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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 December 24, 1999
[ ] 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
incorporation or organization) Identification Number)
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 December 24, 1999, 11,817,390 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 Balance Sheets 3
Condensed Statements of Operations 4
Condensed Statements of Cash Flows 5
Notes to Condensed Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS. 12
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 36
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 37
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 37
SIGNATURES 38
</TABLE>
2
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CHOLESTECH CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
December 24, 1999 March 26, 1999 (1)
----------------- ------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 7,217 $ 5,529
Marketable securities 3,858 3,018
Accounts receivable, net 2,284 2,637
Inventories 3,391 4,532
Prepaid expenses and other current assets 316 140
-------- --------
Total current assets 17,066 15,856
Property and equipment, net 6,384 5,489
Long-term investments 4,923 2,880
Other assets, net 54 58
-------- --------
Total assets $ 28,427 $ 24,283
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 2,024 $ 1,433
Accrued payroll and benefits 1,572 990
Product warranty 91 91
-------- --------
Total current liabilities 3,687 2,514
-------- --------
Contingencies (Note 7) (Note 7)
Shareholders' equity:
Preferred stock -- --
Common stock 71,652 70,311
Accumulated other comprehensive income (loss) (56) 14
Accumulated deficit (46,856) (48,556)
-------- --------
Total shareholders' equity 24,740 21,769
-------- --------
Total liabilities and shareholders' equity $ 28,427 $ 24,283
======== ========
</TABLE>
(1) The information in this column was derived from the Company's audited
financial statements for the fiscal year ended March 26, 1999.
See Notes to Condensed Financial Statements
3
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CHOLESTECH CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Thirteen weeks ended Thirty-nine weeks ended
-------------------------- --------------------------
12/24/99 12/25/98 12/24/99 12/25/98
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Domestic $ 5,535 $ 4,732 $ 15,967 $ 14,047
International 1,220 660 2,891 2,137
-------- -------- -------- --------
6,755 5,392 18,858 16,184
Cost of products sold 2,695 2,602 7,888 7,488
-------- -------- -------- --------
Gross profit 4,060 2,790 10,970 8,696
-------- -------- -------- --------
Operating expenses:
Sales and marketing 1,844 1,462 5,048 4,908
Research and development 974 669 2,247 2,097
General and administrative 1,004 624 2,242 1,755
Other -- -- 219 575
-------- -------- -------- --------
Total operating expenses 3,822 2,755 9,756 9,335
-------- -------- -------- --------
Income (loss) from operations 238 35 1,214 (639)
Interest and other income, net 223 154 556 566
-------- -------- -------- --------
Income (loss) before taxes 461 189 1,770 (73)
Provision for income taxes 28 -- 71 13
-------- -------- -------- --------
Net income (loss) $ 433 $ 189 $ 1,699 $ (86)
======== ======== ======== ========
Net income (loss) per share:
Basic $ 0.04 $ 0.02 $ 0.15 $ (0.01)
======== ======== ======== ========
Diluted $ 0.04 $ 0.02 $ 0.14 $ (0.01)
======== ======== ======== ========
Shares used to compute net income
(loss) per share:
Basic 11,836 11,487 11,661 11,478
======== ======== ======== ========
Diluted 12,227 11,578 11,929 11,478
======== ======== ======== ========
</TABLE>
See Notes to Condensed Financial Statements
4
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CHOLESTECH CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Thirty-nine weeks ended
---------------------------------
Dec. 24, 1999 Dec. 25, 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 1,699 $ (86)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,101 1,149
Allowance for doubtful accounts 20 (112)
Changes in assets and liabilities:
Accounts receivable 333 1,438
Inventories 1,141 (2,148)
Prepaid expenses and other assets (176) (341)
Other assets 2 (14)
Accounts payable and accrued expenses 591 (1,534)
Accrued payroll and benefits 582 (232)
-------- --------
Net cash provided by (used in) operating activities 5,293 (1,880)
-------- --------
Cash flows from investing activities:
Proceeds from sale of marketable securities 22,348 11,693
Purchases of marketable securities (25,301) (9,149)
Purchases of property and equipment (1,993) (2,334)
-------- --------
Net cash provided by (used in) investing activities (4,946) 210
-------- --------
Cash flows from financing activities:
Issuance of common stock 1,341 329
-------- --------
Net cash provided by financing activities 1,341 329
-------- --------
Net change in cash and cash equivalents 1,688 (1,341)
Cash and cash equivalents at beginning of period 5,529 5,130
-------- --------
Cash and cash equivalents at end of period $ 7,217 $ 3,789
======== ========
</TABLE>
See Notes to Condensed Financial Statements
5
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CHOLESTECH CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. INTERIM RESULTS
The interim unaudited financial information of Cholestech Corporation
(the "Company") is prepared in conformity with generally accepted
accounting principles and such principles are applied on a basis
consistent with the audited financial information contained in the
Annual Report on Form 10-K filed with the Securities and Exchange
Commission on June 17, 1999. The financial information included herein
has been prepared by management, without audit by independent
accountants who do not express an opinion thereon, and should be read in
conjunction with the audited financial statements contained in the
Annual Report on Form 10-K for the fiscal year ended March 26, 1999. The
condensed balance sheet as of March 26, 1999, has been derived from, but
does not include all the disclosures contained in, the audited financial
statements for the year ended March 26, 1999. 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 31, 2000.
2. BALANCE SHEET DATA
The components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 24, 1999 MARCH 26, 1999
----------------- --------------
<S> <C> <C>
Raw materials $1,255 $1,598
Work-in-process 1,399 1,398
Finished goods 737 1,536
------ ------
$3,391 $4,532
====== ======
</TABLE>
3. EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing income (loss)
available to common shareholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period.
Diluted earnings per share gives effect to all potential common stock
outstanding during a period, if dilutive.
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CHOLESTECH CORPORATION
A reconciliation of the basic and diluted earnings per share
calculations follows:
(In thousands, except per share data)
<TABLE>
<CAPTION>
Thirteen Weeks Ended Thirty-nine Weeks Ended
December 24, 1999 December 24, 1999
----------------------------- -----------------------------
Net Net
Income Shares Per share Income Shares Per share
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $433 11,836 $0.04 $ 1,699 11,661 $0.15
Effect of dilutive
securities -- 391 -- -- 268 --
Diluted EPS $433 12,227 $0.04 $ 1,699 11,929 $0.14
</TABLE>
<TABLE>
<CAPTION>
Thirteen Weeks Ended Thirty-nine Weeks Ended
December 25, 1998 December 25, 1998
----------------------------- ----------------------------
Net Net
Income Shares Per share Loss Shares Per share
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $189 11,487 $0.02 $ (86) 11,478 $(0.01)
Effect of dilutive
securities -- 91 -- -- -- --
Diluted EPS $189 11,578 $0.02 $ (86) 11,478 $(0.01)
</TABLE>
Due to the loss incurred in the thirty-nine week period ended December
25, 1998, options to purchase 562,000 shares of common stock were
considered antidilutive and were therefore not included in the loss per
share calculation for that period.
4. BORROWING ARRANGEMENTS
The Company has an agreement with Wells Fargo Bank for a $3 million
revolving line of credit (the "line of credit") expiring on November 30,
2000. 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 As of December 24,
1999, there were no borrowings outstanding under the line of credit.
5. NEW ACCOUNTING PRONOUNCEMENTS
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CHOLESTECH CORPORATION
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.
The Company will adopt SFAS No. 133 in fiscal year 2001.
