<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 year ended September 30, 1999 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 77058
- ---------------------------------------- ----------
(address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (281) 228-7200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT NOVEMBER 5, 1999
Common Stock - $0.01 par value 17,714,553
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CYBERONICS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements:
Consolidated Balance Sheets
September 30, 1999 (unaudited) and June 30, 1999............ 3
Consolidated Statements of Operations (unaudited)
three months ended September 30, 1999 and 1998............ 4
Consolidated Statements of Cash Flows (unaudited)
three months ended September 30, 1999 and 1998........... 5
Notes to Consolidated Financial Statements (unaudited)...... 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.................................... 19
</TABLE>
-2-
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CYBERONICS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1999 1999
------------- -------------
ASSETS (Unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents ........................................... $ 982,983 $ 1,544,042
Securities held to maturity ......................................... 16,284,749 19,222,590
Accounts receivable, net ............................................ 4,118,485 5,450,003
Inventories ......................................................... 4,884,922 5,195,114
Other current assets ................................................ 805,810 898,038
------------- -------------
Total current assets ........................................... 27,076,949 32,309,787
Securities held to maturity ............................................. 6,563,643 4,091,491
Property and equipment, net ............................................. 4,126,047 3,272,960
Other assets, net ....................................................... 228,476 108,915
------------- -------------
$ 37,995,115 $ 39,783,153
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable .................................................... $ 927,860 $ 1,704,095
Accrued liabilities ................................................. 3,646,641 4,630,613
------------- -------------
Total current liabilities ...................................... 4,574,501 6,334,708
============= =============
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;
17,649,913 and 17,562,000 shares issued and outstanding at
September 30, 1999 and June 30, 1999, respectively ............. 176,500 175,620
Additional paid-in capital .......................................... 110,007,396 109,280,567
Accumulated other comprehensive income .............................. (107,256) (128,476)
Accumulated deficit ................................................. (76,656,026) (75,879,266)
------------- -------------
Total stockholders' equity ..................................... 33,420,614 33,448,445
------------- -------------
$ 37,995,115 $ 39,783,153
============= =============
</TABLE>
See accompanying Notes to Consolidated Financial Statements (Unaudited).
3
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CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE
MONTHS ENDED
SEPTEMBER 30,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Net sales ................................................................... $ 8,663,236 $ 5,335,757
Cost of sales ............................................................... 2,286,901 1,415,999
------------ ------------
Gross profit ................................................................ 6,376,335 3,919,758
Operating expenses:
Selling, general and administrative ...................................... 6,640,079 7,401,430
Research & development ................................................... 1,675,800 1,853,095
------------ ------------
Total operating expenses ............................................... 8,315,879 9,254,525
------------ ------------
Loss from operations ........................................................ (1,939,544) (5,334,767)
Interest income, net ........................................................ 275,298 482,390
Other income (expense) ...................................................... 6,336 178,112
------------ ------------
Net loss before cumulative effect of a change in accounting principle ....... (1,657,910) (4,674,265)
Cumulative effect on prior years (to June 30, 1999) of changing to a
Different method of depreciation ....................................... 881,150 --
------------ ------------
Net loss .................................................................... $ (776,760) $ (4,674,265)
============ ============
Loss per share, basic and diluted:
Loss before cumulative effect of a change in accounting principle ........... $ (0.09) $ (0.27)
Cumulative effect on prior years (to June 30, 1999) of changing to a
Different method of depreciation ...................................... 0.05 --
------------ ------------
Net Loss .................................................................... $ (0.04) $ (0.27)
============ ============
Shares used in computing net loss per share ................................. 17,590,407 17,269,372
============ ============
Comprehensive Loss:
Net Loss .................................................................... $ (776,760) $ (4,674,265)
Foreign currency transaction adjustment ..................................... 21,220 (129,919)
------------ ------------
Comprehensive Loss .......................................................... $ (755,540) $ (4,804,184)
============ ============
Pro Forma amounts assuming retroactive application of accounting change:
Net Loss .................................................................... $ (1,657,910) $ (4,633,172)
Net Loss per share - basic and diluted ...................................... $ (0.09) $ (0.27)
</TABLE>
See accompanying Notes to Consolidated Financial Statements (Unaudited).
