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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, 1998 or
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission file number: 0-19806
CYBERONICS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 76-0236465
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
16511 Space Center Boulevard, Ste. 600
Houston, Texas 77058
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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 5, 1999
Common Stock - $0.01 par value 17,498,539
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CYBERONICS, INC.
INDEX
<TABLE>
<CAPTION>
Page No.
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<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements:
Consolidated Balance Sheets
December 31, 1998 (unaudited) and June 30, 1998............. 3
Consolidated Statements of Operations (unaudited)
three and six months ended December 31, 1998 and 1997....... 4
Consolidated Statements of Cash Flows (unaudited)
six months ended December 31, 1998 and 1997................. 5
Notes to Consolidated Financial Statements.................. 6
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations......................... 8
PART II. OTHER INFORMATION
Item 6 Exhibits and Reports on Form 8-K............................ 19
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CYBERONICS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1998
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(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................... $ 184,716 $ 1,695,385
Securities held to maturity................................. 22,702,833 36,341,958
Accounts receivable, net.................................... 4,094,827 5,858,634
Inventories................................................. 4,523,943 2,103,603
Prepaid expenses............................................ 900,814 1,163,123
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TOTAL CURRENT ASSETS......................... 32,407,133 47,162,703
Securities held to maturity.................................. 5,516,084 2,106,716
Property and equipment, net................................... 3,957,928 3,152,983
Other assets, net............................................. 224,915 192,892
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$ 42,106,060 $ 52,615,294
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable............................................ $ 2,349,819 $ 3,690,295
Accrued liabilities......................................... 2,904,290 4,226,280
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TOTAL CURRENT LIABILITIES....................... 5,254,109 7,916,575
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 2,500,000 shares
authorized; no shares issued or outstanding............... -- --
Common stock, $.01 par value, 25,000,000 shares authorized;
17,483,439 and 17,266,433 shares issued and outstanding
at December 31, 1998 and June 30, 1998, respectively...... 174,835 172,664
Additional paid-in capital.................................. 108,590,652 107,757,504
Accumulated deficit......................................... (71,895,010) (63,341,714)
Cumulative translation adjustments.......................... (18,526) 110,265
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TOTAL STOCKHOLDERS' EQUITY...................... 36,851,951 44,698,719
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$ 42,106,060 $ 52,615,294
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</TABLE>
See accompanying notes to consolidated 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,
------------------------------- ------------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales.................................. $ 6,602,921 $ 3,335,496 $11,938,678 $ 4,438,730
Cost of sales.............................. 1,632,290 925,395 3,048,289 1,247,269
----------- ----------- ----------- -----------
Gross profit............................... 4,970,631 2,410,101 8,890,389 3,191,461
Operating expenses:
Research and development................ 1,887,192 1,625,490 3,740,287 3,602,022
Selling, general and administrative..... 7,507,784 3,840,708 14,909,214 7,799,933
----------- ----------- ----------- -----------
Total operating expenses............. 9,394,976 5,466,198 18,649,501 11,401,955
----------- ----------- ----------- -----------
Loss from operations....................... (4,424,345) (3,056,097) (9,759,112) (8,210,494)
Interest income, net....................... 566,363 568,224 1,048,753 770,485
Other income (expense)..................... (21,049) 29,746 157,063 24,684
----------- ----------- ----------- -----------
Net loss................................... $(3,879,031) $(2,458,127) $(8,553,296) $(7,415,325)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Net loss per share - basic and diluted..... $ (0.22) $ (0.15) $ (0.49) $ (0.49)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Shares used in computing
net loss per share - basic and diluted.. . 17,409,296 16,549,150 17,339,334 15,185,045
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
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CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
DECEMBER 31
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1998 1997
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<S> <C> <C>
Cash Flow From Operating Activities:
Net loss....................................................... $ (8,553,296) $ (7,415,325)
Non-cash items included in net loss:
Depreciation and amortization............................... 624,006 152,246
Compensation expense related to certain stock options and
common stock issuances................................... -- 9,562
Change in operating assets and liabilities:
Accounts receivable......................................... 1,763,807 (2,078,462)
Inventories................................................. (2,420,340) (207,332)
Prepaid expenses............................................ 262,309 (265,353)
Accounts payable and accrued liabilities.................... (2,662,466) 1,887,447
Other....................................................... (32,023) (64,011)
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Net Cash Used In Operating Activities.................... (11,018,003) (7,981,228)
Cash Flow From Investing Activities:
Purchases of property and equipment............................ (1,428,951) (666,931)
Purchases of investments....................................... (26,677,358) (29,326,711)
Maturities of investments...................................... 36,907,115 7,462,787
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Net Cash Provided By (Used In) Investing Activities...... 8,800,806 (22,530,855)
Cash Flow From Financing Activities:
Proceeds from issuance of Common Stock, net.................... 835,319 47,955,555
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Net Cash Provided By Financing Activities................ 835,319 47,955,555
Effect of exchange rate changes on cash and cash equivalents...... (128,791) (130,317)
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Net (decrease) increase in cash and cash equivalents..... (1,510,669) 17,313,155
Cash and cash equivalents, at beginning of period................. 1,695,385 781,639
------------ ------------
Cash and cash equivalents, at end of period....................... $ 184,716 $ 18,094,794
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</TABLE>
See accompanying notes to consolidated financial statements.
