Cyberonics Management Discusses Q2 2014 Results - Earnings Call Transcript

| About: Cyberonics, Inc. (CYBX)

Cyberonics (NASDAQ:CYBX)

Q2 2014 Earnings Call

November 21, 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

Kaila Krum

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

Matthew J. Dodds - Citigroup Inc, Research Division

Brooks E. West - Piper Jaffray Companies, Research Division

Suraj Kalia - Northland Capital Markets, Research Division

Imron Zafar - Jefferies LLC, Research Division

James Sidoti - Sidoti & Company, LLC

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

Kyle Rose - Canaccord Genuity, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Cyberonics Q2 Fiscal Year 2014 Earnings Conference Call. My name is Sam, 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

Thank you, Sam, and welcome to Cyberonics Fiscal 2014 Second Quarter Conference Call. Joining me today is Greg Browne, our Chief Financial Officer, who will summarize the Safe Harbor statement and provide detailed financial information.

Gregory H. Browne

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 stockholder value; achieving consistent sales growth and profitability growth worldwide; achieving clinical, regulatory and product development milestones; evaluating and advancing other medical device and neuroscience opportunities; completing the previously announced stock repurchase programs and fiscal guidance for fiscal year 2014.

Our actual results may deliver -- 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 26, 2013, and our quarterly report on Form 10-Q, for the fiscal quarter ended July 26, 2013.

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

Daniel Jeffrey Moore

Thanks, Greg, and good morning. The Cyberonics team achieved record financial results during the second quarter and we have reached an important product development milestone. Financial and operating highlights include: record net product sales of $70.1 million, growth of 12%; record U.S. unit sales of 2,518 generators, growth of 8%; strong international unit growth of 10%, again, led by Europe. Record operating earnings of $21.9 million, an 8% increase over the prior year after accounting for the medical device tax, which reduced operating earnings by approximately $900,000 in this quarter alone. Without the medical device tax, the increase in operating earnings would have been approximately 13%.

Growth in the U.S. was in line with our Q2 expectations and our annual guidance for sales, new patients and replacement activity. The newest generation device, the AspireHC, accounted for 26% of sales in the U.S. in Q2, approximately the same percentage as in the first quarter. In addition to continued strong sales growth in Germany and the U.K., European growth was again enhanced by good results from our partners in Eastern Europe. With respect to other international regions, the performance in Latin America was especially strong.

Looking in the areas of market development and reimbursement. We continued support for global peer-to-peer events this quarter. We believe these educational programs are important in helping physicians adopt and utilize VNS Therapy as a more foundational part of their practice for patients with refractory epilepsy. A new physician communication campaign will be introduced at the American Epilepsy Society meeting in Washington, D.C. Expanded focus on patient awareness and education is occurring through a new patient ambassador program called Epilepsy Connections, additional presence in social media and new patient website content, including patient testimonials.

In the U.S., finalization of the CMS hospital outpatient reimbursement rates for calendar 2014 was delayed by the partial government shutdown, but is expected by month end. As discussed earlier, the proposed rates were calculated utilizing a somewhat different approach that includes bundling of other services previously billed separately by the hospital. We do not believe that the impact of this change in methodology will be material to our U.S. sales.

Last quarter, we discussed how reimbursement for privately insured patients in Brazil had been recommended and was in a public comment period. I'm pleased to report that this reimbursement has been approved and we are now working to leverage this approval as we seek public sector reimbursement in Brazil.

In Japan, we extended our contract with Nihon Kohden for up to 5 more years, subject to performance milestones. Additionally, to accelerate market adoption, Cyberonics plans to add direct resources in this important market towards the beginning of next fiscal year. We expect to deploy 3 to 4 field-based people over the next 12 months.

A product development update. In addition to achieving Q2 sales and financial goals to support our full year guidance, we also made significant progress with our new product pipeline. Here are a few of the key highlights by project.

