-----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, P3uHv3utPfQkvqUaomTQdpf2jSBCRS2C4D/J1Wpp1d2oRrRTPwj3EUaK+e9LZDfq CcvS76AuTOFVI8JSbwi6Yw== 0001045969-98-000314.txt : 19980330 0001045969-98-000314.hdr.sgml : 19980330 ACCESSION NUMBER: 0001045969-98-000314 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: OPTICAL SENSORS INC CENTRAL INDEX KEY: 0000907658 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 411643592 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-27600 FILM NUMBER: 98576428 BUSINESS ADDRESS: STREET 1: 7615 GOLDEN TRIANGLE DRIVE STREET 2: STE A CITY: EDEN PRARIE STATE: MN ZIP: 55344 BUSINESS PHONE: 6179445857 MAIL ADDRESS: STREET 1: 7615 GOLDEN TRIANGLE DR STE A CITY: EDEN PRAIRIE STATE: MN ZIP: 55344 10-K405 1 FORM 10-K405 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------ FORM 10-K (Mark one) [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ______________. COMMISSION FILE NO. 0-27600 -------------------- OPTICAL SENSORS INCORPORATED (Exact name of registrant as specified in its charter) DELAWARE 41-164359 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 7615 GOLDEN TRIANGLE DRIVE SUITE A MINNEAPOLIS, MINNESOTA 55344-3733 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (612) 944-5857 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 PREFERRED SHARE PURCHASE RIGHTS 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 is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x] As of March 13, 1998, 8,848,764 shares of Common Stock of the Registrant were outstanding, and the aggregate market value of the Common Stock of the Registrant as of that date (based upon the last reported sale price of the Common Stock at that date as reported by the Nasdaq National Market System), excluding outstanding shares beneficially owned by directors and executive officers, was $40,731,856. DOCUMENTS INCORPORATED BY REFERENCE Parts II and IV of this Annual Report on Form 10-K incorporate by reference information (to the extent specific pages are referred to herein) from the Registrant's Annual Report to Stockholders for the year ended December 31, 1997 (the "1997 Annual Report"). Part III of this Annual Report on Form 10-K incorporates by reference information (to the extent specific sections are referred to herein) from the Registrant's Proxy Statement for its 1998 Annual Meeting to be held May 7, 1998 (the "1998 Proxy Statement"). ================================================================================ PART I This Form 10-K contains certain forward-looking statements. For this purpose, any statements contained in this Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "estimate" or "continue" or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially depending on a variety of factors, including those set forth in the section below entitled "Certain Important Factors." ITEM 1. BUSINESS. GENERAL Optical Sensors Incorporated (the "Company") has developed the SensiCath system, a patient-connected, on-demand arterial blood gas ("ABG") monitoring system, which provides precise and accurate ABG results within 60 seconds without exposure to potentially infectious blood or depleting the patient's blood supply (the "SensiCath System"). ABG tests measure oxygen ("O2"), carbon dioxide ("CO2") and acid-base ("pH") in a sample of blood taken from a patient's artery. These tests, which are among the most frequently ordered and most urgently needed tests for critically ill and unstable patients, are the foremost indicators of the body's ability to absorb and use oxygen. Results of ABG tests provide a basis for medical treatment and intervention and are required to accurately regulate the patient's respiratory support system. The Company believes that the SensiCath System is the first ABG analyzer to be integrated into both an arterial pressure monitoring line and a critical care patient monitoring system. The SensiCath System utilizes a disposable, fiberoptic sensor device (the "SensiCath Sensor") connected to a small modular instrument (the "ABG Module") that is part of the Company's OpticalCAM instrumentation ("OpticalCAM"). The SensiCath System is able to either stand alone or interface with various monitoring platforms, including monitoring systems produced and installed by Marquette Medical Systems, Inc., SpaceLabs Medical, Inc., and the Hewlett-Packard Company. These three producers account for approximately 80% of the installed base of critical care monitoring instrumentation in the United States. The Company's strategy is to become the leader in the design, development and commercialization of sensors and integrated monitoring systems for the measurement of ABG values and other critical parameters at the point-of-care. In May of 1997, the Company voluntarily initiated an action to recover all customer inventory of SensiCath Sensors due to a limited number of performance variations in pH readings on certain patient applications. These performance variations were caused by an interfering agent, called bilirubin, which is elevated in patients that have underdeveloped or failing livers. At the same time, the Company notified the FDA of its action to recover all customer inventory of sensors. In July 1997, the FDA notified the Company that the voluntary action was classified as a product recall. The Company complied with all requirements of the FDA recall action and retrieved all Sensors from customers. In December 1997, the Company completed a number of enhancements to the SensiCath Sensors including enhancements to the pH sensors that reduced potential interference from bilirubin to clinically acceptable levels. In the fourth quarter of 1997 and early 1998, the Company achieved a number of important strategic milestones. These milestones include enhancements to the system that improve sensor performance and ease of use and expand its application in the patient-connected segment of the point-of-care blood gas monitoring market; and implementing aggressive marketing programs for the OpticalCAM instrumentation. The Company began commercial distribution of the enhanced sensor in December 1997. In January 1998, the Company entered into a seven-year strategic partnership with Instrumentation Laboratory Company ("IL") for worldwide distribution of the Company's SensiCath Sensors and OpticalCAM instrumentation. IL will market and distribute the Company's products throughout the world under the names GEM SensiCath and GEM OpticalCAM, as part of the IL GEM family of hospital point-of-care diagnostic products. In January 1998, IL also made an equity investment in the Company of approximately $2.2 million. In January 1998, the Company entered into a seven-year strategic partnership with Instrumentation Laboratory Company ("IL") for worldwide distribution of the Company's SensiCath Sensors and OpticalCAM instrumentation. IL will market and distribute the Company's products throughout the world under the names GEM SensiCath and GEM OpticalCAM, as part of the IL GEM family of hospital point-of-care diagnostic products. In January 1998, IL also made an equity investment in the Company of approximately $2.2 million. The Company was incorporated in Minnesota in May 1989 and reincorporated in Delaware in January 1996. The Company's executive offices are located at 7615 Golden Triangle Drive, Suite A, Minneapolis, Minnesota 55344, and its telephone number is (612) 944-5857. THE SENSICATH SOLUTION By integrating ABG monitoring equipment as part of an existing bedside monitor and an ABG sensor as part of an existing arterial line, the Company believes that the SensiCath System presents the first patient-connected ABG system which addresses the needs of the critically ill, unstable patient population. The SensiCath System has the following benefits: - - FAST AND EASY TO USE. The SensiCath System provides ABG results within 60 seconds. Once installed in the arterial line, the health care provider need only push a button on the monitor and draw the blood over the sensors to obtain ABG readings and automatically record and transmit all results. Testing with the SensiCath System can be conducted by one health care professional, while testing with traditional ABG analyzers requires several hospital personnel. - - CLINICALLY SUPERIOR. The SensiCath System provides accurate and precise ABG results on demand that are comparable to results generated by traditional ABG analyzers. By integrating ABG data with other critical care parameters on a bedside monitor, the SensiCath System provides a valuable management tool for a patient experiencing rapid changes in cardiopulmonary status. By eliminating the requirement for any blood removal, the risk of human error in removing, handling and analyzing the blood sample is significantly reduced. The SensiCath System has also been designed with a quality assurance routine that is easily integrated into standard hospital practices. Furthermore, the SensiCath System only needs to be calibrated once during its approved 144-hour period of use, while traditional ABG analyzers require calibration prior to each test. - - COST-EFFECTIVE. The SensiCath Sensor can be used to take up to 200 ABG tests. The SensiCath System provides cost-effective ABG testing for patients requiring a large number of ABG tests because, unlike other ABG technologies, the SensiCath System does not have a direct per test cost. All test results are immediately captured as part of the patient's paperless record, which is an increasingly important benefit in the current environment for managing health care costs. The Company has priced the SensiCath Sensor to allow hospitals to reduce the cost of ABG testing for critically ill, unstable patients requiring frequent testing during their hospital stay. - - ELIMINATES BLOOD EXPOSURE AND LOSS. The SensiCath Sensor is placed in an arterial line creating a closed-loop system. As a result, no blood is removed from the patient during ABG testing, and the health care provider's exposure to blood is eliminated. Elimination of blood loss is significant for all patients, and is extremely important for neonatal patients who can require blood transfusions as a direct result of frequent ABG analysis using traditional technology. The closed-loop system also significantly reduces the risk of infection to both the health care provider and the patient by removing the need to open the arterial line, attach a syringe and remove blood. The health care 2 provider is not exposed to potentially infectious blood samples or blood contaminated materials during testing. SENSICATH SYSTEM The SensiCath System is able to interface with various monitoring platforms, including monitoring systems produced and installed by Marquette Medical Systems, Inc., SpaceLabs Medical, Inc., and the Hewlett-Packard Company. These three producers account for approximately 80% of the installed base of critical care monitoring instrumentation in the United States. In addition, the OpticalCam provides stand-alone instrumentation capability for the SensiCath System, operating independently of any other monitoring equipment. The SensiCath Sensor contains three optical fibers with fluorescent chemistries for sensing O2, CO2 and pH. The disposable, single-patient sensor has been designed to provide accurate ABG data for the 144-hour approved period of use. The ABG Module is the source and receptor of optical signals, provides signal processing and communicates with other components in the monitoring system. The fiberoptic sensors are located outside the patient's artery (paracorporeal) as a part of an existing arterial pressure monitoring line which is secured to the patient's forearm. The integration of the SensiCath Sensor with an existing arterial line and a bedside monitoring system enables the health care provider to provide integrated bedside management of rapid changes in the patient's cardiopulmonary status. The closed-loop system of the SensiCath Sensor and the arterial line eliminates blood loss and blood exposure resulting from traditional ABG analysis. The SensiCath Sensor is attached to the standard arterial line already in place on critically ill patients. A standard line includes an arterial cannula, pressure monitoring tubing and pressure transducer. The arterial line is constantly filled with saline or other physiologic solution as part of its function as a pressure monitor. The SensiCath Sensor is added to the arterial line in a flow-through configuration which does not disrupt the arterial pressure waveform or interfere with fluid delivery. Unlike electrochemical ABG analyzers, the SensiCath System needs to be calibrated only once at the outset of its use. The calibration procedure takes approximately five minutes and requires only two small pouches of initialization fluid which are included with the SensiCath Sensor. The SensiCath System is then ready to provide ABG measurements. To take an ABG measurement, the health care provider pushes a button on the bedside monitor and draws blood past the sensor. A tone from the monitor signals the health care provider to return the blood to the patient and flush the line. The ABG results then appear on the monitor screen within 60 seconds. The time-consuming and complicated process of removing, handling and analyzing a blood sample, all of which can contribute to delayed and inaccurate results, is unnecessary with the SensiCath System. The SensiCath Sensor contains three fiberoptic chemical sensors enclosed in a sterile, disposable device. The O2 and pH sensors consist of fluorescent dyes immobilized within unique polymer matrices, which are directly bonded onto the distal region of a polymer clad glass fiber. The CO2 sensor consists of a dissolved fluorescent dye within an ultra-miniaturized mechanically encapsulated housing, also bonded onto the distal region of a glass fiber. These captive dyes react with the analyte of interest (i.e., O2, CO2 and pH) to influence optical signals within the fiberoptics. The SensiCath Sensor also contains a temperature control device which enables the sensors to provide accurate measurements at varying blood temperatures. The Company's optical platform, by means of a proprietary ratiometric methodology, provides light source and light detection using solid-state, miniature components. The optics in combination with 3 the sensor dyes provide fully ratioed capability which maintains calibration for the entire 144-hour period. The initialization fluids are liquid stable solutions, administered once to the SensiCath System to enable a two point calibration. This calibration is stable for the 144-hour period of use of the SensiCath System. No external gas tanks with O2 and CO2 are required because the fluids are calibrated at the time of manufacture, unlike traditional ABG analyzers which require calibration prior to each test. SALES AND MARKETING The Company's principal distribution channel for its products is through IL, the Company's worldwide distribution partner. In January 1998, the Company entered into a seven-year strategic partnership with IL for worldwide distribution of the Company's SensiCath Sensors and OpticalCAM instrumentation. IL will market and distribute the Company's products throughout the world under the names GEM SensiCath and GEM OpticalCAM, as part of IL's established GEM line of critical care products. The Company will supply IL with SensiCath Sensors, on an exclusive basis, through 2004 and on a non-exclusive basis through 2007. The Company will also supply IL with OpticalCAM Instruments, on a semi-exclusive basis, through 2004. The Company retains the right to sell OpticalCAM Instruments to manufacturers of physiological monitoring, ventilator and anesthesia delivery systems. IL is required to purchase sufficient quantities of products from the Company that will result in preestablished annual minimum revenues to the Company. These quotas increase each year during the first five years of the relationship. If IL fails to meet the quota requirements, the Company has the right to convert IL's exclusive right to a non-exclusive right. In addition, the Company has the right to convert IL's exclusive right to a non-exclusive right if there is a change in control of the Company. If the Company exercises this right, IL will have the right to terminate the relationship. In January 1998, IL also purchased 441,203 shares of Common Stock from the Company, which represented 4.99% of the Company's outstanding Common Stock following completion of the transaction, for approximately $2.2 million. The Company also maintains a sales and marketing staff whose primary role is to develop joint marketing programs with IL, provide support for customer evaluation of the SensiCath System, provide training, support and technical assistance for IL's sales force and provide technical assistance and support for customers. The Company's sales and marketing staff will continue to identify and establish key customer sites, call on customers and develop relationships with manufacturers of critical care patient bedside monitoring systems. The Company plans to continue to directly market the OpticalCAM to manufacturers of critical care patient bedside monitoring systems, although their customers will purchase sensors directly from IL. The Company regularly exhibits its products at major U.S. and European medical conferences. In addition, a number of papers have been published in medical peer review journals and several abstracts have been presented at medical conferences regarding the SensiCath System. The Company plans to continue to support publications and abstract presentations. The Company has established reference sites for the SensiCath System at key hospitals and medical centers in the U.S. and Europe. RESEARCH AND DEVELOPMENT The Company's research and development staff is dedicated to the research, design and development of the technology used in the SensiCath System. During 1997, the Company's research and development staff completed a number of significant improvements to the SensiCath System, including modifications to the pH sensor to reduce potential interference from bilirubin in the blood to clinically acceptable levels, software upgrades to streamline the process of generating, storing and retrieving 4 measurement data, and hardware and software upgrades that reduce set-up and calibration time for the system. The Company's principal research and development activities currently consist of design and development of new sensors to measure additional blood analytes and further product enhancements, including planned cost reduction programs. There can be no assurance that the Company will be able to successfully develop new products or achieve planned cost reductions on a timely basis or at all. The Company's research and development expenses for the fiscal years ended December 31, 1997, 1996 and 1995 were $4,975,037, $5,632,458 and $5,955,344, respectively. The Company anticipates that it will continue to spend significant amounts on research and development activities for the foreseeable future. MANUFACTURING AND SUPPLY The Company manufactures the SensiCath Sensor at its facility in Minneapolis, Minnesota, which includes approximately 4,000 square feet of manufacturing space. The FDA conducted a scheduled good manufacturing practices ("GMP") inspection of the Company's manufacturing facility in November 1997, and the Company has passed the inspection. The Company has also received ISO 9001 certification for its manufacturing facility. The SensiCath Sensors are manufactured in a unique, reproducible process. The finished device is packaged and sterilized prior to being shipped. The Company has entered into an agreement with a third party in Europe which packages sterilized sensors manufactured by the Company and non-proprietary components for sale of the SensiCath System in Europe. The Company purchases components from various suppliers and relies on single sources for the OpticalCAM monitor, as well as a few key components. To date, the Company has qualified only single sources for certain purchased components of the Company's unique optical platform. While the Company believes that alternate suppliers are available and can be approved in accordance with the Company's vendor qualification procedures, identifying and qualifying such vendors could cause a delay in production of the Company's products. Any such delay could have a material adverse effect on the Company. In addition, the ABG Module is currently manufactured solely by Marquette Medical Systems, Inc. While the Company has entered into an OEM agreement with Marquette for the ABG Module, any delay or disruption in the supply of ABG Modules could have a material adverse effect on the Company. COMPETITION Competition in the medical device industry in general and the ABG analyzer market in particular is intense and expected to increase. The Company believes that the principal competitive factors for ABG analyzers and monitors are accuracy, rapid results, cost-effectiveness, integration with bedside monitors, reduction of blood loss and exposure, and price. The Company believes that it competes favorably with respect to all of these factors. Several other point-of-care or near-patient blood gas testing manufacturers have commercially available products including AVL Scientific Corp., i-STAT Corporation, Diametrics Medical, Inc., SenDx Medical Inc. and VIA Medical, Inc. In addition, some manufacturers of laboratory equipment are marketing "mobile" versions of traditional blood gas testing equipment. The Company also expects that manufacturers of central and satellite laboratory testing equipment will compete to maintain their revenues and market share. Most of the Company's competitors have significantly greater financial, technical, research, marketing, sales, distribution and other resources than the Company. There can be no assurance that the Company's competitors will not succeed in developing or marketing technologies and products that are more effective or less expensive than those developed or marketed by the Company or that would render the Company's technology and products obsolete or noncompetitive. Furthermore, there can be no assurance that the emergence of new products, technologies or procedures will not reduce the need for ABG analysis. 5 PATENTS AND PROPRIETARY RIGHTS The Company seeks to protect technology, inventions and improvements that it considers important through the use of patents and trade secrets. The Company owns or has rights to several U.S. patents and has filed a number of patent applications in the United States, Japan and key European countries. There can be no assurance, however, that the Company's patents will provide competitive advantages for the Company's products, or that such rights will not be challenged or circumvented by competitors. In addition, there can be no assurance that any pending patent applications will issue. Claims made under patent applications may be denied or significantly narrowed and the issued patents, if any, may not provide significant commercial protection to the Company. The Company could incur substantial costs in proceedings before the U.S. Patent and Trademark Office, including interference proceedings. These proceedings could result in adverse decisions as to the priority of the Company's inventions. While the Company does not believe that any of its products infringe any valid claims of patents or other proprietary rights held by third parties, there can be no assurance that the Company does not infringe any patents or other proprietary rights held by third parties. If an infringement claim were made, the costs incurred to defend the claim could be substantial and adversely affect the Company, even if the Company were ultimately successful in defending the claim. If the Company's products were found to infringe any proprietary right of a third party, the Company could be required to pay significant damages or license fees to the third party or cease production. Litigation may also be necessary to enforce patent rights held by the Company, or to protect trade secrets or techniques owned by the Company. Any such claims or litigation could result in substantial costs and diversion of effort by management of the Company. The Company also relies on trade secrets and other unpatented proprietary technology. There can be no assurance that the Company can meaningfully protect its rights in such unpatented proprietary technology or that others will not independently develop substantially equivalent proprietary products or processes or otherwise gain access to the Company's proprietary technology. The Company seeks to protect its trade secrets and proprietary know-how, in part, with confidentiality agreements with employees and consultants. There can be no assurance that the agreements will not be breached, that the Company will have adequate remedies for any breach or that the Company's trade secrets will not otherwise become known to or independently developed by competitors. SensiCath(R) and OpticalCAM(TM) are trademarks of the Company. GEM(R) is a trademark of Instrumentation Laboratory Company. GOVERNMENT REGULATION The Company's products, development activities and manufacturing processes are subject to regulation by numerous governmental authorities, principally the United States Food and Drug Administration ("FDA") and corresponding foreign agencies. In the United States, the FDA administers the Federal Food, Drug and Cosmetics Act and amendments thereto, including the Safe Medical Devices Act of 1990. The Company is subject to the standards and procedures respecting manufacture and marketing of medical devices contained in the Federal Food, Drug and Cosmetics Act and the regulations promulgated thereunder and is subject to inspection by the FDA for compliance with such standards and procedures. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to 6 grant premarket clearance or premarket approval for devices, withdrawal of marketing approvals and criminal prosecution. In the United States, medical devices are classified into one of three classes (class I, II or III), on the basis of the controls deemed necessary by the FDA to reasonably assure their safety and effectiveness. Under FDA regulations, class I devices are subject to general controls (e.g., labeling, premarket notification and adherence to good manufacturing practices) and class II devices are subject to general and special controls (e.g., performance standards, postmarket surveillance, patient registries and FDA guidelines ). In general, class III devices (e.g., life-sustaining, life-supporting and implantable devices, or new devices which have not been found substantially equivalent to a legally marketed device), in addition to being subject to general and special controls, must receive premarket approval ("PMA") by the FDA to ensure their safety and effectiveness. Before a new or significantly modified device can be introduced into the market, the manufacturer must generally obtain marketing clearance through a 510(k) notification or approval of a PMA application. A 510(k) clearance will be granted if the proposed device is "substantially equivalent" to a predicate device (i.e., a legally marketed class I or class II medical device, or a class III medical device for which the FDA has not called for the submission of a PMA application). Commercial distribution of a device for which a 510(k) notification is required can begin only after the FDA issues a written determination that the device is "substantially equivalent" to a predicate device. The process of obtaining a 510(k) clearance typically can take several months to a year or longer. A PMA application must be filed if a proposed device is not substantially equivalent to a legally marketed class I or class II device, or if it is a class III device for which the FDA has called for a PMA application. Certain class III devices that were on the market before May 28, 1976 ("preamendments class III devices"), and devices that are substantially equivalent to them, can be brought to market through the 510(k) process until the FDA calls for the submission of PMA applications for preamendments class III devices. The process of obtaining a PMA can be expensive, uncertain and lengthy, frequently requiring anywhere from one to several years from the date the PMA is submitted to the FDA, if approval is obtained at all. The Company has received 510(k) clearance to market the SensiCath System and the OpticalCAM monitor from the FDA. The Company anticipates submitting 510(k) notifications for other configurations of the SensiCath System and other products that the Company may develop in the future. There can be no assurance that these future 510(k) submissions will be cleared by the FDA on a timely basis, if at all. The Company's 510(k) notice claimed that the SensiCath System is substantially equivalent to certain preamendments class III devices for which the FDA has published a final regulation placing the devices in class III. Pursuant to the FDA's August 14, 1995 order requiring manufacturers of preamendments class III devices to submit safety and effectiveness information to the FDA, the Company submitted safety and effectiveness information to the FDA for the SensiCath System by August 1997. In addition, if the FDA publishes a final regulation calling for PMA applications for the SensiCath predicate devices based on information submitted by the Company and other manufacturers, the Company may be required to submit a PMA application within 90 days after the FDA calls for PMA applications. Although the FDA order requiring submission of safety and effectiveness information characterized the predicate devices as having a high potential for down-classification, there can be no assurance that the devices will be down-classified or that the Company will not be required to submit a PMA application for the SensiCath System. The Company is also subject to regulation in each of the foreign countries in which it sells its products with regard to product standards, packaging requirements, labeling requirements, import 7 restrictions, tariff regulations, duties and tax requirements. Many of the regulations applicable to the Company's products in such countries are similar to those of the FDA. The national health or social security organizations of certain of such countries require the Company's products to be qualified before they can be marketed in those countries. Delays in receipt of, or a failure to receive such approvals or clearances, or the loss of any previously received approvals or clearances, could have a material adverse effect on the Company. To date, the Company has not experienced significant difficulty in complying with these regulations. In February 1997, the Company received the European Medical Devices Directorate ("MDD") approval to place the "CE" mark on its products. The CE mark enables the Company's products to be marketed, sold and used throughout the European Union, subject to limited "safeguard" powers of member states. The Company is subject to periodic inspections by the FDA, which is charged with auditing the Company's compliance with good manufacturing practices ("GMP") established by the FDA and other applicable government standards. The Company is also subject to inspections by the MDD and other European regulatory agencies. Strict regulatory action may be initiated in response to audit deficiencies or to product performance problems. The Company believes that its manufacturing and quality control procedures are in compliance with the requirements of the FDA and MDD regulations. The Company's manufacturing facilities and processes are also subject to periodic inspection and review by its Notified Body in conjunction with the Company's ISO 9001 certification. Failure to maintain GMP and ISO 9001 certifications could have a material adverse effect on the Company. Some of the currently available methods for performing ABG analysis are subject to the Clinical Laboratory Improvements Act of 1988 ("CLIA"), which is intended to ensure the quality and reliability of all medical testing in the United States, regardless of testing site. In June 1996, the Company was notified by the Centers for Disease Control and Prevention ("CDC") that the SensiCath System was not subject to regulation under CLIA. Under CLIA, testing sites are required to comply with certain requirements regarding personnel qualification, administration, participation in proficiency testing, patient test management, quality control, quality assurance and inspections based on the level of "complexity" associated with the test, and each manufacturer of a test analyzer must obtain a classification of the tests its product performs from the FDA and CDC. There can be no assurance that future CDC regulations will not apply to the SensiCath System. THIRD PARTY REIMBURSEMENT Hospitals that purchase and physicians who use medical devices such as the Company's products generally rely upon third party payors such as Medicare, Medicaid, private health insurers and others to pay for some or all of the costs associated with the product. Medicare is the largest single third-party payor for services involving the use of the Company's products which are used primarily for hospital inpatients who are receiving critical care services. The patient population that the Company has initially targeted for the SensiCath System requires numerous ABG tests as part of their critical care stay. Using the average cost of traditional ABG tests and comparing it to the costs associated with the SensiCath System, the Company believes that it is able to demonstrate the cost-effectiveness of the SensiCath System. However, there can be no assurance that the use of the SensiCath System will be considered cost-effective by certain hospitals and physicians in relation to the level of reimbursement typically received for ABG tests or for any reimbursement that might be received for each SensiCath Sensor. Furthermore, the level of reimbursement for ABG testing could decrease in the future. Failure by hospitals and other users of the Company's products to obtain sufficient reimbursement from third party payors and/or changes in governmental and private third party payors' policies toward coverage for ABG tests could have a materially adverse effect on the Company. 8 EMPLOYEES As of December 31, 1997, the Company employed 75 persons full-time and 8 persons on a contract or part-time basis. No employees are covered by collective bargaining agreements, and the Company considers its relationship with its employees to be good. CERTAIN IMPORTANT FACTORS In addition to the factors identified above, there are several important factors that could cause the Company's actual results to differ materially from those anticipated by the Company or which are reflected in any forward-looking statements of the Company. These factors, and their impact on the success of the Company's operations and its ability to achieve its goals, include the following: - - MARKET ACCEPTANCE OF THE SENSICATH SYSTEM. The Company's future revenues will depend on market acceptance of the SensiCath System. The Company will need to demonstrate to health care professionals, hospital administrators and third-party payors the accuracy, reliability, ease of use, safety and cost effectiveness of the SensiCath System. In order to use the SensiCath System, hospitals need to acquire the OpticalCAM instrumentation, which may require capital expenditure approvals by the hospital. - - SALES BY INSTRUMENTATION LABORATORY. The Company's future revenues will depend almost exclusively on sales of the Company's products by IL. In January 1998, the Company entered into a seven-year strategic partnership with IL for worldwide distribution of the Company's SensiCath Sensors and OpticalCAM instrumentation. IL will market and distribute the Company's products throughout the world under the names GEM SensiCath and GEM OpticalCAM. The Company will supply IL with SensiCath Sensors, on an exclusive basis, through 2004 and on a non-exclusive basis through 2007. The Company will also supply IL with OpticalCAM Instruments, on a semi-exclusive basis, through 2004. The Company retains the right to sell OpticalCAM Instruments to manufacturers of physiological monitoring, ventilator and anesthesia delivery systems. Although IL is required to purchase sufficient quantities of products from the Company that will result in pre-established annual minimum revenues to the Company in order to maintain exclusivity, there can be no assurance that IL will achieve sufficient sales for the Company to substantially increase revenues or achieve profitability. - - MANUFACTURING AND SUPPLY. The Company's future plans include planned enhancements to the SensiCath Sensor that will reduce the Company's manufacturing costs. In addition, the Company does not yet have experience in manufacturing sensors in volumes that will be necessary to achieve significant revenues. A failure to implement the planned cost reduction programs in a timely manner or to successfully scale-up manufacturing of sensors could have a material adverse effect on the Company. Currently, the Company has only one supplier for the ABG Module, the OpticalCAM Monitor and certain other key components. Any disruption or delay in the supply of key components or instrumentation could have a material adverse effect on the Company. - - COMPETITION. Competition among companies attempting to provide ABG and other critical blood analyte analysis at the point-of-care is intense and increasing. There can be no assurance that the Company's competitors will not succeed in developing or marketing technologies and products that are more effective or less expensive than the Company's products or that would render the Company's products obsolete or non-competitive. 9 - - REGULATORY APPROVALS. The Company's ability to market its current products and any products that it may develop in the future requires clearances or approvals from the FDA and other governmental agencies, including, in some instances, foreign and state agencies. The process for maintaining and obtaining necessary regulatory clearances and approvals can be expensive and time consuming. There can be no assurance that the Company will be able to maintain or obtain necessary regulatory approvals and clearances in the future. ITEM 2. PROPERTIES. The Company's facilities are located at 7615 Golden Triangle Drive, Minneapolis, Minnesota, and consist of approximately 23,364 square feet. The Company leases these facilities pursuant to a lease that expires on November 30, 1999. The lease provides for rent of approximately $20,800 per month, including base rent and a pro rata share of operating expenses and real estate taxes. The Company expects that these facilities will be sufficient for its operations for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS. There are no material pending or threatened legal, governmental, administrative or other proceedings to which the Company is a party or of which any of its property is subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this Report. ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY. The executive officers of the Company, their ages and the offices held, as of March 13, 1998, are as follows: NAME AGE TITLE - ------------------- --- -------------------------------------------- Sam B. Humphries 55 President and Chief Executive Officer Paulita M. LaPlante 40 Vice President of Worldwide Sales, Marketing and Business Development Byron (Buzz) Moran 55 Vice President of Research and Development and Operations Wesley G. Peterson 50 Chief Financial Officer, Vice President of Finance and Administration and Secretary Information regarding the business experience of the executive officers of the Company is set forth below. SAM B. HUMPHRIES has been the President, Chief Executive Officer and a Director of the Company since October 1991. From January 1988 to October 1991, he served as President and Chief Executive Officer of American Medical Systems ("AMS"), a medical device manufacturer which is a 10 subsidiary of Pfizer, Inc. Mr. Humphries also served as a member of the Board of Directors of the Hospital Products Group at Pfizer, Inc. Mr. Humphries is a Director of Universal Hospital Services, Inc. PAULITA M. LAPLANTE has been the Company's Vice President of Worldwide Sales, Marketing and Business Development since June 1994 and was Director of Marketing and Business Development from April 1992 to June 1994. She also served as the Company's interim Vice President of Research and Development from January 1994 to September 1994. From 1986 to April 1992, Ms. LaPlante held a variety of positions with AMS, including Manager for Prostate Products, Manager of New Business Development and Manager of Worldwide Technical Training. BYRON (BUZZ) MORAN has been the Company's Vice President of Research and Development and Operations since September 1994. From January 1985 to August 1994, Mr. Moran held several management positions, including Vice President and General Manager and Vice President of Research and Development, for Spectramed Incorporated, a medical device manufacturer which is a subsidiary of British Oxygen Corporation. WESLEY G. PETERSON has been the Company's Chief Financial Officer since January 1992, Vice President of Finance and Administration since June 1994 and Secretary since July 1992. He was also Director of Finance and Administration from January 1992 to June 1994. From December 1986 to December 1991, Mr. Peterson was the Vice President of Finance and Administration for CIMA Labs, Inc., a manufacturer and distributor of pharmaceuticals based in Minneapolis, Minnesota. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information under the caption "Common Stock Information" on page 25 of the Company's 1997 Annual Report is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA. The financial information under the caption "Selected Financial Data" on page 23 of the Company's 1997 Annual Report is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information under the caption "Management's Discussion and Analysis" on pages 6 to 9 of the Company's 1997 Annual Report is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK. Not Applicable. 11 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's Financial Statements and Independent Auditors' Report thereon on pages 10 to 23 of the Company's 1997 Annual Report are 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. (A) DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS The information under the captions "Election of Directors -- Information About Nominees" and "Election of Directors -- Other Information About Nominees" in the Company's 1998 Proxy Statement is incorporated herein by reference. The information concerning executive officers of the Company is included in this Report under Item 4a, "Executive Officers of the Company." (B) SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE The information under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's 1998 Proxy Statement is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. The information under the captions "Election of Directors -- Director Compensation" and "Executive Compensation and Other Benefits" in the Company's 1998 Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information under the caption "Principal Shareholders and Beneficial Ownership of Management" in the Company's 1998 Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information under the caption "Certain Transactions" in the Company's 1998 Proxy Statement is incorporated herein by reference. 12 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (A) 1. FINANCIAL STATEMENTS. The following Financial Statements of the Company are incorporated herein by reference from the pages indicated in the Company's 1997 Annual Report: FINANCIAL STATEMENTS: PAGE: Report of Independent Auditors........................... 23 Statements of Operations for the years ended December 31, 1997, 1996 and 1995 and for the period from May 23, 1989 (inception) to December 31, 1997............ 10 Balance Sheets as of December 31, 1997 and 1996.......... 11 Statement of Shareholders' Equity for the period May 23, 1989 (inception) to December 31, 1997............ 12-13 Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 and for the period from May 23, 1989 (inception) to December 31, 1997....... 14 Notes to Financial Statements............................ 15-22 2. FINANCIAL STATEMENT SCHEDULES. All schedules are omitted as the required information is inapplicable or the information is presented in the financial statements or related notes thereto. 3. EXHIBITS The exhibits to this Report are listed in the Exhibit Index on pages 16 to 20 below. A copy of the exhibits referred to above will be furnished at a reasonable cost to any person who was a stockholder of the Company as of March 13, 1998, upon receipt from any such person of a written request for any such exhibit. Such request should be sent to: Optical Sensors Incorporated, 7615 Golden Triangle Drive, Suite A, Minneapolis, Minnesota 55344; Attn: Stockholder Information. The following is a list of each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 13(a): A. Employment Agreement dated October 1, 1991 between the Company and Sam B. Humphries. 13 B. 1989 Omnibus Stock Option Plan, as amended. C. 1991 Stock Option Plan, as amended. D. Non-Statutory Stock Option Agreement dated August 2, 1995 between the Company and Sam B. Humphries. E. Non-Recourse Promissory Note dated September 1, 1995 between the Company and Sam B. Humphries. F. 1993 Stock Option Plan, as amended. G. Form of Non-Statutory Stock Option Agreement for Nonemployees pursuant to 1993 Stock Option Plan. H. Form of Non-Statutory Stock Option Agreement for Nonemployee Directors pursuant to 1993 Stock Option Plan I. Form of Incentive Stock Option Agreement for Employees pursuant to 1993 Stock Option Plan. J. Employee Stock Purchase Plan. (B) REPORTS ON FORM 8-K The Company did not file any Current Reports on Form 8-K during the quarter ended December 31, 1997. 14 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. OPTICAL SENSORS INCORPORATED Dated: March 25, 1998 By: /S/ SAM B. HUMPHRIES ----------------------- Sam B. Humphries President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below on March 25, 1998 by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. NAME TITLE /S/ SAM B. HUMPHRIES President, Chief Executive Officer and - ------------------------------- Director (principal executive officer) Sam B. Humphries /S/ WESLEY G. PETERSON Chief Financial Officer, Vice President - ------------------------------- of Finance and Administration and Wesley G. Peterson Secretary (principal financial and accounting officer) /S/ RICHARD B. EGEN Director - ------------------------------- Richard B. Egen /S/ PROMOD HAQUE, PH.D. Director - ------------------------------- Promod Haque, Ph.D. /S/ RICHARD J. MEELIA Director - ------------------------------- Richard J. Meelia /S/ DEMETRE M. NICOLOFF, M.D. Director - ------------------------------- Demetre M. Nicoloff, M.D. /S/ GARY A. PETERSON Director - ------------------------------- Gary A. Peterson 15 OPTICAL SENSORS INCORPORATED EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997
ITEM NO. ITEM METHOD OF FILING 3.1 Restated Certificate of Incorporation of the Incorporated by reference to Exhibit 3.3 Company. contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 3.2 Certificate of Designation, Preferences and Incorporated by reference to Exhibit 3.2 Rights of Series A Junior Preferred Stock. contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 0-27600). 3.3 Bylaws of the Company. Incorporated by reference to Exhibit 3.5 contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 4.1 Specimen Common Stock Certificate Incorporated by reference to Exhibit 4.1 contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 4.2 Form of Warrant issued in connection with the Incorporated by reference to Exhibit 4.4 Convertible Bridge Loan Agreement dated November contained in the Company's Registration 22, 1991 Statement on Form S-1 (File No. 33-99904). 4.3 Form of Warrant issued in connection with the Incorporated by reference to Exhibit 4.5 On-Call Bridge Loan Agreement dated December 6, contained in the Company's Registration 1991 Statement on Form S-1 (File No. 33-99904). 4.4 Form of Warrant issued in connection with the Incorporated by reference to Exhibit 4.6 Convertible Bridge Loan Agreement dated May 4, contained in the Company's Registration 1993 Statement on Form S-1 (File No. 33-99904). 4.5 Form of Warrant issued in connection with the Incorporated by reference to Exhibit 4.7 Bridge Loan Agreement dated June 1, 1995 contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 4.6 Warrant dated November 6, 1992 issued to Incorporated by reference to Exhibit 4.8 Comdisco, Inc. contained in the Company's Registration Statement on Form S-1 (File No. 33-99904).
4.7 Warrant Dated August 31, 1995 issued to Incorporated by reference to Exhibit 4.9 Comdisco, Inc. contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 4.8 Rights Agreement dated as of December 3, 1996 Incorporated by reference to Exhibit 4.1 between the Company and Norwest Bank Minnesota, contained in the Company's Current Report on N.A. Form 8-K dated December 3, 1996 (File No. 0-27600). 10.1 Lease dated October 7, 1991 between Registrant Incorporated by reference to Exhibit 10.1 and First Industrial L.P. (successor to MIG contained in the Company's Registration Kappa III Companies) Statement on Form S-1 (File No. 33-99904). 10.2 Equipment Lease dated November 6, 1992, as Incorporated by reference to Exhibit 10.2 amended, between the Company and Comdisco, Inc. contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.3 Letter Agreement dated October 1, 1995 between Incorporated by reference to Exhibit 10.3 the Company and Marquette Electronics, Inc. contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.4 Employment Agreement dated October 1, 1991 Incorporated by reference to Exhibit 10.4 between the Company and Sam B. Humphries contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.5 Non-Competition Agreement, dated April 28, 1992 Incorporated by reference to Exhibit 10.6 between the Company and Sam B. Humphries contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.6 Registration Rights Agreement, dated April 28, Incorporated by reference to Exhibit 10.9 1992, as amended contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.7 1989 Omnibus Stock Option Plan, as amended Incorporated by reference to Exhibit 10.11 contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.8 1991 Stock Option Plan, as amended Incorporated by reference to Exhibit 10.12 contained in the Company's Registration Statement on Form S-1 (File No. 33-99904).
10.9 Non-Statutory Stock Option Agreement dated Incorporated by reference to Exhibit 10.13 August 2, 1995 between the Company and Sam B. contained in the Company's Registration Humphries Statement on Form S-1 (File No. 33-99904). 10.10 Non-Recourse Promissory Note dated September 1, Incorporated by reference to Exhibit 10.14 1995 between the Company and Sam B. Humphries contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.11 Pledge Agreement dated September 1, 1995 between Incorporated by reference to Exhibit 10.15 the Company and Sam B. Humphries contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.12 1993 Stock Option Plan, as amended Incorporated by reference to Exhibit 10.21 contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.13 Form of Non-Statutory Stock Option Agreement for Incorporated by reference to Exhibit 10.21 Nonemployees pursuant to 1993 Stock Option Plan contained in the Company's Registration Statement on Form S-1 (File No. 33-99904). 10.14 Form of Non-Statutory Stock Option Agreement for Incorporated by reference to Exhibit 10.18 Nonemployee Directors pursuant to 1993 Stock contained in the Company's Registration Option Plan Statement on Form S-1 (File No. 33-99904). 10.15 Form of Incentive Stock Option Agreement for Incorporated by reference to Exhibit 10.19 Employees pursuant to contained in the Company's Registration 1993 Stock Option Plan Statement on Form S-1 (File No. 33-99904). 10.16 Employee Stock Purchase Plan Incorporated by reference to Exhibit 99.1 contained in the Company's Registration Statement on Form S-8 (File No. 333-17493). 10.17 First Amendment to Lease Agreement dated April Incorporated by reference to Exhibit 10.21 26, 1996 between First Industrial Financing contained in the Company's Annual Report on Form Partnership, L.P. and the Company. 10-K for the year ended December 31, 1996 (File No. 0-27600).
