<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1996
------------------------------------------------
[ ] TRANSFER REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------------------ ----------------------
Commission File Number: 0-21982
--------------------------------------------------------
Diametrics Medical, Inc.
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Minnesota 41-1663185
- -------------------------------------------------------------------------------
(State or other jurisdiction of (IRS employer ID No.)
incorporation or organization)
2658 Patton Road, Roseville, 55113
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
612-639-8035
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- -------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports 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.
[X] Yes [ ] NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practical date.
Common Stock, $.01 Par Value 14,953,702
------------------------------ -----------------------------------
(Class) (Outstanding at March 31, 1996)
1
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DIAMETRICS MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Condensed Financial Statements:
Condensed Balance Sheets as of March 31, 1996
(Unaudited) and December 31, 1995 3
Condensed Statements of Operations
(Unaudited) for the three months ended
March 31, 1996 and 1995 4
Condensed Statements of Cash Flows
(Unaudited) for the three months ended
March 31, 1996 and 1995 5
Notes to Condensed Financial
Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 10
PART II. OTHER INFORMATION
-----------------
Item 6. Exhibits and Reports on Form 8-K 12
SIGNATURES 13
----------
2
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DIAMETRICS MEDICAL, INC.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1996 1995
----------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,679,425 $ 2,702,232
Marketable securities 18,931,621 25,789,265
Accounts receivable:
Trade, net 559,364 562,409
Nontrade 371,632 400,639
Inventories 2,361,203 1,114,332
Prepaid expenses and other current assets 132,577 128,374
----------- -----------
Total current assets 25,035,822 30,697,251
Property and equipment 10,947,627 10,840,323
Less accumulated depreciation and amortization (5,600,156) (5,000,597)
----------- -----------
5,347,471 5,839,726
----------- -----------
Other assets 124,799 82,624
----------- -----------
$30,508,092 $36,619,601
=========== ===========
LIABILITIES AND COMMON SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 806,565 $ 1,554,573
Accrued expenses 1,113,947 847,544
Short-term note payable 11,152 44,608
Capital lease obligations, current portion 1,064,814 1,056,130
Deferred gain on sale/leaseback, current portion 71,045 71,045
----------- -----------
Total current liabilities 3,067,523 3,573,900
Long-term liabilities:
Capital lease obligations, excluding current portion 1,617,902 1,803,982
Deferred gain on sale/leaseback, excluding current portion 29,609 47,369
----------- -----------
Total liabilities 4,715,034 5,425,251
----------- -----------
Common shareholders' equity:
Common stock, 01 par value: $.01 par value: 20,000,000 authorized 14,953,702
and 14,900,141 shares issued and outstanding 149,537 149,001
Additional paid-in capital 87,635,574 87,489,392
Accumulated deficit (61,992,053) (56,444,043)
----------- -----------
Total common shareholders' equity 25,793,058 31,194,350
----------- -----------
$30,508,092 $36,619,601
=========== ===========
</TABLE>
3
<PAGE>
DIAMETRICS MEDICAL, INC.
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended
March 31, March 31,
1996 1995
----------- -----------
(unaudited) (unaudited)
<S> <C> <C>
Net sales $ 609,571 $ 332,767
Cost of sales 2,296,297 1,989,032
----------- -----------
Gross profit (loss) (1,686,726) (1,656,265)
----------- -----------
Operating expenses:
Research and development 1,527,482 1,371,706
General and administrative 925,975 673,477
Sales and marketing 1,603,134 1,188,497
----------- -----------
Total operating expenses 4,056,591 3,233,680
----------- -----------
Operating loss (5,743,317) (4,889,945)
Other income (expense), net 195,307 (1,324)
----------- -----------
Net loss $(5,548,010) $(4,891,269)
=========== ===========
Net loss per common share (unaudited) $ (0.37) $ (0.45)
=========== ===========
Weighted average number of
common shares outstanding (unaudited) 14,912,859 10,779,468
=========== ===========
</TABLE>
4
<PAGE>
DIAMETRICS MEDICAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
March 31, March 31,
1996 1995
----------- -----------
(unaudited) (unaudited)
<S> <C> <C>
Cash flow from operating activities:
Net loss $(5,548,010) $ (4,891,269)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 666,323 595,699
(Gain)/loss on disposal of property and equipment (1,686) 17,977
Change in operating assets and liabilities:
Trade receivables, net 3,045 (153,722)
Nontrade receivables 29,007 10,117
Inventories (1,246,871) (92,969)
Prepaid expenses and other current assets (4,203) 58,856
