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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: December 31, 1997 or
- --- Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ________________ to ________________
Commission file number: 0-19806
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 Boulevard, Ste. 600
Houston, Texas 77062
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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 FEBRUARY 2, 1998
Common Stock - $0.01 par value 16,834,353
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CYBERONICS, INC.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
--------
<S> <C>
Item 1 Financial Statements:
Consolidated Balance Sheets December 31, 1997
(unaudited) and June 30, 1997 . . . . . . . . . . . . . . .3
Consolidated Statements of Operations (unaudited) three
and six months ended December 31, 1997 and 1996 . . . . . .4
Consolidated Statements of Cash Flows (unaudited) six
months ended December 31, 1997 and 1996 . . . . . . . . . .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>
DECEMBER 31, JUNE 30,
1997 1997
------------ ----------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................... $ 18,094,794 $ 781,639
Securities held to maturity......................... 27,666,432 7,129,409
Accounts receivable, net............................ 2,627,004 548,542
Inventories......................................... 1,212,688 1,005,356
Prepaid expenses.................................... 392,152 126,799
------------ ------------
TOTAL CURRENT ASSETS...................... 49,993,070 9,591,745
Securities held to maturity............................ 1,539,309 212,408
Property and equipment, net............................ 877,018 362,333
Other assets, net...................................... 147,262 83,251
------------ ------------
$ 52,556,659 $ 10,249,737
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------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.................................... $ 662,509 $ 365,351
Accrued liabilities................................. 3,053,203 1,462,914
------------ ------------
TOTAL CURRENT LIABILITIES................. 3,715,712 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; 16,637,999 and 13,322,175
shares issued and outstanding at
December 31, 1997 and June 30, 1997, respectively.. 166,380 133,222
Additional paid-in capital.......................... 105,261,253 57,338,856
Deferred compensation............................... (54,188) (63,750)
Accumulated deficit................................. (56,582,327) (49,167,002)
Cumulative translation adjustments.................. 49,829 180,146
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TOTAL STOCKHOLDERS' EQUITY................ 48,840,947 8,421,472
------------ ------------
$ 52,556,659 $ 10,249,737
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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 FOR THE SIX
MONTHS ENDED MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------------- -------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales.................................. $ 3,335,496 $ 437,818 $ 4,438,730 $ 722,761
Cost of sales.............................. 925,395 158,381 1,247,269 227,672
----------- ----------- ----------- -----------
Gross profit............................... 2,410,101 279,437 3,191,461 495,089
Operating expenses:
Research and development............... 1,625,490 1,943,930 3,602,022 3,370,915
Selling, general and administrative.... 3,840,708 1,033,924 7,799,933 1,844,174
----------- ----------- ----------- -----------
Total operating expenses........... 5,466,198 2,977,854 11,401,955 5,215,089
----------- ----------- ----------- -----------
Loss from operations....................... (3,056,097) (2,698,417) (8,210,494) (4,720,000)
Interest income, net....................... 568,224 107,208 770,485 254,535
Other income (expense)..................... 29,746 (105,017) 24,684 (23,282)
----------- ----------- ----------- -----------
Net loss................................... $(2,458,127) $(2,696,226) $(7,415,325) $(4,488,747)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Net loss per share......................... $ (0.15) $ (0.23) $ (0.49) $ (0.39)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Shares used in computing
net loss per share....................... 16,549,150 11,765,178 15,185,045 11,490,707
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
See accompanying notes to financial statements.
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CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
DECEMBER 31,
--------------------------
1997 1996
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<S> <C> <C>
Cash Flow From Operating Activities:
Net loss......................................................................... $(7,415,325) $(4,488,747)
Non-cash items included in net loss:
Depreciation and amortization................................................. 152,246 91,591
Compensation expense related to certain stock options and
common stock issuances.................................................... 9,562 4,460
Change in operating assets and liabilities:
Accounts receivable........................................................... (2,078,462) (42,615)
Inventories................................................................... (207,332) (302,558)
Prepaid expenses.............................................................. (265,353) 115,392
Accounts payable and accrued liabilities...................................... 1,887,447 (982,043)
----------- ----------
Net Cash Used In Operating Activities..................................... (7,917,217) (5,604,520)
Cash Flow From Investing Activities:
Purchases of property and equipment.............................................. (666,931) (111,688)
Purchases of investments......................................................... (29,326,711) (5,834,668)
Maturities of investments........................................................ 7,462,787 1,590,000
----------- ----------
Net Cash Used In Investing Activities..................................... (22,530,855) (4,356,356)
Cash Flow From Financing Activities:
Proceeds from issuance of Common Stock, net...................................... 47,955,555 11,206,786
Other............................................................................ (64,011) (72,190)
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Net Cash Provided By Financing Activities................................. 47,891,544 11,134,596
Effect of exchange rate changes on cash and cash equivalents........................ (130,317) 55,446
----------- ----------
Net increase in cash and cash equivalents................................. 17,313,155 1,229,166
Cash and cash equivalents, at beginning of period................................... 781,639 2,121,930
----------- ----------
Cash and cash equivalents, at end of period......................................... $18,094,794 $3,351,096
----------- ----------
----------- ----------
</TABLE>
See accompanying notes to financial statements.
