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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: JUNE 30, 2000
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
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CYBERONICS, INC.
(Exact name of Registrant as Specified in its Charter)
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DELAWARE 76-0236465
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
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16511 SPACE CENTER BLVD., #600, 77058-2072
HOUSTON, TEXAS (zip code)
(address of principal executive offices)
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Registrant's Telephone Number, Including Area Code: (281) 228-7200
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Securities Registered Pursuant to Section 12(b) of the Act: NONE
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of Class)
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
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 [ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of August 31, 2000, was, based upon the last sales price reported
for such date on the Nasdaq National Market, approximately $228 million. For
purposes of this disclosure, shares of Common Stock held by persons who hold
more than 5% of the outstanding shares of Common Stock and shares held by
officers and directors of the registrant, have been excluded in that such
persons may be deemed to be affiliates. This determination is not necessarily
conclusive.
At August 31, 2000, registrant had outstanding 18,645,694 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
No documents are incorporated by reference herein.
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TABLE OF CONTENTS
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PART I ............................................................ 1
ITEM BUSINESS....................................................
1. 1
ITEM PROPERTIES..................................................
2. 17
ITEM LEGAL PROCEEDINGS...........................................
3. 17
ITEM SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........
4. 17
PART II ............................................................ 17
ITEM MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
5. STOCKHOLDER MATTERS......................................... 17
ITEM SELECTED FINANCIAL DATA.....................................
6. 18
ITEM MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
7. AND RESULTS OF OPERATIONS................................... 18
ITEM FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................
8. 26
ITEM CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
9. AND FINANCIAL DISCLOSURE.................................... 26
PART III ............................................................ 26
ITEM DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..........
10. 26
ITEM EXECUTIVE COMPENSATION......................................
11. 29
ITEM SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
12. MANAGEMENT.................................................. 33
ITEM CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............
13. 34
PART IV ............................................................ 35
ITEM EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
14. 8-K......................................................... 35
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PART I
ITEM 1. BUSINESS
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Exchange 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 Business section below, the financial
statement line item discussions and the Factors Affecting Future Operating
Results set forth in Management's Discussion and Analysis of Financial Condition
and Results of Operations.
GENERAL
Cyberonics, Inc. was founded in 1987 to design, develop, manufacture and
market the Neuro Cybernetic Prosthesis, or NCP(R) System, an implantable medical
device for the treatment of epilepsy and other debilitating neurological,
psychiatric diseases and other disorders.
During fiscal 2000, we began operating our business in three business
units. The three separate business units include the Epilepsy Business Unit, the
Depression Business Unit and the Obesity and Other New Indications Business
Unit. All three of these units are reported for accounting purposes as one
segment and involve designing, developing, manufacturing and marketing our
proprietary NCP System using Vagus Nerve Stimulation (VNS(TM)) for the treatment
of epilepsy and other debilitating neurological, psychiatric diseases and other
disorders. The identification and separation of the Indications Business Units
reflects the different phases of clinical development and product life cycle as
well as the different disorders amenable to treatment by VNS using our
proprietary NCP System. However, each Indication Business Unit has similar
economic characteristics, technology, manufacturing processes, customers,
distribution and marketing strategies, a similar regulatory environment and
shared infrastructures.
Our overall objectives are:
- to transition VNS from being considered a revolutionary new therapy into
being considered a primary adjunctive standard of care for treating
patients who suffer from epilepsy and
- to develop other indications for vagus nerve stimulation covered by our
method patents.
Our strategies to achieve our objectives are to:
- expand market acceptance of VNS by creating physician and patient demand,
- expand reimbursement by third-party payors to hospitals and medical
professionals by communicating the safety and efficacy of the NCP System,
the debilitating nature and the annual cost of treating epilepsy and the
efficacy and cost of alternative treatments,
- expand the clinical study of the NCP System for the treatment of major
depression and
- continue the preliminary evaluation of VNS in new indications as
warranted by our extensive patent portfolio, research and studies and
market dynamics.
EPILEPSY
The Epilepsy Business Unit designs, develops, manufactures and markets the
NCP System for the treatment of epilepsy. The NCP System was approved by the
United States Food and Drug Administration, also referred to as the FDA, on July
16, 1997 as an adjunctive therapy for reducing the frequency of seizures in
patients over 12 years of age with partial onset seizures that are refractory or
resistant to antiepileptic drugs. The NCP System has also received regulatory
approval for sale in Canada, Europe, Australia and certain countries in the Far
East with the broader indication of refractory epilepsy and without
discrimination to patient age. We have completed a total of seven clinical
studies, including five controlled acute phase studies
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involving over 450 patients, a long-term multi-year follow-up study involving
243 patients and a mortality study. To date, over 9,000 patients have
accumulated in excess of 14,000 patient years of treatment experience with the
NCP System.
Epilepsy Overview
Epilepsy is a disorder of the brain characterized by recurrent seizures.
Epileptic seizures are categorized as either partial or generalized at onset.
Generalized seizures, known as "grand mal" seizures, involve the entire brain
from the onset, result in the loss of consciousness and are typically manifested
by convulsions. Partial onset seizures initiate in a localized region of the
brain, and may or may not result in the loss of consciousness. Partial onset
seizures can also develop into generalized seizures. Patients who continue to
have unsatisfactory seizure control or intolerable side effects after treatment
with appropriate antiepileptic therapies for a reasonable period of time are
said to suffer from refractory epilepsy. For reasons that are not clear, partial
onset seizures are generally more refractory to existing therapies than
generalized seizures.
It is estimated that over 2.3 million individuals are currently being
treated for epilepsy in the United States, with over 117,000 new cases diagnosed
each year, and that there are in excess of three million individuals being
treated for epilepsy in Western Europe and Japan, with over 210,000 new cases
diagnosed each year. In addition, it is estimated that approximately 50% of
patients with epilepsy suffer from partial onset seizures and that over 20% of
these patients continue to suffer from seizures in spite of treatment with
antiepileptic drugs. The medical, psychological, sociological and financial
implications of refractory epilepsy can be profound for individuals and their
families. Seizures can be severely debilitating and may result in major
irreversible morbidity which consist of lasting complications or side effects.
Medical consequences may include brain damage from recurrent seizures, injuries
and accidents associated with the loss or impairment of consciousness, and death
as the result of severe seizures. Personal implications of epilepsy may include
suffering the side effects of antiepileptic drugs, strained personal and family
relations, and the inability to obtain and hold meaningful employment or a
driver's license.
Societal implications of epilepsy include the loss or underutilization of
potentially productive citizens and the cost of long-term public assistance for
those disabled by epilepsy. Epilepsy patients, in general, and refractory
patients, to a greater extent, experience a significantly higher mortality rate
than the general population.
Traditional Epilepsy Therapies
Traditionally, there have been two courses of treatment available to
persons suffering from epilepsy: drug therapy and surgery. The efficacy of these
treatments depends in part upon the type of seizures from which a patient
suffers. The efficacy of drugs and surgery for patients suffering from partial
onset seizures is highly variable.
Drug Therapy. Antiepileptic drugs serve as a first-line treatment and are
prescribed for virtually all individuals being treated for epilepsy. There are
13 drugs predominately used for the treatment of epilepsy which are used either
alone or in combination. Lack of patient compliance, which is typical of chronic
drug therapy, inherently reduces the efficacy of a drug therapy regimen. In
addition, side effects are common with antiepileptic drugs. Side effects range
from debilitating central nervous system conditions such as drowsiness,
confusion and cognitive impairment to life-threatening hematologic reactions or
liver failure. Women taking antiepileptic drugs are more likely to bear infants
with birth defects than the general population. Children receiving antiepileptic
drug therapy often experience learning difficulties. Nine of the 13
antiepileptic drugs have received FDA approval since 1993. While each of these
newer antiepileptic drugs demonstrates some efficacy or tolerability benefits
when compared with older antiepileptic drugs, we believe that none of these
newer antiepileptic drugs appear to provide significantly improved clinical
outcomes.
Surgical Treatment. When drug therapy is not effective, the other
traditional treatment alternative has been surgical removal of the portion of
the brain where seizures originate. Surgical treatment of epilepsy has been
proven safe and beneficial for a limited number of patients. Only approximately
2,500 epilepsy surgeries are performed per year in the United States. We believe
that the low number of surgeries is attributable to
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several factors, including: the extensive evaluation and testing required to
screen candidates for surgery and to localize the source of the seizures; the
risks of morbidity and mortality associated with brain surgery; the uncertainty
of long-term benefits; the non-reversible nature of the procedure; and the cost
of evaluation, testing and surgery, which is reported to be approximately
$60,000 in many cases.
The Cyberonics Solution
Our FDA approved NCP System is the only currently approved medical device
alternative for treating epilepsy. The NCP System delivers an electrical signal
through an implantable lead to the left cervical vagus nerve in the patient's
neck on a chronic, intermittent basis. Stimulation may also be initiated by the
patient (or caregiver) with a hand held magnet.
We believe that a successful new therapy for refractory epilepsy should be
clinically proven as effective, provide significant seizure control, be safe and
tolerable with few side effects, provide improvement in quality of life and
long-term benefits and be easy for the physician to prescribe and for the
patient to use. Based on the results of our preclinical studies, mechanism of
action research, seven human clinical trials, and the Cyberonics VNS Patient
Outcome Registry, we believe that the NCP System meets these criteria as
described below.
Clinically Proven. To date over 9,000 patients have accumulated in excess
of 14,000 patient years of treatment experience with the NCP System. On July 16,
1997, the NCP System was approved by the FDA for use as an adjunctive therapy in
reducing the frequency of seizures in adults and adolescents over 12 years of
age with partial onset seizures that are refractory to antiepileptic drugs. The
product is approved for the broader indication of refractory epilepsy in Canada,
the European Union, Australia and other Asian markets.
Significant Seizure Control. In our two randomized, parallel, double blind
active control studies, the treatment groups reported a mean seizure reduction
of approximately 24% and 28% during the three-month acute phase of the studies.
Additionally, many patients, including some who reported no change or an
increase in seizure frequency, also reported a reduction in seizure severity.
Well-tolerated Side Effects. The side effects associated with the NCP
System are generally mild, localized and related to the period of time in which
stimulation is activated. They include hoarseness, coughing, a feeling of
shortness of breath and throat pain. The NCP System has not been associated with
the debilitating central nervous system side effects which frequently accompany
antiepileptic drugs. Additionally, over time, a significant percentage of
patients continued to use the therapy attesting to its tolerability.
Quality of Life. The Cyberonics VNS Patient Outcome Registry collects acute
and long-term follow-up data on patients treated with VNS post-FDA approval.
Global changes were measured in important quality of life areas such as
alertness, verbal communication, memory, school/professional achievements, mood
changes, postictal state and cluster seizures. As of August 31, 2000, the
registry included data on over 3,200 patients of which over 1,800 patients were
at 3-months follow-up and almost 700 patients were at 12-months follow-up.
Compared to pre-implant, approximately half of patients in both the acute and
long-term follow-up exhibit improvements in at least two quality of life areas.
Less than 5% of patients exhibited a worsening of any effect in both the acute
and long-term patient populations.
Long-term Efficacy. Long-term follow-up data, although derived from an
uncontrolled protocol, on the 253 patients in our first four studies suggest
that efficacy is maintained and, for many patients, improves over time when the
NCP System is used as an adjunctive therapy with drugs as part of a patient's
optimized long-term treatment regimen. Analysis of this pooled data showed that
the median percent seizure reduction increased from 17% in the first three
months to 44% after 18 months of treatment. We believe that this data supports
other anecdotal evidence of long-term efficacy.
Easy to Use. The implantation procedure is a straightforward, fully
reversible procedure which takes between 30 minutes and two hours, does not
involve the brain and has been performed by surgeons with a variety of
specializations. Additionally, the NCP System does not interact with existing
therapies and, because the NCP System provides therapy without patient (or
caregiver) administration, full compliance is assured. Moreover, a patient can
use a magnet to temporarily override the pre-programmed stimulation cycle to
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activate on-demand therapy if the patient senses the onset of a seizure. The NCP
System implantation is fully reversible for patients who elect to discontinue
treatment.
Substantially all sales for the years ended June 30, 2000, 1999 and 1998
were epilepsy product sales.
DEPRESSION
The Depression Business Unit is engaged in the conduct of clinical studies
of the NCP System for the treatment of major depression in patients with
unipolar and bipolar depressive disorder. In July 1999, the FDA granted
expedited review status for a future premarket approval application for our NCP
System for these patients. During fiscal 1999, we launched a pilot safety and
efficacy study of vagus nerve stimulation using the NCP System in patients with
treatment resistant chronic or recurrent severe depression which continued in
fiscal 2000 and will continue in 2001. The study protocol included 30 patients
treated for three months with long-term follow-up. In September 1999, the FDA
granted approval for expansion of the pilot clinical study, increasing the
number of implanted patients from 30 to 60. In October 1999, the FDA granted
unconditional approval for a pivotal clinical study of vagus nerve stimulation
for the treatment of depression to include up to 15 institutions and 94
patients. We subsequently received unconditional FDA approval for a revised
final protocol to include up to 20 institutions and 210 implanted patients.
Depression Overview
Depression is a chronic, disabling disorder and a major worldwide public
health problem. Depressive episodes usually recur over time, with risk for
further episodes proportional to the number of prior episodes. After three major
depressive episodes, the probability of recurrence is 90%. In the United States
alone, approximately 18 million people suffer from depression, slightly over 6
million of which are receiving some form of medical treatment. An estimated 1.2
million Americans are believed to suffer from chronic treatment resistant
depression. Over 100,000 Americans each year are treated with electro convulsive
therapy (ECT) for their depression. Roughly 15% of all people with severe
depressions that require hospitalization commit suicide. Depression is also a
very expensive disorder, ranked as the second leading cause of disability
worldwide in 1990. Depression costs in the United States alone are estimated at
over $50 billion per year, including over $12 billion in direct treatment costs.
The total market in the United States for anti-depressants is estimated to
exceed $6 billion.
The exact causes of depressive disorders are unknown, although both
biological abnormalities and psychological factors are thought to precipitate
this disease. Diminished synaptic concentrations of neurotransmitters,
especially serotonin and norepinephrine, are implicated in the pathogenesis of
depression. Current standard therapies are thought to affect either one or both
of these neurotransmitter systems (SSRI drugs -- serotonin-specific reuptake
inhibitors; MAOI drugs -- monoamine oxidase inhibitors that decrease the
breakdown of norepinephrine and serotonin). It is of interest to note that
several antiepileptic compounds, such as carbamazepine, valproate and
lamotrigine, are used as mood stabilizers and that lamotrigine and gabapentin
are also used as antidepressants.
Traditional Depression Therapies
The goals of treatment of depression are to achieve remission of symptoms,
prevent relapse and recurrence, and improve the quality of life and functional
capacity of the patient. Treatment of depression is typically viewed in terms of
acute, continuation, and maintenance phases of treatment. The acute treatment
phase is considered to be 6-12 weeks, the continuation phase is 4-9 months, and
the maintenance phase is greater than 9-12 months. Recurrences of depression are
expected in 50% of cases within two years after maintenance treatment. For well
established, recurrent depressions, the rate of recurrence may approach 75%. In
the United States, over 100,000 patients are treated annually with ECT. ECT
typically involves general anesthesia and multiple treatments that can cost from
$8,000 to as high as $20,000 per patient per year. Treatment morbidity
associated with ECT includes the risks of general anesthesia, as well as short
and long-term cognitive deficits, including memory loss.
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Depression is typically treated with medication, psychotherapy or a
combination of both. Medications include tricyclic antidepressants (TCAs), SSRIs
and others. Not all patients respond to the same therapy, and patients often try
multiple therapies. Other treatments for depression include ECT, light therapy,
and rarely, surgery.
The Cyberonics Solution
VNS using the NCP System under current clinical investigation for
depression is very similar to the therapy for the treatment of epilepsy. The NCP
System delivers intermittent stimulation in the same location, that is, the left
vagus nerve in the neck, under similar programming specifications. As of August
31, 2000, our 20 center, 210 patient pivotal clinical study of VNS in the
treatment of depression is underway, with approximately 11 of 20 clinical sites
initiated, 13 patients enrolled and one patient implanted with the NCP System.
We expect to expend considerable resources completing the pilot study, obtaining
appropriate regulatory approvals, and following receipt of appropriate
approvals, launching the NCP System as a treatment for patients with depression
during fiscal 2001 and beyond.
The clinical study of VNS for the treatment of depression is an
investigational study subject to clinical outcome and significant regulatory
restrictions. While we are encouraged by results to date, we can provide you no
assurance as to the ultimate commercial utility of VNS for the treatment of
depression. In addition, we must obtain regulatory approvals in order to
continue our research of this application. Any delays or failure of the
necessary approvals could harm our ability to market our NCP System for
depression, which could harm our business, financial condition and results of
operations.
OBESITY AND OTHER NEW INDICATIONS
The Obesity and Other New Indications Business Unit is engaged in expanding
the range of treatable disorders for VNS in new indications as warranted by our
extensive patent portfolio, expected or observed clinical outcomes from ongoing
and future pre-clinical and clinical research studies and anecdotal reports of
patient experience and market dynamics. The Obesity and Other New Indications
Business Unit conducts all clinical research on indications that are in the
pre-clinical and or pilot study phases of research and have not progressed to a
pivotal study. We currently have studies underway for the treatment of obesity
and Alzheimer's Disease, as well as studies planned for other disorders covered
by our patent portfolio. In June 2000, the FDA approved an investigational
device exemption (IDE) for a clinical pilot study utilizing a new type of vagus
nerve stimulation to treat obesity. Shortly thereafter, we launched a two-phase
pilot safety and efficacy study using the NCP System to treat obesity. In the
first phase, six patients will be implanted and treated. If the results of the
first phase justify continued research, up to 24 additional patients will be
treated in Phase II, for a total of up to 30 implanted and treated patients in
the pilot study. In June 2000, the Swedish government approved a pilot clinical
study of vagus nerve stimulation for the treatment of Alzheimer's Disease.
Shortly thereafter, we launched a pilot study of up to 10 implanted patients
with a study protocol of three months in the acute study and long-term
follow-up.
Obesity Overview
Obesity is defined as having an excess of body fat, but is typically viewed
as being severely overweight. Obesity is a serious disorder with severe medical,
personal, social and financial implications. Being overweight is defined as
having a body mass index, the ratio of a person's weight to height (weight in
kilograms divided by height in meters squared) of 25 to 29.9 kg/m(2). Being
obese is defined as having a body mass index of 30 kg/m(2) or higher.
Approximately one third of the general population of the United States, or 100
million people, are estimated to be overweight. Approximately 66 million
Americans are obese enough to qualify for treatment with medications, meaning
they are 30% over their ideal body weight or are 20% over a healthy body weight
and have other health risk factors. Approximately 14 million people in the
United States are morbidly obese, meaning that their obesity causes significant
health problems, such as heart disease, stroke, diabetes, certain types of
cancer, gout and gallbladder disease. Being obese can also cause problems such
as sleep apnea and osteoarthritis. Approximately 90% to 95% of the over 10
million diabetics in the United States have Type II diabetes, with obesity being
the major risk factor. The combination of hypertension and obesity
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significantly increases the risk of congestive heart failure, left ventricular
arhythmogensis, and sudden death, as well as the frequency of cerebral stroke.
Obesity-related conditions are estimated to contribute to 300,000 deaths yearly,
ranking second only to smoking as a cause of preventable death. The annual
economic costs of obesity in the United States from excess medical expenses and
loss of income are reported to exceed $68 billion, a figure that does not
include the more than $30 billion spent yearly on diet foods, products and
programs.
The exact causes of obesity are unknown. The basic mechanism is an
imbalance between caloric intake and energy expenditure, but why this imbalance
occurs is unclear. Evidence suggests that obesity has several causes reflecting
inherited, environmental, cultural, socioeconomic, and psychological conditions.
Increasing physiological, biochemical and genetic evidence suggests that being
overweight is a complex disorder of appetite regulation and energy metabolism.
