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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL PERIOD ENDED: APRIL 25, 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
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CYBERONICS, INC.
(Exact name of Registrant as Specified in its Charter)
DELAWARE 76-0236465
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification Number)
organization)
CYBERONICS BUILDING HOUSTON, TEXAS
100 CYBERONICS BLVD., 77058-2072
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(281) 228-7200
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(TITLE OF CLASS)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [ ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 126-2). Yes [X] No [ ]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant as of October 25, 2002, the last business
day of the registrant's most recently completed second fiscal quarter and June
24, 2003, its most recently completed fiscal quarter, was, based upon the last
sales price reported for such date on the Nasdaq National Market, approximately
$258 million and $329 million, respectively. For purposes of this disclosure,
shares of Common Stock held by persons who hold more than 5% of the outstanding
shares of Common Stock and shares held by officers and directors of the
registrant, have been excluded in that such persons may be deemed to be
affiliates. This determination is not necessarily conclusive.
At June 24, 2003, registrant had outstanding 22,467,985 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of Form 10-K will be incorporated by
reference to the registrant's definitive proxy statement for its annual meeting
of stockholders in 2003. To the extent that such proxy statement is not filed
within 120 days of the registrant's fiscal year end, the registrant will file an
amendment to this Form 10-K to include such information.
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TABLE OF CONTENTS
PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 20
Item 3. Legal Proceedings........................................... 20
Item 4. Submission of Matters to a Vote of Security Holders......... 20
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 21
Item 6. Selected Financial Data..................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 23
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 33
Item 8. Financial Statements and Supplementary Data................. 33
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 33
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 34
Item 11. Executive Compensation...................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 34
Item 13. Certain Relationships and Related Transactions.............. 35
Item 14. Controls and Procedures..................................... 35
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 36
1
PART I
ITEM 1. BUSINESS
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Exchange Act of 1933 and Section
21E of the Securities Exchange Act of 1934. Actual results could differ
materially from those projected in the forward-looking statements as a result of
a number of important factors. For a discussion of important factors that could
affect our results, please refer to the Business section below, the financial
statement line item discussions and the Factors Affecting Future Operating
Results both set forth in Management's Discussion and Analysis of Financial
Condition and Results of Operations.
GENERAL
Cyberonics, Inc. was founded in 1987 to design, develop, manufacture and
market the Cyberonics VNS Therapy System, an implantable medical device for the
treatment of epilepsy and other debilitating chronic disorders. Our mission is
to improve the lives of people whose lives have been touched by epilepsy,
depression and other disorders that may prove to be treatable with our patented
therapy, Vagus Nerve Stimulation (VNS). To accomplish that mission we have
pioneered new medical science regarding the vagus nerve and its impact on
neurostransmitters and brain function, a new device based therapy, new study
designs and United States Food and Drug Administration (FDA) approval processes
for neurostimulation, a distinct sales and marketing model to profitably create
awareness, acceptance and demand for a revolutionary device based therapy among
six different customer constituencies in a traditional pharmaceutical market, a
new consensus on pharmacoresistant epilepsy and its treatment, and a totally new
device market.
Our overall objectives are to grow sales, increase profits and
profitability, maintain positive cash flow and develop other indications for VNS
covered by our method patents. Our strategies to achieve our objectives are to
(1) continually develop the people, organization, systems, controls and
processes to improve the profitability, scalability and transferability of our
business model to accelerate penetration of the growing epilepsy market and
realize the full potential of VNS Therapy in other potential new indications,
including depression; (2) improve sales force execution of our proprietary
mission flow chart and patient pull-through sales model; (3) expand market
awareness of VNS Therapy by creating physician and patient demand through new
promotional and educational initiatives, geared to targeted physicians and
patients; (4) maintain end-of-service initiatives to satisfy physician and
patient demand and drive revenue growth; (5) develop and introduce
next-generation products that will provide improved product functionality,
command higher prices and drive higher gross profit margin; (6) demonstrate the
clinical and statistical significance and causal relationship of VNS Therapy in
depression from existing studies long-term data, as appropriate, and (7) expand
the VNS Therapy indication for use and labeling to include depression and other
indications in the United States through a well defined pre-market approval
supplement (PMA-S) process.
In March 2001, we elected to change our fiscal year from June 30 to a 52/53
week year ending on the last Friday in April of each year, effective April 27,
2001. Accordingly, fiscal 2003 started April 27, 2002 and ended April 25, 2003,
fiscal 2002 started April 28, 2001 and ended April 26, 2002 and fiscal 2001
started July 1, 2000 and ended April 27, 2001.
EPILEPSY
In July 1997, we received approval from FDA to market Cyberonics VNS
Therapy System in the U.S. as an adjunctive therapy for reducing the frequency
of seizures in patients over 12 years of age with partial onset seizures that
are refractory or resistant to drugs. We have also received regulatory approval
to sell the VNS Therapy System in Canada, Europe, Australia and certain
countries in the Far East for the treatment of refractory epilepsy and without
patient age or seizure type limitation. To date, over 22,000 patients with
epilepsy have accumulated in excess of over 56,000 patient years of treatment
with the VNS Therapy System.
2
EPILEPSY MARKET OVERVIEW
Epilepsy is a disorder of the brain characterized by recurrent seizures.
Epileptic seizures are categorized as either partial or generalized at onset.
Generalized seizures which involve the entire brain from the onset generally
result in the loss of consciousness and are typically manifested by convulsions.
Partial onset seizures initiate in a localized region of the brain, and may or
may not result in an alternation in consciousness. Partial onset seizures can
also progress to generalized seizures. Patients who continue to have
unsatisfactory seizure control or intolerable side effects after treatment with
appropriate antiepileptic therapies for a reasonable period of time are said to
suffer from refractory epilepsy. For reasons that are not clear, partial onset
seizures are generally more refractory to existing therapies than generalized
seizures.
It is estimated that approximately 2.8 million individuals in the U.S. have
epilepsy, with approximately 150,000 new cases diagnosed each year, and that
there are in excess of 3.3 million individuals with epilepsy in Western Europe
and Japan, with over 210,000 new cases diagnosed each year. In addition, it is
estimated that approximately 50% of patients with epilepsy suffer from partial
onset seizures and that over 20% of these patients continue to suffer from
seizures in spite of treatment with antiepileptic drugs. The medical,
psychological, sociological and financial implications of refractory epilepsy
can be profound for individuals and their families. Seizures can be severely
debilitating and may result in major irreversible morbidity which consist of
lasting complications or side effects. Medical consequences may include brain
damage from recurrent seizures, injuries and accidents associated with the loss
or impairment of consciousness and death as the result of severe seizures.
Personal implications of epilepsy may include suffering the side effects of
antiepileptic drugs, strained personal and family relations, and the inability
to obtain and hold meaningful employment or a driver's license.
TRADITIONAL EPILEPSY THERAPIES
Traditionally, there have been two courses of treatment available to
persons suffering from epilepsy: drug therapy and surgery. The efficacy of these
treatments depends in part upon the type of seizures from which a patient
suffers. The efficacy of drugs and surgery for patients suffering from partial
onset seizures is highly variable.
Drug Therapy. Antiepileptic drugs serve as a first-line treatment and are
prescribed for virtually all individuals being treated for epilepsy. Lack of
patient compliance, which is typical of chronic drug therapy, inherently reduces
the efficacy of a drug therapy regimen. In addition, side effects are common
with antiepileptic drugs. Side effects range from debilitating central nervous
system conditions such as drowsiness, confusion and cognitive impairment to
life-threatening hematologic reactions or liver failure. Women taking
antiepileptic drugs are more likely to bear infants with birth defects than the
general population. Children receiving antiepileptic drug therapy often
experience learning difficulties.
Surgical Treatment. When drug therapy is not effective, the other
traditional treatment alternative has been surgical removal of the portion of
the brain where seizures originate. Surgical treatment of epilepsy has been
proven safe and beneficial for a limited number of patients. Only approximately
2,500 epilepsy surgeries are performed per year in the U.S. We believe that the
low number of surgeries is attributable to several factors, including: the
extensive evaluation and testing required to screen candidates for surgery and
to localize the source of the seizures; the relatively small percentage of
patients who have a clearly identifiable and surgically accessible focus for
their seizures; the risks of morbidity and mortality associated with brain
surgery; the uncertainty of long-term benefits; the non-reversible nature of the
procedure; and the cost of evaluation, testing and surgery, which is reported to
be approximately $60,000 in many cases.
VNS THERAPY
Our FDA approved VNS Therapy System is the only currently approved medical
device alternative for treating epilepsy. The VNS Therapy System delivers an
electrical signal through an implantable lead to the left cervical vagus nerve
in the patient's neck on a chronic, intermittent basis. Stimulation may also be
initiated by the patient (or caregiver) with a hand held magnet.
3
We believe that a successful new therapy for refractory epilepsy should be
clinically proven as effective, provide significant acute and long-term seizure
control, be safe and tolerable with few side effects, provide sustained
improvements in quality of life and be easy for the physician to prescribe and
for the patient to use. Based on the results of our preclinical studies,
mechanism of action research, seven human clinical trials and the Cyberonics VNS
Patient Outcome Registry, we believe that the VNS Therapy System meets these
criteria as described below.
Clinically Proven. To date over 22,000 patients have accumulated in excess
of 56,000 patient years of treatment experience with the VNS Therapy System. In
July 1997, the VNS Therapy System was approved by FDA for use as an adjunctive
therapy in reducing the frequency of seizures in adults and adolescents over 12
years of age with partial onset seizures that are refractory to antiepileptic
drugs. The product is approved for the broader indication of refractory epilepsy
in Canada, the European Union, Australia and other Asian markets.
Significant Seizure Control. In our two randomized, parallel, double-blind
active control studies, the treatment groups reported a mean seizure reduction
of approximately 24% and 28% during the three-month acute phase of the studies.
Additionally, many patients, including some who reported no change or an
increase in seizure frequency, also reported a reduction in seizure severity.
Long-term follow-up data, derived from an uncontrolled protocol, on the 244
patients in our first four studies suggest that efficacy is maintained and, for
many patients, improves over time when the VNS Therapy System is used as an
adjunctive therapy with drugs as part of a patient's optimized long-term
treatment regimen. Analysis of this pooled data showed that the median percent
seizure reduction increased from 17% in the first three months to 41% after 24
months of treatment.
Well-tolerated Side Effects. The side effects associated with the VNS
Therapy System are generally mild, localized and related to the period of time
in which stimulation is activated. They include hoarseness, coughing, a feeling
of shortness of breath and throat pain. The VNS Therapy System has not typically
been associated with the debilitating central nervous system side effects which
frequently accompany antiepileptic drugs. Additionally, side effects decrease
over time, with no single side effect being reported by more than 3% of
patients.
Quality of Life. The Cyberonics VNS Patient Outcome Registry collects
acute and long-term follow-up data on patients treated with VNS Therapy post-FDA
approval. Global changes were measured in important quality of life areas such
as alertness, verbal communication, memory, school/professional achievements,
mood changes, postictal state and cluster seizures. As of April 25, 2003, the
registry included data on over 7,200 patients of which approximately 4,500
patients were at three-months follow-up and over 2,700 patients were at
12-months follow-up. Compared to pre-implant, approximately half of patients in
both the acute and long-term follow-up exhibit improvements in at least two
quality of life areas. Less than 6% of patients exhibited a worsening of any
effect in both the acute and long-term patient populations.
Easy to Use. The implantation procedure is a straightforward, reversible
procedure which takes between 30 and 90 minutes, does not involve the brain and
has been performed by surgeons with a variety of specializations. Additionally,
the VNS Therapy System does not interact with existing therapies and, because
the VNS Therapy System provides therapy without patient (or caregiver)
administration, full compliance is assured. Moreover, a patient can use a magnet
to temporarily override the pre-programmed stimulation cycle to activate
on-demand therapy if the patient senses the onset of a seizure or to temporarily
eliminate stimulation side effects. The VNS Therapy System implantation is
reversible for patients who elect to discontinue treatment.
DEPRESSION
We are conducting clinical studies of the VNS Therapy System for the
treatment of depression in patients with unipolar and bipolar depressive
disorder. The depression study program includes acute and long-term clinical
studies, acute and long-term mechanism of action research and clinical and
economic outcome studies in patients with treatment-resistent depression
receiving standard medical treatment that does not include VNS. These studies
are being conducted to determine the safety, effectiveness and cost
effectiveness
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of VNS Therapy in the treatment of depression, support regulatory approvals and
support post-approval psychiatrist, patient and payer acceptance. The clinical
component consists of two studies: a 60-patient open-label pilot study (D-01)
which was initiated in fiscal 1999 and includes long-term follow-up, with all
continuing patients exceeding two years of follow-up and a 235-patient
randomized, double-blind, placebo-controlled study (D-02) with long-term
open-label follow-up.
The D-01 acute results showed an acute response rate of 31% which increased
to 45% after 12 months of VNS Therapy. In late January 2002, the acute results
of the D-02 study on VNS Therapy were completed and unblinded. The D-02 acute
results showed (1) a 15% response rate in the active treatment group, which did
not represent a statistically significant improvement over the placebo group,
(2) a 10% response rate in the placebo group, confirming the treatment-resistant
nature of the study population, (3) completion of the acute phase by 97% of the
active treatment group, confirming the good short-term tolerability of VNS
Therapy, (4) few significant adverse events, confirming the safety of the
implant procedure and good short-term tolerability of VNS Therapy in depression
and (5) a statistically significant difference favoring VNS in one of the
secondary outcome measures, the Inventory for Depressive Symptomatology (IDS).
The acute response rates in the D-02 study were considerably lower than
expected based upon the D-01 pilot study results. The primary factors considered
to be potential contributors to the unexpectedly low acute response rate are (1)
the amount of stimulation received by the active treatment group and (2) the
level of treatment resistance of the patients enrolled. The patients in the
acute treatment phase of D-02 pivotal study received lower output current
settings than did the patients in the acute treatment phase of the D-01 pilot
study, despite similar programming instructions in studies' protocols.
Approximately 26% of the patients in the D-02 study received output current
settings of 1.0 milliamps or higher, compared to approximately 45% of the D-01
pilot study patients. Therefore, the D-02 study patients did not receive the
same acute therapy as did the D-01 pilot study patients. While there are no
definitive data to suggest there is an increased response with increasing output
current for VNS Therapy, the low output current settings in the acute D-02 study
raise the possibility that the low amount of stimulation may have contributed to
the low response rate acutely. The D-02 study protocol was designed to include
less treatment-resistant patients, as defined by the number of failed drug
trials, than were included in the D-01 pilot study. However, patients enrolled
in the D-02 study appear to have been as treatment-resistant as the patients in
the D-01 pilot study as measured by the number of failed treatments per year in
the current depressive episode and over the life of the patient, the average
lifetime duration of the patients' illness and the percent of patients treated
with electro convulsive therapy (ECT).
We are conducting an observational study (D-04) of patients with
treatment-resistant depression receiving standard medical treatment, excluding
VNS. The study assesses long-term economic and clinical outcomes over a 12-month
period. Patients enrolled in the D-04 study were enrolled primarily at a subset
of the D-02 sites, with 12 of 13 sites also included in the D-02 study, and with
similar enrollment criteria and treatment resistance as those patients in the
D-02 study.
In September 2002, we submitted an Investigational Device Exemption
Supplement (IDE-S) to FDA for our revised statistical plan for the D-02 study,
amending the D-02 protocol's statistical analysis plan to provide a prospective
analysis of the effectiveness of VNS Therapy using existing long-term data
collected as already specified in the D-02 protocol. The plan has three
principal components: (1) the determination of the statistical significance of
the improvements over 12 months of the D-02 patients compared to their baseline
by a repeated measures linear regression analysis; (2) the determination of the
clinical significance of the 12-month outcome in the D-02 patients by
calculating the percentage of patients who achieve and sustain a response
between months nine and 12 of treatment; and (3) the determination of the
causality of the D-02 outcomes by comparison with the D-04 outcomes by using a
repeated measures linear regression analysis on the IDS-SR as the primary
outcome and using ANCOVA (analysis of covariance) for the Hamilton Rating Scale
(HRSD) Score after 12 months of treatment as a secondary outcome.
In January 2003, the analyses of the long-term results of D-02 were
completed. 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 180 patients' chronic or recurrent
treatment-
5
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-value < 0.001. The secondary measures of
statistical 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.
While the D-02 study to date has shown statistical and clinical
significance, no determination as to causality has yet been made. The causal
relationship between VNS Therapy and the D-02 patients' one-year outcomes will
be determined by the end of July 2003 using a repeated measures linear
regression analysis to compare depression improvements over one year in
approximately 200 D-02 patients receiving VNS Therapy and treatment as usual
with the outcomes of approximately 100 patients in a companion study, D-04,
receiving only treatment as usual.
In March 2001, the VNS Therapy System was approved by N.V. KEMA, an
official notified body representing the European Union countries, for the
treatment of chronic or recurrent depression in patients that are in a
treatment-resistant or treatment-intolerant depressive episode. This CE Mark
approval, by definition, includes the treatment of depression in patients with
depressive disorder, or so-called unipolar depression, as well as patients with
bipolar disorder or manic depression. In April 2001, the VNS Therapy System was
approved by Health Canada for the treatment of chronic or recurrent depression
in patients that are in a treatment-resistant or treatment-intolerant depressive
episode. The Canadian approval is similar to CE Mark European approval in that
depressed patients with unipolar depression and bipolar depression are included.
DEPRESSION MARKET OVERVIEW
Depression is a chronic, disabling disorder and a major worldwide public
health problem. Depressive episodes usually recur over time, with risk for
further episodes proportional to the number of prior episodes. After three major
depressive episodes, the probability of recurrence is 90%. In the U.S. alone,
approximately 18 million people suffer from depression over six million of which
are receiving some form of medical treatment. An estimated 1.2 million Americans
are believed to suffer from chronic treatment-resistant depression. Over 100,000
Americans each year are treated with ECT for their depression. Roughly 15% of
all people with severe depression that require hospitalization commit suicide.
Depression is also a very expensive disorder, ranked as the second leading cause
of disability worldwide in 1990. Depression costs in the U.S. alone are
estimated to exceed $50 billion annually, including over $12 billion in direct
treatment costs. The total market in the U.S. for anti-depressants is estimated
to exceed $6 billion.
The exact causes of depressive disorders are unknown, although both
biological abnormalities and psychological factors are thought to precipitate
this disease. Diminished synaptic concentrations of neurotransmitters,
especially serotonin and norepinephrine, are implicated in the pathogenesis of
depression. Most current standard therapies are thought to affect either one or
both of these neurotransmitter systems (1) SSRI drugs (serotonin-specific
reuptake inhibitors) or (2) MAOI drugs (monoamine oxidase inhibitors) that
decrease the breakdown of norepinephrine and serotonin. It is of interest to
note that several antiepileptic compounds, such as carbamazepine, valproate and
lamotrigine, are used as mood stabilizers and that lamotrigine and gabapentin
are also used as antidepressants.
TRADITIONAL DEPRESSION THERAPIES
The goals of treatment of depression are to achieve remission of symptoms,
prevent relapse and recurrence and to improve the quality of life and functional
capacity of the patient. Treatment of depression is typically viewed in terms of
acute, continuation and maintenance phases of treatment. The acute treatment
6
phase is considered to be six and 12 weeks, the continuation phase is four to
nine months and the maintenance phase is greater than nine to 12 months.
Recurrences of depression are expected in 50% of cases within two years after
maintenance treatment. For well-established recurrent depressions, the rate of
recurrence may approach 75%. In the U.S., over 100,000 patients are treated
annually with ECT. ECT typically involves general anesthesia and multiple
treatments that can cost from $8,000 to as high as $20,000 per patient per year.
Treatment morbidity associated with ECT includes the risks of general
anesthesia, as well as short and long-term cognitive deficits, including memory
loss.
Depression is typically treated with medication, psychotherapy or a
combination of both. Medications include tricyclic antidepressants (TCAs), SSRIs
and others. Not all patients respond to the same therapy and patients often try
multiple therapies. Other treatments for depression include light therapy and
rarely, surgery.
VNS THERAPY SYSTEM
VNS Therapy for the treatment of depression, as approved in European Union
countries and Canada and under current clinical investigation in the U.S., is
very similar to VNS Therapy for the treatment of epilepsy. The VNS Therapy
System delivers intermittent stimulation in the same location, that is, the left
vagus nerve in the neck, under similar programming specifications. As of June
24, 2003, all continuing patients in our 21 center, 235 patient pivotal clinical
study (D-02) of VNS Therapy in the treatment of depression have completed more
than 12 months of VNS Therapy. The results of the study have shown statistical
and clinical improvements compared to baseline. Approximately 180 D-02 patients
completed one year of VNS Therapy and qualified for the analyses including
approximately 100 patients from the original acute treatment group and
approximately 80 patients from the original acute placebo group. Statistical and
clinical significance were determined by analyzing changes in the HRSD-24 during
one year of VNS Therapy compared to pre-treatment baseline scores. Approximately
35% of acute treatment group patients and 31% of all patients in the analyses
experienced at least a 50% improvement after one year of VNS Therapy. While the
D-02 study to date has shown statistical and clinical significance, no
determination as to causality has yet been made. The causal relationship between
VNS Therapy and the D-02 patients' one-year outcomes will be determined by the
end of July 2003 using a repeated measures linear regression analysis to compare
depression improvements over one year in approximately 200 D-02 patients
receiving VNS Therapy and treatment as usual with the outcomes of approximately
100 patients in a companion study, D-04, receiving only treatment as usual.
The clinical study of VNS Therapy for the treatment of depression in the
U.S. is an investigational study subject to clinical outcome and significant
regulatory restrictions. We can provide you no assurance as to the ultimate
approval outcome of VNS Therapy for the treatment of depression in the U.S. Any
delays or failure of the necessary approvals could harm our ability to market
the VNS Therapy System for depression, which could harm our business, financial
condition and results of operations.
