CYBX (MM)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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Form 10-K

 

 

Commission file number: 0-19806

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Cyberonics, Inc.

(Exact name of registrant as specified in its charter)

 

 

Cyberonics Building

100 Cyberonics Blvd.

Houston, Texas

77058-2072

(Address of principal executive offices)

(Zip Code)

 

Registrant’s telephone number, including area code:

(281) 228-7200

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Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:  None

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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☑     No ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ☐     No ☑

 

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 ☑     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 ☑    No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☐

 

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 Act).  Yes ☐     No ☑

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of October 24, 2014, the last business day of the registrant’s most recently completed second fiscal quarter, based upon the last sales price reported for such date on the NASDAQ Global Market was approximately $930.3 million. For purposes of this disclosure, shares of common stock held by persons who hold more than 5% of the outstanding shares of common stock and shares held by officers and directors of the registrant have been excluded as such persons may be deemed to be affiliates.

 

At June 9, 2015, 26,012,364 shares of common stock were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the definitive proxy statement of Cyberonics, Inc. for the 2015 Annual Meeting of Stockholders, which will be filed within 120 days of April 24, 2015, are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 

 

 

 

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CYBERONICS, INC.

 

TABLE OF CONTENTS

 

 

In this Annual Report on Form 10-K, “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. and Cyberonics Latam, S.R.L.).

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CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

 

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements. This Annual Report on Form 10-K (this “Form 10-K”) 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”).  These statements can be identified by the use of forward-looking terminology, including the words “may,” “believe,” “will,” “expect,” “anticipate,” “estimate,” “plan,” “intend,” “forecast,” “foresee,” “should,” “would,” “could” or other similar words or phrases. 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. We are not assuming any duty to update this information if those facts change or if we no longer believe the assumptions to be reasonable.  All comments concerning our expectations for future revenues and operating results are based on our forecasts for our existing operations. These forward-looking statements involve significant risks, uncertainties (some of which are beyond our control) and assumptions. They are subject to change, based upon various factors, including but not limited to the risks and uncertainties described in (a) Part I, Item 1A. “Risk Factors” and elsewhere in this Form 10-K; (b) our reports and registration statements filed from time to time with the Securities and Exchange Commission (the “SEC”); and (c) other announcements we make from time to time.

 

Statements contained in this Form 10-K are based on information available to us, as well as assumptions that we believe to be reasonable.  No forward-looking statements can be guaranteed to be accurate and actual outcomes may vary materially. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We will not update any of the forward-looking statements after the date of this Form 10-K to conform these statements to actual results, unless required by law.

 

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PART I

Item 1.  Business

 

General

 

We are a medical device company, incorporated in 1987, engaged in the design, development, sale and marketing of medical devices for epilepsy, depression and heart failure. Our seminal product, the VNS Therapy® System, is an implantable device that provides neuromodulation therapy for the treatment of drug-resistant epilepsy and treatment-resistant depression (“TRD”). Our latest product, the VITARIA™ System, approved in Europe but not the U.S., is an implantable device that provides a form of neuromodulation therapy for the treatment of chronic heart failure (“CHF”). We are also developing non-implantable device solutions for the management of epilepsy.

 

Our VNS Therapy System and our VITARIA System include 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. The life of the battery varies according to the model and the stimulation parameters used for each patient. At or near the end of the active life of a battery, a patient may, in consultation with his or her physician, choose to have another generator implanted, with or without replacing the original lead.

 

The U.S. Food and Drug Administration (“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 resistant to antiepileptic drugs. Regulatory bodies in Canada, the European Economic Area, certain countries in Eastern Europe, including Russia, South America and 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.

 

We sell the VNS Therapy System for drug-resistant epilepsy to hospitals and ambulatory surgery centers. In addition to maintaining and expanding our regulatory approvals, 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. This coverage allows our customers to invoice and be paid by third-party payers. Currently, there is broad coverage, coding and reimbursement for the VNS Therapy System for the treatment of drug-resistant epilepsy.

 

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.

 

Proposed Merger with Sorin S.p.A.

 

On February 26, 2015, we entered into a binding letter of intent (the “LOI”) with Sorin S.p.A., a joint stock company organized under the laws of Italy (“Sorin”), Sand Holdco PLC (f/k/a Sand Holdco Limited), a public limited company incorporated under the laws of England and Wales and a wholly owned subsidiary of Sorin (“Holdco”), and Cypher Merger Sub, Inc., a Delaware corporation and wholly owned subsidiary of Holdco (“Merger Sub”),  providing that, subject only to completion of the employee consultation procedures required under French law, the parties would enter into a definitive merger agreement, which was attached as an exhibit to the LOI,  providing for a business combination transaction between Cyberonics and Sorin. On  March 23, 2015, following completion of the employee consultation procedures required under French law, Cyberonics, Sorin, Holdco and Merger Sub entered into the definitive merger agreement contemplated by the LOI (the “Transaction Agreement”).

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Under the terms of the Transaction Agreement, Cyberonics and Sorin will combine under a newly formed company Holdco, which will be domiciled in the United Kingdom (the “UK”), in an all-stock transaction with a combined equity value of approximately $2.7 billion based on the closing price of shares of Cyberonics and Sorin on February 25, 2015, the last trading day prior to announcement of entry into the LOI.  Pursuant to the Transaction Agreement and subject to the satisfaction or waiver of all conditions under the Transaction Agreement, the business combination transaction will take place in two steps: First, Sorin will be merged with and into Holdco (the “Sorin Merger”), with Holdco surviving as the continuing company.  Immediately following the effective time of the Sorin Merger, Merger Sub will be merged with and into Cyberonics (the “Cyberonics Merger” and, together with the Sorin Merger, the “Mergers”), with Cyberonics surviving as a wholly owned subsidiary of Holdco.    

 

Subject to the terms and conditions of the Transaction Agreement, at the effective time of the Sorin Merger, each issued and outstanding ordinary share of Sorin will be converted into the right to receive 0.0472 ordinary shares of Holdco (“Holdco Shares”) and at the effective time of the Cyberonics Merger, each share of our common stock will be converted into the right to receive one Holdco Share.  In connection with the Mergers, our common stock will be delisted from the NASDAQ stock market and Sorin ordinary shares will be delisted from the Italian Stock Exchange (i.e. Mercato Telematicao Azionario, organized and managed by Borsa Italiana S.p.A.). Holdco will apply to list the Holdco Shares to be issued in the Mergers on the NASDAQ stock market and the London Stock Exchange (the “LSE”).  Following consummation of the Mergers, assuming no withdrawal rights under Italian law are exercised by Sorin shareholders with respect to the Sorin Merger, former Sorin shareholders are expected to own approximately 46 percent of Holdco and former stockholders of Cyberonics are expected to own approximately 54 percent of Holdco, on a fully diluted basis.

 

Closing of the Mergers under the Transaction Agreement is subject to certain closing conditions, including (i) the required approval of each of our stockholders and Sorin’s shareholders, (ii) expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (the “HSR Act”), (iii) the absence of any law, injunction, order or other judgment prohibiting the mergers, (iv) effectiveness of the registration statement for the Holdco Shares, (v) NASDAQ listing approval for the Holdco Shares and the absence of any written indication from the UK Financial Conduct Authority  or the LSE that they will not be willing to admit the Holdco Shares to listing, (vi) the expiration of a sixty-day Sorin creditor opposition period, (vii) subject to certain materiality exceptions, the accuracy of each party’s representations and warranties in the Transaction Agreement and performance by the parties of their respective obligations under the Transaction Agreement; (viii) delivery of a pre-merger compliance certificate to the High Court of England and Wales and (ix) approval by the UK Financial Conduct Authority of the prospectus to be published by Holdco in connection with the issuance and listing on the LSE of the Holdco Shares to be issued in connection with the Mergers, or the absence of an indication in writing by the UK Listing Authority that such approval will not be obtained. Sorin and Cyberonics filed certain information and materials with the Federal Trade Commission (“FTC”) and the Antitrust Division of the Department of Justice (“DOJ”) under the HSR Act and the applicable waiting period under the HSR Act expired on April 13, 2015, without any action having been taken by the FTC or DOJ. On May 26, 2015, at the extraordinary general meeting of Sorin’s shareholders, the Sorin shareholders approved the proposed merger.

 

Sorin and Cyberonics both have long storied histories of medical technology innovation and of dramatically improving the lives of patients suffering from life threatening diseases. While Cyberonics and Sorin have operated successfully as independent companies, largely in different geographies, in many ways we have also been working in parallel. Cyberonics and Sorin both provide physicians the tools they need to help their patients, and we each have products that we believe improve the lives of patients who have been failed by drugs and other remedies. Cyberonics and Sorin also share the same core values of leading with innovation and evolving our businesses for the future, which has helped both companies capitalize on opportunities and successfully navigate many economic cycles.

 

VNS Therapy for Epilepsy

 

Epilepsy is characterized by recurrent seizures that are broadly categorized as either partial or generalized at onset. According to the U.S. Centers for Disease Control and the Epilepsy Foundation of America, approximately three million individuals in the U.S. have some form of epilepsy, with approximately 150,000 new cases diagnosed each year. We estimate, based on a World Health Organization study on epilepsy, there are similar numbers of individuals with epilepsy in Western Europe. In Japan, there are approximately one million individuals with epilepsy and 50,000 new cases diagnosed annually. In addition, it is estimated that approximately 50% of patients with epilepsy experience partial onset seizures. A number of clinical studies have shown that more than 30% of people with epilepsy continue to experience seizures in spite of treatment with seizure medications. People with epilepsy who continue to have unsatisfactory seizure control or intolerable side effects after treatment with appropriate medication therapies for a reasonable period of time are considered to have drug-resistant, or drug-refractory, epilepsy. For reasons that are not clear, partial onset seizures are generally more resistant to currently available therapies than generalized seizures. Globally, there are several broad types of treatment available to persons with epilepsy: multiple seizure medications, various forms of the ketogenic diet, vagus nerve stimulation, resective brain surgery, trigeminal nerve stimulation, responsive intracranial neurostimulation and deep brain stimulation. Seizure medications typically serve as a first-line treatment and are prescribed for virtually all patients diagnosed with epilepsy. After two seizure medications fail to deliver seizure control, the epilepsy is defined as drug-resistant. At this point, adjunctive non-drug options should be considered, including VNS therapy, brain surgery and a  ketogenic diet.

 

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In the U.S. the VNS Therapy System is indicated for use as an adjunctive therapy in reducing the frequency of seizures in adults and adolescents over 12 years of age with partial onset seizures that are refractory to antiepileptic medications. In most markets outside the U.S., the VNS Therapy System is indicated for use as an adjunctive therapy in reducing the frequency of seizures in patients whose epileptic disorder is dominated by partial onset seizures, with or without secondary generalization, or generalized seizures that are refractory to antiepileptic medications. Our analysis of an internal database of patients who received an implant of the VNS Therapy System since 1997, including the first model of our generator,  Model 100, indicates that more than 70% have chosen to continue with the VNS Therapy System when the generator battery is depleted. To date, an estimated 92,000 patients have been treated with the VNS Therapy System for epilepsy.

 

VNS Therapy for Depression

 

Major depressive disorder is one of the most prevalent and serious illnesses in the U.S. It affects nearly 19 million Americans 18 years of age or older every year. Published data indicate that approximately one-third of patients with major depressive disorders will not experience remission of their depressive symptoms after four well-delivered, optimized treatment steps using standard antidepressant therapies. Standard treatment methods for depression include antidepressant drugs, psychotherapy and, in some cases, electroconvulsive therapy (“ECT”). First-line therapy often consists of an antidepressant drug. For patients experiencing persistent depression symptoms in spite of appropriate drug treatment, physicians will often switch to a different drug or use two or more drugs in combination. Physicians usually reserve ECT for patients experiencing depression that has not had an adequate response to multiple trials of antidepressant drugs or when they determine that a rapid response to treatment is desirable.

 

In July 2005, the FDA approved our 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, Brazil, Mexico, Australia, Israel and certain other international markets 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. To date, an estimated 4,100 patients worldwide have been treated with the VNS Therapy System for depression.

 

In May 2007, the Centers for Medicare and Medicaid Services (“CMS”) issued a national determination of non-coverage within the U.S. with respect to reimbursement of the VNS Therapy System for patients with TRD, significantly limiting access to this therapeutic option for most patients. As the result of lack of access following this determination, we have not engaged in active commercial efforts with respect to TRD in any of our markets, however, in the future we intend to re-engage in limited commercial efforts in certain international markets. As a result of new clinical evidence, including the completion of a post-approval dosing study and other studies that have resulted in more than five recent publications in peer-reviewed journals, we submitted a formal request to CMS for reconsideration of VNS therapy for TRD.  CMS declined our request for reconsideration in May 2013. In October 2013, two Medicare beneficiaries appealed the lack of coverage by Medicare through the Departmental Appeals Board (“DAB”) of the Department of Health and Human Services. In January 2015, DAB concluded that the record relating to the non-coverage conclusion by CMS is complete and adequately supports the non-coverage determination.

 

VNS Therapy for Chronic Heart Failure

 

In 2011, we initiated a program to assess the use of our VNS technology for treating patients with chronic heart failure (“CHF”). Our system for treating patients with CHF, the VITARIA System, provides a specific method of VNS called autonomic regulation therapy (“ART”). The VITARIA System includes the same elements as the VNS Therapy System – pulse generator, lead, programming wand and software, programming computer, tunneling tool and accessory pack – without the patient kit with magnets. We conducted a pilot study, ANTHEM-HF, outside the U.S., which concluded during the quarter ended October 24, 2014. The study results support the safety and efficacy of ART delivered by the VITARIA System. The VITARIA System includes an implantable pulse generator, vagus nerve lead, programming system and patient kit that have been specifically designed to deliver ART in a manner that promotes improvements in heart function and reduces symptom expression. We submitted the results to our European Notified Body, DEKRA, and on February 20, 2015, we received Conformité Européenne (“CE”) Mark approval of our VITARIA System for patients who have moderate to severe heart failure (New York Heart Association Class II/III) with left ventricular dysfunction (ejection fraction < 40%), and who remain symptomatic despite stable, optimal heart failure drug therapy.  We commenced a limited market launch in Europe of the VITARIA System, with the first commercial implant in early June 2015. The VITARIA System is not available in the U.S. During the quarter ended October 24, 2014, we also initiated a second pilot study, ANTHEM-HFpEF, to study ART in patients experiencing symptomatic heart failure with preserved ejection fraction. This pilot study is currently underway outside the U.S.

 

VNS Therapy for Other Indications

 

In the past we have conducted or supported animal studies or small human pilot studies for the treatment of a number of therapeutic indications, such as traumatic brain injury and fibromyalgia. At this time, we do not have any immediate, specific plans to conduct studies or further develop the VNS Therapy System for additional therapeutic indications; however, we continue to explore ways to expand the use of the VNS Therapy System.

 

The VNS Therapy System

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The VNS Therapy System was the first medical device treatment approved by the FDA for refractory epilepsy and for TRD. The safety profiles for VNS therapy and the VNS Therapy System, including the implant procedure, are well established in clinical studies of refractory epilepsy and TRD.

 

The VNS Therapy System consists of an implantable pulse generator, a lead that connects the generator to the vagus nerve, surgical equipment to assist with the implant procedure, equipment to enable the treating physician to set the pulse generator stimulation parameters for the patient, instruction manuals and magnets to suspend or induce stimulation manually. The VNS Therapy pulse generator and lead are surgically implanted, generally during an out-patient procedure. The pulse generator is surgically implanted in a subcutaneous pocket in the upper left chest area. The lead is connected to the pulse generator and tunneled under the skin to the vagus nerve in the lower left side of the patient’s neck.

 

The implanted pulse generator delivers a mild electrical pulse through the lead attached to the left vagus nerve. The vagus nerve is the longest of the cranial nerves, extending from the brain stem through the neck to organs in the chest and abdomen. Preclinical studies and mechanism-of-action research suggest that intermittent stimulation of the left vagus nerve in the neck modulates a number of structures and alters blood flow bilaterally in several areas of the brain. These studies have also shown that stimulation of the left cervical vagus nerve is effective in suppressing the intensity or frequency of seizures and results in persistent or cumulative antiepileptic effects. The mechanism-of-action research associated with our depression studies has shown that stimulation of the left vagus nerve results in modulation of areas of the brain thought to be important in the regulation of mood.

 

The VNS Therapy System delivers stimulation to the left vagus nerve by means of electrical pulses on a regular, intermittent basis. For all models, the initial stimulation parameters recommended in the labeling are a 30-second period of stimulation, referred to as ON time, followed by a five-minute period without stimulation, referred to as OFF time. To optimize patient treatment, the current pulse width, amplitude and frequency and the stimulation ON and OFF intervals of the pulse generator can be adjusted non-invasively by the treating physician with a programming computer using our programming wand and software. In addition, patients with epilepsy can use a small, handheld magnet provided with the VNS Therapy System to activate or inhibit stimulation manually. On-demand therapy can be activated by those patients who sense an oncoming seizure and has been reported by a number of patients to abort or reduce the severity or duration of seizures. The magnet can also be used to provide control of stimulation-related side effects by allowing the patient to discontinue stimulation temporarily, if desired.

 

The AspireSR® generator is capable of delivering programmable stimulation comparable to other VNS Therapy generators. The AspireSR generator also enables additional stimulation automatically by responding to a patient’s relative heart-rate changes that exceed certain variable thresholds. Heart-rate changes accompany seizure activity in certain patients. The thresholds are programmed by the patient’s physician and can be adjusted to suit individual patient needs.

