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
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from
__________________________ to ____________________________
Commission file number 000-19392
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DIANON Systems, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 06-1128081
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
200 Watson Boulevard, Stratford, Connecticut 06497
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (203) 381-4000
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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None None
Securities registered pursuant to section 12(g) of the Act:
Common Stock, par value $.01 per share
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(Title of class)
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. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
As of March 16, 1998, the aggregate market value of the voting Common Stock held
by non-affiliates of the registrant was $65,341,720.
Number of shares of Common Stock outstanding as of March 16, 1998: 6,616,883
DOCUMENTS INCORPORATED BY REFERENCE
None
PART I
ITEM 1. BUSINESS
DIANON Systems, Inc. ("DIANON" or the "Company") is a provider of
anatomic pathology and clinical chemistry testing services to physicians,
patients and managed care organizations across the United States.
The Company has traditionally been a specialized laboratory with a
limited line of clinical chemistry and anatomic pathology testing services based
principally on new technology purchased or licensed from test developers. This
technology has been marketed directly to medical oncologists and urologists as
testing and information services rather than as products or test kits.
As a result of the Company's success in providing pathology services,
the mission of the Company has been expanded to include a full line of anatomic
pathology services and related information products to physicians, patients and
managed care organizations throughout the United States. The Company's principal
physician audience for these services includes approximately 50,000 clinicians
engaged in the fields of medical oncology, urology, dermatology, gynecology and
gastroenterology. The Company believes it can become one of the leading
specialized providers of anatomic pathology testing services in the United
States.
While the Company continues in its traditional role of assisting
developers of new technology and physicians evaluating such technology, it is
expected that this activity and the Company's clinical chemistry business will
represent a decreasing proportion of total revenue in future years as anatomic
pathology revenues grow.
The business of the Company is subject to a number of risks and
uncertainties that could adversely affect the Company's ability to achieve its
objectives. See "Management's Discussion and Analysis of Results of Operations
and Financial Condition - Risk Factors: Forward Looking Statements" for a
description of various factors that could have an adverse effect on the
performance of the Company.
MEDICAL TESTING MARKETS
Medical laboratories offer a broad range of testing services to the
medical profession. These testing services are used by physicians in the
diagnosis, prognosis, monitoring and general management of diseases and other
clinical conditions. The tests they use generally detect medically-significant
abnormalities and visual patterns in blood, tissue samples and other specimens.
Management divides the market for medical testing into anatomic
pathology testing and clinical chemistry testing and has set forth in very
general terms some of the major differences between them in the table below:
Anatomic Pathology Testing Clinical Chemistry Testing
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Type of Specimen Tissue or cells - usually obtained Blood or urine - usually collected
by a physician from a biopsy, Pap by a nurse (blood) or by the patient
smear, urine specimen or surgery (urine)
Technology Employed Physician interpretation of tissue Highly automated blood chemistries
slides supplemented by special and immunoassays
antibody stains, DNA probes, genetic
tests
1991 DIANON Net Revenues $ 9 million $18 million
1997 DIANON Net Revenues $44 million $17 million
2
The Company offers a complete line of anatomic pathology testing
services as well as selected clinical chemistry tests for cancer and
gynecological conditions. The Company performed all testing at its main facility
in Stratford, Connecticut until February 1, 1998, at which time it acquired a
second laboratory in Tampa, Florida. It provides most test results to physicians
within forty-eight hours. In 1996, the Company opened a specimen processing
facility at the hub of its airfreight provider in Ohio in order to prepare
certain specimens for more rapid processing when they arrive in Stratford and to
improve overall turnaround time to the physicians. No test accounted for more
than 15% of net revenues in 1997.
INFORMATION SERVICES
The Company's information services are used principally to assist the
physician in the analysis of test results and to help managed care organizations
better manage patient treatment. These services complement the Company's current
service offerings and are not a separate product category. Patient specific
reports aid the physician in analyzing multiple prognostic tests and/or
correlative trends in a patient's test results, treatment, and clinical
condition. Summary reports on all patients in a physician's practice allow the
physician to compare test results on patients with similar conditions, review
multiple patient histories, and compare his or her experience with that of
physicians across the country. Similar reports help managed care organizations
capture and compare utilization and diagnostic trends within their own
organization, with other managed care organizations and with the Company's
national database. The Company's current information services are an important
part of the Company's marketing program, and they provide important value-added
services which help the Company differentiate itself from competitors.
QUALITY ASSURANCE
The Company utilizes a unique quality control program for anatomic
pathology which provides a reduced number of equivocal results reported to
clinicians. This program is applied to all anatomic pathology specimens. By
diminishing the number of indeterminate diagnoses and providing the unequivocal
diagnosis as soon as possible, the Company enables clinicians to treat patients
sooner and more effectively while reducing overall health care costs.
The Company's quality assurance program includes adherence by employees
to the Standard Operating Procedures, continuing education and technical
training of technologists, statistical quality control of all analytical
processes, instrument maintenance, and regular inspection by governmental
agencies and the College of American Pathologists.
EUROPEAN OPERATIONS
In 1995, the Company provided for a reserve of $279,000 due to
management's decision to discontinue European based operations. Approximately
$20,000 of this reserve remains. The Company is in the final process of
liquidating the European based operations and plans to complete the liquidation
process during 1998.
REIMBURSEMENT
In 1997, 1996, and 1995, respectively, approximately 37%, 40%, and 41%
of the Company's net revenues were derived from testing performed for
beneficiaries under the Medicare and Medicaid programs, At least 90% of this
total was derived from the Medicare program. Revenues from testing performed for
other patients are derived principally from other third-party payors, including
commercial insurers, Blue Cross Blue Shield plans, health maintenance and
preferred provider organizations, patients, physicians, hospitals, and other
laboratories (who in turn usually bill non-governmental third-party payors or
patients). For many of the tests performed for Medicare or Medicaid
beneficiaries (except clinical diagnostic laboratory tests for those individuals
being treated by a hospital), laboratories are required to bill Medicare or
Medicaid directly for covered services and to accept Medicare or Medicaid
reimbursement as payment in full for such services. Management has elected, to
date, to accept reimbursement rates set by other third-party payors as payment
in full as well (apart from any co-payment which the payor has established).
Reimbursement rates for some services of the type or similar to the
type performed by the Company have been established by Medicare, Medicaid and
other third-party payors, but have not been established for all services or by
all carriers with respect to any particular service. While most carriers,
including Medicare, do not cover services they determine to be investigational,
or otherwise not reasonable and necessary for diagnosis or treatment, a formal
coverage determination is made with respect to relatively few new procedures.
3
When such determinations do occur for Medicare purposes, they most commonly are
made by the local Medicare carrier which processes claims for reimbursement
within the carrier's geographic jurisdiction. The Company receives Medicare
reimbursement primarily through a single Medicare carrier. A positive coverage
determination, or reimbursement without such determination, by one or more
third-party payors, or clearance for market by the Food and Drug Administration
("FDA"), does not assure reimbursement by other third-party payors. A few
third-party payors have denied payment for services for which the Company
receives reimbursement from other payors. On occasion, Medicare or other
third-payors have decided to cease payment for one or more of the Company's
services that historically have been reimbursed by them because such services
are performed using test kits or other products which have not received FDA
pre-market clearance or because such services may otherwise be deemed
investigational or for other reasons. Furthermore, Medicare and other
third-party payors have, on occasion, ceased reimbursement when certain tests
are ordered for patients with certain diagnoses while maintaining reimbursement
when tests are ordered for other diagnoses deemed appropriate by the carrier.
This practice recently has become more prevalent with respect to Medicare. The
Balanced Budget Act of 1997 ("BBA") requires the Secretary of the Department of
Health and Human Services ("HHS") to divide the country into no more than five
regions and designate a single Medicare carrier for each region to process
laboratory claims (except those performed by independent physicians' offices) no
later than January 1, 1999, and to adopt uniform coverage, administration, and
payment policies for lab tests using a negotiated rulemaking process by July 1,
1998. Depending on the details of how these requirements are implemented, they
could have an impact on the Company's future revenues. In general, reimbursement
disapprovals by the various carriers, reductions or delays in the establishment
of reimbursement rates, and carrier limitations on the insurance coverage of the
Company's services or the use of the Company as a service provider could have a
material adverse effect on the Company's future revenues.
Medicare Fee Schedule Payment for Clinical Chemistry Laboratory
Services. Medicare reimbursement for clinical chemistry laboratory services
constituted approximately 25%, 27% and 35% of the Company's clinical chemistry
revenues in 1997, 1996 and 1995, respectively, although this percentage trended
downward to 21% in the fourth quarter of 1997. In 1984, Congress adopted
legislation establishing a locality-specific fee schedule reimbursement
methodology with Consumer Price Index ("CPI")-related updates for clinical
diagnostic laboratory testing for non-hospital patients and hospital
out-patients under Medicare. (Payment for clinical chemistry laboratory services
performed for Medicare in-patients is included within the prospectively
determined Diagnosis Related Group rate paid to the hospital). In addition,
state Medicaid programs are prohibited from paying more than the Medicare fee
schedule amount. Beginning with the Consolidated Omnibus Budget Reconciliation
Act of 1985 ("OBRA `85"), Congress instituted a national cap on Medicare
clinical chemistry laboratory fee schedules. This national cap has been lowered
each year and now is 74% of the national median. In addition, the Omnibus Budget
Reconciliation Act of 1987 ("OBRA `87") eliminated the CPI update for 1988 and,
in succeeding years, Congress has often either limited or eliminated annual
updates of Medicare clinical chemistry laboratory fee schedules. Most recently,
the Omnibus Budget Reconciliation Act of 1993 ("OBRA `93") eliminated the update
for the years 1994 and 1995. After updates of 3.2% in 1996 and approximately
2.7% in 1997, the BBA will freeze fee schedule payments for the 1998 - 2002
period. The update limitations and changes in the national cap made to date have
not had, and are not expected by the Company to have, a material adverse effect
on the Company's results of operations. Any further significant decrease in such
fee schedules, however, could have a material adverse effect on the Company's
future revenues.
The BBA does include the addition of coverage for a yearly screening
pap smear for Medicare beneficiaries at high risk of developing cervical or
vaginal cancer and for beneficiaries of childbearing age who had not had a
negative test in each of the preceding three years, effective January, 1, 1998,
as well as coverage for annual prostate cancer screening, including a
prostate-specific antigen blood test, for beneficiaries over age 50, effective
January 1, 2000. Although most women of childbearing age and men under age 65
are not Medicare beneficiaries, the addition of Medicare coverage for these
tests could provide additional revenues for the Company.
Other changes in government and other third-party payor reimbursement
which may result from the enactment of health care reform or of deficit
reduction or balanced budget legislation also likely will continue the downward
pressure on prices and make the market for clinical laboratory services more
competitive. For example, the BBA revises the Medicare program substantially to
permit beneficiaries to choose between traditional fee-for-service Medicare and
several non-traditional Medicare options, including managed care plans and
provider-sponsored organization plans. These non-traditional Medicare plans have
considerable discretion in determining whether and how to cover and reimburse
clinical laboratory services and to limit the number of labs with which they
deal.
The BBA also includes provisions to implement competitive bidding for
certain Medicare items and services, including laboratory services, on a
three-site demonstration project basis. These changes likely would have an
4
adverse impact on the Company's revenues if adopted on a widespread basis.
Finally, the BBA contains measures to establish market-oriented purchasing for
Medicare, including prospective payment systems for outpatient hospital
services, home health care, and nursing home care. In addition, the BBA requires
consolidated billing directly by the facility for laboratory and other services
provided to residents of skilled nursing facilities effective July 1, 1998.
Although the details of how these measures will be implemented are yet to be
finalized, they probably will increase pressure on pricing in the clinical
laboratory industry and may have an adverse impact on the Company's revenues.
Because of the uncertainties about how the Medicare changes such as
those described above will be implemented, the Company currently is unable to
predict their ultimate impact on the clinical laboratory industry generally or
on the Company in particular. Even apart from federal legislative action,
reforms may occur at the state level and changes are occurring in the
marketplace as a result of market pressures, including the increasing number of
patients covered by some form of managed care. In general, these changes are
likely to put a downward pressure on price and also may act to limit access by
some laboratories to some managed care patient groups. Because of the
uncertainties about the exact nature, extent, and timing of any such changes,
however, the Company currently is unable to predict their ultimate impact on the
clinical industry generally or on the Company in particular.
Medicare Payment for Anatomic Pathology Services. In addition to
furnishing clinical chemistry laboratory testing services, the Company furnishes
a number of services which are characterized for the purposes of the Medicare
program as anatomic pathology services. Medicare reimbursement for these
services constituted approximately 40%, 45%, and 46% of the Company's net
anatomic pathology revenues in 1997, 1996, and 1995, respectively. As of January
1, 1992, all physician services, including anatomic pathology services, have
been reimbursed by Medicare based on a methodology known as the resource-based
relative value scale ("RBRVS"), which was fully phased in by the end of 1996.
Overall, anatomic pathology reimbursement rates declined during the fee schedule
phase-in period, despite an increase in payment rates for certain pathology
services performed by the Company.
The Medicare RBRVS payment for each service is calculated by
multiplying the total relative value units ("RVUs") established for the service
by a conversion factor that is set by statute. The number of RVUs assigned to
each service is in turn calculated by adding three separate components:
physician work, practice expense, and malpractice expense. Although originally
there were three conversion factors, the BBA has merged them into one effective
January 1, 1998. The new conversion factor is $36.6873, approximately an 8.4%
increase over the 1997 conversion factor applicable to pathology services.
However, due to other relatively more minor changes in the RBRVS formula for
1998, the overall impact on the payment rate for pathology services furnished by
the Company likely will be increased slightly.
In 1997, there was an overall decrease of 5.7% in payments for
pathology services due to a five-year review of the work value component and a
decrease in the 1997 conversion factor applicable to pathology services, plus an
additional decrease in Connecticut, where the Company's primary operations are
located, because of the Health Care Financing Administration's (HCFA) reduction
of the number of different payment localities recognized for RBRVS purposes.
Also in 1997, HCFA published proposed regulations that would recalculate the
practice expense RVUs to reflect resource consumption, rather than the
historical charge data used to establish the original practice expense RVUs.
Overall, HCFA's predicted impact of resource-based practice expense RVUs on
Medicare income of pathologists is an increase of 1%. Of course, the actual
impact on Medicare pathology revenues would depend on the mix of pathology
services furnished. Moreover, under the BBA, implementation of resource-based
practice expense RVUs will not begin until 1999 and will be phased in over the
period 1999 to 2002. In addition, disclosure and evaluation of the methodology
used by HCFA to support its proposal will be required prior to implementation.
In the past, the Company has been able to offset a substantial portion
of the impact of the reduced Medicare reimbursement rates for anatomic pathology
services through the achievement of economies of scale and the introduction of
alternative technologies that will not depend on reimbursement through the RBRVS
system. Despite these offsets, the substantial modifications to the physician
fee schedule in 1997, even as countered by a higher conversion factor and
possibly by the adoption of a resource-based practice expense system in 1999 to
2002, plus the still growing impact of managed care, likely will continue to
have a negative effect on the Company's average unit price. Other potential
legislative and market changes may continue this trend; however, the Company is
not able to predict the exact nature or effect of any other potential changes
affecting its reimbursement for anatomic pathology services at this time.
5
Other Developments Affecting Reimbursement. In 1997, approximately 16%
of the Company's net revenues were in the State of New York. In September, 1996,
New York passed the New York Health Care Reform Act of 1996 ("NYHCRA"). The
NYHCRA requires payors to pay an 8.18% surcharge on the services provided by a
variety of providers, including independent laboratories for services rendered
to residents of the State of New York. If the payor neglects to pay the 8.18%
surcharge directly, providers are required to collect the surcharge plus an
additional assessment of 24% for a total surcharge of 32.18%. Under the NYHCRA,
it is possible that independent labs, such as the Company, will be placed at a
competitive disadvantage with physician office labs and other labs whose
services are not subject to the surcharge. In addition, independent labs
probably will be liable for the surcharge even if the payor fails to pay the
laboratory. Moreover, payors may reduce the fees they pay for laboratory
services in order to offset the surcharge. The New York State Clinical
Laboratory Association, which brought suit against the New York State Department
of Health alleging that these provisions of NYHCRA are unconstitutional under
the United States and New York State Constitutions and should not be enforced,
is currently appealing an adverse decision on its challenge by the New York
lower court. This association also is working to amend the law. Nonetheless, the
law currently is being implemented and could have a negative impact on the
portion of the Company's net revenues derived from the State of New York.
