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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 27, 1998 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER: 000-20198
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CHOLESTECH CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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CALIFORNIA 94-3065493
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
3347 INVESTMENT BLVD., HAYWARD, CALIFORNIA 94545
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 732-7200
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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None None
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, NO PAR VALUE
SERIES A PARTICIPATING PREFERRED STOCK, NO PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of the Common Stock on March
27, 1998 as reported on the Nasdaq National Market, was approximately
$125,972,901. Shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
As of March 27, 1998, registrant had outstanding 11,402,084 shares of
Common Stock.
- - - - - DOCUMENTS INCORPORATED BY REFERENCE - - - - -
None.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains forward looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward looking statements as a result of
certain factors discussed below, including under "General" and "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 incurring negative cash flows, the statement under "Revenues"
regarding the Company's expectation that international revenues may increase in
dollar amount but decrease as a percentage of total revenues, the statement
under "Sales and Marketing" regarding the Company's expectation that sales and
marketing expenses will increase, the statement under "Research and Development"
regarding the development of new test cassettes and the Company's anticipation
that research and development expenditures will increase, 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 and the statements in "Factors Affecting Future Operating Results."
GENERAL
The Company develops, manufactures and markets the Cholestech L-D-X(R)
System which performs near-patient diagnostic screening and therapeutic
monitoring for the management of prevalent chronic diseases (preventive care
testing). The L-D-X System is capable of measuring multiple analytes
simultaneously with a single drop of whole blood within five minutes. The
Company currently markets the L-D-X System, including the L-D-X analyzer and a
variety of single use test cassettes, to the physician office laboratory (POL),
pharmacy and health promotion markets, in the United States and internationally.
Despite recording net income in fiscal 1998, the Company has experienced
significant operating losses prior to fiscal 1998 and, as of March 31, 1998, had
an accumulated deficit of $48.5 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 experienced a relatively lower rate of testing per day in these
markets than in the health promotion market.
For the quarter ended June 26, 1998 the Company anticipates that revenue
will be between $4.9 million and $5.0 million, representing an increase of 15%
to 20% over the same quarter in the prior year, but down from the previous
quarter ended March 27, 1998. Revenues in the quarters ended June 27, 1997 and
March 27, 1998 were $4.2 million and $6.4 million respectively. The Company also
anticipates that earnings for the quarter ended June 26, 1998, before
non-recurring charges, will be between $0.02 per share (diluted) and $0.04 per
share (diluted) across the expected revenue range. This range is up from $0.01
per share (diluted) for the quarter ended June 27, 1997 and down from $0.07 per
share (diluted) for the quarter ended March 27, 1998. The revenue shortfall led
the Company to decide to cancel its proposed common stock offering. This led to
a non-recurring charge of approximately $500,000 or $(0.04) per share (diluted),
which is to be recorded in the quarter ended June 26, 1998.
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RESULTS OF OPERATIONS
Fiscal 1998 and Fiscal 1997
Revenues. The Company's revenues increased 68.4% to $21.7 million in fiscal
1998 from $12.9 million in fiscal 1997. The increase in revenues primarily
reflect 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. Price
changes and changes in the mix of products sold accounted for 9.1% and 15.9% of
the $8.8 million increase.
International revenues represented 14.2% and 9.7% of revenues in fiscal
1998 and fiscal 1997, respectively. The Company expects that the dollar amount
and proportion of international revenues to total 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 increased 51.1% to $10.5
million in fiscal 1998 from $7.0 million in fiscal 1997, primarily as a result
of increased unit sales of single use test cassettes and L-D-X Analyzers. Gross
margin was 51.5% and 45.9% in fiscal 1998 and 1997, respectively. The
improvement in gross margin was primarily attributable to increased volume of
single use test cassettes manufactured and sold 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
certain of its 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 fiscal 1998 and 1997 was $562,000 and $551,000,
respectively, and such amounts were charged to cost of products sold.
Sales and Marketing. Sales and marketing expense includes salaries,
commissions, bonuses, expenses for outside services related to marketing
programs and travel expenses. Sales and marketing expense increased 31.0% to
$5.4 million in fiscal 1998 from $4.1 million in fiscal 1997. This increase was
primarily attributable to continued expansion of the Company's domestic sales
and marketing programs, increased expenses related to greater penetration of the
POL and pharmacy markets and the initiation of an employee cash bonus program.
Sales and marketing expense fell to 24.8% of revenues in fiscal 1998 from 31.9%
in fiscal 1997, primarily due to higher revenues which more than offset
increased sales and marketing expenditures. 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. Research and development expense includes
salaries, bonuses, expenses for outside services, supplies and amortization of
capital equipment. Research and development expense increased 65.8% to $2.2
million in fiscal 1998 from $1.3 million in fiscal 1997. This increase was
primarily attributable to continued development of new single use test cassettes
and a related increase in headcount. Research and development expense as a
percentage of revenues remained relatively constant at 10.3% in fiscal 1998
compared to 10.4% in fiscal 1997. 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. General and administrative expense includes
compensation, benefits and expenses for outside services. General and
administrative expense increased 35.8% to $2.1 million in fiscal 1998 from $1.5
million in fiscal 1997. This increase resulted primarily from professional
services and the initiation of an employee cash bonus program. General and
administrative expenses fell to 9.6% of revenues in fiscal 1998 from 12.0% in
fiscal 1997 due to higher revenues which more than offset increased general and
administrative expenditures.
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Interest Income. Interest income reflects income from the investment of
cash balances and marketable securities. Interest income rose 10.4% to $571,000
in fiscal 1998 from $517,000 in fiscal 1997. This increase was primarily the
result of higher average amounts invested in cash equivalents and marketable
securities in fiscal 1998 over fiscal 1997.
Interest Expense. Interest expense is incurred on capital lease financings.
Interest expense fell to $2,000 in fiscal 1998 from $244,000 in fiscal 1997.
This decline resulted primarily from lower outstanding balances under capital
leases in fiscal 1998 and a prepayment penalty of $112,000 incurred when the
Company retired its long term debt in the second quarter of fiscal 1997.
Income Taxes. The Company has significant net operating loss carryforwards
(NOLs) and tax credit carryforwards. The $41,000 provision for income taxes in
fiscal 1998 represented the estimated federal and state alternative minimum
taxes payable, reduced for the utilization of NOLs and tax credit carryforwards,
resulting in an effective tax rate for fiscal 1998 of 2.0%. Management expects
to utilize NOL and other tax carryforward amounts to the extent taxable income
is earned in fiscal 1999 and beyond. Therefore, the Company's effective tax rate
should continue to be substantially less than the applicable statutory rates. As
of March 31, 1998, the Company had NOL carryforwards available to reduce future
taxable income for federal and state income tax purposes of $44.4 million and
$18.8 million, respectively. Additionally, the Company had research and
development tax credit carryforwards available to reduce income taxes for
federal and state income tax purposes of $1.6 million and $589,000,
respectively. The Company has historically experienced significant operating
losses and operates in an industry subject to rapid technological changes.
Therefore, management believes there is sufficient uncertainty regarding the
Company's ability to generate future taxable income and utilize these NOL and
tax credit carryforwards such that a full valuation allowance for deferred tax
assets was required at March 31, 1998.
As a result of a change in ownership which occurred in May 1990, there is
an annual limitation of approximately $1.5 million for federal and state income
tax purposes on the combined use of approximately $6.1 million of federal NOLs
and the use of $550,000 of federal and state tax credit carryforwards.
Additionally, as a result of the Company's public offering in December 1992,
NOLs and tax credit carryforwards incurred prior to December 1992 are subject to
an annual limitation of $5.5 million for federal and state income tax purposes
on the combined use of $26.2 million of federal and $4.5 million of state NOLs,
and the use of $1.2 million of federal and $379,000 of state tax credit
carryforwards. If the amounts of these limitations are not utilized in a
particular year, the amount not utilized increases the limitation in the
subsequent year.
Fiscal 1997 and Fiscal 1996
Revenues. The Company's revenues increased 87.1% to $12.9 million in fiscal
1997 from $6.9 million in fiscal 1996. The increase in revenues primarily
reflect increased unit sales of single use test cassettes and L-D-X analyzers to
health care providers in the POL and health promotion markets. Price changes and
changes in the mix of products sold each accounted for 6.7% of the $6.0 million
increase. International revenues represented 9.7% and 19.3% of revenues in
fiscal 1997 and fiscal 1996, respectively.
Cost of Products Sold. Cost of products sold increased 55.3% to $7.0
million in fiscal 1997 from $4.5 million in fiscal 1996, primarily as a result
of increased unit sales of single use test cassettes and L-D-X Analyzers. Gross
margin was 45.9% and 34.8% in fiscal 1997 and 1996, respectively. The
improvement in gross margin was primarily attributable to improved cassette
manufacturing yields and growth in the volume of single use test cassettes and
L-D-X Analyzers sold, without corresponding percentage increases in
manufacturing costs.
