<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                             -----------------------

                                  FORM 10-K/A

                               (Amendment No. 1)

         ANNUAL REPORT PURSUANT TO SECTION13 OR 15(D) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1997           Commission File No. 1-9767


                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.


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

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


                        Telephone Number: (818) 709-1244

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

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

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

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

         On March 20, 1998, the aggregate market value of the shares of Common
Stock held by non-affiliates of the Registrant was approximately $25.0 million
based upon the closing price of $4.25 per share of Common Stock as reported on
the American Stock Exchange. Solely for the purpose of determining
"non-affiliates" in this context, shares of Common Stock held by each officer
and director and by each person who owns 5% or more of the outstanding Common
Stock have been excluded. This determination of affiliate status is not
necessarily a determination for other purposes.

         The Registrant had 6,280,193 shares of Common Stock outstanding on
March 20, 1998.

         Part III incorporates information by reference from the Proxy Statement
for the Registrant's 1998 Annual Meeting of Stockholders.


<PAGE>   2

                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.

                           FORM 10-K/A ANNUAL REPORT

                       FISCAL YEAR ENDED DECEMBER 31, 1997
   

<TABLE>
<CAPTION>
   Caption                                                                                                             Page
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<S>                        <C>                                                                                         <C>
   PART I

         Item 1.           Business..................................................................................     3     
         Item 2.           Properties................................................................................    12 
         Item 3.           Legal Proceedings.........................................................................    12  
         Item 4.           Submission of Matters to a Vote of Security Holders.......................................    12 

   PART II

         Item 5.           Market for the Registrant's Common Stock and Related Stockholder
                           Matters...................................................................................    13  
         Item 6.           Selected Financial Data...................................................................    14 
         Item 7.           Management's Discussion and Analysis of Financial Condition and
                           Results of Operations.....................................................................    14 
         Item 8.           Financial Statements and Supplementary Data...............................................    20  
         Item 9.           Changes in and Disagreements with Accountants on Accounting and                              
                           Financial Disclosure......................................................................    21 

   PART III

         Item 10.          Directors and Executive Officers of the Registrant........................................    21 
         Item 11.          Executive Compensation....................................................................    21 
         Item 12.          Security Ownership of Certain Beneficial Owners and  Management...........................    21 
         Item 13.          Certain Relationships and Related Transactions............................................    21 

   PART IV

         Item 14.          Exhibits, Financial Statements, Schedules, and Reports on Form 8-K........................    21 
</TABLE>
    


<PAGE>   3


                                     PART I

ITEM 1.  BUSINESS.

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

OVERVIEW

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

         The Company pioneered its first IVD imaging system application in 1983
with its introduction of The Yellow IRIS family of workstations for urinalysis.
The Company believes that it is still the only supplier of laboratory systems
which fully automate a complete urinalysis, and it introduced its fourth
generation models in 1996 which incorporate significant advancements in speed,
utility and ease of use. In 1996, the Company also received Food and Drug
Administration ("FDA") clearance and began to market the Model 900UDx urine
pathology system designed especially for the high-volume testing requirements of
larger laboratories. The Company also provides ongoing sales of supplies and
service necessary for operation of The Yellow IRIS workstations. Most supplies
are purchased under standing orders and, following an initial one-year warranty
period, the majority of customers purchase annual service contracts.  In 
December 1997, the Company began distributing the UF-100 urine cell analyzer
in the United States under an existing agreement with its manufacturer, TOA 
Medical Electronics, Inc.

   
         The Company has had a major program over a number of years to develop
The White IRIS leukocyte differential analyzer. The White IRIS program began
under the sponsorship of the National Institutes of Health and was continued
under a joint development program with LDA Systems, Inc., a Company-sponsored
research and development entity. The Company acquired LDA Systems and all of its
rights to The White IRIS in 1995 in order to complete development of The White
IRIS. The FDA cleared The White IRIS in May 1996, but its commercial release 
was delayed by other priorities such as the introduction of the UF-100. The
Company is now in discussions with two prestigious medical institutions to serve
as testimonial sites for The White IRIS. The Company's immediate goal is to
install the first two commercial systems at these institutions and develop the
customer references which are a key step toward commercial success of any new
major instrument. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
    

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

         In February 1996, the Company acquired StatSpin, Inc. ("StatSpin"), in
a pooling-of-interests transaction. Through StatSpin, the Company manufactures
and markets a variety of benchtop centrifuges, small instruments and supplies
for the laboratory market. These products are used primarily for manual specimen
preparation and dedicated applications in cytology, hematology and urinalysis.
They appeal to laboratories and physician offices performing too few tests to
justify the cost of an automated IVD imaging system.

THE INDUSTRY

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

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


<PAGE>   4

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

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

THE COMPANY'S STRATEGY

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

         o        Adding New IVD Imaging Applications. The Company believes
                  automated microscopy has a number of potential applications in
                  the clinical laboratory and is expanding beyond the field of
                  urinalysis. In July of 1996, the Company strategically
                  expanded into the field of genetics through the PSI
                  Acquisition, which included the acquisition of the PowerGene
                  family of IVD imaging systems. The Company completed
                  development of The White IRIS leukocyte differential analyzer
                  for hematology in 1997, but its commercial release has been
                  delayed by other priorities.
                   See "--Overview."

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

         o        Expanding in New Geographic Markets.  The Company's growth 
                  strategy also calls for the successful penetration of overseas
                  markets, where its PowerGene systems have already achieved a
                  strong market presence with sales in 40 countries. Neither The
                  Yellow IRIS line nor the StatSpin products, however, have been
                  marketed to a significant degree outside the United States.
                  International markets have witnessed the same trend toward
                  consolidation and emphasis on labor productivity that has
                  characterized the US market for the past 15 years. From a
                  strategic standpoint, management intends to proceed with the
                  introduction of The Yellow IRIS in selected markets where
                  consolidation has already been a factor, by developing
                  relationships with distributors in those countries capable of
                  selling both its clinical systems and small instruments.

         o        Increasing Sales of Supplies and Service. Once an IVD imaging
                  system is installed, the Company generates significant
                  recurring revenue from sales of supplies and service for its
                  operation. The Company seeks to enhance this revenue stream by
                  installing more systems as well as increasing its product
                  offering of supplies for each system. For example, the Company
                  began selling the CHEMSTRIP/IRIStrip urine test strips for The
                  Yellow IRIS systems at the end of 1994. The Company also hopes
                  to introduce specific DNA probe kits and other consumables for
                  chromosome analysis to its PowerGene line and to sell the
                  patented 2-methylpolymethine (2- MPM) cytoprobe for The White
                  IRIS.

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


<PAGE>   5

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

AIM TECHNOLOGY

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

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

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

PRODUCTS

         AIM SYSTEMS

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

         The Yellow IRIS of urinalysis workstations are widely used nationwide,
including hospitals affiliated with over 75% of all United States medical
schools. This family of IVD imaging systems currently consists of three models.
Two models can also perform IVD imaging tests on a number of body fluids other
than urine, including cerebrospinal, peritoneal, pleural, pericardial, synovial
and seminal fluids as well as peritoneal dialyzates and lavages. The third
model, the Model 900UDx, is designed for laboratories testing high numbers of
urine specimens. The Yellow IRIS family of IVD imaging systems currently has
list prices ranging from $100,000 to $195,000.

         The PowerGene family of genetic analyzers perform certain chromosome
tests such as karyotyping, DNA probe analysis in FISH and M-FISH procedures and
comparative genomic hybridization. These tests are typically used for analyzing
genetic abnormalities for both clinical uses (e.g. prenatal screening) and
research applications (e.g. cancer studies). The Company believes the genetics
market is one of the fastest growing segments of the global IVD market. The
Company purchased this family of analyzers in July 1996 in conjunction with the
PSI Acquisition. The PowerGene analyzers currently have list prices ranging from
$20,000 to over $100,000 depending upon the selected options and configuration.

         OTHER SYSTEMS

         In the fourth quarter of 1997, the Company began marketing the UF-100
urine cell analyzer in the United States. The UF-100, developed in Japan by
TOA Medical Electronics Co., Ltd. ("TOA"), utilizes flow 


<PAGE>   6
cytometric laser scanning principles to screen large volumes of urine specimens
for the presence of abnormal sediment compositions. The UF-100 is not an AIM 
system, and many abnormal specimens require subsequent microscopic analysis
through manual methods or with an automated IVD imaging system such as The
Yellow IRIS. The Company is the exclusive distributor for the UF-100 in North
America and receives royalties from TOA on sales of the UF-100 outside of North
America. The UF-100 currently has a list price in the United States of $115,000.
It provides only the sediment portion of a complete urinalysis. Laboratories
desiring to completely automate urinalysis testing can purchase The Yellow IRIS
which, in addition to microscopy, automates the chemistry and specific gravity
portions of a complete urinalysis.

         SYSTEM SUPPLIES AND SERVICE

         In addition to sales of IVD imaging systems and the UF-100, the Company
obtains significant recurring revenue from sales of supplies used in the
operation of these systems and from their service and repair. Supplies for The
Yellow IRIS family include the sheath fluid used to position the particles and
cleanse the system in slideless microscopy and "controls" used in calibrating
and monitoring the performance quality of the systems. The Company also sells
the CHEMSTRIP/IRIStrip for testing urine chemistry on The Yellow IRIS. The
Company introduced the CHEMSTRIP/IRIStrip urine test strips in late 1994 and has
converted over 95% of the installed base of systems to these new test strips.
CHEMSTRIP/IRIStrips urine test strips are produced through an agreement with the
Boehringer Mannheim Group of companies, recently bought by Hoffman-LaRoche,
reorganized and now operated as Roche Diagnostics.

         SMALL INSTRUMENTS AND SUPPLIES

         The Company also manufactures and markets a variety of small
instruments and supplies for the clinical laboratory market. These products
complement the Company's line of IVD imaging systems because they appeal to
smaller laboratories and physician offices performing an insufficient number of
tests to justify the capital cost of an IVD imaging system. StatSpin's
technologically-advanced small benchtop centrifuges are designed to prepare
certain biological specimens for instrumental or microscopic examination in a
fraction of the time required by larger, common laboratory centrifuges. They
have proven ideal for on-demand, point-of-use testing in hospitals, physician's
offices and veterinary laboratories. The basic StatSpin centrifuge unit is
adaptable to a variety of uses by means of application-specific rotors and
consumables. Noted for their compact design and simple, quiet and unobtrusive
operation, they are particularly well-suited to laboratories in which
technicians are located in close proximity to the equipment. These products also
take advantage of the Company's reputation and expertise in urinalysis and
respond to the desire of integrated healthcare providers to purchase systems and
supplies for a variety of clinical settings (both large and small) from one
supplier. This category of products includes special-purpose centrifuges,
digital refractometers for measuring the specific gravity of urine, the CenSlide
System for manual microscopic examination of urine and other supplies intended
primarily for specimen preparation.

         SUMMARY OF REVENUES BY PRODUCT AND SERVICE CATEGORIES

<TABLE>
<CAPTION>
                                                               For the years ended December 31, 
                             ----------------------------------------------------------------------------------------------  
                                 1995                             1996                            1997
                                 ----                             ----                            ----
<S>                          <C>                      <C>     <C>                      <C>     <C>                      <C>
Sales of IVD imaging  
systems                       $ 4,240,627              29%     $ 6,370,346              31%     $11,823,443              43%

Sales of IVD imaging           
system supplies and
service                         6,737,444              46%       9,117,493              44%      10,621,211              39%

Sales of small instruments 
and supplies                    3,414,087              24%       5,066,292              25%       4,447,418              16%

Royalty and license         
revenue                            96,023               1%          42,923              --          603,076               2%
                              -----------             ----     -----------             ----     -----------             ----

Total                         $14,488,181             100%     $20,597,054             100%     $27,495,148             100%
                              ===========             ====     ===========             ====     ===========             ====
</TABLE>

         BACKLOG

The sales backlog for IVD imaging systems was approximately $1.1 million at
December 31, 1996 and $700,000 at December 31, 1997. The Company believes the
amount of backlog at a given date is not necessarily indicative of sales for any
succeeding period.

RESEARCH AND DEVELOPMENT

         The Company maintains an active research and development program to
continually enhance its existing IVD imaging systems and explore other IVD
imaging applications for its AIM technology. In 1995, 1996 and 1997, the Company
focused its research and development efforts on the following major projects, as
well as numerous other smaller projects:

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

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

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


<PAGE>   7


         o        Developing The White IRIS. The Company has had a major program
                  over a number of years, under sponsorship of the National
                  Institutes of Health and later in conjunction with a Company-
                  sponsored research and development entity, to develop The
                  White IRIS leuckocyte differential analyzer. The White IRIS is
                  an automated high-speed workstation used to classify normal,
                  as well as immature and other abnormal white blood cells. The
                  White IRIS performs a differential analysis which includes
                  identifying the five types of normally occurring white blood
                  cells plus a number of abnormally occurring immature white
                  blood cells, variant lymphocytes and other cells.
                  The Company also holds an exclusive, worldwide license to
                  several patents which cover the unique cytoprobe used by The
                  White IRIS, as well as the multi-colored expression of 2-MPM
                  in white blood cells. The White IRIS, FDA cleared in 1996, is
                  undergoing additional refinements pending its commercial
                  launch which has been delayed by other priorities. See
                  "--Overview."

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

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

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

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

         o        Identifying Future Applications. The Company also performs 
                  market research and experiments to identify future
                  applications of its technology. The Company believes its AIM
                  technology may have a number of other potential IVD imaging
                  applications such as cytology, microbiology and histology.

         During the years ended December 31, 1995, 1996 and 1997, the Company
expended $1.2 million, $2.3 million and $2.1 million, respectively on Company
sponsored research and development.

     The Company has in the past partially funded its research and development
programs through (i) grants from NASA and National Institutes of Health, (ii)
joint development programs with strategic partners and (iii) Company-sponsored
research and development entities. In recent years, the Company has entered into
four significant projects, two joint development projects with strategic
partners--Boehringer Mannheim Corporation ("BMC") and Boehringer Mannheim GmbH
("BMG")--and two projects with Company-sponsored research and development
entities--LDA Systems, Inc. ("LDA") and Poly U/A Systems, Inc. ("Poly"). From
1994 to 1996, the Company collaborated with BMC and BMG in the development of
CHEMSTRIP/IRIStrip urine test strips and the Model 900UDx. BMC supplies the
Company with CHEMSTRIP/IRIStrip urine test strips and has agreed to supply the
Company with certain raw materials should the Company elect to manufacture its
own urine test strips, subject to royalty payments. The Company was granted the
non-exclusive right to distribute certain other BMC urinalysis products to
hospitals and commercial laboratories in the United States. The Company
manufactures the Model 900UDx with BMG providing certain components on an OEM
basis at cost. The Company has exclusive marketing rights to the Model 900UDx in
the United States, Canada and Taiwan and non-exclusive rights for the rest of
the world outside of Germany and Italy. During 1997, Hoffman-LaRoche acquired
the Boehringer Mannheim Group of companies, and BMC and BMG are now operated as
Roche Diagnostics.

   
     In 1992, the Company entered into a project with LDA for development of The
White IRIS leukocyte differential analyzer and later acquired LDA for
approximately 498,000 shares of the Company's common stock. In 1995, the Company
entered into a similar project with Poly which is ongoing for development of
several new products to enhance automated urinalysis (the "Poly Products"). The
Company has an option until November 29, 1998 to acquire all the common stock of
Poly for $5.1 million payable, at the Company's discretion, in cash or shares of
the Company's Common Stock.
    



<PAGE>   8

MARKETING AND SALES

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

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

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

COMPETITION

         URINALYSIS

         The Company's primary products for the urinalysis market are The Yellow
IRIS family of urinalysis workstations and the UF-100 urine cell analyzer. The 
principal competitive factors in this market are cost-per-test, ease of use, and
quality of result. The Company believes The Yellow IRIS competes favorably with
regard to these factors in its target markets.

         A number of hospitals conduct urine sediment examinations using the
Kova system made by Hycor Biomedical, Inc., as well as several other similar
products, all of which are composed largely of disposable plastic parts. These
products provide a more standardized method of preparing urine sediment for
microscopical examination as opposed to traditional means. While these
disposable products help somewhat to overcome manipulative imprecision, most of
them do so at the added expense of an increased number of disposable parts and
offer little in time savings. One exception is the CenSlide System acquired by
the Company in March of 1996. This system uses a combination centrifuge tube and
microscope slide, thereby actually eliminating much of the manipulation required
in preparing the urine specimen for microscopic observation. The Company views
these types of products as better suited for laboratories performing a lower
volume of urinalysis tests. Roche Diagnostics, Dade Behring Corporation and
Bayer Diagnostics sell lines of urine test strips which are useful in
determining the concentration of various chemical substances often found in
urine. Some claims have been made that the absence of certain results determined
with these test strips can preclude the need for microscopic examinations of
some specimens. IRIS recently obtained FDA clearance of its claims of improved
performance of The Yellow IRIS over reagent strip measures in detecting
microscopic abnormalities in urine.

         GENETICS

         The Company's products for the genetics market are the PowerGene family
of analyzers. The principal competitive factors in this market are comparative
product features, such as ease-of-use, software utility and user friendliness,
clarity of visual output and the quality and responsiveness of customer service.
The Company believes the PowerGene analyzers compete favorably with regard to
these factors.

         The Company's primary competitors in this worldwide market are Applied
Imaging and Vysis, Inc. which market IVD imaging systems for prenatal and other
genetic testing. Vysis utilizes a strategy of offering its systems as a vehicle
for selling its DNA probes, a strategy that has made it the fastest growing
competitor. Leica (a German microscope manufacturer), MetaSystems and ASI (an
Israeli camera manufacturer) also sell systems for genetic analysis.


<PAGE>   9

         HEMATOLOGY

         The Company's proposed product for the hematology market is The White
IRIS leukocyte differential analyzer. See "Research and Development."
Intelligent Medical Imaging, Inc. ("IMI") is presently manufacturing an IVD
imaging system, called the Micro 21, for performing certain aspects of white
blood cell differential analysis and certain other analyses. Unlike The White
IRIS, which uses imaging flow cytometry, the Micro 21 is a slide- based system.
The Company believes The White IRIS has certain performance advantages over the
Micro 21. For example, The White IRIS (1) uses a closed-tube sampling procedure
which is safer and more convenient because it does not require slide
preparation, (2) is more sensitive and precise because it counts significantly
more white blood cells, (3) allows an easier-to-obtain and more complete answer
because it automatically classifies variant, immature and other abnormal cells,
as compared only to automated classification of normal cells by the Micro 21,
and (4) is more cost effective because it has higher throughput and requires
less attended time. See "Overview".