4
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CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
SEPTEMBER 30,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES:
Net loss ..................................................... $ (776,760) $ (4,674,265)
Non-cash items included in net loss:
Depreciation ............................................... 296,860 225,420
Change in accounting principle ............................. (881,150) --
Change in operating assets and liabilities:
Accounts receivable ........................................ 1,331,518 1,051,723
Inventories ................................................ 310,192 (1,994,545)
Other current assets ....................................... 92,228 751,246
Accounts payable and accrued liabilities ................... (1,760,207) (3,137,419)
Other ...................................................... (119,561) (42,350)
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES .................... (1,506,880) (7,820,190)
CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of property and equipment .......................... (268,797) (735,961)
Purchases of investments ..................................... (15,405,631) (12,234,543)
Maturities of investments .................................... 15,871,320 20,983,541
------------ ------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES ...... 196,892 8,013,037
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock, net .................. 727,709 28,205
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES ................ 727,709 28,205
------------ ------------
Effect of exchange rate changes on cash and cash equivalents .... 21,220 (129,919)
------------ ------------
Net (decrease) increase in cash and cash equivalents ..... (561,059) 91,133
Cash and cash equivalents, at beginning of period ............... 1,544,042 1,695,385
------------ ------------
Cash and cash equivalents, at end of period ..................... $ 982,983 $ 1,786,518
============ ============
</TABLE>
See accompanying Notes to Consolidated Financial Statements (Unaudited).
5
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CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1999
NOTE 1 - BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information, and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three months ended September 30, 1999
are not necessarily indicative of the results that may be expected for the full
year ending June 30, 2000. The financial information presented herein should be
read in conjunction with the audited consolidated financial statements and notes
thereto included in our Annual Report on Form 10-K for the year ended June 30,
1999.
NOTE 2 - INVESTMENT SECURITIES:
At September 30, 1999 and June 30, 1999, our entire investment
portfolio consisted of securities held to maturity that are reported at
amortized cost. Securities held to maturity are primarily corporate bonds,
commercial paper and United States (US) treasury obligations with various
maturity dates and have a fair market value of approximately $22,800,000 and a
gross unrealized holding gain of approximately $48,000 at September 30, 1999.
NOTE 3 - INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 JUNE 30, 1999
------------------ -------------
(Unaudited)
<S> <C> <C>
Raw materials and components.......... $ 1,564,533 $ 2,837,599
Work-in-process ...................... 1,402,116 794,410
Finished goods ....................... 1,918,273 1,563,105
------------------ -------------
$ 4,884,922 $ 5,195,114
=================== =============
</TABLE>
NOTE 4 - OTHER CURRENT ASSETS:
Other current assets consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 JUNE 30, 1999
------------------ -------------
(Unaudited)
<S> <C> <C>
Prepaid assets........................ $ 718,865 $ 835,467
Interest receivables ................. 86,945 62,571
------------------ -------------
$ 805,810 $ 898,038
================== =============
</TABLE>
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NOTE 5 - ACCRUED LIABILITIES:
Accrued liabilities are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 JUNE 30, 1999
------------------ -------------
(Unaudited)
<S> <C> <C>
Payroll and other compensation........ $ 1,052,773 $ 2,086,849
Clinical costs........................ 1,027,407 1,161,291
Warranties............................ 375,000 375,000
Royalties............................. 352,597 398,800
Business insurance.................... 216,879 --
Professional services................. 127,071 129,600
Sales returns and allowances.......... 60,500 205,400
Marketing activities.................. 50,250 50,250
Other................................. 384,164 223,423
------------------ -------------
$ 3,646,641 $ 4,630,613
================== =============
</TABLE>
NOTE 6 - CHANGE IN ACCOUNTING PRINCIPLE:
Effective July 1, 1999, we changed our method of computing depreciation
on domestic fixed assets from the double declining method to the straight-line
method. This change was implemented to better match revenues and expenses taking
into account the nature of these assets and our business. The new depreciation
method was applied retroactively to all domestic assets acquired in prior years.
The cumulative prior years' effect of the changes was $881,150 (net of income
tax of $0) and is included in income of the first quarter of fiscal 2000. The
effect of the change on the loss from operations for the quarter ended September
30, 1999 is not material. The pro forma amounts, shown on the income statement,
reflect the effect of retroactive application on depreciation that would have
been made in the three months ended September 30, 1998 had the straight-line
method been in effect.
NOTE 7 - RECLASSIFICATION
Certain amounts in the balance sheet as of June 30, 1999 have been
reclassified to conform with those at September 30, 1999.
NOTE 8 - NET LOSS PER SHARE
We compute basic net loss per share by dividing our net loss by the
weighted average number of shares outstanding during each period. For purpose of
computing diluted net loss per share, no exercise of options was assumed since
the result would have been antidilutive.
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
our results, please refer to the financial statement line item discussions set
forth in Management's Discussion and Analysis of Financial Condition and Results
of Operations and to the section entitled "Factors That May Affect Future
Operating Results." Readers are also encouraged to refer to our Annual Report on
Form 10-K for the year ended June 30, 1999 for a further discussion of our
business and the risks and opportunities attendant thereto.
