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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
_X_ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended June 27, 1997
___ 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 June 27, 1997, 11,231,205 shares of common stock of the Registrant were
outstanding.
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<PAGE>
CHOLESTECH CORPORATION
PART I
FINANCIAL INFORMATION
Page
----
ITEM 1. FINANCIAL STATEMENTS.
Condensed Balance Sheets 3
Condensed Statements of Operations 4
Condensed Statements of Cash Flows 5
Notes to Condensed Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS. 7
PART II
OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS. 11
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 11
SIGNATURES 12
2
<PAGE>
CHOLESTECH
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
CONDENSED BALANCE SHEETS
(in thousands)
(Unaudited)
<CAPTION>
June 27, 1997 March 28, 1997 (1)
------------- ------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 7,729 $ 6,088
Marketable securities 6,257 7,921
Accounts receivable, net 2,187 1,866
Inventories 2,553 2,353
Prepaid expenses and other current assets 391 280
-------- --------
Total current assets 19,117 18,508
Property and equipment, net 2,370 2,399
Other assets, net 143 180
-------- --------
$ 21,630 $ 21,087
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 2,127 $ 1,629
Accrued payroll and benefits 382 527
Product warranty 214 214
-------- --------
Total current liabilities 2,723 2,870
Other liabilities 3 14
-------- --------
Total liabilities 2,726 2,384
-------- --------
Shareholders' equity:
Preferred stock -- --
Common stock 69,205 69,174
Unrealized gains on investments 51 --
Accumulated deficit (50,352) (50,471)
-------- --------
Total shareholders' equity 18,904 18,703
-------- --------
$ 21,630 $ 21,087
======== ========
<FN>
(1) The information in this column was derived from the Company's audited
financial statements for the fiscal year ended March 28, 1997.
See Notes to Condensed Financial Statements
</FN>
</TABLE>
3
<PAGE>
CHOLESTECH CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(unaudited)
Quarter ended
------------------------------
June 27, 1997 June 28, 1996
------------- ------------
Revenues:
Domestic $ 3,808 $ 2,473
International 395 287
----------- -----------
4,203 2,760
Cost of product sold 1,995 1,643
----------- -----------
Gross profit 2,208 1,117
----------- -----------
Operating expenses:
Research and development 475 184
Sales and marketing 1,176 906
General and administrative 553 415
----------- -----------
Total operating expenses 2,204 1,505
----------- -----------
Income (loss) from operations 4 (388)
Interest income (expense), net 118 (23)
----------- -----------
Income (loss) before taxes 122 (411)
Provision for income taxes 3 --
Net income (loss) $ 119 $ (411)
=========== ===========
Net income (loss) per share $ .01 (0.05)
=========== ===========
Weighted average common shares and
equivalents outstanding 11,545,752 8,161,721
=========== ===========
See Notes to Condensed Financial Statements
4
<PAGE>
<TABLE>
CHOLESTECH CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<CAPTION>
Quarter ended
----------------------------------
June 27, 1997 June 28, 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 119 $ (411)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization 221 150
Changes in assets and liabilities:
Accounts receivable (321) (304)
Inventories (200) (222)
Prepaid and other current assets (111) (421)
Other assets 4 --
Accounts payable and accrued expenses 522 447
Accrued payroll and benefits (145) (30)
-------- --------
Net cash provided by (used in) operating activities 89 (791)
-------- --------
Cash flows from investing activities:
Proceeds from sale of marketable securities 5,441 --
Purchases of marketable securities (3,726) --
Purchases of property and equipment (159) (171)
-------- --------
Net cash provided by (used in) investing activities 1,556 (171)
-------- --------
Cash flows from financing activities:
Principal payments on long-term debt -- (107)
Proceeds from short-term bank borrowing -- 800
Principal payments on capital leases (35) (14)
Issuance of common stock 31 13,200
Accrued stock offering expenses -- 500
Stock subscription receivable -- (13,369)
-------- --------
Net cash provided by (used in) financing activities (4) 1,010
-------- --------
Net change in cash and cash equivalents 1,641 48
Cash and cash equivalents at beginning of period 6,088 361
-------- --------
Cash and cash equivalents at end of period $ 7,729 $ 409
======== ========
<FN>
See Notes to Condensed Financial Statements
</FN>
</TABLE>
5
<PAGE>
CHOLESTECH CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. Interim Results
The interim unaudited financial information of Cholestech Corporation
(the "Company") is prepared in conformity with generally accepted
accounting principles and such principles are applied on a basis
consistent with the audited financial information contained in the
Annual Report on Form 10-K filed with the Securities and Exchange
Commission on June 27, 1997. The financial information included herein
has been prepared by management, without audit by independent
accountants who do not express an opinion thereon, and should be read
in conjunction with the audited financial statements contained in the
Annual Report on Form 10-K. The condensed balance sheet as of March 28,
1997 has been derived from, but does not include all the disclosures
contained in, the audited financial statements for the year ended March
28, 1997. 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 foregoing interim results are not necessarily indicative of the
results of operations for the full fiscal year ending March 27, 1998.
2. Balance Sheet Data
The components of inventories are as follows (in thousands):
June 27, 1997 March 28, 1997
------------- --------------
Raw materials $ 729 $ 703
Work in process 1,096 585
Finished goods 728 1,065
------- -------
$ 2,553 $ 2,353
======= =======
3. Earnings Per Share
Net income (loss) per share is computed by dividing net income (loss)
by the weighted average number of common and common equivalent shares
outstanding during each period. Common equivalent shares, consisting of
stock options, are included in determining net income (loss) per share,
to the extent they are dilutive, using the treasury stock method.
