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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1996 Commission File No. 1-9767

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.

Delaware 94-2579751
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

9162 Eton Avenue, Chatsworth, California 91311
(Address of principal executive offices) (Zip Code)

Telephone Number: (818) 709-1244

Securities registered pursuant to Section 12(b) of the Act: Common Stock
(American Stock Exchange)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No _____

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K._____

On March 25, 1997, the aggregate market value of the shares of Common
Stock held by non-affiliates of the Registrant was approximately $19.4 million
based upon the closing price of $3-7/8 per share of Common Stock as reported on
the American Stock Exchange. Solely for the purpose of determining
"non-affiliates" in this context, shares of Common Stock held by each officer
and director and by each person who owns 5% or more of the outstanding Common
Stock have been excluded. This determination of affiliate status is not
necessarily a determination for other purposes.

The Registrant had 5,963,748 shares of Common Stock outstanding on
March 25, 1997.

Part III incorporates information by reference from the Proxy
Statement for the Registrant's 1997 Annual Meeting of Stockholders.

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INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.

FORM 10-K ANNUAL REPORT

FISCAL YEAR ENDED DECEMBER 31, 1996

Caption Page
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PART I

Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . 15

PART II

Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters . . . . . . . . . . . 16
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . 17
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . . 24

PART III

Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . 25
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . 25
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . 25

PART IV

Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K . . . . . . . . . . . . . . 25

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PART I

ITEM 1. BUSINESS.

A glossary of selected technical terms is included at the end of this
section, and stockholders are encouraged to review the glossary before reading
the description of business.

OVERVIEW

International Remote Imaging Systems, Inc. and its subsidiaries
("IRIS" or the "Company") design, develop, manufacture and market in vitro
diagnostic ("IVD") imaging systems based on patented and proprietary automated
intelligent microscopy ("AIM") technology for automating microscopic procedures
performed in clinical laboratories. AIM combines the Company's capabilities in
automated specimen presentation, including its patented slideless microscope,
and proprietary high-speed digital processing hardware and software to classify
and present images of microscopic particles in easy-to-view displays. The
Company's IVD imaging systems are designed to provide customers with better and
more rapid results and labor cost-savings over manual methods of performing
microscopy. IRIS markets its products primarily to hospital and clinical
reference laboratories.

The Company pioneered its first IVD imaging system application in 1983
with its introduction of The Yellow IRIS family of workstations for urinalysis.
The Company believes that it is still the only supplier of laboratory systems
which fully automate a complete urinalysis, and it recently introduced its
fourth generation models which incorporate significant advancements in speed,
utility and ease of use. In 1996, the Company received Food and Drug
Administration ("FDA") clearance and began to market the Model 900UDx urine
pathology system designed especially for the high-volume testing requirements
of larger laboratories. The Company also provides ongoing sales of supplies
and service necessary for operation of The Yellow IRIS workstations. Most
supplies are purchased under standing orders and, following the initial
one-year warranty period, the majority of customers purchase annual service
contracts.

In addition to urinalysis, the Company has also added new applications
for its IVD imaging systems. It recently completed development of The White
IRIS leukocyte differential analyzer for the field of hematology. The FDA
cleared The White IRIS for marketing in May 1996, and the Company expects to
start sales of this system in 1997. The Company also plans to sell supplies
and service for The White IRIS comparable to those sold for The Yellow IRIS.

In July 1996, the Company entered the field of genetics with the
acquisition (the "PSI Acquisition") of the digital imaging business of
Perceptive Scientific Instruments, Inc. ("PSI"). PSI's principal product is
the PowerGene genetic analyzer -- an IVD imaging system for karyotyping, DNA
probe analysis and comparative genomic hybridization. The Company also
acquired international operations from PSI.

THE INDUSTRY

As a result of cost containment pressures from third-party payors,
healthcare providers are focusing on the more efficient use of their resources.
This goal is driving them to reduce costs while simultaneously improving the
outcome potential of patient care. Meeting this goal depends to a large degree
on reducing the cost and improving the accuracy of medical tests for diagnosing
and monitoring diseases, as well as reporting the results of these tests in
timely and useful ways.

Medical tests are performed either on the patient or on a specimen
removed from the patient. IVD testing refers to analysis of a specimen -- a
sample of blood ("hematology"), urine ("urinalysis"), chromosomes ("genetics")
or other tissue or material removed from the patient -- usually in the clinical
laboratory. Many IVD tests rely on chemical or simple physical measures of
specific characteristics of the specimen. Over the past five decades, the
chemical and particle-counting aspects of these tests have been largely
converted from manual methods to automated instruments, such as clinical
chemistry analyzers and blood cell counters.

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However, many other IVD tests require visual examination of the
specimen through a microscope ("microscopy"). Manual microscopy requires
numerous steps from specimen preparation to visual examination, making the
method labor-intensive, cumbersome, biohazardous, inefficient and imprecise.
More labor time is spent in performing manual microscopy, collectively, than in
any other IVD testing procedure in the clinical laboratory. Nonetheless, the
vast majority of microscopic procedures are still performed manually.

The pressure to reduce the costs and improve the accuracy of IVD
tests, together with recent technological developments, have created an
opportunity for automating microscopic procedures. Advances in image
processing software, computer hardware and solid-state cameras have made it
possible to capture digital images of microscopic specimens in a uniform manner
and perform sophisticated analysis and classification of these images. The
test results can then be electronically transmitted to the central computer
system of the hospital or reference laboratory for clinical use and billing.
The digital images of the specimen can also be stored in electronic format for
future review and, theoretically, transmitted to remote locations for review by
other technologists or specialists.

THE COMPANY'S STRATEGY

The Company's objectives are to maintain its technological leadership,
develop new products, continue market penetration of existing products, expand
the geographic markets for existing products and increase sales of supplies and
service. The Company is pursuing these objectives through the following
strategies:

o Adding New IVD Imaging Applications. The Company believes AIM
technology has a number of potential applications in the
clinical laboratory and is expanding beyond the field of
urinalysis. The Company recently completed development of The
White IRIS leukocyte differential analyzer for hematology and
expects to start sales of this system in 1997. In July of
1996, the Company strategically expanded into the field of
genetics through the PSI Acquisition, which included the
acquisition of the PowerGene family of IVD imaging systems.
Availability of multiplex fluorescent in-situ hybridization
("M-FISH") applications to genetics is expected to stimulate
further growth of this line.

o Continuing Market Penetration for Current Applications of IVD
Imaging Technology. Although more than 75% of all hospitals
affiliated with United States medical schools use The Yellow
IRIS urinalysis workstation, the Company estimates that it has
penetrated less than 20% of the potential market in the United
States for this family of systems. It plans to continue
penetrating this segment of the IVD testing market with
additional sales of its recently introduced fourth generation
models of The Yellow IRIS family and the Model 900UDx urine
pathology system, the latter of which was designed especially
for the high-volume testing requirements of larger
laboratories. The Company also plans to expand its rental
program for The Yellow IRIS which generates revenues based on
the number of tests performed by the customer.

o Expanding in New Geographic Markets. Until recently, the
Company has marketed its IVD imaging systems almost
exclusively in the United States. Through the PSI Acquisition
in July 1996, the Company acquired international operations
which it expects will enable it to expand the geographic
market for its other IVD imaging systems and products.

o Increasing Sales of Supplies and Service. Once an IVD imaging
system is installed, the Company generates significant
recurring revenue from sales of supplies and service for its
operation. The Company seeks to enhance this revenue stream
by installing more systems as well as increasing its product
offering of supplies for each system. For example, the
Company began selling the CHEMSTRIP/IRIStrip urine test strips
for The Yellow IRIS systems at the end of 1994 and will begin
to sell the patented 2-methylpolymethine (2-MPM) cytoprobe for
The White IRIS when this system is introduced. The Company
expects the probes used in M-FISH to offer it similar
potential.

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o Maintaining Technological Edge. The Company maintains an
active research and development program to continually enhance
its IVD imaging systems and explore other potential IVD
imaging applications for its AIM technology.

o Adding Complementary Product Lines. Over the past two years,
the Company has also added several complementary lines of
small instruments and supplies which appeal to smaller
laboratories and respond to the desire of integrated
healthcare providers to purchase systems and supplies for a
variety of clinical settings from one supplier.

AIM TECHNOLOGY

An effective system for automated microscopy in most applications
requires technology for fast, consistent and easily discernable presentation of
the specimen to the microscope ("front end processing") and for rapidly
capturing, analyzing, classifying, enhancing, arranging and displaying images
of the specimen ("back end imaging"). The Company has over the past eighteen
years created and developed its patented and proprietary AIM technology to
address both of these requirements, as well as developed significant patented
and proprietary technology for specific applications.

The Company's AIM technology automates all or most of the front end
processing in its IVD imaging systems. For example, traditional urine sediment
analysis requires manual preparation of a slide from the specimen requiring
several steps, including centrifugation followed by carefully positioning,
staining and coverslipping a sample extracted from the specimen. The slide is
then placed under the microscope and manually manipulated and scanned by a
technologist. This procedure is often time-consuming, imprecise and carries
the potential for human exposure to biohazards. In contrast, the Company's
patented slideless microscope, used in The Yellow IRIS and The White IRIS,
allows microscopic examination of a moving specimen precisely positioned in a
stream of fluid and eliminates the need for manual slide preparation,
manipulation and scanning. The slideless microscope precisely positions the
specimen to within microns in a thin layer for proper focusing as it flows past
the microscope at high-speed ensheathed in a larger stream of fluid. The
method of ensuring proper alignment, particle orientation, focus and
measurement, called "imaging flow cytometry," is patented, and the Company is
unaware of any other company which has developed similar technology. For those
IVD tests where imaging flow cytometry is not optimal or possible, AIM
technology automates the slide manipulation and scanning process. The
Company's PowerGene genetic analyzers use this technology to automatically
locate and focus microscopic particles on a slide as it is precisely
manipulated and scanned by the system.

Once the specimen is located and presented to the microscope, AIM's
back end imaging automatically captures, digitizes, classifies, organizes and
presents the microscopic images displayed on a video monitor for review by the
medical specialist. These digital images of the specimen can then be stored on
magnetic or optical media for later retrieval, even years later.

PRODUCTS

AIM Systems

The Company has three families of AIM systems -- The Yellow IRIS, The
White IRIS and the PowerGene. These systems incorporate sophisticated front
end processing and back end imaging, require customers to make substantial
capital investments and are designed for sale to clinical laboratories
performing a relatively high-volume of IVD tests.

The Yellow IRIS family of urinalysis workstations are widely used in
hospitals nationwide, including over 75% of all hospitals affiliated with
United States medical schools. This family of IVD imaging systems currently
consists of three models. Two models can also perform IVD imaging tests on a
number of body fluids other than urine, including cerebrospinal, peritoneal,
pleural, pericardial, synovial and seminal fluids as well as peritoneal
dialyzates and lavages. The third model, the Model 900UDx, is designed for
laboratories testing high numbers

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of urine specimens. The Yellow IRIS family of IVD imaging systems currently
has list prices ranging from $85,000 to $195,000.

The White IRIS leukocyte differential analyzer is an automated
high-speed workstation used to classify normal, as well as immature and other
abnormal white blood cells. It was cleared by the FDA in May 1996 and, when
introduced in 1997, is expected to be the only commercially available device
cleared for automated classification of abnormal white blood cells. The White
IRIS can perform a differential analysis which includes identifying the five
types of normally occurring white blood cells plus a number of abnormally
occurring immature white blood cells, variant lymphocytes and other cells. The
Company also holds an exclusive, worldwide license to several patents which
cover the unique cytoprobe used by The White IRIS, as well as the multi-colored
expression of 2-MPM in white blood cells. The Company expects to start sales
of this system with an introductory list price of approximately $185,000.

The PowerGene family of genetic analyzers perform certain chromosome
tests such as karyotyping, DNA probe analysis in FISH and M-FISH procedures and
comparative genomic hybridization. These tests are typically used for
analyzing genetic abnormalities for both clinical uses (e.g. prenatal
screening) and research applications (e.g. cancer studies). The Company
believes the genetics market is one of the fastest growing segments of the
global IVD market. The Company purchased this family of analyzers in July 1996
in conjunction with the PSI Acquisition. The PowerGene analyzers currently
have list prices ranging upwards from $35,000 depending upon the selected
options and configuration.

The Company believes its AIM technology may have a number of other
potential IVD imaging applications such as cytology, microbiology and
histology.

IVD Imaging System Supplies and Service

In addition to sales of IVD imaging systems, the Company obtains
significant recurring revenue from sales of supplies used in the operation of
these systems and from their service and repair. Supplies for The Yellow IRIS
family and The White IRIS include the sheath fluid used to position the
particles and cleanse the system in slideless microscopy; proprietary reagents
such as the patented cytoprobe used by The White IRIS; and "controls" used in
calibrating and monitoring the performance quality of the systems. The Company
also sells the CHEMSTRIP/IRIStrips for testing urine chemistry on The Yellow
IRIS. The Company introduced the CHEMSTRIP/IRIStrip urine test strips in late
1994 and has converted over 90% of the installed base of systems to these new
test strips.

Small Instruments and Supplies

The Company also manufacturers and markets a variety of small
instruments and supplies for the clinical laboratory market. These products
complement the Company's line of IVD imaging systems because they appeal to
smaller laboratories and physician offices performing an insufficient number of
tests to justify the capital cost of an IVD imaging system. These products
also take advantage of the Company's reputation and expertise in urinalysis and
respond to the desire of integrated healthcare providers to purchase systems
and supplies for a variety of clinical settings (both large and small) from one
supplier. This category of products includes special-purpose centrifuges,
digital refractometers for measuring the specific gravity of urine, the
CenSlide 1500 System for manual microscopic examination and other supplies
intended primarily for the urinalysis market.

RESEARCH AND DEVELOPMENT

The Company maintains an active research and development program to
continually enhance its existing IVD imaging systems and explore other IVD
imaging applications for its AIM technology. In 1995 and 1996, the Company
focused its research and development efforts on the following major projects,
as well as numerous other smaller projects:

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o Developing the Model 900UDx. The Company introduced its
newest model in The Yellow IRIS family, the Model 900UDx, in
May 1996. The Model 900UDx is the industry's first and only
fully-automated walkaway system for performing complete
macroscopic, chemical and microscopic urinalysis profiles.

o Upgrading The Yellow IRIS. The Company conducts an ongoing
process of refining its AIM technology and the
cost-effectiveness of its systems. Late in the third quarter
of 1995, the Company completed development work on its fourth
generation models of The Yellow IRIS family which offer
increased speed and other performance advantages over the
previous generation of systems.

o Completing The White IRIS. The Company has had a major
program over a number of years, under sponsorship of the
National Institutes of Health and later in conjunction with a
Company-sponsored research and development entity, to develop
The White IRIS leckoeyte differential analyzer. The Company
has received FDA clearance to market the White IRIS and is
refining engineering and manufacturing processes prior to its
expected commercial availability in 1997.

o Expanding PowerGene. The Company has dedicated significant
research and development efforts toward fluorescent in-situ
hybridization ("FISH"). FISH is providing new tools for
direct and specific evaluation, and prediction of human
genetic disease. Utilizing multi-spectral fluorescent
chemical probes, M-FISH methods enhance the sensitivity of
classical karyotyping and provide easier interpretation of
chromosome abnormalities permitting such procedures to be
performed rapidly on uncultured amniotic or cancer cells.

The Company's current research and development efforts include, among
other things:

o Developing the Next Generation Platform for Its IVD Systems.
The Company is pursuing improvements designed to significantly
increase speed and image resolution while simultaneously
reducing the amount of technologist time required to operate
the system.

o Upgrading the PowerGene Cytogenetic Capabilities. Research
and development efforts for this system are focused upon
developing improved karyotyping image classification
algorithms and expanded measures in chromosome analysis using
M-FISH methods.

o Developing the Poly Products. The Company is developing the
Poly Products (discussed below), which are expected, among
other things, to enhance future generations of The Yellow IRIS
family by improving the automated classification of the urine
sediment and reducing the amount of specimen handling.

o Identifying Future Applications. The Company is performing
market research and experiments to identify future
applications of its technology.

The Company has in the past partially funded its research and
development programs through (i) grants from NASA and NIH, (ii) joint
development programs with strategic partners and (iii) Company-sponsored
research and development entities. In recent years, the Company has entered
into four significant projects, two joint development projects with strategic
partners--Boehringer Mannheim Corporation ("BMC") and Boehringer Mannheim GmbH
("BMG")--and two projects with Company-sponsored research and development
entities--LDA Systems, Inc. ("LDA") and Poly U/A Systems, Inc. ("Poly"). From
1994 to 1996, the Company collaborated with BMC and BMG in the development of
CHEMSTRIP/IRIStrip urine test strips and the Model 900UDx. In 1992, the
Company entered into a project with LDA for development of The White IRIS
leukocyte differential analyzer and later acquired LDA for approximately
498,000 shares of common stock, $.01 par value per share ("Common Stock"), of
the Company. In 1995, the Company entered into a similar project with Poly
which is ongoing for development of several new products to enhance automated
urinalysis (the "Poly Products").

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Following a reassessment of its own priorities, BMC decided not to
pursue a joint venture in hematology with the Company and agreed to several
amendments to its contracts with the Company. Through the amendments, BMC
strengthened its ties in the supply and distribution of CHEMSTRIP/IRIStrip
urine test strips while withdrawing from longer-term commitments in the areas
of hematology and urine microscopy. BMC agreed to supply the Company with
CHEMSTRIP/IRIStrip urine test strips at a reduced price and extended the term
of the underlying agreement. BMC also agreed to supply the Company with
certain raw materials at a favorable price should the Company elect to
manufacture its own urine test strips, subject to royalties to be paid to BMC
on such strips. BMC also granted the Company the non-exclusive right to
distribute certain other BMC urinalysis products to hospitals and commercial
laboratories in the United States. In return, the Company relieved BMG of its
obligations to purchase a minimum number of Model 900UDx workstations and to
supply certain technology and components.

The term of the underlying agreement between the Company and BMG to
manufacture and market the Model 900UDx was also extended. The Company will
continue to manufacture the Model 900UDx with BMG providing certain components
on an OEM basis at cost. The Company retained exclusive marketing rights to
the Model 900UDx in Taiwan and secured non-exclusive rights for the rest of the
world outside of Germany and Italy.

As compensation to the Company for potentially missed business
opportunities in hematology, Corange International, Ltd. ("Corange"), an
affiliate of BMC and BMG, allowed the Company to repurchase 469,413 shares of
Common Stock and a warrant to purchase an additional 250,000 shares of Common
Stock held by Corange at their original aggregate purchase price of $2.1
million, or $4.54 per share, a substantial discount from the then current
market price of $7.75 per share.

During 1996, the Company also acquired additional research and
development staff as a result of the PSI Acquisition. This staff conducted
$1.3 million, $797,000 and $410,000 of research and development in 1996, 1995
and 1994, respectively. These expenditures were offset by Small Business
Innovation Research grants from NASA and the National Institutes of Health
totaling $500,000, $489,000 and $317,000 in 1996, 1995 and 1994, respectively.

MARKETING AND SALES

In the United States, the Company's IVD imaging systems are sold and
serviced through the Companys own sales and service forces. Sales activities
consist of direct sales by field sales representatives, telemarketing to
initiate and aid in pursuing sales opportunities, logistics support of the
field sales representatives and after-sales support to customers in the
operation of their systems. In addition to its sales activities, the Company
promotes the advantages of its products through advertising in trade journals,
attendance at trade shows and direct mail. All sales of IVD imaging systems
include installation, customer training and a one-year warranty. The Company's
small instruments, targeted primarily at smaller customers, are sold through
distributors. Through the PSI Acquisition, the Company acquired an overseas
sales office and staff of 14 people based in Chester, England that supports
agents and distributors in more than thirty-five countries. The Company
intends to use this international sales channel to market its other IVD systems
and products.

The Company also maintains a rental program under which it has several
systems currently in place. Under the terms of the rental agreements, payments
generally are based on the number of tests performed with a guaranteed monthly
minimum payment to the Company. The Company is responsible for supply and
service of the systems. Alternatively, some customers lease the Company's IVD
systems from medical equipment leasing companies which, in turn, purchase the
systems from the Company.

