stock. Effective upon the closing of the
Company's IPO, 3,919,179 outstanding shares of preferred stock were converted
to 3,960,017 shares of common stock.
As of December 31, 1995, there were warrants outstanding and exercisable for
110,416 shares of Series F preferred stock at $3.40 per share. Such warrants
were exercised and converted into 56,783 shares of common stock upon the
closing of the Company's IPO.
Common Stock
The Company is authorized to issue 20,000,000 shares of common stock. As of
December 31, 1995 and 1996, there were warrants outstanding to purchase
368,734 shares of common stock at $5.25 per share and 140,000 shares at $4.25
per share. These warrants expire in 1998 and 2000, respectively.
As of December 31, 1996, 1,400,000 shares of common stock were reserved for
issuance under the Company's 1988 Amended and Restated Incentive Stock Option
Plan (the 1988 Option Plan). Under the 1988 Option Plan, stock options may be
granted to Board members, officers, key employees, and consultants at the fair
market value of the common stock at the date of the grant, as determined by
the Board. Options are
38
APPLIED IMAGING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
exercisable over 5 to 10 years from the date of grant, and typically vest
ratably over 4 years. In 1994, the Company enacted a Directors Option Plan
designed to encourage participation on the Company's Board. Under this plan,
5,000 shares per year are automatically granted to non-employee directors. The
terms of the plan allow the granting of stock options upon initial election to
the Board and for each subsequent term on the Board. As of December 31, 1996
there were 120,000 shares reserved for issuance under this plan and no options
have been granted. As of December 31, 1996, 100,000 options were granted to
Board members out of the shares reserved under the 1988 Option Plan.
Accounting for Stock-Based Compensation Plans
The Company has elected to use the intrinsic value-based method of APB
Opinion No. 25 to account for all of its employee stock-based compensation
plans.
As of December 31, 1996, there were 581,238 options available for grant
under the 1988 Option Plan. The Company has recorded for financial statement
purposes, a deferred charge of $1,473,000, representing the difference between
the exercise price and the deemed fair value of the Company's common stock for
246,750 shares subject to common stock options granted in the 12-month period
preceding the IPO, mainly in the first quarter of 1996. The deferred stock
compensation is being amortized to compensation expense over the period during
which the options become exercisable, generally four years.
The Company has adopted the pro forma disclosure provisions of SFAS No. 123.
Had compensation cost for the Company's stock-based compensation plans been
determined in a manner consistent with the fair value approach described in
SFAS No. 123, the Company's net loss and pro forma net loss per share as
reported would have been reduced to the pro forma amounts indicated below:.
YEAR ENDED
DECEMBER 31,
----------------
1996 1995
------- -------
Net loss:
As reported......................................... $(2,881) $(2,546)
Pro forma........................................... $(2,965) (2,558)
Pro forma net loss per share:
As reported......................................... $ (0.48) $ (0.45)
Pro forma........................................... $ (0.50) $ (0.45)
Pro forma net loss reflects only options granted in 1996 and 1995.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 123 is not in the pro forma net loss amounts presented above
because compensation cost is reflected over the period equivalent to options'
vesting period of 4 years and compensation cost for options granted prior to
January 1, 1995 is not considered.
The fair value of each option is estimated on the date of grant using the
fair value method with the following weighted-average assumptions: volatility
of 60%, no dividends, an expected life of three years, and risk-free interest
rates of 6.63% for the year ended December 31, 1995 and 5.71% for the year
ended December 31, 1996.