Following a study of pricing practices in the clinical laboratory
industry, the Office of the Inspector General ("OIG") of HHS conducted a study
of such practices, and in January 1990 issued a final report. This report
addresses how these pricing practices relate to Medicare and Medicaid. The OIG
reviewed the industry's use of one fee schedule for physicians and other
professional accounts and another fee schedule for patients/third-party payors,
including Medicare, in billing for testing services, and focused specifically on
the pricing differential when profiles (or established groups of tests) are
ordered.
Existing federal law authorizes the Secretary of HHS to exclude
providers from participation in the Medicare and Medicaid programs if they
charge state Medicaid programs or Medicare fees "substantially in excess" of
their "usual charges". On January 29, 1992, in the preamble to a Final Rule
implementing program exclusion and civil money penalty authorities established
under the Medicare and Medicaid Patient and Program Protection Act of 1987, the
OIG considered but declined to provide any standards as to when charges for a
service are considered "substantially in excess" of a provider's "usual
charges". However, the OIG stated that it will continue to evaluate the billing
patterns of individuals and entities, including clinical laboratories, on a
case-by-case basis. Then on September 8, 1997, OIG proposed to amend the
exclusion rule to indicate that OIG could exclude a provider that had submitted
claims containing charges substantially in excess of their usual charges for
services furnished to any of its customers, clients or patients. Although no
final rule has as yet been published, the Company is aware that OIG has
informally indicated it will not adopt this proposed amendment. The Medicaid
laws in some states also have prohibitions related to discriminatory pricing.
The Company employs practices similar to those examined in the 1990 OIG report
discussed above in billing for its services. Depending upon the nature of any
regulatory or enforcement action taken or the content of legislation, if any,
which might be adopted to address this issue, the Company could experience a
significant decrease in revenue which could have a material adverse effect on
the Company. The legislation also provides for civil or criminal penalties or
exclusion from participation in Medicare and Medicaid. The Company is unable to
predict at this time whether any further regulatory, enforcement, or legislative
action will be taken.
In December 1992, an unrelated clinical laboratory, National Health
Laboratories, Inc., ("NHL"), pleaded guilty to submitting false medical
reimbursement claims to the United States government, and entered into a
settlement which provides for payment of over $100 million. The United States
government alleged that NHL, by marketing to physicians diagnostic test panels
which bundled, together with a routine blood chemistry series, two other tests
(ferritin and HDL cholesterol), induced physicians to order these other tests
regardless of medical necessity. While NHL's additional charge to physicians for
these two tests ordered as part of the NHL panel was nominal, NHL billed the
Medicare program for them at full price. Since 1993 and continuing to the
present, other laboratories have reached significant financial settlements with
the government in cases involving similar issues. While it is not possible to
predict how broadly the United States government may seek to expand the theory
of liability it developed in these cases, the Company believes its practices
differ materially from those at issue.
In February, 1997, the OIG released a model compliance plan for
laboratories that is based largely on the corporate integrity agreements
negotiated with the laboratories which settled the government's enforcement
actions. The Company has reviewed the model compliance plan and is adopting, or
modifying for adoption, aspects of the model plan that the Company deems
appropriate to the conduct of its business. One key aspect of the corporate
integrity agreements and the model compliance plan is an emphasis on the
responsibilities of laboratories to notify physicians that Medicare covers only
medically necessary services. These requirements, and their likely effect on
physician test ordering habits, focus on chemistry tests, especially routine
6
tests, rather than on anatomic pathology services or the non-automated tests
which make up the majority of the Company's business measured in terms of net
revenues. Nevertheless, they potentially could affect physician test ordering
habits more broadly. The Company is unable to predict whether, or to what
extent, these developments may have an impact on the utilization of the
Company's services.
The Medical Director of the Connecticut Medicare carrier to whom the
Company submits its Medicare claims has orally expressed the view that some
amount of money which the carrier has paid to the Company for certain pathology
services involving DNA measurements in prostate tumor cells (morphometric
analysis of tumor) potentially is recoverable by the carrier. (The company is
not presently submitting claims for this service.) The carrier Medical Director
has never reduced his view to writing or otherwise asserted a claim.
Accordingly, at this time, the Company cannot evaluate any such possible claim,
or the probability of assertion of any such claim.
During 1997, the Company was made aware that an agent based in the
Hartford, Connecticut branch of the U.S. Department of Health and Human Services
Office of the Inspector General ("OIG") was investigating the Company's practice
of supplying pathology specimen collection devices without charge to physician
customers as well as unspecified billing issues that had been raised by the
local medicare carrier. The Company believes that its practices with respect to
specimen collection devices were proper, and a letter describing the Company's
actions and its views regarding applicable regulations was sent by the Company
to the OIG. That letter also requested information about any billing issues of
concern to the OIG so that the Company could address them. As of the date of
this report, the Company had not received a response from or otherwise been
contacted by the OIG regarding these matters, and has not received any formal
notification regarding the matter.
Although the Company seeks to structure its practices to comply with
all applicable laws, and management believes such practices are in compliance,
uncertainty nevertheless exists as to how these matters may develop, and the
Company currently is unable to predict their impact, if any, on the Company.
While management does not believe that this matter will have a material adverse
effect on the Company's financial condition, if the carrier and/or OIG agent
were to pursue and prevail on these matters, any significant recoupment of funds
or civil or criminal penalty potentially resulting from such proceedings could
have a material adverse effect on the Company's business and its results of
operations.
COMPETITION
The Company provides services in a segment of the healthcare industry
that is intensely competitive, both with respect to clinical chemistry as well
as anatomic pathology. The Company estimates that there are over 11,500
laboratories in the United States which might be deemed actual or potential
competitors for the testing business of cancer-treating or cancer-diagnosing
physicians.
On the one hand, the anatomic pathology segment is highly fragmented
and has not yet experienced industry consolidation to any significant degree.
Competitors include physician-owned laboratories, specialized commercial
laboratories and hospital laboratories. None of these competitors have a
material share of the anatomic pathology market.
The clinical chemistry segment, on the other hand, has been
consolidated to an extent and is dominated by the three largest national
clinical laboratories in the U.S., Quest Diagnostics, Smith-Kline and Laboratory
Corporation of America. The Company estimates these competitors accounted for
more than 40% of the total non-hospital clinical laboratory market in 1997.
Their product offerings are broader and they have more substantial financial and
operational resources than the Company. Other competitors in this segment
include special-purpose clinical laboratories and manufacturers of test kits and
other diagnostic tools.
In addition to the competition for customers, there is increasing
competition for qualified personnel, particularly in the laboratory. To date,
such competition has not had an adverse impact on the Company's operations.
Significant factors that enhance the Company's ability to compete
effectively include a highly-trained and knowledgeable sales force, high quality
laboratory operations, accurate and consistent test results, quality of service
to physicians, price, and speed of turnaround for test results.
7
PATENTS AND PROPRIETARY TECHNOLOGY
To date, the Company has not relied heavily on patents or licensed
technology in its business. Tests or related diagnostic products purchased by
the Company may or may not be patented. There can be no assurance that such
tests or related products do not infringe patent rights of others. Any such
infringement could give rise to claims against the Company. Typically the
Company is not indemnified against such risks. There can be no assurance that
any issued patent upon which the Company relies directly or indirectly will
afford protection to the Company in the face of challenges to the patent's
validity.
Other private and public entities, including universities, have filed
applications for (or have been issued) patents in the Company's field and may
obtain additional patents and other proprietary rights to technology that may be
the same as or similar to that utilized by the Company. The scope and validity
of such patents, the extent to which the Company may wish or need to acquire
such rights, and the cost or availability of such rights are presently unknown.
There can be no assurance that others may not obtain access to the Company's
technology or independently develop the same or similar technology to that
utilized by the Company.
The Company believes the Year 2000 IT issues are not material and will
require minimal resources to resolve.
EMPLOYEES
On December 31, 1997, the Company had 396 full-time and 33 part-time
employees.
REGULATORY MATTERS
The Company's business is subject to governmental regulation at the
federal, state and local levels, some of which regulations are described under
"Laboratory", "Food and Drug Administration" and "Other" below.
LABORATORY
The Company's laboratory is certified or licensed under the federal
Medicare program, the Connecticut Medicaid program and the Clinical Laboratories
Improvement Act of 1967, as amended by the Clinical Laboratory Improvement
Amendments of 1988 (collectively, "CLIA '88"). Licensure is maintained under the
clinical laboratory licensure laws of Connecticut, where the Company's clinical
laboratory is located and under the laws of several other jurisdictions. The
Company believes it has obtained all material laboratory licenses required for
its operations. In addition, the laboratory is licensed by the federal Nuclear
Regulatory Commission and is accredited by the College of American Pathology.
The federal and state certification and licensure programs establish
standards for the day-to-day operation of a medical laboratory, including, but
not limited to, personnel and quality control. Compliance with such standards is
verified by periodic inspections by inspectors employed by federal or state
regulatory agencies. In addition, federal regulatory authorities require
participation in a proficiency testing program approved by the HHS for each of
the specialties and subspecialties for which a laboratory seeks approval from
Medicare or Medicaid and licensure under CLIA '88. Proficiency testing programs
involve actual testing of specimens that have been prepared by an entity running
an approved program for testing by the laboratory.
A final rule implementing CLIA `88, published by HHS on February 28,
1992, became effective September 1, 1992. This rule has been revised on several
occasions and further revision is expected in 1998. The CLIA rule covers all
laboratories in the United States, including the Company's laboratory. The
Company has reviewed its operations as they relate to CLIA, including, among
other things, the CLIA rule's requirements regarding laboratory administration,
participation in proficiency testing, patient test management (including patient
preparation, proper specimen collection, identification, preservation,
transportation, processing and result reporting), quality control, quality
assurance and personnel for the types of testing undertaken by the Company, and
believes it to be in compliance with these requirements. However, no assurances
can be given that the Company's laboratory will pass all future inspections
conducted to ensure compliance with CLIA `88 or with any other applicable
licensure or certification laws.
8
Existing federal laws governing Medicare and Medicaid, as well as some
state laws, also regulate certain aspects of the relationship between healthcare
providers, including clinical laboratories, and their referral sources,
including physicians, hospitals and other laboratories. One provision of these
laws, known as the "anti-kickback law," contains extremely broad proscriptions,
and relatively little regulatory guidance or judicial precedent exists
concerning its application. Violation of this provision may result in criminal
penalties, exclusion from Medicare and Medicaid and, as of August 5, 1997,
significant civil monetary penalties. Pronouncements from the OIG have indicated
that enforcement resources may be focused on financial arrangements between
laboratories and physicians and other purchasers of laboratory services,
including, for example, arrangements under which laboratories supply physicians'
offices with phlebotomists (blood-drawing technicians) who potentially could
perform additional tasks that normally are the responsibility of the physician
office staff. Under another provision, known as the "Stark" law or
"self-referral prohibition", physicians who have an investment or compensation
relationship with an entity furnishing clinical laboratory services (including
clinical chemistry and anatomic pathology services) may not, subject to certain
exceptions, refer clinical laboratory testing for Medicare patients to that
entity. Similarly, laboratories may not bill Medicare or Medicaid or any other
party for services furnished pursuant to a prohibited referral. Violation of
these provisions may result in disallowance of Medicare and Medicaid claims for
the affected testing services, as well as the imposition of civil monetary
penalties. On August 14, 1995, HHS published a Final Rule implementing this
prohibition on Medicare referrals. On January 9, 1998, in a proposed rule
implementing an extension of the Stark law to other (non-laboratory) services,
HHS proposed some changes in the regulation applicable to laboratories. The
Company does not expect these changes, if they are finalized, to have a major
effect on the Company. The Company seeks to structure its arrangements with
physicians and other customers to be in compliance with the anti-kickback, Stark
and state laws, and to keep up-to-date on developments concerning their
application by various means including consultation with legal counsel. However,
the Company is unable to predict how these laws will be applied in the future,
and no assurances can be given that its arrangements will not become subject to
scrutiny under them. The Company has a compliance committee which meets on a
regular basis to review various operations and relationships as well as adopt
policies.
Any exclusion or suspension from participation in the Medicare and
Medicaid programs, any loss of licensure or accreditation, or any inability to
obtain any required license or permit, whether arising from any action by HHS,
any state, or any other regulatory authority, would have a material adverse
effect on the Company's business. Any significant civil or criminal penalty
resulting from such proceedings could have a material adverse effect on the
Company's business.
FOOD AND DRUG ADMINISTRATION
The FDA does not currently regulate laboratory testing services, which
is the Company's principal business. However, the Company performs some testing
services using test kits purchased from manufacturers for which FDA premarket
clearance or approval for commercial distribution in the United States has not
been obtained by the manufacturers ("investigational test kits"). Under current
FDA regulations and policies, such investigational test kits may be sold by
manufacturers for investigational use only if certain requirements are met to
prevent commercial distribution. The manufacturers of these investigational test
kits are responsible for marketing them under conditions meeting applicable FDA
requirements. In January 1998, the FDA issued a revised draft Compliance Policy
Guide (CPG) that sets forth FDA's intent to undertake a heightened enforcement
effort with respect to investigational test kits improperly commercialized prior
to receipt of FDA premarket clearance or approval. That draft CPG is not
presently in effect but, if implemented as written, would place greater
restrictions on the distribution of investigational test kits. If the Company
were to be substantially limited in or prevented from purchasing investigational
test kits by reason of the FDA finalizing the new draft CPG, there could be
adverse effects on the Company's ability to access new technology, which could
have a material adverse effect on the Company's business.
The Company also performs some testing services using reagents, known
as analyte specific reagents ("ASRs"), purchased from companies in bulk rather
than as part of a test kit. In November 1997, the FDA issued a new regulation
placing restrictions on the sale, distribution, labeling and use of ASRs, such
as those used by the Company. Most ASRs will be treated by the FDA as low risk
devices, requiring the manufacturer to register with the agency, list its ASRs
(and any other devices), conform to current good manufacturing practice
("CGMPs"), and comply with medical device reporting of adverse events. A smaller
group of ASRs, primarily those used in blood banking and/or screening for fatal
contagious diseases (e.g., HIV / AIDS), will be treated as higher risk devices
requiring premarket clearance or approval from the FDA before commercial
distribution is permitted. The imposition of this new regulatory framework on
ASR sellers may reduce the availability or raise the price of ASRs purchased by
the Company. In addition, when the Company performs a test developed in-house,
using reagents rather than a test kit cleared or approved by the FDA, it will be
9
required to disclose those facts in the test report. However, by clearly
declining to impose any requirement for FDA premarket approval or clearance for
most ASRs, the new rule removes one barrier to reimbursement for tests performed
using these ASRs. In light of all the foregoing factors, it is impossible to
predict exactly how the new regulation will affect the Company's business, and
thus there can be no assurance that the new ASR regulation will not have a
material adverse effect on the Company's business.
OTHER
Certain federal and state laws govern the handling and disposal of
medical specimens, infectious and hazardous wastes and radioactive materials.
Failure to comply with such laws could subject an entity covered by these laws
to fines, criminal penalties and/or other enforcement actions.
Pursuant to the Occupational Safety and Health Act, laboratories have a
general duty to provide a work place to their employees that is safe from
hazard. Over the past few years, the Occupational Safety and Health
Administration ("OSHA") has issued rules relevant to certain hazards that are
found in the laboratory. In addition, OSHA recently has promulgated final
regulations containing requirements healthcare providers must follow to protect
workers from bloodborne pathogens. Failure to comply with these regulations,
other applicable OSHA rules or with the general duty to provide a safe work
place could subject an employer, including a laboratory employer, to substantial
fines and penalties.
ITEM 2. PROPERTIES
The Company leases approximately 90,850 square feet of office and
laboratory space in Stratford, Connecticut and Wilmington, Ohio. For the
Stratford, Connecticut facilities, one lease expires in May 2003 and contains an
option to renew for up to three years and the other is on a year-to-year basis.
The lease for the Wilmington, Ohio facility has a five year term
commencing April 1, 1996 and a renewal option for five additional terms of three
years each.
The Company also leases four regional sales offices located in Florida,
North Carolina, Texas and Ohio. The terms of the leases range from one to three
years.
On February 1, 1998, the Company acquired certain assets of a pathology
laboratory located in Tampa, Florida, and in connection therewith, entered into
a lease for an office and laboratory facility for a five-year term commencing
January 31, 1998 with an option to renew for an additional five-year period. In
addition, the Company assumed leases for four branch offices in Florida with
remaining terms of up to two years.
(See Note 4 to the Company's consolidated financial statements included
herewith).
ITEM 3. LEGAL PROCEEDINGS
On November 19, 1997, a suit was filed against the Company in the
United States District Court, District of South Carolina (Frances P. Hadden v.
DIANON Systems, Inc.). The complaint alleges, among other things, medical
malpractice due to an incorrect diagnosis and seeks $10 million in damages. The
case has been forwarded to the Company's insurance carrier, which has
acknowledged that coverage is available for any costs incurred or amount paid by
the Company in connection with the suit, subject to policy deductibles and
limits. In the opinion of management, based upon the availability of insurance
and other considerations, this suit should not have a material adverse effect on
the Company.