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CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
DECEMBER 31, 1998
NOTE 1 - BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information, and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for
the six months ended December 31, 1998 are not necessarily indicative of the
results that may be expected for the full year ending June 30, 1999. The
financial information presented herein should be read in conjunction with the
audited consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended June 30, 1998.
NOTE 2 - INVESTMENT SECURITIES:
At December 31, 1998 and June 30, 1998, the Company's entire investment
portfolio consisted of securities held to maturity. Securities held to
maturity are primarily various types of corporate bonds and asset-backed
investments with various maturity dates and have a fair market value of
$28,182,232 and a gross unrealized holding loss of $36,685 at December 31,
1998.
NOTE 3 - INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1998
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(Unaudited)
<S> <C> <C>
Raw materials and components..................... $ 2,120,202 $ 976,737
Work-in-process.................................. 492,216 549,885
Finished goods................................... 1,911,525 576,981
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$ 4,523,943 $ 2,103,603
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</TABLE>
NOTE 4 - ACCRUED LIABILITIES:
Accrued liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1998
-------------- ------------
(Unaudited)
<S> <C> <C>
Clinical costs.................................... $ 607,998 $ 270,472
Warranties........................................ 376,572 375,000
Payroll and other compensation.................... 855,821 2,330,449
Professional services............................. 293,657 334,000
Marketing activities.............................. 354,474 196,794
Royalties......................................... 265,601 206,992
Sales Returns and Allowances...................... 31,112 317,080
Other............................................. 119,055 195,493
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$ 2,904,290 $ 4,226,280
-------------- ------------
-------------- ------------
</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 - NEW ACCOUNTING PRONOUNCEMENT:
Effective July 1, 1998, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income, which
establishes new rules for the reporting and display of comprehensive income
and its components. Statement 130 requires companies to report, in addition
to net income, the net effect of other components of comprehensive income.
These items have been historically reported in shareholders' equity.
Total comprehensive income (loss) consisted of net loss and cumulative
translation adjustments and was ($3,878,000) and ($2,803,000) for the three
months ended December 31, 1998 and 1997, respectively, and ($8,682,000) and
($7,546,000) for the six months ended December 31, 1998 and 1997,
respectively.
Adoption of this disclosure standard had no effect on the Company's
reported results of operations or financial position.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION
21E OF THE SECURITIES EXCHANGE ACT OF 1934. ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT
OF A NUMBER OF IMPORTANT FACTORS. FOR A DISCUSSION OF IMPORTANT FACTORS THAT
COULD AFFECT THE COMPANY'S RESULTS, PLEASE REFER TO THE FINANCIAL STATEMENT
LINE ITEM DISCUSSIONS SET FORTH IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND TO THE SECTION ENTITLED
"FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS." READERS ARE ALSO
ENCOURAGED TO REFER TO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED JUNE 30, 1998 FOR A FURTHER DISCUSSION OF THE COMPANY'S BUSINESS AND
THE RISKS AND OPPORTUNITIES ATTENDANT THERETO.
SUMMARY
Cyberonics was founded in 1987 to design, develop and bring to market
medical devices which provide a novel therapy, vagus nerve stimulation, for
the treatment of epilepsy and other debilitating neurological disorders.
Clinical trials of the NCP System began with the first patient implant in
November 1988 under an Investigational Device Exemption ("IDE") from the
United States Food and Drug Administration ("FDA"). The Company received FDA
approval to market the NCP System in the United States in July 1997 for use
as an adjunctive therapy in reducing the frequency of seizures in adults and
adolescents over twelve years of age with partial onset seizures that are
refractory to anti-epileptic drugs ("AEDs"). From inception through July
1997, the Company's primary focus was on obtaining FDA approval for the NCP
System. The Company has had limited revenues 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, 1998, the Company incurred a cumulative
net deficit of approximately $72 million.
Cyberonics was granted regulatory approval in 1994 to market and sell
the NCP System in the member countries of the European Union and also has
permission to sell in certain other international markets. However, through
fiscal 1996, the Company devoted only limited resources to marketing and
sales activities internationally, and only in early fiscal 1997 began
initiating significant marketing and sales activities. International sales of
the NCP System have been limited to date.
