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| CYBX > SEC Filings for CYBX > Form 10-Q on 21-Nov-2008 | All Recent SEC Filings |
21-Nov-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, 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;
- Changes in our profitability;
- Effectiveness of our internal controls over financial reporting;
- Fluctuations in future quarterly operating results;
- Compliance with applicable regulations or changes in laws,
regulations or administrative practices affecting government
regulation of our products, such as the United States ("U.S.") Food
and Drug Administration ("FDA") laws and regulations that increase
the time and/or expense of obtaining approval for products or impose
additional burdens on the manufacture and sale of our products;
- Our indebtedness and debt services, which could adversely affect our
financial condition;
- Our ability to access capital;
- Failure to expand or maintain market acceptance or reimbursement for
the use of vagus nerve stimulation therapy ("VNS Therapy™") or any
component that comprises the VNS Therapy system (the "VNS Therapy
System") for the treatment of epilepsy and depression;
- Any legislative or administrative reform to the U.S. Medicare or
Medicaid systems or international reimbursement systems that
significantly reduces reimbursement for procedures using the VNS
Therapy System or any component thereof, or denies coverage for such
procedures, as well as adverse decisions relating to our products by
administrators of such systems on coverage or reimbursement issues;
- Failure to maintain the current regulatory approvals for our
depression indication and minimizing our required investment for
this indication;
- 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 technology;
- 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 lawsuits and governmental
investigations;
- Changes in accounting rules that adversely affect the
characterization of our results of operations, financial position or
cash flows;
- Availability and cost of credit;
- Changes in customer spending patterns, and;
- Continued volatility in the global market and worldwide economic
conditions.
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 ended April 25, 2008 ("2008
Form 10-K"), (3) our Quarterly Report on Form 10-Q for the period ended July 25,
2008, (4) our reports and registration statements filed and furnished from time
to time with the SEC and (5) 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 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, Canada and Israel 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, there is broad coverage, coding and reimbursement for VNS Therapy for the treatment of refractory epilepsy. The Centers for Medicare and Medicaid Services, ("CMS"), which we estimate pays for approximately 25% of the VNS Therapy implants, issues an annual update to the reimbursement amounts received by our customers. Recently, CMS announced a significant reduction in the rate reimbursed to our customers for the insertion of the lead portion of the VNS Therapy System for calendar 2009, and a small increase in the amount reimbursed for the insertion of the generator. We are engaged in communications with CMS to address the change. This decrease in reimbursement could have an adverse impact on our business and our future operating results.
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 research and development, specifically, seizure detection, tele-medicine and associated technology, and could also include additional investment in clinical studies using VNS Therapy for the treatment of refractory epilepsy.
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 study, or possibly more than one such clinical study, 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 expected to maintain at least a minority interest. We engaged an investment bank to assist us in identifying a partner to provide the funding necessary to execute this plan. This process has not resulted in the receipt of an offer that provides sufficient value to our stockholders. Accordingly, we are evaluating potential actions to maintain the current regulatory approval, while minimizing our required investment.
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. For more information on this arrangement, please see "Licensing Agreements" under "Note 14. Commitments and Contingencies" to our consolidated financial statements.
Since inception, we have incurred substantial expenses, primarily for research and development activities that include product and process development, clinical studies 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 October 24, 2008, we have incurred an accumulated deficit of approximately $259.0 million.
Critical Accounting Policies and Significant Accounting Estimates
The preparation of the consolidated financial statements, in conformity with United States generally accepted accounting principles ("U.S. 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. Statements 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 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 expensed ratably over the service period of one to five years as required under the agreement establishing the grant. We also grant restricted stock subject to performance or market conditions that can vest based on the satisfaction of the conditions of the grant. 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 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.
Net sales for the thirteen weeks ended October 24, 2008 were approximately $36.0 million, which consisted of U.S. net product sales of $29.1 million, international net product sales of $6.6 million and licensing revenue of $0.4 million. Net sales for the twenty-six weeks ended October 24, 2008 were approximately $69.8 million, which consisted of U.S. net product sales of $55.3 million, international net sales of $13.7 million and licensing revenue of $0.8 million.
U.S. net product sales for the thirteen weeks ended October 24, 2008 increased by approximately $6.0 million, or 26%, as compared to the second quarter of fiscal year 2008, due to 20% higher average selling prices and a 6% growth in unit sales volumes. International net sales for the thirteen weeks ended October 24, 2008 increased by approximately $0.7 million, or 12%, as compared to the second quarter of fiscal year 2008, due primarily to higher average selling prices. The increase in international average selling prices was negatively affected by an unfavorable foreign currency exchange impact of 1%.
U.S. net product sales for the twenty-six weeks ended October 24, 2008 increased by approximately $9.2 million, or 20%, as compared to the twenty-six weeks ended October 26, 2007 due to 15% higher average selling prices and a 5% growth in unit sales volumes. International net sales for the twenty-six weeks ended October 24, 2008 increased by approximately $1.8 million, or 15%, as compared to the twenty-six weeks ended October 26, 2007 due to 16% higher average selling prices offset by a 1% decrease in unit sales volume. The increase in average selling prices was due in part to a favorable currency exchange impact of 5%.
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 U.S. net sales attributable to depression for the thirteen weeks ended October 24, 2008 were approximately $0.5 million compared to $1.4 million for the corresponding period last fiscal year, a decrease of approximately 63%. We estimate that our U.S. net sales attributable to depression for the twenty-six weeks ended October, 24, 2008 were approximately $1.0 million as compared to $3.6 million for the twenty-six weeks ended October 26, 2007, a decrease of 73%.
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 and twenty-six weeks ended October 24, 2008, we recognized licensing revenue in the amount of approximately $0.4 and $0.8 million, respectively. There was no licensing revenue in the corresponding quarters of the prior fiscal year.
Gross Profit
The gross profit for product sales for the thirteen weeks ended October 24, 2008 was 85.5% of net sales, compared to 84.2% in the corresponding quarter of last year. The gross profit for the twenty-six weeks ended October 24, 2008 was 85.5% of net sales, compared to 82.5% over the same period of the previous fiscal year. These increases in gross profit margins were primarily a result of higher average selling prices, with improvement in manufacturing efficiencies also contributing to the increases.
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 a rate of approximately 3% of net sales. Gross profit 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 and twenty-six weeks ended October 24, 2008 was approximately $0.4 million and $0.8 million, respectively, or 100%, of licensing revenue. We did not incur any licensing cost during the thirteen and twenty-six weeks ended October 24, 2008. Licensing cost, when incurred, represents legal fees to prosecute patent applications and royalties paid applicable to the assignment of certain patents.
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