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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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|x |  | Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
|- |  | -------------------------------------------------------------------------------------



For the fiscal year ended December 31, 2004



or



| ̈ |  | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- |  | ----------------------------------------------------------------------------------------



For the transition period from
 to
.



Commission File No. 1-9767



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IRIS INTERNATIONAL, INC.

(Exact Name of Registrant as Specified in its Charter)



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



9172 Eton Avenue,
Chatsworth, California 91311

(Address of principal executive offices) (Zip Code)



Telephone Number: (818) 709-1244



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Securities registered pursuant to Section 12(b) of the Act:

None



Securities registered pursuant to Section 12(g) of the
Act:

Common Stock, par value $0.01 per share



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. ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.) Yes  x    No ̈



The aggregate market value of the shares of Common Stock held by non-affiliates of the Registrant was approximately $89.5
million based upon the closing price of $7.55 per share of Common Stock as reported on the NASDAQ National Market on June 30, 2004. 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 16,303,791 shares of Common Stock outstanding on March
11, 2005.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the Registrants definitive Proxy
Statement to be filed with the Securities and exchange Commission pursuant to Regulation 14A in connection with the 2005 Annual Meeting of Shareholders are incorporated by reference into Part III of this Report.



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IRIS INTERNATIONAL, INC.



ANNUAL
REPORT ON FORM 10-K

Fiscal Year Ended December 31, 2004



|           |  |                                                                                                             |  |   
|---------- |  | ----------------------------------------------------------------------------------------------------------- |  | --
|PART I     |  |                                                                                                            
|           |  |                                                                                                            
|Item 1.    |  | Business                                                                                                    |  | 1 
|           |  |                                                                                                            
|Item 2.    |  | Properties                                                                                                  |  | 9 
|           |  |                                                                                                            
|Item 3.    |  | Legal Proceedings                                                                                           |  | 9 
|           |  |                                                                                                            
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                         |  | 9 
|           | 
|PART II    |  |                                                                                                            
|           |  |                                                                                                            
|Item 5.    |  | Market for Registrants Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 10
|           |  |                                                                                                            
|Item 6.    |  | Selected Financial Data                                                                                     |  | 10
|           |  |                                                                                                            
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                       |  | 11
|           |  |                                                                                                            
|Item 7A.   |  | Quantitative and Qualitative Disclosures About Market Risk                                                  |  | 25
|           |  |                                                                                                            
|Item 8.    |  | Financial Statements and Supplementary Data                                                                 |  | 26
|           |  |                                                                                                            
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                        |  | 26
|           |  |                                                                                                            
|Item 9A    |  | Controls and Procedures                                                                                     |  | 26
|           |  |                                                                                                            
|Item 9B    |  | Other Information                                                                                           |  | 27
|           | 
|PART III   |  |                                                                                                            
|           |  |                                                                                                            
|Item 10.   |  | Directors and Executive Officers of the Registrant                                                          |  | 28
|           |  |                                                                                                            
|Item 11.   |  | Executive Compensation                                                                                      |  | 28
|           |  |                                                                                                            
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters              |  | 28
|           |  |                                                                                                            
|Item 13.   |  | Certain Relationships and Related Transactions                                                              |  | 28
|           |  |                                                                                                            
|Item 14.   |  | Principal Accounting Fees and Services                                                                      |  | 28
|           | 
|PART IV    |  |                                                                                                            
|           |  |                                                                                                            
|Item 15.   |  | Exhibits, Financial Statements Schedules                                                                    |  | 29
|           | 
|Signatures |  | 32                                                                                                         





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PART I



Item 1.Business



Overview



IRIS International, Inc., formerly
International Remote Imaging Systems, Inc., was incorporated in California in 1979 and reincorporated in Delaware in 1987. Our company consists of three operating units. Our largest unit, Iris Diagnostics Division, designs, manufactures and markets
in vitro diagnostics (IVD) systems, consumables and supplies for urinalysis. StatSpin, Inc. our small laboratory instruments subsidiary markets small centrifuges and other processing equipment and accessories for rapid specimen processing. Our
Advanced Digital Imaging and Research, LLC (ADIR) subsidiary assists in the advancement of proprietary imaging technology while conducting government-sponsored research and contract development in imaging and pattern recognition.



In August 2003, we launched our new product platform, the iQ®200 System and in February 2005, we initiated shipments of a significant product line
extension, the iQ200 SprintSystem. We believe that our iQ200 product family (iQ200 and iQ200 Sprint Automated Urine Microscopy Systems) are the only instruments in the world that automate all components of routine urinalysis:
chemistry and microscopic particle analysis. We also sell stand-alone urine microscopy instruments; the iQ200 Automated Microscopy Analyzers and the iQ200 Sprint Automated Microscopy Analyzers.



On April 7, 2004, our common stock began to be quoted on the NASDAQ National
Market under the symbol IRIS. Previously our common stock traded on the American Stock Exchange under the symbol IRI.



Diagnostics



Our Diagnostics Division is a leader in automated urinalysis technology with urine microscopy and urine chemistry instruments. Our systems provide
customers more accurate and rapid results and labor cost-savings over traditional manual methods. We sell our products directly in the U.S. and to distributors internationally. Our end-use customers consist of hospitals and clinical reference
laboratories throughout the world.



Routine urinalysis
encompasses two different modalities: urine chemistry and urine microscopy. Urine chemistry consists of a panel of tests that identify a variety of chemical constituents in urine such as glucose, ketones, bilirubin, protein, nitrite, etc. Urine
microscopy is the microscopic analysis of solid particles and cells (formed elements) suspended in urine. The particles analyzed include red blood cells, white blood cells, hyaline casts, pathological casts, crystals, bacteria, sperm, yeast, etc.
These tests are performed as part of most routine medical examinations and are necessary for diagnosis and monitoring of certain diseases including kidney and bladder disease, and urinary tract infections.



Current manual urine testing requires the clinical laboratory to split
samples, perform automated and manual procedures and consolidate the separate results into one report. Urine chemistry is broadly used and fairly generic, however, urine sediment analysis is used less frequently despite the fact that it provides
significant clinical information. The manual procedure for microscopy requires a highly qualified medical technologist to accurately categorize the formed elements observed under the microscope. However, inherent variability in sample preparation,
(i.e. initial sample volume, spin down time and speed, and slide preparation volume) all contribute to significant variability in the quantitative accuracy of the diagnostic result. Furthermore, it is a very tedious and costly process for the
clinical laboratory. We believe the full automation and integration of results of the iQ200 System will accelerate the adoption of automated urine microscopy as a routine test.



iQ200 and iQ200 Sprint Automated Urine Microscopy Analyzers



Our iQ200 Automated Urine Microscopy Analyzer was launched in August 2003
and we have sold 340 iQ200 analyzers as of December 31, 2004. The iQ200 utilizes image flow cytometry, and our patented



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Automated Intelligent Microscopy technology (AIM) to achieve significant reductions in cost and processing time as compared to manual microscopic analysis.
Our AIM technology combines our patented capabilities in slide-less specimen presentation, our proprietary neural network-based Auto-Particle Recognition technology and high-speed digital processing to classify and display images of microscopic
particles in an easy-to-view graphical interface. We believe the iQ200 product family has numerous benefits over competing products, including, increased accuracy, fully automated walk-away urinalysis, automatic identity of 12 formed elements and
user-defined reflexive testing. The iQ200 Sprint Automated Urine Microscopy Analyzer performs 101 tests per hour, 68% faster than the original iQ200 Analyzers. It also provides additional functionality, for the high volume clinical
reference and commercial labs and hospital labs, like load and unload conveyors capable of handling 210 specimens at a time and improved image editing routines to further improve work flow and productivity.



iQ200 System



The iQ200 and iQ200 SprintAutomated Urine Microscopy
Analyzers were engineered as part of a modular platform. We have U.S. distribution rights to sell a urine chemistry analyzer manufactured by ARKRAY, a Japanese diagnostics company. When the iQ200 and iQ200 Sprint Automated Urine Microscopy Analyzers
are combined with ARKRAYs AUTION MAX AX-4280 Automated Urine Chemistry Analyzer or AX-4280, these systems constitute the first fully automated urinalysis systems performing both urine chemistry and microscopy simultaneously. The iQ200 System
allows us to focus on the mid-sized laboratory market, a segment that was not previously accessible to us with our legacy products due to price considerations. The iQ200 Sprint Analyzer targets the clinical reference labs, commercial labs and the
very large-sized hospital laboratory market.



Domestically, we
sell the three major sub-systems, the AX-4280, the iQ200 Automated Microscopy Analyzer and the iQ200 Sprint Automated Urine Microscopy Analyzer, as stand-alone units or together as a fully integrated product. Internationally, we sell
the iQ200 Automated Microscopy Analyzer and the iQ200 Sprint Automated Urine Microscopy Analyzer as stand alone instruments since we do not have international distribution rights for the AX-4280. However, our distributor network
focuses on the installed base of AX-4280 in service throughout the world as a readily available target market for integration with one of the iQ200 product family of automated microscopy analyzers. Most of our international distributors also sell
the bridge system necessary for the integration of the analyzers.



Legacy Products



Prior to the iQ200
platform, we sold larger and more expensive workstations that perform microscopy and chemistry testing, our legacy products Models 500 and 939UDxTM. Model 500 is an operator-attended workstation that performs IVD testing on urine and eight other body fluids but it requires a medical technologist to manually load the specimens and characterize the
microscopic particles manually. The 939UDx is a semi-automated workstation that performs IVD testing on urine only, but uses IRIS first generation neural-network algorithms to automatically characterize the microscopic particles. As of
December 31, 2004, we have an installed base of approximately 330 systems of Models 500s and 939UDxs. These products have a considerable consumable revenue stream. We have stopped marketing our legacy instruments and anticipate sales of legacy
consumables, parts, accessories and domestic service agreements only.



Consumables and Service



We provide
recurring sales of consumables for our legacy products, the iQ200 and iQ200 Sprint Analyzers and our urine chemistry products sourced from ARKRAY. Consumables include reagents, calibrators and controls for our microscopy systems and chemical strips
for the urine chemistry analyzers we distribute. In the U.S., many of our customers purchase consumables under annual standing orders.



All domestic sales of our systems include installation, customer training and a one-year warranty from installation. Following the initial warranty
period, the majority of domestic customers purchase annual service contracts from us. Such services are provided by our qualified service technicians located throughout the U.S. Internationally, our products are serviced by independent distributors.



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Small Laboratory Instruments Subsidiary



Our StatSpin® subsidiary is a
worldwide leader in accelerated sample preparation for blood, body fluids and urine analysis. StatSpin makes centrifuges, semi-automated DNA processing workstations and blood analysis products, including the worlds fastest blood separator,
which separates blood in under 30 seconds. StatSpins worldwide markets include medical institutions, commercial laboratories, clinics, doctors offices, veterinary labs and research facilities. Our bench top centrifuges are dedicated to
applications for manual specimen preparation for coagulation, cytology, hematology, and urinalysis. Our DNA processing workstations automate the DNA denaturation and hybridization steps in a number of fluorescent in-situ-hybridization procedures.



ADIR



Our imaging research and development subsidiary, Advanced Digital Imaging Research, LLC, assists in the advancement of IRIS
proprietary imaging technology while conducting government-sponsored research and development in medical imaging and software. In addition, it pursues contract research for corporate clients, although to date such research for corporate clients has
not been significant.



Growth Strategy



Our objective is to be the leading provider of diagnostic instrumentation in
the urinalysis market and to diversify our business through internal development and selective acquisitions of related medical device companies, technologies or product lines. We expect to increase revenues and accelerate earnings by increasing our
global participation in the urinalysis market and by developing innovative products with increased clinical utility and value for our global customers. We will remain focused in urinalysis, but we plan to follow the chain of treatment of the patient
affected by kidney disease, bladder disease and urinary tract infection. This should reposition our company into the high-value testing areas of urinalysis. Our growth strategy consists of the following key elements:



Increase market penetration. With the release of the iQ200
product family (iQ200 and iQ200 Sprint), we are able to reposition our product line to the broader market. We expect to penetrate market segments that were not previously accessible to us due to price considerations and limited functionality. The
lower price point of the iQ200 product family, in comparison to our Legacy systems, with its value added features allows us to enter the mid-range domestic laboratory market, the clinical reference and commercial laboratories as well as the
international reagent-rental (fee-per-test) market. The iQ200 product family has superior clinical performance, is smaller in size than other competing products and consolidates clinical results to significantly increase the value proposition of our
product offering. To further our market penetration, we have initiated relationships with key opinion leaders that have resulted and may continue to result in peer-reviewed scientific papers describing the importance of urine microscopy and the
advantages of the iQ200 product family compared to manual microscopy and competitive automated systems.



Expand into new geographic markets. Historically, a significant portion of our revenues has been derived domestically. During 2004, our
international sales comprised approximately 18% of our total revenue. However, we believe there are still significant growth opportunities internationally for our products and have increased our marketing efforts abroad. Over the past year, we have
expanded our international distribution network to approximately 35 distributors covering 45 countries. We have opened a French subsidiary, IRIS France S.A. that markets our diagnostics products directly to customers in France and supports all
European distributors. We have also expanded our direct sales, applications support and field service teams in the U.S. We believe the sales and service support systems are in place to sustain our rapidly expanding global distribution network.



Increase sales of consumables and service.
Currently, we have an installed base of approximately 670 analyzers worldwide that provides significant recurring revenue of consumables and service. In 2004, sales from consumables and service comprised 46% of our total revenues. In the U.S., we
anticipate a gradual phase-out of the test strips and replacement readers of our legacy workstations with the introduction of the new iQ200



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systems. As we continue to increase our installed base of iQ200s domestically, we should benefit from an increase in consumables, both for chemistry and
microscopy, and service contracts after the expiration of the one-year warranty period. Internationally, we expect to increase revenues related to our microscopy consumables and spare parts. Our recently released iQ200 Sprint expands
our available market into the very high volume clinical reference laboratory, a market segment with significantly higher consumable usage than the hospital lab  our traditional segment. A recurring theme in our product development plans is to
continue releasing product applications with increased or new consumables trail. A body fluid testing (cerebrospinal fluid, serous and synovial fluids) application and its related high-value consumables are in development.





Continuously enhance and expand system features.Another key element of our growth strategy is to expand and improve the features of the iQ200 system. We plan to expand the iQ200 clinical applications to (i) increase the
clinical utility of the platform providing new information that is not currently available in routine testing, (ii) diversify the technology applications beyond the field of urinalysis and (iii) improve efficiency for medical professionals. We have
submitted a 510(k) Pre-Market Notification (see discussion of 510(k) Pre-Market Notification process under the heading Government Regulations below) to increase the testing capabilities of the iQ200 product family to include various
bodily fluids. As a result, we anticipate this will expand the potential market for the system.



Pursue selective acquisitions.We intend to pursue selective acquisitions to augment our organic growth. Our acquisition strategy is to
target companies, product lines and/or technologies that complement our product offering in urinalysis and specimen processing and, provide synergies with our existing infrastructure. We plan to maximize the utilization of our manufacturing
capabilities, distribution channels and technical and managerial expertise in the field of medical devices and scientific instrumentation.



Technology



Our Company has a history of innovation. Our diversified core technology spans through a number of scientific endeavors, which include in vitro
diagnostics, specimen processing and handling, pattern recognition and, image analysis. IRIS has approximately fifty patents protecting the intellectual property of our operating units. In addition, there are seven patent applications covering the
iQ200 designs and inventions. It is our intent to use our technological core competencies to accelerate the development of new products in our three operating units. For example, we have initiated a technology feasibility program on the diagnosis of
bacteria, cancer and rare cell detection in urine. We have just begun research on a first possible application; automated bacteria identification within a urine sample to replace urine cultures. Given the estimated addressable market of
approximately $300 million and few applications, if any, available for rapid identification of bacteria in urine, the success of our research could have a significant impact on the future market for an expanded iQ200 platform.



An effective system for most automated microscopy applications
requires technology for fast, consistent and easily discernable presentation of the specimen to the automated flow microscope (front end processing) and for rapidly capturing, analyzing, classifying, enhancing, arranging and displaying
images of the specimen (back end imaging). Over the past twenty-five years, we have created and developed our patented and proprietary Automated Intelligent Microscopy, or AIM, technology to address both of these requirements. AIM
technology involves the synthesis of visual microscopy, digital image processing and automated image interpretation/pattern recognition to analyze microscopic specimens using well-trained neural networks.



Traditional urine sediment analysis requires manual preparation of a slide
from the specimen requiring several steps, including centrifugation followed by carefully positioning, staining and cover slipping 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 time-consuming, imprecise, and potentially hazardous. In contrast, our patented slide-less microscope automates the front end processing and allows microscopic examination of a moving specimen precisely
positioned in a stream of fluid. This eliminates the need for manual slide preparation, manipulation and scanning. The slide-less microscope positions the specimen to within microns as it flows past



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the microscope at high-speed, ensheathed within a larger stream of fluid. This method of alignment, particle orientation, focus and measurement is called
imaging flow cytometry. We hold patents on this method and we are unaware of any other company that has developed similar technology.



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



Summary of Revenues by Product Line



The following table presents a summary of revenues for each segment by
product line for each of the three years ended December 31, 2004:



|                                         |  |                         |        |  |      |   |  |      |        |  |     |   |  |   |        |  |     |  
|---------------------------------------- |  | ----------------------- | ------ |  | ---- | - |  | ---- | ------ |  | --- | - |  | - | ------ |  | --- | -
|                                         |  | Year ended December 31, |       
|                                         |  | 2004                    |        |  | 2003 |   |  | 2002 |       
|                                         |  | (000s omitted)          |       
|Iris Diagnostics instruments             |  | $                       | 14,845 |  | 34   | % |  | $    | 7,470  |  | 24  | % |  | $ | 5,515  |  | 20  | %
|Iris Diagnostics consumables and service |  |                         | 20,126 |  | 46   | % |  |      | 17,252 |  | 55  | % |  |   | 16,436 |  | 58  | %
|StatSpin laboratory devices and supplies |  |                         | 8,343  |  | 19   | % |  |      | 6,076  |  | 19  | % |  |   | 5,729  |  | 20  | %
|Royalty and license revenues             |  |                         | 336    |  | 1    | % |  |      | 547    |  | 2   | % |  |   | 508    |  | 2   | %
|                                         |  |                         |        |  |      |   |  |      |        |  |     |   |  |   |        |  |     |  
|Total                                    |  | $                       | 43,650 |  | 100  | % |  | $    | 31,345 |  | 100 | % |  | $ | 28,188 |  | 100 | %
|                                         |  |                         |        |  |      |   |  |      |        |  |     |   |  |   |        |  |     |  



See Note 14 to the
Consolidated Financial Statements, Segment and Geographic Information, for financial information regarding our operating segments and geographic areas.



Backlog



We did not have a material amount of backlog at December 31, 2004 or 2003. Products are usually shipped within ninety days of receipt of sales orders. We
do not believe that backlog is necessarily indicative of sales for any succeeding period.



Research and Development



In 1999, we began a major project to replace our legacy urinalysis workstations and develop the next generation operating platform, now introduced as the iQ200 and iQ200 Sprint. Consequently, over the past three years our
product technology investments (including amounts reimbursed by third parties under research and development contracts and amounts capitalized) amounted to $5.4 million in 2004, $5.9 million in 2003 and $6.3 million in 2002.



We have devoted substantially all of our research and development efforts
over the past four years to development of the iQ200 program. By incorporating more than 20 years of experience and the latest developments in computer technology, we developed the iQ200 product family which: (1) significantly improves the quality
of the images produced by our systems, (2) further reduces the time required to operate the system, (3) reduces our cost of goods and our historical dependence on single-source suppliers by incorporating more off-the-shelf components and
(4) significantly expands the clinical utility and functionality of our urinalysis product line versus our competition. We expect to continue to invest in research and development during 2005 at the same rate as 2004. We also expect to continue the
funding of the research and development efforts of our sample separation business at StatSpin.



ADIR applies for government grants related to projects that have potential applications to the imaging part of our business. Under a typical government grant program, the government has the right to use any new
technology royalty-free, but ADIR retains the right to commercially exploit the new technology. During 2004 ADIR received grants totaling $4.3 million of which a balance $3.1 million was available for future periods as of December 31, 2004. The
largest grant is for research into a three-dimensional biometric face recognition system totaling $2.0 million, over a three-year period.



