1
- --------------------------------------------------------------------------------
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 29, 2000
[ ] 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 29, 2000, 12,074,755 shares of common stock of the Registrant were
outstanding.
2
PART I
FINANCIAL INFORMATION
Page
-----
ITEM 1. FINANCIAL STATEMENTS.
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Income 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS. 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 35
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 36
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS. 37
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 38
SIGNATURES 39
2
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
September 29, 2000 March 31, 2000(1)
------------------ ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 4,961 $ 6,959
Restricted cash 1,000 1,000
Marketable securities 3,974 2,850
Accounts receivable, net 3,862 1,839
Inventories 4,125 3,714
Prepaid expenses and other current assets 1,226 902
-------- --------
Total current assets 19,148 17,264
Property and equipment, net 9,751 8,309
Long-term investments 1,996 3,932
Goodwill 3,270 2,661
Other assets, net 50 52
-------- --------
Total assets $ 34,215 $ 32,218
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 4,383 $ 3,788
Accrued payroll and benefits 1,494 1,563
Product warranty 91 91
Other liabilities -- 300
-------- --------
Total current liabilities 5,968 5,742
-------- --------
Contingencies (Note 6)
Shareholders' equity:
Preferred stock -- --
Common stock 72,708 71,959
Accumulated other comprehensive loss (15) (59)
Accumulated deficit (44,446) (45,424)
-------- --------
Total shareholders' equity 28,247 26,476
-------- --------
Total liabilities and shareholders' equity $ 34,215 $ 32,218
======== ========
(1) The information in this column was derived from the Company's audited
consolidated financial statements for the fiscal year ended March 31, 2000.
See Notes to Condensed Consolidated Financial Statements
3
4
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Thirteen weeks ended Twenty-six weeks ended
---------------------------- ----------------------------
Sept. 29, Sept. 24, Sept. 29, Sept. 24,
2000 1999 2000 1999
--------- -------- --------- ---------
Revenues:
Domestic $ 7,402 $ 5,371 14,887 $ 10,432
International 1,086 957 2,489 1,671
-------- -------- -------- --------
8,488 6,328 17,376 12,103
Cost of revenues 3,221 2,593 6,638 5,193
-------- -------- -------- --------
Gross profit 5,267 3,735 10,738 6,910
-------- -------- -------- --------
Operating expenses:
Sales and marketing 2,761 1,666 5,011 3,204
Research and development 544 679 1,440 1,273
Web site and related costs 730 -- 730 --
General and administrative 1,185 645 2,558 1,238
Goodwill amortization and other 158 173 308 219
-------- -------- -------- --------
Total operating expenses 5,378 3,163 10,047 5,934
-------- -------- -------- --------
Income (loss) from operations (111) 572 691 976
Interest and other income, net 139 185 327 333
-------- -------- -------- --------
Income before taxes 28 757 1,018 1,309
Provision benefits for income taxes (1) 27 40 43
-------- -------- -------- --------
Net income $ 29 $ 730 $ 978 $ 1,266
======== ======== ======== ========
Net income per share:
Basic $ 0.00 $ 0.06 $ 0.08 $ 0.11
======== ======== ======== ========
Diluted $ 0.00 $ 0.06 $ 0.08 $ 0.11
======== ======== ======== ========
Shares used to compute net income per share:
Basic 12,031 11,628 12,004 11,573
======== ======== ======== ========
Diluted 12,524 11,969 12,494 11,899
======== ======== ======== ========
See Notes to Condensed Consolidated Financial Statements
4
5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Twenty-six weeks ended
Sept. 29, 2000 Sept. 24, 1999
-------------- --------------
Cash flows from operating activities:
Net income $ 978 $ 1,266
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,142 717
Allowance for doubtful accounts 26 10
Changes in assets and liabilities:
Accounts receivable (2,044) (460)
Inventories (411) 1,048
Prepaid expenses and other assets (321) (265)
Other assets -- 3
Accounts payable and accrued expenses (12) 153
Accrued payroll and benefits (69) 88
-------- --------
Net cash provided by (used in) operating activities (711) 2,560
-------- --------
Cash flows from investing activities:
Proceeds from sale of marketable securities 1,735 9,423
Purchases of marketable securities (879) (11,417)
Purchases of property and equipment (2,592) (1,098)
-------- --------
Net cash used in investing activities (1,736) (3,092)
-------- --------
Cash flows from financing activities:
Issuance of common stock 449 1,194
-------- --------
Net cash provided by financing activities 449 1,194
-------- --------
Net increase (decrease) in cash and cash equivalents (1,998) 662
Cash and cash equivalents at beginning of period 6,959 5,529
-------- --------
Cash and cash equivalents at end of period $ 4,961 $ 6,191
======== ========
Non-cash financing activities:
Issuance of common stock in exchange for cancellation of
liability $ 300
Additional goodwill accrual relating to purchase of
Health Net assets 607
See Notes to Condensed Consolidated Financial Statements
5
6
NOTES TO CONDENSED CONSOLIDATED 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 June 28, 2000. 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 consolidated financial statements contained
in the Annual Report on Form 10-K for the fiscal year ended March 31,
2000. The condensed consolidated balance sheet as of March 31, 2000, has
been derived from, but does not include all the disclosures contained
in, the audited consolidated financial statements for the fiscal year
ended March 31, 2000. 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 30, 2001.
2. BALANCE SHEET DATA
The components of inventories are as follows (in thousands):
Sept. 29, 2000 March 31, 2000
-------------- --------------
Raw materials $1,298 $1,258
Work-in-process 1,542 1,412
Finished goods 1,285 1,044
------ ------
$4,125 $3,714
====== ======
3. ACCOUNTING POLICIES
The Company identifies and records impairment losses on long-lived
assets used in operations when events and circumstances indicate that
the assets' value is less than the carrying amounts of those assets.
Recoverability is measured by comparison of the assets carrying amount
to future net undiscounted cash flows the assets are expected to
generate. If such assets are considered to be impaired, the impairment
to be recognized is measured by the amount by which the carrying amount
of the assets exceeds the projected discounted future net cash flows
arising from the asset. None of these events have occurred with respect
to the Company's long-lived assets, which consist primarily of computers
and equipment, furniture and fixtures and leasehold improvements.
4. EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing net income
(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.
6
7
4. EARNINGS PER SHARE (continued)
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
Sept. 29, 2000 Sept. 29, 2000
-------------- --------------
Net Net
Income Shares Per Share Income Shares Per Share
Basic EPS $29 12,031 $0.00 $978 12,004 $0.08
Effect of dilutive
securities -- 493 -- -- 490 --
Diluted EPS $29 12,524 0.00 $978 12,494 $0.08
Thirteen Weeks Ended Twenty-six Weeks Ended
Sept. 24, 1999 Sept. 24, 1999
-------------- --------------
Net Net
Income Shares Per share Income Shares Per share
Basic EPS $730 11,628 $0.06 $1,266 11,573 $0.11
Effect of dilutive
securities -- 341 -- -- 326 --
Diluted EPS $730 11,969 $0.06 $1,266 11,899 $0.11
At September 29, 2000, options to purchase 865,489 shares of Common
Stock were considered anti-dilutive because the respective exercise
prices were greater than the average fair market value of the Common
Stock during fiscal 2001. At September 24, 1999, options to purchase
1,535,747 shares of Common Stock were considered anti-dilutive because
the respective exercise prices were greater than the average fair
market value of the Common stock during fiscal 2000.
5. RECENT ACCOUNTING PRONOUNCEMENTS
In March 2000, the Emerging Issues Task Force reached a consensus on
Issue 00-2, "Accounting for the Costs of Developing a Web Site" ("EITF
00-2"). In general, EITF 00-2 states that the costs of developing a web
site should be accounted for under provisions of Statement of Position
(SOP) 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." The Company does not believe that it will
have a material impact on its financial position, results of operations
or cash flows. EITF 00-2 is effective for costs incurred after June 30,
2000.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in
Financial Statements". SAB 101 provides guidance for revenue recognition
under certain circumstances. The accounting and disclosures prescribed
by SAB 101, as amended, will be effective for the fiscal year ended
December 30, 2000. The Company is currently evaluating the impact of SAB
101 on its financial statements and related disclosures and does not
expect any material impact from its application.
7
8
During June 1998, the Financial Accounting Standards Board issued SFAS
No. 133 "Accounting for Derivative Instruments and Hedging Activities"
which establishes accounting and reporting standards for derivative
instruments and hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The
Company, to date, has not engaged in derivative and hedging activities,
and accordingly, does not believe that the adoption of SFAS No. 133 will
have a material impact on the financial reporting and related
disclosures of the Company. The Company will adopt SFAS No. 133 as
required by SFAS 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of the FASB statement No.
133," beginning with the first quarter of fiscal 2002.
In March 2000, the FASB issued FIN 44, "Accounting for Certain
Transactions Involving Stock Compensation - An Interpretation of APB No.
25" which is effective July 1, 2000. The adoption of FIN 44 did not have
a material impact on the consolidated financial statements.