Sales and Marketing. Sales and marketing expense increased 24.3% to $4.1
million in fiscal 1997 from $3.3 million in fiscal 1996. This increase was
primarily attributable to continued expansion of the Company's domestic sales
and marketing organization, the launch of sales and marketing efforts directed
at the POL 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 31.9% of revenues in fiscal 1997 from 48.1% in
fiscal 1996 due to higher revenues which more than offset increased sales and
marketing expenditures.
Research and Development. Research and development expense increased 83.4%
to $1.3 million in fiscal 1997 from $731,000 in fiscal 1996. This increase was
primarily attributable to continued development of new single use test cassettes
and a related increase in headcount. Research and development expense as a
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percentage of revenues decreased slightly to 10.4% in fiscal 1997 from 10.6% in
fiscal 1996 due to higher revenues which more than offset increased research and
development expenditures.
General and Administrative. General and administrative expense increased
23.4% to $1.5 million in fiscal 1997 from $1.2 million in fiscal 1996. The
increase resulted primarily from higher professional fees relating to
recruitment of key personnel, legal fees relating to business development
efforts and an increased investment in the Company's information systems.
General and administrative expenses fell to 12.0% of total revenues in fiscal
1997 from 18.1% in fiscal 1996 due to higher revenues which more than offset
increased general and administrative expenditures.
Interest Income. Interest income rose 82.0% to $517,000 in fiscal 1997 from
$284,000 in fiscal 1996. This increase was primarily the result of higher
average amounts invested in cash equivalents and marketable securities resulting
from the investment of the proceeds of the Company's June 1996 public offering.
Interest Expense. Interest expense increased 74.3% to $244,000 in fiscal
1997 from $140,000 in fiscal 1996. The increase in interest expense in fiscal
1997 resulted primarily from a prepayment penalty of $112,000 incurred when the
Company retired its long term debt in the second quarter of fiscal 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through the sale of
equity securities and, during fiscal 1998, from positive cash flows from
operations. From inception to March 31, 1998, the Company raised $69.0 million
in net proceeds from equity financings. As of March 31, 1998, the Company had
$14.8 million of cash, cash equivalents and short term marketable securities. In
addition to these amounts, the Company has available a $3.0 million revolving
bank line of credit agreement. While the agreement is in effect, the Company is
required to deposit assets with a collective value, as defined in the line of
credit agreement, equivalent to no less than 100% of the outstanding principal
balance. Amounts outstanding under the line of credit bear interest at the
bank's prime rate. The line of credit agreement expires on November 30, 1998. As
of March 31, 1998, there were no borrowings outstanding under the line of
credit.
Net cash provided by operating activities was $2.1 million during fiscal
1998, compared to net cash used in operating activities of $1.0 million during
fiscal 1997. In fiscal 1998, an improvement in operating results was the primary
factor contributing to cash provided by operating activities. In fiscal 1997,
the net loss and increases in accounts receivable and inventory were the primary
factors contributing to cash used in operating activities. Net cash used in
investing activities of $3.7 million in fiscal 1998 and $5.2 million in fiscal
1997 resulted from the Company's net purchases of marketable securities and
property and equipment. Net cash provided by financing activities in fiscal 1998
of $666,000 reflected the issuance of Common Stock pursuant to the employee
stock purchase plan and the stock incentive program. Net cash provided by
financing activities in fiscal 1997 of $11.9 million, reflected the issuance of
Common Stock, primarily pursuant to the Company's June 1996 public offering,
partially offset by repayment of short term bank borrowings and long term debt.
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 flows 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;
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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 "-- Factors
Affecting Future Operating Results -- Possible Future Capital Requirements;
Uncertainty of Additional Funding."
New Accounting Pronouncements. In June 1997, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes
standards for the 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 for fiscal
years beginning after December 15, 1997. 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.
Reclassification of financial statements for earlier periods is required. The
Company will adopt SFAS No. 130 in fiscal 1999 and does not expect such adoption
to have a material impact on its financial condition or results of operations.
In June 1997, FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." This statement establishes standards for
the way companies report information about operating segments in annual
financial statements for fiscal years beginning after December 15, 1997. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The Company will adopt SFAS No. 131 in
fiscal 1999. Because SFAS No. 131 only addresses disclosure and reporting
issues, its adoption will not have a material impact on the Company's financial
statements.
FACTORS AFFECTING FUTURE OPERATING RESULTS
UNCERTAINTY OF MARKET ACCEPTANCE OF THE L-D-X SYSTEM. The Cholestech L-D-X
System, including the L-D-X analyzer (the Company's only product platform) and
single use test cassettes, will continue to account for substantially all of the
Company's revenues for the foreseeable future. In order for the Company to
increase revenues, sustain profitability and maintain positive cash flows from
operations, the L-D-X System must continue to gain market acceptance among
health care providers, particularly physician office laboratories (POLs) and
pharmacies, to which the Company has made only limited sales to date.
Physicians, pharmacists and other health care providers are not likely to use
the L-D-X System unless they determine that it is an attractive alternative to
other means of diagnostic screening or therapeutic monitoring of chronic
diseases. Such determination will depend, in part, upon the L-D-X System's
accuracy, ease of use, rapid test time, reliability and cost effectiveness, as
well as the availability and amount of third party reimbursement. Even if the
advantages of the L-D-X System in diagnosing and monitoring patients with
chronic diseases are established, health care providers may elect not to
purchase and use the L-D-X System for any number of reasons. For example,
physicians and other health care providers may not change their established
means of having such tests performed or may not make the necessary investment to
purchase the L-D-X Analyzer. In addition, the growing prevalence of managed care
may adversely affect the POL market. A growing number of physicians are salaried
employees and have no financial incentive to perform testing. Many managed care
organizations have contracts with laboratories which require participating or
employed physicians to send patient specimens to contracted laboratories.
Finally, physicians are under growing pressure by Medicare and other third party
payors to limit their testing to "medically necessary" tests. Market acceptance
of the L-D-X System by pharmacists will in part depend on the continued
availability and amount of reimbursement to them for performing tests on the
L-D-X System. Even if the Company is successful in continuing to place L-D-X
Analyzers at POLs, pharmacies and other near-patient testing sites, there can be
no assurance that placement of L-D-X Analyzers will result in sustained demand
for the Company's single use test cassettes. As
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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. See "Business -- Market
Overview," "-- Products and Products Under Development," "-- Sales and
Marketing" and "-- Third Party Reimbursement."
HISTORY OF LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY; FLUCTUATIONS IN
OPERATING RESULTS. Historically, the Company has experienced significant
operating losses and negative cash flows from operations and, as of March 31,
1998, had an accumulated deficit of $48.5 million. The Company's first
profitable quarter was the first quarter of fiscal 1998, and its first
profitable year was fiscal 1998. The Company's ability to maintain its recent
profitability and positive cash flows from operations will depend, in part, upon
continued commercialization of existing product offerings, of which there can be
no assurance. The Company's ability to maintain profitability and positive cash
flows from operations will also depend upon the level and timing of research and
development expenditures and the Company's ability to complete the development
of and successfully introduce and market additional tests.
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 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
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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 is obligated to purchase $750,000 of additional
shares of Common Stock at the then current market price upon the completion of
specified milestones by the Company unless Metra Biosystems exercises its right
to terminate the agreement, which it may do at any time. There can be no
assurance that Metra Biosystems will not terminate the agreement or that Metra
Biosystems will purchase any additional Common Stock. 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. See "Business -- Products and Products Under Development,"
"-- Manufacturing" and "-- Government Regulation."
RISKS ASSOCIATED WITH CASSETTE MANUFACTURING. The Company internally
manufactures all of the single use test cassettes that are used with the L-D-X
Analyzer. The manufacture of the test cassettes is a highly complex and precise
process. Such manufacturing is sensitive to a wide variety of factors, including
raw material variations and impurities, manufacturing process variances,
manufacturing equipment performance and manufacturing environment contaminants.