Many persons have a chronic tendency for becoming overweight that needs lifelong
attention. Diminished synaptic concentrations of neurotransmitters, especially
serotonin and norepinephrine, are implicated in the pathogenesis of obesity. It
is of interest to note that some antidepressant compounds are also used as
antiobesity treatments.
Traditional Obesity Therapies
The goals of treatment for obesity are to achieve lasting weight loss,
improve the quality of life, and improve functional capacity of the patients.
Treatment options for obesity include exercise, behavior modifications,
psychotherapy, drug treatment, surgery and combinations of therapies. Although
antiobesity drugs and other treatments such as surgery are available for
patients with obesity, most patients do not loose weight or maintain weight loss
with these treatments.
Despite the significant health consequences of obesity, treatment options
remain limited. Diet modification and behavioral modification programs are
generally unsuccessful for the majority of morbidly obese individuals. While
very low calorie liquid diets can lead to pronounced weight loss in the short
term, the weight loss is often not long lasting. Recently two new agents have
been approved by the FDA, Meridia (Sibutramine) and Xenical (Orlistat). Meridia
is a centrally acting agent that increases the concentration of serotonin and
norephinephrine. Orlistat is the inhibitor of pancreatic lipase and causes a
reduction in fat absorption.
Surgery offers the best long-term efficacy for morbid obesity, with studies
demonstrating weight loss of around 70% of excess weight and preservation of
approximately 50% of weight loss long-term. There are two types of surgical
treatments for obesity, restriction operations and gastric banding. Restriction
operations are the surgeries most often used for producing weight loss. Food
intake is restricted by creating a small pouch at the top of the stomach where
the food enters from the esophagus. The second type of surgical treatment for
obesity is gastric bypass operations. These operations combine creation of small
stomach pouches to restrict food intake and construction of bypasses of the
duodenum and other segments of the small intestine to prevent calories from
being absorbed (malabsorption). There are two types of gastric bypass
operations: Roux-en-Y (RGB) gastric bypass and extensive gastric bypass
(biliopancreatic diversion). A device that restricts the size of the stomach
using a band, called the Lap-Band, is also commercially available in some
non-U.S. markets and under review by the FDA for potential market approval in
the United States.
Up to 30,000 patients a year are treated with surgery for their obesity in
the United States, and many of these patients do not obtain or sustain weight
loss one year or more after the procedure. Obesity surgery is typically an open
procedure that involves general anesthesia and significant morbidity. The
surgical procedure costs from $10,000 to as high as $30,000 per patient.
The Cyberonics Solution
We are currently evaluating the pilot safety and efficacy of a new form of
VNS as a treatment for obesity. In obesity we are evaluating, bilateral
supra-diaphragmatic VNS, where the patient's left and right vagus nerves are
stimulated just above the stomach. This form of VNS differs from VNS used to
treat patients with epilepsy in that it is bilateral, the stimulation is
delivered to the vagus nerve in the area of the gut or chest as opposed to the
neck area, and we expect different stimulation parameters than those used in
epilepsy will be
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employed. As of August 31, 2000, two United States study sites have been
initiated and one patient has been implanted in this pilot study.
Alzheimer's Overview
Alzheimer's Disease is considered an "amnestic dementia" or forgetful
dementia because its most common first symptom is the rapid forgetting of
recently learned material.
Alzheimer's Disease (AD) is a major public health threat in the United
States and worldwide. Estimates indicate that approximately 4 million people in
the United States suffer from AD. Worldwide, it is estimated that 22 million
individuals will develop AD by the year 2025. The cost of AD in the United
States alone exceeds $100 billion per year. AD is the third most costly disease
in the United States, preceded only by heart disease and cancer, with the
average lifetime cost per patient of $174,000. While implantable drug delivery
systems have been tested on a limited basis in patients with AD, to Cyberonics'
knowledge, VNS represents the first implantable stimulator or surgery-like
procedure to be clinically tested for AD.
AD is a progressive neurodegenerative disorder first described in 1907 by
Dr. Alois Alzheimer, who identified senile plaques and neurofibrillary tangles
as the neuropathological hallmarks of the disease. There is no cure for this
disease, and it inevitably leads to severe cognitive as well as physical
impairment in a short period of time. The average duration from diagnosis to
death is approximately 7-10 years. The symptoms of AD usually begin after 65
years of age, but may appear as early as the third decade of life in patients
with relatively rare familial forms of the disease. Since the incidence of AD
rises with advancing age, the prevalence of AD has increased precipitously over
the past century as human life expectancy has lengthened. Despite considerable
advances in recent years in understanding its pathogenesis, AD can neither be
cured nor prevented at present.
In the states of moderate AD, patients may require assistance with routine
daily functions, but they usually retain the capacity to participate in their
own care. They develop worsening movements that limit their ability to perform
tasks such as operating household appliances, dressing and writing. Space and
time disorientation becomes increasingly troublesome as the disease progresses,
often leading to wandering and sleep disturbances. With further progression of
the disease, disturbances in cognition and behavior become global and more
profound. Eventually the patient becomes bedbound.
The symptoms of AD increase in severity over the course of a decade,
leading to a state in which only vegetative neurologic functions are retained.
Death is typically the result of secondary causes, often systemic infections,
rather than degeneration of the brain itself. Notwithstanding the distress that
the symptoms produce in the patient's family, friends, and caregivers, the
progressive loss of cognitive function in AD eventually deprives the individual
of their livelihood, independence, thought and identity. AD invariably reduces
the quality of life of the affected individual and, in many cases, shortens
their life span as well.
Currently there is no cure of AD, therefore, the goals of treatment must be
to improve cognitive functioning. This may be done by increasing the cholinergic
neurotransmission in the brain. Many of the drugs used today for alleviating the
symptomatology of AD are directed at increasing cholinergic neurotransmission
but other drugs, such as serotonergic enhancers, are also used. The effect of
these drugs is a mild increase in cognitive functioning in some of the treated
patients. As for tacrine, the first cholinergic drug to be marketed as a
treatment for AD, about one third of the treated patients experienced an
improvement in cognitive functioning, but one third were unchanged and one third
declined as if they had not been treated. Thus, since at least two thirds of the
patients with AD are medically non-responders to the currently available
therapies, a new treatment option is desirable.
The Cyberonics Solution
Our study of VNS for Alzheimer's Disease was initiated primarily because of
VNS treatment-related improvements in memory reported both in animal research
and in patients with epilepsy. Many epilepsy patients and their physicians have
also reported an improvement in memory following VNS. As of June 30, 2000, the
Cyberonics VNS Patient Outcome Registry had data on over 1,600 epilepsy patients
treated with
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VNS for three months and 572 patients treated with VNS for one year.
Twenty-three percent of those patients treated for three months and 32% of those
patients treated for one year were reporting that their memory was better or
much better. These studies provide a rationale for the hypothesis that vagus
nerve stimulation may enhance memory performance in individuals experiencing
cognitive impairments as a result of AD.
In June 2000, the Swedish government approved a pilot clinical study of
vagus nerve stimulation for the treatment of AD. Shortly thereafter, we launched
a pilot study of up to 10 implanted patients with a study protocol of three
months in the acute study of long-term follow up. Our primary objective is to
examine changes in cognitive performance such as changes in memory over time. In
addition to memory loss, disturbances in attention, mood and executive functions
are often among the earliest symptoms of AD. In a separate study of patients
with depression, VNS has been shown to potentially have mood elevating effects.
In moderate and severe AD, many patients also develop depressive symptoms, so
the potential of VNS to not only enhance memory, but also improve depression is
of interest in this study.
VNS using the NCP System under clinical investigation for the treatment of
AD is very similar to the therapy for the treatment of epilepsy. The NCP System
delivers intermittent stimulation in the same location, that is, the left vagus
nerve in the neck area, under similar programming specifications. As of August
31, 2000, the pilot study has been initiated, with two sites approved and one
patient implanted.
We expect to expend considerable resources completing the pilot studies for
obesity and AD and other indications development research. We cannot assure you
that the clinical outcome of these and other investigational studies will be
adequate to justify advancement of these studies to the next clinical phase of
testing, or that if we do continue ongoing studies in the indications, that we
will be granted the necessary approvals to conduct our studies on a timely basis
or at all.
VAGUS NERVE STIMULATION WITH OUR NCP SYSTEM
The NCP System is a proprietary, integrated system consisting of an
implantable device that delivers an electrical signal to an implantable lead
which is attached to the left vagus nerve. The vagus nerve is the longest of the
cranial nerves, extending from the brain stem through the neck to organs in the
chest and abdomen. The left vagus nerve has been shown to have influence over
numerous areas of the brain. Preclinical studies and mechanism of action
research suggest that intermittent stimulation of the left vagus nerve in the
neck activates a number of structures and increases blood flow bilaterally in
several areas of the brain. These studies have also shown that stimulation of
the left cervical vagus nerve is effective in blocking seizures and results in
persistent or carryover antiepileptic effects which increase with chronic
intermittent stimulation.
The NCP System consists of the NCP Pulse Generator, the Bipolar Lead, the
programming wand and software and the tunneling tool. The NCP Pulse Generator
and Bipolar Lead are surgically implanted in a procedure which takes from 30
minutes to two hours, during which time the patient is under general, regional
or local anesthesia. The NCP Pulse Generator is surgically implanted in a
subcutaneous pocket in the upper left chest. The Bipolar Lead is connected to
the NCP Pulse Generator and attached to the vagus nerve in the lower left side
of the patient's neck. The patient is generally admitted to the hospital the day
of surgery and discharged the same or following day.
The NCP System delivers vagus nerve stimulation therapy on a chronic,
intermittent basis. The initial standard stimulation parameters that we
recommend are a 30 second period of stimulation which we refer to as ON time,
followed by a five minute period without stimulation which we refer to as OFF
time. To optimize patient treatment, the pulse width, output current, signal
frequency, stimulation duration and stimulation OFF intervals of the NCP Pulse
Generator can be noninvasively programmed and adjusted by the treating physician
with a personal computer using our programming wand and software. In addition,
the patient can use a small, hand held magnet which is provided with the NCP
Pulse Generator to manually activate or deactivate stimulation. On-demand
therapy can be useful for those patients who sense an oncoming seizure and has
been reported by a number of patients to abort or reduce the severity or
duration of seizures.
NCP Pulse Generator. Cyberonics manufactures and sells two NCP models,
Model 100 and Model 101. The NCP Pulse Generator is an implantable,
programmable, cardiac pacemaker-like signal generator
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designed to be coupled with the bipolar lead to deliver electrical signals to
the vagus nerve. The NCP Pulse Generator employs a battery which has an expected
life of approximately six years for the Model 100 and nine years for the Model
101 at standard stimulation parameters. Upon expiration of the battery, the NCP
Pulse Generator is removed and a new generator is implanted in a short,
out-patient procedure using local anesthesia.
Bipolar Lead. We have licensed a proprietary nerve lead to convey the
electrical signal from the NCP Pulse Generator to the vagus nerve. The lead
incorporates patented electrodes which are self-sizing and flexible, minimizing
mechanical trauma to the nerve and allowing body fluid interchange within the
nerve structure. The lead's two electrodes and anchor tether wrap around the
vagus nerve and the connector end is tunneled subcutaneously to the chest where
it is attached to the NCP Pulse Generator. The leads are available in two sizes
of inner spiral diameter to ensure optimal electrode placement on different size
nerves.
Programming Wand and Software. Our proprietary programming wand and
software are used to transmit programming information from a personal computer
to the NCP Pulse Generator via electromagnetic signals. These products are
compatible with both Pentium and non-Pentium based platform personal computers.
Programming capabilities include modification of the NCP Pulse Generator's
programmable parameters (pulse width, output current, signal frequency and
stimulation duration and interval), and storage and retrieval of telemetry data.
The NCP programming wand can be connected to a standard personal computer using
a serial connector.
Tunneling Tool. The tunneling tool is a single use disposable surgical tool
designed to be used during surgical placement of the Bipolar Lead. The tool is
used for subcutaneous tunneling of the lead assembly between the nerve site in
the neck and the NCP Pulse Generator site in the chest.
Accessory Pack. The Accessory Pack includes one Pulse Generator resistor
assembly used to test the function of the device prior to implantation, four NCP
Bipolar Lead tie-downs, one hex screwdriver, two setscrews and setscrew plugs.
The NCP System implant procedure, including device costs, hospital charges
and physician fees, costs between $13,000 and $35,000. The current list price
for the NCP System Model 100 is approximately $9,100 and the NCP System Model
101 is approximately $11,450.
MANUFACTURING AND SOURCES OF SUPPLY
Our manufacturing operations are required to comply with the FDA's Quality
System Regulations, commonly referred to as QSR, which incorporates the agency's
former Good Manufacturing Practices regulations. QSR addresses the design,
controls, methods, facilities and quality assurance controls used in
manufacturing, packaging, labeling, storing and installing medical devices. In
addition, certain international markets have quality assurance and manufacturing
requirements that may be more or less rigorous than those in the United States.
Specifically, we are subject to the compliance requirements of ISO 9001
certification and CE Mark directives. We are audited by KEMA, Quality USA on a
semiannual basis and by KEMA, The Netherlands on an annual basis for such
compliance.
The NCP Pulse Generator, which is similar in design and manufacture to a
cardiac pacemaker, is comprised of two printed circuit boards and a battery
which are hermetically sealed in a titanium case. Standard components are
assembled on printed circuit boards using surface-mount technology. The circuit
boards are next assembled and tested. The assembled circuit boards are then
placed in a titanium case which is laser welded. An epoxy header to which the
Bipolar Lead connects is added to all sealed units. Each unit is subject to
final functional release testing prior to being sterilized by a third party
vendor.
During fiscal 2000, we successfully achieved commercial-scale production
capability on a timely basis with acceptable quality, manufacturing yield and
costs. Prior to developing this capability, we relied on a third party
manufacturer for the preliminary construction and assembly of the Model 101. We
can now manufacture the Model 101 in our facility in Houston. In order to
develop this capability in-house, we recruited a management team with over 100
years of combined manufacturing experience. In critical manufacturing processes,
we invested in redundant systems, thereby improving our ability to meet customer
needs and
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product demand. We have invested in technology and human resources to improve
capacity to meet anticipated product demand. Although we believe manufacturing
operations are capable of maintaining commercial-scale production and product
quality, we cannot assure you that there will not be events which could disrupt
or impair our ability to maintain commercial-scale production and product
quality. Any supply or manufacturing disruption could significantly harm our
business.
Cyberonics has relied significantly upon sole source suppliers for certain
key components, materials and contract services used in manufacturing the NCP
System. During fiscal 2000, we identified and qualified secondary sources for
most of our critical components. Furthermore, we initiated or expanded
comprehensive vendor certification and quality programs to assure continuity of
supply while maintaining high quality and reliability. Through these and other
programs, we are developing long-term partnerships with our vendors to drive a
continuous improvement philosophy throughout our organization and within our
vendor base.
We continue to rely upon sole source suppliers for certain materials and
services used in manufacturing the NCP System for reasons of quality assurance,
sole source availability or cost effectiveness. In an effort to reduce potential
product liability exposure, however, certain suppliers have terminated or may
terminate sales of certain materials and parts to manufacturers of implantable
medical devices. The Biomaterials Access Assurance Act was adopted in 1998 to
help ensure availability of raw materials and component parts essential to the
manufacture of medical devices. We cannot estimate the impact of this law on
supplier arrangements. Furthermore, we periodically experience discontinuation
or unavailability of components, materials and contract services which may
require qualification of alternative sources or product design changes. We
believe that pursuing and qualifying alternative sources and/or redesigning
specific components of the NCP System could consume significant resources. In
addition, such changes generally require regulatory submissions and approvals.
Although we believe that any such changes will be made without disruption, 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. Any supply or manufacturing disruption could
significantly harm our business.
MARKETING AND SALES
United States. We market and sell our products through a direct sales force
in the United States. As of August 31, 2000 our United States sales team
consisted of a Vice President, Sales, five regional sales directors, 28 sales
teams consisting of a sales representative and a clinical specialist, the vast
majority of whom have significant medical device or pharmaceutical sales
experience or epilepsy clinical experience. As of August 31, 2000, the United
States marketing team consisted of a Vice President, Marketing, six corporate
marketing personnel, 10 regional marketing personnel and 12 reimbursement
specialists.
Our sales and marketing plan focuses on creating widespread awareness and
demand for the NCP System among neurologists, surgeons and nurse clinicians
involved in the treatment of patients with epilepsy, third party payors who pay
for such treatment and patients and their families whose lives are affected by
epilepsy. To reach each of these groups, we are using a multidisciplinary sales
force consisting of sales personnel with medical device or pharmaceutical sales
experience, clinical specialists with nursing experience in epilepsy,
reimbursement specialists experienced in obtaining third party coverage and
payments for new medical technologies and regional marketing teams experienced
in peer to peer marketing programs. In addition to our direct selling
activities, we facilitate and support peer to peer interactions such as
symposia, conference presentations, journal articles and patient support groups
to provide experienced clinicians and patients the opportunity to share their
perspectives on the NCP System with others.
In August 2000, we established the B.J. Wilder Therapy Access Program to
promote widespread awareness of VNS among patients, neurologists and third party
payors and assist patients with epilepsy who are without medical insurance
coverage and who do not have the financial resources to otherwise pay for the
NCP System. We expect the program to continue for five years and we expect to
donate roughly $250,000 in product cost to the program on an annual basis.
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International. We market and sell our products through a combination of a
direct sales force in certain European countries and distributors elsewhere. As
of August 31, 2000, our international sales and marketing organization consisted
of 12 full time employees and a number of independent distributors.
The NCP System is currently sold by a direct sales force in Germany,
France, Austria, Switzerland, Belgium, Norway, Sweden, Denmark and the United
Kingdom. As of August 31, 2000, we had distribution agreements with independent
distributors covering a number of other countries, principally in Europe. The
distribution agreements generally grant the distributor exclusive rights for the
particular territory for a period of three years. The distributor generally
assumes responsibility for obtaining regulatory and reimbursement approvals for
such territory and agrees to certain minimum marketing and sales expenditures
and purchase commitments. We intend to seek additional regulatory and
reimbursement approvals in the future in those major markets where the NCP
System is not yet approved. The geographic areas initially targeted include
South America and the Far East, in particular, Japan. In Japan, we are working
with an independent distributor to obtain the appropriate regulatory and
reimbursement approvals and to ultimately distribute the NCP System if such
approvals are obtained. The Japanese clinical trial began in July 1993. In
February 1998, our Japanese distributor submitted the results of this study,
along with our other clinical trial data, to the Japanese Ministry of Health for
regulatory approval. Application for reimbursement approval will follow
regulatory approval when and if granted.
THIRD-PARTY REIMBURSEMENT
Our ability to expand the commercialization of 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 associated
procedures and services, and to provide reimbursement 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.
We have implemented a program to provide third-party payors with the clinical
and regulatory information that they will need to reach coverage decisions, both
by sending materials directly to the payors and by assisting hospitals and
physicians in their interactions with the payor.
Once a favorable coverage determination is made with respect to a product,
payors must determine the level of reimbursement for the product and related
therapy and procedures. In making decisions about reimbursement amounts,
third-party private payors typically reimburse for the costs of newly covered
devices and services using the standard methods they employ for other products
and services already covered. Many private insurers and managed care plans use a
variety of payment mechanisms including, but not limited to, discounted charges,
per diem amounts, resource-based payment scales and reimbursed costs. Those
mechanisms have provided payment levels for many other implantable devices that
have been adequate to allow device use and commercial success. Assuming that
most payors determine to cover the NCP System and related services, we have
found that many of these same payment mechanisms have provided reimbursement
levels for the NCP System and related services that physicians and hospitals
view as adequate to support use of the NCP System.
We believe 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 introduced on August 1, 2000 a new prospective payment system based on
Ambulatory Payment Classifications (APCs). The NCP System has been designated a
"pass through" product for the first two or three years of the APC system. The
pass through designation allows hospitals to submit for separate payment of the
device and they are reimbursed based on their charges and cost-to-charge ratios.
