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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 26, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from ______ to _____
Commission file number: 000-20198
CHOLESTECH CORPORATION
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-3065493
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
3347 INVESTMENT BOULEVARD, HAYWARD, CA 94545
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (510) 732-7200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for shorter period that the registrant was
required to file such reports); and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
At June 26, 1998, 11,468,207 shares of common stock of the Registrant were
outstanding.
<PAGE> 2
CHOLESTECH CORPORATION
PART I
FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C>
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. 8
PART II
OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS. 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 26
SIGNATURES 27
</TABLE>
2
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CHOLESTECH CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
June 26, 1998 March 27, 1998 (1)
------------- ------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 5,224 $ 5,130
Marketable securities 8,034 9,621
Accounts receivable, net 2,189 3,793
Inventories 5,313 3,306
Prepaid expenses and other current assets 178 154
-------- --------
Total current assets 20,938 22,004
Property and equipment, net 4,387 3,711
Other assets, net 75 73
-------- --------
$ 25,400 $ 25,788
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 3,126 $ 3,003
Accrued payroll and benefits 1,007 1,136
Product warranty 203 203
-------- --------
Total current liabilities 4,336 4,342
Shareholders' equity:
Preferred stock -- --
Common stock 70,104 69,880
Accumulated other comprehensive income 28 49
Accumulated deficit (49,068) (48,483)
-------- --------
Total shareholders' equity 21,064 21,446
-------- --------
$ 25,400 $ 25,788
======== ========
</TABLE>
(1) The information in this column was derived from the Company's audited
financial statements for the fiscal year ended March 27, 1998.
See Notes to Condensed Financial Statements
3
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CHOLESTECH CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Quarter ended
---------------------------------
June 26, 1998 June 27 1997 (1)
------------- ----------------
<S> <C> <C>
Revenues:
Domestic $ 4,171 $ 3,808
International 514 395
-------- --------
4,685 4,203
Cost of product sold 1,902 1,996
-------- --------
Gross profit 2,783 2,207
-------- --------
Operating expenses:
Sales and marketing 1,628 1,256
Research and development 699 505
General and administrative 485 446
Other 750 --
-------- --------
Total operating expenses 3,562 2,207
-------- --------
Income (loss) from operations (779) 0
Interest income (expense), net 194 122
-------- --------
Income (loss) before taxes (585) 122
Provision for income taxes -- 3
Net income (loss) $ (585) $ 119
======== ========
Net income (loss) per share
Basic $ (.05) $ .01
======== ========
Diluted $ (.05) $ .01
======== ========
Shares used to compute net income (loss) per share
Basic 11,460 11,226
======== ========
Diluted 11,460 11,599
======== ========
</TABLE>
(1) Certain reclassifications have been made to the prior quarter ended June 27,
1997 financial statements to conform to the fiscal 1999 presentation. Such
reclassifications had no effect on previously reported results of operations.
See Notes to Condensed Financial Statements
4
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CHOLESTECH CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Quarter ended
-----------------------------
June 26, 1998 June 27, 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (585) $ 119
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization 316 221
Changes in assets and liabilities:
Accounts receivable 1,604 (321)
Inventories (2,007) (200)
Prepaid expenses and other assets (24) (111)
Other assets (2) 4
Accounts payable and accrued expenses 123 487
Accrued payroll and benefits (129) (145)
------- -------
Net cash provided by (used in) operating activities (704) 54
------- -------
Cash flows from investing activities:
Proceeds from sale of marketable securities 4,826 5,441
Purchases of marketable securities (3,261) (3,726)
Purchases of property and equipment (991) (159)
------- -------
Net cash provided by (used in) investing activities 574 1,556
------- -------
Cash flows from financing activities:
Issuance of common stock 224 31
------- -------
Net cash provided by (used in) financing activities 224 31
------- -------
Net change in cash and cash equivalents 94 1,641
Cash and cash equivalents at beginning of period 5,130 6,088
------- -------
Cash and cash equivalents at end of period $ 5,224 $ 7,729
======= =======
</TABLE>
See Notes to Condensed Financial Statements
5
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CHOLESTECH CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. INTERIM RESULTS
The interim unaudited financial information of Cholestech Corporation
(the "Company") is prepared in conformity with generally accepted
accounting principles and such principles are applied on a basis
consistent with the audited financial information contained in the
Annual Report on Form 10-K filed with the Securities and Exchange
Commission on May 5, 1998. The financial information included herein
has been prepared by management, without audit by independent
accountants who do not express an opinion thereon, and should be read
in conjunction with the audited financial statements contained in the
Annual Report on Form 10-K for the fiscal year ended March 27, 1998.
The condensed balance sheet as of March 27, 1998 has been derived from,
but does not include all the disclosures contained in, the audited
financial statements for the year ended March 27, 1998. The information
furnished includes all adjustments and accruals consisting only of
normal recurring accrual adjustments that are, in the opinion of
management, necessary for a fair presentation of results for the
interim periods. Certain information or footnote disclosure normally
included in financial statements prepared in accordance with generally
accepted accounting principles has been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission.
The foregoing interim results are not necessarily indicative of the
results of operations for the full fiscal year ending March 26, 1999.
2. BALANCE SHEET DATA
The components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 26, 1998 MARCH 27, 1998
------------- --------------
<S> <C> <C>
Raw materials $1,137 $1,292
Work-in-process 1,960 1,038
Finished goods 2,216 976
------ ------
$5,313 $3,306
====== ======
</TABLE>
3. EARNINGS PER SHARE
Basic earnings per share is computed by dividing income (loss)
available to common shareholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period.
Diluted earnings per share gives effect to all potential Common Stock
outstanding during a period, if dilutive. In computing diluted earnings
per share, the average stock price is used in determining the number of
shares assumed to be repurchased from the exercise of stock options.
The following table reconciles the numerator and denominator of the
basic and diluted earnings (loss) per share computations for the
periods presented.
6
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CHOLESTECH CORPORATION
(In thousands except per share data)
<TABLE>
<CAPTION>
Fiscal Quarter Ended Fiscal Quarter Ended
June 26, 1998 June 27, 1997
--------------------------------- --------------------------------
Income (loss) Shares Per share Income Shares Per share
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $ (585) 11,460 $ (.05) $ 119 11,226 $ .01
Effect of dilutive
securities -- 312
--------------------------------- --------------------------------
Diluted EPS $ (585) 11,460 $ (.05) $ 119 11,538 $ .01
================================= ================================
</TABLE>
4. BORROWING ARRANGEMENTS
In December 1997, the Company renewed an agreement with 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 a 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, 1998 and is renewable. As of June 26, 1998, there were
no borrowings outstanding under the line of credit.
5. NEW ACCOUNTING PRONOUNCEMENTS
The Company adopted statement of Financial Accounting Standards Board
("SFAS") issued No. 130, "Reporting Comprehensive Income." SFAS No. 130
establishes standards for reporting and display of comprehensive income
and its components in a full set of general purpose financial
statements that is displayed with the same prominence as other
financial statements. Comprehensive income, as defined, includes all
changes in equity (net assets) during a period from non-owner sources,
including unrealized gains and losses on available-for-sale securities.
For the quarter ended June 26, 1998 and June 27, 1997, comprehensive
income (loss) approximated net income (loss).
The Company adopted SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information" in the first quarter of fiscal
1999. This statement establishes standards for the way companies report
information about operating segments in annual financial statements. It
also establishes standards for related disclosures about products and
services, geographic areas and major customers. The adoption of SFAS
No. 131 has not resulted in a change in the way the Company reports
information.