SUMMARY
We design, develop, manufacture and market the NeuroCybernetic
Prosthesis, or NCP(R) System, an implantable medical device for the treatment of
epilepsy and other debilitating neurological disorders. On July 16, 1997, we
received approval from the United States Food and Drug Administration, also
referred to as the FDA, to market the NCP System in the United States as an
adjunctive therapy for reducing the frequency of seizures in patients over
twelve years of age with partial onset seizures that are refractory or resistant
to antiepileptic drugs. We have also received regulatory approval to sell the
NCP System in Canada, Europe and certain countries in the Far East with the
broader indication of refractory epilepsy and without discrimination to patient
age. From inception through July 1997, our primary focus was on obtaining FDA
approval for the NCP System. Since inception, we have had limited revenues and
have 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. We have been unprofitable since inception. For the period from
inception through September 30, 1999, we have incurred a cumulative net deficit
of approximately $77 million.
We were granted regulatory approval in 1994 to market and sell the NCP
System in the member countries of the European Union and also have permission to
sell in certain other international markets. However, we have devoted limited
resources to marketing and sales activities internationally and international
sales of the NCP System have been limited to date.
We believe that significant market acceptance of the NCP System for the
treatment of epilepsy or other indications will require that the treatment be
eligible for reimbursement from government and private health care payors both
within and outside the United States. We have gained coverage recommendations
from Health Care Administration or HCFA, Blue Cross and Blue Shield,
CHAMPUS/Tricare, Kaiser, a number of State Medicaid agencies and numerous other
payors. We are in the process of seeking additional coverage recommendations and
appropriate payment levels from these and other third party payors in the United
States and in a limited number of key international markets.
8
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We expect to incur substantial costs related to sales and marketing
activities, clinical trials and regulatory activities, product and process
development and infrastructure development. We expect there will be a delay
between the increased levels of spending and any resulting increase in revenues.
Accordingly, we expect to remain unprofitable through at least the quarter
ending December 31, 1999. We cannot assure you that our results of operations
will become profitable after that time or, that if our operations become
profitable, they will remain so in future periods. Furthermore, our results of
operations may fluctuate significantly from quarter to quarter and will depend
upon numerous factors, many of which are outside our control. Such factors
include, but are not limited to, the extent to which the NCP System gains market
acceptance, any approvals for reimbursement by third-party payors, the rate and
size of expenditures in sales and marketing and clinical trials and regulatory
activities, availability of key components, materials and contract services
which may be dependent on our ability to forecast sales, the ability to achieve
acceptable manufacturing yields and costs and the extent and timing of the
development of corporate infrastructure.
RESULTS OF OPERATIONS
Net Sales. Net sales for the three months ended September 30, 1999
totaled $8,663,000 million compared to $5,336,000 million for the three months
ended September 30, 1998, representing an overall increase of $3.3 million, or
62%. Net sales for the three months ended September 30, 1999 consisted of $7.9
million from the United States and $727,000 from international markets. Net
sales for the quarter ended September 30, 1998 consisted of $4.7 million from
the United States and $674,000 from international markets. Future increases in
net sales will depend upon development of increased market acceptance for the
NCP System and upon obtaining or expanding reimbursement approval in key
markets.
Gross Profit. Gross margin, as a percent of net sales, was 73.6% for
the quarter ended September 30, 1999 compared to 73.5% in the prior year period.
The increase over the prior year is attributable primarily to the greater
proportion of net sales being derived from the United States and direct markets
in Europe, which generally have higher gross margins than sales generated
through indirect channels. Cost of sales consist primarily of direct labor,
direct materials and components, allocated manufacturing overhead, third-party
contractor costs and certain manufacturing period expenses. In addition, we are
required to pay royalties at a rate of approximately 4% of net sales. Gross
margin percentages can be expected to fluctuate in future periods based upon the
mix between domestic and international sales, direct and distributor sales, the
NCP System's selling price, manufacturing yields, period expenses and levels of
production volume.