For inpatient implants, Medicare uses a fixed-payment method which is based on
Diagnosis Related Groups or DRGs. Under current
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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 coexisting severe medical problems, also referred to as
comorbidities. 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. We believe that this
DRG grouping would apply to most of the epilepsy patients covered by Medicare.
Medicare uses a resource-based relative value scale to pay for physicians'
services. We believe 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.
We believe that many patients who are good candidates for VNS therapy may
be covered by Medicaid systems. States are responsible for the operation of a
Medicaid program within their borders. Coverage policy and payment mechanisms
are widely variable. To date, approximately 80% of state Medicaid programs cover
VNS therapy and provide some form of reimbursement for the implant procedure
that makes it economically viable for the implanting hospital. Medicaid policy
and payment methodologies change on a regular basis so vigilant and ongoing work
is necessary to insure continued access and acceptable reimbursement for
patients covered by Medicaid programs.
We have growing experience in seeking and successfully obtaining coverage
and payment approvals from third-party payors, but we cannot be certain that we
will be successful in achieving or maintaining coverage or adequate
reimbursement levels. If we are unsuccessful in achieving coverage or adequate
reimbursement levels 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 severely harm our business.
We are continuing to pursue appropriate reimbursement approvals in European
Union member countries. We believe that significant sales volume will be
difficult to generate without appropriate reimbursement approvals. We cannot be
certain 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 us to sell the NCP System on a profitable basis.
PRODUCT DEVELOPMENT
Our product development efforts are directed toward improving the NCP
System and developing new products that provide additional features and
functionality. Product development programs that are underway include ongoing
improvements to the NCP Pulse Generator, such as reduced size. Significant
expenditures include innovative software enhancements to provide more
functionality with a focus on improving product ease-of-use for patients and
doctors. Product development efforts in lead technology include programs to
reduce time in the operating room. We will be required to file for the
appropriate United States and international regulatory approvals, and some
projects may require clinical trials, in connection with the introduction of
improved and new products.
COMPETITION
We believe that in the field of refractory epilepsy, existing and future
antiepileptic drugs are and will continue to be the primary competition for our
NCP System. We may also face competition from other medical device companies for
the treatment of partial seizures. Medtronic, Inc., for example, continues to
clinically assess an implantable signal generator used with an invasive deep
brain probe, or 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. We 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 our competitors have substantially greater
financial, manufacturing, marketing and technical resources than us. 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 could make surgery a more attractive therapy
for epilepsy. The development by others of new treatment methods
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with novel antiepileptic drugs, medical devices or surgical techniques for
epilepsy could render the NCP System non-competitive or obsolete.
We believe that the primary competitive factors within the epilepsy
treatment market are the efficacy and safety of the treatment relative to
alternative therapies, physician and patient acceptance of the product and
procedure, availability of third-party reimbursement, quality of life
improvements and product reliability. We also believe that the NCP System
compares favorably with competitive products as to these factors.
PATENTS, LICENSES AND PROPRIETARY RIGHTS
Proprietary protection for our products is important to our business. We
maintain a policy of seeking method and device patents on our inventions,
acquiring licenses under selected patents of third parties, obtaining copyrights
on our software and other copyrightable materials and entering into invention
and proprietary information agreements with our employees and consultants with
respect to technology which we consider important to our business. We also rely
upon trade secrets, unpatented know-how and continuing technological innovation
to develop and maintain our competitive position.
We entered into an exclusive license agreement with Jacob Zabara, Ph.D., a
co-founder of and consultant to us, pursuant to which we received exclusive
licenses on three United States method patents (and such international
counterparts as have been or may be issued) covering the NCP System for vagus
nerve and other cranial nerve stimulation for the control of epilepsy and other
movement disorders. We believe that these patents give us an advantage. The
license agreement runs for the term of licensed patents, which will begin to
expire in 2010. Pursuant to the license agreement, we are obligated to pay Dr.
Zabara a royalty equal to 3.0% of net sales for the remaining term of the
licensed patents.
We entered into a license agreement with Huntington Medical Research
Institute pursuant to which we have licensed two United States patents
(including their international counterparts, if and when issued) covering two
lead designs. The license agreement provides a license to the licensor's lead
designs for the field-of-use of vagus nerve stimulation for control of epilepsy
and other movement and our patented disorders. Pursuant to the license
agreement, we are obligated to pay the licensor a royalty of 1.0% of net sales
of NCP Systems using the licensor's standard lead (which includes our bipolar
lead) and 1.75% of net sales of NCP Systems which include the licensor's
bidirectional lead. We also agreed to pay minimum royalties of $35,000 for each
fiscal year for the life of the licensed patents.
We are negotiating an exclusive license agreement with Mitchell Roslin,
M.D. on a patent that covers the use of bilateral vagus nerve stimulation for
the treatment of obesity. Pursuant to the proposed license agreement terms, we
will be obligated to pay the licensor a royalty rate of 1.0% of the first $10
million of net sales and 0.5% of net sales thereafter. The license agreement
terms also will obligate us to pay to licensor advances on royalties of $25,000
per year for five years beginning January 1, 2000 and, upon the completion of
certain milestones, up to $325,000 in additional advances on royalties. We
cannot assure you that we will be able to finalize this exclusive license and if
we are unable to do so, our ability to develop our obesity treatment may be
seriously adversely affected.
In addition to the license agreements, as of August 31, 2000, we had United
States patents and patent applications pending covering various aspects of the
NCP Pulse Generator circuits, electrode designs, methods of automatic seizure
detection and various therapeutic applications of vagus nerve stimulation. In
addition to movement disorders, other method patents cover the fields of eating
disorders, endocrine disorders, migraine headaches, dementia, neuropsychiatric
disorders, including depression, motility disorders, sleep disorders, coma,
chronic pain, cardiac disorders and hypertension. In September 1997, we filed
for a limited extension of the term of one of the medical device and method
patents which is licensed from Dr. Zabara. As a result of that filing, the
expiration date for the epilepsy and movement patent has been determined to be
2010. We have filed a Request for Revision of Regulatory Review with the FDA to
extend the patent an additional year. We have filed counterparts of certain of
our key United States patent applications in certain key international
jurisdictions.
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We cannot assure you that patents will be issued from any of the remaining
applications or, that if patents are issued, that they will be of sufficient
scope or strength to provide meaningful protection of our technology. In
addition, we can not assure you that any patents issued to us will not be
challenged, invalidated or circumvented, or that the rights granted thereunder
will provide proprietary protection or commercial advantage to us.
Notwithstanding the scope of the patent protection available to us, a competitor
could develop other methods of controlling epilepsy by stimulation which do not
involve the vagus or other cranial nerves, the stimulation of which is patent
protected, or which use electrodes which are not covered by the licensed
patents.
We believe that the licenses described above provide us with protection in
the United States in the field of cranial nerve stimulation, including vagus
nerve stimulation for the control of epilepsy, depression, movement disorders,
including Parkinson's Disease and essential tremor, eating disorders, dementia
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. We may need to engage in
litigation to enforce patents issued or licensed to us, to protect our trade
secrets or know-how or to defend us against claims of infringement of the rights
of others and to determine the scope and validity of the proprietary rights of
others. Litigation could be costly and divert our attention from other functions
and responsibilities. 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. We are not currently a
party to any patent litigation or other litigation regarding proprietary rights
and are not aware of any challenge to our patents or proprietary rights.
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. In the United States, the NCP System is
regulated as a medical device and is subject to FDA's premarket approval
requirements. Under the Food, Drug, and Cosmetic Act, all medical devices are
classified into three classes, class I, II or III. New class III devices, such
as the NCP System, are subject to the most stringent FDA review, and require
submission and approval of a premarket application before commencement of
marketing, sales and distribution in the United States.
In July 1997, we 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 12 years of age with partial onset
seizures that are refractory to antiepileptic drugs. While we have satisfied
FDA's requirements to commence domestic sales of our product, we continue to be
subject to FDA's ongoing requirements to maintain regulatory compliance.
Additionally, pursuant to the post-market surveillance conditions specified as
part of our FDA marketing approval, we are required to conduct clinical
follow-up on a total of 50 patients during the first five years of stimulation
and to monitor the safety and tolerability of the NCP System. In addition, we
have been required by the FDA to continue to provide information about which
patients benefit most from the device as well as information on any deaths that
occur in patients who have the device implanted. The FDA may raise additional
concerns in the future, accordingly, our business is critically dependent upon
ongoing compliance with FDA regulations and requirements.
In July 1999, the FDA granted Expedited Review status for a future
premarket approval application for our NCP System for the treatment of major
depression in patients with unipolar and bipolar depressive disorder. During
fiscal 1999, we launched a pilot safety and efficacy study of vagus nerve
stimulation using the NCP System in patients with refractory chronic or
recurrent severe depression which continued in fiscal 2000 and will continue in
fiscal 2001. The study protocol included 30 patients treated for three months
with long-term follow up. In September 1999, the FDA granted approval for
expansion of the pilot clinical study, increasing the number of study sites from
four to five and the number of patients from 30 to 60. In October 1999, the FDA
granted unconditional approval for a pivotal clinical study of vagus nerve
stimulation for the
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treatment of depression to include up to 15 institutions and 94 patients. We
subsequently received unconditional FDA approval for a revised final protocol to
include up to 20 institutions and 210 implanted patients.
In June 2000, the FDA approved an investigational device exemption (IDE)
for a clinical study utilizing vagus nerve stimulation to treat obesity. Shortly
thereafter, we launched a two-phase pilot safety and efficacy study using the
NCP System to treat obesity. In the first phase, six patients will be implanted
and treated. If the results of the Phase I study justify continued research, up
to 24 additional patients will be treated in Phase II, for a total of 30
implanted and treated patients in the pilot study.
In June 2000, the Swedish government approved a pilot clinical study of
vagus nerve stimulation of the treatment of AD. In the last quarter of fiscal
2000, we launched a pilot study which will implant up to 10 patients under a
study protocol of three months study with long-term follow up.
We will be required to obtain FDA approval of a new premarket application
or premarket application supplement before making any change to the NCP System
affecting the safety or effectiveness of the device including, but not limited
to, new indications for use of the device, changes in the device's performance
or design specifications and device modifications and future generation
products. New premarket applications and premarket application supplements
generally require submission of information needed to support the proposed
change and may require additional clinical data. If clinical data is required
for a new indication, the FDA can additionally require review of the results of
a clinical study by one of their Advisory Panels. If the clinical testing
required to obtain the information necessary to support the change places
research subjects at risk, we could be required to obtain the FDA's approval of
an investigational device exemption, or IDE, before beginning such testing. We
intend to sponsor additional clinical trials of the NCP System in the United
States for additional epilepsy indications and for non-epilepsy central nervous
system disorders. We believe that we will be required to conduct these
additional clinical trials under one or more FDA-approved IDEs and under the
auspices of one or more independent institutional review boards, also referred
to as IRBs, established pursuant to FDA regulations. We may be unable to obtain
any required FDA or IRB approvals for such clinical trials, or to complete the
studies in a timely manner. Further, the information obtained may not be
sufficient to support the filing of a new premarket application or premarket
application supplement for the proposed changes. Any of these events would
prevent us from obtaining approvals to market our product for the indications
which could harm our business.
We are required to register, and have registered, as a medical device
manufacturer with the FDA and state agencies and to list our products with the
FDA. Our facilities are subject to inspection on a routine basis by the FDA for
compliance with the FDA's QSR and other applicable regulations. The QSR imposes
procedural and documentation requirements upon us with respect to product
designs, manufacturing, testing, control, process validation and similar
activities. As of August 31, 2000, we have been the subject of an FDA
pre-approval and two post-approval site inspections, which were completed with
two minor procedural deficiencies. Additionally, we have voluntarily agreed to
participate as a pilot site for the FDA's new Hazard Analysis and Critical
Control Point inspection process. As part of this process, and in addition to
requirements for routine inspections, we have undergone two separate inspections
by the FDA. Future inspections by the FDA could result in adverse findings which
could harm our ability to manufacture and market our NCP System, which would
significantly harm our business.
In addition, our products are covered by FDA regulations for implantable
medical devices that require us to comply with certain specific record keeping,
reporting, product testing, design, safety and product labeling requirements.
Under these regulations, we are required to file Medical Device Reports with the
FDA for product malfunctions or where our device causes or contributes to a
death or serious injury, or both. Through August 31, 2000, we have filed 27 such
reports, 18 of which were filed during fiscal 2000. New regulations governing
such matters as device tracking and post-market surveillance also apply to the
NCP System. The FDA also actively enforces regulations prohibiting marketing of
products for non-indicated uses. The advertising of most FDA-regulated products,
including our NCP System, is also subject to Federal Trade Commission
jurisdiction and we are also subject to the Occupational Safety and Health
Administration and other governmental entities.
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<PAGE> 18
Clinical testing, manufacturing and sale of our products outside of the
United States are subject to regulatory approval by other jurisdictions which
may be more or less rigorous than in the United States, and which vary from
country to country. In order to market and sell our product in the European
community, we must comply with the medical device directives. Cyberonics also
complies with the ISO 9001, which is similar to the FDA's QSR. We are audited on
a voluntary basis for compliance with these directives. We have obtained several
foreign governmental approvals, including the approval to use the European Union
CE Mark, and have applied for additional approvals. However, we may not be
granted the necessary approvals, including approval of new premarket
applications or supplements to existing premarket applications for the NCP
System, on a timely basis or at all. Delays in receipt of or failure to receive
these approvals, or the withdrawal of previously received approvals, could harm
our international operations and our business.
Changes in existing requirements or the adoption of new requirements could
significantly harm our ability to comply with regulatory requirements. Failure
to comply with applicable regulatory requirements can result in, among other
things, fines, suspensions or withdrawal of approvals, confiscations or recalls
of products, operating restrictions and criminal prosecutions.
PRODUCT LIABILITY AND INSURANCE
The manufacture and sale of our products subjects us to the risk of product
liability claims. As with all medical device businesses, the consequences of a
failure of our product can be life-threatening. Although we maintain product
liability insurance, coverage limits may not be adequate. 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 severely harm our business, results of operations and
financial condition.
EMPLOYEES
As of August 31, 2000, we had 294 full-time employees, including 12 in
engineering and product development, 27 in clinical and regulatory affairs, 119
in manufacturing and quality assurance, 91 in sales and marketing and 45 in
administration. We believe that the success of our business depends, in part, on
our ability to attract and retain qualified personnel. We believe our
relationship with our employees is good. However, we cannot assure you that we
will be successful in hiring or retaining qualified personnel. The loss of key
personnel, or the inability to hire or retain qualified personnel, could
significantly harm our business.
CAUTIONARY FACTORS
A number of statements contained in this document and other written and
oral statements made from time to time by us do not relate strictly to
historical or current facts. Accordingly, they are considered "forward-looking"
statements which indicate current expectations of future events. These
statements can generally be identified by the use of terminology such as
"expect," "may," "will," "intend," "anticipate," "believe," "estimate," "could,"
"possible," "plan," "project," "forecast," and similar expressions. Our
forward-looking statements generally relate to our growth strategies, financial
results, reimbursement programs, product acceptance programs, product
development programs, regulatory approval programs, manufacturing processes and
sales and marketing programs. Forward-looking statements should be carefully
considered as involving a variety of risks and uncertainties. These risks and
uncertainties include ongoing safety and efficacy of VNS with the Cyberonics NCP
System, the overall rate of demand for our products, our ability to hire, train
and retain key personnel, our ability to maintain all appropriate regulatory
approvals, our ability to develop and maintain adequate manufacturing capacities
and sources of supply, the timing and results of future clinical studies, the
rate at which overall corporate infrastructure will be developed and the amount
of timing of expenditures related to those and other activities, and
management's ability to accurately forecast future events. Consequently, no
forward-looking statements can be guaranteed and actual outcomes may vary
materially.
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<PAGE> 19
ITEM 2. PROPERTIES
We lease approximately 75,000 square feet of office and manufacturing space
in Houston, Texas through December 2002, and approximately 4,200 square feet in
a sales office in Brussels, Belgium through April 2001. We believe that these
leased facilities will be adequate to meet our needs at least through June 30,
2001.
ITEM 3. LEGAL PROCEEDINGS
We have terminated a contractual relationship with Hi-Tronics Design, Inc.
(Hi-Tronics) for the manufacture of component parts for certain of our products.
The dispute has been submitted for binding arbitration and is now pending before
the American Arbitration Association, case number 70-489-00325-00. Hi-Tronics
has asserted a claim for a contractual termination fee of approximately $1
million and has asserted the right to use the components for other devices. We
believe we have valid defenses to these claims and intend to vigorously contest
any claims which are asserted in arbitration. In addition, we have asserted
claims that Hi-Tronics breached the contract and is liable for damages caused by
the breach. We have now developed the facilities to manufacture the components
in-house. In light of the preliminary state of the arbitration and the inherent
uncertainties involved in litigation, we are not able to assess the likelihood
of an unfavorable outcome or range of any possible loss.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to security holders during the fourth quarter of
fiscal 2000.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is quoted on the Nasdaq National Market under the symbol
"CYBX." The high and low sale prices for our Common Stock during fiscal 1999 and
2000 are set forth below. Price data reflect actual transactions, but do not
reflect mark-ups, mark-downs or commissions.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
FISCAL YEAR ENDED JUNE 30, 1999
First Quarter............................................... $17.00 $ 5.63
Second Quarter.............................................. 14.38 4.50
Third Quarter............................................... 13.63 7.13
Fourth Quarter.............................................. 14.94 7.31
FISCAL YEAR ENDED JUNE 30, 2000
First Quarter............................................... $20.88 $11.25
Second Quarter.............................................. 19.50 12.50
Third Quarter............................................... 28.25 14.50
Fourth Quarter.............................................. 25.38 11.86
</TABLE>
The stock market has from time to time experienced significant price and
volume fluctuations that are unrelated to the operating performance of
particular companies. Like the stock prices of other medical device companies,
the market price of our Common Stock has in the past been, and may in the future
be, subject to significant volatility. Factors such as reports on the clinical
efficacy and safety of the NCP System, product and component supply issues,
government approval status, fluctuations in our operating results, announcements
of technological innovations or new products by our competitors, changes in
estimates of our performance by securities analysts, failure to meet securities
analysts' expectations, developments with respect to patents or proprietary
rights, public concern as to the safety of products developed by us or others
may have a significant affect on the market price of the Common Stock. In
addition, the price of our stock could be affected by stock price volatility in
the medical device industry or the capital markets in general without regard to
our operating performance.
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<PAGE> 20
As of August 31, 2000, there were 260 stockholders of record.
We currently intend to retain future earnings to fund the development and
growth of our business and, therefore, do not anticipate paying cash dividends
within the foreseeable future. Any future payment of dividends will be
determined by our Board of Directors and will depend on our financial condition,
results of operations and other factors deemed relevant by our Board of
Directors.