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities."
SFAS No. 133 establishes standards for accounting and reporting on
derivative instruments for periods beginning after June 15, 1999 and
early adoption is permitted. SFAS No. 133 requires that all derivative
instruments be recognized in the balance sheet as either assets or
liabilities and measured at fair value. Furthermore, SFAS No. 133
requires current recognition in earnings of changes in the fair value
of derivative instruments depending on the intended use of the
derivative and the resulting designation. The Company is currently
evaluating the effects of the new standard and has not determined its
method or timing of adopting SFAS No. 133 or the impact on its
financial statements. However, the new standard requirement to reflect
at market financial instruments utilized to hedge currency will result
in fluctuations in the fair value being included in shareholders'
equity, net of tax.
7
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CHOLESTECH CORPORATION
6. SHAREHOLDER RIGHTS PLAN
In January 1997, the Board of Directors approved a shareholder
rights plan under which shareholders of record on March 31, 1997
received a right to purchase (the "Right") one-thousandth of a share of
Series A Participating Preferred Stock at an exercise price of $44.00,
subject to adjustment. The Rights will separate from the Common Stock
and Rights certificates will be issued and will become exercisable upon
the earlier of: (i) 10 days (or such later date as may be determined by
a majority of the Board of Directors) following a public announcement
that a person or group of affiliated or associated persons has
acquired, or obtained the right to acquire, beneficial ownership of 15%
or more of the Company's outstanding Common Stock or (ii) 10 business
days following the commencement of, or announcement of an intention to
make, a tender offer or exchange offer, the consummation of which would
result in the beneficial ownership by a person or group of 15% or more
of the Company's outstanding Common Stock. The Rights expire on the
earlier of (i) January 22, 2007 or (ii) redemption or exchange of the
Rights.
7. OTHER EVENTS
In June 1998 the Company cancelled its proposed common stock offering.
This led to a non-recurring charge of approximately $500,000, or $(.04)
per share (diluted) related to the write-off of the offering expenses,
which was recorded in the quarter ended June 26, 1998.
In May 1998 the Company settled an outstanding litigation with a former
employee of the Company. In accordance with the settlement, the Company
agreed to a settlement fee of $250,000, or $(.02) per share (diluted),
which was charged to operating income in the quarter ended June 26,
1998.
8
<PAGE> 9
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 and regulatory approvals for its
products, 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 tests for new disease
states and the Company's anticipation that research and development expenditures
will increase, and the statement in the third paragraph under "Liquidity and
Capital Resources" that the Company's liquid assets and cash from operations
will be sufficient to meet its capital requirements for the foreseeable future.
GENERAL
The Company develops, manufactures and markets the Cholestech L*D*X
System which performs near-patient diagnostic screening and therapeutic
monitoring for the management of prevalent chronic diseases (preventive care
testing). The L*D*X System is capable of measuring multiple analytes
simultaneously with a single drop of whole blood within five minutes. The
Company currently markets the L*D*X System, including the L*D*X Analyzer and a
variety of single use test cassettes, to the physician office laboratory (POL),
pharmacy and health promotion markets, in the United States and internationally.
The Company has experienced significant operating losses and, as of June 26,
1998, had an accumulated deficit of $49.0 million. The L*D*X System, including
the L*D*X Analyzer (the Company's only product platform) and single use test
cassettes, will continue to account for substantially all of the Company's
revenues for the foreseeable future. In order for the Company to increase
revenues, sustain profitability and maintain positive cash flows from
operations, the L*D*X System must continue to gain market acceptance among
health care providers, particularly in POLs and pharmacies, to which the Company
has made only limited sales to date. The Company is developing certain
additional tests designed to extend the capabilities of the L*D*X System. The
Company believes that its future growth will depend, in part, upon its ability
to complete development of and successfully introduce these new tests. The
Company may incur negative cash flows from operations as it expands
manufacturing capacity for existing and new test cassettes, increases product
research and development efforts for new test cassettes, and expands sales and
marketing activities and pursues regulatory clearances and approvals. The
development and commercialization of new tests will require additional
development, sales and marketing, manufacturing and other expenditures. The
required level and timing of such expenditures will have an impact on the
Company's ability to maintain profitability and positive cash flows from
operations. The Company expects its product mix to change from time to time, and
these changes will affect the Company's revenues and operating results. For
example, the Company has recently entered the POL and pharmacy markets. In its
limited experience, the Company generally has found that these markets use a
higher proportion of lipid profile cassettes for therapeutic monitoring
purposes, which test cassettes typically have higher selling prices and
associated gross margins than the Company's other tests. However, the Company
has also
9
<PAGE> 10
CHOLESTECH CORPORATION
experienced a relatively lower rate of testing per day in these markets than in
the health promotion market.
RESULT OF OPERATIONS
QUARTER ENDED JUNE 26, 1998 VS. QUARTER ENDED JUNE 27, 1997
For the quarter ended June 26, 1998, the Company experienced a net loss of
$585,000 ($.05 per share) compared to net income of $119,000 ($.01 per share)
for the quarter ended June 27, 1997. The net loss is attributable to the
combined effects of the revenue shortfall and non-recurring expenses described
below in "Revenues" and "Other," respectively.
Revenues. The Company's revenues increased 11% to $4.7 million in first
quarter ended June 26, 1998 from $4.2 million in first quarter ended June 27,
1997. The increase in revenues primarily reflects increased unit sales of single
use test cassettes and L*D*X analyzers to health care providers in the POL,
pharmacy and health promotion markets. The Company's revenues for the quarter
ended June 26, 1998 were down by 26.8% from revenues of $6.4 million for the
quarter ended March 27, 1998. The revenue reduction is largely due to the delay
of certain key distribution relationships, as well as a slower than expected
distributor sales in the United States.
International revenues increased by 30.1% from $395,000 to $514,000 from
the quarter ended June 27, 1997 to the quarter ended June 26, 1998.
International sales decreased by 62.7%, from $1.4 million to $519,000 from
quarter ended March 27, 1998 to the quarter ended June 26, 1998. This sharp
decline is primarily the result of lower distributor sales.
International revenues represented 10.9% and 9.3% of revenues in the first
quarter of fiscal 1999 and fiscal 1998, respectively. The Company expects that
the dollar amount and proportion of international revenues may fluctuate from
period to period.
Cost of Products Sold. Cost of products sold includes direct labor, direct
material, overhead and royalties. Cost of products sold decreased 4.7% to $1.9
million in first quarter of fiscal 1999 from $2.0 million in first quarter of
fiscal 1998, primarily as a result of decreased unit sales of single use test
cassettes and L*D*X analyzers. Gross margin was 59.4% and 52.5% in first quarter
of fiscal 1999 and 1998, respectively. The improvement in gross margin was
primarily attributable to increased volume of single use test cassettes
manufactured without corresponding percentage increases in manufacturing costs,
improving the absorption of manufacturing overhead and reducing unit costs.
The Company has licensed certain technology used in the manufacturing of
its disposable cassette products. A related agreement, which expires in 2006,
requires the Company to pay a royalty of 2.0% on net sales of the applicable
products. Total royalty expense in the first quarter of fiscal 1999 and 1998 was
$131,000 and $162,000, respectively, and such amounts were charged to cost of
products sold.