39
APPLIED IMAGING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of the status of the Company's stock option activity for the year
ended December 31, 1996, 1995 and 1994, is as follows:
WEIGHTED- WEIGHTED
AVERAGE AVERAGE
EXERCISE FAIR
FIXED OPTIONS SHARES PRICE VALUE
------------- ------- --------- --------
Outstanding at December 31, 1993.................... 330,550 $1.40
Granted............................................. 100,000 3.00
Canceled............................................ (8,063) 1.89
Exercised........................................... (25,937) 0.38
-------
Outstanding at December 31, 1994.................... 396,550 1.86
Granted--Exercise price equals fair value........... 58,500 1.98 0.95
Granted--Exercise price less than fair value........ 8,000 1.98 7.53
Canceled............................................ (12,525) 2.27
Exercised........................................... (94,275) 0.47
-------
Outstanding at December 31, 1995.................... 356,250 2.24
Granted--Exercise price equals fair value........... 238,750 2.66 7.38
Granted--Exercise prices less than fair value....... 53,750 2.66 2.90
Canceled............................................ (78,250) 2.80
Exercised........................................... (89,250) 1.80
-------
Outstanding at December 31, 1996.................... 481,250 $2.48
=======
The weighted-average fair value of options granted was $6.59 and $1.74 in
1996 and 1995, respectively.
The following table summarizes information about fixed stock options
outstanding as of December 31, 1996:
OPTIONS
OPTION OUTSTANDING EXERCISABLE
------------------------------------- -------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE EXERCISE
PRICES OUTSTANDING LIFE PRICE NUMBER PRICE
- ------------------- ----------- ----------- -------- ------- --------
$1.80 357,250 8.45 years $1.80 93,813 $ 1.80
From $2.80 to $3.00 70,250 7.04 years 2.91 42,688 2.89
From $6.30 to $7.00 53,750 8.40 years 6.48 313 7.00
------- ---------- ----- ------- ------
481,250 8.27 years $2.48 136,813 $ 2.15
There were 136,813, 143,668, and 186,938 options exercisable as of December
31, 1996, 1995 and 1994.
On June 19, 1996, the Board adopted, effective upon the closing of the IPO,
the Company's Employee Stock Purchase Plan (the Plan) whereby eligible
employees may purchase common stock through payroll deductions of up to 10% of
compensation, at a per share price of 85% of the fair market value of the
Company's common stock on the enrollment date or the exercise date six months
later, whichever is lower. As of December 31, 1996 there were 200,000 shares
reserved for issuance under the Plan.
(7) INCOME TAXES
The Company has not recorded an income tax benefit in 1996, 1995, and 1994
due to the recording of a valuation allowance as an offset to net deferred tax
assets. A valuation allowance is provided due to uncertainties relating to the
realization of deferred tax assets.
40
APPLIED IMAGING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets are presented below:
DECEMBER 31,
--------------------------------
1996 1995 1994
---------- ---------- ----------
Deferred tax assets:
Accounts receivable, principally due to
the allowance for doubtful accounts...... $ 43,000 $ 24,000 $ 45,000
Inventories, principally due to the
allowance for obsolete inventory, and
additional costs inventoried for tax
purposes................................. 131,000 96,000 134,000
Tangible and intangible assets,
principally due to differences in
depreciation and amortization -- 45,000 149,000
Revenue deferred for financial statement
purposes, not for tax reporting purposes. 220,000 241,000 184,000
Deferred compensation not currently
deductible 101,000 -- --
Accrued expenses, not currently
deductible............................... 90,000 75,000 70,000
Net operating loss carryforwards.......... 4,055,000 3,081,000 2,170,000
Business credit carryforwards............. 386,000 282,000 130,000
---------- ---------- ----------
5,026,000 3,844,000 2,882,000
Less valuation allowance.................. 5,026,000 3,844,000 2,882,000
---------- ---------- ---------- ---
Net deferred tax assets................... $ -- $ -- $ --
========== ========== ========== ===
As of December 31, 1996, the Company had net operating loss carryforwards
for U.S. federal, U.K., and California state tax return purposes of
approximately $10,100,000, $1,200,000, and $2,800,000, respectively. The
federal and California net operating loss carryforwards expire in the years
2012 and 2000, respectively. The Company's U.K. net operating loss
carryforward is available indefinitely to offset its U.K. trading profits
arising from distribution operations. The difference between the tax loss
carryforwards and the accumulated deficit primarily relates to timing
differences in the recognition of deferred revenue, accrued compensation, and
certain reserves.