The Company has in the past experienced lower than expected manufacturing yields
that have adversely affected gross margins and delayed product shipments. To the
extent that the Company does not maintain acceptable manufacturing yields of
test cassettes or experiences product shipment delays, the Company's business,
financial condition and results of operations would be materially adversely
affected. The Company's cassette manufacturing lines would be costly and time
consuming to repair or replace if their operation were interrupted. As the
Company's production levels have increased, the Company has been required to use
its machinery more hours per day and the down time resulting from equipment
failure has increased. The custom nature of much of the Company's manufacturing
equipment increases the time required to remedy equipment failures and replace
equipment. Furthermore, the Company has a limited number of employees dedicated
to the operation and maintenance of the cassette manufacturing equipment, the
loss of whom could impact the Company's ability to effectively operate and
service such equipment. The interruption of cassette manufacturing operations or
the loss of employees dedicated to the cassette manufacturing facility could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company manufactures all of the cassettes at its
Hayward, California manufacturing facility, and any prolonged inability to
utilize such facility as a result of earthquake, fire or otherwise would have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company believes that it will be required to expand its manufacturing
capacity for new and existing test cassettes. The Company currently operates two
manufacturing lines for dry chemistry cassettes. The Company is currently
planning and building a third manufacturing line that the Company anticipates
will become operational in fiscal 2000. There can be no assurance that such
expansion of cassette manufacturing capacity can be completed in a timely
fashion, if ever, or that the Company would not need to increase manufacturing
capacity sooner. In addition, the custom nature of much of the Company's
manufacturing equipment increases the time required to expand manufacturing
capacity. The Company also will be required to build a new cassette
manufacturing line in order to manufacture the immunoassay test cassettes under
development. To date, the Company has not developed the processes and production
equipment necessary for an immunoassay cassette manufacturing line. Failure to
expand manufacturing capacity for dry chemistry
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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. See "Business -- Manufacturing."
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. See "Business -- Manufacturing."
NEED TO MANAGE EXPANDING OPERATIONS. If the Company is successful in
achieving and maintaining market acceptance for the L-D-X System, the Company
will be required to expand its operations, particularly in the areas of sales
and marketing and manufacturing. As the Company expands its operations in these
areas, such expansion will likely result in new and increased responsibilities
for management personnel and place significant strain upon the Company's
management, operating and financial systems and resources. To accommodate any
such growth and compete effectively, the Company will be required to implement
and improve its information systems, procedures and controls, and to expand,
train, motivate and manage its work force. There can be no assurance that the
Company's personnel, systems, procedures and controls will be adequate to
support the Company's future operations. Any failure to implement and improve
the Company's operational, financial and management systems or to expand, train,
motivate or manage employees as required by future growth, if any, could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Business -- Employees" and "Management."
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. See
"Business -- Sales and Marketing" and "-- Strategic Relationships."
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
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<PAGE> 10
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 performed in corporate
wellness programs and at fitness centers is likely not subject to reimbursement.
Third party payors are increasingly scrutinizing and challenging the prices
charged for medical products and services. Decreases in reimbursement amounts
for tests performed using the Company's products may decrease the amounts that
physicians and other practitioners are able to charge patients, which in turn
may adversely affect the Company's ability to sell its products on a profitable
basis. In addition, certain health care providers are moving toward a managed
care system in which such providers contract to provide comprehensive health
care for a fixed cost per patient. Managed care providers are attempting to
control the cost of health care by authorizing fewer elective procedures, such
as the screening of blood for chronic diseases. The Company is unable to predict
what changes will be made in the reimbursement methods utilized by third party
payors. Inability of health care providers to obtain reimbursement from third
party payors or changes in government and third party payors' policies toward
reimbursement of tests employing the Company's products could have a material
adverse effect on the Company's business, financial condition and results of
operations. Additionally, the Company believes that the overall escalating cost
of medical products and services has led to and will continue to lead to
increased pressures on the health care industry, both domestic and
international, to reduce the cost of products and services, including products
offered by the Company. Market acceptance of the Company's products in
international markets is also dependent, in part, upon the availability of
reimbursement within prevailing health care payment systems. Reimbursement and
health care payment systems in international markets vary significantly by
country and include both government sponsored health care and private insurance.
There can be no assurance that third party reimbursement and coverage will be
available or adequate in either United States or international markets, that
current reimbursement amounts will not be decreased in the future or that future
legislation, regulation, or reimbursement policies of third party payors will
not otherwise adversely affect demand for the Company's products or the
Company's ability to sell its products on a profitable basis, any of which could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Business -- Third Party Reimbursement."
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 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
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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 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 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 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 TC, HDL, triglycerides and glucose tests in any combination were
classified as waived under CLIA. In order to successfully commercialize the
tests that are currently under development, the Company believes that it will be
critical to obtain waived classification for such tests under CLIA. There can be
no assurance that any new tests developed by the Company, including the
BUN/Creatinine test cassette, will qualify for CLIA waived classification. Any
failure of the new tests to obtain waived status under CLIA will adversely
impact the Company's ability to commercialize such tests, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, there can be no assurance that any future
amendment of CLIA or the promulgation of additional regulations impacting
laboratory testing will not have an adverse effect on the Company's ability to
market the L-D-X System. For example, if CLIA regulations were modified in a
manner that reduced regulatory requirements and burdens faced by competitive
products, certain competitive advantages of the L-D-X System's waived status
could be reduced or eliminated.
The Company's manufacturing processes, as well as, in certain instances,
those of its contract manufacturers, are subject to stringent federal, state and
local regulations governing the use, generation, manufacture, storage, handling
and disposal of certain materials and wastes. The Company and its contract
manufacturers must economically manufacture products in compliance with federal,
state and foreign regulations regarding the manufacture of health care products
and diagnostic devices, including QSR, and
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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. See "Business -- Government
Regulation."
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.
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
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secrets, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations. See
"Business -- Patents and Proprietary Technology."
HIGHLY COMPETITIVE INDUSTRY; RAPID TECHNOLOGICAL CHANGE. The markets for
diagnostic screening and therapeutic monitoring in which the Company operates
are intensely competitive. The Company's competition consists mainly of clinical
and hospital laboratories, as well as manufacturers of bench top analyzers. In
order to achieve market acceptance for the L-D-X System, the Company will be
required to demonstrate that the L-D-X System is an attractive alternative to
bench top analyzers as well as to clinical and hospital laboratories. This will
require physicians to change their established means of having such tests
performed. There can be no assurance that the L-D-X System will be able to
compete with these other testing services and analyzers. In addition, companies
having a significant presence in the market for therapeutic monitoring, such as
Abbott Laboratories, Clinical Diagnostic Systems, a division of Johnson &
Johnson and formerly a division of Eastman Kodak Company, and Boehringer
Mannheim, have developed or are developing analyzers designed for near-patient
testing. These competitors have substantially greater financial, technical,
research and other resources and larger, more established marketing, sales,
distribution and service organizations than the Company. In addition, such
competitors offer broader product lines than the Company, have greater name
recognition than the Company, and offer discounts as a competitive tactic. In
addition, several smaller companies are currently making or developing products
that compete or will compete with those of the Company.
The Company expects that its competitors will compete intensely to maintain
and increase market share and seek to develop similar multi-analyte tests that
qualify for CLIA waiver. There can be no assurance that these competitors will
not succeed in obtaining CLIA waived status for their products or in developing
or marketing technologies or products that are more effective and commercially
attractive than the Company's current or future products, or that would render
the Company's technologies and products obsolete or noncompetitive. The
Company's current and future products must compete effectively with the existing
and future products of the Company's competitors primarily on the basis of ease
of use, breadth of tests available, market presence, cost effectiveness,
precision, accuracy, immediacy of results and the ability to perform tests near
the patient, to test multiple analytes from a single sample and to conduct tests
without a skilled technician or pre-treating blood. There can be no assurance
that the Company will have the financial resources, technical expertise or
marketing, distribution or support capabilities to compete successfully in the
future or, if the Company does have such resources and capabilities, that it
will employ them successfully. See "Business -- Products and Products Under
Development" and "-- Competition."
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
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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. See "Business -- Product Liability and Insurance."
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,
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."
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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 acquiror to take over the Company, in a manner or on terms not
approved by the Board. The Rights have been declared by the Board in order to
deter coercive tactics, including a gradual accumulation of shares in the open
market, of a 15% or greater position to be followed by a merger or a partial or
two-tier tender offer that does not treat all shareholders equally. The Rights
should not interfere with any merger or other business combination approved by
the Board. However, the Rights may have the effect of rendering more difficult
or discouraging an acquisition of the Company deemed undesirable by the Board.
The Rights may cause substantial dilution to a person or group attempting to
acquire the Company on terms or in a manner not approved by the Board, except
pursuant to an offer conditioned upon the negation, purchase or redemption of
the Rights.
POTENTIAL VOLATILITY OF STOCK PRICE. The market price of the Common Stock,
like that of the common stock of many other medical products and technology
companies, has in the past been, and is likely in the future to continue to be,
highly volatile. Factors such as fluctuations in the Company's operating
results, announcements of technological innovations or new commercial products
by the Company or its competitors, government regulation, changes in the current
structure of the health care financing and payment systems and developments in
or disputes regarding patent or other proprietary rights may have a significant
effect on the market price of the Common Stock. Moreover, the stock market has
from time to time experienced extreme price and volume fluctuations, which have
particularly affected the market prices for medical products and high technology
companies and which have often been unrelated to the operating performance of
such companies. These broad market fluctuations, as well as general economic,
political and market conditions, may adversely affect the market price of the
Common Stock. In the past, following periods of volatility in the market price
of a company's stock, securities class action suits have been filed against the
issuing company. There can be no assurance that such litigation will not occur
in the future with respect to the Company. Such litigation could result in
substantial costs and a diversion of management's attention and resources, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. Any adverse determination in such
litigation could also subject the Company to significant liabilities.