Sales and Marketing Expenses. Sales and marketing expense includes
salaries, commissions, bonuses, expenses for outside services related to
marketing programs and travel expenses. Sales and marketing expense increased
29.6% to $1.6 million in first quarter of fiscal 1999 from $1.3 million in first
quarter of fiscal 1998. This increase was primarily attributable to continued
expansion of the Company's domestic sales and marketing programs and increased
expenses related to greater penetration of the POL and pharmacy markets. Sales
and marketing expense increased to 34.7% of revenues in the first quarter of
fiscal 1999 from 29.9% in the first quarter of fiscal 1998, primarily due to
lower then anticipated revenue. The Company anticipates that the dollar amount
of sales and marketing expense will increase in future periods as the Company
continues to expand sales and marketing activities, particularly in the POL and
pharmacy markets.
Research and Development Expenses. Research and development expense
includes salaries, bonuses, expenses for outside services, supplies and
amortization of capital equipment. Research and development expense increased
38.4% to $699,000 in the first quarter of fiscal
10
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CHOLESTECH CORPORATION
1999 from $505,000 in the first quarter of fiscal 1998. This increase was
primarily attributable to continued development of new single use test cassettes
and a related increase in headcount. Research and development expenses as a
percentage of revenues increased to 14.9% for the first quarter ended June 26,
1998 from 12% for the first quarter ended June 27, 1997. This increase as a
percentage of revenues is largely attributable to lower then anticipated
revenue. The Company is currently developing additional tests for diagnostic
screening and therapeutic monitoring of osteoporosis, liver damage,
cardiovascular disease and diabetes. These new tests are in various stages of
development, and the Company will be required to undertake time consuming and
costly development activities and seek regulatory approval for these new tests
before such tests can be marketed. The Company believes that revenue growth, if
any, and future operating results will depend, in part, upon completing
development of and successfully introducing these tests. The Company currently
anticipates that the dollar amount of research and development expense will
increase significantly in future periods as costs associated with product
development and manufacturing scale up efforts for new cassettes are incurred.
General and Administrative Expenses. General and administrative expense
includes compensation, benefits and expenses for outside services. General and
administrative expense increased 8.7% to $485,000 in the first quarter of fiscal
1999 from $446,000 in first quarter of fiscal 1998. This increase resulted
primarily from an increased utilization of professional services. General and
administrative expenses fell to 10.4% of revenues in first quarter of fiscal
1999 from 10.6% in first quarter of fiscal 1998 due to higher revenues which
more than offset increased general and administrative expenditures
Other. Other expenses of $750,000 reflect non-recurring charges of
approximately $500,000 due to the cancellation of a proposed common stock
offering and $250,000 due to settlement of litigation involving a former
employee.
Interest income (expense), net. Interest income reflects income from
the investment of cash balances and marketable securities. Interest income rose
59% to $194,000 in first quarter of fiscal 1999 from $122,000 in the first
quarter of fiscal 1998. This increase was primarily the result of higher average
amounts invested in cash equivalents and marketable securities in the first
quarter of fiscal 1999 over fiscal 1999.
Income Taxes. No provision for income taxes was made in the first
quarter ended June 26, 1998 as the Company incurred a net loss from operations.
As the Company has significant net operating loss and tax credit carryforwards,
the provisions for income taxes for the first quarter ended June 27, 1997 of
$3,000 represent the estimated alternative minimum tax. Management expects to
utilize additional net operating loss and other tax carryforward amounts to the
extent income is earned during fiscal 1999. Accordingly, the Company's estimated
effective tax rate is expected to remain below the federal statutory rate
throughout fiscal 1999.
New Accounting Pronouncements. The Company adopted statement of
Financial Accounting Standards Board ("SFAS") issued No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements that is displayed with the same prominence as other
financial statements. Comprehensive income, as defined, includes all changes in
equity (net assets) during a period from non-owner sources, including unrealized
gains and losses on available-for-sale securities. For the quarter ended June
26, 1998 and June 27, 1997, comprehensive income (loss) approximated net income
(loss).
The Company adopted SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information" in the first quarter of fiscal 1999. This
statement establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. The adoption of SFAS No. 131 has not resulted in a change in the way
the Company reports information.
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 establishes standards for accounting and reporting on derivative instruments
for periods beginning after June 15, 1999 and early adoption is permitted. SFAS
No. 133 requires that all derivative instruments be recognized in the balance
sheet as either assets or liabilities and measured at fair value. Furthermore,
SFAS No. 133 requires current recognition in earnings of changes in the fair
value of derivative instruments depending on the intended use of the derivative
and the resulting designation. The Company is currently evaluating the effects
of the new standard and has not determined its method or timing of adopting SFAS
No. 133 or the impact on its financial statements. However, the new standard
requirement to reflect at market financial instruments utilized to hedge
currency will result in fluctuations in the fair value being included in
shareholders' equity, net of tax.
11
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CHOLESTECH CORPORATION
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through product
sales, the sale of equity securities and, during fiscal 1998, from positive cash
flows from operations. From inception to June 26, 1998, the Company raised
approximately $70.1 million in net proceeds from equity financings. As of June
26, 1998, the Company had approximately $13.3 million of cash, cash equivalents
and short term marketable securities and an accumulated deficit of $49 million.
In addition, the Company has available a $3 million revolving bank line of
credit agreement. While the revolving line is in effect, the Company is required
to maintain on deposit assets with a collective value, as defined in the line of
credit agreement, equivalent to no less than 100% of the outstanding principal
balance. Amounts outstanding under the line of credit bear interest at the
bank's prime rate. The line of credit agreement expires on November 30, 1998 and
is renewable. As of June 26, 1998, there were no borrowings outstanding under
the line of credit.
Net cash used in operating activities was $704,000 during the first
quarter of fiscal 1999, compared to net cash provided by operating activities of
$54,000 during the first quarter of fiscal 1998. In first quarter of fiscal
1999, the net loss and inventory were the primary factors contributing to cash
used in operating activities both of which are attributable to lower than
expected sales. In the first quarter of fiscal 1998, strong improvement in
operating results was the primary factor contributing to cash provided by
operating activities. Net cash provided by investing activities of $574,000 in
first quarter of fiscal 1999 and $1.6 million in the first quarter of fiscal
1998 resulted primarily from the Company's sale of marketable securities. The
decrease between the two periods is primarily attributable to capital
investments related to manufacturing line. Net cash provided by financing
activities of $224,000 in the first quarter of fiscal 1999 and $31,000 in the
first quarter of fiscal 1998 reflected the issuance of Common Stock pursuant to
the stock incentive program. The Company intends to expend substantial funds for
capital expenditures related to expansion of its manufacturing capacity,
research and development, including expansion of its product line and
enhancement of its current products, expansion of sales and marketing activities
and other working capital and general corporate purposes.
