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Cyberonics (NASDAQ:CYBX)

Q4 2013 Earnings Call

June 05, 2013 9:00 am ET

Executives

Daniel Jeffrey Moore - Chief Executive Officer, President and Executive Director

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

Analysts

Brooks E. West - Piper Jaffray Companies, Research Division

Kaila Krum

Suraj Kalia - Northland Capital Markets, Research Division

William J. Plovanic - Canaccord Genuity, Research Division

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

James Sidoti - Sidoti & Company, LLC

Operator

Good day, ladies and gentlemen, and welcome to the Cyberonics Q4 and Fiscal Year 2013 Earnings Conference Call. My name is Allie, and I will 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 for today, Mr. Dan Moore, President and Chief Executive Officer. Please proceed.

Daniel Jeffrey Moore

Good morning, and thank you, Allie, and let me add my welcome to Cyberonics' Fiscal 2013 Year-End Conference Call. Joining me today is Greg Browne, our Chief Financial Officer.

And before we start, please note that some of the information you'll hear during our discussion this morning consists of forward-looking statements, including without limitation, statements regarding our product development efforts and our guidance for fiscal 2014 such as sales, expenses, profits and other financial projections. Our actual results or trends could differ materially from our projections today. For factors that could cause our actual results to differ, please refer to the risk factors described in our Form 10-K for fiscal year 2012, our Form 10-Q for the third quarter of fiscal 2013 and our recent Form 8-K filed with the SEC including the one filed this morning along with any associated press releases. We assume no obligation to update any forward-looking statements or information, which speak only as of their respective date.

Our discussion today will also include certain financial measures that were not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures can be found on our website at www.cyberonics.com.

And with that, I'll begin the formal discussion.

In fiscal year 2013, the Cyberonics team achieved solid financial results and realized other key performance objectives. Financial and operating highlights include: record annual revenues of $254 million with growth exceeding 16%; record operating earnings of $78.3 million, a 25% increase over the prior year as adjusted; worldwide unit sales of approximately 13,000 generators; and a second consecutive year of strong international growth, particularly in Europe.

Since fiscal 2008, we have added $133 million to annual revenues, more than double the $121 million recorded in fiscal 2008. Of this increase, $86 million has been delivered as an improvement in operating income. We've gone from a loss of $8 million in fiscal '08 to an operating profit of $78 million in the most recent fiscal year.

Other multi-year highlights include worldwide epilepsy unit sales have increased by 60% over this period with both U.S. unit sales and our international business increasing by a similar amount. Replacement revenues are estimated to have grown to approximately $106 million this year, providing a powerful endorsement of the benefits of VNS Therapy. Approximately 80% of our revenue now comes from products introduced during the last 6 years.

Cash has increased by $50 million over the period since the commencement of fiscal 2008 and that's after spending a total of approximately $300 million.

For debt repayments, we spent about $133 million, stock repurchases of $100 million, capital expenditures of $40 million and technology investments of $23 million.

Fiscal 2013 ended well for the company with record quarterly sales, unit sales and operating earnings.

Highlights when compared with the fourth quarter of the prior year include revenues of $68.3 million, an increase of approximately 19%. Sales of VNS Therapy generators reached a new record and units totaled 3,436 units, a 15% increase. We had operating earnings of $20.5 million.

In the area of market development, we continued to make good progress in our global marketing effort. We continued sponsoring significant activities for global peer-to-peer events and believe these meetings are important in helping physicians adopt and utilize VNS Therapy as a more routine part of their practice for patients with refractory epilepsy.

Our fiscal 2013 plan in Japan calls for moderately increasing levels of implants and product sales throughout the year. While we recorded an improvement over the prior year, we are not yet satisfied with the pace of our progress and we will continue to evaluate our options for accelerating adoption in this important market.

Let me move to the area of product development.

We also continued to make progress with our new product pipeline. I'll highlight a few of the key projects. Our AspireSR generator, specifically our EU clinical study also known as the E-36. Patient enrollment increased last quarter, which is one reason for higher R&D spending in Q4. We expect the complete enrollment in the clinical study around the end of the first quarter of fiscal 2014. Our objective is to submit AspireSR for European regulatory approval no later than the end of this fiscal year.

Looking at the E-37 trial, the U.S. trial. The clinical team continues to work with sites and their IRBs to complete activities necessary to initiate the first implant as soon as possible. We expect this to occur in the coming weeks.

