SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1998
or
[ ] 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: 0-25210
NEOPATH, INC.
(Exact name of registrant as specified in its charter)
Washington 91-1436093
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
8271 - 154th Avenue NE, Redmond, Washington 98052
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (425) 869-7284
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 the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practicable
date.
Class Outstanding at November 2, 1998
(Common stock, $.01 par value) 14,499,552
<PAGE>
NEOPATH, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
Page
____
Item 1. Financial Statements 1
Balance Sheets -- September 30, 1998
(unaudited) and December 31, 1997
Statements of Operations (unaudited) --
for the three months and nine months
ended September 30, 1998 and 1997
Statements of Cash Flows (unaudited) --
for the nine months ended
September 30, 1998 and 1997
Notes to Financial Statements
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 13
Part II OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 6. Exhibits and Reports on Form 8-K 14
Signatures 15
<PAGE>
Part I FINANCIAL INFORMATION
Item 1. Financial Statements
NEOPATH, INC.
BALANCE SHEETS
September 30, December 31,
1998 1997
_____________ ____________
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 4,095,567 $ 3,308,970
Securities available-for-sale 10,529,485 25,409,633
Accounts receivable, net 3,690,846 3,863,818
Inventories 9,683,961 7,514,001
Other current assets 406,563 187,147
_____________ ______________
Total current assets 28,406,422 40,283,569
Fee-per-use systems, net 8,127,596 8,564,189
Property and equipment, net 4,519,375 5,979,849
Intangible assets, net 3,304,595 3,383,925
Deposits and other assets 1,302,608 729,280
_____________ ______________
Total assets $ 45,660,596 $ 58,940,812
============= ==============
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 2,156,651 $ 2,173,179
Salaries and wages payable 1,769,738 2,357,045
Customer deposits 341,768 431,877
Other accrued liabilities 841,913 567,759
Current portion of long-term
obligations 2,547,290 80,966
_____________ ______________
Total current liabilities 7,657,360 5,610,826
Long-term obligations, less current
portion 1,895,028 101,872
Shareholders' equity:
Common stock 141,834,782 141,057,881
Accumulated deficit (105,750,743) (87,633,118)
Accumulated other comprehensive
income (loss) 24,169 (196,649)
_____________ ______________
Total shareholders' equity 36,108,208 53,228,114
_____________ ______________
Total liabilities and shareholders'
equity $ 45,660,596 $ 58,940,812
============= ==============
See accompanying notes.
Page 1
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NEOPATH, INC.
STATEMENTS OF OPERATIONS
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
___________________________ __________________________
1998 1997 1998 1997
____________ ____________ ____________ ____________
Revenues $ 1,873,850 $ 3,109,044 $ 9,745,006 $ 7,584,101
Cost of revenues 1,154,404 1,230,849 5,567,004 3,276,289
____________ ____________ ____________ ____________
Gross margin 719,446 1,878,195 4,178,002 4,307,812
Operating expenses:
Research and
development 2,800,913 3,109,225 8,758,156 11,418,727
Selling, general and
administrative 4,391,252 5,231,003 14,227,084 13,635,188
____________ ____________ ____________ ____________
7,192,165 8,340,228 22,985,240 25,053,915
____________ ____________ ____________ ____________
Loss from operations (6,472,719) (6,462,033) (18,807,238) (20,746,103)
Interest income 202,107 537,724 835,183 1,956,999
Interest expense (121,003) (14,540) (145,570) (29,150)
____________ ____________ ____________ ____________
Net Loss $ (6,391,615) $ (5,938,849) $(18,117,625) $(18,818,254)
============ ============ ============ ============
Basic and diluted
net loss per share $ (0.44) $ (0.41) $ (1.25) $ (1.33)
============ ============ ============ ============
Weighted average
common shares
outstanding 14,486,627 14,358,144 14,457,055 14,135,615
============ ============ ============ ============
See accompanying notes.
Page 2
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NEOPATH, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended
September 30,
_________________________________
1998 1997
________________ ______________
Operating activities
Net loss $ (18,117,625) $ (18,818,254)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 4,255,232 2,901,103
Deferred compensation -- 74,246
Accrued interest on securities
available-for-sale 421,312 917,863
Net change in operating accounts:
Accounts receivable 172,972 (2,703,273)
Inventories and fee-per-use systems (3,321,579) (7,151,457)
Accounts payable and accrued liabilities (289,140) 1,361,189
Other (779,029) (523,703)
______________ _____________
Net cash used in operating activities (17,657,857) (23,942,286)
Investing activities
Purchases of securities available-for-sale (792,721) (5,349,511)
Maturities of securities available-for-sale 15,472,375 23,624,921
Purchase of Pathfinder System product line -- (2,696,114)
Additions to property and equipment (591,653) (758,679)
Other -- (4,163)
______________ ______________
Net cash provided by investing activities 14,088,001 14,816,454
Financing activities
Proceeds from note payable to bank 4,950,000 --
Exercise of stock options and warrants 96,973 3,901,601
Principal payments on long-term obligations (690,520) (58,091)
______________ ______________
Net cash provided by financing activities 4,356,453 3,843,510
______________ ______________
Net increase (decrease) in cash and
cash equivalents 786,597 (5,282,322)
Cash and cash equivalents:
Beginning of period 3,308,970 7,871,401
______________ ______________
End of period $ 4,095,567 $ 2,589,079
============== ==============
Noncash transactions and supplemental
disclosures
Inventories reclassified to fee-per-use
systems, net $ 1,156,785 $ 3,083,867
Inventories reclassified to property
and equipment, net (30,444) 1,579,191
See accompanying notes.