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain selected financial data and is
qualified by reference to, and should be read in conjunction with, the
Consolidated Financial Statements and with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere herein. The
selected financial data as of June 30, 2000 and 1999 and for each of the years
in the three-year period ended June 30, 2000, are derived from consolidated
financial statements that have been audited by Arthur Andersen LLP, independent
public accountants, which are included elsewhere herein. The selected financial
data as of June 30, 1998, 1997 and 1996 and for the years ended June 30, 1997
and 1996 are derived from audited financial statements not included herein.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------------------------------------------------
2000 1999 1998 1997 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales......................................... $ 47,888,733 $ 29,927,476 $ 14,912,868 $ 1,372,005 $ 1,416,965
Cost of sales..................................... 11,833,507 7,736,137 3,902,468 372,180 411,562
------------ ------------ ------------ ------------ ------------
Gross profit...................................... 36,055,226 22,191,339 11,010,400 999,825 1,005,403
Operating expenses:
Selling, general and administrative............. 33,269,266 29,585,570 19,781,268 5,933,852 3,420,111
Research and development........................ 8,037,096 6,724,106 7,391,426 6,549,474 8,024,502
------------ ------------ ------------ ------------ ------------
Total operating expenses.................. 41,306,362 36,309,676 27,172,694 12,483,326 11,444,613
Interest income................................... 1,364,985 1,465,549 1,976,792 436,813 423,044
Interest expense.................................. 3,349 -- -- -- --
Other income (expense), net....................... (44,894) 115,236 10,790 (198,143) (97,084)
------------ ------------ ------------ ------------ ------------
Net loss before cumulative effect of a change in
accounting principle............................ (3,934,394) (12,537,552) (14,174,712) (11,244,831) (10,113,250)
Cumulative effect on prior years (to June 30,
1999) of changing to a different method of
depreciation.................................... 881,150 -- -- -- --
------------ ------------ ------------ ------------ ------------
Net loss.................................. $ (3,053,244) $(12,537,552) $(14,174,712) $(11,244,831) $(10,113,250)
------------ ------------ ------------ ------------ ------------
Basic and diluted net loss per share...... $ (0.17) $ (0.72) $ (0.88) $ (0.93) $ (1.06)
============ ============ ============ ============ ============
Shares used in computing basic and diluted net
loss per share.................................. 18,044,692 17,503,169 16,104,922 12,030,171 9,513,038
============ ============ ============ ============ ============
CONSOLIDATED BALANCE SHEET DATA (AS OF YEAR END):
Cash, cash equivalents and marketable
securities...................................... $ 20,537,450 $ 24,858,123 $ 38,037,343 $ 8,123,456 $ 2,201,962
Working capital................................... 30,881,340 25,975,079 39,246,128 7,763,480 1,042,396
Total assets...................................... 44,604,045 39,783,153 52,615,294 10,249,737 3,948,043
Accumulated deficit............................... (78,932,510) (75,879,266) (63,341,714) (49,167,002) (37,922,171)
Common stockholders' equity....................... $ 38,407,975 $ 33,448,445 $ 44,698,719 $ 8,421,472 $ 1,465,050
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion and analysis together with
"Selected Financial Data" and our Consolidated Financial Statements and the
notes to those statements included elsewhere in this Form 10-K. This discussion
contains forward-looking statements based on our current expectations,
assumptions, estimates and projections about us and our industry. These
forward-looking statements involve risks and uncertainties. Our actual results
could differ materially from those indicated in these forward-looking statements
as a result of certain factors, as more fully described under the heading
"Factors Affecting Future Operating Results" and in the "Business" section and
elsewhere in this Form 10-K. Cyberonics undertakes no obligation to update
publicly any forward-looking statements, even if new information becomes
available or other events occur in the future.
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<PAGE> 21
SUMMARY
We were founded in 1987 to design, develop and bring to market medical
devices which provide a unique therapy, vagus nerve stimulation, for the
treatment of epilepsy and other debilitating neurological, psychiatric diseases
and other disorders. Clinical trials of the NCP System began with the first
patient implant in November 1988 under IDE from the FDA. We 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 12 years of age with partial onset seizures that are refractory
or resistent to antiepileptic drugs. We were granted regulatory approval in 1994
to market and sell the NCP System in the member countries of the European Union
and we also have permission to sell in certain other international markets 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 incurred substantial
expenses, primarily for research and development activities which includes
product and process development and clinical trials and related regulatory
activities, sales and marketing activities and manufacturing start-up. We have
also made significant investments in recent periods in connection with the
United States market launch of the NCP System and the clinical research costs
associated with new indications development. Although we reported a profitable
quarter in the third quarter of this fiscal year, we expect to remain
unprofitable through at least fiscal 2002 as we continue our efforts to develop
vagus nerve stimulation for new indications.
For the period from inception through June 30, 2000, we incurred a
cumulative net deficit of approximately $78.9 million. Moreover, we expect to
devote considerable financial resources in our Depression and Other Indications
Business Units for clinical studies in the development of new indications for
the NCP System. The clinical studies for depression are for investigational
therapies that are not expected to generate significant sales prior to FDA
approval, which is not anticipated before calendar 2003. As a result, we will
continue to experience substantial operating losses at levels exceeding the
levels experienced in recent periods. Furthermore, the timing and nature of
these expenditures are contingent upon several factors outside of our control
and may exceed the current expectations of securities analysts and investors. We
do not expect to be profitable before fiscal 2003 if at all.
Recent Developments
On September 11, 2000, Medtronic, Inc. ("Medtronic") publicly announced a
proposal to acquire us for $26.00 per share in value of Medtronic common stock.
Our Board of Directors, with the assistance of Morgan Stanley Dean Witter, our
financial advisor, elected to remain independent to pursue our patent protected
opportunities for vagus nerve stimulation in epilepsy, depression, Alzheimer's
Disease, obesity, and in other indications covered by our United States method
patents. On September 28, 2000, Medtronic announced that it had withdrawn its
offer. Morgan Stanley Dean Witter was engaged to serve as our financial advisor
in connection with this proposal and we are currently obligated to pay them $2.2
million for advisory services. We will be obligated to make an additional
payment to Morgan Stanley Dean Witter of not less than $4.0 million on or before
May 15, 2001. In addition, our Board of Directors has authorized the development
and implementation of a retention plan for officers and key employees. This plan
will provide for cash payments to employees which will range from six months to
three years, depending on seniority, plus bonus and will be payable only upon a
change of control. We have also incurred additional legal and accounting fees as
a result of Medtronic's actions.
RESULTS OF OPERATIONS
Net Sales. Net sales increased to $47.9 million from $29.9 million and
$14.9 for the years ended June 30, 2000, 1999 and 1998, respectively.
International sales were $5.4 million, $3.6 million and $2.3 million in fiscal
2000, 1999 and 1998, respectively, while U.S. sales were $42.5 million, $26.3
million and $12.6 million in the respective periods.
Substantially all sales for the years ended June 30, 2000, 1999 and 1998
were for epilepsy product sales.
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<PAGE> 22
We have experienced significant growth in the U.S. market since FDA
approval. In fiscal 1998, our first full year after FDA approval, U.S. net sales
were $12.6 million. U.S. net sales more than doubled in fiscal 1999 to $26.3
million due entirely to volume increases. For fiscal 2000, U.S. net sales
continue to show aggressive growth of 62%, as a result of volume growth of 45%
and an increase in average system price which generated additional revenue
growth of 17%. In February 2000, we launched the next generation NCP Generator,
the Model 101, which was 31% lighter, had a 90% longer battery life and was
priced at a 34% premium to the existing Model 100. As a result of the favorable
market reception of the Model 101, sales mix towards the Model 101 shifted,
resulting in the improved pricing for the year.
Since regulatory approval in 1994, international sales have grown at a
slower growth rate than the U.S. due to economic and reimbursement limitations
and the Company's focus on penetrating the U.S. market. From fiscal 1998 to
1999, international sales increased by 59% primarily due to volume growth. In
fiscal 2000, international sales increased by 47% due to volume growth of 35%
and an increase in average system price which generated additional revenue
growth of 12%, due to the launch of the Model 101 in March 2000.
While we expect to conduct additional clinical trial activities in the
United States and internationally and may seek reimbursement in connection with
these studies, we do not expect reimbursement amounts to be significant in
future periods. Future increases in net sales will depend upon increased market
acceptance for the NCP System and upon expanding our reimbursement from
third-party payors. We are devoting substantial resources to increasing the
awareness and market acceptance of the NCP System, particularly in the United
States. We believe, however, that there will be delays between sales and
marketing activities and any resulting increase in sales. We cannot assure you
that sales levels in subsequent periods will increase at the rates experienced
in recent periods or at all.
Gross Profit. Cost of sales consist primarily of direct labor, allocated
manufacturing overhead, third-party contractor costs, royalties and the
acquisition cost of raw materials and components. Our gross margin was 75.3% for
the year ended June 30, 2000, compared to 74.2% and 73.8% for fiscal 1999 and
1998, respectively. The increase in gross margin in fiscal 2000 is attributable
primarily to the increase in net sales in the United States, which have higher
gross margins than net sales in international markets and process improvements
in manufacturing. We are obligated to pay royalties at a rate of approximately
4% of net sales in future periods. Gross margins can be expected to fluctuate in
future periods based upon the mix between direct and international sales, direct
and distributor sales, the NCP System's selling price, applicable royalty rates
and the levels of production volume.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $33.3 million, or 69.5% of net sales, for the year
ended June 30, 2000, as compared to $29.6 million, or 98.9% of net sales, for
fiscal 1999 and $19.8 million, or 132.6% of net sales, during fiscal 1998.
Fiscal 2000 expenses increased over fiscal 1999 by 12% due to increases in
personnel costs associated with the expansion of the sales and marketing team
which was offset by reductions in marketing and sales program event costs and
reductions in outside services that were brought in-house during the year.
Fiscal 1999 expense increased over fiscal 1998 expense primarily due to
increases in sales and marketing activities focused on the United States market
launch for the NCP System and to a lesser extent to the continued expansion of
corporate infrastructure. At the end of fiscal 2000, we had over 90 sales and
marketing personnel, up from 60 at the end of fiscal 1999 and 45 at the end of
fiscal 1998. Although we were able to minimize growth in expenses significantly
below sales growth during fiscal 2000, we cannot assure you that we will
continue to achieve spending efficiencies or that selling, general and
administrative expenses will not, in fact, increase at a faster rate in fiscal
2001. The significant decrease in these expenses as a percent of sales in each
year is primarily the result of the increase in sales for the same periods.
Substantially all selling, general and administrative expenses for the
years ended June 30, 2000, 1999 and 1998 were associated with the Epilepsy
Business Unit.
Research and Development Expenses. Research and development expenses are
comprised of both expenses related to our product and process development, and
design efforts and expenses associated with conducting clinical trials and
related regulatory activities. Research and development expenses were $8.0 mil-
20
<PAGE> 23
lion, or 16.8% of net sales, during the year ended June 30, 2000, compared to
$6.7 million, or 22.5% of net sales, during the year ended June 30, 1999 and
$7.4 million, or 49.6% of net sales, during the year ended June 30, 1998. The
significant decrease in these expenses as a percent of sales in each year is
primarily the result of the increase in sales for the same periods. We operate
our business in three Indication Business Units, each of which invests
significant resources into research and development projects.
The Epilepsy Business Unit research and development expenses were $5.8
million in fiscal 2000, compared to $5.3 million and $7.3 million in fiscal 1999
and 1998, respectively. The increase of $0.5 million in fiscal 2000 over prior
year is due to costs associated with additional personnel, higher clinical study
costs and the expansion of our Cyberonics VNS Patient Outcome Registry. The
decrease in research and development costs from fiscal 1998 to fiscal 1999 is
the result of higher absorption of production costs during fiscal 1999 offset by
heightened levels of product design and development activity.
The Depression Business Unit research and development expenses were $1.9
million in fiscal 2000, compared to $0.8 million and $21,000 in fiscal 1999 and
1998, respectively. The significant ramp up of expenses from over the three year
period between fiscal 1998 and fiscal 2000 is a result of expanded clinical
programs for the clinical study of the NCP System for the treatment of major
depression in patients with unipolar and bipolar depressive disorder. During
fiscal 1999, we launched a pilot safety and efficacy study of vagus nerve
stimulation using the NCP System in patients with treatment resistant chronic or
recurrent severe depression which continued in fiscal 2000 and will continue in
fiscal 2001. In fiscal 2000, the FDA granted approval for expansion of the pilot
clinical study, increasing the number of implanted patients from 30 to 60. Also
in fiscal 2000, the FDA granted unconditional approval for a pivotal clinical
study of vagus nerve stimulation for the treatment of depression to include up
to 15 institutions and 94 patients. We subsequently received unconditional FDA
approval for a revised final protocol to include up to 20 institutions and 210
implanted patients. We expect to expend considerable financial resources
completing the pilot study and initiating the pivotal study of the NCP System in
patients with depression during fiscal 2001 and beyond.
The Obesity and Other New Indications Business Unit research and
development expenses were $350,000 in fiscal 2000, compared to $565,000 and
$21,000 in fiscal 1999 and 1998, respectively. The decrease of expenses from
fiscal 2000 to fiscal 1999 and the increase from 1998 to 1999 is directly
related to increases and decreases in total clinical program costs associated
with investigational clinical studies of the NCP System for the treatment of
various neurological disorders. In fiscal 1998, the clinical study costs were
primarily directed toward epilepsy and depression studies in our other business
units. During fiscal 1999, we launched several animal studies of VNS using the
NCP System for a variety of disorders. In fiscal 2000, we focused the majority
of our clinical resources toward the study of VNS in patients suffering from
obesity and AD, while also investigating other neurological disorders covered by
our patent portfolio. In June 2000 the FDA approved an investigational device
exemption (IDE) for a clinical study utilizing a new type of VNS to treat
obesity. Shortly thereafter, we launched a two-phase pilot safety and efficacy
study using the NCP System to treat obesity. In the first phase, six patients
will be implanted and treated. If the results of the Phase I study justify
continued research, up to 24 additional patients will be treated in Phase II,
for a total of up to 30 implanted and treated patients in the pilot study. In
June 2000, the Swedish government approved a pilot clinical study of VNS for the
treatment of AD. Shortly thereafter, we launched a pilot study of up to 10
implanted patients with a study protocol of three months in the acute study and
long-term follow up. We expect to expend considerable resources completing the
pilot studies for obesity and AD and other indications development research
throughout fiscal 2001 and beyond.
Interest Income. Interest income totaled $1.4 million, $1.5 million and
$2.0 million during the years ended June 30, 2000, 1999 and 1998, respectively.
Interest income decreased from fiscal 1997 to fiscal 1998 and from fiscal 1999
to fiscal 2000 as a result of lower average cash and investment balances on
hand. We expect interest and other income to gradually decline in absolute
dollars in future periods as we utilize our resources to fund future working
capital requirements.
Interest Expense. Interest expense was $3,349 during the year ended June
30, 2000, with no interest expense reported in prior years. Interest expense for
fiscal 2000 is associated with capital leases on manufacturing equipment which
bear interest at 6.56% over a term of five years.
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<PAGE> 24
Other Income (Expense), Net. Other income (expense), net totaled ($45,000),
$115,000 and $11,000 during the years ended June 30, 2000, 1999 and 1998,
respectively. For each of these years, other income (expense) consisted
primarily of net gains and losses resulting from foreign currency fluctuations.
We expect other income (expense) to fluctuate in future periods depending upon
the mix between international and domestic business activities and upon
fluctuations in currency exchange rates.
Income Taxes. At June 30, 2000, we had net operating loss carryforwards for
federal income tax purposes of approximately $74.3 million which expire during
the years 2003 through 2020, and tax credit carryforwards of approximately $2.3
million for federal income tax purposes which expire during the years 2006
through 2020. Due to our net operating loss history, to date we have established
a valuation allowance to fully offset our deferred tax assets, including those
related to our carryforwards, resulting in no income tax benefit for financial
reporting purposes. Current federal income tax regulations with respect to
changes in ownership could limit the utilization of our net operating loss
carryforwards.
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 for the fiscal year ended June 30, 2000.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through public
and private placements of our securities. In June 2000 we entered into capital
leases for the acquisition of manufacturing equipment valued at roughly $650,000
and used in the production of the NCP System. The capital leases bear interest
at 6.56% and extend through April 2005.
During fiscal 2000, we used approximately $8.2 million in cash in operating
activities. During the fiscal year, working capital increased significantly in
support of the substantial sales growth experienced during fiscal 2000. Accounts
receivable and inventories increased from $5.4 million and $5.2 million,
respectively, in fiscal 1999 to $8.4 million and $6.6 million respectively in
fiscal 2000. During fiscal 2000, we also used approximately $4.1 million to
purchase capital equipment to expand manufacturing capabilities and provide
significant improvements in integrated business systems. We received roughly
$8.1 million, $1.4 million and $2.7 million in 2000, 1999 and 1998,
respectively, in proceeds from the exercise of stock options held by our
employees. During fiscal 1998, we raised approximately $47.7 million from the
sale of common stock in a public offering. Our liquidity will continue to be
reduced as amounts are expended to support continued growth in sales and
manufacturing, 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
$4.2 million during fiscal 2001, primarily to expand manufacturing capabilities
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, 2002, 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
22
<PAGE> 25
health care and medical device segments in particular, the status of our
international and domestic 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 NEW ACCOUNTING PRONOUNCEMENTS
See Notes 1 and 9 of Notes to Consolidated Financial Statements for a
discussion of the impact of new accounting pronouncements.
FACTORS AFFECTING FUTURE OPERATING RESULTS
In addition to the factors described above in this section and in the
section of this Annual Report on Form 10-K entitled "Business," the following
additional factors could affect 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 for a single
indication: as an adjunctive therapy in reducing the frequency of seizures in
adults and adolescents over 12 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 two 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. The same
uncertainty surrounds our efforts in obesity and AD applications. Our inability
to commercialize successfully the NCP System for depression, obesity and other
indications will severely harm our business.
We may not be able to continue to expand 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 9,000 patients through June 30, 2000, 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
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.
We may not be successful in our efforts to develop VNS for the treatment of
depression, obesity, Alzheimer's Disease or any other indications. We are in the
process of conducting studies to help us evaluate, and ultimately obtain FDA
approval, for the use of VNS as a treatment for depression, obesity, Alzheimer's
Disease and other indications. While we are encouraged by test results to date,
we cannot assure you that our test results will continue to be as positive as we
currently anticipate or that we will receive FDA approval for the use of our
product for the treatment of any other indication. Even if we receive FDA
approval for another indication, we can provide no assurances with respect to
market acceptance. If our test results are not as we anticipate, if we receive
no additional FDA approvals or if alternative indications do not prove to be
commercially viable, our revenues will not experience the growth that we
currently anticipate.
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
23
<PAGE> 26
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 efforts, our
ability to retain qualified sales personnel 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 cannot assure you that our marketing and sales
efforts 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 or to retain our sales force would severely impair our sales
and our business.
If our 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 potential 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.
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
24
<PAGE> 27
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. Medtronic, Inc., for example,
continues to clinically assess an implantable signal generator used with an
invasive deep brain probe, or 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. 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.
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 begun and
intend to continue to significantly expand 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.
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<PAGE> 28
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 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference to the
Consolidated Financial Statements set forth on pages F-1 through F-21 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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<PAGE> 29
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and directors, their ages as of August 31, 2000, and
certain additional information about them, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Robert P. Cummins..................... 46 President and Chief Executive Officer
and Director
Pamela B. Westbrook................... 42 Vice President, Finance and
Administration and Chief Financial
Officer
Leonard G. Milke...................... 52 Vice President, Marketing
Richard P. Kuntz...................... 49 Vice President, Operations
Shawn P. Lunney....................... 37 Vice President, Sales
Reese S. Terry, Jr. .................. 58 Chairman of the Board of Directors and
Secretary
Stanley H. Appel, M.D................. 67 Director
Tony Coelho........................... 58 Director
Thomas A. Duerden, Ph.D............... 70 Director
Michael J. Strauss, M.D............... 47 Director
Alan J. Olsen......................... 53 Director
</TABLE>
Mr. Cummins became a director of Cyberonics in June 1988. He was appointed
President and Chief Executive Officer of Cyberonics in September 1995. Until
September 1995, he was also a general partner of Vista Partners, L.P., a venture
capital partnership which he joined in 1984, a general partner of Vista III
Partners, L.P., a venture capital firm formed in 1986 and Vice President of
Vista Ventures Inc., a venture capital advisory firm. Until July 1998, Mr.
Cummins was also a director of Sigma Circuits Inc., a manufacturer of electronic
interconnect products.
Ms. Westbrook joined Cyberonics as Vice President, Finance and
Administration and Chief Financial Officer in October 1998. From April 1998 to
October 1998, she served as Chief Financial Officer for Physicians Resource
Group, an ophthalmic physician practice management company. Prior to that, from
November 1986 to March 1998, Ms. Westbrook worked for SulzerMedica, a leading
manufacturer of implantable medical devices including pacemakers, heart valves
and orthopedic implants. Most recently, Ms. Westbrook was Vice President,
Finance for SulzerMedica, and Vice President, Controller for Sulzer
Cardiovascular Prosthesis Division.
Mr. Milke joined Cyberonics as Vice President, Marketing in March 2000. Mr.
