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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended March 28, 1997
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to
Commission file number: 000-20198
CHOLESTECH CORPORATION
(Exact Name of Registrant as specified in its charter)
California 94-3065493
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
3347 Investment Blvd., Hayward, CA 94545
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (510) 732-7200
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
Preferred Share Purchase Rights, no par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sales price of the Common Stock on May 30,
1997 as reported on the Nasdaq National Market, was approximately $51,317,819.
Shares of Common Stock held by each officer and director and by each person who
owns 5% or more of the outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
As of May 30, 1997, registrant had outstanding 11,225,920 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the following documents are incorporated by reference into III of
this Form 10-K portions of its Proxy Statement for Registrant's 1997 Annual
Meeting of Shareholders to be held on August 22, 1997.
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PART I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Report constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"). Such forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Such factors include, among other things, the
following: the Company's history of losses and uncertainty of profitability; the
uncertainty of market acceptance of the Cholestech L.D.X System; the Company's
dependence on development and introduction of new products; the Company's
limited sales, marketing and distribution experience and dependence on
distributors; the risks associated with cassette manufacturing; the Company's
highly competitive industry and rapid technological change within the Company's
industry, the uncertainty of patent and proprietary technology protection and
reliance on technology licensed from third parties; changes in, or failure to
comply with, government regulation; the uncertainty of third party reimbursement
for procedures performed using the Company's products; the potential
fluctuations in the Company's annual and quarterly results; the Company's
dependence on, retention and attraction of key employees; general economic and
business conditions; and other factors referenced in this Report.
Cholestech and Cholestech L.D.X are registered trademarks of Cholestech
Corporation. This Report may also includes trademarks of companies other than
Company's.
ITEM 1: BUSINESS
GENERAL
Cholestech Corporation ("Cholestech" or the "Company") develops, manufactures
and markets a proprietary platform technology -- the Cholestech L.D.X(R) System
- -- whose first applications in the preventive care market measure specific
analytes to detect various diseases and disorders within five minutes using a
single drop of whole blood. The Company currently markets its Cholestech L.D.X
System and a series of lipid and glucose panels for diagnostic screening and
therapeutic monitoring applications. In January 1996, the Cholestech L.D.X
System and the Company's total cholesterol, high density lipoproteins,
triglycerides and glucose tests were granted waived status under the Clinical
Laboratory Improvement Amendments of 1988, the first such waiver granted under
Clinical Laboratory Improvement Amendments of 1988's newly-developed ease of
use, accuracy and precision guidelines. The Clinical Laboratory Improvement
Amendments of 1988 waiver allows health care providers to use the Cholestech
L.D.X System without the additional operating costs and extensive regulatory
requirements associated with Clinical Laboratory Improvement Amendments of 1988
compliance. The Company believes that the Cholestech L.D.X System is the only
multi-analyte diagnostic system to be classified as waived under Clinical
Laboratory Improvement Amendments of 1988. The Company believes that the
Cholestech L.D.X System's Clinical Laboratory Improvement Amendments of 1988
waived status, technological flexibility, ease of use, accuracy and low
maintenance costs provide it with competitive advantages over other preventive
care diagnostic systems.
MARKET OVERVIEW
Diagnostic testing of blood for chronic diseases and disorders is typically
performed in independent clinical laboratories or hospital-based laboratories
where large numbers of blood samples are processed in batches and test results
are often not returned to physicians in less than 24 hours. The Company believes
that as a result of the potential benefits and advantages of preventive care
testing, there exists an opportunity to shift certain types of diagnostic
testing from clinical laboratories and hospital-based laboratories to the point
of care. These potential benefits and advantages include permitting the health
care practitioner to provide immediate feedback to the patient. The Company
believes that the Cholestech L.D.X System will assist in the management of
patients with lipid disorders and have a positive impact on patient medication
compliance and persistence that will help patients reach their target
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lipid goals. The Company also believes that point of care testing could assist
in to reducing overall delivery costs and could improve patient outcomes by
providing diagnosis as close to the patient as possible, thereby eliminating the
need for additional patient follow-up visits for test results and redundant and
time consuming procedures and processes, reducing paperwork and minimizing the
time to medical intervention.
Two of the principal markets in which preventive care testing is performed
are the diagnostic screening and therapeutic monitoring markets. The diagnostic
screening market is generally comprised of hospitals, corporate wellness
programs, health promotion service providers, managed care organizations,
community health centers, public health programs, fitness centers, the military
and other independent screeners. These health care providers focus on
identifying patients who may be at risk for certain diseases or disorders and
directing them to appropriate therapeutic or preventive care programs. The
therapeutic monitoring market is generally comprised of physician office
laboratories, lipid clinics, cardiac rehabilitation centers and pharmacies.
These health care providers focus on disease management and perform testing to
monitor (i) patients who are identified as at risk for certain diseases, (ii)
patients on dietary or drug therapy, and (iii) patients at risk of, or who have
suffered, heart attacks or who are in cardiac rehabilitation. The Company
believes that the number of potential point of care testing sites is large. For
example, the National Cholesterol Education Program and American Heart
Association have encouraged cholesterol testing in such places as worksites,
community health centers and a variety of preventive medicine programs in order
to make such testing readily available. Until recently, preventive care testing
has been conducted predominately in the high volume diagnostic screening
settings. Preventive care testing in the therapeutic monitoring market has,
historically, been embraced by low volume physician office laboratories only on
a limited basis due to the costs and administrative burdens associated with
government regulatory requirements. In addition, technological limitations have
restricted the number of tests which can be performed cost effectively at the
point of care.
Historically, the Federal Clinical Laboratory Improvement Amendments of 1967
applied only to clinical and hospital-based laboratories, and physicians were
able to perform any laboratory testing that they believed was appropriate for
their patients. The physician office laboratories market grew as a result of the
development of easy to use laboratory testing equipment and the economic
incentives for physicians to perform such testing in their own offices. In 1988,
the regulatory environment in the physician office laboratories market changed
with the promulgation of Clinical Laboratory Improvement Amendments of 1988
which applied to all laboratories including physician office laboratories, which
perform testing on human specimens. Under Clinical Laboratory Improvement
Amendments of 1988, all laboratories are required to register with the Health
Care Financing Administration, but laboratories conducting non-waived tests must
pay higher registration fees and submit to biannual federal inspections.
Laboratories conducting non-waived tests are also required to implement a
comprehensive quality assurance program, which includes a detailed procedure
manual, enrollment in a proficiency testing program and a requirement to run two
levels of quality control material each day of testing, even if only one patient
sample is run. Moreover, Clinical Laboratory Improvement Amendments of 1988
regulations include personnel requirements that vary depending on the complexity
of tests performed. See "-- Government Regulation." Since physician office
laboratories testing is often done in low volumes and Clinical Laboratory
Improvement Amendments of 1988 requirements can significantly increase the costs
of testing, performing non-waived tests in a physician office laboratories
setting is often not cost effective. When Clinical Laboratory Improvement
Amendments of 1988 regulations went into effect in 1992, many physicians
discontinued all but waived testing. Clinical and hospital-based laboratories,
however, have continued to perform such testing and as a result currently
dominate this market.
Diagnostic Screening Market
In the diagnostic screening market, health care providers perform high volume
preventive risk factor diagnostic screening, particularly for cholesterol and
glucose. Although not subject to reimbursement by Medicare or other third party
payors, risk factor diagnostic screening has proven to be an effective way to
decrease the overall cost of medical care. Hospitals and health departments
offer health diagnostic screening in local communities. Many corporations (70%
of the corporations with greater than 5,000 employees) offer periodic
cholesterol diagnostic screenings to their employees at the worksite as part of
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worksite health promotion programs. Of those companies providing cholesterol
diagnostic screenings, approximately 30% also measure glucose. Worksite health
promotion is advocated by government agencies such as the National Heart, Lung
and Blood Institute and the Centers for Disease Control and Prevention. In
addition, private organizations promote worksite health promotion with a variety
of programs such as the American Heart Association's "Heart at Work" Program and
the YMCA's "Corporate Health Enhancement Program," which serves more than 2,000
worksites nationally. The Public Health Service has set goals for the number of
worksites offering cholesterol education and testing to be increased from 16% in
1983 to 50% by the year 2000. Due to the high volume of testing performed by
health care providers in the diagnostic screening market, the adoption of
Clinical Laboratory Improvement Amendments of 1988 and its resulting cost
increases and administrative burdens did not have a significant negative impact
on testing in the diagnostic screening market. From 1992 when Clinical
Laboratory Improvement Amendments of 1988 went into effect until January 1996,
when the Company's Cholestech L.D.X System and disposable test cassettes were
granted waived status, the Company focused its sales and marketing efforts in
the distribution of its products in the various segments of the diagnostic
screening market. Beginning in January 1996, and continuing to the present, the
Company has expanded its focus its sales and marketing efforts on both the
diagnostic screening market and the therapeutic monitoring market
Therapeutic Monitoring Market
Since the Company received notice from the Centers for Disease Control and
Prevention in January 1996 that the L.D.X System and the total cholesterol, high
density lipoproteins, triglycerides and glucose tests in any combination have
been classified as waived under Clinical Laboratory Improvement Amendments of
1988, the Company has expanded its sales and marketing focus to include the
therapeutic monitoring market, in particular the physician office laboratories
and pharmacy segments. The Company believes there are currently approximately
81,000 physician office laboratories which perform different types of diagnostic
tests. The Company currently offers four of the eight most common blood
chemistry tests performed at physician office laboratories, with an additional
two of these tests under development. In addition, the Company believes there
are currently approximately 53,000 pharmacies which could potentially offer
preventive care testing. The Company believes that long term success in the
pharmacy market will be dependent upon pharmacies developing of patient
therapeutic monitoring programs implemented with managed care practitioners and
physicians on a local basis.
STRATEGY
The Company's business strategy includes the following elements:
o Leverage Core Technologies to Enhance Product Offerings. The Company
intends to leverage the technological flexibility of the Cholestech L.D.X
System by developing new disposable test cassettes which utilize the
existing Cholestech L.D.X Analyzer in order to capitalize on the Company's
installed based of instruments as well as to make the Cholestech L.D.X
System more attractive to new customers. The Company is currently in
various stages of development of new immunoassay products which utilize
biological markers for diagnostic screening and therapeutic monitoring of
certain common diseases, such as metabolic bone diseases and disorders,
diabetes and prostate cancer. In addition, the Company is developing a new
test panel of blood urea nitrogen and creatinine for renal function
analysis and liver enzymes for hepatic damage. There can be no assurance
that the Company will be able to successfully complete the development,
introduction and scale up of manufacturing of any of these future products
or that any such tests will achieve a significant level of market
acceptance. See "-- Products Under Development" and "-- Manufacturing."
o Expand Distribution Channels. The Company intends to augment its direct
sales and marketing efforts by continuing to establish relationships with
selected third party distributors to strategically access target markets.
In the physician office laboratory market segment the Company is
represented by Physician Sales and Services, Inc. ("PSS"). To increase the
market penetration into the physician office laboratory market segment,
the Company entered into a distribution agreement
3
with General Medical Corporation in fiscal 1997. In addition, the Company
entered into a distribution agreement with AmeriSource Health Corporation
("AmeriSource") to target the retail pharmacy market segment. Also, in
fiscal 1997, the Company entered into distribution agreements with three
international distributors, Intermedix in Brazil, Diagnostic Testing LTD.
in England, and JY Trading in Korea, to sell Cholestech L.D.X(R) System
and disposable test cassettes to international markets.
o Increase Penetration of Diagnostic Screening Market and Continue to Expand
into Therapeutic Monitoring Market. The Company believes that the Clinical
Laboratory Improvement Amendments of 1988 waived status of its products
will continue to increase the number of potential customers in the
diagnostic screening market, and will enable the Company to continue to
access the therapeutic monitoring market. The Company is currently
developing new products to make its product line more attractive to the
physician office laboratories market as well as to expand its diagnostic
screening market offerings. In February 1997, the Company entered into a
two-year, minimum $2 million agreement with Health Management Services
Corporation (HMSC) to offer consumers testing of individual cholesterol
levels using the Cholestech L.D.X System at selected Wal-Mart stores
across the country.
o Establish Strategic Relationships. The Company has established and intends
to continue to establish strategic relationships to develop new products
and to expand its customer base. The Company believes that such
relationships will enable it to take advantage of the financial resources,
technological capabilities and market presence of its partners to enhance
its competitive position in the diagnostic screening market and expand
into the therapeutic monitoring market. In May 1996 the Company entered
into a development, marketing and licensing agreement with Metra
Biosystems Inc. ("Metra Biosystems") to develop an immunoassay test
cassette incorporating Metra Biosystems' bone resorption technology to be
used with the Cholestech L.D.X System. The Company is also participating
in a pilot program with the American Pharmaceutical Association funded by
Merck & Co. ("Merck") to demonstrate the ability of pharmacists to improve
patient outcomes with drug therapy and behavior modification.
TECHNOLOGY
The Cholestech L.D.X System is a self-contained, easy to use package of
products consisting of a proprietary, telephone-sized electronic analyzer, a
line of disposable test cassettes, and accessories that enable a user to perform
combinations of diagnostic tests in five minutes or less. Although no special
user training is needed and the test sample does not need to be pre-treated, the
Cholestech L.D.X System produces results that are comparable to the precision
and accuracy typically seen in larger, more expensive bench top and
laboratory-based analyzers. Correlation studies of the Cholestech L.D.X System
and clinical laboratory analyzers have shown that the Cholestech L.D.X System
meets National Cholesterol Education Program guidelines for precision and
accuracy. In addition, the ease of use and precision and accuracy of the System
were factors necessary for the L.D.X System to receive waived status under
Clinical Laboratory Improvement Amendments of 1988. The Company believes that it
is the only manufacturer with a Clinical Laboratory Improvement Amendments of
1988 waived, multi-analyte diagnostic system.
The Company believes the L.D.X System provides the following benefits and
advantages:
o Flexibility of L.D.X System. The design of the L.D.X System incorporates
as much of the system's technology as possible into the test cassettes and
maintains the L.D.X Analyzer as a flexible measuring device that can be
adapted as new tests and other product upgrades are introduced. As new
tests are marketed, encoding on the cassette's magnetic stripe
communicates the product change to the L.D.X Analyzer and provides the
L.D.X Analyzer the information needed to measure and display the test
results. Changes that cannot be captured on the cassette's magnetic stripe
can be accomplished by software changes in the L.D.X Analyzer's removable
read only memory ("ROM") pack. This flexible design is intended to permit
the installed base of users to incorporate new tests and other product
upgrades to the Cholestech L.D.X System without having to purchase a new
analyzer.
4
o Cost Effectiveness. The Company believes that point of care specimen
analysis made possible by the Cholestech L.D.X System may provide savings
to third party payors and physicians. Point of care testing allows the
health care practitioner to provide immediate results to the patient,
thereby increasing the possibility for improved patient outcomes and
eliminating the requirement that the patient return to receive test
results. In addition, the Company believes that the L.D.X System's waived
status under Clinical Laboratory Improvement Amendments of 1988, together
with prevailing third party reimbursement rates and recommended fees, may
provide a financial incentive for many health care providers to test
patients at the point of care and capture revenue rather than forwarding
it to the clinical laboratory.
o Immediate Results. The Cholestech L.D.X System provides the health care
practitioner with results in approximately five minutes, allowing for
immediate point of care risk factor analysis, diagnosis and therapeutic
monitoring. The immediacy of the test results allows the practitioner to
begin treatment during the same visit, perform additional tests if needed
or select an alternative treatment. The Cholestech L.D.X System's ability
to provide immediate test results also improves the usefulness of
diagnostic screening applications, such as worksite testing programs.
o Simultaneous Performance of Multiple Tests. With the Cholestech L.D.X
System, a single cassette can perform up to four tests simultaneously,
enabling the Company to develop test cassettes that meet specific market
needs. In the therapeutic monitoring market, the performance of multiple
tests with a single cassette may also result in more reimbursement revenue
for the physician.
o Ease of Use. The Cholestech L.D.X System requires no special medical or
chemistry training to operate and obtain test results. In addition, the
Cholestech L.D.X System eliminates the need to pre-treat the testing
sample.
o Fewer Opportunities for Error. The Cholestech L.D.X System eliminates many
of the steps traditionally involved in blood testing, including sample
transportation, preparation and storage, and interpretation of analyte
color reactions, thereby reducing opportunities for human error and
preserving the integrity of the sample.
Cholestech L.D.X System
The Cholestech L.D.X System is a four-channel, reflectance photometer that
measures the amount of light reflected from the reaction surfaces and
incorporates a microprocessor with on board software. The Cholestech L.D.X
System contains an entry drawer for insertion of the cassette, three buttons for
user activation and a liquid crystal display to present the test measurements.
The Cholestech L.D.X System can also transmit results to a printer or laboratory
management computer system for data handling and record keeping. The Cholestech
L.D.X System includes cardiac risk assessment software that allows the health
care practitioner to perform cardiac risk assessment using total cholesterol and
high density lipoproteins test results and information about other cardiac risk
factors the health care practitioner enters into the Cholestech L.D.X System.
To run a test, the health care provider presses the "run" button on the
Cholestech L.D.X System to open the cassette drawer, applies the sample of whole
blood directly to the test cassette's sample well, inserts the cassette onto the
drawer and presses the run button again. All further steps are done by the
Cholestech L.D.X System. Utilizing the information and instructions encoded on
the cassette's magnetic stripe, the Cholestech L.D.X System's on board
microprocessor controls the reaction conditions, controls the optical
measurements of analyte concentrations on the cassette's reaction pads, executes
the required calculations and, within approximately five minutes, displays the
quantitative results on the liquid crystal display.
The software that instructs and controls the operation of the Cholestech
L.D.X System's on board microprocessor is contained in a removable ROM pack
mounted in an access well on the bottom of the Cholestech L.D.X System. The
Company intends to upgrade the software in its ROM pack as the Company develops
new products. A user can then easily remove the ROM pack and replace it with a
new ROM pack containing upgraded software. To date, the Company has made
available to existing users a new ROM pack, without charge, containing the
cardiac risk assessment software described above, as well
5
as a new ROM pack, for a fee, reflecting certain changes required to receive the
Clinical Laboratory Improvement Amendments of 1988 waiver.
Disposable Test Cassettes
The focal point of the Cholestech L.D.X System is the line of disposable test
cassettes, which incorporate patented technology, including a method for
distributing precisely measured plasma to multiple reaction pads for
simultaneous testing along with the technology to instruct the L.D.X Analyzer
how to perform the tests and all related calculations.
Each cassette consists of three parts: a main body that contains the sample
well into which the blood sample is dispensed, a reaction bar where plasma is
transferred for analysis, and a magnetic stripe encoded with test instructions
and lot specific calibration information for the various chemistries on the
reaction pads. Capillary action draws a drop of whole blood through a separation
medium within a cassette, stopping the cellular components of the blood while
transferring a small volume of plasma to the cassette's reaction pads. When the
plasma contacts the reaction pads, the dry chemistry on the reaction pads reacts
with the analyte(s) in the plasma producing color. The intensity of color
developed is proportional to the concentration of the analyte(s) in the plasma.
