CHROMAVISION MEDICAL SYSTEMS INC, 10-K405/A, 1998-05-05

CHROMAVISION MEDICAL SYSTEMS INC
10-K405/A, 1998-05-05
LABORATORY ANALYTICAL INSTRUMENTS

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

FORM 10-K/A

MARK ONE

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 0-1000

CHROMAVISION MEDICAL SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 75-2649072
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (IRS EMPLOYER
ORGANIZATION) IDENTIFICATION NUMBER)

33171 PASEO CERVEZA
SAN JUAN CAPISTRANO, CA 92675
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

(714) 443-3355
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION
12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION
12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01

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

Indicate by check mark if the 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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K/A or any
amendment to this Form 10-K/A. [X]

Based on the closing sales price of March 24, 1998 the aggregate market
value of the voting stock held by nonaffiliates of the registrant was
$95,614,163.

The number of shares outstanding of the registrant's Common Stock, $.01 par
value was 17,193,629 at March 24, 1998.

DOCUMENTS INCORPORATED BY REFERENCE

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LOCATION IN FORM 10-K/A INCORPORATED DOCUMENT
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Part III: Items 10, 11, 12 and 13 Proxy Statement for 1998 Annual Meeting of Shareholders
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TABLE OF CONTENTS

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PAGE NUMBER
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PART I
Item 1. Business..................................................................... 1
Item 2. Properties................................................................... 14
Item 3. Legal Proceedings............................................................ 14
Item 4. Submission of Matters to a Vote of Security Holders.......................... 14

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........ 15
Item 6. Selected Financial Data...................................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................... 16
Item 7a. Quantitative and Qualitative Disclosures About Market Risk................... 19
Item 8. Financial Statements and Supplementary Data.................................. 20
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................... 35

PART III
tem 10. Directors and Executive Officers of the Registrant........................... 35
tem 11. Executive Compensation....................................................... 36
tem 12. Security Ownership of Certain Beneficial Owners and Management............... 36
tem 13. Certain Relationships and Related Transactions............................... 37

PART IV
tem 14. Exhibits, Financial Statement Schedules, and Reports of Form 8-K............. 37
SIGNATURES
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Statements in this report describing the plans, goals, strategies,
intentions, and expectations of the Company and anticipated events are
forward-looking statements. Important factors which could cause actual results
to differ materially from those described in such forward-looking statements
include the following: an inadequate supply of biological samples could delay
completion of the clinical trials; the clinical trials could fail to demonstrate
the efficacy of the ChromaVision Automated Cellular Imaging System ("ACIS")
applications; the ability to commercialize the Company's products is dependent
on obtaining appropriate U.S. Food and Drug Administration (the "FDA") and
foreign regulatory approvals, which may not be obtained when anticipated or at
all; manufacture of the ACIS is subject to FDA regulation; commercialization of
the Company's products is dependent on acceptance by the medical community and
medical insurance industry, which acceptance could be delayed or not obtained;
and an adverse determination in the Company's pending intellectual property
litigation could materially adversely affect the Company's ability to
commercialize its first proposed application.

PART I

ITEM 1. BUSINESS

ChromaVision is a laboratory medicine diagnostics company that develops and
manufactures an automated cellular imaging system for a wide variety of clinical
and research applications. The Company currently markets the system to research
centers and is previewing the system to university medical centers and
commercial laboratories in anticipation of receiving clearance from the FDA
based on two filings expected to be made in 1998, which could result in several
commercialized applications. The ChromaVision ACIS(TM) is designed to identify
cells with specific characteristics within a sample of cells on a microscope
slide by detecting color produced by the reaction between common laboratory
reagents and the cells of interest. The intelligent microscope platform
automates the scanning of up to 100 patient samples (slides) and uses
proprietary imaging software to capture digital images of the cell samples to
detect the presence, count the number and measure the intensity of targeted
cells. The system offers substantial flexibility because the software can be
configured to identify different stains and cellular staining characteristics,
thereby allowing the system to be adopted for use with different reagents to
identify a broad range of targeted cellular conditions. The Company seeks to
establish the ChromaVision ACIS as the preferred platform for multiple
diagnostic applications.

The Company believes that the ChromaVision ACIS will be attractive to
healthcare providers and beneficial to their patients because of its ability to
deliver superior diagnostic solutions, thus reducing the need for more invasive
or more costly procedures. Preliminary tests have demonstrated superior accuracy
compared to other existing techniques used in rare event detection, such as
polymerase chain reaction ("PCR") and flow cytometry, because the ChromaVision
ACIS can locate a single abnormal cell among 120 million normal cells. This
improved detection capability enables the ChromaVision ACIS to be applied to a
variety of diagnostic situations, such as high-value rare event detection
procedures, which include the detection of minute quantities of cancer cells
that have spread to parts of the body away from a tumor's primary location.

The Company has identified a broad range of potential applications for the
ChromaVision ACIS, including quantitative viral load measurement, cancer
evaluation and prenatal screening for Down syndrome. The Company focuses on
developing diagnostic applications that are clinically and economically
compelling to patients, providers (laboratories) and payors (insurance and
managed care organizations). The Company has completed clinical trials and has
received 510(k) clearance from the FDA to market the ChromaVision ACIS with a
stain (marker) to screen blood for malignancy. The Company plans to expand this
clearance for a higher-value use of the ChromaVision ACIS in an application
called Triple Plus(TM), a procedure using a related cytochemical measurement as
a marker in the prenatal screening of maternal blood for indicating the risk of
Down syndrome in fetuses.

INDUSTRY OVERVIEW

The healthcare industry, for which total expenditures in the United States
are estimated to have exceeded one trillion dollars in 1996, is experiencing a
shift from predominantly a fee-for-service system to a managed care system. The
pricing structure under the managed care system is based on "firm-fixed"
pricing, as compared to the "cost-plus' pricing under the fee-for-service
system. This change in pricing structure is effectively shifting much of the
economic liability for healthcare from employers and individuals to insurance
companies, healthcare delivery systems, hospitals and physicians. Unlike the
fee-for-service system, in which each diagnostic examination and each treatment
procedure results in a fee, the cost of many diagnostic examinations and
treatment procedures is not directly reimbursable under the managed care system,
which in turn results in reduced revenue and lower profits for healthcare
providers as service utilization increases. Consequently, healthcare providers
are increasingly seeking more efficient and

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more accurate methods of disease diagnosis in order to improve patient care and
eliminate many unnecessary and costly examinations and procedures.

A critical aspect in the diagnosis of many diseases and genetic disorders is
the detection of abnormal cells, or cells and organisms with specific
characteristics, during a microscopic examination of biological specimens taken
from patients. Estimates place the number of diagnostic procedures performed in
the United States at over one billion per year. The biotechnology industry has
responded to this opportunity by rapidly developing a growing number of highly
specific and increasingly sensitive reagents which are used to treat biological
specimens to highlight targeted cellular characteristics. Currently, the cell
detection process in the vast majority of microscopic examinations is performed
manually by a trained technologist or physician. Manual microscope examinations
are currently being performed in approximately 10,800 clinical laboratories in
the United States, and approximately 31,000 clinical laboratories worldwide.

The ability of the microscopist to accurately examine a slide containing the
specimen is generally accepted as extremely difficult to accomplish without
error by even the most skilled technologist or physician. The difficulty of a
technologist's or physician's task is compounded by the need to examine high
volumes of slides on a daily basis.

THE CHROMAVISION ACIS ADVANTAGE

The ChromaVision ACIS is a fully automated, computer-based microscope
designed to detect and count cells based on color and measure specific
diagnostic characteristics of rare cellular events. The ChromaVision ACIS is
designed to enable diagnostic procedures that would be impractical or impossible
by using manual methods. Additionally, the Company believes that the
ChromaVision ACIS can replace the most time consuming and costly part of many
manual microscopic procedures as a result of its ability to scan large amounts
of biological material quickly, accurately and consistently with minimal
operator supervision. The Company believes that the ChromaVision ACIS will
enable healthcare providers to improve the consistency and accuracy of patient
diagnosis, enhance overall patient care and lower costs. The key benefits of the
ChromaVision ACIS include:

Superior Solutions at Lower Cost. The Company believes that the increased
speed and accuracy of the ChromaVision ACIS will lower healthcare costs by
enabling better and more timely diagnoses, which will enable healthcare
providers to avoid more expensive and typically invasive procedures.
Furthermore, as a highly automated system, the ChromaVision ACIS is capable of
operating continuously with limited human supervision and maintenance. The
Company believes that the ChromaVision ACIS can significantly improve the speed,
accuracy and consistency of laboratory results by automating certain steps
involved in the basic microscopic procedure, such as the loading, positioning,
focusing, identification, quantification and scanning of slides thereby enabling
labs to provide superior service to physicians, hospitals and healthcare
systems. The ChromaVision ACIS can automatically scan and process up to 100
slides while operating unattended. As each slide is processed, the ChromaVision
ACIS automatically stores the coordinates of each targeted cell or object
enabling the subsequent examination of cells on the slide, or a stored digital
image of the cell on a computer monitor. The instrument can simultaneously
quantify cell and color characteristics that have prognostic and diagnostic
significance. The ChromaVision ACIS enables diagnosticians to quickly and
efficiently arrive at accurate diagnoses by reviewing relevant data or stored
images of the cells which have been automatically captured, analyzed and stored.

Improved Sensitivity and Accuracy. The ChromaVision ACIS employs
sophisticated proprietary software and algorithms capable of advanced color
detection to identify abnormal cells, specific cells and other objects of
interest using common laboratory stains. The instrument relies on the inherent
sensitivity and specificity of the color characteristics of the reagent reaction
product used in a particular application. This internally developed proprietary
technology was invented by scientists experienced in satellite-based imagery,
reconnaissance and aerial imagery, and complex color space transformations which
are used to yield maximum detail from image-based data. Because of the
sophistication of these software programs and algorithms, the ChromaVision ACIS
technology provides enhanced detection sensitivity for use in clinical
applications. The ChromaVision ACIS can rapidly scan large fields of view at low
magnification to detect the presence of specific color characteristics and then
return under high magnification to capture and store the targeted cells. By
contrast, morphology-based microscopes require higher resolution imaging and are
inherently more complex than the ChromaVision ACIS due to the need to carefully
scrutinize each cell for subtle differences in morphology.

Preliminary tests using specific color-yielding reagents have shown that the
ChromaVision ACIS is capable of consistently detecting one abnormal cell in a
population of 120 million normal cells during "spiking" experiments in which a
known number of malignant cells were mixed with a known quantity of normal
cells. In addition to highly sensitive detection, the Company's advanced
technology can quantify the color characteristics of each targeted cell, thereby
enabling the measurement of the likelihood or severity

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of the disease or condition. Through this capability, the Company believes that
the ChromaVision ACIS can enhance the speed, accuracy and consistency of test
results, thus leading to improved overall patient care and reduction in the
liabilities associated with diagnostic errors. In certain cases, the use of less
sensitive systems which are incapable of detecting conditions in which an
extremely limited number of abnormal cells are present (rare event detection),
can result in false negative diagnoses. In contrast, the ChromaVision ACIS is
capable of extremely high levels of sensitivity making significantly more
reliable "rare event detection" possible. For example, the Company believes that
the superior accuracy and precision of the ChromaVision ACIS can be effectively
used to detect cases of "micrometastases" in patients with previously
undiagnosed and untreated conditions, and "minimal residual disease" in patients
with previously diagnosed and treated conditions, such as cancer. Both of these
conditions are characterized by minute quantities of tumor cells which have
spread to other distant parts of the body away from the tumor (e.g., bone
marrow).

The Company believes that the ChromaVision ACIS's sensitivity and accuracy
will facilitate not only better diagnoses, but better patient outcomes as well.
In particular, the Company believes that the speed, accuracy and consistency of
the ChromaVision ACIS can be valuable in aiding researchers and diagnosticians
in characterizing the degree to which cancer has either been contained
(localized) or spread to distant locations (metastasized) in a patient. This
characterization process, known as "cancer staging" is often dependent upon
finding relatively small numbers of tumor cells among large numbers of normal
cells in various samples including peripheral blood, bone marrow, lymph nodes
and other tissues. The Company believes that the ChromaVision ACIS has the
ability to detect cancer cells from a wide variety of locations and samples
within patients, and in turn will become a valuable tool in the staging process.

Adaptable Platform For Expansion. The Company's technology supports a
variety of established reagents and stains, and as a result the Company believes
its technology can be readily adapted for use in multiple applications. To the
extent new reagents and stains are introduced, the ChromaVision ACIS is designed
to be "reconfigured" to detect new colors. The ability to add new applications
can further increase cost savings for healthcare providers and patients by
minimizing the need for specialized machines performing individual procedures.
The Company believes these capabilities will enable the ChromaVision ACIS to
penetrate potential markets quickly and will enable the Company to commercialize
a broad spectrum of healthcare markets.

Information System Integration. Recently, healthcare providers have begun to
develop information system technologies capable of providing patient-focused
data in a format known as the Computerized Patient Record. Microscopy is one of
the last systems within medical technology to be integrated into such
patient-focused information systems. The Company has designed the ChromaVision
ACIS to capture, store, display and print cellular images and related data in
digital format, which can be integrated into the Computerized Patient Record. As
a result, this portion of patient data may be stored, retrieved, printed or
displayed across local and wide area networks. The Company believes that
providing for more timely, improved diagnostics and collaboration consistent
with the emerging trends in medical technology can result in significantly
enhanced patient care.

STRATEGY

The Company seeks to introduce selected "high-value" applications on the
ChromaVision ACIS and develop a foundation from which to establish the
ChromaVision ACIS as the preferred platform for multiple microscopic diagnostic
applications. The Company plans to pursue this objective through the following
strategic initiatives:

Deliver Value Through Superior Diagnostic Solutions. ChromaVision intends to
offer the ChromaVision ACIS based applications with the specific goal of
enabling clinical laboratories to deliver value to healthcare providers through
superior diagnostic solutions. The Company believes that the ChromaVision ACIS
can provide value to all of the constituents of the healthcare industry by (i)
detecting disease sooner (rare event detection) and thereby enabling the
appropriate treatment, (ii) monitoring therapeutic response, (iii) employing an
adaptable platform which supports multiple applications to achieve
cost-effectiveness, (iv) eliminating costly and invasive procedures and (v)
improving throughput with consistent and rapid results. Consequently, the
Company believes it is well-positioned to benefit from the increased emphasis on
cost and quality driven by both healthcare providers and patients.

