UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C.
20549


_______________





Form 10-K





(Mark
      One)þ
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d)
              OF
      THE SECURITIES EXCHANGE ACT OF 1934For
      the fiscal year ended April 24, 2009oro
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d)
              OF
      THE SECURITIES EXCHANGE ACT OF 1934For
      the transition period
      from                                                                to





Commission
file number: 0-19806


_______________







Cyberonics,
Inc.


(Exact
name of registrant as specified in its charter)





Delaware
            76-0236465(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer
              Identification
      No.)





Cyberonics
Building


100
Cyberonics Blvd.


Houston,
Texas


77058-2072


(Address
of principal executive offices)


(Zip
Code)





Registrant’s
telephone number, including area code:


(281) 228-7200


_______________





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





Title
      of Each Class of Stock
            
            Name
      of Each Exchange on Which RegisteredCommon
      Stock — $0.01 par value per share
            
            The
      NASDAQ Stock Market LLC





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


None


_______________





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes oNo þ





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.  Yes oNo þ





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 þNo o





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).  Yeso     Noo





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





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):





Large
      accelerated filer
            o
            Accelerated
      filer
            þNon-accelerated
      filer
            o
      (Do not check if a smaller reporting company)
            Smaller
      reporting company
            o





Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).  Yes oNo þ





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of October 24, 2008, the last business
day of the registrant’s most recently completed second fiscal quarter, based
upon the last sales price reported for such date on the NASDAQ Global Market was
approximately $207.4 million. For purposes of this disclosure, shares of common
stock held by persons who hold more than 5% of the outstanding shares of common
stock and shares held by officers and directors of the registrant have been
excluded as such persons may be deemed to be affiliates.





At
June 12, 2009, 27,326,402 shares of common stock were
outstanding.





DOCUMENTS
INCORPORATED BY REFERENCE





Portions
of the definitive proxy statement of Cyberonics, Inc. for the 2009 Annual
Meeting of Stockholders, which will be filed within 120 days of
April 24, 2009, are incorporated by reference into Part III of this
Annual Report on Form 10-K.








1





TABLE OF CONTENTS











PART IItem 1.
              Business
              3Item 1A.
              Risk Factors
              17Item 1B.
              Unresolved Staff Comments
              28Item 2.
              Properties
              28Item 3.
              Legal Proceedings
              28Item 4.
              Submission of Matters to a Vote of Security
      Holders
              28PART IIItem 5.
              Market for Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity Securities
              29Item 6.
              Selected Financial Data
              30Item 7.
              Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
              31Item 7A.
              Quantitative and Qualitative Disclosures About Market
      Risk
              41Item 8.
              Financial Statements and Supplementary
    Data
              42Item 9.
              Changes in and Disagreements With Accountants on Accounting
      and Financial Disclosure
              42Item 9A.
              Controls and Procedures
              42Item 9B.
              Other Information
              45PART IIIItem 10.
              Directors, Executive Officers and Corporate
      Governance
              45Item 11.
              Executive Compensation
              45Item 12.
              Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters
              45Item 13.
              Certain Relationships and Related Transactions, and
      Director Independence
              45Item 14.
              Principal Accounting Fees and Services
              45PART IVItem 15.
              Exhibits, Financial Statement Schedules
              46








In this
Annual Report on Form 10-K, “Cyberonics,” “we,” “us” and “our” refer to
Cyberonics, Inc. and


its
consolidated subsidiary (Cyberonics Europe SA).


_______________





2


Table of Contents


CAUTIONARY
STATEMENT ABOUT FORWARD-LOOKING STATEMENTS





The
Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for
certain forward-looking statements. This Annual Report on Form 10-K (this
“Form 10-K”) contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”).  The words
“believe,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,”
“would,” “could” or other similar expressions are intended to identify
forward-looking statements. These forward-looking statements are based on our
current expectations and beliefs concerning future developments and their
potential effects on us. There can be no assurance that future developments
affecting us will be those that we anticipate. All comments concerning our
expectations for future revenues and operating results are based on our
forecasts for our existing operations. These forward-looking statements involve
significant risks, uncertainties (some of which are beyond our control) and
assumptions. They are subject to change based upon various factors, including
but not limited to the risks and uncertainties described in (a) Part I, “Item
1A.  Risk Factors” and elsewhere in this Form 10-K; (b) our reports
and registration statements filed from time to time with the Securities and
Exchange Commission (“SEC”); and (c) other announcements we make from time to
time.





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





PART I





Item 1.Business





General





We are a
neuromodulation company incorporated as a Delaware corporation in 1987, engaged
in the design, development, sales and marketing of implantable medical devices
that provide a unique therapy, vagus nerve stimulation (“VNS”) therapy (“VNS
Therapy”) for the treatment of refractory epilepsy and depression.





Our
proprietary VNS TherapyTM System includes the following:





—
              A
      pulse generator to provide the appropriate stimulation to the vagus
      nerve;—
              A
      bipolar lead extending from the generator to the vagus
    nerve;—
              A
      tunneling tool to assist with implantation surgery;—
              A
      programming wand and software to assist with setting the stimulation
      parameters after implantation of the generator and
lead;—
              Magnets
      to suspend or induce stimulation manually; and—
              Instruction
      manuals.





Surgery
to implant the generator and lead is generally performed on an outpatient
basis.  The battery contained in the generator has a finite life,
which varies according to the model, the stimulation parameters and settings
used for each patient. At or near the end of the useful life of a battery, a
patient may, with the advice of a physician, choose to implant a new generator,
with or without replacing the original lead.





3


Table of Contents





The U.S.
Food and Drug Administration (“FDA”) approved the VNS Therapy System in July
1997 for use as an adjunctive therapy in epilepsy patients over 12 years of
age in reducing the frequency of partial onset seizures that are refractory or
resistant to antiepileptic drugs. Regulatory bodies in Canada, the European
Economic Area, South America, Africa, Australia, China and certain countries in
Eastern Asia have approved VNS Therapy for the treatment of epilepsy, many
without age restrictions or seizure-type limitations. In July 2005, the FDA
approved the VNS Therapy System for the adjunctive long-term treatment of
chronic or recurrent depression for patients 18 years of age or older who
are experiencing a major depressive episode and have not had an adequate
response to four or more adequate anti-depressant treatments. Regulatory bodies
in the European Economic Area, Canada and Israel have approved the VNS
Therapy System for the treatment of chronic or recurrent depression in patients
who are in a treatment-resistant or in a treatment-intolerant depressive episode
without age restrictions.