First, the AspireSR generator, the CE Mark submission. Through substantial effort across many areas of the company, we were able to accelerate the submission of our AspireSR generator for European regulatory approval, over-achieving our original timeline objective. We now anticipate that sales in Europe may commence toward the end of this fiscal year in a phased launch.

The AspireSR generator, the U.S. clinical study, the E-37. In that study, clinical investigators continued to enroll and implant patients. We expect to complete enrollment of the first phase of this trial later this fiscal year. As stated earlier, we plan to utilize the results of this first phase, along with the data from E-36, to optimize the second phase of the U.S. IDE study, a phase expected to begin in our next fiscal year.

The ProGuardian system is our in-home monitoring system designed to aid in the detection, recording and notification of seizures accompanied by heart rate variations or movement. Our objective continues to be to submit the first product of the ProGuardian platform for regulatory approval by the end of fiscal 2014. Following approval, we expect to begin a limited market launch.

The Relay generator. Development of a wireless-enabled VNS Therapy generator is progressing toward regulatory submission.

Our programming tablets. On the last earnings call, we discussed a transition from the handheld PDA programmer, which is used by physicians for patient dosing, to a new tablet computer programmer, the Motion Tablet. First shipments of the new tablet occurred in the second quarter.

The Neural Autonomic Regulation Therapy for chronic heart failure. As announced on our last call, enrollment and implant activity in the ANTHEM-HF pilot study is now complete and we continue to gather follow-up information. Further activities in this area remain contingent on the results from this pilot study, which are expected towards the end of this fiscal year.

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. Product sales in the second quarter of fiscal 2014 were $70.1 million, representing growth of 12% over the second quarter of the prior year. U.S. unit sales increased by 7.7% for the quarter and with both generator ASP growth of 3.8% and increased lead sales, this resulted in an overall increase in U.S. product revenue of 12.4%.

International units increased by 9.8% and revenue by 10.3% over the fiscal 2013 second quarter.

Foreign currency movements when compared to the second quarter of last fiscal year provided approximately a $200,000 positive 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 second quarter was $1.34 compared to $1.27 in the second quarter of fiscal '13, although this impact was largely offset by sales in British pounds and other currencies.

As mentioned on our last call, our quarterly results no longer include license revenue from the 2007 agreement as the remaining revenue was fully recognized in the first quarter. U.S. epilepsy unit growth occurred in both generators and leads over the prior year. Variation 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 second quarter of fiscal 2014, U.S. epilepsy lead sales are estimated at 1,238 as compared with 1,145 in the previous year, an increase of 8.1%. The trailing 4 quarter growth rate in U.S. leads was 9%.

For this fiscal year, we have guided growth for U.S. replacements in the mid-single digits, and our second quarter results are consistent with that estimate. This growth rate is still our expectation for the fiscal year.

The AspireHC generator accounted for 26% of U.S. unit sales in the most recent quarter, as Dan mentioned, unchanged from the prior quarter. The Demipulse generator represented 59% of unit sales in the U.S. and the pulse generator was at 15%. The market adoption of the AspireHC generator was achieved with a solid price premium to the Demipulse generator and in line with our annual plan.

The reported gross profit of 90.1% in the second quarter was consistent with the previous quarter and lower by 167 basis points from the second quarter of fiscal 2013, most of which is the result of the inclusion of a full quarter of the medical device tax in cost of goods sold, although there was also a modest unfavorable impact from the introduction of our tablet form programmer, as indicated on the last call.

For the second quarter of fiscal 2014, operating income was $21.9 million or 31.2% of sales, compared with $20.2 million or 32% of sales in the second quarter of fiscal 2013.

Operating expenses were unchanged from the first quarter's expenses, as adjusted. The activity in preparing new products for regulatory submission has resulted in R&D spending at 16.6% of revenue for the quarter.

