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 June 30, 1999
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 July 21, 1999
(Common stock,$.01 par value) 17,446,309
<PAGE>
NEOPATH, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
Page
____
Item 1. Financial Statements 1
Balance Sheets -- June 30, 1999 (unaudited) and
December 31, 1998
Statements of Operations (unaudited) -- for the
three and six months ended June 30, 1999 and 1998
Statements of Cash Flows (unaudited) -- for the six
months ended June 30, 1999 and 1998
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 15
Part II OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
<PAGE>
Part I FINANCIAL INFORMATION
Item 1. Financial Statements
NEOPATH, INC.
BALANCE SHEETS
June 30, December 31,
1999 1998
______________ _____________
(Unaudited)
Assets
Current Assets:
Cash and cash equivalents $ 6,320,707 $ 5,579,867
Securities available-for-sale 3,589,939 3,374,549
Accounts receivable, net 3,017,766 3,011,078
Inventories 8,912,247 6,744,417
Other current assets 421,677 392,415
_____________ _____________
Total current assets 22,262,336 19,102,326
Fee-per-use systems, net 15,087,925 14,602,963
Property and equipment, net 2,543,302 3,530,694
Deposits and other assets 802,769 913,850
_____________ _____________
Total assets $ 40,696,332 $ 38,149,833
============= =============
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 1,494,461 $ 2,944,252
Salaries and wages payable 887,477 1,681,710
Customer deposits 265,217 332,485
Other accrued liabilities 1,592,981 1,157,077
Current portion of long-term obligations 2,534,170 2,549,151
_____________ _____________
Total current liabilities 6,774,306 8,664,675
Long-term obligations, less current portion 31,255 1,257,027
Shareholders' equity:
Common stock 156,329,799 142,057,561
Accumulated deficit (122,431,241) (113,813,699)
Accumulated other comprehensive loss (7,787) (15,731)
_____________ _____________
Total shareholders' equity 33,890,771 28,228,131
_____________ _____________
Total liabilities and shareholders' equity $ 40,696,332 $ 38,149,833
============= =============
See accompanying notes.
Page 1
<PAGE>
NEOPATH, INC.
STATEMENTS OF OPERATIONS
(Unaudited)
Three months ended Six months ended
June 30, June 30,
___________________________ ___________________________
1999 1998 1999 1998
____________ ____________ ____________ ____________
Revenues $ 2,939,429 $ 4,308,465 $ 4,965,287 $ 7,871,156
Cost of revenues 1,587,985 2,371,840 2,752,375 4,412,600
____________ ____________ ___________ ____________
Gross margin 1,351,444 1,936,625 2,212,912 3,458,556
Operating expenses:
Research and
development 2,362,183 2,911,427 4,780,220 5,957,243
Selling, general
and
administrative 2,631,579 5,329,589 6,190,285 9,835,832
____________ ____________ ____________ ____________
4,993,762 8,241,016 10,970,505 15,793,075
____________ ____________ ____________ ____________
Loss from operations (3,642,318) (6,304,391) (8,757,593) (12,334,519)
Interest income 163,717 267,302 300,961 633,076
Interest expense (70,903) (15,288) (160,888) (24,567)
____________ ____________ ____________ ____________
Net loss $ (3,549,504) $ (6,052,377) $ (8,617,520) $(11,726,010)
============ ============ ============ ============
Basic and diluted
net loss per share $ (0.20) $ (0.42) $ (0.51) $ (0.81)
============ ============ ============ ============
Weighted average
common shares
outstanding 17,420,160 14,468,686 16,804,161 14,442,269
============ ============ ============ ============
See accompanying notes.
Page 2
<PAGE>
NEOPATH, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30,
________________________________
1999 1998
_____________ _____________
Operating activities
Net loss $ (8,617,520) $ (11,726,010)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 2,885,176 2,790,942
Stock-based compensation 7,100 --
Accrued interest on securities
available-for-sale 183,206 360,694
Net change in operating accounts:
Accounts receivable (6,688) (1,008,775)
Inventories and fee-per-use systems (4,479,262) (1,474,927)
Accounts payable and accrued liabilities (2,165,388) (563,874)
Other 102,460 (922,894)
____________ ______________
Net cash used in operating activities (12,090,916) (12,544,844)
Investing activities
Purchases of securities available-for-sale (7,199,372) (202,310)
Sales and maturities of securities
available-for-sale 6,808,719 12,934,765
Additions to property and equipment (58,591) (531,042)
Other (3,077) --
____________ ______________
Net cash (used in) provided by
investing activities (452,321) 12,201,413
Financing activities
Proceeds from private equity transaction, net 14,442,688 --
Proceeds from note payable to bank -- 4,950,000
Payments on note payable to bank (1,237,500) --
Issuance of common stock under employee
stock purchase plan 38,932 70,482
Exercise of options and warrants 73,518 76,660
Principal payments on obligations under
capital leases (33,561) (37,656)
____________ ____________
Net cash provided by financing activities 13,284,077 5,059,486
____________ ____________
Net increase in cash and cash equivalents 740,840 4,716,055
Cash and cash equivalents:
Beginning of period 5,579,867 3,308,970
____________ ____________
End of period $ 6,320,707 $ 8,025,025
============ ============
Noncash transactions and
supplemental disclosures
AutoPap Systems reclassified to
fee-per-use systems, net $ 2,426,091 $ 441,736
See accompanying notes.
