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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from ______ to _____
Commission file number: 000-20198
CHOLESTECH CORPORATION
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-3065493
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
3347 INVESTMENT BOULEVARD, HAYWARD, CA 94545
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (510) 732-7200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for shorter period that the registrant was
required to file such reports); and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
-------- --------
At June 30, 2000, 11,984,801 shares of common stock of the Registrant were
outstanding.
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CHOLESTECH CORPORATION
PART I
FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C>
ITEM 1. FINANCIAL STATEMENTS.
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Income 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS. 10
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 31
SIGNATURES 32
</TABLE>
2
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CHOLESTECH CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
June 30, 2000 March 31, 2000(1)
------------- -----------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 6,229 $ 6,959
Restricted cash 1,000 1,000
Marketable securities 3,833 2,850
Accounts receivable, net 2,600 1,839
Inventories 3,862 3,714
Prepaid expenses and other current assets 1,014 902
-------- --------
Total current assets 18,538 17,264
Property and equipment, net 9,569 8,309
Long-term investments 1,968 3,932
Goodwill 3,017 2,661
Other assets, net 51 52
-------- --------
Total assets $ 33,143 $ 32,218
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 3,851 $ 3,788
Accrued payroll and benefits 1,266 1,563
Product warranty 91 91
Other liabilities 149 300
-------- --------
Total current liabilities 5,357 5,742
-------- --------
Contingencies (Note 7)
Shareholders' equity:
Preferred stock -- --
Common stock 72,305 71,959
Accumulated other comprehensive loss (44) (59)
Accumulated deficit (44,475) (45,424)
-------- --------
Total shareholders' equity 27,786 26,476
-------- --------
Total liabilities and shareholders' equity $ 33,143 $ 32,218
======== ========
</TABLE>
(1) The information in this column was derived from the Company's audited
consolidated financial statements for the fiscal year ended March 31, 2000.
See Notes to Condensed Consolidated Financial Statements
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CHOLESTECH CORPORATION
CONDENSED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Thirteen weeks ended
-------------------------------
June 30, 2000 June 25, 1999
------------- -------------
<S> <C> <C>
Revenues:
Domestic $ 7,485 $ 5,061
International 1,403 714
------- -------
8,888 5,775
Cost of revenues 3,417 2,600
------- -------
Gross profit 5,471 3,175
------- -------
Operating expenses:
Sales and marketing 2,250 1,538
Research and development 896 594
General and administrative 1,373 594
Goodwill amortization and other 150 46
------- -------
Total operating expenses 4,669 2,772
------- -------
Income from operations 802 403
Interest and other income, net 188 149
------- -------
Income before taxes 990 552
Provision for income taxes 41 16
------- -------
Net income $ 949 $ 536
======= =======
Net income per share:
Basic $ 0.08 $ 0.05
======= =======
Diluted $ 0.08 $ 0.05
======= =======
Shares used to compute net income per share:
Basic 11,976 11,518
======= =======
Diluted 12,486 11,546
======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements
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CHOLESTECH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Thirteen Weeks Ended
-----------------------------
June 30,2000 June 25, 1999
------------ -------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 949 $ 536
Adjustments to reconcile net income to net
Cash provided by (used in) operating activities:
Depreciation and amortization 561 364
Allowance for doubtful accounts 14 --
Changes in assets and liabilities:
Accounts receivable (770) 625
Inventories (148) 515
Prepaid expenses and other assets (109) (237)
Accounts payable and accrued expenses (302) (155)
Accrued payroll and benefits (297) (112)
------- -------
Net cash provided by (used in) operating activities (102) 1,536
------- -------
Cash flows from investing activities:
Proceeds from sale of marketable securities 1,704 4,264
Purchases of marketable securities (708) (4,282)
Purchases of property and equipment (1,670) (543)
------- -------
Net cash used in investing activities (674) (561)
------- -------
Cash flows from financing activities:
Issuance of common stock 46 --
------- -------
Net cash provided by financing activities 46 --
------- -------
Net change in cash and cash equivalents (730) (975)
Cash and cash equivalents at beginning of period 6,959 5,529
------- -------
Cash and cash equivalents at end of period $ 6,229 $ 6,504
======= =======
Non-cash financing activities:
Issuance of common stock in exchange for cancellation of
Liability 300
Additional goodwill accrual relating to purchase of
Health Net assets 506
</TABLE>
See Notes to Condensed Consolidated Financial Statements
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CHOLESTECH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. INTERIM RESULTS
The interim unaudited financial information of Cholestech Corporation
(the "Company") is prepared in conformity with generally accepted
accounting principles and such principles are applied on a basis
consistent with the audited financial information contained in the
Annual Report on Form 10-K filed with the Securities and Exchange
Commission on June 28, 2000. The financial information included herein
has been prepared by management, without audit by independent
accountants who do not express an opinion thereon, and should be read in
conjunction with the audited consolidated financial statements contained
in the Annual Report on Form 10-K for the fiscal year ended March 31,
2000. The condensed balance sheet as of March 31, 2000, has been derived
from, but does not include all the disclosures contained in, the audited
consolidated financial statements for the fiscal year ended March 31,
2000. The information furnished includes all adjustments and accruals
consisting only of normal recurring accrual adjustments that are, in the
opinion of management, necessary for a fair presentation of results for
the interim periods. Certain information or footnote disclosure normally
included in financial statements prepared in accordance with generally
accepted accounting principles has been condensed or omitted pursuant to
the rules and regulations of the Securities and Exchange Commission.
The interim results are not necessarily indicative of the results of
operations for the full fiscal year ending March 30, 2001.
2. BALANCE SHEET DATA
The components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30, 2000 MARCH 31, 2000
------------- --------------
<S> <C> <C>
Raw materials $1,278 $1,258
Work-in-process 1,382 1,412
Finished goods 1,201 1,044
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$3,862 $3,714
====== ======
</TABLE>
3. EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing income
available to common shareholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period.
Diluted earnings per share gives effect to all potential common stock
outstanding during a period, if dilutive.
A reconciliation of the basic and diluted earnings per share
calculations follows:
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CHOLESTECH CORPORATION
(In thousands, except per share data)
<TABLE>
<CAPTION>
Thirteen Weeks Ended Thirteen Weeks Ended
June 30, 2000 June 25,1999
----------------------- -----------------------
Net Per Net Per
Income Shares share Income Shares share
------ ------ ----- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $949 11,976 $0.08 $536 11,518 $0.05
Effect of
dilutive
securities -- 510 -- -- 28 --
Diluted EPS $949 12,486 $0.08 $536 11,546 $0.05
</TABLE>
At June 30, 2000, options to purchase 328,533 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. At
June 25, 1999, options to purchase 1,635,747 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
4. NEW ACCOUNTING PRONOUNCEMENTS
During June 1998, the Financial Accounting Standards Board issued SFAS
No. 133 "Accounting for Derivative Instruments and Hedging Activities"
which establishes accounting and reporting standards for derivative
instruments and hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The
Company, to date, has not engaged in derivative and hedging activities,
and accordingly, does not believe that the adoption of SFAS No. 133 will
have a material impact on the financial reporting and related
disclosures of the Company. The Company will adopt SFAS No. 133 as
required by SFAS 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of the FASB statement No.
133," beginning with the first quarter of fiscal 2002.
In March 2000, the FASB issued FIN 44, "Accounting for Certain
Transactions Involving Stock Compensation - An Interpretation of APB No.
25" which is effective July 1, 2000. The Company does not expect FIN 44
to have any material impact on its consolidated financial statements.