Despite the Company's cancellation of its proposed equity
financing in the second quarter of fiscal 1999, the Company believes that the
Company's cash, cash equivalents, marketable securities, cash flows anticipated
to be generated by future operations and available bank borrowings under an
existing line of will be sufficient to meet its capital requirements for the
foreseeable future. However, there can be no assurance that the Company will not
require additional financing. For example, the Company may be required to expend
greater than anticipated funds if unforeseen difficulties arise in expanding
manufacturing capacity for existing cassettes or in
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CHOLESTECH CORPORATION
the course of completing required additional development, obtaining necessary
regulatory approvals, obtaining waived status under the Clinical Laboratory
Improvement Amendments of 1988 ("CLIA") or introducing or scaling up
manufacturing for new tests. The Company's future liquidity and capital
requirements will depend upon numerous additional factors, including: the costs
and timing of expansion of manufacturing capacity; the number and type of new
tests the Company seeks to develop; the success of these development efforts;
the costs and timing of expansion of sales and marketing activities; the extent
to which the Company's existing and new products gain market acceptance;
competing technological and market developments; the progress of
commercialization efforts of the Company's distributors; the costs involved in
preparing, filing, prosecuting, maintaining and enforcing patent claims and
other intellectual property rights; developments related to regulatory and third
party reimbursement matters and CLIA; and other factors. In the event that
additional financing is needed, the Company may seek to raise additional funds
through public or private financing, collaborative relationships or other
arrangements. Any additional equity financing may be dilutive to shareholders,
and debt financing, if available, may involve restrictive covenants.
Collaborative arrangements, if necessary to raise additional funds, may require
the Company to relinquish its rights to certain of its technologies, products or
marketing territories. The failure of the Company to raise capital on acceptable
terms when needed could have a material adverse effect on the Company's
business, financial condition and results of operations. See "--Potential
Factors Affecting Future Operating Results -- Possible Future Capital
Requirements; Uncertainty of Additional Funding."
POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS
UNCERTAINTY OF MARKET ACCEPTANCE OF THE L*D*X SYSTEM. The Cholestech L*D*X
System, including the L*D*X Analyzer (the Company's only product platform) and
single use test cassettes, will continue to account for substantially all of the
Company's revenues for the foreseeable future. In order for the Company to
increase revenues, sustain profitability and maintain positive cash flows from
operations, the L*D*X System must continue to gain market acceptance among
health care providers, particularly physician office laboratories (POLs) and
pharmacies, to which the Company has made only limited sales to date.
Physicians, pharmacists and other health care providers are not likely to use
the L*D*X System unless they determine that it is an attractive alternative to
other means of diagnostic screening or therapeutic monitoring of chronic
diseases. Such determination will depend, in part, upon the L*D*X System's
accuracy, ease of use, rapid test time, reliability and cost effectiveness, as
well as the availability and amount of third party reimbursement. Even if the
advantages of the L*D*X System in diagnosing and monitoring patients with
chronic diseases are established, health care providers may elect not to
purchase and use the L*D*X System for any number of reasons. For example,
physicians and other health care providers may not change their established
means of having such tests performed or may not make the necessary investment to
purchase the L*D*X Analyzer. In addition, the growing prevalence of managed care
may adversely affect the POL market. A growing number of physicians are salaried
employees and have no financial incentive to perform testing. Many managed care
organizations have contracts with laboratories, which require participating or
employed physicians to send patient specimens to contracted laboratories.
Finally, physicians are under growing pressure by Medicare and other third party
payors to limit their testing to "medically necessary" tests. Market acceptance
of the L*D*X System by pharmacists will in part depend on the continued
availability and amount of reimbursement to them for performing tests on the
L*D*X System. Even if the Company is successful in continuing
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to place L*D*X Analyzers at POLs, pharmacies and other near-patient testing
sites, there can be no assurance that placement of L*D*X Analyzers will result
in sustained demand for the Company's single use test cassettes. As a result,
there can be no assurance that demand for the L*D*X System will be sufficient to
sustain revenues and profits from operations. Because the L*D*X System currently
represents the Company's sole product focus, the Company could be required to
cease operations if the L*D*X System does not achieve and maintain a significant
level of market acceptance.
HISTORY OF LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY; FLUCTUATIONS IN
OPERATING RESULTS. The Company may experience significant fluctuations in
revenues and results of operations on a quarter to quarter basis in the future.
Quarterly operating results will fluctuate due to numerous factors, including:
(i) the timing and level of market acceptance of the L*D*X System; (ii) the
timing of the introduction and availability of new tests; (iii) the timing and
level of expenditures associated with development activities; (iv) the timing
and level of expenditures associated with expansion of sales and marketing
activities and overall operations; (v) the Company's ability to cost-effectively
expand cassette manufacturing capacity and maintain consistently acceptable
yields in the manufacture of cassettes; (vi) variations in manufacturing
efficiencies; (vii) the timing of establishment of strategic distribution
arrangements and the success of the activities conducted under such
arrangements; (viii) changes in demand for its products based on changes in
third party reimbursement, competition, changes in government regulation and
other factors; (ix) the timing of significant orders from and shipments to
customers; (x) product pricing and discounts; (xi) variations in the mix of
products sold; and (xii) general economic conditions. These factors are
difficult to forecast, and these or other factors could have a material adverse
effect on the Company's business, financial condition and results of operations.
Fluctuations in quarterly demand for the Company's products may adversely affect
the continuity of the Company's manufacturing operations, increase uncertainty
in operational planning and/or affect cash flows from operations. The Company's
expenses are based in part on the Company's expectations as to future revenue
levels and to a large extent are fixed in the short term. As a result, if actual
revenues do not meet expectations, the Company's ability to adjust spending
levels in the short term will be limited and its business, financial condition
and results of operations could be materially adversely affected. In addition,
as a result of these fluctuations, it is likely that in some future period the
Company's results will not meet the expectations of public market security
analysts or investors. In such event, the trading price of the Common Stock
could be materially adversely affected.
DEPENDENCE ON DEVELOPMENT, INTRODUCTION AND MARKET ACCEPTANCE OF NEW TESTS.
The Company is at various stages of development of tests designed to extend the
capabilities of the L*D*X System. The Company believes that its revenue growth
and future operating results will depend, in part, upon its ability to complete
development of and successfully introduce these new tests. The Company will be
required to undertake time-consuming and costly development, sales and
marketing, manufacturing and other activities, as well as seek regulatory
approval for these new tests. There can be no assurance that the Company will
not experience difficulties that could delay or prevent the successful
development, introduction and marketing of these new tests, that regulatory
clearance or approval of any new tests will be granted by the FDA or the CDC
(for CLIA waived status) on a timely basis, or at all, that the new tests will
adequately meet the requirements of the applicable market or achieve market
acceptance or that the Company will be
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CHOLESTECH CORPORATION
able to achieve and maintain cost efficient, high volume manufacturing capacity
for any new tests. In July 1997, the FDA approved the Company's request for
clearance to market the Company's BUN/Creatinine single use test cassette
pursuant to Section 510(k) of the FDC Act. In September 1997, the Company
submitted to the CDC a request for CLIA waiver for the use of the BUN/Creatinine
test cassette with the L*D*X System. The CDC has not yet acted upon the
Company's request and because the CDC's evaluation of applications for CLIA
waived status is not based upon precisely defined objectively measurable
criteria, the Company cannot predict the likelihood of obtaining waived status.
In order to successfully commercialize the BUN/Creatinine test cassette or other
future tests in the United States, the Company believes it is critical to obtain
waived status under CLIA. In order to successfully commercialize any new tests,
including the BUN/Creatinine test cassette, the Company will be required to
establish and maintain reliable, cost-efficient, high-volume manufacturing
capacity for such tests. The Company has in the past encountered difficulties in
scaling up production of new test cassettes, including problems involving
production yields, quality control and assurance, variations and impurities in
the raw materials and performance of the manufacturing equipment.