Page 3
<PAGE 3>
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, 1998 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 six-month
periods ended June 30, 1999, are not necessarily indicative of
results to be expected for the entire year ending December 31,
1999 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, 1998.
Note 2 -- Restricted Cash
NeoPath's cash and cash equivalents balance at June 30, 1999
includes $2.0 million in restricted cash in an interest-bearing
account with Silicon Valley Bank. This restricted cash is
additional security for NeoPath's loan agreement with the bank.
Note 3 -- Revenue Recognition
The Company recognizes revenue on either a product sale or
fee-per-use basis. Sales of AutoPap(R) Systems are generally
recognized at date of shipment and are subject to continuing
service and license agreements for which revenue is recognized
over the corresponding contract period. Fee-per-use revenue
commences in the month an AutoPap System is initially placed in
commercial use at a customer site and consists of per-slide
monthly billings, fixed rental billings, and minimum payments due
on certain fee-per-use contracts. Fee-per-use revenue is
recognized as earned.
Page 4
<PAGE>
Note 4 -- Comprehensive Net Loss
Components of comprehensive net loss, as defined by
applicable accounting and reporting standards, are as follows:
Three months ended June 30,
_______________________________
1999 1998
_______________________________
Net loss $ (3,549,504) $ (6,052,377)
Unrealized gain on
Securities available-for-sale 15,115 41,507
_______________________________
Comprehensive net loss $ (3,534,389) $ (6,010,870)
===============================
Six months ended June 30,
_______________________________
1999 1998
_______________________________
Net loss $ (8,617,520) $(11,726,010)
Unrealized gain on
Securities available-for-sale 7,944 103,024
_______________________________
Comprehensive net loss $ (8,609,576) $(11,622,986)
================================
Note 5 -- Inventories
Inventories consist of the following:
June 30, 1999 December 31, 1998
___________________________________________
Raw materials $ 3,202,689 $ 2,093,748
Work-in-process 1,732,102 2,365,472
Finished goods 3,977,456 2,285,197
__________________________________________
$ 8,912,247 $ 6,744,417
==========================================
Note 6 -- Private Equity Transaction
On February 9, 1999, NeoPath completed a $14.5 million
private equity transaction in which the Company issued 2.9
million shares of common stock to investors at a price of $5.00
per share. In connection with the financing, NeoPath issued to
Invemed Associates, Inc., a related party, five-year warrants to
purchase 100,000 shares of common stock at an exercise price of
$5.89 per share. On February 12, 1999, NeoPath filed a shelf
registration statement on Form S-3 that will, when declared
effective by the Securities and Exchange Commission, allow resale
of the newly issued shares. NeoPath must use its best efforts to
keep this registration statement effective for two years. The
private equity transaction agreement specified that the purchase
price would be reduced by 2 percent if the registration statement
was not declared effective within 120 days of the transaction closing.
As a result, NeoPath recognized a liability of $290,000 as of
June 30, 1999.
Note 7 -- Agreement to Acquire Technology Rights
On March 26, 1999, AutoCyte, Inc. announced an agreement to
purchase certain Neuromedical, Inc. technology, including patent
rights, for $4.0 million in cash and 1.4 million shares of
AutoCyte common stock. On April 26, 1999, NeoPath and AutoCyte
announced an agreement whereby NeoPath may acquire an undivided
interest in the intellectual property estate of Neuromedical that
AutoCyte had agreed to acquire. Subject to certain conditions,
NeoPath will pay AutoCyte $2.2 million in cash and issue AutoCyte
1.2 million shares of NeoPath common stock at the later of the
transaction closing date or September 1, 1999. On May 18, 1999,
AutoCyte announced that it had completed its acquisition of the
Neuromedical technology.