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CHOLESTECH CORPORATION
5. LITIGATION AND OTHER EVENTS
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. On June 24, 1999, plaintiffs filed an
amended complaint, which expanded the putative class period to June 28,
1996, through June 26, 1998. The amended complaint's substantive
allegations and purported causes of action remain based on allegations
that the Company misled shareholders concerning the Company's business
and its future prospects. The complaint does not specify alleged
damages. On September 20, 1999, defendants filed a motion to dismiss
plaintiff's amended complaint. On March 28, 2000, the court granted
defendant's motion to dismiss pursuant to rule 12(B)(6) with leave for
plaintiffs to amend. The plaintiffs have filed a second amended
complaint. 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.
On December 23, 1999, a complaint requesting an injunction, No. ES
580-199, was filed in Zug, Switzerland by Roche Diagnostics seeking a
cease and desist order barring the Company, and two distributors,
Healthcare Solutions and Euromedix, from distributing HDL assay
single-use test cassettes in Switzerland. The complaint alleges that
Cholestech violated a Roche European patent for HDL. The Company has
filed its response to the complaint. On July 11, 2000 the court denied
the plaintiff's request for an injunction. The plaintiff has appealed
the court ruling. At this point in time no schedule has been set
regarding additional court activity. There can be no assurance as to
whether the plaintiffs will take any additional action, or whether any
additional action will be resolved in the Company's favor.
Additionally, in January, 2000, a complaint, No. 4 O 4/00, was filed in
the District Court, Dusseldorf, Germany against Cholestech and two of
its distributors, seeking a cease and desist order barring the
distributor from shipping HDL single-use test cassettes into Germany.
The complaint alleges the Company and its distributors violated a Roche
German priority patent for HDL by selling Cholestech's single-use test
cassette containing a HDL assay. The Company believes the suit is
without merit and intends to defend the case vigorously. Therefore, the
Company does not believe that the outcome of this matter will result in
a material adverse effect, however, there can be no assurance that the
lawsuit will be resolved in the Company's favor.
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CHOLESTECH CORPORATION
The Company is subject to various legal claims and assessments in the
ordinary course of business, none of which are expected by management to
result in a material adverse effect on the consolidated financial
statements.
6. SEGMENT INFORMATION
In fiscal 2000, the Company adopted Statement of Financial Accounting
Standards ("SFAS") 131, "Disclosures about Segments of an Enterprise and
Related Information." During fiscal 2000, the Company launched two new
business units, WellCheck(TM) and WellCheck.com. As a result, the
Company now has three reportable segments: Diagnostic Products,
WellCheck and WellCheck.com. These segments are strategic business units
that offer different products and as a result are managed separately.
Prior to the third quarter of fiscal 2000 the Company operated in one
segment, the Diagnostic Products business unit. Asset information by
segment has not been presented as the Company does not produce such
information. Results for the thirteen weeks ended June 30, 2000 by
segment are as follows (in thousands):
<TABLE>
<CAPTION>
Diagnostic WellCheck
Products WellCheck .com Total
---------- --------- --------- ------
<S> <C> <C> <C> <C>
Net revenues $7,980 $ 908 $ -- $8,888
Cost of revenues 3,334 83 -- 3,417
------ ----- ----- ------
Gross profit 4,646 825 -- 5,471
------ ----- ----- ------
Operating expenses:
Sales and marketing 1,774 447 29 2,250
Research and development 505 -- 392 896
General and administrative 675 277 420 1,373
Goodwill amortization and
other -- 150 -- 150
------ ----- ----- ------
Total operating expenses 2,954 874 841 4,669
------ ----- ----- ------
Income (loss) from operations $1,692 $ (49) $(841) $ 802
====== ===== ===== ======
</TABLE>
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CHOLESTECH CORPORATION
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated in these forward looking statements as a
result of certain factors discussed below, including under "General" and
"Potential Factors Affecting Future Operating Results." These forward-looking
statements include, but are not limited to, the statement under "General"
regarding the Company's expectation of incurring negative cash flows, the
statement under "Revenues" regarding the Company's expectation that
international revenues will 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, the statements under
"Liquidity and Capital Resources" regarding anticipated capital spending, and
internal funding for capital spending, and the statements in "Factors Affecting
Future Operating Results.".
GENERAL
The Company operates in three business segments:
- Diagnostic Products -- which 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.
- WellCheck(TM) -- which conducts consumer testing within the United
States to assess for risk of certain chronic diseases and to assist
in the monitoring of therapy to treat those diseases.
- WellCheck.com -- which provides interactive tools to consumers
through the Internet to better assess for risk of certain chronic
diseases and to monitor and motivate personal health management of
those diseases.
Diagnostic Products 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 market, the pharmacy market and the health promotion market in
the United States and internationally. 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's current products measure and
monitor blood cholesterol, related lipids, glucose, and liver function, and are
used to perform testing of patients at risk of or suffering from cardiovascular
disease, diabetes or liver disease.
WellCheck currently provides consumer-testing services utilizing the
Cholestech L-D-X System, as well as various other technologies for the
assessment of cholesterol, blood pressure, osteoporosis, glycated hemoglobin and
general health assessment. WellCheck was initiated through the acquisition of
Health Net, Inc. in January of 2000, for approximately $3.3 million,
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CHOLESTECH CORPORATION
including closing costs. The Company intends to expand the WellCheck testing
services offered through a combination of further acquisitions and internal
development with the goal of creating the first truly nationwide consumer
testing service for chronic disease. Substantially all of the revenue of the
WellCheck business is currently derived from promotional programs with major
pharmaceutical companies marketing lipid-lowering statin drugs. The Company
believes that there is an opportunity to further expand the WellCheck business
into retail testing venues and worksite wellness programs.
WellCheck.com consists of the website content and structure, Test Event
Activity Management System ("TEAMS") software, and business unit infrastructure,
and was launched in June, 2000. In collaboration with their healthcare
providers, consumers will have at their disposal tools needed to learn about and
manage certain chronic diseases.
The Company may incur negative cash flows from operations in the
Diagnostic Products business unit as it expands manufacturing capacity for
existing and new test cassettes, increases product research and development
efforts for new test cassettes, expands sales and marketing activities, and
pursues regulatory clearances and approvals. The development and
commercialization of new tests will require additional development, sales and
marketing, manufacturing and other expenditures. The required level and timing
of such expenditures will have an impact on the Company's ability to maintain
profitability and positive cash flows from operations.
The development, launch, and maintenance of WellCheck.com, as well as
the acquisition and other startup costs relating to WellCheck, may also result
in negative cash flows for the Company. The development and commercialization of
new software and testing programs will require sales, marketing, development,
and other expenditures. The amount of expenditures and timing will have an
impact on the Company's ability to maintain profitability and positive cash
flows from the new business units.
The Company expects its revenue mix of the three segments to change from
time to time, and these changes will affect the Company's overall revenues and
operating results.
Within the Diagnostic Products business, the Company generally has found
that customers in the POL market use a higher proportion of lipid profile
cassettes for therapeutic monitoring purposes. These 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 this market than in the health promotion market, which
focuses mainly on risk assessment and experiences a higher rate of testing with
a lower proportion of lipid profile cassettes.
WellCheck's revenue will change as sponsorship progress. As companies
other than pharmaceutical become sponsors, and programs mature, the number of
test sites, and the number of tests will vary. Additionally revenues will be
influenced by seasonality. During the last two months of the calendar year,
people are pursuing other interests, and are less focused on chronic health
issues. Additionally, during the summer months consumers' attention is also less
focused on chronic health issues.
