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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
- ----- EXCHANGE ACT OF 1934
For the quarterly period ended September 25, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
- ----- EXCHANGE ACT OF 1934
For the transition period from ______ to _____
Commission file number: 000-20198
CHOLESTECH CORPORATION
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-3065493
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
3347 INVESTMENT BOULEVARD, HAYWARD, CA 94545
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (510) 732-7200
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 and Exchange Act of 1934
during the preceding 12 months (or for 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
----- -----
At September 25, 1998, 11,486,624 shares of common stock of the Registrant were
outstanding.
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CHOLESTECH CORPORATION
PART I
FINANCIAL INFORMATION
Page
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ITEM 1. FINANCIAL STATEMENTS.
Condensed Balance Sheets 3
Condensed Statements of Operations 4
Condensed Statements of Cash Flows 5
Notes to Condensed Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 9
PART II
OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 29
SIGNATURES 30
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CHOLESTECH CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
ASSETS
September 25, 1998 March 27, 1998(1)
------------------ -----------------
Current assets:
Cash and cash equivalents $ 3,678 $ 5,130
Marketable securities 7,082 9,621
Accounts receivable, net 3,176 3,793
Inventories 5,602 3,306
Prepaid expenses and other current assets 453 154
-------- --------
Total current assets 19,991 22,004
Property and equipment, net 4,527 3,711
Other assets, net 60 73
-------- --------
$ 24,578 $ 25,788
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 1,918 $ 3,003
Accrued payroll and benefits 956 1,136
Product warranty 203 203
-------- --------
Total current liabilities 3,077 4,342
-------- --------
Shareholders' equity:
Preferred stock -- --
Common stock 70,209 69,880
Accumulated other comprehensive income 49 49
Accumulated deficit (48,757) (48,483)
-------- --------
Total shareholders' equity 21,501 21,446
-------- --------
$ 24,578 $ 25,788
======== ========
(1) The information in this column was derived from the Company's audited
financial statements for the fiscal year ended March 27, 1998.
See Notes to Condensed Financial Statements
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CHOLESTECH CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Thirteen weeks ended Twenty-six weeks ended
-------------------- ----------------------
9/25/98 9/26/97 9/25/98 9/26/97
-------- ------- -------- -------
Revenues:
Domestic $ 5,144 $ 4,910 $ 9,315 $ 8,718
International 963 502 1,477 897
-------- ------- -------- -------
6,107 5,412 10,792 9,615
Cost of products sold 2,984 2,705 4,886 4,701
-------- ------- -------- -------
Gross profit 3,123 2,707 5,906 4,914
-------- ------- -------- -------
Operating expenses:
Sales and marketing 1,818 1,394 3,446 2,650
Research and development 729 555 1,428 1,060
General and administrative 646 484 1,131 930
Other (175) -- 575 --
-------- ------- -------- -------
Total operating expenses 3,018 2,433 6,580 4,640
Income (loss) from operations 105 274 (674) 274
Interest income (expense), net 218 172 412 294
-------- ------- -------- -------
Income (loss) before taxes 323 446 (262) 568
Provision for income taxes 13 9 13 12
-------- ------- -------- -------
Net income (loss) $ 310 $ 437 $ (275) $ 556
======== ======= ======== =======
Net income (loss) per share:
Basic $ 0.03 $ 0.04 $ (0.02) $ 0.05
======== ======= ======== =======
Diluted $ 0.03 $ 0.04 $ (0.02) $ 0.05
======== ======= ======== =======
Shares used to compute net
income (loss) per share:
Basic 11,473 11,260 11,473 11,253
======== ======= ======== =======
Diluted 11,764 11,806 11,473 11,761
======== ======= ======== =======
See Notes to Condensed Financial Statements
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CHOLESTECH CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Twenty-six weeks ended
-------------------------------
Sept. 25, 1998 Sept. 26, 1997
-------------- --------------
Cash flows from operating activities:
Net income (loss) $ (275) $ 556
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 904 441
Changes in assets and liabilities:
Accounts receivable 617 (1,367)
Inventories (2,348) (55)
Prepaid expenses and other assets (309) (284)
Other assets (1) 7
Accounts payable and accrued expenses (1,085) 860
Accrued payroll and benefits (180) 95
------- --------
Net cash provided by (used in) operating activities (2,677) 253
------- --------
Cash flows from investing activities:
Proceeds from sale of marketable securities 7,799 9,758
Purchases of marketable securities (5,260) (11,302)
Purchases of property and equipment (1,643) (556)
------- --------
Net cash provided by (used in) investing activities 896 (2,100)
------- --------
Cash flows from financing activities:
Issuance of common stock 329 250
------- --------
Net cash provided by financing activities 329 250
------- --------
Net change in cash and cash equivalents (1,452) (1,597)
Cash and cash equivalents at beginning of period 5,130 6,088
------- --------
Cash and cash equivalents at end of period $ 3,678 $ 4,491
======= ========
See Notes to Condensed Financial Statements
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CHOLESTECH CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. INTERIM RESULTS
The interim unaudited financial information of Cholestech Corporation
(the "Company") is prepared in conformity with generally accepted
accounting principles and such principles are applied on a basis
consistent with the audited financial information contained in the
Annual Report on Form 10-K filed with the Securities and Exchange
Commission on May 5, 1998. The financial information included herein has
been prepared by management, without audit by independent accountants
who do not express an opinion thereon, and should be read in conjunction
with the audited financial statements contained in the Annual Report on
Form 10-K for the fiscal year ended March 27, 1998. The condensed
balance sheet as of March 27, 1998 has been derived from, but does not
include all the disclosures contained in, the audited financial
statements for the year ended March 27, 1998. The information furnished
includes all adjustments and accruals consisting only of normal
recurring accrual adjustments that are, in the opinion of management,
necessary for a fair presentation of results for the interim periods.
Certain information or footnote disclosure normally included in
financial statements prepared in accordance with generally accepted
accounting principles has been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission.
The interim results are not necessarily indicative of the results of
operations for the full fiscal year ending March 26, 1999.
Certain reclassifications have been made in the condensed statements of
operations for the thirteen and twenty-six weeks ended September 26,
1997 to conform to the fiscal 1999 presentation. Such reclassifications
had no effect on previously reported results of operations.
2. BALANCE SHEET DATA
The components of inventories are as follows (in thousands):
SEPTEMBER 25, 1998 MARCH 27, 1998
------------------ --------------
Raw materials $1,644 $1,292
Work-in-process 1,669 1,038
Finished goods 2,289 976
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$5,602 $3,306
====== ======
3. EARNINGS PER SHARE
Basic earnings per share is computed by dividing income (loss) available
to common shareholders (numerator) by the weighted average number of
common shares outstanding (denominator) during the period. Diluted
earnings per share gives effect to all potential Common Stock
outstanding during a period, if dilutive. In computing diluted earnings
per
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CHOLESTECH CORPORATION
share, the average stock price is used in determining the number of
shares assumed to be repurchased from the exercise of stock options.
A reconciliation of the basic and diluted earnings per share
calculations follows:
(In thousands except per share data)
Thirteen Weeks Ended Twenty-six Weeks Ended
September 25, 1998 September 25, 1998
------------------------------ ----------------------------
Income Shares Per share Loss Shares Per share
Basic EPS $307 11,473 $0.03 $(278) 11,473 $(0.02)
Effect of dilutive
securities 291 --
------------------------------ ----------------------------
Diluted EPS $307 11,764 $0.03 $(278) 11,473 $(0.02)
============================== ============================
Thirteen Weeks Ended Twenty-six Weeks Ended
September 26, 1997 September 26, 1997
----------------------------- --------------------------
Income Shares Per share Income Shares Per share
Basic EPS $437 11,260 $0.04 $556 11,253 $0.05
Effect of dilutive
securities 546 508
----------------------------- --------------------------
Diluted EPS $437 11,806 $0.04 $556 11,761 $0.05
============================= ==========================
4. BORROWING ARRANGEMENTS
In December 1997, the Company renewed an agreement with Wells Fargo Bank
for a $3.0 million revolving line of credit (the "Line of Credit").
While the agreement is in effect, the Company is required to maintain on
deposit assets with a collective value, as defined in the Line of
Credit, equivalent to no less than 100% of the outstanding principle
balance. Amounts outstanding under the Line of Credit bear interest at
the bank's prime rate. The Line of Credit agreement expires on November
30, 1998 and is renewable. As of September 25, 1998, there were no
borrowings outstanding under the Line of Credit.