Page 5
<PAGE>
Note 8 -- Agreement to Merge with AutoCyte
On June 4, 1999, NeoPath and AutoCyte agreed to a merger in
which a wholly owned subsidiary of AutoCyte will merge with
NeoPath, and NeoPath will become a wholly owned subsidiary of
AutoCyte. On the effective date of the merger, each issued and
outstanding share of NeoPath common stock will automatically convert
into the right to receive 0.7903 shares of AutoCyte common stock.
AutoCyte will pay cash in lieu of issuing fractional shares of
AutoCyte common stock. Outstanding employee and director options
and certain warrants to purchase shares of NeoPath common stock
will be converted to AutoCyte options and warrants at the same
exchange ratio. The parties expect the merger to be a tax-free
reorganization and to be accounted for as a pooling of interests.
Completion of the acquisition is subject to approval by
AutoCyte's and NeoPath's shareholders and to other customary
closing conditions.
Note 9 -- Litigation
On July 15, 1996, Neuromedical Systems, Inc. filed a lawsuit
against NeoPath 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 and requested monetary damages and injunctive relief. On
September 5, 1996, NeoPath 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 the Company. The parties 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.
Virtually all of NeoPath's domestic revenues, which represented
90 percent of total revenues in the six months ended June 30,
1999, are derived from products that incorporate technology
covered by this patent. NeoPath believes it has a strong
position in this action, and will defend itself vigorously
against these claims. On March 26, 1999, Neuromedical announced
that it had filed a voluntary chapter 11 petition for bankruptcy.
On April 6, 1999, the court removed the case from its active
docket pending further developments in Neuromedical's bankruptcy
proceedings.
On March 31, 1997, NeoPath 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 the court denied in April 1998. In October 1998,
Neuromedical filed another motion for summary judgment that the
court denied. By court order on March 30, 1999, proceedings
have been stayed pending resolution of Neuromedical's bankruptcy
proceedings. Furthermore, the court ordered that these cases be
removed from the court's active caseload.
NeoPath's intellectual property acquisition agreement with
AutoCyte provides that the patent infringement litigation between
NeoPath and Neuromedical will be terminated.
Note 10 -- Reclassifications
Certain prior-period amounts have been reclassified to
conform to the current-period presentation.
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 initial products include two
automated screening systems that integrate proprietary high-speed
morphology computers, video imaging technology, and sophisticated
image interpretation software to capture and analyze thousands of
microscopic images from a Pap smear slide for the early detection
of cervical cancer.
The United States Food and Drug Administration (the "FDA")
approved NeoPath's AutoPap(R) 300 QC Automatic Pap Screener
System (the "AutoPap QC") in 1995. The AutoPap QC is a
rescreening device used for quality control and rescreening of
Pap smear slides previously screened by cytotechnologists.
Clinical studies have shown that the AutoPap QC detects a
significantly higher proportion of undetected abnormal slides
than procedures typically employed by clinical laboratories to
meet federal rescreening requirements. These studies were
performed at independent laboratories, and NeoPath funded the
studies that support the FDA claims.
The FDA approved NeoPath's AutoPap(R) Primary Screening
System (the "AutoPap Screener") in May 1998. The AutoPap
Screener uses the same hardware components as the AutoPap QC, but
uses enhanced software to perform the initial screening of Pap
smear slides and to classify up to 25% of such slides as
requiring no further review. NeoPath also has funded clinical
studies of the effectiveness of the AutoPap Screener by
independent laboratories. These clinical studies have shown that
the AutoPap Screener provides statistically significantly better
sensitivity and specificity when compared to existing laboratory
practice. Currently, it is the only instrument approved by the
FDA that allows Pap smear slides to bypass human review. This
feature of the AutoPap Screener provides customers with an
economic incentive to adopt the technology. The AutoPap Screener
provides customers with the functionality of both the AutoPap QC
as well as a primary screening system; therefore, NeoPath is
focusing its sales efforts on the AutoPap Screener.
The "AutoPap System" refers to the AutoPap Screener and the
AutoPap QC together.
Merger with AutoCyte, Inc.
On June 4, 1999, NeoPath and AutoCyte agreed to a merger in
which a wholly owned subsidiary of AutoCyte will merge with
NeoPath, and NeoPath will become a wholly owned subsidiary of
AutoCyte. On the effective date of the merger, each issued and
outstanding share of NeoPath common stock will automatically convert
into the right to receive 0.7903 shares of AutoCyte common stock.
AutoCyte will pay cash in lieu of issuing fractional shares of
AutoCyte common stock. Outstanding employee and director options
and certain warrants to purchase shares of NeoPath common stock
will be converted to AutoCyte options and warrants at the same
exchange ratio. The parties expect the merger to be a tax-free
reorganization and to be accounted for as a pooling of interests.