Page 3
<PAGE>
NEOPATH, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Presentation
The accompanying unaudited financial statements have been
prepared by NeoPath, Inc. ("NeoPath" or the "Company") in
accordance with generally accepted accounting principles for
interim financial information and according to the rules and
regulations of the Securities and Exchange Commission.
Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management,
all adjustments (which include only normal recurring adjustments)
considered necessary for a fair presentation have been included.
The balance sheet at December 31, 1997 has been derived from the
audited financial statements at that date, but does not include
all of the information and footnotes required by generally
accepted accounting principles for complete financial statements.
The results of operations for the three-month and nine-month
periods ended September 30, 1998, are not necessarily indicative
of results to be expected for the entire year ending December 31,
1998 or for any other fiscal period. For further information,
refer to the financial statements and footnotes thereto
incorporated by reference in the Company's Form 10-K for the year
ended December 31, 1997.
Note 2 - Revenue Recognition
The Company recognizes AutoPap(R) System fee-per-use
revenues based on the number of customer slides processed,
beginning in the month an AutoPap System is initially placed in
commercial use at the customer site. Certain fee-per-use
contracts are subject to agreed-upon minimum processing levels or
minimum rental payments. Sales of AutoPap and Pathfinder Systems
are generally recognized at date of shipment.
Note 3 - Recently Issued Accounting Standards
As of January 1, 1998, NeoPath adopted Financial Accounting
Standards Board ("FASB") Statement No. 130, "Reporting
Comprehensive Income." Statement 130 establishes new rules for
the reporting and display of comprehensive income or loss and its
components; however, the adoption of this Statement had no impact
on the Company's operating results or shareholders' equity.
Statement 130 requires unrealized gains or losses on the
Company's securities available-for-sale, which prior to adoption
were reported within shareholders' equity, to be included in
other comprehensive income or loss. Statement 130 also requires
presentation of accumulated other comprehensive income or loss
separately in shareholders' equity; accordingly, prior year
financial statements have been reclassified to conform to these
requirements.
Components of comprehensive net loss are as follows:
Three months ended September 30,
___________________________________________
1998 1997
___________________________________________
Net loss $ (6,391,615) $ (5,938,849)
Unrealized gain
on securities
available-for-sale 117,794 200,849
___________________________________________
Comprehensive net loss $ (6,273,821) $ (5,738,000)
===========================================
Nine months ended September 30,
___________________________________________
1998 1997
___________________________________________
Net loss $ (18,117,625) $ (18,818,254)
Unrealized gain
on securities
available-for-sale 220,818 264,923
___________________________________________
Comprehensive net loss $ (17,896,807) $ (18,553,331)
===========================================
Page 4
<PAGE>
In 1997, the FASB issued Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information," which
is required to be adopted for periods beginning after December
15, 1997. The new Statement supersedes FASB Statement No. 14,
"Financial Reporting for Segments of a Business Enterprise."
Companies will be required to report each operating segment and
related information, as defined in Statement 131, in the notes to
financial statements. NeoPath plans to adopt the new Statement
in 1998. Statement 131 is not required to be applied to interim
financial statements in the initial year of adoption.
Note 4 - Inventories
Inventories consist of the following:
September 30, 1998 December 31, 1997
____________________________________________
Raw materials $ 2,861,105 $ 3,819,830
Work-in-process 1,614,234 1,061,900
Finished goods 5,208,622 2,632,271
____________________________________________
$ 9,683,961 $ 7,514,001
============================================
The increase in finished goods inventories as of September
30, 1998 was attibutable to NeoPath's manufacturing AutoPap
Systems in anticipation of significant customer contracts. The
balance decreased significantly in October 1998 as AutoPap
Systems were shipped to fee-per-use customers and inventory costs
were reclassified to fee-per-use systems, a long-term asset
category.
Note 5 - Purchase of Pathfinder System Product Line
NeoPath acquired the Pathfinder System product line in June
1997 for an initial purchase price of $4.1 million. The initial
purchase price included cash of $2.7 million (including
transaction-related expenses), a $500,000 short-term note paid in
October 1997, and 48,564 shares of NeoPath common stock. In
addition, certain shares of NeoPath common stock were issued and
were held in escrow contingent upon certain specific technology
decisions to be made within one year of closing. In April 1998
the Company released the remaining shares held in escrow,
consisting of approximately 42,000 shares of NeoPath common
stock, resulting in recognition of an additional $550,000 in
intangible assets that are amortized over the remaining five-year
amortization term established in June 1997.
Note 6 - Note Payable to Bank
In April 1998, NeoPath entered into a loan agreement with a
bank pursuant to which the Company may borrow up to $10 million
through June 1999. The bank debt is secured by substantially all
of NeoPath's assets, excluding intellectual property, and amounts
are repaid over 24 months from the date of each drawdown. In
addition, NeoPath must comply with certain financial covenants.
Borrowings under this agreement bear interest at the bank's
prime rate plus 1 percent per annum (9.5% at September 30, 1998).
The balance outstanding at September 30, 1998 was $4,332,381, of
which $2,475,000 was classified as due within one year.
Page 5
<PAGE>
Note 7 - Litigation
On July 15, 1996, Neuromedical Systems, Inc.