Now that we have submitted AspireSR earlier than anticipated, we are increasing our focus on both ProGuardian and Relay products with the objective of moving them to submission. We do anticipate that spending additional dollars on testing will occur in the third quarter, which could push our R&D spending in the third quarter towards 18% of revenue levels. Although if this occurs, spending would drop back in the fourth quarter.

These assumptions are included in our updated guidance for the full year and we still expect that R&D spending will be approximately 17% of revenue for the full fiscal year.

Generating operating leverage has been a key objective over the last 5 years and we are pleased that operating income represented over 31% of sales during the quarter. While this will continue to be an important focus, we're emphasizing investment in both market and product development, including related clinical activity. As a result, variations in the operating income percentage are likely to occur from quarter to quarter.

Earnings before interest, depreciation, amortization, equity compensation expense and other adjustments, totaled $25.8 million in the second quarter, an increase of 8.5% over an adjusted number for the second quarter fiscal 2013, which included accounting of the gain on the warrant settlement.

For the second quarter of fiscal 2014, we had an effective tax rate of 36.6%, and we continue to expect the tax rate of approximately 36.5% for fiscal 2014. Stock repurchases in the quarter reduced the number of shares included for the purposes of diluted earnings per share calculation this quarter to 27.6 million. As stated in our press release, we repurchased 480,000 shares in the second quarter and we expect to complete purchase of the remaining 260,000 shares of the latest 1 million share authorization in this fiscal year.

Income per diluted share of $0.50, increased by 14% compared to an adjusted $0.44 per share in the second quarter of fiscal 2013. With respect to the balance sheet, our overall day sales outstanding were at 55 days, materially unchanged from the end of the prior quarter of fiscal 2014. Our balance sheet remains strong with stockholders' equity of approximately $236 million, $123 million in cash and short-term investments and no interest-bearing debt.

During the second quarter, we invested approximately $6 million in the Costa Rican manufacturing plant project, as well as Houston facilities, equipment upgrades and technology asset purchases. We expect to submit the first regulatory approvals for the Costa Rican manufacturing facility towards the end of this fiscal year.

Guidance. With respect to our financial targets, for fiscal 2014, we have increased our guidance as follows: Net sales are now expected in the range of $281 million to $285 million. Our assumptions in setting this range include worldwide unit growth of approximately 10%; mid- to high-single digit growth in U.S. new patients; as I mentioned earlier, mid-single digit growth in U.S. replacements; ongoing European growth; and a euro-to-dollar exchange rate of $1.30 to EUR 1. Our gross profit margin is now expected to be between 89.5% and 90% for the full year; and adjusted operating income expected to be in the range of $86 million to $88 million.

Adjusted net income is now anticipated to be in the range of $54 million and $56 million. We anticipate that diluted shares outstanding will average approximately 27.4 million for fiscal 2014. And with these assumptions, adjusted earnings per share is anticipated to be between $1.97 and $2.03 per diluted share.

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

Question-and-Answer Session

Operator

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

Kaila Krum

It's Kaila in for Matt. Just a couple quick ones for us. As far as AspireSR, this timeframe was obviously ahead of our expectation and you mentioned that sales might commence toward the end of this fiscal year. Can you give any sort of idea around the potential impact that this product could have in the European market in the full first year post-approval?

Daniel Jeffrey Moore

Yes. If we are able to get the approval, the CE Mark, by the end of the year, we would expect, like we've done the other launches, to phase that launch. So I wouldn't look for anything outside of what's already been included into the guidance for this year. Further, we'll be looking at giving guidance for next year in June, and our AspireSR assumptions for Europe will be included within that guidance.

Kaila Krum

Okay, great. And then as far as the U.S., what do you believe is driving that new patient growth here? And how do you expect this to trend going forward?

