0001639691-18-000084.txt : 20180802 0001639691-18-000084.hdr.sgml : 20180802 20180802151828 ACCESSION NUMBER: 0001639691-18-000084 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 96 CONFORMED PERIOD OF REPORT: 20180630 FILED AS OF DATE: 20180802 DATE AS OF CHANGE: 20180802 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LivaNova PLC CENTRAL INDEX KEY: 0001639691 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 981268150 STATE OF INCORPORATION: X0 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-37599 FILM NUMBER: 18987978 BUSINESS ADDRESS: STREET 1: 20 EASTBOURNE TERRACE CITY: LONDON STATE: X0 ZIP: W2 6LG BUSINESS PHONE: 4402033250662 MAIL ADDRESS: STREET 1: 20 EASTBOURNE TERRACE CITY: LONDON STATE: X0 ZIP: W2 6LG FORMER COMPANY: FORMER CONFORMED NAME: Sand Holdco Plc DATE OF NAME CHANGE: 20150420 FORMER COMPANY: FORMER CONFORMED NAME: Sand Holdco Ltd DATE OF NAME CHANGE: 20150415 10-Q 1 livn-20180630x10q.htm 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
Form 10-Q
(Mark One)
þ

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2018
 
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _______________ to _______________
Commission file number: 001-37599
lnlogomain280x72.jpg
LivaNova PLC
(Exact name of registrant as specified in its charter)
England and Wales
98-1268150
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
20 Eastbourne Terrace
London, United Kingdom
W2 6LG
(Address of principal executive offices)

(Zip Code)

(44) (0) 20 3325 0660
 
Registrant’s telephone number, including area code:

 
_____________________________________________________________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Ordinary Shares — £1.00 par value per share
The NASDAQ Stock Market LLC
Title of Each Class of Stock
Name of Each Exchange on Which Registered
_____________________________________________________________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ    No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
þ

Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
Emerging growth company
¨
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes ¨     No þ
Class
Outstanding at July 26, 2018
Ordinary Shares - £1.00 par value per share
48,591,937

1



LIVANOVA PLC
TABLE OF CONTENTS
 
 
PART I. FINANCIAL INFORMATION
 
PAGE NO.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
In this Quarterly Report on Form 10-Q, “LivaNova,” “the Company,” “we,” “us” and “our” refer to LivaNova PLC and its consolidated subsidiaries.
This report may contain references to our proprietary intellectual property, including among others:
Trademarks for our VNS therapy systems, the VNS Therapy® System, the VITARIA® System and our proprietary pulse generator products: Model 102 (Pulse®), Model 102R (Pulse Duo®), Model 103 (Demipulse®), Model 104 (Demipulse Duo®), Model 105 (AspireHC®), Model 106 (AspireSR®) and Model 1000 (SenTiva™).
Trademarks for our perfusion systems and products: Inspire®, Heartlink®, Connect™, XTRA®, S5® and Revolution® 
Trademarks for our line of surgical tissue and mechanical valve replacements and repair products: Mitroflow®, Crown PRT®, Solo Smart™, Perceval®, Top Hat®, Reduced Series Aortic Valves™, Carbomedics® Carbo-Seal®, Carbo-Seal Valsalva®, Carbomedics®Standard™, Orbis™ and Optiform®, MEMO 3D®, MEMO 3D® Rechord™, MEMO 4D®, MEMO 4D® ReChord™, AnnuloFlo®, AnnuloFlex®, Bicarbon Slimline™, Bicarbon Filtline™ and Bicarbon Overline®.
These trademarks and trade names are the property of LivaNova or the property of our consolidated subsidiaries and are protected under applicable intellectual property laws. Solely for convenience, our trademarks and tradenames referred to in this Quarterly Report on Form 10-Q may appear without the ® or ™ symbols, but such references are not intended to indicate in any way that we will not assert, to the fullest extent under applicable law, our rights to these trademarks and tradenames.

________________________________________

2



NOTE ABOUT FORWARD LOOKING STATEMENTS
Certain statements in this Quarterly Report on Form 10-Q, other than purely historical information, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements include, but are not limited to, LivaNova’s plans, objectives, strategies, financial performance and outlook, trends, the amount and timing of future cash distributions, prospects or future events and involve known and unknown risks that are difficult to predict. As a result, our actual financial results, performance, achievements or prospects may differ materially from those expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by the use of words such as “may,” “could,” “seek,” “guidance,” “predict,” “potential,” “likely,” “believe,” “will,” “should,” “expect,” “anticipate,” “estimate,” “plan,” “intend,” “forecast,” “foresee” or variations of these terms and similar expressions, or the negative of these terms or similar expressions. Such forward-looking statements are necessarily based on estimates and assumptions that, while considered reasonable by LivaNova and its management based on their knowledge and understanding of the business and industry, are inherently uncertain. These statements are not guarantees of future performance, and stockholders should not place undue reliance on forward-looking statements. There are a number of risks, uncertainties and other important factors, many of which are beyond our control, that could cause our actual results to differ materially from the forward-looking statements contained in this Quarterly Report on Form 10-Q, and include but are not limited to the risks and uncertainties summarized below:
changes in our common stock price;
changes in our profitability;
regulatory activities and announcements, including the failure to obtain regulatory approvals for our new products;
effectiveness of our internal controls over financial reporting;
fluctuations in future quarterly operating results;
failure to comply with, or changes in, laws, regulations or administrative practices affecting government regulation of our products, including, but not limited to, U.S. Food and Drug Administration (“FDA”) laws and regulations;
failure to establish, expand or maintain market acceptance of our products for the treatment of our approved indications;
any legislative or administrative reform to the healthcare system, including the U.S. Medicare or Medicaid systems or international reimbursement systems, that significantly reduces reimbursement for our products or procedures or denies coverage for such products or procedures or enhances coverage for competitive products or procedures, as well as adverse decisions by administrators of such systems on coverage or reimbursement issues relating to our products;
failure to maintain the current regulatory approvals for our products’ approved indications;
failure to obtain or maintain coverage and reimbursement for our products’ approved indications;
unfavorable results from clinical studies;
variations in sales and operating expenses relative to estimates;
our dependence on certain suppliers and manufacturers to provide certain materials, components and contract services necessary for the production of our products;
product liability, intellectual property, shareholder-related, environmental-related, income tax and other litigation, disputes, losses and costs;
protection, expiration and validity of our intellectual property;
changes in technology, including the development of superior or alternative technology or devices by competitors;
competition from providers of alternative medical therapies, such as pharmaceutical companies and providers of cannabis;
failure to comply with applicable U.S. domestic laws and regulations, including federal and state privacy and security laws and regulations;
failure to comply with non-U.S. law and regulations;
non-U.S. operational and economic risks and concerns;
failure to attract or retain key personnel;

3



failure of new acquisitions to further our strategic objectives or strengthen our existing businesses;
losses or costs from pending or future lawsuits and governmental investigations;
changes in accounting rules that adversely affect the characterization of our consolidated financial position, results of operations or cash flows;
changes in customer spending patterns;
continued volatility in the global market and worldwide economic conditions, including volatility caused by the implementation of Brexit and/or changes to existing trade agreements and relationships between the U.S. and other countries;
changes in tax laws, including changes related to Brexit, or exposure to additional income tax liabilities;
harsh weather or natural disasters that interrupt our business operations or the business operations of our hospital-customers; and
failure of the market to adopt new therapies or to adopt new therapies quickly.
Other factors that could cause our actual results to differ from our projected results are described in (1) “Part II, Item 1A. Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q, (2) our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (“2017 Form 10-K”), (3) our reports and registration statements filed and furnished from time to time with the Securities and Exchange Commission (“SEC”) and (4) other announcements we make from time to time.
Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no obligation to update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise. You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this report. Operating results for the three and six months ended June 30, 2018 are not necessarily indicative of future results, including the full fiscal year. You should also refer to our “Annual Consolidated Financial Statements,” “Notes” thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” contained in our 2017 Form 10-K.
Financial Information and Currency of Financial Statements
All of the financial information included in this quarterly report has been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S.” and such principles, “U.S. GAAP”). The reporting currency of our consolidated financial statements is U.S. dollars.

________________________________________


4



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
LIVANOVA PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Net sales
 
$
287,498

 
$
255,843

 
$
537,896

 
$
482,668

Cost of sales
 
91,993

 
84,023

 
176,591

 
163,991

Product remediation
 
1,542

 
1,723

 
5,257

 
931

Gross profit
 
193,963

 
170,097

 
356,048

 
317,746

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
123,439

 
94,264

 
227,600

 
181,604

Research and development
 
34,215

 
33,833

 
65,967

 
54,219

Merger and integration expenses
 
4,409

 
3,512

 
7,369

 
5,698

Restructuring expenses
 
476

 
2,597

 
2,357

 
12,627

Amortization of intangibles
 
9,817

 
8,116

 
18,618

 
16,076

Total operating expenses
 
172,356

 
142,322

 
321,911

 
270,224

Operating income from continuing operations
 
21,607

 
27,775

 
34,137

 
47,522

Interest income
 
232

 
252

 
679

 
525

Interest expense
 
(3,006
)
 
(1,578
)
 
(5,117
)
 
(3,893
)
Gain on acquisitions
 

 
39,428

 
11,484

 
39,428

Foreign exchange and other (losses) gains
 
(70
)
 
(2,837
)
 
(343
)
 
336

Income from continuing operations before tax
 
18,763

 
63,040

 
40,840

 
83,918

Income tax (benefit) expense
 
(1,030
)
 
3,259

 
2,863

 
8,914

Losses from equity method investments
 
(265
)
 
(14,102
)
 
(627
)
 
(16,098
)
Net income from continuing operations
 
19,528

 
45,679

 
37,350

 
58,906

Net (loss) income from discontinued operations
 
(4,462
)
 
1,819

 
(9,011
)
 
(137
)
Net income
 
$
15,066

 
$
47,498

 
$
28,339

 
$
58,769

 
 
 
 
 
 
 
 
 
Basic income (loss) per share:
 
 
 
 
 
