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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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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
.
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
The Registrant has incorporated by reference into Part III of this Form
10-K portions of its Proxy Statement for the 1998 Annual Meeting of Shareholders
to be held August 20, 1998.
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PART I
ITEM 1. BUSINESS
This Annual Report on Form 10-K, including the information incorporated by
reference herein, includes "forward looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). All of the statements contained in this Annual Report on Form 10-K, other
than statements of historical fact, should be considered forward looking
statements, including, but not limited to, those concerning the Company's
strategies, objectives and plans for expansion of its operations, products and
services and growth in demand for the Cholestech L-D-X System. There can be no
assurance that these expectations will prove to have been correct. Certain
important factors that could cause actual results to differ materially from the
Company's expectations (the "Cautionary Statements") are disclosed in this
Annual Report on Form 10-K, including, without limitation, in the section
entitled "Factors Affecting Future Operating Results" in Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operation and this
section. All subsequent written and oral forward looking statements by or
attributable to the Company or persons acting on its behalf are expressly
qualified in their entirety by such Cautionary Statements. Investors are
cautioned not to place undue reliance on these forward looking statements, which
speak only as of the date hereof and are not intended to give any assurance as
to future results. The Company undertakes no obligation to publicly release any
revisions to these forward looking statements to reflect events or reflect the
occurrence of unanticipated events.
GENERAL
The Company develops, manufactures and markets the Cholestech L-D-X(R)
System (the "L-D-X System") which performs near-patient diagnostic screening and
therapeutic monitoring for the management of prevalent chronic diseases
(preventive care testing). The L-D-X System is capable of measuring multiple
analytes simultaneously with a single drop of whole blood within five minutes.
The Company currently markets the L-D-X System, including the L-D-X Analyzer and
a variety of single use test cassettes, to the physician office laboratory (the
"POL"), pharmacy and health promotion markets in the United States and
internationally. The Company's current products measure and monitor blood
cholesterol, related lipids and glucose and are used to perform preventive care
testing of patients at risk of or suffering from cardiovascular disease or
diabetes. In January 1996, the L-D-X Analyzer and the Company's total
cholesterol ("TC"), high density lipoprotein ("HDL"), calculated low density
lipoproteins ("LDL"), triglyceride and glucose tests were granted waived status
under the Clinical Laboratory Improvement Amendments of 1988, as amended
("CLIA"), the first such waivers granted under CLIA's ease of use, accuracy and
precision guidelines. These CLIA waivers allow health care providers to use the
L-D-X System in preventive care settings without the additional operating costs
and extensive regulatory requirements associated with CLIA compliance. The
Company believes that the L-D-X System is the only simultaneous, multi-analyte
testing device which is classified as waived under CLIA. Further, the Company
believes that the waived status, technological flexibility, ease of use,
accuracy, rapid results and low operating costs of the L-D-X System provide it
with competitive advantages.
MARKET OVERVIEW
In 1996, the diagnosis, treatment and monitoring of chronic diseases
accounted for approximately $358 billion of health care expenditures in the
United States. Chronic diseases are long lasting or frequently recurring
illnesses that, due to their protracted and serious nature, are costly to treat
and monitor. The most prevalent chronic diseases include, among others,
cardiovascular disease, diabetes and osteoporosis (loss of bone mass). The
American Heart Association estimates that more than 58 million people suffer
from cardiovascular disease, the leading cause of death of adults in the United
States, resulting in over one million deaths in 1995. High levels of cholesterol
have been linked by conclusive evidence to cardiovascular disease, and National
Cholesterol Education Program ("NCEP") data indicate that more than 50% of the
adult population in the United States has high or borderline high cholesterol
levels. Diabetes is estimated to afflict
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more than 16 million persons in the United States, over a third of whom have not
been identified as being diabetic, and often results in a number of short term
and long term complications such as nerve damage, kidney disease and retinal
damage. Cardiovascular disease and renal failure are the most prevalent causes
of death among diabetics. According to the National Osteoporosis Foundation,
osteoporosis is a threat to over 28 million persons in the United States. The
estimated annual cost of treating osteoporosis related fractures in the United
States is $14 billion.
Pharmaceutical companies have focused considerable resources on developing
drugs for the treatment of cardiovascular disease, diabetes, osteoporosis and
other chronic diseases. While drug therapy is necessary for the overall
treatment of chronic diseases, diagnostic screening, proper therapeutic
monitoring and compliance with drug therapy are also important components of an
effective program to manage chronic diseases. Widespread diagnostic screening
for chronic diseases aids in the early identification of patients who would
benefit from drug therapy. Effective administration of drug therapies often
requires careful therapeutic monitoring of drug impact on body chemistry to
ensure proper drug dosages, monitor improvement and reduce the risk of side
effects. Moreover, ongoing compliance with drug therapy is necessary for
effective treatment and reduces the risk to patients of adverse acute events.
Studies show that noncompliance with drug therapy is a major health care problem
that may be responsible for almost 10% of all hospital admissions, 23% of all
nursing home admissions and the loss of 20 million work days each year.
Traditionally, diagnostic screening and therapeutic monitoring have been
performed primarily in clinical and hospital laboratories. However, testing in
these settings may limit the effectiveness of chronic disease management because
reporting of test results is delayed and in some cases never occurs. Delayed
test results postpone a physician's opportunity to consult with patients and
administer proper therapy. Inconvenient testing sites and delayed reporting may
result in failure to identify those who are at risk and may contribute to
reduced compliance. Studies indicate that more than 50% of all patients
prescribed medication for the treatment of a chronic disease discontinue the
therapy. In addition, evidence suggests that improved access to diagnostic
screening and therapeutic monitoring could result in increased therapy
compliance, improved patient outcomes and cost savings to the health care
system.
Recognizing the benefits of effective chronic disease management, health
care providers and pharmaceutical companies are increasingly conducting
preventive care testing by providing diagnostic screening and therapeutic
monitoring that yield rapid test results in settings closer to the patient.
These settings include POLs, pharmacies and health promotion sites. POLs are
operated by physicians or groups of physicians. Pharmacy sites, including
independent and retail chain pharmacies, have begun positioning themselves to
respond to the trend toward preventive care testing by shifting from a product
oriented approach to a more patient focused approach. Health promotion sites
include a variety of locations such as corporate wellness programs, fitness
centers, health promotion service providers, community health centers, public
health programs, the United States military and other independent screeners. In
addition to improving patient care and outcomes, preventive care testing in
these near-patient sites allows health care providers to capture testing revenue
that previously flowed to clinical and hospital laboratories, as well as
revenues from identifying patients who otherwise might not know they are at risk
of a chronic disease.
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PREVENTIVE CARE TESTING MARKETS
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APPROXIMATE
MARKETS NUMBER OF SITES
POL 88,000
Pharmacy 53,000
Health Promotion 84,000
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Total 225,000
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Despite the potential benefits, growth of preventive care testing has been
limited by both technological constraints and regulatory issues, particularly in
the POL and pharmacy markets. The technological obstacles result partly from the
fact that effective management of chronic diseases requires health care
providers to test
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for multiple analytes because certain chronic diseases are often manifested in a
combination of substances. The broader the range of tests a system can perform,
the more effective it will be in managing an array of chronic diseases, which
are often interrelated. Testing devices capable of performing multiple tests
have traditionally been complex and difficult to operate, making them currently
ineligible for waived status under CLIA. Laboratories conducting non-waived
tests are subject to higher registration fees, federal inspections and personnel
and quality assurance requirements. These regulatory requirements can
significantly increase the cost of performing nonwaived tests, making diagnostic
screening and therapeutic monitoring uneconomical in near-patient settings.
THE CHOLESTECH SOLUTION
The L-D-X System overcomes both the technological and regulatory hurdles
that the Company believes have inhibited the growth and broader acceptance of
preventive care testing for effective management of chronic diseases. The L-D-X
System is an easy to use, multi-analyte testing system consisting of a
proprietary, telephone sized L-D-X Analyzer and a line of single use, credit
card sized test cassettes. The L-D-X System enables health care providers to
perform diagnostic screening and therapeutic monitoring on a single drop of
whole blood within five minutes. The L-D-X System performs a variety of
different tests, several of which can be run simultaneously with a single
cassette. The Company's current cassette products are designed to measure and
monitor blood cholesterol, related lipids and glucose for the treatment of
cardiovascular disease and diabetes. The L-D-X System provides precise and
accurate results comparable to results obtained from testing with larger, more
complex bench top and laboratory based analyzers. Based on its precision,
accuracy and ease of use, the L-D-X System was granted a CLIA waiver in 1996. In
addition to these factors and its simultaneous multi-analyte testing capability,
the L-D-X System provides the following benefits and advantages:
O Improved Access to Testing. Ease of use and CLIA waived status allow the
L-D-X System to be used economically in many preventive care settings
that are more accessible to patients than clinical and hospital
laboratories. The L-D-X System's rapid test results allow health care
providers to determine the need for alternative or additional tests,
diagnose diseases, counsel patients and begin treatment in a single
visit. The Company believes that more convenient testing will increase
the frequency of diagnostic testing and may lead to earlier
identification of patients at risk of or suffering from chronic
diseases.
O Improved Therapy Compliance. Studies have shown that easier access to
testing sites may improve drug therapy compliance. Used in preventive
care settings, the L-D-X System makes therapeutic monitoring more
convenient for patients. Also, the L-D-X System provides patients with
feedback on therapy effectiveness within five minutes. The Company
believes that both of these benefits contribute to increased patient
compliance with drug therapy. The Company believes that the potential
for increased drug sales from improved compliance represents a
significant incentive for pharmaceutical companies to support the L-D-X
System.