6. LITIGATION AND OTHER EVENTS
On February 5, 1999, a complaint entitled Ree v. Pinckert, et al.,
No.C99-0562 (MMC) was filed in the United States District Court for the
Northern District of California. The Action is a putative class action
and the complaint alleges that Cholestech and an officer, Mr. Pinckert,
violated the federal securities laws by misleading investors during the
time period of July 30, 1997 - June 26, 1998, concerning the Company's
business and its future prospects. On June 24, 1999, plaintiffs filed an
amended complaint, which expanded the putative class period to June 28,
1996, through June 26, 1998. The amended complaint's substantive
allegations and purported causes of action remain based on allegations
that the Company misled shareholders concerning the Company's business
and its future prospects. The complaint does not specify alleged
damages. On September 20, 1999, defendants filed a motion to dismiss
plaintiff's amended complaint. On March 28, 2000, the court granted
defendant's motion to dismiss pursuant to rule 12(B)(6) with leave for
plaintiffs to amend. The plaintiffs have filed an amended complaint. The
Company intends to defend the case vigorously. The Company does not
believe that the defendants in the class action engaged in any
wrongdoing, and that the outcome of this matter will not result in a
material adverse effect, however, there can be no assurance that the
lawsuit will be resolved in the Company's favor. The action is in its
preliminary stages and a trial date has not been set.
In September, 2000, the Company was served with a complaint, No. Ei/Ti
ROCH 04002, which was filed in Vienna, Austria by Roche Diagnostics on
January 13, 2000, seeking a cease and desist order barring the Company,
and a distributor from distributing HDL assay single-use test cassettes
in Austria. The complaint alleges that the Company violated a Roche
European patent for HDL. The Company is in the process of responding to
the complaint. At this point in time no schedule has been set regarding
8
9
court activity. There can be no assurance as to whether the plaintiffs
will take any additional action, or whether any additional action will
be resolved in the Company's favor.
On December 23, 1999, a complaint requesting an injunction, No. ES
580-199, was filed in Zug, Switzerland by Roche Diagnostics seeking a
cease and desist order barring the Company, and two distributors, from
distributing HDL assay single-use test cassettes in Switzerland. The
complaint alleges that the Company violated a Roche European patent for
HDL. The Company has filed its response to the complaint. On July 11,
2000 the court denied the plaintiff's request for an injunction. The
plaintiff has appealed the court ruling. At this point in time no
schedule has been set regarding additional court activity. There can be
no assurance as to whether the plaintiffs will take any additional
action, or whether any additional action will be resolved in the
Company's favor.
In January, 2000, a complaint, No. 4 O 4/00, was filed in the District
Court, Dusseldorf, Germany against the Company and two of its
distributors, seeking a cease and desist order barring the distributor
from shipping HDL single-use test cassettes into Germany. The complaint
alleges the Company and its distributors violated a Roche German
priority patent for HDL by selling Cholestech's single-use test cassette
containing a HDL assay. The Company believes the suit is without merit
and intends to defend the case vigorously. Therefore, the Company does
not believe that the outcome of this matter will result in a material
adverse effect, however, there can be no assurance that the lawsuit will
be resolved in the Company's favor.
The Company is subject to various legal claims and assessments in the
ordinary course of business, none of which are expected by management to
result in a material adverse effect on the consolidated financial
statements.
9
10
7. SEGMENT INFORMATION
In fiscal 2000, the Company adopted Statement of Financial Accounting
Standards ("SFAS") 131, "Disclosures about Segments of an Enterprise and
Related Information". During fiscal 2000, the Company launched two new
business units, WellCheck(TM) and WellCheck.com. As a result, the
Company now has three reportable segments: Diagnostic Products,
WellCheck and WellCheck.com. These segments are strategic business units
that offer different products and, as a result, are managed separately.
Prior to the third quarter of fiscal 2000, the Company operated in one
segment, the Diagnostic Products business unit. Asset information by
segment has not been presented as the Company does not produce such
information. Results for the thirteen weeks ended September 29, 2000 by
segment are as follows (in thousands):
Diagnostic WellCheck
Products WellCheck .com Total
--------- --------- ------- -------
Net revenues $ 7,667 $ 821 $ -- $ 8,488
Cost of revenues 3,112 109 -- 3,221
------- ------- ------- -------
Gross profit 4,555 712 -- 5,267
------- ------- ------- -------
Operating expenses:
Sales and marketing 1,990 718 53 2,761
Research and development 544 -- -- 544
Web site and related costs -- -- 730 730
General and administrative 640 229 316 1,185
Goodwill amortization and
other -- 158 -- 158
------- ------- ------- -------
Total operating expenses 3,174 1,105 1,099 5,378
------- ------- ------- -------
Income (loss) from operations $ 1,381 $ (393) $(1,099) $ (111)
======= ======= ======= =======
10
11
7. SEGMENT INFORMATION (Continued)
Results for the twenty-six weeks ended Sept. 29, 2000 by segment are as
follows (in thousands):
Diagnostic WellCheck
Products WellCheck .com Total
--------- --------- --------- -------
Net revenues $15,647 $ 1,729 $ -- $17,376
Cost of revenues 6,446 192 -- 6,638
------- ------- ------- -------
Gross profit 9,201 1,537 -- 10,738
------- ------- ------- -------
Operating expenses:
Sales and marketing 3,764 1,165 82 5,011
Research and development 1,048 -- 392 1,440
Web site and related costs -- -- 730 730
General and administrative 1,316 506 736 2,558
Goodwill amortization and
Other -- 308 -- 308
------- ------- ------- -------
308
Total operating expenses 6,128 1,979 1,940 10,047
------- ------- ------- -------
Income (loss) from operations $ 3,073 $ (442) $(1,940) $ 691
======= ======= ======= =======
11
12
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 below, including under "General" and "Potential Factors
Affecting Future Operating Results." These forward-looking statements include,
but are not limited to, the statements under "General" regarding the Company's
expectation of incurring negative cash flows, the statement under "Revenues"
regarding the Company's expectation that international revenues will fluctuate
from period to period, the statement under "Sales and Marketing" regarding the
Company's expectation that sales and marketing expenses will increase, the
statement under "Research and Development" regarding the development of new test
cassettes and the Company's anticipation that research and development
expenditures will increase, the statements under "Liquidity and Capital
Resources" regarding anticipated capital spending, and internal funding for
capital spending, and the statements in "Factors Affecting Future Operating
Results".
GENERAL
The Company operates in three business segments:
- Diagnostic Products -- develops, manufactures and markets the Cholestech
L-D-X(R) System (the "L-D-X System") which performs near-patient
diagnostic testing to assist in assessing for risk of certain chronic
diseases and to assist in the monitoring of therapy to treat those
diseases.
- WellCheck(TM) -- conducts convenient consumer testing within the United
States to assess for risk of certain chronic diseases and to assist in
the monitoring of therapy to treat those diseases. Combined with the
WellCheck.com website, consumers are able to build their own personal
health management program.
- WellCheck.com -- provides, through the Internet, interactive tools
enabling individuals to partner with a team of virtual experts to help
them manage their own risk of certain chronic diseases and to monitor
and motivate personal health management of those diseases.
Diagnostic Products 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 market, the pharmacy market and the health promotion market in the
United States and internationally. The L-D-X System is capable of measuring
multiple analytes simultaneously with a single drop of whole blood, producing
test results within five minutes. The Company's current products measure and
monitor blood cholesterol, related lipids, glucose, and liver function, and are
used to perform testing of patients at risk of, or suffering from cardiovascular
disease, diabetes or liver disease.
WellCheck currently provides consumer-testing services utilizing the
Cholestech L-D-X System, as well as various other technologies for the
assessment of cholesterol, blood pressure, osteoporosis, glycated hemoglobin and
general health assessment. WellCheck was initiated
12
13
through the acquisition of Health Net, Inc. in January of 2000, for
approximately $3.7 million, including closing costs. The Company intends to
expand the WellCheck testing services offered through a combination of further
acquisitions and internal development with the goal of creating the first truly
nationwide consumer testing service for chronic disease. Substantially all of
the revenue of the WellCheck business is currently derived from promotional
programs with major pharmaceutical companies marketing lipid-lowering statin
drugs. The Company believes that there is an opportunity to further expand the
WellCheck business into retail testing venues and worksite wellness programs.
WellCheck.com consists of the website content and structure, Test Event
Activity Management System ("TEAMS") software, and business unit infrastructure,
and was launched in June, 2000. In collaboration with their healthcare
providers, consumers will have at their disposal tools needed to learn about and
manage certain chronic diseases.
The Company may incur negative cash flows from operations in the Diagnostic
Products business unit as it expands manufacturing capacity for existing and new
test cassettes, increases product research and development efforts for new test
cassettes, 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 continued development and maintenance of WellCheck.com, as well as the
acquisition and other startup costs relating to WellCheck, may also result in
negative cash flows for the Company. The development and commercialization of
new software and testing programs will require sales, marketing, development,
and other expenditures. The amount of expenditures and timing will have an
impact on the Company's ability to maintain profitability and positive cash
flows from the new business units.
The Company expects its revenue mix of the three segments to change from
time to time and these changes will affect the Company's overall revenues and
operating results.
Within the Diagnostic Products business, the Company generally has found
that customers in the POL market use a higher proportion of lipid profile
cassettes for therapeutic monitoring purposes. These 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 this market than in the health promotion market, which
focuses mainly on risk assessment and experiences a higher rate of testing with
a lower proportion of lipid profile cassettes.