In addition, the Company markets most of the supplies used in the
operation of its IVD systems and maintains these systems through its own
national service organization. Service (after the one-year warranty period) is
generally sold under an annual service contract or, less frequently, on a
per-call basis.

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COMPETITION

There are numerous large and well-financed companies engaged in active
research and development programs within and outside of the medical
instrumentation field that have considerable experience in areas of interest to
the Company. The Company cannot determine if any such firms are currently
engaged in potentially competitive research. However, one or more of these
firms may be able to develop and introduce IVD imaging systems comparable or
superior to the Company's current products or any other product ultimately
developed or acquired by the Company.

Urinalysis

The Company's primary products for the urinalysis market are The
Yellow IRIS family of urinalysis workstations. The principal competitive
factors in this market are cost-per-test, ease of use, and quality of result.
The Company believes The Yellow IRIS competes favorably with regard to these
factors in its target markets.

The Company granted TOA Medical Electronics Co., Ltd. ("TOA") a
perpetual license to market an instrument performing only the sediment
examination portion of urinalysis using pre-1989 technology. In 1990, TOA
introduced a urine sediment analyzer, the UA-1000, and in 1993 introduced an
improved model, the UA-2000. Royalty reports from TOA indicate that, as of
December 31, 1996, TOA has sold fewer than fifty systems, all in Japan. In
1996, TOA introduced its new UF-100 urine cell analyzer. This instrument
utilizes the same flow cytometric laser scanning principles inherent in all
modern hematology instruments to determine the presence of abnormal sediment
analytes in urine samples which must then be examined manually using the
traditional method. Unlike The Yellow IRIS workstations, the UF-100 does not
include urine chemistry and specific gravity tests. Based on an existing
agreement with TOA, the Company has the exclusive right to distribute the
UF-100 in North America and a right to receive royalties on sales outside of
North America. See "Legal Proceedings." The Company and TOA are presently
engaged in discussions with the intent to commence sales of the UF-100 in the
United States later this year.

BMG has introduced the Seditron microscopic urine analyzer in Europe
and Asia, a robotic slide-based instrument for automatic sediment examination
and analyte classification. Pursuant to the existing agreement between IRIS
and BMG, IRIS plans to exercise its exclusive option to distribute the Seditron
in the United States. As a low-capacity analyzer with no urine chemistry
capability and requiring significant operator participation, the Company
believes the Seditron is more appropriate for smaller laboratories where The
Yellow IRIS is not typically cost effective.

A number of hospitals conduct urine sediment examinations using the
Kova system made by Hycor Biomedical, Inc., as well as several other similar
products, all of which are composed largely of disposable plastic parts. These
products provide a more standardized method of preparing urine sediment for
microscopical examination as opposed to traditional means. While these
disposable products help somewhat to overcome manipulative imprecision, most of
them do so at the added expense of an increased number of disposable parts and
offer little in time savings. One exception is the CenSlide 1500 System
acquired by the Company in March of 1996. This system uses a combination
centrifuge tube and microscope slide, thereby actually eliminating much of the
manipulation required in preparing the urine specimen for microscopic
observation. The Company views these types of products as better suited for
laboratories performing a lower volume of urinalysis tests.

BMC, Behring Diagnostics, Inc., a subsidiary of Hoechst AG, and the
Bayer Diagnostics division of Bayer AG sell lines of urine test strips which
are useful in determining the concentration of various chemical substances
often found in urine. While some claims have been made that the absence of
certain results determined with these test strips can preclude the need for
microscopic examinations of some specimens, the Company cites evidence to the
contrary in its promotional activities.

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Hematology

The Company's product for the hematology market will be The White IRIS
leukocyte differential analyzer. The principal competitive factors in this
market are accuracy, precision, labor savings and ease of use. The Company
believes The White IRIS will compete favorably with regard to these factors.

Intelligent Medical Imaging, Inc. ("IMI") presently manufactures an
IVD imaging system, the Micro 21, for performing certain aspects of white blood
cell differential analysis and certain other analyses. Unlike The White IRIS,
which uses imaging flow cytometry, the Micro 21 is a slide-based system. The
Company believes The White IRIS has certain performance advantages over the
Micro 21. In comparison to the Micro 21, the Company believes The White IRIS
(i) is safer and more convenient because it uses a closed-tube sampling
procedure which does not require slide preparation, (ii) is more sensitive and
precise because it counts significantly more white blood cells, (iii) allows an
easier-to-obtain and more complete answer because it automatically classifies
variant, immature and other abnormal cells whereas the Micro 21 is capable only
of automated classification of normal cells, and (iv) is more cost effective
because it requires less attended time. Nonetheless, there can be no assurance
of the actual competitiveness of The White IRIS until the Company begins
marketing the workstation.

While other automated blood smear reading instruments capable of
varying degrees of white blood cell differential analysis exist, they are
relatively expensive. There is at least one such instrument currently in
production (made by Omron, a Japanese company), but, to the Company's
knowledge, it is not marketed outside of Japan. The Company is not aware of
any current plans by Omron to market its white blood cell slide readers in the
United States. TOA, Abbott Laboratories and Coulter Corporation, all
manufacturers of blood cell counters, have begun displaying devices which
automate the blood smear preparation process and are attachable to their
respective analyzers but do not provide for automation of white blood cell
differential analysis.

Genetics

The Company's product for the genetics market is the PowerGene
analyzer. The principal competitive factors in this market are product
features, software upgrades, clarity of output and customer service. The
Company believes the PowerGene analyzers compete favorably with regard to these
factors.

The Company's primary competitor in this market is Applied Imaging
which markets IVD imaging systems for prenatal and other genetic testing.
Vysis Inc., a subsidiary of AMOCO Technology Company, also sells IVD imaging
systems for this market. Its strategy has been to offer systems at a discount
as a vehicle for selling its DNA probes, mostly into the genetics research
market in the United States.

Other Potential Competitors

The Company is aware of at least three other companies that sell IVD
imaging systems for cervical cytology application. They include Neuromedical
Systems, Inc. and NeoPath, Inc., both of whom have begun marketing IVD imaging
systems they have developed for PAP smear screening, and, AutoCyte, Inc., a new
venture sponsored by F. Hoffman-La Roche, Inc. and certain venture capitalists.

INTELLECTUAL PROPERTY

The Company's commercial success depends in large part on its ability
to protect and maintain its proprietary rights. As such, the Company pursues
broad protection of its proprietary technology through the filing of various
patent applications. The Company has received numerous United States patents
for its AIM technology and related applications as well as a number of
corresponding foreign patents. These patents also cover developments in image
analysis and blood processing. A number of additional patent applications are
pending in the United States and abroad. Also, numerous patents relating to
digital refractometers, centrifuges, automated slide handling and disposable
urinalysis products were acquired in its recent acquisitions.

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11
The Company has an exclusive license from Cytocolor, Inc. for the
patented 2-MPM cytoprobe to be used in The White IRIS. Cytocolor has pursued
patent protection of this unique reagent through the filing of patent
applications in the United States and abroad. Under the terms of the license,
the Company will pay Cytocolor royalties of $1,000 per system for the first
1,000 sales of The White IRIS plus 8% of the net sales price of all consumable
products containing 2-MPM.

The Company has granted TOA a royalty-bearing license to use pre-1989
technology for urine sediment analyzers. See "--Competition--Urinalysis."

Other companies have filed applications for, or have been issued,
patents relating to products or processes that may be competitive with certain
of the Company's products or processes. The Company has received a letter from
Coulter Corporation informing the Company that the specimen sampling device
used on The White IRIS might infringe one of its patents. Coulter Corporation
offered the Company a license to the patent. However, the Company does not
believe it is infringing the patent and declined the offer. The Company notes
that Coulter Corporation is the distributor for IMI, a competitor in the
hematology market, and has not pursued the matter further. As part of an
arbitration settlement, Coulter and IMI recently terminated the exclusive
nature of Coulter Corporation's distribution rights.

In 1994, the Company notified IMI that its Micro 21 system infringed
upon at least two of the Company's patents. The parties entered into
negotiations regarding the licensing to IMI of these and possibly other Company
patents but were unable to reach an agreement. IMI filed a complaint in the
United States District Court for the Southern District of Florida in 1995, and
the parties recently settled the case. As part of the settlement, IMI
acknowledged the validity of the patents and agreed to pay the Company
royalties on certain sales of the Micro 21. See "--Competition--Hematology"
and "Legal Proceedings."

The Company has trade secrets and unpatented technology and
proprietary knowledge related to the sale, promotion, operation, development
and manufacturing of its products. To protect these rights, the Company enters
into confidentiality agreements with its employees and consultants.

The Company claims copyright in its software and the ways in which it
assembles and displays images, but it has not filed copyright registrations
with the United States Copyright Office or any comparable state or foreign
agency. The Company also owns various federally registered trademarks,
including "IRIS," "The Yellow IRIS," "The White IRIS" and "PowerGene." The
Company owns numerous other registered and unregistered trademarks. The
Company also has certain trademark rights in foreign jurisdictions. The
Company intends to aggressively protect its copyrights and trademarks.

GOVERNMENT REGULATION

Most of the Company's products are subject to stringent government
regulation in the United States and other countries which govern the testing,
manufacture, labeling, storage, record-keeping, distribution, sale, marketing,
advertising and promotion of such products. The regulatory process can be
lengthy, expensive and uncertain, and securing clearances or approvals may
require the submission of extensive official data and other supporting
information. Failure to comply with applicable requirements can result in
fines, recall or seizure of products, total or partial suspension of
production, withdrawal of existing product approvals or clearances, refusal to
approve or clear new applications or notices and criminal prosecution.

In the United States, the FDA regulates medical devices under the
Food, Drug, and Cosmetic Act (the "FDC Act"). Before a new medical device can
be commercially introduced in the United States, the manufacturer usually must
obtain FDA clearance by filing a pre-market notification under Section 510(k)
of the FDC Act (a "510(k) Notification") or obtain FDA approval by filing a
pre-market approval application (a "PMA Application"). The 510(k) Notification
process can be lengthy, expensive and uncertain, but the PMA Application
process is significantly more complex, expensive, time-consuming and uncertain.
To date, the Company has cleared all of its regulated products with the FDA
through the 510(k) Notification process including, most recently, The White
IRIS and the Model 900UDx.

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The Company's business strategy includes the development of additional
products for which FDA clearance or approval may be required, and no assurance
can be given that the Company can secure any necessary FDA clearance to market
these products or that the FDA will not require the filing of a PMA Application
for these products. Furthermore, FDA clearance of a 510(k) Notification or
approval of a PMA Application is subject to continual review, and the
subsequent discovery of previously unknown facts may result in restrictions on
a product's marketing or withdrawal of the product from the market.

The Company is also required to register as a medical device
manufacturer with the FDA and comply with FDA regulations concerning good
manufacturing practices for medical devices ("GMP Standards"). The FDA
recently expanded the scope of the GMP Standards with new regulations requiring
medical device manufacturers to maintain control procedures for the design
process, component purchases and instrument servicing. The FDA periodically
inspects the Company's manufacturing facilities for compliance with GMP
Standards. Based in part upon the results of prior FDA inspections, the
Company believes that it can achieve substantial compliance with GMP Standards.
The Company also believes that it can achieve substantial compliance with the
expanded GMP Standards prior to the FDA's announced deadline of June 1998 and
that achieving compliance will not require significant capital expenditures or
have a material adverse effect on its business.

The FDA also regulates computer software of the type used in the
Company's IVD imaging systems and is currently reevaluating the regulation of
such software. The Company cannot predict the extent to which the FDA will
regulate such software in the future.

Labelling, advertising and promotional activities for medical devices
are subject to scrutiny by the FDA and, in certain instances, by the Federal
Trade Commission. The FDA also enforces statutory and policy prohibitions
against promoting or marketing medical devices for unapproved uses.

Many states have also enacted statutory provisions regulating medical
devices. The State of California's requirements in this area, in particular,
are extensive, and require registration with the state and compliance with
regulations similar to the GMP Standards established by the FDA. While the
impact of such laws and regulations has not been significant to date, there can
be no assurance that future developments in this area will not have a material
adverse effect on the Company.

In addition to domestic regulation of medical devices, many of the
Company's products are subject to regulations in the foreign jurisdictions in
which it operates or sells products. The requirements for the sale of medical
devices in foreign markets vary widely from country to country, ranging from
simple product registrations to detailed submissions similar to those required
by the FDA. Although the Company distributes the PowerGene analyzer in more
than 35 foreign countries, it has not yet applied for regulatory clearances or
approvals to market The Yellow IRIS or The White IRIS in most of these foreign
countries. The Company's business strategy includes expanding the geographic
distribution of these and other products, and there can be no assurance that
the Company can secure the necessary clearances and approvals in the relevant
foreign jurisdictions. Furthermore, the regulations in certain foreign
jurisdictions continue to develop and there can be no assurance that new laws
or regulations will not have a material adverse effect on the Company's
existing business or future plans. Among other things, CE Mark certifications
are, or may soon be, required for the sale of many products in certain
international markets such as the European Community. The Company is actively
pursuing CE Mark certification for many of its products, but there can be no
assurance that the Company will be successful in securing such certification.

In addition, the Company's products are subject to regulation by the
United States Department of Commerce export controls, primarily as they relate
to the associated computers and peripherals. The Company has not experienced
any material difficulties in obtaining necessary export licenses to date.

Any change in existing federal, state or foreign laws or regulations,
or in the interpretation or enforcement thereof, or the discussion or
promulgation of any additional laws or regulations could have a material
adverse effect on the Company.

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13
RECENT ACQUISITIONS AND OTHER SIGNIFICANT DEVELOPMENTS

The Company has experienced substantial developments during the past
year, and the following summarizes the more significant events occurring since
January 1, 1996.

StatSpin Acquisition

The Company acquired StatSpin, Inc. ("StatSpin") in February 1996, in
a transaction accounted for as a pooling-of-interests, for approximately
340,000 shares of Common Stock and the assumption of options and warrants to
purchase an additional 126,000 shares of Common Stock. Through this
acquisition, the Company acquired sample preparation technologies useful for
future IVD imaging applications, a complementary line of products for smaller
laboratories, as well as access to key distributors for small laboratory
instruments and supplies. StatSpin had net sales of $4.3 million, $3.1 million
and $2.9 million in 1996, 1995 and 1994, respectively.

CenSlide Acquisition

In March 1996, the Company purchased the CenSlide 1500 System and
related products for manual microscopic examination from UroHealth Systems,
Inc. for $850,000. Among other things, the Company acquired several United
States and foreign patents, as well as the design for the unique centrifuge
used in the CenSlide 1500 System. The Company recently transferred production
of the CenSlide product line to StatSpin and currently markets it through its
distribution channels. The CenSlide product line generated net sales of
approximately $432,000 and $550,000 for 1996 and 1995, respectively.

PSI Acquisition and Related Financing

In July 1996, the Company acquired the digital imaging business of PSI
for approximately $16.1 million plus a five-year warrant to purchase 875,000
shares of Common Stock at $8.00 per share. PSI's principal product is the
PowerGene cytogenetic analyzer. The Company financed the purchase price with
(i) a $7.0 million subordinated note issued to the seller, (ii) a $7.8 million
term loan from City National Bank and (iii) $1.3 million drawn under a new $1.5
million revolving line of credit with City National Bank. The Company
accounted for the PSI Acquisition using the purchase method of accounting.
Total revenues for this business were $6.1 million, $5.4 million and $4.3
million in 1996, 1995 and 1994, respectively.

Prior to the PSI Acquisition, the Company did not have significant
international sales. With the acquisition, the Company acquired an overseas
operation headquartered in Chester, England supporting agents and distributors
in more than 35 countries. International sales of the PowerGene line accounted
for 64%, 56% and 54% of total sales for this product line in 1996, 1995 and
1994, respectively.

The Company also acquired additional research and development
resources through this acquisition. See "--Research and Development."

Stock Repurchase

In September 1996, as compensation to the Company for potentially
missed business opportunities in hematology resulting from an amendment to the
Company's joint development agreements with BMC and BMG, their affiliate agreed
to the Company's repurchase of 469,413 shares of Common Stock and a warrant to
purchase 250,000 shares of Common Stock held by the affiliate at their original
aggregate purchase price of $2.1 million, or $4.54 per share, a substantial
discount from the then current market price of $7.75 per share. The purchase
price is payable in four installments, and the Company has paid two
installments to date. The two remaining payments are due in the second half of
1997 and total $1.0 million. The Company has the right, if necessary, to
extend the due dates of the remaining installments one year each, paying 8%
interest during the extension periods. See "--Research and Development."

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Restructuring

In response to a third quarter operating loss, the Company
restructured its workforce during the fourth quarter of 1996. The
restructuring reduced manpower by approximately 18% and is expected to reduce
annual operating expenses by more than $1.9 million as compared to expenditure
levels immediately prior to the restructuring. The Company incurred a one-time
earnings charge in the fourth quarter of 1996 of approximately $300,000 for
severance and other incremental costs associated with the restructuring.

Proposed Public Offering

In September 1996, the Company filed a registration statement with the
Securities and Exchange Commission for an underwritten public offering by the
Company of 3,000,000 shares of its Common Stock which was expected to generate
net proceeds of at least $20 million based upon the price of the Common Stock
at that time. The net proceeds of the public offering were to be used
primarily to reduce outstanding indebtedness incurred to finance the PSI
Acquisition and to repurchase the securities from the affiliate of BMC and BMG.
Following the third quarter operating loss, the Company elected not to pursue
the public offering at such time and, as an alternative, to pursue one or more
smaller financing transactions. Most of the expenses of the offering were
charged to operations in the third quarter of 1996.

Amendment to Bank Loan Agreements

As a result of the decision not to pursue the public offering and its
recent operating losses, the Company was unable to comply with the financial
covenants under the term loan and credit facility with City National Bank on
September 30 and December 31, 1996. The inability to comply with these
covenants constituted an event of default under the terms of the loan
documents. In April 1997, the bank agreed to waive the default, amend the
financial covenants and extend the maturity of both loans to April 15, 1998.
In exchange, the Company agreed to increase the interest rates on both loans
and to issue the bank a three-year warrant to purchase 50,000 shares of Common
Stock at $3.875 per share. The Company also agreed to issue additional
warrants to purchase 25,000 shares of Common Stock at prevailing market prices
on each of June 1 and July 1, 1997 if the term loan is still outstanding on
those dates. See "Managements Discussion and Analysis of Financial Condition
and Results of Operations."

Issuance of Preferred Stock

On December 31, 1996, the Company completed a sale of equity
securities for approximately $3 million in a private placement to Thermo Amex
Convertible Growth Fund I, L.P. Specifically, the Company sold (i) 3,000
shares of a new Series A Convertible Preferred Stock ("Series A Preferred
Stock") with a liquidation value of $1,000 per share and (ii) a warrant to
purchase 84,270 shares of the Common Stock at an exercise price of $3.56 per
share. The initial conversion price of the Series A Preferred Stock and the
warrant exercise price were based on the average closing price of the Common
Stock for the five trading days immediately preceding the closing of the sale.

Each share of Series A Preferred Stock is convertible into a number of
shares of Common Stock equal to (i) the liquidation value of a share of Series
A Preferred Stock divided by (ii) a variable conversion price (discussed
below). Any shares of Series A Preferred Stock not voluntarily converted
during the three years following their initial sale will be automatically
converted into Common Stock on December 31, 1999. The Series A Preferred Stock
is non-voting, is not entitled to any preferred dividends and is not subject to
any mandatory or optional redemption provisions. The Company may not pay cash
dividends on the Common Stock or repurchase any shares of the Common Stock
without the written consent of the holders of a majority of the outstanding
shares of Series A Preferred Stock.

The conversion price of the Series A Preferred Stock was fixed at
$3.56 per share of Common Stock until April 1, 1997. Based on this conversion
price, each share of Series A Preferred Stock would be convertible into
approximately 281 shares of Common Stock, and the Company would have issued
approximately 843,000 shares of

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Common Stock if the holder elected to convert all the outstanding shares of
Series A Preferred Stock. The conversion price is currently variable and
equals the lower of (i) 85% of the average closing bid price of the Common
Stock for the five consecutive trading days immediately preceding the
conversion date (but in no event less than $1.50) or (ii) $3.56. The
conversion price is subject to downward adjustments in the event that a
registration statement is not declared effective by May 30, 1997 permitting
public resale of the shares of Common Stock issuable upon conversion of the
Series A Preferred Stock.