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Marketing and Sales



In the United States, we sell and service our products through our 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 support to customers in the operation of their systems. In addition to our sales activities, we promote our
products through advertising in trade journals, attendance at trade shows, direct mail, and our website. All domestic sales of our urinalysis instruments include installation, customer training and a one-year warranty after installation. Our small
instruments, targeted primarily at smaller customers, are sold through distributors. We also maintain a rental program for our urinalysis systems. Under the terms of the rental agreements, payments generally are based on the number of tests
performed, with a guaranteed monthly minimum payment. We are responsible for supply and service of the rental instruments. Alternatively, some customers lease our systems from medical equipment leasing companies that, in turn purchase the
instruments and consumables from us.



Internationally, we sell
our products to distributors in markets around the world with the exception of France. With the introduction of our new iQ200 platform, we have negotiated many new distributor agreements throughout the world. We anticipate the international market
to play a major role in the success of our new product. As of March 1, 2005, we have agreements with distributors covering 45 countries in comparison to 28 countries at the end of 2003.



We market most of the supplies used in the operation of our urinalysis systems and maintain them through our own national
service organization domestically, and through our distributor network internationally. Domestic service contracts are sold under annual service agreements or, less frequently, on a per-call basis.



Competition



Our primary products are the iQ200 product family. The principal competitive factors in the urinalysis market are
cost-per-test, ease of use, and quality of result. We believe our systems compete favorably with regard to these factors in their target markets.



Bayer Diagnostics and Roche Diagnostics are the principal competitors selling lines of urine test strips that are used in determining the concentration of
various chemical substances found in urine. The iQ200 and the iQSprint Systems are the first to fully integrate the urine chemistry and urine microscopy analysis. Despite the Company obtaining FDA clearance for the fully-integrated and walkway iQ200
System, a substantial portion of the urinalysis market has subscribed to the theory that test strips can be relied upon to reduce the number of microscopic examinations. We believe that this is largely due to laboratories reacting to
cost-cutting pressures and labor shortages and, has resulted in slower growth in the demand for microscopic examinations at certain hospitals and reference laboratories. We believe the lower price and ease of use of our iQ200 product family will
result in a better economic return for clinical laboratories and hospitals utilizing manual microscopy, therefore accelerating the adoption of IRIS automated microscopy technology. As urine chemistry test strips remain a large segment of the
urinalysis market and a revenue source for us, the exclusive U.S. distribution agreement with ARKRAY for the Aution Max AX-4280 Automated Urine Chemistry Analyzer offers a competitive alternative in the form of a compact, high-throughput analyzer
with a complete test strip menu.



Our urinalysis systems
currently support automated test strip readers supplied by Roche Diagnostics and Arkray, Inc. Some potential customers who have previously purchased automated test strip readers from Bayer Diagnostics (the dominant company in the urine test strip
business) cannot connect those readers to our legacy products. Our ability to modify our legacy products to support a connection to test strip readers from Bayer Diagnostics and other suppliers is presently subject to significant restrictions under
our existing agreements with Roche Diagnostics. In 2002, Roche Diagnostics exercised its right to terminate its agreements with us, however, in accordance with the term and conditions contained in these agreements, Roche Diagnostics will continue to
supply its test strips through 2009. Our new iQ200 and iQ200 Sprint Automated Microscopy Analyzers can be used as stand-alone systems for those laboratories that continue using Bayer or Roche urine chemistry analyzers.



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Sysmex Corporation (Kobe, Japan) markets its automated urine sediment analyzers globally, and remains our
principal competitor in the urine microscopy business segment. While the Sysmex systems, are automated and easy to use, we believe they have several limitations. These systems are not designed to perform body fluid analysis and are limited in terms
of the number of quantitatively reported analyses. Additionally, when further examination is needed, Sysmex systems, which do not use image analysis, require the technologist to remove the sample, prepare a slide and conduct a manual microscopic
analysis.



In addition to industry competitors, we are
experiencing increased domestic and international pricing pressures in the urinalysis market due to the ongoing consolidation of both hospitals and medical device suppliers. Large hospital chains and groups of affiliated hospitals are negotiating
comprehensive supply contracts with the larger medical device suppliers, who can offer one-stop shopping for a variety of laboratory instruments, supplies and service. In the US, they typically offer hospitals annual rebates based on the total
volume of business with the suppliers. These rebates create financial incentives against purchasing instruments or supplies from others and act as a barrier to the penetration of hospital laboratories covered by the contract.



Intellectual Property



Our commercial success depends on our ability to protect and maintain our proprietary rights. We protect our proprietary
technology by filing various patent applications. We have received numerous United States patents for our 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. We have applied for a number of additional patents covering the iQ200 which are pending in the United States and abroad. Also, we maintain numerous patents relating to digital refractometers, centrifuges, automated
slide handling and disposable urinalysis products sold by Iris Diagnostics and StatSpin.



A royalty-bearing license granted to Sysmex to use pre-1989 technology for urine sediment analyzers and non-medical industrial instruments expired in July 2004.



We have trade secrets and unpatented technology and proprietary knowledge
about the sale, promotion, operation, development and manufacturing of our products. We have confidentiality agreements with our employees and consultants to protect these rights.



We claim copyright in our software and the ways in which it assembles and displays images, and have filed copyright
registrations with the United States Copyright Office. We also own various federally registered trademarks, including IRIS, iQ, The Yellow IRIS and StatSpin. We own other registered and unregistered
trademarks, and have certain trademark rights in foreign jurisdictions. We intend to aggressively protect our patents, copyrights and trademarks.



Government Regulations



Most of our products are subject to stringent government regulation in the United States and other countries. These laws and regulations govern product
testing, manufacture, labeling, storage, record keeping, distribution, sale, marketing, advertising and promotion. The regulatory process can be lengthy, expensive and uncertain, and securing clearances or approvals often requires the submission of
extensive testing and other supporting information. If we do not comply with regulatory requirements, we may be subject to 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. Further, any change in existing federal, state or foreign laws or regulations, or in their interpretation or enforcement, or the enactment of any
additional laws or regulations, could affect us both materially and adversely.



In the United States, the Food and Drug Administration 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



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application (a PMA Application). The PMA Application process is significantly more complex, expensive, time-consuming and uncertain than the
510(k) Notification process. To date, we have cleared all of our regulated products with the FDA through the 510(k) Notification process. We cannot guarantee that we will be able to use the 510(k) Notification process for future 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. We have pending one 510(k) Pre-Market Notification for a new body fluids diagnostics application to be marketed in the iQ200 product family.



We are 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). In 1997, the FDA 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 our manufacturing facilities for compliance with GMP Standards. We believe that we are in substantial compliance with the expanded GMP Standards.



Labeling, 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, it is possible that future developments in this area could affect us both materially and adversely.



In addition to domestic regulation of medical devices, many of our products are subject to regulations in foreign jurisdictions. 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. Our business strategy includes expanding the geographic
distribution of these and other products, and we cannot guarantee that we will be able to secure the necessary clearances and approvals in the relevant foreign jurisdictions. Furthermore, the regulations in certain foreign jurisdictions continue to
develop and we cannot be sure that new laws or regulations will not have a material adverse effect on our existing business or future plans. Among other things, CE Mark certifications are required for the sale of many products in certain
international markets such as the European Community. We secured CE Mark certification for our existing product lines.



We have obtained the ISO 9001, EN 46001 and ISO 13485 certifications for our manufacturing facilities and are subject to surveillance by European notified
bodies.



Our products are also subject to regulation by the
United States Department of Commerce export controls, primarily as they relate to the associated computers and peripherals. We have not experienced any material difficulties in obtaining necessary export licenses to date.



Employees



We had 182 full-time employees at March 1, 2005. We also use outside consultants and part-time and temporary employees in
production, administration, marketing and engineering. No employees are covered by collective bargaining agreements, and we believe that our employee relations are satisfactory.



Available Information



Our Internet website address is http://www.proiris.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our Internet



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website as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange
Commission. Our Internet website and the content contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.



Item 2.Properties



We lease all of our facilities. The leases expire at various times over the next five years. Our headquarters are located at 9172 Eton Avenue, Chatsworth, California 91311. The table below sets forth certain information regarding our
leaseholds as of March 1, 2004:



|                |  |                                  |  |              |        |     |                                         
|--------------- |  | -------------------------------- |  | ------------ | ------ | --- | ----------------------------------------
|Location        |  | Approximate FloorSpace (Sq. Ft.) |  | Monthly Rent |        | Use
|Chatsworth, CA  |  | 51,250                           |  | $            | 34,800 |     | Corporate Headquarters and Manufacturing
|                |  |                                  | 
|Norwood, MA     |  | 10,850                           |  | $            | 8,850  |     | StatSpin subsidiary                     
|                |  |                                  | 
|League City, TX |  | 4,600                            |  | $            | 7,600  |     | ADIR research and development subsidiary



We believe our
facilities are adequate to meet our current and near-term needs.



Item 3.Legal Proceedings



We are not currently involved in any litigation that requires disclosure in this report.



Item 4.Submission of Matters to a Vote of Security Holders



We did not submit any matters to vote of security holders during the quarter ended December 31, 2004.



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PART II



|Item 5. | Market for Registrants Common Stock and Related Stockholder Matters and Issuer Purchases of Equity Securities
|------- | --------------------------------------------------------------------------------------------------------------



On April 7, 2004 our common stock listing was transferred from the American
Stock Exchange under the symbol IRI to the NASDAQ National Market under the symbol IRIS.



The closing price of the Common Stock on March 11, 2005 was $9.95 per share. The table below sets forth high and low closing prices during the period
January 1, 2003 through December 31, 2004:



|               |  |                 |      |      |   |     
|-------------- |  | --------------- | ---- | ---- | - | ----
|               |  | Price per share
|               |  | Low             |      | High
|Fiscal 2004    |  |                 |      |      |   |     
|First Quarter  |  | $               | 5.80 |      | $ | 7.15
|Second Quarter |  |                 | 6.22 |      |   | 9.18
|Third Quarter  |  |                 | 6.29 |      |   | 7.80
|Fourth Quarter |  |                 | 7.45 |      |   | 9.75
|Fiscal 2003    |  |                 |      |      |   |     
|First Quarter  |  | $               | 2.34 |      | $ | 3.03
|Second Quarter |  |                 | 2.40 |      |   | 3.70
|Third Quarter  |  |                 | 3.41 |      |   | 3.95
|Fourth Quarter |  |                 | 3.39 |      |   | 6.82



As of March 11, 2005,
we had approximately 2,800 holders of record of our common stock.



We have never paid any cash dividends. We presently intend to retain any future earnings for use in our business. Furthermore, we may not pay any cash dividends on the common stock, or repurchase any shares of the
common stock, without the written consent of our lender.



Item 6.Selected Financial Data



The following selected financial data should be read in conjunction with our consolidated financial statements. The information set forth below is not necessarily indicative of results of future operations, and should
be read in conjunction with Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included in Item 8, Financial Statements and
Supplementary Data of this Form 10-K in order to understand fully factors that may affect the comparability of the financial data presented below.



|                                                            |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|----------------------------------------------------------- |  | ------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                            |  | Year Ended December 31,               |       
|                                                            |  | 2004                                  |        |   | 2003 |   |        | 2002 |  |   | 2001   |   |  | 2000 |       
|                                                            |  | (in thousands, except per share data) |       
|Statement of Operations Data:                               |  |                                       |        |  
|                                                            |  |                                       |        |   |     
|Net revenues                                                |  | $                                     | 43,650 |   |      | $ | 31,345 |      |  | $ | 28,188 |   |  | $    | 28,648 |   |  | $ | 28,643 |  
|Operating income (loss) from continuing operations          |  |                                       | 4,465  |   |      |   | (543   | )    |  |   | 1,902  |   |  |      | 3,306  |   |  |   | 5,152  |  
|Interest and other expense, net                             |  |                                       | (666   | ) |      |   | (340   | )    |  |   | (441   | ) |  |      | (740   | ) |  |   | (763   | )
|Income (loss) from continuing operations                    |  |                                       | 2,280  |   |      |   | (530   | )    |  |   | 877    |   |  |      | 1,539  |   |  |   | 2,794  |  
|Income (loss) from continuing operations per share basic   |  |                                       | 0.16   |   |      |   | (0.05  | )    |  |   | 0.08   |   |  |      | 0.15   |   |  |   | 0.29   |  
|Income (loss) from continuing operations per share diluted |  |                                       | 0.14   |   |      |   | (0.05  | )    |  |   | 0.08   |   |  |      | 0.14   |   |  |   | 0.27   |  
|                                                            |  |                                       |        |   |     
|Balance Sheet Data:                                         |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                            |  |                                       |        |   |     
|Working capital                                             |  |                                       | 24,959 |   |      |   | 6,614  |      |  |   | 6,445  |   |  |      | 8,636  |   |  |   | 8,472  |  
|Total assets                                                |  |                                       | 48,136 |   |      |   | 32,480 |      |  |   | 27,223 |   |  |      | 26,503 |   |  |   | 28,288 |  
|Total debt                                                  |  |                                       | 0      |   |      |   | 5,032  |      |  |   | 4,245  |   |  |      | 5,249  |   |  |   | 8,149  |  
|Total liabilities                                           |  |                                       | 8,963  |   |      |   | 13,013 |      |  |   | 9,874  |   |  |      | 10,538 |   |  |   | 14,668 |  
|Shareholders equity                                        |  |                                       | 39,173 |   |      |   | 19,467 |      |  |   | 17,349 |   |  |      | 15,965 |   |  |   | 13,619 |  



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Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations



Forward-Looking Statements



This Annual Report on Form 10-K contains forward-looking statements, which reflect our current views about future events and financial results. We have
made these statements in reliance on the safe harbor created by that Private Securities Litigation Reform Act of 1995. Forward-looking statements include our views on future financial results, financing sources, product development, capital
requirements, market growth and the like, and are generally identified by phrases such as anticipates, believes, estimates, expects, intends, plans and similar words.
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:



| |  |  | unexpected technical and marketing difficulties inherent in major product development efforts such as the new platform for our urinalysis workstation,
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the potential need for changes in our long-term strategy in response to future developments,
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | 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 our products,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | rapid technological change in the microelectronics and software industries, and
| | - |  | -------------------------------------------------------------------------------



| |  |  | increasing competition from imaging and non-imaging based in-vitro diagnostic products.
| | - |  | ---------------------------------------------------------------------------------------



Set forth below is additional significant uncertainties and other factors affecting forward-looking statements. The readers
should understand that the uncertainties and other factors identified in this Annual Report are not a comprehensive list of all the uncertainties and other factors that may affect forward-looking statements. We do not undertake any obligation to
update or revise any forward-looking statements or the list of uncertainties and other factors that could affect those statements.



Overview



IRIS International, Inc. originally incorporated in California in 1979, was reincorporated in Delaware in 1987. Our company consists of three operating
units. Our largest unit, Iris Diagnostics Division, designs, manufactures and markets in vitro diagnostics (IVD) systems, consumables and supplies for urinalysis. Our StatSpin subsidiary markets small centrifuges and other processing equipment and
accessories for rapid specimen processing, and our Advanced Digital Imaging and Research LLC (ADIR) subsidiary assists in the advancement of proprietary imaging technology while conducting government-sponsored research and contract development in
imaging and pattern recognition.



We generate revenues
primarily from three sources: Sales of; IVD instruments, IVD consumables and service and small laboratory device instruments and supplies. Sales of IVD consumables supplies and services represent approximately 46% of our revenues and contribute
higher gross margins than other sources of revenues. Consumables include products such as chemical reagents and urine test strips. Service revenues are derived primarily from annual service contracts purchased by our domestic customers after the
initial year of sale which is covered by product warranties. Once our analyzers and systems are installed, we generate recurring revenue from sales of consumables. Consumable and service revenue will continue to expand as the installed base of
related instruments expand. Sales of small laboratory devices and supplies primarily consist of centrifuge systems and related supplies sold by StatSpin. Sales of StatSpins products are made worldwide through distributors.



Sales of IVD analyzers, consumables and services are made both domestically
and internationally. Domestic sales are made directly by our own sales staff to the customer, whereas international sales are made to



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independent distributors. Our international sales represented 18% of consolidated net revenues in 2004, compared to 13% in 2003 and 6%in 2002. With
the launch of our new iQ200 analyzer, we have increased our focus on the international marketplace, with the ultimate goal of balancing our urinalysis business between domestic and international markets. Since our international sales are made
through independent distributors, gross profit margin is lower than domestic sales of the same products but we do not incur sales and marketing costs for such sale.



We make significant investments in research and development for new products and enhancements to existing products. We
internally fund our research and development programs, and through ADIR; we also receive government grants to fund various research activities.



The following table summarizes product technology expenditures for the periods indicated:



|                                                                                                                            |  |                |        |   |      |   |       |      |  |   |       |  
|--------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------ | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                                                                            |  | 2004           |        |   | 2003 |   |       | 2002 | 
|                                                                                                                            |  | (in thousands) |       
|Total product technology expenditures during year                                                                           |  | $              | 5,448  |   |      | $ | 5,929 |      |  | $ | 6,253 |  
|Less: amounts capitalized during year to software development costs as reported in the consolidated statements of cash flow |  |                | (64    | ) |      |   | (600  | )    |  |   | (775  | )
|Less: amounts reimbursed through grants for government sponsored research and development                                   |  |                | (1,464 | ) |      |   | (936  | )    |  |   | (884  | )
|                                                                                                                            |  |                |        |   |      |   |       |      |  |   |       |  
|Research and development expense as reported in the consolidated statements of operations                                   |  | $              | 3,920  |   |      | $ | 4,393 |      |  | $ | 4,594 |  
|                                                                                                                            |  |                |        |   |      |   |       |      |  |   |       |  



Critical Accounting Policies



Our critical accounting policies upon which our financial
position and results of operations depend are those related to revenue recognition, inventory valuation, and income tax assets and liabilities. We summarize our most critical accounting policies below.



Revenue recognition Revenues are derived from the sale
of IVD instruments, sales of consumable supplies and services for IVD systems as well as sales of small laboratory devices and related supplies. Revenue is recognized once all of the following conditions have been met: a) an authorized purchase
order has been received in writing with a fixed and determinable sales price, b) customer credit worthiness has been established, and c) delivery of the product based on shipping terms. The majority of domestic IVD instrument sales generally require
installation and training to be performed.



Revenue is recorded
in accordance with the provisions of Emerging Issues Task Force (EITF) Statement 00-21 Revenue Arrangements with Multiple Deliverables and Staff Accounting Bulletin (SAB) 104 Revenue Recognition in Financial Statements which
generally requires revenue earned on product sales involving multiple-elements to be allocated to each element based on the relative fair values of those elements. Multiple elements of our domestic product sales include IVD instruments and training.
Training elements are valued based on hourly rates, which we charge for these services when sold apart from hardware sales.



Accordingly, we allocate revenue to each element in a multiple-element arrangement based on the elements respective fair value, with the fair value
determined by the price charged when that element is sold and specifically defined in a quotation or contract.



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



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Inventory valuation We value inventories at the lower of cost or market value on a
first-in, first-out basis. Provision for potentially obsolete or slow-moving inventory is made based on managements analysis of inventory levels and future sales forecasts. We recognize that although we have introduced our new iQ200 product
family of analyzers, an installed based of our legacy products still exist. We maintain a base supply of service parts for these products, a portion of which is classified as a long-term asset on our balance sheet. Management will periodically
review the carrying value of such parts to ensure that they continue to have net realizable value.



Capitalized Software We capitalize software development costs in connection with our development of our urine analyzers in accordance with
Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the Cost of Capitalized Software to Be Sold, Leased or Otherwise Marketed. We capitalize software development costs once technological feasibility is
established and such costs are determined to be recoverable against future revenues.



Capitalized software development costs are expensed to cost of sales over periods up to five years. When, in managements estimate, future revenues will not be sufficient to recover previously capitalized
software development costs, we will expense such items as additional software development amortization in the period the impairment is identified. Such adjustments are normally attributable to changes in market conditions or product quality
considerations.