In May 1996, the Company entered into a development, marketing and
licensing agreement with Metra Biosystems to develop an immunoassay cassette
incorporating Metra Biosystems' bone resorption technology to be used on the
L*D*X System. Metra Biosystems has the right to terminate the agreement at any
time. If the Company is unable, for technological or other reasons, to complete
the development, introduction and scale up of manufacturing of any new tests, if
the Company fails to obtain regulatory approval for any such tests on a timely
basis or if such new tests do not achieve a significant level of market
acceptance, the Company's business, financial condition and results of
operations would be materially adversely affected.
RISKS ASSOCIATED WITH CASSETTE MANUFACTURING. The Company internally
manufactures all of the single use test cassettes that are used with the L*D*X
Analyzer. The manufacture of the test cassettes is a highly complex and precise
process. Such manufacturing is sensitive to a wide variety of factors, including
raw material variations and impurities, manufacturing process variances,
manufacturing equipment performance and manufacturing environment contaminants.
The Company has in the past experienced lower than expected manufacturing yields
that have adversely affected gross margins and delayed product shipments. To the
extent that the Company does not maintain acceptable manufacturing yields of
test cassettes or experiences product shipment delays, the Company's business,
financial condition and results of operations would be materially adversely
affected. The Company's cassette manufacturing lines would be costly and time
consuming to repair or replace if their operation were interrupted. As the
Company's production levels have increased, the Company has been required to use
its machinery more hours per day and the down time resulting from equipment
failure has increased. The custom nature of much of the Company's manufacturing
equipment increases the time required to remedy equipment failures and replace
equipment. Furthermore, the Company has a limited number of employees dedicated
to the operation and maintenance of the cassette manufacturing equipment, the
loss of whom could impact the Company's ability to effectively operate and
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CHOLESTECH CORPORATION
service such equipment. The interruption of cassette manufacturing operations or
the loss of employees dedicated to the cassette manufacturing facility could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company manufactures all of the cassettes at its
Hayward, California manufacturing facility, and any prolonged inability to
utilize such facility as a result of earthquake, fire or otherwise would have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company believes that it will be required to expand its manufacturing
capacity for new and existing test cassettes. The Company currently operates two
manufacturing lines for dry chemistry cassettes. The Company is currently
planning and building a third manufacturing line that the Company anticipates
will become operational in fiscal 2000. There can be no assurance that such
expansion of cassette manufacturing capacity can be completed in a timely
fashion, if ever, or that the Company would not need to increase manufacturing
capacity sooner. In addition, the custom nature of much of the Company's
manufacturing equipment increases the time required to expand manufacturing
capacity. The Company also will be required to build a new cassette
manufacturing line in order to manufacture the immunoassay test cassettes under
development. To date, the Company has not developed the processes and production
equipment necessary for an immunoassay cassette manufacturing line. Failure to
expand manufacturing capacity for dry chemistry tests or to successfully develop
an immunoassay cassette manufacturing line and achieve acceptable yields could
lead to an inability to satisfy customer orders and could have a material
adverse effect on the Company's business, financial condition and results of
operations.
DEPENDENCE ON SUPPLIERS. Single source vendors currently provide certain
subassemblies, components and raw materials used in the manufacture of the
Company's products. Any supply interruption in a single source subassembly,
component or raw material could have a material adverse effect on the Company's
ability to manufacture products until a new source of supply is identified and
qualified. There can be no assurance that the Company will be successful in
qualifying additional sources of supply on a timely basis, or at all, and
failure to do so could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, an uncorrected
impurity or supplier's variation in a raw material, either unknown to the
Company or incompatible with the Company's manufacturing process, could have a
material adverse effect on the Company's ability to manufacture products.
Because the Company is a small customer of many of its suppliers and purchases
its subassemblies, components and materials on a purchase order basis, rather
than pursuant to long term commitments, there can be no assurance that the
Company's suppliers will devote adequate resources to supplying the Company's
needs. Any interruption or reduction in the future supply of any subassemblies,
components or raw materials currently obtained from single or limited sources
could have a material adverse effect on the Company's business, financial
condition and results of operations.
NEED TO MANAGE EXPANDING OPERATIONS. If the Company is successful in
achieving and maintaining market acceptance for the L*D*X System, the Company
will be required to expand its operations, particularly in the areas of sales
and marketing and manufacturing. As the Company expands its operations in these
areas, such expansion will likely result in new and increased responsibilities
for management personnel and place significant strain upon the
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CHOLESTECH CORPORATION
Company's management, operating and financial systems and resources. To
accommodate any such growth and compete effectively, the Company will be
required to implement and improve its information systems, procedures and
controls, and to expand, train, motivate and manage its work force. There can be
no assurance that the Company's personnel, systems, procedures and controls will
be adequate to support the Company's future operations. Any failure to implement
and improve the Company's operational, financial and management systems or to
expand, train, motivate or manage employees as required by future growth, if
any, could have a material adverse effect on the Company's business, financial
condition and results of operations.
LIMITED SALES, MARKETING AND DISTRIBUTION EXPERIENCE; DEPENDENCE ON THIRD
PARTY DISTRIBUTORS. In order for the Company to increase revenues and sustain
profitability, the L*D*X System must achieve a significant degree of market
acceptance among health care providers and third party payors. The Company has
only limited experience in marketing and selling to the therapeutic monitoring
market in the United States and relies on third party distributors in this
market. There can be no assurance that the Company will be able to maintain its
existing distribution relationships. The Company also will be required to enter
into additional distribution arrangements in order to achieve broader
distribution of its products, particularly into the pharmacy market. There can
be no assurance that the Company will be able to enter into and maintain such
arrangements on a timely basis, if at all. The Company is dependent upon such
distributors to assist it in promoting market acceptance of the L*D*X System. It
is uncertain whether distributors will devote the resources necessary to provide
effective sales and marketing support to the Company. In addition, the Company's
distributors may give higher priority to the products of other medical
suppliers, thus reducing their efforts to sell the Company's products. If the
Company is unable to establish appropriate arrangements with distributors, or if
any of the Company's distributors do not promote, market and sell the L*D*X
Analyzer and single use test cassettes, the Company's business, financial
condition and results of operations could be materially adversely affected.
UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT. In the United States,
health care providers that purchase products such as the L*D*X System generally
rely on third party payors, including private health insurance plans, federal
Medicare, state Medicaid and managed care organizations, to reimburse all or
part of the cost of the procedure in which the product is being used. The
Company's ability to commercialize its products successfully in the United
States will depend in part on the extent to which reimbursement for the costs of
tests performed with the L*D*X System and related treatment will be available
from government health authorities, private health insurers and other third
party payors. Third party payors can affect the pricing or the relative
attractiveness of the Company's products by regulating the maximum amount of
reimbursement provided for testing services. Reimbursement is currently not
available for certain uses of the Company's products in particular
circumstances. As a general rule, third party reimbursement is available if a
physician has been involved in the decision to perform the test involving the
Company's products. For example, if a physician prescribes a drug that requires
therapeutic monitoring, the use of the Company's products in performing such
tests will be reimbursable. In the health promotion market, use of the Company's
products for diagnostic screening in health promotion clinics is generally
subject to reimbursement. However, diagnostic screening preformed in corporate
wellness programs and at fitness centers is likely not
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CHOLESTECH CORPORATION
subject to reimbursement. Third party payors are increasingly scrutinizing and
challenging the prices charged for medical products and services. Decreases in
reimbursement amounts for tests performed using the Company's products may
decrease the amounts that physicians and other practitioners are able to charge
patients, which in turn may adversely affect the Company's ability to sell its
products on a profitable basis. In addition, certain health care providers are
moving toward a managed care system in which such providers contract to provide
comprehensive health care for a fixed cost per patient. Managed care providers
are attempting to control the cost of health care by authorizing fewer elective
procedures, such as the screening of blood for chronic diseases. The Company is
unable to predict what changes will be made in the reimbursement methods
utilized by third party payors. Inability of health care providers to obtain
reimbursement from third party payors or changes in government and third party
payors' policies toward reimbursement of tests employing the Company's products
could have a material adverse effect on the Company's business, financial
condition and results of operations. Additionally, the Company believes that the
overall escalating cost of medical products and services has led to and will
continue to lead to increased pressures on the health care industry, both
domestic and international, to reduce the cost of products and services,
including products offered by the Company. Market acceptance of the Company's
products in international markets is also dependent, in part, upon the
availability of reimbursement within prevailing health care payment systems.