4. Borrowing Arrangements
In December 1996, the Company entered into an agreement with a Wells
Fargo Bank for a $3 million revolving line of credit (the "line of
credit"). While the agreement is in effect, the Company is required to
maintain on deposit assets with collective value, as defined in the
line of credit agreement, equivalent to no less than 100% of the
outstanding principle balance. Amounts outstanding under the line of
credit bear interest at the bank's prime rate. The line of credit
agreement expires on November 30, 1997 and is renewable. As of March
28, 1997, there were no borrowings outstanding under the line of
credit. The Company repaid the note payable outstanding at March 29,
1996 in July 1996.
6
<PAGE>
CHOLESTECH CORPORATION
5. New Accounting Pronouncement
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings Per Share" ("SFAS 128"), which will be
effective for the Company's third quarter of fiscal 1998. Under SFAS
128, primary earnings per share is replaced by basic earnings per share
and fully diluted earnings per share is replaced by diluted earnings
per share. If the Company had adopted this statement for the quarter
ended June 27, 1997, per share amount for the quarters ended June 27,
1997 and June 28, 1996 would have been the same as presently reported
herein.
In June 1997, the Financial Accounting Standards Board issued Statement
No. 130, "Reporting Comprehensive Income" ("SFAS 130). SFAS 130
establishes standards for the reporting of comprehensive income and it
components in a full set of general purpose financial statements for
periods ending after December 31, 1997. Reclassification of financial
statements for earlier periods for comparative purposes is required.
The Company expects to adopt SFAS 130 in fiscal 1999 and does not
expect such adoption to have a material effect on the financial
statements.
In June 1997, the Financial Accounting Standards Board issued Statement
No. 131, "Disclosures About Segments on An Enterprise and Related
Information" (SFAS 131). SFAS 131 revises information regarding the
reporting of certain operating segments. It also establishes standards
for related disclosures about products and services, geographic areas
and major customers. The Company expects to adopt SFAS 131 in fiscal
1999 and does not expect such adoption to have a material effect on the
financial statements.
6. Shareholder Rights Plan
In January 1997, the Board of Directors approved a shareholder rights
plan under which shareholders of record on March 31, 1997 received a
right to purchase (a "Right") one-thousandth of a share of Series A
Participating Preferred Stock at an exercise price of $44, subject to
adjustment. The Rights will separate from the Common Stock and Rights
certificates will be issued and, will become exercisable upon the
earlier of: (i) 10 days or such later date as may be determined by a
majority of the Board of Directors following a public announcement that
a person or group of affiliated or associated persons has acquired, or
obtained the right to acquire, beneficial ownership of 15% or more of
the Company's outstanding Common Stock or (ii) 10 business days
following the commencement of, or announcement of an intention to make,
a tender offer or exchange offer the consummation of which would result
in the beneficial ownership by a person or group of 15% or more of the
outstanding Common Stock of the Company. The Rights expire on the
earlier of (i) January 22, 2007 or (ii) redemption or exchange of the
Rights.
7
<PAGE>
CHOLESTECH CORPORATION
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion contains forward-looking statements that involve risks
and uncertainties. The Company's actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors discussed herein, under "General" and "Potential Factors Affecting
Future Operating Results." These forward-looking statements include, but are not
limited to, the statement under "General" regarding the Company's expectation of
continuing to incur negative cash flows, the statement under "Research and
Development" regarding the Company's anticipation that research and development
expenditures will increase, the statement under "Sales and Marketing" regarding
the Company's anticipation that sales and marketing expenses will increase, and
the statement in the third paragraph under "Liquidity and Capital Resources"
regarding the length of time that the Company's resources will be sufficient to
meet its capital requirements.
General
The Company develops, manufactures and markets a proprietary platform
technology - the Cholestech L*D*X(R) System - which in the preventive care
market measures specific analytes to detect various diseases and disorders
within five minutes using a single drop of whole blood. The Company has
experienced significant operating losses and, as of June 27, 1997, had an
accumulated deficit of $50.4 million. The Company is developing certain
additional tests designed to extend the Cholestech L*D*X System's capabilities.
The Company believes that its future growth will depend, in part, upon its
ability to complete development and successfully introduce these new tests. The
Company expects to continue to incur negative cash flows from operations as it
expands product research and development efforts for new test panels, pursues
regulatory clearances and approvals, expands sales and marketing activities to
address the therapeutic monitoring market, and develops and expands
manufacturing capacity for existing and new test panels. The development and
commercialization of the 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.
On July 24, 1997, the Food and Drug Administration (FDA) approved the
Company's notification of intent to market pursuant to Section 510 (k) of the
Food, Drug and Cosmetics Act of 1938, as amended, ("Section 510 (k)
Notification") to market a creatinine and blood urea nitrogen diagnostic test
cassette, a renal function test . The Company believes that these tests are
among the most commonly ordered tests in physician offices. Blood urea nitrogen
elevations occur in chronic renal disease as well as urinary tract obstruction.
Blood urea nitrogen is useful to monitor hemodialysis and other therapies.
