CYBERONICS INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended October 25, 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 NOVEMBER 20, 2002
Common Stock - $0.01 par value 22,035,606

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CYBERONICS, INC.

INDEX

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CYBERONICS, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying Notes to Consolidated Financial Statements (Unaudited).

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CYBERONICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (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).

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

OCTOBER 25, 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
six months ended October 25, 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 -- 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% as of
October 25, 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 October 25, 2002, the Company had $7,000,000 in
borrowings outstanding under the credit facility.

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NOTE 4 -- ACCRUED LIABILITIES:

Accrued liabilities are as follows:

NOTE 5 -- 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 $236,000 of compensation expense has been recognized for the
vested portion of this option grant during the six months ended October 25, 2002
and October 26, 2001.

Stock Incentive and Purchase Plans. As of October 25, 2002, the Company
has an aggregate reserve of 12,350,000 shares, 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. 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 and the 1998 Stock Option Plans provide for
issuance of nonstatutory stock options exclusively. For the six months ended
October 25, 2002, the Company has granted approximately 951,500 options at a
weighted average exercise price of approximately $14.04, which were issued at
market rate at the date of grant. Stock options to purchase approximately 7.3
million shares at a weighted average exercise price of $13.52 per share were
outstanding as of October 25, 2002.

NOTE 6 -- 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 reflect the potential dilution that could occur if securities or
other contracts to issue common stock were exercised or converted into common
stock and would then share in net income of the Company.

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The following table sets forth the computation and basic and diluted net
earnings (loss) per share of common stock:

Excluded from the computation of diluted earnings per share are options
to purchase 1,446,139 shares of common stock which were outstanding during the
three months ended October 25, 2002. These options were outstanding during the
applicable period, but were excluded because the option exercise price was
greater than the average market price of the common shares. For the purpose of
computing diluted loss per share for the three months ended October 26, 2001 and
the six months ended October 25, 2002 and October 26, 2001, no exercise of
options was assumed since the result would have been antidilutive. Options to
purchase a total of 7,261,153 and 6,090,587 shares of common stock were
outstanding on October 25, 2002 and October 26, 2001, respectively.

NOTE 7 -- 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

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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
neurologic psychiatric diseases and 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 predictable and profitable growth and the
development of other indications for VNS Therapy covered by our method patent
portfolio.

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 for replacement of generators whose batteries
have reached end of service,

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
of America 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 (AD) and
other neurological disorders covered by our method patent portfolio. In January
2002, the acute results of the pivotal clinical study (D-02) on VNS Therapy for

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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 have amended 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
revised analysis plan is designed to determine the statistical significance of
the D-02 study patients' one-year outcomes through a repeated measures linear
regression analysis and to determine clinical significance through an analysis
of sustained response at one year of treatment. The analysis plan also calls for
a comparison of the D-02 study patients' one-year outcomes with the one-year
outcomes of patients in a companion study, referred to as D-04, treated with
standard medical management at 12 of the 21 D-02 study sites. We expect to
complete the D-02 one year follow-up and release the results with a revised U.S.
regulatory plan by the end of fiscal 2003. In recent communications following
FDA's review of the revised analysis plan, FDA recognized the need for new
treatments for pharmaco-resistant depression, reconfirmed VNS Therapy's
Expedited Review Status and reiterated that until FDA has reviewed the one-year
data they believe another randomized, control study will be required

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. We continue to collect long-term data in the anxiety, AD and
chronic headache pilot studies. New indication study activities are
investigational. We cannot assure you that test results will be positive or that
we will receive FDA approval for the use of our product for the treatment of any
new indications.

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.

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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 October 25, 2002 were
$26,072,000, increasing by $9,190,000 or reflecting an increase of 54.4% over
the $16,882,000 for the same period last year. Second quarter net sales included
$24,376,000 from the U.S. market and $1,696,000 from international markets. U.S.
net sales for the second quarter increased by $9,196,000, or 60.6% over the
$15,180,000 for the same period last year. International net sales decreased by
$6,000 or 0.3% below the $1,702,000 for the same period last year. The increase
in net sales in the U.S. for the three months ended October 25, 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 was very strong and sales of the Model 102 VNS Therapy System have
represented greater than 70% of sales in the U.S. market since launch. The
decrease in international net sales for the three months ended October 25, 2002
is due to a decrease in unit volume offset by a higher average selling price and
a stronger Euro Dollar as compared to the U.S. Dollar.