Cancer, Infectious Disease and Genetically Based Abnormalities Applications.
ChromaVision intends to pursue applications for the ChromaVision ACIS technology
in the diagnosis of breast, prostate, lung, colorectal and other cancers, as
well as infectious agents, genetically-based abnormalities and other diseases.
Because the underlying technology used in the ChromaVision ACIS is based on
color detection, the ChromaVision ACIS offers significant flexibility to aid in
the diagnosis and treatment of multiple diseases. Furthermore, the Company
believes that the ChromaVision ACIS may be effectively used in the
identification of abnormal cells or cells with specific characteristics within a
wide variety of sample types including blood, sputum, bone marrow, tissue and
fine

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needle aspirates. The Company will continue to devote significant time and
resources developing certain of these applications, including those related to
the evaluation of cancer pervasiveness and avoidance of unnecessary invasive
procedures. In addition, the Company also intends to examine market
opportunities for an enhanced ChromaVision ACIS architecture with "front-end"
slide preparation handling components and "back-end" information system
interfaces. See "Business -- Other Potential Applications."

ChromaVision is in clinical trials utilizing the ChromaVision ACIS for
prenatal screening of maternal blood indicating the risk of Down syndrome in
fetuses. In 1990, pilot tests indicated that UR-NAP screening could increase the
detection rate while significantly reducing the occurrence of false positives
from the current Triple Screen test. One conclusion drawn from these pilot
tests, however, was that the commercialization of the UR-NAP application was not
feasible without the development of an automated microscope because of the
impractical and subjective nature of the manual examination for UR-NAP. The
Company is conducting multi-center clinical trials with the initial investigator
of the pilot study using the ChromaVision ACIS technology to evaluate the
utility of Triple Plus(TM) for commercial use. The Company estimates that this
enhanced screening test could lead to cost savings of approximately $85 million
per year as a result of the elimination of as many as 85,000 amniocentesis
procedures in the United States alone. The Triple Plus(TM), which the Company
believes will enhance the widely used Triple Screen, was chosen as the initial
application for the ChromaVision ACIS to pursue near term market acceptance due
to the significant improvement in predictive value and dramatic reduction in
costly and potentially dangerous amniocenteses. Additionally, this application
is particularly attractive as an entry into the automated microscopy market due
to the relatively concentrated distribution of laboratories currently performing
the Triple Screen test. The Company estimates that in the United States, up to
70% of all Triple Screen tests are provided by five laboratory enterprises, and
the balance are provided by an additional 200 hospital-based laboratories. The
Company believes that this concentration of users is ideal for rapid penetration
into the market. The Company further believes that similar market demographics
in Europe also make Triple Plus(TM) an ideal initial application for developing
international markets for the ChromaVision ACIS. In conjunction with its sales
effort, the Company intends to create awareness with obstetricians and
gynecologists on the clinical efficacy, safety and economic value of Triple
Plus(TM) through peer-reviewed publications, selected involvement in clinical
trials and other appropriate educational materials in order to facilitate
worldwide market acceptance. See "Business -- ChromaVision ACIS Applications --
Triple Plus(TM) Application."

Implement "Per Click" Pricing. ChromaVision believes that, by providing
laboratories with the ChromaVision ACIS on a "per click" basis, the Company will
be able to introduce its color-based technology to its targeted markets rapidly
and enhance its long-term revenue potential. The Company believes that
laboratories will be more willing to adopt the ChromaVision ACIS if they are
required to pay only for system usage, rather than commit the capital required
for the purchase of a full system. The "per click" pricing model also includes
all necessary operator training, maintenance and system upgrades. Using a "per
click" approach allows the Company to better monitor and control the use of its
technology to ensure proper use, obtain customer feedback and implement product
upgrades, including new applications.

Form Strategic Alliances. ChromaVision intends to develop and pursue new
applications for the ChromaVision ACIS system through strategic alliances. The
Company is seeking to form strategic alliances with reagent manufacturers,
researchers and other third parties to market reagents using the ChromaVision
ACIS as the platform of choice for the detection and quantification of such
reagents. These application specific alliances will focus on integrating the
reagents and other color-based detection probes with the ChromaVision ACIS
platform in a manner which provides quality and economic value to patients,
laboratories and healthcare payors. In addition, the Company intends to enhance
its distribution capabilities through alliances.

The Company initially plans to work directly with its clinical collaborators
to gain acceptance in the medical community for the Triple Plus(TM) procedure.
However, in capturing market share for this application and pursuing other
applications in which distribution would be more widely disbursed, the Company
intends to pursue relationships with third parties capable of effectively
distributing ChromaVision ACIS and providing related services on a large-scale
basis. The Company believes that such alliances will enable it to minimize
certain risks related to the time, effort and expenses associated with the
internal development of similar distribution capabilities, particularly for
international markets. The first application alliance is with Sigma Diagnostics
Inc., a St. Louis based diagnostic instrument and reagent manufacturer with a
worldwide distribution capability. In October 1997, the Company signed an
exclusive distribution and development agreement with Sigma Diagnostics for
prenatal screening for Down syndrome. The Company believes that each new
application alliance can provide value to all other ChromaVision application
collaborators as new applications will drive new platform installations, and in
turn make the ChromaVision ACIS an increasingly attractive means to access the
marketplace. See "Business -- Strategic Alliances."

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Expeditiously Gain Necessary Regulatory Clearances. The Company has obtained
its first 510(k) clearance from the FDA to market the ChromaVision ACIS with an
NAP marker to screen blood for malignancy.

CHROMAVISION ACIS APPLICATIONS

The Company believes that its technology can be used in the identification
of abnormal cells within blood, sputum, bone marrow, tissue, fine needle
aspirates and other sample types and may be used to aid in the diagnosis of
breast, prostate, lung, colorectal and other cancers, as well as infectious
agents, genetically based abnormalities and other diseases. The following are
the initial target applications being pursued by the Company:

CANCER APPLICATIONS

The Company is currently evaluating the use of the ChromaVision ACIS for
various cancer applications including prostate, breast, lung and colorectal
cancer. The applications currently in clinical trials are referred to as
micrometastases ("MM"), minimal residual disease ("MRD") and hematologic
malignancies. Scientists researching MM and MRD during the last 15 years have
had to employ manual microscopy to test samples from patients with many forms of
cancer. Researchers attempting to detect and quantify MM or MRD seek to address
issues such as the location and pervasiveness of various forms of cancer, and
the effectiveness of treatments in preventing the relapse of a disease.
Typically, MM and MRD require the search for a few tumor cells on slides with
potentially one million or more cells and the tedious manual examination
required for such diseases may hinder clinical acceptance and usefulness of test
procedures. The Company believes that the speed, accuracy and consistency made
possible by the ChromaVision ACIS can have a material impact on addressing
clinical issues such as the location and pervasiveness of various forms of
cancer, and further, can hasten the clinical practicality and acceptance of the
procedure. Such information is important during the on-going monitoring of a
patient's condition as it may contribute to the categorization or "staging" of
the cancer's status. This monitoring and staging procedure is generally regarded
as necessary to prescribing appropriate treatments. Preliminary results from
tests conducted at the Kenneth Norris Cancer Center, at the University of
Southern California and at the University of Rotterdam (Netherlands) indicate
that the ChromaVision ACIS may be useful in MM and MRD applications, and the
Company believes that the ChromaVision ACIS may make MM and MRD applications
practical on a broader scale than had previously been possible.

Recent studies have demonstrated that finding tumor cells in bone marrow
biopsies is a valuable prognostic tool for predicting the risk of cancer
recurrence in patients with early stage breast cancer. In these studies, tumor
cells were detected in 31% of patients who had no tumor cells in their lymph
node glands at the time of surgery. Consequently, those patients who had no
tumor cells in their lymph nodes would have been presumed to have no additional
disease present, even though 31% of the time a bone marrow diagnosis would have
found tumor cells indicating that their disease had spread outside of the
breast. The finding of tumor cells in bone marrow of patients with no tumor in
their lymph nodes suggests that these patients should receive additional
treatment. In fact, among patients with tumors less than two centimeters, tumor
cells in bone marrow were the most powerful predictor of outcome. The Company
believes that its preliminary studies indicate the potential for the
ChromaVision ACIS device to make micrometastases examinations practical in the
clinical arena and to reduce cost, increase accuracy, reproducibility and
sensitivity as compared to manual screening.

BLOOD AND LYMPH NODE MALIGNANCIES

Malignancies involving blood and lymphoid tissue are called leukemias and
lymphomas, respectively. In 1996, 27,600 new leukemia cases and 74,600 new
lymphoma cases occurred in the United States (U.S.). Proper treatment of these
patients requires classification of these leukemias and lymphomas into specific
subtypes to determine proper therapy. Manually identifying special stains on
slides or using automated technology known as flow cytometry are two methods
most commonly used to assist sub-typing these tumors. The former is manual and
the latter is expensive, complex and destructive of the specimen. Alternatively,
the ChromaVision ACIS can enhance and automate these determinations without
destroying the specimen and does not require expensive maintenance or personnel.

QUANTITATIVE VIRAL LOAD (HIV, HPV, CMV)

The Center for Disease Control estimates that approximately 1,000,000
Americans are currently infected with HIV, the virus responsible for Acquired
Immune Deficiency Syndrome (AIDS). Early studies quickly identified the value of
following the levels of certain types of blood cells, known as CD4 and CD8
T-cells, to predict patient prognosis. The absolute level of CD4 T-cells and the
ratio of CD4 to CD8 T-cells are markers of disease progression and prognosis.
The determination of these markers currently requires

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flow cytometry and hematology analyzers. More recent studies have demonstrated
the value of directly measuring the amount of virus in the bloodstream to
predict disease progression and monitor therapy. However, most of the virus is
inside cells and current methods only measure virus that is shed into the blood
fluid. The ChromaVision ACIS can perform viral load quantification at the
cellular level and simultaneous CD4 and CD8 T-cell determinations, allowing more
accurate assessment of prognosis and therapeutic response. The technology also
has application to cervical cancer screening by identifying and quantifying
certain types of Human Papilloma Virus (HPV) in cervical cells that are
associated with a high risk of progression to cervical cancer. Cytomegalovirus
(CMV) is a virus that can cause blindness in immune deficient patients. CMV
serum markers are unreliable in diagnosing active disease and only demonstration
of actual virus in cells justifies treatment to be initiated.

TRIPLE PLUS(TM) APPLICATION

The Company is currently in clinical trials utilizing the ChromaVision ACIS
for the Triple Plus(TM) application. Through its use in prenatal screening,
women who are at high risk of a Down syndrome pregnancy will be more effectively
identified for a diagnostic amniocentesis. The Triple Plus(TM) test makes use of
the cytochemical marker UR-NAP either alone or in combination with one or more
of the biochemical components of the current Triple Screen. Triple Plus(TM) is
intended to become the successor to the Triple Screen test, which is currently
the most commonly used prenatal screen of maternal blood to indicate the degree
of risk of carrying a fetus affected with Down syndrome. The Triple Screen test
is considered to be the "standard of practice" for pregnant women under the age
of 35 years, and the Company believes that it is performed approximately 2.5
million times per year in the United States and approximately 6 million times
per year worldwide. Based on the age of the patient and the results of the
Triple Screen test, the patient is evaluated for the need of undergoing an
amniocentesis to diagnose a Down syndrome fetus. Down syndrome risk estimates
are currently derived by a complex mathematical process that combines results of
the Triple Screen with the known odds of a Down syndrome fetus based on maternal
age. The combined risk indicates likelihood of Down syndrome affecting a
pregnancy, and thus the need for amniocentesis. Approximately 85% of the
patients identified as patients with a high risk pregnancy by the Triple Screen
test choose to undergo amniocentesis.

Cambridge University (Addenbrooke Hospital, Cambridge, England) is leading
multi-site clinical trials with participants including Genzyme Genetics and the
State of California Prenatal Testing Program (Berkeley) to evaluate the Triple
Plus(TM) test. This new test is designed to improve the existing predictive
value and to significantly lower the overall false positive rates in initial
screens for Down syndrome. Clinical trials have begun using samples collected at
more than a dozen sites worldwide. Delays in clinical trials could occur, and
there is no assurance that this application will successfully develop.

OTHER POTENTIAL APPLICATIONS

The Company is evaluating the potential use of the ChromaVision ACIS in
other applications, including colon cancer (133,500 new cases per year in the
U.S.), lung cancer (177,000 new cases per year in the U.S.), blood screening for
various contaminants and mycobacteria (tuberculosis). As with all applications,
the Company intends to employ the ChromaVision ACIS color detection as the
primary means of cellular detection. While the Company believes that the
ChromaVision ACIS may be effective for these potential applications, additional
tests are required to address the clinical efficacy, value propositions,
regulatory requirements and other issues associated with each application. There
can be no assurance that the Company will successfully develop the ChromaVision
ACIS for any of these applications.

THE CHROMAVISION AUTOMATED CELLULAR IMAGING SYSTEM TECHNOLOGY

The ACIS technology was developed at XL Vision, Inc., a Florida-based
developer of application specific electronic imaging systems. In 1996, XL Vision
organized ChromaVision to develop and commercialize ACIS.

Software. The technology underlying the ChromaVision ACIS is the Company's
internally developed software which enables it to detect colored objects (i.e.
stained cells) dramatically better than the human eye and with greater accuracy
and sensitivity than morphology-based automated systems. The Company's software
utilizes advanced imaging concepts referred to as "color spaces" and "color
space conversion." In this manner, the ChromaVision ACIS reduces the cell
detection problem to finding bright objects on a dark background. The
ChromaVision ACIS's ability to locate stained objects is not limited to any
specific reagent color nor is it affected by the brightness of the background.
Additionally, the sophisticated autofocus algorithms, fast image acquisition and
proprietary color space transformations occur at rapid processing speeds,
thereby making possible rare event detection and "imaging on the fly."

<PAGE> 9
Hardware. The hardware components used in the ChromaVision ACIS consist
primarily of (i) an optically superior visible light microscope, (ii) a color
CCD camera, (iii) an automated, precision robotics slide transport system, (iv)
a central processor unit with a specialized image processor subsystem and (v)
system interfaces including a monitor, trackball or mouse, keyboard, serial
dial-up and local area network ports and color printer. The Company employs a
development and manufacturing strategy which uses state of the art components
which are generally available off-the-shelf to make development, service and
upgrades less costly.

The ChromaVision ACIS is designed to enable a laboratory technician to
operate the system using simple "point and click" commands. The system interface
includes one monitor for system commands and status, and one monitor for viewing
high quality color images of the cells. Initial setup of the system is
configurable through extensive preference and configuration menus so that
scanning magnifications, stain types and other operations may be tailored to the
application.

