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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________
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 year ended: June 30, 1998
or
/ / Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 0-19806
___________
CYBERONICS, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 76-0236465
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
16511 SPACE CENTER BLVD., #600, HOUSTON, TEXAS 77058-2072
(address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (281) 228-7200
___________
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)
___________
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. / /
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 / /
The aggregate market value of voting stock held by non-affiliates of the
registrant as of August 31, 1998, was, based upon the last sales price reported
for such date on the Nasdaq National Market, approximately $77.4 million. For
purposes of this disclosure, shares of Common Stock held by persons who hold
more than 5% of the outstanding shares of Common Stock and shares held by
officers and directors of the registrant, have been excluded in that such
persons may be deemed to be affiliates. This determination is not necessarily
conclusive.
At August 31, 1998, registrant had outstanding 17,278,407 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
No documents are incorporated by reference herein.
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TABLE OF CONTENTS
PAGE
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PART I....................................................................... 1
ITEM 1. BUSINESS......................................................... 1
ITEM 2. PROPERTIES....................................................... 15
ITEM 3. LEGAL PROCEEDINGS................................................ 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 15
PART II...................................................................... 16
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.......................................................... 16
ITEM 6. SELECTED FINANCIAL DATA.......................................... 17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................ 17
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................... 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE......................................... 28
PART III..................................................................... 29
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............... 29
ITEM 11. EXECUTIVE COMPENSATION........................................... 32
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT... 34
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................... 35
PART IV...................................................................... 36
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.. 36
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 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 THE
COMPANY'S RESULTS, PLEASE REFER TO THE BUSINESS SECTION BELOW, THE FINANCIAL
STATEMENT LINE ITEM DISCUSSIONS AND THE FACTORS AFFECTING FUTURE OPERATING
RESULTS SET FORTH IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
THE COMPANY
Cyberonics manufactures and markets the NCP System, an implantable medical
device for the treatment of epilepsy. On July 16, 1997, the Company received
approval from the FDA to market the NCP System in the United States as an
adjunctive therapy for reducing the frequency of seizures in patients over
twelve years of age with partial onset seizures that are refractory (resistant)
to antiepileptic drugs ("AEDs"). The Company has also received regulatory
approval to sell the NCP System in Canada, Europe and certain countries in the
Far East. The Company has completed a total of seven clinical studies,
including five controlled acute phase studies involving over 450 patients, a
long-term multi-year follow-up study involving 253 patients and a mortality
study. To date, over 2,500 patients have accumulated in excess of 3,000 patient
years of treatment experience with the NCP System.
EPILEPSY 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, known as "grand mal" seizures, involve the entire brain
from the onset, 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 the loss of consciousness.
Partial onset seizures can also develop into 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 over 1.8 million individuals are currently being
treated for epilepsy in the United States, with over 117,000 new cases
diagnosed each year, and that there are in excess of three million individuals
being treated for 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 suffer from refractory partial onset seizures.
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 (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 AEDs, strained personal and family relations, and the inability to
obtain and hold meaningful employment or a driver's license. Societal
implications of epilepsy include the loss or underutilization of potentially
productive citizens and the cost of long-term public assistance for those
disabled by epilepsy. Epilepsy patients, in general, and refractory patients,
to a greater extent, experience a significantly higher mortality rate than the
general population.
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. AEDs serve as a first-line treatment and are prescribed for
virtually all individuals being treated for epilepsy. There are ten drugs
predominately used for the treatment of epilepsy which are used either alone or
in combination. 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 AEDs. 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 AEDs are more likely to bear infants with birth defects
than the general population. Children receiving AED therapy often experience
learning difficulties. Six of the ten AEDs have received FDA approval since
1993, and no other major AEDs have been introduced in the United States since
1978. While each of these newer AEDs demonstrates some efficacy or tolerability
benefits when compared with other AEDs, the Company believes that none of these
newer AEDs appears to provide significantly improved clinical outcomes. See
"--Competition."
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. However, only
approximately 2,000 epilepsy surgeries are performed per year in the United
States. The Company believes 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
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.
THE CYBERONICS SOLUTION
The Company's FDA approved NCP System is the only currently approved
medical device alternative for treating epilepsy. The NCP System delivers an
electrical signal through an implantable lead to the left 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.
The Company believes that a successful new therapy for refractory epilepsy
should be clinically proven, provide significant seizure control, be safe and
tolerable with few side effects, provide long-term benefits and be easy for the
physician to prescribe and for the patient to use. Based on the results of its
preclinical studies, mechanism of action research and seven human clinical
trials, the Company believes that the NCP System meets these criteria as
described below.
CLINICALLY PROVEN. To date over 2,500 patients have accumulated in excess
of 3,000 patient years of treatment experience with the NCP System. On July 16,
1997, the NCP System was approved by the FDA for use as an adjunctive therapy
in reducing frequency of seizures in adults and adolescents over twelve years
of age with partial onset seizures that are refractory to AEDs.
SIGNIFICANT SEIZURE CONTROL. In the Company's two randomized, parallel,
double blind active control studies, the treatment groups reported a mean
seizure reduction of approximately 24% and 28% during the three
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month acute phase of the studies. Additionally, many patients, including some
who reported no change or an increase in seizure frequency, also reported a
reduction in seizure severity.
WELL-TOLERATED SIDE EFFECTS. The side effects associated with the NCP
System are generally mild, localized and stimulation related. They include
hoarseness, coughing, a feeling of shortness of breath and throat pain. The NCP
System has not been associated with the debilitating central nervous system
side effects which frequently accompany AEDs. Additionally, over time, a
significant percentage of patients continued to use the therapy attesting to
its tolerability. See "--Clinical Trials."
LONG-TERM EFFICACY. Long-term follow-up data, although derived from an
uncontrolled protocol, on the 253 patients in the Company's first four studies
suggest that efficacy is maintained and, for many patients, improves over time
when the NCP System is used as an adjunctive therapy with drugs as part of a
patient's optimized long-term treatment regime. Analysis of this pooled data
showed that the median percent seizure reduction increased from 17% in the
first three months to 44% after 18 months of treatment. See "--Clinical Trials."
EASY TO USE. The implantation procedure is a straightforward, fully
reversible procedure which takes between 30 minutes and two hours, does not
involve the brain and has been performed by surgeons with a variety of
specializations. Additionally, the NCP System does not interact with existing
therapies and, because the NCP System provides therapy without patient (or
caregiver) administration, full compliance is assured. Moreover, a patient can
use a magnet to temporarily override the pre-programmed stimulation cycle to
activate on-demand therapy if the patient senses the onset of a seizure.
VAGUS NERVE STIMULATION WITH THE CYBERONICS NCP SYSTEM
The NCP System is a proprietary, integrated system consisting of an
implantable device that delivers an electrical signal to an implantable lead
which is attached to the left vagus nerve. The vagus nerve is the longest of
the cranial nerves, extending from the brain stem through the neck to organs in
the chest and abdomen. The left vagus nerve has been shown to have influence
over numerous areas of the brain. Preclinical studies and mechanism of action
research suggest that intermittent stimulation of the left vagus nerve in the
neck activates a number of structures and increases blood flow bilaterally in
several areas of the brain. These studies have also shown that stimulation of
the left vagus nerve is effective in blocking seizures and results in
persistent or carryover antiepileptic effects which increase with chronic
stimulation.
The NCP System consists of the NCP Generator, the vagus nerve lead, the
programming wand and software and the tunneling tool. The NCP Generator and
vagus nerve lead are surgically implanted in a procedure which takes from 30
minutes to two hours, during which time the patient is under general or local
anesthesia. The NCP Generator is surgically implanted in a subcutaneous pocket
in the upper left chest. The vagus nerve lead is connected to the NCP Generator
and attached to the vagus nerve in the lower left side of the patient's neck.
The patient is generally admitted to the hospital the day of surgery and
discharged the same or following day.
The NCP System delivers vagus nerve stimulation therapy on a chronic,
intermittent basis. The standard stimulation parameters recommended by the
Company are a 30 second period of stimulation, followed by a five minute period
without stimulation. To optimize patient treatment, the pulse width, output
current, signal frequency and stimulation duration and intervals of the NCP
Generator can be noninvasively programmed and adjusted by the treating
physician with a personal computer using the Company's programming wand and
software. In addition, the patient can use a small, hand held magnet which is
provided with the NCP 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 of seizures.
-3-
NCP GENERATOR. The NCP Generator is an implantable, programmable, cardiac
pacemaker-like signal generator designed to be coupled with the vagus nerve
lead to deliver electrical signals to the vagus nerve. The NCP Generator
currently marketed in the United States employs a battery which has an expected
life of approximately 4.5 years at standard stimulation parameters. The Company
has begun to sell an NCP Generator outside of the United States which employs a
battery which has an estimated life of approximately six (6) years at standard
stimulation parameters, and recently received FDA approval to market this newer
NCP Generator in the United States. Upon expiration of the battery, the NCP
Generator is removed and a new generator is implanted in a short, out-patient
procedure using local anesthesia.
VAGUS NERVE LEAD. Cyberonics has licensed a proprietary nerve lead to
convey the electrical signal from the NCP 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 NCP 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. The Company's proprietary programming wand
and software are used to transmit programming information from a personal
computer to the NCP Generator via electromagnetic signals. Programming
capabilities include modification of the NCP Generator's programmable
parameters (pulse width, output current, signal frequency and stimulation
duration and interval), and storage and retrieval of telemetry data. The NCP
programming wand can be connected to a standard personal computer using a
serial connector.
TUNNELING TOOL. The tunneling tool is a disposable surgical tool designed
to be used during surgical placement of the vagus nerve lead. The tool is used
for subcutaneous tunneling of the lead assembly between the nerve site in the
neck and the NCP Generator site in the chest.
The NCP System implant procedure, including device costs, hospital charges
and physician fees, costs between $13,000 and $30,000. The current list price
for the NCP System is approximately $9,100.
CLINICAL TRIALS
The Company began trials of the NCP System for the treatment of refractory
partial onset seizures in November 1988. As of June 30, 1997, a total of seven
clinical studies have been conducted, consisting of five controlled acute phase
studies involving over 450 patients, a long-term follow-up study involving 253
patients, and a mortality study involving approximately 791 patients with 1,335
patient years of experience. A total of 45 centers participated in these
studies, including 40 in the United States, two in Germany and one each in
Canada, Holland and Sweden. Of the five controlled acute phase studies, two
were randomized, parallel, double blind, active control studies, similar in
design to AED trials. These two studies, E03 and E05, involved 388 enrolled and
310 implanted patients who were included in the efficacy analysis. The duration
of the baseline and treatment periods in both studies was three months. The
following table summarizes the Company's five acute phase clinical studies:
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DESIGN/ NUMBER OF PATIENTS INCLUDED
STUDY DATE SEIZURE TYPE(S) IN EFFICACY ANALYSIS
- ------------ --------- -------------------------- ---------------------------
E01/E02 1988 Single blind/ 15
Partial seizures
E03 1990-1992 Double blind, randomized/ 114
Partial seizures
E04 1991-1995 Open label safety/ 116
All seizures
E05 1995-1996 Double blind, randomized/ 196
Partial seizures
ACUTE PHASE EFFICACY. The primary efficacy objective of the Company's
double blind randomized acute phase clinical studies was to demonstrate a
between group difference in mean and/or median percent change in seizure
frequency between patients treated with "High" stimulation (stimulation
believed to be at therapeutic levels for seizure reduction) and "Low"
stimulation (stimulation believed to be at subtherapeutic levels). The primary
efficacy outcome was achieved in both E03 and E05. In the longitudinal studies,
E01, E02 and E04, the primary efficacy outcome was a within group difference in
mean or median percent change in seizure frequency compared to baseline. These
longitudinal studies also achieved their primary efficacy objectives. The
following table summarizes the mean and median percentage seizure reduction
rates of the treatment groups of the Company's five acute phase studies:
PERCENTAGE SEIZURE REDUCTION
RATES FOR TREATMENT GROUP
----------------------------
STUDY MEAN MEDIAN
------------------------------- -------------- ------------
E01............................ 24.3% 31.6%
E02............................ 39.9% 48.1%
E03............................ 23.6% 22.6%
E04............................ 7.0% 21.8%
E05............................ 27.9% 23.4%
ADVERSE EVENTS, SIDE EFFECTS. The two randomized, parallel studies, E03
and E05, involved 314 patients who accumulated total acute phase and long-term
follow-up exposure of 591 years. The most frequently reported side effects
were: voice alteration/hoarseness which was reported by 50% of patients at
least once during the acute and extension phases, cough which was reported by
41% of patients, throat pain/discomfort which was reported by approximately 27%
of patients, and dyspnea, a feeling of shortness of breath, which was reported
by 18% of patients at least once in the E03 and E05 acute and extension phases.
The NCP System side effects were generally rated as mild, reportedly occurred
only during actual stimulation and were reported less frequently over time. No
adverse effects of vagus nerve stimulation on the heart, lungs or stomach were
observed in any of the studies. The NCP System also did not produce the
debilitating central nervous system conditions such as drowsiness, confusion
and cognitive impairment commonly associated with AEDs.
LONG-TERM EFFICACY. In addition to the acute phase studies, the Company
also provided the FDA with long-term follow-up data on the 253 E01 through E04
study patients. The long-term data came from an uncontrolled open label
protocol where AEDs (both type and dose) and NCP System stimulation parameters
were allowed to be changed. In the Company's long-term follow-up on patients
in studies E01 through E04, a total of 238 out of a possible 251 completed one
year of therapy (95%); 142 out of 172 completed two years of therapy (83%); and
88 out of 126 completed three years of therapy (70%).
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Long-term efficacy results, although derived from an uncontrolled
protocol, indicate that efficacy is maintained and, for many patients, improves
during the first 18 months when the NCP System is used as adjunctive therapy
with drugs as part of an optimized treatment regimen. The pooled E01 through
E04 results indicate that the median percent seizure reduction increased from
17.1% at the end of the three month acute phase to a median reduction of 44.3%
after 18 months of treatment. The percent of patients reporting a greater than
50% reduction compared to baseline showed a similar improvement. The pooled
results indicate that 25.0% of the pooled patients reported a greater than
50.0% reduction after three months of treatment and that 42.9% of patients
reported a greater than 50.0% reduction after 18 months. The Company is
currently in the process of gathering data on EO5 study patients with respect
to long-term efficacy.
Although available long-term clinical data reveal continuing improved
efficacy over the first 18 months of use, this data indicates that improvement
stabilizes thereafter. Data regarding the longer term safety and efficacy of
the NCP System are limited. In addition, although the Company has theories as
to why vagus nerve stimulation reduces epileptic seizures, uncertainty still
exists as to the basic mechanism that provides positive therapeutic effects.
There can be no assurance that the efficacy of the treatment will continue to
improve or will not decline over time, or that long-term operation of the NCP
System will not produce adverse side effects or cause harm or death to
patients. Any such negative long-term effects could adversely affect the
regulatory status and/or market acceptance of the NCP System and thus adversely
affect the Company's business, financial condition and results of operations.
DEVICE COMPLICATIONS. The Company is required to file Medical Device
Reports with the FDA for certain product malfunctions or where its device
causes or contributes to a death or serious injury. Through August 31, 1998,
the Company has filed eight such reports, one of which was filed during
fiscal 1998. During the Company's clinical trials, technical complications
occurred due to lead wire fractures, battery depletion and NCP Generator
malfunctions. Two significant generator complications occurred. One generator
malfunction occurred in 1991 which resulted in permanent paralysis of one
patient's left vocal cord. Subsequent design changes were made and, since
those changes, no similar malfunctions have occurred. The second generator
malfunction was premature battery depletion due to an unexplained transient
high current drain which had no adverse effect on the patient. No similar
malfunctions have occurred. Over fifty leads were verified to have broken or
otherwise developed high impedance during the Company's clinical trials. The
Company made a series of changes in early lead designs to address these
issues, and over 2,000 of the latest generation leads have been implanted
with no reported failures due to lead design, materials or manufacturing.
Although the Company has made several design changes in its generator and
leads and has not recently experienced significant malfunctions or failures,
there can be no assurance that there will not be future failures which could
result in an unsafe condition in patients. The occurrence of malfunctions or
adverse reactions could result in a recall of the Company's products, possibly
requiring removal (and potentially reimplantation) of the NCP Generator and/or
leads. Any product recall could have a material adverse effect on the Company's
business, financial condition or results of operations.
MORTALITY STUDY. As of June 30, 1997, a total of 17 deaths were reported
among the clinical and commercial patients implanted with the NCP System, ten
of which were considered to be possible/probable/definite SUDEP (Sudden
Unexplained Death in Epilepsy Patients). Although treatment was underway at the
time, no deaths have been linked to the implantation of or stimulation by the
NCP System. Based on the 17 deaths, there was a mortality rate in the NCP
cohort of 10.3/1,000 patient years and a SUDEP incidence of 3.0/1,000 patient
years for definite/probable and 5.0/1,000 patient years for
definite/possible/probable. The mortality rate and SUDEP rates for the NCP
cohort are within the ranges expected by a panel of independent experts for a
medically refractory epilepsy population. The mortality data was included in
the Company's submissions to the FDA in connection with its PMA application.
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An update to the mortality study is currently in process, the results of
which will be submitted to the FDA as part of the Company's post-market
surveillance requirements. As of August 14, 1998, a total of 26 deaths were
reported among the clinical and commercial patients implanted with the NCP
System and receiving vagus nerve stimulation therapy. None of those deaths
have been linked to the implantation of the NCP System or vagus nerve
stimulation. The updated mortality and SUDEP rates based on this recent data
are expected to be similar to the rates submitted to the FDA in connection with
the Company's PMA application.