5. NEW ACCOUNTING PRONOUNCEMENTS
The Company adopted Statement of Financial Accounting Standards Board
("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130
establishes standards for reporting and display of comprehensive income
and its components in a full set of general purpose financial statements
that is displayed with the same prominence as other financial
statements. Comprehensive income, as defined, includes all changes in
equity (net assets) during a period from non-owner sources, including
unrealized gains and losses on available-for-sale securities. For all
periods presented, comprehensive income (loss) approximated net income
(loss).
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CHOLESTECH CORPORATION
The Company adopted SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information" in the first quarter of fiscal 1999.
This statement establishes standards for the way companies report
information about operating segments in annual financial statements. It
also establishes standards for related disclosures about products and
services, geographic areas and major customers. The adoption of SFAS No.
131 has not resulted in a change in the way the Company reports
information.
6. SHAREHOLDER RIGHTS PLAN
In January 1997, the Board of Directors approved a shareholder rights
plan under which shareholders of record on March 31, 1997 received a
right to purchase (the "Right") one-thousandth of a share of Series A
Participating Preferred Stock at an exercise price of $44.00, subject to
adjustment. The Rights will separate from the Common Stock and Rights
certificates will be issued and will become exercisable upon the earlier
of: (i) 10 days (or such later date as may be determined by a majority
of the Board of Directors) following a public announcement that a person
or group of affiliated or associated persons has acquired, or obtained
the right to acquire, beneficial ownership of 15% or more of the
Company's outstanding Common Stock or (ii) 10 business days following
the commencement of, or announcement of an intention to make, a tender
offer or exchange offer, the consummation of which would result in the
beneficial ownership by a person or group of 15% or more of the
Company's outstanding Common Stock. The Rights expire on the earlier of
(i) January 22, 2007 or (ii) redemption or exchange of the Rights.
7. OTHER EVENTS
In June 1998, the Company cancelled its proposed common stock offering.
This led to a non-recurring net charge of approximately $325,000, or
$(0.03) per share (diluted) related to the write-off of the offering
expenses.
In May 1998, the Company settled an outstanding litigation with a former
employee of the Company. In accordance with the settlement, the Company
agreed to a settlement fee of $250,000, or $(0.02) per share (diluted),
which was charged to operating income in the quarter ended June 26,
1998.
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CHOLESTECH CORPORATION
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains forward-looking statements that involve risks
and uncertainties. The Company's actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors discussed herein, under "General" and "Potential Factors Affecting
Future Operating Results." These forward-looking statements include, but are not
limited to, the statement under "General" that the Company incur negative cash
flows, as it expends manufacturing, research and development and sales and
marketing and pursues regulatory approvals for its products, the statement under
in the first paragraph under "Revenues" regarding the dollar amount and
proportion of international revenues may fluctuate from period to period, the
statement under "Research and Development" regarding the development of tests
for new disease states and the Company's anticipation that research and
development expenditures will increase, and the statement's in the second and
third paragraphs under "Liquidity and Capital Resources" that the capital
expenditures relating to expansion of manufacturing, research and development
and sales and marketing will increase and the Company's liquid assets and cash
from operations will be sufficient to meet its capital requirements for the
foreseeable future.
GENERAL
The Company develops, manufactures and markets the Cholestech L-D-X(R)
System which performs near-patient diagnostic screening and therapeutic
monitoring for the management of prevalent chronic diseases (preventive care
testing). The L-D-X System is capable of measuring multiple analytes
simultaneously with a single drop of whole blood within five minutes. The
Company currently markets the L-D-X System, including the L-D-X Analyzer and a
variety of single use test cassettes, to the physician office laboratory (POL),
pharmacy and health promotion markets, in the United States and internationally.
The Company has experienced significant operating losses and, as of September
25, 1998, had an accumulated deficit of $48.8 million. The L-D-X System,
including the L-D-X Analyzer (the Company's only product platform) and single
use test cassettes, will continue to account for substantially all of the
Company's revenues for the foreseeable future. In order for the Company to
increase revenues, sustain profitability and maintain positive cash flows from
operations, the L-D-X System must continue to gain market acceptance among
health care providers, particularly in POLs and pharmacies, to which the Company
has made only limited sales to date. The Company is developing certain
additional tests designed to extend the capabilities of the L-D-X System. The
Company believes that its future growth will depend, in part, upon its ability
to complete development of and successfully introduce these new tests. The
Company may incur negative cash flows from operations as it expands
manufacturing capacity for existing and new test cassettes, increases product
research and development efforts for new test cassettes, and expands sales and
marketing activities and pursues regulatory clearances and approvals. The
development and commercialization of new tests will require additional
development, sales and marketing, manufacturing and other expenditures. The
required level and timing of such expenditures will have an impact on the
Company's ability to maintain profitability and positive cash flows from
operations. The Company expects its product mix to change from time to time, and
these changes will affect the Company's revenues and operating results. For
example, the Company has entered the physician office laboratory ("POL") and
pharmacy markets recently. In its limited experience, the Company generally has
found that these markets use a higher proportion
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CHOLESTECH CORPORATION
of lipid profile cassettes for therapeutic monitoring purposes, which test
cassettes typically have higher selling prices and associated gross margins than
the Company's other tests. However, the Company has also experienced a
relatively lower rate of testing per day in these markets than in the health
promotion market.
RESULT OF OPERATIONS
THIRTEEN WEEKS ENDED SEPTEMBER 25, 1998 AND SEPTEMBER 26, 1997
AND
TWENTY-SIX WEEKS ENDED SEPTEMBER 25, 1998 AND SEPTEMBER 26, 1997
Revenues . During the thirteen weeks ended September 25, 1998, revenues
increased 12.8% to $6.1 million from $5.4 million in the thirteen weeks ended
September 26, 1997. The increase in revenues primarily reflects increased unit
sales of single use test cassettes and L-D-X analyzers to health care providers
in the POL and pharmacy markets. In the U.S. pharmacy market the Company began
marketing programs with McKession Drug Company, Bergen Brunswig and eight (8)
regional pharmacy distributors. During the thirteen weeks ended September 25,
1998 pharmacy sales representatives of distribution partners were trained and
each distributor took initial stocking orders. International revenues increased
by 91.8% or $461,000 from $502,000 to $963,000 for the thirteen weeks ended
September 25, 1998 compared to the same period in fiscal 1997. The increase in
international revenues reflects continued product demand in the European market.
The Company expects that the dollar amount and proportion of international
revenues may fluctuate from period to period.
During the first twenty-six weeks of fiscal 1999, revenues increased
$1.2 million (12.2%) to $10.8 million from $9.6 million in the first twenty-six
weeks of fiscal 1997. The increase in revenues primarily reflects increased unit
sales of single use test cassettes and L-D-X analyzers to health care providers
in the POL and pharmacy markets. During the first twenty-six weeks of fiscal
1999, international revenues increased $580,000 (64.7%) to $1.5 million from
$897,000 in the first twenty-six weeks of fiscal 1998. The increase in
international revenues reflects continued product demand in the European market.
Cost of Products Sold. Cost of products sold includes direct labor,
direct material, overhead and royalties. Cost of products sold increased 10.3%
to $3.0 million in the thirteen weeks ended September 25, 1998 of fiscal 1999
from $2.7 million in the thirteen weeks ended September 26, 1997, primarily as a
result of increased unit sales of single use test cassettes and the Cholestech
L-D-X Systems. Also, contributing was the lag in production of Cholestech L-D-X
analyzers due to a six week lead-time in the delivery of a Cholestech L-D-X raw
material. This delivery delay resulted in a loss of production time and
approximately $300,000 of unabsorbed overhead. Gross margin was 51.1% and 50.0%
in the thirteen weeks ended September 25, 1998 and the thirteen weeks ended
September 26, 1997, respectively. The improvement in gross margin was primarily
attributable to increased volume of single use test cassettes manufactured
without corresponding percentage increases in manufacturing costs, improving the
absorption of manufacturing overhead and reducing unit costs.
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CHOLESTECH CORPORATION
During the first twenty-six weeks of fiscal 1999, cost of products sold
increased $185,000 (3.9%) to $4.9 million from $4.7 million in the first
twenty-six weeks of fiscal 1998, as unit sales of disposable test cassettes and
the Cholestech L-D-X Systems. Also contributing was the lag in production of
Cholestech L-D-X analyzers due to a six week lead time in the delivery of a
Cholestech L-D-X raw material. This delivery delay resulted in a loss of
production time and approximately $300,000 of unabsorbed overhead. Gross margin
was 54.7% and 51.1% in the first twenty-six weeks of fiscal 1999 and 1998,
respectively. The improvement in gross margin was primarily attributable to
increased volume of single use test cassettes manufactured without corresponding
percentage increases in manufacturing costs, improving the absorption of
manufacturing overhead and reducing unit costs.