WellCheck's revenue will change as sponsorships progress. As companies
other than pharmaceutical firms become sponsors, and programs mature, the number
of test sites, and the number of tests will vary. Additionally revenues will be
influenced by seasonality. During the last two months of the calendar year,
people are pursuing other interests, and are less focused on chronic health
issues. Additionally, during the summer months consumers' attention is also less
focused on chronic health issues.
13
14
WellCheck.com's revenues are based on the Internet, which is new to the
Company, and remains uncertain. Revenue will be generated by advertising and
sponsorship on the web site. Revenue will depend on the number of persons
visiting the site and the perceived value to sponsors and advertisers. To date
the Company has not signed a revenue generating agreement with a sponsor or
advertiser related specifically to WellCheck.com.
The Company is currently in feasibility studies for additional tests for
diagnostic screening and high cholesterol. These new tests are in various stages
of feasibility, 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 received
510(k) clearance to market the Alanine Aminotransferase (ALT) test for liver
function in September, 1999. Subsequently, in September, 1999, the Company
submitted the ALT test to the Center for Disease Controls and Prevention ("CDC")
seeking Clinical Laboratory Improvement Amendments of 1988, as amended, ("CLIA")
waived status. In January, 2000, responsibility for CLIA waiver was transferred
to the Food and Drug Administration ("FDA"). The Company cannot estimate when
the FDA will determine whether to grant CLIA waived status for this test or
whether such waived status will be granted.
RESULT OF OPERATIONS
THIRTEEN WEEKS ENDED SEPTEMBER 29, 2000, AND SEPTEMBER 24, 1999
AND
TWENTY-SIX WEEKS ENDED SEPTEMBER 29, 2000, AND SEPTEMBER 24, 1999
Revenues. During the thirteen weeks ended September 29, 2000, revenues
increased 34% to $8.5 million from $6.3 million in the thirteen weeks ended
September 24, 1999. Diagnostic Products represented 90% and 100% of our revenues
for the second quarter of fiscal 2001 and 2000, respectively. During the
thirteen weeks ended September 29, 2000, WellCheck represented 10% of our
revenues.
International revenues increased by 14% or $129,000 from $957,000 to $1.1
million for the thirteen weeks ended September 29, 2000, compared to the same
period in fiscal 2000. The Diagnostic Products segment generated all
international revenue.
During the first twenty-six weeks of fiscal 2001, revenues increased 44% to
$17.4 million from $12.1 in the first twenty-six weeks of fiscal 2000.
Diagnostic Products represented 90% and 100% of our revenues for the twenty-six
weeks ending September 29, 2000 and September 24, 1999, respectively. WellCheck
contributed 10% of the revenues for the twenty-six weeks ending September 29,
2000.
14
15
International revenues increased by 49% or $818,000 from $1.7 million to
$2.5 million for the twenty-six weeks ending September 24, 1999 and September
29, 2000, respectively. All international revenues were generated by Diagnostic
Products segment.
Segment performance was as follows:
- Diagnostic Products revenue increased $1.4 million from $6.3 million in
the thirteen weeks ending September 24, 1999 to $7.7 million in the
thirteen weeks ending September 29, 2000. The largest increase related
to a 20% improvement in unit sales of single use test cassettes, which
increased in all markets other than Pharmacy. Additionally, unit sales
of L-D-X Analyzers were higher in the POL and HP markets.
For the twenty-six weeks ending September 24, 1999, revenues increased
$3.5 million or 29%, to $15.6 million, from $12.1 million for the
twenty-six weeks ending September 24, 1999. Single use test cassettes
unit sales volume increased by 27%, mainly in the POL and International
market segments, accounting for most of the revenue increase. L-D-X
Analyzer sales increased by $783,000 representing unit growth in all
market segments other than Pharmacy.
- WellCheck revenue totaled $821,000 in the thirteen weeks ending
September 29, 2000. For the twenty-six weeks ending September 29, 2000
total revenue was $1.7 million. This business unit was not operating
during the twenty-six weeks ending September 24, 1999.
- As of September 29, 2000 WellCheck.com has not generated revenue.
Cost of Revenues. Cost of revenues increased 24% to $3.2 million for the
thirteen weeks ended September 29, 2000, from $2.6 million for the thirteen
weeks ending September 24, 1999. Gross margins were 62% and 59% for the thirteen
weeks ended September 29, 2000, and September 24, 1999, respectively. Diagnostic
Products accounted for 97% and WellCheck accounted for 3% of the cost of
revenues for the thirteen weeks ending September 29, 2000. For the thirteen
weeks ending September 24, 1999 Diagnostic Products accounted for 100% of the
cost of revenues.
For the twenty-six weeks ending September 29, 2000, the cost of revenues
increased $1.4 million, or 28%, to $6.6 million, from $5.2 million for the
twenty-six weeks ending September 24, 1999. Gross margins were 62% and 57% for
the twenty-six weeks ending September 29, 2000 and September 24, 1999,
respectively. Diagnostic Products accounted for 97% of the cost of revenues for
the twenty-six weeks ending September 29, 2000 and 100% for the twenty-six weeks
ending September 24, 1999. WellCheck accounted for 3% of the cost of revenues
for the twenty-six weeks ending September 29, 2000.
Segment performance was as follows:
- Diagnostic Products cost of revenues includes direct labor, direct
material, overhead and royalties. Cost of revenues increased 20%, on a
21% increase in sales, to $3.1 million in the thirteen weeks ended
September 29, 2000, from $2.6 million in the thirteen weeks
15
16
ended September 24, 1999. Gross margin was constant at 59% of total
revenues in both the thirteen weeks ended September 29, 2001, and
September 24, 1999.
The cost of revenues increased by $1.2 million, or 24%, to $6.4 million
from $5.2 million for the twenty-six weeks ending September 29, 2000 and
September 24, 1999, respectively. Gross margin increased to 59% for the
twenty-six weeks ending September 29, 2000 from 57% for the twenty-six
weeks ending September 24, 1999. The increase in gross margin was the
result of a higher sales mix of single use test cassettes, which have a
better margin than L-D-X Analyzers.
- WellCheck cost of revenues includes travel expenses, laboratory
services, medical waste disposal, and the cost of medical testing
equipment and supplies. Costs of product provided by the Company's
Diagnostic Products business are eliminated upon consolidation. For the
thirteen weeks ending September 29, 2000, total cost of revenues was
$109,000 or 13% of revenue. For the twenty-six weeks ending September
29, 2000 cost of revenues were $192,000, or 11% of revenue, resulting in
a gross margin of 89%.
- WellCheck.com did not generate cost of revenues.
Sales and Marketing Expense. Sales and marketing expense includes salaries,
commissions, bonuses, expenses for outside services related to marketing
programs, and travel. Diagnostic Products accounted for 72%, WellCheck accounted
for 26%, and Wellcheck.com accounted for 2% of sales and marketing expense for
the thirteen weeks ending September 29, 2000. Sales and marketing expense
increased 66%, or $1.1 million, to $2.8 million in the thirteen weeks ended
September 29, 2000, from $1.7 million in the thirteen weeks ended September 24,
1999. Sales and marketing expense increased to 33% of revenue in the second
quarter of fiscal 2001 from 26% in the second quarter of fiscal 2000.
For the first twenty-six weeks of fiscal 2001, sales and marketing expense
was $5.0 million compared to $3.2 million for the twenty-six weeks ending
September 24, 1999. As a percent of revenue, sales and marketing expense
increased to 29% from 27% for the twenty-six weeks ending September 29, 2000 and
September 24, 1999, respectively. Diagnostic Products was 75% of sales and
marketing expense for the twenty-six weeks ending September 29, 2000; WellCheck
was 23% and WellCheck.com was 2%.
Sales and marketing expense in each of Cholestech's segments was as follows:
- Diagnostic Products sales and marketing expense increased 19% to $2.0
million in the thirteen weeks ending September 29, 2000, from $1.7
million for the thirteen weeks ending September 24, 1999. The increase
can be attributed to increased spending on advertising, distributor
relations and other marketing activities. Sales and marketing expense
remained at 26% of revenue for the thirteen weeks ending September 29,
2000, and in the corresponding period for fiscal 2000.
For the twenty-six weeks ending September 29, 2000 Diagnostic Products
sales and marketing expense increased by $560,000 to $3.8 million from
$3.2 million for the twenty-six weeks ending September 24, 1999. Most of
the increase was attributed to increased use of advertising and other
promotional expenses.
16
17
- WellCheck sales and marketing expense was $718,000 for the thirteen
weeks ending September 29, 2000. WellCheck did not operate during the
thirteen weeks ending September 24, 1999. WellCheck sales and marketing
expense was 87% of WellCheck revenues for the second quarter of fiscal
2001. A large portion of the expense for the quarter was to support a
demonstration retail-testing program. The demonstration program was not
intended to be profitable, but sponsorship did cover 25% of the cost.
For the twenty-six weeks ending September 29, 2000 sales and marketing
expense was $1.2 million.