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CHOLESTECH CORPORATION
WellCheck.com's revenues are based on the Internet, which is new to the
Company, and remains uncertain. Revenue will be generated by advertising and
sponsorship on the web site. Revenue will depend on the number of persons
visiting the site and the perceived value to sponsors and advertisers. As of
June 30, 2000, the Company has not signed a revenue generating agreement with a
sponsor or advertiser.
The Company is currently in feasibility studies for additional tests for
diagnostic screening and high cholesterol. These new tests are in various stages
of feasibility, 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 received
510(k) clearance to market the Alanine Aminotransferase (ALT) test for liver
function in September, 1999. Subsequently the Company submitted the ALT test to
the Center for Disease Controls and Prevention ("CDC") seeking Clinical
Laboratory Improvement Amendments of 1988, as amended, ("CLIA") waived status in
September, 1999. In January, 2000, responsibility for CLIA waiver was
transferred to the Food and Drug Administration ("FDA"). The Company cannot
estimate when the FDA will determine whether to grant CLIA waived status for
this test or whether such waived status will be granted.
RESULT OF OPERATIONS
THIRTEEN WEEKS ENDED JUNE 30, 2000, AND JUNE 25, 1999
Revenues. During the thirteen weeks ended June 30, 2000, revenues
increased 54% to $8.9 million from $5.8 million in the thirteen weeks ended June
25, 1999. Diagnostic Products represented 90% and 100% of our revenues for the
first quarter of fiscal 2001 and 2000, respectively. During the thirteen weeks
ended June 25, 1999 only the Diagnostic Products business unit was in operation.
International revenues increased by 97% or $689,000 from $714,000 to
$1,403,000 for the thirteen weeks ended June 30, 2000, compared to the same
period in fiscal 2000. The Diagnostic Products business generated all
international revenue.
Segment performance was as follows:
- Diagnostic Products revenue increased $2.2 million from $5.8 million
in the thirteen weeks ending June 25, 1999 to $8.0 million in the
thirteen weeks ending June 30, 2000. Virtually all of the increase
relates to higher unit sales of single use test cassettes in all
markets other than pharmacy. Additionally, unit sales of L-D-X
Analyzers were higher in all markets.
- WellCheck revenue totaled $908,000 in the first thirteen weeks of
fiscal 2001. This business unit was not operating during the
thirteen weeks ending June 25, 1999.
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CHOLESTECH CORPORATION
- WellCheck.com did not generate any revenue during the thirteen weeks
ending June 30, 2000, and was not operating during the thirteen
weeks ending June 25, 1999.
Cost of Revenues. Cost of revenues increased 31% to $3.4 million for the
thirteen weeks ended June 30, 2000, from $2.6 million for the thirteen weeks
ending June 25, 1999. Gross margins were 61.6% and 55.0% for the thirteen weeks
ended June 30, 2000, and June 25, 1999, respectively. Diagnostic Products
accounted for 98% and WellCheck accounted for 2% of the cost of revenues for the
thirteen weeks ending June 30, 2000. For the thirteen weeks ending June 25, 1999
Diagnostic Products accounted for 100% of the cost of revenues.
Segment performance was as follows:
- Diagnostic Products cost of revenues includes direct labor, direct
material, overhead and royalties. Cost of revenues increased 28%, on
a 38% increase in sales, to $3.3 million in the thirteen weeks ended
June 30, 2000, from $2.6 million in the thirteen weeks ended June
25, 1999. Gross margin was 58.2% and 55.0% of total revenues in the
thirteen weeks ended June 30, 2000, and June 25, 1999, respectively.
The improvement in gross margin was primarily attributable to lower
unit cost of single-use test cassettes, for which production
increased 46%, with only a 34% increase in factory spending compared
to the quarter ended June 25, 1999.
- WellCheck cost of revenues includes travel expenses, laboratory
services, medical waste disposal, and the cost of medical testing
equipment and supplies. Costs of product provided by the Company's
Diagnostic Products business are eliminated upon consolidation. For
the thirteen weeks ending June 30, 2000, total cost of revenues was
$83,000.
- WellCheck.com does not generate cost of revenues. When the Web Site
is in full operations the cost of operations will be included in a
unique caption.
Sales and Marketing Expense. Sales and marketing expense includes
salaries, commissions, bonuses, expenses for outside services related to
marketing programs, and travel. Diagnostic Products accounted for 79%, WellCheck
accounted for 20%, and Wellcheck.com accounted for 1% of sales and marketing
expense for the thirteen weeks ending June 30, 2000. Sales and marketing expense
increased 46%, or $0.8 million to $2.3 million in the thirteen weeks ended June
30, 2000, from $1.5 million in the thirteen weeks ended June 25, 1999. Sales and
marketing expense decreased to 25.3% of revenues in the first quarter of fiscal
2001 from 26.6% in the first quarter of fiscal 2000.
Sales and marketing expense in each of Cholestech's segments was as
follows:
- Diagnostic Products sales and marketing expenses increased 15% to
$1.8 million in the thirteen weeks ending June 30, 2000, from $1.5
million for the thirteen weeks ending June 25, 1999. The increase
can be attributed to increased spending on distributor relations and
advertising space. Sales and marketing expense decreased to 22.2% of
sales
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CHOLESTECH CORPORATION
for the thirteen weeks ending June 30, 2000, from 26.6% for the
corresponding period for fiscal 2000.
- WellCheck sales and marketing expense was $447,000 for the thirteen
weeks ending June 30, 2000. WellCheck did not operate during the
thirteen weeks ending June 25, 1999. WellCheck sales and marketing
expense was 49.2% of WellCheck revenues for the first quarter of
fiscal 2001.
- WellCheck.com sales and marketing expense was $29,000 for the
thirteen weeks ending June 30, 2000. WellCheck.com did not operate
during the thirteen weeks ending June 25, 1999.
Research and Development Expenses. Research and development expense
includes salaries, bonuses, expenses for outside services, supplies, certain
costs associated with web hosting, and content, and depreciation of capital
equipment. Research and development expense increased 51% to $896,000 in the
thirteen weeks ended June 30, 2000, from $594,000 in the thirteen weeks ended
June 25, 1999. Research and development expenses as a percentage of revenues
decreased to 10.1% for the thirteen weeks ended June 30, 2000, from 10.3% for
the thirteen weeks ended June 25, 1999. The Diagnostic Products business unit
represented 56% and 100% of the Company's research and development expenses for
the thirteen weeks ended June 30, 2000, and June 25, 1999, respectively. The
WellCheck.com business unit represented approximately 44% and 0% of the
Company's research and development expenses for the first quarter of fiscal 2001
and 2000, respectively.
Research and development expense in each of Cholestech's segments was as
follows:
- Diagnostic Products research and development expenses decreased 18%
to $505,000 in the thirteen weeks ended June 30, 2000 from $594,000
in the thirteen weeks ended June 25, 1999. The decline relates
primarily to decreased development activity while the ALT single
test cassettes await for a FDA CLIA waiver response. Research and
development expense as a percentage of revenues decreased to 6.3% of
revenue for the thirteen weeks ended June 30, 2000, compared to
10.3% in the thirteen weeks ended June 25, 1999.
- WellCheck incurred no research and development expense costs in the
thirteen weeks ended June 30, 2000.
- WellCheck.com research and development expense was $391,000 in the
thirteen weeks ended June 30, 2000. This represents certain period
costs of web site development, exclusive of $875,000 of costs
capitalized during the quarter under AICPA Statement of Position
98-1, "Accounting for the Cost of Computer Software Developed or
Obtained for Internal Use".