ABSENCE OF DIVIDENDS. The Company has never declared or paid any cash
dividends since its inception. The Company currently expects to retain future
earnings, if any, to finance the growth and development of its business and,
therefore, does not anticipate declaring or paying any cash dividends in the
foreseeable future.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements and supplemental data
required by this item and set forth on the pages indicated at Item 14(a) of this
Report.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1)Financial Statements
14
<PAGE> 16
The following financial statements are filed as part of this Report:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants................... F-2
Balance Sheets...................................... F-3
Statements of Operations............................ F-4
Statement in Changes in Shareholders' Equity........ F-5
Statements of Cash Flows............................ F-6
Notes to Financial Statements....................... F-7
</TABLE>
(a)(2) Financial Statement Schedules
II -- Valuation and Qualifying Accounts
CHOLESTECH CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS TO
BEGINNING COSTS AND BALANCE AT
OF PERIOD EXPENSES DEDUCTIONS END OF PERIOD
---------- ------------------ ---------- -------------
<S> <C> <C> <C> <C>
FISCAL YEAR ENDED MARCH 29, 1996
Allowance for doubtful accounts......... $ 25,000 $ 57,000 $ -- $ 82,000
Amortization of other assets............ 344,000 143,000 -- 487,000
FISCAL YEAR ENDED MARCH 28, 1997
Allowance for doubtful accounts......... $ 82,000 $ 49,000 $ 49,000 $ 82,000
Amortization of other assets............ 487,000 140,000 -- 627,000
FISCAL YEAR ENDED MARCH 27, 1998
Allowance for doubtful accounts......... $ 82,000 $ 41,000 $ 13,000 $110,000
Amortization of other assets............ 627,000 101,000 700,000 28,000
</TABLE>
All other Schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore have
been omitted.
(a)(3) Exhibits
<TABLE>
<S> <C>
3.1(2) Restated Articles of Incorporation of Registrant.
3.2(l) Bylaws of Registrant, as amended.
4.2(12) Preferred Share Rights Agreement dated January 22, 1997
between the Registrant and Chase Mellon Shareholder
Services, L.L.C., including the Certificate of
Determination, the form of Rights Certificate and Summary of
Rights attached thereto as Exhibits A, B and C,
respectively.
10.1(3) 1988 Stock Incentive Program and forms of agreements
thereunder.
10.2(15) Employee Stock Purchase Plan.
10.3(l) Standard Industrial Lease Agreement between Registrant and
Sunlife Assurance Company of Canada dated October 22, 1989.
10.3.1(8) First Amendment to Standard Industrial Lease Agreement
between Registrant and Sunlife Assurance Company of Canada
dated April 1995.
10.4(l) Forms of Indemnification Agreements between Registrant and
its officers and its directors.
10.5(l) Employment Agreement between Registrant and Edward L.
Erickson dated December 6, 1991.
10.6(l) Equipment Lease Agreement between Registrant and MMC/GATX
Partnership No. 1 dated August 17, 1990.
</TABLE>
15
<PAGE> 17
<TABLE>
<S> <C>
10.6.1(1) Revised Warrant to Purchase Series D Preferred Stock issued
to MMC/GATX Partnership No. 1.
10.7(l) Master Lease Agreement between Registrant and LINC Venture
Lease Partners II L.T. dated June 13, 1991.
10.7.1(1) Amendment No. 1 to Warrant issued to LINC Venture Lease
Partners II L.P.
10.8(l) Supply Agreement effective the 15th day of February 1991 by
and between Ciba Corning Diagnostics Corp. and the
Registrant.
10.9(4) Employment Agreement between Registrant and Steven L.
Barbato dated April 27, 1992.
10.10(4) Employment Agreement between Registrant and Robert J. Guyon
dated July 13, 1992.
10.11.1(5) Letter Agreement effective September 28, 1993 by and between
Union Bank and Registrant.
10.11.2(5) Promissory Note effective September 28, 1993 by and between
Union Bank and Registrant.
10.11.3(5) Security Agreement effective September 28, 1993 by and
between Union Bank and Registrant.
10.11.4(7) First Amendment to the Letter Agreement by and between Union
Bank and Registrant.
10.11.5(7) First Amendment to the Promissory Note by and between Union
Bank and Registrant.
10.11.6(10) Second Amendment to the Letter Agreement by and between
Union Bank and Registrant.
10.11.7(10) Second Amendment to the Promissory Note by and between Union
Bank and Registrant.
10.12(4) License Agreement between Registrant and Eastman Kodak
Company dated December 23, 1992.
10.13(6) Employment Agreement between Registrant and Linda H.
Masterson dated May 12, 1994.
10.14(9) Loan Agreement between Registrant and Phoenixcor, Inc. dated
August 31, 1995.
10.15(11)* Development, License and Distribution Agreement between
Registrant and Metra Biosystems, Inc. dated May 3, 1996.
10.16(11) Registration Rights Agreement between Registrant and Metra
Biosystems, Inc. dated May 3, 1996.
10.17.1(13) Letter Agreement effective December 20, 1996 by and between
Wells Fargo Bank and the Registrant.
10.17.2(13) Revolving Line of Credit Note effective December 20, 1996 by
and between Wells Fargo Bank and the Registrant.
10.17.3(13) General Pledge Agreement effective December 20, 1996 by and
between Wells Fargo Bank and the Registrant.
10.17.4(18) Revolving Line of Credit Note effective November 30, 1997 by
and between Wells Fargo Bank and Registrant.
10.18(14) Employment Agreement between Registrant and Mark J. Kussman
dated August 8, 1996.
10.19(16) Consulting Agreement between Registrant and Warner-Lambert
Company dated June 18, 1997.
10.20(17) 1997 Stock Incentive Program and Form of Agreement
thereunder.
23.1 Consent of Independent Accountants.
24.1+ Power of Attorney.
</TABLE>
- ---------------
* Confidential treatment has been granted by the Securities and Exchange
Commission with respect to certain portions of this exhibit. The redacted
portions have been filed separately with the Securities and Exchange
Commission.
+ Previously Filed.
(1) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 33-47603) which became effective on June 26,
1992.
16
<PAGE> 18
(2) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 33-54300) which became effective on December 16,
1992.
(3) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-22475) as filed with the Securities and
Exchange Commission on February 28, 1997.
(4) Incorporated by reference to exhibits filed with Registrant's Annual Report
on Form 10-K for the year ended March 26, 1993.
(5) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 23, 1993.
(6) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 24, 1994.
(7) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 23, 1994.
(8) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995.
(9) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 29, 1995.
(10) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 29, 1995.
(11) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 333-03364) as declared effective by the
Commission on June 28, 1996.
(12) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form 8-A (No. 000-20198) as declared effective by the
Commission on March 27, 1997.
(13) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 27, 1996.
(14) Incorporated by reference to exhibits filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended March 28, 1997.
(15) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-38147) as declared effective by the
Commission on October 17, 1997.
(16) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 26, 1997.
(17) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-38151) that became effective on October 17,
1997.
(18) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 26, 1997.
(b) Reports on Form 8-K. The Company did not file any reports on Form 8-K
during the quarter ended March 31, 1998.
(c) Exhibits. See Item 14(a)(3) above.
(d) Financial Statement Schedules. See Item 14(a)(2) above.
17
<PAGE> 19
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Amendment
No. 2 to the Report on Form 10-K to be signed on its behalf by the undersigned,
thereunto duly authorized.
CHOLESTECH CORPORATION
By: /s/ WARREN E. PINCKERT II
------------------------------------
Warren E. Pinckert II
President, Chief Executive Officer
and Director
Date: August 27, 1998
18
<PAGE> 20
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, THIS AMENDMENT NO. 2 TO THE REPORT ON FORM 10-K HAS BEEN SIGNED BELOW
BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND
ON THE DATES INDICATED:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ WARREN E. PINCKERT II President, Chief Executive August 27, 1998
- ----------------------------------------------------- Officer and Director (Principal
(Warren E. Pinckert II) Executive Officer)
/s/ ANDREA J. TILLER Vice President of Finance and August 27, 1998
- ----------------------------------------------------- Chief Financial Officer
(Andrea J. Tiller) (Principal Financial and
Accounting Officer)
Director August 27, 1998
*
- -----------------------------------------------------
(Harvey S. Sadow, Ph.D.)
Director August 27, 1998
*
- -----------------------------------------------------
(Joseph Buchman, M.D.)
