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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
________________________________
COMMISSION FILE NUMBER: 0-28420
INTEG INCORPORATED
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(Exact name of registrant as specified in its charter)
Minnesota 41-1670176
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(State of incorporation or organization) (I.R.S. Employer Identification No.)
2800 Patton Road, St. Paul, Minnesota 55113
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(Address of principal executive offices) (ZIP Code)
(612) 639-8816
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(Registrant's telephone number, including area code)
Securities registered pursuant to
Section 12(b) of the Act: None
Securities registered pursuant to
Section 12(g) of the Act: Common Stock, par value $.01 per share
Common Stock purchase rights
Indicate by checkmark 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 [_]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 20, 1998 was approximately $35,703,000 (based on the last
sale price of $4.5625 as reported by The Nasdaq National Market).
As of March 20, 1998, 9,459,519 shares of the registrant's Common Stock, par
value $.01 per share, were issued and outstanding.
Documents Incorporated by Reference: Part III of this Form 10-K incorporates by
reference information from the registrant's Proxy Statement for its 1998 Annual
Meeting of Shareholders (the "Proxy Statement"), a definitive copy of which will
be filed with the Commission within 120 days of December 31, 1997.
Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
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CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. When used in
this Form 10-K and in future filings by the Company with the Securities and
Exchange Commission, in the Company's press releases and in oral statements made
with the approval of an authorized executive officer, the words or phrases
"believes," "anticipates," "expects," "intends," "will likely result,"
"estimates," "projects" or similar expressions are intended to identify such
forward-looking statements, but are not the exclusive means of identifying such
statements. These forward-looking statements involve risks and uncertainties
that may cause the Company's actual results to differ materially from the
results discussed in the forward-looking statements. Factors that might cause
such differences include, but are not limited to, the following: risks
associated with the development of a new technology; dependence on the LifeGuide
System, which is still under development; risks associated with the Company's
ability to successfully develop a commercial product; history of operating
losses and expectation of future losses; requirement of additional capital prior
to full-scale commercial introduction of the LifeGuide System; limited clinical
testing experience; uncertainty of obtaining Food and Drug Administration
clearances; heightened competition; risks associated with the lack of
manufacturing capability and dependence on contract manufacturers and suppliers;
and risks associated with the company's dependence on proprietary technology,
including those related to adequacy of patent and trade secret protection. The
Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. The Company
undertakes no obligation to revise any forward-looking statements in order to
reflect events or circumstances after the date of such statements. Readers are
urged to carefully review and consider the various disclosures made by the
Company in this report and in the Company's other reports filed with the
Securities and Exchange Commission that attempt to advise interested parties of
the risks and factors that may affect the Company's business. The forward-
looking statements herein are qualified in their entirety by the cautions and
risk factors set forth under "Cautionary Statement" filed as Exhibit 99.1 to
this Annual Report on Form 10-K.
PART I
ITEM 1. BUSINESS
Integ Incorporated ("Integ" or the "Company") is developing the
LifeGuide System, a next generation hand-held glucose monitoring product for use
by people with diabetes that avoids the pain and blood associated with
conventional "finger-stick" technologies. Utilizing the Company's proprietary
interstitial fluid ("ISF") sampling technology, the proposed LifeGuide System is
designed to allow people with diabetes to frequently self-monitor their glucose
levels without repeatedly enduring the pain of lancing their fingers to obtain a
blood sample. The Company believes that the proposed LifeGuide System
represents a significant technological advance in glucose monitoring and will
enable people with diabetes to manage their disease more effectively and
conveniently. The Company anticipates that it will file a 510(k) premarket
notification with the United States Food and Drug Administration (the "FDA") for
the LifeGuide System once the development of the LifeGuide System is complete.
Integ, a Minnesota corporation, was incorporated in April 1990.
INDUSTRY OVERVIEW
It is estimated that there are as many as 120 million people with
diabetes worldwide. Diabetes is a chronic disease affecting overall health
which can lead to severe complications and requires active disease management on
a daily basis.
The use of personal glucose monitors is a key factor in the management
of diabetes. Glucose levels are dynamic and vary throughout the day depending
upon food intake, insulin availability, exercise, stress and illness. People
with diabetes attempt to maintain their glucose levels within an acceptable
range through the use of insulin injections, oral hypoglycemic (glucose
reducing) agents, diet,
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exercise or a combination of these activities. People with diabetes test their
glucose levels at multiple times during the day, including before eating or when
their glucose levels are suspected to be rising or falling faster than desired.
The Company believes that sales of personal blood glucose monitoring
products have increased significantly in recent years due to technological
innovations, the development of retail distribution channels and increasing
awareness of the benefits of frequent glucose monitoring. Historically,
consumers have selected devices that offer the greatest ease of use while
providing fast and accurate blood glucose measurements, and technological
innovators have tended to capture significant market share rapidly.
Due to the release in 1993 of the results of the landmark Diabetes
Control and Complications Trial (the "DCCT"), people with diabetes are becoming
increasingly aware of the need for more intensive glucose monitoring. The
purpose of the trial, which studied more than 1,400 people with Type I (insulin-
dependent or juvenile onset) diabetes over a nine-year period, was to determine
whether tighter control over glucose levels would prevent the onset or slow the
progression of the serious complications that often accompany diabetes.
Participants in the DCCT were randomly assigned to either intensive or
conventional therapy groups. Conventional therapy consisted of testing glucose
levels once or twice a day with one or two daily insulin injections. Intensive
therapy involved testing glucose levels at least four times a day with at least
three insulin injections and appropriate modifications to diet and exercise and
insulin doses in accordance with the measured glucose levels. The DCCT
demonstrated that more intensive treatment of Type I diabetes can reduce the
risk of developing various diabetes-related complications by approximately 60%.
The DCCT panel has recommended that people with Type I diabetes follow
an intensive therapy program, including testing their glucose levels at least
four times a day. Many experts on diabetes also believe that people with Type
II (non-insulin-dependent or adult onset) diabetes, who do not typically check
their glucose levels at regular intervals, would also benefit from regular
monitoring. Currently, however, the majority of people with diabetes who use
insulin monitor their glucose levels approximately once each day.
EXISTING PERSONAL BLOOD GLUCOSE MONITORING SYSTEMS AND NEW ALTERNATIVE
TECHNOLOGIES
Commercially available glucose monitoring systems involve obtaining a
patient's blood sample in order to measure glucose. The primary drawbacks to
this approach are the pain associated with lancing a fingertip to produce the
sample and the mess and inconvenience of handling blood. In conventional
glucose monitoring systems, blood samples are taken from the fingertips because
of the high concentration of capillaries at that site and because the blood
produced at the fingertip can most easily be applied directly to the test strips
used in such devices. Since nerve endings are concentrated in the fingertips,
however, this sampling process results in a significant degree of pain. The
level of patient discomfort is compounded because the fingertips offer a limited
surface area from which to obtain a blood sample, requiring the patient to
repeatedly sample from the same site. In addition, many people with diabetes
are uncomfortable with routinely testing glucose levels in the presence of
others because of the negative perceptions associated with visible blood.
Most currently available personal blood glucose monitoring systems
employ a disposable test strip in conjunction with a battery-powered, hand-held
meter. These systems usually require the user to (1) assemble the finger-
lancing device, (2) determine the calibration code from the test strip package
and adjust the meter as required to be properly calibrated to the test strip
being used, (3) insert the test strip into the meter, (4) lance the finger and
wait for a drop of blood to form on the fingertip, and (5) apply the blood
sample to the test strip and wait for the meter to display the results.
The goal of most recent glucose monitoring research has been to
develop an accurate system to monitor glucose without the pain of a finger lance
or the need to handle blood. The Company believes that most of the current
research and development in this area involves non-invasive near-infrared
spectroscopic, reverse iontophoretic or ISF technologies.
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Non-invasive near-infrared spectroscopic technology generally attempts
to estimate glucose levels by measuring light absorption when an infrared light
signal is transmitted through or reflected off of a body part. Every chemical
entity that absorbs infrared energy has a characteristic waveband where that
absorption occurs. This absorption is proportional to its concentration. It is
this "signature" that allows a chemical entity to be identified and measured.
Reverse iontophoretic technology uses electrical current to draw
glucose molecules out of the skin for measurement. Iontophoresis is a process
by which charged molecules are carried through intact skin by applying a small
amount of electrical current. Reversing that current can pull charged molecules
from the body; with those molecules comes fluid, and with that fluid comes
uncharged molecules like glucose. Such fluid can be accumulated in a test
chamber, in which the glucose can be measured using traditional electro-chemical
means.
ISF technology involves obtaining a sample of ISF from the skin. ISF
technology is the approach being pursued by Integ and others. Illustrative of
other ISF approaches, which are different from the Company's unique approach
described below, would be to create an opening in the skin using a laser or
other means, pull ISF through the opening, and measure the glucose in the ISF
sample using traditional electro-chemical means. Another example would be to
enhance the permeability of the skin through chemical means and allow ISF to
flow into a patch, which could then be measured using traditional electro-
chemical means.
Other approaches in glucose monitoring development continue to involve
the measurement of glucose in blood but attempt to minimize the volume of blood
required and to broaden the sites available for sampling.
No glucose monitor using non-invasive near-infrared spectroscopic,
reverse iontophoretic technologies, ISF technology or any other non-blood based
or non-invasive glucose monitoring technology has ever been approved for
commercialization by the FDA.
The Company believes that the pain and inconvenience associated with
conventional "finger-stick" blood glucose monitoring systems is the primary
reason that most people with diabetes fail to comply with the recommendations of
the DCCT panel. To date, however, completely non-invasive technologies have
failed to provide a practical alternative to commercially available blood
glucose monitoring systems.
THE INTEG SOLUTION
The Company is developing the LifeGuide System, utilizing the
Company's proprietary ISF sampling technology, to allow people with diabetes to
easily and accurately measure their glucose levels without the pain of a finger
lance or the need to handle blood. The LifeGuide System is designed to capture
an extremely small physiological (as it exists in the body) sample of ISF and
then measure the glucose level in that sample in a compact, easy-to-use device.
THE INTEG TECHNOLOGY
The Company's proposed LifeGuide System is based on Company research
indicating that ISF glucose levels correlate closely with blood glucose levels.
ISF is an extracellular fluid that is prevalent throughout the body and the
skin. ISF is the means through which proteins and chemicals, including glucose,
pass between capillaries and cells. Since the LifeGuide System draws a sample
from the outermost layers of the skin, for instance on the forearm, it avoids
the areas of high nerve density and capillaries found in the deeper layers of
the skin, thus eliminating the pain and blood associated with conventional
"finger-stick" sampling approaches.
The Company's proprietary method for ISF sampling involves a simple
procedure that draws an ISF sample from the outermost layers of the skin and
captures that sample for measurement. The ISF sample (approximately 1/50th of a
drop) is analyzed for glucose levels by the LifeGuide Meter utilizing a signal
from the far-infrared waveband region. The proposed LifeGuide System will
utilize
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well-established spectroscopic techniques which the Company is developing into a
compact, hand-held, battery-operated configuration. The proposed LifeGuide Meter
will contain an infrared source aligned with infrared detectors, with the sample
window on the LifeGuide Key inserted between the two. When the infrared energy
generated by the source passes through the sample window, glucose in the ISF
sample absorbs part of the energy in a manner that is detected, measured and
displayed by the LifeGuide Meter.
THE LIFEGUIDE SYSTEM
The Company's LifeGuide System will be comprised of (i) the LifeGuide
Meter, a hand-held, battery-powered monitor, and (ii) the LifeGuide Key, a
single-use, disposable sample collection device.
The proposed LifeGuide Meter will be an integrated, compact, easy-to-
use glucose monitoring device similar in size to the handset of a telephone.
The LifeGuide Meter will consist of an infrared source and detector, an easy-to-
read LCD display screen, a port for the disposable LifeGuide Key and buttons to
access memory and other functional modes. The proposed LifeGuide Meter will
have visual and audible prompts to assist the user through the sampling process.
The LifeGuide Meter is designed to have the ability to indicate when an
appropriate sample has been obtained and to self-diagnose most electronic
malfunctions. In addition, the proposed LifeGuide Meter will be capable of
transmission of data to a personal computer for review and analysis by the
user's physician.
The single-use, disposable LifeGuide Key is designed to be easily
handled by the user and inserted into the LifeGuide Meter. The proprietary
design of the LifeGuide Key will allow for the capture of the required ISF
sample and the retention of the sample during the measurement and disposal
process. The LifeGuide Key contains a very small needle that is used to draw a
microliter sample across a specially designed membrane window through which a
sample can be read. The LifeGuide Key, which will be packaged in a sterile
package, will be similar in size to an average house key.
To operate the LifeGuide System, the user will insert the LifeGuide
Key into the LifeGuide Meter and hold the LifeGuide System against the skin
until the LifeGuide Meter indicates the sampling process is complete. Most
individuals who have tried the LifeGuide System have indicated that the physical
sensation is like pressing a ballpoint pen, with the point retracted, against
the skin. The Company estimates that the average sampling time will be from 20
to 30 seconds depending on the user and the location of sampling. Shortly after
the sampling process is complete, the LifeGuide System will display the user's
glucose level. Because the ISF sample captured by the LifeGuide Key will not
come into contact with the LifeGuide Meter, there should be no need to clean the
LifeGuide Meter after each use. The Company also plans to offer a control
solution that may help the user confirm that the LifeGuide System is functioning
properly.
The Company believes the LifeGuide System will offer significant
advantages over commercially available personal blood glucose monitoring systems
and alternative non-invasive technologies under development, including the
following:
- Eliminates the Pain of Lancing the Fingertips--The LifeGuide System is
designed to allow for the accurate measurement of glucose levels without
the pain of a finger lance. Unlike most commercially available glucose
monitoring systems which involve penetrating the deeper layers of the
skin to obtain a blood sample, the LifeGuide System's proprietary
sampling method draws from only the outermost layers of the skin and
avoids the areas of high nerve density. This sampling technology
eliminates the pain associated with conventional "finger-stick" sampling
approaches.
- Bloodless Approach--The LifeGuide System is designed to allow for the
accurate measurement of glucose levels without drawing blood. This
bloodless approach eliminates the mess and inconvenience of handling a
blood sample and the negative perceptions associated with visible blood.
The elimination of the need for a blood sample will allow people with
diabetes to use the proposed LifeGuide System discretely in any
environment.
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- Sampling Flexibility--The LifeGuide System is designed to be used on
skin almost anywhere on the body, not merely areas (such as the
fingertips) where blood capillaries and nerve endings are concentrated.
- Ease of Use--The Company's proposed LifeGuide System will eliminate some
of the steps required by commercially available personal blood glucose
monitoring systems. With most current systems, after lancing the finger,
a drop of blood must be directed to a small target zone on a thin,
difficult to handle strip. The Company has designed the LifeGuide Key to
be easily handled and inserted into the LifeGuide Meter. The sampling
procedure of the proposed LifeGuide System has been reduced to simply
holding the device against an area of exposed skin until an adequate
sample has been obtained (20 to 30 seconds) and waiting briefly for a
displayed result.