Completion of the acquisition is subject to approval by
AutoCyte's and NeoPath's shareholders and to other customary
closing conditions.
Background
NeoPath recognizes revenue on either a product sale or fee-
per-use basis. Sales of AutoPap Systems are generally
recognized at date of shipment and are subject to continuing
service and license agreements for which revenue is recognized
over the corresponding contract period. Fee-per-use revenue
commences in the month an AutoPap System is initially placed in
commercial use at a customer site and consists of per-slide
monthly billings, fixed rental billings, and minimum payments
due on certain fee-per-use contracts. Fee-per-use revenue is
recognized as earned. The cost of each AutoPap System is
reclassified from inventories to depreciable equipment upon
shipment to a fee-per-use customer site. Such equipment,
reflected on the balance sheet under "fee-per-use systems, net,"
is depreciated on a straight-line basis over a four-year period,
commencing upon commercial operation.
Page 7
<PAGE>
Because the AutoPap Screener is the only FDA-approved
system for automated primary screening of Pap smears, NeoPath's
U.S. strategy includes offering AutoPap Screeners to customers
with initial fee-per-use pricing in line with existing
laboratory economics. Per-slide pricing may increase during
contract periods to reflect expected laboratory cost
efficiencies and overall increased third-party reimbursement
levels.
In October 1998, NeoPath announced an agreement with
SmithKline Beecham Clinical Laboratories pursuant to which
SmithKline agreed to adopt the AutoPap Screener throughout its
domestic laboratory organization. This four-year contract is
intended to enable SmithKline to process 100% of its Pap smear
volume on AutoPap Screeners. SmithKline is NeoPath's largest
fee-per-use customer. In February 1999, SmithKline and Quest
Diagnostics Incorporated announced that Quest had agreed to
purchase SmithKline's clinical laboratory business. While
NeoPath's national agreement with SmithKline is binding on
successor organizations, no additional AutoPap Systems were
shipped to SmithKline during the second quarter. Additional
AutoPap Screener orders have been delayed as the two laboratory
companies work through their combined business issues. Future
negotiations with SmithKline and Quest could change the pricing
and placement rate under the existing SmithKline agreement. In
addition, SmithKline has not fully implemented certain shipped
systems, and SmithKline's current AutoPap Screener usage is
below NeoPath's expectations. NeoPath continues to work with
SmithKline to fully optimize AutoPap usage at those SmithKline
laboratory sites.
Also in October 1998, NeoPath announced a national agreement
with Kaiser Permanente, which is the largest non-profit group
health plan in the United States. This 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
require up to 35 AutoPap Screeners to process its nationwide
volume of Pap smears. The timing of specific purchase orders and
AutoPap Screener shipments will depend on Kaiser's adoption
plans. NeoPath has not recognized any product revenues under
this agreement.
NeoPath believes that increased third-party reimbursement of
Pap smears in general, and increased reimbursement for screening
utilizing the AutoPap System in particular, would increase market
acceptance of the Company's products. Virtually all of NeoPath's
revenues are dependent on customers who rely on third-party
reimbursement. NeoPath has a reimbursement team that works with
third-party insurers and managed care organizations to establish
and/or improve third-party reimbursement levels for the AutoPap
System. On January 1, 1999, revised Physicians' Current
Procedural Terminology ("CPT") codes (established by the American
Medical Association) became effective for the AutoPap Screener.
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 AutoPap QC became available on January 1,
1998.
Results of Operations
(in thousands) June 30, 1999 Change June 30, 1998
____________________________________________________________________
Revenues:
Three months ended $2,939 $(1,369) $4,308
(32%)
Six months ended $4,965 $(2,906) $7,871
(37%)
NeoPath's revenues for the three months ended June 30, 1999
consisted of $2.1 million of fee-per-use and service fees and
$0.8 million of AutoPap product sales. Revenues in the
comparable 1998 quarter included $0.9 million of fee-per-use and
service fees, $3.3 million of AutoPap System product sales, and
$0.1 million of Pathfinder product sales. Pathfinder product
sales were not significant in the three months ended June 30,
1999. NeoPath's fee-per-use and service revenues increased 145
percent from the second quarter of 1998, while AutoPap product
sales decreased 77 percent in the same period. International
revenues accounted for 14 percent of total revenues in the
second quarter of 1999, compared to 31 percent in the comparable
period in 1998.