The ProGuardian system. As a reminder, 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. The ProGuardian system is an important new product platform under development for Cyberonics and the broader patient population with epilepsy. Our objective is also to submit our first product of the ProGuardian platform for regulatory approval in Europe towards the end of this fiscal year.

Relay generator. Our development of a wireless-enabled VNS Therapy generator has progressed with more progress expected through 2014 as we move toward regulatory submissions.

As you can see from my comments on product development, regulatory submissions are key objectives for the new fiscal year. Significant investments in product development have occurred over the last 4 to 5 years with delivering new products in mind, and we expect to see considerable progress in the next 12 months.

Programming tablets. Beginning in the second quarter of fiscal 2014, we are transitioning away from the handheld PDA programmer, which is used by physicians for patient dosing, as we introduce a tablet computer programmer. This will provide a much better experience for physicians although it will come with a higher cost to the company and this increased cost is reflected in our gross margin guidance for fiscal 2014. Greg will provide more details later.

On the topic of depression. As we advised in the press release on May 28, CMS has declined our request to reconsider the 2007 noncoverage determination for the treatment-resistant depression indication. We plan to work with other interested parties to continue to pursue access to this important therapeutic option for patients who could benefit from VNS Therapy, including carefully evaluating all options for obtaining a review of this decision.

Autonomic regulation therapy for chronic heart failure. Our CHF program continues to progress, and with additional enrollment of patients in the ANTHEM pilot study, this study is now over 2/3 enrolled. Further activities in this area remain contingent on the results from this pilot study, which are expected later in this calendar year.

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

Gregory H. Browne

Thank you, Dan. Good morning, everyone.

Sales in fiscal 2013 were $254.3 million, representing growth of 16.4% over the prior year and the highest year-on-year growth rate since fiscal 2009, excluding fiscal 2010, which had an extra week. The U.S. unit sales increased by 10.5% for the year, and along with generator ASP growth of 5%, resulted in an increase in U.S. product revenue of 15%. The international units increased by 22% and international revenue by 27% over fiscal 2012 on a constant currency basis or 24% as reported.

As Dan mentioned, the overall sales in the fourth quarter of fiscal 2013 were a new record of $68.3 million, strong growth of 18.6% from the comparable quarter of fiscal 2012.

Overall product revenue growth of 17% in the U.S. in the fourth quarter was driven by unit increase of 11%, ongoing year-on-year generator ASP improvement of 4.6% and the AspireHC generator accounted for 19% of U.S. generators sold in the quarter.

U.S. epilepsy unit growth occurred in both generators and leads over the prior year. As a remainder, 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 fourth quarter of fiscal 2013, U.S. epilepsy lead sales are estimated at 1,243 as against 1,083 in the previous year, an increase of 14.8%. The trailing 4-quarter growth rate in U.S. leads was 8%.

At this time last year, we advised that our fiscal 2013 U.S. replacement activity was projected to grow in the high single digits and worldwide replacement revenue would total approximately $100 million. Based on our initial estimates for fiscal 2013, the growth in U.S. replacement activity was consistent with this forecast, and worldwide replacement revenue totaled approximately $106 million or 42% of total revenue. Replacement activity has also increased in several European markets, particularly in the U.K., Sweden and Norway.

We anticipate slightly lower growth rates, but still growth, for replacements in the U.S. in fiscal 2014 in the mid-single digits and again consistent with the projection range given in December 2011 at our Investor Day of between 4,750 and 5,300.

Around 40% of all replacements now occur in patients who have already had their first replacement, a significant confirmation of the long-term benefit that VNS provides for patients.

Our international sales in the fourth quarter of $11.9 million were a near record, only $120,000 below the record in the third quarter and most of that was due to currency movements. International sales represented 17% of total revenue in the fourth quarter. Sales performance in Europe yet again continued with the double-digit revenue and unit growth improvement compared with fiscal 2012. And all of the other regions performed well this quarter, especially our Middle East region.

As I mentioned, foreign currency movements when compared to the fourth quarter of last fiscal year had only a small impact on international revenue this quarter.

And as a reminder, our annual guidance is predicated upon an average dollar-euro exchange rate of $1.30.

Average exchange rate for Q4 fiscal '13 was $1.31 compared to $1.32 in the fourth quarter of the prior year.