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

         OTHER POTENTIAL COMPETITORS

         The Company is aware of at least four other companies that sell IVD
imaging systems, all for cytology and/or histology applications. Neuromedical
Systems, Inc. and NeoPath, Inc. offer IVD imaging systems for PAP smears.
Auto-Cyte, Inc. and ChromaVision Medical Systems, two newer ventures, recently
obtained significant funding through initial public offerings. AutoCyte plans to
compete in the PAP smear arena. ChromaVision sells a system for rare event
finding for applications similar in concept to the PowerGene automated rare
event finder recently delivered to the Johnson Space Center of NASA.

INTELLECTUAL PROPERTY

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

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

         The Company has granted TOA a royalty-bearing license to use pre-1989
technology for urine sediment analyzers and non-medical industrial instruments.

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

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


<PAGE>   10

GOVERNMENT REGULATION

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

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

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

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

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

         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, there can
be no assurance that future developments in this area will not have a material
adverse effect on the Company.

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


<PAGE>   11

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

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

FOREIGN OPERATIONS AND EXPORT SALES

See footnote 19 to the Consolidated Financial Statements for information
regarding the Company's foreign operations.

EMPLOYEES


At December 31, 1997, the Company had 159 full-time employees, which is
comparable to the number of employees at the end of 1996. The Company also
uses outside consultants and part-time and temporary employees in production,
administration, marketing and engineering. No employees are covered by
collective bargaining agreements, and the Company believes that its employee
relations are satisfactory.

FORWARD-LOOKING STATEMENTS

     This Annual Report contains various forward-looking statements which
reflect the Company's current views with respect to future events and financial
results and are subject to the safe harbor created by the Private Securities
Litigation Reform Act of 1995. These forward-looking statements include, but are
not limited to, the Company's views with respect to future financial results,
financing sources, capital requirements, market growth, new product
introductions and the like, and are generally identified by phrases such as
"anticipates," "believes," "estimates," "expects," "intends," "plans" and words
of similar import. The Company reminds stockholders that forward-looking
statements are merely predictions, and therefore inherently subject to
uncertainties and other factors, which could cause the actual results to differ
materially from the forward-looking statement. Some of these uncertainties and
other factors are discussed later in this Annual Report. See "Management
Discussion and Analysis of Financial Condition and Results of Operations." In
this section of the Annual Report, the Company has attempted to identify
additional uncertainties and other factors, which may affect its forward-looking
statements.

      Stockholders should understand that the uncertainties and other factors
identified in the Annual Report do not constitute a comprehensive list of all
the uncertainties and other factors which may affect forward-looking
statements. The Company has merely attempted to identity those uncertainties and
other factors which, in its view at the present time, have the highest
likelihood of significantly affecting its forward-looking statements. In
addition, the Company does not undertake any obligation to update or revise any
forward-looking statements or the list of uncertainties and other factors which
could affect such statements.

           POTENTIAL IMPACT OF ARBITRATION PROCEEDING

           The Company is presently in arbitration with the former owner of PSI.
See "Legal Proceedings." Although the Company does not presently anticipate any
material adverse effect as a result of this arbitration proceeding, there can be
no assurance that it will not have such an effect on the Company or result in
additional dilution to holders of the Common Stock.

           DEPENDENCE ON INSTRUMENT SALES

           The Company derives most of its revenues from the sale of two
families of high-priced instruments - The Yellow IRIS urinalysis workstations
and the PowerGene genetic analyzers. These instruments have list prices ranging
from $20,000 to $195,000 depending on model and configuration, and relatively
modest declines in unit sales or gross margins for either product line 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. From time to time, single source suppliers have discontinued
production of key components. Although, in the past, the Company has
successfully transitioned to new components to replace discontinued components,
there can be no assurance that the Company can 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. In the first quarter of 1997, Nikon discontinued production
of the microscope used in The Yellow IRIS. Prior to the end of production, the
Company significantly increased its inventory of these microscopes to facilitate
a two-year period for transitioning to a new microscope. The Company is
presently evaluating the relative merits of several "off-the-shelf" microscopes
versus a custom, OEM microscope. The Company's inability to transition
successfully to replacement components or to secure adequate supplies of
discontinued components on satisfactory terms during the transition could have a
material adverse effect on instrument sales. See"--Dependence on Instrument
Sales."

           DEPENDENCE ON KEY PERSONNEL

           The Company's success depends in significant part upon the continued
service of certain key personnel, and its continuing ability to attract,
assimilate and retain such personnel. Competition for such personnel is intense
and there can be no assurance that the Company can retain its key personnel or
that it can attract, assimilate or retain other highly qualified personnel in
the future. While the Company generally enters into agreements with its
employees regarding patents, confidentiality and related maters, the Company
does not have employment agreements with most of its key employees. The Company
does not maintain life insurance policies on such employees. The loss of key
personnel, especially without advance notice, or the inability to hire or retain
qualified personnel could have a material adverse effect on the Company.

           DIFFICULTIES ASSOCIATED WITH INTRODUCTION OF THE WHITE IRIS AND OTHER
           FUTURE PRODUCTS

           The commercial success of the Company's future products and systems
depends upon their acceptance by the medical community. Capital-intensive
laboratory instruments such as The White IRIS and the Company's other future
products can significantly reduce labor costs, improve precision and offer other
distinctive benefits. However, often there is resistance to products which
require significant capital expenditures or which eliminate jobs through
automation. There can be no assurance that the Company's new products and
systems will achieve significant market acceptance in the future or that sales
of such future products and systems will grow at the rates expected by
management. Furthermore, new product introductions or product enhancements by
the Company's competitors or the use of other technologies could cause a decline
in sales or gross margins on sales or loss of market acceptance of the Company's
systems.

     In addition, work on the initial commercial release of The White IRIS
leukocyte differential analyzer to testimonial sites was temporarily delayed by
other priorities, and expanded commercial release of The White IRIS may require
external funding. See "Management Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources." The failure to
develop influential customer references or secure any required external funding
could have a material adverse effect on the commercial release of The White IRIS
which, in turn, would affect the Company's long-term business strategy and
growth prospects.

           TECHNOLOGICAL CHANGE

           The market for the Company's systems is characterized by rapid
technological advances, changes in customer requirements, and frequent new
product introductions and enhancements. The Company's future success depends
upon its ability to enhance its current product lines, to introduce new products
that keep pace with technological developments and to respond to evolving
customer requirements. Any failure by the Company to anticipate or respond
adequately to technological developments by its competitors or to changes in
customer requirements, or significant delays in product introduction, could
result in a loss of competitiveness and revenues. There can be no assurance that
the Company will be successful in developing and marketing new products or
product enhancements on a timely or cost-effective basis, and such failure could
have a material adverse effect on the Company.

           GOVERNMENT REGULATION

           Most of the Company's products are subject to stringent government
regulation in the United States and other countries. The regulatory process can
be lengthy, expensive and uncertain, and securing clearances or approvals may
require the submission of extensive official data and other supporting
information. Failure to comply with applicable requirements can result in fines,
recall or seizure of products, total or partial suspension of production,
withdrawal of existing product approvals or clearances, refusal to approve or
clear new applications or notices, or criminal prosecution, any of which could
have a material adverse effect on the Company. Furthermore, changes in existing
federal, state or foreign laws or regulations, or in the interpretation or
enforcement thereof, or the discussion or promulgation of any additional laws or
regulations could have a material adverse effect on the Company.

           ACQUISITIONS AND EXPANSION

           As part of the Company's strategy to enhance and maintain its
competitive position, the Company may from time to time consider potential
acquisitions of complementary products, technologies and other businesses. The
Company has completed a number of acquisitions in the past three years. The
evaluation, negotiation and integration of acquisitions may consume significant
time and resources of the Company. There can be no assurance that acquisitions
will not have a material adverse effect upon the Company due to, among other
things, operational disruptions, integration issues, unexpected expenses and
accounting charges associated with such acquisitions.

           HEALTHCARE REFORM POLICIES

           In recent years, an increasing number of legislative proposals have
been introduced or proposed in Congress and in home state legislatures that
would effect major changes in the healthcare system, nationally, at the state
level or both. Future legislation, regulation or payment policies of Medicare,
Medicaid, private health insurance plans, health maintenance organizations and
other third-party payors could adversely affect the demand for the Company's
current or future products and its ability to sell its products on a profitable
basis. Moreover, healthcare legislation is an area of extensive and dynamic
change, and the Company cannot predict future legislative changes in the
healthcare field or their impact on its business.

GLOSSARY OF SELECTED TERMS

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

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

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

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

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

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

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

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

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

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

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

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

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


<PAGE>   12

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

ITEM 2.  PROPERTIES.

         The Company leases all of its facilities. The leases expire at various
times over the next four years. The Company's headquarters are located at 9162
Eton Avenue, Chatsworth, California 91311. The table below sets forth certain
information regarding the Company's leaseholds as of December 31, 1997:

<TABLE>
<CAPTION>
                                 Approximate Floor            Monthly
Location                          Space  (Sq. Ft.)               Rent   Use
----------------------------------------------------------------------------------------------------------------------
<S>                              <C>                      <C>           <C>
Chatsworth, CA                              26,000            $14,100   Sales and Marketing, Research and Development,
                                                                        Manufacturing and Corporate Administration
League City, TX                              7,000             $8,300   Sales and Marketing, Research and Development
                                                                        and Manufacturing
Norwood, MA                                 11,000             $7,200   Sales and Marketing, Research and Development
                                                                        and Manufacturing
Chester, England                             5,000       (pound)4,200   Sales and Marketing and Manufacturing
</TABLE>


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

ITEM 3.  LEGAL PROCEEDINGS.

         In July 1996, the Company acquired PSI from Digital Imaging
Technologies, Inc. ("DITI"). As part of the purchase price, the Company issued
to DITI a five-year warrant to purchase 875,000 shares of Common stock at $8.00
per share. In August 1997, the Company filed a demand for arbitration against
DITI with the American Arbitration Association. The Company's demand for
arbitration alleges material breaches of the representations, warranties and
covenants in the purchase agreement governing the PSI acquisition. DITI
subsequently filed a counterclaim in the arbitration proceeding alleging that
the Company misrepresented or omitted to disclose material facts in connection
with the PSI acquisition. DITI had previously requested a reduction in the
exercise price of the warrant but elected to seek unspecified monetary damages
in the counterclaim. The parties are currently engaged in discovery. Although
the Company does not presently anticipate any material adverse effect as a
result of this arbitration proceeding, there can be no assurance that it will
not have such an effect on the financial position or results of operations of
the Company or result in additional dilution to holders of the Common Stock.

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

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

         None.


<PAGE>   13

                                     PART II

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

         The Company's Common Stock is traded on the American Stock Exchange
("Amex") under the symbol "IRI." The closing price of the Common Stock on March
20, 1998 was $4.25 per share. The table below sets forth high and low closing
prices reported by Amex for the period January 1, 1996 through December 31,
1997:

<TABLE>
<CAPTION>
                                                                         Price per share
                                                                         ---------------
                                                                         High        Low
<S>                                                                   <C>         <C>
FISCAL 1996
        First Quarter..............................................     7-7/8       6-1/4
        Second Quarter.............................................    12-3/4       6-5/8
        Third Quarter..............................................     9-1/2       7-1/4
        Fourth Quarter.............................................     7-1/2       3-3/8
FISCAL 1997
        First Quarter..............................................     5-1/4      3-9/16
        Second Quarter.............................................    4-3/16       3-3/8
        Third Quarter..............................................   4-15/16     3-11/16
        Fourth Quarter.............................................    5-3/16       3-1/4
</TABLE>


         As of March 20, 1998, IRIS had approximately 4,300 holders of record of
its Common Stock.

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

         As partial consideration for renegotiating the Company's loan
agreements in March 1997, the Company issued to City National Bank warrants to
purchase (1) 50,000 shares until January 15, 2000 at $3.875 per share, (2)
25,000 shares until June 1, 2000 at $4.375 per share and (3) 25,000 shares until
July 1, 2000 at $4.0625 per share. The warrant certificates bear appropriate
restrictive legends concerning the registration requirements of the Securities
Act. The Company believes this transaction was exempt from the registration
requirements of the Securities Act based on Section 4(2) of the Securities Act.

         In May 1997, the Company amended an existing agreement with M. Kane &
Company, Inc., an investment banker, to provide ongoing financial advisory
services. Under the terms of the amendment, the Company agreed to issue to M.
Kane & Company a warrant to purchase 10,000 shares of Common Stock until May 15,
2002 at $4.3125 per share. The Company has not yet issued the warrant
certificate, but it will bear an appropriate restrictive legend concerning the
registration requirements of the Securities Act. The Company believes this
transaction was exempt from the registration requirements of the Securities Act
based on Section 4(2) of the Securities Act.

         Between February and May 1997, the Company issued a total of 75,376
shares of Common Stock to Irell & Manella, LLP, as partial payment for legal
services. The certificates bear appropriate restrictive legends concerning the
registration requirements of the Securities Act. The Company believes these
transactions were exempt from the registration requirements of the Securities
Act based on Section 4(2) of the Securities Act.

   
         In November 1997, the Company offered to reduce the exercise price of
its outstanding Series D Warrants from $6.50 to $4.00 per share for holders
exercising their warrants during a one-week period. The holders that accepted
the offer and exercised their Series D Warrants during that period also received
a new Series F Warrant exercisable until March 29, 2000 at an exercise price of
$4.00 per share of Common Stock. The Company received gross proceeds of
approximately $783,000 through the exercise of Series D Warrants and issued
Series F Warrants to purchase an aggregate of 196,633 shares of Common Stock.
The Company also sold to two Series D Warrant holders for $35,000 additional
Series F Warrants covering an aggregate of 75,000 shares of Common Stock.
    

         Concurrently with making the offer, the Company provided the Series D
Warrant holders with copies of its most recent Annual Report (Form 10K),
Quarterly Report (Form 10Q) and Proxy Statement. The Company also obtained
written representations from the participants in the offer confirming their
status as "accredited investors" under Regulation D and confirming their intent
to acquire the securities for their own account and not with a view to resale or
distribution in violation of the Securities Act. The Company did not engage in
general solicitation or advertising, and the securities issued in the
transaction bear appropriate restrictive legends concerning the registration
requirements of the Securities Act. The Company believes this transaction was
exempt from the registration requirements of the Securities Act based on
Regulation D and Section 4(2) of the Securities Act.

         In February 1998, the Company issued Series F Warrants covering 27,000
shares of Common Stock to Alan Stone & Co., a former financial consultant, and
his attorney to settle litigation between the parties. As part of the
settlement, Alan Stone & Co. also surrendered for cancellation Series E Warrants
(exercisable at $7.80 per share) to purchase an equal number of shares of Common
Stock. The Company obtained written representations from the recipients
confirming their status as "accredited investors" under Regulation D and
confirming their intent to acquire the securities for their own account and not
with a view to resale or distribution in violation of the Securities Act. The
securities issued in the transaction bear appropriate restrictive legends
concerning the registration requirements of the Securities Act. The Company
believes this transaction was exempt from the registration requirements of the
Securities Act based on Section 4(2) of the Securities Act.


<PAGE>   14
ITEM 6.  SELECTED FINANCIAL DATA.

         This information as of December 31, 1996 and 1997 and for the years
ended December 31, 1995, 1996 and 1997 is derived in part from, and should be
read in conjunction with, the Company's Financial Statements, including the
Notes thereto, as included elsewhere in this Annual Report.

<TABLE>
<CAPTION>
                                                                                            Year Ended December 31,
                                                 ------------------------------------------------------------------
                                                   1993           1994         1995(1)       1996(1)        1997(1)
                                                 ------------------------------------------------------------------
                                                                          (in thousands, except per share data)
<S>                                               <C>           <C>           <C>           <C>            <C>    
FINANCIAL STATEMENT DATA
Net revenues..................................    $12,428       $12,580       $14,488       $20,597        $27,495
Operating income (loss).......................      1,313         1,495       (1,802)       (10,434)           284
Interest and other income (expense), net......         33            95           282          (452)        (1,080)
Net income (loss).............................      1,323         1,622         2,126        (7,428)          (503)
Net income (loss) per share - basic...........        .26           .30           .35         (1.21)          (.16)
Net income (loss) per share - diluted.........        .25           .28           .34         (1.21)          (.16)
Working capital...............................      6,812         7,779        11,234         1,914          1,650
Total assets..................................     11,181        13,282        22,203        37,860         32,735
Long term debt, including current portion.....        603           367           311        13,000         10,942
Total liabilities.............................      3,415         3,122         3,261        24,096         17,942
Shareholders' equity..........................      7,766        10,160        18,942        13,765         14,792
Cash dividends per share......................         --            --            --            --             --
OTHER FINANCIAL DATA
Operating income (loss) - as adjusted(2) .....      1,313         1,495         1,098        (1,147)         1,622
EBITDA (3)....................................      2,044         2,407         2,150          (849)         4,050

</TABLE>


(1) The years ended December 31, 1995 and 1996 include write-offs of acquired in
process research and development totaling $2.9 million and $7.3 million,
respectively. The year ended December 31, 1996 also includes unusual charges
totaling $1.9 million relating primarily to pooling-of-interest expenses, the
write-off of deferred public offering costs, expenses relating to litigation and
arbitration matters, severance and other incremental costs associated with a
restructuring of the Company's personnel. The year ended December 31, 1997
includes unusual charges totaling $1.3 million relating to expenses for
litigation and arbitration matters, the write-down of deferred private offering
costs and the write-off of goodwill no longer considered recoverable.

(2) Operating income (loss) - as adjusted represents operating income (loss)
before the write-off of acquired in process research and development totaling
$2.9 million and $7.3 million in the years ended December 31, 1995 and 1996,
respectively, and before unusual charges of $1.9 million and $1.3 million in the
years ended December 31, 1996 and 1997, respectively. 

(3) EBITDA represents earnings before taxes, interest expense, write-off of
acquired in process research and development, depreciation and amortization,
including amortization of common stock and stock option compensation. The
Company believes that EBITDA serves as a financial analysis tool for measuring
financial information such as operating performance leverage ratios. EBITDA
should not be considered by the reader as an alternative to net income as an
indicator of the Company's performance or as an alternative to cash flows as a
measure of liquidity.