The magnetic stripe contains information needed by the L.D.X Analyzer to convert
the reflected color reading into a concentration level for the accurate
measurement of analytes being tested. This feature frees the user from having to
interpret any color reaction, relate a reading to a separate chart or input any
calibration information.
For certain future tests, the Company will be required to modify the design
of the existing dry chemistry cassette. For example, the Company's immunoassay
tests currently under development require the use of antibodies bound to the
reaction membrane and a wash step which removes bound reactants that would
interfere with the test. The new immunoassay cassette under development has the
same external dimensions as the currently available dry chemistry cassette, but
will require the Company to develop new technologies that would allow it to
perform an immunoassay test, of which there can be no assurance. The Company
believes that, if the immunoassay cassette is successfully developed, the L.D.X
Analyzer will be the only point of care instrument capable of performing both
dry chemistry and immunoassay-based tests on a single instrument. See "--
Products -- Products Under Development."
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PRODUCTS
The Company's current products include the L.D.X Analyzer and a series of
lipid and glucose test cassettes for the diagnostic screening and therapeutic
monitoring markets. In addition, the Company is in the process of developing new
tests to expand its product menu, including immunoassay-based test cassettes to
provide preventive therapeutic monitoring assays for the detection of metabolic
bone diseases and disorders and prostate cancer. The following table summarizes
the Company's current cassette products and products under development:
L.D.X TEST APPLICATION TEST TYPE STATUS (1)
- ------------------------------ --------------------------- -------------------- --------------------------
CURRENT PRODUCTS
Total Cholesterol Cardiac Risk Dry Chemistry Marketed; FDA cleared;
CLIA waived
Total Cholesterol and High
Density Lipoprotein
Cholesterol Cardiac Risk Dry Chemistry Marketed; FDA cleared;
CLIA waived
Lipid Profile (Total
Cholesterol/High
Density Lipoprotein
Cholesterol/Triglycerides) Cardiac Risk Dry Chemistry Marketed; FDA cleared;
CLIA waived
Total Cholesterol and
Glucose Cardiac & Diabetes Risk Dry Chemistry Marketed; FDA cleared;
CLIA waived
Total Cholesterol/High
Density Lipoprotein
Cholesterol/Glucose Cardiac & Diabetes Risk Dry Chemistry Marketed; FDA cleared;
CLIA waived
Lipid Profile plus Glucose Cardiac & Diabetes Risk Dry Chemistry Marketed; FDA cleared;
CLIA waived
PRODUCTS UNDER DEVELOPMENT
Creatinine/Blood Urea
Nitrogen Renal Function Dry Chemistry 510(k) filed
Bone Markers Osteoporosis Immunoassay Prototype Stage
Liver Enzymes Liver Function Dry Chemistry Feasibility Studies
Prostate Specific Antigen Prostate Disease Immunoassay Feasibility Studies
Glycated Hemoglobin Diabetes Specific Binding Feasibility Studies
- ----------------
(1) "Marketed" means that commercial sales of the product have commenced. "FDA
cleared" means that the product has received 510(k) clearance from the Food
and Drug Administration ("FDA"). "CLIA waived" means that the product has
been classified as waived under Clinical Laboratory Improvement Amendments
of 1988 by the Centers for Disease Control and Prevention. "510(k) filed"
means an application for clearance pursuant to section 510 (k) of the Food,
Drug and Cosmetics Act of 1938, as amended, with the FDA. "Feasibility
studies" means that a theoretical design for the product has been developed
and the test chemistry is being evaluated in the laboratory. "Prototype
stage" means cassette shelf-life is being evaluated, pilot manufacturing
equipment is being developed, and the new test is being evaluated in-house
against samples designed to mimic the range of real patient samples.
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Current Products
The Company's current products are designed to measure and monitor blood
cholesterol and related lipids and glucose. Lipids travel in the blood within
water-soluble particles called lipoproteins. These lipid carriers include
very-low-density lipoproteins, low-density lipoproteins and high density
lipoproteins. Very-low-density lipoproteins, a major carrier of triglycerides in
the blood, and low-density lipoproteins, the major carrier of cholesterol, have
been shown to be associated with deposits on the arterial wall, which are
sometimes referred to as atherosclerotic plaque. The accumulation of this plaque
leads to a narrowing of the arteries and increases the likelihood of coronary
heart disease, the leading cause of death in the United States. High density
lipoprotein cholesterol particles, which circulate in the blood and can pick up
cholesterol from arteries and carry it to the liver for elimination from the
body, counterbalance this mechanism. High density lipoprotein cholesterol is
sometimes called "good cholesterol" because of this function. The development of
coronary heart disease has been associated with three lipoprotein abnormalities:
(i) high levels of low-density lipoproteins; (ii) high levels of
very-low-density lipoproteins; and (iii) low levels of high density
lipoproteins.
Recognizing the relationship between diabetes and dyslipidemia (abnormal
lipid levels), Cholestech developed a glucose test for the L.D.X System.
Diabetes is a complex disorder of carbohydrate, fat and protein metabolism. It
is manifested by a relative or absolute deficiency in insulin, the hormone that
facilitates and controls the use of glucose by the body. Because of the
deficiency of insulin, diabetic patients have an impaired tolerance to glucose,
which leads to a number of short term and long term complications, such as nerve
damage, kidney disease and retinal damage.
The Company's L.D.X System includes the L.D.X Analyzer which measures analyte
concentrations on the test cassette and displays the quantitative results. The
L.D.X Analyzer currently has a list price of $1,795. A description of the
Company's test cassettes is provided below.
Total Cholesterol. A stand alone test for measuring total cholesterol. The
total cholesterol test currently has a list price of $3.95.
Total Cholesterol and high density lipoprotein cholesterol panel. This panel
provides results for total cholesterol and high density lipoproteins, or "good"
cholesterol and calculates the ratio of total cholesterol to high density
lipoproteins, a recognized measure of lipid-induced cardiac risk. The Company
believes that the total cholesterol and high density lipoprotein cholesterol
panel is the only currently available point of care test which, using only a
single drop of whole blood from a simple fingerstick, addresses the National
Institutes of Health guidelines regarding the evaluation of coronary heart
disease through the testing of not only total cholesterol, but also the
important high density lipoproteins component within five minutes. As a result,
the Company believes the total cholesterol and high density lipoprotein
cholesterol panel is particularly useful in corporate wellness and initial
diagnostic screening applications. The total cholesterol and high density
lipoproteins panel currently has a list price of $7.50.
Lipid Profile. The Company offers a Lipid Profile which directly measures
total cholesterol, high density lipoproteins and triglycerides. In addition to
providing direct results for total cholesterol, high density lipoprotein
cholesterol and triglycerides, the Lipid Profile calculates estimated values for
low density lipoprotein cholesterol and very low density lipoprotein cholesterol
and calculates the ratio of total cholesterol to high density lipoprotein
cholesterol. The Lipid Profile thus performs, using a small sample of whole
blood from a simple fingerstick, each test identified by the National Institutes
of Health Amendments of 1988 guidelines as important in the diagnosis and
ongoing therapeutic monitoring of individuals who have high total cholesterol
levels or who exhibit two or more other coronary heart disease risk factors. The
Lipid Profile also allows the health care practitioner to follow the National
Institutes of Health Amendments of 1988 guidelines to perform three lipid
profiles, each one week apart, prior to initiating drug or dietary therapy. The
Lipid Profile currently has a list price of $9.95.
Total Cholesterol and Glucose Panel, Total Cholesterol/High Density
Lipoprotein Cholesterol/Glucose Panel and Lipid Profile Plus Glucose. These
panels address the need for diagnostic screening and therapeutic monitoring
patients with demonstrated or incipient diabetes mellitus and individuals who
may be at risk of cardiovascular disease and individuals who may not be aware
that they are diabetic. These test
8
combinations are potentially desirable because glucose and total cholesterol
tests are frequently conducted at occupational health sites. The total
cholesterol and Glucose Panel, the total cholesterol/high density
lipoproteins/Glucose Panel and the Lipid Profile plus Glucose have a list price
of $3.95, $8.50 and $10.95, respectively.
Markets. In response to conclusive evidence relating high total cholesterol
to heart disease, the National Institutes of Health in 1985 launched the
National Cholesterol Education Program, a nationwide effort to reduce the
prevalence of high blood cholesterol. In 1988, the National Cholesterol
Education Program issued guidelines for the testing of all adults over 20 years
of age for high blood cholesterol, and more extensive lipid therapeutic
monitoring and treatment for those found to be in high risk categories. Testing
guidelines were subsequently expanded to include children over the age of two
with a family history of high blood cholesterol or coronary heart disease and to
include in certain circumstances a lipid profile, consisting of total
cholesterol, high density lipoproteins, low density lipoproteins and
triglycerides. Since the National Cholesterol Education Program initiated its
recommendations, the market for cholesterol and other lipid tests has
experienced significant growth. National Cholesterol Education Program data
indicate that more than 50% of the adult population in the United States has
high or borderline high total cholesterol.
It is estimated that Type II diabetes, which involves insulin deficiency or
insulin resistance, afflicts more than 14 million persons in the United States,
but only half of those with Type II diabetes have been identified. Diagnostic
screening for these patients who have non-symptomatic diabetes is important,
because proper treatment will minimize the long term complications of the
disease.
In order for the Company to further increase revenues and achieve sustainable
profitability and positive cash flows from operations, the Cholestech L.D.X
System must achieve a significant degree of market acceptance among health care
providers in the therapeutic monitoring market, particularly physician office
laboratories and pharmacies. The substantial majority of diagnostic tests used
by physicians and other health care providers are performed by independent
clinical laboratories and hospital-based laboratories. Physicians and other
health care providers will not use the Cholestech L.D.X System unless they
determine that it is an attractive alternative to other means of diagnostic
screening or therapeutic monitoring blood detected diseases, particularly
independent clinical laboratories and hospital-based laboratories, and that the
clinical benefits to the patient and cost savings achieved through use of the
Cholestech L.D.X System outweighs the cost of the system. Such determination
will depend, in part, upon the Cholestech L.D.X System's accuracy, ease of use,
rapid test time, reliability, cost effectiveness, portability and level of third
party reimbursement. Even if the advantages of the Cholestech L.D.X System in
diagnosing and therapeutic monitoring patients with blood detected diseases are
established as clinically significant, physicians, medical clinics, pharmacists
and other health care providers may elect not to purchase and use the Cholestech
L.D.X System for any number of other reasons. For examples, physicians and other
health care providers may not change their established means of having such
tests performed, may not make the necessary investment of purchase the Company's
products or may not be able to obtain adequate reimbursement from third party
payors for test performed using the Cholestech L.D.X System. In addition, the
growth prevalence of managed care and health maintenance organizations may
adversely affect the physician office laboratories market. A growing number of
physicians are salaried employees and have no financial incentive to perform
testing. Many health management organization and managed care organization 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 private insurers to limit their testing
to "medically necessary" tests. As a result of these and other factors, there
can be no assurance that demand for the Cholestech L.D.X System, particularly in
the therapeutic monitoring market, will be sufficient to allow for sustainable
profitable operations.
Products Under Development
The Company's strategy is to use the technological flexibility of the
Cholestech L.D.X System to develop new cassettes that address disease states and
testing markets the Company believes provide attractive commercial
opportunities. The Company is in the early stages of developing new cassettes
that would expand its product line in the diagnostic screening market and would
better position its product line
9
for the physician office laboratories market. To date, the Company has been
engaged primarily in conducting research and development to determine the
feasibility of performing these new tests on the Cholestech L.D.X System. The
Company will initially focus its available resources on the development of blood
urea nitrogen, creatinine and liver enzyme tests, as well as the
immunoassay-based test to detect and monitor metabolic bone diseases and
disorders being developed in conjunction with Metra Biosystems. The Company will
undertake the development of additional tests depending on the progress of its
existing development efforts and its available resources. To complete its
product development programs, particularly with respect to the immunoassays, the
Company may be required to develop new core technologies, processes and
production equipment. In addition, the Company may also be required to retain
additional scientific, engineering and manufacturing staff. There can be no
assurance that the Company will be successful in developing any of the tests
described below, or even if successfully developed, that such tests will receive
regulatory clearance, be capable of being cost effectively manufactured in
sufficient quantities, on a timely basis and in compliance with regulatory
guidelines, or be successfully marketed. In May 1997, the Company submitted
510(k) clearance application to the FDA for its renal function panel. The
Company intends to design and develop most of these products so as to be
eligible for FDA 510(k) clearance and waivers under Clinical Laboratory
Improvement Amendments of 1988, although there can be no assurance that the
Company's products under development will obtain such clearances or waivers. See
"-- Government Regulation."
Products currently being developed by the Company are described below.
Renal Function Test. The Company has developed a menu expansion of tests to
include a test for creatinine and blood urea nitrogen for the physician's
office. The Company believes that these tests are among the most commonly
ordered tests in physician offices. The renal function test will assist
physicians in managing the health of diabetes patients. Blood urea nitrogen
elevations occur in chronic renal disease as well as urinary tract obstruction.
Blood urea nitrogen is useful to monitor hemodialysis and other therapies.
Creatinine is also a measure of renal function and is used in combination with
blood urea nitrogen tests. In addition, creatinine is used as a measure of renal
blood flow which may have become reduced due to congestive heart failure or
dehydration. Low levels of creatinine may result from decreased hepatic
production in advanced liver disease. In May 1997, the Company submitted a
510(k) application for FDA approval for the Renal Function test.
Metabolic bone diseases and disorders. Osteoporosis is the most widespread
form of bone disease characterized by a general loss of bone density. This loss
of bone density can lead to a weakening of the bone, thereby making the bone
more prone to fractures. Biological markers of bone metabolism are secreted in
urine, and it has been shown that the level of secretion correlates to the
amount of bone loss. The measured levels of these markers has also been shown to
be responsive to osteoporosis therapies such as hormone replacement therapy.
According to the National Osteoporosis Foundation, this disease afflicts over 25
million Americans and over 200 million people worldwide. In the United States,
approximately 1.5 million osteoporosis related fractures occur each year. For
Caucasian women, it is estimated that the risk of hip fractures approximates the
combined risks of breast, endometrial and ovarian cancers. The World Health
Organization estimates that the cost of osteoporosis related fractures in the
United States exceeds $7 billion annually.
The Company has entered into an agreement with Metra Biosystems to develop and
market Metra Biosystems' Pyrilinks-D(R) and other related bone marker
technologies on the Cholestech L.D.X System. The Company has successfully
demonstrated the feasibility of meeting the initial specifications for the
Company's technology for this urine-based immunoassay diagnostic test on the
L.D.X System and is in the prototype stage of development. See "-- Strategic
Relationships."
Liver Function Tests. Patients undergoing certain lipid lowering drug
therapies must be monitored for increases in certain enzymes which are
associated with liver damage. The use of a liver function test cassette in
conjunction with the Lipid Profile would allow the physician to monitor, at the
point of care, both the beneficial and potential adverse side effects of the
lipid lowering drug therapies. The Company has demonstrated the technical
feasibility of liver function tests using its cassette technology in the
laboratory.
10
Prostate Specific Antigen ("PSA"). The American Cancer Society estimates that
in 1996, 317,000 Americans will be diagnosed with prostate cancer and predicts
that deaths from prostate cancer in the United States will reach over 41,000
making it the second leading cause of cancer related deaths. The American Cancer
Society recommends that men 50 and older receive a PSA blood test annually. By
making early detection possible, treatment can begin when there is a higher
likelihood of success, leading to better survival rates from the disease. The
Company has demonstrated the feasibility of measuring PSA from a single drop of
whole blood using the Company's technology. The Company expects that the PSA
test may require pre-market approval from the FDA. See "-- Government
Regulation."
Glycated Hemoglobin. Glycated hemoglobin measurement is used by physicians to
assess a diabetic's long term compliance with prescribed diet and insulin usage.
This test measures the percent of the patient's hemoglobin which has become
coupled to glucose. A relatively high percentage of hemoglobin to glucose
indicates poor patient compliance, which can lead to severe health problems. The
American Diabetes Association recommends at least semi-annual measurement for
all diabetic patients. It is estimated that there are seven to eight million
diagnosed type II diabetics in the United States.
The Company received a "Small Business Innovative Research" grant of $100,000
from U.S. Department of Health and Human Services to further develop this test
on the Cholestech L.D.X System. The Company is currently evaluating the
feasibility of a test to detect glycated hemoglobin on the Cholestech L.D.X
System.
Other Products Under Development. The Company currently sells two cassettes
which can calculate low density lipoprotein cholesterol levels from the combined
readings of total cholesterol, high density lipoproteins and triglycerides. Low
density lipoprotein cholesterol is the fraction of total cholesterol which leads
to heart disease and is referred to as "bad" cholesterol. There is now available
a direct version of the low density lipoproteins test, and the Company is
considering adapting this form of the test to the L.D.X System. The advantage of
this direct test over the calculated version of the test is that it does not
require the patient to fast before testing. However, since lipid management
requires the physician to assess a patient treatment on both "good" and "bad"
cholesterol, the disadvantage of the stand alone direct low density lipoproteins
test is the lack of the patient's high density lipoproteins values. The Company
believes that the Cholestech L.D.X System may overcome this problem with its
ability to run multiple tests simultaneously on the system.
Lp(a) is a lipoprotein which is a component of low density lipoproteins. It
has been established in the scientific literature that Lp(a) is a risk factor
for atherosclerosis, and it is believed that Lp(a) may be the component of low
density lipoproteins which is responsible for the risk associated with low
density lipoproteins. The Company believes that a test for Lp(a) may emerge as
the dominate test for cardiac risk in the future. The Company has licensed the
rights to a new technology to measure Lp(a). This technology is currently being
evaluated by the Company and a number of collaborators.
The Company believes that its revenue growth and profitability will depend,
in part, upon its ability to complete development of and successfully introduce
these new tests. In addition, some of these new tests depend on the development
of immunoassay-based technologies and the incorporation of these technologies
into the Cholestech L.D.X System. The Company will be required to undertake
time- consuming and costly development activities and seek regulatory approval
for these new tests. There can be no assurance that the Company will be able to
complete successful development of any of these future products. Furthermore,
there can be no assurance that even if these products and/or any other future
products are successfully developed, the Company will be able to successfully
receive FDA clearance or approval or Clinical Laboratory Improvement Amendments
of 1988 waivers on a timely basis, manufacture such products on a cost effective
basis and in compliance with applicable regulatory standards, or successfully
market thse products. If the Company is unable for technological or other
reasons to complete the development, introduction and scale up of manufacturing
of any new tests or if such new tests do not achieve a significant level of
market acceptance, the Company's business, financial condition and results of
operations could be materially adversely affected.
