10-Q 1 h90395e10-q.txt CYBRONICS, INC. - DATED JULY 27, 2001 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended July 27, 2001 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ______________ to _______________ Commission File Number 0-19806 CYBERONICS, INC. (Exact name of registrant as specified in its charter) Delaware 76-0236465 ---------------------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 16511 Space Center Boulevard, Cyberonics Bldg. Houston, Texas 77058 ---------------------------------------------- ---------------------- (address of principal executive offices) (zip code) Registrant's telephone number, including area code: (281) 228-7200 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT AUGUST 31, 2001 Common Stock - $0.01 par value 21,616,069 2 CYBERONICS, INC. INDEX
PAGE NO. -------- PART I. FINANCIAL INFORMATION Item 1 Financial Statements: Consolidated Balance Sheets July 27, 2001 (unaudited) and April 27,2001.............................. 3 Consolidated Statements of Operations and Comprehensive Income (Loss) (unaudited) Three months ended July 27, 2001 and July 31, 2000.................... 4 Consolidated Statements of Cash Flows (unaudited) Three months ended July 27, 2001 and July 31, 2000.................... 5 Notes to Consolidated Financial Statements (unaudited).................... 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations....................................... 8 Item 3 Quantitative and Qualitative Disclosures About Market Risk.................. 14 PART II. OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K............................................ 14
2 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CYBERONICS, INC. CONSOLIDATED BALANCE SHEETS
JULY 27, APRIL 27, 2001 2001 ------------- ------------- (UNAUDITED) ASSETS Current Assets: Cash and cash equivalents ............................................. $ 45,942,547 $ 55,459,183 Securities held to maturity ........................................... 485,110 1,678,649 Accounts receivable, net .............................................. 7,939,804 6,641,249 Inventories ........................................................... 4,376,251 4,246,560 Other current assets .................................................. 1,579,878 1,376,874 ------------- ------------- Total Current Assets ............................................. 60,323,590 69,402,515 Securities held to maturity ............................................... 78,963 113,075 Property and equipment, net ............................................... 9,010,778 8,650,350 Other assets, net ......................................................... 223,877 148,984 ------------- ------------- $ 69,637,208 $ 78,314,924 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable ...................................................... $ 5,293,468 $ 4,868,288 Accrued liabilities ................................................... 10,031,535 13,286,661 Current portion of long-term debt ..................................... 117,839 115,927 ------------- ------------- Total Current Liabilities ........................................ 15,442,842 18,270,876 Long-term debt ........................................................ 366,778 396,964 ------------- ------------- Total Liabilities ................................................ 15,809,620 18,667,840 Commitments and Contingencies Stockholders' Equity: Preferred stock, $.01 par value per share; 2,500,000 shares authorized; no shares issued and outstanding ................................. -- -- Common stock, $.01 par value per share; 50,000,000 shares authorized; 21,615,969 and 21,474,022 shares issued and outstanding at July 27, 2001 and April 27, 2001, respectively ..................................................... 216,160 214,740 Additional paid-in capital ............................................ 165,919,631 165,170,408 Deferred compensation ................................................. (1,855,900) (1,989,850) Accumulated other comprehensive income (loss) ......................... (185,310) (117,971) Accumulated deficit ................................................... (110,266,993) (103,630,243) ------------- ------------- Total Stockholders' Equity ....................................... 53,827,588 59,647,084 ------------- ------------- $ 69,637,208 $ 78,314,924 ============= =============
See accompanying Notes to Consolidated Financial Statements (Unaudited). 3 4 CYBERONICS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
FOR THE THREE MONTHS ENDED -------------------------------- JULY 27, JULY 31, 2001 2000 -------------- -------------- Net sales ........................................ $ 14,614,924 $ 13,524,005 Cost of sales .................................... 3,108,459 3,320,836 -------------- -------------- Gross Profit ................................ 11,506,465 10,203,169 Operating expenses: Selling, general and administrative ........... 12,548,330 8,734,112 Research & development ........................ 6,127,588 2,949,067 -------------- -------------- Total Operating Expenses .................... 18,675,918 11,683,179 Loss From Operations ........................ (7,169,453) (1,480,010) Interest income .................................. 537,028 404,009 Interest expense ................................. 16,659 3,537 Other income (expense), net ...................... 12,334 (18,150) -------------- -------------- Net loss ......................................... $ (6,636,750) $ (1,097,688) -------------- -------------- Basic and diluted net loss per share ............. $ (0.31) $ (0.06) -------------- -------------- Shares used in computing basic and diluted net loss per share ................................... 21,587,281 18,623,054 -------------- -------------- Comprehensive loss: Net loss ......................................... $ (6,636,750) $ (1,097,688) Foreign currency translation adjustment .......... (67,339) (79,832) -------------- -------------- Comprehensive loss ............................... $ (6,704,089) $ (1,177,520) ============== ==============
