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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

IRIS INTERNATIONAL, INC.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s Telephone Number: (818) 709-1244

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The registrant had 14,815,342 shares of common stock outstanding as of May 5, 2004.

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IRIS INTERNATIONAL, INC.

INDEX TO FORM 10-Q

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PART I

FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

IRIS INTERNATIONAL, INC.

CONSOLIDATED BALANCE SHEETS

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

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IRIS INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

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

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IRIS INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

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

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IRIS INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

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

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IRIS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Company History

IRIS International, Inc., (collectively “IRIS” or the “Company”) was incorporated in California in 1979 and reincorporated during 1987 in Delaware under the name of International Remote Imaging Systems, Inc. The Company changed it name to IRIS International, Inc. in December 2003. The Company designs, develops, manufactures and markets in vitro diagnostic (“IVD”) equipment, including IVD imaging systems based on patented and proprietary automated intelligent microscopy (“AIM”) technology, as well as special purpose centrifuges and other small instruments for automating microscopic procedures performed in clinical laboratories.

2. Summary of Significant Accounting Policies

Basis of Presentation of Unaudited Interim Financial Statements:

In the opinion of management, the accompanying unaudited consolidated financial statements contain all normal recurring adjustments necessary to present fairly the financial position of the Company as of March 31, 2004 and 2003 and the results of its operations for the three-month periods then ended. These statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s latest annual report on Form 10-K. Interim results are not necessarily indicative of results for a full year.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The significant estimates in the preparation of the consolidated financial statements relate to the assessment of the carrying value of accounts receivables, inventories, purchased intangibles, estimated provisions for warranty costs and deferred tax assets. Actual results could differ materially from those estimates.

Principles of Consolidation

The consolidated financial statements include the accounts of IRIS International, Inc. and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in the consolidated financial statements.

Cash Equivalents and Short-Term Investments

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

Accounts Receivable

IRIS sells predominantly to entities in the healthcare industry. IRIS grants uncollateralized credit to its customers, primarily hospitals, clinical and research laboratories, and distributors under normal trade terms. IRIS performs ongoing credit evaluations of its customers before granting uncollateralized credit. Letters of credit may be required from some of our customers in certain circumstances. The Company does not have any single customer, which accounts for 10% or more of its consolidated revenues or 10% or more of its accounts receivable at the balance sheet date.

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Senior management reviews accounts receivable on a monthly basis to determine if any receivables will potentially be uncollectible. We include any accounts receivable balances that are determined to be uncollectible, along with a general reserve, in our overall allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Based on the information available to us, we believe our allowance for doubtful accounts as of March 31, 2004 is adequate. However, actual write-offs might exceed the recorded allowance.

Inventories

Inventories are carried at the lower of cost or market on a first in, first out basis. Provision for potentially obsolete or slow-moving inventory is made based on management’s analysis of inventory levels and future sales forecasts.

Investment available for sale

Management classifies the investment in common shares as available for sale. Investments in such securities are reported at fair value with unrealized holding gains and losses, net of tax, reported as a separate component of shareholders’ equity until realized, or until management believes a permanent decline in value has occurred. Realized gains and losses are included in earnings. There was a realized loss of $7,070 in the first quarter of 2004.

Property and Equipment and Depreciation

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

Goodwill

Goodwill is recorded at cost. The realizability of the goodwill is evaluated periodically, at least annually, or as events or circumstances indicate a possible inability to recover the carrying amount. Such evaluation is based on various analyses, including cash flow and profitability projections. The analysis necessarily involves significant management judgment to evaluate the capacity of an acquired business to perform within projections. At March 31, 2004, the Company evaluated its goodwill and determined that fair value had not decreased below carrying value and no adjustment to impair goodwill was necessary in accordance with SFAS No. 142.

Software Development Costs

The Company capitalizes certain software development costs for new products and product enhancements once all planning, designing, coding and testing activities necessary to establish that the product can be produced to meet its design specifications are completed, and concludes capitalization when the product is ready for general release. Research and development costs relating to software development are expensed as incurred. Amortization of capitalized software development costs is provided on a product-by-product basis at the greater of the amount computed using (a) the ratio of current revenues for a product to the total of current and anticipated future revenues or (b) the straight-line method over the remaining estimated economic life of the product up to five years. The Company capitalized software development costs during the three months ended March 31, 2004 and 2003 of $13,457 and $ 144,425, respectively.

Long-Lived Assets

The Company identifies and records an impairment loss for long-lived assets whenever events or changes in circumstances result in the carrying amount of the assets exceeding the sum of the expected future undiscounted cash flows associated with such assets. The measurement of the impairment losses recognized is based on the difference between the fair values and the carrying amounts of the assets.

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Stock Based Compensation

The Company has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123 defines a fair value based method of accounting for an employee stock option. Fair value of the stock option is determined considering factors such as the exercise price, the expected life of the option, the current price of the underlying stock and its volatility, expected dividends on the stock, and the risk-free interest rate for the expected term of the option. Under the fair value based method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period. Pro forma disclosures for entities that elect to continue to measure compensation cost under the intrinsic method provided by Accounting Principles Board Opinion No. 25 must include the effects of all awards granted. The Company accounts for stock-based awards to non-employees in accordance with SFAS No. 123 and EITF 96-18. An expense is recognized for common stock, warrants or options issued or repriced, for services rendered by non-employees based on the estimated fair value of the security exchanged.

IRIS has adopted the disclosure only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation”, as amended by Statement No. 148. If compensation expense for the stock options had been determined using “fair value” at the grant date for awards in 2003 and 2002, consistent with the provisions of Statement of Financial Accounting Standards No. 123, the Company’s net income (loss) and income (loss) per share would have been reduced to the pro forma amounts indicated below:

The pro forma calculations above are for informational purposes only. Future calculations of the pro forma effects of stock options may vary significantly due to changes in the assumptions described above as well as future grants, and for forfeitures of stock options.

Revenue Recognition

Revenues are derived from the sale of IVD instruments, sales of consumable supplies and services for its IVD systems as well as sales of small laboratory devices and related supplies. Revenue is recognized once all of the following conditions have been met: a) an authorized purchase order has been received in writing with a fixed and determinable sales price, b) customer credit worthiness has been established, and c) delivery of the product based on shipping terms. The majority of domestic IVD instrument sales generally require installation and training to be performed.