AspireHC accounted for 19% of unit sales in the most recent quarter, as I mentioned, which was also roughly consistent with the prior quarter. And Demipulse contributed 66% of U.S. sales; and the Pulse product, 15%.

Turning to gross profit. The gross profit of 90.7% in the fourth quarter was lower by 74 basis points from the previous quarter and by 153 basis points from the fourth quarter of fiscal 2012, most of which is accounted for by the inclusion of a full quarter of the medical device tax in cost of goods sold. For fiscal year 2013 as a whole, gross profit was 91.4%, consistent with prior guidance. I will comment further on this for fiscal 2014 shortly.

For fiscal 2013, operating income was $78.3 million or 30.8% of sales compared with an adjusted $62.7 million or 28.7% of sales in fiscal 2012. So we were again able to generate operating leverage over the prior year.

Please note that our earnings release and the presentation posted to our website today both contain reconciliations between reported numbers and adjusted non-GAAP numbers.

Operating income for the quarter was $20.5 million or 29.9% of sales compared to $18 million in the prior year quarter or 31.2% of sales. This represented an increase of 14% over the fourth quarter of fiscal 2012. It should be noted that quarter-to-quarter variations in operating expenses can and likely will occur.

Operating expenses increased in a number of areas in the fourth quarter, including an appropriate and significant increase in compensation as a result of the record sales performance. We have also added to our marketing team over the last 6 months and have several new initiatives underway in that area. The quarter also included some of the costs of preparing for our Costa Rican facility and moving our Brussels office to a new location. Product development investment around the new products Dan mentioned, particularly for the ProGuardian system, also grew as foreshadowed in our last few calls. And the fourth quarter expenses for our E-36 clinical study were also higher.

While we have continued to focus on generating operating leverage over the last 5 years, it is important to note that, as discussed today, we continue to emphasize product development investment, including related clinical activity in order to accelerate new products to the market.

On our last call, we stated that our expectation was that R&D expenditure as a percentage of revenue would be closer to 16.5% for the fiscal year and had finished at 16.3% for the fiscal year on a higher revenue number. As we head into fiscal 2014, we expect a slightly higher number although there will be quarter-to-quarter variations, as I mentioned earlier, and as we saw in the most recent quarter when R&D accounted for 16.9% of revenue.

Earnings before interest, depreciation, amortization, equity compensation expense and other adjustments totaled $24.2 million in the fourth quarter, an increase of 11% over the fourth quarter of fiscal 2012. For fiscal 2013, adjusted EBITDA totaled $94.7 million, an increase of 21% over fiscal 2012.

For the fourth quarter of fiscal 2013, we had an adjusted effective tax rate of 36.8%. This rate reflected the reinstatement of the R&D tax credit from January 1 and other adjustments. We had a rate of 36.6% as adjusted for fiscal 2013 as a whole and well below the 40.3% in fiscal 2012. The most recent quarter included a tax adjustment of $1.34 million relating to the write-down of our investment in NeuroVista Corporation.

The number of shares included for the purposes of diluted earnings per share calculation this quarter of 27.9 million was somewhat lower than the number in the prior quarter. As stated in our press release, we repurchased 270,000 shares in the fourth quarter and we expect to continue our efforts in this area. For fiscal 2013, the number of shares included for the purposes of diluted EPS calculation was 28 million, consistent with our guidance a year ago.

Adjusted earnings per share of $0.46 increased by 21% compared to $0.38 per share in the fourth quarter of fiscal 2012. And adjusted earnings per share for fiscal 2013 rose by 32% to $1.74 over the previous fiscal year.

Days sales outstanding were 53 days, materially unchanged from the end of the prior quarter of fiscal 2013.

Our balance sheet remains very strong by any standard with stockholders' equity of approximately $230 million, $136 million in cash and short-term investments and no interest-bearing debt.

During fiscal 2013, we spent a total of $20.9 million on a combination of capital expenditure and technology investments.

We expect capital expenditure in fiscal 2014 to be between $17 million and $20 million, particularly relating to the additional manufacturing facility in Costa Rica. This facility is expected to be operational in fiscal 2015.

Let me turn to guidance. With respect to our financial targets for fiscal 2014, we have established net sales guidance in the range of $279 million to $283 million. Our assumptions in setting this range include: worldwide unit growth of approximately 10%; mid- to high single-digit growth in U.S. for new patients; mid-single-digit growth in U.S. replacements growth, but at a lower rate than the prior year; ongoing European improvement; and as I mentioned, a euro-dollar exchange rate of $1.30.