Income taxes  We account
for income taxes in accordance with SFAS No. 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.



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Results of Operations



The following table summarizes results of operations data for the periods indicated. The percentages in the table are based on total revenues with the
exception of percentages for cost of goods sold which are computed on related revenue.



|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|----------------------------------------------- |  | ----------------------- | ------ | - | ---- | --- | - | ---- | - | ------ | - |  | --- | - |  | - | ------ | - |  | --- | -
|                                                |  | Year ended December 31, |       
|                                                |  | 2004                    |        |   | 2003 |     |   | 2002 |  
|                                                |  | (in thousands)          |       
|Revenues                                        |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|IVD instruments                                 |  | $                       | 14,845 |   |      | 34  | % |      | $ | 7,470  |   |  | 24  | % |  | $ | 5,515  |   |  | 20  | %
|IVD consumables and service                     |  |                         | 20,126 |   |      | 46  | % |      |   | 17,252 |   |  | 55  | % |  |   | 16,436 |   |  | 58  | %
|Small laboratory devices and supplies           |  |                         | 8,343  |   |      | 19  | % |      |   | 6,076  |   |  | 19  | % |  |   | 5,729  |   |  | 20  | %
|Royalty and license revenues                    |  |                         | 336    |   |      | 1   | % |      |   | 547    |   |  | 2   | % |  |   | 508    |   |  | 2   | %
|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Total revenues                                  |  |                         | 43,650 |   |      | 100 | % |      |   | 31,345 |   |  | 100 | % |  |   | 28,188 |   |  | 100 | %
|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Cost of Goods Sold                              |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|IVD instruments                                 |  |                         | 10,092 |   |      | 68  | % |      |   | 5,982  |   |  | 80  | % |  |   | 3,649  |   |  | 66  | %
|IVD consumable and supplies                     |  |                         | 7,982  |   |      | 40  | % |      |   | 6,629  |   |  | 38  | % |  |   | 6,177  |   |  | 38  | %
|Small laboratory devices and supplies           |  |                         | 4,185  |   |      | 50  | % |      |   | 3,101  |   |  | 51  | % |  |   | 2,774  |   |  | 48  | %
|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Total costs                                     |  |                         | 22,259 |   |      | 51  | % |      |   | 15,712 |   |  | 50  | % |  |   | 12,600 |   |  | 45  | %
|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Gross margin                                    |  |                         | 21,391 |   |      | 49  | % |      |   | 15,633 |   |  | 50  | % |  |   | 15,588 |   |  | 55  | %
|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Operating expenses                              |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Marketing and selling                           |  |                         | 7,165  |   |      | 16  | % |      |   | 5,346  |   |  | 17  | % |  |   | 4,068  |   |  | 14  | %
|General and administrative                      |  |                         | 5,841  |   |      | 13  | % |      |   | 6,437  |   |  | 21  | % |  |   | 5,025  |   |  | 18  | %
|Research and development, net                   |  |                         | 3,920  |   |      | 9   | % |      |   | 4,393  |   |  | 14  | % |  |   | 4,593  |   |  | 16  | %
|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Total operating expenses                        |  |                         | 16,926 |   |      | 39  | % |      |   | 16,176 |   |  | 52  | % |  |   | 13,686 |   |  | 49  | %
|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Operating income (loss)                         |  |                         | 4,465  |   |      | 10  | % |      |   | (543   | ) |  | 2   | % |  |   | 1,902  |   |  | 7   | %
|Other income (expense)                          |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Interest income                                 |  |                         | 111    |   |      |     |   |      |   | 40     |   |  |     |   |  |   | 57     |   |  |     |  
|Interest expense                                |  |                         | (243   | ) |      |     |   |      |   | (351   | ) |  |     |   |  |   | (537   | ) |  |     |  
|Other income (expense)                          |  |                         | (534   | ) |      |     |   |      |   | (29    | ) |  |     |   |  |   | 39     |   |  |     |  
|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  
|Income (loss) before for income taxes (benefit) |  |                         | 3,799  |   |      | 9   | % |      |   | (883   | ) |  | 3   | % |  |   | 1,461  |   |  | 5   | %
|Net income (loss)                               |  | $                       | 2,280  |   |      | 5   | % |      | $ | (530   | ) |  | 2   | % |  | $ | 877    |   |  | 3   | %
|                                                |  |                         |        |   |      |     |   |      |   |        |   |  |     |   |  |   |        |   |  |     |  



Comparison of Year Ended December
31, 2004 to 2003



Net revenues for the year ended December
31, 2004 increased by 39% over the prior year. Revenues from the IVD urinalysis segment totaled $35.3 million in the current year, up from $25.3 million in the prior year. Sales of IVD instruments increased to $14.8 million from $7.5 million, an
increase of $7.3 million, or 99% over our 2003 sales. The increase is primarily due to sales of the iQ200 analyzers and systems first introduced in August 2003. As expected, sales of our legacy models diminished during the year. Sales of IVD system
consumables and services increased to $20.1 million from $17.3 million, an increase of $2.8 million or 17% over 2003, primarily due to the larger installed base of instruments. Revenues from the small laboratory devices segment increased to $8.3
million from $6.1 million, or 37% over 2003. This increase is primarily due to increased sales of centrifuges, parts and service within this segment. Revenues also include royalty and license fees and approximately $336,000 in 2004 as compared to
$547,000 during 2003. Such revenue ceased in the third quarter of 2004, as the related license expired and we do not expect to receive any royalty or license fees during the next fiscal year.



The decrease in gross margins over the past two year results from our
decision to expand our operations to international markets and lower margins on iQ200 microscopy analyzers due to transitional costs like learning



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curves, small quantity procurement and the lag time between instrument placement and generation of consumable revenues. Conversely, during 2002,
substantially all our sales were to domestic customers. Gross profit margin decreased to 49% in 2004 from 50% in 2003. Gross margin on IVD urinalysis segment was 50% in 2004 and 51% in 2003 and included gross margin on IVD instruments of 32% in 2004
compared to 20% in 2003. This improvement is due to a number of factors; including higher production levels in the first full year of production of the iQ200 analyzer which resulted in greater overhead absorption, as well as other efficiencies
associated with continued production of the iQ200. The improvement in gross profit margins was offset by increased sales of our product to international independent distributors at lower margins than domestic sales and a $250,000 addition to our
reserves during 2004 for possible obsolescence of slow moving legacy inventory. Gross margin of IVD consumables and services was 60% during 2004 compared to 62% during 2003. The decrease resulted primarily from increased sales to international
independent distributors at lower margins as well as the fact that our instruments include a one-year warranty during which period we dont realize service revenue but incur warranty costs. Gross margin for our small laboratory instruments
segment amounted to 50% for 2004 compared to 49% in 2003. The slight increase was due to improved manufacturing overhead absorption due to higher volumes.



Marketing and selling expenses totaled $7.2 million in 2004, compared to $5.3 million in the prior year, a 34% increase. As a percentage of sales such
expenses during 2004 were 16% of revenues compared to 17% the prior year. The increase relates to additional sales and marketing personnel costs amounting to approximately $1.1 million plus approximately $210,000 relating to travel costs to support
the increased sales revenues during the year. In addition we incurred $400,000 of additional costs relating to the expansion of the international distribution support organization.



General and administrative expenses decreased during 2004 to $5.8 million from $6.4 million in the prior year. The decrease
includes management severance costs during 2003 ($1.2 million) which did not occur during 2004 and partially offset by the cost of compliance with Section 404 of Sarbanes Oxley ($400,000), NASDAQ listing fee ($100,000) and higher legal fees
($274,000).



Net research and development expenditures
decreased to $3.9 million for 2004, as compared to $4.4 million in 2003. Research and Development expenses were net of capitalized software development costs ($64,000) and reimbursed costs under research and development grants and contracts $1.5
million. Expenses were down during 2004 as compared to the prior year reflecting the reduced product development activity for the iQ200 Analyzer. Current year expenditures relate to the new iQ200 Sprint product, which was released in the first
quarter of 2005, plus ongoing development activities relating to enhancements to existing product lines and research into new products. We expect to continue to invest in research and development during 2005 at the same rate as 2004.



Interest expense decreased to $243,000 in 2004 from
$351,000 in the prior year as a result of the outstanding debt being repaid in the second quarter and included the write-off of $121,000 in deferred loan costs. Interest income for 2004 amounted to $111,000, an increase from $40,000 in 2003 and
relates to our investment of excess funds during the year.



Other expense during 2004 includes a permanent write-down of a security held for sale in the amount of $531,000.



During 2004 we incurred an income tax provision of approximately $1.5 million as compared to a tax benefit of $353,000 for the year ended December 31,
2003. The tax provision and benefit are non-cash items, since we have significant deferred tax assets, primarily relating to tax loss carryforwards.



Comparison of Year Ended December 31, 2003 to 2002



Net revenues for the year ended December 31, 2003 increased by $3.2 million or 11.2% over the prior year. Revenues from the IVD urinalysis segment totaled
$25.3 million in 2003, up from $22.4 million in the prior year. Sales of IVD instruments increased to $7.5 million from $5.5 million, an increase of $2.0 million, or 35% from the previous year. The increase is primarily due to the release of the
iQ200 analyzer and system in August 2003, and accounted for nearly $4.5 million of sales in this category. As expected, sales of our legacy models declined from the prior year. Sales of IVD system consumables and services increased to $17.3 million
from $16.4 million, an increase of $816,000 or 5% over last year, primarily due to the larger installed base of IVD



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instruments. Revenues from the small laboratory devices segment increased to $6.1 million from $5.7 million, an increase of $347,000 or 6% over 2002. This
increase is primarily due to increased sales of centrifuges, parts and service within this segment. Revenues also included royalty and license fees and approximately $500,000 in each year.



Gross profit margins decreased to 50% during 2003 compared to 55% during
2002. Cost of goods sold as a percentage of revenues for the IVD urinalysis segment totaled 50%, up from 44% in the prior year. Cost of goods sold for IVD instruments as a percentage of related sales was 80% in 2003 as compared to 66% in 2002. This
increase was due to a number of factors. Our lower production levels in the first seven months of 2003 provided a smaller volume of product sales to absorb overhead costs, small quantity procurements and start-up costs related to the production of
the new iQ200. In addition a portion of our 2003 revenues were lower margin international sales that are made through independent distributors. We also increased our reserves for obsolescence of slow moving inventory during 2003 by approximately
$266,000, which further contributed to the increase in this segments cost of goods. Cost of goods sold for IVD consumables and services as a percentage of related sales remained constant during both years at 38%. Cost of goods sold for small
laboratory instruments segment as a percentage of related sales totaled 51% for 2003 as compared to 48% in 2002. This increase was due primarily to increased costs resulting from smaller production runs in the first half of 2003.



Marketing and selling expenses for 2003 totaled $5.3 million, compared to
$4.1 million for 2002, a 31% increase. The increase was due primarily to the addition of sales and service personnel ($535,000), additional travel costs ($300,000), increased commissions due to higher revenues ($65,000) and increased marketing
efforts including trade shows and marketing brochures ($80,000), all associated with the launch of the iQ200. In addition, we created an international subsidiary and opened offices in Milan and Hong Kong to assist our expansion into the
international marketplace. Marketing and selling expenses as a percentage of revenues were 17% in 2003, up from 14% in 2002.



General and administrative expenses increased $1.4 million to $6.4 million in 2003 from $5.0 million in 2002. The increase was due to management
restructuring costs during the current year ($1.2 million) and increased professional fees ($90,000).



Net research and development expenditures decreased to $4.4 million for the year ended December 31, 2003, as compared to $4.6 million in 2002. Total
product technology expenditures which include research and development costs, capitalized software development costs and reimbursed costs under research and development grants and contracts amounted to $5.9 million, down slightly from the prior year
with the completion of the iQ200. The majority of the expenditures during 2003 related to the new iQ200 product, which was released in the third quarter of 2003.



Interest expense decreased 35% to $351,000 in 2003 from $537,000 in the prior year as a result of lower average
interest rates.



The income tax benefit for the year ended
December 31, 2003, amounted to $353,000, as compared an income tax provision of $584,000 in 2002 due to the loss experienced in 2003 and income experienced during 2002. The tax provision and benefit are non-cash items, since we have significant
deferred tax assets, primarily relating to tax loss carryforwards.



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Contractual Obligations and Contingent Liabilities and Commitments



The following table aggregates our expected minimum contractual obligations
and commitments subsequent to December 31, 2004:



|                                   |  |                |       |                 |   |          |  |   |    
|---------------------------------- |  | -------------- | ----- | --------------- | - | -------- |  | - | ---
|                                   |  | Totals         |       | Less than1 year |   | 1-3years
|                                   |  | (In thousands)
|Contractual Obligations*           |  |                |       |                 |   |          |  |   |    
|Capital lease commitments          |  | $              | 106   |                 | $ | 49       |  | $ | 57 
|Operating lease commitments        |  |                | 1,076 |                 |   | 563      |  |   | 513
|                                   |  |                |       |                 |   |          |  |   |    
|Total contractual cash commitments |  | $              | 1,182 |                 | $ | 612      |  | $ | 570
|                                   |  |                |       |                 |   |          |  |   |    

---

|* | There were no lease commitments that extended beyond 3 year as presented in the table above. Not included in the table above are normal recurring accounts payable or accrued
expenses which are presented on the accompanying consolidated financial statements.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Off-Balance Sheet Arrangements



At December 31, 2004 and 2003, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established
for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such
relationships.



Liquidity and Capital Resources



Our primary source of liquidity is cash from operations, which depends
heavily on sales of our IVD urinalysis systems and the subsequent sales of consumables and service for these systems as well as the sale of small laboratory devices and supplies. During the fiscal year ended December 31, 2004, we also realized $10.0
million in cash from financing activities, as described below. Our cash and cash equivalents increased $10.4 million to $12.8 million at December 31, 2004, up from $2.4 million at December 31, 2003.



Operating Cash Flows.  Cash flow provided by operations for
the year ended December 31, 2004 amounted to $1.5 million compared to cash used in operations of $1.1 million in the prior year. The primary reason for this change was net income in the current year as compared to a net loss in the prior year. In
addition, we also made investments in receivables and inventory to support our increased business activity, and resulted in funds used in these operating activities during 2004 in the approximate amount of $5.6 million offset by $4.9 million
provided by deferred income taxes (which is net of a $2.0 million tax benefit from stock option exercises), a write-down of a security held for sale plus depreciation and amortization and increases in accounts payable and accrued expenses of
approximately $1.2 million.



The relationship of receivables to
revenues has improved over the prior year. The number of days sales in accounts receivable has improved to 74 days in 2004 from 83 days at the end of 2003. Inventories at the end of 2004 have increased by 46% over the prior year. The higher
inventory levels are necessary to support increased production volumes due to the increasing sales during 2004 which is anticipated to continue during 2005.



Investing Activities.  Cash used in investing activities totaled $1.1 million in 2004, as compared to $1.8 million in the prior year. The
decrease is due to the reduction in expenditures for property and equipment and capitalized software development from prior year levels.



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Financing Activities.  For the year ended December 31, 2004, financing activities
provided $10.0 million of cash, compared to $3.0 million provided during the year ended December 31, 2003. The changes were as follows:



| |  |  | On April 16, 2004, we signed an agreement with an investment bank for the private placement of 2.1 million shares of common stock and received net proceeds of $11.5 million. In the
prior year we sold, in a private placement, 500,000 shares of common stock and received net proceeds of $1.6 million.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In April 2004, we repaid all the then outstanding bank debt and notes payable in the amount of $5.5 million with a portion of the proceeds from the sale of common stock on April 16,
2004.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During the year ended December 31, 2004, we received $3.3 million from the exercises of common stock options and warrants.
| | - |  | --------------------------------------------------------------------------------------------------------------------------



In May 2004, we signed a new credit facility with a major bank. The credit
facility consists of a $6.5 million revolving line of credit for working capital and a $10.0 million line of credit for acquisitions and product opportunities. Borrowings under the revolving line of credit are limited to a percentage of eligible
receivables and inventory. The entire credit facility has variable interest rates, which will change from time to time based on changes to either the LIBOR rate or the lenders prime rate. As of December 31, 2004, there were no borrowings under
the new credit facility. We are subject to certain financial covenants under the credit facility with the bank and as of December 31, 2004, we were in compliance with such covenants.



We believe that our current cash on hand, together with cash generated from operations and cash available under the credit
facility with the bank will be sufficient to fund normal operations. However additional funding may be required to fund expansion of our business. There is no assurance that such funding will be available, on terms acceptable to us.



New Accounting Pronouncements



In November 2004, the Financial Accounting Standards Board
(FASB) issued SFAS No. 151,Inventory Costs, an amendment of APB Opinion No. 43, Chapter 4. SFAS No. 151 clarifies the language used in Accounting Principles Board (APB) Opinion No. 43 with respect to accounting
for abnormal amounts of idle facility expenses, freight, handling costs and spoilage. The guidance does not result in a substantive change in accounting for these costs but eliminates inconsistencies in wording between U.S. and international
accounting standards. As such, this pronouncement is not expected to have any material impact on our consolidated statements of operations or financial position.



In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123 (Revised 2004), Share-Based
Payment,or SFAS No. 123R, which is a revision of SFAS No. 123. SFAS No. 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. SFAS No. 123R requires all
share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. SFAS No. 123R is effective for us beginning July 1, 2005 and will require us to expense share-based
payments under the modified prospective method. Under this method, compensation expense is recognized for all share-based payments granted after July 1, 2005 and also for all awards granted prior to July 1, 2005 that remain unvested on
the effective date. We will adopt SFAS No. 123R effective July 1, 2005 using the modified prospective method. Consequently, compensation expense for awards that we granted prior to July 1, 2005 that are not fully vested on July 1, 2005 will be
subject to expense beginning July 1, 2005 under SFAS No. 123R. We are currently evaluating the effects of adopting this standard on our results of operations or financial position.



Inflation



We do not foresee any material impact on our operations from inflation.



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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 our current or future products and our ability to sell our products on a profitable basis. Moreover, healthcare legislation is an area of extensive and dynamic change,
and we cannot predict future legislative changes in the healthcare field or their impact on our business.



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RISK FACTORS



Risks Related to Our Business



Our success depends largely on the acceptance of our new iQ200 operating platform.



Our current strategy assumes that our iQ200 operating platform will be
adopted by a large number of end-users. We have invested and continue to invest, a substantial amount of our resources in promotion and marketing of the iQ200 operating platform in order to increase its market penetration, expand its sales into new
geographic areas and enhance and expand its system features. A failure of our iQ200 operating platform to achieve and maintain a significant market presence, or the failure to successfully implement our promotion and marketing strategy, will have a
material adverse effect on our financial condition and results of operations.



Any failure to successfully introduce our future products and systems into the market could adversely affect our business.



The commercial success of our future products and systems depends upon their acceptance by the medical community. Our future
product plans include capital-intensive laboratory instruments. We believe that these products can significantly reduce labor costs, improve precision and offer other distinctive benefits to the medical research community. However, there is often
market resistance to products that require significant capital expenditures or which eliminate jobs through automation. We have no assurance that the market will accept our future products and systems, or that sales of our future products and
systems will grow at the rates expected by our management.



If we fail to meet changing demands of technology, we may not continue to be able to compete successfully with our competitors.



The market for our products and systems is characterized by rapid technological advances, changes in customer requirements, and frequent new product
introductions and enhancements. Our future success depends upon our ability to introduce new products that keep pace with technological developments, enhance current product lines and respond to evolving customer requirements. Our failure to meet
these demands could result in a loss of our market share and competitiveness and could harm our revenues and results of operations.



Any failure or inability to protect our technology and confidential information could adversely affect our business.



Patents.Our commercial success depends in part on our ability
to protect and maintain our Automated Intelligent Microscopy (or AIM) and other proprietary technology. We have received patents with respect to portions of the technologies of AIM. However, ownership of technology patents may not insulate us from
potentially damaging competition. Patent litigation relating to clinical laboratory instrumentation patents (like the ones we own) often involves complex legal and factual questions. Therefore, we can make no assurance that claims under patents
currently held by us, or our pending or future patent applications, will be sufficiently broad to adequately protect what we believe to be our proprietary rights. Additionally, one or more of our patents could be circumvented by a competitor. We
believe that our proprietary rights do not infringe upon the proprietary rights of third parties. However, third parties may assert infringement claims against us in the future. If we are unsuccessful in our defense against any infringement claim
our patents, or patents in which we have licensed rights, may be held invalid and unenforceable.