Revenue is recorded in accordance with the provisions of Emerging Issues Task Force (EITF) Statement 00-21 “Revenue Arrangements with Multiple Deliverables” and Staff Accounting Bulletin (SAB) 104 “Revenue Recognition in Financial Statements” which generally requires revenue earned on product sales involving multiple-elements to be allocated to each element based on the relative fair values of those elements. Multiple elements of the Company’s domestic product sales include IVD instruments and training. Training elements are valued based on hourly rates, which the Company charges for these services when sold apart from hardware sales. Accordingly, IRIS allocates revenue to each element in a multiple- element arrangement based on the element’s respective fair value, with the fair value determined by the price charged when that element is sold and specifically defined in a quotation or contract.

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IRIS recognizes revenues from the sale of instruments, consumables and small laboratory devices when title and risk of loss passes to the customers and revenues from service contracts are recognized ratably over the term of the service period, which typically ranges from twelve to sixty months. Payments for service contracts are generally received in advance. Deferred revenue represents the revenues to be recognized over the remaining term of the service contracts.

Warranties

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

Research and Development Expenditures

Except for certain software development costs required to be capitalized as described above (see Software Development Costs), research and development expenditures are charged to operations as incurred. Net research and development expense includes total research and development costs incurred, including costs incurred under research and development grants and contracts, less costs reimbursed under research and development contracts.

Income Taxes

IRIS accounts for income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes,” which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the differences between the financial statement and the tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.

Marketing Costs

All costs related to marketing and advertising the Company’s products are expensed at the time the advertising takes place.

Fair Value of Financial Instruments

The amount recorded for financial instruments in the Company’s consolidated financial statements approximates fair value as defined in SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”. The fair value of short term borrowings and notes payable described in note 8 approximate their carrying value due to the variable nature of the interest rates in these instruments.

Earnings Per Share

Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding, calculated on the treasury stock method for options and warrants or the as if converted method for convertible preferred stock. Common stock equivalents for the three months ended March 31, 2004 included 1,098,287 from stock options and 696,280 from warrants. Common stock equivalents for the previous year’s quarter are excluded from the computation because their effect is antidilutive.

Segment Reporting

The Company determines and discloses its segments in accordance with SFAS No. 131; “Disclosures about Segments of an Enterprise and Related Information,” which uses a “management” approach for determining business segments. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company’s reportable segments. SFAS No. 131 also requires disclosures about products and services, geographic areas, and major customers. See Note 9 — “Segment and Geographic Information”.

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Certain Risks and Uncertainties

Dependence on Instrument Sales: The Company derives most of its revenues from the sale of the urinalysis analyzers, and related supplies and services. Relatively modest declines in unit sales or gross margins could have a material adverse effect on the Company’s revenues and profits.

Reliance on Single Source Suppliers: Certain key components of the Company’s instruments are manufactured according to the Company’s specifications or are available only from single suppliers. For example, Roche Diagnostics is the sole supplier for the Company’s proprietary CHEMSTRIP/IRIStrip urine test strips and related test reader used in The Yellow IRIS Models 300 and 500. From time to time, single source suppliers have discontinued production of key components or encountered production problems, which potentially could have a material adverse effect on instrument sales. Although, in the past, the Company has successfully transitioned to new components to replace discontinued components, there can be no assurance that the Company can always successfully transition to satisfactory replacement components or that the Company will always have access to adequate supplies of discontinued components on satisfactory terms during the transition period. The Company also is the exclusive North American distributor of the Arkray Aution Max AX-4280 Automated Urine Chemistry Analyzer, which will affect the success of the Company’s domestic sales of new iQ200 urinalysis workstations, which was launched in 2003. The Company’s inability to transition successfully to replacement components, to secure adequate supplies of discontinued components on satisfactory terms, or the loss of the distribution rights to the Arkray product could have a material adverse effect on the Company.

3. Inventories

Inventories consist of the following:

4. Short-Term Borrowings and Notes Payable

At March 31, 2004 we had an $8.0 million credit facility with a bank, which consisted of a $500,000 term loan, a $1.0 million term loan and a $6.5 million revolving line of credit. The $500,000 term loan is payable in 60 equal monthly installments and matures in February 2007. The $1.0 million term loan carried interest only for the first 12 months, followed by 48 months of equal principal payments plus interest, commencing in March 2003 and matures in February 2007. The $6.5 million credit line matures in June 2004. Borrowings under the line of credit are limited to a percentage of eligible receivables and inventory. Dependent on the Company’s debt service coverage ratio, the entire credit facility bears interest at a range between the lender’s prime rate (4.0% on March 31, 2004), or LIBOR rate plus 2.0% and the lender’s prime rate plus 1.0% or LIBOR rate plus 3.0%, and is secured by all of the our assets. We are subject to certain financial covenants under the debt agreement and must maintain a minimum excess borrowing availability of $400,000 under the line of credit portion. As of March 31, 2004, we were in compliance with all financial covenants.

At March 31, 2004, we also had a $1.1 million unsecured subordinated promissory note payable to an unrelated party. The note is payable in monthly installments of approximately $97,000 plus interest. The note bears interest at the prime rate (4.0% on March 31, 2004) plus 2.0% and matures on July 31, 2004. On September 30, 2003, the bank invoked its rights under a subordination agreement between the note holder and the bank, precluding us from making further payments on the note until further notice.

In April 2004, all of our bank debt then outstanding plus subordinated promissory note in the amount of approximately $5.5 million was repaid with the proceeds received from a private placement of the 2,130,000 shares of our common stock (see Note 6).

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5. Income Taxes

The income tax provision for the three month period ended March 31, 2004 was $352,830 as compared to a benefit of $325,645 for the comparable period last year. The income tax provision differs from the federal statutory rate due primarily to state income taxes and permanent differences between income reported for financial statement and income tax purposes.

Realization of deferred tax assets associated with net operating losses (“NOL”) and tax credit carry forward is dependent upon the Company’s being able to generate sufficient taxable income prior to their expiration. Management believes it is more likely than not that the deferred tax assets will be realized through future taxable income or alternative tax strategies. However, the net deferred tax assets could be reduced in the near term if management’s estimates of taxable income during the carryforward period are not realized or are significantly reduced or alternative tax strategies are not available. The Company will continue to review its estimates of taxable income and will make adjustments to the valuation allowance, when necessary.