During normal operation, a laboratory technologist mounts prepared
microscope slides onto a specially designed slide carrier, which has the
capacity to hold up to four slides. Up to 25 slide carriers can be loaded into
the ChromaVision ACIS slide transport system. The operator may specify the size,
shape and location of the area on the microscope slide to be scanned or
alternatively, the system will automatically locate the relevant area. The
scanning process begins with the automatic loading of the first carrier of
slides onto the microscope stage. During this stage of the process, the
ChromaVision ACIS automatically reads bar codes affixed to the slides to
facilitate patient data storage and access. During scanning, the ChromaVision
ACIS automatically focuses each field of the object, images the object using the
CCD camera and processes the resulting digital image through the image
processor. Slides are then scanned at a "low" optical magnification (typically
20x objective) to identify objects of interest based primarily on their color
characteristics. The locations of suspected cells are stored until scanning is
completed. When the "low" power scanning is completed, the system automatically
returns to each suspected object, re-images it at "high" power (typically 60x
objective), verifies that it is a proper cell candidate, and stores a digital
image of the cell for scoring and later review by the laboratory technician or
pathologist.

After scanning is completed, the operator is able to view a montage of all
stored images for interpretation of the detected objects, along with
quantitative information, such as the number of objects detected. If desired,
the operator may also directly view a detected object through oculars using the
ChromaVision ACIS's automatic repositioning feature, which automatically
repositions the slide according to the previously stored cell coordinates. Upon
completion of this review, a report containing relevant images identified by the
ChromaVision ACIS may be printed. Images may be saved on a removable hard disk,
optical disk or archived on magnetic tape. The ChromaVision ACIS can be
configured to support the transmission and reception of images via local area
network and wide area network communications facilities, including the Internet.
The Company believes that by presenting clinical information in a digital
format, including relevant cell images, the ChromaVision ACIS is potentially
capable of integrating cell-based laboratory information with Computerized
Patient Records.

PATENTS AND PROPRIETARY TECHNOLOGY

Substantial elements of the hardware component of the Company's ChromaVision
ACIS were initially developed by XL Vision for Intelligent Medical Imaging, Inc.
("IMI"). Pursuant to an agreement with IMI, XL Vision assigned ownership of the
technology underlying those hardware elements to IMI, subject to a perpetual,
transferable, non-exclusive, fully paid-up license to XL Vision to use, develop
and sell such technology. At the inception of the Company, XL Vision transferred
this license to the Company.

The Company's commercial success will depend in part on its ability to
protect and maintain its proprietary technology and to obtain and enforce
patents on its technology. The Company has applied for two patents with the U.S.
Patent and Trade Mark Office (PTO) regarding certain aspects of the ChromaVision
ACIS software technology. There can be no assurance that any patent will be
issued. The Company is not aware of any patents held by others that would
prevent the Company from manufacturing and commercializing ChromaVision ACIS in
the United States and abroad. However, the Company has not performed an
exhaustive worldwide search. There can be no assurance that any patent
applications filed by the Company will result in the issuance of patents or that
any patents issued to the Company will afford protection against competitors
that develop similar technology, or that a competitor will not reverse-engineer
the Company's software. On November 10, 1997 the Company responded to certain
claims of patent infringement and disparaging statements made by IDEA Research
LLC ("IDEA Research") about the Company and its microscope systems by commencing
litigation against IDEA Research in the federal district court in Santa Ana,
California seeking a determination by the court that the Company's automated
microscope systems do not infringe certain patent rights of IDEA Research. See
Item 3 (Legal Proceedings) for further discussion.

<PAGE> 10
The Company currently relies on a combination of trade secrets, proprietary
knowledge, technological advances and disclosure, confidentiality and
non-competition agreements entered into with its employees and certain
consultants to protect its proprietary rights. No assurance can be given that
the Company's efforts will provide meaningful protection for its un-patented
proprietary technology against others who independently develop or otherwise
acquire substantially equivalent technologies or gain access to misappropriate
or disclose the Company's proprietary technology.

There can be no assurance that other parties will not in the future make
claims or threaten to take legal action against the Company alleging
infringement of patents by the Company. The medical device industry has been the
subject of extensive litigation regarding patents and other rights. Patent
litigation can be costly and time consuming, and there can be no assurance that
the Company's litigation expenses will not increase in the future. If the
Company were determined to be infringing any patent, the Company could be
required to pay damages, alter its products or processes, obtain licenses and/or
cease certain activities. In addition, if patents are issued to others which
contain claims that cover subject matter made, used or sold by the Company, the
Company may be required to obtain licenses to these patents, to develop or
obtain alternative technology or to cease using such technology. If the Company
is required to obtain any licenses, there can be no assurance that the Company
will be able to do so on terms acceptable to the Company, if at all. A
determination that the Company is infringing the patents of others could have a
material adverse effect on the Company's business and results of operations.

MARKETING

The Company intends to focus its marketing efforts on independent reference
laboratories, hospital laboratories and Health Maintenance Organization
laboratories by offering the ChromaVision ACIS on a "per click" basis. This
strategy is intended to simplify customer procurement decisions, facilitate the
introduction of new diagnostic tests as they become available and develop
recurring revenue for the Company.

Currently, the Company intends to market and distribute its Down syndrome
screening product (Triple Plus(TM)), through an agreement with Sigma
Diagnostics, Inc. ("Sigma"). Sigma has a worldwide distribution and service
capability in conjunction with its parent, Sigma-Aldrich. The Company believes
that significant advantages exist as a result of its relationship with Sigma,
which will greatly enhance the time to market and reduce the cost of sales. The
current Triple Screen application is performed by a relatively concentrated
market. The Company estimates that in the United States, approximately 70% of
all tests are performed by five laboratory enterprises. An additional 30% of the
tests are performed at approximately 70 hospital laboratories. Similar
characteristics exist for the European countries. The Company believes that
these market characteristics make the Triple Plus(TM) test the ideal application
to introduce the ChromaVision ACIS device to the healthcare market and to use as
a platform to subsequently launch follow-on applications.

The Company intends to broaden the applicability of the ChromaVision ACIS as
the market recognizes the system's ability to operate effectively in identifying
rare events and the resulting reduction in costs associated with more timely and
cost-effective treatments. Additionally, the Company believes that the expected
improvement in patient outcomes generated by the ChromaVision ACIS will
eventually be viewed as giving managed care providers a strategic advantage in
their effort to attract more subscribers based on superior quality of care.

STRATEGIC ALLIANCES

As part of its business strategy, the Company intends to develop and pursue
new applications for the ChromaVision ACIS product and enhance its distribution,
marketing and manufacturing capabilities through strategic alliances. These
application-specific alliances will focus on integrating the reagents and other
color-based detection probes with the ChromaVision ACIS platform in a manner
which provides quality and economic value to patients, laboratories and
healthcare payors. The Company is seeking to form strategic alliances with
reagent manufacturers, researchers and other third parties under which the
ChromaVision ACIS will be used as the platform of choice for the detection and
quantification of such reagents. The Company believes that each new application
alliance can provide value to all other ChromaVision application partners as new
applications drive new platform installations, and in turn make the ChromaVision
ACIS an increasingly attractive means to access the marketplace for new
applications.

The Company initially plans to work directly with its clinical collaborators
to gain acceptance in the medical community for the Triple Plus(TM) procedure.
In order to capture market share for this application and other applications in
which distribution would be more widely disbursed, the Company intends to pursue
relationships with third parties capable of effectively distributing the

<PAGE> 11
ChromaVision ACIS and providing related services on a large-scale basis. The
Company believes that such alliances will enable it to minimize certain risks
related to the time, effort and expenses associated with the internal
development of similar distribution capabilities, particularly for international
markets.

In October 1997, the Company negotiated a worldwide distribution and
development agreement with Sigma focusing on the Down syndrome test. In addition
to manufacturing the primary reagents used for the test, Sigma also has
worldwide marketing and sales capabilities. Sigma is a vertically integrated,
ISO 9000 certified, in vitro device manufacturer. Sigma was the first in vitro
diagnostics manufacturer to kit chemistries for the clinical diagnostics market.
For the past 50 years, Sigma-Aldrich, the parent company of Sigma, has developed
a worldwide distribution and communication network that serves as the basis for
an extensive distribution capability for Sigma. This capability gives Sigma a
greater sales and distribution reach than it would normally have for a
manufacturer of its size. Sigma is able to utilize the more than 30 subsidiaries
of Sigma-Aldrich throughout the world and their distributors to promote its
products in over 140 countries. In the subsidiaries located in Western Europe
including France, Germany, United Kingdom, Italy, the Netherlands and
Luxembourg, Sigma maintains support capabilities for both reagents and
instruments. All Sigma distributors are trained and qualified to support their
product lines.

GOVERNMENTAL REGULATION

The Company's products are subject to governmental regulation in the United
States and other countries. In the United States, the Medical Device Amendments
to the Federal Food, Drug and Cosmetic Act ("the FDA act") and other statutes
and regulations, including various state statutes and regulations, govern the
testing, manufacture, labeling, storage, record keeping, distribution, sale,
marketing, advertising and promotion of such products. Failure to comply with
applicable requirements can 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
and criminal prosecution.

Prior to commercial sale in the United States, most medical devices,
including the ChromaVision ACIS, must be cleared by the FDA for specific uses.
The regulatory process can be lengthy, expensive and uncertain. Securing FDA
clearance may require the submission of extensive clinical data together with
other supporting information to the FDA. Any clinical testing of medical devices
must be conducted in conformity with applicable FDA regulations. In addition,
state and local approvals may be required for some clinical activities.

Under the FDA Act, medical devices are classified into one of three classes
on the basis of the controls necessary to reasonably ensure their safety and
effectiveness. Class I devices are those whose safety and effectiveness can
reasonably be ensured through general controls, such as labeling, premarket
notification and adherence to FDA-mandated GMP. Class II devices are those whose
safety and effectiveness can reasonably be ensured through "special controls,"
such as performance standards, post-market surveillance, patient registries and
FDA guidelines. Class III devices are devices that must receive premarket
approval ("PMA") by the FDA to ensure their safety and effectiveness. They are
generally life-sustaining, life-supporting or implantable devices, and also
include most devices that were not on the market before May 18, 1976 and for
which the FDA has not made a finding of substantial equivalence based upon a
510(k).

Before a new device or a new use of an existing device can be introduced to
the market, the manufacturer generally must obtain FDA clearance through a
510(k) or approval of a PMA application. Following submission of the 510(k), the
manufacturer may not market the new device until an order is issued by the FDA
finding the device to be "substantially equivalent" to a legally marketed
medical device, i.e., a legally marketed Class I or Class II medical device or a
legally marketed Class III medical device for which the FDA has not called for
PMA applications ("predicate device"). The FDA has no specific time limit by
which it must respond to a 510(k) filing. It generally takes from three to nine
months from the date of submission for the FDA to respond with a clearance for a
510(k) application depending on the complexity of the technology and the level
of review the FDA employs for evaluating the 510(k) filing, but it may take
longer. The FDA may determine that the proposed device is not substantially
equivalent, or that additional clinical or other data are needed before a
substantial equivalence determination can be made. Modification or enhancement
of a product that has been cleared through the 510(k) process requires clearance
of a new 510(k) if the modification or enhancement could significantly affect
the safety or effectiveness of the original device.

The Company has obtained its first 510(k) clearance from the FDA to market
the ChromaVision ACIS with an NAP marker to screen blood for malignancy. The
Company is developing, and intends to develop, additional applications for the
device, and plans on developing new, and/or enhanced capabilities for the
device. The Company expects to file two 510(k) applications with the FDA in

<PAGE> 12
1998, one for immunohistochemistry ("IHC") and the second for in-situ
hybridization ("ISH"). The Company believes that with the clearance of these
1998 filings together with its first 510(k) clearance using a biochemical
marker, a number of applications that utilize these methods could be added to
the ChromaVision ACIS without the need for separate 510(k) filings with the FDA.
The Prenatal screening for Downs Syndrome application utilizes the biochemical
method and therefore the Company believes that a separate filing would not be
required. All slide-based assays currently employ one of these three methods for
cellular analysis. There is no assurance that the FDA will concur strictly with
method based filings, and may require a separate filing for each intended
application.

For future applications, should the FDA determine that the ChromaVision ACIS
is not substantially equivalent to other 510(k) predicate devices, the Company
may be required to file for a PMA. The PMA process is significantly more
complex, expensive and time consuming than the 510(k) process. The PMA process
generally requires the performance of well controlled clinical investigations in
order to obtain FDA clearance, although other kinds of valid scientific evidence
may be sufficient to determine the effectiveness of some devices. The PMA
process typically requires two years, and may never result in approval.
Determination by the FDA that any of the Company's products or applications are
subject to the PMA process could have a material adverse effect on the Company's
business, results of operations and financial condition. Nonetheless, should a
PMA be required, a business benefit can accrue in the sense that a PMA can serve
as a competitive barrier to entry. Although no time frames can be assured for
either a 510(k) clearance or PMA approval, it is generally assumed that a 510(k)
clearance may be more readily obtained.

The FDC Act requires that medical devices be manufactured in accordance with
the FDA's current GMP regulations. These regulations require, among other
things, that (i) the manufacturing process must be regulated and controlled by
the use of written procedures and (ii) the ability to produce devices which meet
the manufacturer's specifications be validated by extensive and detailed testing
of every aspect of the process. They also require investigation of any
deficiencies in the manufacturing process or in the products produced and
detailed record keeping. Manufacturing facilities are therefore subject to FDA
inspection on a periodic basis to monitor compliance with GMP requirements. If
violations of the applicable regulations are noted during FDA inspections of the
Company's manufacturing facilities or the manufacturing facilities of its
contract manufacturers, there may be a material adverse effect on the continued
marketing of the Company's products.

Other applicable requirements include the medical device reporting
regulation, which requires that the Company provide information to the FDA on
deaths or serious injuries alleged to have been associated with the use of its
devices, as well as product malfunctions that would likely cause or contribute
to a death or serious injury if the malfunction were to recur.

The FDA regulates certain computer products as medical devices, such as
control software for imaging or other diagnostic devices, including the
Company's ChromaVision ACIS software. The FDA is in the process of reevaluating
its regulation of such software, and if the FDA undertakes increased or more
rigorous regulation of such software (which the Company cannot predict), the
Company's ChromaVision ACIS software may become subject to further regulatory
processes and clearance requirements. The Company is currently in full
compliance with FDA guidelines with respect to its software. No assurance can be
given that compliance with more extensive regulatory processes will be achieved
or that the necessary clearances for such software will be obtained by the
Company on a timely basis, if at all. The Company may, as a result, be required
to expend additional time, resources and effort in the areas of software design,
production and quality control to ensure full technical compliance.