10.18 Supply Agreement dated August 22, 1996 between Incorporated by reference to Exhibit 10.22 the Company and Marquette Electronics, Inc. (1) ontained in the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 0-27600). 10.19 Manufacturing Supply Agreement dated September Incorporated by reference to Exhibit 10.23 10, 1996 between the Company and SpecTran contained in the Company's Annual Report on Form Specialty Optics Company. (1) 10-K for the year ended December 31, 1996 (File No. 0-27600). 10.20 Purchase Order dated February 21, 1997 between Incorporated by reference to Exhibit 10.24 the Company and SeaMED Corporation. (1) contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 0-27600). 10.21 Second Amendment to Lease Agreement, dated Filed herewith electronically. April 14, 1997, between First Industrial Financing Partnership, L.P. and the Company. 10.22 Master Equipment Lease dated June 15, 1997 Filed herewith electronically. between Phoenix Leasing Incorporated and the Company 10.23 Amendment No. 1 to Master Equipment Lease dated Filed herewith electronically. August 15, 1997 between Phoenix Leasing Incorporated and the Company 10.24 Private Label Reseller Agreement dated as of Incorporated by reference to Exhibit 10.1 January 7, 1998 between the Company and contained in the Company's Current Report on Instrumentation Laboratory Company. (1) Form 8-K, dated January 7, 1998 (File No. 0-27600). 10.25 Stock Purchase Agreement dated as of January 7, Incorporated by reference to Exhibit 10.2 1998 between the Company and Grupo CH Werfen, contained in the Company's Current Report on S.A. Form 8-K, dated January 7, 1998 (File No. 0-27600). 10.26 OEM Agreement dated February 5, 1998 between the Filed herewith electronically. Company and Marquette Medical Systems, Inc. (2) 13.1 Excerpts from the Company's 1997 Annual Report Filed herewith electronically. to Shareholders incorporated by reference herein.
23.1 Independent Auditors' Consent Filed herewith electronically. 27.1 Financial Data Schedule Filed herewith electronically.
- --------------------- (1) Confidential treatment has been granted by the Commission with respect to designated portions contained within document. Such portions have been omitted and filed separately with the Commission pursuant to Rule 24b-2 of the Securities and Exchange Act of 1934, as amended. (2) Confidential treatment has been requested with respect to designated portions contained within document. Such portions have been omitted and filed separately with the Commission pursuant to Rule 24b-2 of the Securities and Exchange Act of 1934, as amended. EX-10.21 2 SECOND AMENDMENT TO LEASE AGREEMENT EXHIBIT 10.21 SECOND AMENDMENT TO LEASE AGREEMENT TO THE LEASE dated October 7, 1991, by and between MIG III-Kappa Corporation and now assigned to First Industrial, L.P. (a Delaware Limited Partnership) as Landlord, and Optical Sensors Incorporated (a Delaware corporation and successor to Optical Senor for Medicine, Inc.) as Tenant. THIS AMENDMENT TO LEASE, entered into and made as of April 14, 1997, by and between First Industrial, L.P., as Landlord and Optical Sensors Incorporated, as Tenant. WITNESSETH: WHEREAS, Landlord and Tenant have heretofore entered into a certain Lease dated October 7, 1991 and amended by First Amendment dated April 26, 1996 (the "Lease") covering that certain space at 7615 Golden Triangle Drive, Suite A, Eden Prairie, MN 55344 (the "Premises"), upon terms and conditions described in said Lease; and WHEREAS, Landlord and Tenant desire to amend said Lease as described below: 1. Effective April 21, 1997, Tenant shall occupy an additional 4,925 square feet of space (totaling 23,264 square feet; 2,181 square feet office, 14,083 square feet warehouse) located at 7615 Golden Triangle Drive, Suite L, as attached on Exhibit A. 2. Monthly Base Rent as set forth in Section 1.4 of the Lease shall be as follows: April 21, 1997 - November 30, 1999 $14,130 per month 3. Right of First Refusal: During the initial term of this Lease and the option periods thereafter, Tenant shall have the Right of First Refusal on the space located at 7615 Golden Triangle Drive, Suite N, as attached on Exhibit B. During said period, Landlord shall provide to Tenant a copy of any bonafide offer received from any third party to lease any portion of the space. Tenant shall thereafter have the option to lease the space which is the subject of said bonafide offer, which option shall be exercisable at any time within five (5) business days after receipt of the copy of said bonafide offer, on the same terms and conditions as set forth therein. In the event that Tenant fails to exercise its option to lease such space, Landlord may lease such space to a third party at any time during the next following sixty (60) day period on terms not more favorable to the Tenant thereof as were set forth in the bonafide offer provided to Tenant. The Right of First Refusal of Tenant under this paragraph is conditioned upon the Lease being in full force and effect without default thereunder on the date the Tenant exercises its right hereunder. 4. Except as hereinafter set forth, all terms, provisions and covenants of the Lease shall remain unchanged and in full force and effect. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date and year first above written. LANDLORD: FIRST INDUSTRIAL L.P., TENANT: OPTICAL SENSORS a Delaware Limited Partnership INCORPORATED, a Delaware corporation By: First Industrial Finance Corporation, a Maryland corporation, its general partner By: /S/ DUANE LUND By: /S/ SAM B. HUMPHRIES ------------------------------ ------------------------------- Its: Senior Regional Director Its: President and CEO EX-10.22 3 MASTER EQUIPMENT LEASE EXHIBIT 10.22 MASTER EQUIPMENT LEASE NO. 053-0070 Under this Master Equipment Lease No. 053-0070 (the "Lease"), dated as of June 15, 1997, PHOENIX LEASING INCORPORATED, a California corporation ("Lessor"), hereby leases to OPTICAL SENSORS INCORPORATED, a Delaware corporation ("Lessee"), and Lessee hereby leases from Lessor, the equipment and certain custom use equipment, installation and delivery costs, purchase tax, toolings software and items generally considered fungible or expendable ("Soft Costs") (herein together called "Equipment") which is described on the schedule attached hereto or any subsequently-executed schedule entered into by Lessor and Lessee and which incorporates this Lease by reference. Any such schedules shall hereinafter individually be referred to as a "Schedule" and collectively be referred to as the "Schedules." Lessor hereby leases the Equipment to Lessee upon the following terms and conditions: 1. TERM OF AGREEMENT. The term of this Lease begins on the date set forth above and shall continue thereafter and be in effect so long as and at any time any Schedule entered into pursuant to this Lease is in effect. The Base Term and rent payable with respect to each leased item of Equipment shall be as set forth in and as stated in the respective Schedule(s). The terms of each Schedule hereto are subject to all conditions and provisions of this Lease as it may at any time be amended. Each Schedule shall constitute a separate and independent lease and contractual obligation of Lessee and shall incorporate the terms and conditions of this Lease and any additional provisions contained in such Schedule. In the event of a conflict between the terms and conditions of this Lease and any additional provisions of such Schedule, the additional provisions of such Schedule shall prevail with respect to such Schedule only. 2. NON-CANCELLABLE LEASE. This Lease and any Schedule cannot be cancelled or terminated except as expressly provided herein. This Lease (including all Schedules to this Lease) constitutes a net lease and Lessee agrees that its obligations to pay all rent and other sums payable hereunder (and under any Schedule) and the rights of Lessor and assignee in and to such rent and other sums, are absolute and unconditional and are not subject to any abatement, reduction, setoff, defense, counterclaim or recoupment due or alleged to be due to, or by reason of, any past, present or future claims which Lessee may have against Lessor, any assignee, the manufacturer or seller of the Equipment, or against any person for any reason whatsoever. 3. LESSOR COMMITMENT. So long as no Event of Default or event which with the giving of notice or passage of time, or both, could become an Event of Default has occurred or is continuing, Lessor agrees to lease to Lessee the groups of Equipment described on each Schedule, subject to the following conditions: (a) that in no event shall Lessor be obligated to lease Equipment to Lessee hereunder where the aggregate purchase price of all Equipment leased to Lessee hereunder would exceed $2,000,000 ("Commitment") of which amount Lessor may purchase Soft Costs Equipment for lease to Lessee having an aggregate purchase price not exceeding an amount equal to 25% of the utilized Commitment; (b) the amount of Equipment purchased by Lessor at any one time shall be at least equal to $20,000 except for a final advance which may be less than $20,000; (c) Lessor shall not be obligated to purchase Equipment hereunder after June 30, 1998; (d) all Lease documentation required by Lessor has been executed by Lessee or provided by Lessee no later than June 15, 1997; (e) the equipment described on the Schedule is acceptable to Lessor and may include equipment manufactured by Lessee provided Lessee certifies such equipment will only be utilized as laboratory equipment; (f) with respect to each funding Lessee has provided to Lessor each of the closing documents and other items described in 1 Exhibit A hereto (which documents shall be in form and substance acceptable to Lessor) and which list may be modified for each subsequent funding; (g) there is no material adverse change in Lessee's condition, financial or otherwise, as determined by Lessor, and Lessee so certifies, from (yy) the date of the most recent financial statements delivered by Lessee to Lessor prior to execution of this Lease, to (zz) the date of the proposed lease of the Equipment; (h) Lessee is performing substantially according to its business plan referred to as "Quarterly Plan (Optical Sensors Incorporated, 1997 Operating Budget, Draft 2/6/97 Statement of Operations, Balance Sheets and Statements of Projected Cash Flows dated 1/31/97)" as may be amended from time to time in form and substance reasonably acceptable to Lessor ("Business Plan"); (i) Lessor or its agent has inspected and placed identification labels on the Equipment; (j) Lessee shall offer to Lessor, on an exclusive basis, all lease transactions for equipment contemplated by Lessee other than motor vehicles until expiration of all Schedules; however if Lessor declines to finance any such transaction or Lessee and Lessor cannot agree upon terms, then Lessee shall be free to seek such financing from any other third party; and (k) Lessor has received in form and substance reasonably acceptable to Lessor: (i) Lessee's interim financial statements signed by a financial officer of Lessee; and (ii) evidence of Lessee's $30,000,000 cash position as of December 31, 1996. 4. NO WARRANTIES BY LESSOR. (a) Lessee has selected both (i) the Equipment and (ii) the suppliers (herein called "Vendor") from whom Lessor is to purchase the Equipment. LESSOR MAKES NO WARRANTY EXPRESS OR IMPLIED AS TO ANY MATTER WHATSOEVER, INCLUDING THE CONDITION OF THE EQUIPMENT, ITS MERCHANTABILITY OR ITS FITNESS FOR ANY PARTICULAR PURPOSE, ITS COMPLIANCE WITH ANY APPLICABLE GOVERNMENTAL REQUIREMENTS AND ITS NON-INFRINGEMENT OF ANY PATENTS OR OTHER RIGHTS, AND AS TO LESSOR, LESSEE LEASES THE EQUIPMENT "AS IS" AND WITH ALL FAULTS. (b) If the Equipment is not properly installed, does not operate as represented or warranted by Vendor or is unsatisfactory for any reason, Lessee shall make any claim on account thereof solely against Vendor and shall, nevertheless, pay Lessor all rent payable under this Lease, Lessee hereby waiving any such claims as against Lessor. Lessor hereby agrees to assign to Lessee solely for the purpose of making and prosecuting any said claim, to the extent assignable, all of the rights which Lessor has against Vendor for breach of warranty or other representation respecting the Equipment. Lessor shall have no responsibility for delay or failure to fill the order. (c) Lessee understands and agrees that neither the Vendor nor any salesman or other agent of the Vendor is an agent of Lessor. No salesman or agent of Vendor is authorized to waive or alter any term or condition of this Lease, and no representations as to the Equipment or any other matter by the Vendor shall in any way affect Lessee's duty to pay the rent and perform its other obligations as set forth in this Lease. (d) Lessee hereby requests Lessor to purchase Equipment from Vendor and to lease Equipment to Lessee on the terms and conditions of the Lease set forth herein. (e) Lessee hereby authorizes Lessor to insert in this Lease and each Schedule hereto the serial numbers and other identification data of the Equipment when determined by Lessor. 5. LESSEE'S REPRESENTATIONS AND WARRANTIES. Lessee represents and warrants that (a) it is in good standing under the laws of the state of its formation, and duly qualified to do business, and will remain duly qualified during the term of this Lease, in each state where the Equipment will be located, as specified on each Schedule hereto, except where the failure to be so qualified would not have a material adverse effect on Lessee; (b) it has full authority to execute and deliver this Lease and perform the terms hereof, and this Lease has been duly authorized and constitutes valid and binding obligations of Lessee enforceable in accordance with its terms; (c) this Lease will not contravene any law, regulation or judgment affecting Lessee or result in any breach of any agreement or 2 other instrument binding on Lessee; (d) no consent of Lessee's shareholders, members or managers or partners, as applicable, or holder of any indebtedness, or filing with, or approval of, any governmental agency or commission, is a condition to the performance of the terms hereof; (e) there is no action or proceeding pending or, to Lessee's knowledge, threatened against Lessee before any court or administrative agency which would have a materially adverse effect on the business, financial condition or operations of Lessee; (f) no deed of trust, mortgage or third party interest arising through Lessee will attach to the Equipment or the Lease; (g) the Equipment will remain at all times under applicable law, removable personal property, free and clear of any lien or encumbrance in favor of Lessee or any other person, notwithstanding the manner in which the Equipment may be attached to any real property; (h) all credit, financial and any other information submitted to Lessor herewith or any other time is true and correct in all material respects at the time submitted to Lessor; and (i) Lessee has provided, or will provide if requested, Lessee's tax identification number. 6. EQUIPMENT ORDERING. Lessee shall be responsible for all packing, rigging, transportation and installation charges for the Equipment and Lessor may separately invoice Lessee for such charges. Lessee has selected the Equipment itself and shall arrange for delivery of Equipment so that it can be accepted in accordance with Section 7 hereof. Lessee hereby agrees to indemnify and hold Lessor harmless from any claims, liabilities, costs and expenses, including reasonable attorneys' fees, incurred by Lessor arising out of any purchase orders or assignments executed by Lessor with respect to any Equipment or services relating thereto. 7. LESSEE ACCEPTANCE. Lessee shall return to Lessor the signed and dated Acceptance Notice attached to each Schedule hereto (a) acknowledging the Equipment has been received, installed and is ready for use and (b) accepting it as satisfactory in all respects for the purposes of this Lease. Lessor is authorized to fill in the Rent Start Date on each Schedule in accordance with the foregoing. 8. LOCATION; INSPECTION; LABELS. The Equipment shall be delivered to and shall not be removed from the Equipment "Location" shown on each Schedule without Lessor's prior written consent, which Location shall in all events be within the United States. Lessor shall have the right to inspect the Equipment at any reasonable time and on reasonable notice. Lessee shall be responsible for all labor, material and freight charges incurred in connection with any removal or relocation of such Equipment which is requested by the Lessee and consented to by Lessor, as well as for any charges due to the installation or moving of the Equipment. The rental payments shall continue during any period in which the Equipment is in transit during a relocation. Lessor or its agent shall mark and label the Equipment, which labels shall state the Equipment is owned by Lessor, and Lessee shall keep such labels on the Equipment as labeled by Lessor or its agent. 9. EQUIPMENT MAINTENANCE. (a) GENERAL. Lessee will locate or base each item of Equipment where designated in an Acceptance Notice and will reasonably permit Lessor to inspect such item of Equipment and its maintenance records at any reasonable time and on reasonable notice. Lessee will at its sole expense comply with all applicable laws, rules and regulations with respect to the use, maintenance, repair, condition, storage and operation of each item of Equipment. Except as required herein, Lessee will not make any addition or improvement to any item of Equipment that is not readily removable without causing material damage to any item or impairing its original value or utility. Any addition or improvement that is so required or cannot be so removed will immediately become the property of Lessor. (b) SERVICE AND REPAIR. Lessee will, at its sole expense, maintain and service, and 3 repair any damage to, each item of Equipment in a manner consistent with prudent industry practice and Lessee's own practice so that such item of Equipment is at all times (i) in the same condition as when delivered to Lessee, except for ordinary wear and tear, (ii) in good operating order for the function intended by its manufacturer's warranties and recommendations. 10. LOSS OR DAMAGE. Lessee assumes the entire risk of loss to the Equipment through use, operation or otherwise. Lessee hereby indemnifies and holds harmless Lessor from and against all claims, loss of rental payments, costs, damages, and expenses relating to or resulting from any loss, damage or destruction of the Equipment, any such occurrence being hereinafter called a "Casualty Occurrence." Within ninety (90) days after such Casualty Occurrence, Lessee shall (a) repair the Equipment, returning it to good operating condition, or (b) replace the Equipment with identical equipment in good condition and repair, the title to which shall vest in Lessor and which thereafter shall be subject to the terms of this Lease; or (c) pay to Lessor (i) any unpaid accrued amounts relating to such Equipment due Lessor under this Lease up to the date of the Casualty Occurrence, and (ii) a sum equal to the Casualty Value as set forth in the Casualty Value table attached to each Schedule hereto for such Equipment. Upon the making of such payment, the term of this Lease as to each unit of Equipment with respect to which the Casualty Value was paid shall terminate. 11. GENERAL INDEMNITY. Lessee will protect, indemnify and save harmless Lessor from and against all liabilities, obligations, claims, damages, penalties, causes of action, costs and expenses, including consequential or special damages of any kind, imposed upon or incurred by or asserted against Lessor or any assignee of Lessor by Lessee or any third party by reason of the occurrence or existence (or alleged occurrence or existence) of any act or event relating to or caused by the Equipment, other than arising from the intentional or grossly negligent acts of Lessor or any failure on the part of Lessee to perform or comply with any of the terms of this Lease. In the event that any action, suit or proceeding is brought against Lessor by reason of any such occurrence, Lessee, upon request of Lessor, will at Lessee's expense resist and defend such action, suit or proceeding or cause the same to be resisted and defended by counsel designated and approved by Lessor. Lessor shall tender and otherwise make available to Lessee control of the defense and resolution of such claim, whether by way of settlement or otherwise. Lessee's obligations under this Section 11 shall survive the expiration of this Lease with respect to acts or events occurring or alleged to have occurred prior to the return of the Equipment to Lessor at the end of the Lease term. 12. INSURANCE. Lessee at its expense shall keep the Equipment insured for the entire term and any extensions of this Lease against all risks of physical loss for at least the replacement value of such Equipment and shall provide for a loss payable endorsement to Lessor and/or any assignee of Lessor. Lessee shall maintain commercial general liability insurance with respect to loss or damage for personal injury, death or property damage in an amount not less than $2,000,000 in the aggregate, naming Lessor and/or Lessor's assignee as additional insured. Such insurance shall contain insurer's agreement to give thirty (30) days written notice to Lessor before cancellation or material change of any policy of insurance. Lessee will provide Lessor and any assignee of Lessor with a certificate of insurance from the insurer evidencing Lessor's or such assignee's interest in the policy of insurance. Such insurance shall cover any Casualty Occurrence to any unit of Equipment. Notwithstanding anything in Section 10 or this Section 12 to the contrary, this Lease and Lessee's obligations hereunder and under each Schedule shall remain in full force and effect with respect to any unit of Equipment which is not subject to a Casualty Occurrence. If Lessee fails to provide or maintain insurance as required herein, Lessor shall have the right, but shall not be obligated to obtain such insurance. In that 4 event, Lessee shall pay to Lessor the reasonable cost thereof. 13. TAXES. Lessee agrees to report the Equipment as equipment leased from Lessor and not as equipment owned by Lessee on Lessee's personal property tax return. Promptly upon receipt of an invoice from Lessor, Lessee agrees to reimburse Lessor for (or pay directly if instructed by Lessor), and agrees to indemnify and hold Lessor harmless from, all fees (including, but not limited to, license, documentation, recording and registration fees), and all sales, use, gross receipts, personal property, occupational, value added or other taxes, levies, imposts, duties, assessments, charges, or withholdings of any nature whatsoever, together with any penalties, fines, additions to tax, or interest thereon (all of the foregoing being hereafter referred to as "Impositions") except same as may be attributable to Lessor's income, arising at any time prior to or during the term of this Lease, or upon termination or early termination of this Lease and levied or imposed upon Lessor directly or otherwise by any Federal, state or local government in the United States or by any foreign country or foreign or international taxing authority upon or with respect to (a) the Equipment, (b) the exportation, importation, registration, purchase, ownership, delivery, leasing, possession, use, operation, storage, maintenance, repair, return, sale, transfer of title, or other disposition thereof, (c) the rentals, receipts, or earnings arising from the Equipment, or any disposition of the rights to such rentals, receipts, or earnings, (d) any payment pursuant to this Lease, and (e) this Lease or the transaction or any part thereof. Lessee's obligations under this Section 13 shall survive the expiration of this Lease with respect to acts or events occurring or alleged to have occurred prior to the return of the Equipment to Lessor at the end of the Lease term. Lessee shall have the right, at its expense, to contest in good faith and by appropriate proceeding, the proprietary of, and other issues relating to, any Imposition for which Lessee has or may have financial responsibility under this Section 13, provided that Lessee shall take any action necessary to prevent the confiscation of or lien attaching against the Equipment. 