Page 8
<PAGE>
For the six months ended June 30, 1999, NeoPath's revenues
consisted of $4.2 million of AutoPap fee-per-use and service fees
and $0.8 million of AutoPap product sales. This compares to $2.0
million of fee-per-use and service fees, $5.7 million of AutoPap
product sales, and $0.2 million of Pathfinder product sales in the
six months ended June 30, 1998. NeoPath's fee-per-use and service
revenues increased 113 percent from the six months ended June 30,
1998, while AutoPap product sales decreased 86 percent in the same
period. International revenues accounted for 10 percent of total
revenues in the six months ended June 30, 1999, compared to 27
percent in the comparable period in 1998.
The increase in fee-per-use and service revenues in the three
and six-month periods ended June 30, 1999 was attributable to a
greater number of AutoPap Systems processing slides under fee-per-
use contracts in 1999 as compared to 1998, as well as improved per-
slide pricing in the current year. NeoPath's AutoPap System
placements have consisted primarily of fee-per-use contracts in
the United States and sale contracts internationally.
Because sale contracts result in immediate revenue
recognition, whereas fee-per-use contracts provide a recurring
revenue stream over several years, any increase or decrease in
unit sale placements between periods can result in a significant
fluctuation in reported revenues. Since NeoPath's international
AutoPap placements are generally product sale agreements, in
comparison to AutoPap placements in the U.S. which are primarily
fee-per-use, a decrease in the total number of international
shipments can correspondingly result in a significant fluctuation
in revenues. The decrease in total revenues from prior periods
was primarily the result of fewer AutoPap product sales in 1999
compared to 1998. In the second quarter of 1998 NeoPath's sale
transactions included four AutoPap Systems in Taiwan; this
contrasts with one international system sale in the second quarter
of 1999. In addition to the Taiwan sales in 1998, Neopath also
recognized a greater number of unit sales to certain other
international and domestic customers in the six months ended June
30, 1998 in comparison to the six months ended June 30, 1999.
NeoPath anticipates that future periods will include product
sales; however, revenue trends are subject to actual product
placements, which have been difficult to project.
NeoPath's AutoPap technology is available internationally
at commercial laboratories in Taiwan, Japan, China (Hong Kong),
Korea, Australia, and in Europe. The Company's international
product placements have primarily been denominated in U.S.
dollars in the past; however, future product revenues may be
subject to foreign exchange rate fluctuations. Payment for the
AutoPap System sold internationally during the second quarter of
1999 is due NeoPath in EUROS and is therefore subject to
exchange rate fluctuations until paid.
<TABLE>
<CAPTION>
Percentage of Percentage of
(in thousands) June 30, 1999 Revenues June 30, 1998 Revenues
____________________________________________________________________________________________
<S> <C> <C> <C> <C>
Cost of revenues:
Three months ended $1,588 54% $2,372 55%
Six months ended $2,752 55% $4,413 56%
Gross margin:
Three months ended $1,351 46% $1,937 45%
Six months ended $2,213 45% $3,459 44%
</TABLE>
The primary components of fee-per-use cost of revenues
include depreciation and allocated service and support costs.
For AutoPap Systems sold, cost of revenues includes the related
manufacturing cost and estimated one-year warranty expense.
Primary screening systems are expected to process a greater
number of slides, on average, than the prior installed base of
AutoPap QCs, which is expected to improve the fee-per-use gross
margin percentage over time.
The gross margin in the three and six months ended June 30,
1999 included the effect of lower margins on fee-per-use systems
that were processing slides below the systems' capacity. Margins
are expected to increase in the future as NeoPath works with its
customers to optimize system utilization.
Page 9
<PAGE>
(in thousands) June 30, 1999 Change June 30, 1998
____________________________________________________________________________
Research and development:
Three months ended $2,362 $(549) $2,911
(19%)
Six months ended $4,780 $(1,177) $5,957
(20%)
Research and development expenses include:
- - salaries and benefits of scientific, engineering, and regulatory personnel;
- - costs relating to clinical studies and submission of applications to the FDA;
- - testing equipment;
- - components used in prototypes;
- - relevant consulting services; and
- - the costs of preparing and filing applications for patent protection of
NeoPath technologies.
NeoPath incurred lower research and development costs in the
three and six-month periods ended June 30, 1999, compared to the
same periods in 1998, due primarily to decreased net development
costs on other AutoPap applications, elimination of Pathfinder
development expenses, and lower patent filing expenditures.
These reductions were offset by increases in expenses related to
NeoPath's clinical study to support AutoPap processing of
AutoCyte's PREP Pap smear as well as $275,000 in severance-
related expenses resulting from a 1/3 reduction of NeoPath's
overall work force on June 7, 1999.