Accounts payable (748,008) (259,038)
Accrued lawsuit settlement - 14,100
Accrued expenses 266,403 241,291
----------- ------------
Net cash used in operating activities (6,584,000) (4,458,958)
Cash flow from investing activities:
Purchases of property and equipment (190,142) (910,154)
Proceeds from sales of property and equipment 102,586 671,136
Purchases of marketable securities (3,967,356) (11,708,783)
Proceeds from maturities of marketable securities 10,825,000 8,604,000
Other assets (42,175) 192,446
----------- ------------
Net cash used in investing activities 6,727,913 (3,151,355)
Cash flow from financing activities:
Principal payments on short-term note payable (33,456) (36,960)
Net proceeds from issuance of common stock 146,718 8,658,844
Payments for redeemable common stock - (1,000,000)
Principal payments on capital lease obligations (279,982) (224,370)
----------- -----------
Net cash provided by financing activities (166,720) 7,397,514
----------- -----------
Net (decrease) increase in cash
and cash equivalents (22,807) (212,799)
Cash and cash equivalents at beginning of period 2,702,232 1,149,311
----------- ------------
Cash and cash equivalents at end of period $ 2,679,425 $ 936,512
=========== ============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 139,607 $ 107,006
=========== ============
</TABLE>
Supplemental disclosure of noncash investing and financing activites:
The Company entered into capital lease obligations for equipment of $102,586 and
$669,186 for the three months ended March 31, 1996 and 1995, respectively.
5
<PAGE>
DIAMETRICS MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
MARCH 31, 1996
(UNAUDITED)
NOTE 1 - UNAUDITED FINANCIAL STATEMENTS
- ---------------------------------------
The accompanying unaudited financial statements of Diametrics Medical, Inc. (the
Company), a Minnesota corporation, have been prepared by the Company in
accordance with generally accepted accounting principles for interim financial
information, pursuant to the rules and regulations of the Securities and
Exchange Commission. Pursuant to such rules and regulations, certain financial
information and footnote disclosures normally included in the financial
statements have been condensed or omitted. The results for the periods indicated
are unaudited, but reflect all adjustments (consisting only of normal recurring
adjustments) which management considers necessary for a fair presentation of
operating results.
Results of operations for the interim periods are not necessarily indicative of
a full year of operations.
NOTE 2 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- -------------------------------------------------------------------------------
DESCRIPTION OF THE BUSINESS
Diametrics Medical, Inc. (the Company), a medical device company,
was incorporated in the state of Minnesota on January 26, 1990, and
commenced operation in June 1990. The Company develops, manufactures
and markets a proprietary in vitro blood chemistry testing system
that provides immediate diagnostic results at the point of patient
care. The Company emerged from development stage in the third
quarter of 1994.
LIQUIDITY
The Company has incurred net operating losses since inception and
has had limited revenue-producing activities. The Company's current
operating plan will require the Company to raise additional capital
by mid-1997. Management's intentions are to raise the capital
through an alliance with a strategic corporate partner, issuance of
debt, or an equity offering. There can be no assurance that adequate
funds will be available when needed or on acceptable terms.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include U.S. government money market
funds. For purposes of the statements of cash flows, the Company
considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents.
6
<PAGE>
MARKETABLE SECURITIES
In accordance with the provisions of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," marketable debt and equity securities
have been classified as held-to-maturity and are stated at amortized
cost, which approximates estimated fair value. Securities held by
the Company include U.S. government, Federal Agency obligations,
certificates of deposit and high grade commercial debt securities.
These securities are classified as held-to-maturity because of the
Company's positive intent and ability hold its investments to
maturity.
INVENTORIES
Inventories are stated at the lower of cost or market using the
first in, first out method, with write-offs taken on IRMA disposable
cartridges at the time shelf life falls below the number of days
deemed acceptable for shipment to customers.
PROPERTY AND EQUIPMENT
Furniture, equipment and leasehold improvements are recorded at
cost. Depreciation is calculated on a straight-line basis over the
estimated useful lives of the assets. Amortization is calculated on
a straight-line basis over the life of the lease.
REVENUE RECOGNITION
The Company recognizes revenue at the later of point of shipment or
final acceptance of trial instruments.
