Cyberonics, Inc.

100 Cyberonics Building
Cyberonics Boulevard
Houston, Texas 77058-2072
U.S.A.
Telephone: (281) 228-7200
Toll Free: (800) 332-1375
Fax: (281) 218-9332
Web site: http://www.cyberonics.com

Public Company
Incorporated: 1987
Employees: 478
Sales: $103.4 million (2005)
Stock Exchanges: NASDAQ
Ticker Symbol: CYBX
NAIC: 334510 Electromedical and Electrotherapeutic Apparatus Manufacturing

Cyberonics, Inc. is a Houston-based medical device company, maker of the Vagus Nerve Stimulation (VNS Therapy) System, an implantable device that sends electrical pulsed signals to the vagus nerve in the left side of the neck. In 1997 the company received Food and Drug Administration (FDA) approval to use the device to treat epilepsy, and later gained FDA approval to treat depression, albeit not without a great deal of controversy. Cyberonics also is pursuing other uses for VNS Therapy, including a method to curb morbid obesity. In addition to the United States, the device is approved for use in Canada, Europe, and Australia. Cyberonics is a public company listed on the NASDAQ.

COMMENCING VNS RESEARCH IN 1971

Cyberonics grew out of the work of Jacob Zabara, a neuroscientist. The native of Philadelphia earned a doctorate at the University of Pennsylvania in 1959 and went on to establish a teaching career. He was a professor at Philadelphia's University School of Medicine in 1971 when he had an insight watching his wife control labor pains through breathing techniques while giving birth to their first child. He was well aware of the prevailing assumption in neuroscience that the vagus nerve provided a one-way connection to the organs of the body, but he now wondered if a reverse action were possible. In the case of his wife, was her breathing making a connection to the brain via the vagus nerve? Then, if this were true, could the vagus nerve serve as a pathway to the brain to control conditions such as seizures or nausea, an area of particular concern because Zabara served as a NASA consultant on space sickness? "Using medical research dating to the 1930s," according to Business Week, "he hypothesized that stimulation of the brain via the vagus nerve could create an anticonvulsion effect." Zabara began conducting research on the vagus nerve of lab animals, eventually succeeding in triggering a seizure in a dog, but his desire to work with human test subjects was greeted with derision from colleagues, and he was unable to persuade any scientific journals to publish his studies.

In the mid-1980s Zabara finally found someone interested in his work: Reese S. Terry. An electrical engineer by training, Reese held a number of patents related to pacemakers and had become the vice-president of technology at Intermedics, a medical device company. Zabara gave him a demonstration of the vagus nerve stimulator that he had implanted in dogs. As described by Fast Company, "When the animals went into seizures, the device seemed to halt them. Terry was intrigued, but when Intermedics funded a study of the device in four monkeys, the outcome was cloudy." Only about half of the animals responded. Intermedics canceled the contract it had made with Zabara to develop a nerve stimulation device to control epilepsy, concluding that it would be too expensive and risky.

When Terry soon found himself a victim of a corporate restructuring effect that left him without a job, he decided to license Zabara's technology and develop the epilepsy product himself. In December 1987 he and Zabara incorporated Cyberonics. Relying on a book, Terry developed a business plan and began trolling for start-up funds. A newly formed Houston venture capital firm, Ventures Medical, kicked in $300,000 and promised several hundred thousand more as the company demonstrated progress. Other investors in this first round of fund-raising were the Vista Group and Dallas-based Sevin Rosen Bayless, the company that once provided seed money to Compaq Computer.

Well aware of how expensive it would be to bring a medical device to market, Terry husbanded his resources. According to Fast Company, "His rented office space was in a strip mall. Personnel matters were discussed in a booth at the Dairy Queen. … To save money, Terry and his medical-device consultants he hired tried to adapt off-the-shelf parts for their purposes instead of designing everything from scratch." Cyberonics soon developed a VNS prototype that could be used in human trials, and Terry managed to find a few doctors willing to give the device a try, but they lacked enthusiasm and some were more interested in disproving Zabara's theory than in validating it. The first device was implanted in a 25-year-old man in late 1988 at Wake Forest Bowman Gray Medical School in North Carolina by Dr. J. Kiffen Penry and neurosurgeon William Bell. The patient's seizure rate decreased by 80 percent, and a second patient, who had been suffering hourly seizures, experienced almost a complete eradication of the events. Over the next several months, another eight patients received the device. Although the improvements were less dramatic, Cyberonics was still able to pursue Phase II of the FDA's review process in which it tested the device on patients who did not respond well to epilepsy drug therapy. The company also attracted another $2 million in a second round of venture capital funding.