See accompanying Notes to Consolidated Financial Statements (Unaudited). 4 5 CYBERONICS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED -------------------------------- JULY 27, JULY 31, 2001 2000 -------------- -------------- CASH FLOW FROM OPERATING ACTIVITIES: Net loss ...................................................... $ (6,636,750) $ (1,097,688) Non-cash items included in net loss: Depreciation ................................................ 861,866 506,072 Gain on disposal of assets .................................. (6,075) -- Amortization of deferred compensation and expense related to stock options ......................... 133,950 -- Changes in operating assets and liabilities: Accounts receivable, net .................................... (1,298,555) 1,413,156 Inventories ................................................. (129,691) 957,886 Prepaid expenses ............................................ (203,004) (475,380) Other assets, net ........................................... (74,893) 7,391 Accounts payable and accrued liabilities .................... (2,829,946) (1,208,547) -------------- -------------- Net cash provided by (used in)operating activities ........ (10,183,098) 102,890 CASH FLOW FROM INVESTING ACTIVITIES: Purchases of property and equipment ........................... (1,216,219) (1,647,038) Purchases of marketable securities ............................ -- (399,194) Maturities of marketable securities ........................... 1,227,651 457,232 -------------- -------------- Net cash provided by (used in) investing activities ....... 11,432 (1,589,000) CASH FLOW FROM FINANCING ACTIVITIES: Proceeds from issuance of Common Stock ........................ 750,643 980,531 Payments on debt .............................................. (28,274) (51,966) -------------- -------------- Net cash provided by financing activities ................. 722,369 928,565 Effect of exchange rate changes on cash and cash equivalents ..... (67,339) (79,832) -------------- -------------- Net decrease in cash and cash equivalents ................. (9,516,636) (637,377) Cash and cash equivalents at beginning of period ................. $ 55,459,183 $ 16,484,945 -------------- -------------- Cash and cash equivalents at end of period ....................... $ 45,942,547 $ 15,847,568 ============== ============== Supplemental Disclosure of Cash Flow Information: Cash paid for interest .................................... $ 8,257 $ 3,537 Noncash purchase of assets under capital leases ........... -- $ 646,959
See accompanying Notes to Consolidated Financial Statements (Unaudited). 5 6 CYBERONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JULY 27, 2001 NOTE 1 -- BASIS OF PRESENTATION: The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information, and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended July 27, 2001 are not necessarily indicative of the results that may be expected for the full year ending April 26, 2002. The financial information presented herein should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the period ended April 27, 2001. NOTE 2 -- INVESTMENT SECURITIES: At July 27, 2001 and April 27, 2001, our entire investment portfolio consisted of cash equivalents and securities held to maturity that are reported at amortized cost. Cash equivalents and securities held to maturity are primarily commercial paper, corporate bonds and United States (US) treasury obligations with various maturity dates and have a fair market value of approximately $42,866,000 and a gross unrealized holding gain of approximately $200 at July 27, 2001. NOTE 3 -- INVENTORIES: Inventories consist of the following:
JULY 27, 2001 APRIL 27, 2001 -------------- -------------- (UNAUDITED) Raw materials and components ........... $ 1,476,892 $ 1,338,885 Work-in-process ........................ 1,515,988 1,257,784 Finished goods ......................... 1,383,371 1,649,891 -------------- -------------- $ 4,376,251 $ 4,246,560 ============== ==============
NOTE 4 -- OTHER CURRENT ASSETS: Other current assets consist of the following:
JULY 27, 2001 APRIL 27, 2001 -------------- -------------- (UNAUDITED) Prepaid expenses ....................... $ 1,521,653 $ 1,303,049 Interest receivable .................... 58,225 73,825 -------------- -------------- $ 1,579,878 $ 1,376,874 ============== ==============
NOTE 5 -- ACCRUED LIABILITIES: Accrued liabilities are as follows:
JULY 27, 2001 APRIL 27, 2001 -------------- -------------- (UNAUDITED) Clinical costs .......................... $ 5,234,211 $ 5,133,692 Payroll and other compensation .......... 2,459,402 2,354,101 Royalties ............................... 702,929 661,340 Warranties .............................. 372,548 423,000 Professional services ................... 140,250 456,275 Business insurance ...................... 96,961 141,128 Financial advisor fees .................. -- 3,785,995 Other ................................... 1,025,234 331,130 -------------- -------------- $ 10,031,535 $ 13,286,661 ============== ==============
6 7 NOTE 6 -- STOCKHOLDERS' EQUITY: Common Stock. In February 2001, the Company issued 2,518,000 shares of its common stock in a private offering for $18.00 per share. Proceeds from the issuance totaled approximately $42.5 million after deducting commissions and offering costs. Deferred Compensation. In June 2000, the Board of Directors granted 450,000 options at $18.00 per share to purchase shares of common stock under a proposed modification to the 1997 Stock Option plan that was subject to shareholder approval. On December 29, 2000, the shareholders approved the modification to the plan, and the Company recorded approximately $2.4 million in deferred compensation relating to these options. The charge reflects the difference between the exercise price and the fair market value of the stock on the date shareholder approval was received. The deferred compensation is being amortized to expense over the five year vesting period of the options. At July 27, 2001, approximately $512,000 of compensation expense has been recognized for the vested portion of the option grant. NOTE 7 -- EARNINGS PER SHARE: SFAS No.128, "Earnings Per Share" requires dual presentation of earnings per share (EPS); basic EPS and diluted EPS. Basic EPS excludes dilution and is computed by dividing net income or loss applicable to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if options or other contracts to issue common stock were exercised or converted into common stock and would then share in net income of the