The Internal Revenue Code of 1986 and the California Conformity Act of 1987
substantially restrict the ability of a corporation to utilize existing net
operating losses and credits in the event of an "ownership change". The
several issuances of preferred stock and the initial public offering have
resulted in multiple ownership changes since inception of the Company.
Approximately $9,800,000 of the federal net operating loss carryforward will
be subject to an annual limitation in the aggregate of $800,000. Any unused
annual limitation can be carried over and added to the succeeding year's
annual limitation within the allowable carryforward period.
(8) COMMITMENTS
The Company has various noncancelable operating leases for equipment,
vehicles, and facilities expiring through 2005. The facilities' leases
generally contain renewal options for periods ranging from two to three years
and require the Company to pay all executory costs such as maintenance,
property taxes, and insurance. Rent expense under operating leases aggregated
$264,000, $326,000, and $287,000 during 1996 1995, and 1994, respectively. The
Company's primary lease commitments are for its facilities in the United
Kingdom, which aggregate approximately (Pounds)100,000 per year through 2001,
with a three-year renewal option held by the Company, and for its facilities
in the United States, which aggregate approximately $86,000, $44,000, and
$22,000 for 1997, 1998, and 1999, respectively.
41
APPLIED IMAGING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(9) OTHER INCOME
The components of other income are as follows:
DECEMBER 31,
-----------------------------
1996 1995 1994
--------- -------- --------
Interest income................................. $ 208,000 $143,000 $ 99,000
Interest expense................................ (86,000) (110,000) (87,000)
Gain/(loss) on foreign exchange................. (112,000) 34,000 32,000
Miscellaneous income............................ 4,000 4,000 8,000
--------- -------- --------
$ 14,000 $ 71,000 $ 52,000
========= ======== ========
(10) FOREIGN OPERATIONS
The Company markets its products worldwide from its operations in the United
States and the United Kingdom and performs research and development in the
United States and Israel. Sales from the United States are primarily to
customers within the United States. Revenues in the United Kingdom resulted
from drop shipments of product from the United States directly to customers.
Selected financial data by primary geographic area for the years ended
December 31, 1996, 1995, and 1994 follow. Operating losses incurred by Israel
are offset by funding received in connection with the grant discussed at
Footnote 11.
DECEMBER 31,
-----------------------------------
1996 1995 1994
----------- ----------- ----------
Sales to unaffiliated customers:
United States.............................. $ 4,797,000 $ 4,254,000 $3,639,000
United Kingdom............................ 7,125,000 6,544,000 5,932,000
----------- ----------- ----------
Total $11,922,000 $10,798,000 $9,571,000
=========== =========== ==========
Operating loss:
United States............................. $ 2,794,000 $ 2,548,000 $2,069,000
United Kingdom............................ 31,000 69,000 953,000
Israel.................................... 70,000 -- --
----------- ----------- ----------
Total $ 2,895,000 $ 2,617,000 $3,022,000
=========== =========== ==========
DECEMBER 31,
-----------------------------------
1996 1995 1994
----------- ----------- ----------
Total assets:
United States............................. $13,032,000 $ 6,473,000 $3,977,000
United Kingdom............................ 3,046,000 2,755,000 3,464,000
Israel.................................... 395,000 145,000 --
----------- ----------- ----------
Total.................................... $16,473,000 $ 9,373,000 $7,441,000
=========== =========== ==========
Net assets:
United States............................. $11,393,000 $ 4,183,000 $1,321,000
United Kingdom............................ 736,000 491,000 1,490,000
Israel.................................... (124,000) 40,000 --
----------- ----------- ----------
Total.................................... $12,005,000 $ 4,714,000 $2,811,000
=========== =========== ==========
Substantially all of the U.K. sales are denominated in British pounds. The
Company generally does not enter into any arrangements to hedge the effect of
foreign currency changes on its foreign currency denominated assets and
liabilities.