Net sales for the six months ended October 25, 2002 were $49,128,000
reflecting an increase of $17,631,000 or 56.0% over the $31,497,000 for the same
period last year. Year-to-date net sales included $45,769,000 from the U.S.
market and $3,359,000 from international markets. For the year-to-date, U.S. net
sales increased by $17,339,000 or 61.0% over the $28,430,000 for the same period
last year. International sales increased by $292,000 or 9.5% over the $3,067,000
for the same period last year. The increase in sales in the U.S. for the six
months ended October 25, 2002 was primarily driven by higher volume and higher
average selling price due to product mix and new product introductions. The
increase in international sales was due primarily to a higher average selling
price and a stronger Euro Dollar as compared to the U.S. Dollar. We anticipate
to achieve annual sales growth world wide of approximately 45% for the remainder
of fiscal 2003.

Gross Profit. Gross profit for the three months ended October 25, 2002
was $22,255,000 or 85.4% of net sales compared to $13,430,000 or 79.6% for the
same period last year. The increase of 581 basis points in gross profit margin
for the three months ended October 25, 2002 is due to higher average selling
prices, product mix and improvements in manufacturing efficiencies resulting in
a reduction of product cost per unit.

Gross profit for the six months ended October 25, 2002 was $41,360,000
or 84.2% of net sales compared to $24,936,000 or 79.2% for the same period last
year. The increase of 502 basis points is due to higher average selling prices,
product mix and improvements in manufacturing efficiencies resulting in
reductions of product cost per unit. We anticipate gross profit margin will
continue to improve over the remainder of fiscal year 2003, achieving 84.5% 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 October 25, 2002 totaled
$16,569,000 or 63.6% of net sales compared to $14,551,000 or 86.2% of net sales
for the same period last year. The increase in selling, general and
administrative expenses for the three months ended October 25, 2002 is primarily
due to additional expenses associated with the expansion of the sales and
marketing teams from approximately 92 people at October 26, 2001 to
approximately 161 people at October 25, 2002.

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Selling, general and administration expenses for the six months ended
October 25, 2002 totaled $34,924,000 or 71.1% of net sales compared to
$27,100,000 or 86.0% of net sales for the same period last year. The increase in
selling, general and administrative expenses for the six months ended October
25, 2002 is primarily due to additional expenses associated with the expansion
of the sales organization to support sales growth in the U.S. market. We
anticipate 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
October 25, 2002 totaled $4,595,000 or 17.6% of net sales, compared to
$6,035,000 or 35.8% 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, AD and other indications covered by our
proprietary patent portfolio.

Research and development expenses for the six months ended October 25,
2002 totaled $9,391,000 or 19.1% of net sales compared to $12,163,000 or 38.6%
of net sales for the same period last year. The decrease in research and
development expenses is primarily due to reduced activities in clinical programs
to determine the effectiveness of VNS Therapy in new indications, including
chronic depression, anxiety, AD and other indications covered by our proprietary
patent protected portfolio. We anticipate 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 October 25,
2002 was $121,000 compared to $341,000 for the same period last year. The
decrease in interest income for the three months ended October 25, 2002 is due
to a decrease in average investment balances, and lower interest rates.

Interest income for the six months ended October 25, 2002 was $251,000
compared to $878,000 for the same period last year. The decrease in interest
income for the six months ended October 25, 2002 is due to a decrease in average
investment balances and lower interest rates.

Interest Expense. Interest expense for the three months ended October
25, 2002 was $123,000 compared to $54,000 for the same period last year. The
increase in interest expense for the three months ended October 25, 2002 is
primarily due to interest incurred as a result of increased borrowings under the
line of credit facility entered into in September 2001.

Interest expense for the six months ended October 25, 2002 was $220,000
compared to $70,000 for the same period last year. The increase in interest
expense for the six months ended October 25, 2002 is primarily due to interest
incurred as a result of increased borrowings under the line of credit facility
entered into in September 2001.

Other Income (Expense), Net. Other income (expense), net for the three
months ended October 25, 2002 was ($85,000) compared to $39,000 for the same
period last year. Other income (expense), net for the three months ended October
25, 2002 is primarily due to transaction gains (losses) associated with currency
exchange.

Other income, net for the six months ended October 25, 2002 was
$254,000 compared to $51,000 for the same period last year. Other income, net is
primarily due to currency exchange gains or losses.

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 federal 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.

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LIQUIDITY AND CAPITAL RESOURCES

Since our inception, we have financed our operations primarily through
public and private placements of our securities. 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. 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 October 25, 2002, we had
$7,000,000 in borrowings outstanding under the credit facility.

