CHROMAVISION MEDICAL SYSTEMS INC, 10-K405, 1999-03-31

CHROMAVISION MEDICAL SYSTEMS INC
10-K405, 1999-03-31
LABORATORY ANALYTICAL INSTRUMENTS

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

----------------

FORM 10-K

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, 1998

[ ] 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 (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)

33171 PASEO CERVEZA
SAN JUAN CAPISTRANO, CA 92675-4824
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

(888) 443-3310
(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
or any amendment to this Form 10-K. [X]

Based on the closing sales price of March 22, 1999 the aggregate market
value of the voting stock held by nonaffiliates of the registrant was
$67,784,236.

The number of shares outstanding of the registrant's Common Stock, $.01
par value was 17,548,129 at March 22, 1999.

DOCUMENTS INCORPORATED BY REFERENCE

LOCATION IN FORM 10-K INCORPORATED DOCUMENT
- --------------------- ---------------------
Part III: Items 10, 11, 12 and 13 Proxy Statement for 1999 Annual Meeting
of Shareholders

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TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE NUMBER
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<S> <C> <C>
PART I
Item 1. Business......................................................... 3
Item 2. Properties....................................................... 13
Item 3. Legal Proceedings................................................ 13
Item 4. Submission of Matters to a Vote of Security Holders.............. 13

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters........................................................ 16
Item 6. Selected Financial Data.......................................... 17
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 18
Item 7a. Quantitative and Qualitative Disclosures About Market Risk....... 21
Item 8. Financial Statements and Supplementary Data...................... 22
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................ 35

PART III

Item 10. Directors and Executive Officers of the Registrant.............. 36
Item 11. Executive Compensation.......................................... 36
Item 12. Security Ownership of Certain Beneficial Owners and Management.. 36
Item 13. Certain Relationships and Related Transactions.................. 36

PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports of
Form 8-K....................................................... 37
SIGNATURES
</TABLE>

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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; NEW APPLICATIONS MAY NOT BE SUCCESSFULLY DEVELOPED; 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 COULD BE DELAYED OR NOT OBTAINED.

PART I

ITEM 1. BUSINESS

ChromaVision Medical Systems, Inc. is a laboratory medical diagnostics
company that develops and manufactures an Automated Cellular Imaging System
(ACIS(TM)) 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 a filing made in November 1998, which
would result in several commercialized applications. The ACIS and one
application, leukocyte alkaline phosphatase (LAP), were cleared for commercial
distribution in the U.S. by the FDA in June of 1997.

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 intelligent imaging technology integrated within a fully automated
microscopy platform creates a powerful diagnostic system that delivers superior
sensitivity, accuracy, labor savings and speed to cell based diagnostics. The
ACIS enables diagnostic procedures, such as rare event detection, that are
either impractical or impossible using today's manual methods.

The ChromaVision ACIS is designed for fully automated, walk away
operation. The slides are automatically scanned by the system, initially at low
magnification to identify potential targeted cells using color characteristics.
The location of targeted cells is discovered utilizing sophisticated color space
transformation techniques. Cells are then re-imaged at a higher power and
verified as a proper cell candidate using additional color and morphological
criteria. Digital images of the targeted cells are stored for scoring and later
review by the technologist and pathologist. Once the image is reviewed and
accepted, the digital images serve as a permanent record of the patient's sample
and test results. The digital image can also be sent electronically for remote
review and consultation.

A broad range of potential applications is targeted for the ACIS with
initial focus in the areas of cancer, infectious disease and prenatal
diagnostics. Each of these applications will have to be developed, feasibility
tested and probably clinically tested. No assurance can be given that any of
these applications will become commercially available.

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 risk of healthcare cost 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

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healthcare providers as service utilization increases. Consequently, healthcare
providers are increasingly seeking more efficient and 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.

Manual microscopic diagnostic examinations performed to date, while
necessary and important, are nonetheless subjective in nature. Among the factors
contributing to this subjectivity is the lack of standardization of methodology
for both the handling and the staining of the specimen. A broad spectrum of
reagents and preparative approaches are often employed for a particular assay
between laboratories, which can substantially influence the final result. The
lack of consensus on required diagnostic criteria, as well as the experience of
the pathologist, can further contribute to subjectivity in interpretation.
Together, these factors can result in variations in reportable results, ranging
from modest (and probably insignificant) differences to the extreme case of
false positive or false negative results.

CORE COMPETENCIES AND STRATEGIES

The Company's major strategic advantage is the flexibility of the ACIS
technology, which can be adapted for use in multiple applications (disease
conditions). The ability to add new applications to an existing platform gives
the ACIS an advantage over other specialized instruments performing single
procedures such as PAP analysis. The Company's core competencies and strategies
are listed below.

BRIGHT FIELD CELLULAR TECHNOLOGY

The ACIS is a fully-automated computer-based microscope designed to
detect and count cells based on color and morphology, and measure specific cell
and tissue based characteristics utilizing its technical platforms (rare-event
detection, scoring, rapid counting and tissue analysis). This technology is
designed to enable diagnostic procedures that would be impossible or impractical
by using manual methods. The ACIS is designed to enable healthcare providers to
improve the consistency and accuracy of patient diagnoses, enhance overall
patient care and lower costs.

The ACIS uses color as its primary discriminator when analyzing slides.
The advantage of this is that the majority of slide based applications currently
being performed in laboratories use some form of color to assist in the
analysis. The color on a microscope slide is produced by the reaction between
common laboratory reagents and the cells of interest. The FDA appears to be
comfortable with the premise of "finding color" primarily because of its
widespread adoption.

THE IMAGE

The end result of analyzing slides on the ACIS is the automated
location of diagnostic cells, quantification of the cells and a montage
displayed on the computer monitor. These images are robust enough to allow a
trained professional to make a diagnosis. Other competing technologies do not
display their results and often require that the specimen be disassociated or
destroyed as part of their processing. The power of visualizing the diagnostic
cells for review on the monitor can be expected to substantially improve the
accuracy of the diagnosis.

SENSITIVITY

Tests, which were performed using specific color-reagents, have shown
that the ACIS is capable of consistently detecting one abnormal cell in a
population of 120 million normal cells. This superior sensitivity is expected to
translate into a very substantial potential market for the ACIS that requires
rare-event detection to be effective, such as the micrometastases / minimum
residual disease cancer market.

MULTI-APPLICATION PLATFORM

The ChromaVision technology supports a variety of established and
FDA-approved reagents and stains. To the extent that new reagents or stains are
developed and introduced to the diagnostic industry, the ACIS is designed to be
reconfigured to work with these new substances. This gives ChromaVision a
competitive advantage over systems that support only one or a limited number of
applications.

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OBJECT-ORIENTED CODE

The software that drives the ACIS is built on an "object-oriented"
foundation. This software development approach is designed to allow each new
(follow-on) application to be built from existing software building blocks, and
therefore completed with a significant savings in time and resources.

PIPELINE OF POTENTIAL APPLICATIONS

It is the Company's plan to maintain a "pipeline" of next-generation
applications ready to move into current product development once initial
applications are commercialized.

This pipeline concept is essential because of the nature of biological
systems. The reaction or outcome of an application cannot be reliably predicted
without rigorous testing and examination. The pipeline allows for an application
to be moved quickly and seamlessly into the development queue in the event that
a current application is unsuccessful or re-prioritized. Additionally, to
maximize the financial return to ChromaVision, we have a diversified base of
potential applications.