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

OVERVIEW

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

         Until 1996, the Company generated most of its revenues from sales of
just two models of The Yellow IRIS urinalysis workstation and related supplies
and services. These two models differ mainly by their speed and price. In 1996,
the Company introduced a third model of The Yellow IRIS, the Model 900UDx urine
pathology system which is a higher capacity automated urinalysis workstation
designed especially for the high-volume testing requirements of large hospitals
and reference laboratories. Finally, the Company began selling the PowerGene
family of genetic analyzers in August 1996 after completing the PSI Acquisition.
See "Business - Overview."

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


<PAGE>   15

<TABLE>
<CAPTION>
                                                                                                  Year Ended December 31,
                                                                                      1995            1996           1997
                                                                                     ------------------------------------
                                                                                               (in thousands)
<S>                                                                                  <C>            <C>            <C>   
Research and development expense, net...........................................     $1,220         $1,978         $2,125
Capitalized software development costs..........................................        299            577            535
Reimbursed costs for research and development grants and contracts..............        843          1,780          1,015
                                                                                    -------        -------        -------
        Total product technology expenditures...................................     $2,362         $4,335         $3,675
                                                                                     ======         ======         ======
</TABLE>


         The Company has in the past partially funded its research and
development programs through (i) grants from NASA and the National Institutes of
Health, (ii) joint development programs with strategic partners and (iii)
Company-sponsored research and development entities. See "Business--Research and
Development."

RESULTS OF OPERATIONS

         The consolidated financial statements reflect the consummation of the
PSI Acquisition on July 31, 1996 which was accounted for using the purchase
method of accounting. Accordingly, the consolidated statements of operations
include the financial results of PSI for the entire 1997 fiscal year, but only
for the period from August 1 to December 31 for fiscal 1996.

         COMPARISON OF YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31,
1996

     Net revenues for the year ended December 31, 1997 increased to $27.5
million from $20.6 million, an increase of $6.9 million or 33% over the prior
year. Sales of IVD imaging systems increased to $11.8 million from $6.4 million,
an increase of $5.4 million or 86% over the prior year. The Company added the
PowerGene family of genetic analyzers to its product line in August 1996 as a
result of the PSI Acquisition. Of the 1997 increase, $4.0 million reflects the
first full year of sales of the PowerGene analyzer in sales of IVD imaging
systems and $1.4 million reflects increased sales of The Yellow IRIS.

         Sales of IVD imaging system supplies and services increased to $10.6
million from $9.1 million, an increase of $1.5 million or 16% over the prior
year, due to the larger installed base of IVD imaging systems and the conversion
of The Yellow IRIS installed base to the new CHEMSTRIP/IRIStrip urine test
strips marketed exclusively by the Company. Sales of small instruments and
supplies decreased to $4.4 million from $5.1 million, a decrease of $619,000 or
12%, over the prior year. The decrease reflects lower sales levels of the
StatSpin products to one of its distributors. Further decline in sales of small
instruments is not anticipated in 1998.

     Royalties and licensing revenues for the year ended December 31, 1997
increased to $603,000 from $43,000, an increase of $560,000 over the prior year.
The increase is primarily the result of increased royalties received, the
receipt of previously disputed royalties relating to the fourth quarter of 1996
and initial fees earned for the license of certain technology. Royalties and
licensing revenues are expected to decrease to historical levels in 1998.

     Cost of goods for IVD imaging systems as a percentage of sales of IVD
imaging systems decreased to 51% for the year ended December 31, 1997 as
compared to 54% in the prior year. The decrease is primarily due to fixed costs
being absorbed by increased sales of The Yellow IRIS, partially offset by
increased costs of goods sold relating to the PowerGene analyzer sales. Cost of
goods for IVD imaging system supplies and services decreased as a percentage of
sales of such products to 50% for the year ended December 31, 1997 from 56% for
the prior year. This decrease is principally due to decreased costs and
increased sales prices. Cost of goods for small instruments and supplies as a
percentage of sales of small instruments and supplies totaled 53% for the year
ended December 31, 1997, and is comparable to the prior year. The net result of
these changes and increased royalties and licensing revenues was an increase in
gross margin for the year ended December 31, 1997 to 50%, as compared to 45% for
the year ended December 31, 1996.

         Marketing and selling expenses consist primarily of salaries,
commissions and related travel expenses of the Company's direct sales force, as
well as salaries for the marketing and distributor relations departments.
Marketing and selling expenses increased to $5.2 million for the year ended
December 31, 1997 from $4.6 million, an increase of $597,000 or 13% over the
prior year, primarily due to the addition of the sales force from the PSI
Acquisition partially offset by decreased marketing and selling expenses related
to The Yellow IRIS. Marketing and selling expenses as a percentage of net
revenues decreased from 22% in the prior year to 19% in the current year.

         General and administrative expenses consist primarily of payroll costs
associated with the Company's management and support personnel, facilities
related costs and legal and accounting fees. General and administrative expenses
increased to $3.5 million for the year ended December 31, 1997 from $3.3
million, an increase of $205,000 or 6% over the comparable period in the prior
year. This increase is the result of the addition of administrative functions
following the PSI Acquisition, partially offset by decreased expenses resulting
from the



<PAGE>   16

restructuring implemented in the fourth quarter of 1996 and decreased
acquisition activities in the current year. General and administrative expenses
as a percentage of net revenues decreased from 16% for 1996 to 13% for the
current year.

         Net research and development expenses consist of costs incurred for the
development of new products and improvements to existing products less
third-party reimbursements under joint development programs, grants and research
and development contracts. Net research and development expenses increased to
$2.1 million for the year ended December 31, 1997 from $2.0 million, an increase
of $147,000 or 7% over the prior year, and decreased as a percentage of net
revenues from 10% to 8%. Reimbursements under joint development programs
decreased to $1.0 million in 1997 from $1.8 million in 1996. Total product
technology expenditures decreased to $3.7 million from $4.3 million, a decrease
of $660,000 or 15% over the prior year, due primarily to reduced spending on the
development of The White IRIS and decreased expenditures on the Poly Products,
partially offset by the addition of research and development staff from the PSI
Acquisition. Total product technology expenditures are expected to remain at
this level for 1998.

         Amortization of intangible assets reflects the amortization of deferred
expenses for warrants issued in connection with joint development projects and
intangible assets arising from acquisitions and patents. Amortization of
intangible assets for the year ended December 31, 1997 increased to $1.3 million
from $794,000, an increase of $515,000 or 65% over the prior year, primarily as
a result of the acquisition of intangible assets in the PSI Acquisition and a
small product line acquisition.

         The results of operations for the year ended December 31, 1997 include
certain unusual charges to earnings of $1.3 million, primarily for the write-off
in the fourth quarter of deferred private offering expenses ($481,000), goodwill
no longer considered recoverable associated with the digital refractometer line
of business ($705,000) and legal expenses ($152,000) relating to a completed
patent litigation matter and the pending arbitration matter against Digital
Imaging Technologies, Inc. See "Legal Proceedings." The unusual charges in the
prior year totaled $1.9 million and related primarily to the write-off of
deferred public offering costs ($686,000), litigation expense ($617,000),
restructuring charges ($298,000) and merger related expenses ($244,000).

     Acquisition of in-process research and development charges for the year
ended December 31, 1996 amounted to $7.3 million. No similar charge was incurred
in 1997.

         The net result of the above described charges was an increase in
operating income in fiscal 1997 to $284,000 as compared to an operating loss of
$10.4 million in the prior year. Excluding the effects of the unusual charges
and acquisition of in-process research and development, operating income would
have been $1.6 million in the current year, compared to an operating loss of
$1.1 million in the previous year.

         Interest income decreased to $57,000 for the year ended December 31,
1997 from $222,000 for the prior year, primarily as the result of decreased
amounts of invested cash in 1997.

         Interest expense increased to $1.2 million for the year ended December
31, 1997 from $681,000 for the prior year due to the indebtedness incurred to
finance the PSI Acquisition and increased interest rates on bank debt.

         Other income increased primarily due to the receipt of government grant
funds for reimbursement of expenses incurred in prior periods.

         The income tax benefit for the year ended December 31, 1997 was
$293,000, as compared to an income tax benefit of $3.5 million for 1996. The
income tax benefit for the year ended December 31, 1997 differs from the federal
statutory rate due to state, local and foreign income taxes and permanent
differences between income reported for the financial statement and income tax
purposes.

         The staff of the Securities and Exchange Commission recently announced
a new position on accounting for convertible preferred stock which is
potentially convertible at a discount to the market price of the common stock,
even if the potential for a discount is only a possibility. The staff has taken
the position that, solely for purposes of calculating earnings per share, the
potential discount is an imputed dividend to the preferred stockholders which
reduces the amount of income available to common stockholders. As a result of
the staff's new accounting position, the issuance of the Series A Preferred
Stock resulted in a one-time reduction in earnings attributable to common
shareholders of $450,000 or $0.08 per share in the first quarter of 1997. The
staff's position is limited to the calculation of earnings per share and did not
have any effect on the Company's net income or cash flow. See "Liquidity and
Capital Resources."

         The above factors contributed to a net loss of $503,000. However, due
to the imputed dividend discussed above, the loss per common share based upon
the net loss attributable to common stockholders of $953,000 amounted to $0.16
per share for the year ended December 31, 1997 as compared to a net loss of $7.4
million or 
<PAGE>   17
$1.21 per share for the year ended December 31, 1996. Excluding the effect of
unusual charges, adjustment to the deferred tax valuation allowance and charges
for the acquisition of in-process research and development from the PSI
Acquisition, the Company would have had net loss attributable to common
stockholders of $108,000 or $0.02 per share for the year ended December 31,
1997, as compared to a net loss of $1.5 million, or $0.24 per share, for the
year ended December 31, 1996.

         COMPARISON OF YEAR ENDED DECEMBER 31, 1996 TO YEAR ENDED DECEMBER 31,
1995

         Net sales for the year ended December 31, 1996 increased to $20.6
million from $14.5 million, an increase of $6.1 million or 42% over the prior
year. Sales of IVD imaging systems increased to $6.4 million from $4.2 million,
an increase of $2.2 million or 50% over the prior year. The increase was due
primarily to the addition of the PowerGene family of genetic analyzers to the
Company's product line in August 1996 as a result of the PSI Acquisition.

         Sales of IVD imaging system supplies and service increased to $9.1
million from $6.7 million, an increase of $2.4 million or 35% over the prior
year, due to the larger installed base of IVD imaging systems and the conversion
of The Yellow IRIS installed base to the new CHEMSTRIP/IRIStrip urine test
strips marketed exclusively by the Company. Sales of small instruments and
supplies increased to $5.1 million from $3.4 million, an increase of $1.7
million or 48%, over the prior year. The increase reflects generally higher
sales levels of the StatSpin products, as well as the addition of the CenSlide
product line in March 1996.

         Cost of goods for IVD imaging systems increased as a percentage of
sales of IVD imaging systems to 54% for the year ended December 31, 1996 from
48% for the prior year due primarily to the addition of the Model 900UDx to the
product line and amortization of increased fixed costs for IVD imaging systems.
These factors were partially offset by the addition of the higher-margin
PowerGene family of genetic analyzers to the Company's product line in August
1996. Cost of goods for IVD imaging system supplies and service increased as a
percentage of sales of such products to 56% for the year ended December 31, 1996
from 47% for the prior year primarily due to relatively lower gross margins on
sales of CHEMSTRIP/IRIStrip urine test strips which accounted for a greater
proportion of sales of system supplies, as well as a decline in gross margins on
service of IVD imaging systems. Cost of goods for small instruments and supplies
decreased as a percentage of sales of small instruments and supplies to 53% for
the year ended December 31, 1996 from 57% for the prior year due to an overall
change in product mix toward higher gross margin items. The net result of these
changes was a decrease in aggregate gross margin to 45% for the year ended
December 31, 1996 from 51% for the prior year.

         Marketing and selling expenses increased to $4.6 million for the year
ended December 31, 1996 from $2.9 million, an increase of $1.7 million or 61%
over the prior period, and increased as a percentage of net sales to 22% from
20%, due to the addition of the sales force from the PSI Acquisition and
increased spending on promotions, telemarketing and customer support.

         General and administrative expenses increased to $3.3 million for the
year ended December 31, 1996 from $2.0 million, an increase of $1.3 million or
60% over the prior year, and increased as a percentage of net sales from 14% to
16%. This increase is primarily the result of an increase in the allowance for
doubtful accounts, increased expenses associated with the addition of the
business acquired from PSI, increased legal and accounting expenses and the
addition of personnel to the corporate staff.

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

         Amortization of intangible assets for the year ended December 31, 1996
increased to $794,000 from $127,000, an increase of $667,000 or 524% over the
prior year, primarily as a result of the acquisition of intangible assets in the
PSI Acquisition, as further described below.

         The results of operations for the year ended December 31, 1996 include
certain unusual charges to earnings of $1.9 million primarily for the write-off
of deferred offering costs ($686,000), litigation expenses ($617,000),
restructuring charges ($298,000) and merger related expenses ($244,000).

         The Company incurred charges of $7.3 million and $2.9 million for the
acquisition of in-process technology for the years ended December 31, 1996 and
1995, respectively. Such in-process technology was valued, along with other
acquired assets, in accordance with valuation techniques commonly used in the
technology industry and was expensed upon acquisition in accordance with
Financial Accounting Standard No. 2, "Accounting for Research and Development
Costs." The 1996 charge represents in-process technology acquired in the PSI
Acquisition. The Company subsequently completed work on the majority of this
technology and introduced the M-Fish system for the PowerGene analyzer in
October 1997 and the next generation PowerGene analyzer in early 1997. The
Company elected in 1997 not to pursue work on the remainder of this technology
which concerned development of a device for automated manipulation of microscope
slides. The 1995 charge represents in-process technology for The White IRIS
leukocyte differential analyzer acquired as part of the acquisition of LDA
Systems, Inc. The Company completed additional work on The White IRIS and
received FDA approval for it in May 1996. The Company subsequently delayed its
commercial release to pursue other priorities and is now seeking prestigious
medical institutions to serve as testimonial sites. See "--Liquidity and Capital
Resources."


<PAGE>   18

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

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

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

         The above factors contributed to a net loss of $7.4 million, or $1.21
per share, for the year ended December 31, 1996 as compared to net income of
$2.1 million, or $0.34 per diluted share, for the year ended December 31, 1995.
Excluding the charges for the acquisition of in-process research and development
from the PSI Acquisition, adjustment to the deferred tax valuation allowance and
the $2.0 million of unusual charges discussed above, the Company would have had
a net loss of approximately $1.5 million, or $0.24 per share, for the year ended
December 31, 1996. Excluding the charges for the acquisition of in-process
research and development from LDA Systems, Inc. and the recognition of the tax
benefit due to the reduction in the deferred tax asset valuation allowance, the
Company would have had net income of approximately $1.4 million, or $0.22 per
share, for the year ended December 31, 1995.

LIQUIDITY AND CAPITAL RESOURCES

         Cash, cash equivalents and short term investments decreased to $1.5
million at December 31, 1997 from $4.3 million at December 31, 1996. The
decrease is primarily due to payments on bank debt, an installment payment on
the repurchase of common stock and capital expenditures for property and
equipment and capitalized software development costs. These expenditures were
only partially offset by cash provided by operations.

         Cash flows from operations increased to $2.0 million for the year ended
December 31, 1997 as compared to $181,000 for the prior year. This improvement
was due to improved results of operations and decreased inventory levels,
partially offset by a significant reduction in accounts payable. Inventory
levels at December 31, 1997 decreased to $3.7 million from $4.8 million at
December 31, 1996. This decrease was due to an inventory reduction program that
was completed in the fourth quarter of 1997. Accounts receivable increased to
$5.3 million at December 31, 1997 from $5.2 million at December 31, 1996,
primarily the result of improved collection efforts offset by the effect of
increased sales. Accounts payable increased in the prior year to $4.6 million at
December 31, 1996, and was reduced to $2.6 million at December 31, 1997.

         In the year ended December 31, 1997, cash flows used by investing
activities totaled $872,000, as compared to $7.8 million used in 1996. In the
prior year $10.3 million was used to fund the purchase of PSI and the Censlide
product line. No business acquisitions were made in fiscal 1997. During 1997,
the Company spent $950,000 for capital equipment and $535,000 for capitalized
software development, as compared to $1.2 million and $577,000, respectively, in
the prior year. The Company does not presently have any material commitments for
capital expenditures. During 1996 the Company liquidated $4.2 million of its
securities to fund the business acquisitions, capital expenditures and
operations. The remainder of its securities totaling $643,000 was liquidated
during 1997 to reduce bank debt.

         Net cash used by financing activities for the year ended December 31,
1997 totaled $3.2 million and consisted primarily of principal payments under a
bank credit facility totaling $3.6 million. An additional $545,000 was used to
reduce notes payable relating to the repurchase of Common Stock and warrant from
a joint venture partner in 1996. Cash proceeds totaled $908,000 from stock sales
to employees under the Company's stock option and purchase plans and to warrant
holders who exercised in connection with an exchange offer. The Company also
issued Common Stock and warrants in satisfaction of accounts payable totaling
$284,000. In connection with the April 1997 bank loan renewal, the Company
issued three-year warrants to purchase Common Stock at the then current market
price. See "Market for Registrant's Common Stock and Related Stockholder
Matters."

         The Company acquired PSI in July 1996 for $16.1 million and financed
the purchase price with (i) a $7.0 million subordinated note issued to the
seller, (ii) a $7.8 million term loan from City National Bank and (iii) $1.3
million drawn under a new $1.5 million revolving line of credit from City
National Bank. On December 31, 1997, the outstanding principal balance of the
term loan was $3.4 million. The outstanding principal balance on the credit
facility was $350,000 on December 31, 1997. The term loan and credit facilities
were initially scheduled to mature on April 15, 1998 and were later extended to
May 15, 1998.