Although VNS Therapy using the VNS Therapy System has been approved in
European Union countries and Canada for the treatment of chronic or recurrent
depression, we do not anticipate significant sales volumes in these countries
until reimbursement approvals have been received in each country and we have
received regulatory approval in the U.S. We cannot be certain when or if such
reimbursement or approval will be obtained or whether the levels of
reimbursement, if received, will be sufficient to enable us to sell the VNS
Therapy System on a profitable basis.
OTHER INDICATIONS DEVELOPMENT
We are engaged in expanding the range of treatable disorders for VNS
Therapy in new indications as warranted by our extensive patent portfolio,
expected or observed clinical outcomes from ongoing and future pre-clinical and
clinical research studies and anecdotal reports of patient experience and market
dynamics. We currently have studies underway for the treatment of Alzheimer's
Disease (AD) and anxiety, as well as studies planned for other disorders covered
by our patent portfolio.
7
VNS THERAPY AND ALZHEIMER'S DISEASE (AD)
Our study of VNS Therapy for AD was initiated primarily because of VNS
Therapy treatment-related improvements in memory reported both in animal
research and in patients with epilepsy. Based on the Cyberonics' VNS Therapy
Patient Outcome Registry, approximately one-fourth of epilepsy patients treated
for three months with VNS Therapy and approximately one-third of those patients
treated for one year report that their memory was better or much better after
VNS Therapy. These studies provide a rationale for the hypothesis that Vagus
Nerve Stimulation may enhance memory performance in individuals experiencing
cognitive impairments as a result of AD.
In April 2000, the Swedish government approved a pilot clinical study of
VNS Therapy for the treatment of AD. Shortly thereafter, we launched a pilot
study of left cervical VNS Therapy in up to 10 implanted patients with a study
protocol of three months in the acute study and long-term follow-up. In November
2001, the results from the 10 patient pilot study were released. After three
months of VNS Therapy, eight of the 10 patients with AD responded where response
is defined as an improvement in or no worsening of AD symptoms based on the
Alzheimer's Disease Assessment Scale-cognitive (ADAS-cog). Of the eight
responders, six had improvements in their symptoms of AD and two had no
worsening. After six months of VNS Therapy, seven of the eight initial
responders continued to sustain their response by having improvements in
symptoms compared to their baseline ADAS-cog assessments. Patients with AD
typically worsen nine points in the ADAS-cog each year. In November 2001, we
received approval to extend the AD pilot study to a total of three sites and 30
patients.
Our primary objective is to examine changes in cognitive performance such
as changes in memory over time. In addition to memory loss, disturbances in
attention, mood and executive functions are often among the earliest symptoms of
AD. In a separate study of patients with depression, VNS Therapy has been shown
to potentially have mood elevating effects. In moderate and severe AD, many
patients also develop depressive symptoms, so the potential of VNS Therapy to
not only enhance memory, but also improve depression is of interest in this
study.
VNS Therapy under clinical investigation for the treatment of AD is very
similar to the therapy for the treatment of epilepsy. The VNS Therapy System
delivers intermittent stimulation in the same location, the left vagus nerve in
the neck area, under similar programming specifications. As of June 24, 2003,
the pilot study has been initiated, two sites have been approved and 21 patients
have been implanted.
The clinical study of VNS Therapy for the treatment of AD in the U.S. is an
investigational study subject to clinical outcome and significant regulatory
restrictions. We can provide you no assurance as to the ultimate approval
outcome of VNS Therapy for the treatment of AD. Any delays or failure of the
necessary approvals could harm our ability to market the VNS Therapy System for
AD, which could harm our business, financial condition and results of
operations.
VNS THERAPY AND ANXIETY
VNS Therapy is now being investigated as a treatment option for depression,
a common co-morbidity in anxiety disorders. SSRIs, one of the common treatments
for depression, are also commonly used to treat anxiety disorders. The idea of
using the VNS Therapy System as a treatment for anxiety disorders was initially
based on subjective observations from epilepsy clinical studies, functional
brain imaging studies in epilepsy patients showing VNS Therapy modulation of
brain regions involved in regulating mood and anxiety, neurochemical analyses
from both clinical and animal studies and the results of a pilot study of VNS
Therapy in patients with depression. In the pilot work in depression,
significant anti-anxiety effects were observed along with the improvements in
depression. Given the successful use of antidepressants in the treatment of
anxiety disorders and the preliminary demonstration of VNS Therapy as an
antidepressant, the study of VNS Therapy in a treatment-resistant population of
patients with anxiety disorders was initiated.
In December 2000, FDA granted Cyberonics an unconditional IDE for a pilot
study of VNS Therapy with the VNS Therapy System in treating patients with
obsessive-compulsive disorder (OCD), panic disorder (PD) and adult onset
post-traumatic stress disorder (PTSD), three of the five major types of anxiety
8
disorders. Up to 30 patients at four sites can be implanted with the VNS Therapy
System and stimulated with left cervical VNS Therapy. As of June 24, 2003, the
pilot study for patients with anxiety disorders has been initiated and four
approved sites have implanted a total of 10 patients.
The clinical study of VNS Therapy for the treatment of anxiety disorders
and other investigational studies are subject to clinical outcome and
significant regulatory restrictions. We can provide you no assurance as to the
ultimate approval outcome of VNS Therapy for the treatment of these disorders.
Any delays or failure of the necessary approvals could harm our ability to
market the VNS Therapy System for these disorders, which could harm our
business, financial condition and results of operations.
VNS THERAPY IN OTHER INDICATION DEVELOPMENT ACTIVITIES
In February 2002, we suspended new enrollments in all new indication
studies in order to allow us to focus our limited clinical and financial
resources towards the determination of the effectiveness of VNS Therapy in
depression. The suspension of patient enrollments in all new indications studies
results in a higher degree of uncertainty surrounding the timing and extent of
anticipated clinical study activities in new indications development. During
fiscal 2003, we completed and closed a pilot study which evaluated the safety
and efficacy of VNS Therapy as a treatment for morbid obesity. No additional
studies in the treatment of obesity are planned at this time.
VAGUS NERVE STIMULATION THERAPY
Vagus Nerve Stimulation Therapy is a proprietary, integrated system
consisting of an implantable device that delivers an electrical signal to an
implantable lead which is attached to the left vagus nerve. The vagus nerve is
the longest of the cranial nerves, extending from the brain stem through the
neck to organs in the chest and abdomen. The left vagus nerve has been shown to
have influence over numerous areas of the brain. Preclinical studies and
mechanism of action research suggest that intermittent stimulation of the left
vagus nerve in the neck modulates a number of structures and alters blood flow
bilaterally in several areas of the brain. These studies have also shown that
stimulation of the left cervical vagus nerve is effective in blocking seizures
and results in persistent or carryover antiepileptic effects which increase with
chronic intermittent stimulation.
The VNS Therapy System consists of the VNS Therapy Pulse Generator, the
Bipolar Lead, the programming wand and software and the tunneling tool. The VNS
Pulse Generator and Bipolar Lead are surgically implanted in a procedure which
takes from 30 to 90 minutes, during which time the patient is under general,
regional or local anesthesia. The VNS Pulse Generator is surgically implanted in
a subcutaneous pocket in the upper left chest. The Bipolar Lead is connected to
the VNS Pulse Generator and attached to the vagus nerve in the lower left side
of the patient's neck. The patient is generally admitted to the hospital the day
of surgery and discharged the same or following day.
The VNS Therapy System delivers vagus nerve stimulation therapy on a
chronic, intermittent basis. The initial standard stimulation parameters that we
recommend are a 30 second period of stimulation which we refer to as ON time,
followed by a five minute period without stimulation which we refer to as OFF
time. To optimize patient treatment, the pulse width, output current, signal
frequency, stimulation duration and stimulation OFF intervals of the VNS Pulse
Generator can be noninvasively programmed and adjusted by the treating physician
with a personal computer using our programming wand and software. In addition,
the patient can use a small, hand held magnet which is provided with the VNS
Pulse Generator to manually activate or deactivate stimulation. On-demand
therapy can be useful for those patients who sense an oncoming seizure and has
been reported by a number of patients to abort or reduce the severity or
duration of seizures. The magnet can also be used to provide patient control of
stimulation side effects by allowing the patient to temporarily deactivate
stimulation.
VNS Pulse Generator. The VNS Pulse Generator is an implantable,
programmable, cardiac pacemaker-like signal generator designed to be coupled
with the bipolar lead to deliver electrical signals to the vagus nerve. The VNS
Pulse Generator employs a battery which has an expected life of approximately
eight to
9
ten years at standard stimulation parameters. Upon expiration of the battery,
the VNS Pulse Generator is removed and a new generator is implanted in a short,
out-patient procedure using local anesthesia.
Bipolar Lead. We have licensed a proprietary nerve lead to convey the
electrical signal from the VNS Pulse Generator to the vagus nerve. The lead
incorporates patented electrodes which are self-sizing and flexible, minimizing
mechanical trauma to the nerve and allowing body fluid interchange within the
nerve structure. The lead's two electrodes and anchor tether wrap around the
vagus nerve and the connector end is tunneled subcutaneously to the chest where
it is attached to the VNS Pulse Generator. The leads are available in two sizes
of inner spiral diameter to ensure optimal electrode placement on different size
nerves.
Programming Wand and Software. Our proprietary programming wand and
software are used to interrogate the device and to transmit programming
information from a personal computer to the VNS Pulse Generator via
electromagnetic signals. These products are compatible with both Pentium and
non-Pentium based platform personal computers. Programming capabilities include
modification of the VNS Pulse Generator's programmable parameters (pulse width,
output current, signal frequency and stimulation duration and interval) and
storage and retrieval of telemetry data. The VNS programming wand can be
connected to a standard personal computer using a serial connector.
Tunneling Tool. The tunneling tool is a single use sterile, disposable
surgical tool designed to be used during surgical placement of the Bipolar Lead.
The tool is used for subcutaneous tunneling of the lead assembly between the
nerve site in the neck and the VNS Pulse Generator site in the chest.
Accessory Pack. The Accessory Pack includes one Pulse Generator resistor
assembly used to test the function of the device prior to implantation, the VNS
Bipolar Lead tie-downs, one hex screwdriver, two setscrews and setscrew plugs.
The VNS Therapy System implant procedure, including device costs, hospital
charges and physician fees, costs between $15,000 and $35,000. The current list
price for the VNS Therapy System is approximately $12,375 for the Model 101
System and approximately $15,150 for the Model 102 System.
MANUFACTURING AND SOURCES OF SUPPLY
Our manufacturing operations are required to comply with FDA's Quality
System Regulations, commonly referred to as QSR, which incorporates the agency's
former Good Manufacturing Practices regulations. QSR addresses the design,
controls, methods, facilities and quality assurance controls used in product
design, manufacturing, packaging, labeling, storing and installing medical
devices. In addition, certain international markets have regulatory, quality
assurance and manufacturing requirements that may be more or less rigorous than
those in the U.S. Specifically, we are subject to the compliance requirements of
International Standards Organization (ISO) 9001 certification and CE Mark
directives. We are audited by KEMA, Quality USA on a semiannual basis and by
KEMA, The Netherlands on an annual basis, respectively, for such compliance.
The VNS Therapy Pulse Generator Models 101 and 102, which are similar in
design and manufacture to a cardiac pacemaker, are comprised of either two or
one printed circuit boards, respectively, and a battery which is hermetically
sealed in a titanium case. Standard components are assembled on printed circuit
boards using surface-mount technology. The circuit boards are next assembled and
tested. The assembled circuit boards and battery are then placed in a titanium
case which is laser welded. A header to which the Bipolar Lead connects is added
to all sealed units. Each unit is subject to final functional release testing
prior to being sterilized by a third-party vendor.
We continue to rely upon sole source suppliers for certain materials and
services used in manufacturing the VNS Therapy System for reasons of quality
assurance, sole source availability or cost effectiveness. We periodically
experience discontinuation or unavailability of components, materials and
contract services which may require qualification of alternative sources or
product design changes. We believe that pursuing and qualifying alternative
sources and/or redesigning specific components of the VNS Therapy System could
consume significant resources. In addition, such changes generally require
regulatory submissions and approvals. Although we believe that any such changes
will be made without disruption, any extended delays in
10
or an inability to secure alternative sources for these or other components,
materials and contract services could result in product supply and manufacturing
interruptions. In an effort to reduce potential product liability exposure,
however, certain suppliers have terminated or may terminate sales of certain
materials and parts to manufacturers of implantable medical devices. The
Biomaterials Access Assurance Act was adopted in 1998 to help ensure
availability of raw materials and component parts essential to the manufacture
of medical devices. We cannot estimate the impact of this law on supplier
arrangements. Any supply or manufacturing disruption could significantly harm
our business.
MARKETING AND SALES
United States. We sell and market our products through a direct sales
force in the U.S. As of June 24, 2003, our U.S. sales and marketing organization
consisted of 197 full-time employees. Our sales and marketing plan focuses on
creating widespread awareness and demand for the VNS Therapy System among
neurologists, surgeons and nurse clinicians involved in the treatment of
patients with epilepsy, third-party payers who pay for such treatment and
patients and their families whose lives are affected by epilepsy. To reach each
of these groups, we are using a multidisciplinary sales force consisting of
sales personnel with medical device, pharmaceutical, or nursing experience,
reimbursement specialists experienced in obtaining third-party coverage and
payments for new medical technologies, regional marketing teams experienced in
peer to peer marketing programs and case managers experienced in patient
insurance issues. In addition to our direct selling activities, we facilitate
and support peer to peer interactions such as symposia, conference
presentations, journal articles and patient support groups to provide
experienced clinicians and patients the opportunity to share their perspectives
on the VNS Therapy System with others.
In January 2003, we began a major productivity assessment of our U.S. sales
organization, with the goal of improving call reach and frequency, message
delivery and new patient demand among neurologists who treat pharmacoresistant
epilepsy. We conducted extensive customer research and designed a plan for sales
force expansion and territory realignment. The process was completed in April
2003 and the resulting plan was launched in May 2003. As an outcome, the U.S.
sales force was expanded from 41 to 84 territories, each balanced for physician
prescribing potential. The geographical size of each territory was reduced
significantly, allowing better coverage and focus on the physician target
audience. The field sales management structure was streamlined and a specialty
force was created to provide increased attention at comprehensive epilepsy
centers around the country. While we expect to achieve long-term improvements in
sales force productivity and efficiencies, the redeployment of many sales
personnel into different roles and/or geographies is likely to result in a
short-term decline in productivity. Improvements in sales force productivity may
take several quarters to achieve and may not ultimately be realized to the
degree or in the time frame currently anticipated.
International. We market and sell our products through a combination of a
direct sales force in certain European countries and distributors elsewhere. As
of June 24, 2003, our international organization consisted of 20 full-time
employees and a number of independent distributors. The VNS Therapy System is
currently sold by a direct sales force in Germany, France, Austria, Switzerland,
Belgium, Norway, Sweden, Denmark and the United Kingdom. As of June 24, 2003, we
had distribution agreements with independent distributors covering a number of
other countries, principally in Europe. The distribution agreements generally
grant the distributor exclusive rights for the particular territory for a period
of three years. The distributor generally assumes responsibility for obtaining
regulatory and reimbursement approvals for such territory and agrees to certain
minimum marketing and sales expenditures and purchase commitments. We intend to
seek additional regulatory and reimbursement approvals in the future in those
major markets where the VNS Therapy System is not yet approved. The geographic
areas initially targeted include South America and the Far East, in particular,
Japan. In Japan, we are working with an independent distributor to obtain the
appropriate regulatory and reimbursement approvals and to ultimately distribute
the VNS Therapy System if such approvals are obtained. The Japanese clinical
trial began in July 1993. In February 1998, our Japanese distributor submitted
the results of this study, along with our other clinical trial data, to the
Japanese Ministry of Health for regulatory approval. Application for
reimbursement approval will follow regulatory approval when and if granted.
11
THIRD-PARTY REIMBURSEMENT
Our ability to expand the commercialization of the Vagus Nerve Stimulation
successfully depends on favorable coverage, coding and reimbursement for VNS
Therapy. Currently, VNS Therapy has been recommended and/or adopted by most
payers across the U.S., including Aetna, Blue Cross/Blue Shield Technology
Evaluation Center, CHAMPUS, Kaiser Permanente, Centers for Medicare & Medicaid
Services (CMS) and most state Medicaid programs.
In deciding to cover a new therapy, payers base their initial coverage
decisions on several factors including, but not limited to, the status of FDA's
review of the product, CMS coverage decision, Blue Cross/ Blue Shield Technology
Evaluation Center, the product's safety and efficacy, the number of studies
performed and peer-reviewed articles published with respect to the product and
how the product and therapy compares to alternative therapies. The Cyberonics
Reimbursement Department is available to assist hospitals and physicians with
any reimbursement questions. The department's Regional Alliance Managers and
Reimbursement Case Managers are available through our Reimbursement Hotline, to
help with coverage, coding and reimbursement issues. VNS Therapy coverage for
epilepsy treatment is generally approved with all payers.
The success of any new medical device therapy also depends on specific
codes that physicians, surgeons and hospitals need to bill for their services.
The VNS Therapy has specifically approved codes for physicians, surgeons and
hospitals to submit claims for their services, and those recognized by American
Medical Association. In making decisions about reimbursement amounts, payers
typically reimburse for the costs of newly covered devices and services using
the standard methods they employ for other products and services already
covered. Many private insurers and managed care plans use a variety of payment
mechanisms including, but not limited to, discounted charges, per diem amounts,
resource-based payment scales, medical surgical case rates and reimbursed costs.
We have found that many of these same payment mechanisms have provided
reimbursement levels for the VNS Therapy and related services that physicians
and hospitals view as adequate to support use of the VNS Therapy.
MEDICARE
Effective July 1, 1999, CMS (formerly the Healthcare Financing
Administration, or HCFA), issued National Coverage Policy Transmittal 144
(Section 60-22). This policy is in accordance with FDA-labeled usage for the
device. Currently, Medicare accounts for a total of 15% to 20% of the patients
implanted with VNS Therapy. The Medicare program uses different payment
mechanisms to reimburse for procedures performed in different settings. For
outpatient implants, Medicare introduced on August 1, 2000 a new prospective
payment system based on Ambulatory Payment Classifications (APCs). Effective
January 1, 2003, the updated APC rates for the VNS Therapy provide adequate
reimbursement to the hospitals. For inpatient implants, Medicare uses a
fixed-payment method, which is an all-inclusive prospective amount known as
Diagnosis Related Groups or DRGs. Under current DRG groupings, hospital
inpatient procedures for implanting the VNS Therapy are assigned to one of two
different DRGs based on whether or not the patient has complications or
coexisting severe medical problems, also referred to as co-morbidities. In our
experience, 90% of the VNS Therapy are implanted in the outpatient setting.
MEDICAID
Medicaid programs cover hospital inpatient and outpatient services that are
medically necessary and appropriate. Currently, Medicaid accounts for 15% to 20%
of patients implanted with the VNS Therapy. Most state Medicaid agencies have
developed their own coverage policy for VNS Therapy or adopted the National CMS
coverage policy. In many cases, prior authorization is required. Medicaid
reimbursement mechanisms vary state by state. Medicaid policy and payment
methodologies change on a regular basis, so vigilant and ongoing work is
necessary to ensure continued access and acceptable reimbursement for patients
covered by Medicaid programs.
12
PRIVATE PAYERS
Private payers also cover hospital inpatient and outpatient services that
are considered to be medically necessary. Currently, private payers (commercial,
managed care and other third-party payers) account for 55% to 60% of patients
implanted with VNS Therapy. As with other payers, many private payers have
developed clinical guidelines for coverage or adopted the National CMS coverage
policy for use of the VNS Therapy. In most cases, written authorization is
required. Reimbursement mechanisms vary by plan.
Although Vagus Nerve Stimulation using the VNS Therapy has been approved
for commercial distribution in European Union countries and Canada for the
treatment of chronic or recurrent depression, we do not anticipate significant
sales volumes in these countries until reimbursement approvals are achieved in
these countries and FDA approval is achieved in the U.S. We are continuing to
pursue appropriate reimbursement approvals in these countries.
PRODUCT DEVELOPMENT
Our product development efforts are directed toward improving the VNS
Therapy System and developing new products that provide additional features and
functionality while improving cost effectiveness. In fiscal 2003, we received
approval for a new family of products represented in the Model 102 System,
including the VNS Therapy Pulse Model 102 Generator, VNS Therapy Lead Model 302,
Model 250 VNS Therapy System Programming Software Version 4.6 for use with the
laptop programming system, the Model 250 VNS Therapy Programming Software 6.1
for use with a handheld programming system, VNS Therapy Tunneler Model 402 and
VNS Therapy Accessory Pack Model 502. We are conducting ongoing product
development programs to design improvements in the VNS Therapy Pulse Generator,
the Bipolar Lead and software enhancements. We will be required to file for the
appropriate U.S. and international regulatory approvals, and some projects may
require clinical trials, in connection with the introduction of improved and new
products.
COMPETITION
We believe that in the field of refractory epilepsy, existing and future
antiepileptic drugs are and will continue to be the primary competition for the
VNS Therapy System. We may also face competition from other medical device
companies for the treatment of partial seizures. Medtronic, Inc., for example,
continues to clinically assess an implantable signal generator used with an
invasive deep brain probe, or thalamic stimulator, for the treatment of
neurological disorders and has received FDA approval for the device for the
treatment of essential tremor and Parkinson's Disease. We could also face
competition from other large medical device companies which have the technology,
experience and capital resources to develop alternative devices for the
treatment of epilepsy. Many of our competitors have substantially greater
financial, manufacturing, marketing and technical resources than us. In
addition, the health care industry is characterized by extensive research
efforts and rapid technological progress. Our competitors may develop
technologies and obtain regulatory approval for products that are more effective
in treating epilepsy than our current or future products. In addition,
advancements in surgical techniques could make surgery a more attractive therapy
for epilepsy. The development by others of new treatment methods with novel
antiepileptic drugs, medical devices or surgical techniques for epilepsy could
render the VNS Therapy System non-competitive or obsolete. We face similar
competition with respect to the development and sale of VNS Therapy as a
treatment for the other indications we are evaluating, including depression, AD,
anxiety disorders and obesity.