Milke has over 30 years of specialty central nervous system pharmaceutical sales
and marketing experience with Warner Chilcott Laboratories, Affiliated Research
Centers, IMS America, CoCensys, Incorporated and Parke-Davis, a division of
Warner Lambert. Mr. Milke's career at Parke-Davis, the worldwide leader in drugs
used to treat epilepsy, spanned almost 20 years. While at Parke-Davis, Mr. Milke
served in a number of positions of increasing responsibility including Sales
Representative, District Sales Manager, Director of Sales Administration, Senior
Product Manager and National Sales Director, CNS Sales.
Mr. Kuntz joined Cyberonics as Vice President, Operations in January 2000.
Mr. Kuntz has over 27 years of manufacturing and operations management
experience in a variety of industries and eight years of experience in medical
device and healthcare operations management. Most recently, Mr. Kuntz was Vice
President of Manufacturing and Customer Support for Spacelabs Medical Inc., a
leader in patient monitoring devices and clinical information systems with
annual revenues in excess of $350 million. Prior to that, he was Vice President
of Operations at Allied Healthcare Products, a supplier of medical gases and
healthcare products and Senior Operations Manager of the Codman and Shurtleff
Division of Johnson & Johnson, a manufacturer of a large number of neurosurgical
and other medical instruments.
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<PAGE> 30
Mr. Lunney joined Cyberonics in April 1991 and served in various sales,
marketing and reimbursement planning positions until May 1996, when he became
Vice President, Marketing. Prior to joining Cyberonics, Mr. Lunney held the
position of Sales and Marketing Manager with Perceptive Systems, Inc., a
hospital laboratory medical instrument manufacturer from December 1985 to April
1991.
Mr. Terry co-founded Cyberonics in December 1987 and served as a director
and Chief Executive Officer of Cyberonics until February 1990, when he became
Chairman of the Board and Executive Vice President. Mr. Terry has also served as
Secretary of Cyberonics from its inception. Mr. Terry resigned from his position
as Executive Vice President in February 2000. From 1976 to 1986, Mr. Terry held
executive positions with Intermedics, Inc., a medical device and electronics
company, including serving as Vice President of Engineering, Vice President of
Corporate Technical Resources and, most recently, as Vice President of Quality.
Dr. Appel has been a director of Cyberonics since December 1996 and the
chair of our Scientific Advisory Board since its formation in 1994. Since 1977,
Dr. Appel has been Chairman of the Department of Neurology, Baylor College of
Medicine.
Mr. Coelho has been a director of Cyberonics since March 1997 and an
independent business consultant since June 1998. From October 1996 to June 1998,
Mr. Coelho was the Chairman and Chief Executive Officer of ETC w/tci, the
Washington-based education, training and communications subsidiary of
Tele-Communications, Inc. From January 1990 to September 1995, Mr. Coelho served
as the President and Chief Executive Officer of Wertheim Schroder Investment
Services, Inc., an asset management firm, and from October 1989 to September
1995, he served as Managing Director of Wertheim Schroder and Co., an investment
banking firm. Mr. Coelho served in the United States House of Representatives
from California from 1979 to 1989, and served as House Majority Whip from 1986
to 1989. Mr. Coelho is also on the Board of Directors of Pinnacle Global Group,
Inc., a public holding company, Service Corporation International, a funeral
service corporation, and IFC Kaiser International, an engineering and project,
construction, and program management service provider.
Dr. Duerden has been a director of Cyberonics since March 1989 and an
independent business consultant since January 1990. Since 1997, Dr. Duerden has
been a director of PathSource, a privately held company which is consolidating
formerly independent laboratories. From December 1988 through January 1990, Dr.
Duerden served as Chairman of the Board and Chief Executive Officer of
Tonometrics, Inc., a medical diagnostic device company. From 1979 through 1988,
Dr. Duerden served as Chairman and Chief Executive Officer of Electro Biology,
Inc., an orthopedic device company.
Dr. Strauss has been a director of Cyberonics since March 1997. He is a
physician entrepreneur whose professional career has focused on new medical
technology and the boundary it shares with health services research, health
policy and business. He currently serves as a senior consultant for Covance
Health Economics and Outcomes Services Inc. (CHEOS), a consulting, outcomes
research and services firm helping medical product manufacturers address
economic, reimbursement and other market issues. Dr. Strauss was a founder and
President of CHEOS and negotiated its sale to Corning Inc. He also is a member
of the Medicare Coverage Advisory Committee (Health Care Financing
Administration) and serves on the Board of Directors of Endocare, Inc.,
manufacturer of products for treating urological diseases, and Kaiser
Permanente's Mid-Atlantic Permanente Medical Group.
Mr. Olsen has been a director of Cyberonics since June 1999. He has over 25
years of medical device sales and marketing experience at Smith & Nephew
Richards, Danek Medical and Sofamor Danek Group. He was founder and President of
Danek Medical, a pioneer in the spinal fixation device market which later became
part of Sofamor Danek Group. He served as a Director of Sofamor Danek Group from
1985 to 1993. He is currently an independent business consultant, which he has
been for more than the past five years, and serves on the boards of several
private and charitable organizations.
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<PAGE> 31
BOARD COMPOSITION
Pursuant to a letter agreement dated March 28, 1997, the Clark Estates is
entitled to designate one person whom it wishes to have appointed to serve on
our Board of Directors. This right lasts for as long as the Clark Estates
retains at least 600,000 of the aggregate of 901,408 shares of Common Stock
purchased on such date by parties affiliated with the Clark Estates. To date,
the Clark Estates has not exercised this right.
BOARD MEETINGS AND COMMITTEES
Our Board of Directors held a total of eight meetings and acted by written
consent one time during the fiscal year ended June 30, 2000. The Board has an
Audit Committee and a Compensation Committee. There is no nominating committee
or other committee performing a similar function.
The Audit Committee, which consists of Michael J. Straus, M.D., Thomas A.
Duerden and Alan J. Olsen, held four meetings during the fiscal year ended June
30, 2000. This Committee recommends engagement of our independent public
accountants and is primarily responsible for approving the services performed by
such accountants and for reviewing and evaluating our accounting principles and
our system of internal accounting controls.
The Compensation Committee, which consists of Tony Coelho and Stanley H.
Appel, held two meetings and acted by written consent 38 times during the fiscal
year ended June 30, 2000. This Committee establishes salary and incentive
compensation of our executive officers and administers employee benefit plans.
During the fiscal year ended June 30, 2000, all current directors attended
at least 75 percent of the meetings of the Board of Directors and the number of
meetings held by committees on which the director served, except Mr. Coelho who
attended five meetings of the Board of Directors and two meetings of the
Compensation Committee.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between our Board of Directors or
Compensation Committee and the board of directors or compensation committee of
any other company, nor has any such interlocking relationship existed in the
past.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934 requires our officers
and directors, and persons who own more than ten percent of a registered class
of our equity securities, to file reports of ownership on Form 3 and changes in
ownership on Form 4 or Form 5 with the Securities and Exchange Commission (SEC).
Such officers, directors and ten-percent stockholders are also required by SEC
rules to furnish us with copies of all Section 16(a) forms they file.
Based solely on our review of the copies of such forms received we believe
that, for the fiscal year ended June 30, 2000, all Section 16(a) filing
requirements applicable to our officers, directors and ten-percent stockholders
were complied with, except as follows: Dr. Duffell did not file Form 4s for
sales and purchases made by his wife from the period of September 1998 through
April 2000; a Form 4 was filed in July 2000 to report these transactions; and
Mr. Lunney did not file a Form 4 for the sale of shares in February 2000; a Form
5 was filed in September 2000 for this sale.
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<PAGE> 32
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth the compensation
paid by us for the year ended June 30, 2000 to the Chief Executive Officer and
each of our other most highly compensated executive officers whose total
compensation exceeded $100,000. These officers are referred to as the named
executive officers:
<TABLE>
<CAPTION>
SECURITIES
UNDERLYING
OPTIONS(#)
------------
LONG-TERM
FISCAL SALARY($) BONUS($) COMPENSATION ALL OTHER
NAME AND PRINCIPAL POSITION YEAR ANNUAL COMPENSATION AWARDS COMPENSATION
--------------------------- ------ --------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Robert P. Cummins(1)............ 2000 $236,538 $170,335 100,000(2) $ 420(3)
President and Chief 1999 200,000 50,000 100,000 420(3)
Executive Officer 1998 200,000 56,000 250,000 253(3)
Reese S. Terry, Jr(4)........... 2000 $ 96,115 $ -- -- $ 4,100(3)
Chairman of the Board and 1999 147,000 36,750 -- 4,214(3)
Executive Vice President 1998 147,000 41,160 -- 4,114(3)
Pamela B. Westbrook............. 2000 $155,769 $ 40,335 -- $ 347(3)
Vice President, Finance & 1999 103,846 33,750 175,000 260(3)
Administration Chief 1998 -- -- -- --
Financial Officer
William H. Duffell, Jr.,
Ph.D(5)....................... 2000 $163,558 $ -- -- $ 363
Vice President, Clinical and 1999 157,500 39,375 -- $ 363(3)
Regulatory Affairs 1998 157,500 44,100 51,235 257(3)
Shawn P. Lunney................. 2000 $155,769 $ 2,835 -- $ 347
Vice President, Marketing 1999 144,231 87,500(6) 25,000 25,294(3)(7)
1998 125,000 37,500 104,750 126(3)
Richard P. Kuntz................ 2000 $ 76,269 $ 32,835 150,000 $12,173(3)(8)
Vice President, Manufacturing 1999 -- -- -- --
1998 -- -- -- --
</TABLE>
---------------
(1) Mr. Cummins became an executive officer of Cyberonics in fiscal 1996.
(2) Excludes a grant of options to purchase 450,000 shares of our Common Stock
at $18.00 per share, which is contingent on stockholder approval of a new or
expanded stock option plan at our next annual meeting. See "Report of the
Compensation Committee" below.
(3) Represents premiums paid for term-life insurance (except as set forth
below).
(4) Mr. Terry resigned from his position as Executive Vice President in February
2000.
(5) Dr. Duffell resigned from his position as Vice President in August 2000.
(6) During fiscal 1999, Mr. Lunney also performed the duties of Sales Area
Director for which he earned an additional bonus of $50,000.
(7) Also includes $25,000 paid to Mr. Lunney for sales awards.
(8) Represents $173 for term-life insurance and $12,000 for expenses paid to Mr.
Kuntz associated with relocating to Houston.
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<PAGE> 33
Option Grants in Last Fiscal Year. The following table sets forth each
grant of stock options made during the year ended June 30, 2000 to each of the
named executive officers:
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------ POTENTIAL REALIZABLE VALUE
PERCENT OF AT ASSUMED ANNUAL RATES
NUMBER OF TOTAL OPTIONS OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES IN TERM($)(2)
OPTIONS FISCAL EXERCISE EXPIRATION ---------------------------
NAME GRANTED(#) YEAR(1) PRICE($/SH) DATE 5% 10%
---- ---------- ------------- ------------ ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Robert P. Cummins............ 100,000(3) 8% $ 18.00 6/9/2010 $1,132,010 $2,868,736
Reese S. Terry, Jr(4)........ -- -- -- -- -- --
Pamela B. Westbrook.......... -- -- -- -- -- --
William H. Duffell, Jr.,
Ph.D(5).................... -- -- -- -- -- --
Shawn P. Lunney.............. -- -- -- -- -- --
Richard P. Kuntz............. 150,000 12% $15.125 1/6/2010 $1,426,805 $3,615,803
</TABLE>
---------------
(1) Total number of shares subject to options granted to employees in fiscal
2000 was 1,202,700 which number includes options granted to employee
directors.
(2) Potential realizable value is based on an assumption that the stock price
appreciates at the annual rate shown (compounded annually) from the date of
grant until the end of the ten-year option term. These numbers are
calculated based on the requirements promulgated by the SEC and do not
reflect our estimate of future stock price growth.
(3) Excludes a grant of options to purchase 450,000 shares of our Common Stock
at $18.00 per share which is contingent on stockholder approval of a new or
expanded stock option plan at our next annual meeting. See "Report of the
Compensation Committee" below.
(4) Mr. Terry resigned from his position as Executive Vice President in February
2000.
(5) Dr. Duffell resigned from his position as Vice President in August 2000.
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-end
Values. The following table sets forth, for each of the named executive
officers, each officer's exercise of stock options during the fiscal year ended
June 30, 2000 and the year-end value of unexercised options:
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES VALUE UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED ON REALIZED OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END
NAME EXERCISE(#) ($)(1) EXERCISABLE/UNEXERCISABLE(#)(2) EXERCISABLE/UNEXERCISABLE($)(3)
---- ----------- ---------- ------------------------------- -------------------------------
<S> <C> <C> <C> <C>
Robert P. Cummins(4)........ 121,050 $2,503,565 387,286/291,664 $2,146,241/$300,000
Reese S. Terry, Jr.(5)...... 10,000 206,875 34,500/10,000 308,344/89,375
Pamela B. Westbrook......... 20,000 371,876 38,334/116,666 263,546/802,079
William H. Duffell, Jr.,
Ph.D(6)................... 82,235 1,223,202 55,669/23,333 303,143/--
Shawn P. Lunney............. -- -- 156,167/49,583 1,122,047/142,031
Richard P. Kuntz............ -- -- 12,500/137,500 --/--
</TABLE>
---------------
(1) Represents market value of underlying securities at date of exercise less
option exercise price.
(2) Options generally vest over a four-year period such that 12.5% of the shares
subject to the option vest on the six-month anniversary of the grant date,
and 1/48 of the optioned shares vest each month thereafter until fully
vested or five year periods and 1/60th of the optioned shares vest each
month until fully vested.
(3) Market value of underlying securities at fiscal year-end ($12.00 per share)
minus the exercise price.
(4) Excludes a grant of options to purchase 450,000 shares of our Common Stock
at $18.00 per share which is contingent on stockholder approval of a new or
expanded stock option plan at our next annual meeting. See "Report of the
Compensation Committee" below.
(5) Mr. Terry resigned from his position as Executive Vice President in February
2000.
(6) Dr. Duffell resigned from his position as Vice President in August 2000.
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<PAGE> 34
REPORT OF THE COMPENSATION COMMITTEE
The following Report of the Compensation Committee of the Board of
Directors (the "Compensation Committee") describes the compensation policies and
rationale applicable to our executive officers with respect to the compensation
paid to such executive officers for the year ended June 30, 2000.
The Compensation Committee, consisting of Dr. Appel and Mr. Coelho, is
responsible for establishing the compensation payable to our executive officers
and for administering our stock plans.
Compensation Policy
Our executive compensation policies are designed to attract, retain and
motivate the highly skilled executive officers upon whose performance we are
dependent by providing compensation packages competitive with those provided by
similarly situated companies with whom we compete for key employees. It is our
policy that compensation of executive officers should include base compensation
coupled with stock-based incentive opportunities and cash bonuses based on their
level of responsibility. We do not contribute to any retirement programs on
behalf of any employees. Compensation levels for all employees, including
executive officers, are generally established for each fiscal year near the
beginning of the fiscal year.
Base Salaries
Base salaries for all employees are generally set at levels that are viewed
as competitive. The increase in annual base salaries for non-officer employees
for fiscal 2000 were established by the Board of Directors in June 1999, and
generally reflected increases of 4% over fiscal 1999 levels. With respect to
officers, the Compensation Committee determined that the primary elements of
officer compensation were to be base salaries together with bonus plan earnings
and equity participation through options. No change was made to the salaries of
the executive officers, except the Chief Executive Officer.
Bonuses
We generally establish target bonus levels for executive officers at the
same time that annual salary levels were established for the fiscal year. For
fiscal 2000, maximum bonus levels were set at 30% of base salary, the same level
as fiscal 1999. Bonus payout is generally tied to a combination of company-wide
and departmental performance goals. Based upon our performance during fiscal
2000, executive officers were paid an average of 65% of their potential bonuses.
Stock Option Awards
The Compensation Committee evaluated the grant of stock options in fiscal
2000 to officers in light of the responsibilities of the officers and their
current stakes in our long-term success. No stock options were granted to
officers, except the Chief Executive Officer and to new officers as an
inducement to enter into employment with the Company.
Compensation of Chief Executive Officer
The Compensation Committee believes that the compensation of the Chief
Executive Officer, Mr. Cummins, should be closely tied to the success of
Cyberonics, and should provide Mr. Cummins with a stake in the future success of
Cyberonics. Mr. Cummins' base salary was increased to an annual base salary of
$300,000, which was effective in March 2000. He was awarded a bonus equal to 72%
of his base salary, which represented 65% of the maximum bonus that could be
paid.
In February 2000, in connection with a comprehensive review of our
executive compensation packages, the Board of Directors engaged the services of
Towers Perrin, a management consulting firm, to conduct an independent
compensation review, including a review of salary, bonus and stock option grants
for our executive officers, including our Chief Executive Officer, as well as
our Vice Presidents. Towers Perrin submitted its recommendations to the
compensation committee in March 2000 and recommended increases in salary, bonus
and stock option grants for Mr. Cummins and increases in salaries and bonuses
for the Vice Presidents. The recommendations were based on Towers Perrin's
survey of comparable high growth medical device and
32
<PAGE> 35
pharamceutical companies. In March 2000, the Board of Directors approved an
increase in the salary and bonus to be paid to Mr. Cummins as recommended by
Towers Perrin. The salary was increased to $300,000 on an annual basis and Mr.
Cummins is eligible for a bonus of up to 100% of salary. Each of these levels
was consistent with the recommendations of Towers Perrin. A grant of additional
options to Mr. Cummins was delayed pending the conclusion of preliminary
discussions with Medtronic regarding a potential combination with us which had
begun in mid-March. In May 2000, the Board of Directors was advised by US
Bancorp Piper Jaffray, our financial advisor at that time, that Medtronic was
not interested in continuing discussions concerning a potential combination. In
June 2000, the Board of Directors resumed the compensation review and determined
that additional stock option grants to Mr. Cummins were appropriate. Consistent
with Towers Perrin's recommendation, options granted to Mr. Cummins included:
100,000 options approved and granted from the 1996 stock option plan at an
exercise price of $18.00 per share and 450,000 options approved for grant
subject to approval of a new or expanded stock option plan to be submitted for
stockholder approval at our next annual meeting. The option grants were also
consistent with the Towers Perrin's recommendation. All of these options have an
exercise price of $18.00 per share. The closing price of Cyberonics' Common
Stock the day before the approval of the additional 100,000 option grants to Mr.
Cummins was $14.50.
COMPENSATION COMMITTEE
Stanley H. Appel, M.D.
Tony Coehlo
BOARD COMPENSATION
Directors do not receive any cash compensation for their services as
members of the Board of Directors. Non-employee directors are eligible for
discretionary option grants under our 1997 Option Plan.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of August 31, 2000 certain information
with respect to the beneficial ownership of our Common Stock (i) by each person
known by us to own beneficially more than five percent of the outstanding shares
of our Common Stock, (ii) by each of our directors, (iii) by each of the named
executive officers and (iv) by all directors and executive officers as a group.
Except as otherwise noted below, we are not aware of any agreements among our
stockholders which relate to voting or investment of our shares of our Common
Stock.
