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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED: JUNE 30, 1997
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
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CYBERONICS, INC.
(Exact Name of Registrant as Specified in its Charter)
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DELAWARE 76-0236465
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification
Number)
17448 HIGHWAY 3, STE. 100, WEBSTER, 77598-4135
TEXAS (zip code)
(address of principal executive
offices)
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Registrant's telephone number, including area code: (281) 332-1375
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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of Class)
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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. / /
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
The aggregate market value of voting stock held by non-affiliates of the
registrant as of August 14, 1997, was based upon the last sales price reported
for such date on the Nasdaq National Market approximately $163.9 million. For
purposes of this disclosure, shares of Common Stock held by persons who hold
more than 5% of the outstanding shares of Common Stock and shares held by
officers and directors of the registrant, have been excluded in that such
persons may be deemed to be affiliates. This determination is not necessarily
conclusive.
At July 31, 1997, registrant had outstanding 13,322,175 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
No documents are incorporated by reference herein.
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TABLE OF CONTENTS
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PART I..................................................................................................... 1
ITEM 1. BUSINESS....................................................................................... 1
ITEM 2. PROPERTIES..................................................................................... 16
ITEM 3. LEGAL PROCEEDINGS.............................................................................. 16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................ 16
PART II.................................................................................................... 17
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.......................... 17
ITEM 6. SELECTED FINANCIAL DATA........................................................................ 18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......... 19
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................................... 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........... 28
PART III................................................................................................... 28
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................................. 28
ITEM 11. EXECUTIVE COMPENSATION......................................................................... 31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................. 34
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................. 36
PART IV.................................................................................................... 37
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................................ 37
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PART I
ITEM 1. BUSINESS
THIS ANNUAL REPORT ON FORM 10-K 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 THE
COMPANY'S RESULTS, PLEASE REFER TO THE BUSINESS SECTION BELOW, THE FINANCIAL
STATEMENT LINE ITEM DISCUSSIONS AND THE FACTORS AFFECTING FUTURE OPERATING
RESULTS SET FORTH IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
THE COMPANY
Cyberonics manufactures and markets the NCP System, an implantable medical
device for the treatment of epilepsy. On July 16, 1997, the Company received
approval from the FDA to market the NCP System in the United States as an
adjunctive therapy for reducing the frequency of seizures in patients over
twelve years of age with partial onset seizures that are refractory (resistant)
to antiepileptic drugs ("AEDs"). The Company has also received regulatory
approval to sell the NCP System in Canada, Europe and certain countries in the
Far East. The Company has 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 253 patients and a mortality study. To
date, over 1,000 patients have accumulated in excess of 2,000 patient years of
treatment experience with the NCP System.
EPILEPSY OVERVIEW
Epilepsy is a disorder of the brain characterized by recurrent seizures.
Epileptic seizures are categorized as either partial or generalized at onset.
Generalized seizures, known as "grand mal" seizures, involve the entire brain
from the onset, result in the loss of consciousness and are typically manifested
by convulsions. Partial onset seizures initiate in a localized region of the
brain, and may or may not result in the loss of consciousness. Partial onset
seizures can also develop into generalized seizures. Patients who continue to
have unsatisfactory seizure control or intolerable side effects after treatment
with appropriate antiepileptic therapies for a reasonable period of time are
said to suffer from refractory epilepsy. For reasons that are not clear, partial
onset seizures are generally more refractory to existing therapies than
generalized seizures.
It is estimated that over 1.8 million individuals are currently being
treated for epilepsy in the United States, with over 117,000 new cases diagnosed
each year, and that there are in excess of three million individuals being
treated for epilepsy in Western Europe and Japan, with over 210,000 new cases
diagnosed each year. In addition, it is estimated that approximately 50% of
patients with epilepsy suffer from partial onset seizures and that over 20% of
these patients suffer from refractory partial onset seizures.
The medical, psychological, sociological and financial implications of
refractory epilepsy can be profound for individuals and their families. Seizures
can be severely debilitating and may result in major irreversible morbidity
(lasting complications or side effects). Medical consequences may include brain
damage from recurrent seizures, injuries and accidents associated with the loss
or impairment of consciousness, and death as the result of severe seizures.
Personal implications of epilepsy may include suffering the side effects of
AEDs, strained personal and family relations, and the inability to obtain and
hold meaningful employment or a driver's license. Societal implications of
epilepsy include the loss or underutilization of potentially productive citizens
and the cost of long-term public assistance for those disabled by epilepsy.
Epilepsy patients, in general, and refractory patients, to a greater extent,
experience a significantly higher mortality rate than the general population.
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TRADITIONAL EPILEPSY THERAPIES
Traditionally, there have been two courses of treatment available to persons
suffering from epilepsy: drug therapy and surgery. The efficacy of these
treatments depends in part upon the type of seizures from which a patient
suffers. The efficacy of drugs and surgery for patients suffering from partial
onset seizures is highly variable.
DRUG THERAPY. AEDs serve as a first-line treatment and are prescribed for
virtually all individuals being treated for epilepsy. There are eight drugs
predominately used for the treatment of epilepsy which are used either alone or
in combination. Lack of patient compliance, which is typical of chronic drug
therapy, inherently reduces the efficacy of a drug therapy regimen. In addition,
side effects are common with AEDs. Side effects range from debilitating central
nervous system conditions such as drowsiness, confusion and cognitive impairment
to life-threatening hematologic reactions or liver failure. Women taking AEDs
are more likely to bear infants with birth defects than the general population.
Children receiving AED therapy often experience learning difficulties. Four of
the eight AEDs have received FDA approval since 1993, and no other major AEDs
have been introduced in the United States since 1978. While each of these newer
AEDs demonstrates some efficacy or tolerability benefits when compared with
other AEDs, the Company believes that none of these newer AEDs appears to
provide significantly improved clinical outcomes. See "--Competition."
SURGICAL TREATMENT. When drug therapy is not effective, the other
traditional treatment alternative has been surgical removal of the portion of
the brain where seizures originate. Surgical treatment of epilepsy has been
proven safe and beneficial for a limited number of patients. However, only
approximately 1,500 epilepsy surgeries are performed per year in the United
States. The Company believes that the low number of surgeries is attributable to
several factors, including: the extensive evaluation and testing required to
screen candidates for surgery and to localize the source of the seizures; the
risks of morbidity and mortality associated with brain surgery; the uncertainty
of long-term benefits; the non-reversible nature of the procedure; and the cost
of evaluation, testing and surgery, which is reported to be approximately
$60,000 in many cases.
THE CYBERONICS SOLUTION
The Company's FDA approved NCP System is the only currently approved medical
device alternative for treating epilepsy. The NCP System delivers an electrical
signal through an implantable lead to the left vagus nerve in the patient's neck
on a chronic, intermittent basis. Stimulation may also be initiated by the
patient (or caregiver) with a hand held magnet.
The Company believes that a successful new therapy for refractory epilepsy
should be clinically proven, provide significant seizure control, be safe and
tolerable with few side effects, provide long-term benefits and be easy for the
physician to prescribe and for the patient to use. Based on the results of its
preclinical studies, mechanism of action research and seven human clinical
trials, the Company believes that the NCP System meets these criteria as
described below.
CLINICALLY PROVEN. To date over 1,000 patients have accumulated in
excess of 2,000 patient years of treatment experience with the NCP System.
On July 16, 1997, the NCP System was approved by the FDA for use as an
adjunctive therapy in reducing frequency of seizures in adults and
adolescents over twelve years of age with partial onset seizures that are
refractory to AEDs.
SIGNIFICANT SEIZURE CONTROL. In the Company's two randomized, parallel,
double blind active control studies, the treatment groups reported a mean
seizure reduction of approximately 24% and 28% during the three month acute
phase of the studies. Additionally, many patients, including some who
reported no change or an increase in seizure frequency, also reported a
reduction in seizure severity.
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WELL-TOLERATED SIDE EFFECTS. The side effects associated with the NCP
System are generally mild, localized and stimulation related. They include
hoarseness, coughing, a feeling of shortness of breath and throat pain. The
NCP System has not been associated with the debilitating central nervous
system side effects which frequently accompany AEDs. Additionally, over
time, a significant percentage of patients continued to use the therapy
attesting to its tolerability. See "--Clinical Trials."
LONG-TERM EFFICACY. Long-term follow-up data, although derived from an
uncontrolled protocol, on the 253 patients in the Company's first four
studies suggest that efficacy is maintained and, for many patients, improves
over time when the NCP System is used as an adjunctive therapy with drugs as
part of a patient's optimized long-term treatment regime. Analysis of this
pooled data showed that the median percent seizure reduction increased from
17% in the first three months to 44% after 18 months of treatment. See
"--Clinical Trials."
EASY TO USE. The implantation procedure is a straightforward, fully
reversible procedure which takes between 30 minutes and two hours, does not
involve the brain and has been performed by surgeons with a variety of
specializations. Additionally, the NCP System does not interact with
existing therapies and, because the NCP System provides continuous
stimulation without patient (or caregiver) administration, full compliance
is assured. Moreover, a patient can use a magnet to temporarily override the
pre-programmed stimulation cycle to activate on-demand therapy if the
patient senses the onset of a seizure.
VAGUS NERVE STIMULATION WITH THE CYBERONICS NCP SYSTEM
The NCP System is a proprietary, integrated system consisting of an
implantable device that delivers an electrical signal to an implantable lead
which is attached to the left vagus nerve. The vagus nerve is the longest of the
cranial nerves, extending from the brain stem through the neck to organs in the
chest and abdomen. The left vagus nerve has been shown to have influence over
numerous areas of the brain. Preclinical studies and mechanism of action
research suggest that intermittent stimulation of the left vagus nerve in the
neck activates a number of structures and increases blood flow in several areas
of the brain. These studies have also shown that stimulation of the left vagus
nerve is effective in blocking seizures and results in persistent or carryover
antiepileptic effects which increase with chronic stimulation.
The NCP System consists of the NCP Generator, the vagus nerve lead, the
programming wand and software and the tunneling tool. The NCP Generator and
vagus nerve lead are surgically implanted in a procedure which takes from 30
minutes to two hours, during which time the patient is typically under general
anesthesia. The NCP Generator is surgically implanted in a subcutaneous pocket
in the upper left chest. The vagus nerve lead is connected to the NCP Generator
and attached to the vagus nerve in the lower left side of the patient's neck.
The patient is generally admitted to the hospital the day of surgery and
discharged the following day.
The NCP System delivers vagus nerve stimulation therapy on a chronic,
intermittent basis. The standard stimulation parameters recommended by the
Company are a 30 second period of stimulation, followed by a five minute period
without stimulation. To optimize patient treatment, the pulse width, output
current, signal frequency and stimulation duration and intervals of the NCP
Generator can be noninvasively programmed and adjusted by the treating physician
with a personal computer using the Company's programming wand and software. In
addition, the patient can use a small, hand held magnet which is provided with
the NCP Generator to manually activate or deactivate stimulation. On-demand
therapy can be useful for those patients who sense an oncoming seizure and has
been reported by a number of patients to abort or reduce the severity of
seizures.
NCP GENERATOR. The NCP Generator is an implantable, programmable, cardiac
pacemaker-like signal generator designed to be coupled with the vagus nerve lead
to deliver electrical signals to the vagus nerve. The NCP Generator approved for
use in the United States employs a battery which has an expected
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life of approximately 4.5 years at standard stimulation parameters. The Company
has begun to sell an NCP Generator outside of the United States which employs a
battery which has an estimated life of approximately 6.5 years at standard
stimulation parameters. The Company intends to seek FDA approval to market this
newer NCP Generator in the United States. Upon expiration of the battery, the
NCP Generator is removed and a new generator is implanted in a short,
out-patient procedure using local anesthesia.
VAGUS NERVE LEAD. Cyberonics has licensed a proprietary nerve lead to
convey the electrical signal from the NCP Generator to the vagus nerve. The lead
incorporates patented electrodes which are self-sizing and flexible, minimizing
mechanical trauma to the nerve and allowing body fluid interchange within the
nerve structure. The lead's two electrodes and anchor tether wrap around the
vagus nerve and the connector end is tunneled subcutaneously to the chest where
it is attached to the NCP Generator. The leads are available in two sizes of
inner spiral diameter to ensure optimal electrode placement on different size
nerves.
PROGRAMMING WAND AND SOFTWARE. The Company's proprietary programming wand
and software are used to transmit programming information from a personal
computer to the NCP Generator via electromagnetic signals. Programming
capabilities include modification of the NCP Generator's programmable parameters
(pulse width, output current, signal frequency and stimulation duration and
interval), and storage and retrieval of telemetry data. The NCP programming wand
can be connected to a standard personal computer using a serial connector.
[Illustration showing placement of the NCP System in a patient and a description
of its components]
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TUNNELING TOOL. The tunneling tool is a disposable surgical tool designed
to be used during surgical placement of the vagus nerve lead. The tool is used
for subcutaneous tunneling of the lead assembly between the nerve site in the
neck and the NCP Generator site in the chest.
The total cost of the NCP System to the patient, including the implant
procedure, is projected to be between approximately $13,000 and $18,000. This
projected cost includes approximately $8,000 for the NCP System plus hospital
costs and physician fees, which vary depending upon the implanting center.
CLINICAL TRIALS
The Company began trials of the NCP System for the treatment of refractory
partial onset seizures in November 1988. As of June 30, 1997, a total of seven
clinical studies have been conducted, consisting of five controlled acute phase
studies involving over 450 patients, a long-term follow-up study involving 253
patients, and a mortality study involving approximately 791 patients with 1,335
patient years of experience. A total of 45 centers participated in these
studies, including 40 in the United States, two in Germany and one each in
Canada, Holland and Sweden. Of the five controlled acute phase studies, two were
randomized, parallel, double blind, active control studies, similar in design to
AED trials. These two studies, E03 and E05, involved 388 enrolled and 310
implanted patients who were included in the efficacy analysis. The duration of
the baseline and treatment periods in both studies was three months. The
following table summarizes the Company's five acute phase clinical studies:
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DESIGN/ NUMBER OF PATIENTS INCLUDED
STUDY DATE SEIZURE TYPE(S) IN EFFICACY ANALYSIS
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E01/E02 1988 Single blind/ 14
Partial seizures
E03 1990-1992 Double blind, randomized/ 114
Partial seizures
E04 1991-1995 Open label safety/ 116
All seizures
E05 1995-1996 Double blind, randomized/ 196
Partial seizures
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ACUTE PHASE EFFICACY. The primary efficacy objective of the Company's
double blind randomized acute phase clinical studies was to demonstrate a
between group difference in mean and/or median percent change in seizure
frequency between patients treated with "High" stimulation (stimulation believed
to be at therapeutic levels for seizure reduction) and "Low" stimulation
(stimulation believed to be at subtherapeutic levels). The primary efficacy
outcome was achieved in both E03 and E05. In the longitudinal studies, E01, E02
and E04, the primary efficacy outcome was a within group difference in mean or
median percent change in seizure frequency compared to baseline. These
longitudinal studies also achieved their
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primary efficacy objectives. The following table summarizes the mean and median
percentage seizure reduction rates of the treatment groups of the Company's five
acute phase studies:
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PERCENTAGE SEIZURE
REDUCTION RATES FOR
TREATMENT GROUP
STUDY MEAN MEDIAN
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E01............................................................. 24.3% 31.6%
E02............................................................. 39.9% 48.1%
E03............................................................. 23.6% 22.6%
E04............................................................. 7.0% 21.8%
E05............................................................. 27.9% 23.4%
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ADVERSE EVENTS, SIDE EFFECTS. The two randomized, parallel studies, E03 and
E05, involved 314 patients who accumulated total acute phase and long-term
follow-up exposure of 591 years. The most frequently reported side effects were:
voice alteration/hoarseness which was reported by 50% of patients at least once
during the acute and extension phases, cough which was reported by 41% of
patients, throat pain/discomfort which was reported by approximately 27% of
patients, and dyspnea, a feeling of shortness of breath, which was reported by
18% of patients at least once in the E03 and E05 acute and extension phases. The
NCP System side effects were generally rated as mild, reportedly occurred only
during actual stimulation and were reported less frequently over time. No
adverse effects of vagus nerve stimulation on the heart, lungs or stomach were
observed in any of the studies. The NCP System also did not produce the
debilitating central nervous system conditions such as drowsiness, confusion and
cognitive impairment commonly associated with AEDs.
LONG-TERM EFFICACY. In addition to the acute phase studies, the Company
also provided the FDA with long-term follow-up data on the 253 E01 through E04
study patients. The long-term data came from an uncontrolled open label protocol
where AEDs (both type and dose) and NCP System stimulation parameters were
allowed to be changed. In the Company's long-term follow-up on patients in
studies E01 through E04, a total of 238 out of a possible 251 completed one year
of therapy (95%); 142 out of 172 completed two years of therapy (83%); and 88
out of 126 completed three years of therapy (70%).
Long-term efficacy results, although derived from an uncontrolled protocol,
indicate that efficacy is maintained and, for many patients, improves during the
first 18 months when the NCP System is used as adjunctive therapy with drugs as
part of an optimized treatment regimen. The pooled E01 through E04 results
indicate that the median percent seizure reduction increased from 17.1% at the
end of the three month acute phase to a median reduction of 44.3% after 18
months of treatment. The percent of patients reporting a greater than 50%
reduction compared to baseline showed a similar improvement. The pooled results
indicate that 25.0% of the pooled patients reported a greater than 50.0%
reduction after three months of treatment and that 42.9% of patients reported a
greater than 50.0% reduction after 18 months.
Although available long-term clinical data reveal continuing improved
efficacy over the first 18 months of use, this data indicates that improvement
stabilizes thereafter. Data regarding the longer term safety and efficacy of the
NCP System are limited. In addition, although the Company has theories as to why
vagus nerve stimulation reduces epileptic seizures, uncertainty still exists as
to the basic mechanism that provides positive therapeutic effects. There can be
no assurance that the efficacy of the treatment will continue to improve or will
not decline over time, or that long-term operation of the NCP System will not
produce adverse side effects or cause harm or death to patients. Any such
negative long-term effects could adversely affect the regulatory status and/or
market acceptance of the NCP System and thus adversely affect the Company's
business, financial condition and results of operations.
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DEVICE COMPLICATIONS. During the Company's clinical trials, technical
complications occurred due to lead wire fractures, battery depletion and NCP
Generator malfunctions. Two significant generator complications occurred. One
generator malfunction occurred in 1991 which resulted in permanent paralysis of
one patient's left vocal cord. This malfunction was reported to the FDA as a
serious adverse event. Subsequent design changes were made and, since those
changes, no similar malfunctions have occurred. The second generator malfunction
was premature battery depletion due to an unexplained transient high current
drain which had no adverse effect on the patient. No similar malfunctions have
occurred. Over fifty leads have been verified to have broken or otherwise
developed high impedence. The Company made a series of changes in early lead
designs to address these issues, and over 500 of the latest generation leads
have been implanted with no reported failures due to lead design, materials or
manufacturing.
Although the Company has made several design changes in its generator and
leads and has not recently experienced malfunctions or failures, there can be no
assurance that there will not be future failures which could result in an unsafe
condition in patients. The occurrence of malfunctions or adverse reactions could
result in a recall of the Company's products, possibly requiring removal (and
potentially reimplantation) of the NCP Generator and/or leads. Any product
recall could have a material adverse effect on the Company's business, financial
condition or results of operations.
MORTALITY STUDY. As of June 30, 1997, a total of 17 deaths were reported
among the clinical and commercial patients implanted with the NCP System, ten of
which were considered to be possible/ probable/definite SUDEP (Sudden
Unexplained Death in Epilepsy Patients). Although treatment was underway at the
time, no deaths have been linked to the implantation of or stimulation by the
NCP System. Based on the 17 deaths, there was a mortality rate in the NCP cohort
of 10.3/1,000 patient years and a SUDEP incidence of 3.0/1,000 patient years for
definite/probable and 5.0/1,000 patient years for definite/ possible/probable.
The mortality rate and SUDEP rates for the NCP cohort are within the ranges
expected by a panel of independent experts for a medically refractory epilepsy
population. The mortality data was included in the Company's submissions to the
FDA in connection with its PMA application.
FUTURE STUDIES. The Company's intends to sponsor additional clinical trials
for the NCP System, initially for additional epilepsy indications such as
Lennox- Gastaut Syndrome and generalized seizures and, in the future, for other
neurological disorders outside the field of epilepsy which are covered by the
Company's method patent portfolio. New clinical trials conducted in the United
States will require additional FDA approvals.
STRATEGY
The Company's strategy is to establish vagus nerve stimulation as a
preferred means for treating patients who suffer from refractory partial
seizures. The following are key elements of the Company's strategy:
LAUNCH THE NCP SYSTEM IN THE UNITED STATES
The NCP System received FDA approval for the treatment of epilepsy patients
suffering from refractory partial onset seizures in July 1997. The Company
intends to launch the NCP System in the United States through a direct sales
force that will target the epileptologists and neurologists involved in treating
patients suffering from epilepsy. The Company has increased its U.S. sales and
marketing staff from 1 professional at June 30, 1996 to 20 professionals at June
30, 1997 and intends to further increase this staffing. In order to create
physician awareness and patient demand, the Company plans to implement a
multi-faceted marketing approach that includes symposia in the United States to
introduce the NCP System, ongoing physician awareness and training programs,
education and support of patient advocacy groups such as the Epilepsy Foundation
of America, publication of peer-reviewed scientific articles concerning the NCP
System and the Company's clinical trials, and dissemination of public
information regarding the benefits of the NCP System for patients suffering from
epilepsy.
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INCREASE INTERNATIONAL MARKET PENETRATION
In June 1994, the Company was granted regulatory approval to market the NCP
System in the twelve-member countries of the European Union. Due to resource
constraints, however, the Company did not devote significant resources to
marketing the NCP System internationally until fiscal 1997. The Company's sales
strategy in international markets is to use a direct sales force in certain key
markets and to rely upon distributors to reach additional markets. The Company
intends to leverage its United States product launch activities to expand its
sales and marketing activities in the European Union member countries and other
key international markets.
ESTABLISH REIMBURSEMENT BY THIRD-PARTY PAYORS
The Company believes that significant market acceptance of the NCP System
for the treatment of epilepsy or other indications will require that the
treatment be eligible for reimbursement from government and private health care
payors both within and outside the United States. The Company is in the process
of seeking the appropriate coverage recommendations from government sources and
from private payor groups. The Company believes that hospitals will gain
adequate reimbursement for the NCP System based on the compelling safety and
efficacy of the NCP System, the debilitating nature and annual cost of treating
refractory epilepsy, and the efficacy and cost of alternative treatments. See
"--Third-Party Reimbursement."
EXPAND RANGE OF TREATABLE INDICATIONS
The Company believes that additional epilepsy types, including
Lennox-Gastaut Syndrome and generalized seizures, as well as severe neurological
disorders outside the field of epilepsy, including movement disorders such as
essential tremor and Parkinson's disease, chronic pain and migraine headaches,
may be amenable to treatment by vagus nerve stimulation with the NCP System. The
Company has been granted method patents relating to the use of vagus nerve
stimulation for the treatment of these and certain other neurological disorders,
and plans to establish a program to discover and develop new applications for
the NCP System both within and outside the field of epilepsy. See "--Product
Development."
MARKETING AND SALES
UNITED STATES. The NCP System was approved for sale in the United States on
July 16, 1997 for use as an adjunctive therapy in reducing the frequency of
seizures in adults and adolescents over twelve years of age with partial onset
seizures that are refractory to AEDs. The Company intends to sell its products
through a direct sales force in the United States. As of August 1, 1997 the
United States sales and marketing team consisted of sixteen direct sales people
(including a Vice President of Sales, four area Directors and eleven territory
managers), all of whom have significant medical device sales experience, and
three national marketing professionals supported by experienced medical device
reimbursement consultants. The Company expects to continue expanding its
marketing and sales team.
The Company's sales and marketing plan focuses on reaching those physicians
who treat a large number of patients with refractory partial onset seizures. To
date, only a limited number of neurologists in the United States have experience
treating patients with the NCP System. In the United States there are a limited
number of neurologists and epileptologists (neurologists who specialize in
epilepsy). The Company believes that a subset of these neurologists and
epileptologists treat most epileptic patients. The Company intends initially to
target these neurologists and epileptologists.
The Company believes that physician acceptance of new medical products like
the NCP System is typically a function of both the clinical utility of the
product, as demonstrated by preclinical studies, mechanism of action research
and human clinical trials, and the credibility of the data supporting the
product's claims regarding safety, efficacy and clinical utility. Resources used
to support sales of medical
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devices, such as the NCP System, include physicians who have used the product,
peer reviewed medical journal articles, the Company's Physician's Manual and the
data to be included in the Summary of Safety and Effectiveness prepared by the
Company and published by the FDA. The Company intends to use all of these
sources to gain acceptance of the NCP System. In addition, in June 1997, the
Company sponsored a symposium at the International Epilepsy Congress in Dublin,
Ireland, which over 150 physicians attended, and in August 1997, the Company is
sponsoring the first North American vagus nerve stimulation symposia in Colorado
Springs, Colorado.
To enhance patient awareness, the Company intends to, among other things,
educate and support national, regional and local epilepsy patient advocacy
groups, such as the Epilepsy Foundation of America, and to provide information
on the NCP System on web sites, in newsletters, at meetings and via mailing
lists. The Company also intends to provide information directly to patients and
to work with experienced epilepsy centers in co-marketing arrangements.
INTERNATIONAL. Although the Company obtained approval to CE Mark the NCP
System and to sell it in the member countries of the European Union in June
1994, through the end of calendar 1996, the Company focused its resources and
efforts primarily on the clinical trials necessary to gain FDA approval to sell
the NCP System in the United States. As a result, the Company until recently
devoted only limited resources to international marketing and sales activities.
The Company began building its international marketing and sales organization in
fiscal 1997. In January 1997, the Company established an International Advisory
Board consisting of epileptologists, neurologists, neurosurgeons and clinical
scientists from Belgium, France, Germany, Italy, Sweden, the United Kingdom and
the United States. As of June 30, 1997, the Company's international sales and
marketing organization consisted of nine full time employees and approximately
28 independent distributors. The NCP System was officially launched at the
Company's vagus nerve stimulation symposium at the International Epilepsy
Congress in Dublin, Ireland on June 28, 1997.
The NCP System is currently sold by a direct sales force in Germany, France,
Austria, Switzerland and the United Kingdom. One of the Company's customers in
the United Kingdom, King's College, accounted for approximately 13% of the
Company's net sales in fiscal 1997. As of June 30, 1997, the Company had
distribution agreements or letters of intent with independent distributors
covering 24 countries including, among others, Australia, China, Italy, The
Netherlands, Spain and Sweden. The distribution agreements generally grant the
distributor exclusive rights for the particular territory for a period of three
years. The distributor generally assumes responsibility for obtaining regulatory
and reimbursement approvals for such territory and agrees to certain minimum
marketing and sales expenditures and purchase commitments.
The Company believes that its success internationally is dependent upon the
acceptance of the NCP System by a concentrated number of key opinion-leading
epileptologists and neurologists. The Company estimates that there are
approximately 200 key opinion-leading epileptologists in Western Europe alone.
These opinion leaders treat a large number of refractory patients, have
significant influence over the treatment decisions made by secondary centers and
are often critical to obtaining approvals for adequate reimbursement coverage in
their respective countries. The Company has implemented several programs to
target these epileptologists, including the International Advisory Board,
international clinical research programs and an international patient registry.
The Company intends to leverage its United States product launch activities,
including the experiences of leading epileptologists and neurologists in the
United States to seek market acceptance of the NCP System in other countries.
Physicians from the United States familiar with the NCP System have in the past
presented their experiences and study results at international symposia, and the
Company intends to encourage the continuation of this practice.