Cyberonics is engaged in obtaining reimbursement approvals from the
various health care provider systems in the United States and in key
international markets, and has received reimbursement approvals from certain
payment authorities in the United States and in a limited number of
international markets. The Company does not expect to achieve significant
sales unless it can maintain and broaden reimbursement approvals.
The Company expects to incur substantial costs related to sales and
marketing activities in the United States and international markets,
expansion of manufacturing capabilities, clinical trials and regulatory
activities and product and process development. It is expected that there
will be a significant delay between the increased levels of spending and any
resulting increase in revenues. Accordingly, the Company expects to remain
unprofitable through at least the fiscal year ending June 30, 1999. There can
be no assurance that the Company will become profitable after that time or,
that if it becomes profitable, it will remain so in future periods.
Furthermore, the Company's results of operations may fluctuate significantly
from quarter to quarter and will depend upon numerous factors, many of which
are outside the Company's control. Such factors include, but are not limited
to, the extent to which the Company's NCP System gains market acceptance, any
approvals for
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<PAGE>
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, 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 December 31, 1998
totaled $6.6 million compared to $3.3 million for the three months ended
December 31, 1997, representing an overall increase of $3.3 million, or 98%.
Net sales for the six months ended December 31, 1998 totaled $11.9 million
compared to $4.4 million for the six months ended December 31, 1997,
representing an overall increase of $7.5 million, or 169%. Net sales for the
three months ended December 31, 1998 consisted of $5.6 million from the
United States and $1.0 million from international markets. Net sales for the
three months ended December 31, 1997 consisted of $2.7 million from the
United States and $627,000 from international markets. Future increases in
net sales will be dependent upon development of increased market acceptance
for the NCP System and upon obtaining or expanding reimbursement approval in
key markets.
GROSS PROFIT. The Company's gross margin percentage was 75.3% for the
three months ended December 31, 1998 compared to 72.3% in the prior year
period. The gross margin percentage for the six months ended December 31,
1998 was 74.5% compared to 71.9% for the same period a year ago. The increase
over the prior year is attributable primarily to the greater proportion of
net sales being derived from the United States, where the Company realized
higher gross margins due to its direct sales model in the United States and a
reduction in certain royalty rates paid by the Company. Cost of sales consist
primarily of direct labor, allocated manufacturing overhead, third-party
contractor costs and the acquisition cost of raw materials and components. In
addition, the Company is obligated to pay royalties at a rate of
approximately 4% of net sales. Gross margin percentages can be expected to
fluctuate in future periods based upon the mix between domestic and
international sales, direct and distributor sales, the NCP System's selling
price and levels of production volume.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses are
comprised of both expenses related to the Company's product and process
development efforts and expenses associated with conducting clinical trials
and certain related regulatory activities. Research and development expenses
totaled $1.9 million, or 28.6% of net sales, for the three months ended
December 31, 1998, compared to $1.6 million, or 48.7% of net sales, in the
prior year period. Research and development expenses were $3.7 million, or
31.3% of sales, and $3.6 million, or 81.1% of sales, for the six months ended
December 31, 1998 and December 31, 1997, respectively. The large decrease of
such expenses as a percentage of net sales is primarily the result of the
increase in sales in the quarter and six months ended December 31, 1998 as
compared to the same prior year periods. The Company intends to conduct
further clinical trials of the NCP System for additional indications both
within and outside the field of epilepsy. Accordingly, the Company expects
research and development expenses to fluctuate in future periods depending
primarily upon the level of clinical trial activity.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses totaled $7.5 million, or 114% of sales, for the three
months ended December 31, 1998 compared to $3.8 million, or 115% for the
three months ended December 31, 1997. Selling, general and administrative
expenses totaled $14.9 million, or 125% of sales, for the six months ended
December 31, 1998, compared to $7.8 million, or 176% of sales, for the same
period a year ago. The increase in absolute dollars was primarily due to
sales and marketing activities focused on the United States market launch for
the NCP System, the continued expansion of corporate infrastructure in
response to the recent business growth and movement of the Company's
headquarters to a new location. The decrease of such expenses as a percentage
of net sales is primarily the result of the increase in sales
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in the quarter and six months ended December 31, 1998 as compared to the same
prior year periods. The Company expects to add administrative personnel in
anticipation of higher levels of business activity in fiscal year 1999.
Accordingly, the Company expects its future selling, general and
administrative expenses in absolute amount to remain at or increase beyond
the amounts incurred during the three months and six months ended December
31, 1998.
INTEREST INCOME. Interest income totaled $566,000 and $568,000 for the
three months ended December 31, 1998 and December 31, 1997, respectively, and
$1,049,000 and $770,000 for the six months ended December 31, 1998 and 1997,
respectively. Interest income decreased for the quarter ended December 31,
1998 as compared to the same prior year period as a result of lower cash and
investment balances on hand. For the six months ended December 31, 1998,
interest income increased over the same period last year due to higher
average cash balances resulting from the completion of a follow-on public
equity offering in December 1997. The Company expects interest income to
gradually decline in absolute amount in future periods as the Company
utilizes its resources to fund future working capital requirements.
