Cyberonics Beats, Ups Guidance

| About: Cyberonics, Inc. (CYBX)

Cyberonics (NASDAQ:CYBX) reported an EPS of 25 cents in the first quarter of fiscal 2011, surpassing both the Zacks Consensus Estimate of 21 cents and 23 cents in the year-ago period. However, excluding the benefit associated with debt refinancing, EPS in the first quarter of fiscal 2010 was 15 cents.

Cyberonics is a medical technology company with core expertise in neuromodulation. The company has developed the Vagus Nerve Stimulation (VNS) therapy system, meant for the treatment of refractory epilepsy and treatment resistant depression. Additionally, it has the potential to treat other neurological disorders, such as Alzheimer’s disease, anxiety, chronic migraine headaches and bulimia.

Revenues were $44.8 million, marginally beating the Zacks Consensus Estimate of $44 million and 16% higher than $38.5 million of the year-ago period. The company’s strong position in the epilepsy market is evident from the fact that more than 15% increase in product sales is associated with this indication. While sales in the domestic market were 22% higher at $37.8 million, international sales were 6% lower at $6.6 million. Economic uncertainty, increased proportion of sales through distributors and unfavorable currency movement were primarily responsible for a decline in revenues from the international market. This is because products sold through distributors are offered at lower prices than employees.

Revenues from the international market are expected to increase following the reimbursement approval of the VNS therapy system in Japan . The company expects to treat 7,500 patients in the first five years and aims at a 10% penetration rate over the next 10 years. While this is encouraging for Cyberonics, the scenario in Europe is different. The company has witnessed weaker unit sales in Europe, especially in Germany and Scandinavia and to a lesser extent in the UK. However, the company expects the situation to improve later in the fiscal year.

Strong 16% growth in revenues coupled with a 2.3% increase in cost of sales led to an 18.6% increase in gross profit. Moreover, gross margin increased 170 basis points based on higher prices, increased production volume and better manufacturing efficiencies. Operating expenses increased 3.7% to $27.64 million driven by a 2% decline in selling, general and administrative expenses ($21.2 million) and a 29% increase in research and development expenses ($6.5 million).

Cyberonics exited the quarter with $56.6 million in cash and cash equivalents, down from $59.23 million of fiscal 2010. During the quarter, the company repurchased $8.4 million of its outstanding convertible debt, thereby reducing the debt burden to $7 million. As at the end of July 2010, the company had repurchased 217,000 shares pursuant to the buyback program of 1 million shares announced earlier in the calendar year.

Based on a strong quarter, Cyberonics raised its outlook for fiscal 2011. The company now expects revenues and income from operations in the range of $184 - $188 million, (previous guidance of $182 - $187 million) and $42- $45 million ($41 - $44 million), respectively.

Cyberonics has a leading position in the medical devices space banking on its pioneer product, VNS therapy system. The company has witnessed strong growth in its core area of epilepsy treatment. Moreover, Cyberonics is targeting the market of Japan, which has immense potential. A significant reduction in the debt burden and share repurchases also bode well for the bottom line. However, we are concerned about the competitive landscape and reimbursement issues being faced by the company.

Based on the long-term potential of the company, we maintain our Neutral rating on the stock, which also corresponds to the Zacks #3 Rank (short-term Hold recommendation).