PER-TEST (CLICK) REVENUE MODEL

ChromaVision intends to place the instruments with customers on a
per-use or annuity model as opposed to outright sale of the instrument. The
per-use, or "per-click", charge will be triggered by the specific application or
test being run. This model removes the capital acquisition barrier to new
instrument placements and shortens the amount of time required to place an
instrument with a customer. ChromaVision will sell instruments into certain
non-commercial research centers that are unable to use the annuity-type
placement.

CHROMAVISION ACIS APPLICATIONS

Although the ACIS has been approved for commercial distribution for
only one application to date, 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:

HER2/NEU

The human epidermal growth factor receptor-2 (HER-2) gene has been
shown to be clinically important in breast and ovarian cancer. In breast cancer,
numerous clinical studies have documented that gene amplification (i.e.
additional copies of the HER-2 gene) or HER-2 protein overexpression is seen in
approximately 25-30% of cases. These features have been shown to correlate with
a poorer clinical outcome for the patient (i.e. relatively shorter survival or
disease-free survival), relative to cases without amplification of this gene or
protein overexpression.

The last several months have witnessed an exciting new development in
the treatment of breast cancer, which is directly related to the HER-2 protein.
Specifically, an antibody-based therapy called Herceptin(TM) has been developed
by Genentech, Inc. and recently cleared by the FDA, which targets the HER-2
protein. Herceptin represents the first example of specific molecular
therapeutic targeting of a human solid tumor. This new therapeutic has been
shown to be clinically effective when used alone or when combined with
conventional cytotoxic chemotherapy. Generally, there is less morbidity
associated with Herceptin therapy than with conventional chemotherapy.

Treatment with Herceptin requires a test for HER-2 gene amplification
or protein overexpression, due to the fact that only patients whose tumor
overexpresses the HER-2 protein have been shown to respond to Herceptin.
Recently, DAKO Corporation with assistance from Genentech, Inc. submitted a new
antibody test called Herceptest for measuring HER-2 protein overexpression for
FDA approval. The test was rapidly approved by the FDA for the purpose of
assisting the oncologist with therapeutic decision-making of Herceptin
treatment.

The FDA cleared HercepTest(TM), a diagnostic antibody test that
utilizes a staining procedure targeted to the HER-2 protein, along with other
reagents which ultimately "color" the HER-2 protein with a brown color that can
be visualized microscopically by the pathologist. Following staining with
HercepTest reagents, the pathologist generally scores the level (intensity) of
the colored product to provide a measurement of the amount of the HER-2 protein
in the patient's tumor. Unfortunately, this method is recognized to be
subjective in nature, with known variability in scoring between pathologists.

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The Company has an agreement to collaborate with DAKO to offer a system
in which the ACIS is used with HercepTest for analysis of HER-2 protein
expression. The imaging system represents a computerized microscopy system,
which has extremely sensitive capability for color detection and highly accurate
and reproducible color-based measurement of HER-2. As compared with manual
microscopy where the interpretation of HER-2 expression is subjective,
computer-based analysis available using the ACIS provides objective,
quantitative, and highly reproducible results. Based on the capability for more
accurate measurement of the level of HER-2 protein expression, the ACIS may
allow for improved identification of patients who warrant treatment with
Herceptin. As such, it holds the potential to provide a powerful new tool in the
diagnostic workup of the breast cancer patient, and ultimately in the clinical
management of the patient. While this is a very promising program, testing and
clinical trials all need to be completed. Thus there remains uncertainty about
the success of the program.

OTHER 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 hematological
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. While the acceptance of the commercial
procedure still involves substantial uncertainty, preliminary results from tests
conducted at the Kenneth Norris Cancer Center, at the University of Southern
California 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 in these recent studies, 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.

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 T-cells,
to predict patient prognosis. The absolute level of CD4 T-cells is a recognized
marker of disease progression and prognosis. The determination of these markers
currently requires 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 T-cell determinations,
allowing more accurate assessment of prognosis and therapeutic response. The
technology also could have potential as an 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 and
other clinical complications 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.

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TRIPLE PLUS(TM) APPLICATION

The Company is currently in clinical trials utilizing the ChromaVision
ACIS for the Triple Plus(TM) application. If the Triple Plus(TM) proves
effective, its use in prenatal screening will mean that 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
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.) and 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.

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. The Company currently has 10
employees dedicated to sales and marketing efforts.

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 limited number of
laboratories performing the Triple Screen greatly facilitates marketing the
Triple Plus(TM).

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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 customers. 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. 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.

In order to capture market share for its applications, the Company
intends to pursue relationships with third parties capable of effectively
distributing the ChromaVision ACIS and providing related services on a
large-scale basis.

The Company initially plans to work directly with its clinical
collaborators to gain acceptance in the medical community for new applications.
In order to capture market share for applications in which distribution would be
more widely disbursed, the Company intends to pursue relationships with third
parties capable of effectively distributing the 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 offer kits 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.

In October 1998, the Company signed an agreement to jointly develop,
market and sell a tissue-based system with DAKO Corporation. The introductory
application will be Herceptest(TM), a FDA cleared diagnostic that is used to
identify breast cancer patients likely to respond to the recently cleared drug
Herceptin(TM) developed by Genentech. Follow-on tissue applications will include
estrogen receptor (ER), progesterone receptor (PR), Ki-67/Mib1 a tumor
proliferation marker, and micromets (MM/MRD). DAKO and ChromaVision will have
joint responsibility for marketing of the system in the United States. DAKO will
have primary responsibility for account management; reagents, autostainers and
contract management and ChromaVision will have primary responsibility for
providing its expertise with respect to the ACIS.

THE CHROMAVISION AUTOMATED CELLULAR IMAGING SYSTEM TECHNOLOGY

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."

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

<PAGE> 9

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. However, the Company does rely on sole source suppliers for certain
components in its product of which any interruption would cause a material
adverse impact on the Company's operations.

The ChromaVision ACIS is designed to enable a laboratory technician to
operate the system using simple "point and click" commands. The system interface
includes a monitor for viewing high quality color images of the cells, system
commands and status. 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 eight patents with the
U.S. Patent and TradeMark Office (PTO) regarding certain aspects of the
ChromaVision ACIS software technology. 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 April 21, 1998 the Company signed a settlement
agreement with IDEA Research LLC ("IDEA Research") related to litigation filed
by the Company on November 10, 1997 involving, among other things, a claim by
IDEA Research of patent infringement against the Company. See Item 3 (Legal
Proceedings) for further discussion.

The Company currently relies on a combination of trade secrets,
proprietary knowledge, technological advances and confidentiality 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

<PAGE> 10

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 will not incur substantial litigation expenses 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.

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 pursuant to a
less extensive procedure known as a 510(k) clearance.

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 a 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 filed in November 1998 a 510(k) application with the

<PAGE> 11

FDA for immunohistochemistry ("IHC"). The Company believes that the clearance
of this filing, together with its first 510(k) clearance using a biochemical
marker, would enable a number of applications that utilize these methods to be
added to the ChromaVision ACIS potentially without the need for additional
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. 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 is
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 FDA 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. 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, a
self-regulated consortium of health care 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

<PAGE> 12

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 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

Although the predominant method of cell based diagnostics will remain
traditional microscopic analysis performed by pathologists, there are several
companies engaged in the development of cell based diagnostic and imaging
systems that could result in potential competition for targeted ACIS markets and
customers.

