UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

For the quarterly period ended July 26, 2013 or

 

 

For the transition period from ______________ to _______________

 

 

CYBERONICS, INC.

 

(Exact name of registrant as specified in its charter)

 

 

(281) 228-7200

(Registrant's telephone number, including area code)

 

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   þNo  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).          Yes    þNo  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

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CYBERONICS, INC.

 

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In this Quarterly Report on Form 10-Q, “Cyberonics,” “the Company,” “we,” “us” and “our” refer to Cyberonics, Inc. and its consolidated subsidiaries (Cyberonics Europe BVBA, Cyberonics France Sarl, Cyberonics Holdings LLC, CYBX Netherlands C.V., Cyberonics Spain, S.L., Cyberonics Latam, S.R.L.).

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PART I.  FINANCIAL INFORMATION

 

 

CYBERONICS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

 

See accompanying notes to the condensed consolidated financial statements.

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CYBERONICS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

 

See accompanying notes to the condensed consolidated financial statements.

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CYBERONICS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

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CYBERONICS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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CYBERONICS, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

For the Period Ended July 26, 2013

 

Note 1. Basis of Presentation and Use of Accounting Estimates

 

The accompanying unaudited condensed consolidated financial statements of Cyberonics, Inc. and its consolidated subsidiaries (collectively “Cyberonics”), at July 26, 2013 have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States of America (“U.S.”) (“U.S. GAAP”) for interim financial information, the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The accompanying condensed consolidated financial statements of Cyberonics at April 26, 2013 have been prepared from audited financial statements. In the opinion of management, all the adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the thirteen weeks ended July 26, 2013 are not necessarily indicative of the results that may be expected for any other interim period or the full year ending April 25, 2014. The financial information presented herein should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the period ended April 26, 2013 (“2013 Form 10-K”).

 

The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Our estimates and assumptions are updated as appropriate, which in most cases is at least quarterly. We base our estimates on historical experience or various 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.

 

The fiscal years 2014 and 2013 will end or ended on April 25, 2014 and April 26, 2013, respectively.

 

Note 2.  Accounts receivable and allowance for bad debt

 

Accounts receivable, net consisted of the following:

 

 

 

 

Note 3.  Inventories

 

Inventories consisted of the following:

 

 

 

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Note 4.  Property, Plant and Equipment

 

Property plant & equipment consisted of the following:

 

 

 

 

Note 5.  Intangible Assets

 

Schedules of finite-lived intangible assets:

 

            

 

The weighted average amortization period in years for our intangible assets at July 26, 2013:

 

 

 

Aggregate intangible asset amortization was $346,162 and $198,471for the thirteen weeks ended July 26, 2013 and July 27, 1012, respectively, which was reported in research and development expense in the condensed consolidated statements of net income.

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The estimated future amortization expense based on our finite-lived intangible assets at July 26, 2013:

 

 

 

Note 6. Investments

 

Short-Term Investments:

 

Our short-term investments are carried at cost, which approximates fair value. Our investments include certificates of deposit with large U.S. and international banks and commercial paper with maturities, at purchase, ranging from 6 to 12 months.

 

Long-Term Investments:

 

Detail of long-term investments:

 

 

 

 

 

 

Note 7.  Accrued Liabilities

 

Accrued liabilities consisted of the following:

 

 

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Note 8.  Long-Term Liabilities

 

Other long-term liabilities consisted of the following:

 

 

 

Note 9.  Commitments and Contingencies

 

Litigation.

 

In April 2012, we filed a complaint in the United States District Court for the Southern District of Texas (12-cv-1118) against Dr. Jacob Zabara in response to a letter from Dr. Zabara alleging that he was entitled to royalties on products that incorporate his patents licensed to us under a 1988 license agreement, even if the patents had expired. The complaint sought a declaratory judgment that Dr. Zabara was not entitled to royalties for expired patents and not entitled to royalties at all unless our device includes an invention claimed in an unexpired, licensed patent. Dr. Zabara answered the complaint and filed counterclaims seeking a declaratory judgment that he was entitled to an ongoing royalty, that we breached the license agreement by failing to pay at least a minimum royalty and by failing to pay a royalty on its tunneling tool, and that we failed to use our “best efforts to develop and market a Product or Products” as required by the license agreement.