We believe that the primary competitive factors within the epilepsy
treatment market are the efficacy and safety of the treatment relative to
alternative therapies, physician and patient acceptance of the product and
procedure, availability of third-party reimbursement, quality of life
improvements and product reliability. We also believe that the VNS Therapy
System compares favorably with competitive products as to these factors.
PATENTS, LICENSES AND PROPRIETARY RIGHTS
Proprietary protection for our products is important to our business. We
maintain a policy of seeking method and device patents on our inventions,
acquiring licenses under selected patents of third parties, obtaining copyrights
on our software and other copyrightable materials and entering into invention
and
13
proprietary information agreements with our employees and consultants with
respect to technology which we consider important to our business. We also rely
upon trade secrets, unpatented know-how and continuing technological innovation
to develop and maintain our competitive position.
We entered into an exclusive license agreement with Jacob Zabara, Ph.D., a
co-founder and consultant to us, pursuant to which we received exclusive
licenses on four U.S. method patents (and such international counterparts as
have been or may be issued) covering the VNS Therapy System for vagus nerve and
other cranial nerve stimulation for the control of epilepsy and other movement
disorders. We believe that these patents give us an advantage. The license
agreement runs for the term of licensed patents, which will give us coverage
through 2011. Pursuant to the license agreement, we are obligated to pay Dr.
Zabara a royalty equal to 3.0% of net sales for the remaining term of the
licensed patents.
We entered into a license agreement with Huntington Medical Research
Institute pursuant to which we have licensed two U.S. patents (including their
international counterparts, if and when issued) covering two lead designs. The
license agreement provides a license to the licensor's lead designs for the
field-of-use of vagus nerve stimulation for control of epilepsy and other
movement disorders and our patented disorders through June 2004. Pursuant to the
license agreement, we are obligated to pay the licensor a royalty of 1.0% of net
sales of VNS Therapy Systems using the licensor's standard lead (which includes
our bipolar lead) and 1.75% of net sales of VNS Therapy Systems which include
the licensor's bidirectional lead. We also agreed to pay minimum royalties of
$35,000 for each fiscal year for the life of the licensed patents.
We entered into an exclusive license agreement with Mitchell Roslin, M.D.
on a patent application that covers the use of bilateral vagus nerve stimulation
for the treatment of obesity. Pursuant to the proposed license agreement terms,
we will be obligated to pay the licensor a royalty rate of 1.0% of the first $10
million of net obesity sales and 0.5% of net obesity sales thereafter. The
license agreement terms also will obligate us to pay to licensor advances on
royalties of $25,000 per year for five years beginning January 1, 2000 and, upon
the completion of certain milestones, up to $325,000 in additional advances on
royalties.
In addition to these license agreements, as of June 24, 2003, we had
approximately 30 U.S. device and method patents and patent applications pending,
covering various aspects of the VNS Therapy System and the VNS method of
treatment for a variety of disorders. In addition to movement disorders, other
method patents cover the fields of eating disorders including obesity, endocrine
disorders, migraine headaches, dementia, neuropsychiatric disorders, including
depression and anxiety disorders, motility disorders, sleep disorders, coma,
chronic pain, cardiac disorders and hypertension. We have filed counterparts of
certain of our key U.S. patent applications in certain key international
jurisdictions.
We cannot assure you that patents will be issued from any of the remaining
applications or, that if patents are issued, that they will be of sufficient
scope or strength to provide meaningful protection of our technology. In
addition, we cannot assure you that any patents issued to us will not be
challenged, invalidated or circumvented, or that the rights granted thereunder
will provide proprietary protection or commercial advantage to us.
Notwithstanding the scope of the patent protection available to us, a competitor
could develop other methods of controlling epilepsy by stimulation which do not
involve the vagus or other cranial nerves, the stimulation of which is patent
protected, or which use electrodes which are not covered by the licensed
patents.
We believe that the licenses described above provide us with protection in
the U.S. in the field of cranial nerve stimulation, including vagus nerve
stimulation for the control of epilepsy, depression, movement disorders,
including Parkinson's Disease and essential tremor, eating disorders, anxiety
disorders, obesity, dementia and additional indications for which method patents
have been issued. The protection offered by the licensed international patents
is not as strong as that offered by the licensed U.S. patents due to differences
in patent laws. In particular, the European Patent Convention prohibits patents
covering methods for treatment of the human body by surgery or therapy. In
addition, there has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. We may need to
engage in litigation to enforce patents issued or licensed to us, to protect our
trade secrets or know-how or to defend us against claims of infringement of the
rights of others and to determine the scope and validity of the proprietary
rights of others. Litigation could be costly and divert our attention from other
functions and responsibilities. Adverse
14
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. We are not currently a party to any
patent litigation or other litigation regarding proprietary rights and are not
aware of any challenge to our patents or proprietary rights.
GOVERNMENT REGULATION
The preclinical and clinical testing, manufacturing, labeling, sale,
distribution and promotion of the 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 U.S., the VNS Therapy System is regulated as a
medical device and is subject to FDA's premarket approval requirements. Under
the Food, Drug, and Cosmetic Act, all medical devices are classified into three
classes, class I, II or III. New class III devices, such as the VNS Therapy
System, are subject to the most stringent FDA review, and require submission and
approval of a premarket application before commencement of marketing, sales and
distribution in the U.S.
In July 1997, we received FDA approval to market the VNS Therapy System in
the U.S. for use as an adjunctive therapy in reducing the frequency of seizures
in adults and adolescents over 12 years of age with partial onset seizures that
are refractory to antiepileptic drugs. While we have satisfied FDA's
requirements to commence domestic sales of our product, we continue to be
subject to FDA's ongoing requirements to maintain regulatory compliance.
Additionally, pursuant to the post-market surveillance conditions specified as
part of our FDA marketing approval, we are required to conduct clinical
follow-up on a total of 50 patients during the first five years of stimulation
and to monitor the safety and tolerability of the VNS Therapy System. This
post-market surveillance has been completed and the final report provided to the
FDA in November 2002. In addition, we have been required by FDA to continue to
provide information about which patients benefit most from the device as well as
information on any deaths that occur in patients who have the device implanted.
FDA may raise additional concerns in the future, and any such concerns could
significantly impact our business prospects. Accordingly, compliance with FDA
regulations and requirements is a priority for us and critical for the continued
success of our business.
In July 1999, FDA granted Expedited Review status for a future premarket
approval application for the VNS Therapy System for the treatment of depression
in patients with unipolar and bipolar depressive disorder. During fiscal 1999,
we launched a pilot safety and efficacy study of vagus nerve stimulation using
the VNS Therapy System in patients with treatment-resistant chronic or recurrent
depression. The study protocol included 30 patients treated for three months
with long-term follow-up. In September 1999, FDA granted approval for expansion
of the pilot clinical study, increasing the number of study sites from four to
five and the number of patients from 30 to 60. The acute phase of the 60 patient
pilot study was completed in fiscal year 2001. In October 1999, FDA granted
unconditional approval for a pivotal clinical study of vagus nerve stimulation
for the treatment of depression to include up to 15 institutions and 94
patients. We subsequently received unconditional FDA approval for a revised
final protocol to include up to 20 institutions and 210 implanted patients. In
June 2001, FDA approved an expansion of the depression pivotal study to include
up to an additional 30 implanted patients. Enrollment in the U.S. pivotal study
including the 30 additional patients was completed by June 30, 2001. In January
2002, the acute results of the D-02 study on VNS Therapy were completed and
unblinded. The D-02 acute results reported (1) a 15% response rate in the active
treatment group, which did not represent a statistically significant improvement
over the placebo group, (2) a 10% response rate in the placebo group, confirming
the treatment-resistant nature of the study population, (3) completion of the
acute phase by 97% of the active treatment group, confirming the good short-term
tolerability of VNS Therapy, (4) few significant adverse events, confirming the
safety of the implant procedure and good short-term tolerability of VNS Therapy
in depression and (5) a statistically significant difference favoring VNS in one
of the secondary outcome measures, the IDS. In September 2002, we submitted an
IDE-S to FDA for our revised statistical plan for the D-02 study, amending the
D-02 protocol's statistical analysis plan to provide a prospective analysis of
the effectiveness of VNS Therapy using existing long-term data collected as
already specified in the D-02 protocol. The plan has three principal components:
(1) the primary analysis is the determination of the statistical significance of
the improvements over
15
12 months of the D-02 patients compared to their baseline by a repeated measures
linear regression analysis; (2) the determination of the clinical significance
of the 12-month outcome in the D-02 patients by calculating the percentage of
patients who achieve and sustain a response between months nine and 12 of
treatment; and (3) the determination of the causality of the D-02 outcomes by
comparison with the D-04 outcomes by using a repeated measures linear regression
analysis on the IDS-SR as the primary outcome and using ANCOVA for the HRSD
score after 12 months of treatment as a secondary outcome.
In April 2000, the Swedish government approved a pilot clinical study of
VNS Therapy for the treatment of AD. Shortly thereafter, we launched a pilot
study of left cervical VNS Therapy in up to 10 implanted patients with a study
protocol of three months in the acute study and long-term follow-up. In November
2000, the results from the 10 patient pilot study were released. After three
months of VNS Therapy, eight of the 10 patients with AD responded where response
is defined as an improvement in or no worsening of AD symptoms based on the
Alzheimer's Disease Assessment Scale-cognitive (ADAS-cog). Of the eight
responders, six had improvements in their symptoms of AD and two had no
worsening. After six months of VNS Therapy, seven of the eight initial
responders continued to sustain their response by having improvements in
symptoms compared to their baseline ADAS-cog assessments. Patients with AD
typically worsen nine points in the ADAS-cog each year. The 10 patients in the
VNS Therapy study had a median improvement in the ADAS-cog of three points after
six months of VNS Therapy. In November 2001, we received approval to extend the
AD pilot study to a total of three sites and 30 patients.
In December 2000, FDA granted Cyberonics an unconditional IDE for a pilot
study of VNS Therapy with the VNS Therapy System in treating patients with OCD,
PD and adult onset PTSD, three of the five major types of anxiety disorders. Up
to 30 patients at four sites can be implanted with the VNS Therapy System and
stimulated with left cervical VNS Therapy.
In August 2000, FDA approved an IDE for a clinical pilot study utilizing a
new type of VNS Therapy to treat obesity. Shortly thereafter, we launched a
two-phase safety and efficacy study using the VNS Therapy System to treat
obesity. In the first phase, six patients were implanted and treated. If the
results of the first phase justify continued research, up to 24 additional
patients will be treated in Phase II, for a total of up to 30 implanted and
treated patients in the pilot study. During fiscal 2003, we completed and closed
Phase I. No additional studies in the treatment of obesity are planned at this
time.
We will be required to obtain FDA approval of a new premarket application
or premarket application supplement before making any change to the VNS Therapy
System affecting the safety or effectiveness of the device including, but not
limited to, new indications for use of the device, changes in the device's
performance or design specifications and device modifications and future
generation products. New premarket applications and premarket application
supplements generally require submission of information needed to support the
proposed change and may require additional clinical data. If clinical data are
required for a new indication, FDA can additionally require review of the
results of a clinical study by one of their Advisory Panels. If the clinical
testing required to obtain the information necessary to support the change
places research subjects at risk, we could be required to obtain FDA's approval
of an investigational device exemption, or IDE, before beginning such testing.
We intend to sponsor additional clinical trials of the VNS Therapy System in the
U.S. for non-epilepsy central nervous system disorders. We believe that we will
be required to conduct these additional clinical trials under one or more
FDA-approved IDEs and under the auspices of one or more independent
institutional review boards, also referred to as IRBs, established pursuant to
FDA regulations. We may be unable to obtain any required FDA or IRB approvals
for such clinical trials or to complete the studies in a timely manner. Further,
the information obtained may not be sufficient to support the filing or approval
of a new premarket application or premarket application supplement for the
proposed changes. Any of these events would prevent us from obtaining approvals
to market our product for the indications which could harm our business.
We are required to register, and have registered, as a medical device
manufacturer with FDA and state agencies and to list our products with FDA. Our
facilities are subject to inspection on a routine basis by FDA for compliance
with FDA's QSR and other applicable regulations. The QSR imposes procedural and
documentation requirements upon us with respect to product designs,
manufacturing, testing, control, process
16
validation and similar activities. We received a joint inspection by FDA and the
Texas Department of Health (TDH) in January 2001 which yielded inspectional
observations resulting in Warning Letters being issued to the Company by FDA and
TDH. These Warning Letters were issued on March 23, 2001 and March 9, 2001
respectively, for not fully complying with the Medical Device Reporting
Regulation, 21CFR 803 and associated corrective preventive action as required
under the Quality System Regulation, 21CFR 820.100. We voluntarily provided a
written response, dated February 22, 2001, which detailed our corrective action
plan to both FDA and TDH before either Warning Letters were issued. Both FDA and
TDH Warning Letters, issued subsequent to the Cyberonics voluntary response,
formally acknowledged receipt of the Cyberonics' response and that the
corrective action plan was adequate. Subsequently, a joint follow-up inspection
by FDA and TDH in January 2002 resulted in FDA closing out the Warning Letter of
March 23, 2001. TDH stated that they were also fundamentally satisfied with
Cyberonics' corrective actions relative to compliance with the Medical Device
Reporting Regulations referenced in TDH Warning Letter of March 9, 2001.
However, TDH issued a Warning Letter II, dated March 6, 2002, relative to
promptness of complaint processing as similar objections were mentioned in their
March 9, 2001 letter. TDH believed that complaint handling procedures could be
improved and TDH formally accepted the February 20, 2002 Cyberonics' response
detailing the corrective action taken in this regard. On October 9, 2002, TDH
performed a follow-up inspection which resulted in TDH closing out the Warning
Letter II of March 6, 2002.
Regulations governing such matters as device tracking and post-market
surveillance also apply to the VNS Therapy System. FDA also actively enforces
regulations prohibiting marketing of products for non-indicated uses. The
advertising of most FDA-regulated products, including the VNS Therapy System, is
also subject to Federal Trade Commission jurisdiction and we are also subject to
the Occupational Safety and Health Administration and other governmental
entities.
The Health Insurance Portability and Accountability Act (HIPAA) regulations
were fully implemented in April 2003. Under the HIPAA privacy rule, the privacy
of all medical records, billing records, and other health information must be
protected. Our proprietary patient identification and pull-through sales and
marketing model relies on direct contact with patients to verify their insurance
and provide education on VNS Therapy. While our sales and market model is fully
compliant with HIPAA regulations, some institutions and physicians may initially
choose to limit direct access to patient information and their patients, which
could negatively impact awareness and acceptance of VNS Therapy among patients
and physicians.
Clinical testing, manufacturing and sale of our products outside of the
U.S. are subject to regulatory approval by other jurisdictions which may be more
or less rigorous than in the U.S., and which vary from country to country. In
order to market and sell our product in the European community, we must comply
with the medical device directives. Cyberonics also complies with the ISO 9001,
which is similar to FDA's QSR as well as ISO13485 and EN46001. We are audited on
a voluntary basis for compliance with these directives. We have obtained several
foreign governmental approvals, including the approval to use the European Union
CE Mark for epilepsy and depression, and have applied for additional approvals.
However, we may not be granted the necessary approvals, including approval of
new premarket applications or supplements to existing premarket applications for
the VNS Therapy System, on a timely basis or at all. Delays in receipt of or
failure to receive these approvals, or the withdrawal of previously received
approvals, could harm our international operations and our business.
Changes in existing requirements or the adoption of new requirements could
significantly harm our ability to comply with regulatory requirements. Failure
to comply with applicable regulatory requirements can result in, among other
things, fines, suspensions or withdrawal of approvals, confiscations or recalls
of products, operating restrictions and criminal prosecutions.
PRODUCT LIABILITY AND INSURANCE
The manufacture and sale of our products subjects us to the risk of product
liability claims. As with all medical device businesses, the consequences of a
failure of our product may be life-threatening. Although we maintain product
liability insurance, coverage limits may not be adequate. Product liability
insurance is expensive and in the future may only be available at significantly
higher premiums or not be available on
17
acceptable terms, if at all. A successful claim brought against us in excess of
our insurance coverage could severely harm our business, results of operations
and financial condition.
EMPLOYEES
As of June 24, 2003, we had 479 full-time employees. We believe that the
success of our business depends, in part, on our ability to attract and retain
qualified personnel. We believe our relationship with our employees is good.
However, we cannot assure you that we will be successful in hiring or retaining
qualified personnel. The loss of key personnel, or the inability to hire or
retain qualified personnel, could significantly harm our business.
FINANCIAL INFORMATION WITH GEOGRAPHIC AREAS
A discussion of our financial information about geographic areas is
described in Note 13 to the consolidated financial statements attached hereto.
CAUTIONARY FACTORS
A number of statements contained in this document and other written and
oral statements made from time to time by us do not relate strictly to
historical or current facts. Accordingly, they are considered "forward-looking"
statements which indicate current expectations of future events. These
statements can generally be identified by the use of terminology such as
"expect," "may," "will," "intend," "anticipate," "believe," "estimate," "could,"
"possible," "plan," "project," "forecast," and similar expressions. Our
forward-looking statements generally relate to our growth strategies, financial
results, reimbursement programs, product acceptance programs, product
development programs, clinical and new indication development programs,
regulatory approval programs, manufacturing processes and sales and marketing
programs. Forward-looking statements should be carefully considered as involving
a variety of risks and uncertainties. These risks and uncertainties include, but
are not limited to: continued market acceptance of VNS Therapy and sales of our
product; the development and satisfactory completion of clinical trials and/or
market tests of VNS Therapy for the treatment of depression, Alzheimer's
Disease, anxiety or other indications; adverse changes in coverage or
reimbursement amounts by third-parties; intellectual property protection and
potential infringement claims; maintaining compliance with government
regulations and obtaining necessary government approvals for new applications;
product liability claims and potential litigation; reliance upon single
suppliers and manufacturers for certain components and the accuracy of
management's estimates of future expenses and sales. Consequently, no
forward-looking statements can be guaranteed and actual outcomes may vary
materially.
EXECUTIVE OFFICERS OF THE COMPANY
Robert P. Cummins, age 49, became a director of Cyberonics in June 1988. He
was appointed President and Chief Executive Officer of Cyberonics in September
1995. He was appointed Chairman of the Board of Cyberonics in June 2001. Until
September 1995, Mr. Cummins was also a general partner of Vista Partners, L.P.,
a venture capital partnership which he joined in 1984, a general partner of
Vista III Partners, L.P., a venture capital firm formed in 1986 and Vice
President of Vista Ventures Inc., a venture capital advisory firm. Until July
1998, Mr. Cummins was also a director of Sigma Circuits Inc., a manufacturer of
electronic interconnect products.
Pamela B. Westbrook, age 45, joined Cyberonics as Vice President, Finance
and Administration and Chief Financial Officer in October 1998. She was
appointed Secretary of Cyberonics in June 2001. Ms. Westbrook has over 20 years
in financial management experience and over 17 years in medical device industry
experience. From April 1998 to October 1998, she served as Chief Financial
Officer for Physicians Resource Group, an ophthalmic physician practice
management company. Prior to that, from November 1986 to March 1998, Ms.
Westbrook worked for SulzerMedica, a leading manufacturer of implantable medical
devices including pacemakers, heart valves and orthopedic implants. During her
employment with
18
SulzerMedica, Ms. Westbrook was Vice President, Finance for SulzerMedica, and
Vice President, Controller for Sulzer Cardiovascular Prosthesis Division.
Michael A. Cheney, age 49, joined Cyberonics in July 2001 as Vice President
of Marketing and Managing Director of the Depression Business Unit. Mr. Cheney
has more than 18 years of pharmaceutical marketing and product launch
experience. Most recently, Mr. Cheney was Senior Director, Obesity Business Unit
at Knoll Pharmaceutical Company (recently acquired by Abbott Laboratories),
where he was responsible for the launch of Meridia(R) (sibutramine
hydrochloride), a leading anti-obesity drug. Prior to that, Mr. Cheney was Group
Director, Central Nervous System Therapeutics Marketing at Wyeth-Ayerst
Laboratories, a subsidiary of American Home Products, where he was responsible
for the marketing of Effexor(R) (venlafaxine hydrochloride) and the launch of
Effexor(R) XR, a leading brand of medication for the treatment of depression.
Shawn P. Lunney, age 39, joined Cyberonics in April 1991 and served in
various sales, marketing and reimbursement planning positions until May 1996,
when he became Vice President, Marketing. He is currently serving as Vice
President of Market Development. Prior to joining Cyberonics, Mr. Lunney held
the position of Sales and Marketing Manager with Perceptive Systems, Inc., a
hospital laboratory medical instrument manufacturer from December 1985 to April
1991.
Richard L. Rudolph, M.D., age 54, joined Cyberonics in August 2001 as Vice
President, Clinical and Medical Affairs and Chief Medical Officer. He has 17
years of pharmaceutical research, medical and management experience in the
neuroscience area. Dr. Rudolph was responsible for the long-term clinical
development of a major antidepressant through all phases of drug development
from Phase I to Phase IV. He has authored and co-authored numerous publications.
Most recently, Dr. Rudolph was Senior Director, Clinical Research and
Development at Wyeth-Ayerst Research. During his 16 year career at Wyeth-Ayerst,
Dr. Rudolph was responsible for numerous clinical studies and research on
Effexor(R) (venlafaxine hydrochloride) and Effexor(R) XR, a leading brand of
medication for the treatment of patients with depression and generalized anxiety
disorder.