 

Pulse Generator.  The pulse generator is an implantable, programmable signal generator designed to be coupled with the lead to deliver mild electrical pulses to the vagus nerve. The pulse generator is a battery-powered device. Shortly before or upon depletion of the battery, the pulse generator may be removed and a new generator implanted in a short, outpatient procedure. The Model 102 (Pulse™), Model 102R (Pulse Duo™), Model 103 (Demipulse®), Model 104 (Demipulse Duo®) and Model 105 (AspireHC®) generators are the VNS Therapy pulse generators we currently offer in the U.S. and most markets worldwide. In addition to these models, we also offer the Model 106 (AspireSR) generator in Europe and other international markets. On June 2, 2015, we announced FDA approval of the AspireSR generator, the first and only VNS Therapy System that provides responsive stimulation to heart-rate increases that are often associated with seizures in people with epilepsy. Our generators are comprised of a printed circuit board and a battery hermetically sealed in a titanium case. Standard components are assembled on the printed circuit board using surface-mount technology. The assembled circuit board is then tested and mounted with the battery in the titanium case, which is closed and sealed by a laser weld. A header to which the lead connects is added, and each unit is subject to final release testing prior to being sterilized and packaged.

 

Lead.  The lead conducts the electrical pulses from the pulse generator to the vagus nerve. The lead incorporates electrodes, which are self-sizing and flexible, minimizing mechanical trauma to the nerve. The lead’s two electrodes and anchor tether wrap around the vagus nerve, and the connector end is tunneled subcutaneously to the upper chest area, where it attaches to the pulse generator. We currently offer two lead models in the U.S., each with differences in flexibility. The leads are available in two inner spiral diameter sizes for use on different-sized nerves. 

 

Programming Wand and Software.  Our programming wand and proprietary software are used to interrogate the implanted pulse generator and to transmit programming information from a programming computer to the pulse generator via an inductive coupling. Programming capabilities include modification of the pulse generator’s programmable parameters (pulse width, amplitude, frequency and stimulation ON and OFF intervals) and storage and retrieval of telemetry data.

 

Programming Computer. Our newest programming computer is a tablet device that functions in conjunction with the programming wand and software described above.  We have recently transitioned to the tablet device from a smaller programming computer device referred to as a personal digital assistant or “PDA.”

 

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Tunneling Tool.  The tunneling tool is a single-use, sterile, disposable surgical tool designed to be used during surgical placement of the lead. The tool is used for subcutaneous tunneling of the lead between the nerve site in the neck and the pulse generator site in the upper chest area.

 

Accessory Pack.  The accessory pack includes two resistor assemblies used to test the function of the device prior to implantation, the lead tie-downs and one hex screwdriver.

 

Patient Essentials Kit.  The patient kit includes two magnets, one on a wrist-band and one with a belt-clip.

 

Battery Replacements.  The battery contained in the generator has a finite life, which may vary between one and 16 years depending on the generator model and the stimulation parameters used for each patient. In all cases, patients are instructed to see a physician to determine whether a replacement may be advisable. If a physician determines that a patient’s battery is at or near the end of its useful life or that the generator should be replaced for clinical reasons, a patient or a patient’s caregiver may choose to implant a new generator. The generator may be replaced with or without replacing the original lead.

 

Manufacturing and Sources of Components and Raw Materials

 

Until recently, we manufactured all of our products at our manufacturing facility located in our corporate headquarters in Houston, Texas, with the exception of the programming computer, which is a purchased component. We constructed a second manufacturing facility in Costa Rica, which began manufacturing and shipping product during the quarter ended April 24, 2015.

 

We purchase the components and raw materials used in manufacturing these products from various suppliers.  For reasons of quality, product availability and expense control, certain components and raw materials are purchased from sole-source suppliers. We work closely with our suppliers, including our sole-source suppliers, to ensure continuity of supply and quality. Due to the FDA’s rigorous quality requirements regarding the manufacture of medical devices, including the VNS Therapy System, we may not be able to change suppliers or to identify alternate suppliers quickly or easily. Although component or raw material supply has not historically been an issue, any reduction or interruption in supply could adversely impact our business.

 

Our U.S. manufacturing operations in Houston, Texas, our Costa Rica plant, and our warehouse and distribution center in Austin, Texas are required to comply with the FDA’s Quality System Regulation (“QSR”). The QSR implements section 520 of the federal Food, Drug and Cosmetic Act (“FDCA”), which requires manufacturers to have a quality system for the design, production, warehousing and distribution of medical devices. The QSR helps assure that medical devices are safe and effective for their intended use.

 

In addition, certain international markets have regulatory, quality assurance and manufacturing requirements that may be more or less rigorous than those in the U.S. Specifically, we have authorized DEKRA to act as our notified body to ensure that our products and quality system complies with the requirements of International Standards Organization – ISO 13485:2003, Medical devices — Quality management systems — Requirements for regulatory purposes, the European Council Directive 90/385/EEC (“ISO 13485”), which relates to active implantable medical devices, and with the requirements of the Canadian medical devices regulations. U.S. manufacturing operations in Houston, Texas, our Costa Rica plant, and our warehouse and distribution center in Austin, Texas comply with international standards.

 

Product Releases and Future Developments

 

Our epilepsy product development efforts are directed toward improving the VNS Therapy System, improving its efficacy, and developing new products that provide additional features and functionality. We are conducting ongoing product development activities to enhance the VNS Therapy System pulse generator, lead and programming software and to introduce new products. We support a variety of studies for our product development efforts and to build clinical evidence for the VNS Therapy System. We will be required to obtain appropriate U.S. and international regulatory approvals, and clinical studies may be a prerequisite to regulatory approvals for some products. Our R&D efforts will require significant funding to complete and may not be successful. Even if successful, additional clinical studies may be needed to achieve regulatory approval and to commercialize any or all new or improved products. Our company sponsored research,  development and regulatory approval activities of $43.3 million, $46.6 million and $41.6 million in the fiscal years 2015, 2014 and 2013, respectively.

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In September 2012, we submitted an Investigational Device Exemption (“IDE”) request to the FDA for the purpose of conducting a U.S. pilot study of the AspireSR generator (designated “E-37”).  The IDE was approved in December 2012 and in December 2014, we announced positive results from the AspireSR clinical studies, E-36 and E-37, which assessed the acute impact of the AspireSR generator on seizure duration and termination, as well as the long-term evaluation of safety, clinical benefit of the automatic stimulation feature and quality of life. During the quarter ended October 24, 2014, we submitted the AspireSR generator for premarket approval (“PMA”) in the U.S. On June 2, 2015, we announced FDA approval of the AspireSR generator, the first and only VNS Therapy System that provides responsive stimulation to heart-rate increases that are often associated with seizures in people with epilepsy.  In February 2014, we received CE Mark approval for the AspireSR generator, and the generator has been commercially available in many European and Middle Eastern countries since late fiscal year 2014.

 

In February 2015, we received CE Mark approval of our VITARIA System for patients who have moderate to severe heart failure (New York Heart Association Class II/III) with left ventricular dysfunction (ejection fraction < 40%), and who remain symptomatic despite stable, optimal heart failure drug therapy. We commenced a limited market launch in Europe of the VITARIA System, with the first commercial implant in early June 2015.

 

We continue to develop the ProGuardian™ System, which includes an external body-worn sensor and bedside hub that uses advanced cardiac and movement-based seizure detection technology for in-home seizure monitoring, logging and notification. The first ProGuardian System product will be the ProGuardianREST™ System for monitoring night-time seizures. In November 2014, we received CE Mark approval for marketing the ProGuardian System in Europe, and we plan a limited market release in England during the first quarter of fiscal year 2016. We are also working toward new stimulation paradigms, rechargeable battery technology and the integration of magnetic resonance imaging compatibility with our leads.

 

Following an internal review of our R&D activities, we are engaging in a re-design of certain aspects of our wireless Centro™ generator that resulted in the write-off of certain obsolete inventory items, production equipment and software that amounted to a loss of $1.6 million,  which was charged to R&D expense in the consolidated statement of income. We also decided to abandon our pursuit of neurological signal feedback and processing technology, and as a result, we fully impaired certain intellectual property and software for a loss of $0.5 million, also charged to R&D expense.

 

We have invested approximately $17.1 million in two innovative medical device start-up companies. We account for these investments under the cost-method, as we do not exercise significant influence over the investees. We invested in Cerbomed GmbH (“Cerbomed”), a privately-held, European development-stage company developing a transcutaneous vagus nerve stimulation (t-VNS) device for several indications, including the treatment of drug-resistant epilepsy. Cerbomed received CE Mark approval for its device for the treatment of epilepsy and depression in March 2010, and has completed a clinical study in Germany to study outcomes in the treatment of refractory epilepsy. During the quarter ended January 23, 2015, we invested an additional €1.0 million, or $1.2 million, in convertible preferred stock.  During fiscal year 2016, consistent with our existing agreement, we expect Cerbomed to seek an IDE from the FDA for their device for the treatment of certain types of epilepsy. We hold an exclusive option for the worldwide sales and distribution of this system for the treatment of epilepsy. In addition, we invested in ImThera Medical, Inc., a privately-held, development-stage, company developing an implantable neurostimulation device system for the treatment of obstructive sleep apnea. In November 2014, ImThera announced that the FDA granted an IDE for their targeted hypoglossal neurostimulation pivotal clinical study and patient enrollment has commenced.

 

Marketing and Sales

 

U.S.

 

We market and sell our products for drug-resistant epilepsy through direct sales and marketing teams.

 

In the U.S., our sales and marketing plan focuses on creating awareness and demand for the VNS Therapy System among epileptologists and neurologists who treat refractory epilepsy, implanting surgeons, ancillary healthcare professionals, third-party payers, hospitals and patients and their families. Our efforts focus on comprehensive epilepsy treatment centers and community-based practices engaged in the treatment of epilepsy.

 

To reach each of these groups, we conduct direct-selling activities using a specialized sales force consisting of:

 

 

In addition to our direct-selling activities, we facilitate and support peer-to-peer interactions such as symposia, conference presentations, journal articles and patient support groups to provide experienced clinicians and patients the opportunity to share their perspectives on the VNS Therapy System with others.

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International

 

We are approved to market our products in more than 70 countries. We market and sell our products in these countries through a combination of a direct sales force in certain European countries and independent distributors elsewhere. Our objectives include increasing sales in existing markets and expanding the number of countries where the VNS Therapy System is available to patients.

 

The VNS Therapy System is currently marketed and sold for epilepsy in every major European market. The majority of sales in Europe are driven by a direct sales force. In some European countries and areas, we establish distribution agreements with independent distributors to better suit the needs of our customers, for example, such as Italy, the Balkans and in eastern Europe. We also have distribution agreements with independent distributors covering a number of other territories outside of Europe, including Canada, Mexico, Australia, parts of Central and South America, the Middle East, China, Japan, and other parts of Asia. The distribution agreements generally grant the distributor exclusive rights for the particular territory. The time periods covered by our contracts with distributors are predominantly annual, although there are some contracts for longer periods. The terms and conditions of our distribution contracts include expectations around regulatory compliance, and provide for title and risk of loss to pass to the distributor when a product is shipped. In addition, distribution contracts may provide for payment terms up to 30 days longer than the standard payments terms for our direct customers.

 

Under the terms of the agreement and local law, we may be required to compensate the distributor in the event that the agreement is terminated by us or is not renewed upon expiration. The distributor generally assumes responsibility for obtaining regulatory and reimbursement approvals for the relevant territory and agrees to certain minimum marketing and sales expenditures, as well as to purchase commitments with limited return rights. Our pricing to distributors is generally fixed under the terms of the distribution agreements, but may change at our election with as little as 30 days prior notice under most agreements. The average sales price in each country is based on local market conditions and is primarily dictated by public and private reimbursement. Typically, the sales price in international markets is lower than in the U.S.

 

Government Regulation

 

The products we manufacture and market are subject to regulation by the FDA under the FDCA and, in some instances, state authorities and foreign governments.

 

U.S. FDA Regulation

 

Before a new medical device can be introduced into the U.S. market, a manufacturer generally must obtain marketing clearance or approval from the FDA through either a 510(k) submission (a premarket notification) or a premarket approval (“PMA”) application.

 

The PMA application procedure is more comprehensive than the 510(k) procedure and typically takes several years to complete. The PMA application claims must be supported by scientific evidence, typically in the form of pre-clinical and clinical data relating to the safety and effectiveness of the device, and must include other information about the device and its components, design, manufacturing and labeling.  The choice of the submission process is determined based on a risk-based classification system and whether similar devices were on the market prior to the introduction of the Medical Device Regulations in 1976. Medical devices are classified into three classes of device: Class 1-low risk, Class 2 - moderate risk and Class 3 – high risk. High risk examples typically include implantable and life-sustaining or life-supporting devices. The 510(k) submission route is used for Class 1 and 2 medical devices. Class 3 medical devices generally fall under the PMA regulations with a few exceptions. FDA classified the VNS Therapy System as a Class 3 medical device, which required that we follow the PMA procedure.

 

When clinical studies of a Class 3 medical device are required in order to obtain FDA approval, the sponsor of the trial is required to file an IDE application before commencing clinical studies. The IDE application must be supported by data, which typically include the results of extensive bench testing, animal testing, and formal lab testing, all of which must be conducted in accordance with good laboratory practices, appropriate design controls and scientific justification. The FDA reviews and must approve an IDE before a study may begin in the U.S. In addition, the study must be approved by an Institutional Review Board charged with protecting study subjects for each clinical site. When all approvals are obtained, the study may begin. The FDA will approve a PMA application only if the application can provide reasonable assurance that the device is safe and effective for its intended use. As part of the PMA application review, the FDA inspects the manufacturer’s facilities for compliance with its QSR. As part of the PMA approval, the FDA may place restrictions on the device, such as requiring additional patient follow-up for an indefinite period of time. If the FDA’s evaluation of the PMA application or the manufacturing facility is not favorable, the FDA may deny approval of the PMA application or issue a “not approvable” letter. The FDA may also require additional clinical studies, which can delay the PMA approval process by several years. After the PMA is approved, if significant changes are made to a device, its manufacturing or labeling, a PMA supplement containing additional information must be filed for FDA approval prior to implementation of the changes.

 

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Since the FDA clearance and approval processes for a medical device are lengthy and expensive, and the outcomes are uncertain, there can be no assurance that we will be able to obtain necessary regulatory clearances or approvals for any new or improved product on a timely basis or at all.

 

After a product is placed on the market, the product and its manufacturer are subject to pervasive and continuing regulation by the FDA. In addition to the marketing clearance and approval process discussed above, device manufacturers must:

 

 

The FDA enforces these requirements by inspection and market surveillance, including our facilities. The FDA periodically inspects our manufacturing facilities, which potentially includes our suppliers. If the FDA observes conditions that may constitute violations, we must correct the conditions or satisfactorily demonstrate the absence of the violations; if we are unable to do so, we may face regulatory action.  Non-compliance with applicable FDA requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the FDA to grant marketing approvals, withdrawal of marketing approvals, a recommendation by the FDA to disallow us to enter into government contracts, and criminal prosecutions. The FDA also has the authority to request repair, replacement or refund of the cost of any device manufactured or distributed by us.

 

Recently, the FDA has placed an increased emphasis on enforcement of the QSR and other post-market regulatory requirements. We continue to expend resources to maintain compliance with our obligations under the FDA’s regulations.

 

Other U.S. Regulation

 

We are subject to the Transparency Reports and Reporting of Physician Ownership or Investment Interests (the “Sunshine Act”) finalized by CMS on February 8, 2013 as part of the federal Patient Protection and Affordable Care Act and Health Care and Education Reconciliation Act of 2010, (the “Affordable Care Act”). This healthcare reform legislation is intended to increase the transparency of healthcare companies’ interactions with healthcare providers. Pursuant to the Sunshine Act, we are required by law to disclose all payments and other transfers of value to U.S. physicians and teaching hospitals effective August 1, 2013. 

 

We and our products are also subject to a variety of state and local laws in those jurisdictions where our products are or will be marketed, and to federal, state and local laws relating to matters such as our responsibilities as an employer, safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. We are also subject to various federal and state laws governing our relationships with the hospitals and physicians and others who purchase or make referrals for our products. For instance, federal law prohibits payments of any form intended to induce a referral for any item payable under Medicare, Medicaid or any other federal healthcare program. Many states have similar laws. There can be no assurance that we will not be required to incur significant costs to comply with such laws and regulations now or in the future or that such laws or regulations will not have a material adverse effect on our ability to do business.

 

Non-U.S. Regulation

 

Internationally, the VNS Therapy System is considered to be a medical device under applicable regulations and directives. We anticipate that this will be true for all of our future products. Sales of medical devices are subject to regulatory requirements in many countries. The regulatory review process may vary greatly from country to country. For example, the European Union has adopted numerous directives and standards relating to medical devices, regulating their design, manufacture, clinical studies, labeling and adverse event reporting. Devices that comply with these requirements are entitled to bear a CE Mark indicating that the device conforms to the essential requirements of the applicable directives and can be commercially distributed in countries that are members of the European Union. In some cases, we rely on our non-U.S. distributors to obtain regulatory approvals, complete product registrations, comply with clinical study requirements and complete those steps that are customarily taken in the applicable jurisdictions.

 

There can be no assurance that new laws or regulations regarding the release or sale of medical devices will not delay or prevent the sale of our current or future products. We continually monitor international regulatory developments to mitigate against any such delays.

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Certain international markets have regulatory, quality assurance and manufacturing requirements that may be more or less rigorous than those in the U.S.  Specifically, we have authorized DEKRA to act as our notified body to ensure that our products and quality systems comply with the requirements of ISO 13485, which relates to active implantable medical devices and the Canadian medical device regulations.

 

Third-Party Reimbursement in the U.S. Market

 

We sell the VNS Therapy System for refractory epilepsy to hospitals and ambulatory surgery centers (“ASCs”) on payment terms that are generally 30 days from the shipment date. In addition to maintaining regulatory approval, our ability to 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. This coverage allows our customers to invoice and be paid by third-party payers. Currently, we have broad coverage, coding and reimbursement for the VNS Therapy System for the treatment of refractory epilepsy.