O Benefits to Health Care Providers and Third Party Payors. Physicians,
pharmacists and other health care providers who use the L-D-X System to
perform preventive care testing may be able to capture revenue from
these tests that otherwise would flow to clinical and hospital
laboratories, as well as revenues from identifying patients who
otherwise might not know they are at risk of chronic disease. The
Company believes preventive care testing with the L-D-X System will also
result in more economical provision of testing services than in
traditional clinical or hospital laboratories and increase patient
satisfaction. Additionally, the Company believes improved patient
outcomes resulting from earlier diagnosis and improved drug compliance
will reduce costs associated with the treatment of chronic diseases.
O Multiple and Flexible Testing Capabilities. Effective management of
chronic diseases often requires testing of multiple analytes. The CLIA
waived L-D-X System performs multiple tests simultaneously, enabling
more efficient testing required for chronic disease management. The
modular and flexible architecture of the L-D-X System places much of the
testing technology in the single use
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test cassettes and system software, which decreases the development
costs and the time to market for new tests added to the L-D-X System.
This architecture facilitates the Company's continued enhancement of the
L-D-X System's multi-analyte testing capabilities.
STRATEGY
The Company's objective is to become the leading provider of preventive
care testing devices for the management of prevalent chronic diseases. The
Company's strategy for achieving this objective includes the following principal
elements:
OIncrease Market Penetration. The Company intends to further penetrate the
POL, pharmacy and health promotion markets for diagnostic screening and
therapeutic monitoring by increasing the installed base of L-D-X
Analyzers. The Company has implemented marketing programs to increase
awareness of the advantages of the L-D-X System among health care
providers and third party payors. In addition, the Company has entered
into strategic relationships with major pharmaceutical companies to
promote preventive care testing with the L-D-X System as critical
components of chronic disease management.
OLeverage Installed Base of L-D-X Analyzers. The Company intends to
leverage its installed base of L-D-X Analyzers by increasing both the type
and number of tests run on each L-D-X Analyzer. The Company is developing
additional tests for the L-D-X Analyzer to offer health care providers a
broader array of tests to better manage targeted chronic diseases. The
Company is also implementing a marketing effort to place L-D-X Analyzers
with health care providers that are potential high volume users of the
Company's test cassettes.
OMaintain Competitive Advantage. The Company plans to leverage its
development experience and capabilities to maintain its competitive
advantage by continuing to develop new tests and test types (e.g.
immunoassay) that are compatible with the L-D-X Analyzer and are CLIA
waived. The Company also plans to develop improvements to the L-D-X
Analyzer and incorporate new technologies into the L-D-X System. In
addition, the Company plans to leverage its operational know-how and
increase manufacturing volume to achieve economies of scale, thereby
maintaining the cost advantage of the L-D-X System.
OFurther Develop Strategic Relationships. The Company has established and
intends to further develop strategic relationships to create new products
and to improve penetration of its target markets. In particular, the
Company intends to further its alliances with major pharmaceutical
companies and other health care companies to position the L-D-X System as
the preferred testing system for chronic disease management. For example,
the Company is participating with Merck & Co., Inc. ("Merck"), and Parke,
Davis & Company ("Parke-Davis") in programs to improve patient compliance
with drug therapy through near-patient therapeutic monitoring.
OExpand Distribution Relationships. The Company intends to augment its
direct sales and marketing efforts by continuing to establish
relationships with select third party distributors and major pharmacy
chains to strategically access the POL, pharmacy and health promotion
markets in the United States and internationally. The Company is currently
pursuing additional domestic distribution agreements similar to its
existing agreements with Physicians Sales & Service, Inc. ("PSS") and
General Medical, Inc., a division of McKesson ("General Medical").
PRODUCTS AND PRODUCTS UNDER DEVELOPMENT
OVERVIEW OF THE L-D-X SYSTEM
The L-D-X System is an easy to use, multi-analyte testing system consisting
of a telephone sized analyzer, a printer and a variety of single use, credit
card sized test cassettes. The L-D-X System enables health care providers to
perform individual tests or combinations of tests with a single drop of whole
blood within five minutes. No special training is required to operate the L-D-X
System and the sample does not need to be pre-treated. To run a test, the health
care provider pricks the patient's finger, transfers a drop of
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blood to the cassette's sample well, inserts the cassette into the L-D-X
Analyzer's cassette drawer and presses the "run" button. All further steps are
performed by the L-D-X System, which produces results comparable in precision
and accuracy to results from larger, more expensive bench top and laboratory
instruments that are not CLIA waived.
The L-D-X System includes software that performs cardiac risk assessments
using risk factor parameters developed from the Framingham study (a long term
study of cholesterol levels and cardiovascular disease), TC and HDL test results
and other cardiac risk factors that the health care provider enters into the
L-D-X Analyzer.
The design of the L-D-X System incorporates as much proprietary technology
as possible into the test cassettes and maintains the L-D-X Analyzer as a
platform that can be easily adapted as new tests and other product upgrades are
introduced. As health care providers perform different tests, encoding on the
cassette's magnetic stripe communicates test specific and calibration
information to the L-D-X Analyzer. Changes that cannot be captured on the
cassette's magnetic stripe can be accomplished by changes to the L-D-X
Analyzer's removable read only memory ("ROM") software pack. This flexible
design enables health care providers to perform a variety of tests using the
same L-D-X Analyzer and to take advantage of new tests and other product
upgrades without having to purchase a new L-D-X Analyzer.
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The following table summarizes the Company's current products and products
under development:
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PRODUCT TARGETED DISEASE STATE REGULATORY STATUS(1)
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INSTRUMENT
L-D-X Analyzer -- FDA cleared; CLIA waived
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CASSETTE PRODUCTS
CURRENT
TC Cardiovascular disease FDA cleared; CLIA waived
TC and HDL Cardiovascular disease FDA cleared; CLIA waived
Lipid Profile (TC/HDL/ Cardiovascular disease FDA cleared; CLIA waived
calculated LDL/Triglycerides)
TC and Glucose Cardiovascular disease; Diabetes FDA cleared; CLIA waived
TC/HDL/Glucose Cardiovascular disease; Diabetes FDA cleared; CLIA waived
Lipid Profile plus Glucose Cardiovascular disease; Diabetes FDA cleared; CLIA waived
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UNDER DEVELOPMENT(2)
BUN/Creatinine Kidney disorder FDA cleared; applied for CLIA
waiver
Alanine Aminotransferase (ALT) Liver damage Not filed or applied
Bone Resorption Osteoporosis Not filed or applied
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IN FEASIBILITY STUDIES(3)
Glycated Hemoglobin Diabetes Not filed or applied
Creatinine Kinase Cardiovascular disease Not filed or applied
Lipoprotein(a) (Lp(a)) Cardiovascular disease Not filed or applied
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(1) "FDA" means the United States Food and Drug Administration, "FDA cleared" means that the product has
received clearance pursuant to Section 510(k) ("510(k)") of the Food, Drug and Cosmetics Act of 1938, as
amended (the "FDC Act"). "CLIA waived" means that the Center for Disease Controls and Prevention (the "CDC")
has granted the Company's application to classify the product as having waived status with respect to CLIA.
(2) Products under development are those in the prototype stage, meaning that cassette shelf life is being
evaluated, the test is being evaluated in-house against samples designed to mimic the range of real patient
samples, pilot manufacturing equipment is being developed and/or the Company has applied for CLIA.
(3) Products in feasibility studies are those for which a theoretical design for the product has been developed
and test chemistry is being evaluated in the laboratory.
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L-D-X ANALYZER
The L-D-X Analyzer is a four channel, reflectance photometer that measures
the amount of light reflected from the reaction surfaces of a test cassette and
incorporates a microprocessor with on-board software. The L-D-X Analyzer
contains a drawer for insertion of the cassette, three buttons for user
activation and a liquid crystal display to present the test results. Utilizing
the information and instructions encoded on the cassette's magnetic stripe, the
L-D-X Analyzer's built-in microprocessor regulates the reaction conditions,
controls the optical measurements of analyte concentrations on the cassette's
reaction pads, executes the required calculations and, within five minutes,
displays the quantitative results on the liquid crystal display. The results are
displayed as a numerical value of the level of the analyte tested and can be
transferred to a printer, computer or computer network.
The software calculates the numeric values of the test results and is
contained in a removable ROM software pack mounted in an access well on the
bottom of the L-D-X Analyzer. The Company will continue
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to upgrade the software as new products are developed, allowing health care
providers to easily replace the existing ROM pack with a new ROM pack containing
upgraded software. The Company has made available to existing users a new ROM
pack containing its cardiac risk assessment software, as well as a new ROM pack
reflecting certain changes required to receive the CLIA waiver. The L-D-X
Analyzer, together with printer, accessories and starter pack, currently has a
list price of $1,795.
CASSETTE PRODUCTS
The Company's line of single use test cassettes for the L-D-X System
incorporates patented technology for distributing precisely measured plasma to
multiple reaction pads for simultaneous testing. Each cassette consists of three
parts: a main body that contains the sample well into which the blood sample is
dispensed; a reaction bar where plasma is transferred for analysis; and a
magnetic stripe encoded with test instructions and lot specific calibration
information for the various chemistries on the reaction pads. Capillary action
draws a drop of whole blood through a separation medium within the cassette,
stopping the cellular components of the blood while transferring a small volume
of plasma to the cassette's reaction pads. When the plasma contacts the reaction
pads, the dry chemistry reacts with the analytes in the plasma, producing color.
The intensity of color developed indicates the concentration of the analytes in
the plasma. The magnetic stripe contains information needed by the L-D-X
Analyzer to convert the reflected color reading into a concentration level for
the accurate measurement of the analytes being tested. This automatic process
frees the health care provider from having to interpret any color reaction,
relate a reading to a separate chart or input calibration information. The
Company's available test cassettes range in current list price from $3.95 to
$10.95.
Current Cassette Products
The Company's current cassette products are designed to measure and monitor
blood cholesterol, related lipids and glucose. Lipids travel in the blood within
water soluble particles called lipoproteins. These lipid carriers include very
low density lipoproteins ("VLDL"), LDL (low density lipoproteins) and HDL (high
density lipoproteins). HDL particles circulate in the blood and can pick up
cholesterol from arteries and carry it to the liver for elimination from the
body. HDL is sometimes called "good cholesterol" because of this function. The
development of cardiovascular disease has been associated with three lipoprotein
abnormalities: (i) high levels of LDL; (ii) high levels of VLDL; and (iii) low
levels of HDL. LDL, the major carrier of cholesterol, and VLDL, a major carrier
of triglycerides in the blood, have been shown to be associated with deposits of
plaque on the arterial wall. High levels of triglycerides can also lead to
development of such plaque. Accumulation of this plaque leads to narrowing of
arteries and increases the likelihood of cardiovascular disease.
In response to conclusive evidence relating high TC to heart disease, the
National Institutes of Health ("NIH") in 1985 launched NCEP, a nationwide effort
to reduce the prevalence of high blood cholesterol. NCEP data indicate that more
than 50% of the adult population in the United States has high or borderline
high TC. In 1988, NCEP issued guidelines for the testing of all adults over 20
years of age for high blood cholesterol, and more extensive lipid monitoring and
treatment for those found to be in high risk categories. Testing guidelines were
subsequently expanded to include children over the age of two with a family
history of high blood cholesterol or cardiovascular disease and to include, in
certain circumstances, a lipid profile consisting of TC, HDL, LDL and
triglycerides. Since NCEP initiated its guidelines, the market for cholesterol
and other lipid tests has experienced significant growth.
Diabetes is a complex disorder of carbohydrate, fat and protein metabolism.
It is manifested by a relative or absolute deficiency of insulin, the hormone
that facilitates and controls the use of glucose by the body. Insulin deficiency
leads to an impaired tolerance to glucose, which leads to a number of short term
and long term complications such as nerve damage, kidney disease and retinal
damage. The most prevalent causes of death among diabetics are cardiovascular
disease and renal failure. It is estimated that diabetes afflicts more than 16
million persons in the United States, over a third of whom have not been
identified as being diabetic. Diagnostic screening for these patients who have
asymptomatic diabetes is important because proper treatment will help minimize
the long term complications of the disease.
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TC. This stand alone test for measuring total cholesterol was the Company's
first test, developed in conjunction with NCEP guidelines issued in 1988. The TC
test is used primarily at health promotion sites for diagnostic screening.
Current NCEP screening guidelines recommend additional testing for HDL.
TC and HDL Panel. The TC and HDL panel addresses current NCEP guidelines
regarding the screening for the risk of cardiovascular disease by testing both
TC and HDL. As a result, the Company believes the TC and HDL panel is
particularly useful in diagnostic screening applications. This panel also
calculates the ratio of TC to HDL, a recognized measure of cholesterol induced
cardiac risk. The Company believes that it provides the only HDL cholesterol
test performed on a single drop of whole blood.
Lipid Profile. The Company offers a lipid profile cassette which directly
measures TC, HDL and triglycerides. In addition, the lipid profile cassette
calculates estimated values for LDL and the ratio of TC to HDL. The lipid
profile cassette thus performs multiple tests in the diagnostic screening and
ongoing therapeutic monitoring of individuals who have high LDL levels or who
exhibit two or more other cardiovascular disease risk factors. NCEP guidelines
recommend that health care providers perform three lipid profiles, each one week
apart, prior to initiating lipid lowering drug therapy.
TC and Glucose Panel, TC/HDL/Glucose Panel and Lipid Profile Plus Glucose
Panel. Recognizing the relationship between diabetes and abnormal lipid levels,
the Company developed a glucose test for the L-D-X System and combined it with
each of its three lipid related test panels. The resulting panels provide input
used in the diagnostic screening and therapeutic monitoring of patients with
diabetes, whether or not they are aware they are diabetic, as well as of
individuals who may be at risk of cardiovascular disease.
Cassette Products Under Development
A key component of the Company's strategy is to leverage the technological
flexibility of the L-D-X System to develop single use test cassettes that
address chronic diseases and markets the Company believes provide attractive
commercial opportunities. The Company is in various stages of development of new
cassettes that would expand its product line for preventive care testing in the
POL, pharmacy and health promotion markets. The Company may develop additional
tests depending on the progress of its existing development efforts and
available resources.
For certain future tests, the Company will be required to modify the design
of its existing dry chemistry cassette. For example, the immunoassay test
cassettes currently under development require the use of antibodies bound to the
reaction membrane and a wash step which removes unbound reactants that would
interfere with the test. The immunoassay cassette will have the same external
dimensions as existing dry chemistry cassettes, but will require the Company to
develop new technologies that would allow the L-D-X Analyzer to perform an
immunoassay test. The Company believes that, if the immunoassay cassette is
successfully developed, the L-D-X Analyzer will be the only near-patient
instrument capable of performing both dry chemistry and immunoassay based tests
on a single platform.
BUN/Creatinine. The Company has developed a renal function panel (the
"BUN/Creatinine panel") that includes tests for blood urea nitrogen ("BUN") and
creatinine primarily for the POL market. The Company believes that these tests
are among the most commonly ordered whole blood tests in physician offices. The
BUN/Creatinine panel is designed to assist physicians in managing the health of
patients at risk of renal failure, including patients suffering from diabetes.
BUN elevations occur in chronic renal disease, as well as in urinary tract
obstruction. BUN is also useful in monitoring hemodialysis and other therapies.
Creatinine is another measure of renal function and is usually tested for in
combination with BUN. In addition, creatinine is used as an indicator of renal
blood flow, which may have become reduced due to congestive heart failure or
dehydration. Low levels of creatinine may also result from decreased hepatic
function in advanced liver disease. The Company received 510(k) clearance to
market the BUN/Creatinine panel in July 1997 and has submitted an application to
the CDC for CLIA waived status.
Alanine Aminotransferase ("ALT"). Patients undergoing certain drug
therapies must be monitored for increases in certain enzymes that are associated
with liver damage. The use of an ALT test combined with the Company's lipid
profile would allow health care providers to monitor, in the POL and pharmacies,
both the
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impact of and potential adverse side effects on the liver from lipid lowering
therapies. The Company has determined the technological feasibility of combining
on one cassette the ALT test with the lipid profile and is evaluating other
potential uses of the test.
Bone Resorption. Osteoporosis is the most widespread form of bone disease
and is characterized by low bone mass and structural deterioration of bone
tissue. This low bone mass can lead to bone weakening, increasing the likelihood
for fractures. Biological markers of bone resorption are secreted in urine, and
it has been shown that the level of secretion corresponds to the amount of bone
loss. The measured levels of these markers have also been shown to be responsive
to osteoporosis therapies such as hormone replacement therapy. According to the
National Osteoporosis Foundation, this disease is a threat to over 28 million
persons in the United States and over 200 million people worldwide. In the
United States, approximately 1.5 million osteoporosis related fractures occur
each year, resulting in an estimated annual treatment cost of $14 billion.
The Company has entered into an agreement with Metra Biosystems, Inc.
("Metra Biosystems") to develop and market Metra Biosystem's Pyrilinks-D
immunoassay and other technologies related to bone resorption for use on the
L-D-X System. The Company is in the prototype stage of developing this urine
based immunoassay test. See "-- Strategic Relationships."
Cassette Products in Feasibility Studies
Glycated Hemoglobin. Glycated hemoglobin measurement is used by health care
providers to assess a diabetic's long term compliance with prescribed diet and
insulin usage. A relatively high percentage of hemoglobin to glucose indicates
poor patient compliance, which can lead to severe health problems. The American
Diabetes Association ("ADA") recommends at least semi-annual measurement of
glycated hemoglobin for all individuals with diabetes. The Company received a
"Small Business Innovative Research" grant of $100,000 from the United States
Department of Health and Human Services to further develop this test on the
L-D-X System.
Creatinine Kinase. This test measures creatinine kinase and is used to
determine whether a patient is having or has recently suffered a heart attack
and, if so, the severity of the attack. When a patient experiences a heart
attack, creatinine kinase is released into the bloodstream by the heart muscle.
The Company is working with Unitika Ltd. ("Unitika") to determine the
feasibility of incorporating this test into the L-D-X System. Unitika is the
largest supplier of creatinine kinase tests in Japan. The existing creatinine
kinase tests are performed primarily in clinical and hospital laboratories, and
consequently, results are often delayed.
Lipoprotein(a) ("Lp(a)"). Lp(a) is a component of LDL that has been
determined to be a risk factor for cardiovascular disease. The Company has
licensed from a third party the rights to a technology for measuring Lp(a) and
has royalty sharing obligations related to revenues from Lp(a) tests. The
Company has licensed rights to this technology to Genzyme Corporation for
clinical laboratory testing of Lp(a).
