-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UKRYKFJMwxzRbtHcyvOgpvfwh6TrxNRoMzY6Z2b5uYhwnWo9og3oHYy92cP2qd5t 2Atsa4g3cHsl6B+K8IRDTA== 0001045969-99-000198.txt : 19990331 0001045969-99-000198.hdr.sgml : 19990331 ACCESSION NUMBER: 0001045969-99-000198 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIAMETRICS MEDICAL INC CENTRAL INDEX KEY: 0000895380 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 411663185 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21982 FILM NUMBER: 99578885 BUSINESS ADDRESS: STREET 1: 2658 PATTON RD CITY: ROSEVILLE STATE: MN ZIP: 55113 BUSINESS PHONE: 6126398035 MAIL ADDRESS: STREET 1: 2658 PATTON ROAD CITY: ROSEVILLE STATE: MN ZIP: 55113 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-21982 DIAMETRICS MEDICAL, INC. (Exact name of registrant as specified in its charter) MINNESOTA 41-1663185 --------- ---------- (State or other jurisdiction (IRS Employer of incorporation or organization) Identification Number) 2658 Patton Road Roseville, Minnesota 55113 -------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (651) 639-8035 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) 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 From 10-K or any amendment to this Form 10-K. [ ] As of February 26, 1999, 23,391,597 shares of Common Stock were outstanding, and the aggregate market value of the common shares (based upon the closing price on said date on The Nasdaq National Market) of DIAMETRICS MEDICAL, INC. held by non-affiliates was approximately $104,532,000. DOCUMENTS INCORPORATED BY REFERENCE Parts of the Registrant's Annual Report to Shareholders for the year ended December 31, 1998 are incorporated by reference in Part II hereof. Parts of the Registrant's definitive Proxy Statement for the 1999 Annual Meeting of Shareholders to be held on May 12, 1999 are incorporated by reference in Part III hereof. PART I Unless the context otherwise indicates, all references to the "Registrant," the "Company," or "Diametrics" in this Annual Report on Form 10-K are to Diametrics Medical, Inc., a Minnesota corporation, incorporated in January 1990, and where the context requires, its subsidiary, Diametrics Medical, Ltd. ("DML"). The following federally registered trademarks of the Company are used in this Annual Report on Form 10-K: Diametrics Medical, Inc.(R), IRMA(R)SL, Neocath(R), Paratrend 7(R), Paratrend 7+(TM), Neotrend(TM) and Neurotrend(TM). SureStep(R)Pro is a registered trademark of LifeScan, a Johnson & Johnson company. Item 1. Business Overview The Company develops, manufactures and markets blood and tissue analysis systems that provide immediate or continuous diagnostic results at the point-of-patient care. Since its commencement of operations in 1990, the Company has transitioned from a development stage company to a full-scale development, manufacturing and sales organization. The Company's goal is to be the world leader in critical care blood and tissue analysis systems. Blood and tissue analysis is an integral part of patient diagnosis and treatment, and access to timely and accurate results is critical to effective patient care. The Company believes that its blood and tissue analysis systems will result in more timely therapeutic interventions by providing accurate, precise and immediate or continuous test results, thereby allowing faster patient transfers out of expensive critical care settings and reducing patient length of stay. In addition, point-of-care testing can save money for hospitals by reducing the numerous steps, paperwork and personnel involved in collecting, transporting, documenting and processing blood and tissue samples. Moreover, point-of-care blood and tissue analysis could ultimately eliminate the need for hospitals to maintain expensive and capital intensive stat laboratories. The Company's primary product focus since its inception in 1990 has been the development, manufacturing and marketing of the IRMA ("Immediate Response Mobile Analysis") System, an electrochemical-based blood analysis system that provides rapid and accurate diagnostic results at the point-of-patient care. The IRMA SL System consists of a portable, microprocessor-based analyzer that employs single-use, disposable cartridges to perform simultaneously several of the most frequently ordered blood tests in a simple 90-second procedure. The Company's first disposable electrochemical cartridge, introduced in May 1994, performs three of the most frequently ordered blood tests for critical care patients--the measurement of oxygen, carbon dioxide and acidity (the "blood gases"). In June 1995, the Company expanded the IRMA System test menu with the introduction of its electrolyte cartridge which measures inorganic compounds including sodium, potassium and ionized calcium. The Company further expanded its critical or "stat" test menu during the third quarter of 1996 with the release of the second-generation system, IRMA SL, and the addition of the measurement of hematocrit (i.e., the concentration of red blood cells in whole blood) to its electrolyte cartridge. With the addition of hematocrit, the IRMA SL System is able to perform 95% of the critical or stat tests performed annually in the United States, comprising an estimated $1.2 billion annual market. In 1997, the Company introduced its third-generation system, IRMA SL Series 2000, and a new combination testing cartridge. The combination cartridge is based upon the Company's new "snapfit" cartridge design and gives clinicians the ability to perform all critical blood gas, electrolyte and hematocrit tests using one small blood sample and one single-use cartridge. During 1998, the Company expanded the test menu of the IRMA System by integrating the LifeScan (a Johnson & Johnson company) SureStep Pro glucose strip testing module into the analyzer. Also under development in 1998 were two additional blood tests, blood urea nitrogen ("BUN") and chloride, and a reusable version of the single use disposable cartridge, called IRMA-M. In the fourth quarter of 1996, the Company expanded its product line with the introduction of a number of new products through the acquisition of Biomedical Sensors, Ltd. ("BSL"), a Pfizer 2 company. With the acquisition of BSL (now known as Diametrics Medical, Ltd.), the Company acquired a world-class continuous monitoring fiberoptic technology platform, which complements the Company's existing electrochemical sensor platform. This product line includes indwelling continuous blood monitoring systems, consisting of a monitor, calibration system and intravascular disposable sensors. Primary products include Paratrend 7+, which provides direct continuous monitoring of blood gases and temperature in critically ill adult and pediatric patients; Neotrend, which provides direct continuous monitoring of blood gases and temperature in critically ill premature babies; and Neurotrend, which measures oxygen, carbon dioxide and acidity in brain tissue and fluids as an indication of cerebral ischemia (i.e., deficient blood supply to the brain) and hypoxia (i.e., inadequate oxygenation of the blood) in patients with severe head injury and in patients undergoing surgical intervention in the brain. The Company has obtained clearances under Section 510(k) of the Food Drug and Cosmetic Act (the "FDC Act") to market the IRMA SL System to test blood gases, electrolytes, glucose, BUN and hematocrit in whole blood in hospital laboratories and at the point-of-care, and the Paratrend 7 and Neotrend to monitor blood gases and temperature. Additionally, in the first quarter of 1998, the Company received clearance from the United States Food and Drug Administration (the "FDA") to market the new IRMA-M multi-use cartridge for its IRMA SL System. The Company submitted a pre-market notification for the Neurotrend monitoring system in January 1998 that is currently under review by the FDA. In August 1998, the Company completed the sale in a private placement of 2,142,858 shares of the Company's Common Stock, at a price of $7.00 per share, for aggregate proceeds of $15,000,006. The purchasers of Common Stock also received warrants to purchase 714,286 shares of Common Stock at $8.40 per share. The five-year warrants are exercisable immediately, and are callable by the Company after a twelve month waiting period if the Common Stock closing price exceeds $12.10 for twenty consecutive trading days and at increasing amounts in subsequent twelve month periods. Proceeds from the sale of Common Stock and exercise of warrants will be used for product development, sales and marketing and other general corporate purposes. In addition, the Company issued Convertible Senior Secured Fixed Rate Notes to an investor group with proceeds aggregating $7,300,000. The notes will be due in five years, require quarterly interest payments at a rate of 7% per annum, and are convertible into the Company's Common Stock at $8.40 per share. Proceeds from the notes were used to retire other debt of the Company. The closing market price of the Company's Common Stock as of the date the private placement was closed and the notes issued was $5.125. In October 1998, the Company entered into an exclusive Distribution Agreement with CODMAN, a Johnson & Johnson company, for worldwide market development and distribution of the Company's Neurotrend monitoring system. The term of the agreement is for six years and is renewable for two years. If minimum sales levels and marketing expenditure levels are not achieved by CODMAN, certain payments will be due to the Company. Also, CODMAN has the right of first refusal to market new continuous monitoring products developed for the neuro market. In addition, Johnson & Johnson Development Corporation has committed to purchase up to $5 million of the Company's Common Stock at the Company's option over the twelve month period ending September 30, 1999 at the then current market value, not to exceed $7.00 per share. The Company's principal executive office is located at 2658 Patton Road, Roseville, Minnesota 55113, and its telephone number is (651) 639-8035. PRINCIPAL PRODUCTS Additional information regarding the Company's principal products is provided below: IRMA SL Series 2000 Blood Analysis System. The IRMA SL Series 2000 ("IRMA SL System"), the third generation IRMA analysis system, was released in the third quarter 1997, and provides the necessary foundation for current and future product enhancements. The IRMA SL System is comprised of the IRMA SL analyzer and a variety of electrochemical-based disposable cartridges which simultaneously perform select combinations of the most frequently ordered critical care diagnostic tests of blood gases, electrolytes and hematocrit in a simple 90-second procedure. The IRMA SL System also 3 features electronic quality control, as an alternative to aqueous quality control measures, which eliminates the need for this costly and time-consuming process for many customers. The IRMA SL analyzer is a battery or AC operated, portable, microprocessor-based instrument weighing approximately four pounds, and includes an on-board printer. The analyzer can be easily linked for data downloading purposes to a hospital's laboratory or information system. In conjunction with a marketing alliance reached in 1997 with LifeScan, the Company incorporated blood glucose monitoring into the IRMA platform by integrating LifeScan's SureStep Pro Glucose Module into the IRMA SL System. The Company began marketing the new integrated workstation during the first half of 1998. IDMS - The IRMA Data Management System. Released in the third quarter of 1996, IDMS, an advanced data management software program, provides a comprehensive data management system for point-of-care testing technologies. Developed initially for the IRMA SL System, IDMS is network compatible and features an open architecture design that provides for the integration of IDMS data with other laboratory or clinical information systems. Capillary Collection Device. The Capillary Collection Device was introduced in the third quarter of 1996 as a feature for use on the IRMA SL System, which provides the capability to collect and test a capillary blood sample. The Capillary Collection Device is used with the IRMA SL System's single use cartridges to perform blood gas, electrolyte, and hematocrit testing. The capillary collection capability of the IRMA SL System is useful in such patient areas as neonatal and pediatric intensive care, and in other situations where a capillary sample is preferred over an arterial or venous sample. AVOXimeter 4000. Under a distribution agreement initiated in the third quarter of 1996 with A-VOX Systems, Inc., the Company exclusively distributes the AVOXimeter 4000 in the United States. The AVOXimeter 4000 is a battery-operated and easily portable system which provides an accurate and timely assessment of the levels of hemoglobin and calculated oxygen content in a patient's blood. Paratrend 7+. Paratrend 7+ is the Company's second generation sensor platform for its continuous monitoring products, and is the only multi-parameter sensor for direct continuous monitoring of blood gases and temperature in critically ill adult and pediatric patients. Inserted via an arterial catheter, the sensor provides constant, precise measurement of vital blood gas parameters. The new technology uses a fluorescent optical sensor for monitoring oxygen, replacing the electrochemical version of its predecessor, Paratrend 7. Neotrend. Based upon the new fluorescent optical sensor technology introduced with the Paratrend 7+, Neotrend is the only multi-parameter system for direct continuous monitoring of blood gases (oxygen, carbon dioxide and acidity) and temperature in critically ill premature babies. Neotrend was introduced in the United Kingdom in November 1997 and the Company received FDA clearance to market Neotrend in the United States in December 1997. Neurotrend. The Neurotrend monitoring system is designed for direct continuous monitoring for cerebral ischemia and hypoxia in patients with severe head injury and also for use during surgical intervention in the brain. Neurotrend continuously measures oxygen, carbon dioxide, acidity and temperature through a small fiberoptic sensor placed directly into the brain tissue or fluids. CE Mark approval has been received, allowing the system to be marketed in Europe, and a 510(k) application has been filed with the FDA in the United States. In October 1998, the Company entered into an exclusive Distribution Agreement with CODMAN, a Johnson & Johnson company, for worldwide market development and distribution of the Company's Neurotrend monitoring system. REGULATORY STATUS Human diagnostic products are subject, prior to clearance for marketing, to rigorous pre-clinical and clinical testing mandated by the FDA and comparable agencies in other countries and, to a lesser extent, by state regulatory authorities. The Company and its products are regulated by the FDA 4 under a number of statutes including the FDC Act. The FDC Act provides two basic review procedures for medical devices. Certain products may qualify for a submission authorized by Section 510(k) of the FDC Act, wherein the manufacturer gives the FDA a pre-market notification of the manufacturer's intention to commence marketing the product. The manufacturer must, among other things, establish that the product to be marketed is substantially equivalent to another legally marketed product. Marketing may commence when the FDA issues a letter finding substantial equivalence. If a medical device does not qualify for the 510(k) procedure, the manufacturer must file a pre-market approval ("PMA") application. This procedure requires more extensive prefiling testing than the 510(k) procedure and involves a significantly longer FDA review process. The Company has obtained clearances under Section 510(k) of the FDC Act to market the IRMA SL System to test blood gases, electrolytes, hematocrit, glucose and BUN in whole blood in hospital laboratories and at the point-of-patient care. The IRMA-M cartridge, which allows multiple test panels to be performed on a single cartridge, received clearance during 1998. Continuous monitoring products which have been cleared under Section 510(k) include the monitoring systems used with the Paratrend 7 sensor for direct continuous monitoring of blood gases and temperature in adults, and the Neotrend sensor for monitoring of blood gases and temperature in critically ill premature babies. The Company submitted an additional pre-market notification for the Neurotrend monitoring system in January 1998 that is currently under review by the FDA. The Neurotrend monitoring system is designed for direct continuous monitoring for cerebral ischemia and hypoxia in patients with severe head injury and also for use during surgical intervention in the brain. Neurotrend continuously measures oxygen, carbon dioxide, acidity and temperature in brain tissue or fluids. A 510(k) clearance is subject to continual review, and later discovery of previously unknown problems may result in restrictions on the product's marketing or withdrawal of the product from the market. The Company's long-term business strategy includes development of cartridges and sensors for performing additional blood and tissue chemistry tests, and any such additional tests will be subject to the same regulatory process. No assurance can be given that the Company will be able to develop such additional products or uses on a timely basis, if at all, or that the necessary clearances for such products and uses will be obtained by the Company on a timely basis or at all, or that the Company will not be subjected to a more extensive prefiling testing and FDA approval process. The Company also markets its products in several foreign markets. Requirements vary widely from country to country, ranging from simple product registrations to detailed submissions such as those required by the FDA. Manufacturing facilities are also subject to FDA inspection on a periodic basis and the Company and its contract manufacturers must demonstrate compliance with current Good Manufacturing Practices promulgated by the FDA. The Company's intermittent testing product's are affected by the Clinical Laboratory Improvement Act of 1988 ("CLIA") which has been implemented by the FDA. This law is intended to assure the quality and reliability of all medical testing in the United States regardless of where tests are performed. The regulations require laboratories performing blood chemistry tests to meet specified standards in the areas of personnel qualification, administration, participation in proficiency testing, patient test management, quality control, quality assurance and inspections. The regulations have established three levels of regulatory control based on test complexity; "waived", "moderate complexity" and "high complexity". The tests performed by the Company's IRMA SL System have been categorized under CLIA as "moderate complexity" tests by the FDA, which places this system in the same category as most other commercially available blood gas and blood chemistry testing instruments. The glucose test is categorized as a "waived" test", which places this test in the same category as most other commercially available point-of-care glucose testing systems. The Company's continuous monitoring products are not affected by CLIA. RESEARCH AND DEVELOPMENT The Company owns two complementary technology platforms; an electrochemical platform, on which IRMA intermittent testing products are based, and a fiberoptic platform, on which the Paratrend 5 7+, Neotrend and Neurotrend continuous monitoring products are primarily based. The Company is pursuing product line extensions from both of these core technology platforms. The Company intends to continue to expand its cartridge and test menus available on the IRMA SL System. Currently under development is the H5 cartridge which tests sodium, potassium, ionized calcium, hematocrit, chloride and BUN using one single-use cartridge. The H5 cartridge is scheduled to begin beta clinical trials in the U.S. by the end of first quarter 1999. In addition to the single-use cartridge, the Company is developing a multi-use application that will incorporate the Company's current sensor and calibration technologies into products that can perform multiple blood test panels over a period of days before disposal. A multi-use system will serve the needs of high volume critical care centers where rapid patient throughput and a low cost per test panel is required. The multi-use module is scheduled to begin clinical trials by the end of the second quarter 1999. The Company is also in the final design stages for a new addition to the IRMA SL's blood test menu, the creatinine assay, with an FDA filing expected by mid 1999. The Company believes that the IRMA SL System and related core technologies provide a flexible platform which, with a limited amount of additional development, will be capable of performing a variety of blood chemistry tests. The Company plans to continually improve the IRMA SL System through software upgrades, manufacturing process improvements and equipment redesign, based on the results of ongoing marketing studies and field experience. In February 1998, the Company filed a 510(k) application with the FDA for its Neurotrend monitoring system. Studies are also underway to apply the continuous monitoring technology to other areas. These include applications which range from the widespread clinical interest in gut perfusion, as an early indicator of multi-system organ failure; to placement in transplants for monitoring adequacy of perfusion; and to monitoring tissue to detect shock. The Company's future development plans also include further expansion of the blood and tissue analysis test menu available on the continuous monitoring platform. The Company has incurred research and development expenses of approximately $6,466,000, $7,232,000 and $6,360,000 for the years ended December 31, 1998, 1997 and 1996, respectively. SALES AND MARKETING The Company is focusing its marketing efforts for its blood analysis systems on acute care hospitals. Near term sales of the Company's products are expected to continue to come from hospital critical care departments where blood tests are frequently requested on a stat basis. The Company's longer-term marketing objective is to penetrate smaller hospitals and alternate-site markets, such as emergency medical facilities, home healthcare agencies, outpatient clinics, skilled nursing homes and doctors' offices or clinics. The Company believes that the potential advantages of its blood analysis systems will form the basis of the Company's marketing efforts to overcome the possible reluctance of acute care hospitals to change standard operating procedures for performing blood testing or incur additional capital expenses. The Company markets and distributes its products in the United States, the United Kingdom and Germany primarily through its direct sales and marketing organization. Outside of these countries, the Company markets and distributes its products through third party distribution channels, including corporate partners strategically positioned to access targeted foreign markets, including Japan and other Pacific Rim Countries, Europe, Mexico, Canada, Latin America and South America. Effective October 1, 1998, the Company entered into an exclusive Distribution Agreement with CODMAN, a Johnson & Johnson company, for worldwide market development and distribution of the Company's Neurotrend monitoring system. The Company may consider additional distribution channels for its products, including joint ventures, licensing arrangements or OEM relationships with strategically positioned corporate partners. Information concerning the Company's export sales is contained in the financial section of the Company's Annual Report to Shareholders for the year ended December 31, 1998, under note 15 of Notes to Consolidated Financial Statements, and is incorporated herein by reference. 6 Additionally, the Company has entered into several arrangements with hospital systems, healthcare facilities and other influential healthcare buying groups which establish the Company as a sole, preferred or dual source supplier of its blood analysis systems. These organizations include Columbia HCA, Vencor, Inc., Health Services Corporation of America, University Healthsystem Consortium (now part of Novation), and Purchase Connection. The Company expects to continue to enter into arrangements with other buying groups and customers with respect to purchases of its blood and tissue analysis systems. MANUFACTURING The Company's manufacturing facilities support its intermittent testing and continuous monitoring platforms and are located in Roseville, Minnesota and High Wycombe, United Kingdom, respectively. The Company manufactures its IRMA electrochemical thick-film sensor chips in its Roseville, Minnesota facility. Components for the Company's continuous monitoring sensors used in the Paratrend 7+, Neotrend and Neurotrend products are sourced from a variety of outside vendors, but the unique assembly and testing of the sensing elements is performed in the Company's High Wycombe facility. Sub-assembly of external plastic assemblies are sub-contracted to outside vendors. The Company uses external manufacturers to produce a range of hardware items, including the Paratrend 7+, Neotrend and Neurotrend monitors. During the last half of 1998, the Company began in-house assembly of the IRMA SL analyzer and portions of the continuous monitoring hardware at the Roseville and High Wycombe facilities, respectively. These devices could be manufactured by a number of microelectronics assembly companies, using primarily off-the-shelf components. Software for the IRMA SL analyzer is developed and maintained by the Company, and software for the continuous monitoring products is jointly developed with an external source, with acceptance and validation performed by the Company. The majority of the raw materials and purchased components used to manufacture the Company's products are readily available. Most of the Company's raw materials are or may be obtained from more than one source. A small number of these materials, however, are unique in their nature, and are therefore single sourced. Plans are ongoing to add additional second sourcing where appropriate. The Company's manufacturing facilities include four clean rooms in Roseville which range from Class 1,000 to Class 100,000, and two clean rooms in High Wycombe, both rated as Class 10,000. The Company believes its current facilities can support production of required cartridges and sensors for the foreseeable future. The Company maintains a comprehensive quality assurance and quality control program, which includes complete documentation of all material specifications, operating procedures, maintenance and equipment calibration procedures, training programs and quality control test methods. To control the quality of its finished product, the Company utilizes ongoing statistical process control systems during the manufacturing process and comprehensive performance testing of finished goods. The Company continues to successfully undergo required inspections of its manufacturing facilities by the FDA (most recently in October 1998 and March 1996 for Roseville and High Wycombe facilities, respectively), and by the British Standards Institution for the High Wycombe facility (most recently in August 1998). As a result of these inspections, the Company's manufacturing facilities and documentation and quality control systems are deemed satisfactory and in compliance with Good Manufacturing Practices. PATENTS AND PROPRIETARY RIGHTS 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 its blood analysis systems and for those inventions most likely to be used by others as competing alternatives. For its intermittent testing platform, the Company currently maintains three patents issued for its calibration technology, two patents related to its sensor technology and three for companion technology. In addition, two patents have been issued and maintained covering the IRMA SL analyzer and 7 disposable cartridge designs. Additionally, the Company has submitted patent applications pertaining to a multi-use sensor module, an enzymatic sensor and coagulation measurement technology. Overseas, the Company has foreign patent applications pending, filed under the Patent Cooperation Treaty, designating various jurisdictions, including Canada, the major European countries, Brazil, Australia and Japan, corresponding to one or more U.S. applications. The Company maintains nine foreign patents; two issued in the United Kingdom, two in Germany, two in Canada and three in Japan. As it relates to its continuous monitoring platform, the Company currently maintains nine U.S. patents associated with the design and manufacture of its sensor technology platforms. These patents are at various patent process stages in the major European countries and Japan. Material patents have expirations ranging from the year 2006 to 2016. The Company is not currently a party to any patent litigation. The Company has federally registered the trademarks "IRMA SL", "Diametrics Medical, Inc.", "Neocath", "Paratrend", "Tissuetrak", "Paratrend 7+", "Neotrend", "Neurotrend", "CAL-POD", "TOM 2000" and claims trademark rights in "When Stat Isn't Fast Enough." COMPETITION The Company believes that potential purchasers of point-of-care blood analysis systems will base their purchase decision upon a combination of factors, including the product's test menu, ease of use, accuracy, price and ability to manage the data collected. The Company is aware of one company, i-STAT, that is marketing a portable point-of-care blood analysis system. The Company believes that the IRMA SL System possesses distinct competitive advantages over i-STAT's products including ease of use, closed instead of open handling of blood samples and room temperature instead of refrigerated storage of reagents. The Company also competes with companies that market near-patient multi-use blood analysis systems. These companies include AVL Scientific Corporation, Radiometer, Inc. (with their acquisition of Sendx