("Neuromedical") filed a lawsuit against NeoPath, Inc. in the
United States District Court for the Southern District of New
York. The complaint alleged patent infringement, unfair
competition, false advertising, and related claims. On September
5, 1996, the Company filed its answer and counter claims. In May
1998, a judge in the United States District Court for the
Southern District of New York denied Neuromedical's motion for a
preliminary injunction against NeoPath. The parties have agreed
to dismiss their claims and counterclaims on all but the patent
issues, and Neuromedical accordingly served an amended complaint
on July 27, 1998 asserting only patent infringement claims. This
lawsuit is still in the discovery stage and a trial date has not
been set. The Company continues to believe it has a strong
position in this action and will defend itself vigorously.
On March 31, 1997, the Company filed a patent infringement
lawsuit against Neuromedical in the United States District Court
for the Western District of Washington. The complaint alleges
patent infringement and seeks permanent injunctions against
Neuromedical. In March and April 1998 this lawsuit was amended,
and NeoPath filed an additional related patent lawsuit against
Neuromedical. Neuromedical filed a motion for summary judgment,
which was denied by the court in April 1998. In October 1998,
Neuromedical filed another motion for summary judgment for which
the judge has not yet rendered a decision. The first lawsuit is
currently scheduled for trial in 1999, and the second lawsuit
is currently in the discovery stage.
Page 6
<PAGE>
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Overview
NeoPath, Inc. ("NeoPath" or the "Company") develops and
markets visual intelligence technology to increase accuracy in
medical testing. NeoPath's current products include (i) two
automated screening systems that integrate proprietary high-speed
morpho-computers, video imaging technology and sophisticated
visual intelligence software to capture and analyze thousands of
microscopic images from a Papanicolaou ("Pap") smear slide for
the early detection of cervical cancer and (ii) the Pathfinder(R)
System product line acquired in 1997.
In 1995, the United States Food and Drug Administration (the
"FDA") cleared for commercial use the Company's first automated
screening product, the AutoPap(R) 300 QC Automatic Pap Screener
System (the "AutoPap QC"). In early 1996, the Health Care
Financing Administration ("HCFA") officially allowed clinical
laboratories to use the AutoPap QC in the quality control review
of Pap smear slides that had been initially screened by
cytologists and classified as normal. The HCFA decision allowed
AutoPap QCs to be used in determining which slides will be
rescreened under the federally mandated rescreening requirement.
NeoPath's second automated screening product is the AutoPap
Primary Screening System (the "AutoPap Screener" and, in
combination with the AutoPap QC, the "AutoPap System"). The
AutoPap Screener uses the same hardware components as the AutoPap
QC; however, it uses enhanced software, including additional cell-
classification algorithms. During 1997, NeoPath completed a
prospective intended-use clinical study to evaluate the
performance of the AutoPap Screener as a primary screening
system. This study included analysis of more than 25,000 Pap
smear slides at five clinical laboratories in the United States
and Canada. In August 1997, NeoPath submitted the results of the
study in an amendment to its pending PreMarket Approval
Supplement to the FDA, which requested approval of the AutoPap
Screener as a primary screener of Pap smear slides. In January
1998, the Hematology and Pathology Devices Advisory Panel of the
FDA unanimously recommended that the FDA approve the supplement
to NeoPath's submission. On May 5, 1998, the FDA followed the
panel's recommendation and approved the AutoPap Screener for use
as a primary Pap smear screener. As approved by the FDA, the
AutoPap Screener demonstrates a statistically significant
increase in identifying disease when compared to current manual
practice.
In October 1998, HCFA notified NeoPath that the slides
designated by the AutoPap Screener as "No Further Review" are not
subject to the manual random quality control rescreening of
negative cases required by current rules and regulations. This
decision eliminates laboratory workflow uncertainty and supports
the effectiveness of the AutoPap Screener.
NeoPath's Pathfinder System provides improved productivity
and quality assurance in clinical cytology laboratories by
computerizing cytotechnologists' microscopes, thereby helping to
eliminate manual screening errors and facilitating critical cell
identification in applications such as Pap smear screening.
Page 7
<PAGE>
Results of Operations
($ amounts in thousands) September 30, 1998 Change September 30, 1997
_______________________________________________________________________________
Revenues:
Three months ended $1,874 $(1,235) $3,109
(40%)
Nine months ended $9,745 $2,161 $7,584
28%
The Company recognizes revenue on either a sale or fee-per-
use basis (subject to certain license agreements, lease
contracts, and minimum payments on fee-per-use contracts). Under
its fee-per-use program, the Company retains ownership of AutoPap
Systems placed at customer sites and assesses customers a charge
for each Pap smear slide analyzed. The reduction in revenues
from the third quarter of the prior year was a result of lower
AutoPap System sales, particularly in Asian markets. On a year-
to-date basis, higher fee-per-use and sale revenues were reported
in 1998 in comparison to the nine months ended September 30,
1997.
The AutoPap Screener is the only FDA-approved system for
automated primary screening of Pap smears. NeoPath has
implemented a strategy to take advantage of this competitive
opportunity by offering AutoPap Screeners to customers with
initial fee-per-use pricing in line with existing laboratory
economics. Per-slide pricing is designed to increase during the
contract period to reflect expected increases in third-party
reimbursement levels. NeoPath will also continue to offer
traditional, fixed price fee-per-use contracts.