Director August 27, 1998
*
- -----------------------------------------------------
(John L. Castello)
Director August 27, 1998
*
- -----------------------------------------------------
(John H. Landon)
Director August 27, 1998
*
- -----------------------------------------------------
(H.R. Shepherd)
Director August 27, 1998
*
- -----------------------------------------------------
(Larry Y. Wilson)
*By /s/ ANDREA J. TILLER
- -----------------------------------------------------
(Andrea J. Tiller)
Attorney-in-Fact
</TABLE>
19
<PAGE> 21
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants........................... F-2
Balance Sheets.............................................. F-3
Statements of Operations.................................... F-4
Statement of Changes in Shareholders' Equity................ F-5
Statements of Cash Flows.................................... F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE> 22
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Cholestech Corporation
In our opinion, the accompanying balance sheets and the related statements
of operations, of changes in shareholders' equity and of cash flows present
fairly, in all material respects, the financial position of Cholestech
Corporation at March 27, 1998 and March 28, 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
March 27, 1998, in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
San Jose, California
April 23, 1998
F-2
<PAGE> 23
CHOLESTECH CORPORATION
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 5,130 $ 6,088
Marketable securities..................................... 9,621 7,921
Accounts receivable, net.................................. 3,793 1,866
Inventories............................................... 3,306 2,353
Prepaid expenses and other assets......................... 154 280
-------- --------
Total current assets.............................. 22,004 18,508
Property and equipment, net................................. 3,711 2,399
Other assets, net........................................... 73 180
-------- --------
$ 25,788 $ 21,087
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.................. $ 3,003 $ 1,643
Accrued payroll and benefits.............................. 1,136 527
Product warranty.......................................... 203 214
-------- --------
Total current liabilities......................... 4,342 2,384
-------- --------
Commitments (Notes 4 and 5)
Shareholders' equity:
Preferred Stock, no par value; 5,000,000 shares
authorized; no shares issued
and outstanding........................................ -- --
Common Stock, no par value; 25,000,000 shares authorized;
11,402,084 and 11,222,040 shares issued and
outstanding............................................ 69,880 69,174
Unrealized gains on investments........................... 49 --
Accumulated deficit....................................... (48,483) (50,471)
-------- --------
Total shareholders' equity........................ 21,446 18,703
-------- --------
$ 25,788 $ 21,087
======== ========
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 24
CHOLESTECH CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED
----------------------------------------
MARCH 27, MARCH 28, MARCH 29,
1998 1997 1996
---------- ----------- -----------
<S> <C> <C> <C>
Revenues............................................. $ 21,664 $ 12,861 $ 6,873
Cost of products sold................................ 10,513 6,957 4,481
---------- ----------- -----------
Gross profit......................................... 11,151 5,904 2,392
---------- ----------- -----------
Operating expenses:
Sales and marketing................................ 5,380 4,108 3,305
Research and development........................... 2,224 1,341 731
General and administrative......................... 2,087 1,537 1,246
---------- ----------- -----------
Total operating expenses................... 9,691 6,986 5,282
---------- ----------- -----------
Income (loss) from operations........................ 1,460 (1,082) (2,890)
Interest income...................................... 571 517 284
Interest expense..................................... (2) (244) (140)
---------- ----------- -----------
Income (loss) before taxes........................... 2,029 (809) (2,746)
Provision for income taxes........................... 41 -- --
---------- ----------- -----------
Net income (loss).................................... $ 1,988 $ (809) $ (2,746)
========== =========== ===========
Net income (loss) per share:
Basic.............................................. $ 0.18 $ (0.08) $ (0.34)
========== =========== ===========
Diluted............................................ $ 0.17 $ (0.08) $ (0.34)
========== =========== ===========
Shares used to compute net income (loss) per share:
Basic.............................................. 11,289,102 10,381,914 8,041,531
========== =========== ===========
Diluted............................................ 11,905,043 10,381,914 8,041,531
========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 25
CHOLESTECH CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK
-------------------- ACCUMULATED
SHARES AMOUNT OTHER DEFICIT TOTAL
---------- ------- ----- ----------- -------
<S> <C> <C> <C> <C> <C>
Balance at March 31, 1995.................. 7,999,962 $55,465 $(36) $(46,916) $ 8,513
Issuance of Common Stock pursuant to
employee stock purchase plan and exercise
of stock options and warrants............ 131,862 140 140
Compensation expense relating to stock
options.................................. 39 39
Forgiveness of loan........................ 36 36
Net loss................................... (2,746) (2,746)
---------- ------- ---- -------- -------
Balance at March 29, 1996.................. 8,131,824 55,644 -- (49,662) 5,982
Sale of Common Stock to the public, net of
issuance costs........................... 2,875,000 12,858 12,858
Issuance of Common Stock pursuant to
employee stock purchase plan and exercise
of stock options and warrants............ 175,690 422 422
Issuance of Common Stock pursuant to a
development, license and distribution
agreement................................ 39,526 250 250
Net loss................................... (809) (809)
---------- ------- ---- -------- -------
Balance at March 28, 1997.................. 11,222,040 69,174 -- (50,471) 18,703
Issuance of Common Stock pursuant to
employee stock purchase plan and exercise
of stock options......................... 180,044 706 706
Unrealized gains on available-for-sale
securities............................... 49 49
Net income................................. 1,988 1,988
---------- ------- ---- -------- -------
Balance at March 27, 1998.................. 11,402,084 $69,880 $ 49 $(48,483) $21,446
========== ======= ==== ======== =======
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 26
CHOLESTECH CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------
MARCH 27, MARCH 28, MARCH 29,
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)...................................... $ 1,988 $ (809) $ (2,746)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization....................... 767 846 612
Deferred revenue.................................... -- (6) (30)
Compensation expense relating to stock options
issued
below market...................................... -- -- 39
Forgiveness of note receivable...................... -- -- 36
Write-off of property and equipment................. -- 3 3
Changes in assets and liabilities:
Accounts receivable............................... (1,927) (759) (443)
Inventories....................................... (953) (443) (559)
Prepaid expenses and other assets................. 126 (113) 1
Other assets...................................... 107 (12) (6)
Accounts payable and accrued liabilities.......... 1,400 (26) 721
Accrued payroll and benefits...................... 609 274 (51)
Product warranty.................................. (11) 27 37
--------- --------- --------
Net cash provided by (used in) operating
activities........................................ 2,106 (1,018) (2,386)
--------- --------- --------
Cash flows from investing activities:
Purchase of marketable securities...................... (33,391) (191,737) (121,016)
Proceeds from sale of marketable securities............ 31,740 187,566 121,266
Purchases of property and equipment.................... (2,079) (1,019) (331)
--------- --------- --------
Net cash (used in) investing activities............. (3,730) (5,190) (81)
--------- --------- --------
Cash flows from financing activities:
Proceeds from long term debt........................... -- -- 1,500
Repayment of long term debt............................ -- (1,298) (202)
Proceeds from short term bank borrowing................ -- 800 250
Repayment of short term bank borrowing................. -- (1,050) --
Principal payments on capital leases................... (40) (47) (90)
Issuance of Common Stock............................... 706 13,530 140
--------- --------- --------
Net cash provided by financing activities........... 666 11,935 1,598
--------- --------- --------
Net change in cash and cash equivalents.................. (958) 5,727 (869)
Cash and cash equivalents at beginning of period......... 6,088 361 1,230
--------- --------- --------
Cash and cash equivalents at end of period............... $ 5,130 $ 6,088 $ 361
========= ========= ========
Supplemental disclosures of cash flow information:
Cash paid for interest................................. $ 2 $ 244 $ 140
========= ========= ========
Cash paid for income taxes............................. $ 25 $ -- $ --
========= ========= ========
Supplemental disclosure of non-cash financing and
investing activities:
Capital lease obligations incurred for acquisition of
property
and equipment....................................... $ -- $ 47 $ --
========= ========= ========
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 27
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. THE COMPANY AND A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Cholestech Corporation (the "Company") was incorporated in February 1988.
The Company develops, manufactures and markets the Cholestech L-D-X System (the
"L-D-X System") which performs near-patient diagnostic screening and therapeutic
monitoring for the management of prevalent chronic diseases. The L-D-X System is
capable of measuring multiple analytes simultaneously with a single drop of
whole blood within five minutes.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR END
The Company's fiscal year is a 52-53 week period ending on the last Friday
in March. Fiscal 1998, 1997 and 1996 each comprised 52 week periods.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year financial
statements to conform to the fiscal 1998 presentation. Such reclassifications
had no effect on previously reported results of operations.
REVENUE RECOGNITION
Revenues from product sales are recognized at the time products are shipped
and are denominated in U.S. dollars. The Company also provides amounts for
estimated sales returns.
CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company considers all highly liquid investments with a maturity of
three months or less at the date of purchase to be cash equivalents; all other
investments are classified as short term marketable securities. The Company has
established policies that limit the type, credit quality and length of maturity
of the securities in which it invests. The Company's investment policy allows no
investments in any single private issuer to exceed $1,000,000 and the
investments must have, at a minimum, a credit rating of AA. Cash equivalents and
marketable securities at March 27, 1998 consist of investments in money market
funds, commercial paper and U.S. government-agency obligations. Marketable
securities are classified as available-for-sale and are carried at their market
value at the balance sheet date. Net unrealized gains and losses are recorded
directly in shareholders' equity until realized. Realized gains and losses on
the sale of marketable securities are determined on the specific identification
method and are reflected in the statements of operations. Realized gains and
losses on sale of marketable securities have not been material.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to credit risk
consist of cash equivalents, marketable securities and accounts receivable. Cash
equivalents and marketable securities are maintained with a high credit quality
institution, and the composition and maturities of the investments are regularly
monitored by management. Generally, these securities are highly liquid and may
be redeemed upon demand and, therefore, have minimal risk associated with them.
The Company has not experienced any material losses on its investments.
The Company's trade accounts receivable generally consist of a large number
of small customers. Concentrations of credit risk with respect to trade accounts
receivable are considered to be limited due to this customer base and the
diversity of the Company's geographic sales areas. The Company performs ongoing
credit evaluations of its customers' financial condition and, generally,
requires no collateral. The Company
F-7
<PAGE> 28
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
maintains a provision for potential credit losses and such amounts, in the
aggregate, have not exceeded management expectations. No single customer
accounted for more than 10% of revenues in fiscal 1998, 1997 or 1996.
INVENTORIES
Inventories are stated at the lower of cost or market, cost being
determined using the first-in, first-out (FIFO) method. Cost includes direct
materials, direct labor and manufacturing overhead.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the related assets
that range from two to five years. Leasehold improvements are amortized over
their estimated useful lives, not to exceed the term of the related lease. The
cost of additions and improvements is capitalized while maintenance and repairs
are charged to expense as incurred.
PRODUCT WARRANTY
The Company's products are generally under warranty against defects in
material and workmanship for a period of one year. The Company accrues for
estimated future warranty costs at the time of sale.
INCOME TAXES
The Company uses the asset and liability method of accounting for income
taxes, which requires the recognition of deferred tax liabilities and assets for
the expected future tax consequences of temporary differences between the
financial reporting and income tax bases of assets and liabilities.
NET INCOME (LOSS) PER SHARE
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings per Share", during the quarter ended December 26, 1997. SFAS
No. 128 requires the presentation of both basic earnings per share and, for
companies with complex capital structures (or potentially dilutive securities,
such as convertible debt, options and warrants), diluted earnings per share on
the face of the statement of operations. All prior period amounts have been
restated to conform with SFAS No. 128. 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 fiscal 1998 basic and
diluted earnings per share computation. For fiscal 1997 and 1996, the numerator
and denominator in the basic and diluted per share computations were the same.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 27, 1998
--------------------------------------
EARNINGS
INCOME SHARES PER SHARE
------- ------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Basic EPS.................................. $1,988 11,289 $0.18
Effect of dilutive securities.............. -- 616 (0.01)
------ ------ -----
Diluted EPS................................ $1,988 11,905 $0.17
====== ====== =====
</TABLE>
Due to the net loss incurred during fiscal 1997 and 1996, options to
purchase 1,074,097 and 875,683 shares of Common Stock outstanding at March 28,
1997 and March 29, 1996, were considered anti-dilutive
F-8
<PAGE> 29
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
and therefore excluded from the calculation of diluted net loss per share. In
addition, at March 27, 1998, options to purchase 156,143 shares of Common Stock
were considered anti-dilutive because the respective exercise prices were
greater than the average fair market value of the Common Stock.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash equivalents, marketable securities and capital
lease obligations approximate their fair value due to the short maturity of
these instruments.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Account Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, compensation cost
is measured as the excess, if any, of the quoted market price of the Company's
stock at the date of grant over the price the employee must pay to acquire the
stock. The Company accounts for consultant stock-based compensation using the
fair value method under SFAS No. 123. The Company provides additional pro forma
disclosures as required under SFAS No. 123, "Accounting for Stock-Based
Compensation" (see Note 6).
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards
for reporting and display of comprehensive income and its components in a full
set of general purpose financial statements that is displayed with the same
prominence as other financial statements for fiscal years beginning after
December 15, 1997. 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. Reclassification of financial
statements for earlier periods is required. The Company will adopt SFAS No. 130
beginning in fiscal 1999 and does not expect such adoption to have a material
impact on its financial position or results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of
an Enterprise and Related Information." This statement establishes standards for
the way companies report information about operating segments in annual
financial statements for fiscal years beginning after December 15, 1997. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The Company will adopt SFAS No. 131 in
fiscal 1999. Because SFAS No. 131 only addresses disclosure and reporting
issues, its adoption will not have a material impact on the Company's financial
position or results of operations.
F-9
<PAGE> 30
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. BALANCE SHEET COMPOSITION
The Company's portfolio of marketable securities consists of the following
(in thousands):
<TABLE>
<CAPTION>
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Money market funds..................................... $ 6,512 7,938
U.S. government and agency securities.................. 3,000 3,733
Corporate securities................................... 4,559 1,264
------- -------
14,071 12,935
</TABLE>
The marketable securities by contractual maturity are as follows (in
thousands):
<TABLE>
<CAPTION>
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Due in one year or less................................ $12,029 $ 9,690
Due one year through two years......................... 2,042 3,245
------- -------
$14,071 $12,935
</TABLE>
Accounts receivable consist of (in thousands):
<TABLE>
<CAPTION>
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Accounts receivable.................................... $ 3,903 $ 1,948
Less allowance for doubtful accounts and sales
returns.............................................. (110) (82)
------- -------
$ 3,793 $ 1,866
======= =======
</TABLE>
Inventories consist of (in thousands):
<TABLE>
<CAPTION>
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Raw materials.......................................... $1,292 $ 703
Work-in-process........................................ 1,038 585
Finished goods......................................... 976 1,065
------ ------
$3,306 $2,353
====== ======
</TABLE>
Property and equipment consist of (in thousands):
<TABLE>
<CAPTION>
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Machinery and equipment................................ $ 5,434 $ 4,780
Furniture and fixtures................................. 474 316
Computer equipment..................................... 1,954 1,067
Leasehold improvements................................. 632 231
Construction-in-progress............................... 447 468
------- -------
8,941 6,862
Less accumulated depreciation and amortization......... (5,230) (4,463)
------- -------
$ 3,711 $ 2,399
======= =======
</TABLE>
Property and equipment include assets under capital leases of $26,000 and
$78,000 and accumulated depreciation of $25,000 and $27,000 at March 27, 1998
and March 28, 1997, respectively.
F-10
<PAGE> 31
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Accounts payable and accrued liabilities consist of (in thousands):
<TABLE>
<CAPTION>
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Trade accounts payable................................. $2,605 $1,080
Accrued royalties...................................... 86 300
Other accrued liabilities.............................. 312 263
------ ------
$3,003 $1,643
====== ======
</TABLE>
3. BORROWING ARRANGEMENTS
In December 1997, the Company renewed an agreement with its primary 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 with the
bank, 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. As of March 27,
1998 and March 28, 1997, there were no borrowings outstanding under the line of
credit.
4. LEASES
The Company leases office and laboratory facilities under a noncancellable
operating lease which expires on March 31, 2000. The lease contains renewal and
option provisions. Rent expense was $229,000, $195,000 and $195,000 for fiscal
1998, 1997 and 1996, respectively.
Future minimum payments required under the Company's noncancellable
operating lease at March 27, 1998 were $241,000 and $247,000 for fiscal years
1999 and 2000, respectively.
5. LICENSE AND DEVELOPMENT AGREEMENTS
The Company has obtained the right to use certain technology in
manufacturing its products. The related agreement, which expires in 2006,
requires the Company to pay a 2.0% royalty on net sales of the applicable
products. Total royalty expense for fiscal 1998, 1997 and 1996 was $562,000,
$551,000 and $381,000, respectively, and was charged to cost of products sold.
In May 1996, the Company entered into a development, marketing and license
agreement (the "Agreement") with Metra Biosystems, Inc. ("Metra Biosystems") to
develop an immunoassay test cassette incorporating Metra Biosystems' bone
resorption technology to be used with the L-D-X System. Pursuant to the
Agreement, Metra Biosystems purchased 39,526 shares of Common Stock for an
aggregate purchase price of $250,000 ($6.325 per share). Metra Biosystems is
obligated to purchase $750,000 of additional shares of Common Stock at the then
current market price, upon completion by the Company of specified development
milestones, unless Metra Biosystems exercises its option to terminate the
Agreement, which it may do at any time.