 
 
 
Continuing operations
 
$
0.40

 
$
0.95

 
$
0.77

 
$
1.22

Discontinued operations
 
(0.09
)
 
0.04

 
(0.18
)
 

 
 
$
0.31

 
$
0.99

 
$
0.59

 
$
1.22

 
 
 
 
 
 
 
 
 
Diluted income (loss) per share:
 
 
 
 
 
 
 
 
Continuing operations
 
$
0.40

 
$
0.95

 
$
0.76

 
$
1.22

Discontinued operations
 
(0.09
)
 
0.03

 
(0.18
)
 

 
 
$
0.31

 
$
0.98

 
$
0.58

 
$
1.22

 
 
 
 
 
 
 
 
 
Shares used in computing basic income (loss) per share
 
48,487

 
48,140

 
48,406

 
48,104

Shares used in computing diluted income (loss) per share
 
49,338

 
48,303

 
49,263

 
48,241


See accompanying notes to the condensed consolidated financial statements
5



LIVANOVA PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(In thousands)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Net income
 
$
15,066

 
$
47,498

 
$
28,339

 
$
58,769

Other comprehensive (loss) income:
 
 
 
 
 
 
 
 
Net change in unrealized gains (losses) on derivatives
 
801

 
(1,310
)
 
(456
)
 
(3,943
)
Tax effect
 
(192
)
 
559

 
111

 
1,283

Net of tax
 
609

 
(751
)
 
(345
)
 
(2,660
)
Foreign currency translation adjustment, net of tax
 
(58,154
)
 
56,587

 
(47,601
)
 
72,017

Total other comprehensive (loss) income
 
(57,545
)
 
55,836

 
(47,946
)
 
69,357

Total comprehensive (loss) income
 
$
(42,479
)
 
$
103,334

 
$
(19,607
)
 
$
128,126



See accompanying notes to the condensed consolidated financial statements
6



LIVANOVA PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(UNAUDITED)
 
 
June 30, 2018
 
December 31, 2017
ASSETS
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
47,380

 
$
93,615

Accounts receivable, net of allowance of $9,561 at June 30, 2018 and $9,418 at December 31, 2017
 
261,915

 
282,145

Inventories
 
157,831

 
144,470

Prepaid and refundable taxes
 
51,944

 
46,274

Assets held for sale
 

 
13,628

Assets of discontinued operations
 

 
250,689

Prepaid expenses and other current assets
 
35,621

 
39,037

Total Current Assets
 
554,691

 
869,858

Property, plant and equipment, net
 
186,156

 
192,359

Goodwill
 
965,697

 
784,242

Intangible assets, net
 
798,434

 
535,397

Investments
 
21,130

 
34,492

Deferred tax assets, net
 
65,539

 
11,559

Other assets
 
5,489

 
75,984

Total Assets
 
$
2,597,136

 
$
2,503,891

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current Liabilities:
 
 
 
 
Current debt obligations
 
$
110,588

 
$
84,034

Accounts payable
 
86,914

 
85,915

Accrued liabilities and other
 
86,153

 
78,942

Taxes payable
 
23,089

 
12,826

Accrued employee compensation and related benefits
 
61,276

 
66,224

Liabilities of discontinued operations
 

 
78,075

Total Current Liabilities
 
368,020

 
406,016

Long-term debt obligations
 
50,413

 
61,958

Contingent consideration
 
178,449

 
33,973

Deferred income taxes liability
 
154,404

 
123,342

Long-term employee compensation and related benefits
 
29,328

 
28,177

Other long-term liabilities
 
33,488

 
35,111

Total Liabilities
 
814,102

 
688,577

Commitments and contingencies (Note 11)
 

 

Stockholders’ Equity:
 
 
 
 
Ordinary Shares, £1.00 par value: unlimited shares authorized; 48,661,493 shares issued and 48,584,123 shares outstanding at June 30, 2018; 48,290,276 shares issued and 48,287,346 shares outstanding at December 31, 2017
 
75,269

 
74,750

Additional paid-in capital
 
1,744,262

 
1,735,048

Accumulated other comprehensive (loss) income
 
(2,633
)
 
45,313

Accumulated deficit
 
(33,755
)
 
(39,664
)
Treasury stock at cost, 77,370 shares at June 30, 2018 and 2,930 shares at December 31, 2017
 
(109
)
 
(133
)
Total Stockholders’ Equity
 
1,783,034

 
1,815,314

Total Liabilities and Stockholders’ Equity
 
$
2,597,136

 
$
2,503,891


See accompanying notes to the condensed consolidated financial statements
7



LIVANOVA PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
 
 
Six Months Ended June 30,
 
 
2018
 
2017
Operating Activities:
 
 
 
 
Net income
 
$
28,339

 
$
58,769

Non-cash items included in net income:
 
 
 
 
Depreciation
 
16,624

 
17,998

Amortization
 
18,609

 
23,095

Stock-based compensation
 
14,220

 
8,564

Deferred income tax benefit
 
(9,909
)
 
(19,791
)
Losses from equity method investments
 
1,838

 
18,482

Gain on acquisitions
 
(11,484
)
 
(39,428
)
Impairment of property, plant and equipment
 
480

 
4,581

Amortization of income taxes payable on inter-company transfers of property
 
5,166

 
17,770

Remeasurement of contingent consideration to fair value
 
(5,546
)
 
155

Other
 
(943
)
 
1,675

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable, net
 
21,799

 
(15,912
)
Inventories
 
(11,285
)
 
(6,927
)
Other current and non-current assets
 
(15,786
)
 
(13,904
)
Accounts payable and accrued current and non-current liabilities
 
(3,870
)
 
(12,438
)
Restructuring reserve
 
284

 
(11,129
)
Net cash provided by operating activities
 
48,536

 
31,560

Investing Activities:
 


 


Acquisitions, net of cash acquired
 
(279,863
)
 
(14,194
)
Purchases of property, plant and equipment and other
 
(13,231
)
 
(14,923
)
Proceeds from the sale of CRM business franchise
 
186,682

 

Proceeds from sale of cost-method investment
 

 
3,192

Loans to equity method investees
 

 
(6,834
)
Proceeds from asset sales
 
13,222

 
5,170

Other
 

 
(145
)
Net cash used in investing activities
 
(93,190
)
 
(27,734
)
Financing Activities:
 
 
 
 
Change in short-term borrowing, net
 
(17,971
)
 
(12,812
)
Proceeds from short-term borrowing (maturities greater than 90 days)
 
240,000

 
20,000

Repayment of short-term borrowing (maturities greater than 90 days)
 
(190,000
)
 

Repayment of long-term debt obligations
 
(12,240
)
 
(11,306
)
Proceeds from exercise of stock options
 
2,731

 
2,442

Payment of deferred consideration - acquisition of Caisson Interventional, LLC
 
(14,073
)
 

Shares repurchased from employees for minimum tax withholding
 
(7,130
)
 
(1,594
)
Other
 
(390
)
 
(97
)
Net cash provided by (used in) financing activities
 
927

 
(3,367
)
Effect of exchange rate changes on cash and cash equivalents
 
(2,508
)
 
2,442

Net (decrease) increase in cash and cash equivalents
 
(46,235
)
 
2,901

Cash and cash equivalents at beginning of period
 
93,615

 
39,789

Cash and cash equivalents at end of period
 
$
47,380

 
$
42,690


See accompanying notes to the condensed consolidated financial statements
8



LIVANOVA PLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Unaudited Condensed Consolidated Financial Statements
Basis of Presentation
The accompanying condensed consolidated financial statements of LivaNova as of, and for the three and six months ended June 30, 2018 and June 30, 2017, have been prepared in accordance with U.S. GAAP for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. The accompanying condensed consolidated balance sheet of LivaNova at December 31, 2017 has been derived from audited financial statements contained in our 2017 Form 10-K, but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) considered necessary for a fair statement of the operating results of LivaNova and its subsidiaries, for the three and six months ended June 30, 2018 and are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. The financial information presented herein should be read in conjunction with the audited consolidated financial statements and notes thereto accompanying our 2017 Form 10-K.
Sale of our Cardiac Rhythm Management Business Franchise
We completed the sale of our Cardiac Rhythm Management (“CRM”) business franchise to MicroPort Cardiac Rhythm B.V. and MicroPort Scientific Corporation (the “CRM Sale”) on April 30, 2018 for total cash proceeds of $195.9 million, less cash transferred of $9.2 million, subject to certain closing adjustments. In conjunction with the CRM Sale, we entered into transition services agreements to provide certain support services for generally up to twelve months from the closing date of the sale. We previously concluded that the sale of CRM represents a strategic shift in our business that will have a major effect on future operations and financial results. As a result, we classified the operating results of CRM as discontinued operations in our condensed consolidated statements of income. The assets and liabilities of CRM are presented as assets or liabilities of discontinued operations in the condensed consolidated balance sheet at December 31, 2017.
Reclassification of Prior-Year Comparative Period Presentation
We have reclassified certain prior period amounts for comparative purposes. These reclassifications did not have a material effect on our financial condition, results of operations or cash flows.
To conform the presentation on the condensed consolidated statement of cash flows for the six months ended June 30, 2017, to the presentation for the year ended December 31, 2017 in our 2017 Form 10-K, loans to cost and equity method investees of $6.8 million was reclassified to Investing Activities from Financing Activities.
We reclassified $34.0 million to contingent consideration from other long-term liabilities at December 31, 2017 to conform to the presentation on the condensed consolidated balance sheet at June 30, 2018.
Significant Accounting Policies
Our significant accounting policies are detailed in "Note 2: Basis of Presentation, Use of Accounting Estimates and Significant Accounting Policies" of our 2017 Form 10-K.
On January 1, 2018, we adopted ASC Update (“ASU”) No 2014-09, Revenue from Contracts with Customers. Refer to “Note 2. Revenue Recognition.” We elected the cumulative effect transition method; however, we recognized no cumulative effect to the opening balance of retained earnings because the impact on the timing of when revenue is recognized within our Cardiac Surgery segment, specifically related to heart-lung machines and preventative maintenance contracts on cardiopulmonary equipment, was insignificant. The timing of revenue recognition for products and related revenue streams within our Neuromodulation segment and discontinued operations did not change.
Note 2. Revenue Recognition
We generate our revenue through contracts with customers that primarily consist of hospitals, healthcare institutions, distributors and other organizations. Revenue is measured based on consideration specified in a contract with a customer, and excludes amounts collected on behalf of third parties. We measure the consideration based upon the estimated amount to be received. The amount of consideration we ultimately receive varies depending upon the return terms, sales rebates, discounts, and other incentives that we may offer, which are accounted for as variable consideration when estimating the amount of revenue to recognize. The estimate of variable consideration requires significant judgment.