To complete its product development programs, particularly with respect to
immunoassay tests, the Company may be required to develop new technologies,
processes and production equipment and may also be required to retain additional
scientific, engineering and manufacturing staff. There can be no assurance that
the Company will be successful in developing any of the tests described above,
or even if successfully developed, that such tests will receive regulatory
clearance or that the Company will be able to successfully manufacture or market
such tests. The Company intends to design and develop most of these products so
as to be eligible for 510(k) clearance and waivers under CLIA, although there
can be no assurance that the Company's products under development will obtain
such clearance or waivers. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Factors Affecting Future
Operating Results -- Dependence on Development, Introduction and Market
Acceptance of New Tests" and "-- Government Regulation."
STRATEGIC RELATIONSHIPS
The Company has established and continually seeks to develop strategic
relationships which it believes will enhance the commercialization of its
products. In particular, the Company intends to enter into additional
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alliances with major pharmaceutical and other companies that will enhance the
Company's market positioning and its product offerings. The Company's current
strategic relationships are described below.
Merck and the American Pharmaceutical Association (the "APhA") ("Project
ImPACT")
In January 1996, the APhA announced Project ImPACT (Improve Persistence And
Compliance to Therapy), a joint effort between the APhA, Merck and the Company.
The goal of this project is to demonstrate the ability of pharmacists to improve
patient outcomes by expanding the pharmacist's role in chronic disease
management to include monitoring the therapeutic effectiveness of medications
and providing counseling to patients. The Company and the APhA believe that
utilizing pharmacists to provide such services may result in both direct and
indirect cost savings to patients and third party payors, as well as provide
economic incentives for pharmacists. The Company supplied L-D-X Systems to
monitor patients in this pharmacy based cholesterol management project. As of
December 31, 1997, Project ImPACT had monitored approximately 700 patients at 29
community based pharmacies across the country for a period of at least 18
months. The full results of the study are expected to be publicly released in
September 1998.
Preliminary results of Project ImPACT were published by the APhA in a
December 1997 newsletter. The newsletter contained preliminary comments from the
29 participating pharmacists and highlighted the project's effects on therapy
compliance. Prior research shows that 50% of patients drop out of lipid lowering
drug programs within the first year of treatment. The Company believes that the
potential for increased drug sales from improved compliance represents a
substantial incentive for pharmaceutical companies to support the L-D-X System
and preventive care testing capabilities.
In addition to its participation in Project ImPACT, the Company has a
nonexclusive agreement with Merck to place L-D-X Systems in pharmacies selected
by Merck. There are no minimum purchase requirements under this agreement, which
expires in December 1999.
Parke-Davis
The Company is currently collaborating on two projects with Parke-Davis, a
major pharmaceutical manufacturer.
Lipitor Trial. The Company has entered into an agreement with
Warner-Lambert Company, the parent company of Parke-Davis, to provide L-D-X
Systems to physicians participating in Phase IV clinical trials of the lipid
lowering drug Lipitor (the "Lipitor Trial"). Parke-Davis and Pfizer Inc.
("Pfizer") have an agreement to jointly market Lipitor. The Company has sold
1,000 L-D-X Analyzers and 30,000 lipid profiles test cassettes to Parke-Davis
pursuant to the agreement. Parke-Davis and Pfizer placed the L-D-X Systems with
a targeted group of physicians who frequently test for and treat abnormal
cholesterol and related lipid levels. The Lipitor Trial involves up to 8,068
patients whose treatment with Lipitor is being studied over a three month
period. The participating physicians will retain the L-D-X Analyzers as part of
their compensation for participating in the Lipitor Trial.
Professional Golf Association ("PGA") Tour Screenings. Parke-Davis,
Cambridge Health Partners and the Lipid Nurse Taskforce are collaborating to
provide free diagnostic screening using the L-D-X System and promote cholesterol
awareness at 10 PGA tour events in 1998.
Metra Biosystems
In May 1996, the Company entered into a development, marketing and
licensing agreement with Metra Biosystems to develop an immunoassay test
cassette incorporating Metra Biosystems' bone resorption technology to be used
on the L-D-X Analyzer. Pursuant to the agreement, Metra Biosystems purchased
$250,000 of Common Stock. Metra Biosystems is obligated to purchase $750,000 of
additional shares of Common Stock 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. The per share purchase price will be
equal to the volume weighted average per share price of the Common Stock for the
five days prior to the
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completion of the applicable milestone. The Company has granted Metra Biosystems
registration rights in connection with its purchase of Common Stock.
In connection with the development of the immunoassay test cassette, Metra
Biosystems granted Cholestech a nonexclusive, royalty bearing license to use,
make, sell, offer to sell, import or distribute the resulting test to assess
bone resorption, a gauge of the effectiveness of treatments of certain metabolic
diseases and disorders, and certain future products worldwide. The Company will
pay royalties to Metra Biosystems on the bone resorption product and on products
that stem from work done in the course of the collaboration but do not
incorporate any of Metra Biosystems' proprietary technology. The parties will
negotiate royalties on future Metra Biosystems products as appropriate. Under
the agreement, the Company will market the immunoassay test through its existing
distribution channels in the United States. The Company and Metra Biosystems
will work together to market and distribute the tests internationally.
There can be no assurance that the Company will be successful in developing
a bone resorption test or any other product under this agreement, that this
agreement will not expire prior to its term, or that even if any products are
developed, they will be successfully marketed. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors Affecting
Future Operating Results -- Dependence on Development, Introduction and Market
Acceptance of New Tests."
The Company expects to enter into additional strategic agreements in the
future to develop, commercialize and sell its current and future products. There
can be no assurance that the Company will be able to negotiate acceptable
agreements in the future, or that such relationships will be successful. In
addition, there can be no assurance that the Company's strategic partners will
not pursue alternative competing technologies or products.
SALES AND MARKETING
The Company's sales and marketing strategy is to increase penetration into
the POL, pharmacy and health promotion markets for preventive care testing and
leverage its installed base of L-D-X Analyzers through increased cassette
utilization. The Company plans to dedicate a significant portion of its sales
and marketing efforts to educate current and potential owners of L-D-X Systems
about the clinical and economic benefits of near-patient diagnostic screening
and therapeutic monitoring with the L-D-X System and about new test cassettes as
they become available for distribution. The sales and marketing efforts of the
Company are conducted by teams focused on each of the major markets for the
Company's products, including POLs, pharmacies and health promotion sites, as
well as on the international market. Each team consists of a market manager, a
national account manager, regional sales managers and technical support
representatives. The Company also plans to continue to cultivate strategic
relationships with development partners, pharmaceutical companies and
distributors. The Company intends to leverage the technology, customer bases,
marketing power and distribution networks of these partners to accelerate market
penetration and cassette usage.
POL. The POL market consists of approximately 88,000 sites registered with
the Health Care Finance Administration (the "HCFA"), approximately 35,000 of
which are registered to perform only CLIA waived tests. The Company has entered
into nonexclusive distribution agreements with two national medical products
distributors, PSS and General Medical, which together have more than 1,300 sales
professionals who focus on the POL market. The Company is seeking to expand the
number of distributors of the L-D-X System targeting this market. The Company
and its distributors are focusing their sales and marketing efforts on
physicians whose practices include a high incidence of the chronic diseases
targeted by the Company's test cassettes, including cardiologists, lipid
clinicians, internists and family practitioners. The Company intends to evaluate
this strategy periodically as it gains more experience in the POL market and
introduces new products.
Pharmacy. The retail pharmacy market consists of approximately 53,000
pharmacies. The Company has recently launched marketing efforts in the pharmacy
market to educate pharmacists about the clinical and economic benefits of
in-pharmacy testing. The Company believes that its success in the pharmacy
market will be dependent in large part upon the development of therapeutic
monitoring programs implemented in conjunction with physicians and third party
payors. The Company believes that pharmacists can effectively perform diagnostic
screening and therapeutic monitoring on a cost effective basis using the L-D-X
System.
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Pharmacists will provide patients with immediate counseling, including a cardiac
risk assessment profile, and encourage patients to discuss the results with
their physicians. Preliminary data from Project ImPACT suggest the potential
benefits of pharmacists assessing the effectiveness of and patient compliance
with drug therapy for chronic diseases. The Company has terminated its exclusive
distribution agreement with AmeriSource Corporation. In an effort to further
penetrate the pharmacy market, the Company is in discussions with several
potential distributors to form nonexclusive agreements to distribute its
products to the pharmacy market.
Health Promotion. The health promotion market includes corporate wellness
programs, fitness centers, health promotion service providers, community health
centers, public health programs, the military and other independent screeners.
In 1997, the Company entered into an agreement with a service provider to offer
consumer testing of individual cholesterol levels using the L-D-X System at
selected Wal-Mart stores across the country and has ongoing relationships with
14 regional distributors who provide equipment and supplies to customers that
conduct diagnostic screening for abnormal cholesterol and related lipid levels
and diabetes. Additionally, through its agreements with regional distributors
and screening organizations, the Company provides the L-D-X System for use in
diagnostic screening for employees of Exxon Corporation, General Motors
Corporation, Ford Motor Company and Sears, Roebuck and Co. The Company intends
to increase the number of regional distributors and corporate relationships in
the health promotion market.
International. The Company's international distribution strategy is to
penetrate targeted geographical markets by selling directly to both high volume
users and distributors in those markets. The Company has entered into
non-exclusive agreements with 39 foreign distributors to distribute the L-D-X
System primarily in Europe, the Pacific Rim and Latin America.