Alan D. Totah, age 59, joined Cyberonics as Vice President, Regulatory
Affairs in February 2001. Mr. Totah is a Certified Regulatory Affairs
Professional and has over 31 years of medical industry regulatory affairs,
quality control and quality assurance management experience including 20 years
in cardiac rhythm management and regulatory affairs management at Medtronic and
Sulzer Intermedics. Most recently, Mr. Totah was Senior Regulatory Manager,
Heart Failure and Low Power Leads at Medtronic Inc. Prior to that, he spent 18
years at Sulzer Intermedics, most recently as Director, Regulatory Affairs.
W. Steven Jennings, age 51, joined Cyberonics in May 2003 as Vice
President, Sales. Mr. Jennings has more than 25 years of pharmaceutical sales
and marketing experience, including over 15 years of sales management experience
at Solvay Pharmaceuticals, CIBA GEIGY and Reed & Carnrick Pharmaceuticals. Most
recently, Mr. Jennings was Global Vice President, Gastrointestinal and Women's
Health at Solvay where he was responsible for worldwide sales and marketing for
the two largest of Solvay's four pharmaceutical divisions. During his 10-year
career at Solvay, he previously held positions in product management, regional
and U.S. national sales management and as a Business Director for Solvay's
Mental Health and Cardiovascular business.
INTERNET WEBSITE OF THE COMPANY
The Company's internet address is www.cyberonics.com. The Company makes
available free of charge on or through its website its annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable
after electronically filing such material with, or furnishing it to the
Securities and Exchange Commission (SEC).
19
ITEM 2. PROPERTIES
We lease approximately 122,513 square feet of office and manufacturing
space in Houston, Texas through December 2009. We also lease approximately 5,400
square feet in a sales office in Brussels, Belgium through April 2010.
ITEM 3. LEGAL PROCEEDINGS
The Company is a named defendant in lawsuits from time to time arising in
the ordinary course of business. While the outcome of such lawsuits or other
proceedings against the Company cannot be predicted with certainty, management
does not expect the outcome of these matters to have a material adverse effect
on the consolidated financial position or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Results of the votes taken in connection with our annual meeting of
stockholders held on November 21, 2002 are set forth below. At our annual
meeting, stockholders were asked to consider and act upon (1) the election of
Directors for the ensuing year; (2) a proposal to amend the Cyberonics, Inc.
1997 Stock Plan to increase the number of Common Shares available for issuance
under the plan by an aggregate of 1,000,000 shares; and (3) a proposal to ratify
the appointment of KPMG LLP as independent accountants to examine the
consolidated financial statements and books and records of Cyberonics, Inc. and
subsidiary for the fiscal year ended April 25, 2003. The following table sets
out, for each matter where applicable, the number of votes cast for, against or
withheld, as well as the number of abstentions and broker non-votes.
(1) Election of Directors:
NAME OF NOMINEE VOTES FOR VOTES AGAINST
- --------------- ---------- -------------
Robert P. Cummins........................................... 18,998,063 573,124
Reese S. Terry.............................................. 19,083,585 487,602
Stanley H. Appel, M.D. ..................................... 18,582,639 988,548
Tony Coelho................................................. 18,650,118 921,069
Thomas A. Duerden, Ph.D. ................................... 19,082,945 488,242
Michael J. Strauss, M.D. ................................... 19,177,165 394,022
Alan J. Olsen............................................... 19,162,245 408,942
Ronald A. Matricaria........................................ 18,658,759 912,428
(2) Proposal to amend the Cyberonics, Inc. 1997 Stock Plan to increase the
number of Common Shares available for issuance under the plan by an
aggregate of 1,000,000 shares:
Number of Votes For: ....................................... 11,647,362
Number of Votes Against: ................................... 7,511,099
Number of Votes Abstaining: ................................ 411,926
Number of Broker Non-Votes: ................................ 0
(3) Proposal to ratify the appointment of KPMG LLP as independent accountants
to examine the financial statements and books and records of Cyberonics,
Inc. for the 2003 fiscal year:
Number of Votes For: ....................................... 19,548,544
Number of Votes Against: ................................... 10,109
Number of Votes Abstaining: ................................ 12,534
Number of Broker Non-Votes: ................................ 0
20
In April 2002, Arthur Andersen LLP was dismissed as our independent
accountants for the 2002 fiscal year. See "Item 9. Changes in and Disagreements
with Accountants on Accounting and Financial Disclosure."
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is quoted on the Nasdaq National Market under the symbol
"CYBX." The high and low sale prices for our Common Stock during fiscal 2002 and
2003 are set forth below. Price data reflect actual transactions, but do not
reflect mark-ups, mark-downs or commissions.
HIGH LOW
------ ------
FISCAL YEAR ENDED APRIL 26, 2002
First Quarter............................................. $17.00 $10.40
Second Quarter............................................ 19.20 13.65
Third Quarter............................................. 29.75 11.47
Fourth Quarter............................................ 17.00 12.56
FISCAL YEAR ENDED APRIL 25, 2003
First Quarter............................................. $16.40 $ 9.26
Second Quarter............................................ 19.70 12.20
Third Quarter............................................. 20.50 14.47
Fourth Quarter............................................ 23.25 16.07
The stock market has from time to time experienced significant price and
volume fluctuations that are unrelated to the operating performance of
particular companies. Like the stock prices of other medical device companies,
the market price of our Common Stock has in the past been, and may in the future
be, subject to significant volatility. Factors such as reports on the clinical
efficacy and safety of the VNS Therapy System for existing and new indications,
fluctuations in our sales and operating results, product and component supply
issues, government approval status, announcements of technological innovations
or new products by our competitors, changes in estimates of our performance by
securities analysts, failure to meet securities analysts' expectations,
developments with respect to patents or proprietary rights, public concern as to
the safety of products developed by us or others may have a significant affect
on the market price of the Common Stock. In addition, the price of our stock
could be affected by stock price volatility in the medical device industry or
the capital markets in general without regard to our operating performance.
As of June 24, 2003, there were 431 stockholders of record.
We currently intend to retain future earnings to fund the development and
growth of our business and, therefore, do not anticipate paying cash dividends
within the foreseeable future. Any future payment of dividends will be
determined by our Board of Directors and will depend on our financial condition,
results of operations and other factors deemed relevant by our Board of
Directors.
Please refer to Item 12 of this Annual Report concerning securities
authorized under our Equity Compensation Plans.
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain selected financial data and is
qualified by reference to, and should be read in conjunction with the
Consolidated Financial Statements and with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere herein. The
selected financial data for the 10 months ended April 27, 2001 and the 52 weeks
ended April 26, 2002 and April 25, 2003 is derived from consolidated financial
statements which are included elsewhere herein. The selected financial data for
the 10 months ended in April 27, 2001 has been audited by Arthur Andersen LLP,
and for the 52 weeks ended April 26, 2002 and April 25, 2003 has been audited by
KPMG LLP, both independent
21
auditing firms. The selected financial data for the 12 months ended April 27,
2001 which were not audited due to the Company's change in fiscal year, and are
presented here for comparison purposes only. The selected financial data for the
years ended June 30, 2000, and June 30, 1999 are derived from audited
consolidated financial statements not included herein. See Item 9. "Changes in
and Disagreements with Accountants on Accounting and Financial Disclosure."
52 WEEKS ENDED 10 MONTHS
---------------------------------------------- ENDED 12 MONTHS ENDED JUNE 30
APRIL 25, APRIL 26, APRIL 27, APRIL 27, ---------------------------
2003 2002 2001 2001 2000 1999
------------- ------------- -------------- ------------- ------------ ------------
(UNAUDITED)(1)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net sales...................... $ 104,466,998 $ 70,111,293 $ 53,567,994 $ 43,418,736 $ 47,888,733 $ 29,927,476
Cost of sales.................. 16,066,229 13,616,374 14,338,769 11,806,353 11,833,507 7,736,137
------------- ------------- ------------- ------------- ------------ ------------
Gross profit................... 88,400,769 56,494,919 39,229,225 31,612,383 36,055,226 22,191,339
Operating expenses:
Selling, general and
administrative............. 65,842,238 59,190,554 39,826,652 33,571,072 33,269,266 29,585,570
Research and development..... 17,874,909 24,516,547 19,414,819 17,201,179 8,037,096 6,724,106
Non-recurring charges........ -- -- 6,467,415 6,467,415 -- --
------------- ------------- ------------- ------------- ------------ ------------
Total operating expenses... 83,717,147 83,707,101 65,708,886 57,239,666 41,306,362 36,309,676
Interest income................ 471,213 1,264,853 1,428,845 1,141,939 1,364,985 1,465,549
Interest expense............... (413,192) (266,270) (68,868) (65,331) (3,349) --
Other income (expense), net.... 572,851 93,694 (37,544) (147,058) (44,894) 115,236
------------- ------------- ------------- ------------- ------------ ------------
Earnings (loss) before
cumulative effect of a change
in accounting principle...... 5,314,494 (26,119,905) (25,157,228) (24,697,733) (3,934,394) (12,537,552)
Cumulative effect on prior
years (to June 30, 1999) of
changing to a different
method of depreciation....... -- -- -- -- 881,150 --
------------- ------------- ------------- ------------- ------------ ------------
Earnings (loss) before income
taxes........................ 5,314,494 (26,119,905) (25,157,228) (24,697,733) (3,053,244) (12,537,552)
Taxes on earnings.............. 129,563 -- -- -- -- --
------------- ------------- ------------- ------------- ------------ ------------
Net earnings (loss)............ $ 5,184,931 $ (26,119,905) $ (25,157,228) $ (24,697,733) $ (3,053,244) $(12,537,552)
============= ============= ============= ============= ============ ============
Basic earnings (loss) per
share........................ $ 0.24 $ (1.21) $ (1.31) $ (1.27) $ (0.17) $ (0.72)
Diluted earnings (loss) per
share........................ $ 0.22 $ (1.21) $ (1.31) $ (1.27) $ (0.17) $ (0.72)
============= ============= ============= ============= ============ ============
Shares used in computing basic
earnings (loss) per share.... 22,034,651 21,655,009 19,247,253 19,382,460 18,044,692 17,503,169
Shares used in computing
diluted earnings (loss) per
share........................ 23,173,324 21,655,009 19,247,253 19,382,460 18,044,692 17,503,169
============= ============= ============= ============= ============ ============
CONSOLIDATED BALANCE SHEET DATA
(AS OF YEAR END):
Cash, cash equivalents and
marketable securities........ $ 43,576,305 $ 38,195,962 $ 57,250,907 $ 57,250,907 $ 20,537,450 $ 24,858,123
Total assets................... 74,954,731 64,322,876 78,314,924 78,314,924 44,498,435 39,783,153
Accumulated deficit............ (124,565,217) (129,750,148) (103,630,243) (103,630,243) (78,932,510) (75,879,266)
Common stockholders' equity.... 48,512,003 36,613,813 59,647,084 59,647,084 38,407,975 33,448,445
- ---------------
(1) The comparative period presented is unaudited because the Company changed
its fiscal year in April 2001.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion and analysis together with
"Selected Financial Data" and our Consolidated Financial Statements and the
notes to those statements included elsewhere in this Form 10-K. This discussion
contains forward-looking statements based on our current expectations,
assumptions, estimates and projections about us and our industry. These
forward-looking statements involve risks and uncertainties. Our actual results
could differ materially from those indicated in these forward-looking statements
as a result of certain factors, as more fully described under the heading
"Factors Affecting Future Operating Results" and in the "Business" section and
elsewhere in this Form 10-K. Cyberonics undertakes no obligation to update
publicly any forward-looking statements, even if new information becomes
available or other events occur in the future.
SUMMARY
We were founded in 1987 to design, develop and bring to market medical
devices which provide a unique therapy, vagus nerve stimulation, for the
treatment of epilepsy and other debilitating neurological, psychiatric diseases
and other disorders. Clinical trials of the VNS Therapy System began with the
first patient implant in November 1988 under IDE from FDA. We received FDA
approval to market the VNS Therapy System in the U.S. in July 1997 for use as an
adjunctive therapy in reducing the frequency of seizures in adults and
adolescents over 12 years of age with partial onset seizures that are refractory
or resistant to antiepileptic drugs. We were granted regulatory approval in 1994
to market and sell the VNS Therapy System in the member countries of the
European Union and we also have permission to sell in certain other
international markets with the broader indication of refractory epilepsy and
without discrimination to patient age.
In March 2001, the VNS Therapy System was approved by N.V. KEMA, an
official notified body representing the European Union countries, for the
treatment of chronic or recurrent depression in patients that are in a
treatment-resistant or treatment-intolerant major depressive episode. This CE
Mark approval, by definition includes the treatment of depression in patients
with major depressive disorder, or so-called unipolar depression, as well as
patients with bipolar disorder, or manic depression. In April 2001, the VNS
Therapy System was approved by Health Canada for the treatment of chronic or
recurrent depression in patients that are in a treatment-resistant or
treatment-intolerant major depressive episode. The Canadian approval is similar
to CE Mark European approval in that patients with unipolar depression and
bipolar depression are included. Although VNS Therapy using the VNS Therapy
System has been approved in European Union countries and Canada for the
treatment of chronic or recurrent depression, we do not anticipate significant
sales volumes in these countries until reimbursement approvals have been
received in each country and we have received regulatory approval in the U.S.
From inception through July 1997, our primary focus was on obtaining FDA
approval for the VNS Therapy System for the treatment of epilepsy. Since
inception, we have incurred substantial expenses, primarily for research and
development activities which include product and process development and
clinical trials and related regulatory activities, sales and marketing
activities, manufacturing start-up costs and system infrastructure. We have also
made significant investments in recent periods in connection with the U.S.
market launch of the VNS Therapy System and the clinical research costs
associated with new indications development, most notably depression. For the
period from inception through April 25, 2003, we incurred a cumulative net
deficit of approximately $124.6 million. The clinical studies for depression are
for investigational therapies that are not expected to generate significant
sales prior to FDA approval, which is not anticipated before calendar 2005, if
at all. Furthermore, the timing and nature of these expenditures are contingent
upon several factors outside of our control and may exceed the current
expectations of securities analysts and investors.
In March 2001, we elected to change our fiscal year from June 30 to a 52/53
week year ending on the last Friday in April of each year, effective April 27,
2001. Accordingly, fiscal 2003 started April 27, 2002 and ended April 25, 2003,
fiscal 2002 started April 28, 2001 and ended April 26, 2002 and fiscal 2001
started July 1, 2000 and ended April 27, 2001.
23
The Company's future success is dependent upon a number of factors which
include, among others, achieving market acceptance and generating sufficient
sales volume, obtaining and maintaining regulatory and reimbursement approvals
for our products, the possibility of competition and technological changes,
developing our sales, marketing and corporate infrastructures, maintaining an
uninterrupted supply of certain sole source components and materials, adding
sufficient manufacturing capacity to meet future possible product demand,
possible product liability or recall, and reliance on key personnel.
CRITICAL ACCOUNTING POLICIES
The Company considers the following accounting policies as the most
critical because, in management's view, they are most important to the portrayal
of the Company's consolidated financial condition and results and most demanding
in terms of requirements and other exercises of 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 equivalents, accounts receivable, accounts
payable, and line of credit approximate their fair values due to the short-term
maturity of these financial instruments.
Revenue Recognition. Revenue from product sales is generally recognized
upon shipment to the customer, net of estimated returns and allowances. The
Company's revenues are dependent upon sales to new and existing customers
pursuant to the Company's policy. A change in this policy or sales terms could
impact the amount and timing of revenue recognized.
Research and Development. All research and development costs are expensed
as incurred. The Company has entered into contractual obligations for the
conduct of clinical studies. Costs are incurred primarily at the time of
enrollment and paid under the terms of the contracts. Research and development
expenses could vary significantly with changes in the timing of clinical
activity.
Warranty Expense. The Company provides at the time of shipment for costs
estimated to be incurred under its product warranties. Provisions for warranty
expenses are made based upon projected product warranties. Amounts actually paid
could vary subject to certain factors discussed in "Factors Affecting Future
Operating Results" discussed below.
Stock Options. The Company has adopted the disclosure-only provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation" and SFAS No. 148,
"Accounting for Stock-Based Compensation -- Transition and Disclosure," which
disclosures are presented in Note 1, "Summary of Significant Accounting Policies
and Related Data -- Stock Options." Because of this election, the Company
continues to account for its employee stock-based compensation plans under
Accounting Principles Board (APB) Opinion No. 25 and the related
interpretations. No stock-based compensation cost is reflected in net income for
employee option grants for options granted under those plans having an exercise
price equal to the market value of the underlying common stock on the date of
grant.
24
Income Taxes. Cyberonics accounts for income taxes under the asset and
liability method. Under this method, deferred income taxes reflect the impact of
temporary differences between financial accounting and tax bases of assets and
liabilities. Such differences relate primarily to the Company's election to
defer the deduction of certain start-up costs for federal income tax purposes,
the deductibility of certain accruals and reserves and the effect of tax loss
and tax credit carryforwards not yet utilized. Deferred tax assets are evaluated
for realization based on a more-likely-than-not criteria in determining if a
valuation allowance should be provided.
RESULTS OF OPERATIONS
Net Sales. Net sales for the 52 weeks ended April 25, 2003 totaled $104.5
million, compared to net sales of $70.1 million for the 52 weeks ended April 26,
2002 and $53.6 million for the 52 weeks ended April 27, 2001. Net sales of
$104.5 million for fiscal 2003 increased over fiscal 2002 by 49% due to
increases in unit sales and increases in average selling prices. Net sales of
$70.1 million for fiscal 2002 increased over fiscal 2001 by 31% due to increases
in unit sales and increases in average selling prices. U.S. net sales for the 52
weeks ended April 25, 2003 were $95.8 million, compared to $63.8 million and
$47.7 million for the 52 weeks ended April 26, 2002 and April 27, 2001,
respectively. International sales for the 52 weeks ended April 25, 2003 were
$8.7 million compared to $6.3 million and $5.9 million for the 52 weeks ended
April 26, 2002 and April 27, 2001, respectively. Future increases in net sales
will depend upon increased market acceptance for the VNS Therapy System and upon
expanding our reimbursement from third-party payers. We cannot assure you that
sales levels in subsequent periods will increase at the rates experienced in
recent periods or at all.
Gross Profit. Cost of sales consist primarily of direct labor, allocated
manufacturing overhead, third-party contractor costs, royalties, and the
acquisition cost of raw materials and components. Gross margin was 84.6% for the
52 weeks ended April 25, 2003, as compared to 80.6% and 73.2% for the 52 weeks
ended April 26, 2002 and April 27, 2001, respectively. The increase in gross
margin in fiscal 2003 and fiscal 2002 is the result of increases in average
selling prices and improvement in manufacturing production efficiencies. We are
obligated to pay royalties at a rate of 4% of net sales in future periods. Gross
margins can be expected to fluctuate in future periods based upon the mix
between U.S. and international sales, direct and distributor sales, the VNS
Therapy System selling price, applicable royalty rates, and the levels of
production volume.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $65.8 million or 63.0% of net sales for the 52
weeks ended April 25, 2003, as compared to $59.2 million or 84.4% of net sales
for the 52 weeks ended April 26, 2002 and $39.8 million or 74.3% of net sales
for the 52 weeks ended April 27, 2001. The increase of 11% in fiscal year 2003
expenses over the prior year reflects additional expenses required to support
sales volume growth of approximately 33%. The increase of 49% in fiscal 2002
expenses over the prior year is primarily due to the additional marketing
programs implemented to expand awareness and acceptance of VNS Therapy,
increased participation in industry marketing events and increased
administrative staffing levels to support the growth of the organization.
Research and Development Expenses. Research and development expenses are
comprised of expenses related to our product and process development, product
design efforts, clinical trials programs and regulatory activities. Research and
development expenses were $17.9 million, or 17.1% of net sales for the 52 weeks
ended April 25, 2003, compared to $24.5 million, or 35.0% of net sales for the
52 weeks ended April 26, 2002 and $19.4 million, or 36.2% of net sales for the
52 weeks ended April 27, 2001. The decrease of $6.7 million, or 27% in fiscal
2003 over the prior year is due to reduced spending in new indications
development, primarily in the depression pivotal study costs which were
significantly lower in fiscal 2003 as the clinical program progressed into the
long term, lower cost phase of the D-02 study. The increase of $5.1 million or
26% in fiscal 2002 over the prior year is due to the additional costs associated
with the enrollment and acute phase of the depression pivotal study and other
new indication pilot studies and expanded regulatory activities.
Non-recurring Charges. Non-recurring charges were $6.5 million for the 52
weeks ended April 27, 2001. On September 11, 2000, Medtronic, Inc. (Medtronic)
publicly announced a proposal to acquire the Company for $26.00 per share in
value of Medtronic common stock. The Company's Board of Directors, with the
assistance of Morgan Stanley Dean Witter, the Company's financial advisor,
elected to remain
25
independent to pursue its patent protected business opportunities. On September
28, 2000, Medtronic announced that it had withdrawn its offer. The Company
incurred non-recurring charges of $6.5 million which includes investment banking
fees to Morgan Stanley Dean Witter of $6.0 million. The Company also incurred
legal, accounting and consulting fees of approximately $350,000 and other
related costs of $117,000.
Interest Income. Interest income was $471,000 during the 52 weeks ended
April 25, 2003, compared to $1,265,000 for the 52 weeks ended April 26, 2002 and
$1,429,000 for the 52 weeks ended April 27, 2001. Interest income declined in
fiscal 2003 due to lower average interest rates and lower average cash balances
on hand throughout the year.
Interest Expense. Interest expense was $413,000 for the 52 weeks ended
April 25, 2003, as compared to $266,000 for the 52 weeks ended April 26, 2002
and $69,000 for the 52 weeks ended April 27, 2001. Interest expense has
increased due to the expanded use of a $10 million credit facility established
in September 2001 and includes interest expense on capital leases for
manufacturing equipment which bears interest at 6.56% over a term of five years.