6. Capital Stock

Subsequent Event – Private Placement of Stock

On April 16, 2004 we signed an agreement with an investment bank for the private placement of 2,130,000 shares of our common stock at $5.85 per share (a 10% discount to market). In addition, each investor received a 5-year warrant to purchase 3 additional shares of common stock at $7.80 per share for each 20 shares of common stock purchased in the offering. The offering agreement required us to file a registration statement which was filed on May 11, 2004 and to have the registration statement declared effective within 90 days of closing (July 21, 2004), registering the shares of common stock sold in the offering plus the shares issuable on the exercise of the related warrants. If the registration statement is not declared effective by July 21, 2004, the Company will incur a 1.5% monthly penalty payable in cash or stock to the investors in the private placement. The Company realized net proceeds (after deducting offering expenses) of approximately $11.5 million. We used approximately $5.5 million of the net proceeds to retire all outstanding indebtedness to the bank and the subordinated note holder and added the balance to working capital.

Stock and Stock Option Issuances

During the three months ended March 31, 2004, the Company (i) issued 292,467 shares of common stock from the exercise of options, (ii) issued options to purchase 145,000 shares of common stock under the Company’s stock option plans and (iii) cancelled options to purchase 25,633 shares of common stock. At March 31, 2004, options to purchase 2,740,430 shares of common stock were issued and outstanding under the Company’s stock options plans and special inducement grants. The outstanding options will expire at different dates by the end of 2012. The exercise price for these options ranges from $0.69 to $6.40 per share. At March 31, 2004, there were 417,942 shares of common stock available for the granting of future options under the Company’s stock option plans.

Warrants

At March 31, 2004, there were outstanding warrants to purchase 853,040 shares of common stock at an exercise price of $1.90 which expire in July 2004 and warrants to purchase an additional 129,767 shares of common stock at an average exercise price per share of $2.11 and expire at various dates through October 2007.

7. Contingencies

Litigation

From time to time, the Company is party to certain litigation arising in the normal course of business. Management believes that the resolution of such matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

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Guarantees

In November 2002, the FASB issued FIN No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others — an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34.” The following is a summary of the Company’s agreements that the Company has determined are within the scope of FIN 45.

The Company enters into indemnification provisions under (i) its agreements with other companies in its ordinary course of business, typically with business partners, contractors, and customers, landlords and (ii) its agreements with investors. Under these provisions the Company generally indemnifies and hold harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities or, in some cases, as a result of the indemnified party’s activities under the agreement. These indemnification provisions often include indemnifications relating to representations made by the Company with regard to intellectual property rights. These indemnification provisions generally survive termination of the underlying agreement. In addition, in some cases, the Company has agreed to reimburse employees for certain expenses and to provide salary continuation during short-term disability. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of March 31, 2004.

8. Royalty Income

A competitor previously developed several urine sediment analyzers under license agreements with IRIS using prior IRIS technology. IRIS received royalties under the license of $186,081 and $129,603 for the three months ended March 31, 2004 and 2003. The license is expected to expire in July 2004.

9. Segments and Geographic Information

The Company’s continuing operations are organized on the basis of products and related services and under SFAS No. 131 operate in two segments: (1) IVD instruments and (2) small laboratory devices and related supplies.

The IVD instrument segment designs, develops, manufactures, markets and distributes IVD systems based on patented and proprietary AIM technology for automating microscopic procedures for urinalysis. The segment also provides ongoing sales of supplies and services necessary for the operation of installed urinalysis workstations. In the United States, these products are sold through a direct sales force. Internationally, these products are sold through distributors.

The small laboratory devices segment designs, develops, manufactures and markets a variety of bench top centrifuges, small instruments and supplies. These products are used primarily for manual specimen preparation and dedicated applications in coagulation, cytology, hematology and urinalysis. These products are sold worldwide through distributors.

The tables below present information about reported segments:

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The Company ships products from two locations in the United States. Substantially all long-lived assets were located in the United States and totaled $6,675,664 at March 31, 2004 and 6,679,729 at December 31, 2003. Sales to international customers amounted to approximately $1.7 and $0.5 million during the three months ended March 31, 2004 and 2003, respectively.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements, which reflect our current views about future events and financial results. We have made these statements in reliance on the safe harbor created by that Private Securities Litigation Reform Act of 1995. Forward-looking statements include our views on future financial results, financing sources, product development, capital requirements, market growth and the like, and are generally identified by phrases such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans” and similar words. Forward-looking statements are merely predictions and therefore inherently subject to uncertainties and other factors which could cause the actual results to differ materially from the forward-looking statement.

These uncertainties and other factors include, among other things:

Set forth below are additional significant uncertainties and other factors affecting forward-looking statements. The readers should understand that the uncertainties and other factors identified in this Annual Report are not a comprehensive list of all the uncertainties and other factors that may affect forward-looking statements. We do not undertake any obligation to update or revise any forward-looking statements or the list of uncertainties and other factors that could affect those statements.

Overview

IRIS International, Inc. was incorporated in California in 1979 and reincorporated in Delaware in 1987. Our company consists of three operating units. Our largest unit, Iris Diagnostics Division, designs, manufactures and

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markets in vitro diagnostics (IVD) systems, consumables and supplies for urinalysis. Our StatSpin subsidiary markets small centrifuges and other processing equipment and accessories for rapid specimen processing, and our Advanced Digital Imaging and Research LLC (ADIR) subsidiary assists in the advancement of proprietary imaging technology while conducting government-sponsored research and contract development in imaging and pattern recognition.

In August 2003, we launched our newest IVD urine analyzer, the iQ200. During 2003, we incurred significant expenses relating to the launch of the iQ200 arising from manufacturing learning curve, international expansion and training relating to new product introduction. In addition, we experienced a significant senior management restructuring during 2003 resulting in approximately $1.2 million in costs arising from severance agreements, of which $400,000 occurred during the first quarter of 2003.

We currently generate revenues primarily from two segments: IVD instruments (IVD instruments, consumables supplies and service); and small laboratory device instruments and supplies. We released the iQ200, in the third quarter of 2003. Although we continue to sell our legacy models (Model 500 and Model 939 Udx), we expect that sales of such products to diminish substantially in the future as they are expected to be replaced by the iQ200 and future upgrades to the iQ200.