 

The Affordable Care Act was enacted into law in March 2010. Certain provisions of the Affordable Care Act will not be effective for a number of years, and there are many programs and requirements for which the details have not yet been fully established or consequences not fully understood, and it is unclear what the full impacts will be from the law. The law levied a 2.3% excise tax on the majority of our U.S. medical device sales effective January 1, 2013. The law also focuses on a number of Medicare provisions aimed at improving quality and decreasing costs. The Medicare provisions include value-based payment programs, increased funding of comparative effectiveness research, reduced hospital payments for avoidable readmissions and hospital-acquired conditions, and pilot programs to evaluate alternative payment methodologies that promote care coordination - such as bundled physician and hospital payments under the APC system. Additionally, the law includes the establishment of an independent payment advisory board to recommend ways of reducing the rate of growth in Medicare spending beginning in 2014. We employ case managers, available through our reimbursement hotline, to help with coverage, coding and reimbursement issues on a case-by-case basis or policy level.

 

CMS annually updates and issues its reimbursement rates under the comprehensive Ambulatory Payment Classification (“APC”) system. We estimate that CMS pays for approximately 25% to 30% of the VNS Therapy System implants performed in the U.S. under Medicare and approximately 20% or more under Medicaid, although this varies by hospital. On October 31, 2014, CMS released the calendar year 2015 final comprehensive APC rates. The VNS Therapy-related rates decreased, as compared to the calendar year 2014 final rates, by 5.3% for full systems and 0.8% for generator-only replacements. These rate decreases were due to a change in reimbursement methodology,  whereby CMS reassigned neurostimulation-related procedures within a smaller number of comprehensive APC categories. The calendar year 2014 rates increased over the calendar year 2013 rates by 7.7% for full systems and 5.1% for generator-only replacements. The calendar year 2013 reimbursement rates increased over the calendar year 2012 rates by 5.7% for full systems and 7.9% for generator-only replacements. Future changes in the determination of comprehensive APC reimbursement rates by CMS could result in additional rate reductions and could have an adverse impact on our future operating results. We believe reimbursement or payment rates from private insurers were largely unchanged over the past year.

 

Medicare

 

Under the current CMS policy, the VNS Therapy System is covered for patients with medically refractory partial onset seizures for whom surgery is not recommended or for whom surgery has failed. In May 2007, CMS concluded that Medicare coverage is not available for the VNS  Therapy System for the treatment for TRD and declined our request for reconsideration of coverage on May 28, 2013.

 

Medicaid

 

Medicaid programs generally cover hospital inpatient and outpatient services that are medically necessary and appropriate. With respect to epilepsy, most state Medicaid agencies have developed their own coverage policy for the VNS Therapy System or have adopted the national CMS coverage policy, although payment amounts vary from state to state. With respect to TRD, a small number of Medicaid programs provide coverage for the VNS Therapy System on a case-by-case basis, but most are still evaluating a coverage policy or have issued a non-coverage policy. CMS’s non-coverage determination for the treatment of TRD has made it difficult to obtain Medicaid coverage for the TRD indication.

 

Medicaid reimbursement mechanisms vary state by state. Medicaid policy and payment methodologies change on a regular basis, so we are engaged in ongoing efforts to obtain or attempt to ensure continued access and acceptable reimbursement for patients covered by Medicaid programs. Recent financial problems at various state Medicaid programs have limited payments for VNS therapy from time to time, and these problems may continue.

 

Private Payers

 

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Private payers (commercial, managed care and other third-party payers) generally cover hospital inpatient and outpatient services that are considered to be medically necessary. Currently, we estimate that private payers account for less than half of new patients implanted with the VNS Therapy System. As with other payers, many private payers have developed clinical guidelines for coverage or have adopted the national CMS coverage policy for use of the VNS Therapy System in epilepsy. Private payers in several states have recently adopted less restrictive guidelines as to which patients would be eligible for the VNS Therapy System, particularly patients with all seizure types, including generalized seizures. Most private payers either have no policy or have a non-coverage policy with respect to coverage for TRD.

 

Payment rates vary among third-party plans based on contracts and payment methods of specific providers. Audits of providers have revealed that the average reimbursement rates for VNS therapy-related procedures are generally acceptable to the providers.

 

In deciding to cover a new product or therapy, private payers base their initial coverage decision on several factors, including, but not limited to:

 

 

Payment for VNS Therapy Outside the U.S.

 

Margins on our VNS Therapy System sales outside the U.S. vary on a country-by-country basis and depend on the method of product distribution chosen by us for that country. In certain countries, governments are involved in setting reimbursement rates or setting limitations on the total number of devices purchased, or both, which generally results in a lower reimbursement rate than in the U.S. market. In fiscal year 2015, our international net product sales accounted for 19% of total net product sales, and the three largest individual country markets were the United Kingdom, Germany and France. In these countries, we sell directly to hospitals, and the amount received may vary even within a country. Total sales are also affected by national and local health budgets and limitations on the number of products purchased in a given year.

 

Increasing prices for the VNS Therapy System, or setting a higher price for the newer models, such as the Demipulse, Demipulse Duo, AspireHC and AspireSR generators, can be a difficult and time-consuming process, in some instances involving submissions to government agencies.

 

Competition

 

The healthcare industry is characterized by extensive research efforts and rapid technological progress. As other forms of neurostimulation are investigated and developed for epilepsy, depression, or heart failure, they may emerge as competition for the VNS Therapy System. In addition, the development by others of new treatment methods with novel drugs or medical devices for epilepsy, depression, or heart failure, could render the VNS Therapy System noncompetitive or obsolete. Advancements in surgical techniques could make surgery a more attractive therapy. We believe that existing and future drug therapies are the primary competition for the VNS Therapy System in the near term for epilepsy and depression, and existing device therapies are the primary competition in heart failure. Any neurostimulation techniques could prove to be more effective, more accessible, more predictable, or more rapidly acting than the VNS Therapy System.

 

We face competition from small, emerging or large medical device or pharmaceutical companies that have the technology, experience and capital resources to develop alternative devices for the treatment of epilepsy and depression. These competitors or potential competitors could have substantially greater financial, manufacturing, marketing and technical resources than we have, and as a result, may develop technologies, obtain patents and regulatory approvals for products that are more effective in treating epilepsy or depression than our current or future products.

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Epilepsy

 

We expect to face competition from other medical device companies for the treatment of epilepsy. Medtronic, Inc. received approval from the FDA for its Activa Neurostimulator, a DBS device indicated for the treatment of essential tremor, Parkinson’s disease and severe obsessive compulsive disorder and Medtronic also submitted a PMA application to the FDA for use of the Activa Neurostimulator for the treatment of refractory epilepsy. The device already has approval for marketing in the European countries governed by CE Mark approval, and Medtronic has begun commercial marketing in several European countries. Another company, CerebralRx Ltd. based in Israel, developed an implantable device capable of vagus nerve stimulation for the treatment of epilepsy and has CE Mark approval. CerebralRx has initiated commercialization efforts in several European countries. In November 2013, the FDA approved NeuroPace, Inc.’s responsive neurostimulation device for the treatment of refractory epilepsy. This technology includes a pulse generator that is positioned in the skull with cortical strip and depth electrodes placed in pre-determined areas in the brain where seizures are thought to originate. NeuroPace has commenced commercial activity in the U.S. A company based in Europe, Neurotech, SA, which is now owned by Sorin, has obtained CE Mark approval for a device capable of vagus nerve stimulation for the treatment of epilepsy.  In addition, we believe that a company in China may be developing an implantable device that provides neuromodulation therapy to the vagus nerve; however we are not privy to details regarding any such device, including its commercial launch.

 

Several non-invasive neurostimulation technologies are emerging, as well. NeuroSigma Inc., based in the U.S., is focused on the development of a trigeminal nerve stimulation device for the treatment of attention deficit hyperactivity disorder, major depressive disorder, and refractory epilepsy. NeuroSigma Inc. received CE Mark approval for this technology for the treatment of refractory epilepsy and has begun commercialization in Europe. Cerbomed GmbH (“Cerbomed”), a privately-held company based in Germany, has developed a transcutaneous vagus nerve stimulation device that is also CE Mark-approved for the treatment of epilepsy. Cerbomed has completed a clinical study in Germany to study outcomes in the treatment of refractory epilepsy. We have invested approximately €4.0 million, or $5.1 million, in Cerbomed to date. During fiscal year 2016, we expect Cerbomed to seek an IDE from the FDA for Cerbomed’s device for the treatment of certain types of epilepsy. We hold an option to obtain exclusive worldwide sales and distribution of this system for the treatment of epilepsy.

 

We believe that the primary competitive factors within the epilepsy treatment markets are the safety, tolerability and efficacy of the treatment relative to alternative therapies, physician and patient acceptance of the product and procedure, availability of third-party reimbursement, quality of life improvements and product reliability. We believe that the VNS Therapy System compares favorably with competitive products as to these factors.

 

Depression

 

A well-established array of antidepressant drugs typically combined with other antidepressants of complementary action or with atypical antipsychotic drugs and/or mood stabilizers, are frequently used for patients with unresponsive or treatment-resistant depression. For patients with certain types of severe depression or those at acute risk for suicide, ECT may be used. These treatment modalities represent the current standard of care as to which the VNS Therapy System must compete to be successful commercially as a therapy for TRD.

 

At least two non-invasive device-based therapies have been approved by the FDA since October 2008 for depression. Repetitive transcranial magnetic stimulation, developed and marketed by Neuronetics Inc., based in the U.S., consists of an externally-placed coil that delivers a pulsed magnetic field and is indicated for depression that has not responded to prior adequate treatments. Other companies, including Brainsway Ltd., based in Israel, have developed various forms of transcranial magnetic stimulation for depression. The Brainsway Ltd. device has also been cleared by the FDA.

 

 Heart Failure

 

Our system for treating patients with CHF, the VITARIA System, has been specifically designed to deliver autonomic regulation therapy in a manner that promotes improvements in heart function. The VITARIA System operates by way of a programmable, personalized open-loop stimulation system, which includes an implantable pulse generator and a lead attached to either the right or left vagus nerve.  Existing device therapies – cardiac resynchronization therapy with pacing or defibrillation function – represent the primary competition for the VITARIA System at present. These devices are available today from Medtronic, Inc., Boston Scientific Corporation, St. Jude Medical, Inc., Biotronik SE & Co. KG and Sorin. In addition, several companies are developing competitive neurostimulation therapies for heart failure. BioControl Medical Ltd., a privately held medical device company headquartered in Israel and Sorin are developing products that may compete with VITARIA for the treatment of CHF.   BioControl Medical’s system is based on a closed-loop therapy control system, which incorporate two leads, one attached to the vagus nerve and another lead positioned in the right ventricular apex with stimulation delivered in response to heart failure. In addition, CVRx, Inc., a private medical device company located in Minnesota, and Boston Scientific Corporation,  offer solutions for the treatment of CHF that operate on an open-loop therapy control system. The CVRx system works by electrically activating the baroreceptors, the body’s natural sensors that regulate cardiovascular function.  CVRx and Cyberonics have systems approved in Europe for treating patients with CHF, and none have approval in the U.S.

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Patents, Licenses and Proprietary Rights

 

As of April 24, 2015, we owned or licensed approximately 205 U.S. patents and 145 pending U.S. patent applications, in addition to foreign patents and applications corresponding to the foregoing U.S. patents and applications.  These patents and patent applications cover various aspects of the VNS Therapy System and methods of treatment for a variety of disorders, including traumatic brain injury, cardiac disorders, hypertension, motility disorders, coma and chronic pain, through electrical stimulation of the vagus nerve or other neural tissue. We have filed counterparts of certain of our key U.S. patent applications in certain international jurisdictions and currently own or license approximately 91 patents issued by the European Patent Office or other international authorities and 94 patent applications pending in the European Patent Office or before other national or international authorities. Patents generally expire twenty years from filing of the patent application, are effective only after issuance, and only in the country where issued. Patents are costly and can be difficult to obtain.

 

A license agreement with Jacob Zabara, Ph.D., dated March 15, 1988, provided us with exclusive rights under a number of U.S. patents and their international counterparts covering the method and devices of the VNS Therapy System for vagus nerve and other cranial nerve stimulation for the control of epilepsy and other movement disorders, as well as a number of other conditions and disorders including depression and chronic pain. The patent covering vagus nerve stimulation for the treatment of neuropsychiatric disorders (including depression) expired May 3, 2011. The last of his U.S. patents covering vagus nerve stimulation for movement disorders expired July 16, 2011. Pursuant to the license agreement, we were obligated to pay Dr. Zabara a royalty equal to 3.0% of sales of generators and leads. We discontinued paying this royalty on July 16, 2011, the expiration date of the last of the patents covering our existing products. 

 

In October 2009, we entered into a license arrangement with Flint Hills Scientific, L.L.C. (“Flint Hills”), which was amended in January 2011 and January 2015, that includes a royalty fee with a minimum annual fee of $350,000 that increases to $700,000 in fiscal year 2017, related primarily to cardiac-based seizure detection patents and patent applications.   The license enables the AspireSR generator to, among other things; provide additional stimulation automatically by responding to a patient’s relative heart-rate changes that exceed variable thresholds.  Starting in fiscal year 2016, we expect that royalty fees due to Flint Hills will be in excess of the minimums due, based upon expected domestic and international AspireSR product sales.

 

We do not have indication-specific patent coverage for vagus nerve stimulation for epilepsy or depression.

 

We cannot assure you that patents will be issued from any of the pending applications, or if patents are issued, that they will be of sufficient scope or strength to provide meaningful protection for our technology. Notwithstanding the scope of the patent protection available to us, a competitor could develop treatment methods or devices that are not covered by our patents.

 

There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. In the future, we may need to engage in litigation to enforce patents issued or licensed to us, to protect our trade secrets or know-how, to defend against claims of infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. Litigation could be costly and could divert our attention from other functions and responsibilities. Adverse determinations in litigation could subject us to significant liabilities to third parties, could require us to seek licenses from third parties and could prevent us from manufacturing, selling or using the VNS Therapy System, any of which could severely harm our business.

 

Product Liability and Insurance

 

The manufacture and sale of our products subjects us to the risk of product liability claims. We are currently named as a defendant in one or more product liability lawsuits in the U.S. As the manufacturer of a medical device, we likely will be named in the future as a defendant in other product liability lawsuits. We do not believe that our products involved in the current lawsuits are defective; however, the outcome of litigation is inherently unpredictable and could result in an adverse judgment and an award of substantial and material damages against us. Although we maintain product liability insurance in amounts that we believe to be reasonable, coverage limits may prove to be inadequate in some circumstances. Product liability insurance is expensive and in the future may only be available at significantly higher premiums or not available on acceptable terms, if at all. A successful claim brought against us in excess of our insurance coverage could severely harm our business and consolidated results of operations and financial position.

 

We have undertaken field corrections to address product defects, and there can be no assurance that we will not be required to perform field corrections and product recalls or removals in the future.  Since the introduction of the VNS Therapy System, we have sent safety alert letters and recommendations and published field notifications for our products.  All of our field notifications and safety alerts affecting a significant patient population are available on our website, www.cyberonics.com. Any such current or future product defects may result in legal claims with material adverse consequences to our business.

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We endeavor to maintain executive and organization liability insurance in a form and with aggregate coverage limits that we believe are adequate for our business purposes, but our coverage limits may prove not to be adequate in some circumstances. In addition, executive and organization liability insurance is expensive and in the future may be available only at significantly higher premiums or not be available on acceptable terms, if at all. Further, insurance companies have been subject to extreme financial stress during recent years, and our insurers may be unable to meet their obligations under the policies they have issued or will issue in the future.

 

Employees

 

As of April 24, 2015, we had 660 employees globally.  We believe that our success and ability to successfully expand the commercialization of our VNS Therapy System will be driven by strong leadership and the high caliber of our employees. We have strengthened our focus on talent assessment and leadership development and are committed to developing our employees and providing them with opportunities to contribute to our growth and success. We are engaged in an ongoing effort to identify, hire, manage and maintain the talent necessary to meet our objectives. We believe our relationship with our employees is generally good; however, we cannot assure you that we will be successful in hiring or retaining qualified personnel. The loss of key personnel, or the inability to hire or retain qualified personnel, could significantly harm our business.

 

Financial Information about Segments and Geographical Areas

 

We operate our business as a single segment with similar economic characteristics, technology, manufacturing processes, customers, distribution and marketing strategies, regulatory environments and shared infrastructures. We are a neurostimulation business focused on creating new markets, improving our products, developing other medical devices for patients suffering from epilepsy.  Our latest product, the VITARIA™ System, approved in Europe but not the U.S., is an implantable device that provides a form of neuromodulation therapy for the treatment of chronic heart failure (“CHF”). We commenced a limited market launch in Europe of the VITARIA System, with the first commercial implant in early June 2015. 

 

Our financial information, including our net sales and long-lived assets by geographical area, is included in the consolidated financial statements and the related notes beginning on page F-1, especially “Note 19. Geographic Information.”

 

Website and Availability of Public Filings with the SEC

 

Our website address is www.cyberonics.com. We make available free of charge on or through our website our Proxy Statements on Schedule 14A, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and reports relating to beneficial ownership of our securities filed or furnished pursuant to Section 16 of the Exchange Act, as soon as reasonably practicable after electronically filing such material with the SEC. Our website also contains the charters for each standing committee of our Board of Directors, our Business Practice Standards, our Code of Ethics, our Corporate Governance Guidelines and our Financial Code of Ethics.

 

Materials we file with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding our company filed electronically with the SEC.

 

We may from time to time provide important disclosures to investors by posting them in the Investor Relations section of our website, as allowed by SEC rules. Information on our website is not incorporated into this Form 10-K.

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Item 1A.  Risk Factors

 

Our common stock price constantly changes.

