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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 PERIOD ENDED: APRIL 27, 2001
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM JULY 1, 2000 TO APRIL 27, 2001
COMMISSION FILE NUMBER 0-19806
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CYBERONICS, INC.
(Exact name of Registrant as Specified in its Charter)
DELAWARE 76-0236465
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
16511 SPACE CENTER BLVD., 77058-2072
CYBERONICS BUILDING, (zip code)
HOUSTON, TEXAS
(address of principal executive offices)
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 10 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 June 30, 2001, was, based upon the last sales price reported
for such date on the Nasdaq National Market, approximately $251 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 June 30, 2001, registrant had outstanding 21,608,103 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
No documents are incorporated by reference herein.
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TABLE OF CONTENTS
PART I ............................................................ 1
ITEM 1. BUSINESS.................................................... 1
ITEM 2. PROPERTIES.................................................. 18
ITEM 3. LEGAL PROCEEDINGS........................................... 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 18
PART II ............................................................ 18
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS......................................... 18
ITEM 6. SELECTED FINANCIAL DATA..................................... 20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... 20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.................................... 28
PART III ............................................................ 28
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 28
ITEM 11. EXECUTIVE COMPENSATION...................................... 32
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................. 35
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 36
PART IV ............................................................ 37
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K......................................................... 37
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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.
We operate our business in three business units, which include the Epilepsy
Business Unit, the Depression Business Unit and the Other 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 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 demand by
satisfying Medical Doctors' patient care, ease of use and practice
economics needs,
- 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
limited efficacy and high cost of alternative treatments,
- expand the clinical study of the NCP System for the treatment of
depression and
- continue the preliminary evaluation of VNS in new indications as
warranted by our extensive patent portfolio, research and studies and
market dynamics.
In March 2001, we elected to change our fiscal year from June 30 to a 52/53
week year ending on the last Friday in April of each year, effective April 27,
2001. Accordingly, fiscal 2001 started July 1, 2000 and ended April 27, 2001.
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 FDA, on July 16,
1997 as an adjunctive therapy for reducing the frequency of seizures in
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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 or seizure type. We have completed a total of
seven clinical studies, including five controlled acute phase studies involving
over 450 patients, a long-term multi-year follow-up study involving 243 patients
and a mortality study. To date, over 12,500 patients with epilepsy have
accumulated in excess of 23,000 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. 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.
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 12,500 patients have accumulated in excess
of 23,000 patient years of treatment experience with the NCP System. On July 16,
1997, the NCP System was approved by 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 May 31, 2001, the
registry included data on over 4,750 patients of which almost 2,900 patients
were at 3-months follow-up and over 1,600 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 7% 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, 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 and 90 minutes, 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.
DEPRESSION
The Depression Business Unit is conducting clinical studies of the NCP
System for the treatment of depression in patients with unipolar and bipolar
depressive disorder. In July 1999, FDA granted expedited review status for a
future premarket approval application (PMA) 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. The study protocol
included 30 patients treated for three months with subsequent long-term
follow-up. In September 1999, FDA granted approval for expansion of the pilot
clinical study, increasing the number of implanted patients from 30 to 60. The
60 patient pilot study was completed in fiscal 2001. In September 1999, 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 implanted patients. We subsequently received unconditional FDA approval for a
revised final protocol to include up to 20 institutions and 210 implanted
patients. In June 2001, FDA approved an expansion of the depression pivotal
study to include up to an additional 30 implanted patients. Enrollment in the US
pivotal study, including the additional 30 patients, was completed by June 30,
2001. We expect to complete and unblind the depression pivotal study by March,
2002. If the data are positive we anticipate submitting the depression study PMA
by June 30, 2002 to FDA for their review.
In March 2001, the NCP System was approved by N.V. KEMA, an official
notified body representing the European Union Countries, for the treatment of
chronic or recurrent depression in patients that are in a treatment-resistant or
treatment-intolerant depressive episode. This CE Mark approval, by definition,
includes the treatment of depression in patients with depressive disorder, or
so-called unipolar depression, as well as patients with bipolar disorder, or
manic depression. In April, 2001, the NCP System was approved by Health Canada
for the treatment of chronic or recurrent depression in patients that are in a
treatment-resistant or treatment intolerant depressive episode. The Canadian
approval is similar to CE Mark European approval in that depressed patients with
unipolar depression and bipolar depression are included.
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.
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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.
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 light therapy, and
rarely, surgery.
The Cyberonics Solution
VNS using the NCP System for depression, as approved in European Union
Countries and Canada and under current clinical investigation in the U.S., is
very similar to VNS 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 June 30,
2001, our 21 center, up to 240 implanted patient pivotal clinical study of VNS
in the treatment of depression is underway and enrollment of all patients is
complete. We expect to expend considerable resources completing the pivotal
study, obtaining appropriate regulatory approvals, and following receipt of
appropriate approvals, launching the NCP System as a treatment for patients with
depression during fiscal 2002 and beyond.
Although VNS using the NCP System has been approved in European Union
Countries and Canada for the treatment of chronic or recurrent depression, we do
not anticipate significant sales volumes in these countries until reimbursement
approvals have been received. We cannot be certain when or if such reimbursement
will be obtained or whether the levels of reimbursement, if received, will be
sufficient to enable us to sell the NCP System on a profitable basis.
The clinical study of VNS for the treatment of depression in the U.S. is an
investigational study subject to clinical outcome and significant regulatory
restrictions. While we are encouraged by pilot study results to date, we can
provide you no assurance as to the ultimate approval outcome of VNS for the
treatment of depression in the U.S. 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.
OTHER INDICATIONS
The Other 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 Other 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, Alzheimer's Disease, and anxiety
disorders as well as studies planned for other disorders covered by our patent
portfolio. In August 2000, 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 were 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
April 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 left neck VNS in up to 10 implanted patients with a
study protocol of three months
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in the acute study and long-term follow-up. As of June 30, 2001, all patients in
the Alzheimer's Disease study have been implanted. In December 2000, FDA granted
Cyberonics an unconditional IDE for a pilot study of VNS with the NCP System in
treating patients with Obsessive-Compulsive Disorder (OCD), Panic Disorder (PD)
and adult onset Post-Traumatic Stress Disorder (PTSD), three of the five types
of anxiety disorders. Up to 30 patients at four sites will be implanted with the
NCP System and stimulated with left cervical VNS.
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 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 lose 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. Two newer agents have been
approved by FDA, Meridia (Sibutramine) and Xenical (Orlistat). Meridia is a
centrally acting agent that increases the concentration of serotonin and
norepinephrine. 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
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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 was recently approved by FDA for the treatment of obesity
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
diaphragmatic VNS, where the patient's left and right vagus nerves are
stimulated just above or just below the diaphragm. 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 employed. In August 2000, 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. As of
June 30, 2001, three U.S. study sites have been initiated and two sites have
implanted six patients 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.
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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 AD 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. Based on the Cyberonics VNS
Patient Outcome Registery approximately one fourth of epilepsy patients treated
for three months with VNS and approximately one third of those patients treated
for one year report that their memory was better or much better after VNS. 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 April 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 June 30,
2001, the pilot study has been initiated, one site has been approved and all 10
patients have been implanted.
Anxiety Disorders Overview
Anxiety disorders are a major public health problem. According to the World
Health Organization and the United States National Institutes of Mental Health
(NIMH), anxiety disorders are the most common of all mental illnesses, affecting
approximately 400 million people worldwide at any one time. Up to 40 million
people in the United States suffer from anxiety disorders. About 20 million
people in the U.S. suffer specifically from OCD, PD and PTSD. Over 1 million
Americans suffer from treatment-resistant anxiety. While each anxiety disorder
has its own distinct features and symptoms, they all have in common excessive
and irrational fear and dread. The majority of patients see no improvement at
all or continue to exhibit at least some symptoms such as panic attacks,
obsessive thoughts, flashbacks, nightmares and countless physical symptoms that
interfere with everyday life. Severe anxiety disorders are associated with a
high prevalence of alcohol and substance abuse, vocational dysfunction,
financial dependence, disability, and excessive use of medical facilities. Major
depression is a common co-morbidity in patients with OCD, PD and PTSD. Recent
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studies suggest that 50% of patients with PTSD, 67% of patients with OCD and 50%
to 65% of patients with PD also suffer from major depression in their lifetimes.
The estimated cost of anxiety disorders in the United States alone exceeds
$40 billion dollars per year, which includes $23.0 billion in non-psychiatric
medical treatment costs, $13.3 billion in psychiatric treatment costs and $4.1
billion in indirect workplace costs. The U.S. market for anxiolytics, the drugs
used to treat various anxiety disorders, is estimated to exceed $1.5 billion per
year. Anxiety has evolved as a vitally important physiological response to
dangerous situations. However, the mechanisms that regulate anxiety may break
down in a wide variety of circumstances, leading to excessive or inappropriate
expression of anxiety. Specific examples include phobias, panic attacks and
generalized anxiety. In addition to these common manifestations of anxiety, OCD
and PTSD are also classified as anxiety disorders. In OCD, patients experience a
high level of anxiety related to their obsessional or compulsive behaviors. When
such an individual fails to carry out repetitive behavior such as hand-washing
or checking, they experience severe anxiety. The five principal anxiety
disorders recognized today are panic disorder (PD), social phobia (SP, also
referred to as social anxiety disorder (SAD), obsessive-compulsive disorder
(OCD), generalized anxiety disorder (GAD), and post-traumatic stress disorder
(PTSD).
For a patient to receive a diagnosis of an anxiety disorder, specific
diagnostic criteria must be met for a particular anxiety disorder. For example,
the diagnosis of OCD requires obsessions or compulsions that have been
recognized by the patient and that cause marked distress, are time consuming, or
significantly interfere with the person's normal routine, occupational (or
academic) functioning, or usual social activities or relationships. These
obsessions or compulsions cannot be caused by a drug, medication or a general
medical condition.
Despite the availability of acutely effective treatments for anxiety
disorders, only a minority of patients experience complete sustained remissions
and the majority remain at least somewhat symptomatic or improve not at all. In
other words, there is a need for a more effective and tolerable long-term or
maintenance treatment for anxiety disorders. In extreme cases of OCD and chronic
anxiety states, psychosurgery is used as a last resort treatment, but this
irreversible treatment is hampered by risks of personality changes, epilepsy,
ethical concerns, societal acceptance, and the availability of this treatment.