Sales from our IVD Segment accounts for approximately 79% of our revenues with IVD consumables supplies and services representing over 50% of our revenues and contributes higher gross margins than other sources of revenues. Consumables include products such as chemical reagents and urine test strips. Service revenues are derived primarily from annual service contracts purchased by our domestic customers. Once our analyzers and systems are installed, we generate recurring revenue from sales of consumables and service (including parts), which should continue to expand as the installed base of related instruments expand. Sales of small laboratory devices and supplies primarily consist of centrifuge systems and related supplies sold by StatSpin. Sales of StatSpin’s products are made worldwide through distributors.

Sales of IVD instruments are made both domestically and internationally. Domestic sales are made directly by our own sales staff directly to the customer, whereas international sales are made through independent distributors. International sales represented 18% of consolidated net revenues during the three months ended March 31, 2004 and approximately 8% during the three months March 31, 2003. With the launch of our new iQ200 analyzer, we have increased our focus on the international marketplace, with the ultimate goal of balancing our urinalysis business between domestic and international markets. Since our international sales are made through independent distributors, our gross profit margin, on such sales, is lower than domestic sales of the same products.

We continue to make significant investments in research and development for new products and enhancements to existing products. We internally fund our research and development programs, however through ADIR; we also receive grants from the National Institutes of Health and to a lesser extent, contracts from third parties.

The following table summarizes product technology expenditures for the periods indicated:

Critical Accounting Policies

Our critical accounting policies upon which our financial position and results of operations depend are those related to revenue recognition, inventory valuation, capitalized software, and income tax assets and liabilities. We summarize our most critical accounting policies below.

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Revenue recognition – Revenues are derived from the sale of IVD instruments, sales of consumable supplies and services for IVD systems as well as sales of small laboratory devices and related supplies. Revenue is recognized once all of the following conditions have been met: a) an authorized purchase order has been received in writing with a fixed and determinable sales price, b) customer credit worthiness has been established, and c) delivery of the product based on shipping terms. The majority of domestic IVD instrument sales generally require installation and training to be performed.

Revenue is recorded in accordance with the provisions of Emerging Issues Task Force (EITF) Statement 00-21 “Revenue Arrangements with Multiple Deliverables” and Staff Accounting Bulletin (SAB) 104 “Revenue Recognition in Financial Statements which generally requires revenue earned on product sales involving multiple-elements to be allocated to each element based on the relative fair values of those elements. Multiple elements of the Company’s domestic product sales include IVD instruments and training. Training elements are valued based on hourly rates, which the Company charges for these services when sold apart from hardware sales.

Accordingly, we allocate revenue to each element in a multiple-element arrangement based on the element’s respective fair value, with the fair value determined by the price charged when that element is sold and specifically defined in a quotation or contract.

We recognize revenues from service contracts ratably over the term of the service period, which typically ranges from twelve to sixty months. Payments for service contracts are generally received in advance. Deferred revenue represents the revenues to be recognized over the remaining term of the service contracts.

Inventory valuation – We value inventories at the lower of cost or market value on a first-in, first-out basis. Provision for potentially obsolete or slow-moving inventory is made based on management’s analysis of inventory levels and future sales forecasts. We recognize that although we have introduced a new urine analyzer in the iQ200, an installed based of the legacy products still exist. We maintain a base supply of service parts for these products, a portion of which is classified as long-term on our balance sheet. Management will periodically review the carrying value of such parts to ensure that they continue to have net realizable value.

Capitalized Software – We capitalize software development costs in connection with our development of our urine analyzers. We account for such software development in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Cost of Capitalized Software to Be Sold, Leased or Otherwise Marketed.” We capitalize software development costs once technological feasibility is established and such costs are determined to be recoverable against future revenues.

Capitalized software development costs are expensed to cost of sales over periods up to five years. When, in management’s estimate, future revenues will not be sufficient to recover previously capitalized software development costs, we will expense such items as additional software development amortization in the period the impairment is identified. Such adjustments are normally attributable to changes in market conditions or product quality considerations.

Income taxes – we account for income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes,” which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the differences between the financial statement and the tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.

Results of Operations

Comparison of Quarter Ended March 31, 2004 to Quarter Ended March 31, 2003

Net revenues for the quarter ended March 31, 2004, increased by $3.2 million to $9.4 million or 53% over the same period in the prior year. Revenues from the IVD urinalysis segment totaled $7.4 million in the current year, up from $4.8 million in the prior year and included sales of IVD instruments which increased to $2.5 million from

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$584,000, an increase of 335% over the first quarter of 2003. The increase is primarily due to sales of the iQ200, which first became available in the third quarter of 2003. Sales of the iQ200 and the iQ200 systems accounted for over $2.0 million of the instrument sales in the current period. Sales of IVD system consumables and services increased in the quarter to $4.7 million from $4.1 million during the prior year quarter, an increase of $542,000, primarily due to the larger installed base of IVD instruments. Segment revenues also include royalty and license fees, which increased to $186,000 from $130,000 in the comparable period from the prior year. However, we expect that such revenue will significantly decrease during the remainder of the year, as the related licenses will begin to expire. Revenues from the small laboratory devices segment increased to $2.0 million from $1.3 million, an increase of $684,000 or 53%. This increase is primarily due to increased sales of centrifuges, parts and service within this segment.

Gross profit margins decreased to 50% in the first quarter of 2004 compared to 52% in the first quarter of 2003. Cost of goods sold as a percentage of revenues for the IVD urinalysis segment totaled 50%, up from 47% in the prior year. Cost of goods sold for IVD instruments as a percentage of sales was 73% in the current period as compared to 138% last year. The high cost percentage of the prior year period was largely the result of low production levels at that time, which provided a small product volume over which production overhead, including significant start-up costs associated with the iQ200, could be absorbed. In the current period, with production of the iQ200 now fully underway, production overhead was more easily absorbed by the increased product volume, resulting in lower cost of goods sold as a percentage of sales. Cost of goods sold for IVD consumables and services, as a percentage of related sales was 39% for the current period as compared to 36% in the same period last year. This increase is primarily due to the mix of the products sold. Cost of goods for small laboratory instruments segment as a percentage of sales totaled 51% for the current period, as compared to 53% in the first quarter of last year. This decrease is due primarily to efficiencies resulting from higher production runs made possible by the increased sales volume in the current period.