 

On May 3, 2013, the district court ruled (i) that we breached the license agreement by failing to pay the $9,000-per-quarter minimum royalty since July 2011, (ii) that the license agreement required us to use our “best efforts to develop and market a Product or Products” regarding each of the licensed patents, and (iii) that a trial would be required to determine whether we used our “best efforts” as required by the license agreement.

 

Dr. Zabara claimed to be entitled to damages of approximately $613,000 for unpaid royalties on the tunneling tool and damages of at least $200 million for royalties he claims would have been earned had we used our “best efforts to develop and market a Product or Products” for the licensed patents not embodied in our epilepsy products.

 

On July 30, 2013, we executed a letter agreement with Dr. Zabara by which we agreed to settle all claims in the pending lawsuit.  The principal terms of settlement include (i) a payment by us of $6.25 million to Dr. Zabara; (ii) the provision of 200 VNS Therapy Systems to Dr. Zabara for research purposes; (iii) termination of the 1988 license agreement and all prior consulting agreements, subject to continuation of an existing sublicense and a non-exclusive, royalty-bearing license to us for future-developed products, if any, covered by Dr. Zabara’s patents; and (iv) mutual releases.  Pursuant to the letter agreement, we and Dr. Zabara will execute final settlement papers.  On July 31, 2013, the district court dismissed the case without prejudice, subject to its reinstatement within 30 days if the settlement is not completely documented, and ordered that the case will be dismissed with prejudice in 30 days, unless a party sooner moves for reinstatement or extension of the conditional dismissal period.  We have incurred and recorded a charge of approximately $7.4 million to account for this settlement, including approximately $0.7 million in associated legal fees, during the thirteen weeks ended July 26, 2013.

 

We are named as a defendant in lawsuits from time to time arising in the ordinary course of business. The outcome of such lawsuits or other proceedings cannot be predicted with certainty and may have a material adverse effect on our consolidated financial position or net income.

 

Clinical Study Agreements.

 

We have agreements associated with clinical studies and registries in connection with which we expect to spend approximately $1.6 million over the next two years.

 

Investment Agreements. 

 

In October 2009, we entered into a contractual arrangement with Flint Hills Scientific, L.L.C. related primarily to cardiac-based seizure detection patents. We agreed to future cancellable minimum or milestone-based fees for intellectual property licensing and consulting and royalty fees. We expect future expenditures of approximately $3.6 million through fiscal year 2019 under our agreement with Flint Hills.

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In October 2011, we entered into an investment agreement with ImThera, a private company developing a neurostimulation medical device for the treatment of obstructive sleep apnea. We agreed to future milestone-based investments and expect a future investment of $4.0 million prior to the current year end.

 

In June 2012, we entered into a patent license agreement and a technology transfer agreement with Imricor Medical Systems, Inc., for the integration of MRI-compatibility with our leads. We agreed to future milestone-based payments and royalties and expect future expenditures of $1.3 million through fiscal year 2019.

 

In September 2012, we entered into an equity investment agreement and marketing arrangement with Cerbomed GmbH, a privately-held, development-stage company working on a transcutaneous (non-invasive) vagus nerve stimulation device for the treatment of epilepsy. This agreement includes future optional milestone-based investments of €3.5 million or approximately $4.7 million.

 

Lease Agreements.    

 

We lease the following facilities and equipment with non-cancellable leases, accounted for as operating leases: (i) a storage and distribution facility in Austin, Texas, (ii) administrative and sales offices in Brussels, Belgium, elsewhere in Europe and the U.S., (iii) sales offices in Beijing, China and Hong Kong, and (iv) transportation and office equipment.

 

Note 10.  Stock-Based Incentive Plans

 

Stock-Based Compensation

 

Amounts of stock-based compensation recognized in the consolidated statement of income by expense category are as follows:

 

 

Amounts of stock-based compensation expense recognized in the consolidated statement of income by type of arrangement are as follows:

 

 

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Stock Option Valuation Assumptions

 

We use the Black-Scholes option pricing methodology to calculate the grant date fair market value of stock option awards. The following table lists the assumptions we utilized as inputs to the Black-Scholes model:

 

 

Stock Option Activity

 

The following tables detail the activity for stock option awards:

 

 

 

 

Restricted Stock and Restricted Stock Units Awards

 

The following tables detail the activity for service-based restricted stock and restricted stock unit awards:

 

 

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The following tables detail the activity for performance-based and market-based restricted stock and restricted stock unit awards:

 

 

 

 

Note 11.  Income Taxes

 