ChromaVision is most often compared to other automated microscope
systems, as the hardware components are somewhat similar. Five of these
companies (Morphometrix Technologies, Inc., Neuromedical Systems, Inc., Neopath,
Inc., Autocyte, Inc. and Intelligent Medical Imaging, Inc. "IMI") utilize
morphology for cell identification, as compared with the color-based approach
that is the foundation of the ChromaVision system. The first four companies are
primarily engaged in the PAP smear market, and IMI has targeted white blood cell
differential tests. ChromaVision's proprietary color-based image analysis
software is completely different than that employed by other automated
microscope systems and offers significant advantages of speed and sensitivity
needed in the detection of rare cellular events. The potential for multiple
applications and markets represents a critical difference from other automated
microscope manufacturers that emphasize labor savings as their primary value
advantage. Other imaging systems such as Applied Imaging Corporation and
Autocyte, Inc. share similar imaging technology yet are focused on specific
research applications as compared to ChromaVision's focus on the clinical
diagnostic market.

Other technologies utilized for rare event detection and cellular
diagnostics include fluorescent in-situ hybridization, flow cytometry and PCR.
The latter two technologies destroy the specimen to analyze it and therefore
they do not allow for a subsequent independent review of the targeted cells.

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

<PAGE> 13

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 19 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 achieving a balance between research and
development innovation and support of focused, market driven requirements.
Research and development spending was approximately, $1,979,000, $3,565,000 and
$4,664,000 for 1996, 1997 and 1998, 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 Company relies on sole
source suppliers for certain components in its product of which any interruption
would cause a material adverse impact on the Company's operations. 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, achieved ISO 9001 certification in October 1998 and a CE Mark in
March 1999.

EMPLOYEES

As of December 31, 1998, the Company employed 56 persons of which 19
persons were in product development and engineering, 17 persons were in
manufacturing, quality assurance and field services, 10 persons were in finance,
executive and administrative capacities and 10 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 $127,000. 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

Note 9, Commitments and Contingencies, of the Notes to Financial
Statement are hereby incorporated by reference.

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, 1998.

<PAGE> 14

EXECUTIVE OFFICERS

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

NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Douglas S. Harrington, M.D. 46 Chief Executive Officer, President and Director
Kenneth D. Bauer, Ph.D. 47 Vice President and Chief Science Officer
Kevin C. O'Boyle 42 Senior Vice President of Operations and Chief Financial Officer
Diethart Reichardt 56 Vice President of International Business Development and Operations
Michael G. Schneider 48 Vice President of Manufacturing and Service
Patricia Sisson 45 Senior Vice President of Marketing, Sales and Strategic Planning
Jose de la Torre-Bueno, Ph.D. 50 Vice President of Research and Development
</TABLE>

DOUGLAS S. HARRINGTON, M.D. has been Chief Executive Officer since
December 1996 and President since December 1998. Prior to joining the Company,
Dr. Harrington served as Chairman and President of Strategic Business Solutions,
Inc., a privately held company specializing in the 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 Board of Directors, Advisory Boards, or
Scientific Advisory Boards of several other related healthcare and medical
device companies. Dr. Harrington is also Associate Professor of Clinical and
Anatomic Pathology at the University of Nebraska Medical Center, and has
authored over 80 peer-reviewed publications. He received his Bachelor of Arts
degree with distinction and a Medical Degree from the University of Colorado.
Professional affiliation memberships include the American Medical Association,
the American Society of Clinical Pathologists, the College of American
Pathologists and the International Academy of Pathology.

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,
Inc. 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 Institutes 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.

KEVIN C. O'BOYLE has been Vice President and Chief Financial Officer of
the Company since December 1996 and Senior Vice President of Operations since
January 1999. 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.

DIETHART REICHARDT has been Vice President of International Business
Development and Operations 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.

<PAGE> 15

PATRICIA SISSON has been Vice President of Marketing of the Company
since December 1997 and Senior Vice President of Sales, Marketing and Strategic
Planning since January 1999. 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 a licensed medical technologist
certified by the American Society of Clinical Pathology.

JOSE DE LA TORRE-BUENO, PH.D. has been Vice President of Research and
Development since February 1999 and Senior Applications Engineer since July
1998. Prior to joining ChromaVision, Dr. Torre-Bueno was engaged as a consultant
to Tower Technologies in Encinitas, California. In 1982, he founded American
Innovision; an image analysis company that configured complete application
systems, designed and built software and hardware. He acted as Owner, President,
and VP of Research and Development for American Innovision until its sale to
Oncor Instrument Systems in 1992. He remained with Oncor for three years after
the sale as Senior Scientist and R&D Manager. Dr. Torre-Bueno has been an
inventor on two issued patents and one pending patent, and has assigned the
rights for two additional inventions to ChromaVision.

<PAGE> 16

PART II

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

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
January 1, 1998 - March 31, 1998......... 11 1/2 7 1/4
April 1, 1998 - June 30, 1998............ 10 3/8 7 3/8
July 1, 1998 - September 30, 1998........ 9 10/16 5 1/2
October 1, 1998 - December 31, 1998...... 8 2 11/16
</TABLE>

- ----------
(1) Date stock began trading

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

As of February 28, 1999, the Company had outstanding 17,548,129 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, 1998, 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 $11.5 million of the net proceeds were used to
fund working capital and research and development.

<PAGE> 17
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.

<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 1,
1996
YEAR ENDED DECEMBER 31, THROUGH
----------------------------- MARCH 27,
1994 1995 1996
----------- ----------- ---------
STATEMENT OF OPERATIONS DATA
<S> <C> <C> <C>
Revenues(1)....................... $ 296,886 $ 900,000 $ -0-
Selling, general and
administrative expenses......... 787,167 1,040,070 221,476
Research and development
expenses(2)..................... 858,389 1,513,014 230,681
Net (loss)(3)(4).................. $(1,581,306) $(1,963,187) $(377,157)
Net loss subsequent to
incorporation...................
Basic and diluted net (loss) per
common share subsequent to
incorporation(3)(4).............
</TABLE>

<TABLE>
<CAPTION>
PERIOD FROM
MARCH 28, PERIOD FROM
1996 APRIL 1, 1993
(INCORPORATION) (INCEPTION)
THROUGH YEAR ENDED YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Revenues(1) .................... $ -0- $ 43,500 $ 16,823 $ 1,257,209
Selling, general and
administrative expenses ...... $ 2,648,694 $ 3,185,583 $ 4,068,675 $ 12,256,616
Research and development
expenses(2) .................. $ 1,747,923 $ 3,565,331 $ 4,664,311 $ 13,128,805
Net (loss)(3)(4) ............... $ (4,030,263) $ (6,343,927) $ (8,078,325) $(23,228,272)
Net loss subsequent to
incorporation ................ $ (4,030,263) $ (6,343,927) $ (8,078,325) $(18,452,515)
Basic and diluted net (loss)
per common share subsequent to
incorporation(3)(4) .......... $ (.37) $ (.47) $ (0.47)
============ ============ ============
</TABLE>

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------------------------------------------------
1994 1995 1996 1997 1998
----------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........ $ -0- $ -0- $ 124,092 $12,926,398 $ 2,853,546
Total assets(5).................. 1,066,328 345,664 880,430 22,249,016 14,630,955
Total liabilities(6)............. 3,501,741 4,744,264 2,535,937 878,720 1,243,735
Accumulated deficit.............. (2,435,413) (4,398,600) (8,806,020) (15,149,947) (23,228,272)
Total stockholders' equity
(deficit)...................... (2,435,413) (4,398,600) (1,655,507) 21,370,296 13,387,220
</TABLE>

- ---------------------
(1) Revenue includes income from prototype instrument sales, technical support
services and monthly rental of the ACIS.

(2) Research and development expenses for the period from March 28, 1996
(incorporation) through December 31, 1996 include the value of Preferred
Stock issued to Centocor, Inc. 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.

(5) 1997 and 1998 include a $5,000,000 demand note from Safeguard Scientific,
Inc. and approximately $2.4 and $3.5 million of investments, respectively.