- Cost Competitive--It is anticipated that the proposed LifeGuide Keys
will be offered at competitive prices and will not be a significant
departure from current consumer buying patterns and reimbursement
practices with respect to commercially available personal glucose
monitoring strips or sensors. Given its innovative features, it is
anticipated that the proposed LifeGuide Meter will be priced at a
premium to existing personal glucose monitoring meters.
Because of these potential advantages, the Company believes that the
proposed LifeGuide System may facilitate greater compliance with the
recommendations of the DCCT panel. The Company, however, has not yet finalized
the development of its LifeGuide System, and there can be no assurance that the
Company will be able to successfully develop a commercially acceptable product.
RESEARCH AND DEVELOPMENT
To date, the Company has been engaged primarily in the research,
development and testing of the LifeGuide System. Since inception, the Company
has incurred approximately $16.1 million in research and development expenses.
The Company spent approximately $5.3 million, $4.8 million and $2.8 million
during fiscal years 1997, 1996 and 1995, respectively, on research and
development, all of which was sponsored by the Company. The Company believes
that it is in the final stages of its product development and expects to
finalize development of a commercial prototype of the LifeGuide System in 1998.
In 1996, the Company conducted studies using a hand-held prototype of
the LifeGuide System incorporating the functional components of the LifeGuide
System (including battery-powered electronics) to demonstrate the accuracy of
the LifeGuide System when testing samples containing known glucose values. This
testing identified areas in which the performance of the system needed to be
improved. In 1997, the Company focused on a systematic identification and
quantification of error sources in the LifeGuide System error budget. Several
sources of error have been resolved, thereby improving the consistency of the
prototype meters and permitting a broader battery of testing. Several sources
of error remain. The Company continues to work on resolving these remaining
sources of error and optimizing the performance of the LifeGuide System. The
Company expects to finalize a commercial prototype of the LifeGuide Meter in
1998, although there can be no assurance that the Company will be able to do so.
The Company's success will depend on its ability to finalize the
design and then manufacture the LifeGuide System in compliance with regulatory
and clinical requirements in a timely manner and in sufficient quantities while
maintaining product quality and acceptable cost. The LifeGuide System must
deliver performance that is acceptable both to the FDA and to the users of the
product. The personal glucose monitoring product market is characterized by
commercial products that are manufactured in large quantities at very low cost.
As a result, the present focus of the LifeGuide Meter development is to finalize
the design of the hand-held, battery-powered prototype into a product that
functions within its performance specifications and that can be reliably and
cost-effectively manufactured. The initial development of the LifeGuide Key was
completed in 1996, and subsequent
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enhancements to the LifeGuide Key were completed in 1997. Both the LifeGuide
Meter and the LifeGuide Key are being designed to use materials and components
that can be readily produced by outside suppliers.
CLINICAL TESTING
The goal of the Company's clinical testing to date has been to
demonstrate the correlation between ISF glucose levels and blood glucose levels,
and to test various prototypes of the LifeGuide System for accuracy and
precision. All ISF samples used in this testing have been obtained utilizing
the Company's proprietary sampling method.
In early 1996, clinical studies were conducted at the Mayo Clinic and
the University of Minnesota. Both of these studies used the LifeGuide System to
draw samples of ISF and a standard laboratory assay for measuring glucose levels
in venous blood and ISF. The Mayo Clinic study provides support for the
conclusion that there is a strong correlation between the glucose levels in ISF
and the glucose levels in blood when the glucose levels are in a relatively
steady state. This study compared the ISF and blood glucose values in 66
individuals and yielded a correlation coefficient of 0.96 (on a 0.0 to 1.0
scale, with 1.0 representing a perfect correlation). This study was published
in the Journal of Diabetes Care (September 1997). The University of Minnesota
study provides support for the conclusion that there is a strong correlation
between the glucose levels in ISF and the glucose levels in blood when the
glucose levels are in a state of rapid change. This study has compared the ISF
and blood glucose values in 17 individuals with Type I diabetes over a five-hour
period of rising and falling glucose values. Cumulative data from these 17
subjects has yielded a correlation coefficient of 0.95. This study was
published in the Journal of Laboratory and Clinical Medicine (October 1997).
The data from both the Mayo clinic study and the University of Minnesota study
were presented in June 1997 at the Annual Scientific Sessions of the American
Diabetes Association in Boston, Massachusetts.
In the third quarter of 1997, the Company conducted additional studies
using a hand-held prototype of the LifeGuide System to compare the glucose
values obtained using the LifeGuide System to those obtained using a laboratory
measure of glucose in a blood sample. This testing was performed on 50 people
with diabetes to obtain a full range of glucose values. The results showed a
correlation coefficient of 0.93 with 98% of the values falling in the A and B
zones of the Clarke Grid. The Clarke Grid, a measure of clinical relevancy for
glucose monitoring devices, is one source that can be used to define whether a
glucose monitoring system's accuracy and precision are acceptable for its
intended use: values falling in zone A are considered clinically accurate, and
values falling in zone B are clinically benign (i.e., although not clinically
accurate, the person acting on that value would do nothing different than if the
values fell in zone A). Values outside of these zones are clinically
unacceptable. The Company continues to work to resolve error sources and
optimize the performance of the LifeGuide System, and the Company expects to
conduct additional testing when the design is finalized to confirm acceptable
performance.
If the Company is able to develop clinically acceptable prototypes of
the LifeGuide System, the Company plans to use these prototypes to obtain
patient-generated clinical data in a three-center, 300 patient trial for use in
the Company's application to the FDA for a 510(k) clearance to market the
LifeGuide System. The Company currently plans to submit this application to the
FDA as soon as feasible after completing development of the LifeGuide Meter.
To date, testing of the LifeGuide System has been performed solely by
Company personnel under controlled circumstances. There can be no assurance
that the Company will not continue to encounter problems in completing the
development of the LifeGuide Meter that would prevent the Company from
initiating clinical testing, and there can be no assurance that the Company will
not encounter problems in clinical testing that would cause the Company to
further delay commercialization of the LifeGuide System. There also can be no
assurance that a commercial version of the LifeGuide System, if developed, will
prove to be accurate and reliable on a consistent basis. Even if accurate and
reliable, there can be no assurance that such testing will show the Company's
product to be safe or cost effective.
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MANUFACTURING
The LifeGuide System is designed to be economically produced using
proven manufacturing methods and equipment. As part of its design strategy, the
Company has consulted with component suppliers, automation firms and OEM
electronics manufacturers.
The Company currently plans to use an outside manufacturer to assemble
the LifeGuide Meter. This manufacturer will be used to build the LifeGuide
Meter once the product is launched and to develop production test methods and
equipment for the Company. This manufacturer will also participate in the
prototype builds of the LifeGuide Meter for testing. The LifeGuide Key will be
assembled by the Company at its facilities from components obtained from outside
suppliers. In manufacturing the LifeGuide Key, the Company will use assembly,
test and packaging equipment employing well-known processes similar to those
used for other high speed assembly applications.
One component of the LifeGuide Key is available from a single source.
If the Company were unable to obtain this component from its supplier, the
Company would be required to make modifications to its existing LifeGuide System
and to obtain an alternative component from an alternative supplier. Although
the Company believes that it can enter into a supply agreement with respect to
this component, any interruption in the supply of this component would have a
material adverse effect on the Company's business, financial condition and
results of operation.
The Company expects that one of its most significant manufacturing
challenges will be to quickly increase LifeGuide Key production volumes after
full-scale commercial introduction of the LifeGuide System. To address this
challenge, the Company anticipates installing and qualifying an initial
automated manufacturing line prior to installation of additional production
lines. If the installation, evaluation and refinement of the initial line are
successfully completed, the Company plans to incrementally add several full-
scale commercial production lines with greater manufacturing capacity as
requirements warrant.
The Company ordered the initial automated manufacturing line for the
LifeGuide Key in late 1996 and anticipates producing initial LifeGuide Keys from
this line in mid-1998. There can be no assurance, however, that the Company
will be able to install and qualify an initial automated manufacturing line or
subsequent commercial productions lines on a timely basis or at all. There also
can be no assurance that the Company will be able to achieve and maintain
product quality and reliability when producing the LifeGuide System in the
quantities required for commercial operations or within a period that will
permit the Company to introduce its products in a timely fashion, or that the
Company will be able to assemble and manufacture its products at an acceptable
cost.
SALES AND MARKETING
The Company intends to direct its sales and marketing efforts at
people with diabetes who use insulin to control their glucose levels, because
they tend to monitor their blood glucose more frequently. The Company believes
that insulin users are more likely to be better educated concerning their
condition, are more motivated to comply with proper disease management and are
most likely to recognize the potential benefits of the LifeGuide System. The
Company will seek to gain product acceptance by implementing a strategy that
both promotes the Company's products directly to people with diabetes and
educates healthcare professionals, managed care decision makers and insurers as
to the potential advantages of the LifeGuide System in facilitating compliance
with the recommendations of the DCCT panel. As part of its education and
awareness strategy, the Company will focus on developing peer reviewed journal
articles authored by leading experts in diabetes, sponsoring publication of
papers based on research covering performance and utility benefits of the
LifeGuide System and conducting regional seminars.
Initially, the Company intends to use various direct marketing methods
to promote its LifeGuide System to people with diabetes, including direct mail,
advertisements in healthcare media
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and internet and on-line computer services. In addition, the Company expects to
utilize other emerging distribution channels, including those supporting managed
care organizations, on-line merchandising services and direct distribution
firms. The Company plans to sell the LifeGuide System directly to consumers
through a toll-free number and will support these sales with a customer service
organization. As the Company's customer base grows, the Company also expects to
use traditional retail distribution channels, including chain and independent
drug stores and other retail outlets. The Company expects eventually to market
and distribute its products outside the United States through third party
distribution channels.
The Company intends to introduce the LifeGuide System in the United
States in two phases: (1) a limited introduction phase subsequent to obtaining
510(k) clearance from the FDA; and (2) a full commercial introduction phase,
expected to commence several months thereafter. During the limited introduction
phase, the Company expects to use an experienced direct sales force to introduce
the LifeGuide System to key opinion leaders in the treatment of diabetes for use
in their practices on a select number of patients. In addition, during this
phase the Company expects to market to select managed care organizations. The
primary purpose of the limited introduction phase is to ensure that the
Company's infrastructure will support full commercial introduction.
During the full commercial introduction phase, the Company plans to
use a three-pronged strategy employing a highly trained and focused direct sales
force. One specialized sales group will concentrate on promotion of the
Company's products to managed care decision makers and insurers. A second group
will promote the Company's products to healthcare professionals and
organizations that influence patient choices. A third specialized sales group
will target the retail distribution channel.
The Company has no experience in marketing the LifeGuide System and
has not yet entered into any marketing or distribution arrangements for the
LifeGuide System. Many of the Company's potential competitors have already
entered into distribution and marketing agreements with major marketing
partners. There can be no assurance that the Company will be able to build a
suitable sales force or enter into satisfactory marketing arrangements with
third parties when commercial potential develops, or that its sales and
marketing efforts will be successful.
PATENTS AND PROPRIETARY RIGHTS
The Company's success will depend in part on its ability to obtain
patent protection for its proposed products and processes, to preserve its trade
secrets and to operate without infringing the proprietary rights of third
parties. The Company pursues a policy of seeking patent protection for each of
the areas of invention embodied in the LifeGuide System. The Company has two
issued United States patents relating to the method of drawing an ISF sample
from the outer layers of the skin, and five additional United States patent
applications directed toward various aspects of the technologies underlying the
LifeGuide System. The Company has also filed three corresponding PCT foreign
patent applications, and four country-specific patent applications related to
its sampling methods, in order to seek similar patent protection outside the
United States.
The Company has implemented a strategy of pursuing patent applications
to provide both design freedom and protection from competitors. This strategy
includes evaluating and seeking patent protection both for inventions most
likely to be used in the Company's LifeGuide System and for related inventions
likely to be used by others as competing alternatives.
The Company also relies upon trade secrets and proprietary know-how in
its manufacturing processes. The Company requires each of its employees,
consultants, advisors and certain of its vendors to execute a confidentiality
agreement upon the commencement of their relationship with the Company.
No assurance can be given that any additional patents will be issued,
that the scope of any patent protection granted to the Company will exclude
competitors or that any of the Company's
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patents will be held valid or enforceable if subsequently challenged. Patenting
medical devices involves complex legal and factual questions, and there is no
consistent policy regarding the breadth of claims pertaining to such
technologies. The Company also relies upon unpatented trade secrets, and no
assurance can be given that others will not independently develop or otherwise
acquire technologies substantially equivalent to those of the Company. In
addition, even if the patents the Company has applied for are ultimately issued,
others may hold or receive patents that contain claims covering the products
proposed to be sold by the Company and which may delay or prevent the sale of
the LifeGuide System or require licenses resulting in the payment of fees or
royalties by the Company in order for the Company to carry on its business.
There can be no assurance that needed or potentially useful licenses will be
available in the future on acceptable terms or at all.
There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. Litigation could
result in substantial costs to and a diversion of effort by the Company, but may
be necessary to enforce any patents issued to the Company, protect trade secrets
or know-how owned by the Company, defend the Company against claimed
infringement of the rights of others or determine the scope and validity of the
proprietary rights of others. The Company is not currently a party to any
patent or other litigation. The Company routinely monitors patent issuances by
others in its industry, and in 1996 became aware of a patent that may relate to
a feature of the LifeGuide System. The Company engaged outside patent counsel,
Moore & Hansen, to review the patent, and such counsel rendered its opinion to
the Company that the patent is not infringed by the Company's technology. In
addition, such counsel advised the Company that if the patent was challenged,
those claims which the Company believes may apply to the LifeGuide System would
be likely to be held invalid based on the existence of prior art not cited by
the patent examiner. There can be no assurance, however, that the holder of the
patent will not pursue litigation which could be costly to the Company. An
adverse determination in any litigation, including any litigation commenced by
the holder of the patent referred to above, could subject the Company to
significant liabilities to third parties, require the Company to seek licenses
from or pay royalties to third parties or prevent the Company from
manufacturing, selling or using its proposed products, any of which could have a
material adverse effect on the Company's business and prospects.
THIRD PARTY REIMBURSEMENT
Private insurance companies, self-insured employers, health
maintenance organizations and governmental payors under Medicare and Medicaid
programs are a source of reimbursement to users of blood glucose monitoring
systems and related products, but there is no uniform policy on reimbursement
among third-party payors. Sales of the Company's proposed products in certain
markets will be dependent in part on availability of adequate reimbursement from
these third-party payors. Although the Company believes that current
reimbursement levels are adequate to support the introduction of the LifeGuide
System, third-party payors are increasingly challenging the pricing of medical
products and services. There can be no assurance that adequate levels of
reimbursement will be available to permit the Company to achieve market
acceptance of the LifeGuide System or maintain price levels sufficient to
realize an appropriate return on its investment in the development or
manufacture of the LifeGuide System. Without adequate support from third-party
payors, the market for the Company's products may be limited.