Our effective tax rate for the quarter ended July 26, 2013 was 35.8%, which was primarily due to our federal income tax rate of 35% plus state and foreign income taxes and permanent differences. Our effective tax rate for the quarter ended July 27, 2012 was 39.1%, which was primarily due to our federal income tax rate of 35% plus state and foreign income taxes and permanent differences. The 3.3% reduction in the tax rate between the two quarters is primarily due to the Texas R&D tax credit which was enacted during the thirteen weeks ended July 26, 2013 and applies to our tax year ended April 26, 2013 and subsequent years. The rate reduction is also due to the domestic manufacturing tax deduction under Internal Revenue Code Section 199, which became available to us during quarter ended July 26, 2013 because we expect to report federal taxable income after utilization of net operating loss carryforwards for fiscal year 2014.  

 

Note 12.  Income Per Share

 

The following table sets forth the computation of basic and diluted net income per share of common stock:

 

 

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Anti-dilutive securities excluded from the computation of earnings per share:

 

 

 

Note 13. Derivatives

 

Foreign Currency Exposure

 

Because we operate in a number of international markets, we are exposed to the impact of foreign currency exchange rate (“FX”) movements on earnings, particularly with respect to the U.S. dollar versus the euro. Our aggregate FX losses for the thirteen weeks ended April 26, 2013 was $130,695, and our FX gains for the thirteen weeks ended April 27, 2012 was $67,348. At times, we may enter into foreign currency forward contracts to partially offset our foreign currency exchange gains and losses; however, we did not entered into a foreign currency derivative during the thirteen weeks ended July 26, 2013 or July 27, 2012.

 

Note 14. Fair Value Measurements

 

Fair value is defined as the exit price or the amount that we would receive upon selling our assets in an orderly transaction to a  market participant as of the period ending on the measurement date. The guidance also establishes a hierarchy for inputs used in measuring fair value. The hierarchy is broken down into three levels defined as follows:

 

 

Observable inputs are inputs market participants would use in valuing the asset based on market data obtained from sources independent of us. Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing our asset and are developed based upon the best information available in the circumstances. The categorization of assets within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Level 3 financial assets include investment securities for which there is limited market activity such that the determination of fair value requires significant judgment or estimation.

 

We have had no assets and liabilities measured at fair value on a recurring basis at July 26, 2013 or at April 26, 2013.

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Investment in Convertible Debt Security

 

We invested in a convertible debt security issued by NeuroVista Corporation (“NeuroVista”) on August 20, 2010. NeuroVista is a privately-held company that was focused on the development of an implantable device intended to inform patients when seizures are likely to occur, as well as to alert caregivers when seizures do occur. We considered this security an ‘available-for-sale’ debt security measured at fair value on a recurring basis using Level 3 inputs, as this investment was in a privately-held entity without quoted market prices. During the quarter ended July 27, 2012, we determined that we were unlikely to receive the return of our principal and accrued interest and performed a fair value analysis of the assets we expected to receive in foreclosure. We estimated the fair value of the debt instrument at $1,450,000, with the resulting impairment loss of $4,058,768 reported as other-than-temporary and separately stated in the consolidated statement of income. During the quarter ended October 26, 2012, NeuroVista advised us that an event of default had occurred under the terms of the convertible debt security, and in February 2013, we conducted a foreclosure sale of the assets subject to our security interest and took possession of the company’s tangible and intangible assets, which resulted in no further gain or loss on the settlement of the debt security.

 

The following table provides a reconciliation of the beginning and ending balance of the NeuroVista debt instrument measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

 

 

Investment in Equity Security

 

Our investment in equity consists of two investments in convertible preferred stock of privately-held companies which we carry at cost; see “Note 6. Investments”.  We do not mark-to-market these investments. Each reporting period we review all available information related to this investee to identify any significant adverse effect on the fair value of our investments. If we identify events or changes in circumstances that indicate a decrease in value of this investment that is other than temporary, we would recognize the loss. The inputs to our fair value measurements are considered Level 3 in the fair value hierarchy.

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ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Cautionary Statement Regarding 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”). The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements. The words “believe,” “potential,” forecast,” “project,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could,” “may,” “estimate,” “project” 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 on various factors, including but not limited to the risks and uncertainties summarized below:

 

 

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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 26, 2013 (“2013 Form 10-K”), (3) our reports and registration statements filed and furnished from time to time with the U.S. Securities and Exchange Commission (“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 update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise. You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this report. Operating results for the thirteen weeks ended July 26, 2013 are not necessarily indicative of future results, including the full fiscal year. You should also refer to our Annual Consolidated Financial Statements, Notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations and “Risk Factors” contained in our 2013 Form 10-K.