(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.

<PAGE> 18

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

OVERVIEW

The Company, a development stage enterprise, is a Delaware corporation
incorporated in March 1996. Prior to its incorporation, the Company's business
was conducted as the MicroVision Medical Systems Division (the "Division") of XL
Vision, Inc. ("XL Vision").

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 equaled the amount of the net assets plus 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, 1998,
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 a filing made in November 1998, which could result in several
commercialized applications. The ACIS and one application, leukocyte alkaline
phosphatase ("LAP") were cleared for commercial distribution in the U.S. by the
FDA in June of 1997.

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 the United Kingdom.

In October 1998, the Company entered into a domestic co-development and
cooperative sales and marketing agreement with DAKO Corporation, an
international diagnostics, reagent and systems manufacturing firm, to market the
ACIS in combination with DAKO's HercepTest(R) kit in the U.S. as an integrated
HER2 protein expression system for the guidance of breast cancer therapy.

In November 1998, the Company filed a 510(k) application with the FDA
for the use of its ACIS in slide-based testing using immunohistochemical ("IHC")
methods, specifically to pursue cancer-related applications, including the HER2
test and infectious disease. The Company anticipates clearance in the first half
of 1999.

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 1998, 1997 and 1996.

<PAGE> 19

YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997

REVENUE. Revenue of approximately $17,000 for the year ended December
31, 1998, is primarily due to the first commercial placement of the Company's
ACIS(TM). The revenue is currently being generated from monthly rental charges
for usage of the ACIS(TM). Revenue of $43,500 for the comparable period in 1997
is comprised of technical services rendered.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Expenses increased
approximately $900,000 or 28% over the comparable period in 1997. The increase
is primarily due to increases in the Company's Sales and Marketing staff and
increases in advertising and trade show costs necessary to support the
commercialization of the Company's applications. These increases in 1998 were
partially offset by relocation costs incurred in 1997 for moving the Company to
California. The Company anticipates selling, general and administrative expenses
to continue to increase in the near future as the Company enters the commercial
phase of its development.

RESEARCH AND DEVELOPMENT EXPENSES. Expenses increased approximately $1.1
million or 31% over the comparable period in 1997. The increase is primarily
attributable to the addition of technical personnel to further develop the
Company's applications and costs of the current clinical trials for prenatal
screening for Down syndrome and cancer. The Company anticipates that research
and development expenses will continue to increase in the near future due to
costs related to the development of new applications, additional clinical trials
and the continuation of technological advances to the ChromaVision ACIS(TM).

LEGAL SETTLEMENT. In April 1998 the Company paid $300,000 in settlement
of certain pending patent litigation. See Note 9 of notes to the financial
statements.

OTHER INCOME (EXPENSE). Other income for year ended December 31, 1998
was approximately $947,000 and consists of net interest income from the
investment of the Company's initial public offering net proceeds in interest
bearing securities. For the comparable period in 1997, net interest income was
lower at approximately $363,000 as the initial public offering proceeds were not
received until approximately August of 1997 and interest expense was incurred
due to borrowings on the Company's revolving line of credit before it was paid
off during the third quarter of 1997.

UNCERTAINTIES AS TO FUTURE OPERATIONS

During 1999 the Company will begin the transition from being focused
almost entirely on the development of its products to focus more on marketing
and sales of the products as they become available for commercial distribution.
The Company faces significant uncertainties in this regard, including its
ability to achieve market acceptance of the products, manufacturer the products
in commercial quantities and achieve satisfactory reimbursement for the products
by third party payers. The Company also faces uncertainties with respect to its
ability to complete development of products in its research and development
pipeline, collaborate successfully with other companies in the development of
new products, initiate and complete clinical trials of new products and obtain
governmental approvals for the products. Lack of success in any one of these
efforts could have a material adverse effect on the future results of the
Company's operations and its ability to generate sufficient cash flow to reduce
its dependence on additional financing.

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, Inc. The
Company is a development stage company and had no revenue or gross profit for
1996.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Expenses increased
approximately $300,000 or 10% over the comparable period 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.

RESEARCH AND DEVELOPMENT EXPENSES. Expenses increased $1.6 million or
80% over the comparable period 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.

<PAGE> 20

OTHER INCOME. Other income for the year ended December 31, 1997
decreased approximately $78,000 to $363,000 as compared to $441,000 in 1996. The
1996 amount included $424,000 of other income recorded relating to design work
performed for Intelligent Medical Imaging, Inc. In 1997 $363,000 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.

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. In June 1998, the
Company entered into a new agreement with its principal bank for a $5,000,000
revolving line of credit. The line expires May 30, 2000. At the Company's
option, the interest rate is prime less .25% or LIBOR plus 1.75%. There were no
borrowings outstanding under the line of credit during the period. Any
borrowings outstanding under the line of credit will be collateralized by the
Company's investment in securities held by the principal bank having a market
value equal to 111% of the principal balance of the loans. At December 31, 1998,
the Company had approximately $11.4 million of cash and cash equivalents, note
receivables and investments and working capital of approximately $10.4 million.

Capital expenditures for the year ended December 31, 1998 were
approximately $2 million and related primarily to the manufacture of the
ChromaVision ACIS instruments used in research and development. Capital
expenditures for the year ended December 31, 1997 were approximately $1.2
million 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 ACIS instruments used in further development and
personal computers for employees. Capital expenditures are expected to be
approximately $4.4 million in 1999, and are expected to be primarily related to
the manufacture of the ChromaVision ACIS for "per-click" placements with
customers, although the Company's present plans could change and this amount
could be materially different. 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 be recognized over the lease
term. The expenditures will be funded by current cash reserves, which will be
partially offset by third party asset-based financing for these instruments
presently totaling $1 million.

The Company anticipates that the remaining proceeds from the offering
will be sufficient to satisfy its operating cash needs for the next twelve
months. Management expects that losses from operations and increases in working
capital requirements will produce significant negative cash flows from
operations for at least the next twelve months and beyond. 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 PROBLEMS

The Company purchases computer hardware and software and also develops
software for use in its ChromaVision ACIS(TM). In addition, purchased software
is run on in-house computer networks. An inventory and assessment of the
Company's product, in-house network software and its reliance on embedded
technology is in process and to date, the Company has not noted any material
Year 2000 problems which would prevent its products and systems from being
capable of correctly interpreting dates beyond the Year

<PAGE> 21

1999. However, until the assessment, validation and testing are completed, there
remains considerable uncertainty due to the possibility of not completing
testing and validation as scheduled and/or uncovering Year 2000 problems that
could create a material impact on the Company's performance. Final testing is
expected to be completed during the second quarter of 1999 with any remediation
and or implementation to be completed by the end of 1999.

The Company is currently in the process of surveying its key suppliers
to determine whether they will be Year 2000 ready. In addition, due to the
Company's development stage status, currently it does not have a customer base
from which to survey Year 2000 problems. A significant interruption in key
suppliers' and potential customers' activities due to Year 2000 problems could
result in a material impact on the Company's financial results and operations.
Also, a portion of the Company's potential revenue will be indirectly dependent
upon our customers' reimbursement from federal, state and municipal government
agencies and insurance companies, and the state of readiness of those third
party payers is of concern. A significant interruption in the ability of one or
more government agencies to reimburse these healthcare providers could lead to a
significant interruption in cash received from those customers.

The Company does not expect that the cost of its Year 2000 program will
be material to its business, financial conditions or results of operations.
Substantially all of the costs of the program have consisted and is expected to
continue to consist of compensation expense allocable to employees who work on
the Year 2000 project. The Company does not separately track these expenses. All
costs are expensed as incurred. The Company intends to determine if contingency
plans are needed for any aspect of its business with respect to Year 2000 issues
(including most reasonably likely worst case Year 2000 scenarios), and to create
those contingency plans by the end of the first quarter of 1999.