NET LOSS PER COMMON SHARE
Net loss per common share is computed based upon the weighted
average number of common shares outstanding.
PRODUCT WARRANTY
The Company, in general, warrants the IRMA/R/ Analyzer and Battery
Charger to be free from defects in material and workmanship under
normal use and service for a period of one year after date of
shipment, and warrants IRMA Cartridges to be free from defect in
material and workmanship under normal use until their stated
expiration date. Provisions are made for the estimated cost of
maintaining product warranties for the IRMA Analyzer System and for
the IRMA disposable cartridges at the time the products are sold.
7
<PAGE>
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income
in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized as income in the
period that includes the enactment date.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS
For 1996, the Company is required to adopt Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and
SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No.
121 is not expected to result in recognition of a cumulative effect
of a change in accounting principle by the Company. SFAS No. 123
prescribes accounting and reporting standards for all stock-based
compensation plans. Since the Company intends to elect continued
recognition of certain stock-based compensation using the intrinsic
value method prescribed under Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees, no effect on the
Company's expense recognition is expected. However, extensive new
disclosures will be required in notes to consolidated financial
statements.
NOTE 3 - INVENTORIES
- --------------------
Inventories consist of the following:
<TABLE>
<CAPTION>
March 31, 1996 December 31, 1995
-------------- -----------------
<S> <C> <C>
Raw materials $1,940,455 $ 782,287
Work-in-process 266,829 238,930
Finished goods 153,919 93,115
------------------------------------------
$2,361,203 $1,114,332
==========================================
</TABLE>
8
<PAGE>
NOTE 4 - SHAREHOLDERS EQUITY
- ----------------------------
On March 31, 1995, pursuant to a settlement agreement entered into between the
Company and PPG Industries in March 1994, PPG exercised its right to put 100,000
shares of Common Stock at $10 per share.
In February 1995, the Company completed the private placement of 1,754,635
shares of Common Stock at $5.50 per share, resulting in net proceeds to the
Company of approximately $8,600,000, net of offering costs of approximately
$1,000,000.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
- -------------
This Management's Discussion and Analysis contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 (the
"Act"). Refer to Exhibit 99 of this Form 10-Q for certain important cautionary
factors, risks and uncertainties related to forward-looking statements.
SUMMARY
- -------
Diametrics Medical, Inc. (the Company), which began operations in 1990, is
engaged in the development, manufacturing and marketing of a proprietary blood
analysis system that utilizes disposable test cartridges to provide immediate
results a the point-of-patient care. The Company's efforts have focused on
comercialization of the IRMA (Immediate Response Mobile Analysis) System as a
blood chemistry testing device for the hospital market.
The Company markets its products primarily to health care organizations in the
United States through a direct sales force and outside the United States using
various distributors. The Company continues to see growing strength in the
overseas market as international revenues comprised approximately 39% of total
first quarter revenues compared to 33% of fourth quarter 1995 revenues
As of March 31, 1996, the primary funding for the operations of the Company has
been approximately $87,400,000 raised through public and private sales of its
equity securities and the issuance of convertible promissory notes, all of which
have been repaid or were converted into Common Stock.
RESULTS OF OPERATIONS
- ---------------------
SALES Sales of the Company's IRMA System were $609,571 for the three months
ended March 31, 1996, compared to $332,767 for the same period last year. The
Company's revenues are affected principally by the number of IRMA Systems placed
in hospitals and other locations and the rate at which IRMA cartridges are used
at these locations. As of March 31, 1996, the Company had 555 IRMA System
placements compared to 451 placements at December 31, 1995.
COST OF SALES The Company incurred manufacturing costs associated with product
sales of $2,296,297 for the three months ended March 31, 1996, compared to
$1,989,032 for the same period in the prior year. This resulted in a negative
gross profit because sales volume was not sufficient to absorb labor and
overhead costs. To the extent that sales volume increases, the Company expects
its gross profit to improve as manufacturing costs (including direct labor and
manufacturing overhead costs) will be spread over a larger number of production
units.
OPERATING EXPENSES Research and development expenditures were $1,527,482 for
the three months ended March 31, 1996 compared to $1,371,706 for the same period
in the prior year. The increase from the prior period reflects increased
expenses associated with the continued expansion of the test menu for the IRMA
System and development of the Company's next generation system, IRMA II. In
addition, the Compnay continued to invest in product and process improvements
designed to improve product performance and reduce production costs.