FUTURE STUDIES. The Company is sponsoring a number of post-market studies
to further the understanding of the NCP System's mechanism of action and
clinical utility for the treatment of epilepsy. Neurological disorders outside
the field of epilepsy which are covered by the Company's method patent
portfolio are also being explored. New clinical trials conducted in the United
States may require additional FDA approvals.
STRATEGY
The Company's strategy is to establish vagus nerve stimulation as a
preferred means for treating patients who suffer from refractory partial
seizures. The following are key elements of the Company's strategy:
ESTABLISH THE NCP SYSTEM IN THE UNITED STATES
The NCP System received FDA approval for the treatment of epilepsy
patients suffering from refractory partial onset seizures in July 1997. The
Company markets and sells the NCP System in the United States through a
multidisciplinary direct sales force that targets the physicians, nurse
clinicians, hospital administrators and payors providing care for, and patients
suffering from, epilepsy. The Company has increased its U.S. sales and
marketing staff from 20 professionals at June 30, 1997 to over 50 professionals
at August 31, 1998. In order to create physician awareness and patient demand,
the Company uses a multi-faceted marketing approach that includes clinician
symposia, ongoing physician awareness and training programs, education and
support of patient advocacy groups such as the Epilepsy Foundation of
America, publication of peer-reviewed scientific articles concerning the NCP
System and the Company's clinical trials, and dissemination of public
information regarding the benefits of the NCP System for patients suffering
from epilepsy.
INCREASE INTERNATIONAL MARKET PENETRATION
In June 1994, the Company was granted regulatory approval to market the
NCP System in the member countries of the European Union. Due to resource
constraints, however, the Company did not devote significant resources to
marketing the NCP System internationally until fiscal 1997. The Company's sales
strategy in international markets is to use a direct sales force in certain key
markets and to rely upon distributors to reach additional markets.
ESTABLISH REIMBURSEMENT BY THIRD-PARTY PAYORS
The Company believes that significant market acceptance of the NCP System
for the treatment of epilepsy or other indications will require that the
treatment be eligible for reimbursement from government and private health care
payors both within and outside the United States. The Company has gained
coverage recommendations from HCFA, Blue Cross and Blue Shield,
CHAMPUS/Tricare, Kaiser, a number of State Medicaid agencies and numerous
other payors. The Company is in the process of seeking additional coverage
recommendations and appropriate payment levels from these and other third
party payors. The Company believes that hospitals will gain adequate
reimbursement for the NCP System based on the compelling safety and efficacy
of the NCP System, the
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debilitating nature and annual cost of treating refractory epilepsy, and the
efficacy and cost of alternative treatments. See "--Third-Party
Reimbursement."
EXPAND RANGE OF TREATABLE INDICATIONS
The Company believes that additional epilepsy types, as well as severe
neurological disorders outside the field of epilepsy, including movement
disorders such as essential tremor and Parkinson's disease, chronic pain and
migraine headaches, may be amenable to treatment by vagus nerve stimulation
with the NCP System. The Company has been granted method patents relating to
the use of vagus nerve stimulation for the treatment of these and certain other
neurological disorders, and plans to establish a program to discover and
develop new applications for the NCP System both within and outside the field
of epilepsy. See "--Product Development."
MARKETING AND SALES
UNITED STATES. The NCP System was approved for sale in the United States
on July 16, 1997 for use as an adjunctive therapy in reducing the frequency of
seizures in adults and adolescents over twelve years of age with partial onset
seizures that are refractory to AEDs. The Company markets and sells its
products through a direct sales force in the United States. As of August 31,
1998 the United States sales team consisted of a Vice President, Sales, three
area directors, sixteen territory managers and seventeen clinical specialists
all of whom have significant medical device sales or epilepsy clinical
experience. As of August 31, 1998, the United States marketing team consisted
of Vice President, Marketing, five corporate marketing personnel, eight
regional marketing personnel and four reimbursement specialists.
The Company's sales and marketing plan focuses on creating widespread
awareness and demand for the NCP System among neurologists, surgeons and nurse
clinicians involved in the treatment of patients with epilepsy, third party
payors who pay for such treatment and patients and their families whose lives
are affected by epilepsy. To reach each of these groups, the Company is using
a multidisciplinary sales force consisting of territory managers experienced in
medical device sales, clinical specialists with nursing experience in epilepsy,
reimbursement specialists experienced in obtaining third party coverage and
payments for new medical technologies and regional marketing teams experienced
in peer to peer marketing programs. In addition to its direct selling
activities, the Company facilitates and supports peer to peer interactions such
as symposia, conference presentations, journal articles and patient support
groups to provide experienced clinicians and patients the opportunity to share
their perspectives on the NCP System with others.
INTERNATIONAL. Although the Company obtained approval to CE Mark the NCP
System and to sell it in the member countries of the European Union in June
1994, through the end of calendar 1996, the Company focused its resources and
efforts primarily on the clinical trials necessary to gain FDA approval to sell
the NCP System in the United States. As a result, the Company until recently
devoted only limited resources to international marketing and sales activities.
The Company began building its international marketing and sales organization
in fiscal 1997. As of August 31, 1998, the Company's international sales and
marketing organization consisted of eight full time employees and a number of
independent distributors.
The NCP System is currently sold by a direct sales force in Germany,
France, Austria, Switzerland and the United Kingdom. As of August 31, 1998,
the Company had distribution agreements with independent distributors covering
a number of other countries including Italy, The Netherlands, Spain and Sweden.
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.
-8-
The Company intends to seek additional regulatory and reimbursement
approvals in the future in those major markets where the NCP System is not yet
approved. The geographic areas initially targeted include South America and the
Far East, in particular, Japan. In Japan, the Company is working with an
independent distributor to obtain the appropriate regulatory and reimbursement
approvals and to ultimately distribute the NCP System if such approvals are
obtained. The Japanese clinical trial began in July 1993. In February 1998,
the Company's Japanese distributor submitted the results of this study, along
with the Company's 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.
MANUFACTURING AND SOURCES OF SUPPLY
Cyberonics' manufacturing operations are required to comply with the FDA's
Quality System regulations ("QSR"), which incorporates the agency's former
Good Manufacturing Practices regulations. QSR addresses the design, controls,
methods, facilities and quality assurance controls used in manufacturing,
packing, storing and installing medical devices. In addition, certain
international markets have quality assurance and manufacturing requirements
that may be more or less rigorous than those in the United States.
Specifically, the Company is subject to the compliance requirements of ISO
9001 and 9002 certification and CE Mark directives. The Company is audited on
a semiannual basis for such compliance. See "--Government Regulation."
The NCP Generator, which is similar in design and manufacture to a cardiac
pacemaker, is comprised of two printed circuit boards and a battery which are
hermetically sealed in a titanium case. Standard components are assembled on
printed circuit boards by a contract manufacturer using surface-mount
technology. The boards are then shipped to the Company for assembly and
testing. The assembled electronics are then placed in a titanium case which is
shipped to a third-party for laser welding and returned to the Company for
attachment of an epoxy header to which the lead connects and for final testing.
Sterilization of the NCP Generator is performed by a third-party.
The Company has a limited history of operations that, to date, has
consisted primarily of manufacturing limited quantities of the NCP System for
clinical investigations, for first year commercial sales activities in the
United States and for commercial sales activities in international markets.
The Company does not have experience manufacturing the NCP System in the
volumes that will be necessary to achieve significant commercial sales. In
addition to its existing manufacturing facility, in September 1997, the Company
entered into a lease for a new headquarters and manufacturing facility, and is
currently in the process of moving its primary manufacturing operations to the
new facility, which is expected to begin production in calendar 1999. The
Company may encounter difficulties in scaling up production of the NCP System,
in procuring the necessary supply of materials, components and contract
services, or in hiring and training additional manufacturing personnel to
support domestic and international demand. The Company will be required to
obtain FDA approval for its change in the manufacturing facility. The new
manufacturing facility will also have to be inspected for compliance with the
FDA's QSR and with ISO 9001 and 9002 standards, which impose certain procedural
and documentation requirements with respect to device design, development,
manufacturing and quality assurance activities, before the Company can begin
commercial-scale production of the NCP System at the new manufacturing
facility. There can be no assurance that the Company will be able to obtain
the necessary FDA and other approvals for its new facilities on a timely basis,
or at all. If the Company is unable to achieve commercial-scale production
capability on a timely basis with acceptable quality and manufacturing yield
and costs, to sustain such capacity, or to achieve FDA and other governmental
approvals, the ability of the Company to deliver products on a timely basis
could be impaired which could have a material adverse effect on the Company's
business, financial condition or results of operations.
-9-
The Company relies upon sole source suppliers for certain of the key
components, materials and contract services used in manufacturing the NCP
System. The Company periodically experiences discontinuation or unavailability
of components, materials and contract services which may require qualification
of alternative sources or, if no such alternative sources are identified,
product design changes. The Company believes that pursuing and qualifying
alternative sources and/or redesigning specific components of the NCP System,
when necessary, could consume significant Company resources. In addition, such
changes generally require regulatory submissions and approvals. Although the
Company believes that any such changes will be made without disruption, any
extended delays in or inability to secure alternative sources for these or
other components, materials and contract services could result in product
supply and manufacturing interruptions which could have a material adverse
effect on the Company's ability to manufacture the NCP System on a timely and
cost competitive basis, and therefore on its business, financial condition or
results of operations.
PRODUCT DEVELOPMENT
Cyberonics' product development efforts are directed toward improving the
NCP System and developing new products which provide additional features and
functionality. Product development programs that are underway include ongoing
improvements to the NCP Generator, such as reduced size and increased battery
life. These and other longer term development activities are expected to be
technically challenging and no assurance can be given that they will result in
marketable products. The Company will be required to file for the appropriate
United States and international regulatory approvals, and undergo clinical
trials, in connection with the introduction of improved and new products. See
"--Government Regulation."
COMPETITION
The Company believes that existing and future AEDs will be the primary
competition for its NCP System. The Company may also face competition from
other medical device companies for the treatment of partial seizures.
Medtronic, Inc. continues to clinically assess an implantable signal generator
used with an invasive deep brain probe (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. The Company 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 the
Company's competitors have substantially greater financial, manufacturing,
marketing and technical resources than the Company and have obtained
third-party reimbursement approvals. In addition, the health care industry is
characterized by extensive research efforts and rapid technological progress.
There can be no assurance that the Company's competitors will not develop
technologies and obtain regulatory approval for products that are more
effective in treating epilepsy than the Company's current or future products.
There can also be no assurance that advancements in surgical techniques will
not make surgery a more attractive therapy for epilepsy. The development by
others of new treatment methods with novel AEDs, medical devices or surgical
techniques for epilepsy could render the NCP System non-competitive or
obsolete. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competition,
including the development and commercialization of new products and technology,
will not have a material adverse effect on the Company's business, financial
condition or results of operations.
Cyberonics believes 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 and product reliability.
The Company believes that the NCP System compares favorably with competitive
products as to these factors.
-10-
PATENTS, LICENSES AND PROPRIETARY RIGHTS
Proprietary protection for the Company's products is important to the
Company's business. The Company maintains a policy of seeking method and device
patents on its inventions, acquiring licenses under selected patents of third
parties, obtaining copyrights on its software and other copyrightable materials
and entering into invention and proprietary information agreements with its
employees and consultants with respect to technology which it considers
important to its business. Cyberonics also relies upon trade secrets,
unpatented know-how and continuing technological innovation to develop and
maintain its competitive position.
The Company entered into an exclusive license agreement with Dr. Jacob
Zabara, a co-founder of and consultant to the Company, pursuant to which the
Company has licensed three United States method patents (and such international
counterparts as have been or may be issued) covering the NCP System for vagus
nerve and other cranial nerve stimulation for the control of epilepsy and other
movement disorders. The License Agreement runs for the term of licensed
patents. Pursuant to the license agreement, the Company is obligated to pay
Dr. Zabara a royalty equal to 3% of net sales for the remaining term of the
licensed patents.
The Company entered into a license agreement with Huntington Medical
Research Institute pursuant to which the Company has licensed two United States
patents (and 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. Pursuant to the license agreement, as amended,
the Company paid an initial license fee of $200,000. In addition, the Company
has a renewable option which, in certain instances, it has exercised to expand
the licensed field-of-use for additional indications for a license fee of
$15,000 per indication. Pursuant to the license agreement, the Company is
obligated to pay the licensor a royalty of 1% of net sales of NCP Systems using
the licensor's standard lead (the Company's vagus nerve lead is a standard
lead) and 1.75% of net sales of NCP Systems which include the licensor's
bidirectional lead. The Company also has agreed to pay minimum royalties of
$35,000 for each fiscal year for the life of the licensed patents. In fiscal
1997, the Company elected not to exercise an option it held under this license
to preserve its exclusivity with respect to the bidirectional lead and, as a
result, the licensor may convert the license regarding the bidirectional lead
to a non-exclusive license.
In addition to the license agreements, as of August 31, 1998, the Company
had United States patents and patent applications pending covering NCP
Generator circuits, electrode designs and various therapeutic applications of
vagus nerve stimulation. In addition to movement disorders, other method
patents cover the fields of eating disorders, endocrine disorders, migraine
headaches, dementia, neuropsychiatric disorders, motility disorders, chronic
pain and hypertension. In September 1997, the Company filed for a limited
extension of the term of one of the medical device and method patents under
which it is licensed from Dr. Zabara. The Company has filed counterparts of
certain of its key United States patent applications in certain key
international jurisdictions.
There can be no assurance that patents will issue from any of the
remaining applications or, if patents are issued, that they will be of
sufficient scope or strength to provide meaningful protection of the Company's
technology. In addition, there can be no assurance that any patents issued to
the Company will not be challenged, invalidated or circumvented, or that the
rights granted thereunder will provide proprietary protection or commercial
advantage to the Company. Notwithstanding the scope of the patent protection
available to the Company, 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.
-11-
Cyberonics believes that the licenses described above provide it with
protection in the United States in the field of cranial nerve stimulation,
including vagus nerve stimulation for the control of epilepsy, movement
disorders, including Parkinson's disease and essential tremor, 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 United States 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. Litigation, which could result in
substantial cost to and diversion of effort by the Company, may be necessary to
enforce patents issued or licensed to the Company, to protect trade secrets or
know-how owned by the Company or to defend the Company 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 the Company to significant liabilities to third parties, could require
the Company to seek licenses from third parties and could prevent the Company
from manufacturing, selling or using the NCP System, any of which could have a
material adverse effect on the Company's business, financial condition or
results of operations. The Company is not currently a party to any patent
litigation or other litigation regarding proprietary rights and is not aware of
any challenge to its patents or proprietary rights.
GOVERNMENT REGULATION
The preclinical and clinical testing, manufacturing, labeling, sale,
distribution and promotion of the NCP System are subject to extensive and
rigorous regulation in the United States by federal agencies, primarily the
FDA, and by comparable state agencies. In the United States, the NCP System is
regulated as a medical device and is subject to FDA's premarket approval
requirements. Under the Food, Drug, and Cosmetic Act, all medical devices are
classified into three classes, class I, II or III. New class III devices, such
as the NCP System, are subject to the most stringent FDA review, and require
submission and approval of a PMA before commencement of marketing, sales and
distribution in the United States.
In July 1997, the Company received FDA approval to market the NCP System
in the United States 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 AEDs. While the Company has satisfied FDA's
requirements to commence domestic sales of its product, it continues to be
subject to FDA's ongoing requirements to maintain regulatory compliance.
Additionally, 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 total of 50 patients during the first five
years of stimulation to monitor the safety and tolerability of the NCP System.
In addition, the Company has been required by the 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.
There can be no assurance that additional concerns will not be raised by the
FDA in the future. The Company's business, financial condition and results of
operations are critically dependent upon ongoing compliance with FDA
regulations and requirements.
The Company will be required to obtain FDA approval of a new PMA or PMA
supplement before making any change to the NCP System affecting the safety or
effectiveness of the device including, but not limited to, new indications for
use of the device, changes in the device's performance or design specifications
and device modifications and future generation products. New PMAs and PMA
supplements generally require submission of information needed to support the
proposed change and often require additional clinical data. If the clinical
testing required to obtain the information necessary to support the change
places research subjects at risk, the Company will be required to obtain the
FDA's approval of an IDE before beginning such testing. The Company intends to
sponsor additional clinical trials of the NCP System in the United States,
initially for additional epilepsy indications
-12-
and, in the future, for non-epilepsy neurological disorders. The Company
believes that it 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 ("IRBs") established pursuant to FDA
regulations. There can be no assurance that the Company will be able to
obtain any required FDA or IRB approvals for such clinical trials, the
studies will be completed in a timely manner or the data and information
obtained will be sufficient to support the filing of a new PMA or PMA
supplement for the proposed charges. In addition, international sales are
subject to foreign government regulation, the requirements of which vary
substantially from country to country. The Company has obtained certain
foreign governmental approvals, including the approval to use the European
Union "CE" Mark, and has applied for additional approvals. There can be no
assurance that the necessary approvals, including approval of new PMAs or
supplements to existing PMAs for the NCP System, will be granted on a timely
basis or at all, and delays in receipt of or failure to receive such
approvals, or the withdrawal of previously received approvals, could have a
material adverse effect on the business, financial condition and results of
operations of the Company.
