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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
- --- Act of 1934
For the fiscal quarter ended: September 30, 1998 or
Transition report pursuant to Section 13 or 15(d) of the Securities
- --- Exchange Act of 1934
For the transition period from to
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Commission file number: 0-19806
CYBERONICS, INC.
(Exact name of registrant as specified in its charter)
Delaware 76-0236465
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
16511 Space Center Blvd. Suite 600
Houston, Texas 77058-2072
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(address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (281) 228-7200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT OCTOBER 30, 1998
Common Stock - $0.01 par value 17,438,892
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CYBERONICS, INC.
INDEX
<TABLE>
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Page No.
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PART I. FINANCIAL INFORMATION
Item 1 Financial Statements:
Consolidated Balance Sheets
September 30, 1998 (unaudited) and June 30, 1998 . . . . . . . . 3
Consolidated Statements of Operations (unaudited)
three months ended September 30, 1998 and 1997 . . . . . . . . . 4
Consolidated Statements of Cash Flows (unaudited)
three months ended September 30, 1998 and 1997 . . . . . . . . . 5
Notes to Consolidated Financial Statements . . . . . . . . . . . 6
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . . . . . . 8
PART II. OTHER INFORMATION
Item 6 Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . .18
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CYBERONICS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1998
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<S> <C> <C>
ASSETS (UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . $ 1,786,518 $ $1,695,385
Securities held to maturity. . . . . . . . . . . . . . . . . . 25,874,857 36,341,958
Accounts receivable, net . . . . . . . . . . . . . . . . . . . 4,806,911 5,858,634
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . 4,098,14 2,103,603
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . 411,877 1163,123
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TOTAL CURRENT ASSETS . . . . . . . . . . . . . . . . . 36,978,311 47,162,703
Securities held to maturity. . . . . . . . . . . . . . . . . . . 3,824,819 2,106,716
Property and equipment, net. . . . . . . . . . . . . . . . . . . 3,663,524 3,152,983
Other assets, net. . . . . . . . . . . . . . . . . . . . . . . . 235,242 192,892
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$ 44,701,896 $ 52,615,294
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . $ 2,206,695 $ 3,690,295
Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . 2,572,461 4,226,280
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TOTAL CURRENT LIABILITIES. . . . . . . . . . . . . . . 4,779,156 7,916,575
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 2,500,000 shares
authorized; no shares issued or outstanding. . . . . . . . . -- --
Common stock, $.01 par value, 25,000,000 shares
authorized; 17,275,643 and 17,266,433 shares
issued and outstanding at September 30, 1998
and June 30, 1998, respectively. . . . . . . . . . . . . . . 172,756 172,664
Additional paid-in capital . . . . . . . . . . . . . . . . . . 107,785,617 107,757,504
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . (68,015,979) (63,341,714)
Cumulative translation adjustments . . . . . . . . . . . . . . (19,654) 110,265
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TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . 39,922,740 44,698,719
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$ 44,701,896 $ 52,615,294
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</TABLE>
See accompanying notes to financial statements.
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CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
SEPTEMBER 30,
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1998 1997
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Net sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,335,757 $ 1,103,234
Cost of sales. . . . . . . . . . . . . . . . . . . . . . . . . . 1,415,999 321,874
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Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . 3,919,758 781,360
Operating expenses:
Research and development . . . . . . . . . . . . . . . . . . . 1,853,095 1,976,532
Selling, general and administrative. . . . . . . . . . . . . . 7,401,430 3,959,225
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Total operating expenses. . . . . . . . . . . . . . . . . . 9,254,525 5,935,757
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Loss from operations . . . . . . . . . . . . . . . . . . . . . . (5,334,767) (5,154,397)
Interest income. . . . . . . . . . . . . . . . . . . . . . . . . 482,390 202,261
Other income (expense), net. . . . . . . . . . . . . . . . . . . 178,112 (5,062)
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Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (4,674,265) $ (4,957,198)
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Net loss per share - basic and diluted . . . . . . . . . . . . . $ (0.27) $ (0.36)
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Shares used in computing net loss per share - basic
and diluted. . . . . . . . . . . . . . . . . . . . . . . . . . 17,269,372 13,820,939
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</TABLE>
See accompanying notes to financial statements.