- WellCheck.com sales and marketing expense was $53,000 for the thirteen
weeks ending September 29, 2000. For the twenty-six weeks ending
September 29, 2000 sales and marketing expense was $82,000.
WellCheck.com did not operate during the twenty-six weeks ending
September 24, 1999.
Research and Development Expenses. Research and development expense includes
salaries, bonuses, outside services, supplies, and depreciation of capital
equipment. Research and development expense decreased 20% to $544,000 in the
thirteen weeks ended September 29, 2000, from $679,000 in the thirteen weeks
ended September 24, 1999. Research and development expenses as a percentage of
revenues decreased to 6% for the thirteen weeks ended September 29, 2000, from
11% for the thirteen weeks ended September 24, 1999. The Diagnostic Products
business unit represented 100% of the Company's research and development
expenses for the thirteen weeks ended September 29, 2000, and September 24,
1999.
During the first twenty-six weeks of fiscal 2001 research and development
expense was $1.4 million, up 13% from $1.3 million for the corresponding period
of fiscal 2000. Diagnostic products accounted for 73%, and Wellcheck.com
accounted for 27% of the total expense for the twenty-six weeks ending September
29, 2000. During the twenty-six weeks of fiscal 2000, Diagnostic products
incurred all expense. Research and development cost declined as percentage of
revenue to 8% during for the first twenty-six weeks ending September 29, 2000,
from 11% for the twenty-six weeks ending September 24, 1999.
Research and development expense in each of Cholestech's segments was as
follows:
- For the thirteen weeks ending September 29, 2000 Diagnostic Products
research and development expense declined by $135,000, or 25%, to
$544,000 compared to $679,000 in the corresponding period ending
September 24, 1999. The decline relates primarily to decreased
development activity while the ALT single test cassettes await a FDA
CLIA waiver response.
During the twenty-six weeks ending September 29, 2000 expenses decreased
by $225,000, or 18%, to $1.0 million from $1.3 million for the
twenty-six weeks ending September 24, 1999. Reduced spending could be
attributed to the lower level of development activity since the ALT
single test cassettes were submitted to the FDA for a CLIA waiver.
- WellCheck incurred no research and development expense costs in either
the thirteen weeks ending September 29, 2000 or twenty-six weeks ending
September 29, 2000.
17
18
- WellCheck.com incurred no research and development expense during the
thirteen weeks ending September 29, 2000.
During the twenty-six weeks ending September 29, 2000, research and
development expense of $392,000 was incurred compared to no cost for the
twenty-six weeks ending September 24, 1999. This represents certain
period costs of web site development incurred prior to the launch of the
web site. Since the launch at the beginning the fiscal month of July,
all operating costs were captured under the heading "Web Site and Other
Related Costs".
Web Site and Related Costs. Web site and related costs include compensation
and benefits, web hosting, site maintenance, content and other outside services
relating to the operations of the Wellcheck.com web site and TEAMS software. For
both the thirteen weeks and twenty-six weeks ending September 29, 2000, expense
was $730,000. As a percentage of revenue, expense was 9% for the thirteen weeks
ending September 29, 2000, and 4% for the twenty-six weeks ending September 29,
2000. The WellCheck.com segment incurred all expenses.
General and Administrative Expense. General and administrative expense
includes compensation, and benefits, and expenses for outside professional
services including information services, legal, and accounting. General and
administrative expense increased 84% to $1.2 million in the thirteen weeks ended
September 29, 2000, from $645,000 in the thirteen weeks ended September 24,
1999. General and administrative expense increased to 14% of revenues in the
thirteen weeks ended September 29, 2000, from 10% in the thirteen weeks ended
September 24, 1999. The Diagnostic Products business unit represented 54% and
100% of the Company's general and administrative expenses for the thirteen weeks
ended September 29, 2000, and September 24, 1999, respectively. WellCheck
represented 19% and WellCheck.com represented approximately 27% of the general
and administrative expenses for the second quarter of fiscal 2001. Most of the
increased spending was attributable to the addition of two division chief
operating officers, increased backroom staff, and outside services.
For the twenty-six weeks ending September 29, 2000 general and
administrative expense increased $1.3 million, or 107% from $1.2 million to $2.6
million for the twenty-six weeks ending September 24, 1999. General and
administrative expense increased to 15% of revenue for the twenty-six weeks
ending September 29, 2000 from 10% for the twenty-six weeks ending September 24,
1999. The Diagnostic Products business unit represented 51% of expense,
WellCheck.com represented 29% and WellCheck represented 20% in the twenty-six
weeks ending September 29, 2000. During the first twenty-six weeks of fiscal
1999, Diagnostic Products represented 100% of the total expense. The addition of
two division chief operating officers, and related costs were the main source of
the increase. Additionally other staff increases and the use of outside services
contributed to the higher spending.
General and administrative expense in each of Cholestech's segments was as
follows:
- Diagnostic Products general and administrative expenses decreased by 1%
to $640,000 for the thirteen weeks ended September 29, 2000 from
$645,000 in the thirteen weeks ending September 24, 1999. The small
decrease was the result of the allocation of shared expenses to the
newly created WellCheck and WellCheck.com business units, which was
substantially offset by the addition of the Chief Operating Officer and
related expense.
18
19
For the twenty-six weeks ending September 29, 2000 expenses increased by
6% to $1.3 million from $1.2 million for the first twenty-six weeks of
fiscal 2000. The increase was attributed to the infrastructure need for
the business unit. This was partially offset by the allocation of shared
expenses to the new business units.
- WellCheck general and administrative expense was $229,000 for the
thirteen weeks ending September 29, 2000, and $506,000 for the
twenty-six weeks ending September 29, 2000. There were no related
expenses for the twenty-six weeks ending September 24, 1999.
- WellCheck.com general and administrative expenses were $315,000 during
the thirteen weeks ending September 29, 2000 and $736,000 for the
twenty-six weeks ending September 29, 2000. No related expenses were
incurred during the twenty-six weeks ending September 24, 1999. Most of
the expenses relate to the addition of a chief operating officer, and
related expenses.
Goodwill amortization and other. The expense for the thirteen weeks ending
September 29, 2000 was $158,000 compared to $173,000 for the first thirteen
weeks of fiscal 2000. The fiscal 2001 expenses relate exclusively to
amortization of the goodwill incurred upon the acquisition of Health Net, Inc.
The fiscal 2000, second quarter expense reflects charges related to the
Company's defense of a putative class action lawsuit and a charge relating to
the amendment of certain outstanding employee stock options to increase their
term by two years.
Interest and other income, net. Interest and other income, net, reflects
income from the investment of cash balances and marketable securities. Interest
income decreased by 25% to $139,000 in the thirteen weeks ended September 29,
2000 from $185,000 in the thirteen weeks ended September 24, 1999.
Income Taxes. As the Company has significant tax credit carry forwards, the
provision for income taxes for the thirteen weeks ended September 29, 2000,
primarily represents the estimated alternative minimum tax. Management expects
to utilize additional net operating loss and other tax carry forward amounts to
the extent income is earned during fiscal 2001. Accordingly, the Company's
estimated effective tax rate is expected to remain below the federal statutory
rate throughout fiscal 2001.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through the sale of equity
securities and from positive cash flows from operations. From inception to
September 29, 2000, the Company raised $72.7 million in net proceeds from equity
financing. As of September 29, 2000, the Company had $11.9 million of cash,
restricted cash, cash equivalents and marketable securities. Restricted cash was
$1.0 million, which is being held in escrow, for the final resolution of the
Health Net purchase. In addition to these amounts, the Company has available an
$8.0 million revolving bank line of credit. While the line of credit is in
effect, the Company is required to 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
19
20
interest at 0.5% below the bank's prime rate. The line of credit agreement
expires on May 1, 2002. As of September 29, 2000, there were no borrowings
outstanding under the line of credit.
During the first twenty-six weeks of fiscal 2001, the Company used $711,000
of cash in operating activities compared to net cash provided of $2.6 million in
the first twenty-six weeks of fiscal 2000. The net cash used in operations in
the first twenty-six weeks of fiscal 2001 was comprised of net income of
$978,000, adjustments for non-cash items including $1.1 million for depreciation
and amortization. This was more than offset by a combined $2.8 million increase
in accounts receivable, inventory, and prepaid expenses. In the corresponding
twenty-six weeks of fiscal 2000, net cash was provided by a net income of $1.3
million plus adjustments for non-cash items mainly $717,000 of depreciation.
Additionally, working capital, excluding cash, equivalents, and marketable
securities, decreased by $567,000.
Net cash used in investing activities was $1.7 million in the first
twenty-six weeks of fiscal 2001, consisting primarily of additional capitalized
web site development costs of $1.1 million and the purchase of $1.2 million of
equipment. This was offset by the net sale of marketable securities. For the
first thirteen weeks of fiscal 2000, the Company purchased $1.1 million of
capital equipment.
Proceeds from the Company's associate stock option program exercises
provided $449,000 in the first twenty-six weeks of fiscal 2001. For the
corresponding thirteen weeks of fiscal 2000, $1.2 million was provided by
exercises of options pursuant to the Company's associate's stock incentive
program.