SALES AND MARKETING
To date, the Company has focused its sales and marketing efforts on
hospitals, managed care organizations, large physician group practices,
corporate wellness programs, community health centers, health
11
promotion service providers and other independent screeners in the diagnostic
screening market. With the recent Clinical Laboratory Improvement Amendments of
1988 waiver of its existing product line, the Company began to focus its sales
and marketing efforts to access the therapeutic monitoring market. The Company
utilizes a combination of a direct sales force and regional distributors to sell
into the diagnostic screening market and has developed a national distribution
network to access the therapeutic monitoring market.
See "-- Strategy -- Expand Distribution Channels."
The Company provides continuing customer support, including an automated
order entry system, and technical support whenever needed to promote customer
satisfaction. A U.S. toll-free number gives customers immediate access to
Cholestech's in-house customer service, inside sales and technical support
group. Customer service representatives also assist customers to order
Cholestech L.D.X System, disposable test cassettes and accessories. The Company
maintains an in-house instrument service capability that provides repairs to
instruments either under warranty or on a parts and labor basis.
Diagnostic Screening Market
The Company's distribution strategy for the diagnostic screening market is to
sell both directly to high volume customers and to selected regional
distributors. The Company believes that its products provide a cost effective,
easy to use alternative for preventive health care programs that are focused on
identifying high risk individuals with possible cardiovascular disease and
diabetes and enrolling them into appropriate disease intervention programs to
reduce their overall health risk.
The Company sells directly through a field sales group which includes eleven
regional sales managers and two area field sales mangers. In addition, the
Company has established a telemarketing effort to support large volume customers
and utilizes direct mail campaigns to increase demand for its products. The
Company also has entered into agreements with thirteen regional distributors
that augment the Company's direct sales efforts. In February 1997, the Company
signed a two-year agreement with Health Management Services Corporation ("HMSC")
to offer consumers testing of individual cholesterol levels using the Cholestech
L.D.X System at selected Wal-Mart stores across the country.
The Company's international distribution strategy for the diagnostic
screening market is designed to opportunistically penetrate targeted
geographical markets by selling both directly to high volume customers and
individual distributors in those areas. The Company has entered into agreements
with fifteen foreign distributors to distribute the Cholestech L.D.X System
primarily in Europe, the Pacific Rim and Latin America.
Therapeutic Monitoring Market
The Company's sales and marketing efforts in the therapeutic monitoring
market will initially be focused on the physician office laboratories and
pharmacy segments. As of April 1, 1996, the Company entered into a national,
non-exclusive distribution agreement with PSS, a national medical products
distributor with more than 700 sales professionals who focus on the physician
office laboratories market. In September 1996, the Company entered into a
similar non-exclusive distribution agreement with General Medical, Inc., a
national medical products distributor with more than 600 sales professionals who
focus on the physician office laboratories market.
The retail pharmacy market consists of approximately 53,000 pharmacies which
may provide point of care testing. The Company believes that marketing success
in the pharmacy market will be dependent upon the development of patient
therapeutic monitoring programs implemented in conjunction with managed care
providers and physicians on a local basis. In January 1996, the American
Pharmaceutical Association announced Project IMPACT (IMprove Persistence And
Compliance to Therapy). Project IMPACT is being funded by Merck, and its goal is
to demonstrate the ability of pharmacists to enhance patient outcomes with drug
therapy and behavior modification. The pilot program enlarges the pharmacist's
role to one in which the pharmacist monitors therapeutic effectiveness of
medications and provides counseling services to the patient. Utilizing
pharmacists to provide such services may result in both direct and indirect cost
savings to the patient and the patient's insurer. The Company is participating
in Project IMPACT through the use of its Cholestech L.D.X System to monitor
patients in this pharmacy-based cholesterol management project. The Company
intends to utilize the program to evaluate the potential
12
market for the Cholestech L.D.X System among pharmacists. Project IMPACT has
monitor approximately 900 patients at 32 community-based pharmacies across the
country for a period of two years. In April 1997, the Company entered into a
multi-year non-exclusive distribution agreement with AmeriSource, a fullservice
wholesaler of pharmaceuticals and health care products and services to
pharmacies throughout the United States. This distributor agreement is to focus
on pharmacy market segment to expand and service the installed based of
Cholestech L.D.X System in the retail pharmacy market placed by Project IMPACT.
Also, the Cholestech L.D.X System will become an integral part of the
AmeriSource Encara(R) Program, which allows pharmacists to track patient disease
states and the effectiveness of pharmaceutical care. Pharmacists using the
Cholestech L.D.X(R) System will be able to efficiently and economically screen
customers for two of the most prevalent disease states, diabetes and
hyperlipidemia (elevated cholesterol), and provide immediate counseling.
Customers will take away a risk assessment profile and be encouraged to discuss
their health with their physicians. In addition to the Encara(R) Program, the
Cholestech L.D.X System complements the Diabetes Shoppe(R) marketing and
educational program recently acquired by AmeriSource.
In order for the Company to increase revenues and achieve profitability, the
Cholestech L.D.X System must achieve a significant degree of market acceptance
among health care providers in the therapeutic monitoring market, particularly
the physician office laboratories market segment. The Company has only limited
experience marketing and selling to the therapeutic monitoring market in the
United States. The Company has only recently entered into a distribution
arrangement with three national distributors, PSS, General Medical and
AmeriSource. The Company may be required to enter into additional distribution
arrangement in order to achieve broad distribution of its products. There can be
no assurance that the Company will be able to maintain the recently established
distribution relationships or that the Company will be able to enter into and
maintain arrangements with additional distributors on a timely basis, if at all.
There can be no assurance that the Company will be able to penetrate the
therapeutic monitoring market, including the physician office laboratories and
pharmacy segments, or the physicians will use the Cholestech L.D.X System
instead of clinical laboratory services for the same tests.
STRATEGIC RELATIONSHIPS
The Company's strategy includes establishing strategic relationships to
develop new products, expand its customer base, and provide the Company with
technological, clinical, marketing, financial and other key resources.
In May 1996, the Company entered into a development, marketing and licensing
agreement with Metra Biosystems to develop an immunoassay test cassette
incorporating Metra Biosystems' bone resorption technology to be used with the
Cholestech L.D.X System. Pursuant to the agreement, Metra Biosystems purchased
39,526 shares of the Company's Common Stock for an aggregate purchase price of
$250,000 ($6.325 per share) and is obligated to purchase $750,000 of additional
shares of Common Stock upon the completion of specified milestones by the
Company. The Company has granted Metra Biosystems registration rights in
connection with Metra Biosystems' purchase of the Company's Common Stock.
In connection with the development of the immunoassay test cassette, Metra
Biosystems granted Cholestech a non-exclusive, royalty-bearing license to use,
make, sell, offer to sell, import or distribute the resulting test to assess
bone resorption, a gauge of the effectiveness of treatments of certain metabolic
diseases and disorders and certain future products worldwide (the "Metra
License"). The Company will pay royalties to Metra Biosystems on the bone
resorption product and on products that stem from work done in the course of the
collaboration but do not incorporate any of Metra Biosystems' proprietary
technology. The parties will negotiate royalties on future Metra Biosystems
products as appropriate. Under the agreement, the Company will market the
immunoassay test through its existing distribution channels in the United
States. The Company and Metra Biosystems will work together to market and
distribute the tests internationally.
There can be no assurance that the Company will be successful in developing a
bone resorption test or any other product under this agreement, that this
agreement will not expire prior to its term, or that
13
even if any products are developed that they will be successfully marketed. The
Company expects to enter into additional strategic agreements in the future to
develop, commercialize and sell its current and future products. There can be no
assurance that the Company will be able to negotiate acceptable agreements in
the future, or that such relationships will be successful. In addition, there
can be no assurance that the Company's strategic partners will not pursue
alternative competing technologies or products. See "Management's Discussion and
Analysis -- Potential Fluctuations and Factors Affecting Future Operating
Results -- Limited Sales, Marketing and Distribution Experiences; Dependence on
Third Party Distributors."
MANUFACTURING
The Company manufactures, tests, performs quality assurance, packages and
ships products at its 43,317 square foot facility located in Hayward,
California. The Company maintains control of those portions of the manufacturing
process that it believes are complex and provide important barriers to entry by
competitors. The production processes employed by the Company to manufacture
cassettes differ significantly from those employed in the manufacture of the
analyzer.
Manufacture of Cassettes
The Company purchases chemicals, membranes and other raw materials from third
party suppliers and converts these raw materials, using proprietary processes,
into cassettes. The Company believes its proprietary processes and
custom-designed equipment are important components of its cassette manufacturing
operations. The Company has developed core manufacturing technologies, processes
and production machinery, including (i) membrane lamination and welding; (ii)
discrete membrane impregnation; (iii) on-line calibration; and (iv) software
control of the manufacturing process. The Company completed validation of the
second cassette manufacturing line and the line became fully operational in July
1996. In the event that cassette sales volume significantly increases, the
Company may be required to construct a third cassette manufacturing line. There
can be no assurance that such expansion of cassette manufacturing capacity can
be completed in a timely fashion, if ever, and the failure to increase cassette
manufacturing capacity on a cost effective and timely basis would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Manufacturing of the cassettes is highly complex and sensitive to a wide
variety of factors, including variations and impurities in the raw materials,
performance of the manufacturing equipment and the level of contaminants in the
manufacturing environment. Incoming inspection of raw materials, in-process
controls, improved manufacturing equipment performance, and better operator
proficiency and training all contribute to improvements in yield. Continuous
improvement of process factors are key determinants of manufacturing output and
efficiency, product quality and reliability and overall profitability. Although
the Company believes that it has acceptable cassette yields and should be able
to maintain the current cassette yield in the future, there can be no assurance
that such improvement will be maintained or that the Company will not suffer
future periodic cassette yield problems in connection with new or existing
products. Failure to maintain the improvements in process yield or failure to
obtain acceptable yields on future products could have a material adverse effect
on the Company's business. The Company's cassette manufacturing lines represent
a single point of potential failure in its manufacturing process that would be
costly and time consuming to replace if their operation were interrupted.
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.
Manufacture of Cholestech L.D.X Analyzer
The analyzer employs a variety of subassemblies and components designed or
specified by the Company, including an optical element, microprocessors, circuit
boards, a liquid crystal display and other
14
electrical components. These components and subassemblies are manufactured by a
variety of third parties and are shipped to the Company for final assembly. The
Company's manufacture of the analyzer consists primarily of assembly, testing,
inspection and packaging. Testing consists of a burn-in period, functional tests
and integrated system testing using specially produced test cassettes. The
Company believes it can expand its current analyzer manufacturing capacity at
minimal cost.
Raw Materials, Quality Assurance
Outside vendors provide Cholestech with subassemblies, components and raw
materials. These materials are purchased, inspected and tested by the Company's
quality control personnel. The Company's quality control personnel also perform
finished goods quality control and inspection and maintain documentation for
compliance with current Good Manufacturing Practices ("cGMP") regulations and
other government manufacturing regulations. Cholestech's manufacturing
facilities are subject to periodic inspection by regulatory authorities. See "--
Government Regulation." Certain key components and raw materials used in the
manufacturing of the Company's products are currently provided by single-source
vendors pursuant to the Company's periodic purchase orders. The Company believes
that it maintains an adequate level of such components and raw materials in
inventory and believes that alternative sources for such components and raw
materials are available. However, any supply interruption in a sole-sourced
component or raw material would have a material adverse effect on the Company's
business once the inventory is depleted and until a new source of supply were
qualified. 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
business. Because the Company is a small customer of many of its suppliers,
there can be no assurance that its suppliers will devote adequate resources to
supplying the Company's needs.
COMPETITION
The diagnostic screening and therapeutic monitoring markets in which the
Company competes is intensely competitive. The Company's competition consists
mainly of independent clinical laboratories and hospital-based laboratories, as
well as manufacturers of bench top and other point of care analyzers. The
substantial majority of diagnostic tests used by physicians and other health
care providers are currently performed by clinical laboratories and
hospital-based laboratories. The Company expects that these laboratories will
compete intensely to maintain their dominance in the therapeutic monitoring
market. In order to achieve broad market acceptance for the Cholestech L.D.X
System, the Company will be required to demonstrate that the Cholestech L.D.X
System is an attractive alternative to the independent clinical laboratory and
hospital-based laboratory. This will require physicians to change their
established means of having such tests performed. There can be no assurance that
the Cholestech L.D.X System will be able to compete with the testing services
provided by these laboratories.
In addition, companies having a significant presence in the diagnostic
market, such as Abbott Laboratories, Clinical Diagnostic Systems, a division of
Johnson and Johnson which was formerly a division of Eastman Kodak Company, and
Roche Boehringer Mannheim Diagnostics, a unit of Roche Holdings Corporation
formerly Boehringer Mannheim, have developed or are developing analyzers
targeted for point of care. 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. The Company believes that it currently has a competitive advantage with
the classification of its existing products as waived under Clinical Laboratory
Improvement Amendments of 1988. The Company expects that the reclassification of
the Cholestech L.D.X System as waived under Clinical Laboratory Improvement
Amendments of 1988 will result in competitors seeking to develop products that
qualify for waived classification. There can be no assurance that the Company's
competitors will not succeed in obtaining Clinical Laboratory Improvement
Amendments of 1988 waived status for their products or in developing or
marketing technologies or products that are more effective and commercially
attractive than the Company's current or future products, or that would render
the Company's technology or products obsolete or noncompetitive.
15
The Company's products must compete effectively overall with the existing and
future products of its competitors primarily on the basis of the ability to
perform tests at the point of care, ease of use, testing of multiple analytes
from a single sample, ability to conduct tests without a skilled technician or a
blood pretreatment step, the breadth of tests available, market presence, cost
effectiveness, precision, accu- racy or immediacy of results. There can be no
assurance that the Company will have the finan- cial resources, technical
expertise or marketing, distribution or support capabilities to compete
successfully in the future. See "Business -- Products," "-- Products Under
Development," "-- Technology" and "-- Competition."
PATENTS AND PROPRIETARY TECHNOLOGY
The Company pursues an active patenting policy to protect inventions and
technology which are important to its business. The Company owns eight United
States patents covering various aspects of the technology incorporated in its
products, including the method for separating high density lipoproteins from
other lipoproteins in a dry chemistry format, the basic design of the testing
cassette and the L.D.X Analyzer and the method of correcting for the effects of
substances that can interfere with testing of a blood sample. The Company has
also filed patent applications relating to its technology internationally under
the Patent Cooperation Treaty and individual foreign applications. The Company
is also the licensee of one United States patent relating to the measurement of
Lp(a) and a number of third party patents relating to its cassette technology.
The medical products industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and any potential
litigation can result in substantial loss or diversion of revenues of the
Company and could have a material adverse effect on the Company.
There can be no assurance that pending patent applications filed by the
Company will be approved or that the issued or pending patents will not be
challenged or circumvented by competitors. Notwithstanding the Company's active
pursuit of patent protection, the Company believes that its future success will
depend primarily upon the technical expertise, creative skills and management
abilities of its officers, directors and key employees rather than on patent
ownership. There can be no assurance that infringement claims will not be
asserted by other parties in the future, that in such event the Company will
prevail or that it will be able to obtain licenses on reasonable terms. Adverse
determinations in any litigation could subject the Company to significant
liabilities and/or require the Company to seek licenses from third parties. If
the Company is unable to obtain necessary licenses or is unable to develop or
implement alternative technology, the Company may be unable to manufacture and
sell the affected products. Any of these outcomes could have a material adverse
effect on the Company's business.
The Company relies substantially on trade secrets, technical know-how and
continuing invention to develop and maintain its competitive position. The
Company works actively to foster continuing technological innovation to maintain
and protect its competitive position, and the Company has taken security
measures to protect its trade secrets and periodically explores ways to further
enhance trade secret security. There can be no assurance that such measures will
provide adequate protection for the Company's trade secrets or other proprietary
information. Although the Company has entered into proprietary information
agreements with its employees, consultants and advisors, there can be no
assurance that these agreements will have adequate remedies for any breach.
There can be no assurance that the Company's competitors will not independently
develop substantially equivalent proprietary information and techniques or
otherwise gain access to the Company's trade secrets or disclose such
technology, or that the Company can meaningfully protect its right to its trade
secrets.
GOVERNMENT REGULATION
Food and Drug Administration and Other Regulations. The manufacture and sale
of the Company's products are subject to regulation by numerous governmental
authorities, principally the United States Federal Food and Drug Administration
(the "FDA") and corresponding state and foreign regulatory agencies. Pursuant to
the Federal Food, Drug And Cosmetic Act of 1938, as amended (the "FDC Act"), the
FDA regulates the clinical testing, manufacture, labeling, distribution and
promotion of medical devices. Noncompliance with applicable requirements can
result in, among other things, fines, injunctions,
16
civil penalties, recall or seizure of products, total or partial suspension of
production, failure of the government to grant premarket clearance or premarket
approval for devices, withdrawal of marketing approvals, a recommendation by the
FDA that the Company not be permitted to enter into government contracts and
criminal prosecution. The FDA also has the authority to request repair,
replacement or refund of the cost of any device manufactured or distributed by
the Company.
In the United States, medical devices are classified into one of three
classes, Class I, II or III, on the basis of the controls deemed by the FDA to
be necessary to reasonably ensure their safety and effectiveness. Class I
devices are subject to general controls (e.g. labeling, premarket notification
and adherence to cGMPs). Class II devices are subject to general controls and to
special controls (e.g. performance standards, postmarket surveillance, patient
registries, and FDA guidelines). Generally, Class III devices are those that
must receive premarket approval by the FDA to assure their safety and
effectiveness (e.g. life-sustaining, life-supporting and implantable devices, or
new devices which have not been found substantially equivalent to legally
marketed devices), and require clinical testing to assure safety and
effectiveness and FDA approval prior to marketing and distribution.
Before a new device can be introduced into the market, the manufacturer must
generally obtain marketing clearance through a pre-market notification under
Section 510(k) of the FDC Act or an approval of a pre-market approval
application under Section 515 of the FDC Act. A 510(k) clearance typically will
be granted if the submitted information establishes that the proposed device is
"substantially equivalent" to a legally marketed Class I or II medical device or
to a Class III medical device for which the FDA has not called for pre-market
approvals. A 510(k) notification must contain information to support a claim of
substantial equivalence, which may include laboratory test results or the
results of clinical studies of the device in humans. It generally takes from
four to twelve months from the date of submission to obtain a 510(k) clearance,
but it may take longer. A "not substantially equivalent" determination by the
FDA, or a request for additional information, could delay the market
introduction of new products that fall into this category. For any devices that
are cleared through the 510(k) process, modifications or enhancements that could
significantly affect safety or effectiveness, or constitute a major change in
the intended use of the device, will require new 510(k) submissions. The
Cholestech Analyzer and all existing disposable test cassettes required that the
Company obtain 510(k) clearance prior to marketing in the United States.