(in thousands) June 30, 1999 Change June 30, 1998
______________________________________________________________________
Selling, general
and administrative:
Three months ended $2,632 $(2,698) $5,330
(51%)
Six months ended $6,190 $(3,646) $9,836
(37%)
Selling, general and administrative expenses include:
- - salaries and benefits of sales, marketing, administrative, and financial
personnel;
- - non-patent application legal expenses;
- - amortization of intangible assets; and
- - certain facility-related costs.
NeoPath has reduced its overall spending rate significantly
over the past several quarters and continues to carefully focus
corporate spending. The decrease in the first six months of 1999
compared to the same period in 1998 is due primarily to these
cost reduction efforts and reduced sales and marketing
expenditures. Decreased expenses also reflect lower required
legal expenses as a result of the expected resolution of
outstanding law suits, and the elimination of Pathfinder-related
administrative expenses (including amortization) following
NeoPath's decision to write-off Pathfinder intangible assets in
the fourth quarter of 1998.
Decreased expenditures were offset by expenses incurred in the
second quarter of 1999 of approximately $500,000 related to
NeoPath's announced merger with AutoCyte, Inc. and $75,000 in
severance-related expenses resulting from a 1/3 reduction of
NeoPath's overall work force on June 7, 1999.
Page 10
<PAGE>
(in thousands) June 30, 1999 Change June 30, 1998
_____________________________________________________________________
Interest income:
Three months ended $164 $(103) $267
(39%)
Six months ended $301 $(332) $633
(52%)
The decrease in interest income in 1999 is due to decreased
cash equivalents and securities available-for-sale resulting from
NeoPath's negative operating cash flow.
(in thousands) June 30, 1999 Change June 30, 1998
____________________________________________________________________
Interest expense:
Three months ended $(71) $(56) $(15)
364%
Six months ended $(161) $(136) $(25)
555%
The increase in interest expense in 1999 is due to NeoPath's
initial draw-down of its debt facility in June 1998.
Liquidity and Capital Resources
As of June 30, 1999, NeoPath had $9.9 million in cash, cash
equivalents, and securities available-for-sale, compared to $9.0
million as of December 31, 1998. The increase was a result of a
$14.5 million private equity transaction completed in February
1999, offset by cash used during the six months ended June 30,
1999 for operating activities. As a result of the equity
transaction, NeoPath issued 2.9 million shares of common stock to
existing institutional NeoPath investors at a price of $5.00 per
share. On February 12, 1999, NeoPath filed a shelf registration
statement on Form S-3 that will, when declared effective by the
Securities and Exchange Commission, allow resale of the newly
issued shares. NeoPath must use its best efforts to keep this
registration statement effective for two years. The private
equity transaction agreement specified that the purchase price
would be reduced by 2 percent if the registration statement was
not declared effective within 120 days of the transaction closing.
As a result, NeoPath recognized a liability of $290,000 as of
June 30, 1999.
NeoPath's cash used in operating activities was $12.1
million in the six months ended June 30, 1999, compared to $12.5
million in the six months ended June 30, 1998. NeoPath expended
cash for property and equipment, excluding AutoPap Systems
reclassified to either fee-per-use systems or reclassified to
property and equipment, of $59,000 in the six months ended June
30, 1999, compared to $531,000 in the six months ended June 30,
1998.
NeoPath has a debt facility with Silicon Valley Bank with
$2.5 million remaining outstanding as of the end of the second
quarter. The bank facility's interest rate was 8.75 percent as
of June 30, 1999, and the facility is secured by $2.0 million
in restricted cash in an interest-bearing account with the
bank. The restricted cash is included in cash and cash
equivalents on the balance sheet. The remaining debt is due
monthly through June 2000. The Company is required to maintain
certain financial covenants, including minimum liquidity
coverage, minimum tangible net worth, and minimum debt-to-
tangible-net-worth figures. NeoPath complied with all
financial covenants as of June 30, 1999. The bank debt is
secured by substantially all of NeoPath's assets, excluding
intellectual property.
Page 11
<PAGE>
NeoPath estimates that existing cash and cash equivalents
will meet its capital requirements through 1999. In the year
2000, the Company expects that cash requirement will depend
primarily on the placement rate and pricing of fee-per-use
AutoPap Screeners. Fee-per-use placements require NeoPath to
invest in initial manufacturing costs to achieve long-term return
through monthly customer payments. The Company cannot guarantee
that the assumptions underlying these estimates will prove to be
accurate.