The Company has licensed certain technology used in the manufacturing of
its disposable cassette products. A related agreement, which expires in 2006,
requires the Company to pay a royalty of 2.0% on net sales of the applicable
products. Total royalty expenses in the thirteen weeks ended September 25, 1998
and September 26, 1997 were $101,000 and $152,000, respectively, and were
charged to cost of products sold. Total royalty expenses for the first
twenty-six weeks of fiscal 1999 and 1998 were $232,000 and $314,000,
respectively, and also were charged to cost of products sold.
Sales and Marketing Expenses. Sales and marketing expense includes
salaries, commissions, bonuses, expenses for outside services related to
marketing programs and travel expenses. Sales and marketing expense increased
30.4% to $1.8 million in the thirteen weeks ended September 25, 1998 from $1.4
million in the thirteen weeks ended September 26, 1997. This increase was
primarily attributable to continued expansion of the Company's domestic sales
and marketing programs to target customers and end-users and increased expenses
related to greater penetration of the physician office laboratory and pharmacy
markets. Sales and marketing expense increased to 29.8% of revenues in the
thirteen weeks ended September 25, 1998 from 25.8% in the thirteen weeks ended
September 26, 1997, primarily due to lower then anticipated revenue.
Sales and marketing expenses first twenty-six weeks of fiscal 1999 were
$3.5 million compared to $2.7 million for the first twenty-six weeks of fiscal
1998. These increases in sales and marketing expenses were attributable to
continued expansion of the Company's domestic sales and marketing organization,
increased expenses related to the continued penetration in the physician office
market, and, to a lesser extent, participation in domestic conferences and trade
shows. Sales and marketing expenses as a percentage of revenues increased to
31.9% for the first twenty-six weeks of fiscal 1999 from 27.6% for the first
twenty-six weeks of fiscal 1998, primarily due to lower then anticipated
revenue.
Research and Development Expenses. Research and development expense
includes salaries, bonuses, expenses for outside services, supplies and
amortization of capital equipment. Research and development expense increased
31.4% to $729,000 in the thirteen weeks ended September 25, 1998 from $555,000
in the thirteen weeks ended September 26, 1997. This increase was primarily
attributable to continued development of new single use test cassettes and
increase in headcount. Research and development expenses as a percentage of
revenues increased to 11.9% for the thirteen weeks ended September 25, 1998 from
10.3% for thirteen weeks ended September 26, 1997.
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CHOLESTECH CORPORATION
Research and development expenses for the first twenty-six weeks of
fiscal 1999 were $1.4 million compared to $1.1 million for the first twenty-six
weeks of fiscal 1998. The increases in research and development expense were
attributable to continued development of additional tests and an increase in
headcount. Research and development expenses as a percentage of revenues
increased to 13.2% for the first twenty-six weeks of fiscal 1999 from 11.0% for
the first twenty-six weeks of fiscal 1998.
The Company is currently developing additional tests for diagnostic
screening and therapeutic monitoring of osteoporosis, liver damage,
cardiovascular disease and diabetes. These new tests are in various stages of
development, and the Company will be required to undertake time consuming and
costly development activities and seek regulatory approval for these new tests
before such tests can be marketed. The Company believes that revenue growth, if
any, and future operating results will depend, in part, upon completing
development of and successfully introducing these tests. The Company currently
anticipates that the dollar amount of research and development expense will
increase in future periods as costs associated with product development and
manufacturing scale up efforts for new cassettes are incurred.
General and Administrative Expense. General and administrative expense
includes compensation, benefits and expenses for outside services. General and
administrative expense increased 33.5% to $646,000 in the thirteen weeks ended
September 25, 1998 from $484,000 in the thirteen weeks ended September 26, 1997.
This increase resulted primarily from an increased utilization of legal and
computer consultant's professional services and increased headcount. General and
administrative expenses increased to 10.6% of revenues in the thirteen weeks
ended September 25, 1998 from 8.9% in thirteen weeks ended September 26, 1997.
General and administrative expenses for the first twenty-six weeks of
fiscal 1999 were $1.1 million compared to $930,000 for the same period in fiscal
1998. This increase resulted primarily from an increased utilization of
professional services and increased headcount. General and administrative
expenses increased to 10.5% of revenues in the first twenty-six weeks of fiscal
1999 from 9.7% in the same period in fiscal 1998.
Other. Other expense for the thirteen weeks ended September 25, 1998 was
a credit of $175,000. This is primarily the result of the Company's management
negotiating a cost reduction in expenses associated with its withdrawn public
stock offering.
Other expenses for the first twenty-six weeks of fiscal 1999 of $575,000
reflect a non-recurring charge of approximately $325,000 due to the cancellation
of a proposed common stock offering and $250,000 due to settlement of litigation
involving a former employee.
Interest income (expense), net. Interest income reflects income from the
investment of cash balances and marketable securities. Interest income rose
52.3% to $262,000 in the thirteen weeks ended September 25, 1998 from $172,000
in the thirteen weeks ended September 26, 1997. This increase was primarily the
result of the mix of marketable securities invested in the thirteen weeks ended
September 25, 1998 compared to same period in fiscal 1998 and adjustments
relative to earned interest.
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CHOLESTECH CORPORATION
Interest income rose 55.1% to $456,000 in first twenty-six weeks in
fiscal 1999 from $294,000 for the same period in fiscal 1997. This increase was
primarily the result of the mix of marketable securities invested in the
thirteen weeks ended September 25, 1998 compared to same period in fiscal 1998.
Income Taxes. As the Company has significant net operating loss and tax
credit carryforwards, the provisions for income taxes for the thirteen weeks
ended September 25, 1998 and the thirteen weeks ended September 26, 1997 and the
twenty-six weeks ended September 25, 1998 and the twenty-six weeks ended
September 26, 1997 represent the estimated alternative minimum tax. Management
expects to utilize additional net operating loss and other tax carryforward
amounts to the extent income is earned during fiscal 1999. Accordingly, the
Company's estimated effective tax rate is expected to remain below the federal
statutory rate throughout fiscal 1999.
New Accounting Pronouncements. The Company adopted Statement of
Financial Accounting Standards Board ("SFAS") No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements that is displayed with the same prominence as other
financial statements. Comprehensive income, as defined, includes all changes in
equity (net assets) during a period from non-owner sources, including unrealized
gains and losses on available-for-sale securities. For all periods presented,
comprehensive income (loss) approximated net income (loss).
The Company adopted SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information" in the first quarter of fiscal 1999. This
statement establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. The adoption of SFAS No. 131 has not resulted in a change in the way
the Company reports information.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through the sale of
equity securities and, during fiscal 1998, from positive cash flows from
operations. From inception to September 25, 1998, the Company raised
approximately $70.2 million in net proceeds from equity financings. As of
September 25, 1998, the Company had approximately $10.8 million of cash, cash
equivalents and short-term marketable securities and an accumulated deficit of
$48.8 million. In addition, the Company has available a $3 million revolving
bank line of credit agreement. While the revolving line is in effect, the
Company is required to maintain on deposit assets with a collective value, as
defined in the line of credit agreement, equivalent to no less than 100% of the
outstanding principal balance. Amounts outstanding under the line of credit bear
interest at the bank's prime rate. The line of credit agreement expires on
November 30, 1998 and is renewable. As of September 25, 1998, there were no
borrowings outstanding under the line of credit.
Net cash used in operating activities was approximately $2.7 million
during the first twenty-six weeks of fiscal 1999 compared to net cash provided
by operating activities of $253,000 during the first twenty-six weeks of fiscal
1998. In the first twenty-six weeks of fiscal
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CHOLESTECH CORPORATION
1999, the net loss of $275,000, decrease in accounts payable and accrued
expenses of approximately $1.1 million and increase in inventory of
approximately $2.3 million were the primary factors contributing to cash used by
operating activities. In the first twenty-six weeks of fiscal 1998, net income
of $556,000 from product sales was the primary factor contributing to cash
provided by operating activities. Net cash provided by investing activities of
$882,000 in the first twenty-six weeks of fiscal 1999 resulted primarily from
the Company's sale of marketable securities. Net cash used in investing
activities of approximately $2.1 million in the first twenty-six weeks of fiscal
resulted from the Company's net purchases of marketable securities and property
and equipment. . The increase in purchases of property and equipment between the
two periods is primarily attributable to capital investments related to the
third manufacturing line. Net cash provided by financing activities of $329,000
in the first twenty-six weeks of fiscal 1999 and $250,000 in the first
twenty-six weeks of fiscal 1998 reflected the issuance of Common Stock pursuant
to the Company's stock incentive program and stock purchase plan. The Company
intends to expend substantial funds for capital expenditures related to
expansion of its manufacturing capacity, research and development, including
expansion of its product line and enhancement of its current products, expansion
of sales and marketing activities and other working capital and general
corporate purposes.
