<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal quarter ended: March 31, 1998 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ________________ to ________________
Commission file number: 0-19806
CYBERONICS, INC.
(Exact name of registrant as specified in its charter)
Delaware 76-0236465
------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
16511 Space Center Boulevard, Ste. 600
Houston, Texas 77062
------------------------------- ----------------
(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 MAY 8, 1998
Common Stock - $0.01 par value 17,238,950
================================================================================
<PAGE> 2
CYBERONICS, INC.
INDEX
<TABLE>
<CAPTION>
Page No.
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets
March 31, 1998 (unaudited) and June 30, 1997.....................3
Consolidated Statements of Operations (unaudited)
three and nine months ended March 31, 1998 and 1997..............4
Consolidated Statements of Cash Flows (unaudited)
nine months ended March 31, 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>
-2-
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CYBERONICS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
1998 1997
------------- -------------
<S> <C> <C>
ASSETS (unaudited)
Current Assets:
Cash and cash equivalents ...................................... $ 285,914 $ 781,639
Securities held to maturity .................................... 41,848,121 7,129,409
Accounts receivable, net ....................................... 4,981,095 548,542
Inventories .................................................... 1,376,302 1,005,356
Prepaid expenses ............................................... 725,862 126,799
------------- -------------
Total current assets ................................ 49,217,294 9,591,745
Securities held to maturity ...................................... 2,283,339 212,408
Property and equipment, net ...................................... 1,634,054 362,333
Other assets, net ................................................ 146,933 83,251
------------- -------------
$ 53,281,620 $ 10,249,737
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ............................................... $ 1,717,474 $ 365,351
Accrued liabilities ............................................ 3,158,048 1,462,914
------------- -------------
Total current liabilities ........................... 4,875,522 1,828,265
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;
17,020,056 and 13,322,175 shares issued and outstanding at
March 31, 1998 and June 30, 1997, respectively ............... 170,021 133,222
Additional paid-in capital ..................................... 106,588,766 57,338,856
Deferred compensation .......................................... (73,788) (63,750)
Accumulated deficit ............................................ (58,260,774) (49,167,002)
Cumulative translation adjustments ............................. (18,127) 180,146
------------- -------------
Total stockholders' equity .......................... 48,406,098 8,421,472
------------- -------------
$ 53,281,620 $ 10,249,737
============= =============
</TABLE>
See accompanying notes to financial statements.
-3-
<PAGE> 4
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE FOR THE NINE
MONTHS ENDED MONTHS ENDED
MARCH 31, MARCH 31,
------------------------------- -------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales ............................. $ 5,172,735 $ 288,979 $ 9,611,465 $ 1,011,740
Cost of sales ......................... 1,325,607 72,669 2,572,876 300,341
------------ ------------ ------------ ------------
Gross profit .......................... 3,847,128 216,310 7,038,589 711,399
Operating expenses:
Research and development .......... 1,785,383 1,521,472 5,387,405 4,892,387
Selling, general and administrative 4,259,654 1,818,264 12,059,587 3,662,438
------------ ------------ ------------ ------------
Total operating expenses ...... 6,045,037 3,339,736 17,446,992 8,554,825
------------ ------------ ------------ ------------
Loss from operations .................. (2,197,909) (3,123,426) (10,408,403) (7,843,426)
Interest income, net .................. 481,890 62,978 1,252,375 317,513
Other income (expense) ................ 37,572 10,420 62,256 (12,862)
------------ ------------ ------------ ------------
Net loss .............................. $ (1,678,447) $ (3,050,028) $ (9,093,772) $ (7,538,775)
============ ============ ============ ============
Net loss per share .................... $ (0.10) $ (0.26) $ (0.58) $ (0.65)
============ ============ ============ ============
Shares used in computing
net loss per share .................. 16,857,559 11,824,121 15,742,549 11,601,845
============ ============ ============ ============
</TABLE>
See accompanying notes to financial statements.