 

Our common stock is traded on the NASDAQ Global Market under the ticker symbol “CYBX.” The price of stock on that trading market fluctuates, and we expect that the market price of our common stock will continue to fluctuate. For example, during the fiscal year ended April 24, 2015, our stock traded from a high of $76.48 to a low of $48.19 per share. Our stock price may be affected by a number of factors, some of which are beyond our control, including, without limitation:

 

 

We are subject to many laws and governmental regulations, both domestically and internationally, and any adverse regulatory action may materially adversely affect our financial condition and business operations.

 

Our medical devices are subject to regulation by numerous government agencies, including the FDA and comparable foreign agencies. To varying degrees, each of these agencies requires us to comply with laws and regulations governing the development, testing, manufacturing, labeling, marketing and distribution of our medical devices. We cannot guarantee that we will be able to obtain marketing clearance for our new products, or enhancements or modifications to existing products, and if we do, such approval may:

 

 

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The failure to receive approval or clearance for significant new products or modifications to existing products on a timely basis could have a material adverse effect on our consolidated financial condition and results of operations. Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations as well as foreign regulatory agencies. We are also subject to periodic inspections by the FDA and foreign regulatory agencies to determine compliance with regulatory requirements, including primarily the quality system regulations and medical device reporting regulations. The results of these inspections by the FDA can include inspectional observations on FDA’s Form 483, warning letters or other forms of enforcement. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could ban these medical devices, detain or seize adulterated or misbranded medical devices, order a recall, repair, replacement, or refund of such devices, refuse to grant pending premarket approval applications, or require certificates of foreign governments for exports and require us to notify health professionals and others that the devices present unreasonable risks of substantial harm to the public health. The FDA may also impose operating restrictions, enjoin and restrain certain violations of applicable law pertaining to medical devices and assess civil or criminal penalties against our officers, employees or us. The FDA may also recommend our prosecution to the U.S. Department of Justice. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively marketing and selling our products. In addition, negative publicity and product liability claims resulting from any adverse regulatory action could have a material adverse effect on our consolidated financial condition and results of operations.

 

Foreign governmental regulations have become increasingly stringent and more common, and we may become subject to even more rigorous regulation by foreign governmental authorities in the future. Penalties for a company’s noncompliance with foreign governmental regulation could be severe, including revocation or suspension of a company’s business license and criminal sanctions. Any domestic or foreign governmental law or regulation imposed in the future may have a material adverse effect on us.

 

We are also subject to various environmental laws and regulations both within and outside the U.S. Our operations involve the use of substances regulated under environmental laws, primarily those used in manufacturing and sterilization processes. Failure to comply with environmental protection laws and regulations could have a material adverse impact on our consolidated earnings, financial condition and/or cash flows.

 

Our annual and quarterly operating results may fluctuate in the future, which may cause our stock price to decline.

 

Our net sales, expenses and operating results may vary significantly from year to year and quarter to quarter for several reasons, including, without limitation:

 

 

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As a result of any of these factors, our consolidated results of operations may fluctuate significantly, which may in turn cause our stock price to fluctuate.

 

Our business, financial condition, results of operations and cash flows could be significantly and adversely affected by healthcare reform legislation and other administrative and legislative proposals.

 

The Patient Protection and Affordable Care Act and Health Care and Education Reconciliation Act of 2010 were enacted into law in March 2010. As a U.S.-headquartered company with significant sales in the United States, these health care reform laws materially impact our business, as well as the U.S. economy. Certain provisions of the law will become effective in future years, and the administrative agencies responsible for issuing regulations that implement some aspects of the law have yet to do so. Accordingly, the consequences of the law are not yet fully understood. The law levied a 2.3% excise tax on the majority of our U.S. medical device sales effective January 1, 2013. Our fiscal year 2015 U.S. net product sales represented approximately 81% of our worldwide consolidated net product sales. The new tax adversely affects gross margins, results of operations and cash flows. The law also focuses on a number of Medicare provisions aimed at improving quality and decreasing costs. It is uncertain at this point what unintended consequences these provisions will have on patient access to new technologies. The Medicare provisions include value-based payment programs, increased funding of comparative effectiveness research, reduced hospital payments for avoidable readmissions and hospital-acquired conditions, and pilot programs to evaluate alternative payment methodologies that promote care coordination (such as bundled physician and hospital payments). Additionally, the law includes a reduction in the annual rate of inflation for hospitals that began in 2011 and the establishment of an independent payment advisory board to recommend ways of reducing the rate of growth in Medicare spending beginning in 2014. We cannot predict what healthcare programs and regulations will be implemented at the federal or state level, or the effect of any future legislation or regulation. However, any changes that lower reimbursement for our products or reduce medical procedure volumes could adversely affect our business and results of operations.

 

In addition, certain state governments and the federal government have enacted legislation aimed at increasing transparency of our interactions with health care providers. As a result, beginning March 31, 2014, we are required by law to disclose payments and other transfers of value to health care providers licensed by certain states and, starting with payments or other transfers of value made on or after August 1, 2013, to all U.S. physicians and U.S. teaching hospitals at the federal level. Any failure to comply with these legal and regulatory requirements could have adverse legal consequences. In addition, we may continue to devote substantial additional time and financial resources to further develop and implement policies, systems, and processes to comply with enhanced legal and regulatory requirements, which may also affect our business. We anticipate that government and congressional scrutiny of our sector will continue and potentially increase, and that additional regulation may increase compliance and legal costs, exposure to litigation, and other adverse effects to our operations. Failure to comply with these requirements could adversely affect our business and results of operations.  

 

We may not develop the VNS Therapy System for the treatment of other indications and, as such, we may not experience revenue growth from these other indications.

 

We have conducted or supported animal and human studies for the treatment of a number of therapeutic indications beyond drug-resistant epilepsy and treatment-resistant depression, including chronic heart failure. Additionally, we have licensed intellectual property from third parties that we believe can stimulate the development of new technologies and products which would further our strategic objectives and strengthen our business. Regulatory approval for any new indications would likely require us to conduct one or more large-scale pivotal clinical studies. We have not conducted such pivotal studies for any indication beyond drug-resistant epilepsy and treatment-resistant depression, and other than the possibility of pivotal studies for chronic heart failure, we do not have any immediate plans to do so. In the event that we do invest in future studies for new indications, we cannot assure you that our study results will be positive. If we elect not to conduct research with regard to new indications, our study results are not positive, we do not receive additional regulatory approvals, or alternative indications do not prove to be commercially viable, our revenue growth, if any, would be limited to revenue from our existing approved indications.

 

We may not be able to maintain or expand market acceptance for the VNS Therapy System, which could cause our sales to be lower than expectations.

 

Market acceptance of the VNS Therapy System depends on our ability to convince the medical community and third-party payers of the clinical efficacy and safety of vagus nerve stimulation and the VNS Therapy System. While the VNS Therapy System has been implanted in approximately 96,000 patients, many physicians are still unfamiliar with this form of therapy. Other therapies, including pharmacologic options, may be more attractive to patients or their physicians than the VNS Therapy System in terms of efficacy, cost or reimbursement availability. We cannot assure you that we will ever receive broad reimbursement coverage for depression or that our sales will increase for either epilepsy or depression. Additionally, we cannot assure you that the VNS Therapy System will achieve expanded market acceptance for the treatment of epilepsy, depression, heart failure or for any other indication. Failure of the VNS Therapy System to gain additional market acceptance could severely harm our business, consolidated financial position and results of operations.

 

The success of our products depends upon strong relationships with physicians.

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If we fail to maintain our working relationships with physicians, our products may not be developed and marketed in line with the needs and expectations of the professionals who use and support our products. The research, development, marketing and sales of many of our new and improved products is dependent upon our working relationships with physicians. We rely on these professionals to provide us with considerable knowledge and experience regarding our products and the marketing of our products. Physicians assist us as researchers, marketing consultants, product consultants, inventors and public speakers. If we are unable to maintain our strong relationships with these professionals and to continue to receive their advice and input, the development and marketing of our products could suffer, which could have a material adverse effect on our consolidated financial condition and results of operations.

 

Patient confidentiality and federal and state privacy and security laws and regulations may adversely impact our selling model.

 

The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) establishes federal rules protecting the privacy and security of personal health information. The privacy and security rules address the use and disclosure of individual health care information and the rights of patients to understand and control how such information is used and disclosed. HIPAA provides both criminal and civil fines and penalties for covered entities that fail to comply. If we fail to comply with the applicable regulations, we could suffer civil penalties up to $25,000 per calendar year for each violation and criminal penalties with fines up to $250,000 and potential imprisonment.

 

In addition to HIPAA, virtually every state has enacted one or more laws to safeguard privacy, and these laws vary significantly from state to state and change frequently. Even if our business model is compliant with the HIPAA Privacy and Security Rule and the Texas privacy laws, it may not be compliant with the privacy laws of all states. Because the operation of our business involves the collection and use of substantial amounts of “protected health information,” we endeavor to conduct our business as a “covered entity” under the HIPAA Privacy and Security Rule and consistent with the Texas privacy laws, obtaining HIPAA-compliant patient authorizations where required to support the collection and use of patient information. We also sometimes act as a “business associate” for a covered entity. The Office for Civil Rights of the Department of Health and Human Services or another government enforcement agency may determine that our business model or operations are not in compliance with the HIPAA Privacy and Security Rules, which could subject us to penalties, could severely limit our ability to market and sell the VNS Therapy System under our existing business model and could harm our business growth and consolidated financial position.

 

We may be unable to obtain and maintain adequate third-party reimbursement on our products, which could have a significant negative impact on our future operating results.

 

Our ability to commercialize the VNS Therapy System successfully depends, in large part, on whether third-party payers, including private healthcare insurers, managed care plans, Medicare and Medicaid programs and others agree to cover the VNS Therapy System and associated procedures and services and to reimburse at adequate levels for the costs of the VNS Therapy System and the related services in the U.S. or internationally. While we currently have reimbursement approval for epilepsy, we do not have any meaningful reimbursement coverage for the treatment of depression.

 

Our products are purchased principally by healthcare providers that typically bill various third-party payors, such as governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed care plans, for the healthcare services provided to their patients. The ability of customers to obtain appropriate reimbursement for their services and the products they provide from government and third-party payors is critical to the success of medical technology companies. The availability of adequate reimbursement affects which procedures customers perform, the products customers purchase and the prices customers are willing to pay. Reimbursement varies from country to country and can significantly impact the acceptance of new technology. After we develop a promising new product, we may find limited demand for the product unless reimbursement approval is obtained from private and governmental third-party payors.

 

In addition, periodic changes to reimbursement methodology for medical devices under the Medicare and Medicaid programs occur and may reduce the rate of increase in federal expenditures for health care costs. Such changes, as well as any future regulatory changes and the failure of the VNS Therapy System to continue to qualify for reimbursement under these programs, may have an adverse impact on our business.

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Cost containment pressures and domestic and foreign legislative or administrative reforms resulting in restrictive reimbursement practices of third-party payors or preferences for alternate therapies could decrease the demand for products purchased by our customers, the prices they are willing to pay for those products and the number of procedures using our devices.

 

Major third-party payors for healthcare provider services in the United States and abroad continue to work to contain healthcare costs. The introduction of cost containment incentives, combined with closer scrutiny of healthcare expenditures by both private health insurers and employers, could result in increased discounts and contractual adjustments to healthcare provider charges for services performed and in the shifting of services between inpatient and outpatient settings. Initiatives to limit the growth of healthcare costs, including price regulation, are also underway in several countries in which we do business. Implementation of healthcare reforms in the United States and in significant overseas markets such as Germany, Japan and other countries may limit the price of, or the level at which, reimbursement is provided for our products and adversely affect both our pricing flexibility and the demand for our products. Healthcare providers may respond to such cost-containment pressures by substituting lower cost products or other therapies for our products.

 

Legislative or administrative reforms to the U.S. or international reimbursement systems that significantly reduce reimbursement for procedures using our medical devices or deny coverage for such procedures, or adverse decisions relating to our products by administrators of such systems in coverage or reimbursement issues, would have an adverse impact on the products, including clinical products, purchased by our customers and the prices our customers are willing to pay for them. This in turn would have an adverse effect on our consolidated financial condition and results of operations.

 

Our current and future expense estimates are based, in large part, on estimates of our future sales, which are difficult to predict.

 

We may be unable to adjust spending quickly enough to offset any unexpected sales shortfall. If increased expenses are not accompanied by increased sales, our consolidated results of operations and financial position for any particular fiscal quarter could be adversely impacted.

 

If our suppliers and manufacturers are unable to meet our demand for materials, components and contract services, we may be forced to qualify new vendors or change our product design, which could impair our ability to deliver products to our customers on a timely basis.

 

We rely upon sole-source suppliers for certain of the key components, materials and contract services used in manufacturing our products. We periodically experience discontinuation or unavailability of components, materials and contract services, which may require us to qualify alternative sources or, if no such alternative sources are identified, change our product design. Pursuing and qualifying alternative sources and/or redesigning specific components of our products, if or when necessary, could consume significant resources. In addition, such changes generally require regulatory submissions and approvals. Any extended delays in securing, or an inability to secure, alternative sources for these or other components, materials and contract services could result in product supply and manufacturing interruptions, which could significantly harm our business.

 

Our products may have defects that result in product recalls, which may result in substantial costs and reduced sales.

 

The VNS Therapy System includes an electronic pulse generator and a lead designed to be implanted in the human body and a programming wand connected to a handheld computer or tablet for programming the pulse generator. Component failures, manufacturing or shipping problems or hardware or software design defects could result in the product not delivering the therapy for which it is indicated or producing other unintended consequences. The occurrence of such problems or other adverse clinical reactions could result in a recall of our products, possibly requiring explantation and potential re-implantation of the products and associated costs, which may increase risk to the patient. Any product recall could result in a substantial loss of physician and patient confidence in our products, with a consequential substantial decrease in sales, and could result in substantial litigation, with liabilities well in excess of our insurance coverage limits, any or all of which could severely harm our business and our consolidated financial position and results of operations.

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We may not be able to protect our technology from unauthorized use, which could diminish the value of our products and impair our ability to compete.

 

Our success depends in part on our ability to obtain and maintain patent and other intellectual property protection for our products and their improvements. To that end, we have acquired licenses under certain patents and have patented and intend to continue to seek patents on our own inventions used in our products and treatment methods. The process of seeking patent protection can be expensive and time-consuming, and we cannot assure you that patents will be issued from our currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection for our technology or any commercial advantage to us. Further, the protection offered by our licensed international patents may not be as strong as that offered by our licensed U.S. patents due to differences in patent laws. In particular, the European Patent Convention prohibits patents covering methods for treatment of the human body by surgery or therapy. Without effective patent protection, whether in the U.S. or abroad, we may be subject to competition that negatively affects our consolidated financial position and results of operations.

 

Additionally, certain countries, including China, do not enforce compliance with laws that protect intellectual property rights with the same degree of vigor as is available under the U.S. judicial system. For this reason, there is a risk that our intellectual property may be subject to misappropriation in such countries. This may permit others to produce copies of our products. There is also a risk that such products may be exported from such countries to other countries.  Our electronically stored intellectual property and other proprietary data may also be subject to misappropriation through a breach of our cybersecurity.  Any misappropriation or misuse of our technology or proprietary information could have a material adverse effect on our business, consolidated financial condition or results of operations.

 

We are subject to domestic and international competition, reducing our sales and earnings.

 

Our indication-specific patent protection for the VNS Therapy System for epilepsy and depression indications has expired.  As a result, we could be subject to wider competition from medical devices without legal recourse to challenge our competitors based on patent infringement. For example, in November 2013, the FDA approved NeuroPace, Inc.’s responsive neurostimulation device for the treatment of refractory epilepsy. This device includes electrodes placed in pre-determined areas in the brain where seizures are thought to originate. NeuroPace has commenced commercial activity in the U.S. In addition, a company based in Europe, Neurotech, SA, which is now owned by Sorin, has obtained CE Mark approval for a device capable of vagus nerve stimulation, and CerebralRx Ltd., based in Israel also has CE Mark approval for an implantable device capable of vagus nerve stimulation. CerebralRx Ltd. has engaged in tender offers in Italy, subjecting us to competition in that market.  As a practical matter, we are always subject to competition from new and existing drugs. In the future, we expect to be subject to competition from both medical devices and drugs in the U.S. and other countries, which may reduce our sales and earnings or limit our growth. In addition, we believe that a company in China may be developing an implantable device that provides neuromodulation therapy to the vagus nerve; however we are not privy to details regarding any such device, including its commercial launch.

 

We believe that existing and future pharmaceutical therapies will continue to be the primary competition for the VNS Therapy System. However, we may also face competition from other medical device companies that have the technology, experience and capital resources to develop alternative devices for the treatment of epilepsy, depression and heart failure. Many of our competitors have substantially greater financial, manufacturing, marketing and technical resources than we do and have obtained third-party reimbursement approvals for their therapies. We may not have invested in the past, or may not be investing in the future, sufficient resources in engineering research and development to prepare our products for competition with other technologies. In addition, the healthcare industry is characterized by extensive research efforts and rapid technological progress. Our competitors may develop technologies and obtain regulatory approval for products that are more effective than our current or future products. In addition, advancements in surgical techniques may make surgery a more attractive therapy for epilepsy and depression. The development by others of new treatment methods with novel drugs, medical devices or surgical techniques could render our products non-competitive or obsolete. We may not be able to compete successfully against current and future competitors, including new products and technology, which could severely harm our business and our consolidated financial position and results of operations.

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We may engage in litigation to protect our proprietary rights, or to defend against infringement claims by third parties, causing us to suffer significant liabilities or expenses or preventing us from selling our products.