 

Business Overview

 

We are a medical device company, incorporated in 1987, engaged in the design, development, sales and marketing of an implantable medical device, the VNS Therapy® System, that provides neuromodulation therapy for the treatment of refractory epilepsy and treatment-resistant depression (“TRD”). We are also investigating neuromodulation therapy for other indications, including chronic heart failure, and developing non-implantable device solutions for the management of epilepsy.

 

Our VNS Therapy System includes the following:

 

 

The VNS Therapy pulse generator and lead are surgically implanted, generally during an outpatient procedure.  The battery contained in the 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 implant a new generator, 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, certain countries in Eastern Europe, Russia, South America, Africa, Australia and certain countries in Asia, including Japan, China and Taiwan, have approved the VNS Therapy System 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.

 

We sell the VNS Therapy System for refractory epilepsy to hospitals and ambulatory surgery centers (“ASCs”). Our ability to successfully expand the commercialization of the VNS Therapy System depends on maintaining regulatory approval and favorable insurance coverage. This coverage allows our customers to invoice and be paid by third-party payers. Currently, there is broad coverage, coding and reimbursement for VNS Therapy for the treatment of refractory epilepsy.

 

In May 2007, the Centers for Medicare and Medicaid Services (“CMS”) issued a national determination of non-coverage with respect to reimbursement of VNS Therapy for patients with TRD, significantly limiting access to this therapeutic option for many patients.  Following this determination, we have not engaged in active commercial efforts with respect to TRD in any of our markets.  As a result of new clinical evidence, including the completion of a post-approval dosing study and publication in four peer-reviewed journals, we submitted a formal request to CMS for reconsideration of its determination and requested coverage for VNS Therapy for TRD for a sub-population of Medicare beneficiaries that is estimated to represent approximately 0.2% of CMS’s patient population.  CMS declined our request for reconsideration on May 28, 2013. 

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We believe reimbursement or payment rates from private insurers were largely unchanged over the past year. In November 2012, CMS announced calendar year 2013 final Ambulatory Payment Classification (APC) reimbursement rates, which were increased over the calendar year 2012 rates by 5.7% for full systems and 7.9% for generator-only replacements.  For calendar year 2014, CMS has proposed a new hospital outpatient rule that creates “comprehensive” APCs for our products.  The new comprehensive APCs are designed to package reimbursement for all items incurred within a period of up to 30 days into a single payment.  This means that costs associated with services having nothing to do with our device-related procedures may be reimbursed from our comprehensive APCs.  In July 2013, CMS announced calendar year 2014 proposed rates for our new comprehensive APCs.  The proposed comprehensive APC rates are increased as compared to the calendar year 2013 APC final rates by 5% for full systems and 29% for generator-only replacements.  We believe that the proposed comprehensive APC for generator-only replacements will also include full-system replacements, but we continue to analyze the proposed comprehensive APCs to determine how they differ from the calendar year 2013 APCs. 

 

Any decrease in reimbursement rates or change in reimbursement methodology by CMS, including the proposed new comprehensive APCs, could have an adverse impact on our business and our future operating results.

 

We continue to invest in and support the development of future generations of our VNS Therapy System, including generators employing new stimulation paradigms, cardiac-based seizure detection, rechargeable battery technology, and wireless communication technology and the integration of magnetic resonance imaging (“MRI”) compatibility with our leads. We also continue to fund and develop other devices that support our focus on device solutions for epilepsy management, such as seizure monitoring, logging and notification technology using external heart monitoring and movement-related sensor advancements. In addition, we are investing in a pilot study related to the use of VNS Therapy for the treatment of chronic heart failure. We also sponsor post-marketing studies in refractory epilepsy and support a variety of studies for our product development efforts or to build clinical evidence for VNS Therapy. A description and the status of these studies may be found at www.clinicaltrials.gov.