42
APPLIED IMAGING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(11) RESEARCH AND DEVELOPMENT ARRANGEMENT
During 1995, the Company was awarded a grant by the Israel-United States
Binational Industrial Research and Development (BIRD) Foundation. With the
funding received from the grant, the Company began research operations in its
Israel subsidiary relating to its fetal cell program. All funds received by
the Company in advance of performing the related research and development are
recorded as a deferred credit in the accompanying consolidated balance sheet
and, as expenses are incurred, the deferred credit is depleted. Over the life
of the grant, the Company will receive up to $543,000 in matching funds. These
funds, as well as any accrued interest, will be required to be paid back to
the BIRD Foundation if future revenues are realized from the related research
and development activities, at the rate of 2 1/2 % of such future revenues
generated in the first year such revenues occur, and 5% of revenues in
succeeding years, over a six-year period, up to a maximum of 150% of the funds
received. To date, the Company has received $362,000 in funding and has
recorded a receivable in the amount of $181,000 relating to the final
installments of the grant. The Company has recognized credits to its expenses
of approximately $361,000 during 1996 and $97,000 during 1995.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
43
PART III
Certain information required by Part III is omitted from this Report on Form
10-K in that the Registrant will file a definitive proxy statement within 120
days after the end of its fiscal year pursuant to Regulation 14A with respect
to the 1997 Annual Meeting of Stockholders (the "Proxy Statement") and certain
information included therein is incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain of the information required by this item relating to directors is
incorporated by reference to the information under the caption "Proposal No. 1
- -- Election of Directors" in the Proxy Statement.
The executive officers of the Registrant, who are elected by the board of
directors, are as follows:
NAME AGE POSITION
- ---- --- --------
Abraham I. Coriat (1)... 48 Chief Executive Officer and Chairman of the Board of Directors
Michael W. Burgett,
Ph.D................... 51 President, Genetic Diagnostics Division
Leslie G. Grant, Ph.D... 44 President and Chief Operating Officer, Cytogenetics Division
Neil E. Woodruff........ 50 Chief Financial Officer and Secretary
Abraham I. Coriat the founder of the Company, has been with the Company
since 1986. He is Chief Executive Officer and Chairman of the Board. From 1981
to 1986, he served as Business Area Manager and Engineering Manager for
International Imaging Systems in their medical and industrial imaging
divisions. Mr. Coriat has 23 years of experience in the imaging and medical
industry, including various senior engineering positions in England, Belgium
and Italy. He holds an Electrical Engineering degree from INSA (Institut
National de Sciences Appliquees), France.
Michael W. Burgett Ph.D., joined the Company as President of the Genetic
Diagnostics Division in February 1996. Dr. Burgett has 23 years of experience
in the medical diagnostics industry, including 14 years in senior management
positions. From 1987 to 1996, Dr. Burgett held various general management,
operations and product development positions with Ortho Diagnostic System
Inc., a Johnson & Johnson Company, most recently acting as Vice President and
General Manager of their blood bank business. Prior to that, Dr. Burgett held
various research and development and program management positions with
SmithKline Beckman, Inc., International Diagnostics Technology, Inc., and
BioRad Laboratories, Inc. Dr. Burgett holds a B.A. and an M.A. in Biology from
San Francisco State University and a Ph.D. in Chemistry from the University of
Texas at Austin.
Leslie G. Grant Ph.D., has been President and Chief Operating Officer of the
Company's Cytogenetics Division since February 1992. He joined the Company in
October 1991 as Managing Director of Applied Imaging International Ltd. From
1980 to 1991, Dr. Grant held various general management and senior engineering
positions with GEC-Marconi. Dr. Grant has 20 years experience in the
instrumentation and medical industry, including 11 years in senior management
positions. Dr. Grant holds a B.S. in Mathematics and a Ph.D. in Mathematics
and Electronic Engineering from the University of Hull, United Kingdom.