In October 1998, NeoPath announced an agreement with
SmithKline Beecham Clinical Laboratories ("SmithKline") pursuant
to which SmithKline has agreed to adopt the AutoPap Screener
throughout its domestic laboratory organization. This four-year
contract is intended to enable SmithKline to process 100 percent
of its Pap smear volume on AutoPap Screeners. At current AutoPap
processing rates, NeoPath estimates that SmithKline may require
up to 125 AutoPap Screeners to process its nationwide volume of
Pap smears under contract. NeoPath has upgraded the AutoPap QCs
at SmithKline's laboratories in St. Louis and Atlanta, and in
October 1998 NeoPath began shipping AutoPap Screeners to
additional SmithKline sites under the national agreement.
SmithKline is one of the three largest clinical laboratory
companies in the United States.
Also in October 1998, NeoPath announced a national agreement
with Kaiser Permanente ("Kaiser"), which is the largest non-
profit group health plan in the United States. The Kaiser
national agreement allows Kaiser and affiliated entities to
purchase AutoPap Screeners during the two-year term of the
agreement, with additional annual service and licensing fees due
over four years. At current AutoPap processing rates, NeoPath
estimates that Kaiser may potentially order up to 35 AutoPap
Screeners to process its nationwide volume of Pap smears. The
timing of specific purchase orders -- and related AutoPap
Screener shipments -- is subject to the adoption plans of Kaiser
laboratories and affiliates.
NeoPath believes that the national agreements with
SmithKline and Kaiser represent significant milestones for the
Company.
Page 8
<PAGE>
The majority of AutoPap Systems in the United States were
placed under multi-year fee-per-use contracts, while
international placements have been primarily sale transactions.
The Company anticipates that, with the exception of the Kaiser
agreement, future AutoPap System placements in the United States
will consist primarily of multi-year fee-per-use contracts such
as the national agreement signed with SmithKline. However,
because an AutoPap sale results in NeoPath's immediate
recognition of product revenue (while a fee-per-use contract
provides lower initial revenues but generally extends over
several years) near-term AutoPap System sale transactions may
account for a higher percentage of total revenues than will the
fee-per-use program. International product placements are
expected to continue to consist primarily of AutoPap sales.
As a result of increased orders, NeoPath has begun
increasing its AutoPap production rate. NeoPath's manufacturing
process consists primarily of final assembly and test; therefore,
initial capacity constraints relate primarily to lead time
associated with component parts from suppliers. NeoPath
maintains excellent relations with its suppliers and is working
closely with them to meet increasing AutoPap demand.
Approximately 45 percent of third quarter 1998 revenues
resulted from AutoPap System sales and upgrades of previously
installed AutoPap QCs to enable operation as AutoPap Screeners.
This compares to approximately 66 percent in the third quarter of
1997. For each of the nine-month periods ended September 30,
1998 and 1997, approximately 67 percent of total revenues were
attributable to AutoPap System sales and upgrades. The remaining
revenues represented fee-per-use contract billings and Pathfinder
System sales. Pathfinder System sales accounted for less than 3
percent of total revenues in each of the nine-month periods.
NeoPath's AutoPap technology is now available at commercial
laboratories in Taiwan, Japan, China (Hong Kong), Korea,
Australia, and in Europe. Year-to-date 1998 AutoPap revenues
included additional AutoPap System placements in Taiwan, Hong
Kong and Japan. The Company's international product placements
have primarily been denominated in U.S. dollars; however, future
product revenues may be subject to foreign exchange rate
fluctuations. Approximately 5 percent of NeoPath's revenues in
the third quarter of 1998 represented sales to customers outside
of the United States, compared to approximately 45 percent in the
same period in 1997. For the nine months ended September 30,
1998, international revenues accounted for approximately 23
percent of total revenues, compared to 59 percent for the same
period in 1997.
NeoPath believes that increased third-party reimbursement of
Pap smears in general, and increased reimbursement for screening
utilizing the AutoPap System in particular, will increase the
Company's future revenues. In early 1998, NeoPath established a
reimbursement team to work with third-party insurers and managed
care organizations to establish and/or improve third-party
reimbursement levels for the AutoPap System. These reimbursement
specialists work closely with NeoPath's field sales personnel
throughout the United States. Effective January 1, 1998, revised
Physicians' Current Procedural Terminology ("CPT") codes
(established by the American Medical Association) became
effective for the AutoPap QC. CPT codes are a standardized
system used by physicians and clinical laboratories to identify
specific procedures when billing insurers for their services.
New CPT codes that address utilization of the new AutoPap Primary
Screener will be available on January 1, 1999. In the interim,
NeoPath's reimbursement team is working with AutoPap System
customers to help them obtain third-party reimbursement by
utilizing "miscellaneous" CPT codes. AutoPap customers should
experience decreased administrative burden after the new codes
become available on January 1, 1999.
Page 9
<PAGE>
($ amounts in September 30, Percentage September 30, Percentage
thousands) 1998 of Revenues 1997 of Revenues
________________________________________________________________________________
Cost of revenues:
Three months ended $1,154 62% $1,231 40%
Nine months ended $5,567 57% $3,276 43%
Gross margin:
Three months ended $719 38% $1,878 60%
Nine months ended $4,178 43% $4,308 57%
The decrease in gross margin percentages in 1998 was due
primarily to the mix of fee-per-use and sale revenues between the
periods. Fee-per-use revenues in the periods included lower-
margin initial AutoPap QC placements. The Company's 1998 year-to-
date gross margin also reflects discounts and incentives included
in AutoPap QC sale pricing in the first half of the year as
customers anticipated the FDA's approval of the AutoPap Screener
as well as pricing incentives offered as initial primary
screening placements were made. The change in gross margin from
the prior year was also attributable to 1997 international sales
under a distribution agreement with higher initial AutoPap System
pricing in comparison to 1998. The gross margin percentage is
expected to increase in the future as NeoPath places AutoPap
Screeners under contracts with improved average per-slide pricing
compared to the prior AutoPap QC installed base. Primary
screening systems are expected to process a greater number of
slides, on average, than the prior installed base of AutoPap QC
Systems, which is also expected to improve the gross margin
percentage.