The Company also is required to register as a medical device manufacturer
with the FDA and state agencies and to list its products with the FDA. The
Company has registered as a medical device manufacturer with the FDA. The
Company's facilities are subject to inspection on a routine basis by the FDA
for compliance with the FDA's QSR and other applicable regulations. The Company
also is required to file Medical Device Reports with the FDA for certain
product malfunctions or where its device causes or contributes to a death or
serious injury. Through August 31, 1998, the Company has filed eight such
reports, one of which was filed during fiscal 1998. QSR impose procedural and
documentation requirements upon the Company with respect to product designs,
manufacturing, testing, control, process validation and similar activities. As
of August 31, 1998, the Company has been the subject of an FDA pre-PMA approval
and FDA post-approval site inspections, both of which were completed with no
deficiencies noted. Additionally, the Company must comply with various FDA
requirements such as those governing advertising, labeling and reporting of
adverse experiences with the use of the product. New regulations governing such
matters as device tracking and post-market surveillance also may apply to the
NCP System. The FDA actively enforces regulations prohibiting marketing of
products for non-indicated uses. 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. Changes in existing requirements or the
adoption of new requirements could adversely affect the Company's ability to
comply with regulatory requirements. Failure to comply with regulatory
requirements could have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition, the Company's products are covered by FDA regulations for
implantable medical devices that require the Company to comply with certain
specific record keeping, reporting, product testing, design, safety and product
labeling requirements. The Company believes that it is in material compliance
with these requirements. There can be no assurance, however, that the Company
will be able to maintain such compliance in the future. Any such failure to
comply could have an adverse effect on the Company's business, financial
condition and results of operations.
The advertising of most FDA-regulated products, including the Company's
NCP System, is subject to both FDA and Federal Trade Commission jurisdiction.
The Company also is subject to regulation by the Occupational Safety and Health
Administration and by other governmental entities.
Clinical testing, manufacture and sale of the Company's products outside
of the United States are subject to regulatory approval by other jurisdictions
which may be more or less rigorous than in the United States. The Company must
comply with its ISO 9001 and 9002 certification, which is similar to the FDA's
QSR, and CE Mark directives. The Company is audited on a semiannual basis for
such compliance. The Company has received
-13-
regulatory approval to market the NCP System in the member countries of the
European Union and Canada, and is pursuing other regulatory approvals outside
the United States.
THIRD-PARTY REIMBURSEMENT
The Company's ability to commercialize the NCP System successfully will
depend in part on whether third party payors, including private health care
insurers, managed care plans, the United States government's Medicare and
Medicaid programs and others, agree both to cover the NCP System, and the
procedures and services associated therewith, and to reimburse at adequate
levels for the costs of the NCP System and the related services.
In deciding to cover a new therapy, third-party payors base their initial
coverage decisions on several factors including, but not limited to, the status
of the FDA's review of the product, 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 Company has implemented a program to provide third-party payors
with the clinical and regulatory information that they will need to reach
coverage decisions, both by sending materials directly to the payors and by
assisting hospitals and physicians in their interactions with the payor. There
can be no assurance that third-party payors will view the Company and the NCP
System favorably with respect to any of the above factors, which may impede the
Company's obtaining favorable coverage decisions on a timely basis, or at all.
A failure to achieve favorable coverage decisions for the NCP System in a
timely manner could deter patients and their physicians from using the
Company's products and could have a material adverse effect on the Company's
business, financial condition or results of operations.
Once a favorable coverage determination is made with respect to a product,
payors must determine the level of reimbursement for the product and related
therapy and procedures. In making decisions about reimbursement amounts,
third-party private payors 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 and reimbursed costs.
Those mechanisms have provided payment levels for many other implantable
devices that have been adequate to allow device use and commercial success.
Assuming that most payors determine to cover the NCP System and related
services, the Company expects that many of these same payment mechanisms will
provide reimbursement levels for the NCP System and related services that
physicians and hospitals will view as adequate to support use of the NCP
System.
The Company believes that a significant number of epilepsy patients in the
United States are either eligible for benefits under the Medicare program or
are uninsured. The Medicare program uses different payment mechanisms to
reimburse for procedures performed in different settings. For outpatient
implants, Medicare uses a system that reimburses hospitals based on their
costs. The Company believes that those payments generally are adequate. For
inpatient implants, Medicare uses a fixed-payment method (based on Diagnosis
Related Groups or "DRGs"). Under current DRG groupings, hospital inpatient
procedures for implanting the NCP System are assigned to one of two different
DRGs based on whether or not the patient has complications or comorbidities
(coexisting severe medical problems). The DRG grouping that would include
implantation of the NCP System for patients without complications or
comorbidities pays hospitals less than the costs of purchasing and implanting
the NCP System. The Company believes that this DRG grouping would apply to
most of the epilepsy patients covered by Medicare. In order to assure
adequate reimbursement for all epileptic patients eligible for benefits under
Medicare, the Company may seek changes in the DRG grouping so that NCP System
implant cases would be reclassified to other, higher-paying DRGs. Medicare
uses a resource-based relative value scale to pay for physicians' services.
The Company believes that the relative value scales for the surgeons and
physicians involved in the implantation and interrogation and reprogramming
of the NCP System provide adequate reimbursement for these physicians'
services.
-14-
The Company has only limited experience in seeking and obtaining coverage
and payment approvals from third-party payors, and there can be no assurance
that the Company would be successful in achieving coverage or adequate
reimbursement levels, or any, or that it can obtain new DRG assignments under
the Medicare program to cover the complete costs of therapy using the NCP
System. If the Company is unsuccessful in achieving coverage or adequate
reimbursement levels or in obtaining new DRG assignments, or if hospitals or
physicians view their payments as inadequate, then patients, physicians and
hospitals could be deterred from using the NCP System, which could have a
material adverse effect on the Company's business, financial condition or
results of operations.
In June 1994, the Company was granted approval to use the CE Mark and to
market the NCP System in the European Union. The Company is continuing to
pursue appropriate reimbursement approvals in the European Union member
countries. The Company believes that significant sales volume will be difficult
to generate without appropriate reimbursement approvals. There can be no
assurance as to when or whether such reimbursement will be obtained in any of
the European Union countries or, if obtained, whether the levels of
reimbursement will be sufficient to enable the Company to sell the NCP System
on a profitable basis.
PRODUCT LIABILITY AND INSURANCE
The manufacture and sale of the Company's products entail the risk of
product liability claims. Although the Company maintains product liability
insurance, there can be no assurance that the coverage limits of the Company's
insurance policies will be adequate. Such insurance is expensive and in the
future may not be available on acceptable terms, if at all. A successful claim
brought against the Company in excess of its insurance coverage could have a
material adverse effect on the Company's business, financial condition or
results of operations.
EMPLOYEES
As of September 15, 1998, the Company had 185 full-time employees,
including 10 in research and development, 11 in clinical and regulatory
affairs, 89 in manufacturing and quality assurance, 55 in sales and marketing
and 20 in administration. The Company believes that the success of its
business will depend, in part, on its ability to attract and retain qualified
personnel including, but not limited to, its key officers and its Board of
Directors. The Company believes its relationship with its employees is good.
There can be no assurance that the Company will be successful in hiring or
retaining qualified personnel. The loss of key personnel, or the inability to
hire or retain qualified personnel, could have a material adverse effect on
the Company's business, financial condition or results of operations.
ITEM 2. PROPERTIES
The Company leases approximately 43,000 square feet of office and
manufacturing space in Houston, Texas through September 2002, approximately
13,500 square feet of manufacturing space in Webster, Texas through 2001, and a
sales office in Brussels, Belgium through January 2000. The Company believes
that these leased facilities will be adequate to meet its needs at least
through June 30, 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not
applicable.
-15-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the Nasdaq National Market under
the symbol "CYBX." The high and low sale prices for the Company's Common Stock
during fiscal 1997 and 1998 are set forth below. Price data reflect actual
transactions, but do not reflect mark-ups, mark-downs or commissions.
HIGH LOW
------ ------
FISCAL YEAR ENDED JUNE 30, 1997
First Quarter...................................... $ 6.56 $ 5.75
Second Quarter..................................... $ 6.69 $ 2.63
Third Quarter...................................... $ 5.13 $ 3.25
Fourth Quarter..................................... $ 9.38 $ 4.63
FISCAL YEAR ENDED JUNE 30, 1998
First Quarter...................................... $16.50 $ 5.88
Second Quarter..................................... $16.50 $10.25
Third Quarter...................................... $32.63 $13.50
Fourth Quarter..................................... $32.88 $ 9.88
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 the Company's Common Stock has in the past been, and may in
the future be, subject to significant volatility. Factors such as reports on
the clinical efficacy and safety of the NCP System, product and component
supply issues, government approval status, fluctuations in the Company's
operating results, announcements of technological innovations or new products
by the Company or its competitors, changes in estimates of the Company's
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 the Company or others
may have a significant effect on the market price of the Common Stock. In
addition, the price of the Company's stock could be affected by stock price
volatility in the medical device industry or the capital markets in general
without regard to the Company's operating performance.
As of August 31, 1998, there were 211 stockholders of record.
The Company currently intends to retain future earnings to fund the
development and growth of its business and, therefore, does not anticipate
paying cash dividends within the foreseeable future. Any future payment of
dividends will be determined by the Company's Board of Directors and will
depend on the Company's financial condition, results of operations and other
factors deemed relevant by its Board of Directors.
-16-
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
Company's Consolidated Financial Statements and with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere herein. The selected consolidated financial data as of June 30, 1998
and 1997, and for each of the years in the three-year period ended June 30,
1998 are derived from consolidated financial statements that have been audited
by Arthur Andersen LLP, independent public accountants, which are included
elsewhere herein. The selected financial data as of June 30, 1996, 1995 and
1994 and for the years ended June 30, 1995 and 1994 are derived from audited
financial statements not included herein.
YEAR ENDED JUNE 30,
-------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales....................................... $ 14,912,868 $ 1,372,005 $ 1,416,965 $ 966,989 $ 399,689
Cost of goods sold.............................. 3,902,468 372,180 411,562 347,457 117,835
------------ ------------ ------------ ----------- -----------
Gross profit.................................... 11,010,400 999,825 1,005,403 619,532 281,854
Operating expenses:
Research and development...................... 7,391,426 6,549,474 8,024,502 5,678,024 4,323,671
Selling, general and administrative........... 19,781,268 5,933,852 3,420,111 2,906,589 2,519,037
------------ ------------ ------------ ----------- -----------
Total operating expenses.................... 27,172,694 12,483,326 11,444,613 8,584,613 6,842,708
Interest income, net............................ 1,976,792 436,813 423,044 688,909 629,993
Other (expense) income, net..................... 10,790 (198,143) (97,084) 37,362 5,136
------------ ------------ ------------ ----------- -----------
Net loss $(14,174,712) $(11,244,831) $(10,113,250) $(7,238,810) $(5,925,725)
------------ ------------ ------------ ----------- -----------
------------ ------------ ------------ ----------- -----------
Basic and diluted net loss per share............ $ (0.88) $ (0.93) $ (1.06) $ (.79) $ (.66)
------------ ------------ ------------ ----------- -----------
------------ ------------ ------------ ----------- -----------
Shares used in computing basic and diluted net
loss per share................................ 16,104,922 12,030,171 9,513,038 9,218,008 8,945,968
CONSOLIDATED BALANCE SHEET DATA (AS OF YEAR END):
Cash, cash equivalents and marketable
securities..................................... $38,037,343 $8,123,456 $2,201,962 $11,852,619 $18,468,154
Working capital.................................. 39,246,128 7,763,480 1,042,396 8,988,373 9,676,289
Total assets..................................... 52,615,294 10,249,737 3,948,043 13,560,593 19,756,148
Accumulated deficit.............................. (63,341,714) (49,167,002) (37,922,171) (27,808,921) (20,570,111)
Common stockholders' equity...................... $44,698,719 $8,421,472 $1,465,050 $11,443,555 $18,503,398
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF A NUMBER OF
IMPORTANT FACTORS. FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD AFFECT THE
COMPANY'S RESULTS, PLEASE REFER TO THE BUSINESS SECTION AND FINANCIAL STATEMENT
LINE ITEM DISCUSSIONS SET FORTH IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
SUMMARY
Cyberonics was founded in 1987 to design, develop and bring to market
medical devices which provide a novel therapy, vagus nerve stimulation, for the
treatment of epilepsy and other debilitating neurological disorders. Clinical
trials of the NCP System began with the first patient implant in November 1988
under an IDE from the FDA. The Company received FDA approval to market the NCP
System in the United States in July 1997 for use as an adjunctive therapy in
reducing the frequency of seizures in adults and adolescents over twelve years
of age
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with partial onset seizures that are refractory to AEDs. From inception
through July 1997, the Company's primary focus was on obtaining FDA approval
for the NCP System. The Company has had limited revenues to date and has
been unprofitable since inception. Since inception, the Company has incurred
substantial expenses, primarily for research and development activities
(including product and process development and clinical trials and related
regulatory activities), sales and marketing activities and manufacturing
start-up. For the period from inception through June 30, 1998, the Company
incurred a cumulative net deficit of approximately $63.3 million.
Cyberonics was granted regulatory approval in 1994 to market and sell the
NCP System in the member countries of the European Union and also has
permission to sell in certain other international markets. However, through
fiscal 1996, the Company devoted only limited resources to marketing and sales
activities internationally, and only in early fiscal 1997 began initiating
significant marketing and sales activities. International sales of the NCP
System have been limited to date.
Cyberonics is engaged in obtaining reimbursement approvals from the
various health care provider systems in the United States and in key
international markets. To date, the NCP System has been reimbursed by certain
payors in the United States and by certain payment authorities in a limited
number of international markets. The Company does not expect to achieve
significant sales unless and until additional reimbursement approvals are
obtained for the NCP System.
The Company has made significant investments in recent periods in
connection with the United States market launch of the NCP System and, to a
lesser extent, in connection with efforts to expand its presence in
international markets. The Company has not been profitable to date, and
expects to remain unprofitable through at least fiscal 1999. Moreover, the
Company expects to substantially increase the level operating expenses
(primarily sales and marketing and, to a lesser extent, clinical trial
expenses) through fiscal 1999 in an effort to accelerate the rate of market
awareness and acceptance of the NCP System. The Company expects that there
will be delays between the initiation of higher spending levels and increased
revenues that may result from such increased spending. Moreover, once
initiated, many of these expenses will be fixed in nature. As a result, if
revenues do not increase substantially over the levels achieved in recent
periods, the Company will continue to experience substantial operating losses,
potentially at levels exceeding the levels experienced in recent periods, and
the point at which the Company achieves profitability would be delayed beyond
the current expectations of securities analysts. Furthermore, even if the
levels of revenues increase substantially, there can be no assurance that the
Company will become profitable when expected to do so or at all or, even if it
becomes profitable, that it will remain so in future periods.
In addition to the foregoing, the Company believes that its results of
operations may fluctuate significantly from quarter to quarter based upon
numerous factors, many of which are outside the Company's control. Such
factors include, but are not limited to, the extent to which the Company's NCP
System gains market acceptance, the extent to which third-party payors approve
reimbursement for the NCP System, the rate and size of expenditures incurred by
the Company as it expands its sales and marketing efforts, availability of key
components, materials and contract services that may be dependent on the
Company's ability to forecast sales and ability to achieve acceptable
manufacturing yields and costs.
RESULTS OF OPERATIONS
NET SALES. Net sales for the fiscal year ended June 30, 1998 increased to
$14.9 million from $1.4 million and $1.4 million for the years ended June 30,
1997 and 1996, respectively. International sales were $2.3 million, $1.3
million and $1.3 million in fiscal 1998, 1997 and 1996, respectively, while
domestic sales were $12.6 million, $24,000 and $110,000 in such respective
periods.