Reimbursement and health care payment systems in international markets vary
significantly by country and include both government sponsored health care and
private insurance. There can be no assurance that third party reimbursement and
coverage will be available or adequate in either United States or international
markets, that current reimbursement amounts will not be decreased in the future
or that future legislation, regulation, or reimbursement policies of third party
payors will not otherwise adversely affect demand for the Company's products or
the Company's ability to sell its products on a profitable basis, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Political, economic and regulatory influences are pushing the health care
industry in the United States to fundamental change. The Company anticipates
that Congress, state legislatures and the private sector will continue to review
and assess alternative health care delivery and payment systems. Potential
approaches that have been considered include mandated basic health care
benefits, controls on health care spending through limitations on the growth of
private health insurance premiums and Medicare and Medicaid spending, the
creation of large insurance purchasing groups, price controls and other
fundamental changes to the health care delivery system. Legislative debate is
expected to continue in the future, and market forces are expected to demand
reduced costs. The Company cannot predict what impact the adoption of any
federal or state health care reform measures, future private sector reform or
market forces may have on its business.
GOVERNMENT REGULATION. The manufacture and sale of diagnostic products,
including the L*D*X System, are subject to extensive regulation by numerous
governmental authorities, principally the FDA and corresponding state and
foreign regulatory agencies. The Company will not be able to commence marketing
or commercial sales in the United States of any of the new tests it is
developing until it receives clearance or approval from the FDA. The process of
obtaining FDA and other required regulatory clearances and approvals is lengthy,
expensive and uncertain. As a result, there can be no assurance that any of the
Company's new tests under
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CHOLESTECH CORPORATION
development, even if successfully developed, will ever obtain such clearance or
approval. Additionally, certain material changes to medical products already
cleared or approved by the FDA are also subject to further FDA review and
clearance or approval. The loss of previously obtained clearances, or failure to
comply with existing or future regulatory requirements, could have a material
adverse effect on the Company's business, financial condition and results of
operations. The L*D*X Analyzer and all existing test cassettes required
clearance pursuant to a 510(k) clearance. Medical devices are subject to
continual review, and later discovery of previously unknown problems with a
cleared product may result in restrictions on the product's marketing or
withdrawal of the product from the market. In general, the Company intends to
develop and market tests that will require 510(k) clearance. It generally takes
from four to twelve months from the date of submission to obtain 510(k)
clearance, but it may take longer. The Company does not believe that its
products under development will require submission of a Pre-market approval
("PMA") application. However, if a future product were to require submission of
a PMA application, regulatory approval of such product would involve a much
longer and more costly process than a 510(k) clearance and would involve the
submission of extensive supporting data and clinical information. A PMA
application may be submitted to the to the United States Food and Drug
Administration (the "FDA") only after clinical trials and the required patient
follow-up for a particular test are successfully completed. Upon filing of a PMA
application, the FDA commences a review process that generally takes one to
three years from the date on which the PMA application is accepted for filing,
but may take significantly longer. There can be no assurance that the Company's
products under development will require only 510(k) clearance rather than the
more lengthy and costly PMA approval. A requirement that the Company file a PMA
application for any new test would significantly delay the Company's ability to
market such test and significantly increase the costs of development.
The European Union ("EU") has promulgated rules that require that devices
such as those developed, manufactured and sold by the Company receive the right
to affix the CE mark, a symbol of adherence to applicable EU directives. The
Company has completed all the testing necessary to comply with applicable
regulations to currently be eligible for self certification and currently has
the right, as self-certified under the product testing requirements, to affix
the CE mark to its products. The Company's products will be covered by the In
Vitro Diagnostics Directives that have not yet been published or adopted. While
the Company intends to satisfy the requisite policies and procedures that will
permit it to continue to affix the CE mark to its products in the future, there
can be no assurance that the Company will be successful in meeting the EU
certification requirements, and failure to receive the right to affix the CE
mark may prohibit the Company from selling its products in EU member countries
and could have a material adverse effect on the Company's business, financial
condition and results of operations.
The use of the Company's products and those of its competitors is also
affected by federal and state regulations, which provide for regulation of
laboratory testing, as well as by the laws and regulations of foreign countries.
The scope of these regulations includes quality control, proficiency testing,
personnel standards and inspections. For example, in the United States, CLIA
categorizes tests as "waived," or as being "moderately complex" or "highly
complex" on the basis of specific criteria. In January 1996, the L*D*X Analyzer
and the Company's total cholesterol, HDL (high density lipoproteins),
triglycerides and glucose tests in any combination were classified as waived
under CLIA. In order to successfully commercialize the tests that are currently
under development, the Company believes that it will be critical to obtain
waived classification for such tests under CLIA. There can be no assurance that
any new tests developed by the Company, including the BUN/Creatinine test
cassette, will qualify for CLIA waived classification. Any failure of the new
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CHOLESTECH CORPORATION
tests to obtain waived status under CLIA will adversely impact the Company's
ability to commercialize such tests, which could have a material adverse effect
on the Company's business, financial condition and results of operations. In
addition, there can be no assurance that any future amendment of CLIA or the
promulgation of additional regulations impacting laboratory testing will not
have an adverse effect on the Company's ability to market the L*D*X System. For
example, if CLIA regulations were modified in a manner that reduced regulatory
requirements and burdens faced by competitive products, certain competitive
advantages of the L*D*X System's waived status could be reduced or eliminated.
The Company's manufacturing processes, as well as, in certain instances,
those of its contract manufacturers, are subject to stringent federal, state and
local regulations governing the use, generation, manufacture, storage, handling
and disposal of certain materials and wastes. The Company and its contract
manufacturers must economically manufacture products in compliance with federal,
state and foreign regulations regarding the manufacture of health care products
and diagnostic devices, including QSR, and other foreign regulations and state
and local health, safety and environmental regulations, which include testing,
control and documentation requirements. Failure to comply with QSR,
ISO9001/EN46001 requirements and other applicable regulatory requirements by the
Company and in certain ISO9001/EN46001 certification regulations circumstances,
its contract manufacturers, including marketing products for unapproved uses,
could result in, among other things, warning letters, fines, injunctions, civil
penalties, recall or seizure of products, total or partial suspension of
production, refusal of the government to grant pre-market clearance or
pre-market approval for devices, withdrawal of approvals and criminal
prosecution. Changes in existing regulations or adoption of new governmental
regulations or policies could prevent or delay regulatory approval of the
Company's products. There can be no assurance that the Company will not be
required to incur significant costs in the future in complying with
manufacturing and environmental regulations.