         On May 8, 1998, the Company terminated the revolving line of credit
with City National Bank and repaid the related term loan with the proceeds of a
new credit facility from Foothill Capital Corporation, a division of Norwest
Bank. The new credit facility consists of a $3.6 million term loan and a $4.0
million revolving line of credit. Borrowings under the new line of credit are
limited to a percentage of eligible accounts receivable and subject to a
combined limit of $7.0 million for the entire credit facility. The Company had
$2.0 million available under the line of credit at inception. The term loan
bears interest at the lender's prime rate (8.5% on May 8, 1998) plus 3% and is
payable in 36 equal monthly installments. The revolving line of credit bears
interest at the lender's prime rate plus 1%. The new credit facility is subject
to minimum interest charges, prepayment penalties and customary fees, is
collateralized by a first priority lien on all the assets of the Company and
matures in 2001. It also contains financial covenants based primarily on
tangible net worth and cash flow and imposes restrictions on acquisitions,
capital expenditures and cash dividends.









<PAGE>   19
         During 1997, the Company issued two 8.0% promissory notes in the
aggregate amount of approximately $1.0 million due in semi-monthly installments
of $100,000 commencing April 1, 1998. These notes constitute the final payments
for the repurchase of Common Stock and a warrant from an affiliate of Boehringer
Mannheim Corporation, a former joint venture partner.

         Excluding the refinancing of the bank debt that occurred in May 1998
and assuming constant interest rates, minimum payments for principal and
interest on outstanding short-term and long-term debt obligations are expected
to total $3.1 million in 1998, $2.8 million in 1999 and $2.2 million in 2000.
The Company believes that its current cash on hand, together with cash expected
from operations and cash available under the new credit facility, will be
sufficient to fund normal operations and pay principal and interest on
outstanding debt obligations through 2000.

         The Company plans to pursue equity financing to reduce indebtedness and
to fund its long-term business strategy. While the FDA cleared The White IRIS
leukocyte differential analyzer in May 1996, its commercial release was delayed
by other priorities such as the introduction of the UF-100 urine sediment
analyzer. The Company is now in discussions with two prestigious medical
institutions to serve as testimonial sites for The White IRIS. The Company's
immediate goal is to install the first two commercial systems at these
institutions and develop the customer references which are a key step toward
commercial success of any new major laboratory instrument. Expanded commercial
release of The White IRIS may also require external funding. The failure to
develop influential customer references or secure any required external funding
could have a material adverse effect on the commercial release of The White
IRIS.


         In September 1995, the Company and Poly entered into a research and
development agreement to develop the Poly Products using the Company's
technology. See "Business - Research and Development." The Company is funding
the first $15,000 per month (up to a maximum of $500,000 of which $80,000
remains outstanding) of the cost of the project, and Poly is reimbursing the
Company for the excess. The Company has an option until November 29, 1998 to
acquire all of the common stock of Poly for an aggregate price of $5.1 million,
payable in cash or shares of Common Stock. If the Company elects to exercise its
option, the portion of the net cost of the acquisition allocated to completed
products would be capitalized and its subsequent amortization may impact future
earnings to the extent profits from products acquired do not cover these costs.
For the portion of the net cost of the acquisition, if any, allocated to
in-process research and development, the Company would record a nonrecurring,
noncash (if purchased with Common Stock) charge against then current earnings.

   
         The Company has outstanding 3,000 shares of Series A Convertible
Preferred Stock ("Preferred Stock"). Each share of Preferred Stock is
convertible into a number of shares of Common Stock equal to (i) its $1,000
liquidation value divided by (ii) a variable conversion price. The conversion
price equals the lower of (a) $3.56 per share or (b) 85% of the average closing
bid price of the Common Stock for the five consecutive trading days preceding
the conversion (but in no event less than $1.50). Assuming conversion prices of
$3.56 and $1.50 per share, the Preferred Stock is convertible into approximately
843,000 and 2,000,000 shares of Common Stock, respectively. Any unconverted
shares of Preferred Stock will automatically be converted into Common Stock on
December 31, 1999. The Preferred Stock is non-voting, is not entitled to any
preferred dividends and is not subject to any mandatory or optional redemption
provisions. The Company may not pay cash dividends on the Common Stock or
repurchase any shares of the Common Stock without the written consent of the
holder of the Preferred Stock.
    


<PAGE>   20

         The Company has conducted a review of its IVD imaging products and
internal computer systems to identify those areas that require Year 2000
compliance. Year 2000 compliance refers to the inability of certain computer
systems to recognize dates commencing on January 1, 2000. The Company currently
believes that by modifying existing software and converting to new software for
certain tasks, Year 2000 compliance will not pose significant marketing or
operational problems and is not anticipated to be material to its future
financial position or results of operations.

INFLATION

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

HEALTHCARE REFORM POLICIES

         In recent years, an increasing number of legislative proposals have
been introduced or proposed in Congress and in some state legislatures that
would effect major changes in the healthcare system, nationally, at the state
level or both. Future legislation, regulation or payment policies of Medicare,
Medicaid, private health insurance plans, health maintenance organizations and
other third-party payors could adversely affect the demand for the Company's
current or future products and its ability to sell its products on a profitable
basis. Moreover, healthcare legislation is an area of extensive and dynamic
change, and the Company cannot predict future legislative changes in the
healthcare field or their impact on its business.

RECENTLY-ISSUED ACCOUNTING STANDARDS

         Recently issued accounting standards are described in Note 2 in the
consolidated financial statements.

FORWARD-LOOKING STATEMENTS

         The foregoing discussion, as well as the other sections of this Annual
Report on Form 10-K/A, contain various forward-looking statements which reflect
the Company's current views with respect to future events and financial results
and are subject to the safe harbor created by that Private Securities Litigation
Reform Act of 1995. These forward-looking statements include, but are not
limited to, the Company's views with respect to future financial results,
financing sources, capital requirements, market growth, new product
introductions and the like, and are generally identified by phrases such as
"anticipates," "believes," "estimates," "expects," "intends," "plans" and words
of similar import. The Company reminds stockholders that forward-looking
statements are merely predictions and therefore inherently subject to
uncertainties and other factors which could cause the actual results to differ
materially from the forward-looking statement. These uncertainties and other
factors include, among other things, (i) the ability of the Company to secure
additional financing to repay the remaining principal balance of its long-term
debt and to fund its long-term business strategy, (ii) unexpected technical and
marketing difficulties inherent in the introduction of sophisticated,
capital-intensive new medical instruments such as The White IRIS and other
planned instrument introductions, (iii) the potential need for changes in the
Company's long-term strategy in response to future developments, (iv) future
advances in diagnostic testing methods and procedures, as well as potential
changes in government regulations and healthcare policies, both of which could
adversely affect the economics of the diagnostic testing procedures automated by
the Company's products, (v) rapid technological change in the microelectronics
and software industries, (vi) increasing competition from imaging and
non-imaging based in-vitro diagnostic products and (vii) difficulties in
assimilating acquired companies and product lines such as PSI.

         The Company has attempted to identify additional significant
uncertainties and other factors affecting forward-looking statements elsewhere
in this Annual Report. See "Business -- Forward-Looking Statements".

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

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


<PAGE>   21

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

         None.

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         Incorporated by reference from "Directors and Executive Officers" in
the Proxy Statement to be filed with the Securities and Exchange Commission for
the 1998 Annual Meeting of IRIS Stockholders.

ITEM 11.  EXECUTIVE COMPENSATION.

         Incorporated by reference from "Executive Compensation" in the Proxy
Statement to be filed with the Securities and Exchange Commission for the 1998
Annual Meeting of IRIS Stockholders.

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

         Incorporated by reference from "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement to be filed with the
Securities and Exchange Commission for the 1998 Annual Meeting of IRIS
Stockholders.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         Incorporated by reference from "Certain Relationships and Related
Transactions" in the Proxy Statement to be filed with the Securities and
Exchange Commission for the 1998 Annual Meeting of IRIS Stockholders.

                                     PART IV

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

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

<TABLE>
<CAPTION>
         1.  Index to Financial Statements                                                             Page
                                                                                                       ----
         <S>                                                                                           <C>
                  Report of Independent Public Accountants.                                              25
                  Consolidated Balance Sheets at December 31, 1997 and 1996.                             26
                  Consolidated Statements of Operations for the Years Ended December 31,
                  1997, 1996, and 1995.                                                                  27
                  Consolidated Statements of Shareholders' Equity for the Years Ended
                  December 31, 1997, 1996, and 1995.                                                     28
                  Consolidated Statements of Cash Flows for the Years Ended December 31,
                  1997, 1996 and 1995.                                                                   31
                  Notes to Consolidated Financial Statements.                                            32

         2.   Financial Statement Schedules Covered by the Foregoing Report of
              Independent Public Accountants.
                  Schedule II-Valuation and Qualifying Accounts                                           *
</TABLE>

         * Omitted in copy distributed to stockholders, unless requested.

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

         3.       Exhibits

<TABLE>
<CAPTION>
  No.                Description
  ---                -----------
<S>                  <C>
  3.1(a)             --  Certificate of Incorporation, as amended (1)
  3.1(b)             --  Certificate of Designations of Series A Convertible Preferred Stock (2)
  3.2                --  Restated Bylaws (3)
  4.1                --  Specimen of Common Stock Certificate (4)
  4.1                --  Certificate of Designations of Series A Convertible Preferred Stock (2)
  10.1               --  Lease of the Company's headquarters facility, as amended (5)
  10.2(a)            --  1982 Stock Option Plans and form of Stock Option Agreement (6)
  10.2(b)            --  1983 and 1986 Stock Option Plans, and forms of Stock Option Agreements for each Plan (7)
  10.2(c)            --  Amended and Restated 1986 Stock Option Plan (8)
  10.2(d)            --  1994 Stock Option Plan and forms of Stock Option Agreements (9)
</TABLE>

<PAGE>   22

<TABLE>
<S>                  <C>
  10.2(e)            --  Certificate of Officer With Respect to Amendment of 1994 Stock Option Plan (10)
  10.2(f)            --  Key Employee Stock Purchase Plan (11)
  10.2(g)            --  1997 Stock Option Plan and form of Stock Option Agreement (18)
  10.3(a)            --  Various Agreements with TOA Medical Electronics Company, Ltd. (12)
  10.3(b)            --  Patent License Agreement dated April 1, 1997 between the Company and TOA Medical
                         Electronics Company, Ltd. (20)
  10.3(c)            --  Termination, Release and Reassignment of Security Interest dated October 30, 1997
                         executed by TOA Medical Electronics Company, Ltd. in favor of the Company (20)
  10.4(a)            --  Agreement for a Strategic Alliance in Urinalysis dated January 7, 1994 between the Company
                         and Boehringer Mannheim Corporation (13)
  10.4(b)            --  Research and Development and Distribution Agreement dated February 6, 1995 by and
                         among the Company, LDA Systems, Inc. and Corange International Limited (13)
  10.4(c)            --  Amendment to Distribution Agreements (14)
  10.5               --  Warrant Certificate dated March 20, 1995 issued to Biovation, Inc. (13) 
  10.6(a)            --  Technology License Agreement dated as of September 29, 1995
                         between the Company and Poly U/A Systems, Inc. (15)
  10.6(b)            --  Research and Development Agreement dated as of September 29, 1995 between the
                         Company and Poly U/A Systems, Inc. (15)
  10.6(c)            --  $100 Class "A" Note dated September 29, 1995 issued by Poly U/A Systems, Inc. in favor of
                         the Company (15)
  10.6(d)            --  Certificate of Incorporation of Poly U/A Systems, Inc. (See Article FOUR regarding the IRIS
                         Option) (15)
  10.6(e)            --  Form of Series D Warrant (20)
  10.6(f)            --  Form of Series E Warrant (20)
  10.6(g)            --  Form of Series F Warrant (20)
  10.7(a)            --  Agreement and Plan of Merger dated January 31, 1996 between the Company and StatSpin,
                         Inc. (16)
  10.7(b)            --  Registration Rights Agreement dated January 31, 1996 between the Company and StatSpin
                         Stockholders (16)
  10.7(c)            --  Employment Agreement dated January 30, 1996 with Thomas F. Kelley (16)
  10.7(d)            --  Letter Agreement dated October 4, 1997 amending Employment
                         Agreement of Thomas F. Kelley (20)
  10.8(a)            --  Asset Purchase Agreement dated as of July 15, 1996 by and among the Company, Digital
                         Imaging Technologies, Inc., Perceptive Scientific Instruments, Inc. and Perceptive Scientific
                         Technologies, Inc. (17)
  10.8(b)            --  Registration Rights and Standstill Agreement dated July 31, 1996 between the Company and
                         Digital Imaging Technologies, Inc. (10)
  10.8(c)            --  Warrant Certificate dated July 31, 1996 issued to Digital Imaging Technologies, Inc. (10)
  10.8(d)            --  Stockholder Guaranty Agreement dated July 31, 1996 between Edward Randall, III and PSII
                         Acquisition Corp., a wholly-owned subsidiary of the Company (now known as Perceptive
                         Scientific Instruments, Inc.) (10)
  10.8(e)            --  Non-Competition Agreement dated as of July 15, 1996 between Edward Randall, III and PSII
                         Acquisition Corp., a wholly-owned subsidiary of the Company (now known as Perceptive
                         Scientific Instruments, Inc.) (10)
  10.8(f)            --  Technology License Agreement dated July 31, 1996 between Perceptive Scientific Imaging
                         Systems, Inc. and PSII Acquisition Corp., a wholly-owned subsidiary of the Company (now
                         known as Perceptive Scientific Instruments, Inc.) (10)
  10.9               --  $7,000,000 Subordinated Note dated July 29, 1996 issued by the Company in favor of Digital
                         Imaging Technologies, Inc. (10)
  10.10(a)           --  $1,500,000 Promissory Note dated July 29, 1996 (Revolving Credit Facility) (10)
  10.10(b)           --  Change in Terms Agreement dated as of January 3, 1997 (Revolving Credit Facility) (19)
  10.10(c)           --  Supplemental Terms Letter dated July 29, 1996 (Revolving Credit Facility) (10)
  10.10(d)           --  Supplemental Terms Letter dated as of January 3, 1997 (Revolving Credit Facility) (19)
  10.10(e)           --  $4,900,000 Amended and Restated Promissory Note dated as of January 3, 1997 (Term
                         Loan) (19)
  10.10(f)           --  Supplemental Terms Letter dated as of January 3, 1997 (Term Loan) (19)
  10.10(g)           --  Waiver of Default dated as of January 3, 1997 (19)
  10.10(h)           --  Warrant to Purchase Common Stock dated March 15, 1997 issued to City National Bank (19)
  10.10(i)           --  Commercial Security Agreement dated July 29, 1996 (10)
  10.10(j)           --  Commercial Pledge Agreement dated July 29, 1996 (10)
  10.10(k)           --  Various Additional Security Agreements dated as of January 3, 1997 (19)
  10.10(l)           --  Warrant to Purchase Common Stock dated June 1, 1997 issued to City National Bank (20)
  10.10(m)           --  Warrant to Purchase Common Stock dated July 1, 1997 issued to City National Bank (20)
</TABLE>

<PAGE>   23

<TABLE>
<S>                  <C>
  10.11(a)           --  Securities Purchase Agreement dated December 31, 1996 by and between the Company and
                         Thermo Amex Convertible Growth Fund I, L.P. (2)
  10.11(b)           --  Common Stock Purchase Warrant dated December 31, 1996 issued to Thermo Amex
                         Convertible Growth Fund I, L.P. (2)
  10.11(c)           --  Registration Rights Agreement dated December 31, 1996 by and between the Company and
                         Thermo Amex Convertible Growth Fund I, L.P. (2)
  10.12              --  Commitment Letter of Foothill Capital Corporation dated March 30, 1998 (20)
  24                 --  Consent of Coopers & Lybrand L.L.P. 
  27.1               --  Financial Data Schedule (1997) (20)
  27.2               --  Financial Data Schedule (Quarter 1997)(20)
  27.3               --  Financial Data Schedule (1995 and 1996)
</TABLE>

-------------------

         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 its Quarterly
         Report on Form 10-Q for the quarter ended September 30, 1993.
(2)      Current Report on Form 8-K dated January 15, 1997.
(3)      Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.
(4)      Registration Statement on Form S-3, as filed with the Securities and
         Exchange Commission on March 27, 1996 (File No. 333-002001).
(5)      Annual Report on Form 10-K for the year ended December 31, 1989, its
         quarterly report on Form 10-Q for the quarter ended September 30, 1993
         and its Annual Report on Form 10-K for the year ended December 31,
         1994.
(6)      Registration Statement on Form S-2, as filed with the Securities and
         Exchange Commission on September 4, 1985 (File No. 2-99240).
(7)      Registration Statement on Form S-8, as filed with the Securities and
         Exchange Commission on May 10, 1982 (File No. 2-77496).
(8)      Annual Report on Form 10-K for the year ended December 31, 1992.
(9)      Registration Statement on Form S-8, as filed with the Securities and
         Exchange Commission on August 8, 1994 (File No. 33-82560).
(10)     Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. (11)
         Registration Statement on Form S-8 filed January 3, 1997.
(12)     Current Report on Form 8-K dated July 15, 1988 and its quarterly report
         on Form 10-Q for the quarter ended June 30, 1995.
(13)     Annual Report on Form 10-K for the year ended December 31, 1994. 
(14)     Report on Form 10-Q for the quarter ended September 30, 1996. 
(15)     Report on Form 10-Q for the quarter ended September 31, 1995. 
(16)     Report on Form 10-K for the year ended December 31, 1995. 
(17)     Current on Form 8-K filed July 17, 1996.
(18)     Registration Statement on Form S-8, as filed with the Securities and
         Exchange Commission on July 16, 1997 (File No. 333-31393).
(19)     Annual Report on Form 10-K for the year ended December 31, 1996.
(20)     Annual Report on Form 10-K for the year ended December 31, 1997.

(b)      Reports on Form 8-K
         None

(c)      See (a)(3) above.

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


<PAGE>   24


                                   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/A 
(Amendment No. 1) to be signed on its behalf by the undersigned, thereunto duly 
authorized, in Chatsworth, California, on June 12, 1998.
    


                                  INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.



                                  By:/s/ Fred H. Deindoerfer
                                     ------------------------------------------
                                     Fred H. Deindoerfer, Chairman of the Board
                                     of Directors, President,
                                     and Chief Executive Officer


         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.