All statements in this Report regarding the Year 2000 problem involve
forward-looking information as to which there is great uncertainty. The actual
results of the Company's program to deal with the Year 2000 problem could differ
materially from what the Company plans and anticipates because of the lack of
experience of the Company and others with problems of this kind, the extent to
which computer and other systems of business and other entities are
inter-related and the lack of control over, and access to information of third
parties upon whom the Company's business is dependent. The failure of the
Company to correctly analyze and anticipate Year 2000 problems in its own
operations or those of third parties or the failure or inability to develop
effective contingency plans could have a material adverse effect on the
Company's business.

RECENT ACCOUNTING DEVELOPMENTS

In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The provisions of the statement require the
recognition of all derivatives as either assets or liabilities in the
consolidated balance sheet and the measurement of those instruments at fair
value. The accounting for changes in the fair value of a derivative depends on
the intended use of the derivative and the resulting designation. This statement
is effective for all fiscal quarters of fiscal years beginning after June
15,1999. We are required to adopt the statement in the first quarter of 2000.

In 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use", which provides
guidance concerning recognition and measurement of costs associated with
developing or acquiring software for internal use.

In 1998, the AICPA also issued Statement of Position 98-5, "Reporting on
the Costs of Start-Up Activities", which provides guidance concerning the costs
of start-up activities. For accounting purposes start-up activities are defined
as one-time activities related to opening a new facility, introducing a new
product or service, conducting business in a new territory or with a new class
of customer, initiating a new process in an existing facility, or commencing
some new operation. Both pronouncements are effective for financial statements
of years beginning after December 15, 1998, with earlier application encouraged.

As of December 31, 1998 the Company does not believe that adoption of
these pronouncements will have a material impact on our financial statements.

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

Not applicable.

<PAGE> 22

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>

Page
----
<S> <C>
Independent Auditors' Report............................................................... 23
Balance Sheets as of December 31, 1997 and 1998............................................ 24
Statements of Operations for the period from January 1, 1996 through
March 27, 1996, the period from March 28, 1996 (incorporation) through
December 31, 1996,and the years ended December 31, 1997 and 1998 and the
period from April 1, 1993 (inception) through December 31, 1998.......................... 25
Statements of Stockholders' Equity (Deficit) for the period from
January 1, 1996 through March 27, 1996, the period from March 28, 1996
(incorporation) through December 31, 1996 and the years ended
December 31, 1997 and 1998............................................................... 26
Statements of Cash Flows for the period from January 1, 1996 through
March 27, 1996, the period from March 28, 1996 (incorporation) through
December 31, 1996, and the years ended December 31, 1997 and 1998 and the
period from April 1, 1993 (inception) through December 31, 1998.......................... 27
Notes to Financial Statements.............................................................. 28
</TABLE>

<PAGE> 23

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 sheets of ChromaVision Medical
Systems, Inc. (a development stage enterprise) as of December 31, 1997 and 1998
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 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 years ended December 31, 1997 and 1998 and for the
cumulative development stage from April 1, 1993 (inception) through December 31,
1998. 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, 1997 and 1998
and the results of operations and cash flows of ChromaVision Medical Systems (a
development stage enterprise), a division of XL Vision, Inc., for 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 years ended December 31,
1997 and 1998 and for the cumulative development stage from April 1, 1993
(inception) through December 31, 1998, in conformity with generally accepted
accounting principles.

/s/ KPMG LLP

Orange County, California
February 4, 1999

<PAGE> 24

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

BALANCE SHEETS

ASSETS

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1997 1998
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 12,926,398 $ 2,853,546
Short-term investments 1,344,534 3,533,747
Note receivable - affiliate 5,000,000 5,000,000
Other 263,422 229,889
------------ ------------
Total current assets 19,534,354 11,617,182
Long-term investments 1,061,544 --
Other 55,791 122,302
Property and equipment, net 1,597,327 2,891,471
------------ ------------
Total assets $ 22,249,016 $ 14,630,955
============ ============

LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY

Current liabilities:
Due to XL Vision, Inc. $ 5,969 $ --
Accounts payable 310,161 466,156
Accrued liabilities 562,590 777,579
------------ ------------
Total current liabilities 878,720 1,243,735

Commitments and contingencies Stockholders' equity (deficit):
Series A convertible preferred stock, $.01 par value,
authorized 7,246,000 shares, none issued and
outstanding -- --
Series B convertible preferred stock, $.01 par value,
authorized 221,850 shares, none issued and
outstanding -- --
Common stock $.01 par value, authorized 50,000,000
shares, issued and outstanding 17,173,629 in 1997
and 17,270,816 in 1998 171,736 172,708
Additional paid-in capital 36,348,507 36,442,784
Deficit accumulated during the development stage (15,149,947) (23,228,272)
Total stockholders' (deficit) equity 21,370,296 13,387,220
------------ ------------
Total liabilities and stockholders' (deficit) equity $ 22,249,016 $ 14,630,955
============ ============
</TABLE>

See accompanying notes to financial statements.

<PAGE> 25

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

STATEMENTS OF OPERATIONS

PERIOD FROM PERIOD FROM
PERIOD FROM MARCH 28, 1996 APRIL 1, 1993
JANUARY 1, 1996 (INCORPORATION) FOR THE YEAR FOR THE YEAR (INCEPTION)
THROUGH THROUGH ENDED ENDED THROUGH
MARCH 27, 1996 DECEMBER 31, 1996 DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1998
-------------- ----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C>
Revenue ........................ $ -- $ -- $ 43,500 $ 16,823 $ 1,257,209
Cost of revenue ................ -- -- -- 9,576 552,315
------------ ------------ ------------ ------------ ------------
Gross profit ......... -- -- 43,500 7,247 704,894
------------ ------------ ------------ ------------ ------------
Operating expenses:
Selling, general and
administrative ............ 221,476 2,648,694 3,185,583 4,068,675 12,256,616
Research and development ..... 230,681 1,747,923 3,565,331 4,664,311 13,128,805
Legal Settlement ............. -- -- -- 300,000 300,000
------------ ------------ ------------ ------------ ------------
Total operating expenses .. 452,157 4,396,617 6,750,914 9,032,986 25,685,421
------------ ------------ ------------ ------------ ------------
Loss from operations ...... (452,157) (4,396,617) (6,707,414) (9,025,739) (24,980,527)
------------ ------------ ------------ ------------ ------------
Other income:
Interest income (expense), net -- 17,829 363,487 947,414 1,328,730
Other income ................. 75,000 348,525 -- -- 423,525
------------ ------------ ------------ ------------ ------------
Total other income ........ 75,000 366,354 363,487 947,414 1,752,255
------------ ------------ ------------ ------------ ------------
Loss before income taxes .. (377,157) (4,030,263) (6,343,927) (8,078,325) (23,228,272)
Income taxes ................... -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Net loss ....................... $ (377,157) $ (4,030,263) $ (6,343,927) $ (8,078,325) $(23,228,272)
============ ============ ============ ============ ============
Basic and diluted net loss
per common share.............. $ (.37) $ (.47) $ (.47)
============ ============ ============
Weighted average number of
common shares outstanding....... 10,850,080 13,455,529 17,233,340
============ ============ ============
</TABLE>

See accompanying notes to financial statements.

