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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 26, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM
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)
CYBERONICS BUILDING HOUSTON, TEXAS
100 CYBERONICS BLVD., 77058-2072
(Address of principal executive offices) (Zip Code)
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 whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate 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. Yes [ ] No [ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of June 25, 2002, was, based upon the last sales price reported
for such date on the Nasdaq National Market, approximately $196 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 25, 2002, registrant had outstanding 21,801,845 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
No documents are incorporated by reference herein.
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TABLE OF CONTENTS
PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 21
Item 3. Legal Proceedings........................................... 21
Item 4. Submission of Matters to a Vote of Security Holders......... 21
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 22
Item 6. Selected Financial Data..................................... 24
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 25
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 33
Item 8. Financial Statements and Supplementary Data................. 33
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 33
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 35
Item 11. Executive Compensation...................................... 38
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 40
Item 13. Certain Relationships and Related Transactions.............. 42
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 43
1
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 both 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.
Our mission is to improve the lives of people whose lives have been touched
by epilepsy, depression and other neurological disorders that may prove to be
treatable with our patented therapy, Vagus Nerve Stimulation (VNS).
Our overall objectives are to:
- Maintain sustained sales growth in excess of neuromodulation market sales
growth,
- Improve bottom line financial performance to achieve sustainable
quarterly profitability beginning in fiscal 2004 and
- Develop other indications for vagus nerve stimulation covered by our
method patents.
Our strategies to achieve our objectives are to:
- Improve sales force execution of our proprietary mission flow chart and
patient pull through sales model by measuring and managing sales
processes at each step in the sales process and implementing new
marketing systems to improve patient conversion rates and cycle times to
implant,
- Expand market awareness of VNS(TM) Therapy by creating physician and
patient demand through new promotional and educational initiatives,
geared to targeted physicians and patients,
- Implement end-of-service initiatives to satisfy physician and patient
demand and drive revenue growth,
- Develop and introduce next-generation products that will provide improved
product functionality, command higher prices and drive higher gross
profit margin,
- Demonstrate the clinical and statistical significance and causal
relationship of VNS Therapy in depression from long-term data in existing
studies and
- Expand the VNS Therapy indication for use and labeling to include
depression and other indications in the United States through a well
defined pre-market approval supplement (PMA-S) process.
We have historically operated our business in three business units, which
included the Epilepsy Business Unit, the Depression Business Unit and the Other
Indications Business Unit. All business units were reported for accounting
purposes as one segment and involved in the design, development, manufacture,
marketing and sales of our proprietary NCP System to deliver VNS Therapy for the
treatment of epilepsy and other disorders that may prove to be treatable with
VNS Therapy. Each business unit shared similar economic characteristics,
technology, manufacturing processes, customers, distribution and marketing
strategies, regulatory environments and shared infrastructures. The
identification and separation of the Indication Business Units reflected the
different phases of clinical and commercial development of each indication and
the different financial objectives of each business unit. In January 2002, the
acute results of the pivotal clinical study (D-02) on
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VNS Therapy for the treatment of depression were completed and unblinded. The
D-02 acute results did not show a statistically significant difference in
response rates between the treatment and placebo non-treatment groups. We are
planning to amend the D-02 protocol's statistical analysis plan to provide a
prospective analysis of the effectiveness of VNS Therapy based upon the D-02 and
pilot study (D-01) long-term results. The collection and analysis of that
long-term data will result in delays in the completion of clinical studies and
U.S. regulatory submissions and a higher degree of uncertainty surrounding the
probability and possible timing of U.S. regulatory approvals and commercial
launch of VNS Therapy for depression. Furthermore, in February 2002, we
suspended new enrollments in all other new indications studies in order to allow
us to focus our limited clinical and financial resources towards the
determination of effectiveness of VNS Therapy in depression. The suspension of
patient enrollments in all new indication studies results in a higher degree of
uncertainty surrounding the probability and timing of the clinical study
activities in the Other Indications Business Unit.
The uncertainties surrounding these clinical development regulatory
approvals and commercialization of VNS Therapy as a treatment for depression and
other new indications makes the allocations of resources and expenses among
Indication Business Units problematic. Therefore, in February 2002, we began
operating our business as a single neurostimulation business unit focused on
sales growth, profitability, cash flow and the determination of the safety and
effectiveness of VNS Therapy for depression. Accordingly, we will no longer
separate our financial results or business operations into the three previously
established business units.
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 2002 started April 28, 2001 and ended April 26, 2002
and fiscal 2001 started July 1, 2000 and ended April 27, 2001.
EPILEPSY
In July 1997, we received approval from the United States Food and Drug
Administration (FDA) to market the NCP System in the U.S. as an adjunctive
therapy for reducing the frequency of seizures in patients over 12 years of age
with partial onset seizures that are refractory or resistant to drugs. We have
also received regulatory approval to sell the NCP System in Canada, Europe,
Australia and certain countries in the Far East with the broader indication of
refractory epilepsy and without discrimination to age or seizure type. To date,
over 16,000 patients with epilepsy have accumulated in excess of over 36,000
patient years of treatment with the NCP System.
EPILEPSY MARKET 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 which involve the entire brain from the onset generally
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 an alternation in consciousness. Partial onset seizures can
also progress to 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 approximately 2.8 million individuals in the U.S. have
epilepsy, with approximately 150,000 new cases diagnosed each year, and that
there are in excess of 3.3 million individuals with 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
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antiepileptic drugs, strained personal and family relations, and the inability
to obtain and hold meaningful employment or a driver's license.
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 U.S. We believe that the
low number of surgeries is attributable to several factors, including: the
extensive evaluation and testing required to screen candidates for surgery and
to localize the source of the seizures; the relatively small percentage of
patients who have a clearly identifiable and surgically accessible focus for
their 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.
VNS THERAPY WITH THE NCP SYSTEM
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 efficacy 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 16,000 patients have accumulated in excess
of over 36,000 patient years of treatment experience with the NCP System. In
July 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 typically been
associated with the debilitating central nervous system side effects which
frequently accompany antiepileptic drugs.
4
Additionally, side effects decrease over time, with no single side effect being
reported by more than 3% of patients.
Quality of Life. The Cyberonics VNS Patient Outcome Registry collects
acute and long-term follow-up data on patients treated with VNS Therapy 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 April 26, 2002, the
registry included data on over 6,165 patients of which approximately 3,800
patients were at three-months follow-up and over 2,100 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 6% 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 244 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 41%
after 24 months of treatment.
Easy to Use. The implantation procedure is a straightforward, 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 activate on-demand therapy if
the patient senses the onset of a seizure or to temporarily eliminate
stimulation side effects. The NCP System implantation is reversible for patients
who elect to discontinue treatment.
DEPRESSION
We are conducting clinical studies of the NCP System for the treatment of
depression in patients with unipolar and bipolar depressive disorder. The
depression study program includes acute and long-term clinical studies,
mechanism of action research and health economics studies to determine the
safety, effectiveness and cost effectiveness of VNS Therapy in the treatment of
depression, support regulatory approvals and support post-approval psychiatrist,
patient and payer acceptance. The clinical component consists of two studies: a
60-patient open-label pilot study (D-01) which was initiated in fiscal 1999 and
includes long-term follow-up, with almost all patients approaching or exceeding
two years of follow-up and a 235-patient randomized, double-blind,
placebo-controlled study (D-02) with long-term open-label follow-up.
The D-01 acute results reported an acute response rate of 31% which
increased to 45% after 12 months of VNS Therapy. In late January 2002, the acute
results of the D-02 study on VNS Therapy were completed and unblinded. The D-02
acute results reported 1) a 15% response rate in the active treatment group,
which did not represent a statistically significant improvement over the placebo
group, 2) a 10% response rate in the placebo group, confirming the
treatment-resistant nature of the study population, 3) completion of the acute
phase by 97% of the active treatment group, confirming the good short-term
tolerability of VNS Therapy and 4) few significant adverse events, confirming
the safety of the implant procedure and good short-term tolerability of VNS
Therapy in depression.
The acute response rates in the D-02 study were considerably lower than
expected based upon the D-01 pilot study results. The primary factors considered
to be potential contributors to the unexpectedly low acute response rate are 1)
the amount of stimulation received by the active treatment group and 2) the
level of treatment resistance of the patients enrolled. The patients in the
acute treatment phase of D-02 pivotal study received lower output current
settings than did the patients in the acute treatment phase of the D-01 pilot
study, despite similar programming instructions in studies' protocols.
Approximately 26% of the patients in the D-02 study received output current
settings of 1.0 milliamps or higher, compared to approximately 45% of the D-01
pilot study patients. Therefore, the D-02 study patients did not receive the
same acute therapy as did the D-01 pilot study patients. While there are no
definitive data to suggest there is an increased response with increasing output
current for VNS Therapy, the low output current settings in the acute D-02 study
raise the
5
possibility that the low amount of stimulation may have contributed to the low
response rate acutely. The D-02 study protocol was designed to include less
treatment-resistant patients, as defined by the number of failed drug trials,
than were included in the D-01 pilot study. However, patients enrolled in the
D-02 study appear to have been as treatment-resistant as the patients in the
D-01 pilot study as measured by the number of failed treatments per year in the
current depressive episode and over the life of the patient, the average
duration of the patients' illness and the percent of patients treated with
electro convulsive therapy (ECT).
Despite the difference in acute response rates between the D-01 and D-02
studies, after 12 months of VNS Therapy, patients in both studies achieved a
response rate of approximately 45%. This improvement in response over time has
also been observed in epilepsy studies and in our epilepsy registry database,
where response rates do not appear to plateau until the second year of
treatment. For the D-02 study, the 12-month response rates only include data on
the first 36 patients reaching one year of VNS Therapy stimulation, so the
results must be interpreted cautiously. However, the results suggest that over
time, VNS Therapy produces a clinically significant response rate in these
highly treatment-resistant depressed patients. Therefore, the results suggest
that eight weeks of fixed dose VNS Therapy at the levels of stimulation received
by the active treatment group is too short a duration of treatment for patients
who are as treatment-resistant as are the patients in the D-02 study.
We are planning to amend the D-02 protocol's statistical analysis plan to
provide a prospective analysis of the effectiveness of VNS Therapy using
existing long-term data collected as already specified in the D-02 protocol. We
have extended the evaluation period of the patients from the acute study to one
year of stimulation experience and we have implemented new treatment guidelines
to increase the amount of stimulation that the patients receive. We intend to
submit an Investigational Device Exemption Supplement (IDE-S) to FDA for our
revised statistical plan for the D-02 study no later than September 2002. By
March 2003, we expect to complete our prospective long-term analysis of the D-02
study and the D-01 pilot study patients.
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 MARKET 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 U.S. alone,
approximately 18 million people suffer from depression, slightly over six
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 ECT for their
depression. Roughly 15% of all people with severe depression 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 U.S. alone are estimated at over $50 billion per year, including
over $12 billion in direct treatment costs. The total market in the U.S. 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. Most 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,
6
such as carbamazepine, valproate and lamotrigine, are used as mood stabilizers
and that lamotrigine and gabapentin are also used as antidepressants.
TRADITIONAL DEPRESSION THERAPIES
The goals of treatment of depression are to achieve remission of symptoms,
prevent relapse and recurrence, 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 U.S., 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.
VNS THERAPY WITH THE NCP SYSTEM
VNS Therapy 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 25,
2002, our 21 center, 235 patient pivotal clinical study (D-02) of VNS Therapy in
the treatment of depression is underway. Continuing in 2003 and beyond, we
expect to expend considerable resources completing the long-term pivotal study,
pursuing the receipt of appropriate regulatory approvals and following receipt
of appropriate approvals no sooner than fiscal 2004, if at all, launching the
NCP System as a treatment for patients with depression.
Although VNS Therapy 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 in each country and we have received
regulatory approval in the U.S. We cannot be certain when or if such
reimbursement or approval 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 Therapy for the treatment of depression in the
U.S. is an investigational study subject to clinical outcome and significant
regulatory restrictions. We can provide you no assurance as to the ultimate
approval outcome of VNS Therapy for the treatment of depression in the U.S. Any
delays or failure of the necessary approvals could harm our ability to market
the NCP System for depression, which could harm our business, financial
condition and results of operations.
OTHER INDICATIONS DEVELOPMENT
We are engaged in expanding the range of treatable disorders for VNS
Therapy 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. We currently have studies underway for the treatment of Alzheimer's
Disease (AD), anxiety and obesity disorders as well as studies planned for other
disorders covered by our patent portfolio.
ALZHEIMER'S DISEASE MARKET OVERVIEW
AD is considered an "amnestic dementia" or forgetful dementia because its
most common first symptom is the rapid forgetting of recently learned material.
7
AD is a major public health threat in the U.S. and worldwide. Estimates
indicate that approximately 4 million people in the U.S. suffer from AD.
Worldwide, it is estimated that 22 million individuals will develop AD by the
year 2025. The cost of AD in the U.S. alone exceeds $100 billion per year. AD is
the third most costly disease in the U.S., 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 Therapy 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 bed bound.
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 for AD, therefore, the goal 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.
VNS THERAPY WITH THE NCP SYSTEM
Our study of VNS Therapy for AD was initiated primarily because of VNS
Therapy treatment-related improvements in memory reported both in animal
research and in patients with epilepsy. Based on the Cyberonics VNS Therapy
Patient Outcome Registry, approximately one fourth of epilepsy patients treated
for three months with VNS Therapy and approximately one third of those patients
treated for one year report that their memory was better or much better after
VNS Therapy. 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
VNS Therapy for the treatment of AD. Shortly thereafter, we launched a pilot
study of left cervical VNS Therapy in up to 10 implanted patients with a study
protocol of three months in the acute study and long-term follow-up. In November
2001, the results from the 10 patient pilot study were released. After three
months of VNS Therapy, eight of the 10
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patients with AD responded where response is defined as an improvement in or no
worsening of AD symptoms based on the Alzheimer's Disease Assessment
Scale-cognitive (ADAS-cog). Of the eight responders, six had improvements in
their symptoms of AD and two had no worsening. After six months of VNS Therapy,
seven of the eight initial responders continued to sustain their response by
having improvements in symptoms compared to their baseline ADAS-cog assessments.
Patients with AD typically worsen nine points in the ADAS-cog each year. The 10
patients in the VNS Therapy study had a median improvement in the ADAS-cog each
year. In November 2001, we received approval to extend the AD pilot study to a
total of three sites and 30 patients.
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 Therapy 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 Therapy to
not only enhance memory, but also improve depression is of interest in this
study.
VNS Therapy 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 25, 2002, the pilot study has been initiated, one site has been
approved and all 16 patients have been implanted.
The clinical study of VNS Therapy for the treatment of AD in the U.S. is an
investigational study subject to clinical outcome and significant regulatory
restrictions. We can provide you no assurance as to the ultimate approval
outcome of VNS Therapy for the treatment of AD in the U.S. Any delays or failure
of the necessary approvals could harm our ability to market the NCP System for
AD, which could harm our business, financial condition and results of
operations.
ANXIETY DISORDERS MARKET 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 U.S. suffer from anxiety disorders. 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). About 20 million people in the U.S. suffer specifically from OCD, PD and
PTSD. Over one million Americans suffer from treatment-resistant anxiety. 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 depressive disorder is a common co-morbidity in
patients with OCD, PD and PTSD. Recent 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 depressive disorder in their lifetimes.
The estimated cost of anxiety disorders in the U.S. alone exceeds $40.0
billion 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.
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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. 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.
VNS THERAPY WITH THE NCP SYSTEM
VNS Therapy 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 showing VNS Therapy 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 Therapy in
patients with depression. In the pilot work in depression, significant
antianxiety effects were observed along with the improvements in depression.
Given the successful use of antidepressants in the treatment of anxiety
disorders and the preliminary demonstration of VNS Therapy as an antidepressant,
the study of VNS Therapy in a treatment-resistant population of patients with
anxiety disorders was initiated.
In December 2000, FDA granted Cyberonics an unconditional IDE for a pilot
study of VNS Therapy with the NCP System in treating patients with OCD, PD and
adult onset PTSD, three of the five major types of anxiety disorders. Up to 30
patients at four sites can be implanted with the NCP System and stimulated with
left cervical VNS Therapy. As of June 25, 2002, the pilot study for patients
with anxiety disorders has been initiated, five sites have been approved and
four of the approved sites have implanted a total of 10 patients.
The clinical study of VNS Therapy for the treatment of anxiety disorders
and other investigational studies are subject to clinical outcome and
significant regulatory restrictions. We can provide you no assurance as to the
ultimate approval outcome of VNS Therapy for the treatment of these disorders.
Any delays or failure of the necessary approvals could harm our ability to
market the NCP System for these disorders, which could harm our business,
financial condition and results of operations.
OBESITY MARKET 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). Obesity is
defined as having a body mass index of 30 kg/m(2) or higher. Approximately one
third of the general population of the U.S., 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 U.S. are morbidly obese which
can be diagnosed when a person is twice his or her ideal weight or at least 100
lbs overweight. Obesity is a significant risk factor for many medical disorders
including diabetes, hypertension and heart 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 U.S. 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, cardiac
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arrhythmias and sudden death, as well as 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 U.S. 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. 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, improve functional capacity and prevent medical or
ameliorate complications such as diabetes. Treatment options for obesity include
diet, exercise, behavior modification, psychotherapy, drug treatment, surgery
and combinations of therapies. Most patients who lose weight do not maintain the
weight loss with currently available treatments.
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, Sibutramine and Orlistat. Sibutramine is a centrally acting agent that
increases the concentration of serotonin and norephinephrine. Orlistat is an
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 commonly being used to treat obesity, restriction operations and
gastric bypass. Restriction operations limit food intake by creating a small
pouch at the top of the stomach where the food enters from the esophagus. The
second type of surgical treatment for obesity is gastric bypass. This operation
combines the creation of a small stomach pouch to restrict food intake and
construction of a bypass of the duodenum and other segments of the small
intestine to prevent calories from being absorbed (malabsorption). There are two
types of gastric bypass: Roux-en-Y (RGB) gastric bypass and extensive gastric
bypass (biliopancreatic diversion). A device that restricts the size of the
stomach using a band, called the Lap-Band, is also commercially available in
some non-U.S. markets and was recently approved by FDA for the treatment of
obesity in the U.S.
Up to 30,000 patients a year are treated with surgery for their obesity in
the U.S. Obesity surgery is typically an open procedure that involves general
anesthesia and significant morbidity and mortality. The surgical procedure costs
from $10,000 to as high as $30,000 per patient.
VNS THERAPY WITH THE NCP SYSTEM
We are currently evaluating the pilot safety and efficacy of VNS Therapy as
a treatment for morbid obesity. In this study we are evaluating the use of
bilateral supra or subdiaphragmatic VNS, where the patient's left and right
vagus nerves just above or just below the diaphragm are stimulated. In this form
of VNS Therapy the vagus nerves in the area of the gut or chest as opposed to
the neck area are stimulated, and it is expected that different stimulation
parameters than those used in epilepsy will be employed. In May 2000, FDA
approved an IDE for a clinical study utilizing VNS Therapy to treat morbid
obesity. Shortly thereafter, we launched a pilot safety and efficacy study using
the NCP System to treat obesity. As of June 25, 2002, three U.S. study sites
have been initiated and two sites have implanted bilateral VNS Therapy in six
patients in this pilot study.
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The clinical study of VNS Therapy for the treatment of morbid obesity and
other investigational studies are subject to clinical outcome and significant
regulatory restrictions. We can provide you no assurance as to the ultimate
approval outcome of VNS Therapy for the treatment of these disorders. Any delays
or failure of the necessary approvals could harm our ability to market the NCP
System for these disorders, which could harm our business, financial condition
and results of operations.
We expect to expend considerable resources completing the pilot studies for
AD, anxiety disorders, obesity and other indications development research in
fiscal 2003 and beyond. In February 2002, we suspended new enrollments in all
new indication studies in order to allow us to focus our limited clinical and
financial resources towards the determination of the effectiveness of VNS
Therapy in depression. The suspension of patient enrollments in all new
indications studies results in a higher degree of uncertainty surrounding the
timing and extent of anticipated clinical study activities in new indications
development.
VAGUS NERVE STIMULATION WITH THE 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 as well as provide patient control of limited stimulation
side effects.
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
eight 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 and in June 2002 received FDA approval for commercial
distribution in the U.S. of the NCP Model 102 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
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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 interrogate the device and to transmit programming
information from a personal computer to the NCP Pulse Generator via
electromagnetic signals. These products are compatible with both Pentium and
non-Pentium based platform personal computers. Programming capabilities include
modification of the NCP Pulse Generator's programmable parameters (pulse width,
output current, signal frequency and stimulation duration and interval) and
storage and retrieval of telemetry data. The NCP programming wand can be
connected to a standard personal computer using a serial connector.
Tunneling Tool. The tunneling tool is a single use 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, the 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 $12,250 for the Model 101 System and
approximately $14,500 for the Model 102 System.
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
U.S. 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 Model 101 and 102 which are similar in design and
manufacture to a cardiac pacemaker, is comprised of either one or two printed
circuit boards respectively 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. 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. 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. Any supply or manufacturing disruption could
significantly harm our business.
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MARKETING AND SALES
United States. We sell and market our products through a direct sales
force in the U.S. As of June 25, 2002, our U.S. sales and marketing organization
consisted of 192 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 payers 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,
regional marketing teams experienced in peer to peer marketing programs and case
managers experienced in patient insurance issues. In addition to our direct
selling activities, we facilitate and support peer to peer interactions such as
symposia, conference presentations, journal articles and patient support groups
to provide experienced clinicians and patients the opportunity to share their
perspectives on the NCP System with others.
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 25, 2002, our international sales and marketing organization consisted
of 20 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
25, 2002, 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 Vagus Nerve Stimulation
successfully depends on favorable coverage, coding and reimbursement for VNS
Therapy. Currently, VNS Therapy has been recommended and/or adopted by most
payers across the U.S., including Aetna, Blue Cross/Blue Shield Technology
Evaluation Center, CHAMPUS, Kaiser Permanente, Centers for Medicare & Medicaid
services (CMS) and most state Medicaid programs.
In deciding to cover a new therapy, payers base their initial coverage
decisions on several factors including, but not limited to, the status of FDA's
review of the product, CMS coverage decision, Blue Cross/ Blue Shield Technology
Evaluation Center, 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. The Cyberonics
Reimbursement Department of 54 employees is available to assist hospitals and
physicians with any reimbursement questions. The department's geography-specific
Regional Alliance Managers and Reimbursement Case Managers are available through
our Reimbursement Hotline, to help with coverage, coding and reimbursement
issues. VNS Therapy coverage for epilepsy treatment is generally approved with
all payers.
In addition to coverage, the success of any new medical device therapy also
depends on specific codes that physicians, surgeons and hospitals need to bill
for their services. The VNS Therapy has specifically approved codes for
physicians, surgeons and hospitals to submit claims for their services to payers
using appropriate codes recognized by American Medical Association. Once a
favorable coverage determination is
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made with respect to a product, payers must determine the level of reimbursement
for the product and related therapy and procedures. In making decisions about
reimbursement amounts payers 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, medical surgical case rates 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 payers determine to cover the VNS Therapy and
related services, we have found that many of these same payment mechanisms have
provided reimbursement levels for the VNS Therapy and related services that
physicians and hospitals view as adequate to support use of the VNS Therapy.
MEDICARE
Effective July 1, 1999, CMS (formerly the Healthcare Financing
Administration, or HCFA), issued National Coverage Policy Transmittal 144
(Section 60-22). This policy is in accordance with FDA-labeled usage for the
device. Currently, Medicare accounts for a total of 20% to 25% of the patients
implanted with VNS Therapy. 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 VNS
Therapy 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. Effective April 1, 2002, the updated APC
rates for the VNS Therapy will positively impact hospital reimbursement. For
inpatient implants, Medicare uses a fixed-payment method, which is an
all-inclusive prospective amount known as Diagnosis Related Groups or DRGs.
Under current DRG groupings, hospital inpatient procedures for implanting the
VNS Therapy 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 co-morbidities. In our experience, 90% of the VNS Therapy are
implanted in the outpatient setting.
MEDICAID
Medicaid programs cover hospital inpatient and outpatient services that are
medically necessary and appropriate. Currently, Medicaid accounts for 15% to 20%
of patients implanted with the VNS Therapy. Most state Medicaid agencies have
developed their own coverage policy for VNS Therapy or adopted the National CMS
coverage policy. In many cases, prior authorization is required. Reimbursement
mechanism varies state by state. 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.
PRIVATE PAYERS
Private payers also cover hospital inpatient and outpatient services that
are considered to be medically necessary. Currently, private payers (commercial,
managed care and other third party payers) accounts for 50% to 55% of patients
implanted with VNS Therapy. As with other payers, many private payers have
developed clinical guidelines for coverage or adopted the National CMS coverage
policy for use of the VNS Therapy. In most cases written authorization is
required. Reimbursement mechanism will vary from plan to plan.
Cyberonics understands that significant sales volume will be difficult to
generate without appropriate reimbursement approvals. We have a dedicated
reimbursement department with 54 employees that includes 30 Case Managers and
eight Regional Alliance Managers to work with all coverage, coding and
reimbursement issues.
Although Vagus Nerve Stimulation using the VNS Therapy has been approved
for commercial distribution in European Union countries and Canada for the
treatment of chronic or recurrent depression, we
15
do not anticipate significant sales volumes in these countries until
reimbursement approvals are achieved in these countries and FDA approval is
achieved in the U.S. We are continuing to pursue appropriate reimbursement
approvals in these countries.
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. Throughout fiscal 2002 and by
the end of June 2002, we received approval for a new family of products
represented in the Model 102 System, including the VNS Therapy Pulse Model 102
Generator, VNS Therapy Lead Model 302, Model 250 NCP Programming Software
Version 4.6 for use with the laptop programming system, the Model 250 NCP
Programming Software 6.1 for use with a handheld programming system, VNS Therapy
Tunneler Model 402 and VNS Therapy Accessory Pack Model 502. We are conducting
ongoing product development programs to design improvements in the NCP Pulse
Generator, the Bipolar Lead and software enhancements. We will be required to
file for the appropriate U.S. 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 the
NCP System. We may also face competition from other medical device companies for
the treatment of partial seizures. Medtronic, Inc., for example, continues to
clinically assess an implantable signal generator used with an invasive deep
brain probe, or thalamic stimulator, for the treatment of neurological disorders
and has received FDA approval for the device for the treatment of essential
tremor, including that associated with Parkinson's Disease. We could also face
competition from other large medical device companies which have the technology,
experience and capital resources to develop alternative devices for the
treatment of epilepsy. Many of our competitors have substantially greater
financial, manufacturing, marketing and technical resources than us. In
addition, the health care industry is characterized by extensive research
efforts and rapid technological progress. Our competitors may develop
technologies and obtain regulatory approval for products that are more effective
in treating epilepsy than our current or future products. In addition,
advancements in surgical techniques could make surgery a more attractive therapy
for epilepsy. The development by others of new treatment methods with novel
antiepileptic drugs, medical devices or surgical techniques for epilepsy could
render the NCP System non-competitive or obsolete. We face similar competition
with respect to the development and sale of VNS Therapy as a treatment for the
other indications we are evaluating, including depression, AD, anxiety disorders
and obesity.
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 and consultant to us, pursuant to which we received exclusive
licenses on four U.S. 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
16
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 U.S. 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 through March 2003. 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 25, 2002, we had
approximately 30 U.S. 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 depression and
anxiety disorders, motility disorders, sleep disorders, coma, chronic pain,
cardiac disorders and hypertension. We have filed counterparts of certain of our
key U.S. 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 U.S. 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 U.S. 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.
17
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 U.S. by federal agencies, primarily FDA, and by
comparable state agencies. In the U.S., 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 U.S.
In July 1997, we received FDA approval to market the NCP System in the U.S.
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 the 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 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 acute phase of 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. In January 2002, the
acute results of the D-02 study on VNS Therapy were completed and unblinded. The
D-02 acute results reported 1) a 15% response rate in the active treatment
group, which did not represent a statistically significant improvement over the
placebo group, 2) a 10% response rate in the placebo group, confirming the
treatment-resistant nature of the study population, 3) completion of the acute
phase by 97% of the active treatment group, confirming the good short-term
tolerability of VNS Therapy and 4) few significant adverse events, confirming
the safety of the implant procedure and good short-term tolerability of VNS
Therapy in depression. We are planning to amend the D-02 protocol's statistical
analysis plan to provide a prospective analysis of the effectiveness of VNS
Therapy using existing long-term data collected as already specified in the D-02
protocol. We have extended the evaluation period of the patients from the acute
study to one year of stimulation experience and we have implemented new
treatment guidelines to increase the amount of stimulation that the patients
receive. We intend to submit an IDE-S to FDA for our revised statistical plan
for the D-02 study no later than September 2002. By March 2003, we expect to
complete our prospective long-term analysis of the D-02 pivotal study and the
D-01 pilot study patients.
In April 2000, the Swedish government approved a pilot clinical study of
VNS Therapy for the treatment of AD. Shortly thereafter, we launched a pilot
study of left cervical VNS Therapy in up to 10 implanted patients with a study
protocol of three months in the acute study and long-term follow-up. In November
2000 the results from the 10 patient pilot study were released. After three
months of VNS Therapy, eight of the 10 patients with AD responded where response
is defined as an improvement in or no worsening of AD symptoms based on the
Alzheimer's Disease Assessment Scale-cognitive (ADAS-cog). Of the eight
18
responders, six had improvements in their symptoms of AD and two had no
worsening. After six months of VNS Therapy, seven of the eight initial
responders continued to sustain their response by having improvements in
symptoms compared to their baseline ADAS-cog assessments. Patients with AD
typically worsen nine points in the ADAS-cog each year. The 10 patients in the
VNS Therapy study had a median improvement in the ADAS-cog of three points after
six months of VNS Therapy. In November 2001, we received approval to extend the
AD pilot study to a total of three sites and 30 patients.
In December 2000, FDA granted Cyberonics an unconditional IDE for a pilot
study of VNS Therapy 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 major types of anxiety
disorders. Up to 30 patients at four sites can be implanted with the NCP System
and stimulated with left cervical VNS Therapy.
In August 2000, FDA approved an IDE for a clinical pilot study utilizing a
new type of VNS Therapy to treat obesity. Shortly thereafter, we launched a
two-phase 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.
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 that 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 U.S. 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 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.
Subsequently a joint follow-up inspection by FDA and TDH in January 2002
resulted in FDA closing out the Warning Letter of March 23, 2001. The TDH stated
that they were also fundamentally satisfied with Cyberonics' corrective actions
relative to compliance with the Medical Device Reporting Regulations referenced
in the TDH Warning Letter of March 9, 2001. However, the TDH issued a Warning
Letter II, dated March 6, 2002, relative to promptness of complaint processing
as
19
similar objections were mentioned in their March 9, 2001 letter. TDH believed
that complaint handling procedures could be improved and TDH formally accepted
the February 20, 2002 Cyberonics' response detailing the corrective action taken
in this regard.
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 the 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
U.S. are subject to regulatory approval by other jurisdictions which may be more
or less rigorous than in the U.S., 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 as well as ISO13485 and EN46001. 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 only be available at significantly
higher premiums or 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 25, 2002, we had 454 full-time employees, including 44 in
engineering and product development, 38 in clinical, 26 in regulatory affairs,
92 in manufacturing and quality assurance, 192 in sales and marketing and 62 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 16 to the consolidated 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 generally be identified by the use of terminology such as
"expect," "may," "will," "intend," "anticipate,"
20
"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, clinical and new indication 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 Therapy 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 92,000 square feet of office and manufacturing space
in Houston, Texas through December 2002. These facilities have renewal options
from three to five years with an automatic renewal option for an additional
three years. We have negotiated the lease of approximately an additional 33,000
square feet in the same building, starting on January 2004. We also lease
approximately 5,400 square feet in a sales office in Brussels, Belgium through
April 2010, and approximately 1,100 square feet in Germany through June 2002.
The property in Germany has a renewal option, and it has been renewed for one
more year, and can be terminated with three months notification.
ITEM 3. LEGAL PROCEEDINGS
The Company is a named defendant in lawsuits from time to time arising in
the ordinary course of business. While the outcome of such lawsuits or other
proceedings against the Company cannot be predicted with certainty, management
does not expect the outcome of these matters will have a material adverse effect
on the financial position or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Results of the votes taken in connection with our annual meeting of
stockholders held on November 29, 2001 are set forth below. At our annual
meeting, stockholders were asked to consider and act upon (1) the election of
Directors for the ensuing year; (2) a proposal to amend the Cyberonics, Inc.
1991 Employee Stock Purchase Plan to increase the number of Common Shares
available for issuance under the plan by an aggregate of 750,000 shares; and (3)
a proposal to ratify the appointment of Arthur Andersen LLP as independent
accountants to examine the financial statements and books and records of
Cyberonics, Inc. for the 2002 fiscal year. The following table sets out, for
each matter where applicable, the number of votes cast for, against or withheld,
as well as the number of abstentions and broker non-votes.
(1) Election of Directors:
NAME OF NOMINEE VOTES FOR VOTES AGAINST
- --------------- ---------- -------------
Robert P. Cummins................................... 16,759,047 1,201,780
Reese S. Terry...................................... 17,735,102 225,725
Stanley H. Appel, M.D............................... 14,598,766 3,362,061
Tony Coelho......................................... 17,827,137 133,690
Thomas A. Duerden, Ph.D............................. 17,828,062 132,765
Michael J. Strauss, M.D............................. 17,818,869 141,958
Alan J. Olsen....................................... 17,828,037 132,790
Ronald A. Matricaria................................ 17,827,737 133,090
21
(2) Proposal to amend the Cyberonics, Inc. 1991 Employee Stock Purchase
Plan to increase the number of Common Shares available for issuance
under the plan by an aggregate of 750,000 shares:
Number of Votes For:........................................ 17,159,535
Number of Votes Against:.................................... 775,190
Number of Votes Abstaining:................................. 26,102
Number of Broker Non-Votes:................................. 0
(3) Proposal to ratify the appointment of Arthur Andersen LLP as
independent accountants to examine the financial statements and books
and records of Cyberonics, Inc. for the 2002 fiscal year:
Number of Votes For:........................................ 17,812,543
Number of Votes Against:.................................... 26,613
Number of Votes Abstaining:................................. 121,671
Number of Broker Non-Votes:................................. 0
In April 2002, Arthur Andersen LLP was dismissed as our independent
accountants for the 2002 fiscal year. See "Item 9. Changes in and Disagreements
with Accountants on Accounting and Financial Disclosure."
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 2001 and
2002 are set forth below. Price data reflect actual transactions, but do not
reflect mark-ups, mark-downs or commissions.
HIGH LOW
------ ------
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
FISCAL YEAR ENDED APRIL 26, 2002
First Quarter............................................... $17.00 $10.40
Second Quarter.............................................. 19.20 13.65
Third Quarter............................................... 29.75 11.47
Fourth Quarter.............................................. 17.00 12.56
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 for existing and new indications, 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 25, 2002, there were 397 stockholders of record.
22
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.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of April 26, 2002 about our
common stock that may be issued upon the exercise of options, warrants and
rights under all of our existing equity compensation plans, including the 1988
Incentive Stock Plan, the Amended and Restated 1996 Stock Option Plan and the
1998 Stock Option Plan.
(A) (B) (C)
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR FUTURE
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE ISSUANCE UNDER EQUITY
ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING COMPENSATION PLANS
OUTSTANDING OPTIONS, OPTIONS, WARRANTS (EXCLUDING SECURITIES REFLECTED
PLAN CATEGORY WARRANTS AND RIGHTS AND RIGHTS IN COLUMN (A))
------------- -------------------------- ------------------------- -------------------------------
Equity compensation plans
approved by security
holders................... 1,577,352 $14.83 234,350
Equity compensation plans
not approved by security
holders(1)................ 5,553,017 $13.26 749,889
--------- ------ -------
Total....................... 7,130,369 $13.60 984,239
========= ====== =======
- ---------------
(1) The 1988 Incentive Stock Plan, the Amended and Restated 1996 Stock Option
Plan and the 1998 Stock Option Plan were approved by our Board of Directors
and became effective in March 1988, November 1996 and October 1998,
respectively. Options granted under the 1988 Incentive Stock Plan and the
Amended and Restated 1996 Stock Option Plan generally vest ratably over four
or five years following their date of grant. Options granted under the 1998
Stock Option Plan generally vest 10 years from the grant date but can
accelerate based upon the achievement of specific milestones related to
regulatory approval and the achievement of Company objectives. Options
granted have a maximum term of 10 years.
23
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 for 12 months ended June 30, 2000, the 10 months ended
April 27, 2001, and the 52 weeks ended April 26, 2002 is derived from
consolidated financial statements which are included elsewhere herein, and that
for the 12 months ended June 30, 2000 and the 10 months ended in April 27, 2001,
has been audited by Arthur Andersen LLP, and for the 52 weeks ended April 26,
2002 has been audited by KPMG LLP, both independent auditing firms, except for
the 12 months ended April 27, 2001 which were not audited due to the Company's
change in fiscal year, and are presented here for comparison purposes. The
selected financial data for the years ended June 30, 2000, June 30, 1999, and
June 30, 1998 are derived from audited financial statements not included herein.
See Item 9. "Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure."
52 WEEKS ENDED 12 MONTHS ENDED JUNE 30
------------------------------- 10 MONTHS ENDED ------------------------------------------
APRIL 26, 2002 APRIL 27, 2001 APRIL 27, 2001 2000 1999 1998
-------------- -------------- --------------- ------------ ------------ ------------
(UNAUDITED)(1)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net sales........................ $ 70,111,293 $ 53,567,994 $ 43,418,736 $ 47,888,733 $ 29,927,476 $ 14,912,868
Cost of sales.................... 13,616,374 14,338,769 11,806,353 11,833,507 7,736,137 3,902,468
------------- ------------- ------------- ------------ ------------ ------------
Gross profit..................... 56,494,919 39,229,225 31,612,383 36,055,226 22,191,339 11,010,400
Operating expenses:
Selling, general and
administrative............... 59,190,554 39,826,652 33,571,072 33,269,266 29,585,570 19,781,268
Research and development....... 24,516,547 19,414,819 17,201,179 8,037,096 6,724,106 7,391,426
Non-recurring charges.......... -- 6,467,415 6,467,415 -- -- --
------------- ------------- ------------- ------------ ------------ ------------
Total operating expenses... 83,707,101 65,708,886 57,239,666 41,306,362 36,309,676 27,172,694
Interest income.................. 1,264,853 1,428,845 1,141,939 1,364,985 1,465,549 1,976,792
Interest expense................. (266,270) (68,868) (65,331) (3,349) -- --
Other income (expense), net...... 93,694 (37,544) (147,058) (44,894) 115,236 10,790
------------- ------------- ------------- ------------ ------------ ------------
Net loss before cumulative effect
of a change in accounting
principle...................... $ (26,119,905) $ (25,157,228) $ (24,697,733) $ (3,934,394) $(12,537,552) $(14,174,712)
Cumulative effect on prior years
of change to a different method
of depreciation................ -- -- -- 881,150 -- --
------------- ------------- ------------- ------------ ------------ ------------
Net loss................... $ (26,119,905) $ (25,157,228) $ (24,697,733) $ (3,053,244) $(12,537,552) $(14,174,712)
============= ============= ============= ============ ============ ============
Basic and diluted net loss
per share................ $ (1.21) $ (1.31) $ (1.27) $ (0.17) $ (0.72) $ (0.88)
============= ============= ============= ============ ============ ============
Shares used in computing basic
and diluted net loss per
share.......................... 21,655,009 19,247,253 19,382,460 18,044,692 17,503,169 16,104,922
============= ============= ============= ============ ============ ============
CONSOLIDATED BALANCE SHEET DATA
(AS OF YEAR END):
Cash, cash equivalents and
marketable securities.......... $ 38,195,962 $ 57,250,907 $ 57,250,907 $ 20,537,450 $ 24,858,123 $ 38,037,343
Working capital.................. 26,917,752 51,131,639 51,131,639 30,881,340 25,975,079 39,246,128
Total assets..................... 64,322,876 78,314,924 78,314,924 44,498,435 39,783,153 52,615,294
Accumulated deficit.............. (129,750,148) (103,630,243) (103,630,243) (78,932,510) (75,879,266) (63,341,714)
Common stockholders' equity...... $ 36,613,813 $ 59,647,084 $ 59,647,084 $ 38,407,975 $ 33,448,445 $ 44,698,719
- ---------------
Note: (1) The comparative period presented is unaudited because the Company
changed its fiscal year in April 2001.
24
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.
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 Investigational Device Exemption (IDE)
from FDA. We received FDA approval to market the NCP System in the U.S. 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 include product and process development and clinical trials and
related regulatory activities, sales and marketing activities, manufacturing
start-up costs and system infrastructure. We have also made significant
investments in recent periods in connection with the U.S. 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, AD, anxiety, obesity, 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 2002 started April 28, 2001 and ended April 26, 2002
and fiscal 2001 started July 1, 2000 and ended April 27, 2001.
For the period from inception through April 26, 2002, we incurred a
cumulative net deficit of approximately $129.8 million. Moreover, we expect to
devote considerable financial resources 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 mid-calendar 2004
if at all. As a result, we will continue to experience operating losses through
fiscal 2003. 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 2004, if at all.
25
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.
CRITICAL ACCOUNTING POLICIES
The Company considers the following accounting policies as the most
critical because, in management's view, they are most important to the portrayal
of the Company's financial condition and results and most demanding in their
calls on judgement.
Accounts Receivable. The Company provides an allowance for doubtful
accounts based upon specific customer risks and a general provision based upon
historical trends. An increase in losses beyond that expected by management or
that historically experienced by the Company would reduce earnings when they
become known.
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. Management considers
potential obsolescence at each balance sheet date. An acceleration of
obsolescence could occur if consumer demand should differ from expectations.
Property and Equipment. Property and equipment are carried at cost, less
accumulated depreciation. Maintenance, repairs and minor replacements are
charged to expense as incurred; significant renewals and betterments are
capitalized for financial reporting purposes, the Company computes depreciation
using the straight-line method over useful lives ranging from three to nine
years. An unanticipated change in the utilization or expected useful life of
property and equipment would result in an acceleration in the timing of the
expenses.
Fair Value of Financial Instruments. The carrying amounts reported in the
consolidated balance sheets for cash and cash equivalents, accounts receivable,
accounts payable, and line of credit approximate their fair values due to the
short-term maturity of these financial instruments.
Revenue Recognition. Revenue from product sales is generally recognized
upon shipment to the customer, net of estimated returns and allowances. The
Company's revenues are dependent upon sales to new and existing customers
pursuant to the Company's policy. A change in this policy or sales terms could
impact the amount and timing of revenue recognized.
Research and Development. All research and development costs are expensed
as incurred. The Company has entered into contractual obligations for the
conduct of clinical studies. Costs are incurred primarily at the time of
enrollment and paid under the terms of the contracts. Research and development
expenses could vary significantly with changes in the timing of clinical
activity.
Warranty Expense. The Company provides at the time of shipment for costs
estimated to be incurred under its product warranties. Provisions for warranty
expenses are made based upon projected product warranties. Amounts actually paid
could vary subject to certain factors discussed in "Factors Affecting Future
Operating Results" discussed below.
RESULTS OF OPERATIONS
Net Sales. Net sales for the 52 weeks ended April 26, 2002 totaled $70.1
million, compared to net sales of $53.6 million for the 52 weeks ended April 27,
2001. Net sales of $53.6 million for the 52 weeks ended April 27, 2001 increased
over fiscal 2000 by 11.9%. The growth is primarily due to increases in unit
sales in the U.S. as well as increases in average selling prices in all markets.
U.S. net sales for the 52 weeks ended April 26, 2002 were $63.8 million,
compared to $47.7 million and $42.5 million for the 52 weeks ended April 27,
2001 and the 12 months ended June 30, 2000, respectively. International sales
for the 52 weeks
26
ended April 26, 2002 were $6.3 million compared to $5.9 million and $5.4 million
for the 52 weeks ended April 27, 2001 and the 12 months ended June 30, 2000,
respectively.
Substantially all sales for all periods presented were for epilepsy product
sales. Future increases in net sales will depend upon increased market
acceptance for the NCP System and upon expanding our reimbursement from
third-party payers. 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. Gross margin was 80.6% for the
52 weeks ended April 26, 2002, as compared to 73.2% and 75.3% for the 52 weeks
ended April 27, 2001 and 12 months ended June 30, 2000 respectively. The
increase in gross margin in fiscal 2002 is the result of increases in average
selling prices and improvement in manufacturing production efficiencies. Gross
profit margin as a percent of sales 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 payers, 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 52 weeks ended April 27, 2001 would have been 76.6%, or an
increase of 1.3% over the 12 months ended June 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 $59.2 million or 84.4% of net sales for the 52
weeks ended April 26, 2002, as compared to $39.8 million or 74.3% of net sales
for the 52 weeks ended April 27, 2001 and $33.3 million or 69.5% of net sales
for the 12 months ended June 30, 2000. The increase in fiscal 2002 over prior
year is primarily due to the additional marketing programs implemented during
fiscal 2002 in the U.S. and Europe to expand awareness and acceptance of VNS
Therapy for the treatment of chronic depression with psychiatrists through
targeted educational initiatives and increased participation in industry
marketing events. Administrative staffing levels also increased to support the
growth of the organization over fiscal 2001. The increase in fiscal 2001 over
fiscal 2000 is primarily due to the expansion of our sales force in late fiscal
2000 and in personnel to support overall infrastructure and business system
improvements.
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 $24.5 million, or 35% of net sales for the 52 weeks
ended April 26, 2002, compared to $19.4 million, or 36.2% of net sales for the
52 weeks ended April 27, 2001 and $8.0 million, or 16.8% of net sales for the 12
months ended June 30, 2000. The increase is due to the additional costs
associated with the depression pivotal study and other new indication pilot
studies and expanded regulatory activities supporting the growth of the
business.
Non-recurring Charges. Non-recurring charges were $6.5 million for the 52
weeks 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 $1.3 million during the 52 weeks
ended April 26, 2002, compared to $1.4 million for the 52 weeks ended April 27,
2001 and $1.4 million for the 12 months ended June 30, 2000. We expect interest
income to gradually decrease in absolute dollars in future periods, as we
utilize our resources to fund future working capital requirements.
27
Interest Expense. Interest expense was $266,000 for the 52 weeks ended
April 26, 2002, as compared to $69,000 for the 52 weeks ended April 27, 2001 and
$3,000 for the 12 months ended June 30, 2000. Interest expense has increased due
to the establishment of a $10 million credit facility in September 2001 which
bears interest of the designated bank rate plus 1.5% on the greater of
$3,000,000 or the average of net balances owed by the Company at the close of
each day during the month and includes interest expense on capital leases for
manufacturing equipment which bears interest at 6.56% over a term of five years.
Other Income (Expense), Net. Other income (expense), net, totaled $94,000
during the 52 weeks ended April 26, 2002, compared to ($38,000) during the 52
weeks ended April 27, 2001 and ($45,000) for the 12 months ended June 30, 2000.
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 26, 2002, we had operating loss carryforwards for
federal income tax purposes of approximately $118.3 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 $881,000 (net of income tax of $0) and is included in
income for the fiscal year ended June 30, 2000.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations primarily through
public and private placements of our securities. In February 2001, we raised
approximately $42.4 million from the sale of Common Stock in a private offering.
On June 30, 2000, we entered into capital leases for the acquisition of
manufacturing equipment valued at approximately $650,000 and used in the
production of the NCP System. The capital leases bear interest of 6.56% and
extend through April 2005. In September 2001 we established a revolving credit
facility for $10,000,000 with a term of three years. The credit facility is
collateralized by accounts receivable, inventory, equipment, documents of title,
general intangibles, subsidiary stock and other collateral. Borrowings against
the facility are based upon eligible accounts receivable. The net available
borrowing base at April 26, 2002 was $1,181,000. Interest is payable in the
amount of the designated bank rate plus 1.5% on the greater of $3,000,000 or the
average of the net balance owed by the Company at the close of each day during
the period. Under the terms of the revolving credit facility, we agreed to
maintain liquidity (being the aggregate of availability under the credit
facility and cash) equal to or greater than $5,000,000 and limit annual capital
expenditures to $4,000,000. As of April 26, 2002, we were in violation of this
loan's capital expenditure provision that was subsequently waived by the lender
for the 52 weeks ended April 26, 2002. An unused line of credit fee is payable
at the rate of 0.5%. As of April 26, 2002, we had $6,500,000 in borrowings
outstanding under the credit facility.
During the 52 weeks ended April 26, 2002, net cash used in operating
activities was approximately $22,951,000. Accounts receivable increased
$3,690,000 to $10,331,000 at April 26, 2002 from $6,641,000 at April 27, 2001.
Inventories increased $282,000 to $4,528,000 at April 26, 2002 from $4,246,000
at April 27, 2001. During the 52 weeks ended April 26, 2002, we used
approximately $5,082,000 in the purchase of property and equipment. During the
same period we received approximately $2,688,000 in proceeds from the exercise
of stock options and $1,792,000 from maturities of marketable securities.
During the 10 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 and common stock acquired
through the Employee Stock Purchase Plan. During the 10 months ended April 27,
2001, we raised approximately $42.4 million from the sale of Common Stock in a
private equity offering.
28
During the 12 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 during the 12 months ended June 30, 2000 in proceeds
from the exercise of stock options held by our employees.
Our liquidity will continue to be reduced as funds are expended to support
clinical trials and related regulatory activities, epilepsy sales growth, and
product and process development. We are a party to a number of contracts
pursuant to which we are paying for clinical studies for which current operating
obligations payable totaled $5.9 million as of April 26, 2002. Although we have
no firm commitments, we expect to make capital expenditures of approximately
$4.0 million during fiscal 2003, primarily to expand manufacturing capabilities,
and to enhance business infrastructure and facilities. Our current projections
indicate that we have sufficient funds and cash flow resources to fund
anticipated business activities through January 25, 2004, without additional
financing.
Our cash flow could, however, be adversely effected by the "Factors
Affecting Future Operating Results" discussed below. We would consider
reasonably priced additional financing which would provide funding for new
indications development and unplanned or expanded clinical studies. Financing
through debt or equity instruments may be available, although the availability
of such financing will depend upon a number of important factors, including the
strength of the U.S. capital markets and economy, the health care and medical
device segments in particular and the status of our business activities,
including epilepsy sales growth and clinical and regulatory activities. The
chart below reflects our current obligations under our material contractual
obligations.
CAPITAL LEASE TOTAL CONTRACTUAL
LINE OF CREDIT OBLIGATIONS OPERATING LEASES OBLIGATIONS
-------------- ------------- ---------------- -----------------
CONTRACTUAL OBLIGATIONS:
Less Than One Year........... $6,500,000 $123,765 $ 1,753,634 $ 8,377,399
1-3 Years.................... -- 274,969 4,009,703 4,284,672
4-5 Years.................... -- -- 4,026,268 4,026,268
Over Five Years.............. -- -- 1,842,066 1,842,066
---------- -------- ----------- -----------
Total Contractual
Obligations................ $6,500,000 $398,734 $11,631,671 $18,530,405
========== ======== =========== ===========
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
See Note 10 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.
Our common stock price constantly changes. A public market for our common
stock has existed since 1996. Our common stock is now traded on the Nasdaq
National Market under their ticker symbol "CYBX." The price of stock on that
trading market fluctuates, and we expect that the market price of common stock
will continue to fluctuate. For instance, since April 28, 2001, our stock has
traded from a low of $10.40 to a high of $29.75 per share. The fluctuation in
our stock price is caused by a number of factors, some of which are beyond our
control, including:
- quarterly variations in our operating results;
- results of studies regarding the efficacy of our VNS Therapy treatment
for other indications including depression, AD, anxiety and obesity
disorders;
29
- announcements of significant contracts, acquisitions, or capital
commitments;
- changes in financial estimates by securities analysts;
- changes in market valuations of medical device companies;
- additions or departures of key personnel;
- sales of common stock; and
- changes in the general conditions of the economy.
In addition, the stock market in recent years has experienced broad price
and volume fluctuations that have often been unrelated to the operating
performance of companies. These broad market fluctuations have also adversely
affected, and may continue to adversely affect, the market price of our common
stock.
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 U.S. for at least the next two
fiscal years, if at all. Although sales of the NCP System have been increasing,
we cannot assure you that sales will continue to increase at the same rate or at
all. 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 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 anxiety disorders, AD applications
and obesity. 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
the NCP System to treat epilepsy, which could cause our sales to
decrease. Continued market acceptance of the 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 16,000 patients through June 25, 2002, 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 continue to achieve
expanded 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 Therapy for the
treatment of depression, AD, anxiety, obesity, or any other indications. We are
in the process of conducting studies to help us evaluate, and potentially obtain
FDA approval, for the use of VNS Therapy as a treatment for depression, AD,
anxiety, obesity and other neurological disorders. We cannot assure you that our
test results will be positive 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 the NCP
System gains market acceptance, the timing of obtaining marketing approvals for
the NCP System for other indications, the timing of any approvals for
reimbursement by third-party payers,
30
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 increased 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 maintain adequate third-party reimbursement on our
product. Our ability to commercialize the NCP System successfully depends in
part on whether third-party payers, including private health care insurers,
managed care plans, the U.S. 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 U.S. or internationally. If we fail to
maintain 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 payers on a broad basis. In addition, due to limited
market awareness of the NCP System, we believe that continuing to expand our
sales could be a lengthy and costly process requiring us to continue to educate
patients, health care providers and third-party payers regarding the clinical
benefits and cost-effectiveness of the NCP System. In certain international
territories, we rely, and intend to continue to rely, upon independent
distributors. We may not be able to recruit and retain skilled marketing and
sales personnel or foreign distributors to support our marketing and sales
efforts. Our failure to successfully market and sell the 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 if
or, 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 defects and result in product
recalls. The NCP System includes a complex electronic generator device and lead
device designed to be implanted in the human body. Component failures,
manufacturing or shipping problems or design defects could result in the product
not delivering the therapy for which it is indicated. The occurrence of such
problems or other adverse clinical reactions could result in a recall of our
products, possibly requiring explantation and potential reimplantation of the
NCP System which may increase risk to the patient. 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
31
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
U.S. 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 the
NCP System. We may also face competition from other medical device companies
that have the technology, experience and capital resources to develop
alternative devices for the treatment of epilepsy. Medtronic, Inc., for example,
continues to clinically assess an implantable signal generator used with an
invasive deep brain probe, or thalamic stimulator, for the treatment of
neurological disorders and has received FDA approval for the device for the
treatment of essential tremor, including that associated with Parkinson's
Disease. Many of our competitors have substantially greater financial,
manufacturing, marketing and technical resources than we do and have obtained
third-party reimbursement approvals for their therapies. In addition, the health
care industry is characterized by extensive research efforts and rapid
technological progress. Our competitors may develop technologies and obtain
regulatory approval for products that are more effective in treating epilepsy
than our current or future products. In addition, advancements in surgical
techniques may make surgery a more attractive therapy for epilepsy. The
development by others of new treatment methods with novel antiepileptic drugs,
medical devices or surgical techniques for epilepsy could render the NCP System
non-competitive or obsolete. We may not be able to compete successfully against
current and future competitors, including new products and technology, which
could severely harm our business, financial condition or results of operations.
If we fail to effectively manage our growth, our ability to maintain our
costs or capture new business could suffer. In connection with the
commercialization of the NCP System in the U.S., 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 only be available at significantly higher premiums or 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 U.S. by
federal agencies, primarily FDA, and by comparable state agencies. In the
future, it will be necessary for us to obtain
32
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 U.S. We may not be successful in
increasing our international market sales or in obtaining reimbursement or any
regulatory approvals required in foreign countries. The anticipated
international nature of our business is also expected to subject us and our
representatives, agents and distributors to laws and regulations of the foreign
jurisdictions in which we operate or where the NCP System is sold. The
regulation of medical devices in a number of such jurisdictions, particularly in
the European Union, continues to develop and new laws or regulations may impair
our ability to market and sell our products in those jurisdictions.
ITEM 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 U.S. Government obligations, our line of credit
and our fixed rate long-term debt. We do not hedge interest rate exposure or
invest in derivative securities. We are exposed to market risk from changes in
foreign currency exchange rates. Our wholly-owned foreign subsidiary is
consolidated into our financial results. Our reported revenues, expenses and
cash flows from this subsidiary are exposed to changing exchange rates. To date
there have not been material fluctuations in foreign currency exchange rates. At
this time, we have not deemed it to be cost effective to engage in a program of
hedging the effect of foreign currency fluctuations on our operating results
using derivative financial instruments.
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-23 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Audit Committee of the Board of Directors annually considers and
recommends to the Board of Directors of Cyberonics the selection of Cyberonics'
independent public accountants. As recommended by Cyberonics' Audit Committee,
Cyberonics' Board of Directors on April 10, 2002 decided to dismiss Arthur
Andersen LLP as Cyberonics' independent public accountants.
Arthur Andersen LLP's reports on Cyberonics' consolidated financial
statements for both of the past two fiscal years did not contain an adverse
opinion or disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principles.
During Cyberonics' two most recent fiscal years and through April 10, 2002,
there were no disagreements with Arthur Andersen LLP on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure, which disagreements, if not resolved to the satisfaction of Arthur
Andersen LLP, would have caused Arthur Andersen LLP to make reference to the
subject matter of the disagreements in connection with Arthur Andersen LLP's
report; and during such period there were no "reportable events" of the kind
listed in Item 304(a)(1)(v) of Regulation S-K.
33
Cyberonics provided Arthur Andersen LLP with a copy of the foregoing
disclosure and requested Arthur Andersen LLP to furnish Cyberonics with a letter
addressed to the Securities and Exchange Commission stating whether it agrees
with the statements by Cyberonics in the foregoing disclosure and, if not,
stating the respects in which it does not agree. We recently received such a
letter indicating that Arthur Andersen LLP agreed with the foregoing statements
on April 16, 2002.
On April 22, 2002, we engaged KPMG LLP to serve as Cyberonics' independent
public accountants and to audit Cyberonics' financial statements for the fiscal
year 2002. The engagement of KPMG LLP was recommended by the Audit Committee and
approved by the Board of Directors of Cyberonics. Our Audit Committee has
reviewed and discussed the audited consolidated financial statements included in
this annual report on Form 10-K, and has recommended, and the Board has approved
their inclusion herein.
During Cyberonics' two most recent fiscal years and through April 22, 2002,
Cyberonics did not consult KPMG LLP with respect to the application of
accounting principles to a specified transaction, either completed or proposed,
or the type of audit opinion that might be rendered on Cyberonics' consolidated
financial statements, or any other matters or reportable events listed in Items
304(a)(2)(i) and (ii) of Regulation S-K.
Arthur Andersen LLP completed its audit of our consolidated financial
statements for the 12 months ended June 30, 2000 and the 10 months ended April
27, 2001 and issued their report with respect to such consolidated financial
statements on June 21, 2001. We requested a consent of Arthur Andersen LLP to
incorporate their report dated June 21, 2001 included in this Form 10-K but were
unsuccessful in obtaining such consent. Recently, Arthur Andersen LLP was
convicted of obstruction of justice for activities relating to its previous work
for Enron Corp., and Arthur Andersen LLP announced that it would cease to audit
publicly held companies by August 31, 2002. We are unable to predict the impact
of this conviction or Arthur Andersen LLP's announcement on Arthur Andersen LLP
or whether other indictments or adverse actions may be taken by governmental or
private parties against Arthur Andersen LLP. If Arthur Andersen LLP ceases the
conduct of its business or has no assets available for creditors, our
stockholders may not be able to recover against Arthur Andersen LLP for any
claims they may have under securities or other laws as a result of Arthur
Andersen LLP's previous role as our independent auditors and as author of the
audit report for the audited consolidated financial statements included herein.
34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and directors, their ages as of June 25, 2002, and
certain additional information about them, are as follows:
NAME AGE POSITION
---- --- --------
Robert P. Cummins..................... 48 Chairman of the Board of Directors,
President and Chief Executive Officer and
Director
Pamela B. Westbrook................... 44 Vice President, Finance and Administration,
Chief Financial Officer and Secretary
Michael A. Cheney..................... 48 Vice President, Marketing
David F. Erinakes..................... 39 Vice President, Sales
Shawn P. Lunney....................... 39 Vice President, Market Development
Richard Rudolph, M.D.................. 53 Vice President, Clinical and Medical Affairs
and Chief Medical Officer
Alan D. Totah......................... 58 Vice President, Regulatory Affairs
Stanley H. Appel, M.D................. 68 Director
Tony Coelho........................... 60 Director
Thomas A. Duerden, Ph.D. ............. 72 Director
Ronald A. Matricaria.................. 59 Director
Alan J. Olsen......................... 55 Director
Michael J. Strauss, M.D. ............. 49 Director
Reese S. Terry, Jr. .................. 59 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, Mr. Cummins was also a general partner of Vista Partners, L.P., a venture
capital partnership which he joined in 1984, a general partner of Vista III
Partners, L.P., a venture capital firm formed in 1986 and Vice President of
Vista Ventures Inc., a venture capital advisory firm. Until July 1998, Mr.
Cummins was also a director of Sigma Circuits Inc., a manufacturer of electronic
interconnect products.
Ms. Westbrook joined Cyberonics as Vice President, Finance and
Administration and Chief Financial Officer in October 1998. She was appointed
Secretary of Cyberonics in June 2001. Ms. Westbrook has over 20 years in
financial management experience and over 16 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. During her
employment with SulzerMedica, Ms. Westbrook was Vice President, Finance for
SulzerMedica, and Vice President, Controller for Sulzer Cardiovascular
Prosthesis Division.
Mr. Cheney joined Cyberonics in July of 2001 as Vice President of Marketing
and Managing Director of the Depression Business Unit. Mr. Cheney has more than
15 years of pharmaceutical marketing and product launch experience. Most
recently, Mr. Cheney was Senior Director, Obesity Business Unit at Knoll
Pharmaceutical Company (recently acquired by Abbott Laboratories), where he was
responsible for the launch of Meridia(R)(sibutramine hydrochloride), a leading
anti-obesity drug. Prior to that, Mr. Cheney was Group Director, Central Nervous
System Therapeutics Marketing at Wyeth-Ayerst Laboratories, a subsidiary of
American Home Products, where he was responsible for the marketing of Effexor(R)
(venlafaxine hydrochloride) and the launch of Effexor(R) XR, a leading brand of
medication for the treatment of depression.
35
Mr. Erinakes joined Cyberonics in 2000. He has served as Regional Sales
Director, Geographic Business Unit Director, and National Sales Director, and
currently serves as Vice President of Sales. Prior to joining Cyberonics, Mr.
Erinakes held the position of CNS and Pediatric Specialty Manager for the
Southeast at Pfizer and Manager of the U.S. Field Force Development/IT. In
addition, Mr. Erinakes serves in the Army Reserve, and has previously served in
the U.S. Army.
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.
Dr. Rudolph joined Cyberonics in August 2001. He has 16 years of
pharmaceutical research, medical and management experience in the neuroscience
area. Dr. Rudolph was responsible for the long-term clinical development of a
major antidepressant through all phases of drug development from Phase I to
Phase IV. He has authored and co-authored numerous publications. Most recently,
Dr. Rudolph was Senior Director, Clinical Research and Development at
Wyeth-Ayerst Research. During his 16 year career at Wyeth-Ayerst, Dr. Rudolph
was responsible for numerous clinical studies and research on Effexor
(venlafaxine hydrochloride) and Effexor XR, a leading brand of medication for
the treatment of patients with depression and generalized anxiety disorder.
Mr. Totah joined Cyberonics as Vice President, Regulatory Affairs in
February 2001. 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.
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.
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, Inc., 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
36
International Corporation since July 1991. In addition to the Cyberonics Board
of Directors, Mr. Matricaria serves on the Board of Directors for St. Jude
Medical, Inc., Endocare, Inc. and Cardiodynamics International Corporation, and
is an advisor to several medically related privately owned companies and a
private equity healthcare fund.
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.
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 is the CEO of PEM Technologies, Inc. which is developing
organ-specific positron emission to tomography, (PET) scanners. Dr. Strauss was
a founder and President of Covance Health Economics and Outcome Services, Inc.
and negotiated its sale to Corning Inc. He also is a member of the Medicare
Coverage Advisory Committee (CMS) 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. 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 for a portion of 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.
BOARD COMPOSITION
Pursuant to a letter agreement dated March 28, 1997, the Clark Estates is
entitled to designate one person whom it wishes to have appointed to serve on
our Board of Directors. This right lasts for as long as the Clark Estates
retains at least 600,000 of the aggregate of 901,408 shares of Common Stock
purchased on such date by parties affiliated with the Clark Estates. To date,
the Clark Estates has not exercised this right.
BOARD MEETINGS AND COMMITTEES
Our Board of Directors held a total of five meetings and acted by written
consent 7 times during the 52 weeks ended April 26, 2002. The Board has an Audit
Committee, a Compensation Committee and a Nominating Committee.
The Audit Committee, which consists of Michael J. Strauss, M.D., Thomas A.
Duerden and Alan J. Olsen, held eight meetings during the 52 weeks ended April
26, 2002. This Committee recommends engagement of our independent auditors and
is primarily responsible for approving the services performed by such
accountants, including the audit conducted by KPMG LLP and included herein, and
for reviewing and evaluating our accounting principles and our system of
internal accounting controls.
The Compensation Committee, which consists of Stanley H. Appel, Tony
Coelho, and Ronald A. Matricaria, held two meetings and acted by written consent
25 times during the 52 weeks ended April 26, 2002. This Committee establishes
salary and incentive compensation of our executive officers and administers
employee benefit plans.
During the 52 weeks ended April 26, 2002, all current directors attended at
least 80% of the meetings of the Board of Directors and the number of meetings
held by committees on which the director served.
37
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,
directors and persons who own more than 10% 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 10% stockholders are also required by SEC rules to
furnish us with copies of all Section 16(a) forms they file.
For fiscal 2002, an initial report on Form 3 for Ronald Matricaria was
filed late. This report reflects that Mr. Matricaria did not own any of our
stock as of the filing date. In addition, an initial report on Form 3 for Burke
Barrett was filed late. Mr. Barrett is no longer with the Company. Annual
reports on Forms 5 for fiscal 2002 were filed late for Robert P. Cummins, Tony
Coelho and Shawn P. Lunney. To our knowledge, all other Section 16(a) filing
requirements applicable to our officers, directors and 10% stockholders were
timely made in compliance with filing requirements.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth the
compensation paid by us for the 52 weeks ended April 26, 2002 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................ 2002 $370,178 $373,348 150,000 $ 396(1)
Chairman of the Board,
President 2001 242,308 105,000 450,000 350(1)
and Chief Executive Officer 2000 236,538 170,335 100,000 420(1)
Pamela B. Westbrook.............. 2002 $201,813 $138,056 15,000 $ 396(1)
Vice President, Finance & 2001 149,423 39,081 -- 289(1)
Administration, Chief Financial 2000 155,769 40,335 -- 347(1)
Officer and Secretary
Shawn P. Lunney.................. 2002 $185,000 $121,182 -- $ 396(1)
Vice President, Market 2001 149,423 32,375 -- 289(1)
Development 2000 155,769 2,835 -- 347(1)
Michael A. Cheney(2)............. 2002 $201,933 $124,942 175,000 $ 82,314(3)
Vice President, Marketing
David F. Erinakes(4)............. 2002 $169,698 $ 31,875 75,000 $240,414(5)
Vice President, Sales
- ---------------
(1) Represents premium paid for term-life insurance.
(2) Mr. Cheney joined the Company in July of 2001; accordingly no compensation
was paid to Mr. Cheney during fiscal years 2001 and 2000.
(3) Represents $396 for term-life insurance and $81,918 for expenses paid to Mr.
Cheney associated with relocation to Houston.
(4) Mr. Erinakes joined the Company in 2000 but was not promoted to Vice
President of Sales until January 2002; accordingly, Mr. Erinakes was not an
executive officer during fiscal years 2001 and 2000.
38
(5) Represents $327 for term-life insurance and $240,414 in commissions paid to
Mr. Erinakes as National Sales Director.
Option Grants in Last Fiscal Year. The following table sets forth each
grant of stock options made during the 52 weeks ended April 26, 2002 to each of
the named executive officers.
INDIVIDUAL GRANTS
------------------------------------------------------ POTENTIAL REALIZABLE VALUE
NUMBER OF PERCENT OF AT ASSUMED ANNUAL RATES
SECURITIES TOTAL OPTIONS OF STOCK PRICE APPRECIATION
UNDERLYING GRANTED TO FOR OPTION TERM ($)(2)
OPTIONS EMPLOYEES IN EXERCISE EXPIRATION ---------------------------
NAME GRANTED(#) FISCAL YEAR(1) PRICE($/SH) DATE 5% 10%
- ---- ---------- -------------- ----------- ---------- ------------ ------------
Robert P. Cummins....... 150,000 5% $12.80 6/25/2011 $1,207,478 $3,059,985
Pamela B. Westbrook..... 15,000 1% $12.80 6/25/2011 120,748 305,999
Shawn P. Lunney......... -- 0% -- -- -- --
Michael A. Cheney....... 150,000 5% $15.10 7/6/2011 1,424,446 3,609,827
Michael A. Cheney....... 25,000 1% $12.45 1/24/2012 195,743 469,052
David F. Erinakes....... 50,000 2% $14.88 10/26/2011 467,898 1,185,744
David F. Erinakes....... 25,000 1% $12.45 1/24/2012 195,743 469,052
- ---------------
(1) Total number of shares subject to options granted to employees in fiscal
2002 was 2,930,989 which includes options granted to employee directors.
(2) Potential realizable value is based on an assumption that the stock price
appreciates at the annual rate shown (compounded annually) from the date of
grant until the end of the ten-year option term. These numbers are
calculated based on the requirements promulgated by the SEC and do not
reflect our estimate of future stock price growth.
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-end
Values. The following table sets forth, for each of the named executive
officers, each officer's exercise of stock options during the 52 weeks ended
April 26, 2002 and the year-end value of unexercised options:
NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED ON VALUE OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END
NAME EXERCISE(#) REALIZED($)(1) EXERCISABLE/UNEXERCISABLE(#)(2) EXERCISABLE/UNEXERCISABLE($)(3)
- ---- ----------- -------------- ------------------------------- -------------------------------
Robert P. Cummins.... -- -- 742,291/536,659 $2,746,334/$298,332
Pamela B. Westbrook.. -- -- 105,002/64,998 $860,204/$555,181
Shawn P. Lunney...... 80,625 $727,511 103,041/22,084 $529,686/$448,421
Michael A. Cheney.... -- -- 23,750/151,250 $1,312/$24,938
David F. Erinakes.... -- -- 31,583/143,417 $14,438/$49,313
- ---------------
(1) Represents market value of underlying securities at date of exercise less
option exercise price.
(2) Options generally vest over (a) 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 (b) 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.
Employment Agreements. During fiscal 2002, Mr. Cummins entered into a
five-year employment agreement with the Company. The term of Mr. Cummins'
employment agreement is extended automatically for an additional year on each
anniversary of the employment agreement, unless terminated by written notice
six-months prior to the anniversary date by either Mr. Cummins or the Company.
The employment agreement provides that Mr. Cummins shall serve as the Company's
Chief Executive Officer and as Chairman of the Company's Board of Directors.
Pursuant to this employment agreement, Mr. Cummins will receive an annual base
salary of $375,000 and a bonus which can be up to 100% of his annual base salary
based on the
39
achievement of performance goals of the Company. During fiscal 2002, Mr. Cummins
earned a bonus equal to his salary based upon the achievement of the performance
goals on which his bonus is determined. Mr. Cummins' employment agreement was
recommended by the compensation committee and approved by the Board, and was in
part based on a survey of comparable companies and recommendations made by
Towers Perrin, a compensation consulting firm. The base salary, included in the
employment agreement, is approximately equal to the fiftieth percentile of the
peer group surveyed by Towers Perrin. In the event of a change of control (as
defined therein), Mr. Cummins will be entitled to a payment which is the greater
of three years annual base salary and bonus or the remaining term of the
contract. The employment agreement also provides for a five-year, term-life
insurance policy. The employment agreement also includes noncompetition
provisions that apply while Mr. Cummins is employed by the Company and for one
year following a termination of Mr. Cummins' employment.
Severance Agreements. During fiscal 2002, Messrs. Westbrook, Lunney,
Cheney, Erinakes, Rudolph and Totah entered into agreements with the Company
(each a "Severance Agreement") that provide certain benefits to the employee
during the protected period (as defined therein) following a change of control
(as defined therein). The initial term of each of the Severance Agreements is
for three years. This term may be extended for one-year terms following the
initial term; however, if a change of control occurs during the term of each of
the Severance Agreements, the Severance Agreement cannot terminate until one
year after the change of control.
The Severance Agreements generally provide for the payment of (a) three
times the sum of the employee's base salary and bonus amount; plus (b) that
portion of the employee's base salary earned, and vacation pay vested for the
prior year and accrued for the current year to the date of termination but not
paid or used, and all other amounts previously deferred by the employee or
earned but not paid as of such date under all Company bonus or pay plans or
programs. Additionally, the Severance Agreements provide that if any payments to
the employee by the Company would be subject to any excise tax imposed by
section 4999 of the Internal Revenue Code, a "gross-up" payment will be made to
place such employee in the same net after-tax position as would have been the
case if no excise tax had been imposed.
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. In fiscal 2002, every
board member was granted a discretionary grant of 13,000 options. Mr. Matricaria
also received an initial grant of 35,000 options for joining the Board of
Directors.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of June 25, 2002, 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,
40
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....................... 2,707,800 12.4%
P.O. Box 7842
Madison, WI 53707
Brookside Capital Investors, Inc. ........................ 1,500,000 6.9%
111 Huntington Avenue
Boston, MA 20116
The Clark Estates(2)...................................... 1,315,483 6.0%
One Rockefeller Plaza, 31st Floor
New York, NY 10020
Robert P. Cummins(3)...................................... 961,041 4.2%
Reese S. Terry, Jr.(4).................................... 624,350 2.9%
Pamela B. Westbrook(5).................................... 122,882 *
Shawn P. Lunney(6)........................................ 209,517 *
Alan Totah(7)............................................. 35,833 *
Michael A. Cheney(8)...................................... 36,066 *
Richard Rudolph, M.D.(9).................................. 32,916 *
David F. Erinakes(10)..................................... 45,306 *
Stanley H. Appel, M.D.(11)................................ 154,550 *
Thomas A. Duerden, Ph.D.(12).............................. 76,250 *
Tony Coelho(13)........................................... 90,550 *
Michael J. Strauss, M.D.(14).............................. 78,250 *
Alan J. Olsen(15)......................................... 38,808 *
Ronald A. Matricaria(16).................................. 13,250 *
All executive officers and directors as a group (14
persons)(17)............................................ 2,519,569 10.8%
- ---------------
* Less than 1%
(1) Based on total shares outstanding of 21,801,845 at June 25, 2002.
Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Shares of our Common Stock subject to options and warrants
currently exercisable, or exercisable within 60 days, are deemed
outstanding for computing the percentage of the person holding such options
but are not deemed outstanding for computing the percentage of any other
person. Except as indicated by footnote, and subject to community property
laws where applicable, the persons named in the table have sole voting and
investment power with respect to all shares of Common Stock shown as
beneficially owned by them.
(2) Pursuant to a letter agreement dated March 28, 1997, the Clark Estates is
entitled to designate one person whom it wishes to have appointed to serve
on our Board of Directors for as long as the Clark Estates retains at least
600,000 of the aggregate of 901,408 shares of Common Stock purchased on
such date by parties affiliated with the Clark Estates. To date, the Clark
Estates has not exercised this right.
(3) Includes 10,000 shares held in trust for the benefit of Mr. Cummins'
children of which Mr. Cummins serves as trustee. Also includes 819,791
shares subject to options exercisable on or before August 25, 2002.
(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 39,000 shares
subject to options exercisable on or before August 25, 2002.
(5) Includes 118,169 shares subject to options exercisable on or before August
25, 2002.
41
(6) Includes 108,542 shares subject to options exercisable on or before August
25, 2002.
(7) Includes 35,833 shares subject to options exercisable on or before August
25, 2002.
(8) Includes 35,916 shares subject to options exercisable on or before August
25, 2002.
(9) Includes 32,916 shares subject to options exercisable on or before August
25, 2002.
(10) Includes 41,831 shares subject to options exercisable on or before August
25, 2002.
(11) Includes 110,750 shares subject to options exercisable on or before August
25, 2002.
(12) Includes 62,750 shares subject to options exercisable on or before August
25, 2002.
(13) Includes 80,750 shares subject to options exercisable on or before August
25, 2002.
(14) Includes 60,750 shares subject to options exercisable on or before August
25, 2002.
(15) Includes 35,333 shares subject to options exercisable on or before August
25, 2002.
(16) Includes 13,250 shares subject to options exercisable on or before August
25, 2002.
(17) Includes 1,595,581 shares subject to options held by executive officers and
directors, which options are exercisable on or before August 25, 2002. 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, and Dr.
Appel and venture capital firms formerly affiliated with Mr. Cummins, are
entitled to certain registration rights with respect to the Common Stock held by
them.
Covance Health Economics and Outcomes Services, Inc. (Covance) has provided
health care reimbursement consulting services to us in prior periods. No
payments were made during the fiscal years ended April 27, 2001 or April 26,
2002. We paid to Covance $431,662 for such services in fiscal 2000. Dr. Strauss,
one of our directors, was the Executive Vice President of Covance through 1999.
Our Bylaws provide that we are required to indemnify our officers and
directors to the fullest extent permitted by Delaware law, including those
circumstances in which indemnification would otherwise be discretionary, and
that we are required to advance expenses to our officers and directors as
incurred. Further, we have entered into indemnification agreements with our
officers and directors. We believe that our charter and bylaw provisions and
indemnification agreements are necessary to attract and retain qualified persons
as directors and officers.
We believe that the transactions described above were made on terms no less
favorable to us than could have been obtained from unaffiliated third parties.
All future transactions between us and our officers, directors, principal
stockholders and affiliates will be approved by a majority of the Board of
Directors, including a majority of the independent and disinterested outside
directors on the Board of Directors, and will be on terms no less favorable to
us than could be obtained from unaffiliated third parties.
42
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 Auditors are
included in pages F-1 through F-23 of this Annual Report on Form 10-K:
PAGE
DESCRIPTION NO.
----------- ----
Independent Auditors' Report................................ F-2
Independent Predecessor Auditors' Report.................... F-3
Consolidated Balance Sheets................................. F-4
Consolidated Statements of Operations and Comprehensive
Income (Loss)............................................. F-5
Consolidated Statements of Stockholders' Equity............. F-6
Consolidated Statements of Cash Flows....................... F-7
Notes to Consolidated Financial Statements.................. F-8
2. Exhibits.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1(1) -- Amended and Restated Certificate of Incorporation of
Registrant.
3.2(2) -- Bylaws of Registrant.
3.3(3) -- Amendment No. 1 to the 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(4) -- Amendment No. 1 to Second Amended and Restated Preferred
Share Rights Agreement, dated April 26, 2001.
10.1(5) -- Amended 1991 Employee Stock Purchase Plan.
10.2(6) -- License Agreement dated March 15, 1988 between the
Registrant and Dr. Jacob Zabara.
10.3(6) -- Patent License Agreement effective as of July 28, 1989
between the Registrant and Huntington Medical Research
Institute.
10.4(7) -- 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(6) -- Form of Indemnification Agreement.
10.6(6) -- Amended and Restated Stockholders' Agreement dated October
16, 1992.
10.7(8) -- Registration Rights Agreement dated March 28, 1997.
10.8(9) -- Amended and Restated 1996 Stock Option Plan.
10.9(7) -- Stockholders' Agreement dated April 8, 1996 between the
Registrant and St. Jude Medical, Inc.
10.10(7) -- Letter Agreement dated March 28, 1997 between the Clark
Estates and the Registrant.
10.11(10) -- Lease Agreement dated August 19, 1997 between the Registrant
and Space Assets II, Inc.
10.12(11) -- Amended and Restated 1997 Stock Plan.
10.13(12) -- 1998 Stock Option Plan.
10.14(13) -- Employment Agreement Between Cyberonics, Inc. and Robert P.
Cummins.
43
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.15(13) -- Severance Agreement Between Cyberonics, Inc. and Shawn P.
Lunney.
10.16(13) -- Severance Agreement Between Cyberonics, Inc. and Alan D.
Totah.
10.17(13) -- Severance Agreement Between Cyberonics, Inc. and Pamela B.
Westbrook.
10.18(14) -- Severance Agreement Between Cyberonics, Inc. and Michael A.
Cheney.
10.19(14) -- Severance Agreement Between Cyberonics, Inc. and Richard
Rudolph, M.D.
10.20(14) -- Severance Agreement Between Cyberonics, Inc. and David F.
Erinakes.
10.21(6) -- 1988 Incentive Stock Plan.
10.22(13) -- First Amendment to the 1988 Incentive Stock Plan.
16.1(16) -- Letter dated April 16, 2002, from Arthur Andersen LLP to the
Securities and Exchange Commission.
21.1(7) -- List of Subsidiaries of the Registrant.
23.1 -- Consent of Independent Auditors.
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-3 (Reg. No. 333-56022) filed on February 21, 2001.
(2) Incorporated by reference to Registrant's Report on Form 8-K filed on
September 12, 2000.
(3) Incorporated by reference to Registrant's Report on Form 8-K filed on March
30, 2001.
(4) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the 10 months ended April 27, 2001.
(5) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Reg. No. 333-66689) filed on November 3, 1998.
(6) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Reg. No. 33-45118) declared effective February 10, 1993.
(7) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended June 30, 1997.
(8) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1997.
(9) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (Reg. No. 333-19785) filed on April 29, 1999.
(10) Incorporated by reference to the Registrant's Annual Report on Form 10-K/A
for the year ended June 30, 1997.
(11) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (Reg. No. 333-56694) filed on March 8, 2001.
(12) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Reg. No. 333-66691) filed on November 3, 1998.
(13) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
quarter ended July 27, 2001.
(14) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended January 25, 2002.
(15) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2000.
(16) Incorporated by reference to Registrant's Report on Form 8-K filed April
17, 2002.
44
(b) Reports on Form 8-K.
A current report on Form 8-K was filed on April 17, 2002 in
connection with the dismissal of Arthur Andersen LLP as the Company's
independent auditors.
A current report on Form 8-K was filed on April 22, 2002 in
connection with the Company's engagement of KPMG LLP as its independent
auditors.
(c) Exhibits.
See Item 14(a)(2) above.
45
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 23, 2002
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, President, July 23, 2002
------------------------------------------------ Chief Executive Officer
Robert P. Cummins (Principal Executive Officer)
/s/ PAMELA B. WESTBROOK Vice President, Finance and July 23, 2002
------------------------------------------------ Administration, Secretary and Chief
Pamela B. Westbrook Financial Officer (Principal
Financial and Accounting Officer)
/s/ REESE S. TERRY, JR. Director July 23, 2002
------------------------------------------------
Reese S. Terry, Jr.
/s/ STANLEY H. APPEL, M.D. Director July 23, 2002
------------------------------------------------
Stanley H. Appel, M.D.
/s/ TONY COELHO Director July 23, 2002
------------------------------------------------
Tony Coelho
/s/ THOMAS A. DUERDEN, PH.D. Director July 23, 2002
------------------------------------------------
Thomas A. Duerden, Ph.D.
/s/ MICHAEL J. STRAUSS, M.D. Director July 23, 2002
------------------------------------------------
Michael J. Strauss, M.D.
/s/ ALAN J. OLSEN Director July 23, 2002
------------------------------------------------
Alan J. Olsen
/s/ RONALD A. MATRICARIA Director July 23, 2002
------------------------------------------------
Ronald A. Matricaria
46
CONSOLIDATED FINANCIAL STATEMENTS
AS OF APRIL 26, 2002 AND APRIL 27, 2001
TOGETHER WITH AUDITORS' REPORTS
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors
Cyberonics, Inc.:
We have audited the accompanying consolidated balance sheet of Cyberonics,
Inc. (a Delaware corporation) and subsidiary as of April 26, 2002, and the
related consolidated statements of operations and comprehensive income (loss),
stockholders' equity and cash flows for the 52 weeks then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. 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 audit provides 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 subsidiary as of April 26, 2002, and the results of their operations
and their cash flows for the 52 weeks then ended, in conformity with accounting
principles generally accepted in the United States of America.
/s/ KPMG LLP
Houston, Texas
May 17, 2002
F-2
INDEPENDENT AUDITORS' REPORT
THE REPORT PRESENTED BELOW IS A COPY OF THE INDEPENDENT AUDITORS'
REPORT ISSUED ON JUNE 21, 2001.
ARTHUR ANDERSEN LLP HAS BEEN UNABLE TO ISSUE AN UPDATED REPORT.
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.
/s/ ARTHUR ANDERSEN LLP
Houston, Texas
June 21, 2001
F-3
CYBERONICS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
APRIL 26, APRIL 27,
2002 2001
------------- -------------
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 38,195,962 $ 55,459,183
Securities held to maturity............................... -- 1,678,649
Accounts receivable, net.................................. 10,330,821 6,641,249
Inventories............................................... 4,528,378 4,246,560
Prepaid expenses.......................................... 1,296,685 1,376,874
------------- -------------
Total Current Assets................................. 54,351,846 69,402,515
Securities held to maturity................................. -- 113,075
Property and equipment, net................................. 9,799,829 8,650,350
Other assets, net........................................... 171,201 148,984
------------- -------------
$ 64,322,876 $ 78,314,924
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 5,633,565 $ 4,868,288
Line of credit............................................ 6,500,000 --
Accrued liabilities....................................... 15,176,764 13,286,661
Current portion of long-term debt......................... 123,765 115,927
------------- -------------
Total Current Liabilities............................ 27,434,094 18,270,876
Long-term debt.............................................. 274,969 396,964
------------- -------------
Total Liabilities.................................... 27,709,063 18,667,840
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; 21,751,261 and 21,474,022 shares issued and
outstanding at April 26, 2002 and April 27, 2001,
respectively........................................... 217,513 214,740
Additional paid-in capital................................ 167,855,437 165,170,408
Deferred compensation..................................... (1,496,250) (1,989,850)
Accumulated other comprehensive income (loss)............. (212,739) (117,971)
Accumulated deficit....................................... (129,750,148) (103,630,243)
------------- -------------
Total Stockholders' Equity........................... 36,613,813 59,647,084
------------- -------------
$ 64,322,876 $ 78,314,924
============= =============
See accompanying notes to consolidated financial statements.
F-4
CYBERONICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
52 WEEKS ENDED
------------------------------- 10 MONTHS ENDED 12 MONTHS ENDED
APRIL 26, 2002 APRIL 27, 2001 APRIL 27, 2001 JUNE 30, 2000
-------------- -------------- --------------- ---------------
(UNAUDITED)(1)
Net sales......................... $ 70,111,293 $ 53,567,994 $ 43,418,736 $47,888,733
Cost of sales..................... 13,616,374 14,338,769 11,806,353 11,833,507
------------ ------------ ------------ -----------
Gross Profit............... 56,494,919 39,229,225 31,612,383 36,055,226
Operating Expenses:
Selling, general and
administrative............... 59,190,554 39,826,652 33,571,072 33,269,266
Research and development........ 24,516,547 19,414,819 17,201,179 8,037,096
Non-recurring charges........... -- 6,467,415 6,467,415 --
------------ ------------ ------------ -----------
Total operating expenses... 83,707,101 65,708,886 57,239,666 41,306,362
------------ ------------ ------------ -----------
Loss From Operations....... (27,212,182) (26,479,661) (25,627,283) (5,251,136)
Interest income................... 1,264,853 1,428,845 1,141,939 1,364,985
Interest expense.................. (266,270) (68,868) (65,331) (3,349)
Other income (expense), net....... 93,694 (37,544) (147,058) (44,894)
------------ ------------ ------------ -----------
Net loss before cumulative effect
of a change in accounting
principle....................... (26,119,905) (25,157,228) (24,697,733) (3,934,394)
Cumulative effect on prior years
of changing to a different
method of depreciation.......... -- -- -- 881,150
------------ ------------ ------------ -----------
Net Loss................... $(26,119,905) $(25,157,228) $(24,697,733) $(3,053,244)
============ ============ ============ ===========
Net loss per share, basic and
diluted:
Net loss before cumulative
effect of a change in
accounting principle.... $ (1.21) $ (1.31) $ (1.27) $ (0.22)
Cumulative effect of a
change in accounting
principle............... -- -- -- 0.05
------------ ------------ ------------ -----------
Basic and Diluted Net Loss
Per Share............... $ (1.21) $ (1.31) $ (1.27) $ (0.17)
============ ============ ============ ===========
Shares Used In Computing
Basic and Diluted Net
Loss Per Share.......... 21,655,009 19,247,253 19,382,460 18,044,692
============ ============ ============ ===========
Comprehensive Income (Loss):
Net loss.......................... $(26,119,905) $(25,157,228) $(24,697,733) $(3,053,244)
Foreign currency translation
adjustment...................... (94,768) (53,337) 50,360 (39,855)
------------ ------------ ------------ -----------
Comprehensive Income
(Loss).................. $(26,214,673) $(25,210,565) $(24,647,373) $(3,093,099)
============ ============ ============ ===========
- ---------------
Note: (1) The comparative period presented is unaudited because the Company
changed its fiscal year in April 2001.
See accompanying notes to consolidated financial statements.
F-5
CYBERONICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ACCUMULATED OTHER
--------------------- ADDITIONAL DEFERRED COMPREHENSIVE
SHARES AMOUNT PAID-IN CAPITAL COMPENSATION INCOME (LOSS) ACCUMULATED DEFICIT
---------- -------- --------------- ------------ ----------------- -------------------
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)
Stock options exercised...... 230,784 2,308 1,818,842 -- -- --
Issuance of Common Stock
under Employee Stock
Purchase Plan.............. 46,455 465 867,245 -- -- --
Offering costs related to the
issuance of Common Stock in
a private equity offering
during the previous year... -- -- (1,058) -- -- --
Amortization of deferred
compensation............... -- -- -- 493,600 -- --
Translation adjustment....... -- -- -- -- (94,768) --
Net Loss..................... -- -- -- -- -- (26,119,905)
---------- -------- ------------ ----------- --------- -------------
Balance at April 26, 2002...... 21,751,261 $217,513 $167,855,437 $(1,496,250) $(212,739) $(129,750,148)
========== ======== ============ =========== ========= =============
See accompanying notes to consolidated financial statements.
F-6
CYBERONICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
52 WEEKS ENDED
------------------------------- 10 MONTHS ENDED 12 MONTHS ENDED
APRIL 26, 2002 APRIL 27, 2001 APRIL 27, 2001 JUNE 30, 2000
-------------- -------------- --------------- ---------------
(UNAUDITED)(1)
Cash Flows From Operating Activities:
Net loss................................... $(26,119,905) $(25,157,228) $(24,697,733) $ (3,053,244)
Noncash items included in net loss:
Depreciation............................. 3,797,000 2,745,710 2,421,262 1,449,333
Loss on disposal of assets............... 135,953 -- 21,847 --
Change in accounting principle........... -- -- -- (881,150)
Amortization of deferred compensation and
expense of certain stock options....... 493,600 435,950 435,950 --
Changes in operating assets and
liabilities:
Accounts receivable, net................. (3,689,572) 1,681,891 1,643,699 (2,834,945)
Inventories.............................. (281,818) 3,403,383 2,393,224 (1,444,670)
Prepaid expenses......................... 80,189 (323,015) 37,845 (516,681)
Other assets, net........................ (22,217) 26,168 5,994 (46,063)
Accounts payable and accrued
liabilities............................ 2,655,380 11,433,327 12,668,358 (848,117)
------------ ------------ ------------ ------------
Net Cash Used In Operating
Activities.......................... (22,951,390) (5,753,814) (5,069,554) (8,175,537)
Cash Flows From Investing Activities:
Purchases of property and equipment........ (5,082,432) (5,126,955) (3,626,903) (4,114,820)
Purchases of marketable securities......... -- (27,695,300) (7,845,792) (52,528,156)
Maturities of marketable securities........ 1,791,724 31,306,650 11,622,039 55,055,237
------------ ------------ ------------ ------------
Net Cash Provided By (Used In)
Investing Activities................ (3,290,708) (1,515,605) 149,344 (1,587,739)
Cash Flows From Financing Activities:
Proceeds from line of credit, net.......... 6,500,000 -- -- --
Proceeds from issuance of Common Stock,
net...................................... 2,687,802 46,431,062 45,450,532 8,052,629
Payments on long-term debt................. (114,157) (134,068) (90,978) (43,090)
------------ ------------ ------------ ------------
Net Cash Provided By Financing
Activities.......................... 9,073,645 46,296,994 45,359,554 8,009,539
Effect of exchange rate changes on cash and
cash equivalents......................... (94,768) (53,337) 50,360 (39,855)
------------ ------------ ------------ ------------
Net Increase (Decrease) In Cash and
Cash Equivalents.................... (17,263,221) 38,974,238 40,489,704 (1,793,592)
Cash and cash equivalents at beginning of
period................................... 55,459,183 16,484,945 14,969,479 16,763,071
------------ ------------ ------------ ------------
Cash and cash equivalents at end of
period................................... $ 38,195,962 $ 55,459,183 $ 55,459,183 $ 14,969,479
============ ============ ============ ============
Supplementary Disclosures Of Cash Flow
Information:
Cash paid for interest..................... $ 239,770 $ 68,680 $ 30,796 $ 3,349
Noncash purchase of assets under capital
leases................................... $ -- $ 646,959 $ -- $ 646,959
- ---------------
Note: (1) The comparative period presented is unaudited because the Company
changed its fiscal year in April 2001.
See accompanying notes to consolidated financial statements.
F-7
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
APRIL 26, 2002
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 System for the treatment of
depression in the European market and in Canada. The NCP System 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 intercompany accounts and transactions have been eliminated.
Use of Estimates. The preparation of the consolidated 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 consolidated financial statements and accompanying notes. Actual
results could differ from those estimates. Critical estimates that require
management judgment relate to the allowance for doubtful accounts, estimates of
any obsolete inventory, useful lives for property and equipment, impairment of
any long-lived assets, sales returns and allowances and product warranties.
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. The gains and losses that result from
this process are shown in the accumulated other comprehensive income section of
stockholders' equity, and are not included in the determination of the results
of operations. 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. Cash equivalents at April 27, 2002 and April 26, 2001 were
$25,857,000 and $50,988,000, respectively.
F-8
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Fair Value of Financial Instruments. The carrying amounts reported in the
consolidated balance sheets for cash and cash equivalents, accounts receivable,
accounts payable and line of credit approximate their fair values due to the
short-term maturity of these financial instruments.
Marketable Securities. At April 27, 2001, 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 $1,786,000 as of April 27, 2001. The Company had no
marketable securities at April 26, 2002. At April 27, 2001, the Company's
investment portfolio consisted of the following:
APRIL 27, 2001
------------------------
FAIR MARKET CARRYING
VALUE VALUE
----------- ----------
Current --
Corporate bonds and commercial paper...................... $ 233,000 $ 226,756
US treasury obligations................................... 1,438,000 1,451,893
---------- ----------
1,671,000 1,678,649
Non-current --
Asset-backed investments.................................. 115,000 113,075
---------- ----------
Total................................................ $1,786,000 $1,791,724
========== ==========
Accounts Receivable. The Company's allowance for doubtful accounts totaled
$249,668 and $138,203 at April 26, 2002 and April 27, 2001, respectively.
Activity in the Company's allowance for doubtful accounts consists of the
following:
52 WEEKS ENDED 10 MONTHS ENDED 12 MONTHS ENDED
APRIL 26, 2002 APRIL 27, 2001 JUNE 30, 2000
-------------- --------------- ---------------
Balance at beginning of period......... $138,203 $162,654 $495,662
Increase in allowance.................. 153,515 -- --
Reductions in allowance................ -- (3,807) (333,008)
Reductions for write-offs.............. (42,030) (20,644) --
-------- -------- --------
Balance at end of period............... $249,688 $138,203 $162,654
======== ======== ========
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. Property and equipment under capital leases
are stated at the lower of the present value of minimum lease payments at the
beginning of the lease term or fair value at the inception of the lease.
Property and equipment under capital leases are depreciated using the
straight-line method over the shorter of the lease term or the estimated useful
life of the property.
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
circum-
F-9
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
stances 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. If this evaluation
indicates that such assets are impaired, the carrying value of the assets is
reduced to the estimated fair value. 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 9, "Stock Incentive and Purchase Plans". Because of this
election, the Company continues to account for its employee stock-based
compensation plans under Accounting Principles Board (APB) Opinion No. 25 and
the related interpretations. Accordingly, deferred compensation is recorded for
stock-based compensation grants based on the excess of the market value of the
common stock on the measurement date over the exercise price. The deferred
compensation is amortized over the vesting period of each unit of stock-based
compensation. If the exercise price of the stock-based compensation grant is
equal to the market price of the Company's stock on the date of grant, no
compensation expense is recorded.
Revenue Recognition. Revenue from product sales is generally recognized
upon shipment to the customer, net of estimated returns and allowances.
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 under the asset and
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.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change of tax rates is recognized in income in the
period that includes the enactment date.
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. Securities convertible into Common
Stock comprised of stock options were 7,130,369; 4,933,251; and 4,128,110 shares
at April 26, 2002, April 27, 2001 and June 30, 2000, respectively.
Comprehensive Income. The Company reports and displays comprehensive
income and its components in accordance with SFAS No. 130, "Reporting
Comprehensive Income". 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).
F-10
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2. INVENTORIES
Inventories consist of the following:
APRIL 26, 2002 APRIL 27, 2001
-------------- --------------
Raw materials.............................................. $1,815,290 $1,338,885
Work-in-process............................................ 1,543,095 1,257,784
Finished goods............................................. 1,169,993 1,649,891
---------- ----------
$4,528,378 $4,246,560
========== ==========
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
APRIL 26, 2002 APRIL 27, 2001
-------------- --------------
Computer equipment......................................... $4,568,869 $3,776,874
Manufacturing equipment.................................... 4,450,990 4,120,223
Offsite programming equipment.............................. 2,535,276 1,691,705
Furniture and fixtures..................................... 2,194,905 1,724,168
Leasehold improvements..................................... 1,901,591 1,741,467
Office equipment........................................... 792,742 120,414
Construction in progress................................... 770,168 197,555
---------- ----------
17,214,541 13,372,406
Accumulated depreciation................................... (7,414,712) (4,722,056)
---------- ----------
$9,799,829 $8,650,350
========== ==========
NOTE 4. LINE OF CREDIT
In September 2001, the Company established a revolving credit facility for
$10,000,000 which is collateralized by accounts receivable, inventory,
equipment, documents of title, general intangibles, subsidiary stock and other
collateral. Borrowings against the facility are based upon eligible accounts
receivable. Interest is payable at the designated bank rate of 4.75% at April
26, 2002 plus 1.5%, totaling 6.25%, on the greater of $3,000,000 or the average
of the net balances owed by the Company at the close of each day during the
month. Under the terms of the revolving credit facility the Company agreed to
maintain liquidity (being the aggregate of the availability under the credit
facility and Company cash) equal to or greater than $5,000,000 and limiting
annual capital expenditures to $4,000,000. Capital expenditures for the 52 weeks
ended April 26, 2002 exceeded $4,000,000. The lender waived this loan covenant
provision for the 52 weeks ended April 26, 2002. An unused line of credit fee is
payable at the rate of 0.5%. The term of the credit facility is three years,
expiring on September 26, 2004. At April 26, 2002, the Company had $6,500,000 in
borrowings outstanding under the credit facility and an available borrowing
capacity of approximately $1,181,000.
F-11
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
APRIL 26, 2002 APRIL 27, 2001
-------------- --------------
Clinical costs............................................. $ 5,927,907 $ 5,133,692
Payroll and other compensation............................. 5,796,040 2,354,101
Royalties.................................................. 797,411 661,340
Employees awards........................................... 505,764 --
Warranties................................................. 407,148 423,000
Accrued taxes.............................................. 394,872 --
Business insurance......................................... 325,267 141,128
Professional services...................................... 250,045 456,275
Legal settlement fees...................................... 75,000 --
Investment fees............................................ -- 3,785,995
Other...................................................... 697,310 331,130
----------- -----------
$15,176,764 $13,286,661
=========== ===========
NOTE 6. CHANGE IN ACCOUNTING PRINCIPLE
Effective July 1, 1999, the Company changed its method of computing
depreciation on domestic fixed assets from the double declining method to the
straight-line method. This change was implemented to better match revenues and
expenses taking into account the nature of these assets and the Company's
business. The new depreciation method was applied retroactively to all domestic
assets acquired in prior years. The cumulative prior years' effect of the
changes was $881,150 (net of income tax of $0) and is included in income for the
fiscal year ended June 30, 2000. The effect of the change for fiscal year 2000
was to decrease the operating loss by approximately $598,000 ($0.03 per share).
NOTE 7. CONTINGENCIES
During the 52 weeks ended April 26, 2002 the Company entered into severance
agreements with certain key employees. These agreements were entered into with
approximately 70 management and key employees and obligate the Company, upon
change of control and constructive termination of such employee, to pay an
amount equal to salary and bonus for one to three years, together with any
earned but unpaid compensation.
NOTE 8. 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 26, 2002. With respect to the shares authorized, the
Company's Board of Directors, at its sole discretion, may determine, fix and
alter dividend rights, dividend rates, conversion rights, voting rights, terms
of redemption, redemption prices, liquidation preferences and the number of
shares constituting any such series and may determine the designation, terms and
conditions of the issuance of any such shares.
Common Stock. Stock option exercises increased the number of common shares
by 230,784; 299,534; and 1,049,971 for the 52 weeks ended April 26, 2002, the 10
months ended April 27, 2001 and the 12 months ended June 30, 2000, respectively.
Issuances of common stock under the Company's Employee Stock Option Plan
increased the number of common shares by 46,455; 13,635; and 30,782 for the 52
weeks ended April 26, 2002, the 10 months ended April 27, 2001 and the 12 months
ended June 30, 2000, respectively.
F-12
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 per share.
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 $473,000 and $394,000 of compensation expense was recognized in
fiscal 2002 and 2001, respectively 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") 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 (SWIB) as an
Exempt Person under the terms of the Plan as long as SWIB is the Beneficial
Owner of less than 20%.
NOTE 9. STOCK INCENTIVE AND PURCHASE PLANS
Stock Options. Cyberonics has reserved an aggregate of 11,350,000 shares
of its Common Stock through April 26, 2002, 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
F-13
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
sales objectives. 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
12 months ended June 30, 2000, 10 months ended April 27, 2001 and 52 weeks ended
April 26, 2002.
OUTSTANDING EXERCISABLE
--------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE EXERCISE
RESERVED SHARES PRICE SHARES PRICE
---------- ---------- -------- ---------- --------
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
Shares reserved............... 2,200,000
Granted....................... (2,930,989) 2,930,989 14.64
Options becoming
exercisable................. 982,186
Exercised..................... (230,784) 7.89 (230,784)
Canceled or forfeited......... 503,087 (503,087) 15.76
---------- ---------- ----------
Balance at April 26, 2002..... 984,239 7,130,369 $13.60 2,739,384 $11.57
========== ========== ==========
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 $493,600 during the 52 weeks ended April 26, 2002, $435,950
during the 10 months ended April 27, 2001 and $0 during the 12 months ended June
30, 2000.
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: risk-free interest rate of 4.5%
for fiscal periods 2002 and 2001 and 5% for fiscal year 2000, expected life of
five years for options and restricted stock, expected life of six months for
purchase plan shares, expected volatility of 210%, 253% and 161%, 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 periods 2002, 2001 and 2000 was $14.64, $16.94
and $15.31, respectively.
F-14
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Had the compensation cost for these plans been determined pursuant to the
alternative method under SFAS No. 123, the Company's net loss and loss per share
would have been increased to the following pro forma amounts:
52 WEEKS ENDED 10 MONTHS ENDED 12 MONTHS ENDED
APRIL 26, 2002 APRIL 27, 2001 JUNE 30, 2000
-------------- --------------- ---------------
Net loss --
As reported.......................... $(26,119,905) $(24,697,733) $ (3,053,244)
Pro forma............................ (45,102,980) (33,207,152) (12,678,014)
Loss per share --
As reported.......................... $ (1.21) $ (1.27) $ (0.17)
Pro forma............................ (2.08) (1.71) (0.70)
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 $101,037; $35,419; and $159,143 related to the
purchase discount offered under the Company's Employee Stock Purchase Plan
during fiscal 2002, 2001 and 2000, respectively. The weighted average fair
values of shares granted to employees were $14.50, $17.32 and $17.57 during
fiscal 2002, 2001 and 2000, 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 26, 2002
OPTIONS OUTSTANDING
------------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED-AVERAGE ------------------------------------
RANGE OF OUTSTANDING AS OF REMAINING WEIGHTED-AVERAGE EXERCISABLE AS OF WEIGHTED-AVERAGE
EXERCISE PRICES APRIL 26, 2002 CONTRACTUAL LIFE EXERCISE PRICE APRIL 26, 2002 EXERCISE PRICE
- --------------- ----------------- ---------------- ---------------- ----------------- ----------------
$2.9900-$5.9750.......... 823,408 4.6 $ 3.66 745,910 $ 3.56
$5.9751-$11.9500......... 857,572 6.7 $ 9.12 404,945 $ 8.83
$11.9501-$17.9250........ 4,148,676 8.2 $14.35 1,181,784 $14.59
$17.9251-$23.9000........ 1,191,463 7.8 $19.87 374,763 $19.52
$23.9001-$29.8750........ 109,250 8.6 $26.91 31,982 $28.08
--------- ---------
7,130,369 $13.60 2,739,384 $11.57
========= =========
During fiscal 2002, 2001 and 2000, the Board of Directors approved grants
outside of the existing stock option plans. The grants, which totaled 300,000;
100,000 and 250,000 options, respectively, were approved for new officers as
inducements essential to their entering into employment with the Company.
Stock Purchase Plan. Under the Cyberonics, Inc. Employee Stock Purchase
Plan (the Stock Purchase Plan), 950,000 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 26, 2002,
725,775 shares remain available for future issuances under the Stock Purchase
Plan.
F-15
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 26,
2002, 4,030 shares remain available for future issuances under the program.
NOTE 10. NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 141 requires all business combinations initiated after June
30, 2001 to be accounted for using the purchase method. Under SFAS No. 142,
goodwill and intangible assets with indefinite lives are no longer amortized but
are reviewed annually (or more frequently if impairment indicators arise) for
impairment. Separable intangible assets that are deemed to have finite lives
will continue to be amortized over their useful lives (but with no maximum
life). The amortization provisions of SFAS No. 142 apply to goodwill and
intangible assets acquired after June 30, 2001. With respect to goodwill and
intangible assets acquired prior to July 1, 2001, SFAS No. 142 is effective for
fiscal years beginning after December 15, 2001. The adoption of SFAS No. 141 and
142 effective January 1, 2002 did not have a material impact on the Company's
consolidated financial position or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". This Statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. As used in this
Statement, a legal obligation is an obligation that a party is required to
settle as a result of an existing or enacted law, statute, ordinance, or written
or oral contract or by legal construction of a contract under the doctrine of
promissory estoppel. This Statement is effective for financial statements issued
for fiscal years beginning after June 15, 2002. The Company believes that the
adoption of SFAS No. 143 will not have material impact on the Company's
operating results or financial condition.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
Under this Statement, the FASB established a single accounting model for
valuation of long-lived assets. The provisions of SFAS No. 144 are required to
be applied to the Company for the 2003 fiscal year and, as such, the Company
will adopt the statement on April 27, 2002. The adoption of SFAS No. 144 did not
have a material impact on the Company's operating results or financial
condition.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections".
This Statement rescinds FASB Statement No. 4, "Reporting Gains and Losses from
Extinguishment of Debt" and an amendment of that Statement, FASB Statement No.
64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". This
Statement also rescinds FASB Statement No. 44, "Accounting for Intangible Assets
of Motor Carriers". This Statement amends FASB Statement No. 13, "Accounting for
Leases", to eliminate an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. This Statement also amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings or
describe their applicability under changed conditions. In general, the
provisions of SFAS No. 145 shall be applied in fiscal years beginning after May
15, 2002. The Company believes that the
F-16
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
adoption of SFAS No. 145 will not have a material impact on the Company's
operating results or financial condition.
NOTE 11. INCOME TAXES
Components of the Company's loss before taxes are as follows:
52 WEEKS ENDED 10 MONTHS ENDED 12 MONTHS ENDED
APRIL 26, 2002 APRIL 27, 2001 JUNE 30, 2000
-------------- --------------- ---------------
Domestic............................... $(22,545,496) $(23,629,170) $(2,198,294)
Foreign................................ (3,574,409) (1,068,563) (854,950)
------------ ------------ -----------
$(26,119,905) $(24,697,733) $(3,053,244)
============ ============ ===========
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate is as follows:
52 WEEKS ENDED 10 MONTHS ENDED 12 MONTHS ENDED
APRIL 26, 2002 APRIL 27, 2001 JUNE 30, 2000
-------------- --------------- ---------------
U.S. statutory rate.................... (34.0)% (34.0)% (34.0)%
Increase in deferred tax valuation
allowance............................ 37.6 37.4 147.9
Other, net............................. (3.6) (3.4) (113.9)
----- ----- ------
0.0% 0.0% 0.0%
===== ===== ======
Significant components of the Company's deferred tax assets and liabilities
are as follows:
APRIL 26, 2002 APRIL 27, 2001 JUNE 30, 2000
-------------- -------------- -------------
Deferred tax assets:
Federal net operating loss
carryforwards......................... $ 40,212,185 $ 33,176,347 $ 25,252,567
Foreign net operating loss
carryforwards......................... 5,452,321 4,141,114 3,772,374
Tax credit carryforwards................. 4,643,666 3,267,666 2,276,648
Clinical costs........................... 204,000 -- 103,927
Warranties............................... 43,793 46,823 127,500
Other, net............................... 904,741 1,047,737 954,388
------------ ------------ ------------
Total deferred tax assets........... 51,460,706 41,679,687 32,487,404
Total deferred tax liabilities, net........ (42,643) (91,011) (126,515)
Deferred tax valuation allowance........... (51,418,063) (41,588,676) (32,360,889)
------------ ------------ ------------
Net deferred tax assets and
liabilities...................... $ -- $ -- $ --
============ ============ ============
At April 26, 2002, the Company has net operating loss carryforwards of
approximately $118.3 million for federal income tax purposes, which expire
during the years 2003 through 2022, and tax credit carryforwards of
approximately $4.6 million for federal income tax purposes, which expire during
the years 2006 through 2022. As the Company has had cumulative losses and there
is no assurance of future taxable income, a valuation allowance totaling $51.4
million has been established as of April 26, 2002, to fully offset the Company's
net deferred tax assets, including those relating to its carryforwards. The
valuation allowance increased $9.8 million and $9.2 million for the 52 weeks
ended April 26, 2002 and the 10 months ended April 27, 2001, 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.
F-17
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12. 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 52 weeks ended April 26, 2002, the
10 months ended April 27, 2001, and the 12 months ended June 30, 2000.
NOTE 13. COMMITMENTS
Postmarket Clinical Surveillance. Pursuant to the postmarket surveillance
conditions specified as part of the Company's FDA marketing approval, the
Company is required to conduct clinical follow-up on a limited number of
patients from its most recent study in order to monitor the safety and
tolerability of the NCP System on an extended basis. The Company expenses the
costs related to these long-term follow-up activities as they are incurred and
establishes accruals for such costs incurred but not paid as of the respective
balance sheet dates.
License Agreements. The Company has executed a license agreement which
provides Cyberonics with worldwide exclusive rights under three U.S. 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 three percent of sales during fiscal 2003 and through the remaining
term of the licensed patents. These patents expire between 2011 and 2016. 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 one 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.
This license agreement expires in March of 2003 and no royalties will be due for
this agreement subsequent to its expiration date. Royalty expenses for the 52
weeks ended April 26, 2002, the 10 months ended April 27, 2001 and the 12 months
ended June 30, 2000 were $2,776,000; $1,785,000; and $1,856,000, respectively.
F-18
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
26, 2002 are as follows:
52/53 WEEKS ENDING ON THE LAST FRIDAY OF APRIL
2003............................................ $1,753,634
2004............................................ 1,880,564
2005............................................ 2,129,139
2006............................................ 2,022,785
2007............................................ 2,003,483
Thereafter...................................... 1,842,066
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 $646,959 are included in manufacturing equipment at April 26, 2002 and April
27, 2001. Accumulated depreciation amounted to $226,436 and $97,044 at April 26,
2002 and April 27, 2001, respectively.
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 26, 2002:
52/53 WEEKS ENDING ON THE LAST FRIDAY OF APRIL
2003............................................. $146,129
2004............................................. 146,129
2005............................................. 147,899
--------
Total minimum lease payments.............. 440,157
Less: amount representing interest............... 41,423
--------
Present value of future minimum lease payments... 398,734
Less: amount due within one year................. 123,765
--------
$274,969
========
The Company's rental expense for the 52 weeks ended April 26, 2002, the 10
months ended April 27, 2001 and the 12 months ended June 30, 2000, amounted to
$1,706,089; $1,374,230; and $1,172,296, respectively.
Other Commitments. At April 26, 2002, Cyberonics had approximately
$951,000 in noncancelable commitments related to domestic marketing programs
planned for the Company's NCP System during fiscal year 2003, of which
approximately $795,000 is scheduled to occur in the first quarter of fiscal year
2003.
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.
NOTE 14. RELATED PARTY TRANSACTIONS
Covance Health Economics and Outcomes Services, Inc. (Covance) provided
healthcare reimbursement consulting services to the Company during the 12 months
ended June 30, 2000 which amounted to $431,662. No amounts were paid during
fiscal 2001 or 2002. 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.
F-19
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15. CONCENTRATIONS
The Company's cash equivalents 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 26, 2002,
management believes that the Company has no significant concentrations of credit
risk related to these assets and has incurred no material impairments in the
carrying values of its cash equivalents and securities held to maturity.
Concentrations of credit risk with respect to trade accounts receivable are
limited due to the large number of customers and their dispersion across a
number of geographic areas. However, essentially all trade receivables are
concentrated in the hospital and health care sectors in the U.S. 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.
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, if or 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.
NOTE 16. SEGMENT AND GEOGRAPHIC INFORMATION
Through January 25, 2002 the Company operated its business in three
Indication Business Units, which have aggregated into one reportable segment,
that of designing, developing, manufacturing and marketing the NCP System using
VNS Therapy for the treatment of epilepsy and other debilitating neurological,
psychiatric diseases and other disorders. Each of the Company's business units
had similar economic characteristics, technology, manufacturing processes,
customers, distribution and marketing strategies, a similar regulatory
environment and shared infrastructures for the 39 weeks ended January 25, 2002.
F-20
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net sales and operating loss by business unit are presented below. The
Depression and Other Indications Business Units' operating expense consist
primarily of pre-clinical, clinical, direct payroll costs and allocations of
general and administrative expenses.
EPILEPSY DEPRESSION OTHER
INDICATION INDICATION INDICATIONS
BUSINESS UNIT BUSINESS UNIT BUSINESS UNIT TOTAL
------------- ------------- ------------- ------------
39 Weeks Ended January 25, 2002
External net sales.............. $49,885,879 $ -- $ -- $ 49,885,879
Operating income (loss)
(unaudited).................. 9,336,927 (23,829,619) (4,749,036) (19,241,728)
52 Weeks Ended April 27, 2001
(unaudited)(1)
External net sales.............. $53,567,994 $ -- $ -- $ 53,567,994
Operating loss.................. (8,558,565) (15,056,069) (2,865,027) (26,479,661)
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)
Twelve Months 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)
- ---------------
Note: (1) The comparative period presented is unaudited because the Company
changed its fiscal year in April 2001.
In January 2002, the acute results of the pivotal clinical study on VNS
Therapy for the treatment of depression (D-02) were completed and unblinded. The
D-02 acute results did not show a statistically significant difference in
response rates between the treatment and placebo groups. We are planning to
amend the D-02 protocol's statistical analysis plan to provide a prospective
analysis of the effectiveness of VNS Therapy based upon the D-02 and pilot study
(D-01) long term results. Those additional clinical activities have resulted in
delays in the completion of clinical studies and a higher degree of uncertainty
surrounding the probability and possible timing of approval and commercial
launch of VNS Therapy for depression. Furthermore, in February 2002, we
suspended new enrollments in all other new indications studies in order to allow
us to focus our limited clinical and financial resources towards the
determination of effectiveness of VNS Therapy in depression. The suspension of
patient enrollments in all new indication studies results in a higher degree of
uncertainty surrounding the timing and extent of anticipated clinical study
activities in the Other Indications Business Unit. The expanded pre-market
clinical activities in the depression studies and suspended enrollments in other
indication clinical studies will delay the commercial launch of VNS Therapy in
depression beyond our original expectation of April 2003 and may effect the
determination of the clinical development phase of the other indication studies.
The uncertainties surrounding these events are problematic in effectively
determining the anticipated shared resource utilization and expense allocation
between Indication Business Units. Therefore, in February 2002, the Company
began operating its business as a single neurostimulation business focused on
sales growth in epilepsy, the approved indication of use for VNS, improving
gross profit margins and improving net financial results to fund clinical
development activity in depression and other new indications development
activities.
F-21
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Geographic Information:
NET SALES
-------------------------------------------------------------------
52 WEEKS ENDED 52 WEEKS ENDED 10 MONTHS ENDED 12 MONTHS ENDED
APRIL 26, 2002 APRIL 27, 2001 APRIL 27, 2001 JUNE 30, 2000
-------------- -------------- --------------- ---------------
(UNAUDITED)(1)
United States............ $63,848,921 $47,713,226 $38,972,088 $42,533,016
International............ 6,262,372 5,854,768 4,446,648 5,355,717
----------- ----------- ----------- -----------
Total............. $70,111,293 $53,567,994 $43,418,736 $47,888,733
=========== =========== =========== ===========
LONG-LIVED ASSETS
----------------------------------
APRIL 26, 2002 APRIL 27, 2001
-------------- -----------------
United States................... $9,706,324 $8,739,338
International................... 264,706 173,071
---------- ----------
Total.................... $9,971,030 $8,912,409
========== ==========
- ---------------
Note: (1) The comparative period presented is unaudited because the Company
changed its fiscal year in April 2001.
NOTE 17. NON-RECURRING CHARGES
Non-recurring charges were $6.5 million for the 10 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.
F-22
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 18. QUARTERLY FINANCIAL INFORMATION -- UNAUDITED
The following table sets forth certain unaudited condensed quarterly
financial data for the 52 weeks ended April 26, 2002, and the 10 months ended
April 27, 2001. This information has been prepared on the same basis as the
consolidated financial statements and all necessary adjustments have been
included in the amounts below to present fairly the selected quarterly
information when read in conjunction with the 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
----------- ----------- ----------- ----------- ------------
52 WEEKS ENDED
APRIL 26, 2002
Net sales.............. $14,614,924 $16,882,244 $18,388,711 $20,225,414 $ 70,111,293
Gross profit........... 11,506,465 13,429,977 14,712,534 16,845,943 56,494,919
Net loss............... (6,636,750) (6,829,747) (5,775,231) (6,878,177) (26,119,905)
Diluted net loss per
share(2)............. (0.31) (0.32) (0.27) (0.32) (1.21)
10 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)
- ---------------
(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
period 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 period EPS.
F-23
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1(1) -- Amended and Restated Certificate of Incorporation of
Registrant.
3.2(2) -- Bylaws of Registrant.
3.3(3) -- Amendment No. 1 to the 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(4) -- Amendment No. 1 to Second Amended and Restated Preferred
Share Rights Agreement, dated April 26, 2001.
10.1(5) -- Amended 1991 Employee Stock Purchase Plan.
10.2(6) -- License Agreement dated March 15, 1988 between the
Registrant and Dr. Jacob Zabara.
10.3(6) -- Patent License Agreement effective as of July 28, 1989
between the Registrant and Huntington Medical Research
Institute.
10.4(7) -- 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(6) -- Form of Indemnification Agreement.
10.6(6) -- Amended and Restated Stockholders' Agreement dated October
16, 1992.
10.7(8) -- Registration Rights Agreement dated March 28, 1997.
10.8(9) -- Amended and Restated 1996 Stock Option Plan.
10.9(7) -- Stockholders' Agreement dated April 8, 1996 between the
Registrant and St. Jude Medical, Inc.
10.10(7) -- Letter Agreement dated March 28, 1997 between the Clark
Estates and the Registrant.
10.11(10) -- Lease Agreement dated August 19, 1997 between the Registrant
and Space Assets II, Inc.
10.12(11) -- Amended and Restated 1997 Stock Plan.
10.13(12) -- 1998 Stock Option Plan.
10.14(13) -- Employment Agreement Between Cyberonics, Inc. and Robert P.
Cummins.
10.15(13) -- Severance Agreement Between Cyberonics, Inc. and Shawn P.
Lunney.
10.16(13) -- Severance Agreement Between Cyberonics, Inc. and Alan D.
Totah.
10.17(13) -- Severance Agreement Between Cyberonics, Inc. and Pamela B.
Westbrook.
10.18(14) -- Severance Agreement Between Cyberonics, Inc. and Michael A.
Cheney.
10.19(14) -- Severance Agreement Between Cyberonics, Inc. and Richard
Rudolph, M.D.
10.20(14) -- Severance Agreement Between Cyberonics, Inc. and David F.
Erinakes.
10.21(6) -- 1988 Incentive Stock Plan.
10.22(13) -- First Amendment to the 1988 Incentive Stock Plan.
16.1(16) -- Letter dated April 16, 2002, from Arthur Andersen LLP to the
Securities and Exchange Commission.
21.1(7) -- List of Subsidiaries of the Registrant.
23.1 -- Consent of Independent Auditors.
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-3 (Reg. No. 333-56022) filed on February 21, 2001.
(2) Incorporated by reference to Registrant's Report on Form 8-K filed on
September 12, 2000.
(3) Incorporated by reference to Registrant's Report on Form 8-K filed on March
30, 2001.
(4) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the 10 months ended April 27, 2001.
(5) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Reg. No. 333-66689) filed on November 3, 1998.
(6) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Reg. No. 33-45118) declared effective February 10, 1993.
(7) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended June 30, 1997.
(8) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1997.
(9) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (Reg. No. 333-19785) filed on April 29, 1999.
(10) Incorporated by reference to the Registrant's Annual Report on Form 10-K/A
for the year ended June 30, 1997.
(11) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (Reg. No. 333-56694) filed on March 8, 2001.
(12) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Reg. No. 333-66691) filed on November 3, 1998.
(13) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
quarter ended July 27, 2001.
(14) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended January 25, 2002.
(15) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2000.
(16) Incorporated by reference to Registrant's Report on Form 8-K filed April
17, 2002.