   
<TABLE>
<CAPTION>
Signature                                                  Title                                      Date
---------                                                  -----                                      ----
<S>                                         <C>                                                  <C>
/s/ Fred H. Deindoerfer         
--------------------------------            Chairman of the Board of Directors,                  June 12, 1998
Fred H. Deindoerfer                         President, and Chief Executive Officer


/s/ Martin S. McDermut        
------------------------------              Vice President Finance and                           June 12, 1998
Martin S. McDermut                          Administration, Secretary,
                                            and Chief Financial Officer,


/s/ Donald E. Horacek         
------------------------------
Donald E. Horacek                           Assistant Secretary, Controller, and                 June 12, 1998
                                            Principal Accounting Officer


/s/ John A. O'Malley                        Director                                             June 12, 1998
---------------------------------
John A. O'Malley



/s/ Steven M. Besbeck                       Director                                             June 12, 1998
-----------------------------------
Steven M. Besbeck



/s/ Thomas F. Kelley                        Director                                             June 12, 1998
-------------------------------------
Thomas F. Kelley
</TABLE>
    




<PAGE>   25

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

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

     We have audited the consolidated financial statements and the financial
statement schedule of International Remote Imaging Systems, Inc. and its
subsidiaries, as listed in the index on page 21 of this Form 10-K/A (Amendment
No. 1). These financial statements and the financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
International Remote Imaging Systems, Inc. and its subsidiaries at December 31,
1997 and 1996, and the consolidated results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 1997, in
conformity with generally accepted accounting principles. In addition, in our
opinion, the financial statement schedule referred to above, when considered in
relation to the basic financial statements taken as a whole, presents fairly, in
all material respects, the information required to be included therein.


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


Los Angeles, California
March 20, 1998, except for Note 8 as to which the date is March 30, 1998.




<PAGE>   26


                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                           CONSOLIDATED BALANCE SHEETS

                                     ASSETS
<TABLE>
<CAPTION>
                                                                                                    At December 31,
                                                                                -----------------------------------
                                                                                         1996                  1997
                                                                                -----------------------------------
Current assets:
<S>                                                                             <C>                      <C>       
   Cash and cash equivalents                                                       $3,602,535            $1,470,861
   Short-term investments                                                             667,589                25,000
   Accounts receivable, net of allowance for doubtful
     accounts of $274,766 in 1996 and $267,579 in 1997                              5,207,933             5,319,539
   Inventories                                                                      4,838,206             3,739,483
   Prepaid expenses and other current assets                                          163,465               259,822
   Deferred tax asset                                                                 936,500               993,950
                                                                                 ------------           -----------
     Total current assets                                                          15,416,228            11,808,655

   Property and equipment, at cost, net of accumulated depreciation                 1,947,713             1,847,746
   Purchased intangibles                                                           10,324,760             8,597,601
   Software development costs, net of accumulated amortization of
    $847,880 in 1996 and $1,223,601 in 1997                                           920,972             1,080,106
   Deferred tax asset                                                               7,276,250             7,621,800
   Other assets                                                                     1,974,322             1,778,669
                                                                                  -----------           -----------
     Total assets                                                                 $37,860,245           $32,734,577
                                                                                  ===========           ===========

                                        LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
  Short-term borrowings                                                            $1,334,755            $  850,000
  Current portion of long-term debt                                                 2,600,000             3,400,000
  Accounts payable                                                                  4,587,407             2,613,297
  Accrued expenses                                                                  3,901,071             2,383,946
  Deferred income - service contracts and other                                     1,079,114               911,459
                                                                                  -----------           -----------
     Total current liabilities                                                     13,502,347            10,158,702

Subordinated note payable                                                           7,000,000             7,000,000
Deferred income - service contracts                                                   193,219               241,507
Notes payable, long-term portion                                                    3,400,000               542,027
                                                                                  -----------           -----------
         Total liabilities                                                         24,095,566            17,942,236

Commitments and contingencies

Shareholders' equity:
  Preferred stock, $.01 par value
    Authorized:  3,000,000 shares
    Convertible Series A,
    Shares issued and outstanding :  1996 and 1997 - 3,000
    ($3,000,000 liquidation preference)                                                    30                    30
  Common stock, $.01 par value
    Authorized:  15,600,000 shares
    Shares issued and outstanding:
    1996 - 5,911,890, 1997 - 6,259,728                                                 59,118                62,597
  Additional paid-in capital                                                       36,311,535            37,788,536
  Treasury stock, at cost (26,240 shares in 1996 and in 1997)                        (103,500)             (103,500)
  Unearned compensation                                                              (385,879)             (333,495)
  Foreign currency translation adjustment                                              37,791                35,877
  Accumulated deficit                                                             (22,154,416)          (22,657,704)
                                                                                  -----------           -----------
          Total shareholders' equity                                               13,764,679            14,792,341
                                                                                  -----------           -----------
          Total liabilities and shareholders' equity                              $37,860,245           $32,734,577
                                                                                  ===========           ===========
</TABLE>

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




<PAGE>   27


                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                                    For the Year Ended December 31,
                                                             ------------------------------------------------------
                                                                     1995                 1996                 1997
                                                             ------------------------------------------------------
<S>                                                          <C>                  <C>                  <C>         
Sales of IVD imaging systems ........................        $  4,240,627         $  6,370,346         $ 11,823,443
Sales of IVD imaging system supplies
  and service .......................................           6,737,444            9,117,493           10,621,211
Sales of small instruments and supplies .............           3,414,087            5,066,292            4,447,418
Royalty and license revenues ........................              96,023               42,923              603,076
                                                             ------------         ------------         ------------

Net revenues ........................................          14,488,181           20,597,054           27,495,148
                                                             ------------         ------------         ------------

Cost of goods- IVD imaging systems ..................           2,014,873            3,423,140            6,077,391
Cost of goods - IVD imaging system
  supplies and service ..............................           3,174,290            5,114,538            5,328,092
Cost of goods - small instruments
  and supplies ......................................           1,937,653            2,693,900            2,345,909
                                                             ------------         ------------         ------------
Cost of goods sold ..................................           7,126,816           11,231,578           13,751,392
                                                             ------------         ------------         ------------

Gross margin ........................................           7,361,365            9,365,476           13,743,756

Marketing and selling ...............................           2,874,442            4,627,089            5,224,513
General and administrative ..........................           2,041,281            3,258,700            3,463,231
Research and development, net .......................           1,220,028            1,978,326            2,125,095
Amortization of intangibles .........................             127,142              793,916            1,308,596
Unusual charges (Note 18)............................                  --            1,891,592            1,338,338
Acquisition of in-process research
  and development ...................................           2,900,430            7,250,000                   --
                                                             ------------         ------------         ------------

Total operating expenses ............................           9,163,323           19,799,623           13,459,773

Operating income (loss) .............................          (1,801,958)         (10,434,147)             283,983

Other income (expense):
   Interest income ..................................             309,929              221,935               56,557
   Interest expense .................................             (42,699)            (681,114)          (1,208,138)
   Other income .....................................              14,507                7,211               71,310
                                                             ------------         ------------         ------------


  Loss before benefit for income taxes ..............          (1,520,221)         (10,886,115)            (796,288)
  Benefit for income taxes ..........................          (3,646,633)          (3,457,927)            (293,000)
                                                             ------------         ------------         ------------

Net income (loss) ...................................           2,126,412           (7,428,188)            (503,288)

Less imputed preferred stock dividend ...............                  --                   --             (450,000)
                                                             ------------         ------------         ------------

Net income (loss) attributable to common stockholders        $  2,126,412         $ (7,428,188)        $   (953,288)
                                                             ============         ============         ============

Net income (loss) per share - basic .................        $        .35         $      (1.21)        $       (.16)
                                                             ============         ============         ============

Net income (loss) per share - diluted ...............        $        .34         $      (1.21)        $       (.16)
                                                             ============         ============         ============

Weighted average number of
common shares outstanding - basic ...................           5,994,739            6,141,657            6,019,041
                                                             ============         ============         ============

Weighted average number of
  common shares outstanding - diluted ...............           6,246,726            6,141,657            6,019,041
                                                             ============         ============         ============
</TABLE>

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



<PAGE>   28


                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                           Additional
                                          Common Stock        Paid-In    Treasury     Unearned      Accumulated
                                     Shares     Amount        Capital       Stock   Compensation         Deficit           Total
                                  ---------   --------   ------------   ---------   ------------    ------------    ------------
<S>                               <C>         <C>        <C>            <C>          <C>            <C>             <C>         
Balance, December 31, 1994 ....   5,330,327   $ 53,304   $ 27,418,271   $(453,386)   $(93,130)      $(16,765,121)   $ 10,159,938


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

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

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

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

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

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

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

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

Net income ....................          --         --             --          --          --          2,126,412       2,126,412
                                  ---------   --------   ------------   ---------    --------       ------------    ------------

Balance,
  December 31, 1995 ...........   6,292,408   $ 62,924   $ 34,154,116   $(453,386)   $(95,884)      $(14,726,228)   $ 18,941,542
</TABLE>

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


<PAGE>   29


                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                      Convertible Series A
                                           Preferred Stock            Common Stock      Additional        Treasury                 
                                           ---------------   ---------------------         Paid-In        Treasury         Unearned
                                         Shares     Amount     Shares       Amount         Capital           Stock     Compensation
                                         ------     ------   --------     --------    ------------    ------------    -------------
<S>                                      <S>        <C>      <C>          <C>         <C>             <C>             <C>          
Balance forward ......................      --          --   6,292,408    $ 62,924    $ 34,154,116    $   (453,386)   $    (95,884)

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

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

Common stock issued or issued from
treasury under Employee Stock
Purchase Plan:
for Cash .............................      --          --      13,297         133          81,369          37,703              --
for Services .........................      --          --      22,136         221         150,159          37,703        (153,190)

Stock option compensation ............      --          --          --          --         437,770              --        (270,925)

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

Repurchase of shares of common
stock and warrants ...................      --          --          --          --        (273,216)     (2,132,141)             --

Retire treasury stock ................      --          --    (553,875)     (5,539)     (2,504,582)      2,510,121              --

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

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

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

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

Net loss .............................      --          --          --          --              --              --              --
                                         -----       -----   ---------    --------    ------------    ------------    ------------

Balance,
  December 31, 1996 ..................   3,000       $  30   5,911,890    $ 59,118    $ 36,311,535    $   (103,500)   $   (385,879)


<CAPTION>
                                         
                                          Foreign Currency
                                               Translation      Accumulated
                                                Adjustment          Deficit          Total
                                          ----------------    -------------   ------------
<S>                                       <C>                 <C>             <C>
Balance forward ......................             --         $(14,726,228)   $ 18,941,542

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

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

Common stock issued or issued from
treasury under Employee Stock
Purchase Plan:
for Cash .............................             --                   --         119,205
for Services .........................             --                   --          34,893

Stock option compensation ............             --                   --         166,845

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

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

Retire treasury stock ................             --                   --              --

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

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

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

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

Net loss .............................             --          (7,428,188)     (7,428,188)
                                         ------------         ------------    ------------

Balance,
  December 31, 1996 ..................   $     37,791         $(22,154,416)   $ 13,764,679
</TABLE>
---------------

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


<PAGE>   30


                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                      Convertible Series A                                                                
                                           Preferred Stock    Common Stock        Additional                              
                                           ---------------    ------------           Paid-In     Treasury       Unearned  
                                         Shares    Amount      Shares    Amount      Capital        Stock   Compensation  
                                         ------    ------   ---------   -------   ----------    ---------   ------------  
<S>                                      <C>       <C>      <C>         <C>       <C>           <C>         <C>           
Balance forward ......................   3,000        $30   5,911,890   $59,118   $36,311,535   $(103,500)     $(385,879) 
                                                                                                                          
Common stock issued                                                                                                       
on exercise of stock options .........      --         --      13,901       139        33,466          --             --  
                                                                                                                          
Common stock issued under                                                                                                 
Employee Stock Purchase Plan:                                                                                             
for Cash .............................      --         --      34,964       350       140,458          --             --  
for Services .........................      --         --      34,964       350       140,458          --       (140,808) 
                                                                                                                          
Issuance of stock options for services      --         --          --        --        73,680          --        (73,680) 
                                                                                                                          
Common stock and warrants to                                                                                              
purchase common stock issued for                                                                                          
cash on exercise of warrants .........      --         --     188,633     1,886       676,492          --             --  
                                                                                                                          
Issuance of common stock and                                                                                              
warrants in satisfaction of accounts 
payable ..............................      --         --      75,376       754       282,947          --             --  
                                                               
Issuance of warrants to purchase                                                                                          
common stock in connection with bank                                                                                      
debt renewal .........................      --         --          --        --       129,500          --             --   
                                                                                                                          
Amortization of unearned                                                                                                  
compensation .........................      --         --          --        --            --          --        266,872  
                                                                                                                          
Foreign currency translation    
adjustment ...........................      --         --          --        --            --          --             --  
                                                                                                                
                                                                                                                          
Net loss .............................      --         --          --        --            --          --             --  
                                         -----        ---   ---------   -------   -----------   ---------      ---------

Balance,                                                                                                                  
  December 31, 1997 ..................   3,000        $30   6,259,728   $62,597   $37,788,536   $(103,500)     $(333,495)
                                         =====        ===   =========   =======   ===========   =========      =========
</TABLE>

<TABLE>
<CAPTION>
                                            Foreign
                                           Currency
                                        Translation   Accumulated
                                         Adjustment       Deficit           Total
                                         ----------  ------------    ------------
<S>                                        <C>       <C>             <C>
Balance forward ......................     $ 37,791  $(22,154,416)   $ 13,764,679
                                         
Common stock issued                      
on exercise of stock options .........           --            --          33,605
                                         
Common stock issued under                
Employee Stock Purchase Plan:            
for Cash .............................           --            --         140,808
for Services .........................           --            --              --
                                         
Issuance of stock options for services           --            --              --
                                         
Common stock and warrants to             
purchase common stock issued for         
cash on exercise of warrants .........           --            --         678,378
                                         
Issuance of common stock and             
warrants in satisfaction of accounts      
payable ..............................           --            --         283,701
                                  
                                         
Issuance of warrants to purchase         
common stock in connection with bank     
debt renewal .........................           --            --         129,500
                                         
Amortization of unearned                 
compensation .........................           --            --         266,872
                                         
Foreign currency translation     
adjustment ...........................       (1,914)           --          (1,914)
                               
                                         
Net loss .............................           --      (503,288)       (503,288)
                                           --------  ------------    ------------

Balance,                                 
  December 31, 1997 ..................     $ 35,877  $(22,657,704)   $ 14,792,341
                                           ========  ============    ============
</TABLE>
---------------
The accompanying notes are an integral part of these consolidated financial
statements.


<PAGE>   31


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

<TABLE>
<CAPTION>
                                                                                                  For the Year Ended December 31,
                                                                                  ----------------------------------------------
                                                                                          1995             1996             1997
                                                                                  ----------------------------------------------
<S>                                                                               <C>              <C>              <C>          
Cash flows from operating activities:
     Net income (loss) .......................................................    $  2,126,412     $ (7,428,188)    $   (503,288)
   Adjustments to reconcile net income (loss) to net
   cash provided by operations:
     Deferred tax benefit ....................................................      (3,705,589)      (3,456,920)        (403,000)
     Acquisition of in-process research and development ......................       2,882,858        7,250,000               --
     Depreciation and amortization ...........................................         635,048        1,769,896        3,413,125
     Common stock and stock option compensation ..............................         109,635          335,858          266,872
     (Gain) loss on disposal of property and equipment .......................              --          (51,401)          62,844
     Allowance for doubtful accounts .........................................              --          198,037           (7,187)
   Changes in assets and liabilities:
     Accounts receivable - trade and other ...................................        (356,739)         (77,240)        (153,983)
     Service contracts, net ..................................................         (95,586)        (475,034)         201,505
     Inventories .............................................................        (875,295)      (1,433,834)       1,096,724
     Prepaid expenses and other current assets ...............................         (80,230)         176,061          (66,386)
     Other assets ............................................................          47,239         (132,992)         (59,339)
     Accounts payable ........................................................         (87,673)       2,851,805       (1,686,728)
     Accrued expenses ........................................................         199,735          375,793           84,071
     Deferred income - other .................................................              --          279,591         (279,591)
                                                                                  ------------     ------------     ------------
   Net cash provided by operating activities .................................         799,815          181,432        1,965,639
                                                                                  ------------     ------------     ------------

Cash flows from investing activities:
     Acquisition of property and equipment ...................................        (820,838)      (1,171,621)        (949,841)
     Sales of property and equipment .........................................              --           85,000               --
     Acquisition of business and product line, net of cash acquired ..........        (886,800)     (10,311,041)              --
     Software development costs ..............................................        (299,016)        (577,421)        (534,855)
     Maturities of securities ................................................       2,915,000        4,169,138          642,589
     Purchases of securities .................................................      (4,295,664)              --               --
     Acquisition of other assets .............................................              --               --          (30,000)
                                                                                  ------------     ------------     ------------
   Net cash used by investing activities .....................................      (3,387,318)      (7,805,945)        (872,107)
                                                                                  ------------     ------------     ------------

Cash flows from financing activities:
     Issuance of common and preferred stock for cash .........................       1,666,999        3,278,720          907,791
     Installment payment on repurchase of common stock .......................              --         (553,148)        (545,057)
     Borrowings under credit facility ........................................              --        1,334,755        3,895,000
     Repayments of credit facility ...........................................              --               --       (4,879,755)
     Repayments of notes payable .............................................        (256,351)      (2,110,633)      (2,600,000)
     Proceeds from notes payable .............................................              --        7,800,000               --
     Deferred offering costs .................................................              --          (35,049)              --
                                                                                  ------------     ------------     ------------
   Net cash provided (used)  by financing activities .........................       1,410,648        9,714,645       (3,222,021)
                                                                                  ------------     ------------     ------------

     Effect of foreign currency rate fluctuation on cash and cash equivalents               --            1,008           (3,185)
                                                                                  ------------     ------------     ------------

     Net increase (decrease) in cash and cash equivalents ....................      (1,176,855)       2,091,140       (2,131,674)
     Cash and cash equivalents at beginning of year ..........................       2,573,384        1,511,395        3,602,535
     Adjustment to cash to reflect change in StatSpin Technologies fiscal year         114,866               --               --
                                                                                  ------------     ------------     ------------
     Cash and cash equivalents at end of year ................................    $  1,511,395     $  3,602,535     $  1,470,861
                                                                                  ============     ============     ============

Supplemental schedule of non-cash financing activities:
     Non cash issuance of common stock and common stock warrants .............    $    109,635     $    153,190     $    562,689
     Stock option compensation ...............................................              --          437,770               --
     Issuance of common stock under a stock for
        stock exercise .......................................................              --          103,500               --
     Issuance of warrants in connection
        with development agreements and for other assets .....................       1,774,733               --           65,000
     Issuance of warrants and subordinated note for asset purchase ...........              --        7,927,000               --
     Accrual for common stock and warrant repurchase .........................              --        1,587,084               --
     Issuance of common stock to acquire shares of LDA .......................       2,977,344               --               --
     Tax benefit related to exercise of nonqualified stock options ...........         214,000           77,313               --
     Unpaid common stock issuance costs ......................................              --               --           55,000
     Issuance of notes payable for accrual liabilities .......................              --               --        1,042,027
Supplemental disclosure of cash flow information:
     Cash paid for income taxes ..............................................          21,456           64,100               --
     Cash paid for interest ..................................................          42,698          526,182        1,104,605
</TABLE>

---------------

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


<PAGE>   32


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

1.    Formation and Business of the Company.

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

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

      On July 31, 1996, the Company, through a wholly owned subsidiary, PSI
Acquisition Corp., acquired the IVD imaging business of Perceptive Scientific
Instruments, Inc. ("Old PSI") for $9.5 million in cash (including $400,000 in
acquisition costs), issuance of a $7.0 million 8.5% subordinated note
("Subordinated Note") and a five year warrant to purchase 875,000 shares of the
Company's common stock at $8.00 per share (valued for accounting purposes at
$927,000). The cash portion of the purchase price was paid primarily with funds
obtained from a bank under a $7.8 million term loan ("Term Loan") and a new $1.5
million revolving line of credit ("Credit Facility"). The Company subsequently
changed the name of PSI Acquisition Corp. to Perceptive Scientific Instruments,
Inc. ("PSI").