14. PAYMENT BY LESSOR. If Lessee shall fail to make any payment or perform any act required hereunder, then Lessor may, but shall not be required to, after such notice to Lessee as is reasonable under the circumstances, make such payment or perform such act with the same effect as if made or performed by Lessee. Lessee will upon demand reimburse Lessor for all sums paid and all costs and expenses incurred in connection with the performance of any such act. 15. SURRENDER OF EQUIPMENT. If required by the terms of this Lease or any Schedule, Lessee will forthwith surrender the Equipment to Lessor delivered in as good order and condition as originally delivered, reasonable wear and tear excepted. Lessor may, at its sole option, arrange for removal and transportation of the Equipment, provided that Lessee's obligations under Sections 10, 11 and 12 shall not be released. Lessee shall bear all expenses of delivering (which include, but are not limited to, the de-installation, insurance, packaging and transportation of) the Equipment to Lessor's location or other location within the United States as Lessor may request. Notwithstanding Lessee's surrender and/or delivery of the Equipment and/or Lessor's removal of the Equipment, all obligations of Lessee under this Lease, including rental payments, shall remain in full force and effect until Lessee delivers the Equipment to Lessor. 16. ASSIGNMENT. WITHOUT LESSOR'S PRIOR WRITTEN CONSENT, SUCH CONSENT NOT TO BE UNREASONABLY WITHHELD, LESSEE SHALL NOT (A) ASSIGN, TRANSFER, PLEDGE, HYPOTHECATE OR OTHERWISE DISPOSE OF THIS LEASE, EQUIPMENT, OR ANY INTEREST THEREIN, OR (B) SUBLET OR LEND EQUIPMENT OR PERMIT IT TO BE USED BY ANYONE OTHER THAN LESSEE OR LESSEE'S EMPLOYEES. 5 LESSOR MAY ASSIGN THIS LEASE OR GRANT A SECURITY INTEREST IN ANY OR ALL EQUIPMENT, OR BOTH, IN WHOLE OR IN PART TO ONE OR MORE ASSIGNEES OR SECURED PARTIES WITHOUT NOTICE TO LESSEE. No assignment under the Lease will relieve Lessor of any obligations it has under the Lease. If Lessee is given notice of such assignment it agrees to acknowledge receipt thereof in writing and Lessee shall execute such additional documentation as Lessor's assignee shall reasonably require. Each such assignee and/or secured party shall have all of the rights, but none of the obligations, of Lessor under this Lease, unless such assignee or secured party expressly agrees to assume such obligations in writing. Lessee shall not assert against any assignee and/or secured party any defense, counterclaim or offset that Lessee may have against Lessor. Notwithstanding any such assignment, and providing no Event of Default has occurred and is continuing, Lessor, or its assignees, secured parties, or their agents or assigns, shall not interfere with Lessee's right to quietly enjoy use of Equipment subject to the terms and conditions of this Lease. Subject to the foregoing, this Lease inures to the benefit of and is binding upon the successors and assignees of the parties hereto. Lessee acknowledges that any such assignment by Lessor will not materially change Lessee's duties or obligations under the Lease or increase any burden of risk on Lessee. 17. DEFAULT. (a) EVENT OF DEFAULT. Any of the following events or conditions shall constitute an "Event of Default" hereunder: (i) Lessee's failure to pay any monies due to Lessor hereunder or under any Schedule beyond the tenth (10th) day after the same is due; (ii) Lessee's failure to comply with its obligations under Section 12 or Section 16; (iii) Lessee's failure to comply with or perform any term, covenant, condition, warranty or representation of this Lease or any Schedule hereto or under any other agreement between Lessee and Lessor or under any lease of real property covering the location of Equipment if such failure to comply or perform is not cured by Lessee within thirty (30) days of receipt of notice thereof; (iv) seizure of the Equipment under legal process; (v) the filing by or against Lessee of a petition for reorganization or liquidation under the Bankruptcy Code or any amendment thereto or under any other insolvency law providing for the relief of debtors; or (vi) the voluntary or involuntary making of an assignment of a substantial portion of its assets by Lessee, or any guarantor ("Guarantor") under any guaranty executed in connection with this Lease ("Guaranty"), for the benefit of its creditors, the appointment of a receiver or trustee for Lessee or any Guarantor for any of Lessee's or Guarantor's assets, the institution by or against Lessee or any Guarantor of any formal or informal proceeding for dissolution, liquidation, settlement of claims against or winding up of the affairs of Lessee or any Guarantor, PROVIDED that in the case of all such involuntary proceedings, same are not dismissed within sixty (60) days after commencement; or (vii) the making by Lessee or any Guarantor of a transfer of all or a material portion of Lessee's or Guarantor's assets or inventory not in the ordinary course of business. (b) REMEDIES. If any Event of Default shall have occurred: (i) Lessor may proceed by appropriate court action or actions either at law or in equity to enforce performance by Lessee, of the applicable covenants of this Lease, or to recover damages therefor; or (ii) Lessee will, without demand, on the next rent payment date following the Event of Default, pay to Lessor as liquidated damages which the parties agree are fair and reasonable under the circumstances existing at the time this Lease is entered into, and not as a penalty, an amount equal to the Casualty Value of the Equipment set forth in the Casualty Value Table attached to such Equipment's Schedule together with any rent or other amounts past due and owing by Lessee hereunder (but not any 6 future rent); and (iii) Lessor may, without notice to or demand upon Lessee; (A) Take possession of the Equipment and lease or sell the same or any portion thereof, for such period, amount, and to such entity as Lessor shall elect. The proceeds of such lease or sale will be applied by Lessor (1) first, to pay all costs and expenses, including reasonable legal fees and disbursements, incurred by Lessor as a result of the default and the exercise of its remedies with respect thereto, (2) second, to pay Lessor an amount equal to any unpaid rent or other amounts past due and payable (but not any future rent) plus the Casualty Value, to the extent not previously paid by Lessee, and (3) third, to reimburse Lessee for the Casualty Value to the extent previously paid. Any surplus remaining thereafter will be retained by Lessor. (B) Take possession of the Equipment and hold and keep idle the same or any portion thereof. Lessee agrees to pay all reasonable internal and out-of-pocket costs of Lessor related to the exercise of its remedies, including direct costs of its in-house counsel and out-of-pocket legal fees and expenses. At Lessor's request, Lessee shall assemble the Equipment and make it available to Lessor at such location as Lessor may designate. Lessee waives any right it may have to redeem the Equipment. Repossession of any or all Equipment shall not terminate this Lease or any Schedule unless Lessor notifies Lessee in writing. None of the above remedies is intended to be exclusive, but each is cumulative and in addition to any other remedy available to Lessor, and all may be enforced separately or concurrently. 18. LATE PAYMENTS. Lessee shall pay to Lessor an amount equal to 10% per month of all amounts owed Lessor by Lessee which are not paid within ten (10) days of when due, but in no event shall Lessee pay more than an amount greater than the highest rate permitted by applicable law. If such funds have not been received by Lessor at Lessor's place of business or by Lessor's designated agent within ten (10) days of the date such funds are due under this Lease, Lessor shall bill Lessee for such charges. Lessee acknowledges that invoices for rentals due hereunder are sent by Lessor for Lessee's convenience only. Lessee's non-receipt of an invoice will not relieve Lessee of its obligation to make rent payments hereunder. 19. LESSOR'S EXPENSE. Lessee shall pay Lessor all reasonable costs and expenses including reasonable attorney's fees and the fees of the collection agencies, incurred by Lessor (a) in enforcing any of the terms, conditions or provisions hereof including, but not limited to, all reasonable out-of-pocket costs of Lessor related to the exercise of its remedies, including reasonable out-of-pocket legal fees and expenses, and (b) in connection with any bankruptcy or post-judgment proceeding, whether or not suit is filed and, including, without limitation, those incurred in each and every action, suit or proceeding, including any and all appeals and petitions therefrom and all fees and costs incurred by Lessor. 7 20. OWNERSHIP; PERSONAL PROPERTY. The Equipment shall be and remain personal property of Lessor, and Lessee shall have no right, title or interest therein or thereto except as expressly set forth in this Lease, notwithstanding the manner in which it may be attached or affixed to real property, and upon termination or expiration of the Lease term, Lessee shall have the duty and Lessor shall have the right to remove the Equipment from the premises where the same be located whether or not affixed or attached to the real property or any building, at the cost and expense of Lessee. 21. ALTERATIONS; ATTACHMENTS. No alterations or attachments shall be made to the Equipment without Lessor's prior written consent, which shall not be given for changes that will affect the reliability and utility of the Equipment or which cannot be removed without damage to the Equipment, or which in any way affect the value of the Equipment for purposes of resale or re-lease. All attachments and improvements to the Equipment shall be deemed to be "Equipment" for purposes of the Lease, and all right, title and interest therein shall immediately vest in Lessor. 22. FINANCING STATEMENT. Lessee will execute financing statements pursuant to the Uniform Commercial Code. Lessee authorizes Lessor to file financing statements signed only by Lessor (where such authorization is permitted by law) at all places where Lessor deems necessary. 23. MISCELLANEOUS. (a) Lessee shall provide Lessor with such corporate resolutions, financial statements and other documents as Lessor shall reasonably request from time to time. (b) Lessee represents that the Equipment is being leased hereunder for business purposes. (c) Time is of the essence with respect to this Lease. (d) Lessee shall keep its books and records in accordance with generally accepted accounting principles and practices consistently applied and shall deliver to Lessor its annual audited financial statements, unaudited monthly financial statements to include any financial information given to Lessee's Board of Directors, and signed by an officer of Lessee and such other unaudited financial statements as may be reasonably requested by Lessor. (e) Lessee will notify Lessor at least 30 days prior to changing its name, principal place of business or chief executive office. 24. NOTICES. All notices hereunder shall be in writing, by registered mail, or reliable messenger or delivery service and shall be directed, as the case may be, to Lessor at 2401 Kerner Boulevard, San Rafael, California 94901, Attention: Asset Management and to Lessee at 7615 Golden Triangle Drive, Suite A, Minneapolis, Minnesota 55344, Attention: Chief Financial Officer. 25. ENTIRE AGREEMENT. Lessee acknowledges that Lessee has read this Lease, understands it and agrees to be bound by its terms, and further agrees that the Lease and each Schedule constitute the entire agreement between Lessor and Lessee with respect to the subject matter hereof and supersedes all previous agreements, promises, or representations. The terms and conditions hereof shall prevail notwithstanding any variance with the terms of any purchase order submitted by the Lessee with respect to any Equipment covered hereby. 26. AMENDMENT. This Lease may not be changed, altered or modified except by an instrument in writing signed by an officer of the Lessor and the Lessee. 27. WAIVER. Any failure of Lessor to require strict performance by Lessee or any waiver by Lessor of any provision herein shall not be construed as a consent or waiver of any other breach of the same or any other provision. 8 28. SEVERABILITY. If any provision of this Lease is held invalid, such invalidity shall not affect any other provisions hereof. 29. JURISDICTION AND WAIVER OF JURY TRIAL. This Lease shall be governed by and construed under the laws of the State of California without giving effect to conflicts of law principles. It is agreed that exclusive jurisdiction and venue for any legal action between the parties arising out of this Lease shall be in the Superior Court for Marin County, California, or, in cases where Federal diversity jurisdiction is available, in the United States District Court for the Northern District of California. 30. NATURE OF TRANSACTION. Lessor makes no representation whatsoever, express or implied, concerning the legal character of the transaction evidenced hereby, for tax or any other purpose. 31. SECURITY INTEREST. (a) One executed copy of the Lease will be marked "Original" and all other counterparts will be duplicates. To the extent, if any, that this Lease constitutes chattel paper (as such term is defined in the Uniform Commercial Code as in effect in any applicable jurisdiction) no security interest in the lease may be created in any documents other than the "Original." (b) There shall be only one original of each Schedule and it shall be marked "Original," and all other counterparts will be duplicates. To the extent, if any, that any Schedule(s) to this Lease constitutes chattel paper (or as such term is defined in the Uniform Commercial Code as in effect in any applicable jurisdiction) no security interest in any Schedule(s) may be created in any documents other than the "Original." 32. SUSPENSION OF OBLIGATIONS. The obligations of Lessor hereunder will be suspended to the extent that it is hindered or prevented from complying therewith because of labor disturbances, including but not limited to strikes and lockouts, acts of God, fires, storms, accidents, failure of the manufacturer to deliver any item of Equipment, governmental regulations or interference, or any cause whatsoever not within the sole and exclusive control of Lessor. 33. SOFTWARE. For the term of this Lease, and so long as no Event of Default has occurred and is continuing, Lessor hereby assigns to Lessee all of Lessor's rights under any License Agreement executed by Lessor in connection with the Equipment (except for any right of Lessor to be reimbursed for the License Fee). Lessee agrees to be bound by the provisions of any such License Agreement and to perform all obligations of Lessor (except Lessor's payment obligations) thereunder. Lessee acknowledges that all of Lessee's obligations under the Lease with respect to the Equipment will apply equally to the software, including but not limited to Lessee's obligation to pay rent to Lessor. 34. COMMITMENT FEE. Lessee has paid to Lessor a commitment fee ("Fee") of $20,000. The Fee shall be applied by Lessor first to reimburse Lessor for all out-of-pocket UCC search costs, inspections and appraisal fees incurred by Lessor, and then proportionally to the first month's rent for each Schedule hereunder in the proportion that the purchase price of the Equipment leased pursuant to the Schedule bears to Lessor's entire commitment. However, the portion of the Fee which is not applied to rental shall be non-refundable except if Lessor defaults in its obligations pursuant to Section 3. 9 35. FINANCE LEASE. The parties agree that this lease is a "Finance Lease" as defined by section 10-103(a)(7) of the California Commercial Code (Cal.Com.C.). Lessee acknowledges either (a) that Lessee has reviewed and approved any written Supply Contract (as defined by Cal.Com.C. Section 10-103(a)(25)) covering Equipment purchased from the "Supplier" (as defined by Cal.Com.C. Section 10-103(a)(24)) thereof for lease to Lessee or (b) that Lessor has informed or advised Lessee, in writing, either previously or by this Lease of the following: (i) the identity of the Supplier; (ii) that the Lessee may have rights under the Supply Contract; and (iii) that the Lessee may contact the Supplier for a description of any such rights Lessee may have under the Supply Contract. Lessee hereby waives any rights and remedies Lessee may have under Cal.Com.C. Sections 10-508 through 522. 36. END OF LEASE POSITION. (a) GENERAL. At the expiration of the Base Term of the first Schedule to the Lease, Lessee shall choose a final purchase or extension option ("End of Lease Position") as specified in the Schedule, and that choice shall be an election of Lessee's End of Lease Position for all, but not less than all, of the Equipment under all Schedules to the Lease. Any Equipment Purchase election shall be a purchase of the Equipment, AS-IS, WHERE-IS. Upon Lessor's receipt of the purchase price, Lessor shall issue to Lessee an equipment bill of sale, transferring valid title to the Equipment, free and clear of all liens and encumbrances arising through Lessor, to the Lessee without any representation or warranty whatsoever, except as to Lessor's title in the Equipment. Lessee shall be responsible for all applicable taxes in connection with any Equipment purchase. Fair market or rental value shall be determined for the Equipment under all Schedules prior to the Base Term's expiration. Until Lessee fulfills an End of Lease Position option or requirement, all Lessee's Lease obligations, including payment of the Monthly Rental Amount, shall continue in full force and effect, on a month-to-month basis. (b) END OF LEASE POSITION REQUIREMENTS. Provided no Event of Default has occurred and is continuing and notwithstanding anything to the contrary in the Lease, Lessee shall elect one of the following alternatives at the Schedule's Base Term expiration. Lessee shall make its election by giving Lessor at least 90 days' prior written notice thereof prior to such expiration. (i) Requirements for Standard Equipment ALTERNATIVE NO. 1 FOR STANDARD EQUIPMENT: Purchase the Equipment for the Equipment's fair market value, in no event less than 10% nor more than 15% of the Equipment's original purchase price. Fair market value shall be determined by Lessor in its reasonable discretion. ALTERNATIVE NO. 2 FOR STANDARD EQUIPMENT: Extend the Schedule's Base Term for an additional 12 months ("Extended Term") for a monthly rate of 1.3% of the Equipment's original purchase price. At the expiration of the Extended Term, Lessee shall purchase the Equipment for $1. In the event Lessee does not provide 90 days' prior written notice, Lessee shall be deemed to have elected Alternative No. 1 above. 10 (ii) Requirements for Soft Cost Equipment: Purchase the Equipment for 15% of the Equipment's original purchase price. 37. FURTHER ASSURANCES. Lessee shall at its expense take such action and execute and deliver all acts and instruments and other documents as Lessor may at any time reasonably request to protect, assure or enforce its interests and rights hereunder. 38. POWER OF ATTORNEY. Lessee hereby irrevocably appoints Lessor as Lessee's attorney-in-fact, with full authority in the place and stead of Lessee and in the name of Lessee, from time to time in Lessor's discretion, to take any action and to execute any instrument which Lessor may deem necessary or advisable to accomplish the purposes of the Lease and any documents and instruments contained therein or thereby to the extent permitted by law. 39. ADJUST-A-LEASE OPTION. (a) GENERAL: After the first 12 months of the term of any Schedule, Lessee shall have the option to remove such Schedule's Equipment ("Removed Equipment") and finance new Equipment ("New Equipment") under a new Schedule ("New Schedule"). (b) NEW SCHEDULE AMOUNT: The amount of the New Schedule shall be an amount equal to the purchase price for the New Equipment plus a prepayment figure for the Removed Equipment. The prepayment figure shall be the original amount of the original Schedule ("Old Schedule") less: (i) any trade-in value or resale proceeds received by Lessor for the Removed Equipment and (ii) a credit for Schedule payments already made (the total Old Schedule payments attributable to the removed Equipment multiplied by the "Allowance Factor" indicated in the table below). In no event shall the Schedule amount of the New Schedule be less than original amount of the Old Schedule. REMOVAL DATE ALLOWANCE FACTOR After 12 Months of Old Schedule 55% After 24 Months of Old Schedule 60% After 36 Months of Old Schedule 65% (c) OLD SCHEDULE: If any Equipment remains on the Old Schedule, the monthly payment amount for the Old Schedule will be reduced in proportion to the Removed Equipment's value. (d) OPTION PRECONDITIONS: Lessee's right to exercise this Adjust-A-Lease Option ("Option") is conditioned upon the following: (i) no Event of Default under the Lease has theretofore occurred or is continuing; (ii) the New Equipment and prepayment of the Removed Equipment are financed by Lessor under a New Schedule, subject to Lessor's current lease rates and documentation acceptable to Lessor; (iii) Lessor is satisfied with Lessee's creditworthiness; (iv) the New Equipment is acceptable to Lessor; and (v) Lessee has given Lessor at least 90 days' prior written notice of its desire to exercise the Option. 11 IN WITNESS WHEREOF, the parties hereto have executed this Lease. PHOENIX LEASING INCORPORATED OPTICAL SENSORS INCORPORATED By: /S/ NORM NELSON By: /S/ SAM B. HUMPHRIES ------------------------------- -------------------------------- Title: SENIOR VICE PRESIDENT Title: PRESIDENT AND CHIEF EXECUTIVE OFFICER --------------------------- -------------------------------------- HEADQUARTERS LOCATION: 7615 Golden Triangle Drive, Suite A Minneapolis, MN 55344 County of Hennepin EXHIBITS AND SCHEDULES: Exhibit A - Closing Memorandum 12 EX-10.23 4 AMENDMENT NO. 1 TO MASTER EQUIPMENT LEASE AMENDMENT NO. 1 TO MASTER EQUIPMENT LEASE AGREEMENT NO. 053-0070 THIS AMENDMENT NO. 1 TO MASTER EQUIPMENT LEASE AGREEMENT NO. 053-0070 ("Amendment") is dated as of August 15, 1997, by and between OPTICAL SENSORS INCORPORATED ("Lessee") and PHOENIX LEASING INCORPORATED ("Lessor"). RECITALS WHEREAS, Lessee and Lessor entered into that certain Master Equipment Lease Agreement No. 053-0070, dated as of June 15, 1997 (the "Lease"); WHEREAS Lessee has requested that the Lease be amended as set forth below; WHEREAS, Lessor is willing to amend the Lease on the terms set forth herein and Lessee is willing to agree to such terms; NOW, THEREFORE, IT IS AGREED THAT: 1. A new Section 40 is added to the Lease to read as follows: 40. SPECIFIC TERMS - SOFT COST EQUIPMENT. Lessee and Lessor agree that if; upon the expiration of the Commitment Period, the amount funded allocable to Soft Cost Equipment exceeds 25 percent (25%) of the Commitment utilized as of such expiration date, then, at Lessor's option, Lessee shall pay to Lessor an amount equal to such excess ("Excess Payment"). Lessee agrees to pay the Excess Payment to Lessor within thirty (30) days of Lessor's invoice. The Excess Payment shall be applied in prorata shares to each Schedule as advance payments under each such Schedule of: (i) first, Lessee's end of lease requirement (which for purposes of this Excess Payment shall be assumed to be the final payment election) and (ii) next, Lessee's last monthly payment obligations. 2. REPRESENTATIONS AND WARRANTIES: Lessee hereby reconfirms as of the date hereof, its representations and warranties set forth in Section 5 of the Lease. 3. CONTINUED VALIDITY OF LEASE. Except as amended by this Amendment, the Lease shall continue in full force and effect as originally constituted and is ratified and affirmed by the parties hereto. Such Amendment shall not amend or otherwise affect any of the Schedules executed and delivered by Lessee prior to the date hereof. 4. AUTHORIZATION. Each party represents to the other that the individual executing this Amendment on its behalf is the duly appointed signatory of such party to this Amendment and that such individual is authorized to execute this Amendment by or on behalf of such party and to take all action required by the terms of this Amendment. 