General and Administrative Expense. General and administrative expense
includes compensation, and benefits, and expenses for outside professional
services including information services, legal, and accounting. General and
administrative expense increased 131% to $1.4 million in the thirteen weeks
ended June 30, 2000, from $594,000 in the thirteen weeks ended June 25, 1999.
General and administrative expenses increased to 15.4% of revenues in the
thirteen weeks ended June 30, 2000, from 10.3% in the thirteen weeks ended June
25, 1999. The Diagnostic Products business unit represented 49% and 100% of the
Company's general and administrative expenses for the thirteen weeks ended June
30, 2000, and June 25, 1999,
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CHOLESTECH CORPORATION
respectively. WellCheck represented 20% and WellCheck.com represented
approximately 31% of the general and administrative expenses for the first
quarter of fiscal 2001.
General and administrative expense in each of Cholestech's segments was
as follows:
- Diagnostic Products general and administrative expenses increased by
14% to $675,000 for the thirteen weeks ended June 30, 2000 from
$593,000 in the thirteen weeks ending June 25, 1999. The increase
was mainly attributable to the addition of the Chief Operating
Officer and related expense. This was partially offset by the
allocation of shared expenses to the newly created WellCheck and
WellCheck.com business units.
- WellCheck general and administrative expense was $277,000 for the
thirteen weeks ending June 30,2000, with no related expenses for the
first quarter of fiscal 2000.
- WellCheck.com general and administrative expenses were $421,000
during the first quarter of fiscal 2001, with no related expenses
for the first quarter of fiscal 2000.
Goodwill amortization and other. The expense for the thirteen weeks
ending June 30, 2000 of $150,000 compared to $46,000 for the first thirteen
weeks of fiscal 2000. The fiscal 2001 expenses relate exclusively to
amortization of the goodwill incurred upon the acquisition of Health Net, Inc.
Interest and other income, net. Interest and other income, net, reflects
income from the investment of cash balances and marketable securities. Interest
income increased 26% to $188,000 in the thirteen weeks ended June 30, 2000 from
$149,000 in the thirteen weeks ended June 25, 1999.
Income Taxes. As the Company has significant tax credit carry forwards,
the provision for income taxes for the thirteen weeks ended June 30, 2000,
primarily represents the estimated alternative minimum tax. Management expects
to utilize additional net operating loss and other tax carry forward amounts to
the extent income is earned during fiscal 2001. Accordingly, the Company's
estimated effective tax rate is expected to remain below the federal statutory
rate throughout fiscal 2001.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through the sale of
equity securities and from positive cash flows from operations. From inception
to June 30, 2000, the Company raised $72.3 million in net proceeds from equity
financing. As of June 30, 2000, the Company had $13.0 million of cash, cash
equivalents and marketable securities. In addition to these amounts, the Company
has available an $8.0 million revolving bank line of credit. While the line of
credit 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 May 1, 2002. As of June 30, 2000, there were no borrowings
outstanding under the line of credit.
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During the first thirteen weeks of fiscal 2001, the Company used
$102,000 of cash in operating activities compared to net cash provided of $1.5
million in the first thirteen weeks of fiscal 2000. The net cash used in
operations in the first thirteen weeks of fiscal 2001 was comprised of net
income of $949,000, adjustments for non-cash items including $561,000 for
depreciation and amortization. This was more than offset by a combined $1.0
million increase in accounts receivable, inventory, and prepaid expenses and a
combined $599,000 decrease in accrued payables and payroll liabilities. In the
corresponding thirteen weeks of fiscal 2000, net cash was provided by a net
income of $536,000 plus adjustments for non-cash items including $364,000 of
depreciation. Additionally, accounts receivable decreased by $625,000.
Net cash used in investing activities was $674,000 in the first thirteen
weeks of fiscal 2001, consisting primarily of purchases of equipment, and
capitalized web site development costs totaling $1.7 million. This was offset by
the net sale of marketable securities. For the first thirteen weeks of fiscal
2000, the Company purchased $543,000 of equipment.
Proceeds from the Company's associate stock option program exercises
provided $46,000 in the first thirteen weeks of fiscal 2001. For the
corresponding thirteen weeks of fiscal 2000, there was no exercises of Common
Stock pursuant to the Company's associate's stock incentive program.
Over the balance of fiscal 2001, the Company intends to expend
approximately $4.3 million for capital purchases related to web site
development, the acquisition of additional testing services companies, expansion
of its WellCheck testing service, expansion of its manufacturing capacity, and
research and development. As of June 30, 2000, however, contracts have not been
signed and schedules have not been set. Accordingly, non-cancelable purchase
commitments at June 30, 2000 were not material.
The Company believes that cash, cash equivalents, marketable securities,
cash flows anticipated to be generated by future operations, and available bank
borrowing under an existing line of credit will be sufficient to meet its
operating requirements for the immediate future. Despite this belief, however,
the Company may require additional financing. The Company may be required to
expend greater than anticipated funds if unforeseen difficulties arise relating
to startup costs for WellCheck and WellCheck.com, web site development,
facilities modification or expansion, obtaining necessary product regulatory
approvals, or scaling up manufacturing for new tests.
The Company's future liquidity and capital requirements will depend upon
numerous additional factors, including: the cost and timing of expansion of
manufacturing capacity, the number and type of new tests the Company seeks to
develop; the successes 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 cost 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.
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In the event that additional financing is needed, the Company may seek
to raise additional funds through debt, public or private financing,
collaborative relationships or arrangements. However, the Company may not be
successful in obtaining necessary funds. Even if the Company does raise funds,
any additional equity financing may be dilutive to shareholders, and debt
financing may involve restrictive covenants that limit the manner in which the
Company may be operated. Collaborative arrangements, if necessary to raise
additional funds, may require the Company to relinquish its rights to certain of
its technologies, products or marketing territories. The failure of the Company
to raise capital on acceptable terms when needed could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "--Potential Factors Affecting Future Operating Results--Possible Future
Capital Requirements; Uncertainty of Additional Funding."
POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS
Cholestech has no prior experience in the testing services or Internet
health management businesses, and if these new businesses are not successful,
Cholestech will be greatly harmed. The testing services business and Internet
health management business to be pursued by Cholestech's WellCheck
and WellCheck.com business units are completely new to Cholestech and our
management team. This will make it more difficult for us to successfully develop
these new businesses. Also, we will be devoting significant resources to
developing these new businesses. If we are not successful in developing these
new businesses, our Diagnostics business will be greatly harmed. Even if we are
successful at developing the new businesses, the demands of attempting to grow
these new businesses may prevent us from devoting significant time and attention
to our traditional business, and that traditional business may decline.
Internet health management is a new and unproven business, which means
that there is more risk that this business will not succeed, resulting in
financial harm to Cholestech. The internet-based personal health management
business is a very new and as yet unproven business. If it does not succeed, our
significant investment in this business will result in significant financial
harm to Cholestech. Cholestech's success in this business will depend upon
individual acceptance of internet-based management of personal health
information. Consumers may not feel comfortable having their health-related
information available over the Internet despite the privacy and security
measures we plan to take. Or there may be other reasons that we have not thought
of that could result in Internet health management not being a viable business.
Thus, consumers may not use our health management system on the Internet, and
our significant investment in this new business would not be recovered. This
would result in a significant financial loss to Cholestech.