6. SHAREHOLDER RIGHTS PLAN
In January 1997, the Board of Directors approved a shareholder rights
plan under which shareholders of record on March 31, 1997, received a
right to purchase (the "Right") one-thousandth of a share of Series A
Participating Preferred Stock at an exercise price of $44.00, subject to
adjustment. The Rights will separate from the Common Stock and Rights
certificates will be issued and will become exercisable upon the earlier
of: (i) 10 days (or such later date as may be determined by a majority
of the Board of Directors) following a public announcement that a person
or group of affiliated or associated persons has acquired, or obtained
the right to acquire, beneficial ownership of 15% or more of the
Company's outstanding Common Stock or (ii) 10 business days following
the commencement of, or announcement of an intention to make, a tender
offer or exchange offer, the consummation of which would result in the
beneficial ownership by a person or group of 15% or more of the
Company's outstanding Common Stock. The Rights expire on the earlier of
(i) January 22, 2007, or (ii) redemption or exchange of the Rights.
7. 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. 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.
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CHOLESTECH CORPORATION
On August 9, 1999, Cholestech filed in the United States District
Court for the Southern District of Indiana a complaint entitled
Cholestech Corporation v. Polymer Technology Systems, Inc. and Tracy
Thompson, No. IP99-1223-C T/G. Cholestech's complaint and substantive
causes of action were based on its allegations that Mr. Thompson, a
former Cholestech employee, disclosed, and/or was likely to disclose,
certain confidential and proprietary information of Cholestech to
Polymer and that Polymer was misappropriating this information. On
August 19, 1999, Polymer and Thompson ("plaintiffs") filed in the Marion
County Superior Court in Indianapolis, Indiana, a complaint entitled
Polymer Technology Systems, Inc. and Tracy Thompson v. Cholestech No.
49D02-9908-CP-001134 ("state court action"). In their complaint,
plaintiffs sought a declaration from the court that the information
Cholestech sought to protect in the federal court action does not
constitute a trade secret. By mutual agreement of the parties,
Cholestech voluntarily dismissed its federal court action, and on
September 1, 1999, filed a counterclaim against the plaintiffs in the
state court action. The parties to this action recently agreed to
resolve this action by way of a settlement agreement. The terms of that
agreement are confidential. The settlement does materially affect the
Company.
On May 6, 1999 The Company filed a complaint, No. 9901251, in the
Brussels Belgium court system seeking a patent infringement claim
against Roche Diagnostics. This action was filed to protect the
Company's European Patent rights for high density lipoproteins ("HDL").
The Company believes this action 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 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 until February 21, 2000 to
generate a response. The Company believes the suit is without merit and
intends to defend the case vigorously. The Company does not believe that
it did not cause 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.
Additionally, we have been informed by one of our Distributors
that during 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 in to Germany. The company
has not been served, nor has been given a formal copy of the complaint.
The complaint alleges the Company and its distributor 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. The Company
does not believe that it did not cause any wrongdoing, and that the
outcome of this matter will not result in a material adverse effect,
however, there
9
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CHOLESTECH CORPORATION
can be no assurance that the lawsuit will be resolved in the Company's
favor. The action is in its preliminary stages and the initial hearing
date is set for March 9, 2000.
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 financial statements.
8. SEGMENT INFORMATION
In June 1997, Financial Accounting Standard 131, "Disclosures About
Segments of an Enterprise and Related Information" ("FAS 131"), was
issued and is effective for fiscal years commencing after December 15,
1997. SFAS 131 requires the Company to report segments based on the
internal organization that is used by management for assessing
performance and making operating decisions. SFAS 131 also requires
disclosure about products and services, geographic areas and major
customers. The Company launched a new business unit during the third
quarter of fiscal 2000WellCheck.com (".COM"), and has included the
appropriate segment disclosures. Prior to the thirteen weeks ending
December 24, 1999, the Company operated in one segment, the Diagnostic
Products business unit. Results for the thirteen weeks ending December
24, 1999 for the Diagnostic Products ("DP") and WellCheck.com (".COM")
are as follows.
CONDENSED INCOME FROM OPERATIONS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
DIAGNOSTIC WELLCHECK
PRODUCTS .COM TOTAL
---------- --------- ------
<S> <C> <C> <C>
Revenues:
Domestic $5,535 $ -- $5,535
International 1,220 -- 1,220
------ ------ ------
Revenue 6,755 -- 6,755
Cost of products sold 2,695 -- 2,695
------ ------ ------
Gross profit 4,060 -- 4,060
------ ------ ------
Operating expenses:
Sales and marketing 1,844 -- 1,844
Research and development 586 388 974
General and administrative 593 411 1,004
------ ------ ------
Total operating expenses 3,023 799 3,822
------ ------ ------
Income (loss) from operations $1,037 $ (799) $ 238
====== ====== ======
</TABLE>
All assets of the Company are located in the United States.
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CHOLESTECH CORPORATION
9. COMPREHENSIVE INCOME
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130. "Reporting Comprehensive Income". This
statement establishes standards for the reporting and display of
comprehensive income and its components for general-purpose financial
statements. Comprehensive income is defined as net income plus all
revenues, expenses, gains and losses from non-owner sources that are
excluded from net income in accordance with generally accepted
accounting principles. For all periods presented, there are no material
differences between net income and comprehensive income.
10. SUBSEQUENT EVENTS
On January 21, 2000 the Company acquired privately held Health Net, Inc.
("Health Net") of Hammond, Louisiana. The purchase price is
approximately $3.0 million with up to an additional $1.0 million subject
to the execution of certain milestones. The acquisition has been
accounted for using the purchase method of accounting. Health Net is a
healthcare wellness testing company that specializes in providing
cholesterol, lipid, glucose, hemoglobin A1c, and osteoporosis testing to
consumers. Health Net administers consumer wellness testing programs in
venues across the United States.
The property the Company occupies for the majority it's manufacturing
and administrative space is leased through March 31, 2000. The lease
provides for an option to extend the lease for three more years, but the
Company did not exercise the option. The Company is currently in
negotiations with the owner of the property to develop mutually
acceptable arrangements for the continued use of the building, which may
include the Company's purchase of the building. The Company may not be
able to come to an agreement with the owner that is acceptable to the
Company, or at all. If the Company does not reach an agreement regarding
the continued use of the building, it will have to seek alternative
space. The market for commercial real estate in the San Francisco Bay
Area is extremely competitive and the Company would be unlikely to
obtain space on terms as favorable as those under the current lease.
This may result in significant additional expense in the future.
Additionally, if the Company does not reach an agreement with the owner
of its current facility, the Company would likely incur significant
expenses in moving to a new facility. The level of such expenses would
depend on how rapidly the Company is required to move.
11
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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 herein, under "General", "Year 2000
Compliance", and "Potential Factors Affecting Future Operating Results." These
forward-looking statements include, but are not limited to: (1) the statement
under "General" that the Company will require significant startup expenditures
for new business units; (2) the statement under "General", that the Company may
incur negative cash flows as it expands manufacturing, research and development,
sales and marketing, and pursues regulatory approvals for its products; (3) the
statement under "General" that the Company expects product mix to change from
time to time; (4) the statement in the first paragraph under "Revenues" that the
dollar amount and proportion of international revenues may fluctuate from period
to period; (5) the statements under "Research and Development" that the
development of tests for new disease states and the Company's anticipation that
research and development expenditures will increase; (6) statements under
"Income Taxes" regarding the use of additional tax net operating losses and
other tax carry forward amounts, and the Company's effective tax rate; and (7)
the statements in the third and third paragraphs under "Liquidity and Capital
Resources" that the capital expenditures relating to expansion of manufacturing,
research and development, and sales and marketing, will be substantial, and that
the Company's liquid assets, cash from operations, and available bank funds,
will be sufficient to meet its capital requirements for the foreseeable future.