The persistent distress and morbidity associated with the anxiety disorders
underscores the importance of developing additional treatment interventions,
particularly for those patients with symptoms resistant to standard
interventions.
The Cyberonics Solution
VNS is now being investigated as a treatment option for depression, a
common co-morbidity in anxiety disorders. SSRIs, one of the common treatments
for depression, are also commonly used to treat anxiety disorders. The idea of
using the NCP System as a treatment for anxiety disorders was initially based on
subjective observations from epilepsy clinical studies, functional brain imaging
studies in epilepsy patients and animals showing VNS modulation of brain regions
involved in regulating mood and anxiety, neurochemical analyses from both
clinical and animal studies, and the results of a pilot study of VNS in patients
with depression. The use of VNS as an anticonvulsant, as well as the positive
results of a preliminary study of VNS in depression, provide the rationale for
this study. In the pilot work in depression, equally significant anti-anxiety
effects were observed along with improvements in depression. Given the
successful use of anticonvulsants and antidepressants in the treatment of
anxiety disorders and the demonstration of VNS as an anticonvulsant and
preliminarily as an antidepressant, the study of VNS in a treatment-resistant
population of patients with anxiety disorders was initiated.
In December 2000, FDA granted Cyberonics an unconditional IDE for pilot
study of left cervical VNS with the NCP System in treating patients with the
anxiety disorders of OCD, PD and PTSD. In early 2001, the first study center was
initiated and the first patient was implanted in this pilot study. The study is
designed to be a 4-center, up to 30 implanted patient open-label pilot study. We
expect to complete the acute portion of the pilot study in fiscal year 2003.
We expect to expend considerable resources completing the pilot studies for
obesity, AD, anxiety disorders and other indications development research. We
cannot assure you that the clinical outcome of these
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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 to
90 minutes, 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. The NCP Pulse Generator is an implantable,
programmable, cardiac pacemaker-like signal generator 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
nine years 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. Cyberonics manufactures the NCP
Model 101 Pulse Generator. The Company's first generation pulse generator, the
Model 100, was discontinued in June 2001.
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.
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Tunneling Tool. The tunneling tool is a single use sterile, 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 $15,000 and $35,000. The current list price
for the NCP System is approximately $11,950.
MANUFACTURING AND SOURCES OF SUPPLY
Our manufacturing operations are required to comply with 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 product
design, 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
respectively 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 and battery
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.
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 sell and market our products through a direct sales
force in the United States. As of June 30, 2001, our U.S. sales and marketing
organization consisted of 107 full time employees. 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
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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 approximately $250,000 in product cost to the program on an annual basis.
Through June 2001, we have donated approximately $50,000 in product costs
towards this program.
International. We market and sell our products through a combination of a
direct sales force in certain European countries and distributors elsewhere. As
of June 30, 2001, our international sales and marketing organization consisted
of 14 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 June
30, 2001, 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 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.
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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 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 42 state Medicaid programs
encompassing 95% of the Medicaid patient population 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 believe that significant sales volume will be difficult to generate
without appropriate reimbursement approvals. Although VNS using the NCP System
has been approved for commercial distribution in European Union Countries and
Canada for the treatment of chronic or recurrent depression, we do not
anticipate significant sales volumes in these countries until reimbursement
approvals have been received. We are continuing to pursue appropriate
reimbursement approvals in these countries. We cannot be certain when or if such
reimbursement will be obtained or whether the levels of reimbursement, if
received, 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 while improving cost effectiveness. Product development programs
that are underway include ongoing improvements to the NCP Pulse Generator and
Bipolar Lead. 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
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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 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 give us
coverage through 2011. 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 disorders 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 entered into an exclusive license agreement with Mitchell Roslin, M.D.
on a patent application 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.
In addition to these license agreements, as of June 30, 2001, we had
approximately 30 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 including obesity, endocrine disorders, migraine
headaches, dementia, neuropsychiatric disorders, including
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depression and anxiety disorders, motility disorders, sleep disorders, coma,
chronic pain, cardiac disorders and hypertension. We have filed counterparts of
certain of our key United States patent applications in certain key
international jurisdictions.
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 cannot 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, anxiety
disorders, obesity, 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 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 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. 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, FDA granted Expedited Review status for a future premarket
approval application for our NCP System for the treatment of 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 depression.
The study protocol included 30 patients
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treated for three months with long-term follow up. In September 1999, 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. The 60 patient pilot study was completed in fiscal year 2001. In October
1999, 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. In June 2001, FDA approved an expansion of the depression
pivotal study to include up to an additional 30 implanted patients. Enrollment
in the U.S. pivotal study including the 30 additional patients was completed by
June 30, 2001. We expect to complete and unblind the depression pivotal study by
March 2002. If the data is positive, we anticipate submitting the depression
study PMA supplement by June 30, 2002 to FDA for Expedited Review.
In June 2000, FDA approved an 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 were implanted and treated at two sites. 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 April 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 to implant up to 10 patients under a study
protocol of three months study with long-term follow up. As of June 2001, all 10
patients in the AD study have been implanted.
In December 2000, FDA granted Cyberonics an unconditional IDE for a pilot
study of VNS with the NCP System in treating patients with Obsessive-Compulsive
Disorder (OCD), Panic Disorder (PD) and adult onset Post-Traumatic Stress
Disorder (PTSD), three of the five types of anxiety disorders. Up to 30 patients
at four sites will be implanted with the NCP System and stimulated with left
cervical VNS.
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, 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 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 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 FDA and state agencies and to list our products with FDA. Our
facilities are subject to inspection on a routine basis by FDA for compliance
with 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. We
received a joint inspection by FDA and the Texas Department of Health (TDH) in
January 2001 which yielded inspectional observations resulting in Warning
Letters being issued to the Company by FDA and TDH. These Warning Letters were
issued on March 23, 2001 and March 9, 2001 respectively, for not fully complying
with the Medical Device Reporting Regulation, 21CFR 803 and associated
corrective preventive action as required under the Quality System Regulation,
21CFR 820.100. We
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voluntarily provided a written response, dated February 22, 2001, which detailed
our corrective action plan to both FDA and TDH before either Warning Letters
were issued. Both FDA and TDH Warning Letters, issued subsequent to the
Cyberonics voluntary response, formally acknowledged receipt of the Cyberonics
response and that the corrective action plan was adequate.
New regulations governing such matters as device tracking and post-market
surveillance also apply to the NCP System. 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.
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 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 for epilepsy and depression, 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 June 30, 2001, we had 310 full-time employees, including 20 in
engineering and product development, 66 in clinical and regulatory affairs, 68
in manufacturing and quality assurance, 107 in sales and marketing and 49 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.
FINANCIAL INFORMATION WITH GEOGRAPHIC AREAS
A discussion of our financial information about geographic areas is
described in note 15 to the financial statements attached hereto.
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
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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.
ITEM 2. PROPERTIES
We lease approximately 77,000 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 2010. We believe that these
leased facilities will be adequate to meet our needs at least through April 30,
2002.
ITEM 3. LEGAL PROCEEDINGS
We recently entered into a Release and Settlement Agreement (Settlement
Agreement) with Hi-Tronics Design, Inc. (Hi-Tronics) to settle fully all claims
and differences between us. While the terms of the Settlement Agreement are
confidential, the amount of the settlement did not have a material adverse
affect on our financial condition or results of operation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to security holders during the fourth quarter of
fiscal 2001. Results of the votes taken in connection with our annual meeting of
stockholders held on December 29, 2000 were included in our form 10-Q for the
quarterly period ended December 31, 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 2000 and
2001 are set forth below. Price data reflect actual transactions, but do not
reflect mark-ups, mark-downs or commissions.
HIGH LOW
------ ------
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
FISCAL YEAR ENDED APRIL 27, 2001
First Quarter............................................... $29.69 $11.94
Second Quarter.............................................. 25.13 16.50
Third Quarter............................................... 23.63 13.38
Fourth Quarter.............................................. 16.58 11.30
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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.
As of June 30, 2001, there were 323 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.
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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 April 27, 2001, and June 30, 2000, and for the ten
months ended April 27, 2001 and for each of the years in the two-year period
ended June 30, 2000, are derived from consolidated financial statements that
have been audited by Arthur Andersen LLP, independent public accountants, except
for the ten months ended April 30, 2000, which are included elsewhere herein.
The selected financial data as of June 30, 1998, and 1997 and for the years
ended June 30, 1998 and 1997 are derived from audited financial statements not
included herein.
TEN MONTHS ENDED
--------------------------- YEAR ENDED JUNE 30,
APRIL 27, APRIL 30, ---------------------------------------------------------
2001 2000 2000 1999 1998 1997
------------- ----------- ------------ ------------ ------------ ------------
(UNAUDITED)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net sales...................... $ 43,418,736 $37,739,474 $ 47,888,733 $ 29,927,476 $ 14,912,868 $ 1,372,005
Cost of sales.................. 11,806,353 9,301,092 11,833,507 7,736,137 3,902,468 372,180
------------- ----------- ------------ ------------ ------------ ------------
Gross profit................... 31,612,383 28,438,382 36,055,226 22,191,339 11,010,400 999,825
Operating expenses:
Selling, general and
administrative............. 33,571,072 27,013,684 33,269,266 29,585,570 19,781,268 5,933,852
Research and development..... 17,201,179 5,823,456 8,037,096 6,724,106 7,391,426 6,549,474
Non-recurring charges........ 6,467,415 -- -- -- -- --
------------- ----------- ------------ ------------ ------------ ------------
Total operating
expenses............. 57,239,666 32,837,140 41,306,362 36,309,676 27,172,694 12,483,326
Interest income................ 1,141,939 1,078,598 1,364,985 1,465,549 1,976,792 436,813
Interest expense............... 65,331 330 3,349 -- -- --
Other income (expense), net.... (147,058) (154,408) (44,894) 115,236 10,790 (198,143)
------------- ----------- ------------ ------------ ------------ ------------
Net loss before cumulative
effect of a change in
accounting
principle.................... $ (24,697,733) $(3,474,898) $ (3,934,394) $(12,537,552) $(14,174,712) $(11,244,831)
Cumulative effect on prior
years (to June 30, 1999) of
changing to a different
method of
depreciation................. -- 881,150 881,150 -- -- --
------------- ----------- ------------ ------------ ------------ ------------
Net loss............... $ (24,697,733) $(2,593,748) $ (3,053,244) $(12,537,552) $(14,174,712) $(11,244,831)
------------- ----------- ------------ ------------ ------------ ------------
Basic and diluted net
loss per share....... $ (1.27) $ (0.14) $ (0.17) $ (0.72) $ (0.88) $ (0.93)
============= =========== ============ ============ ============ ============
Shares used in computing basic
and diluted net loss per
share........................ 19,382,460 17,929,439 18,044,692 17,503,169 16,104,922 12,030,171
============= =========== ============ ============ ============ ============
CONSOLIDATED BALANCE SHEET DATA
(AS OF YEAR END):
Cash, cash equivalents and
marketable securities........ $ 57,250,907 $ 20,537,450 $ 24,858,123 $ 38,037,343 $ 8,123,456
Working capital................ 51,131,639 30,881,340 25,975,079 39,246,128 7,763,480
Total assets................... 78,314,924 44,498,435 39,783,153 52,615,294 10,249,737
Accumulated deficit............ (103,630,243) (78,932,510) (75,879,266) (63,341,714) (49,167,002)
Common stockholders' equity.... $ 59,647,084 $ 38,407,975 $ 33,448,445 $ 44,698,719 $ 8,421,472
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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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 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 resistant 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.