Research and Development Expenses. Research and development expenses
are comprised of both expenses related to our product and process development
efforts and expenses associated with conducting clinical trials and certain
related regulatory activities. Research and development expenses totaled $1.7
million, or 19.3% of net sales, for the three months ended September 30, 1999,
compared to $1.9 million, or 34.7% of net sales, in the prior year period. The
large decrease of such
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expenses as a percentage of net sales is primarily the result of the increase in
sales in the quarter ended September 30, 1999 as compared to the same prior year
period. We intend to conduct further clinical trials of the NCP System for
additional indications both within and outside the field of epilepsy including
chronic depression and morbid obesity. Accordingly, we expect research and
development expenses in dollars to increase.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses totaled $6.6 million, or 76.6% of net sales, for the
three months ended September 30, 1999 compared to $7.4 million, or 138.7% of net
sales, for the three months ended September 30, 1998. The decrease in absolute
dollars was primarily due to reductions in costs associated with national sales
and marketing events during the current quarter as compared to prior year. The
decrease of such expenses as a percentage of net sales is primarily the result
of the increase in sales in the quarter ended September 30, 1999 as compared to
the same prior year period. We expect to add administrative and sales and
marketing personnel in anticipation of higher levels of business activity in
fiscal year 2000. Accordingly, we expect our future selling, general and
administrative expenses in absolute amount to increase beyond the amounts
incurred during the three months ended September 30, 1999.
Interest Income. Interest income totaled $275,000 and $482,000 for the
three months ended September 30, 1999 and September 30, 1998, respectively.
Interest income decreased for the quarter September 30, 1999 as compared to the
same prior year period as a result of lower cash and investment balances on
hand. We expect interest income to gradually decline in future periods as we
utilize our resources to fund future working capital requirements.
Other Income (Expense), Net. Other income totaled $6,000 and $178,000
during the three months ended September 30, 1999 and 1998, respectively. For
each of these periods, other income consisted primarily of net gains and losses
resulting from foreign currency fluctuations. We expect other income to
fluctuate in future periods depending upon the mix between international and
domestic business activities, business exposures to foreign currencies, and upon
fluctuations in currency exchange rates.
Income Taxes. Due to our net operating loss history, to date we have
established a valuation allowance to fully offset deferred tax assets, including
those related to tax carryforwards, resulting in no income tax expense or
benefit for financial reporting purposes. Current federal income tax regulations
with respect to changes in ownership could limit the utilization of the
operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations primarily through
public and private placements of our securities. We had no short or long-term
borrowings outstanding at September 30, 1999, and had no credit facilities
available at that time.
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<PAGE> 11
We expect to incur substantial additional costs related to sales and
marketing activities, clinical trials and regulatory activities, product and
process development and infrastructure development. The amount and timing of
anticipated expenditures will depend upon numerous factors both within and
outside our control, including the nature and timing of marketing and sales
activities, the development of corporate infrastructure and the nature and
timing of additional clinical trials for additional indications, both within and
outside the field of epilepsy. Moreover, our 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 three months ended September 30, 1999, we used approximately
$1.5 million in operating activities. Accounts receivable decreased to $4.1
million, from $5.5 million at June 30, 1999. Inventories decreased to $4.9
million at September 30, 1999 from $5.2 million at June 30, 1999. We also
reduced current liabilities to $4.6 million at September 30, 1999 from $6.3
million at June 30, 1999.
Our liquidity will continue to be reduced as amounts are expended for
sales and marketing activities, continuing clinical trials and related
regulatory affairs, product and process development and infrastructure
development. Although we have no firm commitments, we expect to make capital
expenditures of approximately $2.4 million during the remainder of fiscal 2000,
primarily to support manufacturing operations and to enhance general
infrastructure and facilities.
We believe that our current resources will be sufficient to fund our
operations at least through June 30, 2001, although there can be no assurance of
this as this estimate is based on a number of assumptions, which may not hold
true. The availability of financing either before or after that time will depend
upon a number of important factors, including the state of the United States
capital markets and economy in general and the health care and medical device
segments in particular, the status of our sales activities and the status of our
clinical and regulatory activities. We may not be able to raise additional
capital when needed on terms favorable to us.
IMPACT OF YEAR 2000
Many currently installed computer systems and software products were
coded using two digits rather than four to define the applicable year. As a
result these computer systems and software products have time-sensitive software
that recognize a date using "00" as the year 1900 rather than the year 2000.
This could cause a system failure or miscalculations, causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, to send invoices, or to engage in similar normal business
activities. Some computers may also not properly roll from year 1999 to year
2000, resulting instead with arbitrary dates such as January 4, 1980. Finally,
computer systems and software products may fail to process accurately the leap
year logic associated with the Year 2000.