-4-
<PAGE> 5
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
MARCH 31,
-------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash Flow From Operating Activities:
Net loss .................................................. $ (9,093,772) $ (7,538,775)
Non-cash items included in net loss:
Depreciation and amortization ........................... 246,075 144,615
Compensation expense related to certain stock options and
common stock issuances ................................ 63,108 28,584
Change in operating assets and liabilities:
Accounts receivable ..................................... (4,432,553) (31,076)
Inventories ............................................. (370,946) (342,784)
Prepaid expenses ........................................ (599,063) 148,622
Accounts payable and accrued liabilities ................ 3,047,257 (796,148)
------------ ------------
Net Cash Used In Operating Activities ............... (11,139,894) (8,386,962)
Cash Flow From Investing Activities:
Purchases of property and equipment ....................... (1,517,796) (202,946)
Purchases of investments .................................. (51,907,969) (7,004,036)
Maturities of investments ................................. 15,118,326 2,356,572
------------ ------------
Net Cash Used In Investing Activities ............... (38,307,439) (4,850,410)
Cash Flow From Financing Activities:
Proceeds from issuance of Common Stock, net ............... 49,213,563 18,018,402
Other ..................................................... (63,682) (71,275)
------------ ------------
Net Cash Provided By Financing Activities ........... 49,149,881 17,947,127
Effect of exchange rate changes on cash and cash equivalents (198,273) (45,538)
------------ ------------
Net (decrease) increase in cash and cash equivalents (495,725) 4,664,217
Cash and cash equivalents, at beginning of period ........... 781,639 2,121,930
------------ ------------
Cash and cash equivalents, at end of period ................. $ 285,914 $ 6,786,147
============ ============
</TABLE>
See accompanying notes to financial statements.
-5-
<PAGE> 6
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 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 nine months ended March 31, 1998 are
not necessarily indicative of the results that may be expected for the full year
ending June 30, 1998. 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/A for the year
ended June 30, 1997.
NOTE 2 - INVESTMENT SECURITIES:
At March 31, 1998 and June 30, 1997, 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 over the next 18 months and have a fair market value of
$43,644,602 and a gross unrealized holding loss of $486,858 at March 31, 1998.
NOTE 3 - INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
MARCH 31, 1998 JUNE 30, 1997
---------- ----------
(unaudited)
<S> <C> <C>
Raw materials and components . $ 613,221 $ 454,122
Work-in-process .............. 477,449 206,282
Finished goods ............... 285,632 344,952
---------- ----------
$1,376,302 $1,005,356
========== ==========
</TABLE>
NOTE 4 - ACCRUED LIABILITIES:
Accrued liabilities are as follows:
<TABLE>
<CAPTION>
MARCH 31, 1998 JUNE 30, 1997
-------------- -------------
(unaudited)
<S> <C> <C>
Professional services ........ $ 548,373 $ 114,800
Clinical costs ............... 377,377 688,271
Payroll and other compensation 1,032,312 219,288
Warranties ................... 375,000 231,808
Marketing activities ......... 300,000 58,562
Royalties .................... 484,322 46,320
Customer deposits ............ -- 18,364
Other ........................ 40,664 85,501
---------- ----------
$3,158,048 $1,462,914
========== ==========
</TABLE>
-6-
<PAGE> 7
NOTE 5 - NET LOSS PER SHARE:
In March 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share," and
Cyberonics has adopted the provisions of the new statement. Statement No. 128
requires retroactive revision of the presentation of net loss per share in
historical financial statements; however, the Company's net loss per share
previously presented in its historical financial statements are the same as
those had basic net loss per share under Statement No. 128 been presented.
Additionally, net loss per share as presented herein are also the same as those
had diluted net loss per share under the provisions of Statement No. 128 been
presented, since the Company's outstanding stock options would not have been
included in the calculation of shares outstanding because their effect would
have been anti-dilutive.
-7-
<PAGE> 8
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/A 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 that 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 minimal 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 March 31, 1998, the Company
incurred a cumulative net deficit of approximately $58.3 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 for the NCP System from
the various third-party payment systems in the United States and in key
international markets. To date, the NCP System has been reimbursed by certain
payors in the United States and by certain payment authorities in a limited
number of international markets. Achievement of future sales growth, both in the
United States and internationally, is dependent upon the Company's ability to
maintain and broaden its reimbursement for the NCP System.
The Company has made significant investments in recent periods in
connection with the United States market launch of the NCP System and, to a
lesser extent, in connection with efforts to expand its presence in
international markets. The Company has not been profitable to date, and expects
to remain unprofitable through at least the remainder of the fiscal year ending
June 30, 1998. Moreover, the Company expects to substantially increase the level
operating expenses (primarily sales and marketing and, to a lesser extent,
clinical trial expenses) for the remainder of fiscal 1998 and through fiscal
1999 in an effort to accelerate the rate of market awareness and acceptance of
the NCP System. The Company expects that there will be delays between the
initiation of higher spending levels and increased revenues that may result from
such increased spending. Moreover, once initiated, many of these expenses will
be fixed in nature. As a result, if revenues do not increase substantially over
-8-
<PAGE> 9
the levels achieved in recent periods, the Company will continue to experience
substantial operating losses, potentially at levels exceeding the levels
experienced in recent periods, and the point at which the Company achieves
profitability would be delayed beyond the current expectations of securities
analysts. Furthermore, even if the levels of revenues increase substantially,
there can be no assurance that the Company will become profitable when expected
to do so or at all or, even if it becomes profitable, that it will remain so in
future periods.