GENERAL
On November 30, 1999 the Company announced a strategic expansion to
create three focused business units designed to bring the Company closer to the
healthcare consumer. The three business units are comprised of our historic
diagnostic products business, a new testing service business, and a new internet
based healthcare business.
Our new testing service business, WellCheck, will provide key
face-to-face interaction with the consumer by bringing cholesterol testing to
venues which are convenient to the general public. Starting in selected regions,
and broadening its coverage through a combination of acquisition and internal
growth, the Company plans to develop the first nationwide consumer testing
service; bringing physicians, healthcare providers, and consumers together with
the information they need to improve cardiovascular health, and other chronic
conditions. The acquisition and development of internal growth will require
significant start-up expenditures. This new venture will require the Company to
operate in multiple geographic locations to which our management and financial
systems must be adapted.
Our new consumer internet based healthcare business, WellCheck.com, will
help consumers build a personal health record for themselves and members of
their family to measure and monitor their cardiovascular health in conjunction
with physicians and other healthcare providers. WellCheck.com will also provide
individuals with monitoring and other feedback tools to help maintain compliance
and persistence in physician administered cholesterol-lowering programs and
therapies. The development and implementation of an Internet based will require
significant start-up expenditures. Additionally the success of the business unit
will depend on consumer acceptance of Internet based management of personal
health information.
12
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CHOLESTECH CORPORATION
Our existing business, Diagnostic Products, will continue to develop,
manufacture, and market the L-D-X Analyzer and a variety of single use test
cassettes, which performs near-patient diagnostic screening and therapeutic
monitoring for the management of prevalent chronic diseases (preventive care
testing).
The Company's Diagnostic Products business develops, manufactures and
markets the Cholestech L-D-X(R) System ("L-D-X System"), consisting of the L-D-X
Analyzer and a variety of single use test cassettes, which performs near-patient
diagnostic screening and therapeutic monitoring for the management of prevalent
chronic diseases (preventive care testing). The L-D-X System is capable of
measuring multiple analytes simultaneously with a single drop of whole blood
within five minutes. The Company currently markets the L-D-X System, including
the L-D-X analyzer and a variety of single use test cassettes, to the physician
office laboratory (POL), pharmacy, and health promotion markets in the United
States, and internationally. The Company has experienced significant operating
losses and, as of December 24, 1999, had an accumulated deficit of $46.9
million. The L-D-X System, including the L-D-X Analyzer -the Company's only
product platform- and single use test cassettes, will continue to account for
substantially all of the Company's revenues for the foreseeable future. In order
for the Company to increase revenues, sustain profitability and maintain
positive cash flows from operations, the L-D-X System must continue to gain
market acceptance among healthcare providers, particularly in POLs and
pharmacies, to which the Company has made only limited sales to date. The
acceptance of the Company's L-D-X System by the pharmacy market has progressed
more slowly than anticipated. This is due to the issues of third party
reimbursement, State Government approval, and awareness by the pharmacy market
that the L-D-X System could add value to their businesses. 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 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 of WellCheck.com, and the acquisition and other startup
costs of WellCheck may also incur negative cash flows. 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 revenues and operating
results. In the POL Market, within the Diagnostic Products business unit, the
Company generally has found that customers use a higher proportion of lipid
profile cassettes for therapeutic monitoring purposes, which test
13
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CHOLESTECH CORPORATION
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. WellCheck.com's revenues will be derived from an Internet
based business which represents a new business strategy for the Company. The
Company has no experience developing or operating Internet-based businesses and
revenues from WellCheck.com are uncertain.
The Company is currently developing additional tests for diagnostic
screening and therapeutic monitoring of osteoporosis, liver function, and high
cholesterol. 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 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. The
Company can not estimate when the CDC 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 DECEMBER 24, 1999, AND DECEMBER 25, 1998
AND
THIRTY-NINE WEEKS ENDED DECEMBER 24, 1999, AND DECEMBER 25, 1998
Revenues. During the thirteen weeks ended December 24, 1999, revenues
increased 25.3% to $6.8 million from $5.4 million in the thirteen weeks ended
December 25, 1998. The Diagnostic Products business unit accounted for 100% of
our revenues for both the third quarter of fiscal 2000 and fiscal 1999. It is
expected the WellCheck business unit will start generating revenue during the
fourth quarter of fiscal 2000. The WellCheck.com business unit is not expected
to generate revenue until fiscal 2001, at the earliest.
The increase in revenues primarily reflects an increase in domestic
revenues of $803,000 or 17.0% to $5.5 million from $4.7 million. This increase
reflects a $1.2 million increase in sales of single-use test cassettes, mainly
to healthcare providers in the POL and health promotion markets. The increase in
sales of single-use test cassettes was partially offset by decreases in sales of
accessories and L-D-X Analyzers, mainly in the health promotion market.
International revenues increased by 84.8% or $560,000 from $660,000 to
$1,220,000 for the thirteen weeks ended December 24, 1999, compared to the same
period in fiscal 1999. The increase was attributed to higher sales of single-use
test cassettes and related accessories. Due to lower unit volume, L-D-X
Analyzers revenue was down 13% in third quarter of fiscal 2000, compared to the
third quarter of fiscal 1999. The Company expects that the dollar amount and mix
of international revenues will over time fluctuate from period to period.
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CHOLESTECH CORPORATION
During the first thirty-nine weeks of fiscal 2000, revenues increased
$2.7 million or 16.5% to $18.9 million from $16.2 million in the first
thirty-nine weeks of fiscal 1999.
Domestic revenue increased 13.7% from $14.0 million to $16.0 million
compared to the corresponding thirty-nine weeks of fiscal 1999. The increase in
revenue can be attributed to higher unit sales of single-use test cassettes to
the POL and health promotion markets. Unit sales of L-D-X Analyzers sales have
declined in all markets.
During the first thirty-nine weeks of fiscal 2000, international
revenues increased $754,000 or 35.3% over the first thirty-nine weeks of fiscal
1999. The international revenue growth was primarily in the European market. As
with the domestic market, sales growth came predominantly from the sales of
single-use test cassettes. Additionally the average international sales price of
the single-use test cassettes increased.
Cost of Products Sold. Cost of products sold includes direct labor,
direct material, overhead and royalties. Cost of products sold increased 3.6%,
on a 25.3% increase in sales, to $2.7 million in the thirteen weeks ended
December 24, 1999, from $2.6 million in the thirteen weeks ended December 25,
1998. Gross margin was 60.1% and 51.7% of total revenues in the thirteen weeks
ended December 24, 1999, and December 25, 1998, respectively. The improvement in
gross margin as a percentage of revenues were primarily attributable to lower
unit cost of single-use test cassettes, for which production increased 54%, with
only a $87,000 increase in direct labor and overhead, compared to the quarter
ended December 25, 1999.
For the first thirty-nine weeks of fiscal 2000, cost of product sold
increased $400,000 or 5.3% to $7.9 million from $7.5 million for the first
thirty-nine weeks of fiscal 1999. The increase in cost of product sold was
attributed to higher unit volume of single-use test cassettes sold. Additionally
factory spending was brought into line with production volume. Gross margins
were 58.2% and 53.7% in the first thirty-nine weeks of fiscal 2000 and 1999,
respectively.
The Company has licensed certain technology used in the manufacture of
its disposable cassette products. The license agreement, which expires in 2006,
requires the Company to pay a royalty of 2.0% on net sales of the applicable
products. Total royalty expense in the thirteen weeks ended December 24, 1999,
and December 25, 1998, was $109,000 and $64,000, respectively, and was charged
to cost of products sold. Total royalty expense for the first thirty-nine weeks
of fiscal 2000 and the comparable period of fiscal 1999 was $314,000 and
$160,000, respectively, and also was charged to cost of products sold.
