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| CYBX > SEC Filings for CYBX > Form 10-Q on 25-Aug-2008 | All Recent SEC Filings |
25-Aug-2008
Quarterly Report
Cautionary Statement Regarding Forward Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for certain forward-looking statements. This Quarterly Report on Form 10-Q ("Form 10-Q") contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We have made statements that may constitute "forward-looking statements." The words "believe," "expect," "anticipate," "plan," "intend," "foresee," "should," "would," "could" or other similar expressions are intended to identify forward-looking statements. These forward-looking statements are based on our current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we anticipate. All comments concerning our expectations for future revenues and operating results are based on our forecasts for our existing operations. These forward-looking statements involve significant risks and uncertainties (some of which are beyond our control) and assumptions. They are subject to change based upon various factors, including but not limited to the risks and uncertainties summarized below:
- Changes in our common stock price;
- Our lack of profitability in the past;
- Changes in our profitability;
- Effectiveness of internal controls over financial reporting;
- Fluctuations in future quarterly operating results;
- Compliance with applicable regulations;
- Our indebtedness and debt services, which could adversely affect our financial
condition;
- Our ability to access sufficient, acceptable capital sources;
- Failure to expand or maintain market acceptance or reimbursement for the use
of vagus nerve stimulation ("VNS") therapy ("VNS Therapy™") or any component
which comprises the VNS Therapy system (the "VNS Therapy System") for the
treatment of epilepsy and depression;
- Failure to transfer the business associated with the use of VNS Therapy for
the treatment of depression to a separate business;
- Failure to develop VNS Therapy for the treatment of other indications;
- Unfavorable results from clinical studies;
- Variations in sales and operating expenses relative to estimates;
- Our dependence on certain suppliers and manufacturers to provide certain
materials, components and contract services necessary for the production
of the VNS Therapy System;
- Product liability-related losses and costs;
- Protection and validity of the intellectual property that relates to VNS
Therapy;
- Changes in the competitive or technological horizons;
- Failure to comply with applicable laws and regulations, including federal and
state privacy and security laws and regulations;
- International operational and economic risks and concerns;
- Failure to retain or attract key personnel;
- Outcomes of pending or future governmental investigations; and
- Outcomes of pending and future lawsuits.
Other factors that could cause our actual results to differ from our projected
results are described in (1) Part II, Item 1A and elsewhere in this Form 10-Q,
(2) our Annual Report on Form 10-K for the period ending April 25, 2008 ("2008
Form 10-K"), (3) our reports and registration statements filed and furnished
from time to time with the SEC and (4) other announcements we make from time to
time.
Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise.
Business Overview
We are a neuromodulation company incorporated as a Delaware corporation in 1987, engaged in the design, development, sales and marketing of implantable medical devices that provide a unique therapy, VNS Therapy, for the treatment of refractory epilepsy and depression.
Our proprietary VNS Therapy System includes the following:
- A generator to provide the appropriate stimulation to the vagus nerve;
- A lead that is attached to both the generator and the vagus nerve;
- Associated equipment to assist with necessary implantation surgery;
- Equipment to assist with setting the stimulation parameters particular to the
patient;
- Appropriate instruction manuals; and
- Magnets to suspend or induce stimulation manually.
The implantation of the generator and lead into patients is generally performed on an outpatient basis. The battery contained in this generator has a finite life, which varies according to the model and the stimulation parameters and settings used for each patient. At or near the end of the useful life of a battery, a patient may, with the advice of a physician, choose to have a new generator implanted, with or without replacing the original lead.