Marketing and selling expenses totaled $1.5 million, compared to $969,000 for the comparable prior year period, an increase of $522,000. The increase is due primarily to $165,000 of additional sales and technical support personnel costs, $63,000 additional travel costs and $87,000 increased commissions due to higher revenues, all associated with the increased sales activity following the launch of the iQ200. In addition, the current period includes $130,000 of costs related to our international offices in Milan and Hong Kong, which had not yet been established in the prior year period. Marketing and selling expenses, as a percentage of net revenues were 16% in the quarter ended March 31, 2004, unchanged from the same period last year.

General and administrative expenses decreased $548,000 to $1.2 million from $1.8 million in the comparable period in the prior year. The decrease includes non-recurring costs of $400,000 incurred in the prior year associated with a management restructuring and a reduction of board related expenses of $76,000 in the current year. General and administrative expenses for the period as a percentage of net revenue were 13% as compared to 29% in the same period in the prior year.

Research and development expenses decreased to $1.1 million for the quarter ended March 31, 2004, as compared to $1.2 million in the first quarter of last year. Total product technology expenditures, which include research and development costs, capitalized software development costs and reimbursed costs under research and development grants and contracts, amounted to $1.2 million, down from $1.5 million in the prior year. This decrease is due primarily to a reduction in the expenditures related to the iQ200, which was released in the third quarter of 2003. We expect to continue to invest in research and development during 2004 at about the same rate as in 2003, with our primary focus being on enhancements to our existing products.

Interest expense decreased to $90,000 in the quarter ended March 31, 2004 from $95,000 in the comparable quarter of the prior year as a result of lower average interest rates.

The income tax provision for the quarter ended March 31, 2004 was an expense of $353,000, as compared to a benefit of $326,000 in the quarter ended March 31, 2003. The change is a function of the taxable income or loss. This tax provision is a non-cash item, since the Company has significant deferred tax assets.

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Contractual Obligations and Contingent Liabilities and Commitments

The following table aggregates the Company’s expected contractual obligations and commitments subsequent to March 31, 2004:

Liquidity and Capital Resources

Our primary source of liquidity is cash from operations, which depends heavily on sales of our IVD urinalysis systems and the subsequent sales of consumables and service for these systems as well as the sale of small laboratory devices and supplies. Cash and cash equivalents amounted to $3.2 million at March 31, 2004; $9.8 million at April 30, 2004, up from $2.4 million at December 31, 2003.

Cash provided by operations for the three months ended March 31, 2004, amounted to $147,000 as compared to cash used in operations of $218,000 in the prior year. The primary reason for this change was due to the fact that we experienced pretax income during the current year’s quarter of $882,000 as compared to a pretax loss of $826,000 during the same quarter of the prior year, a $1.7 million improvement which was offset by a reduction in receivables of $323,000 plus a $1.3 million reduction in accounts payable and accrued expenses.

Cash used in investing activities totaled $155,000 during the first quarter of 2004 as compared to $633,000 used in the same quarter of the prior year. The decrease is due to the reduction in expenditures for property and equipment and capitalized software development from prior year level partially offset by $197,000 realized from the sale of short term investments.

Net cash provided by financing activities amounted to $$780,000 during the first quarter as compared to net cash utilized during the same quarter of the prior year of $172,000. During the current year quarter we borrowed an additional $500,000 under our credit facility primarily to pay outstanding payables and accrued expenses. In addition we received $381,000 from the exercise of stock options during the current quarter.

On April 16, 2004, we signed an agreement with an investment bank for the private placement of 2,130,000 shares of our common stock at $5.85 per share (a 10% discount to market). In addition, each investor received a 5-year warrant to purchase 3 additional shares of common stock at $7.80 per share for each 20 shares of common stock purchased in the offering. The offering agreement required us to file a registration statement which was filed on May 11, 2004 and to have the registration statement declared effective within 90 days of closing (July 21, 2004), registering the shares of common stock sold in the offering plus the shares issuable on the exercise of the related warrants. If the registration statement is not declared effective by July 21, 2004, we will incur a 1.5% monthly penalty payable in cash or stock to the investors in the private placement. We realized net proceeds (after deducting offering expenses) of approximately $11.5 million. We used approximately $5.5 million of the net proceeds to retire all outstanding indebtedness to the bank and the subordinated note holder and added the balance to working capital.

We continue to have a credit facility with a bank, which consists of a $6.5 million credit line matures in June 2004. Borrowings under the line of credit are limited to a percentage of eligible receivables and inventory. Depending on the our debt service coverage ratio, the entire credit facility bears interest at a range between the lender’s prime rate (4.0% on March 31, 2004), or LIBOR rate plus 2.0% and the lender’s prime rate plus 1.0% or LIBOR rate plus 3.0%, and is secured by all of our assets. We are also subject to certain financial covenants under the debt agreement and must maintain a minimum excess borrowing availability of $400,000 under its line of credit. At March 31, 2003, total borrowings under the credit facility with the bank amounted to approximately $4.4 million, which were repaid with the net proceeds of the offering described above. As of March 31, 2004, we were in compliance with all the covenants under the debt agreement.

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Inflation

We do not foresee any material impact on our operations from inflation.

Healthcare Reform Policies

In recent years, an increasing number of legislative proposals have been introduced or proposed in Congress and in some state legislatures that would effect major changes in the healthcare system, nationally, at the state level or both. Future legislation, regulation or payment policies of Medicare, Medicaid, private health insurance plans, health maintenance organizations and other third-party payors could adversely affect the demand for our current or future products and our ability to sell our products on a profitable basis. Moreover, healthcare legislation is an area of extensive and dynamic change, and we cannot predict future legislative changes in the healthcare field or their impact on our business.

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RISK FACTORS

Risks Related to Our Business

Our success depends largely on the acceptance of our new iQ200 operating platform.

Our current strategy assumes that our iQ200 operating platform will be adopted by a large number of end-users. We have invested and continue to invest, a substantial amount of our resources in promotion and marketing of the iQ200 operating platform in order to increase its market penetration, expand its sales into new geographic areas and enhance and expand its system features. A failure of our iQ200 operating platform to achieve and maintain a significant market presence, or the failure to successfully implement our promotion and marketing strategy, will have a material adverse effect on our financial condition and results of operations.

We face intense competition and our failure to compete effectively, particularly against larger, more established companies will cause our business to suffer.

