Cyberonics Management Discusses Q3 2013 Results - Earnings Call Transcript

Feb.22.13 | About: Cyberonics, Inc. (CYBX)

Cyberonics (NASDAQ:CYBX)

Q3 2013 Earnings Call

February 22, 2013 9:00 am ET

Executives

Daniel J. Moore - Chief Executive Officer, President and Executive Director

Darren W. Alch - Vice President, Corporate Counsel, Compliance Officer and Assistant Secretary

Gregory H. Browne - Chief Financial Officer, Principal Accounting Officer and Senior Vice President of Finance

Analysts

Matthew O'Brien - William Blair & Company L.L.C., Research Division

Raj Denhoy - Jefferies & Company, Inc., Research Division

Brooks E. West - Piper Jaffray Companies, Research Division

James Sidoti - Sidoti & Company, LLC

William J. Plovanic - Canaccord Genuity, Research Division

Charles Haff - Craig-Hallum Capital Group LLC, Research Division

Suraj Kalia - Northland Capital Markets, Research Division

Stephen G. Brozak - WBB Securities, LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Cyberonics Q3 Fiscal Year 2013 Earnings Conference Call. My name is Mimi, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host, Mr. Dan Moore, President and Chief Executive Officer. Please proceed.

Daniel J. Moore

Thank you, Mimi. And welcome to Cyberonics' Fiscal 2013 Third Quarter Conference Call. Joining me today are Greg Browne, our Chief Financial Officer; and Darren Alch, our Vice President and Corporate Counsel, who will read the Safe Harbor statements.

Darren W. Alch

Thank you, Dan. This presentation and earnings call includes forward-looking statements. Forward-looking statements may be identified by the use of forward-looking terminology including may, believe, will, expect, anticipate, estimate, plan, intend and forecast or other similar words. Statements in this presentation are based on information presently available to us and assumptions that we believe to be reasonable.

Investors are cautioned that all such statements involve risks and uncertainties. Forward-looking statements in this presentation and on this call include statements concerning building shareholder value through consistent sales growth and profitability worldwide, meeting clinical and product development objectives, evaluating and advancing other medical device and neuroscience opportunities and maintaining leadership in medical devices for epilepsy; growing our epilepsy sales, including investing in market development and achieving new patient and replacement cycle growth in the U.S., Europe and Japan, expansion of and continued progress on our new product pipeline and improvements in sales and reimbursement in key international markets, including Europe, Latin America, including Brazil, Russia, and Asia, including India, Japan and China; obtaining reimbursement for the treatment-resistant depression indication for VNS Therapy; conducting and timely completing R&D, clinical and regulatory projects, including completing enrollment of the E-36 clinical study and commencing enrollment of the E-37 clinical study this fiscal year for the AspireSR generator, completing clinical and development projects related to the ProGuardian monitoring system and completing the enrollment and follow-up in our ANTHEM chronic heart failure clinical study; completing the previously announced stock the previously announced stock repurchase programs; and fiscal guidance for net sales, unit sales, replacement unit sales, gross profit margin, income from operations, adjusted net income, capital expenditures, operating expenses, equity compensation expenses, R&D expenses, diluted shares outstanding, adjusted earnings per share, available tax losses, cash taxes and future reported tax rate. Our actual results may differ materially.

For a detailed discussion of the factors that may cause our actual results to differ, please refer to our most recent filings with the SEC, including our Annual Report on Form 10-K for the fiscal year ended April 27, 2012, and our quarterly report on Form 10-Q for the fiscal periods ended January 27, 2012, and October 26, 2012.

With that, I'll turn the call back over to Dan for a business update. Dan?

Daniel J. Moore

Thanks, Darren. My comments may be shorter than your Safe Harbor. Good morning. The Cyberonics team continues to execute well on our plans with consistent and strong results, including near-record quarterly revenues of $62.7 million, a 15% increase over the third quarter of last fiscal year; worldwide sales of VNS Therapy generators in a single quarter again exceeding 3,200 units; U.S. epilepsy revenue growth of 11% and unit growth of 6%; a strong international performance with revenue growth of 37% and unit growth of 36%; seventh quarter of double-digit unit and revenue growth in Europe despite the difficult economic environment; and adjusted EBITDA of $23.8 million, an increase of 14% over the third quarter of last year.

In the area of market development, we continued to make good progress in our global market development efforts. Our fiscal 2013 plan in Japan is based on moderately increasing levels of implants and product sales throughout the year, and ensuring that fiscal 2014 commences with a strong foundation in terms of market acceptance. We will continue to evaluate progress and offer our support wherever possible to increase penetration in this important market. We have continued with significant efforts around our global peer-to-peer events and believe these are important in helping physicians adopt and utilize VNS therapy as a more routine part of their practice for patients with refractory epilepsy.