Despite the Company's cancellation of its proposed equity financing in
the first quarter of fiscal 1999, the Company believes that the Company's cash,
cash equivalents, marketable securities, cash flows anticipated to be generated
by future operations, and available bank borrowings under an existing line of
will be sufficient to meet its capital requirements for the foreseeable future.
However, there can be no assurance that the Company will not require additional
financing. For example, the Company may be required to expend greater than
anticipated funds if unforeseen difficulties arise in expanding manufacturing
capacity for existing cassettes or in the course of completing required
additional development, obtaining necessary regulatory approvals, obtaining
waived status under the Clinical Laboratory Improvement Amendments of 1988
("CLIA") or introducing or scaling up manufacturing for new tests. The Company's
future liquidity and capital requirements will depend upon numerous additional
factors, including: the costs and timing of expansion of manufacturing capacity;
the number and type of new tests the Company seeks to develop; the success of
these development efforts; the costs and timing of expansion of sales and
marketing activities; the extent to which the Company's existing and new
products gain market acceptance; competing technological and market
developments; the progress of commercialization efforts of the Company's
distributors; the costs involved in preparing, filing, prosecuting, maintaining
and enforcing patent claims and other intellectual property rights; developments
related to regulatory and third party reimbursement matters and CLIA; and other
factors. In the event that additional financing is needed, the Company may seek
to raise additional funds through public or private financing, collaborative
relationships or other arrangements. Any additional equity financing may be
dilutive to shareholders, and debt financing, if available, may involve
restrictive covenants. Collaborative arrangements, if necessary to raise
additional funds, may require the Company to relinquish its rights to certain of
its technologies, products or marketing territories. The failure of the Company
to raise capital on acceptable terms when needed could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "-- Potential Factors Affecting Future Operating Results -- Possible Future
Capital Requirements; Uncertainty of Additional Funding."
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POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS
UNCERTAINTY OF MARKET ACCEPTANCE OF THE L-D-X SYSTEM. The Cholestech L-D-X
System, including the L-D-X Analyzer (the Company's only product platform) and
single use test cassettes, will continue to account for substantially all of the
Company's revenues for the foreseeable future. In order for the Company to
increase revenues, sustain profitability and maintain positive cash flows from
operations, the L-D-X System must continue to gain market acceptance among
health care providers, particularly physician office laboratories (POLs) and
pharmacies, to which the Company has made only limited sales to date.
Physicians, pharmacists and other health care providers are not likely to use
the L-D-X System unless they determine that it is an attractive alternative to
other means of diagnostic screening or therapeutic monitoring of chronic
diseases. Such determination will depend, in part, upon the L-D-X System's
accuracy, ease of use, rapid test time, reliability and cost effectiveness, as
well as the availability and amount of third party reimbursement. Even if the
advantages of the L-D-X System in diagnosing and monitoring patients with
chronic diseases are established, health care providers may elect not to
purchase and use the L-D-X System for any number of reasons. For example,
physicians and other health care providers may not change their established
means of having such tests performed or may not make the necessary investment to
purchase the L-D-X Analyzer. In addition, the growing prevalence of managed care
may adversely affect the POL market. A growing number of physicians are salaried
employees and have no financial incentive to perform testing. Many managed care
organizations have contracts with laboratories, which require participating or
employed physicians to send patient specimens to contracted laboratories.
Finally, physicians are under growing pressure by Medicare and other third party
payors to limit their testing to "medically necessary" tests. Market acceptance
of the L-D-X System by pharmacists will in part depend on the continued
availability and amount of reimbursement to them for performing tests on the
L-D-X System. Even if the Company is successful in continuing to place L-D-X
Analyzers at POLs, pharmacies and other near-patient testing sites, there can be
no assurance that placement of L-D-X Analyzers will result in sustained demand
for the Company's single use test cassettes. As a result, there can be no
assurance that demand for the L-D-X System will be sufficient to sustain
revenues and profits from operations. Because the L-D-X System currently
represents the Company's sole product focus, the Company could be required to
cease operations if the L-D-X System does not achieve and maintain a significant
level of market acceptance.
HISTORY OF LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY; FLUCTUATIONS IN
OPERATING RESULTS. The Company may experience significant fluctuations in
revenues and results of operations on a quarter to quarter basis in the future.
Quarterly operating results will fluctuate due to numerous factors, including:
(i) the timing and level of market acceptance of the L-D-X System; (ii) the
timing of the introduction and availability of new tests; (iii) the timing and
level of expenditures associated with development activities; (iv) the timing
and level of expenditures associated with expansion of sales and marketing
activities and overall operations; (v) the Company's ability to cost-effectively
expand cassette manufacturing capacity and maintain consistently acceptable
yields in the manufacture of cassettes; (vi) variations in manufacturing
efficiencies; (vii) the timing of establishment of strategic distribution
arrangements and the success of the activities conducted under such
arrangements; (viii) changes in demand for its products based on changes in
third party reimbursement, competition, changes in government regulation and
other factors; (ix) the timing of significant orders from and shipments to
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CHOLESTECH CORPORATION
customers; (x) product pricing and discounts; (xi) variations in the mix of
products sold; and (xii) general economic conditions. These factors are
difficult to forecast, and these or other factors could have a material adverse
effect on the Company's business, financial condition and results of operations.
Fluctuations in quarterly demand for the Company's products may adversely affect
the continuity of the Company's manufacturing operations, increase uncertainty
in operational planning and/or affect cash flows from operations. The Company's
expenses are based in part on the Company's expectations as to future revenue
levels and to a large extent are fixed in the short term. As a result, if actual
revenues do not meet expectations, the Company's ability to adjust spending
levels in the short term will be limited and its business, financial condition
and results of operations could be materially adversely affected. In addition,
as a result of these fluctuations, it is likely that in some future period the
Company's results will not meet the expectations of public market security
analysts or investors. In such event, the trading price of the Common Stock
could be materially adversely affected.
DEPENDENCE ON DEVELOPMENT, INTRODUCTION AND MARKET ACCEPTANCE OF NEW
TESTS. The Company is at various stages of development of tests designed to
extend the capabilities of the L-D-X System. The Company believes that its
revenue growth and future operating results will depend, in part, upon its
ability to complete development of and successfully introduce these new tests.
The Company will be required to undertake time-consuming and costly development,
sales and marketing, manufacturing and other activities, as well as seek
regulatory approval for these new tests. There can be no assurance that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these new tests, that
regulatory clearance or approval of any new tests will be granted by the FDA or
the CDC (for CLIA waived status) on a timely basis, or at all, that the new
tests will adequately meet the requirements of the applicable market or achieve
market acceptance or that the Company will be able to achieve and maintain cost
efficient, high volume manufacturing capacity for any new tests. In July 1997,
the FDA approved the Company's request for clearance to market the Company's
BUN/Creatinine single use test cassette pursuant to Section 510(k) of the FDC
Act. In September 1997, the Company submitted to the CDC a request for CLIA
waiver for the use of the BUN/Creatinine test cassette with the L-D-X System.
The CDC has not yet acted upon the Company's request and because the CDC's
evaluation of applications for CLIA waived status is not based upon precisely
defined objectively measurable criteria, the Company cannot predict the
likelihood of obtaining waived status. In order to successfully commercialize
the BUN/Creatinine test cassette or other future tests in the United States, the
Company believes it is critical to obtain waived status under CLIA. In order to
successfully commercialize any new tests, including the BUN/Creatinine test
cassette, the Company will be required to establish and maintain reliable, cost-
efficient, high-volume manufacturing capacity for such tests. The Company has in
the past encountered difficulties in scaling up production of new test
cassettes, including problems involving production yields, quality control and
assurance, variations and impurities in the raw materials and performance of the
manufacturing equipment.
In May 1996, the Company entered into a development, marketing and
licensing agreement with Metra Biosystems to develop an immunoassay cassette
incorporating Metra Biosystems' bone resorption technology to be used on the
L-D-X System. Metra Biosystems has the right to terminate the agreement at any
time. If the Company is unable, for technological or other reasons, to complete
the development, introduction and scale up of manufacturing of any new tests, if
the Company fails to obtain regulatory approval for any such tests on a timely
basis or if
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CHOLESTECH CORPORATION
such new tests do not achieve a significant level of market acceptance, the
Company's business, financial condition and results of operations would be
materially adversely affected.