The healthcare industry is highly competitive. We compete in this industry based primarily on product performance, service and price. Many of our competitors have substantially greater financial, technical and human resources than we do, and may also have substantially greater experience in developing products, obtaining regulatory approvals and manufacturing and marketing and distribution. As a result, they may be better able to compete for market share, even in areas in which our products may be superior. Further, our competitive position could be harmed by the establishment of patent protection by our competitors or other companies. The existing competitors or other companies may succeed in developing technologies and products that are more effective or affordable than those being developed by us or that would render our technology and products less competitive or obsolete. If we are unable to effectively compete in our market, our financial condition and results of operations will materially suffer.

We have had a history of declining profitability and recorded an operating loss in 2003. We may incur losses in the future.

We have incurred significant losses since our inception and, as of December 31, 2003, we had accumulated a deficit of approximately $25.0 million. We may not achieve profitability in the future and further losses may arise. Our ability to achieve profitable operations in the future will depend on our ability to sell our products at sufficient volumes and with sufficient margins to be profitable. If we are unable to do so, we will not be profitable and our financial condition and results of operations will suffer.

Our quarterly sales and operating results may fluctuate in future periods, and if we fail to meet expectations the price of our common stock may decline.

Our quarterly sales and operating results have fluctuated significantly in the past and are likely to do so in the future due to a number of factors, many of which are not within our control. If our quarterly sales or operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Factors that might cause quarterly fluctuations in our sales and operating results include the following:

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The amount of expenses we incur depends, in part, on our expectations regarding future sales. In particular, we expect to continue incurring substantial expenses relating to the marketing and promotion of our products. Since many of our costs are fixed in the short term, if we have a shortfall in sales, we may be unable to reduce expenses quickly enough to avoid losses. If this occurs, we will not be profitable. Accordingly, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance.

Our success depends largely on sales of laboratory instruments and related sales of consumables and service contracts.

Historically, we derived most of our revenues from the sale of consumables and service revenue and to a lesser extent from the sale of urinalysis workstations. Modest declines in unit sales of urinalysis workstations or gross margins for this product line could diminish our revenues and profits. In addition, because our installed base of workstations utilize a large annual volume of consumables and produce service revenue, any decline in our installed base will diminish revenues and profits even further.

We rely on independent and some single-source suppliers for key components of our instruments. Any delay or disruption in the supply of components may prevent us from selling our products and negatively impact our operations.

Certain of our components are obtained from outside vendors, the loss or breakdown of our relationships with these outside vendors could subject us to substantial delays in the delivery of our products to our customers. Furthermore certain key components of our instruments are manufactured by single-source suppliers. For example, ARKRAY is the single-source supplier for our new line of urine chemistry analyzers and related consumable products and spare parts. ARKRAY’s AX-4280 Automated Urine Chemistry Analyzer combines with our iQ200 Automated Urine Microscopy Analyzer to constitute our iQ200 system. If we are no longer able to sell ARKRAY’s chemistry analyzer, we will have to replace it with a chemistry analyzer from another source, which could interrupt domestic deliveries of the iQ200 system and have an adverse effect on our results of operations. Roche Diagnostics is the single-source supplier for our proprietary CHEMSTRIP/ IRIStrip urine test strips and related urine test strip readers, both used in the Model 500 and 939UDx urinalysis workstations. Because these suppliers are the only vendors with which we have a relationship for a particular component, we may be unable to sell products if one of these suppliers becomes unwilling or unable to deliver components meeting our specifications. Our inability to sell products to meet delivery schedules could have a material adverse effect on our reputation in the industry as well as our financial condition and results of operations.

One of our single-source suppliers has terminated its agreement with us.

Roche Diagnostics has exercised its right to terminate the agreements relating to the supply of test strips and related urine test strip readers. Roche will continue to supply test strips and replacement readers to our installed base of workstations for six years after termination of these contracts, or 2009. The failure to successfully and timely complete the phase out of their strips and readers with the introduction of our new iQ200 analyzers would have a material adverse effect on our instrument sales and the revenue growth for system supplies and service.

We may need additional capital in the future. If additional capital is not available, we may have to curtail or cease operations.

We have limited capital and will require substantial capital resources to execute our business strategy. We anticipate that if this Offering is fully subscribed, the proceeds from the Offering will be sufficient to fund our operations for at least the next twelve (12) months. This estimate, however, is based upon assumptions that may prove to be wrong. If our assumptions are wrong, we may be required to curtail our operations and/or seek additional financing.

Also, there can be no assurance that all or even a significant portion of the capital sought to be raised in this Offering will be obtained. Any additional equity financings may be dilutive to our existing stockholders and may involve the issuance of securities that have rights, preferences or privileges senior to those of our current stockholders. A debt financing, if available, may involve restrictive covenants on our business that could limit our operational and financial flexibility, and the amount of debt incurred could make us more vulnerable to economic downturns or operational difficulties and limit our ability to compete. Furthermore, financing may not be available when needed and, if available, may not be on terms acceptable to us.

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We operate in a consolidating industry which creates barriers to our market penetration.

The healthcare industry in recent years has been characterized by consolidation. Large hospital chains and groups of affiliated hospitals prefer to negotiate comprehensive supply contracts for all of their supply needs at once. Large suppliers can often equip an entire laboratory and offer these hospital chains and groups one-stop shopping for laboratory instruments, supplies and service. Larger suppliers also typically offer annual rebates to their customers based on the customer’s total volume of business with the supplier. The convenience and rebates offered by these large suppliers are administrative and financial incentives that we do not offer our customers. Our plans for further market penetration in the urinalysis market will depend in part on our ability to overcome these and any new barriers resulting from continued consolidation in the healthcare industry. The failure to overcome such barriers could have a material adverse effect on our financial condition or results of operations.

We operate in a consolidating industry which creates barriers to our market penetration.

The healthcare industry in recent years has been characterized by consolidation. Large hospital chains and groups of affiliated hospitals prefer to negotiate comprehensive supply contracts for all of their supply needs at once. Large suppliers can often equip an entire laboratory and offer these hospital chains and groups one-stop shopping for laboratory instruments, supplies and service. Larger suppliers also typically offer annual rebates to their customers based on the customer’s total volume of business with the supplier. The convenience and rebates offered by these large suppliers are administrative and financial incentives that we do not offer our customers. Our plans for further market penetration in the urinalysis market will depend in part on our ability to overcome these and any new barriers resulting from continued consolidation in the healthcare industry. The failure to overcome such barriers could have a material adverse effect on our financial condition or results of operations.