The United States ("U.S.") Food and Drug Administration ("FDA") approved our VNS Therapy System in July 1997 for use as an adjunctive therapy in epilepsy patients over 12 years of age in reducing the frequency of partial onset seizures that are refractory or resistant to antiepileptic drugs. Regulatory bodies in Canada, the European Economic Area, South America, Africa, Australia and certain countries in Eastern Asia have approved VNS Therapy for the treatment of epilepsy, many without age restrictions or seizure-type limitations. In July 2005, the FDA approved the VNS Therapy System for the adjunctive long-term treatment of chronic or recurrent depression for patients 18 years of age or older who are experiencing a major depressive episode and have not had an adequate response to four or more adequate anti-depressant treatments. Regulatory bodies in the European Economic Area and Canada have approved the VNS Therapy System for the treatment of chronic or recurrent depression in patients who are in a treatment-resistant or in a treatment-intolerant depressive episode without age restrictions.
Our ability to successfully expand the commercialization of the VNS Therapy System depends on obtaining and maintaining favorable insurance coverage, coding and reimbursement for the device, the implant procedure and follow-up care. Currently, we have broad coverage, coding and reimbursement for VNS Therapy for the treatment of refractory epilepsy. The Centers for Medicare and Medicaid Services ("CMS") recently issued a proposed reduction in the rate reimbursed to our customers for the purchase of the lead portion of the VNS Therapy System. We oppose this proposed change and are engaged in communications with CMS to address the change. If adopted, this decrease in reimbursement may have an adverse impact on our business and a negative impact on our future operating results. Because there are currently no favorable national coverage policies and only a few regional coverage policies for VNS Therapy for depression, we have assisted physicians and patients with obtaining case-by-case approvals since FDA approval in July 2005. Any long-term growth in sales for the treatment of depression is dependent on obtaining favorable national and regional coverage policies for VNS Therapy for depression. In May 2007, CMS issued a final determination of non-coverage with respect to reimbursement of VNS Therapy for depression.
In February 2008, we announced that, after consulting with clinical and reimbursement experts, we had developed a plan, including the conduct of an additional randomized clinical trial, or possibly more than one such clinical trial, to obtain reimbursement coverage for our depression indication. We also announced a plan to transfer our depression business to a separate entity, in which we expect to maintain at least a minority interest. We have engaged an investment bank to assist us in identifying a partner to provide the funding necessary to execute this plan. Our efforts in this regard continue and our objective is to finalize this course of action by the end of calendar year 2008.
Our clinical development program has included pilot and pivotal studies in using VNS Therapy (1) as an adjunctive therapy for reducing the frequency of seizures in patients over 12 years of age with partial onset seizures that are refractory to antiepileptic drugs and (2) as an adjunctive treatment of patients 18 years of age and older with chronic or recurrent depression who are in a major depressive episode. We have also conducted or provided support for small pilot studies for the use of VNS Therapy in the treatment of Alzheimer's disease, anxiety, bulimia, fibromyalgia, obesity, obsessive-compulsive disorder, multiple sclerosis and other indications. These studies have been conducted to determine the safety and effectiveness of VNS Therapy in these new indications and to determine which new indications might be considered for pivotal studies and, therefore, are an important component of our clinical research activities.
Proprietary protection for our products is important to our business. We maintain a policy of seeking U.S. and foreign patents on selected inventions, acquiring licenses under selected patents of third parties, and entering into invention and confidentiality agreements with our employees, vendors and consultants with respect to technology that we consider important to our business. We also rely on trade secrets, unpatented know-how and continuing technological innovation to develop and maintain our competitive position.
We are actively engaged in determining how we can license intellectual property rights to third parties in order to optimize our portfolio. This includes the assessment and determination of which of our intellectual property rights for particular indications we do not have immediate plans to develop and identifying whether these rights should be licensed to third parties. It also involves the assessment of the intellectual property rights of third parties in order to determine whether we should attempt to acquire those rights through a license. We recently granted rights to a third party to use our technology to treat obesity.
Since inception, we have incurred substantial expenses, primarily for research and development activities that include product and process development and clinical trials and related regulatory activities, sales and marketing activities, manufacturing start-up costs and systems infrastructure. We have also made significant investments in connection with sales and marketing activities in the U.S. and clinical research costs associated with new indications development, most notably depression. As of July 25, 2008, we have incurred an accumulated deficit of approximately $267.2 million. We are focused on advancing the clinical foundation as a basis for establishing, maintaining and extending reimbursement for VNS Therapy. This may involve increased investment in clinical trials.