Over the balance of fiscal 2001, the Company intends to expend approximately
$2.6 million, including $1.0 million of restricted cash, for capital purchases
related to web site development, the acquisition of additional testing services
companies, expansion of its WellCheck testing service, expansion of its
manufacturing capacity, and research and development. As of September 29, 2000,
however, contracts have not been signed and schedules have not been set.
Accordingly, non-cancelable purchase commitments at September 29, 2000 were not
material.
The Company believes that cash, cash equivalents, marketable securities,
cash flows anticipated to be generated by future operations, and available bank
borrowing under an existing line of credit will be sufficient to meet its
operating requirements for the foreseeable future. Despite this belief, however,
the Company may require additional financing. The Company may be required to
expend greater than anticipated funds if unforeseen difficulties arise relating
to startup costs for WellCheck and WellCheck.com, web site development,
facilities modification or expansion, obtaining necessary product regulatory
approvals, or scaling up manufacturing for new tests.
The Company's future liquidity and capital requirements will depend upon
numerous additional factors, including: the cost and timing of expansion of
manufacturing capacity, the number and type of new tests the Company seeks to
develop; the successes 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 cost involved in preparing, filing, prosecuting, maintaining
and enforcing patent claims and
20
21
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 debt, public or private financing, collaborative
relationships or arrangements. However, the Company may not be successful in
obtaining necessary funds. Even if the Company does raise funds, any additional
equity financing may be dilutive to shareholders, and debt financing may involve
restrictive covenants that limit the manner in which the Company may be
operated. 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".
NEW ACCOUNTING PRONOUNCEMENTS
In March 2000, the Emerging Issues Task Force reached a consensus on
Issue 00-2, "Accounting for the Costs of Developing a Web Site" ("EITF 00-2").
In general, EITF 00-2 states that the costs of developing a web site should be
accounted for under provisions of Statement of Position (SOP) 98-1, "Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use." The
Company does not believe that it will have a material impact on its financial
position, results of operations or cash flows. EITF 00-2 is effective for costs
incurred after June 30, 2000.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements". SAB 101 provides guidance for revenue recognition under certain
circumstances. The accounting and disclosures prescribed by SAB 101, as amended,
will be effective for the fiscal year ended December 30, 2000. The Company is
currently evaluating the impact of SAB 101 on its financial statements and
related disclosures and does not expect any material impact from its
application.
During June 1998, the Financial Accounting Standards Board issued SFAS
No. 133 "Accounting for Derivative Instruments and Hedging Activities" which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The Company, to date, has not engaged in
derivative and hedging activities, and accordingly, does not believe that the
adoption of SFAS No. 133 will have a material impact on the financial reporting
and related disclosures of the Company. The Company will adopt SFAS No. 133 as
required by SFAS 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of the FASB statement No. 133,"
beginning with the first quarter of fiscal 2002.
In March 2000, the FASB issued FIN 44, "Accounting for Certain
Transactions Involving Stock Compensation - An Interpretation of APB No. 25"
which is effective July 1, 2000. The adoption of FIN 44 did not have a material
impact on the consolidated financial statements.
POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS
Cholestech has no prior experience in the testing services or Internet
health management businesses, and if these new businesses are not successful,
Cholestech will be greatly harmed. The testing services business and Internet
health management business to be pursued by
21
22
Cholestech's WellCheck and WellCheck.com business units are completely new to
Cholestech and our management team. This will make it more difficult for us to
successfully develop these new businesses. Also, we will be devoting significant
resources to developing these new businesses. If we are not successful in
developing these new businesses, our Diagnostics business will be greatly
harmed. Even if we are successful at developing the new businesses, the demands
of attempting to grow these new businesses may prevent us from devoting
significant time and attention to our traditional business, and that traditional
business may decline.
Internet health management is a new and unproven business, which means that
there is more risk that this business will not succeed, resulting in financial
harm to Cholestech. The internet-based personal health management business is a
very new and as yet unproven business. If it does not succeed, our significant
investment in this business will result in significant financial harm to
Cholestech. Cholestech's success in this business will depend upon individual
acceptance of internet-based management of personal health information.
Consumers may not feel comfortable having their health-related information
available over the Internet despite the privacy and security measures we plan to
take. Or there may be other reasons that we have not thought of that could
result in Internet health management not being a viable business. Thus,
consumers may not use our health management system on the Internet, and our
significant investment in this new business would not be recovered. This would
result in a significant financial loss to Cholestech.
We have no significant experience in managing geographically diverse
operations. If we are not successful in this area, our geographically dispersed
testing business may not perform well, which would result in financial harm to
Cholestech. Our traditional business has been managed and operated almost
exclusively from our Hayward, California headquarters. The new WellCheck
business will require us to operate in multiple geographic locations. This will
require us to manage multiple, geographically dispersed businesses and adapt our
management and financial systems and controls to this new geographically
dispersed business. We may not be able to manage these changes rapidly,
successfully, or at all. If we cannot successfully manage our geographic
expansion, the testing business will be much less likely to succeed. This would
mean we are less likely to recover our large investment in the testing business.
This, in turn, would likely result in significant financial harm to Cholestech.
Our new testing and Internet health management businesses will require
significant financial resources to develop. These expenditures will hurt our
overall short term financial performance and, if these new businesses are not
successful, this large financial investment will not be returned. This will
result in significant financial damage to Cholestech. The development of the two
new business units, and the WellCheck.com Internet business in particular, will
require significant start-up expenditures. These expenditures are likely to
materially affect the operating results of Cholestech as a whole. The Company
may need to seek additional capital to help fund these start-up expenses. The
required additional capital may not be available to us at favorable or
acceptable terms when required, or at all. If we cannot obtain required
additional capital, we may have to change our business strategy, which would be
disruptive to our business. If we raise additional capital through borrowings,
the terms of such borrowings may impose limitations on how our management may
operate the business in the future. If we raise additional capital by issuing
equity, this may result in a dilution of existing shareholders' interests in
Cholestech. Also, equity issued by us may have rights, preferences, or
privileges senior to those of our
22
23
existing shareholders. We plan to use acquisitions as a significant part of the
development of our new testing business. These acquisitions could be very
costly, could result in dilution to existing investors and could result in
integration problems that harm the business as a whole. The WellCheck business
will be developed in significant part by our acquiring existing testing service
businesses. We may acquire services and/or technology to assist in developing
our WellCheck.com business as well. Any acquisition could result in significant
amounts of cash, potentially dilutive issuances of equity securities, and/or the
incurring of debt or amortization expenses related to goodwill and other
intangible assets. Any of these acquisition financing approaches could
materially harm our operating results and business. Acquisitions may also result
in difficulties in assimilating the operations, technologies, products,
services, and personnel of the acquired company or business. These difficulties
could result in additional expenses. These difficulties could also result in
diversion of management attention, which could prevent the new businesses from
being successful. Any of these results could harm Cholestech financially.
Our new Internet health management business has information security risks
that could result in the business not succeeding or in financial liability for
Cholestech. Our planned WellCheck.com business will involve the provision and
management of individual health-related information over the Internet. Despite
security measures we plan to take, such information may be accessed or
manipulated by third parties without our consent or the consent of the user of
our service. Any such security breach could greatly erode consumer confidence in
our WellCheck.com business. This would likely severely harm that business and
its prospects. Additionally, if an individual's health information is corrupted
by software or technical problems, consumer confidence in the WellCheck.com
business could be severely damaged. If consumer information is altered by third
parties or by technical problems, the affected individual may bring litigation
against Cholestech and/or the Company's web site hosting partners. Any such
litigation could result in significant expense, including any damage awards.
Even if ultimately decided in our favor, such litigation could result in
significant expense and distraction of our management.
Our L-D-X System has not yet achieved broad market acceptance in all of our
target markets and in physician office laboratories and pharmacies, market
acceptance has proceeded slower than anticipated. If broad market acceptance
does not occur, Cholestech will not grow and will suffer significant financial
damage. The Cholestech L-D-X System, including the L-D-X Analyzer (our only
product platform) and single use test cassettes, will continue to account for
substantially all of the Company's Diagnostic Products revenues for the
foreseeable future. If this revenue does not grow, the overall business will be
severely harmed. In order for the Company to increase revenues, sustain
profitability and maintain positive cash flows from operations, the L-D-X System
must gain much broader market acceptance among health care providers,
particularly physician office laboratories and pharmacies. Cholestech has made
only limited sales to physician office laboratories and pharmacists to date.
Market acceptance issues such as awareness, adoption, reimbursement,
distribution, pricing, and education have kept sales to pharmacists at a
significantly low level to date relative to the size of the available market. If
we do not achieve broad market acceptance, Cholestech's Diagnostic Products
business will not grow. This will result in significant financial damage to the
business as a whole. We are relying in significant part on income from the core
Diagnostic Product business to finance the Company's strategic expansion. If the
Diagnostic Products business does not grow, the new
23
24
businesses will not succeed. These results will cause severe financial harm to
Cholestech. Factors that could prevent broad market acceptance of the L-D-X
System include:
- Awareness of the availability of the Company's technology remains at
predominantly low levels in both the physician and pharmacy customer
groups.
- The L-D-X System must be an attractive alternative to other means of
testing. This determination will depend on the L-D-X System's accuracy,
ease of use, rapid test time, reliability and cost effectiveness
compared to other testing alternatives.