Sales and Marketing Expense. Sales and marketing expense includes
salaries, commissions, bonuses, expenses for outside services related to
marketing programs, and travel. The Diagnostic Products business unit incurred
all sales and marketing expense. Sales and marketing expense increased 26.1% to
$1.8 million in the thirteen weeks ended December 24, 1999, from $1.5 million in
the thirteen weeks ended December 25, 1998. Sales and marketing expense
increased to 27.3% of revenues in the third quarter of fiscal 2000 from 27.1% in
the third quarter of fiscal 1999. This increase was related to legal action
against a former employee, the cost of recruiting and relocating new staff,
programs to distributors, and higher commissions due to higher sales.
15
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CHOLESTECH CORPORATION
For the first thirty-nine weeks of fiscal 2000, sales and marketing
expense was $5.0 million compared to $4.9 million for the first thirty-nine
weeks of fiscal 1999. The largest component of the increase was for legal action
against a former employee. Sales and marketing expense decreased to 26.8% of
revenues for the thirty-nine weeks of fiscal 2000 from 30.3% for the first
thirty-nine weeks of fiscal 1999.
Research and Development Expenses. Research and development expense
includes salaries, bonuses, expenses for outside services, supplies, and
depreciation of capital equipment. Research and development expense increased
45.6% to $974,000 in the thirteen weeks ended December 24, 1999, from $669,000
in the thirteen weeks ended December 25, 1998. Research and development expenses
as a percentage of revenues increased to 14.4% for the thirteen weeks ended
December 24, 1999, from 12.4% for the thirteen weeks ended December 25, 1998.
The Diagnostic Products business unit represented 60% and 100% of the Company's
research and development expenses for the thirteen weeks ended December 24,
1999, and December 25, 1998, respectively. The WellCheck.com business unit
represented approximately 40% and 0% of the Company's research and development
expenses for the third quarter of fiscal 2000 and 1999 receptively.
Diagnostic Products research and development expenses decreased 12.4% to
$586,000 in the thirteen weeks ended December 24, 1999 from $669,000 in the
thirteen weeks ended December 25, 1998. The decline relates primarily to the
decreased testing of the ALT test cassettes while awaiting CDC response for CLIA
waiver.
During the initial quarter of operations Wellcheck.com research and
development expenses were $388,000 for the thirteen weeks ending December 24,
1999 with no comparable expenses in the thirteen weeks ended December 25, 1998.
Nearly all costs were associated to outside contracts to determine the web site,
and other software, design and performance requirements.
Research and development expenses for the first thirty-nine weeks of
fiscal 2000 were $2.2 million compared to $2.1 million for the first thirty-nine
weeks of fiscal 1999. Research and development expenses as a percentage of
revenues decreased to 11.9% for the first thirty-nine weeks of fiscal 2000 from
13.0% for the same thirty-nine weeks of fiscal 1999. The Diagnostic Products
business unit represented 83% and 100% of the Company's research and development
expenses for the thirty-nine weeks ended December 24, 1999 and thirty-nine weeks
ended December 25, 1998, respectively. The WellCheck.com business unit
represented approximately 17% and 0% of the Company's research and development
expenses for the first three quarters of fiscal 2000, and 1999 respectively.
Diagnostic Products expenses decreased 11.3% to $1.8 million, from $2.1
million for the first thirty-nine weeks of 1999. This was due to a combination
of lower head count, reduced depreciation, and stronger control of discretionary
spending.
General and Administrative Expense. General and administrative expense
includes compensation, benefits, and expenses for outside services. General and
administrative expense
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CHOLESTECH CORPORATION
increased 60.9% to $1.0 million in the thirteen weeks ended December 24, 1999,
from $624,000 in the thirteen weeks ended December 25, 1998. General and
administrative expenses increased to 14.9% of revenues in the thirteen weeks
ended December 24, 1999, from 11.6% in the thirteen weeks ended December 25,
1998. The Diagnostic Products business unit represented 59% and 100% of the
Company's general and administrative expenses for the thirteen weeks ended
December 24, 1999, and December 25, 1998, respectively. The WellCheck.com
business unit represented approximately 41% and 0% of the Company's general and
administrative expenses for the third quarter of fiscal 2000 and 1999,
receptively.
Diagnostic Products expenses decreased by 5.0% to $593,000 for the
thirteen weeks ended December 24, 1999 from $624,000 in the thirteen weeks
ending December 25, 1998. The reduction was achieved through the allocation of
shared expenses to the newly created WellCheck.com business unit. This was
partially offset by the creation of the Chief Operating Officer position, which
caused the transfer of expense from sales and marketing to general and
administrative expense.
WellCheck.com expenses were $411,000 during the third quarter of fiscal
2000, with no related expenses for the third quarter of fiscal 1999. Expenses
were the combination of the newly created Chief Operating Officer position for
the business unit, and the allocation of shared expenses with the Diagnostic
Products unit.
General and administrative expense for the first thirty-nine weeks of
fiscal 2000 were $2.2 million compared to $1.8 million for the same period in
fiscal 1999. General and administrative expenses increased to 11.8% of revenues
in the first thirty-nine weeks of fiscal 2000 from 10.8% in the same period in
fiscal 1999. The Diagnostic Products business unit represented 82% and 100% of
the Company's general and administrative expenses for the thirty-nine weeks
ended December 24, 1999, and thirty-nine weeks ended December 25, 1998
respectively. The WellCheck.com business unit represented approximately 18% and
0% of the Company's general and administrative expenses for the first third
quarters of fiscal 2000 and 1999 respectively.
Diagnostic Products expenses remained nearly the same at $1.8 million
for both the thirty-nine weeks ending December 24, 1999 and December 25, 1998.
As stated above expenses included the promotion of the vice president of sales
and marketing to the Chief Operating Officer position, and the allocation of
shared expenses with the WellCheck.com business unit.
Other. Other expense for the thirty-nine weeks ending December 24, 1999
of $219,000 compared to $575,000 for the respective thirty-nine weeks of fiscal
1999. The fiscal 2000 expenses relate to the Company's defense of class action
lawsuit and a charge relating to the amendment of certain employee stock options
to increase their term by two years. Expenses for the thirty-nine weeks of
fiscal 1999 included the settlement of litigation involving a former employee
and the cancellation of a proposed common stock offering.
Interest and other income, net. Interest and other income, net reflects
income from the investment of cash balances and marketable securities. Interest
income increased 44.8% to $223,000 in the thirteen weeks ended December 24, 1999
from $154,000 in the thirteen weeks
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CHOLESTECH CORPORATION
ended December 25, 1998. This increase was the result of the positive cash flows
during the thirteen weeks ending December 24, 1999 invested in marketable
securities.
Interest income declined by 1.8% to $556,000 in the first thirty-nine
weeks of fiscal 2000 from $566,000 for the same period in fiscal 1999. The
reduction was attributed to a lower investment value in the first twenty-six
weeks of fiscal 2000.
Income Taxes. As the Company has significant tax credit carry forwards,
the provision for income taxes for the thirteen weeks ended December 24, 1999,
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 2000. Accordingly, the Company's
estimated effective tax rate is expected to remain below the federal statutory
rate throughout fiscal 2000.
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 December 24, 1999, the Company raised $71.5 million in net proceeds from
equity financing. As of December 24, 1999, the Company had $16.0 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, 2000. As of December 24, 1999,
there were no borrowings outstanding under the line of credit.