9



We have historically experienced a low rate of product returns and the total dollar value of product returns has not been significant to our financial statements.
We recognize revenue when a performance obligation is satisfied by transferring the control of a product or providing service to a customer. Some of our contracts include the purchase of multiple products and/or services. In such cases, we allocate the transaction price based upon the relative estimated stand-alone price of each product and/or service sold. We record state and local sales taxes net; that is, we exclude sales tax from revenue. Typically, our contracts do not have a significant financing component.
We incur incremental commission fees paid to the sales force associated with the sale of products. We apply the practical expedient within ASC 606-10-50-22 and have elected to recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset the entity would otherwise recognize is one year or less. As a result, no commissions are capitalized as contract costs at June 30, 2018.
The following is a description of the principal activities (separated by reportable segments) from which we generate our revenue. For more detailed information about our reportable segments including disaggregated revenue results by major product line and primary geographic markets, see “Note 16. Geographic and Segment Information”.
Cardiac Surgery Products and Services
The Cardiac Surgery (“CS”) segment has three primary product lines: cardiopulmonary products, heart valves and advanced circulatory support.
Cardiopulmonary products include oxygenators, heart-lung machines, autotransfusion systems, perfusion tubing systems, cannulae and other related accessories. Heart valves include mechanical heart valves, tissue heart valves and related repair products. Technical services include installation, repair and maintenance of cardiopulmonary equipment under service contracts or upon customer request.
Cardiopulmonary products may include performance obligations associated with assembly and installation of equipment. Accordingly, we allocate a portion of the sales prices to installation obligations and recognize that revenue when the service is provided. We recognize revenue for equipment and accessory product sales when control of the equipment or product passes to the customer.
Heart valve revenue is recognized when control passes to the customer, usually at the point of surgery.
Advanced circulatory support revenue, which represents our recently acquired TandemLife business, is principally derived from the sale of temporary life support product kits that can include a combination of pumps, oxygenators, and cannulae. Revenue is recognized when control passes to the customer, usually at the point of shipment.
Technical service agreements generally provide for upfront payments in advance of rendering services or periodic billing over the contract term. Amounts billed in advance are deferred and recognized as revenue when the performance obligation is satisfied. Technical services are not a significant component of CS revenue and have been presented with the related equipment and accessories revenue.
Neuromodulation Products
Our Neuromodulation (“NM”) segment generates its revenue from the sale of neuromodulation therapy systems for the treatment of drug-resistant epilepsy, treatment-resistant depression and obstructive sleep apnea. The NM product line includes the VNS Therapy System, which consists of an implantable pulse generator, a lead that connects the generator to the vagus nerve, and other accessories. The NM product line also includes an implantable device for the treatment of obstructive sleep apnea that stimulates multiple tongue muscles via the hypoglossal nerve, which opens the airway while a patient is sleeping. We recognize revenue for product sales when control passes to the customer.
Discontinued Operations: Cardiac Rhythm Management Products
CRM generated revenue from the sale of products for the diagnosis, treatment, and management of heart rhythm disorders and heart failure. CRM devices include high-voltage defibrillators and low-voltage pacemakers. We recognize revenue for product sales when control passes to the customer.
Contract Balances
Due to the nature of our products and services, revenue producing activities may result in contract assets and contract liabilities which are insignificant to our financial position and results of operations. These activities relate primarily to CS technical services contracts for short-term and multi-year service agreements. Contract assets are primarily comprised of unbilled revenues, which occur when a performance obligation has been completed, but not billed to the customer. Contract

10



liabilities are made up of deferred revenue, which occurs when a customer pays for a service, before a performance obligation has been completed. Contract assets are included within “Prepaid expenses and other current assets” in the condensed consolidated balance sheets and were insignificant at June 30, 2018 and December 31, 2017. As of June 30, 2018 and December 31, 2017, contract liabilities of $5.1 million and $3.8 million, respectively, are included within “Accrued liabilities and other” and “Other long-term liabilities” in the condensed consolidated balance sheets.
Note 3. Business Combinations
Caisson Interventional, LLC
On May 2, 2017, we acquired the remaining 51% equity interests in Caisson Interventional, LLC (Caisson”) for a purchase price of up to $72.0 million, net of $6.3 million of debt forgiveness, consisting of $18.0 million paid at closing, $14.4 million paid during the second quarter of 2018, and contingent consideration of up to $39.6 million to be paid on a schedule driven primarily by regulatory approvals and a sales-based earnout. Caisson is focused on the design, development and clinical evaluation of a novel transcatheter mitral valve replacement (“TMVR”) implant device with a fully transvenous delivery system for the treatment of mitral valve regurgitation. The purchase price allocation was finalized during the second quarter of 2018 and there were no adjustments to the preliminary purchase price allocation during the measurement period.
We performed a quantitative impairment assessment, as of April 1, 2018, for the goodwill and in-process research and development assets arising from the Caisson acquisition. Based upon the assessment performed, we determined that the goodwill and the in-process research and development assets were not impaired. The quantitative impairment assessment was performed using management’s current estimate of future cash flows which are based on the expected timing of future regulatory approvals. A delay in the anticipated timing of these regulatory approvals or a change in management’s estimates could result in a fair value of the in-process research and development that is below its carrying amount. We will continue to monitor any changes in circumstances for indicators of impairment.
ImThera Medical, Inc.
On January 16, 2018, we acquired the remaining 86% outstanding interest in ImThera Medical, Inc. (“ImThera”) for cash consideration of up to $225 million. Cash of $78.3 million was paid at closing with the balance to be paid based on achievement of a certain regulatory milestone and a sales-based earnout.
Headquartered in San Diego, California, ImThera manufactures an implantable device for the treatment of obstructive sleep apnea that stimulates multiple tongue muscles via the hypoglossal nerve, which opens the airway while a patient is sleeping. ImThera has a commercial presence on the European market, and an FDA pivotal study is ongoing in the U.S. ImThera is highly aligned with our Neuromodulation Business Franchise.
The following table presents the acquisition date fair value of the consideration transferred and the fair value of our interest in ImThera prior to the acquisition (in thousands):
Cash
 
$
78,332

Contingent consideration
 
112,744

Fair value of our interest in ImThera prior to the acquisition (1)
 
25,580

Fair value of consideration transferred
 
$
216,656

(1)
The fair value of our previously-held interest in ImThera was determined based on the fair value of total consideration transferred and application of a discount for lack of control. As a result, we recognized a gain of $11.5 million for the fair value in excess of our carrying value of $14.1 million. The gain is reflected as “Gain on acquisitions” on our condensed consolidated statement of income for the six months ended June 30, 2018.

11



The following table presents the preliminary purchase price allocation at fair value for the ImThera acquisition including certain measurement period adjustments (in thousands):
 
 
Initial Purchase Price Allocation
 
Measurement Period Adjustments (1)
 
Adjusted Purchase Price Allocation
In-process research and development (2)
 
$
151,605

 
$
10,677

 
$
162,282

Developed technology
 
5,661

 
(5,661
)
 

Goodwill
 
87,063

 
(4,467
)
 
82,596

Deferred income tax liabilities, net (3)
 
(27,980
)
 
(1,278
)
 
(29,258
)
Other assets and liabilities, net
 
836

 
200

 
1,036

Net assets acquired
 
$
217,185

 
$
(529
)
 
$
216,656

(1)
During the second quarter of 2018, measurement period adjustments were recorded based upon new information obtained about facts and circumstances that existed as of the acquisition date.
(2)
The fair value of in-process research and development ("IPR&D") was determined using the income approach, which is a valuation technique that provides a fair value estimate based on the market participant expectations of cash flows the asset would generate. The cash flows were discounted commensurate with the level of risk associated with the asset. The discount rates were developed after assigning a probability of success to achieving the projected cash flows based on the current stage of development, inherent uncertainty in reaching certain regulatory milestones and risks associated with commercialization of the product. The IPR&D amount is included in “Intangible assets, net” in the condensed consolidated balance sheet at June 30, 2018.
(3)
The amount includes a provisional estimate for deferred tax assets acquired.
Goodwill arising from the ImThera acquisition, which is not deductible for tax purposes, primarily represents the synergies anticipated between ImThera and our existing neuromodulation business. The assets acquired, including goodwill, are recognized in our Neuromodulation segment.
During the second quarter of 2018, we determined that developments in the ImThera clinical trial will result in a minimum 12-month delay of regulatory approval. This delay constituted a triggering event that required evaluation of the in-process research and development asset for impairment. Based on the quantitative impairment evaluation, the in-process research and development asset was not impaired; however, a further delay or a change in management’s estimates could result in a fair value that is below the carrying amount for such an asset. We will continue to monitor any changes in circumstances for indicators of impairment.
The results of the ImThera acquisition added $0.1 million and $0.2 million in revenue and $2.6 million and $3.6 million in operating losses during the three and six months ended June 30, 2018, respectively. Additionally, we recognized ImThera acquisition-related expenses of approximately $0.2 million and $0.3 million for legal and valuation expenses during the three and six months ended June 30, 2018, respectively. These expenses are included within “Selling, general and administrative” expenses in the condensed consolidated statement of income. Pro forma financial information assuming the ImThera acquisition had occurred as of the beginning of the calendar year prior to the year of acquisition was not material for disclosure purposes.