The Medicare program reimburses people with diabetes for one meter and
for a one month's supply of test strips at a time as approved by their
physicians. In 1998, the Health Care Financing Administration ("HCFA"), which
sets rates for the Medicare program, set a payment limit of $63.73 for personal
blood glucose monitors and set the maximum reimbursement rates for a box of 50
test strips at between $31.22 to $36.73, depending on the state in which the
reimbursement is sought. These payment limits and other future initiatives to
reduce healthcare costs may lead to increased pricing pressures among
manufacturers of existing blood glucose meters and test strips. The Company's
business, financial condition and results of operations could be adversely
affected by the continuing efforts of governmental and private payors to reduce
the costs of healthcare by lowering reimbursement rates.
-10-
<PAGE>
As a provider of products that are reimbursed by Medicare, Medicaid
and other third-party payors, the Company will be subject to the anti-kickback
provisions of the Medicare and Medicaid fraud and abuse laws and similar state
laws. These laws prohibit the exchange of remuneration for referrals of
services or products reimbursed by Medicare and Medicaid or other third-party
payors. Violations of these prohibitions may result in civil and criminal
penalties and exclusion from the Medicare and Medicaid programs. The Company
intends to comply with the federal anti-kickback statute and related safe harbor
regulations regarding discount disclosures.
COMPETITION
The Company believes that its success will depend primarily upon its
ability to create and deliver a glucose monitoring system, on a timely basis and
at a competitive price, that avoids the pain and blood associated with current
glucose monitoring products. In addition, the Company must effectively create
market awareness and acceptance of its products and maintain the proprietary
nature of its technologies and processes. The glucose monitoring industry is
characterized by intense competition and is currently dominated by several
companies with established products and distribution channels. There are
currently four significant competitors in the worldwide blood glucose monitoring
market: LifeScan, Inc., a subsidiary of Johnson & Johnson, Inc.; Boehringer
Mannheim Corporation, a subsidiary of Roche Holding Ltd.; Bayer Diagnostics, a
division of Bayer AG; and Medisense, Inc. (a subsidiary of Abbott Laboratories).
Companies in the glucose monitoring market compete on the basis of
innovative technology, ease of use, price, product reliability and acceptance by
consumers and healthcare professionals. Price competition for the placement of
monitors in the glucose monitoring market is intense and involves marketing
tactics such as rebates, trade-in offers and volume purchase incentive programs.
This competition could result in lower sales prices for the LifeGuide Meter and
the use of purchase incentive programs that could adversely affect the Company's
revenues and profitability.
A number of entities are conducting research on possible non-invasive
and minimally invasive methods of determining glucose levels. Specific
information regarding the precise progress of these companies with respect to
these alternative technologies has not generally been made public. While
several companies have announced dates on which they anticipate submitting their
510(k) application to the FDA, to date only one has done so, and that company
has since withdrawn its application.
There can be no assurance that the Company's competitors and potential
competitors will not succeed in developing or marketing technologies and
products that will be more accepted in the marketplace than the proposed
LifeGuide System or that would render the Company's technology and proposed
products obsolete or noncompetitive. Most of the Company's competitors and
potential competitors have substantially greater capital resources, research and
development staffs and facilities than the Company. In addition, most of the
Company's competitors and potential competitors have substantially greater
experience than the Company in research and new product development, obtaining
regulatory approvals and manufacturing and marketing medical devices. Many of
the Company's potential competitors have already entered into distribution and
marketing agreements with major marketing partners.
Numerous researchers are also investigating alternative treatments or
cures for diabetes. If any of these efforts are successful in reducing the
complications associated with diabetes and can be cost-effectively provided to
people with diabetes, the need for the Company's products could be reduced or
eliminated.
GOVERNMENT REGULATION
Government regulation in the United States and other countries is a
significant factor in the Company's business. The Company's products will be
regulated by the FDA under a number of statutes including the Federal Food, Drug
and Cosmetic Act, as amended (the "FDC Act"), the Safe Medical
-11-
<PAGE>
Devices Act of 1990 (the "SMDA"), and the FDA Modernization Act of 1997 (the
"FDAMA"). Manufacturers of medical devices must comply with applicable
provisions of the FDC Act, the SMDA, the FDAMA, and certain associated
regulations governing the development, testing, manufacturing, labeling,
marketing and distribution of medical devices and the reporting of certain
information regarding their safety. The FDC Act, the SMDA, and the FDAMA require
certain clearances from the FDA before medical devices, such as the Company's
proposed LifeGuide System, can be marketed.
FDA permission must be obtained to distribute a new medical device.
If a new or significantly modified device is "substantially equivalent" to an
existing legally marketed device, the new device can be commercially introduced
after filing a 510(k) premarket notification with the FDA and the subsequent
issuance by the FDA of an order permitting commercial distribution. Changes to
existing devices that do not significantly affect safety or effectiveness may be
made without an additional 510(k) notification. The Company believes and has
confirmed with the FDA that the LifeGuide System will be eligible for 510(k)
clearance with the predicate device being a commercially available personal
blood glucose monitoring instrument. In addition, the FDA has granted Integ
expedited review of its LifeGuide System application, once the Company submits
that application. Expedited review is a process reserved for innovative
technology that directly benefits public health. Expedited review may shorten
the time between submission of clinical trial data and clearance from the FDA to
market the LifeGuide System.
FDA clearances, if obtained, are subject to continual review, and if
the FDA believes that the Company is not in compliance with the FDC Act, the
SMDA, the FDAMA or their associated regulations, it can institute proceedings to
detain or seize the Company's products, require a recall, enjoin future
violations and assess civil and criminal penalties against the Company, its
directors, officers or employees. The FDA may also withdraw market approval for
the Company's products or require the Company to repair, replace or refund the
cost of any device manufactured or distributed by the Company.
The FDC Act will regulate the Company's development, quality control
and manufacturing procedures by requiring the Company to demonstrate compliance
with current Good Manufacturing Practices as implemented through the Quality
System Regulation. The FDA monitors compliance with these requirements by
requiring manufacturers to register with the FDA, which subjects them to
periodic FDA inspections of their manufacturing facilities. In order to ensure
compliance with these requirements, the Company will be required to expend time,
resources and effort in the areas of production and quality control. If
violations of the applicable regulations are noted during FDA inspections, the
continued marketing of any products manufactured by the Company may be adversely
affected.
The Company also plans eventually to market the LifeGuide System in
several foreign markets. No regulatory approvals have yet been obtained in any
such markets and there is no assurance that any will be issued. Requirements
pertaining to the LifeGuide System will vary widely from country to country and
involve anything from simple product registrations to detailed submissions
similar to those required by the FDA.
ADVISORY BOARDS
The Company realizes that, if it is to be successful, its products
must meet the needs of the people who will use them. For this reason, the
Company makes an active effort to seek out experts in the field to advise the
Company on product development and marketing issues. A key factor in this
process has been the Company's establishment of a Medical Advisory Board and a
Diabetes Educator Advisory Board. The Medical Advisory Board comprises leading
physicians in the fields of endocrinology and laboratory medicine. The members
of the Diabetes Educator Advisory Board are all Certified Diabetes Educators.
These boards meet periodically to discuss relevant issues and are also available
for consultation on an as-needed basis.
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<PAGE>
EMPLOYEES
As of March 2, 1998, the Company had a total of 78 full-time
employees. The Company also employed 20 persons on a temporary or contract
basis (full and part-time). Of this total work force, 50 persons were engaged
in research and development activities, 20 persons in manufacturing development,
one person in sales and marketing, 16 persons in clinical, regulatory and
quality functions and 11 persons in support and administrative functions. None
of the Company's employees is covered by a collective bargaining agreement. The
Company believes that it maintains good relations with its employees.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following sets forth certain information regarding the executive
officers of the Company:
<TABLE>
<CAPTION>
Name Age Position
- --------------------- --- -------------------------------------------------------------------------------
<S> <C> <C>
Frank A. Solomon..... 54 President, Chief Executive Officer, Acting Chief Financial Officer and Director
Katia P. Breslawec... 43 Vice President, Regulatory and Quality
Susan L. Critzer..... 42 Vice President, Operations
A. Paul Harding...... 49 Vice President, Sales and Marketing
Richard F. Mussmann.. 41 Vice President, Research and Development
</TABLE>
Frank A. Solomon, one of the founders of the Company, served as a
consultant to the Company from July through December 1990, its President and a
director since January 1991 and as Chief Executive Officer since December 1991.
Mr. Solomon assumed the role of Acting Chief Financial Officer in February 1998.
Mr. Solomon has been involved in the development and marketing of products for
the diagnosis and treatment of diabetes for 14 years. From 1976 to 1989,
Mr. Solomon held various management positions at Eli Lilly and Company ("Eli
Lilly"), including President of Elco Diagnostics, a division of Eli Lilly,
General Manager of the Infusion Products division of Cardiac Pacemakers, Inc., a
subsidiary of Eli Lilly, Manager in Eli Lilly's medical device merger and
acquisition group, and sequentially as National Sales Manager, Director of
Marketing and Sales and Director of Corporate Development at Physio-Control
Corporation, another subsidiary of Eli Lilly.
Katia P. Breslawec joined the Company in April 1996 as Vice President,
Regulatory and Quality. Before joining the Company, Ms. Breslawec spent nine
years with Sanofi Diagnostics Pasteur, Inc., a manufacturer of clinical
laboratory instruments, in vitro diagnosis reagents, and biologicals. Most
recently, as Director of Regulatory Compliance, Ms. Breslawec was responsible
for obtaining FDA approvals required for domestic and international product
commercialization and for maintaining compliance with international quality
standards. Ms. Breslawec was previously Manager of New Product Approvals at
INCSTAR Corp.
Susan L. Critzer joined the Company in January 1995 as Vice President,
Operations. Before joining the Company, Ms. Critzer spent six years with
American Cyanamid Corporation's Davis and Geck ("D&G") Division. Most recently
at D&G, she was Director of Engineering for D&G's start-up Endosurgery division,
where she was responsible for the commercialization of all new laparoscopic
products. From 1986 to 1989, Ms. Critzer was with Becton-Dickinson Corporation,
where she held management positions in manufacturing engineering and quality
control and was involved in the high volume production of intravenous catheters.
Prior to her employment with Becton-Dickinson, Ms. Critzer held a variety of
manufacturing, quality control, and engineering positions with General Motors
Corporation.
A. Paul Harding joined the Company as Vice President, Sales and
Marketing in November 1995, having spent the previous 15 years with Bayer
Diagnostics, a division of Bayer AG ("Bayer"), a leading manufacturer and
marketer of glucose monitoring products. At Bayer, Mr. Harding held various
sales and marketing positions in U.S. and foreign markets, most recently as Vice
President, U.S.
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<PAGE>
Marketing and National Accounts, where he was responsible for business strategy
for the five diagnostic businesses and management of sales, marketing and
distributor relations personnel. Prior to that position, Mr. Harding was
Director of Marketing, U.S. Diabetes Products, where he was responsible for
marketing and sales strategy, including market research functions. Mr. Harding
also served as Area Marketing Director - Asia/Pacific at Bayer, where he was
responsible for achievement of the business objectives of several subsidiary
companies and directly managed sales, marketing and customer support groups.
Richard F. Mussmann joined the Company in July 1997 as Vice President,
Research and Development. Before joining the Company, Mr. Mussmann served for
one year as Product Management Vice President of Telogy Networks, an embedded
communications software company, where he was responsible for product definition
and planning, marketing programs, and key customer relations. From 1993 to
1995, Mr. Mussmann was Group Director, New Product Development for Ethicon Endo-
surgery, a developer and manufacturer of minimally-invasive surgical
instruments, where he was responsible for the successful development and launch
of ten new products. From 1989 to 1993, Mr. Mussmann served as Director of
Corporate Accounts and Research and Development Project Engineering Manager at
Boehringer Mannheim Corporation, where he worked on the development of several
new products, including the Advantage(R) Blood Glucose Monitor. Mr. Mussmann
also held various engineering and engineering management positions while
employed for 11 years at AT&T Bell Laboratories.
In January 1998, the Company announced that it had begun a search for
a successor to Mr. Solomon. It is expected that this search will take
approximately six more months and that Mr. Solomon will remain as President,
Chief Executive Officer and Director until his successor commences employment
with the Company or September 30, 1998, whichever is sooner.
ITEM 2. PROPERTIES
The Company currently leases approximately 42,000 square feet of space
at 2800 Patton Road, St. Paul, Minnesota. The lease expires on September 30,
2000. The Company believes its facilities will be adequate for its needs
through completion of the development of the LifeGuide System. A minor space
expansion at its existing location will be required to accommodate increased
staffing prior to commercial introduction once development of the LifeGuide
System is complete.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is listed and traded on the Nasdaq National
Market under the symbol NTEG. The following table sets forth the high and low
sale prices per share for the Company's common stock as reported by the Nasdaq
National Market for the quarterly periods indicated since the Company's common
stock began trading on June 26, 1996:
High Low
------ -----
Second Quarter 1996..... $10.25 $9.44
Third Quarter 1996...... $11.13 $8.50
Fourth Quarter 1996..... $13.75 $8.63
First Quarter 1997...... $10.25 $6.00
Second Quarter 1997..... $10.25 $2.75
Third Quarter 1997...... $ 8.75 $5.50
Fourth Quarter 1997..... $ 6.00 $3.00
At March 20, 1998, the Company had 124 shareholders of record.
The Company has not declared or paid any cash dividends on its capital
stock since its inception. The Company currently intends to invest any earnings
in the development and expansion of its business and does not intend to pay
dividends in the foreseeable future. The payment of dividends, if any, in the
future will be at the discretion of the Board of Directors and will depend on
the Company's earnings, financial condition, capital requirements and other
relevant factors.
The net proceeds to the Company from its initial public offering in
1996, after deducting expenses, were approximately $26.1 million. The Company
has used the net offering proceeds in the approximate amounts set forth below:
<TABLE>
<CAPTION>
<S> <C>
Investment in short-term, interest bearing securities,
primarily investment grade commercial paper and
money market funds $ 21,750,000
Capital expenditures 1,600,000
Research and development and clinical and regulatory
preparation 1,780,000
Manufacturing scale-up and marketing activities 810,000
Working capital and other general corporate purposes 160,000
Total use of proceeds $ 26,100,000
</TABLE>
Except for officer compensation and relocation payments totaling $578,433 in the
aggregate, director compensation totaling $46,500 in the aggregate, and
consulting fees paid to a director totaling $30,375, none of the net proceeds
from the Company's initial public offering were paid directly or indirectly to
(i) officers or directors of the Company or their affiliates, (ii) persons
owning 10% or more of the Company's equity securities or (iii) affiliates of the
Company.
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company are qualified by
reference to and should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Financial
Statements and the Notes thereto included elsewhere herein. The statements of
operations data for the years ended December 31, 1995, 1996 and 1997 and for the
period from April 3, 1990 (inception) to December 31, 1997, and the balance
sheet data at December 31, 1996 and 1997 are derived from, and are qualified by
reference to, the audited financial statements included elsewhere in this report
and should be read in conjunction with those financial statements and notes
thereto. The statements of operations data for the years ended December 31, 1993
and 1994 and the balance sheet data at December 31, 1993, 1994 and 1995 are
derived from audited financial statements not included herein.