Creatinine is also a measure of renal function and is used in combination with
blood urea nitrogen tests. In addition, creatinine is used as a measure of renal
blood flow which may have become reduced due to congestive heart failure or
dehydration. Low levels of creatinine may result from decreased hepatic
production in advanced liver disease. In order to successfully commercialize the
creatinine and blood urea nitrogen test cassette in the United States, the
Company believes that it will be critical to obtain waived classification under
the Clinical Laboratory Improvement Amendments of 1988. The Company will submit
an application to the Centers for Disease Control and Prevention requesting the
creatinine and blood urea nitrogen disposable test be classified as waived under
the requirements of Clinical Laboratories Improvement Amendments of 1988 (CLIA
'88). There can be no assurance that any new tests developed by the Company,
including the creatinine and blood urea nitrogen, will qualify for the waived
classification. Any failure of the new tests to obtain waived status under the
Clinical Laboratory Improvement Amendments of 1988 will adversely impact the
Company's ability to commercialize such tests. If the waived classification is
obtained, the Company expects to begin shipment of the creatinine and blood urea
nitrogen panel before the end of fiscal 1998.
8
<PAGE>
CHOLESTECH CORPORATION
Result of Operations
Quarter ended June 27, 1997 vs. quarter ended June 28, 1996
Revenues. The Company's revenues increased by 52% to $4.2 million in
the first quarter of fiscal 1998 from $2.8 million in the first quarter of
fiscal 1997 . Domestic revenues increased by 54% to $3.8 million in the first
quarter of fiscal 1998 from $2.5 million in the first quarter of fiscal 1997.
The increase in domestic revenues reflects a continuing unit increase in sales
of the disposable test cassettes and the Cholestech L*D*X(R) System to
hospitals, managed care organizations, public health departments, corporations,
physician office laboratories and other health care providers in the diagnostic
screening and therapeutic monitoring markets. As of June 27, 1997, the Company
has shipped approximately 1,759 Cholestech L*D*X System into the physician
office laboratory market. In April 1996, the Company launched its line of
products waived under the Clinical Laboratory Improvement Amendments of 1988.
International revenues increased 38% to $395,000 in the first quarter
of fiscal 1998 from $287,000 in the first quarter of fiscal 1997. The increase
in international revenues reflects a continued product demand in the European
market. International revenues as a percentage of total revenues declined to 9%
the first quarter of fiscal 1998 from 10% in the first quarter of fiscal 1997.
The decrease in international revenues as a percentage of total revenues
reflects the substantial increase in domestic revenues from sales of the
Cholestech L*D*X System during the first year after the Company's product was
granted waived status. The Company expects that international revenues will
continue to decline as a percentage of total revenues in future periods as the
Company continues to increase sales and marketing efforts in the United States.
Cost of Products Sold. Cost of products sold increased 21% to $2.0
million in the first quarter of fiscal 1998 from $1.6 million in the first
quarter of fiscal 1997, as sales of disposable test cassettes and the Cholestech
L*D*X System increased. Gross margin was 53% and 40% in the first quarter fiscal
1998 and fiscal 1997, respectively. The improvement in the gross margin was
attributable to improved cassette manufacturing yields, growth in the volume of
disposable test cassettes and the Cholestech L*D*X Systems sold, without
corresponding increases in unit costs, and improved quality assurance
procedures.
The Company has obtained rights to use certain technology in the
manufacturing of certain of its products. The related agreements, which expire
at various times in calendar 1997 through 2006, provide for the Company to pay
royalties ranging from 2% to 4.6% of net sales of the applicable products. Total
royalty expense in the first quarter of fiscal 1998 and the first quarter of
fiscal 1997 was $162,000 and $111,000, respectively, and was charged to costs of
products sold.
Research and Development. Research and development expense increased
158% to $475,000 in the first quarter of fiscal 1998 from $184,000 in the first
quarter of fiscal 1997. This increase in research and development expense was
attributable to continued development of additional tests and the increase in
headcount. Research and development expenses as a percentage of revenues
increased to 11% in the first quarter of fiscal 1998 from 7% in the first
quarter of fiscal 1997. The increase as a percentage of revenues resulted from
increased investment in new product development and the unusually low level of
research and development expense in the first quarter of fiscal 1997. The
Company is currently developing additional tests to detect disease states such
as metabolic bone diseases and disorders, liver function, prostate cancer and
diabetes. Each of these new tests is at an early stage of development and the
Company will be required to undertake time-consuming and costly development
activities and seek regulatory approval for these new tests before such tests
can bemarketed. However, the Company believes that its future revenue growth and
profitability will depend, in part, upon its ability to complete development and
successfully introduce new test panels designed to extend the Cholestech L*D*X
System's capabilities to include additional tests useful in the diagnostic
screening and therapeutic monitoring markets. The Company currently anticipates
that research and development expenditures will increase in future periods as
product development and manufacturing scale-up efforts for new tests increase.
9
<PAGE>
CHOLESTECH CORPORATION
Sales and Marketing. Sales and marketing expense increased 30% to $1.2
million in the first quarter of fiscal 1998 from $906,000 in the first quarter
of fiscal 1997. The increase in sales and marketing expense was attributable to
continued expansion of the Company's domestic sales and marketing organization,
increased expenses related to the continued penetration in the therapeutic
monitoring market, increased commissions associated with increased revenues and,
to a lesser extent, participation in domestic conferences and trade shows. Sales
and marketing expense fell to 28% of total revenue in the first quarter of
fiscal 1998 from 33% of total revenue in the first quarter of fiscal 1997 as the
Company continues to align its distribution model more closely to the needs of
its customers. The Company currently anticipates that sales and marketing
expense as a percentage of revenue will continue to decline in future periods.