Daniel Jeffrey Moore

What's driving the new patient growth in the U.S. is nothing other than what we've been doing all along. And that goes back to the basics of, first, starting with a salesforce of territory managers who are incentivized to go out and build good patient pipelines of people who would need VNS Therapy, compensating those sales rep, having good clinical studies in place to support both the efficacy and the economics around VNS Therapy. The many educational symposiums that we do every quarter, both at the national and regional level, and for that matter, at the territory level as well. So it's not just one thing driving new patient growth. You can see consistently, we've been in the higher-single digits and it's the culmination of several efforts.

Operator

Our next question comes from Steve Brozak of WBB Securities.

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

Your financials are, obviously, all continuously trending in the right direction, but there's one item that I'd like to get any kind of clarity or any kind of color you can give us, and that's obviously on refractory depression. What do you expect in 2014 that might be some of the items that we could look for? Because obviously, you've been exceptional at execution in terms of the current model. But what can we look for on the refractory depression side? And I've got one follow-up after that.

Gregory H. Browne

Steve, I think, as we've previously stated following the disappointing news in May, that CMS declined our application, we have been, as we've talked about in the past, proceeding with the support for patient appeals. Those appeals are sort of in process. I don't think that we're looking for significant progress in fiscal 2014 and we'll have to see what 2015 brings.

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

Okay, and back to your basic knitting. Obviously, when you have patients that are implanted, you've got a remarkable rate of continuance. Can you give us some information as to how the clinical community is looking at that? Because obviously, they're now seeing something where, don't do too much, don't do too little base is obviously a by-word here. What kind of feedback are you getting from your marketing people in terms of how good the relationship is and how much more it can grow?

Daniel Jeffrey Moore

As specifically for replacements, Steve?

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

Exactly. That's exactly right.

Daniel Jeffrey Moore

Yes. We've had the data for the earliest generators, for example, the Model 100, where we can track using implant cards that we believe that of the patients who were originally implanted, 70 -- approximately 75% of them came back for reimplant. But that data, of course, goes back many years because it was the first-generation generator. We hear directly from physicians because, in addition to the educational symposia we do, one of the other activities we have is to bring physicians back for key opinion leader visits where they're able to look at our programs, give feedback to what it is we're doing, and while they're here we're asking them questions as well. And I will typically hear when asking a physician what percent of their patients who have been implanted with VNS come back for a reimplant when their battery is depleted, the number's typically around 90%.

Operator

Our next question comes from Matthew Dodds of Citigroup.

Matthew J. Dodds - Citigroup Inc, Research Division

Just on the unit guidance for the full fiscal year, if you just look at the most recent quarter, you hit your first tough comp in Europe and you grew about 10% internationally. It seems like you have to pick it up a little bit in the back half of the year, OUS, to get there, unless you assume acceleration in the U.S. numbers, which are pretty good. Is that the right way to think about the full year?

Daniel Jeffrey Moore

Yes, Matt. I think that is right. I think when you look at Q2, although Europe had a good quarter, in the mid-teens, some of the other international regions were a little weaker, although as Dan mentioned, Latin America was actually quite strong. We are looking for those areas to pick up in the third and fourth quarters. And generally speaking, the fourth quarter is normally our strongest, so we would expect to pick up in the second half of the year.

Matthew J. Dodds - Citigroup Inc, Research Division

And then just one follow-up on the AspireSR. When would we see data from the Europe trial? Is that something that's scheduled or that you might put out now it's been submitted?

Daniel Jeffrey Moore

Yes. I think you can expect to see the first data in the next couple of weeks here. The American Epilepsy Society meeting is in Washington, D.C. in early December and you'll see the first results from the E-36 at that meeting.

Operator

Our next question comes from Brooks West of Piper Jaffray.

Brooks E. West - Piper Jaffray Companies, Research Division

Dan, can you sort of quantify the Brazil opportunity, what does the recent positive news on reimbursement potentially mean there?