The credit facility was increased to $25 million in April 2003 and bears
interest at the designated bank rate plus 1.5% on the greater of $3,000,000 or
the average of net balances owed by the Company at the close of each day during
the month.
Other Income (Expense), Net. Other income (expense), net, was $573,000 for
the 52 weeks ended April 25, 2003, compared to $94,000 during the 52 weeks ended
April 26, 2002 and ($38,000) for the 52 weeks ended April 27, 2001. In all
reported periods, other income (expense) consisted primarily of net gains and
losses resulting from fluctuations in foreign currency transactions and rates.
We expect other income (expense) to fluctuate in future periods depending upon
fluctuations in currency exchange rates.
Income Taxes. At April 25, 2003, we had net operating loss carryforwards
for federal income tax purposes of approximately $112.3 million. The following
is a reconciliation of statutory federal income tax rates to the Company's
effective income tax rate expressed as a percentage of income from operations
before income taxes:
52 WEEKS ENDED 52 WEEKS ENDED 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27,
2003 2002 2001
-------------- -------------- ---------------
Provision for Income Taxes.............. $129,563 -- --
======== ===== =====
U.S. statutory rate..................... 34.0% (34.0)% (34.0)%
Increase in deferred tax valuation
allowance............................. (29.5) 37.6 37.4
State & local tax provision............. 1.7 -- --
Other, net.............................. (3.7) (3.6) (3.4)
-------- ----- -----
2.5% 0.0% 0.0%
======== ===== =====
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through public
and private placements of our securities. In February 2001, we raised
approximately $42.4 million from the sale of Common Stock in a private offering.
In September 2001, we established a revolving credit facility for $10,000,000
with a term of three years. This credit facility was expanded to $25,000,000 in
April 2003 and it is collateralized by accounts receivable, inventory,
equipment, documents of title, general intangibles, subsidiary stock and other
collateral. Borrowings against the facility are based upon eligible accounts
receivable. The net available borrowing base at April 25, 2003 was $655,000.
Interest is payable at the amount of the designated bank rate of 4.25% as of
April 25, 2003 plus 1.5% totaling 5.75% 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 modified 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 $10,000,000. An unused line of
credit fee is payable at the rate of 0.5%. As of April 25, 2003, we had
$8,370,000 in borrowings outstanding under the credit facility.
26
During fiscal 2003, cash on hand increased by $5,380,000 to $43,576,000.
Net cash provided by operating activities in fiscal 2003 was $1,276,000,
compared to net cash used in operating activities in fiscal 2002 of $23,047,000.
The increase in cash provided by operating activities was primarily the result
of the improved earnings performance in fiscal 2003, as net earnings increased
by $31,305,000 over prior year, resulting in net income of $5,185,000 for the
year ended April 25, 2003. In addition, we received approximately $6,476,000 in
fiscal 2003 in connection with the issuance of shares pursuant to our stock
option and employee stock purchase plans and $1,870,000 in proceeds from the
revolving credit facility. Cash proceeds during the period were primarily used
to fund working capital and capital expenditures.
During fiscal 2002, cash on hand decreased by $17,263,000 to $38,196,000.
Net cash used in operating activities was approximately $23,047,000, compared to
net cash used in operating activities in the prior year of $5,717,000. The
increase in cash used in operating activities was primarily due to increases in
working capital supporting the growth of the company. In fiscal 2002, we
received $6,500,000 in proceeds from the revolving line of credit and $2,688,000
in connection with the issuance of shares pursuant to our stock option and
employee stock purchase plans. Cash proceeds during the period were primarily
used to fund working capital and capital expenditures.
During the 12 months ended April 27, 2001, cash on hand increased by
$38,974,000 to $55,459,000. Net cash used in operating activities in fiscal 2001
was $5,717,000. We raised approximately $42,400,000 from the sale of Common
Stock in a private equity offering. In addition, we received approximately
$3,000,000 in connection with the issuance of shares pursuant to our stock
option and employee stock purchase plans. Cash proceeds during the period were
primarily used to fund working capital and capital expenditures.
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 $3.5
million as of April 25, 2003. Although we have no firm commitments, we expect to
make capital expenditures of approximately $5.5 million during fiscal 2004,
primarily to expand manufacturing capabilities, and to enhance business
infrastructure and facilities. Our current projections indicate that we have
sufficient funds and cash flow resources to fund anticipated business activities
through fiscal 2005 without additional financing.
Our cash flow could, however, be adversely effected by the "Factors
Affecting Future Operating Results" discussed below. We would consider
reasonably priced additional financing which would provide funding for new
indications development and unplanned or expanded clinical studies. Financing
through debt or equity instruments may be available, although the availability
of such financing will depend upon a number of important factors, including the
strength of the U.S. capital markets and economy, the health care and medical
device segments in particular and the status of our business activities,
including epilepsy sales growth and clinical and regulatory activities. The
chart below reflects our current obligations under our material contractual
obligations.
TOTAL
LINE OF CAPITAL LEASE OPERATING CONTRACTUAL
CREDIT OBLIGATIONS(1) LEASES(2) MEETINGS(3) OBLIGATIONS
---------- -------------- ----------- ----------- -----------
CONTRACTUAL OBLIGATIONS:
Less Than One Year.............. $8,370,000 $132,133 $ 2,104,689 $831,610 $11,438,432
1-3 Years....................... -- 141,066 4,681,963 66,580 4,889,609
4-5 Years....................... -- -- 4,701,506 -- 4,701,506
Over Five Years................. -- -- 4,071,337 -- 4,071,337
---------- -------- ----------- -------- -----------
Total Contractual
Obligations................ $8,370,000 $273,199 $15,559,495 $898,190 $25,100,884
========== ======== =========== ======== ===========
- ---------------
(1) Consists of capital lease obligations related to manufacturing equipment.
(2) Consists of operating lease obligations related to facilities and office
equipment.
(3) Reflects amounts we expect to expend in connection with sales, marketing and
training events.
27
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
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 consolidated operating results or financial
condition.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. The
adoption of SFAS No. 146 did not have a material impact on the Company's
consolidated operating results or financial condition.
In December 2002, the FASB 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.
In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This statement is an interpretation of FASB Statements
No. 5, 57 and 107 and rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. This Interpretation does not
prescribe a specific approach for subsequently measuring the guarantor's
recognized liability over the term of the related guarantee. This Interpretation
also incorporates, without change, the guidance in FASB Interpretation No. 34,
"Disclosure of Indirect Guarantees of Indebtedness of Others," which is being
superseded. The initial recognition and initial measurement provisions of this
Interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, irrespective of the guarantor's fiscal
year-end. The disclosure requirements in this Interpretation are effective for
financial statements of interim or annual periods ending after December 15,
2002. The adoption of FIN No. 45 did not have a material impact on the Company's
consolidated operating results or financial condition.
28
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." This Interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," addresses consolidation by business
enterprises of variable interest entities. This Interpretation applies
immediately to variable interest entities created after January 31, 2003 and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The interpretation applies to
public enterprises as of the beginning of the applicable interim or annual
period and it applies to nonpublic enterprises as of the end of the applicable
annual period. The adoption of FIN No. 46 will not have a material impact on the
Company's consolidated operating results or financial condition.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments With Characteristics of Both Liabilities and Equity." This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. This statement is effective for the first fiscal period beginning after
December 15, 2003. The Company believes that the adoption of SFAS No. 150 will
not have a material impact on the Company's consolidated operating results or
financial condition.
FACTORS AFFECTING FUTURE OPERATING RESULTS
In addition to the factors described above in this section and in the
section of this Annual Report on Form 10-K entitled "Business," the following
additional factors could affect our future results.
Our common stock price constantly changes. A public market for our common
stock has existed since 1996. Our common stock is now traded on the Nasdaq
National Market under 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 fiscal year ended April 25,
2003, our stock has traded from a low of $9.26 to a high of $23.25 per share.
The fluctuation in our stock price is caused by a number of factors, some of
which are beyond our control, including:
- quarterly variations in our sales and operating results;
- results of studies regarding the efficacy of our VNS Therapy treatment
for other indications including depression, AD, anxiety and other
disorders;
- announcements of significant contracts, acquisitions, or capital
commitments;
- changes in financial estimates by securities analysts;
- changes in market valuations of medical device companies;
- additions or departures of key personnel;
- sales of common stock by the Company, its officers and members of its
Board of Directors; and
- changes in the general conditions of the economy.
In addition, the stock market in recent years has experienced broad price
and volume fluctuations that have often been unrelated to the operating
performance of companies. These broad market fluctuations have also adversely
affected, and may continue to adversely affect, the market price of our common
stock.
We rely on only one product for our revenues and if sales of this product
are not achieved, our operating results will be severely harmed. We have only
one product, the 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. before calendar 2005,
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
29
treatment of depression. We cannot assure you that any approvals for the
treatment of depression with the VNS Therapy System will be granted, nor can we
assure you that even if the approval is granted, we will be successful in
commercializing the VNS Therapy System for the treatment of depression. The same
uncertainty surrounds our efforts in anxiety disorders, AD applications and
obesity. Our inability to commercialize successfully the VNS Therapy System for
depression, obesity and other indications will severely harm our future growth.
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 22,000 patients through June 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,
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
additional market acceptance would severely harm our business, financial
condition and results of operations.
We may not be successful in our marketing and sales efforts, which could
severely harm our business. The realignment and reorganization of the U.S. sales
force implemented in May 2003 resulted in hiring several new sales
representatives and regional managers, who will require training and time on the
job to become effective. This reorganization also created changes in geography,
physician audience or job roles for a substantial portion of the tenured sales
force. While we believe these changes should ultimately improve productivity and
performance going forward, we cannot assure you that those outcomes will be
achieved. The disruption caused by territory realignment and expansion could
take longer than expected to yield improvements in productivity and efficiency.
The time necessary for personnel to establish new territories and relationships
of trust with new physicians may take longer than projected, which could
substantially delay improvements in U.S. sales performance or jeopardize
attainment of quarterly revenue goals. Our inability to achieve annual revenue
growth or achieve our quarterly revenue targets could substantially harm our
results of operations and financial condition.
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 mode. 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 be unable to maintain adequate third-party reimbursement on our
product. Our ability to commercialize the VNS Therapy System successfully
depends in part on whether third-party payers, including private health care
insurers, managed care plans, the U.S. government's Medicare and Medicaid
programs and others, agree both to cover the VNS Therapy System and associated
procedures and services and to reimburse at adequate levels for the costs of the
VNS Therapy System and the related services we have in the U.S. or
internationally. If we fail to maintain favorable coverage decisions for the VNS
Therapy System in a timely manner, patients and their physicians could be
deterred from using the VNS Therapy System which could reduce our sales and
severely harm our business.
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
30
unexpected sales shortfall. If increased expenses are not accompanied by
increased sales, our results of operations and financial condition for any
particular quarter could be harmed.
If our suppliers and manufacturers are unable to meet our demand for
materials, components and contract services, we may be forced to qualify new
vendors or change our product design which would impair our ability to deliver
products to our customers on a timely basis. We rely upon sole source suppliers
for certain of the key components, materials and contract services used in
manufacturing the VNS Therapy System. We periodically experience discontinuation
or unavailability of components, materials and contract services which may
require us to qualify alternative sources or, if no such alternative sources are
identified, change our product design. We believe that pursuing and qualifying
alternative sources and/or redesigning specific components of the VNS Therapy
System if or, when necessary, could consume significant resources. In addition,
such changes generally require regulatory submissions and approvals. Any
extended delays in or an inability to secure alternative sources for these or
other components, materials and contract services could result in product supply
and manufacturing interruptions, which could significantly harm our business.
Our products may be found to have defects and result in product
recalls. The VNS Therapy System includes a complex electronic generator device
and lead device designed to be implanted in the human body. Component failures,
manufacturing or shipping problems or design defects could result in the product
not delivering the therapy for which it is indicated. The occurrence of such
problems or other adverse clinical reactions could result in a recall of our
products, possibly requiring explantation and potential reimplantation of the
VNS Therapy System which may increase risk to the patient. Any product recall
could severely harm our business, financial condition and results of operations.
We may not be able to protect our technology from unauthorized use, which
could diminish the value of our products and impair our ability to compete. Our
success depends upon our ability to obtain and maintain patent and other
intellectual property protection for the VNS Therapy System and its
improvements, and for vagus nerve stimulation therapy. To that end, we have
acquired licenses under certain patents and have patented and intend to continue
to seek patents on our own inventions used in our products and treatment
methods. The process of seeking patent protection can be expensive and time
consuming and we cannot assure you that patents will issue from our currently
pending or future applications or that, if patents are issued, they will be of
sufficient scope or strength to provide meaningful protection of our technology,
or any commercial advantage to us. Further, the protection offered by the
licensed international patents is not as strong as that offered by the licensed
U.S. patents due to differences in patent laws. In particular, the European
Patent Convention prohibits patents covering methods for treatment of the human
body by surgery or therapy.
We may have to engage in litigation to protect our proprietary rights, or
defend against infringement claims by third parties, causing us to suffer
significant expenses or prevent us from selling our products. There has been
substantial litigation regarding patent and other intellectual property rights
in the medical device industry. Litigation, which could result in substantial
cost to and diversion of effort by us, may be necessary to enforce patents
issued or licensed to us, to protect trade secrets or know-how owned by us or to
defend ourselves against claimed infringement of the rights of others and to
determine the scope and validity of the proprietary rights of others. Adverse
determinations in litigation could subject us to significant liabilities to
third parties, could require us to seek licenses from third parties and could
prevent us from manufacturing, selling or using the VNS Therapy System, any of
which could severely harm our business.
Intense competition and rapid technological changes could reduce our
ability to market our products and achieve sales. We believe that existing and
future antiepileptic drugs will continue to be the primary competition for the
VNS Therapy System. We may also face competition from other medical device
companies that have the technology, experience and capital resources to develop
alternative devices for the treatment of epilepsy. Medtronic, Inc., for example,
continues to clinically assess an implantable signal generator used with an
invasive deep brain probe, or thalamic stimulator, for the treatment of
neurological disorders and has received FDA approval for the device for the
treatment of essential tremor, including that associated with Parkinson's
Disease. Many of our competitors have substantially greater financial,
manufacturing, marketing and technical resources than we do and have obtained
third-party reimbursement approvals for their therapies. In addition, the health
care industry is characterized by extensive research efforts and rapid
31
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.
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.
If we fail to effectively manage our growth, our ability to maintain our
costs or capture new business could suffer. In connection with the
commercialization of the VNS Therapy System in the U.S., we have begun and
intend to continue to significantly expand the scope of our operations, in
particular in manufacturing and in marketing and sales. Such activities have
placed, and may continue to place, a significant strain on our resources and
operations. Our ability to effectively manage such growth will depend upon our
ability to attract, hire and retain highly qualified employees and management
personnel. We compete for such personnel with other companies, academic
institutions, government entities and other organizations and we may not be
successful in hiring or retaining qualified personnel. Our success will also
depend upon the ability of our officers and key employees to continue to
implement and improve our operational, management information and financial
control systems. If we fail to manage our growth effectively, our business would
suffer.
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,
32
expenses and operating results may vary significantly from quarter to quarter
for several reasons including the extent to which the VNS Therapy System gains
market acceptance, the timing of obtaining marketing approvals for the VNS
Therapy System for other indications, the timing of any approvals for
reimbursement by third-party payers, the rate and size of expenditures incurred
as we expand our clinical, manufacturing, sales and marketing efforts, our
ability to retain qualified sales personnel and the availability of key
components, materials and contract services, which may depend on our ability to
forecast sales.
We may not be successful in our efforts to develop VNS Therapy for the
treatment of depression, AD, anxiety, obesity, or any other indications. We are
in the process of conducting studies to help us evaluate, and potentially obtain
FDA approval, for the use of VNS Therapy as a treatment for depression, AD,
anxiety 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily
to our short-term investments in U.S. Government obligations, our line of credit
and our fixed rate long-term debt. We do not hedge interest rate exposure or
invest in derivative securities. We are exposed to market risk from changes in
foreign currency exchange rates. Our wholly-owned foreign subsidiary is
consolidated into our financial results. Our reported revenues, expenses and
cash flows from this subsidiary are exposed to changing exchange rates. At this
time, we have not deemed it to be cost effective to engage in a program of
hedging the effect of foreign currency fluctuations on our operating results
using derivative financial instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference to the
Consolidated Financial Statements set forth on pages F-1 through F-22 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Audit Committee of the Board of Directors annually considers and
selects Cyberonics' independent public accountants. As recommended by
Cyberonics' Audit Committee, Cyberonics' Board of Directors on April 10, 2002
decided to dismiss Arthur Andersen LLP as Cyberonics' independent public
accountants.
Arthur Andersen LLP's reports on Cyberonics' consolidated financial
statements did not contain an adverse opinion or disclaimer of opinion and were
not qualified or modified as to uncertainty, audit scope or accounting
principles.
Through the date of Arthur Andersen LLP's dismissal, there were no
disagreements with Arthur Andersen LLP on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of Arthur Andersen LLP, would
have caused Arthur Andersen LLP to make reference to the subject matter of the
disagreements in connection with Arthur Andersen LLP's report; and during Arthur
Andersen LLP's engagement there were no "reportable events" of the kind listed
in Item 304(a)(1)(v) of Regulation S-K.
Cyberonics provided Arthur Andersen LLP with a copy of the foregoing
disclosure and requested Arthur Andersen LLP to furnish Cyberonics with a letter
addressed to the Securities and Exchange Commission stating whether it agrees
with the statements by Cyberonics in the foregoing disclosure and, if not,
stating the respects in which it does not agree. We received such a letter
indicating that Arthur Andersen LLP agreed with the foregoing statements on
April 16, 2002.
We engaged KPMG LLP to serve as Cyberonics' independent public accountants
and to audit Cyberonics' financial statements for the fiscal years ended April
26, 2002 and April 25, 2003. The engagement
33
of KPMG LLP was recommended by the Audit Committee and approved by the Board of
Directors of Cyberonics. Our Audit Committee has reviewed and discussed the
audited consolidated financial statements included in this annual report on Form
10-K, and has recommended, and the Board has approved, their inclusion herein.
Prior to our engagement of KPMG LLP in April 2002, Cyberonics did not
consult KPMG LLP with respect to the application of accounting principles to a
specified transaction, either completed or proposed, or the type of audit
opinion that might be rendered on Cyberonics' consolidated financial statements,
or any other matters or reportable events listed in Items 304(a)(2)(i) and (ii)
of Regulation S-K.
Arthur Andersen LLP completed its audit of our consolidated financial
statements for the 10 months ended April 27, 2001 and issued their report with
respect to such consolidated financial statements on June 21, 2001. We requested
a consent of Arthur Andersen LLP to incorporate their report dated June 21, 2001
included in this Form 10-K but were unsuccessful in obtaining such consent.
Arthur Andersen LLP was convicted of obstruction of justice for activities
relating to its previous work for Enron Corp., and Arthur Andersen LLP announced
that it would cease to audit publicly held companies by August 31, 2002. Because
Arthur Andersen LLP has ceased the conduct of its business, our stockholders are
unlikely to recover against Arthur Andersen LLP for any claims they may have
under securities or other laws as a result of Arthur Andersen LLP's previous
role as our independent auditors and as author of the audit report for the
audited consolidated financial statements included herein.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item as to our directors and executive
officers is hereby incorporated by reference from the information appearing
under the captions "Election of Directors" and "Executive Officers" in our
definitive proxy statement which involves the election of directors and is to be
filed with the SEC pursuant to the Securities Exchange Act of 1934 within 120
days of the end of our fiscal year on April 25, 2003.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item as to our management is hereby
incorporated by reference from the information appearing under the captions
"Executive Compensation" and "Election of Directors -- Director Compensation" in
our definitive proxy statement which involves the election of directors and is
to be filed with the SEC pursuant to the Securities Exchange Act of 1934 within
120 days of the end of our fiscal year on April 25, 2003. Notwithstanding the
foregoing, in accordance with the instructions to Item 402 of Regulation S-K,
the information contained in our proxy statement under the sub-heading "Report
of the Compensation Committee of the Board of Directors" and "Performance Graph"
shall not be deemed to be filed as part of or incorporated by reference into
this annual report on Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this Item as to the ownership by management and
others of our securities is hereby incorporated by reference from the
information appearing under the caption "Stock Ownership of Certain Beneficial
Owners and Management" in our definitive proxy statement which involves the
election of directors and is to be filed with the SEC pursuant to the Securities
Exchange Act of 1934 within 120 days of the end of our fiscal year on April 25,
2003.
34
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item as to certain business relationships
and transactions with our management and other related parties is hereby
incorporated by reference to such information appearing under the captions
"Certain Transactions" and "Compensation Committee Interlocks and Insider
Participation" in our definitive proxy statement which involves the election of
directors and is to be filed with the SEC pursuant to the Securities Exchange
Act of 1934 within 120 days of the end of our fiscal year on April 25, 2003.
ITEM 14. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer have concluded that
our disclosure controls and procedures (as defined in Securities Exchange Act of
1934 Rules 13a-14(c) and 15d-14(c)) are sufficiently effective to ensure that
the information required to be disclosed by us in the reports we file under the
Securities Exchange Act of 1934 is gathered, analyzed and disclosed with
adequate timeliness, accuracy and completeness, based on an evaluation of such
controls and procedures conducted within 90 days prior to the date hereof.
Subsequent to our evaluation, there were no significant changes in internal
controls or other factors that could significantly affect internal controls,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
35
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed with Report
1. Financial Statements. The Consolidated Financial Statements of
Cyberonics, Inc. and its subsidiary, and the Report of Independent Auditors
are included in pages F-1 through F-24 of this Annual Report on Form 10-K:
PAGE
DESCRIPTION NO.
