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 January 24, 2003 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 FEBRUARY 27, 2003
Common Stock - $0.01 par value 22,308,051

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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).

3

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)

JANUARY 24, 2003

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
nine months ended January 24, 2003 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 4.25% as of
January 24, 2003, plus 1.5% totaling 5.75% 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 January 24, 2003, 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 $354,000 of compensation expense has been recognized for the
vested portion of this option grant during the nine months ended January 24,
2003 and January 25, 2002.

Stock Incentive and Purchase Plans. As of January 24, 2003, the Company
has reserved an aggregate of 13,350,000 shares of Common Stock, 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 nine months ended January 24, 2003, the Company has granted
approximately 1,151,150 options at a weighted average exercise price of
approximately $14.57 per share. All grants were made at market prices as of the
date of the grant. Stock options to purchase approximately 7.1 million shares at
a weighted average exercise price of $13.81 per share were outstanding as of
January 24, 2003.

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 for the
three and nine months ended January 24, 2003 were outstanding options to
purchase 1,275,824 and 1,741,599 common shares, respectively, because to include
them would have been antidilutive, meaning the exercise price of these options
exceeds their current fair market value. None of the 6,869,698 options to
purchase common shares outstanding at January 25, 2002 were included in the
computation of diluted earnings per share for the three and nine months ended
January 25, 2002 because to do so would have been antidilutive.

NOTE 7 -- NEW ACCOUNTING PRONOUNCEMENTS:

In December 2002, the Financial Accounting Standards Board issued SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure."
SFAS No. 148 amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition to SFAS No. 123's
fair value method of accounting for stock-based employee compensation. SFAS No.
148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No.
28, "Interim Financial Reporting," to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income and
earnings per share in annual and interim financial statements. While SFAS No.
148 does not amend SFAS No. 123 to require companies to account for employee
stock options using the fair value method, the disclosure provisions of SFAS No.
148 are applicable to all companies with stock-based employee compensation,
regardless of whether they account for that compensation using the fair value
method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25. As
allowed by SFAS No. 123, the Company has elected to continue to utilize the
accounting method prescribed by APB Opinion No. 25 and has adopted the
disclosure requirements of SFAS No. 123.

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. These statements can be identified by
the use of forward-looking terminology, including "may," "believe," "will,"
"expect," "anticipate," "estimate," "plan," "intend," and "forecast," or other
similar words. 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.

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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 and 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 model by measuring and managing each step in
the sales process and implementing marketing systems to improve
patient conversion rates and cycle times to implant,

o Expand market awareness, acceptance and demand for VNS(TM) Therapy
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
expiration,

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 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 the
treatment of chronic depression were completed and unblinded. The D-02 acute
results did not show a statistically significant difference in response to rates
between the treatment and placebo non-treatment groups. We 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: (1) the statistical significance
of the D-02 study patients' one-year outcomes through a repeated measures linear
regression analysis, (2) clinical significance through an analysis of sustained
response at one year of treatment, and (3) causality through a comparison of
one-year D-02 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.

In January 2003, the D-02 study long-term results were completed and
released. The D-02 long-term results showed statistically significant and
clinically significant improvements compared to baseline. The determination of
statistical significance was the primary endpoint of the long-term D-02 analysis
plan. Statistical significance was determined pursuant to the analysis plan
using a repeated measures linear regression analysis to analyze the improvements
from pre-treatment baseline in approximately 200 patients with chronic or
recurrent treatment resistant depression as measured by the 24-item Hamilton
Rating Scale (HRSD-24) throughout the first 12 months of treatment. Statistical
significance was defined as a p-value < 0.05. The HRSD-24 improvements observed
over the first year were highly significant with a p < 0.001. The secondary
measures of statistical

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significance showed similarly positive results. The determination of clinical
significance was a key secondary endpoint of the D-02 analysis plan. Clinical
significance was determined by analyzing the percent of patients who showed a
sustained response between nine and 12 months of treatment with VNS Therapy. In
the absence of published literature that defines a long-term success criterion,
Cyberonics' psychiatric clinical advisors suggested that a sustained response
rate of approximately 30% would be significant. Approximately 30% of the
patients from the original acute treatment group and 25% of all patients in the
analysis showed a sustained response between months nine and 12. The secondary
measures of clinical significance showed similarly positive results.