 

There has been and likely will continue to be substantial litigation regarding patent and other intellectual property rights in the medical device industry. Litigation, which could result in substantial cost to and diversion of effort by us, may be necessary to enforce patents issued or licensed to us, to protect trade secrets or know-how owned by us, to defend ourselves against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. Expenses associated with such litigation could be very substantial, could divert resources from our planned expenditures, delaying or crippling product development and other projects, and could severely harm our business and our consolidated financial position and results of operations. In addition, adverse determinations in litigation could subject us to significant liabilities to third parties, could require us to seek licenses from third parties and could prevent us from manufacturing, selling or using our products, any of which could severely harm our business and our consolidated financial position and results of operations.

 

 

Product liability claims could adversely impact our consolidated financial condition and our earnings and impair our reputation.

 

Our business exposes us to potential product liability risks that are inherent in the design, manufacture and marketing of medical devices. In addition, many of the medical devices we manufacture and sell are designed to be implanted in the human body for long periods of time. Component failures, manufacturing defects, design flaws or inadequate disclosure of product-related risks or product-related information with respect to these or other products we manufacture or sell could result in an unsafe condition or injury to, or death of, a patient. The occurrence of such an event could result in product liability claims or a recall of, or safety alert relating to, one or more of our products, which could ultimately result, in certain cases, in the removal of such products from the body and possible claims regarding costs associated therewith. We have elected to self-insure with respect to a portion of our product liability risks. Product liability claims or product recalls in the future, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation and on our ability to attract and retain customers for our products. Recent Supreme Court case law has clarified that the FDA’s authority over medical devices preempts state tort laws; however, the law continues to evolve, and future court decisions could erode existing law.  Additionally, legislation has been introduced at the federal level to allow state intervention, all of which could lead to increased and inconsistent regulation at the state level and increased risk of adverse product liability judgments.

 

Our self-insured retention program may expose us to future losses.

 

We have elected to insure some of our insurable risks through a self-insured retention (“SIR”) policy. We made this decision based on conditions in the insurance marketplace, including increasing numbers of coverage limitations and dramatically higher insurance premium rates. We continue to monitor the insurance marketplace to evaluate the value to us of obtaining insurance coverage in the future. While, based on historical loss trends, we believe that our SIR is not excessive and that our accruals will be adequate to cover future losses, we cannot guarantee that this will remain true. Historical trends may not be indicative of future losses. Any such losses could have a material adverse impact on our consolidated earnings, financial condition and/or cash flows.

 

If we do not continue to comply with applicable laws and regulations, we could lose our ability to market and sell our products or be subject to substantial fines or other penalties.

 

The preclinical and clinical design, testing, manufacturing, labeling, sale, distribution, servicing and promotion of our products are subject to extensive and rigorous laws and regulations, including regulations from the Department of Health and Human Services (related to Medicare, Medicaid, HIPAA and FDA), comparable state agencies and international agencies. In the future, it will be necessary for us to obtain additional government approvals for new products. It is also necessary for us to ensure that our marketing and sales practices comply with all applicable laws and regulations. Commercial distribution in foreign countries is also subject to regulatory approvals from the appropriate authorities in such countries.

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The process of obtaining FDA and other required regulatory approvals is lengthy, expensive and uncertain. Moreover, regulatory approvals may include regulatory restrictions on the indicated uses for which a product may be marketed. Failure to comply with applicable regulatory requirements can result in, among other things, fines, suspension or withdrawal of approvals, confiscations or recalls of products, operating restrictions and criminal prosecution. Adverse results in post-approval studies may result in limitations on or withdrawal of previously granted approvals. Furthermore, changes in existing regulations or adoption of new regulations could prevent us from obtaining, or affect the timing of, future regulatory approvals. We may not be able to obtain additional future regulatory approvals on a timely basis or at all. Delays in receipt of or failure to receive such future approvals, suspension or withdrawal of previously received approvals, or recalls of products could severely harm our ability to market and sell our current and future products and improvements. As a condition of approval for the depression indication, the FDA required us to conduct a post-approval patient dosing study and a patient registry. The results of the dosing study have been included in our product labeling, and the results of the patient registry may be included in our product labeling. If we fail to complete the patient registry in a timely manner, we may be subject to regulatory action, including withdrawal of our depression indication approval.  Also, any adverse regulatory action, depending on its breadth, may be detrimental to our business.

 

The medical device industry is experiencing greater scrutiny and regulation by governmental authorities and is the subject of numerous investigations, often involving marketing and other business practices. These investigations could result in the commencement of civil and criminal proceedings; lead to substantial fines, penalties and administrative remedies; divert the attention of our management; impose administrative costs and have an adverse effect on our consolidated financial condition, results of operations and liquidity; and may lead to greater governmental regulation in the future.

 

We are subject to certain laws and regulations, including the federal Anti-Kickback Statute, the federal False Claims Act, the HIPAA Privacy Rule and the federal Foreign Corrupt Practices Act, which govern the sales and marketing practices of healthcare companies. The Anti-Kickback Statute contains both civil and criminal sanctions, which are enforced by the Office of the Inspector General of Health and Human Services Department (“OIG”) and the U.S. Department of Justice (“DOJ”). Over the past several years, the U.S. government has accused an increasing number of pharmaceutical and medical device manufacturers of violating the federal Anti-Kickback Statute and the Foreign Corrupt Practices Act based on certain marketing and sales practices and compensation arrangements with referral sources. The Foreign Corrupt Practices Act prohibits payments or the provision of anything of value to foreign officials for the purpose of obtaining or keeping business. Pharmaceutical and medical device manufacturers also have been accused of alleged violations of the federal False Claims Act, which imposes civil liability (including substantial monetary penalties and damages) on any person or corporation that (a) knowingly presents a false or fraudulent claim for payment to the U.S. government, (b) knowingly uses a false record or statement to obtain payment or (c) engages in a conspiracy to defraud the federal government to obtain allowance for a false claim. Under the whistleblower provisions of the federal False Claims Act, private parties may bring actions on behalf of the U.S. government. These private parties are entitled to share in any amounts recovered by the government through trial or settlement. Both direct enforcement activity by the government and whistleblower lawsuits have increased significantly in recent years and have increased the risk that we may be forced to defend a prosecution under the federal Anti-Kickback Statute or the Foreign Corrupt Practices Act, be forced to defend against a false claims action, be liable for monetary fines, or be excluded from the Medicare and Medicaid programs as a result of an investigation resulting from an enforcement action or a whistleblower case. 

 

In addition to the federal government, certain state governments have enacted legislation aimed at increasing transparency of our interactions with healthcare professionals (“HCPs”). As a result, we are required by law to disclose payments and other transfers for value to HCPs licensed by certain states and at the federal level in the future. Any failure to comply with the enhanced legal and regulatory requirements could adversely impact our business.

 

We anticipate that the government will continue to scrutinize our industry closely and that we will continue to be subject to rigorous regulation by governmental authorities in the future.

 

We have Business Practice Standards that we believe address our compliance risks with respect to healthcare laws in the U.S., and International Business Practice Standards that we believe address our compliance risks with respect to international laws and rules.  We continue to monitor these policies to ensure they adequately address our compliance risks.   We endeavor to conduct our business in compliance with our Business Practice Standards and International Business Practice Standards and to ensure continued compliance through regular education of our employees, audits of employee activities, and appropriate responses to violations of the Business Practice Standards and International Business Practice Standards. Given the complexity of our business model, including extensive interactions with patients and healthcare professionals, and the large number of field personnel we employ, violations of our policy and the law could occur. We could be subject to investigation by the OIG or the DOJ or a comparable state or international agency. If investigated, we could be forced to incur substantial expense responding to the investigation and defending our actions. If unsuccessful in our defense, we could be found to be in violation of the healthcare laws and be subject to substantial fines and penalties, including exclusion of our products from Medicare and Medicaid reimbursement.

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Our international operations are subject to risks not generally associated with commercialization efforts in the U.S.

 

We may not be successful in increasing our international sales or in obtaining reimbursement or any regulatory approvals required in foreign countries. The anticipated international nature of our business is also expected to subject us and our representatives, agents and distributors to laws and regulations of the foreign jurisdictions in which we operate or where our products are sold. The regulation of medical devices in a number of such jurisdictions, particularly outside the European Union, continues to develop, and new laws or regulations may impair our ability to market and sell our products in those jurisdictions.

 

We are subject to the risks of international economic and political conditions.    

 

Our international operations are subject to risks that are inherent in conducting business overseas and under foreign laws, regulations and customs. These risks include possible nationalization, expropriation, importation limitations, violations of U.S. or local laws, including, but not limited to, the U.S. Foreign Corrupt Practices Act, pricing restrictions, and other restrictive governmental actions. Any significant changes in the competitive, political, legal, regulatory, reimbursement or economic environment where we conduct international operations may have a material impact on our business and our consolidated financial condition or results of operations.   

 

Our international business is subject to foreign currency fluctuations.

 

The majority of our international sales are invoiced in euros. The strengthening or weakening of the U.S. dollar against the euro generally has an unfavorable or favorable impact on our sales, respectively, which is partially offset by the foreign currency impact on operating expenses.  Additionally, if currencies weaken against the U.S. dollar, a foreign distributor whose payables are denominated in U.S. dollars may not be able to meet their obligations in a timely manner. We have a net receivable position in euros, subject to gains or losses due to currency movements, which we may elect to hedge. If we elect to hedge, we cannot be certain that the hedging activity will eliminate our currency risk.

 

We sell our products in certain emerging economies.

 

Emerging economies have less mature product regulatory systems and can have more volatile financial markets. Our ability to sell products in these economies is dependent on our ability to hire qualified employees or agents to represent our products locally and our ability to obtain the necessary regulatory approvals in a less mature regulatory environment. If we are unable to retain qualified representatives or maintain the necessary regulatory approvals, we will not be able to continue to sell products in these markets. In addition, we are exposed to a higher degree of financial risk if we extend credit to customers in these economies.

 

In many of the international markets in which we do business, including certain parts of Europe, Asia and Latin America we sell our products through distributors who may misrepresent our products.    

 

Selling our products through distributors, particularly in public tenders, can expose us to a higher degree of risk. Our distributors are third parties retained by us to sell our products in different markets. However, our agents and distributors are independent contractors. If they misrepresent our products, do not provide appropriate service and delivery, or commit a violation of local or U.S. law, our reputation could be harmed, and we could be subject to fines, sanctions or both.

 

Our failure to attract and retain qualified personnel and any changes in our key personnel, including officers, could adversely affect our operations.

 

Our ability to grow in the future will depend upon our ability to attract, hire and retain highly qualified employees and management personnel. We compete for such personnel with other companies, academic institutions, government entities and other organizations, and we may not be successful in hiring or retaining qualified personnel.

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Economic conditions could adversely affect our results of operations.

 

Global financial uncertainty can cause disruption in the financial markets, including diminished liquidity and credit availability. There can be no assurance that there will not be further deterioration in the global economy, and these and other factors beyond our control may adversely affect our ability to borrow money in the credit markets and to obtain financing for acquisitions or other general corporate and commercial purposes. Our customers may experience financial difficulties or be unable to borrow money to fund their operations, which may adversely impact their ability or decision to purchase our products or to pay for products they do purchase on a timely basis, if at all.

 

Our manufacturing is currently conducted at two sites, and the occurrence of a catastrophic disaster or other similar event could cause damage to our facilities and equipment, which might require us to cease or curtail operations.

 

We are vulnerable to damage from various types of disasters, including fires, terrorist acts, floods, power losses, communications failures and similar events. For example, in September 2008, Hurricane Ike hit the Texas Gulf Coast and caused significant property damage and a number of fatalities near the area in which our primary facility is located. If any such disaster were to occur, we may not be able to operate our business at our facility. Our manufacturing facilities require FDA approval, which could result in significant delays before we could manufacture products from a replacement facility. The insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions. Therefore, any such catastrophe could seriously harm our business and consolidated results of operations.  We constructed a manufacturing facility in Costa Rica that began manufacturing and shipping product late in fiscal year 2015, and this facility is subject to many of the same risks as our Houston, Texas facility.

 

If we fail to develop or market new products and enhance existing products, we could lose market share to our competitors and our results of operations could suffer.

 

The market for interventional devices is characterized by rapid technological change, new product introductions, technological improvements, changes in physician requirements and evolving industry standards. To be successful, we must continue to develop and commercialize new products and to enhance versions of our existing products. Our products are technologically complex and require significant research, planning, design, development and testing before they may be marketed. This could take up to several years. In addition, product life cycles are relatively short because medical device manufacturers continually develop smaller, more effective and less expensive versions of existing devices in response to physician demand.

 

Our success in developing and commercializing new and enhanced versions of our products is affected by our ability to:

 

Market acceptance of our products depends in part on our ability to demonstrate that our products are cost-effective and easier to use, and that they offer technological advantages. Additionally, we may experience design, manufacturing, marketing or other difficulties that could delay or prevent our development, introduction or marketing of new products or new versions of our existing products. As a result of such difficulties and delays, our development expenses may increase and, as a consequence, our results of operations could suffer.

 

Consolidation in the healthcare industry could have an adverse effect on our revenues and results of operations.

 

Many healthcare industry companies, including medical device companies, are consolidating to create new companies with greater market power. As the healthcare industry consolidates, competition to provide goods and services to industry participants will become more intense. These industry participants may try to use their market power to negotiate price concessions or reductions for medical devices that incorporate components produced by us. If we are forced to reduce our prices because of consolidation in the healthcare industry, our revenues would decrease and our consolidated earnings, financial condition, or cash flow would suffer.

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We may be subject to fines, penalties or injunctions if we are determined to be promoting the use of our products for unapproved or "off-label" uses, which would adversely affect our financial condition.

 

Our promotional materials and training methods must comply with FDA regulations and other applicable laws and regulations, including the prohibition of the promotion of a medical device for a use that has not been cleared or approved by the FDA. Use of a device outside its cleared or approved indications is known as "off-label" use. Physicians may use our products off-label, as the FDA does not restrict or regulate a physician's choice of treatment within the practice of medicine. However, if the FDA determines that our promotional materials or training constitutes the promotion of an off-label use, it could subject us to certain sanctions ranging from a request that we modify our training or promotional materials to further regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine and/or criminal penalties against us or our officers or employees. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our promotional or training materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement. In that event, our reputation could be damaged and adoption of the products could be impaired. Although our policy is to refrain from statements that could be considered off-label promotion of our products, the FDA or another regulatory agency could disagree and conclude that we have engaged in off-label promotion. In addition, the off-label use of our products may increase the risk of injury to patients, and, in turn, the risk of product liability claims. Product liability claims are expensive to defend and could divert our management's attention and result in substantial damage awards against us.

 

We cannot guarantee that existing or future investments, licensed technology, or investment collaborations will be successful.

 

We expect to continue to pursue investment opportunities in and technology licenses with medical technology companies that we believe can stimulate the development of new technologies and products which would further our strategic objectives and strengthen our business. Investments, licenses and investment collaborations in and with medical technology companies involve risks, and we cannot guarantee that any of our previous or future investments or investment collaborations will be successful or will not adversely affect our consolidated earnings, financial condition or cash flows.

 

Changes in tax laws or exposure to additional income tax liabilities could have a material impact on our consolidated financial condition and results of operations.

 

We are subject to income taxes as well as non-income based taxes, in both the United States and various foreign jurisdictions. We are subject to ongoing tax audits in various jurisdictions. Tax authorities may disagree with certain positions we have taken and assess additional taxes. We believe that our accruals reflect the probable outcome of known contingencies. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the actual outcomes of these audits could have a material impact on our consolidated net income or financial condition. Changes in tax laws or tax rulings could materially impact our effective tax rate or results of operations.

 

Risks Related to the Merger with Sorin

 

Completion of our proposed merger with Sorin is subject to certain closing conditions, some of which are outside of the parties’ control, and if these conditions are not satisfied or waived, the merger with Sorin will not be completed.

 

The proposed merger with Sorin is subject to certain closing conditions. If those conditions are not satisfied or waived, the proposed transaction will not be completed. The market price of our common stock may reflect assumptions regarding completion of the proposed transaction and its potential benefits. Accordingly, a delay in completing the proposed transaction or uncertainty about the closing may negatively impact our share price. Closing conditions include the required approval of each of our stockholders and Sorin’s shareholders.

 

On May 26, 2015, at the extraordinary general meeting of Sorin’s shareholders, the Sorin shareholders approved the proposed merger.   

 

In addition, if the merger with Sorin is not completed on or before February 26, 2016 (subject to certain extension rights), we or Sorin may choose not to proceed with the merger. We and Sorin may also terminate the Transaction Agreement under certain circumstances, including, among others, in order to enter into an agreement with respect to a proposal that is determined by our Board of Directors, in the case of a proposal to us, or the Sorin board of directors, in the case of a proposal to Sorin, to be superior to the Transaction Agreement, subject to the terms and conditions of the Transaction Agreement (including a requirement to negotiate in good faith with the other party for a specified period of time after receipt of such proposal to the extent the other party requests).

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Cash costs associated with our proposed merger with Sorin may negatively impact our financial condition, operating results, and cash flow.

 

We have incurred significant costs related to the proposed transaction that are payable whether or not the merger with Sorin closes. In addition, if the merger with Sorin closes, significant additional fees will be payable to advisors. Further, if the merger with Sorin is not completed for any reason, including as a result of our stockholders failing to adopt the Transaction Agreement, our ongoing business may be adversely affected and, without realizing any of the benefits of having completed the merger with Sorin, we would be subject to a number of risks, including the following:

 

In addition, we could be subject to litigation related to any failure to complete the merger with Sorin or related to any enforcement proceeding commenced against us to perform our obligations under the Transaction Agreement. If the merger with Sorin is not completed, these risks may materialize and may adversely affect our business, financial condition, financial results and stock price.

 

The Transaction Agreement contains provisions that restrict our ability to pursue alternatives to the merger with Sorin and, in specified circumstances, could require us to pay Sorin a termination fee and expense reimbursement.