Gross margin may fluctuate depending on the mix of fee-per-
use revenues, AutoPap System sales, upgrades, and other revenues,
as well as initial pricing of fee-per-use contracts and other
sales incentive programs that may be offered. The continued
development of the manufacturing, service and support functions,
as well as overall production levels, are also expected to
contribute to fluctuations in gross margin. Therefore, the
Company's historic gross margins are not necessarily indicative
of future gross margins.
($ amounts in thousands) September 30, 1998 Change September 30, 1997
________________________________________________________________________________
Research and development:
Three months ended $2,801 $(308) $3,109
(10%)
Nine months ended $8,758 $(2,661) $11,419
(23%)
The Company incurred higher research and development costs
in 1997 due primarily to NeoPath's AutoPap Screener clinical
study, which was completed in 1997.
Page 10
<PAGE>
($ amounts in thousands) September 30, 1998 Change September 30, 1997
_______________________________________________________________________________
Selling, general
and administrative:
Three months ended $4,391 $(840) $5,231
(16%)
Nine months ended $14,227 $592 $13,635
4%
For the quarter, selling, general and administrative
expenses decreased from the prior year primarily as a result of
lower overall adminstrative expenses as well as increased
allocation of certain costs to inventories due to higher AutoPap
production rates. As a result of specific cost control
initiatives, NeoPath reduced various sales, marketing, and other
expenses during the third quarter of 1998, compared to the first
two quarters of 1998.
For the nine months ended September 30, 1998, selling,
general and administrative expenses increased from the prior year
due primarily to significant new sales and marketing initiatives
in the first half of 1998, including the market launch of the
AutoPap Screener, and expansion of the sales and reimbursement
team early in 1998. Costs in the first nine months of 1998 also
included the amortization of the allocated purchase price and
integration of the Pathfinder System product line acquired in
June 1997.
($ amounts in thousands) September 30, 1998 Change September 30, 1997
______________________________________________________________________________
Interest income:
Three months ended $202 $(336) $538
(62%)
Nine months ended $835 $(1,122) $1,957
(57%)
The decrease in interest income in 1998 was due to decreased
cash equivalents and securities available-for-sale resulting from
NeoPath's negative operating cash flow.
Liquidity and Capital Resources
As of September 30, 1998, the Company had $14.6 million in
cash, cash equivalents, and securities available-for-sale,
compared to $28.7 million as of December 31, 1997. The decrease
was a result of cash used in the Company's operations for the
nine months ended September 30, 1998, offset by $5 million in
cash obtained from drawing down the first tranche of the
Company's $10 million debt facility (of which NeoPath has repaid
$618,000 as of September 30, 1998). The Company's cash used in
operating activities was $17.7 million in the nine months ended
September 30, 1998 and $23.9 million in the comparable period in
1997. The Company expended cash for property and equipment,
excluding AutoPap Systems reclassified to either fee-per-use
systems or reclassified to property and equipment, of $592,000
and $759,000 in the nine months ended September 30, 1998 and
1997, respectively.
Page 11
<PAGE>
NeoPath's fee-per-use business strategy requires a
significant investment in the production of AutoPap Systems as
well as sufficient resources to meet operating expenses while
this recurring revenue stream grows. As a result of NeoPath's
reemphasis on the fee-per-use program as its core U.S. product
placement strategy, the Company expects negative cash flow from
operations to continue into 2000. The Company's current $10
million bank financing facility is based on the manufacturing
cost of fee-per-use AutoPap Systems placed at customer sites.
NeoPath plans to pursue additional financing options during the
next several months and expects that such financing will be based
primarily on the contract value of multi-year fee-per-use
contracts such as the national agreement with SmithKline. Such
contracts represent a series of future cash flows due NeoPath
over the term of the contracts. There can be no assurance that
the Company will obtain additional cash resources.
The Company currently estimates that its existing cash
resources and established financing facility will enable it to
sustain operations for at least the next three quarters. The
Company's future capital requirements will depend on many
factors, including the extent and rate of adoption of the AutoPap
Screener; the increased market acceptance of the Company's fee-
per-use programs; the mix of fee-per-use and sale placements; the
extent and rate of development of the Company's marketing, sales,
and customer service and support capabilities; and the status of
competing products. The Company may, from time to time, seek
additional funding through public or private financing, including
equity financing. There can be no assurance that adequate
funding will be available as needed or on terms acceptable to the
Company. If additional funds are raised by issuing equity
securities, existing shareholders will experience dilution.
Insufficient funds may require the Company to delay, scale back
or eliminate some or all of its manufacturing, research and
development or clinical programs.
Year 2000 Issue
General Description
The Year 2000 Issue is the result of computer programs being
written using two digits rather than four to define the
applicable year. Any of the Company's internal or product
computer programs or hardware that have date-sensitive software
or embedded chips may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in system
errors or failures, and could significantly disrupt normal
business activities.