12



The ImThera business combination involved contingent consideration arrangements composed of potential cash payments upon the achievement of a certain regulatory milestone and a sales-based earnout associated with sales of products covered by the purchase agreement. The sales-based earnout was valued using projected sales from our internal strategic plan. Both arrangements are Level 3 fair value measurements and include the following significant unobservable inputs (in thousands):
ImThera Acquisition
 
Fair value at January 16, 2018
 
Valuation Technique
 
Unobservable Input
 
Ranges
Regulatory milestone-based payment
 
$
50,429

 
Discounted cash flow
 
Discount rate
 
4.3% - 4.7%
 
 
 
 
 
 
Probability of payment
 
85% - 95%
 
 
 
 
 
 
Projected payment years
 
2020 - 2021
 
 
 
 
 
 
 
 
 
Sales-based earnout
 
62,315

 
Monte Carlo simulation
 
Risk-adjusted discount rate
 
11.5%
 
 
 
 
 
 
Credit risk discount rate
 
4.7% - 5.8%
 
 
 
 
 
 
Revenue volatility
 
29.3%
 
 
 
 
 
 
Probability of payment
 
85% - 95%
 
 

 
 
 
Projected years of earnout
 
2020 - 2025
 
 
$
112,744

 
 
 
 
 
 
TandemLife
On April 4, 2018, we acquired CardiacAssist, Inc., doing business as TandemLife (“TandemLife”) for cash consideration of up to $250 million. Cash of $204 million was paid at closing with up to $50 million in contingent consideration based on achieving regulatory milestones. TandemLife, headquartered in Pittsburgh, Pennsylvania, is focused on the delivery of leading-edge temporary life support systems, including cardiopulmonary and respiratory support solutions. TandemLife complements our Cardiac Surgery portfolio, and expands our existing line of cardiopulmonary products.
The following table presents the acquisition date fair value of the consideration transferred (in thousands):
Cash
 
$
203,671

Contingent consideration
 
40,190

Fair value of consideration transferred
 
$
243,861

The following table presents the preliminary purchase price allocation at fair value for the TandemLife acquisition (in thousands):
In-process research and development (1) (2) (3)
 
$
110,977

Trade names (1)
 
11,539

Developed technology (1)
 
6,387

Goodwill
 
118,917

Inventory
 
10,296

Other assets and liabilities, net
 
3,632

Deferred income tax liabilities, net (3)
 
(17,887
)
Net assets acquired
 
$
243,861

(1)
The amounts above are included in “Intangible assets, net” in the condensed consolidated balance sheet at June 30, 2018. Trade names and developed technology are amortized over remaining useful lives of 15 and 2 years, respectively.
(2)
The fair value of in-process research and development ("IPR&D") was determined using the income approach, which is a valuation technique that provides a fair value estimate based on the market participant expectations of cash flows the asset would generate. The cash flows were discounted commensurate with the level of risk associated with the asset. The discount rates were developed after assigning a probability of success to achieving the projected cash flows based on the current stage of development, inherent uncertainty in reaching certain regulatory milestones and risks associated with commercialization of the product.
(3)
The amounts include provisional estimates based on the information available as of the acquisition date. The Company is gathering additional information necessary to finalize the estimated fair values for deferred tax assets acquired and IPR&D.

13



Goodwill arising from the TandemLife acquisition, which is not deductible for tax purposes, primarily represents the synergies anticipated between TandemLife and our existing cardiac surgery business. The assets acquired, including goodwill, are recognized in our Cardiac Surgery segment.
The results of the TandemLife acquisition added $6.0 million in revenue and $6.1 million in operating losses during each of the three and six months ended June 30, 2018. Additionally, we recognized TandemLife acquisition-related expenses of approximately $1.6 million and $1.9 million for legal and valuation expenses during the three and six months ended June 30, 2018, respectively. These expenses are included within “Selling, general and administrative” expenses in the condensed consolidated statement of income. Pro forma financial information assuming the TandemLife acquisition had occurred as of the beginning of the calendar year prior to the year of acquisition was not material for disclosure purposes.
The TandemLife business combination involved a contingent consideration arrangement composed of potential cash payments upon the achievement of certain regulatory milestones. The arrangement is a Level 3 fair value measurement and includes the following significant unobservable inputs (in thousands):
TandemLife Acquisition
 
Fair value at April 4, 2018
 
Valuation Technique
 
Unobservable Input
 
Ranges
Regulatory milestone-based payments
 
$
40,190

 
Discounted cash flow
 
Discount rate
 
4.2% - 4.8%
 
 
 
 
 
 
Probability of payments
 
75% - 95%
 
 
 
 
 
 
Projected payment years
 
2019 - 2020
Note 4. Discontinued Operations
In November 2017, we concluded that the sale of CRM represented a strategic shift in our business that would have a major effect on future operations and financial results. As a result, we classified the operating results of CRM as discontinued operations in our condensed consolidated statements of income for all the periods presented in this Quarterly Report on Form 10-Q. The assets and liabilities of CRM are presented as assets or liabilities of discontinued operations in the condensed consolidated balance sheets at December 31, 2017.
We completed the CRM Sale on April 30, 2018 for total cash proceeds of $195.9 million, less cash transferred of $9.2 million, subject to certain customary closing adjustments. In conjunction with the sale, we entered into transition services agreements to provide certain support services for generally up to twelve months from the closing date of the sale. The services include, among others, accounting, information technology, human resources, quality assurance, regulatory affairs, supply chain, clinical affairs and customer support. During the six months ended June 30, 2018, we recognized income of $0.9 million for providing these services. Income recognized related to the transition services agreements is recorded as a reduction to the related expenses in the associated expense line items in the condensed consolidated statements of income.

14



The following table represents assets and liabilities of CRM presented as assets and liabilities of discontinued operations in the condensed consolidated balance sheet:
 
 
December 31, 2017
Accounts receivable, net
 
$
64,684

Inventories
 
54,097

Prepaid taxes
 
14,725

Prepaid and other assets
 
3,498

Property, plant and equipment, net
 
12,104

Deferred tax assets, net
 
2,517

Investments
 
6,098

Intangible assets, net
 
92,966

Assets of discontinued operations
 
$
250,689

 
 
 
Accounts payable
 
26,501

Accrued liabilities and other
 
7,669

Taxes payable
 
5,084

Accrued employee compensation and benefits
 
30,753

Deferred income taxes liability
 
8,068

Liabilities of discontinued operations
 
$
78,075

The following table represents the financial results of CRM presented as net (loss) income from discontinued operations in the condensed consolidated statements of income:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018 (1)
 
2017
 
2018 (1)
 
2017
Revenues
$
27,206

 
$
65,544

 
$
87,313

 
$
123,824

Cost of sales
10,391

 
24,800

 
32,529

 
46,285

Gross profit
16,815

 
40,744

 
54,784

 
77,539

Selling, general and administrative expenses
15,073

 
25,960

 
46,899

 
50,997

Research and development
5,929

 
9,118

 
17,210

 
18,377

Merger and integration expenses

 
10

 

 
32

Restructuring expenses

 
(1,479
)
 
651

 
(1,359
)
Amortization of intangibles

 
3,565

 

 
7,019

Revaluation gain on assets and liabilities held for sale

 

 
(1,213
)
 

Loss on sale of CRM
214

 

 
214

 

Total operating expenses
21,216

 
37,174

 
63,761

 
75,066

Operating (loss) income from discontinued operations
(4,401
)
 
3,570

 
(8,977
)
 
2,473

Foreign exchange and other (losses) gains
(67
)
 
(402
)
 
12

 
(172
)
(Loss) income from discontinued operations, before tax
(4,468
)
 
3,168

 
(8,965
)
 
2,301

Income tax (benefit) expense
(6
)
 
54

 
(1,165
)
 
54

Losses from equity method investments

 
(1,295
)
 
(1,211
)
 
(2,384
)
Net (loss) income from discontinued operations (1)
$
(4,462
)
 
$
1,819

 
$
(9,011
)
 
$
(137
)
(1)
CRM financial results for the three and six month periods ended June 30, 2018 include activity through the close of the sale on April 30, 2018.
Cash flows attributable to our discontinued operations are included in our condensed consolidated statements of cash flows. For the six months ended June 30, 2018 and 2017, CRM’s capital expenditures were $0.9 million and $2.4 million, respectively

15



and stock-based compensation expense was $2.1 million and $0.3 million, respectively. For the six months ended June 30, 2017 depreciation and amortization was $9.9 million.
Note 5. Restructuring
Our 2015 and 2016 Reorganization Plans (the “Plans”) were initiated October 2015 and March 2016, respectively, in conjunction with the completion of the merger of Cyberonics, Inc. and Sorin S.p.A. in October 2015. We initiated these plans to leverage economies of scale, streamline distribution and logistics and strengthen operational and administrative effectiveness in order to reduce overall costs. Costs associated with these plans are reported as ‘Restructuring expenses’ in our operating results in the condensed consolidated statements of income.
In March 2017, we committed to a plan to sell our Suzhou Industrial Park facility in Shanghai, China. As a result of this exit plan we recorded an impairment of the building and equipment of $4.6 million and accrued $0.5 million of additional costs, primarily related to employee severance, during the six months ended June 30, 2017. The land, building and equipment were recorded as Assets held for sale on the condensed consolidated balance sheet as of December 31, 2017. We completed the sale of the Suzhou facility in April 2018 and received cash proceeds from the sale of $13.3 million.
The following table presents the Plans’ accruals, inventory obsolescence and other reserves, recorded in connection with the Reorganization Plans including the balances and activity related to the discontinued operations, (in thousands):
 
 
Employee Severance and Other Termination Costs
 
Other
 
Total
Balance at December 31, 2017
 
$
3,889

 
$
2,625

 
$
6,514

Charges
 
2,544

 
464

 
3,008

Cash payments and adjustments
 
(5,431
)
 
(470
)
 
(5,901
)
Balance at June 30, 2018
 
$
1,002

 
$
2,619

 
$
3,621

The following table presents restructuring expense by reportable segment, with discontinued operations included (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Cardiac Surgery (1)
 