Trade Secrets.We have trade secrets, unpatented technology and proprietary knowledge related to the sale, promotion, operation, development
and manufacturing of our products. We generally enter into confidentiality agreements with our employees, suppliers and consultants. However, we cannot guarantee that our trade secrets, unpatented technology or proprietary knowledge will not become
known or be independently developed by competitors. If any of this proprietary information becomes known to third parties, we may have no practical recourse against these parties.



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Copyrights and Trademarks.We claim copyrights in our software and the ways in which it
assembles and displays images. We also claim trademark rights in the United States and other foreign countries. However, we can make no assurance that we will be able to obtain enforceable copyright and trademark protection, nor that this protection
will provide us a significant commercial advantage.



Potential Litigation Expenses.Offensive or defensive litigation regarding patent and other intellectual property rights could be time-consuming and expensive. Additionally, litigation could demand significant attention from
our technical and management personnel. Any change in our ability to protect and maintain our proprietary rights could materially and adversely affect our financial condition and results of operations.



Our products could infringe on the intellectual property rights of
others.



Given the complete factual and legal issues
associated with intellectual property rights, there can be no assurance that our current and future products do not or will not infringe the intellectual property rights of others. A determination that such infringement exists or even a claim that
it exists could involve us in costly litigation and have an adverse effect on our business and financial condition.



We operate in a consolidating industry that creates barriers to our market penetration.



The healthcare industry in recent years has been characterized by
consolidation. Large hospital chains and groups of affiliated hospitals prefer to negotiate comprehensive supply contracts for all of their supply needs at once. Large suppliers can often equip an entire laboratory and offer hospital chains and
groups one-stop shopping for laboratory instruments, supplies and service. Larger suppliers also typically offer annual rebates to their customers based on the customers total volume of business with the supplier. The convenience and rebates
offered by these large suppliers are administrative and financial incentives that we do not offer our customers. Our plans for further market penetration in the urinalysis market will depend in part on our ability to overcome these and any new
barriers resulting from continued consolidation in the healthcare industry. The failure to overcome such barriers could have a material adverse effect on our financial condition or results of operation.



Since we operate in the medical technology industry, our products are
subject to government regulation that could impair our operations.



Most of our products are subject to stringent government regulation in the United States and other countries. These regulatory processes can be lengthy, expensive and uncertain. Additionally, securing necessary
clearances or approvals may require the submission of extensive official data and other supporting information. Our failure to comply with applicable requirements could 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, or criminal prosecution. If any of these events were to occur, they could harm our business. Changes in existing federal,
state or foreign laws or regulations, or in the interpretation or enforcement of these laws, could also materially and adversely affect our business.



Changes in government regulation of the healthcare industry could adversely affect our business.



Federal and state legislative proposals are periodically introduced or
proposed that would affect 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 our current or future products and our ability to sell our products on a profitable basis. Moreover, healthcare legislation is an area of extensive and dynamic change, and we cannot
predict future legislative changes in the healthcare field or their impact on our industry or our business. Any impairment in our ability to market our products could have a material adverse effect on our financial condition and results of
operation.



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We may not be able to realize the deferred tax asset relating to our tax net operating loss carry
forward.



As of December 31, 2004, IRIS has deferred
tax assets of approximately $9.3 million resulting from 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.
There is no assurance that we will be able to generate taxable income in the years that the differences reverse. Also, should the Company undergo an ownership change as defined in Section 382 of the Internal Revenue Code, the Companys NOL
generated prior to the ownership change would be subject to an annual limitation. If this occurs, a valuation allowance may be necessary.



Our success depends largely on sales of laboratory instruments and related sales of consumables and service contracts.



Historically, we derived most of our revenues from the sale of urinalysis
instruments. Relatively modest declines in unit sales or gross margins for this product line could diminish our revenues and profits. In addition, because our installed instruments utilize a large volume of consumables and produce service revenue,
any decline in our installed base will diminish our revenues and profits even further.



We rely on independent and some single-source suppliers for key components of our instruments. Any delay or disruption in the supply of components may prevent us from selling our products and negatively impact
our operations.



Certain of our components are
obtained from outside vendors, and the loss or breakdown of our relationships with these outside vendors could subject us to substantial delays in the delivery of our products to our customers. Furthermore certain key components of our instruments
are manufactured by only one supplier. For example, ARKRAY is the single source supplier for our new line of urine chemistry analyzers and related consumable products and spare parts. Roche Diagnostics is the sole source for our proprietary
CHEMSTRIP/IRIStrip urine test strips and related urine test strip readers, both used in our legacy instruments, the Model 500 and 939 UDx urinalysis workstations. Because these suppliers are the only vendors with which we have a relationship for a
particular component, we may be unable to sell products if one of these suppliers becomes unwilling or unable to deliver components meeting our specifications. Our inability to sell products to meet delivery schedules could have a material adverse
effect on our reputation in the industry as well as our financial condition and results of operation.



One of our single-source suppliers has terminated its agreement with us.



Roche Diagnostics has exercised its right to terminate its agreements with us relating to the supply of test strips and
related urine test strip readers. Roche will continue to supply test strips and replacement readers to our installed base of legacy workstations for six years after termination of these contracts or 2009. The failure to successfully and timely
complete the phase out of their strips and readers with the introduction of our new iQ200 analyzers would have a material adverse affect on our instrument sales and the revenue growth for system supplies and service.



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We face intense competition and our failure to compete effectively, particularly against larger,
more established companies will cause our business to suffer.



The healthcare industry is highly competitive. We compete in this industry based primarily on product performance, service and price. Many of our competitors have substantially greater financial, technical and human resources than we do,
and may also have substantially greater experience in developing products, obtaining regulatory approvals and manufacturing and marketing and distribution. As a result, they may be better able to compete for market share, even in areas in which our
products may be superior. Further, our competitive position could be harmed by the establishment of patent protection by our competitors or other companies. The existing competitors or other companies may succeed in developing technologies and
products that are more effective or affordable than those being developed by us or that would render our technology and products less competitive or obsolete. If we are unable to effectively compete in our market, our financial condition and results
of operation will materially suffer.



Our success depends
on our ability to attract, retain and motivate management and other skilled employees.



Our success depends in significant part upon the continued services of key management and skilled personnel. Competition for qualified personnel is
intense and there are a limited number of people with knowledge of, and experience in, our industry. We do not have employment agreements with most of our key employees nor maintain life insurance polices on them. The loss of key personnel,
especially without advance notice, or our inability to hire or retain qualified personnel, could have a material adverse effect on our instrument sales and our ability to maintain our technological edge. We cannot guarantee that we will continue to
retain our key management and skilled personnel, or that we will be able to attract, assimilate and retain other highly qualified personnel in the future.



Defective products may subject us to liability.



Our products are used to gather information for medical decisions and diagnosis. Accordingly, a defect in the design or manufacture of our products, or a
failure of our products to perform for the use that we specify, could have a material adverse effect on our reputation in the industry and subject us to claims of liability arising from inaccurate or allegedly inaccurate test results. Misuse of our
products by a technician that results in inaccurate or allegedly inaccurate test results could similarly subject us to claims of liability. We currently maintain product liability insurance coverage for up to $1.0 million per incident and up to an
aggregate of $2.0 million per year. We also currently maintain a product liability umbrella policy for coverage of claims aggregating to $10.0 million. Although management believes this liability coverage is sufficient protection against future
claims, there can be no assurance of the sufficiency of these policies. Any substantial underinsured loss would have a material adverse effect on our financial condition and results of operation. Furthermore, any impairment of our reputation could
have a material adverse effect on our sales, revenues and prospects for future business. We have not received any indication that our insurance carrier will not renew our product liability insurance at or near current premiums; however, we cannot
guarantee that this will continue to be the case. In addition, any failure to comply with Federal Drug Administration regulations governing manufacturing practices could hamper our ability to defend against product liability lawsuits.



Business interruptions could adversely affect our business.



Products for Iris Diagnostics and StatSpin are
manufactured in a single facility for each division and are vulnerable to interruption in the event of war, terrorism, fire, earthquake, power loss, floods, telecommunications failure and other events beyond our control. If our facilities were
significantly damaged or destroyed by any cause, we would experience delays in locating a new facility and equipment and qualifying the new facility with the FDA. Our results would suffer. In addition, we may not carry adequate business interruption
insurance to compensate us for losses that may occur and any losses or damages incurred by us could be substantial.



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If we are unable to manage our growth, our results could suffer.



We have been experiencing significant growth in the scope of our operations.
This growth has placed significant demands on our management as well as operational resources. In order to achieve our business objectives, we anticipate that we will need to continue to grow. If this growth occurs, it will continue to place
additional significant demands on our management and our operational resources, and will require that we continue to develop and improve our operational, financial and other internal controls both in the U.S. and internationally. In particular, our
growth rate has increased, if it continues, will increase the challenges in implementing appropriate control systems, expanding our sales and marketing infrastructure capabilities, providing adequate training and supervision to maintain high quality
standards, and preserving our cultural values. The main challenge associated with our growth has been cash flow management. Our inability to scale our business appropriately or otherwise adopt to growth, could cause our business, financial condition
and results of operations to suffer.



Our quarterly sales
and operating results may fluctuate in future periods, and if we fail to meet expectations the price of our common stock may decline.



Our quarterly sales and operating results have fluctuated significantly in the past and are likely to do so in the future due to a number of factors, many
of which are not within our control. If our quarterly sales or operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Factors that might cause quarterly
fluctuations in our sales and operating results include the following:



| |  |  | variation in demand for our products, including seasonality;
| | - |  | ------------------------------------------------------------



| |  |  | our ability to develop, introduce, market and gain market acceptance of new products and product enhancements in a timely manner;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to manage inventories, accounts receivable and cash flows;
| | - |  | ----------------------------------------------------------------------



| |  |  | our ability to control costs;
| | - |  | -----------------------------



| |  |  | the size, timing, rescheduling or cancellation of orders from consumers and distributors; and
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | our ability to forecast future sales and operating results and subsequently attain them.
| | - |  | ----------------------------------------------------------------------------------------



The amount of expenses we incur depends, in part, on our expectations regarding future sales. In particular, we expect to
continue incurring substantial expenses relating to the marketing and promotion of our products. Since many of our costs are fixed in the short term, if we have a shortfall in sales, we may be unable to reduce expenses quickly enough to avoid
losses. If this occurs, we will not be profitable. Accordingly, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance.



We depend on independent distributors to sell our products in international markets.



We sell our products in international markets through independent
distributors. These distributors may not command the necessary resources to effectively market and sell our products. If a distributor fails to meet annual sales goals, it may be difficult and costly to locate an acceptable substitute distributor.
If a change in our distributors becomes necessary, we may experience increased costs, as well as substantial disruption and a resulting loss of sales.



Our sales in international markets are subject to a variety of laws and political and economic risks that may adversely impact our sales and results
of operations in certain regions.



Our ability to
capitalize on growth in new international markets and to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations. These include:



| |  |  | changes in currency exchange rates which impact the price to international consumers;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | the burdens of complying with a variety of foreign laws and regulations;
| | - |  | ------------------------------------------------------------------------



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| |  |  | unexpected changes in regulatory requirements; and
| | - |  | --------------------------------------------------



| |  |  | the difficulties associated with promoting products in unfamiliar cultures.
| | - |  | ---------------------------------------------------------------------------



We are also subject to general, political, economic and regulatory risks in connection with our international sales operations, including:



| |  |  | political instability;
| | - |  | ----------------------



| |  |  | changes in diplomatic and trade relationships;
| | - |  | ----------------------------------------------



| |  |  | general economic fluctuations in specific countries or markets; and
| | - |  | -------------------------------------------------------------------



| |  |  | changes in regulatory schemes.
| | - |  | ------------------------------



Any of the abovementioned factors could adversely affect our sales and results of operations in international markets.



We are subject to currency fluctuations.



We are exposed to certain foreign currency risks in the importation of goods
from Japan The new line of urine chemistry analyzers, two assemblies for our iQ200 platform and related consumables strips and spare parts are sourced from ARKRAY, a supplier located in Kyoto, Japan. Our purchases from this supplier are denominated
in Japanese Yen. These components represent a significant portion of our material costs. Fluctuations in the U.S. Dollar/ Japanese Yen exchange rate could result in increased costs for our key components. Any increases would reduce our gross margins
and would be likely to result in a material adverse effect on our revenues and financial condition. Similarly, we are also exposed to currency fluctuations with respect to the exportation of our products. All of our sales are denominated in U.S.
Dollars. Accordingly, any fluctuation in the exchange rate between the U.S. Dollar and the currency of the country with which we are exporting products could also affect our ability to sell internationally.



Risks Related to Ownership of Our Common Stock



Anti-takeover provisions of Delaware law could delay or prevent an
acquisition of our Company.



We are subject to the
anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control transaction.
They could also have the effect of discouraging others from making tender offers for our common stock or preventing changes in our management.



Item 7A.Quantitative and Qualitative Disclosures About Market Risk



Market Risk



Our business is exposed to various market risks, including changes in interest rates and foreign currency exchange rates. Market risk is the potential
loss arising from adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates. We do not invest in derivatives or other financial instruments for trading or speculative purposes. We have no debt at December
31, 2004.



Foreign Currencies



We are subject to some currency risk on purchases of product from our
Japanese manufacturer of the AX-4280. Our purchases of product are negotiated annually and may be affected by changing foreign currency rates.



Investment Available for Sale



We are subject to market risk relating to the investment in equity investments that are held and carried as available for sale. Market risk is the
potential loss arising from adverse changes in market conditions that may be deemed as other than temporary declines in the fair value of the investment.



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Item 8.Financial Statements and Supplementary Data



Our Index to Financial Statements, Consolidated Financial Statements, the reports thereon, and the notes thereto commence on Page 30 of this Annual Report
on Form 10-K, immediately following Part IV, Item 15.



Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure



None.



Item 9A.Controls and Procedures



We maintain disclosure controls and procedures, which are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms, and that such information is accumulated and communicated to our management, including our chief
executive officer, or CEO, and chief financial officer, or CFO, as appropriate to allow timely decisions regarding required disclosure.



Under the supervision and with the participation of our management, including our CEO and CFO, an evaluation was performed on the effectiveness of the
design and operation of our disclosure controls and procedures as of the end of the period covered by this annual report. Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were
effective as of December 31, 2004.



An evaluation was also
performed under the supervision and with the participation of our management, including our CEO and CFO, of any change in our internal controls over financial reporting that occurred during our last fiscal quarter and that has materially affected,
or is reasonably likely to materially affect, our internal controls over financial reporting. That evaluation did not identify any change in our internal controls over financial reporting that occurred during our latest fiscal quarter and that has
materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.



Managements Report on Internal Control Over Financial Reporting



Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as this term is defined in Exchange Act
Rules 13a-15(f). All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and
presentation.



Under the supervision and with the participation
of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control  Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control  Integrated Framework, our management concluded that our internal control over financial
reporting was effective as of December 31, 2004.



Our
managements assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has been audited by BDO Seidman LLP, an independent registered public accounting firm, as stated in their report which is
included below.



26



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##### Table of Contents

Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting



To the Board of Directors and Stockholders of IRIS International, Inc.



We have audited managements assessment, included in the
accompanying Managements Report on Internal Control Over Financial Reporting, that IRIS International, Inc. (IRIS) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in
Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). IRIS management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of IRIS internal
control over financial reporting based on our audit.



We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control
over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.



A companys internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal
control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only
in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have
a material effect on the financial statements.



Because of its
inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



In our opinion, managements assessment that IRIS maintained effective internal control over financial reporting as of December 31, 2004, is fairly
stated, in all material respects, based on the COSO criteria. Also, in our opinion, IRIS maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.



We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of IRIS International, Inc., as of December 31, 2004 and 2003 and the related consolidated statements of operations, stockholders equity and cash flows for each of the
three years in the period ended December 31, 2004 of IRIS and our report dated February 25, 2005 expressed an unqualified opinion thereon.



/s/ BDO SEIDMAN LLP



Los Angeles, California

February 25, 2005



Item 9B.Other Information



None



27



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##### Table of Contents

PART III



Item 10.Directors and Executive Officers of the Registrant



Information regarding directors and executive officers will appear in the definitive proxy statement for the 2005 annual meeting of IRIS shareholders, and
is incorporated herein by reference. This proxy statement will be filed within 120 days following December 31, 2004.



Item 11.Executive Compensation



Information regarding executive compensation will appear in the definitive proxy statement for the 2005 annual meeting of IRIS shareholders, and is incorporated herein by reference.



Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters



Information regarding security ownership of certain beneficial owners and management and related stockholder matters will appear in the definitive proxy
statement for the 2005 annual meeting of IRIS shareholders, and is incorporated herein by reference.



Item 13.Certain Relationships and Related Transactions



Information regarding certain relationships and related transactions will appear in the definitive proxy statement for the 2005 annual meeting of IRIS
shareholders, and is incorporated herein by reference.



Item 14.Principal Accounting Fees and Services



Information regarding principal accounting fees and services will appear in the definitive proxy statement for the 2005 annual meeting of IRIS
shareholders, and is incorporated herein by reference.



28



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##### Table of Contents

PART IV



Item 15.Exhibits, Financial Statement Schedules



Financial Statements and Financial Statement Schedules:



Reference is made to the Index to Financial Statements, Consolidated Financial Statements, the reports thereon, and the notes thereto commencing on Page
30 of this Annual Report on Form 10-K.