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The substantial increases in revenues in fiscal 1998 are primarily due to
the Company receiving FDA approval to market the NCP System in the United
States in July 1997 and the resulting initial year of sales into the United
States market. Prior to receiving FDA approval to market the NCP System in the
United States, in fiscal 1996 and 1997, the substantial majority of sales were
derived from international markets where the Company had regulatory approval to
sell the NCP System. Domestic sales in such years were limited exclusively to
reimbursements related to the Company's clinical trial activities. While the
Company expects to conduct additional clinical trial activities in the United
States and internationally and may seek reimbursement in connection with such
studies, the Company does not expect such reimbursement revenues to be
significant in future periods. Future increases in net sales will be dependent
upon increased market acceptance for the NCP System and upon expanding its
reimbursement from third-party payors. The Company is devoting substantial
resources to increasing the awareness and market acceptance of the NCP System,
particularly in the United States. The Company believes, however, that there
will be delays between increased sales and marketing activities and any
resulting increase in revenues. As a result, the Company expects to achieve
little, if any, quarter-to-quarter revenue growth in the first quarter of
fiscal 1999. Furthermore, there can be no assurance that net 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 and the acquisition cost
of raw materials and components. The Company's gross margin was 73.8% for the
year ended June 30, 1998, compared to 72.9% and 71.0% for fiscal 1997 and 1996,
respectively. The increase in gross margin in fiscal 1998 is attributable
primarily to the increase in net sales in the United States, which have higher
gross margins than net sales in international markets, and a reduction in the
royalty rate paid by the Company from 7% to 4% of net sales. The Company is
obligated to pay royalties at a rate of approximately 4% of net sales in future
periods. Gross margins can be expected to fluctuate in future periods based
upon the mix between direct and international sales, direct and distributor
sales, the NCP System's selling price, applicable royalty rates and the levels
of production volume.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses are
comprised of both expenses related to the Company's product and process
development efforts, design efforts and expenses associated with conducting
clinical trials and certain related regulatory activities. Research and
development expenses were $7.4 million, or 49.6% of net sales, during the year
ended June 30, 1998, compared to $6.5 million, or 477.4% of net sales, during
fiscal 1997 and $8.0 million, or 566.3% of net sales, during fiscal 1996. The
increase in research and development spending in absolute amount in fiscal 1998
as compared to fiscal 1997 reflects heightened levels of product design and
development activity and manufacturing process improvement efforts, combined
with increased clinical and regulatory staffing in preparation for future
clinical study activities. The decrease in such expenses as a percentage of
net sales in fiscal 1998 over fiscal 1997 results from the rapid increase in
sales following FDA approval to sell the NCP System in the United States. The
decrease in research and development spending in absolute amount and as a
percentage of net sales in fiscal 1997 as compared to fiscal 1996 was due to
the Company completing its confirmatory clinical trial during fiscal 1997. The
Company's confirmatory clinical trial was at its peak level of activity during
fiscal 1996. The Company intends to conduct further clinical trials of the NCP
System for additional indications both within and outside the field of
epilepsy. Accordingly, the Company expects research and development expenses
to fluctuate in both absolute amount and as a percent of net sales in future
periods depending primarily upon the level of such clinical trial activity.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were $19.8 million, or 132.7% of net sales, during the
year ended June 30, 1998, as compared to $5.9 million, or 432.5% of net sales,
during fiscal 1997 and $3.4 million, or 241.4% of net sales, during fiscal
1996. The increase in the absolute amount of selling, general and
administrative expenses in each year compared to the prior year was primarily
due to sales and marketing activities focused on the United States market
launch for the NCP System and
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to a lesser extent to the continued expansion of corporate infrastructure in
response to the recent business expansion and movement of the Company's
headquarters to a new location. The Company began expanding its sales and
marketing staff in late calendar 1996 to more actively pursue international
sales and in early 1997 in anticipation of FDA approval and commercial sales
activities in the United States. By the fourth quarter of fiscal 1998, the
Company further expanded its sales and marketing staff in the United States
from 20 professionals to over 45 professionals as of June 30, 1998. The
Company also expects to continue to add administrative personnel in response
to the recent and potential future business expansion. Accordingly, the
Company expects its future selling, general and administrative expenses to
increase in absolute amount from the amounts incurred during fiscal 1998. In
addition, the Company expects such expenses to increase as a percentage of
net sales in the near term as the Company seeks to rapidly increase its sales
and marketing activities and given the customary delays between increased
sales and marketing expenditures and any increase in revenues.
INTEREST INCOME, NET. Net interest income totaled $2.0 million, $437,000
and $423,000 during the years ended June 30, 1998, 1997 and 1996, respectively.
Interest income increased as a result of higher average cash and investment
balances on hand due to investment of the proceeds from a private placement of
Common Stock completed in March 1997 and from the Company's follow-on public
equity offering completed in October 1997. The Company expects interest and
other income to gradually decline in absolute amount in future periods as the
Company utilizes its resources to fund future working capital requirements.
OTHER (EXPENSE) INCOME, NET. Other income (expense) totaled $11,000,
$(198,000) and $(97,000) during the years ended June 30, 1998, 1997 and 1996,
respectively. For each of these years, other income (expense) consisted
primarily of net gains and losses resulting from foreign currency fluctuations.
The Company expects other income (expense) to fluctuate in future periods
depending upon the mix between international and domestic business activities
and upon fluctuations in currency exchange rates.
INCOME TAXES. At June 30, 1998, the Company had net operating loss
carryforwards for federal income tax purposes of approximately $52.5 million
which expire during the years 2003 through 2013, and tax credit carryforwards
of approximately $1.6 million for federal income tax purposes which expire
during the years 2006 through 2013. Due to its net operating loss history, to
date the Company has established a valuation allowance to fully offset its
deferred tax assets, including those related to its carryforwards, resulting in
no income tax benefit for financial reporting purposes. Current federal income
tax regulations with respect to changes in ownership could limit the
utilization of the Company's net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations primarily
through public and private placements of its securities. The Company had no
short-or long-term borrowings outstanding at June 30, 1998, and had no credit
facilities available at that time.
The Company expects to incur substantial additional costs related to sales
and marketing activities associated with United States and international sales
and marketing activities, expansion of manufacturing capabilities, clinical
trials and regulatory activities and product and process development. The
amount and timing of anticipated expenditures will depend upon numerous factors
both within and outside of the Company's control, including the nature and
timing of marketing and sales activities and the nature and timing of
additional clinical trials for additional indications, both within and outside
the field of epilepsy. Moreover, the Company's ability to generate income from
operations will be dependent upon maintaining and broadening reimbursement
approval from government and third-party payors as well as receiving market
acceptance for the NCP System.
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During fiscal 1998, the Company used approximately $14.8 million in cash
in operating activities. During the fiscal year, inventories increased to $2.1
million at June 30, 1998 from $1.0 million at June 30, 1997 as the Company
built inventory levels in anticipation of higher levels of manufacturing and
sales activities. The Company also used approximately $3.5 million to purchase
capital equipment for its new administrative and manufacturing facility.
During fiscal 1998, the Company raised approximately $47.7 million from the
sale of Common Stock in a public equity offering and received additional
proceeds of approximately $2.7 million related to issuance of its shares,
primarily from the exercise of stock options.
The Company's liquidity will continue to be reduced as amounts are
expended for expansion of sales and marketing activities, manufacturing
expansion, continuing clinical trials and related regulatory affairs, product
and process development and infrastructure development. Although the Company
has no firm commitments, the Company expects to make capital expenditures of
approximately $3.8 million during fiscal 1999, primarily to expand
manufacturing capabilities and to enhance general infrastructure and
facilities.
The Company believes that its current resources will be sufficient to fund
its operations at least through June 30, 2000. This estimate is based on
certain assumptions, which may not hold true. There can be no assurance that
the Company's available cash, cash equivalents, investment securities and
investment income, will be sufficient to meet the Company's capital
requirements through June 30, 2000. The availability of financing either before
or after that time will depend upon a number of important factors, including
the state of the United States capital markets and economy in general and the
health care and medical device segments in particular, the status of the
Company's international and domestic sales activities and the status of the
Company's clinical and regulatory activities. There can be no assurance that
the Company will be able to raise additional capital when needed or that the
terms upon which capital will be available will be favorable to the Company.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
See Note 1 of Notes to Consolidated Financial Statements for a discussion
of the impact of new accounting pronouncements.
IMPACT OF YEAR 2000
Many currently installed computer systems and software products were coded
using two digits rather than four to define the applicable year. As a result
these computer systems and software products have time-sensitive software that
recognize a date using "00" as the year 1900 rather than the year 2000. This
could cause a system failure or miscalculations, causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, to send invoices, or to engage in similar normal business
activities. Finally, computer systems and software products devices may fail
to process accurately leap year logic associated with the Year 2000.
STATE OF READINESS
The Company believes that the adverse impact of Year 2000 issues on its
internal computer systems will not be material. Most of the personal computers
and computer systems used by the Company have been installed in the past three
years, primarily in the past year as the Company has been growing its
organization. The Company has also recently moved most of its organization to
a new facility in Houston, Texas, and has installed new equipment in connection
with such relocation. The Company has conducted a manual review of all of its
software, except for its manufacturing systems and the telephone system at its
Webster manufacturing facility, and found the incidence of Year 2000 coding
issues to be minimal. The Company continues to manufacture the NCP System at
its Webster, Texas facility, but is in the process of establishing
manufacturing capacity at the Houston facility,
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which is expected to be completed in fiscal 1999. The Company is in the
process of evaluating its manufacturing software for Year 2000 compliance,
including systems used at the Webster facility as well as the systems being
implemented at the Houston facility, however, it does not expect that any
necessary changes to its software will be material. In addition, if the
Company continues to manufacture its product at the Webster facility, it
intends to test the telephone system at that location to determine if it is
Year 2000 compliant. The Company has also contacted each of its material
vendors and suppliers to determine if such vendors or suppliers have any Year
2000 compliance issues that have not been resolved, or may not be resolved in
a timely manner.
The Company's software used by customers to program the NCP Generator does
not utilize dating in its processing calculations.
COSTS OF YEAR 2000 COMPLIANCE
The Company does not expect expenditures for upgrades and testing for Year
2000 issues of software used on internal systems to be material. To date, any
such costs incurred have been in connection with the implementation of systems
at its new facility and the purchase of equipment and software for its growing
employee base. The Company estimates that, in the worst case, it may have to
upgrade certain of its manufacturing databases, replace the telephone system at
the Webster location, and replace certain older personal computers currently
being used. The costs of such activities are estimated to be under $100,000.
The Company expects to complete its testing, and any required upgrades by mid
calendar 1999. The Company also does not expect diversion of resources from
other management information systems or manufacturing projects will have a
material adverse impact on the Company.
RISKS OF YEAR 2000 NON-COMPLIANCE AND CONTINGENCY PLANS
In the event of a failure of any software or other electronic devices used
for the Company's internal systems, the Company believes any resulting business
disruption would not have a material adverse effect on the Company, because the
Company believes alternative, less technologically advanced, systems would be
available. The Company is also contacting its vendors and suppliers currently
to determine if a further contingency plan will be needed to ensure timely
receipt of materials and services from such vendors and suppliers.
The costs of the modifications and the date on which the Company believes
it will complete the Year 2000 modifications, if any, are based on management's
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources and other factors.
However, there can be no guarantee that these estimates will be achieved, and
actual results could differ from those anticipated. Factors that might cause
such differences include, but are not limited to, the availability and cost of
personnel trained in this area, the ability to locate an correct all relevant
computer code, and similar uncertainties.
FACTORS AFFECTING FUTURE OPERATING RESULTS
RELIANCE ON SINGLE PRODUCT. The Company has only one product, the NCP
System, which has been approved by the FDA only for a single indication: as an
adjunctive therapy in reducing the frequency of seizures in adults and
adolescents over twelve years of age with partial onset seizures that are
refractory to AEDs. The Company does not expect to have any other product or
approved indication for the NCP System for the foreseeable future. Although the
Company has been able to sell the NCP System in certain countries in Europe
since 1994 and in the United States and Canada since mid 1997, it is only now
in the process of initiating full-scale marketing and sales efforts in the
United States and other countries. The Company's inability to commercialize
successfully the
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NCP System would have a material adverse effect on the Company's business,
financial condition and results of operations.
UNCERTAINTY OF MARKET ACCEPTANCE. Continued market acceptance of the
Company's NCP System will depend on the Company's ability to convince the
medical community of the clinical efficacy and safety of vagus nerve
stimulation and the NCP System, and on the approval and availability of
adequate levels of reimbursement. While the NCP System has been used in
approximately 2,500 patients through June 30, 1998, it provides a new form of
therapy with which many physicians are unfamiliar. The Company believes that
existing AEDs and surgery are the only other approved and currently available
therapies competitive with the NCP System in the treatment of epileptic
seizures. Such therapies may be more attractive to patients or their physicians
than the NCP System in terms of efficacy, cost or reimbursement availability.
There can be no assurance that the NCP System will achieve market acceptance
for the treatment of epilepsy or for any other indication or that adequate
levels of reimbursement from governmental or third-party payors will be
available. Failure of the NCP System to gain market acceptance would have a
material adverse effect on the Company's business, financial condition and
results of operations.
HISTORY OF LOSSES; PROFITABILITY UNCERTAIN; FLUCTUATIONS IN QUARTERLY
OPERATING RESULTS. The Company has incurred net losses and accumulated a
deficit of approximately $63.3 million through June 30, 1998. In July 1997, the
Company received FDA marketing approval which permits the Company to sell the
NCP System in the United States for use as an adjunctive therapy in reducing
the frequency of refractory partial onset seizures in patients over twelve
years of age. In addition, the Company has obtained "CE Marking," the
designation of market approval now accepted by all European Union member
countries, for its NCP System which, when combined with approvals from Canada
and certain other countries, permits the Company to sell the NCP System
internationally. Even with these marketing approvals, there can be no assurance
that the Company will be able to generate adequate sales to achieve
profitability in the future. In addition, in order to develop these markets,
the Company will incur substantial marketing and sales expenses. The amount and
timing of anticipated expenditures will depend on numerous factors, including
the nature and timing of marketing and sales activities, the expansion of the
Company's manufacturing capabilities, the nature and timing of additional
clinical trials, and the Company's product development efforts.
The Company's results of operations may fluctuate significantly from
quarter to quarter and will depend upon numerous factors, many of which are
outside the Company's control. Such factors include, but are not limited to,
the extent to which the Company's NCP System gains market acceptance, timing of
any approvals for reimbursement by third-party payors, the rate and size of
expenditures incurred as the Company expands its sales and marketing efforts
and availability of key components, materials and contract services which may
be dependent on the Company's ability to forecast sales.
LIMITATIONS ON THIRD-PARTY REIMBURSEMENT. The Company's ability to
commercialize the NCP System successfully will depend in part on whether
third-party payors, including private health care insurers, managed care plans,
the United States government's Medicare and Medicaid programs and others, agree
both to cover the NCP System and the procedures and services associated
therewith, and to reimburse at adequate levels for the costs of the NCP System
and the related services.
In deciding to cover a new therapy, third-party payors base their initial
coverage decisions on several factors including, but not limited to, the status
of the FDA's review of the product, 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. There can be no assurance that third-party payors will view the
Company and the NCP System favorably with respect to any of the above factors.
The Company has only
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limited experience in seeking and obtaining coverage decisions from
third-party payors. A failure to achieve favorable coverage decisions for the
NCP System in a timely manner could deter patients and their physicians from
using the NCP System and could have a material adverse effect on the
Company's business, financial condition or results of operations.
Once a favorable coverage determination is made with respect to a product,
payors must determine the level of reimbursement for the product and related
therapy and procedures. In making decisions about reimbursement amounts, third-
party private payors 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 and reimbursed costs.
The Company believes that a significant number of epilepsy patients in the
United States are either eligible for benefits under the Medicare program or
are uninsured. The Medicare program uses different payment mechanisms to
reimburse for procedures performed in different settings. For outpatient
implants, Medicare uses a system that reimburses hospitals based on their
costs. The Company believes that those payments generally are adequate. For
inpatient implants, Medicare uses a fixed-payment method (based on Diagnosis
Related Groups or "DRGs"). Under current DRG groupings, hospital inpatient
procedures for implanting the NCP System are assigned to one of two different
DRGs based on whether or not the patient has complications or comorbidities
(coexisting severe medical problems). The DRG grouping that would include
implantation of the NCP System for patients without complications or
comorbidities pays hospitals less than the costs of purchasing and implanting
the NCP System. The Company believes that this DRG grouping would apply to
most of the epilepsy patients covered by Medicare. In order to assure
adequate reimbursement for all epileptic patients eligible for benefits under
Medicare, the Company may seek changes in the DRG grouping so that NCP System
implant cases would be reclassified to other, higher-paying DRGs. The Company
has only limited experience in seeking and obtaining coverage and payment
approvals from third-party payors, and there can be no assurance that the
Company would be successful in achieving coverage or adequate reimbursement
levels, or that it can obtain new DRG assignments under the Medicare program
to cover the complete costs of therapy using the NCP System. If the Company
is unsuccessful in achieving coverage or adequate reimbursement levels or in
obtaining new DRG assignments, or if hospitals or physicians view their
payments as inadequate, then patients, physicians and hospitals could be
deterred from using the NCP System, which could have a material adverse
effect on the Company's business, financial condition or results of
operations. Medicare uses a resource-based relative value scale to pay for
physicians' services. The Company believes that the relative value scales for
the surgeons and physicians involved in the implantation and interrogation
and reprogramming of the NCP System provide adequate reimbursement for these
physicians' services. See "Business--Third-Party Reimbursement."
In June 1994, the Company was granted approval to use the CE Mark and to
market the NCP System in the European Union. The Company is continuing to
pursue appropriate reimbursement approvals in the European Union member
countries. The Company believes that significant sales volume will be difficult
to generate without appropriate reimbursement approvals. There can be no
assurance as to when or whether such reimbursement will be obtained in any of
the European Union countries or, if obtained, whether the levels of
reimbursement will be sufficient to enable the Company to sell the NCP System
on a profitable basis.
LIMITED MARKETING AND SALES EXPERIENCE. Although the Company has had
approval to market the NCP System in the member countries of the European Union
since 1994, it has only recently received FDA approval to commercialize the NCP
System in the United States and, consequently, it has limited experience in
marketing, direct sales and distribution. The Company has recently expanded its
marketing and sales force for the United States market, but no assurance can be
given that this expanded direct marketing and sales force will succeed in
promoting the NCP System to patients, health care providers or third-party
payors on a broad basis. The Company believes that, to market its products
directly, it must employ a multidisciplinary marketing and sales force with
medical device sales experience, clinical experience with epilepsy, experience
in obtaining reimbursement for new
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medical technologies and experience with peer to peer marketing programs. In
addition, due to the limited market awareness of the NCP System, the Company
believes that the sales process could be lengthy, requiring the Company to
educate patients, health care providers and third-party payors regarding the
clinical benefits and cost-effectiveness of the NCP System. In certain
international territories, the Company relies, and intends to continue
relying, upon independent distributors. There can be no assurance that the
Company will be able to recruit and retain skilled marketing and sales
personnel or foreign distributors, or that the Company's marketing efforts
will be successful. Failure by the Company to successfully market the NCP
System would have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Marketing and
Sales."
LIMITED MANUFACTURING EXPERIENCE. The Company has a limited history of
operations that, to date, has consisted primarily of manufacturing limited
quantities of the NCP System for clinical investigations, for first year
commercial sales activities in the United States and for commercial sales
activities in international markets. The Company does not have experience
manufacturing the NCP System in the volumes that will be necessary to achieve
significant commercial sales. In addition to its existing manufacturing
facility, the Company entered into a lease for a new headquarters and
manufacturing facility, and is in the process of moving its manufacturing
operations to the new facility, which is expected to begin production in
calendar 1999. The Company may encounter difficulties in scaling up production
of the NCP System, in procuring the necessary supply of materials, components
and contract services, or in hiring and training additional manufacturing
personnel to support domestic and international demand. The Company will be
required to obtain FDA approval for its change in the manufacturing facility.
