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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 26, 1999
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)
<TABLE>
<S> <C>
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)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 732-7200
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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<S> <C>
NONE NONE
</TABLE>
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
26, 1999 as reported on the NASDAQ National Market, was approximately
$17,960,000. 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 26, 1999, registrant had outstanding 11,518,240 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 1999 ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD AUGUST 19, 1999.
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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(R) 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 testing to
assist in assessing for risk of certain chronic diseases and to assist in the
monitoring of therapy to treat those diseases. The L-D-X System is capable of
measuring multiple analytes simultaneously with a single drop of whole blood,
producing test results within five minutes. The Company 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") market, the pharmacy
market and the 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"), 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, and proper monitoring of
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 monitoring of therapy 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, in many cases is inconvenient for the
patient, 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 monitoring of therapy
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 monitoring of
therapy 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, although Pharmacists face difficult
reimbursement issues in some states with blocking state legislation. 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.
PREVENTIVE CARE TESTING MARKETS
<TABLE>
<CAPTION>
APPROXIMATE
MARKETS NUMBER OF SITES
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<S> <C>
POL........................................... 96,000
Pharmacy...................................... 53,000
Health Promotion.............................. 84,000
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Total............................... 233,000
=======
</TABLE>
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 for multiple analytes because certain chronic diseases are
often manifested in a combination of substances.
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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:
- 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.
- Improved Therapy Compliance. Studies have shown that easier access to
testing sites may improve drug, diet, and exercise 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.
- 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 can reduce costs associated with the treatment
of chronic diseases.
- 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 test cassettes and system software, which
decreases the development costs and the time to market for new
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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:
- Increase 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.
- Leverage 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.
- Maintain 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.
- Further 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.
- Expand Distribution Relationships. The Company intends to augment its
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"), General
Medical, Inc., a division of McKesson ("General Medical"), and McKesson.
- Provide easier access to the Consumer. The Company intends to capitalize
on its technological advantage of testing outside of the clinical or
hospital laboratory by providing products and services that improve
people's access to Chronic Disease risk assessment and management. The
Company further intends to support its existing customers in the
screening and monitoring markets by expanding the number of venues in
which preventive care testing takes place, and intends to seek strategic
alliances to broaden the adoption of preventive care testing.
- Increase value of Preventive Care Testing to the Consumer and to the
Healthcare Industry. The Company intends to further capitalize on its
technological advantages by adding significant data management
capabilities to the L-D-X System in the future.
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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 variety of single use, credit card sized test
cassettes, a printer and accessories. 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 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.
The following table summarizes the Company's current products and products
under development:
<TABLE>
<CAPTION>
PRODUCT TARGETED DISEASE STATE REGULATORY STATUS(1)
------- ---------------------- --------------------
<S> <C> <C>
INSTRUMENT
L-D-X Analyzer -- FDA cleared; CLIA waived
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
UNDER DEVELOPMENT(2)
BUN/Creatinine Kidney disorder FDA cleared; not CLIA waived
Alanine Aminotransferase Liver damage Filed 510(k) with FDA, not
(ALT) applied for CLIA
Bone Resorption Osteoporosis Not filed or applied
IN FEASIBILITY STUDIES(3)
Glycated Hemoglobin Diabetes Not filed or applied
Creatinine Kinase Cardiovascular disease Not filed or applied
</TABLE>
- ---------------
(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
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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.
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 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, in combination
with a printer, accessories and starter pack, constitutes an L-D-X System, and
currently has a list price of $1,995.
CASSETTE PRODUCTS
The Company's line of single use test cassettes for the L-D-X System
incorporates patented and licensed 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
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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, has 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.
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 recommends 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.
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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 but was denied clearance from the
CDC for CLIA waived status in March, 1999.
Alanine Aminotransferase ("ALT"). Patients undergoing certain drug
therapies must be monitored for increases in certain enzymes that are associated
with liver damage. The availability 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 impact of and potential adverse side effects on the liver
from lipid lowering and diabetic 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. The Company
filed for 510(k) clearance to market ALT in May, 1999. The Company has not yet
applied for CLIA-waived status.
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
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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.
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 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. On
September 14, 1998, the APhA released the preliminary results of Project ImPACT.
During the course of the study, pharmacists at 29 community-based pharmacies
across the country had monitored approximately 700 patients for a period of at
least 18 months. In the September/October issue of the Journal of the American
Pharmaceutical Association, the preliminary results indicated that 84 percent of
patients continued their regimen of medication and 44 percent of those patients
reached the National Cholesterol Education Program goals. This is compared to
other studies where only 10 percent of patients reached their cholesterol goals.
Preliminary results of Project ImPACT were also 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. The Company anticipates that final
results of project imPACT will be announced in February, 2000.
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, or has been, collaborating on three projects with
Parke-Davis, a major pharmaceutical manufacturer.
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Phase IV Clinical Trials: Cholestech supplied approximately 1,000 L-D-X
Systems, together with sufficient Lipid Profile Cassettes and accessories, to
conduct a Phase IV Clinical Trial in support of Parke-Davis' lipid lowering drug
"Lipitor" in June and August of 1998.
Professional Golf Association ("PGA") Tour Screenings. Parke-Davis,
Cambridge Health Partners and the Lipid Nurse Taskforce collaborated to provide
free diagnostic screening using the L-D-X System and promote cholesterol
awareness at 10 PGA tour events in 1998.
"Cholesterol Low Down" Mobile Screening Unit. Parke-Davis and HealthNet
Inc. are collaborating to provide free diagnostic screening using the L-D-X
System for 100 days in 1999. This program is intended to promote cholesterol
awareness throughout the United States courtesy of the LIPITOR (atorvastatin
calcium) Mobile Screening Unit, reaching approximately 60,000 Americans in 1999.
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 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,
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pharmacies and health promotion sites, as well as on the international market.
Each team consists of a market manager, a national sales lead, 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 96,000 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, Physician Sales and Services, Inc. and General Medical (currently
a division of McKesson Corporation), which together have more than 1,300 sales
professionals who focus on the POL market. The Company has additionally expanded
the number of distributors of the L-D-X System targeting this market through the
retention of 30 regional distributors. 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. 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 and Bergen
Brunswig Drug Company have terminated their non-exclusive distribution agreement
to market the Company's product to pharmacists. In an effort to further
penetrate the pharmacy market, the Company is maintaining its nonexclusive
distribution agreement with McKesson Corporation , a national medical products
distributor, to distribute its products to the pharmacy market, although
penetration of this market to date has occurred more slowly than the Company
anticipated. Additionally, the 15 regional distributors who have traditionally
carried the Company's products in the Health Promotion market have begun to
distribute to regional pharmacies in the United States.
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
15 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
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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, Bayer, 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
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 its approximately 49,000 square foot
facilities 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.
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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 terms of its individual subsystems in fiscal 2000,
with full implementation and validation of the entire system in early fiscal
2001. 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 may design
and install a manufacturing line to commercially produce immunoassay cassettes
as its bone resorption product completes development and becomes commercially
available. 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."
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. However, there can be no
guarantee that alternate sources for these materials exist or may be developed
in the event that they become necessary. 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
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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. For example, the Company is aware that
Roche Holdings Ltd. ("Roche") holds an issued European patent relating to the
measurement of HDL. Some distributors of the L-D-X System in Europe have
received notification from Roche claiming that Cholestech's HDL product
infringes upon Roche's European patent. Roche has requested that these
distributors cease selling the L-D-X System. The Company is investigating
Roche's claims in order to ascertain the significance of the allegations and to
determine an appropriate course of action. 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 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
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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 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.
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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 manufacturer's 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, 8 states have regulations that impose requirements on
pharmacies and/or pharmacists that perform clinical testing; four 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.
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 $150 fee, and are not required to
comply with the CLIA requirements otherwise applicable to individual diagnostic
tests. This certificate
17
<PAGE> 18
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. Pharmacists also face
blocking state legislation in a number of states which precludes them from
accessing federally available reimbursement codes and practices. 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 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
18
<PAGE> 19
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.
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 26, 1999, the Company employed 137 full-time, permanent
employees. There were 45 employees in sales, marketing and administration, 75
employees in manufacturing and 17 employees devoted to research and development.
The Company seeks to attract and retain skilled and experienced employees with
directly relevant experience in the fields of interest, 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 employees is covered by a collective
bargaining agreement, and management considers relations with employees to be
excellent.
19
<PAGE> 20
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information concerning the executive
officers of the Company as of March 26, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Warren E. Pinckert II.................... 55 President, Chief Executive Officer and
Director
Andrea J. Tiller......................... 41 Vice President of Finance, Chief Financial
Officer, Treasurer and Secretary
Robert J. Dominici....................... 55 Executive Vice President of Sales and
Marketing
Steven L. Barbato........................ 49 Vice President of Operations
</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
products 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 1994 to 1995,
Ms. Tiller was Director of Corporate Planning at Target Therapeutics, a medical
device manufacturer and currently a division of Boston Scientific Corporation.
From 1991 to 1994 Ms. Tiller was employed as Business Planning Manager of
SynOptics Communications, Inc., a computer networking company now known as
Nortel Networks Inc. Prior to joining SynOptics Communications, Inc., Ms. Tiller
served as 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 also serves on the Board of
Directors of Aspect Technology Corporation, an Israeli-based internet software
development firm. 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.
Robert J. Dominici has served as Executive Vice President of Marketing and
Sales since joining the Company in August 1998. From January of 1997 to May 1998
Mr. Dominici served as Senior Vice President, Corporate Accounts and General
Manager for Boehringer Mannheim Corporation, a healthcare diagnostic products
company currently operating as Roche Boehringer Mannheim. Prior to his position
as Senior Vice President, Corporate Accounts, Mr. Dominici held numerous other
positions with Boehringer Mannheim Corporation from 1988 to 1996, including:
President of the Laboratory System division from 1995 to 1996, President and
Chief Executive Officer of Microgenics Corporation, a wholly owned subsidiary
from 1992 to 1995, and President of the Diagnostic Laboratory System division
from 1988 to 1991. Mr. Dominici earned a B.S. in Biology and Chemistry from
Otterhein College.