company. For the purpose of computing diluted net loss per share for the three months ended July 27, 2001, no exercise of options was assumed since the result would have been antidilutive. Options to purchase approximately 5.7 million shares of common stock at a weighted average price of $13.15 per share were outstanding as of July 27, 2001 but were not included in the computation of diluted net loss per share. NOTE 8 -- NEW ACCOUNTING PRONOUNCEMENT: In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133, as amended by SFAS No. 137, was adopted by the Company on July 1, 2000. The statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows the derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company formally document, designate and assess the effectiveness of transactions that receive hedge accounting treatment. The adoption of SFAS No. 133 did not have a material impact on the Company's consolidated financial position or results of operations. In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of SFAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. SFAS No. 141 and 142 are not anticipated to have an impact on the Company's operating results or financial condition. NOTE 9 -- SEGMENT INFORMATION: The Company operates its business in three Indication Business Units (IBU's) which are aggregated into one reportable segment, that of designing, developing, manufacturing and marketing the NCP System using VNS for the treatment of epilepsy and other debilitating neurological, psychiatric diseases and other disorders. Each of the IBU's has similar economic characteristics, technology, manufacturing processes, customers, distribution and marketing strategies, a similar regulatory environment and shared infrastructures. The following table presents certain financial information about the Company's Indication Business Units. For the three months ended July 31, 2000, the Depression Business Unit and the Other Indications Business Unit expenses consisted primarily of pre-clinical, clinical and payroll expense. For the three months ended July 27, 2001, the Depression Business Unit and the Other 7 8 Indications Business Unit expenses consisted of pre-clinical, clinical, payroll and certain general and administrative costs allocated to each business unit based upon estimated resource utilization. Selling and other income/expense have been entirely allocated to the Epilepsy Business Unit.
EPILEPSY DEPRESSION OTHER INDICATION INDICATION INDICATIONS BUSINESS UNIT BUSINESS UNIT BUSINESS UNIT TOTAL ------------- ------------- ------------- ------------ For the three months ended July 27, 2001 External net sales....... $14,614,924 $ -- $ -- $14,614,924 Net income (loss)........ $ 2,777,346 $(8,057,403) $(1,356,693) $(6,636,750) For the three months ended July 31, 2000 External net sales....... $13,524,005 $ -- $ -- $13,524,005 Net income (loss)........ $ 79,102 $ (929,755) $ (247,035) $(1,097,688)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of important factors. For a discussion of important factors that could affect our results, please refer to the financial statement line item discussions set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations and to the section entitled "Factors Affecting Future Operating Results." Readers are also encouraged to refer to our Annual Report on Form 10-K for the period ended April 27, 2001 for a further discussion of our business and its risks and opportunities. SUMMARY Cyberonics, Inc. was founded in 1987 to design, develop, manufacture and market medical devices which provide a unique therapy, vagus nerve stimulation, for the treatment of epilepsy and other debilitating neurological, psychiatric diseases and other disorders. We operate our business in three business units. The three separate business units include the Epilepsy Business Unit, the Depression Business Unit and the Other Indications Business Unit. All three of these units are reported for accounting purposes as one segment and involve designing, developing, manufacturing and marketing our proprietary NCP System using Vagus Nerve Stimulation (VNS(TM)) for the treatment of epilepsy and other debilitating neurological, psychiatric diseases and other disorders. The identification and separation of the Indication Business Units reflects the different phases of clinical development and product life cycle of our proprietary NCP System. However, each Indication Business Unit has similar economic characteristics, technology, manufacturing processes, customers, distribution and marketing strategies, a similar regulatory environment and shared infrastructures. The Epilepsy Business Unit designs, develops, manufactures and markets the NCP System for the treatment of epilepsy. The NCP System was approved by the United States Food and Drug Administration, also referred to as FDA, on July 16, 1997 as an adjunctive therapy for reducing the frequency of seizures in patients over 12 years of age with partial onset seizures that are refractory or resistant to antiepileptic drugs. The NCP System has also received regulatory approval for sale in Canada, Europe, Australia and certain countries in the Far East with the broader indication of refractory epilepsy and without discrimination to patient age or seizure type. We have completed a total of seven clinical studies, including five controlled acute phase studies involving over 450 patients, a long-term multi-year follow-up study involving 243 patients and a mortality study. 