Laws and regulations regarding the manufacture, sale and use of medical
devices are subject to change and depend heavily on administrative
interpretations. There can be no assurance that future changes in regulations or
interpretations made by the FDA or other regulatory bodies, with possible
retroactive effect, will not adversely affect the Company.

The Company and its products may be subject to a variety of other laws and
regulations in those states and countries where its products are or will be
marketed. These restrictions may hinder the Company's ability to market its
products in those states or countries. Use of the Company's products may further
be subject to periodic inspection, quality control, quality assurance,
proficiency testing, documentation and safety reporting standards pursuant to
the Joint Commission on Accreditation of Healthcare Organizations.

If the FDA believes that the Company is not in compliance with the law, the
FDA can take one or more of the following actions: withdraw previously approved
applications; require notification to users regarding newly found, unreasonable
risks; request repair or refund of faulty devices; request corrective
advertisements, formal recalls or temporary marketing suspension; refuse to
review or clear applications to market any of the Company's future products in
the United States or to allow the Company to enter into government supply
contracts; or institute legal proceedings to detain or seize products, enjoin
future violations or assess criminal or

<PAGE> 13
civil penalties against the Company, its officers or employees. Any such action
by the FDA could result in disruption of the Company's operations for an
indeterminate period of time. Various states in which the Company's product may
be sold in the future may impose additional regulatory requirements.

In addition, the Company's products are subject to a variety of regulations
in certain international markets. Depending on circumstances, including but not
limited to Company strategies and discussions with potential distribution
partners, the Company may develop a distribution strategy that initiates
marketing in international markets prior to marketing in the United States.

THIRD-PARTY REIMBURSEMENT AND HEALTHCARE LEGISLATION

The willingness of hospitals, laboratories and other healthcare providers to
purchase or lease the ChromaVision ACIS may depend on the extent to which such
providers limit capital expenditures due to cost reimbursement regulations,
including regulations promulgated by the Health Care Financing Administration
and other regulatory agencies, and general uncertainty about government
healthcare policy. In addition, sales volumes and prices of the Company's
products will depend in part upon the level of reimbursement available to
hospitals, laboratories and other healthcare providers for automated microscopic
blood tests from third-party payors, such as government and private insurance
plans, health maintenance organizations and preferred provider organizations.
There can be no assurance that existing reimbursement levels will not be
decreased in the future and that any such decrease will not reduce the demand
for, or the price of, the Company's products. Healthcare reform measures adopted
by the federal government or state governments could adversely affect the prices
of medical devices in the United States or the amount of reimbursement
available, and, consequently, could have a material adverse effect on the
Company's business, results of operations and financial condition. No prediction
can be made as to the outcome of any reform initiatives or their impact on the
Company.

COMPETITION

The Company believes that the primary current source of competition for the
ChromaVision ACIS is the use of medical technicians to perform microscopic
analysis. Additionally, the Company is aware of a number of potential
competitors that are substantially engaged in efforts to automate microscope
examinations. Four are currently focused primarily on the use of morphology,
specifically for pap smear testing, as opposed to the color-based approach to
addressing multiple applications that has been developed by ChromaVision.
Several elements of the hardware components and robotics control of the
ChromaVision ACIS system are similar to those used in the system of a fifth
competitor, IMI, although ChromaVision has developed its own proprietary
color-based image analysis application software. A sixth potential competitor,
Intelligent Remote Imaging Systems Inc. utilizes flow cytometry to image
cellular material for various urine and blood applications.

SERVICE

The Company intends to offer service and maintenance to ChromaVision ACIS
customers as part of the "per click" pricing structure. The Company has
developed a support, field service, and parts distribution plan designed with
the goal of enabling greater than 98% system functionality for its customers.
This plan will offer the following services as part of the "per click" fee
structure: (i) installation, (ii) customer training, (iii) a 24-hour a day,
seven-day per week customer help desk available via a toll free number, (iv) the
ability to remotely diagnose ChromaVision ACIS units and load new software via
dial-up modems with a goal of correcting 80% of customer problems at initial
customer contact, and (v) on-site field service and parts replacement utilizing
regionally based ChromaVision field engineers which will be supported by
headquarters development and engineering staff. Additionally, the Company may
enter into agreements with third parties to provide service and support to the
Company's customers.

RESEARCH AND DEVELOPMENT

The Company's core competency to date has been centered on research and
development, specifically in the area of advanced imaging as applied to the
detection and quantification of reagent-stained cellular material. Currently,
the Company has 14 employees dedicated to engineering and research and
development, including several scientists who hold Ph.D. degrees in various
disciplines, primarily in the areas of image science and software algorithms.
The senior members of the research and development staff that initially
developed the proprietary technology have experience in the development of
sophisticated imaging systems including those used in the Strategic Defense
Initiative and the Cruise Missile program. ChromaVision's research and
development staff is experienced in the rapid prototyping and development of
advanced software-based, electro-optical-mechanical systems. The Company intends
to continue to invest heavily in the recruitment of experienced scientists and
engineers with an emphasis on

<PAGE> 14
achieving a balance between research and development innovation and support of
focused, market driven requirements. Research and development spending was
approximately $1,513,000, $1,979,000 and $3,565,000 for 1995, 1996 and 1997,
respectively.

MANUFACTURING

The ChromaVision ACIS is currently developed and manufactured at the
Company's headquarters in San Juan Capistrano, California. At the San Juan
Capistrano facility, components are assembled, the microscope is optically
aligned, software is loaded, and the system is tested. Components of the system
are either manufactured by the Company, purchased off-the-shelf, or manufactured
by subcontractors to the Company's specifications. The system uses an
off-the-shelf CCD camera and an Intel/Microsoft-based personal computer. The
system can be adapted for use with most popular microscopes and related optical
accessories. A proprietary video capture and processing board is used along with
proprietary color detection techniques developed by ChromaVision researchers.
The Company intends to enhance its manufacturing capabilities to coincide with
the commercialization of the ChromaVision ACIS. The Company is GMP compliant and
is working toward, but has not yet achieved ISO 9001 certification.

EMPLOYEES

As of December 31, 1997, the Company employed 39 persons of which 14 persons
were in product development and engineering, 14 persons were in manufacturing,
quality assurance and field services, 8 persons were in finance, executive and
administrative capacities and 3 persons were in sales and marketing. The Company
is not subject to any collective bargaining agreements and the Company believes
that the relationship with its employees is good.

ITEM 2. PROPERTIES

The Company's executive and development and manufacturing facilities are
located in San Juan Capistrano, California, in approximately 21,000 square feet.
The Company leases the space at an annual rent of approximately $123,000. This
lease expires on February 28, 2000 with an option to renew the lease an
additional three years. Management of the Company believes that this facility
will be adequate to meet the Company's needs through the year 2000.

ITEM 3. LEGAL PROCEEDINGS

On November 10, 1997 the Company commenced litigation against IDEA Research
LLC in the federal district court in Santa Ana, California seeking a
determination by the court that the Company's automated microscope systems do
not infringe certain patent rights of IDEA Research. The Company is also seeking
recovery of damages for interference with prospective business advantage in
connection with certain claims of patent infringement and disparaging statements
made by IDEA Research about the Company and its microscope systems.

IDEA Research has responded by denying the material allegations in the
Company's complaint and asserting in its counterclaim that the Company has
infringed the IDEA Research patent, has violated certain copyright and trade
secret rights of IDEA Research, has used the terminology "NAP Finder" in a way
that is misleading, has engaged in acts of unfair competition and has breached
an agreement with IDEA Research entered into in 1996 relating to a potential
business relationship between the two companies. IDEA Research has also asserted
claims against XL Vision, Inc.

The Company believes that all of the claims by IDEA Research are without
merit and intends to defend against them vigorously while pursuing its own
claims against IDEA Research.

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

No matters were submitted to a vote of the security holders of the Company
during the fourth quarter ended December 31, 1997.

PART II

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

<PAGE> 15
The Company's common stock trades on the Nasdaq National Market under the
symbol "CVSN". The table below sets forth the high and low sales prices of the
common stock:

<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
July 2, 1997(1)-- September 30, 1997...... 13 1/2 8 3/4
October 1, 1997-- December 31, 1997....... 11 1/2 6 11/16
</TABLE>

- ----------

(1) Date stock began trading

These quotations reported by NASDAQ represent prices between dealers and do
not include retail mark-ups, mark-downs or commissions. Such quotations may not
represent actual transactions.

The closing sale price of the Company's Common Stock on March 27, 1998 was
$9.88.

As of February 28, 1998, the Company had outstanding 17,173,629 shares of
common stock held by approximately 14,500 shareholders including beneficial
owners of the common stock whose shares are held in the names of various
dealers, clearing agencies, banks, brokers and other fiduciaries.

The Company has not paid cash dividends and does not anticipate paying cash
dividends in the foreseeable future. The Company expects to utilize future
earnings to finance future growth. The actual amount of any dividends paid would
be subject to the discretion of the Board of Directors of the Company and would
depend on the Company's operations, financial and business requirements and
other factors.

USE OF PROCEEDS OF INITIAL PUBLIC OFFERING

The Company completed its initial public offering pursuant to a registration
statement (Registration No. 333-26129) which became effective on July 1, 1997.
Robert W. Baird & Co. was the managing underwriter of the offering. The Company
registered and sold 6,020,000 shares of its common stock and received gross
proceeds of $30.1 million. Selling shareholders registered and sold 1,340,000
shares of common stock for an aggregate of $6.7 million. From the effective date
of the registration statement through December 31, 1997, the Company utilized
approximately $903,000 and $847,000 of the offering proceeds for the
underwriter's discounts, fees and expenses and other offering expenses,
respectively, leaving net offering proceeds of approximately $28.4 million.
Included in other offering expenses is $50,000 paid to Safeguard Scientifics,
Inc., an affiliate of the Company, for its services in the offering.
Approximately $5.5 million of the net proceeds were used for repayment of the
bank line of credit indebtedness and reduction of an inter-company payable to
XL-Vision, Inc. An additional $2.6 million of the net proceeds were used to fund
working capital and research and development.

ITEM 6. SELECTED FINANCIAL DATA

The following table presents selected financial data of the Company. The
following information should be read in conjunction with the Financial
Statements and Notes thereto in Item 8 and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" in Item 7.

<PAGE> 16

<TABLE>
<CAPTION>
PERIOD FROM
PERIOD FROM MARCH 28, PERIOD FROM
JANUARY 1, 1996 APRIL 1, 1993
1996 (INCORPORATION) (INCEPTION)
YEARS ENDED THROUGH THROUGH YEAR ENDED THROUGH
DECEMBER 31, MARCH 27, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1993 1994 1995 1996 1996 1997 1997
--------- ----------- ----------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Revenues(1)................. $ -0- $ 296,886 $ 900,000 $ -0- $ -0- $ 43,500 $ 1,240,386
Selling, general and
administrative expenses. 304,951 787,167 1,040,070 221,476 $ 2,648,694 3,185,583 8,187,941
Research and development
expenses(2)............. 549,156 858,389 1,513,014 230,681 1,747,923 3,565,331 8,464,494
Net (loss)(3)(4)............ $ (854,107) $(1,581,306) $(1,963,187) $ (377,157) $ (4,030,263) $(6,343,927) $(15,149,947)
Net loss subsequent to
incorporation............. $ (4,030,263) $(6,343,927)
Basic and diluted net profit
(loss) per common share
subsequent to
incorporation(3)(4)....... $ (0.37) $ (0.47)
=========== ===========
</TABLE>

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------------------------------------------------
1993 1994 1995 1996 1997
--------- ----------- ----------- ----------- ------------
BALANCE SHEET DATA:
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents... $ -0- $ -0- $ -0- $ 124,092 $ 12,926,398
Total assets(5)............. 60,000 1,066,328 345,664 880,430 22,249,016
Total liabilities(6)........ 914,107 3,501,741 4,744,264 2,535,937 878,720
Accumulated deficit......... (854,107) (2,435,413) (4,398,600) (8,806,020) (15,149,947)
Total stockholders' equity
(deficit)................. (854,107) (2,435,413) (4,398,600) (1,655,507) 21,370,296
</TABLE>

- ----------

(1) Revenue includes income from prototype instrument sales and technical
support services.

(2) Research and development expenses for the period from March 28, 1996
(incorporation) through December 31, 1996 include the value of the Preferred
Stock issued to Centocor as compensation for its clinical collaboration on
the minimal residual disease applications.

(3) See Note 2 of the Notes to the Financial Statements for information
concerning the calculation of net profit (loss) per common share.

(4) Prior to Incorporation on March 28, 1996, the Company operated as a division
of XL Vision, Inc. See Note 1 to the Notes to Financial Statements appearing
elsewhere in the Form 10-K/A.

(5) 1997 includes a $5,000,000 demand note from Safeguard Scientific, Inc. and
approximately $2.4 million of investments.

(6) Includes the outstanding balance on the revolving line of credit and amounts
due to XL Vision through 1996. The Company has no long term debt or capital
leases.

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

OVERVIEW

ChromaVision Medical Systems, Inc., formerly MicroVision Medical Systems,
Inc., a development stage enterprise, ("ChromaVision" or the "Company") is a
Delaware corporation. Prior to the formation of the Company on March 28, 1996,
the Company's business was conducted as the MicroVision Medical Systems Division
(the "Division") of XL Vision, Inc. ("XL Vision").

<PAGE> 17
the assets and liabilities were recorded at their historical book value. As of
the date of incorporation, the Division had assets, net of assumed liabilities,
of $102,677 and an accumulated deficit of $4,775,757. The Company assumed a
liability to XL Vision totaling $4,862,984 which consisted of the net assets and
the accumulated deficit of the Division less consideration paid for common
stock, $15,450.

Subsequent to incorporation, the Company raised $6.4 million from a private
equity placement in June 1996. The proceeds were used primarily to fund the
repayment of amounts due to XL Vision and for working capital.

The Company was established to develop medical imaging technologies and to
introduce a computer-based microscope for the healthcare services market. From
the inception of the business on April 1, 1993 through December 31, 1997, the
Company and its predecessor have devoted substantially all of their resources to
the development of the ChromaVision ACIS technology.