If the Company obtains additional financing prior to July 1, 1997
through a private placement of equity securities (or debt securities
convertible into or coupled with equity securities), the holder of the Series A
Preferred Stock will have the right to exchange some or all of the Series A
Preferred Stock and Warrants then owned by it for the new securities offered by
the Company at an exchange price equal to the purchase price of such new
securities.

The Company obtained written representations from the investor that,
among other things, it was (i) an "accredited investor" as defined in Rule 501
and (ii) acquiring the Series A Preferred Stock for its own account for
investment purposes and not with a view to resale or distribution of such
securities in violation of the Securities Act of 1933. The Company did not
engage in any form of general solicitation or advertising, and the securities
bear appropriate restrictive legends. Based on these representations, the
Company believes the sale of securities in this transaction was exempt from
registration under the Securities Act of 1933 based on Regulation D.

FORWARD LOOKING STATEMENTS

The foregoing description of the Company's business, as well as the
remaining sections of this Annual Report on Form 10-K, contain various
forward-looking statements which reflect the Company's current views with
respect to future events and financial results. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Forward Looking
Statements."

GLOSSARY OF SELECTED TERMS

The following glossary defines certain technical terms used to describe
the Company's business.

AUTOMATED INTELLIGENT MICROSCOPY (AIM). The synthesis of visual
microscopy, digital image processing and automated image interpretation/pattern
recognition to analyze microscopic specimens. The Yellow IRIS, The White IRIS
and PowerGene are all examples of instruments which are based on AIM
technology.

AUTOMATIC KARYOTYPING. A procedure to capture and digitize an image
of a spread of chromosomes from a dividing nucleus (metaphase) which may be
further enhanced by image processing. The individual chromosomes in the
enhanced image are then automatically separated and matched into their
respective pairs (karyotype).

COMPARATIVE GENOMIC HYBRIDIZATION (CGH). A molecular biology method
to globally view DNA for gain or loss (amplifications or deletions) of genetic
material using a FISH procedure.

CYTOPROBE. A chemical reagent which reacts with enzymatic granules
within a cell to produce unique color characteristics which are useful in
identifying the cell.

DNA. Deoxyribonucleic acid, the chemical composition of chromosomes
in the nuclei of living cells, consisting of two long chains of alternating
phosphate and deoxyribose units twisted into a double helix and joined by
hydrogen bonds between the complementary bases adenine and thymine or cytosine
and guanine bound in unique sequences that determine genetic characteristics.

DNA PROBE ANALYSIS. A molecular biology method using synthesized
unique short sequences of DNA (deoxyribonucleotides) to locate their exact
template along the DNA chain in the nucleus of a cell.

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FLUORESCENT IN-SITU HYBRIDIZATION (FISH). A procedure which allows
microscopic observation of the location of a unique sequence of DNA by using a
DNA probe with a molecule attached to it which emits a distinctive color when
illuminated.

IN VITRO DIAGNOSTIC (IVD) TESTING. Testing conducted outside of the
body in a laboratory apparatus using a specimen obtained from the patient
(blood, urine, tissue, etc.) to identify or monitor a disease.

LEUKOCYTE DIFFERENTIAL ANALYZER. An automated, high-speed laboratory
instrument for classifying the white blood cells (or leukocytes) in a blood
specimen into different categories and determining the relative proportion of
each category.

MULTIPLEX FLUORESCENT IN-SITU HYBRIDIZATION (M-FISH). A procedure
which allows the combination of microscopic observations of the locations of a
multiplicity of unique DNA sequences by using a multiplicity of DNA probes,
each specific for one of the unique sequences, and each with one of several
fluorescent molecules attached such that each location is observed to have a
distinguishable color when illuminated.

REFERENCE LABORATORY. A commercial clinical laboratory which performs
general IVD testing of specimens referred from physician offices and more
specialized IVD testing for physician offices and hospitals.

REFRACTOMETER. A device which measures the index of refraction of a
solution, typically to determine its concentration or specific gravity.

SLIDELESS MICROSCOPY. The process of presenting a microscopic
specimen to the optical portion of a microscope without using a conventional
microscope slide. Slideless microscopy is implemented in The Yellow IRIS and
The White IRIS using a patented flowcell through which the specimen literally
flows past a microscope objective.

ITEM 2. PROPERTIES.

The Company leases all of its facilities. The leases expire at
various times over the next four years. The Company's headquarters are located
at 9162 Eton Avenue, Chatsworth, California 91311. The table below sets forth
certain information regarding the Company's leaseholds as of December 31, 1996:

Approximate
Floor Space Monthly
Location (Sq. Ft.) Rent Use
---------------- ------------- -------- ---------------------------------------------------

Chatsworth, CA 26,000 $13,600 Sales and Marketing, Research and Development,
Manufacturing and Corporate Administration
League City, TX 7,000 $8,400 Sales and Marketing, Research and Development and
Manufacturing
Norwood, MA 11,000 $7,200 Sales and Marketing, Research and Development and
Manufacturing

Chester, England 5,000 [Pounds] 4,200 Sales and Marketing and Manufacturing

The Company believes that its facilities are adequate to meet its
current needs. Although it has limited expansion space at its Chatsworth
facility, the Company believes that it can accommodate planned growth at this
facility for the near term by leasing additional office space for certain
non-manufacturing related activities, making modifications to the Chatsworth
facility and adding a second shift to its manufacturing operations.

ITEM 3. LEGAL PROCEEDINGS.

In 1994, the Company became aware that IMI was demonstrating a new
slide-based microscopic imaging system called the Micro 21. See
"Business--Competition--Hematology." After further examination of the IMI

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system, the Company notified IMI that the Micro 21 infringed upon at least two
of the Company's patents. The parties then entered into negotiations regarding
the licensing to IMI of these and possibly other Company patents. The parties
were unable to reach an agreement, and IMI subsequently filed a complaint in
the United States District Court for the Southern District of Florida (Case No.
95-8594CIV).

The Company and IMI settled their dispute during the first quarter of
1997. Under the terms of the settlement, IMI acknowledged the validity of the
two patents in question, and the Company granted IMI a nonexclusive license to
use the patents for sales of the Micro 21 in the United States. IMI will pay
the Company a royalty on distributor sales of the Micro 21 but not on direct
sales. The license does not apply to international sales of the Micro 21.

In 1995, TOA began displaying the UF-100 urine sediment analyzer in
the United States. See "Business--Competition--Urinalysis." The Company
subsequently asserted its rights under an existing agreement between the two
companies to distribute the UF-100 in North America. TOA disputed the right of
the Company to distribute the product and commenced an arbitration proceeding
in March 1996 before the International Chamber of Commerce. Based on the
existing agreement, the arbitrators ruled that the Company was indeed entitled
to exclusive distribution rights in North America for the UF-100 and to
royalties on sales of the UF-100 outside of North America. No damages were
awarded, and each party will bear its own attorneys fees.

As part of the purchase price for the PSI Acquisition, the Company
issued to the seller a five-year warrant to purchase 875,000 shares of Common
Stock at $8.00 per share. Following the Company's restatement in the third
quarter of 1996 of financial results for certain prior periods, the Company
received a request from the seller for a reduction in the exercise price of the
warrant. In its request, the seller asserted that it had relied on the prior
financial information and suffered material damage as a result. The Company
has declined to consider the seller's request until the Company has evaluated
its claims against the seller.

The Company is involved in routine litigation arising in the ordinary
course of its business, and, while the results of the proceedings cannot be
predicted with certainty, the Company believes that the final outcome of such
matters will not have a material adverse effect on the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

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PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.

The Company's Common Stock is traded on the American Stock Exchange
("Amex") under the symbol "IRI." The closing price of the Common Stock on
March 25, 1997 was $3.875 per share. The table below sets forth high and low
closing prices reported by Amex for the period January 1, 1995 through December
31, 1996:

High Low
-------- -------

FISCAL 1995
First Quarter . . . . . . . . . . . . . . . . . . . . . $ 8 7/8 $ 5 1/4
Second Quarter . . . . . . . . . . . . . . . . . . . . . 8 5/8 6
Third Quarter . . . . . . . . . . . . . . . . . . . . . 8 6 1/4
Fourth Quarter . . . . . . . . . . . . . . . . . . . . . 8 6 3/8
FISCAL 1996
First Quarter . . . . . . . . . . . . . . . . . . . . . 7 7/8 6 1/4
Second Quarter . . . . . . . . . . . . . . . . . . . . . 12 3/4 6 5/8
Third Quarter . . . . . . . . . . . . . . . . . . . . . 9 1/2 7 1/4
Fourth Quarter . . . . . . . . . . . . . . . . . . . . . 7 1/2 3 3/8

As of March 25, 1997, IRIS had approximately 4,500 holders of record
of its Common Stock.

The Company intends to employ all available funds in the development
of its business and the repayment of indebtedness and, as a result, does not
expect to pay any cash dividends for the foreseeable future. Furthermore, the
Company may not pay any cash dividends on the Common Stock, or repurchase any
shares of the Common Stock, without the written consent of the holders of a
majority of the outstanding shares of Series A Preferred Stock.

On December 31, 1996, the Company completed a private sale of Series A
Preferred Stock and warrants to purchase Common Stock for approximately $3.0
million to the Thermo Amex Convertible Growth Fund I, L.P. See
"Business--Recent Acquisitions and Other Significant Developments--Issuance of
Preferred Stock."

ITEM 6. SELECTED FINANCIAL DATA.

This information is derived in part from, and should be read in
conjunction with, the Company's Financial Statements, including the Notes
thereto, as included elsewhere in this Annual Report.

Year Ended December 31,
-------------------------------------------------------------------
1992 1993 1994 1995 1996
--------- --------- --------- --------- ---------
(in thousands, except per share data)

Net revenues . . . . . . . . $10,823 $12,393 $12,469 $14,392 $20,554
Interest and other income, net 129 68 206 378 (409)
Net income (loss) . . . . . . 929 1,323 1,622 2,126 (7,428)
Net income (loss) per share . .18 .25 .28 .33 (1.21)
Working capital . . . . . . . 5,339 6,812 7,779 11,234 1,914
Total assets . . . . . . . . 9,290 11,181 13,282 22,203 37,860
Long term debt, including
current portion . . . . . . . 676 603 367 311 13,000
Total liabilities . . . . . . 2,981 3,415 3,122 3,261 24,096
Shareholders' equity . . . . 6,310 7,766 10,160 18,942 13,765
Cash dividends per share . . -- -- -- -- --

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

OVERVIEW

The Company generates revenues from sales of IVD imaging systems based
on its patented and proprietary AIM technology. Following the initial sale,
these systems become part of the "installed base" and generate follow-on sales
of supplies and service necessary for their operation. The Company also
generates revenues from sales of ancillary lines of small laboratory
instruments and supplies.

Until recently, the Company generated most of its revenues from sales
of two models of The Yellow IRIS urinalysis workstation and related supplies
and services. These two models differ mainly by their speed and price. In
1996, the Company introduced a third model of The Yellow IRIS. The Model
900UDx urine pathology system, the latest in The Yellow IRIS family, is a
higher capacity automated urinalysis workstation designed especially for the
high-volume testing requirements of large hospitals and reference laboratories.
The Company received FDA clearance to market the Model 900UDx in March 1996 and
began sales in May of that year. The Company also received FDA clearance to
market The White IRIS leukocyte differential analyzer in May 1996 and expects
to start sales of this system in 1997. Finally, the Company began selling the
PowerGene family of genetic analyzers in August 1996 after completing the PSI
Acquisition.

The Company invests in research and development for new products and
enhancements to existing products. The following table summarizes total
product technology expenditures for the periods indicated:

Year Ended December 31,
---------------------------------
1994 1995 1996
-------- -------- --------
(in thousands)

Research and development expense, net . . . . . . . . . . . . . . . . . . $ 663 $1,220 $1,978
Capitalized software development costs . . . . . . . . . . . . . . . . . 25 299 577
Reimbursed costs for research and development grants and contracts . . . 1,111 843 1,780
------- ------- -------
Total product technology expenditures . . . . . . . . . . . . . $1,799 $2,362 $ 4,335
====== ====== =======

RECENT ACQUISITIONS AND OTHER SIGNIFICANT DEVELOPMENTS

Since January 1, 1996, the Company has completed several important
acquisitions and announced several other significant developments. The
following is a brief summary of those developments.

(1) The Company acquired StatSpin in February 1996 in a
pooling-of-interests transaction. StatSpin manufacturers and markets
special-purpose centrifuges and related supplies for the clinical laboratory
market.

(2) In March 1996, the Company purchased the CenSlide 1500 System
and related products for centrifugal urine sedimentation and manual microscopic
examination from UroHealth Systems, Inc. for $850,000.

(3) The Company completed the PSI Acquisition in July 1996 for
approximately $16.1 million plus a five-year warrant to purchase 875,000 shares
of Common Stock at $8.00 per share, thereby adding the PowerGene genetic
analyzer to its line of IVD imaging systems. The Company financed the
acquisition with (i) a $7.0 million subordinated note (the "Subordinated
Note"), (ii) a $7.8 million term loan (the "Term Loan") and (iii) $1.3 million
drawn under a new $1.5 million revolving line of credit (the "Credit
Facility").

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20
(4) In September 1996, the Company repurchased 469,413 shares of
Common Stock and a warrant to purchase 250,000 shares of Common Stock for $2.1
million from an affiliate of BMC. The Company has paid the first two
installments of the purchase price, and the remaining payments, totaling $1.0
million, are due in the second half of 1997 (the "Stock Repurchase Debt"). The
Company has the right, if necessary, to extend the due dates of the remaining
installments by one year each, but must pay 8% interest during the extension
periods.

(5) In response to a third quarter operating loss, the Company
restructured its workforce during the fourth quarter of 1996 and reduced the
number of employees by approximately 18%.

(6) In September 1996, the Company filed a registration statement
with the Securities and Exchange Commission for an underwritten public
offering. The net proceeds of the public offering were to be used primarily to
reduce outstanding indebtedness incurred to finance the PSI Acquisition and to
pay the Stock Repurchase Debt. Following the third quarter operating loss, the
Company elected not to pursue the public offering and, as an alternative, to
pursue one or more smaller financing transactions. Most of the expenses of the
offering, totaling $686,000, were charged to operations in the third quarter of
1996.

(7) On December 31, 1996, the Company completed a private sale of
Series A Preferred Stock and warrants to purchase Common Stock for
approximately $3.0 million to the Thermo Amex Convertible Growth Fund I, L.P.

(8) As a result of the decision not to pursue the public offering
and its recent operating losses, the Company was unable to comply with the
financial covenants in the Term Loan and the Credit Facility on September 30
and December 31, 1996. The inability to comply with these covenants
constituted an event of default under the terms of the loan documents. In
April 1997, the bank agreed to waive the default, amend the financial covenants
and extend the maturity of both loans to April 15, 1998.

For a detailed description of the above events, see "Business--Recent
Acquisitions and Other Significant Developments."

RESULTS OF OPERATIONS

The consolidated financial statements of the Company contained in this
report have been retroactively restated for all periods presented to include
the financial position, results of operations and cash flows of StatSpin in
accordance with the pooling-of-interests method of accounting. The
consolidated financial statements also reflect the consummation of the PSI
Acquisition on July 31, 1996 which was accounted for using the purchase method
of accounting. Accordingly, the consolidated statements of operations for the
year ended December 31, 1996 include the financial results of PSI from the date
of acquisition, July 31, 1996.

Comparison of Year Ended December 31, 1996 to Year Ended December 31, 1995

Net sales for the year ended December 31, 1996 increased to $20.6
million from $14.4 million, an increase of $6.2 million or 43% over the prior
year. Sales of IVD imaging systems increased to $6.4 million from $4.2
million, an increase of $2.2 million or 50% over the prior year. The increase
was due primarily to the addition of the PowerGene family of genetic analyzers
to the Company's product line in August 1996 as a result of the PSI
Acquisition. The Company believes that the ongoing consolidation in the
healthcare industry may be adversely affecting sales of The Yellow IRIS as some
hospitals and reference laboratories appear to be postponing large capital
investment decisions due to the resulting uncertainty. The Company also
believes that there is a growing trend among potential customers for The Yellow
IRIS toward leasing these systems on a cost-per-test basis rather than
purchasing them. This trend is expected to spread the revenue from system
placements over several years.

Sales of IVD imaging system supplies and service increased to $9.1
million from $6.7 million, an increase of $2.4 million or 35% over the prior
year, due to the larger installed base of IVD imaging systems and the
conversion of The Yellow IRIS installed base to the new CHEMSTRIP/IRIStrip
urine test strips marketed

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21
exclusively by the Company. As of December 31, 1996, the Company had converted
more than 90% of this installed base from test strips marketed by various
distributors to the new strips. Sales of small instruments and supplies
increased to $5.1 million from $3.4 million, an increase of $1.7 million or
48%, over the prior year. The increase reflects generally higher sales levels
of the StatSpin products, as well as the addition of the CenSlide product line
in March 1996.

Cost of goods for IVD imaging systems increased as a percentage of
sales of IVD imaging systems to 51% for the year ended December 31, 1996 from
48% for the prior year due primarily to the addition of the Model 900UDx to the
product line and amortization of increased fixed costs for IVD imaging systems.
These factors were partially offset by the addition of the higher-margin
PowerGene family of genetic analyzers to the Company's product line in August
1996. Although the Model 900UDx currently has a lower gross margin than other
models of The Yellow IRIS due to an OEM component on which the Company
recognizes minimal gross margin, the Company expects the Model 900UDx to
generate higher sales of CHEMSTRIP/IRIStrips and other supplies. Cost of goods
for IVD imaging system supplies and service increased as a percentage of sales
of such products to 56% for the year ended December 31, 1996 from 47% for the
prior year primarily due to relatively lower gross margins on sales of
CHEMSTRIP/IRIStrip urine test strips which accounted for a greater proportion
of sales of system supplies, as well as a decline in gross margins on service
of IVD imaging systems. Cost of goods for small instruments and supplies
decreased as a percentage of sales of small instruments and supplies to 53% for
the year ended December 31, 1996 from 57% for the prior year due to an overall
change in product mix toward higher gross margin items. The net result of
these changes was a decrease in aggregate gross margin to 46% for the year
ended December 31, 1996 from 50% for the prior year.

Marketing and selling expenses consist primarily of salaries,
commissions and related travel expenses of the Company's direct sales force, as
well as salaries for the marketing and distributor relations departments.
Marketing and selling expenses increased to $4.6 million for the year ended
December 31, 1996 from $2.9 million, an increase of $1.7 million or 61% over
the prior period, and increased as a percentage of net sales to 23% from 20%,
due to the addition of the sales force from the PSI Acquisition and increased
spending on promotions, telemarketing and customer support.

General and administrative expenses consist primarily of payroll costs
associated with the Company's management and support personnel, facilities
related costs and legal and accounting fees. General and administrative
expenses increased to $3.3 million for the year ended December 31, 1996 from
$2.0 million, an increase of $1.3 million or 60% over the prior year, and
increased as a percentage of net sales from 14% to 16%.

Net research and development expenses consist of costs incurred for
the development of new products and improvements to existing products less
third-party reimbursements under joint development programs, grants and
research and development contracts. Net research and development expenses
increased to $2.0 million for the year ended December 31, 1996 from $1.2
million, an increase of $758,000 or 62% over the prior year, and increased as a
percentage of net sales to 10% from 8%. Reimbursements under joint development
programs increased to $1.8 million from $843,000. Total product technology
expenditures increased to $4.3 million from $ 2.4 million, an increase of $1.9
million or 84% over the prior year, due primarily to work on the Model 900UDx
and The White IRIS, as well as the addition of research and development staff
from the PSI Acquisition.

Amortization of intangible assets reflects the amortization of
deferred expenses for warrants issued in connection with joint development
projects and intangible assets arising from acquisitions and patents.
Amortization of intangible assets for the year ended December 31, 1996
increased to $794,000 from $127,000, an increase of $667,000 or 524% over the
prior year, primarily as a result of the acquisition of intangible assets in
the PSI Acquisition, as further described below.

The results of operations for the year ended December 31, 1996 include
certain unusual charges to earnings of $2.0 million primarily for the write-off
of deferred offering costs ($686,000), litigation expenses ($617,000),
restructuring charges ($298,000) and merger related expenses ($244,000).