COMPETITION
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. The substantial majority of diagnostic tests used by
physicians and other health care providers are currently performed by clinical
and hospital laboratories. The Company expects that these laboratories will
compete intensely to maintain their dominance in the markets for diagnostic
screening and therapeutic monitoring. In order to achieve broad 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
analyzers and testing services. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Factors Affecting Future
Operating Results -- Uncertainty of Market Acceptance of the L-D-X System" and
"-- Highly Competitive Industry; Rapid Technological Change."
Companies having a significant presence in the markets 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 GmbH, a subsidiary of Roche Holdings Ltd. ("Boehringer
Mannheim"), have developed or are developing analyzers designed for preventive
care 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 believes
that it currently has a competitive advantage due to the status of the L-D-X
System as the only CLIA waived system capable of performing multiple tests
simultaneously on a single instrument. The Company expects that its competitors
will compete actively to maintain and increase market share and will seek to
develop multi-analyte tests that qualify for CLIA waiver. There can be no
assurance that the Company's competitors will not succeed in obtaining CLIA
waived status for their products or in developing or marketing technologies or
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products that are more effective and commercially attractive than the Company's
current or future products, or that would render the Company's technology or
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.
MANUFACTURING
The Company manufactures, tests, performs quality assurance on, and
packages and ships its products from, an approximately 40,300 square foot
facility located in Hayward, California. The Company maintains control of those
portions of the manufacturing process that it believes are complex and provide
an important competitive advantage.
L-D-X Analyzer
The L-D-X Analyzer incorporates a variety of subassemblies and components
designed or specified by the Company, including an optical element,
microprocessors, circuit boards, a liquid crystal display and other electrical
components. These components and subassemblies are manufactured by a variety of
third parties, and are shipped to the Company for final assembly and quality
assurance. The Company's manufacture of the L-D-X Analyzer consists primarily of
assembly, testing, inspection and packaging. Testing consists of a burn-in
period, functional tests and integrated system testing using specially produced
test cassettes. The Company believes it can expand its current L-D-X Analyzer
manufacturing capacity as foreseeably required.
Cassettes
The Company purchases chemicals, membranes and other raw materials from
third party suppliers and converts these raw materials, using proprietary
processes, into single use test cassettes. The Company believes its proprietary
processes and custom designed equipment are important components of its cassette
manufacturing operations. The Company has developed core manufacturing
technologies, processes and production machinery, including: (i) membrane
lamination and welding; (ii) discrete membrane impregnation; (iii) on-line
calibration; and (iv) software control of the manufacturing process. The Company
has two fully operational cassette manufacturing lines. The Company is currently
planning and building a third manufacturing line that the Company anticipates
will become operational in fiscal 2000. In the event that cassette sales volume
significantly increases, the Company may require the added capacity of the third
line prior to its scheduled operational date. The Company plans for the third
manufacturing line to be modular and implemented in phases so that portions of
it could feed the existing two lines before it is fully implemented. In
addition, the Company intends to design and install a manufacturing line to
commercially produce immunoassay cassettes. There can be no assurance that such
expansion of cassette manufacturing capacity can be completed in a timely
fashion, if ever, and the failure to do so would have a material adverse effect
on the Company's business, financial condition and results of operations.
Manufacturing of the cassettes is highly complex and sensitive to a wide
variety of factors, including raw material variations and impurities,
manufacturing equipment performance and the manufacturing environment
containment levels. The interruption of cassette manufacturing operations, the
loss of employees dedicated to the cassette manufacturing facility or the
failure to maintain acceptable process yields for existing or future products
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Factors Affecting Future
Operating Results -- Risks Associated with Cassette Manufacturing."
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Raw Materials; Quality Assurance
Outside vendors provide the Company with the subassemblies, components and
raw materials necessary for the manufacture of the Company's products. These
subassemblies, components and raw materials are inspected and tested by the
Company's quality control personnel. The Company's quality control personnel
also perform finished goods quality control and inspection and maintain
documentation for compliance with Quality Systems Regulations ("QSR;" the
successor regulations to current Good Manufacturing Practice ("cGMP")
Regulations) and other government manufacturing regulations. The Company's
manufacturing facilities are subject to periodic inspection by regulatory
authorities. Certain key components and raw materials used in the manufacturing
of the Company's products are currently provided by single source vendors and on
a purchase order basis. The Company believes that it maintains adequate levels
of such components and materials in inventory and that alternative sources are
available. However, any interruption of the supply of or any impurity or
variation in the quality of such inputs would have a material adverse effect on
the Company's business, financial condition and results of operations once the
inventory is depleted and until a new source of supply were qualified. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation -- Factors Affecting Future Operating Results -- Dependence on
Suppliers" and "-- Government Regulation."
PATENTS AND PROPRIETARY TECHNOLOGY
The Company owns nine United States patents covering various technologies,
including the method for separating HDL from other lipoproteins in a dry
chemistry format, the basic design of the testing cassette and the L-D-X
Analyzer and the method of correcting for the effects of substances that can
interfere with testing of a blood sample. The Company has also filed patent
applications relating to its technology internationally under the Patent
Cooperation Treaty and individual foreign applications. The Company is also the
licensee of United States patents relating to: (i) the measurement of Lp(a);
(ii) the measurement of bone resorption markers (Pyrilinks-D); and (iii) the
Company's cassette technology.
The medical products industry has been characterized by extensive
litigation regarding patents and other intellectual property rights, and any
such litigation could result in substantial loss or diversion of revenues of the
Company and could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
pending patent applications filed by the Company will be approved or that the
Company's issued or pending patents will not be challenged or circumvented by
competitors. The Company believes that its future success will depend primarily
upon the technical expertise, creative skills and management abilities of its
officers, directors and key employees rather than on patent ownership.
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 might 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.
There can be no assurance that patent infringement claims will not be
asserted by other parties in the future, that in such event the Company will
prevail or that it will be able to obtain necessary licenses on reasonable
terms, or at all. Adverse determinations in any litigation could subject the
Company to significant liabilities and/or require the Company to seek licenses
from third parties. If the Company is unable to obtain necessary licenses or is
unable to develop or implement alternative technology, the Company may be unable
to manufacture and sell the affected products. Any of these outcomes could have
a material adverse effect on the Company's business, financial condition or
results of operations.
The Company relies substantially on trade secrets, technical know-how and
continuing invention to develop and maintain its competitive position. The
Company works actively to foster continuing technological
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innovation to maintain and protect its competitive position, and the Company has
taken security measures to protect its trade secrets and periodically explores
ways to further enhance trade secret security. There can be no assurance that
such measures will provide adequate protection for the Company's trade secrets
or other proprietary information. Although the Company has entered into
proprietary information agreements with its employees, consultants and advisors,
there can be no assurance that these agreements will provide adequate remedies
for any breach. There can be no assurance that the Company's competitors will
not independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's trade secrets or disclose
such technology, or that the Company can meaningfully protect its right to its
trade secrets. See "Management's Discussion and Analysis of Financial Condition
and Results of Operation -- Factors Affecting Future Operating
Results -- Dependence on Proprietary Technology; Uncertainty of Patent and
Proprietary Technology Protection; Dependence on Licensing of Technology from
Third Parties."
GOVERNMENT REGULATION
FDA and Other Regulations
The manufacture and sale of the Company's products are subject to
regulation by numerous governmental authorities, principally the FDA and
corresponding state and foreign regulatory agencies. Pursuant to the FDC Act,
the FDA regulates the clinical testing, manufacture, labeling, distribution and
promotion of medical devices. Noncompliance with applicable requirements can
result in, among other things, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the
government to grant pre-market clearance or pre-market approval for devices,
withdrawal of marketing approvals, a recommendation by the FDA that the Company
not be permitted to enter into government contracts and criminal prosecution.
The FDA also has the authority to request repair, replacement or refund of the
cost of any device manufactured or distributed by the Company.
In the United States, medical devices are classified into one of three
classes, Class I, II or III, on the basis of the controls deemed by the FDA to
be necessary to reasonably ensure their safety and effectiveness. Class I
devices are subject to general controls (e.g., labeling, registration, listing
and adherence to QSR). Class II devices are subject to general controls,
pre-market notification and to special controls (e.g., performance standards,
post-market surveillance and patient registries). Generally, Class III devices
are those that must receive pre-market approval ("PMA") by the FDA (e.g., life
sustaining, life supporting and implantable devices, or new devices which have
not been found substantially equivalent to legally marketed devices), and
require clinical testing to assure safety and effectiveness and FDA approval
prior to marketing and distribution.
Before a new device can be introduced into the market, the manufacturer
must generally obtain marketing clearance through a pre-market notification
under Section 510(k) of the FDC Act or an approval of a PMA application under
Section 515 of the FDC Act or be exempt from 510(k) requirements. Under a recent
amendment to the FDC Act, most Class I devices are exempt from 510(k)
requirements. A 510(k) clearance typically will be granted if the submitted
information establishes that the proposed device is "substantially equivalent"
to a legally marketed Class I or II medical device or to a Class III medical
device for which the FDA has not called for a PMA. A 510(k) notification must
contain information to support a claim of substantial equivalence, which may
include laboratory test results or the results of clinical studies of the device
in humans. It generally takes from four to twelve months from the date of
submission to obtain 510(k) clearance, but it may take longer. A "not
substantially equivalent" determination by the FDA, or a request for additional
information, could delay the market introduction of new products that fall into
this category. For any devices that are cleared through the 510(k) process,
modifications or enhancements that could significantly affect safety or
effectiveness, or constitute a major change in the intended use of the device,
will require new 510(k) submissions. The L-D-X Analyzer and all existing test
cassettes required that the Company obtain 510(k) clearance prior to marketing
in the United States.