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CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
DECEMBER 31, 1997
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 six months ended December 31, 1997 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 December 31, 1997 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 $29,309,651 and a gross unrealized holding gain of
$103,910 at December 31, 1997.
NOTE 3 - INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 JUNE 30, 1997
----------------- -------------
(Unaudited)
<S> <C> <C>
Raw materials and components........ $ 707,410 $ 454,122
Work-in-process..................... 309,117 206,282
Finished goods...................... 196,161 344,952
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$1,212,688 $1,005,356
---------- ----------
---------- ----------
</TABLE>
NOTE 4 - ACCRUED LIABILITIES:
Accrued liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 JUNE 30, 1997
----------------- -------------
(Unaudited)
<S> <C> <C>
Professional services................. $ 682,900 $ 114,800
Clinical costs........................ 677,377 688,271
Payroll and other compensation........ 666,405 219,288
Warranties............................ 375,000 231,808
Marketing activities.................. 299,129 58,562
Royalties............................. 258,391 46,320
Customer deposits..................... -- 18,364
Other................................. 94,001 85,501
---------- ----------
$3,053,203 $1,462,914
---------- ----------
---------- ----------
</TABLE>
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NOTE 5 - STOCKHOLDERS' EQUITY:
In September 1997, the Company issued 3,000,000 shares of its Common
Stock in a public offering, generating net proceeds of approximately $44.3
million after deducting commissions and offering costs. In October 1997, the
Company issued an additional 225,000 shares of its Common Stock upon the
exercise of a portion of the underwriter's over-allotment option related to
the Company's public offering. Proceeds from the issuance totaled
approximately $3.4 million after deducting commissions and offering costs.
NOTE 6 - 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.
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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/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 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 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 December 31, 1997, the
Company incurred a cumulative net deficit of approximately $56.6 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 health care provider systems in the United States and in key
international markets. To date, the NCP System has been reimbursed by
certain providers 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 existing level of reimbursement
for the NCP System.
The Company expects to incur substantial costs related to sales and
marketing activities associated with United States and international market
entry, expansion of manufacturing capabilities, clinical trials and
regulatory activities and product and process development. It is expected
that there will continue to be a delay between the increased levels of
spending and resulting increases in revenues for the remainder of fiscal
1998. Accordingly, the Company expects to remain unprofitable through at
least the remainder of the fiscal year ending June 30, 1998. 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
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<PAGE>
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.
RESULTS OF OPERATION
NET SALES. Net sales for the three months ended December 31, 1997
totaled $3.3 million compared to $438,000 for the three months ended
December 31, 1996, representing an overall increase of 662%. Net sales for
the six months ended December 31, 1997 totaled $4.4 million compared to
$723,000 in the same period of the prior year. Net sales for the three
months ended December 31, 1997 consisted of $627,000 from international
markets and $2.7 million from the United States. The substantial majority of
net sales for the three months ended December 31, 1996 were attributable to
the Company's international markets. In July 1997, the Company received FDA
approval to market the NCP System in the United States. The Company's
domestic net sales for the six months ended December 31, 1997 were generated
entirely from commercial sales activities following FDA approval. Domestic
sales activities in previous quarters had been limited exclusively to
reimbursements related to the Company's clinical trials activities. While
such clinical trial reimbursements may continue in future periods, the
Company expects that the substantial majority of future domestic net sales
will be derived from commercial sources. 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 72.3% for the
three months ended December 31, 1997 compared to 63.8% in the prior year
period. 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, ranging from 7% to 7.75% on the first $12 million in
cumulative net sales and from 4% to 4.75% thereafter. Royalties which are
included in cost of sales during the three months ended December 31, 1997.