The new manufacturing facility will also have to be inspected for compliance
with the FDA's Quality System regulations ("QSR") and with ISO 9001 and 9002
standards, which impose certain procedural and documentation requirements with
respect to device design, development, manufacturing and quality assurance
activities, before the Company can begin commercial-scale production of the NCP
System at the new manufacturing facility. There can be no assurance that the
Company will be able to obtain the necessary FDA and other approvals for its
new facilities on a timely basis, or at all. If the Company is unable to
achieve commercial-scale production capability on a timely basis with
acceptable quality an manufacturing yield and costs, to sustain such capacity,
or to achieve FDA and other governmental approvals, the ability of the Company
to deliver products on a timely basis could be impaired which could have a
material adverse effect on the Company's business, financial condition or
results of operations. See "Business--Manufacturing and Sources of Supply."
DEPENDENCE ON KEY SUPPLIERS AND MANUFACTURERS. The Company relies upon
sole source suppliers for certain of the key components, materials and contract
services used in manufacturing the NCP System. The Company periodically
experiences discontinuation or unavailability of components, materials and
contract services which may require qualification of alternative sources or, if
no such alternative sources are identified, product design changes. The Company
believes that pursuing and qualifying alternative sources and/or redesigning
specific components of the NCP System, when necessary, could consume
significant Company resources. In addition, such changes generally require
regulatory submissions and approvals. Any extended delays in or inability to
secure alternative sources for these or other components, materials and
contract services could result in product supply and manufacturing
interruptions. These delays could have a material adverse effect on the
Company's ability to manufacture the NCP System on a timely and cost
competitive basis, and therefore on its business, financial condition or
results of operations. See "Business--Manufacturing and Sources of Supply."
RISK OF PRODUCT RECALL. The NCP System includes a complex electronic
device and lead designed to be implanted in the human body. Component failures,
manufacturing errors or design defects could result in an unsafe condition in
patients. The occurrence of such problems or other adverse reactions could
result in a recall of the Company's products, possibly requiring removal (and
potentially reimplantation) of NCP Generators and/or leads. In 1991, a failure
of an NCP System caused permanent paralysis of one patient's left vocal cord.
In addition, several patients experienced vagus nerve lead failures which,
although not harmful to the patient, reduced the efficacy of
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the treatment and required lead replacement. Since the occurrence of these
failures, changes have been made to the Company's product designs and no
similar failures have been reported to the Company. There can be no
assurance, however, that the Company will not experience similar or other
product problems or that the Company will not be required to recall products.
Any product recall could have a material adverse effect on the Company's
business, financial condition or results of operations. See
"Business-Clinical Trials" and "--Government Regulation."
DEPENDENCE ON PATENTS, LICENSES AND PROPRIETARY RIGHTS. The Company's
success will depend in part on its ability to obtain and maintain patent and
other intellectual property protection for the NCP System and its improvements,
and for vagus nerve stimulation therapy. To that end, the Company has acquired
licenses under certain patents and has patented and intends to continue to seek
patents on its own inventions used in its products and treatment methods. The
process of seeking patent protection can be expensive and time consuming and
there can be no assurance that patents will issue from the currently pending or
future applications or that, if patents are issued, they will be of sufficient
scope or strength to provide meaningful protection of the Company's technology,
or any commercial advantage to the Company.
Cyberonics believes that the licenses held by the Company provide it with
protection in the United States in the field of cranial nerve stimulation,
including vagus nerve stimulation for the control of epilepsy, movement
disorders, including Parkinson's disease and essential tremor, 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 United States 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. Litigation, which could result in
substantial cost to and diversion of effort by the Company, may be necessary to
enforce patents issued or licensed to the Company, to protect trade secrets or
know-how owned by the Company or to defend the Company 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 the Company to significant liabilities to third parties, could require
the Company to seek licenses from third parties and could prevent the Company
from manufacturing, selling or using the NCP System, any of which could have a
material adverse effect on the Company's business, financial condition or
results of operations. There can be no assurance that any required license
would be available on acceptable terms, if at all. See "Business-- Patents,
Licenses and Proprietary Rights."
COMPETITION; RAPID TECHNOLOGICAL CHANGE. The Company believes that
existing and future AEDs will be the primary competition for its NCP System.
The Company may also face competition from other medical device companies for
the treatment of partial seizures. Medtronic, Inc. continues to clinically
assess an implantable signal generator used with an invasive deep brain probe
(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. The Company 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 the Company's competitors have substantially
greater financial, manufacturing, marketing and technical resources than the
Company and have obtained third-party reimbursement approvals. In addition, the
health care industry is characterized by extensive research efforts and rapid
technological progress. There can be no assurance that the Company's
competitors will not develop technologies and obtain regulatory approval for
products that are more effective in treating epilepsy than the Company's
current or future products. There can also be no assurance that advancements in
surgical techniques will not make surgery a more attractive therapy for
epilepsy. The development by others of new treatment methods with novel AEDs,
medical devices or surgical techniques for epilepsy could render the NCP System
non-competitive or obsolete. There can be no
-26-
assurance that the Company will be able to compete successfully against
current and future competitors or that competition, including the development
and commercialization of new products and technology, will not have a
material adverse effect on the Company's business, financial condition or
results of operations. See "Business--Competition."
MANAGEMENT OF GROWTH. In connection with the commercialization of the NCP
System in the United States, the Company has begun and intends to continue to
significantly expand the scope of its operations, in particular in
manufacturing and in marketing and sales. Such activities have placed, and may
continue to place, a significant strain on the Company's resources and
operations. The Company's ability to effectively manage such growth will depend
upon its ability to attract, hire and retain highly qualified employees and
management personnel. The Company competes for such personnel with other
companies, academic institutions, government entities and other organizations.
There can be no assurance that the Company will be successful in hiring or
retaining qualified personnel. The Company's success will also depend on the
ability of its officers and key employees to continue to implement and improve
its operational, management information and financial control systems, of which
there can be no assurance. The Company's inability to manage growth effectively
could have a material adverse effect on the Company's business, financial
condition or results of operations. See "Business--Employees."
PRODUCT LIABILITY AND AVAILABILITY OF INSURANCE. The manufacture and sale
of the NCP System entails the risk of product liability claims. Although the
Company maintains product liability insurance, there can be no assurance that
the coverage limits of the Company's insurance policies will be adequate. Such
insurance is expensive and in the future may not be available on acceptable
terms, if at all. A successful claim brought against the Company in excess of
its insurance coverage could have a material adverse effect on the Company's
business, financial condition or results of operations. See "Business--Product
Liability and Insurance."
GOVERNMENT REGULATION. The preclinical and clinical testing,
manufacturing, labeling, sale, distribution and promotion of the NCP System are
subject to extensive and rigorous regulation in the United States by federal
agencies, primarily the FDA, and by comparable state agencies. The NCP System
is regulated as a medical device by the FDA and is subject to the FDA's
premarket approval ("PMA") requirements. In July 1997, the Company received FDA
approval to market the NCP System in the United States for use as an adjunctive
therapy in reducing the frequency of seizures in adults and adolescents over
twelve years of age with partial onset seizures that are refractory to AEDs.
Nonetheless, in the future, it will be necessary for the Company to file PMA
supplements, and apply for additional regulatory approvals, possibly including
new investigational device exemptions ("IDEs") and additional PMAs, for other
applications of the NCP System and for modified or future-generation products.
Commercial distribution in certain foreign countries is also subject to
obtaining regulatory approvals from the appropriate authorities in such
countries. The process of obtaining FDA and other required regulatory approvals
is lengthy, expensive and uncertain. Moreover, regulatory approvals may include
regulatory restrictions on the indicated uses for which a product may be
marketed. Failure to comply with applicable regulatory requirements can result
in, among other things, fines, suspension or withdrawal of approvals,
confiscations or recalls of products, operating restrictions and criminal
prosecution. Furthermore, changes in existing regulations or adoption of new
regulations could prevent the Company from obtaining, or affect the timing of,
future regulatory approvals. There can be no assurance that the Company will be
able to obtain additional future regulatory approvals on a timely basis or at
all. Delays in receipt of or failure to receive such future approvals,
suspension or withdrawal of previously received approvals, or recalls of the
NCP System could have a material adverse effect on the Company's business,
financial condition or results of operations. See "Business--Government
Regulation."
FUTURE CAPITAL REQUIREMENTS. Although the Company believes that its
current resources will be sufficient to meet its capital requirements at least
through June 30, 2000, there can be no assurance that the Company will
-27-
not require additional financing either before or after that date. This
estimate is based on certain assumptions, which may not hold true. There can
be no assurance that the Company's available cash, cash equivalents,
investment securities and investment income, will be sufficient to meet the
Company's capital requirements through June 30, 2000. The Company's future
capital requirements will depend upon numerous factors, including the extent
and timing of future product sales, the scale-up of the Company's
manufacturing facilities, and the nature, timing and success of clinical
trials for additional indications for the NCP System. Such financing, if
required, may not be available on satisfactory terms, or at all. Lack of
access to sufficient financing would impair the Company's ability to fully
pursue its business objectives, which could have a material adverse effect on
the Company's business, financial condition or results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. Although the NCP System
has been approved for commercialization in the European Union countries since
1994, the Company has not generated significant revenues from such countries to
date. The Company currently is expanding its marketing and sales activities in
international markets. There can be no assurance that the Company will
successfully increase international sales or that the Company will be
successful in obtaining reimbursement or any regulatory approvals required in
foreign countries. Changes in overseas economic conditions, currency exchange
rates, foreign tax laws, or tariffs or other trade regulations could have a
material adverse effect on the Company's business, financial condition or
results of operations. The anticipated international nature of the Company's
business is also expected to subject the Company and its representatives,
agents and distributors to laws and regulations of the foreign jurisdictions in
which they operate or where the NCP System is sold. The regulation of medical
devices in a number of such jurisdictions, particularly in the European Union,
continues to develop and there can be no assurance that new laws or regulations
will not have an adverse effect on the Company's business, financial condition
or results of operations. In addition, the laws of certain foreign countries do
not protect the Company's intellectual property rights to the same extent as do
the laws of the United States. In particular, the European Patent Convention
prohibits patents covering methods for the treatment of the human body by
surgery or therapy. See "Business--Patents and Proprietary Rights" and
"--Government Regulation."
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-18 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
-28-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company, their ages as of
August 31, 1998, and certain additional information about them, are as follows:
NAME AGE POSITION
- ------------------------------ --- -------------------------------------------------------------
Robert P. Cummins............. 44 President and Chief Executive Officer
Reese S. Terry, Jr............ 56 Chairman of the Board, Executive Vice President and Secretary
Rick L. Amos.................. 42 Vice President, Sales
William H. Duffell, Jr, Ph.D.. 38 Vice President, Clinical and Regulatory Affairs Ph.D.
Stephen D. Ford............... 48 Vice President, Manufacturing
Shawn P. Lunney............... 35 Vice President, Marketing
Stanley H. Appel, M.D......... 65 Director
Tony Coelho................... 56 Director
Thomas A. Duerden, Ph.D....... 68 Director
Michael J. Strauss, M.D....... 45 Director
Mr. Cummins became a director of the Company in June 1988. He was
appointed President and Chief Executive Officer of the Company in
September 1995. Until September 1995, he 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.
Mr. Terry co-founded the Company in December 1987 and served as a Director
and Chief Executive Officer of the Company until February 1990, when he became
Chairman of the Board and Executive Vice President. Mr. Terry has also served
as Secretary of the Company from its inception and as President of the Company
for four months in 1995. From 1976 to 1986, Mr. Terry held executive positions
with Intermedics, Inc., a medical device and electronics company, including
serving as Vice President of Engineering, Vice President of Corporate Technical
Resources and, most recently, as Vice President of Quality.
Mr. Amos joined the Company as Area Sales Director, Midwest Region, in
July 1997, and became Vice President, Sales in April 1998. Prior to joining
the Company, from July 1996 to July 1997, Mr. Amos was a Cardiovascular
Alliance Manager with Medronic, Inc., a medical device company, and from
September 1990 to July 1996, he served as regional sales manager for Meadox
Medical, Inc., a medical device company.
Dr. Duffell joined the Company as Vice President, Regulatory and Clinical
Affairs in May 1995. Prior to joining the Company, Dr. Duffell held the
position of Director, Regulatory Affairs and Quality Assurance with
Bristol-Meyers Squibb Companies from April 1991 until May 1995, where his
responsibilities included the areas of regulatory affairs, quality assurance
and clinical research in both corporate and divisional capacities. From
March 1987 to March 1989, Dr. Duffell served as Senior Manager, Regulatory
Affairs and Clinical Research with Dornier Medical, Inc., a manufacturer of
extracaporial shock-wave lithotriptors and related gastrointestinal and
urological products.
Mr. Ford joined the Company as Vice President, Manufacturing in March
1992. Prior to joining the Company, Mr. Ford held the position of Manager of
Manufacturing with the Biomedical Products Division of
-29-
McGaw, Inc. from September 1987 to March 1992. From March 1983 to September
1987, Mr. Ford served as Director of Manufacturing at Quest Medical.
Mr. Lunney joined the Company in April 1991 and served in various sales,
marketing and reimbursement planning positions until May 1996, when he became
Vice President, Marketing. Prior to joining the Company, Mr. Lunney held the
position of Sales and Marketing Manager with Perceptive Systems, Inc., a
hospital laboratory medical instrument manufacturer from December 1985 to April
1991.
Dr. Appel has been a director of the Company since December 1996 and the
chair of Company's Scientific Advisory Board since its formation in 1994. Since
1992, Dr. Appel has been Chairman of the Baylor College of Medicine Department
of Neurology.
Mr. Coelho has been a director of the Company since March 1997 and an
independent business consultant since June 1998. From October 1996 to June
1998, Mr. Coelho was the Chairman and Chief Executive Officer of ETC w/tci, the
Washington-based education, training and communications subsidiary of
Tele-Communications, Inc. From January 1990 to September 1995, Mr. Coelho
served as the President and Chief Executive Officer of Wertheim Schroder
Investment Services, Inc., an asset management firm, and from October 1989 to
September 1995, he served as Managing Director of Wertheim Schroder and Co., an
investment banking firm. Mr. Coelho served in the United States House of
Representatives from California from 1979 to 1989, and served as House Majority
Whip from 1986 to 1989. Mr. Coelho is also a member of the Board of Directors
of ICF Kaiser International, Inc., ITT Educational Services, Inc., Service
Corporation International and TEI, Inc.
Dr. Duerden has been a director of the Company since March 1989 and an
independent business consultant since January 1990. From December 1988 through
January 1990, Dr. Duerden served as Chairman of the Board and Chief Executive
Officer of Tonometrics, Inc., a medical diagnostic device company. From 1979
through 1988, Dr. Duerden served as Chairman and Chief Executive Officer of
Electro Biology, Inc., an orthopedic device company.
Dr. Strauss has been a director of the Company since March 1997. Since
June 1988, Dr. Strauss served first as President and later as Corporate Vice
President and General Manager at Covance Health Economics and Outcomes Services
Inc. (formerly Health Technology Associates, Inc.), a consulting and research
services firm specializing in third-party payor issues.
BOARD COMPOSITION
Pursuant to a letter agreement dated March 28, 1997, the Clark Estates is
entitled to designate one person to serve on the Company's Board of Directors
for as long as the Clark Estates retains at least 600,000 of the aggregate of
901,408 shares of Common Stock purchased on such date by parties affiliated
with the Clark Estates. To date, the Clark Estates has not exercised this
right.
BOARD MEETINGS AND COMMITTEES
The Board of Directors of the Company held a total of six (6) meetings and
acted by written consent one (1) time during the fiscal year ended June 30,
1998. The Board has an Audit Committee and a Compensation Committee. There is
no nominating committee or other committee performing a similar function.
-30-
The Audit Committee, which consists of Thomas A. Duerden and Michael J.
Strauss, M.D., held three (3) meetings during the fiscal year ended June 30,
1998. This Committee recommends engagement of the Company's independent public
accountants and is primarily responsible for approving the services performed
by such accountants and for reviewing and evaluating the Company's accounting
principles and its system of internal accounting controls.
The Compensation Committee, which consists of director Tony Coelho and
Stanley H. Appel, held one meeting and acted by written consent 46 times during
the fiscal year ended June 30, 1998. This Committee establishes salary and
incentive compensation of the executive officers of the Company and administers
the Company's employee benefit plans.
During the fiscal year ended June 30, 1998, all current directors attended
at least seventy five percent of the meetings of the Board of Directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between the Company's Board of
Directors or Compensation Committee and the board of directors or compensation
committee of any other company, nor has any such interlocking relationship
existed in the past.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who own more than ten percent of
a registered class of the Company's equity securities, to file reports of
ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the
Securities and Exchange Commission (the "SEC"). Such officers, directors and
ten-percent stockholders are also required by SEC rules to furnish the Company
with copies of all Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by it, the
Company believes that, for the fiscal year ended June 30, 1998, all Section
16(a) filing requirements applicable to its officers, directors and ten-percent
stockholders were complied with, except as follows: (1) William H. Duffell did
not file two Form 4's for option exercises in February and March 1998; a Form 5
was filed in August 1998 covering those option exercises; (2) Reese S. Terry
did not file a Form 4 for an option exercise in May 1998; a Form 5 was filed in
August 1998 reporting such option exercise; and (3) Rick L. Amos became a
reporting person on April 28, 1998, but did not file a Form 3 until August
1998.