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
division and served in other capacities at Baxter Diagnostics from January 1992
to May 1992. From 1989 to 1990, Mr. Barbato served as Director of Manufacturing
for the Paramax Chemistry Division of Baxter Diagnostics, a division
manufacturing automated whole blood analyzers. From 1987 to 1989, Mr. Barbato
was employed as Manager of Manufacturing by the Paramax Chemistry Division of
Baxter Diagnostics. Mr. Barbato earned a B.S. in Chemical Engineering from
Northeastern University and an M.B.A. from Xavier University.
20
<PAGE> 21
ITEM 2. PROPERTIES
The Company leases 49,000 square feet in Hayward, California. The Company's
facilities contain approximately 8,000 square feet of laboratory space and
10,000 square feet of manufacturing space with the balance devoted to marketing
and 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 believes that this facility is adequate to
meet its requirements through the expiration of its lease.
ITEM 3. LEGAL PROCEEDINGS
On February 5, 1999, a complaint entitled Ree v. Pinckert, et al., No.
C99-0562 (MMC) was filed in the United States District Court for the Northern
District of California. The Action is a putative class action and the complaint
alleges that Cholestech and an officer, Mr. Pinckert, violated the federal
securities laws by misleading investors during the time period of July 30,
1997 - June 26, 1998 concerning the Company's business and its future prospects.
The complaint does not specify alleged damages. The Company intends to defend
the case vigorously. Although the Company does not believe that the defendants
in the class action engaged in any wrongdoing, there can be no assurance that
the lawsuit will be resolved in the Company's favor. The action is in its
preliminary stages and a trial date has not been set.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year through solicitation of proxies or otherwise.
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." On March 26, 1999, the last reported sale price for the
Company's Common Stock on the NASDAQ National Market was $2.00 per share. The
following table sets forth the quarterly high and low trading prices for the
Company's Common Stock.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
FISCAL YEAR 1998
First Quarter.................................... $ 6.25 $ 4.75
Second Quarter................................... 12.25 5.63
Third Quarter.................................... 15.38 9.00
Fourth Quarter................................... 16.13 10.75
FISCAL YEAR 1999
First Quarter.................................... $17.88 $ 6.00
Second Quarter................................... 8.88 4.00
Third Quarter.................................... 5.63 2.78
Fourth Quarter................................... 4.94 1.88
</TABLE>
On March 26, 1999, the closing price of Cholestech Common Stock as reported
on the NASDAQ National Market was $2.00. As of March 26, 1999, there were
approximately 260 holders of record of the Company's Common Stock.
21
<PAGE> 22
DIVIDEND POLICY
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, 1997, 1998 and 1999 and the balance sheet data as of March 31, 1998
and 1999 are derived from financial statements of the Company that have been
audited by PricewaterhouseCoopers LLP, independent accountants, and are included
elsewhere in this Annual Report on Form 10-K and the exhibits hereto.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,(1)
---------------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................... $22,032 $21,664 $12,861 $ 6,873 $ 4,038
Cost of products sold.................. 10,252 10,513 6,957 4,481 4,035
------- ------- ------- ------- -------
Gross profit........................... 11,780 11,151 5,904 2,392 3
------- ------- ------- ------- -------
Operating expenses:
Sales and marketing................. 6,606 5,380 4,108 3,305 2,870
Research and development............ 2,703 2,224 1,341 731 757
General and administrative.......... 2,381 2,087 1,537 1,246 1,663
Other operating expense............. 826 -- -- -- --
------- ------- ------- ------- -------
Total operating expenses....... 12,516 9,691 6,986 5,282 5,290
------- ------- ------- ------- -------
Income (loss) from operations.......... (736) 1,460 (1,082) (2,890) (5,287)
Interest and other income, net......... 663 569 273 144 243
------- ------- ------- ------- -------
Income (loss) before taxes............. (73) 2,029 (809) (2,746) (5,044)
Provision for income taxes............. -- 41 -- -- --
------- ------- ------- ------- -------
Net income (loss)...................... $ (73) $ 1,988 $ (809) $(2,746) $(5,044)
======= ======= ======= ======= =======
Net income (loss) per share:
Basic............................... $ (0.01) $ 0.18 $ (0.08) $ (0.34) $ (0.63)
======= ======= ======= ======= =======
Diluted............................. $ (0.01) $ 0.17 $ (0.08) $ (0.34) $ (0.63)
======= ======= ======= ======= =======
Shares used to compute net income
(loss) per share(2):
Basic............................... 11,484 11,289 10,382 8,042 7,954
======= ======= ======= ======= =======
Diluted............................. 11,484 11,905 10,382 8,042 7,954
======= ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
MARCH 27,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities............................. $ 11,427 $ 14,751 $ 14,009 $ 4,111 $ 5,230
Working capital........................... 13,342 17,662 16,124 4,442 5,929
Total assets.............................. 24,283 25,788 21,087 9,645 10,041
Long term obligations..................... -- -- -- 810 44
Accumulated deficit....................... (48,556) (48,483) (50,471) (49,662) (46,916)
Shareholders' equity...................... 21,769 21,446 18,703 5,982 8,513
</TABLE>
- ---------------
(1) The Company's fiscal year is a 52-53 week period ending on the last Friday
in March. 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 26, 1999, March 27,
23
<PAGE> 24
1998, March 28, 1997, March 29, 1996, and March 30, 1995 as fiscal 1999,
1998, 1997, 1996, and 1995 respectively.
(2) See Note 1 of Notes to financial Statements for an explanation of shares
used to compute net income (loss) per share.
24
<PAGE> 25
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward looking statements as a result of
certain factors discussed below, including under "General" and "Factors
Affecting Future Operating Results." These forward looking statements include,
but are not limited to, the statement under "General" regarding the Company's
expectation of incurring negative cash flows, the statement under "Revenues"
regarding the Company's expectation that international revenues fluctuate from
period to period, the statement under "Sales and Marketing" regarding the
Company's expectation that sales and marketing expenses will increase, the
statement under "Research and Development" regarding the development of new test
cassettes and the Company's anticipation that research and development
expenditures will increase, 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, experienced a loss in fiscal 1999, and, as of March
26, 1999, had an accumulated deficit of $48.6 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, return to profitability and
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. While the
Company has experienced moderate success in marketing its preventive care
testing technology in the health promotion and POL markets, sales to date to
pharmacists have been minimal. The Company attributes this to lack of awareness
within the pharmacy market of its product, insufficient education among
pharmacists regarding the economic benefits of preventive care testing, and a
lack of reimbursement for pharmacy testing. Two of three national distributors
contracted by the Company to sell product into the pharmacy segment have
discontinued actively carrying the Company's product line as of April, 1998 and
May, 1999, respectively.
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 return to profitability and achieve
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.
25
<PAGE> 26
RESULTS OF OPERATIONS
Fiscal 1999 and Fiscal 1998
Revenues. The Company's revenues increased 1.7% to $22.0 million in fiscal
1999 from $21.7 million in fiscal 1998. The increase in revenues reflected
increased unit sales of single use test cassettes across all market segments and
total product sales increases in the physician office laboratory and
international markets. Total product sales decreased year to year in the health
promotion and pharmacy segments of the market.
International revenues represented 9.7% and 14.2% of revenues in fiscal
1999 and fiscal 1998, respectively. The Company expects that the dollar amount
and proportion of international revenues will continue to fluctuate from period
to period.
Cost of Products Sold. Cost of products sold includes direct labor, direct
material, overhead and royalties. Cost of products sold decreased 2.5% to $10.3
million in fiscal 1999 from $10.5 million in fiscal 1998, primarily as a result
of increased unit sales of single use test cassettes. Gross margin was 53.5% and
51.5% in fiscal 1999 and 1998, 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 1999 and 1998 was $379,000 and $562,000,
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 22.8% to
$6.6 million in fiscal 1999 from $5.4 million in fiscal 1998. Sales and
marketing expense increased to 30.0% of revenues in fiscal 1999 from 24.8% in
fiscal 1998, primarily due to the addition of field sales and marketing
personnel and related expenses, continued expansion of the Company's domestic
sales and marketing programs, increased marketing and distribution expenses
related to greater penetration of the POL market and extended launch costs in
the pharmacy market. 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 21.5% to $2.7
million in fiscal 1999 from $2.2 million in fiscal 1998. This increase was
primarily attributable to continued development of new single use test cassettes
and a related increase in headcount. Research and development expense as a
percentage of revenues increased to 12.3% in fiscal 1999 compared to 10.3% in
fiscal 1998. 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 may
increase 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, as well as expenses for outside professional services.
General and administrative expense increased 14.1% to $2.4 million in fiscal
1999 from $2.1 million in fiscal 1998. This increase resulted primarily from the
use of professional outside services, including legal services and information
services and support. General and administrative expenses increased to 10.8% of
revenues in fiscal 1999 from 9.6% in fiscal 1998.
Other Operating Expense. In fiscal 1999 the Company recorded other
operating expenses of $826,000. These expenses included fees relating to the
Company's withdrawn public stock offering, settlement of
26
<PAGE> 27
litigation with a former employee, expenses associated with the Company's
reduction in force, and legal expenses incurred to defend the Company in a filed
class-action litigation. There were no other operating expenses incurred in
fiscal 1998.