<TABLE>
<CAPTION>
SHARES PERCENTAGE OF
BENEFICIALLY OUTSTANDING
NAME OF BENEFICIAL OWNER OWNED(1) SHARES OWNED(1)
------------------------ ------------ ---------------
<S> <C> <C>
Massachusetts Financial Services Co........................ 1,323,795 7.1%
500 Boylston Street, 15th Floor
Boston, MA 20116
The Clark Estates(2)....................................... 1,217,683 6.5%
One Rockefeller Plaza, 31st Floor
New York, NY 10020
RHO Management Partners, L.P............................... 1,214,166 6.5%
152 West 57th Street, 23rd Floor
New York, NY 10019
Reese S. Terry, Jr.(3)..................................... 671,100 3.6%
Robert P. Cummins(4)....................................... 656,235 3.4%
Pamela B. Westbrook(5)..................................... 51,214 *
William H. Duffell, Jr., Ph.D.(6).......................... 139,083 *
Shawn P. Lunney(7)......................................... 166,966 *
Richard P. Kuntz(8)........................................ 22,500 *
Stanley H. Appel, M.D.(9).................................. 141,300 *
Thomas A. Duerden, Ph.D.(10)............................... 79,000 *
Tony Coelho(11)............................................ 74,600 *
Michael J. Strauss, M.D.(12)............................... 55,000 *
</TABLE>
33
<PAGE> 36
<TABLE>
<CAPTION>
SHARES PERCENTAGE OF
BENEFICIALLY OUTSTANDING
NAME OF BENEFICIAL OWNER OWNED(1) SHARES OWNED(1)
------------------------ ------------ ---------------
<S> <C> <C>
Alan J. Olsen(13).......................................... 16,808 *
All executive officers and directors as a group (10
persons)(14)............................................. 2,073,806 10.5%
</TABLE>
---------------
* Less than 1%
(1) Based on total shares outstanding of 18,645,694 at August 31, 2000.
Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Shares of our Common Stock subject to options and warrants
currently exercisable, or exercisable within 60 days, are deemed
outstanding for computing the percentage of the person holding such options
but are not deemed outstanding for computing the percentage of any other
person. Except as indicated by footnote, and subject to community property
laws where applicable, the persons named in the table have sole voting and
investment power with respect to all shares of Common Stock shown as
beneficially owned by them.
(2) Pursuant to a letter agreement dated March 28, 1997, the Clark Estates is
entitled to designate one person whom it wishes to have appointed to serve
on our Board of Directors for as long as the Clark Estates retains at least
600,000 of the aggregate of 901,408 shares of Common Stock purchased on
such date by parties affiliated with the Clark Estates. To date, the Clark
Estates has not exercised this right.
(3) Includes 116,500 shares held in trusts for the benefit of Mr. Terry's
children of which Mr. Terry serves as trustee. Also includes 34,500 shares
subject to options exercisable on or before October 30, 2000. Mr. Terry
resigned from his position as Executive Vice President in February 2000.
(4) Includes 10,000 shares held in trust for the benefit of Mr. Cummins'
children of which Mr. Cummins serves as trustee. Also includes 417,285
shares subject to options exercisable on or before October 30, 2000.
(5) Includes 50,001 shares subject to options exercisable on or before October
30, 2000.
(6) Includes 59,002 shares subject to options exercisable on or before October
30, 2000. Dr. Duffell resigned from his position as Vice President in
August 2000.
(7) Includes 161,166 shares subject to options exercisable on or before October
30, 2000.
(8) Includes 22,500 shares subject to options exercisable on or before October
30, 2000.
(9) Includes 97,500 shares subject to options exercisable on or before October
30, 2000.
(10) Includes 57,500 shares subject to options exercisable on or before October
30, 2000.
(11) Includes 67,500 shares subject to options exercisable on or before October
30, 2000.
(12) Includes 47,500 shares subject to options exercisable on or before October
30, 2000.
(13) Includes 13,333 shares subject to options exercisable on or before October
30, 2000.
(14) Includes 1,027,787 shares subject to options held by executive officers and
directors, which options are exercisable on or before October 30, 2000.
Also includes shares which may be determined to be beneficially owned by
executive officers and directors. See Notes 3 through 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain of our stockholders, including Messrs. Cummins and Terry, Drs.
Appel and Duffell and venture capital firms formerly affiliated with Mr.
Cummins, are entitled to certain registration rights with respect to the Common
Stock held by them.
As of June 30, 1998, Rick L. Amos, formerly our Vice President, Sales owed
us $100,000 under a loan for such amount provided to Mr. Amos in fiscal 1998 to
cover certain relocation expenses. The loan bore interest at 8 1/2% per annum,
and was secured by shares of our Common Stock held by or underlying options held
by Mr. Amos. All principal and interest on the loan was paid in January 1999.
Covance Health Economics and Outcomes Services, Inc. (Covance) provides
health care reimbursement consulting services to us. We paid to Covance
$431,662, $693,844 and $511,459 for such services in fiscal 2000, 1999 and 1998,
respectively. Dr. Strauss, one of our directors, was the Executive Vice
President of Covance through 1999 and currently serves as a senior consultant
for Covance.
34
<PAGE> 37
Our Bylaws provide that we are required to indemnify our officers and
directors to the fullest extent permitted by Delaware law, including those
circumstances in which indemnification would otherwise be discretionary, and
that we are required to advance expenses to our officers and directors as
incurred. Further, we have entered into indemnification agreements with our
officers and directors. We believe that our charter and bylaw provisions and
indemnification agreements are necessary to attract and retain qualified persons
as directors and officers.
We believe that the transactions described above were made on terms no less
favorable to us than could have been obtained from unaffiliated third parties.
All future transactions between us and our officers, directors, principal
stockholders and affiliates will be approved by a majority of the Board of
Directors, including a majority of the independent and disinterested outside
directors on the Board of Directors, and will be on terms no less favorable to
us than could be obtained from unaffiliated third parties.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed with Report
1. Financial Statements. The Consolidated Financial Statements of
Cyberonics, Inc. and its subsidiary, and the Report of Independent Public
Accountants are included at pages F-1 through F-21 of this Annual Report on Form
10-K:
<TABLE>
<CAPTION>
PAGE
DESCRIPTION NO.
----------- --------
<S> <C>
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets as of June 30, 2000 and 1999.... F-3
Consolidated Statements of Operations and Comprehensive
Income (Loss) for the Three Years Ended June 30, 2000..... F-4
Consolidated Statements of Stockholders' Equity for the
Three Years Ended June 30, 2000........................... F-5, F-6
Consolidated Statements of Cash Flows for the Three Years
Ended June 30, 2000....................................... F-7
Notes to Consolidated Financial Statements.................. F-8
</TABLE>
2. Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
3.1(1) -- Restated Certificate of Incorporation of Registrant.
3.2(2) -- Bylaws of Registrant.
4.1(2) -- Second Amended and Restated Preferred Shares Rights
Agreement, dated as of August 21, 2000 between
Cyberonics, Inc. and First National Bank of Boston, --
including the Certificate of Designation, the form of
Rights -- Certificate and the Summary of Rights attached
thereto as -- Exhibit A, B and C, respectively.
10.2(7)* -- Amended 1991 Employee Stock Purchase Plan.
10.3(1) -- License Agreement dated March 15, 1988 between the
Registrant and Dr. Jacob Zabara.
10.4(1) -- Patent License Agreement effective as of July 28, 1989
between the Registrant and Huntington Medical Research
Institute.
10.5(3) -- Lease Agreement dated November 3, 1994 together with
amendments dated April 18, 1996 and April 30, 1997,
respectively, between the Registrant and Salitex II, Ltd.
10.6(1) -- Form of Indemnification Agreement.
10.7(1) -- Amended and Restated Stockholders Agreement dated October
16, 1992.
10.8(4) -- Registration Rights Agreement dated March 28, 1997.
</TABLE>
35
<PAGE> 38
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.9(5)* -- Amended and Restated 1996 Stock Option Plan.
10.10(3) -- Stockholders' Agreement dated April 8, 1996 between the
Registrant and St. Jude Medical, Inc.
10.11(3) -- Letter Agreement dated March 28, 1997 between the Clark
Estates and the Registrant.
10.12(3) -- Lease Agreement dated August 19, 1997 between the
Registrant and Space Assets II, Inc.
10.13(6)* -- 1997 Stock Plan.
10.14(8) -- 1998 Stock Option Plan.
21.1(3) -- List of Subsidiaries of the Registrant.
23.1 -- Consent of Independent Public Accountants.
27 -- Financial Data Schedule.
</TABLE>
---------------
(1) Incorporated by reference to Registrant's Registration Statement on Form S-1
(Reg. No. 33-45118) declared effective February 10, 1993.
(2) Incorporated by reference to Registrant's Report on Form 8-K filed on
September 11, 2000.
(3) Incorporated by reference to Registrant's Annual Report on Form 10-K for the
year ended June 30, 1997.
(4) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1997.
(5) Incorporated by reference to Registrant's Registration Statement on Form S-8
(Reg. No. 333-19785) filed on April 29, 1998.
(6) Incorporated by reference to Registrant's Report on Form 14A filed on
November 26, 1997.
(7) Incorporated by reference to the Registrant's Registration Statement on Form
S-8 (Reg. No. 333-66689) filed on November 3, 1998.
(8) Incorporated by reference to the Registrant's Registration Statement on Form
S-8 (Reg. No. 333-66691) filed on November 3, 1998.
* Document indicated is a compensatory plan.
(b) Reports on Form 8-K.
Not Applicable
(c) Exhibits
See Item 14(a)(2) above
36
<PAGE> 39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Registrant
CYBERONICS, INC.
By: /s/ PAMELA B. WESTBROOK
----------------------------------
Pamela B. Westbrook
Vice President of Finance and
Administration and Chief
Financial Officer
September 28, 2000
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Robert P. Cummins and Pamela B.
Westbrook, jointly and severally, his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to this
Report on Form 10-K, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and conforming all that each of said attorneys-in-fact, or his
substitute or substitutes, any do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE CAPACITY IN WHICH SIGNED DATE
--------- ------------------------ ----
<C> <S> <C>
/s/ REESE S. TERRY, JR. Chairman of the Board September 28, 2000
-----------------------------------------------------
Reese S. Terry, Jr.
/s/ ROBERT P. CUMMINS President, Chief Executive September 28, 2000
----------------------------------------------------- Officer and Director
Robert P. Cummins (Principal Executive
Officer)
/s/ PAMELA B. WESTBROOK Vice President, Finance and September 28, 2000
----------------------------------------------------- Administration and Chief
Pamela B. Westbrook Financial Officer
(Principal Financial and
Accounting Officer)
Director
-----------------------------------------------------
Stanley H. Appel, M.D.
/s/ TONY COELHO Director September 28, 2000
-----------------------------------------------------
Tony Coelho
/s/ THOMAS A. DUERDEN, PH.D. Director September 28, 2000
-----------------------------------------------------
Thomas A. Duerden, Ph.D.
/s/ MICHAEL J. STRAUSS, M.D. Director September 28, 2000
-----------------------------------------------------
Michael J. Strauss, M.D.
/s/ ALAN J. OLSEN Director September 28, 2000
-----------------------------------------------------
Alan J. Olsen
</TABLE>
37
<PAGE> 40
CONSOLIDATED FINANCIAL STATEMENTS
AS OF JUNE 30, 2000
TOGETHER WITH AUDITOR'S REPORT
F-1
<PAGE> 41
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Cyberonics, Inc.
We have audited the accompanying consolidated balance sheets of Cyberonics,
Inc. (a Delaware corporation), and its subsidiary as of June 30, 2000 and 1999,
and the related consolidated statements of operations and comprehensive income
(loss), stockholders' equity and cash flows for each of the three years ended
June 30, 2000. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Cyberonics,
Inc., and its subsidiary as of June 30, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years ended June 30, 2000,
in conformity with accounting principles generally accepted in the United
States.
ARTHUR ANDERSEN LLP
Houston, Texas
August 15, 2000
F-2
<PAGE> 42
CYBERONICS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
--------------------------
2000 1999
----------- ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $14,969,479 $ 16,763,071
Securities held to maturity............................... 5,168,777 4,003,561
Accounts receivable, net.................................. 8,390,558 5,450,003
Inventories............................................... 6,639,784 5,195,114
Prepaid expenses.......................................... 1,414,719 898,038
----------- ------------
Total Current Assets.............................. 36,583,317 32,309,787
Securities held to maturity................................. 399,194 4,091,491
Property and equipment, net................................. 7,466,556 3,272,960
Other assets, net........................................... 154,978 108,915
----------- ------------
$44,604,045 $ 39,783,153
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 1,797,904 $ 1,704,095
Accrued liabilities....................................... 3,794,297 4,630,613
Current portion of long-term debt......................... 109,776 --
----------- ------------
Total Current Liabilities......................... 5,701,977 6,334,708
Long-term debt.............................................. 494,093 --
----------- ------------
Total Liabilities................................. 6,196,070 6,334,708
Commitments and contingencies
Stockholders' Equity:
Preferred Stock, $.01 par value per share; 2,500,000
shares authorized; no shares issued and outstanding.... -- --
Common Stock, $.01 par value per share; 25,000,000 shares
authorized; 18,642,753 and 17,562,000 shares issued and
outstanding at June 30, 2000 and 1999, respectively.... 186,428 175,620
Additional paid-in capital................................ 117,322,388 109,280,567
Accumulated other comprehensive income (loss)............. (168,331) (128,476)
Accumulated deficit....................................... (78,932,510) (75,879,266)
----------- ------------
Total Stockholders' Equity........................ 38,407,975 33,448,445
----------- ------------
$44,604,045 $ 39,783,153
=========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 43
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------------------------
2000 1999 1998
----------- ------------ ------------
<S> <C> <C> <C>
Net sales........................................... $47,888,733 $ 29,927,476 $ 14,912,868
Cost of sales....................................... 11,833,507 7,736,137 3,902,468
----------- ------------ ------------
Gross Profit.............................. 36,055,226 22,191,339 11,010,400
Operating Expenses:
Selling, general and administrative............... 33,269,266 29,585,570 19,781,268
Research and development.......................... 8,037,096 6,724,106 7,391,426
----------- ------------ ------------
Total operating expenses.................. 41,306,362 36,309,676 27,172,694
----------- ------------ ------------
Loss From Operations...................... (5,251,136) (14,118,337) (16,162,294)
Interest income..................................... 1,364,985 1,465,549 1,976,792
Interest expense.................................... 3,349 -- --
Other income (expense), net......................... (44,894) 115,236 10,790
----------- ------------ ------------
Net loss before cumulative effect of a change in
accounting principle.............................. (3,934,394) (12,537,552) (14,174,712)
Cumulative effect on prior years (to June 30, 1999)
of changing to a different method of
depreciation...................................... 881,150 -- --
----------- ------------ ------------
Net Loss.................................. $(3,053,244) $(12,537,552) $(14,174,712)
=========== ============ ============
Net loss per share, basic and diluted:
Net loss before accounting change......... $ (0.22) $ (0.72) $ (0.88)
Cumulative effect of accounting change.... 0.05 -- --
----------- ------------ ------------
Basic and Diluted Net Loss Per Share...... $ (0.17) $ (0.72) $ (0.88)
=========== ============ ============
Shares Used In Computing Basic and Diluted
Net Loss Per Share...................... 18,044,692 17,503,169 16,104,922
=========== ============ ============
Comprehensive Income (Loss):
Net loss............................................ $(3,053,244) $(12,537,552) $(14,174,712)
Foreign currency translation adjustment............. (39,855) (238,741) (69,881)
----------- ------------ ------------
Comprehensive Income (Loss)............... $(3,093,099) $(12,776,293) $(14,244,593)
=========== ============ ============
Pro forma amounts assuming retroactive application
of accounting change:
Net Loss.................................. $(3,934,394) $(11,984,534) $(13,890,013)
Net Loss Per Share -- Basic and Diluted... $ (0.22) $ (0.68) $ (0.86)
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 44
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
---------------------
SHARES AMOUNT
---------- --------
<S> <C> <C>
Balance at June 30, 1997.................................... 13,322,175 $133,222
Issuance of Common Stock in public equity offering, net of
offering costs......................................... 3,225,000 32,250
Stock options and warrants exercised...................... 709,121 7,091
Issuance of Common Stock under Employee Stock Purchase
Plan................................................... 10,137 101
Deferred compensation relating to issuance of certain
stock options.......................................... -- --
Amortization of deferred compensation and expenses related
to certain stock options............................... -- --
Translation adjustment.................................... -- --
Net loss.................................................. -- --
---------- --------
Balance at June 30, 1998.................................... 17,266,433 172,664
Stock options exercised................................... 262,214 2,622
Issuance of Common Stock under Employee Stock Purchase
Plan................................................... 33,353 334
Issuance of options for consultant services............... -- --
Translation adjustment.................................... -- --
Net loss.................................................. -- --
---------- --------
Balance at June 30, 1999.................................... 17,562,000 175,620
Stock options exercised................................... 1,049,971 10,500
Issuance of Common Stock under Employee Stock Purchase
Plan................................................... 30,782 308
Translation adjustment.................................... -- --
Net loss.................................................. -- --
---------- --------
Balance at June 30, 2000.................................... 18,642,753 $186,428
========== ========
</TABLE>
<TABLE>
<CAPTION>
ADDITIONAL DEFERRED
PAID-IN CAPITAL COMPENSATION
--------------- ------------
<S> <C> <C>
Balance at June 30, 1997.................................... $ 57,338,856 $(63,750)
Issuance of Common Stock in public equity offering, net of
offering costs......................................... 47,624,220 --
Stock options and warrants exercised...................... 2,665,309 --
Issuance of Common Stock under Employee Stock Purchase
Plan................................................... 55,973 --
Deferred compensation relating to issuance of certain
stock options.......................................... 73,146 (73,146)
Amortization of deferred compensation and expenses related
to certain stock options............................... -- 136,896
Translation adjustment.................................... -- --
Net loss.................................................. -- --
------------ --------
Balance at June 30, 1998.................................... 107,757,504 --
Stock options exercised................................... 1,136,919 --
Issuance of Common Stock under Employee Stock Purchase
Plan................................................... 308,134 --
Issuance of options for consultant services............... 78,010 --
Translation adjustment.................................... -- --
Net loss.................................................. -- --
------------ --------
Balance at June 30, 1999.................................... 109,280,567 --
Stock options exercised................................... 7,660,286 --
Issuance of Common Stock under Employee Stock Purchase
Plan................................................... 381,535 --
Translation adjustment.................................... -- --
Net loss.................................................. -- --
------------ --------
Balance at June 30, 2000.................................... $117,322,388 $ --
============ ========
</TABLE>
F-5
<PAGE> 45
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY -- (CONTINUED)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE ACCUMULATED
INCOME (LOSS) DEFICIT
------------- ------------
<S> <C> <C>
Balance at June 30, 1997.................................... $ 180,146 $(49,167,002)
Issuance of Common Stock in public equity offering, net of
offering costs......................................... -- --
Stock options and warrants exercised...................... -- --
Issuance of Common Stock under Employee Stock Purchase
Plan................................................... -- --
Deferred compensation relating to issuance of certain
stock options.......................................... -- --
Amortization of deferred compensation and expenses related
to certain stock options............................... -- --
Translation adjustment.................................... (69,881) --
Net loss.................................................. -- (14,174,712)
--------- ------------
Balance at June 30, 1998.................................... 110,265 (63,341,714)
Stock options exercised................................... -- --
Issuance of Common Stock under Employee Stock Purchase
Plan................................................... -- --
Issuance of options for consultant services............... -- --
Translation adjustment.................................... (238,741) --
Net loss.................................................. -- (12,537,552)
--------- ------------
Balance at June 30, 1999.................................... (128,476) (75,879,266)
Stock options exercised................................... -- --
Issuance of Common Stock under Employee Stock Purchase
Plan................................................... -- --
Translation adjustment.................................... (39,855) --
Net loss.................................................. -- (3,053,244)
--------- ------------
Balance at June 30, 2000.................................... $(168,331) $(78,932,510)
========= ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 46
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------------------
2000 1999 1998
------------ ------------ ------------
<S> <C> <C> <C>
Cash Flow From Operating Activities:
Net loss......................................... $ (3,053,244) $(12,537,552) $(14,174,712)
Noncash items included in net loss:
Depreciation.................................. 1,449,333 1,515,273 697,420
Loss on asset disposals....................... -- 102,064 --
Change in accounting principle................ (881,150) -- --
Expense related to certain stock options...... -- 78,010 136,896
Changes in operating assets and liabilities:
Accounts receivable, net...................... (2,940,555) 408,631 (5,310,092)
Inventories................................... (1,444,670) (3,091,511) (1,098,247)
Prepaid expenses.............................. (516,681) 265,085 (1,036,324)
Accounts payable and accrued liabilities...... (742,507) (1,581,867) 6,088,310
Other assets, net............................. (46,063) 83,977 (109,641)
------------ ------------ ------------
Net Cash Used In Operating Activities.... (8,175,537) (14,757,890) (14,806,390)
Cash Flow From Investing Activities:
Purchases of property and equipment.............. (4,114,820) (1,737,314) (3,488,070)
Purchases of marketable securities............... (52,528,156) (45,991,718) (75,229,726)
Maturities of marketable securities.............. 55,055,237 76,345,340 44,122,869
------------ ------------ ------------
Net Cash Provided By (Used In) Investing
Activities............................. (1,587,739) 28,616,308 (34,594,927)
Cash Flow From Financing Activities:
Proceeds from issuance of Common Stock........... 8,052,629 1,448,009 50,384,944
Payments on debt................................. (43,090) -- --
------------ ------------ ------------
Net Cash Provided By Financing
Activities............................. 8,009,539 1,448,009 50,384,944
Effect of exchange rate changes on cash and cash
equivalents................................... (39,855) (238,741) (69,881)
------------ ------------ ------------
Net Increase (Decrease) In Cash and Cash
Equivalents............................ (1,793,592) 15,067,686 913,746
Cash and cash equivalents at beginning of year... 16,763,071 1,695,385 781,639
------------ ------------ ------------
Cash and cash equivalents at end of year......... $ 14,969,479 $ 16,763,071 $ 1,695,385
============ ============ ============
Supplementary Disclosures Of Cash Flow Information:
Cash paid for interest........................... $ 3,349 $ -- $ --
Noncash purchase of assets under capital
leases........................................ $ 646,959 $ -- $ --
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE> 47
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RELATED DATA
Nature of Operations. Cyberonics, Inc. ("Cyberonics" or the "Company"),
designs, develops, manufactures and markets the NeuroCybernetic Prosthesis, or
NCP(R) System, an implantable medical device which delivers a unique therapy,
Vagus Nerve Stimulation (VNS(TM)), for the treatment of epilepsy and other
debilitating neurological, psychiatric diseases and other disorders. In July
1997 the NCP System was approved by the United States Food and Drug
Administration ("FDA") for commercial distribution in the United States, where
the Company presently markets it using its own employee-based direct sales
organization. In addition, the NCP System is marketed internationally
(principally in Europe) using a combination of the Company's own direct sales
organization and independent distributors. Cyberonics is headquartered in
Houston, Texas.