Moving into the area of product development, providing an update here. We also continue to make good progress with our new product development pipeline. Let me highlight a few of our key projects. First, the AspireHC. The value of our product development effort is reinforced by the fact that 20% of our U.S. unit sales in the most recent quarter came from AspireHC, the newest VNS Therapy generator. The product is also available in a limited commercial release in Europe and is experiencing increasing utilization and adoption.

Our E-36 trial, which is the AspireSR European trial. Our investigators continued to enroll patients in the trial, while enrollment in the third quarter made steady process. This process will likely carry over into fiscal 2014 as mentioned on our last earnings call.

The E-37, the AspireSR trial for the U.S. As discussed last quarter, we submitted our IDE application to FDA during the second fiscal quarter and we received conditional approval from FDA. The clinical team is working with sites and their IRBs to complete activities necessary to initiate the first implant as soon as possible. Our objective remains to initiate enrollment in the fourth quarter of this fiscal year.

ProGuardian. ProGuardian is an in-home monitoring system that is designed to aid in the detection, recording and notification of seizures, accompanied by heart rate variations or movement. ProGuardian is an important new product platform under development for Cyberonics and the broader patient population with epilepsy. We continue to be encouraged by patient and physician interest in the product, which has helped us make good progress in the initial clinical component testing.

Depression. As discussed in our last call, the submission of our formal request for reconsideration of coverage to CMS for VNS Therapy in treatment-resistant depression was expected to occur following publication of study data gathered during the past several years. This formal request for reconsideration of coverage has now been submitted to CMS. To review, authors of 4 planned publications made significant progress during the last few quarters. The first paper was accepted for publication in our first fiscal quarter and describes the positive health outcomes for patients covered by Medicare who received VNS Therapy during the available period after FDA approval.

During the second quarter, 2 more papers were published. One describes reductions in the rates of all caused mortality, suicide and suicide attempts for patients with treatment-resistant depression who were treated with VNS Therapy in the TRD Registry. The third paper covers the results of the D-21 dosing study and shows the patients receiving VNS Therapy experienced a significant improvement over time compared to baseline and that effect is durable over 1 year.

The most recently published paper, a meta analysis, reviewed more than 1,000 patients who received VNS Therapy and more than 400 patients with TRD who received ongoing treatment as usual. The paper compares the odds of response and remission for patients receiving adjusted VNS Therapy to those who received ongoing TAU, which is treatment as usual. This paper was accepted for publication in January and should be publicly available soon.

We believe these published articles, in addition to the literature that began appearing in the scientific literature more than 10 years ago, present compelling rationale for a positive coverage decision in a Medicare patient subpopulation. The efforts surrounding this submission has been considerable and I want to thank all involved.

It is important to note that reversing a noncoverage decision is a difficult process. Our objective continues to be to expand access to patients who meet the appropriate criteria and who could benefit from VNS Therapy for TRD.

Our understanding of the process at CMS from this point is as follows. First, the next step. It's a decision from CMS regarding whether they will accept our formal request for reconsideration of the noncoverage decision. We anticipate the initial decision should be available in March 2013. Second, if CMS excepts our submission, their evaluation is expected to take approximately 6 months, although that could be as short as 3 months or as long as 9 months and after which, a draft decision will be published for public comment. After a 90-day public comment period, CMS will issue a final national coverage decision.

Finally, moving over to chronic heart failure, VNS Therapy for chronic heart failure. Our CHF program continues to progress with additional enrollment of patients in the pilot study, further activities in this area remained contingent upon the results from this trial. We are pleased to announce the appointment of Bruce KenKnight as VP of Emerging Technologies. Bruce has done an excellent job in furthering our efforts around CHF.

Greg will now take us through a discussion of our financial results and increased guidance in more detail. Greg?

Gregory H. Browne

Thank you, Dan, and good morning, everyone. As Dan mentioned, overall sales in the third quarter of fiscal 2013 rose to a near-record total of $62.7 million, consistent growth of 15% from the comparable quarter of fiscal 2012. Overall product revenue growth of 10.9% in the U.S. was driven by a unit increase of 6.5% and ongoing year-on-year generator ASP improvement of 4.9%. The AspireHC generator accounted for 20% of the U.S. generators sold in the quarter.

U.S. epilepsy unit growth occurred in both generators and leads over the prior year. Variations in lead sales from quarter-to-quarter will occur for a variety of reasons and may not be indicative of underlying activity. For example, we continue to replace some leads each quarter.

For the third quarter of fiscal 2013, U.S. epilepsy lead sales are estimated at 1,083 as against 1,038 in the previous year, an increase of 4%. The trailing 4-quarter growth rate in U.S. leads was 6%.

Our international sales of $12 million comprised a new record and represented approximately 19% of total revenue in the third quarter. The sales performance in Europe continued the double-digit revenue and unit growth improvement compared with fiscal 2012 and we are particularly pleased that growth continued in all of the other regions this quarter.