There are no other known material legal proceedings against the
Company.
10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 30, 1997, the Company held its 1997 Annual Meeting of
Shareholders at which the following actions were approved: directors were
elected and the appointment of Arthur Andersen, LLP ("Arthur Andersen") as the
Company's independent public accountants for the calendar year ended December
31, 1997 was ratified. At the 1997 Annual Meeting of Shareholders, Messrs. Kevin
C. Johnson, John P. Davis, E. Timothy Geary, G.S. Beckwith Gilbert and Jeffrey
L. Sklar, and Dr. James B. Amberson were elected as directors of the Company.
The table below represents the votes cast:
Director In Favor Withheld
-------- -------- --------
James B. Amberson, M.D. 6,429,430 12,800
John P. Davis 6,420,534 21,696
E. Timothy Geary 6,429,330 12,900
G.S. Beckwith Gilbert 6,429,430 12,800
Kevin C. Johnson 6,424,842 17,388
Jeffrey L. Sklar 6,429,430 12,800
The other action taken at the Company's 1997 Annual Meeting of
Shareholders, to ratify appointment of Arthur Andersen as the Company's
independent public accountant for the calendar year ending December 31, 1997,
had the following votes cast:
For Withheld Absentions
--- -------- ----------
6,426,232 11,498 4,500
11
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
DIANON's Common Stock trades on The Nasdaq Stock Market under the
symbol "DIAN". The following table shows the high and low sales prices of the
Company's Common Stock quoted on The Nasdaq Stock Market, for the periods
indicated below:
High Low
---- ---
1996:
First Quarter $5-1/2 $3-3/8
Second Quarter 8-5/8 4-1/8
Third Quarter 7-3/8 4-1/2
Fourth Quarter 9-5/16 6-3/8
1997:
First Quarter 12-1/2 8-1/8
Second Quarter 10-1/2 8-3/8
Third Quarter 10-3/8 7-3/4
Fourth Quarter 10 7-1/2
As of March 16, 1998, the Company had approximately 2,676
shareholders of record. No dividends have been paid by DIANON and it is not
anticipated that any will be paid in the foreseeable future.
12
ITEM 6. SELECTED FINANCIAL DATA
STATEMENT OF OPERATIONS:
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(in thousands, except per share data)
-------------------------------------
Net revenues $60,887 $56,000 $45,700 $41,017 $38,250
Gross profit 29,766 29,101 25,310 24,300 24,311
Expenses:
Selling, general and
administrative expenses (1) 22,912 22,443 19,620 17,505 18,817
Research and development 1,666 3,157 5,255 4,512 4,342
------------- --------------- ------------- -------------- --------------
Income from operations 5,188 3,500 435 2,283 1,152
Net interest income (expense) 523 307 181 (90) (36)
Provision for income taxes (2) 2,413 1,637 509 832 270
============= =============== ============= ============== ==============
Net income $ 3,298 $ 2,170 $ 107 $ 1,361 $ 846
============= =============== ============= ============== ==============
EPS:
Basic $ .51 $ .35 $ .02 $ .26 $ .16
Diluted $ .48 $ .35 $ .02 $ .26 $ .16
Weighted average shares outstanding
Basic 6,430 6,151 5,542 5,297 5,246
Diluted 6,808 6,287 5,549 5,308 5,329
BALANCE SHEET DATA:
Working capital $21,387 $18,058 $16,974 $11,931 $11,110
Total assets 36,889 34,536 30,455 25,206 24,614
Long-term obligations 107 272 750 1,674 2,519
Stockholders' equity (3) 29,046 26,549 23,452 18,664 17,147
(1) During 1997, 1996, 1995, 1994 and 1993, non-recurring charges relating to
severance, restructuring, accelerated amortization and other one-time
costs of $324,000, $609,000, $2,668,000, $692,000 and $2,542,000,
respectively, were incurred. (See Notes 2, 7, 10 and 12 to the Company's
consolidated financial statements included herewith).
(2) The Company's provision for income taxes in 1995, 1994 and 1993 includes
the benefit received from the utilization of tax credits. (See Note 3 to
the Company's consolidated financial statements included herewith).
(3) No dividends were paid by the Company during the periods presented above.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
The Company's results of operation over the three-year period ended
December 31, 1997 reflects its investment in and movement toward an anatomic
pathology strategy. Several initiatives begun in 1995 and prior years, such as
operational restructurings and capital investments to build the anatomic
pathology product line, came to fruition in 1996 and 1997 and resulted in a
dramatic improvement in the Company's profitability.
RESULTS OF OPERATIONS
o NET REVENUES
Net revenues increased to $60.9 million in 1997 from $56.0 million in
1996 and $45.7 million in 1995, representing annual increases of 8.7% and 22.5%,
respectively. The strong revenue growth reflects the Company's increased
penetration in the anatomic pathology segment, offset somewhat by reimbursement
pressures (primarily impacting the clinical chemistry segment) and somewhat
reduced volume in clinical chemistry and hospital-based tissue testing services.
o COST OF SALES
Cost of sales, which consists primarily of payroll, laboratory
supplies, outside services, logistics (shipping and handling) and depreciation
expense, increased to $31.1 million in 1997 from $26.9 million in 1996 and $20.4
million in 1995. As a percentage of sales, cost of sales totaled 51.1%, 48.0%
and 44.6%, respectively. The increasing percentage of revenue represented by
cost of sales largely reflects the Company's strategic focus on anatomic
pathology. This market segment requires a larger laboratory work force,
resulting in an increase in salaries and wages from $6.1 million in 1995 to $8.7
million in 1996 and further to $10.9 million in 1997. In addition, overhead
expenses (primarily building rent, utilities, and depreciation) increased from
$5.5 million in 1995 to $7.9 million in 1996 and $9.0 million in 1997. These
increases reflect additional facilities expenses associated with the
introduction of the anatomic pathology line, and more specifically the initial
expansion and equipping of the Company's facilities in 1996. Logistics expenses
rose to $5.8 million in 1997 from $4.6 million in 1996 and $4.0 million in 1995
due to increased volume. Cost of lab supplies decreased modestly to $5.4 million
in 1997 from $5.7 million in 1996, after increasing from $4.8 million in 1995
due to higher volume and increased costs for reagents used in certain of the
Company's testing services. However, as a percentage of sales, the cost of lab
supplies decreased over the period from 10.5% in 1995 to 8.8% in 1997.
o GROSS PROFIT
Gross profit totaled $29.8 million in 1997 versus $29.1 million in 1996
and $25.3 million in 1995, while gross profit margins were 48.9%, 52.0% and
55.4% respectively. The increase in anatomic pathology sales as a percentage of
total sales results in higher average unit pricing with lower gross margin
percentages, due to the higher costs associated with providing these services.
Gross margins have been further reduced due to the erosion of the average price
reimbursed for certain clinical chemistry testing services.
The clinical laboratory industry, which includes both clinical
chemistry and anatomic pathology, has seen steady and continuing downward
pressure on prices exerted by both government and private third party payors.
Also, payment for services such as those provided by the Company is and likely
will continue to be affected by periodic reevaluations made by payors concerning
which services to reimburse and which to cease reimbursing.
The reduction in reimbursement rates, particularly by Medicare,
generally has decreased the average unit price for most of the Company's
clinical chemistry services each year. In keeping with this trend, as part of
OBRA `93 and the BBA, Congress reduced over time the national cap on Medicare
laboratory fee schedules (under which the Company's clinical chemistry services
are reimbursed). This national cap has been lowered each year and now is 74% of
the national median. OBRA `93 also eliminated the annual updates of Medicare
laboratory fee schedules for the years 1994 and 1995. After updates of 3.2% in
1996 and approximately 2.7% in 1997, the BBA freezes fee schedule payments for
the 1998 - 2002 period.
14
With respect to the Company's anatomic pathology services, which are
not reimbursed under the Medicare laboratory fee schedules, the Medicare fees
for these services also generally declined with the implementation of the RBRVS
system which went into effect in 1992 and was fully phased in by the end of
1996. In 1997, there was an overall decrease of 5.7% in payments for pathology
services due to a five-year review of the work value component and a decrease in
the 1997 conversion factor applicable to pathology services, plus an additional
decrease in Connecticut, where the Company's primary operations are located,
because of the Health Care Financing Administration's (HCFA) reduction of the
number of different payment localities recognized for RBRVS purposes. Although
the conversion factor (which is a component of the reimbursement calculation)
increased by 8.4% in 1998, the overall impact on the Company's revenues will be
only modestly positive due to, among other factors, other changes in the RBRVS
formula in 1998.
Other changes in government and other third-party payor reimbursement,
which may come about as a consequence of enactment of health care reform or of
deficit reduction or balanced budget legislation, are also likely to continue
the downward pressure on prices and make the market for clinical laboratory
services more competitive. The provisions of the BBA that permit beneficiaries
to select non-traditional Medicare plan options, implement competitive bidding
for certain Medicare items and services, and establish market-oriented
purchasing for Medicare, previously described in the reimbursement section, are
examples. Because of the uncertainties about how these Medicare changes will be
implemented, the Company currently is unable to predict their ultimate impact on
the clinical laboratory industry generally or on the Company in particular.
Even apart from federal legislative action, reforms may occur at the
state level and changes are occurring in the marketplace as a result of market
pressures, including the increasing number of patients covered by some form of
managed care. In the past, the Company has offset a substantial portion of the
impact of price decreases and coverage changes through the achievement of
economies of scale and other strategies such as more favorable purchase
contracts and the introduction of alternative technologies. However, if price
decreases (for example arising from the Medicare changes discussed above) or
coverage changes were to be rapidly and fully implemented, they would be likely
to have an adverse impact on gross profits from the Company's testing services
until management was able to mitigate such impact. Furthermore, in recent years
the Company's gross profit margin has trended down from over 55% to 47%, and
there can be no assurances that such trends may not continue.
See also discussion under "Business-Reimbursement."
o SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased from $19.6
million in 1995 to $22.4 million in 1996, with another modest increase in 1997
to $22.9 million. As a percentage of sales, selling, general and administrative
expenses decreased over the period from 42.9% in 1995 to 37.6% in 1997, as the
Company began to realize operating leverage in this area. Selling expenses were
$10.1 million in 1997, or 16.7% of sales, versus $10.6 million in 1996 and $9.7
million in 1995, or 19.0% and 21.2% of sales, respectively. The decrease in
selling expenses was offset somewhat by growth in general and administrative
expenses.
In addition, 1995 reflects the impact of several charges of a
non-recurring nature recorded by the Company, including: i) a $765,000
accelerated amortization charge based on management's estimate of future
benefits anticipated from a customer list; ii) a severance charge of $595,000
resulting from the streamlining of operating expenses and the resignation of
certain officers of the Company; iii) a $530,000 write-down of an investment in
common stock of a publicly-traded company (which was subsequently written-off in
1996 with a $62,000 charge); and iv) a $279,000 restructuring provision related
to management's decision to discontinue the Company's European-based operations.
o RESEARCH AND DEVELOPMENT
Research and development expenses decreased from $5.3 million in 1995
to $3.2 million in 1996 and $1.7 million in 1997. The higher expense in 1995 and
1996 reflects the costs associated with launching the anatomic pathology testing
services, including the cost of building the Company's database. The reduction
in 1997 reflects the completion of this launch, and the resulting expense
primarily represents the Company's continuing evaluation of existing and new
technologies.
15
o INCOME FROM OPERATIONS
Income from operations increased from approximately $435,000 in 1995 to
$3.5 million in 1996 and $5.2 million in 1997, reflecting the factors discussed
above and especially the Company's investment in, and shift toward, an anatomic
pathology strategy.
o NET INTEREST INCOME
Net interest income grew to $522,000 in 1997, from $307,000 in 1996 and
$181,000 in 1995. This reflects the increased cash and cash equivalent position
of the Company over the period, partially resulting from cash generated by
operations and partially resulting from the private placement in 1995 as further
described in Note 13 of the Consolidated Financial Statements included elsewhere
herein.
o PROVISION FOR INCOME TAXES
The provision for income taxes increased from $509,000 in 1995 to $1.6
million in 1996 and $2.4 million in 1997, reflecting the increased profitability
of the Company. The effective tax rate was 82.6%, 43.0% and 42.2%, respectively,
with the high tax rate in 1995 reflecting the non-deductibility of certain
charges, primarily the aforementioned investment write-down of $530,000.
o NET INCOME
Net income increased 52% to $3.3 million in 1997, from $2.2 million in
1996 and $107,000 in 1995. The dramatic profitability improvements reflect the
Company's investment in and shift toward an anatomic pathology strategy.
Basic earnings per share increased 45.7% in 1997 to $0.51 per share,
from $0.35 per share in 1996 and $0.02 per share in 1995. Diluted earnings per
share increased 37.1% in 1997 to $0.48 per share, from $0.35 per share in 1996
and $0.02 per share in 1995.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had total cash and cash equivalents
of $12.4 million, substantially all of which was invested in a fund holding U.S.
Treasury securities with maturities of less than three months. Working capital
was $21.4 million versus $18.1 million as of December 31, 1996, and the current
ratios were 3.8:1 and 3.4:1, respectively.
Accounts receivable (net of allowances) totaled $14.4 million as of
December 31, 1997 representing approximately 90 days of average sales, compared
to $15.4 million as of December 31, 1996 or 79 days of average sales. The
increase in days sales outstanding is a result of growth in the anatomic
pathology segment and its associated billing complexity which results in a
higher DSO.
Capital expenditures for 1997, 1996 and 1995 were $1.9 million, $3.4
million and $2.3 million, respectively. Expenditures in 1997 primarily related
to the expansion of the Company's laboratory facilities and the purchase of a
new mainframe computer system.
Effective February 17, 1998, the Company entered into a three-year, $15
million line of credit agreement with a bank. The agreement includes various
financial covenants.
On October 5, 1995 the Company completed a $5.6 million private
placement with an investor for one million shares of Common Stock and a two-year
warrant for 800,000 shares. Proceeds (net of expenses) from the placement of the
shares and the exercise of the warrants approximated $4.7 million in 1995 and
$4.0 million in 1996. See Note 13 of the Consolidated Financial Statements
contained elsewhere herein.
As of December 31, 1997, the Company has purchased 197,617 shares of
Common Stock as required by its Employee Stock Purchase Plan ("ESPP"). The
Company's Board of Directors has authorized the expenditure of up to $2 million
for additional share repurchases.
16
The Company believes that cash flows from operations and available cash
and cash equivalents are adequate to fund the Company's operations for the
foreseeable future.
Risk Factors; Forward Looking Statements
The Management's Discussion and Analysis and the information provided
elsewhere in this 10K (including, without limitation, in the third and fourth
paragraphs of "Item 1. Business" and under "Gross Profit" and "Liquidity and
Capital Resources" above) contain forward looking statements regarding the
Company's future plans, objectives, and expected performance. These statements
are based on assumptions that the Company believes are reasonable, but are
subject to a wide range of risks and uncertainties, and a number of factors
could cause the Company's actual results to differ materially from those
expressed in the forward-looking statements referred to above. These factors
include, among others, the uncertainties in reimbursement rates and
reimbursement coverage of various tests sold by the Company to beneficiaries of
the Medicare program (see e.g. Item 1 - Business "Reimbursement"); being deemed
to be not in compliance with Federal or state regulatory requirements (see e.g.
Item 1 - Business - "Regulatory"); the uncertainties relating to the ability of
the Company to convince physicians and/or managed care organizations to use the
Company as a provider of anatomic pathology testing services; the ability of the
Company to maintain superior quality relative to its competitors; the ability of
the Company to maintain its hospital-based business in light of the competitive
pressures and changes occurring in hospital healthcare delivery; the
uncertainties relating to states erecting barriers to the performance of
anatomic pathology testing by out-of-state laboratories; the ability of the
Company to find, attract and retain qualified management and technical
personnel; the uncertainties associated with competitive pressures from the
large national laboratories, small specialized laboratories and well established
local pathologists; and the uncertainties which would arise if integrated
delivery systems closed to outside providers emerged as the dominant form of
health care delivery.
17
PART III
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and schedule and the
reports of independent public accountants thereon appear beginning on page F-2.
See index to such consolidated financial statements and schedules and reports on
page F-1.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following information with respect to the principal occupation or
employment, other affiliations and business experience of each director and
executive officer during the last five years has been furnished to the Company
by such director or executive officer. Except as indicated, each of the
directors and executive officers has had the same principal occupation for the
last five years.
INFORMATION REGARDING DIRECTORS
Set forth below is certain information concerning each director of
Dianon Systems, Inc.