9
<PAGE>
The Company intends to seek additional regulatory and reimbursement
approvals in the future in those major markets where the NCP System is not yet
approved. The geographic areas initially targeted include South America and the
Far East, in particular, Japan. In Japan, the Company is working with an
independent distributor to obtain the appropriate regulatory and reimbursement
approvals and to ultimately distribute the NCP System if such approvals are
obtained. The Japanese clinical trial began in July 1993. To date, 34 patients
have been implanted and treated for an average of 2.5 years. The Company's
Japanese distributor expects to submit the results of this study, along with the
Company's other clinical trial data, in calendar 1997 to the Japanese Ministry
of Health for regulatory approval. Application for reimbursement approval will
follow regulatory approval when and if granted.
MANUFACTURING AND SOURCES OF SUPPLY
Cyberonics' manufacturing operations are required to comply with the FDA's
QSR, which incorporates the agency's former Good Manufacturing Practices
regulations. QSR addresses the design, controls, methods, facilities and quality
assurance controls used in manufacturing, packing, storing and installing
medical devices. In addition, certain international markets have quality
assurance and manufacturing requirements that may be more or less rigorous than
those in the United States. Specifically, the Company is subject to the
compliance requirements of ISO 9001 and 9002 certification and CE Mark
directives. The Company is audited on a semiannual basis for such compliance.
See "--Government Regulation."
The NCP Generator, which is similar in design and manufacture to a cardiac
pacemaker, is comprised of two printed circuit boards and a battery which are
hermetically sealed in a titanium case. Standard components are assembled on
printed circuit boards by a contract manufacturer using surface-mount
technology. The boards are then shipped to the Company for assembly and testing.
The assembled electronics are then placed in a titanium case which is shipped to
a third-party for laser welding and returned to the Company for attachment of an
epoxy header to which the lead connects and for final testing. Sterilization of
the NCP Generator is performed by a third-party.
The Company has a limited history of operations that, to date, has consisted
primarily of manufacturing limited quantities of the NCP System for clinical
investigations and for commercial sales activities in international markets. The
Company does not have experience manufacturing the NCP System in the volumes
that will be necessary to achieve significant commercial sales. The Company has
recently entered into a lease for a new facility, and intends to move all of its
manufacturing operations to the new facility, which is expected to begin
production in early calendar 1998. The Company may encounter difficulties in
scaling up production of the NCP System, in procuring the necessary supply of
materials, components and contract services, or in hiring and training
additional manufacturing personnel to support domestic and international demand.
The Company will be required to obtain FDA approval for its change in the
manufacturing facility. The new manufacturing facility will also have to be
inspected for compliance with the FDA's QSR and with ISO 9001 and 9002
standards, which impose certain procedural and documentation requirements with
respect to device design, development, manufacturing and quality assurance
activities, before the Company can begin commercial-scale production of the NCP
System at the new manufacturing facility. In addition, one of the Company's
contract manufacturers has moved its manufacturing operations to a new facility.
The Company will be required to obtain FDA approval for the change in the
location of the contractor's manufacturing facility, which generally requires a
preapproval inspection by the FDA to determine the contractor's compliance with
the QSR. There can be no assurance that the Company will be able to obtain the
necessary FDA and other approvals for its or its contract manufacturers' new
facilities on a timely basis, or at all. If the Company is unable to achieve
commercial-scale production capability on a timely basis with acceptable quality
and manufacturing yield and costs, to sustain such capacity, or to achieve FDA
and other governmental approvals, the ability of the Company to deliver products
on a timely basis could be impaired which could have a material adverse effect
on the Company's business, financial condition or results of operations.
10
<PAGE>
The Company relies upon sole source suppliers for certain of the key
components, materials and contract services used in manufacturing the NCP
System. The Company periodically experiences discontinuation or unavailability
of components, materials and contract services which may require qualification
of alternative sources or, if no such alternative sources are identified,
product design changes. The Company believes that pursuing and qualifying
alternative sources and/or redesigning specific components of the NCP System,
when necessary, could consume significant Company resources. In addition, such
changes generally require regulatory submissions and approvals. Although the
Company believes that any such changes will be made without disruption, any
extended delays in or inability to secure alternative sources for these or other
components, materials and contract services could result in product supply and
manufacturing interruptions which could have a material adverse effect on the
Company's ability to manufacture the NCP System on a timely and cost competitive
basis, and therefore on its business, financial condition or results of
operations.
PRODUCT DEVELOPMENT
Cyberonics' product development efforts are directed toward improving the
NCP System and developing new products which provide additional features and
functionality. Product development programs that are underway include ongoing
improvements to the NCP Generator, such as reduced size and increased battery
life. The Company intends to file an application with the FDA for a battery
which has an expected life of approximately 6.5 years at standard stimulation
parameters. This unit is already approved for sale in the European market. These
and other longer term development activities are expected to be technically
challenging and no assurance can be given that they will result in marketable
products. The Company will be required to file for the appropriate United States
and international regulatory approvals, and undergo clinical trials, in
connection with the introduction of improved and new products. See "--Government
Regulation."
COMPETITION
The Company believes that existing and future AEDs will be the primary
competition for its NCP System. The Company may also face competition from other
medical device companies for the treatment of partial seizures. Medtronic, Inc.
has clinically assessed an implantable signal generator used with an invasive
deep brain probe (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. The
Company could also face competition from other large medical device companies
which have the technology, experience and capital resources to develop
alternative devices for the treatment of epilepsy. Many of the Company's
competitors have substantially greater financial, manufacturing, marketing and
technical resources than the Company and have obtained third-party reimbursement
approvals. In addition, the health care industry is characterized by extensive
research efforts and rapid technological progress. There can be no assurance
that the Company's competitors will not develop technologies and obtain
regulatory approval for products that are more effective in treating epilepsy
than the Company's current or future products. There can also be no assurance
that advancements in surgical techniques will not make surgery a more attractive
therapy for epilepsy. The development by others of new treatment methods with
novel AEDs, medical devices or surgical techniques for epilepsy could render the
NCP System non-competitive or obsolete. There can be no assurance that the
Company will be able to compete successfully against current and future
competitors or that competition, including the development and commercialization
of new products and technology, will not have a material adverse effect on the
Company's business, financial condition or results of operations.
Cyberonics believes that the primary competitive factors within the epilepsy
treatment market are the efficacy and safety of the treatment relative to
alternative therapies, physician and patient acceptance of the product and
procedure, availability of third-party reimbursement and product reliability.
The Company believes that the NCP System compares favorably with competitive
products as to these factors.
11
<PAGE>
PATENTS, LICENSES AND PROPRIETARY RIGHTS
Proprietary protection for the Company's products is important to the
Company's business. The Company maintains a policy of seeking method and device
patents on its inventions, acquiring licenses under selected patents of third
parties, obtaining copyrights on its software and other copyrightable materials
and entering into invention and proprietary information agreements with its
employees and consultants with respect to technology which it considers
important to its business. Cyberonics also relies upon trade secrets, unpatented
know-how and continuing technological innovation to develop and maintain its
competitive position.
The Company entered into an exclusive license agreement with Dr. Jacob
Zabara, a co-founder of and consultant to the Company, pursuant to which the
Company has licensed three United States method patents (and such international
counterparts as have been or may be issued) covering the NCP System for vagus
nerve and other cranial nerve stimulation for the control of epilepsy and other
movement disorders. The License Agreement runs for the term of licensed patents.
Pursuant to the license agreement, the Company is obligated to pay Dr. Zabara a
royalty equal to the greater of $36,000 per year or 6% of net sales of the NCP
System on the first $12 million in cumulative sales, and at the rate of 3%
thereafter for the remaining term of the licensed patents.
The Company entered into a license agreement with Huntington Medical
Research Institute pursuant to which the Company has licensed two United States
patents (and their international counterparts, if and when issued) covering two
lead designs. The license agreement provides a license to the licensor's lead
designs for the field-of-use of vagus nerve stimulation for control of epilepsy
and other movement disorders. Pursuant to the license agreement, as amended, the
Company paid an initial license fee of $200,000. In addition, the Company has a
renewable option to expand the licensed field-of-use for additional indications
for a license fee of $15,000 per indication. Pursuant to the license agreement,
the Company is obligated to pay the licensor a royalty of 1% of net sales of NCP
Systems using the licensor's standard lead (the Company's vagus nerve lead is a
standard lead) and 1.75% of net sales of NCP Systems which include the
licensor's bidirectional lead. The Company also paid royalties during fiscal
1995 and during each of fiscal 1996 and 1997, and has agreed to pay minimum
royalties of $35,000 for fiscal 1998 and each fiscal year thereafter for the
life of the licensed patents. In fiscal 1997, the Company elected not to
exercise an option it held under this license to preserve its exclusivity with
respect to the bidirectional lead and, as a result, the licensor may convert the
license regarding the bidirectional lead to a non-exclusive license.
In addition to the license agreements, as of June 30, 1997, the Company had
United States patents and patent applications pending covering NCP Generator
circuits, electrode designs and various therapeutic applications of vagus nerve
stimulation. In addition to movement disorders, recently issued method patents
cover the fields of eating disorders, endocrine disorders, migraine headaches,
dementia, neuropsychiatric disorders, motility disorders and chronic pain. The
Company currently intends to file for a limited extension of the term of one of
the medical device and method patents under which it is licensed from Dr.
Zabara. The Company has filed counterparts of certain of its key United States
patent applications in certain key international jurisdictions.
There can be no assurance that patents will issue from any of the remaining
applications or, if patents are issued, that they will be of sufficient scope or
strength to provide meaningful protection of the Company's technology. In
addition, there can be no assurance that any patents issued to the Company will
not be challenged, invalidated or circumvented, or that the rights granted
thereunder will provide proprietary protection or commercial advantage to the
Company. Notwithstanding the scope of the patent protection available to the
Company, a competitor could develop other methods of controlling epilepsy by
stimulation which do not involve the vagus or other cranial nerves, the
stimulation of which is patent protected, or which use electrodes which are not
covered by the licensed patents.
12
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Cyberonics believes that the licenses described above provide it with
protection in the United States in the field of cranial nerve stimulation,
including vagus nerve stimulation for the control of epilepsy, movement
disorders, including Parkinson's disease and essential tremor, and additional
indications for which method patents have been issued. 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. In addition, 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 the Company, may be necessary to enforce patents
issued or licensed to the Company, to protect trade secrets or know-how owned by
the Company or to defend the Company 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 the Company to
significant liabilities to third parties, could require the Company to seek
licenses from third parties and could prevent the Company from manufacturing,
selling or using the NCP System, any of which could have a material adverse
effect on the Company's business, financial condition or results of operations.
The Company is not currently a party to any patent litigation or other
litigation regarding proprietary rights and is not aware of any challenge to its
patents or proprietary rights.
GOVERNMENT REGULATION
The preclinical 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 United States, the NCP System is
regulated as a medical device and is subject to FDA's premarket approval
requirements. Under the Food, Drug, and Cosmetic Act, all medical devices are
classified into three classes, class I, II or III. New class III devices, such
as the NCP System, are subject to the most stringent FDA review, and require
submission and approval of a PMA before commencement of marketing, sales and
distribution in the United States.
In July 1997, the Company received FDA approval to market the NCP System in
the United States for use 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 AEDs. While the Company has satisfied FDA's
requirements to commence domestic sales of its product, it continues to be
subject to FDA's ongoing requirements to maintain regulatory compliance.
Additionally, pursuant to the post-market surveillance conditions specified as
part of the Company's FDA marketing approval, the Company is required to conduct
clinical follow-up on a total of 50 patients during the first five years of
stimulation to monitor the safety and tolerability of the NCP System. In
addition, the Company has been required by the FDA to continue to provide
information about which patients benefit most from the device as well as
information on any deaths that occur in patients who have the device implanted.
There can be no assurance that additional concerns will not be raised by the FDA
in the future. The Company's business, financial condition and results of
operations are critically dependent upon ongoing compliance with FDA regulations
and requirements.
The Company will be required to obtain FDA approval of a new PMA or PMA
supplement before making any change to the NCP System affecting the safety or
effectiveness of the device including, but not limited to, new indications for
use of the device, changes in the device's performance or design specifications
and device modifications and future generation products. New PMAs and PMA
supplements generally require submission of information needed to support the
proposed change and often require additional clinical data. If the clinical
testing required to obtain the information necessary to support the change
places research subjects at risk, the Company will be required to obtain the
FDA's approval of an IDE before beginning such testing. The Company intends to
sponsor additional clinical trials of the NCP System in the United States,
initially for additional epilepsy indications and, in the future, for
non-epilepsy neurological disorders. The Company believes that it will be
required to conduct these additional clinical
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trials under one or more FDA-approved IDEs and under the auspices of one or more
independent institutional review boards ("IRBs") established pursuant to FDA
regulations. There can be no assurance that the Company will be able to obtain
any required FDA or IRB approvals for such clinical trials, the studies will be
completed in a timely manner or the data and information obtained will be
sufficient to support the filing of a new PMA or PMA supplement for the proposed
charges. In addition, international sales are subject to foreign government
regulation, the requirements of which vary substantially from country to
country. The Company has obtained certain foreign governmental approvals,
including the approval to use the European Union "CE" Mark, and has applied for
additional approvals. There can be no assurance that the necessary approvals,
including approval of new PMAs or supplements to existing PMAs for the NCP
System, will be granted on a timely basis or at all, and delays in receipt of or
failure to receive such approvals, or the withdrawal of previously received
approvals, could have a material adverse effect on the business, financial
condition and results of operations of the Company.
The Company also is required to register as a medical device manufacturer
with the FDA and state agencies and to list its products with the FDA. The
Company has registered as a medical device manufacturer with the FDA. The
Company's facilities are subject to inspection on a routine basis by the FDA for
compliance with the FDA's QSR and other applicable regulations. The Company also
is required to file Medical Device Reports with the FDA for certain product
malfunctions or where its device causes or contributes to a death or serious
injury. QSR impose procedural and documentation requirements upon the Company
with respect to product designs, manufacturing, testing, control, process
validation and similar activities. As of June 30, 1997, the Company has been the
subject of an FDA pre-PMA approval site inspection, which was completed with no
deficiencies noted. Additionally, the Company must comply with various FDA
requirements such as those governing advertising, labeling and reporting of
adverse experiences with the use of the product. New regulations governing such
matters as device tracking and post-market surveillance also may apply to the
NCP System. The FDA actively enforces regulations prohibiting marketing of
products for non-indicated uses. Failure to comply with applicable regulatory
requirements can result in, among other things, fines, suspensions or withdrawal
of approvals, confiscations or recalls of products, operating restrictions and
criminal prosecutions. Changes in existing requirements or the adoption of new
requirements could adversely affect the Company's ability to comply with
regulatory requirements. Failure to comply with regulatory requirements could
have a material adverse effect on the Company's business, financial condition
and results of operations.
In addition, the Company's products are covered by FDA regulations for
implantable medical devices that require the Company to comply with certain
specific record keeping, reporting, product testing, design, safety and product
labeling requirements. The Company believes that it is in material compliance
with these requirements. There can be no assurance, however, that the Company
will be able to maintain such compliance in the future. Any such failure to
comply could have an adverse effect on the Company's business, financial
condition and results of operations.
The advertising of most FDA-regulated products, including the Company's NCP
System, is subject to both FDA and Federal Trade Commission jurisdiction. The
Company also is subject to regulation by the Occupational Safety and Health
Administration and by other governmental entities.
Clinical testing, manufacture and sale of the Company's products outside of
the United States are subject to regulatory approval by other jurisdictions
which may be more or less rigorous than in the United States. The Company must
comply with its ISO 9001 and 9002 certification, which is similar to the FDA's
QSR, and CE Mark directives. The Company is audited on a semiannual basis for
such compliance. The Company has received regulatory approval to market the NCP
System in the thirteen member countries of the European Union, Canada, and is
pursuing other regulatory approvals outside the United States.
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THIRD-PARTY REIMBURSEMENT
The Company's ability to commercialize the NCP System successfully will
depend 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 the
procedures and services associated therewith, and to reimburse for the costs of
the NCP System and the related services at adequate levels.
In deciding to cover a new therapy, third-party payors base their initial
coverage decisions on several factors including, but not limited to, the status
of the FDA's review of the product, the product's safety and efficacy, the
number of studies performed and peer-reviewed articles published with respect to
the product and how the product and therapy compares to alternative therapies.
The Company has implemented a program to provide third-party payors with the
clinical and regulatory information that they will need to reach coverage
decisions, both by sending materials directly to the payors and by assisting
hospitals and physicians in their interactions with the payor. There can be no
assurance that third-party payors will view the Company and the NCP System
favorably with respect to any of the above factors, which may impede the
Company's obtaining favorable coverage decisions on a timely basis, or at all. A
failure to achieve favorable coverage decisions for the NCP System in a timely
manner could deter patients and their physicians from using the Company's
products and could have a material adverse effect on the Company's business,
financial condition or results of operations.
Once a favorable coverage determination is made with respect to a product,
payors must determine the level of reimbursement for the product and related
therapy and procedures. The Company believes that coverage and reimbursement for
most epilepsy patients who are likely candidates for treatment may be implanted
with the NCP System will need to be obtained from third-party private payors. In
making decisions about reimbursement amounts, third-party private payors
typically reimburse for the costs of newly covered devices and services using
the standard methods they employ for other products and services already
covered. Many private insurers and managed care plans use a variety of payment
mechanisms including, but not limited to, discounted charges, per diem amounts,
resource-based payment scales and reimbursed costs. Those mechanisms have
provided payment levels for many other implantable devices that have been
adequate to allow device use and commercial success. Assuming that most payors
determine to cover the NCP System and related services, the Company expects that
many of these same payment mechanisms will provide reimbursement levels for the
NCP System and related services that physicians and hospitals will view as
adequate to support use of the NCP System.
The Company believes that a significant number of epilepsy patients in the
United States are either eligible for benefits under the Medicare program or are
uninsured. The Medicare program uses a fixed-payment method (based on Diagnosis
Related Groups or "DRGs") to pay for hospital inpatient services and uses a
resource-based relative value scale to pay for physicians' services. Under
current DRG groupings, hospital inpatient procedures for implanting the NCP
System are assigned to one of two different DRGs based on whether or not the
patient has complications or comorbidities (coexisting severe medical problems).
The DRG grouping that would include implantation of the NCP System for patients
without complications or comorbidities pays hospitals less than the costs of
purchasing and implanting the NCP System. The Company believes that this DRG
grouping would apply to most of the epilepsy patients covered by Medicare. In
order to assure adequate reimbursement for all epileptic patients eligible for
benefits under Medicare, the Company intends to seek changes in the DRG grouping
so that NCP System implant cases would be reclassified to other, higher-paying
DRGs.
The Company has only limited experience in seeking and obtaining coverage
and payment approvals from third-party payors, and there can be no assurance
that the Company would be successful in achieving coverage or adequate
reimbursement levels, or any, or that it can obtain new DRG assignments under
the Medicare program to cover the complete costs of therapy using the NCP
System. If the Company is
15
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unsuccessful in achieving coverage or adequate reimbursement levels or in
obtaining new DRG assignments, or if hospitals or physicians view their payments
as inadequate, then patients, physicians and hospitals could be deterred from
using the NCP System, which could have a material adverse effect on the
Company's business, financial condition or results of operations.
In June 1994, the Company was granted approval to use the CE Mark and to
market the NCP System in the European Union. The Company is continuing to pursue
appropriate reimbursement approvals in the European Union member countries. The
Company believes that significant sales volume will be difficult to generate
without appropriate reimbursement approvals. There can be no assurance as to
when or whether such reimbursement will be obtained in any of the European Union
countries or, if obtained, whether the levels of reimbursement will be
sufficient to enable the Company to sell the NCP System on a profitable basis.
PRODUCT LIABILITY AND INSURANCE
The manufacture and sale of the Company's products entail the risk of
product liability claims. Although the Company maintains product liability
insurance, there can be no assurance that the coverage limits of the Company's
insurance policies will be adequate. Such insurance is expensive and in the
future may not be available on acceptable terms, if at all. A successful claim
brought against the Company in excess of its insurance coverage could have a
material adverse effect on the Company's business, financial condition or
results of operations.
EMPLOYEES
As of August 15, 1997, the Company had 69 full-time employees, including 7
in research and development, 9 in clinical and regulatory affairs, 22 in
manufacturing and quality assurance, 24 in field sales and 7 in marketing and
administration. The Company believes that the success of its business will
depend, in part, on its ability to attract and retain qualified personnel
including, but not limited to, its key officers and its Board of Directors. The
Company believes its relationship with its employees is good. There can be no
assurance that the Company will be successful in hiring or retaining qualified
personnel. 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 or results of operations.
ITEM 2. PROPERTIES
PROPERTIES
The Company leases approximately 25,000 square feet of office and
manufacturing space in Webster, Texas through October 1997 and a sales office in
Brussels, Belgium through January 2000. In August 1997, the Company entered into
an operating lease agreement for a new domestic office and manufacturing
facility totaling approximately 22,000 square feet beginning in October 1997,
expanding to approximately 41,000 square feet by March 1998. The Company
believes that these leased facilities, together with its planned additional
space, will be adequate to meet its needs at least through June 30, 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
16
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the Nasdaq National Market under the
symbol "CYBX." The high and low sale prices for the Company's Common Stock
during Fiscal 1996 and 1997 are set forth below. Price data reflect actual
transactions, but do not reflect mark-ups, mark-downs or commissions.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
FISCAL YEAR ENDED JUNE 30, 1996
First Quarter................................................................ $ 6.00 $ 4.00
Second Quarter............................................................... $ 8.00 $ 4.50
Third Quarter................................................................ $ 6.25 $ 4.00
Fourth Quarter............................................................... $ 7.50 $ 4.25
FISCAL YEAR ENDED JUNE 30, 1997
First Quarter................................................................ $ 6.56 $ 5.75
Second Quarter............................................................... $ 6.69 $ 2.63
Third Quarter................................................................ $ 5.13 $ 3.25
Fourth Quarter............................................................... $ 9.38 $ 4.63
</TABLE>
The stock market has from time to time experienced significant price and
volume fluctuations that are unrelated to the operating performance of
particular companies. Like the stock prices of other medical device companies,
the market price of the Company's Common Stock has in the past been, and may in
the future be, subject to significant volatility. Factors such as reports on the
clinical efficacy and safety of the NCP System, product and component supply
issues, government approval status, fluctuations in the Company's operating
results, announcements of technological innovations or new products by the
Company or its competitors, changes in estimates of the Company's performance by
securities analysts, failure to meet securities analysts' expectations,
developments with respect to patents or proprietary rights, public concern as to
the safety of products developed by the Company or others may have a significant
effect on the market price of the Common Stock. In addition, the price of the
Company's stock could be affected by stock price volatility in the medical
device industry or the capital markets in general without regard to the
Company's operating performance.
As of July 31, 1997, there were 155 stockholders of record.
The Company currently intends to retain future earnings to fund the
development and growth of its business and, therefore, does not anticipate
paying cash dividends within the foreseeable future. Any future payment of
dividends will be determined by the Company's Board of Directors and will depend
on the Company's financial condition, results of operations and other factors
deemed relevant by its Board of Directors.
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ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain selected financial data and is
qualified by reference to, and should be read in conjunction with, the Company's
Consolidated Financial Statements and with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere herein. The
selected consolidated financial data as of June 30, 1997 and 1996, and for each
of the years in the three-year period ended June 30, 1997 are derived from
consolidated financial statements that have been audited by Arthur Andersen LLP,
independent public accountants, which are included elsewhere herein. The
selected financial data as of June 30, 1995, 1994 and 1993 and for the years
ended June 30, 1994 and 1993 are derived from audited financial statements not
included herein.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net sales....................... $ 1,372,005 $ 1,416,965 $ 966,989 $ 399,689 $ 149,775
Cost of goods sold.............. 372,180 411,562 347,457 117,835 50,463
-------------- -------------- -------------- -------------- --------------
Gross profit.................... 999,825 1,005,403 619,532 281,854 99,312
Operating expenses:
Research and development...... 6,549,474 8,024,502 5,678,024 4,323,671 3,390,037
Selling, general and
administrative.............. 5,933,852 3,420,111 2,906,589 2,519,037 2,154,070
-------------- -------------- -------------- -------------- --------------
Total operating expenses.... 12,483,326 11,444,613 8,584,613 6,842,708 5,544,107
Interest income, net............ 436,813 423,044 688,909 629,993 326,408
Other (expense) income, net..... (198,143) (97,084) 37,362 5,136 (3,333)
-------------- -------------- -------------- -------------- --------------
Net loss........................ $ (11,244,831) $ (10,113,250) $ (7,238,810) $ (5,925,725) $ (5,121,720)
-------------- -------------- -------------- -------------- --------------
-------------- -------------- -------------- -------------- --------------
Net loss per share.............. $ (0.93) $ (1.06) $ (.79) $ (.66) $ (.65)
-------------- -------------- -------------- -------------- --------------
-------------- -------------- -------------- -------------- --------------
Shares used in computing net
loss per share................ 12,030,171 9,513,038 9,218,008 8,945,968 7,882,857
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and
marketable securities......... $ 8,123,456 $ 2,201,962 $ 11,852,619 $ 18,468,154 $ 24,385,755
Working capital................. 7,763,480 1,042,396 8,988,373 9,676,289 20,489,855
Total assets.................... 10,249,737 3,948,043 13,560,593 19,756,148 25,195,514
Accumulated deficit............. (49,167,002) (37,922,171) (27,808,921) (20,570,111) (14,644,386)
Common stockholders' equity..... $ 8,421,472 $ 1,465,050 $ 11,443,555 $ 18,503,398 $ 24,134,127
</TABLE>
18
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS ANNUAL REPORT ON FORM 10-K 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 THE
COMPANY'S RESULTS, PLEASE REFER TO THE BUSINESS SECTION AND FINANCIAL STATEMENT
LINE ITEM DISCUSSIONS SET FORTH IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
SUMMARY
Cyberonics was founded in 1987 to design, develop and bring to market
medical devices which provide a novel therapy, vagus nerve stimulation, for the
treatment of epilepsy and other debilitating neurological disorders. Clinical
trials of the NCP System began with the first patient implant in November 1988
under an IDE from the FDA. The Company received FDA approval to market the NCP
System in the United States in July 1997 for use as an adjunctive therapy in
reducing the frequency of seizures in adults and adolescents over twelve years
of age with partial onset seizures that are refractory to AEDs. From inception
through July 1997, the Company's primary focus was on obtaining FDA approval for
the NCP System. The Company has had minimal revenues to date, primarily
consisting of sales to clinical investigators and international sales, and has
been unprofitable since inception. Since inception, the Company has incurred
substantial expenses, primarily for research and development activities
(including product and process development and clinical trials and related
regulatory activities), sales and marketing activities and manufacturing
start-up. For the period from inception through June 30, 1997, the Company
incurred a cumulative net deficit of approximately $49.2 million.
Cyberonics was granted regulatory approval in 1994 to market and sell the
NCP System in the member countries of the European Union and also has permission
to sell in certain other international markets. However, through fiscal 1996,
the Company devoted only limited resources to marketing and sales activities
internationally, and only in early fiscal 1997 began initiating significant
marketing and sales activities. International sales of the NCP System have been
limited to date.
Cyberonics is engaged in obtaining reimbursement approvals from the various
health care provider systems in the United States and in key international
markets, and has received reimbursement approvals from certain payment
authorities in a limited number of international markets. The Company does not
expect to achieve significant sales unless and until additional reimbursement
approvals are obtained for the NCP System.
The Company expects to incur substantial costs related to sales and
marketing activities associated with United States and international market
entry, expansion of manufacturing capabilities, clinical trials and regulatory
activities and product and process development. It is expected that there will
be a significant delay between the increased levels of spending and any
resulting increase in revenues. Accordingly, the Company expects to remain
unprofitable through at least the fiscal year ending June 30, 1999. There can be
no assurance that the Company will become profitable after that time or, that if
it becomes profitable, it will remain so in future periods. Furthermore, the
Company's results of operations may fluctuate significantly from quarter to
quarter and will depend upon numerous factors, many of which are outside the
Company's control. Such factors include, but are not limited to, the extent to
which the Company's NCP System gains market acceptance, any approvals for
reimbursement by third-party payors, the rate and size of expenditures incurred
by the Company as it expands its sales and marketing efforts, availability of
key components, materials and contract services which may be dependent on the
Company's ability to forecast sales and ability to achieve acceptable
manufacturing yields and costs.