Please note that the licensing revenue of $1.5 million per annum that has been recognized annually since fiscal 2008 will be completed sometime during fiscal 2014.

Gross profit is expected to be approximately 89.5% for the full year 2014, approximately 200 basis points less than in fiscal 2013, and there are several key points to note: firstly, fiscal 2014 will include a full year of the medical device tax; and secondly, the gross profit rate will likely decline progressively over the year due to gradually increasing costs relating to the Costa Rican facility and the introduction of our new tablet programmer later in the year and as Dan mentioned earlier.

Operating income is expected to fall in the range of $85 million to $88 million after taking into account improved SG&A leverage, again partially offset by increased R&D investment, which is expected to be between 16.5% and 17% of revenue.

We're anticipating an effective tax rate of 36.5% for fiscal 2014 assuming the renewal of the research and development tax credit at the end of this calendar year.

We expect tax losses at the beginning of fiscal 2014 to be approximately $65 million and that the cash tax rate for the year will be between 4% and 6%. For fiscal 2015 onwards, the company expects to be paying federal income taxes in cash.

Net income is anticipated to fall in the range of $53 million and $56 million.

We anticipate that fully diluted shares outstanding will be approximately 27.5 million in fiscal '14.

With these assumptions, earnings per share is anticipated to be between $1.93 and $2.01 per diluted share.

At the midpoint of our guidance range, our guidance implies approximate growth over the adjusted numbers for fiscal 2013 as follows: revenue, 10%; operating income, 10%; and earnings per share of 13%. It also implies that operating income as a percentage of sales will be 30.6%. Consistent with prior years, our philosophy is to set appropriate targets and then strive to exceed our plans at all times, both with respect to sales and other projects, including product development and clinical trial milestones.

We will now open up the call for questions. Operator, first question, please.

Question-and-Answer Session

Operator

Our first question comes from Brooks West of Piper Jaffray and Company.

Brooks E. West - Piper Jaffray Companies, Research Division

Dan, I wanted to start with depression. We've had this conversation before that CMS has typically been the gateway to reimbursement in United States, but depression is not really a Medicare patient population. As you think now about perhaps going back to the private payers directly, I'm wondering -- you must have thought about this, kind of how you might approach that? Do you feel like you have appropriate clinical evidence? Any kind of expanded thoughts there would be appreciated.

Daniel Jeffrey Moore

Okay. First, I think the gateway to private is CMS. That's something that we would want to have as we approach privates as we continue the effort. The second thing to keep in mind is there are Medicare patients, albeit at a younger age, and they end up in the Medicare system because of the disability, the disabling effects of their depression lands them in -- among the Medicare patient population.

Brooks E. West - Piper Jaffray Companies, Research Division

Okay. So you would still look to pursue CMS then prior to going directly to privates?

Daniel Jeffrey Moore

Yes.

Brooks E. West - Piper Jaffray Companies, Research Division

Okay. Then could you again give the time line on the heart failure project? I missed the comments on where you were in that trial. And then when might we actually see some data or see a product?

Daniel Jeffrey Moore

Yes, we expect to be seeing data from that initial pilot trial that we mentioned is more than 2/3 enrolled around the end of the calendar year.

Brooks E. West - Piper Jaffray Companies, Research Division

Okay. And then could that put you on track for maybe a European launch a year after that?

Daniel Jeffrey Moore

Well, it could put you on track to a CE Mark, but that's not certain. And once you had CE Mark, you could be launching in Europe.

Brooks E. West - Piper Jaffray Companies, Research Division

Right, right. And then just last on the cash, you've got a nice epilepsy pipeline. You've got the heart failure out there. But maybe you do have an opportunity to look at some acquisitions. Could you just refresh your thoughts on kind of appetite and approach around potential acquisitions?

Daniel Jeffrey Moore

I think we're always looking for acquisition opportunities, be that of technology or a product line or a company. It's the -- it's from our perspective the best use of cash if we can see a return on that investment.

Operator

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

Kaila Krum

This is Kaila in for Matt. So you mentioned mid- to high single-digit growth in the U.S. patients. What are you seeing in that market that gives you comfort with that guidance for the full year?