Kevin C. Johnson, age 43, a Director since May 1996, is President and
Chief Executive Officer of the Company. Mr. Johnson joined Dianon as President
in May 1996, and was appointed to the additional position of Chief Executive
Officer in February 1997. Formerly, Mr. Johnson was with Corning Inc., a
manufacturer of specialty materials and a provider of laboratory services, for
eighteen years, serving most recently as Vice President and General Manager of
Corning Clinical Laboratories' Eastern region in Teterboro, New Jersey.
John P. Davis, age 56, a Director since 1984, is President and Chief
Executive Officer of Infant Advantage, Inc., a child development company since
December 1997. From May 1995 through December 1997, Mr. Davis was President and
Chief Executive Officer of Calypte Biomedical Corp., a diagnostic products
company. From 1984 to January 1995, Mr. Davis was an officer of the Company. Mr.
Davis joined the Company in January 1984 as President and Chief Operating
Officer, and subsequently became co-Chief Executive Officer in 1992 and Chief
Executive Officer in 1994. In January 1995, Mr. Davis resigned as Chief
Executive Officer of the Company and became Vice Chairman of the Board. As of
February 1997, Mr. Davis was elected non-executive Chairman of the Board. Mr.
Davis also serves as Chairman of the Board of CytoLogix, Inc.
James B. Amberson, age 46, a Director since January 1995, is Senior
Vice President and Chief Medical Officer of the Company. Dr. Amberson joined
Dianon in 1989 as Director, Cytometry Business Unit, and has served as Vice
President of Pathology Services, Vice President of Medical Affairs and Senior
Vice President and General Manager of the Anatomic Pathology Unit before his
present position. Prior to joining the Company, Dr. Amberson was Assistant
Professor of Pathology, Cornell University Medical College for six years. Dr.
Amberson holds an MD from Johns Hopkins University and an MBA from Columbia
University School of Business.
Bruce K. Crowther, age 46, a Director since December 1997, is President
and Chief Executive Officer of Northwest Community Healthcare, Northwest
Community Hospital, In Arlington Heights, Illinois and certain of its affiliates
since January 1992. Mr. Crowther is a Fellow of the American College of
Healthcare Executives, Chairman of the Board of the Illinois Hospital and
HealthSystems Association and serves on the Board of both Chicago Hospital Risk
Pooling Program and Barrington Bank and Trust. Mr. Crowther received an M.B.A.
from Virginia Commonwealth University Medical College in Richmond, VA.
E. Timothy Geary, age 46, a Director since June 1997, is Chairman,
President and Chief Executive Officer of National Surgery Centers, Inc. of
Chicago, Illinois, the leading independent owner and operator of ambulatory
surgery centers in the country. Prior to founding National Surgery Centers in
1987, Mr. Geary served as a Vice President with Medical Care International. Mr.
Geary is a member of the Board of Directors of the Federated Ambulatory Surgery
Association. Mr. Geary holds an MBA and BA from the University of Chicago.
18
G. S. Beckwith Gilbert, age 56, a Director since October 1995, is
President, Chief Executive Officer and a Director of Field Point Capital
Management Company in Greenwich, Connecticut, a merchant banking firm. Mr.
Gilbert is also a partner of Wolsey & Co., a merchant banking firm. In addition,
Mr. Gilbert is Chairman of the Board and a Director of Megadata Corporation as
well as a Director of Davidson Hubeny Brands, Inc., Kionix, Inc. and
Transgenomic, Inc. Mr. Gilbert is a graduate of Princeton University and holds
an MBA from New York University. In February 1997, the Board elected Mr. Gilbert
Chairman of the Executive Committee.
Jeffrey L. Sklar, age 50, a Director since 1994, is Professor of
Pathology, Harvard Medical School, and Director, Divisions of Diagnostic
Molecular Biology and of Molecular Oncology, Department of Pathology, Brigham
and Women's Hospital. Dr. Sklar has served on numerous editorial boards and has
consulted widely to the biotechnology industry. In addition, Dr. Sklar serves on
the Scientific Advisory Committee for Clinical Science, The Fred Hutchinson
Cancer Center, Seattle, Washington; the Scientific Advisory Committee, New
England Primate Research Center, Harvard University; the External Review
Committee, Dana-Farber Cancer Institute, Boston, and the Pathology B Study
Section, National Institutes of Health. Dr. Sklar also serves as a Director of
Transgenomic, Inc. and holds an MD and Ph.D. from Yale University and an MA
(honorary) from Harvard University.
COMPENSATION OF DIRECTORS
Directors who are not employees of the Company are paid $1,500 for each
meeting of the Board of Directors attended in person and $500 for each meeting
attended by telephone, and committee members are paid $500 for each committee
meeting attended which does not occur on the same day as a Board meeting.
Directors are also reimbursed for expenses to attend meetings of the Board and
its committees. In addition, the Company has made payments to Brigham & Women's
Hospital, Inc., for which Dr. Sklar is director, Division of Diagnostic
Molecular Biology, Department of Pathology. See "Compensation Committee
Interlocks and Insider Participation."
Commencing January 1, 1998, Mr. Davis and Mr. Gilbert, in connection
with their capacities as non-Executive Chairman of the Board and Chairman of the
Executive Committee, respectively, also receive $50,000 annually (payable
monthly at $4,166) and an annual grant of 3,000 stock options, at a price equal
to the market value on the date of grant, pursuant to the Company's 1996 Stock
Incentive Plan. They each also received a one-time grant of 13,000 stock options
in December 1997 pursuant to this same plan, in connection with their services
in the aforementioned positions during 1997.
Pursuant to the Company's 1996 Stock Incentive Plan, Directors who are
not employees of the Company receive (i) automatic initial and quarterly grants
of stock options with tandem limited stock appreciation rights beginning July
1995, (ii) automatic quarterly grants of shares of Common Stock beginning
January 1997 and (iii) additional stock options or other awards to the extent
granted by the Board of Directors in its discretion.
Each initial and quarterly stock option which is automatically granted
under such plan is exercisable for that number of shares obtained by dividing
$5,000 by the closing price of the Common Stock on the date of grant and is
exercisable at that price. Each such option has a 10-year term and vests with
respect to 10% of the underlying shares on the date which is three months after
the date of grant, and an additional 10% at the end of each three-month period
thereafter. Each such option can be exercised for five years following a
director's termination of service to the extent it had vested prior to
termination. Each automatic quarterly stock grant is for the number of shares
obtained by dividing $2,000 by the closing price of the Common Stock on the date
of grant, and is fully vested at grant.
In November 1996, pursuant to authorization by the Board of Directors,
the Company granted to Dr. Sklar an option to purchase 10,000 shares of Common
Stock at an exercise price of $6.375 to compensate him for his services as a
Director. Such option vests 40% on grant, and an additional 20% on each of
August 4, 1997, August 4, 1998 and August 4, 1999. Such grant is a replacement
of an option to purchase 10,000 shares of Common Stock authorized by the Board
in 1994, but not accepted by Dr. Sklar at that time due to the conditions of his
employment by Brigham & Women's Hospital, Inc. In October 1996, pursuant to
authorization by the Board of Directors, the Company granted an option to
purchase 10,000 shares of Common Stock at an exercise price of $7.125 per share
to a director in replacement of options issued in June 1993 which had the same
exercise price, were due to expire in June 2000 and were 80% vested as of June
4, 1997 with the remaining 20% vesting on June 4, 1998. These replacement
options vested 100% in October 1996 and expire ten years from the date of grant.
19
Mr. Johnson and Dr. Amberson, who are employees of the Company, receive
no additional compensation for their services as Directors of the Company.
INFORMATION REGARDING EXECUTIVE OFFICERS
James T. Barry, age 36, has served as Vice President, Marketing and
Technology since December 1996. Mr. Barry joined the Company in July 1989 as
Corporate Recruiter and subsequently served as Director of Managed Care. Before
joining the Company, Mr. Barry was a major in the U.S. Marine Corps. Mr. Barry
holds a BA from Rhode Island College.
Steven T. Clayton, age 31, has served as Vice President, Information
Services since he joined the Company in December 1996. Prior to joining the
Company, Mr. Clayton was with Corning Clinical Laboratories for nine years
serving most recently as the Midwest Regional Director of Information Systems.
Mr. Clayton holds an ASM from Thomas Edison State College.
John S. Fanuko, age 38, has served as Vice President, Finance and
Corporate Controller since January 1998 when he joined the Company. Formerly,
Mr. Fanuko was Senior Vice President and Chief Financial Officer of American
Vision Centers, Inc. from June 1994 through January 1998, and prior to that, a
Senior Manager at Ernst & Young LLP. Mr. Fanuko holds an MBA from New York
University and a BS from Manhattan College and is a Certified Public Accountant.
David R. Schreiber, age 38, has served as Senior Vice President,
Finance, Chief Financial Officer and Corporate Secretary since November 1996
when he joined the Company. Formerly, Mr. Schreiber was with Corning Clinical
Laboratories, a provider of laboratory services, for 10 years, serving most
recently as Vice President and General Manager of the laboratory's Midwest
region. Mr. Schreiber holds an MBA from Northern Illinois University.
Martin J. Stefanelli, age 37, has served as Vice President, Laboratory
Operations since May 1997. Mr. Stefanelli joined the Company in January 1990 as
a Sales Representative and subsequently served as Logistics Manager, Marketing
Manager and Director of Operations, Anatomic Pathology. Before joining the
Company, Mr. Stefanelli was a captain in the U.S. Army. Mr. Stefanelli holds a
BS from the United States Military Academy.
For information with respect to Mr. Johnson and Dr. Amberson, who are
also directors, see ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- - Information Regarding Directors.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors and executive officers, and persons who own more than ten
percent of a registered class of the Company's equity securities, to file with
the Securities and Exchange Commission initial reports of ownership and reports
of changes in ownership of Common Stock and other equity securities of the
Company. Officers, directors and greater than ten percent shareholders are
required to furnish the Company with copies of all Section 16(a) forms they
file.
To the Company's knowledge, based solely on review of the copies of
such reports furnished to the Company and representations that no other reports
were required during the fiscal year ended December 31, 1997, all Section 16(a)
reporting requirements applicable to its officers, directors and greater than
ten percent beneficial shareholders were complied with except for the following:
Mr. Stefanelli who was late in filing his initial Form 3 when becoming subject
to the Section 16 reporting requirements and Mr. Verfurth (formerly Vice
President of Sales) filed one late report with respect to one transaction.
20
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information with respect to the
following named executive officers: (i) the person who served as Chief Executive
Officer ("CEO") during 1997, (ii) the four executive officers other than the CEO
serving at December 31, 1997 whose total salary and bonus for 1997 exceeded
$100,000, and (iii) one additional executive officer who terminated employment
with the Company during 1997.
SUMMARY COMPENSATION TABLE
Long Term
Annual Compensation Compensation
----------------------------------------- --------------
Other Securities
Name and Annual Underlying All Other
Principal Position Year Salary Bonus Compensation Options Compensation
------------------ ---- ------ ----- ------------ ------- ------------
Kevin C. Johnson (1) 1997 $281,939 $82,378 $ -- -- $158,360 (3)
President, Chief Executive 1996 174,520 94,000 (2) -- 200,000 1,507
Officer and Director
James B. Amberson, M.D. 1997 238,790 35,451 -- 20,000 2,630 (4)
Senior Vice President, 1996 200,013 47,869 -- 15,000 2,530
Operations and Chief Medical 1995 185,465 36,997 -- 25,000 2,104
Officer and Director
James T. Barry 1997 118,666 20,862 -- 15,000 604 (5)
Vice President, Marketing and 1996 85,000 20,000 -- 20,000 84
Technology 1995 75,000 11,934 -- 5,000 84
Steven T. Clayton (6) 1997 120,000 35,568 -- 15,000 73,073 (8)
Vice President, Information 1996 6,923 14,000 (7) -- 15,000 --
Services
David R. Schreiber (9) 1997 191,170 65,702 -- 20,000 149,167 (11)
Senior Vice President Finance, 1996 29,231 80,000 (10) -- 50,000 1,742
Chief Financial Officer and
Corporate Secretary
Richard A. Sandberg (12) 1997 228,775 -- -- -- 5,007 (13)
Chairman of the Board 1996 212,500 20,000 -- -- 3,681
1995 212,500 36,975 -- -- 3,681
21
(1) Mr. Johnson joined the Company as President in May 1996 and was appointed
to the position of Chief Executive Officer in February 1997.
(2) $50,000 of the $94,000 indicated for Mr. Johnson represents a sign-on bonus
he received when he joined the Company in May 1996.
(3) The $158,360 indicated for Mr. Johnson represents a stock grant of 15,000
shares of Common Stock on January 2, 1997 at a market value of $8.50 per
share, relocation costs, contributions paid by the Company pursuant to the
Company's 401(K) Retirement Plan and premiums paid by the Company for term
life insurance which for 1997 amounted to $127,500, $27,725, $1,600 and
$1,535, respectively.
(4) The $2,630 indicated for Dr. Amberson represents contributions paid by the
Company pursuant to the Company's 401(K) Retirement Plan and premiums paid
by the Company for term life insurance which for 1997 amounted to $1,600
and $1,030, respectively.
(5) The $604 indicated for Mr. Barry represents contributions paid by the
Company pursuant to the Company's 401(K) Retirement Plan and premiums paid
by the Company for term life insurance which for 1997 amounted to $520 and
$84, respectively.
(6) Mr. Clayton joined the Company as Vice President, Information Systems in
December 1996.
(7) The $14,000 indicated for Mr. Clayton represents a sign-on bonus he
received when he joined the Company in December 1996.
(8) The $73,073 indicated for Mr. Clayton represents relocation costs and
premiums paid by the Company for term life insurance which for 1997
amounted to $72,989 and $84, respectively.
(9) Mr. Schreiber joined the Company as Senior Vice President, Finance, Chief
Financial Officer and Corporate Secretary in November 1996.
(10) The $80,000 indicated for Mr. Schreiber represents a sign-on bonus he
received when he joined the Company in November 1996.
(11) The $149,167 indicated for Mr. Schreiber represents a stock grant of 7,500
shares of Common Stock on April 1, 1997 at a market value of $8.75 per
share, relocation costs and premiums paid by the Company for term life
insurance which for 1997 amounted to $65,625, $83,458 and $84,
respectively.
(12) Mr. Sandberg ceased serving as Chief Executive Officer of the Company in
May 1996, but continued to serve as an employee holding the title Chairman
of the Board until February 1997 when he resigned as Chairman of the Board
and as an officer of the Company. Mr. Sandberg continued to serve as a
Director of the Company until the Company's Annual Meeting in October 1997.
In connection with his resignation in February 1997, the Company and Mr.
Sandberg entered into an Agreement whereby Mr. Sandberg was employed by the
Company as a consultant to the President until February 1998, when his
employment terminated with the Company.
(13) The $5,007 indicated for Mr. Sandberg represents contributions paid by the
Company pursuant to the Company's 401(K) Retirement Plan and premiums paid
by the Company for term life insurance which for 1997 amounted to $1,600
and $3,407, respectively.
22
EMPLOYMENT AND SEVERANCE AGREEMENTS
The Company entered into an employment agreement with Mr. Johnson on
May 2, 1996. The agreement provides for Mr. Johnson to serve as President of the
Company at an initial base salary of $275,000 per annum, the grant of options to
purchase 200,000 shares of Common Stock with a 10-year term and an exercise
price of $5.69, stock grants of 15,000 shares of Common Stock on January 2, 1997
and 15,000 additional shares on January 2, 1998 provided Mr. Johnson continues
to be employed with the Company on such date, a signing bonus of $50,000 and a
loan of $150,000. The loan carries an interest rate of 5.9%, payable annually,
and is repayable upon termination of Mr. Johnson's employment with the Company.
If Mr. Johnson continues to be employed with the Company, the loan principal
will be forgiven at the rate of $2,500 per completed month of employment from
January 31, 1998 through December 31, 2002. This agreement provides that in the
event of a termination of Mr. Johnson's employment other than for "Cause," as
defined in the agreement, he is entitled to receive one year's salary and other
benefits. Subject to the foregoing, this agreement is subject to termination at
will by either party.
The Company entered into an employment agreement with David R.
Schreiber on September 30, 1996 as the Chief Financial Officer and Senior Vice
President, Finance. The agreement provides for an initial base salary of
$190,000 per annum, the grant of options to purchase 50,000 shares of Common
Stock with a 10-year term and an exercise price of $6.625, a signing bonus of
$80,000 and a stock grant of 7,500 shares of Common Stock on April 1, 1997. This
agreement provides that in the event of a termination of Mr. Schreiber's
employment other than for "Cause," as defined in the agreement, he is entitled
to receive one year's salary (and certain other benefits) if such termination
occurs within the first year of employment or six months after the Company is
acquired by another business entity, or six month's salary (and certain other
benefits) if such termination occurs after such period. Subject to the
foregoing, this agreement is subject to termination at will by either party.
