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| CYBX > SEC Filings for CYBX > Form 10-Q on 24-Aug-2009 | All Recent SEC Filings |
24-Aug-2009
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;
- 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
consolidated 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 which
comprises 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, expiration 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
consolidated 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 ending April 24, 2009 ("2009
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 connects the generator to 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, including China and Taiwan, 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 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. In calendar 2008, 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. 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. In November 2008, we submitted an amendment to the protocol of the TRD patient dosing study to the FDA. We requested, and the FDA approved, a reduction in the number of study subjects from 460 to 330. We completed enrollment at 331 study subjects in February 2009 and expect to complete follow-up by March 2010.
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 did not result in the receipt of an offer that provides sufficient value to our stockholders. Accordingly, we continue to evaluate alternative actions intended to maintain the current regulatory approval, while minimizing our required investment, as well as ensuring that VNS Therapy continues to be available to patients in the United States and certain international markets.
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 determining 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.
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 24, 2009, we have incurred an accumulated deficit of approximately $234.7 million.
Critical Accounting Policies and Significant Accounting Estimates
The preparation of the consolidated financial statements, in conformity with U.S. 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.
Accounts Receivable. We provide an allowance for doubtful accounts based upon specific customer risks and general historical trends. An increase in losses beyond that expected by management or what we have historically experienced would reduce earnings 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. Management considers potential obsolescence at each balance sheet date. An acceleration of obsolescence could occur if consumer demand differs from expectations.
Property and Equipment. Property and equipment are carried at cost, less accumulated depreciation. Maintenance, repairs and minor replacements are charged to expense as incurred; significant renewals, improvements and expansions are capitalized. For financial reporting purposes, we compute depreciation using the straight-line method over useful lives ranging from two to nine years. An unanticipated change in the utilization or expected useful life of property and equipment could result in acceleration in the timing of the expenses.
Leases. 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 contracts 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 rent holidays are recognized on a straight-line basis over the term of the lease.
Revenue Recognition. We recognize revenue when title to the goods and risk of loss transfer to customers, provided that we have no remaining performance obligations 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 net sales 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 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. We have entered into contractual obligations for the conduct of clinical studies. Costs are incurred over the duration of the studies and paid under the terms of the contracts. Research and development expenses could vary significantly due to possible changes in the timing of clinical activity.
Stock Options. We account for our employee stock-based compensation plans under
FASB Statement No. 123 (revised 2004), "Share-Based Payment" ("FAS
123(R)"). Under FAS 123(R) the fair value of compensatory stock options is
determined using the Black-Scholes option valuation model, which is affected by
assumptions regarding a number of complex and subjective variables.
Restricted Stock, Restricted Stock Units and Other Share-Based Awards. We may grant restricted stock, restricted stock units or stock awards to directors, officers and key employees which have no purchase cost to the grantee. Nonvested restricted stock entitles the grantees to dividends, if any, and voting rights for their respective shares. Sale or transfer of the shares is restricted until they are vested. Typically, awards are service based and vest ratably over the service period of four to five years, or cliff vest after three years, as required under the agreement establishing the award. Compensation cost is expensed ratably over the service period. Generally, the fair value of restricted stock is determined for accounting purposes using the market closing price on the grant date. We also award restricted stock subject to performance or market conditions that can vest based on the satisfaction of the conditions of the award. The fair market value and derived service period of market condition-based awards is determined using the Monte Carlo simulation method. The derived service period for performance-based awards is estimated based on our judgment of likely future performance. The Monte Carlo simulation method is subject to variability as several factors utilized must be estimated, including the derived service period, which is estimated based on our judgment of likely future performance, and our stock price volatility. We issue new shares for awards of restricted stock.
Foreign Currency Translation. The assets and liabilities of our subsidiary, Cyberonics Europe, SA, 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 section of Stockholders' Equity and Comprehensive Income 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.
Income Taxes. We account for income taxes under FASB Statement 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. 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
Net sales for the thirteen weeks ended July 24, 2009 were approximately $38.5 million, which consisted of U.S. net product sales of $30.9 million, international net product sales of $7.2 million and licensing revenue of $0.4 million. Net sales for the thirteen weeks ended July 25, 2008 were approximately $33.7 million, which consisted of U.S. net product sales of $26.2 million, international net product sales of $7.1 million and licensing revenue of $0.4 million.