Gregory H. Browne

Well, I think, Kaila, we've come off a pretty solid year here in fiscal '13. Our sales force has performed well obviously over the last 12 months. We believe that, that, if you like, the impetus coming out of fiscal '13 will flow through into fiscal '14. We continue to expand the U.S. sales effort slowly but surely in terms of the sales force. And as I mentioned earlier, we have some new initiatives on the marketing side, particularly around social media and other aspects concerning patients. And so we're excited about that. And I think the U.S. sales force feels confident that they can achieve that going into the new year. And at the bottom of it all, of course, is the fact that there are significant numbers. As we know, over 80% of people are not getting treated with the device that could possibly do it so we have the very large potential market out there for our product and it gives us confidence as we go into the new year.

Daniel Jeffrey Moore

If you go back to December of 2009 when we were not growing our new patient population, we projected at the time that we would turn that from a negative number to slightly positive. And as time went on, we'd get into the mid-single digits, and hopefully with new products, get upwards of 8% to 10% for an overall compound annual growth rate of 6% over the 5-year period and we're 3.5 years into that. And I think that's pretty much held true so far that when we come out with new products, that's one way that helps. But we do see some quarter-to-quarter variation. But overall, that mid-single digits has held true for the last few years.

Kaila Krum

Okay, great. And then on the gross margin side, the full year decline, how much of that decline can be attributed to the medical device tax versus the Costa Rican facility and then the introduction of the tablet programmer?

Gregory H. Browne

Yes, so of the 200 or so basis points that I mentioned, probably 2/3 of that is accounted for the med device tax and the balance by the other factors.

Operator

Our next question comes from Suraj Kalia of Northland Securities.

Suraj Kalia - Northland Capital Markets, Research Division

Dan, this might be an unfair question, but I'll still ask. Can you give us some color on cerbomed's pricing in Germany or wherever else they are selling? And the reason I asked is there is excitement on the noninvasive VNS portion of the equation. I think so I heard you briefly make some comments on the clinical trials. I'm very curious in terms of where you'll see the pricing for noninvasive versus where we are currently.

Daniel Jeffrey Moore

Yes, we need to be clear about what our involvement with cerbomed is. We have an investment in cerbomed. We have no control over the company and wouldn't control their pricing. So their pricing decisions, whether those are in Germany or throughout Europe, are really decisions that they're making. And quite frankly, I'm not aware of where their pricing levels are.

Suraj Kalia - Northland Capital Markets, Research Division

Fair enough. And Greg, in terms of ASP expectations for next year for the generator and leads, both U.S. and international, maybe you mentioned it, forgive me, I missed it somehow. Share that again, cover again?

Gregory H. Browne

Yes, in terms of our ASP expectations in the U.S., as you know, we have taken a 3% price increase across the full range of our products on January 1 each year. That would be our objective on January 1 next year as well here in the U.S. We believe that the HC -- AspireHC penetration will range between 20 or -- perhaps as high as 25% during the fiscal year of 2014. As far as the international ASP is concerned, I think that what we will see, of course, the international ASP is somewhat dependent on the mix between what is sold direct in Europe and what is sold through distributors as well as currency movements, so there are a number of moving factors there. We don't build a particular ASP increase into our international sales at the beginning of the year. In some countries in Europe, we are able to take advantage of some price increases and where we can, we do, as we do with some of our distributors. But overall, I wouldn't anticipate a significant increase over the year internationally.

Operator

Our next question comes from Bill Plovanic of Canaccord Genuity.

William J. Plovanic - Canaccord Genuity, Research Division

A couple of questions here. First on international, I was wondering can you provide us with the new lead placements for that, please?

Daniel Jeffrey Moore

I'm going to let Greg take that one.

Gregory H. Browne

So Bill, the lead sales internationally was 687 compared with 577 a year ago.

William J. Plovanic - Canaccord Genuity, Research Division

Okay. And then, what exactly -- you kind of gave general number, how much did you pay in med device tax in the quarter? What was the nominal amount?

Gregory H. Browne

Well, I think you'll see in our filings approximately what that will be, that it's about -- I think we talked on the last call that overall it's about 1.75% or so of U.S. sales, about $1.2 million or so.

William J. Plovanic - Canaccord Genuity, Research Division

Okay. And then you said the FX impact was minimal, plus/minus $100,000, $200,000, just ...