However, the Company expects that the absolute level of sales and marketing
expenses will increase in future periods as the Company continues to expand
sales and marketing activities to address the therapeutic monitoring market.
General and Administrative. General and administrative expense
increased 33% to $553,000 in the first quarter of fiscal 1998 from $415,000 in
the first quarter of fiscal 1997. The increase in general and administrative
expenses resulted primarily from increased investment in the Company's
information systems. General and administrative expenses fell to 13% of total
revenues in the first quarter of fiscal 1998 from 15% in the first quarter of
fiscal 1997. This decrease in general and administrative expense as a percentage
of total revenues occurred due to revenue growth outpacing spending increases in
the administrative functions.
Interest Income (Expense), Net. Interest income (expense), net consists
of interest income earned on investment of cash and marketable security
balances, offset in part by interest expense incurred on capital lease
financing, and for the first quarter of fiscal 1997, other borrowings of the
Company. The Company recorded net interest income of $118,000 in the first
quarter of fiscal 1998. For the first quarter of fiscal 1997, the Company
recognized net interest expense of $23,000. The increase in net interest income
in the first quarter of fiscal 1998, as compared to the same period in fiscal
1997, primarily reflects higher interest income earned on investment of cash
balances generated from the Company's public offering of common stock in June
1996 and lower average borrowings outstanding during the first quarter of fiscal
1998.
Income Taxes. As the Company has significant net operating loss and tax
credit carryforwards, the provision for income taxes for the quarter ended June
27, 1997 represents the estimated alternative minimum tax. Management expects to
utilize additional net operating loss and other tax carryforward amounts to the
extent of income earned during fiscal 1998. According by, the Company's
estimated effective tax rate is expected to remain low throughout fiscal 1998.
10
<PAGE>
CHOLESTECH CORPORATION
Liquidity and Capital Resources
The Company finances its operations primarily through the sale of
equity securities and, to a lesser extent, through capital lease financing. From
inception to June 27, 1997, the Company raised approximately $69 million in net
proceeds from equity financings. As of June 27, 1997, the Company had
approximately $14.0 million of cash, cash equivalents and short-term marketable
securities and such level represented a substantial increase from $409,000 as of
June 28, 1996. In addition, the Company has available a $3 million revolving
bank line of credit agreement. While the agreement is in effect, the Company is
required to maintain on deposit assets with a collective value, as defined in
the line of credit agreement, equivalent to no less than 100% of the outstanding
principal balance. Amounts outstanding under the line of credit bear interest at
the bank's prime rate. The line of credit agreement expires on November 30, 1997
and is renewable. As of June 27, 1997, there were no borrowings outstanding
under the line of credit.
Net cash provided by operating activities was approximately $89,000 in
the first quarter of fiscal 1998 compared to net cash used by operating
activities of $791,000 in first quarter of fiscal 1997. In the first quarter of
fiscal 1998, net income was the primary factor contributing to cash provided by
operating activities. In the first quarter of fiscal 1997, the net loss was the
primary factor contributing to the use of cash by operations. In first quarter
of fiscal 1998, net cash provided by in investing activities reflected the
Company's sale of marketable securities, offset in part by purchases of property
and equipment. During first quarter of fiscal 1997, net cash used in investing
activities reflected the Company's purchases of property and equipment. Net cash
used in financing activities in the first quarter of fiscal 1998 was $4,000 and
reflects principal payments on capital leases, offset in part by the issuance of
Common Stock pursuant to employee stock options, while net cash provided by
financing activities of $1 million in the first quarter of fiscal 1997 reflected
borrowing under the line of credit and issuance of Common Stock.
The Company intends to expend substantial funds for product research
and development, continued expansion of sales and marketing activities,
expansion of manufacturing capacity and other working capital and general
corporate purposes. Although the Company believes that its cash, cash
equivalents and short-term marketable securities balances as of June 27, 1997,
available bank line of credit, together with amounts to be generated from
operations, will be sufficient to meet its capital requirements for the
foreseeable future, there can be no assurance that the Company will not require
additional financing. The Company's actual liquidity and capital requirements
will depend upon numerous factors, including the costs and timing of expansion
of manufacturing capacity, the number and type of new tests the Company seeks to
develop, the costs and timing of expansion of sales and marketing activities,
the extent to which the Company's existing and new products gain market
acceptance, competing technological and market developments, the progress of
commercialization efforts of the Company's distributors, the costs involved in
preparing, filing, prosecuting, maintaining and enforcing patent claims and
other intellectual property rights, developments related to regulatory and third
party reimbursement matters and Clinical Laboratory Improvement Amendments of
1988, and other factors. In the event that additional financing is needed, the
Company may seek to raise additional funds through public or private financing,
collaborative relationships or other arrangements. Any additional equity
financing may be dilutive to shareholders, and debt financing, if available, may
involve restrictive covenants. Collaborative arrangements, if necessary, to
raise additional funds, may require the Company to relinquish its rights to
certain of its technologies, products or marketing territories. The failure of
the Company to raise capital when needed could have a material adverse effect on
the Company's business, financial condition and results of operations. There can
be no assurance that such financing, if required, will be available on
satisfactory terms, if at all.