Our
ability to successfully expand the commercialization of the VNS Therapy System
depends on obtaining and maintaining favorable insurance coverage, coding and
reimbursement for the device, the implant procedure and follow-up
care.  Currently, there is broad coverage, coding and reimbursement
for VNS Therapy for the treatment of refractory epilepsy. The Centers for
Medicare and Medicaid Services, (“CMS”), which we estimate pays for
approximately 25% of the VNS Therapy implants, issues an annual update to the
reimbursement amounts received by our customers.  Recently, CMS
announced a significant reduction in the rate reimbursed to our customers for
the insertion of the lead portion of the VNS Therapy System for calendar 2009
and a small increase in the amount reimbursed for the insertion of the
generator. This decrease in reimbursement could have an adverse impact on our
business and our future operating results.





We are
focused on advancing the clinical foundation as a basis for establishing,
maintaining and extending reimbursement for VNS Therapy.  This may
involve increased investment in research and development, specifically, seizure
detection, telemedicine and associated technology, and could also include
additional investment in clinical studies using VNS Therapy for the treatment of
refractory epilepsy.





In May
2007, the CMS issued a final determination of non-coverage with respect to
reimbursement of VNS Therapy for depression. In February 2008, we announced,
after consulting with clinical and reimbursement experts, a plan which included
the conduct of an additional randomized clinical study, or possibly more than
one such clinical study, to provide additional data supporting a new application
for reimbursement coverage for our depression indication.  In November
2008, we submitted an amendment to the protocol of the TRD patient dosing study
to the FDA.  We are requesting a reduction in the number of study
subjects from 460 to 330, a level that was reached in February
2009.  We have suspended further patient enrollment while we wait for
the FDA’s decision. Based on a reassessment of the study power and size we
believe that this proposal maintains appropriate study power.  In
April 2009 the FDA requested additional information on the proposed change in
sample size which we submitted in May 2009.  We do not know when to
expect a decision from the FDA.





In
February 2008, we also announced a plan to transfer our depression business to a
separate entity, in which we expected to maintain at least a minority
interest.  We engaged an investment bank to assist us in identifying a
partner to provide the funding necessary to execute this plan. This process did
not result in the receipt of an offer that would provide sufficient value to our
stockholders.  Accordingly, we decided not to conduct a new clinical
study in depression at this time and we continue to evaluate alternative actions
intended to maintain the current regulatory approval, while minimizing our
required investment, as well as ensuring that VNS Therapy continues to be
available to patients in the United States and certain international markets.
However, we have curtailed marketing for the depression indication at this
time.





Our
clinical development program has included pilot and pivotal studies in using VNS
Therapy (1) as an adjunctive therapy for reducing the frequency of seizures
in patients over 12 years of age with partial onset seizures that are
refractory to antiepileptic drugs and (2) as an adjunctive treatment for
patients 18 years of age and older with chronic or recurrent depression who
are in a major depressive episode. We have also conducted or provided support
for small pilot studies for the use of VNS Therapy in the treatment of
Alzheimer’s disease, anxiety, bulimia, fibromyalgia, obesity,
obsessive-compulsive disorder, multiple sclerosis and other indications. These
studies have been conducted to determine the safety and effectiveness of VNS
Therapy in these new indications and to determine which new indications might be
considered for pivotal studies.





4


Table of Contents





Proprietary
protection for our products is important to our business.  We maintain
a policy of seeking U.S. and foreign patents on selected inventions, acquiring
licenses under selected patents of third parties, and entering into invention
and confidentiality agreements with our employees, vendors and consultants with
respect to technology that we consider important to our business.  We
also rely on trade secrets, unpatented know-how and continuing technological
innovation to develop and maintain our competitive position.





We are
actively engaged in determining how we can license intellectual property (“IP”)
rights to third parties in order to optimize our portfolio. This includes the
assessment and determination of which of our IP rights for particular
indications we do not have immediate plans to develop and identifying whether
these rights should be licensed to third parties. It also involves the
assessment of the IP rights of third parties in order to determine whether we
should attempt to acquire those rights through a license.





Since
inception, we have incurred substantial expenses, primarily for research and
development activities that include product and process development, clinical
studies and related regulatory activities, sales and marketing activities,
manufacturing start-up costs and systems infrastructure. As of April 24, 2009,
we had incurred an accumulated deficit of approximately
$242.5 million.  We are focused on advancing the use of VNS
Therapy and possibly other medical devices for the treatment of epilepsy, and
this may involve increased investment in clinical studies.





VNS
Therapy Epilepsy Indication Overview





Epilepsy
is a disorder of the brain characterized by recurrent seizures that are
categorized as either partial or generalized at onset. Patients who continue to
have unsatisfactory seizure control or intolerable side effects after treatment
with appropriate antiepileptic therapies for a reasonable period of time are
said to suffer from refractory epilepsy. For reasons that are not clear, partial
onset seizures are generally more refractory to existing therapies than
generalized seizures. Epilepsy is the second most prevalent neurological
disorder in the world. According to the U.S. Centers for Disease Control and the
National Epilepsy Foundation between 2.5 and 2.7 million individuals in the
U.S. have some form of epilepsy, with approximately 150,000 new cases
diagnosed in 2009. We estimate, based on a World Health Organization study on
Epilepsy, that there are in excess of 3.0 million individuals with epilepsy
in Western Europe with over 150,000 new cases diagnosed each year.  In
addition, it is estimated that approximately 50% of patients with epilepsy
suffer from partial onset seizures and that over 30% of these patients continue
to suffer from seizures in spite of treatment with antiepileptic drugs. There
are three standard types of treatment available to persons with epilepsy:
antiepileptic drug therapy, VNS Therapy and surgery. Antiepileptic drugs serve
as a first-line treatment and are prescribed for virtually all individuals being
treated for epilepsy. When drug therapy is not effective, VNS Therapy may be
considered.  Surgery may also be an option for some patients. There
are a number of other treatments under development for the treatment of
epilepsy, including direct deep brain stimulation (“DBS”) and the Responsive
Neurostimulator System (“RNStm”),
but these treatments are not currently approved for commercial U.S.
distribution. In December 2008, following the publication of clinical data from
a pivotal study for DBS therapy in patients with severe epilepsy, Medtronic,
Inc. announced its intention to seek FDA approval for this
indication.