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Acquisition of in-process research and development for the year ended
December 31, 1996 reflects the PSI Acquisition which resulted in a
non-recurring charge of $7.3 million. Acquisition of in-process research and
development for the year ended December 31, 1995 reflects the acquisition of
LDA which resulted in a non-recurring, non-cash charge of $2.9 million. The
FDA cleared The White IRIS, acquired from LDA, in May 1996.

Interest income consists of income from investments and decreased to
$222,000 for the year ended December 31, 1996 from $310,000 for the comparable
period, primarily as the result of decreased amounts of invested cash during
1996.

Interest expense increased to $681,000 for the year ended December 31,
1996 from $43,000 for the comparable period due to the indebtedness incurred to
finance the PSI Acquisition.

The income tax benefit for the year ended December 31, 1996 was $3.5
million as compared to an income tax benefit of $3.6 million for 1995. The
Company recognized a deferred tax benefit of $3.6 million in 1995 due to a
significant reduction in the Company's deferred tax asset valuation allowance.
This reduction in the valuation allowance resulted principally from the
Company's assessment of the realizability of its net operating loss
carryforwards based on recent operating history. At December 31, 1996, the
Company increased the valuation allowance by $437,000 based on an assessment of
operating results and other factors. Although realization is not assured,
management believes it is more likely than not that the remaining net deferred
tax asset will be realized. The amount of the deferred tax assets considered
realizable, however, could be reduced in the future if estimates of taxable
income during the carryforward period decrease.

The above factors contributed to a net loss of $7.4 million, or $1.21
per share, for the year ended December 31, 1996 as compared to net income of
$2.1 million, or $0.33 per share, for the year ended December 31, 1995.
Excluding the charges for the acquisition of in-process research and
development from the PSI Acquisition and the $2.0 million of unusual charges
discussed above, the Company would have had a net loss of approximately $ 1.5
million, or $0.25 per share, for the year ended December 31, 1996. Excluding
the charges for the acquisition of in-process research and development from LDA
and the recognition of the tax benefit due to the reduction in the deferred tax
asset valuation allowance, the Company would have had net income of
approximately $1.4 million, or $0.22 per share, for the year ended December 31,
1995.

The staff of the Securities and Exchange Commission recently announced
a new position on accounting for convertible preferred stock which is
potentially convertible at a discount to the market price of the common stock,
even if the potential for a discount is only a possibility. The staff has
taken the position that, solely for purposes of calculating earnings per share,
the potential discount is an embedded dividend to the preferred stockholders
which reduces the amount of income available to common stockholders. As a
result of the staff's new accounting position, the issuance of the Series A
Preferred Stock could result in a reduction in earnings per share of up to
$0.08 in the first quarter of 1997. The staff's position is limited to the
calculation of earnings per share and will not have any effect on the Company's
net income or cash flow.

Comparison of Year Ended December 31, 1995 to Year Ended December 31, 1994

Net sales increased to $14.4 million for 1995 from $12.5 million for
1994, an increase of $1.9 million or 15%. Sales of IVD imaging systems
decreased to $4.2 million in 1995 from $4.6 million in 1994, a decrease of
$318,000 or 7% from the prior year due to the sale of fewer systems in 1995.
Sales of IVD imaging system supplies and service increased to $6.7 million from
$5.0 million, an increase of $1.7 million or 34% over the prior year, due to
the larger installed base of IVD imaging systems and the introduction of the
new CHEMSTRIP/IRIStrip urine test strips in late 1994. Sales of small
instruments and supplies increased to $3.4 million from $2.9 million, an
increase of $528,000 or 18%. The increase reflects generally higher sales of
the StatSpin product line and the addition of the Biovation product line in
March 1995.

Cost of goods for IVD imaging systems as a percentage of sales of IVD
imaging systems totaled 48% for 1995, the same as for 1994. Cost of goods for
IVD imaging system supplies and service decreased as a

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23
percentage of sales of IVD imaging system supplies and service to 47% for 1995
from 50% for 1994 due to a decrease in service costs, offset to some extent by
lower gross margins on the CHEMSTRIP/IRIStrip urine test strips. Cost of goods
for small instruments and supplies decreased as a percentage of sales of small
instruments and supplies to 57% for 1995 from 63% for 1994 due to higher gross
margins on the recently added Biovation product line as well as improved gross
margins on the StatSpin product lines due to increased sales volume. The net
result of these changes and the overall change in product mix was an increase
in gross margin to 50% for 1995 from 48% for 1994.

Marketing and selling expenses increased to $2.9 million for 1995 from
$2.1 million for 1994, an increase of $789,000 or 38%, due to increased
spending on direct sales and after-sales support, and increased as a percentage
of net sales to 20% from 17%.

General and administrative expenses increased to $2.0 million for 1995
from $1.6 million for 1994, an increase of $396,000 or 24%, and increased as a
percentage of net sales from 13% in 1994 to 14% in 1995.

Net research and development expenses increased to $1.2 million for
1995 from $663,000 for 1994, an increase of $557,000 or 84%, and also increased
as a percentage of net sales to 8% from 5%. The increase in net research and
development expenses was due principally to a decrease in reimbursements under
research and development contracts and increased spending by the Company on the
continued development of The White IRIS. Reimbursements under research and
development contracts and joint development programs decreased to $843,000 from
$1.1 million, a decrease of $268,000 or 24%, due to the acquisition of LDA.
Total product technology expenditures increased to $2.4 million from $1.8
million, an increase of $563,000 or 31%, reflecting the addition of two new
research projects, a modest increase in general research and development
activity and continuing expenditures by the Company on The White IRIS to
complete its development and pursue FDA clearance.

Amortization of intangible assets for the year ended December 31, 1995
increased to $127,000 from $81,000, an increase of $46,000 or 57% over the
prior year, primarily as a result of the acquisition of the digital
refractometer product line of Biovation, Inc. during the first quarter of 1995.

Interest income increased to $310,000 for 1995 from $168,000 for the
prior year, primarily the result of increased amounts of invested cash during
1995 as a result of the exercise of outstanding warrants issued in connection
with the formation of LDA and stock sales to employees under the Company's
stock option and purchase plans.

Interest expense consisted of interest incurred on notes issued by
StatSpin and decreased to $43,000 for 1995 from $73,000 for the prior year due
to a reduction in the outstanding principal balances.

Other income consisted principally of royalties for sales of licensed
products and remained constant at $111,000 for 1995 and 1994.

Acquisition of in-process research and development in 1995 reflects
the acquisition of LDA which resulted in a non-recurring, non-cash charge of
$2.9 million.

The income tax benefit for 1995 was $3.6 million as compared to a
$79,000 provision in 1994. The Company recognized a deferred tax benefit of
$3.6 million in 1995 due to a significant reduction in the Company's deferred
tax asset valuation allowance. This reduction in the valuation allowance
resulted principally from the Company's assessment of the realizability of its
net operating loss carryforwards based on recent operating history. The amount
of the deferred tax assets considered realizable, however, could be reduced in
the future if estimates of taxable income during the carryforward period
decrease.

Net income increased to $2.1 million, or $0.33 per share, for 1995 as
compared to net income of $1.6 million, or $0.28 per share, for 1994.
Excluding the effects of the non-recurring charge for the acquisition of
in-process research and development and the recognition of the tax benefit due
to the reduction in the deferred

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tax asset valuation allowance, the Company would have had net income of
approximately $1.4 million, or $0.22 per share, for 1995.

LIQUIDITY AND CAPITAL RESOURCES

Cash, cash equivalents and short-term investments decreased to $4.3
million at December 31, 1996 from $6.2 million at December 31, 1995. The
decrease is primarily attributable to operating losses, acquisition expenses,
increased levels of inventory and accounts receivable and additions to plant
and equipment. Inventory levels during 1996 increased to $4.8 million from
$2.9 million. This increase was primarily due to the increase in raw materials
and finished goods associated with the introduction of the Model 900UDx and
anticipated sales increases. Total accounts receivable increased to $5.2
million at December 31, 1996 from $3.8 million at December 31, 1995. This
increase was primarily the result of acquisitions.

In 1996, the Company expended $1.2 million for capital equipment and
$577,000 in capitalized software development. The Company expended $821,000
and $266,000 for capital equipment and $299,000 and $25,000 in capitalized
software development in 1995 and 1994, respectively. The Company does not
presently have any material commitments for capital expenditures.

During 1996, the Company generated cash of $350,000 from stock sales
to employees under the Company's stock option and purchase plans and from
exercises of stock options assumed in connection with acquisitions. The
Company generated cash of $1.7 million and $356,000 in 1995 and 1994,
respectively, from exercises of outstanding warrants issued in connection with
joint development programs and stock sales to employees under the Company's
stock option and purchase plans.

The Company financed the purchase price for the PSI Acquisition with
the Subordinated Note ($7.0 million), the Term Loan ($7.8 million) and the
Credit Facility ($1.3 million). The Term Loan and Credit Facility impose
certain operating and financial covenants on the Company. Due to an inability
to comply with these financial covenants, the Company was in default on both
loans at September 30 and December 31, 1996. During the first quarter of 1997,
the bank waived the default, amended the financial covenants and extended the
maturity of both loans. In exchange, the Company agreed to increase the
interest rates on both loans and to issue the bank a three-year warrant to
purchase 50,000 shares of Common Stock at $3.875 per share. The Company also
agreed to issue additional warrants to purchase 25,000 shares of Common Stock
at prevailing market prices on each of June 1 and July 1, 1997 if the Term Loan
is still outstanding on those dates. (The following discussion reflects the
amendments to the Term Loan and Credit Facility). See "Business--Recent
Acquisitions and Other Significant Developments--Amendment to Bank Loan
Agreements."

On December 31, 1996, the outstanding principal balance of the Term
Loan was $6.0 million. Since that date, the Company has reduced the
outstanding principal balance of the Term Loan to $4.2 million, in large part
with the net proceeds from the sale of the Series A Preferred Stock. See
"Business--Recent Acquisitions and Other Significant Developments--Issuance of
Preferred Stock." The Term Loan is collateralized by a first priority lien on
all the assets of the Company and bears interest monthly at the bank's prime
rate (8.50% on April 1, 1997) plus 1.5%. The interest rate increases an
additional 0.25 percentage points on each of June 1 and July 1, 1997. The
Company is required to pay $100,000 of principal each month, and the balance is
due April 15, 1998. The Company may prepay the Term Loan at any time without
premium or penalty.

The outstanding principal balance on the Credit Facility was $1.3
million on December 31, 1996. Under the terms of the Credit Facility, the
Company can borrow and reborrow up to a maximum principal amount of $1.5
million at a variable interest rate equal to the bank's prime rate plus 1.5%.
The interest rate increases an additional 0.25 percentage points on each of
June 1 and July 1, 1997 if the Term Loan is still outstanding on those dates.
The Credit Facility, collateralized by a first priority lien on all assets,
matures April 15, 1998.

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The outstanding principal balance on the Subordinated Note was $7.0
million on December 31, 1996. The Subordinated Note bears interest at a fixed
rate of 8.5% per annum payable in quarterly installments. The entire principal
is due on or before July 31, 2001. The Company may prepay the Subordinated
Note at any time without premium or penalty. Upon the issuance by the Company
of equity securities generating net proceeds in excess of $14.5 million, the
Company must apply fifty percent of the excess to the prepayment of the
Subordinated Note. The payment of principal and interest on the Subordinated
Note is subordinated in right of payment, to the extent and in the manner
provided therein, to the prior payment in full of all indebtedness to City
National Bank. The default under the Term Loan and Credit facility did not
cause a default under the Subordinated Note because the bank did not accelerate
the maturity of the Term Loan or the Credit Facility.

On December 31, 1996, the outstanding balance of the Stock Repurchase
Debt was approximately $1.6 million. The Company has since paid the second of
four installments, and the remaining installments, due in the second half of
1997, total $1.0 million. The Company has the right, if necessary, to extend
the due dates of the remaining installments by one year each, but must pay 8%
interest during the extension periods. See "Business--Recent Acquisitions and
Other Significant Developments--Stock Repurchase."

In March 1996, the Company purchased the CenSlide 1500 System and
related products for manual microscopic examination for $850,000. See
"Business--Recent Acquisitions--CenSlide Acquisition."

The Company believes that its current cash on hand plus short-term
investments, together with cash generated by operations, will be sufficient to
fund normal operations and pay interest on outstanding debt obligations for at
least the next year. However, there can be no assurance that these goals will
be achieved.

The Company is presently pursuing additional financing to repay
outstanding principal on its long-term indebtedness and to fund its long-term
business strategy. There can be no assurance that the Company can secure
adequate additional financing on favorable terms, if at all. If the Company is
unable to obtain the necessary financing during the next twelve months, the
Company will have to pursue an arrangement with its creditors to restructure
its long-term indebtedness and revise its long-term business strategy.
Additional outside financing (or a restructuring of existing indebtedness)
could result in dilution to holders of Common Stock and significant financial
and operational restrictions on the Company.

In September 1995, the Company and Poly entered into a research and
development agreement to develop the Poly Products using the Company's
technology. The Company is funding the first $15,000 per month (up to a
maximum of $500,000) of the cost of the project, and Poly is reimbursing the
Company for the excess. The Company has an option until 121 days after
termination of the agreement with Poly to acquire all of the common stock of
Poly for an aggregate price increasing on August 1, 1997 from $4.4 million to
$5.1 million payable in cash or shares of Common Stock of the Company. If the
Company elects to exercise its option, the portion of the net cost of the
acquisition allocated to completed products would be capitalized and its
subsequent amortization would impact future earnings. For the portion of the
net cost of the acquisition allocated to in-process research and development,
the Company would record a nonrecurring, noncash (if purchased with Common
Stock), charge against then current earnings. See "Business--Research and
Development."

INFLATION

The Company does not foresee any material impact on its operations
from inflation.

HEALTHCARE REFORM POLICIES

In recent years, an increasing number of legislative proposals have
been introduced or proposed in Congress and in some state legislatures that
would effect major changes in the healthcare system, nationally, at the state
level or both. Future legislation, regulation or payment policies of Medicare,
Medicaid, private health insurance plans, health maintenance organizations and
other third-party payors could adversely affect the demand for the Company's
current or future products and its ability to sell its products on a profitable
basis. Moreover,

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healthcare legislation is an area of extensive and dynamic change, and the
Company cannot predict future legislative changes in the healthcare field or
their impact on its business.

RECENTLY-ISSUED ACCOUNTING STANDARDS

In February, 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 "Earnings per Share" ("SFAS
No. 128"). SFAS No. 128 requires dual presentation of newly defined basic and
diluted earnings per share on the face of the income statement for all entities
with complex capital structures. This method is considered more compatible
with International Accounting Standards. SFAS No. 128 is effective for all
fiscal years ending after December 15, 1997. The Company has not yet
determined the impact of SFAS No. 128.

FORWARD-LOOKING STATEMENTS

The foregoing discussion, as well as the other sections of this Annual
Report on Form 10-K, contain various forward-looking statements which reflect
the Company's current views with respect to future events and financial
results. Forward-looking statements usually include the verbs "anticipates,"
"believes," "estimates," "expects," "intends," "plans," "projects,"
"understands" and other verbs suggesting uncertainty. The Company reminds
stockholders that forward-looking statements are merely predictions and
therefore inherently subject to uncertainties and other factors which could
cause the actual results to differ materially from the forward-looking
statement. These uncertainties and other factors include, among other things,
(i) the ability of the Company to secure additional financing to repay the
remaining principal balance of its long-term debt and to fund its long-term
business strategy, (ii) the degree to which the Company's recent restructuring
will reduce future operating expenses, (iii) unexpected technical and marketing
difficulties inherent in the introduction of sophisticated, capital-intensive
new medical instruments such as The White IRIS and other planned instrument
introductions, (iv) the potential need for changes in the Company's long-term
strategy in response to future developments, (v) future advances in diagnostic
testing methods and procedures, as well as potential changes in government
regulations and healthcare policies, both of which could adversely affect the
economics of the diagnostic testing procedures automated by the Company's
products, (vi) rapid technological change in the microelectronics and software
industries, (vii) increasing competition from imaging and non-imaging based
in-vitro diagnostic products and (viii) difficulties in assimilating acquired
companies and product lines such as PSI.

The Company has attempted to identify additional significant
uncertainties and other factors affecting forward-looking statements in Exhibit
99 to this Form 10-K ("Additional Information Regarding Forward-Looking
Statements"). The Company will provide copies of Exhibit 99 to registered
stockholders free of charge upon receipt of a written request submitted to the
Company's Controller at 9162 Eton Avenue, Chatsworth, California 91311.
Stockholders may also obtain copies of Exhibit 99 for a nominal charge from the
Public Reference Section of the Securities and Exchange Commission at 450 Fifth
Street, N.W., Washington, D.C. 20549 and at its Regional Office at 5757
Wilshire Boulevard, Los Angeles, California 90036. Exhibit 99 is also
available through the SEC's World Wide Web site located at http://www.sec.gov.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The financial statements are listed in the Index to Financial
Statements in Part IV, Item 14(a)1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Incorporated by reference from "Directors and Executive Officers" in
the Proxy Statement to be filed with the Securities and Exchange Commission for
the 1997 Annual Meeting of IRIS Stockholders.

ITEM 11. EXECUTIVE COMPENSATION.

Incorporated by reference from "Executive Compensation" in the Proxy
Statement to be filed with the Securities and Exchange Commission for the 1997
Annual Meeting of IRIS Stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

Incorporated by reference from "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement to be filed with the
Securities and Exchange Commission for the 1997 Annual Meeting of IRIS
Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Incorporated by reference from "Certain Relationships and Related
Transactions" in the Proxy Statement to be filed with the Securities and
Exchange Commission for the 1997 Annual Meeting of IRIS Stockholders.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K.

(a) The following documents are filed as a part of this report:

1. Index to Financial Statements
Page
----
Report of Independent Public Accountants. F-1
Independent Auditors' Report. F-1
Consolidated Balance Sheets at December 31, 1996 and 1995. F-2
Consolidated Statements of Operations for the Years Ended December 31,
1996, 1995, and 1994. F-3
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1996, 1995, and 1994. F-4
Consolidated Statements of Cash Flows for the Years Ended December 31,
1996, 1995 and 1994. F-7
Notes to Consolidated Financial Statements. F-8

2. Financial Statement Schedules Covered by the Foregoing Report of
Independent Public Accountants.

Schedule II-Valuation and Qualifying Accounts F-24

Other financial statement schedules have been omitted since they are
not required, are not applicable, or the required information is shown in the
Financial Statements or Related Notes.