In general, the Company intends to develop and market tests that will require
no more than a 510(k) clearance. However, if the Company cannot establish that a
proposed test cassette is substantially equivalent to a legally marketed device,
the Company must seek pre-market approval of the proposed test cassette from the
FDA through the submission of a pre-market approval application. Certain
products under development, including the Prostate Specific Antigen ("PSA")
test, may require submission of a pre-market approval application. A pre-market
approval application generally must be supported by extensive data including,
laboratory, preclinical and clinical data to demonstrate safety and efficacy, as
well as a complete description of the device and its components, and detailed
description of the methods, facilities and controls used to manufacture the
device. In addition, the submission must include the proposed labeling,
advertising literature and training methods (if required). Upon receipt of a
pre-market approval application, the FDA makes a threshold determination as to
whether the application is sufficiently complete to permit a substantive review.
If the FDA determines that the pre-market approval application is sufficiently
complete to permit a substantive review, the FDA will accept the application for
filing. An pre-market approval process can be lengthy, expensive and uncertain.
An FDA review of a pre-market approval application generally takes one to three
years from the date the pre-market approval application is accepted for filing,
but may take significantly longer.
Any products manufactured or distributed by the Company pursuant to FDA
clearance or approvals are subject to pervasive and continuing regulation by FDA
and certain state agencies, including record keeping requirements and reporting
of adverse experience with the use of the device. Labeling and promotional
activities are subject to scrutiny by FDA and, in certain circumstances, by the
Federal Trade Commission. Current Food and Drug Administration enforcement
policy prohibits the marketing of approved medical devices for unapproved uses.
17
The FDC Act regulates the Company's quality control and manufacturing
procedures by requiring the Company and its contract manufacturers to
demonstrate compliance with cGMP. The FDA monitors compliance with these
requirements by requiring manufacturers to register with the FDA, which subjects
them to periodic inspections. While the Company's manufacturing processes,
facilities and practices have not been inspected by the FDA, the Company
believes that its manufacturing practices are in compliance with cGMP. The State
of California also regulates and inspects Cholestech's manufacturing facilities.
The Company has been inspected twice by the State of California to date and is
manufacturing under an issued medical device manufacturers facility license from
the State of California. If violations of the applicable regulations are noted
during a FDA or State of California inspection of the Company's manufacturing
facilities or the manufacturing facilities of its contract manufacturers, the
continued marketing of the Company's product could be adversely affected.
The Company and its products are also subject to a variety of state and local
laws an regulation in those states or localities where its products are or will
be marketed. Any applicable state or local laws or regulations may hinder the
Company's ability to market it products in those states or localities.
The Company is also subject to numerous federal, state and local laws
relating to such matters as safe working conditions, manufacturing practices,
environmental protection, fire hazard control and disposal of hazardous or
potentially hazardous substances. There can be no assurance that the Company
will not be required to incur significant costs to comply with such laws and
regulations now or it's the future or that such laws or regulations will not
have a material adverse affect upon the Company.
Changes in existing requirements or adoption of new requirements or policies
could increase the cost of or otherwise adversely affect the ability of the
Company to comply with regulatory requirements. Failure to comply with
regulatory requirements could have a material adverse effect on the Company.
Clinical Laboratory Improvement Amendments of 1988 Regulations. The use of
the Company's products in the United States is subject to Clinical Laboratory
Improvement Amendments of 1988, which provides for federal regulation of
laboratory testing, an activity also regulated by most states. Laboratories
either must obtain a registration certificate from Health Care Financing
Administration, register with an approved accreditation agency or obtain a state
license in a state with a federally approved license program. The Clinical
Laboratory Improvement Amendments of 1988 regulations seek to ensure the quality
of medical testing. The Clinical Laboratory Improvement Amendments of 1988
regulations took effect in September 1992 with a two-year phase-in of certain
requirements. The three primary mechanisms to accomplish this goal are daily
quality control requirements to ensure the accuracy of laboratory devices and
procedures, proficiency testing to measure testing accuracy, and personnel
standards to assure appropriate training and experience for laboratory workers.
Clinical Laboratory Improvement Amendments of 1988 categorizes tests as
"waived," or as being "moderately complex" or "highly complex" on the basis of
specific criteria.
Prior to January 1996, the Cholestech L.D.X System, including all current
cassettes, was categorized under Clinical Laboratory Improvement Amendments of
1988 as moderately complex. In January 1996, the L.D.X System and the total
cholesterol, high density lipoproteins, Triglycerides and Glucose tests in any
combination were reclassified as waived under Clinical Laboratory Improvement
Amendments of 1988. Under the waived classification, users are only required to
obtain a certificate of waiver from Health Care Financing Administration and pay
a $100 fee. This certificate must be renewed every two years. Current Cholestech
L.D.X System users, including managed care organizations, hospitals,
self-insured businesses and health promotion organizations, will now be able to
use the Cholestech L.D.X System at a lower cost. The Company provides United
States purchasers of its products with the documentation, systems and support
necessary for the purchaser to comply with Clinical Laboratory Improvement
Amendments of 1988. 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 Clinical Laboratory
Improvement Amendments of 1988. There can be no assurance that any new tests
developed by the Company will qualify for the waived classification. Any failure
of the new tests to obtain waived status under Clinical Laboratory Improvement
Amendments of 1988 will adversely impact the Company's ability to commercialize
such tests, which could have a material adverse effect on the Company's
business, financial
18
condition and results of operations. In addition, there can be no assurance that
any future amendment of Clinical Laboratory Improvement Amendments of 1988 or
the promulgation of additional regulations impacting laboratory testing will not
have an adverse effect on the Company's ability to market the L.D.X System. If
Clinical Laboratory Improvement Amendments of 1988 regulations were modified in
a manner that reduced regulatory requirements and burdens faced by competitive
products, any competitive advantage of the L.D.X System's waived status would be
reduced or eliminated.
THIRD PARTY REIMBURSEMENT
In the United States, health care providers, such as hospitals and
physicians, that purchase diagnostic products, including the Company's L.D.X
System, generally rely on third party payors, principally private health
insurance plans, federal Medicare and state Medicaid, 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 cost of such
products and related treatment will be available from government health
administration authorities (such as Health Care Financing Administration, which
determines Medicare reimbursement levels), private health insurers and other
organizations. Such third party payors can affect the pricing or the relative
attractiveness of the Company's products by regulating the maximum amount of
reimbursement provided by such payors for testing services. Reimbursement is
currently not available for certain uses of the Company's products. For example,
the cost of the L.D.X Analyzer is generally not subject to reimbursement by
government or other third party payors. In addition, the tests performed by
public health departments, corporate wellness programs and other large volume
users in the diagnostic screening market are generally not subject to
reimbursement. In addition, certain health care providers are moving towards a
managed care system in which such providers contract to provide comprehensive
health care for a fixed cost per patient. Managed care providers are attempting
to control the cost of health care by authorizing fewer elective procedures,
such as diagnostic screening of blood disease levels. The Company is unable to
predict what changes will be made in the reimbursement methods utilized by third
party payors. The Company could be adversely affected by changes in
reimbursement policies of governmental or private health care payors,
particularly to the extent any such changes affect reimbursement for procedures
in which the Company's products are used. Third party payors are increasingly
scrutinizing and challenging the prices charged for medical products and
services. Decreases in reimbursement amounts for tests performed using the
Company's products may decrease amounts physicians and other practitioners are
able to charge patients, which in turn may adversely affect the Company's
ability to sell its products on a profitable basis. Failure by physicians and
other users to obtain reimbursement from third party payors, or changes in
government and private third party payors' policies toward reimbursement of
tests employing the Company's products could have a material adverse effect on
the Company's business. Given the efforts to control and reduce health care
costs in the United States in recent years, there can be no assurance that
currently available levels of reimbursement will continue to be available, or
that adequate reimbursement will be available in the future for the Company's
existing products or products under development. See "Management's Discussion
and Analysis -- Potential Fluctuations and Factors Affecting Future
Profitability -- Uncertainty Relating to Third Party Reimbursement."
Effective October 1, 1991, Health Care Financing Administration adopted new
regulations providing for the inclusion of capital-related costs in the
prospective payment system, under which providers are reimbursed on a
per-diagnosis basis at fixed rates unrelated to actual costs, based on
diagnostic related groups ("DRGs"). Under this system of reimbursement,
equipment costs generally will not be reimbursed separately, but rather, will be
included in a single, fixed-rate, per patient reimbursement. These regulations
are being phased in over a ten-year period, and, although the full implications
of these regulations cannot yet be known, the Company believes that the new
regulations will place more pressure on hospitals' operating margins, causing
them to limit capital expenditures. These regulations could have an adverse
effect on the Company if hospitals decide to defer obtaining medical equipment
as a result of any such limitation on their capital expenditures. The Company is
unable to predict what adverse impact on the Company, if any, additional
government regulations, legislation or initiatives or changes by other payors
affecting reimbursement or other matters that may influence decisions to obtain
medical equipment may have.
19
In addition, market acceptance of the Company's products in international
markets is dependent, in part, upon the availability of reimbursement within
prevailing health care payment systems. Reimbursement and health care payment
systems in international markets vary significantly by country, and include both
government sponsored health care and private insurance.
The Company believes that the overall escalating cost of medical products and
services has led to and will continue to lead to increased pressures on the
health care industry, both foreign and domestic, to reduce the cost of products
and services, including products offered by the Company. There can be no
assurance as to either United States or foreign markets that third party
reimbursement and coverage will be available or adequate, that current
reimbursement amounts will not be decreased in the future or that future
legislation, regulation, or reimbursement policies of third party payors will
not otherwise adversely affect the demand for the Company's products or its
ability to sell its products on a profitable basis.
PRODUCT LIABILITY AND INSURANCE
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 result in personal injury. The Company also faces the possibility that
defects in the design or manufacture of its products might necessitate a product
recall. There can be no assurance that the Company will not experience losses
due to product liability claims or recalls in the future. The Company currently
maintains product liability insurance with coverage limits of $5.0 million per
occurrence and $5.0 million annually in the aggregate, and there can be no
assurance that the coverage limits of the Company's insurance policies will be
adequate. Such insurance is expensive, difficult to obtain and may not be
available in the future on acceptable terms, or at all. No assurance can be
given that product liability insurance can be maintained in the future at a
reasonable cost or in sufficient amounts to protect the Company against losses
due to liability. An inability to maintain insurance at an acceptable cost or to
otherwise protect against potential product liability could prevent or inhibit
the continued commercialization of the Company's products. In addition, a
product liability claim in excess of relevant insurance coverage or product
recall could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company has liability insurance covering its property and operations with
coverage and deductible amounts and exclusions which the Company believes are
customary for companies of its size in its industry. The Company's personal
property is insured for up to $4.3 million and it has comprehensive general
liability coverage of up to $5.0 million. In addition, the Company has business
interruption insurance of up to $5.6 million. There can be no assurance that the
Company's current insurance coverage is adequate or that it will be able to
maintain insurance at an acceptable cost or otherwise to protect against
liability.
EMPLOYEES
As of March 31, 1997, the Company employed 107 full-time employees. There
were 41 employees in sales, marketing and administration and 52 employees in
manufacturing and 14 employees devoted to research and development. The Company
seeks to attract and retain skilled and experienced employees with directly
relevant experience in the fields of interest, although there can be no
assurance that it will continue to do so in the future. The loss of key
personnel or the inability to hire or retain qualified personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations. None of the employees are covered by a collective
bargaining agreement, and management considers relations with employees to be
excellent.
ITEM 2: PROPERTIES
The Company leases a 40,317 square foot facility in Hayward, California. The
Company's facility contains approximately 8,000 square feet of laboratory space,
10,000 square feet of manufacturing space and approximately 22,317 square feet
devoted to sales, marketing, administrative and common areas. The Company's
lease on the facility expires in the year 2000. The Company believes that this
facility is adequate to meet its requirements through the expiration of its
lease.
20
ITEM 3: LEGAL PROCEEDINGS
The Company is not a party to any legal proceedings.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
Not Applicable.
EXECUTIVE OFFICERS OF THE COMPANY
The Executive Officers of the Company and their ages as of May 8, 1996 are as
follows:
NAME AGE POSITION
- ---------------------- ----- ---------------------------------------------------
Warren E. Pinckert II.. 53 President, Chief Executive Officer and Director
Steven L. Barbato .... 47 Vice President of Manufacturing
Gary E. Hewett ........ 45 Vice President of Diagnostic Development
Mark J. Kussman ....... 49 Vice President of Sales and Marketing
Andrea J. Tiller ...... 39 Vice President of Finance and Chief Financial
Officer
Warren E. Pinckert II joined the Company as Chief Financial Officer and Vice
President of Business Development in 1989. Mr. Pinckert was Corporate Secretary
from February 1990 to January 1997. Mr. Pinckert became Executive Vice President
of Operations in May 1991 while retaining his previous positions. In June 1993,
Mr. Pinckert became President and Chief Executive Officer and was appointed to
the Board of Directors. Prior to joining Cholestech, he was Chief Financial
Officer for Sunrise Medical Inc., an international durable medical equipment
manufacturer, from 1983 to 1989. Mr. Pinckert also serves on the Board of
Directors of PacifiCare Health Systems, a managed care organization. Mr.
Pinckert earned a B.S. in Accounting and an M.B.A. from the University of
Southern California and is a certified public accountant.
Steven L. Barbato joined the Company as Vice President of Manufacturing in
May 1992. From 1990 to January 1992, Mr. Barbato served as Vice President of
Operations of the Pandex Division of Baxter Diagnostics, Inc. ("Baxter
Diagnostics"), a biotechnical instrument and reagent development division and
served in other capacities at Baxter Diagnostics from January 1992 to May 1992.
From 1989 to 1990, Mr. Barbato served as Director of Manufacturing for the
Paramax Chemistry Division of Baxter Diagnostics, a division manufacturing
automated whole blood analyzers. From 1987 to 1989, Mr. Barbato was employed as
Manager of Manufacturing by the Paramax Division of Baxter Diagnostics. Mr.
Barbato earned a B.S. in Chemical Engineering from Northeastern University and
an M.B.A. from Xavier University.
Gary E. Hewett, a co-founder of the Company, has served as Vice President of
Diagnostic Development since the Company's inception in 1988. From 1985 to 1988,
Mr. Hewett was employed by Genelabs, Inc., a biotechnology company, as Vice
President of Diagnostics. Prior to 1985, he was employed in a variety of
management and technical positions at the following companies: Cetus
Corporation, a biotechnology firm, from 1983 to 1985; Molecular Design, Inc., a
computer software company, from 1980 to 1983; Beckman Instruments, Inc., a
clinical instrument company, from 1978 to 1983; and Durrum Instrument (Dionics),
an analytical instrument firm, from 1975 to 1978. Mr. Hewett earned a B.A. in
Neurophysiology from the University of California, Berkeley.
Mark J. Kussman joined the Company in August 1996 as Vice President of Sales
and Marketing. From 1994 to June 1996, Mr. Kussman served as Vice President of
Sales and Marketing of the Medical Analysis Systems, a manufacture of controls
and blood chemistry reagents. From 1990 to 1994, Mr. Kussman served as Marketing
Manager for Syva a division of Syntex, which manufacture drugs-of-abuse
detection systems, therapeutic drug therapeutic monitoring and infectious
disease detection systems. From 1988 to 1990, Mr. Kussman was employed as Vice
President of Sales and Marketing by the International Bioclinical, Inc., a
manufacture of medical reagents and medical assay developer. From 1977 to 1988,
Mr. Kussman was employed as U.S. Marketing Manager by the Abbott Laboratories,
diagnostics division. Mr. Kussman earned a B.S. in Marketing Management from
Southern Illinois University and an M.B.A. from St. Louis University.
21
Andrea J. Tiller joined the Company as Vice President of Finance and Chief
Financial Officer in December 1996 and became Secretary in January 1997. Prior
to joining Cholestech, Ms. Tiller was a management consultant for Left Brain, a
consulting company. From 1994 to 1995 Mr. Tiller held a postion as Director of
Corporate Planning and Finance with Target Therapeutics, currently a division of
Boston Scientific, a medical device manufacturer. From 1991 through 1994 she
held a position as Business Planning Manager of SynOptics Communications,
currently Bay Networks. Prior to joining SynOptics Communications, Ms. Tiller
was employed as Senior Marketing Research Specialist by the E.I. Dupont de
Nemours & Company and has twice owned and operated consulting practices in the
areas of business strategy and development. Ms. Tiller earned a B.A. in
Economics from Stanford University and an M.B.A. from the San Francisco State
University Graduate School of Business.
PART II
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
SHAREHOLDER MATTERS
The Company's Common Stock is quoted on the Nasdaq National Market under the
symbol "CTEC." The following table sets forth the quarterly high and low closing
sales prices for the Company's Common Stock.
FISCAL YEAR 1995 HIGH LOW
---------------- -------- --------
First Quarter .. $ 5.25 $ 2.50
Second Quarter . 3.25 1.75
Third Quarter .. 3.25 1.13
Fourth Quarter . 3.00 1.50
FISCAL YEAR 1996 HIGH LOW
---------------- -------- --------
First Quarter .. $ 2.50 $ 1.50
Second Quarter . 3.00 2.13
Third Quarter .. 3.75 2.25
Fourth Quarter . 7.56 3.13
FISCAL YEAR 1997 HIGH LOW
---------------- -------- --------
First quarter .. $ 7.50 $ 5.25
Second quarter . 6.63 4.13
Third quarter .. 6.13 4.88
Fourth quarter . 6.50 4.88
On June 3, 1997, there were approximately 326 holders of record of the
Company's Common Stock.
The Company has never declared or paid cash dividends on its capital stock.
The Company currently expects to retain future earnings, if any, to finance the
growth and development of its business and, therefore, does not anticipate
paying any cash dividends in the foreseeable future.
Sales of Unregistered Securities
In May 1996, the Company issued and sold (without payment of any selling
commission to any person) 39,526 shares of Common Stock to Metra Biosystems,
Inc. ("Metra Biosystems") at a price of $6.325 per share.
The sale of the above securities was deemed to be exempt from registration
under the Securities Act of 1933, as amended, or Regulation D promulgated
thereunder, as a transaction by an issuer not involving a public offering. Metra
Biosystems represented its intention to acquire the securities for investment
only and not with a view to or for sale in connection with any distribution
thereof and appropriate legends were affixed to the share certificates issued in
such transaction. Metra Biosystems has adequate access, through its relationship
with the Company, to information about the Company.