ChromaVision is a laboratory medicine diagnostics company that develops and
manufactures an automated cellular imaging system for a wide variety of clinical
and research applications. The Company currently markets the products to
research centers and is previewing the system to university medical centers and
commercial laboratories in anticipation of receiving clearance from the FDA
based on two filings expected to be made in 1998, which could result in several
commercialized applications. The ChromaVision ACIS is designed to identify cells
with specific characteristics within a sample of cells on a microscope slide by
detecting color produced by the reaction between common laboratory reagents and
the cells of interest. The intelligent microscope platform automates the
scanning of up to 100 patient samples (slides) and uses proprietary imaging
software to capture digital images of the cell samples to detect the presence,
count the number and measure the intensity of targeted cells. The system offers
substantial flexibility because the software can be configured to identify
different stains and cellular staining characteristics, thereby allowing the
system to be adopted for use with different reagents to identify a broad range
of targeted cellular conditions. The Company seeks to establish the ChromaVision
ACIS as the preferred platform for multiple diagnostic applications.

In March 1997, the Company relocated its headquarters and principal
executive offices from Sebastian, Florida to San Juan Capistrano, California.

In October 1997, the Company signed a three-year exclusive distribution and
development agreement with Sigma Diagnostics, Inc., a subsidiary of Sigma
Aldrich, to market the Company's proprietary prenatal Down syndrome screening
test, which uses the ChromaVision ACIS. The ChromaVision test is currently in
clinical trials in the U.S. and Great Britain.

RESULTS OF OPERATIONS

Overview. During 1996, the Company was operated as a business division of XL
Vision until March 28, 1996. After its incorporation on March 28, 1996, the
Company operated as a subsidiary of XL Vision. While the financial statements
segregate the results of operations between periods prior to and after the
Company's incorporation, for comparison purposes below, the results have been
combined for all of 1996 in order to facilitate comparisons of results for 1997,
1996 and 1995.

YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996

Revenue and gross profits. The revenue and related gross profit of $43,500
is comprised of technical services rendered to Centocor. The Company is a
development stage company and had no revenue or gross profit for 1996. The
Company anticipates commercialization of several of its applications in the
second half of 1998.

Selling, general and administrative expenses. Expenses increased
approximately $300,000 to $3.2 million as compared to $2.9 million in 1996. This
increase is due primarily to the increase in the number of management and
administrative personnel necessary to support the growth of the business and to
relocation costs incurred in moving the Company to California. Offsetting the
increase in 1997 were one time severance costs in the fourth quarter of 1996 of
$912,050 associated with the resignation of the Company's former President,
including $443,700 for the repurchase of vested stock options. The Company
anticipates general and administrative expenses to increase in the future
primarily due to increases in selling and marketing expenditures necessary to
support the commercialization of its applications.

<PAGE> 18
Research and development expenses. Expenses increased $1.6 million to $3.6
million in 1997 as compared to $2.0 million in 1996. The increase is primarily
attributable to the cost of the first clinical trial related to the Company's
510(k) clearance received from the U.S. Food and Drug Administration on June 5,
1997, its cost of the current clinical trials for prenatal screening for Down
syndrome and cancer and the addition of technical personnel to further develop
the Company's applications. Included in 1996 research and development
expenditures was $770,192 of value attributed to Preferred Stock which was
issued to Centocor for its clinical collaboration on a minimal residual disease.
The Company anticipates that research and development expenses will increase in
the future due to costs related to the development of new applications, the
onset of additional clinical trials and the continuation of technological
advances to the ChromaVision ACIS.

Other income. Other income decreased $77,867 to $363,487 in 1997 as compared
to $441,354 in 1996. The 1996 amount included $423,525 of other income recorded
relating to design work performed for IMI. In 1997 $363,487 of net interest
income resulted from the investment of the Company's initial public offering net
proceeds in interest bearing securities, which was offset by interest expense
incurred on the Company's revolving line of credit before it was paid off during
the third quarter of 1997. Interest income is anticipated to significantly
increase during 1998 from the investment of the Company's net proceeds from the
offering.

YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995

Revenue and gross profits. The Company is a development stage company and
had no revenue or gross profit in 1996. Revenue of $900,000 and related gross
profit of $589,897 for 1995 consisted of the sale of six prototype ChromaVision
ACIS systems.

Selling, general and administrative expenses. Expenses increased $1.8
million to $2.9 million for 1996 as compared to $1.1 million for 1995. The
increase in 1996 was due primarily to $912,050 in severance costs associated
with the resignation of the Company's former President, including $443,700 for
the repurchase of vested stock options. The balance of the increase was
associated with the hiring of additional management, marketing and technical
personnel.

Research and development expenses. Expenses increased $465,590 to $2.0
million for 1996 as compared to $1.5 million for 1995. The increase in 1996
consisted of $770,192 of value attributed to Preferred Stock issued to Centocor
for its clinical collaboration on the minimal residual disease application (see
Note 9 of the Notes to Financial Statements) which is offset by a decrease
primarily related to the completion of the initial development of the
ChromaVision ACIS.

Other income. Other income of $441,354 related to the reimbursement of the
Company's cost for design work performed for IMI totaling $423,525 (see Note 3
of the Notes to Financial Statements) and interest income of $17,829. There was
no comparable income for the previous periods.

LIQUIDITY AND CAPITAL RESOURCES

On August 13, 1997, the Company completed its initial public offering of
6,020,000 shares of Common Stock. The Company received net proceeds of
approximately $28.4 million after deducting underwriting discounts and offering
expenses. Prior to this offering, the Company's primary source of financing was
a $5.0 million revolving line of credit and a $6.4 million private placement in
June 1996.

In August and September of 1997, approximately $5.5 million of net proceeds
from the initial public offering were used for repayment of the bank line of
credit indebtedness and reduction of an inter-company payable to XL Vision, Inc.
The bank line of credit expired January 31, 1998. At December 31, 1997, the
Company had approximately $20.3 million of cash and cash equivalents, note
receivables and investments and working capital of approximately $18.7 million.

Capital expenditures for the year ended December 31, 1996 were $472,426 and
related primarily to the manufacture of the ChromaVision ACISs used in research
and development. Capital expenditures for the year ended December 31, 1997 were
$1,169,397 and related primarily to investments in the Company's research and
development capabilities such as an on-site medical laboratory, the manufacture
of additional ChromaVision ACISs used in further development and personal
computers for employees. Capital expenditures are expected to be approximately
$1 million in 1998, and are expected to be primarily related to the manufacture
of the ChromaVision ACIS for clinical trial purposes. The expenditures will be
funded by current cash reserves. An additional $2 million is expected to be
incurred due to the manufacture of the ChromaVision ACIS as a "fee-per-use"
system placed for commercial

<PAGE> 19
application. The Company's business plan anticipates placing these instruments
with users at no charge and charging a "per click" fee for each use of the
instrument. The manufacture of these instruments will require a significant
outlay of cash for which revenues will not be recognized until future periods.
As a result, the Company is currently negotiating to arrange third-party
financing for these instruments.

The Company anticipates that the net proceeds of the offering will be
sufficient to satisfy its operating cash needs for the foreseeable future.
Management expects that losses from operations and increases in working capital
requirements will produce significant negative cash flows from operations for
the foreseeable future. In addition, to support the Company's future cash needs
it intends to consider, but not be limited to, additional debt or equity
financing. However there can be no assurance that any such financing will be
available to the Company, or that adequate funds for the Company's operations
will be available when needed, or on terms attractive to the Company. If the
Company is unable to obtain sufficient additional funds, the Company may have to
delay, scale back or eliminate some or all of its development activities,
clinical studies and/or regulatory activities.

YEAR 2000 COMPLIANCE

The Company develops and purchases software for use in its ChromaVision
ACIS. In addition, purchased software is run on in-house computer networks. The
Company believes that its proprietary software and the software run on its
in-house network is Year 2000 compliant. The Company is currently in the process
of surveying its key suppliers to determine whether they will be Year 2000
compliant. The Company does not expect Year 2000 issues to materially impact its
financial position or results of operations.

RECENT ACCOUNTING DEVELOPMENTS

The Company intends to adopt Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" (SFAS 130), and Statement of Financial
Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information" (SFAS 131), in fiscal 1998. Both standards will require
additional disclosure, but will not have a material effect on the Company's
financial position or results of operations. SFAS 130 establishes standards for
the reporting and display of comprehensive income and is expected to first be
reflected in the Company's first quarter of 1998 interim financial statements.
Components of comprehensive income include items such as net earnings, foreign
currency translation adjustments and changes in value of available-for-sale
securities. SFAS 131 changes the way companies report segment information and
requires segments to be determined and reported based on how management measures
performance and makes decisions about allocating resources. SFAS 131 will first
be reflected in the Company's 1998 Annual Report.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CHROMAVISION MEDICAL SYSTEMS, INC.
(FORMERLY MICROVISION MEDICAL SYSTEMS, INC.)
(A DEVELOPMENT STAGE ENTERPRISE)

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
<S> <C>
Independent Auditors' Report................................................................................... 21
Balance Sheets as of December 31, 1996 and 1997................................................................ 22
Statements of Operations for the year ended December 31, 1995, the period from January 1, 1996 through March
27, 1996, the period from March 28, 1996 (incorporation) through December 31, 1996, the year ended December
31, 1997 and the period from April 1, 1993 (inception) through December 31, 1997............................ 23
Statements of Stockholders' Equity (Deficit) at December 31, 1995, 1996 and 1997............................... 24
Statements of Cash Flows for the year ended December 31, 1995, the period from January 1, 1996 through March
27, 1996, the period from March 28, 1996 (incorporation) through December 31, 1996, the year ended December
31, 1997 and the period from April 1, 1993 (inception) through December 31, 1997............................ 25
Notes to Financial Statements.................................................................................. 26
</TABLE>

<PAGE> 20
INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of
ChromaVision Medical Systems, Inc.
(formerly MicroVision Medical Systems, Inc.):

We have audited the accompanying balance sheet of ChromaVision Medical
Systems, Inc. (a development stage enterprise) as of December 31, 1996 and 1997
and the related statements of operations, stockholders' equity (deficit) and
cash flows of ChromaVision Medical Systems (a development stage enterprise), a
division of XL Vision, Inc., for the year ended December 31, 1995 and the period
from January 1, 1996 through March 27, 1996, and ChromaVision Medical Systems,
Inc. (a development stage enterprise) for the period from March 28, 1996
(incorporation) through December 31, 1996, and for the year ended December 31,
1997 and for the cumulative development stage from April 1, 1993 (inception)
through December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of ChromaVision Medical
Systems, Inc. (a development stage enterprise) as of December 31, 1996 and 1997
and the results of operations and cash flows of ChromaVision Medical Systems (a
development stage enterprise), a division of XL Vision, Inc., for the year ended
December 31, 1995 and the period from January 1, 1996 through March 27, 1996,
and ChromaVision Medical Systems, Inc. (a development stage enterprise) for the
period from March 28, 1996 (incorporation) through December 31, 1996 and for the
year ended December 31, 1997 and for the cumulative development stage from April
1, 1993 (inception) through December 31, 1997, in conformity with generally
accepted accounting principles.

KPMG PEAT MARWICK LLP
Orange County, California
February 3, 1998

<PAGE> 21
CHROMAVISION MEDICAL SYSTEMS, INC.
(FORMERLY MICROVISION MEDICAL SYSTEMS, INC.)
(A DEVELOPMENT STAGE ENTERPRISE)

BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
ASSETS 1996 1997
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents .................................. $ 124,092 $ 12,926,398
Short-term investments ..................................... -- 1,344,534
Note receivable - affiliate ................................ -- 5,000,000
Prepaid expenses and other ................................. 28,227 128,105
Capitalized offering costs ................................. 144,760 --
Interest receivable ........................................ -- 135,317
------------ ------------
Total current assets ............................... 297,079 19,534,354
Long-term investments ........................................ -- 1,061,544
Deposits ..................................................... -- 55,791
Property and equipment, net .................................. 583,351 1,597,327
------------ ------------
Total assets ....................................... $ 880,430 $ 22,249,016
============ ============
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Due to XL Vision, Inc. ..................................... $ 380,439 $ 5,969
Accounts payable ........................................... 127,808 310,161
Accrued liabilities:
Salaries and benefits ................................... 89,066 219,730
Severance costs ......................................... 912,050 --
Warranty costs .......................................... 60,000 --
Offering costs .......................................... 105,000 --
Other ................................................... 55,565 342,860
------------ ------------
Total current liabilities .......................... 1,729,928 878,720
Revolving line of credit ................................... 806,009 --
------------ ------------
Total liabilities .................................. 2,535,937 878,720
------------ ------------
Commitments and contingencies
Stockholders' equity (deficit):
Series A convertible preferred stock, $.01 par value,
authorized 7,246,000 shares, issued and outstanding
7,135,064 shares in 1996 and none in 1997 ............... 71,351 --
Series B convertible preferred stock, $.01 par value,
authorized 221,850 shares, none issued and outstanding in
1996 and 1997 ........................................... -- --
Common stock $.01 par value, authorized 50,000,000 shares,
issued and outstanding 1,931,250 shares in 1996 and
17,173,629 in 1997 ...................................... 19,313 171,736
Additional paid-in capital ................................. 7,059,849 36,348,507
Deficit accumulated during the development stage ........... (8,806,020) (15,149,947)
------------ ------------
Total stockholders' (deficit) equity ............... (1,655,507) 21,370,296
------------ ------------
Total liabilities and stockholders' (deficit) equity ......... $ 880,430 $ 22,249,016
============ ============
</TABLE>

See accompanying notes to financial statements.

<PAGE> 22
CHROMAVISION MEDICAL SYSTEMS, INC.
(FORMERLY MICROVISION MEDICAL SYSTEMS, INC.)
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF OPERATIONS

See accompanying notes to financial statements.