Foreign currency movements when compared to the third quarter of last fiscal year had an immaterial impact on international revenue for this quarter. As a reminder, our annual guidance is predicated upon an average dollar-euro exchange rate of $1.30 to EUR 1. The average exchange rate for the third quarter of this fiscal year was $1.31 compared to $1.32 in the third quarter of fiscal 2012.

As stated earlier, the AspireHC accounted for 20% of U.S. unit sales in the most recent quarter. The Demipulse was at 64% and the 102 or the Pulse was at 16%.

Turning to gross profit. The final number of 91.4% in the third quarter was somewhat lower than previous quarters. As stated in our press release, we have included the medical device tax and cost of goods sold since its implementation effective January 1 this year, and this had an impact of approximately 50 basis points on our margin. With this new tax included for a full quarter in the fourth quarter, we now expect the gross profit margin to be approximately 91.5% for fiscal 2013 as a whole and approximately 91% for the fourth quarter of this year. We continue to be very pleased with the performance of our manufacturing team.

Operating income for the quarter was $20.4 million or 32.6% of sales compared to $16.4 million in the prior-year quarter or 30.1% of sales. This represents an increase of 25% on the third quarter of fiscal 2012 on a 15% increase in net sales.

While we have continued to focus on generating operating leverage over the last 5 years, it's important to note that as discussed on our last call and again today, we continue to emphasize product development investment, including related clinical activity. Our operating income guidance reflects an expectation of high spending levels in these areas in the fourth quarter of the year.

Operating expenses have increased by $2.9 million or 8.4% when compared with the third quarter of last year. The increase over last year results from several factors, including channels [ph] and other compensation on increased sales, as well as R&D investment which increased by 12.6%.

Further and as mentioned earlier, clinical activity in product development investments have risen as expected. This trend should continue during the remainder of this year. The expectation is that R&D expenditure as a percentage of revenue will now be closer to 16.5% of the current fiscal year.

Earnings before interest, depreciation, amortization and equity compensation expense, a non-GAAP measure, totaled $23.8 million in the third quarter, an increase of 14% over the number for the third quarter of fiscal 2012.

Certain key points should be noted with respect to our tax situation. First, tax losses available at the beginning of fiscal year 2013 are approximately $120 million. Second, we expect to pay cash taxes at around 2% to 3% through fiscal 2013 and at approximately 5% to 6% for fiscal 2014.

For the third quarter of fiscal 2013, we have utilized an effective tax rate of 35.2%. This lower rate reflects approximately 200 basis points relating to the reinstatement of the research and development tax credit effective from January 1, 2012. Of this amount, approximately 100 basis points reflects an adjustment relating to the last 4 months of fiscal 2012 and the balance relates to the current fiscal year. On an adjusted basis, our effective tax rate for fiscal 2013 as a whole is now expected to be approximately 37.5%.

The number of shares included for the purposes of diluted earnings per share calculation this quarter of 28.1 million was materially unchanged from the number in the prior quarter. As stated in our press release, we've repurchased 145,000 shares in the third quarter. And with the increased stock repurchase authorization announced last month, we expect to continue our efforts in this area.

Earnings per share of $0.47 increased by 38% compared to the $0.34 per share in the third quarter of fiscal 2012. There were no non-GAAP adjustments to earnings this quarter although the impact of the retroactive research and development tax credit applicable to last fiscal year added approximately $0.01 to earnings for the third quarter.

Overall day sales outstanding was 52 days, materially unchanged from the end of the prior quarter of this fiscal year. Our balance sheet remains strong, the stockholders' equity exceeding $224 million and over $131 million in cash and short-term investments and no interest-bearing debt.

Capital expenditure for fiscal 2013 was estimated to be lower than discussed on the last call at approximately $12 million, with the expected activity related to our manufacturing facility outside the U.S. and upgrades to the manufacturing equipment and our headquarters building here in Houston. The additional manufacturing facility is expected to be operational in fiscal 2015.

Guidance. So the general comments about the increases to our guidance are appropriate. Our philosophy is to strive to exceed our plans at all times, both with respect to sales and other projects, including product developments and clinical trial milestones. We have had another very good sales year-to-date. As always, there continued to be external challenges in various regions although the improved consistency from our international sales is encouraging.

Further, our product development expense is expected to increase over the fourth quarter of this year, primarily driven by increased clinical activity. The E-36 now has some enrollment momentum, as Dan mentioned. And E-37, which received the FDA conditional approval last quarter, is preparing for initial enrollment. Further, we anticipate increased activity on both ProGuardian and the preparation for the manufacturing facility in Costa Rica.

After reporting consistent and growing results for the first 3 quarters, we feel comfortable increasing our full year guidance in all areas: revenue, operating income, adjusted net income and earnings per share. As a reminder, at the midpoint of the range, our increased full year guidance implies growth over fiscal 2012 as follows: revenue, 14%; operating income, 25%; operating income as a percentage of sales at 30.5% versus 28% in fiscal 2012; and adjusted earnings per share growth of 32%.