The Company's future success is dependent upon a number of factors which
include, among others, achieving market acceptance and generating sufficient
sales volume, obtaining and maintaining regulatory and reimbursement approvals
for its products, the possibility of competition and technological changes,
developing its sales, marketing and corporate infrastructures, maintaining an
uninterrupted supply of certain sole source components and materials, adding
sufficient manufacturing capacity to meet future possible product demand,
possible product liability or recall, and reliance on key personnel.
Consolidation. The accompanying consolidated financial statements include
the Company and its wholly-owned subsidiary, Cyberonics Europe, S.A. All
significant inter-company accounts and transactions have been eliminated.
Use of Estimates. The preparation of the financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
Foreign Currency Translation. The assets and liabilities of Cyberonics
Europe S.A. are generally translated into U.S. dollars at exchange rates in
effect on reporting dates, while capital accounts and certain obligations of a
long-term nature payable to the parent company are translated at historical
rates. Income statement items are translated at average exchange rates in effect
during the financial statement period. Gains and losses resulting from foreign
currency transactions denominated in currency other than the functional currency
are included in other income and expense.
Cash and Cash Equivalents. The Company considers all highly liquid
investments with a maturity of three months or less at the time of purchase to
be cash equivalents.
Marketable Securities. At June 30, 2000 and 1999, the Company's investment
portfolios 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 ranging up to approximately 33 months and have a fair market
value of approximately $5,290,000 and
F-8
<PAGE> 48
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$8,009,000, as of June 30, 2000 and 1999, respectively. At June 30, 2000 and
1999, the Company's investment portfolio consists of the following:
<TABLE>
<CAPTION>
2000 1999
------------------------ ------------------------
FAIR MARKET CARRYING FAIR MARKET CARRYING
VALUE VALUE VALUE VALUE
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Securities held to maturity --
Current --
Corporate bonds and commercial
paper......................... $1,624,000 $1,626,390 $3,570,000 $3,626,824
US treasury obligations......... 3,270,000 3,542,387 375,000 376,737
---------- ---------- ---------- ----------
4,894,000 5,168,777 3,945,000 4,003,561
Non-current --
Asset-backed investments........ 396,000 399,194 -- --
Corporate bonds and commercial
paper......................... -- -- 1,625,000 1,630,619
US treasury obligations......... -- -- 2,439,000 2,460,872
---------- ---------- ---------- ----------
396,000 399,194 4,064,000 4,091,491
---------- ---------- ---------- ----------
Total...................... $5,290,000 $5,567,971 $8,009,000 $8,095,052
========== ========== ========== ==========
</TABLE>
Inventories. Cyberonics states its inventories at the lower of cost,
first-in, first-out (FIFO) method, or market. Cost includes the acquisition cost
of raw materials and components, direct labor and overhead.
Property and Equipment. Property and equipment are carried at cost, less
accumulated depreciation. Maintenance, repairs and minor replacements are
charged to expense as incurred; significant renewals and betterments are
capitalized. For financial reporting purposes, the Company computes depreciation
using the straight-line method over useful lives ranging from three to nine
years.
Long-Lived Assets. In accordance with Statement of Financial Accounting
Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of, the Company evaluates the
recoverability of property and equipment and intangible assets if facts and
circumstances indicate that any of those assets might be impaired. If an
evaluation is required, the estimated future undiscounted cash flows associated
with the asset are compared to the asset's carrying amount to determine if a
write-down to market value or discounted cash flow value is necessary. Assets to
be disposed of are reported at the lower of the carrying amount or fair value
less costs to sell.
Stock Options. The Company has adopted the disclosure-only provisions of
SFAS No. 123, Accounting for Stock-Based Compensation, which disclosures are
presented in Note 8, "Stock Incentive and Purchase Plans." Because of this
election, the Company continues to account for its employee stock-based
compensation plans under Accounting Principles Board (APB) Opinion No. 25 and
the related interpretations. Accordingly, deferred compensation is recorded for
stock-based compensation grants based on the excess of the market value of the
common stock on the measurement date over the exercise price. The deferred
compensation is amortized over the vesting period of each unit of stock-based
compensation. If the exercise price of the stock-based compensation grant is
equal to the market price of the Company's stock on the date of grant, no
compensation expense is recorded.
Revenue Recognition. Revenue from product sales is generally recognized
upon shipment to the customer, net of estimated returns and allowances. United
States sales activities prior to the Company's July 1997 receipt of FDA approval
depended entirely upon the Company conducting clinical trial activities under
arrangements with certain investigational centers.
F-9
<PAGE> 49
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Accounts Receivable. The Company's allowance for doubtful accounts totaled
$162,654 and $495,662 at June 30, 2000 and 1999, respectively.
Research and Development. All research and development costs are expensed
as incurred.
Warranty Expense. The Company provides at the time of shipment for costs
estimated to be incurred under its product warranties.
License Agreements. The Company has executed licensing agreements under
which it has secured the rights provided under certain patents. Royalties,
payable under the terms of these agreements, are expensed as incurred.
Income Taxes. Cyberonics accounts for income taxes in accordance with the
liability method. Under this method, deferred income taxes reflect the impact of
temporary differences between financial accounting and tax bases of assets and
liabilities. Such differences relate primarily to the Company's election to
defer the deduction of certain start-up costs for federal income tax purposes,
the deductibility of certain accruals and reserves and the effect of tax loss
and tax credit carryforwards not yet utilized. Deferred tax assets are evaluated
for realization based on a more-likely-than-not criteria in determining if a
valuation allowance should be provided.
Net Loss Per Share. In accordance with SFAS No. 128, Earnings Per Share,
the Company's net loss per share is based on the weighted average number of
common shares outstanding. Common equivalent shares, consisting of the effect of
stock options and warrants, are excluded from the per share calculations, as the
effect of their inclusion is antidilutive.
Comprehensive Income. The Company adopted SFAS No. 130, Reporting
Comprehensive Income, effective July 1, 1998. SFAS No. 130 establishes standards
for reporting and displaying comprehensive income and its components.
Comprehensive income is the total of net income and all other non-owner changes
in equity. A reconciliation of reported net loss to comprehensive income (loss)
is included in the consolidated statements of operations and comprehensive
income (loss).
Reclassification. Certain amounts in the balance sheet as of June 30, 1999
have been reclassified to conform with those at June 30, 2000.
NOTE 2. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JUNE 30,
-----------------------
2000 1999
---------- ----------
<S> <C> <C>
Raw materials and components................................ $2,378,933 $2,837,599
Work-in-process............................................. 1,089,891 794,410
Finished goods.............................................. 3,170,960 1,563,105
---------- ----------
$6,639,784 $5,195,114
========== ==========
</TABLE>
F-10
<PAGE> 50
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
JUNE 30,
-------------------------
2000 1999
----------- -----------
<S> <C> <C>
Manufacturing equipment.................................... $ 2,727,269 $ 1,708,654
Computer equipment......................................... 2,627,418 1,523,760
Furniture and fixtures..................................... 1,559,175 1,188,572
Leasehold improvements..................................... 1,405,824 1,181,140
Construction in progress................................... 1,388,960 162,670
Offsite programming equipment.............................. 785,693 --
Office equipment........................................... 98,765 80,591
----------- -----------
10,593,104 5,845,387
Accumulated depreciation................................... (3,126,548) (2,572,427)
----------- -----------
$ 7,466,556 $ 3,272,960
=========== ===========
</TABLE>
NOTE 4. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
JUNE 30,
-----------------------
2000 1999
---------- ----------
<S> <C> <C>
Payroll and other compensation.............................. $1,391,158 $2,086,849
Clinical costs.............................................. 1,059,665 1,161,291
Royalties................................................... 557,077 398,800
Warranties.................................................. 375,000 375,000
Professional services....................................... 108,953 129,600
Sales returns and allowances................................ 105,610 205,400
Marketing activities........................................ -- 50,250
Other....................................................... 196,834 223,423
---------- ----------
$3,794,297 $4,630,613
========== ==========
</TABLE>
NOTE 5. DEBT
Debt consists of the following:
<TABLE>
<CAPTION>
JUNE 30,
---------------
LONG-TERM DEBT INTEREST RATE MATURITY DATE 2000 1999
-------------- ------------- ------------- -------- ----
<S> <C> <C> <C> <C>
Capitalized lease obligations.............. 6.56% April 2005 $603,869 $ --
Less: current maturities................... 109,776 --
-------- ----
Total long-term debt............. $494,093 $ --
======== ====
</TABLE>
Maturities of long-term debt for the next five fiscal years are as follows:
2001, $109,776; 2002, $117,198; 2003, $125,122; 2004, $133,581; 2005, $118,192.
Debt is secured by certain manufacturing equipment of the Company.
F-11
<PAGE> 51
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. CHANGE IN ACCOUNTING PRINCIPLE
Effective July 1, 1999, the Company changed its 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 the Company's
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 for the
fiscal year ended June 30, 2000. The effect of the change for fiscal year 2000
was to decrease the operating loss by approximately $598,000 ($0.03 per share).
Pro forma amounts are presented on the consolidated statements of operations and
comprehensive income (loss) showing the effect of applying the new method
retroactively.
NOTE 7. STOCKHOLDERS' EQUITY
Preferred Stock. The Company has 2,500,000 shares of undesignated Preferred
Stock authorized and available for future issuance, of which none have been
issued through June 30, 2000. With respect to the shares authorized, the
Company's Board of Directors, at its sole discretion, may determine, fix and
alter dividend rights, dividend rates, conversion rights, voting rights, terms
of redemption, redemption prices, liquidation preferences and the number of
shares constituting any such series, and may determine the designation, terms
and conditions of the issuance of any such shares.
Common Stock. During the year ended June 30, 1998, stock option and warrant
exercises and issuances of Common Stock under the Company's Employee Stock
Purchase Plan increased the number of common shares by 709,121 and 10,137,
respectively. During the year ended June 30, 1999, stock option exercises and
issuances of Common Stock under the Company's Employee Stock Purchase Plan
increased the number of common shares by 262,214 and 33,353, respectively.
During the year ended June 30, 2000, stock option exercises and issuances of
Common Stock under the Company's Employee Stock Purchase Plan increased the
number of common shares by 1,049,971 and 30,782, respectively.
In September 1997, the Company issued 3,000,000 shares of its Common Stock
in a follow-on public equity offering for $15.88 per share and, in October 1997,
subsequently issued an additional 225,000 shares at the same price per share
upon the exercise of a portion of the related underwriter's overallotment
option. Proceeds from the combined issuances totaled approximately $47.7 million
after deducting commissions and offering costs.
Preferred Share Purchase Rights. In January 1997, the Company's Board of
Directors declared a dividend of one Preferred Share Purchase Right ("Right") on
each outstanding share of the Company's Common Stock to stockholders of record
on March 10, 1997. The Company amended and restated the Preferred Share Rights
Plan on August 21, 2000. The Rights will become exercisable following the tenth
day after a person or group of affiliate persons (an "Acquiring Person"),
acquires beneficial ownership of 15 percent or more of the Company's Common
Stock or announces commencement of a tender offer, the consummation of which
would result in such person or group of persons becoming an Acquiring Person (a
"Triggering Event"). Each Right entitles the holder thereof to buy 1/1000 of a
share of the Company's Series A Participating Preferred Stock at an exercise
price of $150 (the "Exercise Price"). The Company will be entitled to redeem the
Rights at $.01 per Right at any time prior to a Triggering Event. If, prior to
redemption of the Rights, a person becomes an Acquiring Person, each Right
(except for Rights owned by the Acquiring Person, which will thereafter be void)
will entitle the holder thereof to purchase, at the Right's then current
exchange price, that number of shares of Common Stock of the Company (or, in
certain circumstances as determined by the Board, cash, other property or other
securities) having a market value at that time of twice the Right's exercise
price. In the event a person becomes an Acquiring Person and the Company sells
more than 50% of its assets or earning power or is acquired in a merger or other
business combination, proper provision must be made so that a holder of a Right
which has not theretofore been
F-12
<PAGE> 52
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
exercised (except for Rights owned by the Acquiring Person, which will
thereafter be void), will thereafter have the right to receive, upon exercise of
a Right, shares of Common Stock of the acquiring company having a value equal to
two times the then current Exercise Price. At any time after a Triggering Event
and prior to acquisition by such Acquiring Person of 50% or more of the
outstanding Common Stock, the Board of Directors of the Company may exchange the
Rights (other than Rights owned by the Acquiring Person or its affiliates) for
the Common Stock of the Company at an exchange ratio of one share of Common
Stock per Right.
NOTE 8. STOCK INCENTIVE AND PURCHASE PLANS
Stock Options. Cyberonics has reserved an aggregate of 8,150,000 shares of
its Common Stock through June 30, 2000, for issuance pursuant to its Amended
1988 Incentive Stock Option Plan, its 1996 Stock Option Plan, its 1997 Stock
Option Plan and its 1998 Stock Option Plan (the "Stock Option Plans"). Options
granted under the Stock Option Plans generally vest ratably over four or five
years following their date of grant. The vesting of certain options occurs up to
10 years from the grant date but can accelerate based upon the achievement of
specific milestones related to regulatory approvals and the achievement of
Company sales objectives. In June 1997, 446,147 shares vested upon receipt of
FDA panel recommendation and, in July 1997, an additional 356,156 shares vested
upon FDA approval. During fiscal 1999, 9,250 shares vested upon certain sales
milestone achievements. Options granted under the Stock Option Plans have
maximum terms of 10 years. The Amended 1988 Incentive Stock Option Plan and the
1997 Stock Plan allow issuance of either nonstatutory or incentive stock
options, while the 1996 Stock Option Plan provides for issuance of nonstatutory
stock options exclusively.
F-13
<PAGE> 53
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of the Company's stock option activity for the
three years ended June 30, 2000:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
--------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE EXERCISE
RESERVED SHARES PRICE SHARES PRICE
---------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C>
Balance at June 30, 1997...... 1,110,203 2,205,390 $ 3.13 1,045,140 $3.04
Shares reserved............... 1,750,000
Granted....................... (2,740,154) 2,740,154 12.73
Options becoming
exercisable................. 1,341,962
Exercised..................... (708,482) 3.79 (708,482)
Canceled or forfeited......... 181,291 (181,291) 10.67
---------- ---------- ----------
Balance at June 30,
1998.............. 301,340 4,055,771 9.16 1,678,620 4.72
Shares reserved............... 800,000
Granted....................... (1,529,450) 1,529,450 6.98
Options becoming
exercisable................. 659,510
Exercised..................... (262,214) 4.35 (262,214)
Canceled or forfeited......... 675,343 (675,343) 9.95
---------- ---------- ----------
Balance at June 30,
1999.............. 247,233 4,647,664 8.62 2,075,916 6.56
Shares reserved............... 1,600,000
Granted....................... (1,202,700) 1,202,700 16.54
Options becoming
exercisable................. 618,382
Exercised..................... (1,049,971) 7.02 (1,049,971)
Canceled or forfeited......... 672,283 (672,283) 10.58
---------- ---------- ----------
Balance at June 30,
2000.............. 1,316,816 4,128,110 $11.00 1,644,327 $8.03
========== ========== ==========
</TABLE>
For certain options granted, the Company recognizes as compensation or
other expense the excess of the deemed value for accounting purposes of the
Common Stock on the date the options were granted over the aggregate exercise
price of such options. Compensation expense is amortized ratably over the
vesting period of each option. The Company recognized compensation or other
expense totaling $0 during fiscal 2000, $78,010 during fiscal 1999 and $136,896
during fiscal 1998.
The fair values of each option grant and purchase plan discounts are
estimated using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in fiscal years 2000, 1999 and
1998: risk-free interest rate of 5% for fiscal years 2000 and 1999 and 5.5% for
fiscal year 1998, expected life of five years for options and restricted stock,
expected life of six months for purchase plan shares, expected volatility of
161%, 290% and 100%, respectively, and no expected dividend yields. The weighted
average fair value of options granted at prices equal to the Company's market
value in fiscal years 2000, 1999 and 1998 was $15.31, $8.05 and $9.76,
respectively.
F-14
<PAGE> 54
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Had the compensation cost for these plans been determined pursuant to the
alternative method under SFAS No. 123, the Company's net loss and loss per share
would have been increased to the following pro forma amounts:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------------------
2000 1999 1998
------------ ------------ ------------
<S> <C> <C> <C>
Net loss --
As reported.............................. $ (3,053,244) $(12,537,552) $(14,174,712)
Pro forma................................ (12,678,014) (19,320,345) (19,252,232)
Loss per share --
As reported.............................. $ (0.17) $ (0.72) $ (0.88)
Pro forma................................ (0.70) (1.10) (1.20)
</TABLE>
Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to July 1, 1995, the resulting pro forma compensation cost
may not be representative of that to be expected in future years. Additionally,
the pro forma amounts include $159,143, $67,393 and $57,963 related to the
purchase discount offered under the Company's Employee Stock Purchase Plan
during fiscal 2000, 1999 and 1998, respectively. The weighted average fair
values of shares granted to employees were $17.57, $11.27 and $11.25 during
fiscal 2000, 1999 and 1998, respectively.
The Company's outstanding options are segregated into the following five
categories in accordance with SFAS No. 123:
OPTIONS OUTSTANDING AND EXERCISABLE BY PRICE RANGE
AS OF 6/30/2000
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- ------------------------------------
WEIGHTED-AVERAGE WEIGHTED- WEIGHTED-
RANGE OF OUTSTANDING AS OF REMAINING AVERAGE EXERCISE EXERCISABLE AS OF AVERAGE EXERCISE
EXERCISE PRICES 6/30/2000 CONTRACTUAL LIFE PRICE 6/30/2000 PRICE
--------------- ----------------- ---------------- ---------------- ----------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 0.0000 -$ 0.6700 950 1.4 $ 0.67 950 $ 0.67
$ 0.6800-$ 5.9750 1,033,631 6.0 $ 3.55 891,965 $ 3.35
$ 5.9751-$11.9500 1,015,378 7.8 $ 8.50 224,233 $ 8.74
$11.9510-$17.9250 1,750,351 8.0 $14.94 483,929 $14.74
$17.9251-$29.8750 327,800 9.3 $21.17 43,250 $25.85
--------- ---------
4,128,110 7.5 $11.00 1,644,327 $ 8.03
========= =========
</TABLE>
During fiscal 2000, the Board of Directors approved two grants outside of
the existing stock option plans. The grants, which totaled 250,000 options, were
approved for new officers as inducements essential to their entering into
employment with the Company.