General and administrative expenses totaled $925,975 for the three months ended
March 31, 1996, compared to $673,477 for the same period in the prior year.
The increase from the prior period reflects the reclassification of certain
corporate support functions to general and administrative.
10
<PAGE>
Sales and marketing expenses totaled $1,603,134 for the three months ended March
31, 1996, compared to $1,188,497 for the same period in the prior year. The
period-to-period increase reflects expansion of the direct sales force, addition
of marketing personnel, and increased advertising and promotional activities. As
of March 31, 1996, the Company had twenty-one direct sales representitives,
three regional managers and three clinical specialists.
OTHER INCOME (EXPENSE) Net other income was $195,307 for the three months ended
March 31, 1996 compared to a net expense of $1,324 for the same period in the
prior year. The Company realized interest income of $362,986 for the three
months ended March 31, 1996, compared to $177,541 for the same period in the
prior year. The period-to-period increase reflects higher average cash balances
resulting from the Company's financing activities. Interest expense totaled
$139,607 for the three months ended March 31, 1996, compared to $121,106 for the
same period in the prior year. The period-to-period increase reflects increased
lease financing during 1996 and 1995.
NET LOSS Net loss for the three months ended March 31, 1996 was $5,548,010
compared to $4,891,269 for the same period in the prior year. The increase in
net loss from the prior period reflects the Company's increased investments in
sales and marketing, and development of the next-generation IRMA.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
At March 31, 1996, the Company had working capital of approximately $21,968,299,
a decrease of $5,155,052 from the working capital reported at December 31, 1995.
This decrease is primarily the result of the net loss for the quarter. The
Company has financed its operations to date primarily through the public and
private sales of its equity securities, the issuance of convertible promissory
notes and equipment financing arrangements.
At March 31, 1996, the Company had property and equipment of $10,947,627 less
accumulated depreciation of $5,600,156 to support its development, manufacturing
and administrative activities. The Company financed approximately $5,050,000
million through capital lease obligations, including $100,000 financed during
1996.
At March 31, 1996, the Company had net operating loss and research and
development tax credit carry forwards for income tax purposes of approximately
$58,846,000 and $701,000 respectively. Pursuant to the Tax Reform Act of 1986,
use of the Company's net operating loss carry forwards may be limited if a
cumulative "change in ownership" of more than 50 percent occurs within any three
year period. In connection with prior sales by the Company of its securities, in
public and private offerings, the Company has experienced a "change of
ownership." As a result, the utilization of the Company's net operating loss and
certain credit carry forwards incurred prior to these changes are subject to
annual limitations.
The Company has incurred net operating losses since inception and has had
limited revenue-producing activities. The Company's current operating plan will
require the Company to raise additional capital by mid-1997. Management's
intentions are to raise the capital through an alliance with a strategic
corporate partner, issuance of debt, or an equity offering. There can be no
assurance that adequate funds will be available when needed or on acceptable
terms.
11
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
a. Exhibits
27 Financial Data Schedule
99 Cautionary Statements Under Private Securities Litigation Reform
Act of 1995.
b. Reports on Form 8-K
None
12
<PAGE>
DIAMETRICS MEDICAL, INC.
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.
Date: May 3, 1996
DIAMETRICS MEDICAL, INC.