Exhibits



|              |  |                                                                                                                                                             |  |                   
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------
|ExhibitNumber |  | Description                                                                                                                                                 |  | Reference Document
|              |  |                                                                                                                                                            
|3.1(a)        |  | Certificate of Incorporation, as amended                                                                                                                    |  | (1)               
|              |  |                                                                                                                                                            
|3.1(b)        |  | Certificate of Designations, Preferences and Rights of Series C Preferred                                                                                   |  | (3)               
|              |  |                                                                                                                                                            
|3.1(c)        |  | Certificate of Ownership and Merger                                                                                                                         |  | (17)              
|              |  |                                                                                                                                                            
|3.2           |  | Restated Bylaws as amended                                                                                                                                  |  | (17)              
|              |  |                                                                                                                                                            
|4.1           |  | Specimen of Common Stock Certificate                                                                                                                        |  | (4)               
|              |  |                                                                                                                                                            
|4.2           |  | Rights Agreement, dated as of January 21, 2000, between the Company and Continental Stock Transfer & Trust Company, as Rights Agent, with related exhibits. |  | (3)               
|              |  |                                                                                                                                                            
|4.3           |  | Certificate of Designations, Preferences and Rights of Series C Preferred                                                                                   |  | (3)               
|              |  |                                                                                                                                                            
|10.1(a)       |  | Lease of the Companys headquarters facility, as amended                                                                                                    |  | (5)               
|              |  |                                                                                                                                                            
|10.1(b)       |  | Lease of the Companys adjacent headquarters facility                                                                                                       |  | (16)              
|              |  |                                                                                                                                                            
|10.2(a)       |  | 1994 Stock Option Plan and forms of Stock Option Agreements                                                                                                 |  | (6)              
|              |  |                                                                                                                                                            
|10.2(b)       |  | Certificate of Officer With Respect to Amendment of 1994 Stock Option Plan                                                                                  |  | (7)               
|              |  |                                                                                                                                                            
|10.2(c)       |  | Employee Stock Purchase Plan                                                                                                                                |  | (14)             
|              |  |                                                                                                                                                            
|10.2(d)       |  | 1997 Stock Option Plan and form of Stock Option Agreement                                                                                                   |  | (8)              
|              |  |                                                                                                                                                            
|10.2(e)       |  | 1998 Stock Option Plan and form of Stock Option Agreement                                                                                                   |  | (9)              
|              |  |                                                                                                                                                            
|10.3(a)       |  | Patent License Agreement dated April 1, 1997 between the Company and Sysmex Corporation, formerly TOA Medical Electronics Company, Ltd.                     |  | (10)              
|              |  |                                                                                                                                                            
|10.3(b)       |  | Amendment No. 1 to Patent License Agreement dated February 29, 2000                                                                                         |  | (14)              
|              |  |                                                                                                                                                            
|10.4(a)       |  | Agreement for a Strategic Alliance in Urinalysis dated January 7, 1994 between the Company and Boehringer Mannheim Corporation                              |  | (11)              
|              |  |                                                                                                                                                            
|10.4(b)       |  | Amendment to Distribution Agreements                                                                                                                        |  | (12)              
|              |  |                                                                                                                                                            
|10.5(a)       |  | Registration Rights and Standstill Agreement dated July 31, 1996 between the Company and Digital Imaging Technologies, Inc.                                 |  | (7)               
|              |  |                                                                                                                                                            
|10.5(b)       |  | Warrant Certificate dated March 14, 2001 issued to Digital Imaging Technologies, Inc. to purchase 853,040 shares of Common Stock                            |  | (15)              
|              |  |                                                                                                                                                            
|10.5(c)       |  | Form of Warrant issued to April 2004 investors to purchase an aggregate of 319,500 shares of Common Stock                                                   |  | (18)              
|              |  |                                                                                                                                                            
|10.5(d)       |  | Warrant Certificate dated April 19, 2004, issued to Oppenheimer & Co. Inc. to purchase 122,475 shares of Common Stock                                       |  | *                 



29



---

##### Table of Contents

|              |  |                                                                                                                                                                           |  |                   
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------
|ExhibitNumber |  | Description                                                                                                                                                               |  | Reference Document
|              |  |                                                                                                                                                                          
|10.6          |  | Registration Rights Agreement dated December 31, 1996 by and between the Company and Thermo Amex Convertible Growth Fund I, L.P.                                          |  | (13)              
|              |  |                                                                                                                                                                          
|10.7          |  | Asset Purchase Agreement dated as of July 6, 2000 among the company, Perceptive Scientific Instruments, LLC and Applied Imaging Corporation                               |  | (14)              
|              |  |                                                                                                                                                                          
|10.8(a)       |  | Business Loan Agreements dated February 7, 2002 by and between the Company and California Bank & Trust                                                                    |  | (16)              
|              |  |                                                                                                                                                                          
|10.8(b)       |  | Promissory Notes dated February 7, 2002 by and between the Company and California Bank & Trust                                                                            |  | (16)              
|              |  |                                                                                                                                                                          
|10.8(c)       |  | Change in Terms Agreement dated May 25, 2004 by and between the Company and California Bank & Trust                                                                       |  | *                 
|              |  |                                                                                                                                                                          
|10.8(d)       |  | Business Loan Agreement dated May 25, 2004 by and between the Company and California Bank & Trust                                                                         |  | *                 
|              |  |                                                                                                                                                                          
|10.8(e)       |  | Promissory Note dated May 25, 2004 by and between the Company and California Bank & Trust                                                                                 |  | *                 
|              |  |                                                                                                                                                                          
|10.8(f)       |  | Commercial Security Agreements dated May 25, 2004 by and between the Company and California Bank & Trust                                                                  |  | *                 
|              |  |                                                                                                                                                                          
|10.8(g)       |  | Landlords Consent dated February 7, 2002 by and between the Company, the Companys Landlord and California Bank & Trust                                                  |  | (16)              
|              |  |                                                                                                                                                                          
|10.8(h)       |  | Commercial Guaranty Agreement dated May 25, 2004 by and between the Company, Statspin, Inc (the Companys affiliate) and California Bank & Trust                          |  | *                 
|              |  |                                                                                                                                                                          
|10.8(i)       |  | Commercial Guaranty Agreement dated May 25, 2004 by and between the Company, Advanced Digital Imaging Research, LLP (the Companys affiliate) and California Bank & Trust |  | *                 
|              |  |                                                                                                                                                                          
|10.9          |  | Employment Agreement dated January 5, 2004 by and between the Company and Martin G. Paravato                                                                              |  | (17)             
|              |  |                                                                                                                                                                          
|10.10         |  | Employment Agreement dated February 13, 2004 by and between the Company and Cesar M Garcia                                                                                |  | (17)             
|              |  |                                                                                                                                                                          
|10.11         |  | Stock Purchase Agreement, dated April 19, 2004, by and between the Company and the purchasers identified therein.                                                         |  | (18)              
|              |  |                                                                                                                                                                          
|21            |  | List of Subsidiaries                                                                                                                                                      |  | *                 
|              |  |                                                                                                                                                                          
|23            |  | Consent of BDO Seidman, LLP                                                                                                                                               |  | *                 
|              |  |                                                                                                                                                                          
|31.1          |  | Statement Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 By Chief Executive Officer                                                                            |  | *                 
|              |  |                                                                                                                                                                          
|31.2          |  | Statement Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 By Chief Financial Officer                                                                            |  | *                 
|              |  |                                                                                                                                                                          
|32.1          |  | Statement Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 By Chief Executive Officer                                                                            |  | *                 
|              |  |                                                                                                                                                                          
|32.2          |  | Statement Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 By Chief Financial Officer                                                                            |  | *                 

---

|* | Filed herewith
|- | --------------

| | Each a management contract or compensatory plan or arrangement required to be filed as an
exhibit to this annual report on Form 10-K.
|- | -------------------------------------------------------------------------------------------------------------------------------------



30



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##### Table of Contents

Exhibits followed by a number in parenthesis are incorporated by reference to the similarly numbered
Company document cited below:



|(1) | Current Report on Form 8-K dated August 13, 1987 and Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.
|--- | ----------------------------------------------------------------------------------------------------------------------------

|(2) | Intentionally omitted.
|--- | ----------------------

|(3) | Current Report on Form 8-K dated January 26, 2000.
|--- | --------------------------------------------------

|(4) | Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.
|--- | -----------------------------------------------------------------------

|(5) | Annual Report on Form 10-K for the year ended December 31, 1989, Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 and Annual Report on Form 10-K for the year
ended December 31, 1994.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Registration Statement on Form S-8, as filed with the Securities and Exchange Commission on August 8, 1994 (File No. 33-82560).
|--- | -------------------------------------------------------------------------------------------------------------------------------

|(7) | Quarterly Report on Form 10-Q for the quarter ended June 30, 1996.
|--- | ------------------------------------------------------------------

|(8) | Registration Statement on Form S-8, as filed with the Securities and Exchange Commission on July 16, 1997 (File No. 333-31393).
|--- | -------------------------------------------------------------------------------------------------------------------------------

|(9) | Registration Statement on Form S-8, as filed with the Securities and Exchange Commission on October 9, 1998 (File No. 333-65547).
|--- | ---------------------------------------------------------------------------------------------------------------------------------

|(10) | Annual Report on Form 10-K for the year ended December 31, 1997
|---- | ---------------------------------------------------------------

|(11) | Annual Report on Form 10-K for the year ended December 31, 1994
|---- | ---------------------------------------------------------------

|(12) | Quarterly Report on Form 10-Q for the quarter ended September 30, 1996
|---- | ----------------------------------------------------------------------

|(13) | Quarterly Report on Form 10-Q for the quarter ended June 30, 2000
|---- | -----------------------------------------------------------------

|(14) | Annual Report on Form 10-K for the year ended December 31, 1999
|---- | ---------------------------------------------------------------

|(15) | Annual Report on Form 10-K for the year ended December 31, 2000
|---- | ---------------------------------------------------------------

|(16) | Annual Report on Form 10-K for the year ended December 31, 2002
|---- | ---------------------------------------------------------------

|(17) | Annual Report on Form 10-K for the year ended December 31, 2003
|---- | ---------------------------------------------------------------

|(18) | Current Report on Form 8-K dated April 22, 2004.
|---- | ------------------------------------------------



31



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##### Table of Contents

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 March 11, 2005.



IRIS INTERNATIONAL, INC./s/    CESAR M.
GARCIACesar M. Garcia,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/    CESAR M.
GARCIACesar M.
Garcia         |  | President and Chief Executive Officer (Principal Executive Officer) |  | March 11, 2005
|                                              |  |                                                                    
|/s/    MARTIN G.
PARAVATOMartin G.
Paravato   |  | Chief Financial Officer and Secretary (Principal Financial Officer) |  | March 11, 2005
|                                              |  |                                                                    
|/s/    DONALD E.
HORACEKDonald E.
Horacek     |  | Controller (Principal Accounting Officer)                           |  | March 11, 2005
|                                              |  |                                                                    
|/s/    RICHARD H.
WILLIAMSRichard H.
Williams |  | Chairman of the Board                                               |  | March 11, 2005
|                                              |  |                                                                    
|/s/    STEVEN M.
BESBECKSteven M.
Besbeck     |  | Director                                                            |  | March 11, 2005
|                                              |  |                                                                    
|/s/    THOMAS F.
KELLEYThomas F.
Kelley       |  | Director                                                            |  | March 11, 2005
|                                              |  |                                                                    
|/s/    MICHAEL D.
MATTEMichael D.
Matte       |  | Director                                                            |  | March 11, 2005
|                                              |  |                                                                    
|/s/    RICHARD G.
NADEAURichard G.
Nadeau     |  | Director                                                            |  | March 11, 2005



32



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##### Table of Contents

Index to Financial Statements



|                                                                                                   |  |   
|-------------------------------------------------------------------------------------------------- |  | --
|Report of Independent Registered Public Accounting Firm                                            |  | 34
|                                                                                                   | 
|Consolidated Balance Sheets at December 31, 2004 and 2003                                          |  | 35
|                                                                                                   | 
|Consolidated Statements of Operations for the three years ended December 31, 2004                  |  | 36
|                                                                                                   | 
|Consolidated Statements of Shareholders Equity for the three years ended December 31, 2004        |  | 37
|                                                                                                   | 
|Consolidated Statements of Cash Flow for the three years ended December 31, 2004                   |  | 39
|                                                                                                   | 
|Consolidated Statements of Comprehensive Income (loss) for the three years ended December 31, 2004 |  | 40
|                                                                                                   | 
|Notes to Consolidated Financial Statements                                                         |  | 41



33



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Shareholders

of IRIS International, Inc.

Chatsworth, California



We have
audited the accompanying consolidated balance sheets of IRIS International, Inc. (formerly known as International Remote Imaging Systems, Inc.) as of December 31, 2004 and 2003, the related consolidated statements of operations, shareholders
equity, cash flows and comprehensive income (loss) for the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits.



We conducted our
audits in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). 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 presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
financial position of IRIS International, Inc. at December 31, 2004 and 2003, and the results of its operations, cash flows and comprehensive income (loss) for the three years in the period ended December 31, 2004 in conformity with accounting
principles generally accepted in the United States of America.



We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of IRIS International, Inc.s internal control over financial reporting as of December 31, 2004,
based on criteria established in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 25, 2005 expressed an unqualified opinion
thereon.



/s/ BDO Seidman, LLP



Los Angeles, California

February 25, 2005





34



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##### Table of Contents

IRIS INTERNATIONAL, INC.



CONSOLIDATED BALANCE SHEETS



|                                                                                                               |  |                 |         |   |      |   |         |  
|-------------------------------------------------------------------------------------------------------------- |  | --------------- | ------- | - | ---- | - | ------- | -
|                                                                                                               |  | At December 31, |        
|                                                                                                               |  | 2004            |         |   | 2003 |  
|                                                                                                               |  | (In thousands)  |        
|Assets                                                                                                         |  |                 |         |   |      |   |         |  
|Current assets:                                                                                                |  |                 |         |   |      |   |         |  
|Cash and cash equivalents (note 2)                                                                             |  | $               | 12,839  |   |      | $ | 2,444   |  
|Accounts receivable, net of allowance for doubtful accounts and sales returns of $336 and $312 (notes 2 and 8) |  |                 | 8,847   |   |      |   | 7,193   |  
|Inventories, net (notes 2, 3 and 8)                                                                            |  |                 | 7,834   |   |      |   | 5,353   |  
|Prepaid expenses and other current assets                                                                      |  |                 | 381     |   |      |   | 462     |  
|Investment available for sale (note 2)                                                                         |  |                 | 198     |   |      |   | 582     |  
|Deferred tax asset (note 9)                                                                                    |  |                 | 3,650   |   |      |   | 1,573   |  
|                                                                                                               |  |                 |         |   |      |   |         |  
|Total current assets                                                                                           |  |                 | 33,749  |   |      |   | 17,607  |  
|Property and equipment, at cost, net of accumulated depreciation(notes 2 and 4)                                |  |                 | 3,880   |   |      |   | 3,613   |  
|Goodwill (note 2)                                                                                              |  |                 | 189     |   |      |   | 189     |  
|Software development costs, net of accumulated amortization of $2,186 and $1,655 in 2003 (note 2)              |  |                 | 1,930   |   |      |   | 2,397   |  
|Deferred tax asset (note 9)                                                                                    |  |                 | 5,665   |   |      |   | 7,220   |  
|Inventories  long term portion (note 3)                                                                       |  |                 | 290     |   |      |   | 973     |  
|Other assets (note 5)                                                                                          |  |                 | 2,433   |   |      |   | 481     |  
|                                                                                                               |  |                 |         |   |      |   |         |  
|Total assets                                                                                                   |  | $               | 48,136  |   |      | $ | 32,480  |  
|                                                                                                               |  |                 |         |   |      |   |         |  
|Liabilities And Shareholders Equity                                                                           |  |                 |         |   |      |   |         |  
|Current liabilities:                                                                                           |  |                 |         |   |      |   |         |  
|Accounts payable                                                                                               |  | $               | 4,258   |   |      | $ | 3,636   |  
|Accrued expenses (note 7)                                                                                      |  |                 | 3,398   |   |      |   | 2,956   |  
|Short-term borrowings (note 8)                                                                                 |  |                 |        |   |      |   | 2,900   |  
|Current portion of long-term debt (note 8)                                                                     |  |                 |        |   |      |   | 350     |  
|Deferred service contract revenue                                                                              |  |                 | 1,134   |   |      |   | 1,151   |  
|                                                                                                               |  |                 |         |   |      |   |         |  
|Total current liabilities                                                                                      |  |                 | 8,790   |   |      |   | 10,993  |  
|Long-term debt (note 8)                                                                                        |  |                 |        |   |      |   | 1,782   |  
|Deferred service contract revenue, long term                                                                   |  |                 | 173     |   |      |   | 238     |  
|                                                                                                               |  |                 |         |   |      |   |         |  
|Total liabilities                                                                                              |  |                 | 8,963   |   |      |   | 13,013  |  
|                                                                                                               |  |                
|Commitments and contingencies (note 11)                                                                        |  |                 |         |   |      |   |         |  
|                                                                                                               |  |                
|Shareholders equity: (note 10)                                                                                |  |                 |         |   |      |   |         |  
|Common stock, $.01 par value                                                                                   |  |                 |         |   |      |   |         |  
|Authorized: 50 million shares;issued and outstanding: 15,962 shares and 11,901 shares                          |  |                 | 159     |   |      |   | 119     |  
|Additional paid-in capital                                                                                     |  |                 | 61,972  |   |      |   | 44,717  |  
|Unearned compensation                                                                                          |  |                 | (125    | ) |      |   | (45     | )
|Accumulated other comprehensive income (loss)                                                                  |  |                 | 11      |   |      |   | (200    | )
|Accumulated deficit                                                                                            |  |                 | (22,844 | ) |      |   | (25,124 | )
|                                                                                                               |  |                 |         |   |      |   |         |  
|Total shareholders equity                                                                                     |  |                 | 39,173  |   |      |   | 19,467  |  
|                                                                                                               |  |                 |         |   |      |   |         |  
|Total liabilities and shareholders equity                                                                     |  | $               | 48,136  |   |      | $ | 32,480  |  
|                                                                                                               |  |                 |         |   |      |   |         |  



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





35



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##### Table of Contents

IRIS INTERNATIONAL, INC.



CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|-------------------------------------------------------------- |  | ---------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                               |  | For the Year ended December 31,          |       
|                                                               |  | 2004                                     |        |   | 2003 |   |        | 2002 | 
|                                                               |  | (In thousands, except per share amounts) |       
|Sales of IVD instruments                                       |  | $                                        | 14,845 |   |      | $ | 7,470  |      |  | $ | 5,515  |  
|Sales of IVD consumables and service                           |  |                                          | 20,126 |   |      |   | 17,252 |      |  |   | 16,436 |  
|Sales of small laboratory devices and supplies                 |  |                                          | 8,343  |   |      |   | 6,076  |      |  |   | 5,729  |  
|Royalty and license revenues                                   |  |                                          | 336    |   |      |   | 547    |      |  |   | 508    |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Net revenues                                                   |  |                                          | 43,650 |   |      |   | 31,345 |      |  |   | 28,188 |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Cost of goods  IVD instruments                                |  |                                          | 10,092 |   |      |   | 5,982  |      |  |   | 3,649  |  
|Cost of goods  IVD consumable and supplies                    |  |                                          | 7,982  |   |      |   | 6,629  |      |  |   | 6,177  |  
|Cost of goods  small laboratory devices and supplies          |  |                                          | 4,185  |   |      |   | 3,101  |      |  |   | 2,774  |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Cost of goods sold                                             |  |                                          | 22,259 |   |      |   | 15,712 |      |  |   | 12,600 |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Gross margin                                                   |  |                                          | 21,391 |   |      |   | 15,633 |      |  |   | 15,588 |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Marketing and selling                                          |  |                                          | 7,165  |   |      |   | 5,346  |      |  |   | 4,068  |  
|General and administrative                                     |  |                                          | 5,841  |   |      |   | 6,437  |      |  |   | 5,024  |  
|Research and development, net                                  |  |                                          | 3,920  |   |      |   | 4,393  |      |  |   | 4,594  |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Total operating expenses                                       |  |                                          | 16,926 |   |      |   | 16,176 |      |  |   | 13,686 |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Operating income (loss)                                        |  |                                          | 4,465  |   |      |   | (543   | )    |  |   | 1,902  |  
|Other income (expense):                                        |  |                                          |        |   |      |   |        |      |  |   |        |  
|Interest income                                                |  |                                          | 111    |   |      |   | 40     |      |  |   | 57     |  
|Interest expense                                               |  |                                          | (243   | ) |      |   | (351   | )    |  |   | (537   | )
|Other income (expense)                                         |  |                                          | (534   | ) |      |   | (29    | )    |  |   | 39     |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Income (loss) before provision (benefit) for income taxes      |  |                                          | 3,799  |   |      |   | (883   | )    |  |   | 1,461  |  
|Provision (benefit) for income taxes                           |  |                                          | 1,519  |   |      |   | (353   | )    |  |   | 584    |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Net income (loss)                                              |  | $                                        | 2,280  |   |      | $ | (530   | )    |  | $ | 877    |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Basic net income (loss) per share                              |  | $                                        | 0.16   |   |      | $ | (0.05  | )    |  | $ | 0.08   |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Diluted net income (loss) per share                            |  | $                                        | 0.14   |   |      | $ | (0.05  | )    |  | $ | 0.08   |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Weighted average number of common shares outstanding  basic   |  |                                          | 14,459 |   |      |   | 11,245 |      |  |   | 10,566 |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  
|Weighted average number of common shares outstanding  diluted |  |                                          | 15,818 |   |      |   | 11,245 |      |  |   | 11,542 |  
|                                                               |  |                                          |        |   |      |   |        |      |  |   |        |  



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





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IRIS INTERNATIONAL, INC.



CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY

(in thousands)



|                                                                       |  |                                   |   |  |              |    |                           |        |                      |        |   |                                     |  |   |                    |  |   |       |   |  |   |      |   |  |   |         |   |  |   |        |  
|---------------------------------------------------------------------- |  | --------------------------------- | - |  | ------------ | -- | ------------------------- | ------ | -------------------- | ------ | - | ----------------------------------- |  | - | ------------------ |  | - | ----- | - |  | - | ---- | - |  | - | ------- | - |  | - | ------ | -
|                                                                       |  | Callable Series B Preferred Stock |   |  | Common Stock |    | AdditionalPaid-In Capital |        | UnearnedCompensation |        |   | AccumulatedOtherComprehensiveIncome |  |   | AccumulatedDeficit |  |   | Total |  
|                                                                       |  | Shares                            |   |  | Amount       |    |                           | Shares |                      | Amount |   |                                     |  |   |                   
|Balance, January 1, 2002                                               |  | 205                               |   |  | $            | 2  |                           |        | 10,265               |        | $ | 103                                 |  | $ | 41,311             |  | $ | (55   | ) |  | $ | 73   |   |  | $ | (25,471 | ) |  | $ | 15,963 |  
|Common stock issued on exercise of stock options and warrants          |  |                                  |   |  |              |   |                           |        | 318                  |        |   | 3                                   |  |   | 550                |  |   |      |   |  |   |     |   |  |   |        |   |  |   | 553    |  
|Common stock issued under employee stock purchase plan for cash        |  |                                  |   |  |              |   |                           |        | 14                   |        |   |                                    |  |   | 30                 |  |   | (15   | ) |  |   |     |   |  |   |        |   |  |   | 15     |  
|Conversion of Series B Preferred                                       |  | (205                              | ) |  |              | (2 | )                         |        | 248                  |        |   | 2                                   |  |   |                   |  |   |      |   |  |   |     |   |  |   |        |   |  |   |       |  
|Amortization of unearned compensation                                  |  |                                  |   |  |              |   |                           |        |                     |        |   |                                    |  |   |                   |  |   | 53    |   |  |   |     |   |  |   |        |   |  |   | 53     |  
|Unrealized losses on investments                                       |  |                                  |   |  |              |   |                           |        |                     |        |   |                                    |  |   |                   |  |   |      |   |  |   | (113 | ) |  |   |        |   |  |   | (113   | )
|Net income for year                                                    |  |                                  |   |  |              |   |                           |        |                     |        |   |                                    |  |   |                   |  |   |      |   |  |   |     |   |  |   | 877     |   |  |   | 877    |  
|                                                                       |  |                                   |   |  |              |    |                           |        |                      |        |   |                                     |  |   |                    |  |   |       |   |  |   |      |   |  |   |         |   |  |   |        |  
|Balance, December 31, 2002                                             |  |                                  |   |  |              |   |                           |        | 10,845               |        | $ | 108                                 |  | $ | 41,891             |  | $ | (17   | ) |  | $ | (40  | ) |  | $ | (24,594 | ) |  | $ | 17,348 |  
|Common stock issued on exercise of stock options                       |  |                                   |   |  |              |    |                           |        | 518                  |        |   | 5                                   |  |   | 709                |  |   |      |   |  |   |     |   |  |   |        |   |  |   | 714    |  
|Common stock issued under employee stock purchase plan for cash        |  |                                   |   |  |              |    |                           |        | 38                   |        |   | 1                                   |  |   | 139                |  |   | (70   | ) |  |   |     |   |  |   |        |   |  |   | 70     |  
|Private placement of stock, net of offering costs                      |  |                                   |   |  |              |    |                           |        | 500                  |        |   | 5                                   |  |   | 1,613              |  |   |      |   |  |   |     |   |  |   |        |   |  |   | 1,618  |  
|Effect of variable accounting for options granted to certain employees |  |                                   |   |  |              |    |                           |        |                     |        |   |                                    |  |   | 336                |  |   | (70   | ) |  |   |     |   |  |   |        |   |  |   | 266    |  
|Issuance of warrants for services                                      |  |                                   |   |  |              |    |                           |        |                     |        |   |                                    |  |   | 29                 |  |   | (29   | ) |  |   |     |   |  |   |        |   |  |   |       |  
|Amortization of unearned compensation                                  |  |                                   |   |  |              |    |                           |        |                     |        |   |                                    |  |   |                   |  |   | 141   |   |  |   |     |   |  |   |        |   |  |   | 141    |  
|Unrealized losses on investments                                       |  |                                   |   |  |              |    |                           |        |                     |        |   |                                    |  |   |                   |  |   |      |   |  |   | (160 | ) |  |   |        |   |  |   | (160   | )
|Net loss for year                                                      |  |                                   |   |  |              |    |                           |        |                     |        |   |                                    |  |   |                   |  |   |      |   |  |   |     |   |  |   | (530    | ) |  |   | (530   | )
|                                                                       |  |                                   |   |  |              |    |                           |        |                      |        |   |                                     |  |   |                    |  |   |       |   |  |   |      |   |  |   |         |   |  |   |        |  
|Balance, December 31, 2003                                             |  |                                  |   |  | $            |   |                           |        | 11,901               |        | $ | 119                                 |  | $ | 44,717             |  | $ | (45   | ) |  | $ | (200 | ) |  | $ | (25,124 | ) |  | $ | 19,467 |  
|                                                                       |  |                                   |   |  |              |    |                           |        |                      |        |   |                                     |  |   |                    |  |   |       |   |  |   |      |   |  |   |         |   |  |   |        |  



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





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IRIS INTERNATIONAL, INC.



CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY (continued)



|                                                                |  |              |  |                           |     |                       |   |        |                                             |   |      |                     |  |   |       |   |  |   |         |   |  |   |        |  
|--------------------------------------------------------------- |  | ------------ |  | ------------------------- | --- | --------------------- | - | ------ | ------------------------------------------- | - | ---- | ------------------- |  | - | ----- | - |  | - | ------- | - |  | - | ------ | -
|                                                                |  | Common Stock |  | AdditionalPaid-In Capital |     | Unearned Compensation |   |        | AccumulatedOtherComprehensive Income (Loss) |   |      | Accumulated Deficit |  |   | Total |  
|                                                                |  | Shares       |  | Amount                    |     |                       |   |        |                                            
|Balance, December 31, 2003                                      |  | 11,901       |  | $                         | 119 |                       | $ | 44,717 |                                             | $ | (45  | )                   |  | $ | (200  | ) |  | $ | (25,124 | ) |  | $ | 19,467 |  
|Common stock issued on exercise of stock options and warrants   |  | 1,864        |  |                           | 18  |                       |   | 3,285  |                                             |   |     |                     |  |   |      |   |  |   |        |   |  |   | 3,303  |  
|Tax benefit from stock options                                  |  |             |  |                           |    |                       |   | 2,015  |                                             |   |     |                     |  |   |      |   |  |   |        |   |  |   | 2,015  |  
|Common stock issued under employee stock purchase plan for cash |  | 67           |  |                           | 1   |                       |   | 470    |                                             |   | (224 | )                   |  |   |      |   |  |   |        |   |  |   | 247    |  
|Private placement of stock, net of offering costs               |  | 2,130        |  |                           | 21  |                       |   | 11,485 |                                             |   |     |                     |  |   |      |   |  |   |        |   |  |   | 11,506 |  
|Amortization of unearned compensation                           |  |             |  |                           |    |                       |   |       |                                             |   | 144  |                     |  |   |      |   |  |   |        |   |  |   | 144    |  
|Realized loss on investments                                    |  |             |  |                           |    |                       |   |       |                                             |   |     |                     |  |   | 538   |   |  |   |        |   |  |   | 538    |  
|Unrealized loss on investments                                  |  |             |  |                           |    |                       |   |       |                                             |   |     |                     |  |   | (327  | ) |  |   |        |   |  |   | (327   | )
|Net income for year                                             |  |             |  |                           |    |                       |   |       |                                             |   |     |                     |  |   |      |   |  |   | 2,280   |   |  |   | 2,280  |  
|                                                                |  |              |  |                           |     |                       |   |        |                                             |   |      |                     |  |   |       |   |  |   |         |   |  |   |        |  
|Balance, December 31, 2004                                      |  | 15,962       |  | $                         | 159 |                       | $ | 61,972 |                                             | $ | (125 | )                   |  | $ | 11    |   |  | $ | (22,844 | ) |  | $ | 39,173 |  
|                                                                |  |              |  |                           |     |                       |   |        |                                             |   |      |                     |  |   |       |   |  |   |         |   |  |   |        |  



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





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IRIS INTERNATIONAL, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                         |  |                                 |        |   |      |   |        |      |  |   |        |  
|---------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                         |  | For the Year ended December 31, |       
|                                                                                         |  | 2004                            |        |   | 2003 |   |        | 2002 | 
|                                                                                         |  | (In thousands)                  |       
|Cash flows from operating activities:                                                    |  |                                 |        |   |      |   |        |      |  |   |        |  
|Net income (loss)                                                                        |  | $                               | 2,280  |   |      | $ | (530   | )    |  | $ | 877    |  
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operations: |  |                                 |        |   |      |   |        |      |  |   |        |  
|Deferred taxes                                                                           |  |                                 | 1,353  |   |      |   | (408   | )    |  |   | 645    |  
|Depreciation and amortization                                                            |  |                                 | 1,731  |   |      |   | 1,010  |      |  |   | 1,012  |  
|Common stock and stock option compensation                                               |  |                                 | 144    |   |      |   | 406    |      |  |   | 53     |  
|Loss on sale/write down of investment                                                    |  |                                 | 538    |   |      |   | 30     |      |  |   |       |  
|Changes in assets and liabilities:                                                       |  |                                 |        |   |      |   |        |      |  |   |        |  
|Accounts receivable                                                                      |  |                                 | (1,654 | ) |      |   | (2,916 | )    |  |   | 647    |  
|Deferred service contract revenue                                                        |  |                                 | (82    | ) |      |   | 307    |      |  |   | (205   | )
|Inventories, net                                                                         |  |                                 | (1,798 | ) |      |   | (902   | )    |  |   | 154    |  
|Prepaid expenses and other current assets                                                |  |                                 | 81     |   |      |   | (131   | )    |  |   | (62    | )
|Other assets                                                                             |  |                                 | (2,200 | ) |      |   | (87    | )    |  |   | (130   | )
|Accounts payable                                                                         |  |                                 | 622    |   |      |   | 982    |      |  |   | 358    |  
|Accrued expenses                                                                         |  |                                 | 497    |   |      |   | 1,152  |      |  |   | 101    |  
|                                                                                         |  |                                 |        |   |      |   |        |      |  |   |        |  
|Net cash provided by (used in) operating activities                                      |  |                                 | 1,512  |   |      |   | (1,087 | )    |  |   | 3,450  |  
|                                                                                         |  |                                 |        |   |      |   |        |      |  |   |        |  
|Cash flows from investing activities:                                                    |  |                                 |        |   |      |   |        |      |  |   |        |  
|Acquisition of property and equipment                                                    |  |                                 | (1,203 | ) |      |   | (1,375 | )    |  |   | (1,882 | )
|Software development costs                                                               |  |                                 | (64    | ) |      |   | (600   | )    |  |   | (775   | )
|Sale of short-term investments                                                           |  |                                 | 197    |   |      |   |       |      |  |   |       |  
|Loan to related party                                                                    |  |                                 |       |   |      |   | 125    |      |  |   | (125   | )
|                                                                                         |  |                                 |        |   |      |   |        |      |  |   |        |  
|Net cash used in investing activities                                                    |  |                                 | (1,070 | ) |      |   | (1,850 | )    |  |   | (2,782 | )
|                                                                                         |  |                                 |        |   |      |   |        |      |  |   |        |  
|Cash flows from financing activities:                                                    |  |                                 |        |   |      |   |        |      |  |   |        |  
|Issuance of common and preferred stock and warrants for cash                             |  |                                 | 15,056 |   |      |   | 2,401  |      |  |   | 568    |  
|Borrowings under line of credit                                                          |  |                                 | 2,900  |   |      |   | 10,800 |      |  |   | 4,500  |  
|Repayments of line of credit                                                             |  |                                 | (5,800 | ) |      |   | (8,900 | )    |  |   | (3,500 | )
|Borrowings under term loan                                                               |  |                                 |       |   |      |   |       |      |  |   | 1,500  |  
|Repayments of term loan                                                                  |  |                                 | (1,079 | ) |      |   | (329   | )    |  |   | (2,508 | )
|Repayments of notes payable                                                              |  |                                 | (1,069 | ) |      |   | (875   | )    |  |   | (1,167 | )
|Payments of capital lease obligations                                                    |  |                                 | (55    | ) |      |   | (53    | )    |  |   | (36    | )
|                                                                                         |  |                                 |        |   |      |   |        |      |  |   |        |  
|Net cash provided by (used in) financing activities                                      |  |                                 | 9,953  |   |      |   | 3,044  |      |  |   | (643   | )
|                                                                                         |  |                                 |        |   |      |   |        |      |  |   |        |  
|Net increase (decrease) in cash and cash equivalents                                     |  |                                 | 10,395 |   |      |   | 107    |      |  |   | 25     |  
|Cash and cash equivalents at beginning of year                                           |  |                                 | 2,444  |   |      |   | 2,337  |      |  |   | 2,312  |  
|                                                                                         |  |                                 |        |   |      |   |        |      |  |   |        |  
|Cash and cash equivalents at end of year                                                 |  | $                               | 12,839 |   |      | $ | 2,444  |      |  | $ | 2,337  |  
|                                                                                         |  |                                 |        |   |      |   |        |      |  |   |        |  
|Supplemental schedule of non-cash financing activities:                                  |  |                                 |        |   |      |   |        |      |  |   |        |  
|Non-cash issuance of common stock and common stock warrants                              |  | $                               | 224    |   |      | $ | 169    |      |  | $ | 15     |  
|Conversion of series B convertible preferred stock into common stock                     |  |                                 |       |   |      |   |       |      |  |   | 2      |  
|Supplemental disclosure of cash flow information:                                        |  |                                 |        |   |      |   |        |      |  |   |        |  
|Cash paid for income taxes                                                               |  |                                 | 74     |   |      |   | 64     |      |  |   | 77     |  
|Cash paid for interest                                                                   |  |                                 | 97     |   |      |   | 176    |      |  |   | 279    |  



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





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IRIS INTERNATIONAL, INC.



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)



|                                              |  |                                |       |   |      |   |      |      |  |   |      |  
|--------------------------------------------- |  | ------------------------------ | ----- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                                              |  | For the Year endedDecember 31, |      
|                                              |  | 2004                           |       |   | 2003 |   |      | 2002 | 
|                                              |  | (In thousands)                 |      
|Net income (loss)                             |  | $                              | 2,280 |   |      | $ | (530 | )    |  | $ | 877  |  
|Realized loss on investment                   |  |                                | 538   |   |      |   |     |      |  |   |     |  
|Unrealized losses on investment, net of taxes |  |                                | (327  | ) |      |   | (160 | )    |  |   | (113 | )
|                                              |  |                                |       |   |      |   |      |      |  |   |      |  
|Comprehensive income (loss)                   |  | $                              | 2,491 |   |      | $ | (690 | )    |  | $ | 764  |  
|                                              |  |                                |       |   |      |   |      |      |  |   |      |  



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





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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1.
Company History



IRIS International, Inc. (collectively
IRIS or the Company), was incorporated in California in 1979 and reincorporated during 1987 in Delaware under the name of International Remote Imaging Systems, Inc. The Company changed its name to IRIS International, Inc. in
December 2003. The Company designs, develops, manufactures and markets in vitro diagnostic (IVD) equipment, including IVD imaging systems based on patented and proprietary automated intelligent microscopy (AIM) technology, as
well as special purpose centrifuges and other small instruments for automating microscopic procedures performed in clinical laboratories.



2. Summary of Significant Accounting Policies



Use of Estimates



The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 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 assets. Actual results could differ materially from those estimates.



Principles of Consolidation



The financial statements include the accounts of IRIS International, Inc. and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in the consolidated financial statements.



Cash Equivalents and Short-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. 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. The Company does not have any single customer, which accounts for 10% or
more of its consolidated revenues or 10% or more of its accounts receivable at the balance sheet date.



Accounts receivable are customer obligations due under normal trade terms. We sell our products to distributors and customers in the health care industry.
We perform credit evaluations of our customers financial condition and although we generally do not require collateral, letters of credit may be required from our customers in certain circumstances.



Senior management reviews accounts receivable on a monthly basis to determine
if any receivables will potentially be uncollectible. We include any accounts receivable balances that are determined to be uncollectible,



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



along with a general reserve, in our overall allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is
written off against the allowance. Based on the information available to us, we believe our allowance for doubtful accounts as of December 31, 2004 is adequate. See Note 16.



Inventories



Inventories are carried at the lower of cost or market on a first in, first out basis. Provision for potentially obsolete or slow-moving inventory is made
based on managements analysis of inventory levels and future sales forecasts. The Company currently has approximately $290,000 of non-current inventory relating to spare parts for its legacy instruments which are no longer produced but which
the Company will continue to support and provide maintenance repairs for our customers. Other inventory that is considered excess inventory is fully reserved by the Company.



Investment available for sale



Management classifies an investment in common equity securities as available for sale. Investments in available for sale securities are reported at fair
value with unrealized holding gains and losses, net of tax, reported as a separate component of shareholders equity until realized, or until management believes a permanent decline in value has occurred. Realized gains and losses are included
in earnings. There were no realized gains and losses for the years ended December 31, 2003 and 2002.



During 2004, management determined that a permanent decline in the value of its investment in equity securities had taken place and recorded a write-down
in the carrying value of this investment in the amount of $531,000. The write-down is included in other expense on the accompanying statements of operations. In addition a portion of the investment was sold during the year resulting in a realized
loss in the amount of $7,000.



The cost, gross unrealized
holding losses and fair value of securities held for sale are as follows:



|                     |  |      |     |                            |   |      |           |  |   |    
|-------------------- |  | ---- | --- | -------------------------- | - | ---- | --------- |  | - | ---
|                     |  | Cost |     | GrossUnrealizedGains(Loss) |   |      | FairValue
|At December 31, 2004 |  | $    | 180 |                            | $ | 18   |           |  | $ | 198
|                     |  |      |     |                            |   |      |           |  |   |    
|At December 31, 2003 |  | $    | 915 |                            | $ | (333 | )         |  | $ | 582
|                     |  |      |     |                            |   |      |           |  |   |    



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.



Goodwill



Goodwill is recorded at cost. The realizability of the goodwill is evaluated
periodically, at least annually, or as events or circumstances indicate a possible inability to recover the carrying amount. Such evaluation is based on various analyses, including cash flow and profitability projections. The analysis necessarily
involves significant management judgment to evaluate the capacity of an acquired business to perform within projections.



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



At December 31, 2004, the Company evaluated its goodwill and determined that fair value had not decreased below carrying value and no adjustment to impair
goodwill was necessary in accordance with SFAS No. 142.



Prior
to 2002, goodwill, representing the excess of the purchase price over the estimated fair value of the net assets of the acquired business, was amortized over the period of expected benefit of 10 years. However, effective January 1, 2002, the Company
adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets,  (SFAS No. 142) which requires that the Company cease amortization of all intangible assets having indefinite useful economic
lives. Such assets with an indefinite useful life should be tested for impairment annually or on an interim basis if events or circumstances indicate that the fair value of the asset has decreased below its carrying value. There was no write-down of
goodwill during 2004, 2003 or 2002.



Software Development Costs



The Company capitalizes certain software development
costs for new products and product enhancements once all planning, designing, coding and testing activities necessary to establish that the product can be produced to meet its design specifications are completed, and concludes capitalization when
the product is ready for general release. Research and development costs relating to software development are expensed as incurred. Amortization of capitalized software development costs is provided on a product-by-product basis at the greater of
the amount computed using (a) the ratio of current revenues for a product to the total of current and anticipated future revenues or (b) the straight-line method over the remaining estimated economic life of the product up to five years. The Company
capitalized the following software development costs; $64,000 in 2004, $600,000 in 2003 and $774,000 in 2002. Amortization expense of software development costs was $531,000 in 2004, $110,000 in 2003, and $13,000 in 2002.



Long-Lived Assets



The Company identifies and records an impairment loss for long-lived assets whenever events or changes in circumstances
result in the carrying amount of the assets exceeding the sum of the expected future undiscounted cash flows associated with such assets. The measurement of the impairment losses recognized is based on the difference between the fair values and the
carrying amounts of the assets. There were no impairments at December 31, 2004, 2003 and 2002.



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. The Company accounts for stock-based awards to non-employees in accordance with SFAS No. 123
and EITF 96-18. An expense is recognized for common stock, warrants or options issued or repriced, for services rendered by non-employees based on the estimated fair value of the security exchanged.