Critical Accounting Policies and Significant Accounting Estimates
The preparation of the consolidated financial statements, in conformity with U.S. generally accepted accounting principles ("GAAP"), requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the related notes. Our estimates and assumptions are updated as appropriate, which in most cases is at least quarterly. We base our estimates on historical experience and assumptions that we believe to be reasonable under the circumstances, and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. Actual results may differ materially from these estimates.
We consider the following accounting policies to be the most critical because, in management's view, they are most important to the portrayal of our consolidated financial position and results of operations and most demanding in terms of requiring estimates and other exercises of judgment.
Use of Estimates. The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. Actual results could differ from those estimates. Critical estimates that require management's judgment relate to the allowance for doubtful accounts, estimates of any obsolete inventory, useful lives for property and equipment, impairment of any long-lived assets, sales returns and allowances, recognition of licensing revenue, product warranties, stock option expenses and income tax valuation allowances.
Foreign Currency Translation. The assets and liabilities of our subsidiary, Cyberonics Europe, NV are generally translated into U.S. dollars at exchange rates in effect on reporting dates, while capital accounts are translated at historical rates. Statement of Operations items are translated at average exchange rates in effect during the financial statement period. The gains and losses that result from this process are shown in the accumulated other comprehensive income (loss) section of Stockholders' Equity (Deficit) and Comprehensive Income (Loss) and are not included in the determination of the results of operations. Gains and losses resulting from foreign currency transactions denominated in currency other than the functional currency are included in other income and expense.
Accounts Receivable. We provide an allowance for doubtful accounts based upon specific customer risks and a general provision based upon historical trends. An increase in losses beyond that expected by management or that historically have been experienced by us would negatively affect operations when they become known.
Inventories. We state our inventories at the lower of cost, the first-in first-out ("FIFO") method or market. Our calculation of cost includes the acquisition cost of raw materials and components, direct labor and overhead net of obsolescence provisions.
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. We compute depreciation using the straight-line method over useful lives ranging from two to nine years. Property and equipment under capital leases are stated at the lower of the present value of minimum lease payments at the beginning of the lease term or fair value at the inception of the lease. Property and equipment under capital leases are depreciated using the straight-line method over the shorter of the lease term or the estimated useful life of the property.
Leases. Financial Accounting Standards Board ("FASB") Statement No. 13,"Accounting for Leases" ("FAS 13") establishes standards of financial accounting and reporting for leases by lessees and lessors. We are a party to the contract of leased facilities and other lease obligations recorded in compliance with FAS 13. The lease terms provide for tenant improvement allowances that are recorded as deferred rent and amortized, using the straight line method, as reduction to rent expense over the term of the lease. Scheduled rent increases and paid holidays are recognized on a straight-line basis over the term of the lease.
Stock Options. Before April 29, 2006, we adopted the disclosure-only provisions
of FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("FAS 123")
and FASB Statement 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure" ("FAS 148"). Because of this election, we accounted for our
employee stock-based compensation plans under Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25")
and the related interpretations.
We adopted FASB Statement No. 123 (revised 2004), "Share-Based Payment" ("FAS 123(R)") on April 29, 2006 using the Black-Scholes option pricing model and the Modified Prospective Method, which requires the compensation cost to be recognized for grants issued after the adoption date and the unvested portion of grants issued prior to the adoption date.
Restricted Stock, Restricted Stock Units and Other Stock-Based Awards. We may grant restricted stock, restricted stock units or stock awards to directors, officers and key employees. Nonvested restricted stock grantees are entitled to dividends, if any, and voting rights for their respective shares. Sale or transfer of the shares is restricted until they are vested. Share grants have no purchase cost to the grantee. Typically grants vest ratably and compensation costs are amortized over the requisite service period of one to five years. We also grant restricted stock subject to performance or market conditions that can vest over derived service periods. The fair value of restricted stock is determined for accounting purposes, on grant date using the grant date fair market value of our stock. We utilize the Monte Carlo simulation method to establish the fair value, the expected vesting date and derived service period of the market conditions based grants. The Monte Carlo simulation method is subject to variability as several factors utilized must be estimated, including stock price volatility.