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RESULTS OF OPERATIONS
NET SALES. Net sales for the fiscal year ended June 30, 1997 totaled $1.4
million compared to $1.4 million and $967,000 for the years ended June 30, 1996
and 1995, respectively. The substantial majority of sales in each period
presented were derived from international markets where the Company had
regulatory approval to sell the NCP System. Through fiscal 1997, domestic sales
have depended entirely upon the Company's conducting clinical trial activities
under arrangements with certain investigational centers, some of which receive
research funding from the Company. Domestic sales made in connection with such
clinical studies have been limited to date and, in certain cases, have been made
pursuant to risk-sharing provisions. Sales made under risk-sharing arrangements
are deferred until Cyberonics receives payment from the centers and the centers
in turn receive third-party reimbursement or satisfy other terms set forth in
their respective arrangements. International sales were $1.3 million, $1.3
million and $763,000 in fiscal 1997, 1996 and 1995, respectively, while domestic
sales, net of risk sharing provisions, were $24,000, $110,000 and $204,000 in
such periods. In July 1997, the Company received FDA approval to market the NCP
System in the United States. Although the Company may utilize risk-sharing
arrangements in connection with clinical trials for additional indications for
the NCP System, the Company expects that such revenues will not represent a
material component of its net sales in any future period. While the Company
currently has regulatory approval to sell the NCP System in the United States
and in a number of significant key international markets, significant increases
in sales will be dependent upon achieving market acceptance for the NCP System
and upon obtaining reimbursement approval in key markets.
GROSS PROFIT. Cost of sales consist primarily of direct labor, allocated
manufacturing overhead and the acquisition cost of raw materials and components.
In addition, the Company is obligated to pay royalties ranging from 7% to 7.75%
on the first $12 million in cumulative net sales, and from 4% to 4.75%
thereafter. Expenses related to royalty obligations under the Company's license
agreements totaled $46,000 during each of the years ended June 30, 1997, 1996
and 1995, and will continue at or above this level in future years. The Company
will include substantially all royalties in cost of sales in future periods.
The Company's gross margin percentage was 72.9% for the year ended June 30,
1997 compared to 71.0% and 64.1% for fiscal 1996 and 1995, respectively. The
fiscal 1997 increase is attributable primarily to a shift in international sales
mix toward markets where the Company sells its products directly, resulting in
reduced distributor discounts and consequently, higher gross margins. Gross
margin percentages can be expected to fluctuate in future periods based upon the
mix between direct and distributor sales, the NCP System's selling price and the
levels of production volume.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses are
comprised of both expenses related to the Company's product and process
development efforts and expenses associated with conducting clinical trials and
certain related regulatory activities. Research and development expenses totaled
$6.5 million, $8.0 million and $5.7 million during the years ended June 30,
1997, 1996 and 1995, respectively. The Company's research and development
spending decreased during fiscal 1997 as the Company completed its confirmatory
clinical trial. The increased level of research and development expenditures in
1996 over 1995 was due primarily to the costs associated with the Company's
confirmatory clinical trial which was at its peak level of activity during
fiscal 1996. The Company intends to conduct clinical trials of the NCP System
for additional indications both within and outside the field of epilepsy.
Accordingly, the Company expects research and development expenses to fluctuate
in future periods depending primarily upon the level of clinical trial activity.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses totaled $5.9 million, $3.4 million and $2.9 million
during the years ended June 30, 1997, 1996 and 1995, respectively. The continued
increases from year to year were primarily due to expanded international market
development activities and, during the second half of fiscal 1997, preparations
for United States product launch. The Company began expanding its sales and
marketing staff in late calendar 1996 and early 1997 to more actively pursue
international sales and in anticipation of FDA approval in the United
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States and expects to add further sales and marketing personnel during fiscal
1998. The Company also expects to add administrative personnel in anticipation
of higher levels of business activity. Accordingly, the Company expects its
sales, general and administrative expenses to increase substantially in absolute
amount over the fiscal 1997 level.
INTEREST INCOME, NET. Net interest income totaled $437,000, $423,000 and
$689,000 during the years ended June 30, 1997, 1996 and 1995, respectively.
Interest income increased in fiscal 1997 over fiscal 1996 as a result of higher
average cash and investment balances during fiscal 1997 due to investment of the
proceeds from private placements of Common Stock completed during fiscal 1997.
The decrease in interest income in 1996 compared to 1995 resulted from lower
average cash and investment balances available for investment during 1996.
OTHER (EXPENSE) INCOME, NET. Other income (expense) totaled $(198,000),
$(97,000) and $37,000 during the three years ended June 30, 1997, 1996 and 1995,
respectively. For each of these years, other income (expense) consisted of net
gains and losses resulting from foreign currency fluctuations.
INCOME TAXES. At June 30, 1997, the Company had net operating loss
carryforwards for federal income tax purposes of approximately $42.2 million
which expire during the years 2003 through 2012, and tax credit carryforwards of
approximately $1.3 million for federal income tax purposes which expire during
the years 2006 through 2012. Due to its net operating loss history, to date the
Company has established a valuation allowance to fully offset its deferred tax
assets, including those related to its carryforwards, resulting in no income tax
benefit for financial reporting purposes. Current federal income tax regulations
with respect to changes in ownership could limit the utilization of the
Company's net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
From inception through February 1993, the Company financed its operations
primarily through private placements of its securities through which it raised
approximately $16.5 million in net proceeds. In February 1993, the Company
completed an initial public offering of 2,000,000 shares of its Common Stock,
generating net proceeds to the Company of approximately $22 million. In July
1996, the Company raised an additional $11.2 million in net proceeds in a sale
of 2,181,818 shares of its Common Stock to St. Jude and, in March 1997, the
Company raised an additional approximately $6.8 million in a sale of 1,534,374
shares of its Common Stock in a private placement. Additionally, through June
30, 1997, the Company has funded approximately $530,000 of its equipment needs
with proceeds from an equipment lease agreement. The Company had no short-or
long-term borrowings outstanding at June 30, 1997, and had no credit facilities
available at that time.
The Company expects to incur substantial additional costs related to sales
and marketing activities associated with United States and international market
entry, expansion of manufacturing capabilities, clinical trials and regulatory
activities and product and process development. The amount and timing of
anticipated expenditures will depend upon numerous factors both within and
outside of the Company's control, including the nature and timing of marketing
and sales activities and the nature and timing of additional clinical trials for
additional indications, both within and outside the field of epilepsy. Moreover,
the Company's ability to generate income from operations will be dependent upon
obtaining reimbursement approval from government and third-party payors as well
as receiving market acceptance for the NCP System.
During fiscal 1997, the Company used approximately $12.0 million in cash in
operating activities. During the fiscal year, inventories increased to $1.0
million from $672,000 at June 30, 1996 as the Company built inventory levels in
anticipation of higher levels of manufacturing and sales activities. During
fiscal 1997, the Company raised approximately $18.0 million from the sale of
Common Stock in two private
21
<PAGE>
placement transactions, one of which (approximately $11.2 million) was completed
in July 1996 and the other (approximately $6.8 million) was completed in March
1997.
The Company's liquidity will continue to be reduced as amounts are expended
for expansion of sales and marketing activities, manufacturing expansion,
continuing clinical trials and related regulatory affairs, and product and
process development. Although the Company has no firm commitments, the Company
expects to make capital expenditures of approximately $1.6 million during the
remainder of fiscal 1998 and approximately $3.0 million in fiscal 1999,
primarily to expand manufacturing capabilities and to enhance general
infrastructure and facilities.
The Company believes that its current resources, combined with the proceeds
from an anticipated public offering of Common Stock, will be sufficient to fund
its operations at least through June 30, 1999. This estimate is based on certain
assumptions, which may not hold true, including the timely completion of a
financing. There can be no assurance that such financing will be completed on a
timely basis, or at all, or that proceeds from such financing, if any, combined
with the Company's available cash, cash equivalents, investment securities and
investment income, will be sufficient to meet the Company's capital requirements
through June 30, 1999. The availability of financing either before or after that
time will depend upon a number of important factors, including the state of the
United States capital markets and economy in general and the health care and
medical device segments in particular, the status of the Company's international
and domestic sales activities and the status of the Company's clinical and
regulatory activities. There can be no assurance that the Company will be able
to raise additional capital when needed or that the terms upon which capital
will be available will be favorable to the Company.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
See Note 1 of Notes to Consolidated Financial Statements for a discussion of
the impact of new accounting pronouncements.
FACTORS AFFECTING FUTURE OPERATING RESULTS
RELIANCE ON SINGLE PRODUCT. The Company has only one product, the NCP
System, which has been approved by the FDA only for a single indication: as an
adjunctive therapy in reducing the frequency of seizures in adults and
adolescents over twelve years of age with partial onset seizures that are
refractory to antiepileptic drugs ("AEDs"). The Company does not expect to have
any other product or approved indication for the NCP System for the foreseeable
future. Although the Company has been able to sell the NCP System in certain
countries in Europe since 1994 and recently received United States FDA approval
and Canadian approval, it is only now in the process of initiating full-scale
marketing and sales efforts in the United States and other countries. The
Company's inability to commercialize successfully the NCP System would have a
material adverse effect on the Company's business, financial condition and
results of operations.
UNCERTAINTY OF MARKET ACCEPTANCE. Although the NCP System was approved for
commercial sale in a number of European countries beginning in 1994, the Company
has sold, through June 30, 1997, a limited number of NCP Systems. Market
acceptance of the Company's NCP System will depend on the Company's ability to
convince the medical community of the clinical efficacy and safety of vagus
nerve stimulation and the NCP System, and on the approval and availability of
adequate levels of reimbursement. While the NCP System has been used in
approximately 1,000 patients through June 30, 1997, it provides a new form of
therapy with which many physicians are unfamiliar. The Company believes that
existing AEDs and surgery are the only other approved and currently available
therapies competitive with the NCP System in the treatment of epileptic
seizures. Such therapies may be more attractive to patients or their physicians
than the NCP System in terms of efficacy, cost or reimbursement availability.
There can be no assurance that the NCP System will achieve market acceptance for
the treatment of epilepsy or for any other indication or that adequate levels of
reimbursement from governmental or third-party payors will be available. Failure
22
<PAGE>
the NCP System to gain market acceptance would have a material adverse effect on
the Company's business, financial condition and results of operations.
HISTORY OF LOSSES; PROFITABILITY UNCERTAIN; FLUCTUATIONS IN QUARTERLY
OPERATING RESULTS. The Company has incurred net losses and accumulated a
deficit of approximately $49.2 million through June 30, 1997. In July 1997, the
Company received FDA marketing approval which permits the Company to sell the
NCP System in the United States for use as an adjunctive therapy in reducing the
frequency of refractory partial onset seizures in patients over twelve years of
age. In addition, the Company has obtained "CE Marking," the designation of
market approval now accepted by all European Union member countries, for its NCP
System which, when combined with approvals from Canada and certain other
countries, permits the Company to sell the NCP System internationally. Even with
these marketing approvals, there can be no assurance that the Company will be
able to generate adequate sales to achieve profitability in the future. In
addition, in order to develop these markets, the Company will incur substantial
marketing and sales expenses. The amount and timing of anticipated expenditures
will depend on numerous factors, including the nature and timing of marketing
and sales activities, the expansion of the Company's manufacturing capabilities,
the nature and timing of additional clinical trials, and the Company's product
development efforts.
The Company's results of operations may fluctuate significantly from quarter
to quarter and will depend upon numerous factors, many of which are outside the
Company's control. Such factors include, but are not limited to, the extent to
which the Company's NCP System gains market acceptance, timing of any approvals
for reimbursement by third-party payors, the rate and size of expenditures
incurred as the Company expands its sales and marketing efforts and availability
of key components, materials and contract services which may be dependent on the
Company's ability to forecast sales.
LIMITATIONS ON THIRD-PARTY REIMBURSEMENT. The Company's ability to
commercialize the NCP System successfully will depend 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 the procedures and services associated
therewith, and to reimburse for the costs of the NCP System and the related
services at adequate levels.
In deciding to cover a new therapy, third-party payors base their initial
coverage decisions on several factors including, but not limited to, the status
of the FDA's review of the product, the product's safety and efficacy, the
number of studies performed and peer-reviewed articles published with respect to
the product and how the product and therapy compares to alternative therapies.
There can be no assurance that third-party payors will view the Company and the
NCP System favorably with respect to any of the above factors. The Company has
only limited experience in seeking and obtaining coverage decisions from
third-party payors. A failure to achieve favorable coverage decisions for the
NCP System in a timely manner could deter patients and their physicians from
using the NCP System and could have a material adverse effect on the Company's
business, financial condition or results of operations.
Once a favorable coverage determination is made with respect to a product,
payors must determine the level of reimbursement for the product and related
therapy and procedures. The Company believes that coverage and reimbursement for
most epilepsy patients who are likely candidates for treatment with the NCP
System will need to be obtained from third-party private payors. In making
decisions about reimbursement amounts, third-party private payors typically
reimburse for the costs of newly covered devices and services using the standard
methods they employ for other products and services already covered. Many
private insurers and managed care plans use a variety of payment mechanisms,
including, but not limited to, discounted charges, per diem amounts,
resource-based payment scales and reimbursed costs. The Company believes that a
significant number of epilepsy patients in the United States are either eligible
for benefits under the Medicare program or are uninsured. The Medicare program
uses a fixed-payment method (based on Diagnosis Related Groups or "DRGs") to pay
for hospital inpatient services and uses a resource-based relative value scale
to pay for physicians' services. Under current DRG
23
<PAGE>
groupings, hospital inpatient procedures for implanting the NCP System are
assigned to one of two different DRGs based on whether or not the patient has
complications or comorbidities (coexisting severe medical problems). The DRG
grouping that would include implantation of the NCP System for patients without
complications or comorbidities pays hospitals less than the costs of purchasing
and implanting the NCP System. The Company believes that this DRG grouping would
apply to most of the epilepsy patients covered by Medicare. In order to assure
adequate reimbursement for all epileptic patients eligible for benefits under
Medicare, the Company intends to seek changes in the DRG grouping so that NCP
System implant cases would be reclassified to other, higher-paying DRGs. The
Company has only limited experience in seeking and obtaining coverage and
payment approvals from third-party payors, and there can be no assurance that
the Company would be successful in achieving coverage or adequate reimbursement
levels, or that it can obtain new DRG assignments under the Medicare program to
cover the complete costs of therapy using the NCP System. If the Company is
unsuccessful in achieving coverage or adequate reimbursement levels or in
obtaining new DRG assignments, or if hospitals or physicians view their payments
as inadequate, then patients, physicians and hospitals could be deterred from
using the NCP System, which could have a material adverse effect on the
Company's business, financial condition or results of operations. See
"Business--Third-Party Reimbursement."
In June 1994, the Company was granted approval to use the CE Mark and to
market the NCP System in the European Union. The Company is continuing to pursue
appropriate reimbursement approvals in the European Union member countries. The
Company believes that significant sales volume will be difficult to generate
without appropriate reimbursement approvals. There can be no assurance as to
when or whether such reimbursement will be obtained in any of the European Union
countries or, if obtained, whether the levels of reimbursement will be
sufficient to enable the Company to sell the NCP System on a profitable basis.
LIMITED MARKETING AND SALES EXPERIENCE. Although the Company has had
approval to market the NCP System in the member countries of the European Union
since 1994, it has only recently received FDA approval to commercialize the NCP
System in the United States and, consequently, it has limited experience in
marketing, direct sales and distribution. The Company has recently established a
marketing and sales force for the United States market, but no assurance can be
given that the Company's direct marketing and sales force will succeed in
promoting the NCP System to patients, health care providers or third-party
payors. The Company believes that, to market its products directly, it must
employ a marketing and sales force with technical expertise. In addition, due to
the limited market awareness of the NCP System, the Company believes that the
sales process could be lengthy, requiring the Company to educate patients,
health care providers and third-party payors regarding the clinical benefits of
the NCP System. In certain international territories, the Company relies, and
intends to continue relying, upon independent distributors. There can be no
assurance that the Company will be able to recruit and retain skilled marketing
and sales personnel or foreign distributors, or that the Company's marketing
efforts will be successful. Failure by the Company to successfully market the
NCP System would have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Marketing and
Sales."
LIMITED MANUFACTURING EXPERIENCE. The Company has a limited history of
operations that, to date, has consisted primarily of manufacturing limited
quantities of the NCP System for clinical investigations and for commercial
sales activities in international markets. The Company does not have experience
manufacturing the NCP System in the volumes that will be necessary to achieve
significant commercial sales. The Company has recently entered into a lease for
a new facility, and intends to move all of its manufacturing operations to the
new facility, which is expected to begin production in early calendar 1998. The
Company may encounter difficulties in scaling up production of the NCP System,
in procuring the necessary supply of materials, components and contract
services, or in hiring and training additional manufacturing personnel to
support domestic and international demand. The Company will be required to
obtain FDA approval for its change in the manufacturing facility. The new
manufacturing facility will also
24
<PAGE>
have to be inspected for compliance with the FDA's Quality System regulations
("QSR") and with ISO 9001 and 9002 standards, which impose certain procedural
and documentation requirements with respect to device design, development,
manufacturing and quality assurance activities, before the Company can begin
commercial-scale production of the NCP System at the new manufacturing facility.
In addition, one of the Company's contract manufacturers has moved its
manufacturing operations to a new facility. The Company will be required to
obtain FDA approval for the change in the location of the contractor's
manufacturing facility, which generally requires a preapproval inspection by the
FDA to determine the contractor's compliance with the QSR. There can be no
assurance that the Company will be able to obtain the necessary FDA and other
approvals for its or its contract manufacturers' new facilities on a timely
basis, or at all. If the Company is unable to achieve commercial-scale
production capability on a timely basis with acceptable quality and
manufacturing yield and costs, to sustain such capacity, or to achieve FDA and
other governmental approvals, the ability of the Company to deliver products on
a timely basis could be impaired which could have a material adverse effect on
the Company's business, financial condition or results of operations. See
"Business--Manufacturing and Sources of Supply."
DEPENDENCE ON KEY SUPPLIERS AND MANUFACTURERS. The Company relies upon sole
source suppliers for certain of the key components, materials and contract
services used in manufacturing the NCP System. The Company periodically
experiences discontinuation or unavailability of components, materials and
contract services which may require qualification of alternative sources or, if
no such alternative sources are identified, product design changes. The Company
believes that pursuing and qualifying alternative sources and/or redesigning
specific components of the NCP System, when necessary, could consume significant
Company resources. In addition, such changes generally require regulatory
submissions and approvals. Any extended delays in or inability to secure
alternative sources for these or other components, materials and contract
services could result in product supply and manufacturing interruptions. These
delays could have a material adverse effect on the Company's ability to
manufacture the NCP System on a timely and cost competitive basis, and therefore
on its business, financial condition or results of operations. See
"Business--Manufacturing and Sources of Supply."
RISK OF PRODUCT RECALL. The NCP System includes a complex electronic device
and lead designed to be implanted in the human body. Component failures,
manufacturing 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 the Company's products, possibly requiring removal (and
potentially reimplantation) of NCP Generators and/or leads. In 1991, a failure
of an NCP System caused permanent paralysis of one patient's left vocal cord. In
addition, several patients experienced vagus nerve 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 the Company's product designs and no similar failures have been reported to
the Company. There can be no assurance, however, that the Company will not
experience similar or other product problems or that the Company will not be
required to recall products. Any product recall could have a material adverse
effect on the Company's business, financial condition or results of operations.
See "Business--Clinical Trials" and "--Government Regulation."
DEPENDENCE ON PATENTS, LICENSES AND PROPRIETARY RIGHTS. The Company's
success will depend in part on its 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, the Company has acquired
licenses under certain patents and has patented and intends to continue to seek
patents on its own inventions used in its products and treatment methods. The
process of seeking patent protection can be expensive and time consuming and
there can be no assurance that patents will issue from the currently pending or
future applications or that, if patents are issued, they will be of sufficient
scope or strength to provide meaningful protection of the Company's technology,
or any commercial advantage to the Company.
25
<PAGE>
Cyberonics believes that the licenses held by the Company provide it with
protection in the United States in the field of cranial nerve stimulation,
including vagus nerve stimulation for the control of epilepsy, movement
disorders, including Parkinson's disease and essential tremor, and additional
indications for which method patents have been issued. 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. In addition, 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 the Company, may be necessary to enforce patents
issued or licensed to the Company, to protect trade secrets or know-how owned by
the Company or to defend the Company 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 the Company to
significant liabilities to third parties, could require the Company to seek
licenses from third parties and could prevent the Company from manufacturing,
selling or using the NCP System, any of which could have a material adverse
effect on the Company's business, financial condition or results of operations.
There can be no assurance that any required license would be available on
acceptable terms, if at all. See "Business-- Patents, Licenses and Proprietary
Rights."
COMPETITION; RAPID TECHNOLOGICAL CHANGE. The Company believes that existing
and future AEDs will be the primary competition for its NCP System. The Company
may also face competition from other medical device companies for the treatment
of partial seizures. Medtronic, Inc. has clinically assessed an implantable
signal generator used with an invasive deep brain probe (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. The Company could also face competition from other large
medical device companies which have the technology, experience and capital
resources to develop alternative devices for the treatment of epilepsy. Many of
the Company's competitors have substantially greater financial, manufacturing,
marketing and technical resources than the Company and have obtained third-party
reimbursement approvals. In addition, the health care industry is characterized
by extensive research efforts and rapid technological progress. There can be no
assurance that the Company's competitors will not develop technologies and
obtain regulatory approval for products that are more effective in treating
epilepsy than the Company's current or future products. There can also be no
assurance that advancements in surgical techniques will not make surgery a more
attractive therapy for epilepsy. The development by others of new treatment
methods with novel AEDs, medical devices or surgical techniques for epilepsy
could render the NCP System non-competitive or obsolete. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors or that competition, including the development and
commercialization of new products and technology, will not have a material
adverse effect on the Company's business, financial condition or results of
operations. See "Business--Competition."
MANAGEMENT OF GROWTH. In connection with the commercialization of the NCP
System in the United States, the Company has begun and intends to continue to
significantly expand the scope of its operations, in particular in
manufacturing, marketing and sales. Such activities have placed, and may
continue to place, a significant strain on the Company's resources and
operations. The Company's ability to effectively manage such growth will depend
upon its ability to attract, hire and retain highly qualified employees and
management personnel. The Company competes for such personnel with other
companies, academic institutions, government entities and other organizations.
There can be no assurance that the Company will be successful in hiring or
retaining qualified personnel. The Company's success will also depend on the
ability of its officers and key employees to continue to implement and improve
its operational, management information and financial control systems, of which
there can be no assurance. The Company's inability to manage growth effectively
could have a material adverse effect on the Company's business, financial
condition or results of operations. See "Business--Employees."
26
<PAGE>
PRODUCT LIABILITY AND AVAILABILITY OF INSURANCE. The manufacture and sale
of the NCP System entails the risk of product liability claims. Although the
Company maintains product liability insurance, there can be no assurance that
the coverage limits of the Company's insurance policies will be adequate. Such
insurance is expensive and in the future may not be available on acceptable
terms, if at all. A successful claim brought against the Company in excess of
its insurance coverage could have a material adverse effect on the Company's
business, financial condition or results of operations. See "Business--Product
Liability and Insurance."
GOVERNMENT REGULATION. The preclinical 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. The NCP System is regulated
as a medical device by the FDA and is subject to the FDA's premarket approval
("PMA") requirements. In July 1997, the Company received FDA approval to market
the NCP System in the United States for use as an adjunctive therapy in reducing
the frequency of seizures in adults and adolescents over twelve years of age
with partial onset seizures that are refractory to AEDs. Nonetheless, in the
future, it will be necessary for the Company to file PMA supplements, and apply
for additional regulatory approvals, possibly including new investigational
device exemptions ("IDEs") and additional PMAs, 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. Furthermore,
changes in existing regulations or adoption of new regulations could prevent the
Company from obtaining, or affect the timing of, future regulatory approvals.
There can be no assurance that the Company will 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 have a material adverse
effect on the Company's business, financial condition or results of operations.
See "Business--Government Regulation."
FUTURE CAPITAL REQUIREMENTS. Although the Company believes that its current
resources, together with the proceeds from an anticipated public offering of
Common Stock, will be sufficient to meet its capital requirements at least
through June 30, 1999, there can be no assurance that the Company will not
require additional financing either before or after that date. This estimate is
based on certain assumptions, which may not hold true, including the timely
completion of a financing. There can be no assurance that such financing will be
completed on a timely basis, or at all, or that proceeds from such financing, if
any, combined with Company's available cash, cash equivalents, investment
securities and investment income, will be sufficient to meet the Company's
capital requirements through June 30, 1999. The Company's future capital
requirements will depend upon numerous factors, including the extent and timing
of future product sales, the scale-up of the Company's manufacturing facilities,
and the nature, timing and success of clinical trials for additional indications
for the NCP System. Such financing, if required, may not be available on
satisfactory terms, or at all. Lack of access to sufficient financing would
impair the Company's ability to fully pursue its business objectives, which
could have a material adverse effect on the Company's business, financial
condition or results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. Although the NCP System has
been approved for commercialization in the European Union countries since 1994,
the Company has not generated significant revenues from such countries to date.
The Company currently is expanding its marketing and sales activities in
international markets. There can be no assurance that the Company will
successfully increase international sales or that the Company will be successful
in obtaining reimbursement or any regulatory approvals required in foreign
countries. Changes in overseas economic conditions, currency exchange
27
<PAGE>
rates, foreign tax laws, or tariffs or other trade regulations could have a
material adverse effect on the Company's business, financial condition or
results of operations. The anticipated international nature of the Company's
business is also expected to subject the Company and its representatives, agents
and distributors to laws and regulations of the foreign jurisdictions in which
they 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 there can be no assurance that new laws or regulations will not
have an adverse effect on the Company's business, financial condition or results
of operations. In addition, the laws of certain foreign countries do not protect
the Company's intellectual property rights to the same extent as do the laws of
the United States. In particular, the European Patent Convention prohibits
patents covering methods for the treatment of the human body by surgery or
therapy. See "Business--Patents and Proprietary Rights" and "--Government
Regulation."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference to the
Consolidated Financial Statements set forth on pages F-1 through F-18 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company, their ages as of August
15, 1997, and certain additional information about them, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------- --- -------------------------------------------------------
<S> <C> <C>
Robert P. Cummins........................ 43 President and Chief Executive Officer
Reese S. Terry, Jr....................... 55 Chairman of the Board, Executive Vice President and
Secretary
John K. Bakewell......................... 36 Vice President, Finance and Administration and Chief
Financial Officer
Michael D. Dale.......................... 38 Vice President, Global Sales
William H. Duffell, Jr., 37 Vice President, Clinical and Regulatory Affairs Ph.D
Stephen D. Ford.......................... 47 Vice President, Manufacturing
Shawn P. Lunney.......................... 34 Vice President, Marketing
Stanley H. Appel, M.D.................... 64 Director
Tony Coelho.............................. 55 Director
Thomas A. Duerden, Ph.D.................. 67 Director
Michael J. Strauss, M.D.................. 44 Director
</TABLE>
Mr. Cummins became a director of the Company in June 1988. He was appointed
President and Chief Executive Officer of the Company in September 1995. Until
September 1995, he was also a general partner of Vista Partners, L.P., a venture
capital partnership which he joined in 1984, a general partner of Vista III
Partners, L.P., a venture capital firm formed in 1986 and Vice President of
Vista Ventures Inc., a venture capital advisory firm. Mr. Cummins is also a
director of Sigma Circuits Inc., a manufacturer of electronic interconnect
products.
Mr. Terry co-founded the Company in December 1987 and served as a Director
and Chief Executive Officer of the Company until February 1990, when he became
Chairman of the Board and Executive Vice
28
<PAGE>
President. Mr. Terry has also served as Secretary of the Company from its
inception and as President of the Company for four months in 1995. From 1976 to
1986, Mr. Terry held executive positions with Intermedics, Inc., a medical
device and electronics company, including serving as Vice President of
Engineering, Vice President of Corporate Technical Resources and, most recently,
as Vice President of Quality.