By: /s/ David T. Giddings
------------------------------
David T. Giddings
Chief Executive Officer
By: /s/ Dennis J. McFadden
--------------------------------------------
Dennis J. McFadden
Chief Financial Officer
13
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 2,679,425
<SECURITIES> 18,931,621
<RECEIVABLES> 1,014,996
<ALLOWANCES> 84,000
<INVENTORY> 2,361,203
<CURRENT-ASSETS> 25,035,822
<PP&E> 10,947,627
<DEPRECIATION> 5,600,156
<TOTAL-ASSETS> 30,508,092
<CURRENT-LIABILITIES> 3,067,523
<BONDS> 0
<COMMON> 149,537
0
0
<OTHER-SE> 25,643,521
<TOTAL-LIABILITY-AND-EQUITY> 30,508,092
<SALES> 609,571
<TOTAL-REVENUES> 609,571
<CGS> 2,296,297
<TOTAL-COSTS> 6,352,888
<OTHER-EXPENSES> 26,634
<LOSS-PROVISION> 3,124
<INTEREST-EXPENSE> 139,607
<INCOME-PRETAX> (5,548,010)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,548,010)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,548,010)
<EPS-PRIMARY> (0.37)
<EPS-DILUTED> 0
</TABLE>
<PAGE>
Exhibit 99
Cautionary Factors Under the
Private Securities Litigation Reform Act
Diametrics Medical, Inc. desires to take advantage of the new "safe harbor"
provisions contained in the Private Securities Litigation Reform Act of 1995
(the "Act"). Contained in this Form 10-Q are statements which are intended as
"forward-looking statements" within the meaning of the Act. The words or phrases
"expects," "will continue," "is anticipated," "managements believes,"
"estimate," "projects," "hope" or expressions of a similar nature denote
forward-looking statements. Those statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from
historical results or from those results presently anticipated or projected. The
Company wishes to caution readers not to place undue reliance on forward-looking
statements. Readers should also be advised that the factors listed below have
affected the Company's performance in the past and could affect future
performance. Those factors include, but are not limited to, the lack of, or slow
rate of, market acceptance of the Company's products; the impact of competitors'
products and pricing; the effect of changes in customer demands; the risk that
there will be technical difficulties in production; the inability of the Company
to attract and retain skilled employees in the product development and
manufacturing areas.
Other factors include the following:
EARLY STAGE OF COMMERCIALIZATION; LIMITED RELEVANT OPERATING HISTORY
The Company was founded in 1990 and until recently has been engaged
primarily in the research, development and testing of, and the development of
manufacturing capabilities for, the IRMA System. The Company began marketing
the IRMA System on a national basis in the third quarter of 1994 and on an
international basis in 1995. There is no assurance that the Company will be
successful in transitioning to commercial operations, including commercial-scale
manufacturing. Additionally, the Company has a limited operating history upon
which an evaluation of its prospects can be made. Such prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered in establishing a new business in the evolving, heavily-regulated
medical device industry, which is characterized by an increasing number of
entrants, intense competition and a high failure rate.
ABSENCE OF PROFITABILITY; ANTICIPATED FUTURE LOSSES
The Company has only recently begun to generate revenues from sales of the
IRMA System and has incurred net operating losses since its inception. Net
losses for the years ended December 31, 1993, 1994 and 1995 and the three months
ended March 31, 1996 were approximately $13,819,000, $12,455,000, $23,046,000
and
<PAGE>
$5,548,000, respectively. The Company had an accumulated deficit of
approximately $61,992,000 at March 31, 1996. The Company expects to incur
substantial net operating losses at least through 1997. There is no assurance
that the Company will ever generate substantial revenues or achieve
profitability.
NEW TECHNOLOGY; UNCERTAIN MARKET ACCEPTANCE
The Company's success is dependent upon acceptance of the IRMA System by
the medical community as reliable, accurate and cost-effective. Because the IRMA
System is a point-of-care blood testing device, the IRMA System represents a new
practice in the testing of blood analytes. Critical or stat blood testing is
currently performed primarily by central and stat laboratories of hospitals or
by independent commercial laboratories, rather than at the point of care.
Although professional awareness of point-of-care blood testing is increasing,
most acute care hospitals have already installed costly benchtop blood testing
instruments for use in their central and stat laboratories and may be reluctant
to change standard operating procedures for performing blood testing or incur
additional capital expenditures for new blood analysis equipment. In addition,
the limited number of tests that can be performed on the IRMA System may cause
certain hospitals not to consider the IRMA System. The Company is unable to
predict how quickly, if at all, the IRMA System will be accepted by members of
the medical community or, if accepted, the number of tests that will be
performed using the IRMA System. Therefore, the Company is unable to provide any
assurance as to sales volume of the IRMA Analyzer or the related sales volume of
IRMA cartridges.
FUTURE ADDITIONAL CAPITAL REQUIREMENTS
The Company expects that its existing capital resources, current and future
lease financing arrangements and strategic alliances will enable the Company to
maintain its current and planned operations through mid 1997. Nonetheless, the
Company's capital requirements depend on numerous factors, including the rate of
market acceptance of the Company's products, the level of resources devoted to
expanding the Company's marketing organization and manufacturing capabilities,
the Company's research and development activities, the availability of lease
financing for capital acquisitions and other factors. The timing and amount of
such capital requirements cannot accurately be predicted. If capital
requirements vary materially from those currently planned, the Company will
require additional capital at an earlier time. The Company has no commitments
for any additional financing, and no assurance exists that any such commitments
can be obtained on favorable terms, if at all. Any additional equity financings
may be dilutive to shareholders, and debt financing, if available, may involve
restrictive covenants. The Company is also pursuing corporate strategic
alliances. Such alliances may require the Company to relinquish rights to
certain of its technologies, products or marketing territories.