More specifically, looking at our financial targets for fiscal year 2013, we're increasing our net sales guidance to a range of $248 million to $250 million from a previously provided range of between $246 million and $249 million. Our assumptions in calculating this range include: worldwide unit growth of approximately 12%, somewhat higher than our fiscal 2012 results; mid to high single digit growth in U.S. new patients, with replacement growth of closer to 10%; continued adoption of our AspireHC generator; continuing to improve European performance; consistent activity in Japanese implants and sales; and as mentioned earlier, a euro-dollar exchange rate of $1.30.

Further, the company now expects that income from operations will total between $75 million and $77 million from the previously provided range of between $73 million and $75 million. This guidance is given up to take into account anticipated increases in product development expense, including clinical spending. The guidance also assumes that gross profit will be approximately 91.5% for the full fiscal year.

With respect to the medical device tax, and as discussed earlier, we have now included the tax in our full year operating income guidance. With the renewal of the research and development tax credit, we're anticipating an adjusted effective tax rate of approximately 37.5% for the full fiscal year.

Net income as adjusted for the financial impact of the investment write-down and the gain on warrant derivative liability recorded in prior quarters and after taking to account a lower effective tax rate is now anticipated to fall in the range of $46 million and $48 million, an increase from the previously provided range of $43 million and $45 million.

We continue to anticipate that diluted shares outstanding will be closer to $28 million in fiscal year 2013. With these assumptions, earnings per share as adjusted for the financial impact of the investment write-down and the gain on the warrant derivative liability and including the impact of the medical device tax is expected to be between $1.66 and $1.72 per diluted share.

We will now open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Matthew O'Brien of William Blair.

Matthew O'Brien - William Blair & Company L.L.C., Research Division

I was hoping we could talk a little bit about guidance, understanding you want to be somewhat conservative with your view on things but -- and looking at the guidance you've provided for Q4 here on the top and even the bottom line at the higher end of the ranges, I would assume a little bit of a slowdown when you're facing an easier comparison here in the U.S. this quarter and then internationally, assuming a pretty material slowdown after a couple of very, very strong quarters. Can you just give us a sense for this? Any thought process for those kind of expectations?

Gregory H. Browne

I think when we look at our guidance and when we prepare our guidance, we take into account obviously a number of factors. We are looking at a top line increase both in the U.S. and internationally. And we have traditionally been somewhat conservative, but we try to be also realistic in our guidance. We, as I mentioned, we have a number of challenges going on internationally in a couple of key markets for us, which, although not large in themselves, are important on the margin, both in the Middle East, and as well as in Latin America, and of course, Europe continues to face economic challenges. So I think it's appropriate to be conservative in the light of that which is going on. We feel as though we will achieve continued growth in the U.S. And as I mentioned in my remarks, we strive to exceed our plans at all times, I know our sales team does both here and internationally, and I'm sure they will again in the fourth quarter. As far as moving further down the income statement is concerned, our increased guidance at the operating income, net income and earnings per share level [ph] is driven by both an increase in sales over what we originally guided to both at the beginning of this year in June as well as on our last call, so increased sales plays a part. We now have the impact of the medical device tax. Expenditure has been somewhat lower than we thought at the beginning of the year and of course, the change in the tax rate has been material as well. But I think that our guidance is reasonable. We haven't blown away the guidance on the top line this quarter, but we have gradually overachieved for this year, but we try to be realistic as we put it together.

Matthew O'Brien - William Blair & Company L.L.C., Research Division

Okay. And then one more on the international business. Again, very, very strong. Can you just help us get a little bit better visibility in terms of where that strength is coming from? Is it a broad-based improvement you're seeing across many geographies or is it just a handful of countries that are driving a majority of the growth? And then just your sense on Japan, where that's at now and when do you think it will really kick in, in terms of benefiting the international opportunity going forward?

Gregory H. Browne

Yes. So as far as the first part of your question is concerned, our growth internationally this quarter came from all regions. It was strong in Europe, yet again, we've now had 7 good quarters in Europe in the face of a difficult economic environment and they've really done a very nice job with the revamped team that was put in place 2 years ago. As far as our other regions are concerned, we saw growth in all of the other regions, so it really was broad-based from that perspective. I think that as far as Japan is concerned, we continue to make some progress in Japan. I don't believe -- we certainly don't feel as though we've cracked the code in terms of making Japan a material contributor. It does contribute to our sales in a moderate sort of way, but it's -- and at the beginning of this year, I think we guided to about 1.5 points of revenue coming from Japan. I think that's probably where we're going to finish the year. I think that it's going to take some time and we continue to learn more about the market with each quarter. We are working well with our partner there now in Nihon Kohden. We continue to provide them with support as requested. And so I think -- will it give us a boost in fiscal '14? We very much hope so. But I think when -- until it actually starts to achieve the sort of rapid acceleration that we expected a year or 2 ago when we first went into the market, I think it would be a bit early to state that.