$
398

 
$
501

 
$
1,739

 
$
6,503

Neuromodulation
 
11

 
(233
)
 
17

 
439

Other
 
67

 
2,329

 
601

 
5,685

Restructuring expense from continuing operations
 
476

 
2,597

 
2,357

 
12,627

Discontinued operations
 

 
(1,479
)
 
651

 
(1,359
)
Total
 
$
476

 
$
1,118

 
$
3,008

 
$
11,268

(1)
Cardiac Surgery restructuring expense for the six months ended June 30, 2017 included building and equipment impairment and additional costs of $5.1 million related to the Suzhou, China facility exit plan.
Note 6. Product Remediation Liability
On December 29, 2015, we received an FDA Warning Letter (the “Warning Letter”) alleging certain violations of FDA regulations applicable to medical device manufacturing at our Munich, Germany and Arvada, Colorado facilities. On October 13, 2016, the Centers for Disease Control and Prevention (“CDC”) and FDA separately released safety notifications regarding the 3T Heater-Cooler devices in response to which we issued a Field Safety Notice Update for U.S. users of 3T Heater-Cooler devices to proactively and voluntarily contact facilities to facilitate implementation of the CDC and FDA recommendations.
At December 31, 2016, we recognized a liability for a product remediation plan related to our 3T Heater-Cooler device (“3T device”). The remediation plan we developed consists primarily of a modification of the 3T device design to include internal sealing and the addition of a vacuum system to new and existing devices. These changes are intended to address regulatory actions and to reduce further the risk of possible dispersion of aerosols from 3T devices in the operating room. We concluded that it was probable that a liability had been incurred upon management’s approval of the plan and the commitments made by management to various regulatory authorities globally in November and December 2016, and furthermore, the cost associated

16



with the plan was reasonably estimable. The deployment of this solution for commercially distributed devices has been dependent upon final validation and verification of the design changes and approval or clearance by regulatory authorities worldwide, including FDA clearance in the U.S. It is reasonably possible that our estimate of the remediation liability could materially change in future periods due to the various significant assumptions involved such as customer behavior, market reaction and the timing of approvals or clearance by regulatory authorities worldwide.
In April 2017, we obtained CE Mark in Europe for the design change of the 3T device and in May 2017 we completed our first vacuum and sealing upgrade on a customer-owned device. We are currently implementing the vacuum and sealing upgrade program in as many countries as possible throughout 2018 and beyond until all devices are upgraded. As part of the remediation plan, we also intend to perform a no-charge deep disinfection service (deep cleaning service) for 3T device users as we receive the required regulatory approvals. On April 12, 2018, the FDA agreed to allow us to move forward with the deep cleaning service in the U.S., adding to the growing list of countries around the world in which we offer this service. Finally, we are continuing to offer the loaner program for 3T devices, initiated in the fourth quarter of 2016, to provide existing 3T device users with a new loaner 3T device at no charge pending regulatory approval and implementation of the vacuum system addition and deep disinfection service worldwide. This loaner program began in the U.S. and is being made available progressively on a global basis, prioritizing and allocating devices to 3T device users based on pre-established criteria.
Changes in the carrying amount of the product remediation liability are as follows (in thousands):
Balance at December 31, 2017
 
$
27,546

Remediation activity
 
(7,272
)
Effect of changes in foreign currency exchange rates
 
(557
)
Balance at June 30, 2018 (1)
 
$
19,717

(1)
At June 30, 2018, the product remediation liability balance is held within ‘Accrued liabilities and other’ and ‘Other long-term liabilities’ in the condensed consolidated balance sheet.
For further information, please refer to “Note 11. Commitments and Contingencies.” At this stage, we have recognized no liability with respect to any lawsuits related to the 3T device and our related legal costs are expensed as incurred.
Note 7. Investments
Cost-Method Investments
Our cost-method investments are included in “Investments” in the condensed consolidated balance sheets and consist of our equity positions in the following privately-held companies (in thousands):
 
 
June 30, 2018
 
December 31, 2017
Respicardia Inc. (1)
 
$
17,705

 
$
17,422

ImThera Medical, Inc. (2)
 

 
12,900

Rainbow Medical Ltd. (3)
 
1,140

 
1,172

MD Start II (4)
 
1,164

 
1,199

Highlife S.A.S. (5)
 
1,104

 

Other
 
17

 
17

 
 
$
21,130

 
$
32,710

(1)
Respicardia Inc. (“Respicardia”) is a privately funded U.S. company developing an implantable device designed to restore a more natural breathing pattern during sleep in patients with central sleep apnea ("CSA") by transvenously stimulating the phrenic nerve. We have a loan outstanding to Respicardia with a carrying amount of $0.5 million, as of June 30, 2018, which is included in “Prepaid expenses and other current assets” in the condensed consolidated balance sheet.
(2)
On January 16, 2018, we acquired the remaining outstanding interests in ImThera. Refer to “Note 3. Business Combinations”.
(3)
Rainbow Medical Ltd. is a private Israeli venture capital company that seeds and grows companies developing medical devices in a diverse range of medical fields.
(4)
MD Start II is a private venture capital collaboration for the development of medical device technology in Europe.
(5)
Due to an additional investment by a third party during the three months ended June 30, 2018, our equity interest in Highlife S.A.S. (“Highlife”) decreased to 17.5% from 24.6%. We determined that we no longer had significant influence over Highlife and it is now considered a cost method investment. The carrying amount of our equity-method investment in Highlife was $1.8 million at December 31, 2017.

17



Note 8. Fair Value Measurements
We review the fair value hierarchy classification on a quarterly basis. Changes in the ability to observe valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy. There were no transfers between Level 1, Level 2, or Level 3 during the six months ended June 30, 2018.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table provides information by level for assets and liabilities that are measured at fair value on a recurring basis (in thousands):
 
 
Fair Value as of June 30, 2018
 
Fair Value Measurements Using Inputs Considered as:
 
 
 
Level 1
 
Level 2
 
Level 3
Liabilities:
 
 
 
 
 
 
 
 
Derivative liabilities - designated as cash flow hedges (foreign currency exchange rate "FX")
 
$
1,209

 
$

 
$
1,209

 
$

Derivative liabilities - designated as cash flow hedges (interest rate swaps)
 
1,221

 

 
1,221

 

Derivative liabilities - freestanding instruments (FX)
 
827

 

 
827

 

Contingent consideration (1)
 
181,133

 

 

 
181,133

 
 
$
184,390

 
$

 
$
3,257

 
$
181,133

 
 
Fair Value as of December 31, 2017
 
Fair Value Measurements Using Inputs Considered as:
 
 
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Derivative assets - freestanding instruments (FX)
 
$
519

 
$

 
$
519

 
$

 
 
$
519

 
$

 
$
519

 
$

 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Derivative liabilities - designated as cash flow hedges (FX)
 
$
460

 
$

 
$
460

 
$

Derivative liabilities - designated as cash flow hedges (interest rate swaps)
 
1,585

 

 
1,585

 

Contingent consideration (1)
 
33,973

 

 

 
33,973

 
 
$
36,018

 
$

 
$
2,045

 
$
33,973

(1)
The contingent consideration liability represents contingent payments related to five completed acquisitions: Cellplex PTY Ltd., Inversiones Drilltex SAS, Caisson, ImThera and TandemLife. See the table below for additional information.

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Our recurring fair value measurements, using significant unobservable inputs (Level 3), relate solely to our contingent consideration liability. The following table provides a reconciliation of the beginning and ending balance of the contingent consideration liability (in thousands):
Total contingent consideration liability at December 31, 2017
 
$
33,973

Purchase price - ImThera contingent consideration
 
112,744

Purchase price - TandemLife contingent consideration
 
40,190

Payments
 
(196
)
Changes in fair value (1)
 
(5,546
)
Effect of changes in foreign currency exchange rates
 
(32
)
Total contingent consideration liability at June 30, 2018
 
181,133

Less current portion of contingent consideration liability at June 30, 2018
 
2,684

Long-term portion of contingent consideration liability at June 30, 2018
 
$
178,449

(1)
Includes a decrease of $6.1 million due to the delay in the timing of anticipated regulatory approval for ImThera. See “Note 3. Business Combinations” for additional discussion.
Note 9. Financing Arrangements
The outstanding principal amount of long-term debt (in thousands, except interest rates):
 
 
June 30, 2018
 
December 31, 2017
 
Maturity
 
Interest Rate
European Investment Bank (1)
 
$
58,213

 
$
69,893

 
June 2021

 
0.95
%
Mediocredito Italiano (2)
 
8,406

 
9,118

 
December 2023

 
0.50% - 3.10%

Banca del Mezzogiorno (3)
 
4,137

 
5,499

 
December 2019

 
0.50% - 3.15%

Region Wallonne
 
756

 
845

 
December 2023 and June 2033

 
0.00% - 2.45%

Mediocredito Italiano - mortgages and other
 
536

 
997

 
September 2021 and September 2026

 
0.80% - 1.30%

Bpifrance (ex-Oséo)
 

 
1,450

 

 
2.58
%
Total long-term facilities
 
72,048

 
87,802

 
 
 
 
Less current portion of long-term debt
 
21,635

 
25,844

 
 
 
 
Total long-term debt
 
$
50,413

 
$
61,958

 
 
 
 
(1)
The European Investment Bank (“EIB”) loan was obtained in July 2014 to support product development projects. The interest rate for the EIB loan is reset by the lender each quarter based on the Euribor. Interest payments are paid quarterly and principal payments are paid semi-annually.
(2)
We obtained the Mediocredito Italiano Bank loan in July 2016 as part of the Fondo Innovazione Teconologica program implemented by the Italian Ministry of Education.
(3)
The Banca del Mezzogiorno loan was obtained in January 2015 to support R&D projects as a part of the Large Strategic Project program of the Italian Ministry of Education.
Revolving Credit
The outstanding principal amount of our short-term unsecured revolving credit agreements and other agreements with various banks was $89.0 million and $58.2 million, at June 30, 2018 and December 31, 2017, respectively, with interest rates ranging from 0.1% to 9.3% and loan terms ranging from one day to 180 days.
On April 10, 2018, we entered into an amendment and restatement agreement with Barclays Bank PLC amending the revolving facility agreement originally dated October 21, 2016 (the “Amendment”). The Amendment increases the borrowing capacity under the facility from $40.0 million to $70.0 million and extends the term of the facility one year, terminating October 20, 2019. Borrowings under the facility bear interest at a rate of LIBOR plus 0.85%. At June 30, 2018 this facility is fully utilized.
In connection with the CRM sale, the borrowing capacity under our June 2017 finance contract with the European Investment Bank decreased from €100.0 million (approximately $116.4 million) to €90.0 million (approximately $104.8 million) and the availability for drawdowns was extended through December 31, 2020.