 

Under the Transaction Agreement, we are  restricted, subject to certain exceptions, from soliciting, initiating, knowingly encouraging, discussing or negotiating, or furnishing information with regard to, any inquiry, proposal or offer for a competing acquisition proposal from any person or entity. If we receive a competing acquisition proposal and our Board of Directors determines (after consultation with our financial advisor and legal counsel) that such proposal is more favorable to our stockholders than the merger with Sorin and our Board of Directors recommends such proposal to our stockholders, we or Sorin would be entitled, upon complying with certain requirements, to terminate the Transaction Agreement, subject to the terms of the Transaction Agreement. Under such circumstances, we would be required to pay Sorin a termination fee equal to $50 million. Additionally, if the Transaction Agreement is terminated by Sorin because of an uncured breach of the Transaction Agreement by us that gives rise to the failure of certain conditions preventing the merger with Sorin from closing, we would be required to reimburse Sorin for all expenses incurred in connection with the Transaction Agreement up to a cap of $15 million. These provisions could discourage a third party that may have an interest in acquiring all or a significant part of our business from considering or proposing such an acquisition, even if such third party were prepared to enter into a transaction that would be more favorable to us and our stockholders than the merger with Sorin. 

 

Our business relationships may be subject to disruption due to uncertainty associated with the merger.

 

Parties with which we do business may experience uncertainty associated with the merger with Sorin, including with respect to current or future business relationships with us or the combined company following the merger. Our business relationships may be subject to disruption as customers, distributors, suppliers, vendors and others may attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than us or the combined company after the merger. These disruptions could have an adverse effect on our business and the business, financial condition, results of operations or prospects of the combined company, including an adverse effect on the combined company’s ability to realize the anticipated benefits of the merger. The risk and adverse effect of such disruptions could be exacerbated by a delay in completion of the merger or termination of the Transaction Agreement.

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In order to complete the merger with Sorin, we and Sorin must make certain governmental filings and obtain certain governmental authorizations, and if such filings and authorizations are not made or granted or are granted with conditions, completion of the merger with Sorin may be jeopardized or the anticipated benefits of the merger with Sorin could be reduced.

 

Although we and Sorin have agreed in the Transaction Agreement to use our reasonable best efforts to make certain governmental filings and obtain the required governmental authorizations or termination of relevant waiting periods, as the case may be, there can be no assurance that the relevant authorizations will be obtained. In addition, the governmental authorities from which these authorizations are required have broad discretion in administering the governing regulations. As a condition to authorization of the merger, these governmental authorities may impose requirements, limitations or costs or require divestitures or place restrictions on the conduct of the combined company’s business after completion of the merger. There can be no assurance that regulators will not impose conditions, terms, obligations or restrictions and that such conditions, terms, obligations or restrictions will not have the effect of delaying completion of the merger or imposing additional material costs on or materially limiting the revenues of the combined company following the merger, or otherwise adversely affecting, including to a material extent, the combined company’s business and results of operations after completion of the merger. In addition, there can be no assurance that these conditions, terms, obligations or restrictions will not result in the delay or abandonment of the merger with Sorin.    

 

Risks Related to the Combined Company Following Completion of the Merger with Sorin

 

The combined company may not realize the cost savings, synergies and other benefits that the parties expect to achieve from the merger.

 

The combination of two independent companies is a complex, costly and time-consuming process. As a result, the combined company will be required to devote significant management attention and resources to integrating the business practices and operations of Sorin and Cyberonics. The integration process may disrupt the business of either or both of the companies and, if implemented ineffectively, could preclude realization of the full benefits expected by Sorin and Cyberonics. The failure of the combined company to meet the challenges involved in successfully integrating the operations of Sorin and Cyberonics or otherwise to realize the anticipated benefits of the merger could cause an interruption of the activities of the combined company and could seriously harm its results of operations. In addition, the overall integration of the two companies may result in material unanticipated problems, expenses, liabilities, competitive responses, loss of client relationships and diversion of management’s attention, and may cause the combined company’s stock price to decline. The difficulties of combining the operations of the companies include, among others:

 

 

Many of these factors will be outside of the combined company’s control and any one of them could result in increased costs, decreased revenues and diversion of management’s time and energy, which could materially impact the combined company’s business, financial condition and results of operations. In addition, even if the operations of Sorin and Cyberonics are integrated successfully, the combined company may not realize the full benefits of the merger, including the synergies, cost savings or sales or growth opportunities that we expect. These benefits may not be achieved within the anticipated time frame, or at all. As a result, we cannot assure our stockholders that the combination of Sorin and Cyberonics will result in the realization of the full benefits anticipated.

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We will incur significant transaction and merger-related costs in connection with the merger with Sorin.

 

We and Sorin have incurred and expect to incur a number of non-recurring direct and indirect costs associated with the merger. These costs and expenses include fees paid to financial, legal and accounting advisors, facilities and systems consolidation costs, severance and other potential employment-related costs, including payments that may be made to certain Sorin and Cyberonics executives, filing fees, printing expenses and other related charges. Some of these costs are payable by Sorin and Cyberonics regardless of whether the merger is completed. We currently estimate the aggregate amount of these expenses to equal $27.8 million and Sorin currently estimates the aggregate amount of expenses for legal, financial, accounting and other professional advisors and equity issuance costs to equal €14.7 million. There are also processes, policies, procedures, operations, technologies and systems that must be integrated in connection with the merger and the integration of the two companies’ businesses. While both we and Sorin have assumed that a certain level of expenses would be incurred in connection with the merger and the other transactions contemplated by the Transaction Agreement and continue to assess the magnitude of these costs, there are many factors beyond our control that could affect the total amount or the timing of the integration and implementation expenses.

 

There may also be additional unanticipated significant costs in connection with the merger that we may not recoup. These costs and expenses could reduce the realization of efficiencies and strategic benefits we expect the combined  company to achieve from the merger. Although we expect that these benefits will offset the transaction expenses and implementation costs over time, this net benefit may not be achieved in the near term or at all.

 

Certain of the combined company’s debt instruments will require it to comply with certain affirmative covenants and certain specified financial covenants and ratios.

 

These restrictions could affect the combined company’s ability to operate its business and may limit its ability to react to market conditions or to take advantage of potential business opportunities as they arise. For example, such restrictions could adversely affect the combined company’s ability to finance its operations, make strategic acquisitions, investments or alliances, restructure its organization or finance its capital needs. Additionally, the combined company’s ability to comply with these covenants and restrictions may be affected by events beyond its control such as prevailing economic, financial, regulatory and industry conditions. If it breaches any of these covenants (including financial covenants or ratios) or restrictions, the company could be in default under one or more of its debt instruments, which, if not cured or waived, could result in acceleration of the indebtedness under such agreements and cross defaults under its other debt instruments. Any such actions could result in the enforcement of its lenders’ security interests and/or force the company into bankruptcy or liquidation, which could have a material adverse effect on the combined company’s business, financial condition and results of operations.

 

If counterparties to certain agreements with Cyberonics or Sorin do not consent to the merger, change of control rights under those agreements may be triggered as a result of the merger, which could cause the combined company to lose the benefit of such agreements and incur liabilities or replacement costs.

 

Cyberonics and Sorin could be parties to agreements or possess permits that contain change of control provisions that will be triggered as a result of the merger. If the counterparties to these agreements or the authorities responsible for such permits do not consent to the merger, the counterparties or authorities may have the ability to exercise certain rights (including termination rights), resulting in the combined company incurring liabilities as a consequence of breaching such agreements or operating without such permits, or causing the combined company to lose the benefit of such agreements or permits or incur costs in seeking replacement agreements or permits.

 

We may have difficulty attracting, motivating and retaining executives and other key employees due to uncertainty associated with the merger.

 

The combined company’s success after the merger has been completed will depend in part upon the ability of the combined company to retain key employees of Sorin and Cyberonics. Competition for qualified personnel can be intense. Current and prospective employees of ours may experience uncertainty about the effect of the merger with Sorin, which may impair our ability to attract, retain and motivate key management, sales, marketing, technical and other personnel prior to and following the merger with Sorin. Employee retention may be particularly challenging during the pendency of the merger with Sorin, as both our employees and employees of Sorin may experience uncertainty about their future roles with the combined company.

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In addition, pursuant to change-in-control provisions in our employment and transition agreements, certain of our key employees are entitled to receive severance payments upon a constructive termination of employment. Certain of our key employees potentially could terminate their employment following specified circumstances set forth in the applicable employment or transition agreement, including certain changes in such key employees’ title, status, authority, duties, responsibilities or compensation, and collect severance. Such circumstances could occur in connection with the merger with Sorin as a result of changes in roles and responsibilities. If our key employees depart, the integration of the companies may be more difficult and the combined company’s business following the merger may be harmed. Furthermore, the combined company may have to incur significant costs in identifying, hiring and retaining replacements for departing employees and may lose significant expertise and talent relating to the businesses of Sorin or Cyberonics, and the combined company’s ability to realize the anticipated benefits of the merger may be adversely affected. In addition, there could be disruptions to or distractions for the workforce and management associated with activities of labor unions or works councils or integrating employees into the combined company. Accordingly, no assurance can be given that the combined company will be able to attract or retain key employees of Sorin and Cyberonics to the same extent that we or Sorin have been able to attract or retain our own employees in the past.

 

The market price of the combined company’s ordinary shares after the merger with Sorin may be affected by factors different from those currently affecting our common stock or Sorin ordinary shares.

 

Upon completion of the merger with Sorin, holders of our common stock will become holders of Holdco Shares. Holdco’s business following the merger with Sorin will differ from our business and the business of Sorin prior to the completion of the merger with Sorin in important respects and, accordingly, after the merger with Sorin, the market price of Holdco Shares may be affected by factors different from those currently affecting the market price of our common stock.

 

Item 1B.  Unresolved Staff Comments

 

None. 

 

Item 2.  Properties

 

We own our headquarters building, which is located in Houston, Texas and consists of approximately 144,000 square feet of manufacturing and office space. We constructed, and own, a second manufacturing facility located in Costa Rica, which consists of approximately 50,000 square feet. Late in fiscal year 2015, our Costa Rica facility began to manufacture and ship product.

 

We lease approximately 20,000 square-foot facility in Austin, Texas, which we utilize for warehousing and distribution. We lease a total of approximately 19,000 square feet of administrative and sales office space in the following locations: Brussels, Belgium and elsewhere in Europe, China, Hong Kong and the U.S. All of our property lease terms expire between June 30, 2015 and February 2022. All leased properties include the appropriate space to accommodate expected growth in our respective domestic and international businesses.

 

Item 3.  Legal Proceedings

 

For a description of our material pending legal and regulatory proceedings and settlements, refer to “Note 10.  Commitments and Contingencies – Litigation” of our consolidated financial statements.

 

Item 4.  Mine Safety Disclosures

 

Not applicable.

 

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Index 

PART II

 

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock is quoted on the NASDAQ Global Market under the symbol “CYBX.” The high and low sale prices for our common stock during the fiscal years 2015 and 2014 are set forth below. Price data reflect actual transactions, but do not reflect mark-ups, mark-downs or commissions.

 

 

 

 

As of June 9, 2015, according to data provided by our transfer agent, there were 416 stockholders of record.

 

We have not declared or paid any cash dividends. We intend to retain future earnings primarily to fund the development and growth of our business and, therefore, do not currently anticipate paying cash dividends within the foreseeable future. Any future payment of dividends will be determined by our Board of Directors and will depend on our consolidated financial position and results of operations and other factors deemed relevant by our Board of Directors. 

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The table below presents purchases of equity securities by us and our affiliated purchasers:

 

 

 

 

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Index 

Item 6.  Selected Financial Data

 

The following table summarizes certain selected financial data and is qualified by reference to, and should be read in conjunction with, the consolidated financial statements and related notes and with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Form 10-K. The selected financial data and the related notes for the 52 weeks ended April 24, 2015, April 25, 2014 and April 26, 2013 are derived from audited consolidated financial statements that are included in this or prior years Form 10-K.

 

 

 

 

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Index 

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

You should read the following discussion and analysis together with Part I of this Form 10-K, including the matters set forth in “Cautionary Statement About Forward-Looking Statements,” “Item 1A. Risk Factors” and our consolidated financial statements and the related notes included elsewhere in this Form 10-K.

 

This item provides material historical and prospective disclosures enabling investors and other users to assess our consolidated financial position and results of operations.

 

Overview

 

We are a medical device company, incorporated in 1987, engaged in the design, development, sale and marketing of medical devices for epilepsy, depression and heart failure. Our seminal product, the VNS Therapy® System, is an implantable device that provides neuromodulation therapy for the treatment of drug-resistant epilepsy and treatment-resistant depression (“TRD”). Our latest product, the VITARIA™ System, approved in Europe but not the U.S., is an implantable device that provides a form of neuromodulation therapy for the treatment of chronic heart failure (“CHF”). We commenced a limited market launch in Europe of the VITARIA System, with the first commercial implant in early June 2015. We are also developing non-implantable device solutions for the management of epilepsy.

 

Our VNS Therapy System and our VITARIA System include the following:

 

 

The VNS Therapy System 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 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.

 

We sell the VNS Therapy System to hospitals and ASCs on payment terms that are generally 30 days from the shipment date. In addition to maintaining and expanding our regulatory approvals, 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. This coverage allows our customers to invoice and be paid by third-party payers. Currently, we have broad coverage, coding and reimbursement for the VNS Therapy System for the treatment of refractory epilepsy. We estimate that the CMS pays for approximately 25% to 30% of the VNS Therapy System implants under Medicare and approximately 20% to 25% under Medicaid. CMS issues an annual update to the reimbursement amounts available to our customers under Medicare. The Medicaid reimbursement rates, while based on the CMS rates, vary by state. A decrease in reimbursement rates or a change in reimbursement methodology by CMS could have an adverse impact on our business and our future operating results.

 

Our product development efforts are directed toward improving the VNS Therapy System and the VITARIA System, improving their efficacy, and developing new products that provide additional features and functionality. We are conducting ongoing product development activities to enhance the VNS Therapy System and the VITARIA System pulse generator, lead and programming software and to introduce new products. We support a variety of studies for our product development efforts and to build clinical evidence for the VNS Therapy System and the VITARIA System. We will be required to obtain appropriate U.S. and international regulatory approvals, and clinical studies may be a prerequisite to regulatory approvals for some products. Our R&D efforts will require significant funding to complete and may not be successful. Even if successful, additional clinical studies may be needed to achieve regulatory approval and to commercialize any or all new or improved products. Our company sponsored research, development and regulatory approval activities of $43.2 million, $46.6 million and $41.6 million in the fiscal years 2015, 2014 and 2013, respectively.

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The AspireSR generator provides the benefits of VNS therapy, with an additional feature: automatic stimulation in response to detection of changes in heart rate indicative of a seizure. The AspireSR generator is capable of delivering additional stimulation automatically by responding to a patient’s relative heart-rate changes that exceed certain variable thresholds. Heart-rate changes accompany seizure activity in certain patients. The thresholds are programmed by the patient’s physician and can be adjusted to suit the patient’s level of physical activity or for other reasons. In February 2014, we received CE Mark approval for the AspireSR generator, and the generator has been commercially available in many European and Middle Eastern countries since late fiscal year 2014. During the quarter ended October 24, 2014, we submitted the AspireSR generator for premarket approval (“PMA”) in the U.S. On June 2, 2015, we announced FDA approval of the AspireSR generator.  We  owe royalty fees to Flint Hills Scientific, L.L.C. on sales of AspireSR product sales.  

 

In 2011, we commenced a program to ascertain whether VNS therapy could be utilized for treating patients with CHF. Our system for treating patients with CHF, the VITARIA System,  has been specifically designed to deliver autonomic regulation therapy in a manner that promotes improvements in heart function. The VITARIA System operates using an open-loop therapy control system, with one lead attached to either the right or left vagus nerve. In February 2015, we received CE Mark approval of our VITARIA System for patients who have moderate to severe heart failure (New York Heart Association Class II/III) with left ventricular dysfunction (ejection fraction < 40%), and who remain symptomatic despite stable, optimal heart failure drug therapy. We commenced a limited market launch in Europe of the VITARIA System, with the first commercial implant in early June 2015.

 

We continue to develop the ProGuardian™ System, which includes an external body-worn sensor and bedside hub that uses advanced cardiac and movement-based seizure detection technology for in-home seizure monitoring, logging and notification. The first ProGuardian System product will be the ProGuardianREST™ System for monitoring night-time seizures. In November 2014, we received CE Mark approval for marketing the ProGuardian System in Europe, and we plan a limited market release in England during the first quarter of fiscal year 2016. We are also working toward new stimulation paradigms, rechargeable battery technology and the integration of magnetic resonance imaging compatibility with our leads.

 

Following an internal review of our R&D activities, we are engaging in a re-design of certain aspects of our wireless Centro™ generator that resulted in the write-off of certain obsolete inventory items, production equipment and software that amounted to a loss of $1.6 million, which was charged to R&D expense in the consolidated statement of income. We also decided to abandon our pursuit of neurological signal feedback and processing technology, and as a result, we fully impaired certain intellectual property and wrote-off obsolete software for a loss of $0.5 million, also charged to R&D expense. 

 

We have invested approximately $17.1 million in two innovative medical device start-up companies. We account for these investments under the cost-method, as we do not exercise significant influence over the investees. We invested in Cerbomed GmbH (“Cerbomed”), a privately-held, European development-stage company developing a transcutaneous vagus nerve stimulation (t-VNS) device for several indications, including the treatment of drug-resistant epilepsy. Cerbomed received CE Mark approval for its device for the treatment of epilepsy and depression in March 2010. Cerbomed has completed a clinical study in Germany to study outcomes in the treatment of refractory epilepsy. During the quarter ended January 23, 2015, we invested an additional €1.0 million, or $1.2 million, in convertible preferred stock. During fiscal year 2016, we expect Cerbomed to seek an investigational device exemption (“IDE”) from the FDA for Cerbomed’s device for the treatment of certain types of epilepsy. We hold an exclusive option for the worldwide sales and distribution of this system for the treatment of epilepsy. In addition, we invested in ImThera Medical, Inc., a privately-held, development-stage, company developing an implantable neurostimulation device system for the treatment of obstructive sleep apnea. In November 2014, ImThera announced that the FDA granted an IDE for their targeted hypoglossal neurostimulation pivotal clinical study, and patient enrollment has commenced.