Terry brought in someone to take over as chief executive officer while he stayed on as chairman. He also succeed in raiding rival firms to bring in other talented executives, such as Ross G. Baker, Intermedics' former director of electronic design, who served as director of research and development. In addition to controlling epileptic seizures, the company was interested in testing VNS technology as a treatment in areas such as Parkinson's disease, cerebral palsy, circulation problems, bladder control, and intractable pain. The development of a VNS device appeared so promising at this point that pharmaceutical giant Pfizer invested $2.5 million in Cyberonics in 1990, and pledged another $5 million as the VNS device successfully navigated the FDA approval process.

INITIAL PUBLIC OFFERING IN 1993

The venture capital firms were, by now, eager to get their money out, and in 1990 it appeared that their best exit strategy was for Cyberonics to be sold to a major pharmaceutical company. Instead, the company was taken public in 1993. With Morgan Stanley & Co. acting as manager, Cyberonics held an initial public offering of stock, raising $24 million, despite some problems with its FDA application, which the company learned was incomplete. Cyberonics resubmitted its application in June 1993, but in 1994 it learned that the FDA wanted twice as many patients to be studied, 200 instead of 100. The rejection appeared to be nothing less than a death sentence for the independent company, even though in 1994 the company received approval to use the device on refractory epilepsy in Europe. However, the major money was to be found in the U.S. market, and with about $20 million remaining from the stock offering, the company lacked the money necessary to fund another year of FDA trials with twice as many patients.

COMPANY PERSPECTIVES

Cyberonics is a sharply innovative and progressive medical device company whose commitment to our mission is unsurpassed! Our products and achievements speak for themselves. We stand committed to our mission to improve the lives of people touched by epilepsy, depression and other chronic disorders that may prove treatable with our patented therapy, VNS.

According to Fast Company, "The CEO left, as did the vice president who'd come from Eli Lilly. Cyberonics shrunk from 50 employees to about 35. 'We had to cut back advanced development, lay off people, squinch by,' Terry says. 'It was the lowest point of my career.' But the company didn't go out of business." Terry raised more money through private placements of stock and then hired a new CEO to shepherd the device through the third attempt at FDA approval. But the former Johnson & Johnson executive had a last minute change of heart and backed out of the agreement, forcing Terry to step in as CEO.

It was at this delicate point in Cyberonics' history that Robert P. "Skip" Cummins became actively involved in the running of the company. A general partner at one of the venture capital firms that provided seed money, Vista Group, Cummins had served as a director on Cyberonics' board since 1988. In June 1995, according to Fast Company, he "was drafted to serve as acting chief. He took the job—temporarily, he thought—in part to help Cyberonics' investors to cash out…. One part of Cummins's mission as CEO was to scrounge enough money to keep the company moving toward FDA approval, but another was to find a corporate savior that would buy it."

Cummins was able to convince medical device manufacturer St. Jude Medical to invest $12 million in Cyberonics and take an option on buying the company. The money helped to complete the trials needed to satisfy the FDA. In April 1996 St. Jude agreed to pay approximately $72 million to acquire Cyberonics, but the trial results released in August of that year were not strong enough for the likes of St. Jude, which backed out of the deal. Although the price of Cyberonics' stock tanked, much to the displeasure of shareholders, the St. Jude interlude at least bought time for Cyberonics, which had enough cash available to complete the FDA submission.

Cummins became committed to the Cyberonics cause and accepted the CEO post on a permanent basis. He was a fiery leader. The New York Times offered a vivid description of the man: "The modern C.E.O. is supposed to be cool, calm, collected—imperturbable in the face of criticism. Skip Cummins is none of these things. Mr. Cummins is, to put it bluntly, a hothead. A 6'2" former Dartmouth football player, he favors the shaved-head look, which gives him an intimidating mien that he uses to great effect." Hedge fund manager and television host James Cramer called Cummins the "most antagonistic C.E.O. in America." But there was no doubting his passion and commitment to forwarding Cyberonics' agenda. In June 1997 he took a team of six doctors to Washington, D.C., to meet with the FDA advisory panel, which was then persuaded to make a unanimous recommendation to the agency to grant approval for the VNS system for use with epilepsy. A month later, after ten years of effort and $50 million, Cyberonics finally succeeded in gaining FDA approval. The company was now able to recoup that investment by raising $50 million in a secondary stock offering.