OTHER INCOME (EXPENSE), NET. Other income (expense) totaled $(21,000)
and $30,000 during the three months ended December 31, 1998 and 1997,
respectively, and $157,000 and $25,000 for the six months ended December 31,
1998 and 1997, respectively. For each of these periods, other income
(expense) consisted primarily of net gains and losses resulting from foreign
currency fluctuations. The Company expects other income (expense) to
fluctuate in future periods depending upon the mix between international and
domestic business activities, business exposures to foreign currencies, and
upon fluctuations in currency exchange rates.
INCOME TAXES. Due to its net operating loss history, to date the Company
has established a valuation allowance to fully offset its deferred tax
assets, including those related to its carryforwards, resulting in no income
tax expense or benefit for financial reporting purposes. Current federal
income tax regulations with respect to changes in ownership could limit the
utilization of the Company's net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations primarily
through public and private placements of its securities. The Company had no
short or long-term borrowings outstanding at December 31, 1998, and had no
credit facilities available at that time.
The Company expects to incur substantial additional costs related to
sales and marketing activities associated with United States and
international sales and marketing activities, expansion of manufacturing
capabilities, clinical trials and regulatory activities and product and
process development. The amount and timing of anticipated expenditures will
depend upon numerous factors both within and outside of the Company's
control, including the nature and timing of marketing and sales activities,
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, the Company's ability to generate
income from operations will be dependent upon maintaining and broadening
reimbursement approval from government and third-party payors as well as
receiving market acceptance for the NCP System.
During the six months ended December 31, 1998, the Company used
approximately $11.0 million in operating activities. Accounts receivable
decreased to $4.1 million, from $5.9 million at June 30, 1998. Inventories
increased to $4.5 million at December 31, 1998 from $2.1 million at June 30,
1998 as the Company built inventory levels in anticipation of higher levels
of manufacturing and sales activities and in preparation for
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the relocation of manufacturing operations to its new facility. The Company
also reduced current liabilities to $5.2 million at December 31, 1998 from
$7.9 million at June 30, 1998.
The Company's liquidity will continue to be reduced as amounts are
expended for sales and marketing activities, manufacturing expansion,
continuing clinical trials and related regulatory affairs, product and
process development and infrastructure development. Although the Company has
no firm commitments, the Company expects to make capital expenditures of
approximately $2.0 million during the remainder of fiscal 1999, primarily to
expand manufacturing capabilities and to enhance general infrastructure and
facilities.
The Company believes that its current resources will be sufficient to
fund its operations at least through June 30, 2000. This estimate is based on
certain assumptions, which may not hold true. There can be no assurance that
the Company's available cash, cash equivalents, investment securities and
investment income, will be sufficient to meet the Company's capital
requirements at least through June 30, 2000. The availability of financing
either before or after that time will depend upon a number of important
factors, including the state of the United States capital markets and economy
in general and the health care and medical device segments in particular, the
status of the Company's international and domestic sales activities and the
status of the Company's clinical and regulatory activities. There can be no
assurance that the Company will be able to raise additional capital when
needed or that the terms upon which capital will be available will be
favorable to the Company.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
See Note 5 of Notes to Consolidated Financial Statements for a
discussion of the impact of new accounting pronouncements.
IMPACT OF YEAR 2000
Many currently installed computer systems and software products were
coded using two digits rather than four to define the applicable year. As a
result, these computer systems and software products have time-sensitive
software that recognize a date using "00" as the year 1900 rather than the
year 2000. This could cause a system failure or miscalculations, causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, to send invoices, or to engage in similar
normal business activities. Finally, computer systems and software products
devices may fail to process accurately leap year logic associated with the
Year 2000.
STATE OF READINESS
The Company believes that the adverse impact of Year 2000 issues on its
internal computer systems will not be material. Most of the personal
computers and computer systems used by the Company have been installed in the
past three years as the Company has been growing its organization. The
Company has also recently moved most of its organization to a new facility in
Houston, Texas, and has installed new equipment in connection with such
relocation. The Company has conducted a manual review of all of its software,
except for its manufacturing systems, and found the incidence of Year 2000
coding issues to be minimal. The Company continues to manufacture the NCP
System at its Webster, Texas facility, in addition to its Houston facility.
The Company is in the process of evaluating its manufacturing software for
Year 2000 compliance, including systems used at the Webster facility as well
as the systems that were implemented at the Houston facility, however, it
does not expect that any necessary changes to its software will be material.