RISKS ASSOCIATED WITH CASSETTE MANUFACTURING. The Company internally
manufactures all of the single use test cassettes that are used with the L-D-X
Analyzer. The manufacture of the test cassettes is a highly complex and precise
process. Such manufacturing is sensitive to a wide variety of factors, including
raw material variations and impurities, manufacturing process variances,
manufacturing equipment performance and manufacturing environment contaminants.
The Company has in the past experienced lower than expected manufacturing yields
that have adversely affected gross margins and delayed product shipments. To the
extent that the Company does not maintain acceptable manufacturing yields of
test cassettes or experiences product shipment delays, the Company's business,
financial condition and results of operations would be materially adversely
affected. The Company's cassette manufacturing lines would be costly and time
consuming to repair or replace if their operation were interrupted. As the
Company's production levels have increased, the Company has been required to use
its machinery more hours per day and the down time resulting from equipment
failure has increased. The custom nature of much of the Company's manufacturing
equipment increases the time required to remedy equipment failures and replace
equipment. Furthermore, the Company has a limited number of employees dedicated
to the operation and maintenance of the cassette manufacturing equipment, the
loss of whom could impact the Company's ability to effectively operate and
service such equipment. The interruption of cassette manufacturing operations or
the loss of employees dedicated to the cassette manufacturing facility could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company manufactures all of the cassettes at its
Hayward, California manufacturing facility, and any prolonged inability to
utilize such facility as a result of earthquake, fire or otherwise would have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company believes that it will be required to expand its
manufacturing capacity for new and existing test cassettes. The Company
currently operates two manufacturing lines for dry chemistry cassettes. The
Company is currently planning and building a third manufacturing line that the
Company anticipates will become operational in fiscal 2000. There can be no
assurance that such expansion of cassette manufacturing capacity can be
completed in a timely fashion, if ever, or that the Company would not need to
increase manufacturing capacity sooner. In addition, the custom nature of much
of the Company's manufacturing equipment increases the time required to expand
manufacturing capacity. The Company also will be required to build a new
cassette manufacturing line in order to manufacture the immunoassay test
cassettes under development. To date, the Company has not developed the
processes and production equipment necessary for an immunoassay cassette
manufacturing line. Failure to expand manufacturing capacity for dry chemistry
tests or to successfully develop an immunoassay cassette manufacturing line and
achieve acceptable yields could lead to an inability to satisfy customer orders
and could have a material adverse effect on the Company's business, financial
condition and results of operations.
DEPENDENCE ON SUPPLIERS. Single source vendors currently provide certain
subassemblies, components and raw materials used in the manufacture of the
Company's products. Any supply interruption in a single source subassembly,
component or raw material could have a material
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CHOLESTECH CORPORATION
adverse effect on the Company's ability to manufacture products until a new
source of supply is identified and qualified. There can be no assurance that the
Company will be successful in qualifying additional sources of supply on a
timely basis, or at all, and failure to do so could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, an uncorrected impurity or supplier's variation in a raw material,
either unknown to the Company or incompatible with the Company's manufacturing
process, could have a material adverse effect on the Company's ability to
manufacture products. Because the Company is a small customer of many of its
suppliers and purchases its subassemblies, components and materials on a
purchase order basis, rather than pursuant to long term commitments, there can
be no assurance that the Company's suppliers will devote adequate resources to
supplying the Company's needs. Any interruption or reduction in the future
supply of any subassemblies, components or raw materials currently obtained from
single or limited sources could have a material adverse effect on the Company's
business, financial condition and results of operations.
NEED TO MANAGE EXPANDING OPERATIONS. If the Company is successful in
achieving and maintaining market acceptance for the L-D-X System, the Company
will be required to expand its operations, particularly in the areas of sales
and marketing and manufacturing. As the Company expands its operations in these
areas, such expansion will likely result in new and increased responsibilities
for management personnel and place significant strain upon the Company's
management, operating and financial systems and resources. To accommodate any
such growth and compete effectively, the Company will be required to implement
and improve its information systems, procedures and controls, and to expand,
train, motivate and manage its work force. There can be no assurance that the
Company's personnel, systems, procedures and controls will be adequate to
support the Company's future operations. Any failure to implement and improve
the Company's operational, financial and management systems or to expand, train,
motivate or manage employees as required by future growth, if any, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
LIMITED SALES, MARKETING AND DISTRIBUTION EXPERIENCE; DEPENDENCE ON
THIRD PARTY DISTRIBUTORS. In order for the Company to increase revenues and
sustain profitability, the L-D-X System must achieve a significant degree of
market acceptance among health care providers and third party payors. The
Company has only limited experience in marketing and selling to the therapeutic
monitoring market in the United States and relies on third party distributors in
this market. There can be no assurance that the Company will be able to maintain
its existing distribution relationships. The Company also will be required to
enter into additional distribution arrangements in order to achieve broader
distribution of its products, particularly into the pharmacy market. There can
be no assurance that the Company will be able to enter into and maintain such
arrangements on a timely basis, if at all. The Company is dependent upon such
distributors to assist it in promoting market acceptance of the L-D-X System. It
is uncertain whether distributors will devote the resources necessary to provide
effective sales and marketing support to the Company. In addition, the Company's
distributors may give higher priority to the products of other medical
suppliers, thus reducing their efforts to sell the Company's products. If the
Company is unable to establish appropriate arrangements with distributors, or if
any of the Company's distributors do not promote, market and sell the L-D-X
Analyzer and single use test cassettes, the Company's business, financial
condition and results of operations could be materially adversely affected.
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CHOLESTECH CORPORATION
UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT. In the United States,
health care providers that purchase products such as the L-D-X System generally
rely on third party payors, including private health insurance plans, federal
Medicare, state Medicaid and managed care organizations, to reimburse all or
part of the cost of the procedure in which the product is being used. The
Company's ability to commercialize its products successfully in the United
States will depend in part on the extent to which reimbursement for the costs of
tests performed with the L-D-X System and related treatment will be available
from government health authorities, private health insurers and other third
party payors. Third party payors can affect the pricing or the relative
attractiveness of the Company's products by regulating the maximum amount of
reimbursement provided for testing services. Reimbursement is currently not
available for certain uses of the Company's products in particular
circumstances. As a general rule, third party reimbursement is available if a
physician has been involved in the decision to perform the test involving the
Company's products. For example, if a physician prescribes a drug that requires
therapeutic monitoring, the use of the Company's products in performing such
tests will be reimbursable. In the health promotion market, use of the Company's
products for diagnostic screening in health promotion clinics is generally
subject to reimbursement. However, diagnostic screening preformed in corporate
wellness programs and at fitness centers is likely not subject to reimbursement.
Third party payors are increasingly scrutinizing and challenging the prices
charged for medical products and services. Decreases in reimbursement amounts
for tests performed using the Company's products may decrease the amounts that
physicians and other practitioners are able to charge patients, which in turn
may adversely affect the Company's ability to sell its products on a profitable
basis. In addition, certain health care providers are moving toward a managed
care system in which such providers contract to provide comprehensive health
care for a fixed cost per patient. Managed care providers are attempting to
control the cost of health care by authorizing fewer elective procedures, such
as the screening of blood for chronic diseases. The Company is unable to predict
what changes will be made in the reimbursement methods utilized by third party
payors. Inability of health care providers to obtain reimbursement from third
party payors or changes in government and third party payors' policies toward
reimbursement of tests employing the Company's products could have a material
adverse effect on the Company's business, financial condition and results of
operations. Additionally, the Company believes that the overall escalating cost
of medical products and services has led to and will continue to lead to
increased pressures on the health care industry, both domestic and
international, to reduce the cost of products and services, including products
offered by the Company. Market acceptance of the Company's products in
international markets is also dependent, in part, upon the availability of
reimbursement within prevailing health care payment systems. Reimbursement and
health care payment systems in international markets vary significantly by
country and include both government sponsored health care and private insurance.