- ----------- ----
Independent Auditors' Report................................ F-2
Independent Predecessor Auditors' Report.................... F-3
Consolidated Balance Sheets................................. F-4
Consolidated Statements of Operations and Comprehensive
Income (Loss)............................................. F-5
Consolidated Statements of Stockholders' Equity............. F-6
Consolidated Statements of Cash Flows....................... F-7
Notes to Consolidated Financial Statements.................. F-8
2. Exhibits
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1(1) -- Amended and Restated Certificate of Incorporation of
Registrant.
3.2(2) -- Bylaws of Registrant.
3.3(3) -- Amendment No. 1 to the Bylaws of Registrant.
4.1(2) -- Second Amended and Restated Preferred Shares Rights
Agreement, dated as of August 21, 2000 between Cyberonics,
Inc. and First National Bank of Boston, -- including the
Certificate of Designation, the Form of
Rights -- Certificate and the Summary of Rights attached
thereto as -- Exhibit A, B and C, respectively.
4.2(4) -- Amendment No. 1 to Second Amended and Restated Preferred
Share Rights Agreement, dated April 26, 2001.
10.1(5) -- Amended 1991 Employee Stock Purchase Plan.
10.2(6) -- License Agreement dated March 15, 1988 between the
Registrant and Dr. Jacob Zabara.
10.3(6) -- Patent License Agreement effective as of July 28, 1989
between the Registrant and Huntington Medical Research
Institute.
10.4(7) -- Lease Agreement dated November 3, 1994 together with
amendments dated April 18, 1996 and April 30, 1997,
respectively, between the Registrant and Salitex II, Ltd.
10.5(6) -- Form of Indemnification Agreement.
10.6(6) -- Amended and Restated Stockholders' Agreement dated October
16, 1992.
10.7(8) -- Registration Rights Agreement dated March 28, 1997.
10.8(9) -- Amended and Restated 1996 Stock Option Plan.
10.9(7) -- Stockholders' Agreement dated April 8, 1996 between the
Registrant and St. Jude Medical, Inc.
10.10(7) -- Letter Agreement dated March 28, 1997 between the Clark
Estates and the Registrant.
10.11(10) -- Lease Agreement dated August 19, 1997 between the Registrant
and Space Assets II, Inc.
10.12(11) -- Amended and Restated 1997 Stock Plan.
10.13(12) -- 1998 Stock Option Plan.
10.14* -- Employment Agreement effective as of June 1, 2003 between
Cyberonics, Inc. and Robert P. Cummins.
10.15* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Pamela B. Westbrook.
36
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.16* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Shawn P. Lunney.
10.17* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Alan D. Totah.
10.18* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Michael A. Cheney.
10.19* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Richard L. Rudolph.
10.20* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and William Steven Jennings.
10.21* -- Severance Agreement between Cyberonics, Inc. and William
Steven Jennings.
10.22(13) -- Severance Agreement between Cyberonics, Inc. and Shawn P.
Lunney.
10.23(13) -- Severance Agreement between Cyberonics, Inc. and Alan D.
Totah.
10.24(13) -- Severance Agreement between Cyberonics, Inc. and Pamela B.
Westbrook.
10.25(14) -- Severance Agreement between Cyberonics, Inc. and Michael A.
Cheney.
10.26(14) -- Severance Agreement between Cyberonics, Inc. and Richard L.
Rudolph, M.D.
10.27(6) -- 1988 Incentive Stock Plan.
10.28(13) -- First Amendment to the 1988 Incentive Stock Plan.
16.1(16) -- Letter dated April 16, 2002, from Arthur Andersen LLP to the
Securities and Exchange Commission.
21.1(7) -- List of Subsidiaries of the Registrant.
23.1* -- Consent of Independent Auditors.
24.1 -- Powers of Attorney (included on the Signature Page to this
Form 10-K).
99.1* -- Certification of the Chief Executive Officer and Chief
Financial Officer of Cyberonics, Inc. pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
- ---------------
* Filed herewith.
(1) Incorporated by reference to Registrant's Registration Statement on Form
S-3 (Reg. No. 333-56022) filed on February 21, 2001.
(2) Incorporated by reference to Registrant's Report on Form 8-K filed on
September 12, 2000.
(3) Incorporated by reference to Registrant's Report on Form 8-K filed on March
30, 2001.
(4) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the 10 months ended April 27, 2001.
(5) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Reg. No. 333-66689) filed on November 3, 1998.
(6) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Reg. No. 33-45118) declared effective February 10, 1993.
(7) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended June 30, 1997.
(8) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1997.
(9) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (Reg. No. 333-19785) filed on April 29, 1999.
37
(10) Incorporated by reference to the Registrant's Annual Report on Form 10-K/A
for the year ended June 30, 1997.
(11) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (Reg. No. 333-56694) filed on March 8, 2001.
(12) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Reg. No. 333-66691) filed on November 3, 1998.
(13) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
quarter ended July 27, 2001.
(14) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended January 25, 2002.
(15) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2000.
(16) Incorporated by reference to Registrant's Report on Form 8-K filed April
17, 2002.
(b) Reports on Form 8-K
A current report on Form 8-K was filed on June 4, 2003 relating to the
Company's presentations to investors.
A current report on Form 8-K was filed on June 18, 2003 in connection
with the Company's results for fiscal 2003 and guidance for fiscal 2004.
(c) Exhibits
See Item 15(a)(2) above.
38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Registrant
CYBERONICS, INC.
By: /s/ PAMELA B. WESTBROOK
------------------------------------
Pamela B. Westbrook
Vice President of Finance and
Administration, Secretary and
Chief Financial Officer
July 18, 2003
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Robert P. Cummins and Pamela B.
Westbrook, jointly and severally, his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to this
Report on Form 10-K, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and conforming all that each of said attorneys-in-fact, or his
substitute or substitutes, any do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE CAPACITY IN WHICH SIGNED DATE
--------- ------------------------ ----
/s/ ROBERT P. CUMMINS Chairman of the Board, President, July 18, 2003
------------------------------------------------ Chief Executive Officer
Robert P. Cummins (Principal Executive Officer)
/s/ PAMELA B. WESTBROOK Vice President, Finance and July 18, 2003
------------------------------------------------ Administration, Secretary and Chief
Pamela B. Westbrook Financial Officer
(Principal Financial and Accounting
Officer)
/s/ REESE S. TERRY, JR. Director July 18, 2003
------------------------------------------------
Reese S. Terry, Jr.
Director
------------------------------------------------
Stanley H. Appel, M.D.
/s/ TONY COELHO Director July 18, 2003
------------------------------------------------
Tony Coelho
/s/ THOMAS A. DUERDEN, PH.D. Director July 18, 2003
------------------------------------------------
Thomas A. Duerden, Ph.D.
39
SIGNATURE CAPACITY IN WHICH SIGNED DATE
--------- ------------------------ ----
/s/ MICHAEL J. STRAUSS, M.D. Director July 18, 2003
------------------------------------------------
Michael J. Strauss, M.D.
/s/ ALAN J. OLSEN Director July 18, 2003
------------------------------------------------
Alan J. Olsen
/s/ RONALD A. MATRICARIA Director July 18, 2003
------------------------------------------------
Ronald A. Matricaria
/s/ GUY C. JACKSON Director July 18, 2003
------------------------------------------------
Guy C. Jackson
40
CERTIFICATION
I, Robert P. Cummins, Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Cyberonics, Inc.;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual 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 annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. 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 registrant's Board of Directors (or persons performing the equivalent
functions):
(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
6. The registrant's other certifying officer and I have indicated in this
annual report whether 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.
/s/ ROBERT P. CUMMINS
--------------------------------------
Robert P. Cummins
Chairman of the Board, President and
Chief Executive Officer
(Principal Executive Officer)
Date: July 18, 2003
41
CERTIFICATION
I, Pamela B. Westbrook, Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Cyberonics, Inc.;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual 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 annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. 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 registrant's Board of Directors (or persons performing the equivalent
functions):
(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
6. The registrant's other certifying officer and I have indicated in this
annual report whether 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.
/s/ PAMELA B. WESTBROOK
--------------------------------------
Pamela B. Westbrook
Vice President, Finance and
Administration,
Secretary and Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: July 18, 2003
42
CONSOLIDATED FINANCIAL STATEMENTS
AS OF APRIL 25, 2003 AND APRIL 26, 2002
TOGETHER WITH AUDITORS' REPORTS
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors
Cyberonics, Inc.:
We have audited the accompanying consolidated balance sheets of Cyberonics,
Inc. (a Delaware corporation) and subsidiary as of April 25, 2003 and April 26,
2002, and the related consolidated statements of operations and comprehensive
income (loss), stockholders' equity and cash flows for the 52 weeks then ended.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Cyberonics,
Inc. and subsidiary as of April 25, 2003 and April 26, 2002, and the results of
their operations and their cash flows for the 52 weeks then ended, in conformity
with accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Houston, Texas
May 19, 2003
F-2
INDEPENDENT AUDITORS' REPORT
THE REPORT PRESENTED BELOW IS A COPY OF THE INDEPENDENT AUDITORS'
REPORT ISSUED ON JUNE 21, 2001
ARTHUR ANDERSEN LLP HAS BEEN UNABLE TO ISSUE AN UPDATED REPORT
To Cyberonics, Inc.:
We have audited the accompanying consolidated balance sheets of Cyberonics,
Inc. (a Delaware corporation), and its subsidiary as of April 27, 2001 and June
30, 2000, and the related consolidated statements of operations and
comprehensive income (loss), stockholders' equity and cash flows for the period
ended April 27, 2001 and the two years ended June 30, 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Cyberonics,
Inc., and its subsidiary as of April 27, 2001 and June 30, 2000, and the results
of their operations and their cash flows for the period ended April 27, 2001 and
the two years ended June 30, 2000, in conformity with accounting principles
generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Houston, Texas
June 21, 2001
F-3
CYBERONICS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
APRIL 25, APRIL 26,
2003 2002
------------- -------------
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 43,576,305 $ 38,195,962
Accounts receivable, net.................................. 14,164,771 10,330,821
Inventories............................................... 6,046,106 4,528,378
Other current assets...................................... 1,344,777 1,296,685
------------- -------------
Total Current Assets................................... 65,131,959 54,351,846
Property and equipment, net............................... 9,590,240 9,799,829
Other assets.............................................. 232,532 171,201
------------- -------------
$ 74,954,731 $ 64,322,876
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 5,420,831 $ 5,633,565
Line of credit............................................ 8,370,000 6,500,000
Accrued liabilities....................................... 12,378,698 15,176,764
Current portion of long-term debt......................... 132,133 123,765
------------- -------------
Total Current Liabilities.............................. 26,301,662 27,434,094
Long-term debt.............................................. 141,066 274,969
------------- -------------
Total Liabilities...................................... 26,442,728 27,709,063
Commitments and Contingencies
Stockholders' Equity:
Preferred Stock, $.01 par value per share; 2,500,000
shares authorized; no shares issued and outstanding.... -- --
Common Stock, $.01 par value per share; 50,000,000 shares
authorized; 22,385,736 and 21,751,261 shares issued and
outstanding at April 25, 2003 and April 26, 2002,
respectively........................................... 223,857 217,513
Additional paid-in capital................................ 174,325,339 167,855,437
Deferred compensation..................................... (1,023,750) (1,496,250)
Accumulated other comprehensive loss...................... (448,226) (212,739)
Accumulated deficit....................................... (124,565,217) (129,750,148)
------------- -------------
Total Stockholders' Equity............................. 48,512,003 36,613,813
------------- -------------
$ 74,954,731 $ 64,322,876
============= =============
See accompanying notes to consolidated financial statements.
F-4
CYBERONICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
52 WEEKS ENDED
-------------------------------------------- 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27, APRIL 27,
2003 2002 2001 2001
------------ ------------ -------------- ----------------
(UNAUDITED)(1)
Net sales.......................... $104,466,998 $ 70,111,293 $ 53,567,994 $ 43,418,736
Cost of sales...................... 16,066,229 13,616,374 14,338,769 11,806,353
------------ ------------ ------------ ------------
Gross Profit.................. 88,400,769 56,494,919 39,229,225 31,612,383
Operating Expenses:
Selling, general and
administrative................ 65,842,238 59,190,554 39,826,652 33,571,072
Research and development......... 17,874,909 24,516,547 19,414,819 17,201,179
Non-recurring charges............ -- -- 6,467,415 6,467,415
------------ ------------ ------------ ------------
Total Operating Expenses...... 83,717,147 83,707,101 65,708,886 57,239,666
------------ ------------ ------------ ------------
Earnings (Loss) From
Operations.................. 4,683,622 (27,212,182) (26,479,661) (25,627,283)
Interest income.................... 471,213 1,264,853 1,428,845 1,141,939
Interest expense................... (413,192) (266,270) (68,868) (65,331)
Other income (expense), net........ 572,851 93,694 (37,544) (147,058)
------------ ------------ ------------ ------------
Earnings (loss) before income
taxes............................ 5,314,494 (26,119,905) (25,157,228) (24,697,733)
Taxes on earnings.................. 129,563 -- -- --
------------ ------------ ------------ ------------
Net Earnings (Loss).............. $ 5,184,931 $(26,119,905) $(25,157,228) $(24,697,733)
============ ============ ============ ============
Basic earnings (loss) per share.... $ 0.24 $ (1.21) $ (1.31) $ (1.27)
Diluted earnings (loss) per
share............................ $ 0.22 $ (1.21) $ (1.31) $ (1.27)
============ ============ ============ ============
Shares used in computing basic
earnings (loss) per share........ 22,034,651 21,655,009 19,247,253 19,382,460
Shares used in computing diluted
earnings (loss) per share........ 23,173,324 21,655,009 19,247,253 19,382,460
============ ============ ============ ============
Comprehensive Income (Loss):
Net earnings (loss).............. $ 5,184,931 $(26,119,905) $(25,157,228) $(24,697,733)
Foreign currency translation
adjustment.................... (235,487) (94,768) (53,337) 50,360
------------ ------------ ------------ ------------
Comprehensive Income (Loss)... $ 4,949,444 $(26,214,673) $(25,210,565) $(24,647,373)
============ ============ ============ ============
- ---------------
(1) The comparative period presented is unaudited because the Company changed
its fiscal year in April 2001.
See accompanying notes to consolidated financial statements.
F-5
CYBERONICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED
OTHER
COMMON STOCK ADDITIONAL COMPREHENSIVE
--------------------- PAID-IN DEFERRED INCOME ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION (LOSS) DEFICIT
---------- -------- ------------ ------------ ------------- -------------
Balance at June 30, 2000....... 18,642,753 $186,428 $117,322,388 $ -- $(168,331) $ (78,932,510)
Issuance of Common Stock in
private equity offering,
net of offering costs...... 2,518,000 25,180 42,445,152 -- -- --
Stock options exercised...... 299,534 2,995 2,774,246 -- -- --
Issuance of Common Stock
under Employee Stock
Purchase Plan.............. 13,635 136 200,511 -- -- --
Issuance of Common Stock for
services................... 100 1 2,311 -- -- --
Issuance of options for
consultant services........ -- -- 63,300 (63,300) -- --
Deferred compensation
relating to issuance of
certain stock options...... -- -- 2,362,500 (2,362,500) -- --
Amortization of deferred
compensation and expense of
certain stock options...... -- -- -- 435,950 -- --
Translation adjustment....... -- -- -- -- 50,360 --
Net Loss..................... -- -- -- -- -- (24,697,733)
---------- -------- ------------ ----------- --------- -------------
Balance at April 27, 2001...... 21,474,022 214,740 165,170,408 (1,989,850) (117,971) (103,630,243)
Stock options exercised...... 230,784 2,308 1,818,842 -- -- --
Issuance of Common Stock
under Employee Stock
Purchase Plan.............. 46,455 465 867,245 -- -- --
Offering costs related to the
issuance of Common Stock in
a private equity offering
during the previous year... -- -- (1,058) -- -- --
Amortization of deferred
compensation............... -- -- -- 493,600 -- --
Translation adjustment....... -- -- -- -- (94,768) --
Net Loss..................... -- -- -- -- -- (26,119,905)
---------- -------- ------------ ----------- --------- -------------
Balance at April 26, 2002...... 21,751,261 217,513 167,855,437 (1,496,250) (212,739) (129,750,148)
Stock options exercised........ 566,339 5,663 5,587,370 -- -- --
Issuance of Common Stock under
Employee Stock Purchase
Plan......................... 68,136 681 882,532 -- -- --
Amortization of deferred
compensation................. -- -- -- 472,500 -- --
Translation adjustment......... -- -- -- -- (235,487) --
Net Earnings................... -- -- -- -- -- 5,184,931
---------- -------- ------------ ----------- --------- -------------
Balance at April 25, 2003...... 22,385,736 $223,857 $174,325,339 $(1,023,750) $(448,226) $(124,565,217)
========== ======== ============ =========== ========= =============
See accompanying notes to consolidated financial statements.
F-6
CYBERONICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
52 WEEKS ENDED
------------------------------------------- 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27, APRIL 27,
2003 2002 2001 2001
----------- ------------ -------------- ---------------
(UNAUDITED)(1)
Cash Flows From Operating Activities:
Net earnings (loss)........................... $ 5,184,931 $(26,119,905) $(25,157,228) $(24,697,733)
Noncash items included in net earnings (loss):
Depreciation................................ 4,648,061 3,805,716 2,749,019 2,431,440
(Gain) loss on disposal of assets........... (182,028) 126,613 -- 21,847
Unrealized (gain) loss in foreign currency
transactions.............................. (566,834) (85,822) 50,727 125,385
Amortization of deferred compensation and
expense of certain stock options.......... 472,500 493,600 435,950 435,950
Changes in operating assets and liabilities:
Accounts receivable, net.................... (3,490,665) (3,698,592) 1,668,699 1,564,618
Inventories................................. (1,513,822) (269,538) 3,400,681 2,379,937
Other current assets........................ (15,364) 70,328 (326,497) 27,457
Other assets, net........................... (50,042) (23,064) 28,296 9,890
Accounts payable and accrued liabilities.... (3,211,071) 2,653,975 11,433,327 12,687,655
----------- ------------ ------------ ------------
Net Cash Provided By (Used In)
Operating Activities................. 1,275,666 (23,046,689) (5,717,026) (5,013,554)
----------- ------------ ------------ ------------
Cash Flows From Investing Activities:
Purchases of property and equipment........... (4,206,728) (5,080,684) (5,131,132) (3,641,563)
Purchases of marketable securities............ -- -- (27,695,300) (7,845,792)
Maturities of marketable securities........... -- 1,791,724 31,306,650 11,622,039
----------- ------------ ------------ ------------
Net Cash Provided By (Used In)
Investing Activities................. (4,206,728) (3,288,960) (1,519,782) 134,684
----------- ------------ ------------ ------------
Cash Flows From Financing Activities:
Proceeds from line of credit, net............. 1,870,000 6,500,000 -- --
Proceeds from issuance of Common Stock, net... 6,476,245 2,687,802 46,431,062 45,450,532
Payments on long-term debt.................... (125,535) (114,157) (134,068) (90,978)
----------- ------------ ------------ ------------
Net Cash Provided By Financing
Activities........................... 8,220,710 9,073,645 46,296,994 45,359,554
----------- ------------ ------------ ------------
Effect of exchange rate changes on cash and cash
equivalents................................... 90,695 (1,217) (85,948) 9,020
----------- ------------ ------------ ------------
Net Increase (Decrease) in Cash and
Cash Equivalents..................... 5,380,343 (17,263,221) 38,974,238 40,489,704
Cash and cash equivalents at beginning of
period........................................ 38,195,962 55,459,183 16,484,945 14,969,479
----------- ------------ ------------ ------------
Cash and cash equivalents at end of period...... $43,576,305 $ 38,195,962 $ 55,459,183 $ 55,459,183
=========== ============ ============ ============
Supplementary Disclosures of Cash Flow
Information:
Cash paid for interest.......................... $ 368,082 $ 239,770 $ 68,680 $ 30,796
Cash paid for income taxes...................... $ 78,483 $ -- $ -- $ --
Noncash purchase of assets under capital
leases........................................ $ -- $ -- $ 646,959 $ --
- ---------------
(1) The comparative period presented is unaudited because the Company changed
its fiscal year in April 2001.
See accompanying notes to consolidated financial statements.
F-7
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
APRIL 25, 2003
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RELATED DATA
Nature of Operations. Cyberonics, Inc. ("Cyberonics" or the "Company"),
designs, develops, manufactures and markets the VNS Therapy System, an
implantable medical device which delivers a unique therapy, Vagus Nerve
Stimulation, for the treatment of epilepsy and other debilitating neurological,
psychiatric diseases and other disorders. In July 1997, the VNS Therapy System
was approved by the United States Food and Drug Administration ("FDA") for
commercial distribution in the United States for the treatment of epilepsy. In
addition, the Company has received regulatory approval to market and sell the
VNS Therapy System in Canada, Europe, Australia and other markets. During fiscal
2001, Cyberonics obtained regulatory approval for commercial distribution of the
VNS Therapy System for the treatment of depression in the European market and in
Canada. Cyberonics is headquartered in Houston, Texas.
We operate our business as a single segment sharing similar economic
characteristics, technology, manufacturing processes, customers, distribution
and marketing strategies, regulatory environments and shared infrastructures. We
are a single neurostimulation business focused on sales growth, profitability,
positive cash flow and developing other indications for VNS covered by our
method patents.
In March 2001, the Company elected to change its fiscal year from June 30
to a 52/53 week year ending on the last Friday of April of each year, effective
April 27, 2001. Accordingly, fiscal 2001 started July 1, 2000 and ended April
27, 2001, fiscal 2002 started April 28, 2001 and ended April 26, 2002, fiscal
2003 started April 27, 2002 and ended April 25, 2003.