Richard A. Sandberg resigned as Chairman of the Board and as an officer
of the Company effective February 27, 1997. In connection with his resignation,
the Company and Mr. Sandberg entered into an agreement, dated February 27, 1997
and amended on April 30, 1997, pursuant to which the Company agreed to employ
Mr. Sandberg, and Mr. Sandberg agreed to be employed, as a consultant to the
President until February 28, 1998 or his earlier death, disability, resignation,
or termination for "Cause," as defined in the agreement. Such agreement provided
for Mr. Sandberg to receive annual base compensation of $232,000 plus all
benefits provided to management employees of the Company other than
participation in management incentive programs. In addition, such agreement
provided that all options to purchase Common Stock held by Mr. Sandberg as of
February 27, 1997 became fully vested on such date to the extent not previously
vested. Mr. Sandberg also had, pursuant to his agreement, the right to sell each
such option to the Company at any time on or before May 28, 1997 for cash at a
price equal to (i) the number of shares of Common Stock covered by such option
being sold multiplied by (ii) the amount by which $10.875 exceeds the exercise
price of such option (which right was not exercised by Mr. Sandberg during such
period). The agreement was not renewed by mutual agreement of the Company and
Mr. Sandberg and was terminated by its terms on February 28, 1998, at which time
Mr. Sandberg received six-months severance in one lump sum gross payment of
$116,000. Mr. Sandberg will also receive medical insurance premiums and car
allowance during his six months severance period from February 28, 1998 through
August 31, 1998. Mr. Sandberg's stock options to purchase 20,000 shares of
Common Stock will terminate in May 1998 and options to purchase 156,000 shares
will terminate in February 2000. Mr. Sandberg has agreed that he will not
compete with the Company within the United States for a period of two years from
his termination date of February 28, 1998. The Company also loaned Mr. Sandberg
$300,000, which loan is repayable in full in two years and bears interest,
payable annually, at the rate of 9.5% per annum.
The Company entered into an agreement with Dr. James B. Amberson on
September 1, 1996, which provide that following a "Change in Control" of the
Company, as defined in the agreement, if Dr. Amberson's employment is terminated
other than for "Cause," as defined in the agreement, he is entitled to receive
one year's salary and bonus and all his stock options will vest completely. Dr.
Amberson's agreement expires in September 2001 and is subject to successive
automatic one-year renewals thereafter (unless certain notice is given).
The Company also entered into an employment agreement with Dr. James B.
Amberson on September 1, 1996. Pursuant to such agreement, Dr. Amberson is
entitled to a salary as determined by the Company and other employee benefits
made available by the Company to its employees. This agreement provides that in
the event of a termination of Dr. Amberson's employment for other than "Stated
Cause" (as defined in the agreement), he is entitled to receive six month's
salary and other benefits. Subject to the foregoing, this agreement is subject
to termination at will by either party.
23
The Company entered into an employment agreement with Steven T. Clayton
on November 18, 1996 as Vice President, Information Services of the Company. The
agreement provides for an initial base salary of $120,000 per annum, a signing
bonus of $14,000 and the grant of options to purchase 15,000 shares of Common
Stock with a 10-year term and an exercise price of $7.875.
During the third quarter 1997, the Company recorded a charge of
$100,250 for severance benefits relating to Mr. Verfurth, an officer of the
Company who resigned his full-time employment and officer position in September
1997. The severance agreement provided for a six-month period after his
termination and an additional three months had he not obtained other employment.
The Company made monthly payments for a six-month period after his termination
and was not required to make the additional three months of severance payments.
During the first quarter 1998, the Company recorded a charge of $97,750
for severance benefits relating to Mr. Wells, an officer of the Company who
resigned his full-time employment and officer position in January 1998. The
Company is making monthly payments for a three-month period after his
termination and for an additional two months if he does not obtain other
employment. In addition, Mr. Wells will be paid a $15,000 bonus for the first
quarter 1998, on or before April 30, 1998, pursuant to his employment agreement.
Mr. Wells agrees to comply with the provisions of the non-competition and
confidentiality agreement.
STOCK OPTIONS
The following table shows, as to the named executive officers of the
Company, information about option grants in the last fiscal year. The Company,
as of December 31, 1997, has not granted any Stock Appreciation Rights to
officers.
INDIVIDUAL GRANTS
- ------------------------------------------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF STOCK
SECURITIES OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED TO EXERCISE OR FOR OPTION TERM
OPTIONS EMPLOYEES BASE PRICE EXPIRATION ------------------------
NAME GRANTED(#) IN 1997 ($/SHARE) DATE 5%($) 10%($)
---- ---------- ------- --------- ---- ----- ------
James B. Amberson, M.D. 20,000 (1) 7% $8.75 12/11/2007 $110,057 $278,905
James T. Barry 15,000 (1) 5% 8.75 12/11/2007 82,542 209,179
Steven T. Clayton 15,000 (1) 5% 8.75 12/11/2007 82,542 209,179
Kevin C. Johnson -- -- -- -- -- --
David R. Schreiber 20,000 (1) 7% 8.75 12/11/2007 110,057 278,905
Richard A. Sandberg -- -- -- -- -- --
(1) In December 1997, the Company granted certain employees and officers
options to purchase 301,000 shares of Common Stock at $8.75 per share.
These options vest 40% in December 1999 and 20% during each year
thereafter. Upon termination, all unvested options are cancelled and
all vested options expire 90 days after termination of employment.
24
The following table shows aggregate option exercises in the last fiscal year and
fiscal year-end option values for the named executive officers. The Company, as
of December 31, 1997, has not granted any Stock Appreciation Rights.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES
VALUE
REALIZED VALUE OF UNEXERCISED
(MARKET NUMBER OF SECURITIES IN-THE-MONEY OPTIONS AT FY-END
PRICE AT UNDERLYING UNEXERCISED OPTIONS (BASED ON FY-END PRICE OF
EXERCISE AT FY-END(#) $9.375/SHARE) ($) (1)
SHARES LESS ---------------------------------
ACQUIRED ON EXERCISE
NAME EXERCISE(#) PRICE)($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- --------- ----------- ------------- ----------- -------------
James B. Amberson, M.D. -- $ -- 34,140 57,360 $157,484 $154,813
James T. Barry -- -- 3,286 38,000 14,442 81,750
Steven T. Clayton -- -- -- 30,000 -- 31,875
Kevin C. Johnson -- -- -- 200,000 -- 737,500
David R. Schreiber -- -- -- 70,000 -- 150,000
Richard A. Sandberg(2) -- -- 156,000 -- 171,600 --
(1) Computed based upon difference between aggregate fair market value and
aggregate exercise price.
(2) Mr. Sandberg resigned as Chairman of the Board and as an officer of the
Company effective February 27, 1997. In connection with his resignation,
the Company and Mr. Sandberg entered into an agreement that provided that
all options to purchase Common Stock held by Mr. Sandberg as of February
27, 1997 became fully vested on such date to the extent not previously
vested (which resulted in options to purchase 26,976 shares of Common Stock
becoming fully vested on such date). See "Executive Compensation -
Employment and Severance Agreements."
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Dr. Sklar served as a member of the Compensation Committee of the
Company's Board of Directors during the last completed fiscal year and is
continuing to serve as such in the 1998 fiscal year. In 1995 the Company entered
into a three-year research and development agreement with Brigham & Women's
Hospital, Inc., for which Dr. Sklar is director, Division of Diagnostic
Molecular Biology, Department of Pathology. The agreement required the Company
to make quarterly payments of $30,000 in exchange for an option to obtain rights
in certain existing inventions as well as inventions developed during the course
of the research in the areas of cancer detection and diagnosis. The research was
to be conducted by Dr. Sklar. The Company paid $60,000, $120,000 and $60,000
under this agreement in 1997, 1996 and 1995, respectively. The Company
terminated this agreement effective as of June 30, 1997 and has made all
required payments as of December 31, 1997. In addition, the Company has made
payments to Brigham & Women's Hospital, Inc. of $30,000 in each of 1996 and 1995
for consulting services.
25
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
OWNERSHIP OF VOTING STOCK BY MANAGEMENT
The following table gives information concerning the beneficial
ownership of the Company's Common Stock as of March 16, 1998 by each director
and each of the executive officers named in the summary compensation table and
all current directors and executive officers (as of March 16, 1998) as a group.
Total Shares
Beneficially Direct Right to Percent of
Beneficial Owners Owned(1)(2) Ownership Acquire(3) Class(4)
- ----------------- ----------- --------- ---------- --------
James B. Amberson, M.D. 73,827 25,172 37,858 1%
James T. Barry 5,295 2,009 3,286 -- (5)
Steven T. Clayton -- -- -- -- (5)
Bruce K. Crowther 314 205 109 -- (5)
John P. Davis 239,123 117,334 121,789 4%
Timothy E. Geary 1,141 651 490 -- (5)
G.S. Beckwith Gilbert 1,805,900 1,801,114 4,786 27% (6)
Kevin C. Johnson 121,170 30,373 80,000 2%
Richard A. Sandberg 172,845 7,325 165,520 3%
David R. Schreiber 18,297 7,500 -- -- (5)
Jeffrey L. Sklar 12,819 1,114 11,705 -- (5)
All current directors and executive officers
as a group (12 persons) 2,256,750 1,985,472 260,481 33%
(1) The information as to beneficial ownership is based on statements
furnished to the Company by its executive officers and directors. Each
executive officer and director has sole voting and sole investment power
with respect to his respective shares listed above, except that the
shares reported for Mr. Gilbert include 121,951 shares which are held by
a trust of which Mr. Gilbert is a trustee, as to which Mr. Gilbert shares
voting and investment powers. Amounts shown for each of Messrs. Johnson
and Schreiber and Dr. Amberson include 10,797 shares held in the
Company's 401(K) Retirement Plan, as to which such officers share voting
power as trustees of such plan and each individual plan participant has
investment power, subject to the terms of such plan, of the shares in his
account; such amount includes 373 and 4,955 shares in Mr.
Johnson's and Mr. Sandberg's account, respectively.
(2) Includes shares listed under the captions "Direct Ownership" and "Right
to Acquire," as well as shares held in the Company's 401(K) Retirement
Plan which are beneficially owned by the named individuals as trustees of
such plan but as to which such trustees have no economic interest.
(3) Individuals have the right to acquire these shares within 60 days of
March 16, 1998 by the exercise of stock options or through purchases
under the Company's Employee Stock Purchase Plan.
(4) For the purposes of this table, "Percent of Class" held by each
individual has been calculated based on a total class equal to the sum of
(i) 6,616,883 shares of Common Stock issued and outstanding on March 16,
1998 plus (ii) for such individual the number of shares of Common Stock
subject to stock options presently exercisable, or exercisable within 60
days after March 16, 1998, held by that individual, and which percent is
rounded to the nearest whole number.
(5) Owns less than 1% of the outstanding Common Stock.
(6) As of March 16, 1998, Mr. Gilbert cannot vote, without restriction, any
Common Stock or other voting securities of the Company beneficially owned
by him representing greater than 20% of the total voting power of the
Company's voting securities outstanding from time to time, or 1,323,377
votes as of March 16, 1998. Excess votes above this amount are required
to be voted in proportion to the votes cast by all other shareholders of
the Company.
26
OWNERSHIP OF VOTING STOCK BY CERTAIN BENEFICIAL OWNERS
The following table sets forth information with respect to the only
persons who, to the best knowledge of the Company as derived from Schedules 13F,
13D and 13G filed by such persons, beneficially owned more than five percent of
the Common Stock of the Company as of March 16, 1998. Unless otherwise indicated
below, each person included in the table has sole voting and investment power
with respect to all shares included therein.
Amount and Nature
Name and Address of of Beneficial Percent
Title of Class Beneficial Owner Ownership of Class(1)
- -------------- ---------------- --------- -----------
Common Stock G. S. Beckwith Gilbert et al 1,805,900 (2)(3) 27% (3)
104 Field Point Road
Greenwich, CT 06830
Common Stock Oracle Management Partners, Inc. 471,328 7%
and Affiliates
712 E 5th Avenue - 45th Floor
New York, NY 10019
Common Stock John M. Bryan et al 356,412 5%
Bryan and Edwards
600 Montgomery Street - 35th Floor
San Francisco, CA 94111
(1) For the purposes of this table, "Percent of Class" held by each person
has been calculated based on a total class equal to the sum of (i)
6,616,883 shares of Common Stock issued and outstanding on March 16, 1998
plus (ii) for such person the number of shares of Common Stock subject to
stock options or warrants presently exercisable, or exercisable within 60
days after March 16, 1998, held by that person, and which percent is
rounded to the nearest whole number.
(2) Mr. Gilbert has shared voting and investment power with respect to
121,951 shares included in the table above.
(3) As of March 16, 1998, Mr. Gilbert cannot vote, without restriction, any
Common Stock or other voting securities of the Company beneficially owned
by him representing greater than 20% of the total voting power of the
Company's voting securities outstanding from time to time, or 1,323,377
votes as of March 16, 1998. Excess votes above this amount are required
to be voted in proportion to the votes cast by all other shareholders of
the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See Item 11 - Executive Compensation - "Compensation Committee
Interlocks and Insider Participation" and Notes 6 and 13 of the Company's
consolidated financial statements included herewith.
Pursuant to his employment agreement, the President of the Company
received a loan in 1996 totaling $150,000 which bears interest at 5.9%, payable
annually, and is repayable upon termination of his employment with the Company.
In addition, the loan principal will be forgiven at a rate of $2,500 per month
over the period January 1998 through December 2002 if the President continues to
be employed by the Company.
27
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements, Financial Statement Schedules Filed.
1) Financial Statements - See accompanying Consolidated Financial
Statements and Schedules, Pages F-1 through F-18.
2) Financial Statement Schedules - See accompanying Consolidated
Financial Statements and Schedules, Pages F-1 through F-18.
3) Exhibits - Refer to 14(c) below.
(b) The Company filed no reports on Form 8-K in the fourth quarter of 1997
with the Securities and Exchange Commission.
(c) Exhibit Index
3.1 Restated Certificate of Incorporation of the Company, as amended
through June 12, 1991 (incorporated by reference to Exhibit 3.1 of the
Registrant's Registration Statement No. 33-41226).
3.2 Restated By-Laws of the Company, as amended through October 24, 1996
(incorporated by reference to Exhibit 4.2 of the Registrant's
Registration Statement No. 333-18817).
3.3 Restated By-Laws of the Company, as amended through February 2, 1997
(incorporated by reference to Exhibit 4.2 of the Registrant's
Registration Statement No. 333-18817).
10.1 Consulting Agreement, dated August 4, 1989, between DIANON Systems,
Inc. and Nonda Katopodis (incorporated by reference to Exhibit 10.7 of
the Registrant's Registration Statement No. 33-41226).**
10.2 Executive Vesting Agreement, dated as of June 11, 1991, between DIANON
Systems, Inc. and James B. Amberson (incorporated by reference to
Exhibit 10.13 of the Registrant's Registration Statement No.
33-41226).**
10.3 1991 Stock Incentive Plan (incorporated by reference to Exhibit 10.17
of the Registrant's Registration Statement No. 33-41226).**
10.4 Management Incentive Plan (incorporated by reference to Exhibit 10.18
of the Registrant's Registration Statement No. 33-41226).**
10.5 Stock Option Grant to Walter O. Fredericks, dated April 27, 1990
(incorporated by reference to Exhibit 10.23 of the Registrant's
Registration Statement No. 33-41226).**
10.6 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991
(incorporated by reference to Exhibit 10.24 of the Registrant's
Registration Statement No. 33-41226).**
10.7 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991
(incorporated by reference to Exhibit 10.25 of the Registrant's
Registration Statement No. 33-41226).**
10.8 Lease Agreement, made as of February 14, 1989, between Watson Boulevard
Development Limited Partnership, as lessor, and DIANON Systems, Inc.,
as lessee, for premises located at 200 Watson Boulevard (incorporated
by reference to Exhibit 10.29 of the Registrant's Registration
Statement No. 33-41226).
10.9 License Agreement, dated June 9, 1983, between Sloan-Kettering
Institute for Cancer Research and N-K Laboratories Limited Partnership
(incorporated by reference to Exhibit 10.30 of the Registrant's
Registration Statement No. 33-41226).
10.10 License Agreement, dated July 29, 1987, between University of Rochester
and DIANON Systems, Inc. (incorporated by reference to Exhibit 10.32 of
the Registrant's Registration Statement No. 33-41226).
10.11 Development Agreement, effective September 25, 1987, between
Connecticut Product Development Corporation and DIANON Systems, Inc.
(incorporated by reference to Exhibit 10.33 of the Registrant's
Registration Statement No. 33-41226).