During the six months ended October 25, 2002, net cash used in
operating activities was approximately $29,000. Accounts receivable increased
$1,264,000 to $11,595,000 at October 25, 2002 from $10,331,000 at April 26,
2002. Inventories increased $1,244,000 to $5,772,000 at October 25, 2002 from
$4,528,000 at April 26, 2002. Accounts payable and accrued liabilities increased
$1,733,000 to $22,543,000 at October 25, 2002 from $20,810,000 at April 26,
2002. During the six months ended October 25, 2002 we used approximately
$2,885,000 in the purchase of property and equipment. During the same period we
received approximately $2,925,000 in proceeds from the exercise of stock
options. The chart below reflects our current obligations at October 25, 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. 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 $5.5 million as of October 25, 2002. We expect cash flow from operations
and existing credit and capital resources to provide sufficient funds to
maintain minimum cash and cash equivalents balances in excess of $30 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.

IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS

See Note 7 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, 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

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1993. Our common stock is traded on the Nasdaq National Market under the 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, from July 26, 2002 to October 25, 2002 our stock has traded from a
high of $19.70 to a low of $12.20 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, AD,
anxiety and other 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 and chronic headache.
Our inability to commercialize successfully the VNS Therapy System for
depression 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 17,000 patients through October
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, safety, cost or 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.

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We may not be successful in our efforts to develop VNS Therapy for the
treatment of depression, AD, anxiety, 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,
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 may 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, or changes in, 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 State 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 related services in the U.S. or internationally. 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 that 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.

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.

15

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 device-based therapies 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, Parkinsonian tremor, and
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 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

16

could suffer. In connection with the commercialization of the VNS Therapy System
in the U.S., we have experienced significant growth since 1997. Our ability to
effectively continue to 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.

17

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 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 4. CONTROLS AND PROCEDURES

Within the 90-day period prior to the filing of this report, an
evaluation was carried out under the supervision and with the participation of
Cyberonics' management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-14 (c) under the
Securities and Exchange Act of 1934). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the design and
operation of these disclosure controls and procedures were effective. No
significant changes were made in our internal controls or in other factors that
could significantly affect these controls subsequent to the date of their
evaluation.

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

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.

18

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, Secretary and
Chief Financial Officer (Principal
Financial and Accounting Officer)
Dated: December 3, 2002

19

CERTIFICATION OF
CHIEF EXECUTIVE OFFICER
OF CYBERONICS, INC.

I, Robert P. Cummins, Chief Executive 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;

(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 the registrant as of, and for, the periods
presented in this quarterly report;

(iv) The Registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls and
procedures (as defined in the Exchange Act Rules 13a-14 and 15d-14) for
the registrant and we have:

(a) designed such disclosure controls and procedures
to ensure that material information relating to the
registrant, including its consolidated subsidiary, is made
known to us by others within those entities, particularly
during the period in which this quarterly report is being
prepared;

(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this quarterly report (the
"Evaluation Date"); and

(c) presented in this quarterly report our
conclusions about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the Evaluation
Date;

(v) The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the registrant's
auditors and the audit committee of the registrant's board of directors
(or persons performing the equivalent function):

(a) all significant deficiencies in the design or
operation of internal controls which could adversely affect
the registrant's ability to record, process, summarize and
report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and

(vi) The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

Date: December 3, 2002

/s/ ROBERT P. CUMMINS
------------------------------------

Name: Robert P. Cummins
Title: Chairman of the Board,
President, Chief Executive
Officer (Principal Executive
Officer)

20

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;

(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 the registrant as of, and for, the periods
presented in this quarterly report;

(iv) The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls and
procedures (as defined in the Exchange Act Rules 13a-14 and 15d-14) for
the registrant and we have:

(a) designed such disclosure controls and procedures
to ensure that material information relating to the
registrant, including its consolidated subsidiary, is made
known to us by others within those entities, particularly
during the period in which this quarterly report is being
prepared;

(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this quarterly report (the
"Evaluation Date"); and

(c) presented in this quarterly report our
conclusions about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the Evaluation
Date;

(v) The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the registrant's
auditors and the audit committee of the registrant's board of directors
(or persons performing the equivalent function):

(a) all significant deficiencies in the design or
operation of internal controls which could adversely affect
the registrant's ability to record, process, summarize and
report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and

(vi) The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

Date: December 3, 2002

/s/ PAMELA B. WESTBROOK
----------------------------------------

Name: Pamela B. Westbrook
Title: Vice President, Finance
and Administration, Secretary and
Chief Financial Officer
(Principal Financial and
Accounting Officer)

21

INDEX TO EXHIBITS