We have no significant experience in managing geographically diverse
operations. If we are not successful in this area, our geographically dispersed
testing business may not perform well, which would result in financial harm to
Cholestech. Our traditional business has been managed and operated almost
exclusively from our Hayward, California headquarters. The new WellCheck
business will require us to operate in multiple geographic locations. This will
require us to manage multiple, geographically dispersed businesses and adapt our
management and financial systems and controls to this new geographically
dispersed business. We may not be
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CHOLESTECH CORPORATION
able to manage these changes rapidly, successfully, or at all. If we cannot
successfully manage our geographic expansion, the testing business will be much
less likely to succeed. This would mean we are less likely to recover our large
investment in the testing business. This, in turn, would likely result in
significant financial harm to Cholestech.
Our new testing and Internet health management businesses will require
significant financial resources to develop. These expenditures will hurt our
overall short term financial performance and, if these new businesses are not
successful, this large financial investment will not be returned. This will
result in significant financial damage to Cholestech. The development of the two
new business units, and the WellCheck.com Internet business in particular, will
require significant start-up expenditures. These expenditures are likely to
materially affect the operating results of Cholestech as a whole. The Company
may need to seek additional capital to help fund these start-up expenses. The
required additional capital may not be available to us at favorable or
acceptable terms when required, or at all. If we cannot obtain required
additional capital, we may have to change our business strategy, which would be
disruptive to our business. If we raise additional capital through borrowings,
the terms of such borrowings may impose limitations on how our management may
operate the business in the future. If we raise additional capital by issuing
equity, this may result in a dilution of existing shareholders' interests in
Cholestech. Also, equity issued by us may have rights, preferences, or
privileges senior to those of our existing shareholders. We plan to use
acquisitions as a significant part of the development of our new testing
business. These acquisitions could be very costly, could result in dilution to
existing investors and could result in integration problems that harm the
business as a whole. The WellCheck business will be developed in significant
part by our acquiring existing testing service businesses. We may acquire
services and/or technology to assist in developing our WellCheck.com business as
well. Any acquisition could result in significant amounts of cash, potentially
dilutive issuances of equity securities, and/or the incurring of debt or
amortization expenses related to goodwill and other intangible assets. Any of
these acquisition financing approaches could materially harm our operating
results and business. Acquisitions may also result in difficulties in
assimilating the operations, technologies, products, services, and personnel of
the acquired company or business. These difficulties could result in additional
expenses. These difficulties could also result in diversion of management
attention, which could prevent the new businesses from being successful. Any of
these results could harm Cholestech financially.
Our new Internet health management business has information security
risks that could result in the business not succeeding or in financial liability
for Cholestech. Our planned WellCheck.com business will involve the provision
and management of individual health-related information over the Internet.
Despite security measures we plan to take, such information may be accessed or
manipulated by third parties without our consent or the consent of the user of
our service. Any such security breach could greatly erode consumer confidence in
our WellCheck.com business. This would likely severely harm that business and
its prospects. Additionally, if an individual's health information is corrupted
by software or technical problems, consumer confidence in the WellCheck.com
business could be severely damaged. If consumer information is altered by third
parties or by technical problems, the affected individual may bring litigation
against Cholestech and/or the Company's web site hosting partners. Any such
litigation could result in significant expense, including any damage awards.
Even if
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ultimately decided in our favor, such litigation could result in significant
expense and distraction of our management.
Our L-D-X System has not yet achieved broad market acceptance in all of
our target markets and in physician office laboratories and pharmacies, market
acceptance has proceeded slower than anticipated. If broad market acceptance
does not occur, Cholestech will not grow and will suffer significant financial
damage. The Cholestech L-D-X System, including the L-D-X Analyzer (our only
product platform) and single use test cassettes, will continue to account for
substantially all of the Company's Diagnostic Products revenues for the
foreseeable future. If this revenue does not grow, the overall business will be
severely harmed. In order for the Company to increase revenues, sustain
profitability and maintain positive cash flows from operations, the L-D-X System
must gain much broader market acceptance among health care providers,
particularly physician office laboratories and pharmacies. Cholestech has made
only limited sales to physician office laboratories and pharmacists to date.
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. If
we do not achieve broad market acceptance, Cholestech's Diagnostic Products
business will not grow. This will result in significant financial damage to the
business as a whole. We are relying in significant part on income from the core
Diagnostic Product business to finance the Company's strategic expansion. If the
Diagnostic Products business does not grow, the new businesses will not succeed.
These results will cause severe financial harm to Cholestech. Factors that could
prevent broad market acceptance of the L-D-X System include:
- Awareness of the availability of the Company's technology remains at
predominantly low levels in both the physician and pharmacy customer
groups.
- The L-D-X System must be an attractive alternative to other means of
testing. This determination will depend on the L-D-X System's
accuracy, ease of use, rapid test time, reliability and cost
effectiveness compared to other testing alternatives.
- 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.
- The growing prevalence of managed care may adversely affect the
physician office laboratory 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.
- Physicians are under growing pressure by Medicare and other third
party Payors to limit their testing to "medically necessary" tests.
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- Market acceptance of the L-D-X System will in part depend on the
continued availability and amount of reimbursement for performing
tests on the L-D-X System.
- Even if the Company is successful in continuing to place L-D-X
Analyzers at POLs, pharmacies and other near-patient testing sites,
there can be no assurance that placement of L-D-X Analyzers will
result in sustained demand for the Company's single use test
cassettes.
As a result of these many hurdles to achieving broad market acceptance
for the L-D-X System, demand for the L-D-X System may not be sufficient to
sustain revenues and profits from operations. Because the L-D-X System currently
contributes the vast majority of our revenues, Cholestech could be required to
cease operations if the L-D-X System does not achieve and maintain a significant
level of market acceptance.
Our business has experienced a history of operating losses and
fluctuating operating results. Results are likely to continue to fluctuate and
we may (especially in light of investment in our new businesses) experience
losses in the future. Historically, Cholestech has experienced significant
operating losses and negative cash flows from operations. As of June 20, 2000,
we had an accumulated deficit of $44.5 million. Cholestech's first profitable
quarter was the first quarter of fiscal 1998, and our first profitable year was
fiscal 1998. However, we recorded a net loss of $73,000 for fiscal 1999, before
returning to profitability in fiscal 2000. Cholestech's profitability and
positive cash flows from operations in the future will require:
- Broadening market acceptance of our existing diagnostic product
offerings.
- Completing the development, successful introduction and marketing of
additional cassette based tests or other products for the Diagnostic
Products business unit.
- Successfully developing our new testing services and Internet health
management businesses.
Cholestech 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 amount of expenditures required for the continued
development of our new testing services and Internet health
management businesses.
- 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 research and
development activities.
- The timing and level of expenditures associated with expansion of
sales and marketing activities and overall operations.
- Our ability to reduce the cost of cassette manufacturing.
- Variations in manufacturing efficiencies.
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- The timing and establishment of strategic distribution arrangements
and the success of the activities conducted under such arrangements.
- Changes in demand for the Company's 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.
- General economic conditions.
These and other factors are difficult to predict, and could have a
material adverse effect on Cholestech's business, financial condition and
results of operations. Fluctuations in quarterly demand for our products may
cause our manufacturing operations to fluctuate in volume, increase uncertainty
in operational planning and/or affect cash flows from operations. Many of our
expenses are made in advance, based upon our expectations of future business
needs. These costs are largely fixed in the short term. As a result, when
business levels do not meet expectations, our fixed costs will not be recovered
and we will experience losses. This situation is likely to result in the future
because of the variability and unpredictability of our revenues. This also means
that Cholestech's results will likely not meet the expectations of public market
security analysts or investors at one time or another. This could cause the
trading price of Cholestech's common stock to decline significantly.