Operator

Our next question comes from Raj Denhoy of Jefferies.

Raj Denhoy - Jefferies & Company, Inc., Research Division

I wonder if I could ask about the path forward with Depression. You didn't include in your path any sort of panel. Are you expecting there might be, assuming CMS accepts the submission, that there might be a panel that reviews it?

Daniel J. Moore

I think the answer to that is there could be. But really, that's not our decision to make, and that's why we haven't commented on it. But yes, they could call together a med cap panel.

Raj Denhoy - Jefferies & Company, Inc., Research Division

Okay. And then as this starts to progress here in 2013, at what point do you as a company start to invest and build out your capability to perhaps serve that market should you get CMS to start to cover it?

Daniel J. Moore

Probably after -- we would conservatively invest after we've seen CMS's initial draft decision.

Raj Denhoy - Jefferies & Company, Inc., Research Division

Okay. So you even assume it as first quarter of next year perhaps or fiscal next year?

Daniel J. Moore

That would be a nice position to be in, but I wouldn't be that aggressive in saying that will happen.

Raj Denhoy - Jefferies & Company, Inc., Research Division

Okay. And then staying on your fiscal '14 for a minute. You may not want to give any real detailed guidance for '14 yet, but is there anything that makes you think that the really strong growth that we've been seeing lately, even your guidance here for the fiscal year '13, wouldn't continue into next year? Is there any changes coming perhaps in the outlook that gives you any pause at this point?

Gregory H. Browne

I do think it's -- first of all, in answer to your question, we don't want to give any fiscal '14 guidance at this point. Obviously, we will continue to strive to the 3 great handles here in the U.S. around new patients, the replacement. I think if you go back to our December 2011 slide deck on replacements and the forecast we put out at that time, I think that given that range, you would continue to see some growth in replacements in the U.S. I think the international is still a bit of a question mark, particularly outside of Europe, but also in Europe, as we go forward in the face of what is now 7 quarters of very good growth. So I think we'll have to wait and see as we put together our final plans for next fiscal year.

Operator

Our next question comes from Brooks West of Piper Jaffray.

Brooks E. West - Piper Jaffray Companies, Research Division

I wanted to -- one on AspireHC. You mentioned now 20% of U.S. unit sales. Where do you think that goes in terms of mix? And Dan or Greg, if you could remind me on the pricing differential there. And then I wanted to get a little bit more color on the limited release in Europe and how we should think about that progressing?

Gregory H. Browne

Yes. So Brooks, we've got -- we're certainly running ahead of where we thought we would be at this time, at 20%. I think our sales force is thinking that 25% is achievable whether that will be -- when that will occur, we'll have to wait and see, but 25% is probably something that we'll look for some time in fiscal 2014. The price differential is approximately 10% over our Demipulse. We have been in a more limited launch in Europe. Several markets there requires special reimbursement approval. And in other markets, the price differential is not as significant. So we will continue to push it in Europe as fast as we can from a reimbursement standpoint and a market acceptance standpoint.

Brooks E. West - Piper Jaffray Companies, Research Division

So is reimbursement the limiting factor I mean when does a limited launch become a full launch?

Gregory H. Browne

Well, there are several markets where we are in full launch in Europe and there are several markets where we're not launched at all, so probably a little bit of a misnomer, but we're certainly across the whole of spectrum in Europe. It's more limited because of the reimbursement constraints, as well as just market adoption.

Operator

Our next question comes from Jim Sidoti of Sidoti & Company.

James Sidoti - Sidoti & Company, LLC

You have talked about in the past 2 calls about this new facility you're building. Can you just remind us what do you expect that to -- how do you expect that to impact margins once it's complete?

Daniel J. Moore

On the -- just on a timeline standpoint, we have contracted for land in Costa Rica. We are actively building a facility now in Costa Rica. We expect, about this summer, to have the exterior of the building built out. But then we would need to do the interior work, so we're looking at fiscal '15 before it's operational. And as far as the contribution from a tax standpoint, I'll leave that to Greg.

Gregory H. Browne

Yes. We had -- there's a couple of impacts on the margins that I'll just comment on, first of all, when it becomes operational. We don't expect that to have a material impact on our gross margin. We do expect there to be a tax impact, which will start -- if you recall at our Investor and Analyst Day in December 2011, we did outline a target, effective tax rate of around 33%, which we thought we could achieve in fiscal 2015 and certainly target in 2015. I think whether we get there in 2015 or 2016 will depend somewhat on the exact operationalizing of this facility. But certainly, that's where we're hopefully headed.

James Sidoti - Sidoti & Company, LLC

All right. And I -- assuming that the need for this facility -- it's because increased demand on the epilepsy side alone, I mean, your decision isn't at all based on pending reimbursement for depression, is it?