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3. EXHIBITS

No. Description
-- -----------

3.1(a) -- Certificate of Incorporation, as amended (1)
3.1(b) -- Certificate of Designations of Series A Convertible Preferred Stock (2)
3.2 -- Restated Bylaws (3)
4.1 -- Specimen of Common Stock Certificate (4)
4.1 -- Certificate of Designations of Series A Convertible Preferred Stock (2)
10.1 -- Lease of the Company's headquarters facility, as amended (5)
10.2(a) -- 1982 Stock Option Plans and form of Stock Option Agreement (6)
10.2(b) -- 1983 and 1986 Stock Option Plans, and forms of Stock Option Agreements for each Plan (7)
10.2(c) -- Amended and Restated 1986 Stock Option Plan (8)
10.2(d) -- 1994 Stock Option Plan and forms of Stock Option Agreements (9)
10.2(e) -- Certificate of Officer With Respect to Amendment of 1994 Stock Option Plan (10)
10.2(f) -- Key Employee Stock Purchase Plan (11)
10.3 -- Various Agreements with TOA Medical Electronics (12)
10.4(a) -- Agreement for a Strategic Alliance in Urinalysis dated January 7, 1994 between the Company
and Boehringer Mannheim Corporation (13)
10.4(b) -- Research and Development and Distribution Agreement dated February 6, 1995 by and among the
Company, LDA Systems, Inc. and Corange International Limited (13)
10.4(c) -- Amendment to Distribution Agreements (14)
10.5 -- Warrant Certificate dated March 20, 1995 issued to Biovation, Inc. (13)
10.6(a) -- Technology License Agreement dated as of September 29, 1995 between the Company and Poly U/A
Systems, Inc. (15)
10.6(b) -- Research and Development Agreement dated as of September 29, 1995 between the Company and
Poly U/A Systems, Inc. (15)
10.6(c) -- $100 Class "A" Note dated September 29, 1995 issued by Poly U/A Systems, Inc. in favor of
the Company (15)
10.6(d) -- Certificate of Incorporation of Poly U/A Systems, Inc. (See Article FOUR regarding the
IRIS Option) (15)
10.7(a) -- Agreement and Plan of Merger dated January 31, 1996 between the Company and StatSpin, Inc. (16)
10.7(b) -- Registration Rights Agreement dated January 31, 1996 between the Company and StatSpin
Stockholders (16)
10.8(a) -- Asset Purchase Agreement dated as of July 15, 1996 by and among the Company, Digital Imaging
Technologies, Inc., Perceptive Scientific Instruments, Inc. and Perceptive Scientific
Technologies, Inc. (17)
10.8(b) -- Registration Rights and Standstill Agreement dated July 31, 1996 between the Company and
Digital Imaging Technologies, Inc. (10)
10.8(c) -- Warrant Certificate dated July 31, 1996 issued to Digital Imaging Technologies, Inc. (10)
10.8(d) -- Stockholder Guaranty Agreement dated July 31, 1996 between Edward Randall, III and PSII
Acquisition Corp., a wholly-owned subsidiary of the Company (now known as Perceptive
Scientific Instruments, Inc.) (10)
10.8(e) -- Non-Competition Agreement dated as of July 15, 1996 between Edward Randall, III and PSII
Acquisition Corp., a wholly-owned subsidiary of the Company (now known as Perceptive
Scientific Instruments, Inc.) (10)
10.8(f) -- Technology License Agreement dated July 31, 1996 between Perceptive Scientific Imaging
Systems, Inc. and PSII Acquisition Corp., a wholly-owned subsidiary of the Company
(now known as Perceptive Scientific Instruments, Inc.) (10)
10.9 -- $7,000,000 Subordinated Note dated July 29, 1996 issued by the Company in favor of Digital
Imaging Technologies, Inc. (10)
10.10(a) -- $1,500,000 Promissory Note dated July 29, 1996 (Revolving Credit Facility) (10)
10.10(b) -- Change in Terms Agreement dated as of January 3, 1997 (Revolving Credit Facility)

-26-
29

10.10(c) -- Supplemental Terms letter dated July 29, 1996 (Revolving Credit Facility) (10)
10.10(d) -- Supplemental Terms Letter dated as of January 3, 1997 (Revolving Credit Facility)
10.10(e) -- $4,900,000 Amended and Restated Promissory Note dated as of January 3, 1997 (Term Loan)
10.10(f) -- Supplemental Terms Letter dated as of January 3, 1997 (Term Loan)
10.10(g) -- Waiver of Default dated as of January 3, 1997
10.10(h) -- Warrant to Purchase Common Shares
10.10(i) -- Commercial Security Agreement dated July 29, 1996 (10)
10.10(j) -- Commercial Pledge Agreement dated July 29, 1996 (10)
10.10(k) -- Various Additional Security Agreements dated as of January 3, 1997
10.11(a) -- Securities Purchase Agreement dated December 31, 1996 by and between the Company and
Thermo Amex Convertible Growth Fund I, L.P. (2)
10.11(b) -- Common Stock Purchase Warrant dated December 31, 1996 issued to Thermo Amex Convertible
Growth Fund I, L.P. (2)
10.11(c) -- Registration Rights Agreement dated December 31, 1996 by and between the Company and
Thermo Amex Convertible Growth Fund I, L.P. (2)
11 -- Statement re: Computation of Per Share Earnings
24.1 -- Consent of Coopers & Lybrand L.L.P.
24.2 -- Consent of KPMG Peat Marwick LLP
27 -- Financial Data Schedule
99 -- Additional Information Regarding Forward Looking Statements
- -------------------

The following items are incorporated by reference to the Company's documents
cited below.

(1) Current Report on Form 8-K dated August 13, 1987 and its Quarterly Report
on Form 10-Q for the quarter ended September 30, 1993.
(2) Current Report on Form 8-K dated January 15, 1997.
(3) Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.
(4) Registration Statement on Form S-3, as filed with the Securities and
Exchange Commission on March 27, 1996 (File No. 333-002001).
(5) Annual Report on Form 10-K for the year ended December 31, 1989, its
quarterly report on Form 10-Q for the quarter ended September 30, 1993 and
its Annual Report on Form 10-K for the year ended December 31, 1994.
(6) Registration Statement on Form S-2, as filed with the Securities and
Exchange Commission on September 4, 1985 (File No. 2-99240).
(7) Registration Statement on Form S-8, as filed with the Securities and
Exchange Commission on May 10, 1982 (File No. 2-77496).
(8) Annual Report on Form 10-K for the year ended December 31, 1992.
(9) Registration Statement on Form S-8, as filed with the Securities and
Exchange Commission on August 8, 1994 (File No. 33-82560).
(10) Quarterly Report on Form 10-Q for the quarter ended June 30, 1996.
(11) Registration Statement on Form S-8 filed January 3, 1997.
(12) Current Report on Form 8-K dated July 15, 1988 and its quarterly report on
Form 10-Q for the quarter ended June 30, 1995.
(13) Annual Report on Form 10-K for the year ended December 31, 1994.
(14) Quarterly Report on Form 10-Q for the quarter ended September 30, 1996.
(15) Quarterly Report on Form 10-Q for the quarter ended September 31, 1995.
(16) Annual Report on Form 10-K for the year ended December 31, 1995.
(17) Current Report on Form 8-K filed July 17, 1996.

(b) Reports on Form 8-K

During the quarter ended December 31, 1996, the Company filed a report on
Form 8-K: (i) on October 1, 1996 to report a press release announcing an
amendment to a series of agreements with Boehringer Mannheim Corporation and
its affiliates which modifies the relationship of IRIS with these companies;
(ii) on October 2, 1996 to report a press release announcing that IRIS had
filed a registration statement with the

-27-
30
Securities and Exchange Commission for a public offering of 3,000,000 shares of
its Common Stock; and (iii) on October 31, 1996 to report a press release
announcing a workforce restructuring. The Company also filed a report on Form
8-K on January 15, 1997 to report the sale of 3,000 shares of Series A
Convertible Preferred Stock and Warrants to the Thermo Amex Convertible Growth
Fund I, L.P.

(d) See (a)(1) and (2) above.

-28-
31
SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report on Form 10-K to be signed
on its behalf by the undersigned, thereunto duly authorized, in Chatsworth,
California, on April 14, 1997.

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.

By: /s/ Fred H. Deindoerfer
------------------------------------------
Fred H. Deindoerfer, Chairman of the Board
of Directors, 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 Title Date
- --------- ----- ----

/s/ Fred H. Deindoerfer Chairman of the Board of Directors, April 14, 1997
- ------------------------------- President, and Chief Executive Officer
Fred H. Deindoerfer

/s/ Martin S. McDermut Vice President, Finance and April 14, 1997
- ------------------------------- Administration and Chief Financial
Martin S. McDermut Officer

/s/ E. Eduardo Benmaor Secretary, Controller, and April 14, 1997
- ------------------------------- Principal Accounting Officer
E. Eduardo Benmaor

/s/ John A. O'Malley Director April 14, 1997
- -------------------------------
John A. O'Malley

/s/ Steven M. Besbeck Director April 14, 1997
- -------------------------------
Steven M. Besbeck

/s/ Thomas F. Kelley Director and Vice President April 14, 1997
- ------------------------------
Thomas F. Kelley

-29-
32
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Shareholders of International Remote Imaging
Systems, Inc.

We have audited the consolidated financial statements and the financial
statement schedule of International Remote Imaging Systems, Inc. and its
subsidiaries, as listed in the index on page 25 of this Form 10-K. These
financial statements and the financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits. We did not
audit the financial statements of StatSpin, Inc., a wholly owned subsidiary,
for the year ended March 31, 1995. The financial statements of StatSpin, Inc.
reflect total revenues of 22% in 1994, of the related consolidated totals. The
financial statements of StatSpin, Inc. for the year ended March 31, 1995 were
audited by other auditors whose report was furnished to us, and our opinion,
insofar as it relates to the amounts included for StatSpin, Inc. for the year
ended December 31, 1994, is based solely on the report of the other auditors.

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.

The consolidated financial statements give retroactive effect to the
merger of International Remote Imaging Systems, Inc. and StatSpin, Inc. on
February 1, 1996, which has been accounted for as a pooling of interests as
described in Note 1 to the consolidated financial statements.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of International Remote Imaging Systems, Inc. and its subsidiaries at December
31, 1996 and 1995, and the consolidated results of their operations and their
cash flows for each of the three years in the period ended December 31, 1996,
in conformity with generally accepted accounting principles. In addition, in
our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.

/s/ Coopers & Lybrand L.L.P.

Los Angeles, California
March 21, 1997, (except for Note 8 and Note 14,
for which the dates are April 10, 1997 and April 6, 1997, respectively.)

INDEPENDENT AUDITORS' REPORT

The Board of Directors of StatSpin, Inc:

We have audited the statements of income and accumulated deficit, and cash
flows of StatSpin, Inc. for the year ended March 31, 1995. These financial
statements, which are not presented separately herein, are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of StatSpin, Inc.'s operations and its cash
flows for the year ended March 31, 1995, in conformity with generally accepted
accounting principles.

/s/ KPMG Peat Marwick LLP

May 26, 1995
Boston, Massachusetts

F-1

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS

ASSETS

At December 31,
----------------------------------
1995 1996
---- ----

Current assets:
Cash and cash equivalents $1,511,395 $3,602,535
Short-term investments 4,736,727 667,589
Accounts receivable net of allowance for doubtful
accounts of $87,759 in 1995 and $328,766 in 1996 3,786,119 5,207,933
Inventories 2,941,021 4,838,206
Prepaid expenses and other current assets 285,683 163,465
Deferred tax asset 919,489 936,500
------------ ------------
Total current assets 14,180,434 15,416,228

Property and equipment, at cost, net of accumulated depreciation 995,044 1,947,713
Purchased intangibles 915,649 10,324,760
Software development costs, net of accumulated amortization of
$667,425 in 1995 and $847,880 in 1996 298,030 920,972
Long-term investments 100,000 --
Deferred warrant costs 1,574,780 1,155,452
Deferred tax asset 3,594,100 7,276,250
Other assets 544,508 818,870
------------ ------------
Total assets $ 22,202,545 $ 37,860,245
============ ============

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Short-term borrowings $ -- $ 1,334,755
Current portion of long term debt 185,633 2,600,000
Accounts payable 810,819 4,587,407
Accrued expenses 1,238,599 3,901,071
Deferred income - service contracts 710,907 799,523
Deferred income - other -- 279,591
------------ ------------
Total current liabilities 2,945,958 13,502,347

Subordinated note payable -- 7,000,000
Deferred income - service contracts and other 190,045 193,219
Notes payable, long-term portion 125,000 3,400,000
------------ ------------
Total liabilities 3,261,003 24,095,566

Commitments and contingencies

Shareholders' equity:
Preferred stock, $.01 par value
Authorized: 3,000,000 shares
Convertible Series A,
Shares issued and outstanding : 1995 - none, 1996 - 3,000
($3,000,000 liquidation preference) -- 30
Common stock, $.01 par value
Authorized: 15,600,000 shares
Shares issued and outstanding:
1995 - 6,292,408, 1996 - 5,911,890 62,924 59,118
Additional paid-in capital 34,154,116 36,311,535
Treasury stock, at cost (96,473 shares in 1995 and 26,240 shares in 1996) (453,386) (103,500)
Unearned compensation (95,884) (385,879)
Foreign currency translation adjustment -- 37,791
Accumulated deficit (14,726,228) (22,154,416)
------------ ------------
Total shareholders' equity 18,941,542 13,764,679
------------ ------------
Total liabilities and shareholders' equity $ 22,202,545 $ 37,860,245
============ ============

The accompanying notes are an integral part of these consolidated financial
statements.

F-2
34
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

For the Year Ended December 31,
----------------------------------------------------------------
1994 1995 1996
----------------------------------------------------------------

Sales of IVD imaging systems . . . $ 4,559,044 $ 4,240,627 $ 6,370,346
Sales of IVD imaging system
supplies and service . . . . . . 5,024,521 6,737,444 9,117,493
Sales of small instruments and
supplies . . . . . . . . . . . . 2,885,712 3,414,087 5,066,292
----------- ----------- -----------
Net sales . . . . . . . . . . . . . 12,469,277 14,392,158 20,554,131
---------- ---------- ----------

Cost of goods- IVD imaging systems 2,178,318 2,014,873 3,278,140
Cost of goods - IVD imaging system
supplies and service . . . . . . 2,495,797 3,174,290 5,114,538
Cost of goods - small instruments
and supplies . . . . . . . . . . 1,824,913 1,937,653 2,693,900
----------- ----------- -----------
Cost of goods sold . . . . . . . . 6,499,028 7,126,816 11,086,578
----------- ----------- -----------

Gross margin . . . . . . . . . . . 5,970,249 7,265,342 9,467,553

Marketing and selling . . . . . . . 2,085,022 2,874,442 4,627,089
General and administrative . . . . 1,645,678 2,041,281 3,258,700
Research and development, net . . . 663,231 1,220,028 1,978,326
Amortization of intangibles . . . . 81,224 127,142 793,916
Unusual charges . . . . . . . . . . -- -- 2,036,592
Acquisition of in-process research
and development . . . . . . . . . -- 2,900,430 7,250,000
----------- ----------- -----------

Total operating expenses . . . . . 4,475,155 9,163,323 19,944,623

Operating income (loss) . . . . . . 1,495,094 (1,897,981) (10,477,070)

Other income (expense):
Interest income . . . . . . . . 167,924 309,929 221,935
Interest expense . . . . . . . . (73,238) (42,699) (681,114)
Other income . . . . . . . . . . 111,240 110,530 50,134
----------- ----------- -----------

Income (loss) before provision
(benefit) for income taxes . . . 1,701,020 (1,520,221) (10,886,115)
Provision (benefit)
for income taxes . . . . . . . . 79,456 (3,646,633) (3,457,927)
----------- ----------- -----------

Net income (loss) . . . . . . . . . $ 1,621,564 $ 2,126,412 $(7,428,188)
----------- ----------- -----------
Net income (loss) per share . . . . $.28 $.33 $(1.21)
---- ---- ------

Weighted average number of
common shares and common
share equivalents outstanding
for the period . . . . . . . . . 5,698,620 6,418,518 6,141,657
--------- --------- ---------

The accompanying notes are an integral part of these consolidated financial
statements.

F-3
35
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Common Stock Additional Shareholders'
------------ Paid-In Treasury Notes Unearned Accumulated
Shares Amount Capital Stock Receivable Compensation Deficit Total
------ ------ ------- ----- ---------- ------------ ------- -----

Balance,
December 31, 1993 . . . . . 5,138,346 $51,384 $26,327,059 $(142,016) $(6,667) $(76,803) $(18,386,685) $7,766,272

Common stock issued
on exercise of stock options 200,832 2,008 445,015 -- -- -- -- 447,023

Common stock issued under
Employee Stock Purchase
Plan:
for Cash . . . . . . . . . 22,811 228 100,559 -- -- -- -- 100,787
for Services . . . . . . . 22,811 228 100,559 -- -- (100,787) -- --

Common stock issued for cash
on exercise of warrants . . 15,800 158 59,092 -- -- -- -- 59,250

Issuance of warrants . . . -- -- 385,285 -- -- -- -- 385,285

Principal payments received
on shareholders' notes
receivable . . . . . . . . -- -- -- -- 6,667 -- -- 6,667

Amortization of unearned
compensation . . . . . . . -- -- -- -- -- 84,460 -- 84,460

Repurchase of common stock (70,273) (702) 702 (311,370) -- -- -- (311,370)

Net income . . . . . . . . -- -- -- -- -- -- 1,621,564 1,621,564
--------- -------- ---------- --------- -------- --------- ------------ -----------
Balance,
December 31, 1994 . . . . 5,330,327 $53,304 $27,418,271 $(453,386) -- $(93,130) $(16,765,121) $10,159,938

The accompanying notes are an integral part of these consolidated financial
statements.

F-4
36
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Common Stock Additional
------------ Paid-In Treasury Unearned Accumulated
Shares Amount Capital Stock Compensation Deficit Total
------ ------ ------- ----- ------------ ----------- -----

Balance forward . . . . . . 5,330,327 $53,304 $27,418,271 $(453,386) $(93,130) $(16,765,121) $10,159,938

Common stock issued
on exercise of stock
options . . . . . . . . . . 21,900 219 44,231 -- -- -- 44,450

Common stock issued under
Employee Stock Purchase
Plan:
for Cash. . . . . . . . . . 9,997 100 67,141 -- -- -- 67,241
for Services. . . . . . . . 16,976 170 112,219 -- (89,915) -- 22,474

Common stock issued for
cash on exercise of
warrants. . . . . . . . . . 414,749 4,147 1,551,161 -- -- -- 1,555,308

Issuance of warrants. . . . -- -- 1,774,733 -- -- -- 1,774,733

Common stock issued in
exchange for LDA Systems,
Inc. callable common
stock . . . . . . . . . . . 498,459 4,984 2,972,360 -- -- -- 2,977,344

Amortization of unearned
compensation. . . . . . . . -- -- -- -- 87,161 -- 87,161

Income tax benefit
related to exercise of
nonqualified stock
options . . . . . . . . . . -- -- 214,000 -- -- -- 214,000

Adjustment to reflect
change in StatSpin, Inc.
fiscal year. . . . . . . . -- -- -- -- -- (87,519) (87,519)

Net income. . . . . . . . . -- -- -- -- -- 2,126,412 2,126,412
--------- ------- ----------- --------- -------- ------------ -----------
Balance,
December 31, 1995 . . . . 6,292,408 $62,924 $34,154,116 $(453,386) $(95,884) $(14,726,228) $18,941,542

The accompanying notes are an integral part of these consolidated financial
statements.

F-5
37
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Convertible Series A
Preferred Stock Common Stock Additional
--------------- ------------ Paid-In
Shares Amount Shares Amount Capital
------ ------ ------ ------ -------

Balance forward . . . . . . . . -- -- 6,292,408 $62,924 $34,154,116

Issuance of convertible
preferred stock for cash . . . 3,000 30 -- -- 2,928,291

Common stock issued on
exercise of stock options . . . -- -- 137,924 1,379 333,315

Common stock issued or issued
from treasury under Employee
Stock Purchase Plan:
for Cash . . . . . . . . . . . -- -- 13,297 133 81,369
for Services . . . . . . . . . -- -- 22,136 221 150,159

Stock option compensation . . . -- -- -- -- 437,770

Issuance of warrants in
connection with acquisition of
Perceptive Scientific
Instruments, Inc. . . . . . . . -- -- -- -- 927,000

Repurchase of shares of common
stock and warrants . . . . . . -- -- -- -- (273,216)

Retire treasury stock . . . . . -- -- (553,875) (5,539) (2,504,582)

Amortization of unearned
compensation . . . . . . . . . -- -- -- -- --

Income tax benefit related to
exercise of nonqualified stock
options . . . . . . . . . . . . -- -- -- -- 77,313

Foreign currency translation
adjustment . . . . . . . . . . -- -- -- -- --

Stock tendered as payment for
options exercised . . . . . . . -- -- -- -- --

Net income (loss) . . . . . . . -- -- -- -- --
----- --- --------- ------- -----------
Balance,
December 31, 1996 . . . . . . 3,000 $30 5,911,890 $59,118 $36,311,535
===== === ========= ======= ===========

Foreign
Currency
Treasury Unearned Translation Accumulated
Stock Compensation Adjustment Deficit Total
----- ------------ ---------- ------- -----

Balance forward . . . . . . . . $(453,386) $(95,884) -- $(14,726,228) $18,941,542

Issuance of convertible
preferred stock for cash . . . -- -- -- -- 2,928,321

Common stock issued
on exercise of stock options. . -- -- -- -- 334,694

Common stock issued or issued
from treasury under Employee
Stock Purchase Plan:
for Cash . . . . . . . . . . . 37,703 -- -- -- 119,205
for Services . . . . . . . . . 37,703 (153,190) -- -- 34,893

Stock option compensation . . . -- (270,925) -- -- 166,845

Issuance of warrants in
connection with acquisition of
Perceptive Scientific
Instruments, Inc. . . . . . . . -- -- -- -- 927,000

Repurchase of shares of common
stock and warrants . . . . . . (2,132,141) -- -- -- (2,405,357)

Retire treasury stock . . . . . 2,510,121 -- -- -- --

Amortization of unearned
compensation . . . . . . . . . -- 134,120 -- -- 134,120

Income tax benefit related to
exercise of nonqualified stock
options . . . . . . . . . . . . -- -- -- -- 77,313

Foreign currency translation
adjustment . . . . . . . . . . -- -- 37,791 -- 37,791

Stock tendered as payment for
options exercised . . . . . . . (103,500) -- -- -- (103,500)

Net income (loss) . . . . . . . -- -- -- (7,428,188) (7,428,188)
---------- ---------- ------- ------------- -----------
Balance,
December 31, 1996 . . . . . . $(103,500) $(385,879) $37,791 $(22,154,416) $13,764,679
========== ========== ======= ============ ===========

The accompanying notes are an integral part of these consolidated financial
statements.