DEPENDENCE ON PROPRIETARY TECHNOLOGY; UNCERTAINTY OF PATENT AND PROPRIETARY
TECHNOLOGY PROTECTION; DEPENDENCE ON LICENSING OF TECHNOLOGY FROM THIRD PARTIES.
The Company's ability to compete effectively will depend in part on its ability
to develop and maintain the proprietary aspects of its technology and operate
without infringing the proprietary rights of others. The Company has nine United
States patents and has filed patent applications relating to its technology
internationally under the Patent Cooperation Treaty and individual foreign
patent applications. There can be no assurance that any of the Company's pending
patent applications will result in the issuance of any patents, or that, if
issued, any such patents will offer protection against competitors with similar
technology. There can be no assurance that any patents issued to the Company
will not be challenged, invalidated or circumvented in the future or that the
rights created thereunder will provide a competitive advantage. In addition,
there can be no assurance that competitors, many of which have substantially
greater resources than the Company and have made substantial investments in
competing technologies, will not seek to apply for and obtain patents covering
technologies that are more effective than the Company's technologies, that would
render the Company's technologies or products obsolete or uncompetitive or that
would prevent, limit or interfere with the Company's ability to make, use or
sell its products either in the United States or in international markets.
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CHOLESTECH CORPORATION
The medical products industry has been characterized by extensive litigation
regarding patents and other intellectual property rights. There can be no
assurance that the Company will not in the future become subject to patent
infringement claims and litigation or interference proceedings conducted in the
United States Patent and Trademark Office ("USPTO") to determine the priority of
inventions. The defense and prosecution of intellectual property suits, USPTO
interference proceedings and related legal and administrative proceedings are
both costly and time consuming. Litigation may be necessary to enforce any
patents issued to the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforceability, scope and validity of the
proprietary rights of others. Any litigation or interference proceedings will
result in substantial expense to the Company and significant diversion of effort
by the Company's technical and management personnel. An adverse determination in
litigation or interference proceedings to which the Company may become a party
could subject the Company to significant liabilities to third parties or require
the Company to seek licenses from third parties which may not be available on
commercially reasonable terms or at all.
The Company's current products incorporate technologies which are the
subject of patents issued to, and patent applications filed by, others. The
Company has obtained licenses for certain of these technologies and may be
required to obtain licenses for others. There can be no assurance that the
Company will be able to obtain licenses for technology patented by others on
commercially reasonable terms, or at all, that it will be able to develop
alternative approaches if unable to obtain licenses or that the Company's
current and future licenses will be adequate for the operation of the Company's
business. The failure to obtain such licenses or identify and implement
alternative approaches could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company also relies upon trade secrets, technical know-how and
continuing invention to develop and maintain its competitive position, and no
assurance can be given that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
the Company's trade secrets or disclose such technology, or that the Company can
meaningfully protect its right to its trade secrets, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
HIGHLY COMPETITIVE INDUSTRY; RAPID TECHNOLOGICAL CHANGE. The markets for
diagnostic screening and therapeutic monitoring in which the Company operates
are intensely competitive. The Company's competition consists mainly of clinical
and hospital laboratories, as well as manufacturers of bench top analyzers. In
order to achieve market acceptance for the L*D*X System, the Company will be
required to demonstrate that the L*D*X System is an attractive alternative to
bench top analyzers as well as to clinical and hospital laboratories. This will
require physicians to change their established means of having such tests
performed. There can be no assurance that the L*D*X System will be able to
compete with these other testing services and analyzers. In addition, companies
having a significant presence in the market for therapeutic monitoring, such as
Abbott Laboratories, Clinical Diagnostic Systems, a division of Johnson &
Johnson and formerly a division of Eastman Kodak Company, and Boehringer
Mannheim, have developed or are developing analyzers designed for near-patient
testing. These competitors have substantially greater financial, technical,
research and other resources and larger, more established marketing, sales,
distribution and service organizations than the Company. In addition, such
competitors offer broader product lines than the Company, have greater name
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CHOLESTECH CORPORATION
recognition than the Company, and offer discounts as a competitive tactic. In
addition, several smaller companies are currently making or developing products
that compete or will compete with those of the Company.
The Company expects that its competitors will compete intensely to maintain
and increase market share and seek to develop similar multi-analyte tests that
qualify for CLIA waiver. There can be no assurance that these competitors will
not succeed in obtaining CLIA waived status for their products or in developing
or marketing technologies or products that are more effective and commercially
attractive than the Company's current or future products, or that would render
the Company's technologies and products obsolete or noncompetitive. The
Company's current and future products must compete effectively with the existing
and future products of the Company's competitors primarily on the basis of ease
of use, breadth of tests available, market presence, cost effectiveness,
precision, accuracy, immediacy of results and the ability to perform tests near
the patient, to test multiple analytes from a single sample and to conduct tests
without a skilled technician or pre-treating blood. There can be no assurance
that the Company will have the financial resources, technical expertise or
marketing, distribution or support capabilities to compete successfully in the
future or, if the Company does have such resources and capabilities, that it
will employ them successfully.
DEPENDENCE ON ATTRACTION AND RETENTION OF KEY EMPLOYEES. The Company's
success depends in significant part upon the continued service of certain key
scientific, technical, regulatory and managerial personnel, and its continuing
ability to attract and retain additional highly qualified personnel in those
areas. Competition for such personnel is intense, and there can be no assurance
that the Company will be able to retain such personnel or that it can attract or
retain other highly qualified personnel in the future, including key sales and
marketing personnel. The loss of key personnel or the inability to hire or
retain qualified personnel could have a material adverse effect upon the
Company's business, financial condition and results of operations.
RISK OF PRODUCT LIABILITY; PRODUCT LIABILITY INSURANCE MAY BE INSUFFICIENT
OR UNAVAILABLE. Sale of the Company's products entails risk of product liability
claims. The medical testing industry has historically been litigious, and the
Company faces financial exposure to product liability claims in the event that
use of its products results in personal injury or improper diagnosis. The
Company also faces the possibility that defects in the design or manufacture of
its products might necessitate a product recall. There can be no assurance that
the Company will not experience losses due to product liability claims or
recalls in the future. The Company currently maintains product liability
insurance, but there can be no assurance that the coverage limits of the
Company's insurance policies will be adequate. Such insurance is expensive and
difficult to obtain, and no assurance can be given that product liability
insurance can be maintained in the future on acceptable terms, in sufficient
amounts to protect the Company against losses due to product liability, or at
all. Inability to maintain insurance at an acceptable cost or to otherwise
protect against potential product liability could prevent or inhibit the
continued commercialization of the Company's products. In addition, a product
liability claim in excess of relevant insurance coverage or a product recall
could have a material adverse effect on the Company's business, financial
condition and results of operations.
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YEAR 2000 COMPLIANCE RISKS. The L*D*X System contains software that may be
used to integrate test results with an end user's medical records systems. It is
likely that, commencing in the year 2000, the functionality of certain medical
records systems will be adversely affected when one or more component products
of such systems are unable to process four digit characters representing years
and, therefore, the medical records system would not be in "Year 2000
compliance." Although the Company believes its products are in Year 2000
compliance, there can be no assurance that the Company's products will be able
to function properly when integrated with other vendors' non-compliant component
products. The inability of the L*D*X System to properly manage and manipulate
data related to the Year 2000 could result in a material adverse effect on the
Company's business, financial condition and results of operations, including
increased warranty costs, customer satisfaction issues and potential lawsuits.