- 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.
- The growing prevalence of managed care may adversely affect the
physician office laboratory 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.
- 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 will in part depend on the
continued availability and amount of reimbursement 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 of these many hurdles to achieving broad market acceptance for
the L-D-X System, demand for the L-D-X System may not be sufficient to sustain
revenues and profits from operations. Because the L-D-X System currently
contributes the vast majority of our revenues, Cholestech could be required to
cease operations if the L-D-X System does not achieve and maintain a significant
level of market acceptance.
Our business has experienced a history of operating losses and fluctuating
operating results. Results are likely to continue to fluctuate and we may
(especially in light of investment in our new businesses) experience losses in
the future. Historically, Cholestech has experienced significant operating
losses and negative cash flows from operations. As of June 20, 2000, we had an
accumulated deficit of $44.5 million. Cholestech's first profitable quarter was
the second quarter of fiscal 1998, and our first profitable year was fiscal
1998. However, we recorded a net
24
25
loss of $73,000 for fiscal 1999, before returning to profitability in fiscal
2000. Cholestech's profitability and positive cash flows from operations in the
future will require:
- Broadening market acceptance of our existing diagnostic product
offerings.
- Completing the development, successful introduction and marketing of
additional cassette based tests or other products for the Diagnostic
Products business unit.
- Successfully developing our new testing services and Internet health
management businesses.
Cholestech 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:
- The timing and amount of expenditures required for the continued
development of our new testing services and Internet health management
businesses.
- The timing and level of market acceptance of the L-D-X System.
- The timing of the introduction and availability of new tests.
- The timing and level of expenditures associated with research and
development activities.
- The timing and level of expenditures associated with expansion of sales
and marketing activities and overall operations.
- Our ability to reduce the cost of cassette manufacturing.
- Variations in manufacturing efficiencies.
- The timing and establishment of strategic distribution arrangements and
the success of the activities conducted under such arrangements.
- Changes in demand for the Company's products based on changes in third
party reimbursement, competition, changes in government regulation and
other factors.
- The timing of significant orders from, and shipments, to customers.
- Product pricing and discounts.
- Variations in the mix of products sold.
- General economic conditions.
These and other factors are difficult to predict, and could have a material
adverse effect on Cholestech's business, financial condition and results of
operations. Fluctuations in quarterly demand for our products may cause our
manufacturing operations to fluctuate in volume, increase uncertainty in
operational planning and/or affect cash flows from operations. Many of our
expenses are made in advance, based upon our expectations of future business
needs. These costs are largely fixed in the short term. As a result, when
business levels do not meet expectations, our fixed costs will not be recovered
and we will experience losses. This situation is likely to result in the future
because of the variability and unpredictability of our revenues. This also means
that Cholestech's results will likely not meet the expectations of public market
25
26
security analysts or investors at one time or another. This could cause the
trading price of Cholestech's common stock to decline significantly.
In order to grow the Diagnostic Products business significantly, Cholestech
must successfully develop, introduce and market new tests. These activities are
very costly and, if not successful, could result in significant financial harm
to Cholestech's business. The vast majority of Cholestech's revenues come from
its Diagnostics Products business. We anticipate this will continue for the near
term. Cholestech is also relying on revenue from the Diagnostics Products
business to fund the development of its new testing services and Internet health
management businesses. Cholestech also believes that its Diagnostic Products
business will not grow significantly if it does not develop new tests to use
with the L-D-X System. If new tests are not developed and accepted in the
market, Cholestech's business will not grow significantly and the business will
be harmed. Developing new tests involves many significant problems and risks,
including:
- Research and development is a very expensive process.
- Research and development takes a very long time to result in a
marketable product.
- Significant costs (including diversion of resources) may be incurred in
development prior to knowing if the development will result in a test
that is commercially viable.
- A new test will not be successful unless it is effectively marketed to
its target market.
- A new test must be able to be manufactured in a reliable,
cost-efficient, high-volume manufacturing process for such tests and the
manufacturing process must be developed and implemented in a timely
manner in order to produce the test for sale.
- New tests must meet a significant market need in order to be successful.
- New tests must obtain proper regulatory approvals to be marketed.
Cholestech could experience difficulties that could delay or prevent the
successful development, introduction and marketing of new tests. Also,
regulatory clearance or approval of any new tests may not be granted on a timely
basis, or at all.
Cholestech has experienced difficulties obtaining regulatory approval for
tests in the past. In September 1999, the FDA approved the Company's request for
clearance to market Cholestech's newly developed ALT single use test cassette.
As of June 2000, the FDA has not approved our request for CLIA waiver for the
use of the ALT test cassette with the L-D-X System. Because the FDA's evaluation
of applications for CLIA waived status is not based upon precisely defined,
objectively measurable criteria, Cholestech cannot predict the likelihood of
obtaining waived status in the future for the ALT product or other products. In
order to successfully commercialize the ALT 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 ALT test cassette, the Company will be required to establish and
maintain reliable, cost-efficient, high-volume manufacturing capacity for such
tests.
Cholestech 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 raw materials and
performance of the manufacturing equipment.
26
27
Manufacturing Cholestech's tests cassettes is a complex and delicate process
and interruption of cassette manufacturing could result in insufficient
cassettes to meet orders, which could result in financial harm to Cholestech.
Cholestech internally manufactures all of the single use test cassettes that are
used with the L-D-X Analyzer. The manufacture of single use test cassettes is a
highly complex and precise process that is sensitive to a wide variety of
factors. 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. Manufacturing yields could be harmed by:
- Raw materials variations or impurities,
- Occurrence of manufacturing process variances,
- Decreased manufacturing equipment performance, and
- Introduction of manufacturing environment impurities.
Cholestech's cassette manufacturing lines would be costly and time consuming
to repair or replace if the operation were interrupted. The interruption of
cassette manufacturing operations or the loss of employees dedicated to the
cassette manufacturing facility could severely harm Cholestech's business. The
risks involving the manufacturing lines include:
- As Cholestech's production levels have increased, Cholestech 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 Cholestech's manufacturing equipment
increases the time required to remedy equipment failures and replace
equipment.
- Cholestech has a limited number of employees dedicated to the operation
and maintenance of the cassette manufacturing equipment, the loss of
whom could impact Cholestech's ability to effectively operate and
service such equipment.
- Cholestech manufactures all cassettes at its Hayward, California
manufacturing facility, so manufacturing operations are at risk to
interruption from earthquake, fire or other events affecting this one
location.
Cholestech will need to reduce manufacturing costs in order to achieve
long-term success, and it may not be able to reduce these costs. We believe that
we will be required to reduce manufacturing costs for new and existing test
cassettes in order to achieve sustained profitability. Cholestech currently
operates two manufacturing lines for dry chemistry cassettes. We are planning
and building a third manufacturing line that we anticipate will become fully
operational in the third quarter of fiscal 2001. The complexity and custom
nature of our manufacturing process increases the amount of time and money
required to add an additional manufacturing line. Despite our efforts, the new
cassette manufacturing line may not be completed in a timely fashion, or at all.
Also, we may need to implement cassette manufacturing cost reduction programs
sooner. Failure to develop the new dry chemistry manufacturing line could
prevent us from satisfying customer orders in a timely manner, which could lead
to customer dissatisfaction and loss of business. Failure to develop the new
line could also prevent us from reducing
27
28
manufacturing costs for dry chemistry tests, and prevent us from achieving
sustained profitability.
Cholestech may have to develop new manufacturing processes and a new
manufacturing line in order to market immunoassay tests in development, or we
will not be able to recover the costs of these tests in development. We may also
be required to build a new cassette manufacturing line in order to manufacture
the immunoassay test cassettes under development. To date, we have not developed
the processes and production equipment necessary for an immunoassay cassette
manufacturing line. Failure to successfully develop an immunoassay cassette
manufacturing line and achieve acceptable yields, could lead to an inability to
cost-effectively satisfy customer orders and could have a material adverse
effect on the Company's business, financial condition and results of operations.
Cholestech depends on single source suppliers for inputs to its
manufacturing process. Cholestech's business will be harmed if these suppliers
cannot provide supplies to Cholestech or experience problems with quality of
supplied materials. Single source vendors currently provide subassemblies,
components and raw materials used in the manufacture of Cholestech's products.
Any supply interruption in a single source subassembly, component, or raw
material could restrict Cholestech's ability to manufacture products until a new
source of supply is identified and qualified. Cholestech may not be successful
in qualifying additional sources of supply on a timely basis, or at all. Failure
to obtain a usable alternative source could prevent manufacturing our products,
resulting in inability to fill orders, customer dissatisfaction and loss of
business. This would likely severely harm our business. In addition, an
uncorrected impurity or supplier's variation in a raw material, either unknown
to Cholestech or incompatible with Cholestech's manufacturing process, could
interfere with our ability to manufacture products. Because Cholestech 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, Cholestech's suppliers may not devote adequate resources to
supplying Cholestech'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 severely harm Cholestech's business.
If Cholestech is successful in growing sales, this success may be undermined
if it cannot effectively manage the operational and management challenges of
growth. If Cholestech is successful in achieving and maintaining market
acceptance for the L-D-X System, Cholestech will be required to expand its
operations, particularly in the areas of sales and marketing and manufacturing.