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<PAGE> 12
STATE OF READINESS AND CONTINGENCY PLANS
We believe that the adverse impact of Year 2000 issues on our internal
computer systems will not be material. Most of the personal computers and
computer systems we use have been installed in the past three years as we have
been growing our organization. We have also moved the remainder of our
organization to a new facility in Houston, Texas, and have installed new
equipment in connection with the relocation. We recently completed a
comprehensive review of all of our equipment and software, and found the
incidence potential of Year 2000 issues to be minimal but not non-existent. We
are in the process of defining and resolving all Year 2000 issues, which we
expect to complete by the end of November 1999. We have also contacted each of
our key material vendors and suppliers to determine if they have any Year 2000
compliance issues that have not been resolved, or may not be resolved in a
timely manner. The results of these inquiries will lead into supplier
contingency planning efforts during the last quarter of calendar 1999.
Additionally, we have contacted our major customers and informed them of our
Year 2000 readiness plans and processes. All of our products are fully Year 2000
compliant with the exception of the programming software, which does not use
dating in its processing calculations, but does use dating in its reporting
functions. These reporting functions include a few non-therapy related reports
that may produce more information than expected when database dates span the
millennium. These reports in no way affect the programming of the implanted
device, and are easily interpreted by users of the programming system. As such,
the programming software has been designated Year 2000 ready, and no software
updates are planned to address the small anomalies.
In the past, we have, as a service to our customers, provided laptop
computers which may be used to host the NCP System programming software. A
variety of computer models have been shipped over several years, some of which
are not compliant. During the last calendar quarter of 1999, we intend to
initiate a program to communicate to our customers how they may test their
laptops to determine their compliance state, and how they may reset internal
dates or upgrade them if necessary.
An independent assessment of our Year 2000 plans, progress and
documentation was conducted at the end of the quarter ended September 30, 1999.
The results of this independent assessment indicate that we have adequately
identified any remaining issues and have adequate procedures in place to assign
resources as needed to ensure our readiness.
COSTS OF YEAR 2000 COMPLIANCE
We do not expect expenditures for upgrades and testing for Year 2000
issues of software used on internal systems to be material. To date, any such
costs incurred have been in connection with the implementation of systems at our
new facility and the purchase of equipment and software for our growing employee
base. We estimate that we may need to upgrade some of our manufacturing
databases and replace a small number of our older pieces of manufacturing test
equipment. The costs of such activities are estimated to be under $100,000,
including the independent assessment of our Year 2000 program. We expect to
complete our testing, and any
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<PAGE> 13
required upgrades by early fourth quarter calendar 1999. We also do not expect
diversion of resources from other management information systems or
manufacturing projects to significantly harm our business.
RISKS OF YEAR 2000 NON-COMPLIANCE AND CONTINGENCY PLANS
In the event of a failure of any software or other electronic devices
used for our internal systems, we believe any resulting business disruption
would not significantly impact our business because we believe alternative, less
technologically advanced, systems are available.
The costs of the modifications and the date on which we believe we will
complete the Year 2000 modifications, if any, are based on management's
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources and other factors.
However, we cannot assure you that these estimates will be achieved, and actual
results could differ from those anticipated.
FACTORS AFFECTING FUTURE OPERATING RESULTS
In addition to the factors described above in this section, the
following additional factors could effect our future results.
We rely on only one product for our revenues and if sales of this
product are not achieved, our operating results will be severely harmed. We have
only one product, the NCP System, which has been approved by the FDA only for a
single indication: as an adjunctive therapy in reducing the frequency of
seizures in adults and adolescents over twelve years of age with partial onset
seizures that are refractory to antiepileptic drugs. We do not expect to have
any other product or approved indication for the NCP System in the United States
for at least the next three years. Although sales of our NCP System have been
increasing, we cannot assure you that sales will continue to increase at the
same rate or at all. We are currently requesting approval for the use of the NCP
System for the treatment of major depression in-patients with unipolar and
bipolar depressive disorder. We do not yet have approvals necessary to
commercialize the NCP System for the treatment of depression. We cannot assure
you that any approvals for the treatment of depression with the NCP System will
be granted, nor can we assure you that even if the approval is granted, we will
be successful in commercializing the NCP System for the treatment of depression
or any other indications. Our inability to commercialize successfully the NCP
System will severely harm our business.
We may not achieve market acceptance of the use of our NCP System to
treat epilepsy, which could cause our sales to decrease. Continued market
acceptance of our NCP System will depend on our ability to convince the medical
community of the clinical efficacy and safety of vagus nerve stimulation and the
NCP System. While the NCP System has been used in approximately 6,000 patients
through September 30, 1999, many physicians are still unfamiliar with this form
of therapy. We believe that existing antiepileptic drugs and surgery are the
only other approved and currently available therapies competitive with the NCP
System in the treatment of epileptic seizures. These
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<PAGE> 14
therapies may be more attractive to patients or their physicians than the NCP
System in terms of efficacy, cost or reimbursement availability. We cannot
assure you that the NCP System will achieve market acceptance for the treatment
of epilepsy or for any other indication. Failure of the NCP System to gain
market acceptance would severely harm our business, financial condition and
results of operations.