11
<PAGE>
CHOLESTECH CORPORATION
Potential Factors Affecting Future Operating Results
History of Losses; Uncertainty of Future Profitability. The Company has
experienced significant operating losses since inception and as of June 27,
1997, had an accumulated deficit of $50.4 million. The Company may experience
significant fluctuations in revenues and results of operations on a quarter to
quarter basis in the future. Quarterly operating results will fluctuate due to
numerous factors, such as (i) the timing and level of market acceptance of the
Cholestech L*D*X(R) System, particularly with respect to the therapeutiC
monitoring market; (ii) the timing of introduction and availability of new
tests; (iii) the timing and level of expenditures associated with new product
development activities; (iv) the timing and level of expenditures associated
with expansion of sales and marketing activities and overall operations; (v) the
Company's ability to cost-effectively expand cassette manufacturing capacity and
maintain consistently acceptable yields in the manufacture of disposable test
cassettes; (vi) the timing of establishment of strategic distribution
arrangements and the success of the activities conducted under such
arrangements; (vii) variations in manufacturing efficiencies; (viii) changes in
demand for its products based on changes in third party reimbursement,
competition, changes in government regulation and other factors; (ix) the timing
of significant orders from and shipments to customers; and (x) general economic
conditions. These factors are difficult to forecast, and these or other factors
could have a material adverse effect on the Company's business, financial
condition and results of operations. Fluctuations in quarterly demand for
products may adversely affect the continuity of the Company's manufacturing
operations, increase uncertainty in operational planning, and/or affect cash
flow from operations. The Company's expenses are based in part on the Company's
expectations as to future revenue levels and to a large extent are fixed in the
short-term. If actual revenues do not meet expectations, the Company's business,
financial condition and results of operations could be materially adversely
affected.
Uncertainty of Market Acceptance of the Cholestech L*D*X System. The
Company has generated revenues to date, primarily from sales of the Cholestech
L*D*X System to hospitals, public health departments, corporate wellness
programs, health promotion service providers, managed care organizations,
community health centers, the military, others in the diagnostic screening
market and therapeutic monitoring market . In order for the Company to increase
revenues, achieve sustained profitability and maintain positive cash flows from
operations, the Cholestech L*D*X System must achieve a significant degree of
market acceptance among health care providers in the therapeutic monitoring
market, particularly physician office laboratories. Physicians and other health
care providers are not likely to use the Cholestech L*D*X System unless they
determine that it is an attractive alternative to other means of diagnostic
screening or therapeutic monitoring blood detected diseases. Even if the
advantages of the Cholestech L*D*X System in diagnosing and therapeutic
monitoring patients with blood detected diseases are established, physicians,
medical clinics, pharmacists and other health care providers may elect not to
purchase and use the Cholestech L*D*X System for any number of reasons. As a
result, there can be no assurance that demand for the Cholestech L*D*X System,
particularly in the therapeutic monitoring market, will be sufficient to allow
sustainable profits from operations.
Dependence on Development and Introduction of New Products. The Company
is in the early stages of developing tests designed to extend the Cholestech
L*D*X System's capability to include additional tests useful to health care
providers, particularly physician office laboratories. The Company believes that
its revenue growth and future profitability will depend, in part, upon its
ability to complete development of and successfully introduce these new tests.
The Company will be required to undertake time-consuming and costly development
activities and seek regulatory approval for these new tests. There can be no
assurance that the Company will not experience difficulties that could delay or
prevent the successful development, introduction and marketing of these new
tests, that regulatory clearance or approval of any new tests will be granted by
the FDA or the Center for Disease Control and Prevention (for waived status) on
a
12
<PAGE>
CHOLESTECH CORPORATION
timely basis, if at all, or that the new tests will adequately meet the
requirements of the applicable market or achieve market acceptance. On July 24,
1997, the FDA approved the Company's Section 510(K) Notification to market the
Company's Creatinine and blood urea nitrogen disposable test cassette. The
Company has submitted a request for waived classification to the Centers for
Disease Control and Prevention for the use of the Creatinine and blood urea
nitrogen test cassette with the L*D*X System'. To date, the Centers for Disease
Control and Prevention has not acted upon the Company's request. In order to
successfully commercialize the Creatinine and blood urea nitrogen disposable
test cassette in the United States, the Company believes it is critical to
obtain waived status under the Clinical Laboratory Improvement Amendments of
1988. In order to successfully commercialize any new tests, including the
Creatinine blood urea nitrogen disposable test cassette, the Company will be
required to establish and maintain reliable, cost-efficient, high-volume
manufacturing capacity for such tests. The Company has in the past encountered
difficulties in scaling up production of new test cassettes, including problems
involving production yields, quality control and assurance, variations and
impurities in the raw materials and performance of the manufacturing equipment.
If the Company is unable for technological or other reasons to complete the
development, introduction and scale up of manufacturing of any new tests or if
such new tests do not achieve a significant level of market acceptance, the
Company's business, financial condition and results of operations could be
materially adversely affected.