22
ITEM 6: SELECTED FINANCIAL DATA
MARCH 28, MARCH 29, MARCH 31, MARCH 25, MARCH 26,
YEAR ENDED (1) 1997 1996 1995 1994 1993
- --------------------------------------------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA
Revenues .................................... $12,861 $ 6,873 $ 4,038 $ 3,029 $ 3,744
Cost of products sold ....................... 6,952 4,505 3,933 4,972 4,908
------- ------- ------- ------- -------
Gross profit (loss) ......................... 5,909 2,368 105 (1,943) (1,164)
------- ------- ------- ------- -------
Operating expenses:
Research and development .................. 1,254 714 715 2,134 1,843
Sales and marketing ....................... 3,891 3,168 2,694 2,909 2,171
General and administrative ................ 1,846 1,376 1,983 2,288 3,133
------- ------- ------- ------- -------
Total operating expenses ............... 6,991 5,258 5,392 7,331 7,147
------- ------- ------- ------- -------
Loss from operations ........................ (1,082) (2,890) (5,287) (9,274) (8,311)
Interest income, net ........................ 273 144 243 364 246
------- ------- ------- ------- -------
Net loss .................................... $ (809) $(2,746) $(5,044) $(8,910) $(8,065)
======= ======= ======= ======= =======
Net loss per share (2) ...................... $ (.08) $ (.34) $ (.63) $ (1.14) $ (1.57)
======= ======= ======= ======= =======
Weighted average common shares (2) ......... 10,382 8,042 7,954 7,791 5,122
======= ======= ======= ======= =======
BALANCE SHEET DATA
MARCH 28, MARCH 29, MARCH 31, MARCH 25, MARCH 26,
YEAR ENDED (1) 1997 1996 1995 1994 1993
- ------------------------------------- ----------- ----------- ----------- ----------- -----------
(IN THOUSANDS)
Cash, cash equivalents and marketable $ 14,009 $ 4,111 $ 5,230 $ 11,058 $ 18,964
securities ..........................
Working capital ...................... 16,138 4,442 5,929 9,239 14,660
Total assets ......................... 21,087 9,645 10,041 15,685 25,399
Long-term liabilities ................ 14 810 44 54 361
Accumulated deficit .................. (50,471) (49,662) (46,916) (41,872) (32,962)
Shareholders' equity ................. 18,703 5,982 8,513 13,412 21,991
- ----------------
(1) The Company's fiscal year is a 52-53 week period ending on the last Friday
in March. All fiscal years in this report consist of 52 weeks, except
fiscal 1995, which consisted of 53 weeks.
(2) See Note 1 of Notes to Financial Statements for an explanation of shares
used in computing net loss per share.
23
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion contains forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors discussed herein, under "General" and "Potential Factors
Affecting Future Operating Results." These forward-looking statements include,
but are not limited to, the statement under "General" regarding the Company's
expectation of continuing to incur operating losses as well as negative cash
flows, the statement under "Sales and Marketing" regarding the Company's
anticipation that sales and marketing expenses will increase, the statement
under "Research and Development" regarding the Company's anticipation that
research and development expenditures will increase and the statement in the
third paragraph under "Liquidity and Capital Resources" regarding the length of
time that the Company's resources will be sufficient to meet its capital
requirements.
GENERAL
The Company develops, manufactures and markets a proprietary platform
technology -- the Cholestech L.D.X(R) System -- which in the preventive care
market measures specific analytes to detect various diseases and disorders
within five minutes using a single drop of whole blood. The Company has
experienced significant operating losses since inception and, as of March 28,
1997, had an accumulated deficit of $50.5 million. The Company is developing
certain additional tests designed to extend the Cholestech L.D.X System's
capabilities. The Company believes that its future growth will depend, in part,
upon its ability to complete development and successfully introduce these new
tests. The Company expects to continue to incur negative cash flows from
operations as it expands product research and development efforts for new test
panels, pursues regulatory clearances and approvals, expands sales and marketing
activities to address the therapeutic monitoring market, and develops and
expands manufacturing capacity for existing and new test panels. The development
and commercialization of the 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
achieve profitability and positive cash flows from operations.
RESULTS OF OPERATIONS
Years Ended March 28, 1997 And March 29, 1996
Revenues. The Company's revenues increased by 87% to $12.9 million in fiscal
1997 from $6.9 million in fiscal 1996. Domestic revenues increased by 107% to
$11.6 million in fiscal 1997 from $5.6 million in fiscal 1996 while
international revenues remained constant at $1.3 million in both fiscal 1997 and
1996. The increase in domestic revenues reflects a continuing unit increase in
sales of the disposable test cassettes and the Cholestech L.D.X System to
hospitals, managed care organizations, public health departments, corporations,
physician office laboratories and other health care providers in the diagnostic
screening and therapeutic monitoring markets. As of March 28, 1997, the Company
had approximately 1,478 active health promotion accounts. In April 1996, the
Company launched its Clinical Laboratory Improvement Amendments of 1988 waived
product line. The Company had shipped approximately 1,144 Cholestech L.D.X
Systems into the physician office laboratory market as of March 28, 1997. The
Company is represented in the physician office laboratories market segment by
Physician Sales and Service, Inc. and General Medical. In the pharmacy market
segment of therapeutic market the Company is represented by AmeriSource Health
Corporation.
International revenues as a percent of total revenues declined to 10.8% for
the fiscal year ended March 28, 1997 from 23.9% for the fiscal year ended March
29, 1996. The decrease in international revenues as a percentage of total
revenues reflects the substantial increase in domestic revenues from sales of
the Cholestech L.D.X System after the Company's product had been granted waived
status. During fiscal 1997, a single European distributor accounted for 47% of
the Company's international revenues, a slight increase over 45% in fiscal 1996.
The Company expects that international revenues will continue to decline as a
percentage of total revenues in future periods as the Company continues to
increase sales and marketing efforts in the United States.
24
Costs of Products Sold. Costs of products sold increased 54% to $7 million in
fiscal 1997 from $4.5 million in fiscal 1996, as sales of disposable test
cassettes and the Cholestech L.D.X System increased. Gross margin was 45.9% and
34.5% in fiscal 1997 and 1996, respectively. The improvement in the gross margin
was primarily attributable to improved cassette manufacturing yields, growth in
the volume of disposable test cassettes and the Cholestech L.D.X System sold,
without corresponding increases in costs, and improved quality assurance
procedures.
The Company has obtained rights to use certain technology in the
manufacturing of certain of its products. The related agreements, which expire
at various times in calendar 1997 through 2006, provide for the Company to pay
royalties ranging from 2% to 4.6% of net sales of the applicable products. Total
royalty expense in fiscal 1997, 1996 and 1995 were $551,000, $381,000 and
$132,000, respectively, and was charged to cost of products sold.
Research and Development. Research and development expenses increased 76% to
$1.3 million in fiscal 1997 from $714,000 in fiscal 1996. This increase in
research and development expense was primarily attributable to continued
development of additional tests and the increase in headcount to fourteen from
four at the end of fiscal 1996. Research and development expenses as a
percentage of revenues decreased to 9.8% in fiscal 1997 from 10.4% in fiscal
year 1996. Such decrease as a percentage of revenues resulted from faster
revenue growth than the Company's ability to responsibly build infrastructure.
The Company is currently developing additional tests to detect disease states
such as renal function, kidney function, metabolic bone diseases and disorders,
liver function, prostate cancer and diabetes. Each of these new tests is at an
early stage 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. However, the Company
believes that its future revenue growth and profitability will depend, in part,
upon its ability to complete development and successfully introduce new test
panels designed to extend the Cholestech L.D.X System's capabilities to include
additional tests useful in the diagnostic screening and therapeutic monitoring
markets. The Company currently anticipates that research and development
expenditures will increase significantly in future periods as product
development and manufacturing scale-up efforts for new tests increase.
Sales and Marketing. Sales and marketing expense increased 22.8% to $3.9
million in fiscal 1997 from $3.2 million in fiscal 1996. This increase in sales
and marketing expense were primarily attributable to continued expansion of the
Company's domestic sales and marketing organization, increased expenses related
to the penetration in the therapeutic monitoring market, increased commissions
associated with increased revenues and, to a lesser extent, participation in
domestic conferences and trade shows. Sales and marketing expense fell to 30.2%
of total revenue in fiscal 1997 from 46.1% of total revenues in fiscal 1996 due
to revenue growth that out paced the Company's ability to responsibly build its
sales and marketing infrastructure. The Company currently anticipates that sales
and marketing expenses will increase in future periods as the Company continues
to expand sales and marketing activities to address the therapeutic monitoring
market, in particular the physician office laboratory and the pharmacy segments.
General and Administrative. General and administrative expense increased 34%
to $1.8 million in fiscal 1997 from $1.4 million in fiscal 1996. The increase in
general and administrative expenses resulted primarily from higher professional
fees relating to recruitment of key personnel, legal fees relating to business
development efforts, and an increased investment in the Company's information
systems. General and administrative expenses fell to 14.4% of total revenues in
fiscal 1997 from 20.0% in fiscal 1996. This decrease in general and
administrative expense as a percentage of total revenues occurred due to faster
revenue growth than the Company's ability to responsibly build its
infrastructure.
Interest Income. Interest income reflects income from the investment of cash
balances and marketable securities. Interest income rose 82% to $517,000 in
fiscal 1997 from $284,000 in fiscal 1996. The growth in interest income in
fiscal 1997 over fiscal 1996 is primarily the result of investing the proceeds
from the Company's public offering of Common Stock in June 1996.
Interest Expense. Interest expense is incurred on capital lease financings,
the bank line of credit and long-term debt. Interest expense increased 74% to
$244,000 in fiscal 1997 from $140,000 in fiscal 1996. The
25
rise in interest expense in fiscal 1997 resulted primarily from the imposition
of a prepayment penalty of $112,000 when the Company retired its long-term debt
in the second quarter of fiscal 1997.
Years ended March 29, 1996 and March 31, 1995
Revenues. The Company's total revenues increased by 70.2% to $6.9 million in
fiscal 1996 from $4.0 million in fiscal 1995. Domestic revenues increased by
72.2% to $5.6 million in fiscal 1996 from $3.2 million in fiscal 1995 while
international revenues increased by 62.2% to $1.3 million in fiscal 1996 from
$817,000 in fiscal 1995. The increase in total revenues reflected increased unit
sales of the Cholestech L.D.X System and disposable test cassettes to hospitals,
managed care organizations, public health departments, corporations and other
health care providers in the diagnostic screening market. The Company's product
sales to the United States therapeutic monitoring market were minimal in each
fiscal year.
For the fiscal year ended March 29, 1996, international revenues increased
$508,000 (62.2%) to $1.3 million from $817,000 for the fiscal year ended March
31, 1995. The increase in international revenue reflects the shipment of an
unusual number of Cholestech L.D.X System to Europe in the fiscal year ended
March 29, 1996. International revenues as a percent of total revenues declined
slightly to 23.9% for the fiscal year ended March 29, 1996 from 25.3% for the
fiscal year ended March 31, 1995. The decline of international revenues as a
percent of total revenues reflects the 72.2% increase in domestic revenues in
fiscal 1996 from fiscal 1995. During fiscal 1996, a single European distributor
accounted for 45% of the Company's international revenues. No single
international distributor accounted for a material percentage of international
revenues in fiscal 1995.
Costs of Products Sold. Costs of products sold increased 14.5% to $4.5
million in fiscal 1996 from $3.9 million in fiscal 1995, as unit sales of the
Cholestech L.D.X System and disposable test cassettes increased. Gross margin
was 34.5% and 2.6% in fiscal 1996 and 1995, respectively. The improvement in the
gross margin was primarily attributable to improved cassette manufacturing
yields, improved quality assurance procedures and growth in the volume of units
sold. During fiscal 1995, the Company improved cassette manufacturing yields and
quality assurance procedures and reduced staffing levels by eliminating
technical and engineering positions specific to initial product development and
scale-up of manufacturing capacity. The resulting manufacturing efficiencies and
cost reductions were reflected for the full year of fiscal 1996.
Research and Development. Research and development expenses remained nearly
constant at $715,000 from $714,000 between fiscal 1996 and fiscal 1995,
respectively, as a result of the Company's decision to concentrate available
resources on expansion of sales and marketing activities for existing test
panels. As a result of the Company's expanding sales of the Cholestech L.D.X
System and its cassettes without a corresponding increase in research and
development expenditures, research and development expense as a percentage of
total revenues fell to 10.4% in fiscal 1996 from 17.7% in fiscal 1995.
Sales and Marketing. Sales and marketing expense increased 17.6% to $3.2
million in fiscal 1996 from $2.7 million in fiscal 1995. The increase in sales
and marketing expense was primarily attributable to expansion of the Company's
domestic direct sales and marketing organization, increased commissions
associated with increased product sales and, to a lesser extent, participation
in domestic conferences and trade shows. Sales and marketing expense fell to
46.1% of total revenues in fiscal 1996 from 66.7% of total revenues in fiscal
1995 due to revenue growth that out paced the Company's ability to responsibly
build its sales and marketing infrastructure.
General and Administrative. General and administrative expenses decreased
30.6% to $1.4 million in fiscal 1996 from $2.0 million in fiscal 1995. The
decrease in general and administrative expenses was primarily a result of
reduced headcount and reduced expenditures for rent and insurance. General and
administrative expenses fell to 20.0% to total revenues in fiscal 1996 from
49.1% in fiscal 1995. These decreases in general and administrative expense as a
percentage of total revenues occurred due to faster revenue growth than the
Company's ability to responsibly build its infrastructure. In fiscal 1995,
general and administrative expenses included a one-time charge of approximately
$114,000 as a result of headcount reductions. Absent such one-time charge,
general and administrative expenses for fiscal 1995 would have been $1.9
million.
26
Interest Income. Interest income was earned on investment of cash balances
generated from prior equity financings of the Company. Interest income rose
slightly to $284,000 from $278,000 in fiscal 1996.
Interest Expense. Interest expense was incurred on capital lease financings,
the bank line of credit and long-term debt obtained by the Company. Interest
expense rose three-fold to $140,000 in fiscal 1996 from $35,000 in fiscal 1995
due to capital lease financings obtained by the Company.
Income Tax Carryforwards. As of March 28, 1997, the Company had net operating
loss carryforwards available to reduce taxable income through 2012 for federal
and state income tax purposes of approximately $46.2 million and $22.2 million,
respectively. Additionally, the Company had research and development credit
carryforwards available to reduce income taxes through 2012 for federal and
state income tax purposes of approximately $1.5 million and $532,000,
respectively. There is an annual limitation of approximately $1.5 million for
federal and state income tax reporting purposes on the use of approximately $8.1
million and $1.1 million of net operating losses, and of $390,000 and $160,000
of tax credit carryforwards, respectively. The Company's net operating losses
and tax credit carryforwards incurred prior to December 1992 are subject to an
annual limitation of approximately $5.5 million for federal and state income tax
reporting purposes on the use of approximately $28.2 million and $8.1 million of
net operating loss carryforwards, respectively, and of $1.2 million and $379,000
of tax credit carryforwards, respectively. If the amounts of these limitations
are not utilized in any year, the amount not utilized increases the allowable
limit in the subsequent year.
Impact of Adoption of New Accounting Standards. The Company continues to
account for its stock option and employee stock purchase plans in accordance
with the provisions of Accounting Principles Board's Opinion No. 25, "Accounting
for Stock Issued to Employees." In 1995 the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 123, "Accounting for
Stock Based Compensation" ("SFAS 123") which established a fair value based
method of accounting for stock based compensation plans. Under the terms of SFAS
123, companies can elect to account for stock based compensation plans using the
fair value method or continue measuring compensation expense for those plans
using the intrinsic value method must make pro forma disclosures of net income
and earnings per share as if the fair value method defined in SFAS 123 had been
applied. The Company has adopted the disclosure method of SFAS 123 in fiscal
1997 and, consequently, SFAS 123 had no impact on the Company's financial
condition and results of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through the sale of equity
securities and, to a lesser extent, through capital lease financing and a
long-term note payable. Through March 28, 1997, the Company had raised
approximately $69 million in net proceeds from equity financings. As of March
28, 1997, the Company had approximately $14 million of cash, cash equivalents
and short-term marketable securities. In addition, the Company has a $3 million
revolving bank line of credit. While the agreement is in effect, the Company is
required to maintain on 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, 1997
and is renewable. As of March 28, 1997, there were no borrowings outstanding
under the line of credit.
Net cash used in operating activities was approximately $1 million, $2.4
million and $5.0 million in fiscal 1997, 1996 and 1995, respectively. The
primary factor contributing to decrease in cash used in operations from year to
year was the decrease in net losses, offset in part by increases in accounts
receivable and inventory. Accounts receivable, net, increased due to increased
sales volume. Inventory increased primarily to support increased production
ramps to meet increasing demand for products and for increases in finished goods
inventory to support a larger installed base. In fiscal 1997, net cash used in
investing activities reflected the Company's purchases of property and equipment
and purchases of short-term marketable securities. During fiscal 1996, net cash
used in investing activities reflected the Company's purchases of property and
equipment. Net cash provided by investing activities in fiscal 1995 resulted
primarily from the sales of marketable securities. Net cash provided by
financing activities in fiscal 1997
27
of $11.9 million reflects issuance of Common Stock, primarily from the public
offering, offset in part by principal payments on capital leases, repayment of
long-term debt and repayment of short-term bank borrowings. Net cash provided by
financing activities of $1.6 million in fiscal 1996 reflected approximately $1.7
million in net proceeds from a note payable, borrowing under the line of credit
and issuance of Common Stock while the net cash used in financing activities in
fiscal 1995 reflected the repayment of capital lease obligations.
The Company intends to expend substantial funds for product research and
development, continued expansion of sales and marketing activities, expansion of
manufacturing capacity and other working capital and general corporate purposes.
Although the Company believes that its cash, cash equivalents and short-term
marketable securities balances as of March 28, 1997, available bank line of
credit, together with amounts to be generated from operations, will be
sufficient to meet its capital requirements for the foreseeable future, there
can be no assurance that the Company will not require additional financing. The
Company's actual liquidity and capital requirements will depend upon numerous
factors, including the costs and timing of expansion of manufacturing capacity,
the number and type of new tests the Company seeks to develop, 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 Clinical Laboratory Improvement Amendments of 1988,
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 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, if at all.
POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS
History of Losses; Uncertainty of Future Profitability. The Company has
experienced significant operating losses since inception and as of March 28,
1997, had an accumulated deficit of $50.5 million. The Company may experience
significant fluctuations in revenues and results of operations on annual and/or
a quarter to quarter basis in the future. Annual and/or quarterly operating
results will fluctuate due to numerous factors, such as (i) the timing and level
of market acceptance of the Cholestech L.D.X(R) System, particularly with
respect to the therapeutic monitoring market; (ii) the timing of introduction
and availability of new tests; (iii) the timing and level of expenditures
associated with new product development activities; (iv) the timing and level of
expenditures associated with expansion of sales and marketing activities and
overall operations; (v) the Company's ability to cost-effectively expand
cassette manufacturing capacity and maintain consistently acceptable yields in
the manufacture of disposable test cassettes; (vi) the timing of establishment
of strategic distribution arrangements and the success of the activities
conducted under such arrangements; (vii) variations in manufacturing
efficiencies; (viii) changes in demand for its products based on changes in
third party reimbursement, competition, changes in government regulation and
other factors; (ix) the timing of significant orders from and shipments to
customers; and (x) general economic conditions. These factors are difficult to
forecast, and these or other factors could have a material adverse effect on the
Company's business, financial condition and results of operations. Fluctuations
in annual and/or quarterly demand for products may adversely affect the
continuity of the Company's manufacturing operations, increase uncertainty in
operational planning, and/or affect cash flow 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. If actual revenues do
not meet expectations, the Company's business, financial condition and results
of operations could be materially adversely affected.