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, applicable royalty rates 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, design efforts and expenses associated with conducting
clinical trials and certain related regulatory activities. Research and
development expenses totaled $1.6 million for the three months ended December
31, 1997 compared to $1.9 million in the prior year period. Research and
development expenses were $3.6 million and $3.4 million during the six months
ended December 31, 1997 and 1996, respectively. The decrease from period to
period reflects decreased levels of clinical and regulatory costs related to
FDA approval activities versus the year-ago period, offset to a substantial
degree by product design and development efforts. 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 $3.8 million for the three months ended
December 31, 1997 compared to $1.0 million for the three months ended
December 31, 1996. Selling, general and administrative expenses totaled $7.8
million and $1.8 million during the six months ended December 31, 1997 and
1996, respectively. The increase in the second quarter versus the prior year
period was primarily due to United States market launch activities for the
NCP System and to the continued
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<PAGE>
expansion of international market development efforts. 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. The Company also expects to add administrative
personnel in anticipation of higher levels of business activity.
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 December 31, 1997.
INTEREST INCOME, NET. Net interest income totaled $568,000 and $107,000
during the three months ended December 31, 1997 and 1996, respectively, and
$770,000 and $255,000 for the six months ended December 31, 1997 and 1996,
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 that the investment of proceeds from the Company's follow-on
public equity offering will continue to generate investment income in future
quarters.
OTHER INCOME (EXPENSE), NET. Other income (expense), totaled $30,000
and $(105,000) during the three months ended December 31, 1997 and 1996,
respectively, and $25,000 and $(23,000) for the six months ended December 31,
1997 and 1996, respectively. Other income consists of net gains and losses
resulting from foreign currency transactions.
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 December 31,
1997, the Company has funded approximately $530,000 of its equipment needs
with proceeds from an equipment lease agreement. The Company had no short-
or long-term borrowings outstanding at December 31, 1997, and had no credit
facilities available at that time.
The Company expects to incur substantial additional costs related to
sales and marketing activities associated with United States and
international market entry, expansion of manufacturing capabilities, clinical
trials and regulatory activities and product and process development. The
amount and timing of anticipated expenditures will depend upon numerous
factors both within and outside of the Company's control, including the
nature and timing of marketing and sales activities and the nature and timing
of additional clinical trials for additional indications, both within and
outside the field of epilepsy. Moreover, the Company's ability to generate
income from operations will be dependent upon maintaining and broadening
reimbursement approval from government and third-party payors as well as
receiving market acceptance for the NCP System.
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During the six months ended December 31, 1997, the Company used
approximately $7.9 million in cash in operating activities. During the
period, accounts receivable increased to $2.6 million from $549,000 at June
30, 1997 reflecting the higher level of sales, and inventories increased to
$1.2 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 six months ended December 31, 1997, the Company
raised approximately $47.7 million from the sale of Common Stock in a public
equity offering.
The Company's liquidity will continue to be reduced as amounts are
expended for expansion of sales and marketing activities, manufacturing
expansion, continuing clinical trials and related regulatory affairs, and
product and process development. Although the Company has no firm
commitments, the Company expects to make capital expenditures of
approximately $1.0 million during the remainder of fiscal 1998 and
approximately $3.0 million in fiscal 1999, primarily to expand manufacturing
capabilities and to enhance general infrastructure and facilities.
The Company believes that its current resources 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 1,500 patients through December 31, 1997, it
provides a new form of therapy with which many physicians are unfamiliar.
The Company believes that existing AEDs and surgery are the only other
approved and currently available therapies competitive with the NCP System in
the treatment of epileptic seizures. Such therapies may be more attractive
to patients or their physicians than the NCP System in terms of efficacy,
cost or reimbursement availability. There can be no assurance that the NCP
System will achieve market acceptance for the treatment of epilepsy or for
any other indication or that adequate levels of reimbursement from
governmental or third-party payors will be available. Failure of the NCP
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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 internationally. Even with these marketing approvals,
there can be no assurance that the Company will be able to generate adequate
sales to achieve profitability in the future. In addition, in order to
develop these markets, the Company will incur substantial marketing and sales
expenses. The amount and timing of anticipated expenditures will depend on
numerous factors, including the nature and timing of marketing and sales
activities, the expansion of the Company's manufacturing capabilities, the
nature and timing of additional clinical trials, and the Company's product
development efforts.
The Company's results of operations may fluctuate significantly from
quarter to quarter and will depend upon numerous factors, many of which are
outside the Company's control. Such factors include, but are not limited to,
the extent to which the Company's NCP System gains market acceptance, timing
of any approvals for reimbursement by third-party payors, the rate and size
of expenditures incurred as the Company expands its sales and marketing
efforts and availability of key components, materials and contract services
which may be dependent on the Company's ability to forecast sales.
LIMITATIONS ON THIRD-PARTY REIMBURSEMENT. The Company's ability to
commercialize the NCP System successfully will depend in part on whether
third-party payors, including private health care insurers, managed care
plans, the United States government's Medicare and Medicaid programs and
others, agree both to cover the NCP System and the procedures and services
associated therewith, and to reimburse for the costs of the NCP System and
the related services at adequate levels.