In order to grow the Diagnostic Products business significantly,
Cholestech must successfully develop, introduce and market new tests. These
activities are very costly, and if not successful could result in significant
financial harm to Cholestech's business. The vast majority of Cholestech's
revenues come from its Diagnostics Products business. We anticipate this will
continue for the near term. Cholestech is also relying on revenue from the
Diagnostics Products business to fund the development of its new testing
services and Internet health management businesses. Cholestech also believes
that its Diagnostic Products business will not grow significantly if it does not
develop new tests to use with the L-D-X System. If new tests are not developed
and accepted in the market, Cholestech's business will not grow significantly
and the business will be harmed. Developing new tests involves many significant
problems and risks, including:
- Research and development is a very expensive process.
- Research and development takes a very long time to result in a
marketable product.
- Significant costs (including diversion of resources) may be incurred
in development prior to knowing if the development will result in a
test that is commercially viable.
- A new test will not be successful unless it is effectively marketed
to its target market.
- A new test must be able to be manufactured in a reliable,
cost-efficient, high-volume manufacturing process for such tests and
the manufacturing process must be developed and implemented in a
timely manner in order to produce the test for sale.
- New tests must meet a significant market need in order to be
successful.
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CHOLESTECH CORPORATION
- New tests must obtain proper regulatory approvals to be marketed.
Cholestech could experience difficulties that could delay or prevent the
successful development, introduction and marketing of new tests. Also,
regulatory clearance or approval of any new tests may not be granted on a timely
basis, or at all.
Cholestech has experienced difficulties obtaining regulatory approval
for tests in the past. In September 1999, the FDA approved the Company's request
for clearance to market Cholestech's newly developed ALT single use test
cassette. As of June 2000, the FDA has not approved our request for CLIA waiver
for the use of the ALT test cassette with the L-D-X System. Because the FDA's
evaluation of applications for CLIA waived status is not based upon precisely
defined, objectively measurable criteria, Cholestech cannot predict the
likelihood of obtaining waived status in the future for the ALT product or other
products. In order to successfully commercialize the ALT test cassette or other
future tests in the United States, the Company believes it is critical to obtain
waived status under CLIA. In order to successfully commercialize any new tests,
including the ALT test cassette, the Company will be required to establish and
maintain reliable, cost-efficient, high-volume manufacturing capacity for such
tests.
Cholestech 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.
Manufacturing Cholestech's test cassettes is a complex and delicate
process and interruption of cassette manufacturing could result in insufficient
cassettes to meet orders, which could result in financial harm to Cholestech.
Cholestech internally manufactures all of the single use test cassettes that are
used with the L-D-X Analyzer. The manufacture of single use test cassettes is a
highly complex and precise process that is sensitive to a wide variety of
factors. 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. Manufacturing yields could be harmed by:
- Raw materials variations or impurities,
- Occurrence of manufacturing process variances,
- Decreased manufacturing equipment performance, and
- Introduction of manufacturing environment impurities.
Cholestech's cassette manufacturing lines would be costly and time
consuming to repair or replace if their operation were interrupted. The
interruption of cassette manufacturing operations or the loss of employees
dedicated to the cassette manufacturing facility could severely harm
Cholestech's business. The risks involving the manufacturing lines include:
- As Cholestech's production levels have increased, Cholestech 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 Cholestech's manufacturing equipment
increases the time required to remedy equipment failures and replace
equipment.
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CHOLESTECH CORPORATION
- Cholestech has a limited number of employees dedicated to the
operation and maintenance of the cassette manufacturing equipment,
the loss of whom could impact Cholestech's ability to effectively
operate and service such equipment.
- Cholestech manufactures all cassettes at its Hayward, California
manufacturing facility, so manufacturing operations are at risk to
interruption from earthquake, fire or other events affecting this
one location.
Cholestech will need to reduce manufacturing costs in order to achieve
long-term success, and it may not be able to reduce these costs. We believe that
we will be required to reduce manufacturing costs for new and existing test
cassettes in order to achieve sustained profitability. Cholestech currently
operates two manufacturing lines for dry chemistry cassettes. We are planning
and building a third manufacturing line that we anticipate will become fully
operational in the third quarter of fiscal 2001. The complexity and custom
nature of our manufacturing process increases the amount of time and money
required to add an additional manufacturing line. Despite our efforts, the new
cassette manufacturing line may not be completed in a timely fashion, or at all.
Also, we may need to implement cassette manufacturing cost reduction programs
sooner. Failure to develop the new dry chemistry manufacturing line could
prevent us from satisfying customer orders in a timely manner, which could lead
to customer dissatisfaction and loss of business. Failure to develop the new
line could also prevent us from reducing manufacturing costs for dry chemistry
tests, and prevent us from achieving sustained profitability.
Cholestech may have to develop new manufacturing processes and a new
manufacturing line in order to market immunoassay tests in development, or we
will not be able to recover the costs of these tests in development. We may also
be required to build a new cassette manufacturing line in order to manufacture
the immunoassay test cassettes under development. To date, we have not developed
the processes and production equipment necessary for an immunoassay cassette
manufacturing line. Failure to successfully develop an immunoassay cassette
manufacturing line 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.
Cholestech depends on single source suppliers for inputs to its
manufacturing process. Cholestech's business will be harmed if these suppliers
cannot provide supplies to Cholestech or experience problems with quality of
supplied materials. Single source vendors currently provide subassemblies,
components and raw materials used in the manufacture of Cholestech's products.
Any supply interruption in a single source subassembly, component, or raw
material could restrict Cholestech's ability to manufacture products until a new
source of supply is identified and qualified. Cholestech may not be successful
in qualifying additional sources of supply on a timely basis, or at all. Failure
to obtain a usable alternative source could prevent manufacturing our products,
resulting in inability to fill orders, customer dissatisfaction and loss of
business. This would likely severely harm our business. In addition, an
uncorrected impurity or supplier's variation in a raw material, either unknown
to Cholestech or incompatible with Cholestech's manufacturing process, could
interfere with our ability to manufacture products. Because Cholestech 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, Cholestech's suppliers may not devote adequate resources to
supplying Cholestech's needs. Any interruption or reduction in the future supply
of any subassemblies,
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CHOLESTECH CORPORATION
components or raw materials currently obtained from single or limited sources
could severely harm Cholestech's business.
If Cholestech is successful in growing sales, this success may be
undermined if it cannot effectively manage the operational and management
challenges of growth. If Cholestech is successful in achieving and maintaining
market acceptance for the L-D-X System, Cholestech will be required to expand
its operations, particularly in the areas of sales and marketing and
manufacturing. As Cholestech expands its operations, this expansion will likely
result in new and increased responsibilities for management personnel and place
significant strain upon Cholestech's management, operating and financial systems
and resources. To accommodate any such growth and compete effectively,
Cholestech will be required to implement and improve its information systems,
procedures and controls, and to expand, train, motivate and manage its work
force. Our personnel, systems, procedures and controls may not be adequate to
support our future operations. Any failure to implement and improve operational,
financial and management systems or to expand, train, motivate or manage
employees as required by future growth, if any, could harm our business and
prevent us from improving our financial condition as a result of increased
sales.