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<PAGE>
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
1998 1997
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CASH FLOW FROM OPERATING ACTIVITIES:
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (4,674,265) $ (4,957,198)
Non-cash items included in net loss:
Depreciation and amortization. . . . . . . . . . . . . . . . 237,376 47,271
Compensation expense related to certain stock options
and common stock issuances . . . . . . . . . . . . . . . . -- 4,781
Change in operating assets and liabilities:
Accounts receivable. . . . . . . . . . . . . . . . . . . . . 1,051,723 (426,306)
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . (1,994,545) (126,832)
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . 751,246 (226,731)
Accounts payable and accrued liabilities . . . . . . . . . . (3,137,419) 1,241,704
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . (42,350) (63,493)
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Net cash used in operating activities. . . . . . . . . . . (7,808,234) (4,506,804)
CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of property and equipment. . . . . . . . . . . . . . (747,917) (256,185)
Purchases of investments . . . . . . . . . . . . . . . . . . . (12,234,543) (9,325,720)
Maturities of investments. . . . . . . . . . . . . . . . . . . 20,983,541 3,818,278
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Net cash provided by (used in) investing activities. . . . 8,001,081 (5,763,627)
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net. . . . . . . . . . 28,205 44,424,991
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Net cash provided by financing activities. . . . . . . . . 28,205 44,424,991
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS . . (129,919) 214,440
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Net increase in cash and cash equivalents. . . . . . . . . 91,133 34,369,000
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD . . . . . . . . 1,695,385 781,639
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CASH AND CASH EQUIVALENTS AT END OF PERIOD . . . . . . . . . . . $ 1,786,518 $ 35,150,639
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</TABLE>
See accompanying notes to financial statements.
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<PAGE>
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1998
NOTE 1 - BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information, and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three months ended September 30, 1998
are not necessarily indicative of the results that may be expected for the full
year ending June 30, 1999. The financial information presented herein should be
read in conjunction with the audited consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
June 30, 1998.
NOTE 2 - INVESTMENT SECURITIES:
At September 30, 1998 and June 30, 1998, the Company's entire investment
portfolios consisted of securities held to maturity. Securities held to
maturity are primarily various types of corporate bonds and asset-backed
investments with various maturity dates and have a fair market value of
$30,117,280 and a gross unrealized holding gain of $417,604 at September 30,
1998.
NOTE 3 - INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 JUNE 30, 1998
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(UNAUDITED)
<S> <C> <C>
Raw materials and components . . $ 1,935,304 $ 976,737
Work-in-process . . . . . . . . . 631,127 549,885
Finished goods . . . . . . . . . 1,531,717 576,981
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$ 4,098,148 $ 2,103,603
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</TABLE>
NOTE 4 - ACCRUED LIABILITIES:
Accrued liabilities are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 JUNE 30, 1998
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(UNAUDITED)
<S> <C> <C>
Clinical costs . . . . . . . . . $ 248,109 $ 270,472
Warranties . . . . . . . . . . . 376,572 375,000
Payroll and other compensation . 920,642 2,330,449
Professional services . . . . . . 376,956 334,000
Marketing activities . . . . . . 196,794 196,794
Royalties . . . . . . . . . . . . 248,200 206,992
Sales returns and allowances. . . 86,564 317,080
Other . . . . . . . . . . . . . . 118,624 195,493
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$ 2,572,461 $ 4,226,280
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</TABLE>
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<PAGE>
NOTE 5 - NEW ACCOUNTING PRONOUNCEMENT
Effective July 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, Reporting Comprehensive Income, which establishes new
rules for the reporting and display of comprehensive income and its components.
Statement 130 requires companies to report, in addition to net income, the net
effect of other components of comprehensive income. These items have been
historically reported in shareholders' equity.
Total comprehensive income (loss) consisted of net loss and cumulative
translation adjustments and was ($4,804,184) and ($4,742,758) for the three
months ended September 30, 1998 and September 30, 1997, respectively.