In deciding to cover a new therapy, third-party payors base their
initial coverage decisions on several factors including, but not limited to,
the status of the FDA's review of the product, the product's safety and
efficacy, the number of studies performed and peer-reviewed articles
published with respect to the product and how the product and therapy
compares to alternative therapies. There can be no assurance that third-party
payors will view the Company and the NCP System favorably with respect to any
of the above factors. The Company has only limited experience in seeking and
obtaining coverage decisions from third-party payors. A failure to achieve
favorable coverage decisions for the NCP System in a timely manner could
deter patients and their physicians from using the NCP System and could have
a material adverse effect on the Company's business, financial condition or
results of operations.
Once a favorable coverage determination is made with respect to a
product, payors must determine the level of reimbursement for the product and
related therapy and procedures. The Company believes that coverage and
reimbursement for most epilepsy patients who are likely candidates for
treatment with the NCP System will need to be obtained from third-party
private payors. In making decisions about reimbursement amounts, third-party
private payors typically reimburse for the costs of newly covered devices and
services using the standard methods they employ for other products and
services already covered. Many private insurers and managed care plans use a
variety of payment mechanisms, including, but not limited to, discounted
charges, per diem amounts, resource-based payment scales and reimbursed
costs. The Company believes that a significant number of epilepsy patients
-12-
<PAGE>
in the United States are either eligible for benefits under the Medicare
program or are uninsured. The Medicare program uses a fixed-payment method
(based on Diagnosis Related Groups or "DRGs") to pay for hospital inpatient
services and uses a resource-based relative value scale to pay for
physicians' services. Under current DRG groupings, hospital inpatient
procedures for implanting the NCP System are assigned to one of two different
DRGs based on whether or not the patient has complications or comorbidities
(coexisting severe medical problems). The DRG grouping that would include
implantation of the NCP System for patients without complications or
comorbidities pays hospitals less than the costs of purchasing and implanting
the NCP System. The Company believes that this DRG grouping would apply to
most of the epilepsy patients covered by Medicare. In order to assure
adequate reimbursement for all epileptic patients eligible for benefits under
Medicare, the Company intends to seek changes in the DRG grouping so that NCP
System implant cases would be reclassified to other, higher-paying DRGs. The
Company has only limited experience in seeking and obtaining coverage and
payment approvals from third-party payors, and there can be no assurance that
the Company would be successful in achieving coverage or adequate
reimbursement levels or in obtaining new DRG assignments, or if hospitals or
physicians view their payments as inadequate, then patients, physicians and
hospitals could be deterred from using the NCP System, which could have a
material adverse effect on the Company's business, financial condition or
results of operations.
In June 1994, the Company was granted approval to use the CE Mark and to
market the NCP System in the European Union. The Company is continuing to
pursue appropriate reimbursement approvals in the European Union member
countries. The Company believes that significant sales volume will be
difficult to generate without appropriate reimbursement approvals. There can
be no assurance as to when or whether such reimbursement will be obtained in
any of the European Union countries or, if obtained, whether the levels of
reimbursement will be sufficient to enable the Company to sell the NCP System
on a profitable basis.
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
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<PAGE>
and international demand. The Company will be required to obtain FDA
approval for its change in the manufacturing facility. The new manufacturing
facility will also have to be inspected for compliance with the FDA's Quality
System regulations ("QSR") and with ISO 9001 and 9002 standards, which impose
certain procedural and documentation requirements with respect to device
design, development, manufacturing and quality assurance activities, before
the Company can begin commercial-scale production of the NCP System at the
new manufacturing facility. In addition, one of the Company's contract
manufacturers has moved its manufacturing operations to a new facility. The
Company will be required to obtain FDA approval for the change in the
location of the contractor's manufacturing facility, which generally requires
a preapproval inspection by the FDA to determine the contractor's compliance
with the QSR. There can be no assurance that the Company will be able to
obtain the necessary FDA and other approvals for its or its contract
manufacturers' new facilities on a timely basis, or at all. If the Company
is unable to achieve commercial-scale production capability on a timely basis
with acceptable quality and manufacturing yield and costs, to sustain such
capacity, or to achieve FDA and other governmental approvals, the ability of
the Company to deliver products on a timely basis could be impaired which
could have a material adverse effect on the Company's business, financial
condition or results of operations.
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.