<PAGE> 23
CHROMAVISION MEDICAL SYSTEMS, INC.
(FORMERLY MICROVISION MEDICAL SYSTEMS, INC.)
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

PREFERRED STOCK
--------------------------------------------------------------------
SERIES A SERIES B
---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT
----------- ---------- --------- ------------
<S> <C> <C> <C> <C>
Balances at
December 31,
1994 ........... -- $ -- -- $ --
Net loss ......... -- -- -- --
----------- ------------- --------- ------------
Balances at
December 31,
1995 ........... -- -- -- --
Net loss ......... -- -- -- --
----------- ------------- --------- ------------
Balances at March
27, 1996 ......... -- -- -- --
Net loss ......... -- -- -- --
Issuance of common
stock on March
28, 1996
(Incorporation) . -- -- -- --
Sale of preferred
stock .......... 6,364,872 63,649 -- --
Issuance of
preferred stock
for release of
rights and
claims ......... 770,192 7,702 -- --
Five-for-four
common stock
split .......... -- -- -- --
----------- ------------- --------- ------------
Balances at
December 31,
1996 ........... 7,135,064 71,351 -- --
Sale of preferred
stock .......... -- -- 221,850 2,219
Conversion of
preferred
stock .......... (7,135,064) (71,351) (221,850) (2,219)
Sale of common
stock .......... -- -- -- --
Exercise of stock
options ........ -- -- -- --
Offering costs ... -- -- -- --
Net loss ......... -- -- -- --
Balances at
December 31,
1997 ........... -- $ -- -- $ --
=========== ============ ========= ============
</TABLE>

<TABLE>
<CAPTION>
DEFICIT
ACCUMULATED
COMMON STOCK ADDITIONAL DURING THE
---------------------------- PAID-IN DEVELOPMENT
SHARES AMOUNT CAPITAL STAGE TOTAL
---------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balances at
December 31,
1994 ........... -- $ -- -- $ (2,435,413) $ (2,435,413)
Net loss ......... -- -- -- (1,963,187) (1,963,187)
---------- ------------ ------------ ------------ ------------
Balances at
December 31,
1995 ........... -- -- -- (4,398,600) (4,398,600)
Net loss ......... -- -- -- (377,157) (377,157)
---------- ------------ ------------ ------------ ------------
Balances at March
27, 1996 ......... -- -- -- (4,775,757) (4,775,757)
Net loss ......... -- -- -- (4,030,263) (4,030,263)
Issuance of common
stock on March
28, 1996
(Incorporation) . 1,545,000 15,450 -- -- 15,450
Sale of preferred
stock .......... -- -- 6,301,222 -- 6,364,871
Issuance of
preferred stock
for release of
rights and
claims ......... -- -- 762,490 -- 770,192
Five-for-four
common stock
split .......... 386,250 3,863 (3,863) -- --
---------- ------------ ------------ ------------ ------------
Balances at
December 31,
1996 ........... 1,931,250 19,313 7,059,849 (8,806,020) (1,655,507)
Sale of preferred
stock .......... -- -- 996,106 -- 998,325
Conversion of
preferred
stock .......... 9,196,129 91,961 (18,391) -- --
Sale of common
stock .......... 6,020,000 60,200 30,039,800 -- 30,100,000
Exercise of stock
options ........ 26,250 262 20,738 -- 21,000
Offering costs ... -- -- (1,749,595) -- (1,749,595)
Net loss ......... -- -- -- (6,343,927) (6,343,927)
---------- ------------ ------------ ------------ ------------
Balances at
December 31,
1997 ........... 17,173,629 $ 171,736 $ 36,348,507 $(15,149,947) $ 21,370,296
========== ============ ============ ============ ============
</TABLE>

See accompanying notes to financial statements.

<PAGE> 24
CHROMAVISION MEDICAL SYSTEMS, INC.
(FORMERLY MICROVISION MEDICAL SYSTEMS, INC.)
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
PERIOD FROM MARCH 28, APRIL 1,
JANUARY 1, 1996 1993
FOR THE YEAR 1996 (INCORPORATION) FOR THE YEAR (INCEPTION)
ENDED THROUGH THROUGH ENDED THROUGH
DECEMBER 31, MARCH 27, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1996 1997 1997
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Cash flows from development
stage activities:
Net loss ................................ $ (1,963,187) $ (377,157) $ (4,030,263) $ (6,343,927) $(15,149,947)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization ...... 54,417 6,080 28,659 155,421 271,736
Preferred stock issued for
services .......................... -- -- 770,192 -- 770,192
Write-off of note receivable ....... 40,000 -- -- -- 40,000
Changes in operating assets and
liabilities:
Accounts receivable ................ (100,000) 200,000 -- -- --
Prepaid expenses and other ......... -- -- (28,227) (99,878) (128,105)
Deposits ........................... -- -- -- (55,791) (55,791)
Interest receivable ................ -- -- -- (135,317) (135,317)
Accounts payable ................... 8,317 -- 119,025 182,353 310,161
Accrued liabilities ................ 5,080 21,514 1,191,321 (659,091) 562,590
------------ ------------ ------------ ------------ ------------
Net cash used in operating
activities .................. (1,955,373) (149,563) (1,949,293) (6,956,230) (13,514,481)
------------ ------------ ------------ ------------ ------------
Cash flows from investing
activities:
Note receivable - affiliate ............. -- -- -- (5,000,000) (5,825,000)
Collections on notes receivable ......... 785,000 -- -- -- 785,000
Purchases of investments ................ -- -- -- (2,406,078) (2,406,078)
Purchases of property and equipment ..... (58,753) (2,236) (470,190) (1,169,397) (1,869,063)
------------ ------------ ------------ ------------ ------------
Net cash provided by (used in)
investing activities ........ 726,247 (2,236) (470,190) (8,575,475) (9,315,141)
------------ ------------ ------------ ------------ ------------
Cash flows from financing activities:
Due to (from) XL Vision, Inc. ........... 1,229,126 151,799 (4,497,995) (374,470) 5,969
Proceeds from exercise of stock
options ................................. -- -- -- 21,000 21,000
Sale of common stock .................... -- -- 15,450 30,100,000 30,115,450
Borrowing (repayments) under
revolving line of credit ................ -- -- 806,009 (806,009) --
Sale of preferred stock ................. -- -- 6,364,871 998,325 7,363,196
Offering costs .......................... -- -- (144,760) (1,604,835) (1,749,595)
------------ ------------ ------------ ------------ ------------
Net cash provided by financing
activities .................. 1,229,126 151,799 2,543,575 28,334,011 35,756,020
------------ ------------ ------------ ------------ ------------
Net increase (decrease) in cash
and cash equivalents ........ -- -- 124,092 12,802,306 12,926,398
Cash and cash equivalents beginning
of period ............................... -- -- -- 124,092 --
------------ ------------ ------------ ------------ ------------
Cash and cash equivalents end of
period .................................. $ -- $ -- $ 124,092 $ 12,926,398 $ 12,926,398
============ ============ ============ ============ ============
Supplemental disclosure of cash flow
information:
Cash paid for interest .................. $ -- $ 124,092 $ 156,902 $ 156,902
============ ============ ============ ============
</TABLE>

See accompanying notes to financial statements.

<PAGE> 25
CHROMAVISION MEDICAL SYSTEMS, INC.
(FORMERLY MICROVISION MEDICAL SYSTEMS, INC.)
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS

(1) ORGANIZATION

OVERVIEW

On March 28, 1996, the assets and liabilities of the Division were
contributed to the Company, which was a wholly owned subsidiary of XL Vision.
This transaction was accounted for as a reorganization of entities under common
control and, accordingly, the assets and liabilities were recorded at their
historical book value. As of the date of incorporation, the Division had assets,
net of assumed liabilities, of $102,677 and an accumulated deficit of
$4,775,757. The Company assumed a liability to XL Vision totaling $4,862,984
which consisted of the net assets and the accumulated deficit of the Division
less consideration paid for common stock, $15,450.

ChromaVision is a laboratory medicine diagnostics company that develops and
manufactures an automated cellular imaging system for a wide variety of clinical
and research applications. The Company currently markets the products to
research centers and is previewing the system to university medical centers and
commercial laboratories in anticipation of receiving clearance from the U.S.
Food and Drug Administration (the "FDA") based on two filings expected to be
made in 1998, which could result in several commercialized applications. The
ChromaVision ACIS is designed to identify cells with specific characteristics
within a sample of cells on a microscope slide by detecting color produced by
the reaction between common laboratory reagents and the cells of interest. The
intelligent microscope platform automates the scanning of up to 100 patient
samples (slides) and uses proprietary imaging software to capture digital images
of the cell samples to detect the presence, count the number and measure the
intensity of targeted cells. The system offers substantial flexibility because
the software can be configured to identify different stains and cellular
staining characteristics, thereby allowing the system to be adopted for use with
different reagents to identify a broad range of targeted cellular conditions.
The Company seeks to establish the ChromaVision ACIS as the preferred platform
for multiple diagnostic applications.

In March 1997, the Company relocated its headquarters and principal
executive offices from Sebastian, Florida to San Juan Capistrano, California.

In October 1997, the Company signed a three-year exclusive distribution and
development agreement with Sigma Diagnostics, Inc., a subsidiary of Sigma
Aldrich, to market the Company's proprietary pre natal Down syndrome screening
test, which uses the ChromaVision ACIS. The ChromaVision test is currently in
clinical trials in the U.S. and Great Britain.

<PAGE> 26
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Development Stage

From the inception of ChromaVision on April 1, 1993, the Company was
considered to be in the development stage as defined by the Statement of
Financial Accounting Standards ("SFAS") No. 7, "Accounting and Reporting by
Development Stage Enterprises". The Company will be considered in the
development stage until it begins to realize significant revenue associated from
its planned operations.

(b) Reclassification

Certain 1995 and 1996 amounts have been reclassified to conform to the 1997
presentation.

The Company's revenues in 1995 were derived from the sale of ACISs and in
1997 were derived from the provision of technical services. The Company's
revenue recognition policy was to recognize product revenues when an ACIS was
sold and title transferred to the buyer. Technical services revenue was
recognized at the completion of the performance of the related engineering
services.

The Company anticipates placing its instruments with users at no charge and
billing on a "per click" or per use basis. Revenue will be recognized based on
usage. It is anticipated that under this new pricing model the Company will own
all ACISs that are engaged in service and accordingly, all development and
maintenance costs will be expensed as incurred.

(d) Cash and Cash Equivalents and Investments in Marketable Securities

Cash and cash equivalents consist of amounts held as bank deposits and
highly liquid debt instruments with a maturity of three months or less. The
Company has investments in short and long-term debt securities that have been
classified under the provisions of SFAS No. 115 as held to maturity. These
investments are intended to be held to maturity and accordingly are carried on
the balance sheet at amortized cost and temporary unrealized gains or losses are
not recognized.

Short-term investments have various maturity dates which do not exceed one
year. Long-term investments have various maturity dates ranging from one year to
sixteen months.

Cash equivalents and fixed income securities are comprised of investment
grade corporate bonds, and no single investment exceeds 5% of the combined total
of cash and cash equivalents, investments and notes receivable. The Company's
cash and cash equivalents are held by its principal bank.

The Company has not experienced any significant losses on cash, cash
equivalents, or investments. The Company believes it is not exposed to any
significant credit risk on cash, cash equivalents or investments.

The cost and estimated fair value of the investment in marketable securities
as of December 31, 1997 are as follows:

<TABLE>
<CAPTION>
GROSS FAIR
COST UNREALIZED LOSS VALUE
---- --------------- -----
<S> <C> <C> <C>
Cash and cash equivalents....... $ 12,926,398 $ -- $12,926,398
Fixed income securities:
Short-term.................... 1,344,534 (1,635) 1,342,899
Long-term..................... 1,061,544 (1,775) 1,059,769
------------ ------- -----------
Total................. $ 15,332,476 $(3,410) $15,329,066
============ ======= ===========
</TABLE>

<PAGE> 27
(e) Depreciation and Amortization

Property and equipment are depreciated and amortized on the straight-line
basis over the following estimated useful lives:

<TABLE>
<S> <C>
Office, Computer and Laboratory Equipment.... 3 to 5 years
Automated Cellular Imaging Systems (ACIS).... 3 years
Furniture and Fixtures....................... 5 years
Leasehold Improvements....................... Life of lease
</TABLE>

Expenditures for maintenance, repairs and minor improvements are charged
to expense as incurred. Major improvements and additions are capitalized.
ChromaVision ACISs begin depreciation upon completion at which time depreciation
related to ACISs placed for research and development or placed for commercial
use are expensed in research and development or cost of sales, respectively.
When property is sold or retired, the cost and related accumulated depreciation
are removed from the accounts and the resulting gain or loss is included in
other expense.

The following is a summary of property and equipment:

<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1996 1997
---------- ----------
<S> <C> <C>
Office, computer and laboratory equipment ..... 86,281 608,285
Automated Cellular Imaging Systems (ACIS) ..... 388,990 506,418
ACIS in progress .............................. 113,521 486,727
Furniture and fixtures ........................ 5,874 12,641
Leasehold improvements ........................ -0- 134,339
---------- ----------
594,666 1,748,410
Less: accumulated depreciation and amortization 11,315 151,083
---------- ----------
Property and equipment, net ................... $ 583,351 $1,597,327
========== ==========
</TABLE>

(f) Income Taxes

Since its incorporation on March 28, 1996, the Company accounts for income
taxes using the asset and liability method. Deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.

Prior to March 28, 1996, the Company operated as a division of XL Vision
and, as such, did not record any income tax benefit for losses prior to that
date.

(g) Stock-Based Compensation

During 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation", which permits entities to recognize as expense over
the vesting period the fair value of all stock-based awards on the date of
grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net earnings and pro
forma earnings per share disclosures for stock option grants made in 1996 and
future years as if the fair-value-based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.

(h) Net Loss Per Share

In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earning per Share". Statement 128 supersedes Accounting Principles
Board Opinion No. 15, Earnings per Share (APB15), and specifies the computation,
presentation, and disclosure requirements for earnings per share (EPS) for
entities with publicly held common stock or potential common stock. Statement
128 replaces the presentation of primary and fully diluted EPS with a
presentation of basic and diluted EPS respectively. In connection with Statement
128, the Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 98, requiring

<PAGE> 28
dilutive instruments issued for nominal consideration during periods covered by
an initial public offering registration statement, to be retroactively reflected
in the calculation of earnings per share for all periods presented. All net loss
per share amounts for all periods have been restated to conform to Statement 128
and SAB 98 requirements.

The stock options described in Note 6 were not included in the diluted
earnings per share calculation as they would be antidilutive.

(i) Use of Estimates

The preparation of the Company's 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,
disclosure of contingent assets and liabilities and the reported amounts of
revenues and expenses. Actual results could differ from those estimates. In
particular, as further described in note 1, significant assumptions were made to
allocate indirect costs from XL Vision to ChromaVision for periods prior to
incorporation on March 28, 1996.

(j) Financial Instruments

The Company estimates the fair value of its monetary assets and liabilities
based upon the existing interest rates related to such assets and liabilities
compared to current market rates of interest for instruments with a similar
nature and degree of risk. The Company estimates that the fair value of all of
its monetary assets and liabilities approximates fair value as of December 31,
1996 and 1997.