Adoption of this disclosure standard had no effect on the Company's reported
results of operations or financial position.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E
OF THE SECURITIES EXCHANGE ACT OF 1934. ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF A NUMBER
OF IMPORTANT FACTORS. FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD AFFECT
THE COMPANY'S RESULTS, PLEASE REFER TO THE FINANCIAL STATEMENT LINE ITEM
DISCUSSIONS SET FORTH IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS AND TO THE SECTION ENTITLED "FACTORS THAT
MAY AFFECT FUTURE OPERATING RESULTS." READERS ARE ALSO ENCOURAGED TO REFER TO
THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR A FURTHER DISCUSSION OF THE
COMPANY'S BUSINESS AND THE RISKS AND OPPORTUNITIES ATTENDANT THERETO.
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 Investigational Device Exemption ("IDE") from the United States Food
and Drug Administration ("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
anti-epileptic drugs ("AEDs"). From inception through July 1997, the Company's
primary focus was on obtaining FDA approval for the NCP System. The Company has
had limited revenues to date, 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
September 30, 1998, the Company incurred a cumulative net deficit of
approximately $68 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 the United States and in a limited number of
international markets. The Company does not expect to achieve significant
sales unless it can maintain and broaden reimbursement approvals.
The Company expects to incur substantial costs related to sales and
marketing activities in the United States and international markets, 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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<PAGE>
RESULTS OF OPERATION
NET SALES. Net sales for the three months ended September 30, 1998 totaled
$5.3 million compared to $1.1 million for the three months ended September 30,
1997, representing an overall increase of $4.2 million, or 384%. Net sales for
the three months ended September 30, 1998 consisted of $4,662,000 from the
United States and $674,000 from the international markets. Net sales for the
three months ended September 30, 1997 consisted of $554,000 from the United
States and $549,000 from international markets. In July 1997, the Company
received FDA approval to market the NCP System in the United States. Future
increases in net sales will be dependent upon development of increased market
acceptance for the NCP System and upon obtaining reimbursement approval in key
markets.
GROSS PROFIT. The Company's gross margin percentage was 73.5% for the
three months ended September 30, 1998 compared to 70.8% in the prior year
period. The increase over prior year is attributable primarily to the
greater proportion of net sales being derived from the United States, where
the Company realizes higher gross margins due to its direct sales model in
the United States and a reduction in certain royalty rates paid by the
Company. Cost of sales consist primarily of direct labor, allocated
manufacturing overhead, third-party contractor costs and the acquisition cost
of raw materials and components. In addition, the Company is obligated to
pay royalties at a rate of approximately 4% of net sales. Gross margin
percentages can be expected to fluctuate in future periods based upon the mix
between domestic and international sales, direct and distributor sales, the
NCP System's selling price and 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 $1.9 million or 34.7% of net sales for the three months ended
September 30, 1998 compared to $2.0 million, or 179.2% of net sales in the prior
year period. The decrease in absolute dollar amount in the quarter ended
September 30, 1998 as compared to the quarter ended September 30, 1997 is
primarily due to the completion of certain clinical studies, product design and
development activities and manufacturing processing improvements. The large
decrease of such expenses as a percentage of net sales is primarily the result
of the increase in sales in the quarter ended September 30, 1998 as compared to
the prior year period. The Company intends to conduct further 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 $7.4 million, or 138.7% of sales for the three
months ended September 30, 1998 compared to $4.0 million, or 358.9% for the
three months ended September 30, 1997. The increase in absolute dollars was
primarily due to sales and marketing activities focused on the United States
market launch for the NCP System, the continued expansion of corporate
infrastructure in response to the recent business growth and movement of the
Company's headquarters to a new location. The large decrease of such expenses
as a percentage of net sales is primarily the result of the increase in sales in
the quarter ended September 30, 1998 as compared to the prior year period. 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 States. The Company expects to add administrative
personnel in anticipation of higher levels of business activity in fiscal year
1999. Accordingly, the Company expects its future selling, general and
administrative expenses in absolute amount to remain at or increase beyond the
amounts incurred during the three months ended September 30, 1998.
INTEREST INCOME. Interest income totaled $482,000 for the three months
ended September 30, 1998 compared to $202,000 for the same period in the prior
year. Interest income increased as a result of higher average cash and
investment balances on hand due to the completion of a follow-on public equity
offering in September 1997. The Company expects interest income to gradually
decline in absolute amount in future periods as the Company utilizes its
resources to fund future working capital requirements.