There can be no assurance that third party reimbursement and coverage will be
available or adequate in either United States or international markets, that
current reimbursement amounts will not be decreased in the future or that future
legislation, regulation, or reimbursement policies of third party payors will
not otherwise adversely affect demand for the Company's products or the
Company's ability to sell its products on a profitable basis, any of which could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Political, economic and regulatory influences are pushing the health
care industry in the United States to fundamental change. The Company
anticipates that Congress, state legislatures
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CHOLESTECH CORPORATION
and the private sector will continue to review and assess alternative health
care delivery and payment systems. Potential approaches that have been
considered include mandated basic health care benefits, controls on health care
spending through limitations on the growth of private health insurance premiums
and Medicare and Medicaid spending, the creation of large insurance purchasing
groups, price controls and other fundamental changes to the health care delivery
system. Legislative debate is expected to continue in the future, and market
forces are expected to demand reduced costs. The Company cannot predict what
impact the adoption of any federal or state health care reform measures, future
private sector reform or market forces may have on its business.
GOVERNMENT REGULATION. The manufacture and sale of diagnostic products,
including the L-D-X System, are subject to extensive regulation by numerous
governmental authorities, principally the FDA and corresponding state and
foreign regulatory agencies. The Company will not be able to commence marketing
or commercial sales in the United States of any of the new tests it is
developing until it receives clearance or approval from the FDA. The process of
obtaining FDA and other required regulatory clearances and approvals is lengthy,
expensive and uncertain. As a result, there can be no assurance that any of the
Company's new tests under development, even if successfully developed, will ever
obtain such clearance or approval. Additionally, certain material changes to
medical products already cleared or approved by the FDA are also subject to
further FDA review and clearance or approval. The loss of previously obtained
clearances, or failure to comply with existing or future regulatory
requirements, could have a material adverse effect on the Company's business,
financial condition and results of operations. The L-D-X Analyzer and all
existing test cassettes required clearance pursuant to a 510(k) clearance.
Medical devices are subject to continual review, and later discovery of
previously unknown problems with a cleared product may result in restrictions on
the product's marketing or withdrawal of the product from the market. In
general, the Company intends to develop and market tests that will require
510(k) clearance. It generally takes from four to twelve months from the date of
submission to obtain 510(k) clearance, but it may take longer. The Company does
not believe that its products under development will require submission of a
Pre-Market Approval ("PMA") application. However, if a future product were to
require submission of a PMA application, regulatory approval of such product
would involve a much longer and more costly process than a 510(k) clearance and
would involve the submission of extensive supporting data and clinical
information. A PMA application may be submitted to the United States Food and
Drug Administration ("FDA") only after clinical trials and the required patient
follow-up for a particular test are successfully completed. Upon filing of a PMA
application, the FDA commences a review process that generally takes one to
three years from the date on which the PMA application is accepted for filing,
but may take significantly longer. There can be no assurance that the Company's
products under development will require only 510(k) clearance rather than the
more lengthy and costly PMA approval. A requirement that the Company file a PMA
application for any new test would significantly delay the Company's ability to
market such test and significantly increase the costs of development.
The European Union ("EU") has promulgated rules that require that
devices such as those developed, manufactured and sold by the Company receive
the right to affix the CE mark, a symbol of adherence to applicable EU
directives. The Company has completed all the testing necessary to comply with
applicable regulations to currently be eligible for self certification and
currently has the right, as self-certified under the product testing
requirements, to affix the CE mark to its products. The Company's products will
be covered by the In Vitro Diagnostics
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CHOLESTECH CORPORATION
Directives that have not yet been published or adopted. While the Company
intends to satisfy the requisite policies and procedures that will permit it to
continue to affix the CE mark to its products in the future, there can be no
assurance that the Company will be successful in meeting the EU certification
requirements, and failure to receive the right to affix the CE mark may prohibit
the Company from selling its products in EU member countries and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The use of the Company's products and those of its competitors is also
affected by federal and state regulations, which provide for regulation of
laboratory testing, as well as by the laws and regulations of foreign countries.
The scope of these regulations includes quality control, proficiency testing,
personnel standards and inspections. For example, in the United States, CLIA
categorizes tests as "waived," or as being "moderately complex" or "highly
complex" on the basis of specific criteria. In January 1996, the L-D-X Analyzer
and the Company's total cholesterol, HDL (high density lipoproteins),
triglycerides and glucose tests in any combination were classified as waived
under CLIA. In order to successfully commercialize the tests that are currently
under development, the Company believes that it will be critical to obtain
waived classification for such tests under CLIA. There can be no assurance that
any new tests developed by the Company, including the BUN/Creatinine test
cassette, will qualify for CLIA waived classification. Any failure of the new
tests to obtain waived status under CLIA will adversely impact the Company's
ability to commercialize such tests, which could have a material adverse effect
on the Company's business, financial condition and results of operations. In
addition, there can be no assurance that any future amendment of CLIA or the
promulgation of additional regulations impacting laboratory testing will not
have an adverse effect on the Company's ability to market the L-D-X System. For
example, if CLIA regulations were modified in a manner that reduced regulatory
requirements and burdens faced by competitive products, certain competitive
advantages of the L-D-X System's waived status could be reduced or eliminated.
The Company's manufacturing processes, as well as, in certain instances,
those of its contract manufacturers, are subject to stringent federal, state and
local regulations governing the use, generation, manufacture, storage, handling
and disposal of certain materials and wastes. The Company and its contract
manufacturers must economically manufacture products in compliance with federal,
state and foreign regulations regarding the manufacture of health care products
and diagnostic devices, including QSR, and other foreign regulations and state
and local health, safety and environmental regulations, which include testing,
control and documentation requirements. Failure to comply with QSR,
ISO9001/EN46001 requirements and other applicable regulatory requirements by the
Company and in certain ISO9001/EN46001 certification regulations circumstances,
its contract manufacturers, including marketing products for unapproved uses,
could result in, among other things, warning letters, fines, injunctions, civil
penalties, recall or seizure of products, total or partial suspension of
production, refusal of the government to grant pre-market clearance or
pre-market approval for devices, withdrawal of approvals and criminal
prosecution. Changes in existing regulations or adoption of new governmental
regulations or policies could prevent or delay regulatory approval of the
Company's products. There can be no assurance that the Company will not be
required to incur significant costs in the future in complying with
manufacturing and environmental regulations.
DEPENDENCE ON PROPRIETARY TECHNOLOGY; UNCERTAINTY OF PATENT AND
PROPRIETARY TECHNOLOGY PROTECTION; DEPENDENCE ON LICENSING OF TECHNOLOGY FROM
THIRD PARTIES. The
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CHOLESTECH CORPORATION
Company's ability to compete effectively will depend in part on its ability to
develop and maintain the proprietary aspects of its technology and operate
without infringing the proprietary rights of others. The Company has nine United
States patents and has filed patent applications relating to its technology
internationally under the Patent Cooperation Treaty and individual foreign
patent applications. There can be no assurance that any of the Company's pending
patent applications will result in the issuance of any patents, or that, if
issued, any such patents will offer protection against competitors with similar
technology. There can be no assurance that any patents issued to the Company
will not be challenged, invalidated or circumvented in the future or that the
rights created thereunder will provide a competitive advantage. In addition,
there can be no assurance that competitors, many of which have substantially
greater resources than the Company and have made substantial investments in
competing technologies, will not seek to apply for and obtain patents covering
technologies that are more effective than the Company's technologies, that would
render the Company's technologies or products obsolete or uncompetitive or that
would prevent, limit or interfere with the Company's ability to make, use or
sell its products either in the United States or in international markets.
The medical products industry has been characterized by extensive
litigation regarding patents and other intellectual property rights. There can
be no assurance that the Company will not in the future become subject to patent
infringement claims and litigation or interference proceedings conducted in the
United States Patent and Trademark Office ("USPTO") to determine the priority of
inventions. The defense and prosecution of intellectual property suits, USPTO
interference proceedings and related legal and administrative proceedings are
both costly and time consuming. Litigation may be necessary to enforce any
patents issued to the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforceability, scope and validity of the
proprietary rights of others. Any litigation or interference proceedings will
result in substantial expense to the Company and significant diversion of effort
by the Company's technical and management personnel. An adverse determination in
litigation or interference proceedings to which the Company may become a party
could subject the Company to significant liabilities to third parties or require
the Company to seek licenses from third parties which may not be available on
commercially reasonable terms or at all.