28
Exhibit Index (continued)
10.12 Stock Option Grant to James B. Amberson, dated April 23, 1991
(incorporated by reference to Exhibit 28.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1991).**
10.13 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991, as
amended (incorporated by reference to Exhibit 10.37 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1991).**
10.14 Asset Purchase Agreement, dated April 30, 1993, by and among the
Registrant and Molecular Oncology, Inc., and Oncologix, Inc.
(incorporated by reference to Exhibit 1.1 to the Registrant's Form 8-K
dated April 30, 1993, filed with the Securities and Exchange Commission
on May 14, 1993).
10.15 Asset Purchase Agreement, dated June 29, 1993, by and among the
Registrant and Collaborative Research, Inc. (incorporated by reference
to Exhibit 1.2 to the Registrant's Form 8-K dated June 29, 1993, filed
with the Securities and Exchange Commission on July 13, 1993).
10.16 Term Loan Agreement, dated July 14, 1993, by and among the Registrant
and the Union Trust Company (incorporated by reference to Exhibit 10.34
to the Registrant's Annual Report on Form 10-K/A Amendment 1 for the
year ended December 31, 1993, filed with the Securities and Exchange
Commission on April 28, 1994).
10.17 Rights Agreement, dated April 29, 1994, by and among the Registrant and
American Stock and Trust Company, as Rights Agent (incorporated by
reference to Exhibit 1 to the Registrant's Form 8-K dated April 29,
1994, filed with the Securities and Exchange Commission on May 9,
1994).
10.18 Severance Agreement, dated January 20, 1995, by and among the
Registrant and John P. Davis (incorporated by reference to Exhibit
10.36 to the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1995, filed with the Securities and Exchange Commission on
March 29, 1996).**
10.19 Employment Agreement, dated May 3, 1996, by the Registrant and Kevin C.
Johnson (incorporated by reference to Exhibit 10.37 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996).**
10.20 Executive Employment Agreement, dated September 1, 1996, by the
Registrant and Richard A. Sandberg (incorporated by reference to
Exhibit 10.38 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996).**
10.21 Employment Agreement, dated September 1, 1996, by the Registrant and
Dr. James B. Amberson (incorporated by reference to Exhibit 10.39 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.22 Executive Employment Agreement, dated September 1, 1996, by the
Registrant and Dr. James B. Amberson (incorporated by reference to
Exhibit 10.40 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996).**
10.23 Severance Agreement, dated September 27, 1996, by the Registrant and
Carl R. Iberger (incorporated by reference to Exhibit 10.41 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.24 Employment Agreement, dated September 30,1996, by the Registrant and
David R. Schreiber (incorporated by reference to Exhibit 10.42 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.25 Employment Agreement, dated November 18, 1996, by the registrant and
Steven T. Clayton.**
10.26 Severance Agreement dated November 18, 1996, by the registrant and
Daniel J. Cronin, III.**
10.27 Amendment dated as of October 4, 1995 to Rights Agreement dated as of
April 29, 1994 between the Registrant and American Stock Transfer and
Trust Company, as Rights Agent (incorporated by reference to Exhibit
No. 1 to the Registrant's Form 8-K dated October 30, 1996 filed with
the Securities and Exchange Commission on November 8, 1995).
10.28 1996 Stock Incentive Plan (incorporated by reference to Appendix A to
the Registrant's Statement on Schedule 14A filed with the Securities
and Exchange Commission on September 23, 1996).**
10.29 Stock and Warrant Purchase Agreement, dated as of October 4, 1995,
among the Gilbert Family Trust, the G.S. Beckwith Gilbert I.R.A.
Contributory Account, G.S. Beckwith Gilbert and the Registrant.
10.30 Registration Rights Agreement, dated as of October 4, 1995, among the
Gilbert Family Trust, the G.S. Beckwith Gilbert I.R.A. Contributory
Account, G.S. Beckwith Gilbert and the Registrant.
10.31 Warrant No. 1, dated as of October 4, 1995, by the Registrant in favor
of G.S. Beckwith.
10.32 Promissory Note, dated October 4, 1995, by G.S. Beckwith Gilbert in
favor of the Registrant.
10.33 Stock Option Grant dated October 24, 1996 by the Registrant to Andre de
Bruin.**
29
Exhibit Index (continued)
10.34 Stock Option Grant dated November 4, 1996 by the Registrant to Jeffrey
M. Sklar, M.D.**
10.35 Loan Agreement dated December 3, 1996 by the Registrant to Kevin C.
Johnson).**
10.36 Form of standard Stock Option Grant for outside directors.**
10.37 Amendment to Warrant Certificate No. W-1 dated as of October 2, 1996
between the Registrant and G.S. Beckwith Gilbert.
10.38 Severance Agreement dated February 27, 1997 by the Registrant and
Richard A. Sandberg.**
10.39 Amendment dated April 30, 1997 by the Registrant and Richard A.
Sandberg.**
10.40 Security Agreement dated April 30, 1997 by the Registrant and Richard
A. Sandberg.**
10.41 Secured Promissory Note dated April 30, 1997 by the Registrant and
Richard A. Sandberg.**
10.42 Non-Compete Agreement dated September 3, 1997 by the Registrant and
Vernon L. Wells.**
10.43 Severance Agreement dated September 15, 1997 by the Registrant and
Robert C. Verfurth.**
10.44 Consulting and Proprietary Information and Inventions Agreement dated
October 1, 1997 by the Registrant and Dr. Jeffrey L. Sklar, MD, PhD
(filed herewith).
10.45 Severance Agreement dated January 27, 1998 by the Registrant and Vernon
L. Wells (filed herewith).**
11.1 Statement re: computation of per share earnings. *
22.1 List of Subsidiaries of the Company (incorporated by reference to
Exhibit 22.1 of the Registrant's Registration Statement No. 33-41226).
23.1 1996 Consent of Arthur Andersen LLP (incorporated by reference to
Exhibit 23.1 of the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995).
23.2 1997 Consent of Arthur Andersen LLP (incorporated by reference to
Exhibit 23.2 of the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1996).
23.3 1998 Consent of Arthur Andersen LLP (filed herewith).
27.1 Financial Data Schedule.
- --------------
* Not applicable or contained elsewhere herein.
** A management contract or compensatory plan or arrangement
required to be filed as an exhibit to this form pursuant to
Item 14(c) of this report.
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
DATED: March 27, 1998
DIANON SYSTEMS, INC.
By: /s/ KEVIN C. JOHNSON
-------------------------------------
Kevin C. Johnson,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Signature Capacity Date
- --------- -------- ----
/s/ KEVIN C. JOHNSON President and Chief Executive March 27, 1998
- ----------------------------- Officer and a Director
Kevin C. Johnson (Principal Executive Officer)
/s/ DAVID R. SCHREIBER Senior Vice President, Finance March 27, 1998
- ----------------------------- and Chief Financial Officer
David R. Schreiber (Principal Financial Officer)
/s/ JOHN S. FANUKO Vice President, Finance and March 27, 1998
- ----------------------------- Corporate Controller
John S. Fanuko (Principal Accounting Officer)
/s/ JOHN P. DAVIS Chairman of the Board March 27, 1998
- -----------------------------
John P. Davis
/s/ G. S. BECKWITH GILBERT Director and Chairman of the March 27, 1998
- ----------------------------- Executive Committee
G. S. Beckwith Gilbert
/s/ JAMES B. AMBERSON, MD Director, Chief Medical March 27, 1998
- ----------------------------- Officer and Senior Vice
James B. Amberson, M.D. President
/s/ BRUCE K. CROWTHER Director March 27, 1998
- -----------------------------
Bruce K. Crowther
/s/ E. TIMOTHY GEARY Director March 27, 1998
- -----------------------------
E. Timothy Geary
/s/ JEFFREY L. SKLAR, MD PhD Director March 27, 1998
- -----------------------------
Jeffrey L. Sklar, M.D., Ph.D.
31
DIANON SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Page
----
Report of Independent Public Accountants F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-3 & F-4
Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1997, 1996 and 1995 F-6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995 F-7 & F-8
Notes to Consolidated Financial Statements F-9 to F-16
Schedules:
Report of Independent Public Accountants F-17
Schedule II - Valuation and Qualifying Accounts F-18
All other schedules required by Regulation S-X have been omitted
because they are not applicable or because the required information is included
in the consolidated financial statements or notes thereto.
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To DIANON Systems, Inc.:
We have audited the accompanying consolidated balance sheets of DIANON
Systems, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997
and 1996, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended 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 DIANON Systems, Inc.
and subsidiaries as of December 31, 1997 and 1996 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Stamford, Connecticut,
February 18, 1998
F-2
DIANON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS AS OF
DECEMBER 31, 1997 AND 1996
1997 1996
---------------- --------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $12,401,062 $ 7,488,590
Accounts receivable, net of allowances of $1,292,095 and
$1,056,920, at December 31, 1997 and 1996, respectively 14,444,767 15,426,221
Prepaid expenses and employee advances 529,887 1,189,139
Prepaid and refundable income taxes -- 329,371
Inventory 729,658 662,567
Deferred income taxes 1,016,797 677,277
---------------- --------------
Total current assets 29,122,171 25,773,165
---------------- --------------
PROPERTY AND EQUIPMENT, at cost
Laboratory and office equipment 8,489,323 12,233,989
Leasehold improvements 3,676,200 3,612,198
Less - accumulated depreciation and amortization (6,057,511) (8,606,176)
---------------- --------------
6,108,012 7,240,011
---------------- --------------
INTANGIBLE ASSETS, net of accumulated amortization of $3,207,570 and
$2,991,286, at December 31, 1997 and 1996, respectively 388,030 604,313
DEFERRED INCOME TAXES 670,191 458,465
OTHER ASSETS 600,657 459,696
================ ==============
TOTAL ASSETS $36,889,061 $34,535,650
================ ==============
The accompanying notes to consolidated
financial statements are an integral part
of these balance sheets.
F-3
DIANON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS AS OF
DECEMBER 31, 1997 AND 1996 (CONTINUED)
1997 1996
--------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,540,922 $ 2,123,661
Accrued employee compensation 1,631,180 1,504,430
Accrued employee stock purchase plan 549,619 549,540
Accrued income taxes payable 747,564 --
Current portion of capitalized lease obligations 41,470 26,107
Current portion of note payable -- 650,154
Other accrued expenses 3,224,613 2,861,268
--------------- ---------------
Total current liabilities 7,735,368 7,715,160
--------------- ---------------
LONG-TERM PORTION OF CAPITALIZED LEASE OBLIGATIONS 107,449 69,611
DEFERRED INCOME TAXES -- 201,951
--------------- ---------------
Total liabilities 7,842,817 7,986,722
--------------- ---------------
STOCKHOLDERS' EQUITY:
Common stock, par value $.01 per share, 20,000,000 shares authorized,
6,791,320 and 6,712,774 shares issued and
outstanding at December 31, 1997 and 1996, respectively 67,914 67,128
Additional paid-in capital 27,880,223 27,965,560
Retained earnings (deficit) 2,743,380 (554,317)
Common stock held in treasury, at cost - 197,617 and 117,196
shares at December 31, 1997 and 1996, respectively (1,645,273) (929,443)
--------------- ---------------
Total stockholders' equity 29,046,244 26,548,928
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $36,889,061 $34,535,650
=============== ===============
The accompanying notes to consolidated
financial statements are an integral part
of these balance sheets.
F-4
DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995
--------------- --------------- ---------------
NET REVENUES $60,887,193 $55,998,995 $45,700,321
COST OF SALES 31,121,507 26,897,576 20,390,742
--------------- --------------- ---------------
GROSS PROFIT 29,765,686 29,101,419 25,309,579
SELLING, GENERAL, AND ADMINISTRATIVE
EXPENSES 22,912,147 22,443,192 19,619,773
RESEARCH AND DEVELOPMENT EXPENSES 1,665,735 3,157,846 5,255,032
--------------- --------------- ---------------
INCOME FROM OPERATIONS 5,187,804 3,500,381 434,774
INTEREST INCOME, NET 522,427 306,840 181,240
--------------- --------------- ---------------
INCOME BEFORE PROVISION FOR INCOME TAXES 5,710,231 3,807,221 616,014
PROVISION FOR INCOME TAXES 2,412,534 1,637,105 508,918
--------------- --------------- ---------------
NET INCOME $ 3,297,697 $ 2,170,116 $ 107,096
=============== =============== ===============
EARNINGS PER SHARE:
BASIC $ .51 $ .35 $ .02
DILUTED $ .48 $ .35 $ .02
WEIGHTED AVERAGE SHARES OUTSTANDING:
BASIC 6,430,060 6,151,061 5,542,402
DILUTED 6,808,250 6,287,159 5,549,280
The accompanying notes to consolidated
financial statements are an integral
part of these statements.
F-5
DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
Foreign
Additional Retained Unrealized Currency
Common Stock Paid-In Earnings Holdings Translation
Shares Amount Capital (Deficit) Gains/(Losses) Adjustment
-------------------------------------------------------------------------------
BALANCE, December 31, 1994 5,296,879 $52,969 $21,591,942 ($2,831,529) ($90,383) ($58,938)
Stock options exercised 14,572 146 59,286 -- -- --
Issuance of common stock and
warrants, net of issuance costs 1,000,000 10,000 4,976,443 -- -- --
Common stock acquired for treasury -- -- -- -- -- --
Shareholder note receivable -- -- -- -- -- --
Stock compensation expense -
stock options -- -- (18,014) -- -- --
Write-off of unrealized holding
losses -- -- -- -- 90,383 --
Write-off of foreign currency
translation adjustment -- -- -- -- -- 58,938
Net income -- -- -- 107,096 -- --
-------------------------------------------------------------------------------
BALANCE, December 31, 1995 6,311,451 63,115 26,609,657 (2,724,433) -- --
Stock options exercised 23,621 236 107,476 -- -- --
Exercise of warrants, net of
exercise costs 377,702 3,777 1,536,540 -- -- --
Common stock acquired for treasury -- -- -- -- -- --
Extinguishment of shareholder
note receivable -- -- (296,000) -- -- --
Stock compensation expense -
stock options -- -- 7,887 -- -- --
Net income -- -- -- 2,170,116 -- --
-------------------------------------------------------------------------------
BALANCE, December 31, 1996 6,712,774 67,128 27,965,560 ( 554,317)
Stock options exercised 51,764 518 248,498 -- -- --
Employee stock purchase plan -- -- (564,822) -- -- --
Stock grants 26,782 268 230,987 -- -- --
Common stock acquired for treasury -- -- -- -- -- --
Net income -- -- -- 3,297,697 -- --
-------------------------------------------------------------------------------
BALANCE, December 31, 1997 6,791,320 $67,914 $27,880,223 $2,743,380 $ -- $ --
===============================================================================
[TABLE CONTINUED ON THE FOLLOWING PAGE F-6B]
The accompanying notes to consolidated
financial statements are an integral
part of these statements.
F-6A
[TABLE CONTINUED FROM PAGE F-6A]
Common Stock Shareholder
Acquired for Treasury Note
Shares Amount Receivable Total
---------------------------------------------------
BALANCE, December 31, 1994 -- $ -- $ -- $18,664,061
Stock options exercised -- -- -- 59,432
Issuance of common stock and
warrants, net of issuance costs -- -- -- 4,986,443
Common stock acquired for treasury (50,000) (200,000) -- (200,000)
Shareholder note receivable -- -- (296,000) (296,000)
Stock compensation expense -
stock options -- -- -- (18,014)
Write-off of unrealized holding
losses -- -- -- 90,383
Write-off of foreign currency
translation adjustment -- -- -- 58,938
Net income -- -- -- 107,096
---------------------------------------------------
BALANCE, December 31, 1995 (50,000) (200,000) (296,000) 23,452,339
Stock options exercised -- -- -- 107,712
Exercise of warrants, net of
exercise costs 422,298 2,478,889 -- 4,019,206
Common stock acquired for treasury (489,494) (3,208,332) -- (3,208,332)
Extinguishment of shareholder
note receivable -- -- 296,000 --
Stock compensation expense -
stock options -- -- -- 7,887
Net income -- -- -- 2,170,116
---------------------------------------------------
BALANCE, December 31, 1996 (117,196) (929,443) -- 26,548,928
Stock options exercised -- -- -- 249,016
Employee stock purchase plan 146,579 1,220,200 -- 655,378
Stock grants -- -- -- 231,255
Common stock acquired for treasury (227,000) (1,936,030) -- (1,936,030)
Net income -- -- -- 3,297,697
---------------------------------------------------
BALANCE, December 31, 1997 (197,617) ($1,645,273) $ -- $29,046,244
===================================================
The accompanying notes to consolidated
financial statements are an integral
part of these statements.