During the first thirty-nine weeks of fiscal 2000, the Company provided
$5.3 million in net cash from operating activities compared to net cash used of
$1.9 million in the first thirty-nine weeks of fiscal 1999. The net cash
generated from operations in the first thirty-nine weeks of fiscal 2000 was
primarily due to net income of $1.7 million, adjustments for non-cash items
including $1.1 million for depreciation and amortization, $1.2 million increase
in current liabilities and $1.1 million for decreased inventories. In the
corresponding thirty-nine weeks of fiscal 1999, a net loss of $86,000 plus
adjustments for non-cash items including $2.1 million for increased inventories
and $1.5 million for decreases in accounts payable were the primary factors
contributing to cash used in operations activities.
Net cash used by investing activities was $4.9 million in the first
thirty-nine weeks of fiscal 2000, consisting primarily of net purchases of
marketable securities totaling $2.9 million and purchase of equipment totaling
$2.0 million. For the thirty-nine weeks of fiscal 1999, the Company provided
$2.5 million of net cash from the sale of marketable securities and purchased
$2.3 million of equipment.
Proceeds from the Company's stock option incentive program sales
provided $1.3 million in the first thirty-nine weeks of fiscal 2000. For the
corresponding thirty-nine weeks of fiscal
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CHOLESTECH CORPORATION
1999, $329,000 was provided by the issuance of Common Stock pursuant to the
Company's stock incentive program.
Over the balance of fiscal 2000, the Diagnostic Products business unit
intends to expend approximately $300,000 for capital purchases related to
expansion of its manufacturing capacity and research and development.
Additionally the Company plans to spend approximately $2.2 million for the
acquisition of Health Net, to be incorporated into the of the WellCheck business
unit. The Company also plans to spend up to $4.0 million for the software and
web site development costs for the WellCheck.com business unit may be required.
At this point in time, Contracts have not been signed and schedules have not
been set, and the payments may fall into the next fiscal year. Non-cancelable
purchase commitments at December 24, 1999 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 foreseeable 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 Well Check.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.
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."
NEW ACCOUNTING PRONOUNCEMENTS
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CHOLESTECH CORPORATION
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. The Company will adopt SFAS No. 133, as
required, in fiscal year 2001.
YEAR 2000 COMPLIANCE
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.
As of the first three week of January 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. 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 products for Year 2000
dependencies and Year 2000 compliance. Based on that evaluation, the Company
believes its products, are Year 2000 compliant.
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, during the
Year 2000, the functionality of certain medical records systems will be
adversely affected when one or more component products of such systems are
unable to process four digit characters representing years and, therefore, the
medical records system would not be 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, the Company has not experienced a single delay in order
receipt, or receipt of materials from suppliers related to Year 200 compliance.
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 has worked with the key
suppliers of products and services as well as distributors of the Company's
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CHOLESTECH CORPORATION
products to determine whether their systems, products, and services are Year
2000 compliant. This investigation 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 will continue into
the year 2000. Despite this effort the Company anticipates that there may still
exists the potential for substantial litigation which may be brought against
vendors of component products provided to 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.
At this point in time, nearly all of the sole source and key suppliers
have made representations of being year 2000 compliant, and the Company has an
adequate inventory to bridge any short-term delivery problems. 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 sole source and key vendors, suppliers, or distributors
have systems that are not Year 2000 compliant, 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.
Cholestech has incurred and may continue to incur various costs to
conduct testing and modification of its products and to provide customer support
services regarding Year 2000 issues. To date, the costs incurred and anticipated
costs 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. If any litigation arises from
Year 2000 dependency issues that we have not identified, cost relating to such
issues could extend into calendar year 2000 and beyond.
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. Should there be a major
failure in many customers' software systems, purchases could be delayed or
eliminated. Additionally, payments could potentially be late or lost. This would
result in reduced operating income, reduced cash flow, and inventory exposure.
This could have a material adverse effect on the Company's business, operating
results, or financial condition.
POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS
NO EXPERIENCE IN THE TESTING SERVICES OR INTERNET BUSINESSES. The
testing services business and the Internet business to be pursued through our
newly created WellCheck and WellCheck.com business units are completely new to
Cholestech and our management team. To date our business has been exclusively in
the area of manufacturing and marketing the Cholestech L-D-X(R) System. We may
not be able to successfully develop these new businesses. The demands of
attempting to grow these new businesses may prevent us from devoting
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CHOLESTECH CORPORATION
significant time and attention to our traditional business, and that traditional
business may decline.
INTERNET HEALTH MANAGEMENT IS A NEW AND UNPROVEN BUSINESS. The
internet-based health information management business is a very new and as yet
unproven market. Whether we succeed in this business will depend upon individual
acceptance of internet-based management of personal health information. People
may not feel comfortable having their health-related information available over
the Internet despite the privacy and security measures we plan to take.
MINIMAL EXPERIENCE IN MANAGING GEOGRAPHICALLY DIVERSE OPERATIONS. Our
traditional business has been managed and operated almost exclusively from our
Hayward, California headquarters. The new WellCheck business we are adopting
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 able to manage these changes rapidly,
successfully, or at all.
SIGNIFICANT STARTUP EXPENSES. 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
effect 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 on 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.
ACQUISITION RELATED RISKS. 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 such 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 which could materially harm our operating results and business.
Additional risks from the acquisition(s) we plan may include:
Difficulties in assimilating the operations, technologies, products,
services, and personnel of the acquired company or business - especially
assimilating multiple small businesses that Cholestech may acquire. The
diversion of our management's attention from other business concerns; and the
potential loss of key employees of the acquired company or business.
INTERNET BUSINESS RISKS. 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, or the individual's
consent. Any such security breach could greatly erode
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CHOLESTECH CORPORATION
consumer confidence in our WellCheck.com business and could 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 ultimately decided in our favor, such litigation could
result in significant expense and distraction of our management.
UNCERTAINTY OF MARKET ACCEPTANCE OF THE L-D-X SYSTEM. The L-D-X System,
including the L-D-X Analyzer (the Company's only product platform) and single
use test cassettes, will continue to account for substantially all of the
Company's revenues for the foreseeable future. In order for the Company to
increase revenues, sustain profitability, and maintain positive cash flows from
operations, the L-D-X System must continue to gain market acceptance among
healthcare providers, particularly 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 healthcare 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, healthcare providers may elect
not to purchase and use the L-D-X System for any number of reasons. For example,
physicians and other healthcare 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
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CHOLESTECH CORPORATION
Company's sole product focus, the Company could be required to cease operations
if the L-D-X System does not achieve and maintain a significant level of market
acceptance.
HISTORY OF LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY; FLUCTUATIONS IN
OPERATING RESULTS. Historically, the Company has experienced significant
operating losses and negative cash flows from operations and, as of December 24,
1999, had an accumulated deficit of $46.9 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 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, or loss, 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.
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CHOLESTECH CORPORATION
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.
The Company received 510(k) clearance to market the Alanine
Aminotransferase (ALT) test for liver function in September, 1999. The Company
submitted an application in September, 1999, to the CDC seeking CLIA waived
status. 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
ALT product. 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 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 BUB/Creatinine test cassette with the
L-D-X System. The CDC rejected the Company's Request in March, 1999. The product
is not currently in the development priority.
In order to successfully commercialize any new tests, including the
Alanine Aminotransferase (ALT) 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, acquired by Quidel Corporation in
July 1999, to develop an immunoassay cassette for Quidel's bone resorption assay
to be used on the L-D-X System. Quidel 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 Quidel exercises its
right to terminate the agreement, which it may do at any time. To date the
Company and Quidel have not been able to complete the development work
contemplated under the agreement and are discussing what steps they should take
in the future. There can be no assurance that Quidel will not terminate the
agreement or that Quidel will purchase any additional Common Stock.
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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 could be materially adversely affected.