In March 2001, the NCP System was approved by N.V. KEMA, an official
notified body representing the European Union Countries, for the treatment of
chronic or recurrent depression in patients that are in a treatment-resistant or
treatment-intolerant major depressive episode. This CE Mark approval, by
definition includes the treatment of depression in patients with major
depressive disorder, or so-called unipolar depression, as well as patients with
bipolar disorder, or manic depression. In April, 2001, the NCP System was
approved by Health Canada for the treatment of chronic or recurrent depression
in patients that are in a treatment-resistant or treatment-intolerant major
depressive episode. The Canadian approval is similar to CE Mark European
approval in that patients with unipolar depression and bipolar depression are
included.
From inception through July 1997, our primary focus was on obtaining FDA
approval for the NCP System for the treatment of epilepsy. 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 costs. 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, most notably depression. We expect to remain unprofitable through
at least fiscal 2003 as we continue our efforts to develop vagus nerve
stimulation for new indications, including depression, obesity, AD, anxiety and
other disorders covered by our proprietary patent portfolio.
In March 2001, we elected to change our fiscal year from June 30 to a 52/53
week year ending on the last Friday in April of each year, effective April 27,
2001. Accordingly, fiscal 2001 started July 1, 2000 and ended April 27, 2001.
For the period from inception through April 27, 2001, we incurred a
cumulative net deficit of approximately $103.6 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.
RESULTS OF OPERATIONS
Net Sales. Net sales for the ten months ended April 27, 2001, totaled
$43.4 million, compared to sales of $37.7 million for the ten months ended April
30, 2000, or an increase of 15%. This increase is due to a combination of volume
and product mix. Sales for the twelve months ended June 30, 2000 were $47.9
million, as compared to $29.9 million for the twelve months ended June 30, 1999.
International sales were $4.4 million for the ten months ended April 27, 2001,
as compared to sales of $3.9 million for the ten months ended April 30, 2000, or
an increase of 13%. International sales for the twelve months ended June 30,
2000 were $5.4 million, as compared to $3.6 million for the twelve months ended
June 30, 1999. U.S. sales were $39.0 million for the ten months ended April 27,
2001, as compared to $33.8 million for the ten months ended
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April 30, 2000, or an increase of 15%. U.S. sales were $42.5 million for the
twelve months ended June 30, 2000, as compared to $26.3 million for the twelve
months ended June 30, 1999.
Substantially all sales for the year ended April 27, 2001, and the years
ended June 30, 2000 and 1999 were for epilepsy product sales.
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 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 cost, royalties, and the
acquisition cost of raw materials and components. Our gross margin was 72.8% for
the ten months ended April 27, 2001, as compared to 75.4% for the ten months
ended April 30, 2000. The gross margin for the twelve months ended June 30, 2000
and 1999, was 75.3% and 74.2% respectively. Gross margin decreased in fiscal
2001 due to $1.8 million in obsolescence costs. In February 2000, the Model 101
was introduced and immediately gained acceptance with payors, patients and
physicians, causing an unanticipated product preference shift away from the
Model 100. As a result of the change in demand, existing inventories of the
Model 100 were deemed obsolete and written off in fiscal 2001. Without the
additional obsolescence charges, the gross margin for the ten months ended April
27, 2001 would have been 77.0%, or an increase of 1.6% over the ten months ended
April 30, 2000. We are obligated to pay royalties at a rate of 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 selling price, applicable royalty rates, and
the levels of production volume.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $33.6 million or 77.3% of sales for the ten months
ended April 27, 2001, as compared to $27.0 million or 71.6% of sales for the ten
months ended April 2000. The increase is primarily due to the additional
expenses associated with the expansion of the sales force in late fiscal 2000
and other increases in personnel to support overall infrastructure and business
system improvements. Selling, general and administrative expenses were $33.3
million or 69.5% of sales for the twelve months ended June 30, 2000 and $29.6
million or 98.9% of sales for the twelve months ended June 30, 1999. We expect a
significant increase in selling, general and administrative expenses during the
fiscal year 2002, largely associated with pre-launch marketing programs for
Depression.
In fiscal 2001, we incurred certain direct administrative expenses in each
Indication Business Unit and we began allocating certain administrative expenses
to Indications Business Units based upon estimated resource utilization.
Selling, general and administrative expenses in the Epilepsy Business Unit for
the ten months ended April 27, 2001 were $29.1 million, compared to $27.0
million for the ten months ended April 30, 2000. Selling, general and
administrative expenses in the Depression Business Unit for the ten months ended
April 27, 2001 were $3.5 million, compared to no expenses for the ten months
ended April 30, 2000. Selling, general and administrative expenses in the Other
Indications Business Unit for the ten months ended April 27, 2001 were $1.0
million, compared to no expenses for the ten months ended April 30, 2000.
Research and Development Expenses. Research and development expenses are
comprised of expenses related to our product and process development, product
design efforts, clinical trials programs and regulatory activities. Research and
development expenses were $17.2 million, or 39.6% of sales for the ten months
ended April 27, 2001, compared to $5.8 million, or 15.4% of sales for the ten
months ended April 30, 2000. The increase is due to the additional costs
associated with the Depression pivotal study and other new indication pilot
studies. Research and development expenses were $8.0 million for the twelve
months ended June 30, 2000 and $6.7 million for the twelve months ended June 30,
1999.
Research and development expenses for the Epilepsy Business Unit during the
ten months ended April 27, 2001, were $4.7 million, compared to $4.5 million for
the ten months ended April 30, 2000. The
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research and development expenses for the Epilepsy Business Unit were $5.8
million for the twelve months ended June 30, 2000 and $5.3 million for the
twelve months ended June 30, 1999.
Research and development expenses for the Depression Business Unit for the
ten months ended April 27, 2001, were $10.8 million, compared to $1.1 million
for the ten months ended April 30, 2000. The increase is primarily due to the
additional costs associated with the completion of the pilot study and the
launch of the up to 240 patient pivotal study. The research and development
expenses for the Depression Business Unit were $1.9 million for the twelve
months ended June 30, 2000 and $0.8 million for the twelve months ended June 30,
1999.
Research and development expenses for the Other Indications Business Unit
for the ten months ended April 27, 2001, were $1.7 million, as compared to $0.2
million for the ten months ended April 30, 2000. The increase is the result of
ongoing clinical pilot study programs evaluating other applications for VNS,
including obesity, Alzheimer's disease, anxiety, and other indications supported
by our proprietary patent portfolio. The research and development expenses for
the Obesity and Other Indications Business Unit were $0.35 million for the
twelve months ended June 30, 2000 and $0.57 million for the twelve months ended
June 30, 1999.
Non-recurring Charges. Non-recurring charges were $6.5 million for the ten
months ended April 27, 2001. On September 11, 2000, Medtronic, Inc.
("Medtronic") publicly announced a proposal to acquire the Company 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 its patent protected business
opportunities. On September 28, 2000, Medtronic announced that it had withdrawn
its offer. The Company incurred non-recurring charges of $6.5 million which
includes investment banking fees to Morgan Stanley Dean Witter of $6.0 million.
The Company also incurred legal, accounting and consulting fees of approximately
$350,000 and other related costs of $117,000.
Interest Income. Interest income totaled $1.1 million during the ten
months ended April 27, 2001, compared to $1.1 million for the ten months ended
April 30, 2000. Interest income totaled $1.4 million for the twelve months ended
June 30, 2000, compared to $1.5 million for the twelve months ended June 30,
1999. We expect interest and other income to gradually decrease in absolute
dollars in future periods, as we utilize our resources to fund future working
capital requirements.
Interest Expense. Interest expense was $65,000 for the ten months ended
April 27, 2000, as compared to $330 for the ten months ended April 30, 2000.
Interest expense was $3,300 for the twelve months ended June 30, 2000, with no
interest expense to report in prior periods. Interest expense is associated with
capital leases in manufacturing equipment which bears interest at 6.56% over a
term of five years.
Other Income (Expense), Net. Other income (expense), net, totaled
($147,000) during the ten months ended April 27, 2001, compared to ($154,000)
during the ten months ended April 30, 2000. Other income (expense) net, totaled
($44,900) for the twelve months ended June 30, 2000, compared to $115,000 for
the twelve months ended June 30, 1999. In all reported periods, 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 fluctuations in currency exchange rates.
Income Taxes. At April 27, 2001, we had operating loss carryforwards for
federal income tax purposes of approximately $97.6 million.
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.
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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 the ten months ended April 27, 2001, we used approximately $5.1
million of cash from operating activities. Accounts receivable and inventories
decreased from $8.3 million and $6.6 million respectively in June 2000 to $6.6
million and $4.3 million respectively in April 2001. We also used approximately
$3.6 million to purchase capital equipment to expand manufacturing and business
system capabilities. We received approximately $3.0 million in proceeds from the
exercise of stock options held by our employees. During the ten months ended
April 27, 2001, we raised approximately $42.5 million from the sale of Common
Stock in a private equity offering.
During the twelve months ended June 30, 2000, we used approximately $8.2
million of cash from operating activities. Accounts receivable and inventories
increased from $5.4 million and $5.2 million respectively, in June 1999, to $8.3
million and $6.6 million respectively in June 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
approximately $8.1 million and $1.4 million during the twelve months ended June
30, 2000 and 1999 in proceeds from the exercise of stock options held by our
employees. Our liquidity will continue to be reduced as amounts are expensed to
support 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 2002, primarily to expand manufacturing capabilities, and
to enhance business infrastructure and facilities.
We believe that our current resources will be sufficient to fund our
operations at least through April 30, 2003, although there can be no assurance
of this as this estimate is based on a number of assumptions, which may not hold
true. The availability of financing either before or after that time will depend
upon a number of important factors, including the state of the United States
capital markets and economy in general and the health care and medical device
segments in particular, the status of our 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 8 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 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 fiscal 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 depression in patients with unipolar and bipolar depressive
disorder. We do not yet have the regulatory or reimbursement 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
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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,
anxiety disorders 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 12,500 patients through June 30, 2001, 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, anxiety 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, anxiety 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
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 or maintain 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-
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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 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
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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.
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 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 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
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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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily
to our short-term investments in United States Government obligations and our
fixed rate long-term debt. Short-term investments are classified as held to
maturity and are carried at amortized costs. We do not hedge interest rate
exposure or invest in derivative securities.
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-19 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and directors, their ages as of June 30, 2001, and
certain additional information about them, are as follows:
NAME AGE POSITION
- ---- --- --------
Robert P. Cummins..................... 47 Chairman of the Board of Directors,
President and Chief Executive
Officer and Director
Pamela B. Westbrook................... 43 Vice President, Finance and
Administration, Chief Financial
Officer and Secretary
Shawn P. Lunney....................... 38 Vice President, Market Development
Richard P. Kuntz...................... 50 Vice President, Operations
Alan D. Totah......................... 57 Vice President, Regulatory Affairs
Leonard G. Milke...................... 53 Vice President, Marketing
Burke T. Barrett...................... 37 Vice President, Business and
Technology Development
Reese S. Terry, Jr. .................. 58 Director
Stanley H. Appel, M.D. ............... 67 Director
Tony Coelho........................... 59 Director
Thomas A. Duerden, Ph.D. ............. 71 Director
Michael J. Strauss, M.D. ............. 48 Director
Alan J. Olsen......................... 53 Director
Ronald A. Matricaria.................. 58 Director
Mr. Cummins became a director of Cyberonics in June 1988. He was appointed
President and Chief Executive Officer of Cyberonics in September 1995. He was
appointed Chairman of the Board of Cyberonics in June 2001. 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.
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Ms. Westbrook joined Cyberonics as Vice President, Finance and
Administration and Chief Financial Officer in October 1998. She was appointed
Secretary of Cyberonics in June 2001. Ms. Westbrook has over 20 years in
financial management experience and over 14 years in medical device industry
experience. 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. 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. He is currently serving as Vice President of Market
Development. 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. 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
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.
Mr. Totah joined Cyberonics as Vice President, Regulatory Affairs. Mr.
Totah is a Certified Regulatory Affairs Professional and has over 30 years of
medical industry regulatory affairs, quality control and quality assurance
management experience including 20 years in cardiac rhythm management and
regulatory affairs management at Medtronic and Sulzer Intermedics. Most
recently, Mr. Totah was Senior Regulatory Manager, Heart Failure and Low Power
Leads at Medtronic Inc. Prior to that, he spent 18 years at Sulzer Intermedics,
most recently as Director, Regulatory Affairs.
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. Barrett joined Cyberonics in December 1997 as Director, Technology
Development. In June 2001, he was promoted to Vice President, Business and
Technology Development. Mr. Barrett has fifteen years of experience in business
development, regulatory and clinical affairs. Prior to joining Cyberonics, Mr.
Barrett was Director, Business Development/Regulatory and Clinical Affairs for
Biofield Corp, a medical technology company engaged in breast cancer diagnosis
research and development. Prior to that, Mr. Barrett was Director, Regulatory
and Clinical Affairs with Dornier Medical Systems, Inc., a global medical device
and services organization. He previously held positions in regulatory and
clinical affairs with Bausch & Lomb, Inc.
Mr. Terry co-founded Cyberonics in December 1987 and served as Chairman of
the Board and Chief Executive Officer of Cyberonics until February 1990, when he
became Chairman of the Board and Executive Vice President. He also served as
Chief Executive Officer several months in 1995. Mr. Terry resigned from his
position as Executive Vice President in February 2000 and from his position as
Chairman of the Board and Secretary in June 2001. 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.
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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 Service Corporation
International, a funeral service corporation, Warren Resources, an oil and gas
exploration company, and Mango Soft Inc., a software company.
Dr. Duerden has been a director of Cyberonics since March 1989 and an
independent business consultant since January 1990. From 1997 to 1999, Dr.
Duerden was a director of PathSource, a privately held company which
consolidated 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.
Mr. Matricaria joined the Board of Directors in June, 2001. He has over
thirty years of medical device and pharmaceutical experience at St. Jude
Medical, Inc. and Eli Lilly and Company, Inc. In April 1993, he was named
President and CEO of St. Jude Medical, Inc. and was elected Chairman of the
Board of Directors in January 1995. Prior to joining St. Jude Medical, Mr.
Matricaria spent 23 years with Eli Lilly and Company, Inc. His last position was
Executive Vice President of the Pharmaceutical Division of Eli Lilly and Company
and president of its North American operations. He also served as President of
Eli Lilly International Corporation since July 1991. In addition to the
Cyberonics Board of Directors, Mr. Matricaria also serves as Chairman of the
Board of Directors for St. Jude Medical and is an advisor or board member to
several medically related privately owned companies and a private equity
healthcare fund.
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.
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BOARD MEETINGS AND COMMITTEES
Our Board of Directors held a total of fifteen meetings and acted by
written consent two times during the fiscal period ended April 27, 2001. 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 five meetings during the fiscal period ended
April 27, 2001. 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 four meetings and acted by written consent 38 times during the
fiscal period ended April 27, 2001. This Committee establishes salary and
incentive compensation of our executive officers and administers employee
benefit plans.
During the fiscal period ended April 27, 2001, 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 Dr.
Appel who attended eleven meetings of the Board of Directors and all 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.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
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.
For the fiscal period ended April 27, 2001, an initial report on Form 3 for
Alan Totah was filed late. This report reflects that Mr. Totah does not own any
of our stock. To our knowledge, all other Section 16(a) filing requirements
applicable to our officers, directors and ten-percent stockholders were in
compliance with filing requirements.
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ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth the
compensation paid by us for the fiscal period ended April 27, 2001 to the Chief
Executive Officer and each of our other most highly compensated executive
officers whose total compensation exceeded $100,000. These officers are referred
to as the named executive officers:
SECURITIES
UNDERLYING
OPTIONS(#)
------------
LONG-TERM
FISCAL SALARY($) BONUS($) COMPENSATION ALL OTHER
NAME AND PRINCIPAL POSITION YEAR ANNUAL COMPENSATION AWARDS COMPENSATION
- --------------------------- ------ --------- ------------ ------------ ------------
Robert P. Cummins(1)......... 2001 $242,308 $105,000 450,000(2) $ 350(3)
Chairman of the Board 2000 236,538 170,335 100,000 420(3)
President and Chief 1999 200,000 50,000 100,000 420(3)
Executive Officer
Pamela B. Westbrook.......... 2001 $149,423 $ 39,081 -- $ 289(3)
Vice President, Finance & 2000 155,769 40,335 -- 347(3)
Administration, Chief 1999 103,846 33,750 175,000 260(3)
Financial Officer,
Secretary
Shawn P. Lunney.............. 2001 $149,423 $ 32,375 -- $ 289(3)
Vice President, Market 2000 155,769 2,835 -- 347(3)
Development 1999 144,231 87,500(4) 25,000 25,294(3)(5)
Richard P. Kuntz............. 2001 $149,038 $ 42,250 -- $89,304(6)
Vice President, Operations 2000 76,269 32,835 150,000 12,173(7)
Leonard G. Milke............. 2001 $130,904 $ 27,019 -- $69,238(8)
Vice President, Marketing 2000 50,580 3,028 100,000 38,808(9)
- ---------------
(1) Mr. Cummins became an executive officer of Cyberonics in fiscal 1996.
(2) Includes a grant of options to purchase 450,000 shares of our Common Stock
at $18.00 per share dated June 2000, which received stockholder approval at
the annual meeting in December, 2000.
(3) Represents premiums paid for term-life insurance (except as set forth
below).
(4) During fiscal 1999, Mr. Lunney also performed the duties of Sales Area
Director for which he earned an additional bonus of $50,000.
(5) Also includes $25,000 paid to Mr. Lunney for sales awards.
(6) Represents $289 for term life insurance and $89,015 for expenses paid to Mr.
Kuntz associated with relocation to Houston.
(7) Represents $173 for term-life insurance and $12,000 for expenses paid to Mr.
Kuntz associated with relocating to Houston.
(8) Represents $201 for term-life insurance and $69,037 for expenses paid to Mr.
Milke associated with relocating to Houston.
(9) Represents $87 for term-life insurance and $38,721 for expenses paid to Mr.
Milke associated with relocating to Houston.
32
35
Option Grants in Last Fiscal Year. The following table sets forth each
grant of stock options made during the year ended June 30, 2000 to each of the
named executive officers:
INDIVIDUAL GRANTS
----------------------------------------------------- POTENTIAL REALIZABLE VALUE
PERCENT OF AT ASSUMED ANNUAL RATES
NUMBER OF TOTAL OPTIONS OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES IN TERM($)(2)
OPTIONS FISCAL EXERCISE EXPIRATION --------------------------
NAME GRANTED(#) YEAR(1) PRICE($/SH) DATE 5% 10%
- ---- ---------- ------------- ----------- ---------- ----------- ------------
Robert P. Cummins........... 450,000(3) 26% $18.00 6/9/2010 $5,094,046 $12,909,314
Pamela B. Westbrook......... -- -- -- -- -- --
Shawn P. Lunney............. -- -- -- -- -- --
Richard P. Kuntz............ -- -- -- -- -- --
Leonard C. Milke............ -- -- -- -- -- --
- ---------------
(1) Total number of shares subject to options granted to employees in fiscal
2001 was 1,738,000 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) Includes a grant of options to purchase 450,000 shares of our Common Stock
at $18.00 per share dated June 2000 which received stockholder approval at
the annual meeting in December 2000.
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-end
Values. The following table sets forth, for each of the named executive
officers, each officer's exercise of stock options during the fiscal period
ended April 27, 2001 and the year-end value of unexercised options:
NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES VALUE UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED ON REALIZED OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END
NAME EXERCISE(#) ($)(1) EXERCISABLE/UNEXERCISABLE(#)(2) EXERCISABLE/UNEXERCISABLE($)(3)
- ---- ----------- -------- ------------------------------- -------------------------------
Robert P. Cummins(4)....... -- -- 537,288/591,662 $2,069,481/$202,416
Pamela B. Westbrook........ -- -- 67,501/87,499 428,294/555,181
Shawn P. Lunney............ -- -- 168,666/37,084 1,067,868/113,662
Richard P. Kuntz........... -- -- 37,500/112,500 --/--
Leonard G. Milke........... -- -- 21,667/78,333 --/--
- ---------------
(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 ($11.47 per share)
minus the exercise price.
(4) Includes a grant of options to purchase 450,000 shares of our Common Stock
at $18.00 per share dated June 2000 which received stockholder approval at
the annual meeting in December 2000.
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 fiscal period ended April 27, 2001.
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.
33
36
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 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. The increase in annual base
salaries for officers for fiscal 2001 was established by the Board of Directors
in September 2000 and generally reflected increases of 20% over fiscal 2000 and
1999 levels.
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 2001, maximum bonus levels were set at 50% of base salary, compared to
30% for fiscal 2000. Bonus payout is generally tied to a combination of
company-wide and departmental performance goals. Based upon our performance
during fiscal 2001, executive officers were paid an average of 53% of their
potential bonuses.
Stock Option Awards
The Compensation Committee evaluated the grant of stock options in fiscal
2001 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 remained unchanged at an annual base salary
of $300,000. He was awarded a bonus equal to 48% of his base salary, which
represented 48% of the maximum bonus that could be paid.
COMPENSATION COMMITTEE
Stanley H. Appel, M.D.
Tony Coelho
34
37
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 June 30, 2001 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.
SHARES PERCENTAGE OF
BENEFICIALLY OUTSTANDING
NAME OF BENEFICIAL OWNER OWNED(1) SHARES OWNED(1)
- ------------------------ ------------ ---------------
State of Wisconsin Investment Board........................ 2,752,800 12.7%
P.O. Box 7842
Madison, WI 53707
Massachusetts Financial Services Co........................ 1,780,441 8.2%
500 Boylston Street, 15th Floor
Boston, MA 20116
The Clark Estates(2)....................................... 1,344,233 6.2%
One Rockefeller Plaza, 31st Floor
New York, NY 10020
Robert P. Cummins(3)....................................... 703,538 3.2%
Reese S. Terry, Jr.(4)..................................... 621,750 2.9%
Pamela B. Westbrook(5)..................................... 82,881 *
Shawn P. Lunney(6)......................................... 194,017 *
Richard P. Kuntz(7)........................................ 53,833 *
Alan Totah(8).............................................. 10,000 *
Leonard G. Milke(9)........................................ 28,718 *
Burke T. Barrett(10)....................................... 40,001 *
Stanley H. Appel, M.D.(11)................................. 146,116 *
Thomas A. Duerden, Ph.D.(12)............................... 67,816 *
Tony Coelho(13)............................................ 79,416 *
Michael J. Strauss, M.D.(14)............................... 59,816 *
Alan J. Olsen(15).......................................... 25,791 *
Ronald A. Matricaria(16)................................... 2,400 *
All executive officers and directors as a group (14
persons)(17)............................................. 2,116,093 9.3%
- ---------------
* Less than 1%
(1) Based on total shares outstanding of 21,608,103 at June 30, 2001.
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.
35
38
(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 10,000 shares held in trust for the benefit of Mr. Cummins'
children of which Mr. Cummins serves as trustee. Also includes 602,288
shares subject to options exercisable on or before August 29, 2001.
(4) Includes 102,400 shares held in trusts for the benefit of Mr. Terry's
children of which Mr. Terry serves as trustee. Also includes 35,150 shares
subject to options exercisable on or before August 29, 2001. Mr. Terry
resigned from his position as Chairman and Secretary in June 2001.
(5) Includes 79,668 shares subject to options exercisable on or before August
29, 2001.
(6) Includes 113,042 shares subject to options exercisable on or before August
29, 2001.
(7) Includes 48,333 shares subject to options exercisable on or before August
29, 2001.
(8) Includes 10,000 shares subject to options exercisable on or before August
29, 2001.
(9) Includes 28,333 shares subject to options exercisable on or before August
29, 2001.
(10) Includes 17,998 shares subject to options exercisable on or before August
29, 2001.
(11) Includes 102,316 shares subject to options exercisable on or before August
29, 2001.
(12) Includes 54,316 shares subject to options exercisable on or before August
29, 2001.
(13) Includes 72,316 shares subject to options exercisable on or before August
29, 2001.
(14) Includes 52,316 shares subject to options exercisable on or before August
29, 2001.
(15) Includes 22,316 shares subject to options exercisable on or before August
29, 2001.
(16) Includes 2,400 shares subject to options exercisable on or before August
29, 2001.
(17) Includes 1,240,792 shares subject to options held by executive officers and
directors, which options are exercisable on or before August 29, 2001. Also
includes shares which may be determined to be beneficially owned by
executive officers and directors. See Notes 3 through 16.
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 $0,
$431,662 and $693,844 for such services in fiscal 2001, 2000, and 1999
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.
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,
36
39
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-19 of this Annual Report on Form
10-K:
PAGE
DESCRIPTION NO.
- ----------- ----
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations and Comprehensive
Income (Loss)............................................. F-4
Consolidated Statements of Stockholders' Equity............. F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
2. Exhibits
EXHIBIT
NUMBER DESCRIPTION
------- -----------
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.
4.2 -- Amendment No. 1 to Second Amended and Restated Preferred
Share Rights Agreement, dated April 26, 2001.
10.1(7)* -- Amended 1991 Employee Stock Purchase Plan.
10.2(1) -- License Agreement dated March 15, 1988 between the
Registrant and Dr. Jacob Zabara.
10.3(1) -- Patent License Agreement effective as of July 28, 1989
between the Registrant and Huntington Medical Research
Institute.
10.4(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.
10.5(1) -- Form of Indemnification Agreement.
10.6(1) -- Amended and Restated Stockholders' Agreement dated
October 16, 1992.
10.7(4) -- Registration Rights Agreement dated March 28, 1997.
10.8(5)* -- Amended and Restated 1996 Stock Option Plan.
10.9(3) -- Stockholders' Agreement dated April 8, 1996 between the
Registrant and St. Jude Medical, Inc.
37
40
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.10(3) -- Letter Agreement dated March 28, 1997 between the Clark
Estates and the Registrant.
10.11(3) -- Lease Agreement dated August 19, 1997 between the
Registrant and Space Assets II, Inc.
10.12(6)* -- 1997 Stock Option Plan.
10.13(8) -- 1998 Stock Option Plan.
21.1(3) -- List of Subsidiaries of the Registrant.
23.1 -- Consent of Independent Public Accountants.
24.1 -- Powers of Attorney (included on the Signature Page to
this Form 10-K).
- ---------------
(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
38
41
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, Secretary and
Chief Financial Officer
July 21, 2001
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.
SIGNATURE CAPACITY IN WHICH SIGNED DATE
--------- ------------------------ ----
/s/ ROBERT P. CUMMINS Chairman of the Board, July 21, 2001
- ----------------------------------------------------- President, Chief Executive
Robert P. Cummins Officer (Principal Executive
Officer)
/s/ PAMELA B. WESTBROOK Vice President, Finance and July 21, 2001
- ----------------------------------------------------- Administration, Secretary and
Pamela B. Westbrook Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/ REESE S. TERRY, JR. Director July 21, 2001
- -----------------------------------------------------
Reese S. Terry, Jr.
/s/ STANLEY H. APPEL, M.D. Director July 21, 2001
- -----------------------------------------------------
Stanley H. Appel, M.D.
/s/ TONY COELHO Director July 21, 2001
- -----------------------------------------------------
Tony Coelho
/s/ THOMAS A. DUERDEN, PH.D. Director July 21, 2001
- -----------------------------------------------------
Thomas A. Duerden, Ph.D.
39
42
SIGNATURE CAPACITY IN WHICH SIGNED DATE
--------- ------------------------ ----
/s/ MICHAEL J. STRAUSS, M.D. Director July 21, 2001
- -----------------------------------------------------
Michael J. Strauss, M.D.
/s/ ALAN J. OLSEN Director July 21, 2001
- -----------------------------------------------------
Alan J. Olsen
/s/ RONALD A. MATRICARIA Director July 21, 2001
- -----------------------------------------------------
Ronald A. Matricaria
40
43
CONSOLIDATED FINANCIAL STATEMENTS
AS OF APRIL 27, 2001
TOGETHER WITH AUDITOR'S REPORT
F-1
44
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 April 27, 2001 and June
30, 2000, and the related consolidated statements of operations and
comprehensive income (loss), stockholders' equity and cash flows for the period
ended April 27, 2001 and the two 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 April 27, 2001 and June 30, 2000, and the results
of their operations and their cash flows for the period ended April 27, 2001 and
the two years ended June 30, 2000, in conformity with accounting principles
generally accepted in the United States.
ARTHUR ANDERSEN LLP
Houston, Texas
June 21, 2001
F-2
45
CYBERONICS, INC.
CONSOLIDATED BALANCE SHEETS
APRIL 27, JUNE 30,
2001 2000
------------- ------------
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 55,459,183 $ 14,969,479
Securities held to maturity............................... 1,678,649 5,168,777
Accounts receivable, net.................................. 6,641,249 8,284,948
Inventories............................................... 4,246,560 6,639,784
Prepaid expenses.......................................... 1,376,874 1,414,719
------------- ------------
Total Current Assets.............................. 69,402,515 36,477,707
Securities held to maturity................................. 113,075 399,194
Property and equipment, net................................. 8,650,350 7,466,556
Other assets, net........................................... 148,984 154,978
------------- ------------
$ 78,314,924 $ 44,498,435
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 4,868,288 $ 1,797,904
Accrued liabilities....................................... 13,286,661 3,688,687
Current portion of long-term debt......................... 115,927 109,776
------------- ------------
Total Current Liabilities......................... 18,270,876 5,596,367
Long-term debt.............................................. 396,964 494,093
------------- ------------
Total Liabilities................................. 18,667,840 6,090,460
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; 50,000,000 shares
authorized; 21,474,022 and 18,642,753 shares issued and
outstanding at April 27, 2001 and June 30, 2000,
respectively........................................... 214,740 186,428
Additional paid-in capital................................ 165,170,408 117,322,388
Deferred compensation..................................... (1,989,850) --
Accumulated other comprehensive income (loss)............. (117,971) (168,331)
Accumulated deficit....................................... (103,630,243) (78,932,510)
------------- ------------
Total Stockholders' Equity........................ 59,647,084 38,407,975
------------- ------------
$ 78,314,924 $ 44,498,435
============= ============
See accompanying notes to consolidated financial statements.
F-3
46
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
TEN MONTHS ENDED YEAR ENDED JUNE 30,
------------------------------- --------------------------
APRIL 27, 2001 APRIL 30, 2000 2000 1999
-------------- -------------- ----------- ------------
(UNAUDITED)
Net sales.............................. $ 43,418,736 $37,739,474 $47,888,733 $ 29,927,476
Cost of sales.......................... 11,806,353 9,301,092 11,833,507 7,736,137
------------ ----------- ----------- ------------
Gross Profit................. 31,612,383 28,438,382 36,055,226 22,191,339
Operating Expenses:
Selling, general and
administrative.................... 33,571,072 27,013,684 33,269,266 29,585,570
Research and development............. 17,201,179 5,823,456 8,037,096 6,724,106
Non-recurring charges................ 6,467,415 -- -- --
------------ ----------- ----------- ------------
Total operating expenses..... 57,239,666 32,837,140 41,306,362 36,309,676
------------ ----------- ----------- ------------
Loss From Operations......... (25,627,283) (4,398,758) (5,251,136) (14,118,337)
Interest income........................ 1,141,939 1,078,598 1,364,985 1,465,549
Interest expense....................... 65,331 330 3,349 --
Other income (expense), net............ (147,058) (154,408) (44,894) 115,236
------------ ----------- ----------- ------------
Net loss before cumulative effect of a
change in accounting principle....... (24,697,733) (3,474,898) (3,934,394) (12,537,552)
Cumulative effect on prior years (to
June 30, 1999) of changing to a
different method of depreciation..... -- 881,150 881,150 --
------------ ----------- ----------- ------------
Net Loss..................... $(24,697,733) $(2,593,748) $(3,053,244) $(12,537,552)
============ =========== =========== ============
Net loss per share, basic and diluted:
Net loss before cumulative
effect of a change in
accounting principle....... $ (1.27) $ (0.19) $ (0.22) $ (0.72)
Cumulative effect of a change
in accounting principle.... -- 0.05 0.05 --
------------ ----------- ----------- ------------
Basic and Diluted Net Loss
Per Share.................. $ (1.27) $ (0.14) $ (0.17) $ (0.72)
============ =========== =========== ============
Shares Used in Computing
Basic and Diluted Net Loss
Per Share.................. 19,382,460 17,929,439 18,044,692 17,503,169
============ =========== =========== ============
Comprehensive Income (Loss):
Net loss............................... $(24,697,733) $(2,593,748) $(3,053,244) $(12,537,552)
Foreign currency translation
adjustment........................... 50,360 63,842 (39,855) (238,741)
------------ ----------- ----------- ------------
Comprehensive Income
(Loss)..................... $(24,647,373) $(2,529,906) $(3,093,099) $(12,776,293)
============ =========== =========== ============
Pro forma amounts assuming retroactive
application of cumulative effect of a
change in accounting principle:
Net Loss..................... $(24,697,733) $(3,474,898) $(3,934,394) $(11,984,534)
Net Loss Per Share -- Basic
and Diluted................ $ (1.27) $ (0.19) $ (0.22) $ (0.68)
See accompanying notes to consolidated financial statements.
F-4
47
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED
OTHER
COMMON STOCK COMPREHENSIVE
---------------------- ADDITIONAL DEFERRED INCOME ACCUMULATED
SHARES AMOUNT PAID-IN CAPITAL COMPENSATION (LOSS) DEFICIT
----------- -------- --------------- ------------ ------------- -------------
Balance at June 30, 1998................ $17,266,433 $172,664 $107,757,504 $ -- $ 110,265 $ (63,341,714)
Stock options exercised................ 262,214 2,622 1,136,919 -- -- --
Issuance of Common Stock under Employee
Stock Purchase Plan.................. 33,353 334 308,134 -- -- --
Issuance of options for consultant
services............................. -- -- 78,010 -- -- --
Translation adjustment................. -- -- -- -- (238,741) --
Net Loss............................... -- -- -- -- -- (12,537,552)
----------- -------- ------------ ----------- --------- -------------
Balance at June 30, 1999................ 17,562,000 175,620 109,280,567 -- (128,476) (75,879,266)
Stock options exercised................ 1,049,971 10,500 7,660,286 -- -- --
Issuance of Common Stock under Employee
Stock Purchase Plan.................. 30,782 308 381,535 -- -- --
Translation adjustment................. -- -- -- -- (39,855) --
Net Loss............................... -- -- -- -- -- (3,053,244)
----------- -------- ------------ ----------- --------- -------------
Balance at June 30, 2000................ 18,642,753 186,428 117,322,388 -- (168,331) (78,932,510)
Issuance of Common Stock in private
equity offering, net of offering
costs................................ 2,518,000 25,180 42,445,152 -- -- --
Stock options exercised................ 299,534 2,995 2,774,246 -- -- --
Issuance of Common Stock under Employee
Stock Purchase Plan.................. 13,635 136 200,511 -- -- --
Issuance of Common Stock for
services............................. 100 1 2,311 -- -- --
Issuance of options for consultant
services............................. -- -- 63,300 (63,300) -- --
Deferred compensation relating to
issuance of certain stock options.... -- -- 2,362,500 (2,362,500) -- --
Amortization of deferred compensation
and expense of certain stock
options.............................. -- -- -- 435,950 -- --
Translation adjustment................. -- -- -- -- 50,360 --
Net Loss............................... -- -- -- -- -- (24,697,733)
----------- -------- ------------ ----------- --------- -------------
Balance at April 27, 2001............... $21,474,022 $214,740 $165,170,408 $(1,989,850) $(117,971) $(103,630,243)
=========== ======== ============ =========== ========= =============
See accompanying notes to consolidated financial statements.
F-5
48
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
TEN MONTHS ENDED YEAR ENDED JUNE 30,
------------------------------- ---------------------------
APRIL 27, 2001 APRIL 30, 2000 2000 1999
-------------- -------------- ------------ ------------
(UNAUDITED)
Cash Flows From Operating Activities:
Net loss.............................. $(24,697,733) $ (2,593,748) $ (3,053,244) $(12,537,552)
Noncash items included in net loss:
Depreciation....................... 2,421,262 1,126,910 1,449,333 1,515,273
Loss on disposal of assets......... 21,847 -- -- 102,064
Change in accounting principle..... -- (881,150) (881,150) --
Amortization of deferred
compensation and expense of
certain stock options............ 435,950 -- -- 78,010
Changes in operating assets and
liabilities:
Accounts receivable, net........... 1,643,699 (3,078,537) (2,834,945) 408,631
Inventories........................ 2,393,224 (2,454,829) (1,444,670) (3,091,511)
Prepaid expenses................... 37,845 (155,821) (516,681) 265,085
Other assets, net.................. 5,994 (66,237) (46,063) 83,977
Accounts payable and accrued
liabilities...................... 12,668,358 592,314 (848,117) (1,581,867)
------------ ------------ ------------ ------------
Net Cash Used In Operating
Activities.................. (5,069,554) (7,511,098) (8,175,537) (14,757,890)
Cash Flows From Investing Activities:
Purchases of property and equipment... (3,626,903) (2,594,946) (4,114,820) (1,737,314)
Purchases of marketable securities.... (7,845,792) (41,030,731) (52,528,156) (45,991,718)
Maturities of marketable securities... 11,622,039 43,722,709 55,055,237 76,345,340
------------ ------------ ------------ ------------
Net Cash Provided By (Used In)
Investing Activities........ 149,344 97,032 (1,587,739) 28,616,308
Cash Flows From Financing Activities:
Proceeds from issuance of Common
Stock.............................. 45,450,532 7,072,098 8,052,629 1,448,009
Payments on debt...................... (90,978) -- (43,090) --
------------ ------------ ------------ ------------
Net Cash Provided By Financing
Activities.................. 45,359,554 7,072,098 8,009,539 1,448,009
Effect of exchange rate changes on
cash and cash equivalents.......... 50,360 63,842 (39,855) (238,741)
------------ ------------ ------------ ------------
Net Increase (Decrease) In
Cash and Cash Equivalents... 40,489,704 (278,126) (1,793,592) 15,067,686
Cash and cash equivalents at beginning
of period.......................... 14,969,479 16,763,071 16,763,071 1,695,385
------------ ------------ ------------ ------------
Cash and cash equivalents at end of
period............................. $ 55,459,183 $ 16,484,945 $ 14,969,479 $ 16,763,071
============ ============ ============ ============
Supplementary Disclosures Of Cash Flow
Information:
Cash paid for interest................ $ 30,796 $ -- $ 3,349 $ --
Noncash purchase of assets under
capital leases..................... $ -- $ -- $ 646,959 $ --
See accompanying notes to consolidated financial statements.
F-6
49
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
APRIL 27, 2001
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 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 for the
treatment of epilepsy, where the Company presently markets it using its own
employee-based direct sales organization. In addition, the NCP System is
marketed internationally for the treatment of epilepsy (principally in Europe)
using a combination of the Company's own direct sales organization and
independent distributors. During fiscal 2001, Cyberonics obtained regulatory
approval for commercial distribution of the NCP device for the treatment of
depression in the European market and in Canada. The NCP device will be marketed
for the treatment of depression in those countries where approval has been
obtained. These marketing activities will be expanded to other countries, as
approvals are obtained from the applicable regulatory agencies. Cyberonics is
headquartered in Houston, Texas.
In March 2001, the Company elected to change its fiscal year from June 30
to a 52/53 week year ending on the last Friday of April of each year, effective
April 27, 2001. Accordingly, fiscal 2001 started July 1, 2000 and ended April
27, 2001.
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 April 27, 2001 and June 30, 2000, 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 24 months and have a fair market
value of approximately
F-7
50
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$1,786,000 and $5,290,000, as of April 27, 2001 and June 30, 2000, respectively.
At April 27, 2001 and June 30, 2000, the Company's investment portfolio consists
of the following:
APRIL 27, 2001 JUNE 30, 2000
------------------------ ------------------------
FAIR MARKET CARRYING FAIR MARKET CARRYING
VALUE VALUE VALUE VALUE
----------- ---------- ----------- ----------
Current --
Corporate bonds and commercial
paper........................... $ 233,000 $ 226,756 $1,624,000 $1,626,390
US treasury obligations............ 1,438,000 1,451,893 3,270,000 3,542,387
---------- ---------- ---------- ----------
1,671,000 1,678,649 4,894,000 5,168,777
Non-current --
Asset-backed investments........... 115,000 113,075 396,000 399,194
---------- ---------- ---------- ----------
Total...................... $1,786,000 $1,791,724 $5,290,000 $5,567,971
========== ========== ========== ==========
Accounts Receivable. The Company's allowance for doubtful accounts totaled
$138,203 and $162,654 at April 27, 2001 and June 30, 2000, respectively.
Activity in the Company's allowance for doubtful accounts consists of the
following:
APRIL 27, JUNE 30, JUNE 30,
2001 2000 1999
--------- --------- --------
Balance at beginning of period...................... $162,654 $ 495,662 $505,560
Increase in allowance............................... -- -- 25,411
Reductions in allowance............................. (3,807) (333,008) --
Reductions for write-offs........................... (20,644) -- (35,309)
-------- --------- --------
Balance at end of period............................ $138,203 $ 162,654 $495,662
======== ========= ========
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. During fiscal 2001,
the Company recorded obsolescence charges of $1.8 million.
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. Effective July 1, 1999 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 7, "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
F-8
51
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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).
Reclassifications. Certain amounts in the balance sheet as of June 30,
2000 have been reclassified to conform with those at April 27, 2001.
NOTE 2. INVENTORIES
Inventories consist of the following:
APRIL 27, JUNE 30,
2001 2000
---------- ----------
Raw materials............................................... $1,338,885 $2,378,933
Work-in-process............................................. 1,257,784 1,089,891
Finished goods.............................................. 1,649,891 3,170,960
---------- ----------
$4,246,560 $6,639,784
========== ==========
F-9
52
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
APRIL 27, JUNE 30,
2001 2000
----------- -----------
Manufacturing equipment.................................... $ 4,120,223 $ 2,727,269
Computer equipment......................................... 3,776,874 2,627,418
Leasehold improvements..................................... 1,741,467 1,405,824
Furniture and fixtures..................................... 1,724,168 1,559,175
Offsite programming equipment.............................. 1,691,705 785,693
Construction in progress................................... 197,555 1,388,960
Office equipment........................................... 120,414 98,765
----------- -----------
13,372,406 10,593,104
Accumulated depreciation................................... (4,722,056) (3,126,548)
----------- -----------
$ 8,650,350 $ 7,466,556
=========== ===========
NOTE 4. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
APRIL 27, JUNE 30,
2001 2000
----------- ----------
Clinical costs.............................................. $ 5,133,692 $1,059,665
Financial advisor fees...................................... 3,785,995 --
Payroll and other compensation.............................. 2,354,101 1,391,158
Royalties................................................... 661,340 557,077
Professional services....................................... 456,275 108,953
Warranties.................................................. 423,000 375,000
Business insurance.......................................... 141,128 --
Other....................................................... 331,130 196,834
----------- ----------
$13,286,661 $3,688,687
=========== ==========
NOTE 5. 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 6. 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 April 27, 2001. 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,
F-10
53
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 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. During the period
ended April 27, 2001, stock option exercises and issuances of common stock under
the Company's Employee Stock Purchase Plan increased the number of common shares
by 299,534 and 13,635, respectively.
In February 2001, the Company issued 2,518,000 shares of its common stock
in a private offering for $18.00 per share. Proceeds from the issuance totaled
approximately $42.5 million after deducting commission and offering costs.
In November 2000, the Company issued 100 shares of its Common Stock to an
individual. The transaction was recorded at the fair market value on the day of
the issuance, or $23.12.
Deferred Compensation. In June 2000, the Board of Directors granted
450,000 options at $18.00 per share to purchase shares of common stock under a
proposed modification to the 1997 Stock Option plan that was subject to
shareholder approval. On December 29, 2000, the shareholders approved the
modifications to the plan, and the Company recorded approximately $2.4 million
in deferred compensation relating to the options. The charge reflects the
difference between the exercise price and the fair market value of the stock on
the date shareholder approval was received. The deferred compensation is being
amortized to expense over the five year vesting period of the options.
Approximately $394,000 of compensation expense has been recognized in fiscal
2001 for the vested portion of the grant.
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 ("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 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. In April 2001, the Company amended
the Plan to designate the State of Wisconsin Investment Board
F-11
54
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(SWIB) as an Exempt Person under the terms of the Plan as long as SWIB is the
Beneficial Owner of less than 20%.
NOTE 7. STOCK INCENTIVE AND PURCHASE PLANS
Stock Options. Cyberonics has reserved an aggregate of 9,150,000 shares of
its Common Stock through April 27, 2001, 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. 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 Option Plan allow issuance of either nonstatutory or incentive stock
options, while the 1996 Stock Option Plan provides for issuance of nonstatutory
stock options exclusively.
The following is a summary of the Company's stock option activity for the
years ended June 30, 1999 and June 30, 2000, and the period ended April 27,
2001:
OUTSTANDING EXERCISABLE
--------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE EXERCISE
RESERVED SHARES PRICE SHARES PRICE
---------- ---------- -------- ---------- --------
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
---------- ---------- ----------
Shares reserved................... 1,000,000
Granted........................... (1,748,000) 1,748,000 17.29
Options becoming exercisable...... 643,189
Exercised......................... (299,534) 9.27 (299,534)
Canceled or forfeited............. 643,325 (643,325) 14.07
---------- ---------- ----------
Balance at April 27,
2001.................. 1,212,141 4,933,251 $12.93 1,987,982 $9.76
========== ========== ==========
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 $435,950 during fiscal 2001, $0 during fiscal 2000, and $78,010
during fiscal 1999.
F-12
55
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 2001, 2000, and
1999: risk-free interest rate of 4.5% for fiscal period 2001 and 5% for fiscal
years 2000 and 1999, expected life of five years for options and restricted
stock, expected life of six months for purchase plan shares, expected volatility
of 253%, 161%, and 290%, 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 2001, 2000, and 1999 was $16.94, $15.31,
and $8.05, respectively.
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:
TEN MONTHS
ENDED FISCAL YEARS ENDED JUNE 30,
--------------- ---------------------------
APRIL 27, 2001 2000 1999
--------------- ------------ ------------
Net loss --
As reported.............................. $(24,697,733) $ (3,053,244) $(12,537,552)
Pro forma................................ (33,207,152) (12,678,014) (19,320,345)
Loss per share --
As reported.............................. $ (1.27) $ (0.17) $ (0.72)
Pro forma................................ (1.71) (0.70) (1.10)
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 $35,419, $159,143, and $67,393 related to the
purchase discount offered under the Company's Employee Stock Purchase Plan
during fiscal 2001, 2000, and 1999, respectively. The weighted average fair
values of shares granted to employees were $17.32, $17.57, and $11.27 during
fiscal 2001, 2000, and 1999, 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 APRIL 27, 2001
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- ------------------------------------
OUTSTANDING AS OF WEIGHTED-AVERAGE EXERCISABLE AS OF
RANGE OF APRIL 27, REMAINING WEIGHTED-AVERAGE APRIL 27, WEIGHTED-AVERAGE
EXERCISE PRICES 2001 CONTRACTUAL LIFE EXERCISE PRICE 2001 EXERCISE PRICE
- --------------- ----------------- ---------------- ---------------- ----------------- ----------------
$ 0.0000-$ 0.6700 950 .5 $ 0.67 950 $ 0.67
$ 0.6701-$ 5.9750 950,425 5.3 $ 3.59 837,926 $ 3.43
$ 5.9751-$11.9500 722,965 7.2 $ 8.45 255,545 $ 8.50
$11.9501-$17.9250 2,051,793 8.0 $14.75 708,098 $14.81
$17.9251-$29.8750 1,207,118 9.1 $19.88 185,463 $20.82
--------- ---------
4,933,251 7.6 $12.93 1,987,982 $ 9.76
========= =========
During fiscal 2001 and 2000, the Board of Directors approved grants outside
of the existing stock option plans. The grants, which totaled 100,000 and
250,000 options, respectively, were approved for new officers as inducements
essential to their entering into employment with the Company.
F-13
56
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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 April 27, 2001,
22,230 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 April 27,
2001, 4,030 shares remain available for future issuances under the program.
NOTE 8. NEW ACCOUNTING PRONOUNCEMENT
The Financial Accounting Standards Board approved the issuance of SFAS No.
141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible
Assets in July 2001. SFAS No. 141 will require all business combinations to be
accounted for using the purchase method of accounting; use of the
pooling-of-interest method will be prohibited. The provisions of SFAS No. 141
will apply to all business combinations initiated after June 30, 2001. SFAS No.
142 will require that goodwill should not be amortized but should be tested for
impairment at least annually at the reporting unit level. SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001 for all goodwill
and other intangible assets regardless of when those assets were initially
recognized. SFAS No. 141 and 142 are not anticipated to have an impact on the
Company's operating results or financial condition when adopted.