Medical, Inc.), Instrumentation Laboratories (with their acquisition of the GEM Premier) and Bayer (with their acquisition of Chiron Diagnostics). However, the Company believes that to be successful in the point-of-care market, a device must not only be able to perform a variety of commonly ordered blood chemistry tests, but also be very portable to facilitate ease of use at the patient's bedside. The Company's blood analysis systems also compete with manufacturers providing traditional blood analysis systems to central and stat laboratories of hospitals. Although these laboratory-based instruments provide the same tests available with the Company's products, they are complex, expensive and require the use of skilled technicians. The Company believes that its blood analysis systems offer several advantages over these laboratory-based instruments including immediate or continuous results, ease-of-use, reduced opportunity for error and cost effectiveness. The Company believes that its multi-parameter continuous arterial blood gas monitoring systems are currently the only products of its kind commercially available. The Company's products are competitively priced with other point-of-care product offerings. While competitive cost data is not easily attainable, the high volume, centralized testing labs can provide testing at a lower cost per test, but do not provide the convenience and fast turnaround time for test results that point-of-care products offer. Their costs are also highly dependent on volume, given the large investment required for facilities, equipment and trained personnel. Many of the companies in the medical technology industry have substantially greater capital resources, research and development staffs and facilities than the Company. Such entities may be developing or could in the future attempt to develop additional products competitive with the Company's blood and tissue analysis systems. Many of these companies also have substantially greater experience than the Company in research and development, obtaining regulatory approvals, manufacturing and marketing, and may therefore represent significant competition for the Company. There can be no 8 assurance that the Company's competitors will not succeed in developing or marketing technologies and products that will be more effective or less expensive than those being marketed by the Company or that would render the Company's technology and products obsolete or noncompetitive. EXECUTIVE OFFICERS Name Age Position ---- --- -------- David T. Giddings 55 President, Chief Executive Officer and Chairman Roy S. Johnson 46 Executive Vice President and President and Managing Director of Diametrics Medical, Ltd. Laurence L. Betterley 45 Senior Vice President and Chief Financial Officer James R. Miller 45 Senior Vice President of Sales and Marketing and Commercial Development Mr. Giddings was appointed Chairman of the Board of Directors, President and Chief Executive Officer of the Company in April 1996. Mr. Giddings was formerly President and Chief Operating Officer of the United States operations of Boehringer Mannheim Corporation ("BMC"), a U.S. subsidiary of Corange Ltd., a private global healthcare corporation. He joined BMC in 1992 after a 26 year career with Eastman Kodak Company, where he held a number of senior management positions, including General Manager and Vice President of Marketing and Sales, clinical products division. He also served as Vice President and General Manager of Kodak's imaging information system group and of its printing and publishing division. Mr. Johnson joined the Company in November 1996 as an Executive Vice President, and the President and Managing Director of DML, a subsidiary of the Company established in conjunction with the acquisition in November 1996 of BSL. DML markets a line of indwelling monitoring systems for continuous blood and tissue assessment of critically ill patients. Beginning in 1977, Mr. Johnson served in a number of management positions for the predecessors of the BSL business, most recently as President and Chief Executive Officer while it was a subsidiary of Orange Medical Instruments, Inc. and later when it was an operating unit of Pfizer Inc. Mr. Johnson started his career in 1974 with Burroughs Welcome in pharmaceutical production management and was the head of manufacturing in Burroughs` Sidney, Australia subsidiary. Mr. Betterley has been Senior Vice President of the Company since October 1996 and Chief Financial Officer since August 1996. Prior to this, he was with Cray Research, Inc. in various management and financial positions including Chief Financial Officer from 1994 to 1996, Vice President of Finance from 1993 to 1994 and Corporate Controller from 1989 to 1993. Cray Research develops, manufactures and sells high performance computing systems used for computational research. Mr. Miller joined the Company in March 1995 as Vice President of Sales and Marketing, was Senior Vice President of Commercial and Business Development since July 1996, and Senior Vice President of Sales and Marketing and Commercial Development since January 1998. From 1991 to early 1995, Mr. Miller was Vice President of Sales and Marketing at IMED Corporation, where he had global sales and marketing responsibility for infusion and monitoring products for hospital and alternate site markets. 9 EMPLOYEES As of December 31, 1998, the Company had a total of 179 full-time employees, including 45 persons engaged in research and development activities. None of the Company's employees are covered by a collective bargaining agreement, and Diametrics believes it maintains good relations with its employees. FORWARD-LOOKING STATEMENTS This Form 10-K Annual Report and the Company's financial statements and other documents incorporated by reference contain forward-looking statements that involve risk and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those contained above in this Item 1-Business, the "Management's Discussion and Analysis of Results of Operations and Financial Condition" in Item 7 and Exhibit 99 to this Report. ITEM 2. PROPERTIES The Company's principal properties are as follows:
Location of Use of Approximate Lease Property Facility Square Footage Expiration Date - ---------------- --------------------- -------------- --------------- Roseville, Minnesota Manufacturing, research 46,500 September 1999 and development, sales, to September 2001 marketing and administration Malvern, Pennsylvania Research and development 2,000 March 1999(1) High Wycombe, Manufacturing, process 14,500 September 2005 United Kingdom engineering, purchasing and distribution High Wycombe, Sales, marketing and 5,500 January 2015 United Kingdom administration High Wycombe, Research and development 6,000 April 1999(1) United Kingdom
(1) During the first quarter 1999, lease was extended through March 2002 and April 2004, respectively. The Company believes that its facilities are sufficient for its projected needs through 2000. ITEM 3. LEGAL PROCEEDINGS The Company is currently not subject to any material pending or threatened legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 10 The Company's Common Stock, $.01 par value, trades on The Nasdaq National Market under the symbol "DMED." The information contained under the heading "Stock Information" in the Company's Annual Report to Shareholders for the year ended December 31, 1998 (the "Annual Report to Shareholders"), is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The information contained under the heading "Selected Five-Year Financial Data" on page 13 in the Annual Report to Shareholders is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The information contained under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition" on pages 13 through 19 in the Annual Report to Shareholders is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information contained under the heading "Market Risk" on page 18 in the Annual Report to Shareholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information contained under the headings "Consolidated Statements of Operations", "Consolidated Balance Sheets," "Consolidated Statements of Shareholders' Equity," "Consolidated Statements of Cash Flows," "Notes to Consolidated Financial Statements" on pages 20 through 34 and "Report of Independent Auditors" on page 35 in the Annual Report to Shareholders is incorporated herein by reference. 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 DIRECTORS OF THE REGISTRANT The information contained under the heading "Election of Directors" in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Shareholders to be held on May 12, 1999, which definitive Proxy Statement will be filed within 120 days after the close of the fiscal year ended December 31, 1998 (the "Proxy Statement"), is incorporated herein by reference. EXECUTIVE OFFICERS OF THE REGISTRANT See Part I, Item 1 of this Report for information on Executive Officers of the Company. The information contained under the heading "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Proxy Statement is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information contained under the heading "Executive Compensation" in the Proxy Statement is incorporated herein by reference, except that, pursuant to Item 402(a)(8) of Regulation S-K, the subsections 11 under "Executive Compensation" entitled "Report of Compensation Committee on Executive Compensation" and "Comparative Stock Performance" provided in response to paragraphs (k) and (l) of Item 402 are not incorporated by reference herein. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information contained under the heading "Security Ownership of Certain Beneficial Owners and Management" 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 by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements The following consolidated financial statements of Diametrics Medical, Inc., which are included in the Annual Report to Shareholders, are incorporated by reference in Item 8 hereof: Report of Independent Auditors Consolidated Statements of Operations for each of the years in the three year period ended December 31, 1998 Consolidated Balance Sheets at December 31, 1998 and 1997 Consolidated Statements of Shareholders' Equity for each of the years in the three year period ended December 31, 1998 Consolidated Statements of Cash Flows for each of the years in the three year period ended December 31, 1998 Notes to Consolidated Financial Statements Except for the financial statements listed above and the items specifically incorporated by reference in Items 5, 6, 7 and 8 hereof, the Annual Report to Shareholders is not deemed to be filed as part of this Annual Report on Form 10-K. 2. Financial Statement Schedules All schedules have been omitted because they are not applicable or not required, or because the required information is included in the financial statements or the notes thereto. 3. Exhibits
Exhibit No. Description Method of Filing - --- ----------- ---------------- 3.1 Articles of Incorporation of the Company (as amended) (7) 3.2 Bylaws of the Company (as amended) (6) 4.1 Form of Certificate for Common Stock (1)
12 4.2 Form of Registration Rights Agreement between the Company and certain of its shareholders and warrant holders (1) 4.3 Form of Registration Rights Agreement dated as of February 3, 1995 between the Company and certain of its shareholders (3) 4.4 Registration Rights Agreement, dated as of January 30, 1997, by and between the Company and purchasers of Series I Junior Participating Preferred Stock (5) 4.5 Registration Rights Agreement, dated as of June 10, 1997, by and between the Company and the Purchasers (8) 4.6 Form of Certificate for Series I Junior Participating Preferred Stock (5) 4.7 Form of Stock Purchase Warrant, dated as of January 30, 1997 (5) 4.8 Form of Stock Purchase Warrant, dated as of June 10, 1997 (8) 10.1 Real Property Lease Agreements dated July 31, 1996, between Commers-Klodt, a Minnesota General Partnership, and the Company Filed herewith 10.2 Master Equipment Lease Agreement dated as of June 15, 1993, between the Company and Phoenix Growth Capitol Corp., as amended by Amendment No. 1 dated June 8, 1994 (including form of warrant issued in connection therewith) (1) 10.3* 1990 Stock Option Plan (as amended and restated), including form of option agreement (10) 10.4* 1993 Directors' Stock Option Plan, as amended and restated (10) 10.5* 1995 Equalizing Director Stock Option Plan (4) 10.6 1995 Employee Stock Purchase Plan (as revised and restated) (6) 10.7 Agreement dated January 1, 1995 between the Company and Vencor, Inc. (3) 10.8 Settlement Agreement and Mutual General Releases dated March 25, 1994 among PPG Industries, Inc., the Company, Walter L. Sembrowich, David W. Deetz and Kee Van Sin (1) 10.9 Letter agreement dated as of February 1, 1995 among the Company, Allstate Venture Capital and Frazier and Company L.P. (2) 10.10 Agreement dated June 29, 1990 between the Company and David W. Deetz, as supplemented by the letter agreement dated March 28, 1995 (2) 10.11 Agreement dated December 21, 1995 between the Company and Walter L. Sembrowich, Ph.D. (4)
13 10.12 Stock Purchase Agreement, dated as of January 30, 1997, between the Company and the Purchasers named therein (5) 10.13 Stock Purchase Agreement dated as of June 10, 1997, between the Company and the Purchasers named therein (8) 10.14 Loan and Security Agreement, dated March 31, 1998, between DVI Business Credit and the Company (9) 10.15 Common Stock Purchase Agreement, dated June 30, 1998, between the Company and the Purchasers named therein (10) 10.16 Form of Stock Purchase Warrant, dated August 4, 1998 (10) 10.17 Note Purchase Agreement, dated August 4, 1998, between the Company and the Purchasers named therein (10) 10.18 Form of Convertible Senior Secured Fixed Rate Note due August 4, 2003 (10) 10.19 Distribution Agreement, dated October 1, 1998, between the Company and Johnson & Johnson Professional, Inc. (11) 10.20 Put Option and Stock Purchase Agreement, dated October 1, 1998, between the Company and Johnson & Johnson Development Corporation (11) 10.21 Severance Pay Agreement (in the event of Change of Control) dated July 31, 1998, between the Company and David T. Giddings (11) 10.22 Form of Severance Pay Agreement (in the event of Change of Control) dated July 31, 1998, between the Company and its executive officers (11) 10.23 Form of Severance Pay Agreement (in the event of Termination Without Cause) dated July 31, 1998, between the Company and its executive officers (11) 13 Portions of the Company's Annual Report to Shareholders for the year ended December 31, 1998 incorporated by reference in this Form 10-K Filed herewith 21 List of Subsidiaries Filed herewith 23 Consent of KPMG Peat Marwick LLP Filed herewith 24 Powers of Attorney (included in signature page of Report) Filed herewith 27 Financial Data Schedule (electronic filing only) Filed herewith 99 Cautionary Factors Under the Private Securities Litigation Reform Act Filed herewith
- ------------------- * Management compensatory plan filed pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K. (1) Incorporated by reference to the Company's Registration Statement on Form S-1 (Registration Number 33-78518) (the "Registration Statement"). (2) Incorporated by reference to the Company's 1994 Annual Report on Form 10-K. 14 (3) Incorporated by reference to the Company's Registration Statement on Form S-1 (Registration Number 33-94442). (4) Incorporated by reference to the Company's 1995 Annual Report on Form 10-K. (5) Incorporated by reference to the Company's Current Report on Form 8-K filed March 25, 1997. (6) Incorporated by reference to the Company's 1996 Annual Report on Form 10-K. (7) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the Quarter ended March 31, 1997. (8) Incorporated by reference to the Company's Current Report on Form 8-K filed June 26, 1997. (9) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the Quarter ended March 31, 1998. (10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the Quarter ended June 30, 1998. (11) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the Quarter ended September 30, 1998. (b) Reports on Form 8-K No Current Reports on Form 8-K were filed by the Company during the fourth quarter of the year ended December 31, 1998. (c) See Item 14(a)(3) above. (d) See Item 14(a)(2) above. 15 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Roseville, State of Minnesota, on March 30, 1999. DIAMETRICS MEDICAL, INC. By /s/ David T. Giddings ------------------------ David T. Giddings President, Chief Executive Officer and Chairman 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 and on March 30, 1999. KNOW ALL MEN BY THESE PRESENTS, that the undersigned do hereby constitute and appoint David T. Giddings and Laurence L. Betterley, and each of them, each with full power to act without the other, his true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to the Annual Report on Form 10-K for the year ended December 31, 1998 of Diametrics Medical, Inc. , and to file the same, with any and all exhibits thereto, and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all of each of said attorneys-in-fact and agents or any of them may lawfully do or cause to be done by virtue thereof. Name Title ---- ----- /s/ David T. Giddings President, Chief Executive Officer and -------------------------- Chairman (Principal Executive Officer) David T. Giddings /s/ Laurence L. Betterley Senior Vice President and Chief Financial -------------------------- Officer (Principal Financial Officer) Laurence L. Betterley /s/ Jill M. Nussbaum Corporate Controller -------------------------- (Principal Accounting Officer) Jill M. Nussbaum /s/ Gerald L. Cohn -------------------------- Gerald L. Cohn Director /s/ Andre de Bruin -------------------------- Andre de Bruin Director /s/ Roy S. Johnson -------------------------- Roy S. Johnson Director /s/ Mark B. Knudson -------------------------- Mark B. Knudson, Ph.D. Director /s/ David V. Milligan -------------------------- David V. Milligan, Ph.D. Director /s/ Richard A. Norling -------------------------- Richard A. Norling Director EXHIBIT INDEX Exhibit No. Description --- ----------- 10.1 Real Property Lease Agreements dated July 31, 1996, between Commers-Klodt, a Minnesota General Partnership, and the Company 13 Portions of the Company's Annual Report to Shareholders for the year ended December 31, 1998 incorporated by reference in this Form 10-K 21 List of Subsidiaries 23 Consent of KPMG Peat Marwick LLP 24 Power of Attorney (included in signature page of Report) 27 Financial Data Schedule (electronic filing only) 99 Cautionary Statements Under the Private Securities Litigation Reform Act EX-10.1 2 REAL PROPERTY LEASE AGREEMENTS EXHIBIT 10.1 LEASE AGREEMENT This Lease Agreement, made this 31st day of July, 1996, between Roseville Properties Management Company, Inc., as agent for COMMERS-KLODT, a Minnesota general partnership (hereinafter called "Landlord"), and Diametrics Medical, Inc., a Minnesota Corporation (hereinafter called "Tenant"); Witnesseth, That: 1. DEMISED PREMISES. Landlord, subject to the terms and conditions hereof, hereby leases to Tenant the premises (hereinafter referred to as the "Demised Premises") shown outlined in red on the floor plan attached hereto as Exhibit A and comprising approximately 26,113 square feet of Office and 5,320 square feet of Warehouse, for a total of 31,433 square feet in the building known as Roseville Business Commons II, located at 2640- 2652 Patton Road, Roseville, Minnesota, 55113 (hereinafter referred to as the "Building"), to be used by Tenant for general office, showroom, light manufacturing and/or warehouse uses and purposes and for no other use or purpose, together with a right of access over and across all common areas of the Project. The parcel or parcels of land on which they are built, and all improvements thereon, are hereinafter referred to as the "Project". 2. TERM. Tenant takes the Demised Premises from Landlord, upon the terms and conditions herein contained, to have and to hold the same for the term ("Lease Term") of Five (5) years and two (2) months commencing on the first day of August , 1996, and ending on the thirtieth day of September, 2001, unless sooner terminated as herein provided. a. If the Landlord, for any reason whatsoever, cannot deliver possession of the said Demised Premises to the Tenant at the commencement of the Lease Term hereof, this Lease shall not be void or voidable, nor shall Landlord be liable to Tenant for any loss or damage resulting therefrom, nor shall the expiration date of the above Lease Term be in any way extended, but in that event, all rent shall be abated during the period between the commencement of said Lease Term and the time when Landlord delivers possession. b. In the event that Landlord shall permit Tenant to occupy the Demised Premises prior to the commencement date of the Lease Term, such occupancy shall be subject to all the provisions of this Lease. Said early possession shall not advance the termination date hereinabove provided. 3. BASE RENT. For years one and two of the lease term, Tenant shall pay to Landlord base rent in equal monthly installments of nineteen thousand one hundred twenty-one and 74/100 dollars ($19,l21.74) payable on or before the first day of each month in advance at the office of Landlord at 2575 Fairview Avenue North, Suite 250, Roseville, Minnesota, 55113, or at such other place as may from time to time be designated by Landlord. 4. OPERATING COSTS. Tenant shall, for the entire Lease Term, pay to Landlord as additional rent, without any set-off or deduction therefrom, Tenant's share of all costs which Landlord may incur in owning, maintaining and operating the Project for each calendar year during the Lease Term. Said costs are referred to herein as "Operating Costs" and are hereby defined to include, but shall not be limited to, all real estate taxes and annual installments of special assessments payable with respect to the Project, maintenance, repair, replacement and care of all heating, lighting, plumbing and air conditioning fixtures, equipment and systems serving the common areas, parking and landscape areas, signs, snow removal, non-structural repair and maintenance of the exterior of the Building (including the costs of equipment purchased and used for such purposes), management fees, insurance premiums, utility costs, costs of wages, services, equipment and supplies, and all other costs of any nature whatsoever which for federal tax purposes may be expensed rather than capitalized, but exclusive only of leasing commissions, depreciation, costs of tenant improvements, and payments of principal and interest on any mortgages covering the Project. Operating Costs shall also include any expenses or the yearly amortization of capital costs incurred by Landlord for improvements or structural repairs to the Project required to comply with any change in the laws, rules or regulations of any governmental authority having jurisdiction, or for purpose of reducing Operating Costs, which costs shall be amortized over the useful life of such improvements or repairs, as reasonably estimated by Landlord. Tenant's proportionate share of operating expenses shall be that fraction, the numerator of which is the area of Tenant's Demised Premises and the denominator of which is the total area of the Building. As soon as reasonably practicable prior to the commencement of each calendar year during the Lease Term, Landlord shall furnish to Tenant an estimate of Tenant's share of Operating Costs for the ensuing calendar year, and Tenant shall pay, as additional rent hereunder together with each installment of monthly base rent, one-twelfth (1/12th) of its estimated annual share of such Operating Costs. As soon as reasonably practicable after the end of each calendar year during the Lease Term, Landlord shall furnish to Tenant a statement of the actual Operating Costs for the previous calendar year, including Tenant's share of such amount, and within thirty (30) days thereafter, Tenant shall pay to Landlord, or Landlord to Tenant as the case may be, the difference between such actual and estimated excess Operating Costs paid by Tenant. Tenant's share of such excess Operating Costs for the years in which this Lease commences and terminates, and shall be prorated based upon the dates of commencement and termination of the Lease Term. 5. ADDITIONAL TAXES. Tenant shall pay as additional rent to Landlord, together with each installment of monthly base rent, the amount of any gross receipts tax, sales tax or similar tax (but excluding therefrom any income tax) payable, or which will be payable, by Landlord, by reason of the receipt of the monthly base rent and adjustments thereto. 6. UTILITIES. Landlord shall provide mains and conduits to supply water, gas, electricity and sanitary sewer service to the Demised Premises. Tenant shall pay, when due, either directly to the utility company if billed individually, or to Landlord if billed as an operating expense, all charges for sewer usage or rental, garbage disposal, refuse removal, water, electricity, gas, telephone and/or other utility services or energy source furnished to the Demised Premises during the term of this Lease, or any renewal or extension thereof. Landlord shall not exceed the rate Tenant would be required to pay to a utility company or service company furnishing any of the foregoing utilities or services. The charges thereof shall be deemed operating costs in accordance with Section 4 if the charges are not billed directly to Tenant by the utility company. Tenant agrees that if it uses water in its Demised Premises for any use other than for toilets and lavatories in number comparable to typical office/showroom/warehouse tenants, it will allow Landlord to submeter its water usage and bill Tenant directly therefor. 7. CARE AND REPAIR OF DEMISED PREMISES. Tenant shall, at all times throughout the terms of this Lease, including renewals RBCIV4/94 - 2 - and extensions, and at its sole expense, keep and maintain the Demised Premises in a clean, safe, sanitary and first-class condition, and in compliance with all applicable laws, codes, ordinances, rules and regulations. Tenant's obligations hereunder shall include but not be limited to the maintenance, repair and replacement, if necessary, of all lighting and plumbing fixtures and equipment, HVAC equipment serving the Demised Premises and other equipment, fixtures, motors and machinery, all interior walls, partitions, doors and windows, including the regular painting thereof, all exterior entrances, windows, doors, and docks and the replacement of all broken glass. When used in this provision, the term "repairs" shall include replacements or renewals when necessary, and all such repairs made by Tenant shall keep and maintain all portions of the Demised Premises and the sidewalks and areas adjoining the same in a clean and orderly condition, free of accumulation of dirt, rubbish and snow. If Tenant fails, refuses or neglects to maintain or repair the Demised Premises as required in this Lease after notice shall have been given to Tenant, Landlord may make such repairs without liability to Tenant for any loss or damage that may accrue to Tenant's merchandise, fixtures or other property or to Tenant's business by reason thereof, and upon completion thereof, Tenant shall pay to Landlord all costs plus fifteen percent (15%) for overhead incurred by landlord in making such repairs upon presentation to Tenant of bill therefor. Landlord shall keep the foundation, exterior walls (except plate glass or glass or other breakable materials used in structural portions) and roof in good repair and, if necessary or required by proper governmental authority, make modifications or replacements thereof, except that Landlord shall not be required to make any such repairs, modifications or replacements which become necessary or desirable by reason of the negligence of Tenant, its agents, servants or employees, or by reason of anyone illegally entering in or upon the Premises. Landlord shall manage all outside maintenance of the Project, including grounds and parking areas. The cost of such maintenance shall be prorated in accordance with Section 4 of this Lease. All such maintenance which is provided by Landlord shall be provided as reasonably necessary for the comfortable use and occupancy of Demised Premises during business hours, except Saturdays, Sundays, and holidays, upon the condition that Landlord shall not be liable for damages for failure to do so due to causes beyond its control. 8. CONSTRUCTION OF DEMISED PREMISES. Landlord agrees to construct Tenant's space in accordance with the attached Exhibit B using building standard materials and finishes, at no cost to Tenant. Tenant may make changes or alterations to the attached floor plan prior to construction provided such changes or alterations do not substantially change the construction costs of the Demised Premises. Should such changes substantially increase the construction costs in the opinion of Landlord, such costs shall be borne by Tenant. 