Uncertainty of Market Acceptance of the Cholestech L.D.X System. The Company
has generated revenues to date, primarily from sales of the Cholestech L.D.X
System to hospitals, public health
28
departments, corporate wellness programs, health promotion service providers,
managed care organizations, community health centers, the military, others in
the diagnostic screening market and therapeutic monitoring market. In order for
the Company to increase revenues, achieve sustained profitability and maintain
positive cash flows from operations, the Cholestech L.D.X System must achieve a
significant degree of market acceptance among health care providers in the
therapeutic monitoring market, particularly physician office laboratories.
Physicians and other health care providers are not likely to use the Cholestech
L.D.X System unless they determine that it is an attractive alternative to other
means of diagnostic screening or therapeutic monitoring blood detected diseases.
Even if the advantages of the Cholestech L.D.X System in diagnosing and
therapeutic monitoring patients with blood detected diseases are established,
physicians, medical clinics, pharmacists and other health care providers may
elect not to purchase and use the Cholestech L.D.X System for any number of
reasons. As a result, there can be no assurance that demand for the Cholestech
L.D.X System, particularly in the therapeutic monitoring market, will be
sufficient to allow for profitable operations.
Dependence on Development and Introduction of New Products. The Company is in
the early stages of developing tests designed to extend the Cholestech L.D.X
System's capability to include additional tests useful to health care providers,
particularly physician office laboratories. The Company believes that its
revenue growth and future profitability 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
activities and 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 Centers for Disease Control and Prevention (for waived status) on
a timely basis, if at all, or that new tests will adequately meet the
requirements of the applicable market or achieve market acceptance. In order to
successfully commercialize any new tests, the Company will be required to
establish and maintain reliable, cost-efficient, high-volume manufacturing
capacity for such tests. The Company has in the past encountered difficulties in
scaling up production of new test cassettes, including problems involving
production yields, quality control and assurance, variations and impurities in
the raw materials and performance of the manufacturing equipment. If the Company
is unable for technological or other reasons to complete the development,
introduction and scale up of manufacturing of any new tests or if such new tests
do not achieve a significant level of market acceptance, the Company's business,
financial condition and results of operations could be materially adversely
affected.
Limited Sales, Marketing and Distribution Experience; Dependence on Third
Party Distributors. In order for the Company to increase revenues and achieve
sustainable profitability, the Cholestech L.D.X System must achieve a
significant degree of market acceptance among health care providers in the
monitoring market, particularly physician office laboratories and pharmacy
market segments. The Company has only limited experience in marketing and
selling to the monitoring market in the United States. The Company has recently
entered into distribution arrangement with two national distributors, General
Medical and AmeriSource. The Company may be required to enter into additional
distribution arrangements in order to achieve broad distribution of its
products. There can be no assurance that the Company will be able to enter into
and maintain arrangements with additional distributors on a timely basis, if at
all. The Company will be dependent upon these distributors to assist it in
promoting market acceptance that these distributors will devote the resources
necessary to provide effective sales and marketing support to the Company. In
addition, the Company 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 become unwilling or unable
to promote, market and sell the Cholestech L.D.X System and disposable test
cassettes, the Company's business, financial condition and results of operations
would be materially adversely affected.
Risks Associated with Cassette Manufacturing. The Company internally
manufactures all the disposable test cassettes that are components of the
Cholestech L.D.X System. The manufacture of the disposable test cassettes is a
highly complex and precise process. Such manufacturing is sensitive to a wide
29
variety of factors, including variations and impurities in the raw materials,
difficulties in the manufacturing process, performance of the manufacturing
equipment and the level of contaminants in the manufacturing environment. The
Company has in the past experienced lower than expected production yields that
have adversely affected gross margins and delayed product shipments. The Company
believes that it may be required to expand manufacturing capacity for new and
existing test cassettes. There can be no assurance that such expansion of
cassette manufacturing capacity can be completed in a timely fashion, if ever.
In addition, the Company may be required to build a new cassette manufacturing
line for the immunoassay test cassettes under development. To date, the Company
has not developed the core technologies, processes and productions equipment for
an immunoassay cassette manufacturing line. To the extent the Company does not
achieve acceptable manufacturing yields of disposable test cassettes or
experiences product shipment delays, the Company's business, financial condition
and results of operations would be materially adversely affected.
Highly Competitive Industry; Rapid Technological Change. The diagnostic
screening and therapeutic monitoring markets in which the Company competes is
intensely competitive. The Company's competition consists mainly of independent
clinical laboratories and hospital-based laboratories, as well as manufacturers
of bench top and other preventive care Systems. In order to achieve market
acceptance for the Cholestech L.D.X System, the Company will be required to
demonstrate that the Cholestech L.D.X System is an attractive alternative to the
clinical laboratory and hospital-based laboratory, as well as bench top and
other preventive care systems. This will require physicians to change their
established means of having such tests performed. The Company expects that the
reclassification of the Cholestech L.D.X System as waived under Clinical
Laboratory Improvement Amendments of 1988 will result in competitors seeking to
develop products that qualify for waived classification. The Company expects
that such competitors will compete intensely to maintain and increase their
market shares. There can be no assurance that the Company's competitors will not
succeed in obtaining Clinical Laboratory Improvement Amendments of 1988 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. There can be no assurance that the Cholestech L.D.X
System will be able to compete with the testing services provided by these
laboratories and analyzers.
Dependence on Proprietary Technology, Uncertainty of Patent and Proprietary
Technology Protection, Dependence on License of Technology of Third Parties. The
Company's ability to compete effectively will depend in part on its ability to
develop and maintain proprietary aspects of its technology, and operate without
infringing the proprietary rights of others. Cholestech has eight United States
patents and one foreign issued patent and is currently prosecuting several
patent applications with certain foreign patent offices. 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 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. 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
USPTO to determine the priority of inventions. 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 parties which may not be available on
commercially reasonable terms.
Government Regulation. The manufacture and sale of diagnostic products,
including the Cholestech 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 until
it receives clearance or approval from the FDA. 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 would have a material adverse effect on the Company's business,
financial condition and results of
30
operations. 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 can take longer.
In addition, certain of the Company's products under development, such as the
PSA test, may require submission of a pre-market approval application which is
much longer and more costly process and involves the submission of extensive
supporting data and clinical information. A pre-market approval application may
be submitted to the FDA only after clinical trials and the required patient
follow-up for a particular test are successfully completed. Upon filing of a
pre-market approval application, the FDA commences a review process that
generally takes one to three years from the date on which the pre-market
approval 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 pre-market approval
approval. A requirement that the company file a pre-market approval application
for a new test would significantly delay the Company's ability to market such
test and significantly increase the costs of development.
Sales of medical devices outside the United States are subject to regulatory
requirements that vary from country to country. The time required to obtain
approval to market medical devices may be shorter or longer than that required
for FDA approval, and the requirements could differ. Such requirements could
adversely effect the Company's ability to sell its products internationally.
The use of Cholestech's products and those of its competitors is also
affected by Clinical Laboratory Improvement Amendments of 1988 and related
federal and state regulations, which provide for regulation of laboratory
testing. The scope of these regulations includes quality control, proficiency
testing, personnel standards and federal inspections. Clinical Laboratory
Improvement Amendments of 1988 categorizes tests as "waived," or as being
"moderately complex" or "highly complex," on the basis of specific criteria. In
January 1996, the Cholestech L.D.X System and the total cholesterol, high
density lipoprotein cholesterol, triglycerides and glucose tests in any
combination were reclassified as waived under Clinical Laboratory Improvement
Amendments of 1988. 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 Clinical Laboratory
Improvement Amendments of 1988. There can be no assurance that any new tests
developed by the Company will qualify for the waived classification. Any failure
of the new tests to obtain waived status under Clinical Laboratory Improvement
Amendments of 1988 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.
Uncertainty Relating to Third Party Reimbursement. In the United States,
health care providers, such as hospitals and physicians, that purchase
diagnostic products such as the Company's System, generally rely on third party
payers, principally private health insurance plans, federal Medicare and state
Medicaid, 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 such products and related treatment will be
available from government health authorities, private health insurers and other
organizations. Such third party payers can affect the pricing or the relative
attractiveness of the Company's products by regulating the maximum amount of
reimbursement provided by such payers for testing services. Reimbursement is
currently available for the Company's current product line of disposable test
cassettes. The cost of the Cholestech L.D.X System is generally not subject to
reimbursement by government and other third party payers. In addition, the tests
performed by public health departments, corporate wellness programs and other
large volume users in the screening market are generally not subject to
reimbursement. In addition, certain health care providers are moving towards a
managed care system in which such providers contract to provide comprehensive
health care for a fixed cost per patient. Failure by physicians and other users
to obtain reimbursement from third party payers, or changes in government and
private third party payers' policies toward reimbursement of test employing the
Company's products could have a material adverse effect on the Company's
business, financial condition and results of operations. Given the efforts to
control and reduce health care costs in the United States in recent years, there
can be no assurance that currently available levels of reimbursement will
continue to be available in the future for the Company's existing products or
products under development.
31
In addition, market acceptance of the Company's products in international
markets is dependent, in part, upon the availability of reimbursement within
prevailing health care payment systems. Reimbursement and health care payment
systems in international markets vary significantly by country, and include both
government sponsored health care and private insurance.
Dependence on Suppliers. Certain key components and raw materials used in
manufacturing of the Company's products are currently provided by single-source
vendors. Any supply interruption in a single-source component or raw material
would have a material adverse effect on the Company's ability to manufacture
products until a new source of supply were qualified. There can be no assurance
that the Company will be successful in qualifying additional sources on a timely
basis or at all, which would have a material adverse effect on the Company's
business. 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. Also, because the Company is a small customer
of many of its suppliers, there can be no assurance that suppliers will devote
adequate resources to supplying the Company's needs. Any interruption or
reduction in the future supply of any key components or raw materials currently
obtained from single or limited sources could have a material adverse effect on
the Company's business, operating results and financial condition in any given
period.
Dependence on Retention and Attraction 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 scientific, technical,
clinical, regulatory and managerial personnel. 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
scientific, technical, clinical, regulatory and managerial 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 result in personal injury. The Company also faces the
possibility that defects in the design or manufacture of its products might
necessitate a product recall. The Company currently maintains product liability
insurance with coverage limits of $5.0 million per occurrence and $5.0 million
annually in the aggregate, and there can be no assurance that the coverage
limits of the Company's insurance policies will be adequate. Such insurance is
expensive, difficult to obtain and may not be available in the future on
acceptable terms, or at all. No assurance can be given that product liability
insurance can be maintained in the future at a reasonable cost or in sufficient
amounts to protect the Company against losses due to liability. In addition, a
product liability claim in excess of relevant insurance coverage or product
recall could have a material adverse effect on the Company's business, financial
condition and results of operations.
Issuance of Preferred Stock Could Delay or Prevent Corporate Takeover. The
Board of Directors has the authority to issue up to 5,000,000 shares of
undesignated Preferred Stock and to determine the rights, preferences,
privileges and restrictions of such shares without any further vote or action by
the shareholders. To date, the Board of Directors has designated 25,000 shares
as Series A Participating Preferred Stock in connection with the Company's
Shareholder 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.
On January 22, 1997, pursuant to a Preferred Shares Rights Agreement (the
"Rights Agreement") between the Company and ChaseMellon Shareholder Services, L.
L. C. (the "Rights Agent"), the Company's Board of Directors declared a dividend
of one right (a "Right") to purchase on one-thousandth share of the Company's
Series A Participating Preferred Stock ("Series A Preferred") for each
outstanding share of Common Stock of the Company. The dividend was payable on
March 31, 1997 (the "Record
32
Date") to stockholders of record as of the close of business on that day. Each
Right entitles the registered holder to purchase from the Company on
one-thousandth of a share of Series A Preferred at an exercise price of $44.00
(the "Purchase Price"), subject to adjustment. The Rights approved by the Board
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 acquirer
to take over the Company, in a manner or on terms not approved by the Board of
Directors. 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 stockholders equally. The Rights should not
interfere with any merger or business combination approved by the Board of
Directors. However, the Rights may have the effect of rendering more difficult
or discouraging an acquisition of the Company deemed undesirable by the Board of
Directors. The Rights may cause substantial dilution to a person or group that
attempts to acquire the Company on terms or in a manner not approved by the
Company's Board of Directors, except pursuant to an offer conditioned upon the
negation, purchase or redemption of the Rights.
Potential Volatility of Stock Price. The market price of shares of Common
Stock, like that of the common stock of many other medical products and high
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 competitors, government regulation, changes in the
current structure of the health care financing and payment systems, developments
in or disputes regarding patent or other proprietary rights, economic and other
external factors and general market conditions 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
Company's Common Stock. In the past, following periods of volatility in the
market price of a company's stock, securities class action litigations have
occurred 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, operating results and financial condition. Any adverse
determination in such litigation could also subject the Company to significant
liabilities.
Absence of Dividends. The Company has not paid any cash dividends since
inception and does not anticipate paying cash dividends in the foreseeable
future.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements and supplemental data required
by this item and set forth at the pages indicated in Item 14(a) of this Report.
ITEM 9: DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
33
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item concerning the Company's Directors is
incorporated by reference from the sections captioned "Election of Directors --
Nominees" and "Sections 16(a) Beneficial Ownership Reporting Compliance"
contained in the Company's Proxy Statement related to the 1997 Annual Meeting of
Shareholders to be held August 22, 1997, to be filed by the Company with the
Securities and Exchange Commission within 120 days of the end of the Company's
fiscal year pursuant to General Instructions G(3) of the Form 10-K (the "Proxy
Statement"). Certain information required by this item concerning executive
officers is set forth in Part I of this Report and certain information required
by this item is incorporated by reference from the section captioned "Section
16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement.
ITEM 11: EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
section captioned "Executive Compensation" contained in the Proxy Statement.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" contained in the Proxy Statement.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
sections captioned "Compensation Committee Interlocks and Insider Participation"
and "Certain Transactions with Management" contained in the Proxy Statement.
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
The following financial statements are filed as part of this Report:
PAGE
----
Report of Independent Accountants ................. F-2
Balance Sheets .................................... F-3
Statements of Operations .......................... F-4
Statements of Changes in Shareholders' Equity .... F-5
Statements of Cash Flows .......................... F-6
Notes to Financial Statements ..................... F-7
(a)(2) Financial Statement Schedules
The following schedule is filed as part of this Report:
Schedule II -- Valuation and qualifying accounts for each of the three years
in the period ended March 28, 1997.
All other schedules are omitted because they are not applicable, or because
the required information is included in the financial statements or notes
thereto.
34
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
CHOLESTECH CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
BALANCE AT CHARGED BALANCE AT
BEGINNING TO COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
------------ ---------------- ------------ ------------
FISCAL YEAR ENDED MARCH 31, 1995
Allowance for doubtful accounts $ 76,000 $ 17,000 $68,000 $ 25,000
Amortization of other assets 202,000 142,000 -- 344,000
FISCAL YEAR ENDED MARCH 29, 1996
Allowance for doubtful accounts $ 25,000 $ 57,000 $ -- $ 82,000
Amortization of other assets 344,000 143,000 -- 487,000
FISCAL YEAR ENDED MARCH 28, 1997
Allowance for doubtful accounts $ 82,000 $ 49,000 $49,000 $ 82,000
Amortization of other assets 487,000 140,000 -- 627,000
(a)(3) Exhibits
3.1(2) Restated Articles of Incorporation of Registrant. 3.2(1) Bylaws
of Registrant, as amended.
4.1(14) Preferred Share Rights Agreement, dated January 27, 1997, between
the Registrant and ChaseMellon Shareholder Services L.L.C.
10.1(15) 1988 Stock Incentive Program and forms of agreements thereunder.
10.2(11) Employee Stock Purchase Plan. 10.3(1) Standard Industrial Lease
Agreement between Registrant and Sunlife Assurance Company of
Canada dated October 22, 1989.
10.3.1(8) First Amendment to Standard Industrial Lease Agreement between
Registrant and Sunlife Assurance Company of Canada dated April
1995.
10.3.2 Third Amendment to Standard Industrial Lease Agreement between
Registrant and Sunlife Assurance Company of Canada dated March
25, 1997.
10.4(1) Forms of Indemnification Agreements between Registrant and its
officers and its directors.
10.5(1) Employment Agreement between Registrant and Edward L. Erickson
dated December 6, 1991.
10.6(1) Equipment Lease Agreement between Registrant and MMC/GATX
Partnership No. 1 dated August 17, 1990.
10.6.1(1) Revised Warrant to Purchase Series D Preferred Stock issued to
MMC/GATX Partnership No. 1.
10.7(1) Master Lease Agreement between Registrant and LINC Venture Lease
Partners II L.P. dated June 13, 1991. 10.7.1(1) Amendment No. 1
to Warrant issued to LINC Venture Lease Partners II L.P.
10.8(1) Supply Agreement effective the 15th day of February 1991 by and
between Ciba Corning Diagnostics Corp. and the Registrant.
10.9(4) Employment Agreement between Registrant and Steven L. Barbato
dated April 27, 1992.
10.10(4) Employment Agreement between Registrant and Robert J. Guyon dated
July 13, 1992.
10.11.1(5) Letter Agreement effective September 28 1993 by and between Union
Bank and Registrant.
10.11.2(5) Promissory Note effective September 28 1993 by and between Union
Bank and Registrant.
35
10.11.3(5) Security Agreement effective September 28, 1993 by and between
Union Bank and Registrant.
10.11.4(7) First Amendment to the Letter Agreement by and between Union Bank
and Registrant.
10.11.5(7) First Amendment to the Promissory Note by and between Union Bank
and Registrant.
10.11.6(10) Second Amendment to the Letter Agreement by and between Union
Bank and Registrant.
10.11.7(10) Second Amendment to the Promissory Note by and between Union Bank
and Registrant.
10.12(4) License Agreement between Registrant and Eastman Kodak Company
dated December 23, 1992.
10.13(6) Employment Agreement between Registrant and Linda H. Masterson
dated May 12, 1994.
10.14(9) Loan Agreement between Registrant and Phoenixcor, Inc. dated
August 31, 1995.
10.15(12)* Development, License and Distribution Agreement between
Registrant and Metra Biosystems, Inc. dated May 3, 1996.
10.16(12) Registration Rights Agreement between Registrant and Metra
Biosystems, Inc. dated May 3, 1996.