Daniel Jeffrey Moore

Yes. It's early for us to characterize what will happen in Brazil. And the reason there's some hesitancy there is just, as we came into this business, I think we've done everything we said we would do on the top line over all and on the bottom line as well. But Brooks, where we haven't been as accurate in our forecasting is what happens in individual markets. It took us longer to get new patients in the U.S., to get that growth now that we've had for several years, but it took us some time to turn that around. It took us more time than we expected to turn around Europe, but we've had 10 good quarters now in Europe. Japan, as a big country market, we're still not where we want to be with Japan. And I wouldn't expect Brazil at this point, even though we've got some positive news on the reimbursement side, to do a whole lot, yet. It tends to, even after you have reimbursement, to take some time to get the patient pipelines going and to grow individual markets.

Brooks E. West - Piper Jaffray Companies, Research Division

Okay. And then another data question. Just on the ANTHEM part failure data, Dan, when might we see something there? Could we see something maybe at the Analyst Day?

Daniel Jeffrey Moore

Not a lot at the Analyst Day. I mean, we're accumulating data now, but there's 6-month follow-up in that data. So it'll be -- by the time we're seeing -- although we're seeing data on an ongoing basis, it will really be around the end of the fiscal year, April or May, before we're seeing all of the data together for all 60 patients. And then from there, I think the decision by the academic community will be when can they get that published or to a major meeting.

Gregory H. Browne

I just apologize that we're having a fire alarm here at the office. So Greg and I will sit through that for right now.

Operator

Our next question comes from Suraj Kalia of Northland Securities.

Suraj Kalia - Northland Capital Markets, Research Division

I'll be very brief here. On the ANTHEM-HF trial, Dan, to the extent that you can share, the titration parameters for the VNS Therapy, are they going to be the same through the 60, 65 patients? I'm just trying to understand what kind of improvements we are going to be talking in the clinical study and what parameters of thresholds are going to be used to make a determination to go ahead or not?

Daniel Jeffrey Moore

I think on the parameters for programming, like we do with epilepsy, I think they will program to get effect, to get therapy, but they're very similar to what we're doing for the epilepsy parameters. As far as endpoints, we're looking at things like improving the ejection fraction, improving the walk test, the normal things that you would do in a cardiac clinical study. There is a publication out there explaining the endpoints, and that's in the Journal of Cardiac Failure.

Suraj Kalia - Northland Capital Markets, Research Division

Fair enough. And Dan, as you very well know, NeuroPace's RNS just got approved. How do you all see the market stratify? I understand the quote point for the NeuroPace is going to be completely different than VNS. I'm just curious how you would look upon it as -- with the entry of NeuroPace, especially in this bundled environment?

Daniel Jeffrey Moore

Okay. If you start with where 2/3 of patients are getting their therapy, that's with pharmaceuticals, and we expect that to continue. And then when a patient's seen refractory where the pharmaceuticals aren't working, today, you can look for a surgical resection as one therapy, you can look to use the ketogenic diet or you can look at VNS. And obviously, with VNS, there's another level of invasiveness, although we're done with 2 small incisions in an outpatient situation. I think as you move to RNS and you're talking about putting generators into the skull, you're talking about at least an inpatient procedure and more often a combination of an inpatient and outpatient procedure. So when you think about the continuum of care, there's a whole other level of invasiveness that patients will have to undergo and be willing to undergo in order to take an RNS generator. The other thing that I think we will see is cost. There's obviously, as those procedures are very different, you'll see a difference in cost, and that's both initial cost and based on some things we're seeing about generator life, you have to consider the replacement cost if you're replacing one of those generators in the head, every 2 or 3 years. And then if you go further, there appears to be a reimbursement gap, and we know what it's like to struggle to get reimbursement from our depression experience. And then finally, just another consideration is the feet on the street. We have roughly 100 people that are out there in the U.S. and that's not an inexpensive endeavor. So on the continuum of care, at least from my perspective, just based on the invasiveness alone, I would expect that patients would try VNS first.