The Company has also
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contacted each of its material vendors and suppliers to determine if such
vendors or suppliers have any Year 2000 compliance issues that have not been
resolved, or may not be resolved in a timely manner.
The Company's software used by customers to program the NCP Generator
does not utilize dating in its processing calculations.
COSTS OF YEAR 2000 COMPLIANCE
The Company does not expect expenditures for upgrades and testing for
Year 2000 issues of software used on internal systems to be material. To
date, any such costs incurred have been in connection with the implementation
of systems at its new facility and the purchase of equipment and software for
its growing employee base. The Company estimates that, in the worst case, it
may have to upgrade certain of its manufacturing databases and replace
certain older personal computers currently being used. The costs of such
activities are estimated to be under $100,000. The Company expects to
complete its testing, and any required upgrades by mid-calendar 1999. The
Company also does not expect diversion of resources from other management
information systems or manufacturing projects will have a material adverse
impact on the Company.
RISKS OF YEAR 2000 NON-COMPLIANCE AND CONTINGENCY PLANS
In the event of a failure of any software or other electronic devices
used for the Company's internal systems, the Company believes any resulting
business disruption would not have a material adverse effect on the Company,
because the Company believes alternative, less technologically advanced,
systems would be available. The Company is also contacting its vendors and
suppliers currently to determine if a further contingency plan will be needed
to ensure timely receipt of materials and services from such vendors and
suppliers.
The costs of the modifications and the date on which the Company
believes it will complete the Year 2000 modifications, if any, are based on
management's estimates, which were derived utilizing numerous assumptions of
future events, including the continued availability of certain resources and
other factors. However, there can be no guarantee that these estimates will
be achieved, and actual results could differ from those anticipated. Factors
that might cause such differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer code, and similar uncertainties.
FACTORS AFFECTING FUTURE OPERATING RESULTS
RELIANCE ON SINGLE PRODUCT. The Company has only one product, the NCP
System, which has been approved by the FDA only for a single indication: as
an adjunctive therapy in reducing the frequency of seizures in adults and
adolescents over twelve years of age with partial onset seizures that are
refractory to AEDs. The Company does not expect to have any other product or
approved indication for the NCP System for the foreseeable future. Although
the Company has been able to sell the NCP System in certain countries in
Europe since 1994 and in the United States and Canada since mid 1997, it has
only recently initiated full-scale marketing and sales efforts in the United
States and other countries. The Company's inability to commercialize
successfully the NCP System would have a material adverse effect on the
Company's business, financial condition and results of operations.
UNCERTAINTY OF MARKET ACCEPTANCE. Continued market acceptance of the
Company's NCP System will depend on the Company's ability to convince the
medical community of the clinical efficacy and safety of vagus nerve
stimulation and the NCP System, and on the approval and availability of
adequate levels of reimbursement. While the NCP System has been used in over
3,500 patients through December 31, 1998, it provides a new form
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of therapy with which many physicians are unfamiliar. The Company believes
that existing AEDs and surgery are the only other approved and currently
available therapies competitive with the NCP System in the treatment of
epileptic seizures. Such therapies may be more attractive to patients or
their physicians than the NCP System in terms of efficacy, cost or
reimbursement availability. There can be no assurance that the NCP System
will achieve market acceptance for the treatment of epilepsy or for any other
indication or that adequate levels of reimbursement from governmental or
third-party payors will be available. Failure of the NCP System to gain
market acceptance would have a material adverse effect on the Company's
business, financial condition and results of operations.
HISTORY OF LOSSES; PROFITABILITY UNCERTAIN; FLUCTUATIONS IN QUARTERLY
OPERATING RESULTS. The Company has incurred net losses and accumulated a
deficit of approximately $72 million through December 31, 1998. In July 1997,
the Company received FDA marketing approval which permits the Company to sell
the NCP System in the United States for use as an adjunctive therapy in
reducing the frequency of refractory partial onset seizures in patients over
twelve years of age. In addition, the Company has obtained "CE Marking,"
the designation of market approval now accepted by all European Union member
countries, for its NCP System which, when combined with approvals from Canada
and certain other countries, permits the Company to sell the NCP System
internationally. Even with these marketing approvals, there can be no
assurance that the Company will be able to generate adequate sales to achieve
profitability in the future. In addition, in order to develop these markets,
the Company will incur substantial marketing and sales expenses. The amount
and timing of anticipated expenditures will depend on numerous factors,
including the nature and timing of marketing and sales activities, the
expansion of the Company's manufacturing capabilities, the nature and timing
of additional clinical trials, and the Company's product development efforts.