10.17.1(13) Letter effective December 20, 1996 by and between Wells Fargo
Bank and the Registrant.
10.17.2(13) Revolving Line of Credit Note effective December 20, 1996 by and
between Wells Fargo Bank and the Registrant.
10.17.3(13) General Pledge Agreement effective December 20, 1996 by and
between Wells Fargo Bank and the Registrant.
10.18 Employment Agreement between Registrant and Mark J. Kussman dated
August 8, 1996.
10.19 Employment Agreement between Registrant and Andrea J. Tiller
dated November 14, 1996.
23.1 Consent of Price Waterhouse LLP, Independent Accountants.
27.1 Financial Data Schedule.
- -----------------
* Confidential treatment has been requested with respect to certain portions
of this exhibit. The redacted portions have been filed separately with the
Securities and Exchange Commission.
(1) Incorporated by reference to exhibits filed with Registrant' s
Registration Statement on Form S-1 (no. 33-47603) which became effective
on June 26, 1992.
(2) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 33-54300) which became effective on December
16, 1992.
(3) Incorporated by reference to exhibits filed with Registrant's Statement on
Form S-8 (No. 333-4148) as filed with the Securities and Exchange
Commission on April 26, 1996.
(4) Incorporated by reference to exhibits filed with Registrant's Annual
Report on Form 10-K for the year ended March 26, 1993.
(5) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 23, 1993.
(6) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 24, 1994.
(7) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 23, 1994.
(8) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995.
(9) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 29, 1995.
36
(10) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 29, 1995.
(11) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-4146) as filed with the Securities and
Exchange Commission on April 25, 1996.
(12) Incorporated by reference to exhibits filed with Registrant's Statement on
Form S-1 (No. 333-3367) filed with the Commission on May 9, 1996.
(13) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 27, 1996.
(14) Incorporated by reference to exhibits filed with Registrant's Statement on
Form 8-A (No. 000-20198) as filed with the Securities and Exchange
Commission on January 27, 1997.
(15) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-22475) as filed with the Securities and
Exchange Commission on February 27, 1997.
(b)Reports on Form 8-K. The Company did not file any reports on Form 8-K
during the quarter ended March 28, 1997.
(c) Exhibits. See Item 14(a)(3) above.
(d) Financial Statement Schedules: See Item 14(a)(2) above.
37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Report to
be signed on its behalf the undersigned, thereunto duly authorized.
CHOLESTECH CORPORATION
By /s/ WARREN E. PINCKERT II
-----------------------------------------------
(Warren E. Pinckert II)
President, Chief Executive Officer and Director
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Warren E. Pinckert II and Andrea J. Tiller
and each one of them, his true and lawful attorney-in-fact and agents, each with
full power of substitution and resubstitution, to sign any and all amendments
(including post-effective amendments) to this Annual Report on From 10-K and to
file the same, with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents, or their substitute or substitutes, or any of them, shall do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1934, as amended, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and dates indicated:
SIGNATURE TITLE DATE
- ---------------------------- ------------------------------------------ -----------------
/s/ WARREN E. PINCKERT II President, Chief Executive Officer and June 26, 1997
- -------------------------- Director (Principal Executive Officer)
(Warren E. Pinckert II)
/s/ ANDREA J. TILLER Vice President of Finance and Chief June 26, 1997
- -------------------------- Financial Officer (Principal Financial
(Andrea J. Tiller) and Accounting Officer)
/s/ HARVEY S. SADOW, PH.D. Chairman of the Board June 26, 1997
- --------------------------
(Harvey S. Sadow, Ph.D.)
/s/ JOSEPH BUCHMAN, M.D. Director June 26, 1997
- --------------------------
(Joseph Buchman, M.D.)
/s/ JOHN L. CASTELLO Director June 26, 1997
- --------------------------
(John L. Castello)
/s/ H.R. SHEPHERD Director June 26, 1997
- --------------------------
(H.R. Shepherd)
38
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Cholestech Corporation
In our opinion, the financial statements listed in the index appearing under
Item 14(a)(1) and (2) on page 34 present fairly, in all material respects, the
financial position of Cholestech Corporation at March 28, 1997 and March 29,
1996, and the results of its operations and its cash flows for each of the three
fiscal years in the period ended March 28, 1997, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
San Jose, California
April 24, 1997
F-2
CHOLESTECH CORPORATION BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
MARCH 28, MARCH 29,
1997 1996
------------ ------------
Current assets:
Cash and cash equivalents ................................ $ 6,088 $ 361
Marketable securities .................................... 7,921 --
Restricted marketable securities ......................... -- 3,750
Accounts receivable, net ................................. 1,866 1,107
Inventories .............................................. 2,353 1,910
Prepaid expenses and other assets ........................ 280 167
------------ ------------
Total current assets ............................... 18,508 7,295
Property and equipment, net ................................ 2,399 2,041
Other assets, net .......................................... 180 309
------------ ------------
$ 21,087 $ 9,645
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank borrowings ............................... $ -- $ 250
Accounts payable and accrued expenses .................... 1,629 1,664
Accrued payroll and benefits ............................. 527 253
Product warranty ......................................... 214 187
Current portion of long-term debt ........................ -- 499
------------ ------------
Total current liabilities .......................... 2,370 2,853
Long-term debt, less current portion ....................... -- 799
Other liabilities .......................................... 14 11
------------ ------------
Total liabilities .................................. 2,384 3,663
------------ ------------
Commitments (Notes 4 and 5)
Shareholders' equity:
Preferred Stock, no par value; 5,000,000 shares
authorized; no shares issued and outstanding ........... -- --
Common Stock, no par value; 25,000,000 shares
authorized; 11,222,040 and 8,131,824 shares
issued and outstanding .................................. 69,174 55,644
Accumulated deficit ........................................ (50,471) (49,662)
------------ ------------
Total shareholders' equity ......................... 18,703 5,982
------------ ------------
$ 21,087 $ 9,645
============ ============
See accompanying notes to financial statements.
F-3
CHOLESTECH CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
YEAR ENDED YEAR ENDED YEAR ENDED
MARCH 28, MARCH 29, MARCH 31,
1997 1996 1995
------------ ------------ ------------
Revenues:
Domestic ............................ $ 11,610 $ 5,548 $ 3,221
International ....................... 1,251 1,325 817
------------ ------------ ------------
12,861 6,873 4,038
Cost of products sold ................. 6,952 4,505 3,933
------------ ------------ ------------
Gross profit .......................... 5,909 2,368 105
------------ ------------ ------------
Operating expenses:
Research and development ............ 1,254 714 715
Sales and marketing ................. 3,891 3,168 2,694
General and administrative .......... 1,846 1,376 1,983
------------ ------------ ------------
Total operating expenses ...... 6,991 5,258 5,392
------------ ------------ ------------
Loss from operations .................. (1,082) (2,890) (5,287)
Interest income ....................... 517 284 278
Interest expense ...................... (244) (140) (35)
------------ ------------ ------------
Net loss .............................. $ (809) $ (2,746) $ (5,044)
============ ============ ============
Net loss per share .................... $ (.08) $ (.34) $ (.63)
============ ============ ============
Weighted average common shares
and equivalents outstanding ......... 10,381,914 8,041,531 7,954,284
============ ============ ============
See accompanying notes to financial statements
F-4
CHOLESTECH CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
COMMON STOCK
---------------------- NOTE ACCUMULATED
SHARES AMOUNT RECEIVABLE DEFICIT TOTAL
------------ --------- ------------ ----------- ---------
Balance at March 25, 1994 .......... 7,910,612 $55,321 $ (36) $(41,872) $13,413
Issuance of Common Stock pursuant
to employee stock purchase plan
and exercise of stock options and
warrants .......................... 89,350 72 72
Compensation expense relating to
stock options ..................... 72 72
Net loss ........................... (5,044) (5,044)
------------ --------- ------------ ----------- ---------
Balance at March 31, 1995 .......... 7,999,962 55,465 (36) (46,916) 8,513
Issuance of Common Stock pursuant
to employee stock purchase plan
and exercise of stock options and
warrants .......................... 131,862 140 140
Compensation expense relating to
stock options ..................... 39 39
Forgiveness of loan ................ 36 36
Net loss ........................... (2,746) (2,746)
------------ --------- ------------ ----------- ---------
Balance at March 29, 1996 .......... 8,131,824 55,644 -- (49,662) 5,982
Sale of Common Stock to the public,
net of issuance costs ............. 2,875,000 12,858 12,858
Issuance of Common Stock pursuant
to employee stock purchase plan
and exercise of stock options and
warrants .......................... 175,690 422 422
Issuance of Common Stock pursuant
to Development, License and
Distribution Agreement ............ 39,526 250 250
Net loss ........................... (809) (809)
------------ --------- ------------ ----------- ---------
Balance at March 28, 1997 ..........11,222,040 $69,174 $ -- $(50,471) $18,703
============ ========= ============ =========== =========
See accompanying notes to financial statements.
F-5
CHOLESTECH CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
MARCH 28, MARCH 29, MARCH 31,
YEAR ENDED 1997 1996 1995
- ---------------------------------------------------- ----------- ----------- -----------
Cash flows from operating activities:
Net loss ......................................... $ (809) $ (2,746) $ (5,044)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ................... 846 612 729
Deferred revenue ................................ (6) (30) (74)
Compensation expense relating to stock options
issued below market ............................. -- 39 72
Forgiveness of note receivable .................. -- 36 --
Write-off of property and equipment ............. 3 3 2
Changes in assets and liabilities:
Accounts receivable .......................... (759) (443) (283)
Inventories .................................. (443) (559) 103
Prepaid expenses and other assets ............ (113) 1 2
Other assets ................................. (12) (6) (8)
Accounts payable and accrued expenses ........ (26) 721 (115)
Accrued payroll and benefits ................. 274 (51) (391)
Product warranty ............................. 27 37 --
--------- --------- ---------
Net cash used in operating activities .... (1,018) (2,386) (5,007)
--------- --------- ---------
Cash flows from investing activities:
Purchase of marketable securities ................ (191,737) (121,016) (47,567)
Proceeds from sale of marketable securities ...... 187,566 121,266 53,197
Purchases of property and equipment .............. (1,019) (331) (625)
--------- --------- ---------
Net cash provided by (used in)
investing activities .................... (5,190) (81) 5,005
--------- --------- ---------
Cash flows from financing activities:
Proceeds from long-term debt ..................... -- 1,500 --
Repayment of long-term debt ...................... (1,298) (202) --
Proceeds from short-term bank borrowing .......... 800 250 --
Repayment of short-term bank borrowing ........... (1,050) -- --
Principal payment on capital leases .............. (47) (90) (268)
Issuance of Common Stock ......................... 13,530 140 72
--------- --------- ---------
Net cash provided by (used in)
financing activities .................... 11,935 1,598 (196)
--------- --------- ---------
Net change in cash and cash equivalents ........... 5,727 (869) (198)
Cash and cash equivalents at beginning of period .. 361 1,230 1,428
--------- --------- ---------
Cash and cash equivalents at end of period ........ $ 6,088 $ 361 $ 1,230
========= ========= =========
Supplemental disclosures of cash flow information:
Cash paid during the year for interest ........... $ 244 $ 140 $ 35
========= ========= =========
Supplemental disclosures of non-cash financing
and investing activities:
Capital lease obligations incurred for acquisition
of property and equipment ....................... $ 47 $ -- $ 105
========= ========= =========
See accompanying notes to financial statements.
F-6
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Operations
Cholestech Corporation (the "Company") was incorporated February 2, 1988. The
Company develops, manufactures and markets a proprietary platform technology --
the Cholestech L.D.X System -- which in the preventive care market measures
specific analytes to detect and monitor treatment of various diseases and
disorders within five minutes using a single drop of whole blood.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year End
The Company's fiscal year is a 52-53 week period ending on the last Friday in
March. Fiscal 1997, 1996 and 1995 comprised 52, 52 and 53 week periods,
respectively.
Public Offering
On June 28, 1996, the Company completed a public offering and issued
2,500,000 shares of Common Stock at $5.00 per share. On July 9, 1996, the
underwriters for the public offering exercised their over allotment option to
purchase an additional 375,000 shares of Cholestech Common Stock at $5.00 per
share. Aggregate proceeds to the Company from the public offering and over
allotment option (collectively the "Public Offering") were $12.9 million, net of
underwriting discounts and commissions and offering expenses.
Revenue Recognition
Revenues from product sales are recognized at the time products are shipped
and are denominated in U.S. dollars. The Company also provides an amount for
estimated sales returns.
Cash and Cash Equivalents and Marketable Securities
The Company considers all highly liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents; all other
investments are classified as short-term marketable securities. The Company has
established policies which limit the type, credit quality and length of maturity
of the securities in which it invests. The Company's investment policy allows no
investments in any single private issuer to exceed $1,000,000 and the
investments must have, at a minimum, a credit rating of AA. Cash equivalents and
marketable securities at March 28, 1997 consist principally of investments in
money-market funds, commercial paper and U.S. government-agency obligations and
are classified as available for sale. Marketable securities are carried at
amortized cost, which approximates market.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to credit risk
consist of cash equivalents, short-term investments and accounts receivables.
Cash equivalents and short-term investments are maintained with a high quality
institution, the composition and maturities of which are regularly monitored by
management. Generally, these securities maintain a highly liquid market and may
be re-deemed upon demand and therefore, bear minimal risk. The Company has not
experienced any material losses on its investments.
A majority of the Company's trade receivables are derived from a large number
of individual smaller customers. Concentration of credit risk with respect to
trade receivable are considered to be limited due to its customer base and the
diversity of its geographic sales areas. The Company performs ongoing credit
evaluations of its customers' financial condition. The Company maintains a
provision for potential credit losses and such losses, in the aggregate, have
not exceeded management expectations. No single customer accounted for more then
10% of revenues in fiscal 1997, 1996 and 1995.
F-7
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (Continued)
Inventories
Inventories are stated at the lower of cost or market, cost being determined
using the first-in, first-out (FIFO) method. Cost includes direct materials,
direct labor and manufacturing overhead.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the related assets which
range from two to five years. Leasehold improvements are amortized over their
estimated useful lives, not to exceed the term of the related lease. The cost of
additions and improvements is capitalized while maintenance and repairs are
charged to expense as incurred.
Product Warranty
The Company's products are generally under warranty against defects in
material and workmanship for a period of one year. The Company accrues for
estimated future warranty costs at the time of sale.
Income Taxes
The Company uses the asset and liability method of accounting for income
taxes, which requires the recognition of deferred tax liabilities and assets for
the expected future tax consequences of temporary differences between the
financial reporting and income tax bases of assets and liabilities.
Net Loss Per Share
Net loss per share is computed by dividing the net loss by the weighted
average number of common and common equivalent shares outstanding during each
period. Common equivalent shares, consisting of stock options, are included in
determining net loss per share, to the extent they are dilutive, using the
treasury stock method.
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earnings Per Share" ("SFAS 128"), which is effective for the Company's
third quarter of fiscal 1998. Under SFAS 128, primary earnings per share is
replaced by basic earnings per share and fully diluted earnings per share is
replaced by diluted earnings per share. If the Company had adopted this
statement for the year ended March 28, 1997, the Company's net loss per share
for the each of the years ended March 28, 1997, March 29, 1996 and March 31,
1995 would have been the same for basic net loss per share and diluted net loss
per share as is presently reported as net loss per share.
Fair Value of Financial Instruments
The carrying value of cash equivalents, marketable securities, short-term
bank borrowings and the current portion of long-term debt approximate fair value
due to the short maturity of those instruments.
The fair value of the Company's long-term debt, which approximates its
carrying value, is estimated based on the quoted market prices for the same or
similar issues or on the current rates offered to the Company for debt of
similar maturities.
Use of Estimates
The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Accounting for Stock-Based Compensation
In October 1995, Statement of Financial Accounting Standards No. 123,
"Accounting for Stock- Based Compensation" ("SFAS 123") was issued and is
effective for fiscal years beginning after December 15, 1995. SFAS 123 requires
additional footnote disclosures relating to stock-based awards. Additionally,
F-8
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (Continued)
companies are encouraged, but not required, to recognize expense for stock-based
awards based on their fair value on the date of grant. In accordance with SFAS
123, the Company has elected to continue to apply Accounting Principles Board
Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock option and stock purchase
plan and provide pro forma disclosures required by SFAS 123.
2. BALANCE SHEET COMPOSITION
Accounts receivable consist of (in thousands):
MARCH 28, MARCH 29,
1997 1996
----------- ----------
Accounts receivable .......................... $ 1,948 $ 1,189
Less allowance for doubtful accounts and sales
returns ..................................... (82) (82)
------- -------
$ 1,866 $ 1,107
======= =======
Inventories consist of (in thousands):
MARCH 28, MARCH 29,
1997 1996
----------- -----------
Raw materials ......... $ 703 $ 875
Work-in-process ....... 585 380
Finished goods ........ 1,065 655
------ ------
$2,353 $1,910
====== ======
Property and equipment consist of (in thousands):
MARCH 28, MARCH 29,
1997 1996
--------- ---------
Machinery and equipment ...................... $ 4,780 $ 4,322
Furniture and fixtures ....................... 316 280
Computer equipment ........................... 1,067 866
Leasehold improvements ....................... 231 215
Construction-in-progress ..................... 468 131
------- -------
6,862 5,814
Less accumulated depreciation and amortization (4,463) (3,773)
------- -------
$ 2,399 $ 2,041
======= =======
Property and equipment include assets under capital leases of $78,000 and
$841,000 and accumulated depreciation of $27,000 and $802,000 at March 28, 1997
and March 29, 1996, respectively.
Accounts payable and accrued expenses consist of (in thousands):
MARCH 28, MARCH 29,
1997 1996
----------- -----------
Trade accounts payable.. $1,080 $ 982
Accrued royalties ...... 300 292
Other accrued expenses.. 249 390
----------- -----------
$1,629 $1,664
=========== ===========
F-9
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (Continued)
3. BORROWING ARRANGEMENTS
In December 1996, the Company entered into an agreement with Wells Fargo Bank
for a $3 million revolving line of credit (the "line of credit"). While the
agreement is in effect, the Company is required to maintain on deposit assets
with a collective value, as defined in the line of credit agreement, equivalent
to no less than 100% of the outstanding principle balance. Amounts outstanding
under the line of credit bear interest at the bank's prime rate. The line of
credit agreement expires on November 30, 1997 and is renewable. As of March 28,
1997, there were no borrowings outstanding under the line of credit. The Company
repaid the note payable outstanding at March 29, 1996 in July 1996.
4. LEASES
The Company leases office and laboratory facilities under a noncancellable
operating lease which expires in 2000. The lease provides for renewal and
options. Rent expense was $195,000, $195,000 and $300,000 for fiscal 1997, 1996
and 1995, respectively.
The Company also leases equipment and furniture under capital leases which
contain renewal options and/or options to purchase the equipment and furniture
at fair market value.