-31-
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table sets forth the
compensation paid by the Company for the year ended June 30, 1998 to the Chief
Executive Officer of the Company and each of the other most highly compensated
executive officers of the Company whose total compensation exceeded $100,000
(collectively, the "Named Executive Officers"):
Vice President, Sales
SECURITIES
UNDERLYING
OPTIONS (#)
-----------
SALARY ($) BONUS ($) LONG-TERM
FISCAL ---------- --------- COMPENSATION ALL OTHER
NAME AND PRINCIPAL POSITION YEAR ANNUAL COMPENSATION AWARDS COMPENSATION
- ----------------------------------- ------ -------------------- ------------ ------------
Robert P. Cummins(1)............... 1998 $200,000 $ 56,000 250,000 $ 253(2)
President and Chief Executive 1997 196,596 68,530 356,000 294(2)
Officer 1996 140,758 32,930 50,000 8,194(2)(3)
Reese S. Terry, Jr................. 1998 $147,000 $ 41,160 -- $ 4,114(2)
Chairman of the Board and 1997 146,693 32,596 63,500 6,705(2)
Executive Vice President 1996 130,880 32,950 -- 5,321(2)
William H. Duffell, Jr., Ph.D.(4).. 1998 $157,500 $ 44,100 51,235 $ 257(2)
Vice President, Clinical and 1997 157,356 32,963 90,000 13,952(5)
Regulatory Affairs 1996 150,000 27,886 -- 27,881(6)
John K. Bakewell(7)................ 1998 135,000 $ 37,800 50,000 $ 213(2)
Vice President Finance and 1997 131,187 29,527 135,000 263(2)
Administration and Chief 1996 105,502 27,537 -- 225(2)
Financial Officer
Rick L. Amos(8).................... 1998 140,769 $165,427(9) 175,000 $ 5,831(2)(10)
Vice President, Sales
- ------------------
(1) Mr. Cummins became an executive officer of the Company in fiscal 1996.
(2) Represents premiums paid by the Company for term life insurance (except
as set forth below).
(3) Also includes $7,900 paid to Mr. Cummins in fiscal 1996 as a travel/auto
allowance.
(4) Dr. Duffell joined the Company in 1995. Dr. Duffell's bonus in fiscal
1996 includes a $10,000 bonus related to Dr. Duffell's relocation to
Houston.
(5) Represents $332 paid by the Company for term life insurance and $13,620
paid to Dr. Duffell for expenses related to relocation to Houston.
(6) Represents $315 paid by the Company for term life insurance and $27,566
paid to Dr. Duffell for expenses related to relocation to Houston.
(7) Mr. Bakewell resigned from his position with the Company in July 1998.
(8) Mr. Amos joined the Company in July 1997 as Area Sales Director-Midwest
Region, and became Vice President, Sales in April 1998.
(9) Includes $158,427 in sales commissions based on Mr. Amos' performance
as an Area Sales Director.
(10) Also includes an $5,631 Area Sales Director automobile allowance.
-32-
OPTION GRANTS IN LAST FISCAL YEAR. The following table sets forth each
grant of stock options made during the year ended June 30, 1998 to each of the
Named Executive Officers:
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
---------------------------------------------------------- VALUE AT ASSUMED
PERCENT OF ANNUAL RATES OF STOCK
NUMBER OF TOTAL OPTIONS PRICE APPRECIATION
SECURITIES GRANTED TO FOR OPTION TERM($)(2)
UNDERLYING EMPLOYEES IN EXERCISE ---------------------
OPTIONS FISCAL PRICE EXPIRATION
NAME GRANTED(#) YEAR(2) ($/SH) DATE 5% 10%
- ------------------------ ----------- -------------- ---------- ---------- ---------- ---------
Robert P. Cummins....... 250,000 5.5% $15.125 10/13/2007 $2,378,008 $6,026,339
Reese S. Terry, Jr...... -- -- -- -- -- --
John K. Bakewell (3).... 50,000 1.1% $15.125 10/13/2007 475,602 1,205,268
William H. Duffell, Jr.,
Ph.D.................. 50,000 1.1% $15.125 10/13/2007 475,602 1,205,268
1,235 * $ 9.56 02/09/2008 7,425 18,817
Rick L. Amos............ 75,000 1.7% $ 7.25 07/15/2007 341,961 866,597
100,000 2.2% $ 13.75 05/19/2008 864,730 2,191,396
- ------------------
* Less than 0.1%
(1) Total number of shares subject to options granted to employees in fiscal
1998 was 4,518,154 which number includes options granted to employee
directors.
(2) Potential realizable value is based on an assumption that the stock price
appreciates at the annual rate shown (compounded annually) from the date of
grant until the end of the ten-year option term. These numbers are
calculated based on the requirements promulgated by the SEC and do not
reflect the Company's estimate of future stock price growth.
(3) Mr. Bakewell resigned from his position with the Company in July 1998.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END VALUES.
The following table sets forth, for each of the Named Executive Officers, each
exercise of stock options during the fiscal year ended June 30, 1998 and the
year-end value of unexercised options:
NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES VALUE UNDERLYING UNEXERCISED IN-THE-MONEY
ACQUIRED REALIZED OPTIONS AT FISCAL YEAR-END OPTIONS AT FISCAL YEAR-END
NAME ON EXERCISE(#) ($)(1) EXERCISABLE/UNEXERCISABLE(#)(2) EXERCISABLE/UNEXERCISABLE($)(3)
- -------------------------------- -------------- ---------- ------------------------------- -------------------------------
Robert P. Cummins............... 8,000 $ 80,625 383,334/216,666 $ 2,646,875/$0
Reese S. Terry, Jr.............. 9,000 65,813 44,500/10,000 $ 336,531/$75,625
John K. Bakewell (4)............ -- -- 169,665/55,335 $1,223,399/$88,789
William H. Duffell, Jr., Ph.D... 64,998 1,378,958 94,901/66,336 $ 696,690/$169,640
Rick L. Amos.................... 14,000 336,000 4,853/156,147 $ 10,756/$195,119
- ------------------
(1) Represents market value of underlying securities at date of exercise less
option exercise price.
(2) Options granted by the Company generally vest over a four-year period
such that 12.5% of the shares subject to the option vest on the six month
anniversary of the grant date, and 1/48 of the optioned shares vest each
month thereafter until fully vested.
(3) Market value of underlying securities at fiscal year-end ($10.625/per
share) minus the exercise price.
(4) Mr. Bakewell resigned from his position with the Company in July 1998.
BOARD COMPENSATION
Directors do not receive any cash compensation for their services as
members of the Board of Directors. Nonemployee directors are eligible for
discretionary option grants under the Company's 1996 Option Plan. During fiscal
1998, each nonemployee director was granted an option to purchase 5,000 shares
of Common Stock with an exercise price equal to the fair market value of the
Common Stock on the date of grant.
-33-
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of August 31, 1998 certain information
with respect to the beneficial ownership of Cyberonics Common Stock (i) by each
person known by Cyberonics to own beneficially more than five percent of the
outstanding shares of Cyberonics Common Stock, (ii) by each director of
Cyberonics, (iii) by each of the Chief Executive Officer and four other most
highly paid executive officers of Cyberonics who earned over $100,000 in fiscal
1998 and were officers as of August 31, 1998 and (iv) by all directors and
executive officers as a group. Except as otherwise noted below, Cyberonics
knows of no agreements among its stockholders which relate to voting or
investment of its shares of Cyberonics Common Stock.
SHARES PERCENTAGE OF
BENEFICIALLY OUTSTANDING SHARES
NAME OF BENEFICIAL OWNER OWNED(1) OWNED(1)
- ------------------------ ------------ ------------------
St. Jude Medical, Inc.(2)............................ 1,501,181 8.7%
One Lillehei Plaza
St. Paul, MN 55117-9983
The Clark Estates(3)................................. 1,426,208 8.3%
30 Wall Street
New York, NY 10005
Reese S. Terry, Jr.(4)............................... 735,500 4.2%
Robert P. Cummins(5)................................. 564,951 3.2%
William H. Duffell, Jr., Ph.D.(6).................... 171,348 1.0%
Stanley H. Appel, M.D.(7)............................ 116,300 *
Thomas A. Duerden, Ph.D.(8).......................... 53,000 *
Tony Coelho(9)....................................... 44,432 *
Michael J. Strauss, M.D.(10)......................... 40,000 *
Rick L. Amos(11)..................................... 30,470 *
All executive officers and directors as a group
(10 persons)(12)................................... 2,056,145 11.3%
- ------------------
* Less than 1%
(1) Based on total shares outstanding of 17,278,407 at August 31, 1998.
Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Shares of Cyberonics Common Stock subject to options and
warrants currently exercisable, or exercisable within 60 days, are deemed
outstanding for computing the percentage of the person holding such options
but are not deemed outstanding for computing the percentage of any other
person. Except as indicated by footnote, and subject to community property
laws where applicable, the persons named in the table have sole voting and
investment power with respect to all shares of Cyberonics Common Stock
shown as beneficially owned by them.
(2) In connection with the acquisition of these shares, St. Jude also
entered into a Stockholders' Agreement which provides, among other
things, that St. Jude will not acquire additional shares of Common
Stock.
(3) Pursuant to a letter agreement dated March 28, 1997, the Clark Estates is
entitled to designate one person to serve on the Company's Board of
Directors for as long as the Clark Estates retains at least 600,000 of the
aggregate of 901,408 shares of Common Stock purchased on such date by
parties affiliated with the Clark Estates. To date, the Clark Estates has
not exercised this right.
(4) Includes 134,500 shares held in trusts for the benefit of Mr. Terry's
children of which Mr. Terry serves as trustee. Also includes 44,500 shares
subject to options exercisable on or before October 31, 1998.
(5) Includes 10,000 shares held in trust for the benefit of Mr. Cummins'
children of which Mr. Cummins serves as trustee. Also includes 400,001
shares subject to options exercisable on or before October 31, 1998.
-34-
(6) Includes 101,000 shares subject to options exercisable on or before
October 31, 1998.
(7) Includes 72,500 shares subject to options exercisable on or before
October 31, 1998.
(8) Includes 32,500 shares subject to options exercisable on or before
October 31, 1998.
(9) Includes 40,832 shares subject to options exercisable on or before
October 31, 1998.
(10) Includes 22,500 shares subject to options exercisable on or before
October 31, 1998.
(11) Includes 17,770 shares subject to options exercisable on or before
October 31, 1998
(12) Includes 1,014,853 shares subject to options held by executive officers
and directors, which options are exercisable on or before October 31, 1998.
Also includes shares which may be determined to be beneficially owned by
executive officers and directors. See Notes 4 through 11.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain stockholders of the Company, including Messrs. Cummins and Terry,
Drs. Appel and Duffell and venture capital firms formerly affiliated with
Mr. Cummins, are entitled to certain registration rights with respect to the
Common Stock held by them.
As of June 30, 1998, Rick L. Amos, Vice President, Sales of the Company,
owed the Company $100,000 under a loan for such amount provided to Mr. Amos in
fiscal 1998 to cover certain relocation expenses. The loan bears interest at
8-1/2% per annum, and is secured by the shares of Cyberonics common stock
held by or underlying options held by Mr. Amos. All principal and interest on
the loan is due on the earliest to occur of (i) the termination of Mr. Amos'
employment with the Company, regardless of the reason for such termination,
(ii) the closing of a merger or reorganization of the Company or the sale of
all or substantially all of the assets of the Company, and (iii) December 31,
2000, provided that if Mr. Amos sells any shares of Cyberonics common stock
held by him or issued to him upon exercise of options held by him, the
proceeds from such sale shall be used to repay the principal and accrued
interest in whole or in part even if such sale occurs prior to the due date
of the loan.
The Company's Bylaws provide that the Company is required to indemnify its
officers and directors to the fullest extent permitted by Delaware law,
including those circumstances in which indemnification would otherwise be
discretionary, and that the Company is required to advance expenses to its
officers and directors as incurred. Further, the Company has entered into
indemnification agreements with its officers and directors. The Company
believes that its charter and bylaw provisions and indemnification agreements
are necessary to attract and retain qualified persons as directors and
officers.
The Company believes that all of the transactions set forth above were
made on terms no less favorable to the Company than could have been obtained
from unaffiliated third parties. All future transactions between the Company
and its officers, directors, principal stockholders and affiliates will be
approved by a majority of the Board of Directors, including a majority of the
independent and disinterested outside directors on the Board of Directors, and
will be on terms no less favorable to the Company than could be obtained from
unaffiliated third parties.
-35-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed with Report
1. FINANCIAL STATEMENTS. The following consolidated financial statements of
Cyberonics, Inc. and subsidiary, and the Report of Independent Public
Accountants are included at pages F-1 through F-18 of this Form 10-K:
PAGE
DESCRIPTION NO.
- ----------- ----
Report of Independent Public Accountants..................... F-2
Consolidated Balance Sheets as of June 30, 1998 and 1997..... F-3
Consolidated Statements of Operations for the Three Years
Ended June 30, 1998........................................ F-4
Consolidated Statements of Stockholders' Equity for the
Three Years Ended June 30, 1998............................ F-5
Consolidated Statements of Cash Flows for the Three Years
Ended June 30, 1998........................................ F-6
Notes to Consolidated Financial Statements................... F-7
2. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
3.1(1) Restated Certificate of Incorporation of Registrant.
3.2(1) Bylaws of Registrant.
4.1(2) Preferred Shares Rights Agreement, dated as of March 4, 1997 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.
10.1(1)* 1988 Incentive Stock Plan, as amended.
10.2(1)* 1991 Employee Stock Purchase Plan.
10.3(1) License Agreement dated March 15, 1988 between the Registrant and
Dr. Jacob Zabara.
10.4(1) Patent License Agreement effective as of July 28, 1989 between the
Registrant and Huntington Medical Research Institute.
10.5(3) 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.
10.6(1) Form of Indemnification Agreement.
10.7(1) Amended and Restated Stockholders Agreement dated October 16, 1992.
10.8(4) Registration Rights Agreement dated March 28, 1997.
10.9(5)* 1996 Stock Option Plan.
10.10(3) Stockholders' Agreement dated April 8, 1996 between the Registration
and St. Jude Medical, Inc.
10.11(3) Letter Agreement dated March 28, 1997 between the Clark Estates and
the Registrant.
10.12(6) Lease Agreement dated August 19, 1997 between the Registrant and Space
Assets II, Inc.
10.13(7)* 1997 Stock Plan.
10.14* 1998 Stock Option Plan.
21.1(3) List of Subsidiaries of the Registrant.
23.1 Consent of Independent Public Accountants.
27 Financial Data Schedule.
- ------------------
(1) Incorporated by reference to the Company's Registration Statement on
Form S-1 (Reg. No. 33-45118) declared effective February 10, 1993.
(2) Incorporated by reference to the Company's Registration Statement on
Form 8-A (Commission File No. 000-19806) filed on March 6, 1997.
(3) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended June 30, 1997.
-36-
(4) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997.
(5) Incorporated by reference to the Company's Registration Statement on Form
S-8 (Reg. No. 333-19785) filed on January 14, 1997.
(6) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended June 30, 1997.
(7) Incorporated by reference to the Company's Report on Form 14A filed on
November 26, 1997.
* Document indicated is a compensatory plan.
(b) Reports on Form 8-K.
Not Applicable
(c) Exhibits
See Item 14(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/ Robert P. Cummins
----------------------------------------
Robert P. Cummins
President and Chief Executive Officer
September 25, 1998
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Reese S. Terry, Jr. and Robert P.
Cummins, 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/ Reese S. Terry, Jr.
- ------------------------------- Chairman of the Board and Executive September 25, 1998
Reese S. Terry, Jr. Vice President
/s/ Robert P. Cummins
- ------------------------------- President, Chief Executive Officer September 25, 1998
Robert P. Cummins and Director (Principal Executive
Officer, Principal Financial and
Accounting Officer)
/s/ Stanley H. Appel, M.D.
- ------------------------------- Director September 25, 1998
Stanley H. Appel, M.D.
/s/ Tony Coelho
- ------------------------------- Director September 25, 1998
Tony Coelho
/s/ Thomas A. Duerden, Ph.D.
- ------------------------------- Director September 25, 1998
Thomas A. Duerden, Ph.D.
/s/ Michael J. Strauss
- ------------------------------- Director September 25, 1998
Michael J. Strauss
-38-
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- --------- -----------
3.1(1) Restated Certificate of Incorporation of Registrant.
3.2(1) Bylaws of Registrant.
4.1(2) Preferred Shares Rights Agreement, dated as of March 4, 1997 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.
10.1(1)* 1988 Incentive Stock Plan, as amended.
10.2(1)* 1991 Employee Stock Purchase Plan.
10.3(1) License Agreement dated March 15, 1988 between the Registrant and
Dr. Jacob Zabara.
10.4(1) Patent License Agreement effective as of July 28, 1989 between the
Registrant and Huntington Medical Research Institute.
10.5(3) 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.
10.6(1) Form of Indemnification Agreement.
10.7(1) Amended and Restated Stockholders Agreement dated October 16, 1992.
10.8(4) Registration Rights Agreement dated March 28, 1997.
10.9(5)* 1996 Stock Option Plan.
10.10(3) Stockholders' Agreement dated April 8, 1996 between the Registration
and St. Jude Medical, Inc.
10.11(3) Letter Agreement dated March 28, 1997 between the Clark Estates and
the Registrant.