Interest and Other Income, Net. Interest income reflects income from the
investment of cash balances and marketable securities net of expenses relating
to those investments. Interest income rose 16.5% to $663,000 in fiscal 1999 from
$569,000 in fiscal 1998. This increase was primarily the result of realized
gains on marketable securities in fiscal 1999.
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.
Management expects to utilize NOL and other tax carryforward amounts to the
extent income is earned in fiscal 2000 and beyond. Therefore, the Company's
effective tax rate should continue to be substantially less than the applicable
statutory rates. As of March 26, 1999, the Company had NOL carryforwards
available to reduce future taxable income for federal and state income tax
purposes of $43.3 million and $12.2 million, respectively. Additionally, the
Company had research and development credit carryforwards available to reduce
income taxes for federal and state income tax purposes of $1.8 million and
$651,000, 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 26, 1999.
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 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.
Cost of Products Sold. 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.
Sales and Marketing. 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.
Research and Development. 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
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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.
General and Administrative. 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.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through the sale of
equity securities and, in fiscal 1998, from positive cash flows from operations.
From inception to March 26, 1999, the Company raised $69.0 million in net
proceeds from equity financings. As of March 26, 1999, the Company had $11.4
million of cash, cash equivalents and 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, 1999. As of March 26,
1999, there were no borrowings outstanding under the line of credit.
During fiscal 1999, the Company used $830,000 in cash from operating
activities compared to providing cash of $2.1 million in fiscal 1998. The use of
cash in fiscal 1999 was primarily due to an increase in inventories of $1.2
million and a decrease in accounts payable and accrued benefits of $1.6 million,
partially offset by a decrease in accounts receivable of $1.2 million and
depreciation expense of $1.1 million. Cash provided from operations in fiscal
1998 was primarily due to net income of $2.0 million and increases in accounts
payable and accrued liabilities of $1.4 million partially offset by increases in
accounts receivable and inventories of $1.9 million and $1.0 million,
respectively.
Net cash provided by investing activities was $798,000 in fiscal 1999
consisting primarily of net maturities of marketable securities of $3.7 million
offset against purchases of property and equipment of $2.9 million. In fiscal
1998, the Company used $3.7 million of cash in investing activities through the
purchase of property and equipment of $2.1 million and the net purchases of
marketable securities of $1.6 million.
Net cash provided by financing activities was $431,000 in fiscal 1999 as
compared to $666,000 for fiscal 1998. For both years, cash provided by financing
activities was primarily from the issuance of common stock pursuant to the
employee stock purchase plan and stock incentive plan.
During fiscal 2000, the Company intends to expend approximately $3 million
for capital purchases related to expansion of its manufacturing capacity and
research and development.
FACTORS AFFECTING FUTURE OPERATING RESULTS
YEAR 2000 COMPLIANCE RISKS. Cholestech has an ongoing program of assessing
the extent to which its internal systems and products evaluate date information
("Year 2000 dependencies"), and, if so, whether they can properly process and
evaluate dates on or after the Year 2000 (whether they are "Year 2000
compliant"). The Company is taking remedial action where its systems and
products are not year 2000 compliant. The
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Company is also evaluating contingency plans for continuing operations if Year
2000 problems arise despite its steps to avoid them. The Company expects these
activities to continue throughout calender 1999.
The Company believes that it has identified the Year 2000 dependencies in
its internal systems. It has examined all critical systems including
manufacturing, sales, development, communications and financial systems. It has
also examined its non-computer electronic devices that contain microprocessors
and that are critical to the Company's operations (for example, telephones,
manufacturing machinery and security systems). As these dependencies have been
identified, Cholestech has been taking the remedial measures it believes are
necessary for its internal systems to be Year 2000 compliant. These measures
have included establishing a Year 2000 Task Force, increased
awareness/communication of the Year 2000 issues, inventorying the Company's
systems and equipment, assessment of the inventory and implementation and review
of remediated systems and equipment. The Company is not currently aware of any
Year 2000 dependencies in its internal systems that could have a material impact
on its business should the Company fail to make such systems Year 2000
compliant. The Company is also not aware of any material operational issues or
costs associated with preparing its internal systems for the Year 2000. However,
no assurances can be given that Cholestech will not experience unanticipated
material costs caused by undetected errors or defects in its internal systems.
Delays in implementation of new information systems and a failure to identify
and remediate all of its Year 2000 dependencies could result in material adverse
consequences to the Company's business, financial conditions and results of
operations.
Cholestech has also taken measures to ensure that its products are Year
2000 compliant, including an evaluation of all of it's current products for Year
2000 dependencies and Year 2000 Compliance. Based on that evaluation the Company
believes its products are Year 2000 complaint. Despite this belief the Company
anticipates that there exists the potential for substantial litigation which may
be brought against vendors of all component products provided by the Company.
The Company believes that any such claims, with or without merit, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The L-D-X System contains software that may be used to integrate test
results with an end user's medical records system. It is likely that, commencing
in the Year 2000 or before, 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 Year 2000 compliant. At this time, the
Company believes that its products are Year 2000 compliant. The Company has not,
and does not plan to, poll all of its customers to determine whether they are
using the L-D-X System with other systems that are not Year 2000 compliant. If a
significant portion of the Company's customers were to be unable to integrate
L-D-X System data with their other information systems, such customers may stop
using the L-D-X System. This would materially and adversely effect the Company's
business, financial condition and results of operations.
Additionally, 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. Cholestech is
working with the key suppliers of products and services as well as distributors
of the Company's products to determine whether their systems, products and
services are Year 2000 compliant. The Company is also attempting to monitor
their progress toward Year 2000 compliance. This investigational and monitoring
process has included questionnaires that the Company has sent to the
organizations with which the Company conducts a material amount of business.
These efforts are not yet completed and the Company expects these efforts to
continue for the foreseeable future. Even if the Company identifies Year 2000
dependency problems in its key vendors or suppliers, there can be no assurance
that such dependencies will be remediated. If any of the Company's key vendors,
supplies or distributors have systems that are not Year 2000 complaint,
Cholestech may be prevented from manufacturing and/or distributing its products
for a significant period of time. The Company may not be able to establish
alternative business relationships in a timely fashion, on acceptable terms or
at all. This could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company currently is
developing a contingency plan to address such an event.
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Cholestech has incurred and will incur various costs to conduct testing and
modification of its products and to provide customer support services regarding
Year 2000 issues. It also anticipates that these costs will continue through
calendar year 1999. To date, the costs incurred related to the Company's Year
2000 readiness program have been immaterial. This estimate is based on a current
assessment and is subject to change as the Company's Year 2000 readiness program
progresses.
Cholestech believes that the purchasing patterns of its customers and
potential customers may also be affected by the Year 2000 issues as they expend
significant resources to bring their current software systems into Year 2000
compliance. These expenditures could result in reduced funds available to
purchase products such as those offered by the Company. This could have a
material adverse effect on the Company's business, operating results or
financial condition.
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. In
particular, adoption of the preventive care testing model promoted by the
Company in the pharmacy market has remained at very low levels. Awareness of the
availability of the Company's technology remains at predominantly low levels in
both the physician and pharmacy customer groups. 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. Additionally,
market acceptance issues such as awareness, adoption, reimbursement,
distribution, pricing, and education have kept sales to pharmacists at a
significantly low level to date relative to the size of the available market.
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,
1999, had an accumulated deficit of $48.6 million. The Company's first
profitable quarter was the first quarter of fiscal 1998, and its first
profitable year was fiscal 1998, however, the Company recorded a net loss of
$73,000 for fiscal 1999. The Company's ability to return to 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 return to profitability and positive cash
flows from operations will also depend upon the level and timing of research and
development expenditures and the
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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:
- The timing and level of market acceptance of the L-D-X System;
- The timing of the introduction and availability of new tests;
- The timing and level of expenditures associated with development
activities;
- The timing and level of expenditures associated with expansion of sales
and marketing activities and overall operations;
- The Company's ability to reduce cost of cassette manufacturing
- Variations in manufacturing efficiencies;
- The timing of establishment of strategic distribution arrangements and
the success of the activities conducted under such arrangements;
- Changes in demand for its products based on changes in third party
reimbursement, competition, changes in government regulation and other
factors;
- The timing of significant orders from and shipments to customers;
- Product pricing and discounts;
- Variations in the mix of products sold; and
- General economic conditions.
These factors are difficult to predict, 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 December 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 rejected the Company's request in March of 1999. Because the CDC's
evaluation of applications for CLIA waived status is not based upon precisely
defined, objectively measurable criteria, the Company cannot predict the
likelihood of obtaining waived status in the future for the BUN/Creatinine
product. In order to successfully commercialize the BUN/Creatinine test cassette
or other future tests in the United States, the
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Company believes it is critical to obtain waived status under CLIA. In order to
successfully commercialize any new tests, including the BUN/Creatinine test
cassette, the Company will be required to establish and maintain reliable,
cost-efficient, high-volume manufacturing capacity for such tests. The Company
has in the past encountered difficulties in scaling up production of new test
cassettes, including problems involving production yields, quality control and
assurance, variations and impurities in raw materials and performance of the
manufacturing equipment.