RISKS ASSOCIATED WITH CASSETTE MANUFACTURING. The Company internally
manufactures all of the single use test cassettes that are used with the L-D-X
Analyzer. The manufacture of the test cassettes is a highly complex and precise
process. Such manufacturing is sensitive to a wide variety of factors, including
raw material variations and impurities, manufacturing process variances,
manufacturing equipment performance, and manufacturing environment contaminants.
The Company has in the past experienced lower than expected manufacturing yields
that have adversely affected gross margins and delayed product shipments. To the
extent that the Company does not maintain acceptable manufacturing yields of
test cassettes or experiences product shipment delays, the Company's business,
financial condition and results of operations would be materially adversely
affected. The Company's cassette manufacturing lines would be costly and time
consuming to repair or replace if their operation were interrupted. As the
Company's production levels have increased, the Company has been required to use
its machinery more hours per day and the down time resulting from equipment
failure has increased. The custom nature of much of the Company's manufacturing
equipment increases the time required to remedy equipment failures and replace
equipment. Furthermore, the Company has a limited number of employees dedicated
to the operation and maintenance of the cassette manufacturing equipment, the
loss of whom could impact the Company's ability to effectively operate and
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 and achieve acceptable yields, could
lead to an
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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 healthcare 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
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to enter into and maintain such arrangements on a timely basis, if at all. The
Company is dependent upon such distributors to assist it in promoting market
acceptance of the L-D-X System. It is uncertain whether distributors will devote
the resources necessary to provide effective sales and marketing support to the
Company. In addition, the Company's distributors may give higher priority to the
products of other medical suppliers, thus reducing their efforts to sell the
Company's products. If the Company is unable to establish appropriate
arrangements with distributors, or if any of the Company's distributors do not
promote, market, and sell the L-D-X Analyzer and single use test cassettes, the
Company's business, financial condition, and results of operations could be
materially adversely affected.
UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT. In the United States,
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. The
Company's ability to commercialize its products successfully in the United
States will depend in part on the extent to which reimbursement for the costs of
tests performed with the L-D-X System and related treatment will be available
from government health authorities, private health insurers and other third
party payors. Third party payors can affect the pricing or the relative
attractiveness of the Company's products by regulating the maximum amount of
reimbursement provided for testing services. Reimbursement is currently not
available for certain uses of the Company's products in particular
circumstances. As a general rule, third party reimbursement is available if a
physician has been involved in the decision to perform the test involving the
Company's products. For example, if a physician prescribes a drug that requires
therapeutic monitoring, the use of the Company's products in performing such
tests will be reimbursable.
In the health promotion market, use of the Company's products for
diagnostic screening in health promotion clinics is generally subject to
reimbursement. However, diagnostic screening preformed in corporate wellness
programs and at fitness centers is likely not 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 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 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
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
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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 the Company.
Market acceptance of the Company'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. There can be no assurance
that third party reimbursement and coverage will be available or adequate in
either United States or international markets, that current reimbursement
amounts will not be decreased in the future or that future legislation,
regulation, or reimbursement policies of third party payors will not otherwise
adversely affect demand for the Company's products or the Company's ability to
sell its products on a profitable basis, any of which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Political, economic and regulatory influences are pushing the healthcare
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 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. The Company
cannot predict what impact the adoption of any federal or state healthcare
reform measures, future private sector reform or market forces may have on its
business.
GOVERNMENT REGULATION. The manufacture and sale of diagnostic products,
including the L-D-X System, are subject to extensive regulation by numerous
governmental authorities, principally the FDA and corresponding state and
foreign regulatory agencies. The Company will not be able to commence marketing
or commercial sales in the United States of any of the new tests it is
developing until it receives clearance or approval from the FDA. The process of
obtaining FDA and other required regulatory clearances and approvals is lengthy,
expensive and uncertain. As a result, there can be no assurance that any of the
Company's new tests under development, even if successfully developed, will ever
obtain such clearance or approval.
Additionally, certain material changes to medical products already
cleared or approved by the FDA are also subject to further FDA review and
clearance or approval. The loss of previously obtained clearances, or failure to
comply with existing or future regulatory requirements, could have a material
adverse effect on the Company's business, financial condition and results of
operations. The L-D-X Analyzer and all existing test cassettes required
clearance pursuant to a 510(k) clearance. Medical devices are subject to
continual review, and later discovery of previously unknown problems with a
cleared product may result in restrictions on the product's marketing or
withdrawal of the product from the market.
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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. 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. 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 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
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promulgation of additional regulations impacting laboratory testing will not
have an adverse effect on the Company's ability to market the L-D-X System. For
example, if CLIA regulations were modified in a manner that reduced regulatory
requirements and burdens faced by competitive products, certain competitive
advantages of the L-D-X System's waived status could be reduced or eliminated.
The Company's manufacturing processes, as well as, in certain instances, those
of its contract manufacturers, are subject to stringent federal, state and local
regulations governing the use, generation, manufacture, storage, handling and
disposal of certain materials and wastes. The Company and its contract
manufacturers must economically manufacture products in compliance with federal,
state and foreign regulations regarding the manufacture of healthcare products
and diagnostic devices, including QSR, and other foreign regulations and state
and local health, safety and environmental regulations, which include testing,
control and documentation requirements. Failure to comply with QSR,
ISO9001/EN46001 requirements and other applicable regulatory requirements by the
Company and in certain ISO9001/EN46001 certification regulations circumstances,
its contract manufacturers, including marketing products for unapproved uses,
could result in, among other things, warning letters, fines, injunctions, civil
penalties, recall or seizure of products, total or partial suspension of
production, refusal of the government to grant pre-market clearance or
pre-market approval for devices, withdrawal of approvals and criminal
prosecution. Changes in existing regulations or adoption of new governmental
regulations or policies could prevent or delay regulatory approval of the
Company's products. There can be no assurance that the Company will not be
required to incur significant costs in the future in complying with
manufacturing and environmental regulations.
DEPENDENCE ON PROPRIETARY TECHNOLOGY; UNCERTAINTY OF PATENT AND
PROPRIETARY TECHNOLOGY PROTECTION; DEPENDENCE ON LICENSING OF TECHNOLOGY FROM
THIRD PARTIES. The Company's ability to compete effectively will depend in part
on its ability to develop and maintain the proprietary aspects of its technology
and operate without infringing the proprietary rights of others. The Company has
nine United States patents and has filed patent applications relating to its
technology internationally under the Patent Cooperation Treaty and individual
foreign patent applications. There can be no assurance that any of the Company's
pending patent applications will result in the issuance of any patents, or that,
if issued, any such patents will offer protection against competitors with
similar technology. There can be no assurance that any patents issued to the
Company will not be challenged, invalidated or circumvented in the future or
that the rights created thereunder will provide a competitive advantage. In
addition, there can be no assurance that competitors, many of which have
substantially greater resources than the Company and have made substantial
investments in competing technologies, will not seek to apply for and obtain
patents covering technologies that are more effective than the Company's
technologies, that would render the Company's technologies or products obsolete
or uncompetitive or that would prevent, limit or interfere with the Company's
ability to make, use or sell its products either in the United States or in
international markets.