 

Proprietary protection for our products is important to our business. We seek U.S. and foreign patents on selected inventions, acquire licenses under selected patents of third parties, and enter into 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 periodically evaluate whether to out-license or to in-license intellectual property rights to optimize our portfolio. This includes identifying our intellectual property rights for indications we do not have plans to develop and determining whether these rights can be licensed or otherwise granted to third parties. It also involves assessing the intellectual property rights owned by third parties to determine whether we should attempt to license or otherwise acquire those rights. We have entered into several license and investment agreements that may involve substantial future payments; see “Note 9. Commitments and Contingencies – Investment Agreements” in our condensed consolidated financial statements for additional information.

 

Significant Accounting Policies and Critical Accounting Estimates

 

We have adopted various accounting policies in preparing the consolidated financial statements in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are disclosed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended April 26, 2013 (“2013 Annual Report on Form 10-K”).

 

Preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires us to adopt various accounting policies and to make estimates and assumptions that affect the reported amounts in such financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates and assumptions, including those related to sales return reserves, amortization periods for and impairment of intangible assets, income taxes and stock-based compensation. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, and the results form the basis for making judgments about the reported value of assets, liabilities, revenues and expenses. Actual results may differ from these estimates. There have been no material changes to our critical accounting policies from the information provided in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2013 Annual Report on Form 10-K.

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Deferred Licensing Revenue

 

Effective in December 2007, we entered into an agreement granting an exclusive license to certain patents and patent applications pertaining to weight reduction, hypertension and diabetes in exchange for an up-front, non-refundable payment of $9.5 million, plus a royalty on future commercial sales of any product covered by the licensed patents. We retained the responsibility to prosecute the licensed patent applications and estimated that our obligation would be satisfied during the quarter ended April 27, 2014. However, during the quarter ended July 26, 2013, our obligations under the contract ended,  and we amortized the remaining balance of our deferred revenue resulting in recognition of licensing revenue in the consolidated statement of income of $1.5 million for the thirteen weeks ended July 26, 2013, as compared to $0.4 million for the thirteen weeks ended July 27, 2012.

 

Results of Operations

 

Net Sales

 

The table below illustrates comparative net product revenue and unit sales by geographic area and our licensing revenues. Product shipped to destinations outside the U.S. is classified as “International” sales, (in thousands, except unit sales and percentages):

 

 

 

⁽¹⁾ Sales volume increases are based on unit sales, which are the number of generators sold.

 

U.S. net product sales for the thirteen weeks ended July 26, 2013 increased by $5.5 million, or 10.8%, as compared to the thirteen weeks ended July 27, 2012, due to a sales volume of 6.2% and increased average selling prices of 4.6%. The average selling price increased due to continued market penetration of our higher-priced AspireHC™ generator and price increase effective January 1, 2013.

 

International net product sales for the thirteen weeks ended July 26, 2013 increased by $2.0 million, or 21.9%, as compared to the thirteen weeks ended July 27, 2012, due primarily to increased sales volume of 20.7% and a higher average selling price of 1.2%. Sales volume increased due to higher sales in almost all international markets. The average selling price increased slightly due to higher market penetration of our higher-priced AspireHC in certain countries. We experienced a favorable foreign currency impact of $0.1 million. On a constant currency basis, international sales increased by 20.2%.

 

Licensing revenues for the thirteen weeks ended July 26, 2013 increased by $1.1 million as compared to the thirteen weeks ended July 27, 2012, due to the amortization of the remaining balance of deferred revenue. In December 2007, we entered into an agreement granting an exclusive license to certain patents and patent applications pertaining to weight reduction, hypertension and diabetes in exchange for an up-front, non-refundable payment of $9.5 million. Due to our obligations under the agreement we recorded the up-front payment as deferred revenue and have been amortizing the balance at approximately $0.4 million per quarter. However, during the quarter ended July 26, 2013, our obligations under the contract ended and we amortized the remaining balance. 

 

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Cost of Sales and Expenses

 

The table below illustrates our cost of sales and major expenses as a percent of net sales:

 

 

 

Cost of Sales

 

Cost of sales consists primarily of direct labor, allocated manufacturing overhead and the acquisition cost of raw materials and components and the new medical device excise tax (“MDET”). Our cost of sales as a percent of net sales for the thirteen weeks ended July 26, 2013 increased by 1.2 percentage points to 9.5% when compared to the quarter ended July 27, 2012. This increase was primarily due to the 2.3% MDET on medical devices sold domestically that added $0.9 million to cost of sales for the quarter ended July 26, 2013 as compared to the quarter ended July 27, 2012.