 

The healthcare industry is characterized by extensive research efforts and rapid technological progress. As other forms of neurostimulation are investigated and developed for epilepsy, depression, or heart failure, they may emerge as competition for the VNS Therapy System. In addition, the development by others of new treatment methods with novel drugs or medical devices for epilepsy, depression, or heart failure, could render the VNS Therapy System noncompetitive or obsolete. Advancements in surgical techniques could make surgery a more attractive therapy. We believe that existing and future drug therapies are the primary competition for the VNS Therapy System in the near term for epilepsy and depression, and existing device therapies are the primary competition in heart failure. Any neurostimulation techniques could prove to be more effective, more accessible, more predictable, or more rapidly acting than the VNS Therapy System.

 

We face competition from small, emerging or large medical device or pharmaceutical companies that have the technology, experience and capital resources to develop alternative devices for the treatment of epilepsy and depression. These competitors or potential competitors could have substantially greater financial, manufacturing, marketing and technical resources than we have, and as a result, may develop technologies, obtain patents and regulatory approvals for products that are more effective in treating epilepsy or depression than our current or future products.

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We believe that in the refractory epilepsy and TRD indications, existing and future drug therapies are the primary competition for the VNS Therapy System at present. We also believe that the primary competitive factors within the epilepsy treatment markets are the safety, tolerability and efficacy of the treatment relative to alternative therapies, physician and patient acceptance of the product and procedure, availability of third-party reimbursement, quality of life improvements, and in the case of device-based therapies, product reliability. We believe that the VNS Therapy System compares favorably with competitive products as to these factors.

 

We expect to face competition from other medical device companies for the treatment of epilepsy. Medtronic, Inc. has received approval from the FDA for its Activa Neurostimulator, a DBS device indicated for the treatment of essential tremor, Parkinson’s Disease and severe obsessive compulsive disorder and has submitted a PMA application to the FDA for use of the Activa Neurostimulator for the treatment of refractory epilepsy. The device already has approval for marketing in the European countries governed by CE Mark approval, and Medtronic has begun commercial marketing in several European countries. Another company, CerebralRx Ltd. based in Israel, developed an implantable device capable of vagus nerve stimulation for the treatment of epilepsy and has CE Mark approval. CerebralRx has initiated commercialization efforts in several European countries. In November 2013, the FDA approved NeuroPace, Inc.’s responsive neurostimulation device for the treatment of refractory epilepsy. This technology includes a pulse generator that is positioned in the skull with cortical strip and depth electrodes placed in pre-determined areas in the brain where seizures are thought to originate. NeuroPace has commenced commercial activity in the U.S.  Several non-invasive neurostimulation technologies are emerging as well. NeuroSigma Inc., based in the U.S., is focused on the development of a trigeminal nerve stimulation device for the treatment of attention deficit hyperactivity disorder, major depressive disorder, and refractory epilepsy. NeuroSigma Inc. received CE Mark approval for this technology for the treatment of refractory epilepsy and has begun commercialization in Europe. Cerbomed GmbH (“Cerbomed”), a privately-held company based in Germany, has developed a transcutaneous vagus nerve stimulation device that is also CE Mark-approved for the treatment of epilepsy. We have invested approximately €4.0 million, or $5.1 million, in Cerbomed to date. A company based in Europe, Neurotech, SA, now owned by Sorin, has obtained CE Mark approval for a device capable of vagus nerve stimulation for the treatment of epilepsy. In addition, we believe that a company in China may be developing an implantable device that provides neuromodulation therapy to the vagus nerve; however we are not privy to details regarding any such device, including its commercial launch. 

 

A well-established array of antidepressant drugs typically combined with other antidepressants of complementary action or with atypical antipsychotic drugs and/or mood stabilizers, are frequently used for patients with unresponsive or treatment-resistant depression. For patients with certain types of severe depression or those at acute risk for suicide, ECT may be used. These treatment modalities represent the current standard of care against which the VNS Therapy System must compete to be successful commercially as a therapy for TRD. At least two non-invasive device-based therapies have been approved by the FDA since October 2008 for depression. Repetitive transcranial magnetic stimulation, developed and marketed by U.S. based Neuronetics Inc., consists of an externally-placed coil that delivers a pulsed magnetic field and is indicated for depression that has not responded to prior adequate treatments. Other companies, including Brainsway Ltd., based in Israel, have developed various forms of transcranial magnetic stimulation for depression. The Brainsway Ltd. device has also been cleared by the FDA.

 

Existing device therapies – cardiac resynchronization therapy with pacing or defibrillation function – represent the primary competition for the VITARIA System at present. These devices are available today from Medtronic, Inc., Boston Scientific Corporation, St. Jude Medical, Inc., Biotronik SE & Co. KG and Sorin. In addition, several companies are developing competitive neurostimulation therapies for heart failure. BioControl Medical, Ltd. a privately held medical device company headquartered in Israel and Sorin are developing products that may compete with VITARIA for the treatment of CHF. BioControl Medical’s system is based on a closed-loop therapy control system with two leads, one attached to the vagus nerve and one implanted endocardial lead, positioned in the right ventricular apex, with stimulation delivered in response to heart function. In addition, CVRx, Inc. a private medical device company located in Minnesota, and Boston Scientific Corporation, offer solutions for the treatment of CHF that operate on an open-loop therapy control system.  The CVRx system works by electrically activating the baroreceptors, the body’s natural sensors that regulate cardiovascular function. CVRx and Cyberonics have systems approved in Europe for treating patients with CHF, and none have approval in the U.S. 

 

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 do not have indication-specific patent coverage for vagus nerve stimulation to treat epilepsy or depression.

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We periodically evaluate whether to out-license or 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; refer to “Note 10. Commitments and Contingencies – License Agreements” in our consolidated financial statements for additional information.

 

We concluded construction of our new manufacturing facility in Costa Rica. The production line qualification phases have been completed, and we received appropriate regulatory approvals.  Late in fiscal year 2015, the Costa Rica plant started manufacturing and shipping product; however, the plant is not expected to operate at full capacity in fiscal year 2016.

 

Significant Accounting Policies and Critical Accounting Estimates

 

We have adopted various accounting policies to prepare the consolidated financial statements in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”). Our most significant accounting policies are disclosed in “Note 1. Basis of Presentation and Use of Accounting Estimates” in the consolidated financial statements.

 

To prepare our consolidated financial statements in conformity with U.S. GAAP, management makes estimates and assumptions that may affect the reported amounts of our assets and liabilities, the disclosure of contingent liabilities as of the date of our consolidated financial statements and the reported amounts of our revenues and expenses during the reporting period. Our actual results may differ from these estimates. We consider estimates to be critical if we are required to make assumptions about material matters that are uncertain at the time of estimation, or if materially different estimates could have been made or it is reasonably likely that the accounting estimate will change from period to period. The following are areas requiring management’s judgment that we consider critical:

 

Intangible Assets

 

Intangible assets shown on the consolidated balance sheet are finite-lived assets. Developed Technology Rights consists primarily of purchased patents, related know-how and licensed patent rights. Other Intangible Assets consist of purchased clinical data. We amortize our intangible assets over their useful lives, generally the life of the patents, using the straight-line method. The carrying value of our intangible assets amounted to $10.2 million at April 24, 2015, with an average amortization period of 15 years. The determination of useful lives and impairment is subject to a high degree of estimation and management judgment. We evaluate our intangible assets each reporting period to determine whether events and circumstances indicate either a different amortization period or impairment. Impairment indicators include a determination that a patent or technology lacks future utility. In fiscal year 2015, we recorded an impairment loss for intangible assets of $0.5 million.  Refer to  “Note 5. Intangible Assets” for further details of these investments. 

 

Investments in Equity Securities 

 

We invested in the convertible preferred shares of two privately-held start-up entities. The investments are accounted for under the cost-method and have a total carrying value of $17.1 million as of April 24, 2015. The carrying value of these entities is reviewed each reporting period for events or changes in circumstances that indicate an impairment of our investment. Impairment indicators include failed clinical studies, adverse regulatory actions, changes in the investees’ competitive position and difficulty in raising funds. If an impairment indicator is identified, the measurement of any potential impairment is subject to a high degree of management judgment, as these investments do not have quoted market prices. We have not recorded any impairment of these investments. Refer to “Note 6. Investments”  and “Note 17. Fair Value Measurements,” for further details.

 

Stock-Based Compensation

 

Stock Option Awards

 

Our stock option award compensation expense is based on the fair market value of our awards. The fair market value of an award is amortized ratably over the award vesting period. We use the Black-Scholes option pricing methodology to estimate the grant date fair market value of stock option awards. This methodology takes into account variables such as the future expected volatility of our stock price, the amount of time expected to elapse between the date of grant and the date of exercise and a risk-free interest rate. Fair values of stock options issued in the future may vary significantly from fair values recorded in the current period depending on our estimates and judgments regarding these variables and therefore expense in future periods may differ significantly from current-period expense.

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Restricted Stock and Restricted Stock Unit Awards

 

Service-Based Restricted Stock. We grant restricted stock and restricted stock units at no purchase cost to the grantee. The fair market values of serviced-based restricted stock and restricted stock units are determined using the market closing price on the grant date and compensation is expensed ratably over the vesting period. Calculation of compensation for service-based restricted share awards requires estimation of, and depends upon, forfeiture rates. Compensation expense may vary significantly from our estimates if employee turnover rates differ from our expectations.

 

Market and Performance-Based Restricted Stock and Performance-Based Restricted Stock Units. We grant restricted stock and restricted stock unit awards subject to market or performance conditions that vest based on the satisfaction of the conditions of the award. The fair market values of market condition-based awards are determined using the Monte Carlo simulation method. The Monte Carlo simulation method is subject to variability as several factors utilized must be estimated, including the derived service period estimate based on our judgment of likely future performance and our stock price volatility. The fair value of performance-based awards is based on the market closing price on the grant date. The amount of compensation expense recognized depends on management’s estimates of likely future performance. If performance differs from management’s estimates, compensation expense could be significantly different from our expectations.

 

Income Taxes

 

We are subject to federal, state and foreign income taxes, and we use significant judgment and estimates in accounting for our income taxes. This involves assessing changes in temporary differences resulting from differing treatment of events for tax and accounting purposes. These assessments result in deferred tax assets and liabilities, which 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. Actual tax expense may significantly differ from our expectations if, for example, judicial interpretations of tax law, tax regulations or tax rates change.

 

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 our fiscal year 1992 and subsequent years, with certain exceptions. Tax authorities may disagree with certain positions we have taken and assess additional taxes and as a result, we establish reserves for uncertain tax positions, which require a significant degree of management judgment. We regularly assess the likely outcomes of our tax positions in order to determine the appropriateness of our reserves for uncertain tax positions; however, the actual outcome of an audit can be significantly different than our expectations, which could have a material impact on our tax provision. The total amount of unrecognized tax benefit, as of April 24, 2015, if recognized, would reduce our income tax expense by approximately $5.8 million.

 

We are required to periodically assess the recoverability of our deferred tax assets by considering whether it is more likely than not that some or all of the actual benefit of those assets will be realized.  To the extent that realization does not meet the “more-likely-than-not” criterion, we establish a valuation allowance. We periodically review the adequacy and necessity of the valuation allowance by considering significant positive and negative evidence relative to our ability to recover deferred tax assets and to determine the timing and amount of valuation allowance that should be released. Changes in our assessment of the factors related to the recoverability of our deferred tax assets could result in materially different income tax provisions. As of April 24, 2015, we have valuation allowances of $1.6 million that are primarily related to a  capital loss carryforward and pre-operating expenses in Costa Rica. If the valuation allowances related to these two items were to be released, our tax provision would be reduced by $1.5 million.

 

 

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Results of Operations

 

Net Sales

 

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

 

 

 

 

 

 

U.S. net product sales for the 52 weeks ended April 24, 2015 increased $10.3 million, or 4.5%, as compared to the 52 weeks ended April 25, 2014, due to increased generator unit sales volume of 1.4% and an increased average selling price of 3.1%. The decreased generator unit growth rate of 1.4% as compared to the prior year unit growth rate of 4.0%  was primarily due to a lower adoption rate for new patients. The average selling price increased 3.1% this year as compared to the prior year’s price growth rate of 3.9%. This decrease in the growth rate was primarily due to the unfavorable effect of a decline in lead sales as a percent of generator sales. Our generator replacement growth rate has increased as compared to the prior fiscal year and was slightly less than our expected mid-single digit growth rate.

 

U.S. net product sales for the 52 weeks ended April 25, 2014 increased $16.6 million, or 7.9%, as compared to the 52 weeks ended April 26, 2013, due to increased unit sales of 4.0% and an increased average selling price of 3.9%. The average selling price increased due to continued higher market penetration of our higher-priced AspireHC generator and price increases effective January 1, 2013 and January 1, 2014. The unit sales increase in the U.S. was 4.0%, which was less than the equivalent prior period growth rate of 10.5%, due in part to certain circumstances occurring in the third quarter, which ended January 24, 2014. These circumstances included a combination of holidays that fell in the middle of the week, inclement weather that disrupted hospital and patient schedules and the disruptive effects of health insurance coverage changes. The approval by the FDA of a competitive implantable neuromodulation device for the treatment of epilepsy in November 2013 may have contributed to the decrease in the growth rate. Our generator replacement growth rates have declined as compared to the prior fiscal year and were slightly less than our expected mid-single digit growth rate.

 

International net product sales for the 52 weeks ended April 24, 2015 increased by $0.8 million, or 1.4%, as compared to the 52 weeks ended April 25, 2014,  due to a generator unit sales volume increase of 9.3%, offset by a  7.9% decreased average selling price.  Generator unit sales increased in most of our international markets. The unit growth rate of 9.3% decreased as compared to the equivalent prior year period growth rate of 18.6%, however, last year’s growth rate included one customer order that accounted for a significant part of the prior year’s volume growth. If the order is excluded from our prior year’s sales, this year’s unit growth rate would have been 15.4%. The average selling price decreased by 7.9% due to a 5.4% unfavorable foreign currency effect, a 0.7% unfavorable effect due to a decline in lead sales as a percent of generator sales and the effect of an increase in sales through lower margin distributors, partially offset by a favorable impact from increasing sales of the higher priced AspireSR generator. On a constant currency basis, international revenues would have increased by 6.8%, and if we also exclude the one order from prior year results, international revenues would have grown by 16.9%. Overall sales, both domestic and international, on a constant currency basis and if we also exclude the one order from prior year results, would have grown by 6.8%.

 

 

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International net product sales for the 52 weeks ended April 25, 2014 increased by $11.1 million, or 25.3%, as compared to the 52 weeks ended April 26, 2013, due to increased unit sales of 18.6% and an increased average selling price of 6.7%. Unit sales increased in the majority of our international markets, and the average selling price increased due to the mix of sales by country; however, two related shipments to one customer accounted for a significant part of our international growth. Without this one customer, our international unit growth was 12.3%, and our average selling price increased 2.2%. In addition, we experienced a favorable foreign currency impact on international revenues of $1.0 million due to the strengthening of the euro against the U.S. dollar and British pound. On a constant currency basis, international revenues would have increased by 22.9%, and if we also exclude the one order from the results, international revenues would have grown by 12.1%. Overall sales, both domestic and international, on a constant currency basis and if we also exclude the one order from prior year results, would have grown by 8.7%. 

 

Our license revenue has consisted of the amortization of deferred license revenue. The deferred revenue consisted of a one-time up-front receipt of $9.5 million in December 2007 for the licensing of certain of our patent and patent applications. During fiscal year 2014, all deferred revenue was fully amortized, and we have not received any additional licensing revenue. 

 

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 consisted primarily of direct labor, allocated manufacturing overhead, the acquisition cost of raw materials and components, and the medical device excise tax (“MDET”). Our cost of sales as a percent of net sales for fiscal year 2015, at 9.4% was not materially different from last year’s rate of  9.7%.

 

Our cost of sales, as a percent of net sales for fiscal year 2014, increased by 1.1% to 9.7%, when compared to fiscal year 2013. This increase was primarily the result of the MDET on devices sold domestically, which added an incremental $2.3 million, or 0.8%, to the cost of sales. This excise tax was applied to medical devices sold domestically beginning January 1, 2013.

 

We expect that our consolidated gross margin will decrease in fiscal year 2016 due to the following factors: we expect to ship an increased volume of our new and more expensive programming tablet that we provide free to physicians and hospitals worldwide, we expect a larger portion of our production to originate at our new Costa Rica manufacturing plant that is not expected to be operating at full capacity, and we expect increased royalty fee expense due to the royalty fees for AspireSR sales.

 

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

 

SG&A expenses, which exclude transaction expenses incurred in connection with the proposed merger with Sorin, are comprised of sales, marketing, general and administrative activities. SG&A expenses as a percent of net sales for the 52 weeks ended April 24, 2015, at 42.4%, as compared to the prior year’s rate of at 42.8%, was materially unchanged.

 

SG&A expenses decreased  by 1.4% to 42.8% as a percent of net sales when comparing fiscal year 2014 to fiscal year 2013,   primarily due to more efficient use of our sales and marketing expenditures and a reduction in stock-based compensation expense.