19



Bridge Facility Agreement
In connection with the April 2018 acquisition of TandemLife, LivaNova entered into a bridge facility agreement (the “Bridge Facility Agreement”) providing a term loan facility with the aggregate principal amount of $190.0 million. On April 3, 2018, we borrowed $190.0 million under the Bridge Facility Agreement to facilitate the initial payment for our acquisition of TandemLife. We used the proceeds from the sale of the CRM business franchise to repay the borrowings under the Bridge Facility Agreement in full during the second quarter of 2018.
Note 10. Derivatives and Risk Management
Due to the global nature of our operations, we are exposed to foreign currency exchange rate fluctuations. In addition, due to certain loans with floating interest rates, we are also subject to the impact of changes in interest rates on our interest payments. We enter into foreign currency exchange rate (“FX”) derivative contracts and interest rate swap contracts to reduce the impact of foreign currency rate and interest rate fluctuations on earnings and cash flow. We measure all outstanding derivatives each period end at fair value and report the fair value as either financial assets or liabilities in the condensed consolidated balance sheets. We do not enter into derivative contracts for speculative purposes. At inception of the contract, the derivative is designated as either a freestanding derivative or a hedge. Derivatives that are not designated as hedging instruments are referred to as freestanding derivatives with changes in fair value included in earnings.
If the derivative qualifies for hedge accounting, depending on the nature of the hedge and hedge effectiveness, changes in the fair value of the derivative will either be recognized immediately in earnings or recorded in accumulated other comprehensive income (“AOCI”) until the hedged item is recognized in earnings upon settlement/termination. FX derivative gains and losses in AOCI are reclassified to the condensed consolidated statements of income as shown in the tables below and interest rate swap gains and losses in AOCI are reclassified to interest expense in the condensed consolidated statements of income. We evaluate hedge effectiveness at inception and on an ongoing basis. If a derivative is no longer expected to be highly effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is recorded in earnings. Cash flows from derivative contracts are reported as operating activities in the condensed consolidated statements of cash flows.
Freestanding Derivative FX Contracts
The gross notional amount of FX derivative contracts, not designated as hedging instruments, outstanding at June 30, 2018 and December 31, 2017 was $256.0 million and $231.9 million, respectively. These derivative contracts are designed to offset the FX effects in earnings of various intercompany loans, our EIB loan, and trade receivables. We recorded net losses for these freestanding derivatives of $4.1 million and $5.4 million for the three months ended June 30, 2018 and June 30, 2017, respectively and net losses of $11.7 million and $7.2 million for the six months ended June 30, 2018 and June 30, 2017, respectively. The net losses are included in “Foreign exchange and other (losses) gains” in the condensed consolidated statements of income.
Cash Flow Hedges
Notional amounts of open derivative contracts designated as cash flow hedges (in thousands):
Description of Derivative Contract
 
June 30, 2018
 
December 31, 2017
FX derivative contracts to be exchanged for British Pounds
 
$
11,655

 
$
16,847

FX derivative contracts to be exchanged for Japanese Yen
 
22,122

 
32,302

FX derivative contracts to be exchanged for Canadian Dollars
 
15,779

 
16,494

FX derivative contracts to be exchanged for Euros
 
38,581

 

Interest rate swap contracts
 
46,570

 
55,965

 
 
$
134,707

 
$
121,608


20



After-tax net loss associated with derivatives designated as cash flow hedges recorded in the ending balance of AOCI and the amount expected to be reclassified to earnings in the next twelve months (in thousands):
Description of Derivative Contract
 
June 30, 2018
 
Amount Expected to be Reclassified to Earnings in Next 12 Months
FX derivative contracts
 
$
(1,011
)
 
$
(1,011
)
Interest rate swap contracts
 
(253
)
 
(64
)
 
 
$
(1,264
)
 
$
(1,075
)
Pre-tax gains (losses) for derivative contracts designated as cash flow hedges recognized in Other Comprehensive Income (Loss) (“OCI”) and the amount reclassified to earnings from AOCI (in thousands):
 
 
 
 
Three Months Ended June 30,
 
 
 
 
2018
 
2017
Description of Derivative Contract
 
Location in Earnings of Reclassified Gain or Loss
 
Losses Recognized in OCI
 
(Losses) Gains Reclassified from AOCI to Earnings
 
Losses Recognized in OCI
 
(Losses) Gains Reclassified from AOCI to Earnings
FX derivative contracts
 
Foreign exchange and other gains (losses)
 
$
(25
)
 
$
(1,358
)
 
$
(755
)
 
$
(532
)
FX derivative contracts
 
SG&A
 

 
549

 

 
544

Interest rate swap contracts
 
Interest expense
 

 
(17
)
 

 
543

 
 
 
 
$
(25
)
 
$
(826
)
 
$
(755
)
 
$
555

 
 
 
 
Six Months Ended June 30,
 
 
 
 
2018
 
2017
Description of Derivative Contract
 
Location in Earnings of Reclassified Gain or Loss
 
Gains Recognized in OCI
 
(Losses) Gains Reclassified from AOCI to Earnings
 
Losses Recognized in OCI
 
(Losses) Gains Reclassified from AOCI to Earnings
FX derivative contracts
 
Foreign exchange and other gains (losses)
 
$
189

 
$
(512
)
 
$
(7,587
)
 
$
(5,210
)
FX derivative contracts
 
SG&A
 

 
1,174

 

 
1,354

Interest rate swap contracts
 
Interest expense
 

 
(17
)
 

 
212

 
 
 
 
$
189

 
$
645

 
$
(7,587
)
 
$
(3,644
)

21



The following tables present the fair value on a gross basis, and the location of, derivative contracts reported in the condensed consolidated balance sheets (in thousands):
June 30, 2018
 
Liability Derivatives
Derivatives Designated as Hedging Instruments
 
Balance Sheet Location
 
Fair Value (1)
Interest rate swap contracts
 
Accrued liabilities
 
$
683

Interest rate swap contracts
 
Other long-term liabilities
 
538

FX derivative contracts
 
Accrued liabilities
 
1,209

Total derivatives designated as hedging instruments
 

 
2,430

Derivatives Not Designated as Hedging Instruments
 

 

FX derivative contracts
 
Accrued liabilities
 
827

Total derivatives not designated as hedging instruments
 

 
827

Total derivatives
 

 
$
3,257

December 31, 2017
 
Asset Derivatives
 
Liability Derivatives
Derivatives Designated as Hedging Instruments
 
Balance Sheet Location
 
Fair Value (1)
 
Balance Sheet Location
 
Fair Value (1)
Interest rate swap contracts
 
Prepaid expenses and other current assets
 
$

 
Accrued liabilities
 
$
834

Interest rate swap contracts
 
Other assets
 

 
Other long-term liabilities
 
751

FX derivative contracts
 
Prepaid expenses and other current assets
 

 
Accrued liabilities
 
460

Total derivatives designated as hedging instruments
 
 
 

 
 
 
2,045

Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
FX derivative contracts
 
Prepaid expenses and other current assets
 
519

 
Accrued liabilities
 

Total derivatives not designated as hedging instruments
 
 
 
519

 
 
 

Total derivatives
 
 
 
$
519

 
 
 
$
2,045

(1)
For the classification of inputs used to evaluate the fair value of our derivatives, refer to “Note 8. Fair Value Measurements.”
Note 11. Commitments and Contingencies
FDA Warning Letter
On December 29, 2015, the FDA issued a Warning Letter alleging certain violations of FDA regulations applicable to medical device manufacturers at our Munich, Germany and Arvada, Colorado facilities.
The FDA inspected the Munich facility from August 24, 2015 to August 27, 2015 and the Arvada facility from August 24, 2015 to September 1, 2015. On August 27, 2015, the FDA issued a Form 483 identifying two observed non-conformities with certain regulatory requirements at the Munich facility. We did not receive a Form 483 in connection with the FDA’s inspection of the Arvada facility. Following the receipt of the Form 483, we provided written responses to the FDA describing corrective and preventive actions that were underway or to be taken to address the FDA’s observations at the Munich facility. The Warning Letter responded in part to our responses and identified other alleged violations related to the manufacture of our 3T device that were not previously included in the Form 483.