F-6
38

INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Year Ended December 31,
------------------------------------------------------
1994 1995 1996
-------------------------------------------------------

Cash flows from operating activities:
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . $1,621,564 $2,126,412 $(7,428,188)
Adjustments to reconcile net income (loss) to net
cash provided by operations:
Deferred tax benefit . . . . . . . . . . . . . . . . . . . . . -- (3,705,589) (3,456,920)
Acquisition of in-process research and development . . . . . . -- 2,882,858 7,250,000
Depreciation and amortization . . . . . . . . . . . . . . . . 548,420 635,048 1,769,896
Common stock and stock option compensation . . . . . . . . . . 84,460 109,635 335,858
Gain on disposal of property and equipment . . . . . . . . . . -- -- (51,401)
Allowance for doubtful accounts . . . . . . . . . . . . . . . -- -- 252,037
Changes in assets and liabilities:
Accounts receivable - trade and other . . . . . . . . . . . . (555,586) (356,739) (131,240)
Service contracts, net . . . . . . . . . . . . . . . . . . . . 23,715 (95,586) (475,034)
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . 390,479 (875,295) (1,433,834)
Prepaid expenses and other current assets . . . . . . . . . . (79,561) (80,230) 176,061
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . (106,270) 47,239 (132,992)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . 266,325 (87,673) 2,851,805
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . (151,224) 199,735 375,793
Deferred income - other . . . . . . . . . . . . . . . . . . . -- -- 279,591
---------- ---------- ----------
Net cash provided by operating activities . . . . . . . . . . . 2,042,322 799,815 181,432
---------- ---------- ----------
Cash flows from investing activities:
Acquisition of property and equipment . . . . . . . . . . . . (266,360) (820,838) (1,171,621)
Sales of property and equipment . . . . . . . . . . . . . . . -- -- 85,000
Acquisition of business and product line, net of cash acquired -- (886,800) (10,311,041)
Software development costs . . . . . . . . . . . . . . . . . . (25,411) (299,016) (577,421)
Maturities of certificates of deposit . . . . . . . . . . . . 210,000 215,000 200,000
Purchases of certificates of deposit . . . . . . . . . . . . . (100,000) -- --
Maturities of held-to-maturity debt securities . . . . . . . . 1,000,000 2,700,000 3,969,138
Purchases of held-to-maturity debt securities . . . . . . . . (3,441,062) (4,295,664) --
---------- ---------- ----------
Net cash used by investing activities . . . . . . . . . . . . . (2,622,833) (3,387,318) (7,805,945)
---------- ---------- ----------
Cash flows from financing activities:
Issuance of common and preferred stock for cash . . . . . . . 254,823 1,599,758 3,159,515
Repurchase of common stock . . . . . . . . . . . . . . . . . . (59,920) -- (553,148)
Principal payments received on shareholders' notes receivable 4,569 -- --
Increase (decrease) in line of credit borrowings . . . . . . . (160,000) -- 1,334,755
Repayments of notes payable . . . . . . . . . . . . . . . . . (373,605) (256,351) (2,110,633)
Proceeds from notes payable . . . . . . . . . . . . . . . . . 166,660 -- 7,800,000
Issuance of common stock for cash under Employee Stock
Purchase Plan . . . . . . . . . . . . . . . . . . . . . . . 100,787 67,241 119,205
Deferred offering costs . . . . . . . . . . . . . . . . . . . . -- -- (35,049)
---------- ---------- ----------
Net cash provided (used) by financing activities . . . . . . . (66,686) 1,410,648 9,714,645
---------- ---------- ----------
Effect of foreign currency rate fluctuation on cash
and cash equivalents . . . . . . . . . . . . . . . . . . . . -- -- 1,008
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents . . . . . (647,197) (1,176,855) 2,091,140
Cash and cash equivalents at beginning of year . . . . . . . . 3,220,581 2,573,384 1,511,395
Adjustment to cash to reflect change in StatSpin
Technologies fiscal year -- 114,866 --
---------- ---------- ----------
Cash and cash equivalents at end of year . . . . . . . . . . . $2,573,384 $1,511,395 $3,602,535
========== ========== ==========

Supplemental schedule of non-cash financing activities:
Issuance of common stock in exchange for services . . . . . . $ 100,787 $109,635 $153,190
Stock option compensation . . . . . . . . . . . . . . . . . . -- -- 437,770
Issuance of common stock under a stock for
stock exercise . . . . . . . . . . . . . . . . . . . . . . 251,450 -- 103,500
Issuance of warrants in connection
with development agreements . . . . . . . . . . . . . . . . 385,285 1,774,733 --
Issuance of warrants and subordinated note for asset purchase -- -- 7,927,000
Accrual for common stock and warrant repurchase . . . . . . . -- -- 1,587,084
Issuance of common stock to acquire shares of LDA . . . . . . -- 2,977,344 --
Tax benefit related to exercise of nonqualified stock options -- 214,000 77,313
Supplemental disclosure of cash flow information:
Cash paid for income taxes . . . . . . . . . . . . . . . . . . 112,921 21,456 64,100
Cash paid for interest . . . . . . . . . . . . . . . . . . . . 118,379 42,698 526,182

The accompanying notes are an integral part of these consolidated financial
statements.

F-7

39
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. FORMATION AND BUSINESS OF THE COMPANY.

International Remote Imaging Systems, Inc. was incorporated in California
in 1979 and reincorporated during 1987 in Delaware. International Remote
Imaging Systems, Inc. and its subsidiaries (collectively "IRIS" or the
"Company") operate primarily in one segment. The Company designs, develops,
manufactures and markets in vitro diagnostic ("IVD") imaging equipment,
including IVD imaging systems based on patented and proprietary automated
intelligent microscopy ("AIM") technology, and special purpose centrifuges and
other small instruments for automating microscopic procedures performed in
clinical laboratories. AIM combines the Company's capabilities in automated
specimen presentation, including its patented slideless microscope, and
proprietary high-speed digital processing hardware and software to classify and
visually present images of microscopic particles in easy-to-use displays. The
Company's IVD imaging systems are designed to provide customers with better and
more rapid results and labor cost-savings over manual methods of performing
microscopy. The Company also provides on-going service and supplies to support
equipment sold. The Company's products are sold directly and through
distributors primarily to clinical, hospital, veterinary, physicians offices
and research laboratories in North America.

On February 1, 1996, a newly formed subsidiary of IRIS completed its
merger with StatSpin, Inc. ("StatSpin"), which became a wholly owned subsidiary
of IRIS. StatSpin manufactures special purpose centrifuges and other small
instruments. IRIS issued approximately 340,000 shares of common stock for all
of the outstanding common stock and appreciation rights of StatSpin and assumed
options and warrants to purchase an additional 126,000 shares of IRIS common
stock. This represented an exchange ratio of 4.095 shares of IRIS common stock
for each common share and stock appreciation right of StatSpin. This
transaction was accounted for as a pooling-of-interests. Accordingly, the
consolidated financial statements have been retroactively restated for all
periods presented to include the financial position, results of operations and
cash flows of StatSpin.

StatSpin previously used the fiscal year ended March 31 for its financial
reporting. To conform to the Company's December 31 fiscal year end, StatSpin's
operating results for the period January 1, 1995 through March 31, 1995 have
been included in the operating results of the Company for the fiscal years
ended December 31, 1995 and 1994. The resulting duplication of revenue and net
income of StatSpin for the period from January 1, 1995 through March 31, 1995
amounted to $710,000 and $87,519, respectively, which has been adjusted by a
$87,519 charge to accumulated deficit during the year ended December 31, 1995.

Combined and separate results of IRIS and StatSpin are as follows:

IRIS StatSpin Combined
--------------- ------------- -------------
Year ended December 31, 1994 (StatSpin year (unaudited) (unaudited)
ended March 31, 1995)
- ---------------------

Net sales $9,583,565 $2,885,712 $12,469,277
Net income 1,472,886 148,678 1,621,564

Year ended December 31, 1995
- ----------------------------

Net sales 11,292,559 3,099,599 14,392,158
Net income 1,861,228 265,184 2,126,412

Year ended December 31, 1996
- ----------------------------
Net sales 16,264,790 4,289,341 20,554,131
Net income (loss) (7,624,931) 196,743 (7,428,188)

On July 31, 1996, the Company, through a wholly owned subsidiary, PSI
Acquisition Corp., acquired the IVD imaging business of Perceptive Scientific
Instruments, Inc. ("Old PSI") for $9.5 million in cash (including $400,000 in
acquisition costs), issuance of a $7.0 million 8.25% subordinated note
("Subordinated Note") and a five year warrant to purchase 875,000 shares of the
Company's common stock at $8.00 per share (valued for accounting purposes at
$927,000). The cash portion of the purchase price was paid primarily with
funds obtained from a bank under a $7.8 million term loan ("Term Loan") and a
new $1.5 million revolving line of credit ("Credit Facility").

F-8
40
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company subsequently changed the name of PSI Acquisition Corp. to
Perceptive Scientific Instruments, Inc. ("PSI").

PSI designs, develops, manufactures and markets IVD imaging systems for
biological, clinical and research applications. PSI's primary business is
providing cytogenetic analysis instrumentation and related services through
worldwide sales of its proprietary PowerGene product line. The PowerGene
product line is used in various procedures for chromosome analysis, including
karyotyping, DNA probe analysis via fluorescent in-situ hybridization methods
and comparative genomic hybridization analysis. The PowerGene system is
marketed in North America from PSI's Houston headquarters and internationally
through its U.K. subsidiary.

The PSI acquisition has been accounted for using the purchase method of
accounting, and accordingly, the purchase price has been allocated to the
assets purchased and the liabilities assumed based upon their estimated fair
value at the date of acquisition. The excess of the purchase price over the
fair values of the net assets acquired was $16.8 million, of which $7.3 million
has been expensed as in-process research and development related to technology
for which the technological feasibility had not been established and does not
have an alternative use. The remainder has been allocated to acquired
technology and know-how and the international distribution channel which are
being amortized over six years and twenty-five years, respectively. The net
purchase price was allocated as follows:

Working capital other than cash $ (324,009)
Property, plant, and equipment 514,648
Other assets 391,110
Intangibles 9,532,668
In-process research & development 7,250,000
-----------
Total $17,364,417
===========

The operating results of the acquired business of PSI are included in the
Consolidated Statement of Operations from the date of acquisition, August 1,
1996. The following unaudited summary, prepared on a pro forma basis, combines
the consolidated results of operations as if PSI had been acquired as of the
beginning of fiscal 1995. The pro forma information excludes the write-offs of
in-process research and development, but includes the impact of certain
adjustments, such as amortization of intangibles, increased interest on the
acquisition debt, and related income tax effects.

For the year ended December 31,
----------------------------------------------

1995 1996
---- ----
(unaudited) (unaudited)

Sales $19,786,000 $24,229,000

Net income (loss) 2,392,000 (3,890,629)

Net income (loss) per share $0.37 $(0.63)

The unaudited pro forma information is provided for informational purposes
only. This information is based on historical information and is not
necessarily indicative of what the actual consolidated results of operations
might have been if the acquisition had been in effect for the entire period
presented, nor is it indicative of future results of operations of the combined
entities.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.

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 periods. The significant estimates in the preparation of the

F-9
41
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

consolidated financial statements relate to the assessment of the carrying
value of accounts receivables, inventories, purchased intangibles, estimated
provisions for warranty costs and deferred tax asset. Actual results could
differ from those estimates.

Principles of Consolidation:

The financial statements include the accounts of International Remote
Imaging Systems, Inc. and its wholly-owned subsidiaries. All intercompany
accounts and transactions have been eliminated in the consolidated financial
statements.

Foreign Currency:

The financial statements of the Company's foreign subsidiary are
translated into U.S. dollars using the exchange rate prevailing at each balance
sheet date for assets and liabilities and average exchange rates for each
reporting period for revenues and expenses. Translation adjustments are
recorded directly to a separate component of shareholders' equity. Gains and
losses resulting from foreign currency transactions are included in operations
currently.

Cash Equivalents, Short-Term Investments, and Long-Term Investments:

Short term investments principally include certificates of deposit and
debt instruments of the United States Government with maturities greater than
three months and less than one year. Long term investments represent
certificates of deposit and debt instruments of the United States Government
with maturities greater than one year. For purposes of the statement of cash
flows, IRIS considers all highly liquid debt instruments purchased with a
remaining maturity of three months or less when purchased to be cash
equivalents. IRIS places its cash and investments with high credit quality
financial institutions. At times, these deposits may be in excess of the
federally insured limit.

Accounts Receivable:

IRIS sells predominantly to entities in the healthcare industry. IRIS
grants uncollateralized credit to its customers, primarily hospitals, clinical
and research laboratories, and distributors. IRIS performs ongoing credit
evaluations of its customers before granting uncollateralized credit.

Inventories:

Inventories are carried at the lower of cost or market on a first in,
first out basis.

Property and Equipment and Depreciation:

Property and equipment are recorded at cost, less accumulated depreciation
and amortization. Depreciation is generally computed using the straight-line
method over three to five years, the estimated useful lives of the assets.
Leasehold improvements are amortized over the lesser of their useful life or
the remaining term of the lease.

Costs of maintenance and repairs are charged to expense when incurred;
costs of renewals and betterments are capitalized. Upon sale or retirement,
the cost and related accumulated depreciation are eliminated from the
respective accounts, and the resulting gain or loss is included in current
income.

Purchased Intangibles:

Purchased intangibles are comprised of goodwill, acquired technology and
know-how and international distribution channel, and are being amortized on a
straight-line basis over ten years, six years and twenty-five years,
respectively. The realizability of purchased intangibles is evaluated
periodically as events or circumstances indicate a possible inability to
recover the carrying amount. Such evaluation is based on various analysis,
including cash flow and profitability projections. The analysis necessarily
involves significant management judgement to evaluate the capacity of an
acquired business to perform within projections. In the event the projected
undiscounted cash flows are less than net book value of the assets, the
carrying value of the assets will be written down to their fair value.

F-10
42
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Software Development Costs:

IRIS capitalizes certain software development costs for new products and
product enhancements once technological feasibility has been established. IRIS
amortizes capitalized software costs using the greater of the straight line
method over the estimated product life of generally one to three years, or a
percentage of total units sold over the projected unit sales. Amortization
expense of software development costs was approximately $108,000, $41,600 and
$180,500 for 1994, 1995, and 1996, respectively.

Deferred Warrant Costs:

Deferred warrant costs result from the issuance of warrants in conjunction
with various development, distribution and technology license agreements.
These costs are being amortized over the estimated term of the related
agreements, or with respect to perpetual technology license agreements, over
the expected life of the related technology of, generally, ten years.

Long-Lived Assets:

In March 1995, Statement of Financial Accounting Standards (SFAS) No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed of," was issued. SFAS No. 121 requires that long-lived assets
and certain identifiable intangibles to be held and used or disposed of by an
entity be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. During
1996, the Company adopted this statement and the effect of adoption was not
material.

Stock Based Compensation:

The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 123 defines a fair value
based method of accounting for an employee stock option. Fair value of the
stock option is determined considering factors such as the exercise price, the
expected life of the option, the current price of the underlying stock and its
volatility, expected dividends on the stock, and the risk-free interest rate
for the expected term of the option. Under the fair value based method,
compensation cost is measured at the grant date based on the fair value of the
award and is recognized over the service period. Pro forma disclosures for
entities that elect to continue to measure compensation cost under the
intrinsic method provided by Accounting Principles Board Opinion No. 25 must
include the effects of all awards granted in fiscal years that begin after
December 15, 1994.

Revenue Recognition:

IRIS derives revenue from the sale of IVD imaging systems, sales of
supplies and service for its IVD imaging systems and sales of small laboratory
instruments and related supplies. IRIS generally recognizes product revenues
once all of the following conditions have been met: a) an authorized purchase
order has been received in writing, b) customer credit worthiness has been
established, and c) shipment of the product to the customer designated location
has occurred. Estimated installation expense is recognized as part of the
accrual for warranty expense at the time of shipment.

IRIS recognizes service revenues ratably over the term of the service
period, which typically ranges from twelve to sixty months. Payments for
service contracts are generally made in advance. Deferred revenue represents
the revenues to be recognized over the remaining term of the service contracts.

Warranties:

IRIS recognizes the full estimated cost of warranty expense, including
installation costs, at the time of product shipment.

F-11
43
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Research and Development Expenditures:

Except for certain software development costs required to be capitalized
as described above (see Software Development Costs), research and development
expenditures are charged to operations as incurred. Net research and
development expense includes total research and development costs incurred,
including costs incurred under research and development grants and contracts,
less costs reimbursed under research and development contracts (see Note 18).

Income Taxes:

IRIS accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes," which
requires recognition of deferred tax liabilities and assets for the expected
future tax consequences of events that have been included in the financial
statements or tax returns. Under this method, deferred tax liabilities and
assets are determined based on the differences between the financial statement
and the tax bases of assets and liabilities using enacted tax rates in effect
for the year in which the differences are expected to reverse. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amount expected to be realized. Income tax expense represents the tax payable
for the period and the change during the period in deferred tax assets and
liabilities.

Marketing Costs:

All costs related to marketing and advertising the Company's products are
expensed in the period incurred.

Reclassifications:

Certain reclassifications have been made to the 1994 and 1995 financial
statements to conform with the 1996 presentation.

Recently Issued Accounting Standard:

In February, 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 " Earnings Per Share"
("SFAS No. 128"). SFAS No. 128 requires dual presentation of newly defined
basic and diluted earnings per share on the face of the income statement for
all entities with complex capital structures. This method is considered more
compatible with International Accounting Standards. SFAS No. 128 is effective
for all fiscal years ending after December 15, 1997. The Company has not yet
determined the impact of SFAS No. 128.

Certain Risks and Uncertainties:

Reliance on Unique Products: The Company has derived, and expects to
continue to derive, in the near term, a substantial portion of its revenues
from sales of The Yellow IRIS family of urinalysis workstations and related
supplies and service. Relatively modest declines in sales or gross margins for
these workstations could have a material adverse effect on the Company's
revenues and profits.

Reliance on Single Source Suppliers: Certain key components of the
Company's instruments are manufactured according to the Company's
specifications or are available only from single suppliers. Some single source
suppliers have notified the Company that they have discontinued, or will soon
discontinue, production of key components. Although, in the past, the Company
has successfully transitioned to new components to replace discontinued
components, there can be no assurance that the Company can successfully
transition to satisfactory replacement components or that the Company will have
access to adequate supplies of discontinued components on satisfactory terms
during the transition period. The Company's inability to transition
successfully to replacement components or to secure adequate supplies of
discontinued components on satisfactory terms could have a material adverse
effect on the Company.

3. MARKETABLE DEBT SECURITIES.

At December 31, 1995, the carrying value of marketable debt securities,
classified as "held-to-maturity" are carried at amortized cost, which
approximates fair value, and is included in short-term and long-term
investments:

F-12
44
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1995 Expected Maturity Value and Date
----------------- ----------------------------------------

Amortized Cost Within One Year One to Five Years
-------------- --------------- -----------------

U.S. Treasury Bills $3,236,725 $3,318,000 $ --
U.S. Treasury Notes 803,376 800,000 --

No material gains or losses were realized from the sale of marketable debt
securities in 1994, 1995 and 1996.