Business interruptions could adversely affect our business.

Products for Iris Diagnostics and StatSpin are manufactured in a single facility for each division and are vulnerable to interruption in the event of war, terrorism, fire, earthquake, power loss, floods, telecommunications failure and other events beyond our control. If our facilities were significantly damaged or destroyed by any cause, we would experience delays in locating a new facility and equipment and qualifying the new facility with the FDA. Our results would suffer. In addition, we may not carry adequate business interruption insurance to compensate us for losses that may occur and any losses or damages incurred by us could be substantial.

If we are unable to manage our growth, our results could suffer.

We have been experiencing significant growth in the scope of our operations. This growth has placed significant demands on our management as well as operational resources. In order to achieve our business objectives, we anticipate that we will need to continue to grow. If this growth occurs, it will continue to place additional significant demands on our management and our operational resources, and will require that we continue to develop and improve our operational, financial and other internal controls both in the U.S. and internationally. In particular, our growth rate has increased and if it continues to do so, we will face many challenges in implementing appropriate control systems, expanding our sales and marketing infrastructure capabilities, providing adequate training and supervision to maintain high quality standards, and preserving our cultural values. Currently, the main challenge associated with our growth has been cash flow management. Our inability to scale our business appropriately or otherwise adopt to growth would cause our business, financial condition and results of operations to suffer.

Our success depends on our ability to attract, retain and motivate management and other skilled employees.

Our success depends in significant part upon the continued services of key management and skilled personnel. Competition for qualified personnel is intense and there are a limited number of people with knowledge of, and experience in, our industry. We do not have employment agreements with most of our key employees nor maintain life insurance policies on them. The loss of key personnel, especially without advance notice, or our inability to hire or retain qualified personnel, could have a material adverse effect on our instrument sales and our ability to maintain our technological edge. We cannot guarantee that we will continue to retain our key management and skilled personnel, or that we will be able to attract, assimilate and retain other highly qualified personnel in the future.

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Any failure to successfully introduce our future products and systems into the market could adversely affect our business.

The commercial success of our future products and systems depends upon their acceptance by the medical community. Our future product plans include capital-intensive laboratory instruments. There is often market resistance to products that require significant capital expenditures or which eliminate jobs through automation. We have no assurance that the market will accept our future products and systems, or that sales of our future products and systems will grow at the rates expected by our management.

Our sales in international markets are subject to a variety of laws and political and economic risks that may adversely impact our sales and results of operations in certain regions.

Our ability to capitalize on growth in new international markets and to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations. These include:

We are also subject to general political, economic regulatory risks in connection with our international sales operations, including:

Any of the abovementioned factors could adversely affect our sales and results of operations in international markets.

We depend on independent distributors to sell our products in international markets.

We sell our products in international markets through independent distributors. These distributors may not command the necessary resources to effectively market and sell our products. If a distributor fails to meet annual sales goals, it may be difficult and costly to locate an acceptable substitute distributor. If a change in our distributors becomes necessary, we may experience increased costs, as well as substantial disruption and a resulting loss of sales.

If we fail to meet changing demands of technology, we may not continue to be able to compete successfully with our competitors.

The market for our products and systems is characterized by rapid technological advances, changes in customer requirements, and frequent new product introductions and enhancements. Our future success depends upon our ability to introduce new products that keep pace with technological developments, enhance current product lines and respond to evolving customer requirements. Our failure to meet these demands could result in a loss of our market share and competitiveness and could harm our revenues and results of operations.

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Changes in government regulation of the healthcare industry could adversely affect our business.

Federal and state legislative proposals are periodically introduced or proposed that would affect major changes in the healthcare system, nationally, at the state level or both. Future legislation, regulation or payment policies of Medicare, Medicaid, private health insurance plans, health maintenance organizations and other third-party payors could adversely affect the demand for our current or future products and our ability to sell our products on a profitable basis. Moreover, healthcare legislation is an area of extensive and dynamic change, and we cannot predict future legislative changes in the healthcare field or their impact on our industry or our business. Any impairment of our ability to market our products could have a material adverse effect on our financial condition and results of operations.

Since we operate in the medical technology industry, our products are subject to government regulation that could impair our operations.

Most of our products are subject to stringent government regulation in the United States and other countries. These regulatory processes can be lengthy, expensive and uncertain. Additionally, securing necessary clearances or approvals may require the submission of extensive official data and other supporting information. Our failure to comply with applicable requirements could result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices, or criminal prosecution. If any of these events were to occur, they could harm our business. Changes in existing federal, state or foreign laws or regulations, or in the interpretation or enforcement of these laws, could also materially and adversely affect our business.

We are subject to currency fluctuations.

We are exposed to certain foreign currency risks in the importation of goods from Japan The new line of urine chemistry analyzers, some assemblies for our iQ200 platform and related consumables strips and spare parts are sourced from ARKRAY, a supplier located in Kyoto, Japan. Our purchases from this supplier are dominated in Japanese Yen. These components represent a significant portion of our material costs. Fluctuations in the U.S. Dollar/ Japanese Yen exchange rate would result in increased costs for our key components. Any such increases would reduce our gross margins and would be likely to result in a material adverse effect on our revenues and financial condition. Similarly, we are also exposed to currency fluctuations with respect to the exportation of our products. Although our international sales are denominated in U.S. Dollars, we have agreements with our distributors to share fluctuations outside of a certain range in such exchange rates. Accordingly, any fluctuation in the exchange rate between the U.S. Dollar and the currency of the country with which we are exporting products would also reduce our gross margins and would be likely to result in a material adverse effect on our financial condition and results of operations.

Our copyrights and trademarks may not be enforceable.

We claim copyrights in our software and the ways in which it assembles and displays images. We also claim trademark rights in the United States and other foreign countries. However, we can make no assurance that we will be able to obtain enforceable copyright and trademark protection, or that this protection will provide us a significant commercial advantage.

Our products could infringe on the intellectual property rights of others.

Given the complete factual and legal issues associated with intellectual property rights, there can be no assurance that our current and future products do not or will not infringe the intellectual property rights of others. A determination that such infringement exists or even a claim that it exists could involve us in costly litigation and have an adverse effect on our business and financial condition.