22



The Warning Letter further stated that our 3T devices and other devices we manufactured at our Munich facility are subject to refusal of admission into the U.S. until resolution of the issues set forth by the FDA in the Warning Letter. The FDA has informed us that the import alert is limited to the 3T devices, but that the agency reserves the right to expand the scope of the import alert if future circumstances warrant such action. The Warning Letter did not request that existing users cease using the 3T device, and manufacturing and shipment of all of our products other than the 3T device remain unaffected by the import limitation. To help clarify these issues for current customers, we issued an informational Customer Letter in January 2016 and that same month agreed with the FDA on a process for shipping 3T devices to existing U.S. users pursuant to a certificate of medical necessity program.
Finally, the Warning Letter stated that premarket approval applications for Class III devices to which certain Quality System regulation deviations identified in the Warning Letter are reasonably related will not be approved until the violations have been corrected; however, this restriction applies only to the Munich and Arvada facilities, which do not manufacture or design devices subject to Class III premarket approval.
We continue to work diligently to remediate the FDA’s inspectional observations for the Munich facility, as well as the additional issues identified in the Warning Letter. We take these matters seriously and intend to respond timely and fully to the FDA’s requests.
CDC and FDA Safety Communications and Company Field Safety Notice Update
On October 13, 2016, the CDC and the FDA separately released safety notifications regarding the 3T devices. The CDC’s Morbidity and Mortality Weekly Report (“MMWR”) and Health Advisory Notice (“HAN”) reported that tests conducted by CDC and its affiliates indicate that there appears to be genetic similarity between both patient and 3T device strains of the non-tuberculous mycobacterium (“NTM”) bacteria M. chimaera isolated in hospitals in Iowa and Pennsylvania. Citing the geographic separation between the two hospitals referenced in the investigation, the report asserts that 3T devices manufactured prior to August 18, 2014 could have been contaminated during the manufacturing process. The CDC’s HAN and FDA’s Safety Communication, issued contemporaneously with the MMWR report, each assess certain risks associated with 3T devices and provide guidance for providers and patients. The CDC notification states that the decision to use the 3T device during a surgical operation is to be taken by the surgeon based on a risk approach and on patient need. Both the CDC’s and FDA’s communications confirm that 3T devices are critical medical devices and enable doctors to perform life-saving cardiac surgery procedures.
Also on October 13, 2016, in response to the Warning Letter and CDC’s HAN and FDA’s Safety Communication, we issued a Field Safety Notice Update for U.S. users of 3T devices to proactively and voluntarily contact facilities to aid in implementation of the CDC and FDA recommendations. In the fourth quarter of 2016, we initiated a program to provide existing 3T device users with a new loaner 3T device at no charge pending regulatory approval and implementation of additional risk mitigation strategies worldwide. This loaner program began in the U.S. and is being made available progressively on a global basis, prioritizing and allocating devices to 3T device users based on pre-established criteria. We anticipate that this program will continue until we are able to address customer needs through a broader solution that includes implementation of one or more of the risk mitigation strategies currently under review with regulatory agencies. We are also currently implementing a vacuum and sealing upgrade program in as many countries as possible throughout 2018 and beyond until all devices are upgraded. Furthermore, we intend to perform a no-charge deep disinfection service (deep cleaning service) for 3T device users as we receive the required regulatory approvals. On April 12, 2018, the FDA agreed to allow us to move forward with the deep cleaning service in the U.S. adding to the growing list of countries around the world in which we offer this service.
On December 31, 2016, we recognized a liability for our product remediation plan related to our 3T device. We concluded that it was probable that a liability had been incurred upon management’s approval of the plan and the commitments made by management to various regulatory authorities globally in November and December 2016, and furthermore, the cost associated with the plan was reasonably estimable. At June 30, 2018, the product remediation liability was $19.7 million. Refer to “Note 6. Product Remediation Liability” for additional information.
Litigation
Product Liability
The Company is currently involved in litigation involving our 3T device. The litigation includes a class action complaint in the U.S. District Court for the Middle District of Pennsylvania, federal multi-district litigation in the U.S. District Court for the Middle District of Pennsylvania, various U.S. state court cases and cases in jurisdictions outside the U.S. As of July 31, 2018, we are involved in approximately 135 claims worldwide, with the majority of the claims in various federal or state courts throughout the United States. The complaints generally seek damages and other relief based on theories of strict liability,

23



negligence, breach of express and implied warranties, failure to warn, design and manufacturing defect, fraudulent and negligent misrepresentation/concealment, unjust enrichment, and violations of various state consumer protection statutes. The class action consists of all Pennsylvania residents who underwent open heart surgery at WellSpan York Hospital and Penn State Milton S. Hershey Medical Center between 2011 and 2015 and who currently are asymptomatic for NTM infection. Members of the class seek declaratory relief that the 3T devices are defective and unsafe for intended uses, medical monitoring, damages, and attorneys’ fees. LivaNova has filed a petition for permission to appeal the class certification order with the U.S. Court of Appeals for the Third Circuit. We have not recognized an expense related to damages in connection with these matters because any potential loss is not currently probable or reasonably estimable. In addition, we cannot reasonably estimate a range of potential loss, if any, that may result from these matters.
Civil Investigative Demand
On May 31, 2017, the Company received a Civil Investigative Demand (“CID”) from the US Attorney’s Office for the Northern District of Georgia.  The CID requested, and we have provided, certain documents relating to the sales and marketing of VNS devices and related products in the State of Georgia.  We have not recognized an expense related to this matter because any potential loss is not currently probable or reasonably estimable. In addition we cannot reasonably estimate a range of potential loss, if any, that may result from this matter.
Environmental Liability
SNIA Litigation
Our subsidiary, Sorin S.p.A. (“Sorin”) was created as a result of a spin-off (the “Sorin spin-off”) from SNIA S.p.A. (“SNIA”) in January, 2004. SNIA subsequently became insolvent and the Italian Ministry of the Environment and the Protection of Land and Sea (the “Italian Ministry of the Environment”), sought compensation from SNIA in an aggregate amount of approximately $4 billion for remediation costs relating to the environmental damage at chemical sites previously operated by SNIA’s other subsidiaries.
In September 2011 and July 2014, the Bankruptcy Court of Udine and the Bankruptcy Court of Milan held (in proceedings to which we are not parties) that the Italian Ministry of the Environment and other Italian government agencies (the “Public Administrations”) were not creditors of either SNIA or its subsidiaries in connection with their claims in the Italian insolvency proceedings. The Public Administrations appealed and in January 2016, the Court of Udine rejected the appeal. The Public Administrations have also appealed that decision.
In January 2012, SNIA filed a civil action against Sorin in the Civil Court of Milan asserting joint liability of a parent and a spun-off company. On April 1, 2016, the Court of Milan dismissed all legal actions of SNIA and of the Public Administrations further requiring the Public Administrations to pay Sorin approximately $340,000 for legal fees. The Public Administrations appealed the 2016 Decision to the Court of Appeal of Milan and a final decision is pending.
We have not recognized an expense in connection with this matter because any potential loss is not currently probable or reasonably estimable. In addition, we cannot reasonably estimate a range of potential loss, if any, that may result from this matter.
Environmental Remediation Order
On July 28, 2015, Sorin received an administrative order (the “Remediation Order”) from the Italian Ministry of the Environment directing prompt commencement of environmental remediation at the chemical sites previously operated by SNIA’s other subsidiaries. We challenged the Remediation Order before the Administrative Court of Lazio in Rome (the “TAR”), and the TAR annulled the Remediation Order. The Italian Ministry of the Environment appealed to the Administrative Court of Appeal. A hearing occurred on June 14, 2018, and a final decision is pending. We have not recognized an expense in connection with this matter because any potential loss is not currently probable or reasonably estimable. In addition, we cannot reasonably estimate a range of potential loss, if any, that may result from this matter.
Opposition to Merger Proceedings
On July 28, 2015, the Public Administrations filed an opposition proceeding to the merger between Sorin and Cyberonics, Inc. (the “Merger”), before the Commercial Courts of Milan. The Court authorized the Merger and the Public Administrations did not appeal this decision. The proceeding then continued as a civil case, with the Public Administration seeking damages. The Commercial Court of Milan delivered a decision in October 2016, fully rejecting the Public Administration’s request and awarding us approximately $480,000 in damages for frivolous litigation and legal fees. The Public Administrations appealed to the Court of Appeal of Milan. On May 15, 2018, the Court of Appeal of Milan confirmed its decision authorizing the Merger, but reduced the penalty of $480,000 in damages for frivolous litigation and legal fees to $58,000 for legal fees. The Public

24



Administrations subsequently filed an appeal with the Supreme Court against the decision of the Court of Appeal of Milan. We have not recognized an expense in connection with this matter because any potential loss is not currently probable or reasonably estimable. In addition, we cannot reasonably estimate a range of potential loss, if any, that may result from this matter.
Patent Litigation
On May 11, 2018, a non-practicing entity (NPE) filed a complaint in the Southern District of Texas asserting that the VNS Therapy System, when used with the SenTiva Model 1000 generator, infringes the claims of a single U.S. patent owned by the NPE. The NPE requests damages that include a royalty, costs, interest, and attorneys’ fees. We have not recognized an expense in connection with this matter because any potential loss is not currently probable or reasonably estimable. In addition, we cannot reasonably estimate a range of potential loss, if any, that may result from this matter.
Tax Litigation
In a tax audit report received October 30, 2009, the Regional Internal Revenue Office of Lombardy (the “Internal Revenue Office”) informed Sorin Group Italia S.r.l. that, among several issues, it was disallowing in part (for a total of €102.6 million (approximately $119.5 million), related to tax years 2002 through 2006) a tax-deductible write down of the investment in the U.S. company, Cobe Cardiovascular Inc., which Sorin Group Italia S.r.l. recognized in 2002 and deducted in five equal installments, beginning in 2002. In December 2009, the Internal Revenue Office issued notices of assessment for 2002, 2003 and 2004. The assessments for 2002 and 2003 were automatically voided for lack of merit. In December 2010 and October 2011, the Internal Revenue Office issued notices of assessment for 2005 and 2006, respectively. We challenged all three notices of assessment (for 2004, 2005 and 2006) before the relevant Provincial Tax Courts.
The preliminary challenges filed for 2004, 2005 and 2006 were denied at the first jurisdictional level. We appealed these decisions. The appeal submitted against the first-level decision for 2004 was successful. The Internal Revenue Office appealed this second-level decision to the Italian Supreme Court (Corte di Cassazione) on February 3, 2017. The Italian Supreme Court’s decision is pending.
The appeals submitted against the first-level decisions for 2005 and 2006 were rejected. We appealed these adverse decisions to the Italian Supreme Court, where the matters are still pending.
In November 2012, the Internal Revenue Office served a notice of assessment for 2007, and in July 2013, served a notice of assessment for 2008. In these matters the Internal Revenue Office claims an increase in taxable income due to a reduction (similar to the previous notices of assessment for 2004, 2005 and 2006) of the losses reported by Sorin Group Italia S.r.l. for the 2002, 2003 and 2004 tax periods, and subsequently utilized in 2007 and 2008. We challenged both notices of assessment. The Provincial Tax Court of Milan has stayed its decision for years 2007 and 2008 pending resolution of the litigation regarding years 2004, 2005, and 2006. The total amount of losses in dispute is €62.6 million (approximately $72.9 million). We have continuously reassessed our potential exposure in these matters, taking into account the recent, and generally adverse, trend to Italian taxpayers in this type of litigation. Although we believe that our defensive arguments are strong, noting the adverse trend in some of the court decisions, we have recognized a reserve for an uncertain tax position of €17.0 million (approximately $19.7 million).
Other Matters
Additionally, we are the subject of various pending or threatened legal actions and proceedings that arise in the ordinary course of our business. These matters are subject to many uncertainties and outcomes that are not predictable and that may not be known for extended periods of time. Since the outcome of these matters cannot be predicted with certainty, the costs associated with them could have a material adverse effect on our consolidated net income, financial position or liquidity.