Mr. Bakewell joined the Company as Vice President, Finance and
Administration and Chief Financial Officer in May 1993. Prior to joining the
Company, Mr. Bakewell held the position of Chief Financial Officer with Zeos
International, Ltd., a manufacturer and direct marketer of personal computers
and related products from October 1990 until May 1993. From May 1988 to October
1990, Mr. Bakewell served as Manager with the Entrepreneurial Services Group of
Ernst & Young, an international accounting firm. From August 1983 to May 1988,
Mr. Bakewell held various positions with KPMG Peat Marwick, an international
accounting firm. Mr. Bakewell is a certified public accountant.
Mr. Dale joined the Company in October 1996 as Vice President, Global Sales
and as Managing Director of the Company's international subsidiary, Cyberonics
Europe, S.A. Prior to joining the Company, Mr. Dale held positions of increasing
responsibility with St. Jude Medical, Inc., most recently as Business Unit
Director, Heart Valves for St. Jude Medical Europe from May 1994 to October 1996
and as Marketing Manager, Heart Valves and Cardiac Assist Products for St. Jude
Medical Europe from January 1991 to May 1994.
Dr. Duffell joined the Company as Vice President, Regulatory and Clinical
Affairs in May 1995. Prior to joining the Company, Dr. Duffell held the position
of Director, Regulatory Affairs and Quality Assurance with Bristol-Meyers Squibb
Companies from April 1991 until May 1995, where his responsibilities included
the areas of regulatory affairs, quality assurance and clinical research in both
corporate and divisional capacities. From March 1987 to March 1989, Dr. Duffell
served as Senior Manager, Regulatory Affairs and Clinical Research with Dornier
Medical, Inc., a manufacturer of extracaporial shock-wave lithotriptors and
related gastrointestinal and urological products.
Mr. Ford joined the Company as Vice President, Manufacturing in March 1992.
Prior to joining the Company, Mr. Ford held the position of Manager of
Manufacturing with the Biomedical Products Division of McGaw, Inc. from
September 1987 to March 1992. From March 1983 to September 1987, Mr. Ford served
as Director of Manufacturing at Quest Medical.
Mr. Lunney joined the Company in April, 1991 and served in various sales,
marketing and reimbursement planning positions until May 1996, when he became
Vice President, Marketing. Prior to joining the Company, Mr. Lunney held the
position of Sales and Marketing Manager with Perceptive Systems, Inc., a
hospital laboratory medical instrument manufacturer from December 1985 to April
1991.
Dr. Appel has been a director of the Company since December 1996 and the
chair of Company's Scientific Advisory Board since its formation in 1994. Since
1992, Dr. Appel has been Chairman of the Baylor College of Medicine Department
of Neurology.
Mr. Coelho has been a director of the Company since March 1997. Mr. Coelho
is the Chairman and Chief Executive Officer of ETC w/tci, the Washington-based
education, training and communications subsidiary of Tele-Communications, Inc.,
a position he held since October 1996. From January 1990 to September 1995, Mr.
Coelho served as the President and Chief Executive Officer of Wertheim Schroder
Investment Services, Inc., an asset management firm, and from October 1989 to
September 1995, he served as Managing Director of Wertheim Schroder and Co., an
investment banking firm. Mr. Coelho served in the United States House of
Representatives from California from 1979 to 1989, and served as House Majority
Whip from 1986 to 1989. Mr. Coelho is also a member of the Board of Directors of
Auto Lend Group, Inc., ICF Kaiser International, Inc., International
Thoroughbred Breeders, Inc., Service Corporation International, TEI, Inc. and
Tele-Communications, Inc.
29
<PAGE>
Dr. Duerden has been a director of the Company since March 1989 and an
independent business consultant since January 1990. From December 1988 through
January 1990, Dr. Duerden served as Chairman of the Board and Chief Executive
Officer of Tonometrics, Inc., a medical diagnostic device company. From 1979
through 1988, Dr. Duerden served as Chairman and Chief Executive Officer of
Electro Biology, Inc., an orthopedic device company.
Dr. Strauss has been a director of the Company since March 1997. Since June
1988, Dr. Strauss served first as President and later as Corporate Vice
President and General Manager at Covance Health Economics and Outcomes Services
Inc. (formerly Health Technology Associates, Inc.), a consulting and research
services firm specializing in third-party payor issues.
BOARD COMPOSITION
Pursuant to a letter agreement dated March 28, 1997, the Clark Estates is
entitled to designate one person to serve on the Company's Board of Directors
for as long as the Clark Estates retains at least 600,000 of the aggregate of
901,408 shares of Common Stock purchased on such date by parties affiliated with
the Clark Estates. To date, the Clark Estates has not exercised this right.
BOARD MEETINGS AND COMMITTEES
The Board of Directors of the Company held a total of 9 meetings during the
fiscal year ended June 30, 1997. The Board has an Audit Committee and a
Compensation Committee. There is no nominating committee or other committee
performing a similar function.
The Audit Committee, which consists of Thomas A. Duerden and Stanley H.
Appel, did not meet during the fiscal year ended June 30, 1997. This Committee
recommends engagement of the Company's independent public accountants and is
primarily responsible for approving the services performed by such accountants
and for reviewing and evaluating the Company's accounting principles and its
system of internal accounting controls.
The Compensation Committee, which consists of director Thomas A. Duerden and
Stanley H. Appel, did not meet during the fiscal year ended June 30, 1997. This
Committee establishes salary and incentive compensation of the executive
officers of the Company and administers the Company's employee benefit plans.
During the fiscal year ended June 30, 1997, compensation decisions were made by
the Board of Directors.
During the fiscal year ended June 30, 1997, all current directors attended
at least seventy five percent of the meetings of the Board of Directors, with
the exception of Mr. Coehlo, who missed two of the four meetings held since he
became a director.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file reports of
ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the
Securities and Exchange Commission (the "SEC"). Such officers, directors and
ten-percent stockholders are also required by SEC rules to furnish the Company
with copies of all Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by it, the
Company believes that, for the fiscal year ended June 30, 1997, all Section
16(a) filing requirements applicable to its officers, directors and ten-percent
stockholders were complied with.
30
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table sets forth the compensation
paid by the Company for the year ended June 30, 1997 to the Chief Executive
Officer of the Company and each of the other most highly compensated executive
officers of the Company whose total compensation exceeded $100,000
(collectively, the "Named Executive Officers"):
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
-------------
ANNUAL COMPENSATION SECURITIES
FISCAL ------------------------ UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) OPTIONS (#) COMPENSATION
- ---------------------------------------------------- ----------- ----------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Robert P. Cummins(1)................................ 1997 196,596 68,530 356,000 294(2)
President and Chief Executive Officer 1996 140,758 32,930 50,000 8,194(2)(3)
Reese S. Terry, Jr.................................. 1997 146,693 32,596 63,500 6,705(2)
Chairman of the Board and Executive 1996 130,880 32,950 -- 5,321(2)
Vice President 1995 127,746 11,158 20,000 5,544(2)
William H. Duffell, Jr.(4).......................... 1997 157,356 32,963 90,000 13,952(5)
Vice President, Clinical and Regulatory 1996 150,000 27,886 -- 27,881(6)
Affairs 1995 23,077 5,000 85,000 --
John K. Bakewell.................................... 1997 131,187 29,527 135,000 263(2)
Vice President Finance and Administration 1996 105,502 27,537 -- 225(2)
and Chief Financial Officer 1995 101,620 8,630 55,000 226(2)
Shawn P. Lunney..................................... 1997 119,423 54,744 137,750 231(2)
Vice President, Marketing
</TABLE>
- ------------------------
(1) Mr. Cummins became an executive officer of the Company in fiscal 1996.
(2) Represents premiums paid by the Company for term life insurance.
(3) Also includes $7,900 paid to Mr. Cummins in fiscal 1996 as a travel/auto
allowance.
(4) Mr. Duffell joined the Company in 1995. Mr. Duffell's bonus in fiscal 1996
includes a $10,000 bonus related to Mr. Duffell's relocation to Houston.
(5) Represents $332 paid by the Company for term life insurance and $13,620 paid
to Mr. Duffell for expenses related to relocation to Houston.
(6) Represents $315 paid by the Company for term life insurance and $27,566 paid
to Mr. Duffell for expenses related to relocation to Houston.
31
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR. The following table sets forth each
grant of stock options made during the year ended June 30, 1997 to each of the
Named Executive Officers:
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------- POTENTIAL REALIZABLE
PERCENT OF VALUE AT ASSUMED
NUMBER OF TOTAL OPTIONS ANNUAL RATES OF STOCK
SECURITIES GRANTED TO PRICE APPRECIATION
UNDERLYING EMPLOYEES IN EXERCISE FOR OPTION TERM($)(2)
OPTIONS FISCAL PRICE EXPIRATION ---------------------
NAME GRANTED(#) YEAR(2) ($/SH) DATE 5% 10%
- ---------------------------------------- ----------- ------------- ----------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Robert P. Cummins....................... 2,000(3) 0.1% $ 3.06 06/01/03 2,318 5,342
2,000(3) 0.1% $ 3.06 07/05/04 2,776 6,589
2,000(3) 0.1% $ 3.06 06/01/05 3,183 7,749
50,000(3) 2.6% $ 3.06 10/11/05 83,391 204,912
300,000 15.8% $ 3.06 11/01/06 577,325 1,463,056
Reese S. Terry, Jr...................... 20,000(3) 1.1% $ 3.06 09/20/04 28,488 67,920
43,500 2.3% 11/01/06 83,712 212,143
John K. Bakewell........................ 45,000(3) 2.4% $ 3.06 05/10/03 51,388 118,151
15,000(3) 0.8% $ 3.06 09/20/04 21,366 50,940
75,000 4.0% $ 3.06 11/01/06 144,331 365,764
William H. Duffell, Jr.................. 90,000(3) 4.8% $ 3.06 11/01/06 173,197 438,917
Shawn P. Lunney......................... 3,000(3) 0.2% $ 3.06 12/09/02 3,172 7,213
10,000(3) 0.5% $ 3.06 03/25/03 11,249 25,805
15,000(3) 0.8% $ 3.06 09/20/04 21,640 51,812
104,750 5.5% $ 3.06 11/01/06 201,583 510,850
</TABLE>
- ------------------------
(1) Total number of shares subject to options granted to employees in fiscal
1997 was 1,893,388, which number includes options granted to employee
directors.
(2) Potential realizable value is based on an assumption that the stock price
appreciates at the annual rate shown (compounded annually) from the date of
grant until the end of the ten-year option term. These numbers are
calculated based on the requirements promulgated by the SEC and do not
reflect the Company's estimate of future stock price growth.
(3) In November 1996, the Company repriced stock options that had an exercise
price in excess of the fair market value in effect on the date of repricing.
The option grants indicated reflect previously granted options that were
repriced as if such options had been newly granted in November 1996.
32
<PAGE>
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END
VALUES. The following table sets forth, for each of the Named Executive
Officers, each exercise of stock options during the fiscal year ended June 30,
1997 and the year-end value of unexercised options:
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES VALUE UNDERLYING UNEXERCISED IN-THE-MONEY
ACQUIRED REALIZED OPTIONS AT FISCAL YEAR-END OPTIONS AT FISCAL YEAR-END
NAME ON EXERCISE(#) ($)(1) EXERCISABLE/UNEXERCISABLE(#)(2) EXERCISABLE/UNEXERCISABLE($)(3)
- ----------------------------- ----------------- --------- ---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Robert P. Cummins............ -- -- 176,750/181,250 $ 829,078/$850,063
Reese S. Terry, Jr........... -- -- 27,219/36,281 $ 127,657/$170,158
John K. Bakewell............. -- -- 104,355/70,645 $ 481,771/$327,629
William H. Duffell, Jr....... -- -- 83,542/91,458 $ 382,708/$421,892
Shawn P. Lunney.............. 7,125 $ 29,231 86,081/74,669 $ 399,546/$349,802
</TABLE>
- ------------------------
(1) Represents market value of underlying securities at date of exercise less
option exercise price.
(2) Options granted by the Company generally vest over a four-year period such
that 12.5% of the shares subject to the option vest on the six month
anniversary of the grant date, and 1/48 of the optioned shares vest each
month thereafter until fully vested.
(3) Market value of underlying securities at fiscal year-end ($7.75/per share)
minus the exercise price.
BOARD COMPENSATION
Directors do not receive any cash compensation for their services as members
of the Board of Directors. Nonemployee directors are eligible for discretionary
option grants under the Company's 1996 Option Plan. During fiscal 1997, each
nonemployee director was granted an option to purchase 35,000 shares of Common
Stock with an exercise price equal to the fair market value of the Common Stock
on the date of grant.
EMPLOYMENT AGREEMENTS
The Company does not have employment agreements with any Named Executive
Officer.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Cummins, formerly a member of the Compensation Committee, was appointed
President and Chief Executive Officer in September 1995. In connection with this
appointment, Mr. Cummins ceased to serve on the Compensation Committee. During
fiscal 1997, compensation decisions were made by the entire Board of Directors.
Messrs. Cummins and Terry abstained from decisions relating to their own
compensation.
33
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of July 31, 1997 certain information with
respect to the beneficial ownership of Cyberonics Common Stock (i) by each
person known by Cyberonics to own beneficially more than five percent of the
outstanding shares of Cyberonics Common Stock, (ii) by each director of
Cyberonics, (iii) by each of the Chief Executive Officer and four other most
highly paid executive officers of Cyberonics who earned over $100,000 in fiscal
1997 and (iv) by all directors and executive officers as a group. Except as
otherwise noted below, Cyberonics knows of no agreements among its stockholders
which relate to voting or investment of its shares of Cyberonics Common Stock.
<TABLE>
<CAPTION>
SHARES PERCENTAGE OF
BENEFICIALLY OUTSTANDING SHARES
NAME OF BENEFICIAL OWNER OWNED(1) OWNED(1)
- --------------------------------------------------------------------------------- ----------- -------------------
<S> <C> <C>
St. Jude Medical, Inc.(2)........................................................ 2,181,818 16.4%
One Lillehei Plaza
St. Paul, MN 55117-9983
Vista III, L.P.(3)............................................................... 1,573,204 11.8%
36 Grove Street
New Canaan, CT 06840
The Clark Estates(4)............................................................. 1,226,208 9.2%
30 Wall Street
New York, NY 10005
Reese S. Terry, Jr.(5)........................................................... 978,625 7.3%
c/o Cyberonics, Inc.
17448 Highway 3, Suite 100
Webster, TX 77598-4135
SmallCap World Fund Inc.......................................................... 864,800 6.5%
c/o Capital Research and Management
333 South Hope Street
Los Angeles, CA 90071
Wisconsin Investment Board....................................................... 718,000 5.4%
P.O. Box 7842
Madison, WI 53707
Robert P. Cummins(6)............................................................. 328,500 2.4%
John K. Bakewell(7).............................................................. 139,130 1.0%
William H. Duffell(8)............................................................ 132,692 1.0%
Shawn P. Lunney(9)............................................................... 105,471 *
Thomas A. Duerden, Ph.D.(10)..................................................... 51,000 *
Stanley H. Appel, M.D.(11)....................................................... 82,500 *
Tony Coelho(12).................................................................. 31,833 *
Michael J. Strauss(13)........................................................... 8,750 *
All executive officers and directors as a group (11 persons)(14)................. 2,115,886 14.7%
</TABLE>
- ------------------------
* Less than 1%
34
<PAGE>
(1) Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Shares of Cyberonics Common Stock subject to options and
warrants currently exercisable, or exercisable within 60 days, are deemed
outstanding for computing the percentage of the person holding such options
but are not deemed outstanding for computing the percentage of any other
person. Except as indicated by footnote, and subject to community property
laws where applicable, the persons named in the table have sole voting and
investment power with respect to all shares of Cyberonics Common Stock shown
as beneficially owned by them.
(2) St. Jude acquired these shares pursuant a Common Stock Purchase Agreement
dated April 8, 1996, which acquisition closed in July 1996. On April 8,1996,
the Company and St. Jude also entered into an Agreement and Plan of Merger,
pursuant to which the Company granted to St. Jude the right, but not the
obligation, to acquire the Company on or before October 18, 1996 in the form
of a merger. On October 18, 1996, St. Jude's right to acquire the Company
expired unexercised. In connection with the Stock Purchase Agreement, St.
Jude also entered into a Stockholders' Agreement which provides, among other
things, that St. Jude will not acquire additional shares of Common Stock. In
addition, St. Jude has agreed that, through July 1, 1998, it will vote its
shares of Common Stock in favor of director nominees as recommended by the
Board of Directors and, for so long as it holds any Common Stock, to vote
its shares of Common Stock on all other matters submitted to the
stockholders for a vote as recommended by the Board of Directors or in the
same proportion as the votes cast by all other stockholders. Finally, St.
Jude has agreed with the Company not to sell or otherwise dispose of its
shares of Common Stock on or before March 31, 1998.
(3) Mr. Cummins, the Chief Executive Officer, President and a director of
Cyberonics, is a limited partner of the partnership that controls Vista III,
L.P.
(4) Pursuant to a letter agreement dated March 28, 1997, the Clark Estates is
entitled to designate one person to serve on the Company's Board of
Directors for as long as the Clark Estates retains at least 600,000 of the
aggregate of 901,408 shares of Common Stock purchased on such date by
parties affiliated with the Clark Estates. To date, the Clark Estates has
not exercised this right.
(5) Includes 148,500 shares held in trusts for the benefit of Mr. Terry's
children of which Mr. Terry serves as trustee. Also includes 42,625 shares
subject to options exercisable on or before November 30, 1997.
(6) Includes 5,000 shares held in trust for the benefit of Mr. Cummins' daughter
of which Mr. Cummins serves as trustee. Also includes 283,000 shares subject
to options exercisable on or before November 30, 1997. Excludes shares held
by Vista III, L.P. as to which Mr. Cummins disclaims beneficial ownership
except to the extent of his pecuniary interest therein.
(7) Includes 138,000 shares subject to options exercisable on or before November
30, 1997.
(8) Includes 122,500 shares subject to options exercisable on or before November
30, 1997.
(9) Includes 98,346 shares subject to options exercisable on or before November
30, 1997.
(10) Includes 27,500 shares subject to options exercisable on or before November
30, 1997.
(11) Includes 42,500 shares subject to options exercisable on or before November
30, 1997.
(12) Includes 31,833 shares subject to options exercisable on or before November
30, 1997.
(13) Includes 8,750 shares subject to options exercisable on or before November
30, 1997.
(14) Includes 1,049,971 shares subject to options held by executive officers and
directors, which options are exercisable on or before November 30, 1997.
Also includes shares which may be determined to be beneficially owned by
executive officers and directors. See Notes 5 through 13.
35
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain stockholders of the Company, including Messrs. Cummins and Terry,
Drs. Appel and Duffell and venture capital firms formerly affiliated with Mr.
Cummins, are entitled to certain registration rights with respect to the Common
Stock held by them.
The Company's Bylaws provide that the Company is required to indemnify its
officers and directors to the fullest extent permitted by Delaware law,
including those circumstances in which indemnification would otherwise be
discretionary, and that the Company is required to advance expenses to its
officers and directors as incurred. Further, the Company has entered into
indemnification agreements with its officers and directors. The Company believes
that its charter and bylaw provisions and indemnification agreements are
necessary to attract and retain qualified persons as directors and officers.
The Company believes that all of the transactions set forth above were made
on terms no less favorable to the Company than could have been obtained from
unaffiliated third parties. All future transactions between the Company and its
officers, directors, principal stockholders and affiliates will be approved by a
majority of the Board of Directors, including a majority of the independent and
disinterested outside directors on the Board of Directors, and will be on terms
no less favorable to the Company than could be obtained from unaffiliated third
parties.
36
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed with Report
1. FINANCIAL STATEMENTS. The following consolidated financial statements
of Cyberonics, Inc. and subsidiary, and the Report of Independent Public
Accountants are included at pages F-1 through F-19 of this Form 10-K:
<TABLE>
<CAPTION>
PAGE
DESCRIPTION NO.
- ----------------------------------------------------------------------------------------------------------- -----
<S> <C>
Report of Independent Public Accountants................................................................... F-1
Consolidated Balance Sheets as of June 30, 1997 and 1996................................................... F-2
Consolidated Statements of Operations for the Three Years Ended June 30, 1997.............................. F-3
Consolidated Statements of Stockholders' Equity for the Three Years Ended June 30, 1997.................... F-4
Consolidated Statements of Cash Flows for the Three Years Ended June 30, 1997.............................. F-5
Notes to Consolidated Financial Statements................................................................. F-6
</TABLE>
2. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- -------- ----------------------------------------------------------------------
<S> <C>
3.1(1) Restated Certificate of Incorporation of Registrant.
3.2(1) Bylaws of Registrant.
4.1(2) Preferred Shares Rights Agreement, dated as of March 4, 1997 between
Cyberonics, Inc. and First National Bank of Boston, including the
Certificate of Designation, the form of Rights Certificate and the
Summary of Rights attached thereto as Exhibit A, B and C,
respectively.
10.1(1)* 1988 Incentive Stock Plan, as amended.
10.2(1)* 1991 Employee Stock Purchase Plan.
10.3(1) License Agreement dated March 15, 1988 between the Registrant and Dr.
Jacob Zabara.
10.4(1) Patent License Agreement effective as of July 28, 1989 between the
Registrant and Huntington Medical Research Institute.
10.5(3) Lease Agreement dated November 3, 1994 together with amendments dated
April 18, 1996 and April 30, 1997, respectively, between the
Registrant and Salitex II, Ltd.
10.6(1) Form of Indemnification Agreement.
10.7(1) Amended and Restated Stockholders Agreement dated October 16, 1992.
10.8(4) Registration Rights Agreement dated March 28, 1997.
10.9(5)* 1996 Stock Option Plan.
10.10(3) Stockholders' Agreement dated April 8, 1996 between the Registration
and St. Jude Medical, Inc.
10.11(3) Letter Agreement dated March 28, 1997 between the Clark Estates and
the Registrant.
10.12 Lease Agreement dated August 19, 1997 between the Registrant and Space
Assets II, Inc.
21.1(3) List of Subsidiaries of the Registrant.
23.1(3) Consent of Independent Public Accountants.
</TABLE>
37
<PAGE>
<TABLE>
<S> <C>
27(3) Financial Data Schedule.
</TABLE>
- ------------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Reg. No. 33-45118) declared effective February 10, 1993.
(2) Incorporated by reference to the Company's Registration Statement on Form
8-A (Commission File No. 000-19806) filed on March 6, 1997.
(3) Incorporated by reference to the Company's Report on Form 10-K for the year
ended June 30, 1997.
(4) Incorporated by reference to the Company's Report on Form 10-Q for the
quarter ended March 31, 1997.
(5) Incorporated by reference to the Company's Registration Statement on Form
S-8 (Reg. No. 333-19785) filed on January 14, 1997.
* Document indicated is a compensatory plan.
(b) Reports on Form 8-K.
Not Applicable
(c) Exhibits
See Item 14(a)(2) above
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
<TABLE>
<S> <C>
Registrant
CYBERONICS, INC.
By: /s/ JOHN K. BAKEWELL
----------------------------------------
John K. Bakewell
VICE PRESIDENT, FINANCE AND
ADMINISTRATION
AND CHIEF FINANCIAL OFFICER (PRINCIPAL
FINANCIAL AND ACCOUNTING OFFICER)
</TABLE>
September 24, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE CAPACITY IN WHICH SIGNED DATE
- ----------------------------------- ------------------------- ----------------
REESE S. TERRY, JR.*
- ----------------------------------- Chairman of the Board and September 24,
Reese S. Terry, Jr. Executive Vice President 1997
President, Chief
ROBERT P. CUMMINS* Executive Officer and September 24,
- ----------------------------------- Director (Principal 1997
Robert P. Cummins Executive Officer)
Vice President, Finance
/s/ JOHN K. BAKEWELL and Administration and
- ----------------------------------- Chief Financial Officer September 24,
John K. Bakewell (Principal Financial and 1997
Accounting Officer)
STANLEY H. APPEL, M.D.*
- ----------------------------------- Director September 24,
Stanley H. Appel, M.D. 1997
TONY COELHO*
- ----------------------------------- Director September 24,
Tony Coelho 1997
THOMAS A. DUERDEN, PH.D.*
- ----------------------------------- Director September 24,
Thomas A. Duerden, Ph.D. 1997
MICHAEL J. STRAUSS*
- ----------------------------------- Director September 24,
Michael J. Strauss 1997
<TABLE>
<S> <C> <C>
*By: /s/ JOHN K. BAKEWELL
------------------------------------
John K. Bakewell
(ATTORNEY-IN-FACT)
</TABLE>
39
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Cyberonics, Inc.:
We have audited the accompanying consolidated balance sheets of Cyberonics,
Inc. (a Delaware corporation), and subsidiary as of June 30, 1997 and 1996, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended June 30, 1997. 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 in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Cyberonics,
Inc., and subsidiary as of June 30, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 1997, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Houston, Texas
August 7, 1997
F-1
<PAGE>
CYBERONICS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
-----------------------------
1997 1996
------------- --------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................................................ $ 781,639 $ 2,121,930
Securities held to maturity...................................................... 7,129,409 --
Accounts receivable, net......................................................... 548,542 473,038
Inventories...................................................................... 1,005,356 671,836
Prepaid expenses................................................................. 126,799 258,585
------------- --------------
TOTAL CURRENT ASSETS........................................................... 9,591,745 3,525,389
Securities held to maturity........................................................ 212,408 80,032
Property and equipment, net........................................................ 362,333 332,881
Other assets, net.................................................................. 83,251 9,741
------------- --------------
$ 10,249,737 $ 3,948,043
------------- --------------
------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................................................. $ 365,351 $ 924,059
Accrued liabilities.............................................................. 1,462,914 1,558,934
------------- --------------
TOTAL CURRENT LIABILITIES...................................................... 1,828,265 2,482,993
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; 25,000,000 shares authorized; 13,322,175
and 9,577,115 shares issued and outstanding at June 30, 1997 and 1996,
respectively................................................................... 133,222 95,771
Additional paid-in capital....................................................... 57,338,856 39,261,602
Deferred compensation............................................................ (63,750) (4,460)
Accumulated deficit.............................................................. (49,167,002) (37,922,171)
Cumulative translation adjustment................................................ 180,146 34,308
------------- --------------
TOTAL STOCKHOLDERS' EQUITY..................................................... 8,421,472 1,465,050
------------- --------------
$ 10,249,737 $ 3,948,043
------------- --------------
------------- --------------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
F-2
<PAGE>
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------------------------
1997 1996 1995
-------------- -------------- -------------
<S> <C> <C> <C>
Net sales......................................................... $ 1,372,005 $ 1,416,965 $ 966,989
Cost of sales..................................................... 372,180 411,562 347,457
-------------- -------------- -------------
GROSS PROFIT................................................ 999,825 1,005,403 619,532
Operating Expenses:
Research and development........................................ 6,549,474 8,024,502 5,678,024
Selling, general and administrative............................. 5,933,852 3,420,111 2,906,589
-------------- -------------- -------------
Total operating expenses...................................... 12,483,326 11,444,613 8,584,613
-------------- -------------- -------------
LOSS FROM OPERATIONS........................................ (11,483,501) (10,439,210) (7,965,081)
Interest income, net.............................................. 436,813 423,044 688,909
Other (expense) income, net....................................... (198,143) (97,084) 37,362
-------------- -------------- -------------
NET LOSS.................................................... $ (11,244,831) $ (10,113,250) $ (7,238,810)
-------------- -------------- -------------
-------------- -------------- -------------
NET LOSS PER SHARE.......................................... $ (.93) $ (1.06) $ (.79)
-------------- -------------- -------------
-------------- -------------- -------------
SHARES USED IN COMPUTING NET LOSS PER SHARE................. 12,030,171 9,513,038 9,218,008
-------------- -------------- -------------
-------------- -------------- -------------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
F-3
<PAGE>
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL CUMULATIVE
--------------------- PAID-IN DEFERRED ACCUMULATED TRANSLATION
SHARES AMOUNT CAPITAL COMPENSATION DEFICIT ADJUSTMENT
---------- --------- ---------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1994.................... 9,051,054 $ 90,511 $39,205,998 $(223,000) ($20,570,111) $ --
Stock options exercised..................... 415,616 4,156 27,775 -- -- --
Issuance of Common Stock under Employee
Stock Purchase Plan....................... 32,391 324 94,485 -- -- --
Issuance of Common Stock under Employee
Special Recognition Stock Program......... 200 2 748 -- -- --
Amortization of deferred compensation....... -- -- -- 91,200 -- --
Translation adjustment...................... -- -- -- -- -- (39,723)
Net loss.................................... -- -- -- -- (7,238,810) --
---------- --------- ---------- ------------- ------------ -----------
Balance at June 30, 1995.................... 9,499,261 94,993 39,329,006 (131,800) (27,808,921) (39,723)
Stock options exercised..................... 63,849 638 44,875 -- -- --
Issuance of Common Stock under Employee
Stock Purchase Plan....................... 14,005 140 54,485 -- -- --
Effect of employee terminations on deferred
compensation and related balances......... -- -- (166,764) 56,264 -- --
Amortization of deferred compensation....... -- -- -- 71,076 -- --
Translation adjustment...................... -- -- -- -- -- 74,031
Net loss.................................... -- -- -- -- (10,113,250) --
---------- --------- ---------- ------------- ------------ -----------
Balance at June 30, 1996.................... 9,577,115 95,771 39,261,602 (4,460) (37,922,171) 34,308
Issuance of Common Stock in corporate
relationship.............................. 2,181,818 21,818 11,154,663 -- -- --
Issuance of Common Stock in private
placement................................. 1,534,374 15,344 6,768,599 -- -- --
Stock options exercised..................... 10,734 108 13,914 -- -- --
Issuance of Common Stock under Employee
Stock Purchase Plan....................... 18,134 181 47,423 -- -- --
Deferred compensation relating to issuance
of certain stock options.................. -- -- 76,500 (76,500) -- --
Amortization of deferred compensation and
expenses related to certain stock
options................................... -- -- 16,155 17,210 -- --
Translation adjustment...................... -- -- -- -- -- 145,838
Net loss.................................... -- -- -- -- (11,244,831) --
---------- --------- ---------- ------------- ------------ -----------
Balance at June 30, 1997.................... 13,322,175 $ 133,222 $57,338,856 $ (63,750) ($49,167,002) $ 180,146
---------- --------- ---------- ------------- ------------ -----------
---------- --------- ---------- ------------- ------------ -----------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
F-4
<PAGE>
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------------------------
1997 1996 1995
-------------- -------------- -------------
<S> <C> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES:
Net loss........................................................ $ (11,244,831) $ (10,113,250) $ (7,238,810)
Noncash items included in net loss:
Depreciation.................................................. 253,615 273,905 329,738
Compensation expense (income) related to certain stock
options..................................................... 33,365 (39,424) 91,200
Issuance of Common Stock under Employee Stock Recognition
Program..................................................... -- -- 750
Change in operating assets and liabilities:
Accounts receivable........................................... (75,504) (133,380) (265,627)
Inventories................................................... (333,520) (66,280) (180,257)
Prepaid expenses.............................................. 131,786 8,721 (47,693)
Accounts payable and accrued liabilities...................... (654,728) 427,581 983,685
Other........................................................... (73,510) 3,738 4,356
-------------- -------------- -------------
NET CASH USED IN OPERATING ACTIVITIES....................... (11,963,327) (9,638,389) (6,322,658)
CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of property and equipment............................. (283,067) (124,811) (260,497)
Purchases of marketable securities.............................. (11,614,676) (3,181,598) (8,050,344)
Maturities of marketable securities............................. 4,352,891 6,091,192 18,920,809
-------------- -------------- -------------
NET CASH (USED IN) PROVIDED BY
INVESTING ACTIVITIES...................................... (7,544,852) 2,784,783 10,609,968
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock.......................... 18,022,050 100,138 126,740
Payments of capital lease obligations........................... -- (61,626) (119,397)
-------------- -------------- -------------
Net Cash Provided By Financing Activities................... 18,022,050 38,512 7,343
-------------- -------------- -------------
Effect of exchange rate changes on cash and cash equivalents.... 145,838 74,031 (39,723)
-------------- -------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........ (1,340,291) (6,741,063) 4,254,930
Cash and cash equivalents at beginning of year.................... 2,121,930 8,862,993 4,608,063
-------------- -------------- -------------
Cash and cash equivalents at end of year.......................... $ 781,639 $ 2,121,930 $ 8,862,993
-------------- -------------- -------------
-------------- -------------- -------------
</TABLE>
INTEREST PAYMENTS TOTALED $14,953 AND $13,348 DURING THE YEARS ENDED JUNE
30, 1996 AND 1995, RESPECTIVELY.