5


Table of Contents





VNS
Therapy for Epilepsy





The VNS
Therapy System is indicated as an adjunctive treatment for patients who are
refractory to antiepileptic drugs. In the two randomized, parallel,
double-blind, active-controlled studies that led to FDA approval of our epilepsy
indication, the patients who received adjunctive VNS Therapy had a mean seizure
reduction of approximately 24% and 28% during the three-month acute phase of the
studies. Additionally, many patients, including some who reported no change or
an increase in seizure frequency, also reported a reduction in seizure severity.
Long-term follow-up data derived from an uncontrolled protocol on the
440 patients in five studies showed that efficacy was maintained and, for
many patients, improved over time during treatment with the VNS Therapy System.
Analysis of the pooled data showed that the median percentage seizure reduction
was 44% after 24 months of treatment and was sustained at that level at
36 months. Our analysis of an internal database of patients who received an
implant of VNS Therapy including the first model of our generator (the Model
100) indicates that over 68% have chosen to continue with VNS Therapy when the
generator battery is depleted, generally 5 to 6 years after initial implant. In
the treatment of refractory epilepsy, the side effects associated with the VNS
Therapy System are generally mild, localized and related to the period of time
in which stimulation is activated. The side effects include voice alteration,
neck discomfort, increased cough, shortness of breath and difficulty swallowing.
The VNS Therapy System has not typically been associated with the debilitating
central nervous system side effects that frequently accompany antiepileptic
drugs. Additionally, side effects of VNS Therapy typically decrease over time.
To date, an estimated 55,000 patients worldwide have been treated with the
VNS Therapy System for epilepsy.





VNS
Therapy Depression Indication Overview





Major
depressive disorder is one of the most prevalent and serious illnesses in the
U.S. It affects nearly 19 million Americans 18 years of age or
older every year. Recently published data indicate that approximately one-third
of patients with major depressive disorder will not achieve a remission of their
depressive symptoms after four well-delivered, optimized treatment steps using
standard antidepressant therapies. Standard treatment methods for depression
include antidepressant drugs, psychotherapy and electroconvulsive therapy
(“ECT”). First-line therapy often consists of an antidepressant drug. For
patients who do not respond adequately to initial antidepressant treatment,
physicians will often switch to a different drug or use two or more drugs in
combination. Physicians usually reserve ECT for patients who have not had an
adequate response to multiple trials of antidepressant drugs or when they
determine a rapid response to treatment is desirable. There are a number of
other neuromodulation treatments at various stages in the development cycle for
the treatment of depression, including repetitive transcranial magnetic
stimulation (“rTMS”), which has received FDA approval, and DBS, which is not
currently approved for commercial distribution to treat depression.





VNS
Therapy for Depression





The VNS
Therapy System is indicated as an adjunctive treatment for patients 18 years of
age or older who have chronic or recurrent treatment-resistant depression who
are experiencing a major depressive episode andhave not had
an adequate response to four or more adequate antidepressant treatments. In
Canada and the European Union, VNS Therapy is indicated for the treatment of
chronic or recurrent depression in patients who are in a treatment-resistant or
treatment-intolerant major depressive episode. VNS Therapy was generally well
tolerated in the depression clinical studies.  The most commonly
reported adverse events were similar to those observed in patients being treated
with VNS Therapy for epilepsy. These side effects tended to occur during
stimulation, tended to be reported as mild or moderate and tended to be reported
less frequently over time.





6


Table of Contents





FDA
Post-Approval Study Commitments and Other Clinical Research Studies





Pursuant
to the post-market surveillance conditions specified as part of our FDA
marketing approval, we are required to conduct two clinical studies on
treatment-resistant depression (“TRD”) patients.  One study of
460 patients, the dosing study, is a randomized controlled study assessing
three different stimulation paradigms.  The other study, the TRD
registry, is a longitudinal registry that will follow 500 VNS patients and 500
non-VNS patients for up to five years. To maintain timely progress in the dosing
study, we announced a program in early 2007 whereby we are donating the VNS
Therapy Systems and paying for the facility and surgery related costs (at a
negotiated rate) for patients being enrolled in the dosing study.  In
November 2008, we submitted an amendment to the protocol of the TRD patient
dosing study to the FDA.  We are requesting a reduction in the number
of study subjects from 460 to 330, a level that was reached in February 2009. We
have suspended further patient enrollment while we wait for the FDA’s decision.
Based on a reassessment of the study power and size we believe that this
proposal maintains appropriate study power. We met with the FDA in February 2009
to discuss the proposed change in sample size. In early April 2009, FDA
requested additional information on the proposed change in sample size. We
submitted the additional information in May 2009.  We do not know when
to expect a decision from the FDA.





We also
sponsor post-marketing studies in refractory epilepsy and support a variety of
studies to further understand predictors of VNS success. The E-06 Study is an
open randomized post-marketing study being conducted in Europe to assess the
efficacy and safety of adjunctive VNS Therapy versus standard antiepileptic drug
treatment in children (age 17 or less) with refractory seizures. Enrollment in
the study was terminated in December 2008 and follow-up is expected to be
completed in March 2010. The European indication for use allows children under
the age of 12 to be implanted with VNS Therapy. We expect to continue to invest
in future research activities as appropriate.





VNS
Therapy System





VNS
Therapy is the first treatment approved by the FDA for medically refractory
epilepsy and for treatment-resistant depression. The safety profiles for VNS
Therapy and the VNS Therapy System, including the implant procedure, are well
established in clinical studies of refractory epilepsy and
depression.  The VNS Therapy System has been implanted in an estimated
58,000 patients.





The VNS
Therapy System is a proprietary, integrated system consisting of an implantable
generator that delivers an electrical signal to an implantable lead attached to
the left vagus nerve. The vagus nerve is the longest of the cranial nerves,
extending from the brain stem through the neck to organs in the chest and
abdomen. The left vagus nerve has been shown to have influence over numerous
areas of the brain. Preclinical studies and mechanism-of-action research suggest
that intermittent stimulation of the left vagus nerve in the neck modulates a
number of structures and alters blood flow bilaterally in several areas of the
brain. These studies have also shown that stimulation of the left cervical vagus
nerve is effective in suppressing the intensity or frequency of seizures and
results in persistent or carryover antiepileptic effects, which increase with
chronic intermittent stimulation. The mechanism-of-action research associated
with our depression studies has shown stimulation of the left vagus nerve
results in modulation of areas of the brain thought to be important in the
regulation of mood.