Although the Company believes its products are Year 2000 compliant, the Company
anticipates that substantial litigation may be brought against vendors of all
component products that operate in connection with medical records systems,
including those component products provided by the Company. The Company believes
that any such claims, with or without merit, could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, parties with whom the Company does business may not be in Year 2000
compliance, which could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company has identified Year 2000 dependencies in its internal
information systems and has implemented changes to such systems to make them
Year 2000 compliant. While the Company currently expects that the Year 2000 will
not pose significant operational problems, delays in the implementation of new
information systems, or a failure to fully identify all Year 2000 dependencies
in the Company's systems could have material adverse consequences, including
delays in the delivery or sale of the Company's products.
POSSIBLE FUTURE CAPITAL REQUIREMENTS; UNCERTAINTY OF ADDITIONAL FUNDING. The
Company intends to expend substantial funds for capital expenditures related to
expansion of its manufacturing capacity, research and development, including
expansion of its product line and enhancement of its current products, expansion
of sales and marketing activities and other working capital and general
corporate purposes. Although the Company believes that the Company's cash, cash
equivalents, marketable securities, cash flow anticipated to be generated by
future operations and available bank borrowings under an existing line of credit
will be sufficient to meet its capital requirements for the foreseeable future,
there can be no assurance that the Company will not require additional
financing. For example, the Company may be required to expend greater than
anticipated funds if unforeseen difficulties arise in expanding manufacturing
capacity for existing cassettes or in the course of completing required
additional development, obtaining necessary regulatory approvals, obtaining
waived status under CLIA or introducing or scaling up manufacturing for new
tests. The Company's future liquidity and capital requirements will depend upon
numerous additional factors, including: the costs and timing of expansion of
manufacturing capacity; the number and type of new tests the Company seeks to
develop; the success of these development efforts; the costs and timing of
expansion of sales and marketing activities; the extent to which the Company's
existing and new products gain market acceptance; competing technological and
market developments; the progress of commercialization efforts of the Company's
distributors; the costs involved in preparing, filing,
23
<PAGE> 24
CHOLESTECH CORPORATION
prosecuting, maintaining and enforcing patent claims and other intellectual
property rights; developments related to regulatory and third party
reimbursement matters and CLIA; and other factors. In the event that additional
financing is needed, the Company may seek to raise additional funds through
public or private financing, collaborative relationships or other arrangements.
Any additional equity financing may be dilutive to shareholders, and debt
financing, if available, may involve restrictive covenants. Collaborative
arrangements, if necessary to raise additional funds, may require the Company to
relinquish its rights to certain of its technologies, products or marketing
territories. The failure of the Company to raise capital on acceptable terms
when needed could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
such financing, if required, will be available on satisfactory terms, or at all.
See "-- Liquidity and Capital Resources."
ANTI-TAKEOVER PROVISIONS. The Company's Board of Directors (the "Board") has
the authority to issue up to 5,000,000 shares of preferred stock and to
determine the rights, preferences, privileges and restrictions of such shares
without any further vote or action by the Company's shareholders. To date, the
Board has designated 25,000 shares as Series A Participating Preferred Stock
("Series A Preferred") in connection with the Company's Preferred Share Purchase
Rights Plan. The issuance of preferred stock under certain circumstances could
have the effect of delaying or preventing a change in control of the Company or
otherwise adversely affecting the rights of the holders of Common Stock.
Pursuant to the Company's Preferred Shares Rights Agreement (the "Rights
Agreement") each share of Common Stock carries a right (a "Right") which
entitles the registered holder to purchase from the Company one-thousandth of a
share of Series A Preferred at an exercise price of $44.00, subject to
adjustment. The Rights are designed to protect and maximize the value of the
outstanding equity interests in the Company in the event of an unsolicited
attempt by an acquirer to take over the Company, in a manner or on terms not
approved by the Board. The Rights have been declared by the Board in order to
deter coercive tactics, including a gradual accumulation of shares in the open
market, of a 15% or greater position to be followed by a merger or a partial or
two-tier tender offer that does not treat all shareholders equally. The Rights
should not interfere with any merger or other business combination approved by
the Board. However, the Rights may have the effect of rendering more difficult
or discouraging an acquisition of the Company deemed undesirable by the Board.
The Rights may cause substantial dilution to a person or group attempting to
acquire the Company on terms or in a manner not approved by the Board, except
pursuant to an offer conditioned upon the negation, purchase or redemption of
the Rights.
POTENTIAL VOLATILITY OF STOCK PRICE. The market price of the Common Stock,
like that of the common stock of many other medical products and technology
companies, has in the past been, and is likely in the future to continue to be,
highly volatile. Factors such as fluctuations in the Company's operating
results, announcements of technological innovations or new commercial products
by the Company or its competitors, government regulation, changes in the current
structure of the health care financing and payment systems and developments in
or disputes regarding patent or other proprietary rights may have a significant
effect on the market price of the Common Stock. Moreover, the stock market has
from time to time experienced extreme price and volume fluctuations, which have
particularly affected the market prices for medical products
24
<PAGE> 25
CHOLESTECH CORPORATION
and high technology companies and which have often been unrelated to the
operating performance of such companies. These broad market fluctuations, as
well as general economic, political and market conditions, may adversely affect
the market price of the Common Stock. In the past, following periods of
volatility in the market price of a company's stock, securities class action
suits have been filed against the issuing company. There can be no assurance
that such litigation will not occur in the future with respect to the Company.
Such litigation could result in substantial costs and a diversion of
management's attention and resources, which could have a material adverse effect
on the Company's business, financial condition and results of operations. Any
adverse determination in such litigation could also subject the Company to
significant liabilities.
ABSENCE OF DIVIDENDS. The Company has never declared or paid any cash dividends
since its inception. The Company currently expects to retain future earnings, if
any, to finance the growth and development of its business and, therefore, does
not anticipate declaring or paying any cash dividends in the foreseeable future.
25
<PAGE> 26
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 26, 1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
27.1 Financial Data Schedule.
(b) Reports on Form 8-K. One report on Form 8-K was filed during the
quarter ended June 26, 1998. The report was filed on May 28, 1998
and reported, under Item 5 of Form 8-K, on May 21, 1998
Cholestech Corporation issued a press release reporting that it
had settled outstanding litigation with a former employees of the
Company.
26
<PAGE> 27
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 14, 1998 /s/ Warren E. Pinckert II
-----------------------------------------
Warren E. Pinckert II
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Andrea J. Tiller
-----------------------------------------
Andrea J. Tiller
Vice President of Finance and Chief
Financial Officer
(Principal Financial and Accounting
Officer)
27
<PAGE> 28
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-26-1999
<PERIOD-END> JUN-26-1998
<CASH> 5,224
<SECURITIES> 8,034
<RECEIVABLES> 2,263
<ALLOWANCES> 74
<INVENTORY> 5,313
<CURRENT-ASSETS> 20,938
<PP&E> 9,931
<DEPRECIATION> 5,544
<TOTAL-ASSETS> 25,400
<CURRENT-LIABILITIES> 4,336
<BONDS> 0
0
0
<COMMON> 70,104
<OTHER-SE> (49,040)
<TOTAL-LIABILITY-AND-EQUITY> 25,400
<SALES> 4,685
<TOTAL-REVENUES> 4,685
<CGS> 1,902
<TOTAL-COSTS> 5,464
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (585)
<INCOME-TAX> 0
<INCOME-CONTINUING> (585)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (585)
<EPS-PRIMARY> (.05)
<EPS-DILUTED> (.05)
</TABLE>