5. WHEN AMENDMENT IS EFFECTIVE. This Amendment shall be binding and deemed effective when executed by Lessee and accepted and executed by Lessor. Upon such effectiveness this Amendment shall be deemed to have amended the Lease as provided herein. 6. CAPTIONS. Section headings and numbers have been set forth herein for convenience only. Unless the contrary is compelled by the context, everything contained in each section applies equally to this entire Amendment. 7. NO NOVATION. This Amendment is not intended to be, and shall not be construed to create, a novation or accord and satisfaction, and, except as otherwise provided herein, the Lease shall remain in full force and effect. 8. SEVERABILITY. Each provision of this Amendment shall be severable from every other provision of this Amendment for the purpose of determining the legal enforceability of any specific provision. 9. ENTIRE AGREEMENT. The Lease as amended by this Amendment constitutes the entire agreement between Lessee and Lessor with respect to the subject matter hereof and supersedes all prior and contemporaneous negotiations, communications, discussions and agreements concerning such subject matter. Lessee acknowledges and agrees that Lessor has not made any representation, warranty or covenant in connection with this Amendment. 10. CONFLICTS. In the event of any conflict between the terms of this Amendment and terms of the Master Equipment Lease No. 053-0070, the terms of this Amendment shall prevail. IN WITNESS WHEREOF, the parties hereto have executed and delivered this Amendment as of the date first set forth above. LESSOR: LESSEE: PHOENIX LEASING INCORPORATED OPTICAL SENSORS INCORPORATED By: /S/ JOAN WINTER By: /S/ WES PETERSON ----------------------------- ------------------------------ Title: CONTRACTING ADMINISTRATOR Title: CHIEF FINANCIAL OFFICER --------------------------- ---------------------------- EX-10.26 5 OEM AGREEMENT OEM AGREEMENT THIS AGREEMENT, effective this 5th day of February, 1998, by and between MARQUETTE MEDICAL SYSTEMS, INC., a Wisconsin corporation, having a place of business at 8200 West Tower Avenue, Milwaukee, Wisconsin 53223 (hereinafter called "Seller") and OPTICAL SENSORS INCORPORATED, a Delaware corporation, with principal offices located at 7615 Golden Triangle Drive, Suite A, Minneapolis, Minnesota 55344 (hereinafter called "Buyer"). W I T N E S S E T H: WHEREAS, Seller currently manufactures and markets directly to end users and through the Buyer an optical blood gas module known as OnlineABG (the "Module"). WHEREAS, Seller and Buyer desire to enter into this Agreement to supersede and replace the Supply Agreement dated August 22, 1996 between Seller and Buyer (the "Supply Agreement"). . WHEREAS, Buyer markets a stand-alone medical monitor and desires to purchase Modules from Seller pursuant to this Agreement to incorporate the Module into Buyer's monitor. NOW, THEREFORE, in consideration of the mutual covenants and agreements hereinafter set forth, and for other good and valuable consideration, the receipt of which is hereby mutually acknowledged, the parties hereto agree as follows: 1. DEFINITIONS A. The term "Accessory Items" shall mean service/repair parts or accessories for use in connection with Modules. B. The term "Affiliate" shall mean any person, firm or entity controlling, controlled by or under common control with, a party to this Agreement. C. The term "Agreement" shall mean this OEM Agreement. D. The term "Contract Products" shall mean Modules and Accessory Items currently manufactured, assembled or sold by Seller. The Accessory Items being manufactured, assembled, or sold by Seller as of the date of this Agreement are listed in Schedule C hereto. E. The term "Contract Year" shall mean each sequential twelve (12) month period during the term of this Agreement with the first such period commencing on the effective date. F. The term "Monitor" shall mean all medical monitors manufactured or assembled by or on behalf of Buyer during the term of this Agreement into which Buyer incorporates or includes as an add-on Modules or Accessory Items. The Monitor being manufactured or assembled by or on behalf of Buyer, or as to which manufacture or assembly is contemplated by Buyer, as of the date of this Agreement is listed in Schedule B hereto. G. The term "Specifications" shall mean the specifications for the Module set forth in Schedule A hereto, as may be amended from time to time upon mutual agreement of the parties. 2. SUPPLY OF CONTRACT PRODUCTS A. Seller shall manufacture the Modules in accordance with the Specifications. Seller shall sell to Buyer such quantities of Contract Products as Buyer orders pursuant to Section 4.B. Contract Products purchased by Buyer from Seller hereunder shall be used by Buyer solely in the design, manufacture or assembly of Monitors or for the replacement of Contract Products so used. B. Notwithstanding the above, nothing herein shall grant Buyer any right with respect to any of Seller's trademarks, except as they may appear on Contract Products. 3. PRICES A. The unit price for each Module shall be $_________. The Buyer may elect to purchase Accessory Items from the Seller and the unit prices for Accessory Items shall be the prices set forth in Schedule C, plus any sales, use, excise or similar taxes. The Buyer may elect to purchase Accessory Items directly from original manufacturers and if the Buyer elects to do so, the Seller shall supply a letter of authorization to the original manufacturers. [PORTIONS OF THIS SECTION HAVE BEEN OMITTED PURSUANT TO A REQUEST FOR CONFIDENTIALITY UNDER RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. A COPY OF THIS AGREEMENT WITH THIS SECTION INTACT HAS BEEN FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.] B. Prices, billing, and payment hereunder shall be in U.S. Dollars. 4. PURCHASES A. Commencing on the date of this Agreement and on the first day of every calendar quarter thereafter while this Agreement is in effect, Buyer shall deliver to Seller a forecast covering its estimated requirements for Modules 2 for the next twelve (12) calendar months. Such forecast shall constitute a non-binding good faith of estimate of Buyer's anticipated purchases for those months. B. Buyer will, from time to time, submit written purchase orders for Modules to Seller specifying a shipment date, which shipment date shall in no event be less than 90 days from the date of delivery of such purchase order. Buyer shall also submit purchase orders for Accessory Items it purchases pursuant to this Agreement. Each purchase order, without any acceptance by Seller, shall give rise to a contract for the purchase of Modules under the terms set forth in this Agreement to the exclusion of any additional or contrary terms set forth in any purchase order, acceptance, invoice or other document. C. Buyer agrees to purchase and take delivery from Seller during each Contract Year, a minimum of _____ (___) Modules. In the event that Buyer, as of the end of any Contract Year, shall not have ordered _____ (___) Modules, Seller may immediately invoice Buyer for the delivery of the remaining modules, provided that Seller actually deliver such Modules to Buyer. [PORTIONS OF THIS SECTION HAVE BEEN OMITTED PURSUANT TO A REQUEST FOR CONFIDENTIALITY UNDER RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. A COPY OF THIS AGREEMENT WITH THIS SECTION INTACT HAS BEEN FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.] D. Title and risk of loss or damage to Contract Products shall pass to Buyer upon delivery at Seller's plant to either Buyer or a common carrier. Shipping costs and insurance are the sole obligation of Buyer. Seller will make all arrangements for shipments of Contract Products in accordance with Buyer's shipping instructions. Buyer shall insure each shipment of Contract Products with a reputable insurer for the full invoice value of such shipment. 5. PAYMENT Seller will invoice Buyer upon shipment of Contract Products. All purchases hereunder shall be for cash, with the amount thereof due and payable within thirty (30) days after delivery of Contract Products. Interest at a rate of one and one-half (1 1/2%) percent per month shall be applied to alL accounts delinquent by more than thirty (30) days. 6. CONTRACT ACCESSORY AND SERVICE ITEMS Seller shall supply Accessory Items to Buyer for the entire duration of this Agreement and for a period of three (3) years following the last Module shipment. During each year of said three (3) year period, the prices for Accessory Items shall be subject to negotiation by the parties hereto annually. 3 7. WARRANTY A. Seller warrants that each Module purchased under this Agreement will conform to the Specifications (or any revised specifications agreed to by the Buyer) and is free from any defect in design, workmanship, and materials. B. Buyer shall inspect the Contract Products within thirty (30) days of receipt to determine whether the Contract Products conform to the Purchase Order and whether the Modules function in accordance with the Specifications. Buyer's inspection for determining whether the Modules function in accordance with the Specifications shall be approved in advance by Seller, which approval shall not be unreasonably withheld or delayed. Buyer's failure to notify Seller, in writing, within 30 days of delivery by the Seller of the Contract Products to Buyer shall constitute an irrevocable acceptance of such Contract Products and a waiver of any claim for breach of any warranty with respect to such Contract Products. Any Contract Product not passing this inspection may, at Buyer's option, be returned to Seller for repair or replacement within 60 days following delivery of the Contract Product to the Buyer, provided that Buyer has filed notice with the Seller as provided above. C. Seller's sole obligation under warranty shall be to repair or replace, without charge, Contract Products or parts of Modules to Buyer. Seller shall pay shipping costs in both directions for warranty related activities. D. For any Module not covered by Seller's warranty, Buyer will have right either to service the Module directly, or to ask Seller to provide Buyer with quotation for contract service. Seller's warranty shall not apply to any Modules that are serviced by Buyer. E. THE FOREGOING WARRANTIES ARE IN LIEU OF ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. EXCEPT AS OTHERWISE SPECIFICALLY PROVIDED IN THIS AGREEMENT, SELLER'S LIABILITY ON ANY CLAIM, WHETHER IN CONTRACT OR OTHERWISE, FOR ANY LOSS OR DAMAGE ARISING OUT OF, CONNECTED WITH, OR RESULTING FROM THE MANUFACTURE, SALES, DELIVERY, RESALE, REPAIR, REPLACEMENT OR USE OF ANY CONTRACT PRODUCT OR ANY PART THEREOF SHALL IN NO CASE EXCEED THE PRICE PAID BY BUYER FOR SAID CONTRACT PRODUCT WHICH GIVES RISE TO THE CLAIM. IN NO EVENT SHALL SELLER BE LIABLE FOR INCIDENTAL, CONSEQUENTIAL OR SPECIAL DAMAGES TO BUYER EXCEPT WHEN AND TO THE EXTENT THAT SUCH DAMAGES ARE DIRECTLY CAUSED BY A DEFECT IN CONTRACT PRODUCTS PURCHASED PURSUANT TO 4 THIS AGREEMENT AND RESULT IN BODILY INJURY TO ANY PERSON. 8. INTELLECTUAL PROPERTY Seller acknowledges that all intellectual property rights relating to the Contract Products are the sole and exclusive property of Buyer, subject only the limited license granted by Buyer to Seller pursuant the letter agreement, dated September 7, 1995, between Buyer and Seller. 9. PRODUCT LIABILITY INDEMNITY A. Seller will indemnify, protect, and save Buyer harmless from all claims, demands, suits, or actions for damages to property (excluding losses of income due to down time of equipment) or person which may be sustained by any third party, including Buyer's personnel which may be asserted against Buyer and which are caused or are alleged to be caused by any defect in design, workmanship or materials of any of the Contract Products purchased or used under this Agreement. The foregoing covenant of indemnity shall survive the expiration or termination of this Agreement, but Seller shall not be responsible for any loss or damage caused by negligence acts or omission of Buyer or Buyer's personnel nor shall the covenant be enforceable in the event that such loss or damage is caused by Buyer's modification to either the hardware or the software constituting the subject Contract Product. Seller shall have no liability or responsibility of any kind to Buyer or Buyer personnel under this Paragraph 9 for any claims, demands, suits, or actions, unless Seller shall be notified in writing of any such claim, demand, suit, or action promptly upon Buyer's learning of the event and shall have had an adequate opportunity to defend, unless such failure to so notify does not prejudice Seller. The obligations of the parties set forth in this Paragraph 9 shall continue notwithstanding the termination or expiration of this Agreement. B. Buyer will indemnify, protect, and save Seller harmless from all claims, demands, suits, or actions, for damages to property or person which may be sustained by any third party, including Seller personnel, arising from any deficiency in the design or deficiency in the manufacture of products by Buyer, incorporating or including as an add-on, Contract Products with the exception of claims, demands, suits, or actions covered by Paragraphs 8 and 9A above. The foregoing indemnity shall survive the expiration or termination of this Agreement, but Buyer shall not be responsible for any loss or damage caused by negligent acts or omissions of Seller or Seller personnel. Buyer shall have no liability or responsibility of any kind to Seller, or Seller personnel, under this Paragraph 8 for any claims, demands, suits, or actions, unless Buyer shall be notified in writing of any such claim, demand, suit, or 5 action promptly upon Seller's learning of the event, and shall have had an adequate opportunity to defend, unless such failure to so notify does not prejudice Buyer. The obligations of the parties set forth in this Paragraph 9 shall continue notwithstanding the termination or expiration of this Agreement. C. Each party hereto shall maintain, at its own expense, with an insurance company reasonably acceptable to the other party hereto, Bodily Injury and Property Damage Liability Insurance with limits of at least $1,000,000 for injuries to one (1) person and $3,000,000 for injuries to two (2) or more persons, in any one accident, and $300,000 for property damage in any one accident. Each party has furnished to the other a certificate or certificates of insurance duly executed by an authorized representative of the insurance company or companies evidencing the maintenance of the insurance coverage provided for by this Paragraph and containing a provision to the effect that in the event any insurance covered by such certificates is canceled or modified, before the expiration of such insurance coverage, the insurer will give the other party hereto ten (10) days prior written notice thereof. D. Each party agrees to promptly notify the other if a suit or other legal action is commenced against it or its customers which, if brought against the other party hereto, would entitle such other party to be indemnified hereunder by the notifying party, provided that such other party shall not disclose information concerning such suit or action to any third party, except to the extent necessary for such other party to fulfill other obligations it may have under law or by court or administrative order. 10. PRODUCT ALTERATIONS A. Seller acknowledges and agrees that Buyer intends to modify the software incorporated into the Modules, and Buyer may make other modifications to the Contract Products. Buyer will notify Seller in writing within ten (10) business days of the part number, description and serial number of all modified modules and Contract Products. Neither Seller nor Buyer shall make any modifications to the Specifications to which Seller is required to manufacture Modules without the other part's prior written consent. Should any such agreed upon modification to the Specifications result in increased costs to or expenditures by Seller or result in either an increase or decrease in Seller's cost of production of the Contract Products, then the parties shall negotiate in good faith appropriate adjustments to the pricing of the Contract Products to reflect such cost changes or expenditures. B. Seller acknowledges that Buyer intends to modify certain Modules currently owned and in possession of Buyer. Buyer will notify Seller in writing of the part number, description, and serial number of all such Modules being modified. Buyer agrees that Seller's one-year warranty obligation with respect 6 to such Modules shall expire effective upon notice from Buyer to Seller of such modification. 11. FORCE MAJEURE Neither Seller nor Buyer shall be liable for any delay in, or failure of, performance hereunder due to act of God or similar casualty beyond its control. When only a part of Seller's or Buyer's capacity to perform is excused under this Paragraph, Seller or Buyer must fairly allocate production and deliveries among various customers or suppliers then under contract for similar goods during the period when Buyer or Seller is partially unable to perform, subject to any contractual obligations of Seller to any third party. The allocation must be effected in a commercially fair and equitable manner. 12. REGULATORY MATTERS AND RECALLS A. Seller warrants that the Modules will be manufactured in compliance with all applicable federal, state and local laws and regulations including, but not limited to, the Food, Drug and Cosmetic Act, as amended, and U.S. Food and Drug Administration (the "FDA") Good Manufacturing Practice for Medical Devices regulations ("GMP"). Seller represents and warrants to Buyer that Seller's manufacturing facility is certified "DIN EN ISO 9001/EN46001/MDD" and that Seller has all approvals and consents required to mark Modules with the "CE" mark. Seller further covenants with Buyer that Seller will maintain such certification during the term of this Agreement. Seller will notify Buyer of any audits of Seller's manufacturing facility to be conducted by TUV Product Services or any other notified body for such certification, provide Buyer with a written copy of the results of such audit, to the extent that such audit relates directly to the manufacture of Modules, and Seller's proposed corrective response to such audit, if any required. B. In the event of a governmental regulatory ruling, of standards promulgated and issued by the government or any product deficiency affecting patient safety or efficacy that requires the recall or field modification of the Modules, Seller agrees to "swap" with Buyer or fix (at Seller's option) all defective Contract Products or parts of Modules, for acceptable Contract Products or parts of Modules at charges mutually agreed upon after negotiations in good faith. Except as ordered by a governmental agency, no recall or field modification action shall be initiated without the mutual agreement of the parties hereto unless the initiating party is prepared to solely bear the costs thereof. Each party shall notify the other in writing if either becomes aware of any recall or field modification action and both parties shall cooperate in reaching a consistent response. Neither party shall withhold any information from the other or from any regulatory agency involving patient safety or efficacy required by any recall or field modification action. 7 C. Both parties shall be responsible for maintaining records and meeting all government laws and regulations as they may pertain to Contract Products or products incorporating or including as an add-on Contract Products sold by each party including, but not limited to, U.S. export and re-export control laws and neither party assumes any risk arising out of the other party's failure to comply with such laws or regulations with respect to products sold by such other party. Component and product serial number/lot number assigned and records shall be maintained and supplied to either party for purposes of product or component tracing, recall or field modifications or compliance with government laws and regulations. D. Each party will forward to the other copies of customer complaints and medical device reports ("MDR") relating to events required to reported by the FDA in accordance with 21 CFR Part 803 relating to the manufacture and operation of the Module, and each party will cooperate fully with the other party in investigating and resolving such complaints, including any necessary testing and analysis of the Module. E. Seller will at its sole cost and expense, timely register with the FDA as a Contract Medical Device Manufacturer, or cause to be timely registered with the FDA, in accordance with 21 CFR Part 807, each establishment which Seller or a subcontractor of Seller intends to manufacture and/or repair the Module. F. Seller will provide Buyer with copies of any FDA Form 483 observations, follow-up warning letters and/or close-out reports for those portions of GMP compliance inspection reports relating specifically to the manufacture of Modules for any facility where Modules are manufactured. G. Either party may, upon not less than seven (7) days prior written notice to the other, inspect other's manufacturing facilities for compliance with quality and regulatory requirements no more than once every three months. H. Buyer shall be solely responsible for, and shall indemnify and hold Seller harmless from and against any and all claims, demands, suits or actions which may be asserted against Seller arising out of fraudulent or substantially inaccurate promotional activities, labeling or materials relating to the sale or promotion of Monitors. 13. TERM AND TERMINATION A. This Agreement shall become effective as of the date first above written and, unless previously terminated, shall continue in effect until the end of the second Contract Year. 8 B. Prior to the end of the second Contract Year, either party may terminate this Agreement as follows: 1. By giving written notice to the other party in the event the other party is in material breach of this Agreement and shall have failed either to cure such material breach within thirty (30) days of receipt of written notice thereof or, if cure is not possible within thirty (30) days, to have taken reasonable steps to commence to cure such material breach within such thirty (30) day period; or 2. By giving written notice if the other party attempts to assign this Agreement, except incident to a sale of its business, without prior written consent of the other party; or 3. At any time by giving written notice to the other party, which notice shall be effective upon dispatch, should the other party file a bankruptcy petition or have a bankruptcy petition filed against it which is not discharged within thirty (30) days, be declared bankrupt, become insolvent, make an assignment for the benefit of creditors or go into liquidation or receivership. C. At the end of the second Contract Year, this Agreement shall renew automatically provided that either party may terminate this Agreement upon ninety (90) days prior written notice, with or without cause, at any time after the end of the second Contract Year. 14. OBLIGATIONS UPON TERMINATION Upon termination by either party, each party shall be obliged to pay all amounts then owing and, unless Seller has terminated by reason of a material breach by Buyer, Seller shall fill all purchase orders previously accepted. Anything herein to the contrary notwithstanding, the parties obligations under Sections 8, 9, 12, 15 and 16 shall survive such termination. 15. LABELING Modules will be labeled by Seller as "Manufactured for Optical Sensors Incorporated by Marquette Medical Systems", with an appropriate traceable serial number. This label will be in accordance with appropriate FDA and MDD regulations and the Specifications. Buyer may add its own Module labels, identifying the Module as Buyer's product. Buyer shall not remove, alter or conceal Seller's traceable serial number. 