INVESTING AND FINANCING ACTIVITIES NOT RESULTING IN CASH RECEIPTS OR
PAYMENTS CONSIST OF THE DEFERRAL OF $76,500 OF COMPENSATION COSTS INCURRED IN
THE ISSUANCE OF CERTAIN STOCK OPTIONS DURING THE YEAR ENDED JUNE 30, 1997, AND
RECLASSIFICATIONS OF $56,264 OF DEFERRED COMPENSATION TO ADDITIONAL PAID-IN
CAPITAL DURING THE YEAR ENDED JUNE 30, 1996.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
F-5
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RELATED DATA
NATURE OF OPERATIONS. Cyberonics, Inc. ("Cyberonics" or the "Company"),
designs, develops, manufactures and markets medical devices which deliver a
novel therapy, vagus nerve stimulation (VNS-TM-), for the treatment of epilepsy
and other debilitating neurological disorders. In July 1997, Cyberonics' sole
product, its proprietary implantable device, the NCP-Registered Trademark-
System, was approved by the United States Food and Drug Administration ("FDA")
for commercial distribution in the United States, where the Company intends to
market it using its own employee-based direct sales organization. In addition,
the NCP System is marketed internationally (principally in Europe) using a
combination of the Company's own direct sales organization and independent
distributors. Cyberonics is headquartered in Webster, Texas.
The Company's future success is dependent upon a number of factors which
include, among others, obtaining and maintaining regulatory and reimbursement
approvals for its products, achieving market acceptance and generating
sufficient sales volume, the possibility of competition and technological
changes, developing its sales and marketing infrastructures, maintaining an
uninterrupted supply of certain sole source components and materials, adding
sufficient manufacturing capacity to meet future possible product demand,
possible product liability or recall, and reliance on key personnel.
Additionally, in order for the Company to execute its intended business plan,
which includes the commercial launch of the NCP System in the United States and
the continued development of the Company's international marketplace, the
Company will require additional financing. The Company intends to seek to raise
such financing in fiscal 1998 in an amount sufficient to fund its intended
business plan and the related operating expense levels that are expected to be
significantly higher than those incurred during the year ended June 30, 1997. If
the Company is unable to raise sufficient financing in fiscal 1998, operating
activities will require extensive reductions and, in certain cases, elimination
to enable the Company's present levels of cash and investments to provide
sufficient liquidity to fund the Company into fiscal 1999.
CONSOLIDATION. The accompanying consolidated financial statements include
the Company and its wholly-owned subsidiary, Cyberonics Europe, S.A. All
significant intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES. The preparation of the financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
FOREIGN CURRENCY TRANSLATION. The assets and liabilities of Cyberonics
Europe S.A. are generally translated into U.S. dollars at exchange rates in
effect on reporting dates, while capital accounts and certain obligations of a
long-term nature payable to the parent company are translated at historical
rates. Income statement items are translated at average exchange rates in effect
during the financial statement period. Gains and losses resulting from foreign
currency transactions denominated in currency other than the functional currency
are included in other income and expense.
CASH AND CASH EQUIVALENTS. The Company considers all highly liquid
investments with a maturity of three months or less at the time of purchase to
be cash equivalents.
MARKETABLE SECURITIES. At June 30, 1997 and 1996, the Company's investment
portfolios consisted of securities held to maturity that are reported at
amortized cost. Securities held to maturity are primarily
F-6
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RELATED DATA (CONTINUED)
corporate bonds, international treasury obligations and asset-backed investments
with various maturity dates ranging up to approximately 18 months and have a
fair market value of $7,382,721 and $79,442, respectively. At June 30, 1997 and
1996, the Company's investment portfolio consists of the following:
<TABLE>
<CAPTION>
1997 1996
-------------------------- ----------------------
FAIR MARKET CARRYING FAIR MARKET CARRYING
VALUE VALUE VALUE VALUE
------------ ------------ ----------- ---------
<S> <C> <C> <C> <C>
Securities held to maturity--
Current--
Corporate bonds..................................... $ 6,668,976 $ 6,636,281 $ -- $ --
International treasury obligations.................. 500,000 493,128 -- --
------------ ------------ ----------- ---------
7,168,976 7,129,409 -- --
Noncurrent--
Corporate bonds..................................... 213,745 212,408 62,384 62,931
Collateralized mortgage obligations................. -- -- 17,058 17,101
------------ ------------ ----------- ---------
213,745 212,408 79,442 80,032
------------ ------------ ----------- ---------
Total............................................. $ 7,382,721 $ 7,341,817 $ 79,442 $ 80,032
------------ ------------ ----------- ---------
------------ ------------ ----------- ---------
</TABLE>
INVENTORIES. Cyberonics states its inventories at the lower of cost,
first-in, first-out (FIFO) method, or market. Cost includes the acquisition cost
of raw materials and components, direct labor and overhead.
PROPERTY AND EQUIPMENT. Property and equipment are carried at cost, less
accumulated depreciation. Maintenance, repairs and minor replacements are
charged to expense as incurred; significant renewals and betterments are
capitalized. For financial reporting purposes, the Company computes depreciation
using the double declining balance method over useful lives ranging from three
to seven years.
STOCK OPTIONS. In October 1995, the Financial Accounting Standards Board
issued Statement No. 123, "Accounting for Stock-Based Compensation," which
allows the Company to adopt one of two methods for accounting for stock options.
The Company has elected the method that requires disclosure of stock-based
compensation. Because of this election, the Company continues to account for its
employee stock-based compensation plans under Accounting Principles Board (APB)
Opinion No. 25 and the related interpretations. Accordingly, deferred
compensation is recorded for stock-based compensation grants based on the excess
of the market value of the common stock on the measurement date over the
exercise price. The deferred compensation is amortized over the vesting period
of each unit of stock-based compensation. If the exercise price of the
stock-based compensation grant is equal to the market price of the Company's
stock on the date of grant, no compensation expense is recorded.
REVENUE RECOGNITION. Revenue from product sales is generally recognized
upon shipment to the customer. Domestic sales activities prior to the Company's
July 1997 receipt of FDA approval have depended entirely upon the Company
conducting clinical trial activities under arrangements with certain
investigational centers, some of which employed risk-sharing provisions.
Domestic sales made under such risk-sharing arrangements were deferred until
Cyberonics received payment from the centers and the centers in turn received
third-party reimbursement or satisfied other terms set forth in their respective
arrangements. During fiscal year 1997, one customer represented approximately 13
percent of net sales.
F-7
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RELATED DATA (CONTINUED)
ACCOUNTS RECEIVABLE. During fiscal year 1997, the Company recorded an
allowance for doubtful accounts of $58,826, and no write-offs have been charged
against the allowance through June 30, 1997.
RESEARCH AND DEVELOPMENT. All research and development costs are expensed
as incurred.
WARRANTY EXPENSE. The Company provides at the time of shipment for the
estimated costs which may be incurred under its product warranties.
LICENSE AGREEMENTS. The Company has executed licensing agreements under
which it has secured the rights provided under certain patents. License fees and
royalties, payable under the terms of these agreements, are expensed as
incurred.
INCOME TAXES. Cyberonics accounts for income taxes in accordance with the
liability method prescribed by Financial Accounting Standards Board Statement of
Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes."
Under this method, deferred income taxes reflect the impact of temporary
differences between financial accounting and tax bases of assets and
liabilities. Such differences relate primarily to the Company's election to
defer the deduction of certain start-up costs for federal income tax purposes,
the deductibility of certain accruals and reserves and the effect of tax loss
and tax credit carryforwards not yet utilized. Deferred tax assets are evaluated
for realization based on a more-likely-than-not criteria in determining if a
valuation allowance should be provided.
NET LOSS PER SHARE. The Company's net loss per share is based on the
weighted average number of common shares outstanding. Common equivalent shares,
consisting of the effect of stock options and warrants, are excluded from the
per share calculations, as the effect of their inclusion is antidilutive. In
March 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings Per Share." For periods ending after December 15, 1997, Cyberonics
will adopt the provisions of the new statement and the Company will
retroactively revise the presentation of net loss per share in historical
financial statements to present both basic and diluted net loss per share as
required by SFAS No. 128. The Company's net loss per share presented in the
accompanying financial statements, as calculated under the provisions of APB
Opinion No. 15, are the same as those had basic net loss per share under SFAS
No. 128 been presented. Additionally, net loss per share as presented herein is
also the same as those had diluted net loss per share under the provisions of
SFAS No. 128 been presented, since the Company's outstanding stock options and
warrants would not have been included in the calculation because their effect
would have been antidilutive.
NOTE 2. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JUNE 30,
------------------------
1997 1996
------------ ----------
<S> <C> <C>
Raw materials and components........................................ $ 454,122 $ 307,707
Work-in-process..................................................... 206,282 227,821
Finished goods...................................................... 344,952 136,308
------------ ----------
$ 1,005,356 $ 671,836
------------ ----------
------------ ----------
</TABLE>
F-8
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
JUNE 30,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
Furniture and fixtures............................................. $ 357,510 $ 232,704
Office equipment................................................... 64,223 59,633
Computer equipment................................................. 730,085 612,113
Research and development equipment................................. 115,898 109,959
Manufacturing equipment............................................ 515,950 501,309
Leasehold improvements............................................. 243,123 243,123
----------- -----------
2,026,789 1,758,841
Accumulated depreciation........................................... (1,664,456) (1,425,960)
----------- -----------
$ 362,333 $ 332,881
----------- -----------
----------- -----------
</TABLE>
NOTE 4. ACCRUED LIABILITIES
Accrued liabilities are as follows:
<TABLE>
<CAPTION>
JUNE 30,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Clinical costs.................................................... $ 688,271 $ 618,885
Warranties........................................................ 231,808 167,778
Payroll and other compensation.................................... 219,288 257,468
Professional services............................................. 114,800 209,540
Marketing activities.............................................. 58,562 155,526
Royalties......................................................... 46,320 48,444
Customer deposits................................................. 18,364 48,916
Other............................................................. 85,501 52,377
------------ ------------
$ 1,462,914 $ 1,558,934
------------ ------------
------------ ------------
</TABLE>
NOTE 5. STOCKHOLDERS' EQUITY
PREFERRED STOCK. The Company has 2,500,000 shares of undesignated Preferred
Stock authorized and available for future issuance, of which none have been
issued through June 30, 1997. With respect to the shares authorized, the
Company's Board of Directors, at its sole discretion, may determine, fix and
alter dividend rights, dividend rates, conversion rights, voting rights, terms
of redemption, redemption prices, liquidation preferences and the number of
shares constituting any such series, and may determine the designation, terms
and conditions of the issuance of any such shares.
COMMON STOCK. During the year ended June 30, 1995, stock option exercises
and issuances of Common Stock under the Company's Employee Stock Purchase Plan
and the Company's Employee Stock Recognition Program increased the number of
common shares by 415,616, 32,391 and 200, respectively. During the year ended
June 30, 1996, stock option exercises and issuances of Common Stock under the
Company's Employee Stock Purchase Plan increased the number of common shares by
63,849 and 14,005,
F-9
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 5. STOCKHOLDERS' EQUITY (CONTINUED)
respectively. During the year ended June 30, 1997, stock option exercises and
issuances of Common Stock under the Company's Employee Stock Purchase Plan
increased the number of common shares by 10,734 and 18,134, respectively.
In April 1996, Cyberonics and St. Jude Medical, Inc. ("St. Jude") entered
into an Agreement and Plan of Merger ("Merger Agreement") and a related Common
Stock Purchase Agreement (the "Stock Purchase Agreement"). Pursuant to the Stock
Purchase Agreement, in July 1996, Cyberonics sold to St. Jude 2,181,818 newly
issued shares of Cyberonics Common Stock at $5.50 per share, providing proceeds
to the Company of approximately $11,200,000 after offering costs. In October
1996, St. Jude's right, pursuant to the Merger Agreement, to acquire the
Company's remaining outstanding common shares for approximately $7.00 per share
expired unexercised.
In March 1997, the Company completed a private equity financing, issuing
1,534,374 new shares of the Company's Common Stock in exchange for $4.44 per
share, providing additional proceeds to the Company of approximately $6,800,000
after offering costs.
WARRANTS. In connection with the execution of certain lease agreements,
Cyberonics granted warrants to a third-party leasing company to effectively
purchase up to 9,104 shares of the Company's Common Stock. Through June 30,
1997, the warrant holder has exercised its rights to purchase 7,534 shares,
netting 5,185 shares upon the execution of a cashless exercise. A warrant for
the purchase of 1,570 shares at an exercise price of $5.33 per common share was
outstanding at June 30, 1997, and was exercised in August 1997.
PREFERRED SHARE PURCHASE RIGHTS. In January 1997, the Company's Board of
Directors declared a dividend distribution of one Preferred Share Purchase Right
("Right") on each outstanding share of the Company's Common Stock to
stockholders of record on March 10, 1997. The Rights will become exercisable
following the tenth day after a person or group announces an acquisition of 20
percent or more of the Company's Common Stock or announces commencement of a
tender offer, the consummation of which would result in ownership by the persons
or group of 20 percent or more of the Common Stock. Each Right entitles
stockholders to buy 1/1000 of a share of the Company's Series A Participating
Preferred Stock at an exercise price of $30. The Company will be entitled to
redeem the Rights at $.01 per Right at any time on or before the tenth day
following acquisition by a person or group of 20 percent or more of the
Company's Common Stock. If, prior to redemption of the Rights, a person or group
acquires 20 percent or more of the Company's Common Stock, each Right not owned
by a holder of 20 percent or more of the Common Stock will entitle its holder to
purchase, at the Right's then current exchange price, that number of shares of
Common Stock of the Company (or, in certain circumstances as determined by the
Board, cash, other property or other securities) having a market value at that
time of twice the Right's exercise price. If, after the tenth day following
acquisition by a person or group of 20 percent or more of the Company's Common
Stock, the Company sells more than 50 percent of its assets or earning power or
is acquired in a merger or other business combination, the acquiring person must
assume the obligations under the Rights and the Rights will become exercisable
to acquire Common Stock of the acquiring person at the discounted price. At any
time after an event triggering exercisability of the Rights at a discounted
price and prior to the acquisition by the acquiring person of 50 percent or more
of the outstanding Common Stock, the Board of Directors of the Company may
exchange the Rights (other than those owned by the acquiring person or its
affiliates) for the Common Stock of the Company at an exchange ratio of one
share of Common Stock per Right.
F-10
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 6. STOCK INCENTIVE AND PURCHASE PLANS
STOCK OPTIONS. Cyberonics has reserved an aggregate of 4,000,000 shares of
its Common Stock through June 30, 1997, for issuance pursuant to its Amended
1988 Incentive Stock Option Plan and its 1996 Stock Option Plan (the "Stock
Option Plans"). Options granted under the Stock Option Plans generally vest
ratably over four or five years following their date of grant. The vesting of
certain options occurs up to 10 years from the grant date but can accelerate
based upon the achievement of specific milestones related to regulatory
approvals and the achievement of Company sales objectives. In June 1997, 446,147
shares vested upon receipt of FDA panel recommendation, and in July 1997 an
additional 356,156 shares vested upon FDA approval. Options granted under the
Stock Option Plans have maximum terms of 10 years. The Amended 1988 Incentive
Stock Option Plan allows issuance of either nonstatutory or incentive stock
options, while the 1996 Stock Option Plan provides for issuance of nonstatutory
stock options exclusively.
The following is a summary of the Company's stock option activity for the
three years ended June 30, 1997:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
----------------------- -----------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE EXERCISE
RESERVED SHARES PRICE SHARES PRICE
----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Balance at June 30, 1994............................. 427,129 892,713 $2.39 486,185 $ 1.26
Shares reserved.................................... 500,000
Granted............................................ (613,800) 613,800 4.12
Options becoming exercisable....................... 133,523
Exercised.......................................... (429,666) .17 (429,666)
Canceled or forfeited.............................. 273,396 (273,396) 5.58
----------- ---------- ----------
Balance at June 30, 1995............................. 586,725 803,451 3.82 190,042 2.94
Granted............................................ (52,000) 52,000 4.77
Options becoming exercisable....................... 167,412
Exercised.......................................... (63,849) .71 (63,849)
Canceled or forfeited.............................. 72,050 (72,050) 3.38
----------- ---------- ----------
Balance at June 30, 1996............................. 606,775 719,552 4.20 293,605 4.74
Shares reserved.................................... 2,000,000
Granted............................................ (1,893,388) 1,893,388 3.11
Options becoming exercisable....................... 762,269
Exercised.......................................... (10,734) 1.31 (10,734)
Canceled or forfeited.............................. 396,816 (396,816) 5.05
----------- ---------- ----------
Balance at June 30, 1997............................. 1,110,203 2,205,390 $3.13 1,045,140 $ 3.04
----------- ---------- ----------
----------- ---------- ----------
</TABLE>
F-11
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 6. STOCK INCENTIVE AND PURCHASE PLANS (CONTINUED)
For certain options granted, the Company recognizes as compensation expense
the excess of the deemed value for accounting purposes of the Common Stock on
the date the options were granted over the aggregate exercise price of such
options. This compensation expense is amortized ratably over the vesting period
of each option. The Company recognized compensation expense totaling $33,365
during fiscal 1997, $71,076 during fiscal 1996 and $91,200 during fiscal 1997.
The Company also recognized adjustments totaling $56,264 during fiscal 1996 to
reduce deferred compensation balances as a result of employee terminations.
The fair values of each option grant and purchase plan discounts are
estimated using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in fiscal years 1997 and 1996:
risk-free interest rate of 7.2 percent, expected life of five years for options
and restricted stock, expected life of six months for purchase plan shares,
expected volatility of 78 percent and no expected dividend yields. The weighted
average fair value of options granted at prices equal to the Company's market
value in fiscal years 1997 and 1996 was $2.20 and $3.22, respectively, and was
$2.12 for options granted below the Company's market value during fiscal 1997.
Had the compensation cost for these plans been determined pursuant to the
alternative method under Statement No. 123, the Company's net loss and loss per
share would have been increased to the following pro forma amounts:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------
1997 1996
-------------- --------------
<S> <C> <C>
Net loss--
As reported................................................. $ (11,244,831) $ (10,113,250)
Pro forma................................................... (13,003,529) (10,227,189)
Loss per share--
As reported................................................. (.93) (1.06)
Pro forma................................................... (1.08) (1.08)
</TABLE>
Because the Statement No. 123 method of accounting has not been applied to
options granted prior to July 1, 1995, the resulting pro forma compensation cost
may not be representative of that to be expected in future years. Additionally,
the 1997 pro forma amounts include $5,028 related to the purchase discount
offered under the Company's Employee Stock Purchase Plan. The weighted average
fair value of shares granted to employees in fiscal year 1997 was $3.25.
The Company's outstanding options are segregated into the following three
categories in accordance with Statement No. 123:
<TABLE>
<CAPTION>
WEIGHTED
WEIGHTED AVERAGE
RANGE OF AVERAGE REMAINING
OUTSTANDING EXERCISABLE EXERCISE EXERCISE CONTRACTUAL
SHARES SHARES PRICE PRICE LIFE
- ----------- ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C>
25,502 25,502 $ 0.37-$0.67 $ 0.51 4.2 years
2,058,388 998,221 2.55-3.50 3.04 8.8 years
121,500 21,417 4.00-8.25 5.09 8.9 years
</TABLE>
F-12
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 6. STOCK INCENTIVE AND PURCHASE PLANS (CONTINUED)
In December 1994, Cyberonics canceled outstanding stock options for the
purchase of 100,700 shares of the Company's Common Stock with a weighted average
exercise price of $7.46 per share and in exchange granted stock options for the
same number of shares and with the same vesting provisions following a one-year
halt on exercisability at an exercise price of $5.25 per share, which equaled
the Company's market value per share on the date of reissuance. In November
1996, Cyberonics canceled outstanding stock options for the purchase of 354,800
shares of the Company's Common Stock with a weighted average exercise price of
$5.20 per share and in exchange granted stock options for the same number of
shares and with the same vesting provisions following a halt on exercisability
until the sooner of 14 months expired or FDA advisory panel approval was
received for the Company's product, at an exercise price of $3.06 per share,
which equaled the Company's market value per share on the date of reissuance.
STOCK PURCHASE PLAN. Under the Cyberonics, Inc. Employee Stock Purchase
Plan (the "Stock Purchase Plan"), 100,000 shares of the Company's Common Stock
have been reserved for issuance. Subject to certain limits, the Stock Purchase
Plan allows eligible employees to purchase shares of the Company's Common Stock
through payroll deductions of up to 15 percent of their respective current
compensation at a price equaling the lesser of 85 percent of the fair market
value of the Company's Common Stock on (a) the first business day of the
purchase period or (b) the last business day of the purchase period. Purchase
periods, under provisions of the Stock Purchase Plan, are six months in length
and begin on the first business days of June and December. At June 30, 1997,
10,137 shares remain available for future issuances under the Stock Purchase
Plan.
STOCK RECOGNITION PROGRAM. In May 1992, the Company's Board of Directors
established the Cyberonics Employee Stock Recognition Program. Since its
inception, a total of 8,600 shares of the Company's Common Stock has been
reserved for issuance as special recognition grants. The shares are granted to
employees for special performances and/or contributions at the discretion of the
Company's President, based on nominations made by fellow employees. At June 30,
1997, 4,030 shares remain available for future issuances under the program.
NOTE 7. INCOME TAXES
Components of the Company's loss before taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------------------------
1997 1996 1995
-------------- -------------- -------------
<S> <C> <C> <C>
Domestic...................................... $ (8,730,646) $ (8,772,435) $ (6,604,780)
Foreign....................................... (2,514,185) (1,340,815) (634,030)
-------------- -------------- -------------
$ (11,244,831) $ (10,113,250) $ (7,238,810)
-------------- -------------- -------------
-------------- -------------- -------------
</TABLE>
F-13
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 7. INCOME TAXES (CONTINUED)
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
U.S. statutory rate.......................................... (34.0)% (34.0)% (34.0)%
Increase in deferred tax valuation allowance................. 35.1 30.8 31.4
Amortization of deferred compensation........................ 0.1 (0.1) 0.4
Other, net................................................... (1.2) 3.3 2.2
--------- --------- ---------
0.0% 0.0% 0.0%
--------- --------- ---------
--------- --------- ---------
</TABLE>
Significant components of the Company's deferred tax assets and liabilities
are as follows:
<TABLE>
<CAPTION>
JUNE 30,
----------------------------
1997 1996
------------- -------------
<S> <C> <C>
Deferred tax assets:
Federal net operating loss carryforwards..................... $ 14,350,529 $ 11,436,378
Foreign net operating loss carryforwards..................... 1,191,384 210,852
Tax credit carryforwards..................................... 1,254,312 1,003,964
Warranties................................................... 78,816 57,046
Depreciation................................................. 76,006 77,787
Clinical costs............................................... 55,083 81,772
Other, net................................................... 132,586 169,161
------------- -------------
Total deferred tax assets.................................. 17,138,716 13,036,960
Total deferred tax liabilities, net............................ (12,676) (23,514)
Deferred tax valuation allowance............................... (17,126,040) (13,013,446)
------------- -------------
------------- -------------
Net deferred tax assets and liabilities.................... $ -- $ --
------------- -------------
------------- -------------
</TABLE>
At June 30, 1997, the Company has net operating loss carryforwards of
approximately $42,200,000 for federal income tax purposes, which expire during
the years 2003 through 2012, and tax credit carryforwards of approximately
$1,300,000 for federal income tax purposes, which expire during the years 2006
through 2012. As the Company has had cumulative losses and there is no assurance
of future taxable income, a valuation allowance totaling $17,126,040 is
established as of June 30, 1997, to fully offset the Company's net deferred tax
assets, including those relating to its carryforwards. The valuation allowance
increased $4,112,594 and $3,117,728 for the years ended June 30, 1997 and 1996,
due primarily to the Company's additional net operating losses. Current federal
income tax regulations with respect to changes in ownership could limit the
utilization of the Company's net operating loss carryforwards.