Neil E. Woodruff has served as Chief Financial Officer of the Company since
April 1990 and Secretary since 1993. Mr. Woodruff has 25 years experience in
finance and the high technology industry. From 1983 to 1990, Mr. Woodruff held
various financial and general management positions with General Signal Corp.
Prior to that, Mr. Woodruff held various finance posts with Epitaxy, Inc.,
National Semiconductor and General Instrument Corp. Mr. Woodruff holds a B.S.
in Finance from the University of Santa Clara.
44
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information under the caption "Executive Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
information under the caption "Record Date and Stock Ownership" in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information under the caption "Certain Transactions" in the Proxy Statement.
45
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)1. FINANCIAL STATEMENTS
The following Financial Statements of Applied Imaging Corp. and Report
of KPMG Peat Marwick LLP, have been provided as Item 8, above:
Report of KPMG Peat Marwick LLP, Certified Public Accountants
Consolidated Balance Sheets, 1996 and 1995
Consolidated Statements of Operations, Years Ended December 31, 1996,
1995 and 1994
Consolidated Statements of Stockholders' Equity, Years Ended December
31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows, Years Ended December 31, 1996,
1995 and 1994
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES
The financial statement schedule entitled "Valuation and Qualifying
Accounts" is included at page 50 of this Form 10-K.
All other schedules are omitted because they are not applicable or the
required information is shown in the Financial Statements or the notes
thereto.
3. EXHIBITS
Refer to (c) below.
(B) REPORTS ON FORM 8-K
The Company was not required to and did not file any reports on Form 8-K
during the three months ended March 31, 1997.
(C) EXHIBITS
EXHIBIT
NO. DESCRIPTION
------- -----------
3.1(1) Certificate of Incorporation of the Registrant.
3.2(1) Form of Restated Certificate of Incorporation, to be filed after
the closing of the offering made under this Registration Statement.
3.3(1) Bylaws of the Registrant.
4.1(1) Specimen Common Stock Certificate.
10.1(1) Form of Indemnification Agreement for directors and officers.
10.2(1) Amended and Restated 1988 Incentive Stock Option Plan and form of
agreement thereunder.
10.3(1) 1994 Director Option Plan and form of subsequent agreement
thereunder.
10.4(1) Employee Stock Purchase Plan.
10.5(1) Amended and Restated Registration Rights Agreements.
10.6(1) License Agreement dated December 1, 1993 between the Registrant and
Chronomed, Inc.
10.7(1) Assignment dated December 1, 1993 by and between the Registrant and
Alex Saunders, M.D.
10.8(1) Lease dated February 15, 1994 for the Registrant's headquarters in
Santa Clara, CA.
10.9(a)(1) Lease for Site No. BT. 2003/1A, Hylton Park, Sunderland, England,
between English Industrial Estates Corporation and Applied Imaging
International Ltd., dated June 12, 1992.
10.9(b)(1) Lease for Site No. BT.2003/3A, Hylton Park, Sunderland, England,
between English Industrial Estates Corporation and Applied Imaging
International Ltd., dated June 12, 1992.
46
EXHIBIT
NO. DESCRIPTION
------- -----------
10.9(c)(1) Underlease for Site No. BT.2003/1A between Applied Imaging
International Ltd. and RTC North Limited, dated February 14, 1996.
10.9(d)(1) Supplement to Underlease for Site No. BT.2003/1A between Applied
Imaging International Ltd. and RTC North Limited, dated February
14, 1996.
10.10(1) Lease Agreement dated October 31, 1995 between Asaf Harofe Hospital
and Applied Imaging Ltd. for Registrant's Israeli entity in Tzipin,
Israel.
10.11(1) Employment Letter Agreement dated August 12, 1991 between the
Registrant and Leslie G. Grant.
10.12(1) Amendment to Employment Letter Agreement between the Registrant and
Leslie G. Grant, dated February 12, 1996.