The Company's results of operations may fluctuate significantly from
quarter to quarter and will depend upon numerous factors, many of which are
outside the Company's control. Such factors include, but are not limited to,
the extent to which the Company's NCP System gains market acceptance, timing
of any approvals for reimbursement by third-party payors, the rate and size
of expenditures incurred as the Company expands its sales and marketing
efforts, the availability of key components, materials and contract services
which may be dependent on the Company's ability to forecast sales, and the
extent and timing of the development of corporate infrastructure.
LIMITATIONS ON THIRD-PARTY REIMBURSEMENT. The Company's ability to
commercialize the NCP System successfully will depend in part on whether
third-party payors, including private health care insurers, managed care
plans, the United States government's Medicare and Medicaid programs and
others, agree both to cover the NCP System and the procedures and services
associated therewith, and to reimburse at adequate levels for the costs of
the NCP System and the related services.
In deciding to cover a new therapy, third-party payors base their
initial coverage decisions on several factors including, but not limited to,
the status of the FDA's review of the product, the product's safety and
efficacy, the number of studies performed and peer-reviewed articles
published with respect to the product and how the product and therapy
compares to alternative therapies. There can be no assurance that third-party
payors will view the Company and the NCP System favorably with respect to any
of the above factors. The Company has only limited experience in seeking and
obtaining coverage decisions from third-party payors. A failure to achieve
favorable coverage decisions for the NCP System in a timely manner could
deter patients and their physicians from using the NCP System and could have
a material adverse effect on the Company's business, financial condition or
results of operations.
Once a favorable coverage determination is made with respect to a
product, payors must determine the level of reimbursement for the product and
related therapy and procedures. In making decisions about reimbursement
amounts, third-party private payors typically reimburse for the costs of
newly covered devices and
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services using the standard methods they employ for other products and
services already covered. Many private insurers and managed care plans use a
variety of payment mechanisms, including, but not limited to, discounted
charges, per diem amounts, resource-based payment scales and reimbursed
costs. The Company believes that a significant number of epilepsy patients in
the United States are either eligible for benefits under the Medicare program
or are uninsured. The Medicare program uses different payment mechanisms to
reimburse for procedures performed in different settings. For outpatient
implants, Medicare uses a system that reimburses hospitals based on their
costs. The Company believes that those payments generally are adequate. For
inpatient implants, Medicare uses a fixed-payment method (based on Diagnosis
Related Groups or "DRGs"). Under current DRG groupings, hospital inpatient
procedures for implanting the NCP System are assigned to one of two different
DRGs based on whether or not the patient has complications or comorbidities
(coexisting severe medical problems). The DRG grouping that would include
implantation of the NCP System for patients without complications or
comorbidities pays hospitals less than the costs of purchasing and implanting
the NCP System. The Company believes that this DRG grouping would apply to
most of the epilepsy patients covered by Medicare. In order to assure
adequate reimbursement for all epileptic patients eligible for benefits under
Medicare, the Company may seek changes in the DRG grouping so that NCP System
implant cases would be reclassified to other, higher-paying DRGs. The Company
has only limited experience in seeking and obtaining coverage and payment
approvals from third-party payors, and there can be no assurance that the
Company would be successful in achieving coverage or adequate reimbursement
levels, or that it can obtain new DRG assignments under the Medicare program
to cover the complete costs of therapy using the NCP System. If the Company
is unsuccessful in achieving coverage or adequate reimbursement levels or in
obtaining new DRG assignments, or if hospitals or physicians view their
payments as inadequate, then patients, physicians and hospitals could be
deterred from using the NCP System, which could have a material adverse
effect on the Company's business, financial condition or results of
operations. Medicare uses a resource-based relative value scale to pay for
physicians' services. The Company believes that the relative value scales for
the surgeons and physicians involved in the implantation and interrogation
and reprogramming of the NCP System provide adequate reimbursement for these
physicians' services.
In June 1994, the Company was granted approval to use the CE Mark and to
market the NCP System in the European Union. The Company is continuing to
pursue appropriate reimbursement approvals in the European Union member
countries. The Company believes that significant sales volume will be
difficult to generate without appropriate reimbursement approvals. There can
be no assurance as to when or whether such reimbursement will be obtained in
any of the European Union countries or, if obtained, whether the levels of
reimbursement will be sufficient to enable the Company to sell the NCP System
on a profitable basis.