Revenue Recognition. We recognize revenue when title to the goods and risk of loss transfer to customers, providing there are no remaining performance obligations required of us or any matters requiring customer acceptance. We record estimated sales returns and discounts as a reduction of net sales in the same period revenue is recognized. Our revenues are dependent upon sales to new and existing customers pursuant to our current policies. Changes in these policies or sales terms could impact the amount and timing of revenue recognized.
Licensing Revenue. We evaluate our license agreements and recognize licensing revenue considering the guidance provided by Staff Accounting Bulletin ("SAB") Topic 13, "Revenue Recognition," EITF 00-21, "Revenue Arrangements with Multiple Deliverables," Regulation S-X Rule 5-03(b)(1), "Sales and Revenue," EITF 01-14, "Income Statement Characterization of Reimbursement of Out-of-Pocket Expenses" and other regulations as applicable.
Licensing Expense. We have executed license agreements under which we have secured the rights provided under certain patents. Royalties payable under the terms of these agreements are expensed as incurred.
Research and Development. All research and development costs are expensed as incurred.
Income Taxes. We account for income taxes under FASB Statement No. 109, "Accounting for Income Taxes" ("FAS 109"). Under this method, deferred income taxes reflect the impact of temporary differences between financial accounting and tax bases of assets and liabilities. The differences relate primarily to the deductibility of certain accruals and reserves and the effect of tax loss and tax credit carry-forwards not yet utilized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date. Deferred tax assets and liabilities are evaluated for realization based on a more-likely-than-not criterion in determining if a valuation allowance should be provided.
Results of Operations
Net Sales
We sell VNS Therapy Systems to hospitals and ambulatory surgical centers ("ASCs") for both epilepsy and depression indications, but we often do not know the intended use for a specific VNS Therapy System at the time of its sale. As a result, we use information available from two separate internal databases to estimate our sales by indication for use.
The FDA has designated our VNS Therapy System, which is a Class III implantable medical device, as a "tracked" device under the FDA's Medical Device Tracking regulation. Consistent with the tracking regulation, we urge each implanting hospital or ASC to complete and return to us an implant card that provides information from which we can identify the corresponding indication for use. We maintain the returned information in an implant card database. Separately, we accumulate information relating to prospective and actual patients, prescribing and implanting physicians, and hospitals and ASCs in a sales-related database.
We do not receive an implant card for each device we sell, and we sometimes sell devices that are not the subject of data included in our sales-related database. In addition, the delay between the date of a sale and the date of receipt of the corresponding implant card may result in an implant card being received in a fiscal quarter subsequent to the fiscal quarter corresponding to the date of the sale. We assume that any delay, however, will affect each fiscal quarter by approximately the same extent. By combining information derived from both the tracking and sales-related databases, we form an estimate of the split between units and net sales for the epilepsy and depression indications. The accuracy of our estimates of sales by indication for use, however, may vary from one fiscal quarter to the next, and investors should exercise caution in relying on these estimates.
U.S. net product sales for the thirteen weeks ended July 25, 2008 increased by approximately $3.1 million, or 14%, as compared to the fiscal year 2008 first quarter due to growth in unit sales volumes and higher average selling prices. International net sales for the thirteen weeks ended July 25, 2008 increased by approximately $1.1 million, or 19%, as compared to fiscal year 2008 first quarter due to a decrease in unit sales volume of 2% offset by an increase in average selling prices of 20%. The increase in average selling prices was due in part to a favorable currency exchange impact of 10%.