SELECTED STATEMENTS OF OPERATIONS DATA
(in thousands, except per share data)
<TABLE>
<CAPTION>
Period from
April 3, 1990
(Inception) to
Year Ended December 31, December 31,
------------------------------------------------ ------------
1997 1996 1995 1994 1993 1997
-------- ------- ------- ------- ------ ------------
<S> <C> <C> <C> <C> <C> <C>
Operating loss ($12,462) ($9,920) ($5,281) ($2,522) ($679) ($32,453)
Net loss ($11,564) ($9,083) ($5,049) ($2,492) ($683) ($30,438)
Net loss per share:
Basic and diluted ($ 1.24) ($1.86) ($11.65) ($7.72) ($2.73) ($17.40)
Weighted average
number of common
shares outstanding:
Basic and diluted 9,305 4,889 433 323 250 1,749
</TABLE>
SELECTED BALANCE SHEET DATA
(in thousands, except employee data)
<TABLE>
<CAPTION>
December 31,
---------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
Current assets $21,914 $34,151 $15,860 $ 569 $ 115
Current liabilities 2,340 1,574 523 354 231
Working capital 19,574 32,577 15,337 215 (116)
Total assets 29,216 37,716 17,376 1,247 195
Long-term obligations 3,030 1,298 447 499 24
Shareholders' equity
(deficiency) 23,846 34,844 16,405 (4,738) (2,246)
Number of full time employees 79 63 45 19 7
</TABLE>
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Integ, a development stage company, was incorporated on April 3, 1990
to develop the LifeGuide System, a next generation, hand-held glucose monitoring
product for use by people with diabetes that avoids the pain and blood
associated with conventional "finger-stick" technologies. By using the
Company's proprietary interstitial fluid sampling technology, the LifeGuide
System will allow people with diabetes to frequently self-monitor their glucose
levels without repeatedly enduring the pain of lancing their fingers to obtain a
blood sample.
RESULTS OF OPERATIONS
From inception through December 31, 1997, the Company has incurred
losses totaling $30,438,348, consisting of $16,086,149 of research and
development expenses, $6,804,184 of general and administrative expenses,
$4,997,189 of manufacturing development expenses and $2,550,826 of other
expenses net of interest income. The Company's activities have consisted
primarily of research and product development, product design, and development
of the manufacturing equipment and processes and marketing strategies needed for
the introduction of the LifeGuide System. The Company has generated no revenue
and has sustained significant operating losses each year since inception. The
Company expects such losses to continue for the next several years.
The Company's future success is entirely dependent upon the successful
development, commercialization and market acceptance of the LifeGuide System,
the development of which is ongoing and the complete efficacy of which has not
yet been demonstrated. The Company is currently focused on the research and
development activities necessary to modify the current design in order for the
LifeGuide System to meet the Company's product specifications. In addition to
the engineering effort required to identify and resolve the remaining design
issues in the LifeGuide Meter, the Company is pursuing parallel efforts to
prepare the entire LifeGuide System for high volume manufacturing.
General: Net losses increased to $11,564,391 during 1997, up from
$9,083,432 during 1996 and $5,048,730 during 1995.
Research and development expenses: Research and development expenses
increased to $5,318,900 during 1997 from $4,802,773 during 1996 and $2,824,057
during 1995. The increase in research and development expenses in 1997 is
primarily attributable to increases in staffing costs ($504,000) and consulting
and contractor expenses ($400,000), which were partially offset by lower
licensing fees ($200,000) and facility costs ($166,000). The increase in
research and development expenses in 1996 when compared to 1995 is primarily
attributable to increases in staffing costs ($510,000), prototype material
($502,000), consulting expenses ($446,000), licensing fees ($200,000) and
depreciation ($155,000). The increase in research and development expenses in
1995 when compared to 1994 is primarily attributable to increases in prototype
material ($418,000) and staffing costs ($407,000).
Manufacturing development expenses: Manufacturing development
expenses increased to $2,513,224 during 1997 from $1,623,122 during 1996 and
$805,413 during 1995. The increase in manufacturing development expenses in
1997 is primarily attributable to increases in pre-manufacturing expenses,
consisting of facility costs associated with the additional space being
allocated to manufacturing for setting up the initial automated assembly line
for the LifeGuide Key ($381,000), staffing costs ($346,000), prototype materials
and tooling expenses ($198,000), and higher travel costs associated with the
development of the automated assembly line ($76,000), which were partially
offset by lower consulting expenses ($196,000). The increase in manufacturing
development expenses in 1996 when compared to 1995 is primarily attributable to
increases in staffing costs ($382,000) and consulting expenses ($157,000). The
increase in manufacturing development expenses in 1995 when compared to 1994 is
primarily attributable to increases in staffing costs ($503,000) and consulting
expenses ($78,000).
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<PAGE>
Clinical and regulatory expenses: Clinical and regulatory expenses
increased to $1,168,187 during 1997 from $791,481 during 1996 and $338,592
during 1995. The increase in clinical and regulatory expenses in 1997 is
primarily attributed to increases in staffing costs ($427,000) which were
partially offset by decreases in consulting expenses ($95,000). The increase in
clinical and regulatory expenses in 1996 when compared to 1995 is primarily
attributable to increases in staffing costs ($245,000) and consulting expenses
($116,000). The increase in clinical and regulatory expenses in 1995 when
compared to 1994 is primarily attributable to increases in staffing costs
($155,000) and consulting expenses ($63,000).
General and administrative expenses: General and administrative
expenses increased to $2,681,615 during 1997 from $1,749,467 during 1996 and
$912,842 during 1995. The increase in general and administrative expenses in
1997 included a special charge totaling $654,000 associated with the planned
resignation of the Company's President and Chief Executive Officer in 1998. The
remaining increase in general and administrative expenses in 1997 is primarily
attributable to increases in staffing costs ($126,000) and various insurance,
investor and director costs associated with being a public company ($219,000),
which were partially offset by lower consulting expenses ($76,000). The increase
in general and administrative expenses in 1996 when compared to 1995 is
primarily attributable to increases in staffing costs ($298,000), various
insurance, investor and director costs associated with being a public company
($282,000) and consulting expenses ($120,000). The increase in general and
administrative expenses in 1995 when compared to 1994 is primarily attributable
to higher staffing costs.
Sales and marketing expenses: Sales and marketing expenses totaled
$779,732, $953,112 and $399,947 during 1997, 1996 and 1995, respectively. The
decrease in sales and marketing expenses in 1997 is primarily attributable to
lower staffing costs. The increase in sales and marketing expenses in 1996 when
compared to 1995 is primarily attributable to increases in staffing costs. The
increase in sales and marketing expenses in 1995 when compared to 1994 is
primarily attributable to higher staffing costs ($129,000) and higher expenses
associated with market research and other marketing programs ($103,000).
Interest income: Interest income increased to $1,564,190 during 1997
from $1,306,460 during 1996 and $580,840 in 1995. The increase in interest
income in 1997 and 1996 resulted from higher average balances of cash and cash
equivalents resulting from the investment of net proceeds totaling approximately
$26 million received in July 1996 from the Company's initial public offering.
Interest expense: Interest expense increased to $684,001 during 1997
from $226,959 during 1996 and $348,719 in 1995. The increase in interest
expense in 1997 is attributable to increased borrowings against the line of
credit agreement signed in 1996. Approximately $3 million was borrowed in 1997
as compared to $1.3 million in 1996. The decrease in interest expense in 1996
when compared to 1995 is primarily attributable to the conversion of $2.9
million of bridge loan debt into Series E Preferred Stock in June 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations since inception have been funded by net
proceeds from the sale of Common and Preferred Stock totaling approximately $52
million and proceeds from borrowing under an equipment loan agreement totaling
approximately $4.3 million. As of December 31, 1997 the Company had cash and
cash equivalents of approximately $21.8 million and working capital of $19.6
million.
In 1998, the Company expects to focus its resources on resolving the
remaining technical issues in order for the LifeGuide System to meet its
required specifications. As a result of the uncertain nature of developing a
product of this type, the Company is not able to estimate how long it will take
to achieve the required performance level of the LifeGuide System. The Company
expects to continue to use cash at a rate between $3 million and $4 million per
quarter until such time as it resolves these remaining technical issues. The
Company believes that, at this rate of spending, its current cash balances, when
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<PAGE>
combined with the $8.2 million unused portion of its line of credit facility,
will be sufficient to fund its operations through approximately the third
quarter of 1999. However, the Company expects that if it is successful at
resolving the above mentioned technical issues, the use of cash for operations
and capital equipment investments will increase substantially as it prepares for
clinical trials and the market launch of the LifeGuide System. If the Company
were able to resolve the above mentioned technical issues in the first half of
1998, the Company would need to raise additional debt or equity capital during
the second half of 1998. The Company's future liquidity and capital
requirements will depend on numerous factors, including when or if the
performance of the LifeGuide System will meet the required performance
specifications, the extent to which the Company's LifeGuide System gains market
acceptance, the timing of regulatory actions regarding the LifeGuide System, the
costs and timing of expansion of sales, marketing and manufacturing activities,
the results of clinical trials, and competition. See Exhibit 99.1 to this Form
10-K for a more detailed description of the factors that may affect the
Company's future liquidity and capital requirements.
The Company believes that inflation has not had a material impact on
its operations or liquidity to date.
YEAR 2000 IMPACT ON COMPUTER SYSTEMS
The Company is currently conducting an inventory of all its computer
systems. Software vendors will be contacted to verify year 2000 compliance, and
where possible and deemed necessary, the Company's systems will be tested. The
Company expects that all testing and replacing necessary will be completed by
the first quarter of 1999. The Company does not anticipate that its expenses in
becoming year 2000 compliant or the inability of any of the Company's suppliers
or vendors to become year 2000 compliant will have a material adverse effect on
the Company's results of operations, liquidity or capital resources.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements and notes thereto are included on
pages F-1 to F-24 of this report. See Index to Financial Statements at page F
for a listing of the financial information filed with this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained under the heading "Election of Directors" in
the Proxy Statement is incorporated herein by reference. The information
contained under the heading "Executive Officers of the Registrant" in Part I
hereof is also incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained under the headings "Compensation of
Directors" and "Executive Compensation" in the Proxy Statement is incorporated
herein by reference, except that the information set forth under the caption
"Report of Compensation Committee on Executive Compensation" and the
"Comparative Stock Performance" graph are not incorporated herein by reference.
-19-
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained under the heading "Principal Shareholders"
in the Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained under the heading "Certain Transactions" in
the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K
(a) Exhibits, Financial Statements and Financial Statement Schedules
1. Financial Statements
The Company's financial statements are attached hereto beginning at
page F-1. See Index to Financial Statements at page F.
2. Financial Statement Schedules
All financial statement schedules are omitted since the required
information is not represented or is not present in amounts sufficient to
require submission of such schedules, or because the information required is
included in the financial statements and notes thereto.
3. Exhibits
Exhibit
Number Description
------ -----------
3.1 Amended and Restated Articles of Incorporation of the
Company (incorporated by reference to Exhibit 3.2 to the
Company's Registration Statement on Form S-1 (SEC File No.
333-4352))
3.2 Amended Bylaws of the Company (incorporated by reference to
Exhibit 3.3 to the Company's Registration Statement on Form
S-1 (SEC File No. 333-4352))
4.1 Amended and Restated Articles of Incorporation of the
Company (incorporated by reference to Exhibit 3.2 to the
Company's Registration Statement on Form S-1 (SEC File No.
333-4352))
4.2 Form of Stock Warrant for Shares of Common Stock
(incorporated by reference to Exhibit 4.2 to the Company's
Registration Statement on Form S-1 (SEC File No. 333-4352))
4.3 Form of Stock Warrant for Shares of Series D Convertible
Preferred Stock (incorporated by reference to Exhibit 4.3 to
the Company's Registration Statement on Form S-1 (SEC File
No. 333-4352))
4.4 Form of Purchase Warrant for Shares of Series E-2
Convertible Preferred Stock (incorporated by reference to
Exhibit 4.4 to the Company's Registration Statement on Form
S-1 (SEC File No. 333-4352))
-20-
<PAGE>
4.5 Warrant to Purchase Shares of Common Stock, dated March 27,
1996, to Venture Lending & Leasing, Inc. (incorporated by
reference to Exhibit 4.5 to the Company's Registration
Statement on Form S-1 (SEC File No. 333-4352))
4.6 Registration Rights Provisions applicable to shares of
Preferred Stock (which were automatically converted into
Common Stock upon the closing of the Company's initial
public offering on July 1, 1996) (incorporated by reference
to Exhibit 4.6 to the Company's Registration Statement on
Form S-1 (SEC File No. 333-4352))
4.7 Rights Agreement, dated November 26, 1996, between the
Company and Norwest Bank Minnesota, N.A., as Rights Agent
(incorporated by reference to Exhibit 1 to the Company's
Registration Statement on Form 8-A, dated December 6, 1996
(SEC file number 0-28420))
10.1 Real Property Lease Agreement dated June 14, 1994 between
the Company and Commers-Klodt III, and Amendment thereto
dated November 6, 1995 (incorporated by reference to Exhibit
10.1 to the Company's Registration Statement on Form S-1
(SEC File No. 333-4352))
10.2 Equipment Sublease Agreement dated August 15, 1992, between
the Company and FIM, Inc. (incorporated by reference to
Exhibit 10.2 to the Company's Registration Statement on Form
S-1 (SEC File No. 333-4352))
10.3 Equipment Sublease Agreement dated July 14, 1994, between
the Company and FIM II, Inc. (incorporated by reference to
Exhibit 10.3 to the Company's Registration Statement on Form
S-1 (SEC File No. 333-4352))
10.4 Loan Agreement dated March 27, 1996, between the Company and
Venture Lending & Leasing, Inc. (incorporated by reference
to Exhibit 10.4 to the Company's Registration Statement on
Form S-1 (SEC File No. 333-4352))
10.5 Amendment dated August 7, 1997 to the Loan Agreement dated
March 27, 1996, between the Company and Venture Lending &
Leasing, Inc. (incorporated by reference to Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 1997 (SEC file number 0-28420))
10.6 *1990 Incentive and Stock Option Plan, including form of
option agreement (incorporated by reference to Exhibit 10.5
to the Company's Registration Statement on Form S-1 (SEC
File No. 333-4352))
10.7 *1991 Incentive and Stock Option Plan, including form of
option agreement (incorporated by reference to Exhibit 10.6
to the Company's Registration Statement on Form S-1 (SEC
File No. 333-4352))
10.8 *1994 Long-Term Incentive and Stock Option Plan (as revised
and restated), including form of option agreement
(incorporated by reference to Exhibit 10.7 to the Company's
Registration Statement on Form S-1 (SEC File No. 333-4352))
10.9 *1996 Directors' Stock Option Plan (incorporated by
reference to Exhibit 10.8 to the Company's Registration
Statement on Form S-1 (SEC File No. 333-4352))
10.10 *Restricted Stock Award Agreement dated August 9, 1994
between the Company and Frank A. Solomon (incorporated by
reference to Exhibit 10.9 to the Company's Registration
Statement on Form S-1 (SEC File No. 333-4352))
-21-
<PAGE>
10.11 *Amendment to Promissory Note dated August 15, 1996 from
Frank A. Solomon to the Company (incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the fiscal quarter ended September 30, 1996 (SEC
file number 0-28420))
10.12 Form of Stock Option from the Company to Medical Innovation
Fund (for options granted outside of the Stock Option Plans)
(incorporated by reference to Exhibit 10.10 to the Company's
Registration Statement on Form S-1 (SEC File No. 333-4352))
10.13 *Consulting Agreement dated March 14, 1997 between the
Company and Mark B. Knudson (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 31, 1997 (SEC file number
0-28420))
10.14 *Change in Control Agreement dated May 1, 1996 between the
Company and Frank A. Solomon (incorporated by reference to
Exhibit 10.13 to the Company's Registration Statement on
Form S-1 (SEC File No. 333-4352))
10.15 *Form of Change in Control Agreement between the Company and
its Vice Presidents (incorporated by reference to Exhibit
10.14 to the Company's Registration Statement on Form S-1
(SEC File No. 333-4352))
23.1 Consent of Ernst & Young LLP
23.2 Consent of Moore & Hansen
24 Powers of Attorney
27 Financial Data Schedules
99.1 Cautionary Statement for Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform Act
of 1995
___________________
* Denotes management contracts and compensatory plans, contracts, and
arrangements.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the
fourth quarter of 1997.