Daniel J. Moore

No. In fact, we're blessed that we could supply the world or we -- today, we supply the world from this facility that we're currently in, in one shift a week, so we've got plenty of capacity here in Texas. We'll have plenty of capacity in Costa Rica, whether that's used for increasing epilepsy sales, for depression, for anything else that we might do.

Operator

Our next question comes from Bill Plovanic from Canaccord.

William J. Plovanic - Canaccord Genuity, Research Division

So a couple of questions here. Just the international mix, your direct versus distributor in the quarter [indiscernible]?

Gregory H. Browne

Yes, Bill. Our distributors accounted for 43% of the international unit sales this quarter. That number was 36% in the third quarter of last year.

William J. Plovanic - Canaccord Genuity, Research Division

Okay. But that's pretty stable with the last quarter. And then as you look into the end of the -- we ended the calendar year in this quarter, was there any stock in [ph] and buy-in by any of the international distributors? It doesn't look like it, but I just wanted to check from a distribution standpoint.

Gregory H. Browne

Well, the answer to that is, as you know outside of Europe, we sell-through distributors. Those distributors tend to order about once a quarter. So it's been pretty consistent over the last year or so although the first quarter was a little weak. If you remember through [ph] with our distributor business. But no, I don't think there's been anything particularly special there.

William J. Plovanic - Canaccord Genuity, Research Division

Okay. And then your lead sales internationally? You gave us the U.S. number, but I don't think you gave the international one.

Gregory H. Browne

International lead sales was 629 units for the quarter, that was up from 523 a year ago.

William J. Plovanic - Canaccord Genuity, Research Division

Okay. And then just -- as I think about the guidance you gave and I know you've talked about it, but you've been growing the top line at 15% to 17% this year and for Q4, the high end of the range, if my math is correct, gets me to 11%. And then as I look even running through the P&L, I mean you've got your operating profits down almost $2 million or $3 million sequentially in the guidance. And that just seems very conservative or from a spending standpoint -- or you have a lot of spending you're going to build in this SG&A line and then on revenue, it just seems -- yes, that's much different than what we've seen. And I think somebody else earlier commented that it's not even a tough comp you're working off of.

Gregory H. Browne

Well, just -- yes, I think -- a couple of points. One is we had a very strong fourth quarter last year and so it will make this a tougher comp. So I think -- and also as far as the operating margin is concerned, we have to absorb a full quarter of the medical device tax. As I mentioned, that's now going into our cost of goods sold. For this quarter, we only had 3 or 4 weeks of that. So I think, and as I indicated in my remarks, we are anticipating a higher spend on our product development and clinical activity in the fourth quarter. So I think for all of those reasons, we try to give realistic guidance. And as I said earlier in response to another question, we will strive to exceed our plans as we go forward.

William J. Plovanic - Canaccord Genuity, Research Division

Okay. And then the last question, as we think of the med tech device tax in COG, I mean, is that roughly 1.75% of U.S. revenues or what kind of multiplier should we use on U.S. revenues?

Gregory H. Browne

Based on the regulations that were put out by the IRS in December, we are putting the number to around about 1.75% of U.S. sales, that's correct, and that is going into cost of goods sold.

Operator

Our next question comes from Charles Haff with Craig-Hallum.

Charles Haff - Craig-Hallum Capital Group LLC, Research Division

I had couple of questions. First, I was very impressed with the margin expansion this quarter given such strong international growth of 37%. Can you kind of discuss the ASP and margin differences between U.S. and international? And if international continues to outperform the U.S. dramatically, how do you see that impacting margins going forward?

Gregory H. Browne

Yes. Well, just on the ASP side, our international ASP was a little higher this quarter, it was 10,660 on the generator side, it was up 4.4% on a year ago. But bear in mind, that's a number that is a mix of currency and price and other things. I think the general question is more around international revenue as a percentage of total revenue, which was at 19% this quarter, and to the extent that, that continues to increase as a proportion of total revenue. In other words, if international grows faster than our U.S. revenue, we will see a slight impact on -- at the gross margin level and possibly at the operating income level. Although as you know, from -- when we sell through distributors, whilst that gross margin is impacted, we don't pick up many of the operating expenses and so that tends to drop through. So I think there's a bit of a mix message in that, but it will have some impact on the gross margin line.

Charles Haff - Craig-Hallum Capital Group LLC, Research Division

Okay. And on the operating margin side, is the U.S. and the international markets pretty similar?

Gregory H. Browne

We have different margins, if you will, with respect to international and the U.S. without going into that much detail in our operations. But clearly, here in the U.S., we're picking up a lot of corporate expenses that are not borne by our international business. And the markets are different in terms of selling, expenses and marketing and so and so. I don't know that, that I can really announce [ph] yet that much in much more detail.