9 16. CONFIDENTIALITY Each party acknowledges and agrees that all the information provided by the other party that is marked as proprietary or confidential or which from its nature or the context in which it is given should reasonably be understood to be confidential shall be deemed "Confidential Information" for purposes of this Agreement. Without limiting the foregoing, the parties acknowledge that the Specifications constitute "Confidential Information." Each party agrees not to use any Confidential Information for any purpose other than as permitted or required for performance by it under this Agreement and not to disclose or provide any Confidential Information to any third party and to take all necessary measures to prevent any such disclosure by its employees, agents, contractors or consultants. Upon request or termination of this Agreement, each party will return all such Confidential Information of the other party to the other party. Each party's obligations under this Section 16 shall survive termination of this Agreement. 17. CUSTOMER'S STATUS During the term hereof, the relationship of Seller to Buyer is that of an independent contractor. Nothing herein contained shall be deemed to authorize or empower either Seller or the Buyer, its agents, or employees, to act as agent for Seller or the Buyer, or conduct business in the name, or for the account of, Seller or the Buyer or any of their Affiliates or otherwise bind it to them in any manner. Amendments hereto shall be made only in writing referencing this Agreements and executed by both parties. 18. NON-WAIVER The failure of Buyer and Seller to enforce at any time or for any period of time any of the provisions of this Agreement shall not constitute a waiver of such provisions. 19. SEVERABILITY If any provision of this Agreement should be held unenforceable or illegal, it shall be deemed severable from the other provisions which shall remain valid and enforceable. 20. COMPLETE UNDERSTANDING This Agreement is the complete and exclusive statement of the understandings between the parties concerning Seller's supply of Modules to the Buyer, superseding all proposals, oral or written, and all negotiations, conversations and discussions with respect to the supply relationship, including, but not limited to the Supply Agreement. 10 21. ARBITRATION Any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in accordance with the Rules of the American Arbitration Association, and judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. 22. GOVERNING LAW; COUNTERPARTS This Agreement shall be governed by the laws of the State of Wisconsin. This Agreement may be executed in any number of counterparts, each of which shall be an original but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement by their duly authorized officials as of the day and year first above written. MARQUETTE MEDICAL SYSTEMS, INC. By: /S/ GERALD WOODARD ---------------------------------------- Its: SENIOR VICE PRESIDENT MONITORING GROUP --------------------------------------- OPTICAL SENSORS INCORPORATED By: /S/ PAULITA LAPLANTE ---------------------------------------- Its: VICE PRESIDENT BUSINESS DEVELOPMENT --------------------------------------- 11 SCHEDULE A MODULE SPECIFICATIONS [THIS SCHEDULE HAS BEEN OMITTED PURSUANT TO A REQUEST FOR CONFIDENTIALITY UNDER RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. A COPY OF THIS AGREEMENT WITH THIS SECTION INTACT HAS BEEN FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.] 12 SCHEDULE B BUYER MONITOR [THIS SCHEDULE HAS BEEN OMITTED PURSUANT TO A REQUEST FOR CONFIDENTIALITY UNDER RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. A COPY OF THIS AGREEMENT WITH THIS SECTION INTACT HAS BEEN FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.] 13 SCHEDULE C ACCESSORY ITEMS AND PRICES [THIS SCHEDULE HAS BEEN OMITTED PURSUANT TO A REQUEST FOR CONFIDENTIALITY UNDER RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. A COPY OF THIS AGREEMENT WITH THIS SECTION INTACT HAS BEEN FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.] 14 EX-13.1 6 ANNUAL REPORT ON FORM 10-K EXHIBIT 13.1 ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS COMMON STOCK INFORMATION The common stock of Optical Sensors Incorporated has been traded on The Nasdaq National Market, under the symbol OPSI, since the company's initial public offering on February 14, 1996. The following table sets forth the high and low closing prices for the company's common stock, as reported by the Nasdaq National Market, for the periods indicated: QUARTER ENDED HIGH LOW - ------------------------------------------------- March 31, 1997 $ 11.500 $ 7.500 June 30, 1997 8.750 4.500 September 30, 1997 7.375 4.500 December 31, 1997 8.000 4.500 March 31, 1996 $ 14.875 $ 10.375 June 30, 1996 14.250 10.250 September 30, 1996 10.750 5.250 December 31, 1996 9.250 7.750 The foregoing prices reflect inter-dealer prices, without dealer markup, mark-down or commissions, and may not represent actual transactions. As of March 13, 1998, the company had 268 shareholders of record of its common stock and an estimated 3,500 beneficial holders whose shares were registered in the names of nominees. Optical Sensors Incorporated has never paid any cash dividends on its common stock, and does not anticipate paying any cash dividends on its common stock in the foreseeable future. During 1997, the Company sold a total of 14,647 shares of common stock pursuant to the exercise of warrants with an exercise price ranging from $3.15 to $9.00 per share, under Section 4(2) of the Securities Act of 1933. ITEM 6. SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31, ------------------------------------------------------------ 1997 1996 1995 1994 1993 ------------------------------------------------------------ (In thousands, except per share data) STATEMENTS OF OPERATIONS DATA Net sales $ 141 163 $ -- $ -- $ -- Operating expenses 10,472 9,734 8,249 6,463 5,586 Loss from operations (12,527) (10,940) (8,249) (6,463) (5,586) Interest income, net 1,193 1,555 118 183 149 Net loss $ (11,333) $ (9,385) $(8,131) $ (6,280) $ (5,437) Net loss per common share Basic and diluted $ (1.35) $ (1.30) $ (19.27) $ (21.88) $ (18.72)
DECEMBER 31, ----------------------------------------------------------- 1997 1996 1995 1994 1993 ----------------------------------------------------------- (In thousands) BALANCE SHEET DATA Cash and cash equivalents $ 17,101 $ 30,135 $ 5,395 $ 2,851 $ 9,105 Working capital 18,220 30,039 5,242 2,363 8,734 Total assets 21,626 32,369 6,367 3,582 9,741 Long-term debt 472 -- -- -- 89 Total shareholders' equity 20,157 31,050 5,778 2,987 9,182
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS OVERVIEW Optical Sensors Incorporated (the "Company") has developed the SensiCath system, a patient-connected, on-demand arterial blood gas ("ABG") monitoring system, which provides precise and accurate ABG results within 60 seconds without exposure to potentially infectious blood or depleting the patient's blood supply (the "SensiCath System"). ABG tests measure oxygen ("O2"), carbon dioxide ("CO2") and acid-base ("pH") in a sample of blood taken from a patient's artery. These tests, which are among the most frequently ordered and most urgently needed tests for critically ill and unstable patients, are the foremost indicators of the body's ability to absorb and use oxygen. Results of ABG tests provide a basis for medical treatment and intervention and are required to accurately regulate the patient's respiratory support system. The Company believes that the SensiCath System is the first ABG analyzer to be integrated into both an arterial pressure monitoring line and a critical care patient monitoring system. The SensiCath System utilizes a disposable, fiberoptic sensor device (the "SensiCath Sensor") connected to a small modular instrument (the "ABG Module") that is part of the Company's OpticalCAM instrumentation ("OpticalCAM"). The SensiCath System is able to either stand alone or interface with various monitoring platforms, including monitoring systems produced and installed by Marquette Medical Systems, Inc., SpaceLabs Medical, Inc., and the Hewlett-Packard Company. These three producers account for approximately 80% of the installed base of critical care monitoring instrumentation in the United States. In May of 1997, the Company voluntarily initiated an action to recover all customer inventory of SensiCath Sensors due to a limited number of performance variations in pH readings on certain patient applications. These performance variations were caused by an interfering agent, called bilirubin, which is elevated in patients that have underdeveloped or failing livers. At the same time, the Company notified the FDA of its action to recover all customer inventory of sensors. In July 1997, the FDA notified the Company that the voluntary action was classified as a product recall. The Company complied with all requirements of the FDA recall action and retrieved all Sensors from customers. In December 1997, the Company completed a number of enhancements to the SensiCath Sensor including enhancements to the pH sensor that reduced potential interference from bilirubin to clinically acceptable levels. In the fourth quarter of 1997 and early 1998, the Company achieved a number of important strategic milestones. These milestones include enhancements to the system that improve sensor performance and ease of use and expand its application in the patient-connected segment of the point-of-care blood gas monitoring market; and implementing aggressive marketing programs for the OpticalCAM instrumentation. The Company began commercial distribution of the enhanced sensor in December 1997. In January 1998, the Company entered into an agreement with Instrumentation Laboratory Company ("IL") for worldwide distribution of the Company's SensiCath Sensors and OpticalCAM instrumentation. IL will market and distribute the Company's products throughout the world under the names GEM SensiCath and GEM OpticalCAM. The Company has agreed to supply IL with SensiCath Sensors, on an exclusive basis, through 2004 and on a non-exclusive basis through 2007. The Company has also agreed to supply IL with OpticalCAM Instruments, on a semi-exclusive basis, through 2004. The Company retains the right to sell OpticalCAM Instruments to manufacturers of physiological monitoring, ventilator and anesthesia delivery systems. In January 1998, IL also purchased 441,203 shares of Common Stock from the Company, which represented 4.99% of the Company's outstanding Common Stock following completion of the transaction, at a price of $5.00 per share for a total price of $2,206,015. RESULT OF OPERATIONS Fiscal Years Ended December 31, 1997 and 1996 Net sales were $140,936 and $163,068 for 1997 and 1996, respectively. Sales in 1997 were adversely affected by the Company's action in May of 1997 to voluntarily recall its product as described above. The Company completed a number of significant product enhancements in the second half of 1997 and began commercial distribution of the enhanced sensor in December 1997. In 1997, approximately 64% of net sales were from the sale of SensiCath Sensors, and approximately 36% of net sales were from the placement of OpticalCAM instrumentation. Sales in 1996 were primarily from sensors purchased by customers and third parties for evaluation purposes. The Company did not have any instrument sales in 1996. Costs of products sold were $2,195,714 and $1,369,221 in 1997 and 1996, respectively, an increase of $826,493. A total of $446,000 of the increase for 1997 represents a write-down of OpticalCAM inventories to estimated market value. The amount of the write-down reflects the difference between the Company's estimated net realizable value based on the future selling price to its customers of the OpticalCAM System and the cost of inventories on hand or on order at the end of 1997. The major component of cost of products sold for 1997 and the primary reason for the increase from 1996 to 1997, excluding the inventory write-down, is manufacturing infrastructure costs necessary for anticipated future sales levels, which was established to its current level in the latter part of 1996. Under the agreement between the Company and IL, the Company has agreed to sell OpticalCAM instrumentation to IL at the lower of the Company's direct cost of manufacturing or previously scheduled amounts. Accordingly, the Company does not expect to generate any gross margin from the sale of OpticalCAM instrumentation in future periods. The Company has reduced the cost of manufacturing the OpticalCAM instrumentation to the anticipated approximate selling price and initiated programs to reduce the cost of manufacturing sensors. The Company expects an improving relationship between sales and cost of product sold for sensors once sales volumes for sensors begin to increase. Gross margins in future periods will also be affected by the mix of sensor sales and instrumentation sales in future periods. The Company believes it has the capacity to increase production levels to approximately 50,000 sensors per year without materially increasing manufacturing infrastructure costs. Research and development expenses were $4,975,037 and $5,632,458 in 1997 and 1996, respectively, a decrease of $657,421, or 12% in 1997. The Company completed development of the OpticalCAM in late 1996, which was a significant component of research and development expense in 1996 that did not recur in 1997, and the Company spent less on clinical research activities during 1997 as the SensiCath System reached development maturity. These two factors accounted for the majority of the decrease in research and development expenses. Research and development expenses also included payments under an agreement with Marquette Medical Systems, Inc. entered into in September 1995 pursuant to which the Company acquired ownership of the technology used in the SensiCath System. Payments to Marquette were $500,000 and $553,250 in 1997 and 1996, respectively. The Company is obligated to make a final payment of $500,000 if Marquette sells certain minimum quantities of ABG Modules. The Company currently expects to make this final payment to Marquette in 1998. The Company anticipates that 1998 research and development expenses will remain at levels comparable to that experienced in 1997 due to planned development of new sensors to measure additional blood analytes and further product enhancements, including planned cost reduction programs. Selling, general and administrative expenses were $5,496,772 and $4,102,147 in 1997 and 1996, respectively, an increase of $1,394,625, or 34%, in 1997. The increase is attributable primarily to organizational expansion of sales and marketing and product positioning activities beginning the latter half of 1996. During late 1996, the Company completed the initial hiring of its sales and marketing staff to support product positioning and initial product launch activities. Salaries and benefits for the expanded sales and marketing staff and travel expenses related to their activities and depreciation for OpticalCAM demonstration units accounted for a significant portion of the increase in selling, general and administrative expenses in 1997. The Company's administrative expenses decreased slightly in 1997 from the prior year. The Company expects selling, general and administrative expenses to increase only moderately in 1998 because the Company does not plan to increase its sales and marketing staff. Net interest income decreased $308,824 to $1,246,662 in 1997 from $1,555,486 in 1996, due to declining cash reserves resulting from negative cash flows. The Company incurred a net loss of $11,333,358 in 1997 compared to a net loss of $9,385,272 in 1996. Since inception, the Company has incurred a cumulative net loss of $46,548,720. The increase in net loss in 1997 was primarily due to the increase in operating expenses described above. The Company anticipates that its operating losses will continue for the foreseeable future. Fiscal Years Ended December 31, 1996 and 1995 The Company had no sales in 1995 as the Company received regulatory clearance to market the SensiCath System in January 1996. Net sales for 1996 were $163,068. In 1996, approximately 62% of sales were to Marquette for demonstration purposes and for clinical marketing studies, approximately 18% of sales were to international distributors for demonstration purposes, and approximately 20% of sales were commercial sales to customers. Costs of products sold in 1996 were primarily related to the establishment of commercial manufacturing operations and manufacturing of sensors for marketing studies and other testing purposes. Costs of products sold were $1,369,221 in 1996. In 1995, comparable costs of $981,151 were recorded as research and development expenses because the Company had no sales in that period. The increase in 1996 from comparable costs in 1995 resulted from increased activities to scale up manufacturing to meet anticipated future sales demand. Research and development expenses were $5,632,458 and $5,995,344 (including $981,151 related to manufacturing costs described above) in 1996 and 1995, respectively. Research and development expenses included payments under the 1995 technology acquisition agreement with Marquette of $553,250 and $759,750 in 1996 and 1995, respectively. Research and development expenses (excluding payments to Marquette and 1995 manufacturing costs included in research and development expenses) increased $864,765, or 21%, in 1996 from 1995. This increase is primarily attributable to development expenses incurred for the Company's OpticalCAM monitor. Selling, general and administrative expenses were $4,102,147 and $2,293,435 in 1996 and 1995, respectively. Selling, general and administrative expenses included amortization of deferred compensation expenses (for options granted in 1995) of $623,452 and $1,008,467 in 1996 and 1995, respectively. Selling, general and administrative expenses (after adjusting for compensation expenses described above) increased $2,193,727, or 171%, in 1996 from the prior year. During 1996, the Company completed the initial hiring of its sales and marketing staff. Salaries and benefits for the expanded sales and marketing staff and travel expenses related to their activities accounted for a significant portion of the increase in 1996. The Company's administrative expenses also increased primarily due to the Company's higher level of activity associated with initial commercialization of the Company's products and additional costs associated with being a public company. Net interest income increased $1,437,724 to $1,555,486 in 1996 from 1995. The increase is due to interest earned on the proceeds from the Company's initial public offering, which was completed in the first quarter of 1996. The Company incurred a net loss of $9,385,272 in 1996 compared to a net loss of $8,131,017 in 1995. The increase in net loss in 1996 was primarily due to the increase in operating expenses described above. LIQUIDITY AND CAPITAL RESOURCES To date, the Company has financed its operations primarily through the sale of equity securities. From inception through December 31, 1995, the Company raised net proceeds of $30,400,000 from private equity financings and stock option exercises. In the first quarter of 1996, the Company completed an initial public offering of 2,875,000 shares of Common Stock. The net proceeds to the Company from the public offering were approximately $33,916,000. The Company's Common Stock is quoted on the Nasdaq National Market under the symbol "OPSI." In January 1998, the Company sold 441,203 shares of Common Stock to IL, which represented 4.99% of the Company's outstanding Common Stock following completion of the transaction, at a price of $5.00 per share for a total price of $2,206,015. The Company granted IL and its affiliates certain pre-emptive rights to participate in future sales of equity securities by the Company, and certain demand and incidental registration rights under a registration rights agreement previously entered into by the Company and shareholders that purchased shares of stock in private transactions prior to the Company's initial public offering in February 1996. IL is prohibited from selling or otherwise transferring its shares of Common Stock for a period of one year, except to an affiliate or pursuant to the exercise of its registration rights. IL and its affiliates are also subject to certain standstill provisions for a period of five years that prohibit them from (a) acquiring more than 5.0% of the Company's outstanding Common Stock, (b) entering into a voting agreement with respect to the shares IL purchased from the Company, (c) participating in any proxy solicitation or becoming a participant in an election contest, or (d) joining a group for the purpose of acquiring, holding, voting or disposing of shares of Common Stock. The Company's cash and cash equivalents were $17,101,130 and $30,134,800 at December 31, 1997 and December 31, 1996, respectively. The decrease in the Company's cash balance is due to the operating losses described above. The Company incurred cash expenditures of $11,949,325 for operations and $1,127,097 for capital expenditures in 1997. In addition, the Company acquired equipment and tooling under capital leases for a total of $679,892 in 1997. The capital equipment expenditures were principally for the acquisition of OpticalCAM instrumentation for demonstration and promotional purposes, tooling and equipment for commercial production of the Company's products and for research and development purposes. As of December 31, 1997, the Company had no material commitments outstanding for tooling and equipment. As of December 31, 1997, the Company had commitments outstanding for approximately $557,000 to purchase inventory components for its OpticalCAM instrumentation. The Company increased its inventory levels during 1997 to support future product sales. A substantial portion of the inventory level at December 31, 1997 consisted of key components and ABG Modules and OpticalCAM monitors for which the Company relies on sole suppliers. The Company believes that sufficient liquidity is available to satisfy its working capital through 1998 and into early 1999. YEAR 2000 SOFTWARE PERFORMANCE EXPOSURE The Company has determined that the software embedded in the AMB modules is Year 2000 compliant and that its internal computer information systems are either Year 2000 compliant or will be modified to be Year 2000 compliant in 1998 without any significant interruption to the Company's operations. The Company has initiated discussions with its significant suppliers, large customers and financial institutions to ensure that those parties have appropriate plans to remediate Year 2000 issues where their systems interface with the Company's systems or otherwise impact its operations. The Company is assessing the extent to which its operations are vulnerable should those organizations fail to remediate properly their computer systems. The Company's Year 2000 initiative is being managed by internal staff and is scheduled to be completed in early 1999. While the Company believes its planning efforts are adequate to address its Year 2000 concerns, there can be no assurance that the systems of other companies which may impact the Company's operations will be converted on a timely basis and will not have a material effect on the Company. The cost of the Year 2000 initiatives is not expected to be material to the Company's results of operations or financial position. CERTAIN IMPORTANT FACTORS There are several important factors that could cause the Company's actual results to differ materially from those anticipated by the Company or which are reflected in any forward-looking statement of the Company. These factors, and their impact on the success of the Company's operations and its ability to achieve its goals include the following: - - MARKET ACCEPTANCE OF THE SENSICATH SYSTEM. The Company's future revenues will depend on market acceptance of the SensiCath System. The Company will need to demonstrate to health care professionals, hospital administrators and third- party payors the accuracy, reliability, ease of use, safety and cost effectiveness of the SensiCath System. In order to use the SensiCath System, hospitals need to acquire the OpticalCAM instrumentation, which may require capital expenditure approvals by the hospital. - - SALES BY INSTRUMENTATION LABORATORY. The Company's future revenues will depend almost exclusively on sales of the Company's products by IL. In January 1998, the Company entered into a seven-year strategic partnership with IL for worldwide distribution of the Company's SensiCath Sensors and OpticalCAM instrumentation. IL will market and distribute the Company's products throughout the world under the names GEM SensiCath and GEM OpticalCAM. The Company will supply IL with SensiCath Sensors, on an exclusive basis, through 2004 and on a non-exclusive basis through 2007. The Company will also supply IL with OpticalCAM Instruments, on a semi-exclusive basis, through 2004. The Company retains the right to sell OpticalCAM Instruments to manufacturers of physiological monitoring, ventilator and anesthesia delivery systems. Although IL is required to purchase sufficient quantities of products from the Company that will result in pre-established annual minimum revenues to the Company in order to maintain exclusivity, there can be no assurance that IL will achieve sufficient sales for the Company to substantially increase revenues or achieve profitability. - - MANUFACTURING AND SUPPLY. The Company's future plans include planned enhancements to the SensiCath Sensor that will reduce the Company's manufacturing costs. Although the Company has established and validated manufacturing processes, equipment and infrastructure to manufacture sensors in volumes that will be necessary to achieve significant revenues, the Company has limited experience in producing sensors at these volumes. A failure to implement the planned cost reduction programs in a timely manner or to successfully scale-up manufacturing of sensors could have a material adverse effect on the Company. Currently, the Company has only one supplier for the ABG Module, the OpticalCAM Monitor and certain other key components. Any disruption or delay in the supply of key components or instrumentation could have a material adverse effect on the Company. - - COMPETITION. Competition among companies attempting to provide ABG and other critical blood analyte analysis at the point-of-care is intense and increasing. There can be no assurance that the Company's competitors will not succeed in developing or marketing technologies and products that are more effective or less expensive than the Company's products or that would render the Company's products obsolete or non-competitive. - - REGULATORY APPROVALS. The Company's ability to market its current products and any products that it may develop in the future requires clearances or approvals from the FDA and other governmental agencies, including, in some instances, foreign and state agencies. The process for maintaining and obtaining necessary regulatory clearances and approvals can be expensive and time consuming. There can be no assurance that the Company will be able to maintain or obtain necessary regulatory approvals and clearances in the future. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Optical Sensors Incorporated (A Development Stage Company) Financial Statements Years ended December 31, 1997 and 1996 CONTENTS Report of Independent Auditors............................................1 Audited Financial Statements Balance Sheets............................................................2 Statements of Operations..................................................3 Statement of Shareholders' Equity.........................................4 Statements of Cash Flows.................................................12 Notes to Financial Statements............................................13 Report of Independent Auditors Board of Directors Optical Sensors Incorporated We have audited the accompanying balance sheets of Optical Sensors Incorporated (a development stage company) as of December 31, 1997 and 1996, and the related statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997 and the period from May 23, 1989 (inception) to December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Optical Sensors Incorporated (a development stage company) at December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 and the period from May 23, 1989 (inception) to December 31, 1997, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP February 12, 1998 1 Optical Sensors Incorporated (A Development Stage Company) Balance Sheets
DECEMBER 31 1997 1996 ------------------------------- ASSETS Current assets: Cash and cash equivalents $17,101,130 $30,134,800 Accounts receivable 27,100 91,040 Inventories 2,017,497 931,917 Prepaid expenses and other current assets 70,491 200,731 ------------------------------- Total current assets 19,216,218 31,358,488 Property and equipment: Leased equipment 679,892 - Research and development equipment 594,542 292,488 Leasehold improvements 259,172 199,211 Furniture and equipment 109,214 77,895 Marketing equipment 986,483 344,448 Production equipment 259,363 167,635 ------------------------------- 2,888,666 1,081,677 Less accumulated depreciation (974,887) (488,043) ------------------------------- 1,913,779 593,634 Other assets: Patents 434,752 328,630 Other assets 60,785 88,445 ------------------------------- 495,537 417,075 ------------------------------- Total assets $21,625,534 $32,369,197 =============================== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 437,039 $ 740,804 Employee compensation 404,513 577,228 Other liabilities and accrued expenses 2,154 1,541 Obligations under capital lease, current portion 152,756 - ------------------------------- Total current liabilities 996,462 1,319,573 Obligations under capital lease, less current portion 472,206 - Shareholders' equity: Preferred Stock, par value $.01 per share Authorized shares--5,000,000 Common Stock, par value $.01 per share: Authorized shares--30,000,000 Issued and outstanding shares 1997-- 8,400,554; 1996--8,341,497 84,006 83,415 Additional paid-in capital 67,088,370 66,974,345 Deficit accumulated during the development stage (46,548,720) (35,215,362) Deferred compensation (221,790) (547,774) Note receivable from officer (245,000) (245,000) ------------------------------- Total shareholders' equity 20,156,866 31,049,624 ------------------------------- Total liabilities and shareholders' equity $21,625,534 $32,369,197 ===============================
See accompanying notes. 2 Optical Sensors Incorporated (A Development Stage Company) Statements of Operations
CUMULATIVE MAY 23, 1989 YEAR ENDED DECEMBER 31 (INCEPTION) TO ---------------------------------------------------- DECEMBER 31, 1997 1996 1995 1997 --------------------------------------------------------------------------- Net sales $ 140,936 $ 163,068 $ - $ 304,004 Cost of goods sold (2,195,714) (1,369,221) - (3,564,935) --------------------------------------------------------------------------- Gross margin (2,054,778) (1,206,153) - (3,260,931) Operating expenses: Research and development 4,975,037 5,632,458 5,955,344 29,997,903 Selling, general and administrative 5,496,772 4,102,147 2,293,435 16,517,731 --------------------------------------------------------------------------- Total operating expenses 10,471,809 9,734,605 8,248,779 46,515,634 --------------------------------------------------------------------------- Operating loss (12,526,587) (10,940,758) (8,248,779) (49,776,565) Interest expense (21,143) - (19,333) (162,528) Interest income 1,267,805 1,555,486 137,095 3,443,806 Other expense (53,433) - - (53,433) ----------------------------------------------------------------------------- 1,193,229 1,555,486 117,762 3,227,845 ---------------------------------------------------------------------------- Net loss and deficit accumulated during development stage $ (11,333,358) $(9,385,272) $(8,131,017) $(46,548,720) =============================================================================== Net loss per common share: Basic and diluted $ (1.35) $ (1.30) $ (19.27) $ (11.44) Shares used in calculation of net loss per share: Basic and diluted 8,375,000 7,222,000 421,900 4,069,000
See accompanying notes. 3 Optical Sensors Incorporated (A Development Stage Company) Statement of Shareholders' Equity Period from May 23, 1989 (inception) to December 31, 1997
SERIES A SERIES B SERIES C CONVERTIBLE CONVERTIBLE CONVERTIBLE PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK ------------------------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ------------------------------------------------------------------------------------- Subscriptions for sale of Common Stock at $.45 per share Payments received on stock subscriptions, net of placement costs Issuance of Common Stock Issuance of Common Stock for consulting services Net loss for period of May 23, 1989 (inception) to December 31, 1989 ------------------------------------------------------------------------------------- Balance at December 31, 1989 Issuance of Common Stock, net of offering costs of $121,502 Issuance of Common Stock for services provided in the private placement Issuance of Common Stock for consulting services Issuance of Common Stock upon debt conversion in April, conversion price of $4.50 per share Payments received on stock subscription Issuance of Common Stock in July at $9.00 per share Net loss ------------------------------------------------------------------------------------- Balance at December 31, 1990 Issuance of Series A Convertible Preferred Stock net of offering costs of $49,904 94,370 $944 Issuance of Common Stock for technology Net loss ------------------------------------------------------------------------------------- Balance at December 31, 1991 94,370 944
4
DEFICIT ACCUMULATED COMMON STOCK ADDITIONAL DURING THE COMMON PREFERRED -------------------- PAID-IN DEVELOPMENT STOCK STOCK DEFERRED SHARES AMOUNT CAPITAL STAGE SUBSCRIPTION SUBSCRIPTION COMPENSATION TOTAL - ----------------------------------------------------------------------------------------------------------------------------------- 127,037 $1,270 $ 57,022 $(58,292) $ - (3,987) 55,792 51,805 9,560 96 13,205 (10,000) 3,301 350 4 1,256 1,260 $(181,793) (181,793) - -------------------------------------------------------------------------------------------------------------------------------- 136,947 1,370 67,496 (181,793) (12,500) (125,427) 92,678 927 711,671 712,598 6,260 63 (63) - 640 6 5,751 5,757 26,088 261 117,135 117,396 12,500 12,500 16,667 167 149,833 150,000 (636,266) (636,266) - -------------------------------------------------------------------------------------------------------------------------------- 279,280 2,794 1,051,823 (818,059) - 236,558 1,011,652 $(10,635) 1,001,961 2,778 28 24,972 25,000 (1,511,013) (1,511,013) - -------------------------------------------------------------------------------------------------------------------------------- 282,058 2,822 2,088,447 (2,329,072) - (10,635) (247,494)
5 Optical Sensors Incorporated (A Development Stage Company) Statement of Shareholders' Equity (continued)
SERIES A SERIES B SERIES C CONVERTIBLE CONVERTIBLE CONVERTIBLE PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK ------------------------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ------------------------------------------------------------------------------------- Issuance of Series B Convertible Preferred Stock, net of offering costs of $93,903 418,387 $4,184 Issuance of Series B Convertible Preferred Stock upon debt cancellation in April for $12.60 per share 81,129 811 Issuance of Common Stock for consulting services Payment received on stock subscriptions Net loss ------------------------------------------------------------------------------------- Balance at December 31, 1992 94,370 $944 499,516 4,995 Issuance of Series C Convertible Preferred Stock, net of offering costs of $815,320 958,200 $ 9,582 Issuance of Series C Convertible Preferred Stock upon debt cancellation 79,817 798 Issuance of Common Stock upon exercise of warrants Issuance of Common Stock Net loss ------------------------------------------------------------------------------------- Balance at December 31, 1993 94,370 944 499,516 4,995 1,038,017 10,380 Issuance of Common Stock upon exercise of warrants Value assigned to warrants issued in connection with debt and lease financings Net loss ------------------------------------------------------------------------------------- Balance at December 31, 1994 94,370 944 499,516 4,995 1,038,017 10,380
6
DEFICIT ACCUMULATED COMMON STOCK ADDITIONAL DURING THE COMMON PREFERRED -------------------- PAID-IN DEVELOPMENT STOCK STOCK DEFERRED SHARES AMOUNT CAPITAL STAGE SUBSCRIPTION SUBSCRIPTION COMPENSATION TOTAL - ----------------------------------------------------------------------------------------------------------------------------------- $ 5,173,589 $ 5,177,773 1,021,416 1,022,227 317 $ 3 2,853 2,856 $10,635 10,635 $ (3,653,474) (3,653,474) - ----------------------------------------------------------------------------------------------------------------------------------- 282,375 2,825 8,286,305 (5,982,546) $ - - 2,312,523 11,248,418 11,258,000 1,004,924 1,005,722 6,658 66 35,787 35,853 833 8 7,492 7,500 (5,437,113) (5,437,113) - ----------------------------------------------------------------------------------------------------------------------------------- 289,866 2,899 20,582,926 (11,419,659) - - 9,182,485 778 7 7,493 7,500 76,051 76,051 (6,279,414) (6,279,414) - ----------------------------------------------------------------------------------------------------------------------------------- 290,644 2,906 20,666,470 (17,699,073) - - 2,986,622
7 Optical Sensors Incorporated (A Development Stage Company) Statement of Shareholders' Equity (continued)
SERIES A SERIES B SERIES C SERIES D SERIES E CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK ----------------------------------------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ----------------------------------------------------------------------------------------------------- Valuation assigned to options issued in connection with a consulting agreement Issuance of Series D Convertible Preferred Stock, net of offering costs of $88,501 1,900,183 $19,002 Issuance of Series D Convertible Preferred Stock upon debt cancellation 310,645 3,107 Issuance of Common Stock upon exercise of options and warrants Issuance of Convertible Preferred Stock pursuant to antidilution provisions in Series A through C 18,853 $ 189 157,061 $1,571 377,991 $ 3,779 Issuance of Series E Convertible Preferred Stock, net of offering costs of $33,660 370,338 $3,703 Value assigned to warrants in connection with debt and lease financing Deferred compensation related to stock options Amortization of deferred compensation Net loss ----------------------------------------------------------------------------------------------------- Balance at December 31, 1995 113,223 1,133 656,577 6,566 1,416,008 14,159 2,210,828 22,109 370,338 3,703
8
DEFICIT ACCUMULATED COMMON STOCK ADDITIONAL OFFICER DURING THE COMMON PREFERRED -------------------- PAID-IN RECEIVABLE DEVELOPMENT STOCK STOCK DEFERRED SHARES AMOUNT CAPITAL FOR STOCK STAGE SUBSCRIPTION SUBSCRIPTION COMPENSATION TOTAL - ---------------------------------------------------------------------------------------------------------------------------------- $6,150 $ 6,150 5,877,647 5,896,649 975,689 978,796 319,799 $3,199 288,147 $(245,000) 46,346 (5,539) - 2,962,637 2,966,340 19,464 19,464 2,179,693 $(2,179,693) - 1,008,467 1,008,467 $ (8,131,017) (8,131,017) - ------------------------------------------------------------------------------------------------------------------------------- 610,443 6,105 32,970,358 (245,000) (25,830,090) $ - $ - (1,171,226) 5,777,817
9 Optical Sensors Incorporated (A Development Stage Company) Statement of Shareholders' Equity (continued)
SERIES A SERIES B SERIES C SERIES D SERIES E CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK ----------------------------------------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ----------------------------------------------------------------------------------------------------- Issuance of Common Stock in conjunction with public offering, net of expenses of $3,459,218 Conversion of Preferred Stock in conjunction with public offering (113,223) $(1,133)(656,577) $(6,566) (1,416,008) $(14,159) (2,210,828) $(22,109) (370,338) $(3,703) Issuance of Common Stock upon exercise of options and warrants Value assigned to warrants in connection with debt and lease financing Amortization of deferred compensation Net loss ----------------------------------------------------------------------------------------------------- Balance at December 31, 1996 - - - - - - - - - - Issuance of Common Stock upon exercise of options and warrants Value assigned to warrants in connection with debt and lease financing Amortization of deferred compensation Net loss --------------------------------------------------------------------------------------------------- Balance at December 31, 1997 - $ - - $ - - $ - - $ - - $ - ===================================================================================================
See accompanying notes. 10
DEFICIT ACCUMULATED COMMON STOCK ADDITIONAL OFFICER DURING THE COMMON PREFERRED - --------------------- PAID-IN RECEIVABLE DEVELOPMENT STOCK STOCK DEFERRED SHARES AMOUNT CAPITAL FOR STOCK STAGE SUBSCRIPTION SUBSCRIPTION COMPENSATION TOTAL - -------------------------------------------------------------------------------------------------------------------------------- 2,875,000 $28,750 $33,887,032 $33,915,782 4,766,974 47,670 - 89,080 890 98,856 99,746 18,099 18,099 623,452 623,452 $ (9,385,272) (9,385,272) - -------------------------------------------------------------------------------------------------------------------------------- 8,341,497 83,415 66,974,345 $(245,000) (35,215,362) $ - $ - (547,774) 31,049,624 59,057 591 97,093 97,684 16,932 16,932 325,984 325,984 (11,333,358) (11,333,358) - -------------------------------------------------------------------------------------------------------------------------------- 8,400,554 $84,006 $67,088,370 $(245,000) $(46,548,720) $ - $ - $(221,790) $20,156,866 ================================================================================================================================
11 Optical Sensors Incorporated (A Development Stage Company) Statements of Cash Flows
CUMULATIVE MAY 23, 1989 (INCEPTION) TO YEAR ENDED DECEMBER 31 DECEMBER 31, 1997 1996 1995 1997 ------------------------------------------------------------------ OPERATING ACTIVITIES Net loss $(11,333,358) $(9,385,272) $(8,131,017) $(46,548,720) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 510,537 124,452 104,800 1,145,441 Loss on write-off of research and development equipment - - - 133,919 Loss on write-off of prepaid royalties - - 135,201 135,201 Amortization of deferred loss on sale leaseback - - - 11,196 Deferred compensation amortization 325,984 623,452 1,008,467 1,957,903 License fee financed with long-term debt - - - 193,700 Issuance of Common Stock for services - - - 37,091 Writedown of inventory 445,706 - - 445,706 Issuance of Common Stock in lieu of interest payments on notes payable - - - 35,412 Amortization of warrants in connection with debt and lease financing 16,933 18,099 19,464 81,030 Issuance of options in connection with consulting services - - 6,150 55,690 Changes in operating assets and liabilities: Receivables 63,940 (91,040) - (27,100) Inventories (1,531,286) (931,917) - (2,463,203) Prepaid expenses and other assets 28,086 132,602 (414,391) (589,308) Accounts payable and accrued expenses (475,867) 730,259 82,572 843,706 ------------------------------------------------------------------ Net cash used in operating activities (11,949,325) (8,779,365) (7,188,754) (44,552,336) INVESTING ACTIVITIES Purchases of property, plant and equipment (1,806,989) (496,084) (66,999) (3,511,518) Proceeds from disposal of equipment - - - 46,947 ------------------------------------------------------------------ Net cash used in investing activities (1,806,989) (496,084) (66,999) (3,464,571) FINANCING ACTIVITIES Proceeds from sale leaseback - - - 283,030 Net proceeds from issuance of Common Stock 97,684 34,015,528 46,346 35,142,360 Net proceeds from issuance of Preferred Stock - - 9,841,785 27,290,155 Proceeds from notes payable - - 1,053,663 3,177,926 Payments on long-term debt and lease obligations 624,960 - (1,142,415) (771,934) Reimbursement to founder and shareholder - - - (3,500) ------------------------------------------------------------------ Net cash provided by financing activities 722,644 34,015,528 9,799,379 65,118,037 ------------------------------------------------------------------ Increase (decrease) in cash and cash equivalents (13,033,670) 24,740,079 2,543,626 17,101,130 Cash and cash equivalents at beginning of period 30,134,800 5,394,721 2,851,095 - ------------------------------------------------------------------ Cash and cash equivalents at end of period $17,101,130 $30,134,800 $ 5,394,721 $17,101,130 ==================================================================