In general, the Company intends to develop and market tests that will
require no more than 510(k) clearance. However, if the Company cannot establish
that a proposed test cassette is substantially equivalent
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to a legally marketed device, the Company will be required to seek pre-market
approval of the proposed test cassette from the FDA through the 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. The Company does not believe
that its products under development will require the submission of a PMA
application. A PMA application generally must be supported by extensive data,
including laboratory, preclinical and clinical data to demonstrate safety and
efficacy, as well as a complete description of the device and its components and
a detailed description of the methods, facilities and controls used to
manufacture the device. In addition, the PMA submission must include the
proposed labeling, advertising literature and training methods (if required).
The PMA approval process can be lengthy, expensive and uncertain. An FDA review
of a PMA application generally takes one to three years from the date the PMA
application is accepted for filing, but may take significantly longer.
Any products manufactured or distributed by the Company pursuant to FDA
clearance or approvals are subject to pervasive and continuing regulation by the
FDA and certain state agencies, including record keeping requirements and
reporting of adverse experience with the use of the device. Labeling and
promotional activities are subject to scrutiny by the FDA and, in certain
circumstances, by the Federal Trade Commission. Current FDA enforcement policy
prohibits the marketing of approved medical devices for unapproved uses.
The FDC Act regulates the Company's quality control and manufacturing
procedures by requiring the Company and its contract manufacturers to
demonstrate compliance with QSR. The FDA monitors compliance with these
requirements by requiring manufacturers to register with the FDA, which subjects
them to periodic inspections. The State of California also regulates and
inspects the Company's manufacturing facilities. The Company has been inspected
twice by the State of California to date and is manufacturing under an issued
medical device manufacturers facility license from the State of California. If
any violations of the Company's applicable regulations are noted during an FDA,
European Notified Body or State of California inspection of the Company's
manufacturing facilities or the manufacturing facilities of its contract
manufacturers, the continued marketing of the Company's products could be
materially adversely affected.
The European Union ("EU") has promulgated rules that require that devices
such as those developed, manufactured and sold by the Company receive the right
to affix the CE mark, a symbol of adherence to applicable EU directives. The
Company has completed all the testing necessary to comply with applicable
regulations to currently be eligible for self certification and currently has
the right, as self certified under the product testing requirements, to affix
the CE mark to its products. The Company's products will be covered by the In
Vitro Diagnostics Directives that have not yet been published or adopted. While
the Company intends to satisfy the requisite policies and procedures that will
permit it to continue to affix the CE mark to its products in the future, there
can be no assurance that the Company will be successful in meeting 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 Company and its products are also subject to a variety of state and
local laws and regulations in those states or localities where its products are
or will be marketed. Any applicable state or local laws or regulations may
hinder the Company's ability to market its products in those states or
localities. For example, 20 states have regulations that impose requirements on
pharmacies and/or pharmacists that perform clinical testing, five of which
states have regulations that prohibit certain pharmacy based testing. The
Company is also subject to numerous federal, state and local laws relating to
such matters as safe working conditions, manufacturing practices, environmental
protection, fire hazard control and disposal of hazardous or potentially
hazardous substances. There can be no assurance that the Company will not be
required to incur significant costs to comply with such laws and regulations now
or in the future or that such laws or regulations will not have a material
adverse effect upon the Company.
Changes in existing requirements or adoption of new requirements or
policies could increase the cost of or otherwise adversely affect the ability of
the Company to comply with regulatory requirements. Failure to comply with
regulatory requirements could have a material adverse effect on the Company.
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CLIA Regulations
The use of the Company's products in the United States is subject to CLIA,
which provides for federal regulation of laboratory testing, an activity also
regulated by most states. Laboratories either must obtain a registration
certificate from the HCFA, register with an approved accreditation agency or
obtain a state license in a state with a federally approved license program. The
CLIA regulations seek to ensure the quality of medical testing and generally
took effect in September 1992 with a two year phase-in of certain requirements.
The three primary mechanisms to accomplish this goal are daily quality control
requirements to ensure the accuracy of laboratory devices and procedures,
proficiency testing to measure testing accuracy and personnel standards to
assure appropriate training and experience for laboratory workers. CLIA
categorizes tests as "waived," or as being "moderately complex" or "highly
complex" on the basis of specific criteria.
Prior to January 1996, the L-D-X System, including the Company's current
cassettes, was categorized under CLIA as moderately complex. In January 1996,
the L-D-X System and the TC, HDL, triglycerides and glucose tests in any
combination were reclassified as waived under CLIA. CLIA waiver allows health
care providers to use the L-D-X System at a lower cost. Under the waived
classification, users of the L-D-X System are only required to obtain a
certificate of waiver from HCFA and pay a $100 fee, and are not required to
comply with the CLIA requirements otherwise applicable to individual diagnostic
tests. This certificate must be renewed every two years. The Company provides
United States purchasers of its products with the documentation, systems and
support necessary to comply with CLIA. In order to successfully commercialize
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 will qualify for 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. If the Company does not receive CLIA waiver
for any of its products in development, the Company may choose to market such
products in the United States as moderately complex products and/or market such
products outside of the United States. These decisions will be made on a
product-by-product basis. 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. 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. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Factors Affecting Future Operating
Results -- Government Regulation."
THIRD PARTY REIMBURSEMENT
In the United States, health care providers, such as hospitals and
physicians, that purchase products such as the L-D-X System and single use test
cassettes, generally rely on third party payors, including private health
insurance plans, federal Medicare, state Medicaid and managed care
organizations, to reimburse all or part of the cost of the procedure in which
the product is being used. The Company's ability to commercialize its products
successfully in the United States will depend in part on the extent to which
reimbursement for the costs of tests performed with the L-D-X System and related
treatment will be available from government health authorities, private health
insurers and other third party payors. Third party payors can affect the pricing
or the relative attractiveness of the Company's products by regulating the
maximum amount of reimbursement provided by such payors for testing services.
Reimbursement is currently not available for certain uses of the Company's
products in particular circumstances. Tests performed in the health promotion
market are generally 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 amounts 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
18
<PAGE> 19
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 healthcare providers to obtain reimbursement from third
party payors, or changes in 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. Given the
efforts to control and reduce health care costs in the United States in recent
years, there can be no assurance that currently available levels of
reimbursement will continue to be available in the future for the Company's
existing products or products under development.
Effective October 1, 1991, HCFA adopted regulations providing for the
inclusion of capital related costs in the prospective payment system for
hospital inpatient services under which most hospitals are reimbursed by
Medicare on a per diagnosis basis at fixed rates unrelated to actual costs,
based on DRGs. Under this system of reimbursement, equipment costs generally
will not be reimbursed separately, but rather will be included in a single,
fixed rate, per patient reimbursement. These regulations are being phased in
over a ten year period. Recently enacted Medicare reform legislation requires
HCFA to implement a prospective payment system for outpatient hospital services
by 1999 as well. This system might also provide for a per-patient fixed rate
reimbursement for outpatient department capital costs. Although the full
implications of these changes cannot be known, the Company believes that the
regulations will place more pressure on hospitals' operating margins, causing
them to limit capital expenditures. These regulations could have an adverse
effect on the Company if hospitals decide to defer obtaining medical equipment
as a result of any such limitation on their capital expenditures. The recent
Medicare legislation also requires HCFA to adopt uniform coverage and
administration policies for laboratory tests. The Company is unable to predict
what adverse impact on the Company, if any, additional government regulations,
legislation or initiatives or changes by other payors affecting reimbursement or
other matters that may influence decisions to obtain medical equipment may have.
The Company believes that the escalating cost of medical products and
services has led to and will continue to lead to increased pressures on the
health care industry, both foreign and domestic, to reduce the cost of products
and services, including products offered by the Company. In addition, market
acceptance of the Company's products in international markets is dependent, in
part, upon the availability of reimbursement within prevailing health care
payment systems. Reimbursement and health care payment systems in international
markets vary significantly by country, and include both government sponsored
health care and private insurance. There can be no assurance in either United
States or foreign markets that third party reimbursement and coverage will be
available or adequate, 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 the demand for the
Company's products or its ability to sell its products on a profitable basis.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors Affecting Future Operating Results -- Uncertainty Relating
to Third Party Reimbursement."
PRODUCT LIABILITY AND INSURANCE
The 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. 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, difficult to obtain and no assurance can
be given that product liability insurance can be maintained in the future on
acceptable terms, or in sufficient amounts to protect the Company against losses
due to liability, or at all. An inability to maintain insurance at an acceptable
cost or to otherwise protect against potential product liability could prevent
or inhibit the continued commercialization of the Company's products. In
addition, a product liability claim in excess of relevant insurance coverage or
a product recall could have a material adverse effect on the Company's business,
financial condition and results of operations.
19
<PAGE> 20
The Company has liability insurance covering its property and operations
with coverage and deductible amounts and exclusions which the Company believes
are customary for companies of its size in its industry. However, there can be
no assurance that the Company's current insurance coverage is adequate or that
it will be able to maintain insurance at an acceptable cost or otherwise to
protect against liability. See "Risk Factors -- Risk of Product Liability;
Product Liability Insurance May Be Insufficient or Unavailable."
EMPLOYEES
As of March 31, 1998, the Company employed 141 full time employees. There
were 31 employees in sales and marketing, 10 employees in administration, 83
employees in manufacturing and 17 employees in research and development. The
Company seeks to attract and retain skilled and experienced employees, although
there can be no assurance that it will continue to do so in the future. The loss
of key personnel or the inability to hire or retain qualified personnel could
have a material adverse effect on the Company's business, financial condition
and results of operations. None of the Company's employees is covered by a
collective bargaining agreement, and management considers relations with
employees to be good.