In June 2000 the Board of Directors granted 450,000 options at $18.00 per
share subject to stock option plan approval by the shareholders at the next
annual meeting. If approved, vesting of the options is scheduled to occur
ratably over a five-year period starting in June 2000. The grant will be issued
upon shareholder approval. The Company will recognize compensation expense on
the measurement date if at that date the fair market value of the Company's
Common Stock exceeds the option grant price.
Stock Purchase Plan. Under the Cyberonics, Inc. Employee Stock Purchase
Plan (the Stock Purchase Plan), 200,000 shares of the Company's Common Stock
have been reserved for issuance. Subject to certain limits, the Stock Purchase
Plan allows eligible employees to purchase shares of the Company's Common Stock
through payroll deductions of up to 15 percent of their respective current
compensation at a price equaling the lesser of 85 percent of the fair market
value of the Company's Common Stock on (a) the first
F-15
<PAGE> 55
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
business day of the purchase period or (b) the last business day of the purchase
period. Purchase periods, under provisions of the Stock Purchase Plan, are six
months in length and begin on the first business days of June and December. At
June 30, 2000, 35,865 shares remain available for future issuances under the
Stock Purchase Plan.
Stock Recognition Program. In May 1992, the Company's Board of Directors
established the Cyberonics Employee Stock Recognition Program. Since its
inception, a total of 8,600 shares of the Company's Common Stock has been
reserved for issuance as special recognition grants. The shares are granted to
employees for special performances and/or contributions at the discretion of the
Company's President, based on nominations made by fellow employees. At June 30,
2000, 4,030 shares remain available for future issuances under the program.
NOTE 9. NEW ACCOUNTING PRONOUNCEMENT
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin 101, Revenue Recognition in Financial Statements (SAB 101),
which provides guidance related to revenue recognition based on interpretations
and practices followed by the SEC. SAB 101, as amended, is effective for the
first quarter of the Company's fiscal year beginning July 1, 2000 and requires
companies to report any changes in revenue recognition as a cumulative change in
accounting principle at the time of implementation. Cyberonics' management
believes that its revenue recognition policy is in accordance with SAB 101 and
does not believe that implementation of this SAB will have a material impact on
Cyberonics' financial position or results of operations.
NOTE 10. INCOME TAXES
Components of the Company's loss before taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------------------------
2000 1999 1998
----------- ------------ ------------
<S> <C> <C> <C>
Domestic.................................... $(2,198,294) $(10,697,153) $(10,142,530)
Foreign..................................... (854,950) (1,840,399) (4,032,182)
----------- ------------ ------------
$(3,053,244) $(12,537,552) $(14,174,712)
=========== ============ ============
</TABLE>
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------
2000 1999 1998
------ ----- -----
<S> <C> <C> <C>
U.S. statutory rate......................................... (34.0)% (34.0)% (34.0)%
Increase in deferred tax valuation allowance................ 147.9 37.7 37.3
Other, net.................................................. (113.9) (3.7) (3.3)
------ ----- -----
0.0% 0.0% 0.0%
====== ===== =====
</TABLE>
F-16
<PAGE> 56
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
are as follows:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------
2000 1999
------------ ------------
<S> <C> <C>
Deferred tax assets:
Federal net operating loss carryforwards............... $ 25,252,567 $ 20,993,968
Foreign net operating loss carryforwards............... 3,772,374 3,481,691
Tax credit carryforwards............................... 2,276,648 1,945,542
Warranties............................................. 127,500 127,500
Depreciation........................................... -- 216,920
Clinical costs......................................... 103,927 285,851
Other, net............................................. 954,388 794,685
------------ ------------
Total deferred tax assets...................... 32,487,404 27,846,157
Total deferred tax liabilities, net...................... (126,515) --
Deferred tax valuation allowance......................... (32,360,889) (27,846,157)
------------ ------------
Net deferred tax assets and liabilities........ $ -- $ --
============ ============
</TABLE>
At June 30, 2000, the Company has net operating loss carryforwards of
approximately $74.3 million for federal income tax purposes, which expire during
the years 2003 through 2020, and tax credit carryforwards of approximately $2.3
million for federal income tax purposes, which expire during the years 2006
through 2020. As the Company has had cumulative losses and there is no assurance
of future taxable income, a valuation allowance totaling $32.4 million has been
established as of June 30, 2000, to fully offset the Company's net deferred tax
assets, including those relating to its carryforwards. The valuation allowance
increased $4.5 million and $4.7 million for the years ended June 30, 2000 and
1999, respectively, due primarily to the Company's additional net operating
losses. Current federal income tax regulations with respect to changes in
ownership could limit the utilization of the Company's net operating losses and
tax credit carryforwards.
NOTE 11. EMPLOYEE RETIREMENT SAVINGS PLAN
Cyberonics sponsors an employee retirement savings plan (the Plan) which
qualifies under Section 401(k) of the Internal Revenue Code. The Plan is
designed to provide eligible employees with an opportunity to make regular
contributions into a long-term investment and savings program. Substantially all
U.S. employees are eligible to participate in the Plan beginning with the first
quarterly open enrollment date following start of employment. Employer
contributions are made solely at the Company's discretion. No employer
contributions were made to the Plan for the years ended June 30, 2000, 1999 and
1998.
NOTE 12. COMMITMENTS AND CONTINGENCIES
Postmarket Clinical Surveillance. Pursuant to the postmarket surveillance
conditions specified as part of the Company's FDA marketing approval, the
Company is required to conduct clinical follow-up on a limited number of
patients from its most recent study in order to monitor the safety and
tolerability of the NCP System on an extended basis. The Company expenses the
costs related to these long-term follow-up activities as they are incurred and
establishes accruals for such costs incurred but not paid as of the respective
balance sheet dates.
License Agreements. The Company has executed a license agreement which
provides Cyberonics with worldwide exclusive rights under three United States
patents (and their international counterparts) covering the method and devices
of the NCP System for vagus nerve and other cranial nerve stimulation for the
control of epilepsy and other movement disorders. The license agreement provides
that the Company will pay a royalty equal to the greater of $36,000 per year or
at the rate of 3 percent of sales during fiscal 2000 and
F-17
<PAGE> 57
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
through the remaining term of the licensed patents. The license agreement runs
for successive three-year terms, renewable at the Company's election. The
license agreement, and its periods of extension, may not be terminated by the
licensor without cause. The Company's royalty payments pursuant to this
agreement are expensed as incurred.
The Company has executed a license agreement for a specific application of
lead designs to be used in vagus nerve stimulation for the control of epilepsy
and other movement disorders. The licensor retains all rights to this patent for
applications outside the above specified use. Pursuant to the license agreement,
the Company has a limited-term option to expand the licensed field of use for
additional indications for a license fee of $15,000 per indication and has made
partial payments for certain such indications. In addition, the Company is
obligated to pay the licensor an earned royalty equal to the greater of $35,000
per year or at the rate of 1 percent of the Company's net sales price of
implantable systems incorporating the licensor's standard lead and 1.75 percent
of net sales incorporating the licensor's bi-directional lead for the life of
the licensed patents. Amounts due under this agreement are expensed as incurred.
Lease Agreements. The Company leases offices, manufacturing and sales
distribution facilities as well as transportation and office equipment under
operating leases. Future minimum payments relating to these agreements at June
30, 2000, are as follows:
<TABLE>
<S> <C>
YEAR ENDING JUNE 30 --
2001..................................................... $1,374,060
2002..................................................... 1,257,912
2003..................................................... 498,053
2004..................................................... 15,056
2005..................................................... 3,143
----------
$3,148,224
==========
</TABLE>
The Company leases certain manufacturing equipment under long-term capital
leases. Capitalized costs of $646,959 and $0 are included in construction in
progress at June 30, 2000 and 1999, respectively. Accumulated depreciation
amounted to $0 at June 30, 2000 and 1999.
The following is a schedule of future minimum lease payments under
long-term capital leases together with the present value of the net minimum
lease payments as of June 30, 2000:
<TABLE>
<S> <C>
YEAR ENDING JUNE 30 --
2001..................................................... $146,129
2002..................................................... 146,129
2003..................................................... 146,129
2004..................................................... 146,129
2005..................................................... 121,773
--------
Total minimum lease payments................... 706,289
Less: amount representing interest....................... 102,420
--------
Present value of future minimum lease payments........... 603,869
Less: amount due within one year......................... 109,776
--------
Amount due after one year...................... $494,093
========
</TABLE>
The Company's rental expense for the years ended June 30, 2000, 1999 and
1998 amounted to $1,172,296, $1,276,760 and $800,640, respectively.
F-18
<PAGE> 58
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Other Commitments. At June 30, 2000, Cyberonics had approximately $894,000
in noncancelable commitments related to domestic marketing programs planned for
the Company's NCP System during fiscal year 2001, of which approximately
$774,000 is scheduled to occur in the first quarter of fiscal year 2001.
Litigation. The Company terminated a contractual relationship with
Hi-Tronics Design, Inc. (Hi-Tronics) for the manufacture of component parts for
certain of its products. The dispute has been submitted for binding arbitration
and is now pending before the American Arbitration Association, case number
70-489-00325-00. Hi-Tronics has asserted a claim for a contractual termination
fee of approximately $1 million and has asserted the right to use the components
for other devices. The Company believes it has valid defenses to these claims
and intends to vigorously contest any claims which are asserted in arbitration.
In addition, the Company has asserted claims that Hi-Tronics breached the
contract and is liable for damages caused by the breach. The Company has now
developed the facilities to manufacture the components in-house. In light of the
preliminary state of the arbitration and the inherent uncertainties involved in
litigation, the Company is not able to assess the likelihood of an unfavorable
outcome or range of any possible loss.
NOTE 13. RELATED PARTY TRANSACTIONS
Covance Health Economics and Outcomes Services, Inc. (Covance) provides
healthcare reimbursement consulting services to the Company. Amounts paid for
such services in fiscal years 2000, 1999 and 1998 were $431,662, $693,844 and
$511,459, respectively. Dr. Strauss is a member of the Board of Directors of the
Company and was the Executive Vice President of Covance through 1999. He
currently serves as a senior consultant for Covance.
NOTE 14. CONCENTRATIONS OF CREDIT RISK
The Company's cash equivalents, securities held to maturity and trade
accounts receivable represent potential concentrations of credit risk.
The Company minimizes potential concentrations of credit risk in cash
equivalents and marketable securities by placing investments in high quality
financial instruments and, as required by its corporate investment policy,
limiting the amount of investment in any one issuing party. At June 30, 2000,
management believes that the Company has no significant concentrations of credit
risk related to these assets and has incurred no material impairments in the
carrying values of its cash equivalents and securities held to maturity.
Concentrations of credit risk with respect to trade accounts receivable are
limited due to the large number of customers and their dispersion across a
number of geographic areas. However, essentially all trade receivables are
concentrated in the hospital and health care sectors in the United States and
several other countries and, accordingly, are exposed to their respective
business, economic and country-specific variables. Although the Company does not
currently foresee a concentrated credit risk associated with these receivables,
repayment is dependent upon the financial stability of these industry sectors
and the respective countries' national economics and health care systems.
NOTE 15. SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates its business in three Indication Business Units, which
are aggregated into one reportable segment, that of designing, developing,
manufacturing and marketing the NCP System using VNS for the treatment of
epilepsy and other debilitating neurological, psychiatric diseases and other
disorders. Each of the Company's business units has similar economic
characteristics, technology, manufacturing processes, customers, distribution
and marketing strategies, a similar regulatory environment and shared
infrastructures.
F-19
<PAGE> 59
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net sales and operating loss by business unit are presented below. The
Depression and Other Indications Business Units' operating expense consist
primarily of pre-clinical, clinical and direct payroll costs. General
administration expense and depreciation have been entirely allocated to
Epilepsy.
<TABLE>
<CAPTION>
EPILEPSY DEPRESSION OTHER
INDICATION INDICATION INDICATIONS
BUSINESS UNIT BUSINESS UNIT BUSINESS UNIT TOTAL
------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
Fiscal Year Ended June 30, 2000
External net sales................... $ 47,888,733 $ -- $ -- $ 47,888,733
Operating loss(1).................... (3,012,123) (1,884,251) (354,762) (5,251,136)
Fiscal Year Ended June 30, 1999
External net sales................... $ 29,927,476 $ -- $ -- $ 29,927,476
Operating loss(1).................... (12,185,623) (815,013) (564,683) (13,565,319)
Fiscal Year Ended June 30, 1998
External net sales................... $ 14,912,868 $ -- $ -- $ 14,912,868
Operating loss(1).................... (15,877,595) (21,454) (21,454) (15,920,503)
</TABLE>
---------------
(1) The depreciation expense component of operating loss for the Epilepsy
Indication Business Unit assumes retroactive application of accounting
change.
Geographic Information:
<TABLE>
<CAPTION>
NET SALES
---------------------------------------
FY2000 FY1999 FY1998
----------- ----------- -----------
<S> <C> <C> <C>
United States................................. $42,533,016 $26,278,585 $12,615,309
International................................. 5,355,717 3,648,891 2,297,559
----------- ----------- -----------
Total............................... $47,888,733 $29,927,476 $14,912,868
=========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
LONG-LIVED ASSETS,
YEAR ENDED
JUNE 30,
-----------------------
2000 1999
---------- ----------
<S> <C> <C>
United States............................................... $7,850,419 $7,372,742
International............................................... 170,309 100,624
---------- ----------
Total............................................. $8,020,728 $7,473,366
========== ==========
</TABLE>
NOTE 16. SUBSEQUENT EVENTS
On September 11, 2000, Medtronic, Inc. ("Medtronic") publicly announced a
proposal to acquire us for $26.00 per share in value of Medtronic common stock.
The Company's Board of Directors, with the assistance of Morgan Stanley Dean
Witter, the Company's financial advisor, elected to remain independent to pursue
our patent protected opportunities for vagus nerve stimulation in epilepsy,
depression, Alzheimer's Disease, obesity, and in other indications covered by
our United States method patents. On September 28, 2000, Medtronic announced
that it had withdrawn its offer. Morgan Stanley Dean Witter was engaged to serve
as the Company's financial advisor in connection with this proposal and the
Company is currently obligated to pay them $2.2 million for advisory services.
The Company will be obligated to make an additional payment to Morgan Stanley
Dean Witter of not less than $4.0 million on or before May 15, 2001. In
addition, the Company's Board of Directors has authorized the development and
implementation of a retention plan for officers and key employees. This plan
will provide for cash payments to employees which will range from six
F-20
<PAGE> 60
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
months to three years, depending on seniority, plus bonus and will be payable
only upon a change of control. The Company has also incurred additional legal
and accounting fees as a result of Medtronic's actions.
NOTE 17. QUARTERLY FINANCIAL INFORMATION -- UNAUDITED
The following table sets forth certain unaudited condensed quarterly
financial data for the fiscal years ended June 30, 2000 and 1999. This
information has been prepared on the same basis as the consolidated financial
statements and all necessary adjustments have been included in the amounts
stated below to present fairly the selected quarterly information when read in
conjunction with its consolidated financial statements and notes thereto.
Historical quarterly financial results and trends may not be indicative of
future results.
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH ANNUAL
QUARTER QUARTER QUARTER QUARTER TOTALS
----------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
FISCAL YEAR ENDED JUNE
30, 2000
Net sales............... $ 8,663,236 $11,117,439 $14,034,508 $14,073,550 $ 47,888,733
Gross profit............ 6,376,335 8,477,467 10,761,854 10,439,570 36,055,226
Net earnings
(loss)(1)............. (776,760) (223,764) 13,629 (2,066,349) (3,053,244)
Diluted net earnings
(loss) per share(2)... (0.04) (0.01) -- (0.11) (0.17)
FISCAL YEAR ENDED JUNE
30, 1999
Net sales............... $ 5,335,757 $ 6,602,921 $ 8,054,457 $ 9,934,341 $ 29,927,476
Gross profit............ 3,919,758 4,970,631 5,933,809 7,367,141 22,191,339
Net loss(1)............. (4,674,265) (3,879,031) (3,223,443) (760,813) (12,537,552)
Diluted net loss per
share(2).............. (0.27) (0.22) (0.18) (0.04) (0.72)
</TABLE>
---------------
(1) Net loss for the first quarter of fiscal year ended June 30, 2000 includes
the cumulative effect of a change in accounting principle. Net loss for
quarters in fiscal year ended June 30, 1999 are the historical quarterly
financial results.
(2) Loss per share (EPS) in each quarter is computed using the weighted-average
number of shares outstanding during that quarter while EPS for the full year
is computed using the weighted-average number of shares outstanding during
the year. Thus, the sum for the four quarters' EPS does not equal the
full-year EPS.
F-21
<PAGE> 61
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
3.1(1) -- Restated Certificate of Incorporation of Registrant.
3.2(2) -- Bylaws of Registrant.
4.1(2) -- Second Amended and Restated Preferred Shares Rights
Agreement, dated as of August 21, 2000 between
Cyberonics, Inc. and First National Bank of Boston, --
including the Certificate of Designation, the form of
Rights -- Certificate and the Summary of Rights attached
thereto as -- Exhibit A, B and C, respectively.
10.2(7)* -- Amended 1991 Employee Stock Purchase Plan.
10.3(1) -- License Agreement dated March 15, 1988 between the
Registrant and Dr. Jacob Zabara.
10.4(1) -- Patent License Agreement effective as of July 28, 1989
between the Registrant and Huntington Medical Research
Institute.
10.5(3) -- Lease Agreement dated November 3, 1994 together with
amendments dated April 18, 1996 and April 30, 1997,
respectively, between the Registrant and Salitex II, Ltd.
10.6(1) -- Form of Indemnification Agreement.
10.7(1) -- Amended and Restated Stockholders Agreement dated October
16, 1992.
10.8(4) -- Registration Rights Agreement dated March 28, 1997.
10.9(5)* -- Amended and Restated 1996 Stock Option Plan.
10.10(3) -- Stockholders' Agreement dated April 8, 1996 between the
Registrant and St. Jude Medical, Inc.
10.11(3) -- Letter Agreement dated March 28, 1997 between the Clark
Estates and the Registrant.
10.12(3) -- Lease Agreement dated August 19, 1997 between the
Registrant and Space Assets II, Inc.
10.13(6)* -- 1997 Stock Plan.
10.14(8) -- 1998 Stock Option Plan.
21.1(3) -- List of Subsidiaries of the Registrant.
23.1 -- Consent of Independent Public Accountants.
27 -- Financial Data Schedule.
</TABLE>
---------------
(1) Incorporated by reference to Registrant's Registration Statement on Form S-1
(Reg. No. 33-45118) declared effective February 10, 1993.
(2) Incorporated by reference to Registrant's Report on Form 8-K filed on
September 11, 2000.
(3) Incorporated by reference to Registrant's Annual Report on Form 10-K for the
year ended June 30, 1997.
(4) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1997.
(5) Incorporated by reference to Registrant's Registration Statement on Form S-8
(Reg. No. 333-19785) filed on April 29, 1998.
(6) Incorporated by reference to Registrant's Report on Form 14A filed on
November 26, 1997.
(7) Incorporated by reference to the Registrant's Registration Statement on Form
S-8 (Reg. No. 333-66689) filed on November 3, 1998.
<PAGE> 62
(8) Incorporated by reference to the Registrant's Registration Statement on Form
S-8 (Reg. No. 333-66691) filed on November 3, 1998.
* Document indicated is a compensatory plan.