The VNS
Therapy System consists of a pulse generator, a bipolar lead, a programming wand
and software and a tunneling tool. The pulse generator and bipolar lead are
surgically implanted in a procedure that takes from 60 to 90 minutes,
during which time the patient is under general, regional or, rarely, local
anesthesia. The pulse generator is surgically implanted in a subcutaneous pocket
in the upper left chest. The bipolar lead is connected to the pulse generator
and attached to the vagus nerve in the lower left side of the patient’s
neck.





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Table of Contents





The VNS
Therapy System delivers stimulation by means of electrical pulses on a chronic,
intermittent basis. The initial stimulation parameters that we typically
recommend are a 30-second period of stimulation, which we refer to as ON time,
followed by a five-minute period without stimulation, which we refer to as OFF
time. To optimize patient treatment, the current pulse width, amplitude,
frequency and stimulation ON and OFF intervals of the pulse generator can be
adjusted non-invasively by the treating physician with a handheld computer using
our programming wand and software. In addition, epilepsy patients can use a
small, handheld magnet provided with the VNS Therapy System to activate or
deactivate stimulation manually. On-demand therapy can be useful for those
epilepsy patients who sense an oncoming seizure and has been reported by a
number of patients to abort or reduce the severity or duration of seizures. The
magnet can also be used to provide epilepsy patient control of stimulation side
effects by allowing the patient to deactivate stimulation
temporarily.





Pulse
Generator.  The pulse generator is an implantable, programmable
signal generator designed to be coupled with the bipolar lead to deliver
electrical signals to the vagus nerve. The pulse generator is a battery powered
device. Shortly before or upon depletion of the battery, the pulse generator may
be removed and a new generator implanted in a short, outpatient
procedure.





The Model
102, 102R, DemipulseTM and Demipulse DuoTM VNS Therapy pulse generators, the only
pulse generators we currently offer in the U.S., are similar in design and
manufacture to a cardiac pacemaker. The generators are comprised of one printed
circuit board and a battery hermetically sealed in a titanium case. Standard
components are assembled on printed circuit boards using surface-mount
technology. The assembled circuit boards are then tested and mounted with the
battery in the titanium case, which is laser welded. A header to which the
bipolar lead connects is added and each unit is subject to final release testing
prior to being sterilized.





Bipolar Lead.  The
bipolar lead conveys the electrical signal from the pulse generator to the vagus
nerve. The lead incorporates electrodes, which are self-sizing and flexible,
minimizing mechanical trauma to the nerve and allowing body fluid interchange
within the nerve structure. The lead’s two electrodes and anchor tether wrap
around the vagus nerve and the connector end is tunneled subcutaneously to the
chest, where it attaches to the pulse generator. The leads are available in two
sizes of inner spiral diameter to ensure optimal electrode placement on
different size nerves.





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





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





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





Patient Essentials Kit. 
The patient kit includes two magnets, one watch style and one pager
style.





Product
Development





Our
product development efforts, focused primarily on epilepsy, are directed toward
improving the VNS Therapy System, improving its efficacy and developing new
products that provide additional features and functionality while improving cost
effectiveness.





8


Table of Contents





In May
2005, we received approval from KEMA Registered Quality, Inc. (“KEMA”) to market
our Demipulse and Demipulse Duo VNS Therapy System generators in the member
countries of the European Union for the approved epilepsy and depression
indications for use. The Demipulse generator is our newest single-connector VNS
Therapy System generator, and the Demipulse Duo generator is our newest
dual-connector VNS Therapy System generator for use in patients whose physicians
have elected replacement of their previous dual-connector generator at the end
of its battery life. Both the Demipulse and Demipulse Duo generators are capable
of delivering greater functionality and are smaller and lighter than the
previous models. We submitted the Premarket Approval Application Supplement
(“PMA-S”) for both the Demipulse and the Demipulse Duo generators to the FDA in
January 2007 and initiated limited release in Europe in May 2007. We received
FDA approval  in July 2007, initiated limited release in the U.S. in
late 2007 and commenced commercial release in May 2008.





The VNS
Therapy Perenniatm
Lead  (now called PerenniaDURATM) was approved by the FDA in May 2006
and by KEMA in August 2006. Functionally, the new lead is the same as its
predecessor, the Model 302 Lead, but it incorporates a new design and is
constructed from more durable components. Mechanical tests conducted in a
laboratory setting have shown the PerenniaDURA Lead to be more robust than its
predecessor.  The next generation lead is the Perennia Flextm,which was approved by the FDA in December 2008 and by KEMA in April 2009
and incorporates a minor design change to the commercially available Model 302
Lead. Additionally, this lead  incorporates some elements of the VNS
Therapy PerenniaDURA Lead.





We are
conducting ongoing product development activities to enhance the VNS Therapy
System pulse generator, the bipolar lead and programming software. In connection
with the introduction of new and improved products, we will be required to file
for the appropriate U.S. and international regulatory approvals, and some
projects may require clinical trials.





We are
focused on developing new and improved products for patients with epilepsy, in
particular by:





—
              examining
      whether significant variations in the stimulation parameters improve the
      efficacy of the device;—
              evaluating
      methods of detecting and predicting seizures and delivering responsive
      therapy, recording the seizure, or alerting the patient, caregiver or
      physician; and—
              incorporating
      telemedicine or wireless telemetry into our
  devices.





These new
product development efforts are still in the early stage, and may require
significant funding to complete. Further, we are collaborating with other
entities on several of these projects, any one of which may not be successful.
Even if successful, additional clinical trials may be needed to bring any or all
of these products to market, and we are not yet able to determine when any such
products could be ready for market launch.