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

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

2.    Summary of Significant Accounting Policies.

Use of Estimates:

      The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. The significant estimates in the preparation of the
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 from those estimates.


<PAGE>   33

Principles of Consolidation:

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

Foreign Currency:

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

Cash Equivalents 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.

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.


Property and Equipment and Depreciation:

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

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

Purchased Intangibles:

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

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 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. Generally, an original
estimated economic life of one and one half years to three years is assigned to
capitalized software development costs. Amortization expense of software
development costs was approximately $41,600, $180,500 and $375,721 for 1995,
1996 and 1997, respectively.

<PAGE>   34

Deferred Warrant Costs:

      Deferred warrant costs are included in other assets and result from the
issuance of warrants in conjunction with various development, distribution and
technology license agreements. These costs are generally being amortized over
the estimated term of the related agreements.

Long-Lived Assets:

      On January 1, 1996, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of." This statement requires
recognition of impairment losses 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 to be recognized is to be based
on the difference between the fair values and the carrying amounts of the
assets. During 1996, the Company adopted this policy and determined that no
impairment loss was required for applicable assets; however, as a result of
certain events discussed in Note 6, a $704,579 charge was recorded for
write-down of long-lived assets in the fourth quarter of 1997.

Stock Based Compensation:

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

      An expense is recognized for common stock, warrants or options issued or
repriced for services rendered by a non-employee based on the estimated fair
value of the security exchanged.

Revenue Recognition:

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

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

Warranties:

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

Research and Development Expenditures:

      Except for certain software development costs required to be capitalized
as described above (see Software Development Costs), research and development
expenditures are charged to operations as incurred. Net research and development
expense includes total research and development costs incurred, including costs
incurred under research and development grants and contracts, less costs
reimbursed under research and development contracts (see Note 17).

Income Taxes:

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


<PAGE>   35

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.

Earnings Per Share:

      In the fourth quarter of 1997, the Company adopted Statement of Financial
Accounting Standards No. 128 "Earnings Per Share" ("SFAS No. 128"). SFAS No 128
requires dual presentation of newly defined basic and diluted earnings per share
on the face of the income statements of all entities with complex capital
structures. Also, as required by SFAS No. 128, this standard has been
retroactively applied for all periods presented.

Reclassifications:

      Certain reclassifications have been made to the 1995 and 1996 financial
statements to conform with the 1997 presentation.

Recently Issued Accounting Standards:

      In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS
130"). FAS 130 establishes standards for reporting and displaying comprehensive
income and its components (revenue, expenses, gains and losses) in financial
statements. FAS 130 requires that all items that are required to be recognized
under accounting standards as components of comprehensive income be reported in
a financial statement that is displayed with the same prominence as other
financial statements. It is effective for fiscal years beginning after December
15, 1997. The Company intends to disclose the information required by FAS 130
beginning with its 1998 fiscal year.

      In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("FAS 131"). This statement requires that a
public business enterprise report financial and descriptive information about
its reportable operating segments. Generally, financial information is required
to be reported on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments. It is effective
for fiscal years beginning after December 15, 1997. The Company intends to adopt
this new standard in fiscal year 1998.

Certain Risks and Uncertainties:

     Dependence on Instrument Sales: The Company derives most of its revenues
from the sale of two families of high-priced instruments - The Yellow IRIS
urinalysis workstation, and the PowerGene genetic analyzers. These instruments
have list prices ranging from $20,000 to $195,000 depending on model and
configuration, and relatively modest declines in unit sales or gross margins for
either product line 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. From time to time, single source
suppliers have discontinued production of key components. Although, in the past,
the Company has successfully transitioned to new components to replace
discontinued components, there can be no assurance that the Company can 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's inability to
transition successfully to replacement components or to secure adequate supplies
of discontinued components on satisfactory terms could have a material adverse
effect on the Company.


<PAGE>   36

         Year 2000: The Company has conducted a review of its IVD imaging
products and internal computer systems to identify those areas that require Year
2000 compliance. Year 2000 compliance refers to the inability of certain
computer systems to recognize dates commencing on January 1, 2000. The Company
currently believes that by modifying existing software and converting to new
software for certain tasks, Year 2000 compliance will not pose significant
marketing or operational problems and is not anticipated to be material to its
future financial position or results of operations of the Company.


3.    Inventories.

      Inventories consist of the following:

<TABLE>
<CAPTION>
                                                                                            At December 31,
                                                                              -----------------------------
                                                                                    1996               1997
                                                                              ----------        ----------
                  <S>                                                         <C>               <C> 
                  Finished goods.......................................         $631,116        $  766,525
                  Work-in-process......................................          646,031           788,374
                  Raw materials, parts and sub-assemblies .............        3,561,059         2,184,584
                                                                              ----------        ----------
                                                                              $4,838,206        $3,739,483
                                                                              ==========        ==========  
</TABLE>

4.    Property and Equipment.

      Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                                                            At December 31,
                                                                              -----------------------------
                                                                                    1996               1997
                                                                              ----------        ----------
                  <S>                                                         <C>               <C> 
                  Leasehold improvements...............................         $402,537          $406,308
                  Furniture and fixtures...............................          251,617           274,828
                  Machinery and equipment..............................        3,366,361         3,691,466
                  Tooling, dies and molds..............................          729,472           767,355
                  Rental units.........................................          577,610           930,407
                                                                             ------------       -----------
                                                                               5,327,597         6,070,364
                  Less accumulated depreciation........................       (3,379,884)       (4,222,618)
                                                                             ------------       -----------
                                                                              $1,947,713        $1,847,746
                                                                              ==========        ==========
</TABLE>

      Property and equipment includes $2,015,694 and $2,710,335, respectively,
at December 31, 1996 and 1997, of fully depreciated assets which remain in
service. Depreciation expense was $449,653, $830,914 and $983,003, for 1995,
1996, and 1997, respectively.

5.    Equipment Leasing and Third Party Transactions

      The Company leases equipment to customers under sales-type leases as
defined in Statement of Financial Accounting Standards No. 13. All sales-type
leases originated by the Company have been sold on a non-recourse basis to a
financial institution ("Third Party"). The Third Party assumes the
administrative responsibility for the collection of the lease receivable and the
credit risk. Also, in connection with these leases the Company agrees to provide
on-going supplies and maintenance service with respect to the equipment. For
these obligations the Company receives its normal supply and maintenance
revenues. The agreements with the Third Party provide the Company with residual
rights in revenues, if any, derived from the equipment after the Third Party has
received a designated return. Equipment sales revenues arising from these
transactions with the Third Party were none, $125,000 and $525,000 for the years
ended December 31, 1995, 1996 and 1997, respectively.

      Any lease that does not meet the criteria for a sales type or financing
lease is accounted for as an operating lease. Under these leases the Company
also provides supplies and services. Generally operating leases are for periods
less than one year and contain provisions for early termination with a penalty
and renewal. The cost of leased systems is depreciated to a zero value on a
straight-line basis over five years. Accumulated depreciation on leased systems
was $98,523 and $232,302 at December 31, 1996 and 1997, respectively. Minimum
rentals receivables, net of estimated costs for supplies and service, under
existing operating leases as of December 31, 1997 are as follows: 1998-$602,000,
1999-$124,000, 2000-$41,000 and none thereafter.


<PAGE>   37

6.    Purchased Intangibles

Purchased intangibles, at cost, consist of the following:


<TABLE>
<CAPTION>
                                                                                            At December 31,
                                                                              -----------------------------
                                                                                    1996               1997
                                                                              --------------    ----------
                  <S>                                                         <C>               <C> 
                  Goodwill.............................................           $1,377,973      $383,108
                  International distribution channel...................            5,571,728     5,571,728
                  Acquired technology and know-how.....................            3,960,904     3,960,904
                                                                              -------------     ----------
                                                                                  10,910,605     9,915,740
                  Less accumulated amortization........................             (585,845)   (1,318,139)
                                                                              --------------    ----------
                  Total................................................          $10,324,760    $8,597,601
                                                                              ==============    ==========
</TABLE>

      In the fourth quarter of 1997, the Company was notified that a certain
distributor would no longer carry the digital refractometer product line. Based
on this development, the Company determined that estimated cash flows
(undiscounted and without interest charges) from this product line would not be
sufficient to recover the associated goodwill, and that it had become impaired.
The Company measured impairment based on a discounted cash flow approach. As a
result, the Company recorded a $704,579 charge to earnings in the fourth quarter
of 1997 as an impairment loss.

7.    Accrued Expenses.

      Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                                                                            At December 31,
                                                                              -----------------------------
                                                                                    1996               1997
                                                                              ----------        ----------
                  <S>                                                         <C>               <C> 
                  Accrued bonuses...........................                    $186,985          $194,444
                  Accrued commissions.......................                     237,422           260,296
                  Accrued payroll...........................                     203,574            21,121
                  Accrued vacation..........................                     207,947           301,337
                  Accrued taxes and other...................                      28,755           101,528
                  Accrued professional fees.................                     254,577           156,321
                  Accrued warranty expense..................                     278,563           466,569
                  Accrued interest..........................                     154,932           133,242
                  Accrued amount due BMC....................                   1,587,084                --
                  Accrued - other...........................                     761,232           749,088
                                                                              ----------        ----------
                                                                              $3,901,071        $2,383,946
                                                                              ==========        ==========
</TABLE>

8.    Short Term Borrowings and Notes Payable.

     The Company financed the purchase price for the PSI Acquisition with the
Subordinated Note ($7.0 million), the Term Loan ($7.8 million) and the Credit
Facility ($1.3 million). The Term Loan and Credit Facility impose certain
operating and financial covenants on the Company. Due to an inability to comply
with these financial covenants, the Company was in default on both loans at
September 30 and December 31, 1996. In April of 1997, the bank waived the
default, amended the financial covenants and extended the maturity of both
loans. In exchange, the Company agreed to increase the interest rates on both
loans and to issue the bank a three year warrant to purchase 50,000 shares of
Common Stock at $3.875 per share and additional warrants if the Term Loan was
still outstanding on June 1 and July 1, 1997. On June 1 and July 1, 1997, the
Company issued three year warrants to purchase 25,000 shares each of common
stock at $4.375 and $4.0625 per share, respectively. The warrants were valued
for accounting purposes at their estimated aggregate fair value of $129,500.

   On December 31, 1997 the outstanding principal balance of the Term Loan was
$3.4 million. The Term Loan is collateralized by a first priority lien on all
the assets of the Company and bears interest monthly at the bank's prime rate
(8.5% on December 31, 1997) plus 2.0%. The Company is required to pay $100,000
of principal each month, and the balance is due April 15, 1998. The Company may
prepay the Term Loan at any time without premium or penalty.


<PAGE>   38

     The outstanding principal balance on the Credit Facility was $350,000 on
December 31, 1997. Under the terms of the Credit Facility, the Company can
borrow and reborrow up to a maximum principal amount of $1.5 million at a
variable interest rate equal to the bank's prime rate plus 2.0%. The Credit
Facility matures April 15, 1998 and is collateralized by a first priority lien
on all of the assets of the Company.

    On March 30, 1998, the Company received a commitment for a new loan facility
(the "New Facility") from a financial institution to refinance the Term Loan and
Credit Facility. The commitment is subject to definitive loan documentation and
customary closing conditions. Management believes that such conditions will be
satisfactorily met. The New Facility will provide for a maximum line of credit
of $7.0 million, comprised of a term loan of up to $3.6 million and a
revolving line of credit of up to $4.0 million based on a percentage of
eligible accounts receivable. The Company expects to have approximately $1.7
million available under the revolving credit line at inception. The term loan
will bear interest at the lender's prime rate (8.5% on March 30, 1998) plus
3.0% and is payable in 36 equal monthly installments. The revolving credit
line will bear interest at the lender's prime rate plus 1.0%. Interest will be
charged on a minimum loan balance of $3.0 million. Borrowings will be
collateralized by a first priority lien on all assets of the Company. The New
Facility will mature in 2001.






<PAGE>   39
   The New Facility will contain financial covenants based on tangible net
worth, interest coverage and various operating ratios. It will also restrict
purchases of fixed assets and prohibit the payment of cash dividends. The
Company will pay an initial commitment fee of 0.75% of the total facility, an
unused line fee of 0.375% per annum on the unused portion of the total facility
and certain other administrative fees. The New Facility will be subject to
prepayment penalties of 3.0%, 2.0% and 1.0% of the maximum credit line in the
first, second and third years, respectively.


   The outstanding principal balance on the Subordinated Note was $7.0 million
on December 31, 1997. The Subordinated Note bears interest at a fixed rate of
8.5% per annum, payable in quarterly installments. The entire principal is due
on or before July 31, 2001. The Company may prepay the Subordinated Note at any
time without premium or penalty. Upon the issuance by the Company of equity
securities generating net proceeds in excess of $14.5 million, the Company must
apply fifty percent of the excess to the prepayment of the Subordinated Note.
The payment of principal and interest on the Subordinated Note is subordinated
in right of payment, to the extent and in the manner provided therein, to the
prior payment in full of the Term Loan and Credit Facility.

   
   In 1996, Corange International Limited, an affiliate of the Boehringer
Mannheim Group of companies, sold to the Company 469,413 shares of Common Stock
and the warrant to purchase 250,000 shares of Common Stock previously acquired
from the Company in connection with various joint development projects at their
original aggregate purchase price of $2.1 million, or $4.54 per share of Common
Stock. During 1997, the Company issued two 8.0% promissory notes in the
aggregate amount of $1.0 million due in semi-monthly installments of $100,000
commencing April 1, 1998. These notes constitute the final payments for the
repurchase of Common Stock and a warrant from an affiliate of Boehringer
Mannheim Corporation, a former joint venture partner.
    

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

   Annual maturities of bank and other short term borrowings and long term debt
are $4,250,000 (1998), $542,027 (1999) and $7,000,000 (2001).

9.    Income Taxes.

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


<TABLE>
<CAPTION>
                                                 For the Year Ended December 31,
                            ----------------------------------------------------
Currently payable:                 1995                1996                 1997
                            -----------         -----------         ----------- 
<S>                         <C>                 <C>                 <C>         
  Federal                   $    26,000         $   (22,161)        $        -- 
  State .                        32,956              21,154              60,000 
  Foreign                            --                  --              50,000 
                            -----------         -----------         ----------- 
                                 58,956              (1,007)            110,000 
                            -----------         -----------         ----------- 
                                                                                
Deferred:                                                                       
  Federal                    (3,655,589)         (3,197,790)           (325,000)
  State .                       (50,000)           (259,130)            (78,000)
                            -----------         -----------         ----------- 
                             (3,705,589)         (3,456,920)           (403,000)
                            -----------         -----------         ----------- 
                            $(3,646,633)        $(3,457,927)        $  (293,000)
                            ===========         ===========         =========== 
</TABLE>

      The provision (benefit) for income taxes differs from the amount obtained
by applying the federal statutory income tax rate to income before income taxes
for the years ended December 31, 1995, 1996 and 1997 as follows:

<TABLE>
<CAPTION>
                                                                 For the Year Ended December 31,
                                             ---------------------------------------------------
                                                    1995                1996                1997
                                             -----------         -----------         ----------- 
<S>                                          <C>                 <C>                 <C>         
Tax provision (benefit) computed at
  Federal statutory rate ............        $  (516,875)        $(3,701,280)        $  (270,738)
Increase (decrease) in taxes due to:
  Change in valuation allowance .....         (3,587,000)            437,000                  --
  Utilization of net
    operating loss carryforward .....           (662,819)                 --                  --
  Write-off of in-process research
    and development .................          1,089,962                  --                  --
  State taxes, net of federal benefit             26,156            (195,807)            (41,903)
  Nondeductible expenses ............            (22,057)             44,220              19,641
  Other .............................             26,000             (42,060)                 --
                                             -----------         -----------         ----------- 
                                             ($3,646,633)        ($3,457,927)        $  (293,000)
                                             ===========         ===========         ===========
</TABLE>


<PAGE>   40

      In 1995, IRIS recognized a tax benefit of $3,587,000 through a reduction
in the Company's deferred tax asset valuation allowance. This reduction in the
valuation allowance resulted principally from the Company's reassessment of the
realizability of its net operating loss carryforwards based on recent operating
history. Realization of the deferred tax assets is dependent upon generation of
sufficient taxable income prior to expiration of the loss carryforwards. At
December 31, 1996, the Company increased the valuation allowance by $437,000
based on its current assessment of operating results and other factors. Although
realization is not assured, management believes it is more likely than not that
the remaining net deferred tax assets will be realized. The amount of the
deferred tax assets considered realizable, however, could be reduced in the
future if estimates of future taxable income during the carryforward period are
reduced.