U.S. net product sales for the first quarter of fiscal year 2010 increased by $4.7 million, or 17.9%, as compared to the first quarter of fiscal year 2009 due to a volume increase of 6.8% and increased average selling prices of 11.1%. The average selling price has increased, in part, due to the market penetration of our new models, the DemipulseTM generator (single pin) and the Demipulse DuoTM generator (dual pin). International net product sales for the first quarter of fiscal year 2010 increased by $0.1 million, or 1.2%, as compared to the first quarter of fiscal year 2009 due to a volume increase of 11.6% and offset by decreased average selling prices of 10.4%. The average selling prices decreased primarily due to an unfavorable foreign currency impact.
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 24, 2009 and July 25, 2008, we recognized revenue in the amount of approximately $0.4 million applicable to our licensing activity.
Gross Profit Margin
The gross profit margins for the thirteen weeks ended July 24, 2009 and July 25, 2008 are 86.1% and 85.7%, respectively. The slight increase in the gross profit margin was primarily a result of higher production volumes. 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. Gross profit 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.
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 $21.6 million for the thirteen weeks ended July 24, 2009, an increase of approximately $0.1 million, or 0.4%, compared to the thirteen weeks ended July 25, 2008. The increase in expenses was primarily due to increased salaries and commissions offset by decreased legal expenses.
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 $5.0 million for the thirteen weeks ended July 24, 2009 which represents an increase of approximately $0.4 million, or 9.2%, compared to fiscal year 2009 first quarter. The increase was primarily due to our increased product development efforts with respect to the treatment of refractory epilepsy offset by decreased dosing study and the TRD registry expenses.
Interest Income
Interest income of approximately $42,000 for the thirteen weeks ended July 24, 2009 decreased by 92% as compared to interest income of approximately $508,000 for the thirteen weeks ended July 25, 2008 due to significantly lower cash balances and interest rates.
Interest Expense
Interest expense of approximately $503,000 for the thirteen weeks ended July 24, 2009 decreased by approximately $659,000, or 57%, as compared to the fiscal year 2009 first quarter. The change is due to the cumulative repurchases of our Convertible Notes which totaled approximately $78.3 million during the second quarter of fiscal year 2009 through the first quarter of fiscal year 2010.
Other Income, Net
Other income, net was approximately $493,000 for the thirteen weeks ended July 24, 2009 compared to $17,000 for the thirteen weeks ended July 25, 2008. Other income, net consists primarily of the effects of transaction gains and losses associated with changes in foreign currency exchange rates. The increased gain is primarily due to weakening of the dollar against the euro in the thirteen weeks ended July 24, 2009 as compared to the thirteen weeks ended July 25, 2008.
Income Taxes
We estimate our effective tax rate for the thirteen weeks ended July 24, 2009 to be less than 3%, due primarily to the change in the balance of our valuation allowance combined with federal income tax, state and local income taxes and income 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 Internal Revenue Code ("IRC") Section 382, most recently in August 2006. Our ability to utilize certain net operating losses to offset future taxable income in any particular year may be limited pursuant to IRC Section 382. Due to our operating loss history and possible limitations pursuant to IRC Section 382, we have established a valuation allowance that fully offsets our federal net deferred tax assets, including those related to tax loss carry-forwards, resulting in no regular U.S. federal income tax expense or benefit for financial reporting purposes.
FAS 109 requires that deferred tax assets be reduced by a valuation allowance if the weight of available evidence indicates that it is more likely than not that some portion of the deferred tax assets will not be realized. Therefore, we maintained a valuation allowance for most of our deferred tax assets for the thirteen weeks ended July 24, 2009, because historically we have experienced significant operating losses and operate in an industry subject to rapid technological change. We expect to continue to achieve profitability during the remainder of the current year and expect to continue to be profitable in the next fiscal year. We continue to evaluate the future realization of our deferred tax assets based on expectations of future taxable income. Depending on our continued ability to achieve expected levels of profitability, we may have sufficient evidence in the remaining quarters of fiscal year 2010 to conclude that it is more likely than not that we will recognize the value of our deferred tax assets, in whole or in part, during fiscal year 2010. The reversal of the valuation allowance will likely result in reporting a significant benefit in our consolidated results of operations during fiscal year 2010 if our earnings trend continues as expected.
Liquidity and Capital Resources
Overview
Net cash decreased by approximately $10.0 million during the thirteen weeks ended July 24, 2009 due primarily to the repurchase of approximately $15.6 . . .
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