9. OBLIGATIONS OF TENANT. Tenant agrees that it shall: a. Observe such rules and regulations as from time to time may be put in effect by Landlord for the general safety, comfort and convenience of Landlord, occupants and tenants of said Building. b. Give Landlord access to the Demised Premises at all reasonable times, without charge or diminution of rent, to enable Landlord to examine the same and to make such repairs, additions and alterations as Landlord may deem advisable. RBCIV4/94 - 3 - c. Keep the Demised Premises in good order and condition and replace all glass broken by Tenant with glass of the same quality as that broken, save only glass broken by fire and extended coverage type risks, and commit no waste on the Demised Premises. d. Pay for all electric lamps, starters and ballasts as replaced in the Demised Premises. e. Upon the termination of this Lease in any manner whatsoever, remove Tenant's goods and effects and those of any other person claiming under Tenant, and quit and deliver up the Demised Premises to Landlord peaceably and quietly in as good order and condition as the same are now in or hereafter may be put in by Landlord or Tenant, reasonable use and wear thereof and repairs which are Landlord's obligation excepted. Goods and effects not removed by Tenant at the termination of this Lease, however terminated, shall be considered abandoned and Landlord may dispose of the same as it deems expedient. f. Not either voluntarily or by operation of law, assign, transfer, mortgage, pledge, hypothecate or encumber this Lease or any interest therein, and shall not sublet the Demised Premises or any part thereof, or any right or privilege appurtenant thereto, or suffer any other person (the employees, agents, servants and invitees of Tenant excepted) to occupy or use the Demised Premises or any portion thereof, without the prior written consent of Landlord. Notwithstanding the foregoing, any subtenant or assignee must have at least the financial strength of the original Tenant. Consent to one assignment, subletting, occupation or use by any other person shall not be deemed to be a consent to any subsequent assignment, subletting, occupation or use by another person. Any such assignment or subletting without such consent shall be void, and shall, at the option of Landlord, constitute a default under this Lease. Regardless of Landlord's consent, no subletting or assignment shall release Tenant of Tenant's obligation to pay the rent and perform all other obligations to be performed by Tenant hereunder for the term of this Lease. The acceptance of rent by Landlord from any other person shall not be deemed to be a waiver by Landlord of any provision hereof or any right hereunder. Any subrent charged to subtenant by Tenant which is in excess of the rent charged by Landlord to Tenant shall be passed on in full to Landlord. Any such subrent, in no event, may be based on net income. g. Not place signs on or about the Demised Premises without first obtaining Landlord's written consent thereto. Tenant's signs on exterior of Building shall conform to sign criteria attached hereto as Exhibit C. h. Not overload, damage or deface the Demised Premises or do any act which may make void or voidable any insurance on the Demised Premises or the Building or which may render an increased or extra premium payable for insurance. i. Not make any alteration of or addition to the Demised Premises without the written approval of the Landlord, and all alterations, additions or improvements which may be made by either of the parties hereto upon the Demised Premises, except movable office furnishings, shall be the property of the Landlord, and shall remain upon and be surrendered with the Demised Premises, as a part thereof, at the termination of this Lease or any extension thereof. j. Keep the Demised Premises and the property in which the Demised Premises are situated free from any liens arising out of any work performed, materials furnished or obligations incurred RBCIV4/94 - 4 - by Tenant. Landlord may require, at Landlord's sole option, that Tenant shall provide to Landlord, at Tenant's sole cost and expense, a lien and completion bond in an amount equal to one and one-half (1-1/2) times any and all estimated costs of any improvements, additions, or alterations in the Demised Premises, to insure Landlord against any liability for mechanics' and materialmen's liens and to insure completion of the work. k. Cause to be performed by a competent service company, preventative maintenance of all rooftop HVAC units and warehouse unit heaters serving the Demised Premises, as recommended by the equipment manufacturer, unless performed by Landlord at Landlord's option. 1. Not place any additional locks on any of Tenant's doors without the written consent of Landlord. Landlord shall have the right to keep pass keys to the Demised Premises. m. Tenant agrees and acknowledges that it shall be the sole responsibility of the Tenant to comply with any and all provisions of the Americans with Disabilities Act of 1990 thereinafter "ADA"), as such compliance may be required to operate the Demised Premises. The Tenant further agrees to indemnify and hold the Landlord harmless against any claims which may arise out of Tenant's failure to comply with the ADA. Such indemnification shall include, but not necessarily be limited to reasonable attorney's fees, court costs and judgments as a result of said claims. Tenant's obligations under this Section 9 to do or not to do a specified act shall extend to and include Tenant's obligations to see to it that Tenant's employees, agents and invitees shall do or shall not do such acts, as the case may be. 10. PARKING AND DRIVES. Tenant, its employees, and invitees shall have the non-exclusive right to use the common driveways and parking lots along with the other tenants and customers of the Building. The use of such driveways and parking facilities are subject to such reasonable rules and regulations as Landlord may impose. Tenant further agrees not to use, or permit the use by its employees, the parking areas for the overnight storage of automobiles or other vehicles without the written consent of Landlord. 11. CASUALTY LOSS. In case of damage to the Demised Premises or the Building by fire or other casualty, Tenant shall give immediate notice to Landlord who shall thereupon cause the damage to be repaired with reasonable speed at the expense of the Landlord, subject to delays which may arise by reason of adjustment of loss under insurance policies and for delays beyond the reasonable control of Landlord, and to the extent that the Demised Premises are rendered untenantable, the rent shall proportionately abate, except in the event such damage resulted from or was contributed to by the act, fault or neglect of Tenant, Tenant's employees or agents, in which event there shall be no abatement of rent. In the event the damage shall he so extensive that the Landlord, in its sole discretion, shall decide not to repair or rebuild, this Lease shall, at the option of Landlord, be terminated as of the date of such damage by written notice from the Landlord to the Tenant, and the rent shall be adjusted to the date of such damage and Tenant shall thereupon promptly vacate the Demised Premises. 12. INDEMNITY AND INSURANCE. Tenant agrees to indemnify and save harmless Landlord from and against all claims of whatever nature arising from any act, omission or negligence of Tenant, or Tenant's officers, agents, servants, licensees or contractors, or arising from any accident, injury or damage whatsoever caused to RBCIV4/94 - 5 - any person or to the property of any person during the term hereof in or about the Demised Premises. This indemnity and hold harmless agreement shall include indemnity against all costs, expenses, and liabilities incurred in connection with any such claim or proceeding brought thereon and the defense thereof. Tenant agrees to use and occupy the Demised Premises and further agrees that Landlord shall have no responsibility or liability for any loss or damage to fixtures, equipment, merchandise or other personal property of Tenant. Tenant shall not carry any stock of goods or do anything in or about said Demised Premises which will in any way tend to increase insurance rates on said Demised Premises or the Building in which the same are located. If Landlord shall consent to such use, Tenant agrees to pay as additional rental any increase in premiums for insurance against loss by fire or extended coverage risks resulting from the business carried on in the Demised Premises by Tenant. If Tenant installs any electrical equipment that overloads the power lines to the Building or if any insurance company insuring the Building or the Demised Premises makes any safety recommendations regarding the Demised Premises, Tenant shall at its own expense, make whatever changes are necessary to comply with the requirements of insurance underwriters, insurance rating bureaus, loss control specialists or governmental authorities having jurisdiction. Tenant agrees to procure and maintain a policy or policies of insurance, at its own cost and expense, insuring Landlord and Tenant from all claims, demands, or actions made by or on behalf of any person or persons, firm, or corporation arising from, related to, or connected with the conduct and operation of Tenant's business in the Demised Premises for injury to or death of one or more persons and for damage to property in the combined single limit of not less than $1,000,000 each occurrence. Tenant shall carry like coverage against loss or damage by boiler or internal explosion by boilers, if there is a boiler in the Demised Premises. Said insurance shall not be subject to cancellation except after at least thirty (30) days' prior written notice to Landlord, and the policy or policies, or duly executed certificate or certificates for the same, together with satisfactory evidence of the payment of premium thereon, shall be deposited with Landlord at the commencement of the term and renewals thereof no less than thirty (30) days prior to the expiration of the term of such coverage. If Tenant fails to comply with such requirement, Landlord may obtain such insurance and keep the same in effect, and Tenant shall pay Landlord the premium cost thereof upon demand. Landlord shall procure at its own expense during the term of this Lease fire, windstorm, extended coverage, such other insurance as Landlord may obtain, and rental loss insurance on the Project provided, however, Tenant shall reimburse Landlord for its share of the actual net cost and expense to Landlord of such fire, windstorm, extended coverage, and rental loss insurance. Tenant shall procure at its own expense from the time Tenant takes possession until the end of the Lease Term, fire, extended coverage, vandalism, and sprinkler leakage insurance on the Demised Premises. This property insurance shall include floor coverings and/or any improvements and fixtures and signs installed by Landlord. Each of Landlord and Tenant hereby releases the other from any and all liability or responsibility (to the other or anyone claiming through or under them by way of subrogation or otherwise) for any loss or damage to property caused by fire or any other insured peril, even if such fire or other casualty shall have been caused by the fault or negligence of the other party or anyone for RBCIV4/94 - 6 - whom such party may be responsible. Tenant also agrees to obtain a waiver of subrogation from its insurer, subject to availability. 13. EMINENT DOMAIN. If the entire Demised Premises are taken by eminent domain, this Lease shall automatically terminate as of the date of taking. If a portion of the Demised Premises is taken by eminent domain, Landlord shall have the right to terminate this Lease as of the date of taking by giving written notice thereof to Tenant within ninety (90) days after such date of taking. If Landlord does not elect to terminate this Lease, it shall, at its expense, restore the Demised Premises, exclusive of any improvements or other changes made therein by Tenant, to as near the condition which existed immediately prior to the date of taking as reasonably possible, and to the extent that the Demised Premises are rendered untenantable, the rent shall proportionately abate. All damages awarded for a taking under the power of eminent domain shall belong to and be the exclusive property of Landlord, whether such damages be awarded as compensation for diminution in value of the leasehold estate hereby created, or to the fee of the Demised Premises provided, however, that Landlord shall not be entitled to any separate award made to Tenant for the value and cost of removal of its personal property and fixtures. 14. DEFAULT. Tenant hereby agrees that in case Tenant shall default in making its payments hereunder or in performing any of the other agreements, terms and conditions of this Lease then, in any such event, Landlord, in addition to all other rights and remedies available to Landlord, by law or by other provisions hereof, may without process re-enter immediately into the Demised Premises and remove all persons and property therefrom and, at Landlord's option, annul and cancel this Lease as to all future rights of Tenant, and Tenant hereby expressly waives the service of any notice in writing of intention to re-enter as aforesaid. Landlord, in addition to the foregoing, may also accelerate rent due and owing for the remainder of the term. Tenant further agrees that in case of any such termination, Tenant will indemnify the Landlord against all loss of rents and other damage which Landlord may incur by reason of such termination including, but not limited to, costs of restoring and repairing the Demised Premises and putting the same in rentable condition, costs of renting the Demised Premises to another tenant, loss or diminution of rents and other damage which Landlord may incur by reason of such termination, and all reasonable attorney's fees and expenses incurred in enforcing any of the terms of this Lease. Neither acceptance of rent by Landlord, with or without knowledge of breach, nor failure of Landlord to take action on account of any breach hereof or to enforce its rights hereunder, shall be deemed a waiver of any breach, and absent written notice or consent, said breach shall be a continuing one. Tenant further agrees that if (i) Tenant is declared bankrupt or insolvent, (ii) Tenant petitions for, or consents to, the appointment of a receiver of all or substantially all of Tenant's assets, (iii) Tenant petitions or consents to be declared a bankrupt or an insolvent, or (iv) a petition if filed by a third person to have Tenant declared bankrupt or insolvent or to have a receiver appointed with respect to all or substantially all of Tenant's assets and such petition is not discharged within sixty (60) days after service thereof is made on Tenant, then, at Landlord's option, without limiting Landlord's other rights and remedies to which Landlord is entitled under law and/or equity by reason of any of the aforesaid occurrences and without relieving Tenant of Tenant's obligations under this Lease, Landlord may terminate this Lease and, whether or not this Lease is terminated, may re-enter the Demised Premises and remove all persons therefrom, all as set forth in the foregoing paragraph of this Section 14. RBCIV4/94 - 7 - 15. NOTICES. All bills, statements, notices or communications which Landlord may desire or be required to give to Tenant shall be deemed sufficiently given or rendered if in writing and either delivered to Tenant personally or sent by registered or certified mail addressed to Tenant at the Building, and the time of rendition thereof or the giving of such notice or communication shall be deemed to be the time when the same is delivered to Tenant or deposited in the mail as herein provided. Any notice by Tenant to Landlord must be served by registered or certified mail addressed to Landlord at the address where the last previous rental hereunder was payable, or in case of subsequent change upon notice given, to the latest address furnished. 16. HOLDING OVER. Should Tenant continue to occupy the Demised Premises after expiration of said Lease Term or any renewal or renewals thereof, or after a forfeiture incurred, such tenancy shall be from month-to-month, and in no event from year-to-year or for any longer term. The monthly base rent during such month-to-month tenancy shall be one and a half (1.5) times the amount of the monthly base rent set forth in Paragraph 3 of this Lease. 17. SUBORDINATION. The rights of Tenant shall be subordinate to the lien of any first mortgage now or hereafter in force against the real estate on or in which the Demised Premises are located, and Tenant shall execute such further instruments subordinating this Lease to the lien or liens of any such mortgage or mortgages as shall be requested by Landlord. Notwithstanding the foregoing provisions, Tenant agrees that any First Mortgagee shall have the right at any time to subordinate any rights of such First Mortgagee to the rights of Tenant under this Lease on such terms and subject to such conditions as such First Mortgagee deems appropriate. 18. ESTOPPEL CERTIFICATE. Tenant shall at any time and from time to time upon not less than ten (10) days' prior written notice from Landlord, execute, acknowledge and deliver to Landlord a statement in writing certifying (i) that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease as so modified, is in full force and effect); (ii) the date of commencement of the term of this Lease; (iii) that rent is paid currently without any offset or defense thereto; (iv) the amount of rent, if any, paid in advance; and (v) that there are no uncured defaults by Landlord or stating those claimed by Tenant, provided that, in fact, such facts are accurate and ascertainable. Any such statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the real property of which the Demised Premises are a part. Failure to sign the statement or failure to specify any default claimed shall be deemed approval of the statement submitted to Tenant by Landlord. 19. MORTGAGEE PROTECTION. Tenant agrees to give any mortgagees and/or trust deed holders, by registered mail, a copy of any notice of default served upon Landlord, provided that prior to such notice Tenant has been notified, in writing (by way of Notice of Assignment of Rents and Leases, or otherwise) of the address of such mortgagees and/or trust deed holders. Tenant agrees to send such notices to Teachers Insurance and Annuity Association, 730 Third Avenue, New York, New York 10017, Attention Senior Vice President, Mortgage Department. Tenant further agrees that if Landlord shall have failed to cure such default within the term provided for in this Lease, then the mortgagees and/or trust deed holders shall have an additional thirty (30) days within which to cure such default or, if such default cannot be cured within that time, then such additional time as may be necessary, if within such thirty (30) days any mortgagee and/or trust deed holder has commenced and is diligently pursuing the remedies necessary to cure such default (including, but not limited to commencement of foreclosure proceedings, if necessary to effect such cure), in RBCIV4/94 - 8 - which event this Lease shall not be terminated while such remedies are being so diligently pursued. 20. SERVICE CHARGE. Tenant agrees to pay a service charge equal to twelve percent (12%) per annum on any portion thereof of any payment of monthly base rent or additional charge payable by Tenant hereunder which is not paid within ten (10) days from the date due, or $25.00 per month or portion thereof, whichever is greater. 21. SECURITY DEPOSIT. Tenant has deposited with Landlord the total sum of Five thousand 00/100 Dollars ($5,000.00) on May 11, 1990, check #002, of which two thousand five hundred and 00/100 Dollars ($2,500.00) shall be held for security/damage to the above referenced demised premises. Upon expiration of the lease agreement dated July 31, 1996 for the demised premises commonly described as 2654-2664 Patton Road, any remaining security deposit shall transfer to the demised premises herein and be held as additional security deposit by Landlord. Said sum shall be held by Landlord as security for the faithful performance by Tenant of all the terms, covenants, and conditions of this Lease to be kept and performed by Tenant during the term hereof. If Tenant defaults with respect to any provisions of this Lease including, but not limited to, the provisions relating to the payment of rent, Landlord may (but shall not be required to) use, apply or retain all or any part of this security deposit for the payment of any amount which Landlord may spend or become obligated to spend by reason of Tenant's default, or to compensate Landlord for any other loss or damage which Landlord may suffer by reason of Tenant's default. If any portion of said security deposit is so used or applied, Tenant shall within five (5) days after written demand therefor, deposit cash with Landlord in an amount sufficient to restore the security deposit to its original amount, and Tenant's failure to do so shall be a material breach of this Lease. Landlord shall not be required to keep this security deposit separate from its general funds, and Tenant shall not be entitled to interest on such deposit. If Tenant shall fully and faithfully perform every provision of this Lease to be performed by it, the security deposit or any balance thereof shall be returned to Tenant (or, at Landlord's option, to the last assignee of Tenant's interest hereunder) at the expiration of the Lease Term. In the event of termination of Landlord's interest in this Lease, Landlord shall transfer said deposit to Landlord's successor in interest. 22. PROPERTY TAXES. Tenant shall pay, or cause to be paid, before delinquency, any and all taxes levied or assessed and which become payable during the term hereof upon all Tenant's leasehold improvements, equipment, furniture, fixtures and personal property located in the Demised Premises except that which has been paid for by Landlord and is the standard of the Building. In the event any or all of the Tenant's leasehold improvements, equipment, furniture, fixtures and personal property shall be assessed and taxed with the Building, Tenant shall pay to Landlord its share of such taxes within ten (10) days after delivery to Tenant by Landlord of a statement in writing setting forth the amount of such taxes applicable to Tenant's property. 23. NOVATION IN EVENT OF SALE OR TRANSFER. In the event of the sale of the Building or the transfer of the title thereto, Landlord shall be relieved of all of the covenants and obligations created by this Lease, except as to breaches thereof occurring prior to such sale or transfer, and such sale or transfer shall automatically result in the purchaser or transferee assuming and agreeing to carry out all of the covenants and obligations of Landlord herein from and after such sale or transfer. 24. DISPLAYS. Tenant shall not display or suffer to be displayed on the outside of the Demised Premises, on the outside of RBCIV4/94 - 9 - the Building or on the sidewalks, driveways, or parking areas adjoining the Building, any goods or merchandise whatsoever, except with Landlord's written consent. 25. INTERRUPTION OF SERVICES. No liability shall attach to Landlord for any inconvenience, loss, or damage sustained by Tenant or any other person, or to the property of Tenant or such other person, due to interruption of electric power, water, or gas to the Building or to the Demised Premises or by reason of the failure of any piping, wiring, or apparatus in the Building or for any inconvenience, loss, or damage sustained by Tenant as a result of any of the causes set forth in Section 12 or caused by any act or thing done or suffered to be done by any other tenant of the Building or any servant, employee, agent, invitee, or customer of Tenant. However, Landlord shall make all reasonable effort to remedy such interruption of services. 26. ZONING. Tenant covenants that it has satisfied itself prior to execution of this Lease that the Demised Premises are properly zoned to permit Tenant's intended use of the Demised Premises. Any changes with respect to the interior finishing of the premises in order to comply with any local or municipal by-laws shall be at the sole expense of Tenant. 27. QUIET ENJOYMENT. Conditional upon the faithful performance of the terms, covenants and provisions herein contained by Tenant, Landlord covenants that Tenant shall quietly have, hold and enjoy the Demised Premises for the term hereof except or otherwise herein provided. 28. JANITORIAL SERVICES. Tenant shall provide all janitorial and, at the option of Landlord, all refuse removal services for the Demised Premises, at the expense of Tenant. 29. HAZARDOUS MATERIALS. Tenant shall not (either with or without negligence) cause or permit the escape, disposal or release of any biologically or chemically active or other hazardous substances, or materials. Tenant shall not allow the storage or use of such substances or materials in any manner not sanctioned by law or by the highest standards prevailing in the industry for the storage and use of such substances or materials, nor allow to be brought into the Project any such materials or substances except to use in the ordinary course of Tenant's business, and then only after written notice is given to Landlord of the identity of such substances or materials. Without limitation, hazardous substances and materials shall include those described in the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. Section 9601 et seq., the Resource Conservation and Recovery Act, as amended, 42 U.S.C. Section 6901 et seq., any applicable state or local laws and the regulations adopted under these acts. If any lender or governmental agency shall ever require testing to ascertain whether or not there has been any release of hazardous materials, then the reasonable costs thereof shall be reimbursed by Tenant to Landlord upon demand as additional charges if such requirement applies to the Premises. In addition, Tenant shall execute affidavits, representations and the like from time to time at Landlord's request concerning Tenant's best knowledge and belief regarding the presence of hazardous substances or materials on the Premises. In all events, Tenant shall indemnify Landlord from any release of hazardous materials on the Premises-occurring while Tenant is in possession or elsewhere if caused by Tenant or persons acting under Tenant. The within covenants shall survive the expiration or earlier termination of the lease term. 30. MEMORANDUM. Upon the request of either Landlord or Tenant, the parties shall enter into a memorandum, in recordable form, setting forth a summary of the terms hereof relating only to RBCIV4/94 - 10 - the description of the Demised Premises, the term hereof, and the conditions of assignment or subletting. 31. GENERAL. This Lease does not create the relationship of principal and agent or of partnership or of joint venture or of any association between Landlord and Tenant, the sole relationship between Landlord and Tenant being that of lessor and lessee. No waiver of any default of Tenant hereunder shall be implied from any omission by Landlord to take any action on account of such default if such default persists or is repeated, and no express waiver shall affect any default other than the default specified in the express waiver and that only for the time and to the extent therein stated. Each term and each provision of this Lease performable by Tenant shall be construed to be both a covenant and a condition. The topical headings of the several paragraphs and clauses are for convenience only and do not define, limit or construe the contents of such paragraphs or clauses. All preliminary negotiations are merged into and incorporated in this Lease. This Lease can only be modified or amended by an Agreement in writing signed by the parties hereto. All provisions hereof shall be binding upon the heirs, successors and assigns of each party hereto. 32. BASE RENT ADJUSTMENT. During years three through five of the lease term (year five being August 1, 2000-September 30, 2001), Tenant covenants and agrees to pay to Landlord as Base Rent during each of such lease years an amount equal to the product obtained by multiplying two hundred twenty-nine thousand four hundred sixty and 90/100 Dollars ($229,460.90) by a fraction, the numerator of which is the "Consumer Price Index - Seasonally Adjusted U.S. City Average For All Items For All Urban Consumers (1982-84=100, 1996 Definition)" published monthly in the "Monthly Labor Review" of the Bureau of Labor Statistics of the United States Department of Labor ("CPI-U"), for the first calendar month of the lease year, and the denominator of which is the CPI-U for the first full calendar month of the first lease year. In any event, the annual base rent increase will be a minimum of three percent (3%). If the CPI-U is discontinued, the "Consumer Price Index Seasonally Adjusted U.S. city Average For All Urban Wage Earners and Clerical Workers (1982-84=100, 1996 Definition)" published monthly in the "Monthly Labor Review" by the Bureau of Labor Statistics of the United States Department of Labor ("CPI-W"), shall be used for making the computation above. If the CPI-W is discontinued, comparable statistics on the purchasing power of the consumer dollar published by the Bureau of Labor Statistics of the United States Department of Labor shall be used for making the computation above. If the Bureau of Labor Statistics shall no longer maintain statistics on the purchasing power of the consumer dollar, comparable statistics published by a responsible financial periodical or recognized authority selected by Lessor shall be used for making the computation above. If the base year "(1982=100)" or other base year used in computing the CPI-U is changed, the figures used in making the adjustment above shall be changed accordingly so that all increases in the CPI-U are taken into account notwithstanding any such change in the base year for calculation of Base Rent. 33. IMPROVEMENTS. Landlord, at its sole cost and expense, shall replace carpets in areas mutually agreeable between Landlord and Tenant. 34. PRIOR LEASE AGREEMENTS. Landlord and Tenant's rights and obligations under prior lease agreements dated May 3, 1990, July 2, 1991, December 13, 1991, December 30, 1992, May 10, 1993 and RBCIV4/94 - 11 - September, 1994 and any lease addendum, amendment or renewal pertaining to the above-referenced lease agreements and any agreement dated prior to July 23, 1996, shall be null and void upon the execution of this lease agreement. 