10.13(1) Employment Letter Agreement dated January 12, 1996 between the
Registrant and Michael W. Burgett, Ph.D., and supplement thereto,
dated January 20, 1996.
10.14(1) Know-How License Agreement dated November 1989 between Medical
Research Council and Shandon Scientific Limited (assigned to the
Registrant in November 1989), as amended, July 5, 1994.
10.15(1) Cooperative Research and Development Agreement, dated June 10, 1995
between Registrant and the National Institute of Health.
10.16(1) Supply & Distribution Agreement dated March 3, 1994 between
Cytocell Ltd. and Registrant.
10.17(1) Research Purchase Agreement dated March 26, 1996 between Pharmacia
Biotech AB and Registrant.
10.18(1) Development Agreement dated February 5, 1996 between Em Industries
and Registrant.
10.19(1) Cooperation and Project Funding Agreement dated July 16, 1995
between the Israel-United Stated Binational Industrial Research and
Development Foundation, the Registrant and Applied Imaging Ltd.
10.20(1) Security and Loan Agreement datetd September 5, 1995 between
Registrant and Imperial Bank.
10.21(1) Extension to Security and Loan Agreement dated September 16, 1996
between Registrant and Imperial.
10.22(1) Agreement dated October 3, 1996 between Mitchell S. Golbus and the
Registrant.
11.1 Calculation of pro forma net loss per common share.
21.1(1) List of Subsidiaries of the Registrant.
24.1 Power of Attorney (included at page 48 below).
27.1 Financial Data Schedule.
- --------
(1) Filed as an Exhibit to the Company's Registration Statement on Form S-1
(File No. 333-06703) and incorporated herein by reference.
47
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Applied Imaging Corp.
By /s/ Abraham I. Coriat
----------------------------------
ABRAHAM I. CORIAT
CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY
KNOW ALL MEN AND WOMEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Abraham I. Coriat his or her attorneys-
in-fact, with the power of substitution, for him or her in any and all
capacities, to sign any amendments to this Report on Form 10-K, and to file
the same, with exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission, hereby ratifying and confirming
all that said attorneys-in-fact, or his or her substitute or substitutes, may
do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ Abraham I. Coriat Chief Executive March 24, 1997
- ------------------------------------- Officer and
(ABRAHAM I. CORIAT) Director (Principal
Executive Officer)
/s/ Neil E. Woodruff Chief Financial March 24, 1997
- ------------------------------------- Officer (Principal
(NEIL E. WOODRUFF) Financial and
Accounting Officer)
/s/ John F. Blakemore, Jr. Director March 24, 1997
- -------------------------------------
(JOHN F. BLAKEMORE, JR.)
/s/ Michael S. Elias Director March 24, 1997
- -------------------------------------
(MICHAEL S. ELIAS)
/s/ Gilbert J.R. McCabe Director March 24, 1997
- -------------------------------------
(GILBERT J.R. MCCABE)
48
SIGNATURES TITLE DATE
---------- ----- ----
Director
- -------------------------------------
(THOMAS C. MCCONNELL)
/s/ Andre F. Marion Director March 24, 1997
- -------------------------------------
(ANDRE F. MARION)
Director
- -------------------------------------
(ROBERT C. MILLER)
/s/ G. Kirk Raab Director March 24, 1997
- -------------------------------------
(G. KIRK RAAB)
49
APPLIED IMAGING CORP.
- --------------------------------------------------------------------------------
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND DEDUCTIONS/ END OF
YEAR EXPENSES RECOVERIES YEAR
------------ ---------- ----------- ----------
ALLOWANCE FOR DOUBTFUL
ACCOUNTS
Year ended December 31,
1996 $166 $76 $14 $228
Year ended December 31,
1995 $122 $93 $49 $166
Year ended December 31,
1994 $ 95 $66 $39 $122
50
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
------- -----------
11.1 Statement Re: Computation of Pro Forma Net Loss per Common Share
24.1 Power of Attorney, included at page 48, above.
27.1 Financial Data Schedule.
51