(3) NOTES RECEIVABLE

In June 1993, the Company executed a letter of understanding with
Intelligent Medical Imaging, Inc. ("IMI") under which ChromaVision agreed in
principle to manufacture IMI's Micro21 System design units. During 1993,
ChromaVision advanced $40,000 to IMI in contemplation of an equity investment in
IMI. During 1994, an additional $785,000 was advanced. In addition to amounts
advanced, ChromaVision incurred costs in developing hardware for the Micro21
System. The parties were unable to agree to definitive terms for the equity
investment and their manufacturing relationship. On July 23, 1994, a settlement
agreement was reached whereby IMI issued an $825,000 secured convertible
promissory note payable (the "$825,000 note"), a $500,000 noninterest bearing
secured promissory note payable (the "$500,000 note") and a $220,000 purchase
order (the "purchase order") to ChromaVision. During 1994 the purchase order was
paid in full. In 1995, ChromaVision accepted $785,000 in full payment of the
$825,000 note.

The $500,000 note was issued by IMI for support services but was not
recognized as income based upon doubts as to its collectibility. During 1996,
ChromaVision accepted $423,525 in full payment of the $500,000 note, all of
which has been reflected in other income during 1996.

In August 1997, the Company advanced $5,000,000 to Safeguard Scientifics,
Inc. ("Safeguard") which is a principal stockholder of the Company pursuant to
the terms of a revolving note agreement. The terms of the agreement call for a
payment on demand with interest payable monthly at Safeguard's effective rate of
borrowing less .75% (6.31% at December 31, 1997). Interest income earned during
1997 amounted to approximately $75,000, and of this amount, approximately
$24,000 was due at December 31, 1997. Management intends to collect on
this note in the next twelve months.

(4) LINE OF CREDIT

The Company had an unsecured line of credit with a bank under which it may
borrow up to $5,000,000 at the LIBOR plus 2.1% (7.82% at December 31, 1997)
which expired January 31, 1998. The Company's line of credit was guaranteed by
Safeguard Scientifics, Inc., a principal stockholder of the Company.

The Company is currently negotiating a new line of credit with its existing
bank (Bank of America). The terms of the agreement provide a $5,000,000 secured
line of credit at the bank's reference rate less .25%. The new line would be
secured by a minimum of 110% of the market value of the borrowing with the
Company's cash and investment accounts held by the bank.

<PAGE> 29
(5) PREFERRED STOCK

Through private placement, the Company sold 6,364,872 shares of Series A
Preferred Stock in 1996 and 221,850 shares of Series B Preferred Stock in 1997.
Each share of Series A and Series B convertible preferred stock was converted
into 1.25 shares of common stock during 1997, as required upon successful
completion of the initial public offering. The holders of the Series A and
Series B convertible preferred stock were entitled to vote as a separate class
to elect two directors to the Board of Directors of the Company and had
liquidation preference over the common stock shares.

(6) STOCK OPTIONS

The Company has a stock option plan (the "Plan") pursuant to which its Board
of Directors may grant stock options to officers, key employees and advisors.
The Plan authorizes grants of options to purchase up to 1,920,000 shares of
authorized but unissued common stock. The number of authorized shares reflects a
500,000 share increase approved by the Board of Directors in February 1998,
subject to stockholder approval. All options granted by the Company during 1996
and 1997 had an exercise price equal to the stock's deemed fair market value at
the date of grant. Stock options granted during 1996 and 1997 have a maximum of
ten year terms which become exercisable in increments over periods of up to four
years.

In June 1996 and November 1997, the Company granted 975,688 and 90,000,
respectively, non-qualified stock options outside of the Plan to officers, key
employees and members of the Company's Advisory Board, including an option to
purchase 554,626 shares which were issued to its former President. In December
1996, the Company agreed to repurchase the option of the former President, which
was then exercisable to purchase 277,313 shares for $2.40 per share less the
$.80 per share exercise price and the option was terminated as to the remaining
shares. The aggregate cash paid of $443,700 was accrued and expensed in selling
general and administrative expenses during 1996 and paid in 1997. The Company
granted stock options to purchase 71,875 shares to members of the Company's
Advisory Board in 1996.

The Company also sold 134,000 shares of Series A Preferred Stock (described
in Note 5) to members of its Advisory Board in 1996.

The Company granted non-qualified stock options in 1997 to purchase 31,000
shares to members of the Scientific Advisory Board of ChromaVision at prices
between $5.00 and $11.88 per share. At December 31, 1997, none of these options
was exercisable.

Option activity is summarized as follows:

<TABLE>
<CAPTION>
1997 1996
---------------------------------- -----------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- -------------- --------- --------------
<S> <C> <C> <C> <C>
Outstanding at beginning of
year ......................................... 1,370,438 $ 1.91 $ -- $ --
Options granted .............................. 479,950 6.19 2,185,001 1.50
Options exercised ............................ (26,250) .80 (537,251) .80
Options canceled ............................. (5,625) 5.00 (277,312) .80
--------- -----------
Outstanding at end of year ................... 1,818,513 $ 3.04 1,370,438 $ 1.91
========= ===========
Options exercisable at
year-end ..................................... 733,206 267,767
Shares available for future
grant ........................................ 86,300 560,625
</TABLE>

The following summarizes information about the Company's stock options
outstanding at December 31, 1997:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED AVG. ------------------------------
NUMBER REMAINING WEIGHTED AVG. NUMBER WEIGHTED AVG.
RANGE OF OUTSTANDING CONTRACTUAL LIFE EXERCISE EXERCISABLE AT EXERCISE
EXERCISE PRICES AT 12/31/97 (IN YEARS) PRICE 12/31/97 PRICE
- ----------------- ----------- ---------------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
at $ .80 394,813 5.5 $ .80 273,634 $ .80
$2.40 - $ 2.40 1,118,125 8.0 2.40 456,822 2.40
$5.00 - $ 11.88 305,575 9.6 8.30 2,750 5.00
--------- -------
$ .80 - $ 11.88 1,818,513 7.7 $ 3.04 733,206 $ 1.81
========= =======
</TABLE>

<PAGE> 30
The Company applies APB 25 and related interpretations in accounting for
stock option plans. Had compensation cost been recognized consistent with SFAS
123, the Company's consolidated net income and earnings per share would have
been reduced to the pro forma amounts indicated below (1996 net loss is
subsequent incorporation):

<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Consolidated net loss As reported.... $(6,343,927) $(4,030,263)
Pro forma...... $(6,679,851) $(4,312,126)
Loss per share -- Basic and
Diluted As reported.... $ (.47) $ (.37)
Pro forma...... $ (.50) $ (.40)
</TABLE>

The per share weighted-average fair value of stock options issued by the
Company during 1997 and 1996 was $3.35 and $.51, respectively, on the date of
grant.

The following assumptions were used by the Company to determine the fair
value of stock options granted using the Black Schoels option-pricing model:

<TABLE>
<CAPTION>
1997 1996
---------- -----------
<S> <C> <C>
Dividend yield ............ 0.0% 0.0%
Expected volatility ....... 55.0% 0.0%
Average expected option ... 5 years 6.75 years
life
Risk-free interest rate ... 5.9 - 6.8% 6.4%
</TABLE>

1997 assumptions reflect factors which changed with the Company's initial
public offering in 1997.

(7) INCOME TAXES

Prior to March 28, 1996 (incorporation), the Company operated as a division
of XL Vision, Inc., and, as such, was not subject to income taxes. Accordingly,
no income tax disclosures are presented for periods prior to 1996. Net operating
losses generated prior to March 28, 1996 were included in XL Vision's tax
returns. There are no net operating loss-related deferred tax assets from this
period reflected on the balance sheet. Had the Company recorded a tax provision
prior to March 28, 1996 on a separate return basis, any deferred tax asset
resulting from net operating loss carryforwards would have been completely
offset by valuation allowances.

As of December 31, 1997, the Company has net operating loss carryforwards
for federal income tax purposes of approximately $10,800,000 which are available
to offset future federal taxable income, if any, through 2012. A state net
operating loss carryforward of $6,600,000 is available to offset future state
taxable income, if any, through 2005.

As ChromaVision was not a legal entity prior to incorporation, the transfer
of funds to XL Vision of approximately $4,800,000 was deemed, for income tax
purposes, to be the cost of the technology transfer from XL Vision (see note 1).
For income tax purposes, this amount is considered to be an intangible asset
which is being amortized over a fifteen year period.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes.

The following table summarizes the tax effects of temporary differences
which give rise to significant portions of the deferred tax assets and liability
at December 31:

<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward ................. $ 4,081,519 $ 1,185,019
Intangible asset, net of amortization ........... 1,678,997 1,701,363
Accrued liabilities and other deferred tax assets 108,654 40,883
----------- -----------
Deferred tax assets ..................... 5,869,170 2,927,265
Deferred tax liability:
Depreciation .................................... (28,791) (1,859)
----------- -----------
Total ................................... 5,840,379 2,925,406
Less valuation allowance for deferred tax assets .. (5,840,379) (2,925,406)
----------- -----------
Deferred tax assets (liability), net .... $ -0- $ -0-
=========== ===========
</TABLE>

<PAGE> 31
The valuation allowance increased by $2,914,973 for the year ended December
31, 1997.

Actual income tax expense differs from amounts computed by applying the U.S.
federal income tax rate of 34% to pretax income as a result of the following:

<TABLE>
<CAPTION>
1997
-----------
<S> <C>
Computed expected tax benefit ... $(2,156,935)
State income taxes net of federal
benefit ......................... (496,552)
Change in valuation allowance ... 2,914,973
Other ........................... (261,486)
-----------
Actual tax expense .... $ -0-
===========
</TABLE>

The difference between the "expected" tax benefit (computed by applying the
federal corporate income rate of 34% to the loss before income taxes) and the
actual tax benefit for 1996 is due to limitations on the benefit for the net
operating losses recognized, resulting from allocations of the consolidated
income tax results of XL Vision for the year ended December 31, 1996, and the
effect of the valuation allowance.

In accordance with Internal Revenue Code Section 382, the annual utilization
of net operating loss carryforwards and credits existing prior to a change in
control in the Company may be limited.

(8) RELATED PARTY TRANSACTIONS

XL Vision provided certain personnel and administrative services to the
Company through June 1997. Related charges were either allocated to the Company
or charged under an administrative services agreement. Allocations consisted of
all direct costs and certain indirect costs based upon the proportional value of
all expenses incurred by XL Vision. Management of the Company believes the
allocated costs reasonably reflect the costs of the operations of the Company as
if it were on a stand-alone basis. Administrative service fees allocated or
charged amounted to $740,000 and $260,000 respectively during 1996 and 1997.

Effective January 1997, the Company entered into an additional
administrative service agreement which specifies a fee based upon a percentage
of gross revenues. The fee is payable quarterly. The fee is payable to Safeguard
and XL Vision based upon an aggregate of 1.5% (.75% each) of gross revenues
subject to an annual limit of $300,000. The fee is payable upon achievement of
positive cash flow from operations. The agreement extends through January 31,
2002 and continues thereafter unless terminated by either party. Per the initial
stock purchase agreement, the Company paid Safeguard $50,000 for services in
connection with the initial public offering.

Effective December 31, 1997, amounts due to XL Vision are due within thirty
days of receipt. The average outstanding balance due to XL Vision for the years
ended December 31, 1996, and 1997 were $2,553,537 and $193,204 respectively. An
analysis of amounts due to XL Vision is summarized as follows:

<TABLE>
<S> <C>
Amounts due to XL Vision at December 31, 1995 ..................... $ 4,726,635
Allocation of costs and funding of working capital to the Company 1,846,752
Cash transferred to XL Vision ................................... (6,275,000)
Transfers of inventory, at cost ................................. 82,052
-----------
Amount due to XL Vision at December 31, 1996 ...................... 380,439
Allocation of costs and funding of working capital to the Company 169,261
Cash transferred to XL Vision ................................... (543,731)
-----------
Amount due to XL Vision at December 31, 1997 ...................... $ 5,969
===========
</TABLE>

(9) COMMITMENTS AND CONTINGENCIES

Agreement with Centocor. The Company sold Centocor six ACISs in 1995 to
facilitate its clinical trials for cancer applications. As Centocor received
feedback from those trials the Company, which was continuing its research and
development efforts, incorporated the feedback into its technology. In July
1996, both parties entered into an agreement stipulating their various rights to
the reagents being tested for cancer and the ACIS technology. As an outcome of
this agreement, the Company agreed to a put option by which Centocor would have
the right to return the six instruments for $800,000 and the issuance of 770,192
shares of preferred stock at $1.00. As a result of this agreement, the Company
recognized $770,192 of research and development expenses during 1996. During
December 1996 negotiations commenced which prompted Centocor's waiver of its
rights to return the six instruments and

<PAGE> 32
extinguished any commitment to repurchase these instruments. In exchange for
Centocor's waiver, the Company agreed to provide a specified number of hours of
technical support and software development services through September 1997.

Agreement with Sigma. The Company signed a three-year exclusive distribution
and development agreement in October 1997 with Sigma Diagnostics, Inc., a
subsidiary of Sigma Aldrich, to market the Company's proprietary pre-natal Down
syndrome screening test, which uses the ChromaVision ACIS. The ChromaVision test
is currently in clinical trials in the U.S. and Great Britain.

The agreements have performance measures, specifically minimums as to the
number of ACIS placements and as to revenue per ACIS that need to be met in
order for Sigma to retain its exclusivity on the prenatal Down syndrome
screening test. The Company's obligations to Sigma Diagnostics are to maintain
an adequate inventory level to support ACIS placements and turn-around time on
sales orders placed.

Voluntary Employee Savings 401(k) Plan. The Company has a voluntary employee
savings 401(k) plan which is available to all full time employees 21 years or
older. The plan provides for a matching by the Company of the employee's
contribution to the plan for 50% of the first 6% of the employee's annual
compensation. The Company's matching contributions were approximately $36,000
for the year ended December 31, 1997 and $12,000 in 1996.

Lease Commitment. The Company leases furniture and office space under
operating leases expiring in February and April 2000. The Company has rental
commitments under these agreements for 1998, 1999 and 2000 of $162,858, $167,912
and $28,118, respectively. Total rent expense related to these leases was
approximately $139,000 for the year ended December 31, 1997.

Litigation. On November 10, 1997 the Company commenced litigation against
IDEA Research LLC in the federal district court in Santa Ana, California seeking
a determination by the court that the Company's automated microscope systems do
not infringe certain patent rights of IDEA Research. The Company is also seeking
recovery of damages for interference with prospective business advantage in
connection with certain claims of patent infringement and disparaging statements
made by IDEA Research about the Company and its microscope systems.

The Company believes that all of the claims by IDEA Research are without
merit and intends to defend against them vigorously while pursuing its own
claims against IDEA Research. As of December 31, 1997, no amounts have been
accrued for and the resolution of this matter is not expected to have a material
impact on the Company's results of operations or financial position.