6. SHAREHOLDERS' EQUITY
PREFERRED STOCK
The Company is authorized to issue 5,000,000 shares of Preferred Stock. The
Board of Directors has the authority to issue the Preferred Stock in one or more
series and to fix the price, rights, preferences, privileges and restrictions
thereof, including dividend rights, dividend rates, conversion rights, voting
rights, terms of redemption, redemption prices, liquidation preferences and the
number of shares constituting a series or the
F-11
<PAGE> 32
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
designation of such series, without any further vote or action by the Company's
shareholders. In connection with the Company's shareholder rights plan, 25,000
shares of the Preferred Stock have been designated Series A Participating
Preferred Stock. None of the shares of Series A Participating Preferred Stock
were outstanding as of March 27, 1998, nor was there any activity relating to
Preferred Stock during the three years ended March 27, 1998.
WARRANTS
During fiscal 1997, warrants to purchase 19,336 shares of Common Stock were
exercised at a price of $3.50 per share. As consideration for the exercise,
19,906 warrants to purchase 19,906 shares of Common Stock were surrendered to
the Company having an "in the money" value of $3.40 per share, resulting in zero
cash proceeds to the Company. There were no warrants outstanding at March 27,
1998.
STOCK INCENTIVE PROGRAM
The 1988 Stock Incentive Program (the "1988 Program") provides that
incentive stock options ("ISOs") and nonqualified stock options ("NSOs") for
shares of Common Stock may be granted to employees and consultants of the
Company. In accordance with the 1988 Program, the exercise price may not be less
than 100% and 85% of the fair market value of Common Stock on the date of grant
for ISOs and NSOs, respectively. The 1988 Program provides that options shall be
exercisable over a period not to exceed five years and a day. Options vest over
four years at a rate of at least 25 percent each year. Vesting of individual
option grants may be accelerated upon the occurrence of certain events as
described in the stock option agreement. In August 1995, the shareholders
approved an increase in the number of shares of Common Stock reserved for
issuance under the 1988 Program from 1,300,000 to 1,550,000 and in August 1996,
the shareholders approved an additional increase in the number of shares of
Common Stock reserved for issuance under the 1988 Program from 1,550,000 to
2,050,000. The 1988 Program expired in February 1998. There are no shares
available for future grant under the 1988 Program.
In August 1997, the shareholders approved the 1997 Stock Incentive Program
(the "1997 Program") which provides that ISOs and NSOs for shares of Common
Stock may be granted to employees and consultants of the Company. In accordance
with the 1997 Program, the exercise price may not be less than 100% of the fair
market value of Common Stock on the date of grant for ISOs and NSOs. The 1997
Program provides that options shall be exercisable over a period not to exceed
five years and a day. Options vest over four years at a rate of at least 25
percent each year. Vesting of individual option grants may be accelerated upon
the occurrence of certain events as described in the stock option agreement.
Pursuant to the terms of the 1997 Program, 900,000 shares of Common Stock were
reserved for future issuance.
F-12
<PAGE> 33
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Stock option activity under the 1988 and 1997 Programs is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OUTSTANDING EXERCISE PRICE
BALANCE OPTIONS PER SHARE
------- ----------- ----------------
<S> <C> <C>
Balance, March 31, 1995.......................... 879,028 $3.19
Granted.......................................... 212,923 $2.71
Exercised........................................ (79,885) $0.62
Canceled......................................... (136,383) $3.28
---------
Balance, March 29, 1996.......................... 875,683 $3.29
Granted.......................................... 427,500 $4.82
Exercised........................................ (137,707) $2.53
Canceled......................................... (91,379) $2.73
---------
Balance, March 28, 1997.......................... 1,074,097 $3.68
Granted.......................................... 449,893 $8.66
Exercised........................................ (150,286) $3.74
Canceled......................................... (78,039) $6.56
---------
Balance, March 27, 1998.......................... 1,295,665 $5.41
=========
</TABLE>
At March 27, 1998, options for 877,600 shares of Common Stock were
available for future grant under the 1997 Program.
The following table summarizes information about stock options outstanding
at March 27, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- ------------------------
WEIGHTED AVG. WEIGHTED AVG. WEIGHTED AVG.
RANGE OF EXERCISE PRICES NUMBER CONTRACTUAL LIFE EXERCISE PRICE NUMBER EXERCISE PRICE
- ------------------------ --------- ---------------- -------------- ------- --------------
<S> <C> <C> <C> <C> <C>
$1.75 - $ 3.25 128,286 2.1 $ 2.42 95,156 $ 2.44
$3.26 - $ 6.56 1,011,236 3.0 $ 4.69 557,787 $ 4.08
$6.57 - $10.50 156,143 4.8 $12.52 1,558 $10.66
--------- -------
1,295,665 3.1 $ 5.41 654,501 $ 3.86
========= =======
</TABLE>
EMPLOYEE STOCK PURCHASE PLAN
In April 1992, the Company adopted the Employee Stock Purchase Plan (the
"Stock Purchase Plan"), which reserved 75,000 shares of Common Stock to be
issued in accordance with the Internal Revenue Code under such terms as approved
by the Board of Directors. In August 1995, the shareholders approved an increase
in the number of shares reserved for issuance under the Stock Purchase Plan from
75,000 to 200,000. In August 1997, the shareholders approved an additional
increase in the number of shares reserved for issuance under the Stock Purchase
Plan from 200,000 to 400,000. Under the term of the Stock Purchase Plan,
employees can choose semi-annually to have up to 15% of their compensation
withheld to purchase shares of Common Stock. The purchase price is equal to 85%
of the lower of the closing price of the Common Stock on the Nasdaq National
Market on the day the Stock Purchase Plan period begins or ends. Under the Stock
Purchase Plan, the Company sold 29,758, 21,543 and 50,814 shares of Common Stock
to employees in fiscal 1998, 1997 and 1996, respectively.
F-13
<PAGE> 34
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
PRO FORMA DISCLOSURES
Had compensation cost for the Company's stock option and stock purchase
plans been determined based on the fair value of the options at the grant dates,
as prescribed in SFAS No. 123, the Company's net income (loss) and net income
(loss) per share would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED
--------------------------------------
MARCH 27, MARCH 28, MARCH 29,
1998 1997 1996
---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net income (loss):
As reported....................................... $1,988 $ (809) $(2,746)
Pro forma......................................... $1,195 $(1,035) $(2,786)
Net income (loss) per share:
As reported -- basic.............................. $ 0.18 $ (0.08) $ (0.34)
Pro forma -- basic................................ $ 0.11 $ (0.10) $ (0.34)
As reported -- diluted............................ $ 0.17 $ (0.08) $ (0.34)
Pro forma -- diluted.............................. $ 0.10 $ (0.10) $ (0.34)
</TABLE>
The fair value of each stock option is estimated on the date of grant using
the Black-Scholes valuation model, with the following assumptions used for
grants during the applicable periods: dividend yield of 0.0% for all periods;
risk-free interest rates of 5.9%, 6.3% and 6.0% for options granted during
fiscal 1998, 1997 and 1996, respectively; volatility factors of 78%, 79% and 79%
for options granted during fiscal 1998, 1997 and 1996, respectively; and a
weighted average expected option term of 4.0 years, 2.5 years and 2.5 years for
fiscal 1998, 1997 and 1996, respectively. The weighted average fair values of
stock options granted in fiscal 1998, 1997 and 1996 were $5.03, $2.44 and $1.65
per share, respectively.
The fair value of stock purchase rights is estimated using the
Black-Scholes valuation model, with the following assumptions; dividend yield of
0.0% for all periods; an expected life of 6 months for all periods; expected
volatility factors of 81%, 74% and 95% for fiscal 1998, 1997 and 1996,
respectively; and risk-free interest rates of 5.4%, 5.3% and 5.5% for fiscal
1998, 1997 and 1996, respectively. The weighted average fair values of stock
purchase rights granted in fiscal 1998, 1997 and 1996 were $1.85, $1.21 and
$0.77, respectively. The weighted average exercise prices of stock purchase
rights granted in fiscal 1998, 1997 and 1996 were $8.20, $5.54, and $2.83,
respectively.
The pro forma effect on net income (loss) and net income (loss) per share
for fiscal 1998, 1997 and 1996 is not representative of the pro forma effect on
net income (loss) in future periods because it does not take into consideration
pro forma compensation expense related to grants made prior to fiscal 1996.
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.