Our quarterly operating results may fluctuate in the future, which may
cause our stock price to decline. Our results of operations may fluctuate
significantly from quarter to quarter and may be below the expectations of
security analysts. If so, the market price of our shares may decline. Our
quarterly revenues, expenses and operating results may vary significantly from
quarter to quarter for several reasons including the extent to which our NCP
System gains market acceptance, the timing of obtaining marketing approvals for
our NCP System for other indications, the timing of any approvals for
reimbursement by third-party payors, the rate and size of expenditures incurred
as we expand our clinical, manufacturing, sales and marketing corporate
infrastructure development efforts and the availability of key components,
materials and contract services, which may depend on our ability to forecast
sales.
Our current and future expense estimates are based, in large part, on
estimates of future sales, which are difficult to predict. We may be unable to,
or may elect not to, adjust spending quickly enough to offset any unexpected
sales shortfall. If our expenses were not accompanied by increased sales, our
results of operations and financial condition for any particular quarter would
be harmed.
We may be unable to obtain adequate third-party reimbursement on our
product. Our ability to commercialize the NCP System successfully depends in
part on whether third-party payors, including private health care insurers,
managed care plans, the United States government's Medicare and Medicaid
programs and others, agree both to cover the NCP System and associated
procedures and services and to reimburse at adequate levels for the costs of the
NCP System and the related services we have in the United States or
internationally. If we fail to achieve or expand favorable coverage decisions
for the NCP System in a timely manner, patients and their physicians could be
deterred from using the NCP System which could reduce our sales and severely
harm our business.
We may not be successful in our marketing and sales efforts, which
could severely harm our business. We have only recently expanded our marketing
and sales force for the United States market, and we cannot assure you that this
expanded direct marketing and sales force will succeed in promoting the NCP
System to patients, health care providers or third-party payors on a broad
basis. In addition, due to limited market awareness of the NCP System, we
believe that the sales process could be lengthy, requiring us to continue to
educate patients, health care providers and third-party payors regarding the
clinical benefits and cost-effectiveness of the NCP System. In certain
international territories, we rely, and intend to continue to rely, upon
independent distributors. We may not be able to recruit and retain skilled
marketing and sales personnel or foreign distributors to support our marketing
and sales efforts. Our failure to successfully market and sell our NCP System
would severely impair our sales and our business.
14
<PAGE> 15
We have limited manufacturing experience and may not be able to ramp up
our manufacturing to meet anticipated product demand. Our manufacturing
activities to date have consisted primarily of manufacturing limited quantities
of the NCP System for clinical investigations, for two years of commercial sales
activities in the United States and for commercial sales activities in
international markets. We do not have experience manufacturing the NCP System in
the volumes that will be necessary to achieve significant commercial sales. We
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. In addition, our manufacturing facilities must
continue to comply with the FDA's QSR and with ISO 9001 and 9002 standards,
which impose certain procedural and documentation requirements with respect to
device design, development, manufacturing and quality assurance activities. If
we are 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 maintain FDA and other governmental approvals, our ability to
deliver products on a timely basis could be impaired which could severely harm
our business.
If our sole suppliers and manufacturers are unable to meet our demand
for materials, components and contract services, we may be forced to qualify new
vendors or change our product design which would impair our ability to deliver
products to our customers on a timely basis. We rely upon sole source suppliers
for certain of the key components, materials and contract services used in
manufacturing the NCP System. We periodically experience discontinuation or
unavailability of components, materials and contract services which may require
us to qualify alternative sources or, if no such alternative sources are
identified, change our product design. We believe that pursuing and qualifying
alternative sources and/or redesigning specific components of the NCP System,
when necessary, could consume significant resources. In addition, such changes
generally require regulatory submissions and approvals. Any extended delays in
or an inability to secure alternative sources for these or other components,
materials and contract services could result in product supply and manufacturing
interruptions, which could significantly harm our business.
Our products may be found to have significant defects that could harm
the human body and result in product recalls. The NCP System includes a complex
electronic device and lead designed to be implanted in the human body. Component
failures, manufacturing or shipping errors or design defects could result in an
unsafe condition in patients. The occurrence of such problems or other adverse
reactions could result in a recall of our products, possibly requiring removal
and potentially reimplantation of the NCP System or a component of the NCP
System. For example, in 1991, a failure of an NCP System caused permanent
paralysis of one patient's left vocal cord. In addition, several patients
experienced bipolar lead failures which, although not harmful to the patient,
reduced the efficacy of the treatment and required lead replacement. Since the
occurrence of these failures, changes have been made to our product designs and
no similar failures have been reported. However in the future, we may experience
similar or other product problems or may be required to recall products. Any
product recall could severely harm our business, financial condition and results
of operations.