25



Note 12. Stockholders’ Equity
Comprehensive income
The table below presents the change in each component of AOCI, net of tax, and the reclassifications out of AOCI into net income for the six months ended June 30, 2018 and June 30, 2017 (in thousands):
 
 
Change in Unrealized Gain (Loss) on Derivatives
 
Foreign Currency Translation Adjustments Gain (Loss) (1)
 
Total
As of December 31, 2017
 
$
(919
)
 
$
46,232

 
$
45,313

Other comprehensive income (loss) before reclassifications, before tax
 
189

 
(38,590
)
 
(38,401
)
Tax expense
 
(45
)
 

 
(45
)
Other comprehensive income (loss) before reclassifications, net of tax
 
144

 
(38,590
)
 
(38,446
)
Reclassification of gain from accumulated other comprehensive income, before tax
 
(645
)
 
(9,011
)
(2) 
(9,656
)
Reclassification of tax expense
 
156

 

 
156

Reclassification of gain from accumulated other comprehensive income, after tax
 
(489
)
 
(9,011
)
 
(9,500
)
Net current-period other comprehensive (loss) income, net of tax
 
(345
)
 
(47,601
)
 
(47,946
)
As of June 30, 2018
 
$
(1,264
)
 
$
(1,369
)
 
$
(2,633
)
 
 
 
 
 
 
 
As of December 31, 2016
 
$
3,619

 
$
(72,106
)
 
$
(68,487
)
Other comprehensive (loss) income before reclassifications, before tax
 
(7,587
)
 
72,017

 
64,430

Tax benefit
 
1,821

 

 
1,821

Other comprehensive (loss) income before reclassifications, net of tax
 
(5,766
)
 
72,017

 
66,251

Reclassification of loss from accumulated other comprehensive income, before tax
 
3,644

 

 
3,644

Reclassification of tax benefit
 
(538
)
 

 
(538
)
Reclassification of loss from accumulated other comprehensive income, after tax
 
3,106

 

 
3,106

Net current-period other comprehensive (loss) income, net of tax
 
(2,660
)
 
72,017

 
69,357

As of June 30, 2017
 
$
959

 
$
(89
)
 
$
870

(1)
Taxes are not provided for foreign currency translation adjustments as translation adjustments are related to earnings that are intended to be reinvested in the countries where earned.
(2)
Cumulative foreign currency translation adjustments eliminated upon the sale of CRM.
Note 13. Stock-Based Incentive Plans
Stock-based incentive plans compensation expense (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Service-based stock appreciation rights ("SARs")
 
$
2,675

 
$
1,731

 
$
4,023

 
$
3,331

Service-based restricted stock units ("RSUs")
 
2,634

 
2,114

 
4,790

 
4,318

Market performance-based restricted stock units
 
959

 
170

 
1,305

 
174

Operating performance-based restricted stock units
 
1,185

 
371

 
2,032

 
407

Total stock-based compensation expense
 
$
7,453

 
$
4,386

 
$
12,150

 
$
8,230

During the six months ended June 30, 2018, we issued stock-based compensatory awards with contract terms agreed upon by us and the respective individuals, as approved by the Compensation Committee of our Board of Directors. The awards with service conditions generally vest ratably over four years, subject to forfeiture unless service conditions are met. Market

26



performance-based awards cliff vest after three years subject to the rank of our total shareholder’s return for the three-year period ending December 31, 2020 relative to the total shareholder returns for a peer group of companies. Operating performance-based awards cliff vest after three years subject to the achievement of certain thresholds of cumulative adjusted free cash flow for the three year period ending 2020. Compensation expense related to awards granted during 2018 for the three and six months ended June 30, 2018 was $3.4 million and $3.9 million, respectively.
Stock-based compensation agreements issued during the six months ended June 30, 2018, representing potential shares and their weighted average grant date fair values by type follows (shares in thousands, fair value in dollars):
 
 
Six Months Ended June 30, 2018
 
 
Shares
 
Weighted Average Grant Date Fair Value
Service-based SARs
 
634

 
$
27.87

Service-based RSUs
 
227

 
$
91.91

Market performance-based RSUs
 
41

 
$
99.97

Operating performance-based RSUs
 
41

 
$
88.38

Note 14. Income Taxes
Our effective income tax rate from continuing operations for the three months ended June 30, 2018 was (5.5)% compared with 5.2% for the three months ended June 30, 2017. For the six months ended June 30, 2018, the effective income tax rate from continuing operations was 7.0% compared with 10.6% for the six months ended June 30, 2017. Our effective income tax rate fluctuates based on, among other factors, changes in pretax income in countries with varying statutory tax rates, changes in valuation allowances, changes in tax credits and incentives, and changes in unrecognized tax benefits associated with uncertain tax positions.
Compared with the three and six months ended June 30, 2017, the lower effective tax rates for the three and six months ended June 30, 2018 were primarily attributable to the impact of the reduction to the U.S. federal statutory tax rate as a result of the U.S. “Tax Cuts and Jobs Act” (the “Tax Act”), the benefit of foreign derived intangible income partially offset by the repeal of the U.S. domestic production activity deduction, certain tax law changes in the UK that occurred during the three months ended December 31, 2017 and the impact of discrete tax items.
During the three months ended June 30, 2018, we entered into an audit settlement impacting one of our uncertain tax positions. This audit settlement resulted in the recognition of an additional of $1.7 million in income tax expense.
Note 15. Net Income (Loss) Per Share
Reconciliation of the shares used in the basic and diluted earnings per share computations for the three and six months ended June 30, 2018 and June 30, 2017 are as follows (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Basic weighted average shares outstanding
 
48,487

 
48,140

 
48,406

 
48,104

Add effects of share-based compensation instruments (1)
 
851

 
163

 
857

 
137

Diluted weighted average shares outstanding
 
49,338

 
48,303

 
49,263

 
48,241

(1)
Excluded from the computation of diluted earnings per share were stock options, SARs and restricted share units totaling 0.7 million and 1.8 million shares as of June 30, 2018 and June 30, 2017, respectively, because to include them would be anti-dilutive.
Note 16. Geographic and Segment Information
We identify operating segments based on the way we manage, evaluate and internally report our business activities for purposes of allocating resources and assessing performance. We have two reportable segments: Cardiac Surgery and Neuromodulation.
The Cardiac Surgery segment generates its revenue from the development, production and sale of cardiopulmonary products, heart valves and advanced circulatory support. Cardiopulmonary products include oxygenators, heart-lung machines, autotransfusion systems, perfusion tubing systems, cannulae and other related accessories. Heart valves include mechanical

27



heart valves, tissue heart valves and related repair products. Advanced circulatory support, which represents our recently acquired TandemLife business, includes temporary life support product kits that can include a combination of pumps, oxygenators, and cannulae.
The Neuromodulation segment generates its revenue from the design, development and marketing of neuromodulation therapy systems for the treatment of drug-resistant epilepsy and treatment-resistant depression. Neuromodulation products include the VNS Therapy System, which consists of an implantable pulse generator, a lead that connects the generator to the vagus nerve, and other accessories. On January 16, 2018, we acquired the remaining 86% outstanding interest in ImThera which is also included in our Neuromodulation segment. ImThera manufactures an implantable device for the treatment of obstructive sleep apnea that stimulates multiple tongue muscles via the hypoglossal nerve, which opens the airway while a patient is sleeping.
“Other” includes corporate shared service expenses for finance, legal, human resources and information technology and corporate business development (“New Ventures”). New Ventures is focused on new growth platforms and identification of other opportunities for expansion.
Effective January 1, 2018, we began to include the results of heart failure within the Neuromodulation segment for internal reporting purposes in order to manage and evaluate business activities for purposes of allocating resources and assessing performance. Previously, the results of heart failure were reported within “Other”. Segment results for the three and six months ended June 30, 2017 have been recast to conform to the current period presentation.
Net sales of our reportable segments include revenues from the sale of products they each develop and manufacture or distribute. We define segment income as operating income before merger and integration, restructuring and amortization of intangibles.

28



We operate under three geographic regions: United States, Europe, and Rest of world. The table below presents net sales by operating segment and geographic region (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Cardiopulmonary
 
 
 
 
 
 
 
 
United States
 
$
42,139

 
$
39,719

 
$
80,584

 
$
71,895

Europe
 
35,916

 
33,959

 
72,786

 
64,568

Rest of world
 
58,584

 
50,467

 
108,399

 
94,980

 
 
136,639

 
124,145

 
261,769

 
231,443

Heart Valves
 
 
 
 
 
 
 
 
United States
 
6,147

 
6,205

 
12,683

 
12,274

Europe
 
11,863

 
10,684

 
23,979

 
21,031

Rest of world
 
15,792

 
17,552

 
28,182

 
33,042

 
 
33,802

 
34,441

 
64,844

 
66,347

Advanced Circulatory Support
 
 
 
 
 
 
 
 
United States
 
5,468

 

 
5,468

 

Europe
 
353

 

 
353

 

Rest of world
 
194

 

 
194

 

 
 
6,015

 

 
6,015

 

Cardiac Surgery
 
 
 
 
 
 
 
 
United States
 
53,754

 
45,924

 
98,735

 
84,169

Europe