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
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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. There can be no
assurance that the Company will be able to obtain licenses for technology
patented by others on commercially reasonable terms, or at all, that it will be
able to develop alternative approaches if unable to obtain licenses or that the
Company's current and future licenses will be adequate for the operation of the
Company's business. The failure to obtain such licenses or identify and
implement alternative approaches could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company also relies upon trade secrets, technical know-how and continuing
invention to develop and maintain its competitive position, and no assurance can
be given that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to the Company's
trade secrets or disclose such technology, or that the Company can meaningfully
protect its right to its trade secrets, any of which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
HIGHLY COMPETITIVE INDUSTRY; RAPID TECHNOLOGICAL CHANGE. The markets for
diagnostic screening and therapeutic monitoring in which the Company operates
are intensely competitive. The Company's competition consists mainly of clinical
and hospital laboratories, as well as manufacturers of bench top analyzers. In
order to achieve market acceptance for the L-D-X System, the Company will be
required to demonstrate that the L-D-X System is an attractive alternative to
bench top analyzers as well as to clinical and hospital laboratories. This will
require physicians to change their established means of having such tests
performed. There can be no assurance that the L-D-X System will be able to
compete with these other testing services and analyzers. In addition, companies
having a significant presence in the market for therapeutic monitoring, such as
Abbott Laboratories, Clinical Diagnostic Systems, a division of Johnson &
Johnson and formerly a division of Eastman Kodak Company, and 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
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addition, several smaller companies are currently making or developing products
that compete or will compete with those of the Company.
The Company expects that its competitors will compete intensely to maintain and
increase market share and seek to develop similar multi-analyte tests that
qualify for CLIA waiver. There can be no assurance that these competitors will
not succeed in obtaining CLIA waived status for their products or in developing
or marketing technologies or products that are more effective and commercially
attractive than the Company's current or future products, or that would render
the Company's technologies and products obsolete or noncompetitive. The
Company's current and future products must compete effectively with the existing
and future products of the Company's competitors primarily on the basis of ease
of use, breadth of tests available, market presence, cost effectiveness,
precision, accuracy, immediacy of results and the ability to perform tests near
the patient, to test multiple analytes from a single sample and to conduct tests
without a skilled technician or pre-treating blood. There can be no assurance
that the Company will have the financial resources, technical expertise or
marketing, distribution or support capabilities to compete successfully in the
future or, if the Company does have such resources and capabilities, that it
will employ them successfully.
DEPENDENCE ON ATTRACTION AND RETENTION OF KEY EMPLOYEES. The Company's
success depends in significant part upon the continued service of certain key
scientific, technical, regulatory and managerial personnel, and its continuing
ability to attract and retain additional highly qualified personnel in those
areas. Competition for such personnel is intense, and there can be no assurance
that the Company will be able to retain such personnel or that it can attract or
retain other highly qualified personnel in the future, including key sales and
marketing personnel. The loss of key personnel or the inability to hire or
retain qualified personnel could have a material adverse effect upon the
Company's business, financial condition and results of operations.
RISK OF PRODUCT LIABILITY; PRODUCT LIABILITY INSURANCE MAY BE
INSUFFICIENT OR UNAVAILABLE. Sale of the Company's products entails risk of
product liability claims. The medical testing industry has historically been
litigious, and the Company faces financial exposure to product liability claims
in the event that use of its products results in personal injury or improper
diagnosis. The Company also faces the possibility that defects in the design or
manufacture of its products might necessitate a product recall. There can be no
assurance that the Company will not experience losses due to product liability
claims or recalls in the future.
The Company currently maintains product liability insurance, but there
can be no assurance that the coverage limits of the Company's insurance policies
will be adequate. Such insurance is expensive and difficult to obtain, and no
assurance can be given that product liability insurance can be maintained in the
future on acceptable terms, in sufficient amounts to protect the Company against
losses due to product liability, or at all. Inability to maintain insurance at
an acceptable cost or to otherwise protect against potential product liability
could prevent or inhibit the continued commercialization of the Company's
products. In addition, a product liability claim in excess of relevant insurance
coverage or a product recall could have a material adverse effect on the
Company's business, financial condition and results of operations.
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POSSIBLE FUTURE CAPITAL REQUIREMENTS; UNCERTAINTY OF ADDITIONAL FUNDING.
The Company intends to expend substantial funds for capital equipment related to
the 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
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CHOLESTECH CORPORATION
acquiror to take over the Company, in a manner or on terms not approved by the
Board. The Rights have been declared by the Board in order to deter coercive
tactics, including a gradual accumulation of shares in the open market, of a 15%
or greater position to be followed by a merger or a partial or two-tier tender
offer that does not treat all shareholders equally. The Rights should not
interfere with any merger or other business combination approved by the Board.
However, the Rights may have the effect of rendering more difficult or
discouraging an acquisition of the Company deemed undesirable by the Board. The
Rights may cause substantial dilution to a person or group attempting to acquire
the Company on terms or in a manner not approved by the Board, except pursuant
to an offer conditioned upon the negation, purchase or redemption of the Rights.
POTENTIAL VOLATILITY OF STOCK PRICE. The market price of the Common
Stock, like that of the common stock of many other medical products and
technology companies, has in the past been, and is likely in the future to
continue to be, highly volatile. Factors such as fluctuations in the Company's
operating results, announcements of technological innovations or new commercial
products by the Company or its competitors, government regulation, changes in
the current structure of the healthcare 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.
35
<PAGE> 36
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 25, 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. 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 August 9, 1999, Cholestech filed in the United States District
Court for the Southern District of Indiana a complaint entitled
Cholestech Corporation v. Polymer Technology Systems, Inc. and Tracy
Thompson, No. IP99-1223-C T/G. Cholestech's complaint and substantive
causes of action were based on its allegations that Mr. Thompson, a
former Cholestech employee, disclosed, and/or was likely to disclose,
certain confidential and proprietary information of Cholestech to
Polymer and that Polymer was misappropriating this information. On
August 19, 1999, Polymer and Thompson ("plaintiffs") filed in the Marion
County Superior Court in Indianapolis, Indiana, a complaint entitled
Polymer Technology Systems, Inc. and Tracy Thompson v. Cholestech No.
49D02-9908-CP-001134 ("state court action"). In their complaint,
plaintiffs sought a declaration from the court that the information
Cholestech sought to protect in the federal court action does not
constitute a trade secret. By mutual agreement of the parties,
Cholestech voluntarily dismissed its federal court action, and on
September 1, 1999, filed a counterclaim against the plaintiffs in the
state court action. The parties to this action recently agreed to
resolve this action by way of a settlement agreement. The terms of that
agreement are confidential. The settlement does materially affect the
Company.
On May 6, 1999 The Company filed a complaint, No. 9901251, in the
Brussels Belgium court system seeking a patent infringement claim
against Roche Diagnostics. This action was filed to protect the
Company's European Patent rights for high density lipoproteins ("HDL").
The Company believes this action 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.
36
<PAGE> 37
CHOLESTECH CORPORATION
On December 23, 1999 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 until February 21, 2000 to
generate a response. The Company believes the suit is without merit and
intends to defend the case vigorously. The Company does not believe that
it did not cause 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.
Additionally, we have been informed by one of our Distributors
that during 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 in to Germany. The company
has not been served, nor has been given a formal copy of the complaint.
The complaint alleges the Company and its distributor 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. The Company
does not believe that it did not cause 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 the
initial hearing date is set for March 9, 2000.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the security holder during
the thirteen weeks ending December 24, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
10.17.6 Revolving Line of Credit Note effective
November 30, 1999 by and between Wells Fargo
Bank and the Registrant.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K. No Reports on Form 8-K were filed
during the thirteen weeks ended December 24, 1999.
37
<PAGE> 38
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 02/04/00 /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)
38
<PAGE> 39
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibits No. Description
- ------------ -----------
<S> <C>
10.17.6 Revolving Line of Credit Note effective November 30, 1999 by and
between Wells Fargo Bank and the Registrant.