The Company's current products incorporate technologies which are the
subject of patents issued to, and patent applications filed by, others. The
Company has obtained licenses for certain of these technologies and may be
required to obtain licenses for others. There can be no assurance that the
Company will be able to obtain licenses for technology patented by others on
commercially reasonable terms, or at all, that it will be able to develop
alternative approaches if unable to obtain licenses or that the Company's
current and future licenses will be adequate for the operation of the Company's
business. The failure to obtain such licenses or identify and implement
alternative approaches could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company also relies upon trade secrets, technical know-how and
continuing invention to develop and maintain its competitive position, and no
assurance can be given that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
the Company's trade secrets or disclose such technology, or that the Company can
meaningfully protect its right to its trade secrets, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
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CHOLESTECH CORPORATION
HIGHLY COMPETITIVE INDUSTRY; RAPID TECHNOLOGICAL CHANGE. The markets for
diagnostic screening and therapeutic monitoring in which the Company operates
are intensely competitive. The Company's competition consists mainly of clinical
and hospital laboratories, as well as manufacturers of bench top analyzers. In
order to achieve market acceptance for the L-D-X System, the Company will be
required to demonstrate that the L-D-X System is an attractive alternative to
bench top analyzers as well as to clinical and hospital laboratories. This will
require physicians to change their established means of having such tests
performed. There can be no assurance that the L-D-X System will be able to
compete with these other testing services and analyzers. In addition, companies
having a significant presence in the market for therapeutic monitoring, such as
Abbott Laboratories, Clinical Diagnostic Systems, a division of Johnson &
Johnson and formerly a division of Eastman Kodak Company, and Boehringer
Mannheim, have developed or are developing analyzers designed for near-patient
testing. These competitors have substantially greater financial, technical,
research and other resources and larger, more established marketing, sales,
distribution and service organizations than the Company. In addition, such
competitors offer broader product lines than the Company, have greater name
recognition than the Company, and offer discounts as a competitive tactic. In
addition, several smaller companies are currently making or developing products
that compete or will compete with those of the Company.
The Company expects that its competitors will compete intensely to
maintain and increase market share and seek to develop similar multi-analyte
tests that qualify for CLIA waiver. There can be no assurance that these
competitors will not succeed in obtaining CLIA waived status for their products
or in developing or marketing technologies or products that are more effective
and commercially attractive than the Company's current or future products, or
that would render the Company's technologies and products obsolete or
noncompetitive. The Company's current and future products must compete
effectively with the existing and future products of the Company's competitors
primarily on the basis of ease of use, breadth of tests available, market
presence, cost effectiveness, precision, accuracy, immediacy of results and the
ability to perform tests near the patient, to test multiple analytes from a
single sample and to conduct tests without a skilled technician or pre-treating
blood. There can be no assurance that the Company will have the financial
resources, technical expertise or marketing, distribution or support
capabilities to compete successfully in the future or, if the Company does have
such resources and capabilities, that it will employ them successfully.
DEPENDENCE ON ATTRACTION AND RETENTION OF KEY EMPLOYEES. The Company's
success depends in significant part upon the continued service of certain key
scientific, technical, regulatory and managerial personnel, and its continuing
ability to attract and retain additional highly qualified personnel in those
areas. Competition for such personnel is intense, and there can be no assurance
that the Company will be able to retain such personnel or that it can attract or
retain other highly qualified personnel in the future, including key sales and
marketing personnel. The loss of key personnel or the inability to hire or
retain qualified personnel could have a material adverse effect upon the
Company's business, financial condition and results of operations.
RISK OF PRODUCT LIABILITY; PRODUCT LIABILITY INSURANCE MAY BE
INSUFFICIENT OR UNAVAILABLE. Sale of the Company's products entails risk of
product liability claims. The medical testing industry has historically been
litigious, and the Company faces financial exposure to
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CHOLESTECH CORPORATION
product liability claims in the event that use of its products results in
personal injury or improper diagnosis. The Company also faces the possibility
that defects in the design or manufacture of its products might necessitate a
product recall. There can be no assurance that the Company will not experience
losses due to product liability claims or recalls in the future. The Company
currently maintains product liability insurance, but there can be no assurance
that the coverage limits of the Company's insurance policies will be adequate.
Such insurance is expensive and difficult to obtain, and no assurance can be
given that product liability insurance can be maintained in the future on
acceptable terms, in sufficient amounts to protect the Company against losses
due to product liability, or at all. Inability to maintain insurance at an
acceptable cost or to otherwise protect against potential product liability
could prevent or inhibit the continued commercialization of the Company's
products. In addition, a product liability claim in excess of relevant insurance
coverage or a product recall could have a material adverse effect on the
Company's business, financial condition and results of operations.
YEAR 2000 COMPLIANCE RISKS. Cholestech has an ongoing program of
assessing the extent to which its internal systems and products evaluate date
information ("Year 2000 dependencies"), and, if so, whether they can properly
process and evaluate dates on or after the Year 2000 (whether they are "Year
2000 compliant"). The Company is taking remedial action where its systems and
products are not year 2000 compliant. The Company is also evaluating contingency
plans for continuing operations if Year 2000 problems arise despite its steps to
avoid them. The Company expects these activities to continue throughout fiscal
1999.
The Company believes that it has identified the Year 2000 dependencies
in its internal systems. It has examined all critical systems including
manufacturing, sales, development, communications and financial systems. It has
also examined many of its non-computer electronic devices that contain
microprocessors (for example, telephones, manufacturing machinery and security
systems). As these dependencies have been identified, Cholestech has been taking
the remedial measures it believes are necessary for its internal systems to be
Year 2000 compliant. These measures have included establishing a Year 2000 Task
Force, increase awareness/communication of the Year 2000 issues, inventory the
Company's systems and equipment, assessment of the inventory and implementation
and review of remediated systems and equipment. The Company is not currently
aware of any Year 2000 dependencies in its internal systems that could have a
material impact on its business should the Company fail to make such systems
Year 2000 compliant. The Company is also not aware of any material operational
issues or costs associated with preparing its internal systems for the Year
2000. However, no assurances can be given that Cholestech will not experience
unanticipated material costs caused by undetected errors or defects in its
internal systems. Delays in implementation of new information systems and a
failure to identify and remediate all of its Year 2000 dependencies could result
in material adverse consequences to the Company's business, prospects and
results of operations.
Cholestech has also taken measures to ensure that its products are Year
2000 compliant. At this time, the Company believes that its products are Year
2000 compliant. However, the L-D-X System contains software that may be used to
integrate test results with an end user's medial records system. It is likely
that, commencing in the Year 2000, the functionality of certain medical records
systems will be adversely affected when one or more component products of such
systems are unable to process four digit characters representing years and,
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CHOLESTECH CORPORATION
therefore, the medical records system would not be Year 2000 compliant. The
inability of the L-D-X System to properly manage and manipulate financial
condition and results of operations, including increased warranty costs,
customer satisfaction issues and potential lawsuits. Although the Company
believes its products are Year 2000 complaint, the Company anticipates that
substantial litigation may be brought against vendors of all component products
provided by the Company. The Company believes that any such claims, with or
without merit, could have a material adverse effect on the Company's business,
financial condition and results of operations.
Cholestech has incurred and will incur various costs to conduct testing
and modification of its products and to provide customer support services
regarding Year 2000 issues. It also anticipates that these costs will continue
through fiscal year 1999 and thereafter.
Additionally, parties with whom the Company does business may not be in
Year 2000 compliance, which could have a material adverse effect on the
Company's business, financial condition and results of operations. Cholestech is
working with the key suppliers of products and services used in determining
whether their systems, products and services are Year 2000 compliant. The
Company is also attempting to monitor their progress toward Year 2000
compliance. This investigational and monitoring process has included
questionnaires that the Company has sent to the organizations with which the
Company conducts a material amount of business. The Company expects these
efforts to continue for the foreseeable future. Even if the Company identifies
Year 2000 dependency problems in its key vendors or suppliers their can be no
assurance that such dependencies will be remediated or that the company would be
able to establish alternative business relationships in a timely fashion, on
acceptable terms or at all. The failure to correct these dependencies or find
alternative relationships could have a material adverse effect on the Company's
business, financial condition and results of operations.
To date, the Company has incurred costs related to its Year 2000
Readiness Program of approximately $150,000. In fiscal year 1999, these costs
are estimated to be approximately $200,000. This estimate is based on a current
assessment and is subject to change as the Company's Year 2000 readiness program
progresses. The predominant portion of the costs incurred to date, as well as
those expected to be incurred, relate to assessment phase of the Company's Year
2000 readiness program. This estimate does not include potential costs related
to customer or other claims, or costs related to internal software and hardware
replaced in the normal course of business.
Cholestech currently expects that the Year 2000 issue will not pose
significant internal, operational problems. However, a delay in implementing new
information systems, or a failure to fully identify all Year 2000 dependencies
in the Company's internal systems or in the systems of its suppliers and
distribution partners could have material adverse consequences, including delays
in the delivery or sale of products. Therefore, the Company is developing
contingency plans for continuing operations should these types of problems
arise. The Company believes that its contingency planning will be completed by
March 1999.