15
<PAGE> 16
We may not be able to protect our technology from unauthorized use,
which could diminish the value of our products and impair our ability to
compete. Our success depends upon our ability to obtain and maintain patent and
other intellectual property protection for the NCP System and its improvements,
and for vagus nerve stimulation therapy. To that end, we have acquired licenses
under certain patents and have patented and intend to continue to seek patents
on our own inventions used in our products and treatment methods. The process of
seeking patent protection can be expensive and time consuming and we cannot
assure you that patents will issue from our currently pending or future
applications or that, if patents are issued, they will be of sufficient scope or
strength to provide meaningful protection of our technology, or any commercial
advantage to us. Further, the protection offered by the licensed international
patents is not as strong as that offered by the licensed United States patents
due to differences in patent laws. In particular, the European Patent Convention
prohibits patents covering methods for treatment of the human body by surgery or
therapy.
We may have to engage in litigation to protect our proprietary rights,
or defend against infringement claims by third parties, causing us to suffer
significant expenses or prevent us from selling our products. There has been
substantial litigation regarding patent and other intellectual property rights
in the medical device industry. Litigation, which could result in substantial
cost to and diversion of effort by us, may be necessary to enforce patents
issued or licensed to us, to protect trade secrets or know-how owned by us or to
defend ourselves against claimed infringement of the rights of others and to
determine the scope and validity of the proprietary rights of others. Adverse
determinations in litigation could subject us to significant liabilities to
third parties, could require us to seek licenses from third parties and could
prevent us from manufacturing, selling or using the NCP System, any of which
could severely harm our business.
Intense competition and rapid technological changes could reduce our
ability to market our products and achieve sales. We believe that existing and
future antiepileptic drugs will continue to be the primary competition for our
NCP System. We may also face competition from other medical device companies
that have the technology, experience and capital resources to develop
alternative devices for the treatment of epilepsy. Many of our competitors have
substantially greater financial, manufacturing, marketing and technical
resources than we do and have obtained third-party reimbursement approvals for
their therapies.
In addition, the health care industry is characterized by extensive
research efforts and rapid technological progress. Our competitors may develop
technologies and obtain regulatory approval for products that are more effective
in treating epilepsy than our current or future products. In addition,
advancements in surgical techniques may make surgery a more attractive therapy
for epilepsy. The development by others of new treatment methods with novel
antiepileptic drugs, medical devices or surgical techniques for epilepsy could
render the NCP System non-competitive or obsolete. We may not be able to compete
successfully against current and future competitors, including new products and
technology, which could severely harm our business, financial condition or
results of operations.
16
<PAGE> 17
If we fail to effectively manage our growth, our ability to maintain
our costs or capture new business could suffer. In connection with the
commercialization of the NCP System in the United States, we have significantly
expanded the scope of our operations, in particular in manufacturing and in
marketing and sales. Such activities have placed, and may continue to place, a
significant strain on our resources and operations. Our ability to effectively
manage such growth will depend upon our ability to attract, hire and retain
highly qualified employees and management personnel. We compete for such
personnel with other companies, academic institutions, government entities and
other organizations and we may not be successful in hiring or retaining
qualified personnel. Our success will also depend upon the ability of our
officers and key employees to continue to implement and improve our operational,
management information and financial control systems. If we fail to manage our
growth effectively, our business would suffer.
We are subject to claims of product liability and we may not have the
resources or insurance to cover the cost for losses under these claims. As an
implantable medical device, the manufacture and sale of the NCP System entails
the risk of product liability claims. Our product liability coverage may not be
adequate to cover any of these claims. Product liability insurance is expensive
and in the future may not be available on acceptable terms, if at all. A
successful claim brought against us in excess of our insurance coverage could
significantly harm our business and financial condition.
If we do not continue to comply with changing government regulations,
we could lose our ability to market and sell our product. The preclinical and
clinical testing, manufacturing, labeling, sale, distribution and promotion of
the NCP System are subject to extensive and rigorous regulation in the United
States by federal agencies, primarily the FDA, and by comparable state agencies.