 

Selling, General and Administrative (“SG&A”) Expenses

 

SG&A expenses are comprised of sales, marketing, general and administrative activities. SG&A expenses for the thirteen weeks ended July 26, 2013 decreased as a percentage of net sales by 4.4 percentage points to 42.6% as compared to the thirteen weeks ended July 27, 2012. This decrease is due primarily to more efficient use of our sales and marketing expenditures and a reduction in cash-based and share-based compensation.

 

Research and Development (“R&D”) Expenses

 

R&D expenses consist of expenses related to our product and process development, product design efforts, clinical trial programs and regulatory activities. R&D expense increased 1.3 percentage points to 17.4% as a percentage of sales for the thirteen weeks ended July 26, 2013, as compared to the thirteen weeks ended July 27, 2012. R&D spending increased primarily due to an increase in our product development and clinical study efforts with respect to the AspireSR™ generator, the ProGuardian™ event monitoring system, rechargeable battery and wireless communication technology and the treatment of chronic heart failure with Autonomic Regulation Therapy.  

 

Litigation Settlement

 

We executed a letter agreement with Dr. Zabara settling a dispute regarding our 1988 patent license agreement,  resulting in a $7.4 million charge, before a tax benefit of $2.7 million, recorded in our consolidated statement of income for the quarter ended July 26, 2013. For a description of this matter, see “Note 9. Commitments and Contingencies – Litigation” in the notes to our condensed consolidated financial statements.

 

Impairment of Investment

 

During the quarter ended July 27, 2012, we determined that the fair value of our investment in a convertible debt instrument of NeuroVista, a privately-held, development-stage medical device company, was below the carrying value and recorded an other-than-temporary impairment loss of $4.1 million.

 

Other Income (Expense), Net

 

Other income (expense), net consisted of foreign currency transaction gains and losses. For the thirteen weeks ended July 26, 2013, our FX transaction losses were $131,000, as compared to FX transaction gains of $67,000 for the thirteen weeks July 27, 2012. We operate in a number of international markets and are exposed to the impact of foreign currency exchange rate movements on earnings, particularly with respect to the U.S. dollar versus the euro.

 

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Income Taxes

 

Our effective tax rates were 35.8% and 39.1% for the thirteen weeks ended July 26, 2013 and July 27, 2012, respectively. The rates were primarily due to our federal income tax rate of 35%, plus state and foreign income taxes and permanent differences.  The 3.3% reduction in the tax rate between the two quarters is primarily due to the Texas R&D tax credit, which was enacted during the thirteen weeks ended July 26, 2013 and applies to our tax year ended April 26, 2013 and subsequent years. The rate reduction is also due to the domestic manufacturing tax deduction under Internal Revenue Code Section 199, which became available to us during the quarter ended July 26, 2013, because we expect to report federal taxable income after utilization of net operating loss carryforwards for fiscal year 2014. As of the quarter ended July 26, 2013, we have not provided for U.S. income taxes for the undistributed earnings of our foreign subsidiaries. These earnings, while not material to our consolidated statements of income, are intended to be permanently reinvested outside the United States.

 

We are subject to income tax examinations for our U.S. federal income taxes, non-U.S. income taxes and state and local income taxes for the fiscal year 1992 and subsequent years, with certain exceptions.  Our European subsidiary, Cyberonics Europe BVBA, is currently under examination by the Belgium tax authority with respect to transfer pricing. We are unable to assess the impact the examination may have on our consolidated financial statements, at this time. The Belgium tax losses of Cyberonics, BVBA are subject to a full valuation allowance.

 

Liquidity and Capital Resources

 

Cash, Cash Equivalents

 

Cash Flows

 

Net cash provided by (used in) operating, investing and financing activities for the thirteen weeks ended July 26, 2013 and July 27, 2012 was as follows (in thousands):

 

 

 

Operating Activities

 

Cash provided by operating activities during the thirteen weeks ended July  26, 2013 was $9.5  million and was primarily due to net income of $8.7 million, plus non-cash income and expense items of $2.5 million, offset by cash used in operating assets and liabilities of $1.7 million. Non-cash item expense items consisted primarily of stock-based compensation expense of $3.2 million and depreciation of $1.0 million. Non-cash income consisted of the amortization of the remaining balance of deferred license revenue of $1.5 million. Cash used for operating assets and liabilities included a decrease in accounts payable and accrued liabilities of $9.2 million due to reduced compensation accruals based on timing of payments, offset by an increase in the accrued liability for the litigation settlement of $7.1 million. Refer to “Litigation Settlement” above.