LIMITED MARKETING AND SALES EXPERIENCE. Although the Company has had
approval to market the NCP System in the member countries of the European
Union since 1994, it only received FDA approval to commercialize the NCP
System in the United States in July 1997 and, consequently, it has limited
experience in marketing, direct sales and distribution. The Company has
recently expanded its marketing and sales force for the United States market,
but no assurance can be given that this expanded direct marketing and sales
force will succeed in promoting the NCP System to patients, health care
providers or third-party payors on a broad basis. The Company believes that,
to market its products directly, it must employ a multidisciplinary marketing
and sales force with medical device sales experience, clinical experience
with epilepsy, experience in obtaining reimbursement for new medical
technologies and experience with peer to peer marketing programs. In
addition, due to the limited market awareness of the NCP System, the Company
believes that it is necessary for the Company to educate patients, health
care providers and third-party payors regarding the clinical benefits and
cost-effectiveness of the NCP System. In certain international territories,
the Company relies, and intends to continue relying, upon independent
distributors. There can be no assurance that the Company will be able to
recruit and retain skilled marketing and sales personnel or foreign
distributors, or that the Company's marketing efforts will
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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 AND FACILITY TRANSITION ISSUES. The
Company has a limited history of manufacturing the NCP System in the volumes
that will be necessary to achieve significant commercial sales. In addition
to its existing manufacturing facility in Webster, Texas, the Company is in
the process of moving its manufacturing operations to its new facility in
Houston, Texas, where it initiated production activities in February 1999.
The Company has only recently received regulatory approvals from both the FDA
and KEMA (ISO9000 notified body) for its new facility. Although the Company
has been able to meet demand requirements for the NCP System to date, it may
encounter difficulties in relocating the materials and equipment, quality and
yield problems, bringing production back on-line and restoring capacity to
previous levels. Delays in reinitiating production due to unanticipated
facility problems, personnel training issues or equipment problems could have
an adverse effect on the Company's ability to support product demand. The
Company may encounter difficulties in scaling up production of the NCP System
if demand increases, in procuring the necessary supply of materials,
components and contract services, or in hiring and training additional
manufacturing personnel to support domestic and international demand. If the
Company is unable to achieve and maintain commercial-scale production
capability with acceptable quality and manufacturing yield and costs, to
sustain such capacity, or to maintain 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 to
minimize the occurrence of these problems. There can be no assurance,
however, that the Company will not experience similar or other product
problems or that the Company will not be required to recall products. Any
product recall could have a material adverse effect on the Company's
business, financial condition or results of operations.
DEPENDENCE ON PATENTS, LICENSES AND PROPRIETARY RIGHTS. The Company's
success will depend in part on its ability to obtain and maintain patent and
other intellectual property protection for the NCP System and its
improvements, and for vagus nerve stimulation therapy. To that end, the
Company has acquired licenses under certain patents and has patented and
intends to continue to seek patents on its own inventions used in its
products and treatment methods. The process of seeking patent protection can
be expensive and time consuming and there can be no assurance that patents
will issue from the currently pending or future applications or that, if
patents are issued, they will be of sufficient scope or strength to provide
meaningful protection of the Company's technology, or any commercial
advantage to the Company.
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Cyberonics believes that the licenses held by the Company provide it
with protection in the United States in the field of cranial nerve
stimulation, including vagus nerve stimulation for the control of epilepsy,
movement disorders, including Parkinson's disease and essential tremor, and
additional indications for which method patents have been issued. The
protection offered by the licensed international patents is not as strong as
that offered by the licensed United States patents due to differences in
patent laws. In particular, the European Patent Convention prohibits patents
covering methods for treatment of the human body by surgery or therapy. In
addition, there has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. Litigation,
which could result in substantial cost to and diversion of effort by the
Company, may be necessary to enforce patents issued or licensed to the
Company, to protect trade secrets or know-how owned by the Company or to
defend the Company against claimed infringement of the rights of others and
to determine the scope and validity of the proprietary rights of others.
Adverse determinations in litigation could subject the Company to significant
liabilities to third parties, could require the Company to seek licenses from
third parties and could prevent the Company from manufacturing, selling or
using the NCP System, any of which could have a material adverse effect on
the Company's business, financial condition or results of operations. There
can be no assurance that any required license would be available on
acceptable terms, if at all.
COMPETITION; RAPID TECHNOLOGICAL CHANGE. The Company believes that
existing and future AEDs will be the primary competition for its NCP System.
The Company may also face competition from other medical device companies for
the treatment of partial seizures. Medtronic, Inc. continues to clinically
assess an implantable signal generator used with an invasive deep brain probe
(thalamic stimulator) for the treatment of neurological disorders and has
received FDA approval for the device for the treatment of essential tremor,
including that associated with Parkinson's disease. The Company could also
face competition from other large medical device companies which have the
technology, experience and capital resources to develop alternative devices
for the treatment of epilepsy. Many of the Company's competitors have
substantially greater financial, manufacturing, marketing and technical
resources than the Company. In addition, the health care industry is
characterized by extensive research efforts and rapid technological progress.
There can be no assurance that the Company's competitors will not develop
technologies and obtain regulatory approval for products that are more
effective in treating epilepsy than the Company's current or future products.
There can also be no assurance that advancements in surgical techniques will
not make surgery a more attractive therapy for epilepsy. The development by
others of new treatment methods with novel AEDs, medical devices or surgical
techniques for epilepsy could render the NCP System non-competitive or
obsolete. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competition,
including the development and commercialization of new products and
technology, will not have a material adverse effect on the Company's
business, financial condition or results of operations.