-22-
<PAGE>
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 30, 1998 INTEG INCORPORATED
By: /s/ Frank A. Solomon
-------------------------------------
Frank A. Solomon
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 30, 1998.
/s/ Frank A. Solomon
- -------------------------------------
Frank A. Solomon, President, Chief Executive Officer, March 30, 1998
Acting Chief Financial Officer (principal executive
officer, principal financial and accounting officer)
and Director
* March 30, 1998
- -------------------------------------
Mark B. Knudson, Ph.D, Director
* March 30, 1998
- -------------------------------------
Frank B. Bennett, Director
* March 30, 1998
- -------------------------------------
Terrance G. McGuire, Director
* March 30, 1998
- -------------------------------------
Robert R. Momsen, Director
* March 30, 1998
- -------------------------------------
Robert S. Nickoloff, Director
* March 30, 1998
- -------------------------------------
Walter L. Sembrowich, Ph.D, Director
* March 30, 1998
- -------------------------------------
Winston R. Wallin, Director
*By: /s/ Frank A. Solomon
---------------------------------
Frank A. Solomon
Attorney-in-Fact**
_______________
** Executed on behalf of the indicated persons by Frank A. Solomon pursuant
to the Power of Attorney included as Exhibit 24 to this annual report.
-23-
<PAGE>
Integ Incorporated
Index to Financial Statements
-----------------------------
<TABLE>
<CAPTION>
Page Number
------------
<S> <C>
Report of Independent Auditors F-1
Balance Sheets as at December 31, 1997 and December 31, 1996 F-2
Statements of Operations for the Years Ended December 31, 1997, F-3
1996 and 1995 and for the period from April 3, 1990 (inception) to
December 31, 1997
Statements of Shareholders' Equity from April 3, 1990 (inception) F-4 to F-8
to December 31, 1997
Statements of Cash Flows for the Years Ended December 31, 1997, F-9 to F-10
1996 and 1995 and for the period from April 3, 1990 (inception) to
December 31, 1997
Notes to Financial Statements F-11 to F-24
</TABLE>
<PAGE>
Report of Independent Auditors
Board of Directors
Integ Incorporated
We have audited the accompanying balance sheets of Integ Incorporated (a
development stage company) as of December 31, 1997 and 1996 and the related
statements of operations, changes in shareholders' equity (deficiency) and cash
flows for each of the three years in the period ended December 31, 1997, and for
the period from April 3, 1990 (inception) to December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Integ Incorporated at December
31, 1997 and 1996 and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 1997, and for the period
from April 3, 1990 (inception) to December 31, 1997, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
February 13, 1998
F-1
<PAGE>
Integ Incorporated
(A Development Stage Company)
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------------
1997 1996
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 21,776,757 $ 33,879,608
Receivables 113,254
Prepaid expenses 137,037 157,933
------------ ------------
Total current assets 21,913,794 34,150,795
------------ ------------
Furniture and equipment 8,464,943 3,701,648
Less accumulated depreciation (1,644,051) (821,476)
------------ ------------
6,820,892 2,880,172
Other assets 481,607 684,933
------------ ------------
Total assets $ 29,216,293 $ 37,715,900
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 1,384,551 $ 1,236,348
Current portion of capital lease obligations 155,901 140,167
Current portion of long-term debt 799,913 197,110
------------ ------------
Total current liabilities 2,340,365 1,573,625
------------ ------------
Long-term liabilities:
Capital lease obligations, less current portion 159,673 306,995
Long-term debt, less current portion 2,870,061 991,489
------------ ------------
Total long-term liabilities 3,029,734 1,298,484
------------ ------------
Shareholders' equity:
Common Stock, par value $.01 per share:
Authorized shares 20,000,000
Issued and outstanding shares 9,366,666 - 1997;
9,275,704 1996 93,667 92,757
Additional paid-in capital 54,518,671 54,269,333
Deficit accumulated during the development stage (30,438,348) (18,873,957)
------------ ------------
24,173,990 35,488,133
Deferred compensation (327,796) (644,342)
------------ ------------
Total shareholders' equity 23,846,194 34,843,791
------------ ------------
Total liabilities and shareholders' equity $ 29,216,293 $ 37,715,900
============ ============
</TABLE>
See accompanying notes.
F-2
<PAGE>
Integ Incorporated
(A Development Stage Company)
Statements of Operations
<TABLE>
<CAPTION>
APRIL 3, 1990
YEAR ENDED DECEMBER 31 (INCEPTION) TO
-------------------------------------------- DECEMBER 31,
1997 1996 1995 1997
------------ ----------- ----------- --------------
<S> <C> <C> <C> <C>
Operating expenses:
Research and development $ 5,318,900 $ 4,802,773 $ 2,824,057 $ 16,086,149
Manufacturing development 2,513,224 1,623,122 805,413 4,997,189
Clinical and regulatory 1,168,187 791,481 338,592 2,369,374
General and administrative 2,681,615 1,749,467 912,842 6,804,184
Sales and marketing 779,732 953,112 399,947 2,195,850
------------ ----------- ----------- ------------
12,461,658 9,919,955 5,280,851 32,452,746
------------ ----------- ----------- ------------
Operating loss (12,461,658) (9,919,955) (5,280,851) (32,452,746)
Other income (expense):
Interest income 1,564,190 1,306,460 580,840 3,538,878
Interest expense (684,001) (226,959) (348,719) (1,298,580)
Other 17,078 (242,978) (225,900)
------------ ----------- ----------- ------------
897,267 836,523 232,121 2,014,398
------------ ----------- ----------- ------------
Net loss for the period
and deficit accumulated
during development stage $(11,564,391) $(9,083,432) $(5,048,730) $(30,438,348)
============ =========== =========== ============
Net loss per share
Basic and diluted $(1.24) $(1.86) $(11.65) $(17.40)
============ =========== =========== ============
Weighted average number of
common shares outstanding
Basic and diluted 9,305,332 4,889,245 433,333 1,749,273
============ =========== =========== ============
</TABLE>
See accompanying notes.
F-3
<PAGE>
Integ Incorporated
(A Development Stage Company)
Statement of Changes in Shareholders' Equity (Deficiency)
<TABLE>
<CAPTION>
DEFICIT
CONVERTIBLE ACCUMULATED
PREFERRED COMMON STOCK ADDITIONAL DURING THE
-------------- --------------- PAID-IN DEVELOPMENT DEFERRED
SHARES AMOUNT SHARES AMOUNT CAPITAL STAGE COMPENSATION TOTAL
------ ------ ------- ------ ---------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Founders' Common Stock issued during
April 1990 at $.015 per share -- $ -- 250,000 $2,500 $ 1,250 $ -- $ -- $ 3,750
Net loss for the period -- -- -- -- -- (290,900) -- (290,900)
------ ------ ------- ------ ---------- ----------- ------------ ----------
Balance at December 31, 1990 -- -- 250,000 2,500 1,250 (290,900) -- (287,150)
Net loss for the year -- -- -- -- -- (622,016) -- (622,016)
------ ------ ------- ------ ---------- ----------- ------------ ----------
Balance at December 31, 1991 -- -- 250,000 2,500 1,250 (912,916) -- (909,166)
Net loss for the year -- -- -- -- -- (653,934) -- (653,934)
------ ------ ------- ------ ---------- ----------- ------------ ----------
Balance at December 31, 1992 -- -- 250,000 2,500 1,250 (1,566,850) -- (1,563,100)
Net loss for the year -- -- -- -- -- (682,725) -- (682,725)
------ ------ ------- ------ ---------- ----------- ------------ ----------
Balance at December 31, 1993 -- -- 250,000 2,500 1,250 (2,249,575) -- (2,245,825)
Deferred compensation related to
restricted stock grant -- -- 183,333 1,833 149,417 -- (151,250) --
Net loss for the year -- -- -- -- -- (2,492,220) -- (2,492,220)
------ ------ ------- ------ ---------- ---------- ------------ ----------
Balance at December 31, 1994
(carried forward) -- -- 433,333 4,333 150,667 (4,741,795) (151,250) (4,738,045)
</TABLE>
F-4
<PAGE>
Integ Incorporated
(A Development Stage Company)
Statement of Changes in Shareholders' Equity (Deficiency) (continued)
<TABLE>
<CAPTION>
DEFICIT
CONVERTIBLE ACCUMULATED
PREFERRED COMMON STOCK ADDITIONAL DURING THE
-------------- --------------- PAID-IN DEVELOPMENT DEFERRED
SHARES AMOUNT SHARES AMOUNT CAPITAL STAGE COMPENSATION TOTAL
------ ------ ------- ------ ---------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994
(brought forward) -- $ -- 433,333 $4,333 $ 150,667 $(4,741,795) $(151,250) $(4,738,045)
Previously issued redeemable convertible
preferred stock; all shareholders agreed
to cancel their respective redemption
privileges during June 1995:
Series A Convertible Preferred,
authorized 928,571 shares, liquidating
preference of $.56 per share, sold
during April and November 1990 928,571 9,286 -- -- 510,714 -- -- 520,000
Series B Convertible Preferred,
authorized 800,000 shares, liquidating
preference of $1.00 per share, sold
during May 1991 800,000 8,000 -- -- 792,000 -- -- 800,000
Series C Convertible Preferred,
authorized 356,000 shares, liquidating
preference of $2.50 per share, sold
during January 1992 to
May 1993 346,000 3,460 -- -- 861,540 -- -- 865,000
Series D Convertible Preferred,
authorized 1,209,731 shares,
liquidating preference of $2.75 per
share, less offering expenses of
$7,245, sold during February and May
1994 1,074,372 10,743 -- -- 2,936,534 -- -- 2,947,277
</TABLE>
F-5
<PAGE>
Integ Incorporated
(A Development Stage Company)
Statement of Changes in Shareholders' Equity (Deficiency) (continued)
<TABLE>
<CAPTION>
DEFICIT
CONVERTIBLE ACCUMULATED
PREFERRED COMMON STOCK ADDITIONAL DURING THE
--------------- ---------------- PAID-IN DEVELOPMENT DEFERRED
SHARES AMOUNT SHARES AMOUNT CAPITAL STAGE COMPENSATION TOTAL
------ ------ ------- ------ ---------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Series E Convertible Preferred Class 1,
authorized 5,879,655, liquidating
preference of $4.00 per share, less
offering expenses of $1,861,168, sold
during June 1995 5,604,655 $56,047 -- $ -- $20,501,405 $ -- $ -- $20,557,452
Value of warrants to purchase Preferred
Stock issued in connection with bridge
loan financing -- -- -- -- 179,800 -- -- 179,800
Value of stock options to purchase Common
Stock issued for consulting services -- -- -- -- 24,000 -- -- 24,000
Value of options and warrants to purchase
Common Stock issued in connection with
guarantee of leases -- -- -- -- 104,841 -- -- 104,841
Value related to the extension of the
exercise period of certain stock options
previously granted to individuals -- -- -- -- 6,750 -- -- 6,750
Deferred compensation related to stock
options -- -- -- -- 960,208 -- (960,208) --
Amortization of deferred compensation -- -- -- -- -- -- 187,106 187,106
Net loss for the year -- -- -- -- -- (5,048,730) -- (5,048,730)
------ ------ ------- ------ ---------- ----------- ------------ ----------
Balance at December 31, 1995
(carried forward) 8,753,598 87,536 433,333 4,333 27,028,459 (9,790,525) (924,352) 16,405,451
</TABLE>
F-6
<PAGE>
Integ Incorporated
(A Development Stage Company)
Statement of Changes in Shareholders' Equity (Deficiency) (continued)
<TABLE>
<CAPTION>
DEFICIT
CONVERTIBLE ACCUMULATED
PREFERRED COMMON STOCK ADDITIONAL DURING THE
--------------- ---------------- PAID-IN DEVELOPMENT DEFERRED
SHARES AMOUNT SHARES AMOUNT CAPITAL STAGE COMPENSATION TOTAL
------ ------ ------- ------ ---------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995
(brought forward) 8,753,598 $ 87,536 433,333 $ 4,333 $27,028,459 $ (9,790,525) $(924,352) $16,405,451
Value of warrants to purchase
Common Stock issued in
connection with equipment
loan agreement -- -- -- -- 874,416 -- -- 874,416
Shares issued in connection
with initial public offering
less offering expenses of
$2,375,706 -- -- 3,000,000 30,000 26,094,294 -- -- 26,124,294
Conversion of preferred stock (8,753,598) (87,536) 5,835,705 58,357 29,179 -- -- --
Shares issued pursuant to
exercise of stock options -- -- 6,666 67 7,056 -- -- 7,123
Deferred compensation related
to stock options -- -- -- -- 56,329 -- (56,329) --
Value of options granted
to purchase Common Stock
issued for consulting
services -- -- -- -- 179,600 -- (179,600) --
Amortization of deferred
compensation -- -- -- -- -- -- 515,939 515,939
Net loss for the year -- -- -- -- -- (9,083,432) -- (9,083,432)
--------- -------- ------- ------- ----------- ------------ --------- -----------
Balance at December 31, 1996
(carried forward) -- -- 9,275,704 92,757 54,269,333 (18,873,957) (644,342) 34,843,791
</TABLE>
F-7
<PAGE>
Integ Incorporated
(A Development Stage Company)
Statement of Changes in Shareholders' Equity (Deficiency) (continued)
<TABLE>
<CAPTION>
DEFICIT
CONVERTIBLE ACCUMULATED
PREFERRED COMMON STOCK ADDITIONAL DURING THE
--------------- ----------------- PAID-IN DEVELOPMENT DEFERRED
SHARES AMOUNT SHARES AMOUNT CAPITAL STAGE COMPENSATION TOTAL
------ ------ -------- ------ ---------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996
(brought forward) -- $ -- 9,275,704 $92,757 $54,269,333 $(18,873,957) $(644,342) $ 34,843,791
Shares issued pursuant to employee
stock purchase plan and exercise
of stock options -- -- 69,154 692 111,624 -- -- 112,316
Shares issued pursuant to exercise of
warrants, net of 9,303 redeemed -- -- 21,808 218 66,444 -- -- 66,662
Amortization of deferred compensation -- -- -- -- -- -- 294,484 294,484
Deferred compensation adjustment
for cancellation of stock options -- -- -- -- (22,062) -- 22,062 --
Value related to the acceleration of
vesting and extension of the exercise
period of certain stock options
previously granted to an officer and
director -- -- -- -- 93,332 -- -- 93,332
Net loss for the year -- -- -- -- -- (11,564,391) -- (11,564,391)
------ ------ -------- ------- ----------- ------------ ------------ ------------
Balance at December 31, 1997 -- $ -- 9,366,666 $93,667 $54,518,671 $(30,438,348) $(327,796) $ 23,846,194
====== ====== ======== ======= =========== ============ ============ ============
</TABLE>
See accompanying notes.