Gregory H. Browne

No. Well, I think it was minimal for the quarter. I think it cost us maybe about $75,000 on the top line and so we didn't make an adjusted number for that.

William J. Plovanic - Canaccord Genuity, Research Division

Okay. And then -- sorry, just kind of getting through. You mentioned AspireHC, 20% to 25% for fiscal '14. I think as we look at it, it was about 19% this quarter, 20% last quarter. It had been climbing and then it seems to stabilize here. Do you expect it to really kind of move to 25% by the end of the year or it has seemed like this 20% is kind of maybe where we'll be stabilizing for that as a percent of mix?

Gregory H. Browne

Well, Bill, I think what we've said in the past we weren't quite sure where it was going to end up and we actually exceeded our plans that we set at the beginning of fiscal '13. In fact, we -- even though the percentage was slightly down in Q4 compared to Q3, we actually sold more HC generators in the quarter. And I think just a couple of accounts maybe accounted for the difference in -- from a -- on a percentage basis. I think the sales force is thinking that, that number will finish up somewhere between 20% and 25% as I mentioned earlier in fiscal '14, but that's probably about as close as we can get at this point.

William J. Plovanic - Canaccord Genuity, Research Division

Okay. And then my last question is more of a bigger picture question. I mean, you've got a lot of products in development that will take a little while to come through. You've done a phenomenal job turning the company around, getting it profitable, continuing to drive that growth. I see your next opportunity maybe -- Japan isn't performing, maybe that's an opportunity. But going beyond that, you're generating a lot of cash, you have the buyback, you've made some small acquisitions. Any thoughts on a dividend or kind of -- that's question one. Then two is kind of what's -- is there anything else big in the pipeline that could come near term in the next 12 to 24 months?

Gregory H. Browne

So Bill, let me comment on the first part. I mean, as you know, we have an active stock repurchase program in place. As Dan mentioned, we spent $100 million on that over the last few years and we still have 945,000 shares left under our current authorization from the board and we would anticipate probably completing that over the fiscal year. I think that we have returned considerable amounts to shareholders in the form of stock buybacks. And whilst we would consider a dividend from time-to-time at the board level, it's not something that's currently contemplated. I'll let Dan answer the rest of that.

Daniel Jeffrey Moore

Yes, on the bigger picture side, is there any one product that's going to move things considerably in the next year? I think the answer to that is no. But that's not a bad thing. Consistent with what we've been doing for the last 5 years and the hypothesis in coming into the company was there's an underserved patient population there. And despite 5 or 6 years of good financial results, we still have an underserved patient population with less than 20% penetration. And our reps understand that and they go out every day trying to bring new reps -- or new patients to the therapy, and that's our primary objective. As the new products come in, it helps, but that's not the major theme that we use and have been using to build the business overall. We're really not a milestone-driven company. Our reps are out today as we're on this call and they're looking for new patients and that's how we grow the top line.

Operator

[Operator Instructions] Our next question comes from Charles Haff of Craig-Hallum Capital.

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

I had a couple of questions here. First, on Japan, I know you don't like to break down too much on the country level, but can you help us out directionally how Japan is tracking? I know you've said in the past couple of quarters it was starting to pick up a little bit. Could you give us any color on if it was increased in fiscal fourth quarter versus fiscal third quarter? Any color there would be helpful.

Gregory H. Browne

Charles, I think what we've said in the past on calls is that we thought Japan revenue this fiscal year, fiscal '13, would be around 1.5% of total revenue. It was around that number. The fourth quarter, compared to the third quarter, was roughly consistent but it wasn't much of an increase. So as Dan said in his remarks, we haven't yet achieved what we expected to in Japan. We have seen some increase in fiscal '13 over fiscal '12. But there's still a lot of work to do and we continue to evaluate our options with respect to the market.

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

Okay, great. And then my next question is on the replacement growth guidance for fiscal '14 in the mid-single digits, as you mentioned, is a little bit of a step-down from where it was in fiscal '13. I'm wondering if you could get a little more granular on that. What are kind of the drivers or the assumptions that are going into that?