Charles Haff - Craig-Hallum Capital Group LLC, Research Division

Sure, sure. And then I wanted to ask you a more qualitative question. There's been a lot of talk due to the wrongful termination lawsuit which was filed and then dropped from a former employee. I'm wondering if you could just kind of maybe qualitatively describe your sales practices and compliance practices around replacement growth?

Daniel J. Moore

Yes. I'll just start with the sales practices. I think we've built a company on integrity and honesty and we'll continue to do that. When it comes to a replacement, it's pretty important to remember that in all cases, patients are instructed to see their physician. Ultimately, battery life calculation -- the whole battery life thing is driven almost entirely by program parameters and for the patient's duty cycle. Our product labeling provides technical information to physicians with several tables of information to help them calculate end of service, but no specifics are provided due to the complexity and the uniqueness for each patient. Physicians can request a battery life check from our clinical technical department and they will help calculate and estimate based on the available current and historical usage of that product, but it's not a perfect science. When we look at an individual generator and we've got more than one model out there, there are diagnostic tests that are run on the product, and our devices have an end of service indicator. So our newer models are more like a cellphone where you would see a battery icon display that provides a picture of the battery with the color range to alert the physician when a device nears and reaches end of service. On the older models, there's an end of service alert message that when displayed, signals the physician to replace the generator. The physicians, again, ultimately make the decision with their patients based on the patient's specific situation to choose when to replace a generator due to clinical reasons. We can help in that process, but again, that's a patient-physician interaction.

Operator

Our next question comes from Suraj Kalia of Northland Securities.

Suraj Kalia - Northland Capital Markets, Research Division

Dan, to the extent that you can share, can you give us some color on the meta analysis vis-a-vis the D-21 study? If memory serves me correctly, the D-21 study wasn't exactly -- there was some induplication issues and related durability of response between the various arms. I understand that the meta analysis has not been published, but it would be very curious if you could give us at least some top line color on what -- where this trends?

Daniel J. Moore

Yes. I mean, if you go back first to the D-21 and look at the inclusion criteria for that study and D-21 became part of the meta analysis, but it is not the entire meta analysis. Now, we had patients going into the D-21 that had an average depression for 28 years. They were 9 years in their current episode. They had failed roughly 14 drugs. They've been hospitalized for their depression on average 3.5x. They had ECT of 57% of the cases. They've had shock therapy, 46% have attempted suicide. And if you look at the meta analysis, the patients going into that collection of studies was much the same. In D-21, we've commented about the 5 different rating scales and seeing up to a 53% improvement in that very sick patient population. We saw up to a 42% improvement. We saw up to a 23% remission rate of their depression symptoms. And although the meta analysis has not been published yet, it looked at a response and remission a different way comparing the treated group with patients who were treated with VNS therapy versus the treatment-as-usual group and looked at likelihood of response. And we'll -- we won't give the answer here because it still needs to be published shortly. But the bottom line is you get better response -- you get better odds of response and a better odds of remission for those patients who had, had VNS than those who didn't. So D-21 looked at some areas and then meta analysis cut across many studies and looked at likelihood or probability of response and remission versus treatment as usual, all encouraging results.

Suraj Kalia - Northland Capital Markets, Research Division

Okay. Dan, moving on to Japan, again, to the extent that you can share. One of the things that we have started picking up recently is ASP declines, not specifically VNS, but in med tech land, we have started hearing blurbs about ASP declines. Would love to get some color from you and what you'll see for VNS land in Japan as you launch going forward?

Daniel J. Moore

Yes. There's 2 different parts to that question. One is the reimbursement, and fortunately, we just got reimbursement a couple of years ago for the procedure. And then more recently, I believe, April of last year, received reimbursement for the programming service of the product. So on one hand, there is reimbursement. But at the end of the day, we're paid by a distributor and we're paid in U.S. dollars. And it's a fraction of those reimbursement rates. So we don't see the impact.

Suraj Kalia - Northland Capital Markets, Research Division

Fair enough. Final question. Dan, again, I just wonder -- a follow-up on the previous analyst question. So if I heard you correctly, in terms of replacement testing, in terms of battery testing and replacement cycle and all that, the company has a certain protocol as in compliance, has done things ethically. I guess one of the questions I would have, by inference, if the company is kosher, and we have no reason to believe you're lying, why wouldn't you consider suing Mr. Hagerty for defamation considering the extent of things he has said in his lawsuit?

Daniel J. Moore

We have not and will not go into the specifics on legal cases. We are going to reserve comment.

Operator

Our next question comes from Steve Brozak of WBB Securities.