Manufacturing
and Sources of Components and Raw Materials





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





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Our
manufacturing operations are required to comply with the FDA’s Quality System
Regulation (“QSR”).  The QSR is promulgated under section 520 of
the Food, Drug and Cosmetic Act, which requires manufacturers to have a quality
system for the design and production of medical devices. The Food, Drug and
Cosmetic Act requires that:





—
              various
      specifications and controls be established for devices;—
              devices
      be designed under a quality system to meet these
      specifications;—
              devices
      be manufactured under a quality system;—
              finished
      devices meet these specifications;—
              devices
      be correctly implanted, checked and serviced;—
              quality
      data be analyzed to identify and correct quality
      problems; and—
              complaints
      be processed and reported.





Thus, the
QSR helps assure that medical devices are safe and effective for their intended
use. In addition, certain international markets have regulatory, quality
assurance and manufacturing requirements that may be more or less rigorous than
those in the U.S. Specifically, we have authorized KEMA to ensure that we
are in compliance with the requirements of International Standards Organization
13485:2003, “Medical devices — Quality management systems —
Requirements for regulatory purposes” and the European Council Directive
90/385/EEC relating to Active Implantable Medical Devices (“AIMD”). KEMA is an
entity that confirms that a company’s products and quality systems are
compliant, serves as our notified body within the scope and framework of the
European Council Directive 90/385/EEC relating to AIMD, and audits us on an
annual basis for such compliance.





Marketing
and Sales





U.S.





We market
and sell our products for refractory epilepsy through direct sales and marketing
forces and no longer actively sell or market our product for
depression.





Epilepsy
Sales





In
the U.S., our sales and marketing plan focuses on creating awareness and
demand for the VNS Therapy System among epileptologists and neurologists
who treat refractory epilepsy, implanting surgeons, nurses, third-party
payers, hospitals and patients and their families. In particular, our efforts
are primarily directed to comprehensive epilepsy treatment centers.





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





—
              sales
      personnel with medical device, pharmaceutical, or nursing
      experience;—
              field
      clinical engineers and marketing personnel focused on educational and
      promotional marketing programs; and—
              case
      managers experienced in patient education, insurance verification and
      authorization issues.





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





Depression
Sales





During
fiscal year 2008, we restructured our sales organization to establish separate
sales groups for the epilepsy and depression indications. We experienced a
significant sales decline in depression in fiscal year 2008, primarily, as a
result of the unfavorable May 2007 National Coverage Determination by CMS.
During fiscal year 2009, we eliminated active marketing efforts with respect to
depression.





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We do not
anticipate any meaningful sales growth in depression until we obtain favorable
coverage policies for VNS Therapy in depression.  Favorable coverage
policies are not expected until we have completed one or more additional
clinical studies, and submitted further evidence of the efficacy of VNS Therapy
for depression.  This evidence is not expected to be available until
2010 or later.





International





We are
approved to market our products in 70 countries through a combination of a
direct sales force in certain European countries and independent distributors
elsewhere.  Our objectives include increasing sales and expanding the
number of countries where VNS Therapy can be made available to patients. We no
longer actively market our products internationally for the treatment of
depression.





The VNS
Therapy System is currently sold by a direct sales force in Austria, Belgium,
Denmark, France, Germany, Luxemburg, The Netherlands, Norway, Spain, Sweden,
Switzerland and the United Kingdom. The sales price in each direct country is
based on local market conditions, including public and private reimbursement,
and is generally lower than the sales price in the U.S.





We have
distribution agreements with independent distributors covering a number of other
territories including Canada, Mexico, Australia, parts of Central and South
America, China, Japan, and other parts of Asia, the Middle East and Europe. The
distribution agreements generally grant the distributor exclusive rights for the
particular territory for a specified period of time, generally one to three
years.  Under the terms of the agreement and local law, we may be
required to compensate the distributor in the event that the agreement is
terminated by us or is not renewed upon expiration. The distributor generally
assumes responsibility for obtaining regulatory and reimbursement approvals for
the relevant territory and agrees to certain minimum marketing and sales
expenditures and purchase commitments. Our pricing to distributors is generally
fixed under the terms of the distribution agreements, but may change at our
election with as little as 30 days prior notice under most agreements.
Sales incentives, if provided, are recorded as reductions to net sales in the
same period net sales are recognized.





In
November 2008, we facilitated an application for regulatory approval for the
epilepsy indication in Japan. This application was filed by Nihon Kohden
Corporation, and is still pending before the Japanese Ministry of Health, Labour
and Welfare. Additionally, in April 2009, we entered into a distribution
agreement granting Nihon Kohden Corporation exclusive distribution rights in
Japan should we obtain regulatory approval for the epilepsy indication in Japan.
The regulatory approval process in Japan could be time-consuming and expensive,
particularly if Japanese authorities require further clinical trials, and we are
unable at this time to predict if or when we may obtain an
approval.





Third-Party
Reimbursement in the U.S. Market





We sell
the VNS Therapy System for refractory epilepsy to hospitals and ambulatory
surgery centers (“ASCs”) on payment terms that are generally 30 days from the
shipment date. Our ability to successfully expand the commercialization of the
VNS Therapy System depends on obtaining and maintaining favorable coding,
reimbursement and coverage for the VNS Therapy System, the associated implant
procedure and follow-up care. Favorable reimbursement coverage allows our
customers to invoice and be paid by third party payers for the costs
of  the VNS Therapy System, the associated surgery and patient care.
Reimbursement or payment rates from private insurers were largely unchanged over
the past year, although Medicare made significant changes to the amounts that
are reimbursed to hospitals for the generator and the lead, effective on January
1, 2009. These changes include an increase from approximately $11,877 to $12,545
in the amount paid for the generator, and a decrease from approximately $14,061
to $7,234 in the amount paid for a lead and the insertion procedure. The
reimbursement rates will vary depending on geographic area. We continue to work
with the CMS to insure favorable and appropriate reimbursement for our products
and related procedures; however, these changes and other potential changes in
the future could have a material, long-term adverse impact on our ability to
procure sales to hospitals.  With respect to epilepsy, the coverage
environment was largely unchanged, with virtually all technology assessments
being favorable and most third-party payers having favorable coverage
policies.








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Coverage
for VNS Therapy in depression has been extremely difficult to obtain, and we
have elected to discontinue active commercial efforts until more favorable
coverage is available.


We employ
case managers, available through our reimbursement hotline, to help with
coverage, coding and reimbursement issues on a case-by-case basis or policy
level.