Cyberonics estimated that the epilepsy market could be worth as much as $200 million a year, but Cummins was not content with just this business. The company looked for new and possibly more lucrative applications for its VNS device, such as controlling depression, which it estimated could be worth $2 billion. During epilepsy trials a number of subjects who did not experience a reduction in seizures by using the device found themselves feeling happier, leading the researchers to pursue depression control through VNS. The company was also hopeful about using VNS to treat obesity, Alzheimer's disease, and anxiety, but decided to focus most of its resources on depression, an application it hoped could win FDA approval in a shorter time frame. A pilot study was launched in 1998 at the University of Texas Southwestern Medical Center, and a year later early results were encouraging. Of the 30 severely depressed patients, about 40 percent saw their symptoms cut by half in a matter of three months, and after nine months more than 50 percent of the patients benefited.

KEY DATES

1987:: Cyberonics is founded.
1990:: Pfizer invests in the company.
1993:: An initial public offering of stock is completed.
1995:: Skip Cummins takes over as CEO.
1997:: VNS gains FDA approval to treat epilepsy.
2005:: VNS gains FDA approval to treat depression.

REJECTING A BUYOUT OFFER IN 2000

Once again Cyberonics was a company to be reckoned with. In 2000 Medtronics Inc., a major medical device company, tried to acquire the company for $480 million, even making the bid public in order to put pressure on Cummins, but in the end the Cyberonics board rejected the offer, electing to remain independent instead. In the meantime, a second study with a larger sample of depressed patients, 235 in all, was launched. To the surprise of Cummins and his management team, the preliminary results released in January 2002 showed no statistical difference between the patients receiving VNS treatment and the control group that never had their devices activated and continued to rely solely on drugs to control their depression. On release of the news, the price of Cyberonics' stock tumbled 17 points.

There was no shortage of opinions on why the numbers were so poor. Perhaps the patients in the second study were more depressed than the ones in the first, the electrical stimulation was too weak, or stimulation should have lasted longer than the eight weeks allotted to the trial. Cummins rejected the idea of starting all over, electing instead to hire experts to review the numbers and make changes to the trial already underway. In January 2003 a retooled application was submitted to the FDA, and in the spring of 2004 the FDA advisory panel recommended approval. In August 2004, however, the company received a "non-approval" letter from the agency. Once more the price of Cyberonics stock plummeted. The company also faced another takeover attempt, this time a $524 million bid from Advanced Neuromodulation Systems Inc. Again Cyberonics rejected and Cummins refused to accept the FDA ruling as the final word.

In July 2005 the FDA granted approval for the use of VNS therapy on depressed patients who failed to show improvement with at least four other available treatments. Cyberonics called it the "dawning of a new era" and Cummins was talking about revenues in excess of $1 billion by 2010, but there were also critics of the way the approval was granted, in particular the role played by Daniel Schultz, the director of the FDA's device center. According to a Senate investigation concluded in 2006, Schultz overruled the unanimous opinion of his scientific staff to grant approval. Nevertheless, the decision stood. Whether the market was as large as Cummins claimed and insurers could be persuaded to pay for VNS treatment to fight depression remained to be seen. With little more than $100 million in annual sales and a net loss of $12.2 million in 2005, it also remained very much an open question whether Cyberonics would ever reach the heights its backers had long predicted.

PRINCIPAL SUBSIDIARIES

Cyberonics Europe, S.A.

PRINCIPAL COMPETITORS

Athena Neurosciences; Shire PLC; Taro Pharmaceutical Industries Ltd.

Cyberonics, Inc.

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Cyberonics, Inc.

100 Cyberonics Building
Cyberonics Boulevard
Houston, Texas 77058-2072
U.S.A.
Telephone: (281) 228-7200
Toll Free: (800) 332-1375
Fax: (281) 218-9332
Web site: http://www.cyberonics.com