 

Investing Activities

 

Cash used in investing activities during the thirteen weeks ended July 26, 2013 was $17.1 million, which consisted primarily of net purchases of certificates of deposit of $5.0 million, purchases of commercial paper of $5.0 million, investment in land, plant and equipment of $5.5 million, and intangible asset purchases of $1.3 million focused on the integration of MRI compatibility with our leads and the development of a neurostimulation device with cardiac-based seizure detection capabilities.  Plant and equipment investment consisted of Houston facilities and equipment of $4.6 million and construction costs for our manufacturing facility in Costa Rica of $0.9 million. We expect to expend approximately $17 million for capital development during fiscal year 2014, including the Costa Rica project. The construction of the Costa Rica manufacturing facility is expected to be completed in fiscal year 2014 and operational in fiscal year 2015.

 

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Financing Activities

 

Cash used in financing activities during the thirteen weeks ended July 26, 2013 was $6.8 million primarily due to purchases of treasury stock of $13.0 million offset by proceeds from the exercise of stock options of $2.6 million and excess tax benefits from exercises of stock options and restricted stock of $4.5 million. Our Board of Directors authorizes purchases of our common stock on the open market, and the volume and timing of such purchases depend on market conditions and other factors. During the thirteen weeks ended July 26, 2013, we repurchased shares of our stock on the open market at a cost of $10.7 million and from our employees for withholding tax obligations on the vesting of restricted stock at a cost of $2.3 million. 

 

Liquidity

 

We believe our current liquidity and capital resources will be adequate to fund anticipated business activities for the next 12 months. Our liquidity could be adversely affected by the factors affecting future operating results, including those referred to in “Item 1A. Risk Factors” previously.

 

Contractual Obligations and Commitments

 

A summary of contractual obligations as of July 26, 2013 are as follows:

 

 

 

 

 

 

 

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ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to certain market risks as part of our ongoing business operations, including risks from foreign currency exchange rates and concentration of credit that could adversely affect our condensed consolidated balance sheet, net income and cash flow. We manage these risks through regular operating and financing activities and, at certain times, derivative financial instruments. Quantitative and qualitative disclosures about these risks are included in our Annual Report on Form 10-K for the year ended April 26, 2013 in Part II, Item 7A. There have been no material changes from the information provided therein.

 

ITEM 4.   CONTROLS AND PROCEDURES

 

Evaluation and Disclosure Controls and Procedures

 

We maintain a system of disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. This information is also accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the most recent fiscal quarter reported on herein.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of July 26, 2013.

 

Changes in Internal Control over Financial Reporting

 

During the thirteen weeks ended July 26, 2013, there have been no changes that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

PART II.  OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

We are the subject of various pending or threatened legal actions and proceedings that arise in the ordinary course of our business.  Such matters are subject to many uncertainties and outcomes that are not predictable with assurance and that may not be known for extended periods of time.  Any material legal proceedings are discussed in “Note 9. Commitments and Contingencies - Litigation” in the Notes to Condensed Consolidated Financial Statements and are incorporated herein by reference.  Since it is not possible to predict the outcome of certain legal proceedings discussed in Note 9, the costs associated with such proceedings could have a material adverse effect on our consolidated net income, financial position or cash flows.

 

ITEM 1A.  RISK FACTORS

 

Our business faces many risks. Any of the risks referenced below or elsewhere in this Form 10-Q or our other SEC filings could have a material impact on our business and consolidated financial position or results of operations.  Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also impair our business operations.

 

For a detailed discussion of the risk factors that should be understood by any investor contemplating investment in our stock, please refer to “Item 1A. Risk Factors” in our 2013 Form 10-K. There has been no material change in the risk factors set forth in our 2013 Form 10-K. 

 

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ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

 

 

 

 

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ITEM 6.   EXHIBITS

 

The exhibits marked with the asterisk symbol (*) are filed, or furnished in the case of Exhibit 32.1, with this Form 10-Q.

 

 

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SIGNATURE

 

Pursuant to the requirements 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.

 

Date:  August 23, 2013

 

 

 

 

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INDEX TO EXHIBITS

 

The exhibits marked with the asterisk symbol (*) are filed, or furnished in the case of Exhibit 32.1, with this Form 10-Q.

 

 

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