F-6B
DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995
--------------- --------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $3,297,697 $2,170,116 $ 107,096
Adjustments to reconcile net income to net cash provided
by (used in) operations -
Non-cash charges
Depreciation and amortization 3,109,515 2,463,325 2,758,611
Stock compensation expense 231,255 7,887 (18,014)
Loss on disposal of fixed assets 55,241 27,240 56,266
Investment write-down -- 61,846 529,625
Deferred tax provision (753,197) (168,539) (97,211)
Changes in other current assets and liabilities
Decrease (increase) in accounts receivable 981,454 (5,772,250) 1,345,427
Decrease (increase) in prepaid expenses and
employee advances 988,623 (278,127) (147,728)
(Increase) decrease in inventory (67,091) (108,169) 158,643
(Increase) in other assets (160,853) (320,176) (29,075)
Increase in accounts payable and other accrued
liabilities 646,762 1,740,665 1,424,496
--------------- --------------- ---------------
Net cash provided by (used in) operating activities 8,329,406 (176,182) 6,088,136
--------------- --------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,860,646) (3,431,895) (2,290,720)
Proceeds from the sale of stock held for investment 9,064 73,661 14,867
Proceeds from the sale of fixed assets 7,060 7,500 10,040
--------------- --------------- ---------------
Net cash (used in) investing activities (1,844,522) (3,350,734) (2,265,813)
--------------- --------------- ---------------
The accompanying notes to consolidated
financial statements are an integral
part of these statements.
F-7
DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
1997 1996 1995
--------------- --------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of note payable $ (650,154) $ (916,150) $ (862,446)
Net borrowings (repayments) of capitalized lease
obligations 109,378 22,839 (53,614)
Net proceeds from issuance of common stock
and warrants -- -- 4,690,443
Net proceeds from exercise of warrants -- 4,019,206 --
Purchase of common stock held in treasury (1,936,030) (3,208,332) (200,000)
Exercise of stock options 249,016 107,712 59,432
Employee stock purchase plan 655,378 -- --
--------------- --------------- ---------------
Net cash (used in) provided by financing activities (1,572,412) 25,275 3,633,815
--------------- --------------- ---------------
Net increase (decrease) in cash and cash equivalents 4,912,472 (3,501,641) 7,456,138
CASH AND CASH EQUIVALENTS,
beginning of year 7,488,590 10,990,231 3,534,093
--------------- --------------- ---------------
CASH AND CASH EQUIVALENTS,
end of year $12,401,062 $ 7,488,590 $10,990,231
=============== =============== ===============
1997 1996 1995
--------------- --------------- ---------------
SUPPLEMENTAL CASH FLOWS DISCLOSURES:
Cash paid during the year:
Interest $ 27,416 $ 77,782 $ 135,644
Income taxes 2,171,422 1,712,200 588,149
The accompanying notes to consolidated
financial statements are an integral
part of these statements.
F-8
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY
DIANON Systems, Inc. (the "Company") provides a full line of anatomic
pathology testing services, as well as a number of genetic and clinical
chemistry testing services to patients, physicians and managed care
organizations throughout the United States. A significant portion of the
services provided by the Company are paid for by either the patients' Medicare
or private medical insurance carriers. The remaining services are generally paid
for by patients, physicians or hospitals directly.
(2) SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation -
The consolidated financial statements include the accounts of the
Company and all of its subsidiaries. All significant intercompany transactions
have been eliminated in consolidation.
Use of Estimates -
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents -
The Company considers all highly liquid instruments purchased with a
maturity of three months or less to be cash equivalents. At December 31, 1997
and 1996, the Company had approximately $12 million and $6 million,
respectively, invested in short-term U.S. treasury funds with maturities of less
than three months. The carrying amount of the cash equivalents approximates its
fair value due to the relatively short period to maturity of these instruments.
Interest income per the consolidated statements of operations is presented net
of interest expense of $26,869, $77,466 and $136,113 for 1997, 1996 and 1995,
respectively.
Inventory -
Inventory consists primarily of bulk reagents, specimen collection kits
and devices. Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out method.
Intangible Assets -
Intangible assets are amortized on a straight-line basis over the
respective economic life as follows:
Years
-----
Unamortized customer lists 7
Noncompete agreement 5
The Company periodically reviews the anticipated revenues related to
intangible assets to determine whether any adjustment to their carrying value is
necessary. During 1996, the Company recorded an accelerated amortization charge
of approximately $44,000, based on the Company's revised estimate of future
benefits from a customer list.
F-9
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition -
Revenues are recognized in the period in which services are provided.
Revenues subject to Medicare, direct physician and hospital billing are based on
fixed reimbursement fee schedules. All remaining revenues subject to third-party
reimbursement are recorded at estimated reimbursable amounts based on Uniform
Customary Charges. Such estimates are revised periodically based upon the
Company's actual reimbursement experience.
Depreciation and Amortization -
Laboratory and office equipment is depreciated using the straight-line
method over a useful life of two to seven years. Leasehold improvements are
amortized over the shorter of their economic useful life or the remaining life
of the lease.
Research and Development -
Research and development costs are charged to expense as incurred.
Income Taxes -
The Company utilizes the liability method of accounting for income
taxes as set forth in Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes." Under this method, deferred income taxes are
determined based on the difference between the financial statement and tax bases
of assets and liabilities using presently enacted tax rates and regulations.
Earnings Per Share -
In 1997, the Company has adopted Statement of Financial Accounting
Standards No. 128 "Earning per share," effective December 15, 1997. Basic
earnings per share have been computed based on the weighted average number of
common shares outstanding during each year. Diluted earnings per share have been
computed based on the weighted average number of common shares and common
equivalent shares outstanding during each year. Common equivalent shares
outstanding include the common equivalent shares calculated for warrants and
stock options under the treasury stock method. Reported earnings per share for
all prior periods have been restated.
Below is a reconciliation of the numerators and denominators of the basic and
diluted EPS computations:
1997 1996 1995
---- ---- ----
BASIC EARNING PER SHARE
Weighted-average number of common shares outstanding 6,430,060 6,151,061 5,542,402
DILUTED EFFECT OF:
Stock options / ESPP 378,190 136,098 6,878
-------------- ------------- -------------
DILUTED EARNINGS PER SHARE
Weighted-average number of common shares outstanding 6,808,250 6,287,159 5,549,280
============== ============= =============
NET INCOME $3,297,697 $2,170,116 $107,096
============== ============= =============
BASIC EARNINGS PER SHARE $0.51 $0.35 $0.02
============== ============= =============
DILUTED EARNINGS PER SHARE $0.48 $0.35 $0.02
============== ============= =============
F-10
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Options to purchase 291,556 shares of common stock at prices ranging
from $8.75 and $12.25 per share were outstanding as of December 31, 1997 but
were not included in the computation of diluted earnings per share because the
options' exercise price was greater than the average market price of common
shares.
Foreign Currency Translation -
In 1995, the Company charged to income the Germany currency translation
adjustment of $160,567 due to management's decision to discontinue European
based operations.
Reclassifications -
Certain reclassifications have been made to prior year amounts to
conform to the classifications used in the current year presentation.
(3) INCOME TAXES
The income tax provisions for the years ended December 31, 1997, 1996 and
1995 consist of the following:
Year Ended December 31
-------------------------------------------
1997 1996 1995
---------------- ------------- ------------
Current
Federal $2,444,187 $1,387,967 $461,361
State 721,544 446,091 152,593
---------------- ------------- ------------
Total Current 3,165,731 1,834,058 613,954
---------------- ------------- ------------
Deferred
Federal (598,785) (152,112) (33,532)
State (154,412) (44,841) (71,504)
---------------- ------------- ------------
Total Deferred (753,197) (196,953) (105,036)
---------------- ------------- ------------
Total provision for income taxes $2,412,534 $1,637,105 $508,918
================ ============= ============
The reasons for the differences between the statutory and effective rates
are as follows:
Year Ended December 31
------------------------------------------
1997 1996 1995
-------------- ------------ --------------
Statutory federal income tax rate 34.0% 34.0% 34.0%
State taxes, net of federal tax benefit 6.6 7.0 8.7
Utilization of research & development credits -- -- (5.7)
Utilization of AMT credit -- -- (4.6)
Non-deductible expenses 1.3 2.9 9.6
Non-deductible write-down of investment in stock (.1) .7 37.5
Other .4 (1.6) 3.1
============== ============ ==============
42.2% 43.0% 82.6%
============== ============ ==============
F-11
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The net deferred tax asset is a result of the following temporary
differences:
Year Ended December 31
-------------------------------------------
1997 1996 1995
-------------- -------------- -------------
Allowance for bad debts $520,986 $428,761 $316,090
Accrued expense 417,457 (4,395) 19,982
Depreciation 416,824 95,067 (62,256)
Compensation not currently recognized for tax reporting 215,103 180,126 213,100
International restructuring reserve 72,835 196,417 188,415
Amortization 43,783 37,264 22,441
Other -- 550 67,480
============== ============== =============
$1,686,988 $933,790 $765,252
============== ============== =============
During 1996 and 1995, the Company recorded a capital write-down of
$61,846 and $529,625, respectively, for which a tax benefit has not been
recognized, $9,064 of that write-down was subsequently recovered in 1997.
(4) LEASE OBLIGATIONS
Included in property and equipment at December 31, 1997 and 1996 is
laboratory and office equipment held under capitalized leases as follows:
1997 1996
---- ----
Property and equipment $278,645 $752,240
Less - accumulated depreciation (135,181) (660,312)
============= =============
$143,464 $ 91,928
============= =============
The future minimum lease payments under non-cancelable operating leases
and the present value of future minimum capital lease payments at December 31,
1997 are:
Capital Operating
Leases Leases
------ ------
1998 $ 52,468 $ 882,405
1999 38,302 798,073
2000 34,440 797,126
2001 34,440 730,695
2002 15,756 710,775
Thereafter -- 296,156
-------------------------
Minimum lease payments 175,406 $4,215,230
=============
Less - amount representing interest 26,487
-----------
Present value of total minimum lease payments $148,919
===========
Total rental expense relating to operating leases for the years ended
December 31, 1997, 1996, and 1995 was $997,869, $1,041,127 and $864,549,
respectively.
The Company leases office and laboratory space at two facilities in
Stratford, Connecticut. One lease expires in May 2003 and contains an option to
renew for up to three years and the other is on a year-to-year basis. The annual
rent on these leases will be increased by a pro rata portion of the increase in
real estate taxes and the increase in common area maintenance.
The Company also leases four regional sales offices located in Florida,
North Carolina, Texas and Ohio. The terms of the leases range from one to three
years.
F-12
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In March 1996, the Company executed a lease for a laboratory facility
in Wilmington, Ohio with a five-year term commencing April 1, 1996 and a renewal
option for five additional terms of three years each.
Subsequent to year-end in connection with an acquisition (see Note 14),
the Company entered into a lease for an office and laboratory facility in Tampa,
Florida for a five-year term commencing January 31, 1998 with an option to renew
for an additional five-year period. In addition, the Company assumed leases for
four branch offices in Florida with remaining terms of up to two years.
(5) STOCK-BASED COMPENSATION PLANS
In June 1991, the Company adopted the 1991 Stock Incentive Plan which
provides for up to 400,000 shares of the Company's Common Stock, par value $.01
per share ("Common Stock"), to be reserved for potential future issuance of
stock options or awards. This plan is the successor to the Company's previous
plan which expired. In June 1994, the Company offered certain officers and key
employees the opportunity to revise the terms of their original stock options
issued in 1991, 1992 and 1993; all such revisions are reflected in the
information presented below. As of December 31, 1997, 12,213 shares of Common
Stock are available under the 1991 Stock Incentive Plan for future issuance. The
majority of the options vest 40% in the second year after grant and 20% each
year thereafter and expire ten years from the original grant date.
In October 1996, the Company's shareholders approved the Company's
adoption of the 1996 Stock Incentive Plan, which provides for up to 700,000
shares of Common Stock to be reserved for potential future issuance of stock
options or awards. This plan is the successor to the 1991 Stock Incentive Plan
for which only a limited number of shares of Common Stock remain available for
grants. As of December 31, 1997, 198,514 shares of Common Stock are available
under the 1996 Stock Incentive Plan. The majority of options issued to officers
and key employees of the Company vest at a rate of 40% in the second year after
grant and 20% per year thereafter or 40% in the third year after grant and 20%
per year thereafter and expire ten years from the original date of grant. The
majority of options issued to directors vest at a rate of 10% per quarter and
expire ten years from the original date of grant.
The Company accounts for these plans under Accounting Principles Board
Opinion No. 25, under which no compensation cost has been recognized. Had
compensation cost for these plans been determined consistent with the Statement
of Financial Accounting Standards No. 123, the Company's net income and earnings
per share would have been reduced to the following pro forma amounts:
1997 1996 1995
---- ---- ----
Net Income: As Reported $3,297,697 $2,170,116 $107,096
Pro Forma $2,703,542 $1,586,169 $11,403
Basic earnings per share: As Reported $.51 $.35 $.02
Pro Forma $.42 $.26 $.00
Diluted earnings per share: As Reported $.48 $.35 $.02
Pro Forma $.40 $.25 $.00
F-13
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For purposes of the pro forma information above, the fair value of each
option grant is estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions used for grants in
1997, 1996 and 1995, respectively,: risk-free interest rates of 6.52, 6.67 and
6.78 percent; expected lives of 8.6 for 1997 and 8.1 years for 1996 and 1995;
expected volatility of 74 percent for 1997 and 80 percent for 1996 and 1995. A
summary of the status of the Company's two fixed stock option plans as of
December 31, 1997, 1996 and 1995, and changes during the years ending on those
dates is presented below:
-------------------------- ------------------------- --------------------------
1997 1996 1995
-------------------------- ------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
FIXED OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE
- ------------- ------ ----- ------ ----- ------ -----
Outstanding at beginning of year 597,676 $6.00 397,153 $5.42 298,736 $5.89
Granted 338,351 8.61 296,550 6.43 197,409 5.26
Exercised (51,764) 4.81 (23,621) 4.56 (4,688) 4.08
Forfeited / cancelled (102,805) 5.65 (72,406) 5.06 (94,304) 6.78
--------- -------- --------
Outstanding at end of year 781,458 7.24 597,676 6.00 397,153 5.42
-------- -------- --------
Options exercisable at year-end 152,218 6.24 120,512 6.35 93,440 6.73
Weighted-average fair value of
options granted $6.82 $5.19 $4.25
------------ ------------- ----------- ------------- ----------- --------------
The table below contains information with respect to the 781,458
options outstanding for the Company's 1991 and 1996 Stock Incentive Plan as of
December 31, 1997:
EXERCISE PRICE EXERCISABLE OPTIONS
-------------------------------------- --------------------------------------
WEIGHTED
OPTIONS WEIGHTED REMAINING AVERAGE
OUTSTANDING RANGE AVERAGE CONTRACTUAL LIFE OPTIONS EXERCISE PRICE
----------- ----- ------- ---------------- ------- --------------
175,594 $4.13 - $6.00 $4.91 5.8 105,936 $4.76
570,152 $6.01 - $9.00 $7.75 9.4 12,928 $6.92
35,712 $9.01 - $10.75 $10.59 2.9 33,354 $10.68
In addition to the disclosures above related to options granted under
the Company's 1991 Stock Incentive Plan and 1996 Stock Incentive Plan, the
disclosure that follows relates to options granted pursuant to employment
agreements or otherwise not under such plans.
In January 1995, the Chief Executive Officer of the Company resigned
his employment with the Company. As part of the severance agreement, stock
options to purchase 69,916 shares of Common Stock at prices ranging from $4.56
to $10.75 were canceled and stock options to purchase 116,084 shares of Common
Stock were amended to set their exercise price at $5.25. These amended options
have fully vested as of December 31, 1997 and remain outstanding.
In July 1995, the Company adopted the DIANON Systems, Inc. Employee
Stock Purchase Plan (the "ESPP" or "Plan") as described in Section 423 of the
Internal Revenue Code. The Plan provides for the sale of not more than 300,000
shares of Common Stock, subject to adjustments in the event of stock splits and
other changes in capitalization. The Plan provides that all shares issued
pursuant to the Plan be treasury shares acquired by the Company in open market
transactions and that no shares issued will be authorized but unissued Common
Stock. Commencing on August 15, 1995, the Company offered the ESPP to eligible
employees as defined by the Plan at a purchase price equal to the lesser of 85%
of the market price at the date of grant or 85% of the market price at the date
of purchase or as otherwise defined in the grant offering.
F-14
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In May 1996, the Company granted an officer options to purchase 200,000
shares of Common Stock at $5.69 per share pursuant to the terms of an employee
agreement. These options vest 40% in May 1998 and 20% over each year thereafter.
In October 1996, the Company granted options to purchase 10,000 shares
of Common Stock at $7.13 per share to an outside director of the Company, in
replacement of options issued in June 1993. These options vested immediately and
expire ten years from the date of grant.