F-14
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 8. EMPLOYEE RETIREMENT SAVINGS PLAN
In September 1994, Cyberonics implemented an employee retirement savings
plan (the "Plan") which qualifies under Section 401(k) of the Internal Revenue
Code. The Plan is designed to provide eligible employees with an opportunity to
make regular contributions into a long-term investment and savings program.
Substantially all U.S. employees are eligible to participate in the Plan
beginning with the first quarterly open enrollment date following start of
employment. Employer contributions are made solely at the Company's discretion.
No employer contributions were made to the Plan for the years ended June 30,
1997, 1996 and 1995.
NOTE 9. COMMITMENTS AND CONTINGENCIES
POSTMARKET CLINICAL SURVEILLANCE. Pursuant to the postmarket surveillance
conditions specified as part of the Company's recent FDA marketing approval, the
Company is required to conduct clinical follow-up on a limited number of
patients from its most recent study in order to monitor the safety and
tolerability of the NCP-Registered Trademark- System on an extended basis. The
Company expenses the costs related to these long-term follow-up activities as
they are incurred and establishes accruals for such costs incurred but not paid
as of the respective balance sheet dates.
LICENSE AGREEMENTS. The Company executed a license agreement which provides
Cyberonics with worldwide exclusive rights under three United States patents
(and their international counterparts) covering the method and devices of the
NCP System for vagus nerve and other cranial nerve stimulation for the control
of epilepsy and other movement disorders. The license agreement provides that
the Company will pay a royalty equal to the greater of $36,000 per year or at
the rate of 6 percent on the first $12 million of sales and at the rate of 3
percent thereafter for the remaining term of the licensed patents. The license
agreement runs for successive three-year terms, renewable at the Company's
election. The license agreement, and its periods of extension, may not be
terminated by the licensor without cause. The Company's royalty payments
pursuant to this agreement are ratably charged to expense.
On July 28, 1989, the Company executed a license agreement for a specific
application of lead designs to be used in vagus nerve stimulation for the
control of epilepsy and other movement disorders. The licensor retains all
rights to this patent for applications outside the above specified use. Pursuant
to the license agreement, as amended in 1991, the Company was obligated to pay a
license fee of $200,000, of which all had been paid as of June 30, 1997. The
Company has a limited-term option to expand the licensed field of use for
additional indications for a license fee of $15,000 per indication and has made
partial payments for certain such indications. Amounts due under this agreement
are being charged to expense as incurred. In addition, the Company is obligated
to pay the licensor an earned royalty of 1 percent of the Company's net sales
price of implantable systems incorporating the licenser's standard lead and 1.75
percent of net sales incorporating the licenser's bi-directional lead. The
Company paid royalties of $26,000 during fiscal year 1995 and $35,000 during
each of fiscal years 1996 and 1997, and has agreed to pay minimum royalties of
$35,000 in each fiscal year thereafter for the life of the licensed patents.
F-15
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASE AGREEMENTS. The Company leases offices, manufacturing and sales
distribution facilities as well as transportation and office equipment under
operating leases. Future minimum payments relating to these agreements at June
30, 1997, are as follows:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
- ----------------------------------------------------
<S> <C>
1998................................................ $ 282,934
1999................................................ 160,737
2000................................................ 83,409
2001................................................ 16,307
2002................................................ 13,778
----------
$ 557,165
----------
----------
</TABLE>
The Company is negotiating an operating lease agreement for a new domestic
office and manufacturing facility totaling approximately 22,000 square feet and
expanding to approximately 41,000 square feet by March 1998. Future minimum
payments relating to this lease are expected to be approximately $287,000 for
the year ending June 30, 1998, $679,000 for each of the years ending June 30,
1999 through 2002, and $848,000 in aggregate beyond June 30, 2002.
OTHER COMMITMENTS. At June 30, 1997, Cyberonics had approximately $650,000
in noncancelable commitments related to domestic launch activities planned for
the Company's NCP System during fiscal 1998.
NOTE 10. CONCENTRATIONS OF CREDIT RISK
The Company's cash equivalents and securities held to maturity represent
potential concentrations of credit risk. The Company minimizes potential
concentrations of credit risk in cash equivalents and marketable securities by
placing investments in high quality financial instruments and, as required by
its corporate investment policy, limiting the amount of investment in any one
issuing party. At June 30, 1997, management believes that the Company has no
significant concentrations of credit risk and has incurred no material
impairments in the carrying values of its cash equivalents and securities held
to maturity.
NOTE 11. GEOGRAPHIC AREA INFORMATION
The Company's business activities are represented by a single industry
segment, the manufacturing and distribution of medical products. For management
purposes, the Company is segmented into two geographic areas: North America and
Europe (which includes all export sales to unaffiliated customers in Europe, the
Middle East, Africa and Asia/Pacific). Sales between geographic areas are made
at prices which would approximate transfers to unaffiliated distributors.
Because of the interdependence of the Company's geographic areas, the operating
loss as presented below may not be representative of the geographic distribution
which would occur if the areas were not interdependent.
F-16
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 11. GEOGRAPHIC AREA INFORMATION (CONTINUED)
The Company's net sales, losses from operations and assets by geographic
area for the fiscal years that separate geographic business units have operated
are as follows:
<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE ELIMINATIONS CONSOLIDATED
-------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
1997
Customer sales..................................... $ 24,452 $ 1,347,553 $ -- $ 1,372,005
Intercompany sales................................. 1,256,150 -- (1,256,150) --
-------------- ------------- ------------- --------------
Total net sales.................................... $ 1,280,602 $ 1,347,553 $ (1,256,150) $ 1,372,005
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
Loss from operations............................... $ (11,610,600) $ (2,314,614) $ 2,441,713 $ (11,483,501)
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
Identifiable assets................................ $ 9,902,199 $ 1,135,011 $ (787,473) $ 10,249,737
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
</TABLE>
<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE ELIMINATIONS CONSOLIDATED
-------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
1996
Customer sales..................................... $ 109,691 $ 1,307,274 $ -- $ 1,416,965
Intercompany sales................................. 1,227,500 -- (1,227,500) --
-------------- ------------- ------------- --------------
Total net sales.................................... $ 1,337,191 $ 1,307,274 $ (1,227,500) $ 1,416,965
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
Loss from operations............................... $ (10,492,597) $ (1,243,843) $ 1,297,230 $ (10,439,210)
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
Identifiable assets................................ $ 3,689,080 $ 420,193 $ (161,230) $ 3,948,043
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
</TABLE>
<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE ELIMINATIONS CONSOLIDATED
-------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
1995
Customer sales..................................... $ 204,187 $ 762,802 $ -- $ 966,989
Intercompany sales................................. 778,437 -- (778,437) --
-------------- ------------- ------------- --------------
Total net sales.................................... $ 982,624 $ 762,802 $ (778,437) $ 966,989
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
Loss from operations............................... $ (7,917,323) $ (671,384) $ 623,626 $ (7,965,081)
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
Identifiable assets................................ $ 13,509,248 $ 282,305 $ (230,960) $ 13,560,593
-------------- ------------- ------------- --------------
-------------- ------------- ------------- --------------
</TABLE>
F-17
<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 (CONTINUED)
NOTE 12. QUARTERLY FINANCIAL INFORMATION--UNAUDITED
The tables below contain summarized unaudited quarterly data for the years
ended June 30, 1997 and 1996. The Company believes this information reflects all
adjustments, consisting of normal recurring accruals, considered necessary for a
fair presentation of the quarterly information presented. The operating results
for any quarter presented are not necessarily indicative of the results that may
be expected for future periods.
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH ANNUAL
QUARTER QUARTER QUARTER QUARTER TOTALS
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
1997
Net sales............................. $ 284,943 $ 437,818 $ 288,979 $ 360,265 $ 1,372,005
Gross profit.......................... 215,652 279,437 216,310 288,426 999,825
Operating expenses.................... 2,237,235 2,977,854 3,339,736 3,928,501 12,483,326
Net loss.............................. (1,792,521) (2,696,226) (3,050,028) (3,706,056) (11,244,831)
Net loss per share.................... $ (.16) $ (.23) $ (.26) $ (.28) $ (.93)
Shares used in computing net loss per
share............................... 11,216,235 11,765,178 11,824,121 13,315,148 12,030,171
</TABLE>
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH ANNUAL
QUARTER QUARTER QUARTER QUARTER TOTALS
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
1996
Net sales............................. $ 192,310 $ 400,236 $ 292,818 $ 531,601 $ 1,416,965
Gross profit.......................... 136,250 299,977 221,203 347,973 1,005,403
Operating expenses.................... 2,414,645 2,892,027 2,665,176 3,472,765 11,444,613
Net loss.............................. (2,129,564) (2,475,081) (2,340,296) (3,168,309) (10,113,250)
Net loss per share.................... $ (.22) $ (.26) $ (.25) $ (.33) $ (1.06)
Shares used in computing net loss per
share............................... 9,500,209 9,503,971 9,509,345 9,538,626 9,513,038
</TABLE>
Quarterly and annual loss per share are computed independently based upon
the applicable number of weighted average common shares and share equivalents
for each period.
F-18
<PAGE>
LEASE AGREEMENT
BETWEEN
SPACE ASSETS II, INC.
AND
CYBERONICS, INC.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
1. LEASED PREMISES ....................................................... 1
2. TERM .................................................................. 2
3. USE.................................................................... 3
4. RENT................................................................... 3
5. RENT ADJUSTMENTS ...................................................... 4
6. PAYMENT OF RENT ....................................................... 6
7. PARKING AND SERVICE AREAS ............................................. 7
8. FURNITURE, FIXTURES AND PERSONAL PROPERTY ............................. 7
9. SIGNS ................................................................. 7
10. SERVICES TO BE PROVIDED BY LESSOR...................................... 8
11. REPAIRS, MAINTENANCE AND IMPROVEMENTS BY LESSOR ....................... 9
12. FORCE MAJEURE.......................................................... 10
13. REPAIRS AND CARE OF PREMISES BY LESSEE................................. 11
14. MECHANIC'S LIENS....................................................... 11
15. NUISANCE OR HAZARDOUS USE.............................................. 12
16. TAXES AND INSURANCE.................................................... 12
17. QUIET ENJOYMENT........................................................ 13
18. ALTERATION............................................................. 13
19. ASSIGNMENT AND SUBLETTING.............................................. 13
20. ABANDONMENT............................................................ 14
21. FIRE AND OTHER CASUALTY................................................ 15
22. CONDEMNATION........................................................... 15
23. HOLD HARMLESS.......................................................... 15
24. DEFAULT BY LESSEE...................................................... 16
25. DEFAULT BY LESSOR...................................................... 17
26. ATTORNEY'S FEES........................................................ 17
27. NON-WAIVER............................................................. 17
28. RULES AND REGULATIONS.................................................. 17
29. ASSIGNMENT BY LESSOR................................................... 17
30. LIABILITY OF LESSOR.................................................... 18
31. BUILDING MORTGAGE...................................................... 18
32. HOLDING OVER........................................................... 19
33. SEVERABILITY........................................................... 19
34. NOTICES................................................................ 20
35. OBLIGATIONS OF SUCCESSORS.............................................. 20
36. ENTIRE AGREEMENT....................................................... 21
37. SECTION HEADINGS....................................................... 21
38. CHANGES, DELETIONS AND ADDITIONS TO CONTRACT .......................... 21
39. ESTOPPEL............................................................... 21
40. BROKER'S COMMISSION.................................................... 21
EXHIBITS
A1 - A3 LEASED PREMISES
B - PROPERTY METES AND BOUNDS DESCRIPTION
C - RULES AND REGULATIONS
</TABLE>
<PAGE>
LEASE AGREEMENT
STATE OF TEXAS Section
COUNTY OF HARRIS Section
THIS LEASE AGREEMENT ("Lease") made and entered into as of the 19th Day
of August, 1997, by and between SPACE ASSETS II, INC., a Delaware
corporation, hereinafter called "Lessor", and CYBERONICS, INC., a Texas
corporation, hereinafter called "Lessee".
SECTION 1. LEASED PREMISES
A. Subject to and upon the terms, provisions and conditions hereinafter
set forth, and each in consideration of the duties, covenants and obligations of
the other hereunder, Lessor hereby leases to Lessee, and Lessee hereby leases
from Lessor, 42,954 net Rentable Square Feet, as hereinafter defined, of office
space on the first, fifth and sixth floors as detailed in the attached Exhibits
A1, A2 and A3 ("Leased Premises"), in the building known as Space Center II,
(hereinafter called the "Building") located at 16511 Space Center Boulevard,
Houston, Harris County, Texas, upon that real property ("Land") more fully
described in Exhibit "B" attached hereto.
The rental due hereunder shall be computed as provided herein on the basis
of rentable area, measured in square feet ("Rentable Square Feet") as determined
by architectural measurement of the existing Building drawings, and in
accordance with the Building Owners and Managers Association (BOMA) standard
(ANSI Z65.1-1996). The resulting usable area and rentable area of the Leased
Premises is as follows:
<TABLE>
<CAPTION>
NET USABLE AREA NET RENTABLE AREA ILLUSTRATED BY EXHIBIT
------------------ ----------------- ----------------------
<S> <C> <C> <C>
First Floor 3,526 Square Feet 4,132 Square Feet A1
Fifth Floor 17,826 Square Feet 19,411 Square Feet A2
Sixth Floor 17,826 Square Feet 19,411 Square Feet A3
Totals 39,178 Square Feet 42,954 Square Feet
</TABLE>
The foregoing Rentable Square Feet shall be subject to verification by
Lessee on or before August 15th, 1997.
B. Lessee shall have the right to expand into the entirety of the 4th
Floor of the Building at any time during a six (6) month period commencing
January 1st, 1998 upon thirty (30) days prior written notice to Lessor given on
or before May 31st, 1998. During said six month period ending June 30th 1998,
Lessor agrees to hold the 4th Floor off of the market and to not enter into
lease negotiations with any third party. At the termination of the six month
period, and as long as this Lease is in effect, if Lessee has not exercised its
right to expand into the 4th Floor, Lessee shall then have a continuing right of
first refusal to lease all of the 4th Floor, or in the event Lessor elects to
lease less than the entire floor, that portion of the 4th Floor Lessor has
elected to lease. Should Lessee exercise the right of expansion or the right
of first refusal to expand on the 4th Floor, terms and conditions of the
expansion shall be the same as the Lease except that the lease term of said
expansion shall be coterminous with the Lease and, if said expansion occurs
after the six (6) month period, the improvement allowance of $20.00 per square
foot shall be prorated based on the remaining months of the Lease (i.e. if 36
months remain, the improvement allowance shall be 36/60th of $20.00 or $12.00).
Under Lessee's right of first refusal, Lessee
<PAGE>
shall have five (5) business days to respond to Lessor's written
notice of intent to lease to a third party. The commencement of the
expansion term for the 4th Floor and the payment of rent for expanded 4th
Floor space shall occur at the earliest of ninety (90) days from the written
notice by Lessee of its intent to expand or the date of satisfactory
completion of the structural final inspection by the City of Houston Building
Department of the expanded premises.
C. At any time after January 1st, 1998, Lessee shall have the continuing
right of first refusal to expand into any remaining unleased space on any floor
of the Building. Should Lessee exercise its right of first refusal to expand
into available space, terms and conditions of the expansion shall be the same as
the Lease except that the lease term of said expansion shall be coterminous with
the Lease and the improvement allowance of $20.00 per square foot shall be
prorated based on the remaining months of the Lease (i.e. if 36 months remain,
the improvement allowance shall be 36/60th of $20.00 or $12.00). Under Lessee's
right of first refusal, Lessee shall have five (5) business days to respond to
Lessor's written notice of intent to lease to a third party. The commencement
of the expansion term for available space shall occur at the earliest of ninety
(90) days from the written notice by Lessee of its intent to expand or the date
of satisfactory completion of the structural final inspection by the City of
Houston Building Department of the expanded premises.
SECTION 2. TERM
A. With respect to the Leased Premises including the 1st and 6th Floors,
as described in Section 1, this Lease shall continue in force for a term
("Term") of sixty (60) months, beginning October 1st, 1997 ("First Commencement
Date"), and expiring at midnight on September 30th, 2002 ("Expiration Date").
With respect to the Leased Premises including the 5th Floor, as described
in Section 1, this Lease shall continue in force for a term ("Term") of fifty
eight (58) months, beginning December 1st, 1997 ("Second Commencement Date"),
and expiring at midnight on September 30th, 2002 ("Expiration Date").
B. Provided Lessee is not in default of any of the terms and provisions of
this Lease, Lessee shall have an option to renew this Lease for one (1)
additional term of five (5) years upon giving at least six (6) months prior
written notice to Lessor of exercise of such renewal option. The Base Rent for
each year of the Renewal Term shall be at the then prevailing fair market rent
for comparable lease space in the greater Clear Lake Area of Houston, Texas. In
no event shall the Base Rent for the Renewal Term be less than the Base Rent
paid during the initial Lease Term. The Basic Operating Costs for the renewal
term shall be actual operating costs for the calendar year 2002. A
refurbishment allowance of $3.00 per rentable square foot shall be granted for
leasehold improvements to Leased Premises subject to renewal under the
provisions of this renewal option.
C. The Leased Premises are now scheduled for, or under construction, and
Lessor is desirous of having same completed as soon as possible. If, however,
the Leased Premises are not ready for occupancy by the time of said Commencement
Date(s) for any reason or cause, Lessor shall not be liable or responsible for
any claims, damages or liabilities in connection therewith or by reason thereof;
and this Lease shall be effective only from the time(s) that the Leased Premises
have been prepared and are ready for the occupancy of Lessee as defined by the
later of: satisfactory completion of the structural final inspection by the City
of Houston Building Department, said inspection not to be requested until
substantial completion of construction punch list items as compiled by Lessee
and Lessor in conjunction with the architect and construction general contractor
for the Leased Premises, or October 31st, 1997 with respect to the Leased
Premises including the 1st and 6th Floors and March 31st, 1998 with respect to
the Leased Premises including the 5th Floor, which date(s) shall be the revised
Commencement Date(s) of
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<PAGE>
this Lease, but in no event later than the date on which Lessee commences
occupancy of the Leased Premises for the conduct of Lessee's business. In
such event, Base Rent shall not commence until said revised Commencement
Date(s), and the stated Term(s) in this Lease shall thereupon commence and
the Expiration Date shall be extended so as to give effect to the full stated
Term(s).
D. Notwithstanding the fact that the Lease term will commence at a date
subsequent to the execution of this instrument, the parties intend that both of
them shall have vested rights immediately upon the signing of this instrument,
and that this instrument shall be fully binding and in full force and effect
from and after the execution hereof.
E. At such time as Lessee occupies at least three full floors of Floors
Two through Six, and for the balance of the initial five year term, Lessee
shall have the option to extend the initial term(s) of this Lease by no less
than twelve (12) months and no more than thirty six (36) months, such extension
period to be designated in Lessee's written notice.
SECTION 3. USE
The Leased Premises are to be used and occupied by Lessee for general
office purposes, business and commercial use, scientific research and
development, and high technology manufacturing utilizing clean room environments
and related uses and shall be used for no other purpose, without the prior
written consent of Lessor, which shall not be unreasonably withheld or delayed.
In the event that any person or governmental authority alleges in any legal
proceeding or by a notice given pursuant to any law that Lessee does not have
the right to use the Leased Premises for the purposes being used, Lessor agrees
to join in the defense of Lessee's right to use the Leased Premises for such
purpose provided Lessee pays all costs of such defense. Should a court ruling
or order or permanent injunction be issued determining that Lessee may not use
the Leased Premises for such purpose or permanently enjoining Lessee from such
use, Lessee shall immediately cease all such activities enjoined.
SECTION 4. RENT
A. For the period from the First Commencement Date until March 31st, 1998,
as rent ("Base Rent") for the Lease and use of the Leased Premises including the
1st and 6th Floor, as described in Section 1, and the attached facilities,
Lessee will pay Lessor or Lessor's assigns, at the management office of Lessor,
or Lessor's Managing Agent, or at such other address as Lessor may from time to
time designate, without demand and without deduction, abatement or set-off,
except as otherwise set forth herein, an amount calculated at Sixteen Dollars
($16.00) per net rentable square foot per year, said rate being equivalent to
the sum of Three Hundred and Seventy Six Thousand and Six Hundred and Ninety Two
Dollars ($376,692.00) per year payable in equal monthly installments of Thirty
One Thousand and Three Hundred and Ninety One Dollars ($31,391.00) on or before
the first day of each calendar month, in advance, in lawful money of the United
States.
For the period from April 1st, 1998 to the Expiration Date, as rent ("Base
Rent") for the Lease and use of the Leased Premises including the 1st , 5th and
6th Floor, as described in Section 1, and the attached facilities, Lessee will
pay Lessor or Lessor's assigns, at the management office of Lessor, or Lessor's
Managing Agent, or at such other address as Lessor may from time to time
designate, without demand and without deduction, abatement or set-off, except as
otherwise set forth herein, an amount calculated at Sixteen Dollars ($16.00) per
net rentable square foot per year, said rate being equivalent to the sum of Six
Hundred and Eighty Seven Thousand and Two Hundred and Sixty Four Dollars
($687,264.00) per year payable in equal monthly installments of Fifty Seven
Thousand and Two Hundred and Seventy Two Dollars
3
<PAGE>
($57,272.00) on or before the first day of each calendar month, in advance,
in lawful money of the United States. The Base Rents shall be subject to
adjustments as hereinafter provided.
B. The amount of Ninety Four Thousand and One Hundred & Seventy Three
Dollars ($94,173.00) is payable on the execution date of this Lease for the Base
Rent for the first month of occupancy and a security deposit in an amount equal
to two months Base Rent. If Lessee performs all of its obligations hereunder,
an amount equal to one month's Base Rent shall be returned to Lessee at the end
of twelve (12) months from Lease Commencement. The remainder of said deposit
shall be returned to Lessee within ten (10) days after the expiration of the
Term hereof, providing Lessee is not in monetary default at the expiration of
the Term.
SECTION 5. RENT ADJUSTMENTS
The Base Rent payable by Lessee during each lease year shall be adjusted in
accordance with this Section 5.
A. Definitions
(1) The term "Operating Costs" shall mean all reasonable and customary
operating expenses of the Building, parking garage and other facilities
appurtenant thereto, which shall be computed on the accrual basis and which
shall include all expenses, costs, and disbursements of every kind and nature
which Lessor shall pay or become obligated to pay because of, or in connection
with, the ownership and operation of the Land and Building, parking garage and
attached facilities, including, but not limited to, the following:
(a) All taxes, impositions, assessments, and all other
governmental charges, if any, which are levied, assessed or imposed
upon or become due and payable in connection with, or as a lien
upon, the Land, the Building, the parking garage, or facilities
used in connection therewith, or the operation thereof, (excepting
federal and state taxes on income) including taxes levied by
present or any future taxing authorities and all taxes of
whatsoever nature that are imposed in substitution for or in lieu
of any of the taxes, impositions, assessments or other charges
included in this definition of taxes; provided, however, taxes
shall not include the portion of any ad valorem taxes against the
Leased Premises that are paid by Lessee as a separate charge
pursuant to Section 19 of this Lease.
(b) Wages and salaries of all employees engaged in the
operation and maintenance of the Land, Building, and parking garage
including taxes, insurance and benefits relating thereto; prorated
if such employee is not exclusively employed at the Building;
(c) All supplies and materials used in the operation and
maintenance of the Building;
(d) Costs of water, sewage, power, heating, lighting,
air conditioning, ventilating, and other utilities furnished in
connection with the operation of the Building (excluding any such
cost billed to specific lessees);
(e) Costs of all maintenance and service agreements on
equipment, including, but not limited to, security service, access
control services, alarm services, window cleaning, janitorial
service and elevator maintenance;
4
<PAGE>
(f) Costs of casualty, rental interruption and liability
insurance applicable to the Building and related facilities and
Lessor's personal property used in connection therewith;
(g) Costs of repairs and general maintenance of the
interior, parking areas, and landscaping of the Land and the
Building, excluding repairs and general maintenance paid by the
proceeds of insurance or any lessee or other third parties, and
alterations attributable solely to lessees of the Building other
than Lessee;
(h) Management fees not to exceed a sum equal to
five percent (5%) of the Base Rents derived from the Building; and
(i) A reasonable amortization charge on account of
any capital expenditures incurred to effect a reduction in
operating expenses of the Building and related facilities; and
Expressly excluded from the definition of the term Operating Costs are:
(i) Replacement of capital investment items (except as provided in
Section 5.A(i) hereof;
(ii) Rental and similar commissions, other than those set forth in
Section 5.A(h) hereof, advertising, appraiser and legal expenses;
(iii) Depreciation;
(iv) Specific costs billed to and paid by specific lessees;
(v) Principal, interest, and other costs directly related to
financing; and
(vi) Ground Rent.
Notwithstanding anything to the contrary contained in the Lease,
Operating Costs shall also exclude; compensation or bonuses paid to officers
or executives of Lessor, administrative wages and salaries, depreciation or
accelerated cost recovery of the Building or any equipment, furniture or
property attached to or installed in the Building, capital expenditures,
ground rents, interest or amortization of mortgages, taxes measured solely by
the net income of Lessor from the operation of the Building, costs of
maintaining Lessor's corporate existence, legal expenses, franchise taxes,
travel expenses, leasing costs or brokerage commissions, advertising costs or
renting commissions, greater than five percent (5%) annual increase in
management fees or employees' salaries or benefits or both, costs in
connection with art work or interior decoration of the Building, costs to
correct original construction defects, costs for improving any other tenant's
space, any repair or other work necessitated by condemnation, fire or other
casualty, services or benefits provided to some tenants but not to Lessee,
and any costs or fines due to Lessor's violation of any governmental rule or
authority.
For the purposes herein, the term "Basic Operating Costs" shall be deemed
to be the actual operating costs for calendar year 1998.
(2) The term "Lessee's Share" shall mean the proportion that the
Rentable Square Feet of the Leased Premises bears to the total Rentable
Square Feet of the Building. (which shall be deemed to be 144,346 square
feet). For the purpose of this Lease, Lessee's share shall be deemed to be
16.3% for occupancy of the 1st and 6th Floors, as described in Section 1, and
29.8% for occupancy of the 1st, 5th and 6th Floors, as described in Section 1.
5
<PAGE>
(3) The term "Lease Year" shall mean the twelve (12) month period
commencing January 1st and ending December 31st of each year. If any of the
factors included in Basic Operating Costs are not payable, billed or
otherwise due so as to allow an accurate calculation of said factors on a
calendar year basis (e.g., ad valorem taxes and long-term contracts), then
Lessor in its reasonable discretion, may estimate and prorate said factors on
a calendar year basis; and said factors shall be properly adjusted by Lessor
when they actually become due and payable.
(4) The term "Monthly Escalation Payments" shall mean the
escalations owed or to be owed by Lessee as herein provided and paid to
Lessor in monthly installments.
B. In addition to the Base Rent as provided in Section 4, Lessee
shall be obligated to pay Lessor, as additional rent, Lessee's share
of Operating Costs in excess of Basic Operating Costs, if any.
C. Lessor shall have the right to collect Monthly Escalation
Payments in such amounts as are estimated by Lessor in its reasonable
discretion which shall be based on the amount by which the prior
year's actual expenses exceed Basic Operating Costs. The Monthly
Escalation Payments shall be due and payable at the same time as the
Base Rent is due and payable under Section 4 above.