Gregory H. Browne

I would just add something as well. I think from the experience of what we've seen in Europe over the last couple of years, where DBS has been in selected markets and we've had some other competition, I think the approval of RNS in the U.S. will bring additional awareness to the use of device-based solutions. And in general, that'll be good for people with -- who suffer from epilepsy, refractory epilepsy. I'd point out that this is epilepsy awareness month, and perhaps that's why the FDA chose to announce that this month, although I'm sure the company would have preferred it earlier. But I think in general, it's good for people with epilepsy to have other solutions.

Daniel Jeffrey Moore

So we don't -- net effect here, we don't see this as a downside at all, as we stated when we saw DBS coming as well, and we're coming off of 10 good quarters in Europe with DBS having been there. So we think we're in a good position to continue to do what we've been doing, which is to move patients with refractory epilepsy into the device market and they may play a role as well, but I would predict later on in the cycle.

Suraj Kalia - Northland Capital Markets, Research Division

Just forgive me, just one quick follow-up. Excellent answer on that. And if I look at it, at least I'm speaking from memory, RNS is -- some of the patient baseline data -- again maybe I'm wrong here, but if I remember correctly, they have failed VNS, at least 20% or so. And I'm just curious, so you don't see any effect on replacement cycles for VNS Therapy from RNS also? Is that a fair statement to make?

Daniel Jeffrey Moore

We're not expecting any, we're not expecting any negative impact on our business.

For those of you who like the CEO and CFO, the good news is the fire alarm has gone off and it's no longer beeping. So we're either in a lot of trouble or I think we're okay at this point. So we'll continue the call.

Operator

Our next question comes from Imron Zafar of Jefferies.

Imron Zafar - Jefferies LLC, Research Division

First, a quick question on the HC. You mentioned penetration was flat sequentially and I wonder if you think that number has peaked or do you think that -- or if you could offer up any reasons why you think that might have stalled in the quarter?

Gregory H. Browne

Yes. So I think at the beginning of the year, we were thinking 15% to 20% was our original thoughts on penetration for the fiscal year, and clearly we've been ahead of that now for 2 quarters. It seems to be generating some enthusiasm amongst the physician community, although as you point out, sort of flat sequentially. I think it was up slightly, but on a rounded basis, it looked flat. I think there's a possibility it could move up a little bit further, but at this stage, I wouldn't be looking for it to increase dramatically as the year goes on.

Imron Zafar - Jefferies LLC, Research Division

Okay. So the ASP trends that we saw in the quarter would likely continue for the balance of the year then, for the 4%?

Gregory H. Browne

I think, yes. The generator ASP was up 3.8% year-on-year for the quarter. As is our normal practice, we do look to a price increase effective January 1 and next January is no exception to that. So hopefully we'll see the impact of that in -- somewhat in Q3, but more in Q4. So that trend should roughly continue.

Imron Zafar - Jefferies LLC, Research Division

Okay. And then on Japan, I realize that, that launch and market development there has been slower than we all had originally expected. And I wonder if you could give us any kind of metrics that gives us a little better sense of where you are versus where you were, say, a couple of quarters ago in terms of maybe units or even sales or number of docs trained? Any metrics you could provide would be helpful.

Daniel Jeffrey Moore

Yes, we could. The idea of training docs, and I think we have very good numbers there, and total number of centers, total number of neurologists and epileptologists, total number of surgeons who implant the device. But the reality is when you look at the revenue, which is what matters most to us at this point, the revenue is smaller than a U.S. territory. So it's really immaterial. And even if we were to double it at this point, you're still, the size of it, less than 2 U.S. territories. So it's nothing to get excited about at this point. However, we're still optimistic about that market and the potential in that market, and that's why we're continuing to work with the Nihon Kohden to find ways to build those patient referral networks. So we're out training more prescribers, talking to them about VNS with our partner Nihon Kohden. We're looking for ways to build those patient networks where we're finding ways to pass patients from the prescribers into treating centers and then back out to the prescribing physicians who will ultimately program those patients. So it's been more difficult for us to set that up in Japan because quite frankly, it didn't exist before we came into the market. So one other solution there that we've talked a little bit about that I mentioned in my script is that we are planning, with our new agreement with Nihon Kohden, to put 3 or 4 direct people from Cyberonics into the market next year, next fiscal year as well.