35. ENTIRE AGREEMENT. This Lease Agreement, as well as Exhibit(s) A contain the entire understanding of the parties hereto with respect to the transaction contemplated thereby and supersedes all prior agreements and understandings between the parties with respect to the subject matter. NO representations, warranties, undertakings or promises, whether oral, implied, written or otherwise, have been made by either party hereto to the other unless expressly stated in this Lease or unless mutually agreed to in writing between the parties hereto and after the date hereof, and neither party has relied on any verbal representation, agreements, or understandings not expressly set forth herein. In Witness Whereof, the parties hereto have executed this Lease the day and year first above written. LANDLORD: Roseville Properties Management Company, Inc. as agent for COMMERS- KLODT, a Minnesota general partnership BY: /s/ Daniel P. Commers ITS: President TENANT Diametrics Medical Inc., a Minnesota Corporation, BY: /s/ David T. Giddings ITS: Chief Executive Officer RBCIV4/94 - 12 - LEASE AGREEMENT This Lease Agreement, made this 31st day of July, 1996, between Roseville Properties Management Company, Inc., as agent for COMMERS-KLODT, a Minnesota general partnership (hereinafter called "Landlord"), and Diametrics Medical, Inc., a Minnesota Corporation (hereinafter called "Tenant"); Witnesseth, That: 1. DEMISED PREMISES. Landlord, subject to the terms and conditions hereof, hereby leases to Tenant the premises (hereinafter referred to as the "Demised Premises") shown outlined in red on the floor plan attached hereto as Exhibit A and comprising approximately 14,693 square feet of Office and 3,639 square feet of Warehouse, for a total of 18,332 square feet in the building known as Roseville Business Commons II, located at 2654- 2664 Patton Road, Roseville, Minnesota, 55113 (hereinafter referred to as the "Building"), to be used by Tenant for general office, showroom, light manufacturing and/or warehouse uses and purposes and for no other use or purpose, together with a right of access over and across all common areas of the Project. The parcel or parcels of land on which they are built, and all improvements thereon, are hereinafter referred to as the "Project". 2. TERM. Tenant takes the Demised Premises from Landlord, upon the terms and conditions herein contained, to have and to hold the same for the term ("Lease Term") of Three (3) years and two (2) months commencing on the first day of August , 1996, and ending on the thirtieth day of September, 1999, unless sooner terminated as herein provided. a. If the Landlord, for any reason whatsoever, cannot deliver possession of the said Demised Premises to the Tenant at the commencement of the Lease Term hereof, this Lease shall not be void or voidable, nor shall Landlord be liable to Tenant for any loss or damage resulting therefrom, nor shall the expiration date of the above Lease Term be in any way extended, but in that event, all rent shall be abated during the period between the commencement of said Lease Term and the time when Landlord delivers possession. b. In the event that Landlord shall permit Tenant to occupy the Demised Premises prior to the commencement date of the Lease Term, such occupancy shall be subject to all the provisions of this Lease. Said early possession shall not advance the termination date hereinabove provided. 3. BASE RENT. For the initial year of the lease term, Tenant shall pay to Landlord base rent in equal monthly installments of twelve thousand two hundred ninety-seven and 72/100 dollars ($12,297.72) payable on or before the first day of each month in advance at the office of Landlord at 2575 Fairview Avenue North. Suite 250. Roseville, Minnesota, 55113, or at such other place as may from time to time be designated by Landlord. 4. OPERATING COSTS. Tenant shall, for the entire Lease Term, pay to Landlord as additional rent, without any set-off or deduction therefrom, Tenant's share of all costs which Landlord may incur in owning, maintaining and operating the Project for each calendar year during the Lease Term. Said costs are referred to herein as "Operating Costs" and are hereby defined to include, but shall not be limited to, all real estate taxes and annual installments of special assessments payable with respect to the Project, maintenance, repair, replacement and care of all heating, lighting, plumbing and air conditioning fixtures, equipment and systems serving the common areas, parking and landscape areas, signs, snow removal, non-structural repair and maintenance of the exterior of the Building (including the costs of equipment purchased and used for such purposes), management fees, insurance premiums, utility costs, costs of wages, services, equipment and supplies, and all other costs of any nature whatsoever which for federal tax purposes may be expensed rather than capitalized, but exclusive only of leasing commissions, depreciation, costs of tenant improvements, and payments of principal and interest on any mortgages covering the Project. Operating Costs shall also include any expenses or the yearly amortization of capital costs incurred by Landlord for improvements or structural repairs to the Project required to comply with any change in the laws, rules or regulations of any governmental authority having jurisdiction, or for purpose of reducing Operating Costs, which costs shall be amortized over the useful life of such improvements or repairs, as reasonably estimated by Landlord. Tenant's proportionate share of operating expenses shall be that fraction, the numerator of which is the area of Tenant's Demised Premises and the denominator of which is the total area of the Building. As soon as reasonably practicable prior to the commencement of each calendar year during the Lease Term, Landlord shall furnish to Tenant an estimate of Tenant's share of Operating Costs for the ensuing calendar year, and Tenant shall pay, as additional rent hereunder together with each installment of monthly base rent, one-twelfth (l/12th) of its estimated annual share of such Operating Costs. As soon as reasonably practicable after the end of each calendar year during the Lease Term, Landlord shall furnish to Tenant a statement of the actual Operating Costs for the previous calendar year, including Tenant's share of such amount, and within thirty (30) days thereafter, Tenant shall pay to Landlord, or Landlord to Tenant as the case may be, the difference between such actual and estimated excess Operating Costs paid by Tenant. Tenant's share of such excess Operating Costs for the years in which this Lease commences and terminates, and shall be prorated based upon the dates of commencement and termination of the Lease Term. 5. ADDITIONAL TAXES. Tenant shall pay as additional rent to Landlord, together with each installment of monthly base rent, the amount of any gross receipts tax, sales tax or similar tax (but excluding therefrom any income tax) payable, or which will be payable, by Landlord, by reason of the receipt of the monthly base rent and adjustments thereto. 6. UTILITIES. Landlord shall provide mains and conduits to supply water, gas, electricity and sanitary sewer service to the Demised Premises. Tenant shall pay, when due, either directly to the utility company if billed individually, or to Landlord if billed as an operating expense, all charges for sewer usage or rental, garbage disposal, refuse removal, water, electricity, gas, telephone and/or other utility services or energy source furnished to the Demised Premises during the term of this Lease, or any renewal or extension thereof. Landlord shall not exceed the rate Tenant would be required to pay to a utility company or service company furnishing any of the foregoing utilities or services. The charges thereof shall be deemed operating costs in accordance with Section 4 if the charges are not billed directly to Tenant by the utility company. Tenant agrees that if it uses water in its Demised Premises for any use other than for toilets and lavatories in number comparable to typical office/showroom/warehouse tenants, it will allow Landlord to submeter its water usage and bill Tenant directly therefor. 7. CARE AND REPAIR OF DEMISED PRENISES. Tenant shall, at all times throughout the terms of this Lease, including renewals RBCIV4/94 - 2 - and extensions, and at its sole expense, keep and maintain the Demised Premises in a clean, safe, sanitary and first-class condition, and in compliance with all applicable laws, codes, ordinances, rules and regulations. Tenant's obligations hereunder shall include but not be limited to the maintenance, repair and replacement, if necessary, of all lighting and plumbing fixtures and equipment, HVAC equipment serving the Demised Premises and other equipment, fixtures, motors and machinery, all interior walls, partitions, doors and windows, including the regular painting thereof, all exterior entrances, windows, doors, and docks and the replacement of all broken glass. When used in this provision, the term ""repairs"" shall include replacements or renewals when necessary, and all such repairs made by Tenant shall keep and maintain all portions of the Demised Premises and the sidewalks and areas adjoining the same in a clean and orderly condition, free of accumulation of dirt, rubbish and snow. If Tenant fails, refuses or neglects to maintain or repair the Demised Premises as required in this Lease after notice shall have been given to Tenant, Landlord may make such repairs without liability to Tenant for any loss or damage that may accrue to Tenant's merchandise, fixtures or other property or to Tenant's business by reason thereof, and upon completion thereof, Tenant shall pay to Landlord all costs plus fifteen percent (15%) for overhead incurred by landlord in making such repairs upon presentation to Tenant of bill therefor. Landlord shall keep the foundation, exterior walls (except plate glass or glass or other breakable materials used in structural portions) and roof in good repair and, if necessary or required by proper governmental authority, make modifications or replacements thereof, except that Landlord shall not be required to make any such repairs, modifications or replacements which become necessary or desirable by reason of the negligence of Tenant, its agents, servants or employees, or by reason of anyone illegally entering in or upon the Premises . Landlord shall manage all outside maintenance of the Project, including grounds and parking areas. The cost of such maintenance shall be prorated in accordance with Section 4 of this Lease. All such maintenance which is provided by Landlord shall be provided as reasonably necessary for the comfortable use and occupancy of Demised Premises during business hours, except Saturdays, Sundays, and holidays, upon the condition that Landlord shall not be liable for damages for failure to do so due to causes beyond its control. 8. CONSTRUCTION OF DEMISED PREMISES. Landlord agrees to construct Tenant's space in accordance with the attached Exhibit B using building standard materials and finishes, at no cost to Tenant. Tenant may make changes or alterations to the attached floor plan prior to construction provided such changes or alterations do not substantially change the construction costs of the Demised Premises. Should such changes substantially increase the construction costs in the opinion of Landlord, such costs shall be borne by Tenant. 9. OBLIGATIONS OF TENANT. Tenant agrees that it shall: a. Observe such rules and regulations as from time to time may be put in effect by Landlord for the general safety, comfort and convenience of Landlord, occupants and tenants of said Building. b. Give Landlord access to the Demised Premises at all reasonable times, without charge or diminution of rent to enable Landlord to examine the same and to make such repairs; additions and alterations as Landlord may deem advisable. RBCIV4/94 - 3 - c. Keep the Demised Premises in good order and condition and replace all glass broken by Tenant with glass of the same quality as that broken, save only glass broken by fire and extended coverage type risks, and commit no waste on the Demised Premises. d. Pay for all electric lamps, starters and ballasts as replaced in the Demised Premises. e. Upon the termination of this Lease in any manner whatsoever, remove Tenant's goods and effects and those of any other person claiming under Tenant, and quit and deliver up the Demised Premises to Landlord peaceably and quietly in as good order and condition as the same are now in or hereafter may be put in by Landlord or Tenant, reasonable use and wear thereof and repairs which are Landlord's obligation excepted. Goods and effects not removed by Tenant at the termination of this Lease, however terminated, shall be considered abandoned and Landlord may dispose of the same as it deems expedient. f. Not either voluntarily or by operation of law, assign, transfer, mortgage, pledge, hypothecate or encumber this Lease or any interest therein, and shall not sublet the Demised Premises or any part thereof, or any right or privilege appurtenant thereto, or suffer any other person (the employees, agents, servants and invitees of Tenant excepted) to occupy or use the Demised Premises or any portion thereof, without the prior written consent of Landlord. Notwithstanding the foregoing, any subtenant or assignee must have at least the financial strength of the original Tenant. Consent to one assignment, subletting, occupation or use by any other person shall not be deemed to be a consent to any subsequent assignment, subletting, occupation or use by another person. Any such assignment or subletting without such consent shall be void, and shall, at the option of Landlord, constitute a default under this Lease. Regardless of Landlord's consent, no subletting or assignment shall release Tenant of Tenant's obligation to pay the rent and perform all other obligations to be performed by Tenant hereunder for the term of this Lease. The acceptance of rent by Landlord from any other person shall not be deemed to be a waiver by Landlord of any provision hereof or any right hereunder. Any subrent charged to subtenant by Tenant which is in excess of the rent charged by Landlord to Tenant shall be passed on in full to Landlord. Any such subrent, in no event, may be based on net income. g. Not place signs on or about the Demised Premises without first obtaining Landlord's written consent thereto. Tenant's signs on exterior of Building shall conform to sign criteria attached hereto as Exhibit C. h. Not overload, damage or deface the Demised Premises or do any act which may make void or voidable any insurance on the Demised Premises or the Building or which may render an increased or extra premium payable for insurance. i. Not make any alteration of or addition to the Demised Premises without the written approval of the Landlord, and all alterations, additions or improvements which may be made by either of the parties hereto upon the Demised Premises, except movable office furnishings, shall be the property of the Landlord, and shall remain upon and be surrendered with the Demised Premises, as a part thereof, at the termination of this Lease or any extension thereof. j. Keep the Demised Premises and the property in which the Demised Premises are situated free from any liens arising out of any work performed, materials furnished or obligations incurred RBCIV4/94 - 4 - by Tenant. Landlord may require, at Landlord's sole option, that Tenant shall provide to Landlord, at Tenant's sole cost and expense, a lien and completion bond in an amount equal to one and one-half (1-1/2) times any and all estimated costs of any improvements, additions, or alterations in the Demised Premises, to insure Landlord against any liability for mechanics' and materialmen's liens and to insure completion of the work. k. Cause to be performed by a competent service company, preventative maintenance of all rooftop HVAC units and warehouse unit heaters serving the Demised Premises, as recommended by the equipment manufacturer, unless performed by Landlord at Landlord's option. 1. Not place any additional locks on any of Tenant's doors without the written consent of Landlord. Landlord shall have the right to keep pass keys to the Demised Premises. m. Tenant agrees and acknowledges that it shall be the sole responsibility of the Tenant to comply with any and all provisions of the Americans with Disabilities Act of 1990 (hereinafter "ADA"), as such compliance may be required to operate the Demised Premises. The Tenant further agrees to indemnify and hold the Landlord harmless against any claims which may arise out of Tenant's failure to comply with the ADA. Such indemnification shall include, but not necessarily be limited to reasonable attorney's fees, court costs and judgments as a result of said claims. Tenant's obligations under this Section 9 to do or not to do a specified act shall extend to and include Tenant's obligations to see to it that Tenant's employees, agents and invitees shall do or shall not do such acts, as the case may be. 10. PARKING AND DRIVES. Tenant, its employees, and invitees shall have the non-exclusive right to use the common driveways and parking lots along with the other tenants and customers of the Building. The use of such driveways and parking facilities are subject to such reasonable rules and regulations as Landlord may impose. Tenant further agrees not to use, or permit the use by its employees, the parking areas for the overnight storage of automobiles or other vehicles without the written consent of Landlord. 11. CASUALTY LOSS. In case of damage to the Demised Premises or the Building by fire or other casualty, Tenant shall give immediate notice to Landlord who shall thereupon cause the damage to be repaired with reasonable speed at the expense of the Landlord, subject to delays which may arise by reason of adjustment of loss under insurance policies and for delays beyond the reasonable control of Landlord, and to the extent that the Demised Premises are rendered untenantable, the rent shall proportionately abate, except in the event such damage resulted from or was contributed to by the act, fault or neglect of Tenant, Tenant's employees or agents, in which event there shall be no abatement of rent. In the event the damage shall be so extensive that the Landlord, in its sole discretion, shall decide not to repair or rebuild, this Lease shall, at the option of Landlord, be terminated as of the date of such damage by written notice from the Landlord to the Tenant, and the rent shall be adjusted to the date of such damage and Tenant shall thereupon promptly vacate the Demised Premises. 12. INDEMNITY AND INSURANCE. Tenant agrees to indemnify and save harmless Landlord from and against all claims of whatever nature arising from any act, omission or negligence of Tenant, or Tenant's officers, agents, servants, licensees or contractors, or arising from any accident, injury or damage whatsoever caused to RBCIV4/94 - 5 - any person or to the property of any person during the term hereof in or about the Demised Premises. This indemnity and hold harmless agreement shall include indemnity against all costs, expenses, and liabilities incurred in connection with any such claim or proceeding brought thereon and the defense thereof. Tenant agrees to use and occupy the Demised Premises and further agrees that Landlord shall have no responsibility or liability for any loss or damage to fixtures, equipment, merchandise or other personal property of Tenant. Tenant shall not carry any stock of goods or do anything in or about said Demised Premises which will in any way tend to increase insurance rates on said Demised Premises or the Building in which the same are located. If Landlord shall consent to such use, Tenant agrees to pay as additional rental any increase in premiums for insurance against loss by fire or extended coverage risks resulting from the business carried on in the Demised Premises by Tenant. If Tenant installs any electrical equipment that overloads the power lines to the Building or if any insurance company insuring the Building or the Demised Premises makes any safety recommendations regarding the Demised Premises, Tenant shall at its own expense, make whatever changes are necessary to comply with the requirements of insurance underwriters, insurance rating bureaus, loss control specialists or governmental authorities having jurisdiction. Tenant agrees to procure and maintain a policy or policies of insurance, at its own cost and expense, insuring Landlord and Tenant from all claims, demands, or actions made by or on behalf of any person or persons, firm, or corporation arising from, related to, or connected with the conduct and operation of Tenant's business in the Demised Premises for injury to or death of one or more persons and for damage to property in the combined single limit of not less than $1,000,000 each occurrence. Tenant shall carry like coverage against loss or damage by boiler or internal explosion by boilers, if there is a boiler in the Demised Premises. Said insurance shall not be subject to cancellation except after at least thirty (30) days' prior written notice to Landlord, and the policy or policies, or duly executed certificate or certificates for the same, together with satisfactory evidence of the payment of premium thereon, shall be deposited with Landlord at the commencement of the term and renewals thereof no less than thirty (30) days prior to the expiration of the term of such coverage. If Tenant fails to comply with such requirement, Landlord may obtain such insurance and keep the same in effect, and Tenant shall pay landlord the premium cost thereof upon demand. Landlord shall procure at its own expense during the term of this Lease fire, windstorm, extended coverage, such other insurance as Landlord may obtain, and rental loss insurance on the Project provided, however, Tenant shall reimburse Landlord for its share of the actual net cost and expense to Landlord of such fire, windstorm, extended coverage, and rental loss insurance. Tenant shall procure at its own expense from the time Tenant takes possession until the end of the Lease Term, fire, extended coverage, vandalism, and sprinkler leakage insurance on the Demised Premises. This property insurance shall include floor coverings and/or any improvements and fixtures and signs installed by Landlord. Each of Landlord and Tenant hereby releases the other from any and all liability or responsibility (to the other or anyone claiming through or under them by way of subrogation or otherwise) for any loss or damage to property caused by fire or any other insured peril, even if such fire or other casualty shall have been caused by the fault or negligence of the other party or anyone for RBCIV4/94 - 6 - whom such party may be responsible. Tenant also agrees to obtain a waiver of subrogation from its insurer, subject to availability. 13. EMINENT DOMAIN. If the entire Demised Premises are taken by eminent domain, this Lease shall automatically terminate as of the date of taking. If a portion of the Demised Premises is taken by eminent domain, Landlord shall have the right to terminate this Lease as of the date of taking by giving written notice thereof to Tenant within ninety (90) days after such date of taking. If Landlord does not elect to terminate this Lease, it shall, at its expense, restore the Demised Premises, exclusive of any improvements or other changes made therein by Tenant, to as near the condition which existed immediately prior to the date of taking as reasonably possible, and to the extent that the Demised Premises are rendered untenantable, the rent shall proportionately abate. All damages awarded for a taking under the power of eminent domain shall belong to and be the exclusive property of Landlord, whether such damages be awarded as compensation for diminution in value of the leasehold estate hereby created, or to the fee of the Demised Premises provided, however, that Landlord shall not be entitled to any separate award made to Tenant for the value and cost of removal of its personal property and fixtures. 14. DEFAULT. Tenant hereby agrees that in case Tenant shall default in making its payments hereunder or in performing any of the other agreements, terms and conditions of this Lease then, in any such event, Landlord, in addition to all other rights and remedies available to Landlord, by law or by other provisions hereof, may without process re-enter immediately into the Demised Premises and remove all persons and property therefrom and, at Landlord's option, annul and cancel this Lease as to all future rights of Tenant, and Tenant hereby expressly waives the service of any notice in writing of intention to re-enter as aforesaid. Landlord, in addition to the foregoing, may also accelerate rent due and owing for the remainder of the term. Tenant further agrees that in case of any such termination, Tenant will indemnify the Landlord against all loss of rents and other damage which Landlord may incur by reason of such termination including, but not limited to, costs of restoring and repairing the Demised Premises and putting the same in rentable condition, costs of renting the Demised Premises to another tenant, loss or diminution of rents and other damage which Landlord may incur by reason of such termination, and all reasonable attorney's fees and expenses incurred in enforcing any of the terms of this Lease. Neither acceptance of rent by Landlord, with or without knowledge of breach, nor failure of Landlord to take action on account of any breach hereof or to enforce its rights hereunder, shall be deemed a waiver of any breach, and absent written notice or consent, said breach shall be a continuing one. Tenant further agrees that if (i) Tenant is declared bankrupt or insolvent, (ii) Tenant petitions for, or consents to, the appointment of a receiver of all or substantially all of Tenant's assets, (iii) Tenant petitions or consents to be declared a bankrupt or an insolvent, or (iv) a petition if filed by a third person to have Tenant declared bankrupt or insolvent or to have a receiver appointed with respect to all or substantially all of Tenant's assets and such petition is not discharged within sixty (60) days after service thereof is made on Tenant, then, at Landlord's option, without limiting Landlord's other rights and remedies to which Landlord is entitled under law and/or equity by reason of any of the aforesaid occurrences and without relieving Tenant of Tenant's obligations under this Lease, Landlord may terminate this Lease and, whether or not this Lease is terminated, may re-enter the Demised Premises and remove all persons therefrom, all as set forth in the foregoing paragraph of this Section 14. RBCIV4/94 - 7 - 15. NOTICES. All bills, statements, notices or communications which Landlord may desire or be required to give to Tenant shall be deemed sufficiently given or rendered if in writing and either delivered to Tenant personally or sent by registered or certified mail addressed to Tenant at the Building, and the time of rendition thereof or the giving of such notice or communication shall be deemed to be the time when the same is delivered to Tenant or deposited in the mail as herein provided. Any notice by Tenant to Landlord must be served by registered or certified mail addressed to Landlord at the address where the last previous rental hereunder was payable, or in case of subsequent change upon notice given, to the latest address furnished. 16. HOLDING OVER. Should Tenant continue to occupy the Demised Premises after expiration of said Lease Term or any renewal or renewals thereof, or after a forfeiture incurred, such tenancy shall be from month-to-month, and in no event from year-to-year or for any longer term. The monthly base rent during such month-to-month tenancy shall be one and a half (1.5) times the amount of the monthly base rent set forth in Paragraph 3 of this Lease. 17. SUBORDINATION. The rights of Tenant shall be subordinate to the lien of any first mortgage now or hereafter in force against the real estate on or in which the Demised Premises are located, and Tenant shall execute such further instruments subordinating this Lease to the lien or liens of any such mortgage or mortgages as shall be requested by Landlord. Notwithstanding the foregoing provisions, Tenant agrees that any First Mortgagee shall have the right at any time to subordinate any rights of such First Mortgagee to the rights of Tenant under this Lease on such terms and subject to such conditions as such First Mortgagee deems appropriate. 18. ESTOPPEL CERTIFICATE. Tenant shall at any time and from time to time upon not less than ten (10) days' prior written notice from Landlord, execute, acknowledge and deliver to Landlord a statement in writing certifying (i) that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease as so modified, is in full force and effect); (ii) the date of commencement of the term of this Lease; (iii) that rent is paid currently without any offset or defense thereto; (iv) the amount of rent, if any, paid in advance; and (v) that there are no uncured defaults by Landlord or stating those claimed by Tenant, provided that, in fact, such facts are accurate and ascertainable. Any such statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the real property of which the Demised Premises are a part. Failure to sign the statement or failure to specify any default claimed shall be deemed approval of the statement submitted to Tenant by Landlord. 19. MORTGAGEE PROTECTION. Tenant agrees to give any mortgagees and/or trust deed holders, by registered mail, a copy of any notice of default served upon Landlord, provided that prior to such notice Tenant has been notified, in writing (by way of Notice of Assignment of Rents and Leases, or otherwise) of the address of such mortgagees and/or trust deed holders. Tenant agrees to send such notices to Teachers Insurance and Annuity Association, 730 Third Avenue, New York, New York 10017, Attention Senior Vice President, Mortgage Department. Tenant further agrees that if Landlord shall have failed to cure such default within the term provided for in this Lease, then the mortgagees and/or trust deed holders shall have an additional thirty (30) days within which to cure such default or, if such default cannot be cured within that time, then such additional time as may be necessary, if within such thirty (30) days any mortgagee and/or trust deed holder has commenced and is diligently pursuing the remedies necessary to cure such default (including, but not limited to commencement of foreclosure proceedings, if necessary to effect such cure), in RBCIV4/94 - 8 - which event this Lease shall not be terminated while such remedies are being so diligently pursued. 