In the future, it will be necessary for us to obtain additional government
approvals for other applications of the NCP System and for modified or
future-generation products. Commercial distribution in certain foreign countries
is also subject to obtaining regulatory approvals from the appropriate
authorities in such countries. The process of obtaining FDA and other required
regulatory approvals is lengthy, expensive and uncertain. Moreover, regulatory
approvals may include regulatory restrictions on the indicated uses for which a
product may be marketed. Failure to comply with applicable regulatory
requirements can result in, among other things, fines, suspension or withdrawal
of approvals, confiscations or recalls of products, operating restrictions and
criminal prosecution. Furthermore, changes in existing regulations or adoption
of new regulations could prevent us from obtaining, or affect the timing of,
future regulatory approvals. We may not be able to obtain additional future
regulatory approvals on a timely basis or at all. Delays in receipt of or
failure to receive such future approvals, suspension or withdrawal of previously
received approvals, or recalls of the NCP System could severely harm our ability
to market and sell our current and future products and improvements.
Our international operations are subject to risks not generally
associated with commercialization efforts in the United States. We have recently
begun to focus our marketing and sales activities in international markets. We
may not be successful in increasing our international market sales or in
obtaining reimbursement or any regulatory approvals required in foreign
countries. The anticipated international nature of our business is also expected
to subject us and our
17
<PAGE> 18
representatives, agents and distributors to laws and regulations of the foreign
jurisdictions in which we operate or where the NCP System is sold. The
regulation of medical devices in a number of such jurisdictions, particularly in
the European Union, continues to develop and new laws or regulations may impair
our ability to market and sell our products in those jurisdictions.
18
<PAGE> 19
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
18 Letter regarding change of accounting principles, Arthur
Andersen, LLP
27 Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the
quarter ended September 30, 1999.
19
<PAGE> 20
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CYBERONICS, INC.
Registrant
BY: /s/ PAMELA B. WESTBROOK
---------------------------------------
Pamela B. Westbrook
Vice President, Finance and Administration
and Chief Financial Officer (principal
financial and accounting officer)
Dated: November 15, 1999
20
<PAGE> 21
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
NUMBER
EXHIBITS DESCRIPTION
- -------- -----------
<S> <C>
18 Letter regarding change of accounting principles, Arthur
Andersen, LLP
27 Financial Data Schedule.
</TABLE>
<PAGE> 1
EXHIBIT 18
September 30, 1999
Cyberonics, Inc.
16511 Space Center Blvd.
Suite 600
Houston, Texas 77058
Re: Report for the quarter ended September 30, 1999
Gentlemen/Ladies:
This letter is written to meet the requirements of Regulation S-K calling for a
letter from a registrant's independent accountants whenever there has been a
change in accounting principle or practice.
We have been informed that, as of July 1, 1999, the Company changed from the
double declining method of accounting for depreciation to the straight-line
method. According to the management of the Company, this change was made to
better match revenues and expenses taking into account the nature of these
assets and Cyberonics' business.
A complete coordinated set of financial and reporting standards for determining
the preferability of accounting principles among acceptable alternative
principles has not been established by the accounting profession. Thus, we
cannot make an objective determination of whether the change in accounting
described in the preceding paragraph is to a preferable method. However, we have
reviewed the pertinent factors, including those related to financial reporting,
in this particular case on a subjective basis, and our opinion stated below is
based on our determination made in this manner.
We are of the opinion that the Company's change in method of accounting is to an
acceptable alternative method of accounting, which, based upon the reasons
stated for the change and our discussions with you, is also preferable under the
circumstances in this particular case. In arriving at this opinion, we have
relied on the business judgement and business planning of your management.
We have not audited the application of his change to the financial statements of
any period subsequent to June 30, 1999. Further, we have not examined and do not
express any opinion with respect to your financial statements for the three
months ended September 30, 1999.
Very truly yours,
Arthur Andersen, LLP
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 982,983
<SECURITIES> 16,284,749
<RECEIVABLES> 4,453,571
<ALLOWANCES> (335,086)
<INVENTORY> 4,884,922
<CURRENT-ASSETS> 27,076,949
<PP&E> 6,119,642
<DEPRECIATION> (1,993,595)
<TOTAL-ASSETS> 37,995,115
<CURRENT-LIABILITIES> 4,574,501
<BONDS> 0
0
0
<COMMON> 176,500
<OTHER-SE> 33,244,114
<TOTAL-LIABILITY-AND-EQUITY> 37,995,115
<SALES> 8,663,236
<TOTAL-REVENUES> 8,663,236
<CGS> 2,286,901
<TOTAL-COSTS> 2,286,901
<OTHER-EXPENSES> 8,315,879
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,657,910)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 881,150
<NET-INCOME> (776,760)
<EPS-BASIC> (0.04)
<EPS-DILUTED> (0.04)
</TABLE>