Based on recent assessments, the Company determined that it
will be required to modify or replace certain portions of its
internal systems and product software and certain hardware so
that those systems will properly recognize dates beyond December
31, 1999. To date, the Company has completed its assessment of
all internal and product systems that could be significantly
affected by the Year 2000. The assessment indicated that certain
of the Company's internal and product systems could be affected.
However, no significant Year 2000 issues have been identified
that cannot be resolved through software or hardware upgrades
that are currently available or expected to be available soon.
The Company presently believes that with modifications or
replacements of existing software and certain hardware, the Year
2000 Issue as it relates to the Company's internal systems and
products can be effectively mitigated. However, if such
modifications and replacements are not made, or are not completed
in a timely manner, the Year 2000 Issue could have a material
impact on NeoPath's and its customers' operations.
In addition, the Company has gathered information about the
Year 2000 compliance status of its significant suppliers and
subcontractors and continues to monitor their compliance.
Timetable and Cost
The Company will utilize existing internal resources to
reprogram or replace, test, and implement the internal systems
and product software and certain hardware modifications necessary
for Year 2000 compliance. The total cost of the Year 2000
project is not expected to be material. The project is estimated
to be completed by mid-1999.
Page 12
<PAGE>
Third Parties
The Company has queried its significant suppliers and
subcontractors as to their Year 2000 compliance status. To date,
the Company is not aware of any external agent with Year 2000
problems that would materially impact the Company's results of
operations, liquidity, or capital resources. However, the
Company has no means of ensuring that external agents will be
Year 2000 ready. The inability of external agents to complete
their Year 2000 resolution process in a timely fashion could
materially impact the Company. The Company cannot determine the
effect of non-compliance by external agents.
Contingency Plans and Risk
The Company currently has no contingency plans in place in
the event it does not complete all phases of the Year 2000
program or in the event that its external agents are not Year
2000 ready. The Company plans to evaluate the status of its own
Year 2000 program in the first quarter of 1999 and determine
whether such a plan is necessary.
NeoPath management believes it has an effective program in
place to resolve the Year 2000 issues within its control in a
timely manner. The Company believes that with modifications to
NeoPath's products, existing internal software and conversions to
new software, the Year 2000 Issue will not pose significant
operational problems for its computer systems. However, if the
Company or external agents do not make necessary modifications
and conversions, or do not complete them on time, the Year 2000
Issue could disrupt NeoPath's operations and materially affect
its business, financial condition, and results of operations.
Forward-Looking Statements
The preceding Management's Discussion and Analysis of
Financial Condition and Results of Operations contains "forward-
looking statements" which reflect the Company's current views
with respect to future events and financial performance. These
forward-looking statements are subject to certain risks and
uncertainties that could cause actual results to differ
materially from historical results or those anticipated. The
words "plan," "expect," "anticipate," and similar expressions
identify forward-looking statements. Readers are cautioned not
to place undue reliance on these forward-looking statements,
which speak only as of their dates. The Company undertakes no
obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future
events, or otherwise. Factors that could cause actual results to
differ materially from historical results or those anticipated
include, without limitation, the following: specific timing of
customer orders under national agreements, including the
agreements with SmithKline and Kaiser; market acceptance of the
Company's products, marketing and sales programs; availability of
adequate reimbursement for customers; product and manufacturing
regulatory approvals; the Company's limited marketing, sales,
customer service and support capabilities; uncertainties relating
to international transactions; availability of additional
capital; the Company's sole or limited source of supply of
certain components; the Company's ability to manufacture AutoPap
Screeners at required levels; the status of competing products;
dependence on single product line; product liability; dependence
on patents and property rights; and the risk of third-party
claims of infringement. For a more detailed discussion of these
and other factors, see "Factors Affecting Future Results and
Forward-Looking Statements" of the Company's Form 10-K for the
fiscal year ended December 31, 1997.
Item 3. Quantitative and Qualitative Disclosures About Market
Risk
Not applicable.
Page 13
<PAGE>
Part II OTHER INFORMATION
Item 1. Legal Proceedings
On July 15, 1996, Neuromedical Systems, Inc.
("Neuromedical") filed a lawsuit against NeoPath, Inc. in the
United States District Court for the Southern District of New
York. The complaint alleged patent infringement, unfair
competition, false advertising, and related claims. On September
5, 1996, the Company filed its answer and counter claims. In May
1998, a judge in the United States District Court for the
Southern District of New York denied Neuromedical's motion for a
preliminary injunction against NeoPath. The parties have agreed
to dismiss their claims and counterclaims on all but the patent
issues, and Neuromedical accordingly served an amended complaint
on July 27, 1998 asserting only patent infringement claims. This
lawsuit is still in the discovery stage and a trial date has not
been set. The Company continues to believe it has a strong
position in this action and will defend itself vigorously.
On March 31, 1997, the Company filed a patent infringement
lawsuit against Neuromedical in the United States District Court
for the Western District of Washington. The complaint alleges
patent infringement and seeks permanent injunctions against
Neuromedical. In March and April 1998 this lawsuit was amended,
and NeoPath filed an additional related patent lawsuit against
Neuromedical. Neuromedical filed a motion for summary judgment,
which was denied by the court in April 1998. In October 1998,
Neuromedical filed another motion for summary judment for which
the judge has not yet rendered a decision. The first lawsuit is
currently scheduled for trial in 1999, and the second lawsuit
is currently in the discovery stage.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this report.