IRIS has adopted the disclosure only provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock Based Compensation, as amended by Statement No. 148. If compensation expense for the stock options had been determined using fair value at the grant date for awards in 2004,
2003 and 2002,



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



consistent with the provisions of Statement of Financial Accounting Standards No. 123, the Companys net income (loss) and income (loss) per share would
have been reduced to the pro forma amounts indicated below:



|                                                                                                                                             |  |                                |       |   |      |   |       |      |  |   |      |  
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ----- | - | ---- | - | ----- | ---- |  | - | ---- | -
|                                                                                                                                             |  | For the Year EndedDecember 31, |      
|                                                                                                                                             |  | 2004                           |       |   | 2003 |   |       | 2002 | 
|                                                                                                                                             |  | (In thousands)                 |      
|Net income (loss) as reported                                                                                                                |  | $                              | 2,280 |   |      | $ | (530  | )    |  | $ | 877  |  
|Add: Stock-based employee compensation expense included in reported income, net of related tax effects                                       |  |                                | 86    |   |      |   | 244   |      |  |   | 32   |  
|Deduct: Total stock-based Employee compensation expense determined under fair value based methods for all awards, net of related tax
effects |  |                                | (924  | ) |      |   | (557  | )    |  |   | (320 | )
|                                                                                                                                             |  |                                |       |   |      |   |       |      |  |   |      |  
|Net income (loss) pro forma                                                                                                                  |  | $                              | 1,442 |   |      | $ | (843  | )    |  | $ | 589  |  
|                                                                                                                                             |  |                                |       |   |      |   |       |      |  |   |      |  
|Income (loss) per diluted share as reported                                                                                                  |  | $                              | 0.14  |   |      | $ | (0.05 | )    |  | $ | 0.08 |  
|                                                                                                                                             |  |                                |       |   |      |   |       |      |  |   |      |  
|Income (loss) per diluted share proforma                                                                                                     |  | $                              | 0.09  |   |      | $ | (0.07 | )    |  | $ | 0.05 |  
|                                                                                                                                             |  |                                |       |   |      |   |       |      |  |   |      |  



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.



In December 2004, the Financial Accounting Standards
Board, or FASB, issued SFAS No. 123 (Revised 2004), Share-Based Payment,or SFAS No. 123R, which is a revision of SFAS No. 123. SFAS No. 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No.
95, Statement of Cash Flows. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. SFAS No. 123R is effective for us
beginning July 1, 2005 and will require us to expense share-based payments under the modified prospective method. Under this method, compensation expense is recognized for all share-based payments granted after July 1, 2005 and also for
all awards granted prior to July 1, 2005 that remain unvested on the effective date. We will adopt SFAS No. 123R effective July 1, 2005 using the modified prospective method. Consequently, compensation expense for awards that we granted prior to
July 1, 2005 that are not fully vested on July 1, 2005 will be subject to expense beginning July 1, 2005 under SFAS No. 123R. We are currently evaluating the effects of adopting this standard on our results of operations or financial position.



Revenue Recognition



Revenues are derived from the sale of IVD instruments, sales of consumable
supplies and services for its IVD systems as well as sales of small laboratory devices and related supplies. Revenue is recognized once all of the following conditions have been met: a) an authorized purchase order has been received in writing with
a fixed and determinable sales price, b) customer credit worthiness has been established, and c) delivery of the product based on shipping terms. The majority of domestic IVD instrument sales generally require installation and training to be
performed.



Revenue is recorded in accordance with the
provisions of Emerging Issues Task Force (EITF) Statement 00-21 Revenue Arrangements with Multiple Deliverables and Staff Accounting Bulletin (SAB) 104 Revenue Recognition in Financial Statements which generally requires revenue
earned on product sales involving multiple-elements to be allocated to each element based on the relative fair values of those elements. Multiple elements of the Companys domestic product sales include IVD instruments and training. Training
elements are valued based on hourly rates, which the Company charges for these services when sold apart from hardware sales. Accordingly, IRIS allocates revenue to each element in a multiple- element arrangement based on the



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



elements respective fair value, with the fair value determined by the price charged when that element is sold and specifically defined in a quotation
or contract.



IRIS recognizes revenues from the sale of
instruments, consumables and small laboratory devices when title and risk of loss passes to the customers and revenues from service contracts are recognized ratably over the term of the service period, which typically ranges from twelve to sixty
months. Payments for service contracts are generally received in advance. Deferred revenue represents the revenues to be recognized over the remaining term of the service contracts.



Warranties



IRIS recognizes the warranty expense, based on managements estimate of expected cost, as an accrued liability at the time of sale.



Research and Development Expenditures



Except for certain software development costs 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.



The Company, from time to time receives grants from agencies of the U.S. Government. We do not recognize any revenue from such grants since they are cost
reimbursement grants whereby the Company submits requests for reimbursement for certain costs incurred. There are no ongoing obligations or requirements with respect to the grants received, the Company retains ownership of any intellectual property
that results from the research and development and the U.S. Government receives a right to use the results of the research for government projects. The Company received costs reimbursements (government grants) of $1.5 million, $0.9 million and 0.9
million during the years ended December 31, 2004, 2003 and 2002.



Income
Taxes



IRIS accounts for income taxes in accordance with
SFAS No. 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 at the time the advertising takes place.



Fair Value of
Financial Instruments



The amount recorded for financial
instruments in the Companys consolidated financial statements approximates fair value as defined in SFAS No. 107, Disclosures about Fair Value of Financial Instruments.



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Earnings Per Share



Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share is
computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding, calculated on the treasury stock method for options and warrants or the converted method for convertible preferred stock.
Common stock equivalents are excluded from the computation when their effect is antidilutive.



New Accounting Pronouncement



In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, Inventory Costs, an amendment of APB Opinion No. 43, Chapter 4. SFAS No. 151 clarifies the language used in Accounting
Principles Board (APB) Opinion No. 43 with respect to accounting for abnormal amounts of idle facility expenses, freight, handling costs and spoilage. The guidance does not result in a substantive change in accounting for these costs but
eliminates inconsistencies in wording between U.S. and international accounting standards. As such, this pronouncement is not expected to have any material impact on our consolidated statements of operations or financial position.



Reclassifications



Certain reclassifications have been made to the 2003 and 2002 financial statements to conform to the 2004 presentation with
no change in the previously reported net income or shareholders equity.



Certain Risks and Uncertainties



Dependence on
Instrument Sales: The Company derives most of its revenues from the sale of the urinalysis analyzers, and related supplies and services. Relatively modest declines in unit sales or gross margins 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. For example, Roche Diagnostics is the sole supplier for the
Companys proprietary CHEMSTRIP/IRIStrip urine test strips and related test reader used in The Yellow IRIS Models 300 and 500. From time to time, single source suppliers have discontinued production of key components or encountered production
problems, which potentially could have a material adverse effect on instrument sales. 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 always successfully transition to satisfactory replacement components or that the Company will always have access to adequate supplies of discontinued components on satisfactory terms during the transition period. The Company also is the
exclusive North American distributor of the Arkray Aution Max AX-4280 Automated Urine Chemistry Analyzer, which will affect the success of the Companys domestic sales of new iQ200 urinalysis workstations, which was launched in 2003. The
Companys inability to transition successfully to replacement components, to secure adequate supplies of discontinued components on satisfactory terms, or the loss of the distribution rights to the Arkray product could have a material adverse
effect on the Company.



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



3. Inventories



Inventories consist of the following:



|                                          |  |                 |       |   |      |   |       |  
|----------------------------------------- |  | --------------- | ----- | - | ---- | - | ----- | -
|                                          |  | At December 31, |      
|                                          |  | 2004            |       |   | 2003 |  
|                                          |  | (In thousands)  |      
|Finished goods                            |  | $               | 2,642 |   |      | $ | 1,852 |  
|Work-in-process                           |  |                 | 664   |   |      |   | 703   |  
|Raw materials, parts and sub-assemblies   |  |                 | 4,818 |   |      |   | 3,772 |  
|                                          |  |                 |       |   |      |   |       |  
|                                          |  |                 | 8,124 |   |      |   | 6,326 |  
|Less non-current portion, net of reserves |  |                 | (290  | ) |      |   | (973  | )
|                                          |  |                 |       |   |      |   |       |  
|Inventories  current portion             |  | $               | 7,834 |   |      | $ | 5,353 |  
|                                          |  |                 |       |   |      |   |       |  



See Note 16 regarding
reserves as of December 31, 2004 and 2003.



4.Properties and
Equipment



Property and equipment consist of the
following:



|                               |  |                 |        |   |      |   |        |  
|------------------------------ |  | --------------- | ------ | - | ---- | - | ------ | -
|                               |  | At December 31, |       
|                               |  | 2004            |        |   | 2003 |  
|                               |  | (In thousands)  |       
|Leasehold improvements         |  | $               | 1,878  |   |      | $ | 1,800  |  
|Furniture and fixtures         |  |                 | 509    |   |      |   | 464    |  
|Machinery and equipment        |  |                 | 4,863  |   |      |   | 4,227  |  
|Tooling, dies and molds        |  |                 | 1,947  |   |      |   | 1,832  |  
|Rental units                   |  |                 | 300    |   |      |   | 800    |  
|                               |  |                 |        |   |      |   |        |  
|                               |  |                 | 9,497  |   |      |   | 9,123  |  
|Less accumulated depreciation. |  |                 | (5,617 | ) |      |   | (5,510 | )
|                               |  |                 |        |   |      |   |        |  
|                               |  | $               | 3,880  |   |      | $ | 3,613  |  
|                               |  |                 |        |   |      |   |        |  



Property and equipment
includes $2,913,000 and $2,704,000 at December 31, 2004 and 2003, of fully depreciated assets that remain in service. Depreciation expense was $936,000, $658,000 and $652,000 in 2004, 2003 and 2002.



5. Equipment Leasing



The components of net investment in sales-type leases recorded in other assets consist of the following:



|                                    |  |                 |       |   |      |  
|----------------------------------- |  | --------------- | ----- | - | ---- | -
|                                    |  | At December 31,
|                                    |  | 2004            |       |   | 2003
|                                    |  | (In thousands) 
|Total minimum lease payments        |  | $               | 2,981 |   |      | 
|Less: Unearned income               |  |                 | 340   |   |      | 
|                                    |  |                 |       |   |      |  
|Net investment in sales-type leases |  |                 | 2,641 |   |      | 
|Less: Current portion               |  |                 | (499  | ) |      | 
|                                    |  |                 |       |   |      |  
|                                    |  | $               | 2,142 |   |      | 
|                                    |  |                 |       |   |      |  



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Future minimum lease payments due from customers under sales-type leases for each of the five
succeeding years: $499,000 in 2005, $525,000 in 2006, $551,000 in 2007, $537,000 in 2008 and $529,000 in 2009.



6. Related Party Transaction



In April 2002, the Company made a $125,000 loan to the former Chairman, CEO and President of the Company in accordance with his employment agreement. The loan bore interest at the rate of five percent per annum and had a term of five years.
In June 2003,the loan was repaid in full, including interest.



7. Accrued
Expenses



Accrued expenses consist of the following:



|                          |  |                 |       |      |   |      
|------------------------- |  | --------------- | ----- | ---- | - | -----
|                          |  | At December 31,
|                          |  | 2004            |       | 2003
|                          |  | (In thousands) 
|Accrued bonuses           |  | $               | 777   |      | $ | 532  
|Accrued commissions       |  |                 | 338   |      |   | 193  
|Accrued payroll           |  |                 | 476   |      |   | 205  
|Accrued vacation          |  |                 | 539   |      |   | 471  
|Accrued professional fees |  |                 | 155   |      |   | 167  
|Accrued warranty          |  |                 | 356   |      |   | 370  
|Accrued interest          |  |                 |      |      |   | 35   
|Accrued  other           |  |                 | 757   |      |   | 983  
|                          |  |                 |       |      |   |      
|                          |  | $               | 3,398 |      | $ | 2,956
|                          |  |                 |       |      |   |      



Changes in the accrued
warranty liability were as follows:



|                                     |  |                 |      |   |      |   |      |  
|------------------------------------ |  | --------------- | ---- | - | ---- | - | ---- | -
|                                     |  | At December 31, |     
|                                     |  | 2004            |      |   | 2003 |  
|                                     |  | (In thousands)  |     
|Balance  beginning of year          |  | $               | 370  |   |      | $ | 298  |  
|Additions for provisions during year |  |                 | 550  |   |      |   | 406  |  
|Reductions during year               |  |                 | (564 | ) |      |   | (334 | )
|                                     |  |                 |      |   |      |   |      |  
|Balance  end of year                |  | $               | 356  |   |      | $ | 370  |  
|                                     |  |                 |      |   |      |   |      |  



8. Short-Term Borrowings and Notes
Payable



In May 2004, we signed a new credit facility with
a major bank. The credit facility consists of a $6.5 million revolving line of credit for working capital and a $10.0 million line of credit for acquisitions and product opportunities. Borrowings under the revolving line of credit are limited to a
percentage of eligible receivables and inventory. The entire credit facility has variable interest rates, which will change from time to time based on changes to either the LIBOR rate or the lenders prime rate. As of December 31, 2004, there
were no borrowings under the new credit facility. The Company is subject to certain financial covenants under the credit facility with the bank and as of December 31, 2004, we were in compliance with such covenants.



Prior to May 2004, we had an $8.0 million credit facility, which consisted of
a $500,000 term loan, a $1.0 million term loan and a $6.5 million revolving line of credit. Borrowings under the line of credit were limited to a percentage of eligible receivables and inventory. At December 31, 2003, the outstanding amounts under
the



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Companys credit facility consist of $308,000 under the first term loan, $771,000 under the second term loan and $2.9 million under the revolving line
of credit.



At December 31, 2003, we also had a $1.1 million
unsecured Subordinated Note Payable. The note was payable in monthly installments of approximately $97,000 plus interest on the unpaid balance. The note bore interest at the prime rate plus 2.0% and matured on July 31, 2004. However, on September
30, 2003, the bank invoked its rights under a subordination agreement between the note holder and the bank precluding us from making further payments of the amounts owed on the Subordinated Note Payable until further notice. Since the timing of
future payments is indeterminate, the remaining balance of the note at December 31, 2003 was classified as a non-current liability in the financial statements.



In April 2004, the then outstanding balances of the bank debt and the Subordinated Note Payable were both repaid including interest with the net
proceeds from the private placement described in Note 10.



|9. | Income Taxes
|-- | ------------



The provision (benefit) for income taxes from continuing operations consists of the following:



|          |  |                                |       |      |   |      |      |  |   |    
|--------- |  | ------------------------------ | ----- | ---- | - | ---- | ---- |  | - | ---
|          |  | For the Year EndedDecember 31,
|          |  | 2004                           |       | 2003 |   |      | 2002
|          |  | (In thousands)                
|Current:  |  | $                              |      |      | $ |     |      |  | $ |   
|Federal   |  |                                |       |      |   |      |      |  |   |    
|State     |  |                                | 24    |      |   |     |      |  |   | 14 
|          |  |                                |       |      |   |      |      |  |   |    
|          |  |                                | 24    |      |   |     |      |  |   | 14 
|          |  |                                |       |      |   |      |      |  |   |    
|Deferred: |  |                                |       |      |   |      |      |  |   |    
|Federal   |  |                                | 914   |      |   | (314 | )    |  |   | 470
|State     |  |                                | 581   |      |   | (39  | )    |  |   | 100
|          |  |                                |       |      |   |      |      |  |   |    
|          |  |                                | 1,495 |      |   | (353 | )    |  |   | 570
|          |  |                                |       |      |   |      |      |  |   |    
|          |  | $                              | 1,519 |      | $ | (353 | )    |  | $ | 584
|          |  |                                |       |      |   |      |      |  |   |    



The provision for
income taxes differs from the amount obtained by applying the federal statutory income tax rate to income before provision for income taxes for the years ended December 31, 2004, 2003 and 2002 as follows:

|                                                           |  |                                |       |   |      |   |      |      |  |   |     |  
|---------------------------------------------------------- |  | ------------------------------ | ----- | - | ---- | - | ---- | ---- |  | - | --- | -
|                                                           |  | For the Year EndedDecember 31, |      
|                                                           |  | 2004                           |       |   | 2003 |   |      | 2002 | 
|                                                           |  | (In thousands)                 |      
|Tax provision (benefit) computed at Federal statutory rate |  | $                              | 1,291 |   |      | $ | (300 | )    |  | $ | 497 |  
|Decrease in taxes due to change in valuation allowance     |  |                                |      |   |      |   | (569 | )    |  |   |    |  
|Expiration of Federal or State NOLs                        |  |                                | 62    |   |      |   | 598  |      |  |   |    |  
|State taxes, net of federal benefit                        |  |                                | 190   |   |      |   | (44  | )    |  |   | 73  |  
|Nondeductible expenses                                     |  |                                | 166   |   |      |   | 17   |      |  |   | 30  |  
|Other                                                      |  |                                | (190  | ) |      |   | (55  | )    |  |   | (16 | )
|                                                           |  |                                |       |   |      |   |      |      |  |   |     |  
|                                                           |  | $                              | 1,519 |   |      | $ | (353 | )    |  | $ | 584 |  
|                                                           |  |                                |       |   |      |   |      |      |  |   |     |  



At December 31, 2004,
the Company had federal net operating loss carry forward of approximately $18.3 million, and state net operating loss carry forward of $4.4 million, which expire in fiscal years ending in 2005 through 2019.



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



During 2004, our deferred income tax asset increased by $2.0 million resulting from a tax benefit we
realized from the exercise of stock options by current and former employees. The primary components of temporary differences, which give rise to the Companys net deferred tax asset at December 31, 2004 and 2003, are as follows:



|                                   |  |                 |       |   |      |   |       |  
|---------------------------------- |  | --------------- | ----- | - | ---- | - | ----- | -
|                                   |  | At December 31, |      
|                                   |  | 2004            |       |   | 2003 |  
|                                   |  | (In thousands)  |      
|Depreciation and amortization      |  | $               | 528   |   |      | $ | 294   |  
|Allowance for doubtful accounts    |  |                 | 139   |   |      |   | 130   |  
|Accrued liabilities                |  |                 | 1,646 |   |      |   | 1,335 |  
|Deferred revenue-service contracts |  |                 | 270   |   |      |   | 309   |  
|Net operating loss carry forward   |  |                 | 6,840 |   |      |   | 6,905 |  
|Other                              |  |                 | (108  | ) |      |   | (179  | )
|                                   |  |                 |       |   |      |   |       |  
|                                   |  | $               | 9,315 |   |      | $ | 8,794 |  
|                                   |  |                 |       |   |      |   |       |  



Realization of
deferred tax assets associated with net operating losses (NOL) and tax credit carry forward is dependent upon the Companys being able to generate sufficient taxable income prior to their expiration. Management believes it is more
likely than not that the deferred tax assets will be realized through future taxable income or alternative tax strategies. However, the net deferred tax assets could be reduced in the near term if managements estimates of taxable income during
the carryforward period are not realized or are significantly reduced or alternative tax strategies are not available. The Company will continue to review its estimates of taxable income and will make adjustments to the valuation allowance, when
necessary.



Also, should the Company undergo an ownership
change as defined in Section 382 of the Internal Revenue Code, the Companys NOL generated prior to the ownership change would be subject to an annual limitation. If this occurs, a valuation allowance may be necessary.



10. Capital Stock



Private Placements



In April 2004, the Company sold 2,130,000 shares of the Companys common stock in a private placement at a price of $5.85 per share (a 10% discount
to market). In addition, the investors received five-year warrants to purchase 319,500 additional shares of common stock at an exercise price of $7.80 per share. In addition, the investment bank received five-year warrants to purchase 122,475 shares
of common stock at an exercise price of $7.80 per share. The agreement required us to file a registration statement within 30 days of closing and to have the registration statement declared effective within 90 days of closing. In May 2004, we filed
a registration statement, which was declared effective on May 21, 2004. We realized net proceeds (after deducting offering expense of $1.0 million) of approximately $11.5 million. We used approximately $5.5 million of the net proceeds to retire all
our outstanding indebtedness to the bank and the Subordinated Note Holder. See Note 8.