See accompanying notes. 12 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements December 31, 1997 1. BUSINESS ACTIVITY Optical Sensors Incorporated is a development stage company engaged in developing, manufacturing and marketing fiberoptic chemical sensors for blood gas monitoring for medically unstable patients in critical and intensive care units. The Company was incorporated on May 23, 1989 and reincorporated in Delaware on January 4, 1996. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Investments classified as cash equivalents consist primarily of commercial paper and municipal bonds. The market value of investments is based on quoted market prices which approximates cost. INVENTORIES Inventories are recorded at the lower of cost or market (FIFO basis). PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is provided on a straight-line basis over three to five years. Leasehold improvements are amortized over the shorter of the term of the lease or life of the asset. Equipment under capital leases is depreciated over the lease term. PATENTS Patents are stated at cost and are amortized upon issuance of a patent on a straight-line basis over sixty months. The carrying value of patents will be reviewed if the facts and circumstances suggest that it may be impaired. If this review indicates that patent cost will not be recoverable, as determined based on the undiscounted cash flows over the remaining amortization period, the Company's carrying value of the patents will be reduced by the estimated shortfall of cash flows. 13 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INCOME TAXES The Company accounts for income taxes using the liability method. Deferred income taxes are provided for temporary differences between the financial reporting and tax bases of assets and liabilities. STOCK-BASED COMPENSATION The Company follows Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and related interpretations in accounting for its stock options. Under APB 25, when the exercise price of stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company has adopted the disclosure only provisions of the Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("Statement 123"). Accordingly, the Company has made pro forma disclosures of what net loss and net loss per share would have been had the provisions of Statement 123 been applied to the Company's stock options. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from the estimates. ACCOUNTING FOR LONG-LIVED ASSETS The Company records losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. 14 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NET LOSS PER SHARE In February 1997, the Financial Accounting Standards Board (FASB) issued Statement No. 128, Earnings Per Share. Statement 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. All earnings per share amounts for all periods have been presented, and where necessary, restated to conform to the Statement 128 requirements. 3. COMMON STOCK In 1989, the Company issued 4,930 shares of Common Stock in exchange for a release from a covenant not to compete. The non-compete covenant related to the founder's position of president with a former company. Also, in 1989 and 1990, the Company sold 93,789 shares of Common Stock in a private placement for $844,100 less related costs of $121,502 plus 6,260 shares of Common Stock issued at $9.00 per share for services provided in the private placement. Additionally, in July 1990, the Company sold 16,667 shares of Common Stock for $150,000 related to the same offering. The Company completed an initial public offering of Common Stock in 1996 in which it sold 2,875,000 shares of Common Stock, resulting in net proceeds of $33,915,782. SHAREHOLDER RIGHTS PLAN In December 1996, the Company's Board of Directors adopted a Shareholder Rights Plan by declaring a dividend of one preferred share purchase right (the "Right") for each outstanding share of Common Stock. Under certain circumstances, a Right may be exercised to purchase one one-thousandth of a share of Series A Junior Preferred Stock for $90. The rights become exercisable if a person or group acquires 15 percent or more of the Company's outstanding Common Stock, subject to certain exceptions. If a person 15 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 3. COMMON STOCK (CONTINUED) or group acquires 15 percent or more of the Company's outstanding Common Stock, subject to certain exceptions, each right will entitle its holder to buy Common Stock of the Company having a market value of twice the exercise price of the Right. The Rights expire in December 2006 and may be redeemed by the Company for $.001 per Right at any time before, or, in certain circumstances, within 10 days (subject to extension) following the announcement that a person has acquired 15 percent or more of the Company's outstanding Common Stock. Until a Right is exercised, the holder of a Right, as such, has no rights as a shareholder of the Company. In connection with the adoption of the Shareholder Rights Plan, the Company authorized 250,000 shares of Series A Junior Preferred Stock (the "Preferred Stock"). Subject to the rights of holders of any Senior Securities, if any, holders of the Preferred Stock are entitled to quarterly dividends, when, as and if declared by the Board of Directors, in the amount of one thousand times the aggregate per share amount of dividends paid to Common Stock shareholders. Each Preferred Stock share is entitled to one thousand votes on all matters submitted to a vote of the shareholders of the Company. The Preferred Stock has liquidation preference over the Company's Common Stock. The liquidation rate on the Preferred Stock is the greater of (a) $1,000 per share plus accrued dividends, whether or not earned or declared, or (b) an amount equal to one thousand times the amount distributed to the Common Stock shareholders. 4. CONVERTIBLE PREFERRED STOCK In February 1991, the Company created a new class of stock, Convertible Preferred Stock, Series A. From March 1991 to November 1991, the Company sold 94,370 shares of this new class at $11.25 per share for a total consideration of $1,062,500, less related offering costs of $49,904. In April 1992, the Company created a new class of Preferred Stock, Convertible Preferred Stock, Series B. From April 1992 to July 1992, the Company sold 418,387 shares of this new class at $12.60 per share for a total consideration of $5,271,676 less related offering costs of $93,903. See Note 5 for cancellation of related bridge loans. 16 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 4. CONVERTIBLE PREFERRED STOCK (CONTINUED) In June 1993, the Company created a new class of Preferred Stock, Convertible Preferred Stock, Series C. From June 1993 to September 1993, the Company sold 958,200 shares of this new class at $12.60 per share for a total consideration of $12,073,752 less related offering costs of $815,320. In connection with the sale thereof, the Company issued warrants to a placement agent to purchase 79,869 shares of Common Stock at $7.38 per share. The warrants were exercised in 1997. See Note 5 for cancellation of related bridge loans. In July 1995, the Company created a new class of Preferred Stock, Convertible Preferred Stock, Series D. From July 1995 to September 1995, the Company sold 2,210,828 shares of this new class at $3.15 per share for a total consideration of $6,963,946 less related offering costs of $88,501. See Note 5 for cancellation or conversion of related bridge loans. On November 28, 1995, the Company sold an aggregate of 370,338 shares of Series E Preferred Stock to certain existing shareholders, pursuant to the Company's Series E Convertible Preferred Stock Purchase Agreement, at a price of $8.10 per share for a total consideration of $3,000,000 less related offering costs of $33,660. Upon completion of the Company's initial public offering of Common Stock in February 1996, all shares of outstanding Convertible Preferred Stock were converted into 4,766,974 shares of Common Stock. 5. NOTES PAYABLE In 1989, the Company received working capital loans totaling $110,000. The notes bore interest at an annual rate of 12%. In April 1990, notes totaling $85,000 plus the accrued interest of $4,396 were converted to Common Stock at a conversion price of $4.50 per share. In November 1990, the remaining note totaling $25,000 plus the accrued interest of $3,000 was converted to Common Stock at a conversion price of $4.50 per share. In 1991, the Company received working capital convertible bridge loans totaling $220,000. One of the notes for $50,000 was from a company that is owned by a Company Director. In 1992, the Company received an additional $780,000 of working capital 17 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 5. NOTES PAYABLE (CONTINUED) convertible bridge loans. The notes bore interest at an annual rate of 2% over the First Bank National Association reference rate. Upon the completion of the sale of Series B Convertible Preferred Stock on April 28, 1992, the convertible bridge loans of $1,000,000 plus the accrued interest of $22,227 were automatically canceled as payment for 81,129 shares of Series B Convertible Preferred Stock at a price of $12.60 per share. In consideration of the purchase of the notes, the Company issued warrants to the investors to purchase 24,076 shares of Common Stock at $9.00 per share. In 1993, the Company received working capital convertible bridge loans totaling $999,933. The notes bore interest at an annual rate of 8%. Upon completion of the sale of Series C Convertible Preferred Stock, bridge loans of $999,933 plus the accrued interest of $5,789 were automatically canceled as payment for 79,817 shares of Series C Convertible Preferred Stock at a price of $12.60 per share. In consideration of the purchase of the notes, the Company issued warrants to the investors to purchase 26,871 shares of Common Stock at $12.60 per share. In 1995, the Company received working capital convertible bridge loans totaling $967,887. The notes bore interest at an annual rate of 8%. Upon completion of the sale of Series D Convertible Preferred Stock, bridge loans of $967,887, plus the accrued interest of $10,909, were automatically canceled or converted into 310,645 shares of Series D Convertible Preferred Stock at a price of $3.15 per share. In consideration of the purchase of the notes, the Company issued warrants to the investors to purchase 61,429 shares of Common Stock at $3.15 per share. 6. LEASES OPERATING LEASES The Company leases its office and research and development facility under an operating lease that expires on November 30, 1999. Operating expenses, including maintenance, utilities, real estate taxes and insurance, are paid by the Company. The Company also leases certain office equipment under operating leases. 18 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 6. LEASES (CONTINUED) Total rent expense under operating leases was $869,764, $921,000 and $765,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Future minimum lease payments under noncancelable operating leases with initial or remaining terms of one year or more as of December 31, 1997 are as follows: Year ending December 31: 1998 $ 613,194 1999 502,361 2000 48,404 2001 8,329 ----------- $1,172,288 =========== CAPITAL LEASES In June 1997, the Company entered into an equipment lease agreement. Under the lease agreement, the Company is allowed to lease up to $2,000,000 of equipment between June 15, 1997 and June 30, 1998. Assets leased under the agreement at December 31, 1997 were approximately $680,000 with a related obligation of $624,962 at December 31, 1997. The terms of each lease schedule under the lease are 42 months with payments due the first of each month. Future payments under capital leases are as follows: 1998 $227,302 1999 227,302 2000 259,839 2001 71,460 Thereafter - ---------------- 785,903 Less amount representing payment of interest (160,941) ---------------- 624,962 Less current portion (152,756) ---------------- Long-term capital lease obligations $472,206 ================ 19 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 7. INCOME TAXES At December 31, 1997, the Company has cumulative net operating loss carryforwards for tax purposes of approximately $42,920,000 plus research and development tax credit carryforwards of approximately $1,000,000. These carryforwards are available to offset future taxable income through 2012. As a result of the sales of Preferred Stock and additional shares of Common Stock, the Company has experienced a change in ownership under the net operating loss limitation rules. The use of losses, incurred through the change in ownership date, to offset future taxable income, will be limited during the carryforward period. The credits will also be subject to limitations under these same rules. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows: DECEMBER 31 1997 1996 ---------------------------------- Deferred tax assets: Net operating loss carryforwards $15,900,000 $11,900,000 Tax credit carryforwards 1,000,000 1,000,000 Deferred compensation on stock options 724,000 604,000 Vacation accrual 86,000 71,000 Book over tax depreciation 239,000 98,000 ---------------------------------- Total deferred tax assets 17,949,000 13,673,000 Deferred tax liabilities: Other 33,000 - ---------------------------------- Total deferred tax liabilities 33,000 - ---------------------------------- Net deferred tax assets 17,916,000 13,673,000 Valuation allowance (17,916,000) (13,673,000) ---------------------------------- $ - $ - ================================== 20 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 8. STOCK OPTIONS AND WARRANTS The Company has three stock option plans that include both incentive and non-statutory stock options to be granted to directors, officers, employees and consultants of the Company. Option activity is summarized as follows: OPTIONS WEIGHTED SHARES OUTSTANDING AVERAGE --------------- EXERCISE AVAILABLE TOTAL PRICE PER FOR GRANT SHARES SHARE ---------------------------------------- Balance at December 31, 1994 42,282 342,607 $9.04 Additional shares reserved 948,444 - - Granted--incentive stock options (698,666) 698,666 1.25 Granted--non-statutory stock options (289,240) 289,240 .94 Options canceled 305,854 (305,854) 8.84 Options exercised - (319,861) .91 ----------------------------- Balance at December 31, 1995 308,674 704,798 1.80 Granted--incentive stock options (151,650) 151,650 8.42 Options canceled 36,140 (36,140) 4.62 Options exercised - (86,300) .94 ----------------------------- Balance at December 31, 1996 193,164 734,008 3.11 Granted--incentive stock options (148,205) 148,205 5.22 Options canceled 24,986 (24,986) 5.71 Options exercised - (40,032) 1.28 ----------------------------- Balance at December 31, 1997 69,945 817,195 $3.50 ============================= The weighted average fair value of options granted is summarized as follows: 1997 1996 1995 ------------------------------ Stock price equals exercise price $3.02 $5.26 $4.03 Stock price is greater than exercise price - 5.41 2.70 21 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 8. STOCK OPTIONS AND WARRANTS (CONTINUED) The exercise price of options outstanding at December 31, 1997 ranged from $.90 to $13.00 per share, as summarized in the following table:
WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE RANGE OF SHARES OUTSTANDING AT REMAINING CONTRACTUAL SHARES EXERCISE PRICE EXERCISE PRICE DECEMBER 31, 1997 LIFE EXERCISABLE PER SHARE --------------------------------------------------------------------------------------------------------- $ .90 to 4.50 487,762 7.50 years 265,865 $ 1.18 4.51 to 9.00 272,683 7.71 years 59,991 6.03 9.01 to 13.00 56,750 7.92 years 23,790 11.35 -------------------------------------------------------------- Total 817,195 7.74 years 349,646 $ 3.50 ==============================================================
The number of shares exercisable at December 31, 1996 and 1995 was 239,784 and 197,897, respectively, at a weighted average exercisable price per share of $3.06 and $1.90, respectively. Pro forma information regarding net loss and net loss per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: 1997 1996 1995 ------------------------------------------ Expected stock price volatility 75% 78% 78% Risk-free interest rate 6.5% 5.5% 6.3% Expected life of options 7 years 7 years 7 years The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. 22 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 8. STOCK OPTIONS AND WARRANTS (CONTINUED) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information is as follows: 1997 1996 1995 ------------------------------------------ Pro forma net loss $11,714,634 $9,451,264 $8,131,017 Pro forma net loss per common share: Basic and diluted $1.40 $1.31 $2.70 These pro forma amounts may not be indicative of future years' amounts since the Statement provides for a phase-in of option values beginning with those granted in 1995. At December 31, 1997, the Company has total exercisable warrants outstanding to purchase shares of its Common Stock as follows: 36,262 shares at $9.00 per share, 26,871 shares at $12.60 per share, 71,471 shares at $3.15 per share. These warrants expire at various dates in 1998 through 2001. DEFERRED COMPENSATION For options granted during the period June 17, 1995 through October 3, 1995 to purchase a total of 971,640 shares of Common Stock at exercise prices ranging from $.90 to $2.70 per share, the Company recognized in August 1995, $2,179,693 as deferred compensation for the excess of the deemed value for accounting purposes of the Common Stock issuable upon exercise of such options over the aggregate exercise price of such options. The deferred compensation expense is amortized ratably over the vesting period of the options. Deferred compensation expense was $325,984, $623,452 and $1,008,467 for the years ended December 31, 1997, 1996 and 1995, respectively. The remaining unamortized deferred compensation is expected to be charged to operations as follows: 1998 $166,186 1999 55,605 ------------------- $221,791 =================== 23 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 9. TECHNOLOGY AGREEMENTS In August 1991, the Company entered into an agreement to purchase certain fiberoptic chemical sensor technology for $10,000. In addition, the Company issued 2,778 shares of Common Stock to the licensor upon assignment of the technology. The Company has agreed to pay royalties on sales of industrial and environmental products for which the technology purchased is a significant part. The royalties shall be 5%, 4% and 3% on the first, second and third $10 million sales increments and 2% on sales in excess of $40 million. For sales of such products by any future licensees of the Company, the Company shall pay 25% of all licensing fees received up to $500,000 and 10% thereafter. The Company has made all payments for the technology. The Company does not intend to use the technology in the future and, therefore, does not anticipate paying any royalties under the agreement. In September 1995, the Company entered into an agreement with Marquette Medical Systems, Inc. to acquire exclusive ownership of certain technology that had been jointly developed by the Company and Marquette. In consideration for the technology, the Company has agreed to pay $2,000,000 payable as follows: $500,000 upon execution of the agreement, $500,000 upon completion of the technology, $500,000 once the product has been sold and installed in 20 hospitals and $500,000 once the product has been sold and installed in an additional 50 hospitals. The Company also agreed to pay $50,000 per month for engineering and technical support from August 1, 1995 through January 31, 1996. As of December 31, 1997, the Company has a remaining obligation of $500,000 under this agreement which will become payable if Marquette meets the product sales requirements. 10. PURCHASE COMMITMENTS The Company has entered into purchase commitments with two companies for the purchase of Arterial Blood Gas Modules and OpticalCAM instruments. Under the terms of the agreements, the Company has agreed to purchase, under a specified pricing structure, a fixed number of units in 1998. As of December 31, 1997, the Company is committed to purchase $556,815 of inventory during 1998. 24 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 11. EMPLOYMENT AGREEMENT The Company has an employment agreement ("agreement") with the President and Chief Executive Officer of the Company. The agreement provides for a base salary of $185,000 per year, which may be increased by the Board of Directors and provides for an annual incentive bonus in an amount not less than 20% of the base salary if the Company reaches milestones agreed to by the Board and the President. The President also receives an automobile allowance of $500 per month. The agreement requires the President to assign to the Company patents and other proprietary rights related to the Company's business and to keep the Company's proprietary information confidential. The President is also prohibited from competing with the Company for a period of one year following termination of employment with the Company. Additionally, the agreement provides for severance pay equal to twelve months of base salary if the President is terminated without cause. In connection with the employment agreement, the Company granted the President options to purchase 121,162 shares of Common Stock at a price of $9.00 per share. In August of 1995, these options were canceled, and the Board of Directors granted the President a non-statutory option to purchase 272,222 shares of Common stock at a price of $.90 per share. In September 1995, the President exercised this option under the Company's 1991 Stock Option Plan to purchase 272,222 shares of Common Stock at a price of $.90 per share. The right to retain certain of the shares is subject to the President's continued employment through August 2, 1999. As payment for the shares, the President executed a $245,000 promissory note, payable in full on August 1, 1998, at an interest rate of 5.91%. The note is secured by the shares of Common Stock and proceeds of any dividend or other distribution attributable to the shares. The compensation expense associated with this transaction is part of the amounts disclosed in Note 8. 12. EMPLOYEE BENEFIT PLANS In July 1992, the Company adopted a 401(k) savings plan. Employees employed on July 1, 1992 were automatically eligible to participate and employees hired after July 1, 1992 are eligible to participate after six months of service and attaining the age of 21. Employees may contribute up to the maximum amount which will not violate provisions 25 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 12. EMPLOYEE BENEFIT PLANS (CONTINUED) of the Plan or cause the Plan to exceed the maximum amount allowable as a deduction to the employer. The Company, at its discretion, may make matching contributions equal to a percentage of the employee's contribution. The Company did not contribute to the Plan in 1997, 1996 or 1995. 13. EMPLOYEE STOCK PURCHASE PLAN In December 1996, the Company adopted an Employee Stock Purchase Plan. Eligible employees can authorize payroll withholdings in each pay period to be designated for stock purchase. Payroll deductions cannot exceed 10% of total compensation and no more than 1,500 shares may be purchased by any one employee in one offering period. There are four three-month offering periods in each year, in which employees may purchase shares of Common Stock at the end of each three-month offering period at a price equal to 85% of the market price on the first or last day of the offering period, whichever is lower. Shares issued under the plan at December 31, 1997 were 8,711. 14. SUBSEQUENT EVENT In January 1998, the Company entered into an agreement with Instrumentation Laboratory Company (IL) for worldwide distribution of the Company's SensiCath Sensors and OpticalCAM Instruments. IL will market and distribute the Company's products throughout the world under the names GEM SensiCath and GEM OpticalCAM. The Company has agreed to supply IL with SensiCath Sensors, on an exclusive basis, through 2004 and on a non-exclusive basis through 2007. The Company has also agreed to supply IL with OpticalCAM Instruments, on a semi-exclusive basis, through 2004. The Company retains the right to sell OpticalCAM Instruments to manufacturers of physiological monitoring, ventilator and anesthesia delivery systems. IL is required to purchase sufficient quantities of products from the Company under the agreement that will result in preestablished annual minimum revenues to the Company. These quotas increase each year during the first five years of the agreement. If IL fails to meet the quota requirements, the Company has the right to convert IL's exclusive right to a non-exclusive right. If there is a change in control of the Company, the Company will have the right to convert the agreement into a non-exclusive distributorship agreement. If the Company exercises this right, IL will have the right to terminate the agreement. 26 Optical Sensors Incorporated (A Development Stage Company) Notes to Financial Statements (continued) 14. SUBSEQUENT EVENT (CONTINUED) In January 1998, the Company also sold 441,203 shares of Common Stock to IL, which represented 4.99% of the Company's outstanding Common Stock following completion of the transaction, at a price of $5.00 per share for a total price of $2,206,015. The Company granted IL and its affiliates certain pre-emptive rights to participate in future sales of equity securities by the Company, and certain demand and incidental registration rights under a registration rights agreement previously entered into by the Company and shareholders that purchased shares of stock in private transactions prior to the Company's initial public offering in February 1996. IL is prohibited from selling or otherwise transferring its shares of Common Stock for a period of one year, except to an affiliate or pursuant to the exercise of its registration rights. IL and its affiliates are also subject to certain standstill provisions for a period of five years that prohibit them from (a) acquiring more than 5.0% of the Company's outstanding Common Stock, (b) entering into a voting agreement with respect to the shares IL purchased from the Company, (c) participating in any proxy solicitation or becoming a participant in an election contest, or (d) joining a group for the purpose of acquiring, holding, voting or disposing of shares of Common Stock. 27 EX-23.1 7 CONSENT OF INDEPENDENT AUDITOR Exhibit 23.1 Consent of Ernst & Young LLP We consent to the incorporation by reference in this Annual Report (Form 10-K) of Optical Sensors Incorporated of our report dated February 12, 1998, included in the 1997 Annual Report to Shareholders of Optical Sensors Incorporated. We also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-04373) pertaining to the Optical Sensors Incorporated 1989 Omnibus Stock Option Plan and the Optical Sensors Incorporated 1993 Stock Option Plan and, in the Registration Statement (Form S-8 No. 333-17493) pertaining to the Optical Sensors Incorporated Employee Stock Purchase Plan, of our report dated February 12, 1998, with respect to the financial statements of Optical Sensors Incorporated, incorporated by reference in this Annual Report (Form 10-K) for the year ended December 31, 1997. /s/ Ernst & Young LLP Minneapolis, Minnesota March 27, 1998 EX-27.1 8 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 432,917 16,668,213 27,100 0 2,017,498 19,216,218 2,888,666 974,887 21,625,534 996,462 0 84,006 0 0 20,072,860 21,625,534 140,936 140,936 2,195,714 2,195,714 10,471,809 0 21,143 (11,333,358) 0 0 0 0 0 (11,333,358) (1.35) 0
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