Exhibit No. Description
___________ ___________
27 Financial Data Schedule
10.29* Equipment User Agreement with SmithKline
Beecham Clinical Laboratories dated as of
September 29, 1998
_____________________________________________________________________
* Confidential treatment requested
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
September 30, 1998.
Page 14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
NeoPath, Inc.
Date: November 13, 1998 By: /s/ ALAN C. NELSON
__________________
Alan C. Nelson
President, CEO and Chairman
By: /s/ ROBERT C. BATEMAN
_____________________
Robert C. Bateman
Vice President and Chief
Financial Officer
Page 15
<PAGE>
NEOPATH, INC.
INDEX TO EXHIBITS
Exhibit No. Description
___________ ___________
27 Financial Data Schedule
10.29* Equipment User Agreement with SmithKline
Beecham Clinical Laboratories dated as of
September 29, 1998
_______________________________________________________________________
* Confidential treatment requested
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Form
10-Q as of September 30, 1998 and for the nine months then ended, and is
qualified in its entirety by reference to such financial statements and
footnotes.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 4,095,567
<SECURITIES> 10,529,485
<RECEIVABLES> 3,690,846
<ALLOWANCES> 0
<INVENTORY> 9,683,961
<CURRENT-ASSETS> 28,406,422
<PP&E> 4,519,375
<DEPRECIATION> 0
<TOTAL-ASSETS> 45,660,596
<CURRENT-LIABILITIES> 7,657,360
<BONDS> 0
0
0
<COMMON> 141,834,782
<OTHER-SE> (105,726,574)
<TOTAL-LIABILITY-AND-EQUITY> 45,660,596
<SALES> 0
<TOTAL-REVENUES> 9,745,006
<CGS> 0
<TOTAL-COSTS> 5,567,004
<OTHER-EXPENSES> 22,985,240
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 145,570
<INCOME-PRETAX> (18,117,625)
<INCOME-TAX> 0
<INCOME-CONTINUING> (18,117,625)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,117,625)
<EPS-PRIMARY> (1.25)<F1>
<EPS-DILUTED> 0.00
<FN>
<F1>Basic and diluted net loss per share are the same amount.
</FN>
</TABLE>
EXHIBIT 10.29
"[*]" = omitted, confidential material, which material has been separately
filed with the Securities and Exchange Commission pursuant to a request for
confidential treatment.
<PAGE>
[NeoPath, Inc. logo]
EQUIPMENT USER AGREEMENT
WITH
SMITHKLINE BEECHAM CLINICAL LABORATORIES
1201 South Collegeville Road
Collegeville, PA 19426
____________________________________________________________
Section 1. Overview of Agreement
This Agreement is made and entered into by and between
NeoPath, Inc. ("NeoPath") and SmithKline Beecham Clinical
Laboratories ("SBCL"). This Agreement supercedes all prior
agreements between NeoPath and SBCL. This Agreement
includes, and incorporates by this reference NeoPath's
Standard Terms and Conditions, NeoPath's Equipment User
Agreement Supplemental Terms and Conditions, and NeoPath's
AutoPap System Product Insert.
NeoPath agrees to provide SBCL, and SBCL agrees to order
from NeoPath, sufficient AutoPap(R) Primary Screening
Systems ("System") to process 100 percent of SBCL's
internally processed automated Pap smear volume by the end
of the Term. The initial upgrade of all AutoPap QC Systems
to AutoPap Primary Screening Systems at the SBCL St. Louis
and Atlanta sites will be performed immediately, but no
later than September 30, 1998. By [*], NeoPath and SBCL
will agree to a delivery schedule for AutoPap Primary
Screening Systems to be shipped in 1998 and 1999. By [*],
NeoPath and SBCL will agree to a delivery schedule for
Systems to be shipped during the remaining Term.
Section 2. Definitions
The following terms will have the following meanings when
used in this Agreement with initial letters capitalized:
"Anniversary Date" means September 1, 1999, 2000, and 2001.
"Annual Period" means any period of twelve consecutive
calendar months during the Term beginning on September 1,
1998 or any Anniversary Date.
"Base Fee-Per-Slide" or "Base FPS" means the minimum amount
due NeoPath per Pap smear slide processed on a System during
the Term. Unless adjusted, the Base FPS is established as
follows:
Period Base FPS
______ ________
1: September 1, 1998 - August 31, 1999 [*]
2: September 1, 1999 - August 31, 2000 [*]
3: September 1, 2000 - August 31, 2001 [*]
4: September 1, 2001 - August 31, 2002 [*]
"Current Payment" means the national average payment
received by SBCL on a per Pap smear basis for all Pap smear
slides processed between [*].
"Fee-Per-Slide" means the Base FPS or the Adjusted Base
FPS, in either case as the same may be adjusted pursuant to
Section 4 below.
_______________________
[*]Confidential treatment requested
Page 1
<PAGE>
"Quarter" means a calendar quarter (i.e., a period of three
consecutive months commencing with January, April, July or
October).
"Term" means a period of four years commencing September 1,
1998.
"Total Payment" means the national average payment received
by SBCL on a per Pap smear basis for Pap smear slides
processed utilizing the AutoPap System during the twelve
months ending [*].
The parties acknowledge that Total Payment does not
encompass [*]. The Parties agree that if SBCL incorporates
such technology into the Pap smear process, there may be an
increase in the cost of Pap smear slides. To the extent
these increased costs change total payment, the parties
agree to factor such amounts into the Total Payment
calculation.
"System" means any AutoPap System subject to this Agreement.