Lessor shall, within the period of one hundred twenty (120)
days after the close of the Lease Year, give written notice thereof to
Lessee, which notice shall also contain or be accompanied by a
statement, prepared in accordance with generally accepted accounting
principles with copies of invoices or other supporting documentation,
of the Operating Cost of Lessor's operation of the Building during the
preceding Lease Year, and by a computation of such additional rent.
For any years in which the Building is not fully occupied, Operating
Costs that vary based upon occupancy shall be computed and prorated as
if Building were 95% occupied. Failure of Lessor to give Lessee said
notice within said time period shall not be a waiver of Lessor's right
to collect said additional rent. When the Lessor presents Lessee with
the statements of amounts due by Lessee for any escalation set out
herein, Lessee shall, within (30) days after receipt of said
statement, pay Lessor the difference between its proportionate share
of said escalation and amount of Monthly Escalation Payments made by
Lessee attributable to said escalation; or Lessee shall receive a
credit therefor, if Lessee's proportionate share is less than the
amount of Monthly Escalation Payments collected by Lessor, said credit
to be applied to future Monthly Escalation Payments.
Lessee shall have the right to audit the Operating Costs and in
the event such audit indicates an overstatement of amounts owed by
Lessee of more than five percent (5%), the cost of said audit shall be
paid by Lessor.
SECTION 6. PAYMENT OF RENT
A. Lessee hereby covenants and agrees to pay promptly, when due,
all Base Rent, adjusted as herein provided, and Additional Rent and
any other charges payable by Lessee under the provisions of this
Lease; and Lessee further covenants and agrees that all such rent or
other charges due and unpaid as of the date of termination of this
Lease shall be deemed due and payable on such termination date.
Lessee specifically agrees that the covenants recited in this Section
shall survive the expiration or termination of the Term of this Lease.
B. In addition to the Base Rent, Additional Rent, Operating Cost
and Monthly Escalation Payments, Lessee agrees to pay to Lessor as
additional rent, all charges for any services, goods, or materials
furnished by Lessor at Lessee's written request which are not required
to be furnished by Lessor under this Lease Agreement as well as all
other sums payable by Lessee hereunder. Any monthly Base Rent,
Additional Rent or Monthly Escalation Payments to be paid
6
<PAGE>
to Lessor not received in advance on or before the fifth (5th) day of
each month; or any charge for goods, services, or materials not
received within thirty (30) days after receipt of written notice from
Lessor rendering a statement to Lessee shall be charged a late charge
at the maximum rate permitted by law per day from date due until paid.
Failure to pay charges when due subjects Lessee to default (Section
27). All such additional charges are considered rent hereunder.
C. Lessor will not provide monthly statements for Base Rent or
other recurring charges due by Lessee to Lessor. Lessee is
responsible for assuring that monthly charges are received by Lessor
in advance on or before the first of each month.
SECTION 7. PARKING AND SERVICE AREAS
Subject to the terms hereof Lessor shall have control over the
parking of automobiles and other vehicles and shall designate parking
areas and building service areas. Lessor shall lease to Lessee and
Lessee shall lease from Lessor total covered parking spaces in the
Building parking garage at a ratio of 4 spaces per 1,000 square feet
of rentable area. There shall be no additional rent for parking
spaces over and above the Base Rent as provided for in Section 4.
Lessor shall provide reserved parking spaces at a ratio of 0.25 spaces
per 1,000 square feet of rentable area, to be designated by Lessor,
from the total spaces leased, reserved by name for Lessee's designated
employees or customers in an assigned area on Level 2 of the parking
garage. Reserved parking on Level 2 shall be assigned to Lessee in
contiguous blocks, where possible, and as close to the entrance to the
Level 2 elevator lobby as available space permits.
In the event Lessee exercises any expansion option, the total
number of covered parking spaces to be provided shall increase at a
rate of 4 spaces per 1,000 square feet leased and the number of
reserved spaces shall increase at a rate of .25 spaces per 1,000
square feet leased.
Lessor agrees to place signage in the front visitor parking lot
and at the entrance to the parking garage directing visitors into the
parking garage, said signage to aid visitors in the event of
unavailable parking in the front visitor lot.
SECTION 8. FURNITURE, FIXTURES AND PERSONAL PROPERTY
Lessee may remove its trade fixtures, office supplies, movable
office furniture, and business and telephone equipment not attached to
the Building provided: (a) such removal is made prior to the
termination of the term of this Lease (subject to the special rights
of holdover set forth in Section 32 as to which removal shall only be
required prior to expiration of the holdover period); (b) Lessee is
not in default of any monetary obligation or covenant under this Lease
at the time of such removal; and (c) Lessee promptly repairs all
damage caused by such removal. All other property at the Leased
Premises on the roof or above the ceiling grid, and any alterations or
additions to the Leased Premises (including wall-to-wall carpeting,
paneling or other wall covering) and any other article attached or
affixed to the floor, wall or ceiling of the Leased Premises (other
than Lessee's manufacturing and other specialty equipment, provided
Lessee shall repair any damage other than ordinary wear and tear
caused by such removal) shall become the property of Lessor and shall
remain upon and be surrendered with the Leased Premises as a part
thereof at the termination of this Lease by lapse of time or otherwise.
SECTION 9. SIGNS
A. Lessee shall have signage on the interior building directory and on the
entrance doors to Lessee's suite. In addition, Lessee shall have signage on the
entirety of both sides of the south Building exterior monument marker. Costs
for said interior directory and exterior monument marker signage shall be the
responsibility of Lessor. Signage above the entrance to the Building
7
<PAGE>
shall be available to Lessee at such time as Lessee leases the
entirety of the 6th and 5th floors of the Building. Costs for said
entrance signage shall be the responsibility of Lessee. All exterior
building signage shall be subject to approval by the Clear Lake City
Community Association, where applicable, and to the mutual agreement
and reasonable approval of both Lessor and Lessee and in conformance
with the existing style and quality of Building signage. Lessor
specifically approves the use of Lessee's corporate logo and trademark
in connection with the signage permitted hereunder.
B. Except as permitted pursuant to Section 9.A. no sign, symbol
or identifying mark shall be put on the Land, Building, in the halls,
elevators, staircases, entrances, parking areas, or upon the doors or
walls, or in or around the Leased Premises so that it may be seen from
elevator lobbies, other tenant's premises, or outside the Building or
common areas, without prior written approval of Lessor which shall not
be unreasonably withheld or delayed. All signs or lettering shall
conform in all respects to the sign and/or lettering criteria
established by Lessor. All signage (including, without limitation,
any changes thereto) is, however, subject to applicable restrictive
covenants including, without limitation, the rights of Clear Lake
City Community Association to approve or disapprove same.
SECTION 10. SERVICES TO BE PROVIDED BY LESSOR
Lessor agrees to furnish Lessee, while occupying the Leased
Premises, the following services:
A. Electricity for ordinary office uses equivalent to at least
six (6) watts per rentable square foot;
B. Elevator service;
C. Janitorial services on a five-day a week basis; the work of
the building janitorial contractor shall not be hindered by Lessee
after 5:00 p.m. and such work may be done at any time when offices are
vacant. Lessee shall have the right to enter into a contract for
certain janitorial services, in coordination with Lessee's janitorial
services, for that portion of the Leased Premises which is subject to
special cleanliness standards (collectively referred to as
"Laboratories and Manufacturing Facilities") as designated by Lessee.
In such event the janitorial contractor shall be subject to Lessor's
prior approval, which shall not be unreasonably withheld, delayed or
conditioned.
D. Hot and cold water at those points of supply provided for
general use of all lessees in the Building;
E. Air conditioning and heating as reasonably required for
comfortable use and occupancy (subject to governmental regulations)
under normal office conditions from 7:30 a.m. to 6:00 p.m. Monday
through Friday and 8:00am to 1:00pm on Saturdays, and without charge,
at any other times as may be requested by Lessee;
F. Lamp and ballast replacement in ceiling mounted fluorescent
fixtures installed by Lessor as building standard;
G. Security for the Building and its appurtenances as may be
deemed necessary by Lessor;
H. Interior Building Directory with listing of Lessee's major functional
departments.
8
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If there is an interruption in electricity, air-conditioning,
elevator service, water or sewer or any other utility which results in
Lessee being unable to conduct business in the Premises, there shall
be an abatement in rent during such period. If such interruption
continues for ten (10) consecutive business days, Lessee may, at its
option, cancel this Lease by providing Lessor notice in writing.
Notwithstanding any other term or provision hereof, Lessee shall
pay to Lessor monthly, as additional rent, any charges as may be
metered separately for electric service utilized by Lessee.
SECTION 11. REPAIRS, MAINTENANCE AND IMPROVEMENTS BY LESSOR
A. Lessor shall provide for the cleaning and maintenance of the
public portions of the Building, including painting and landscaping
surrounding the Building, in keeping with the standard first class
office buildings in the Houston, Texas area. Unless otherwise
expressly stipulated herein, Lessor shall not be required to make any
improvements or repairs of any kind or character to the Leased
Premises and public portions during the term of this Lease, except
such maintenance and/or repairs as may be deemed necessary by Lessor
in normal maintenance operations, which shall include repairs to the
exterior walls, corridors, windows, roof and other structural elements
and equipment of the Building, and such additional maintenance as may
be necessary because of damage caused by persons other than Lessee,
its agents, employees, invitees or visitors.
B. Lessor, its officers, agents and representatives, mortgagee
and insurance underwriters, subject to any security regulations
imposed upon Lessee by any governmental authority, shall have the
right to enter all parts of the Leased Premises upon no less than
twenty-four (24) hours notice, except in emergencies and for routine
daily janitorial services, at all reasonable hours to inspect, clean,
make repairs, alterations and additions to the Building or the Leased
Premises which it may deem necessary or desirable, or to provide any
service which it is obligated to furnish Lessee; and Lessee shall not
be entitled to any abatement or reduction of rent by reason thereof.
Notwithstanding the foregoing, any entry to the Laboratories and
Manufacturing Facilities shall only occur in compliance with the
applicable regulatory standards and, in the absence of an emergency
involving a threat to health or safety, upon prior notice to Lessee.
C. Lessor covenants, that to the best of Lessor's knowledge, the
Building and the Premises comply with all the requirements of all
municipal, county, state, federal and other applicable governmental
authorities then in effect or promulgated prior to the commencement of
this Lease, including without limitation the Americans with
Disabilities Act (ADA) and the comparable laws of the State of Texas.
Lessor shall, at Lessor's cost, take appropriate and timely action to
maintain the Building and the Premises in compliance with all
municipal, county, state, federal and other applicable regulations
hereafter imposed by order of any governmental agency or any other
authority during the term of the Lease and any extensions thereof.
D. Lessor shall provide an allowance ("Improvement Allowance")
for Lessee's construction of, and improvements to, the Leased
Premises comprising 42,954 square feet, at the rate of Twenty Dollars
($20.00) per rentable square foot for a total amount of Eight Hundred
and Fifty Nine Thousand and Eighty Dollars ($859,080.00). In the
event Lessee exercises its expansion option with respect to the 4th
Floor, Lessee shall be provided an additional improvement allowance in
the amount of Twenty Dollars ($20.00) per rentable square foot,
subject to the proration provisions of Section 1.B. Said improvements
and construction to be in accordance with construction plans as
approved by Lessee and Lessor and as prepared by an architect selected
by Lessee and approved by Lessor. Costs for said construction plans
and architectural services shall be paid from the Improvement
Allowance. The Improvement Allowance may be used for leasehold
improvements including; materials, labor, architectural
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fees, modular office furniture and any other equipment or system which
becomes a permanent part of the Leased Premises. Any portion of the
Improvement Allowance not used for improvements to the Leased Premises
may be used for Lessee's moving expenses, provided that said moving
expenses paid from the Improvement Allowance do not exceed $15,000, or
to supplement the above stated improvement allowance as granted to
Lessee under the terms of expansion into the 4th Floor, comprising
19,411 square feet, providing that Lessee has given its notice or
exercised its right of first refusal no later than 30 June 1998.
Lessor shall competitively bid the construction to the Leased Premises
against the approved construction plans with a minimum of three
qualified general contractors acceptable to both Lessor and Lessee.
Selection of a general contractor shall be agreed to by both Lessor
and Lessee. Lessor shall not charge any supervision or management
costs to the construction.
E. Lessor agrees to refurbish the main entrance lobby to the
Building and the restrooms on the 1st, 5th and 6th Floors at a cost to
Lessor not to exceed $150,000.00 ("Lobby Allowance"). Lessor shall
retain the services of an interior design architect for the purposes
of design changes including but not limited to; lobby entrance doors,
lobby flooring, lobby walls, lobby ceiling and lighting, lobby
directory, lobby guard station, main hallway corridor, elevator cabs
and fixture, lighting and wall finishes in the restrooms on the 1st,
5th and 6th Floors. Said improvements to the 1st, 5th and 6th Floor
restrooms shall be made in compliance with the Americans with
Disabilities Act ("ADA") and the comparable laws of the State of
Texas. All costs for architectural and design fees for lobby and
restroom renovation shall be included in, and paid from, the Lobby
Allowance. Plans and materials for lobby and restroom renovation
shall be approved by Lessor and Lessee, said approval based on
preliminary plans to be available by September 1st, 1997. Projected
completion of lobby and restroom renovation shall be December 5th,
1997. In the event such improvements are not completed by December
5th, 1997, Lessee shall have the right to complete such improvements
and be reimbursed for any and all costs expended by Lessee in
connection therewith. If Lessor does not reimburse Lessee within
forty five (45) days after written notice from Lessee, Lessee may
reduce it payments of Base Rent until such amount has been reimbursed.
F. Lessee and Lessor each acknowledge that the Lessee desires to
occupy the 1st Floor and the 6th Floor during the month of October,
1997, and in any event no later than October 31st, 1997, and that
Lessee and Lessor also desire to complete the lobby renovations
addressed by Section 11.E. above by December 5th, 1997, and that
failure of either party to act promptly could delay completion.
Lessee and Lessor agree that each will act with diligence to plan the
space, agree upon the space plans, agree upon necessary revisions to
the space plans, agree upon the construction drawings, agree upon
necessary revisions to the construction drawings, and agree upon
identity of the contractor. After completion of the initial space
plans, Lessor and Lessee agree that each will use all reasonable
efforts, when a response is required, to respond within three (3)
business days. Lessor agrees that once the contractor has been
selected, the Lessor will cause such contractor to commence
construction and proceed diligently to completion.
G. Lessor agrees to aggressively coordinate and control the
appearance of other third party tenant's 1st Floor lobby exposure to
insure a professional appearance consistent with other Class A
buildings in the Clear Lake area.
SECTION 12. FORCE MAJEURE
It is understood and agreed that with respect to any services to
be furnished, or obligations to be performed, by Lessor to Lessee,
Lessor shall in no event be liable for failure to furnish or perform
the same when prevented from doing so by strike, lockout, breakdown,
accident, order or regulation of or by any governmental authority, or
failure of supply or inability by the exercise of reasonable diligence
to obtain supplies, parts, or employees necessary to furnish such
services, or because of war or other emergency, or for any cause
beyond Lessor's
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reasonable control, or for any cause due to any act or neglect of
Lessee or its servants, agents, employees, licensees, or any person
claiming by, through or under Lessee. Upon interruption of services
to Lessee , under the provisions of this Section, which results in
Lessee being unable to conduct business in the Leased Premises, Lessee
shall be entitled to an abatement of rent during such period of
interruption.
SECTION 13. REPAIRS AND CARE OF PREMISES BY LESSEE
Lessee agrees, at its own cost and expense, to repair or replace
any damage or injury done to the Building, or any part thereof, caused
by Lessee, Lessee's agents, employees, licensees, or invitees;
provided, however, if Lessee fails to make such repairs or
replacements promptly, Lessor may, at its option, make such repairs or
replacements and Lessee shall pay the cost, after written notice,
thereof to Lessor on demand. Lessor further agrees to maintain and
keep the interior of the Leased Premises in good repair and condition
at Lessee's expense. Lessee agrees not to commit or allow any waste
or damage to be committed on any portion of the Leased Premises or the
Building, and to maintain the Leased Premises in as good condition as
on date of possession by Lessee, ordinary wear and tear alone
excepted. Upon such termination of this Lease, subject to the
provisions of Section 32, Lessor shall have the right to re-enter and
resume possession of the Leased Premises.
Furthermore, no abatement, diminution, reduction of rent charges
or other compensation shall be claimed by or allowed by Lessee or to
any person claiming under any circumstances whether for any
inconvenience or discomfort otherwise arising from the making of
alterations, changes, additions, improvements, or repairs to the
Building or by virtue or by cause by present or future government of
laws, ordinance, requirements, orders, rules, regulations except (i)
in the event Lessee is actually prevented from utilizing a portion of
the Leased Premises as a result thereof and (ii) in the event such
action creates a physical barrier which prevents access to the Leased
Premises or causes an intrusion into the Leased Premises.
SECTION 14. MECHANIC'S LIENS
Lessee shall not suffer or permit any mechanic's lien to be filed
against the Leased Premises or any portion of the Building or premises
of which the Leased Premises are a part by reason of work, labor,
services, or materials supplied or claimed to have been supplied to
the Lessee; and nothing in this Lease contained shall be deemed or
construed in any way as constituting the consent or request of the
Lessor, expressed or implied, by inference or otherwise, to any
contractor, subcontractor, laborer or materialman for the performance
of any labor or furnishing of any materials or any specific
improvement, alteration or repair of or to the Leased Premises which
are a part, or any part thereof, nor of giving the Lessee any right,
power or authority to contract for, or permit the rendering of, any
services or the furnishing of any materials that would give rise to
the filing of any mechanic's lien against the Leased Premises or any
portion of the Building or premises of which the Leased Premises are a
part. If any such mechanic's lien shall at any time be filed against
the Leased Premises or any portion of the Building or premises of
which the Leased Premises are a part, the Lessee covenants that it
will promptly take and diligently prosecute appropriate action to have
the same discharged and will pursue such action at the Lessee's cost
and expense to the ultimate disposition thereof, and upon its failure
to do so, the Lessor, in addition to any other right or remedy that it
may have, may take such action as may be reasonably necessary to
protect its interest; and any amounts paid by the Lessor in connection
with such action, and all reasonable legal and other expenses of the
Lessor in connection therewith, including reasonable attorney's fees,
court costs and other necessary disbursements, with interest thereon
at the maximum rate permitted by law from the date of payment, shall
be repaid by the Lessee to the Lessor on demand.
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SECTION 15. NUISANCE OR HAZARDOUS USE
Lessee will not use, occupy, or permit the use or occupancy of the
Leased Premises for any purpose which is directly or indirectly
forbidden by law, ordinance or governmental or municipal regulation or
order, or which may be dangerous to life, limb, or property; or permit
the maintenance of any public or private nuisance, or do or permit any
operation which might emit offensive odors or conditions into other
portions of the Building; or use any apparatus which might make undue
noise or set up vibrations in the Building; or permit anything to be
done which would increase the fire and extended coverage insurance
rates on the Building or contents; or permit anything to be done or
not to be done which would shorten the normal useful life of any
building system beyond that typical for first class office buildings
in Houston, Texas; and if there is any increase in such rates by acts
of Lessee, then Lessee agrees to pay such increase promptly upon
demand therefor by Lessor. Lessor acknowledges that a portion of the
Leased Premises will be used for manufacturing under controlled,
sterile conditions, but involving the use of various chemicals such as
nitrogen and alcohol, and agrees such activities are not violative of
the foregoing provisions.
SECTION 16. TAXES AND INSURANCE
A. Lessor shall pay all ad valorem taxes and assessments on the
building.
Lessor shall maintain fire and extended coverage insurance on the
Building, in amounts desired by Lessor. Lessor shall likewise
maintain a policy or policies of commercial general liability
insurance in such amounts as it may desire. If the annual premiums to
be paid by Lessor exceed the standard rates because Lessee's
operations result in additional risk or exposure as determined by
Lessor's insurance carrier, then Lessee shall promptly pay the excess
amount of the premium upon request by Lessor and provided evidence of
such additional premium is given to Lessee.
B. Notwithstanding the Language of Section 16A. of this Lease,
Lessor may, at its sole option, elect to self-insure the Building,
provided the party obligated to make such self-insurance payments
shall have a net worth of at least One Hundred and Fifty Million
Dollars ($150,000,000.00).
C. Lessee shall pay all taxes assessed against its furniture,
equipment, fixtures, or other property in or on the Leased Premises.
Lessee shall, at all times during the term of this Lease, at its
own expense, maintain a policy or policies of insurance with premiums
fully paid in advance, issued by and binding upon a solvent insurance
company, insuring all of Lessee's personal property located in the
Leased Premises and the improvements placed upon the Leased Premises
by Lessee (including all items covered by Lessee's plans as approved
by Lessor) against all risks of direct physical damage or loss for the
full replacement value thereof. Lessee also shall maintain a policy
or policies of commercial general liability insurance with premiums
fully paid in advance, issued by and binding upon a solvent insurance
company, such insurance to afford minimum protection of not less than
$1,000,000 per occurrence and $2,000,000 aggregate combined single
limit for personal injury, death, property damage liability.
The policy or policies of insurance to be maintained by Lessee
shall name Lessor as an Additional Insured; be endorsed to provide
Waiver of Subrogation in favor of Lessor; and shall contain an
endorsement that such policies cannot be cancelled, amended or
modified as to Lessor without thirty (30) days prior written notice to
Lessor. Lessee shall deliver duplicate original policies or
certificates of insurance in form satisfactory to Lessor prior to
entry upon the Leased Premises and not less than twenty (20) days
prior to the expiration of old insurance policies.
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D. Anything in this Lease to the contrary notwithstanding, Lessor and
Lessee each hereby waive any and all rights of recovery, claims, actions or
causes of action against the other, its agents, officers and employees for
any loss or damage that may occur to the Building or any part thereof, or to
any of the personal property of such parties therein by reason of fire, the
elements, or any other cause which is insured against under the terms of the
policies of fire and extended coverage insurance and/or public liability
insurance carried by either Lessor or Lessee in respect thereof, to the
extent and only to the extent, of any proceeds actually received by Lessor
and Lessee, respectively, with respect thereto, regardless of its cause or
origin, including negligence of either party hereto, its agents, officers, or
employees, and each party covenants that no insurer shall hold any right of
subrogation against the other party. Lessor will not be responsible for any
lost or stolen personal property, equipment, money or jewelry from Lessee's
area or public areas regardless of whether such loss occurs when the area is
locked against entry or not.
SECTION 17. QUIET ENJOYMENT
Lessor covenants that it will put Lessee in actual possession of the
Leased Premises at the Commencement Date of the Term aforesaid, and that
Lessee, on paying the said rent and performing the covenants herein agreed to
be by it performed, shall and may peaceably and quietly have, hold and enjoy
the Leased Premises for said term. If for any reason, the Leased Premises
are not ready for occupancy by Lessee on the Commencement Date, this Lease
shall not be affected thereby, and Lessor shall not be liable to Lessee by
reason thereof, but no rent shall be payable for the period during which the
Leased Premises are not ready for occupancy. All claims for damage arising
from any such delay are hereby waived and released by Lessee.
SECTION 18. ALTERATION
Lessee agrees that it will not make or allow to be made any alterations,
physical additions or improvements in or to the Leased Premises, which would
affect the basic building systems or structural integrity without first
obtaining the written consent of Lessor and without first furnishing Lessor
fifteen (15) days advance written notice outlining in detail the proposed
changes or alterations. In any instance where Lessor grants such consent,
Lessor may grant such consent upon the condition that Lessee's contractors,
laborers and materialmen must work in harmony with and not interfere with any
other work being conducted on behalf of Lessor or any other lessee of the
Building. Said consent shall not be unreasonably withheld or delayed by
Lessor.
SECTION 19. ASSIGNMENT AND SUBLETTING
A. Neither Lessee nor Lessee's legal representatives or successors in
interest by operation of law or otherwise shall assign this Lease or sublease
the Leased Premises or any part thereof or mortgage, pledge or hypothecate
its leasehold interest therein without the prior express written permission
of Lessor, any attempt to do so by Lessee or Lessee's successors in interest
shall be void and of no effect. Said permission and consent shall not be
unreasonably withheld or delayed. Lessor agrees and acknowledges that any
transfer of this lease by Lessee as a result of merger or consolidation of
Lessee shall not constitute an assignment for the purpose of this Lease.
B. If Lessee should desire to assign this Lease or sublet the Leased
Premises or any portion thereof, Lessee shall give Lessor written notice of
such desire at least thirty (30) days in advance of the date on which Lessee
desires to make such assignment or sublease. Lessor shall then have a period
of thirty (30) days following receipt of such notice within which to notify
Lessee in writing that Lessor elects either (1) to permit Lessee to assign or
sublet the Leased Premises or any portion thereof, subject, however, to
subsequent written approval of the
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proposed assignee or sublessee by Lessor or (2) to refuse to consent to
Lessee's assignment or subletting of the Leased Premises or any portion
thereof and to continue this Lease in full force and effect as to the entire
Leased Premises. If Lessor should fail to notify Lessee of such election
within said thirty (30) day period, Lessor shall be deemed to have elected
option (2) above. Lessor and Lessee specifically agree that, in the event of
any approved assignment or subletting, the rights of any such assignee or
sublessee of Lessee herein to the use and occupancy of the Leased Premises
shall be subject to all of the terms, conditions and provisions of this
Lease, including, without limitation, restrictions on use and the covenant to
pay Base Rent, Monthly Escalation Payments, Operating Costs and other sums
due. Lessor may collect Base Rent, Monthly Escalation Payments, Operating
Costs and other sums due directly from such assignee or sublessee and apply
the amount so collected to the rents herein reserved. No such consent to or
recognition of any such assignment or subletting shall constitute a release
of Lessee or any guarantor or Lessee's performance hereunder, from further
performance by Lessee or such guarantor of covenants undertaken to be
performed by Lessee herein, and Lessee and such guarantor will remain liable
and responsible for all rents and other obligations herein imposed upon
Lessee.
C. Notwithstanding anything to the contrary contained herein, this Lease
may be subleased without Lessor's consent to Lessee's customers or
subcontractors working with Lessee in the Premises. In the event Lessee
subleases all or a portion of the Premises to Lessee's customers or
subcontractors, Lessee will not be required to comply with Section 19A or
Section 19B. Lessee will remain liable and responsible for all rents and
other obligations herein imposed upon Lessee.
D. Consent by Lessor to a particular assignment or sublease or other
transaction shall not be deemed a consent to any other subsequent
transaction. If this Lease be assigned or if the Leased Premises be subleased
(whether in whole or in part) or in the event of the mortgage, pledge or
hypothecation of the leasehold interest without the prior express written
permission of Lessor, Lessor may nevertheless collect rent from the assignee,
sublessee, mortgagee, pledgee, or party to whom the leasehold interest was
hypothecated, or other occupant and apply the net amount collected to the
rent payable hereunder, but no such transaction or collection of rent or
application thereof by Lessor shall be deemed a waiver of these provisions or
a re1ease of Lessee from the further performance by Lessee of its covenants,
duties and obligations hereunder. One-half (1/2) of any rent or other
consideration payable to Lessee, after deduction of all costs associated with
such transaction, under any permitted assignment or sublease, in excess of
the Base Rent set forth in this Lease and one-half (1/2) of any additional
rent payable to Lessee in excess of the Monthly Escalation Payments set forth
in this Lease, shall be payable to the Lessor.
SECTION 20. ABANDONMENT
If the Leased Premises are abandoned by Lessee, coupled with the
non-payment of rent, Lessor shall have the right, but not the obligation, to
relet same for the remainder of the period covered hereby, and if the rent
received through such reletting is not at least equal to the rent provided
hereunder, Lessee shall pay and satisfy any deficiencies between the amount
of the rent required pursuant to this Lease and the amount received through
reletting, plus Lessee shall pay all expenses incurred by any such reletting
including, but not limited to, the cost of renovating, altering, and
decorating for a new lessee. Nothing herein shall be construed as in any way
of denying Lessor the right, in case of abandonment, vacation of the Leased
Premises or other breach of this Lease by Lessee to treat the same as an
entire breach and act of default herein and at Lessor's option immediately
sue for the entire breach of this Lease and any and all damages occasioned
Lessor thereby.