Cholestech relies on distributors to sell its products, and has had
difficulty in the past maintaining some distributor relationships. In order for
Cholestech to increase revenues and achieve sustained profitability, we will
have to maintain and expand our existing distribution relationships and develop
new distribution relationships. Cholestech is dependent upon such distributors
to assist it in promoting market acceptance of the L-D-X System. If we do not
maintain and expand these relationships, our sales will not grow and our
business will be greatly harmed. We have in the past had problems maintaining
relationships with our distributors to the pharmacy market. Distribution
agreements with Amerisource and Bergen Brunswig Drug Company, both national
distributors to the pharmacy market, were cancelled due to contractual
performance issues. Also, we may not be able to enter into and maintain new
arrangements on a timely basis, or at all. Even if we do enter into additional
distributor relationships, those distributors may not devote the resources
necessary to provide effective sales and marketing support to our products. We
do not have the ability to prevent distributors from distributing products that
compete with our products. The distributors may also give higher priority to the
products of our competitors.
If third party reimbursement for use of Cholestech's products is
eliminated or reduced, our sales will be greatly reduced and our business may
fail. In the United States, healthcare 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. Cholestech will not be able to successfully market
its products if the purchase and use of these products is not subject to
reimbursement from government health authorities, private health insurers and
other third party payors. If this reimbursement is not available or is limited,
healthcare providers will be much less likely to use Cholestech's products, our
sales will be greatly reduced and our business will likely fail.
Reimbursement is currently not available for certain uses of
Cholestech'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 our products. For example, if a physician
prescribes a drug that requires therapeutic monitoring, the use of our products
in
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performing such tests will be reimbursable. In the health promotion market, use
of our 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.
There are current conditions in healthcare that increase the possibility
that third party payors may reduce or eliminate reimbursement for tests using
Cholestech's products in certain settings. These circumstances include:
- Third party Payors are increasingly scrutinizing and challenging the
prices charged for medical products and services.
- Healthcare providers are moving toward a managed care system in
which such providers contract to provide comprehensive healthcare
for a fixed cost per patient. Managed care providers are attempting
to control the cost of healthcare by authorizing fewer elective
procedures, such as uses of Cholestech's products for diagnostic
screening.
- There is general uncertainty regarding what changes will be made in
the reimbursement methods utilized by third party payors and how
that will affect use of products such as Cholestech's. This
uncertainty may deter healthcare providers from adopting use of
Cholestech Diagnostic Products.
- Cholestech believes that the overall escalating cost of medical
products and services has led to and will continue to lead to
increased pressures on the healthcare industry, both domestic and
international, to reduce the cost of products and services,
including products offered by Cholestech.
Market acceptance of Cholestech's products in international markets is
also dependent, in part, upon the availability of reimbursement within
prevailing healthcare payment systems. Reimbursement and healthcare payment
systems in international markets vary significantly by country and include both
government sponsored healthcare and private insurance. Third party reimbursement
and coverage may not be available or adequate in either the United States or
international markets, and current reimbursement amounts may be decreased in the
future. Also, future legislation, regulation, or reimbursement policies of third
party Payors may adversely affect demand for our products or our ability to sell
our products on a profitable basis. Any of these events could materially harm
our business. See "Business -- Third Party Reimbursement."
There is a good likelihood that the healthcare system in the United
States will undergo fundamental change, and there is no way to predict whether
these changes will harm our business or how severe the effect will be.
Political, economic and regulatory influences are pushing the healthcare
industry in the United States to fundamental change. Cholestech anticipates that
Congress, state legislatures and the private sector will continue to review and
assess alternative healthcare delivery and payment systems. Potential approaches
that have been considered include mandated basic healthcare benefits, controls
on healthcare 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
healthcare delivery system. Legislative debate is expected to continue in the
future, and market forces are expected to demand reduced costs. Cholestech
cannot predict what impact the adoption of any federal or state health care
reform measures,
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future private sector reform or market forces may have on its business. There is
the potential that changes in the healthcare system could have extremely
negative effects on our business.
Cholestech's products are subject to multiple levels of government
regulation that impose significant restrictions on Cholestech's business and
could change in ways that are difficult to predict and that could be very
damaging to our business. 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. Cholestech 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 required clearances and approvals. The process of
obtaining required regulatory clearances and approvals is lengthy, expensive and
uncertain. As a result, Cholestech's new tests under development, even if
successfully developed, may never obtain such clearance or approval.
Additionally, certain material changes to medical products already cleared or
approved by are subject to further review and clearance or approval. 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. The loss of
previously obtained clearances, or failure to comply with existing or future
regulatory requirements, could prevent marketing of products affected, which
would depress revenues and severely harm our business.
In addition, any future amendment of regulations or the promulgation of
additional regulations impacting Cholestech's products could prevent Cholestech
from marketing the L-D-X System. Regulatory changes could hurt our business by
increasing burdens on our products. Regulatory changes could also harm our
business by reducing 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.
Currently, Cholestech's Diagnostic Products are regulated in the United
States by the Food and Drug Administration. The L-D-X Analyzer and all existing
test cassettes required clearance by the Food and Drug Administration. Food and
Drug Administration clearance or approval of products such as Cholestech's can
be obtained by either of two processes:
- The 510(k) clearance process, which generally takes from four to
twelve months from the date of submission to obtain, but may take
longer.
- The pre-market approval process, which is a much longer and more
costly process than a 510(k) clearance process, involves the
submission of extensive supporting data and clinical information and
generally takes one to three years from the date on which the
application is accepted for filing, but may take significantly
longer.
If Cholestech's future products are required to obtain a pre-market
approval, this would significantly delay our ability to market those tests and
significantly increase the costs of development.
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. In the United States, clinical laboratory
testing is regulated under the Clinical Laboratory Improvements Act of 1976. The
L-D-X
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Analyzer and Cholestech's total cholesterol, HDL (high density lipoproteins),
Triglycerides and glucose tests in any combination have been classified as
waived from the application of many of the requirements under the Clinical
Laboratory Improvements Act. Cholestech believes that this waived classification
is critical for its products to be successful in their markets. Cholestech's new
tests, including the ALT test cassette, may not qualify for waived
classification. Any failure of the new tests to obtain waived status under the
Clinical Laboratory Improvements Act will severely limit ability to
commercialize such tests. Loss of waived status for existing Diagnostic Products
or failure to obtain waived status for new products could limit our sales and
revenues, which would severely harm our business.
The European Union has promulgated rules that require that devices such
as those developed, manufactured and sold by Cholestech receive the right to
affix the CE mark, a symbol of adherence to applicable European Union
directives. Cholestech 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. Cholestech's products will
be covered by the In Vitro Diagnostics Directives that have not yet been
officially published or adopted. Cholestech may lose its self-certified status
if it is not successful in meeting the European Union certification
requirements. Failure to receive the right to affix the CE mark may prohibit
Cholestech from selling its products in European Union member countries. This
would result in lost sales and market share and significant financial harm to
our business.
Cholestech's manufacturing processes are subject to regulation and, if
we do not comply with these regulations, our manufacturing could be suspended,
resulting in unfilled orders, customer dissatisfaction, and lost sales, revenues
and market share. Cholestech's manufacturing processes, as well as, in certain
instances, those of our contract manufacturers, are subject to stringent
federal, state and local regulations governing the use, generation, manufacture,
storage, handling and disposal of certain materials and wastes. Failure to
comply with these regulations 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. Any of these could harm our business. Cholestech and
our contract manufacturers are subject to federal, state and foreign regulations
regarding the manufacture of healthcare products and diagnostic devices,
including:
- Quality System Records ("QSR"), which requires the company to
maintain a quality system consistent with FDA regulations.
- ISO9001/EN46001 requirements, which is an industry standard for
maintaining quality standards and assuring conformance to said
standards.