"No Review" means slides that the AutoPap System designates
as needing no human review. The No Review rate is the
percent of all eligible slides that are so designated.
Section 3. Prior Agreements
The terms of this Agreement also apply to AutoPap Systems
currently installed at SBCL sites in St. Louis and Atlanta
under terms of earlier contracts signed October 5, 1995 and
May 9, 1996 respectively, except that the instrument minimum
volumes of [*] slides processed per year still apply to each
of those instruments.
Section 4. Fee-Per-Slide
Section 4.1 General
The Fee-Per-Slide will be equal to the Base FPS, as the same
may be adjusted pursuant to Section 4.2 or 4.3.
Section 4.2 Adjusted Base FPS
The Base FPS for any Annual Period may be adjusted if the
following formula yields a fee per slide different from the
Base FPS specified for the corresponding period (in no event
is the Adjusted Base FPS less than the initial Base FPS):
Adjusted Base FPS: [*]
Example for first
Anniversary Date: Current Payment assumption = [*]
Total Payment assumption = [*]
Then Adjusted Base FPS for the second Annual Period: [*]
SBCL or NeoPath may exercise such option only by giving
written notice of such exercise within 30 days prior to the
commencement of the applicable Annual Period.
_________________
[*]Confidential treatment requested
Page 2
<PAGE>
Section 4.3. Workload Reduction Adjustment
Upon NeoPath's delivery of an FDA-approved upgraded System
capability, the Base FPS (or Adjusted Base FPS, as
applicable) will be increased by [*] per Pap smear slide
processed for [*]. Such increase per slide will be payable
with respect to all slides processed after the beginning of
the Quarter following delivery, installation, and full
implementation of the upgrade.
Section 5. Records and Audit
SBCL will keep and maintain accurate records of any and all
payments received for the processing of Pap smear slides.
NeoPath may designate an independent certified public
accountant to audit SBCL's documentation and records as
required to verify any proposed Adjusted Base FPS. Unless
otherwise agreed by the parties, any such audit will be
conducted upon not less than ten (10) business days' advance
written notice to SBCL, during SBCL's normal business hours
and in a manner that does not interfere with SBCL's normal
business operations. The expense of such audit will be
borne by [*]. NeoPath will not conduct any such audit more
than once in any twelve (12)-month period.
Section 6. Exclusivity
During the Term, SBCL agrees to exclusively utilize AutoPap
Systems for all eligible internally processed automated Pap
smear reading needs. By the end of the Term, SBCL agrees to
process 100 percent of eligible internally processed Pap
smear slides at installed sites through the AutoPap System.
Section 7. Other Terms
NeoPath will deliver the AutoPap Systems FOB carrier at the
NeoPath manufacturing facility. [*] will be responsible for
all transportation costs.
Section 8. Additional Systems
If the average number of slides processed per Quarter with
all of the Systems located at any SBCL site during any two
consecutive Quarters exceeds [*] slides per System per
Quarter, then SBCL may order additional Systems as needed to
bring the projected average requirement at such SBCL site
down to approximately [*] slides per System per Quarter.
Unless otherwise agreed upon by the parties, NeoPath will
use its best efforts to deliver such additional System(s)
within [*] days after receipt of SBCL's order for the same,
and the Term with respect to any such System will commence
upon [*] and will end upon [*].
Section 9. Early Termination
If the average number of slides processed per Quarter with
all of the Systems located at any SBCL site during any two
(2) consecutive Quarters is significantly less than [*]
slides per System per Quarter, then NeoPath may terminate
the Term with respect to any Systems located at such SBCL
site; provided that after any such termination, the Systems
remaining at such SBCL site are sufficient to process a
projected average requirement at such SBCL site not greater
than approximately [*] slides per System per Quarter, and
provided that at least one System sufficient to handle the
eligible slides at that site remains on-site.
______________________
[*]Confidential treatment requested
Page 3
<PAGE>
Section 10. Press Releases
Each party to this agreement will give the other party
reasonable advance notice of, and the opportunity to review,
comment upon and approve, any press release or marketing
materials that the other party may desire to publish with
regard to either the utilization of Systems at SBCL's sites,
or the NeoPath system generally.
Section 11. Accessories
11.1 Each offered AutoPap System includes the following
NeoPath accessories:
Quantity Description
________ ___________
40 AutoPap Slide Trays
1 Operator Manual
1 Start-Up Kit*
* Start-Up Kit will include one package of printer paper
and one roll of Bar Code Labels (5,000 sets of 4 labels
per role)
11.2 The following additional accessories are offered by
NeoPath at the current indicated prices (prices subject
to change):
Description Price
___________ _____
Bar Code Labels [*] (U.S.) per roll
AutoPap Slide Tray [*] (U.S.) per tray
Section 12. Contract Signatures
OFFERED BY: ACCEPTED BY:
NeoPath, Inc. SmithKline Beecham Clinical Laboratories
Signature: /s/ Alan C. Nelson Signature: /s/ John B. Okkerse, Jr.
____________________________________ ________________________________________
Printed Name: Alan C. Nelson, Ph.D. Printed Name: John B. Okkerse, Jr.
Title: President, CEO and Chairman Title: President
Date Signed: September 29, 1998 Date Signed: September 29, 1998
___________________________________ ________________________________________
/s/ Edward A. Kaufman
________________________________________
Edward A. Kaufman
________________________________________
Vice-President/National Medical Director
________________________________________
29 September 98
________________________________________
Page 4
<PAGE>