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information concerning the executive
officers of the Company as of March 31, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Warren E. Pinckert II......... 54 President, Chief Executive Officer and Director
Andrea J. Tiller.............. 40 Vice President of Finance, Chief Financial Officer,
Treasurer and Secretary
Steven L. Barbato............. 48 Vice President of Operations
Gary E. Hewett................ 46 Vice President and Chief Scientific Officer
Mark J. Kussman............... 50 Vice President of Sales and Marketing
</TABLE>
Warren E. Pinckert II has served as President, Chief Executive Officer and
a director of the Company since June 1993. Mr. Pinckert served as Executive Vice
President of Operations of the Company from 1991 to June 1993 and as Chief
Financial Officer and Vice President of Business Development of the Company from
1989 to June 1993. Mr. Pinckert also served as Secretary of the Company from
1989 to January 1997. Prior to joining the Company, Mr. Pinckert was Chief
Financial Officer of Sunrise Medical Inc., an international durable medical
equipment manufacturer, from 1983 to 1989. Mr. Pinckert also serves on the Board
of Directors of PacifiCare Health Systems, Inc., a managed care organization.
Mr. Pinckert earned a B.S. in Accounting and a M.B.A. from the University of
Southern California and is a certified public accountant.
Andrea J. Tiller has served as Vice President of Finance, Chief Financial
Officer and Treasurer since joining the Company in November 1996. Ms. Tiller has
also served as Secretary of the Company since January 1997. From March 1996 to
November 1996, Ms. Tiller was an independent management consultant. From
September 1994 to December 1995, Ms. Tiller was Director of Corporate Planning
at Target Therapeutics Inc., a medical device manufacturer and currently a
division of Boston Scientific Corporation. From 1991 to September 1994, Ms.
Tiller was employed as Business Planning Manager of SynOptics Communications,
Inc., a computer networking company now known as Bay Networks Inc. Prior to
joining SynOptics Communications, Inc., Ms. Tiller served as a Senior Marketing
Research Specialist at E.I. du Pont de Nemours and Company and has twice owned
and operated consulting practices in the areas of business strategy and
development. Ms. Tiller earned a B.A. in Economics from Stanford University and
a M.B.A. from the San Francisco State University Graduate School of Business.
Steven L. Barbato has served as Vice President of Operations of the Company
since September 1997. Prior to that Mr. Barbato served as Vice President of
Manufacturing of the Company from 1992. From 1990 to 1992, Mr. Barbato served as
Vice President of Operations of the Pandex Division of Baxter Diagnostics, Inc.
("Baxter Diagnostics"), a biotechnical instrument and reagent development
company and served in other capacities at Baxter Diagnostics from January 1992
to May 1992. From 1989 to 1990, Mr. Barbato served as
20
<PAGE> 21
Director of Manufacturing for the Paramax Chemistry Division of Baxter
Diagnostics, a manufacturer of automated whole blood analyzers. From 1987 to
1989, Mr. Barbato was employed as Manager of Manufacturing by the Pandex
Division of Baxter Diagnostics. Mr. Barbato earned a B.S. in Chemical
Engineering from Northeastern University and a M.B.A. from Xavier University.
Gary E. Hewett, a co-founder of the Company, has served as Vice President
and Chief Scientific Officer of the Company since October 1997. Prior to that
Mr. Hewett was Vice President of Research and Development of the Company from
its inception in 1988. From 1985 to 1988, Mr. Hewett was employed by Genelabs
Technologies, Inc., a biopharmaceutical company, as Vice President of
Diagnostics. Prior to 1985, Mr. Hewett was employed in a variety of management
and technical positions at the following companies: Cetus Corporation, a
biotechnology firm, from 1983 to 1985; Molecular Design, Inc., a computer
software company, from 1980 to 1983; Beckman Instruments, Inc., a clinical
instrument company, from 1978 to 1983; and Durrum Instrument (Dionics), an
analytical instrument firm, from 1975 to 1978. Mr. Hewett earned a B.A. in
Neurophysiology from the University of California, Berkeley.
Mark J. Kussman has served as Vice President of Sales and Marketing of the
Company since August 1996. From June 1994 to June 1996, Mr. Kussman served as
Vice President of Sales and Marketing of Medical Analysis Systems, Inc., a
manufacturer of controls and blood chemistry reagents. From 1991 to June 1994,
Mr. Kussman served as Marketing Manager for the Syva division of Syntex
Corporation, a manufacturer of drug abuse detection, therapeutic drug monitoring
and infectious disease detection systems. From 1988 to 1990, Mr. Kussman was
employed as U.S. Marketing Manager by the Diagnostics Division of Abbott
Laboratories. Mr. Kussman earned a B.S. in Marketing Management from Southern
Illinois University and a M.B.A. from St. Louis University.
ITEM 2. PROPERTIES
The Company leases a facility in Hayward, California of approximately
40,300 square feet. The Company's facility contains approximately 8,000 square
feet of laboratory space, 10,000 square feet of manufacturing space and the
balance is devoted to sales, marketing administrative and common areas. The
Company's lease on the facility expires in the year 2000 with an option to renew
the lease for three years at 90% of the then current market rate. The Company is
currently seeking additional space for offsite storage. See
"Business -- Manufacturing."
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company may be involved in litigation relating to
claims arising out of its operations in the normal course of business. As of the
date of this Annual Report on Form 10-K, the Company was not engaged in any
legal proceedings that are expected, individually or in the aggregate, to have a
material adverse effect on the Company's business, financial condition or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
21
<PAGE> 22
PART II
ITEM 5.MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the Nasdaq National Market under
the symbol "CTEC." The following table sets forth the quarterly high and low
sale prices per share of the Common Stock.
<TABLE>
<CAPTION>
FISCAL YEAR 1997 HIGH LOW
---------------- ------ ------
<S> <C> <C>
First Quarter............................................... $ 7.50 $ 5.25
Second Quarter.............................................. 6.63 4.13
Third Quarter............................................... 6.13 4.88
Fourth Quarter.............................................. 6.50 4.88
</TABLE>
<TABLE>
<CAPTION>
FISCAL YEAR 1998 HIGH LOW
---------------- ------ ------
<S> <C> <C>
First Quarter............................................... $ 6.25 $ 4.75
Second Quarter.............................................. 12.25 5.63
Third Quarter............................................... 15.38 9.00
Fourth Quarter.............................................. 16.13 10.75
</TABLE>
On March 27, 1998, there were approximately 274 holders of record of the
Company's Common Stock.
The Company has never declared or paid cash dividends on its capital stock.
The Company currently expects to retain future earnings, if any, to finance the
growth and development of its business and, therefore, does not anticipate
paying any cash dividends in the foreseeable future.
22
<PAGE> 23
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
the Company's Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Annual Report on Form 10-K and the exhibits hereto.
The statement of operations data set forth below for the fiscal years ended
March 31, 1998, 1997 and 1996 and the balance sheet data as of March 31, 1998
and 1997 are derived from financial statements of the Company that have been
audited by Price Waterhouse LLP, independent accountants, and are included
elsewhere in this Annual Report on Form 10-K and the exhibits hereto. The
statement of operations data for the fiscal years ended March 31, 1995 and 1994
and the balance sheet data as of March 31, 1996, 1995 and 1994 are derived from
financial statements of the Company that have been audited by Price Waterhouse
LLP and are not included herein. The historical results are not necessarily
indicative of results to be expected in future periods.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,(1)
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................. $ 21,664 $ 12,861 $ 6,873 $ 4,038 $ 3,029
Cost of products sold..................... 10,513 6,957 4,481 4,035 5,434
-------- -------- -------- -------- --------
Gross profit (loss)....................... 11,151 5,904 2,392 3 (2,405)
-------- -------- -------- -------- --------
Operating expenses:
Sales and marketing.................... 5,380 4,108 3,305 2,870 3,168
Research and development............... 2,224 1,341 731 757 2,263
General and administrative............. 2,087 1,537 1,246 1,663 1,438
-------- -------- -------- -------- --------
Total operating expenses............. 9,691 6,986 5,282 5,290 6,869
-------- -------- -------- -------- --------
Income (loss) from operations............. 1,460 (1,082) (2,890) (5,287) (9,274)
Interest income, net...................... 569 273 144 243 364
-------- -------- -------- -------- --------
Income (loss) before taxes................ 2,029 (809) (2,746) (5,044) (8,910)
Provision for income taxes................ 41 -- -- -- --
-------- -------- -------- -------- --------
Net income (loss)......................... $ 1,988 $ (809) $ (2,746) $ (5,044) $ (8,910)
======== ======== ======== ======== ========
Net income (loss) per share:
Basic.................................. $ 0.18 $ (0.08) $ (0.34) $ (0.63) $ (1.14)
======== ======== ======== ======== ========
Diluted................................ $ 0.17 $ (0.08) $ (0.34) $ (0.63) $ (1.14)
======== ======== ======== ======== ========
Shares used to compute net income (loss)
per share(2):
Basic.................................. 11,289 10,382 8,042 7,954 7,791
======== ======== ======== ======== ========
Diluted................................ 11,905 10,382 8,042 7,954 7,791
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
MARCH 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities............................. $ 14,751 $ 14,009 $ 4,111 $ 5,230 $ 11,058
Working capital........................... 17,662 16,124 4,442 5,929 9,239
Total assets.............................. 25,788 21,087 9,645 10,041 15,685
Long term obligations..................... -- -- 810 44 54
Accumulated deficit....................... (48,483) (50,471) (49,662) (46,916) (41,872)
Shareholders' equity...................... 21,446 18,703 5,982 8,513 13,412
</TABLE>
- ---------------
(1) The Company's fiscal year is a 52-53 week period ending on the last Friday
in March, and its first three fiscal quarters end on the Friday nearest the
end of the calendar quarter. All fiscal years referenced in this Annual
Report on Form 10-K consisted of 52 weeks, except fiscal 1995, which
consisted of 53 weeks. For convenience, the Company has indicated in this
Annual Report on Form 10-K that its fiscal year ends on March 31 and refers
to the fiscal years ending March 27, 1998, March 28, 1997 and March 29, 1996
as fiscal 1998, fiscal 1997 and fiscal 1996, respectively.