As Cholestech expands its operations, this expansion will likely result in new
and increased responsibilities for management personnel and place significant
strain upon Cholestech's management, operating and financial systems and
resources. To accommodate any such growth and compete effectively, Cholestech
will be required to implement and improve its information systems, procedures
and controls, and to expand, train, motivate and manage its work force. Our
personnel, systems, procedures and controls may not be adequate to support our
future operations. Any failure to implement and improve operational, financial
and management systems or to expand, train, motivate or manage employees as
required by future growth, if any, could harm our business and prevent us from
improving our financial condition as a result of increased sales.
Cholestech relies on distributors to sell its products, and has had
difficulty in the past maintaining some distributor relationships. In order for
Cholestech to increase revenues and
28
29
achieve sustained profitability, we will have to maintain and expand our
existing distribution relationships and develop new distribution relationships.
Cholestech is dependent upon such distributors to assist it in promoting market
acceptance of the L-D-X System. If we do not maintain and expand these
relationships, our sales will not grow and our business will be greatly harmed.
We have in the past had problems maintaining relationships with our distributors
to the pharmacy market. Distribution agreements with Amerisource and Bergen
Brunswig Drug Company, both national distributors to the pharmacy market, were
cancelled due to contractual performance issues. Also, we may not be able to
enter into and maintain new arrangements on a timely basis, or at all. Even if
we do enter into additional distributor relationships, those distributors may
not devote the resources necessary to provide effective sales and marketing
support to our products. We do not have the ability to prevent distributors from
distributing products that compete with our products. The distributors may also
give higher priority to the products of our competitors.
If third party reimbursement for use of Cholestech's products is eliminated
or reduced, our sales will be greatly reduced and our business may fail. In the
United States, healthcare 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. Cholestech will not be able to successfully market its products if the
purchase and use of these products is not subject to reimbursement from
government health authorities, private health insurers and other third party
payors. If this reimbursement is not available or is limited, healthcare
providers will be much less likely to use Cholestech's products, our sales will
be greatly reduced and our business will likely fail.
Reimbursement is currently not available for certain uses of Cholestech'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 our products. For example, if a physician prescribes
a drug that requires therapeutic monitoring, the use of our products in
performing such tests will be reimbursable. In the health promotion market, use
of our 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.
There are current conditions in healthcare that increase the possibility
that third party payors may reduce or eliminate reimbursement for tests using
Cholestech's products in certain settings. These circumstances include:
- Third party Payors are increasingly scrutinizing and challenging the
prices charged for medical products and services.
- Healthcare providers are moving toward a managed care system in which
such providers contract to provide comprehensive healthcare for a fixed
cost per patient. Managed care providers are attempting to control the
cost of healthcare by authorizing fewer elective procedures, such as
uses of Cholestech's products for diagnostic screening.
- There is general uncertainty regarding what changes will be made in the
reimbursement methods utilized by third party payors and how that will
affect use of products such as Cholestech's. This uncertainty may deter
healthcare providers from adopting use of Cholestech Diagnostic
Products.
29
30
- Cholestech believes that the overall escalating cost of medical products
and services has led to and will continue to lead to increased pressures
on the healthcare industry, both domestic and international, to reduce
the cost of products and services, including products offered by
Cholestech.
Market acceptance of Cholestech's products in international markets is also
dependent, in part, upon the availability of reimbursement within prevailing
healthcare payment systems. Reimbursement and healthcare payment systems in
international markets vary significantly by country and include both government
sponsored healthcare and private insurance. Third party reimbursement and
coverage may not be available or adequate in either the United States or
international markets, and current reimbursement amounts may be decreased in the
future. Also, future legislation, regulation, or reimbursement policies of third
party Payors may adversely affect demand for our products or our ability to sell
our products on a profitable basis. Any of these events could materially harm
our business. See "Business -- Third Party Reimbursement."
There is a good likelihood that the healthcare system in the United States
will undergo fundamental change, and there is no way to predict whether these
changes will harm our business or how severe the effect will be. Political,
economic and regulatory influences are pushing the healthcare industry in the
United States to fundamental change. Cholestech anticipates that Congress, state
legislatures and the private sector will continue to review and assess
alternative healthcare delivery and payment systems. Potential approaches that
have been considered include mandated basic healthcare benefits, controls on
healthcare 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
healthcare delivery system. Legislative debate is expected to continue in the
future, and market forces are expected to demand reduced costs. Cholestech
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. There is the potential that changes in the healthcare system could
have extremely negative effects on our business.
Cholestech's products are subject to multiple levels of government
regulation that impose significant restrictions on Cholestech's business and
could change in ways that are difficult to predict and that could be very
damaging to our business. 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. Cholestech 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 required clearances and approvals. The process of
obtaining required regulatory clearances and approvals is lengthy, expensive and
uncertain. As a result, Cholestech's new tests under development, even if
successfully developed, may never obtain such clearance or approval.
Additionally, certain material changes to medical products already cleared or
approved by are subject to further review and clearance or approval. 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. The loss of
previously obtained clearances, or failure to comply with existing or future
regulatory requirements, could prevent marketing of products affected, which
would depress revenues and severely harm our business.
30
31
In addition, any future amendment of regulations or the promulgation of
additional regulations impacting Cholestech's products could prevent Cholestech
from marketing the L-D-X System. Regulatory changes could hurt our business by
increasing burdens on our products. Regulatory changes could also harm our
business by reducing 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.
Currently, Cholestech's Diagnostic Products are regulated in the United
States by the Food and Drug Administration. The L-D-X Analyzer and all existing
test cassettes required clearance by the Food and Drug Administration. Food and
Drug Administration clearance or approval of products such as Cholestech's can
be obtained by either of two processes:
- The 510(k) clearance process, which generally takes from four to twelve
months from the date of submission to obtain, but may take longer.
- The pre-market approval process, which is a much longer and more costly
process than a 510(k) clearance process, involves the submission of
extensive supporting data and clinical information and generally takes
one to three years from the date on which the application is accepted
for filing, but may take significantly longer.
If Cholestech's future products are required to obtain a pre-market
approval, this would significantly delay our ability to market those tests and
significantly increase the costs of development.
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. In the United States, clinical laboratory
testing is regulated under the Clinical Laboratory Improvements Act of 1976. The
L-D-X Analyzer and Cholestech's total cholesterol, HDL (high density
lipoproteins), Triglycerides and glucose tests in any combination have been
classified as waived from the application of many of the requirements under the
Clinical Laboratory Improvements Act. Cholestech believes that this waived
classification is critical for its products to be successful in their markets.
Cholestech's new tests, including the ALT test cassette, may not qualify for
waived classification. Any failure of the new tests to obtain waived status
under the Clinical Laboratory Improvements Act will severely limit ability to
commercialize such tests. Loss of waived status for existing Diagnostic Products
or failure to obtain waived status for new products could limit our sales and
revenues, which would severely harm our business.
The European Union has promulgated rules that require that devices such as
those developed, manufactured and sold by Cholestech receive the right to affix
the CE mark, a symbol of adherence to applicable European Union directives.
Cholestech 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. Cholestech's products will be covered by the In
Vitro Diagnostics Directives that have not yet been officially published or
adopted. Cholestech may lose its self-certified status if it is not successful
in meeting the European Union certification requirements. Failure to receive the
right to affix the CE mark may prohibit Cholestech from selling its products in
European Union member countries. This would result in lost sales and market
share and significant financial harm to our business.
31
32
Cholestech's manufacturing processes are subject to regulation and, if we do
not comply with these regulations, our manufacturing could be suspended,
resulting in unfilled orders, customer dissatisfaction, and lost sales, revenues
and market share. Cholestech's manufacturing processes, as well as, in certain
instances, those of our 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. Failure to
comply with these regulations 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. Any of these could harm our business. Cholestech and
our contract manufacturers are subject to federal, state and foreign regulations
regarding the manufacture of healthcare products and diagnostic devices,
including:
- Quality System Records ("QSR"), which requires the company to maintain a
quality system consistent with FDA regulations.
- ISO9001/EN46001 requirements, which is an industry standard for
maintaining quality standards and assuring conformance to said
standards.
- And other foreign regulations and state and local health, safety and
environmental regulations, which include testing, control and
documentation requirements.
Changes in existing regulations or adoption of new governmental regulations
or policies could prevent or delay regulatory approval of the Company's
products. Cholestech may be required to incur significant costs in the future in
complying with manufacturing and environmental regulations.
Our business depends on our ability to protect our proprietary technology
through patents and other means, which may not be successful or may require
costly litigation to enforce. If our protective measures are not successful our
competitors will be able to use our technology to compete with us, and if we
have to enforce our protective measures we may have to divert time and money
from operating our business. The 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. Risks of relying on the proprietary
nature of our technology include:
- Our pending patent applications may not result in the issuance of any
patents, or, if issued, such patents may not offer protection against
competitors with similar technology.
- Our patents may be challenged, invalidated or circumvented in the
future, and the rights created under our patents may not provide a
competitive advantage.