10.12(6) Lease Agreement dated August 19, 1997 between the Registrant and Space
Assets II, Inc.
10.13(7)* 1997 Stock Plan.
10.14* 1998 Stock Option Plan.
21.1(3) List of Subsidiaries of the Registrant.
23.1 Consent of Independent Public Accountants.
27 Financial Data Schedule.
- ------------------
(1) Incorporated by reference to the Company's Registration Statement on
Form S-1 (Reg. No. 33-45118) declared effective February 10, 1993.
(2) Incorporated by reference to the Company's Registration Statement on
Form 8-A (Commission File No. 000-19806) filed on March 6, 1997.
(3) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended June 30, 1997.
(4) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997.
(5) Incorporated by reference to the Company's Registration Statement on Form
S-8 (Reg. No. 333-19785) filed on January 14, 1997.
(6) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended June 30, 1997.
(7) Incorporated by reference to the Company's Report on Form 14A filed on
November 26, 1997.
* Document indicated is a compensatory plan.
-39-
CYBERONICS, INC.
CONSOLIDATED FINANCIAL STATEMENTS
AS OF JUNE 30, 1998
TOGETHER WITH AUDITORS' REPORT
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Cyberonics, Inc.:
We have audited the accompanying consolidated balance sheets of Cyberonics,
Inc. (a Delaware corporation), and subsidiary as of June 30, 1998 and 1997,
and the related consolidated statements of operations, stockholders' equity
and cash flows for each of the three years in the period ended June 30, 1998.
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 generally accepted auditing
standards. 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 June 30, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years
in the period ended June 30, 1998, in conformity with generally accepted
accounting principles.
/s/ ARTHUR ANDERSEN LLP
Houston, Texas
August 13, 1998
F-2
CYBERONICS, INC.
CONSOLIDATED BALANCE SHEETS
June 30,
---------------------------
1998 1997
------------ ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,695,385 $ 781,639
Securities held to maturity 36,341,958 7,129,409
Accounts receivable, net 5,858,634 548,542
Inventories 2,103,603 1,005,356
Prepaid expenses 1,163,123 126,799
------------ -----------
TOTAL CURRENT ASSETS 47,162,703 9,591,745
Securities held to maturity 2,106,716 212,408
Property and equipment, net 3,152,983 362,333
Other assets, net 192,892 83,251
------------ -----------
$ 52,615,294 $10,249,737
------------ -----------
------------ -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,690,295 $ 365,351
Accrued liabilities 4,226,280 1,462,914
------------ -----------
TOTAL CURRENT LIABILITIES 7,916,575 1,828,265
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; 25,000,000 shares
authorized; 17,266,433 and 13,322,175 shares issued and
outstanding at June 30, 1998 and 1997, respectively 172,664 133,222
Additional paid-in capital 107,757,504 57,338,856
Deferred compensation - (63,750)
Accumulated deficit (63,341,714) (49,167,002)
Cumulative translation adjustment 110,265 180,146
------------ -----------
TOTAL STOCKHOLDERS' EQUITY 44,698,719 8,421,472
------------ -----------
$ 52,615,294 $10,249,737
------------ -----------
------------ -----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-3
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended June 30,
-------------------------------------------
1998 1997 1996
------------- ------------ ------------
Net sales $ 14,912,868 $ 1,372,005 $ 1,416,965
Cost of sales 3,902,468 372,180 411,562
------------- ------------ ------------
GROSS PROFIT 11,010,400 999,825 1,005,403
OPERATING EXPENSES:
Research and development 7,391,426 6,549,474 8,024,502
Selling, general and administrative 19,781,268 5,933,852 3,420,111
------------- ------------ ------------
Total operating expenses 27,172,694 12,483,326 11,444,613
------------- ------------ ------------
LOSS FROM OPERATIONS (16,162,294) (11,483,501) (10,439,210)
Interest income, net 1,976,792 436,813 423,044
Other income (expense), net 10,790 (198,143) (97,084)
------------- ------------ ------------
NET LOSS $ (14,174,712) $(11,244,831) $(10,113,250)
------------- ------------ ------------
------------- ------------ ------------
BASIC AND DILUTED NET LOSS PER SHARE $ (.88) $ (.93) $ (1.06)
------------- ------------ ------------
------------- ------------ ------------
SHARES USED IN COMPUTING BASIC AND
DILUTED NET LOSS PER SHARE 16,104,922 12,030,171 9,513,038
------------- ------------ ------------
------------- ------------ ------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-4
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Additional Cumulative
------------------------- Paid-in Deferred Accumulated Translation
Shares Amount Capital Compensation Deficit Adjustment
---------- --------- ------------- ------------ ------------ ------------
Balance at June 30, 1995 9,499,261 $ 94,993 $ 39,329,006 $ (131,800) $(27,808,921) $ (39,723)
Stock options exercised 63,849 638 44,875 - - -
Issuance of Common Stock under
Employee Stock Purchase Plan 14,005 140 54,485 - - -
Effect of employee terminations on
deferred compensation and related balances - - (166,764) 56,264 - -
Amortization of deferred compensation - - - 71,076 - -
Translation adjustment - - - - - 74,031
Net loss - - - - (10,113,250) -
---------- --------- ------------- ------------ ------------ -----------
Balance at June 30, 1996 9,577,115 95,771 39,261,602 (4,460) (37,922,171) 34,308
Issuance of Common Stock in
corporate relationship 2,181,818 21,818 11,154,663 - - -
Issuance of Common Stock in
private placement 1,534,374 15,344 6,768,599 - - -
Stock options exercised 10,734 108 13,914 - - -
Issuance of Common Stock under
Employee Stock Purchase Plan 18,134 181 47,423 - - -
Deferred compensation relating to
issuance of certain stock options - - 76,500 (76,500) - -
Amortization of deferred compensation and
expenses related to certain stock options - - 16,155 17,210 - -
Translation adjustment - - - - - 145,838
Net loss - - - - (11,244,831) -
---------- --------- ------------- ------------ ------------ -----------
Balance at June 30, 1997 13,322,175 133,222 57,338,856 (63,750) (49,167,002) 180,146
Issuance of Common Stock in public
equity offering, net of offering costs 3,225,000 32,250 47,624,220 - - -
Stock options and warrants exercised 709,121 7,091 2,665,309 - - -
Issuance of Common Stock under
Employee Stock Purchase Plan 10,137 101 55,973 - - -
Deferred compensation relating to
issuance of certain stock options - - 73,146 (73,146) - -
Amortization of deferred compensation and
expenses related to certain stock options - - - 136,896 - -
Translation adjustment - - - - - (69,881)
Net loss - - - - (14,174,712) -
---------- --------- ------------- ------------ ------------ -----------
Balance at June 30, 1998 17,266,433 $ 172,664 $ 107,757,504 $ - $(63,341,714) $ 110,265
---------- --------- ------------- ------------ ------------ -----------
---------- --------- ------------- ------------ ------------ -----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-5
CYBERONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended June 30,
-----------------------------------------------------
1998 1997 1996
------------- ------------- -------------
CASH FLOW FROM OPERATING ACTIVITIES:
Net loss $(14,174,712) $(11,244,831) $(10,113,250)
Noncash items included in net loss:
Depreciation 697,420 253,615 273,905
Compensation expense (income) related to certain stock
options 136,896 33,365 (39,424)
Change in operating assets and liabilities:
Accounts receivable (5,310,092) (75,504) (133,380)
Inventories (1,098,247) (333,520) (66,280)
Prepaid expenses (1,036,324) 131,786 8,721
Accounts payable and accrued liabilities 6,088,310 (654,728) 427,581
Other (109,641) (73,510) 3,738
------------ ------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (14,806,390) (11,963,327) (9,638,389)
CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of property and equipment (3,488,070) (283,067) (124,811)
Purchases of marketable securities (75,229,726) (11,614,676) (3,181,598)
Maturities of marketable securities 44,122,869 4,352,891 6,091,192
------------ ------------ ------------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (34,594,927) (7,544,852) 2,784,783
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock 50,384,944 18,022,050 100,138
Payments of capital lease obligations - - (61,626)
------------ ------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 50,384,944 18,022,050 38,512
------------ ------------ ------------
Effect of exchange rate changes on cash and cash equivalents (69,881) 145,838 74,031
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 913,746 (1,340,291) (6,741,063)
Cash and cash equivalents at beginning of year 781,639 2,121,930 8,862,993
------------ ------------ ------------
Cash and cash equivalents at end of year $ 1,695,385 $ 781,639 $ 2,121,930
------------ ------------ ------------
------------ ------------ ------------
INVESTING AND FINANCING ACTIVITIES NOT RESULTING IN CASH RECEIPTS OR PAYMENTS
CONSIST OF THE DEFERRAL OF COMPENSATION COSTS INCURRED IN THE ISSUANCE OF
CERTAIN STOCK OPTIONS TOTALING $73,146 AND $76,500 DURING THE YEARS ENDED
JUNE 30, 1998 AND 1997, RESPECTIVELY, AND RECLASSIFICATIONS OF $56,264 OF
DEFERRED COMPENSATION TO ADDITIONAL PAID-IN CAPITAL DURING THE YEAR ENDED JUNE
30, 1996.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-6
CYBERONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RELATED DATA
NATURE OF OPERATIONS. Cyberonics, Inc. ("Cyberonics" or the "Company"),
designs, develops, manufactures and markets medical devices which deliver a
novel therapy, vagus nerve stimulation (VNS-TM-), for the treatment of
epilepsy and other debilitating neurological disorders. In July 1997,
Cyberonics' sole product, its proprietary implantable device, the
NCP-Registered Trademark-System, was approved by the United States Food and
Drug Administration ("FDA") for commercial distribution in the United States,
where the Company presently markets it using its own employee-based direct
sales organization. In addition, the NCP System is marketed internationally
(principally in Europe) using a combination of the Company's own direct sales
organization and independent distributors. Cyberonics is headquartered in
Houston, Texas.
The Company's future success is dependent upon a number of factors which
include, among others, obtaining and maintaining regulatory and reimbursement
approvals for its products, achieving market acceptance and generating
sufficient sales volume, the possibility of competition and technological
changes, developing its sales and marketing 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 financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
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. Gains and losses resulting
from foreign currency transactions denominated in currency other than the
functional currency are included in other income and expense.
CASH AND CASH EQUIVALENTS. The Company considers all highly liquid
investments with a maturity of three months or less at the time of purchase
to be cash equivalents.
F-7
MARKETABLE SECURITIES. At June 30, 1998 and 1997, the Company's investment
portfolios consisted of securities held to maturity that are reported at
amortized cost. Securities held to maturity are primarily corporate bonds
and commercial paper, international treasury obligations, and asset-backed
investments with various maturity dates ranging up to approximately 30 months
and have a fair market value of $38,260,506 and $7,382,721 as of June 30, 1998
and 1997, respectively. At June 30, 1998 and 1997, the Company's investment
portfolio consists of the
following:
1998 1997
---------------------------- --------------------------
Fair Market Carrying Fair Market Carrying
Value Value Value Value
------------- ------------- ------------ ------------
Securities held to maturity-
Current-
Corporate bonds and commercial paper $ 34,391,325 $ 34,862,020 $ 6,668,976 $ 6,636,281
International treasury obligations 1,459,875 1,479,938 500,000 493,128
------------- ------------- ------------ ------------
35,851,200 36,341,958 7,168,976 7,129,409
Noncurrent-
Asset-backed investments 2,409,306 2,106,716 - -
Corporate bonds and commercial paper - - 213,745 212,408
------------- ------------- ------------ ------------
2,409,306 2,106,716 213,745 212,408
------------- ------------- ------------ ------------
Total $ 38,260,506 $ 38,448,674 $ 7,382,721 $ 7,341,817
------------- ------------- ------------ ------------
------------- ------------- ------------ ------------
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. For financial reporting purposes, the Company computes
depreciation using the double declining balance method over useful lives
ranging from three to seven years.
STOCK OPTIONS. The Company has adopted the disclosure-only provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation," which disclosures are presented in Note 6, "Stock
Incentive and Purchase Plans." Because of this election, the Company
continues to account for its employee stock-based compensation plans under
Accounting Principles Board ("APB") Opinion No. 25 and the related
interpretations. Accordingly, deferred compensation is recorded for
stock-based compensation grants based on the excess of the market value of
the common stock on the measurement date over the exercise price. The
deferred compensation is amortized over the vesting period of each unit of
stock-based compensation. If the exercise price of the stock-based
compensation grant is equal to the market price of the Company's stock on the
date of grant, no compensation expense is recorded.
REVENUE RECOGNITION. Revenue from product sales is generally recognized upon
shipment to the customer, net of estimated returns and allowances. United
States sales activities prior to the Company's July 1997 receipt of FDA
approval have depended entirely upon the Company conducting clinical trial
activities under arrangements with certain investigational centers, some of
which employed risk-sharing provisions. Sales made under such risk-sharing
arrangements in the United States were deferred until Cyberonics received
payment from the centers and the centers in turn received third-party
reimbursement or satisfied other terms set forth in their respective
arrangements.
F-8
ACCOUNTS RECEIVABLE. The Company's allowance for doubtful accounts totaled
$505,560 and $58,826 at June 30, 1998 and 1997, respectively. During fiscal
1998, the Company made additional provisions of $446,734 and recorded no
write-offs against the allowance.
RESEARCH AND DEVELOPMENT. All research and development costs are expensed as
incurred.
WARRANTY EXPENSE. The Company provides at the time of shipment for the
estimated costs which may be incurred under its product warranties.
LICENSE AGREEMENTS. The Company has executed licensing agreements under
which it has secured the rights provided under certain patents. License fees
and royalties, payable under the terms of these agreements, are expensed as
incurred.
INCOME TAXES. Cyberonics accounts for income taxes in accordance with the
liability method prescribed by Financial Accounting Standards Board SFAS No.
109, "Accounting for Income Taxes." 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.
NET LOSS PER SHARE. The Company's net loss per share is based on the
weighted average number of common shares outstanding. Common equivalent
shares, consisting of the effect of stock options and warrants, are excluded
from the per share calculations, as the effect of their inclusion is
antidilutive. In March 1997, the Financial Accounting Standards Board issued
SFAS No. 128, "Earnings Per Share." Cyberonics adopted the provisions of the
new statement in fiscal 1998, which required the retroactive revision of the
presentation of net loss per share in historical financial statements to
present both basic and diluted net loss per share. The Company's net loss
per share presented in the accompanying financial statements, as calculated
under the provisions of SFAS No. 128, are the same as those previously
presented in historical financial statements as calculated under the
provisions of APB Opinion No. 15. Additionally, net loss per share as
presented herein is also the same as those had diluted net loss per share
under the provisions of SFAS No. 128 been presented, since the Company's
outstanding stock options and warrants would not have been included in the
calculation because their effect would have been antidilutive.
NOTE 2. INVENTORIES
Inventories consist of the following:
June 30,
---------------------------
1998 1997
------------ ------------
Raw materials and components $ 976,737 $ 454,122
Work-in-process 549,885 206,282
Finished goods 576,981 344,952
------------ ------------
$ 2,103,603 $ 1,005,356
------------ ------------
------------ ------------
F-9
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
June 30,
---------------------------
1998 1997
------------ ------------
Furniture and fixtures $ 757,113 $ 357,510
Office equipment 77,408 64,223
Computer equipment 1,425,150 730,085
Research and development equipment 118,928 115,898
Manufacturing equipment 1,083,015 515,950
Leasehold improvements 554,560 243,123
Construction in progress 1,495,524 -
------------ ------------
5,511,698 2,026,789
Accumulated depreciation (2,358,715) (1,664,456)
------------ ------------
$ 3,152,983 $ 362,333
------------ ------------
------------ ------------
NOTE 4. ACCRUED LIABILITIES
Accrued liabilities are as follows:
June 30,
---------------------------
1998 1997
------------ ------------
Clinical costs $ 270,472 $ 688,271
Warranties 375,000 231,808
Payroll and other compensation 2,330,449 219,288
Professional services 334,000 114,800
Marketing activities 196,794 58,562
Royalties 206,992 46,320
Sales returns and allowances 317,080 -
Other 195,493 103,865
------------ ------------
$ 4,226,280 $ 1,462,914
------------ ------------
------------ ------------
NOTE 5. 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 June 30, 1998. 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. During the year ended June 30, 1996, stock option exercises
and issuances of Common Stock under the Company's Employee Stock Purchase
Plan increased the number of common shares by 63,849 and 14,005,
respectively. During the year ended June 30, 1997, stock option exercises and
issuances of Common Stock under the Company's Employee Stock Purchase Plan
increased the number of common shares by 10,734 and 18,134, respectively.
During the year ended June 30, 1998, stock option exercises, warrant
exercises and issuances of Common Stock under the Company's Employee Stock
Purchase Plan increased the number of common shares by 708,482, 639 and
10,137, respectively.
F-10
In April 1996, Cyberonics and St. Jude Medical, Inc. ("St. Jude") entered
into an Agreement and Plan of Merger ("Merger Agreement") and a related
Common Stock Purchase Agreement (the "Stock Purchase Agreement"). Pursuant
to the Stock Purchase Agreement, in July 1996, Cyberonics sold to St. Jude
2,181,818 newly issued shares of Cyberonics Common Stock at $5.50 per share,
providing proceeds to the Company of approximately $11,200,000 after offering
costs. In October 1996, St. Jude's right, pursuant to the Merger Agreement,
to acquire the Company's remaining outstanding common shares for
approximately $7.00 per share expired unexercised.
In March 1997, the Company completed a private equity financing, issuing
1,534,374 new shares of the Company's Common Stock in exchange for $4.44 per
share, providing additional proceeds to the Company of approximately
$6,800,000 after offering costs.