<PAGE>
HIGHLY COMPETITIVE MARKETS; RISK OF TECHNOLOGICAL OBSOLESCENCE
The medical technology industry is characterized by rapidly evolving
technology and intense competition. The Company is aware of one other
commercially available portable point-of-care blood analysis system, which is
manufactured and marketed by i-STAT Corporation ("i-STAT"). The Company expects
that manufacturers of central and stat laboratory testing equipment will also
compete to maintain their revenues and market share. Many of the companies in
the medical technology industry and manufacturers of central and stat laboratory
equipment have substantially greater capital resources, research and development
staffs and facilities than the Company. Such entities have developed, may be
developing or could in the future attempt to develop additional products
competitive with the IRMA System. Many of these companies also have
substantially greater experience than the Company in research and development,
obtaining regulatory approvals, manufacturing and marketing, and may therefore
represent significant competition for the Company. There can be no assurance
that the Company's competitors will not succeed in developing or marketing
technologies and products that are more effective or less expensive than those
developed or marketed by the Company or that would render the Company's
technology and products obsolete or noncompetitive. Although the Company
believes that its products may offer certain technological advantages over its
competitors' currently-marketed products, earlier entrants in the market in a
therapeutic area often obtain and maintain significant market share relative to
later entrants. In the future, the Company may experience competitive pricing
pressures that may adversely affect unit prices and sales levels.
LIMITED MANUFACTURING EXPERIENCE
The Company must manufacture the IRMA System in compliance with regulatory
requirements, in sufficient quantities and on a timely basis, while maintaining
product quality and acceptable manufacturing costs. The IRMA System consists of
two principal components: the portable, microprocessor-based IRMA Analyzer and
the disposable IRMA cartridge. The Company has limited experience producing the
IRMA cartridge for testing blood gases in large commercial quantities, and has
only recently begun to produce the cartridge for testing electrolytes. Although
the Company believes that, based on its manufacturing experience to date, it
will be able to achieve and maintain product accuracy and reliability when
producing IRMA cartridges in the quantities required for profitable operations,
on a timely basis and at an acceptable cost, there can be no assurance that it
will be able to do so. The IRMA Analyzer is manufactured for the Company by an
outside vendor, and there can be no assurance that such vendor will be able to
provide the Company with a sufficient number of IRMA Analyzers to meet the
Company's needs.
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DEPENDENCE ON PATENTS AND PROPRIETARY TECHNOLOGY
The Company's success will depend in part on its ability to obtain patent
protection for products and processes, to preserve its trade secrets and to
operate without infringing the proprietary rights of third parties. The validity
and breadth of claims covered in medical technology patents involves complex
legal and factual questions and, therefore, may be highly uncertain. No
assurance can be given that any patents under pending patent applications or any
future patent applications will be issued, that the scope of any patent
protection will exclude competitors or provide competitive advantages to the
Company, that any of the Company's patents will be held valid if subsequently
challenged or that others will not claim rights in or ownership to the patents
and other proprietary rights held by the Company. Furthermore, there can be no
assurance that others have not developed or will not develop similar products,
duplicate any of the Company's products or, if patents are issued to the
Company, design around such patents. In addition, whether or not the Company's
patents are issued, others may hold or receive patents which contain claims
having a scope that covers products developed by the Company. The Company also
relies upon unpatented trade secrets to protect its proprietary technology, and
no assurance can be given that others will not independently develop or
otherwise acquire substantially equivalent techniques or otherwise gain access
to the Company's proprietary technology or disclose such technology or that the
Company can ultimately protect meaningful rights to such unpatented proprietary
technology.
RISK OF PATENT LITIGATION
There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. Litigation, which
could result in substantial cost to and diversion of effort by the Company, may
be necessary to enforce patents issued to the Company, to protect trade secrets
or know-how owned by the Company, to defend the Company against claimed
infringement of the rights of others or to determine the ownership, scope or
validity of the proprietary rights of the Company and others. An adverse
determination in any such litigation could subject the Company to significant
liabilities to third parties, could require the Company to seek licenses from
third parties and could prevent the Company from manufacturing, selling or using
its products, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company is not
currently a party to any patent litigation.
DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL
The success of the Company and of its business strategy is dependent in
large part on the ability of the Company to attract and retain key management
and operating personnel. Such individuals are in high demand and are often
subject to competing offers. In particular, the Company's success will depend on
its ability to retain the services of its executive officers. In addition, the
Company will have an
<PAGE>
ongoing need to expand its management personnel and support staff. The loss of
the services of one or more members of the management group or the inability to
hire additional personnel as needed may have an adverse effect on the Company.
UNCERTAINTY OF GOVERNMENT HEALTH CARE POLICY AND FUTURE REIMBURSEMENT
The willingness of hospitals to purchase the IRMA System may depend on the
extent to which hospitals limit capital expenditures due to cost reimbursement
regulations, including regulations promulgated by the Health Care Financing
Administration ("HCFA"), and general uncertainty relating to government health
care policy. In addition, sales volumes and prices of the Company's products in
certain markets will be dependent in part on the level of availability of
reimbursement to hospitals for blood analysis from third-party payors, such as
government and private insurance plans, health maintenance organizations and
preferred provider organizations. There can be no assurance that current
reimbursement amounts, if any, will not be decreased in the future, and that any
such decrease will not reduce the demand for or the price of the Company's
products. Any health care reform measures adopted by the federal government
could adversely affect the price of medical devices in the United States or the
amount of reimbursement available, and consequently could be adverse to the
Company. No prediction can be made as to the outcome of any reform initiatives
or their impact on the Company.
GOVERNMENT REGULATION AND NEW PRODUCT DEVELOPMENT
Human diagnostic products are subject, prior to clearance for marketing, to
rigorous pre-clinical and clinical testing mandated by the United States Food
and Drug Administration (the "FDA") and comparable agencies in other countries
and, to a lesser extent, by state regulatory authorities. The Company has
obtained premarket notification clearances under Section 510(k) ("Section
501(k)") of the Food, Drug and Cosmetic Act (the "FDC Act") to market the IRMA
System to test blood gases, electrolytes and hematocrit in whole blood in
hospital laboratories and at the point of care. A 510(k) clearance is subject to
continual review and later discovery of previously unknown problems may result
in restrictions on the product's marketing or withdrawal of the product from the
market. The Company's long-term business strategy includes development of IRMA
cartridges containing sensors for performing additional blood chemistry tests,
and any such additional tests will be subject to the same regulatory process. No
assurance can be given that the Company will be able to develop such additional
products or uses on a timely basis, if at all, or that the necessary clearances
for such products and uses will be obtained by the Company on a timely basis or
at all, or that the Company will not be subjected to a more extensive prefiling
testing and FDA approval process. The Company also plans to market the IRMA
System in several foreign markets. Requirements pertaining to the IRMA System
vary widely from country to country, ranging from simple product registrations
to detailed submissions such as those required by the FDA. No regulatory
clearances have yet been obtained in any other
<PAGE>
countries and there is no assurance that any will be received. Manufacturing
facilities are also subject to FDA inspection on a periodic basis and the
Company and its contract manufacturers must demonstrate compliance with current
Good Manufacturing Practices ("GMP") promulgated by the FDA. The Company will be
required to expend time, resources and effort in the areas of production and
quality control to ensure full technical compliance. If violations of the
applicable regulations are noted during FDA inspections of the Company's
manufacturing facilities or the manufacturing facilities of its contract
manufacturers, the continued marketing of the Company's products may be
adversely affected.
EFFECT OF CLINICAL LABORATORY IMPROVEMENT ACT OF 1988
The Company's products are affected by the Clinical Laboratory Improvement
Act of 1988 ("CLIA") which is being implemented by the FDA. This law is intended
to assure the quality and reliability of all medical testing in the United
States regardless of where tests are performed. The regulations require
laboratories performing blood chemistry tests to meet specified standards in the
areas of personnel qualification, administration, participation in proficiency
testing, patient test management, quality control, quality assurance and
inspections. The regulations have established three levels of regulatory control
based on test complexity--" "waived," "moderate complexity" and "high
complexity." Although the tests performed by the IRMA System have been
categorized as moderate complexity tests, there can be no assurance that they
will continue to be so categorized. Personnel standards for high complexity
tests are more rigorous than those for moderate complexity tests, requiring that
testing personnel have more education and experience than personnel conducting
moderate complexity tests. Any recategorization of the tests performed by the
Company's IRMA System as high complexity tests could affect the Company's
ability to successfully market the IRMA System. As a result of the CLIA
requirements, hospitals may be discouraged from expanding point-of-care testing
and previously unregulated testing markets, including physician office
laboratories and small volume test sites, and may be dissuaded from initiating,
continuing or expanding patient testing. There can be no assurance that the CLIA
regulations or future administrative interpretations of CLIA or various state
regulations requiring licensed technicians to operate point-of-care devices will
not have a material adverse effect on the Company.