The Company's future success is dependent upon a number of factors which
include, among others, achieving market acceptance and generating sufficient
sales volume, obtaining and maintaining regulatory and reimbursement approvals
for its products, the possibility of competition and technological changes,
developing its sales, marketing and corporate infrastructures, maintaining an
uninterrupted supply of certain sole source components and materials, adding
sufficient manufacturing capacity to meet future possible product demand,
possible product liability or recall and reliance on key personnel.
Consolidation. The accompanying consolidated financial statements include
the Company and its wholly-owned subsidiary, Cyberonics Europe, S.A. All
significant intercompany accounts and transactions have been eliminated.
Use of Estimates. The preparation of the consolidated financial statements
in conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates. Critical estimates that require
management's judgment relate to the allowance for doubtful accounts, estimates
of any obsolete inventory, useful lives for property and equipment, impairment
of any long-lived assets, sales returns and allowances and product warranties.
Foreign Currency Translation. The assets and liabilities of Cyberonics
Europe, S.A. are generally translated into U.S. dollars at exchange rates in
effect on reporting dates, while capital accounts and certain obligations of a
long-term nature payable to the parent company are translated at historical
rates. Income statement items are translated at average exchange rates in effect
during the financial statement period. The gains and losses that result from
this process are shown in the accumulated other comprehensive income section of
stockholders' equity, and are not included in the determination of the results
of operations. Gains and losses resulting from foreign currency transactions
denominated in currency other than the functional currency are included in other
income and expense.
Cash Equivalents. The Company considers all highly liquid investments with
a maturity of three months or less at the time of purchase to be cash
equivalents. Cash equivalents at April 25, 2003 and April 26, 2002 were
$25,816,444 and $25,856,905, respectively.
F-8
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Fair Value of Financial Instruments. The carrying amounts reported in the
consolidated balance sheets for cash equivalents, accounts receivable, accounts
payable and line of credit approximate their fair values due to the short-term
maturity of these financial instruments.
Accounts Receivable. The Company's allowance for doubtful accounts totaled
$292,176 and $249,688 at April 25, 2003 and April 26, 2002, respectively.
Activity in the Company's allowance for doubtful accounts consists of the
following:
52 WEEKS ENDED 52 WEEKS ENDED 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27,
2003 2002 2001
-------------- -------------- ---------------
Balance at beginning of period.......... $249,688 $138,203 $162,654
Increase in allowance................... 63,155 153,515 --
Reductions in allowance................. -- -- (3,807)
Reductions for write-offs............... (20,667) (42,030) (20,644)
-------- -------- --------
Balance at end of period................ $292,176 $249,688 $138,203
======== ======== ========
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.
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. The Company computes depreciation using the straight-line method
over useful lives ranging from two to nine years. Property and equipment under
capital leases are stated at the lower of the present value of minimum lease
payments at the beginning of the lease term or fair value at the inception of
the lease. Property and equipment under capital leases are depreciated using the
straight-line method over the shorter of the lease term or the estimated useful
life of the property.
Long-Lived Assets. Statement of Financial Accounting Standards (SFAS) No.
144, "Accounting for the Impairment or Disposals of Long-Lived Assets," provides
a single accounting model for long-lived assets to be disposed of. SFAS No. 144
also changes the criteria for classifying an asset as held for sale, and
broadens the scope of business to be disposed of that qualify for reporting as
discontinued operations and changes the timing of recognizing losses on such
operations. The Company adopted SFAS No. 144 on April 27, 2002. The adoption of
SFAS No. 144 did not have an impact on the Company's consolidated financial
statements.
Stock Options. The Company has adopted the disclosure-only provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation" and SFAS No. 148,
"Accounting for Stock-Based Compensation -- Transition and Disclosure," which
disclosures are presented in Note 7, "Stock Incentive and Purchase Plans."
Because of this election, the Company continues to account for its employee
stock-based compensation plans under Accounting Principles Board (APB) Opinion
No. 25 and the related interpretations. No stock-based compensation cost is
reflected in net income for employee option grants, as most options granted
under those plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. There is only one exception
further disclosed under Note 6. Accordingly, deferred compensation is recorded
for stock-based compensation grants based on the excess of the market value of
the common stock on the measurement date over the exercise price. The deferred
compensation is amortized over the vesting period of each unit of stock-based
compensation. If the exercise price of the stock-based compensation grant is
equal to the market price of the Company's stock on the date of the grant, no
compensation expense is recorded.
The following table illustrates the effect on net income and earnings per
share if the company had applied the fair value recognition provision of SFAS
No. 123, "Accounting for Stock-Based Compensation" and
F-9
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SFAS No. 148 "Accounting for Stock-Based Compensation -- Transition and
Disclosure," to stock-based employee compensation.
52 WEEKS ENDED 52 WEEKS ENDED 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27,
2003 2002 2001
-------------- -------------- ---------------
Net earnings (loss) as reported......... $ 5,184,931 $(26,119,905) $(24,697,733)
Add: Stock-based employee compensation
expense included in reported net
income, net of related tax effects.... 472,500 472,500 393,750
Deduct: Total stock-based employee
compensation expense determined under
the fair value method for all awards,
net of related tax effects............ (18,060,760) (19,455,575) (8,903,169)
------------ ------------ ------------
Pro forma net loss.................... $(12,403,329) $(45,102,980) $(33,207,152)
============ ============ ============
Earnings (loss) per share:
Basic -- as reported.................. $ 0.24 $ (1.21) $ (1.27)
Basic -- pro forma.................... $ (0.56) $ (2.08) $ (1.71)
Diluted -- as reported................ $ 0.22 $ (1.21) $ (1.27)
Diluted -- pro forma.................. $ (0.56) $ (2.08) $ (1.71)
Revenue Recognition. Revenue from product sales is generally recognized
upon shipment to the customer, net of estimated returns and allowances.
Research and Development. All research and development costs are expensed
as incurred.
Product Warranty. The Company offers warranties in its leads and
generators for two years from the date of implant. 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.
Changes in the Company's liability for product warranties during the 52
weeks ended April 25, 2003, April 26, 2002 and the 10 months ended April 27,
2001 are as follows:
BALANCE AT THE
BEGINNING OF THE WARRANTIES WARRANTIES BALANCE AT THE END
YEAR YEAR ISSUED SETTLED OF THE YEAR
- ---- ---------------- ---------- ---------- ------------------
2003............................. $128,803 $ 45,000 $(13,222) $160,581
2002............................. 137,716 (4,393) (4,520) 128,803
2001............................. -- 143,536 (5,820) 137,716
License Agreements. The Company has executed licensing agreements under
which it has secured the rights provided under certain patents. Royalties,
payable under the terms of these agreements, are expensed as incurred.
Income Taxes. Cyberonics accounts for income taxes under the asset and
liability method. Under this method, deferred income taxes reflect the impact of
temporary differences between financial accounting and tax bases of assets and
liabilities. Such differences relate primarily to the Company's election to
defer the deduction of certain start-up costs for federal income tax purposes,
the deductibility of certain accruals and reserves and the effect of tax loss
and tax credit carryforwards not yet utilized. Deferred tax assets are evaluated
for realization based on a more-likely-than-not criteria in determining if a
valuation allowance should be provided.
F-10
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change of tax rates is recognized in income in the
period that includes the enactment date.
Net Earnings (Loss) Per Share. The Company's net earnings (loss) per share
is based on the weighted average number of common shares outstanding. Common
equivalent shares, consisting of the effect of stock options and warrants, were
excluded from the per share calculations for the 52 weeks ended April 26, 2002,
as the effect of their inclusion was anti-dilutive. Common equivalent shares,
consisting of the effect of stock options and warrants, are included in the per
share calculations for the 52 weeks ended April 25, 2003, as the effect of their
inclusion is dilutive. Securities convertible into Common Stock comprised of
stock options were 7,012,684, 7,130,369 and 4,933,251 shares at April 25, 2003,
April 26, 2002 and April 27, 2001, respectively.
SFAS No. 128, "Earnings Per Share" requires dual presentation of earnings
per share (EPS): basic EPS and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income or loss applicable to common shareholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if 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.
The following table sets forth the computation and basic and diluted net
earnings (loss) per share of common stock:
52 WEEKS ENDED 52 WEEKS ENDED 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27,
2003 2002 2001
-------------- -------------- ---------------
Numerator:
Net earnings (loss)..................... $ 5,184,931 $(26,119,905) $(24,697,733)
Denominator:
Basic weighted average shares
outstanding........................... 22,034,651 21,655,009 19,382,460
Effect of dilutive stock options........ 1,138,673 -- --
----------- ------------ ------------
Diluted weighted average shares
outstanding........................... 23,173,324 21,655,009 19,382,460
----------- ------------ ------------
Basic earnings (loss) per share......... $ 0.24 $ (1.21) $ (1.27)
Diluted earnings (loss) per share....... $ 0.22 $ (1.21) $ (1.27)
=========== ============ ============
Excluded from the computation of diluted earnings per share for the
52-weeks ended April 25, 2003 were outstanding options to purchase 1,677,375
common shares, because to include them would have been antidilutive, meaning the
exercise price of these options exceeds their current fair market value. The
Company incurred net losses for the 52 weeks ended April 26, 2002 and 10 months
ended April 27, 2001, and has not included the 7,130,369 and 4,933,251 options,
respectively, to purchase common shares outstanding at April 26, 2002 and April
27, 2001 in the computation of diluted earnings per share because to do so would
have been antidilutive.
Comprehensive Income (Loss). Comprehensive income is the total of net
income and all other non-owner changes in equity. A reconciliation of reported
net loss to comprehensive income (loss) is included in the consolidated
statements of operations and comprehensive income (loss).
Reclassifications. Certain reclassifications have been made to prior
period financial statements to conform with the April 25, 2003 presentation with
no effect on net loss previously reported.
F-11
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2. INVENTORIES
Inventories consist of the following:
APRIL 25, APRIL 26,
2003 2002
---------- ----------
Raw materials............................................... $3,157,622 $1,815,290
Work-in-process............................................. 1,582,761 1,543,095
Finished goods.............................................. 1,305,723 1,169,993
---------- ----------
$6,046,106 $4,528,378
========== ==========
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
APRIL 25, APRIL 26,
2003 2002
------------ -----------
Computer equipment........................................ $ 5,999,625 $ 4,568,869
Manufacturing equipment................................... 5,368,882 4,450,990
Offsite programming equipment............................. 3,211,684 2,535,276
Leasehold improvements.................................... 2,515,639 1,901,591
Furniture and fixtures.................................... 2,357,582 2,194,905
Construction in progress.................................. 1,104,297 770,168
Office equipment.......................................... 913,164 792,742
------------ -----------
21,470,873 17,214,541
Accumulated depreciation.................................. (11,880,633) (7,414,712)
------------ -----------
$ 9,590,240 $ 9,799,829
============ ===========
NOTE 4. LINE OF CREDIT
In September 2001, the Company established a revolving credit facility for
$10,000,000 which is collateralized by accounts receivable, inventory,
equipment, documents of title, general intangibles, subsidiary stock and other
collateral. Effective April 1, 2003, this limit was increased to $25,000,000.
Borrowings against the facility are based upon eligible accounts receivable.
Interest is payable at the designated bank rate of 4.25% at April 25, 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 amended 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 $10,000,000. 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. At April 25, 2003, the Company had
$8,370,000 in borrowings outstanding under the credit facility and an available
borrowing capacity of approximately $655,000.
F-12
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
APRIL 25, APRIL 26,
2003 2002
----------- -----------
Payroll and other compensation............................. $ 4,565,474 $ 6,301,804
Clinical costs............................................. 3,471,258 5,927,907
Royalties.................................................. 1,267,537 797,411
Business insurance......................................... 662,037 325,267
Other...................................................... 2,412,392 1,824,375
----------- -----------
$12,378,698 $15,176,764
=========== ===========
NOTE 6. STOCKHOLDERS' EQUITY
Preferred Stock. The Company has 2,500,000 shares of undesignated
Preferred Stock authorized and available for future issuance, of which none have
been issued through April 25, 2003. With respect to the shares authorized, the
Company's Board of Directors, at its sole discretion, may determine, fix and
alter dividend rights, dividend rates, conversion rights, voting rights, terms
of redemption, redemption prices, liquidation preferences and the number of
shares constituting any such series and may determine the designation, terms and
conditions of the issuance of any such shares.
Common Stock. Stock option exercises increased the number of common shares
by 566,339 and 230,784 for the years ended April 25, 2003 and April 26, 2002,
respectively. Issuances of common stock under the Company's Employee Stock
Purchase Plan increased the number of common shares by 68,136 and 46,455 for the
years ended April 25, 2003 and April 26, 2002, respectively.
In February 2001, the Company issued 2,518,000 shares of its common stock
in a private offering for $18.00 per share. Proceeds from the issuance totaled
approximately $42.5 million after deducting commission and offering costs.
In November 2000, the Company issued 100 shares of its Common Stock to an
individual. The transaction was recorded at the fair market value on the day of
the issuance, or $23.12 per share.
Deferred Compensation. In June 2000, the Board of Directors granted
450,000 options at $18.00 per share to purchase shares of common stock under a
proposed modification to the 1997 Stock Option Plan that was subject to
shareholder approval. On December 29, 2000, the shareholders approved the
modifications to the plan and the Company recorded approximately $2.4 million in
deferred compensation relating to the options. The charge reflects the
difference between the exercise price and the fair market value of the stock on
the date shareholder approval was received. The deferred compensation is being
amortized to expense over the five-year vesting period of the options.
Approximately $473,000 of compensation expense was recognized in fiscal 2003 and
2002, for the vested portion of the grant.
Preferred Share Purchase Rights. In January 1997, the Company's Board of
Directors declared a dividend of one Preferred Share Purchase Right ("Right") on
each outstanding share of the Company's Common Stock to stockholders of record
on March 10, 1997. The Company amended and restated the Preferred Share Rights
("Plan") on August 21, 2000. The Rights will become exercisable following the
tenth day after a person or group of affiliate persons (an "Acquiring Person"),
acquires beneficial ownership of 15 percent or more of the Company's Common
Stock or announces commencement of a tender offer, the consummation of which
would result in such person or group of persons becoming an Acquiring Person (a
"Triggering Event"). Each Right entitles the holder thereof to buy 1/1000 of a
share of the Company's Series A Participating Preferred Stock at an exercise
price of $150 (the "Exercise Price"). The Company will
F-13
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
be entitled to redeem the Rights at $.01 per Right at any time prior to a
Triggering Event. If, prior to redemption of the Rights, a person becomes an
Acquiring Person, each Right (except for Rights owned by the Acquiring Person,
which will thereafter be void) will entitle the holder thereof to purchase, at
the Right's then current exchange price, that number of shares of Common Stock
of the Company (or, in certain circumstances as determined by the Board, cash,
other property or other securities) having a market value at that time of twice
the Right's exercise price. In the event a person becomes an Acquiring Person
and the Company sells more than 50% of its assets or earning power or is
acquired in a merger or other business combination, proper provision must be
made so that a holder of a Right which has not theretofore been exercised
(except for Rights owned by the Acquiring Person, which will thereafter be
void), will thereafter have the right to receive, upon exercise of a Right,
shares of common stock of the acquiring company having a value equal to two
times the then current Exercise Price. At any time after a Triggering Event and
prior to acquisition by such Acquiring Person of 50% or more of the outstanding
Common Stock, the Board of Directors of the Company may exchange the Rights
(other than Rights owned by the Acquiring Person or its affiliates) for the
Common Stock of the Company at an exchange ratio of one share of common stock
per Right. In April 2001, the Company amended the Plan to designate the State of
Wisconsin Investment Board (SWIB) as an Exempt Person under the terms of the
Plan as long as SWIB is the Beneficial Owner of less than 20%.
NOTE 7. STOCK INCENTIVE AND PURCHASE PLANS
Stock Options. Cyberonics has reserved an aggregate of 13,350,000 shares
of its Common Stock through April 25, 2003, for issuance pursuant to its Amended
1988 Incentive Stock Option Plan, its 1996 Stock Option Plan, its 1997 Stock
Option Plan and its 1998 Stock Option Plan (the "Stock Option Plans"). Options
granted under the Stock Option Plans generally vest ratably over four or five
years following their date of grant. The vesting of certain options occurs up to
10 years from the grant date but can accelerate based upon the achievement of
specific milestones related to regulatory approvals and the achievement of
Company sales objectives. Options granted under the Stock Option Plans have
maximum terms of 10 years. The Amended 1988 Incentive Stock Option Plan and the
1997 Stock Option Plan allow issuance of either nonstatutory or incentive stock
options, while the 1996 Stock Option Plan provides for issuance of nonstatutory
stock options exclusively.
F-14
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of the Company's stock option activity for the
52 weeks ended April 25, 2003, April 26, 2002 and for the 10 months ended April
27, 2001.
OUTSTANDING EXERCISABLE
-------------------- --------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE EXERCISE
RESERVED SHARES PRICE SHARES PRICE
---------- --------- -------- --------- --------
Balance at June 30, 2000............ 1,316,816 4,128,110 $11.00 1,644,327 $ 8.03
Shares reserved..................... 1,000,000 -- -- -- --
Granted............................. (1,748,000) 1,748,000 17.29 -- --
Options becoming exercisable........ -- -- -- 643,189 --
Exercised........................... -- (299,534) 9.27 (299,534) --
Canceled or forfeited............... 643,325 (643,325) 14.07 -- --
---------- --------- ---------
Balance at April 27, 2001........... 1,212,141 4,933,251 12.93 1,987,982 9.76
Shares reserved..................... 2,200,000 -- -- -- --
Granted............................. (2,930,989) 2,930,989 14.64 -- --
Options becoming exercisable........ -- -- -- 982,186 --
Exercised........................... -- (230,784) 7.89 (230,784) --
Canceled or forfeited............... 503,087 (503,087) 15.76 -- --
---------- --------- ---------
Balance at April 26, 2002........... 984,239 7,130,369 13.60 2,739,384 11.57
Shares reserved..................... 2,000,000 -- -- -- --
Granted............................. (1,303,275) 1,303,275 15.10 -- --
Options becoming exercisable........ -- -- -- 1,190,798 --
Exercised........................... -- (566,339) 9.96 (566,339) --
Canceled or forfeited............... 854,621 (854,621) 15.29 -- --
---------- --------- ---------
Balance at April 25, 2003........... 2,535,585 7,012,684 $13.97 3,363,843 $12.76
========== ========= =========
For certain options granted, the Company recognizes as compensation or
other expense the excess of the deemed value for accounting purposes of the
Common Stock on the date the options were granted over the aggregate exercise
price of such options. Compensation expense is amortized ratably over the
vesting period of each option. The Company recognized compensation or other
expense totaling $473,000 during the 52 weeks ended April 25, 2003, $494,000
during the 52 weeks ended April 26, 2002, $436,000 during the 10 months ended
April 27, 2001.
The fair values of each option grant and purchase plan discounts are
estimated using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants: risk-free interest rates of 3.4%,
4.5% and 4.5% for fiscal periods 2003, 2002 and 2001, respectively, expected
life of 5.7 years for options and restricted stock in fiscal year 2003 and five
years for options and restricted stock in fiscal years 2002 and 2001,
respectively, expected life of six months for purchase plan shares, expected
volatility of 90.2%, 210% and 253% for fiscal years 2003, 2002 and 2001,
respectively, and no expected dividend yields.
The weighted average fair value of options granted at prices equal to the
Company's market value in fiscal periods 2003, 2002, and 2001 was $10.08, $14.64
and $16.94, respectively.
F-15
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Had the compensation cost for these plans been determined pursuant to the
alternative method under SFAS No. 123 and SFAS No. 148, the Company's net loss
and loss per share would have been increased to the following pro forma amounts:
52 WEEKS ENDED 52 WEEKS ENDED 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27,
2003 2002 2001
-------------- -------------- ---------------
Net earnings (loss) as reported......... $ 5,184,931 $(26,119,905) $(24,697,733)
Add: Stock-based employee compensation
expense included in reported net
income, net of related tax effects.... 472,500 472,500 393,750
Deduct: Total stock-based employee
compensation expense determined under
the fair based value method for all
awards, net of tax-related effects.... (18,060,760) (19,455,575) (8,903,169)
------------ ------------ ------------
Pro forma net loss.................... $(12,403,329) $(45,102,980) $(33,207,152)
============ ============ ============
Earnings (loss) per share --
Basic -- as reported.................. $ 0.24 $ (1.21) $ (1.27)
Basic -- pro forma.................... (0.56) (2.08) (1.71)
Diluted -- as reported................ $ 0.22 $ (1.21) $ (1.27)
Diluted -- pro forma.................. (0.56) (2.08) (1.71)
Because the SFAS No. 123 and 148 method of accounting has not been applied
to options granted prior to July 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
Additionally, the pro forma amounts include $155,861, $101,037 and $35,419
related to the purchase discount offered under the Company's Employee Stock
Purchase Plan during fiscal 2003, 2002 and 2001, respectively. The weighted
average fair values of shares granted to employees were $15.25, $14.50 and
$17.32 during fiscal 2003, 2002 and 2001, respectively.
The Company's outstanding options are segregated into the following five
categories in accordance with SFAS No. 123:
OPTIONS OUTSTANDING AND EXERCISABLE BY PRICE RANGE
AS OF APRIL 25, 2003
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------- ------------------------------------
OUTSTANDING AS OF WEIGHTED-AVERAGE WEIGHTED- EXERCISABLE AS OF
RANGE OF APRIL 25, REMAINING AVERAGE APRIL 25, WEIGHTED-AVERAGE
EXERCISE PRICES 2003 CONTRACTUAL LIFE EXERCISE PRICE 2003 EXERCISE PRICE
- --------------- ----------------- ---------------- -------------- ----------------- ----------------
$2.9900-$5.9750........ 630,218 3.7 $ 3.83 602,721 $ 3.81
$5.9751-$11.9500....... 877,072 6.7 $ 9.22 499,168 $ 8.90
$11.9501-$17.9250...... 4,142,454 7.9 $14.53 1,659,850 $14.55
$17.9251-$23.9000...... 1,262,582 7.7 $19.51 557,326 $19.42
$23.9001-$29.8750...... 100,358 7.7 $27.03 44,778 $27.72
--------- ---------
7,012,684 7.3 $13.97 3,363,843 $12.76
========= =========
During fiscal 2002 and 2001, the Board of Directors approved grants outside
of the existing stock option plans. The grants, which totaled 300,000 and
100,000 options, respectively, were approved for new officers as inducements
essential to their entering into employment with the Company. No such grants
were approved for 2003.