In May 1996, the Company entered into a development, marketing and
licensing agreement with Metra Biosystems to develop an immunoassay cassette
incorporating Metra Biosystems' bone resorption technology to be used on the
L-D-X System. Metra Biosystems is obligated to purchase $750,000 of additional
shares of Common Stock at the then current market price upon the completion of
specified milestones by the Company unless Metra Biosystems exercises its right
to terminate the agreement, which it may do at any time. There can be no
assurance that Metra Biosystems will not terminate the agreement or that Metra
Biosystems will purchase any additional Common Stock. If the Company is unable,
for technological or other reasons, to complete the development, introduction
and scale up of manufacturing of any new tests, if the Company fails to obtain
regulatory approval for any such tests on a timely basis or if such new tests do
not achieve a significant level of market acceptance, the Company's business,
financial conditional and results of operations would be materially adversely
affected. See "Business -- 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 reduce manufacturing costs
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 fully operational in early fiscal 2001. There can be no assurance
that the new cassette manufacturing line can be completed in a timely fashion,
if ever, or that the Company would not need to implement cassette manufacturing
cost reduction programs sooner. In addition, the custom nature of much of the
Company's manufacturing equipment increases the time required to plan and build
new manufacturing lines. The Company may 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
reduce manufacturing costs for dry chemistry tests, or to successfully develop
an immunoassay cassette manufacturing line
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and achieve acceptable yields, could lead to an inability to cost effectively
satisfy customer orders and could have a material adverse effect on the
Company's business, financial condition and results of operations.
DEPENDENCE ON SUPPLIERS. Single source vendors currently provide certain
subassemblies, components and raw materials used in the manufacture of the
Company's products. Any supply interruption in a single source subassembly,
component, or raw material could have a material adverse effect on the Company's
ability to manufacture products until a new source of supply is identified and
qualified. There can be no assurance that the Company will be successful in
qualifying additional sources of supply on a timely basis, or at all, and
failure to do so could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, an uncorrected
impurity or supplier's variation in a raw material, either unknown to the
Company or incompatible with the Company's manufacturing process, could have a
material adverse effect on the Company's ability to manufacture products.
Because the Company is a small customer of many of its suppliers and purchases
its subassemblies, components and materials on a purchase order basis, rather
than pursuant to long term commitments, there can be no assurance that the
Company's suppliers will devote adequate resources to supplying the Company's
needs. Any interruption or reduction in the future supply of any subassemblies,
components or raw materials currently obtained from single or limited sources
could have a material adverse effect on the Company's business, financial
condition and results of operations.
NEED TO MANAGE EXPANDING OPERATIONS. If the Company is successful in
achieving and maintaining market acceptance for the L-D-X System, the Company
will be required to expand its operations, particularly in the areas of sales
and marketing and manufacturing. As the Company expands its operations in these
areas, such expansion will likely result in new and increased responsibilities
for management personnel and place significant strain upon the Company's
management, operating and financial systems and resources. To accommodate any
such growth and compete effectively, the Company will be required to implement
and improve its information systems, procedures and controls, and to expand,
train, motivate and manage its work force. There can be no assurance that the
Company's personnel, systems, procedures and controls will be adequate to
support the Company's future operations. Any failure to implement and improve
the Company's operational, financial and management systems or to expand, train,
motivate or manage employees as required by future growth, if any, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
LIMITED SALES, MARKETING AND DISTRIBUTION EXPERIENCE; DEPENDENCE ON THIRD
PARTY DISTRIBUTORS. In order for the Company to increase revenues and sustain
profitability, the L-D-X System must achieve a significant degree of market
acceptance among health care providers and third party Payors. The Company has
only limited experience in marketing and selling to the therapeutic monitoring
market in the United States and relies on third party distributors in this
market. There can be no assurance that the Company will be able to maintain its
existing distribution relationships. Distribution agreements with Amerisource
and Bergen Brunswig Drug Company, both national distributors to the pharmacy
market, have been cancelled due to contractual performance issues. The Company
also will be required to enter into additional distribution arrangements in
order to achieve broader distribution of its products, particularly into the
pharmacy market. There can be no assurance that the Company will be able to
enter into and maintain such arrangements on a timely basis, if at all. The
Company is dependent upon such distributors to assist it in promoting market
acceptance of the L-D-X System. It is uncertain whether distributors will devote
the resources necessary to provide effective sales and marketing support to the
Company. In addition, the Company's distributors may give higher priority to the
products of other medical suppliers, thus reducing their efforts to sell the
Company's products. If the Company is unable to establish appropriate
arrangements with distributors, or if any of the Company's distributors do not
promote, market and sell the L-D-X Analyzer and single use test cassettes, the
Company's business, financial condition and results of operations could be
materially adversely affected. See "Business -- Sales and Marketing" and
"-- Strategic Relationships."
UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT. In the United States,
health care providers that purchase products such as the L-D-X System generally
rely on third party Payors, including private health insurance plans, federal
Medicare, state Medicaid and managed care organizations, to reimburse all or
part of the cost of the procedure in which the product is being used. The
Company's ability to commercialize its products successfully in the United
States will depend in part on the extent to which reimbursement for the
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costs of tests performed with the L-D-X System and related treatment will be
available from government health authorities, private health insurers and other
third party Payors. Third party Payors can affect the pricing or the relative
attractiveness of the Company's products by regulating the maximum amount of
reimbursement provided for testing services. Reimbursement is currently not
available for certain uses of the Company's products in particular
circumstances. As a general rule, third party reimbursement is available if a
physician has been involved in the decision to perform the test involving the
Company's products. For example, if a physician prescribes a drug that requires
therapeutic monitoring, the use of the Company's products in performing such
tests will be reimbursable. In the health promotion market, use of the Company's
products for diagnostic screening in health promotion clinics is generally
subject to reimbursement. However, diagnostic screening preformed in corporate
wellness programs and at fitness centers is likely not subject to reimbursement.
Third party Payors are increasingly scrutinizing and challenging the prices
charged for medical products and services. Decreases in reimbursement amounts
for tests performed using the Company's products may decrease the amounts that
physicians and other practitioners are able to charge patients, which in turn
may adversely affect the Company's ability to sell its products on a profitable
basis. In addition, certain health care providers are moving toward a managed
care system in which such providers contract to provide comprehensive health
care for a fixed cost per patient. Managed care providers are attempting to
control the cost of health care by authorizing fewer elective procedures, such
as the screening of blood for chronic diseases. The Company is unable to predict
what changes will be made in the reimbursement methods utilized by third party
Payors. Inability of health care providers to obtain reimbursement from third
party Payors or changes in government and third party Payors' policies toward
reimbursement of tests employing the Company's products could have a material
adverse effect on the Company's business, financial condition and results of
operations. Additionally, the Company believes that the overall escalating cost
of medical products and services has led to and will continue to lead to
increased pressures on the health care industry, both domestic and
international, to reduce the cost of products and services, including products
offered by the Company.
Market acceptance of the Company's products in international markets is
also dependent, in part, upon the availability of reimbursement within
prevailing health care payment systems. Reimbursement and health care payment
systems in international markets vary significantly by country and include both
government sponsored health care and private insurance. There can be no
assurance that third party reimbursement and coverage will be available or
adequate in either United States or international markets, that current
reimbursement amounts will not be decreased in the future or that future
legislation, regulation, or reimbursement policies of third party Payors will
not otherwise adversely affect demand for the Company's products or the
Company's ability to sell its products on a profitable basis, any of which could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Business -- Third Party Reimbursement."
Political, economic and regulatory influences are pushing the health care
industry in the United States to fundamental change. The Company anticipates
that Congress, state legislatures and the private sector will continue to review
and assess alternative health care delivery and payment systems. Potential
approaches that have been considered include mandated basic health care
benefits, controls on health care spending through limitations on the growth of
private health insurance premiums and Medicare and Medicaid spending, the
creation of large insurance purchasing groups, price controls and other
fundamental changes to the health care delivery system. Legislative debate is
expected to continue in the future, and market forces are expected to demand
reduced costs. The Company cannot predict what impact the adoption of any
federal or state health care reform measures, future private sector reform or
market forces may have on its business.
GOVERNMENT REGULATION. The manufacture and sale of diagnostic products,
including the L-D-X System, are subject to extensive regulation by numerous
governmental authorities, principally the FDA and corresponding state and
foreign regulatory agencies. The Company will not be able to commence marketing
or commercial sales in the United States of any of the new tests it is
developing until it receives clearance or approval from the FDA. The process of
obtaining FDA and other required regulatory clearances and approvals is lengthy,
expensive and uncertain. As a result, there can be no assurance that any of the
Company's new tests under development, even if successfully developed, will ever
obtain such clearance or approval. Additionally,
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<PAGE> 35
certain material changes to medical products already cleared or approved by the
FDA are also subject to further FDA review and clearance or approval. The loss
of previously obtained clearances, or failure to comply with existing or future
regulatory requirements, could have a material adverse effect on the Company's
business, financial condition and results of operations. The L-D-X Analyzer and
all existing test cassettes required clearance pursuant to a 510(k) clearance.
Medical devices are subject to continual review, and later discovery of
previously unknown problems with a cleared product may result in restrictions on
the product's marketing or withdrawal of the product from the market. In
general, the Company intends to develop and market tests that will require
510(k) clearance. It generally takes from four to twelve months from the date of
submission to obtain 510(k) clearance, but it may take longer. The Company does
not believe that its products under development will require submission of a
Pre-Market Approval ("PMA") application. However, if a future product were to
require submission of a PMA application, regulatory approval of such product
would involve a much longer and more costly process than a 510(k) clearance and
would involve the submission of extensive supporting data and clinical
information. A PMA application may be submitted to the United States Food and
Drug Administration ("FDA") only after clinical trials and the required patient
follow-up for a particular test are successfully completed. Upon filing of a PMA
application, the FDA commences a review process that generally takes one to
three years from the date on which the PMA application is accepted for filing,
but may take significantly longer. There can be no assurance that the Company's
products under development will require only 510(k) clearance rather than the
more lengthy and costly PMA approval. A requirement that the Company file a PMA
application for any new test would significantly delay the Company's ability to
market such test and significantly increase the costs of development.