In January 1997, the Company purchased 89,000 shares of Common Stock
from the then Chairman of the Board, at the current market price of $8.50 per
share.
(6) RELATED PARTIES
The Company pays a stockholder, who is also Chairman Emeritus, and who
was a director until January 1995, a royalty of 6% of revenue on sales of
certain technology covered by a license agreement. In addition, the Company
provides this stockholder with certain insurance benefits, the use of an
automobile and the reimbursement of expenses incident to his performance as a
consultant to the Company. The Company paid licensing and royalty fees to this
stockholder of approximately $42,000, $79,000 and $122,000 during the years
ended December 31, 1997, 1996 and 1995, respectively.
In 1995, the Company entered into a three-year research and development
agreement with Brigham & Women's Hospital, Inc. The agreement required the
Company to make quarterly payments of $30,000 in exchange for an option to
obtain rights in certain existing inventions as well as inventions developed
during the course of the research in the areas of cancer detection and
diagnosis. The research was to be conducted by a director of the Company. The
Company paid $60,000, $120,000 and $60,000 under this agreement in 1997, 1996
and 1995, respectively. The Company terminated this agreement effective as of
June 30, 1997 and has made all required payments as of December 31, 1997. In
addition, the Company made payments to Brigham & Women's Hospital, Inc. of
$30,000 in each of 1996 and 1995 for consulting services.
Pursuant to his employment agreement, the President of the Company
received a loan in 1996 totaling $150,000 which bears interest at 5.9%, payable
annually, and is repayable upon termination with the Company. In addition, the
loan principal will be forgiven at a rate of $2,500 per month over the period
January 1998 through December 2002 if the President continues to be employed by
the Company.
In the fourth quarter 1997, the Company entered into a one-year
consulting and proprietary information and inventions agreement with Dr. Jeffrey
L. Sklar, a director of the Company. The agreement requires the Company to make
quarterly payments at the beginning of each quarter for $5,000 in exchange for
delivery of services for molecular diagnosis. The Company paid $5,000 under this
agreement in 1997.
See also Note 13.
(7) RESTRUCTURING COSTS
In 1995, the Company provided for a reserve of $279,000 due to
management's decision to discontinue European based operations, of which
approximately $20,000 remains. The Company is in the final process of
liquidating the European based operations and plans to complete the liquidation
process during 1998.
(8) COMMITMENTS
The Company is involved in certain legal matters which periodically
arise in the normal course of business. Management believes that the outcome of
these legal matters will not have a material adverse effect on the financial
position and results of operations of the Company.
F-15
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) EMPLOYEE BENEFIT PLAN
The Company established a 401(k) employee benefit plan pursuant to
which participants receive certain benefits upon retirement, death or
termination of employment. The Company is required to contribute amounts equal
to 20% of the contributions made by employees up to 1% of their total annual
salary (subject to tax code limits). The Company contributed approximately
$105,000, $88,000 and $67,000 to the plan during 1997, 1996 and 1995,
respectively. The Company offers no other post-retirement benefits or
post-employment benefits to its employees.
(10) INVESTMENT IN COMMON STOCK AND WARRANTS
During 1995, the Company recorded charges of $530,000 to write-down the
investment in common stock of a publicly traded company as the loss in value was
deemed other than temporary. During 1996, a similar charge of $62,000 was
recorded to completely write-off the investment.
(11) RIGHTS AGREEMENT
On April 29, 1994, the Board of Directors of DIANON Systems, Inc.
declared a dividend distribution of one Right for each outstanding share of
Common Stock, par value $.01 per share, of the Company to stockholders of record
on May 10, 1994. Each Right entitles the registered holder to purchase from the
Company a unit ("Unit") consisting of one one-hundredth of a share of Series A
Junior Participating Preferred Stock, par value $.01 per share, of the Company,
at a price of $20 per Unit, subject to adjustment, upon change of control in the
Company, as defined in the rights agreement.
(12) SEVERANCE COSTS
The Company recorded charges of approximately $324,000, $148,000 and
$595,000 during 1997, 1996 and 1995, respectively, for severance costs as a
result of streamlining its operations and of the resignation of certain officers
of the Company. The remaining reserve as of December 31, 1997 is approximately
$218,000.
(13) PRIVATE PLACEMENT
On October 5, 1995, the Company completed a $5,612,000 private
placement with an investor for one million shares of Common Stock and a two-year
warrant for 800,000 shares exercisable at $6.00 per share of Common Stock
(except as otherwise described below). The Company received cash of $5,316,000
and a two-year promissory note for $296,000 bearing 7% interest, which note was
classified as a reduction to additional paid-in capital. Some or all of the
warrants could be exercised at a price of $5.00 at any time on or before October
31, 1996. Upon such election the Company would be required to extinguish as an
adjustment to the purchase price paid for such warrants, for each such warrant
for which such election has been made, $0.37 of the principal amount of the note
upon payment of the interest due on such extinguished amount for the outstanding
period. If the warrants for 800,000 shares were all exercised on or before
October 31, 1996, the two year promissory note for $296,000 would be fully
extinguished. On August 20, 1996, the Company's Board of Directors approved an
amendment to the terms of the warrants to extend from October 4, 1996 to October
31, 1996, the date through which the warrants could be exercised at $5.00 per
share. The amendment was approved in connection with the scheduling of the
Company's Annual Meeting for October 24, 1996 to enable voting at such meeting
on the Company's agreement to enable the investor to vote shares of the
Company's common stock owned by such investor and certain affiliates
representing up to 20% of the total voting power of the Company's voting
securities outstanding from time to time to be completed prior to the expiration
of the $5.00 per share exercise price. The Company's agreement was approved at
the Company's Annual Meeting on October 24, 1996. On October 29, 1996, the
investor exercised warrants for all 800,000 shares and in exchange for the
payment of approximately $4.0 million in cash representing the aggregate
exercise price of such warrants and interest on the principal amount of the
two-year promissory note for the outstanding period, the Company issued to the
investor 800,000 shares of its Common Stock and fully extinguished and cancelled
the promissory note.
(14) SUBSEQUENT EVENT
On February 1, 1998, the Company acquired certain assets of a pathology
laboratory located in Tampa, Florida and the acquisition will be accounted for
pursuant to the purchase method of accounting.
F-16
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To DIANON Systems, Inc.:
We have audited in accordance with generally accepted auditing
standards, the consolidated financial statements of DIANON Systems, Inc. and
subsidiary companies included in this Form 10-K and have issued our report
thereon dated February 18, 1998. Our audits were made for the purpose of forming
an opinion on the basic consolidated financial statements taken as a whole. The
schedule listed in the index to consolidated financial statements is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic consolidated financial statements. This schedule has been subjected to
the auditing procedures applied in the audits of the basic consolidated
financial statements and, in our opinion, fairly states in all material respects
the financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Stamford, Connecticut
February 18, 1998
F-17
DIANON SYSTEMS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
Balance at
Beginning of Provision for Charges to Balance at End
Year Allowance Allowance of Year
---------------- ----------------- ----------------- ----------------
For the year ended December 31, 1995:
Allowance for bad debts $ 735,250 $ 51,670 $ -- $ 786,920
Domestic restructuring reserve 37,748 -- 33,191 4,557
International restructuring reserve 62,702 118,000 18,661 162,041
Non-deductible write-down of investment
in stock -- 529,625 -- 529,625
For the year ended December 31, 1996:
Allowance for bad debts 786,920 270,000 -- 1,056,920
Domestic restructuring reserve 4,557 -- 4,557 --
International restructuring reserve 162,041 -- 6,566 155,475
Non-deductible write-down of investment
in stock 529,625 -- 529,625 --
For the year ended December 31, 1997:
Allowance for bad debts 1,056,920 300,294 65,119 1,292,095
International restructuring reserve 155,475 -- 135,404 20,071
F-18
EXHIBIT INDEX
-------------
Exhibit
Document
No. Reference
- --- ---------
3.1 Restated Certificate of Incorporation of the Company, as amended
through June 12, 1991 (incorporated by reference to Exhibit 3.1 of the
Registrant's Registration Statement No. 33-41226).
3.2 Restated By-Laws of the Company, as amended through October 24, 1996
(incorporated by reference to Exhibit 4.2 of the Registrant's
Registration Statement No. 333-18817).
3.3 Restated By-Laws of the Company, as amended through February 2, 1997
(incorporated by reference to Exhibit 4.2 of the Registrant's
Registration Statement No. 333-18817).
10.1 Consulting Agreement, dated August 4, 1989, between DIANON Systems,
Inc. and Nonda Katopodis (incorporated by reference to Exhibit 10.7 of
the Registrant's Registration Statement No. 33-41226).**
10.2 Executive Vesting Agreement, dated as of June 11, 1991, between DIANON
Systems, Inc. and James B. Amberson (incorporated by reference to
Exhibit 10.13 of the Registrant's Registration Statement No.
33-41226).**
10.3 1991 Stock Incentive Plan (incorporated by reference to Exhibit 10.17
of the Registrant's Registration Statement No. 33-41226).**
10.4 Management Incentive Plan (incorporated by reference to Exhibit 10.18
of the Registrant's Registration Statement No. 33-41226).**
10.5 Stock Option Grant to Walter O. Fredericks, dated April 27, 1990
(incorporated by reference to Exhibit 10.23 of the Registrant's
Registration Statement No. 33-41226).**
10.6 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991
(incorporated by reference to Exhibit 10.24 of the Registrant's
Registration Statement No. 33-41226).**
10.7 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991
(incorporated by reference to Exhibit 10.25 of the Registrant's
Registration Statement No. 33-41226).**
10.8 Lease Agreement, made as of February 14, 1989, between Watson Boulevard
Development Limited Partnership, as lessor, and DIANON Systems, Inc.,
as lessee, for premises located at 200 Watson Boulevard (incorporated
by reference to Exhibit 10.29 of the Registrant's Registration
Statement No. 33-41226).
10.9 License Agreement, dated June 9, 1983, between Sloan-Kettering
Institute for Cancer Research and N-K Laboratories Limited Partnership
(incorporated by reference to Exhibit 10.30 of the Registrant's
Registration Statement No. 33-41226).
10.10 License Agreement, dated July 29, 1987, between University of Rochester
and DIANON Systems, Inc. (incorporated by reference to Exhibit 10.32 of
the Registrant's Registration Statement No. 33-41226).
10.11 Development Agreement, effective September 25, 1987, between
Connecticut Product Development Corporation and DIANON Systems, Inc.
(incorporated by reference to Exhibit 10.33 of the Registrant's
Registration Statement No. 33-41226).
10.12 Stock Option Grant to James B. Amberson, dated April 23, 1991
(incorporated by reference to Exhibit 28.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1991).**
10.13 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991, as
amended (incorporated by reference to Exhibit 10.37 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1991).**
10.14 Asset Purchase Agreement, dated April 30, 1993, by and among the
Registrant and Molecular Oncology, Inc., and Oncologix, Inc.
(incorporated by reference to Exhibit 1.1 to the Registrant's Form 8-K
dated April 30, 1993, filed with the Securities and Exchange Commission
on May 14, 1993).
10.15 Asset Purchase Agreement, dated June 29, 1993, by and among the
Registrant and Collaborative Research, Inc. (incorporated by reference
to Exhibit 1.2 to the Registrant's Form 8-K dated June 29, 1993, filed
with the Securities and Exchange Commission on July 13, 1993).
F-19
Exhibit
Document
No. Reference
- --- ---------
10.16 Term Loan Agreement, dated July 14, 1993, by and among the Registrant
and the Union Trust Company (incorporated by reference to Exhibit 10.34
to the Registrant's Annual Report on Form 10-K/A Amendment 1 for the
year ended December 31, 1993, filed with the Securities and Exchange
Commission on April 28, 1994).
10.17 Rights Agreement, dated April 29, 1994, by and among the Registrant and
American Stock and Trust Company, as Rights Agent (incorporated by
reference to Exhibit 1 to the Registrant's Form 8-K dated April 29,
1994, filed with the Securities and Exchange Commission on May 9,
1994).
10.18 Severance Agreement, dated January 20, 1995, by and among the
Registrant and John P. Davis (incorporated by reference to Exhibit
10.36 to the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1995, filed with the Securities and Exchange Commission on
March 29, 1996).**
10.19 Employment Agreement, dated May 3, 1996, by the Registrant and Kevin C.
Johnson (incorporated by reference to Exhibit 10.37 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996).**
10.20 Executive Employment Agreement, dated September 1, 1996, by the
Registrant and Richard A. Sandberg (incorporated by reference to
Exhibit 10.38 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996).**
10.21 Employment Agreement, dated September 1, 1996, by the Registrant and
Dr. James B. Amberson (incorporated by reference to Exhibit 10.39 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.22 Executive Employment Agreement, dated September 1, 1996, by the
Registrant and Dr. James B. Amberson (incorporated by reference to
Exhibit 10.40 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996).**
10.23 Severance Agreement, dated September 27, 1996, by the Registrant and
Carl R. Iberger (incorporated by reference to Exhibit 10.41 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.24 Employment Agreement, dated September 30,1996, by the Registrant and
David R. Schreiber (incorporated by reference to Exhibit 10.42 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.25 Employment Agreement, dated November 18, 1996, by the registrant and
Steven T. Clayton.**
10.26 Severance Agreement dated November 18, 1996, by the registrant and
Daniel J. Cronin, III.**
10.27 Amendment dated as of October 4, 1995 to Rights Agreement dated as of
April 29, 1994 between the Registrant and American Stock Transfer and
Trust Company, as Rights Agent (incorporated by reference to Exhibit
No. 1 to the Registrant's Form 8-K dated October 30, 1996 filed with
the Securities and Exchange Commission on November 8, 1995).
10.28 1996 Stock Incentive Plan (incorporated by reference to Appendix A to
the Registrant's Statement on Schedule 14A filed with the Securities
and Exchange Commission on September 23, 1996).**
10.29 Stock and Warrant Purchase Agreement, dated as of October 4, 1995,
among the Gilbert Family Trust, the G.S. Beckwith Gilbert I.R.A.
Contributory Account, G.S. Beckwith Gilbert and the Registrant.
10.30 Registration Rights Agreement, dated as of October 4, 1995, among the
Gilbert Family Trust, the G.S. Beckwith Gilbert I.R.A. Contributory
Account, G.S. Beckwith Gilbert and the Registrant.
10.31 Warrant No. 1, dated as of October 4, 1995, by the Registrant in favor
of G.S. Beckwith.
10.32 Promissory Note, dated October 4, 1995, by G.S. Beckwith Gilbert in
favor of the Registrant.
10.33 Stock Option Grant dated October 24, 1996 by the Registrant to Andre de
Bruin.**
10.34 Stock Option Grant dated November 4, 1996 by the Registrant to Jeffrey
M. Sklar, M.D.**
10.35 Loan Agreement dated December 3, 1996 by the Registrant to Kevin C.
Johnson).**
10.36 Form of standard Stock Option Grant for outside directors.**
F-20
Exhibit
Document
No. Reference
- --- ---------
10.37 Amendment to Warrant Certificate No. W-1 dated as of October 2, 1996
between the Registrant and G.S. Beckwith Gilbert.
10.38 Severance Agreement dated February 27, 1997 by the Registrant and
Richard A. Sandberg.**
10.39 Amendment dated April 30, 1997 by the Registrant and Richard A.
Sandberg.**
10.40 Security Agreement dated April 30, 1997 by the Registrant and Richard
A. Sandberg.**
10.41 Secured Promissory Note dated April 30, 1997 by the Registrant and
Richard A. Sandberg.**
10.42 Non-Compete Agreement dated September 3, 1997 by the Registrant and
Vernon L. Wells.**
10.43 Severance Agreement dated September 15, 1997 by the Registrant and
Robert C. Verfurth.**
10.44 Consulting and Proprietary Information and Inventions Agreement dated
October 1, 1997 by the Registrant and Dr. Jeffrey L. Sklar, MD, PhD
(filed herewith).
10.45 Severance Agreement dated January 27, 1998 by the Registrant and Vernon
L. Wells (filed herewith).**
11.1 Statement re: computation of per share earnings. *
22.1 List of Subsidiaries of the Company (incorporated by reference to
Exhibit 22.1 of the Registrant's Registration Statement No. 33-41226).
23.1 1996 Consent of Arthur Andersen LLP (incorporated by reference to
Exhibit 23.1 of the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995).
23.2 1997 Consent of Arthur Andersen LLP (incorporated by reference to
Exhibit 23.2 of the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1996).
23.3 1998 Consent of Arthur Andersen LLP (filed herewith).
27.1 Financial Data Schedule.
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* Not applicable or contained elsewhere herein.
** A management contract or compensatory plan or arrangement
required to be filed as an exhibit to this form pursuant to
Item 14(c) of this report.
F-21