We expect to complete the D-04 companion study to determine the
existence of a causal relationship between the statistically and clinically
significant D-02 outcomes and VNS Therapy in July 2003. At that time, we will
complete our revised US regulatory plan. 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
indication studies in order to allow us to focus our limited clinical and
financial resources on the determination of effectiveness of VNS Therapy in
chronic depression. We continue to collect long-term data in the anxiety,
Alzheimer's disease 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 two to nine years.
An unanticipated change in the utilization or expected useful life of property
and equipment could 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 January 24, 2003 were
$27,562,000, increasing by $9,173,000 or 49.9% over the $18,389,000 for the same
period last year. Third quarter net sales included $25,062,000 from the U.S.
market and $2,500,000 from international markets. U.S. net sales for the third
quarter increased by $8,281,000, or 49.3% over the $16,781,000 for the same
period last year. International net sales increased by $892,000 or 55.5% over
the $1,608,000 for the same period last year. Net sales for the nine months
ended January 24, 2003 were $76,690,000 reflecting an increase of $26,804,000 or
53.7% over the $49,886,000 for the same period last year. Year-to-date net sales
included $70,830,000 from the U.S. market and $5,860,000 from international
markets. For the year-to-date, U.S. net sales increased by $25,619,000 or 56.7%
over the $45,211,000 for the same period last year. International sales
increased by $1,185,000 or 25.3% over the $4,675,000 for the same period last
year. The increase in net sales in the U.S. for the three and nine months ended
January 24, 2003 is primarily due to higher volume driven by patient demand and
increases in average selling prices resulting primarily from new product
introductions. The increase in international net sales for the three and nine
months ended January 24, 2003 is due to an increase in unit volume, a higher
average selling price and a stronger Euro as compared to the U.S. Dollar. We
anticipate annual worldwide sales growth of approximately 45% for the remainder
of fiscal 2003.

Gross Profit. Gross profit for the three months ended January 24, 2003
was $23,387,000 or 84.9% of net sales compared to $14,713,000 or 80.0% for the
same period last year. Gross profit for the nine months ended January 24, 2003
was $64,748,000 or 84.4% of net sales compared to $39,645,000 or 79.5% for the
same period last year. The improvement in gross profit margin for the three and
nine months ended January 24, 2003 was due to higher average selling prices,
product mix and improvements in manufacturing efficiencies. We anticipate gross
profit margin will remain at similar levels for 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 January 24, 2003 totaled
$15,506,000 or 56.3% of net sales compared to $14,289,000 or 77.7% of net sales
for the same period last year. Selling, general and administrative expenses for
the nine months ended January 24, 2003 totaled $50,431,000 or 65.8% of net sales
compared to $41,385,000 or 83.0% of net sales for the same period last year. The
increase in selling, general and administrative expenses for the three and nine
months ended January 24, 2003 is primarily due to additional expenses associated
with the expansion of the sales and marketing organization from approximately 73
people at January 25, 2002 to approximately 161 people at January 24, 2003.

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
January 24, 2003 totaled $4,310,000 or 15.6% of net sales, compared to
$6,272,000 or 34.1% of net sales for the same period last year. Research and
development expenses for the nine months ended January 24, 2003 totaled
$13,700,000 or 17.9% of net sales compared to $18,436,000 or 37.0% of net sales
for the same period last year. The decrease in research and development expenses
is primarily due to reduced clinical programs

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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.

Interest Income. Interest income for the three months ended January 24,
2003 was $119,000 compared to $207,000 for the same period last year. Interest
income for the nine months ended January 24, 2003 was $370,000 compared to
$1,085,000 for the same period last year. The decrease in interest income for
the three and nine months ended January 24, 2003 is due to a decrease in average
investment balances and lower interest rates.