During the fourth quarter of 2003 we sold, through a private placement, 500,000 shares of our Common Stock at $3.75 per share realizing net proceeds (after deducting $67,000 of offering costs) of $1.6 Million. The net
proceeds were utilized primarily for working capital.



Conversion of
Preferred Stock



On August 3, 2002, the Companys
Series B Preferred Stock automatically converted into common stock at the ratio of 1.21 shares of common stock for each share of preferred stock, a total of 248,050 common shares



50



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##### Table of Contents

IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



were issued. The conversion ratio represented the ratio of the liquidation value of each preferred share ($3.00 per share) divided by the average daily
closing price of the common stock for the five trading days ending three trading days prior to the August 3, 2002 conversion date ($2.47 per share).



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 one year. The employees 50% portion of stock purchases under the plan may not exceed 15% of the employees total compensation
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 one year 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 2004, 2003 and 2002, IRIS issued 67,000, 38,000 and 14,000 shares of common stock in exchange for $247,000, $70,000 and $15,000 in cash and services.



Stock Option Plans and Employee Benefit Plans



As of December 31, 2004, the Company had three stock option plans under
which it may grant non-qualified stock options, incentive stock options and stock appreciation rights. No stock appreciation rights have been granted under these plans.



The following schedule sets forth options authorized, exercised, outstanding and available for grant under the
Companys three stock option plans as of December 31, 2004:



|          |  |                         |  |           |  |             |  |          
|--------- |  | ----------------------- |  | --------- |  | ----------- |  | ---------
|          |  | Number of Option Shares
|          |  |                         |  |           |  |             |  | Available
|Plan      |  | Authorized              |  | Exercised |  | Outstanding |  | for Grant
|          |  | (In thousands)         
|1994 Plan |  | 700                     |  | 524       |  | 139         |  | 37       
|1997 Plan |  | 600                     |  | 421       |  | 145         |  | 34       
|1998 Plan |  | 2,900                   |  | 967       |  | 1,850       |  | 83       
|          |  |                         |  |           |  |             |  |          
|          |  | 4,200                   |  | 1,912     |  | 2,134       |  | 154      
|          |  |                         |  |           |  |             |  |          



In addition to the
above, as of December 31, 2004 there were stock options outstanding to purchase 130,000 shares of common stock that were issued under special inducement grants.



The Compensation Committee of the Board of Directors determines the exercise price of options. Payment of the exercise price may be made in cash or
with shares of common stock. The options generally vest over either three or four years and expire either five or ten years from the date of grant. 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 2004, 2003 and 2002:



|                        |  |                                |   |  |      |   |  |      |  
|----------------------- |  | ------------------------------ | - |  | ---- | - |  | ---- | -
|                        |  | For the Year EndedDecember 31, |  
|                        |  | 2004                           |   |  | 2003 |   |  | 2002 |  
|                        |  | (In thousands)                 |  
|Risk free interest rate |  | 3.60                           | % |  | 3.17 | % |  | 4.18 | %
|Expected lives (years)  |  | 5                              |   |  | 5    |   |  | 5    |  
|Expected volatility     |  | 39                             | % |  | 44   | % |  | 57   | %
|Expected dividend yield |  |                               |   |  |     |   |  |     |  



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following table sets forth certain information relative to stock options during the years ended
December 31, 2002, 2003 and 2004.



|                                  |  |                                      |   |  |                |  |                 |  |                                       
|--------------------------------- |  | ------------------------------------ | - |  | -------------- |  | --------------- |  | --------------------------------------
|                                  |  | Shares                               |   |  | Range          |  | WeightedAverage |  | Fair Value atGrant DateWeightedAverage
|                                  |  | (In thousands, except for per share)
|Outstanding at December 31, 2001  |  | 2,328                                |   |  | $0.69 to $4.38 |  | $1.47           |  |                                       
|Granted                           |  | 514                                  |   |  | $2.01 to $3.01 |  | $2.61           |  | $1.52                                 
|Exercised                         |  | (51                                  | ) |  | $0.88 to $2.00 |  | $1.34           |  |                                       
|Canceled or expired               |  | (115                                 | ) |  | $0.75 to $3.03 |  | $1.74           |  |                                       
|                                  |  |                                      |   |  |                |  |                 |  |                                       
|Outstanding at December 31, 2002  |  | 2,676                                |   |  | $0.69 to $4.38 |  | $1.73           |  |                                       
|Granted                           |  | 1,004                                |   |  | $2.50 to $5.71 |  | $3.82           |  | $1.68                                 
|Exercised                         |  | (518                                 | ) |  | $0.88 to $3.01 |  | $1.38           |  |                                       
|Canceled or expired               |  | (253                                 | ) |  | $1.25 to $3.01 |  | $2.32           |  |                                       
|                                  |  |                                      |   |  |                |  |                 |  |                                       
|Outstanding at December 31, 2003  |  | 2,909                                |   |  | $0.69 to $5.71 |  | $2.46           |  | $3.06                                 
|Granted                           |  | 528                                  |   |  | $6.25 to $8.58 |  | $7.73           |  |                                       
|Exercised                         |  | (1,033                               | ) |  | $0.88 to $5.71 |  | $1.77           |  |                                       
|Canceled or expired               |  | (140                                 | ) |  | $1.31 to $5.71 |  | $3.05           |  |                                       
|                                  |  |                                      |   |  |                |  |                 |  |                                       
|Outstanding at December 31, 2004  |  | 2,264                                |   |  | $0.69 to $8.58 |  | $3.97           |  |                                       
|Outstanding at December 31, 2004  |  |                                      |   |  |                |  |                 |  |                                       
|Weighted average life  53 months |  | 2,264                                |   |  |                |  | $3.97           |  |                                       
|Exercisable at December 31, 2004  |  |                                      |   |  |                |  |                 |  |                                       
|Weighted average life  55 months |  | 1,415                                |   |  |                |  | $3.03           |  |                                       



In 1996, the Company
adopted a 401(k) Plan. All employees are eligible to participate in the plan at the beginning of the first quarter following their start date. Although the Companys contributions are discretionary, our current practice is to match $0.25 per $1
contributed by the employees up to 4% of the employees contributions. Employees vest in amounts contributed by the Company immediately. The Company contributed $83,000, $73,000 and $63,000 to the plan for 2004, 2003 and 2002.



Warrants



In July 2004 warrants to purchase 853,040 shares of common stock were exercised at a price of $1.90 per share and we
received $1.6 million. At December 31, 2004, the following warrants to purchase common stock were outstanding and exercisable:



|                 |  |                 |  |                 
|---------------- |  | --------------- |  | ----------------
|Number of Shares |  | Per Share Price |  | Expiration Date 
|50,000           |  | $2.13           |  | October 31, 2005
|45,000           |  | $2.22           |  | October 1, 2006 
|35,000           |  | $1.92           |  | October 1, 2007 
|442,000          |  | $7.80           |  | April 23, 2009  



11. Commitments and Contingencies



Leases



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



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Future minimum rental payments required under capital and operating leases that have an initial term
in excess of one year as of December 31, 2004, are as follows:



|                        |  |                |         |                 |   |          
|----------------------- |  | -------------- | ------- | --------------- | - | ---------
|                        |  | CapitalLeases  |         | OperatingLeases
|                        |  | (In thousands)
|Year Ended December 31, |  |                |         |                 |   |          
|2005                    |  | $              | 49,000  |                 | $ | 563,000  
|2006                    |  |                | 36,000  |                 |   | 513,000  
|2007                    |  |                | 21,000  |                 |   |         
|                        |  |                |         |                 |   |          
|                        |  | $              | 106,000 |                 | $ | 1,076,000
|                        |  |                |         |                 |   |          



Rent expense under all
operating leases during 2004, 2003 and 2002 was $636,000 $608,000 and $584,000.



Litigation



From time to time, the Company is
party to certain litigation arising in the normal course of business. Management believes that the resolution of such matters will not have a material adverse effect on the Companys financial position, results of operations or cash flows.



Guarantees



The Company enters into indemnification provisions under (i) its agreements
with other companies in its ordinary course of business, typically with business partners, contractors, and customers, landlords and (ii) its agreements with investors. Under these provisions the Company generally indemnifies and hold harmless the
indemnified party for losses suffered or incurred by the indemnified party as a result of the Companys activities or, in some cases, as a result of the indemnified partys activities under the agreement. These indemnification provisions
often include indemnifications relating to representations made by the Company with regard to intellectual property rights. These indemnification provisions generally survive termination of the underlying agreement. In addition, in some cases, the
Company has agreed to reimburse employees for certain expenses and to provide salary continuation during short-term disability. The maximum potential amount of future payments the Company could be required to make under these indemnification
provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal.
Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2004.



12. Earnings per Share



The computation of per share amounts for 2004, 2003 and 2002 is based on the average number of common shares outstanding for each period. Options and warrants to purchase 805,000, 3,891,000 and 622,000 shares of common stock were not
considered in the computation of diluted EPS for 2004, 2003 and 2002, because their inclusion would have been antidilutive.



53



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following is a reconciliation of weighted average shares used in computing basic and diluted
earnings per share:



|                                           |  |                |  |        |  |       
|------------------------------------------ |  | -------------- |  | ------ |  | ------
|                                           |  | 2004           |  | 2003   |  | 2002  
|                                           |  | (In thousands)
|Weighted average number of shares  basic  |  | 14,459         |  | 11,245 |  | 10,566
|Effect of dilutive securities:             |  |                |  |        |  |       
|Options                                    |  | 926            |  |       |  | 561   
|Warrants                                   |  | 433            |  |       |  | 269   
|Preferred stock                            |  |               |  |       |  | 146   
|                                           |  |                |  |        |  |       
|Weighed average number of shares  diluted |  | 15,818         |  | 11,245 |  | 11,542
|                                           |  |                |  |        |  |       



13. License



Sysmex Corporation developed several urine sediment analyzers under licenses
(which expired in July 2004), from IRIS using IRIS technology. IRIS received royalties under this license of $336,000, $547,000 and $408,000 in 2004, 2003 and 2002.



14. Segments and Geographic Information



The Companys operations are organized on the basis of products and related services and under SFAS No. 131, the Company operates in two segments:
(1) IVD instruments and (2) small laboratory devices and related supplies.



The IVD instrument segment designs, develops, manufactures, markets and distributes IVD systems based on patented and proprietary AIM technology for automating microscopic procedures for urinalysis. The segment also
provides ongoing sales of supplies and services necessary for the operation of installed urinalysis workstations. In the United States, these products are sold through a direct sales force. Internationally, these products are sold through
distributors. The segment also includes the operations of the ADIR research subsidiary.



The small laboratory devices segment designs, develops, manufactures and markets a variety of benchtop centrifuges, small instruments and supplies. These products are used primarily for manual specimen preparation and
dedicated applications in coagulation, cytology, hematology and urinalysis. These products are sold worldwide through distributors.



The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies. The Company
evaluates the performance of its segments and allocates resources to them based on earnings before income taxes, excluding corporate charges (Segment Profit).



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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The tables below present information about reported segments for the three years ended December 31,
2004:



|                                     |  |                |        |                        |   |                              |  |   |        |   |  |   |        |  
|------------------------------------ |  | -------------- | ------ | ---------------------- | - | ---------------------------- |  | - | ------ | - |  | - | ------ | -
|                                     |  | IVDInstrument  |        | SmallLaboratoryDevices |   | UnallocatedCorporateExpenses |  |   | Total  |  
|                                     |  | (In thousands) |       
|                                     |  |                |        |                       
|For the Year Ended December 31, 2004 |  |                |        |                        |   |                              |  |   |        |   |  |   |        |  
|Revenues                             |  | $              | 35,307 |                        | $ | 8,343                        |  | $ |       |   |  | $ | 43,650 |  
|Interest income                      |  |                | 106    |                        |   | 5                            |  |   |       |   |  |   | 111    |  
|Interest expense                     |  |                | 6      |                        |   |                             |  |   | 237    |   |  |   | 243    |  
|Depreciation and amortization*       |  |                | 1,729  |                        |   | 90                           |  |   | 56     |   |  |   | 1,875  |  
|Other non-cash items                 |  |                | 538    |                        |   |                             |  |   |       |   |  |   | 538    |  
|Segment profit (loss)                |  |                | 5,658  |                        |   | 1,945                        |  |   | (3,804 | ) |  |   | 3,799  |  
|Segment assets                       |  |                | 35,769 |                        |   | 3,052                        |  |   | 9,315  |   |  |   | 48,136 |  
|Investment in long-lived assets      |  |                | 1,133  |                        |   | 134                          |  |   |       |   |  |   | 1,267  |  
|                                     |  |                |        |                       
|For the Year Ended December 31, 2003 |  |                |        |                        |   |                              |  |   |        |   |  |   |        |  
|Revenues                             |  | $              | 25,269 |                        | $ | 6,076                        |  | $ |       |   |  | $ | 31,345 |  
|Interest income                      |  |                | 38     |                        |   | 1                            |  |   |       |   |  |   | 40     |  
|Interest expense                     |  |                | 8      |                        |   |                             |  |   | 343    |   |  |   | 351    |  
|Depreciation and amortization*       |  |                | 921    |                        |   | 91                           |  |   | 140    |   |  |   | 1,152  |  
|Other non-cash items                 |  |                | 30     |                        |   |                             |  |   | 266    |   |  |   | 296    |  
|Segment profit (loss)                |  |                | 2,445  |                        |   | 960                          |  |   | (4,288 | ) |  |   | (883   | )
|Segment assets                       |  |                | 21,348 |                        |   | 2,339                        |  |   | 8,793  |   |  |   | 32,480 |  
|Investment in long-lived assets      |  |                | 1,895  |                        |   | 80                           |  |   |       |   |  |   | 1,975  |  
|                                     |  |                |        |                       
|For the Year Ended December 31, 2002 |  |                |        |                        |   |                              |  |   |        |   |  |   |        |  
|Revenues                             |  | $              | 22,459 |                        | $ | 5,729                        |  | $ |       |   |  | $ | 28,188 |  
|Interest income                      |  |                | 55     |                        |   | 2                            |  |   |       |   |  |   | 57     |  
|Interest expense                     |  |                | 7      |                        |   |                             |  |   | 530    |   |  |   | 537    |  
|Depreciation and amortization*       |  |                | 932    |                        |   | 86                           |  |   | 47     |   |  |   | 1,065  |  
|Other non-cash items                 |  |                |       |                        |   |                             |  |   |       |   |  |   |       |  
|Segment profit (loss)                |  |                | 2,738  |                        |   | 1,589                        |  |   | (2,866 | ) |  |   | 1,461  |  
|Segment assets                       |  |                | 16,837 |                        |   | 2,107                        |  |   | 8,279  |   |  |   | 27,223 |  
|Investment in long-lived assets      |  |                | 2,619  |                        |   | 38                           |  |   |       |   |  |   | 2,657  |  

---

|* | Included in depreciation and amortization in the table above is amortization of deferred compensation in the amounts of $144,000 in 2004; $142,000 in 2003, and $53,000 in 2002.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company ships products from two locations in
the United States. Substantially all long-lived assets were located in the United States and totaled $8,722,000 and $7,653,000 as of December 31, 2004 and 2003. Sales to international customers amounted to approximately $8.0 million in 2004, $4.1
million in 2003 and $1.4 million in 2002.



Long-lived assets
include property and equipment, goodwill, software development costs, long-term portion of inventory and other long-term assets. Deferred income tax is excluded from long-lived assets.





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IRIS INTERNATIONAL, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



15. Selected Quarterly Data (Unaudited)



The following table summarizes certain financial information by quarter for 2004 and 2003:



|                               |  |                    |       |         |   |              |  |             |        |  |   |       
|------------------------------ |  | ------------------ | ----- | ------- | - | ------------ |  | ----------- | ------ |  | - | ------
|                               |  | 2004 Quarter Ended
|                               |  | March 31           |       | June 30 |   | September 30 |  | December 31
|                               |  | (In thousands)    
|Net revenues                   |  | $                  | 9,375 |         | $ | 10,325       |  | $           | 11,764 |  | $ | 12,186
|Gross margin                   |  |                    | 4,704 |         |   | 4,780        |  |             | 5,811  |  |   | 6,096 
|Net income                     |  |                    | 529   |         |   | 439          |  |             | 481    |  |   | 831   
|Net income per share  basic   |  | $                  | 0.04  |         | $ | 0.03         |  | $           | 0.03   |  | $ | 0.05  
|                               |  |                    |       |         |   |              |  |             |        |  |   |       
|Net income per share  diluted |  | $                  | 0.04  |         | $ | 0.03         |  | $           | 0.03   |  | $ | 0.05  
|                               |  |                    |       |         |   |              |  |             |        |  |   |       



|                                                               |  |                    |       |   |         |   |       |              |  |             |       |  |   |       
|-------------------------------------------------------------- |  | ------------------ | ----- | - | ------- | - | ----- | ------------ |  | ----------- | ----- |  | - | ------
|                                                               |  | 2003 Quarter Ended
|                                                               |  | March 31           |       |   | June 30 |   |       | September 30 |  | December 31
|                                                               |  | (In thousands)    
|Net revenues                                                   |  | $                  | 6,134 |   |         | $ | 6,531 |              |  | $           | 8,421 |  | $ | 10,259
|Gross margin                                                   |  |                    | 3,167 |   |         |   | 3,490 |              |  |             | 4,264 |  |   | 4,712 
|Net income                                                     |  |                    | (488  | ) |         |   | (250  | )            |  |             | 128   |  |   | 80    
|Income per share attributable to common shareholders  basic   |  | $                  | (0.04 | ) |         | $ | (0.02 | )            |  | $           | 0.01  |  | $ | 0.01  
|                                                               |  |                    |       |   |         |   |       |              |  |             |       |  |   |       
|Income per share attributable to common shareholders  diluted |  | $                  | (0.04 | ) |         | $ | (0.02 | )            |  | $           | 0.01  |  | $ | 0.01  
|                                                               |  |                    |       |   |         |   |       |              |  |             |       |  |   |       



16. Valuation and Qualifying
Accounts



|                                   |  |                  |       |                            |   |                                  |  |            |  |   |               |      |  |   |      
|---------------------------------- |  | ---------------- | ----- | -------------------------- | - | -------------------------------- |  | ---------- |  | - | ------------- | ---- |  | - | -----
|                                   |  | BeginningBalance |       | Charged ToCost andExpenses |   | AdditionsChargedTo OtherAccounts |  | Deductions |  |   | EndingBalance
|                                   |  | (In thousands)  
|                                   |  |                  |       |                            |  
|Year Ended December 31, 2004       |  |                  |       |                            |   |                                  |  |            |  |   |               |      |  |   |      
|Allowance for doubtful accounts    |  | $                | 262   |                            | $ | 24                               |  |           |  | $ | (78           | )(1) |  | $ | 208  
|Allowance for sales returns        |  |                  | 50    |                            |   | 237                              |  |           |  |   | (159          | )(1) |  |   | 128  
|Reserve for inventory obsolescence |  |                  | 959   |                            |   | 304                              |  |           |  |   | (70           | )(1) |  |   | 1,193
|                                   |  |                  |       |                            |  
|Year Ended December 31, 2003       |  |                  |       |                            |   |                                  |  |            |  |   |               |      |  |   |      
|Allowance for doubtful accounts    |  | $                | 298   |                            |   |                                  |  |           |  | $ | (36           | )(1) |  | $ | 262  
|Allowance for sales returns        |  |                  |      |                            |   | 50                               |  |           |  |   |              |      |  |   | 50   
|Reserve for inventory obsolescence |  |                  | 798   |                            |   | 265                              |  |           |  |   | (104          | )(1) |  |   | 959  
|                                   |  |                  |       |                            |  
|Year Ended December 31, 2002       |  |                  |       |                            |   |                                  |  |            |  |   |               |      |  |   |      
|Allowance for doubtful accounts    |  | $                | 286   |                            | $ | 79                               |  |           |  | $ | (67           | )(1) |  | $ | 298  
|Reserve for inventory obsolescence |  |                  | 1,215 |                            |   |                                 |  |           |  |   | (417          | )(1) |  |   | 798  

---

|(1) | Relates to the write-off of accounts receivable, return of merchandise, disposal of obsolete inventory or specific portion of the accounts receivable reserve or
reserve for sales returns no longer needed.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



56