NeoPath's future capital requirements will depend on numerous
factors, including:
- - sales of AutoPap Screeners and fee-per-use revenues;
- - completion of the announced merger with AutoCyte, and related expenses;
- - research and development programs for the development of enhanced products;
- - additional clinical trials;
- - relationships with existing and future corporate collaborators, if any;
- - competing technological and market developments;
- - the time and costs involved in obtaining regulatory approvals;
- - the costs involved in filing, prosecuting, defending and enforcing patent
claims; and
- - the time and costs of manufacturing scale-up and commercialization
activities.
NeoPath may require additional funds to produce AutoPap
Systems for its fee-per-use program and cover continuing losses.
The Company may be unable to obtain adequate funds, whether
obtained through financial markets or from collaborative or other
arrangements with corporate partners or other sources, when the
funds are needed, or NeoPath may be unable to find adequate
funding on favorable terms, if at all. NeoPath intends to seek
additional funding through private debt financing to provide
additional resources to support AutoPap Primary Screener
production, but the Company may be unable to do so. To date,
NeoPath has had discussions with various potential lenders. A
lender's collateral would be based primarily on AutoPap Systems
placed on multi-year fee-per-use contracts. SmithKline Beecham
Clinical Laboratories is NeoPath's largest customer; therefore,
the February 1999 announcement that Quest Diagnostics
Incorporated agreed to purchase SmithKline may delay NeoPath's
ability to obtain debt financing.
If NeoPath raises additional funds by issuing equity
securities, existing shareholders will suffer dilution of their
interest in NeoPath. In addition, if NeoPath obtains additional
funds through arrangements with collaborative partners, the
Company may have to relinquish rights to certain of technologies
or potential products that NeoPath would otherwise seek to
develop or commercialize itself.
Impact of Year 2000
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 NeoPath'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 assessments made in 1998, NeoPath determined that
it would 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, NeoPath has completed its
assessment of all internal and product systems that could be
significantly affected by the Year 2000 issue. The assessment
indicated that certain of NeoPath'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. NeoPath presently believes that
with modifications or replacements of existing software and
certain hardware, the Year 2000 issue as it relates to
NeoPath'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, NeoPath has gathered
information about the Year 2000 compliance status of its
significant suppliers and subcontractors and continues to
monitor their compliance.
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<PAGE>
NeoPath uses 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 has
been borne primarily by operating departments with existing
personnel and infrastructure; therefore, incremental costs have
not been material and remaining incremental costs are estimated
at less than $100,000. A significant portion of the project is
complete, and NeoPath expects the remaining items to be completed
during the third quarter.
NeoPath has asked its significant suppliers and
subcontractors about their Year 2000 compliance status.
NeoPath is not aware of any external agent with Year 2000
problems that are likely to materially impact NeoPath's results
of operations, liquidity, or capital resources. However,
NeoPath cannot ensure that its external agents will be Year
2000 ready. NeoPath's business could be affected if external
agents do not complete their Year 2000 resolution process in a
timely fashion. NeoPath cannot determine the effect of non-
compliance by external agents.
NeoPath currently has no contingency plans in place in the
event it does not complete all phases of the Year 2000 program,
including if its external agents are not Year 2000 ready.
NeoPath evaluated its status during the second quarter of 1999
and determined that no contingency 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. NeoPath believes that with modifications to its
products, existing internal software and conversions to new
software, the Year 2000 Issue will not pose significant
operational problems for its computer systems. However, in the
worst case scenario, if NeoPath 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.
Page 13
<PAGE>
Forward-Looking Statements
The preceding Management's Discussion and Analysis of
Financial Condition and Results of Operations contains "forward-
looking statements" which reflect NeoPath'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. NeoPath 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:
- history of losses and uncertainty of profitable operations;
- potential need for additional capital;
- uncertainty of market acceptance of NeoPath's products;
- market consolidation and concentration among a few large customers;
- uncertainty of product regulatory clearance;
- sole or limited source of supply for key components;
- governmental regulation of NeoPath's manufacturing;
- competition in the industry;
- dependence on third-party reimbursement;
- dependence on a single product line;
- product liability and availability of adequate insurance;
- dependence on patents and proprietary rights;
- risk of third-party claims of infringement;
- dependence on key personnel;
- highly volatile stock price;
- potential fluctuations in future quarterly results; and
- Year 2000 issues.
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, 1998 as well as other documents filed with the
Securities and Exchange Commission.
Page 14
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk related to changes
in interest rates, which could adversely affect the value of
the Company's investments in securities available-for-sale or
increase the interest expense on outstanding debt. The Company
does not use derivative financial instruments.