20. SERVICE CHARGE. Tenant agrees to pay a service charge equal to twelve percent (12%) per annum on any portion thereof of any payment of monthly base rent or additional charge payable by Tenant hereunder which is not paid within ten (10) days from the date due, or $25.00 per month or portion thereof, whichever is greater. 21. SECURITY DEPOSIT. Tenant has deposited with Landlord the total sum of Five thousand 00/100 Dollars ($5,000.00) on May 11, 1990, check #002, of which two thousand five hundred and 00/100 Dollars ($2,500.00) shall be held for security/damage to the above referenced demised premises. Upon expiration of this lease agreement, any remaining security deposit shall transfer to the demised premises commonly described in the lease agreement dated July 31, 1996 as 2640-2652 Patton Road, Roseville, Minnesota, and be held as additional security deposit by Landlord for said demised premises. Said sum shall be held by Landlord as security for the faithful performance by Tenant of all the terms, covenants, and conditions of this Lease to be kept and performed by Tenant during the term hereof. If Tenant defaults with respect to any provisions of this Lease including, but not limited to, the provisions relating to the payment of rent, Landlord may (but shall not be required to) use, apply or retain all or any part of this security deposit for the payment of any amount which Landlord may spend or become obligated to spend by reason of Tenant's default, or to compensate Landlord for any other loss or damage which Landlord may suffer by reason of Tenant's default. If any portion of said security deposit is so used or applied, Tenant shall within five (5) days after written demand therefor, deposit cash with Landlord in an amount sufficient to restore the security deposit to its original amount, and Tenant's failure to do so shall be a material breach of this Lease. Landlord shall not be required to keep this security deposit separate from its general funds, and Tenant shall not be entitled to interest on such deposit. If Tenant shall fully and faithfully perform every provision of this Lease to be performed by it, the security deposit or any balance thereof shall be returned to Tenant (or, at Landlord's option, to he last assignee of Tenant's interest hereunder) at the expiration of the Lease Term. In the event of termination of Landlord's interest in this Lease, Landlord shall transfer said deposit to Landlord's successor in interest. 22. PROPERTY TAXES. Tenant shall pay, or cause to be paid, before delinquency, any and all taxes levied or assessed and which become payable during the term hereof upon all Tenant's leasehold improvements, equipment, furniture, fixtures and personal property located in the Demised Premises except that which has been paid for by Landlord and is the standard of the Building. In the event any or all of the Tenant's leasehold improvements, equipment, furniture, fixtures and personal property shall be assessed and taxed with the Building, Tenant shall pay to Landlord its share of such taxes within ten (10) days after delivery to Tenant by Landlord of a statement in writing setting forth the amount of such taxes applicable to Tenant's property. 23. NOVATION IN EVENT OF SALE OR TRANSFER. In the event of the sale of the Building or the transfer of the title thereto, Landlord shall be relieved of all of the covenants and obligations created by this Lease, except as to breaches thereof occurring prior to such sale or transfer, and such sale or transfer shall automatically result in the purchaser or transferee assuming and agreeing to carry out all of the covenants and obligations of Landlord herein from and after such sale or transfer. RBCIV4/94 - 9 - 24. DISPLAYS. Tenant shall not display or suffer to be displayed on the outside of the Demised Premises, on the outside of the Building or on the sidewalks, driveways, or parking areas adjoining the Building, any goods or merchandise whatsoever, except with Landlord's written consent 25. INTERRUPTION OF SERVICES. No liability shall attach to Landlord for any inconvenience, loss, or damage sustained by Tenant or any other person, or to the property of Tenant or such other person, due to interruption of electric power, water, or gas to the Building or to the Demised Premises or by reason of the failure of any piping, wiring, or apparatus in the Building or for any inconvenience, loss, or damage sustained by Tenant as a result of any of the causes set forth in Section 12 or caused by any act or thing done or suffered to be done by any other tenant of the Building or any servant, employee, agent, invitee, or customer of Tenant. However, Landlord shall make all reasonable effort to remedy such interruption of services. 26. ZONING. Tenant covenants that it has satisfied itself prior to execution of this Lease that the Demised Premises are properly zoned to permit Tenant's intended use of the Demised Premises. Any changes with respect to the interior finishing of the premises in order to comply with any local or municipal by-laws shall be at the sole expense of Tenant. 27. QUIET ENJOYMENT. Conditional upon the faithful performance of the terms, covenants and provisions herein contained by Tenant, Landlord covenants that Tenant shall quietly have, hold and enjoy the Demised Premises for the term hereof except or otherwise herein provided. 28. JANITORIAL SERVICES. Tenant shall provide all janitorial and, at the option of Landlord, all refuse removal services for the Demised Premises, at the expense of Tenant. 29. HAZARDOUS MATERIALS. Tenant shall not (either with or without negligence) cause or permit the escape, disposal or release of any biologically or chemically active or other hazardous substances, or materials. Tenant shall not allow the storage or use of such substances or materials in any manner not sanctioned by law or by the highest standards prevailing in the industry for the storage and use of such substances or materials, nor allow to be brought into the Project any such materials or substances except to use in the ordinary course of Tenant's business, and then only after written notice is given to Landlord of the identity of such substances or materials. Without limitation, hazardous substances and materials shall include those described in the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. Section 9601 et seq., the Resource Conservation and Recovery Act, as amended, 42 U.S.C. Section 6901 et seq., any applicable state or local laws and the regulations adopted under these acts. If any lender or governmental agency shall ever require testing to ascertain whether or not there has been any release of hazardous materials, then the reasonable costs thereof shall be reimbursed by Tenant to Landlord upon demand as additional charges if such requirement applies to the Premises. In addition, Tenant shall execute affidavits, representations and the like from time to time at Landlord's request concerning Tenant's best knowledge and belief regarding the presence of hazardous substances or materials on the Premises. In all events, Tenant shall indemnify Landlord from any release of hazardous materials on the Premises occurring while Tenant is in possession or elsewhere if caused by Tenant or persons acting under Tenant. The within covenants shall survive the expiration or earlier termination of the lease term. RBCIV4/94 - 10 - 30. MEMORANDUM. Upon the request of either Landlord or Tenant, the parties shall enter into a memorandum, in recordable form, setting forth a summary of the terms hereof relating only to the description of the Demised Premises, the term hereof, and the conditions of assignment or subletting. 31. GENERAL. This Lease does not create the relationship of principal and agent or of partnership or of joint venture or of any association between Landlord and Tenant, the sole relationship between Landlord and Tenant being that of lessor and lessee. No waiver of any default of Tenant hereunder shall be implied from any omission by Landlord to take any action on account of such default if such default persists or is repeated, and no express waiver shall affect any default other than the default specified in the express waiver and that only for the time and to the extent therein stated. Each term and each provision of this Lease performable by Tenant shall be construed to be both a covenant and a condition. The topical headings of the several paragraphs and clauses are for convenience only and do not define, limit or construe the contents of such paragraphs or clauses. All preliminary negotiations are merged into and incorporated in this Lease. This Lease can only be modified or amended by an Agreement in writing signed by the parties hereto. All provisions hereof shall be binding upon the heirs, successors and assigns of each party hereto. 32. BASE RENT ADJUSTMENT. During years two and three of the lease term (year three being August 1, 1998-September 30, 1999), Tenant covenants and agrees to pay to Landlord as Base Rent during each of such lease years an amount equal to the product obtained by multiplying one hundred forty-seven thousand five hundred seventy-two and 60/lO0 Dollars ($147,572.60) by a fraction, the numerator of which is the "Consumer Price Index - Seasonally Adjusted U.S. City Average For All Items For All Urban Consumers (1982-84=100, 1996 Definition)" published monthly in the "Monthly Labor Review" of the Bureau of Labor Statistics of the United States Department of Labor ("CPI-U"), for the first calendar month of the lease year, and the denominator of which is the CPI-U for the first full calendar month of the first lease year. In any event, the annual base rent increase will be a minimum of three percent (3%). If the CPI-U is discontinued, the "Consumer Price Index Seasonally Adjusted U.S. City Average For All Urban Wage Earners and Clerical Workers (1982-84=100, 1996 Definition)" published monthly in the "Monthly Labor Review" by the Bureau of Labor Statistics of the United States Department of Labor ("CPI-W"), shall be used for making the computation above. If the CPI-W is discontinued, comparable statistics on the purchasing power of the consumer dollar published by the Bureau of Labor Statistics of the United States Department of Labor shall be used for making the computation above. If the Bureau of Labor Statistics shall no longer maintain statistics on the purchasing power of the consumer dollar, comparable statistics published by a responsible financial periodical or recognized authority selected by Lessor shall be used for making the computation above. If the base year "(1982=100)" or other base year used in computing the CPI-U is changed, the figures used in making the adjustment above shall be changed accordingly so that all increases in the CPI-U are taken into account notwithstanding any such change in the base year for calculation of Base Rent. 33. IMPROVEMENTS. Landlord, at its sole cost and expense, shall provide the following improvements: 1. Replace carpets in areas mutually agreeable between Landlord and Tenant, RBCIV4/94 - 11 - 2. Repair and reline entire parking lot, 3. Provide Tenant with new signage that is mutually agreeable to Landlord and Tenant and complies with all building aesthetics and city zoning codes and ordinances . 34. PRIOR LEASE AGREEMENTS. Landlord and Tenant's rights and obligations under prior lease agreements dated May 3, 1990, July 2, 1991, December 13, 1991, December 30, 1992, May 10, 1993 and September, 1994 and any lease addendum, amendment or renewal pertaining to the above-referenced lease agreements and any agreement dated prior to July 23, 1996, shall be null and void upon the execution of this lease agreement and the lease agreement for the demised premises commonly described as 2640-2652 Patton Road dated July 31, 1996." 35. ENTIRE AGREEMENT. This Lease Agreement, as well as Exhibit(s) A contain the entire understanding of the parties hereto with respect to the transaction contemplated thereby and supersedes all prior agreements and understandings between the parties with respect to the subject matter. No representations, warranties, undertakings or promises, whether oral, implied, written or otherwise, have been made by either party hereto to the other unless expressly stated in this Lease or unless mutually agreed to in writing between the parties hereto and after the date hereof, and neither party has relied on any verbal representation, agreements, or understandings not expressly set forth herein. In Witness Whereof, the parties hereto have executed this Lease the day and year first above written. LANDLORD: Roseville Properties Management Company, Inc. as agent for COMMERS- KLODT, a Minnesota general partnership BY: /s/ Daniel P. Commers ITS: President TENANT Diametrics Medical Inc., a Minnesota Corporation, BY: /s/ David T. Giddings ITS: Chief Executive Officer RBCIV4/94 - 12 - EX-13 3 PORTIONS OF COMPANY'S ANNUAL REPORT EXHIBIT 13 SELECTED FIVE-YEAR FINANCIAL DATA
(in thousands, except share and per share amounts) Years ended December 31, - ------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 Statement of Operations Data:(3) Net sales $ 12,156 $ 10,434 $ 3,797 $ 1,607 $ 331 Operating loss (16,916) (20,510) (23,782) (23,387) (12,733) Net loss (17,388) (21,037) (23,575) (23,046) (12,455) Net loss per share (1), (2) (0.79) (1.13) (1.56) (1.82) (1.50) Weighted average shares outstanding 21,996,382 18,665,837 15,088,493 12,640,212 8,323,894 Balance Sheet Data: Working capital $ 11,415 $ 12,509 $ 6,649 $ 27,123 $ 7,413 Total assets (3) 25,346 28,662 24,059 36,620 17,393 Long-term liabilities 8,345 8,969 8,582 1,851 1,759 Shareholders' equity 11,366 12,773 8,674 31,194 11,157
(1) The Company has not paid any dividends since inception. (2) Basic and diluted net loss per share amounts are identical as the effect of potential common shares is antidilutive. (3) On November 6, 1996 the Company acquired all of the outstanding capital stock of Biomedical Sensors, Ltd. and certain assets of Howmedica, Inc. The Company accounted for the acquisition using the purchase method of accounting and, accordingly, the results of operations of the acquired entities have been included in the Company's consolidated financial statements from November 6, 1996. Further detail on the acquisition is provided in note 18 of Notes to Consolidated Financial Statements. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SUMMARY Diametrics Medical, Inc., which began operations in 1990, is engaged in the development, manufacturing and marketing of critical care blood and tissue analysis systems which provide immediate or continuous diagnostic results at the point-of-patient care. Since its commencement of operations in 1990, the Company has transitioned from a development stage company to a full-scale development, manufacturing and sales organization. As of December 31, 1998, the primary funding for the operations of the Company has been approximately $130 million raised through public and private sales of its equity securities and issuance of convertible promissory notes. During 1998, the Company continued to achieve significant improvements in its operating results, including annual sales growth of 16%, the first positive annual gross margin with an improvement of 167% over 1997, containment of operating expenses and a reduction of the annual operating loss of approximately 18%. The achievement of several product and partnering milestones during the year positively impacted 1998 operating results, and are expected to have a greater impact in 1999 and future years. Sales growth in 1998 was positively impacted by the commencement of global commercialization of Neotrend, designed specifically to provide continuous monitoring of blood gases and temperature in critically ill premature babies. The Company received FDA clearance to market Neotrend in the U.S. in late 1997 and received CE Mark in the second quarter 1998, allowing Neotrend to be marketed in Europe. Over 30 customer evaluations of Neotrend are currently in process, with approximately 80 evaluations pending placement at neonatal intensive care unit sites. Also contributing to 1998 sales growth was the commercialization of another continuous monitoring product, Neurotrend. Neurotrend allows clinicians to monitor oxygen, carbon dioxide, acidity and temperature in the brain of a patient who is undergoing surgery or has experienced severe head injury. CE Mark was received in the second quarter 1998 and FDA clearance in the U.S. is pending. In October 1998, the Company entered into an exclusive Distribution Agreement with CODMAN, a Johnson & Johnson company, for worldwide market development and distribution of the Neurotrend system. In 1998, the Company completed the transition from its first generation cartridge format to the full-scale production of the new snapfit combination cartridge introduced in 1997 for use with the IRMA(R)SL Blood Analysis System. Nearly all existing customers were converted to the new format by the end of 1998. The combination cartridge gives clini- 13 cians the ability to perform all critical blood gas, electrolyte and hematocrit tests using one small blood sample on a single-use cartridge. The combination cartridge extends the system's application to all critical care areas in the hospital including the operating room, and provides lower unit manufacturing costs and improved gross margins. Another significant achievement in 1998 which positively impacted operating results was the integration of the LifeScan SureStep(R)Pro Glucose Module with the IRMA SL Blood Analysis System and the commercialization of this new integrated workstation in the first half of 1998. Through a partnership with LifeScan, a Johnson & Johnson company, the IRMA SL integrates inexpensive blood glucose strip testing on its platform, offering an expanded blood test panel. Since FDA clearance in first quarter 1998, the Company has shipped over 350 IRMA SL systems with the glucose modules. The Company also continued to pursue agreements with hospital systems and influential buying groups which establish the Company as a sole or preferred supplier of its blood analysis systems. Accomplishments in 1998 included a sole source agreement with Columbia Healthcare Corporation, the largest owned hospital system in the U.S., and a three-year preferred supplier agreement with Health Services Corporation of America, a leading national organization providing purchasing agreements for more than 800 acute care hospitals. Such agreements have helped open new markets to the Company's blood analysis systems, and have increased market penetration in existing markets. RESULTS OF OPERATIONS SALES Sales of the Company's products were $12,155,526 for 1998, compared to $10,434,366 for 1997 and $3,796,816 for 1996. The 175% increase in sales from 1996 to 1997 was affected by the inclusion in 1997 of the first full year of sales from the operations of the Company's subsidiary, Diametrics Medical, Ltd. (DML), acquired in November 1996. This contributed approximately $3.9 million to the increase in sales between periods, with the remaining increase of $2.7 million reflecting growth in sales of the Company's intermittent blood testing products. Sales increased 16% in 1998 from 1997, reflecting a 15% growth in sales of instruments and a 19% increase in disposable cartridge and sensor sales. Sales to international customers accounted for 60% of 1998 sales, compared to 62% in 1997 and 39% in 1996. Intermittent testing products represented 63%, 59% and 91% of sales in 1998, 1997 and 1996, respectively, with continuous monitoring products comprising the remaining sales in each year. For the year ended December 31, 1998, intermittent blood testing products revenue was comprised of 59% instrument related revenue and 41% disposable cartridge related revenue. Continuous monitoring products revenue was comprised of 41% instrument related revenue and 59% disposable sensor revenue. The Company's revenues are affected principally by the number of instruments, both monitors and IRMA analyzers, placed with customers and the rate at which disposable sensors and cartridges are used in connection with these products. As of December 31, 1998, the Company has sold over 3,000 instruments. Unit sales of instruments in 1998 increased approximately 11% from 1997, while disposable sensor and cartridge unit sales increased approximately 48%. As the Company grows, it is expected that the Company's growing customer base will increase its rate of usage of disposable products, with the result that overall disposable product sales will exceed that of instrument sales. The Company has targeted 1999 revenues to grow at a rate in excess of the growth rate experienced during 1998, as a result of further planned expansion of the blood and tissue analysis product lines and continued market penetration of existing products. COST OF SALES Cost of sales totaled $11,334,721 for 1998, compared to $11,666,142 for 1997 and $9,860,259 for 1996. Cost of sales as a percentage of revenue was 93% in 1998, 112% in 1997 and 260% in 1996. The significant year-to- year improvement in the Company's cost of sales as a percentage of revenue reflects increased cartridge sales volumes and the impact of cost controls and manufacturing process changes. These improvements resulted in the achievement in 1998 of the Company's first positive annual gross margin at $820,805, a $2 million or 167% improvement from 1997. The Company is targeting continued improvements in gross margin during 1999 as a result of new product introductions and further reductions in unit product costs, stemming from increased sales volumes; further expected improvements in manufacturing yields; and in-house (vs. third party vendor) assembly of IRMA analyzers and components of the monitors. OPERATING EXPENSES Total operating expenses decreased by $1.5 million or 8% from 1997 to 1998, following an increase of $1.6 million or 9% from 1996 to 1997. The increase in 1997 was due primarily to the inclusion of a full year of expenses from the operations of the Company's subsidiary, DML, adding approximately $5.3 million to 1997 expenses. This was partially offset by a reduction of $870,845 in restructuring charges and a $2.9 million reduction in operating expenses in the Company's U.S. operations, stemming from work force reductions during 1996 and 1997 which reduced average headcount in the U.S. operations by 28% between years. On a pre-restructure charge basis, 1998 operating expenses decreased $1.1 mil- 14 lion or 6% relative to 1997, primarily the result of the 1997 work force reductions, reducing average headcount between years by 13% in the Company's U.S. operations. Research and development expenses totaled $6,466,154 in 1998, compared to $7,231,669 in 1997 and $6,359,844 in 1996. The 14% increase from 1996 to 1997 is due to the incremental impact of DML expenses ($2.9 million), partially offset by $2 million of expense reductions in the Company's U.S. operations, primarily the result of average headcount reductions of 40% between years and implementation of cost and process improvements. The 11% reduction in expenses between 1997 and 1998 is primarily the result of further work force reductions during 1997, with average headcount declining 16% between years. Sales and marketing expenses totaled $8,009,318 in 1998, compared to $7,893,284 in 1997 and $6,781,943 in 1996. The 16% increase in expenses from 1996 to 1997 is primarily due to the incremental impact of a full year of DML expenses ($1.4 million), partially offset by reduced expenses in the Company's U.S. operations due to organizational efficiencies and improved deployment of resources. The 1% increase in expenses from 1997 to 1998 is primarily impacted by higher commissions on increased direct sales and increased sales support costs for placement of the Company's products with new customers. General and administrative expenses totaled $3,261,098 in 1998, compared to $3,689,036 in 1997 and $3,242,320 in 1996. The 14% increase in expenses from 1996 to 1997 is due to the impact of the inclusion of a full year of DML expenses ($854,000), partially offset by reduced expenses in the Company's U.S. operations, stemming primarily from work force reductions which reduced average headcount between years by 28%. The 12% decline in expenses from 1997 to 1998 is primarily the result of further work force reductions during 1997. Restructuring and other charges totaled $0 in 1998, $463,816 in 1997 and $1,334,661 in 1996. Charges in 1996 consisted of approximately $584,000 for severance costs related to restructuring of the management team in early 1996 and a work force reduction, $464,000 for the write-off of purchased in-process research and development created from the DML acquisition, and $287,000 for the write-down of excess and obsolete equipment, resulting from the work force reductions and process changes. Charges in 1997 consisted of severance costs of approximately $319,000 associated with work force reductions, primarily in the Company's U.S. manufacturing, research and development and general and administrative areas, and $145,000 for the write-down of excess and obsolete equipment resulting from the work force reductions and further process changes. OTHER INCOME (EXPENSE) Net other expense in 1998 was $471,897, compared to $526,962 in 1997 and net other income of $207,117 in 1996. The Company realized interest income of $422,441 in 1998, compared to $658,625 in 1997 and $929,603 in 1996. The year-to-year decline reflects the impact of lower average cash balances due to the timing of the Company's financing activities between 1995 and 1998, and also due to a net use of cash in operations for each period. Interest expense totaled $807,411 in 1998, compared to $1,017,657 in 1997 and $607,342 in 1996. The increase in expense between 1996 and 1997 primarily reflects interest accrued on a long-term note payable issued in connection with the Company's acquisition of DML in November 1996. The decline in expense between 1997 and 1998 primarily reflects a reduction in the amount of higher interest bearing capital lease debt relative to total debt outstanding. NET LOSS Net loss for the year ended December 31, 1998 was $17,387,662, compared to $21,036,543 in 1997 and $23,575,094 in 1996. The year-to-year improvement in net loss reflects revenue growth, coupled with the impact of work force reductions implemented during 1996 and 1997, cost controls, increased production volumes and manufacturing process improvements. The Company is targeting continued improvement in net loss in 1999. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1998, the Company had working capital of approximately $11.4 million, a decrease of $1.1 million from the working capital of $12.5 million reported at December 31, 1997. The net decrease primarily reflects the impact of the amount and timing of proceeds from private equity placements in 1997 and 1998, and net cash used in operating activities for the year ended December 31, 1998. Through December 31, 1998, the Company raised approximately $130 million through the public and private sales of its equity securities and the issuance of convertible promissory notes. Net cash used in operating activities totaled $18.8 million for the year ended December 31, 1998, compared to $16.6 million and $20.3 million for the same periods in 1997 and 1996, respectively. This was the result of net losses of $17.4 million, $21 million and $23.6 million for these same periods in 1998, 1997 and 1996, respectively, adjusted by changes in key operating assets and liabilities, primarily accounts receivable, inventories and accounts payable and accrued expenses. As discussed in note 19 of Notes to Consolidated Financial Statements, effective January 1, 1998, the Company changed the year-end of its wholly-owned subsidiary, DML, to December 31 from November 30 to produce a consis- 15 tent reporting period for the consolidated entity. As a result of this change in year-end, DML's net results of operations for the month of December 1997 were closed to beginning accumulated deficit as of January 1, 1998. Additionally, the changes in DML's operating assets and liabilities during the month of December 1997 are included in the Consolidated Statement of Cash Flows for the year ended December 31, 1998. The discussion below of changes in accounts receivable, inventories, accounts payable and accrued expenses includes the impact of the DML year-end change on these balances. Net accounts receivable increased $1.7 million for the year ended December 31, 1998, compared to $1.2 million in 1997 and $581,000 in 1996. The year-to-year increases are primarily due to increased sales in each year and the timing of sales and related customer payments. Inventories increased $1.3 million for the year ended December 31, 1998, after a decrease of $876,000 in 1997 and an increase of $633,000 in 1996. The increase in 1998 is due to increased inventory levels needed to begin internal assembly of the Company's IRMA SL analyzers and to meet an expected increase in demand. The prior year decrease was due primarily to an improvement in inventory turnover during the year, stemming from improved inventory management. Accounts payable and accrued expenses decreased $1.5 million for the year ended December 31, 1998, after an increase of $418,000 and $348,000 in 1997 and 1996, respectively. The decrease in 1998 is affected primarily by a reduction in accrued interest payable, due to the timing of interest payments and reductions in product upgrade accruals as upgrades are completed, combined with timing of payments to vendors and employees. Increases in 1997 and 1996 were primarily the result of the timing of vendor payments. Net cash provided by investing activities totaled $3.2 million for the year ended December 31, 1998, following a net use of cash in 1997 of $7.8 million and net cash provided by investing activities of $19.8 million in 1996. These year- to-year changes were primarily affected by the amounts and timing of private equity placements, which affected the amount of cash available for the purchase of marketable securities. Purchases of property and equipment also affected net cash provided by or used in investing activities, and totaled $2.3 million for the year ended December 31, 1998, $3 million in 1997 and $1.6 million in 1996. Capital additions in each year consisted primarily of investments in development and production equipment and instruments for internal use in R&D and sales. In 1999, the Company expects total capital expenditures and new lease commitments to approximate $2.4 million for the year, primarily reflecting investments to support new product development and production. Net cash provided by financing activities totaled $16.4 million for the year ended December 31, 1998, compared to $25.3 million in 1997 and $278,000 in 1996. The year-to-year changes were due primarily to the amounts and timing of private equity placements in 1997 and 1998. In late 1996 and throughout 1997, the Company entered into long-term debt obligations of approximately $8.9 million. The original debt consisted of a $7.3 million senior secured fixed rate loan note issued to Pfizer Inc. in connection with the Company's acquisition of DML and approximately $1.6 million in notes payable for equipment financing. Proceeds from the issuance in August 1998 of $7.3 million of Convertible Senior Secured Fixed Rate Notes, issued in conjunction with a private equity placement, were simultaneously used to retire the $7.3 million Pfizer note. The Company's long-term debt and capital lease obligations require principal and interest repayments of approximately $1 million in 1999, $900,000 in each of years 2000 and 2001, $600,000 in 2002 and $7.6 million in 2003. Effective March 31, 1998, the Company secured a $1,000,000 receivable backed line of credit. The loan agreement requires the Company's accounts receivable collections to be applied to reduce the loan balance, including advances, interest and fees. At December 31, 1998, the Company had an outstanding balance owed of $828,823 under the line of credit. At December 31, 1998, the Company had U.S. net operating loss and research and development tax credit carryforwards for income tax purposes of approximately $103.8 million and $939,000, respectively. Pursuant to the Tax Reform Act of 1986, use of the Company's net operating loss carryforwards are limited due to a "change in ownership." (See note 12 of Notes to Consolidated Financial Statements for further discussion). In August 1998, the Company completed a private equity placement of 2,142,858 shares of Common Stock which generated aggregate proceeds to the Company of $15,000,006. Also, as part of an exclusive Distribution Agreement initiated on October 1, 1998, the Company entered into a $5,000,000 Put Option and Stock Purchase Agreement with Johnson & Johnson Development Corporation who committed to purchase up to $5,000,000 of the Company's Common Stock at the Company's option over the twelve month period ending September 30, 1999. The Company believes proceeds from the $5,000,000 Put Option & Stock Purchase Agreement along with currently available funds and cash generated from projected operating revenues, supplemented by proceeds from employee stock plans, warrant exercises, asset based credit and corporate alliances, will meet the Company's working capital needs through 1999. If the amount or timing of funding from these sources or cash requirements 16 vary materially from those currently planned, the Company could require additional capital. The Company's long-term capital requirements will depend upon numerous factors, including the rate of market acceptance of the Company's products and the level of resources devoted to expanding the sales and marketing organization, manufacturing capabilities and research and development activities. While there can be no assurance that adequate funds will be available when needed or on acceptable terms, management believes that the Company will be able to raise adequate funding if needed. YEAR 2000 COMPLIANCE The Company is addressing the issues associated with computing difficulties that may affect existing computer systems as a result of programming code malfunction in distinguishing 21st century dates from 20th century dates (the "Year 2000" issue). The Year 2000 issue is a pervasive problem affecting many information technology systems and embedded technologies in all industries. The Company has identified teams of internal staff to review its products; its internal financial, manufacturing and other process control systems; and its interface with major customers and suppliers in order to assess and remediate Year 2000 concerns. The Company's information technology (IT) systems consist of computer hardware systems and software supplied by third parties. IT systems in the Company's U.S. operations are Year 2000 compliant. The Company has identified necessary software and hardware upgrades to achieve compliance for IT systems in its U.K. operations, with completion scheduled for mid 1999, allowing adequate time for testing and training. The Company's assessment of internal systems includes a review of non IT systems (systems that contain embedded technology in manufacturing or process control equipment containing microprocessors or other similar circuitry). This assessment includes a review of the Company's internal manufacturing equipment and facilities (including building maintenance, security, electrical, lighting, fire protection, telephone, heating and cooling systems). Based upon this review, the Company believes that its manufacturing processes and equipment and internal process control equipment are Year 2000 compliant company wide. The Company has assessed Year 2000 compliance of its products offered for sale to customers, and believes that all are currently compliant. Contacts are being made with the Company's customers regarding test procedures they can apply to verify compliance of the Company's products. The Company has identified third parties with which it has material relationships, including suppliers of components for its products and providers of critical utility services. The majority of the raw materials and purchased components used to manufacture the Company's products are readily available. Most of the raw materials are or may be obtained from more than one source. A small number of these materials, however, are unique in their nature, and are therefore single sourced. The Company has contacted all major U.S. third party suppliers and has received representations that if not currently compliant, each has plans in place to ensure that products purchased by the Company from such suppliers will function properly in the Year 2000 and that such suppliers' internal systems will be Year 2000 compliant no later than June 1999. The Company is in the process of contacting all major international suppliers to assess their status of compliance, and expects to complete that process by June 30, 1999. The Company is also currently evaluating alternative supplier sources, where appropriate, in cases where it is single sourced. These actions are intended to help mitigate the possible external impact of the Year 2000 problem. Even assuming that all material third parties confirm that they are or expect to be Year 2000 compliant by December 31, 1999, it is not possible to state with certainty that such parties will be so compliant. It is impossible to fully assess the potential consequences in the event service interruptions from component suppliers occur or in the event that there are disruptions in such infrastructure areas as utilities, communications, transportation, banking and government. The total estimated incremental cost required to address the Company's Year 2000 compliance is approximately $150,000, including the cost of software and hardware upgrades. The majority of this cost will be incurred in 1999. The actual cost, however, could exceed this estimate. These costs are not expected to have a material effect on the Company's financial position, results of operations or cash flows. Based upon its assessments to date, the Company believes it will not experience any material disruption in its operations as a result of Year 2000 problems in its products, in its internal financial, manufacturing and other process control systems, or in its interface with major customers and suppliers. However, if major suppliers, including those providing component parts, electricity, communications and transportation services, experience difficulties resulting in disruption of critical supplies or services to the Company, a shutdown of the Company's operations could occur for the duration of the disruption. As previously noted, the Company is working on minimizing the component supply risk by evaluating alternative suppliers, where appropriate, in cases where it is single-sourced, with completion of this evaluation expected by June 1999. The Company has not yet developed a contingency plan to provide for continuity of normal business operations in the event the other described problem scenarios arise, but it will assess the need to develop such a plan based upon the outcome of 17 compliance areas currently under review, and the results of remaining survey feedback from its major suppliers. Assuming no major disruption in service from critical third party providers, the Company believes that it will be able to manage the Year 2000 transition without any material effect on the Company's results of operations or financial position. There can be no assurance, however, that unexpected difficulties will not arise and, if so, that the Company will be able to timely develop and implement a contingency plan. MARKET RISK The Company's primary market risk exposure is foreign exchange rate fluctuations of the British pound sterling to the U.S. dollar as the financial results of the Company's U.K. subsidiary, DML, are translated into U.S. dollars in consolidation. The Company's exposure to foreign exchange rate fluctuations also arises from certain intercompany payable or receivable balances which are expected to be settled in the foreseeable future under the terms of the Company's intercompany agreement. Additionally, the Company has a small exposure to currency risk arising from German deutschemark denominated sales from DML to German customers. DML sells continuous monitoring products to customers and distributors located outside of North America. The Company also sells intermittent testing products from its U.S. operations to distributors located throughout the world. All sales from the Company's U.S. operations are denominated in U.S. dollars, and, with the exception of sales to customers in Germany, all sales made from DML are denominated in British pounds sterling. As sales to German customers have historically comprised only 5% of consolidated sales, the Company's method of minimizing exposure to currency risk due to fluctuations between the exchange rates for the British pound sterling and the German deutschemark has been to offset deutschemark denominated payment obligations with deutschemark denominated receipts to the full extent possible. Remaining exposure due to German deutschemark denominated sales is not expected to be material. The effect of foreign exchange rate fluctuations on the Company's financial results for the years ended December 31, 1998, 1997 and 1996 was not material. The Company does not currently use derivative financial instruments to hedge against exchange rate risk. Because foreign exchange exposure to these rate fluctuations increases as sales and intercompany balances grow, the Company will continue to evaluate the need to initiate hedging programs to mitigate the impact on intercompany balances of changes in the exchange rate of the British pound sterling to the U.S. dollar. The Company's exposure to interest rate risk is limited to short-term borrowings under its $1,000,000 receivable backed credit line. Any advances under the line of credit bear interest on the unpaid principal amount at a fluctuating rate tied to the Prime Rate. The Company does not use derivative financial instruments to manage interest rate risk. As borrowings at any one time are limited to $1,000,000 and are generally repaid within a few months, the Company's exposure is not believed to be material. All other existing debt agreements of the Company bear interest at fixed rates, and are therefore not subject to exposure from fluctuating interest rates. EURO CONVERSION Effective January 1, 1999, 11 of the 15 member countries of the European Union (EU) adopted the euro as their common legal currency. On that date, the participating countries established fixed euro conversion rates between their existing local currencies and the euro. During the three-and-a-half year transition period following its introduction, participating countries will be allowed to transact business both in the euro and in their local currencies. On July 1, 2002, the euro will be the sole official currency in participating EU countries. The Company sells and distributes its products globally, with significant sales in Europe. Additionally, as noted under "Market Risk", the Company's subsidiary, DML, conducts its operations from the U.K. All sales from the Company's U.S. operations are denominated in U.S. dollars and the majority of sales from the Company's U.K. operations are denominated in British pounds sterling. The U.K. is one of the four countries of the EU that did not adopt the euro as its legal currency effective January 1, 1999; however, the U.K. may convert to the euro at a later date. The conversion to the euro by the participating countries of the EU is not expected to result in large-scale changes to the denominations or pricing of the Company's sales contracts, unless the U.K. were to adopt the euro as its official currency, in which case all sales from the Company's U.K. operations would be denominated in euros. The Company has assessed the potential impact of the euro conversion on business processes, information technology systems and fixed assets in its U.K. operations, and is making required changes in tandem with required Year 2000 related upgrades. The Company is in the process of addressing these and other issues raised by the conversion to the euro. The Company does not presently expect that the conversion to the euro will result in any material increase in costs to the Company. While the Company will continue to evaluate the impact of the euro conversion over time, based upon currently available information, management does not believe that the conversion to the euro currency will have a material impact on the Company's financial condition or overall trends in results of operations. 18 NEW ACCOUNTING PRONOUNCEMENTS In 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. The statement requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company plans to adopt the new standard in 1999. The Company is currently evaluating SFAS No. 133, but does not expect that it will have a material effect on its financial statements. In 1998, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 provides guidance on accounting for the costs of computer software developed or obtained for internal use and does not require additional disclosures. The Company intends to adopt SOP 98-1 in 1999. Costs incurred prior to the initial application of the SOP will not be adjusted to conform with SOP 98-1. The adoption is not expected to have a material impact on the Company's financial position or results of operations. The Company's discussion and analysis of results of operations and financial condition, including statements regarding the Company's expectations about new and existing products, future financial performance, Year 2000 compliance, market risk exposure and other forward looking statements are subject to various risks and uncertainties, including, without limitation, demand and acceptance of new and existing products, technological advances and product obsolescence, competitive factors, stability of domestic and international financial markets and the availability of capital to finance growth. These and other risks are discussed in greater detail in an exhibit in the Company's Form 10-K filed with the U.S. Securities and Exchange Commission. 19 Consolidated Statements of Operations
Years ended December 31, -------------------------------------------------------------- DIAMETRICS MEDICAL, INC. AND SUBSIDIARY 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------- Net sales $ 12,155,526 $ 10,434,366 $ 3,796,816 Cost of sales 11,334,721 11,666,142 9,860,259 -------------------------------------------------------------- Gross profit (loss) 820,805 (1,231,776) (6,063,443) Operating expenses: Research and development 6,466,154 7,231,669 6,359,844 Sales and marketing 8,009,318 7,893,284 6,781,943 General and administrative 3,261,098 3,689,036 3,242,320 Restructuring and other charges - 463,816 1,334,661 -------------------------------------------------------------- 17,736,570 19,277,805 17,718,768 -------------------------------------------------------------- Operating loss (16,915,765) (20,509,581) (23,782,211) Interest income 422,441 658,625 929,603 Interest expense (807,411) (1,017,657) (607,342) Other expense, net (86,927) (167,930) (115,144) -------------------------------------------------------------- Net loss $ (17,387,662) $ (21,036,543) $ (23,575,094) ============================================================== Basic and diluted net loss per common share $ (0.79) $ (1.13) $ (1.56) ============================================================== Weighted average common shares outstanding 21,996,382 18,665,837 15,088,493 ==============================================================
The accompanying notes are an integral part of these consolidated financial statements. 20 Consolidated Balance Sheets
December 31, --------------------------------------- DIAMETRICS MEDICAL, INC. AND SUBSIDIARY 1998 1997 - ---------------------------------------------------------------------------------------------------------------------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 3,432,614 $ 3,358,684 Marketable securities 2,976,443 8,401,642 Accounts receivable, net of allowance for doubtful accounts of $280,000 in 1998 and $188,599 in 1997 5,420,092 3,768,528 Inventories 4,767,537 3,588,218 Prepaid expenses and other current assets 454,291 311,173 --------------------------------------- Total current assets 17,050,977 19,428,245 --------------------------------------- PROPERTY AND EQUIPMENT, NET 6,922,793 7,385,972 OTHER ASSETS, NET 1,372,544 1,847,316 --------------------------------------- $ 25,346,314 $ 28,661,533 ======================================= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 2,535,343 $ 2,261,822 Accrued expenses 1,855,004 3,687,597 Short-term borrowings 828,823 - Current portion of long-term liabilities 416,509 969,950 --------------------------------------- Total current liabilities 5,635,679 6,919,369 --------------------------------------- LONG-TERM LIABILITIES: Long-term liabilities, excluding current portion 8,163,307 8,537,742 Other liabilities 181,764 431,145 --------------------------------------- Total liabilities 13,980,750 15,888,256 --------------------------------------- SHAREHOLDERS' EQUITY: Preferred stock, $.01 par value: 5,000,000 shares authorized, none issued -- - Common stock, $.01 par value: 35,000,000 shares authorized, 23,391,597 and 20,889,945 shares issued and outstanding at December 31, 1998 and 1997, respectively 233,916 208,899 Additional paid-in capital 130,477,220 113,970,247 Accumulated other comprehensive loss (225,165) (350,189) Accumulated deficit (119,120,407) (101,055,680) --------------------------------------- Total shareholders' equity 11,365,564 12,773,277 --------------------------------------- Commitments and contingencies (notes 7, 8, 16, and 17) $ 25,346,314 $ 28,661,533 =======================================
The accompanying notes are an integral part of these consolidated financial statements. 21 Consolidated Statements of Shareholders' Equity
Accumulated Additional other Preferred Common paid-in Accumulated comprehensive DIAMETRICS MEDICAL, INC. AND SUBSIDIARY stock stock capital deficit income (loss) - -------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1995 $ - $ 149,001 $ 87,489,392 $ (56,444,043) $ - ----------------------------------------------------------------------------- Net loss - - - (23,575,094) - Foreign currency translation adjustment - - - - 89,309 ----------------------------------------------------------------------------- Comprehensive loss for the year ended December 31, 1996 - - - (23,575,094) 89,309 Issued common stock under employee stock purchase plan - 741 300,140 - - Exercise of options to common stock - 2,353 662,440 - - ----------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1996 - 152,095 88,451,972 (80,019,137) 89,309 ----------------------------------------------------------------------------- Net loss - - - (21,036,543) - Foreign currency translation adjustment - - - - (69,725) Minimum pension liability - - - - (369,773) ----------------------------------------------------------------------------- Comprehensive loss for the year ended December 31, 1997 - - - (21,036,543) (439,498) Issued preferred stock on January 30, 1997 7,500 - 11,857,799 - - Conversion of preferred stock to common stock on April 10, 1997 (7,500) 30,000 (22,500) - - Issued common stock on June 10, 1997 - 14,933 7,840,236 - - Issued common stock under employee stock purchase plan - 554 205,574 - - Exercise of options to common stock - 2,291 1,057,733 - - Exercise of warrants to common stock - 9,026 4,551,025 - - Issued stock options in lieu of cash compensation - - 28,408 - - ----------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1997 - 208,899 113,970,247 (101,055,680) (350,189) ----------------------------------------------------------------------------- Net loss - - - (17,387,662) - Foreign currency translation adjustment - - - - (98,328) Minimum pension liability - - - - 223,352 ----------------------------------------------------------------------------- Comprehensive loss for the year ended December 31, 1998 - - - (17,387,662) 125,024 Issued common stock on August 4, 1998 - 21,582 14,792,052 - - Issued common stock under employee stock purchase plan - 450 209,646 - - Exercise of options to common stock - 2,441 1,183,531 - - Exercise of warrants to common stock - 544 309,144 - - Issued stock options in lieu of cash compensation - - 12,600 - - Effect of subsidiary's year-end change - - - (677,065) - ----------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1998 $ - $ 233,916 $ 130,477,220 $(119,120,407) $ (225,165) ============================================================================= Total Total shareholders' comprehensive DIAMETRICS MEDICAL, INC. AND SUBSIDIARY equity income (loss) - ----------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1995 $ 31,194,350 -------------------------------------------- Net loss (23,575,094) $ (23,575,094) Foreign currency translation adjustment 89,309 89,309 -------------------------------------------- Comprehensive loss for the year ended December 31, 1996 - $ (23,485,785) Issued common stock under employee stock purchase plan 300,881 Exercise of options to common stock 664,793 -------------------------------------------- BALANCE, DECEMBER 31, 1996 8,674,239 -------------------------------------------- Net loss (21,036,543) $ (21,036,543) Foreign currency translation adjustment (69,725) (69,725) Minimum pension liability (369,773) (369,773) -------------------------------------------- Comprehensive loss for the year ended December 31, 1997 - $ (21,476,041) Issued preferred stock on January 30, 1997 11,865,299 Conversion of preferred stock to common stock on April 10, 1997 - Issued common stock on June 10, 1997 7,855,169 Issued common stock under employee stock purchase plan 206,128 Exercise of options to common stock 1,060,024 Exercise of warrants to common stock 4,560,051 Issued stock options in lieu of cash compensation 28,408 -------------------------------------------- BALANCE, DECEMBER 31, 1997 12,773,277 -------------------------------------------- Net loss (17,387,662) $ (17,387,662) Foreign currency translation adjustment (98,328) (98,328) Minimum pension liability 223,352 223,352 -------------------------------------------- Comprehensive loss for the year ended December 31, 1998 - $ (17,262,638) Issued common stock on August 4, 1998 14,813,634 Issued common stock under employee stock purchase plan 210,096 Exercise of options to common stock 1,185,972 Exercise of warrants to common stock 309,688 Issued stock options in lieu of cash compensation 12,600 Effect of subsidiary's year-end change (677,065) -------------------------------------------- BALANCE, DECEMBER 31, 1998 $ 11,365,564 ============================================
The accompanying notes are an integral part of these consolidated financial statements. 22 Consolidated Statements of Cash Flows
Years ended December 31, ----------------------------------------------------------- DIAMETRICS MEDICAL, INC. AND SUBSIDIARY 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (17,387,662) $ (21,036,543) $ (23,575,094) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 3,147,460 4,162,997 3,114,293 Write-off of acquired in-process technology - - 464,460 Common stock and options issued in lieu of cash compensation 12,600 28,408 - (Gain) loss on disposal of property and equipment 652 (80,921) (1,686) Changes in operating assets and liabilities (net of effects of acquisition in 1996): Receivables, net (1,652,185) (1,178,760) (580,891) Inventories (1,325,613) 875,881 (632,551) Prepaid expenses and other current assets (44,360) 232,582 523,050 Accounts payable 393,253 649,432 (97,319) Accrued expenses (1,899,428) (231,365) 445,619 ----------------------------------------------------------- Net cash used in operating activities (18,755,283) (16,578,289) (20,340,119) ----------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (2,252,544) (2,957,958) (1,597,218) Purchases of marketable securities (6,558,430) (26,208,044) (8,343,433) Proceeds from maturities of marketable securities 11,983,629 21,209,000 30,730,100 Acquisition of DML, net of cash received - - (1,067,848) Other assets 11,891 199,954 65,694 ----------------------------------------------------------- Net cash provided by (used in) investing activities 3,184,546 (7,757,048) 19,787,295 ----------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on borrowings (1,306,067) (129,714) (108,477) Proceeds from borrowings 1,818,823 1,058,626 500,000 Net proceeds from issuance of preferred stock - 11,865,299 - Net proceeds from issuance of common stock 16,519,390 13,681,372 965,674 Principal payments on capital lease obligations (611,809) (1,165,522) (1,078,802) ----------------------------------------------------------- Net cash provided by financing activities 16,420,337 25,310,061 278,395 ----------------------------------------------------------- EFFECT OF SUBSIDIARY'S YEAR-END CHANGE ON CASH AND CASH EQUIVALENTS (664,819) - - EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (110,851) (68,033) 24,190 Net increase (decrease) in cash and cash equivalents 73,930 906,691 (250,239) Cash and cash equivalents at beginning of year 3,358,684 2,451,993 2,702,232 ----------------------------------------------------------- Cash and cash equivalents at end of year $ 3,432,614 $ 3,358,684 $ 2,451,993 =========================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for interest $ 1,544,161 $ 377,849 $ 510,399 ===========================================================