<PAGE> 26

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

STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
PREFERRED STOCK
-------------------------------------------------------------
SERIES A SERIES B
--------------------------- --------------------------
SHARES AMOUNT SHARES AMOUNT
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
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 .... -- $ -- -- $ --
Exercise of stock options ........ -- -- -- --
Net loss ......................... -- -- -- --
Balances at December 31, 1998 .... -- $ -- -- $ --
</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, 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
Exercise of stock options ........ 97,187 972 94,277 -- 95,249
Net loss ......................... -- -- -- (8,078,325) (8,078,325)
Balances at December 31, 1998 .... 17,270,816 $ 172,708 $ 36,442,784 $(23,228,272) $ 13,387,220
</TABLE>

See accompanying notes to financial statements.

<PAGE> 27

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
1996 (INCORPORATION) FOR THE YEAR FOR THE YEAR (INCEPTION)
THROUGH THROUGH ENDED ENDED THROUGH
MARCH 27, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1996 1997 1998 1998
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Cash flows from development
stage activities:
Net loss ............................... $ (377,157) $ (4,030,263) $ (6,343,927) $ (8,078,325) $(23,228,272)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and amortization ..... 6,080 28,659 155,421 671,087 942,823
Preferred stock issued for services -- 770,192 -- -- 770,192
Write-off of note receivable ...... -- -- -- -- 40,000
Changes in operating assets
and liabilities:
Accounts receivable ............... 200,000 -- -- -- --
Other ............................. -- (28,227) (290,986) (32,978) (352,191)
Accounts payable .................. -- 119,025 182,353 155,995 466,156
Accrued liabilities ............... 21,514 1,191,321 (659,091) 214,989 777,579
------------ ------------ ------------ ------------ ------------
Net cash used in operating
activities ................... (149,563) (1,949,293) (6,956,230) (7,069,232) (20,583,713)
------------ ------------ ------------ ------------ ------------
Cash flows from investing activities:
Note receivable - affiliate ............ -- -- (5,000,000) -- (5,825,000)
Collections on notes receivable ........ -- -- -- -- 785,000
Purchases of investments, net .......... -- -- (2,406,078) (1,127,669) (3,533,747)
Purchases of property and equipment .... (2,236) (470,190) (1,169,397) (1,965,231) (3,834,294)
------------ ------------ ------------ ------------ ------------
Net cash used in investing
activities .................... (2,236) (470,190) (8,575,475) (3,092,900) (12,408,041)
------------ ------------ ------------ ------------ ------------
Cash flows from financing activities:
Due to (from) XL Vision, Inc. .......... 151,799 (4,497,995) (374,470) (5,969) --
Proceeds from exercise of stock options -- -- 21,000 95,249 116,249
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 .................... 151,799 2,543,575 28,334,011 89,280 35,845,300
------------ ------------ ------------ ------------ ------------
Net increase (decrease) in cash
and cash equivalents .......... -- 124,092 12,802,306 (10,072,852) 2,853,546
Cash and cash equivalents beginning
of period ........................... -- -- 124,092 12,926,398 --
------------ ------------ ------------ ------------ ------------
Cash and cash equivalents end
of period ........................... $ -- $ 124,092 $ 12,926,398 $ 2,853,546 $ 2,853,546
============ ============ ============ ============ ============
Supplemental disclosure of cash flow
information:
Cash paid for interest ................. $ -- $ -- $ 156,902 $ -- $ 156,902
============ ============ ============ ============ ============
</TABLE>

See accompanying notes to financial statements.

<PAGE> 28

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

NOTES TO FINANCIAL STATEMENTS

(1) ORGANIZATION

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").

(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 1996 and 1997 amounts have been reclassified to conform to the
1998 presentation.

<PAGE> 29

The Company's revenues in 1997 were derived from the provision of
technical services and in 1998 from a monthly lease of an ACIS for research
purposes. Technical service revenue was recognized at the completion of the
performance of the related engineering services.

The Company anticipates placing most of 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 most of the ACIS instruments 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-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.

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, 1998 are as follows:

<TABLE>
<CAPTION>
GROSS FAIR
COST UNREALIZED LOSS VALUE
---------- --------------- ----------
<S> <C> <C> <C>
Cash and cash equivalents...... $2,853,546 $ -- $2,853,546
Fixed income securities:
Short-term................... 3,533,747 (17,015) 3,516,732
---------- -------- ----------
Total................ $6,387,293 $(17,015) $6,370,278
========== ======== ==========
</TABLE>

(E) DEPRECIATION AND AMORTIZATION

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

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

Expenditures for maintenance, repairs and minor improvements are charged
to expense as incurred. Major improvements and additions are capitalized.
ChromaVision ACIS instruments begin depreciation upon placement at which time
depreciation related to ACIS instruments 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.

<PAGE> 30

The following is a summary of property and equipment:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1998
---------- ----------
<S> <C> <C>
Office, computer and laboratory equipment...... $ 608,285 $ 901,073
Automated Cellular Imaging Systems (ACIS)...... 506,418 1,765,458
ACIS in progress............................... 486,727 586,753
Furniture and fixtures......................... 12,641 86,234
Leasehold improvements......................... 134,339 374,123
---------- ----------
1,748,410 3,713,641
Less: accumulated depreciation and amortization 151,083 822,170
---------- ----------
Property and equipment, net.................... $1,597,327 $2,891,471
=========== ==========
</TABLE>

(F) INCOME TAXES

Since its incorporation on March 28, 1996, the Company has accounted 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 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.

<PAGE> 31

(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, 1997 and 1998.

(K) RECENT ACCOUNTING DEVELOPMENTS

As of December 31, 1998 the Company does not believe that adoption of
these pronouncements will have a material impact on our financial statements.

(3) NOTES RECEIVABLE

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% (5.58% at December 31, 1998). Interest
income earned during 1998 amounted to approximately $308,000, and of this
amount, approximately $25,000 was due at December 31, 1998. Management intends
to collect on this note in the next twelve months.

(4) LINE OF CREDIT

On June 9, 1998, the Company entered into an agreement with its
principal bank for a $5,000,000 revolving line of credit. The line expires May
30, 2000. At the Company's option, the interest rate is either prime less .25%
or LIBOR plus 1.75%. There were no borrowings outstanding under the line of
credit during the period. Any borrowings outstanding under the line of credit
will be collateralized by the Company's investment in securities held by the
principal bank having a market value equal to 111% of the principal balance of
the loans.

(5) PREFERRED STOCK

The Company sold in a private placement 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 stockholders.

(6) STOCK OPTIONS

The Company has a stock option plan (the "Plan") pursuant to which its
Board of Directors may grant stock options to employees, directors and
consultants. All options granted by the Company had an exercise price equal to
the stock's fair market value at the date of grant. Stock options granted 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 non-qualified
options to purchase 975,688 and 90,000 shares, respectively, 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 was 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 and 1998 to
purchase 31,000 shares and 145,000 shares respectively, to consultants and
directors of ChromaVision at prices between $5.00 and $11.88 per share. At
December 31, 1998, options to purchase 126,186 of these shares were exercisable.