4. INVENTORIES.

Inventories consist of the following:

December 31,
----------------------------------
1995 1996
----------------------------------

Finished goods . . . . . . . . . . . $422,115 $631,116
Work-in-process . . . . . . . . . . 276,115 646,031
Raw materials, parts and
sub-assemblies . . . . . . . . . . 2,242,791 3,561,059
---------- ----------
$2,941,021 $4,838,206
========== ==========

5. PROPERTY AND EQUIPMENT.

Property and equipment consist of the following:

December 31,
----------------------------------
1995 1996
----------------------------------

Leasehold improvements . . . . . . . $327,178 $402,537
Furniture and fixtures . . . . . . . 115,544 251,617
Machinery and equipment . . . . . . 2,422,835 3,204,361
Tooling, dies and molds . . . . . . 532,070 891,472
Rental units . . . . . . . . . . . . 330,220 577,610
----------- -----------
3,727,847 5,327,597
Less accumulated depreciation (2,732,803) (3,379,884)
----------- -----------
$ 995,044 $ 1,947,713
=========== ===========

Property and equipment includes $1,284,488 and $2,015,694, respectively,
at December 31, 1995 and 1996, of fully depreciated assets which remain in
service. Depreciation expense was $327,293, $449,653 and $830,914, for 1994,
1995, and 1996, respectively.

The Company is the lessor of IVD imaging systems under operating leases
for periods from one to five years. Under these leases the Company also
provides supplies and services. Generally, operating leases contain provisions
for early termination. The cost of the rental units is depreciated on a
straight line basis over five years. Rental units are carried at cost less
accumulated depreciation of $163,952 and $98,523 at December 31, 1995 and 1996,
respectively. Minimum rentals receivable, net of estimated costs for supplies
and service, under existing operating leases as of December 31, 1996 are as
follows: 1997 - $424,000, 1998 - $243,000, 1999 - $177,000, 2000 - $136,000,
2001 - 114,000, and thereafter - $21,000.

F-13
45
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. PURCHASED INTANGIBLES

Purchased intangibles, at cost, consist of the following:

December 31,
-----------------------------
1995 1996
---- ----

Goodwill . . . . . . . . . . . . . . . $994,799 $1,377,973
International distribution channel . . -- 5,571,728
Acquired technology and know-how . . . -- 3,960,904
-------------- -------------
994,799 10,910,605
Less accumulated amortization . . . . . (79,150) (585,845)
---------- --------------
Total . . . . . . . . . . . . . . . . . $915,649 $10,324,760
======== ===========

7. ACCRUED EXPENSES.

Accrued expenses consist of the following:

December 31,
-----------------------------
1995 1996
---- ----

Accrued bonuses . . . . . . . . . . . . $366,372 $186,985
Accrued commissions . . . . . . . . . . 76,079 237,422
Accrued payroll . . . . . . . . . . . . 88,228 203,574
Accrued vacation . . . . . . . . . . . 135,832 207,947
Accrued taxes and other . . . . . . . . 70,642 28,755
Accrued professional fees . . . . . . . 155,552 254,577
Accrued warranty expense . . . . . . . 269,823 278,563
Accrued interest . . . . . . . . . . . -- 154,932
Accrued amount due BMC . . . . . . . . -- 1,587,084
Accrued - other . . . . . . . . . . . . 76,071 761,232
------ -------

$1,238,599 $3,901,071
========== ==========

8. SHORT TERM BORROWINGS AND NOTES PAYABLE.

The Company financed the purchase price for the PSI acquisition with the
Subordinated Note ($7.0 million), the Term Loan ($7.8 million) and the Credit
Facility ($1.3 million). The Term Loan and Credit Facility impose certain
operating and financial convenants on the Company. Due to an inability to
comply with these financial covenants, the Company was in default on both loans
at September 30 and December 31, 1996. In April of 1997, the bank waived the
default, amended the financial covenants and extended the maturity of both
loans. In exchange, the Company agreed to increase the interest rates on both
loans and to issue the bank a three year warrant to purchase 50,000 shares of
Common Stock at $3.875 per share. The Company also agreed to issue additional
warrants to purchase 25,000 shares of Common Stock at prevailing market prices
on each of June 1 and July 1, 1997 if the Term Loan is still outstanding on
those dates.

On December 31, 1996, the outstanding principal balance of the Term Loan was
$6.0 million. Since that date, the Company has reduced the outstanding
principal balance of the Term Loan to $4.2 million, in large part with the net
proceeds from the sale of the Series A Preferred Stock (see Note 14). The Term
Loan is collateralized by a first priority lien on all the assets of the
Company and bears interest monthly at the bank's prime rate (8.25% on December
31, 1996) plus 1.5%. The interest rate increases an additional 0.25 percentage
points on each of June 1 and July 1, 1997. The Company is required to pay
$100,000 of principal each month, and the balance is due April 15, 1998. The
Company may prepay the Term Loan at any time without premium or penalty.

The outstanding principal balance on the Credit Facility was $1.3 million on
December 31, 1996. Under the terms of the Credit Facility, the Company can
borrow and reborrow up to a maximum principal amount of $1.5 million at a
variable interest rate equal to the bank's prime rate plus 1.5%. The interest
rate increases an additional 0.25 percentage points on each of June 1 and July
1, 1997 if the Term Loan is still outstanding on those dates. The Credit
Facility matures April 15, 1998 and is collateralized by a first priority lien
on all of the assets of the Company.

F-14

46
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The outstanding principal balance on the Subordinated Note was $7.0 million
on December 31, 1996. The Subordinated Note bears interest at a fixed rate of
8.5% per annum, payable in quarterly installments. The entire principal is due
on or before July 31, 2001. The Company may prepay the Subordinated Note at
any time without premium or penalty. Upon the issuance by the Company of
equity securities generating net proceeds in excess of $14.5 million, the
Company must apply fifty percent of the excess to the prepayment of the
Subordinated Note. The payment of principal and interest on the Subordinated
Note is subordinated in right of payment, to the extent and in the manner
provided therein, to the prior payment in full of the Term Loan and Credit
Facility. The default under the Term Loan and Credit facility did not cause a
default under the Subordinated Note because the bank did not accelerate the
maturity of the Term Loan or the Credit Facility.

The Company is presently pursuing additional financing to repay principal on
its outstanding indebtedness and to fund its long-term business strategy.
There can be no assurance that the Company can secure adequate additional
financing on favorable terms, if at all.

Annual maturities of bank and other long term debt are $2,600,000 (1997),
$3,400,000 (1998) and $7,000,000 (2001).

9. INCOME TAXES.

The provision (benefit) for income taxes consisted of the following:

1994 1995 1996
------------------------------------------

Currently payable:
Federal..................................... $30,000 $26,000 $(22,161)
State....................................... 49,456 32,956 21,154
------- ------- --------
79,456 58,956 (1,007)
------- ------- --------
Deferred:
Federal..................................... -- (3,655,589) (3,197,790)
State....................................... -- (50,000) (259,130)
------- ------- --------
-- (3,705,589) (3,456,920)
------- ------- --------
$79,456 $ (3,646,633) $ (3,457,927)
======= ============ ============

The provision (benefit) for income taxes differs from the amount obtained
by applying the federal statutory income tax rate to income before income taxes
for the years ended December 31, 1994, 1995 and 1996 as follows:

1994 1995 1996
-----------------------------------------------------

Tax provision (benefit) computed at
Federal statutory rate ................ $578,347 ($ 516,875) ($3,701,280)
Increase (decrease) in taxes due to:
Change in valuation allowance ......... -- (3,587,000) 437,000
Utilization of net
operating loss carryforward ......... (583,316) (662,819) --
Write-off of in-process research
and development ..................... -- 1,089,962 --
State taxes, net of federal benefit 36,979 26,156 (195,807)
Nondeductible expenses ................ 21,952 (22,057) 44,220
Other ................................. 25,494 26,000 (42,060)
-------- ------------ -----------
$ 79,456 ($ 3,646,633) ($3,457,927)
======== ============ ===========

In 1995, IRIS recognized a tax benefit of $3,587,000 through a reduction
in the Company's deferred tax asset valuation allowance. This reduction in the
valuation allowance resulted principally from the Company's reassessment of the
realizability of its net operating loss carryforwards based on recent operating
history. Realization of the deferred tax assets is dependent upon generation
of sufficient taxable income prior to expiration of the loss carryforwards. At
December 31, 1996, the Company increased the valuation allowance by $437,000
based on its current assessment of operating results and other factors.
Although realization is not assured,

F-15
47
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

management believes it is more likely than not that the remaining net deferred
tax assets will be realized. The amount of the deferred tax assets considered
realizable, however, could be reduced in the future if estimates of future
taxable income during the carryforward period are reduced.

At December 31, 1996, the Company had federal net operating loss
carryforwards of approximately $18.8 million and state net operating loss
carryforwards of approximately $2.5 million which expire in fiscal years ending
in 1999 through 2011. As of December 31, 1996, IRIS had investment tax and
research and experimentation credit carryforwards of $71,719 expiring in fiscal
years through 2003.

The primary components of temporary differences which give rise to the
Company's net deferred tax asset at December 31, 1994, 1995 and 1996 are as
follows:

December 31,
--------------------------------------------------
1994 1995 1996
--------------------------------------------------

Depreciation and amortization ................ $ 129,200 $ 146,200 $ 200,300
Allowance for doubtful accounts .............. 32,600 32,400 101,700
Accrued liabilities .......................... 189,100 256,600 338,700
Deferred revenue-service contracts ........... 202,200 145,800 82,800
Deferred research and development ............ -- 537,000 2,857,000
Net operating loss carryforwards ............. 5,135,800 4,840,000 6,423,900
Other ........................................ 98,100 118,589 208,350
Valuation allowance .......................... (5,787,000) (1,563,000) (2,000,000)
----------- ---------- -----------
$ - $4,513,589 $ 8,212,750
=========== ========== ==========

10. LDA AND WARRANTS.

In October, 1992 LDA Systems, Inc. ("LDA"), completed an initial public
offering of 107,750 units, each unit consisting of one share of callable LDA
Common Stock and ten IRIS Warrants, each five warrants entitling the holder to
purchase one share of IRIS Common Stock for $3.75, exercisable at any time from
November 16, 1992 through July 31, 1995. LDA received net proceeds of $774,000
from the unit offering. These funds were used throughout 1993 to engage IRIS
to conduct research and development, clinical evaluations and pre-market
testing of The White IRIS, a proposed new product, in accordance with a
research and development contract. In addition, IRIS committed to fund
$500,000 of the development costs at a rate of $15,000 per month during this
period.

On April 25, 1994, LDA completed the sale of additional units to Corange
International Limited consisting of 85,714 shares of callable LDA common stock
and warrants to purchase an aggregate of 248,571 shares of IRIS common stock at
an exercise price of $3.75 per share. As part of the investment agreement,
Corange International Limited was granted the option to participate with LDA in
the joint development, manufacture, and marketing of certain future hematology
instruments. This option expired October 30, 1995.

IRIS had the option to purchase for cash or shares of IRIS common stock
all of the outstanding shares of LDA common stock at $20 per share. The option
expired 121 days after termination of the research and development agreement,
which was to conclude no later than July 31, 1995. In June 1995, IRIS
completed the acquisition of LDA for approximately 498,000 shares of IRIS
Common Stock. IRIS acquired LDA pursuant to the exercise of its call option
under the LDA Restated Certificate of Incorporation to purchase all the
outstanding shares of LDA Common Stock. Accordingly, IRIS tendered 2.5765
shares of IRIS Common Stock for each share of LDA Common Stock. As a result of
the acquisition, IRIS incurred a non-recurring charge of approximately $2.9
million against earnings in 1995 for the acquisition of in-process research and
development (i.e. work in process not yet cleared for interstate commerce by
the Food and Drug Administration).

11. POLY DEVELOPMENT AGREEMENT.

On September 29, 1995, Poly U/A Systems, Inc. ("Poly") engaged IRIS to
develop several new products based on IRIS and other technology to further
enhance automation in the urinalysis field. Under the terms of the project,
Poly will have the right to use the IRIS technology and any newly developed
technology for developing, manufacturing and marketing the new products as
stand-alone devices, and IRIS will have the right to use any newly developed
technology for any other purpose and to incorporate the new products into The
Yellow IRIS. Poly

F-16
48
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

has retained IRIS to conduct the research, development, clinical evaluation and
pre-market testing of the proposed new products. IRIS will fund the first
$15,000 per month (up to a maximum of $500,000) of the cost of the project, and
Poly will reimburse IRIS for the excess. IRIS has an option until 121 days
after termination of the project (which terminates no later than July 31, 1998)
to acquire all of the Common Stock of Poly at prices rising over time from $14
to $20 per share of Poly Common Stock. IRIS may pay the option exercise price
in cash or with shares of IRIS Common Stock. IRIS is also providing financial
and administrative services to Poly at cost.

Poly, a privately-held company based in Los Angeles, California, was
organized in June 1995 to undertake the commercial development of several
potential products based on technology developed or licensed by IRIS. In order
to fund its share of the project, Poly, in 1995, raised net proceeds of $2.0
million through the sale of 128 units at a price of $20,000 per unit. Each
unit consists of 2,000 shares of Poly's Callable Common Stock and a warrant to
purchase 4,000 shares of IRIS Common Stock. In the aggregate, investors
purchased 256,000 shares of Poly's callable Common Stock and warrants to
purchase 512,000 shares of IRIS Common Stock. The IRIS warrants are
exercisable at $6.50 per share during the last two years of their three-year
duration. In connection with Poly's sale of units, IRIS also issued warrants
to the placement agent and finder to purchase an aggregate of 150,000 shares of
IRIS Common Stock. These warrants are exercisable at $7.80 per share for a
five year period and include certain registration rights.

12. REFERENCE LAB AGREEMENT.

During the first quarter of 1995, IRIS and Boehringer Mannheim GmbH
("BMG"), a German affiliate of Boehringer Mannheim Corporation ("BMC"),
announced a joint project to develop a high capacity automated urinalysis
system primarily for reference laboratories based on the proprietary
technologies of both companies. The program was jointly funded by both
companies. In addition to designing specific components on the new system, BMG
agreed to pay IRIS a fixed amount of $640,000 for its research and development
of the project. In connection with this project and certain distribution
considerations, IRIS issued Corange International Limited (an affiliate of BMG)
warrants to purchase 250,000 shares of IRIS Common Stock at an exercise price
of $7.375 per share and granted Corange International Limited certain
registration rights with respect to the shares of IRIS Common Stock issuable
upon exercise of these warrants.

13. PRODUCT LINE ACQUISITIONS.

During the first quarter of 1995, IRIS acquired the digital refractometer
product line of Biovation, Inc. for $850,000 and warrants to purchase 75,000
shares of IRIS Common Stock at an exercise price of $8.125 per share. IRIS
granted Biovation certain registration rights with respect to the shares of
IRIS Common Stock issuable upon exercise of these warrants. The product line
consists of a patented device known as a digital refractometer and the related
consumables used in the operation and maintenance of the refractometer.

In March 1996, IRIS acquired the CenSlide product line of UroHealth
Sciences, Inc., for $850,000. The product line consists of the CenSlide 1500
System and related products for centrifugal urine sedimentation and manual
microscopic examination.

14. CAPITAL STOCK.

Issuance of Preferred Stock:

On December 31, 1996, the Company completed a sale of equity securities
for approximately $3 million in a private placement. Specifically, the Company
sold (i) 3,000 shares of a new Series A Convertible Preferred Stock ("Preferred
Stock") with a liquidation value of $1,000 per share and (ii) a warrant (the
"Warrant") to purchase 84,270 shares of the Company's common stock at an
exercise price of $3.56 per share. The Warrant exercise price was based on the
average closing price of the common stock for the five trading days immediately
preceding the closing of the sale.

Each share of Preferred Stock is convertible into a number of shares of
common stock equal to the liquidation value of a share of Preferred Stock
divided by (ii) a variable conversion price (discussed below). Any shares of
Preferred Stock not voluntarily converted during the three years following
their initial sale will be automatically converted into common stock on
December 31, 1999. The Preferred Stock is non-voting, is not entitled to any

F-17

49
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

preferred dividends and is not subject to any mandatory or optional redemption
provisions. As long as any of the shares of Preferred Stock are outstanding,
the Company may not pay dividends on, or repurchase any shares of, the common
stock without the written consent of the holders of a majority of the
outstanding shares of Preferred Stock.

The conversion price of the Preferred Stock (the "Conversion Price") was
fixed at $3.56 per share of Common Stock until April 1, 1997. Based on this
Conversion Price, each share of Preferred Stock would be convertible into
approximately 281 shares of common stock, and the Company would issue
approximately 843,000 shares of common stock if the holder elected to convert
all of the outstanding shares of Preferred Stock. Commencing April 1, 1997,
the Conversion Price was equal to the lower of (i) 85% of the average closing
bid price of the common stock for the five consecutive trading days immediately
preceding the conversion date (but in no event less than $1.50) or (ii) $3.56.
The Company has agreed to file with the Securities and Exchange Commission a
registration statement for resale of the shares of common stock issuable upon
conversion of the Preferred Stock and exercise of the Warrant, and the
Conversion Price is subject to certain adjustments in the event that the
registration statement is not declared effective by May 30, 1997. The Company
has reserved 2,000,000 shares of common stock for issuance upon conversion of
the Preferred Stock.

Furthermore, if the Company obtains additional financing prior to July 1,
1997 through a private placement of equity securities (or debt securities
convertible into or coupled with equity securities), the holder will have the
right to exchange some or all of the Preferred Stock and Warrants then owned by
it for the new securities offered by the Company at an exchange price equal to
the purchase price of such new securities.

The staff of the Securities and Exchange Commission recently announced a
new position on accounting for convertible preferred stock which is potentially
convertible at a discount to the market price of the common stock, even if the
potential for a discount is only a possibility. The staff has taken the
position that, solely for purposes of calculating earnings per share, the
potential discount is an embedded dividend to the preferred stockholders which
reduces the amount of income available to common stockholders. As a result of
the staff's new accounting position, the issuance of the Preferred Stock could
result in a reduction in earnings per share. The staff's position is limited
to the calculation of earnings per share and will not have any effect on the
Company's net income or cash flow.

Repurchase of Common Stock and Warrant:

As described above, Corange International Limited sold to the Company the
469,413 shares of common stock and the warrant to purchase 250,000 shares of
common stock previously acquired from the Company in connection with various
joint development projects at their original aggregate purchase price of $2.1
million or $4.54 per share of common stock. The unamortized cost of $273,216
related to the repurchased warrant has been offset against additional paid in
capital.

Stock Issuances:

During 1990, the IRIS Board of Directors adopted an Employee Stock
Purchase Plan designed to allow employees of the Company to buy its shares at
50% of the then current market price, provided that the employee agrees to hold
the shares purchased for a minimum of two years. Payment for the 50% portion
may be made at the option of the employee either by payroll deduction or by
lump sum payment, but in no event may it exceed more than 15% of the employee's
salary during any year. The remaining 50% portion is recorded as deferred
compensation and amortized over the vesting period. The shares purchased
pursuant to this plan may not be transferred, except following the death of the
employee or a change in control, for a period of two years following the date
of purchase. During the period of the limitation on transfer, the Company has
the option to repurchase the shares at the employee's purchase price if the
employee terminates employment with the Company either voluntarily or as a
result of termination for cause. During 1994, 1995 and 1996, IRIS issued
45,622, 26,973, and 35,433 shares of common stock, respectively, in exchange
for $201,574, $179,630, and $307,288 in cash and services, respectively, under
this plan.

F-18

50
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Stock Option Plans and Employee Benefit Plans:

As of December 31, 1996, the Company had one stock option plan under which
it may grant non-qualified stock options, incentive stock options and stock
appreciation rights. Options remain outstanding under the other plans,
although no new options may be granted thereunder. No stock appreciation
rights or incentive stock options have been granted under these plans. During
1996, the Company exhausted the remaining options under the 1994 Plan and
issued approximately 205,500 additional options subject the adoption of a new
stock option plan.

In April 1997, the Company adopted a new stock option plan under which it
may grant non-qualified stock options, incentive stock options and stock
appreciation rights. Under the 1997 Plan, the Company is authorized to issue
options up to an aggregate of 600,000 shares of common stock. However, in
accordance with the rules of the American Stock Exchange, the Company may not
issue options under the plan aggregating more than 5% of the outstanding common
stock in any one year, or more than 10% of the outstanding common stock in any
five-year period.