8 9 The Depression Business Unit is conducting clinical studies of the NCP System for the treatment of depression in patients with unipolar and bipolar depressive disorder. FDA has granted expedited review status for a future premarket approval application (PMA) for our NCP System for these patients. We have completed a 60 patient pilot safety and efficacy study of vagus nerve stimulation using the NCP System in patients with treatment-resistant chronic or recurrent depression. We are conducting a pivotal clinical study of vagus nerve stimulation for the treatment of depression to include up to 21 institutions and 235 implanted patients. Enrollment in the US pivotal study was completed by June 30, 2001. We expect to complete and unblind the depression pivotal study by March 2002. If the data are positive we anticipate submitting the depression study PMA by June 30, 2002 to FDA for their review. In March 2001, the NCP System was approved by N.V. KEMA, an official notified body representing the European Union Countries, for the treatment of chronic or recurrent depression in patients that are in a treatment-resistant or treatment-intolerant depressive episode. This CE Mark approval, by definition, includes the treatment of depression in patients with depressive disorder, or so-called unipolar depression, as well as patients with bipolar disorder, or manic depression. In April, 2001, the NCP System was approved by Health Canada for the treatment of chronic or recurrent depression in patients that are in a treatment-resistant or treatment intolerant depressive episode. The Canadian approval is similar to CE Mark European approval in that depressed patients with unipolar depression and bipolar depression are included. The Other Indications Business Unit is engaged in expanding the range of treatable disorders for VNS in new indications as warranted by our extensive patent portfolio, expected or observed clinical outcomes from ongoing and future pre-clinical and clinical research studies and anecdotal reports of patient experience and market dynamics. The Other Indications Business Unit conducts all clinical research on indications that are in the pre-clinical and/or pilot study phases of research and have not progressed to a pivotal study. We currently have studies underway for the treatment of obesity, Alzheimer's Disease, anxiety disorders and chronic migraine headache as well as studies planned for other disorders covered by our patent portfolio. For the period from inception through July 27, 2001, we incurred a cumulative net deficit of approximately $110.3 million. We have incurred substantial expenses, primarily for research and development activities that include product and process development and clinical trials and related regulatory activities, sales and marketing activities and manufacturing start-up. We expect to devote considerable financial resources in our Depression and Other Indications Business Units for clinical studies in the development of new indications for the NCP System. The clinical studies for depression are for investigational therapies that are not expected to generate significant sales prior to FDA approval, which is not anticipated before calendar 2003, if at all. As a result, we will continue to experience substantial operating losses at levels that may exceed the levels experienced in recent periods. Furthermore, the timing and nature of these expenditures are contingent upon several factors including some outside of our control and may exceed the current expectations of securities analysts and investors. We do not expect to be profitable before fiscal 2003, if at all. RESULTS OF OPERATIONS Net Sales. Net sales for the three months ended July 27, 2001 were $14,615,000 reflecting an increase of 8% compared to net sales of $13,524,000 for the three months ended July 31, 2000. First quarter net sales included $13,250,000 from the U.S. market and $1,365,000 from international markets. U.S. net sales for the first quarter increased by 11% over the $11,919,000 in U.S. net sales reported over the same period last year. International net sales decreased by 15% below the $1,605,000 reported during the same period last year. The increase in U.S. net sales is primarily due to higher volume in units sold, product mix, and a higher average selling price. The decrease in international sales is primarily due to lower volume in units sold, and a lower average selling price due to local currency weakness against the U.S. Dollar. Gross Profit. Gross profit for the quarter ended July 27, 2001 was $11,506,000 or 78.7% of net sales compared to gross profit of $10,203,000 or 75.4% of net sales for the quarter ended July 31, 2000. The increase in gross profit margin is due to a higher average selling price, higher volume in sales, product mix, and improvements in manufacturing efficiencies. Selling, General and Administrative Expenses. Selling, general and administrative expenses totaled $12,548,000 or 86% of net sales for the three months ended July 27, 2001 compared to $8,734,000 or 65% of net sales for the quarter ended July 31, 2000. The increase in selling, general and administrative expenses is primarily due to additional pre-launch marketing program costs in the depression business unit. We have incurred certain direct administrative expenses in each Indication Business Unit, and we have allocated certain administrative expenses to the Indication Business Units based upon estimated resource utilization. Selling, general and administrative expenses in the Epilepsy Business Unit, the Depression Business Unit and the Other Indications Business Unit were $7,646,000, $4,355,000 and $547,000 respectively for the quarter ended July 27, 2001, and $8,734,000 for Epilepsy, and none for Depression or 9 10 the Other Indications Business Units for the quarter ended July 31, 2000. Research and Development Expenses. Research and development expenses are comprised of both expenses related to our product and process development efforts and expenses associated with conducting clinical trials and certain related regulatory activities. Research and development expenses totaled $6,128,000 or 42% of net sales for the quarter ended July 27, 2001, compared to $2,949,000 or 22% of net sales for the quarter ended July 31, 2000. The increase in research and development expenses is primarily the result of expanded clinical programs in support of clinical studies of the NCP System to develop new indications, including depression, obesity, Alzheimer's Disease, anxiety, and other indications covered by the Company's proprietary patent portfolio. The Epilepsy Business Unit research and development expenses were $1,615,000 or 11% of net sales for the quarter ended July 27, 2001, compared to $1,772,000 or 13% of net sales for the quarter ended July 31, 2000. The decrease in expenses during the current quarter as compared to the same quarter during last year, is primarily due to reduced resource utilization in Epilepsy, offset by an increase in the Depression, and Other Indications Business Units development programs. The Depression Business Unit research and development expenses were $3,703,000 for the quarter ended July 27, 