Stephen G. Brozak - WBB Securities, LLC, Research Division

I'll come straight to the point because obviously it's been a longer call than a lot of people probably expected. Your numbers are, to say at least, stellar in terms of growth, but Europe is counterintuitive. I mean, they're going through the most devastating financial problems we've seen and the idea is that you're getting traction there. Now can you give us some granularity as to -- they're cash strapped, they have a population that's problematic in terms of health care. How are you able to get this kind of traction? What's the feedback that you're getting, because you're pushing envelope in terms of growth, and I would like to know more about what your thoughts are there? And one follow-up after that.

Daniel J. Moore

Steve, a financial crisis can be devastating. The effects of epilepsy on a patient and a family are even more devastating and I think that's where it starts.

Stephen G. Brozak - WBB Securities, LLC, Research Division

All right. Let's talk about the payer system over there because obviously, it's a fractional payer system where you've got many different systems in -- that you're looking at. How have you tailored your system to address that because obviously, with the growth you've got to have taken that into consideration?

Daniel J. Moore

We do. I mean, I think you start with all politics are local, all budgets end up being local. I think it's a 2-tiered approach. We're always aware on what's happening on a national level and where appropriate, trying to get additional reimbursement or budgets allocated for Vagus Nerve Stimulation for epilepsy because we know it not only makes clinical sense and helps a lot of people, it makes economic sense as well. That's been shown and bearing out -- borne out in several studies. So yes, in a national level, we'll try to do things where appropriate, and then at a local level, too, to get hospitals and physicians to allocate more of their budgets towards this procedure that eventually saves systems money. We will operate at a hospital level as well.

Operator

Our next question comes from Matthew O'Brien of William Blair.

Matthew O'Brien - William Blair & Company L.L.C., Research Division

Just quickly on the competitive environment that you guys are thinking about going forward, there is a panel today for a competitor enroll case [ph] and just was hoping to get your thoughts on the competitive landscape going forward.

Daniel J. Moore

Well, our biggest competitor has been and continues to be treatment as usual, more drugs. The reality is that despite the financial results you saw this quarter this and you've seen for the last 5 or 6 years, the reality is we're still less than 20% penetrated. So that says that as we sit here, 8 out of 10 patients who could benefit from VNS are not. And so at the global level, that's our challenge every day. What happens beyond that, whether some of the DVS or RNS plays, responsive neurostimulation, eventually get regulatory traction, and then go through whatever reimbursement hurdles they might face, we'll deal with those as they come. But overall, we're feeling very good about what Vagus Nerve Stimulation does for patients with refractory epilepsy and that's primarily where we focus.

Matthew O'Brien - William Blair & Company L.L.C., Research Division

Okay. And when you talk to clinicians, is a big feature of VNS Therapy versus the others that are coming along all the clinical data that you can provide that demonstrate safety and efficacy or is there something else that they tend to focus on with you guys? And then Dan, you mentioned those 8 out of 10 patients that don't get therapy today, do you need a bigger competitor in the space to help you increase awareness of the therapy or how do you start to access those patients?

Daniel J. Moore

Yes. On the -- another competitor in the space, we don't think that would hurt, especially when you start to compare treatment cycles and what happens after a patient has failed their drugs, which, unfortunately, it's about 1/3 of patients don't get adequate relief from their drugs, what are their options? Well, they might be a surgical candidate for surgical reception. There are a few thousand of those done in the U.S. each year. They might benefit, at least short-term, from a ketogenic diet, that's an option. And then there's VNS. And I think you're onto something. I mean, if you need to go surgical, this is an outpatient procedure where we are able to impact the brain without doing brain surgery. And I think to your point on treatment cycles, you go from drugs to a little more invasive, something done in an outpatient procedure with nearly a thousand clinical papers out there that speak to the safety and efficacy of this procedure that's been around now for 15 years plus in the U.S. And then, you move on to more invasive things that one day, may get regulatory approval but nonetheless, they are more invasive. And with that, not only comes the clinical cost or the clinical burden, it also comes with an economic cost. So all that needs to be worked through as well. So we think we are well-positioned to continue to execute every day on what we need to do to get more patients to benefit from this procedure.

Operator

Thank you. I'm showing no further questions on the queue at this time, I'll hand the call back to management for closing remarks.

Daniel J. Moore

Okay. Thank you, Mimi. Well, the whole team at Cyberonics, as you can see, has continued to perform at a high level as demonstrated by our consistent performance over this quarter and indeed, over the last 5 years. As I stated before, our products have brought relief not only to tens of thousands of patients who suffer from epilepsy but also to their families. We have now formally initiated a process, which we hope will result in an equivalent benefit to those with treatment-resistant depression, and we'll continue to seek and develop optimized device solutions for patients with epilepsy and other neurological conditions.

Thanks for listening today and for your interest in Cyberonics. and we'll talk to you again in June. Have a good day.

Operator

Thank you. Ladies and gentlemen, this concludes the conference for today. You may all disconnect and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Cyberonics (CYBX): FQ3 EPS of $0.47 beats by $0.08. Revenue of $62.7M (+15% Y/Y) beats by $2.11M. (PR)