Interest Expense. Interest expense for the three months ended January
24, 2003 was $99,000 compared to $95,000 for the same period last year. The
increase in interest expense for the three months ended January 24, 2003 is due
to higher borrowings under the line of credit facility entered into in September
2001, partially offset by lower interest rates. Interest expense for the nine
months ended January 24, 2003 was $320,000 compared to $165,000 for the same
period last year. The increase in interest expense for the nine months ended
January 24, 2003 is primarily due to increased borrowings under the line of
credit facility over a period of nine months in fiscal 2003 as compared to lower
borrowings over a period of six months in fiscal 2002, partially offset by lower
interest rates.

Other Income (Expense), Net. Other income, net for the three months
ended January 24, 2003 was $258,000 compared to an expense of $38,000 for the
same period last year. Other income, net for the three months ended January 24,
2003 is primarily due to transaction gains associated with currency exchange.

Other income, net for the nine months ended January 24, 2003 was
$512,000 compared to $13,000 for the same period last year. Other income, net is
primarily due to currency exchange gains.

Income Taxes. We estimated that our effective tax rate for the nine
months ended January 24, 2003 was 2.4%, due primarily to the effects of net
operating loss carry-forwards and state income taxes. The effective tax rate
represents the Company's estimate of the rate expected to be applicable for the
full fiscal year and includes the reversal of a portion of existing valuation
allowances. Due to our operating loss history, to date we have established a
valuation allowance that fully offsets our deferred tax assets, including those
related to tax loss carry-forwards, resulting in no federal income tax expense
or benefit for financial reporting purposes. Current federal income tax
regulations with respect to change in ownership could limit the utilization of
the operating loss carry-forward.

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 January 24, 2003, we had
$7,000,000 in borrowings outstanding under the credit facility.

During the nine months ended January 24, 2003, net cash used in
operating activities was approximately $267,000. Accounts receivable increased
$2,285,000 to $12,616,000 at January 24, 2003 from $10,331,000 at April 26,
2002. Inventories increased $1,372,000 to $5,900,000 at January 24, 2003 from
$4,528,000 at April 26, 2002. Accounts payable and accrued liabilities decreased
$1,244,000 to $19,566,000 at January 24, 2003 from $20,810,000 at April 26,
2002. During the nine months ended January 24, 2003 we used approximately
$3,620,000 in the purchase of property and equipment. During the same period we
received approximately $5,105,000 in proceeds from the exercise of stock
options. The chart below reflects our current obligations at January 24, 2003
under our material contractual obligations.

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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. Operating leases are primarily obligations applicable to the
lease of facilities and office equipment. Meetings are commitments made for
future events. 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 $4.4 million as of January 24, 2003. 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 $35 million
throughout fiscal 2003 and to 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 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, during the period from October 26,
2002 to January 24, 2003 our stock has traded from a high of $20.50 to a low of
$14.47 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,
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

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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, Alzheimer's disease 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 over 20,000 patients through January 24, 2003,
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.

We may not be successful in our efforts to develop VNS Therapy for the
treatment of depression, Alzheimer's disease, anxiety, or any other indications.
We are in the process of conducting studies to help us evaluate the use of VNS
Therapy as a treatment for depression, Alzheimer's disease, 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 would anticipate with the
successful development of any of these indications.

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.

14

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. 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.

Patient confidentiality and regulations such as the Health Insurance
Portability and Accountability Act (HIPAA) of 1996 may limit our ability to
secure a third party payment for our patients and impact our patient pull
through selling model. HIPAA regulations are required to be fully implemented
for all health care providers by April 14, 2003. Under the HIPAA privacy rule,
the privacy of all medical records, billing records, and other identified health
information ("Protected Health Information" or "PHI") must be protected. Such
regulations may hinder our ability to utilize our Patient Identification and
Qualification (PIQ) process as well as our VNS Patient Outcomes Registry
(Registry), both of which are key elements of our patient pull through sales
model. The discontinuation of our PIQ and Registry processes could severely
limit our ability to market and sell VNS Therapy under our existing sales model
and could harm our business growth and financial condition.

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. 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 or in claims of injury
caused by our device in patients. 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.

15

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 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

16

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: March 5, 2003

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 officer 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 officer 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 officer 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: March 5, 2003

/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 officer 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 officer 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 officer 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: March 5, 2003

/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