(10) STOCK TRANSACTIONS

On March 19, 1997, the Company authorized a five-for-four common stock
split. As of December 31, 1996 preferred stock conversion factors, stock options
outstanding and common shares outstanding have been adjusted to reflect
retroactive effect of this stock split.

In August 1997, the Company completed an initial public offering and sold
6,020,000 shares of common stock. The Company received net proceeds of
approximately $28.4 million after deducting underwriting discounts and offering
expenses. Approximately $5.5 million of the net proceeds were used for repayment
of the bank line of credit indebtedness and reduction of an inter-company
payable to XL Vision, Inc.

(11) SUBSEQUENT EVENT

The Company is currently negotiating a new line of credit with its existing
bank (Bank of America). The terms of the agreement provide a $5,000,000 secured
line of credit at the bank's reference rate less .25%. The new line would be
secured by a minimum of 110% of the market value of the borrowings with the
Company's cash and investment accounts held by the bank.

<PAGE> 33
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None

<PAGE> 34
PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

EXECUTIVE OFFICERS:

The following persons were executive officers of the Company at March 13,
1998:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Douglas S. Harrington, M.D. 45 Chief Executive Officer and Director
Kenneth D. Bauer, Ph.D. 46 Vice President and Chief Science Officer
Kenneth S. Garber 44 Vice President of Sales and Business Development
Kevin C. O'Boyle 41 Vice President and Chief Financial Officer
Diethart Reichardt 55 Vice President, Global Product & Int'l Market Development
Michael G. Schneider 47 Vice President of Manufacturing and Service
Patricia Sisson 44 Vice President of Marketing and Strategic Planning
</TABLE>

Douglas S. Harrington, M.D. has been Chief Executive Officer since December
1996. From 1995 until he joined the Company in 1996, Dr. Harrington served as
Chairman and President of Strategic Business Solutions, Inc., a privately held
company specializing in commercialization of biotechnology, and as a Principal
in Douglas S. Harrington and Associates, a strategic consulting firm. From 1992
to 1995, Dr. Harrington served as President of Nichols Institute, a publicly
traded healthcare laboratory services provider, now part of Quest Diagnostics,
Inc., a publicly traded laboratory services provider. Prior to 1992, Dr.
Harrington held various management positions within Nichols Institute including
Vice President of Operations and Medical Director. Dr. Harrington currently sits
on the Boards, Advisory Boards, or Scientific Advisory Boards of ten healthcare
and medical device companies, including as a director of Pacific Biometrics,
Inc., a publicly traded company and is an Associate Professor of Clinical and
Anatomic Pathology at the University of Nebraska Medical Center. Dr. Harrington
has over 18 years experience in the commercialization of healthcare technology
and has published over 80 peer-reviewed publications.

Kenneth D. Bauer, Ph.D. has been Vice President and Chief Science Officer
since August 1997. From 1992 until he joined the Company, Dr. Bauer was Senior
Scientist in the Immunology Division and head of Cytometry for Genentech, a
publicly traded biotechnology company. Prior to Genentech, Bauer was Associate
Professor of Pathology at Northwestern University Medical School and Director of
the Quantitative Cytology Laboratory at the Northwestern Memorial Hospital in
Chicago, Illinois. He has authored more than 90 scientific publications, and
served as Associate Editor of Cytometry for the Journal of the Society of
Analytical Cytology for ten years. Dr. Bauer has been a member of the scientific
advisory boards for several public companies and served on scientific review
sections for the National Institute of Health, Department of Energy, and
National Aeronautics and Space Administration. He is currently an Adjunct
Professor of Pathology and Laboratory Medicine at the University of Pennsylvania
School of Medicine and a subcommittee member of the National Committee for
Clinical Laboratory Standards.

Kenneth S. Garber has been Vice President of Marketing, Sales and Business
Development of the Company since March 1996. From 1994 to 1996, Mr. Garber was
Vice President and General Manager of the Imagelink Business Unit for Kodak
Health Imaging Systems, Inc. In 1993, he was Assistant to the President of Kodak
Health Imaging Systems and during 1992 was Director of Strategic Sales
Development for Kodak Health Imaging Systems, Inc. From 1990 to 1991, Mr. Garber
also was Director of Strategic Sales Development for Vortech Data, Inc. He
previously held sales management and sales positions with Hughes Network
Systems, Satellite Business Systems and Federal Data.

Kevin C. O'Boyle has been Vice President and Chief Financial Officer of the
Company since December 1996. From 1990 to 1994, Mr. O'Boyle was the Chief
Financial Officer and from 1994 to 1996, he was Sr. Vice President of Operations
for Albert Fisher North America, a publicly traded international food processor
and distributor. From 1984 to 1990, Mr. O'Boyle served as the Vice President and
Controller of American Cablesystems, a publicly traded cable television firm. He
previously held various accounting positions on the audit and tax staff with
Pannell, Kerr & Forster, a public accounting firm.

<PAGE> 35
Diethart Reichardt has been Vice President of Global Product and
International Business Development of the Company since January 1998.
Previously, Mr. Reichardt spent more than twenty years with Allergan, Inc., a
publicly traded provider of therapeutic eye care. Mr. Reichardt held various
senior management positions including Corporate Vice President and head of the
global optical, consumer and over-the-counter division.

Michael G. Schneider has been Vice President of Manufacturing and Service
since June 1996. From 1995 to May 1996, Mr. Schneider was Vice President of
Manufacturing at Kodak Health Imaging Systems, Inc. From 1993 to 1995, Mr.
Schneider was Director of Worldwide Service at Kodak's Customer Service
Division. From 1990 to 1993, Mr. Schneider was Manager of Services Support at
Kodak's Health Science Division. Mr. Schneider has twenty-four years of
experience in manufacturing and service management.

Patricia Sisson has been Vice President of Marketing of the Company since
December 1997. From 1995 to 1997, Ms. Sisson was Vice President of Marketing at
Quest Diagnostics, Inc., a commercial laboratory having more than a billion
dollars in revenue. From 1986 to 1995, Ms. Sisson served as Vice President of
Marketing at Nichols Institute and Vice President of Marketing and Sales for
Nichols Institute Diagnostics, a reference laboratory. In addition, Ms. Sisson
spent more than a decade with Beckman Instruments, Inc. in product and marketing
management roles. Ms. Sisson is an ASCP Licensed Medical Technologist.

DIRECTORS

The Company incorporates by reference the information contained under the
caption "ELECTION OF DIRECTORS" in its definitive Proxy Statement relative to
its June 3, 1998 annual meeting of shareholders, to be filed within 120 days
after the end of the year covered by this Form 10-K/A pursuant to Regulation 14A
under the Securities Act of 1934, as amended.

DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K

The Company incorporates by reference the information contained under the
caption "SECTION 16 (a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" in its
definitive Proxy Statement relative to its June 3, 1998 annual meeting of
shareholders, to be filed within 120 days after the end of the year covered by
this Form 10-K/A pursuant to Regulation 14A under the Securities Exchange Act of
l934, as amended.

ITEM 11. EXECUTIVE COMPENSATION

The Company incorporates by reference the information contained under the
captions "Directors' Compensation," "Compensation Committee Interlocks and
Insider Participation" and "EXECUTIVE COMPENSATION" in its definitive Proxy
Statement relative to its June 3, 1998 annual meeting of shareholders, to be
filed within 120 days after the end of the year covered by this Form 10-K/A
pursuant to Regulation 14A under the Securities Exchange Act of l934, as
amended.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The Company incorporates by reference the information contained under the
caption "SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in
its definitive Proxy Statement relative to its June 3, 1998 annual meeting of
shareholders, to be filed within 120 days after the end of the year covered by
this Form 10-K/A pursuant to Regulation 14A under the Securities Exchange Act of
l934, as amended.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The Company incorporates by reference the information contained under the
captions "Compensation Committee Interlocks and Insider Participation," "Certain
Relationships" and "Certain Transactions" in its definitive Proxy Statement
relative to its June 3, 1998 annual meeting of shareholders, to be filed within
120 days after the end of the year covered by this Form 10-K/A pursuant to
Regulation 14A under the Securities Exchange Act of l934, as amended.

<PAGE> 36
PART IV

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

(a) Financial Statements and Schedules

The following financial statements and schedules listed below are included
in this Form 10-K/A.

Financial Statements (See Item 8)
Report of Independent Accountants
Balance Sheets as of December 31, 1996 and 1997
Statements of Operations for the Years Ended December 31, 1995, 1996,
and 1997
Statements of Shareholders' Equity (Deficit) for the Years Ended
December 31, 1995, 1996, and 1997
Statements of Cash Flows for the Years Ended December 31, 1995, 1996,
and 1997
Notes to Consolidated Financial Statements

Financial Statement Schedules

All information for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission is either included in the
financial statement or is not required under the related instruction or are
inapplicable, and therefore have been omitted.

(b) Reports on Form 8-k

No reports on Form 8-k were filed by the Company during the last quarter of
fiscal year 1997.

The following is a list of exhibits required by Item 601 of Regulation S-K
filed as part of this Form 10-K/A. Where so indicated by footnotes, exhibits
which were previously filed are incorporated by reference. For exhibits
incorporated by reference, the location of the exhibit in the previous filing is
indicated in parentheses.

<PAGE> 37
EXHIBIT INDEX

<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------ ----------- ------------
<S> <C> <C>
3.1 Certificate of Incorporation of the Company (as amended)** ..............

3.2 By-laws of the Company, as amended** ....................................

10.1 ChromaVision Medical Systems, Inc. 1996 Equity Compensation Plan**(c) ...

10.2 Stock Option Grant Letter (Dr. Douglas S. Harrington)**(c) ..............

10.3 Stock Option Grant Letter (Kevin C. O'Boyle)**(c) .......................

10.4 Stock Option Grant Letter (Michael G. Schneider)**(c) ...................

10.5 Stock Option Grant Letter (Kenneth S. Garber)**(c) ......................

10.6 Employment Agreement between Dr. Douglas S. Harrington and the Company,
as of December 30, 1996**(c) ............................................

10.7 Employment Agreement between Kenneth S. Garber and the Company, dated
February 15, 1996**(c) ..................................................

10.8 Employment Agreement between Kevin C. O'Boyle and the Company, dated
November 27, 1996**(c) ..................................................

10.9 Separation Agreement between Michael S. Shiff and the Company, dated
December 27, 1996**(c) ..................................................

10.10 Stock Purchase Agreement between the Company and the Series A Preferred
Stockholders, dated as of June 6, 1996** ................................

10.11 Registration Rights Agreement between the Company and the Series A
Preferred Stockholders, dated as of June 6, 1996** ......................

10.12 Stockholders' Agreement between the Company and the Series A Preferred
Stockholders, dated as of June 6, 1996** ................................

10.13 Loan Agreement between the Company and the Barnett Bank, N.A., dated
December 24, 1996** .....................................................

10.14 Unconditional and Unlimited Guaranty Agreement between Safeguard
Scientifics, Inc. and Barnett Bank, N.A., dated December 24, 1996** .....

10.15 Promissory Note by the Company to Barnett Bank, N.A., dated December 24,
1996** ..................................................................

10.16 Tax Indemnity Agreement between the Company and Barnett Bank, N.A., dated
December 24, 1996** .....................................................

10.17 Administrative Services Agreement among the Company, XL Vision, Inc. and
Safeguard Scientifics, Inc. dated as of March 31, 1997** ................

10.18 Direct Charge Administrative Services Agreement between the Company and
XL Vision, Inc., dated as of March 31, 1997** ...........................

10.20 Subscription Agreement between the Company and Safeguard Scientifics,
Inc., dated as of December 31, 1996** ...................................

10.21 Contribution Agreement between the Company and XL Vision, Inc., dated as
of May 13, 1996** .......................................................

10.22 Collaboration Agreement between the Company, XL Vision, Inc. and
Centocor, Inc., as amended, as of February 25, 1997** ...................

10.23 Lease Agreement between Blue Family Trust, Lingo Family Trust and the
Company, dated January 13, 1997** .......................................

10.24 Distribution Agreement between ChromaVision Medical Systems, Inc. and
Sigma Diagnostics, Inc. dated October 22, 1997*** .......................

10.25 UR-NAP Application Development Agreement and Right of First Refusal of
New Applications between the Company and Sigma Diagnostics, Inc. dated
October 22, 1997*** .....................................................

11.1 Statement Regarding Computation of Earnings Per Share* ..................

21.1 Subsidiaries of the Registrant** ........................................

27.1 Financial Data Schedule# ................................................
</TABLE>

<PAGE> 38
- ----------

* Filed herewith.

** Filed on April 30, 1997 as an exhibit to the Company's Registration
Statement on Form S-1 (No. 333-26129) and incorporated by reference.

*** Previously filed as an exhibit to the Company's Form 10-Q on November 14,
1997 and incorporated by reference.

# Previously filed as an exhibit to the Company's Form 10-K on March 31,
1998 and incorporated by reference.

<PAGE> 39
SIGNATURES

Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in San Juan
Capistrano, California on May 5, 1998.

CHROMAVISION MEDICAL SYSTEMS, INC.

By: /s/ DOUGLAS S. HARRINGTON
-------------------------------
Douglas S. Harrington
Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities indicated on
May 4, 1998.

<TABLE>
<CAPTION>
SIGNATURES TITLE(S)
---------- --------
<S> <C>
/s/ DOUGLAS S. HARRINGTON Chief Executive Officer and Director
- -------------------------------
Douglas S. Harrington (Principal Executive Officer)

/s/ KEVIN O'BOYLE Vice President and Chief Financial Officer
- -------------------------------
Kevin O'Boyle (Principal Financial and Accounting Officer)

/s/ JOHN S. SCOTT Chairman of the Board of Directors
- -------------------------------
John S. Scott

/s/ CHRISTOPHER MOLLER Director
- -------------------------------
Christopher Moller

/s/ RICHARD MORGAN Director
- -------------------------------
Richard Morgan

/s/ CHARLES A. ROOT Director
- -------------------------------
Charles A. Root
</TABLE>

<PAGE> 1
EXHIBIT 11.1

COMPUTATION OF EARNINGS PER SHARE
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997

<TABLE>
<CAPTION>
1996 1997
----------- ------------
<S> <C> <C>
Net Loss..................................... $(4,030,263)(a) $ (6,343,927)
----------- ------------
Weighted average common stock shares
outstanding.................................. 10,580,080 13,455,529
=========== ============

Basic and diluted loss per share............. $ (.37) $ (.47)
=========== ============
</TABLE>

- ----------

(a) 1996 Net loss is subsequent to incorporation.