In September 1997, the Company issued 3,000,000 shares of its Common Stock in
a follow-on public equity offering for $15.88 per share and, in October 1997,
subsequently issued an additional 225,000 shares at the same price per share
upon the exercise of a portion of the related underwriter's overallotment
option. Proceeds from the combined issuances totaled approximately $47.7
million after deducting commissions and offering costs.
PREFERRED SHARE PURCHASE RIGHTS. In January 1997, the Company's Board of
Directors declared a dividend distribution 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 Rights will become exercisable
following the tenth day after a person or group announces an acquisition of
20 percent or more of the Company's Common Stock or announces commencement of
a tender offer, the consummation of which would result in ownership by the
persons or group of 20 percent or more of the Common Stock. As amended in
April 1998, each Right entitles stockholders to buy 1/1000 of a share of the
Company's Series A Participating Preferred Stock at an exercise price of
$150. The Company will be entitled to redeem the Rights at $.01 per Right at
any time on or before the tenth day following acquisition by a person or
group of 20 percent or more of the Company's Common Stock. If, prior to
redemption of the Rights, a person or group acquires 20 percent or more of
the Company's Common Stock, each Right not owned by a holder of 20 percent or
more of the Common Stock will entitle its holder 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. If, after the tenth day following acquisition by a
person or group of 20 percent or more of the Company's Common Stock, the
Company sells more than 50 percent of its assets or earning power or is
acquired in a merger or other business combination, the acquiring person must
assume the obligations under the Rights and the Rights will become
exercisable to acquire Common Stock of the acquiring person at the discounted
price. At any time after an event triggering exercisability of the Rights at
a discounted price and prior to the acquisition by the acquiring person of 50
percent or more of the outstanding Common Stock, the Board of Directors of
the Company may exchange the Rights (other than those 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.
NOTE 6. STOCK INCENTIVE AND PURCHASE PLANS
STOCK OPTIONS. Cyberonics has reserved an aggregate of 5,750,000 shares of
its Common Stock through June 30, 1998, for issuance pursuant to its Amended
1988 Incentive Stock Option Plan, its 1996 Stock Option Plan and its 1997
Stock 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. In June 1997,
F-11
446,147 shares vested upon receipt of FDA panel recommendation, and in
July 1997 an additional 356,156 shares vested upon FDA approval.
During fiscal 1998, 88,538 shares vested upon certain sales milestone
achievements. Options granted under the Stock Option Plans have
maximum terms of 10 years. The Amended 1988 Incentive Stock Option
Plan and the 1997 Stock Plan allow issuance of either nonstatutory or
incentive stock options, while the 1996 Stock Option Plan provides for
issuance of nonstatutory stock options exclusively.
The following is a summary of the Company's stock option activity for the
three years ended June 30, 1998:
Outstanding Exercisable
-------------------------- --------------------------
Weighted Weighted
Average Average
Shares Exercise Exercise
Reserved Shares Price Shares Price
----------- ---------- --------- ----------- ----------
Balance at June 30, 1995 586,725 803,451 $ 3.82 190,042 $ 2.94
Granted (52,000) 52,000 4.77
Options becoming exercisable 167,412
Exercised (63,849) .71 (63,849)
Canceled or forfeited 72,050 (72,050) 3.38
----------- ---------- -----------
Balance at June 30, 1996 606,775 719,552 4.20 293,605 4.74
Shares reserved 2,000,000
Granted (1,893,388) 1,893,388 3.11
Options becoming exercisable 762,269
Exercised (10,734) 1.31 (10,734)
Canceled or forfeited 396,816 (396,816) 5.05
----------- ---------- -----------
Balance at June 30, 1997 1,110,203 2,205,390 3.13 1,045,140 3.04
Shares reserved 1,750,000
Granted (2,740,154) 2,740,154 12.73
Options becoming exercisable 1,341,962
Exercised (708,482) 3.79 (708,482)
Canceled or forfeited 181,291 (181,291) 10.67
----------- ---------- -----------
Balance at June 30, 1998 301,340 4,055,771 9.16 1,678,620 4.72
----------- ---------- -----------
----------- ---------- -----------
For certain options granted, the Company recognizes as compensation 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. This compensation expense is amortized ratably over the vesting
period of each option. The Company recognized compensation expense totaling
$136,896 during fiscal 1998, $33,365 during fiscal 1997 and $71,076 during
fiscal 1996. The Company also recognized adjustments totaling $56,264 during
fiscal 1996 to reduce deferred compensation balances as a result of employee
terminations.
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 in fiscal years 1998 and 1997:
risk-free interest rate of 5.5 percent and 7.2 percent, respectively,
expected life of five years for options and restricted stock, expected life
of six months for purchase plan shares, expected volatility of 100 percent
and 78 percent, 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 years 1998 and 1997 was $9.76 and $2.20, respectively, and
was $2.12 for options granted below the Company's market value during fiscal
1997.
F-12
Had the compensation cost for these plans been determined pursuant to the
alternative method under Statement No. 123, the Company's net loss and loss
per share would have been increased to the following pro forma amounts:
Year Ended June 30,
----------------------------------
1998 1997
--------------- ---------------
Net loss-
As reported $ (14,174,712) $ (11,244,831)
Pro forma (19,252,232) (13,003,529)
Loss per share-
As reported $(.88) $(.93)
Pro forma (1.20) (1.08)
Because the Statement No. 123 method of accounting has not been applied to
options granted prior to July 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
Additionally, the pro forma amounts include $57,963 and $5,028 related to the
purchase discount offered under the Company's Employee Stock Purchase Plan
during fiscal 1998 and 1997, respectively. The weighted average fair values
of shares granted to employees were $5.53 and $3.25 during fiscal 1998 and
1997, respectively.
The Company's outstanding options are segregated into the following three
categories in accordance with Statement No. 123:
Weighted
Weighted Average
Range of Average Remaining
Outstanding Exercisable Exercise Exercise Contractual
Shares Shares Price Price Life
----------- ----------- -------------- ---------- -----------
6,950 6,950 $ 0.37 - $0.67 $ 0.54 3.1 years
1,870,735 1,450,408 3.00 - 8.25 3.24 7.7 years
2,118,020 198,730 8.31 - 16.13 12.93 9.2 years
60,066 22,532 16.25 - 29.88 29.08 9.7 years
In November 1996, Cyberonics canceled outstanding stock options for the
purchase of 354,800 shares of the Company's Common Stock with a weighted
average exercise price of $5.20 per share and in exchange granted stock
options for the same number of shares and with the same vesting provisions
following a halt on exercisability until the sooner of 14 months expired or
FDA advisory panel approval was received for the Company's product, at an
exercise price of $3.06 per share, which equaled the Company's market value
per share on the date of reissuance.
STOCK PURCHASE PLAN. Under the Cyberonics, Inc. Employee Stock Purchase Plan
(the "Stock Purchase Plan"), 200,000 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 June 30, 1998, 100,000 shares remain available for future
issuances under the Stock Purchase Plan.
F-13
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 June 30, 1998, 4,030 shares remain available for future issuances under
the program.
NOTE 7. INCOME TAXES
Components of the Company's loss before taxes are as follows:
Year Ended June 30,
------------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
Domestic $ (10,142,530) $ (8,730,646) $ (8,772,435)
Foreign (4,032,182) (2,514,185) (1,340,815)
--------------- --------------- ---------------
$ (14,174,712) $ (11,244,831) $ (10,113,250)
--------------- --------------- ---------------
--------------- --------------- ---------------
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate is as follows:
Year Ended June 30,
-----------------------------------
1998 1997 1996
------ ------- -------
U.S. statutory rate (34.0)% (34.0)% (34.0)%
Increase in deferred tax valuation allowance 43.7 35.1 30.8
Amortization of deferred compensation - 0.1 (0.1)
Benefit of stock option exercise (6.4) - -
Other, net (3.3) (1.2) 3.3
------ ------- -------
0.0 % 0.0 % 0.0 %
------ ------- -------
------ ------- -------
Significant components of the Company's deferred tax assets and liabilities
are as follows:
June 30,
----------------------------
1998 1997
------------- -------------
Deferred tax assets:
Federal net operating loss carryforwards $ 17,853,619 $ 14,350,529
Foreign net operating loss carryforwards 2,763,935 1,191,384
Tax credit carryforwards 1,590,215 1,254,312
Warranties 127,501 78,816
Depreciation 74,384 76,006
Clinical costs 110,357 55,083
Other, net 622,475 132,586
------------- -------------
Total deferred tax assets 23,142,486 17,138,716
Total deferred tax liabilities, net (23,514) (12,676)
Deferred tax valuation allowance (23,118,972) (17,126,040)
------------- -------------
Net deferred tax assets and liabilities $ - $ -
------------- -------------
------------- -------------
F-14
At June 30, 1998, the Company has net operating loss carryforwards of
approximately $52.5 million for federal income tax purposes, which expire
during the years 2003 through 2013, and tax credit carryforwards of
approximately $1.6 million for federal income tax purposes, which expire
during the years 2006 through 2013. As the Company has had cumulative losses
and there is no assurance of future taxable income, a valuation allowance
totaling $23.1 million is established as of June 30, 1998, to fully offset
the Company's net deferred tax assets, including those relating to its
carryforwards. The valuation allowance increased $6.0 million and $4.1
million for the years ended June 30, 1998 and 1997, respectively, due
primarily to the Company's additional net operating losses. Current federal
income tax regulations with respect to changes in ownership could limit the
utilization of the Company's net operating loss carryforwards.
NOTE 8. EMPLOYEE RETIREMENT SAVINGS PLAN
Cyberonics sponsors an employee retirement savings plan (the "Plan") which
qualifies under Section 401(k) of the Internal Revenue Code. The Plan is
designed to provide eligible employees with an opportunity to make regular
contributions into a long-term investment and savings program. Substantially
all U.S. employees are eligible to participate in the Plan beginning with the
first quarterly open enrollment date following start of employment. Employer
contributions are made solely at the Company's discretion. No employer
contributions were made to the Plan for the years ended June 30, 1998, 1997
and 1996.
NOTE 9. COMMITMENTS AND CONTINGENCIES
POSTMARKET CLINICAL SURVEILLANCE. Pursuant to the postmarket surveillance
conditions specified as part of the Company's FDA marketing approval, the
Company is required to conduct clinical follow-up on a limited number of
patients from its most recent study in order to monitor the safety and
tolerability of the NCP-Registered Trademark- 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 United States
patents (and their international counterparts) covering the method and
devices of the NCP System for vagus nerve and other cranial nerve stimulation
for the control of epilepsy and other movement disorders. The license
agreement provides that the Company will pay a royalty equal to the greater
of $36,000 per year or at the rate of 3 percent of sales during fiscal 1999
and through the remaining term of the licensed patents. 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 ratably charged to expense.
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 or at the rate of 1 percent of the Company's
net sales price of implantable systems incorporating the licenser's standard
lead and 1.75 percent of net sales incorporating the licenser's
bi-directional lead for the life of the licensed patents. Amounts due under
this agreement are being charged to expense as incurred.
F-15
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
June 30, 1998, are as follows:
Year ending June 30-
1999 $ 1,237,275
2000 1,043,110
2001 917,881
2002 892,989
2003 213,600
-------------
$ 4,304,855
-------------
-------------
OTHER COMMITMENTS. At June 30, 1998, Cyberonics had approximately $1,250,000
in noncancelable commitments related to domestic marketing programs planned
for the Company's NCP System during fiscal 1998. At June 30, 1998, the
Company has prepaid approximately $900,000 related to such programs that are
scheduled to occur in the first quarter of fiscal 1999.
YEAR 2000 ISSUES. The Company has taken measures, including designing and
testing the most current versions of its products, to ensure the proper
processing of Year 2000 data, and management believes that its products and
systems are Year 2000 compliant. The Company is continually testing its
products and new systems to ensure Year 2000 support and compliance. There
can be no assurance, however, that, despite such testing, undetected errors
or defects will not exist that could cause a product or system to fail to
process Year 2000 data correctly. The Company is not aware of any material
operational issues or costs associated with Year 2000 compliance of its own
products or systems.
NOTE 10. CONCENTRATIONS OF CREDIT RISK
The Company's cash equivalents, securities held to maturity 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 June 30,
1998, 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 United States 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.
F-16
NOTE 11. GEOGRAPHIC AREA INFORMATION
The Company's business activities are represented by a single industry
segment, the manufacturing and distribution of medical products. For
management purposes, the Company is segmented into two geographic areas:
North America (which includes sales in the United States and export sales to
unaffiliated customers in Canada and certain developing international
markets) and Europe (which includes export sales to unaffiliated customers in
Europe, the Middle East, Africa and Asia/Pacific). Sales between geographic
areas are made at prices which would approximate transfers to unaffiliated
distributors. Because of the interdependence of the Company's geographic
areas, the operating loss as presented below may not be representative of the
geographic distribution which would occur if the areas were not
interdependent.
The Company's net sales, losses from operations and assets by geographic area
for the fiscal years that separate geographic business units have operated
are as follows:
North
America Europe Eliminations Consolidated
------------- ------------ ------------- --------------
1998
- -------------------------------------------------------------------------------------------------
Customer sales $ 12,785,391 $ 2,127,477 $ - $ 14,912,868
Intercompany sales 2,076,800 - (2,076,800) -
------------- ------------ ------------- --------------
Total net sales $ 14,862,191 $ 2,127,477 $ (2,076,800) $ 14,912,868
------------- ------------ ------------- --------------
------------- ------------ ------------- --------------
Loss from operations $ (16,183,842) $ (4,041,519) $ 4,063,067 $ (16,162,294)
------------- ------------ ------------- --------------
------------- ------------ ------------- --------------
Identifiable assets $ 52,008,112 $ 895,225 $ (288,043) $ 52,615,294
------------- ------------ ------------- --------------
------------- ------------ ------------- --------------
North
America Europe Eliminations Consolidated
------------- ------------ ------------- --------------
1997
- -------------------------------------------------------------------------------------------------
Customer sales $ 24,452 $ 1,347,553 $ - $ 1,372,005
Intercompany sales 1,256,150 - (1,256,150) -
------------- ------------ ------------- --------------
Total net sales $ 1,280,602 $ 1,347,553 $ (1,256,150) $ 1,372,005
------------- ------------ ------------- --------------
------------- ------------ ------------- --------------
Loss from operations $ (11,610,600) $ (2,314,614) $ 2,441,713 $ (11,483,501)
------------- ------------ ------------- --------------
------------- ------------ ------------- --------------
Identifiable assets $ 9,902,199 $ 1,135,011 $ (787,473) $ 10,249,737
------------- ------------ ------------- --------------
------------- ------------ ------------- --------------
North
America Europe Eliminations Consolidated
------------- ------------ ------------- --------------
1996
- -------------------------------------------------------------------------------------------------
Customer sales $ 109,691 $ 1,307,274 $ - $ 1,416,965
Intercompany sales 1,227,500 - (1,227,500) -
------------- ------------ ------------- --------------
Total net sales $ 1,337,191 $ 1,307,274 $ (1,227,500) $ 1,416,965
------------- ------------ ------------- --------------
------------- ------------ ------------- --------------
Loss from operations $ (10,492,597) $ (1,243,843) $ 1,297,230 $ (10,439,210)
------------- ------------ ------------- --------------
------------- ------------ ------------- --------------
Identifiable assets $ 3,689,080 $ 420,193 $ (161,230) $ 3,948,043
------------- ------------ ------------- --------------
------------- ------------ ------------- --------------
F-17
NOTE 12. QUARTERLY FINANCIAL INFORMATION - UNAUDITED
The tables below contain summarized unaudited quarterly data for the years
ended June 30, 1998 and 1997. The Company believes this information reflects
all adjustments, consisting of normal recurring accruals, considered
necessary for a fair presentation of the quarterly information presented.
The operating results for any quarter presented are not necessarily
indicative of the results that may be expected for future periods.
First Second Third Fourth Annual
Quarter Quarter Quarter Quarter Totals
------------ ------------ ------------ ------------ -------------
1998
- ------------------------------------------------------------------------------------------------------------------
Net sales $ 1,103,234 $ 3,335,496 $ 5,172,735 $ 5,301,403 $ 14,912,868
Gross profit 781,360 2,410,101 3,847,128 3,971,811 11,010,400
Operating expenses 5,935,757 5,466,198 6,045,037 9,724,702 27,172,694
Net loss (4,957,198) (2,458,127) (1,678,447) (5,080,940) (14,174,712)
Net loss per share, basic and
diluted $ (.36) $ (.15) $ (.10) $ (.29) $ (.88)
Shares used in computing
basic and diluted net loss
per share 13,820,939 16,549,150 16,857,559 17,192,038 16,104,922
First Second Third Fourth Annual
Quarter Quarter Quarter Quarter Totals
------------ ------------ ------------ ------------ -------------
1997
- ------------------------------------------------------------------------------------------------------------------
Net sales $ 284,943 $ 437,818 $ 288,979 $ 360,265 $ 1,372,005
Gross profit 215,652 279,437 216,310 288,426 999,825
Operating expenses 2,237,235 2,977,854 3,339,736 3,928,501 12,483,326
Net loss (1,792,521) (2,696,226) (3,050,028) (3,706,056) (11,244,831)
Net loss per share, basic and
diluted $ (.16) $ (.23) $ (.26) $ (.28) $ (.93)
Shares used in computing
basic and diluted net loss
per share 11,216,235 11,765,178 11,824,121 13,315,148 12,030,171
Quarterly and annual loss per share are computed independently based upon the
applicable number of weighted average common shares and share equivalents for
each period.
F-18