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Research and Development (“R&D”) Expenses

 

R&D expenses consist of product and process development, product design efforts, clinical trial programs and regulatory activities. R&D expenses for the 52 weeks ended April 24, 2015 decreased, as a percent of net sales, by 1.7% to 14.8%, as compared to the prior year, representing a decrease of $3.3 million in expenditures. R&D spending decreased due to completion of work, adaption to longer developmental schedules or cancellation of work.  Following an internal review of our R&D activities, we are engaging in a re-design of certain aspects of our wireless Centro™ generator that resulted in the write-off of certain obsolete inventory items, production equipment and software that amounted to a loss of $1.6 million, which was charged to R&D expense in the consolidated statement of income. We also decided to abandon our pursuit of neurological signal feedback and processing technology, and as a result, we fully impaired certain intellectual property and wrote-off obsolete software for a loss of $0.5 million, also charged to R&D expense.

 

R&D expenses for fiscal year 2014 increased, as a percent of net sales, by 0.2% to 16.5%, as compared to fiscal year 2013, representing an increase of $5.0 million in expenditures.  This increase was due to our on-going product development efforts for the treatment of refractory epilepsy and our clinical development efforts with respect to the VITARIA System for the treatment of chronic heart failure.

 

We continue to focus resources on new stimulation paradigms, rechargeable battery technology and the integration of magnetic resonance imaging compatibility with our leads. We continue to develop our wireless capabilities, the Centro generator and the VITARIA System for the treatment of chronic heart failure. We expect a decrease in R&D expenditures in fiscal year 2016 as a percentage of revenue, as compared to fiscal year 2015.    

 

Merger Expenses

 

We incurred $8.7 million in merger expenses related to the proposed merger with Sorin.  These expenses consisted of professional fees for legal services, accounting services, due diligence, a fairness opinion and the preparation of registration and regulatory filings in the U.S. and Europe. We reported these expenses as a separate operating expense in the consolidated statement of income.

 

Litigation Settlement - Zabara

 

We settled a lawsuit relating to our 1988 patent license agreement with Dr. Jacob Zabara, resulting in a $7.4 million charge, before a tax benefit of $2.7 million, recorded as a separate item in our operating expenses in the consolidated statement of income in fiscal year 2014.

 

Impairment of Investment - Convertible Debt

 

During the fiscal year 2013,  we determined that the fair value of our investment in a convertible debt instrument of NeuroVista Corporation, a privately-held, development-stage medical device company, was below the carrying value and, as a result, we recorded an other-than-temporary impairment loss of $4.1 million, which was recorded as a non-operating expense in the consolidated statement of income. Further, during the fiscal year 2013, NeuroVista advised us that an event of default had occurred under the terms of the convertible debt security, and as a result we settled the debt instrument in a foreclosure sale and took possession of the company’s tangible and intangible assets. We estimated the fair value of the assets obtained in foreclosure at $1.45 million, which resulted in no gain or loss on the foreclosure settlement of the debt instrument. Refer to  “Note 17. Fair Value Measurements” in the notes to the consolidated financial statements for further information regarding this investment.

 

Gain on Warrants’ Liability

 

In September 2005, in conjunction with the issuance of $125 million of senior subordinated convertible notes, all of which were retired by September 2012, we sold warrants for $25.2 million to Merrill Lynch International. The warrants were recorded as common stock warrants in the equity section of our consolidated balance sheets. The warrants entitled the holder to receive the net value for the purchase of 3,012,050 shares of our common stock for the amount in excess of $50.00 per share. The warrant agreement was amended during the fiscal year 2013, and as a result, a portion of the common stock warrants were reclassed to a liability and were settled in fiscal year 2013, for a gain of $1.3 million. Refer to “Note 9. Warrants” in the notes to the consolidated financial statements for further information.

 

Other Income (Expense), Net

 

Other income (expense), net was $0.5  million, ($0.3) million and ($0.3) million during the fiscal years 2015, 2014 and 2013, respectively, which were primarily the result of our foreign currency transaction (“FX”) gains and losses. We operate in a number of international markets and are exposed to the impact of foreign currency exchange rate movements, particularly with respect to the U.S. dollar versus the euro.

 

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Income Taxes

 

Our effective tax rate for the fiscal year 2015 was 35.2%, primarily due to our U.S. federal income tax,  state and foreign income taxes, and permanent differences. Permanent differences relate to transactions that are reported for U.S. GAAP purposes but are not reported for income tax purposes in accordance with the Internal Revenue Code. Permanent differences for fiscal year 2015 included: (i) the domestic production activities deduction of $2.6 million, which resulted in a 2.9% reduction to the effective tax rate, (ii) $3.2 million of Federal and State R&D tax credits, which included the recognition this fiscal year of prior year unrecognized R&D tax credits, for a 3.6% reduction to the effective tax rate, and (iii) other permanent differences, such as non-deductible officer’s compensation, subpart F income incurred by our European subsidiary, Cyberonics Europe, BVBA, adjustments related to a change in international structure and non-deductible meals and entertainment, which resulted in an increase in the effective tax rate of 2.5%.  

 

Our effective tax rate for the fiscal year 2014 was 31.3%, primarily due to our U.S. federal income, state and foreign income taxes, the release of the Cyberonics Europe BVBA valuation allowance on its NOL and other permanent differences.

 

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 our fiscal year 1992 and subsequent years, with certain exceptions. Tax authorities may disagree with certain positions we have taken and assess additional taxes and as a result, we establish reserves for uncertain tax positions, which require a significant degree of management judgment. We regularly assess the likely outcomes of our tax positions in order to determine the appropriateness of our reserves for uncertain tax positions. The total amount of unrecognized tax benefit, as of April 24, 2015, if recognized, would reduce our income tax expense by approximately $5.8 million. We are unable to estimate the amount of change in our unrecognized tax benefits over the next 12 months; however, we do not anticipate a significant change.

 

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.

 

Liquidity and Capital Resources

 

Cash and cash equivalents

 

Cash Flows

 

Net cash and cash equivalents provided by (used in) operating, investing and financing activities and the net increase (decrease) in the balance of cash and cash equivalents were as follows (in thousands):

 

 

 

 

 

 

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Operating Activities

 

Cash provided by operating activities during fiscal year 2015 increased as compared to fiscal year 2014 by $25.5 million, to $79.7 million, primarily due to a $3.0 million increase in net income, an increase in non-cash operating expenses, of $17.9 million, and a decrease in cash outflow from operating assets and liabilities of $4.6 million. The increase in non-cash expenses as compared to last year was due primarily to the increase in the utilization of deferred tax assets of $14.6 million. The utilization of deferred tax assets related to (i) the usage of tax credits and net operating losses in Europe, (ii) an adjustment to deferred tax assets related to filing tax accounting method changes, and (iii) an  adjustment related to changes in the ownership structure in Europe. The decrease in cash outflow from operating assets and liabilities was primarily the result of our improved cash flow from  accounts receivable and operating liabilities offset by inventory build-up. Accounts receivables improved cash flows by $8.0 million,  due to the collection this year of $3.8 million from a single international customer plus the effect of slower sales growth in the final quarter of fiscal year 2015 as compared to fiscal year 2014.  Payables and accrued liabilities added $5.5 million to operating cash flow due to increased balances in these accounts as compared to fiscal year 2014. Accruals for accounting and legal fees increased due to the proposed merger with Sorin, the effect of which was partially offset by a reduction to our bonus compensation accruals at year end as compared to the prior year end. This cash flow improvement from operating assets and liabilities was partially offset by increased inventory purchases of $7.4 million, as compared to the equivalent prior-year period, which was primarily due to increased purchases to ensure an adequate supply of our new programming tablets and increased inventory levels at our new Costa Rica manufacturing plant. 

 

Cash provided by operating activities during fiscal year 2014 decreased as compared to fiscal year 2013 by $24.9 million to $54.2 million,  primarily due to a decrease in non-cash operating expenses of $29.9 million, an increase in operating cash assets of $1.0 million and a decrease in operating cash liabilities of $4.5 million,  offset by increased net income of $8.5 million.  Non-cash operating expenses decreased in fiscal year 2014 primarily due to the decrease in the utilization of deferred tax benefit from NOLs of $27.6 million. The cash flow decrease from operating assets was primarily due to prepayment of our fiscal year 2015 federal income tax in fiscal year 2014. The cash flow decrease from operating liabilities was primarily due to lower incentive compensation accruals for fiscal year 2014 as compared to fiscal year 2013. 

 

Investing Activities

 

Cash used in investing activities decreased by $24.6 million to $9.8 million during fiscal year 2015 as compared to fiscal year 2014. For the comparative periods, our funding of short-term investments fell by $8.0 million due to our having nearly reached our preferred level of investment in short-term securities last fiscal year. During fiscal year 2015 we moved an additional $1.9 million to commercial paper from cash. Our short-term securities mature six months from purchase date. Our property, plant and equipment (“PP&E”) investments fell by $8.5 million for comparable periods primarily due to completion of our new Costa Rica manufacturing facility, a decrease in our headquarters building improvements and a decrease in our software systems infrastructure spending.  Our fiscal year 2015 investments in intangible assets and cost-method equity investments fell by $8.0 million, as our only expenditure in fiscal 2015 was the purchase of an additional tranche of convertible preferred stock in Cerbomed GmbH, a European company developing a transcutaneous vagus nerve stimulation device for the treatment of epilepsy, for €1.0 million, or approximately $1.2 million. 

 

Cash used in investing activities was $34.4 million in fiscal year 2014 compared to $36.0 million for fiscal year 2013. Our PP&E investments increased $5.5 million, to $15.2 million due to increased investments in our headquarters building, in our software systems infrastructure and in our Costa Rica manufacturing facility. These increases were partially offset by a decrease in expenditures for short-term investments in certificates of deposit of $5.0 million. We purchased $3.8 million in intangible assets during fiscal 2014 and $4.6 million in fiscal year 2013 primarily related to patents focused on sleep apnea treatment, the integration of magnetic resonance imaging compatibility for our leads and the development of our cardiac-based seizure detection capabilities. In fiscal 2014, we invested €1.0 million, or $1.4 million, in preferred stock of Cerbomed GmbH and $4.0 million in ImThera Medical, Inc. ImThera Medical, Inc. is developing an implantable neurostimulation device system for the treatment of obstructive sleep apnea.

 

Financing Activities

 

Cash used in financing activities during fiscal year 2015 increased as compared to fiscal year 2014 by $11.0 million to $48.3 million. This increase in overall financing cash outflow was primarily due to decreased cash inflows of (i) $21.9 million primarily related to excess tax benefits from the utilization of equity-based net operating loss carry-forwards,  and (ii) $6.6 million in proceeds from the exercise of options for common stock. Excess tax benefits are derived from activity in our equity compensation plan and are considered a financing cash source.  These effects were partially offset by the decreased cash outflow of $17.3 million for the purchase of treasury stock. Our Board of Directors authorizes purchases of our common stock on the open market, and the volume and timing of such purchases depend on the market conditions and other factors. On November 18, 2014, the Board authorized the repurchase of one million shares; however, on February 27, 2015, our treasury stock purchase plan under Rule 10b5-1 of the Exchange Act (the "Plan"), entered into under the authority of the Board of Directors, terminated, and we stopped repurchasing shares of our stock.

 

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Cash used in financing activities during fiscal year 2014 increased by $18.4 million as compared to fiscal year 2013. This increase was primarily due to increased treasury stock purchases of $39.3 million,  partially offset by increased financing cash inflow from equity-based tax benefits of $22.3 million.

 

Contractual Obligations

 

A summary of contractual obligations as of April 24, 2015 are as follows:

 

 

 

 

 

 

We believe our current liquidity and capital resources will be adequate to fund anticipated business activities through the end of fiscal year 2016, without taking into consideration the proposed merger with Sorin. Our liquidity could be adversely affected by the factors affecting future operating results, including those referred to in “Item 1A. Risk Factors” above.

 

Factors Affecting Future Operating Results and Common Stock Price

 

The factors affecting our future operating results and common stock prices are disclosed in “Item 1A. Risk Factors.”

 

Item 7A.  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, concentration of credit and concentration of procurement suppliers that could adversely affect our 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.

 

Foreign Currency Exchange Rate Risk

 

Due to the global reach of our business, we are also exposed to market risk from the impact of foreign currency exchange rate movements on earnings, particularly with respect to the USD versus the EUR and GBP. We choose not to offset our foreign currency exchange exposures for a variety of reasons, including but not limited to immateriality, accounting considerations and the prohibitive economic cost of offsetting particular exposures. Based on our exposure to foreign currency exchange rate risk, and not taking into consideration foreign currency derivative offsets, a sensitivity analysis indicates that if the USD had uniformly weakened 10% against the EUR and the GBP, the effect on net income after tax for the fiscal year ended April 24, 2015 would have been favorable by approximately $853,000 or 1.5%. Conversely, if the USD had uniformly strengthened 10% against the EUR and the GBP, the impact on net income after tax for the fiscal year ended April 24, 2015 would have been unfavorable by approximately $577,000 or 1.0%. 

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Index 

Concentration of Credit Risk

 

Our trade accounts receivable represent potential concentrations of credit risk. This risk is limited due to the large number of customers and their dispersion across a number of geographic areas and our efforts to control our exposure to credit risk by monitoring our receivables and the use of credit approvals and credit limits. In addition, historically, we have had strong collections and minimal write-offs. While we believe that our reserves for credit losses are adequate, essentially all of our trade receivables are concentrated in the hospital and healthcare sectors in the U.S. and several other countries, and accordingly, we are exposed to their respective business, economic and country-specific variables. Although we do not currently foresee a concentrated credit risk associated with these receivables, repayment is dependent on the financial stability of these industry sectors and the respective countries’ national economies and healthcare systems.

 

Item 8.  Financial Statements and Supplementary Data

 

The information required by this Item is incorporated by reference to the consolidated financial statements beginning on page F-1.

 

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A.  Controls and Procedures

 

Disclosure Controls and Procedures

 

(a)  Evaluation of 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 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 (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure. Our management, under the supervision and with the participation of our CEO and CFO, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Form 10-K. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of April 24, 2015.

 

(b)  Management’s Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In connection with the preparation of our annual consolidated financial statements, our management, under the supervision and with the participation of our CEO and CFO, assessed the effectiveness of our internal control over financial reporting based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control — Integrated Framework (1992). Based on this assessment, our management has concluded that our internal control over financial reporting was effective as of April 25, 2014.

 

KPMG LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this Form 10-K, has issued a report on our internal control over financial reporting as of April 24, 2015. This report, dated June 15, 2015, appears on page 47.

 

(c)  Changes in Internal Control Over Financial Reporting

 

During the 52 weeks ended April 24, 2015, there have been no changes that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

Item 9B.  Other Information

 

None.

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Cyberonics, Inc.:

We have audited Cyberonics, Inc.’s internal control over financial reporting as of April 24, 2015, based on criteria established in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Cyberonics, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A(b)). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Cyberonics, Inc. maintained, in all material respects, effective internal control over financial reporting as of April 24, 2015, based on criteria established in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Cyberonics, Inc. and subsidiaries as of April 24, 2015 and April 25,  2014, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for the 52 weeks ended April 24, 2015, April 25, 2014 and April 26, 2013, and our report dated June 15, 2015 expressed an unqualified opinion on those consolidated financial statements.

 

/s/  KPMG LLP

 

Houston, Texas

June 15, 2015

 

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Index 

PART III

 

Item 10.  Directors, Executive Officers and Corporate Governance

 

Pursuant to general instruction G to Form 10-K, we incorporate by reference into this item the information to be disclosed in our definitive proxy statement for our 2015 Annual Meeting of Stockholders.

 

Financial Code of Ethics

 

Our Board has adopted a Financial Code of Ethics, which represents the code of ethics applicable to our principal executive officer, principal financial officer, principal accounting officer, controller and other senior financial officers (“senior financial officers”).  A copy of the Financial Code of Ethics is available on our website, www.cyberonics.com,  and a copy will be mailed, without charge, upon written request to our investor relations department.  We intend to disclose any amendments to or waivers of the Financial Code of Ethics on behalf of our senior financial officers on our website, at www.cyberonics.com promptly following the date of the amendment or waiver.

 

Item 11.  Executive Compensation

 

Pursuant to general instruction G to Form 10-K, we incorporate by reference into this Item the information to be disclosed in our definitive proxy statement for our 2015 Annual Meeting of Stockholders.

 

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

Pursuant to general instruction G to Form 10-K, we incorporate by reference into this Item the information to be disclosed in our definitive proxy statement for our 2015 Annual Meeting of Stockholders.

 

Item 13.  Certain Relationships and Related Transactions, and Director Independence

 

Pursuant to general instruction G to Form 10-K, we incorporate by reference into this Item the information to be disclosed in our definitive proxy statement for our 2015 Annual Meeting of Stockholders.

 

Item 14.  Principal Accounting Fees and Services

 

Pursuant to general instruction G to Form 10-K, we incorporate by reference into this Item the information to be disclosed in our definitive proxy statement for our 2015 Annual Meeting of Stockholders.

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Index 

PART IV

 

Item 15.  Exhibits, Financial Statement Schedules

 

(1) Financial Statements

 

The Consolidated Financial Statements of Cyberonics, Inc. and its subsidiaries, and the Report of Independent Registered Public Accounting Firm are included in this Form 10-K beginning on page F-1:

 

 

(2) Financial Statement Schedules

 

All schedules required by Regulation S-X have been omitted as not applicable or not required, or the information required has been included in the notes to the consolidated financial statements.

 

(3) 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-K. The exhibits marked with the cross symbol (†) are management contracts or compensatory plans or arrangements filed pursuant to Item 601(b)(10)(iii) of Regulation S-K.  The exhibits marked with the pound symbol (#) have been redacted and are the subject of an application for confidential treatment filed with the SEC pursuant to Rule 24b-2 of the general rules and regulations promulgated under the Exchange Act.

 

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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: June 15, 2015

 

POWER OF ATTORNEY

 

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Daniel J. Moore and Gregory H. Browne, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10‑K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: