CYBERONICS INC - 10-Q Quarterly Report

Back to GetFilings.com

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the quarterly period ended July 26, 2002 or

[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the transition period from ______________ to _______________

Commission File Number 0-19806

CYBERONICS, INC.
(Exact name of registrant as specified in its charter)

Delaware 76-0236465
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

100 Cyberonics Boulevard
Houston, Texas 77058
-------------- -----
(address of principal executive offices) (zip code)

Registrant's telephone number, including area code: (281) 228-7200

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

CLASS OUTSTANDING AT AUGUST 16, 2002
Common Stock - $0.01 par value 21,803,095

CYBERONICS, INC.

INDEX

2

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CYBERONICS, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying Notes to Consolidated Financial Statements (Unaudited).

3

CYBERONICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)

See accompanying Notes to Consolidated Financial Statements (Unaudited).

4

CYBERONICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

See accompanying Notes to Consolidated Financial Statements (Unaudited).

5

CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

JULY 26, 2002

NOTE 1 -- BASIS OF PRESENTATION:

The accompanying unaudited consolidated financial statements of
Cyberonics, Inc. (the Company) have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information, and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
three months ended July 26, 2002 are not necessarily indicative of the results
that may be expected for any other interim period or the full year ending April
25, 2003. The financial information presented herein should be read in
conjunction with the audited consolidated financial statements and notes thereto
included in our Annual Report on Form 10-K for the period ended April 26, 2002.

NOTE 2 -- INVENTORIES:

Inventories consist of the following:

NOTE 3 -- OTHER CURRENT ASSETS:

Other current assets consist of the following:

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 July 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 limit annual capital
expenditures to $4,000,000. 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. As of July 26, 2002, the Company had $10,000,000 in borrowings
outstanding under the credit facility.

6

NOTE 5 -- ACCRUED LIABILITIES:

Accrued liabilities are as follows:

NOTE 6 -- STOCKHOLDERS' EQUITY:

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
modification to the plan, and the Company recorded approximately $2.4 million in
deferred compensation relating to these 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 $118,000 of compensation expense has been recognized for the
vested portion of the option grant during the three months ended July 26, 2002
and July 27, 2001.

Stock Incentive and Purchase Plans. For the three months ended July 26,
2002, the Company has reserved an additional 1,000,000 shares for issuance
pursuant to its 1996 Stock Option Plan with an aggregate reserve of 12,350,000
shares as of July 26, 2002, for issuance pursuant to its Amended 1988 Incentive
Stock Option Plan, 1996 Stock Option Plan, 1997 Stock Option Plan and 1998 Stock
Option Plan (collectively "the Stock Option Plans"). Options granted under the
Stock Option Plans generally vest ratably over four or five years following
their date of grant. The vesting of certain options occurs up to 10 years from
the grant date but can accelerate based upon the achievement of specific
milestones related to regulatory approvals and the achievement of Company sales
objectives. 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. For the three months ended July 26, 2002, the Company has granted
approximately 722,500 options at a weighted average exercise price of
approximately $13.45, which were issued at market rate at the date of grant.
Stock options to purchase approximately 7.45 million shares at a weighted
average exercise price of $13.50 per share were outstanding as of July 26, 2002.

NOTE 7 -- EARNINGS PER SHARE:

SFAS No.128, "Earnings Per Share" requires dual presentation of earnings
per share (EPS); basic EPS and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income or loss applicable to common shareholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if options or other contracts
to issue common stock were exercised or converted into common stock and would
then share in net income or loss of the Company. For the purpose of computing
diluted net loss per share for the three months ended July 26, 2002, no exercise
of options was assumed since the result would have been antidilutive. Options to
purchase approximately 7.45 million shares of common stock at a weighted average
exercise price of $13.50 per share were outstanding as of July 26, 2002 but were
not included in the computation of diluted net loss per share.

7

NOTE 8 -- NEW ACCOUNTING PRONOUNCEMENTS:

In June 2001, the Financial Accounting Standard Board (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 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 adoption of SFAS No. 145 will not
have a material impact on the Company's operating results or financial
condition.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". The provision
of this statement is effective for exit or disposal activities that are
initiated after December 31, 2002, with early applications encouraged. The
Company believes that the adoption of SFAS No. 146 will not have a material
impact on the Company's consolidated operating results or financial condition.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. Actual results could differ materially
from those projected in the forward-looking statements as a result of a number
of important factors. For a discussion of important factors that could affect
our results, please refer to the financial statement line item discussions set
forth in Management's Discussion and Analysis of Financial Condition and Results
of Operations and to the section entitled "Factors Affecting Future Operating
Results". Readers are also encouraged to refer to our Annual Report on Form 10-K
for the period ended April 26, 2002 for a further discussion of our business and
its risks and opportunities.

SUMMARY

Cyberonics, Inc. was founded in 1987 to design, develop, manufacture and
market the Neuro Cybernetic Prosthesis, or VNS Therapy System, an implantable
medical device for the treatment of epilepsy and other debilitating neurological
psychiatric diseases and other disorders.

8

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 no later than the
fourth quarter of fiscal 2003 and develop other indications for vagus nerve
stimulation covered by our method patents.

Our strategies to achieve our objectives are to:

o 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,

o 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,

o Implement end-of-service initiatives to satisfy physician and
patient demand and drive revenue growth,

o Develop and introduce next-generation products that will provide
improved product functionality, command higher prices and drive
higher gross profit margin,

o Demonstrate the clinical and statistical significance and causal
relationship of VNS Therapy in depression from long-term data in
existing studies and

o 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 been conducting clinical studies to determine the effectiveness
of VNS Therapy in chronic depression, anxiety, Alzheimer's Disease and other
neurological disorders supported by our proprietary method patent portfolio. In
January 2002, the acute results of the pivotal clinical study (D-02) on VNS
Therapy for the treatment of chronic 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
study 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 chronic 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 chronic depression. The suspension of patient
enrollments in all new indication studies results in a higher degree of
uncertainty surrounding the probability and timing of these other clinical study
activities.

For the period from inception through July 26, 2002, we incurred a
cumulative net deficit of approximately $133.4 million. We have incurred
substantial expenses, primarily for research and development activities that
include product and process development and clinical trials and related
regulatory activities, sales and marketing activities, system infrastructure
development and manufacturing start-up. We expect to devote additional financial
resources for clinical studies in the development of depression and new
indications for the VNS Therapy System. The clinical studies for depression and
other indications are for investigational therapies that are not expected to
generate significant sales prior to FDA approval, which is not anticipated
before calendar 2005, if at all. As a result, we will continue to experience
substantial operating losses at levels that may exceed the levels experienced in
recent periods. Furthermore, the timing and nature of these expenditures are
contingent upon several factors including some outside of our control and may
exceed the current expectations of securities analysts and investors. We do not
expect to be profitable on an annual basis before fiscal 2004, if at all.

9

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 judgment.

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 three months ended July 26, 2002 were
$23,056,000 reflecting an increase of $8,441,000 or 57.8% over the $14,615,000
for the same period last year. First quarter net sales included $21,393,000 from
the U.S. market and $1,663,000 from international markets. U.S. net sales for
the first quarter increased by $8,143,000, or 61.5% over the $13,250,000 for the
same period last year. International net sales increased by $298,000 or 21.8%
over the $1,365,000 for the same period last year. The increase in net sales in
the U.S. for the three months ended July 26, 2002 is primarily due to higher
volume driven by patient demand and increases in average selling prices
resulting primarily from new product introductions. In June 2002, we launched
the Model 102 VNS Therapy System, which is priced at approximately $14,500,
representing an 18% price increase over the Model 101 System. Customer
acceptance of the new product introduction was very strong and sales of the
Model 102 VNS Therapy System represented over 40% of sales in the U.S. market in
the

10

first quarter of fiscal 2003. The increase in international net sales for the
three months ended July 26, 2002 is due to an increase in unit volume and a
stronger Euro Dollar as compared to the U.S. Dollar. We expect to achieve annual
sales growth of 45% for the remainder of fiscal 2003.

Gross Profit. Gross profit for the three months ended July 26, 2002 was
$19,106,000 or 82.9% of net sales compared to $11,506,000 or 78.7% for the same
period last year. The increase of 420 basis points in gross profit margin for
the three months ended July 26, 2002 is due to higher average selling prices,
product mix, and improvements in manufacturing efficiencies resulting in a
reduction of product cost per unit. We anticipate gross profit margin will
continue to improve over the remainder of fiscal year 2003, achieving 83.3% for
fiscal 2003, assuming we achieve our sales and production objectives.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended July 26, 2002 totaled
$18,356,000 or 79.6% of net sales compared to $12,548,000 or 85.9% of net sales
for the same period last year. The increase in sales, general and administrative
expenses for the three months ended July 26, 2002 is primarily due to additional
expenses incurred by the Epilepsy sales force associated with the expansion of
the sales force from approximately 78 people at July 27, 2001 to approximately
156 people at July 26, 2002. We expect selling, general and administrative
expenses to be less than 72% of sales for the fiscal year 2003, although
quarterly results will vary.

Research and Development Expenses. Research and development expenses are
comprised of both expenses related to our product and process development
efforts and expenses associated with conducting clinical trials and certain
regulatory activities. Research and development expenses for the quarter ended
July 26, 2002 totaled $4,796,000 or 20.8% of net sales, compared to $6,128,000
or 41.9% of net sales for the same period last year. The decrease in research
and development expenses is primarily due to reduced clinical programs
activities to determine the effectiveness of VNS Therapy in new indications,
including chronic depression, anxiety, Alzheimer's Disease and other indications
covered by our proprietary patent portfolio. We expect research and development
expenses to be approximately 20% of sales for fiscal 2003, although quarterly
results will vary.

Interest Income. Interest income for the three months ended July 26,
2002 was $130,000 compared to $537,000 for the same period last year. The
decrease in interest income for the three months ended July 26, 2002 is due to a
decrease in average investment balances, and lower interest rates.

Interest Expense. Interest expense for the three months ended July 26,
2002 was $98,000 compared to $17,000 for the same period last year. The increase
in interest expense for the three months ended July 26, 2002 is primarily due to
interest incurred as a result of borrowings under the line of credit facility
entered into in September 2001.

Other Income, Net. Other income, net for the three months ended July 26,
2002 was $339,000 compared to $12,000 for the same period last year. Other
income, net for the three months ended July 26, 2002 is primarily due to
transaction gains (losses) associated with a weaker U.S. dollar currency
exchange.

Income Taxes. Due to our operating loss history, to date we have
established a valuation allowance to fully offset deferred tax assets, including
those related to tax carry-forwards, resulting in no income tax expense or
benefit for financial reporting purposes. Current federal income tax regulations
with respect to changes in ownership could limit the utilization of the
operating loss carry-forwards.

LIQUIDITY AND CAPITAL RESOURCES

Since our inception, we have financed our operations primarily through
public and private placements of our securities. On June 30, 2000, we entered
into capital leases for the acquisition of manufacturing equipment which is and
used in the production of the VNS Therapy System. The capital leases bear
interest of 6.56% and extend through April 2005. In February 2001, we raised
approximately $42.4 million from the sale of Common Stock in a private offering.
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

11

of title, general intangibles, subsidiary stock and other collateral. Borrowings
against the facility are based upon eligible accounts receivable. 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. An unused line of credit fee is payable at
the rate of 0.5%. As of July 26, 2002, we had $10,000,000 in borrowings
outstanding under the credit facility.

During the three months ended July 26, 2002, net cash used in operating
activities was approximately $6,827,000. Accounts receivable increased
$2,160,000 to $12,491,000 at July 26, 2002 from $10,331,000 at April 26, 2002.
Inventories increased $893,000 to $5,421,000 at July 26, 2002 from $4,528,000 at
April 26, 2002. Accounts payable and accrued liabilities decreased $1,899,000 to
$18,911,000 at July 26, 2002 from $20,810,000 at April 26, 2002. During the
three months ended July 26, 2002, we used approximately $1,549,000 in the
purchase of property and equipment. During the same period we received
approximately $618,000 in proceeds from the exercise of stock options. The chart
below reflects our current obligations at July 26, 2002 under our material
contractual obligations.

Capital leases are for manufacturing equipment used in the production of
the VNS Therapy System. The capital leases bear interest at 6.56% and extend
through April 2005. Our liquidity will continue to be reduced as funds are
expended to support continuing 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 $5.7 million as
of July 26, 2002. Our current projections indicate that we have sufficient funds
and cash flow resources to maintain minimum cash and cash equivalents balances
in excess of $20 million throughout fiscal 2003 and fund anticipated business
activities through fiscal year 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 United
States 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.

IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS

See Note 8 of Notes to Consolidated Financial Statements for a
discussion of the impact of new accounting pronouncements.

12

FACTORS AFFECTING FUTURE OPERATING RESULTS

In addition to the factors described above in this section 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 1993. Our common stock is 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 26, 2002, our stock has
traded from a high of $16.40 to a low of $9.26 per share. The fluctuation in our
stock price is caused by a number of factors, some of which are beyond our
control, including:

o quarterly variations in our operating results;

o results of studies regarding the efficacy of our VNS Therapy
treatment for other indications including depression,
Alzheimer's Disease (AD), anxiety and obesity disorders;

o announcements of significant contracts, acquisitions, or capital
commitments;

o changes in financial estimates by securities analysts;

o changes in market valuations of medical device companies;

o additions or departures of key personnel;

o sales of common stock; and

o 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 VNS Therapy 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 VNS Therapy System in the U.S.
for at least the next two fiscal years, if at all. Although sales of the VNS
Therapy 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 VNS Therapy
System for the treatment of depression. We cannot assure you that any approvals
for the treatment of depression with the VNS Therapy System will be granted, nor
can we assure you that even if the approval is granted, we will be successful in
commercializing the VNS Therapy 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 VNS Therapy System for
depression, obesity and other indications may harm our business.

We may not be able to continue to expand market acceptance of the use of
the VNS Therapy System to treat epilepsy, which could cause our sales to
decrease. Continued market acceptance of the VNS Therapy System will depend on
our ability to convince the medical community of the clinical efficacy and
safety of vagus nerve stimulation and the VNS Therapy System. While the VNS
Therapy 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 VNS Therapy System in the
treatment of epileptic seizures. These therapies may be more attractive to
patients or their physicians than the VNS Therapy System in terms of efficacy,
cost or

13

reimbursement availability. We cannot assure you that the VNS Therapy System
will continue to achieve expanded market acceptance for the treatment of
epilepsy or for any other indication. Failure of the VNS Therapy 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 VNS
Therapy System gains market acceptance, the timing of obtaining marketing
approvals for the VNS Therapy System for other indications, the timing of any
approvals for reimbursement by third-party payers, 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 VNS Therapy 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 VNS Therapy System and associated
procedures and services and to reimburse at adequate levels for the costs of the
VNS Therapy System and the related services we have in the U.S. or
internationally. The Center for Medicare & Medicaid Services (CMS) has issued a
new proposed rule for outpatient prospective payment system for the calendar
year 2003. If the proposed policy is approved as it is, this could harm our
business. Patient confidentiality and regulations such as the Health Insurance
Portability and Accountability Act of 1996 (HIPPA), may limit our ability to
secure third party payment for our patients. If we fail to maintain favorable
coverage decisions for the VNS Therapy System in a timely manner, patients and
their physicians could be deterred from using the VNS Therapy 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 VNS Therapy System to patients, health
care providers or third-party payers on a broad basis. In addition, due to
limited market awareness of the VNS Therapy 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 VNS Therapy
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 VNS
Therapy System or to retain our sales force would severely impair our sales and
our business.

14

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 VNS Therapy 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 VNS Therapy
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 VNS Therapy 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
VNS Therapy 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 VNS Therapy System and its
improvements, and for vagus nerve stimulation therapy. To that end, we have
acquired licenses under certain patents and have patented and intend to continue
to seek patents on our own inventions used in our products and treatment
methods. The process of seeking patent protection can be expensive and time
consuming and we cannot assure you that patents will issue from our currently
pending or future applications or that, if patents are issued, they will be of
sufficient scope or strength to provide meaningful protection of our technology,
or any commercial advantage to us. Further, the protection offered by the
licensed international patents is not as strong as that offered by the licensed
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 VNS Therapy 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
VNS Therapy 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

15

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 VNS Therapy
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 VNS Therapy 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 VNS Therapy 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 VNS Therapy 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 additional government
approvals for other applications of the VNS Therapy 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 VNS Therapy 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 VNS Therapy 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 3. 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 commercial paper, 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

16

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.

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

10.1 First Amendment to Cyberonics, Inc. Amended and
Restated 1997 Stock Plan.

99.1 Certification of Chief Executive Officer of
Cyberonics, Inc. pursuant to 18 U.S.C. Section 1350.

99.2 Certification of Chief Financial Officer of
Cyberonics, Inc. pursuant to 18 U.S.C. Section 1350.

(b) Reports on Form 8-K

None.

17

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

CYBERONICS, INC. Registrant

BY: /s/ PAMELA B. WESTBROOK
-----------------------------------------
Pamela B. Westbrook
Vice President, Finance and Administration
and Chief Financial Officer (principal
financial and accounting officer)
Dated: September 6, 2002

18

CERTIFICATION OF
CHIEF EXECUTIVE OFFICER
OF CYBERONICS, INC.

I, Robert P. Cummins, Chief Executive Officer of Cyberonics, Inc. (the
"Company"), hereby certify that:

(i) I have reviewed this quarterly report on Form 10-Q of
Cyberonics, Inc.;

(ii) Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of
the circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report; and

(iii) Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition,
results of operations and cash flows of Cyberonics as of, and
for, the periods presented in this quarterly report.

/s/ ROBERT P. CUMMINS
---------------------------
Name: Robert P. Cummins
Date: September 6, 2002

EXPLANATORY NOTE REGARDING CERTIFICATIONS: Representations 4, 5 and 6 of
the Certification as set forth in Form 10-Q have been omitted, consistent with
the Transition Provisions of SEC Exchange Act Release No. 34-46427, because this
quarterly report of Form 10-Q covers a period ending before the Effective Date
of Rules 13a-14 and 15d-14.

19

CERTIFICATION OF
CHIEF FINANCIAL OFFICER
OF CYBERONICS, INC.

I, Pamela B. Westbrook, Chief Financial Officer of Cyberonics, Inc.,
hereby certify that:

(i) I have reviewed this quarterly report on Form 10-Q of
Cyberonics, Inc.;

(ii) Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of
the circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report; and

(iii) Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition,
results of operations and cash flows of Cyberonics as of, and
for, the periods presented in this quarterly report.

/s/ PAMELA B. WESTBROOK
---------------------------
Name: Pamela B. Westbrook
Date: September 6, 2002

EXPLANATORY NOTE REGARDING CERTIFICATIONS: Representations 4, 5 and 6 of
the Certification as set forth in Form 10-Q have been omitted, consistent with
the Transition Provisions of SEC Exchange Act Release No. 34-46427, because this
quarterly report of Form 10-Q covers a period ending before the Effective Date
of Rules 13a-14 and 15d-14.

20

INDEX TO EXHIBITS

Exhibits

10.1 First Amendment to Cyberonics, Inc. Amended and Restated
1997 Stock Plan.

99.1 Certification of Chief Executive Officer of Cyberonics,
Inc. pursuant to 18 U.S.C. Section 1350.

99.2 Certification of Chief Financial Officer of Cyberonics,
Inc. pursuant to 18 U.S.C. Section 1350.

21