<PAGE> 32

Option activity is summarized as follows:

<TABLE>
<CAPTION>
1996 1997 1998
---------------------------- --------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- -------------- --------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C>
Outstanding at beginning of year -- $ -- 1,370,438 $1.91 1,818,513 $3.04
Options granted ................. 2,185,001 1.50 479,950 6.19 646,600 6.26
Options exercised ............... (537,251) .80 (26,250) .80 (97,187) .98
Options canceled ................ (277,312) .80 (5,625) 5.00 (316,988) 8.76
--------- --------- ---------
Outstanding at end of year ...... 1,370,438 $1.91 1,818,513 $3.04 2,050,938 $3.27
========= ========= =========
Options exercisable at year-end . 267,767 733,206 1,107,998
Shares available for future grant 560,625 86,300 166,688
</TABLE>

The following summarizes information about the Company's stock options
outstanding at December 31, 1998:

<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 12/31/98 (IN YEARS) PRICE 12/31/98 PRICE
--------------- ----------- ---------------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
at $ .80 308,563 4.5 $ .80 308,563 $ .80
at $2.40 1,074,375 7.1 2.40 732,394 2.40
$3.44 - $11.88 668,000 9.2 5.81 67,041 5.81
--------- ---------
$ .80 - $11.88 2,050,938 7.4 $3.27 1,107,998 $2.16
========= =========
</TABLE>

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 loss and loss per share would have been
increased to the pro forma amounts indicated below (1996 net loss is subsequent
incorporation):

<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C> <C>
Consolidated net loss As reported..... $(4,030,263) $(6,343,927) $(8,078,325)
Pro forma....... $(4,312,126) $(6,679,851) $(8,914,666)
Loss per share --
Basic and Diluted As reported..... $ (.37) $ (.47) $ (.47)
Pro forma....... $ (.40) $ (.50) $ (.52)
</TABLE>

The per share weighted-average fair value of stock options issued by the
Company during 1996, 1997 and 1998 was $.51, $3.35 and $.3.54, 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>
1996 1997 1998
--------- --------- ----------
<S> <C> <C> <C>
Dividend yield............ 0.0% 0.0% 0.0%
Expected volatility....... 0.0% 55.0% 70.0%
Average expected option life.... 6.75 years 5 years 4 years
Risk-free interest rate......... 6.4% 5.9 - 6.8% 4.18 - 6.8%
</TABLE>

1997 and 1998 assumptions reflect factors, which changed with the
Company's initial public offering in 1997.

On December 14, 1998, the Company repriced all employee stock options
outstanding, which had an option price exceeding $6.50. The vesting dates with
respect to such options were extended six months; however, all other terms were
maintained. The Company did not recognize compensation expense related to the
repricing of the employee stock options, as the adjusted exercise price was
equal to the fair value of the common stock as of the repricing date.

<PAGE> 33

(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 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 1998
--------- ---------
<S> <C> <C>
Deferred tax assets:
Current assets:
Accrued liabilities and other deferred
tax assets............................... $ 59,334 $ 109,679
Less valuation allowance for current
deferred tax assets..................... (58,404) (109,412)
Net current deferred tax assets........... 930 267
Noncurrent assets:
Net operating loss carryforward........... 4,081,519 7,289,530
Intangible asset, net of amortization..... 1,678,997 1,552,280
Accrued liabilities and other deferred
tax assets.............................. 49,320 165,255
Federal tax credit carryover.............. -- 147,610
----------- -----------
Deferred tax assets............... 5,809,836 9,154,675
Deferred tax liability:
Depreciation.............................. (28,791) (22,547)
----------- -----------
Total............................. 5,781,975 (9,132,395)
Less valuation allowance for deferred tax... (5,781,975) (9,132,395)
------------ -----------
Deferred tax assets (liability),
net............................ $ -0- $ -0-
=========== ===========
</TABLE>

The valuation allowance increased by $3,401,428 for the year ended
December 31, 1998.

Actual income tax expense for 1998 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>
<S> <C>
Computed expected tax benefit..................... $(2,746,632)
State income taxes net of federal benefit......... (471,322)
Nondeductible expenses ........................... 10,586
Change in valuation allowance..................... 3,401,428
Other............................................. (194,060)
-----------
Actual tax expense............................ $ -0-
===========
</TABLE>

As of December 31, 1998, the Company had net operating loss
carryforwards for federal income tax purposes of approximately $19,094,000,
which are available to offset future federal taxable income, if any, through
2018. As of December 31, 1998, the Company has tax credit carryforwards for
federal income tax purposes of $148,000, which are available to offset future
federal tax, if any, through 2018.

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.

<PAGE> 34

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 service 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, and
none in 1998.

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, 1998, no amounts were due to XL Vision. The
average outstanding balance due to XL Vision for the years ended December 31,
1996, 1997 and 1998 were $2,553,537, $193,204 and $2,985 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
Cash transferred to XL Vision....................... (5,969)
-----------
Amount due to XL Vision at December 31, 1998........ $ -0-
===========
</TABLE>

(9) COMMITMENTS AND CONTINGENCIES

AGREEMENT WITH CENTOCOR, INC. The Company sold Centocor, Inc. six ACIS
units in 1995 to facilitate their 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
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 Corporation, 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 the
United Kingdom.

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.

<PAGE> 35

AGREEMENT WITH DAKO CORPORATION. In October 1998, the Company signed an
agreement to jointly develop, market and sell a tissue-based system with DAKO
Corporation. The introductory application will be Herceptest(TM); a FDA cleared
diagnostic that is used to identify breast cancer patients likely to respond to
the recently cleared drug Herceptin(TM) from Genentech. Follow-on tissue
applications to be pursued will include ER, PR, Ki-67/Mib1, and micromets
(MM/MRD). DAKO and ChromaVision will have joint responsibility for marketing of
the system in the United States. DAKO will have primary responsibility for
account management; reagents, autostainers and contract management and
ChromaVision will have primary responsibility for providing its expertise with
respect to the ACIS.

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 $79,000 in 1998.

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 1999 and 2000 of approximately $168,000
and $28,000, respectively. Total rent expense related to these leases was
approximately $139,000 and $163,000 for the years ended December 31, 1997 and
1998, respectively.

LITIGATION. On April 21, 1998, the Company signed a settlement agreement
with IDEA Research LLC ("IDEA Research") related to litigation filed by the
Company on November 10, 1997 involving, among other things, a claim by IDEA
Research of patent infringement against the Company. The agreement contemplates
a collaboration between both parties on a screening test for Down syndrome for a
period of two years and provides for the grant of a license to the Company under
the patent, an up front payment by the Company of $300,000 upon the signing of
the settlement agreement, a $150,000 payment if certain requirements with
respect to commercializing the Down syndrome screening test are met and a five
percent royalty payable to IDEA Research on net collectible revenues for each
Down syndrome screening test performed. In April 1998, the $300,000 up front
payment was paid to IDEA Research and included in legal settlement charges on
the statement of operations.

(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 the
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 a bank line of credit indebtedness and reduction of an inter-company payable
to XL Vision, Inc.

(11) SUBSEQUENT EVENT

In March 1999, the Company adopted a Stockholder Rights Plan, which
provides each stockholder of the Company with one right for each share of common
stock held. Generally, if a person or entity becomes the beneficial owner of 15%
or more of the Company's outstanding common stock, each right (other than those
held by that new 15% stockholder) would be exercisable to purchase that number
of shares of the Company's Common Stock having, at that time, a market value
equal to two times the then current exercise price. The exercise price will
initially be $30 per right, subject to adjustment for certain events. Certain
acquisitions by the holders of 15% or more of the Company's Common Stock on the
date the Stockholder Rights Plan was adopted do not result in the rights
becoming exercisable.

The record date set for distribution of the rights under the Rights Plan
was March 22, 1999, and after that date any shares of common stock traded will
automatically be accompanied by the associated rights. No separate certificate
will be issued to evidence the Rights until they become exercisable. The rights
expire on February 9, 2009 (unless they previously became exercisable), and are
subject to redemption by the Board of Directors of the Company at $.001 per
right at any time prior to the first date upon which they become exercisable.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None

<PAGE> 36

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS

The Company incorporates by reference the information contained under
the caption "ELECTION OF DIRECTORS" in its definitive Proxy Statement relative
to its June 2, 1999 annual meeting of shareholders, to be filed within 120 days
after the end of the year covered by this Form 10-K pursuant to Regulation 14A
under the Securities Act of 1934, as amended.