NOTE 9. INCOME TAXES
Components of the Company's loss before taxes are as follows:
TEN MONTHS
ENDED YEAR ENDED JUNE 30,
-------------- --------------------------
APRIL 27, 2001 2000 1999
-------------- ----------- ------------
Domestic.................................... $(23,629,170) $(2,198,294) $(10,697,153)
Foreign..................................... (1,068,563) (854,950) (1,840,399)
------------ ----------- ------------
$(24,697,733) $(3,053,244) $(12,537,552)
============ =========== ============
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate is as follows:
TEN MONTHS YEAR ENDED
ENDED JUNE 30,
-------------- --------------
APRIL 27, 2001 2000 1999
-------------- ------ -----
U.S. statutory rate..................................... (34.0)% (34.0)% (34.0)%
Increase in deferred tax valuation allowance............ 37.4 147.9 37.7
Other, net.............................................. (3.4) (113.9) (3.7)
----- ------ -----
0.0% 0.0% 0.0%
===== ====== =====
F-14
57
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
are as follows:
JUNE 30,
---------------------------
APRIL 27, 2001 2000 1999
-------------- ------------ ------------
Deferred tax assets:
Federal net operating loss
carryforwards.......................... $ 33,176,347 $ 25,252,567 $ 20,993,968
Foreign net operating loss
carryforwards.......................... 4,141,114 3,772,374 3,481,691
Tax credit carryforwards.................. 3,267,666 2,276,648 1,945,542
Warranties................................ 46,823 127,500 127,500
Depreciation.............................. -- -- 216,920
Clinical costs............................ -- 103,927 285,851
Other, net................................ 1,047,737 954,388 794,685
------------ ------------ ------------
Total deferred tax assets......... 41,679,687 32,487,404 27,846,157
Total deferred tax liabilities, net......... (91,011) (126,515) --
Deferred tax valuation allowance............ (41,588,676) (32,360,889) (27,846,157)
------------ ------------ ------------
Net deferred tax assets and
liabilities..................... $ -- $ -- $ --
============ ============ ============
At April 27, 2001, the Company has net operating loss carryforwards of
approximately $97.6 million for federal income tax purposes, which expire during
the years 2003 through 2021, and tax credit carryforwards of approximately $3.3
million for federal income tax purposes, which expire during the years 2006
through 2021. As the Company has had cumulative losses and there is no assurance
of future taxable income, a valuation allowance totaling $41.6 million has been
established as of April 27, 2001, to fully offset the Company's net deferred tax
assets, including those relating to its carryforwards. The valuation allowance
increased $9.2 million and $4.5 million for the period ended April 27, 2001 and
the year ended June 30, 2000, 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 10. 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 period ended April 27, 2001, and the
years ended June 30, 2000, and 1999.
NOTE 11. 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.
F-15
58
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 2001 and 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 April
27, 2001, are as follows:
YEAR ENDING ON THE LAST FRIDAY OF APRIL
2002.................................................... $1,549,341
2003.................................................... 995,982
2004.................................................... 231,927
2005.................................................... 136,906
2006.................................................... 83,874
----------
$2,998,030
==========
The Company leases certain manufacturing equipment under long-term capital
leases with a 6.56% interest rate that mature in April 2005. Capitalized costs
of $0 and $646,959 are included in construction in progress at April 27, 2001,
and June 30, 2000 respectively. Accumulated depreciation amounted to $97,044 and
$0 at April 27, 2001, and June 30, 2000 respectively.
F-16
59
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 April 27, 2001:
YEAR ENDING ON THE LAST FRIDAY OF APRIL
2002...................................................... $146,129
2003...................................................... 146,129
2004...................................................... 146,129
2005...................................................... 146,129
--------
Total minimum lease payments.................... 584,516
Less: amount representing interest........................ 71,625
--------
Present value of future minimum lease payments............ 512,891
Less: amount due within one year.......................... 115,927
--------
Amount due after one year....................... $396,964
========
The Company's rental expense for the period ended April 27, 2001 and the
years ended June 30, 2000, and June 30, 1999 amounted to $1,374,230, $1,172,296,
and $1,276,760 respectively.
Other Commitments. At April 27, 2001, Cyberonics had approximately
$849,000 in noncancelable commitments related to domestic marketing programs
planned for the Company's NCP System during fiscal year 2002, of which
approximately $767,000 is scheduled to occur in the first quarter of fiscal year
2002.
Litigation. The Company is involved in legal actions arising in the
ordinary course of business. Management does not believe the outcome of such
legal actions will have a material adverse effect on the Company's financial
position or results of operations.
The Company recently entered into a Release and Settlement Agreement
(Settlement Agreement) with Hi-Tronics Design, Inc. (Hi-Tronics) to settle fully
all claims and differences between the Company and Hi-Tronics. While the terms
of the Settlement Agreement are confidential, the amount of the settlement was
accrued as of April 27, 2001 and did not have a material adverse effect on the
Company's financial position or results of operations.
NOTE 12. RELATED PARTY TRANSACTIONS
Covance Health Economics and Outcomes Services, Inc. (Covance) provided
healthcare reimbursement consulting services to the Company during fiscal years
2000 and 1999. Amounts paid for such services in fiscal year 2000 and 1999, were
$431,662 and $693,844 respectively. No amounts were paid during fiscal 2001. A
member of the Board of Directors of the Company was the Executive Vice President
of Covance through 1999, and he currently serves as a Senior Consultant for
Covance.
NOTE 13. 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 April 27, 2001,
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
F-17
60
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 14. 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.
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, direct payroll costs, and allocations of
general and administrative expenses.
EPILEPSY DEPRESSION OTHER
INDICATION INDICATION INDICATIONS
BUSINESS UNIT BUSINESS UNIT BUSINESS UNIT TOTAL
------------- ------------- ------------- ------------
Ten Months Ended April 27, 2001
External net sales.................. $ 43,418,736 $ -- $ -- $ 43,418,736
Operating loss...................... (8,635,991) (14,252,361) (2,738,931) (25,627,283)
Ten Months Ended April 30, 2000
(unaudited)
External net sales.................. $ 37,739,474 $ -- $ -- $ 37,739,474
Operating loss...................... (3,084,806) (1,084,282) (229,670) (4,398,758)
Fiscal Year Ended June 30, 2000
External net sales.................. $ 47,888,733 $ -- $ -- $ 47,888,733
Operating loss...................... (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)
- ---------------
(1) The depreciation expense component of operating loss for the Epilepsy
Indication Business Unit assumes retroactive application of accounting
change.
Geographic Information:
NET SALES
-------------------------------------------------------------
TEN MONTHS TEN MONTHS
ENDED APRIL 27, ENDED APRIL 30,
2001 2000 FY2000 FY1999
--------------- --------------- ----------- -----------
(UNAUDITED)
United States.................. $38,972,088 $33,791,875 $42,533,016 $26,278,585
International.................. 4,446,648 3,947,599 5,355,717 3,648,891
----------- ----------- ----------- -----------
Total................ $43,418,736 $37,739,474 $47,888,733 $29,927,476
=========== =========== =========== ===========
F-18
61
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LONG-LIVED ASSETS, AS OF
-------------------------
APRIL 27, JUNE 30,
2001 2000
----------- -----------
United States............................................... $8,739,338 $7,850,419
International............................................... 173,071 170,309
---------- ----------
Total............................................. $8,912,409 $8,020,728
========== ==========
NOTE 15. NON-RECURRING CHARGES
Non-recurring charges were $6.5 million for the ten months ended April 27,
2001. On September 11, 2000, Medtronic, Inc. ("Medtronic") publicly announced a
proposal to acquire the Company 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 its patent protected business opportunities. On September
28, 2000, Medtronic announced that it had withdrawn its offer. The Company
incurred non-recurring charges of $6.5 million which includes investment banking
fees to Morgan Stanley Dean Witter of $6.0 million. The Company also incurred
legal, accounting and consulting fees of approximately $350,000 and other
related costs of $117,000.
NOTE 16. QUARTERLY FINANCIAL INFORMATION -- UNAUDITED
The following table sets forth certain unaudited condensed quarterly
financial data for the fiscal period ended April 27, 2001, and the year ended
June 30, 2000. 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.
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER(1) TOTALS
----------- ----------- ----------- ----------- ------------
TEN MONTHS ENDED APRIL
27, 2001
Net sales............. $13,353,357 $14,201,205 $14,323,721 $ 1,540,453 $ 43,418,736
Gross profit.......... 9,908,765 10,808,779 10,470,936 423,903 31,612,383
Net loss.............. (9,946,352) (3,444,817) (4,559,052) (6,747,512) (24,697,733)
Diluted net loss per
share(2)............ (0.53) (0.18) (0.23) (0.31) (1.27)
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)... (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)
- ---------------
(1) Fourth quarter for fiscal year 2001 represents activity for the month of
April only, due to the change in fiscal year from June 30 to the last Friday
of April.
(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-19
62
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
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.
4.2 -- Amendment No. 1 to Second Amended and Restated Preferred
Share Rights Agreement, dated April 26, 2001.
10.1(7)* -- Amended 1991 Employee Stock Purchase Plan.
10.2(1) -- License Agreement dated March 15, 1988 between the
Registrant and Dr. Jacob Zabara.
10.3(1) -- Patent License Agreement effective as of July 28, 1989
between the Registrant and Huntington Medical Research
Institute.
10.4(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.
10.5(1) -- Form of Indemnification Agreement.
10.6(1) -- Amended and Restated Stockholders' Agreement dated
October 16, 1992.
10.7(4) -- Registration Rights Agreement dated March 28, 1997.
10.8(5)* -- Amended and Restated 1996 Stock Option Plan.
10.9(3) -- Stockholders' Agreement dated April 8, 1996 between the
Registrant and St. Jude Medical, Inc.
10.10(3) -- Letter Agreement dated March 28, 1997 between the Clark
Estates and the Registrant.
10.11(3) -- Lease Agreement dated August 19, 1997 between the
Registrant and Space Assets II, Inc.
10.12(6)* -- 1997 Stock Option Plan.
10.13(8) -- 1998 Stock Option Plan.
21.1(3) -- List of Subsidiaries of the Registrant.
23.1 -- Consent of Independent Public Accountants.
24.1 -- Powers of Attorney (included on the Signature Page to
this Form 10-K).
- ---------------
(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.
63
(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.