2001, compared to $930,000 for the quarter ended July 31, 2000. The increase in expenses over the same quarter last year, is the result of expanded clinical studies of the NCP System for the treatment of chronic or recurrent depression in patients with unipolar and bipolar depressive disorders. The Depression Business Unit is conducting clinical studies of the NCP System for the treatment of depression in patients with unipolar and bipolar depressive disorder. FDA has granted expedited review status for a future PMA for our NCP System for these patients. We have completed a 60 patient pilot safety and efficacy study of vagus nerve stimulation using the NCP System in patients with treatment-resistant chronic or recurrent severe depression. We are conducting a pivotal clinical study of vagus nerve stimulation for the treatment of depression to include up to 21 institutions and 235 implanted patients. Enrollment in the U.S. pivotal study was completed by June 30, 2001. We expect to complete and unblind the depression pivotal study by March 2002. If the data are positive we anticipate submitting the depression study PMA by June 30, 2002 to FDA for their review. In March 2001, the NCP System was approved by N.V. KEMA, an official notified body representing the European Union Countries, for the treatment of chronic or recurrent depression in patients that are in a treatment-resistant or treatment-intolerant depressive episode. This CE Mark approval, by definition, includes the treatment of depression in patients with depressive disorder, or so-called unipolar depression, as well as patients with bipolar disorder, or manic depression. In April 2001, the NCP System was approved by Health Canada for the treatment of chronic or recurrent depression in patients that are in a treatment-resistant or treatment intolerant depressive episode. The Canadian approval is similar to CE Mark European approval in that depressed patients with unipolar depression and bipolar depression are included. The Other Indications Business Unit research and development expenses were $810,000 for the quarter ended July 27, 2001, compared to $247,000 for the quarter ended July 31, 2000. The increase in expenses over the same quarter last year is the result of expanded clinical programs cost associated with investigational clinical studies for the NCP System for the treatment of various disorders, including obesity, Alzheimer's Disease, anxiety and other indications treatable by VNS and covered by the Company's proprietary patent portfolio. Interest Income. Interest income totaled $537,000 and $404,000 for the quarters ended July 27, 2001, and July 31, 2000 respectively. The increase in interest income is due to a higher balance in cash and cash equivalents, offset by lower interest rates. Other Income (Expense). Other income (expense) totaled ($4,000) and ($22,000) for the quarters ended July 27, 2001 and July 31, 2000 respectively. The decrease in other expense is primarily due to interest expense of $16,000 offset by other income of $12,000 due to gain in foreign currency translation for a net expense of $4,000 for the quarter ended July 27, 2001, compared to $4,000 in interest expense and $18,000 in exchange loss, for a net other expense of $22,000 during the quarter ended July 31, 2000. Income Taxes. Due to our net operating loss history, to date we have established a valuation allowance to fully offset deferred tax assets, including those related to tax carryforwards, resulting in no income tax expense or benefit for financial reporting purposes. Current federal income tax regulations with respect to changes in ownership could limit the utilization of the operating loss carryforwards. LIQUIDITY AND CAPITAL RESOURCES Since our inception, we have financed our operations primarily through public and private placements of our securities. On June 10 11 30, 2000, we entered into capital leases for the acquisition of manufacturing equipment valued at approximately $650,000 and used in the production of the NCP System. The capital leases bear interest of 6.56% and extend through April 2005. During the three months ended July 27, 2001, net cash used in operating activities was approximately $10,183,000. Accounts receivable increased $1,299,000 to $7,940,000 from $6,641,000 at April 27, 2001. Inventories increased $130,000 to $4,376,000 from $4,246,000 at April 27, 2001. Current liabilities decreased $2,828,000 to $15,443,000 from $18,271,000 at April 27, 2001. During the three months ended July 27, 2001, we used approximately $1,216,000 in the purchase of property and equipment. During the same period we received approximately $751,000 in proceeds from the exercise of stock options. In February 2001, we raised approximately $42.5 million from the sale of common stock in a private offering. Our liquidity will continue to be reduced as amounts are expended to support continuing clinical trials and related regulatory affairs, product and process development and infrastructure development. We believe that our current resources will be sufficient to fund our operations through April 30, 2003, although there can be no assurance of this as this estimate is based on a number of assumptions, which may not hold true. The availability of financing either before or after that time will depend upon a number of important factors, including the strength of the United States capital markets and economy in general and the health care and medical device segments in particular, the status of our sales activities and the status of our clinical and regulatory activities. We may not be able to raise additional capital when needed on terms favorable to us or at will. IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS See Note 8 of Notes to Consolidated Financial Statements for a discussion of the impact of new accounting pronouncements. FACTORS AFFECTING FUTURE OPERATING RESULTS In addition to the factors described above in this section the following additional factors could affect our future results. We currently rely on only one product for our revenues and if sales of this product are not achieved, our operating results will be severely harmed. We have only one product, the NCP System, which has been approved by the FDA for a single indication: as an adjunctive therapy in reducing the frequency of seizures in