EXECUTIVE OFFICERS

The information with respect to executive officers required by this Item
is set forth in Part I of this report.

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 2, 1999 annual meeting of shareholders, to be
filed within 120 days after the end of the year covered by this Form 10-K
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 2, 1999 annual meeting of
shareholders, to be filed within 120 days after the end of the year covered by
this Form 10-K 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 2, 1999 annual meeting of shareholders, to be
filed within 120 days after the end of the year covered by this Form 10-K
pursuant to Regulation 14A under the Securities Exchange Act of l934, as
amended.

<PAGE> 37

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.

Financial Statements (See Item 8)
Report of Independent Accountants
Balance Sheets as of December 31, 1997 and 1998
Statements of Operations for the Years Ended December 31, 1996, 1997,
and 1998
Statements of Shareholders' Equity (Deficit) for the Years
Ended December 31, 1996, 1997, and 1998
Statements of Cash Flows for the Years Ended December 31,
1996, 1997, and 1998
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 statements 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 1998.

The following is a list of exhibits filed as part of this Form 10-K.
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> 38
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**.................
10.2 Stock Option Grant Letter (Dr. Douglas S. Harrington)**...........................
10.3 Stock Option Grant Letter (Kevin C. O'Boyle)**.....................................
10.4 Stock Option Grant Letter (Michael G. Schneider)**.................................
10.5 Stock Option Grant Letter (Kenneth S. Garber)**....................................
10.6 Employment Agreement between Dr. Douglas S. Harrington and the Company, as of
December 30, 1996**................................................................
10.7 Employment Agreement between Kevin C. O'Boyle and the Company, dated
November 27, 1996**................................................................
10.8 Administrative Services Agreement among the Company, XL Vision, Inc. and Safeguard
Scientifics, Inc. dated as of March 31, 1997**.....................................
10.9 Subscription Agreement between the Company and Safeguard Scientifics, Inc., dated
as of December 31, 1996**..........................................................
10.10 Lease Agreement between Blue Family Trust, Lingo Family Trust and the Company,
dated January 13, 1997**...........................................................
10.11 Distribution Agreement between ChromaVision Medical Systems, Inc. and Sigma
Diagnostics, Inc. dated October 22, 1997***........................................
10.12 UR-NAP Application Development Agreement and Right of First Refusal of New
Applications between the Company and Sigma Diagnostics, Inc. dated October 22,
1997***............................................................................
21.1 Subsidiaries of the Registrant**...................................................
23 Consent of KPMG LLP*...............................................................
27.1 Financial Data Schedule*...........................................................
</TABLE>
- ----------
* 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.

<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 March 31, 1999.

CHROMAVISION MEDICAL SYSTEMS, INC.

By: /s/ DOUGLAS S. HARRINGTON, M.D.
-------------------------------
Douglas S. Harrington, M.D.
CHIEF EXECUTIVE OFFICER
AND PRESIDENT

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 March 31, 1999.

SIGNATURES TITLE(S)
---------- --------
<S> <C>
/s/ DOUGLAS S. HARRINGTON, M.D. Chief Executive Officer, President and Director
- ----------------------------------------------- (Principal Executive Officer)
Douglas S. Harrington, M.D.

/s/ KEVIN C. O'BOYLE Senior Vice President of Operations and Chief
- ----------------------------------------------- Financial Officer
Kevin C. O'Boyle (Principal Financial and Accounting Officer)

/s/ JOHN S. SCOTT, PH.D. Chairman of the Board of Directors
- -----------------------------------------------
John S. Scott, Ph.D.

/s/ CHRISTOPHER MOLLER, PH.D. Director
- -----------------------------------------------
Christopher Moller, Ph.D.

/s/ RICHARD C. E. MORGAN Director
- -----------------------------------------------
Richard C. E. Morgan

/s/ MARY LAKE POLAN, M.D., PH.D. Director
- -----------------------------------------------
Mary Lake Polan, M.D., Ph.D.

/s/ CHARLES A. ROOT Director
- -----------------------------------------------
Charles A. Root

/s/ THOMAS R. TESTMAN Director
- -----------------------------------------------
Thomas R. Testman
</TABLE>

<PAGE> 40

EXHIBIT INDEX

EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
<S> <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**.................
10.2 Stock Option Grant Letter (Dr. Douglas S. Harrington)**...........................
10.3 Stock Option Grant Letter (Kevin C. O'Boyle)**.....................................
10.4 Stock Option Grant Letter (Michael G. Schneider)**.................................
10.5 Stock Option Grant Letter (Kenneth S. Garber)**....................................
10.6 Employment Agreement between Dr. Douglas S. Harrington and the Company, as of
December 30, 1996**................................................................
10.7 Employment Agreement between Kevin C. O'Boyle and the Company, dated
November 27, 1996**................................................................
10.8 Administrative Services Agreement among the Company, XL Vision, Inc. and Safeguard
Scientifics, Inc. dated as of March 31, 1997**.....................................
10.9 Subscription Agreement between the Company and Safeguard Scientifics, Inc., dated
as of December 31, 1996**..........................................................
10.10 Lease Agreement between Blue Family Trust, Lingo Family Trust and the Company,
dated January 13, 1997**...........................................................
10.11 Distribution Agreement between ChromaVision Medical Systems, Inc. and Sigma
Diagnostics, Inc. dated October 22, 1997***........................................
10.12 UR-NAP Application Development Agreement and Right of First Refusal of New
Applications between the Company and Sigma Diagnostics, Inc. dated October 22,
1997***............................................................................
21.1 Subsidiaries of the Registrant**...................................................
23 Consent of KPMG LLP*...............................................................
27.1 Financial Data Schedule*...........................................................
</TABLE>
- ----------
* 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.

<PAGE> 1

Exhibit 23

Independent Auditor's Consent

The Board of Directors
ChromaVision Medical Systems, Inc.

We consent to incorporation by reference in the registration statement (No.
333-65815) on Form S-8 of ChromaVision Medical Systems, Inc. (a development
stage enterprise) of our report dated February 4, 1999, relating to the balance
sheets of ChromaVision Medical Systems, Inc. (a development stage enterprise) as
of December 31, 1997 and 1998, and the related statements of operations,
stockholders' equity (deficit) and cash flows of ChromaVision Medical Systems,
Inc. (a development stage enterprise), a division of XL Vision, Inc., for 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 through December 31, 1996, and for the years ended December 31, 1997 and
1998 and for the cumulative development stage from April 1, 1993 (inception)
through December 31, 1998, which report appears in the December 31, 1998 annual
report on Form 10-K of ChromVision Medical Systems, Inc.

KPMG LLP

Orange County, California
March 30, 1999

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,853,546
<SECURITIES> 3,533,747
<RECEIVABLES> 5,000,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 11,617,182
<PP&E> 3,713,641
<DEPRECIATION> 822,170
<TOTAL-ASSETS> 14,630,955
<CURRENT-LIABILITIES> 1,243,735
<BONDS> 0
0
0
<COMMON> 172,708
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 14,630,955
<SALES> 16,823
<TOTAL-REVENUES> 16,823
<CGS> 9,576
<TOTAL-COSTS> 9,576
<OTHER-EXPENSES> (947,414)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (8,078,325)
<INCOME-TAX> 0
<INCOME-CONTINUING> (8,078,325)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,078,325)
<EPS-PRIMARY> (.47)
<EPS-DILUTED> (.47)

</TABLE>