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<PAGE>
OTHER INCOME (EXPENSE), NET. Other income (expense) totaled $178,112 and
($5,000) during the three months ended September 30, 1998 and 1997,
respectively. For each of these periods, other income (expense) consisted
primarily of net gains and losses resulting from foreign currency fluctuations.
The Company expects other income (expense) to fluctuate in future periods
depending upon the mix between international and domestic business activities
and upon fluctuations in currency exchange rates.
INCOME TAXES. 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 expense
or 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
Since its inception, the Company has financed its operations primarily
through public and private placements of its securities. The Company had no
short-or long-term borrowings outstanding at September 30, 1998, 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 sales
and marketing activities, 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 maintaining and broadening reimbursement approval from
government and third-party payors as well as receiving market acceptance for the
NCP System.
During the quarter ended September 30, 1998, the Company used approximately
$7.8 million in operating activities. Accounts receivables decreased to $4.8
million, from $5.9 million at June 30, 1998. Inventories increased to $4.1
million at September 30, 1998 from $2.1 million at June 30, 1998 as the Company
built inventory levels in anticipation of higher levels of manufacturing and
sales activities. The Company also reduced current liabilities to $4.8 million
at September 30, 1998 from $7.9 million at June 30, 1998.
The Company's liquidity will continue to be reduced as amounts are expended
for sales and marketing activities, manufacturing expansion, continuing clinical
trials and related regulatory affairs, product and process development and
infrastructure development. Although the Company has no firm commitments, the
Company expects to make capital expenditures of approximately $3.1 million
during the remainder of fiscal 1999, primarily to expand manufacturing
capabilities and to enhance general infrastructure and facilities.
The Company believes that its current resources will be sufficient to fund
its operations at least through June 30, 2000. This estimate is based on
certain assumptions, which may not hold true. There can be no assurance that the
Company's available cash, cash equivalents, investment securities and investment
income, will be sufficient to meet the Company's capital requirements at least
through June 30, 2000. 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.
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<PAGE>
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
See Note 5 of Notes to Consolidated Financial Statements for a discussion
of the impact of new accounting pronouncements.
IMPACT OF YEAR 2000
Many currently installed computer systems and software products were coded
using two digits rather than four to define the applicable year. As a result,
these computer systems and software products have time-sensitive software that
recognize a date using "00" as the year 1900 rather than the year 2000. This
could cause a system failure or miscalculations, causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, to send invoices, or to engage in similar normal business
activities. Finally, computer systems and software products devices may fail to
process accurately leap year logic associated with the Year 2000.
STATE OF READINESS
The Company believes that the adverse impact of Year 2000 issues on its
internal computer systems will not be material. Most of the personal computers
and computer systems used by the Company have been installed in the past three
years as the Company has been growing its organization. The Company has also
recently moved most of its organization to a new facility in Houston, Texas, and
has installed new equipment in connection with such relocation. The Company has
conducted a manual review of all of its software, except for its manufacturing
systems and the telephone system at its Webster manufacturing facility, and
found the incidence of Year 2000 coding issues to be minimal. The Company
continues to manufacture the NCP System at its Webster, Texas facility, but is
in the process of establishing manufacturing capacity at the Houston facility,
which is expected to be completed in fiscal 1999. The Company is in the process
of evaluating its manufacturing software for Year 2000 compliance, including
systems used at the Webster facility as well as the systems being implemented at
the Houston facility, however, it does not expect that any necessary changes to
its software will be material. In addition, if the Company continues to
manufacture its product at the Webster facility, it intends to test the
telephone system at that location to determine if it is Year 2000 compliant.
The Company has also contacted each of its material vendors and suppliers to
determine if such vendors or suppliers have any Year 2000 compliance issues that
have not been resolved, or may not be resolved in a timely manner.
The Company's software used by customers to program the NCP Generator does
not utilize dating in its processing calculations.
COSTS OF YEAR 2000 COMPLIANCE
The Company does not expect expenditures for upgrades and testing for Year
2000 issues of software used on internal systems to be material. To date, any
such costs incurred have been in connection with the implementation of systems
at its new facility and the purchase of equipment and software for its growing
employee base. The Company estimates that, in the worst case, it may have to
upgrade certain of its manufacturing databases, replace the telephone system at
the Webster location, and replace certain older personal computers currently
being used. The costs of such activities are estimated to be under $100,000.