In addition to the foregoing, the Company believes that it's results of
operations may fluctuate significantly from quarter to quarter based 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, the extent to which third-party payors approve
reimbursement for the NCP System, 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 that may be dependent on the
Company's ability to forecast sales and ability to achieve acceptable
manufacturing yields and costs.
RESULTS OF OPERATIONS
Net Sales. Net sales for the three months ended March 31, 1998 increased
1,690% to $5.2 million compared to $289,000 for the three months ended March 31,
1997. Net sales for the nine months ended March 31, 1998 increased 850% to $9.6
million compared to $1.0 million in the prior year period. Net sales for the
three months ended March 31, 1998 consisted of $4.4 million from the United
States and $730,000 from international markets. Net sales for the three months
ended March 31, 1997 were attributable entirely to the Company's international
markets. Net sales for the nine month period ended March 31, 1998 consisted of
$7.7 million from the United States and $1.9 million from international markets.
Substantially all of the Company's net sales for the nine months ended March 31,
1997 were attributable to international markets.
The substantial increases in the three and nine month periods ended
March 31, 1997 are a result of the Company receiving FDA approval to market the
NCP System in the United States in July 1997 and the resulting sales into the
United States market. Prior to receiving FDA approval to market the NCP System
in the United States, domestic sales were limited exclusively to reimbursements
related to the Company's clinical trials activities. While the Company expects
to conduct additional clinical trial activities in the United States and
internationally and may seek reimbursement in connection with such studies, the
Company does not expect such reimbursement revenues to be significant in future
periods. Future increases in net sales will be dependent upon increased market
acceptance for the NCP System and upon expanding its reimbursement from
third-party payors. The Company is devoting substantial resources to increasing
the awareness and market acceptance of the NCP System, particularly in the
United States. The Company believes, however, that there will be delays between
increased sales and marketing activities and any resulting increase in revenues.
As a result, the Company expects to achieve little, if any, quarter-to-quarter
revenue growth in the fourth quarter of fiscal 1998. Furthermore, there can be
no assurance that net sales levels in subsequent periods will increase at the
rates experienced in recent periods or at all.
Gross Profit. Cost of sales consist primarily of direct labor, allocated
manufacturing overhead, third-party contractor costs, the acquisition cost of
raw materials and components and royalty payments. The Company's gross margin
was 74.4% for the three months ended March 31, 1998 compared to 74.9% in the
prior year period. The Company's gross margin for the nine months ended March
31, 1998 was 73.2% compared to 70.3% in the prior year period. During the three
months ended March 31, 1998, the Company incurred royalty expenses of
approximately $300,000. The Company is obligated to pay royalties at a rate of
approximately 4% of net sales in future periods. Gross margins 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, applicable royalty rates and levels of production volume.
-9-
<PAGE> 10
Research and Development Expenses. Research and development expenses are
comprised of both expenses related to the Company's product and process
development efforts, design efforts and expenses associated with conducting
clinical trials and certain related regulatory activities. Research and
development expenses were $1.8 million, or 34.5% of net sales, for the three
months ended March 31, 1998 compared to $1.5 million, or 526.5% of net sales, in
the prior year period. Research and development expenses were $5.4 million, or
56.1% of net sales, and $4.9 million, or 483.6% of net sales, during the nine
months ended March 31, 1998 and 1997, respectively. The increase in research and
development spending in absolute amount from period to period reflects
heightened levels of product design and development activity and manufacturing
process improvement efforts, combined with increased clinical and regulatory
staffing in preparation for future clinical study activities. The decrease in
such expenses as a percentage of net sales results from the rapid increase in
sales following FDA approval to sell the NCP System in the United States. 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 both absolute amount and as a percent of net sales in future periods
depending primarily upon the level of such clinical trial activity.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses totaled $4.3 million, or 82.3% of net sales, for the
three months ended March 31, 1998 compared to $1.8 million, or 692.2% of net
sales, for the three months ended March 31, 1997. Selling, general and
administrative expenses totaled $12.1 million, or 125.5% of net sales, and $3.7
million, or 362.0% of net sales, during the nine months ended March 31, 1998 and
1997, respectively. The increase in the absolute amount of selling, general and
administrative expenses in the third fiscal quarter of the current year compared
to the prior year period was primarily due to sales and marketing activities
focused on the United States market launch for the NCP System and to a lesser
extent to the continued expansion of corporate infrastructure in response to the
recent and potential future business expansion. 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 and expects to add further sales and marketing personnel during fiscal
1998 and 1999. The Company also expects to continue to add administrative
personnel in response to the recent and potential future business expansion.