Medicare





Under the
current CMS policy, VNS Therapy is covered for patients with medically
refractory partial onset seizures for whom surgery is not recommended or for
whom surgery has failed. In May 2007, the CMS issued its Decision Memorandum for
Vagus Nerve Stimulation for Treatment of Resistant Depression (CAS-00313R),
concluding that Medicare coverage is not available for VNS Therapy as a
treatment for depression. For additional information, see “General”
above.





Medicaid





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





Medicaid
reimbursement mechanisms vary state by state. Medicaid policy and payment
methodologies change on a regular basis, so we are engaged in vigilant and
ongoing work to ensure continued access and acceptable reimbursement for
patients covered by Medicaid programs.





Private
Payers





Private
payers (commercial, managed care and other third-party payers) generally cover
hospital inpatient and outpatient services that are considered to be medically
necessary. Currently, we estimate that private payers account for 50% to 60% of
patients implanted with the VNS Therapy System. As with other payers, many
private payers have developed clinical guidelines for coverage or adopted the
national CMS coverage policy for use of VNS Therapy in epilepsy. As of the end
of fiscal year 2009, coverage for VNS Therapy for depression is still very
limited. Most plans have either no policy or a non-coverage policy with respect
to coverage for depression.





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





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





—
              the
      status of the FDA’s review of the product;—
              CMS’s
      national coverage determinations, as well as local coverage determinations
      by Medicare contractors;—
              BlueCross
      BlueShield Technology Evaluation Center
recommendations;—
              other
      technology assessments, including but not limited to those provided by
      Hayes, Inc., the ECRI Institute and the California Technology Assessment
      Forum;—
              the
      product’s safety and efficacy;—
              the
      number of clinical studies performed and peer-reviewed articles published
      with respect to the product; and—
              how
      the product and therapy compare to alternative
  therapies.








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Payment
for VNS Therapy outside the U.S.





Payment
by customers for VNS Therapy Systems outside the U.S. varies on a
country-by-country basis and depends on the method of product distribution
chosen by the company for that country. In almost all countries, governments are
involved in setting the final reimbursement rates to be paid, which is generally
lower than the reimbursement rates in the U.S. market. In fiscal year 2009, our
international net product sales accounted for 19% of total net product sales,
and the three largest individual country markets were the United Kingdon, France
and Germany. In those countries, we sell directly to hospitals, and the amount
received may vary even within that country.  Total sales are also
affected by national and local health budgets.





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





Although
the VNS Therapy System has been approved for commercial distribution in European
Union countries and Canada for the treatment of chronic or recurrent depression,
we are not actively marketing the device in those countries for this indication
because of the lingering effect of the negative reimbursement environment in the
U.S. for the depression indication and because of the extent of the investment
that would be required.





Competition





We
believe that in the fields of refractory epilepsy, existing and future drug
therapies are and will continue to be the primary competition for the VNS
Therapy System. We may eventually face competition from other medical device
companies for the treatment of partial seizures and depression. Medtronic, Inc.,
for example, has completed a clinical study involving an implantable signal
generator used with an invasive deep brain probe  (deep brain
stimulation, or “DBS”) for the treatment of epilepsy and continues to conduct a
similar study of a DBS system for the treatment of depression. Medtronic, Inc.
has received FDA approval for a DBS device system for the treatment of essential
tremor and Parkinson’s Disease and has announced that it intends to seek FDA
approval for a DBS system for the treatment of epilepsy.  St. Jude
Medical, Inc. has also announced the initiation of a trial of a DBS system for
the treatment of depression, and NeuroPace, Inc. has developed a closed-loop
“responsive neurostimulation system” for the treatment of epilepsy and is
currently conducting a pivotal study for this device. We could also face
competition from other large medical device and pharmaceutical companies that
have the technology, experience and capital resources to develop alternative
devices for the treatment of epilepsy and depression. Many of our competitors
have substantially greater financial, manufacturing, marketing and technical
resources than we have. In addition, the healthcare industry is characterized by
extensive research efforts and rapid technological progress. Our competitors may
develop technologies and obtain patents and regulatory approval for products
that are more effective in treating epilepsy or depression than our current or
future products. In addition, advancements in surgical techniques could make
surgery a more attractive therapy for epilepsy or depression. The development by
others of new treatment methods with novel antiepileptic and depression drugs,
medical devices or surgical techniques for epilepsy or depression could render
the VNS Therapy System noncompetitive or obsolete.





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





At least
one other device-based therapy has recently been approved for depression that
has not responded to one failed treatment trial – repetitive transcranial
magnetic stimulation, or (“rTMS”).  This is a non-invasive device
treatment. Likewise, a well-established array of antidepressant drugs, typically
combined with other antidepressants of complementary action or with atypical
antipsychotic drugs and/or mood stabilizers, are frequently used for patients
with unresponsive, or treatment-resistant, depression. For patients with certain
types of severe depression or those at acute risk for suicide, ECT
(electroconvulsive therapy) is often used. These treatment modalities may pose a
competitive threat in the near term, to the extent that they may delay a
decision to offer VNS Therapy to patients with depression or be more readily
accessible due to more favorable reimbursement and coverage by third party
payers.





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As other
forms of neurostimulation are investigated and developed for epilepsy or
depression, these may emerge as competition for VNS Therapy. Other less invasive
treatments such as magnetic seizure therapy may compete for a similar place in
the depression treatment market as they are developed. Finally, ECT is
undergoing refinements in technique to increase specificity and reduce the
cognitive deficit side effects; if successful, the tolerability and patient
acceptance of ECT could improve in the future. These neurostimulation techniques
could prove to be more effective, more predictable, or more rapidly acting than
VNS Therapy.





Patents,
Licenses and Proprietary Rights





As of
April 24, 2009, we owned or licensed 46 U.S. patents and 84 pending
U.S. patent applications, covering various aspects of the VNS Therapy
System, improvements to the VNS Therapy System and methods of treatment for a
variety of disorders through electrical stimulation of the vagus nerve or other
cranial nerves. In addition to epilepsy and neuropsychiatric disorders
(including depression), other method patents cover the fields of eating
disorders (including obesity and bulimia), endocrine disorders, migraine
headaches, dementia, motility disorders, sleep disorders, coma, chronic pain,
cardiac disorders and hypertension. We have filed counterparts of certain of our
key U.S. patent applications in certain international jurisdictions and
currently own or license 13 patents issued by the European Patent Office or
other international authorities and 105 patent applications pending in the
European Patent Office or before other national or international
authorities.