U.S. net product sales attributable to the depression indication have declined significantly since the May 2007 issuance by the CMS of a national non-coverage determination with respect to VNS Therapy for depression. We estimate that our net domestic sales attributable to depression for the thirteen weeks ended July 25, 2008 were approximately $0.5 million compared to $2.2 million for the corresponding period last year, a decrease of approximately 79%.
In December 2007, we received a $9.5 million up-front payment relating to the licensing of certain of our patent rights pertaining to weight reduction, hypertension and diabetes. We are amortizing this up-front payment on a straight-line basis until April 2014, the estimated end of our obligation to prosecute the related licensed patent applications. During the thirteen weeks ended July 25, 2008, we recognized revenue in the amount of approximately $0.4 million applicable to our licensing activity. There was no licensing revenue in the first quarter of the prior fiscal year.
Gross Profit
The gross profit for the thirteen weeks ended July 25, 2008 was 86% of net sales, compared to 81% in the corresponding quarter of last year. The increase in gross profit was primarily a result of higher production volumes and improved efficiencies.
Cost of sales consists primarily of direct labor, allocated manufacturing overhead, third-party contractor costs, royalties, and the acquisition cost of raw materials and components. We are obligated to pay royalties at rates of about 3% of net sales in future periods. Gross margins can be expected to fluctuate in future periods based upon the mix between U.S. and international sales, direct and distributor sales, the VNS Therapy System selling price, applicable royalty rates, and the levels of production volume.
Gross profit in licensing revenue for the thirteen weeks ended July 25, 2008 was approximately $0.4 million, or 100%, of licensing revenue. The cost of licensing revenue, when incurred, represents legal fees to prosecute patent applications and royalties paid applicable to the assignment of certain patents.
Operating Expenses
Selling, General and Administrative ("SG&A") Expenses. SG&A expenses are comprised of sales, marketing, development, general and administrative activities. SG&A expenses were approximately $21.5 million for the thirteen weeks ended July 25, 2008, a decrease of approximately $3.6 million, or 14.3%, compared to the thirteen weeks ended July 27, 2007. The decrease in expenses was primarily due to our efforts to reduce sales and marketing activities for the depression indication and a reduction of legal and equity compensation expense partially offset by an increase in international SG&A.
Research and Development ("R&D") Expenses. R&D expenses are comprised of expenses related to our product and process development, product design efforts, clinical trials programs and regulatory activities. R&D expenses were approximately $4.6 million for the thirteen weeks ended July 25, 2008 which represents a decrease of approximately $1.7 million, or 27%, compared to fiscal year 2008 first quarter. The decrease was primarily due to our reduced efforts for the depression indication and personnel reductions.
Interest Income
Interest income of approximately $0.5 million for the thirteen weeks ended July 25, 2008 decreased by 55% as compared to interest income of approximately $1.1 million for fiscal year 2008 first quarter primarily due to lower interest rates partially offset by higher cash balances.
Interest Expense
Interest expense of approximately $1.2 million for the thirteen weeks ended July 25, 2008 decreased by approximately $0.2 million, or 17%, as compared to the fiscal year 2008 first quarter. The change is primarily due to the termination of the line of credit under the revolving line of credit with Merrill Lynch Capital, a division of Merrill Lynch Business Financial Services, Inc. (the "Credit Agreement").
Other Income (Expense), Net
Other expense, net was approximately $17,000 for the thirteen weeks ended July 25, 2008, compared to $43,000 for the fiscal year 2008 first quarter. Other expense, net generally includes the effects of transaction gains and losses associated with changes in foreign currency exchange rates and realized gains and losses in connection with the disposal of assets.
Income Taxes
We estimate our effective tax rate for the thirteen weeks ended July 25, 2008 to be less than 4%, due primarily to the change in the balance of our valuation allowance combined with federal income tax, state and local taxes and tax on foreign operations. The effective tax rate represents our best estimate of the rate expected to be applicable for the full fiscal year. In the past we have experienced ownership changes as defined in IRC Section 382 and most recently we . . .
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