Gregory H. Browne

Yes, I can, at least as best I can on the call, Charles. When you go back to replacements, you're really looking at, given the average battery life on the family of generators that are implanted out in the field, if you will, the average life is going to be in the 5- to 8-year range for the ones that are coming up for replacement mostly this year. And if you go back 5 to 8 years, that was -- particularly earlier than that, that was at a time when our new patient implants were declining 5 to 8 years ago and so we are seeing a little bit of an impact of that. It's been offset, of course, by the rapid growth in the number of people coming back for their third, fourth or sometimes even fifth generator and that's why we continue to see the growth that we expect in the mid-single digits. By the way, that number is also consistent with the forecast that we gave out at the Investor Day in December 2011. I think the next time we put out a sort of a longer-range forecast, perhaps even later this year, we would start to see some increase in later years from the Demipulse unit, which has now been in the market for about 5 years in considerable numbers, 4 or 5 years. And so we'll start to see that have an impact on replacements. So we'll see how the -- but for this year, we think 5% was about the right number.

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

Okay. And I know with a smaller footprint of Demi, the battery life is a little bit shorter. Can you remind us what the battery life is, the average is, for Demi?

Gregory H. Browne

Well, the average, we will have to see in a way in the sense that you don't really know the average until it's been implanted and replaced in some numbers. I think our anticipation is going to be in the 4- to 6-year range. And as time goes on, we'll have a chance to see whether that proves accurate or not.

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

Great. And just lastly on the share repurchase, so I was going to ask you if your fiscal '14 EPS guidance assumes completion of the share repurchase, but in response to the earlier question from Bill, I think you said you expect to complete it over '14. So just closing the loop there, I would assume that the share repurchase is embedded in the EPS guidance, is that accurate?

Gregory H. Browne

Well, what I said in my guidance was that we felt that shares outstanding for fiscal '14 would be 27.5 million, which is, by this new definition, an average number for the fiscal year. So that would imply that it's completed over the fiscal year and as a result the EPS guidance does assume that, yes.

Operator

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

James Sidoti - Sidoti & Company, LLC

Can you talk a little more about the Costa Rica facility? Specifically, when you think you'll start production there? What the near-term impact on margins will be? Will the margins actually decrease because you'll have 2 facilities running in parallel? And what the capital expense related to that is?

Daniel Jeffrey Moore

Yes, on the progress, we are making good progress. We acquired land and we've cleared that land. We have a facility that's being built with real walls, a roof, working on some of the inside now. So it's coming along nicely and we're projecting for that to become operational in fiscal 2015. The financials around that, I'll let Greg comment on.

Gregory H. Browne

So I think there are a couple of implications, Jim. As I mentioned in my remarks, it will have some impact on our gross margins this year and through -- to the end -- towards the end of fiscal '14 as we start to add some people down there, but before we start production and that will continue a little bit into fiscal '15 before we get into full production down at that facility. Once it becomes operational, I don't think -- it's not anticipated it will have a significant impact on our gross margin in terms of a much cheaper cost of production. And we've talked about that in the past, but we do expect that as we go into -- towards the end of fiscal '15 and particularly into fiscal 2016, it will help us from an effective tax rate standpoint.

James Sidoti - Sidoti & Company, LLC

Okay. And capital expense?

Gregory H. Browne

I'm sorry. Capital expenditure would be in the area of $7 million to $8 million this year and that was embedded in the number that I mentioned earlier of $17 million to $20 million.

James Sidoti - Sidoti & Company, LLC

Okay, all right. And I assume the next Investor Day will be at that facility?

Gregory H. Browne

That's to be considered at a later date.

Daniel Jeffrey Moore

Depending on if you want to be in the mud or if you expect to see grass in a landscape facility fully operational. But thanks for that suggestion.

Operator

Our next question is a follow-up from Bill Plovanic of Canaccord Genuity.

William J. Plovanic - Canaccord Genuity, Research Division

O U.S. sales, I was wondering if you could provide the unit sale mix between distributor and direct for the o U.S.?

Gregory H. Browne

I can, Bill. It was 45% distributors, sales from distributors this quarter. That compared to 44% in the fourth quarter of last fiscal year '12 and 43%, I think, in the third quarter of fiscal '13.

William J. Plovanic - Canaccord Genuity, Research Division

Great. And then just one more on Japan. As you look at the guidance you've provided this year, you're reviewing that operation. This current guidance basically assumes status quo with current partners?