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: On November 6, 1996, the Company entered into a senior secured fixed rate loan note of $7,300,000 in connection with the acquisition of DML. On August 4, 1998, the Company entered into a convertible senior secured fixed rate note of $7,300,000 in connection with a private equity placement and used the proceeds to retire the 1996 note. The accompanying notes are an integral part of these consolidated financial statements. 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF THE BUSINESS Diametrics Medical, Inc. along with its subsidiary (the Company), is a medical device company engaged in the development, manufacture and commercialization of critical care blood and tissue analysis systems which provide immediate or continuous diagnostic results at the point-of-patient care. The Company markets its products primarily to health care organizations through a direct sales force in the United States, the United Kingdom and Germany and various distributors outside of these countries. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of Diametrics Medical, Inc. and Diametrics Medical, Ltd., its wholly-owned subsidiary (the Company). All material intercompany accounts and transactions have been eliminated. TRANSLATION OF FOREIGN CURRENCIES The financial statements of the Company's foreign subsidiary are translated in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 52. Under this Statement, all assets and liabilities are translated using period-end exchange rates and statements of operations items are translated using average exchange rates for the period. The resulting translation adjustments are recorded as a separate component of shareholders' equity. Foreign currency transaction gains and losses are included in determining net income, but have not been material in any of the years presented. CASH AND CASH EQUIVALENTS The Company considers highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. At December 31, 1998, cash and cash equivalents consist mainly of U.S. government money market funds and investment grade commercial paper. MARKETABLE SECURITIES In accordance with the provisions of SFAS No. 115, Investment in Certain Instruments in Debt and Equity Securities, investments in marketable debt securities are classified as held to maturity and are stated at amortized cost, which approximates estimated fair value. At December 31, 1998, marketable securities consist mainly of investment grade commercial paper, with original maturities ranging from three to eight months. These securities are classified as held-to-maturity because of the Company's intent and ability to hold its investments to maturity. INVENTORIES Inventories are stated at the lower of cost or market using the first in, first out method. PROPERTY AND EQUIPMENT Leasehold improvements are recorded at cost and amortized over the term of the underlying lease. Furniture and equipment are recorded at cost and depreciated on a straight-line basis over their estimated useful lives of 2 to 7 years. Maintenance and repairs are expensed as incurred. OTHER ASSETS Other assets consist principally of intangible assets representing purchased completed technology and other intangible assets resulting from the excess of the cost of a purchased business over the fair value of the net assets acquired. The intangible assets are amortized using the straight-line method over five years. The recoverability of the purchased completed technology and other intangible assets is assessed quarterly based upon an analysis of undiscounted cash flows projected to be generated by the acquired business. REVENUE RECOGNITION The Company recognizes revenue upon shipment of product to customers or, in the case of trial instruments and monitors, upon the customer's acceptance of the product. NET LOSS PER COMMON SHARE In accordance with SFAS No. 128, Earnings per Share, basic EPS is calculated by dividing net earnings (loss) by the weighted average common shares outstanding during the period. Diluted EPS reflects the potential dilution to basic EPS that could occur upon conversion or exercise of securities, options, or other such items, to common shares using the treasury stock method based upon the weighted average fair value of the Company's common shares during the period. For each period presented, basic and diluted loss per share amounts are identical, as the effect of potential common shares is antidilutive. PRODUCT WARRANTY The Company, in general, warrants its new hardware and software products to the original purchaser to be free from defects in material and workmanship under normal use and service for a period of one year after date of shipment, and warrants its disposable products to be free from defects in material and workmanship under normal use until its stated expiration date. Provisions are made for the estimated cost of maintaining product warranties for the hardware, software and disposable products at the time the products are sold. INCOME TAXES Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes 24 the enactment date. Due to historical net losses of the Company, a valuation allowance is established to offset the net deferred tax asset. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. STOCK BASED COMPENSATION The Company applies the intrinsic value method prescribed in APB Opinion No. 25 to account for the issuance of stock incentives to employees and directors and, accordingly, no compensation expense related to employees' and directors' stock incentives has been recognized in the financial statements. Effective January 1, 1996, in accordance with SFAS No. 123, Accounting for Stock Based Compensation, pro forma information reflecting compensation cost for such issuances is presented in note 9. IMPAIRMENT OF LONG-LIVED ASSETS The Company utilizes the undiscounted cash flows alternative to detect impairment in long-lived assets. COMPREHENSIVE INCOME In the current year, the Company adopted SFAS No. 130, "Reporting Comprehensive Income" which establishes new rules for the reporting and display of comprehensive income and its components. RECLASSIFICATIONS Certain 1997 and 1996 amounts have been reclassified from prior reported balances to conform to the 1998 presentation. (2) LIQUIDITY As reflected in the accompanying consolidated financial statements, the Company incurred a net loss of $17,387,662 for the year ended December 31, 1998. In addition, the Company has incurred net losses and has had negative cash flows from operating activities since inception. In August 1998, the Company completed a private equity placement of 2,142,858 shares of Common Stock which generated aggregate proceeds to the Company of $15,000,006. Also, as part of an exclusive Distribution Agreement initiated on October 1, 1998, the Company entered into a $5,000,000 Put Option and Stock Purchase Agreement with Johnson & Johnson Development Corporation who committed to purchase up to $5,000,000 of the Company's Common Stock at the Company's option over the twelve month period ending September 30, 1999. The Company believes proceeds from the $5,000,000 Put Option & Stock Purchase Agreement along with currently available funds and cash generated from projected operating revenues, supplemented by proceeds from employee stock plans, warrant exercises, asset based credit and corporate alliances, will meet the Company's working capital needs through 1999. If the amount or timing of funding from these sources or cash requirements vary materially from those currently planned, the Company could require additional capital. The Company's long-term capital requirements will depend upon numerous factors, including the rate of market acceptance of the Company's products and the level of resources devoted to expanding the sales and marketing organization, manufacturing capabilities and research and development activities. While there can be no assurance that adequate funds will be available when needed or on acceptable terms, management believes the Company will be able to raise adequate funding if needed. (3) INVENTORIES Inventories consist of the following at December 31:
1998 1997 -------------------------- Raw materials $ 974,886 $ 957,049 Works-in-process 741,719 442,527 Finished goods 3,050,932 2,188,642 -------------------------- $ 4,767,537 $ 3,588,218 ==========================
25 (4) PROPERTY AND EQUIPMENT Property and equipment consist of the following at December 31:
1998 1997 --------------------------------- Manufacturing equipment $ 5,653,623 $ 4,649,831 Laboratory fixtures and equipment 1,970,294 1,956,841 Office furniture and equipment 3,421,541 3,409,351 Leasehold improvements 3,388,445 3,359,680 Tooling 2,069,438 1,870,755 Demonstration instruments 2,513,659 1,864,042 Capital-in-progress 1,060,383 949,627 --------------------------------- 20,077,383 18,060,127 Less accumulated depreciation & amortization (13,154,590) (10,674,155) --------------------------------- $ 6,922,793 $ 7,385,972 =================================
(5) OTHER ASSETS Other assets consist of the following at December 31:
1998 1997 ---------------------------------- Purchased completed technology, net $ 1,122,569 $ 1,516,630 Acquired customer base and other intangible assets, net 222,615 303,326 Other 27,360 27,360 ---------------------------------- $ 1,372,544 $ 1,847,316 =================================
Amortization charged to expense for intangible assets was $474,772, $507,981 and $45,925 in 1998, 1997 and 1996, respectively. (6) ACCRUED EXPENSES Accrued expenses consist of the following at December 31:
1998 1997 ---------------------------------- Employee compensation $ 1,015,850 $ 1,171,572 Product upgrades 73,629 711,168 Deferred revenue 174,662 - Interest payable - 736,750 Other 590,863 1,068,107 ---------------------------------- $ 1,855,004 $ 3,687,597 ==================================
(7) BORROWINGS Borrowings consist of the following at December 31:
1998 1997 ------------------------------------- Long-term debt: Convertible senior secured fixed rate notes $ 7,300,000 $ - Senior secured fixed rate loan note - 7,300,000 Notes payable 1,177,821 1,460,846 ------------------------------------- 8,477,821 8,760,846 Less current portion of long-term debt (314,514) (283,025) ------------------------------------- $ 8,163,307 $ 8,477,821 ===================================== Short-term borrowings: Credit line $ 828,823 $ - =====================================
The aggregate maturities of outstanding long-term debt are: Year ending December 31: 1999 $ 314,514 2000 349,511 2001 388,400 2002 125,396 2003 7,300,000 -------------- $ 8,477,821 ==============
On August 4, 1998, the Company issued Convertible Senior Secured Fixed Rate Notes to an investor group, with proceeds aggregating $7,300,000. Proceeds of the notes were paid by the investor group directly to Pfizer Inc. to retire a $7,300,000 senior secured fixed rate loan note issued to Pfizer in connection with the Company's acquisition of DML in November 1996. Interest on the Convertible Senior Secured Fixed Rate Notes is payable on December 31, 1998 and quarterly in arrears thereafter, at 7.00% per annum. The full principal balance is due August 4, 2003. The notes are secured by the issued and outstanding shares of Diametrics Medical, Ltd., 100% of which are owned by the Company. The Convertible Senior Secured Fixed Rate Note agreements contain provisions, which in the event of a change in control of the Company, allow the note holders to require the Company to repurchase all or a portion of the holder's notes at a purchase price of 100% of the principal amount plus accrued and unpaid interest. In addition, the note agreements contain provisions under which the note holders may convert the notes into shares of Common Stock of the Company at a conversion price of $8.40 per share, subject to adjustment for the impact of certain transactions initiated by the Company that result in dilution of the note holders investment in the Company. The notes payable balance requires principal and interest payments in monthly installments at varying amounts 26 through September 2002, at annual interest rates ranging from 10.1% to 10.95%. Maturity dates of the notes range from December 1, 2001 to September 25, 2002, and all notes are secured by equipment. See also note 14. The Company has a $1,000,000 receivable backed credit line. The loan agreement requires the Company's accounts receivable collections be applied to reduce the loan balance, including advances, interest and fees. All advances under the line of credit bear interest on the unpaid principal amount at a fluctuating rate equal to the Prime Rate plus three percent. Interest is payable monthly in arrears. The loan agreement requires the monthly payment of an annualized unutilized loan fee equal to one half of one percent (.5%) of the difference between the committed available loan amount and the average outstanding loan balance. The unused portion of the line of credit at December 31, 1998 was $171,177. See also note 14. (8) LEASES The Company is obligated under various capital leases for furniture and equipment that expire at various dates in 1999. The gross amount included in property and equipment and related accumulated amortization relating to capital leases is as follows at December 31:
1998 1997 ------------------------------- Manufacturing equipment $ 144,370 $ 1,415,465 Laboratory fixtures and equipment 40,202 377,019 Office furniture and equipment 345,090 1,180,893 Leasehold improvements - 16,668 Tooling - 7,030 ------------------------------- 529,662 2,997,075 Less accumulated amortization (524,667) (2,733,165) ------------------------------- $ 4,995 $ 263,910 ===============================
The present value of future minimum capital lease payments is as follows: Total minimum lease payments year ending December 31, 1999 $ 103,217 Less amount representing interest (1,222) ---------- Present value of minimum capital lease payments $ 101,995 ==========
(9) STOCK OPTIONS AND WARRANTS Under the terms of the 1990 Stock Option Plan, incentive stock options and non-qualified stock options to purchase up to 3,750,000 shares of common stock may be granted to Company employees and consultants. Additionally, the 1993 Directors' Stock Option Plan provides grants to non- employee directors of the Company of non-qualified stock options to purchase up to an aggregate of 367,500 shares of common stock. Under the plans, the option price is equal to the fair value on the date of grant. Under the 1990 Stock Option Plan, options become exercisable over varying periods and terminate up to ten years from the date of grant. Under the 1993 Directors' Stock Option Plan, initial grants of options to new directors become exercisable over a three year period and terminate ten years from the date of grant. Subsequent annual grants to directors vest six months after the date of grant. At December 31, 1998, 632,913 and 166,284 additional shares were available for grant under the 1990 Stock Option Plan and 1993 Directors' Stock Option Plan, respectively. The following tables reflect the per share weighted-average fair value of stock options granted during 1998, 1997 and 1996 under each of the plans on the date of grant using the Black Scholes option-pricing model with the following assumptions: annualized volatility of 84.42%, 74.15% and 70.81% for 1998, 1997 and 1996, respectively; risk-free interest rate of 5.0% in 1998, 5.7% in 1997 and 5.5% in 1996; and for each year, an expected life of five and three years for the 1990 Stock Option Plan and 1993 Directors' Stock Option Plan, respectively. 27 Summarized below is the status of the Company's stock option plans as of December 31, 1998, 1997 and 1996 and changes during those years:
1998 1997 -------------------------------------- -------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE 1990 Stock Option Plan SHARES EXERCISE PRICE SHARES EXERCISE PRICE -------------- -------------------- -------------- --------------------- Outstanding at beginning of year 2,387,797 $ 5.26 2,290,395 $ 5.15 Granted 317,140 6.61 452,415 5.94 Exercised (236,062) 4.87 (210,621) 4.63 Expired (63,575) 6.12 (144,392) 6.57 -------------- -------------- Outstanding at end of year 2,405,300 5.45 2,387,797 5.26 ============== ============== Options exercisable at year-end 1,422,903 5.06 1,258,262 4.85 Weighted-average fair value of options granted during the year $ 4.59 $ 3.84 1993 DIRECTORS' STOCK OPTION PLAN Outstanding at beginning of year 122,000 $ 6.13 170,000 $ 6.16 Granted 53,466 7.82 40,000 6.00 Exercised (8,000) 4.63 (18,500) 4.63 Expired - - (69,500) 6.53 -------------- -------------- Outstanding at end of year 167,466 6.74 122,000 6.13 ============== ============== Options exercisable at year-end 138,591 6.83 76,625 5.81 Weighted-average fair value of options granted during the year $ 4.45 $ 3.13 1996 ---------------------------------------- WEIGHTED AVERAGE 1990 STOCK OPTION PLAN SHARES EXERCISE PRICE -------------- -------------------- Outstanding at beginning of year 1,450,188 $ 4.66 Granted 1,322,400 5.47 Exercised (235,244) 2.83 Expired (246,949) 6.25 -------------- Outstanding at end of year 2,290,395 5.15 ============== Options exercisable at year-end 1,172,405 4.70 Weighted-average fair value of options granted during the year $ 3.44 1993 DIRECTORS' STOCK OPTION PLAN Outstanding at beginning of year 126,500 $ 6.89 Granted 55,500 4.95 Exercised - - Expired (12,000) 8.27 -------------- Outstanding at end of year 170,000 6.16 ============== Options exercisable at year-end 112,000 6.08 Weighted-average fair value of options granted during the year $ 2.50
The following table summarizes information concerning stock options outstanding and exercisable options at December 31, 1998 for the above plans:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------------------------------------- -------------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE ----------------------------------------------------------------------------- -------------------------------- $ 1.72 - 1.72 160,910 2.0 $ 1.72 160,910 $ 1.72 3.25 - 3.88 161,675 3.2 3.52 155,675 3.51 4.13 - 4.88 613,075 7.6 4.63 338,825 4.65 5.00 - 5.94 482,200 8.0 5.32 284,991 5.31 6.00 - 6.88 726,100 6.7 6.15 440,375 6.15 7.00 - 7.95 99,210 8.2 7.30 70,360 7.32 8.00 - 12.00 329,596 8.7 8.50 110,358 9.10 ---------- ------- ------- ------------- --------- 2,572,766 7.0 5.53 1,561,494 5.21 ========== =============
28 The Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock- based compensation plans as they relate to employees and directors. Had the Company determined compensation cost based upon the fair value at the grant date for its stock options under SFAS No. 123, the Company's net loss and net loss per share would have increased to the pro forma amounts indicated below:
1998 1997 1996 ----------------------------------------------------- Net loss as reported $(17,387,662) $(21,036,543) $(23,575,094) Net loss pro forma $(19,284,933) $(23,365,049) $(26,017,576) Net loss per share as reported $ (0.79) $ (1.13) $ (1.56) Net loss per share pro forma $ (0.88) $ (1.25) $ (1.72)
Pro forma net loss reflects only options granted in 1998, 1997, 1996 and 1995. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net loss amounts presented, because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to January 1, 1995 is not considered. In connection with certain financing and marketing arrangements, the Company has granted stock purchase warrants for the purchase of 3,044,680 shares of common stock. The stock purchase warrants become exercisable over varying periods and expire up to 10 years from the date of grant. At December 31, 1998, stock purchase warrants representing 1,671,753 shares were exercisable with an additional 33,333 shares becoming exercisable on a monthly basis over 16 months and an additional 8,000 shares becoming exercisable upon achieving certain purchasing levels of the Company's products. Stock warrants outstanding under these arrangements are summarized as follows:
1998 1997 1996 ---------------------------- ------------------------ --------------------------- EXERCISE EXERCISE EXERCISE PRICE PRICE PRICE SHARES PER SHARE SHARES PER SHARE SHARES PER SHARE ------------ ------------ ---------- ----------- ------------ ------------- Outstanding at beginning of year 1,028,160 $ 1.72 - 6.75 786,814 $ 1.72 - 6.13 843,314 $ 1.72 - 6.13 Granted 739,286 5.19 - 8.40 1,328,334 4.53 - 6.75 16,000 5.00 Exercised (54,360) 5.19 - 6.13 (902,617) 4.77 - 6.75 - - Expired - - (184,371) 4.77 - 5.06 (72,500) - ---------- ------------- --------- ------------- -------- ------------- Outstanding at end of year 1,713,086 1.72 - 8.40 1,028,160 1.72 - 6.75 786,814 1.72 - 6.13 ========== ========= ======== Warrants exercisable at year-end 1,671,753 1.72 - 8.40 961,827 1.72 - 6.75 706,314 1.72 - 6.13
(10) EMPLOYEE STOCK PURCHASE PLAN The Company adopted an employee stock purchase plan (the "Plan") effective July 3, 1995, under which 300,000 shares of common stock are available for sale to employees. The Plan enables all employees, after a 90-day waiting period, to contribute up to 10 percent of their wages toward the purchase of the Company's common stock at 85 percent of the lower of fair market value for such shares on the first business day of each quarter or the last business day of each quarter. Participant elections resulted in the issuance of 45,012 shares at an average price per share of $4.67 in 1998, 55,394 shares at an average price per share of $3.72 in 1997 and 74,096 shares at an average price per share of $4.06 in 1996. (11) EMPLOYEE BENEFIT PLANS In the current year, the Company adopted SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" which standardizes employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of these plans. The Company has a 401(k) savings plan for its U.S. employees. U.S. employees of the Company who meet certain age and service requirements may contribute up to 20 percent of their salaries to the plan on a pre-tax basis. The Company has the discretion to match employee contributions up to 6 percent of compensation. The Company has not made any contributions to the plan. As part of its acquisition of DML in November 1996, the Company assumed sponsorship of the subsidiary's contributory defined benefit retirement plan (the "Retirement Plan"), covering the majority of the subsidiary's employees. The Retirement Plan provides benefits based upon final pensionable salary and years of credited service. The Company's funding policy for the Retirement Plan is to contribute into a trust fund at a rate that is intended to remain at a level percentage of total pensionable payroll. 29 The assets of the Retirement Plan are held separately from those of the Company and invested in the London and Manchester Secure Growth Fund, Balanced Fund and a small holding in the Performance Fund. A portion of the Retirement Plan assets are also invested in the Scottish Equitable Funds. Contributions to the Retirement Plan are charged to expense so as to spread the cost of the pensions over the employees' working lives with the Company. The contributions are determined by a qualified actuary on the basis of a valuation using the "attained age" valuation method. The Company's Statement of Operations for the year ended December 31, 1996 includes approximately one month of activity for DML, and pension expense charged to operations during that period was minimal. The following provides a reconciliation of the projected benefit obligation, plan assets and funded status of the Retirement Plan at December 31, along with the components of net periodic pension cost for each year presented:
1998 1997 ============================ CHANGE IN PROJECTED BENEFIT OBLIGATION Projected benefit obligation at beginning of year $ 3,954,675 $ 2,762,245 Service cost 344,864 296,062 Interest cost 268,596 216,988 Plan participants' contributions 95,537 86,327 Actuarial (gain) loss 363,268 736,104 Benefits paid (135,495) (126,450) Foreign currency exchange rate changes 33,013 (16,601) ---------------------------- Projected benefit obligation at end of year $ 4,924,458 $ 3,954,675 ============================ CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $ 3,234,425 $ 2,660,923 Actual return on plan assets 465,437 405,314 Employer contribution 284,145 220,525 Plan participants' contributions 95,537 86,327 Benefits paid (135,495) (126,450) Foreign currency exchange rate changes 26,148 (12,214) ---------------------------- Fair value of plan assets at end of year $ 3,970,197 $ 3,234,425 ============================ Funded status $ (954,261) $ (720,250) Unrecognized actuarial loss 918,918 658,878 ---------------------------- Net amount recognized $ (35,343) $ (61,372) ============================ Amounts recognized in the balance sheet consist of: Accrued benefit liability $ (181,764) $ (431,145) Minimum pension liability 146,421 369,773 ------------------------------- Net amount recognized $ (35,343) $ (61,372) =============================== RATE ASSUMPTIONS: Discount rate 6.00% 7.00% Rate of salary progression 3.75% 5.00% Long-term rate of return on assets 7.75% 7.50% Years ended December 31, COMPONENTS OF NET PERIODIC BENEFIT COST 1998 1997 =============================== Service cost $ 344,864 $ 296,062 Interest cost 268,596 216,988 Expected return on plan assets (271,912) (246,156) Recognized net actuarial loss 13,264 - ------------------------------- $ 354,812 $ 266,894 ===============================
30 (12) INCOME TAXES The Company has incurred net operating losses since inception. The Company has not reflected any benefit of such net operating loss carryforwards in the accompanying financial statements in accordance with SFAS No. 109. As of December 31, 1998 the Company had U.S. tax net operating loss and research and development tax credit carryforwards of approximately $103,800,000 and $939,000, respectively. Use of the Company's net operating loss carryforwards may be limited if a cumulative "change in ownership" of more than 50 percent occurs within a three-year period. In connection with prior sales by the Company of its securities in private and public offerings, the Company has experienced a "change in ownership". As a result, the utilization of the Company's net operating loss and certain credit carryforwards incurred prior to these changes are subject to annual limitations. The Company estimates that the use of the U.S. net operating losses incurred prior to August 4, 1995 are subject to annual limitations of approximately $9.8 million per year. Net operating losses incurred since August 4, 1995 are not currently subject to the "change in ownership" limitations. If not used, these net operating loss carryforwards begin to expire in 2005. The Company's foreign subsidiary also has a net operating loss carryforward of approximately $45,700,000 which can be carried forward indefinitely. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows at December 31:
1998 1997 --------------------------------------- Tax credits $ 939,000 $ 889,000 Federal net operating loss carryforward 38,424,000 33,643,000 Foreign net operating loss carryforward 15,089,000 13,428,000 Fixed asset depreciation 895,000 910,000 Amortization of goodwill 254,000 137,000 Vacation accrual 167,000 125,000 Inventory reserve 17,000 34,000 Product upgrade accrual 11,000 153,000 Other differences 141,000 114,000 Valuation allowance (55,937,000) (49,433,000) --------------------------------------- Net deferred tax asset $ - $ - =======================================
The provision for income taxes differs from the expected tax expense, computed by applying the federal corporate rate of 34% to earnings before income taxes as follows:
1998 1997 1996 ---------------------------------------------------------------- Expected federal benefit $ (5,912,000) $ (7,152,000) $ (8,016,000) State tax, net of federal benefit (522,000) (493,000) (699,000) Other (70,000) (88,000) (28,000) Increase in valuation allowance 6,504,000 7,733,000 20,571,000 Decrease in valuation allowance of acquired foreign subsidiary - - (11,828,000) ---------------------------------------------------------------- $ - $ - $ - ================================================================
31 (13) RESTRUCTURING AND OTHER CHARGES Throughout 1996 and 1997, the Company made operational changes intended to better align its resources with its evolving strategy, improve its efficiency, and achieve a more competitive cost structure. Restructuring and other charges totaled $463,816 in 1997 and $1,334,661 in 1996. Charges in 1996 consisted of approximately $584,000 for severance costs related to restructuring of the management team in early 1996 and a work force reduction in November, $464,000 for the write-off of purchased in-process research and development created from the DML acquisition, and $287,000 for the write-down of excess and obsolete equipment, resulting from the work force reductions and process changes. Charges in 1997 consisted of severance costs of approximately $319,000 associated with work force reductions, primarily in the Company's U.S. manufacturing, research and development and general and administrative areas, and $145,000 for the write-down of excess and obsolete equipment resulting from the work force reductions and further process changes. These restructuring activities were completed before or shortly after the end of the quarter of the years in which charges were incurred, and the Company does not have any material future cash obligations relative to the described restructuring activities. The impact of work force reductions on future operating results and cash flows is not expected to be material in future periods, as savings achieved in these areas have been and will continue to be reinvested in other areas of the Company, including the Company's international operations. (14) RELATED PARTY TRANSACTIONS In August 1998, the Company completed the sale in a private placement of 2,142,858 shares of Common Stock at a price of $7.00 per share as part of a Common Stock Purchase Agreement, resulting in aggregate proceeds to the Company of $15,000,006. The purchasers also received five-year warrants to purchase 714,286 shares of Common Stock at $8.40 per share. In addition, the Company issued Convertible Senior Secured Fixed Rate Notes, with proceeds aggregating $7,300,000, which were used to retire other debt of the Company. The investor group in both transactions was led by BCC Acquisition II LLC. Two of the directors of the Company are affiliated with BCC Acquisition II LLC, and one of these directors participated in the Common Stock Purchase Agreement and the related sale of Convertible Senior Secured Fixed Rate Notes. This director is also a director of DVI, Inc., a health care finance company with which the Company has an outstanding credit line and notes payable as of December 31, 1998. See note 7 for further detail on the credit line, notes payable and Convertible Senior Secured Fixed Rate Notes. (15) BUSINESS SEGMENT INFORMATION In the current year, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which establishes standards for disclosure about operating segments, products, geography and major customers. The Company develops, manufactures and markets blood and tissue analysis systems that provide immediate or continuous diagnostic results at the point-of-patient care. The Company's blood and tissue analysis systems consist of two technology platforms. The first platform includes intermittent blood testing products based on electrochemical and optical technology, and the second platform includes continuous monitoring products based on fiberoptic technology. The Company's products are sold primarily to acute care hospitals via direct sales (primarily in the United States, United Kingdom and Germany) or third party distribution channels including corporate partners strategically positioned to access foreign markets. The Company's disposable cartridges and sensors for the intermittent and continuous monitoring technology platforms, respectively, are manufactured at the Company's facilities. Hardware components of both technology platforms are sub-contracted to outside vendors with portions of the hardware assembly performed internally at the Company's facilities. Both technology platforms are subject to similar regulatory monitoring by the United States Food and Drug Administration and comparable agencies in other countries. The Company's long term outlook for the two technology platforms is that with increased sales volumes, they will exhibit similar financial performance in terms of sales trends and gross margins. Based upon the above, the Company has identified one reportable operating segment consisting of medical diagnostic products which provide blood and tissue analysis at the point-of-patient care. Information regarding the Company's operations in different geographies for the years ended December 31 is as follows:
1998 1997 1996 -------------------------------------------------------- Sales to unaffiliated customers United States $ 4,879,367 $ 3,947,287 $ 2,318,038 Japan 1,215,037 2,222,610 465,770 All other foreign countries 6,061,122 4,264,469 1,013,008 -------------------------------------------------------- $ 12,155,526 $ 10,434,366 $ 3,796,816 ======================================================== Long-lived assets United States $ 3,682,879 $ 4,053,383 $ 4,908,408 United Kingdom 3,239,914 3,332,589 3,379,344 -------------------------------------------------------- $ 6,922,793 $ 7,385,972 $ 8,287,752 ========================================================
32 Sales attributed to geographic areas are based upon customer location. Long-lived assets consist of property and equipment located at the Company's facilities in the United States and the United Kingdom. Sales to one major customer exceeded 10% of total net sales for the years ended December 31, 1998 and 1997 and resulted in sales of approximately $1,675,000 and $2,284,000, respectively. The customer for which the sales were generated is a distributor of the Company operating in the medical diagnostic device industry. No single customer comprised 10% of total net sales in 1996. (16) COMMITMENTS The Company leases its facilities and some of its equipment under non- cancelable operating lease arrangements. The rental payments under these leases are charged to expense as incurred. Rent expense included in the accompanying consolidated statements of operations was $940,027, $829,106 and $412,295 for the years ended December 31, 1998, 1997 and 1996, respectively. The following is a schedule of future minimum rental payments, excluding property taxes and other operating expenses, required under all non- cancelable operating leases:
Year ending December 31: 1999 $ 848,542 2000 613,162 2001 458,348 2002 199,757 2003 173,250 Thereafter 476,438 ------------- Total minimum lease payments $ 2,769,497 =============
(17) LEGAL PROCEEDINGS There are no legal proceedings pending, threatened against or involving the Company, which, in the opinion of management, will have a material adverse effect upon consolidated results of operations or financial condition. (18) ACQUISITIONS On November 6, 1996, the Company acquired all the outstanding capital stock of Biomedical Sensors, Ltd. ("BSL"), an operating unit of Pfizer Inc. and certain assets from Howmedica, Inc. (a wholly-owned subsidiary of Pfizer Inc.), for $1,500,000 in cash and a $7,300,000 senior secured fixed rate loan note, due November 4, 2002 (see note 7). In the purchase of BSL (now known as Diametrics Medical, Ltd.), the Company acquired fiberoptic and electrochemical technology for monitoring blood gases on a continual basis via sensors that dwell inside arterial lines. Core technology was also purchased for future product derivatives under development. The Company accounted for the acquisition using the purchase method. As such, the excess of the purchase price over the fair value of the identifiable tangible assets acquired was allocated to purchased completed technology (70%), purchased in-process technology (16%), and the value of the acquired customer base and other unidentifiable intangible assets or goodwill (14%), totaling $2,770,359. The in-process technology ($464,460) was written off to operating expenses, leaving $2,305,899 of intangible assets and goodwill on the balance sheet at the acquisition date. Due to the rapid pace of technological change in the medical device industry, the completed technology has an estimated useful life of five years. The customer base has an estimated useful life of three years and other unidentifiable assets, seven years. This results in a weighted average amortization period of five years for the intangible assets not immediately written off. The unaudited pro forma consolidated condensed results of operations for the Company for fiscal year 1996, had the acquisition occurred at the beginning of that year, are as follows:
1996 ----------- Net sales $ 7,021,000 Net loss (33,586,000) Net loss per common share (2.23)
Included in total revenue and net loss for 1996 are revenues and net loss from DML's operations of $326,000 and $(421,000), respectively. 33 (19) CHANGE IN YEAR-END OF SUBSIDIARY Effective January 1, 1998, the Company changed the year-end of its wholly- owned subsidiary, DML, to December 31 from November 30 to produce a consistent reporting period for the consolidated entity. As a result of this change in year-end, DML's net results of operations for the month of December 1997 were closed to beginning accumulated deficit on the balance sheet as of January 1, 1998. The impact of this change was an increase in the beginning accumulated deficit of approximately $677,000. (20) SUBSEQUENT EVENT (UNAUDITED) As part of an exclusive Distribution Agreement initiated on October 1, 1998, the Company entered into a $5,000,000 Put Option and Stock Purchase Agreement with Johnson & Johnson Development Corporation (JJDC) who committed to purchase up to $5,000,000 of the Company's Common Stock at the Company's option over the twelve month period ending September 30, 1999. Effective March 26, 1999, the Company exercised approximately $4 million of the available Put Option, resulting in the issuance of 773,184 shares of the Company's Common Stock to JJDC at a per share price of $5.1734. Proceeds to the Company of approximately $4 million will be used for product development, sales and marketing and other general corporate purposes. The Company may exercise the remaining available $1,000,000 balance of the Put Option through September 30, 1999. (21) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ---------------------------------------------------------------- 1998 Net sales $ 2,416,703 $ 3,052,048 $ 3,102,430 $ 3,584,345 Gross profit 14,013 241,980 155,952 408,860 Operating loss (4,121,949) (4,089,871) (4,705,886) (3,998,059) Net loss (4,303,193) (4,326,440) (4,792,354) (3,965,675) Net loss per common share (0.21) (0.20) (0.21) (0.17) 1997 Net sales $ 1,954,966 $ 2,607,679 $ 2,829,279 $ 3,042,442 Gross profit (loss) (872,980) (213,895) (189,668) 44,767 Operating loss (5,602,223) (5,090,759) (4,960,888) (4,855,711) Net loss (5,772,013) (5,254,034) (5,153,267) (4,857,229) Net loss per common share (0.38) (0.29) (0.25) (0.23)
34 REPORT OF INDEPENDENT AUDITORS THE BOARD OF DIRECTORS AND SHAREHOLDERS DIAMETRICS MEDICAL, INC.: We have audited the accompanying consolidated balance sheets of Diametrics Medical, Inc. and subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Diametrics Medical, Inc. and subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP Minneapolis, Minnesota February 8, 1999 35 CORPORATE AND SHAREHOLDER INFORMATION EXECUTIVE OFFICERS David T. Giddings President, Chief Executive Officer and Chairman of the Board Roy S. Johnson Executive Vice President President and Managing Director of Diametrics Medical, Ltd. Laurence L. Betterley Senior Vice President and Chief Financial Officer James R. Miller Senior Vice President Sales and Marketing and Commercial Development DIRECTORS Andre de Bruin (2) President and Chief Executive Officer QUIDEL Corporation Gerald L. Cohn (1)(2) Consultant and Private Investor David T. Giddings Roy S. Johnson Mark B. Knudson, Ph.D. (1) Chairman and Founder HeartStent David V. Milligan, Ph.D. Vice President Bay City Capital Richard A. Norling (1) (2) Chief Executive Officer Premier, Inc. (1) Member of the Compensation Committee of the Board of Directors (2) Member of the Audit Committee of the Board of Directors SHAREHOLDER INFORMATION STOCK LISTING The Company's common stock is traded on The Nasdaq National Market under the symbol DMED. STOCK TRANSFER AGENT American Stock Transfer & Trust Company 40 Wall Street New York, NY 10005 Phone: (800) 937-5449 FORM 10-K A copy of the Company's annual report on Form 10-K as filed with the Securities and Exchange Commission is available to stockholders free of charge by writing to Diametrics Medical, Inc. ANNUAL MEETING The annual meeting of Diametrics Medical, Inc. shareholders will be held May 12, 1999, at 3:30 p.m. at the Minneapolis Marriott City Center, 30 South Seventh Street, Minneapolis, Minnesota. All shareholders and other interested parties are invited to attend. INVESTOR INQUIRIES Please direct all inquiries to Laurence L. Betterley, Senior Vice President and Chief Financial Officer, at the Company's corporate offices. STOCK INFORMATION High and low quarterly closing prices for Diametrics Medical, Inc., common stock as quoted on The Nasdaq National Market were:
1998 High Low ---------------------------------------------------------------------------------------- First Quarter $ 8 1/4 $ 5 1/4 Second Quarter 8 7/8 6 5/8 Third Quarter 7 15/16 3 5/8 Fourth Quarter 5 1/2 2 3/4 1997 High Low ---------------------------------------------------------------------------------------- First Quarter $ 5 3/4 $3 1/2 Second Quarter 9 1/4 3 Third Quarter 9 15/16 6 9/16 Fourth Quarter 10 1/8 4 5/8
There were 521 common shareholders of record and the Company estimates approximately 5,800 shareholders holding stock in "street name" accounts as of December 31, 1998. The Company has not paid any stock dividends on its common stock since its inception, and management does not anticipate paying cash dividends in the foreseeable future. CORPORATE ADDRESS INTERNATIONAL SUBSIDIARY Diametrics Medical, Inc. Diametrics Medical, Ltd. 2658 Patton Road 5 Manor Court Yard, Hughenden Ave. St. Paul, Minnesota 55113 High Wycombe, Bucks. HP13 5RE Phone: (651) 639-8035 England Website: www.diametrics.com Phone: +44(0)1494 446651 36 EX-21 4 LIST OF SUBSIDIARIES Exhibit 21 SUBSIDIARIES OF DIAMETRICS MEDICAL, INC. The Company's consolidated subsidiaries are shown below, together with the percentage of voting securities owned and the state or jurisdiction of each subsidiary: Percentage of Outstanding Voting Subsidiaries Securities Owned - ------------ ---------------- Diametrics Medical, Ltd. 100% (United Kingdom) EX-23 5 CONSENT OF KPMG PEAT MARWICK LLP EXHIBIT 23 Independent Auditor's Consent The Board of Directors and Shareholders Diametrics Medical, Inc. We consent to the incorporation by reference in the Registration Statement (Nos. 333-63689, 333-63687, 333-51951, 333-33257, 333-24169, 333-24167, 333-24079 and 33-83572) on Forms S-3 and S-8 of Diametrics Medical, Inc., of our report dated February 8, 1999, relating to the consolidated balance sheets of Diametrics Medical, Inc. as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998, which report is incorporated by reference in the Annual Report on Form 10-K of Diametrics Medical, Inc. /s/ KPMG Peat Marwick LLP Minneapolis, Minnesota March 30, 1999 EX-27 6 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 3,432,614 2,976,443 5,700,092 280,000 4,767,537 17,050,977 20,077,383 13,154,590 25,346,314 5,635,679 8,163,307 0 0 233,916 11,131,648 25,346,314 12,155,526 12,155,526 11,334,721 17,736,570 471,897 259,506 807,411 (17,387,662) 0 (17,387,662) 0 0 0 (17,387,662) (0.79) (0.79)
EX-99 7 CAUTIONARY STATEMENTS Exhibit 99 CAUTIONARY STATEMENT Forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "PSLRA") are included in our Form 10-K. The words or phrases "believes," "may," "will," "expects," "should," "continue," "anticipates," "intends," "will likely result," "estimates," "projects" or similar expressions identify forward-looking statements in our Form 10-K and in our future filings with the Securities and Exchange Commission, in our press releases, in our presentations to securities analysts or investors, and in oral statements made by or approved by an executive officer of Diametrics Medical, Inc. Forward-looking statements involve risks and uncertainties that may materially and adversely affect our business, results of operations, financial condition or prospects, and may cause our actual results to differ materially from historical results or the results discussed in the forward-looking statements. You should consider carefully the following cautionary statements if you own our common stock or are planning to buy our common stock. We intend to take advantage of the "safe harbor" provisions of the PSLRA by providing this discussion. We are not undertaking to address or update each factor in future filings or communications regarding our business or results except to the extent required by law. WE ARE AT AN EARLY STAGE OF COMMERCIALIZATION WITH LIMITED OPERATING HISTORY Founded in 1990, we were engaged primarily in the research, development and testing of, and the development of manufacturing capabilities for, the IRMA(R) (Immediate Response Mobile Analysis) System and the Paratrend(R) 7 until 1995. Our marketing efforts began for both products during 1994. We have limited operating history upon which an evaluation of our prospects can be made. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered in establishing a new business in the evolving, heavily-regulated medical device industry, which is characterized by an increasing number of entrants, intense competition and a high failure rate. WE HAVE A HISTORY OF OPERATING LOSSES AND EXPECT FUTURE LOSSES We have only recently begun to generate revenues and have incurred net operating losses since our inception. We expect to incur substantial net operating losses at least through 1999. We cannot assure you that we will ever generate substantial revenues or achieve profitability. OUR SUCCESS DEPENDS UPON MARKET ACCEPTANCE OF NEW TECHNOLOGY Our success depends upon acceptance of our products by the medical community as reliable, accurate and cost-effective. Our point-of-care blood testing and monitoring devices represent a new practice in critical or stat blood testing, which is currently performed primarily by central and stat laboratories of hospitals or by independent commercial laboratories. Although professional awareness of point-of-care blood testing is increasing, most acute care hospitals have already installed expensive blood testing instruments for use in their central and stat laboratories and may be reluctant to change standard operating procedures or incur additional capital expenditures for new blood analysis equipment. In addition, the limited number of blood analytes that can be analyzed on our products may cause certain hospitals not to consider them. We are unable to predict how quickly, if at all, our products will be accepted by the medical community or, if accepted, predict the volume of our products or the related disposable cartridges and sensors we can expect to sell. WE FACE SIGNIFICANT INDUSTRY COMPETITION AND RISK OF PRODUCT OBSOLESCENCE The medical technology industry is characterized by rapidly evolving technology and intense competition. We are aware of one other commercially available hand-held point-of-care blood analysis system, which is 1 manufactured and marketed by i-STAT Corporation, but we expect that manufacturers of central and stat laboratory testing equipment will also develop new products to maintain their revenues and market share. Many of our competitors have substantially greater capital resources, research and development staffs, and facilities than we do, and many of these companies also have greater experience in research and development, obtaining regulatory approvals, manufacturing, and sales and marketing. We cannot assure you that our competitors will not succeed in developing or marketing technologies and products that are more effective or less expensive than ours that could render our products obsolete or noncompetitive. Although we believe that our products may offer certain technological advantages over our competitors' current products, earlier entrants in the market in a therapeutic area often obtain and maintain significant market share. Our product pricing is competitive with other point of care suppliers and is, in general, slightly higher than prices of existing high volume central and near patient labs operating near capacity, but which lack the convenience and turnaround time of point-of-care testing. In the future, we may experience competitive pricing pressures that may cause a decrease in unit prices and sales levels. WE HAVE LIMITED MANUFACTURING EXPERIENCE We must manufacture our products in compliance with regulatory requirements, in sufficient quantities and on a timely basis, and still maintain product quality and acceptable manufacturing costs. Our products consist of two principal components: portable, microprocessor-based instruments and disposable sensors. We have limited experience producing our products in large commercial quantities. Although we believe that we will be able to achieve and maintain product accuracy and reliability when producing in large quantities, on a timely basis and at an acceptable cost, we cannot assure you that we will be able to do so. Also, product design changes, equipment failures and manufacturing process changes may disrupt our existing operations and impact sales. WE DEPEND ON PATENTS AND PROPRIETARY TECHNOLOGY, WHICH WE MAY NOT BE ABLE TO PROTECT Our success will depend in part on our ability to obtain patent protection for our products and processes, to preserve our trade secrets and to operate without infringing the intellectual property rights of others. The patent positions of medical device companies are uncertain and involve complex and evolving legal and factual questions. We cannot assure you that any of our pending or future patent applications will result in issued patents, that any current or future patents will not be challenged, invalidated or circumvented, that the scope of any of our patents will exclude competitors or that the patent rights granted to us will provide us any competitive advantage. In addition, we cannot assure you that our competitors will not seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use or sell our products either in the United States or in international markets. Further, the laws of certain foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States. In addition to patents, we rely on trade secrets and proprietary knowledge that we seek to protect, in part, through confidentiality agreements with employees, consultants and others. We cannot assure you that our proprietary information or confidentiality agreements will not be breached, that we will have adequate remedies for any breach, or that our trade secrets will not otherwise become known to or independently developed by competitors. WE MAY FACE INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS WHICH WOULD BE COSTLY TO RESOLVE There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry and our competitors may resort to intellectual property litigation as a means of competition. Intellectual property litigation is complex and expensive and the outcome is difficult to predict. We cannot assure you that we will not become subject to patent infringement claims or litigation. Litigation or regulatory proceedings may also be necessary to enforce our patents or other intellectual property rights. We may not always have the financial resources to assert patent infringement suits or to defend ourselves from claims. An adverse result in any litigation could subject us to liabilities to, or require us to seek licenses from or pay royalties to, others that may be 2 substantial. Furthermore, we cannot assure you that the necessary licenses would be available to us on satisfactory terms, if at all. OUR SUCCESS MAY DEPEND IN PART ON UNCERTAIN GOVERNMENT HEALTH CARE POLICIES AND REIMBURSEMENT BY THIRD PARTIES The willingness of hospitals to purchase our products may depend on the extent to which hospitals limit their own capital expenditures due to existing or future cost reimbursement regulations. In addition, sales volumes and prices of our products in certain markets will depend in part on the level of reimbursement to hospitals for blood analysis from third-party payors, such as government and private insurance plans, health maintenance organizations and preferred provider organizations. Third-party payors are increasingly challenging the pricing of medical procedures they consider unnecessary, inappropriate or not cost-effective. We cannot assure you that current reimbursement amounts, if any, will not be decreased in the future, and that any decrease will not reduce the demand for or the price of our products. Any federal or state health care reform measures could adversely affect the price of medical devices in the United States, including our products, or the amount of reimbursement available. We cannot predict whether any reform measures will be adopted or what impact they may have on us. WE MUST OBTAIN REGULATORY APPROVAL FOR NEW PRODUCTS WE DEVELOP Human diagnostic products are subject to rigorous pre-clinical and clinical testing mandated by the United States Food and Drug Administration (the "FDA") and comparable agencies in other countries and, to a lesser extent, by state regulatory authorities. We have obtained pre-market notification clearances under Section 510(k) of the Food, Drug and Cosmetic Act (the "FDC Act") to market our IRMA SL System to test blood gases, electrolytes (i.e., inorganic compounds including sodium, potassium, chloride and ionized calcium), blood urea nitrogen and hematocrit (i.e., the concentration of red blood cells) in whole blood in hospital laboratories and at the point of care, and to market the Paratrend 7 and Paratrend 7+ to monitor blood gases and temperature. Additional pre-market notification clearances were obtained in late 1997 to market Neotrend for blood gas monitoring of critically ill babies, and in early 1998 for the addition of glucose testing capability to the IRMA SL system. A Section 510(k) clearance is subject to continual review, and later discovery of previously unknown problems may result in restrictions on marketing or withdrawal of the product from the market. Our long-term business strategy includes development of cartridges and sensors for performing additional blood and tissue chemistry tests, and any new tests will be subject to the same regulatory process. We cannot assure you that we will be able to develop additional products or uses or that we will obtain the necessary clearances for new products and uses on a timely basis or at all. We also market our products in several foreign markets. Requirements vary widely from country to country, ranging from simple product registrations to detailed submissions such as those required by the FDA. Our manufacturing facilities are also subject to FDA inspection on a periodic basis and we and our contract manufacturers must demonstrate compliance with current Good Manufacturing Practices promulgated by the FDA. Violations of the applicable regulations at our manufacturing facilities or the manufacturing facilities of our contract manufacturers may prevent us from marketing of our products. OUR PRODUCTS AND THE TECHNICIANS AUTHORIZED TO USE THEM MAY BE RESTRICTED BY THE CLINICAL LABORATORY IMPROVEMENT ACT OF 1988 Our products are affected by the Clinical Laboratory Improvement Act of 1988 ("CLIA") which has been implemented by the FDA. This law is intended to assure the quality and reliability of all medical testing in the United States regardless of where tests are performed. The regulations require laboratories performing blood chemistry tests to meet specified standards in the areas of: o personnel qualification, o administration, o participation in proficiency testing, 3 o patient test management, o quality control, o quality assurance, and o inspections. The regulations have established three levels of regulatory control based on test complexity - "waived," "moderate complexity" and "high complexity." Although the tests performed by our products have been categorized as moderate complexity tests, we cannot assure you that our products will not be placed in a more restrictive category. Personnel standards for high complexity tests are more rigorous than those for moderate complexity tests, requiring more education and experience. If our products are recategorized as high complexity tests, our ability to successfully market them to hospitals or other potential buyers may suffer. We cannot assure you that the CLIA regulations or various state licensing requirements for technicians will not have a material adverse effect on our financial condition or results of operation. OUR PRODUCTS MAY EXPOSE US TO COSTLY LITIGATION We may be exposed to product liability claims if a patient is adversely affected by our products. We maintain a general insurance policy which includes coverage for product liability claims. The policy is limited to a maximum of $1,000,000 per product liability claim and an annual aggregate policy limit of $2,000,000. We also carry umbrella liability insurance which provides coverage up to $10,000,000. We cannot assure you that our existing insurance coverage limits are adequate to cover any liabilities we might incur or that insurance will continue to be available on commercially reasonable terms, if at all. WE DEPEND ON CONTRACT MANUFACTURERS AND SUPPLIERS FOR KEY COMPONENTS OF OUR PRODUCTS Our monitors and IRMA analyzers are manufactured for us by single vendors, generally from off-the-shelf components. A few components are supplied by a single source and manufactured to our specifications. Although we believe that we could find alternative vendors, any interruption in supply could have a material and adverse effect on our ability to manufacture our products, and our financial condition and results of operations. INTERNATIONAL OPERATIONS WILL EXPOSE US TO ADDITIONAL RISKS We market a majority of our products through distributors in international markets, subject to receipt of required foreign regulatory approvals. We cannot assure you that international distributors for our products will devote adequate resources to selling our products. Doing business outside of the United States also exposes us to various risks that could have a material and adverse effect on our ability to market our products internationally, including: o changes in overseas economic and political conditions, o currency exchange rate fluctuations, o foreign tax laws, or o tariffs or other trade regulations. Our business is also expected to subject us and our representatives, agents and distributors to laws and regulations of the foreign jurisdictions in which they operate or our products are sold. We may depend on foreign distributors and agents for compliance and adherence to foreign laws and regulations. We have no control over most of these risks and may be unable to anticipate changes in international economic and political conditions, and may be unable to alter our business practices in time to avoid any adverse effects. 4 CONCENTRATION OF OWNERSHIP MAY GIVE SOME SHAREHOLDERS SUBSTANTIAL INFLUENCE AND MAY PREVENT OR DELAY A CHANGE IN CONTROL As of December 31, 1998, directors, executive officers and principal shareholders, and certain of their affiliates, owned beneficially approximately 43% of our outstanding common stock, assuming all vested stock options, stock purchase warrants and convertible debt held by them are exercised or converted. These shareholders, may be able to exercise substantial influence over all matters requiring shareholder approval, including the election of directors, and approval of significant corporate transactions. This concentration of ownership could also have the effect of delaying, deferring or preventing a change in control of Diametrics Medical, Inc. OUR CHARTER DOCUMENTS AND MINNESOTA LAW MAY DISCOURAGE AN ACQUISITION OF DIAMETRICS MEDICAL, INC. Provisions of our articles of incorporation, including our ability to issue up to 5,000,000 shares of preferred stock without any further vote or action by the shareholders, our bylaws and Minnesota law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders. WE MAY BE UNABLE TO MEET OUR FUTURE CAPITAL REQUIREMENTS We expect that our existing capital resources should enable us to maintain our current and planned operations through 1999. Nonetheless, our capital requirements depend on many factors, including the rate of market acceptance of our products, the level of resources we devote to expanding our marketing organization and manufacturing capabilities, our research and development activities, the availability of financing for capital acquisitions and other factors. We cannot accurately predict the timing and amount of our capital needs. If capital requirements vary materially from those currently planned, we will require additional capital. Issuing additional shares of capital stock may be dilutive to our shareholders, and debt financing, if available, may involve restrictive covenants. OUR PRODUCTS AND SYSTEMS MAY BE SUBJECT TO YEAR 2000 PROBLEMS We have identified teams to review our products, our internal financial, manufacturing and other process control systems, and our interface with major customers and suppliers in order to assess and remediate Year 2000 issues. Based upon our assessments to date, we believe we will not experience any material disruption in our operations as a result of Year 2000 problems. However, if major suppliers, including those providing component parts, electricity, communications and transportation services, experience difficulties resulting in disruption of critical supplies or services to us, a shutdown of our operations could occur for the duration of the disruption. We are working on minimizing component supply risk by evaluating alternative suppliers in cases where we are single-sourced, with completion of our evaluation expected by June 1999. We have not yet developed a contingency plan in the event the other described problem scenarios arise, but we will assess the need to develop a plan based upon the outcome of compliance areas currently under review, and the results of remaining survey feedback from our major suppliers. Assuming no major disruption in service from critical third party providers, we believe that we will be able to manage the Year 2000 transition without any material effect on our results of operations or financial position. 5 -----END PRIVACY-ENHANCED MESSAGE-----