Accordingly, the Company expects its future selling, general and administrative
expenses to increase in absolute amount from the amounts incurred during the
three months ended March 31, 1998. In addition, the Company expects such
expenses to increase as a percentage of net sales in the near term as the
Company seeks to rapidly increase its sales and marketing activities and given
the customary delays between increased sales and marketing expenditures and any
increase in revenues.
Interest Income, Net. Net interest income totaled $482,000 and $63,000
during the three months ended March 31, 1998 and 1997, respectively, and $1.3
million and $318,000 for the nine months ended March 31, 1998 and 1997,
respectively. Interest income increased as a result of higher average cash and
investment balances on hand due to investment of the proceeds from a private
placement of Common Stock completed in March 1997 and from the Company's
follow-on public equity offering completed in October 1997. The Company expects
interest and other income to gradually decline in absolute amount in future
periods as the Company utilizes its resources to fund future working capital
requirements.
Other Income (Expense), Net. Other income (expense), totaled $38,000 and
$10,000 during the three months ended March 31, 1998 and 1997, respectively, and
$62,000 and $(13,000) for the nine months ended March 31, 1998 and 1997,
respectively. Other income consists of net gains and losses resulting from
foreign currency transactions. The Company expects other income (expense) to
fluctuate in future periods depending
-10-
<PAGE> 11
upon the mix between international and domestic business activities and upon
fluctuations in currency exchange rates.
Income Taxes. The Company has historically operated at a loss, and has
not incurred material 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
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 Medical, Inc. 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. In October
1997, the Company completed a public equity offering of 3,225,000 shares of its
Common Stock, generating net proceeds of approximately $47.7 million.
Additionally, through March 31, 1998, 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 March 31, 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 its 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 nine months ended March 31, 1998, the Company used
approximately $11.1 million in cash in operating activities. During the period,
accounts receivable increased to $5.0 million from $549,000 at June 30, 1997
reflecting the higher level of sales, and inventories increased to $1.4 million
from $1.0 million at June 30, 1997 as the Company continued to build inventory
levels in anticipation of higher levels of manufacturing and sales activities.
During the nine months ended March 31, 1998, the Company raised approximately
$47.7 million from the sale of Common Stock in a public equity offering and
received additional proceeds of approximately $1.6 million related to issuance
of its shares, primarily from the exercise of employee stock options.
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, product
and process development, and infrastructure development. Although the Company
has no firm commitments, the Company expects to make capital expenditures of
approximately $700,000 during the remainder of fiscal 1998 and
-11-
<PAGE> 12
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 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. 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, 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, if needed, or that the terms upon which capital
will be available will be favorable to the Company.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
The Company's future operating results can be expected to vary based
upon a number of factors, including those described below.
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 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. Continued development of market
acceptance for 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 2,000 patients through March 31, 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 $56.6 million through December 31, 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
-12-
<PAGE> 13
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 compare 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 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-
-13-
<PAGE> 14
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 in obtaining new DRG assignments. 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.
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 on a broad basis. 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.
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. In addition to its existing manufacturing
facility, the Company has recently entered into a lease for a new facility, and
intends to begin manufacturing product for the international market from this
facility in mid-calendar 1998, and further expects this facility to begin
production of U.S. product in early calendar 1999. 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 additional 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.
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
-14-
<PAGE> 15
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.
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.
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.
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
-15-
<PAGE> 16
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. 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 that 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.
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 ability 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
-16-
<PAGE> 17
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, 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 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.
-17-
<PAGE> 18
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 March 31, 1998.
-18-
<PAGE> 19
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/ JOHN K. BAKEWELL
------------------------------------
John K. Bakewell
Vice President, Finance and
Administration and Chief Financial
Officer (principal financial and
accounting officer)
Dated: May 14, 1998
<PAGE> 20
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> MAR-31-1998
<CASH> 285,914
<SECURITIES> 44,131,460
<RECEIVABLES> 4,981,095
<ALLOWANCES> 422,195
<INVENTORY> 1,376,302
<CURRENT-ASSETS> 49,217,294
<PP&E> 1,634,054
<DEPRECIATION> 1,905,025
<TOTAL-ASSETS> 53,281,620
<CURRENT-LIABILITIES> 4,875,522
<BONDS> 0
0
0
<COMMON> 170,021
<OTHER-SE> 48,236,077
<TOTAL-LIABILITY-AND-EQUITY> 53,281,620
<SALES> 9,611,465
<TOTAL-REVENUES> 9,611,465
<CGS> 2,572,876
<TOTAL-COSTS> 20,019,868
<OTHER-EXPENSES> (37,572)
<LOSS-PROVISION> 422,195
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (9,093,772)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,093,772)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,093,772)
<EPS-PRIMARY> (.58)
<EPS-DILUTED> 0
</TABLE>