-14-
<PAGE>
Cyberonics believes that the licenses held by the Company provide it
with protection in the United States in the field of cranial nerve
stimulation, including vagus nerve stimulation for the control of epilepsy,
movement disorders, including Parkinson's disease and essential tremor, and
additional indications for which method patents have been issued. The
protection offered by the licensed international patents is not as strong as
that offered by the licensed United States patents due to differences in
patent laws. In particular, the European Patent Convention prohibits patents
covering methods for treatment of the human body by surgery or therapy. In
addition, there has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. Litigation,
which could result in substantial cost to and diversion of effort by the
Company, may be necessary to enforce patents issued or licensed to the
Company, to protect trade secrets or know-how owned by the Company or to
defend the Company against claimed infringement of the rights of others and
to determine the scope and validity of the proprietary rights of others.
Adverse determinations in litigation could subject the Company to significant
liabilities to third parties, could require the Company to seek licenses from
third parties and could prevent the Company from manufacturing, selling or
using the NCP System, any of which could have a material adverse effect on
the Company's business, financial condition or results of operations. There
can be no assurance that any required license would be available on
acceptable terms, if at all.
COMPETITION; RAPID TECHNOLOGICAL CHANGE. The Company believes that
existing and future AEDs will be the primary competition for its NCP System.
The Company may also face competition from other medical device companies for
the treatment of partial seizures. Medtronic, Inc. has clinically assessed
an implantable signal generator used with an invasive deep brain probe
(thalamic stimulator) for the treatment of neurological disorders and has
received FDA approval for the device for the treatment of essential tremor,
including that associated with Parkinson's disease. The Company could also
face competition from other large medical device companies which have the
technology, experience and capital resources to develop alternative devices
for the treatment of epilepsy. Many of the Company's competitors have
substantially greater financial, manufacturing, marketing and technical
resources than the Company and have obtained third-party reimbursement
approvals. In addition, the health care industry is characterized by
extensive research efforts and rapid technological progress. There can be no
assurance that the Company's competitors will not develop technologies and
obtain regulatory approval for products that are more effective in treating
epilepsy than the Company's current or future products. There can also be no
assurance that advancements in surgical techniques will not make surgery a
more attractive therapy for epilepsy. The development by others of new
treatment methods with novel AEDs, medical devices or surgical techniques for
epilepsy could render the NCP System non-competitive or obsolete. There can
be no assurance that the Company will be able to compete successfully against
current and future competitors or that competition, including the development
and commercialization of new products and technology, will not have a
material adverse effect on the Company's business, financial condition or
results of operations.
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.
-15-
<PAGE>
PRODUCT LIABILITY AND AVAILABILITY OF INSURANCE. The manufacture and
sale of the NCP System entails the risk of product liability claims.
Although the Company maintains product liability insurance, there can be no
assurance that the coverage limits of the Company's insurance policies will
be adequate. Such insurance is expensive and in the future may not be
available on acceptable terms, if at all. A successful claim brought against
the Company in excess of its insurance coverage could have a material adverse
effect on the Company's business, financial condition or results of
operations.
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 medial 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, together with the proceeds from an anticipated public
offering of Common Stock, will be sufficient to meet its capital requirements
at least through June 30, 1999, there can be no assurance that the Company
will not require additional financing either before or after that date. This
estimate is based on certain assumptions, which may not hold true, including
the timely completion of a financing. There can be no assurance that such
financing will be completed on a timely basis or at all, or that proceeds
from such financing, if any, combined with Company's available cash, cash
equivalents, investment securities and investment income, will be sufficient
to meet the Company's capital requirements through June 30, 1999. The
Company's future capital requirements will depend upon numerous factors,
including the extent and timing of future product sales, the scale-up of the
Company's manufacturing facilities, and the nature, timing and success of
clinical trials for additional indications for the NCP System. Such
financing, if required, may not be available on satisfactory terms, or at
all. Lack of access to sufficient financing would impair the Company's
ability to fully pursue its business objectives, which could have a material
adverse effect on the Company's business, financial condition, or results of
operations.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. Although the NCP System
has been approved for commercialization in the European Union countries since
1994, the Company has not generated significant revenues from such countries
to date. The Company currently is expanding its marketing and sales
activities in international markets. There can be no assurance that the
Company will successfully increase international sales or that the Company
will be successful in obtaining reimbursement or any regulatory approvals
required in foreign countries. Changes in overseas economic conditions,
currency exchange rates, foreign tax laws or tariffs or other
-16-
<PAGE>
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>
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 December 31, 1997.
-18-
<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/ JOHN K. BAKEWELL
-----------------------------------
John K. Bakewell
Vice President, Finance and
Administration and Chief Financial
Officer (principal financial and
accounting officer)
Dated: February 9, 1998
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