adults and adolescents over 12 years of age with partial onset seizures that are refractory to antiepileptic drugs. Although sales of our NCP System have been increasing, we cannot assure you that sales will continue to increase at the same rate or at all. We are currently requesting approval for the use of the NCP System for the treatment of chronic or recurrent depression in patients with unipolar and bipolar depressive disorder. Although we have received approval for VNS in the treatment of chronic recurrent depression in the European Union and Canada, we do not yet have the reimbursement approvals necessary to effectively commercialize the NCP System for the treatment of depression. We cannot assure you that any future approvals for the treatment of depression with the NCP System will be granted, nor can we assure you that even if the approval is granted, we will be successful in commercializing the NCP System for the treatment of depression. The same uncertainty surrounds our efforts in obesity, Alzheimer's Disease, anxiety and chronic migraine headache. Our inability to successfully commercialize the NCP System for depression, and other indications may severely harm our business. We may not be able to continue to expand market acceptance of the use of our NCP System to treat epilepsy, which could cause our sales to decrease. Continued market acceptance of our NCP System will depend on our ability to convince the medical community of the clinical efficacy and safety of vagus nerve stimulation and the NCP System. While the NCP System has been used in approximately 12,750 patients through July 27, 2001, many physicians are still unfamiliar with this form of therapy. We believe that existing antiepileptic drugs and surgery are the only other approved and currently available therapies competitive with the NCP System in the treatment of epileptic seizures. These therapies may be more attractive to patients or their physicians than the NCP System in terms of efficacy, cost or reimbursement availability. We cannot assure you that the NCP System will achieve market acceptance for the treatment of epilepsy or for any other indication. Failure of the NCP System to gain market acceptance would severely harm our business, financial condition and results of operations. We may not be successful in our efforts to develop VNS for the treatment of depression, obesity, Alzheimer's Disease, anxiety, chronic migraine headache or any other indications. We are in the process of conducting studies to help us evaluate, and ultimately obtain FDA approval for, the use of VNS as a treatment for depression, obesity, Alzheimer's Disease, anxiety, chronic migraine headache and other indications. While we are encouraged by test results to date, we cannot assure you that our test results will continue to be as positive as we currently anticipate or that we will receive FDA approval for the use of our product for the treatment of any other indication. Even if we receive FDA approval for another indication, we can provide no assurances with respect to market 11 12 acceptance. If our test results are not as we anticipate, if we receive no additional FDA approvals or if alternative indications do not prove to be commercially viable, our revenues will not experience the growth we currently anticipate. Our quarterly operating results may fluctuate in the future, which may cause our stock price to decline. Our results of operations may fluctuate significantly from quarter to quarter and may be below the expectations of security analysts. If so, the market price of our shares may decline. Our quarterly revenues, expenses and operating results may vary significantly from quarter to quarter for several reasons including the extent to which our NCP System gains market acceptance, the timing of obtaining marketing approvals for our NCP System for other indications, the timing of any approvals for reimbursement by third-party payors, the rate and size of expenditures incurred as we expand our clinical, manufacturing, sales and marketing efforts, our ability to retain qualified sales personnel and the availability of key components, materials and contract services, which may depend on our ability to forecast sales. Our current and future expense estimates are based, in large part, on estimates of future sales, which are difficult to predict. We may be unable to, or may elect not to, adjust spending quickly enough to offset any unexpected sales shortfall. If our expenses were not accompanied by increased sales, our results of operations and financial condition for any particular quarter may be harmed. We may be unable to obtain or maintain adequate third-party reimbursement on our product. Our ability to commercialize the NCP System successfully depends in part on whether third-party payors, including private health care insurers, managed care plans, the United States government's Medicare and Medicaid programs and others, agree both to cover the NCP System and associated procedures and services and to reimburse at adequate levels for the costs of the NCP System and the related services we have in the United States or internationally. If we fail to achieve or maintain favorable coverage decisions for the NCP System in a timely manner, patients and their physicians could be deterred from using the NCP System, which could reduce our sales and severely harm our business. We may not be successful in our marketing and sales efforts, which could severely harm our business. We cannot assure you that our marketing and sales efforts will succeed in promoting the NCP System to patients, health care providers or third-party payors on a broad basis. In addition, due to limited market awareness of the NCP System, we believe that the sales process could be lengthy, requiring us to continue to educate patients, health care providers and third-party payors regarding the clinical benefits and cost-effectiveness of the NCP System. In certain international territories, we rely, and intend to continue to rely, upon independent distributors. We may not be able to recruit and retain skilled marketing and sales personnel or foreign distributors to support our marketing and sales efforts. Our failure to successfully market and sell our NCP System or to retain our sales force would severely impair our sales and our business. If