MANAGEMENT OF GROWTH. In connection with the commercialization of the
NCP System in the United States, the Company has begun and intends to
continue to significantly expand the scope of its operations, in particular
in manufacturing and in marketing and sales. Such activities have placed, and
may continue to place, a significant strain on the Company's resources and
operations. The Company's ability to effectively manage such growth will
depend upon its ability to attract, hire and retain highly qualified
employees and management personnel. The Company competes for such personnel
with other companies, academic institutions, government entities and other
organizations. There can be no assurance that the Company will be successful
in hiring or retaining qualified personnel. The Company's success will also
depend on the ability of its officers and key employees to continue to
implement and improve its operational, management information and financial
control systems, of which there can be no assurance. The Company's inability
to manage growth effectively could have a material adverse effect on the
Company's business, financial condition or results of operations.
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<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 medical device by the FDA and is subject to the
FDA's premarket approval ("PMA") requirements. In July 1997, the Company
received FDA approval to market the NCP System in the United States for use
as an adjunctive therapy in reducing the frequency of seizures in adults and
adolescents over twelve years of age with partial onset seizures that are
refractory to AEDs. Nonetheless, in the future, it will be necessary for the
Company to file PMA supplements, and apply for additional regulatory
approvals, possibly including new investigational device exemptions
("IDEs") and additional PMAs, for other applications of the NCP System and
for modified or future-generation products. Commercial distribution in
certain foreign countries is also subject to obtaining regulatory approvals
from the appropriate authorities in such countries. The process of obtaining
FDA and other required regulatory approvals is lengthy, expensive and
uncertain. Moreover, regulatory approvals may include regulatory restrictions
on the indicated uses for which a product may be marketed. Failure to comply
with applicable regulatory requirements can result in, among other things,
fines, suspension or withdrawal of approvals, confiscations or recalls of
products, operating restrictions and criminal prosecution. Furthermore,
changes in existing regulations or adoption of new regulations could prevent
the Company from obtaining, or affect the timing of, future regulatory
approvals. There can be no assurance that the Company will be able to obtain
additional future regulatory approvals on a timely basis or at all. Delays in
receipt of or failure to receive such future approvals, suspension or
withdrawal of previously received approvals, or recalls of the NCP System
could have a material adverse effect on the Company's business, financial
condition or results of operations.
FUTURE CAPITAL REQUIREMENTS. Although the Company believes that its
current resources will be sufficient to meet its capital requirements at
least through June 30, 2000, there can be no assurance that the Company will
not require additional financing either before or after that date. This
estimate is based on certain assumptions, which may not hold true. There can
be no assurance that the Company's available cash, cash equivalents,
investment securities and investment income, will be sufficient to meet the
Company's capital requirements through June 30, 2000. The Company's future
capital requirements will depend upon numerous factors, including the extent
and timing of future product sales, the scale-up of the Company's
manufacturing facilities, and the nature, timing and success of clinical
trials for additional indications for the NCP System. Such financing, if
required, may not be available on satisfactory terms, or at all. Lack of
access to sufficient financing would impair the Company's ability to fully
pursue its business objectives, which could have a material adverse effect on
the Company's business, financial condition or results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. Although the NCP System
has been approved for commercialization in the European Union countries since
1994, the Company has not generated significant revenues from such countries
to date. The Company currently is focusing its marketing and sales activities
in certain international markets. There can be no assurance that the Company
will successfully increase international sales or that the Company will be
successful in obtaining reimbursement or any regulatory approvals required in
foreign countries. Changes in overseas economic conditions, currency exchange
rates, tax laws, or tariffs or other trade regulations could have a material
adverse effect on the Company's business, financial condition or results of
operations. The anticipated international nature of the Company's business is
also expected to subject the Company
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<PAGE>
and its representatives, agents and distributors to laws and regulations of
the foreign jurisdictions in which they operate or where the NCP System is
sold. The regulation of medical devices in a number of such jurisdictions,
particularly in the European Union, continues to develop and there can be no
assurance that new laws or regulations will not have an adverse effect on the
Company's business, financial condition or results of operations. In
addition, the laws of certain foreign countries do not protect the Company's
intellectual property rights to the same extent as do the laws of the United
States. In particular, the European Patent Convention prohibits patents
covering methods for the treatment of the human body by surgery or therapy.
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<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the
quarter ended December 31, 1998.
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<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CYBERONICS, INC.
Registrant
BY: /s/ PAMELA B. WESTBROOK
-------------------------------
Pamela B. Westbrook
Vice President, Finance
and Administration and Chief
Financial Officer (principal
financial and accounting
officer)
Dated: February 12, 1999
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