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SECTION 21. FIRE AND OTHER CASUALTY
The parties hereto mutually agree that if the Leased Premises are
partially or totally destroyed or damaged by fire or other casualty covered
by the fire and extended coverage insurance to be carried by Lessor under the
terms hereof, the Lessor shall, repair and restore the Leased Premises as
soon as it is reasonably practicable, to substantially the same condition in
which the Leased Premises were before such damage; provided, however, that in
the event the Leased Premises are so destroyed or damaged that repairs cannot
be commenced within thirty (30) days and completed within ninety (90) days
thereafter, then this Lease shall be terminable, as of the date of the
occurrence of the damage or destruction by either party hereto by serving
written notice upon the other and, provided further that in any event if
repairs have not been commenced within ninety (90) days from the date of said
damage and thereafter completed within a reasonable time, in no case to
exceed six (6) months, this Lease may be immediately terminated by Lessee as
of the date of occurrence of the damage or destruction, by serving notice
upon the Lessor.
In the event the Leased Premises are completely destroyed or so damaged
by fire or other casualty covered by the fire and extended coverage insurance
to be carried by Lessor under the terms hereof that it cannot reasonably be
used by Lessee for the purposes herein provided and this Lease is not
terminated as above provided, then there shall be a total abatement of rent
until the Leased Premises are made usable. In the event the Leased Premises
can be only partially used by Lessee for the purposes herein provided, then
there shall be a partial abatement in the rent corresponding to the time and
extent which the Leased Premises cannot be used by Lessee.
SECTION 22. CONDEMNATION
If all of the Leased Premises or the use or occupancy thereof shall be
taken as a result of the exercise of the power of eminent domain, this Lease
shall terminate as of the date Lessee is deprived of possession thereby. If
such a substantial portion of the Leased Premises or the use or occupancy
thereof or such a substantial portion of the Building or the adjoining
parking areas and driveways used by the Building are so taken so that
Lessee's use of the Leased Premises, or the balance of the Leased Premises
then remaining, is substantially handicapped, impeded or impaired, either
Lessor or Lessee shall have the right to terminate this Lease by written
notice to the other within thirty (30) days after the date of such taking.
In the event of any taking, Lessor shall be entitled to any and all
compensation, damages, income, rent and awards with respect thereto except
for any award specified by the condemning authority for any property that
Lessee has the right to remove upon termination of this Lease. Lessee shall
have no claim against Lessor for the value of any unexpired term of this
Lease. In the event of a partial taking of the Leased Premises which does
not result in a termination of this Lease, the Base Rent and additional rent
thereafter to be paid shall be equitably reduced.
SECTION 23. HOLD HARMLESS
The Lessee will indemnify and hold Lessor harmless and Lessor will
indemnify and hold Lessee harmless from and against all fines, suits, claims,
demands, damages, expenses, liabilities and actions (including costs and
expenses of defending against such claims) resulting or alleged to result
from any breach, violation or non-performance of any covenant or condition
hereof or from the use or occupancy of the Leased Premises by the other party
or the other party's agents, employees, licensees, or invitees. Neither
party shall be liable to the other or their agents, employees, licensees, or
invitees for any damage to person or property resulting from any act or
omission or negligence of any co-lessee or co-lessor, visitor or other
occupant(s) of the Building, except to the extent Lessor's or Lessee's own
negligence may contribute thereto.
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SECTION 24. DEFAULT BY LESSEE
The term "Act of Default" refers to the occurrence of any one or more of
the following: (i) failure of Lessee after ten (10) days after receipt of
written notice from Lessor of Lessee's default to pay when due any Base Rent,
Monthly Escalation Payments, and/or additional rent, or any charges for any
services, goods, or materials furnished by Lessor at Lessee's request, or
other amount required to be paid under this Lease (such failure of Lessee to
pay such sums shall hereinafter be referred to as "Monetary Default"; (ii)
failure of Lessee after thirty (30) days after receipt of written notice from
Lessor of Lessee's default, other than a Monetary Default, in the performance
of any Lessee's obligations, covenants or agreements; (iii) the adjudication
of Lessee to be a bankrupt; (iv) the filing by Lessee of a voluntary petition
in bankruptcy, receivership, or other related or similar proceedings; (v) the
making by Lessee of a general assignment for the benefit of creditors; (vi)
the appointment of a receiver of Lessee's interest in the Leased Premises in
any action, suit, or proceeding by or against Lessee's interest in the Leased
Premises or by or against Lessee; (vii) any other voluntary or involuntary
proceeding instituted by or against Lessee under any bankruptcy or similar
laws, unless the occurrence of any such involuntary receivership or
proceeding is cured by the same being dismissed or stayed within ninety (90)
days thereafter, or (viii) any attempted sale under execution or other legal
process of the interest of the Lessee in the Leased Premises.
If any Act of Default occurs, Lessor at any time thereafter prior to the
curing of such Act of Default and without waiving any other right available
to Lessor herein, at law or in equity, may terminate this Lease. Lessor may
with notice and with court proceedings, re-enter and repossess the Leased
Premises, and remove all persons and property therefrom, and Lessee hereby
waives any claim arising by reason thereof or by reason of issuance of any
distress warrant or writ of sequestration and agrees to hold Lessor harmless
from any such claims. If Lessor elects to terminate this Lease, it may treat
the Act of Default as an entire breach of this Lease, and Lessee immediately
shall become liable to Lessor for damages for the entire breach in the amount
equal to the amount by which (i) the Total Base Rent, as adjusted by the
Monthly Escalation Payments which would be payable by Lessee during the
unexpired balance of the Term, and all other payments due for the balance of
the Term is in excess of (ii) the fair market rent value of the Leased
Premises for the balance of the Term as of the time of default, both
discounted at the rate of six percent (6%) per annum to the then present
value. Such amount shall be due and payable upon Lessor's notice to Lessee
of termination of the Lease and shall bear interest until paid at the maximum
rate permitted by law. If Lessor elects to terminate Lessee's right to
possession of the Leased Premises without terminating this Lease, Lessor may
lease the Leased Premises or any part thereof for the account of Lessee to
any person or persons, for such rent and upon such terms and other conditions
as Lessor deems practical, and Lessee shall be liable to Lessor for the
amount, if any, by which the total Base Rent and all other payments herein
provided for the unexpired balance of the Term exceed the net amount, if any,
received by Lessor from such reletting, being the gross amount so received by
Lessor less the cost of repossession, reletting, remodeling, and other
expenses. Such sum or sums shall be paid by Lessee in monthly installments on
the first day of each month of the Term. In no case shall Lessor have any
obligation to, or be liable for failure to, relet the Leased Premises or
collect the rent due under such reletting. If Lessor elects to terminate
Lessee's right to possession without terminating this Lease, Lessor shall
have the right at any time thereafter to terminate this Lease, whereupon the
foregoing provisions with respect to termination will thereafter apply. If
an Act of Default occurs or in case of any holding over or possession by
Lessee of the Leased Premises after the expiration or termination of this
Lease, except as permitted pursuant to Section 32, Lessee shall reimburse
Lessor on demand for all costs incurred by Lessor in connection therewith
including, but not limited to, reasonable attorney's fees, court costs, and
related costs plus interest thereon at the rate of fifteen percent (15%) per
annum from the date such costs are paid by Lessor.
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SECTION 25. DEFAULT BY LESSOR
The term "Lessor's Act of Default" shall mean the failure of Lessor for
seventy two (72) hours, after receipt of written notice from Lessee of
Lessor's default, to diligently cure or to use reasonable efforts to cure
Lessor's default in making any payment or in the performance of any of
Lessor's obligations, covenants or agreements under this Lease or under any
subsequent rental agreements, if any. After any Lessor's Act of Default
occurs, Lessee shall have the right, without limiting any other rights it may
have under this Lease or at law, at Lessee's expense, to do whatever is
reasonably necessary to cure Lessor's Act of Default and, in so doing and to
the extent necessary, shall have the right of access to portions of the
Building normally under the control of Lessor. Lessee shall have the right
to deduct from or set-off against Lessee's Base Rent, Annual Escalation
Payments and other amounts payable by Lessee to Lessor hereunder or under any
subsequent rental agreements, if any, all payments made and costs incurred by
Lessee by reason of or in curing or beginning or attempting to cure Lessor's
Act of Default, and such deduction or set-off shall be accompanied by a
statement setting forth, in reasonable detail, all costs incurred by Lessee
and deducted from the Base Rent, Annual Escalation Payments and other amounts
payable by Lessee to Lessor hereunder.
SECTION 26. ATTORNEY'S FEES
In the event that any action shall be commenced by either party hereto
arising out of, or concerning this Lease or any right or obligation derived
therefrom, then in addition to all other relief at law or in equity, the
prevailing party shall be entitled to recover reasonable attorney's fees and
costs as fixed by the court.
SECTION 27. NON-WAIVER
Neither acceptance of rent by Lessor nor failure by Lessor to complain of
any action, non-action or default of Lessee, whether singular or repetitive,
shall constitute a waiver of any of Lessor's rights hereunder. Waiver by
Lessor or Lessee of any right or any default of the other party shall not
constitute a waiver of any right for either a subsequent default of the same
obligation or any other default. No act or thing done by Lessor or its
agents shall be deemed to be an acceptance or surrender of the Leased
Premises and no agreement to accept a surrender of the Leased Premises shall
be valid unless it is in writing and signed by a duly authorized officer or
agent of Lessor. Receipt by Lessor of Lessee's keys to the Leased Premises
shall not constitute an acceptance or surrender of the Leased Premises.
SECTION 28. RULES AND REGULATIONS
Lessee shall comply with the rules and regulations incorporated in
Exhibit C, attached hereto and made a part hereof. Lessor shall have the
right at all times to change such rules and regulations or to amend them in
any reasonable manner as may be deemed advisable to Lessor, all of which
changes and amendments will be sent by Lessor to Lessee in writing and shall
be thereafter carried out and observed by Lessee.
SECTION 29. ASSIGNMENT BY LESSOR
Lessor shall have the right to assign or transfer in whole or in part,
every feature of its rights and obligations hereunder and in the Building and
Leased Premises. Such assignments or transfers may be made to a corporation,
trust, trust company, individual or group of individuals, and howsoever made
shall be in all things respected and recognized by Lessee. Upon any such
assignment, the assigning Lessor shall be released from all liability
hereunder, except for any existing Lessor default.
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SECTION 30. LIABILITY OF LESSOR
It is expressly understood and agreed that the obligations of Lessor
under this Lease shall be binding upon Lessor and its successors and assigns
and any future owner of the Building only with respect to breaches occurring
during its and their respective ownership of the Building. In addition,
Lessee specifically agrees to look solely to Lessor's interest in the
Building and insurance policies for the recovery of any judgment from Lessor
pursuant to this Lease, it being agreed that neither Lessor nor any successor
or assign of Lessor nor any future owner of the Building shall ever be
personally liable for any such judgment.
SECTION 31. BUILDING MORTGAGE
Lessor represents and warrants that as of the date of this Lease, no
mortgage or deed of trust is of record against the Building. This Lease
shall automatically be subject and subordinate to any first or second lien
and/or mortgage or deed of trust which may hereafter encumber the Land or
the Building of which the Leased Premises form a part and to all renewals,
modifications, consolidations, replacements and extensions thereof if, at the
time such mortgage is executed or within sixty (60) days thereafter, the
Lessor, the Lessee and the mortgagee execute a mutually acceptable
subordination, non-disturbance and attornment agreement.. In confirmation of
such subordination, however, Lessee shall, at Lessor's request, execute
promptly any appropriate certificate or instrument that Lessor may request in
accordance with the terms of this Lease, as may be reasonably required to
further effect such subordination. The Lessee shall promptly furnish
Mortgagee with a Lessee's estoppel letter, at any time and from time to time
as reasonably requested by Mortgagee or Lessor, such estoppel letter to set
forth the rental rates, terms, any options, acceptance and occupancy of
Leased Premises, offsets and the like. In the event of the enforcement by the
trustee or the beneficiary under such mortgage or deed of trust of the
remedies provided for by law or by such mortgage or deed of trust, Lessee
will automatically become the Lessee of such successor in interest without
change in the terms or other provisions of this Lease; provided, however,
that such successor in interest shall not be bound by any payment of rent or
additional rent for more than one month in advance. Upon request by such
successor in interest or Lessor, Lessee shall promptly execute and deliver an
instrument or instruments confirming the attornment herein provided for.
The Lessee understands and acknowledges that (i) Lessor shall execute a
conditional assignment of this Lease in favor of any first mortgagee or
beneficiary under a first or second mortgage or deed of trust on the Building
("Mortgagee"); (ii) notwithstanding said assignment, all rental payments
under this Lease shall be paid in accordance with the terms of this Lease
until and unless Lessee is notified to the contrary in writing by Mortgagee;
(iii) under the conditions of said assignment and after the date thereof, it
is expressly agreed that, unless the written consent of Mortgagee be first
obtained, no rents are to be collected more than fifteen (15) days in advance
of the due date thereof, and no alterations, modifications, amendments,
terminations, waivers, consents, approvals or other actions whatsoever are to
be made or become effective with respect to this Lease; and (iv) the interest
of the Lessor in this Lease shall be assigned to Mortgagee solely as
additional security for the loan and Mortgagee assumes no duty, liability or
obligation under this Lease, either by virtue of said assignment or by any
subsequent receipt or collection or rents hereunder.
Lessee will give written notice to Mortgagee of any substantial default
under the Lease by Lessor by mailing a copy of same by certified United
States mail, postage prepaid, return receipt requested, to such address as
may be specified by Mortgagee; and, in such event, Mortgagee shall be
permitted to cure or begin to cure any such default within the period of time
during which Lessor would be permitted to cure or begin to cure such default
as set forth in this Lease, but in any event Mortgagee shall have a period of
thirty (30) days after receipt of said notification in which to cure or begin
to cure such default; provided, however, in the event
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Mortgagee is unable to cure or begin to cure said default by the exercise of
reasonable diligence within such thirty (30) day period, Mortgagee shall have
such additional period of time as may be reasonably required for it to remedy
such default with diligence and continuity.
Generally, the subordination and non-disturbance agreement shall provide that
(1) Lessee's possession of the Leased Premises under the Lease or any
extension or renewals thereof, shall not be diminished or interfered with by
the Mortgagee or the holder of the Deed of Trust in the exercise of the
Mortgagee's rights under the Mortgage or in the exercise by the holder of the
Deed of Trust of its rights under the Deed of Trust; (2) Lessee's occupancy
of the Leased Premises including any additional space added to the Leased
Premises shall not be disturbed by Mortgagee or the holder of the Deed of
Trust in the exercise of any of its rights during the term of the Lease or
any renewals thereof and (3) Mortgagee or the holder of the Deed of Trust
will not join Lessee as a party defendant in any action or proceeding for the
purpose of terminating Lessee's interest and estate under the Lease because
of any default under the Mortgage or the Deed of Trust.
SECTION 32. HOLDING OVER
Upon the termination of this Lease for any reason, Lessee shall
immediately surrender and vacate the Leased Premises, and Lessor shall have
the right to re-enter and resume possession of the Leased Premises. If
Lessee should remain in possession of the Leased Premises after the
termination of this Lease without the execution by Lessor and Lessee of a new
lease, then Lessee shall be deemed to be occupying the Leased Premises as a
tenant at sufferance subject to all the covenants of this Lease except the
amount of rent, which rent for any such holdover period shall be one hundred
and ten percent (110%) the Total Monthly Rent (including, without limitation,
Base Rent, Monthly Escalation Payments and parking charges) being paid by
Lessee immediately prior to the Expiration Date; and Lessee shall indemnify
Lessor and hold Lessor harmless from any claims which may be asserted by any
third party who is unable to enter or occupy the Leased Premises because of
Lessee's holdover occupancy thereof. No holding over by Lessee after the
term of this Lease, either with or without the consent and acquiescence of
Lessor, shall operate to extend this Lease.
Notwithstanding the foregoing, Lessee shall have the right to hold over
pursuant to the terms of this Lease as to approximately 19,411 rentable
square feet identified as the 5th Floor ("Approved Hold Over Space"). Such
right shall arise upon Lessee's written notice to Lessor prior to termination
of this Lease that Lessee is exercising this right. Upon the giving of such
notice Lessee shall be obligated for all obligations hereunder as to such
Approved Hold Over Space provided such occupancy by Lessee be terminated by
Lessee upon six (6) months written notice or by Lessor upon twelve (12)
months written notice of its election to cancel. The Approved Hold Over
Space rental rate will be 110% of the rental rate of this Lease. If Lessee
elects to retain Approved Hold Over Space, it shall be subjected to all terms
and conditions of the Lease, except as modified hereby.
SECTION 33. SEVERABILITY
This Lease shall be construed in accordance with the laws of the State of
Texas. Any suit for the enforcement of this Lease shall be brought in the
court of Harris County, Texas, which shall have exclusive venue, except when
it becomes necessary, for jurisdictional purposes, to bring suit against
Lessee in another state of the United States. If any clause or provision of
this Lease is illegal, invalid, or unenforceable, under present or future
laws effective during the term hereof, then it is the intention of the
parties hereto that the remainder of this Lease shall not be affected
thereby, and it is also the intention of both parties that in lieu of each
clause or provision that is illegal, invalid or unenforceable, there be added
as a part of this Lease a clause or
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provision as similar in terms to such illegal, invalid, or unenforceable
clause or provision as may be possible and be legal, valid and enforceable.
SECTION 34. NOTICES
Whenever in this Lease it shall be required or permitted that notice or
demand be given or served by either party to this Lease to or on the other,
such notice or demand shall be given or served and shall be deemed to have
been given or served upon receipt of Certified or Registered Mail, or express
courier, postage prepaid, addressed as follows:
TO LESSOR:
Space Assets II, Inc.
Attention: President
USX Realty Development
600 Grant Street, Room 2656
Pittsburgh, PA 15219-4776
With copies to: USX Corporation
Attorney-Real Estate
Room 1538 - USX Tower
600 Grant Street
Pittsburgh, PA l5219-4776
USX Realty Development
Attention: General Manager - Southwest
5200 East McKinney Rd., Suite 100
Baytown, Texas 77520
TO LESSEE (prior to Commencement Date):
Cyberonics, Inc.
17448 Highway Three, Suite 100
Webster, Texas 77598
Attention: Facilities Manager
TO LESSEE (after Commencement Date):
Cyberonics, Inc.
16511 Space Center Boulevard, Suite 600
Houston, Texas 77058
Attention: Facilities Manager
Such addresses may be changed from time to time by either party by serving
notices as provided above. All notices shall be effective when received by
the party to whom addressed.
SECTION 35. OBLIGATIONS OF SUCCESSORS
The Lessor and Lessee agree that all the provisions hereof are to be
construed as covenants and agreements as though the words imparting such
covenants were used in each separate section hereof, and that, except as
restricted by the provisions hereof, shall bind and inure to the benefit of
the parties hereto, their respective heirs, legal representatives, successors
and assigns.
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SECTION 36. ENTIRE AGREEMENT
This Lease and any attached addenda or exhibits signed by the parties
constitute the entire agreement between Lessor and Lessee. No prior written
or contemporaneous oral promises or representations shall be binding. This
Lease shall not be amended, changed, or extended except by written instrument
signed by both parties hereto.
SECTION 37. SECTION HEADINGS
The section headings in this Lease are for Lessor's and Lessee's
convenience only and neither limit or amplify the provisions of this Lease.
Lessee agrees, at Lessor's request, to execute a recordable Memorandum of
this Lease.
SECTION 38. CHANGES, DELETIONS AND ADDITIONS TO CONTRACT
As noted, changes, deletions or additions, on any and all pages of this
Lease agreed on by both parties become a part of this Lease for all purposes.
SECTION 39. ESTOPPEL
Lessee will, at such time or times as Lessor may request, sign a
certificate stating whether this Lease is in full force and effect; whether
any amendments or modifications exist; whether there are any defaults
hereunder, and such other information and agreements as may be reasonably
requested in accordance with the terms of this Lease.
SECTION 40. BROKER'S COMMISSION
Each of the parties represents and warrants that there are no claims for
brokerage commissions or finder's fees in connection with the execution of
this Lease except to Clear Lake Asset Management, Inc. and Jesse J. Tollett &
Company, and each of the parties agrees to indemnify the other against, and
hold it harmless from, all liabilities arising from any such claim
(including, without limitation, the cost of counsel fees in connection
therewith).
IN WITNESS WHEREOF, the parties hereto have executed this Lease Agreement
on the date indicated below.
EXECUTED in multiple counterparts, together with Exhibits A, B and C,
each of which shall have the force and effect of an original, on this the
19th day of August, 1997.
LESSOR:
SPACE ASSETS II, INC.
By: /s/ A. E. FERRARA, JR.
--------------------------
A. E. Ferrara, Jr.
President
LESSEE:
CYBERONICS, INC.
By: /s/ ROBERT P. CUMMINS
--------------------------
Robert P. Cummins
Chief Executive Officer
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EXHIBIT "B"
PROPERTY METES AND BOUNDS DESCRIPTION
of a 2.4148 Acre Tract of Land
In the Sarah Deel League, Abstract No. 13
Harris County, Texas
(SPACE CENTER II)
Being a 2.4148 acre tract of land in the Sarah Deel League, Abstract No. 13,
Harris County, Texas, and being a portion of unrestricted Reserve "E" of
Armand Section One as per plat recorded in Volume 268, Page 141 of the Harris
County Map Records and being a portion of those lands sold to Tiffany Bay,
Ltd., as described in deed recorded under Harris County Clerk's File
No. G 432149 and G 459791 and a portion of that land sold to Bay Colony, Ltd.,
as described in deed recorded under Harris County Clerk's File No. F 886937 and
a portion of that 2.1905 acre tract of land sold to G. Phillip Albright,
Trustee, as described in deed recorded under Harris County Clerk's File
No. H 591231 and all of that 0.3566 acre tract sold to G. Phillip Albright and
Walker L. Nichols, Jr. as described in deed recorded under Harris County
Clerk's File No. H 849875 and being more particularly described by metes and
bounds as follows with bearings based on said deed.
BEGINNING at a 5/8 inch iron rod found marking the most northerly cut-back
corner of the intersection of the northeasterly right-of-way line of Space
Center Boulevard, 100.00 feet wide, with the southeasterly right-of-way line
of Skywalker Drive, 60.00 feet wide; said point also marking the western most
corner of the herein described tract and said Reserve "E";
THENCE along the southeasterly right-of-way line of said Skywalker Drive,
N 23 DEG. 14' 14" E, 260.00 feet to a point marking the westerly north corner
of the herein described tract;
THENCE departing the southeasterly right-of-way line of said Skywalker Drive,
S 66 DEG. 45' 44" E, 206.00 feet to a point for corner;
THENCE S 23 DEG. 14' 16" W, 10.00 feet to a point for corner;
THENCE S 66 DEG. 45' 44" E, 191.04 feet to a point for corner;
THENCE S 23 DEG. 14' 17" W, a distance of 257.93 feet to a 5/8 inch iron rod
found marking the south corner of the herein described tract and a point in
the northeasterly right-of-way line of said Space Center Boulevard as
established by right-of-way deed recorded under Harris County Clerk's File
No. H 429026; said point being in a curve concave to the northeast;
THENCE westerly 74.34 feet along the northeasterly right-of-way line of said
Space Center Boulevard and along the arc of said curve concave to the
northeast having a radius of 1334.35 feet, a central angle of 03 DEG. 11' 31"
and whose chord bears N 68 DEG. 21' 30" W, 74.33 feet to a 5/8 inch iron rod
found marking the point of tangency of said curve concave to the northeast;
THENCE continuing along the northeasterly right-of-way line of said Space
Center Boulevard, N 66 DEG. 45' 44" W, 312.74 feet to a 5/8 inch iron rod
found marking the southerly cut-back corner of the intersection of the
northeasterly right-of-way line of Space Center Boulevard with the
southeasterly right-of-way line of said Skywalker Drive;
THENCE along the cut-back N 21 DEG. 45' 45" W, 14.14 feet to the POINT OF
BEGINNING and containing 2.4148 acres of land.
<PAGE>
EXHIBIT "C"
SPACE CENTER II
RULES AND REGULATIONS
1. Lessee will refer all contractors, contractors' representatives
and installation technicians rendering any service for Lessee to Lessor
for Lessor's supervision and/or approval before performance of any such
contractual services. This shall apply to all work performed in the
Building including, but not limited to, installation of telephones,
telegraph equipment, electrical devices and attachments, and
installations of any and every nature affecting floors, walls,
woodwork, trim, windows, ceilings, equipment or any other physical
portion of the Building. None of this work shall be done by Lessee
without Lessor's written approval.
2. The work of the janitor or cleaning personnel shall not be
hindered by Lessee after 5:00 p.m. and such work may be done at any
time when the offices are vacant. The windows, doors, and fixtures may
be cleaned at any time. Lessee shall provide adequate waste and
rubbish receptacles, cabinets, bookcases, map cases, etc. necessary to
prevent unreasonable hardship to Lessor in discharging its obligation
regarding cleaning service. This rule is subject to and subordinate to
the provisions of Section 10.C. of the Lease.
3. Movement in or out of the Building of furniture or office
equipment, or dispatch or receipt by Lessee of any merchandise or
materials which requires the use of elevators or stairways, or movement
through the Building entrances or lobby shall be restricted to the
hours designated by Lessor from time to time. All such movement shall
be as directed by Lessor and in a manner to be agreed upon between
Lessee and Lessor by pre-arrangement before performance. Such
pre-arrangement initiated by Lessee shall include determination by
Lessor and subject to its decision and control of the time, method, and
routing of movement. Limitations are imposed by safety or other
concerns which may prohibit any article, equipment or any other item
from being brought into the Building. Lessee expressly assumes all
risk of damage to any and all articles so moved, as well as injury to
any person or persons or the public engaged or not engaged in such
movement, including equipment, property, and personnel of Lessor if
damaged or injured as a result of any acts in connection with carrying
out this service for Lessee from the time of entering property to
completion of the work; and Lessor shall not be liable for the act or
acts of any person or persons so engaged in, or any damage or loss to
any property of persons resulting directly or indirectly from any act
in connection with such service performed by or for Lessee.
4. Except as expressly permitted by provisions of Section 9 of the
Lease, no sign or signs will be allowed in any form on the exterior of
the Building or any windows inside or outside of the Building and no
sign or signs, except in uniform location and uniform style fixed by
Lessor, will be permitted in the public corridors or on corridor doors
or entrances to Lessee's space. All signs may be contracted for by
Lessor for Lessee at the rate fixed by Lessor from time to time and
Lessee will be billed and pay for such service accordingly. Written
consent from Lessor is an absolute prerequisite for any such sign or
signs any Lessee may be so permitted to use.
5. Lessee shall not place, install or operate on the Leased Premises
or in any part of the Building, any engine, or stove, or conduct
mechanical operations or cook thereon or therein, or place or use in or
about the Leased Premises any explosives, gasoline, kerosene, oil,
acids, caustics, or any other inflammable, explosive or hazardous
material without the written consent of Lessor first had and obtained,
except as permitted by provisions of Sections 3 and 15 of the Lease.
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6. Lessor will not be responsible for any lost or stolen personal
property, equipment, money, or jewelry from Lessee's area or public
room regardless of whether such loss occurs when the area is locked
against entry or not.
7. No birds or animals with the exception of seeing eye or hearing
assistance dogs shall be brought in or about the Leased Premises.
8. Lessor may permit entrance to Lessee's office by use of pass keys
by contractors, or service personnel supervised or employed by Lessor
only with prior notice and consent of Lessee.
9. None of the entries, passages, elevator doors, hallways, or
stairways, shall be blocked or obstructed, or any rubbish, litter,
trash or material of any nature placed, emptied or thrown into these
areas, or such areas be used at any time except for access or egress by
Lessee, Lessee's agents, employees, or invitees.
10. Lessor desires to maintain high standards of environment, comfort
and convenience for its lessees. It will be appreciated if any
undesirable conditions or lack of courtesy or attention by its
employees be reported directly to Lessor.
11. Smoking is prohibited inside the building. This includes the
common area hallways, restrooms, elevators, and inside any Leased
Premises.