      At December 31, 1997, the Company had federal net operating loss
carryforwards of approximately $17.9 million and state net operating loss
carryforwards of approximately $2.5 million which expire in fiscal years ending
in 1999 through 2011. As of December 31, 1997, IRIS had investment tax, research
and experimentation and foreign tax credit carryforwards of $121,700 expiring in
fiscal years through 2003.

      The primary components of temporary differences which give rise to the
Company's net deferred tax asset at December 31, 1995, 1996 and 1997 are as
follows:

<TABLE>
<CAPTION>
                                                                                     At December 31,
                                                                     -----------------------------------------
                                                                           1995           1996           1997
                                                                     -----------------------------------------
<S>                                                                    <C>            <C>            <C>     
            Depreciation and amortization ...................          $146,200       $200,300       $960,800
            Allowance for doubtful accounts..................            32,400        101,700         99,000
            Accrued liabilities..............................           256,600        338,700        597,700
            Deferred revenue-service contracts...............           145,800         82,800        138,000
            Deferred research and development................           537,000      2,857,000      2,549,000
            Net operating loss carryforwards.................         4,840,000      6,423,900      6,112,000
            Other............................................           118,589        208,350        159,250

            Valuation allowance..............................        (1,563,000)    (2,000,000)    (2,000,000)
                                                                     -----------    -----------    ----------
                                                                     $4,513,589     $8,212,750     $8,615,750
                                                                     ==========     ==========     ==========
</TABLE>

10. LDA and Warrants.

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

      IRIS had the option to purchase for cash or shares of IRIS common stock
all of the outstanding shares of LDA common stock at $20 per share. In June
1995, IRIS completed the acquisition of LDA for approximately 498,000 shares of
IRIS Common Stock. IRIS acquired LDA pursuant to the exercise of its call option
under the LDA Restated Certificate of Incorporation to purchase all the
outstanding shares of LDA Common Stock. Accordingly, IRIS tendered 2.5765 shares
of IRIS Common Stock for each share of LDA Common Stock. As a result of the
acquisition, IRIS incurred a non-recurring charge of approximately $2.9 million
against earnings in 1995 for the acquisition of in-process research and
development (i.e. work in process not yet cleared for interstate commerce by the
Food and Drug Administration).

11.   Poly Development Agreement.

      On September 29, 1995, Poly U/A Systems, Inc. ("Poly") engaged IRIS to
develop several new products based on IRIS and other technology to further
enhance automation in the urinalysis field. Under the terms of the project, Poly
will have the right to use the IRIS technology and any newly developed
technology for developing,


<PAGE>   41
manufacturing and marketing the new products as stand-alone devices, and IRIS
will have the right to use any newly developed technology for any other purpose
and to incorporate the new products into The Yellow IRIS. Poly has retained IRIS
to conduct the research, development, clinical evaluation and pre-market testing
of the proposed new products. IRIS will fund the first $15,000 per month (up to
a maximum of $500,000) of the cost of the project, and Poly will reimburse IRIS
for the excess. IRIS has an option until November 29, 1998 to acquire all of
the Common Stock of Poly at an aggregate price of $5.1 million. IRIS may pay the
option exercise price in cash or with shares of IRIS Common Stock. IRIS is also
providing financial and administrative services to Poly at cost.

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

12.   Reference Lab Agreement.

      During the first quarter of 1995, IRIS and Boehringer Mannheim GmbH
("BMG"), a German affiliate of Boehringer Mannheim Corporation ("BMC"),
announced a joint project to develop a high capacity automated urinalysis system
primarily for reference laboratories based on the proprietary technologies of
both companies. The program was jointly funded by both companies. In addition to
designing specific components on the new system, BMG agreed to pay IRIS a fixed
amount of $640,000 for its research and development of the project. In
connection with this project and certain distribution considerations, IRIS
issued Corange International Limited (an affiliate of BMG) warrants to purchase
250,000 shares of IRIS Common Stock at an exercise price of $7.375 per share and
granted Corange International Limited certain registration rights with respect
to the shares of IRIS Common Stock issuable upon exercise of these warrants. 
The Company later repurchased these securities. See Notes 8 and 13.

13.      Capital Stock.

Issuance of Common and Preferred Stock:

      During the fourth quarter of 1997, 188,633 shares of common stock were
issued to certain warrant holders who exercised their warrants at a temporarily
reduced price under the terms of an exercise offer made by the Company. As part
of the exercise offer, new warrants with a price of $4.00 per share and an
expiration date of March 29, 2000 were issued to participating warrant holders
to replace those warrants exercised pursuant to the offer.

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

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

      The conversion price of the Preferred Stock (the "Conversion Price") was
fixed at $3.56 per share of Common Stock until April 1, 1997. Based on this
Conversion Price, each share of Preferred Stock would be convertible into
approximately 281 shares of common stock, and the Company would issue
approximately 843,000 shares of common stock if the holder elected to convert
all of the outstanding shares of Preferred Stock. Commencing April 1, 1997, the
Conversion Price was equal to the lower of (i) 85% of the average closing bid
price of the common stock for the five consecutive trading days immediately
preceding the conversion date (but in no event less than $1.50) or (ii) $3.56.
The Company has filed with the Securities and Exchange Commission a registration
statement for resale of the shares of common stock issuable upon conversion of
the Preferred Stock and exercise of the Warrant. The Company has reserved
2,000,000 shares of common stock for issuance upon conversion of the Preferred
Stock.


<PAGE>   42

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

Repurchase of Common Stock and Warrant:

      As described above in Note 8, in 1996 Corange International Limited sold
to the Company the 469,413 shares of common stock and the warrant to purchase
250,000 shares of common stock previously acquired from the Company in
connection with various joint development projects at their original aggregate
purchase price of $2.1 million or $4.54 per share of common stock. The
unamortized cost of $273,216 related to the repurchased warrant has been offset
against additional paid in capital.

Stock Issuances:

      During 1990, the IRIS Board of Directors adopted an Employee Stock
Purchase Plan designed to allow employees of the Company to buy its shares at
50% of the then current market price, provided that the employee agrees to hold
the shares purchased for a minimum of two years. The employee's 50% portion of
stock purchases under the plan may not exceed 15% of the employee's salary
during any year. The remaining 50% portion is recorded as deferred compensation
and amortized over the vesting period. The shares purchased pursuant to this
plan may not be transferred, except following the death of the employee or a
change in control, for a period of two years following the date of purchase.
During the period of the limitation on transfer, the Company has the option to
repurchase the shares at the employee's purchase price if the employee
terminates employment with the Company either voluntarily or as a result of
termination for cause. During 1995, 1996 and 1997, IRIS issued 26,973, 35,433
and 69,928 shares of common stock, respectively, in exchange for $179,630,
$307,288 and $281,616 in cash and services, respectively, under this plan.

Stock Option Plans and Employee Benefit Plans:

      As of December 31, 1997, the Company had two stock option plans under
which it may grant non-qualified stock options, incentive stock options and
stock appreciation rights. Options remain outstanding under another plan,
although no new options may be granted thereunder. No stock appreciation rights
or incentive stock options 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, 1997.

<TABLE>
<CAPTION>
                                                                           Number of Option Shares
                       ---------------------------------------------------------------------------
                       Plan                  Authorized     Exercised      Outstanding   for Grant
                       ---------------------------------------------------------------------------
                       <S>                  <C>             <C>            <C>           <C>
                       1986                    360,000       242,469          93,600            --
                       1994                    700,000         2,100         656,000        41,900
                       1997                    600,000            --         516,700        83,300
                                            ----------       -------      ----------       -------
                                             1,660,000       244,569       1,266,300       125,200
                                             =========       =======       =========       =======
</TABLE>


      The exercise price of the above options was determined by the Compensation
Committee. Payment of the exercise price may be made in cash or with shares of
common stock. The options generally vest over three years and expire either five
or ten years from the date of grant.

      IRIS has adopted the disclosure only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock Based Compensation." If
compensation expense for the stock options had been determined using "fair
value" at the grant date for awards in 1995, 1996 and 1997, consistent with the
provisions of Statement of Financial Accounting Standards No. 123, the Company's
net earnings and earnings per share would have been reduced to the pro forma
amounts indicated below:


<PAGE>   43


<TABLE>
<CAPTION>
                                                                                            For the year ended December 31,
                                                                              -------------------------------------------------
                                                                                    1995                1996               1997
                                                                              -------------------------------------------------
<S>                                                                           <C>                <C>                  <C>       
Net earnings (loss) attributable to common stockholders as reported           $2,126,412         $(7,428,188)         $(953,228)
Net earnings (loss) attributable to common stockholders  pro forma             2,052,090          (7,890,943)        (1,604,718)
Earnings per diluted share (loss) as reported                                       $.34              $(1.21)             $(.16)
Earnings per diluted share (loss) pro forma                                         $.33               (1.28)              (.27)
</TABLE>

      The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1995, 1996 and 1997.

<TABLE>
<CAPTION>
                                                                                                 For the year ended December 31,
                                                                         ---------------------------------------------------------
                                                                            1995                      1996                    1997
                                                                         ---------------------------------------------------------
<S>                                                                        <C>                       <C>                     <C>  
                  Risk free interest rate                                  6.11%                     5.98%                   6.10%
                  Expected lives (years)                                      5                         5                       5
                  Expected volatility                                        55%                       55%                     54%
                  Expected dividend yield                                    --                        --                      --
</TABLE>

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

   The following table sets forth certain information relative to stock options
during the years ended December 31, 1995, 1996 and 1997.

<TABLE>
<CAPTION>
                                                                                              Option Price        Fair Value at
                                                                                                  Weighted           Grant Date
                                                    Shares                          Range         Average      Weighted Average
                                           --------------------------------------------------------------------------------------
<S>                                               <C>                      <C>                     <C>         <C>
Outstanding at January 1, 1995                     435,901                  $1.10to $5.42            3.39                    --
  Granted                                          217,500                 $4.25 to $7.87           $5.71                 $3.16
  Exercised                                       (21,900)                 $1.10 to $4.00           $2.03                    --

  Canceled or expired                              (9,700)                 $1.57 to $4.00           $2.75                    --
                                           --------------------------------------------------------------------------------------
Outstanding at December 31, 1995                   621,801                 $1.16 to $7.37           $4.22                    --
  Granted                                          650,300                 $3.61 to $8.29           $5.55                 $4.41
  Exercised                                      (116,133)                 $1.75 to $5.00           $2.19                    --

  Canceled or expired                            (131,934)                 $2.90 to $8.29           $5.98                    --
                                           --------------------------------------------------------------------------------------
Outstanding at December 31, 1996                 1,024,034                 $1.90 to $6.22           $3.02

  Granted                                          325,100                 $3.19 to $4.50           $3.73                 $3.84
  Exercised                                       (13,901)                 $1.90 to #3.03           $2.64                    --

  Canceled or expired                             (68,933)                 $2.59 to $6.22           $4.04                    --
                                           --------------------------------------------------------------------------------------
Outstanding at December 31, 1997                 1,266,300                 $3.03 to $4.50           $3.21
                                                 =========                 ==============           =====



Outstanding at December 31, 1997
Weighted average life - 95 months               1,266,300                                           $3.21

Outstanding at December 31, 1996
  Weighted average life -   3 months                1,000                                           $1.90
  Weighted average life - 72 months             1,023,034                                           $3.03


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

Exercisable at December 31, 1997                  537,167                                           $3.03

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

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


<PAGE>   44

      In connection with the merger with StatSpin, each outstanding option and
warrant of StatSpin was converted into an option to purchase IRIS common stock
at a ratio of 4.095 shares of IRIS common stock for each share of StatSpin
common stock, resulting in options to purchase an aggregate of 126,000 shares of
IRIS common stock. The exercise price ranged from $3.66 to $7.32 per share of
IRIS common stock. During 1996, options to purchase 19,050 shares at $7.32 per
share expired, and options to purchase 21,791 shares at $3.66 per share were
exercised. During 1997, options to purchase 10,283 shares at $3.66 per share
were exercised. At December 31, 1997, options to purchase 74,876 shares at
prices ranging from $3.66 to $4.58 remain outstanding. These options will expire
in March 1998.

      In 1996, the Company adopted a 401(k) Plan. All employees are eligible to
participate in the plan. Contributions by the Company are discretionary.
Employees vest in amounts contributed by the Company immediately. The Company
contributed $44,751 and $34,190 to the plan for 1996 and 1997, respectively.

Warrants:

      At December 31, 1997, the following warrants were outstanding and
exercisable:

<TABLE>
<CAPTION>
         Number of Warrants                     Price                 Expiration Date
         ------------------                     -----              ------------------
         <S>                                   <C>                 <C>
                     75,000                    $8.125                  March 30, 1998
                    323,000                      6.50              September 29, 1998
                    150,000                      7.80              September 28, 2000
                    875,000                      8.00                   July 31, 2001
                     84,270                      3.56               December 31, 2001
                     50,000                     3.875                January 15, 2000
                     25,000                     4.375                    June 1, 2000
                     10,000                    4.3125                    May 15, 2002
                     25,000                    4.0625                    July 1, 2000
                    188,633                      4.00                  March 29, 2000
</TABLE>


14.   Commitments and Contingencies.

Leases:

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

      Future minimum rental payments required under operating leases that have
an initial term in excess of one year as of December 31, 1997, are as follows:

<TABLE>
<CAPTION>
                                Year Ended December 31,                 Amount
                                ----------------------------------------------
                                <S>                                  <C>
                                1998                                 $453,724
                                1999                                  300,583
                                2000                                  110,555
                                2001                                   84,240
</TABLE>

      Rent expense under all operating leases during 1995, 1996 and 1997 was
$453,762, $347,925 and $489,500, respectively.

Other:

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



<PAGE>   45


<TABLE>
<CAPTION>
                                Year Ended December 31,                 Amount
                                ----------------------------------------------
                                <S>                                  <C>
                                1998                                 $20,000
                                1999                                  20,000
                                2000                                  20,000
                                2001                                  20,000
                                2002                                  20,000
                                Years thereafter                     220,000
                                                                    --------
                                                                    $320,000
                                                                    ========
</TABLE>

      In connection with the development agreement with Poly, IRIS has agreed to
fund $15,000 per month (up to a maximum of $500,000 of which $80,000 remains
outstanding) of the cost of the development project for several new products to
enhance automation in the urinalysis field (see Note 11).

Litigation

      In July 1996, the Company acquired PSI from Digital Imaging Technologies,
Inc. ("DITI"). As part of the purchase price, the Company issued to DITI a
five-year warrant to purchase 875,000 shares of Common Stock at $8.00 per share.
In August 1997, the Company filed a demand for arbitration against DITI with the
American Arbitration Association. The Company's demand for arbitration alleges
material breaches of the representations, warranties and covenants in the
purchase agreement governing the PSI acquisition. DITI subsequently filed a
counterclaim in the arbitration proceeding alleging that the Company
misrepresented or omitted to disclose material facts in connection with the PSI
acquisition. DITI had previously requested a reduction in the exercise price of
the warrant but elected to seek unspecified monetary damages in the
counterclaim. The parties are currently engaged in discovery. Although the
Company does not presently anticipate any material adverse effect as a result of
this arbitration proceeding, there can be no assurance that it will not have
such an effect on financial position or results of operation of the Company or
result in additional dilution to holders of the Common Stock.

15.   Earnings Per Share.

      The computation of per share amounts for 1996 and 1997 is based on the
average number of common shares outstanding for the period. Options and warrants
to purchase 2,636,034 and 3,072,203 shares of common stock outstanding during
1996 and 1997, respectively, were not considered in the computation of diluted
EPS because their inclusion would have been antidilutive.

      Preferred stock convertible into 842,697 common shares at December 31,
1996 and 1997 was also not considered in the computation of diluted EPS because
its inclusion would have been antidilutive.


<PAGE>   46

      The following is a reconciliation of net income and shares used in
computing basic and diluted earnings per share amounts for 1995.

<TABLE>
<CAPTION>
                                           Income            Shares      Per Share Amount
                                           ------            ------      ----------------
<S>                                    <C>                <C>                        <C> 
Basic EPS
Income available to common
shareholders                           $2,126,412         5,994,739                  $.35

Effects of Dilutive Securities
   Warrants                                    --            95,868                    --
   Options                                     --           156,119                  (.01)  

Diluted EPS
Income available to common
shareholders plus assumed               _________          ________                  ____
conversions                            $2,126,412         6,246,726                  $.34
                                       ==========         =========                  ====
</TABLE>


      Options and warrants to purchase 475,000 shares of common stock at $7.375
to $8.125 were outstanding during 1995 but were not included in the computation
of diluted EPS because the exercise price was greater than the average market
price of the common shares during the period.

16.   License.

      TOA Medical Electronics Co., Ltd. has developed several urine sediment
analyzers under license from IRIS using pre-1989 IRIS technology. IRIS received
royalties under this license of $96,000, $43,000, and $513,000 in 1995, 1996 and
1997, respectively.

17. Research and Development Grants and Contracts.

      The Company has in the past partially funded its research and development
programs through (i) grants from NASA and the National Institutes of Health (ii)
joint development programs with strategic partners and (iii) Company-sponsored
research and development entities. In recent years, the Company has entered into
four significant externally-funded projects, two joint development projects with
strategic partners -- Boehringer Mannheim Corporation ("BMC") and Boehringer
Mannheim Gmbh ("BMG") -- and two projects with Company-sponsored research and
development entities -- LDA Systems, Inc. ("LDA") and Poly U/A Systems, Inc.
("Poly"). 

     From 1994 to 1996, the Company collaborated with BMC and BMG in the
development of CHEMSTRIP/IRIStrip urine test strips and the Model 900UDx. BMC
supplies the Company with CHEMSTRIP/IRIStrip urine test strips and has agreed to
supply the Company with certain raw materials should the Company elect to
manufacture its own urine test strips, subject to royalty payments. The Company
was granted the non-exclusive right to distribute certain other BMC urinalysis
products to hospitals and commercial laboratories in the United States. The
Company manufactures the Model 900UDx with BMG providing certain components on
an OEM basis at cost. The Company has exclusive marketing rights to the Model
900UDx in the United States, Canada and Taiwan and non-exclusive rights for the
rest of the world outside of Germany and Italy. During 1997, Hoffman-LaRoche
acquired the Boehringer Mannheim Group of companies, and BMC and BMG are now
operated as Roche Diagnostics.