We have
an exclusive license agreement with Jacob Zabara, Ph.D., a co-founder and
consultant to us, pursuant to which we currently maintain exclusive licenses on
six U.S. method patents (and such international counterparts that have been
or may be issued) covering the VNS Therapy System for vagus nerve and other
cranial nerve stimulation for the control of movement disorders (including
epilepsy), neuropsychiatric disorders (including depression) and other
disorders, and two pending U.S. patent applications.  We believe that
these patents give us an advantage by limiting competition in VNS to treat
refractory epilepsy and depression in the U.S. The license agreement will give
us coverage for movement disorders until expiration of the applicable patent in
July 2011 and coverage for neuropsychiatric disorders until expiration of the
applicable patent in May 2011.  We do not have indication-specific
patent coverage for movement disorders outside the U.S. or for neuropsychiatric
disorders outside the U.S. and Japan. Pursuant to the license agreement, we are
obligated to pay Dr. Zabara a royalty equal to 3.0% of net sales through
July 2011, after which our royalty obligation to Dr. Zabara will end unless, in
the meantime, we commence the sale of VNS Therapy Systems for an indication
covered by another patent issued to Dr. Zabara.





Effective
December 13, 2007, we licensed from Southern Illinois University the exclusive
rights to three additional U.S. patents pertaining to VNS for the treatment of
traumatic brain injury, modulating brain neural plasticity, and improving memory
and learning. During fiscal year 2009, we entered into agreements with other
third parties licensing IP rights pertaining to seizure detection and prediction
and to new VNS stimulation parameters for the control of epilepsy and other
disorders.  We are currently engaged in negotiations to obtain
additional IP rights pertaining to seizure detection and prediction, but we can
give no assurances that our negotiations will be successful.





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





There has
been substantial litigation regarding patent and other IP rights in the medical
device industry. In the future, we may need to engage in litigation to enforce
patents issued or licensed to us, to protect our trade secrets or know-how, to
defend us against claims of infringement of the rights of others or to determine
the scope and validity of the proprietary rights of others. Litigation could be
costly and could divert our attention from other functions and responsibilities.
Adverse determinations in litigation could subject us to significant liabilities
to third parties, could require us to seek licenses from third parties and could
prevent us from manufacturing, selling or using the VNS Therapy System, any of
which could severely harm our business. We are not currently a party to any
patent litigation or other litigation regarding proprietary rights and are not
aware of any challenge to our patents or proprietary rights.





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Licenses
Granted by Us to Other Persons





Effective
December 17, 2007, we entered into an Exclusive Patent License Agreement (the
“EES License Agreement”) with Ethicon Endo-Surgery, Inc. (“EES”), granting EES
an exclusive, worldwide license, with the right to grant non-exclusive
sublicenses, for a specified field of use (treatment by means of nerve
stimulation for weight reduction or for hypertension or diabetes in patients
having a body mass index of 25 or more) under nine U.S. patents and nine U.S.
patent applications, and future related patents and international counterparts.
Under the terms of the EES License Agreement, EES paid us a non-refundable fee
of $9.5 million. EES also agreed to pay us a royalty on future net sales of
products covered by any of the subject patents, and EES will reimburse us for
future patent-related expenses associated with the filing, prosecution, and
maintenance of the licensed patents and patent applications outside the U.S. EES
has also been granted a right of first refusal to negotiate for a license under
any patent rights acquired by us within the specified field of use and offered
for licensing.





Product
Liability and Insurance





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





In
November 2006, we sent physicians a safety alert letter warning of a software
anomaly that can cause the VNS Therapy System’s pulse generator to deliver an
output current of eight milliamps during an interrupted programming
session.  This amount of output current is within the range of
currents originally approved by the FDA as safe and effective, but it is higher
than is recommended for use.  The FDA classified this anomaly as a
Class II recall and approved our decision to address this situation by means of
the safety alert letter.  Although an event can be painful until
stimulation is terminated by application of a magnet to the device, we are not
aware of any permanent injury to a patient as a consequence of an event;
however, additional events could occur and could result in injuries and claims
with material adverse consequences to our business.





In August
2007, we published a field notification regarding the potential for dissolution
of the lead in the area of a lead fracture if stimulation continues after the
fracture.  Lead dissolution has been associated with localized pain,
inflammation and vocal cord dysfunction in some patients.  The field
notification advised physicians to program the generator to zero output current
if a lead fracture is suspected. The FDA classified this adverse event as a
Class II recall and approved our decision to address this adverse event by means
of a technical bulletin or safety alert letter.  Despite our efforts,
a patient could experience a related adverse event and pursue a product
liability claim with eventual material adverse consequences to our
business.





In
October 2007, we sent physicians a safety alert letter warning of a software
anomaly that can cause the screen on a Model 250 Handheld Programmer to freeze
during an interrogation.  The anomaly is limited to versions of the
Model 250 Programmer using a Dell X5 handheld computer.  A screen
freeze does not produce a direct adverse health consequence, but could result in
an indirect adverse health consequence as a result of delay in programming the
generator.  The FDA classified this anomaly as a Class III recall and
approved our decision to address this situation by means of the safety alert
letter.  We are not aware of any permanent injuries as a result of
this anomaly, but a claim with material adverse consequences to our business
could be asserted in the future.





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In
February 2008, we sent physicians a safety alert letter warning of a software
anomaly that can cause the VNS Therapy Demipulse and Demipulse Duo generators to
reset (set the output current to zero) during a magnet swipe or in the presence
of a strong electric field.  The FDA classified this anomaly as a
Class III recall and approved our decision to address this situation by means of
a safety alert letter.  In December 2008, we obtained FDA approval to
upgrade the software in implanted generators to a version without the software
anomaly. We are not aware of any permanent injuries as a result of this anomaly
or efforts to upgrade the software, but a claim with material adverse
consequences to our business could be asserted in the future.





We may in
the future identify other product defects, and any such defects may result in
legal claims with material adverse consequences to our business.





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





Employees





As of May
30, 2009, we had 440 full-time employees.  We believe that the
success of our business depends, in part, on our ability to attract and retain
qualified personnel. We believe our relationship with our employees is generally
good. We are also engaged in an ongoing effort to identify, hire, manage and
maintain the talent necessary to meet the company’s objectives. However, we
cannot assure you that we will be successful in hiring or retaining qualified
personnel. The loss of key personnel, or the inability to hire or retain
qualified personnel, could significantly harm our business.