our suppliers and manufacturers are unable to meet our demand for materials, components and contract services, we may be forced to qualify new vendors or change our product design which would impair our ability to deliver products to our customers on a timely basis. We rely upon sole source suppliers for certain of the key components, materials and contract services used in manufacturing the NCP System. We periodically experience discontinuation or unavailability of components, materials and contract services which may require us to qualify alternative sources or, if no such alternative sources are identified, change our product design. We believe that pursuing and qualifying alternative sources and/or redesigning specific components of the NCP System, when necessary, could consume significant resources. In addition, such changes generally require regulatory submissions and approvals. Any extended delays in or an inability to secure alternative sources for these or other components, materials and contract services could result in product supply and manufacturing interruptions, which could significantly harm our business. Our products may be found to have significant defects that could harm the human body and result in product recalls. The NCP System includes a complex electronic device and lead designed to be implanted in the human body. Component failures, manufacturing or shipping errors or design defects could result in an unsafe condition in patients. The occurrence of such problems or other adverse reactions could result in a recall of our products, possibly requiring removal and potential reimplantation of the NCP System or a component of the NCP System. For example, in 1991, a failure of an NCP System caused permanent paralysis of one patient's left vocal cord. In addition, several patients experienced bipolar lead failures which, although not harmful to the patient, reduced the efficacy of the treatment and required lead replacement. Since the occurrence of these failures, changes have been made to our product designs and no similar failures have been reported. However in the future, we may experience similar or other product problems or may be required to recall products. Any product recall could severely harm our business, financial condition and results of operations. We may not be able to protect our technology from unauthorized use, which could diminish the value of our products and impair our ability to compete. Our success depends upon our ability to obtain and maintain patent and other intellectual property protection for the NCP System and its improvements, and for vagus nerve stimulation therapy. To that end, we have acquired licenses under 12 13 certain patents and have patented and intend to continue to seek patents on our own inventions used in our products and treatment methods. The process of seeking patent protection can be expensive and time consuming and we cannot assure you that patents will issue from our currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection of our technology, or any commercial advantage to us. Further, the protection offered by the licensed international patents is not as strong as that offered by the licensed United States patents due to differences in patent laws. In particular, the European Patent Convention prohibits patents covering methods for treatment of the human body by surgery or therapy. We may have to engage in litigation to protect our proprietary rights, or defend against infringement claims by third parties, causing us to suffer significant expenses or prevent us from selling our products. There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. Litigation, which could result in substantial cost to and diversion of effort by us, may be necessary to enforce patents issued or licensed to us, to protect trade secrets or know-how owned by us or to defend ourselves against claimed infringement of the rights of others and to determine the scope and validity of the proprietary rights of others. Adverse determinations in litigation could subject us to significant liabilities to third parties, could require us to seek licenses from third parties and could prevent us from manufacturing, selling or using the NCP System, any of which could severely harm our business. Intense competition and rapid technological changes could reduce our ability to market our products and achieve sales. We believe that existing and future antiepileptic drugs will continue to be the primary competition for our NCP System. We may also face competition from other medical device companies that have the technology, experience and capital resources to develop alternative devices for the treatment of epilepsy. Medtronic, Inc., for example, continues to clinically assess an implantable signal generator used with an invasive deep brain probe, or thalamic stimulator, for the treatment of neurological disorders and has received FDA approval for the device for the treatment of essential tremor, including that associated with Parkinson's Disease. Many of our competitors have substantially greater financial, manufacturing, marketing and technical resources than we do and have obtained third-party reimbursement approvals for their therapies. In addition, the health care industry is characterized by extensive research efforts and rapid technological progress. Our competitors may develop technologies and obtain regulatory approval for products that are more effective in treating epilepsy than our current or future products. In addition, advancements in surgical techniques may make surgery a more attractive therapy for epilepsy. The development by others of new treatment methods with novel antiepileptic drugs, medical devices or surgical techniques for epilepsy could render the NCP System non-competitive or obsolete. We may not be able to compete successfully against current and future competitors, including new products and technology, which could severely harm our business, financial condition or results of operations. If we fail to effectively manage our growth, our ability to maintain our costs or capture new business could suffer. In connection with the commercialization of the NCP System in the United States and potential regulatory approval of VNS in the treatment of chronic or recurrent depression, we have begun and intend to