Daniel Jeffrey Moore

It does, and we don't have any plan to abandon our current partner there. What we're doing is just spending more time understanding the market and beginning to really build those referral channels. If you recall, we started off with surgeons-only, epilepsy surgeons-only, who were really involved in the effort. And where a lot of our focus has been with our partner, Nihon Kohden, has been around really educating the prescribers, the neurologists, the epileptologists, the psychiatrists, the pediatric doctors who take care of patients with epilepsy and then setting up those referral systems that allow them to refer patients into epilepsy surgery centers and then back to them for the programming.

William J. Plovanic - Canaccord Genuity, Research Division

So given that -- in the U.S., I mean as management team you came in, you had to fix what was broken in the U.S. and Europe and in Japan you're really putting it in place. I mean, can you kind of give us an estimate -- or estimation or thoughts on how long do you think it'll take to get that referral process set up to where this can start becoming a meaningful contributor and grower for the overall operation?

Daniel Jeffrey Moore

Well, it's a 2-sided answer. The first part is that it's continuous to try to get one of those systems set up and then they build upon so you want several of those. And that's what we've done in the U.S., that's what we've done in Europe, is build -- learn to build patient pipelines and we need to do the same thing in Japan. The two-sided part of this is, in one way, we expect our U.S. business to continue to grow. We expect the rest of our international business to continue to grow. So we want Japan to grow as well. But if it doesn't become a bigger percent of the overall total, as long as the other ones are growing well, we're okay with that as well.

Operator

Our next question is a follow-up from Brooks West of Piper Jaffray and Company.

Brooks E. West - Piper Jaffray Companies, Research Division

Greg, just a quick one on the gross margin guidance for the year. You said 89.5% and you're going to see a kind of a deceleration throughout the year. Is it fair to say we're going to start kind of where we are and maybe finish -- I'm trying to get a sense of where we're going to exit the year for gross margin and then what kind of a sustainable gross margin might look like going forward?

Gregory H. Browne

Yes, so I think -- as you look at the year, when obviously in the first quarter we'll have medical device tax, which we didn't have in the first quarter of last year, I think where we finish up the year is probably going to be closer to 89% and that's probably where it'll settle out on a go-forward basis.

Operator

Our next question is a follow-up from Charles Haff of Craig-Hallum Capital.

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

My follow-up question is regarding SR. On the E-37 trial, are you trying to get any amendments to your IDE or are you expecting that you're going to -- the protocol is going to be the same as you originally expected when you got the IDE?

Daniel Jeffrey Moore

The initial protocol will be the same. And our plan is to take some E-36 patients, combine that with a short series of E-37 patients. And from those 2 data sets, look at the end points to see if we have the appropriate end points at that point, then we would go for an IDE amendment for the pivotal phase or the second phase of the E-37 trial.

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

Okay. And then when you think about the enrollment expectations for E-37, have your biostatisticians given you any estimate on when you may be able to port some of those patients from E-36 to E-37 or when we might hear an update on that?

Daniel Jeffrey Moore

Well, the targets, like anything else, whether they're financial targets or targets for E-36 enrollment or E-37 enrollment or unblinding and analyzing the data, sure, we have that. And as we've said -- I mean, we have those targets and we work from a base plan and then try to achieve stretch targets. And as we said, our objective is to submit a CE Mark or submit for a CE Mark off of E-36 by the end of the year. So during this fiscal year, we will be seeing E-36 results or we expect to be seeing E-36 results.

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

Okay, great. And then my last question is regarding the wrongful termination lawsuit that was filed a while back, is there any update on that at all?

Daniel Jeffrey Moore

There's no communications from Mr. Hagerty. And as far as we know, he has not refiled a lawsuit and there's no demand for arbitration that we're aware of.

Okay. I think with that, we're coming up on the hour. And I just want to close by saying that the Cyberonics team has continued to perform at a high level as demonstrated by our consistent performance during the quarter, during the fiscal year, and indeed, during the last 5 to 6 years. As we've stated before, our products have brought relief not only to tens of thousands of patients who suffer from debilitating epilepsy, but also to their families. And we will continue to seek and develop optimized device solutions for patients with epilepsy and other neurological conditions. I want to thank the Cyberonics team for all these results because it truly is a team effort that Greg and I gets the honor to speak about. And I want to thank all of you for listening today and your interest in Cyberonics, and we'll be talking to you next probably in August. Thanks for your time.

Operator

Ladies and gentlemen, this does conclude today's conference. You may all disconnect, and have a wonderful day.

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