NeoPath maintains a short-term investment portfolio
consisting of interest bearing securities with an average
maturity of less than two years. These securities are
classified as "available-for-sale" securities. The interest
bearing securities are subject to interest rate risk and will
fall in value if market interest rates increase. If market
interest rates were to increase immediately and uniformly by
10% from levels at June 30, 1999, the fair value of the
portfolio would decline by an immaterial amount.
In a like manner, a 10% increase in market interest rates
would have an immaterial effect on the Company's long-term
obligations. The Company does not expect its operating results
or cash flows to be affected to any significant degree by a
sudden change in market interest rates.
Page 15
<PAGE>
Part II OTHER INFORMATION
Item 1. Legal Proceedings
On July 15, 1996, Neuromedical Systems, Inc. filed a lawsuit
against NeoPath 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 and requested monetary damages and injunctive relief. On
September 5, 1996, NeoPath 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 the Company. The parties 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.
Virtually all of NeoPath's domestic revenues, which represented
90 percent of total revenues in the six months ended June 30,
1999, are derived from products that incorporate technology
covered by this patent. NeoPath believes it has a strong
position in this action, and will defend itself vigorously
against these claims. On March 26, 1999, Neuromedical announced
that it had filed a voluntary chapter 11 petition for bankruptcy.
On April 6, 1999, the court removed the case from its active
docket pending further developments in Neuromedical's bankruptcy
proceedings.
On March 31, 1997, NeoPath 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 the court denied in April 1998. In October 1998,
Neuromedical filed another motion for summary judgment that the
court denied. By court order on March 30, 1999, proceedings
have been stayed pending resolution of Neuromedical's bankruptcy
proceedings. Furthermore, the court ordered that these cases be
removed from the court's active caseload.
NeoPath's intellectual property acquisition agreement with
AutoCyte provides that the patent infringement litigation between
NeoPath and Neuromedical will be terminated.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits required by Item 601 of Regulation S-K:
Exhibit No. Description
___________ ___________
2.1 Agreement and Plan of Merger among AutoCyte,
Inc., Trilogy Acquisition Corporation and
NeoPath, Inc. dated as of June 4, 1999 (filed
as Exhibit 2.1 to the registrant's Current
Report on Form 8-K dated June 23, 1999 and
incorporated herein by reference)
27 Financial Data Schedule
__________________________________________________________________
(b) Reports on Form 8-K
The Company filed a Form 8-K on June 23, 1999 to disclose
a merger in which a wholly owned subsidiary of AutoCyte, Inc.
will merge with NeoPath, and NeoPath will become a wholly owned
subsidiary of AutoCyte. On the effective date of the merger,
each issued and outstanding share of NeoPath common stock will
automatically convert into the right to receive 0.7903 shares
of AutoCyte common stock.
Page 16
<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: August 9, 1999 By: /s/ RONALD R. BROMFIELD
_______________________
Ronald R. Bromfield
President and Chief Executive Officer
By: /s/ ROBERT C.BATEMAN
____________________
Robert C. Bateman
Vice President and Chief Financial Officer
Page 17
<PAGE>
NEOPATH, INC.
INDEX TO EXHIBITS
Exhibit No. Description
___________ ___________
2.1 Agreement and Plan of Merger among AutoCyte,
Inc., Trilogy Acquisition Corporation and
NeoPath, Inc. dated as of June 4, 1999 (filed
as Exhibit 2.1 to the registrant's Current
Report on Form 8-K dated June 23, 1999 and
incorporated herein by reference)
27 Financial Data Schedule
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Form
10-Q as of June 30, 1999 and for the six months then ended, and is qualified in
its entirety by reference to such financial statements and footnotes.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 6,320,707
<SECURITIES> 3,589,939
<RECEIVABLES> 3,017,776
<ALLOWANCES> 0
<INVENTORY> 8,912,247
<CURRENT-ASSETS> 22,262,336
<PP&E> 2,543,302
<DEPRECIATION> 0
<TOTAL-ASSETS> 40,696,332
<CURRENT-LIABILITIES> 6,774,306
<BONDS> 0
0
0
<COMMON> 156,329,799
<OTHER-SE> (122,439,028)
<TOTAL-LIABILITY-AND-EQUITY> 40,696,332
<SALES> 0
<TOTAL-REVENUES> 4,965,287
<CGS> 0
<TOTAL-COSTS> 2,752,375
<OTHER-EXPENSES> 10,970,505
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 160,888
<INCOME-PRETAX> (8,617,520)
<INCOME-TAX> 0
<INCOME-CONTINUING> (8,617,520)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,617,520)
<EPS-BASIC> (0.51)<F1>
<EPS-DILUTED> 0.00
<FN>
<F1>Basic and diluted net loss per share are the same amount.
</FN>
</TABLE>