PRODUCT LIABILITY RISK; NO ASSURANCE INSURANCE IS ADEQUATE
The Company faces an inherent business risk of exposure to product
liability claims in the event that the use of its products is alleged to have
resulted in adverse effects to a patient. Although the Company has not
experienced any product liability claims to date, any such claims could have an
adverse impact on the Company. The Company maintains a general insurance policy
which includes coverage for product liability claims. The policy is limited to a
maximum of $1,000,000 per product liability claim and an annual aggregate policy
limit of $2,000,000. There can be no assurance that liability claims will not
exceed the coverage limits of such policy or
<PAGE>
that such insurance will continue to be available on commercially reasonable
terms or at all. Consequently, a product liability claim or other claim with
respect to uninsured liabilities or in excess of insured liabilities could have
a material adverse effect on the Company.
DEPENDENCE ON CONTRACT MANUFACTURERS AND SUPPLIERS
The IRMA Analyzer is manufactured for the Company by a single vendor,
generally from off-the-shelf components. One component of the IRMA Analyzer is
currently supplied by a single source and manufactured to the Company's
specifications. Although the Company believes that it could find alternative
vendors for the IRMA Analyzer (the Company has already switched manufacturing of
the IRMA Analyzer from its original vendor) and for the single-source component
of the IRMA Analyzer, any interruption in supply could have a material adverse
effect on the Company. Materials used in the IRMA cartridges are purchased from
outside suppliers and are readily available from multiple sources. The Company
is developing alternative materials for one of the components of the IRMA
cartridge which it presently obtains from a single source. Although the Company
believes that alternative sources for key components are available, any
interruption in supply of these components could have a material adverse effect
on the Company's ability to manufacture the IRMA cartridges.
CONTROL BY EXISTING SHAREHOLDERS
As of May 1, 1996, directors, executive officers and principal shareholders
of the Company, and certain of their affiliates, owned beneficially
approximately 37% of the Company's outstanding Common Stock. Accordingly, these
shareholders, individually and as a group, may be able to influence the outcome
of shareholder votes, including votes concerning the election of directors,
adopting or amending provisions in the Company's Articles of Incorporation and
Bylaws and approving certain mergers or other similar transactions, such as
sales of substantially all of the Company's assets. Such control by existing
shareholders could have the effect of delaying, deferring or preventing a change
in control of the Company.
POSSIBLE VOLATILITY OF STOCK PRICE IN THE PUBLIC MARKET
The securities markets have from time to time experienced significant price
and volume fluctuations that may be unrelated to the operating performance of
particular companies. The market prices of the common stock of many publicly
traded medical device companies have in the past been, and can in the future be
expected to be, especially volatile. Announcements of technological innovations
or new products by the Company or its competitors, developments or disputes
concerning patents or proprietary rights, regulatory developments and economic
and other external factors, as well as period-to-period fluctuations in the
Company's financial results, may have a significant impact on the market price
of the Common
<PAGE>
Stock. Sales of Common Stock in the public market could adversely affect
prevailing market prices.
POSSIBLE ISSUANCES OF PREFERRED STOCK; ANTI-TAKEOVER EFFECT OF MINNESOTA LAW
The Board of Directors has authority to issue up to 5,000,000 shares of
preferred stock and to fix the rights, preferences, privileges and restrictions,
including voting rights, of those shares without any further vote or action by
the shareholders. The rights of the holders of Common Stock will be subject to,
and may be adversely affected by, the rights of the holders of any preferred
stock that may be issued in the future. The issuance of preferred stock could
have the effect of delaying, deferring or preventing a change in control of the
Company. In addition, certain provisions of Minnesota law applicable to the
Company could have the effect of discouraging certain attempts to acquire the
Company which could deprive the Company's shareholders of opportunities to sell
their shares of Common Stock at prices higher than prevailing market prices.