(2) See Note 1 of Notes to Financial Statements for an explanation of shares
used to compute net income (loss) per share.
23
<PAGE> 24
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 continuing to incur 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 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.
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 reflected
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.
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 may fluctuate from period to period.
24
<PAGE> 25
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.
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
25
<PAGE> 26
amounts to the extent 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 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 reflected
increased unit sales of single use test cassettes and L-D-X Analyzers to health
care providers in the POL and health promotion markets. 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
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.
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LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through the sale of
equity securities and, more recently, 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.
On April 29, 1998, the Company filed a Registration Statement on Form S-3
with the Securities and Exchange Commission for the sale of up to 3,000,000
shares of Common Stock by the Company (plus an option to the underwriters for
the purchase of an additional 450,000 shares to cover over-allotments, if any).
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,
together with the proceeds of the offering proposed in its April 29, 1998
Registration Statement, 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. See "-- Factors Affecting Future
Operating Results -- Possible Future Capital Requirements; Uncertainty of
Additional Funding."
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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 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
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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. 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, as to which there can be no assurance. 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
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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 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
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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 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. Tests performed in the health promotion market are generally 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
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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 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
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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 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
33
<PAGE> 34
individual foreign patent applications. There can be no assurance that any of
the Company's pending patent applications will result in the issuance of any
patents, or that, if issued, any such patents will offer protection against
competitors with similar technology. There can be no assurance that any patents
issued to the Company will not be challenged, invalidated or circumvented in the
future or that the rights created thereunder will provide a competitive
advantage. In addition, there can be no assurance that competitors, many of
which have substantially greater resources than the Company and have made
substantial investments in competing technologies, will not seek to apply for
and obtain patents covering technologies that are more effective than the
Company's technologies, that would render the Company's technologies or products
obsolete or uncompetitive or that would prevent, limit or interfere with the
Company's ability to make, use or sell its products either in the United States
or in international markets.
The medical products industry has been characterized by extensive
litigation regarding patents and other intellectual property rights. There can
be no assurance that the Company will not in the future become subject to patent
infringement claims and litigation or interference proceedings conducted in the
United States Patent and Trademark Office ("USPTO") to determine the priority of
inventions. The defense and prosecution of intellectual property suits, USPTO
interference proceedings and related legal and administrative proceedings are
both costly and time consuming. Litigation may be necessary to enforce any
patents issued to the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforceability, scope and validity of the
proprietary rights of others. Any litigation or interference proceedings will
result in substantial expense to the Company and significant diversion of effort
by the Company's technical and management personnel. An adverse determination in
litigation or interference proceedings to which the Company may become a party
could subject the Company to significant liabilities to third parties or require
the Company to seek licenses from third parties which may not be available on
commercially reasonable terms or at all.
The Company's current products incorporate technologies which are the
subject of patents issued to, and patent applications filed by, others. The
Company has obtained licenses for certain of these technologies and may be
required to obtain licenses for others. There can be no assurance that the
Company will be able to obtain licenses for technology patented by others on
commercially reasonable terms, or at all, that it will be able to develop
alternative approaches if unable to obtain licenses or that the Company's
current and future licenses will be adequate for the operation of the Company's
business. The failure to obtain such licenses or identify and implement
alternative approaches could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company also relies upon trade secrets, technical know-how and
continuing invention to develop and maintain its competitive position, and no
assurance can be given that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
the Company's trade secrets or disclose such technology, or that the Company can
meaningfully protect its right to its trade secrets, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations. 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
34
<PAGE> 35
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 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
35
<PAGE> 36
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. On April 29, 1998, the Company filed a
Registration Statement on Form S-3 with the Securities and Exchange Commission
for the sale of up to 3,000,000 shares of Common Stock by the Company (plus an
option to the underwriters for the purchase of 450,000 shares to cover
over-allotments, if any). 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, together with the net proceeds of the offering proposed in its April 29,
1998 Registration Statement, 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."
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,
36
<PAGE> 37
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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
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<PAGE> 38
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item concerning the Company's Directors is
incorporated by reference from the sections captioned "Election of
Directors -- Nominees" and "Section 16(a) Beneficial Ownership Reporting
Compliance" contained in the Company's Proxy Statement related to the 1998
Annual Meeting of Shareholders to be held August 20, 1998, to be filed by the
Company within 120 days of the end of the Company's fiscal year pursuant to
General Instruction G(3) of Form 10-K (the "Proxy Statement"). Certain
information required by this item concerning executive officers set forth in
Part I of this Report under "Business -- Executive Officers of the Company" and
certain information required by reference from the section captioned "Section
16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item concerning the compensation of the
Company's executive officer is incorporated by reference from the section
captioned "Executive Compensation" contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
Section captioned "Security Ownership of Certain Beneficial Owners and
Management" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
sections captioned "Compensation Committee Interlocks and Insider Participation"
and "Certain Transactions with Management" contained in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1)Financial Statements
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
38
<PAGE> 39
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.
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.
</TABLE>
39
<PAGE> 40
<TABLE>
<S> <C>
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 (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.
(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.
(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.
40
<PAGE> 41
(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.
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<PAGE> 42
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 Report 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: May 5, 1998
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Warren E. Pinckert II and Andrea J.
Tiller, and each of them, his or her true and lawful attorneys-in-fact and
agents, each with full power of substitution and resubstitution, to sign any and
all amendments (including post-effective amendments) to this Annual Report on
Form 10-K and to file the same, with all exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in connection therewith, as fully to all intents and purposes as he or she might
or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, or any of
them, shall do or cause to be done by virtue hereof.
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<PAGE> 43
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, THIS REPORT 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 May 5, 1998
- ----------------------------------------------------- Officer and Director (Principal
(Warren E. Pinckert II) Executive Officer)
/s/ ANDREA J. TILLER Vice President of Finance and May 5, 1998
- ----------------------------------------------------- Chief Financial Officer
(Andrea J. Tiller) (Principal Financial and
Accounting Officer)
/s/ HARVEY S. SADOW, PH.D. Director May 5, 1998
- -----------------------------------------------------
(Harvey S. Sadow, Ph.D.)
/s/ JOSEPH BUCHMAN, M.D. Director May 5, 1998
- -----------------------------------------------------
(Joseph Buchman, M.D.)
/s/ JOHN L. CASTELLO Director May 5, 1998
- -----------------------------------------------------
(John L. Castello)
/s/ JOHN H. LANDON Director May 5, 1998
- -----------------------------------------------------
(John H. Landon)
/s/ H.R. SHEPHERD Director May 5, 1998
- -----------------------------------------------------
(H.R. Shepherd)
/s/ LARRY Y. WILSON Director May 5, 1998
- -----------------------------------------------------
(Larry Y. Wilson)
</TABLE>
43
<PAGE> 44
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> 45
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.
PRICE WATERHOUSE LLP
San Jose, California
April 23, 1998, except as
to Note 10, which is
as of April 29, 1998
F-2
<PAGE> 46
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> 47
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> 48
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> 49
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 disclosures 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> 50
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 principally 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.
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 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.
F-7
<PAGE> 51
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 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.
F-8
<PAGE> 52
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 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
statements.
2. BALANCE SHEET COMPOSITION
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>
F-9
<PAGE> 53
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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.
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.
F-10
<PAGE> 54
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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. The Company has granted Metra Biosystems
registration rights in connection with its purchase of Common Stock.
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 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 year
period 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.
F-11
<PAGE> 55
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
In August 1997, the shareholders approved the 1997 Stock Incentive Program
(the "1997 Program") which 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 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.
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
F-12
<PAGE> 56
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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.
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 for fiscal 1998,
1997 and 1996, respectively; 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 or 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
F-13
<PAGE> 57
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
right to acquire, beneficial ownership of 15% or more of the Company's
outstanding Common Stock or (ii) 10 business days following the commencement of,
or announcement of an intention to make, a tender offer or exchange offer, the
consummation of which would result in the beneficial ownership by a person or
group of 15% or more of the Company's outstanding Common Stock. The Rights
expire on the earlier of (i) January 22, 2007 or (ii) redemption or exchange of
the Rights.
7. 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 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 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
F-14
<PAGE> 58
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
$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.
10. SUBSEQUENT EVENT
On April 29, 1998, the Company filed a Registration Statement on Form S-3
with the Securities and Exchange Commission to register and sell 3,000,000
shares of Common Stock.
F-15
<PAGE> 59
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.
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.
</TABLE>
<PAGE> 60
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIAL
NO. DESCRIPTION PAGE NO.
------- ----------- ----------
<S> <C> <C>
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.
(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.
(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.
<PAGE> 61
(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, except as to Note 10, which is as of April
29, 1998, appearing on page F-2 of this Form 10-K.
PRICE WATERHOUSE LLP
San Jose, California
May 4, 1998