The following schedule sets forth options authorized, exercised,
outstanding and available for grants under the Company's five stock option
plans as of December 31, 1996.

Options
Options Options Options Available
Plan Authorized Exercised Outstanding for Grant
------------------------------------------------------------------------------

1982 84,000 75,034 4,000 --
1983 100,000 90,435 1,000 --
1986 360,000 229,568 117,701 --
1994 700,000 2,100 696,833 2,067
1997 600,000 -- 205,500 394,500
--------- ------- --------- -------
1,844,000 397,137 1,025,034 396,567
========= ======= ========= =======

The exercise price of the above options was determined by the Compensation
Committee. Payment of the exercise price may be made in cash or with shares of
common stock. The options generally vest over three years and expire either
five or ten years from the date of grant. On December 29, 1996, the
Compensation Committee approved the repricing of certain outstanding stock
options to $3.03 per option, excluding lower priced options.

IRIS has adopted the disclosure only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock Based Compensation." If
compensation expense for the stock options had been determined using "fair
value" at the grant date for awards in 1995 and 1996, consistent with the
provisions of Statement of Financial Accounting Standards No. 123, the
Company's net earnings and earnings per share would have been reduced to the
pro forma amounts indicated below:

1995 1996
---- ----

Net earnings (loss) as reported $2,126,412 $(7,428,188)
Net earnings (loss) pro forma 2,052,090 $(7,890,943)
Earnings per share (loss) as reported .33 (1.21)
Earnings per share (loss) pro forma .32 (1.28)

The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted
average assumptions used for grants in 1995 and 1996.

1995 1996
------- ---------

Risk free interest rate 6.11% 5.98%
Expected lives (years) 5 5
Expected volatility 55% 55%
Expected dividend yield -- --

F-19

51
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The pro forma calculations above are for informational purposes only.
Future calculations of the pro forma effects of stock options may vary
significantly due to changes in the assumptions described above as well as
future grants, and for forfeitures of stock options.

The following table sets forth certain information relative to stock options
during the years ended December 31, 1994, 1995 and 1996.

Weighted Avg Fair
Weighted Avg. Value at Grant
Shares Option Price Exercise Price Date
------ ------------ -------------- ----

Outstanding at January 1, 1994 472,367 $1.10 to $4.25
Granted 192,600 $3.72 to $5.42 $4.14 $1.44
Exercised (200,832) $1.10 to $3.75 $2.23 --
Canceled or expired (28,234) $1.55 to $4.25 $2.39 --
---------- -----
Outstanding at December 31, 1994 435,901 $1.10 to $5.42 $3.39 --
Granted 217,500 $4.25 to $7.87 $5.71 $3.16
Exercised (21,900) $1.10 to $4.00 $2.03 --
Canceled or expired (9,700) $1.57 to $4.00 $2.75 --
----------- -----
Outstanding at Dececember 31, 1995 621,801 $1.16 to $7.37 $4.22
Granted 650,300 $3.61 to $8.29 $5.55 $4.41
Exercised (116,133) $1.75 to $5.00 $2.19 --
Canceled or expired (131,934) $2.90 to $8.29 $5.98 --
--------- -----
Outstanding at December 31, 1996 1,024,034 $1.90 to $6.22 $3.02 --
========= =====

Weighted Average
Outstanding at December 31, 1996 Shares Option Price
------ ------------

Weighted average life - 3 months 1,000 $1.90
Weighted average life - 72 months 1,023,034 $3.03

Outstanding at December 31, 1995
Weighted average life - 10 months 114,134 $1.98
Weighted average life - 78 months 342,667 $4.02
Weighted average life - 117 months 165,000 $6.10

Outstanding at December 31, 1994
Weighted average life - 5 months 11,700 $1.50
Weighted average life - 21 months 128,134 $2.00
Weighted average life - 83 months 284,467 $4.02
Weighted average life - 87 months 11,600 $5.29

Exercisable at December 31, 1996
Weighted average life - 3 months 1,000 $1.90
Weighted average life - 72 months 271,773 $3.03

Exercisable at December 31, 1995
Weighted average life - 10 months 114,134 $1.98
Weighted average life - 72 months 70,334 $3.86
Weighted average life - 117 months 6,267 $5.18

Exercisable at December 31, 1994
Weighted average life - 5 months 11,700 $1.50
Weighted average life - 21 months 105,423 $2.00
Weighted average life - 83 months 35,775 $3.81
Weighted average life - 87 months 3,600 $5.00

F-20

52
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In connection with the merger with StatSpin, each outstanding option and
warrant of StatSpin was converted into an option to purchase IRIS common stock
at a ratio of 4.095 shares of IRIS common stock for each share of StatSpin
common stock, resulting in options to purchase an aggregate of 126,000 shares
of IRIS common stock. The exercise price ranges from $3.66 to $7.32 per share
of IRIS common stock. During 1996, options to purchase 19,050 shares at $7.32
per share expired, and options to purchase 21,791 shares at $3.66 per share
were exercised. At December 31, 1996, options to purchase 85,213 shares at
prices ranging from $3.66 to $4.58 remained outstanding. Certain of these
options were scheduled to expire in March 1997, but were extended an additional
year.

In 1996, the Company adopted a deferred compensation plan. All employees
are eligible to participate in the plan. Contributions by the Company are
discretionary. Employees vest in amounts contributed by the Company over five
years. The Company contributed $44,751 to the plan for 1996.

Warrants:

At December 31, 1996, there were warrants outstanding and exercisable to
purchase 75,000 shares at $8.125 per share until March 30, 1998; 512,000 shares
at $6.50 per share until September 29, 1998; 150,000 shares at $7.80 per share
until September 28, 2000; and 875,000 shares at $8.00 per share until July 31,
2000.

15. COMMITMENTS.

Leases:

The Company leases real property under agreements which expire at various
times over the next four years. Certain leases contain renewal options and
generally require the Company to pay utilities, insurance, taxes and other
operating expenses.

Future minimum rental payments required under operating leases that have
an initial term is excess of one year as of December 31, 1996, are as follows:

Year Ended December 31, Amount
------------------------------------------------------

1997 $436,596
1998 405,328
1999 207,992
2000 21,483
----------
$1,071,399
==========

Rent expense under all operating leases during 1994, 1995 and 1996 was
$290,294, $453,762 and $347,925, respectively.

Other:

IRIS has consulting and licensing agreements with Cytocolor, Inc. relating
to the use of its patented leukocyte stain in The White IRIS. Under the terms
of the agreements, IRIS is subject to the following future minimum royalty
payments:

Year Ended December 31, Amount
----------------------------------------------------

1997 $20,000
1998 20,000
1999 20,000
2000 20,000
Years thereafter 260,000
--------
$340,000
========

In connection with the development agreement with Poly, IRIS has agreed to
fund $15,000 per month (up to a maximum of $500,000) of the cost of the
development project for several new products to enhance automation in the
urinalysis field (see Note 11).

F-21
53
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As part of the purchase price for the PSI acquisition, the Company issued
the seller a five year warrant to purchase 875,000 shares of common stock at
$8.00 per share. Following the Company's restatement in the third quarter of
1996 of financial results for certain prior periods, the Company received a
request from the seller for a reduction in the exercise price of the warrant.
In its request, the seller asserts that it had relied on the prior financial
information and suffered material damage as a result. The Company has declined
to consider the seller's request until the Company has evaluated its claims
against the seller.

16. EARNINGS PER SHARE.

The computation of per share amounts for 1994, 1995 and 1996 is based on
the weighted average number of common shares and common share equivalents
outstanding for the period, unless antidilutive. Fully diluted and primary
earnings (loss) per share were $.28, $.33 and ($1.21) for the years ended
December 31, 1994, 1995 and 1996, respectively. As described in Note 14,
future calculations of earnings per share may be adversely impacted by the
issuance of the Preferred Stock.

17. LICENSE.

TOA Medical Electronics Co., Ltd. has developed several urine sediment
analyzers under license from IRIS using pre-1989 IRIS technology. IRIS
received royalties under this license of $111,000, $98,000, and $65,000 in
1994, 1995 and 1996, respectively.

18. RESEARCH AND DEVELOPMENT GRANTS AND CONTRACTS.

The Company has in the past partially funded its research and development
programs through (i) grants from NASA and National Institute of Health (ii)
joint development programs with strategic partners and (iii) Company-sponsored
research and development entities. In recent years, the Company has entered
into four significant externally-funded projects, two joint development
projects with strategic partners and two projects with Company-sponsored
research and development entities. From 1994 to 1996, the Company collaborated
with Boehringer Mannheim Corporation ("BMC"), an Indianapolis-based
manufacturer of diagnostic products, and Boehringer Mannheim GmbH ("BMG"),
BMC's German affiliate and a world leader in clinical chemistry, in the
development of (I) the CHEMSTRIP/IRIStrip urine test strips for The Yellow IRIS
and (ii) the Model 900UDx, the latest model in The Yellow IRIS family. The
Company entered into a project in October 1992 with LDA, a Company-sponsored
research and development entity, for development of The White IRIS leukocyte
differential analyzer. In June 1995, the Company acquired LDA for
approximately 498,000 shares of common stock. As a result of the LDA
acquisition, the Company incurred a non-recurring, non-cash charge of $2.9
million for the year ended December 31, 1995 for the acquisition of in-process
research and development since The White IRIS had not yet received FDA
clearance. The White IRIS received FDA clearance in May 1996, and the Company
expects to begin marketing The White IRIS in 1997. The Company entered into a
similar project in September 1995 with Poly U/A Systems, Inc., another
Company-sponsored research and development entity, for development of several
new products to enhance automated urinalysis ("the Poly Products"). The
program with Poly is currently ongoing.

BMC and BMG recently agreed to several amendments to their contracts with
the Company, strengthening their ties in the supply and distribution of
CHEMSTRIP/IRIStrips urine test strips while withdrawing from longer term mutual
commitments in the areas of hematology and urine microscopy. Among other
things, BMC agreed to supply the Company with CHEMSTRIP/IRIStrips urine test
strips at a reduced price and extended the term of the underlying supply
agreement. In return, the Company relieved BMC of its obligation to purchase a
minimum number of Model 900UDx systems and to supply certain technology and
components.

The Company will continue to manufacture the Model 900UDx with BMG
providing certain components on a OEM basis at cost. The Company retained
exclusive marketing rights to the Model 900UDx in Taiwan and secured
non-exclusive rights for the rest of the world outside of Germany and Italy.

As compensation to the Company for potentially missed business
opportunities in hematology, Corange International Limited sold to the Company
the 469,413 shares of Common Stock and the warrant to purchase 250,000 shares
of common stock previously acquired from the Company in connection with various
joint development projects at their original aggregate purchase price of $2.1
million, or $4.54 per share of Common Stock. On December 31, 1996, the
outstanding balance of the purchase price was approximately $1.6 million.

F-22
54
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company has the right, if necessary, to extend the due date of the last two
installments by one year but must pay 8% interest during the extension period.

Reimbursements are recognized under research and development grants and
contracts in amounts equivalent to reimbursable research and development costs
incurred on the related project plus, where contractually provided for, an
amount to cover general and administrative costs of the project.

Reimbursements and direct costs connected with research and development
grants and agreements were as follows:

Years Ended December 31,
----------------------------------------------------
1994 1995 1996
---- ---- ----

Reimbursements $1,110,878 $ 842,663 1,779,820
Costs 1,258,405 1,494,873 1,498,165
--------- --------- ---------
Net costs $ 147,527 $ 652,210 $(281,655)
========== ========== ==========

Net costs incurred under research and development grants and contracts
have been included in research and development expense in the statements of
operations.

19. UNUSUAL CHARGES

The results of operations for the year ended December 31, 1996 included
unusual charges totaling $2,036,592. Due to the Company's decision not to
pursue a previously announced public offering, the Company recognized $685,721
of expenses associated with the offering. The charge also included $617,266
for expenses related to recently completed litigation and arbitration matters.
In the fourth quarter of 1996, the Company incurred a charge of $298,113 for
severance and other incremental costs associated with a restructuring of the
Company's personnel. Legal and accounting expenses for the Company's merger
with StatSpin totaled $244,492. Reductions in the net realizable value of
inventory and other assets totaled $191,000.

20. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

The following table summarizes certain financial information by quarter for
1995 and 1996:

1995
--------------------------------------------------------------
March 31 June 30 September 30 December 31
--------------------------------------------------------------

Net revenues $3,167,277 $3,715,883 $3,743,641 $3,765,357
Gross margin on net revenues 1,535,808 1,908,864 1,931,560 1,889,110
Other income net 118,137 87,207 65,597 106,819
Net income (loss) 397,494 (2,916,490) 563,818 4,081,590
Net income (loss) per share 0.07 (0.53) 0.09 0.61

1996
--------------------------------------------------------------
March 31 June 30 September 30 December 31
--------------------------------------------------------------

Net revenues $3,904,096 $4,823,455 $5,543,448 $6,283,132
Gross margin on net revenues 1,862,847 2,400,628 2,343,007 2,694,226
Other income (expense), net 82,248 80,753 (166,612) (405,434)
Net income (loss) 206,912 351,116 (6,250,834) (1,735,382)
Net income (loss) per share .03 .05 (.98) (.30)

The quarters ended June 30, 1995 and September 30, 1996 include the
write-off of acquired in-process research and development of $3,175,645 and
$7,250,000, respectively.

F-23
55
INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS

Additions
----------------------------------
Charged to Cost Charged to Ending
Beginning Balance and Expenses Other Accounts Deductions Balance
----------------- --------------- -------------- ---------- -------

Year Ended December 31, 1996
Allowance for Doubtful Accounts $ 87,759 $252,037 $10,000 $ (31,030)(1) $ 328,700
Reserve for Inventory Obsolescence $ 380,845 -- -- $ (208,860)(1) $ 171,985
Deferred Tax Asset Valuation Allowance $1,563,000 $437,000 -- -- $2,000,000

Year Ended December 31, 1995
Allowance for Doubtful Accounts $ 89,335 -- -- $ (1,576)(1) $ 87,750
Reserve for Inventory Obsolescence $ 332,926 $ 47,919 -- -- $ 380,840
Deferred Tax Asset Valuation Allowance $5,787,000 -- -- $(4,224,000)(2) $1,563,000

Year Ended December 31, 1994
Allowance for Doubtful Accounts $ 93,842 $ 11,000 -- $ (15,507)(1) $ 89,335
Reserve for Inventory Obsolescence $ 212,989 $131,105 -- $ (11,168)(1) $ 332,926
Deferred Tax Asset Valuation Allowance $6,414,352 -- -- $ (627,352)(2) $5,787,000

- ------------------------
(1) Relates to the write-off of accounts receivable or disposal of obsolete inventory.
(2) Relates to change and/or utilization in valuation allowance.

F-24

EXHIBIT INDEX

No. Description
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3.1(a) -- Certificate of Incorporation, as amended (1)
3.1(b) -- Certificate of Designations of Series A Convertible Preferred Stock (2)
3.2 -- Restated Bylaws (3)
4.1 -- Specimen of Common Stock Certificate (4)
4.1 -- Certificate of Designations of Series A Convertible Preferred Stock (2)
10.1 -- Lease of the Company's headquarters facility, as amended (5)
10.2(a) -- 1982 Stock Option Plans and form of Stock Option Agreement (6)
10.2(b) -- 1983 and 1986 Stock Option Plans, and forms of Stock Option Agreements for each Plan (7)
10.2(c) -- Amended and Restated 1986 Stock Option Plan (8)
10.2(d) -- 1994 Stock Option Plan and forms of Stock Option Agreements (9)
10.2(e) -- Certificate of Officer With Respect to Amendment of 1994 Stock Option Plan (10)
10.2(f) -- Key Employee Stock Purchase Plan (11)
10.3 -- Various Agreements with TOA Medical Electronics (12)
10.4(a) -- Agreement for a Strategic Alliance in Urinalysis dated January 7, 1994 between the Company
and Boehringer Mannheim Corporation (13)
10.4(b) -- Research and Development and Distribution Agreement dated February 6, 1995 by and among the
Company, LDA Systems, Inc. and Corange International Limited (13)
10.4(c) -- Amendment to Distribution Agreements (14)
10.5 -- Warrant Certificate dated March 20, 1995 issued to Biovation, Inc. (13)
10.6(a) -- Technology License Agreement dated as of September 29, 1995 between the Company and Poly U/A
Systems, Inc. (15)
10.6(b) -- Research and Development Agreement dated as of September 29, 1995 between the Company and
Poly U/A Systems, Inc. (15)
10.6(c) -- $100 Class "A" Note dated September 29, 1995 issued by Poly U/A Systems, Inc. in favor of
the Company (15)
10.6(d) -- Certificate of Incorporation of Poly U/A Systems, Inc. (See Article FOUR regarding the
IRIS Option) (15)
10.7(a) -- Agreement and Plan of Merger dated January 31, 1996 between the Company and StatSpin, Inc. (16)
10.7(b) -- Registration Rights Agreement dated January 31, 1996 between the Company and StatSpin
Stockholders (16)
10.8(a) -- Asset Purchase Agreement dated as of July 15, 1996 by and among the Company, Digital Imaging
Technologies, Inc., Perceptive Scientific Instruments, Inc. and Perceptive Scientific
Technologies, Inc. (17)
10.8(b) -- Registration Rights and Standstill Agreement dated July 31, 1996 between the Company and
Digital Imaging Technologies, Inc. (10)
10.8(c) -- Warrant Certificate dated July 31, 1996 issued to Digital Imaging Technologies, Inc. (10)
10.8(d) -- Stockholder Guaranty Agreement dated July 31, 1996 between Edward Randall, III and PSII
Acquisition Corp., a wholly-owned subsidiary of the Company (now known as Perceptive
Scientific Instruments, Inc.) (10)
10.8(e) -- Non-Competition Agreement dated as of July 15, 1996 between Edward Randall, III and PSII
Acquisition Corp., a wholly-owned subsidiary of the Company (now known as Perceptive
Scientific Instruments, Inc.) (10)
10.8(f) -- Technology License Agreement dated July 31, 1996 between Perceptive Scientific Imaging
Systems, Inc. and PSII Acquisition
Corp., a wholly-owned subsidiary of the Company (now known as Perceptive Scientific
Instruments, Inc.) (10)
10.9 -- $7,000,000 Subordinated Note dated July 29, 1996 issued by the Company in favor of
Digital Imaging Technologies, Inc. (10)
10.10(a) -- $1,500,000 Promissory Note dated July 29, 1996 (Revolving Credit Facility) (10)

10.10(b) -- Change in Terms Agreement dated as of January 3, 1997 (Revolving Credit Facility)
10.10(c) -- Supplemental Terms letter dated July 29, 1996 (Revolving Credit Facility) (10)
10.10(d) -- Supplemental Terms Letter dated as of January 3, 1997 (Revolving Credit Facility)
10.10(e) -- $4,900,000 Amended and Restated Promissory Note dated as of January 3, 1997 (Term Loan)
10.10(f) -- Supplemental Terms Letter dated as of January 3, 1997 (Term Loan)
10.10(g) -- Waiver of Default dated as of January 3, 1997
10.10(h) -- Warrant to Purchase Common Shares
10.10(i) -- Commercial Security Agreement dated July 29, 1996 (10)
10.10(j) -- Commercial Pledge Agreement dated July 29, 1996 (10)
10.10(k) -- Various Additional Security Agreements dated as of January 3, 1997
10.11(a) -- Securities Purchase Agreement dated December 31, 1996 by and between the Company and
Thermo Amex Convertible Growth Fund I, L.P. (2)
10.11(b) -- Common Stock Purchase Warrant dated December 31, 1996 issued to Thermo Amex Convertible
Growth Fund I, L.P. (2)
10.11(c) -- Registration Rights Agreement dated December 31, 1996 by and between the Company and
Thermo Amex Convertible Growth Fund I, L.P. (2)
11 -- Statement re: Computation of Per Share Earnings
24.1 -- Consent of Coopers & Lybrand L.L.P.
24.2 -- Consent of KPMG Peat Marwick LLP
27 -- Financial Data Schedule
99 -- Additional Information Regarding Forward Looking Statements
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The following items are incorporated by reference to the Company's documents
cited below.