Imron Zafar - Jefferies LLC, Research Division

Okay. And then lastly on a modeling question. Costa Rica, I wonder if you could just remind us, even just directionally over the next, call it 3 years, what the gross margin implications are of Costa Rica. Are we going to see a decline with -- when you have some redundancy? And then what magnitude of expansion, if any, do you expect there after?

Daniel Jeffrey Moore

Yes, before Greg gets the margin impact, just a quick update. We have secured land. We've built the building. The exterior of that building is done and we're working on the interior of that building now. So that project is well underway and as you heard us, say, earlier, we expect to be submitting our first -- for our first regulatory approvals to begin activity in Costa Rica later this fiscal year. So Greg, you want to talk margin?

Gregory H. Browne

Yes. So with the timeline that Dan outlined, we expect to commence production activity there about this time next year. And the impact on gross margin, we'll talk a little bit about at our Investor and Analyst Day on December 5, as it goes out to fiscal '16 and '17. I would not look for it to have a significant impact in fiscal '15 at this point.

Operator

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

James Sidoti - Sidoti & Company, LLC

What products will you be manufacturing first in Costa Rica?

Gregory H. Browne

Jim, we expect to be manufacturing product for our international market. In particular, I think we're going to start off with the Demipulse generator and then over time -- and leads. And over time, expand that into the full range of products.

James Sidoti - Sidoti & Company, LLC

All right. And then can you just remind me, with the SR version, what is expected battery life for that? Is it shorter because of the enhanced capabilities?

Daniel Jeffrey Moore

Well, it would be shorter than AspireHC, but pretty much in line with the other generators.

James Sidoti - Sidoti & Company, LLC

Okay. So in line with the Demipulse?

Daniel Jeffrey Moore

Yes.

Operator

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

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

Question for you on EU. You had very impressive growth of 10% in light of a very tough comparison of a positive 28%. I know that you recently increased your salesforce. How much of an impact did that have in this quarter on your EU performance?

Daniel Jeffrey Moore

More than 10%. It's -- the number for Europe is actually higher than 10%. As Greg mentioned, it's more in the mid-teens range.

Gregory H. Browne

In terms of the salesforce, we've had more modest increases in Europe in the sales, salesforce expansion. It's continued penetration in some of the key markets that we mentioned, both in the U.K. and Germany, as well as through some of our partners in Eastern Europe where we've done particularly well over the last year or so.

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

Okay. And then on the American Epilepsy Society meeting, you mentioned first results for the E-37 trial. Is there anything else that we should expect at that meeting that's noteworthy?

Daniel Jeffrey Moore

It would be actually the first results for the E-36, the European trial, not the U.S. trial yet. And I think in addition, we'll just have our regular number of posters. In Montréal, I think we had more than 10 for the international lead. And we had that same kind of impact at Passy [ph] ES's. Just posters on a variety of topics related to Vagus Nerve Stimulation.

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

Okay. And then my last question, I'll jump back in the queue. I know that you started a Cyberonics Phone Facts conference call series for caregivers and for patients. I'm wondering how much of an impact, if at all, that's having right now and what kind of levels of participation or pull-through that you're having from the Cyberonics Phone Facts calls?

Daniel Jeffrey Moore

We -- it's really nothing new. If you look at our total program of what we do with the physician community and patient community, we do usually -- we've done a couple of Kiffin Penry courses in the first couple of quarters of this year. So call that 1 -- 2 to 4 a year of those. And then if you go down a level and you start looking at regional meetings, we do roughly one every week. You bring it down to the territory level and we're at 1 to 2 a day somewhere in the U.S. The phone calls, it's a monthly conference call. It's roughly 50 patients or so and it's led by a physician and a patient advocate, but we'll typically get around 50 potential patients on those calls.