Cholestech believes that the purchasing patterns of its customers and
potential customers may also be affected by the Year 2000 issues as they expend
significant resources to bring their current software systems into Year 2000
compliance. These expenditures could result in reduced funds available to
purchase products such as those offered by the Company. This could have a
material adverse effect on the Company's business, operating results or
financial condition.
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CHOLESTECH CORPORATION
POSSIBLE FUTURE CAPITAL REQUIREMENTS; UNCERTAINTY OF ADDITIONAL FUNDING.
The Company intends to expend substantial funds for capital expenditures related
to expansion of its manufacturing capacity, research and development, including
expansion of its product line and enhancement of its current products, expansion
of sales and marketing activities and other working capital and general
corporate purposes. Although the Company believes that the Company's cash, cash
equivalents, marketable securities, cash flow anticipated to be generated by
future operations and available bank borrowings under an existing line of credit
will be sufficient to meet its capital requirements for the foreseeable future,
there can be no assurance that the Company will not require additional
financing. For example, the Company may be required to expend greater than
anticipated funds if unforeseen difficulties arise in expanding manufacturing
capacity for existing cassettes or in the course of completing required
additional development, obtaining necessary regulatory approvals, obtaining
waived status under CLIA or introducing or scaling up manufacturing for new
tests. The Company's future liquidity and capital requirements will depend upon
numerous additional factors, including: the costs and timing of expansion of
manufacturing capacity; the number and type of new tests the Company seeks to
develop; the success of these development efforts; the costs and timing of
expansion of sales and marketing activities; the extent to which the Company's
existing and new products gain market acceptance; competing technological and
market developments; the progress of commercialization efforts of the Company's
distributors; the costs involved in preparing, filing, prosecuting, maintaining
and enforcing patent claims and other intellectual property rights; developments
related to regulatory and third party reimbursement matters and CLIA; and other
factors. In the event that additional financing is needed, the Company may seek
to raise additional funds through public or private financing, collaborative
relationships or other arrangements. Any additional equity financing may be
dilutive to shareholders, and debt financing, if available, may involve
restrictive covenants. Collaborative arrangements, if necessary to raise
additional funds, may require the Company to relinquish its rights to certain of
its technologies, products or marketing territories. The failure of the Company
to raise capital on acceptable terms when needed could have a material adverse
effect on the Company's business, financial condition and results of operations.
There can be no assurance that such financing, if required, will be available on
satisfactory terms, or at all. See "o Liquidity and Capital Resources."
ANTI-TAKEOVER PROVISIONS. The Company's Board of Directors (the "Board")
has the authority to issue up to 5,000,000 shares of preferred stock and to
determine the rights, preferences, privileges and restrictions of such shares
without any further vote or action by the Company's shareholders. To date, the
Board has designated 25,000 shares as Series A Participating Preferred Stock
("Series A Preferred") in connection with the Company's Preferred Share Purchase
Rights Plan. The issuance of preferred stock under certain circumstances could
have the effect of delaying or preventing a change in control of the Company or
otherwise adversely affecting the rights of the holders of Common Stock.
Pursuant to the Company's Preferred Shares Rights Agreement (the "Rights
Agreement") each share of Common Stock carries a right (a "Right") which
entitles the registered holder to purchase from the Company one-thousandth of a
share of Series A Preferred at an exercise price of $44.00, subject to
adjustment. The Rights are designed to protect and maximize the value of the
outstanding equity interests in the Company in the event of an unsolicited
attempt by an
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CHOLESTECH CORPORATION
acquiror to take over the Company, in a manner or on terms not approved by the
Board. The Rights have been declared by the Board in order to deter coercive
tactics, including a gradual accumulation of shares in the open market, of a 15%
or greater position to be followed by a merger or a partial or two-tier tender
offer that does not treat all shareholders equally. The Rights should not
interfere with any merger or other business combination approved by the Board.
However, the Rights may have the effect of rendering more difficult or
discouraging an acquisition of the Company deemed undesirable by the Board. The
Rights may cause substantial dilution to a person or group attempting to acquire
the Company on terms or in a manner not approved by the Board, except pursuant
to an offer conditioned upon the negation, purchase or redemption of the Rights.
POTENTIAL VOLATILITY OF STOCK PRICE. The market price of the Common
Stock, like that of the common stock of many other medical products and
technology companies, has in the past been, and is likely in the future to
continue to be, highly volatile. Factors such as fluctuations in the Company's
operating results, announcements of technological innovations or new commercial
products by the Company or its competitors, government regulation, changes in
the current structure of the health care financing and payment systems and
developments in or disputes regarding patent or other proprietary rights may
have a significant effect on the market price of the Common Stock. Moreover, the
stock market has from time to time experienced extreme price and volume
fluctuations, which have particularly affected the market prices for medical
products and high technology companies and which have often been unrelated to
the operating performance of such companies. These broad market fluctuations, as
well as general economic, political and market conditions, may adversely affect
the market price of the Common Stock. In the past, following periods of
volatility in the market price of a company's stock, securities class action
suits have been filed against the issuing company. There can be no assurance
that such litigation will not occur in the future with respect to the Company.
Such litigation could result in substantial costs and a diversion of
management's attention and resources, which could have a material adverse effect
on the Company's business, financial condition and results of operations. Any
adverse determination in such litigation could also subject the Company to
significant liabilities.
ABSENCE OF DIVIDENDS. The Company has never declared or paid any cash dividends
since its inception. The Company currently expects to retain future earnings, if
any, to finance the growth and development of its business and, therefore, does
not anticipate declaring or paying any cash dividends in the foreseeable future.
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CHOLESTECH CORPORATION
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On August 20, 1998, the Company held its 1998 Annual Meeting of
Shareholders. The following is a brief description of each matter voted upon at
the meeting and a statement of the number of votes cast for, against or withheld
and the number of abstentions and the number of broker non-votes with respect to
each matter.
1. The shareholders elected the following Directors:
Nominee In Favor Withheld
---------------------- ---------- --------
Dr. Harvey S. Sadow 10,178,542 323,111
Warren E. Pinckert, II 10,185,499 316,154
Joseph Buchman, M.D. 10,385,964 115,689
John L. Castello 10,378,231 123,422
John H. Landon 10,371,465 130,188
H.R. Shepherd 10,377,744 123,909
Larry Y. Wilson 10,381,371 120,282
2. The shareholders approved the amendment of the Company's 1997
Stock Incentive Program to increase the annual non-discretionary
grant under such plan to the Chairman of Board of Directors of
the Company to 20,000 shares of common stock per annum.
For Against Abstain Broker Non-Vote
--------- ------- ------- ---------------
8,827,984 1,287,613 171,409 214,617
3 The shareholders ratified the appointment of
PriceWaterhouseCoopers LLP as independent public accountants of
the Company for the fiscal year ending March 26, 1999.
For Against Abstain Broker Non-Vote
---------- ------- ------- ---------------
10,448,844 26,860 25,949 0
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CHOLESTECH CORPORATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
(b)
10.21.1 Distribution Agreement between registrant and McKesson
Drug Company dated August 18, 1998.
10.21.2 Distribution Agreement between registrant Bergen
Brunswig Drug dated July 20, 1998.
10.3.2 Standard Industrial Sublease Agreement between
Registrant and Schlumberger Resource Management
Services, Inc. dated August 5, 1998.
10.3.3 Consent to Sublease Agreement between Registrant and
Spieker Properties, L.P. dated August 5, 1998.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K. No reports on Form 8-K were filed during the
quarter ended September 26, 1998.
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CHOLESTECH CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHOLESTECH CORPORATION
Date November 6, 1998 /s/ Warren E. Pinckert II
-------------------- -------------------------------------
Warren E. Pinckert II
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Andrea J. Tiller
-------------------------------------
Andrea J. Tiller
Vice President of Finance and Chief
Financial Officer
(Principal Financial and Accounting
Officer)
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EXHIBIT INDEX
Exhibit No. Description
----------- -------------
10.21.1 Distribution Agreement between registrant and McKesson
Drug Company dated August 18, 1998.
10.21.2 Distribution Agreement between registrant Bergen
Brunswig Drug dated July 20, 1998.
10.3.2 Standard Industrial Sublease Agreement between
Registrant and Schlumberger Resource Management
Services, Inc. dated August 5, 1998.
10.3.3 Consent to Sublease Agreement between Registrant and
Spieker Properties, L.P. dated August 5, 1998.
27.1 Financial Data Schedule.