F-16
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock Purchase Plan. Under the Cyberonics, Inc. Employee Stock Purchase
Plan (the Stock Purchase Plan), 950,000 shares of the Company's Common Stock
have been reserved for issuance. Subject to certain limits, the Stock Purchase
Plan allows eligible employees to purchase shares of the Company's Common Stock
through payroll deductions of up to 15 percent of their respective current
compensation at a price equaling the lesser of 85 percent of the fair market
value of the Company's Common Stock on (a) the first business day of the
purchase period or (b) the last business day of the purchase period. Purchase
periods, under provisions of the Stock Purchase Plan, are six months in length
and begin on the first business days of June and December. At April 25, 2003,
657,639 shares remain available for future issuances under the Stock Purchase
Plan.
Stock Recognition Program. In May 1992, the Company's Board of Directors
established the Cyberonics Employee Stock Recognition Program. Since its
inception, a total of 8,600 shares of the Company's Common Stock has been
reserved for issuance as special recognition grants. The shares are granted to
employees for special performances and/or contributions at the discretion of the
Company's President, based on nominations made by fellow employees. At April 25,
2003, 4,030 shares remain available for future issuances under the program.
NOTE 8. NEW ACCOUNTING PRONOUNCEMENTS
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 consolidated operating results or financial
condition.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. The
adoption of SFAS No. 146 did not have a material impact on the Company's
consolidated operating results or financial condition.
In December 2002, the FASB 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
F-17
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This statement is an interpretation of FASB Statements
No. 5, 57 and 107 and rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. This Interpretation does not
prescribe a specific approach for subsequently measuring the guarantor's
recognized liability over the term of the related guarantee. This Interpretation
also incorporates, without change, the guidance in FASB Interpretation No. 34,
"Disclosure of Indirect Guarantees of Indebtedness of Others," which is being
superseded. The initial recognition and initial measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, irrespective of the guarantor's fiscal
year-end. The disclosure requirements in this Interpretation are effective for
financial statements of interim or annual periods ending after December 15,
2002. The adoption of FIN No. 45 did not have a material impact on the Company's
consolidated operating results or financial condition.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." This Interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," addresses consolidation by business
enterprises of variable interest entities. This Interpretation applies
immediately to variable interest entities created after January 31, 2003 and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The interpretation applies to
public enterprises as of the beginning of the applicable interim or annual
period and it applies to nonpublic enterprises as of the end of the applicable
annual period. The adoption of FIN No. 46 will not have a material impact on the
Company's consolidated operating results or financial condition.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments With Characteristics of Both Liabilities and Equity." This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. This statement is effective for the first fiscal period beginning after
December 15, 2003. The Company believes that the adoption of SFAS No. 150 will
not have a material impact on the Company's consolidated operating results or
financial condition.
F-18
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9. INCOME TAXES
The U.S. and foreign components of income before income taxes and the
provision for income taxes are presented in this table:
52 WEEKS ENDED 52 WEEKS ENDED 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27,
2003 2002 2001
-------------- -------------- ---------------
Income (loss) before income taxes:
Domestic.............................. $5,964,872 $(22,545,496) $(23,629,170)
Foreign............................... (650,378) (3,574,409) (1,068,563)
---------- ------------ ------------
$5,314,494 $(26,119,905) $(24,697,733)
========== ============ ============
Provision for current income taxes:
Federal............................... $ 40,505 $ -- $ --
State and local....................... 89,058 -- --
---------- ------------ ------------
$ 129,563 $ -- $ --
========== ============ ============
The following is a reconciliation of the statutory federal income tax rate
to the Company's effective income tax rate expressed as a percentage of earnings
(loss) from operations before income taxes:
52 WEEKS ENDED 52 WEEKS ENDED 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27,
2003 2002 2001
-------------- -------------- ---------------
U.S. statutory rate..................... 34.0% (34.0)% (34.0)%
Change in deferred tax valuation
allowance............................. (29.5) 37.6 37.4
State and local tax provision........... 1.7 -- --
Other, net.............................. (3.7) (3.6) (3.4)
----- ----- -----
2.5% 0.0% 0.0%
===== ===== =====
F-19
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
are as follows:
APRIL 25, APRIL 26,
2003 2002
-------------- --------------
Deferred tax assets:
Federal net operating loss carryforwards............. $ 38,167,193 $ 40,212,185
Foreign net operating loss carryforwards............. 5,673,450 5,452,321
Federal tax credit carryforwards..................... 5,165,662 4,643,666
State net operating loss carryforwards and other..... 1,863,164 --
Reserves............................................. 460,357 285,275
Inventory costs capitalized.......................... 412,975 273,768
Accrued expenses..................................... 285,447 368,509
Property and equipment............................... 294,402 132,771
Other, net........................................... 132,772 92,211
------------ ------------
Total deferred tax assets......................... 52,455,422 51,460,706
Total deferred tax liabilities, net.................... -- (42,643)
Deferred tax valuation allowance....................... (52,455,422) (51,418,063)
------------ ------------
Net deferred tax assets and liabilities........... $ -- $ --
============ ============
At April 25, 2003, the Company has net operating loss carryforwards of
approximately $112.3 million for federal income tax purposes, which expire
during the years 2003 through 2022, and tax credit carryforwards of
approximately $5.2 million for federal income tax purposes, which expire during
the years 2006 through 2022. At April 25, 2003, the Company has net operating
loss carryforwards of approximately $34.1 million for state and local income tax
purposes, which expire at various dates beginning in 2004. Internal Revenue
Code, Section 382, contains provisions regarding cumulative ownership changes
that may subject utilization of federal net operating loss and credit
carryforwards to annual limitations. The Company is subject to examination by
the Internal Revenue Service as well as state and local tax authorities.
A valuation allowance is established if it is more likely than not that all
or a portion of the deferred tax assets will not be realized. The Company has
historically experienced significant operating losses and operates in an
industry subject to rapid technological changes. The Company believes there is
sufficient uncertainty regarding future taxable income and realizability of
deferred tax assets such that a valuation allowance is required to fully offset
deferred tax assets for year ended April 25, 2003. The Company continually
reviews the adequacy and necessity of the valuation allowance in accordance with
the provision of SFAS No. 109. Of the total valuation allowance for year ended
April 25, 2003, approximately $6.5 million relates to stock option compensation
deductions. The tax benefit associated with stock option compensation deductions
will be credited to equity when realized. The valuation allowance increased
approximately $1.0 million for year ended April 25, 2003 compared to year ended
April 26, 2002 due primarily to increases in state net operating losses and
federal tax credit carryforwards offset by a utilization of net operating loss
carryforwards for tax year 2003.
NOTE 10. EMPLOYEE RETIREMENT SAVINGS PLAN
Cyberonics sponsors an employee retirement savings plan (the Plan) which
qualifies under Section 401(k) of the Internal Revenue Code. The Plan is
designed to provide eligible employees with an opportunity to make regular
contributions into a long-term investment and savings program. Substantially all
U.S. employees are eligible to participate in the Plan beginning with the first
quarterly open enrollment date following start of employment. Employer
contributions are made solely at the Company's discretion. No
F-20
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
employer contributions were made to the Plan for the 52 weeks ended April 25,
2003, April 26, 2002 and the 10 months ended April 27, 2001.
NOTE 11. COMMITMENTS
Postmarket Clinical Surveillance. Pursuant to the post-market surveillance
conditions specified as part of the Company's FDA marketing approval, the
Company is required to conduct clinical follow-up on a limited number of
patients from its most recent study in order to monitor the safety and
tolerability of the VNS Therapy System on an extended basis. The Company
expenses the costs related to these long-term follow-up activities as they are
incurred and establishes accruals for such costs incurred but not paid as of the
respective balance sheet dates.
License Agreements. The Company has executed a license agreement which
provides Cyberonics with worldwide exclusive rights under three U.S. patents
(and their international counterparts) covering the method and devices of the
VNS Therapy System for vagus nerve and other cranial nerve stimulation for the
control of epilepsy and other movement disorders. The license agreement provides
that the Company will pay a royalty equal to the greater of $36,000 per year or
at the rate of three percent of net sales during fiscal 2004 and through the
remaining term of the licensed patents. These patents expire between 2011 and
2016. The license agreement runs for successive three-year terms, renewable at
the Company's election. The license agreement, and its periods of extension, may
not be terminated by the licensor without cause. The Company's royalty payments
pursuant to this agreement are expensed as incurred.
The Company has executed a license agreement for a specific application of
lead designs to be used in vagus nerve stimulation for the control of epilepsy
and other movement disorders. The licensor retains all rights to this patent for
applications outside the above specified use. Pursuant to the license agreement,
the Company has a limited-term option to expand the licensed field of use for
additional indications for a license fee of $15,000 per indication and has made
partial payments for certain such indications. In addition, the Company is
obligated to pay the licensor an earned royalty equal to the greater of $35,000
per year or at the rate of one percent of the Company's net sales price of
implantable systems incorporating the licensor's standard lead and 1.75 percent
of net sales incorporating the licensor's bi-directional lead for the life of
the licensed patents. Amounts due under this agreement are expensed as incurred.
This license agreement expires in June 25, 2004 and no royalties will be due for
this agreement subsequent to its expiration date. Royalty expenses for the 52
weeks ended April 25, 2003, the 52 weeks ended April 26, 2002 and the 10 months
ended April 27, 2001 were $4,099,000, $2,776,000 and $1,785,000, respectively.
Lease Agreements. The Company leases offices, manufacturing and sales
distribution facilities as well as transportation and office equipment under
operating leases. Future minimum payments relating to these agreements at April
25, 2003 are as follows:
52/53 WEEKS ENDING ON THE LAST FRIDAY OF APRIL
2004........................................................ $2,104,689
2005........................................................ 2,365,927
2006........................................................ 2,316,036
2007........................................................ 2,336,338
2008........................................................ 2,365,168
Thereafter.................................................. 4,071,337
The Company leases certain manufacturing equipment under long-term capital
leases with a 6.56% interest rate that matures in April 2005. Capitalized costs
of $646,959 are included in manufacturing equipment at April 25, 2003 and April
26, 2002. Accumulated depreciation amounted to $355,827 and $226,436 at April
25, 2003 and April 26, 2002, respectively.
F-21
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a schedule of future minimum lease payments under
long-term capital leases together with the present value of the net minimum
lease payments as of April 25, 2003:
52/53 WEEKS ENDING ON THE LAST FRIDAY OF APRIL
2004........................................................ $146,129
2005........................................................ 146,129
--------
Total minimum lease payments.............................. 292,258
Less: amount representing interest.......................... 19,059
--------
Present value of future minimum lease payments.............. 273,199
Less: amount due within one year............................ 132,133
--------
$141,066
========
The Company's rental expense for the 52 weeks ended April 25, 2003, the 52
weeks ended April 26, 2002 and the 10 months ended April 27, 2001, amounted to
$1,720,425, $1,706,089 and $1,374,230, respectively.
Other Commitments. At April 25, 2003, Cyberonics had approximately
$898,190 in noncancelable commitments related to domestic marketing programs
planned for the Company's VNS Therapy System during fiscal year 2004, 2005 and
2006, of which approximately $807,927 is scheduled to occur in the first quarter
of fiscal year 2004.
Litigation. The Company is involved in legal actions arising in the
ordinary course of business. Management does not believe the outcome of such
legal actions will have a material adverse effect on the Company's consolidated
financial position or results of operations.
NOTE 12. CONCENTRATIONS
The Company's cash equivalents and trade accounts receivable represent
potential concentrations of credit risk.
The Company minimizes potential concentrations of credit risk in cash
equivalents and marketable securities by placing investments in high quality
financial instruments and, as required by its corporate investment policy,
limiting the amount of investment in any one issuing party. At April 25, 2003,
management believes that the Company has no significant concentrations of credit
risk related to these assets and has incurred no material impairments in the
carrying values of its cash equivalents and securities held to maturity.
Concentrations of credit risk with respect to trade accounts receivable are
limited due to the large number of customers and their dispersion across a
number of geographic areas. However, essentially all trade receivables are
concentrated in the hospital and health care sectors in the U.S. and several
other countries and, accordingly, are exposed to their respective business,
economic and country-specific variables. Although the Company does not currently
foresee a concentrated credit risk associated with these receivables, repayment
is dependent upon the financial stability of these industry sectors and the
respective countries' national economics and health care systems.
We rely upon sole source suppliers for certain of the key components,
materials and contract services used in manufacturing the 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,
F-22
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
materials and contract services could result in product supply and manufacturing
interruptions, which could significantly harm our business.
We rely upon favorable reimbursement, coverage and coding for VNS Therapy.
Essentially all patients implanted with VNS therapy are covered by private
payers, Medicare and Medicaid. VNS Therapy has specifically approved codes for
physicians, surgeons and hospitals. Since reimbursement policies and payment
methodologies change on a regular basis, vigilant and ongoing work is necessary
to ensure continued access and acceptable reimbursement for patients, physicians
and hospitals. Any changes in reimbursement policies or payment methodologies
could result in reduced reimbursement, which could significantly harm our
business.
NOTE 13. GEOGRAPHIC INFORMATION
Geographic Information:
NET SALES
------------------------------------------------------------------
52 WEEKS ENDED 52 WEEKS ENDED 52 WEEKS ENDED 10 MONTHS ENDED
APRIL 25, APRIL 26, APRIL 27, APRIL 27,
2003 2002 2001 2001
-------------- -------------- -------------- ---------------
(UNAUDITED)(1)
United States............ $ 95,761,687 $63,848,921 $47,713,226 $38,972,088
International............ 8,705,311 6,262,372 5,854,768 4,446,648
------------ ----------- ----------- -----------
Total.................. $104,466,998 $70,111,293 $53,567,994 $43,418,736
============ =========== =========== ===========
LONG-LIVED ASSETS
-----------------------
APRIL 25, APRIL 26,
2003 2002
---------- ----------
United States............................................... $9,493,423 $9,706,324
International............................................... 329,349 264,706
---------- ----------
Total..................................................... $9,822,772 $9,971,030
========== ==========
- ---------------
(1) The comparative period presented is unaudited because the Company changed
its fiscal year in April 2001.
NOTE 14. NON-RECURRING CHARGES
Non-recurring charges were $6.5 million for the 10 months ended April 27,
2001. On September 11, 2000, Medtronic, Inc. (Medtronic) publicly announced a
proposal to acquire the Company for $26.00 per share in value of Medtronic
common stock. The Company's Board of Directors, with the assistance of Morgan
Stanley Dean Witter, the Company's financial advisor, elected to remain
independent to pursue its patent protected business opportunities. On September
28, 2000, Medtronic announced that it had withdrawn its offer. The Company
incurred non-recurring charges of $6.5 million which includes investment banking
fees to Morgan Stanley Dean Witter of $6.0 million. The Company also incurred
legal, accounting and consulting fees of approximately $350,000 and other
related costs of $117,000.
NOTE 15. QUARTERLY FINANCIAL INFORMATION -- UNAUDITED
The following table sets forth certain unaudited condensed quarterly
financial data for the 52 weeks ended April 25, 2003 and April 26, 2002. This
information has been prepared on the same basis as the consolidated financial
statements and all necessary adjustments have been included in the amounts below
to present fairly
F-23
CYBERONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the selected quarterly information when read in conjunction with the
consolidated financial statements and notes thereto. Historical quarterly
financial results and trends may not be indicative of future results.
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTALS(1)
----------- ----------- ----------- ----------- ------------
52 WEEKS ENDED APRIL
25, 2003
Net Sales......... $23,055,593 $26,072,385 $27,561,545 $27,777,475 $104,466,998
Gross Profit...... 19,105,556 22,254,849 23,387,375 23,652,989 88,400,769
Net earnings
(loss).......... (3,674,807) 1,004,106 3,821,669 4,033,963 5,184,931
Diluted earnings
(loss) per
share........... (0.17) 0.04 0.16 0.17 0.22
52 WEEKS ENDED APRIL
26, 2002
Net Sales......... $14,614,924 $16,882,244 $18,388,711 $20,225,414 $ 70,111,293
Gross Profit...... 11,506,465 13,429,977 14,712,534 16,845,943 56,494,919
Net loss.......... (6,636,750) (6,829,747) (5,775,231) (6,878,177) (26,119,905)
Diluted loss per
share........... (0.31) (0.32) (0.27) (0.32) (1.21)
- ---------------
(1) Earnings or loss per share (EPS) in each quarter is computed using the
weighted-average number of shares outstanding during that quarter while EPS
for the full period is computed using the weighted-average number of shares
outstanding during the year. Thus, the sum for the four quarters' EPS does
not equal the full period EPS.
F-24
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1(1) -- Amended and Restated Certificate of Incorporation of
Registrant.
3.2(2) -- Bylaws of Registrant.
3.3(3) -- Amendment No. 1 to the Bylaws of Registrant.
4.1(2) -- Second Amended and Restated Preferred Shares Rights
Agreement, dated as of August 21, 2000 between Cyberonics,
Inc. and First National Bank of Boston, -- including the
Certificate of Designation, the Form of
Rights -- Certificate and the Summary of Rights attached
thereto as -- Exhibit A, B and C, respectively.
4.2(4) -- Amendment No. 1 to Second Amended and Restated Preferred
Share Rights Agreement, dated April 26, 2001.
10.1(5) -- Amended 1991 Employee Stock Purchase Plan.
10.2(6) -- License Agreement dated March 15, 1988 between the
Registrant and Dr. Jacob Zabara.
10.3(6) -- Patent License Agreement effective as of July 28, 1989
between the Registrant and Huntington Medical Research
Institute.
10.4(7) -- Lease Agreement dated November 3, 1994 together with
amendments dated April 18, 1996 and April 30, 1997,
respectively, between the Registrant and Salitex II, Ltd.
10.5(6) -- Form of Indemnification Agreement.
10.6(6) -- Amended and Restated Stockholders' Agreement dated October
16, 1992.
10.7(8) -- Registration Rights Agreement dated March 28, 1997.
10.8(9) -- Amended and Restated 1996 Stock Option Plan.
10.9(7) -- Stockholders' Agreement dated April 8, 1996 between the
Registrant and St. Jude Medical, Inc.
10.10(7) -- Letter Agreement dated March 28, 1997 between the Clark
Estates and the Registrant.
10.11(10) -- Lease Agreement dated August 19, 1997 between the Registrant
and Space Assets II, Inc.
10.12(11) -- Amended and Restated 1997 Stock Plan.
10.13(12) -- 1998 Stock Option Plan.
10.14* -- Employment Agreement effective as of June 1, 2003 between
Cyberonics, Inc. and Robert P. Cummins.
10.15* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Pamela B. Westbrook.
10.16* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Shawn P. Lunney.
10.17* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Alan D. Totah.
10.18* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Michael A. Cheney.
10.19* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and Richard L. Rudolph.
10.20* -- Employment Agreement effective as of June 2, 2003 between
Cyberonics, Inc. and William Steven Jennings.
10.21* -- Severance Agreement between Cyberonics, Inc. and William
Steven Jennings.
10.22(13) -- Severance Agreement between Cyberonics, Inc. and Shawn P.
Lunney.
10.23(13) -- Severance Agreement between Cyberonics, Inc. and Alan D.
Totah.
10.24(13) -- Severance Agreement between Cyberonics, Inc. and Pamela B.
Westbrook.
10.25(14) -- Severance Agreement between Cyberonics, Inc. and Michael A.
Cheney.
10.26(14) -- Severance Agreement between Cyberonics, Inc. and Richard L.
Rudolph, M.D.
10.27(6) -- 1988 Incentive Stock Plan.
10.28(13) -- First Amendment to the 1988 Incentive Stock Plan.
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
16.1(16) -- Letter dated April 16, 2002, from Arthur Andersen LLP to the
Securities and Exchange Commission.
21.1(7) -- List of Subsidiaries of the Registrant.
23.1* -- Consent of Independent Auditors.
24.1 -- Powers of Attorney (included on the Signature Page to this
Form 10-K).
99.1* -- Certification of the Chief Executive Officer and Chief
Financial Officer of Cyberonics, Inc. pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
- ---------------
* Filed herewith.
(1) Incorporated by reference to Registrant's Registration Statement on Form
S-3 (Reg. No. 333-56022) filed on February 21, 2001.
(2) Incorporated by reference to Registrant's Report on Form 8-K filed on
September 12, 2000.
(3) Incorporated by reference to Registrant's Report on Form 8-K filed on March
30, 2001.
(4) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the 10 months ended April 27, 2001.
(5) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Reg. No. 333-66689) filed on November 3, 1998.
(6) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Reg. No. 33-45118) declared effective February 10, 1993.
(7) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended June 30, 1997.
(8) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1997.
(9) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (Reg. No. 333-19785) filed on April 29, 1999.
(10) Incorporated by reference to the Registrant's Annual Report on Form 10-K/A
for the year ended June 30, 1997.
(11) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (Reg. No. 333-56694) filed on March 8, 2001.
(12) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Reg. No. 333-66691) filed on November 3, 1998.
(13) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
quarter ended July 27, 2001.
(14) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended January 25, 2002.
(15) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2000.
(16) Incorporated by reference to Registrant's Report on Form 8-K filed April
17, 2002.