27.1 Financial Data Schedule.
</TABLE>
<PAGE> 1
EXHIBIT 10.17.6
WELLS FARGO BANK REVOLVING LINE OF CREDIT NOTE
- --------------------------------------------------------------------------------
$3,000,000.00 Oakland, California
November 30,1999
FOR VALUE RECEIVED, the undersigned CHOLIESTECH CORPORATION ('Borrower')
promises to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION ("Bank')
at its office at East Say RCSO, One Kaiser Plaza Suite SSO, Oakland, CA 94612,
or at such other place as the holder hereof may designate, in lawful money of
the United States of America and in immediately available funds, the principal
sum of $3,000,000.00, or so much thereof as may be advanced and be outstanding,
with interest thereon, to be computed on each advance from the date of its
disbursement as set forth herein.
INTEREST:
(a) Interest. The outstanding principal balance of this Note shall bear
interest (computed on the basis of a 360-day year, actual days elapsed)
at a rate per annum equal to the Prime Rate in effect from time to time.
The 'Prime Rate' is a base rate that Bank from time to time establishes
and which serves as the basis upon which effective rates of interest are
calculated for those loans making reference thereto. Each change in the
rate of interest hereunder shall become effective on the date each Prime
Rate change is announced within Bank.
(b) Payment of Interest. Interest accrued on this Note shall be payable
on the 30th day of each month, commencing December 30,1999.
(c) Default Interest. From and after the maturity date of this Note, or
such earlier date as all principal owing hereunder becomes due and
payable by acceleration or otherwise, the outstanding principal balance
of this Note shall bear interest until paid in full at an increased rate
per annum (computed on the basis of a 360-day year, actual days elapsed)
equal to 4% above the rate of interest from time to time applicable to
this Note.
(d) Collection of Payments. Borrower authorizes Bank to collect all
interest due hereunder by charging Borrower's demand deposit account
number 4187-516166 with Bank, or any other demand deposit account
maintained by any Borrower with Bank, for the full amount thereof.
Should there be insufficient funds in any such demand deposit account to
pay all such sums when due, the full amount of such deficiency shall be
immediately due and payable by Borrower.
BORROWING AND REPAYMENT:
(a) Borrowing and Repayment. Borrower may from time to time during the
term of this Note borrow, partially or wholly repay its outstanding
borrowings, and reborrow, subject to all of the limitations, terms and
conditions of this Note and of any document executed in connection with
or governing this Note; provided however, that the total outstanding
borrowings under this Note shall not at any time exceed the principal
amount stated above. The unpaid principal balance of this obligation at
any time shall be the total amounts advanced hereunder by the holder
hereof less the amount of principal payments made hereon by or for any
Borrower, which balance may be endorsed hereon from time to time by the
holder. The outstanding principal balance of this Note shall be due and
payable in full on November 30, 2000.
(b) Advances. Advances hereunder, to the total amount of the principal
sum available hereunder, may be made by the holder at the oral or
written request of (i) Warren Pinckert or Andrea Tiller, any one acting
alone, who are authorized to request advances and direct the disposition
of any advances until written notice of the revocation of such authority
is received by the holder at the office designated above, or (ii) any
person, with respect to advances deposited to the credit of any account
of any Borrower with the holder, which advances, when so deposited,
shall be conclusively presumed to have been made to or for the benefit
of each Borrower regardless
<PAGE> 2
of the fact that persons other than those authorized to request advances
may have authority to draw against such account. The holder shall have
no obligation to determine whether any person requesting an advance is
or has been authorized by any Borrower.
(c) Application of Payments. Each payment made on this Note shall be
credited first, to any interest then due and second, to the outstanding
principal balance hereof.
EVENTS OF DEFAULT:
The occurrence of any of the following shall constitute an 'Event of Default'
under this Note:
(a) The failure to pay any principal, interest, fees or other charges when due
hereunder or under any contract, instrument or document executed in connection
with this Note.
(b) The filing of a petition by or against any Borrower, any guarantor of this
Note or any general partner or joint venturer in any Borrower which is a
partnership or a joint venture (with each such guarantor, general partner and/or
joint venturer referred to herein as a 'Third Party Obligor') under any
provisions of the Bankruptcy Reform Act. Title 11 of the United States Code, as
amended or recodified from time to time, or under any similar or other law
relating to bankruptcy, insolvency, reorganization or other relief for debtors;
the, appointment of a receiver, trustee, custodian or liquidator of or for any
part of the assets or property of any Borrower or Third Party Obligor; any
Borrower or Third Party Obligor becomes insolvent, makes a general assignment
for the benefit of creditors or is generally not paying its debts as they become
due; or any attachment or like levy on any property of any Borrower or Third
Party Obligor.
(c) The death or incapacity of any individual Borrower or Third Party Obligor,
or the dissolution or liquidation of any Borrower or Third Party Obligor which
is a corporation, partnership, joint venture or other type of entity.
(d) Any default in the payment or performance of any obligation, or any defined
event of default, under any provisions of any contract, instrument or document
pursuant to which any Borrower or Third Party Obligor has incurred any
obligation for borrowed money, any purchase obligation, of any other liability
of any kind to any person or entity, including the holder.
(e) Any financial statement provided by any Borrower or Third Party Obligor to
Bank proves to be incorrect, false or misleading in any material respect.
(f) Any sale or transfer of all or a substantial or material part of the assets
of any Borrower or Third Party Obligor other than in the ordinary course of its
business.
(g) Any violation or breach of any provision of, or any defined event of default
under, any addendum to this Note or any loan agreement, guaranty, security
agreement, deed of trust, mortgage or other document executed in connection with
or securing this Note.
MISCELLANEOUS:
(a) Remedies. Upon the occurrence of any Event of Default, the holder of this
Note, at the holder's option, may declare all sums of principal and interest
outstanding hereunder or to be immediately due and payable without presentment,
demand, notice of nonperformance, notice of protest, protest of notice of
dishonor, all of which are expressly waived by each Borrower, and the
obligation, if any, of the holder to extend any further credit hereunder shall
immediately cease and terminate. Each Borrower shall pay to the holder
immediately upon demand the full amount of all payments, advances, charges,
costs and expenses, including reasonable attorneys' fees (to include outside
counsel fees and of allocated costs of the holder's in-house counsel), expanded
or incurred by the holder in connection with the enforcement of the holder's
rights and/or the collection of any amounts which become due to the harder under
this Note, and the prosecution or defense of any action in any way related to
this Note, including without limitation, any
<PAGE> 3
action for declaratory relief, whether incurred at the trial or appellate level,
in an arbitration proceeding or otherwise, and including any of the foregoing
incurred in connection with any bankruptcy proceeding including without
limitation, any adversary proceeding, contested matter or motion brought by Bank
or any other person) relating to any Sot-rower or any other person or entity.
(b) Obligations Joint and Several. Should more than one person or entity sign
this Note as a Borrower, the obligations of each such Borrower shall be joint
and several.
(c) Governing Law. This Note shall be governed by and construed in accordance
with the laws of the state of California.
IN WITNESS WHEREOF, the undersigned has executed this Note as of the date first
written above.
CHOLESTECH CORPORATION
By: /s/ WARREN PINCKERT
--------------------------
Warren Pinckert, President
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<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> MAR-28-1999
<PERIOD-END> DEC-24-1999
<CASH> 7,217
<SECURITIES> 3,858
<RECEIVABLES> 2,381
<ALLOWANCES> 97
<INVENTORY> 3,391
<CURRENT-ASSETS> 17,066
<PP&E> 13,803
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0
0
<COMMON> 71,652
<OTHER-SE> (46,912)
<TOTAL-LIABILITY-AND-EQUITY> 24,740
<SALES> 18,858
<TOTAL-REVENUES> 18,858
<CGS> 7,888
<TOTAL-COSTS> 17,425
<OTHER-EXPENSES> 219
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,770
<INCOME-TAX> 71
<INCOME-CONTINUING> 1,699
<DISCONTINUED> 0
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