F-14
<PAGE> 35
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. RETIREMENT SAVINGS PLAN
Effective September 1990, the Company adopted the Cholestech Corporation
Retirement Savings Plan (the "401(k) Plan") in which all employees of the
Company are entitled to participate. An eligible employee may elect to defer, in
the form of contributions to the 401(k) Plan, between 1% and 15% of the
employees' W-2 income, not to exceed $10,000 per year (adjusted for
cost-of-living increases). Employee contributions are invested in selected
mutual funds or a money market fund as specified by the employee. Employee
contributions are fully vested and nonforfeitable at all times. The 401(k) Plan
provides for employer contributions as determined by the Board of Directors. In
fiscal 1998, the Board of Directors approved a contribution of $164,000 by the
Company to the 401(k) Plan. No company contributions were made in fiscal 1997
and 1996.
8. INCOME TAXES
The provision for income taxes of $41,000 for the year ended March 27, 1998
represents current federal and state alternative minimum taxes payable, reduced
for the utilization of net operating loss and tax credit carryforwards. No
provision for income taxes was recorded for the years ended March 28, 1997 and
March 29, 1996 as the Company incurred net operating losses for income tax
purposes.
Deferred tax assets (liabilities) consist of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Net operating loss carryforwards............................ $ 16,834 $ 17,810
Research and development tax credit carryforwards........... 2,237 2,031
Capitalized research and development........................ 358 280
Other....................................................... (328) (862)
Valuation allowance for deferred tax assets................. (19,101) (19,259)
-------- --------
$ -- $ --
======== ========
</TABLE>
The Company has historically experienced significant operating losses and
operates in an industry subject to rapid technological changes. Therefore,
management believes that there is sufficient uncertainty regarding the Company's
ability to generate future taxable income and utilize its net operating loss and
tax credit carryforwards such that a full valuation allowance for deferred tax
assets was required at March 27, 1998.
At March 27, 1998, the Company has net operating loss carryforwards
available to reduce future taxable income through 2012 for federal and state
income tax purposes of approximately $44,380,000 and $18,756,000, respectively.
Additionally, the Company had research and development credit carryforwards
available to reduce income taxes payable through 2012 for federal and state
income tax purposes of approximately $1,648,000 and $589,000, respectively.
As a result of a change in ownership which occurred in May 1990, there is
an annual limitation of approximately $1,500,000 for federal and state income
tax purposes on the combined use of approximately $6,131,000 of federal net
operating loss carryforwards and the use of $550,000 of federal and state tax
credit carryforwards. Additionally, as a result of the Company's public offering
in December 1992, net operating loss and tax credit carryforwards incurred prior
to December 1992 are subject to an annual limitation of approximately $5,450,000
for federal and state income tax purposes on the combined use of approximately
$26,208,000 of federal and $4,534,000 of state net operating loss carryforwards,
and the use of $1,151,000 of federal and $379,000 of state tax credit
carryforwards. If the amounts of these limitations are not utilized in a
particular year, the amount not utilized increases the limitation in the
subsequent year.
9. GEOGRAPHIC INFORMATION
The Company's export sales were $3,067,000, $1,251,000 and $1,325,000 for
fiscal 1998, 1997 and 1996, respectively. Sales to Europe were $2,170,000,
$908,000 and $825,000, in fiscal 1998, 1997 and 1996, respectively, with the
remainder of export sales to the Pacific Rim and Latin America.
F-15
<PAGE> 36
CHOLESTECH CORPORATION
EXHIBIT LIST
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIAL
NO. DESCRIPTION PAGE NO.
------- ----------- ----------
<S> <C> <C>
3.1(2) Restated Articles of Incorporation of Registrant.
3.2(l) Bylaws of Registrant, as amended.
4.2(12) Preferred Share Rights Agreement dated January 22, 1997
between the Registrant and Chase Mellon Shareholder
Services, L.L.C., including the Certificate of
Determination, the form of Rights Certificate and Summary of
Rights attached thereto as Exhibits A, B and C,
respectively.
10.1(3) 1988 Stock Incentive Program and forms of agreements
thereunder.
10.2(15) Employee Stock Purchase Plan.
10.3(l) Standard Industrial Lease Agreement between Registrant and
Sunlife Assurance Company of Canada dated October 22, 1989.
10.3.1(8) First Amendment to Standard Industrial Lease Agreement
between Registrant and Sunlife Assurance Company of Canada
dated April 1995.
10.4(l) Forms of Indemnification Agreements between Registrant and
its officers and its directors.
10.5(l) Employment Agreement between Registrant and Edward L.
Erickson dated December 6, 1991.
10.6(l) Equipment Lease Agreement between Registrant and MMC/GATX
Partnership No. 1 dated August 17, 1990.
10.6.1(1) Revised Warrant to Purchase Series D Preferred Stock issued
to MMC/ GATX Partnership No. 1.
10.7(l) Master Lease Agreement between Registrant and LINC Venture
Lease Partners II L.T. dated June 13, 1991.
10.7.1(1) Amendment No. 1 to Warrant issued to LINC Venture Lease
Partners II L.P.
10.8(l) Supply Agreement effective the 15th day of February 1991 by
and between Ciba Corning Diagnostics Corp. and the
Registrant.
10.9(4) Employment Agreement between Registrant and Steven L.
Barbato dated April 27, 1992.
10.10(4) Employment Agreement between Registrant and Robert J. Guyon
dated July 13, 1992.
10.11.1(5) Letter Agreement effective September 28, 1993 by and between
Union Bank and Registrant.
10.11.2(5) Promissory Note effective September 28, 1993 by and between
Union Bank and Registrant.
10.11.3(5) Security Agreement effective September 28, 1993 by and
between Union Bank and Registrant.
10.11.4(7) First Amendment to the Letter Agreement by and between Union
Bank and Registrant.
10.11.5(7) First Amendment to the Promissory Note by and between Union
Bank and Registrant.
10.11.6(10) Second Amendment to the Letter Agreement by and between
Union Bank and Registrant.
</TABLE>
<PAGE> 37
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIAL
NO. DESCRIPTION PAGE NO.
------- ----------- ----------
<S> <C> <C>
10.11.7(10) Second Amendment to the Promissory Note by and between Union
Bank and Registrant.
10.12(4) License Agreement between Registrant and Eastman Kodak
Company dated December 23, 1992.
10.13(6) Employment Agreement between Registrant and Linda H.
Masterson dated May 12, 1994.
10.14(9) Loan Agreement between Registrant and Phoenixcor, Inc. dated
August 31, 1995.
10.15(11)* Development, License and Distribution Agreement between
Registrant and Metra Biosystems, Inc. dated May 3, 1996.
10.16(11) Registration Rights Agreement between Registrant and Metra
Biosystems, Inc. dated May 3, 1996.
10.17.1(13) Letter Agreement effective December 20, 1996 by and between
Wells Fargo Bank and the Registrant.
10.17.2(13) Revolving Line of Credit Note effective December 20, 1996 by
and between Wells Fargo Bank and the Registrant.
10.17.3(13) General Pledge Agreement effective December 20, 1996 by and
between Wells Fargo Bank and the Registrant.
10.17.4(18) Revolving Line of Credit Note effective November 30, 1997 by
and between Wells Fargo Bank and Registrant.
10.18(14) Employment Agreement between Registrant and Mark J. Kussman
dated August 8, 1996.
10.19(16) Consulting Agreement between Registrant and Warner-Lambert
Company dated June 18, 1997.
10.20(17) 1997 Stock Incentive Program and Form of Agreement
thereunder.
23.1 Consent of Independent Accountants.
24.1+ Power of Attorney (See page 43).
</TABLE>
- ---------------
* Confidential treatment has been granted by the Securities and Exchange
Commission with respect to certain portions of this exhibit. The redacted
portions have been filed separately with the Securities and Exchange
Commission.
+ Previously Filed.
(1) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 33-47603) which became effective on June 26,
1992.
(2) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 33-54300) which became effective on December 16,
1992.
(3) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-22475) as filed with the Securities and
Exchange Commission on February 28, 1997.
(4) Incorporated by reference to exhibits filed with Registrant's Annual Report
on Form 10-K for the year ended March 26, 1993.
(5) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 23, 1993.
(6) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 24, 1994.
<PAGE> 38
(7) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 23, 1994.
(8) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995.
(9) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 29, 1995.
(10) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 29, 1995.
(11) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 333-03364) as declared effective by the
Commission on June 28, 1996.
(12) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form 8-A (No. 000-20198) as declared effective by the
Commission on March 27, 1997.
(13) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 27, 1996.
(14) Incorporated by reference to exhibits filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended March 28, 1997.
(15) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-38147) as declared effective by the
Commission on October 17, 1997.
(16) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 26, 1997.
(17) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-38151) that became effective on October 17,
1997.
(18) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 26, 1997.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 333-38151 and 333-38147) of Cholestech Corporation
of our report dated April 23, 1998, appearing on page F-2 of this Form 10-K/A.
PRICEWATERHOUSECOOPERS LLP
San Jose, California
August 26, 1998