Operator

Our next question comes from Bill Plovanic of Canaccord.

Kyle Rose - Canaccord Genuity, Research Division

This is actually Kyle on for Bill. A lot of our questions have been asked, but I just wanted to see one quick modeling question. Can you break out OUS lead sales for us?

Gregory H. Browne

Yes, I can, Kyle. OUS lead sales for the quarter were 699.

Operator

We do have a follow-up from Charles Haff of Craig Hallum.

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

My question is regarding Nihon Kohden. As it was mentioned earlier, that has been frustrating for you guys for the past couple of years. I'm sure by having this new 5-year agreement, you took a holistic view and evaluated kind of the stumbles in the early years and kind of where you're at today. I wondered if you can kind of give us some qualitative comments in what led you to sign this new 5-year agreement to help us understand what may be different in the future versus what's happened in the past?

Daniel Jeffrey Moore

I think you start with Nihon Kohden and what their primary business is. They're the dominant supplier of EEG technology in Japan. And that's actually an advantage that we don't have in the U.S. in the sense that there are many patients each year with epilepsy, particularly refractory epilepsy, that end up going into epilepsy monitoring units across the U.S., across Japan, across the world. And Nihon Kohden is a supplier of equipment to those EMUs. So from our perspective, it makes a lot of sense to have them as a partner. Now they've got a different approach that they've used because of the business they're in. And although, yes, frustrating because we tend to be impatient when it comes to building sales and getting this therapy out to patients, I think we've made good progress in a market that was much more difficult than either of us, either Nihon Kohden or us, anticipated. Again, the patient profiles are different in Japan. Many of the patients who have epilepsy, despite their age and growing into adulthood, they're still with their pediatrician, which is a phenomenon that you rarely see in the U.S. Some of the patients are with psychiatrists. So for us to build patient pipelines, meaning finding physicians who are seeing those patients and then having them get comfortable prescribing VNS, to the point where they know where to refer that patient for an implant and then knowing they're going to get the patient back and being comfortable with the programming, that's a lot of work to get done. So I think we've made decent progress on starting to build infrastructure. We've definitely learned a lot with Nihon Kohden and if we were alone in that market, I don't think we would be learning as fast as we are. So it is a true partnership and we want to continue to work with them.

Gregory H. Browne

I could just add as well, we're encouraged by their response to some of the suggestions that we have made in respect to the structure of their salesforce and the composition of the salesforce, and they have been supportive of our move to add some field-based people, employees of Cyberonics, into the market in Japan. So I think all of that bode us well for the partnership in the future.

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

And do they have a call point with pediatricians and psychiatrists? Or is that kind of what these 3 to 4 direct people are going to be doing? Or are you targeting that call point differently in the future than they have in the past?

Daniel Jeffrey Moore

Yes, I think their typical call point would not be there. So where we'll send the reps is no different than how we do it in the U.S. and how we do it in Europe, and that is go find the physicians with patients who can help you set up a network to get patients implanted and then programmed. So we won't be selective in who we go to see.

Daniel Jeffrey Moore

Well, I think we're going to wrap it up at this point. I just wanted to close by saying that the Cyberonics team continues to perform well in fiscal 2014, as you can see, by meeting our revenue and operating income targets and also achieving the first of our most important product development goals. I wanted to use this opportunity to thank the entire Cyberonics team for their efforts this quarter, efforts that resulted in setting new records again and achieving important milestones. We look forward to presenting our longer-term goals at the Investor and Analyst Day scheduled for December 5 in New York and hope to see you there.

Thanks for participating today and for your interest in Cyberonics, and have a good Thanksgiving. Talk to you all next -- well in December.

Operator

Thank you, sir. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a wonderful day.

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