The European Union ("EU") has promulgated rules that require that devices
such as those developed, manufactured and sold by the Company receive the right
to affix the CE mark, a symbol of adherence to applicable EU directives. The
Company has completed all the testing necessary to comply with applicable
regulations to currently be eligible for self certification and currently has
the right, as self-certified under the product testing requirements, to affix
the CE mark to its products. The Company's products will be covered by the In
Vitro Diagnostics Directives that have not yet been officially published or
adopted. While the Company intends to satisfy the requisite policies and
procedures that will permit it to continue to affix the CE mark to its products
in the future, there can be no assurance that the Company will be successful in
meeting the EU certification requirements, and failure to receive the right to
affix the CE mark may prohibit the Company from selling its products in EU
member countries and could have a material adverse effect on the Company's
business, financial condition and results of operations.
The use of the Company's products and those of its competitors is also
affected by federal and state regulations, which provide for regulation of
laboratory testing, as well as by the laws and regulations of foreign countries.
The scope of these regulations includes quality control, proficiency testing,
personnel standards and inspections. For example, in the United States, CLIA
categorizes tests as "waived," or as being "moderately complex" or "highly
complex" on the basis of specific criteria. In January 1996, the L-D-X Analyzer
and the Company's total cholesterol, HDL (high density lipoproteins),
Triglycerides and glucose tests in any combination were classified as waived
under CLIA. In order to successfully commercialize the tests that are currently
under development, the Company believes that it will be critical to obtain
waived classification for such tests under CLIA. There can be no assurance that
any new tests developed by the Company, including the BUN/Creatinine test
cassette, will qualify for CLIA waived classification. Any failure of the new
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,
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<PAGE> 36
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 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. The Company may
in the future be required to obtain licenses for new products. For example, the
Company is aware that Roche Holdings Ltd. ("Roche") holds an issued European
patent relating to the measurement of HDL. Some distributors of the L-D-X System
in Europe have received notification from Roche claiming that Cholestech's HDL
product infringes upon Roche's European patent. Roche has requested that these
distributors cease selling the L-D-X System. The Company is investigating
Roche's claims in order to ascertain the significance of the allegations and to
determine an appropriate course of action. There can be no assurance that the
Company will be able to obtain licenses for technology patented by others on
commercially
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<PAGE> 37
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 Roche Boehringer
Mannheim, have developed or are developing analyzers designed for near-patient
testing. These competitors have substantially greater financial, technical,
research and other resources and larger, more established marketing, sales,
distribution and service organizations than the Company. In addition, such
competitors offer broader product lines than the Company, have greater name
recognition than the Company, and offer discounts as a competitive tactic. In
addition, several smaller companies are currently making or developing products
that compete or will compete with those of the Company.
The Company expects that its competitors will compete intensely to maintain
and increase market share and seek to develop similar multi-analyte tests that
qualify for CLIA waiver. There can be no assurance that these competitors will
not succeed in obtaining CLIA waived status for their products or in developing
or marketing technologies or products that are more effective and commercially
attractive than the Company's current or future products, or that would render
the Company's technologies and products obsolete or noncompetitive. The
Company's current and future products must compete effectively with the existing
and future products of the Company's competitors primarily on the basis of ease
of use, breadth of tests available, market presence, cost effectiveness,
precision, accuracy, immediacy of results and the ability to perform tests near
the patient, to test multiple analytes from a single sample and to conduct tests
without a skilled technician or pre-treating blood. There can be no assurance
that the Company will have the financial resources, technical expertise or
marketing, distribution or support capabilities to compete successfully in the
future or, if the Company does have such resources and capabilities, that it
will employ them successfully. See "Business -- Products and Products Under
Development" and "-- Competition."
DEPENDENCE ON ATTRACTION AND RETENTION OF KEY EMPLOYEES. The Company's
success depends in significant part upon the continued service of certain key
scientific, technical, regulatory and managerial personnel, and its continuing
ability to attract and retain additional highly qualified personnel in those
areas. Competition for such personnel is intense, and there can be no assurance
that the Company will be able to retain such personnel or that it can attract or
retain other highly qualified personnel in the future, including key sales and
marketing personnel. The loss of key personnel or the inability to hire or
retain qualified personnel could have a material adverse effect upon the
Company's business, financial condition and results of operations.
RISK OF PRODUCT LIABILITY; PRODUCT LIABILITY INSURANCE MAY BE INSUFFICIENT
OR UNAVAILABLE. Sale of the Company's products entails risk of product liability
claims. The medical testing industry has historically been litigious, and the
Company faces financial exposure to product liability claims in the event that
use of its
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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."
POSSIBLE FUTURE CAPITAL REQUIREMENTS; UNCERTAINTY OF ADDITIONAL
FUNDING. The Company intends to expend substantial funds for capital
expenditures related to expansion of its manufacturing capacity, research and
development, including expansion of its product line and enhancement of its
current products, expansion of sales and marketing activities and other working
capital and general corporate purposes. Although the Company believes that the
Company's cash, cash equivalents, marketable securities, cash flow anticipated
to be generated by future operations, and available bank borrowings under an
existing line of credit will be sufficient to meet its operating 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
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approved by the Board. The Rights have been declared by the Board in order to
deter coercive tactics, including a gradual accumulation of shares in the open
market, of a 15% or greater position to be followed by a merger or a partial or
two-tier tender offer that does not treat all shareholders equally. The Rights
should not interfere with any merger or other business combination approved by
the Board. However, the Rights may have the effect of rendering more difficult
or discouraging an acquisition of the Company deemed undesirable by the Board.
The Rights may cause substantial dilution to a person or group attempting to
acquire the Company on terms or in a manner not approved by the Board, except
pursuant to an offer conditioned upon the negation, purchase or redemption of
the Rights.
POTENTIAL VOLATILITY OF STOCK PRICE. The market price of the Common Stock,
like that of the common stock of many other medical products and technology
companies, has in the past been, and is likely in the future to continue to be,
highly volatile. Factors such as fluctuations in the Company's operating
results, announcements of technological innovations or new commercial products
by the Company or its competitors, government regulation, changes in the current
structure of the health care financing and payment systems and developments in
or disputes regarding patent or other proprietary rights may have a significant
effect on the market price of the Common Stock. Moreover, the stock market has
from time to time experienced extreme price and volume fluctuations, which have
particularly affected the market prices for medical products and high technology
companies and which have often been unrelated to the operating performance of
such companies. These broad market fluctuations, as well as general economic,
political and market conditions, may adversely affect the market price of the
Common Stock. In the past, following periods of volatility in the market price
of a company's stock, securities class action suits have been filed against the
issuing company. There can be no assurance that such litigation will not occur
in the future with respect to the Company. Such litigation could result in
substantial costs and a diversion of management's attention and resources, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. Any adverse determination in such
litigation could also subject the Company to significant liabilities.
ABSENCE OF DIVIDENDS. The Company has never declared or paid any cash
dividends since its inception. The Company currently expects to retain future
earnings, if any, to finance the growth and development of its business and,
therefore, does not anticipate declaring or paying any cash dividends in the
foreseeable future.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company is
exposed to financial market risks due primarily to changes in interest rates.
The Company does not use derivatives to alter interest characteristics of its
investment securities. The Company has no holdings of derivative or commodity
instruments and does not transact business in foreign currencies.
The fair value of the Company's investment portfolio or related income
would not be significantly impacted by changes in interest rates since the
investment maturities are short and the interest rates are primarily fixed.
The Company anticipates interest on cash balances for fiscal 2000 to be
approximately $150,000 at an estimated average interest rate of 3%. It is not
possible to anticipate the level of interest and the rates past fiscal 2000.
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 in Item 14(a) of this
Report.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
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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 1999
Annual Meeting of Shareholders to be held August 19, 1999, 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 information required "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 officers 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
section 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-1
Balance Sheets.............................................. F-2
Statements of Operations.................................... F-3
Statement of Changes in Shareholders' Equity................ F-4
Statements of Cash Flows.................................... F-5
Notes to Financial Statements............................... F-6
</TABLE>
(a)(2) Financial Statement Schedules
II -- Valuation and Qualifying Accounts
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<PAGE> 41
CHOLESTECH CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS TO COSTS BALANCE AT END OF
BEGINNING OF PERIOD AND EXPENSES DEDUCTIONS PERIOD
------------------- ------------------ ---------- -----------------
<S> <C> <C> <C> <C>
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
FISCAL YEAR ENDED MARCH 26, 1999
Allowance for doubtful accounts.... $110,000 -- 35,000 $ 75,000
Amortization of other assets....... 28,000 5,000 -- 33,000
</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 therefor have
been omitted.
(a)(3) Exhibits
<TABLE>
<S> <C>
3.1(2) Restated Articles of Incorporation of Registrant.
3.2(1) 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(1) 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.
10.3.2(19) Standard Industrial Sublease Agreement between Registrant
and Schlumberger Resource Management Services, Inc. dated
August 5, 1998.
10.3.3(19) Consent to Sublease Agreement between Registrant and Spieker
Properties, L.P. dated August 5, 1998.
10.4(1) Forms of Indemnification Agreements between Registrant and
its officers and its directors.
10.5(1) Employment Agreement between Registrant and Edward L.
Erickson dated December 6, 1991.
10.6(1) 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 issues
to MMC/GATX Partnership No. 1.
10.7(1) 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(1) 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 Steven L. Barbato dated April
27, 1992.
10.10(4) Employment Agreement between Registrant and Robert J. Guyon
dated July 13, 1992.
</TABLE>
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<PAGE> 42
<TABLE>
<S> <C>
10.11.1(5) Letter Agreement effective September 28, 1993 by and between
Union Bank and Registrant.
10.11.2(5) Promissory Note effective September 28, 1993 by and between
Union Bank and Registrant.
10.11.3(5) Security Agreement effective September 28, 1993 by and
between Union Bank and Registrant.
10.11.4(7) First Amendment to the Letter Agreement by and between Union
Bank and Registrant.
10.11.5(7) First Amendment to the Promissory Note by and between Union
Bank and Registrant.
10.11.6(10) Second Amendment to the Letter Agreement by and between
Union Bank and Registrant.
10.11.7(10) Second Amendment to the Promissory Note by and between Union
Bank and Registrant.
10.12(4) License Agreement between Registrant and Eastman Kodak
Company dated December 23, 1992.
10.13(6) Employment Agreement between Registrant and Linda H.
Masterson dated May 12, 1994.
10.14(9) Loan Agreement between Registrant and Phoenixcor, Inc. dated
August 31, 1995.
10.15(11)* Development, License and Distribution Agreement between
Registrant and Metra Biosystems, Inc. dated May 3, 1996.
10.16(11) Registration Rights Agreement between Registrant and Metra
Biosystems, Inc. dated May 3, 1996.
10.17.1(13) Letter Agreement effective December 20, 1996 by and between
Wells Fargo Bank and the Registrant.
10.17.2(13) Revolving Line of Credit Note effective December 20, 1996 by
and between Wells Fargo Bank and the Registrant.
10.17.3(13) General Pledge Agreement effective December 20, 1996 by and
between Wells Fargo Bank and the Registrant.
10.17.4(18) Revolving Line of Credit Note effective November 30, 1997 by
and between Wells Fargo Bank and Registrant.
10.17.5(20) Revolving Line of Credit Note effective November 30, 1998 by
and between Wells Fargo Bank and the 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.
10.21.1(19) Distribution Agreement between Registrant and McKesson Drug
Company dated August 18, 1998.
10.21.2(19) Distribution Agreement between Registrant Bergen Brunswig
Drug dated July 20, 1998.
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (see page 43).
27.1 Financial Data Schedule.
</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.
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<PAGE> 43
(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.
(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 effected 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.
(19) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 25, 1998.
(20) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 25, 1998.
(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.
43
<PAGE> 44
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, 1999
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 attorney-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 thereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934, AS
AMENDED, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF
THE REGISTRANT AND IN THE CAPABILITIES AND ON THE DATES INDICATED:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ WARREN E. PINCKERT II President, Chief Executive May 5, 1999
- ----------------------------------------------------- Officer and Director (Principal
(Warren E. Pinckert II) Executive Officer)
/s/ ANDREA J. TILLER Vice President of Finance, Chief May 5, 1999
- ----------------------------------------------------- Financial Officer, Treasurer and
(Andrea J. Tiller) Secretary (Principal Financial
and Accounting Officer)
/s/ HARVEY S. SADOW, PH.D. Director May 5, 1999
- -----------------------------------------------------
(Harvey S. Sadow, Ph.D.)
/s/ JOHN H. LANDON Director May 5, 1999
- -----------------------------------------------------
(John H. Landon)
/s/ JOSEPH BUCHMAN, M.D. Director May 5, 1999
- -----------------------------------------------------
(Joseph Buchman, M.D.)
</TABLE>
44
<PAGE> 45
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ JOHN L. CASTELLO Director May 5, 1999
- -----------------------------------------------------
(John L. Castello)
/s/ LARRY Y. WILSON Director May 5, 1999
- -----------------------------------------------------
(Larry Y. Wilson)
</TABLE>
45
<PAGE> 46
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Cholestech Corporation
In our opinion, financial statements listed in the index appearing under
Item 14(a)(1) on page 30 present fairly, in all material respects, the financial
position of Cholestech Corporation at March 26, 1999 and March 27, 1998, and the
results of its operations and its cash flows for each of the three years in the
period ended March 26, 1999, in conformity with generally accepted accounting
principles. In addition, in our opinion, the financial statement schedule listed
on the index appearing under Item 14(a)(2) on page 30 presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
San Jose, California
April 23, 1999
F-1
<PAGE> 47
CHOLESTECH CORPORATION
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
MARCH 26, MARCH 27,
1999 1998
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 5,529 $ 5,130
Marketable securities..................................... 3,018 9,621
Accounts receivable, net.................................. 2,637 3,793
Inventories............................................... 4,532 3,306
Prepaid expenses and other assets......................... 140 154
-------- --------
Total current assets.............................. 15,856 22,004
Property and equipment, net................................. 5,489 3,711
Long-term investments....................................... 2,880 --
Other assets, net........................................... 58 73
-------- --------
Total assets...................................... $ 24,283 $ 25,788
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................... $ 1,433 $ 3,003
Accrued payroll and benefits.............................. 990 1,136
Product warranty.......................................... 91 203
-------- --------
Total current liabilities......................... 2,514 4,342
Commitments and contingencies (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;
11,518,240 and 11,402,084 shares issued and
outstanding............................................ 70,311 69,880
Accumulated other comprehensive income.................... 14 49
Accumulated deficit....................................... (48,556) (48,483)
-------- --------
Total shareholders' equity........................ 21,769 21,446
-------- --------
$ 24,283 $ 25,788
======== ========
</TABLE>
See accompanying notes to financial statements.
F-2
<PAGE> 48
CHOLESTECH CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------
MARCH 26, MARCH 27, MARCH 28,
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Revenues.................................................... $22,032 $21,664 $12,861
Cost of products sold....................................... 10,252 10,513 6,957
------- ------- -------
Gross profit................................................ 11,780 11,151 5,904
------- ------- -------
Operating expenses:
Sales and marketing....................................... 6,606 5,380 4,108
Research and development.................................. 2,703 2,224 1,341
General and administrative................................ 2,381 2,087 1,537
Other operating expense................................... 826 -- --
------- ------- -------
Total operating expenses............................. 12,516 9,691 6,986
------- ------- -------
Income (loss) from operations............................... (736) 1,460 (1,082)
Interest and other income, net.............................. 663 569 273
------- ------- -------
Income (loss) before taxes.................................. (73) 2,029 (809)
Provision for income taxes.................................. -- 41 --
------- ------- -------
Net income (loss)......................................... $ (73) $ 1,988 $ (809)
======= ======= =======
Net income (loss) per share:
Basic..................................................... $ (0.01) $ 0.18 $ (0.08)
======= ======= =======
Diluted................................................... $ (0.01) $ 0.17 $ (0.08)
======= ======= =======
Shares used to compute net income (loss) per share:
Basic..................................................... 11,484 11,289 10,382
======= ======= =======
Diluted................................................... 11,484 11,905 10,382
======= ======= =======
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 49
CHOLESTECH CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK ACCUMULATED ACCUMULATED
-------------------- COMPREHENSIVE ------------------
SHARES AMOUNT INCOME DEFICIT TOTAL
---------- ------- ------------- -------- -------
<S> <C> <C> <C> <C> <C>
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 (50471) 18,703
Issuance of Common Stock pursuant to
employee stock purchase plan and
exercise of stock options and
warrants............................. 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
Issuance of Common Stock pursuant to
employee stock purchase plan and
exercise of stock options............ 116,156 431 431
Unrealized losses on available-for-sale
securities........................... (35) (35)
Net loss................................ (73) (73)
---------- ------- ---- -------- -------
Balance at March 26, 1999................. 11,518,240 $70,311 $ 14 $(48,556) $21,769
========== ======= ==== ======== =======
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 50
CHOLESTECH CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------
MARCH 26, MARCH 27, MARCH 28,
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)....................................... $ (73) $ 1,988 $ (809)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization........................ 1,112 767 846
Deferred revenue..................................... -- -- (6)
Write-off of property and equipment.................. -- -- 3
Changes in assets and liabilities:
Accounts receivable.................................. 1,156 (1,927) (759)
Inventories.......................................... (1,226) (953) (443)
Prepaid expenses and other assets.................... 14 126 (113)
Other assets......................................... 15 107 (12)
Accounts payable and accrued liabilities............. (1,570) 1,400 (26)
Accrued payroll and benefits......................... (146) 609 274
Product warranty..................................... (112) (11) 27
-------- -------- ---------
Net cash provided by (used in) operating activities..... (830) 2,106 (1,018)
-------- -------- ---------
Cash flows from investing activities:
Purchases of marketable securities...................... (19,225) (33,391) (191,737)
Maturities of marketable securities..................... 22,913 31,740 187,566
Purchase of property and equipment...................... (2,890) (2,079) (1,019)
Net cash provided by (used in) investing activities..... 798 (3,730) (5,190)
-------- -------- ---------
Cash flows from financing activities:
Repayment of long term debt............................. -- -- (1,298)
Proceeds from short term bank borrowing................. -- -- 800
Repayment of short term bank borrowing.................. -- -- (1,050)
Principal payments on capital leases.................... -- (40) (47)
Issuance of common stock................................ 431 706 13,530
Net cash provided by financing activities............... 431 666 11,935
-------- -------- ---------
Net change in cash and cash equivalents................... 399 (958) 5,727
Cash and cash equivalents at beginning of period.......... 5,130 6,088 361
Cash and cash equivalents at end of period................ $ 5,529 $ 5,130 $ 6,088
======== ======== =========
Supplemental disclosures of cash flow information:
Cash paid for interest.................................. $ -- $ 2 $ 244
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-5
<PAGE> 51
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. THE COMPANY AND A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
OPERATIONS
Cholestech Corporation (the "Company") was incorporated February 2, 1988.
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. The L-D-X System is capable of
measuring multiple analytes simultaneously with a single drop of whole blood
within five minutes. The Company operates in one industry segment.
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 1997, 1998 and 1999 each comprised 52 week periods.
REVENUE RECOGNITION
All revenues from product sales are recognized at the time products are
shipped and are denominated in U.S. dollars.
CASH AND 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; other
investments with a maturity of less than one year are classified as short term
marketable securities. The Company has established policies which 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 26,
1999 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
data. Realized gains and losses on sales of all such securities are reported in
earnings and computed using the specific identification cost method. All
investments with maturity dates greater than 365 days are classified as
non-current.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to credit risk
consist of cash equivalents, marketable securities and accounts receivable. Cash
and 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, therefor, 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. Concentration 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 been material. In fiscal
1999 one customer accounted for 15.4% of total revenues. No single customer
accounted for more than 10% of revenues in fiscal 1998 or 1997. In fiscal 1999
three customers accounted for 14.1%, 12.2% and 11.1%
F-6
<PAGE> 52
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
of accounts receivable, respectively, compared to two customers in fiscal 1998,
who accounted for 23.8% and 12.5% of accounts receivable, respectively.
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
which 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.
WARRANTIES
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. The Company is currently
dependent on sole or limited suppliers for certain key components used in its
products which may cause shortages that limit production capacity. There can be
no assurance that such shortages will not adversely affect future operating
results.
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
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
F-7
<PAGE> 53
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
dilutive. The following table reconciles the numerator (net income or loss) and
denominator (number of shares) used in the basic and diluted per share
computations.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 26, 1999
-------------------------------------
NET INCOME
(LOSS) SHARES PER SHARE
----------- -------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Fiscal Year ended March 28, 1997
Basic..................................................... $ 809 10,382 $(0.08)
Effect of dilutive securities............................. -- -- $ 0.00
Diluted................................................... $ 809 10,382 $(0.08)
Fiscal Year ended March 27, 1998
Basic..................................................... $1,988 11,289 $ 0.18
Effect of dilutive securities............................. -- 616 (0.01)
Diluted................................................... $1,988 11,905 $ 0.17
Fiscal Year ended March 26, 1999
Basic..................................................... $ (73) 11,484 $(0.01)
Effect of dilutive securities............................. -- -- $ 0.00
Diluted................................................... $ (73) 11,484 $(0.01)
</TABLE>
Due to the net loss incurred during fiscal 1999, options to purchase 1.9
million shares of common stock were considered anti-dilutive and therefore
excluded from the calculation of dilutive net loss per share. At March 27, 1998,
options to purchase 156,143 shares of Common Stock were considered anti-dilutive
because the respective exercise prices were greater than the average fair market
value of the Common Stock.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash equivalents, marketable securities and capital
lease obligations approximate their fair value due to the short maturity of
these instruments.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Account Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, compensation cost
is measured as the excess, if any, of the quoted market price of the Company's
stock at the date of grant over the price the employee must pay to acquire the
stock. The Company provides additional pro forma disclosures as required under
SFAS No. 123, "Accounting for Stock-Based Compensation" (see note 6).
REPORTING COMPREHENSIVE INCOME
The Company has adopted the Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" (SFAS 130) effective December 31, 1998.
SFAS 130 establishes standards for reporting and display of comprehensive income
and its components for general-purpose financial statements.
F-8
<PAGE> 54
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Comprehensive income is defined as net income plus all revenues, expenses, gains
and losses that are excluded from net income in accordance with generally
accepted accounting principles. For the years ended March 26, 1999, March 27,
1998 and March 28, 1997 there are no material differences between comprehensive
income and net income.
NEW ACCOUNTING PRONOUNCEMENT
During June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" (FAS 131). FAS 131 replaces FAS 14,
"Financial Reporting for Segments of a Business Enterprise" and changes the way
the public companies report segment information. FAS 131 is effective for fiscal
years beginning after December 15, 1997 and has been adopted by the Company for
the year ending March 26, 1999.
2. BALANCE SHEET COMPOSITION
Accounts receivable consist of (in thousands):
<TABLE>
<CAPTION>
MARCH 26, MARCH 27,
1999 1998
--------- ---------
<S> <C> <C>
Accounts receivable......................................... $ 2,712 $ 3,903
Less allowance for doubtful accounts........................ (75) (110)
------- -------
$ 2,637 $ 3,793
======= =======
</TABLE>
Inventories consist of (in thousands)
<TABLE>
<CAPTION>
MARCH 26, MARCH 27,
1999 1998
--------- ---------
<S> <C> <C>
Raw materials............................................... $ 1,598 $ 1,292
Work-in-progress............................................ 1,398 1,038
Finished goods.............................................. 1,536 976
------- -------
$ 4,532 $ 3,306
======= =======
</TABLE>
Property and equipment consist of (in thousands):
<TABLE>
<CAPTION>
MARCH 26, MARCH 27,
1999 1998
--------- ---------
<S> <C> <C>
Machinery and equipment..................................... $ 6,093 $ 5,434
Furniture and fixtures...................................... 565 474
Computer equipment.......................................... 2,106 1,954
Leasehold improvements...................................... 654 632
Construction-in-progress.................................... 2,413 447
------- -------
11,831 8,941
Less accumulated depreciation and amortization.............. (6,342) (5,230)
------- -------
$ 5,489 $ 3,711
======= =======
</TABLE>
F-9
<PAGE> 55
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Property and equipment include assets under capital leases of $26,000 and
accumulated depreciation of $25,000 at March 27, 1998.
Accounts payable and accrued liabilities consist of (in thousands):
<TABLE>
<CAPTION>
MARCH 26, MARCH 27,
1999 1998
--------- ---------
<S> <C> <C>
Trade accounts payable...................................... $ 871 $ 2,605
Accrued royalties........................................... 222 86
Other accrued liabilities................................... 340 312
------- -------
$ 1,433 $ 3,003
======= =======
</TABLE>
3. BORROWING ARRANGEMENTS
The Company has 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, 1999. As of March 26, 1999 and March 27, 1998,
there were no borrowings outstanding under the line of credit.
4. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases office and laboratory facilities under noncancellable
operating leases which expires between March and June of 2000. The leases
contain renewal and option provisions. Rent expense was $409,000, $229,000, and
$195,000 for fiscal 1999, 1998 and 1997, respectively.
Future minimum payment required under the Company's noncancellable
operating leases at March 26, 1999 were $290,800 and $10,950 for fiscal years
2000, and 2001, respectively.
LITIGATION
On February 5, 1999, a complaint entitled Ree v. Pinckert, et al., No.
C99-0562 (MMC) was filed in the United States District Court for the Northern
District of California. The Action is a putative class action and the complaint
alleges that Cholestech and an officer, Mr. Pinckert, violated the federal
securities laws by misleading investors during the time period of July 30,
1997 -- June 26, 1998 concerning the Company's business and its future
prospects. The complaint does not specify alleged damages. The Company intends
to defend the case vigorously. The Company does not believe that the defendants
in the class action engaged in any wrongdoing, and that the outcome of this
matter will not result in a material adverse effect, however, there can be no
assurance that the lawsuit will be resolved in the Company's favor. The action
is in its preliminary stages and a trial date has not been set.
The Company is subject to other claims and legal actions in the ordinary
course of business, none of which are expected to result in a material adverse
outcome.
5. LICENSE AND DEVELOPMENT AGREEMENTS
The Company has obtained rights 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 1999, 1998, and 1997 was $379,000, $562,000, and $551,000
respectively, and was charged to cost of products sold.
F-10
<PAGE> 56
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. SHAREHOLDERS' EQUITY
PREFERRED STOCK
The Company is authorized to issue 5,000,000 shares of Preferred Stock. The
Board of Directors has authority to issue the Preferred Stock in one or more
series and to fix the price, rights preferences, privileges and restrictions
thereof, including the 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 26, 1999, nor was there any activity relating to Preferred Stock during
the three year period ended March 26, 1999.
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 the
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. The 1988 Program expired in
February 1998. There are no shares available for future grant under the 1988
Program.
In August 1997, the shareholders approved the 1997 Stock Incentive Program
(the "1997 Program") which provides ISOs and NSOs for shares of Common Stock may
be granted to employees and consultants of the Company. In accordance with the
1997 Program, the exercise price may not be less than 100% of the fair market
value of Common Stock on the date of the grant for ISOs and NSOs, respectively.
The 1997 Program provides that options shall be exercisable over a period not to
exceed five years and a day. Options vest over four years at a rate of at least
25 percent each year. Vesting of individual option grants may be accelerated
upon the occurrence of certain events as described in the stock option
agreement. Pursuant to the terms of the 1997 Program, 900,000 shares of Common
Stock were reserved for future issuance.
F-11
<PAGE> 57
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Stock option activity under the Program is as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE PRICE
OUTSTANDING OPTIONS PER SHARE
------------------- ----------------
<S> <C> <C>
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
Granted.......................... 982,386 $6.73
Exercised........................ (66,804) $3.39
Canceled......................... (300,151) $6.47
--------- -----
Balance, March 26, 1999............ 1,911,096 $5.99
========= =====
</TABLE>
As of March 27, 1999, options for 195,365 shares of Common Stock were
available for future grant under the 1997 Program.
The following table summarizes information about stock options outstanding
at March 26, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- ---------------------------
RANGE OF WEIGHTED AVG. WEIGHTED AVG. WEIGHTED AVG.
EXERCISE PRICES NUMBER CONTRACTUAL LIFE EXERCISE PRICE NUMBER EXERCISE PRICE
- --------------- --------- ---------------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C>
$1.75 - $ 3.25 257,324 3.4 $ 2.24 102,228 $ 2.42
$3.26 - $ 6.56 1,310,043 2.7 $ 5.10 826,111 $ 4.66
$6.57 - $13.38 343,729 4.1 $12.20 94,126 $12.17
--------- --- ------ --------- ------
1,911,096 3.0 $ 5.99 1,022,465 $ 5.13
========= === ====== ========= ======
</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 terms of the Stock
Purchase Plan, employees can choose to semi-annually to have up to 15% of their
compensation withheld to purchase shares of Common Stock. The purchase price is
equal to 85% of the lower of the closing price of the Common Stock on the NASDAQ
National Market on the day the Stock Purchase Plan period begins or ends. Under
the Stock Purchase Plan, the Company sold 49,352, 29,758, and 21,543 shares of
Common Stock to employees in fiscal 1999, 1998, and 1997 respectively.
F-12
<PAGE> 58
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
PRO FORMA DISCLOSURES
Had compensation cost for the Company's stock option and stock purchase
plans been determined based on the fair market 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 26, MARCH 27, MARCH 28,
1999 1998 1997
---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net income (loss):
As reported....................................... $ (73) $1,988 $ (809)
Pro forma......................................... $ (871) $1,195 $(1,035)
Net income (loss) per share:
As reported -- basic.............................. $(0.01) $ 0.18 $ (0.08)
Pro forma -- basic................................ $(0.08) $ 0.11 $ (0.10)
As reported -- diluted............................ $(0.01) $ 0.17 $ (0.08)
Pro forma -- diluted.............................. $(0.08) $ 0.10 $ (0.10)
</TABLE>
The fair value of each stock option is estimated on the date of the 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 5.3%, 5.9%, and 6.3% for options granted during
fiscal 1999, 1998, and 1997, respectively; volatility factors of 93%, 78%, and
79% for options granted during fiscal 1999, 1998, and 1997, respectively; and a
weighted average expected option term of 4.0 years, 4.0 years, and 2.5 years for
fiscal 1999, 1998, and 1997, respectively. The weighted average fair value of
stock options granted in fiscal 1999, 1998, and 1997 were $4.20, $5.03, and
$2.44 per share, respectively.
The fair value of stock purchase rights is estimated using the
Black-Scholes valuation model with the following assumptions for fiscal 1999,
1998, and 1997, respectively; dividend yield of 0.0% for all periods; an
expected life of 6 months for all periods; expected volatility factors of 93%,
81%, and 74% for fiscal 1999, 1998, and 1997, respectively. The weighted average
fair value of stock purchase rights granted in fiscal 1999, 1998, and 1997 were
$1.12, $1.85, and $1.21 per share, respectively. The weighted average exercise
prices of stock purchase rights granted in fiscal 1999, 1998, and 1997 were
$4.16, $8.20, and $5.54 respectively.
The pro forma effect on net income (loss) and net income (loss) per share
for fiscal 1999, 1998, and 1997 is not representative of the pro forma effect on
net income (loss) in future periods because it does not take into consideration
pro forma compensation expense related to grants made prior to 1996.
SHAREHOLDER RIGHTS PLAN
In January 1997, the Board of Directors approved a shareholder rights plan
under which shareholders of record on March 31, 1997 received a right to
purchase (the "Right") one-thousandth of a share of Series A Participating
Preferred Stock at an exercise price of $44.00, subject to adjustment. The
Rights will separate from the Common Stock and Rights certificates will be
issued and will become exercisable upon the earlier of: (I) 10 days (or such
later date as may be determined by a majority of the Board of Directors)
following a public announcement that a person or group of affiliated or
associated persons has acquired, or obtained the right to acquire, beneficial
ownership of 15% or more of the Company's outstanding Common Stock or (ii) 10
business days following the commencement of, or announcement of an intention to
make, a tender offer or exchange offer, the consummation of which would result
in the beneficial ownership by a person or group of 15% or more of the Company's
outstanding Common Stock. The Rights expire on the earlier of (I) January 22,
2007 or (ii) redemption or exchange of the Rights.
F-13
<PAGE> 59
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. RETIREMENT SAVINGS PLAN
Effective September 1990, the Company adopted the Cholestech Corporation
Retirement Savings Plan (the "401(k) Plan") in which all employees of the
Company are entitled to participate. An eligible employee may elect to defer, in
the form of contributions to the 401(k) Plan, between 1% and 15% of the
employees' W-2 income, not to exceed $10,000 per year (adjusted for
cost-of-living increases). Employee contributions are invested in selected
mutual funds or a money market fund as specified by the employee. Employee
contributions are fully vested and nonforfeitable at all times. The 401(k) Plan
provides for employer contributions as determined by the Board of Directors.
Company contributions to the 401(k) Plan were $67,000, $164,000, and $0, in
fiscal 1999, 1998, and 1997, respectively.
8. INCOME TAXES
A provision for income taxes of $41,000 was recorded for the year ended
March 27, 1998 and no provision was recorded for the years ended March 26, 1999,
and March 28, 1997 as the Company incurred net operating losses for income tax
purposes.
Deferred tax assets (liabilities) consist of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 26, MARCH 27,
1999 1998
--------- ---------
<S> <C> <C>
Net operating loss carryforwards....................... $ 15,847 $ 16,834
Research and development tax credit carryforwards...... 2,413 2,237
Capitalized research and development................... 278 358
Other.................................................. 177 (328)
Valuation allowance for deferred tax assets............ (18,715) (19,101)
-------- --------
$ -- $ --
======== ========
</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 26, 1999.
At March 26, 1999 the Company has net operating loss carryforwards
available to reduce future taxable income through 2011 for federal and state
income tax purposes of approximately $43,284,000 and $12,161,000, respectively.
Additionally, the Company has research and development credit carryforwards
available to reduce income taxes for federal and state income tax purposes of
approximately $1,760,000 and $651,000, 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 approximately $550,000 of federal
and state tax credit carryforwards. Additionally, as a result of the Company's
public offering in December 1992, net operating loss and tax credit
carryforwards incurred prior to December 1992 are subject to an annual
limitation of approximately $5,450,000 for federal and state income tax purposes
on the combined use of approximately $26,208,000 of federal and $4,534,000 of
state net operating loss carryforwards, and the use of $1,151,000 and $379,000
of state tax credit carryforwards. If the amount of these limitations are not
utilized in a particular year, the amount not utilized increases limitation in
the subsequent year.
F-14
<PAGE> 60
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. GEOGRAPHIC INFORMATION
The Company's export sales were $2,148,000, $3,067,000, and $1,251,000 for
fiscal 1999, 1998 and 1997, respectively. Sales to Europe were $2,070,000,
$2,170,000, and $908,000 in fiscal 1999, 1998 and 1997, respectively, with the
remainder of export sales to the Pacific Rim and Latin America.
All of the Company assets are located in the United States.
F-15
<PAGE> 61
CHOLESTECH CORPORATION
EXHIBIT LIST
<TABLE>
<S> <C>
3.1(2) Restated Articles of Incorporation of Registrant.
3.2(1) 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(1) 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.
10.3.2(19) Standard Industrial Sublease Agreement between Registrant
and Schlumberger Resource Management Services, Inc. dated
August 5, 1998.
10.3.3(19) Consent to Sublease Agreement between Registrant and Spieker
Properties, L.P. dated August 5, 1998.
10.4(1) Forms of Indemnification Agreements between Registrant and
its officers and its directors.
10.5(1) Employment Agreement between Registrant and Edward L.
Erickson dated December 6, 1991.
10.6(1) 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 issues
to MMC/GATX Partnership No. 1.
10.7(1) 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(1) 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 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.
</TABLE>
<PAGE> 62
<TABLE>
<S> <C>
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.
10.17.5(20) Revolving Line of Credit Note effective November 30, 1998 by
and between Wells Fargo Bank and the 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.
10.21.1(19) Distribution Agreement between Registrant and McKesson Drug
Company dated August 18, 1998.
10.21.2(19) Distribution Agreement between Registrant Bergen Brunswig
Drug dated July 20, 1998.
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (see page 43).
27.1 Financial Data Schedule.
</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.
<PAGE> 63
(5) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 23, 1993.
(6) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 24, 1994.
(7) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 23, 1994.
(8) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995.
(9) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 29, 1995.
(10) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 29, 1995.
(11) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 333-03364) as declared effective by the
Commission on June 28, 1996.
(12) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form 8-A (No. 000-20198) as declared effective by the
Commission on March 27, 1997.
(13) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 27, 1996.
(14) Incorporated by reference to exhibits filed with Registrant's Annual Report
on Form 10-K for the fiscal year ended March 28, 1997.
(15) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-38147) as declared effected 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.
(19) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 25, 1998.
(20) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 25, 1998.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement
of Cholestech Corporation on Form S-8 (File Nos. 333-38151 and 333-38147) of our
report dated April 23, 1999, on our audits of the consolidated financial
statements and financial statement schedule of Cholestech Corporation as of
March 26, 1999 and March 27, 1998, and for the years ended March 26, 1999, March
27, 1998, and March 28, 1997, which report is included in this Annual Report on
Form 10-K.
PRICEWATERHOUSECOOPERS LLP
San Jose, California
June 17, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-26-1999
<PERIOD-START> MAR-30-1998
<PERIOD-END> MAR-31-1999
<CASH> 5,529,000
<SECURITIES> 5,898,000
<RECEIVABLES> 2,712,000
<ALLOWANCES> 75,000
<INVENTORY> 4,532,000
<CURRENT-ASSETS> 15,856,000
<PP&E> 11,831,000
<DEPRECIATION> 6,342,000
<TOTAL-ASSETS> 24,283,000
<CURRENT-LIABILITIES> 2,514,000
<BONDS> 0
0
0
<COMMON> 70,311,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 24,283,000
<SALES> 22,032,000
<TOTAL-REVENUES> 22,032,000
<CGS> 10,252,000
<TOTAL-COSTS> 21,942,000
<OTHER-EXPENSES> 826,000
<LOSS-PROVISION> 75,000
<INTEREST-EXPENSE> 663,000
<INCOME-PRETAX> (73,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (73,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (73,000)
<EPS-BASIC> (0.01)
<EPS-DILUTED> (0.01)
</TABLE>