The Company expects to complete its testing, and any required upgrades by mid
calendar 1999. The Company also does not expect diversion of resources from
other management information systems or manufacturing projects will have a
material adverse impact on the Company.
RISKS OF YEAR 2000 NON-COMPLIANCE AND CONTINGENCY PLANS
In the event of a failure of any software or other electronic devices used
for the Company's internal systems, the Company believes any resulting business
disruption would not have a material adverse effect on the Company, because the
Company believes alternative, less technologically advanced, systems would be
available. The Company
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<PAGE>
is also contacting its vendors and suppliers currently to determine if a further
contingency plan will be needed to ensure timely receipt of materials and
services from such vendors and suppliers.
The costs of the modifications and the date on which the Company believes
it will complete the Year 2000 modifications, if any, are based on management's
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources and other factors.
However, there can be no guarantee that these estimates will be achieved, and
actual results could differ from those anticipated. Factors that might cause
such differences include, but are not limited to, the availability and cost of
personnel trained in this area, the ability to locate and correct all relevant
computer code, and similar uncertainties.
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 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 in the United States and Canada since mid 1997, it has only
recently initiated 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. Continued 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 over 2,500 patients through
September 30, 1998, 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 of 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 $68.0 million through September 30, 1998. 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
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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 at adequate levels for the costs of the NCP System
and the related services.
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. 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 different payment mechanisms to reimburse
for procedures performed in different settings. For outpatient implants,
Medicare uses a system that reimburses hospitals based on their costs. The
Company believes that those payments generally are adequate. For inpatient
implants, Medicare uses a fixed-payment method (based on Diagnosis Related
Groups or "DRGs"). 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 may 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. Medicare uses a resource-based relative value scale to
pay for physicians' services. The Company believes that the relative value
scales for the surgeons and physicians involved in the implantation and
interrogation and reprogramming of the NCP System provide adequate reimbursement
for these physicians' services.
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
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<PAGE>
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 only received FDA approval to commercialize the NCP System in the
United States in July 1997 and, consequently, it has limited experience in
marketing, direct sales and distribution. The Company has recently expanded its
marketing and sales force for the United States market, but no assurance can be
given that this expanded direct marketing and sales force will succeed in
promoting the NCP System to patients, health care providers or third-party
payors on a broad basis. The Company believes that, to market its products
directly, it must employ a multidisciplinary marketing and sales force with
medical device sales experience, clinical experience with epilepsy, experience
in obtaining reimbursement for new medical technologies and experience with peer
to peer marketing programs. In addition, due to the limited market awareness of
the NCP System, the Company believes that it is necessary for the Company to
educate patients, health care providers and third-party payors regarding the
clinical benefits and cost-effectiveness of the NCP System. In certain
international territories, 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.
LIMITED MANUFACTURING EXPERIENCE. The Company has a limited history of
manufacturing the NCP System. The Company does not have experience
manufacturing the NCP System in the volumes that will be necessary to achieve
significant commercial sales. In addition to its existing manufacturing
facility, the Company is in the process of moving its manufacturing
operations to a new facility, where it expects to begin production in
calendar 1999. 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 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. There can be no assurance that the Company will
be able to obtain the necessary FDA and other approvals for its new
facilities on a timely basis, or at all. 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. 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.
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.
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<PAGE>
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 to minimize the occurrence of these problems. 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.
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.
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.
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. continues to clinically assess 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. 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
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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.
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
and in 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.
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.
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.
FUTURE CAPITAL REQUIREMENTS. Although the Company believes that its
current resources will be sufficient to meet its capital requirements at least
through June 30, 2000, 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. There can be no assurance
that 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, 2000. 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
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<PAGE>
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 focusing its marketing and sales activities
in certain 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
rates, 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.
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<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the
quarter ended September 30, 1998.
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<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CYBERONICS, INC.
Registrant
BY: /s/ Pamela B. Westbrook
-----------------------------------
Pamela B. Westbrook
Vice President, Finance and
Administration and Chief Financial
Officer (principal financial and
accounting officer)
Dated: November 12, 1998
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