continue to significantly expand the scope of our operations. Such activities have placed, and may continue to place, a significant strain on our resources and operations. Our ability to effectively manage such growth will depend upon our ability to attract, hire and retain highly qualified employees and management personnel. We compete for such personnel with other companies, academic institutions, government entities and other organizations and we may not be successful in hiring or retaining qualified personnel. Our success will also depend upon the ability of our officers and key employees to continue to implement and improve our operational, management information and financial control systems. If we fail to manage our growth effectively, our business would suffer. We are subject to claims of product liability and we may not have the resources or insurance to cover the cost for losses under these claims. As an implantable medical device, the manufacture and sale of the NCP System entails the risk of product liability claims. Our product liability coverage may not be adequate to cover any of these claims. Product liability insurance is expensive and in the future may not be available on acceptable terms, if at all. A successful claim brought against us in excess of our insurance coverage could significantly harm our business and financial condition. If we do not continue to comply with changing government regulations, we could lose our ability to market and sell our product. The pre-clinical and clinical testing, manufacturing, labeling, sale, distribution and promotion of the NCP System are subject to extensive and rigorous regulation in the United States by federal agencies, primarily the FDA, and by comparable state agencies. In the future, it will be necessary for us to obtain additional government approvals for other applications of the NCP System and for modified or future-generation products. Commercial distribution in certain foreign countries is also subject to obtaining regulatory approvals from the appropriate authorities in such countries. The process of obtaining FDA and other required regulatory approvals is lengthy, expensive and uncertain. Moreover, regulatory approvals may include regulatory restrictions on the indicated uses for which a product may be marketed. Failure to comply with applicable regulatory requirements can result in, among other things, fines, suspension or withdrawal of approvals, confiscations or recalls of products, operating restrictions and criminal prosecution. 13 14 Furthermore, changes in existing regulations or adoption of new regulations could prevent us from obtaining, or affect the timing of, future regulatory approvals. We may not be able to obtain additional future regulatory approvals on a timely basis or at all. Delays in receipt of or failure to receive such future approvals, suspension or withdrawal of previously received approvals, or recalls of the NCP System could severely harm our ability to market and sell our current and future products and improvements. Our international operations are subject to risks not generally associated with commercialization efforts in the United States. We may not be successful in increasing our international market sales or in obtaining reimbursement or any regulatory approvals required in foreign countries. The anticipated international nature of our business is also expected to subject us and our representatives, agents and distributors to laws and regulations of the foreign jurisdictions in which we operate or where the NCP System is sold. The regulation of medical devices in a number of such jurisdictions, particularly in the European Union, continues to develop and new laws or regulations may impair our ability to market and sell our products in those jurisdictions. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial and operational risks inherent in our international operations. We are subject to exposures that arise from foreign exchange rate fluctuations which are associated with transactions denominated in foreign currencies, primarily from translation of results of operations from outside the United States, intercompany loans and intercompany purchases of inventory. We are also exposed to interest rate risk. We adhere to a conservative investment policy, whereby its principal concern is the preservation of liquid funds while maximizing its yield on such assets. Cash, cash equivalents and marketable securities are invested in different types of investment-grade securities with the intent of holding these securities to maturity. Although the portfolio is subject to fluctuations in interest rates and market conditions, no gain or loss on any security would actually be recognized in earnings unless the instrument was sold. PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Employment Agreement Between Cyberonics, Inc. and Robert P. Cummins dated June 1, 2001 10.2 Severance Agreement Between Cyberonics, Inc. and Burke Barrett dated May 1, 2001 10.3 Severance Agreement Between Cyberonics, Inc. and Richard P. Kuntz dated May 1, 2001 10.4 Severance Agreement Between Cyberonics, Inc. and Shawn P. Lunney dated May 1, 2001 10.5 Severance Agreement Between Cyberonics, Inc. and Alan D. Totah dated May 1, 2001 10.6 Severance Agreement Between Cyberonics, Inc. and Pamela B. Westbrook dated May 1, 2001
(b) Reports on Form 8-K none SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CYBERONICS, INC. Registrant BY: /s/ PAMELA B. WESTBROOK ------------------------------------------ Pamela B. Westbrook Vice President, Finance and Administration and Chief Financial Officer (principal financial and accounting officer) Dated: September 7, 2001 14 15 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.1 Employment Agreement Between Cyberonics, Inc. and Robert P. Cummins dated June 1, 2001 10.2 Severance Agreement Between Cyberonics, Inc. and Burke Barrett dated May 1, 2001 10.3 Severance Agreement Between Cyberonics, Inc. and Richard P. Kuntz dated May 1, 2001 10.4 Severance Agreement Between Cyberonics, Inc. and Shawn P. Lunney dated May 1, 2001 10.5 Severance Agreement Between Cyberonics, Inc. and Alan D. Totah dated May 1, 2001 10.6 Severance Agreement Between Cyberonics, Inc. and Pamela B. Westbrook dated May 1, 2001
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