Limited Sales, Marketing and Distribution Experience; Dependence on
Third Party Distributors. In order for the Company to increase revenues and
achieve sustainable profitability, the Cholestech L*D*X System must achieve a
significant degree of market acceptance among health care providers in the
monitoring market, particularly physician office laboratories and retail
pharmacies. The Company has only limited experience in marketing and selling to
the monitoring market in the United States. In the last twelve months, the
Company has entered into distribution arrangement with two national
distributors, General Medical Inc. and AmeriSource Health Corporation. The
Company may be required to enter into additional distribution arrangements in
order to achieve broad distribution of its products. There can be no assurance
that the Company will be able to enter into and maintain arrangements with
additional distributors on a timely basis, if at all. The Company will be
dependent upon these distributors to assist it in promoting market acceptance
that these distributors will devote the resources necessary to provide effective
sales and marketing support to the Company. In addition, the Company
distributors may give higher priority to the products of other medical
suppliers, thus reducing their efforts to sell the Company's products. If the
Company is unable to establish appropriate arrangements with distributors or if
any of the Company's distributors become unwilling or unable to promote, market
and sell the Cholestech L*D*X System and disposable test cassettes, the
Company's business, financial condition and results of operations would be
materially adversely affected.
Risks Associated with Cassette Manufacturing. The Company internally
manufactures all the disposable test cassettes that are components of the
Cholestech L*D*X System. The manufacture of the disposable test cassettes is a
highly complex and precise process. Such manufacturing is sensitive to a wide
variety of factors, including variations and impurities in the raw materials,
difficulties in the manufacturing process, performance of the manufacturing
equipment and the level of contaminants in the manufacturing environment. The
Company has in the past experienced lower than expected production yields that
have adversely affected gross margins and delayed product shipments. The Company
believes that it may be required to expand manufacturing capacity for new and
existing test cassettes. In fiscal 1997, the Company added a second
manufacturing line for dry chemistry cassettes. The Company intends to add a
third manufacturing line for dry chemistry cassettes in the second or third
quarter of fiscal 1998 to address future constraints on capacity. There can be
no assurance that such expansion of cassette manufacturing capacity can be
completed in a timely fashion, if ever. In addition, the Company may be required
to build a new cassette manufacturing line for the immunoassay test cassettes
under development. To date, the Company has not developed the core technologies,
processes
13
<PAGE>
CHOLESTECH CORPORATION
and productions equipment for an immunoassay cassette manufacturing line. To the
extent the Company does not achieve acceptable manufacturing yields of
disposable test cassettes or experiences product shipment delays, the Company's
business, financial condition and results of operations would be materially
adversely affected.
Highly Competitive Industry; Rapid Technological Change. The diagnostic
screening and therapeutic monitoring markets in which the Company competes is
intensely competitive. The Company's competition consists mainly of independent
clinical laboratories and hospital-based laboratories, as well as manufacturers
of bench top and other preventive care testing systems. In order to achieve
market acceptance for the Cholestech L*D*X System, the Company will be required
to demonstrate that the Cholestech L*D*X System is an attractive alternative to
the clinical laboratory and hospital-based laboratory, as well as bench top and
other preventive care systems. This will require physicians to change their
established means of having such tests performed. The Company expects that the
reclassification of the Cholestech L*D*X System as waived under Clinical
Laboratory Improvement Amendments of 1988 will result in competitors seeking to
develop products that qualify for waived classification. If the BUN/Creatinine
disposable test cassette is not granted waived status, there can be no assurance
that the Company will be able to obtain waived status, that if such status is
not obtained, the BUN/Creatinine cassette will achieve market acceptance or that
competitors will not obtain waived status for a similar product. The Company
expects that such competitors will compete intensely to maintain and increase
their market shares. There can be no assurance that the Company's competitors
will not succeed in obtaining Clinical Laboratory Improvement Amendments of 1988
waived status for their products or in developing or marketing technologies or
products that are more effective and commercially attractive than the Company's
current or future products, or that would render the Company's technologies and
products obsolete or noncompetitive. There can be no assurance that the
Cholestech L*D*X System will be able to compete with the testing services
provided by these laboratories and analyzers.
Dependence on Proprietary Technology, Uncertainty of Patent and
Proprietary Technology Protection, Dependence on License of Technology of Third
Parties. The Company's ability to compete effectively will depend in part on its
ability to develop and maintain proprietary aspects of its technology, and
operate without infringing the proprietary rights of others. Cholestech has
eight United States patents and one foreign issued patent and is currently
prosecuting several patent applications with certain foreign patent offices.
There can be no assurance that any of the Company's pending patent applications
will result in the issuance of any patents, or that, if issued, any assurance
that any patents issued to the Company will not be challenged, invalidated or
circumvented in the future or that the rights created thereunder will provide a
competitive advantage. The medical products industry has been characterized by
extensive litigation regarding patents and other intellectual property rights.
There can be no assurance that the Company will not in the future become subject
to patent infringement claims and litigation or interference proceedings
conducted in the USPTO to determine the priority of inventions. An adverse
determination in litigation or interference proceedings to which the Company may
become a party could subject the Company to significant liabilities to third
parties or require the Company to seek licenses from parties which may not be
available on commercially reasonable terms.