- And other foreign regulations and state and local health, safety and
environmental regulations, which include testing, control and
documentation requirements.
Changes in existing regulations or adoption of new governmental
regulations or policies could prevent or delay regulatory approval of the
Company's products. Cholestech may be required to incur significant costs in the
future in complying with manufacturing and environmental regulations.
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CHOLESTECH CORPORATION
Our business depends on our ability to protect our proprietary
technology through patents and other means, which may not be successful or may
require costly litigation to enforce. If our protective measures are not
successful our competitors will be able to use our technology to compete with
us, and if we have to enforce our protective measures we may have to divert time
and money from operating our business. 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. Risks of
relying on the proprietary nature of our technology include:
- Our pending patent applications may not result in the issuance of
any patents, or, if issued, such patents may not offer protection
against competitors with similar technology.
- Our patents may be challenged, invalidated or circumvented in the
future, and the rights created under our patents may not provide a
competitive advantage.
- Competitors, many of which have substantially greater resources than
us and have made substantial investments in competing technologies,
may seek to apply for and obtain patents covering technologies that
are more effective than ours. This could render our technologies or
products obsolete or uncompetitive or could prevent, limit or
interfere with our ability to make, use or sell our 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.
Cholestech may in the future become subject to patent infringement
claims and litigation or interference proceedings conducted in the
United States Patent and Trademark Office to determine the priority
of inventions. Litigation may also be necessary to enforce any
patents issued to us, to protect our trade secrets or know-how or to
determine the enforceability, scope and validity of the proprietary
rights of others. The defense and prosecution of intellectual
property suits, patent interference proceedings and related legal
and administrative proceedings are both costly and time consuming
and will likely result in substantial diversion of attention of
technical and management personnel.
- An adverse determination in litigation or interference proceedings
to which Cholestech may become a party could subject us to
significant liabilities to third parties or require us to seek
licenses from third parties, which may not be available on
commercially reasonable terms or at all.
If third party sponsorship of WellCheck testing service is eliminated or
reduced, our revenues will be greatly reduced and our business may fail.
WellCheck derives the majority of its revenue from third parties using the
Company's testing service to promote their products. If the third parties
decline to participate in the future, or the amount of sponsorship is reduced,
consumers will be much less likely to use our testing service and our revenue
will be greatly reduced and our business will likely fail.
We will need to locate an adequate number of testing venues for the
WellCheck testing service. In order for the testing service to be successful,
the Company will need to maintain the
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CHOLESTECH CORPORATION
current number of testing sites and find a greater number of locations, and more
diverse venues to perform consumer testing. The Company will need to convince
operators of the venues there will be economic benefits from the testing
service. If the number of testing sites do not increase or are reduced,
Cholestech could be harmed financially.
If third party sponsorship of the WellCheck.com web site is eliminated
or reduced, our revenues will be greatly reduced and our business may fail. The
WellCheck.com web site anticipates all revenues will be derived form third
parties advertising, sponsorship, or offering services to web site members. If
third parties decline to participate, or fees are significantly lower than
estimated, revenue will be greatly reduced and our business will likely fail.
The Company will have to maintain a significant active membership in the
WellCheck.com web site. In order to generate expected revenues we will need to
demonstrate to web site sponsors the number of visitors, and the number or
repeat visitors. If web site membership does not reach the required level or use
of the web site declines, revenues will be eliminated or significantly reduced.
We will need to effectively implement and use the TEAMS software, which
transfers consumer information from test locations to the WellCheck web site. In
order to meet consumer expectations of timely feed back, the TEAMS software will
be the conduit, which will transfer the large number of consumer test results in
a timely manner. If the TEAMS software is not available, manual data entry by
the company or the customer will be required. The additional time and
inconvenience could reduce the number of people willing to become a member of
the web site. If customers are not provided an efficient method of accessing the
data on the web site membership can be eliminated or significantly reduced,
which could harm Cholestech financially.
The Company will need to market the use of TEAMS software to sponsors of
testing programs. TEAMS software is a proprietary tool to transfer large amounts
of information from testing sites to our web site. We must be able to convince
sponsors it is a cost effective method, and will improve the testing experience
for consumers. If we are unable to have event sponsors pay for the use of TEAMS,
we would be unable to recover the cost of developing and maintaining TEAMS,
which could significantly reduce profits.
Our testing system may not properly process year 2000 dates, which would
result in loss of sales and in financial harm to Cholestech. Cholestech
implemented a program to assess 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"). As of the first twenty-one weeks of
calendar 2000, the Company has not been able to detect any material Year 2000
related issue to its internal systems and products. Additionally, the Company is
not currently aware of any Year 2000 dependencies in its internal systems or
products that could have a material impact on its business. Although the company
believes no material events will occur, no assurances can be given that
Cholestech will not experience unanticipated material costs caused by undetected
errors or defects in its internal systems.
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CHOLESTECH CORPORATION
PART II - OTHER INFORMATION
ITEM 1. 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. On
June 24, 1999, plaintiffs filed an amended complaint, which expanded the
putative class period to June 28, 1996, through June 26, 1998. The amended
complaint's substantive allegations and purported causes of action remain based
on allegations that the Company misled shareholders concerning the Company's
business and its future prospects. The complaint does not specify alleged
damages. On September 20, 1999, defendants filed a motion to dismiss plaintiff's
amended complaint. On March 28, 2000, the court granted defendant's motion to
dismiss pursuant to rule 12(B)(6) with leave for plaintiffs to amend. The
plaintiffs have filed a second amended complaint. 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.
On December 23, 1999, a complaint requesting an injunction, No. ES
580-199, was filed in Zug, Switzerland by Roche Diagnostics seeking a cease and
desist order barring the Company, and two distributors, Healthcare Solutions and
Euromedix, from distributing HDL assay single-use test cassettes in Switzerland.
The complaint alleges that Cholestech violated a Roche European patent for HDL.
The Company has filed its response to the complaint. On July 11, 2000 the court
denied the plaintiff's request for an injunction. The plaintiff has appealed the
court ruling and it will be several weeks before we are notified of the case
details. There can be no assurance as to weather the plaintiffs will take any
additional action, or any additional action be resolved in the Company's favor.
Additionally, in January, 2000, a complaint, No. 4 O 4/00, was filed in
the District Court, Dusseldorf, Germany against Cholestech and two of its
distributors, seeking a cease and desist order barring the distributor from
shipping HDL single-use test cassettes into Germany. The complaint alleges the
Company and its distributors violated a Roche German priority patent for HDL by
selling Cholestech's single-use test cassette containing a HDL assay. The
Company believes the suit is without merit and intends to defend the case
vigorously. Therefore, the Company does not believe that the outcome of this
matter will result in a material adverse effect, however, there can be no
assurance that the lawsuit will be resolved in the Company's favor.
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CHOLESTECH CORPORATION
The Company is subject to various legal claims and assessments in the
ordinary course of business, none of which are expected by management to result
in a material adverse effect on the consolidated financial statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
27.1 Financial Data Schedule
(b) Reports on Form 8-K. No Reports on Form 8-K were filed during the
thirteen weeks ended June 30, 2000.
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CHOLESTECH CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHOLESTECH CORPORATION
Date 08/09/00 /s/ Warren E. Pinckert II
------------ ---------------------------------------------
Warren E. Pinckert II
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Andrea J. Tiller
---------------------------------------------
Andrea J. Tiller
Vice President of Finance and Chief
Financial Officer
(Principal Financial and Accounting Officer)
32