     In 1992, the Company entered into a project with LDA for development of The
White IRIS leukocyte differential analyzer and later acquired LDA for
approximately 498,000 shares of the Company's common stock. The FDA cleared The
White IRIS in May 1996, but its commercial release has been delayed by other
priorities. In 1995, the Company entered into a similar project with Poly which
is ongoing for development of several new products to enhance automated
urinalysis (the "Poly Products"). The Company has an option until November 29,
1998 to acquire all the common stock of Poly for $5.1 million payable at the
Company's discretion in cash or shares of the Company's Common Stock.


<PAGE>   47


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

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

<TABLE>
<CAPTION>
                                                                 For the Year Ended December  31,
                                        -----------------------------------------------------------------
                                             1995                     1996                  1997
                                        -----------------------------------------------------------------
<S>                                    <C>                      <C>                     <C>     
Reimbursements                           $842,663               $1,779,820            $1,014,520
Costs                                   1,494,873                1,498,165             1,414,113
                                        ---------               ----------            ----------
Net costs                              $  652,210               $(281,655)              $399,593
                                       ==========               =========             ==========
</TABLE>


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

18.   Unusual Charges

      The results of operations for the year ended December 31, 1996 included
unusual charges totaling $1,891,592. Due to the Company's decision not to pursue
a previously announced public offering, the Company recognized $685,721 of
expenses associated with the offering. The charge also included $617,266 for
expenses related to recently completed litigation and arbitration matters. In
the fourth quarter of 1996, the Company incurred a charge of $298,113 for
severance and other incremental costs associated with a restructuring of the
Company's personnel. Legal and accounting expenses for the Company's merger with
StatSpin totaled $244,492. Reductions in the net realizable value of other
assets totaled $46,000. The results of operations for the year ended December
31, 1997 include certain unusual charges to earnings of $1,338,338 primarily for
the write-off of deferred offering costs ($481,325), goodwill associated with
the digital refractometer line of business ($704,579) and legal expenses
($152,434) relating to the recently completed Intelligent Medical Imaging, Inc.
patent litigation and the pending arbitration matter against Digital Imaging
Technologies, Inc.

19.  Foreign Operations and Export Sales

     The Company markets its products worldwide from its operations in the
United States and United Kingdom. Sales from the United States are primarily to
domestic customers. The majority of revenues from the United Kingdom are to
customers in Europe. Selected financial data by primary geographic area for the
years ended December 31, 1995, 1996 and 1997 follow.

<TABLE>
<CAPTION>
                                                1995(1)            1996(1)         1997(1)
                                             ------------      ------------      ------------
<S>                                         <C>               <C>               <C>         
Sales to unaffiliated
customers:
                          United States      $ 14,488,181      $ 18,894,619      $ 24,259,485

                          United Kingdom               --         1,659,512         2,632,587
                                             ------------      ------------      ------------
                                             $ 14,488,181      $ 20,554,131      $ 26,892,072
                                             ============      ============      ============


Operating profit or loss

                          Unites States      $ (1,801,958)     $(10,568,268)     $    813,767

                          United Kingdom               --           134,121          (529,784)
                                             ------------      ------------      ------------
                                             $ (1,801,958)     $(10,434,147)     $    283,983
                                             ============      ============      ============

Identifiable assets

                          United States      $ 22,202,545      $ 31,124,766      $ 26,685,635

                          United Kingdom               --         6,735,479         6,048,942
                                             ------------      ------------      ------------
                                             $ 22,202,545      $ 37,860,245      $ 32,734,577
                                             ============      ============      ============

Export sales

                          United States      $    342,091      $    490,905      $  1,158,127
                                             ============      ============      ============
</TABLE>

(1)   The years ended December 31, 1995 and 1996 include write-offs of acquired
      in process research and development totaling $2.9 million and $7.3
      million, respectively. The years ended December 31, 1996 and 1997 include
      unusual charges of $1.9 million and $1.3 million, respectively.

20.   Selected Quarterly Financial Data (Unaudited)

      The following table summarizes certain financial information by quarter
for 1996 and 1997:


<TABLE>
<CAPTION>
                                                                                                         1996 Quarter Ended
                                                        -------------------------------------------------------------------
                                                               March 31           June 30      September 30     December 31
                                                        -------------------------------------------------------------------
<S>                                                          <C>               <C>               <C>             <C>       
        Net revenues                                         $3,925,931        $4,823,455        $5,564,536      $6,283,132
        Gross margin on net revenues                          1,884,682         2,458,214         2,219,095       2,694,226
        Other income (expense), net                              60,413            80,753         (187,700)       (405,434)
        Net income (loss)                                       206,912           351,116       (6,250,834)     (1,735,382)
        Net income (loss) per share - Basic                        $.03              $.06            $(.98)          $(.30)
        Net income (loss) per share - Diluted                      $.03              $.05            $(.98)          $(.30)
</TABLE>
<PAGE>   48
        The quarters ended March 31 and June 30, 1996 include unusual charges
totaling $199,365 and $70,740, respectively, relating to StatSpin merger
expenses. The quarter ended September 30, 1996 includes unusual charges totaling
$1,047,310 relating to the write-off of deferred offering costs, litigation and
arbitration matters and write-down of other assets and includes the write-off of
acquired in-process research and development of $7,250,000. The quarter ended
December 31, 1996 includes unusual charges totaling $421,064 relating to
litigation and arbitration matters and $298,113 for severance and other
incremental costs associated with a restructuring of the Company's personnel.

<TABLE>
<CAPTION>
                                                                                                       1997 Quarter Ended
                                                    ---------------------------------------------------------------------
                                                           March 31         June 30         September 30      December 31
                                                    ---------------------------------------------------------------------
<S>                                                     <C>              <C>                  <C>              <C>       
        Net revenues                                    $6,290,035       $6,604,284           $7,196,713       $7,404,116
        Gross margin on net revenues                     3,029,037        3,402,827            3,612,316        3,699,576
        Other income (expense), net                       (291,062)        (269,616)            (234,666)        (284,927)
        Net income (loss)                                 (202,075)          17,330              214,381         (532,924)
        Net income (loss) per share - Basic                  $(.11)            $.00                 $.04            $(.09)
        Net income (loss) per share - Diluted                $(.11)            $.00                 $.03            $(.09)
</TABLE>

        The quarters ended March 31, June 30 and September 30, 1997 include
unusual charges totaling $95,129, $2,900 and $31,633 relating to litigation and
arbitration matters. The quarter ended December 31, 1997 includes unusual
charges totaling $1,208,676 primarily relating to the write-off of deferred
private offering costs and the write-off of goodwill no longer considered
recoverable.

21.     Subsequent Event (Unaudited)

        On May 8, 1998, the Company terminated the City National Bank revolving
line of credit and repaid the related term loan with the proceeds of a new
credit facility (the "New Facility") from Foothill Capital Corporation, a
division of Norwest Bank. The new credit facility consists of a $3.6 million
term loan and a $4.0 million revolving line of credit. Borrowings under the line
of credit are limited to a percentage of eligible accounts receivable and
subject to a combined limit of $7.0 million for the entire credit facility. The
Company had $2.0 million available under the line of credit at inception. The
term loan bears interest at the lender's prime rate (8.5% on May 8, 1998) plus
3% and is payable in 36 equal monthly installments. The revolving line of credit
bears interest at the lender's prime rate plus 1%. The new credit facility is
subject to minimum interest charges, prepayment penalties and customary fees, is
collateralized by a first priority lien on all the assets of the Company and
matures in 2001. It also contains financial covenants based primarily on
tangible net worth and cash flow and imposes restrictions on acquisitions,
capital expenditure and cash dividends.
<PAGE>   49


                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                                   SCHEDULE II
                        VALUATION AND QUALIFYING ACCOUNTS



<TABLE>
<CAPTION>
                                                                                      Additions
                                                             ----------------------------------
                                              Beginning      Charged to cost         Charged to                            Ending
                                                Balance         and expenses     other accounts           Deductions      Balance
                                           --------------------------------------------------------------------------------------
<S>                                        <C>               <C>                 <C>                   <C>               <C>
Year Ended December 31, 1997

Allowance for Doubtful Accounts               $ 274,766              $15,105            $10,714         $(33,006)(1)     $267,579

Reserve for Inventory Obsolescence             $404,611             $417,787                 --        $(232,626)(1)     $589,772

Deferred Tax Asset Valuation Allowance       $2,000,000                   --                 --               --       $2,000,000

Year Ended December 31, 1996

Allowance for Doubtful Accounts                 $87,759             $198,037            $10,000        $(21,030) (1)     $274,766

Reserve for Inventory Obsolescence             $380,845              232,626                 --       $(208,860) (1)     $404,611

Deferred Tax Asset Valuation Allowance       $1,563,000             $437,000                 --                   --   $2,000,000

Year Ended December 31, 1995

Allowance for Doubtful Accounts                 $89,335                   --                 --         $(1,576) (1)      $87,759

Reserve for Inventory Obsolescence             $332,926              $47,919                 --                   --     $380,845

Deferred Tax Asset Valuation Allowance       $5,787,000                   --                 --     $(4,224,000) (2)   $1,563,000
</TABLE>


(1) Relates to the write-off of accounts receivable or disposal of obsolete
inventory.

(2) Relates to change and/or utilization in valuation allowance

<PAGE>   50


                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
  No.                                                         Description
  ---                                                         -----------
<S>            <C>   <C>
  3.1(a)       --    Certificate of Incorporation, as amended (1)
  3.1(b)       --    Certificate of Designations of Series A Convertible Preferred Stock (2)
  3.2          --    Restated Bylaws (3)
  4.1          --    Specimen of Common Stock Certificate (4)
  4.1          --    Certificate of Designations of Series A Convertible Preferred Stock (2)
  10.1         --    Lease of the Company's headquarters facility, as amended (5)
  10.2(a)      --    1982 Stock Option Plans and form of Stock Option Agreement (6)
  10.2(b)      --    1983 and 1986 Stock Option Plans, and forms of Stock Option Agreements for each Plan (7)
  10.2(c)      --    Amended and Restated 1986 Stock Option Plan (8)
  10.2(d)      --    1994 Stock Option Plan and forms of Stock Option Agreements (9)
  10.2(e)      --    Certificate of Officer With Respect to Amendment of 1994 Stock Option Plan (10)
  10.2(f)      --    Key Employee Stock Purchase Plan (11)
  10.2(g)      --    1997 Stock Option Plan and form of Stock Option Agreement (18)
  10.3(a)      --    Various Agreements with TOA Medical Electronics Company, Ltd. (12)
  10.3(b)      --    Patent License Agreement dated April 1, 1997 between the Company and TOA Medical
                     Electronics Company, Ltd. (20)
  10.3(c)      --    Termination, Release and Reassignment of Security Interest dated October 30, 1997
                     executed by TOA Medical Electronics Company, Ltd. in favor of the Company (20)
  10.4(a)      --    Agreement for a Strategic Alliance in Urinalysis dated January 7, 1994 between the Company
                     and Boehringer Mannheim Corporation (13)
  10.4(b)      --    Research and Development and Distribution Agreement dated February 6, 1995 by and
                     among the Company, LDA Systems, Inc. and Corange International Limited (13)
  10.4(c)      --    Amendment to Distribution Agreements (14)
  10.5         --    Warrant Certificate dated March 20, 1995 issued to Biovation, Inc. (13) 
  10.6(a)      --    Technology License Agreement dated as of September 29, 1995
                     between the Company and Poly U/A Systems, Inc. (15)
  10.6(b)      --    Research and Development Agreement dated as of September 29, 1995 between the
                     Company and Poly U/A Systems, Inc. (15)
  10.6(c)      --    $100 Class "A" Note dated September 29, 1995 issued by Poly U/A Systems, Inc. in favor of
                     the Company (15)
  10.6(d)      --    Certificate of Incorporation of Poly U/A Systems, Inc. (See Article FOUR regarding the IRIS
                     Option) (15)
  10.6(e)      --    Form of Series D Warrant (20)
  10.6(f)      --    Form of Series E Warrant (20)
  10.6(g)      --    Form of Series F Warrant (20)
  10.7(a)      --    Agreement and Plan of Merger dated January 31, 1996 between the Company and StatSpin,
                     Inc. (16)
  10.7(b)      --    Registration Rights Agreement dated January 31, 1996 between the Company and StatSpin
                     Stockholders (16)
  10.7(c)      --    Employment Agreement dated January 30, 1996 with Thomas F. Kelley (16) 
  10.7(d)      --    Letter Agreement dated October 4, 1997 amending Employment
                     Agreement of Thomas F. Kelley (20)
  10.8(a)      --    Asset Purchase Agreement dated as of July 15, 1996 by and among the Company, Digital
                     Imaging Technologies, Inc., Perceptive Scientific Instruments, Inc. and Perceptive Scientific
                     Technologies, Inc. (17)
  10.8(b)      --    Registration Rights and Standstill Agreement dated July 31, 1996 between the Company and
                     Digital Imaging Technologies, Inc. (10)
  10.8(c)      --    Warrant Certificate dated July 31, 1996 issued to Digital Imaging Technologies, Inc. (10)
  10.8(d)      --    Stockholder Guaranty Agreement dated July 31, 1996 between Edward Randall, III and PSII
                     Acquisition Corp., a wholly-owned subsidiary of the Company (now known as Perceptive
                     Scientific Instruments, Inc.) (10)
  10.8(e)      --    Non-Competition Agreement dated as of July 15, 1996 between Edward Randall, III and PSII
                     Acquisition Corp., a wholly-owned subsidiary of the Company (now known as Perceptive
                     Scientific Instruments, Inc.) (10)
  10.8(f)      --    Technology License Agreement dated July 31, 1996 between Perceptive Scientific Imaging
                     Systems, Inc. and PSII Acquisition Corp., a wholly-owned subsidiary of the Company (now
                     known as Perceptive Scientific Instruments, Inc.) (10)
  10.9         --    $7,000,000 Subordinated Note dated July 29, 1996 issued by the Company in favor of Digital
                     Imaging Technologies, Inc. (10)
</TABLE>


<PAGE>   51

   
<TABLE>
<S>            <C>   <C>
  10.10(a)     --    $1,500,000 Promissory Note dated July 29, 1996 (Revolving Credit Facility) (10)
  10.10(b)     --    Change in Terms Agreement dated as of January 3, 1997 (Revolving Credit Facility) (19)
  10.10(c)     --    Supplemental Terms letter dated July 29, 1996 (Revolving Credit Facility) (10)
  10.10(d)     --    Supplemental Terms Letter dated as of January 3, 1997 (Revolving Credit Facility) (19)
  10.10(e)     --    $4,900,000 Amended and Restated Promissory Note dated as of January 3, 1997 (Term
                     Loan) (19)
  10.10(f)     --    Supplemental Terms Letter dated as of January 3, 1997 (Term Loan) (19)
  10.10(g)     --    Waiver of Default dated as of January 3, 1997 (19)
  10.10(h)     --    Warrant to Purchase Common Stock dated March 15, 1997 issued to City National Bank (19)
  10.10(i)     --    Commercial Security Agreement dated July 29, 1996 (10)
  10.10(j)     --    Commercial Pledge Agreement dated July 29, 1996 (10)
  10.10(k)     --    Various Additional Security Agreements dated as of January 3, 1997 (19)
  10.10(l)     --    Warrant to Purchase Common Stock dated June 1, 1997 issued to City National Bank (20)
  10.10(m)     --    Warrant to Purchase Common Stock dated July 1, 1997 issued to City National Bank (20)
  10.11(a)     --    Securities Purchase Agreement dated December 31, 1996 by and between the Company and
                     Thermo Amex Convertible Growth Fund I, L.P. (2)
  10.11(b)     --    Common Stock Purchase Warrant dated December 31, 1996 issued to Thermo Amex
                     Convertible Growth Fund I, L.P. (2)
  10.11(c)     --    Registration Rights Agreement dated December 31, 1996 by and between the Company and
                     Thermo Amex Convertible Growth Fund I, L.P. (2)
  10.12        --    Commitment Letter of Foothill Capital Corporation dated March 30, 1998 (20)
  24           --    Consent of Coopers & Lybrand L.L.P.
  27.1         --    Financial Data Schedule (1997) (20)
  27.2         --    Financial Data Schedule (Quarter 1997) (20)
  27.3         --    Financial Data Schedule (1995 and 1996)

</TABLE>
    

-------------------

         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 its Quarterly 
         Report on Form 10-Q for the quarter ended September 30, 1993.
  (2)    Current Report on Form 8-K dated January 15, 1997.
  (3)    Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.
  (4)    Registration Statement on Form S-3, as filed with the Securities and
         Exchange Commission on March 27, 1996 (File No. 333-002001).
  (5)    Annual Report on Form 10-K for the year ended December 31, 1989, its
         quarterly report on Form 10-Q for the quarter ended September 30, 1993
         and its Annual Report on Form 10-K for the year ended December 31,
         1994.
  (6)    Registration Statement on Form S-2, as filed with the Securities and
         Exchange Commission on September 4, 1985 (File No. 2-99240).
  (7)    Registration Statement on Form S-8, as filed with the Securities and
         Exchange Commission on May 10, 1982 (File No. 2-77496).
  (8)    Annual Report on Form 10-K for the year ended December 31, 1992.
  (9)    Registration Statement on Form S-8, as filed with the Securities and
         Exchange Commission on August 8, 1994 (File No. 33-82560).
  (10)   Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. 
  (11)   Registration Statement on Form S-8 filed January 3, 1997.
  (12)   Current Report on Form 8-K dated July 15, 1988 and its quarterly report
         on Form 10-Q for the quarter ended June 30, 1995.
  (13)   Annual Report on Form 10-K for the year ended December 31, 1994.
  (14)   Quarterly Report on Form 10-Q for the quarter ended September 30, 1996.
  (15)   Quarterly Report on Form 10-Q for the quarter ended September 31, 1995.
  (16)   Annual Report on Form 10-K for the year ended December 31, 1995.
  (17)   Current Report on Form 8-K filed July 17, 1996.
  (18)   Registration Statement on Form S-8, as filed with the Securities and 
         Exchange Commission on July 16, 1997 (File No. 333-31393).
  (19)   Annual Report on Form 10-K for the year ended December 31, 1996.
  (20)   Annual Report on Form 10-K for the year ended December 31, 1997.