Government Regulation. The manufacture and sale of diagnostic products,
including the Cholestech L*D*X System, are subject to extensive regulation by
numerous governmental authorities, principally the FDA and corresponding state
and foreign regulatory agencies. The Company will not be able to commence
marketing or commercial sales in the United States of any of the new tests until
it receives clearance or approval from the FDA. Additionally, certain material
changes to medical products already cleared or approved by the FDA are also
subject to further FDA review and clearance or approval. The loss of previously
obtained clearances, or
14
<PAGE>
CHOLESTECH CORPORATION
failure to comply with existing or future regulatory requirements would have a
material adverse effect on the Company's business, financial condition and
results of operations. In general, the Company intends to develop and market
tests that will require 510(k) clearance. It generally takes from four to twelve
months from the date of submission to obtain 510(k) clearance, but it can take
longer. In addition, certain of the Company's products under development, such
as the PSA test, may require submission of a pre-market approval application
which is much longer and more costly process and involves the submission of
extensive supporting data and clinical information. A pre-market approval
application may be submitted to the FDA only after clinical trials and the
required patient follow-up for a particular test are successfully completed.
Upon filing of a pre-market approval application, the FDA commences a review
process that generally takes one to three years from the date on which the
pre-market approval application is accepted for filing, but may take
significantly longer. There can be no assurance that the Company's products
under development will require only 510(k) clearance rather than the more
lengthy pre-market approval. A requirement that the company file a pre-market
approval application for a new test would significantly delay the Company's
ability to market such test and significantly increase the costs of development.
Sales of medical devices outside the United States are subject to
regulatory requirements that vary from country to country. The time required to
obtain approval to market medical devices may be shorter or longer than that
required for FDA approval, and the requirements could differ. Such requirements
could adversely effect the Company's ability to sell its products
internationally.
The use of Cholestech's products and those of its competitors is also
affected by Clinical Laboratory Improvement Amendments of 1988 and related
federal and state regulations, which provide for regulation of laboratory
testing. The scope of these regulations includes quality control, proficiency
testing, personnel standards and federal inspections. Clinical Laboratory
Improvement Amendments of 1988 categorizes tests as "waived," or as being
"moderately complex" or "highly complex," on the basis of specific criteria. In
January 1996, the Cholestech L*D*X System and the TC, HDL, triglycerides and
glucose tests in any combination were reclassified as waived under Clinical
Laboratory Improvement Amendments of 1988. In order to successfully
commercialize the tests that are currently under development, the Company
believes that it will be critical to obtain waived classification for such tests
under Clinical Laboratory Improvement Amendments of 1988. There can be no
assurance that any new tests developed by the Company will qualify for the
waived classification, including the creatinine and blood urea nitrogen
disposable test cassette. Any failure of the new tests to obtain waived status
under Clinical Laboratory Improvement Amendments of 1988 will adversely impact
the Company's ability to commercialize such tests, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Uncertainty Relating to Third Party Reimbursement. In the United
States, health care providers, such as hospitals and physicians, that purchase
diagnostic products such as the Company's System, generally rely on third party
payers, principally private health insurance plans, federal Medicare and state
Medicaid, to reimburse all or part of the cost of the procedure in which the
product is being used. The Company's ability to commercialize its products
successfully in the United States will depend in part on the extent to which
reimbursement for the costs of such products and related treatment will be
available from government health authorities, private health insurers and other
organizations. Such third party payers can affect the pricing or the relative
attractiveness of the Company's products by regulating the maximum amount of
reimbursement provided by such payers for testing services. Reimbursement is
currently not available for certain uses of the Company's products. For example,
the cost of the Cholestech L*D*X System is generally not subject to
reimbursement by government and other third party payers. In addition, the tests
performed by public health departments, corporate wellness programs and other
large volume users in the screening market are generally not subject
15
<PAGE>
CHOLESTECH CORPORATION
to reimbursement. In addition, certain health care providers are moving towards
a managed care system in which such providers contract to provide comprehensive
health care for a fixed cost per patient. Failure by physicians and other users
to obtain reimbursement from third party payers, or changes in government and
private third party payers' policies toward reimbursement of test employing the
Company's products could have a material adverse effect on the Company's
business, financial condition and results of operations. Given the efforts to
control and reduce health care costs in the United States in recent years, there
can be no assurance that currently available levels of reimbursement will
continue to be available in the future for the Company's existing products or
products under development.
In addition, market acceptance of the Company's products in
international markets is dependent, in part, upon the availability of
reimbursement within prevailing health care payment systems. Reimbursement and
health care payment systems in international markets vary significantly by
country, and include both government sponsored health care and private
insurance.
Dependence on Suppliers. Certain key components and raw materials used
in manufacturing of the Company's products are currently provided by
single-source vendors. Any supply interruption in a single-source component or
raw material would have a material adverse effect on the Company's ability to
manufacture products until a new source of supply were qualified. There can be
no assurance that the Company will be successful in qualifying additional
sources on a timely basis or at all, which would have a material adverse effect
on the Company's business. In addition, an uncorrected impurity or supplier's
variation in a raw material, either unknown to the Company or incompatible with
the Company's manufacturing process, could have a material adverse effect on the
Company's ability to manufacture products. Also, because the Company is a small
customer of many of its suppliers, there can be no assurance that suppliers will
devote adequate resources to supplying the Company's needs. Any interruption or
reduction in the future supply of any key components or raw materials currently
obtained from single or limited sources could have a material adverse effect on
the Company's business, operating results and financial condition in any given
period.