F-8
<PAGE>
Integ Incorporated
(A Development Stage Company)
Statements of Cash Flows
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 3, 1990
YEAR ENDED DECEMBER 31 (INCEPTION) TO
------------------------------------------------- DECEMBER 31,
1997 1996 1995 1997
------------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss $(11,564,391) $(9,083,432) $(5,048,730) $(30,438,348)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation 824,348 543,717 203,184 1,680,216
Deferred compensation amortization 294,484 515,939 187,106 997,529
Amortization of loan commitment fee 77,463 172,611 250,074
Loss on sale of equipment and deposit
write-off 27,436 68,209 95,645
Value of options and warrants related
to debt financing, lease guarantee,
extension of options and consulting
services 116,334 23,321 231,481 371,136
Changes in operating assets and
liabilities:
Receivables 84,425 (72,261) 8,648 (28,829)
Prepaid expenses and other assets (7,213) (90,682) (109,757) (230,007)
Accounts payable and accrued
expenses 148,203 860,535 156,097 1,384,551
------------- ------------ ------------ -------------
Net cash used in operating activities (9,998,911) (7,062,043) (4,371,971) (25,918,033)
------------- ------------ ------------ -------------
INVESTING ACTIVITIES:
Purchase of furniture and equipment (4,756,243) (2,095,773) (884,931) (7,794,715)
Proceeds from sale of furniture and
equipment 3,750 18,500 46,829
------------- ------------ ------------ -------------
Net cash used in investing activities (4,752,493) (2,077,273) (884,931) (7,747,886)
------------- ------------ ------------ -------------
FINANCING ACTIVITIES:
Proceeds from sale of Convertible
Preferred Stock 17,657,452 22,789,732
Proceeds from bridge loan debt 2,900,000 2,900,000
Proceeds from borrowings under loan
agreement 2,995,879 1,352,274 4,348,153
Payments on long-term debt (383,533) (147,330) (530,863)
Payments on capital lease obligations (142,771) (81,575) (38,370) (378,491)
Proceeds from sale of Common Stock 178,978 26,131,417 26,314,145
------------- ------------ ------------ -------------
Net cash provided by financing activities 2,648,553 27,254,786 20,519,082 55,442,676
------------- ------------ ------------ -------------
(Decrease) increase in cash and cash
equivalents (12,102,851) 18,115,470 15,262,180 21,776,757
Cash and cash equivalents at beginning of
period 33,879,608 15,764,138 501,958
------------- ------------ ------------ -------------
Cash and cash equivalents at end of period $ 21,776,757 $33,879,608 $15,764,138 $ 21,776,757
============= ============ ============ =============
</TABLE>
F-9
<PAGE>
Integ Incorporated
(A Development Stage Company)
Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
Period from
April 3, 1990
YEAR ENDED DECEMBER 31 (Inception) to
--------------------------------------- DECEMBER 31,
1997 1996 1995 1997
------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Fixed assets capitalized under capital lease and
loan agreements $11,182 $ -- $ 130,260 $ 141,442
The Company converted $2,900,000 of debt into
Series E Convertible Preferred Stock. $ -- $ -- $2,900,000 $2,900,000
</TABLE>
See accompanying notes.
F-10
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements
December 31, 1997
1. DESCRIPTION OF BUSINESS
Integ Incorporated was formed in April 1990 and is a development stage company
engaged in the development of a hand-held glucose monitoring product for use by
people with diabetes that avoids the pain and blood associated with conventional
"finger stick" technology. Utilizing the Company's proprietary interstitial
fluid sampling technology, the Lifeguide System will allow people with diabetes
to frequently monitor their glucose levels without repeatedly enduring the pain
of lancing their fingers to obtain a blood sample.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with a maturity of
three months or less when purchased to be cash equivalents. At December 31, 1996
and 1997, the Company's cost of investments in government securities
approximated market value, with no resulting unrealized gains and losses
recognized. The cash equivalents are considered available-for-sale.
FURNITURE AND EQUIPMENT
Furniture and equipment are recorded at cost and depreciated primarily on a
straight-line basis over estimated useful lives of three to five years.
INCOME TAXES
The Company accounts for income taxes under the liability method. Deferred
income taxes are provided for temporary differences between the financial
reporting and tax bases of assets and liabilities.
STOCK COMPENSATION PLANS
The Company follows Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees ("APB 25"), and related interpretations in accounting
for its stock options. Under APB 25, when the exercise price of stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
F-11
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
2. Summary of Significant Accounting Policies (CONTINUED)
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
("Statement 123"). The Company adopted the disclosure only provisions of
Statement 123. Accordingly, the Company has made pro forma disclosures of what
net loss and loss per share would have been had the provisions of Statement 123
been applied to the Company's stock options.
NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of shares of
common stock outstanding during the periods presented. In 1997, the Financial
Accounting Standards Board issued Statement No. 128, Earnings per Share.
Statement 128 replaced the calculation of primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Diluted earnings per share is very similar
to the previously reported fully diluted earrings per share. All earnings per
share amounts for all periods have been presented, and where appropriate,
restated to conform to the Statement 128 requirements.
AUTOMATIC CONVERSION OF PREFERRED STOCK
Upon the closing of the initial public offering on July 1, 1996, all outstanding
shares of convertible preferred stock were automatically converted into an
aggregate of 5,835,705 shares of common stock.
RECLASSIFICATIONS
Certain amounts in the 1995 and 1996 financial statements have been reclassified
to conform with the 1997 presentation.
F-12
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
3. CAPITAL AND OPERATING LEASES
The Company leases its office facility and certain office equipment under
operating leases. Rent expense of $251,724, $369,880 and $432,686 was recorded
for noncancelable operating leases and sub-leases for the years ended
December 31, 1995, 1996 and 1997, respectively. Future minimum lease commitments
for operating leases with remaining terms in excess of one year, excluding
executory costs such as real estate taxes, insurance and maintenance expense,
are payable as follows:
Year ending December 31:
1998 $ 393,498
1999 398,931
2000 299,057
----------
$1,091,486
==========
The Company leases certain furniture and laboratory and office equipment under
other leases which are accounted for as capital leases for financial statement
purposes. The cost of furniture and equipment in the accompanying balance sheets
includes the following amounts under capital leases:
DECEMBER 31
1997 1996
--------- ---------
Cost $ 665,499 $ 686,449
Less accumulated amortization (471,566) (323,393)
--------- ---------
$ 193,933 $ 363,056
========= =========
F-13
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
3. CAPITAL AND OPERATING LEASES (CONTINUED)
Future minimum lease payments required under capital leases together with the
present value of the net future minimum lease payments at December 31, 1997 are
as follows:
Year ending December 31:
1998 $ 178,883
1999 153,674
2000 14,218
---------
Total minimum lease payments 346,775
Less amount representing interest (31,201)
---------
Present value of net minimum payments 315,574
Less current portion (155,901)
---------
Capital lease obligations, net of current portion $ 159,673
=========
4. LONG-TERM DEBT
During 1996, the Company entered into an equipment loan agreement which provides
for borrowings up to $12.5 million to finance the purchase of equipment and
fixtures including automated manufacturing equipment and tooling. Loans are paid
back monthly over a four year period. The obligation of the lender to make
additional loans expires December 31, 1998. The Company borrowed $1,352,274 and
$2,995,879 in 1996 and 1997, respectively, under this agreement.
<TABLE>
<CAPTION>
DECEMBER 31
1997 1996
------------- --------------
<S> <C> <C>
10.65% note payable for equipment loan, due in monthly installments
of $26,495 through February 2000, and $138,962 due April 2000 $ 643,577 $ 813,120
10.65% note payable for equipment loan, due in monthly installments
of $12,082 through November 2000, and $63,879 due January 2001 347,912 375,479
10.65% note payable for equipment loan, due in monthly installments
of $49,636 through February 2001, and $262,439 due April 2001 1,530,634 --
10.90% note payable for equipment loan, due in monthly installments
of $35,507 through August 2001, and $186,943 due October 2001 1,147,851 --
------------- --------------
3,669,974 1,188,599
Less current portion (799,913) (197,110)
------------- --------------
Long-term debt, net of current portion $2,870,061 $ 991,489
============= ==============
</TABLE>
F-14
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
5. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND PREFERRED STOCK
During June 1995, all holders of Series A, B, C and D Convertible Preferred
Stock agreed to cancel the redemption privileges.
Series A, B, C, D and E Convertible Preferred Shares were automatically
converted three shares of preferred into two shares of common stock upon the
closing of the public offering of the Company's securities on July 1, 1996.
During June 1995, the Company received net proceeds of $20,557,452 from the sale
of 5,604,655 shares of its Series E Convertible Preferred Stock, Class 1. During
January 1995, in anticipation of this pending offering, the Company received
proceeds of $2,900,000 and issued one-year, 8.5% promissory notes under a bridge
loan arrangement with certain investors, including $1,500,000 received from
Medical Innovation Fund II (MIF II) and $500,000 received from Artesian
Management, Inc. (Artesian), both significant shareholders of the Company. Upon
consummation of the offering in June 1995, these promissory notes and all
accrued interest thereon totaling $2,987,620 were automatically converted into
746,905 shares of Series E Convertible Preferred Stock, Class 1, at $4.00 per
share. In connection with such bridge financing, investors received warrants for
the purchase of 429,630 shares of Series E Convertible Preferred Stock, Class 2,
at $3.375 per share (convertible into 286,420 shares of Common Stock at $5.06
per share), including warrants for 222,222 shares issued to MIF II and warrants
for 74,074 shares issued to Artesian. The liquidating preference of the Series E
Convertible Preferred Stock, Class 2, is $3.375 per share. The Company has
included $179,800 as additional interest expense during the year ended December
31, 1995 which represents the value of the warrants issued in connection with
the bridge loan (see Note 7).
6. UNDESIGNATED CAPITAL STOCK AUTHORIZATION AND STOCK SPLIT
On April 24, 1996, the Board of Directors approved a reverse stock split of 2-
for-3 for the Company's common stock. Accordingly, all share, per share,
weighted average share, and stock option information has been restated to
reflect the split. The reverse stock split impacted the conversion prices of the
preferred stock and the numbers of shares of common stock into which the
preferred stock would convert but had no effect upon the numbers of preferred
stock warrants and shares of preferred stock issued and outstanding.
F-15
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
6. UNDESIGNATED CAPITAL STOCK AUTHORIZATION AND STOCK SPLIT (CONTINUED)
Accordingly, all preferred stock and preferred stock price amounts have not been
adjusted for the reverse stock split. In addition, the Board of Directors
approved an increase in the authorized shares of capital stock to 25,000,000,
including 20,000,000 shares of common stock and 5,000,000 shares of undesignated
preferred stock.
7. STOCK OPTIONS AND WARRANTS
STOCK OPTIONS AND RESTRICTED STOCK GRANT
The Company has 1990, 1991 and 1994 stock option plans which provide for the
issuance of incentive and nonqualified stock options and restricted stock grants
to employees and consultants. Under the plans, the exercise price of options
granted is determined by the Company's Board of Directors, but incentive stock
options must be granted at exercise prices greater than or equal to the fair
market value of the Company's stock as of the grant date. A total of 2,213,333
shares of the Company's common stock have been reserved for issuance under all
three plans as of December 31, 1997.
Options outstanding were granted as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES PLAN NON-PLAN EXERCISE
AVAILABLE OPTIONS OPTIONS Price
FOR GRANT OUTSTANDING OUTSTANDING PER SHARE
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1994 31,017 298,983 42,993 $0.83
Shares reserved 400,000 -- -- --
Granted at market price (80,663) 80,663 -- 0.83
Granted below market price (351,963) 351,963 -- 1.14
Canceled 84,657 (84,657) -- 0.83
------------------------------------------------------
Balance at December 31, 1995 83,048 646,952 42,993 0.98
Shares reserved 1,300,000
Granted at market price (452,745) 452,745 -- 9.63
Granted below market price (81,747) 81,747 -- 8.81
Exercised (6,666) -- 1.07
Canceled 15,000 (15,000) -- 9.88
------------------------------------------------------
Balance at December 31, 1996 863,556 1,159,778 42,993 4.66
Granted at market price (618,625) 618,625 -- 6.26
Exercised (47,953) -- 0.84
Canceled 15,483 (15,483) -- 3.01
------------------------------------------------------
Balance at December 31, 1997 260,414 1,714,967 42,993 $5.34
======================================================
</TABLE>
F-16
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
The following table summarizes information about the stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------- ------------------------------------
WEIGHTED
AVERAGE
REMAINING WEIGHTED
RANGE OF EXERCISE NUMBER CONTRACTUAL WEIGHTED AVERAGE NUMBER AVERAGE
PRICES OUTSTANDING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ .83 - $1.20 635,240 6.69 years $ .99 452,794 $0.93
3.50 - $5.75 339,625 9.82 years 4.69
6.00 - $8.75 172,750 9.41 years 7.32 54,373 7.05
9.00 - $12.25 610,345 8.62 years 9.68 203,815 9.71
------------- -----------
$ .83 - $12.25 1,757,960 8.23 years $5.34 710,982 $3.92
============= ===========
</TABLE>
During 1991 and 1993, the Company granted options outside the plans to purchase
42,993 shares of the Company's common stock at $.83 per share to Medical
Innovation Fund ("MIF"), a significant shareholder of the Company (see Note 10).
Options outstanding expire at various dates during the period from October 2000
through December 2007. The number of options exercisable as of December 31,
1995, 1996 and 1997 were 295,427, 481,736 and 710,982, respectively, at weighted
average prices of $.94, $2.38 and $3.92 per share, respectively.
The weighted average grant date fair value of options granted at market prices
during the years ended December 31, 1995, 1996 and 1997 was $.62, $7.18 and
$4.92 per share, respectively. The weighted average grant date fair value of
options granted below market prices during the years ended December 31, 1995 and
1996 was $4.01 and $6.93 per share, respectively.