- Competitors, many of which have substantially greater resources than us
and have made substantial investments in competing technologies, may
seek to apply for and obtain patents covering technologies that are more
effective than ours. This could render our technologies or products
obsolete or uncompetitive or could prevent, limit or interfere with our
ability to make, use or sell our products either in the United States or
in international markets.
32
33
- The medical products industry has been characterized by extensive
litigation regarding patents and other intellectual property rights.
Cholestech may in the future become subject to patent infringement
claims and litigation or interference proceedings conducted in the
United States Patent and Trademark Office to determine the priority of
inventions. Litigation may also be necessary to enforce any patents
issued to us, to protect our trade secrets or know-how or to determine
the enforceability, scope and validity of the proprietary rights of
others. The defense and prosecution of intellectual property suits,
patent interference proceedings and related legal and administrative
proceedings are both costly and time consuming and will likely result in
substantial diversion of attention of technical and management
personnel.
- An adverse determination in litigation or interference proceedings to
which Cholestech may become a party could subject us to significant
liabilities to third parties or require us to seek licenses from third
parties, which may not be available on commercially reasonable terms or
at all.
If third party sponsorship of WellCheck testing service is eliminated or
reduced, our revenues will be greatly reduced and our business may fail.
WellCheck derives the majority of its revenue from third parties using the
Company's testing service to promote their products. If the third parties
decline to participate in the future, or the amount of sponsorship is reduced,
consumers will be much less likely to use our testing service and our revenue
will be greatly reduced and our business will likely fail.
We will need to locate an adequate number of testing venues for the
WellCheck testing service. In order for the testing service to be successful,
the Company will need to maintain the current number of testing sites and find a
greater number of locations, and more diverse venues to perform consumer
testing. The Company will need to convince operators of the venues there will be
economic benefits from the testing service. If the number of testing sites do
not increase or are reduced, Cholestech could be harmed financially.
If third party sponsorship of the WellCheck.com web site is eliminated or
reduced, our revenues will be greatly reduced and our business may fail. The
WellCheck.com web site anticipates all revenues will be derived form third
parties advertising, sponsorship, or offering services to web site members. If
third parties decline to participate, or fees are significantly lower than
estimated, revenue will be greatly reduced and our business will likely fail.
The Company will have to maintain a significant active membership in the
WellCheck.com web site. In order to generate expected revenues we will need to
demonstrate to web site sponsors the number of visitors, and the number or
repeat visitors. If web site membership does not reach the required level or use
of the web site declines, revenues will be eliminated or significantly reduced.
We will need to effectively implement and use the TEAMS software, which
transfers consumer information from test locations to the WellCheck web site. In
order to meet consumer expectations of timely feed back, the TEAMS software will
be the conduit, which will transfer the large number of consumer test results in
a timely manner. If the TEAMS software is not available, manual data entry by
the company or the customer will be required. The additional time and
inconvenience could reduce the number of people willing to become a member of
the
33
34
web site. If customers are not provided an efficient method of accessing the
data on the web site membership can be eliminated or significantly reduced,
which could harm Cholestech financially.
The Company will need to market the use of TEAMS software to sponsors of
testing programs. TEAMS software is a proprietary tool to transfer large amounts
of information from testing sites to our web site. We must be able to convince
sponsors it is a cost effective method, and will improve the testing experience
for consumers. If we are unable to have event sponsors pay for the use of TEAMS,
we would be unable to recover the cost of developing and maintaining TEAMS,
which could significantly reduce profits.
Our testing system may not properly process year 2000 dates, which would
result in loss of sales and in financial harm to Cholestech. Cholestech
implemented a program to assess 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). As of the first twenty-one weeks of
calendar 2000, the Company has not been able to detect any material Year 2000
related issue to its internal systems and products. Additionally, the Company is
not currently aware of any Year 2000 dependencies in its internal systems or
products that could have a material impact on its business. Although the company
believes no material events will occur, no assurances can be given that
Cholestech will not experience unanticipated material costs caused by undetected
errors or defects in its internal systems.
34
35
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. We do not use derivative financial
instruments in our investment portfolio and had no holdings of derivative
financial or commodity instruments at September 29, 2000. Securities held are
subject to interest rate risk and will fall in value if market interest rates
increase. We do not believe near-term changes in interest rates should not
materially adversely affect our financial position, results of operations or
cash flows.
35
36
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On February 5, 1999, a complaint entitled Ree v. Pinckert, et al.,
No.C99-0562 (MMC) was filed in the United States District Court for the Northern
District of California. The Action is a putative class action and the complaint
alleges that Cholestech and an officer, Mr. Pinckert, violated the federal
securities laws by misleading investors during the time period of July 30, 1997
- - June 26, 1998, concerning the Company's business and its future prospects. On
June 24, 1999, plaintiffs filed an amended complaint, which expanded the
putative class period to June 28, 1996, through June 26, 1998. The amended
complaint's substantive allegations and purported causes of action remain based
on allegations that the Company misled shareholders concerning the Company's
business and its future prospects. The complaint does not specify alleged
damages. On September 20, 1999, defendants filed a motion to dismiss plaintiff's
amended complaint. On March 28, 2000, the court granted defendant's motion to
dismiss pursuant to rule 12(B)(6) with leave for plaintiffs to amend. The
plaintiffs have filed an amended complaint. The Company intends to defend the
case vigorously. The Company does not believe that the defendants in the class
action engaged in any wrongdoing, and that the outcome of this matter will not
result in a material adverse effect, however, there can be no assurance that the
lawsuit will be resolved in the Company's favor. The action is in its
preliminary stages and a trial date has not been set.
In September, 2000, the Company was served with a complaint, No. Ei/Ti ROCH
04002, was filed in Vienna, Austria by Roche Diagnostics on January 13, 2000.
seeking a cease and desist order barring the Company, and a distributor,
Euromedix, from distributing HDL assay single-use test cassettes in Austria. The
complaint alleges that Cholestech violated a Roche European patent for HDL. The
Company is in the process of responding to the complaint. At this point in time
no schedule has been set regarding court activity. There can be no assurance as
to whether the plaintiffs will take any additional action, or whether any
additional action will be resolved in the Company's favor.
On December 23, 1999, a complaint requesting an injunction, No. ES 580-199,
was filed in Zug, Switzerland by Roche Diagnostics seeking a cease and desist
order barring the Company, and two distributors, Healthcare Solutions and
Euromedix, from distributing HDL assay single-use test cassettes in Switzerland.
The complaint alleges that Cholestech violated a Roche European patent for HDL.
The Company has filed its response to the complaint. On July 11, 2000 the court
denied the plaintiff's request for an injunction. The plaintiff has appealed the
court ruling and it will be several weeks before we are notified of the case
details. There can be no assurance as to weather the plaintiffs will take any
additional action, or any additional action be resolved in the Company's favor.
Additionally, in January, 2000, a complaint, No. 4 O 4/00, was filed in the
District Court, Dusseldorf, Germany against Cholestech and two of its
distributors, seeking a cease and desist order barring the distributor from
shipping HDL single-use test cassettes into Germany. The complaint alleges the
Company and its distributors violated a Roche German priority patent for HDL by
selling Cholestech's single-use test cassette containing a HDL assay. The
Company
36
37
believes the suit is without merit and intends to defend the case vigorously.
Therefore, the Company does not believe that the outcome of this matter will
result in a material adverse effect, however, there can be no assurance that the
lawsuit will be resolved in the Company's favor.
The Company is subject to various legal claims and assessments in the
ordinary course of business, none of which are expected by management to result
in a material adverse effect on the consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On August 17, 2000, the Company held its 2000 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
John H. Landon 10,314,962 487,681
Molly J. Coye, MD. 10,312,462 490,181
John L. Castello 10,315,962 482,181
Warren E. Pinckert, II 10,148,233 654,410
Dr. Harvey S. Sadow 10,320,552 482,181
Larry Y. Wilson 10,318,962 483,681
2. The shareholders approved the adoption of the Company's 2000
Stock Incentive Program and authorized the reservation of 590,000
shares of common stock for issuance thereunder.
For Against Abstain Broker Non-Vote
3,573,815 1,315,643 52,473 5,911,722
3. The shareholders approved an amendment to the Company's 1992
Employee Stock Purchase Plan to increase the aggregate number of
shares of common stock authorized for issuance under such plan by
200,000.
For Against Abstain Broker Non-Vote
4,302,097 587,756 52,078 5,911,722
4. The shareholders ratified the appointment of
PriceWaterhouseCoopers LLP as independent accountants of the
Company for the fiscal year ending March 30, 2001.
For Against Abstain Broker Non-Vote
10,669,285 82,450 101,918
37
38
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
10.3.4 Standard Industrial Lease Agreement between Registrant
and Terradev Jefferson LLC dated July 28, 2000.
27.1 Financial Data Schedule
(b) Reports on Form 8-K. One Report on Form 8-K was filed
during the thirteen weeks ended September 29, 2000. The
report was filed on July 7, 2000, and reported, under Item
2 of form 8-K. On January 21, 2000, Cholestech Corporation
completed the purchase of certain assets of Health Net,
Inc.
38
39
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 11/10/00 /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)
39
40
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
10.3.4 Standard Industrial Lease Agreement between Registrant
and Terradev Jefferson LLC dated July 28, 2000.
27.1 Financial Data Schedule