Dependence on Retention and Attraction of Key Employees. The Company's
success depends in significant part upon the continued service of certain key
scientific, technical, regulatory and managerial personnel, and its continuing
ability to attract and retain additional highly qualified scientific, technical,
clinical, regulatory and managerial personnel. Competition for such personnel is
intense, and there can be no assurance that the Company will be able to retain
such personnel or that it can attract or retain other highly qualified
scientific, technical, clinical, regulatory and managerial personnel in the
future, including key sales and marketing personnel. The loss of key personnel
or the inability to hire or retain qualified personnel could have a material
adverse effect upon the Company's business, financial condition and results of
operations.
Risk of Product Liability; Product Liability Insurance May Be
Insufficient or Unavailable. Sale of the Company's products entails risk of
product liability claims. The medical testing industry has historically been
litigious, and the Company faces financial exposure to product liability claims
in the event that use of its products result in personal injury. The Company
also faces the possibility that defects in the design or manufacture of its
products might necessitate a product recall. The Company currently maintains
product liability insurance with coverage limits of $5.0 million per occurrence
and $5.0 million annually in the aggregate, and there can be no assurance that
the coverage limits of the Company's insurance policies will be adequate. Such
insurance is expensive, difficult to obtain and may not be available in the
future on acceptable terms, or at all. No assurance can be given that product
liability insurance can be maintained in the future at a reasonable cost or in
sufficient amounts to protect the Company against losses due to liability. In
addition, a product liability claim in excess of
16
<PAGE>
CHOLESTECH CORPORATION
relevant insurance coverage or product recall could have a material adverse
effect on the Company's business, financial condition and results of operations.
Issuance of Preferred Stock Could Delay or Prevent Corporate Takeover.
The Board of Directors has the authority to issue up to 5,000,000 shares of
undesignated Preferred Stock and to determine the rights, preferences,
privileges and restrictions of such shares without any further vote or action by
the shareholders. To date, the Board of Directors has designated 25,000 shares
as Series A Participating Preferred Stock in connection with the Company's
Shareholder Rights Plan. The issuance of Preferred Stock under certain
circumstances could have the effect of delaying or preventing a change in
control of the Company or otherwise adversely affecting the rights of the
holders of Common Stock.
On January 22, 1997, pursuant to a Preferred Shares Rights Agreement
(the "Rights Agreement") between the Company and ChaseMellon Shareholder
Services, LLC (the "Rights Agent"), the Company's Board of Directors declared a
dividend of one right (a "Right") to purchase on one-thousandth share of the
Company's Series A Participating Preferred Stock ("Series A Preferred") for each
outstanding share of Common Stock of the Company. The dividend was payable on
March 31, 1997 (the "Record Date") to stockholders of record as of the close of
business on that day. Each Right entitles the registered holder to purchase from
the Company on one-thousandth of a share of Series A Preferred at an exercise
price of $44.00 (the "Purchase Price"), subject to adjustment. The Rights
approved by the Board are designed to protect and maximize the value of the
outstanding equity interests in the Company in the event of an unsolicited
attempt by an acquirer to take over the Company, in a manner or on terms not
approved by the Board of Directors. The Rights have been declared by the Board
in order to deter coercive tactics, including a gradual accumulation of shares
in the open market of a 15% or greater position to be followed by a merger or a
partial or two-tier tender offer that does not treat all stockholders equally.
The Rights should not interfere with any merger or business combination approved
by the Board of Directors. However, the Rights may have the effect of rendering
more difficult or discouraging an acquisition of the Company deemed undesirable
by the Board of Directors. The Rights may cause substantial dilution to a person
or group that attempts to acquire the Company on terms or in a manner not
approved by the Company's Board of Directors, except pursuant to an offer
conditioned upon the negation, purchase or redemption of the Rights.
Potential Volatility of Stock Price. The market price of shares of the
Company's Common Stock, like that of the common stock of many other medical
products and high technology companies, has in the past been, and is likely in
the future to continue to be highly volatile. Factors such as fluctuations in
the Company's operating results, announcements of technological innovations or
new commercial products by the Company or competitors, government regulation,
changes in the current structure of the health care financing and payment
systems, developments in or disputes regarding patent or other proprietary
rights, economic and other external factors and general market conditions may
have a significant effect on the market price of the Common Stock. Moreover, the
stock market has from time to time experienced extreme price and volume
fluctuations which have particularly affected the market prices for medical
products and high technology companies and which have often been unrelated to
the operating performance of such companies. These broad market fluctuations, as
well as general economic, political and market conditions, may adversely affect
the market price of the Company's Common Stock. In the past, following periods
of volatility in the market price of a company's stock, securities class action
litigations have occurred against the issuing company. There can be no assurance
that such litigation will not occur in the future with respect to the Company.
Such litigation could result in substantial costs and a diversion of
management's attention and resources, which could have a material adverse effect
on the Company's business, operating results and financial condition. Any
adverse determination in such litigation could also subject the Company to
significant liabilities.
17
<PAGE>
CHOLESTECH CORPORATION
Absence of Dividends. The Company has not paid any cash dividends since
inception and does not anticipate paying cash dividends in the foreseeable
future.
18
<PAGE>
CHOLESTECH CORPORATION
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the security holders during the
quarter ended June 27, 1997.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
27.1 Financial Data Schedule.
(b) Reports on Form 8-K. No reports on Form 8-K were
filed during the quarter ended June 27, 1997.
19
<PAGE>
CHOLESTECH CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHOLESTECH CORPORATION
Date August 11, 1997 /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)
20
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