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB 25") and related Interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
Accounting for Stock-Based Compensation ("Statement 123"), requires use of
option valuation models that
F-17
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
were not developed for use in valuing employee stock options. Under APB 25, if
the exercise price of the Company's employee stock options equals or exceeds the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.
Pro forma information regarding net loss per share is required by Statement 123,
and has been determined as if the Company had accounted for its employee stock
options under the fair value method of Statement 123. The fair value for these
options was estimated at the date of grant using the Black-Scholes option
pricing model with the following weighted-average assumptions for 1995, 1996 and
1997: risk free interest rates of 6.37%, 6.59% and 6.33%, respectively; no
dividend yield; volatility factor of the expected market price of the Company's
common stock of .562, .562 and .656, respectively; and a weighted-average life
of the option of 10 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------------------------------------
<S> <C> <C> <C>
Pro forma net loss $(13,535,200) $(9,662,422) $(5,085,863)
Pro forma net loss per common share-basic and
diluted $ (1.45) $ (1.82) $ (2.44)
</TABLE>
F-18
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
The pro forma effect on net loss for 1995, 1996 and 1997 is not representative
of the pro forma effect on net loss in future years because it does not take
into consideration pro forma compensation expense related to grants made prior
to 1995.
DEFERRED COMPENSATION
During August 1994, the Company issued a restricted stock grant under the
Company's stock option plans to its President and Chief Executive Officer for
183,333 shares of common stock at a fair market value determined to be $.83 per
share in exchange for two promissory notes. The Company recognized $151,250 as
deferred compensation and is amortizing this amount ratably over the restriction
period of three years and, during the year ended December 31, 1995, 1996, and
1997, $109,937, $38,863, and $2,450 was expensed, respectively. In addition to
the shares being held by the Company until the restriction lapse occurs, the
President and Chief Executive Officer signed two notes in the amount of the fair
market value of the stock grant. In 1995 and 1996, $24,291 and $102,892,
respectively, of principal and accrued interest was forgiven and the Company
awarded this individual an additional bonus adequate to cover related income
taxes due on this debt forgiveness.
During 1995 and 1996 options were granted to purchase a total of 433,710 shares
of the Company's common stock at exercise prices below the current market price.
The Company recognized $960,208 and $56,329 during the years ended 1995 and
1996, respectively, as deferred compensation for the excess of the deemed value
for accounting purposes of the common stock issuable upon exercise of such
options over the aggregate exercise price of such options. The deferred
compensation is amortized ratably over the vesting period of the options. For
the years ended 1995, 1996 and 1997, $77,169, $477,076 and $314,096,
respectively, was expensed.
During 1996, the Company granted 30,000 options to certain advisors of the
Company. In accordance with FASB 123, the Company recognized $179,600 as
deferred compensation. The deferred compensation is amortized ratably over the
vesting period of the options. In 1996 and 1997, $65,279 and $87,835 was charged
to expense.
F-19
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
The remaining unamortized deferred compensation is expected to be charged to
operations as follows:
1998 $126,206
1999 67,233
2000 23,437
2001 23,338
2002 23,338
Thereafter 64,244
-----------
$327,796
===========
WARRANTS
In connection with the sale of Series C Convertible Preferred Stock during 1992
and 1993, the Company issued warrants to the holders for the purchase of
46,665 shares (including warrants for 13,333 shares issued to MIF (see Note 10),
and warrants for 17,778 shares issued to Artesian Capital Limited Partnership)
of its common stock exercisable immediately at a price of $3.75 per share. These
MIF and Artesian Capital Limited Partnership warrants were exercised in 1997 and
the remaining warrants expire at various dates during the period from January
1998 through May 1998. During May 1994 the Company issued warrants which expire
during May 1999 to a consultant/stockholder for the purchase of 6,666 shares of
common stock exercisable immediately at a price of $4.13 per share. The value of
these warrants was determined to be $24,000, based on the value of the services
received and was expensed. In addition, during March and December of 1994 and
June 1995 the Company issued warrants for the purchase of 159,042 shares of
Series D Convertible Preferred Stock (convertible into 106,027 shares of common
stock at $4.13 per share) to MIF II, exercisable immediately at $2.75 per share
(see Note 10). Warrants for the purchase of 27,273 shares expire during February
1999, warrants for the purchase of 108,085 shares expire during December 2004,
and warrants for the purchase of 23,684 shares expire during June 2005.
In connection with the bridge loan arrangement during January 1995 discussed in
Note 5, the Company issued warrants to investors for the purchase of 429,630
shares of Series E Convertible Preferred Stock, Class 2, at $3.375 per share
(convertible into 286,420 shares
F-20
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
of common stock at $5.06 per share). These warrants expire during January 2005.
The value of these warrants was determined to be $179,800 based on the
difference between the stated interest rate and the Company's estimated
effective borrowing rate for the term of the notes and was expensed as
additional interest expense during 1995.
In consideration of the equipment loan agreement discussed in Note 4, the
Company has agreed to issue warrants for the purchase of common stock equal to
8.8% of the total dollar value of the credit line available under the agreement.
Warrants are to be issued as the line is funded, or at the expiration date of
the line in December 1998 for any unfunded portion of the credit line. The value
of these warrants was determined to be $874,416 and will be expensed over the
term of the loan agreement. Each warrant is exercisable initially at $6.00 per
share or, subsequent to any equity financing, at 80% of the per share price of
each subsequent financing, if such occurs. Warrants for the purchase of 18,518
and 34,689 shares of common stock were issued in 1996 and 1997, respectively.
The weighted average exercise price of these warrants was $6.43 and $7.60,
respectively. These warrants expire in December 2003.
8. EMPLOYEE STOCK PURCHASE PLAN
The 1997 Employee Stock Purchase Plan (the Purchase Plan), as approved by the
shareholders on June 4, 1997, is a qualified plan pursuant to Internal Revenue
Code Section 423. The Purchase Plan allows eligible employees an opportunity to
purchase an aggregate of 300,000 shares of the Company's common stock through a
series of annual offerings for each calendar year (except for the initial
purchase period of the Purchase Plan which was for a six month period beginning
July 1, 1997). Payroll deductions between 1% and 10% of an employee's eligible
compensation may be used to purchase stock at a price per share equal to 85% of
the lesser of the fair market value of the Company's common stock at the
beginning or end of each purchase period. Under terms of the Purchase Plan, no
participant may acquire more than 10,000 shares of the Company's common stock or
more than $10,000 in aggregate fair market value of common stock (as determined
at the beginning of each purchase period) during any purchase period. Common
shares sold to employees under the Purchase Plan in 1997 totaled 21,201.
F-21
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
8. EMPLOYEE STOCK PURCHASE PLAN (CONTINUED)
The fair value of the employees' rights under the Purchase Plan is estimated at
the beginning of each purchase period (July 1 in 1997) using the Black-Scholes
model with the following assumptions: no dividend yield; an expected life of six
months; expected volatility of .656; and risk free interest rate of 6.50%. The
fair market value of each purchase right granted for the six month period ended
December 31, 1997 was $4.12.
9. INCOME TAXES
The Company has incurred net operating losses since inception. As of December
31, 1997, the Company had net operating losses (NOL) and research and
development tax credit carryforwards of approximately $11,123,000 and $642,000,
respectively, available to offset its future income tax liability. The NOL and
tax credit carryforwards begin to expire in the year 2005. No benefit has been
recorded for such loss carryforwards, and utilization in future years may be
limited, if significant ownership changes have occurred.
Components of deferred tax assets at December 31 are as follows:
DECEMBER 31
1997 1996
-----------------------------
Net operating loss and credit carryforward $ 4,757,000 $ 3,167,000
Start-up costs 6,825,000 4,129,000
Valuation allowance (11,582,000) (7,296,000)
-----------------------------
Net deferred tax assets $ $
=============================
10. RELATED PARTY TRANSACTIONS
Laboratory and office furniture and equipment used by the Company with an
original cost of approximately $801,000 as of December 31, 1996 and 1997 are
leased under sublease arrangements with FIM, Inc. and FIM II, Inc., both
entities related to the Company through MIF and MIF II, which are significant
shareholders of the Company. These leases are accounted for as capital leases
for financial statement purposes. In addition, MIF and MIF II have guaranteed
future lease payments, of which approximately $306,995 is
F-22
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
10. RELATED PARTY TRANSACTIONS (CONTINUED)
payable as of December 31, 1997. In consideration of such guarantee by MIF, the
Company issued nonqualified options to MIF for the purchase of 42,993 shares of
common stock exercisable immediately at a price of $.83 per share. Options for
30,523 shares expire during May 2001 and options for 12,470 shares expire during
April 2003. The value of these options was determined to be $20,878 based on the
difference between the stated interest rate and the Company's estimated
effective borrowing rate for the term of the lease. Approximately $6,600, $633
and $313 was charged to interest expense during the years ended December 31,
1995, 1996 and 1997, respectively, and the remainder will be amortized over the
term of the lease. In consideration of such guarantee by MIF II, the Company
issued warrants to MIF II for the purchase of 131,769 shares of Series D
Convertible Preferred Stock exercisable immediately at a price of $2.75 per
share which are convertible into 87,845 shares of common stock at $4.13 per
share. These warrants expire during the period from December 2004 through June
2005. The value of these warrants was determined to be $83,962 based on the
difference between the stated interest rate and the Company's estimated
effective borrowing rate for the term of the lease. Approximately $14,350,
$22,688 and $22,689 was charged to interest expense during the year ended
December 31, 1995, 1996 and 1997, respectively, and the remainder will be
amortized over the term of the lease.
In consideration of a bridge loan arrangement during 1993, the Company issued to
MIF II warrants for the purchase of 27,273 shares of Series D Convertible
Preferred Stock exercisable immediately at a price of $2.75 per share. These
warrants, which are convertible into 18,182 shares of common stock at $4.13 per
share, expire during February 1999.
In consideration of the bridge loan arrangement during January 1995 discussed in
Note 7, the Company issued to MIF II warrants for the purchase of 222,222 shares
of Series E Convertible Preferred Stock, Class 2, exercisable immediately at a
price of $3.375 per share which are convertible into 148,148 shares of common
stock at $5.06 per share. The value of these warrants was determined to be
$93,000 of the $179,800 total discussed in Note 7. These warrants expire during
January 2005.
F-23
<PAGE>
Integ Incorporated
(A Development Stage Company)
Notes to Financial Statements (continued)
10. RELATED PARTY TRANSACTIONS (CONTINUED)
From inception through December 31, 1995, the Company made payments under
consulting agreements with two directors, one of which is a limited partner of
MIF's general partner, and one shareholder. In 1995, the total expense under
these agreements was $129,000. In 1996 and 1997, the Company made payments under
a consulting agreement with a director who is a limited partner of MIF's general
partner totaling $81,000 per year.
F-24
<PAGE>
Integ Incorporated
Index of Exhibits
-----------------
Annual Report on Form 10-K
For the Year Ended December 31, 1997
Exhibit Page
Number Description Number
- -------- ----------- -----------
23.1 Consent of Ernst & Young LLP Filed Electronically
23.2 Consent of Moore & Hansen Filed Electronically
24 Powers of Attorney Filed Electronically
27 Financial Data Schedules Filed Electronically
99.1 Cautionary Statement for Purposes
of the "Safe Harbor" Provisions of
the Private Securities Litigation
Reform Act of 1995 Filed Electronically
<PAGE>
Exhibit 23.1
------------
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8) pertaining to the Integ Incorporated 1990 Incentive and Stock Option Plan,
1991 Incentive and Stock Option Plan, 1994 Long-Term Incentive and Stock Option
Plan, 1996 Directors' Stock Option Plan and 1997 Employee Stock Purchase Plan
of our report dated February 13, 1998, with respect to the financial statements
of Integ Incorporated for the three years ended December 31, 1997, included in
its Annual Report (Form 10-K) filed with the Securities and Exchange Commission.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
March 23, 1998
<PAGE>
Exhibit 23.2
------------
[Letterhead of Moore & Hansen]
LAW OFFICES
MOORE & HANSEN
PATENTS AND TRADEMARKS
3000 NORWEST CENTER
90 SOUTH SEVENTH STREET
MINNEAPOLIS, MINNESOTA 55402
We hereby consent to the reference made to our firm, Moore & Hansen,
under the captions "Patents and Proprietary Rights" and "Dependence on Patents
and Proprietary Technology" in Part I and Exhibit 99.1, respectively, of the
Annual Report of Integ Incorporated filed on Form 10-K for the fiscal year
ending December 31, 1997.
Dated: March 19, 1998
MOORE & HANSEN
/s/ Malcolm L. Moore
Malcolm L. Moore
<PAGE>
Exhibit 24
----------
POWERS OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Frank A. Solomon as his true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities, to sign the Annual Report on Form 10-K of Integ Incorporated for the
fiscal year ended December 31, 1997 and all amendments to such Annual Report on
Form 10-K, and to file the same, with all exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorney-in-fact and agent full power and authority to do and perform
each and every act and thing requisite or necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or his substitute, may lawfully do or cause to be done by virtue hereof.
Signatures Date
- ---------- --------------
/s/ Mark B. Knudson March 20, 1998
- -------------------------------
Mark B. Knudson, Ph.D, Director
/s/ Frank B. Bennett March 20, 1998
- -------------------------------
Frank B. Bennett, Director
/s/ Terrance G. McGuire March 20, 1998
- -------------------------------
Terrance G. McGuire, Director
/s/ Robert R. Momsen March 20, 1998
- -------------------------------
Robert R. Momsen, Director
/s/ Robert S. Nickoloff March 20, 1998
- -------------------------------
Robert S. Nickoloff, Director
/s/ Walter L. Sembrowich March 20, 1998
- -------------------------------
Walter L. Sembrowich, Ph.D, Director
/s/ Winston R. Wallin March 20, 1998
- -------------------------------
Winston R. Wallin, Director
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
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<PAGE>
Exhibit 99.1
------------
CAUTIONARY STATEMENT
Integ Incorporated ("Integ" or the "Company"), or persons acting on
behalf of the Company, or outside reviewers retained by the Company making
statements on behalf of the Company, or underwriters, from time to time, may
make, in writing or orally, "forward-looking statements" as defined under the
Private Securities Litigation Reform Act of 1995 (the "Act"). This Cautionary
Statement is for the purpose of qualifying for the "safe harbor" provisions of
the Act and is intended to be a readily available written document that contains
factors which could cause results to differ materially from those projected in
such forward-looking statements. These factors are in addition to any other
cautionary statements, written or oral, which may be made or referred to in
connection with any such forward-looking statement.