We may be subject to litigation regarding our patent and other intellectual property rights.

Offensive or defensive litigation regarding patent and other intellectual property rights could be time-consuming and expensive. Additionally, litigation could demand significant attention from our technical and management personnel. Any change in our ability to protect and maintain our proprietary rights could materially and adversely affect our financial condition and results of operations.

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Any failure or inability to protect our technology and confidential information could adversely affect our business.

Patents. Our commercial success depends in part on our ability to protect and maintain our Automated Intelligent Microscopy (or AIM) and other proprietary technology. We have received patents with respect to portions of the technologies of AIM. However, ownership of technology patents may not insulate us from potentially damaging competition. Patent litigation relating to clinical laboratory instrumentation patents (like the ones we own) often involves complex legal and factual questions. Therefore, we can make no assurance that claims under patents currently held by us, or our pending or future patent applications, will be sufficiently broad to adequately protect what we believe to be our proprietary rights. Additionally, one or more of our patents could be circumvented by a competitor.

Trade Secrets. We have trade secrets, unpatented technology and proprietary knowledge related to the sale, promotion, operation, development and manufacturing of our products. We generally enter into confidentiality agreements with our employees and consultants. However, we cannot guarantee that our trade secrets, unpatented technology or proprietary knowledge will not become known or be independently developed by competitors. If any of this proprietary information becomes known to third parties, we may have no practical recourse against these parties.

We may not be able to realize the deferred tax asset relating to our tax net operating loss carry forward.

As of March 31, 2004, we have deferred tax assets in excess of $8.0 million resulting from the differences between the financial statement and the tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. There is no assurance that we will be able to generate taxable income in the years that the differences reverse.

Defective products may subject us to liability.

Our products are used to gather information for medical decisions and diagnosis. Accordingly, a defect in the design or manufacture of our products, or a failure of our products to perform for the use that we specify, could have a material adverse effect on our reputation in the industry and subject us to claims of liability arising from inaccurate or allegedly inaccurate test results. Misuse of our products by a technician that results in inaccurate or allegedly inaccurate test results could similarly subject us to claims of liability. We currently maintain product liability insurance coverage for up to $1.0 million per incident and up to an aggregate of $2.0 million per year. We also currently maintain a product liability umbrella policy for coverage of claims aggregating to $10.0 million. Although management believes this liability coverage is sufficient protection against future claims, there can be no assurance of the sufficiency of these policies. Any substantial underinsured loss would have a material adverse effect on our financial condition and results of operations. Furthermore, any impairment of our reputation could have a material adverse effect on our revenues and prospects for future business. We have not received any indication that our insurance carrier will not renew our product liability insurance at or near current premiums, however, we cannot guarantee that this will continue to be the case. In addition, any failure to comply with Food and Drug Administration regulations governing manufacturing practices could hamper our ability to defend against product liability lawsuits.

Our business could suffer if we are unsuccessful in integrating business combinations, additional product lines or strategic alliances.

While we have no commitments or agreements to acquire other companies or product lines or enter into strategic alliances, we may pursue acquisitions of companies, additional product lines or enter into strategic alliances. Our ability to grow through acquisitions or strategic alliances depends upon our ability to identify, negotiate, complete and integrate suitable acquisitions or strategic alliance with our current operations. There can be no assurance that we will be able to identify and enter into acquisitions or strategic alliances on acceptable terms. Even if we do so, we may experience: difficulties in integrating any acquired companies, personnel and product lines into our existing business, delays in realizing the benefits of any acquired companies, product lines or strategic alliances, diversion of our management’s time and attention from other business concerns, a higher cost of integration than we expected, assumption of undisclosed liabilities, adverse market reaction, difficulties in retaining key employees who are necessary to manage these acquisitions or alliances and additional risks we may assume in connection with such transactions.

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Risks Related to Ownership of Our Common Stock

Our Certificate of Incorporation and Bylaws could delay or prevent an acquisition or sale of our company.

Our Certificate of Incorporation empowers the Board of Directors to establish and issue a class of preferred stock, and to determine the rights, preferences and privileges of the preferred stock. Our Certificate of Incorporation also prohibits stockholder action by written consent. These provisions give the Board of Directors the ability to deter, discourage or make more difficult a change in control of our Company, even if such a change in control would be in the interest of a significant number of our stockholders or if such a change in control would provide our stockholders with a substantial premium for their shares over the then-prevailing market price for the common stock.

Anti-takeover provisions of Delaware law could delay or prevent an acquisition of our Company.

We are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control transaction. They could also have the effect of discouraging others from making tender offers for our common stock or preventing changes in our management.

Item 3. Quantitative And Qualitative Disclosures About Market Risk.

There was no material change in the Company’s exposure to market risk on March 31, 2004 as compared to its market risk exposure on December 31, 2003. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2003.

Item 4. Controls and Procedures

The Company maintains controls and procedures designed to ensure that it is able to collect the information it is required to disclose in the reports it files with the SEC and to approve, summarize and disclose this information within the time periods specified in the rules of the SEC. The Company’s Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining these procedures, and, as required by the rules of the SEC, evaluate their effectiveness. Based on their evaluation of the Company’s disclosure controls and procedures which took place as of a date within 90 days of the filing date of this report, the Chief Executive and Chief Financial Officers believe that these procedures are adequate and effective to ensure that the Company is able to collect, process and disclose the information it is required to disclose in the reports it files with the SEC within the required time periods.

Changes in Internal Controls

The Company maintains a system of internal controls designed to provide reasonable assurance that transactions are executed in accordance with management’s general or specific authorization; transactions are recorded as necessary (1) to permit preparation of financial statements in conformity with generally accepted accounting principles, (2) to maintain accountability for assets, and (3) to ensure that access to assets is permitted only in accordance with management’s general or specific authorization; and the recorded accountability for access is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.

Since the date of the most recent evaluation of the Company’s internal controls by the Chief Executive Officer and Chief Financial Officers, there have been no significant changes in such controls or in other factors that could have significantly affected those controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, the Company is party to certain litigation arising in the normal course of business. Management believes that the resolution of such matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Item 6. Exhibits And Reports On Form 8-K.[needs to be updated]

(a) Exhibits

(b) Reports on Form 8-K

During the three months ended March 31, 2004, the following Form 8-Ks were filed:

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: May 14, 2004

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