Future minimum payments required under capital and noncancellable operating
leases at March 28, 1997 are as follows (in thousands):
CAPITAL OPERATING
FISCAL YEAR ENDING LEASES LEASES TOTAL
- ------------------- -------- -------- ------
1998 .................................................. $ 31 $229 $260
1999 .................................................. 15 241 256
2000 .................................................. -- 247 247
---- ---- ----
Total minimum lease payments .......................... 46 $717 $763
==== ====
Imputed interest ...................................... (2)
----
Present value of net minimum lease payments ........... 44
Current portion of capital lease obligations .......... (30)
----
Capital lease obligations, less current portion ....... $ 14
====
5. COMMITMENTS
The Company has obtained rights to use certain technology in the manufacture
of certain of its products. The related agreements, which expire at various
times in calendar 1997 through 2006, require the Company to pay royalties
ranging from 2.0% to 4.6% of net sales of the applicable products. Total royalty
expense for fiscal 1997, 1996 and 1995 was $551,000, $381,000 and $132,000,
respectively, and was charged to cost of products sold.
In May 1996, the Company entered into a development, marketing and license
agreement (the "Agreement") with Metra Biosystems, Inc. ("Metra Biosystems") to
develop an immunoassay test cassette incorporating Metra Biosystems' bone
resorption technology to be used with the Cholestech System. Pursuant to the
Agreement, Metra Biosystems purchased 39,526 shares of the Company's Common
Stock for an aggregate purchase price of $250,000 ($6.325 per share) and is
obligated to purchase $750,000 of additional shares of Common Stock upon the
completion of specified development milestones by the Company.
6. SHAREHOLDERS' EQUITY
Preferred Stock
The Company is authorized to issue 5,000,000 shares of Preferred Stock. The
Board of Directors has the authority to issue the Preferred Stock in one or more
series and to fix the price, rights, preferences,
F-10
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (Continued)
privileges and restrictions thereof, including dividend rights, dividend rates,
conversion rights, voting rights, terms of redemption, redemption prices,
liquidation preferences and the number of shares constituting a series or the
designation of such series, without any further vote or action by the Company's
shareholders. In connection with the Company's shareholders rights plan, 25,000
shares of the Company's Preferred Stock have been designated Series A
Participating Preferred Stock. None of the shares of Series A Participating
Preferred Stock are outstanding as of March 28, 1997 nor was there any activity
relating to the Preferred Stock during the three year period ending March 28,
1997.
Warrants
During fiscal 1997, warrants to purchase 19,336 shares of the Company's
Common Stock were exercised at price of $3.50 per share. As consideration for
the exercise, 19,906 warrants to purchase 19,906 shares of the Company's Common
Stock were surrendered to the Company having an "in the money" value of $3.40
per share, resulting in zero net proceeds to the Company. There are no warrants
outstanding at March 28, 1997.
Stock Incentive Program
The Board of Directors adopted the 1988 Stock Incentive Program (the
"Program") which provides that incentive stock options (ISOs) and nonqualified
stock options (NSOs) for shares of Common Stock may be granted to employees and
consultants of the Company. In accordance with the Program, the stated exercise
price may not be less than 100% and 85% of the fair market value of Common Stock
on the date of grant for ISOs and NSOs, respectively. The Program provides that
the options shall be exercisable over a period not to exceed five years and a
day. Options vest over four years at a rate of at least 25 percent each year.
Vesting of individual option grants may be accelerated upon the occurrence of
certain events as described in the stock option agreement. In August 1995, the
shareholders approved an increase in the number of shares of Common Stock
reserved for issuance under the Program from 1,300,000 to 1,550,000 and in
August 1996, the shareholders approved an increase in the number of shares of
Common Stock reserved for issuance under the Program from 1,550,000 to
2,050,000.
As a result of the Company's initial public offering of Common Stock in June
1992, options issued in November 1991 were determined to have been issued at an
amount less than the estimated fair value of the Company's Common Stock at the
date the options were granted. The difference between the option price and the
estimated fair value of the Company's Common Stock was determined to contain a
compensatory element. The compensatory element resulted in a charge to
operations in fiscal 1997, 1996 and 1995 of $0, $39,000 and $72,000,
respectively.
In August 1994, the Company's Board of Directors approved a plan to offer all
current employees and consultants holding outstanding options to purchase Common
Stock of the Company with exercise prices in excess of $3.50 per share the
opportunity to exchange such options for options priced at $3.50 per share. In
exchange for the new options, the employees and consultants forfeited
approximately 25 percent of their vesting credit. At the time of the approval,
the fair market value of the Company's Common Stock was $2.50 per share.
F-11
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (Continued)
Stock option activity under the Program is as follows:
OUTSTANDING WEIGHTED AVERAGE
BALANCE OPTIONS EXERCISE PRICE PER SHARE
------------------------ ------------- ------------------------
Balance, March 25, 1994 775,303 $5.50
Granted ................. 860,381 $3.25
Exercised ............... (47,161) $1.26
Canceled ................ (709,495) $5.97
-------------
Balance, March 31, 1995 879,028 $3.19
Granted ................. 212,923 $2.71
Exercised ............... (79,885) $0.62
Canceled ................ (136,383) $3.28
-------------
Balance, March 29, 1996 875,683 $3.29
Granted ................. 427,500 $4.82
Exercised ............... (137,707) $2.53
Canceled ................ (91,379) $2.73
------------- ------------------------
Balance, March 28, 1997 1,074,097 $3.68
============= ========================
At March 28, 1997, options for 349,492 shares of Common Stock were available
for future grant. As of March 28, 1997, there were 2,050,000 shares of Common
Stock reserved for issuance under the program.
The following table summarizes information about stock options outstanding at
March 28, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------- ------------------------
WEIGHTED AVG. WEIGHTED AVG. WEIGHTED AVG.
RANGE OF EXERCISE PRICES: NUMBER CONTRACTUAL LIFE EXERCISE PRICE NUMBER EXERCISE PRICE
- ------------------------ ----------- ---------------- -------------- --------- --------------
$1.75 - $3.25 ........... 590,847 2.6 $ 2.47 486,222 $ 2.48
$3.26 - $6.56 ........... 460,250 4.4 $ 4.90 68,935 $ 5.37
$6.56 - $10.50 .......... 23,000 0.6 $ 10.50 23,000 $ 10.50
--------- -------
1,074,097 3.3 $ 3.68 578,157 $ 3.14
========= =======
Employee Stock Purchase Plan
In April 1992, the Company adopted the Employee Stock Purchase Plan (the
"Plan") which reserved 75,000 shares of Common Stock to be issued in accordance
with the Internal Revenue Code under such terms as approved by the Board of
Directors of the Company. In August 1995, the shareholders approved an increase
in the number of shares reserved for issuance under the Plan from 75,000 to
200,000. Under the term of the Plan, employees can choose semi-annually to have
up to 15% of their compensation withheld to purchase the Company's Common Stock.
The purchase price is equal to 85% of the lower the closing price of the
Company's Common Stock on the NASDAQ National Market on the day the Plan period
begins or ends. Under the Plan, the Company sold 21,543, 50,814 and 40,885
shares to employees in fiscal 1997, 1996 and 1995, respectively.
F-12
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (Continued)
Pro forma Disclosures
Had compensation cost for the Company's stock option and stock purchase plans
been determined based on the fair value at the grant dates, as prescribed in
SFAS 123, the Company's net loss and net loss per share would have been as
follows:
MARCH 28, MARCH 29,
YEAR ENDED 1997 1996
- ---------- ----------- -----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
Net loss:
As reported .......................... $ (809) $ (2,746)
Pro forma ............................ $ (1,035) $ (2,786)
Net loss per share:
As reported .......................... $ (.08) $ (.34)
Pro forma ............................ $ (.10) $ (.34)
The fair value of each stock option grant is estimated on the date of grant
using the Black-Scholes option pricing model, with the following assumptions
used for grants during the applicable periods: dividend yield of 0.0% for both
periods; risk-free interest rate of 6.26% for options granted during the fiscal
year ended March 28, 1997 and 5.96% for options granted during fiscal year ended
March 29, 1996; volatility factor of 79% for options granted during fiscal year
ended March 28, 1997 and 79% for options granted during fiscal year ended March
29, 1996 and a weighted average expected option term of 2.5 years for both
periods. The weighted average fair value of stock options granted in fiscal 1997
and 1996 were $2.44 and $1.65 per share, respectively.
The fair value of the employees' stock purchase rights, is estimated using
the Black-Scholes option pricing model, with the following assumptions for
fiscal 1997 and 1996, respectively; dividend yield of 0.0% for both periods; and
expected life of 6 months for all years; expected volatility of 74% and 95%; and
risk-free interest rate of 5.316% and 5.535%. The weighted-average fair value of
the stock purchase rights granted in fiscal 1997 and 1996 were $1.21 and $.77,
respectively. The weighted-average exercise price of stock purchase rights
granted in fiscal 1997 and 1996 were $5.54 and $2.83, respectively.
The pro forma effect on net loss and loss per share for fiscal 1997 and 1996
is not representative of the pro forma effect on net income or loss in future
years because it does not take into consideration pro forma compensation expense
related to grants made prior to fiscal 1996.
Shareholder Rights Plan
In January 1997, the Board of Directors approved a shareholder rights plan
under which shareholders of record on March 31, 1997 received a right to
purchase (a "Right") one-thousandth of a share of Series A Participating
Preferred Stock at an exercise price of $44, 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 outstanding Common Stock of
the Company. The Rights expire on the earlier of (i) January 22, 2007 or (ii)
redemption or exchange of the Rights.
F-13
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (Continued)
7. INCOME TAXES
Deferred tax assets (liabilities) consist of the following (in thousands):
MARCH 28, MARCH 29,
1997 1996
-------- --------
Net operating loss carryforwards ..................... $ 17,810 $ 17,611
Research and development tax credit carryforwards .... 2,031 1,963
Capitalized research and development ................. 280 487
Other ................................................ (862) (756)
Valuation allowance for deferred tax assets .......... (19,259) (19,305)
-------- --------
$ -- $ --
======== ========
The Company has net operating loss carryforwards available to reduce taxable
income through 2012 for federal and state income tax purposes of approximately
$46,289,000 and $22,275,000, respectively. Additionally, the Company has
research and development credit carryforwards available to reduce taxes payable
through 2012 for federal and state income tax purposes of approximately
$1,499,000 and $532,000, respectively.
As a result of the Series C Preferred Stock offerings in May 1990, there is
an annual limitation of approximately $1,500,000 for federal and state income
tax purposes on the use of approximately $8,100,000 and $1,080,000 of net
operating losses, and of $390,000 and $160,000 of tax credit carryforwards,
respectively. Additionally, as a result of the Company's public offering in
December 1992, the Company's net operating losses and tax credit carryforwards
incurred prior to December 1992 are subject to an annual limitation of
approximately $5,450,000 for federal and state income tax reporting purposes on
the use of approximately $28,176,000 and $8,099,000 of net operating loss
carryforwards, respectively, and of $1,151,000 and $379,000 of tax credit
carryforwards, respectively. If the amount of these limitations are not utilized
in any year, the amount not utilized increases the allowable limit in the
subsequent year.
8. RETIREMENT SAVINGS PLANS
Effective in September 1990, the Company adopted the Cholestech Corporation
Retirement Savings Plan (the "401(k) Plan") in which all employees of the
Company are entitled to participate. An eligible employee may elect to defer, in
the form of contributions to the 401(k) Plan, between 1% and 15% of the
employees' W-2 income, not to exceed $9,500 per year (adjusted for
cost-of-living increases). Employee contributions are invested in selected
mutual funds or a money market fund according to the directions of the employee.
The contributions are fully vested and nonforfeitable at all times. The 401(k)
Plan provides for employer contributions as determined by the Board of
Directors. The Company has not made any contributions through fiscal 1997.
9. RELATED PARTY TRANSACTIONS
In April 1988, the Company granted a loan to an officer in connection with
his purchase of 35,640 shares of the Company's Common Stock pursuant to a stock
purchase agreement. The loan was evidenced by a promissory note in the amount of
$35,640 due in April 1993, which bore interest at the annual rate of 8%. In June
1993, the Board of Directors approved an amendment to the loan agreement
providing for forgiveness of the principal loan balance in April 1995 as long as
the officer remained employed by the Company until such time. The loan was
forgiven in April 1995.
F-14
CHOLESTECH CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (Continued)
In April 1992, the Company entered into an employment agreement with an
officer providing for certain relocation benefits, and a bridge loan. In July
1992, the officer executed a promissory note evidencing a $100,000 bridge loan.
This interest free promissory note was repaid in full in October 1992. In July
1992, the officer borrowed $65,000 from the Company pursuant to a second
promissory note. This promissory note bore an interest rate of 8.0% per annum,
was due in September 1994, and provided for quarterly forgiveness of $8,125 of
the outstanding balance and any accrued interest as long as the officer remained
employed with the Company. The loan was forgiven in full, and recorded as
compensation expense in the statement of operations, as of March 31, 1995.
In August 1996, the Company entered into an employment agreement with an
officer providing for certain relocation benefits and a bridge loan. In August
1996, the officer borrowed $20,000 from the Company pursuant to a promissory
note. This promissory note bears an interest rate of 7.0% per annum, is due in
September 1998, and provides for quarterly forgiveness of $2,500 of the
outstanding balance and any accrued interest as long as the officer remains
employed with the Company. As of March 28, 1997, $5,700 has been forgiven, and
recorded as compensation expense in the statement of operations.
10. GEOGRAPHIC INFORMATION
The Company's export sales were $1.3 million, $1.3 million and $817,000 for
fiscal 1997, 1996 and 1995, respectively. Sales to Europe were $908,000,
$825,000 and $431,000, sales to Pacific Rim were $248,000, $170,000 and $287,000
and sales to Latin America were $95,000, $330,000 and $99,000 in fiscal 1997,
1996 and 1995, respectively. A European distributor accounted for 47%, 45% and
0% of international sales for fiscal 1997, 1996 and 1995, respectively.
F-15
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- --------------- ------------------------------------------------------------------------ ----------------
3.1(2) Restated Articles of Incorporation of Registrant.
3.2(1) Bylaws of Registrant, as amended.
4.1(14) Preferred Share Rights Agreement, dated January 27, 1997,
between the Registrant and ChaseMellon Shareholders Services
L.L.C.
10.1(15) 1988 Stock Incentive Program and forms of agreements thereunder.
10.2(11) Employee Stock Purchase Plan.
10.3(1) Standard Industrial Lease Agreement between Registrant and Sunlife
Assurance Company of Canada dated October 22, 1989.
10.3.1(8) First Amendment to Standard Industrial Lease Agreement between
Registrant and Sunlife Assurance Company of Canada dated April 1995.
10.3.2 Third Amendment to Standard Industrial Lease Agreement between
Registrant and Sunlife Assurance Company of Canada dated March 25, 1997
10.4(1) Forms of Indemnification Agreements between Registrant and its officers
and its directors.
10.5(1) Employment Agreement between Registrant and Edward L. Erickson dated
December 6, 1991.
10.6(1) Equipment Lease Agreement between Registrant and MMC/GATX Partnership
No. 1 dated August 17, 1990.
10.6.1(1) Revised Warrant to Purchase Series D Preferred Stock issued to MMC/GATX
Partnership No. 1.
10.7(1) Master Lease Agreement between Registrant and LINC Venture Lease
Partners II L.P. dated June 13, 1991.
10.7.1(1) Amendment No. 1 to Warrant issued to LINC Venture Lease Partners II L.P.
10.8(1) Supply Agreement effective the 15th day of February 1991 by and between
Ciba Corning Diagnostics Corp. and the Registrant.
10.9(4) Employment Agreement between Registrant and Steven L. Barbato dated
April 27, 1992.
10.10(4) Employment Agreement between Registrant and Robert J. Guyon dated July
13, 1992.
10.11.1(5) Letter Agreement effective September 28 1993 by and between Union Bank
and Registrant.
10.11.2(5) Promissory Note effective September 28 1993 by and between Union Bank
and Registrant.
10.11.3(5) Security Agreement effective September 28, 1993 by and between Union
Bank and Registrant.
10.11.4(7) First Amendment to the Letter Agreement by and between Union Bank and
Registrant.
10.11.5(7) First Amendment to the Promissory Note by and between Union Bank and
Registrant.
10.11.6(10) Second Amendment to the Letter Agreement by and between Union Bank and
Registrant.
10.11.7(10) Second Amendment to the Promissory Note by and between Union Bank and
Registrant.
10.12(4) License Agreement between Registrant and Eastman Kodak Company dated
December 23, 1992.
10.13(6) Employment Agreement between Registrant and Linda H. Masterson dated May
12, 1994.
10.14(9) Loan Agreement between Registrant and Phoenixcor, Inc. dated August 31,
1995.
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- --------------- ------------------------------------------------------------------------ ----------------
10.15(12)* Development, License and Distribution Agreement between Registrant and
Metra Biosystems, Inc. dated May 3, 1996.
10.16(12) Registration Rights Agreement between Registrant and Metra Biosystems,
Inc. dated May 3, 1996.
10.17.1(13) Letter Agreement effective December 20, 1996 by and between Wells Fargo
Bank and the Registrant.
10.17.2(13) Revolving Line of Credit Note effective December 20, 1996 by and
between Wells Fargo Bank and the Registrant.
10.17.3(13) General Pledge Agreement effective December 20, 1996 by and
between Wells Fargo Bank and the Registrant.
10.18 Employment Agreement between Registrant and Mark J. Kussman dated August
8, 1996.
10.19 Employment Agreement between Registrant and Andrea J. Tiller dated
November 14, 1996.
23.1 Consent of Price Waterhouse LLP, Independent Accountants (see page
II-6).
27.1 Financial Data Schedule.
- -----------------
* Confidential treatment has been requested with respect to certain portions
of this exhibit. Omitted portions have been filed separately with the
Securities and Exchange Commission.
(1) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 33-47603) which became effective on June 26,
1992.
(2) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 33-54300) which became effective on December 16,
1992.
(3) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-4148) as filed with the Securities and
Exchange Commission on April 26, 1996.
(4) Incorporated by reference to exhibits filed with Registrant's Annual Report
on Form 10-K for the year ended March 26, 1993.
(5) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 23, 1993.
(6) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 24, 1994.
(7) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 23, 1994.
(8) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995.
(9) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 29, 1995.
(10) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 29, 1995.
(11) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-4146) as filed with the Securities and
Exchange Commission on April 25, 1996.
(12) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (No. 333-3367) filed with the Commission on May 9,
1996.
(13) Incorporated by reference to exhibits filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 27, 1996.
(14) Incorporated by reference to exhibits filed with Registrant's Statement of
Form 8-A (No. 000-20198) as filed with the Securities and Exchange
Commission on January 27, 1997.
(15) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-8 (No. 333-22475) as filed with the Securities and
Exchange Commission on February 27, 1997.