The following matters, among others, may have a material adverse
effect on the business, financial condition, liquidity, results of operations or
prospects, financial or otherwise, of the Company. Reference to this Cautionary
Statement in the context of a forward-looking statement shall be deemed to be a
statement that any one or more of the following factors may cause actual results
to differ materially from those which might be projected, forecast, estimated or
budgeted by the Company in such forward-looking statement or statements:
DEVELOPMENT OF NEW TECHNOLOGY; DEPENDENCE ON THE LIFEGUIDE SYSTEM; UNCERTAINTY
OF MARKET ACCEPTANCE
The Company's future success is entirely dependent upon the successful
development, commercialization and market acceptance of the LifeGuide System,
the development of which is ongoing and the complete efficacy of which has not
yet been demonstrated. The Company has tested benchtop prototypes and
commercial prototypes of the LifeGuide Meter and the LifeGuide Key. However,
there can be no assurance that unforeseen problems will not occur in research
and development, clinical testing, regulatory submissions and approval, product
manufacturing and commercial scale up, marketing or product distribution. Any
such occurrence could materially delay the commercialization of the LifeGuide
System or prevent its market introduction entirely. Further, even if
successfully developed, the commercial success of the LifeGuide System will
depend upon its acceptance as an accurate, reliable and cost-effective
alternative to existing blood glucose monitoring techniques. The glucose
monitoring industry is currently dominated by several companies with established
markets and distribution channels. Because the proposed LifeGuide System will
represent a new practice in the monitoring of glucose levels, the Company is
unable to predict how quickly, if at all, its products will be accepted by
members of the medical community and people with diabetes. There is no
assurance that the Company will ever derive substantial revenues from the sale
of the LifeGuide System.
HISTORY OF OPERATING LOSSES; ACCUMULATED DEFICIT; EXPECTATION OF FUTURE LOSSES
The Company has generated no revenue and has sustained significant
operating losses each year since its inception. As of December 31, 1997, the
Company had an accumulated deficit of $30.4 million. Net losses for the years
ended December 31, 1995, 1996 and 1997 were approximately $5,048,730, $9,083,432
and $11,564,391, respectively, and the Company expects such losses to continue
through 2000 and to increase at least through the end of 1999. The Company may
never generate substantial operating revenue or achieve profitability. The
Company's ability to generate revenue from operations and achieve profitability
is dependent upon successful development, regulatory approval and
commercialization of the LifeGuide System and the Company's successful
transition from a development stage company to a fully operating company.
-1-
<PAGE>
LIMITED CLINICAL TESTING EXPERIENCE; UNCERTAINTY OF OBTAINING FDA CLEARANCES
Testing of the LifeGuide System has been performed on benchtop
prototypes and hand-held prototypes solely by Company personnel under controlled
circumstances. The Company expects to make commercial prototypes of the
LifeGuide System available for clinical testing by people with diabetes as soon
as the LifeGuide Meter development is complete, and to use the data derived from
this testing to support a 510(k) notification with the Food and Drug
Administration ("FDA") to permit commercialization of the LifeGuide System in
the United States. There can be no assurance that the Company will not
encounter problems in clinical testing which will cause the Company to delay
commercialization of the LifeGuide System, and there can be no assurance that
the LifeGuide System will prove to be accurate and reliable on a consistent
basis. Even if accurate and reliable, there can be no assurance that such
testing will show the Company's product to be safe or effective. There can also
be no assurance that the required FDA clearances will be obtained on a timely
basis or at all. The Company believes and has confirmed with the FDA that the
LifeGuide System will be eligible for a 510(k) clearance from the FDA. Still,
there can be no assurance that the required FDA clearances or approvals will be
obtained on a timely basis or at all. The Company has no experience in
obtaining regulatory approval.
HIGHLY COMPETITIVE MARKETS; RISK OF TECHNOLOGICAL OBSOLESCENCE
The glucose monitoring industry is characterized by continuously
evolving technology and intense competition, and the market is currently
dominated by several companies with established products and distribution
channels. In addition, other companies are attempting to develop minimally- or
non-invasive glucose monitoring products competitive with the proposed LifeGuide
System. There can be no assurance that the Company's competitors and potential
competitors will not succeed in developing or marketing technologies and
products that will be more accepted in the marketplace than the proposed
LifeGuide System or that would render the Company's technology and proposed
device obsolete or noncompetitive. In addition, numerous researchers are
investigating alternative treatments or cures for diabetes. If any of these
efforts are successful in reducing the complications associated with diabetes
and can be cost-effectively provided to people with diabetes, the need for the
Company's products could be mitigated or become entirely nonexistent.
Most of the Company's competitors and potential competitors have
substantially greater capital resources, research and development staffs and
facilities than the Company. In addition, most of the Company's competitors and
potential competitors have substantially greater experience than the Company in
research and new product development, obtaining regulatory approvals and
manufacturing and marketing medical devices. Many of the Company's potential
competitors have already entered into distribution and marketing agreements with
major marketing partners. Competition within the glucose monitoring industry
could also result in reductions of the prices of the Company's products and the
use of purchase incentive programs that could adversely affect the Company's
revenues and profitability.
LACK OF MANUFACTURING CAPABILITY; DEPENDENCE ON CONTRACT MANUFACTURERS AND
SUPPLIERS
The Company's LifeGuide System is still in development and the Company
has not yet created or manufactured a commercial prototype of its device. To be
successful, the Company must manufacture the LifeGuide System in compliance with
regulatory requirements, in a timely manner and in sufficient quantities while
maintaining product quality and acceptable manufacturing costs. The LifeGuide
Meter will be manufactured for the Company by an outside vendor from primarily
off-the-shelf components. The LifeGuide Key will be assembled by the Company
from components to be purchased from outside suppliers. The Company ordered the
initial automated manufacturing line for the LifeGuide Key in late 1996 and
anticipates producing initial LifeGuide Keys from this line in mid-1998.
However, one component of the LifeGuide Key is available from a single source.
If the Company were unable to obtain this component from its supplier, the
Company would be required to make modifications to its existing LifeGuide System
and to obtain an alternative component from an alternative supplier. Any
-2-
<PAGE>
interruption in the supply of this component would have a material adverse
effect on the Company's business, financial condition and results of operation.
Manufacturers often encounter difficulties in scaling up production of new
products, including problems involving production yields, quality control and
assurance, component supplies and shortages of personnel. There can be no
assurance, however, that the Company will be able to install and qualify an
initial automated manufacturing line or subsequent commercial productions lines
on a timely basis or at all. There also can be no assurance that the Company
will be able to achieve and maintain product quality and reliability when
producing the LifeGuide System in the quantities required for commercial
operations or within a period that will permit the Company to introduce its
products in a timely fashion, or that the Company will be able to assemble and
manufacture its products at an acceptable cost.
DEPENDENCE ON PATENTS AND PROPRIETARY TECHNOLOGY
The Company's success will depend in part on its ability to obtain
patent protection for its proposed products and processes, to preserve its trade
secrets and to operate without infringing the proprietary rights of third
parties. As of the date of this Form 10-K, the Company has two issued United
States patents relating to the methods of drawing an ISF sample from the outer
layers of the skin, and five additional United States Patent Applications
directed toward various aspects of the technologies underlying the LifeGuide
System. There can be no assurance, however, that any additional patents will be
issued, that the scope of any patent protection granted to the Company will
prevent competitors from introducing products competitive with the LifeGuide
System or that any of the Company's patents will be held valid or enforceable if
subsequently challenged. Patenting medical devices involves complex legal and
factual questions, and there is no consistent policy regarding the breadth of
claims which issue pertaining to such technologies. The Company also relies
upon unpatented trade secrets, and no assurance can be given that others will
not independently develop or otherwise acquire unpatented technologies
substantially equivalent to those of the Company. In addition, even if the
patents for which the Company has applied are ultimately issued, other parties
may hold or receive patents that contain claims covering the LifeGuide System
and which may delay or prevent the sale of the LifeGuide System or require
licenses resulting in the payment of fees or royalties by the Company in order
for the Company to carry on its business. There can be no assurance that needed
or potentially useful licenses will be available in the future on acceptable
terms or at all.
There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. Litigation could
result in substantial costs to and a diversion of effort by the Company, but may
be necessary to enforce any patents issued to the Company, protect trade secrets
or know-how owned by the Company, defend the Company against claimed
infringement of the rights of others or determine the scope and validity of the
proprietary rights of others. The Company is not currently a party to any patent
or other litigation. The Company routinely monitors patent issuances by others
in its industry, and as a result became aware in 1996 of a patent that may
relate to a feature of the LifeGuide System. The Company engaged outside patent
counsel, Moore & Hansen, to review the patent, and such counsel rendered its
opinion to the Company that the patent is not infringed by the Company's
technology. In addition, such counsel advised the Company that if the patent
was challenged, those claims which the Company believes may apply to the
LifeGuide System would be likely to be held invalid based on the existence of
prior art not cited by the patent examiner. There can be no assurance, however,
that the holder of the patent will not pursue litigation which could be costly
to the Company. An adverse determination in any litigation, including any
litigation commenced by the holder of the patent referred to above, could
subject the Company to significant liabilities to third parties, require the
Company to seek licenses from or pay royalties to third parties or prevent the
Company from manufacturing, selling or using its proposed products, any of which
could have a material adverse effect on the Company's business and prospects.
GOVERNMENT REGULATION; NEED FOR ADDITIONAL GOVERNMENT CLEARANCES
Government regulation in the United States and other countries is a
significant factor in the Company's business. The Company's products will be
regulated by the FDA under a number of statutes
-3-
<PAGE>
including the Federal Food, Drug and Cosmetic Act, as amended (the "FDC Act"),
the Safe Medical Devices Act of 1990 (the "SMDA"), and the FDA Modernization Act
(the "FDAMA"). Manufacturers of medical devices must comply with applicable
provisions of the FDC Act, the SMDA, the FDAMA and certain associated
regulations governing the development, testing, manufacturing, labeling,
marketing and distribution of medical devices and the reporting of certain
information regarding their safety. The FDC Act, the SMDA, and the FDAMA require
certain clearances from the FDA before medical devices, such as the Company's
proposed LifeGuide System, can be marketed.
The Company has not obtained FDA clearance to market the LifeGuide
System. The regulatory process may delay the marketing of new products for
lengthy periods, impose substantial additional costs and provide an advantage to
those of the Company's competitors who have greater financial resources. FDA
marketing clearance regulations depend heavily on administrative interpretation.
There can be no assurance that interpretations made by the FDA or other
regulatory bodies, with possible retroactive effect, will not adversely affect
the Company. There can be no assurance that any such clearance will be obtained
in a timely manner, or at all. In addition, even if obtained, FDA clearances
are subject to continual review, and if the FDA believes that the Company is not
in compliance with the FDC Act, the SMDA, the FDAMA, or their associated
regulations, it can institute proceedings to detain or seize the Company's
products, require a recall, enjoin future violations and assess civil and
criminal penalties against the Company, its directors, officers or employees.
The FDA may also withdraw market approval for the Company's products or require
the Company to repair, replace or refund the cost of any device manufactured or
distributed by the Company.
The FDC Act will regulate the Company's development, quality control
and manufacturing procedures by requiring the Company to demonstrate compliance
with current Good Manufacturing Practices as implemented through the Quality
System Regulation. The FDA monitors compliance with these requirements by
requiring manufacturers to register with the FDA, which subjects them to
periodic FDA inspections of their manufacturing facilities. In order to ensure
compliance with these requirements, the Company will be required to expend time,
resources and effort in the areas of production and quality control. If
violations of the applicable regulations are noted during FDA inspections, the
continued marketing of any products manufactured by the Company may be halted or
adversely affected.
The Company also plans to eventually distribute its products in
several foreign countries. The Company's products will be subject to a wide
variety of laws and regulations in these markets. Generally, the extent and
complexity of the regulation of medical devices is increasing worldwide, with
regulations in some countries already nearly as exhaustive as those applicable
in the United States. This trend may continue and the cost and time required to
obtain marketing approval in any given country may increase. There can be no
assurance that any foreign approvals will be allowed on a timely basis or at
all.
LACK OF COMMERCIAL SALES OR MARKETING EXPERIENCE
The Company has no experience in marketing the LifeGuide System and
has not yet entered into any marketing or distribution arrangements for its
proposed LifeGuide System. In addition, many of the Company's potential
competitors have already entered into distribution and marketing agreements with
major marketing partners. There can be no assurance that the Company will be
able to build a suitable sales force or enter into satisfactory marketing
arrangements with third parties when commercial potential develops, if ever, or
that its sales and marketing efforts will be successful.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
The success of the Company is dependent in large part upon the ability
of the Company to attract and retain key management and operating personnel.
Qualified individuals are in high demand and are often subject to competing
offers. The Company is currently searching for a successor to its President and
Chief Executive Officer, Frank Solomon. It is expected that Mr. Solomon will
remain
-4-
<PAGE>
as President, Chief Executive Officer and Director until his successor commences
employment with the Company or September 30, 1998, whichever is sooner. There
can be no assurance, however, that the Company will be able to find a suitable
successor to Mr. Solomon in a timely fashion. In the future, the Company will
also need to add additional skilled personnel in the areas of research and
development, sales, marketing and manufacturing. There can be no assurance that
the Company will be able to attract and retain the qualified personnel needed
for its business. The loss of the services of additional members of the
Company's research, manufacturing or management group or the inability to hire
additional personnel as needed would likely have a material adverse effect on
the Company's business and prospects.
FUTURE CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE
At its current rate of spending, the Company's existing cash, when
combined with the unused portion of its line of credit, will be sufficient to
fund the Company's operations through approximately the third quarter of 1999.
The Company will require substantial additional funds to meet its working
capital requirements for a full-scale commercial introduction of its proposed
LifeGuide System. In order to meet its needs beyond this period, the Company
may be required to raise additional funds through public or private financings,
including equity financings. Adequate funds for the Company's operations,
whether from financial markets or from other sources, may not be available when
needed on terms attractive to the Company or at all. Insufficient funds may
require the Company to delay, scale back or eliminate some or all of its
programs designed to facilitate the commercial introduction of the LifeGuide
System or prevent such commercial introduction altogether.
UNCERTAINTY OF THIRD PARTY REIMBURSEMENT
Sales of the Company's proposed products in certain markets will be
dependent in part on availability of adequate reimbursement for personal glucose
monitoring products from third-party healthcare payors, such as government and
private insurance plans, health maintenance organizations and preferred provider
organizations. Third party payors are increasingly challenging the pricing of
medical products and services. There can be no assurance that adequate levels
of reimbursement will be available to enable the Company to achieve market
acceptance of the LifeGuide System or maintain price levels sufficient to
realize an appropriate return on its investment in the development or
manufacture of its proposed LifeGuide System. Without adequate support from
third-party payors, the market for the Company's LifeGuide System may be
limited.
PRODUCT LIABILITY RISK; LIMITED INSURANCE COVERAGE
The Company faces an inherent business risk of exposure to product
liability claims in the event that an end-user is adversely affected by its
prospective products. The Company currently carries a product liability
insurance policy covering the Company's clinical testing with an aggregate limit
of $1.0 million. Although the Company expects to obtain product liability
insurance coverage in connection with the commercialization of the LifeGuide
System, there can be no assurance that such insurance will be available on
commercially reasonable terms, or at all, or that such insurance, even if
obtained, would adequately cover any product liability claim. A product
liability or other claim with respect to uninsured liabilities or in excess of
insured liabilities could have a material adverse effect on the business and
prospects of the Company.
The foregoing review of factors pursuant to the Act should not be
construed as exhaustive or as any admission regarding the adequacy of
disclosures made by the Company prior to the effective date of the Act.
-5-