Financial
Information about Segments and Geographical Areas





We
operate our business as a single segment with similar economic characteristics,
technology, manufacturing processes, customers, distribution and marketing
strategies, regulatory environments and shared infrastructures. We are a
neurostimulation business focused on creating new markets, improving our
products, developing other medical devices for patients suffering from epilepsy
and expanding our business into other neuromodulation
opportunities.





Our
financial information, including our net sales and long-lived assets by
geographical area, is included in the Consolidated Financial Statements and the
related Notes beginning on page F-1, especially “Note
17.  Geographic Information”.





Website
and Availability of Public Filings with the SEC





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





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





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





Item 1A.Risk
Factors





Our
common stock price constantly changes.





Our
common stock is traded on the NASDAQ Global Market under the ticker symbol
“CYBX.” The price of stock on that trading market fluctuates, and we expect that
the market price of our common stock will continue to fluctuate. For example,
during the fiscal year ended April 24, 2009, our stock traded from a high
of $28.95 to a low of $9.84 per share. Our stock price may be affected by a
number of factors, some of which are beyond our control, including, without
limitation:





—
              changes
      in the general conditions of the economy including the valuation of the
      dollar versus other currencies;—
              regulatory
      activities and announcements;—
              governmental
      enforcement initiatives related to medical device
    companies;—
              changes
      in market conditions and valuations of medical device companies in
      general;—
              national
      and regional coverage determinations by third-party payers, including
      private insurance companies, Medicare, state Medicaid programs and other
      international bodies responsible for coverage
    determinations;—
              results
      of studies regarding the safety and efficacy of our VNS Therapy treatment
      for various indications including epilepsy, depression, fibromyalgia,
      multiple sclerosis, obesity, bulimia, Alzheimer’s disease, anxiety,
      obsessive-compulsive and other disorders;—
              results
      of studies regarding the safety and efficacy of drugs or devices that are
      potential competitors to our VNS Therapy System;—
              quarterly
      variations in our sales and operating results;—
              announcements
      of significant contracts, acquisitions or capital
    commitments;—
              our
      ability to develop an alternative strategy for VNS Therapy for
      depression;—
              our
      ability to find licensees for some of our technology and the terms or any
      licenses we grant;—
              changes
      in financial estimates by securities analysts;—
              additions
      or departures of key management or other personnel;—
              risks
      and costs associated with the previously disclosed inquiries by the SEC
      staff and the U.S. Attorney and any litigation relating thereto or to
      our stock option grants, procedures and practices;—
              the
      potential identification of material weaknesses in our internal controls
      over financial reporting;—
              uncertainties
      associated with governmental and regulatory inquiries;
  and—
              uncertainties
      associated with litigation.





In
addition, the stock market in recent years has experienced broad price and
volume fluctuations that have often been unrelated to the operating performance
of companies. The market price and trading volume of our common stock may
continue to be subject to significant fluctuations due not only to general stock
market conditions but also to variability in the prevailing sentiment regarding
our operations or business prospects, as well as potential further sales of our
common stock due to margin calls on loans secured by pledges of our common
stock. These broad market fluctuations have also adversely affected, and may
continue to adversely affect, the market price of our common stock.





We have been
profitable for only twelve fiscal quarters since our
inception in 1987.





Through
April 24, 2009, we incurred an accumulated deficit of approximately
$242.5 million. Although we were profitable in fiscal year 2009, we can
provide no assurance that our net sales will grow or that our expenses will
decline sufficiently to enable us to remain profitable in the
future.





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





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





—
                  the
      extent to which the VNS Therapy System gains market
      acceptance;—
                  the
      existence and timing of any approvals or non-coverage determinations for
      reimbursement by third-party payers;—
                  the
      rate and size of expenditures incurred on our clinical, manufacturing,
      sales, marketing and product development efforts;—
                  our
      ability to retain qualified personnel;—
                  the
      availability of key components, materials and contract services, which
      depends on our ability to forecast sales among other
    things;—
                  investigations
      of our business and business-related activities by regulatory or other
      governmental authorities;—
                  increased
      competition, patent expiration, new technology or
    treatments;—
                  product
      recalls or safety alerts;—
                  litigation,
      including product liability, securities class action, stockholder
      derivative, general commercial and other lawsuits; and—
                  the
      financial health of our customers, and their ability to purchase VNS
      Therapy Systems, in the current economic
  environment.





As a
result of any of these factors, our consolidated results of operations may
fluctuate significantly and may be below security analyst expectations, which
may in turn cause our stock price to decline.





We may fail to
comply with one or more of the many regulations that govern our business
activities.





We are
subject to extensive and rigorous ongoing regulation of the research,
development, testing, manufacture, labeling, promotion, advertising,
distribution and marketing of VNS Therapy System. Our failure to comply with
regulations or to identify and resolve manufacturing or safety problems prior to
commercial marketing could lead to the need for product marketing restrictions,
product withdrawal or recall or other voluntary or regulatory action, any of
which could delay further marketing until VNS Therapy System is brought into
compliance. Our failure to comply with these requirements could have a
significant negative impact on our future operating results and may also subject
us to stringent penalties and lawsuits.





Our indebtedness
and debt service obligations may adversely affect our cash flow, cash position and
stock price.





As of
April 24, 2009, we had $62.3 million in convertible debt with
aggregate annual debt service obligations, excluding repayment of principal, of
approximately $1.9 million. If we issue other securities in the future, our
debt service obligations and interest expense will increase further. We intend
to fulfill our debt service obligations from earnings and our existing cash and
investments. In the future, if we are unable to generate cash or raise
additional cash through financing sufficient to meet these obligations, we may
have to delay or curtail our research, development and commercialization
programs. Our indebtedness could have significant additional negative
consequences, including, without limitation:





—
              requiring
      the dedication of a portion of our cash to service our indebtedness and to
      pay off the principal at maturity, thereby reducing the amount of our
      expected cash available for other purposes, including funding our
      research, development and commercialization efforts and planned capital
      expenditures;—
              increasing
      our vulnerability to general adverse economic
  conditions;—
              limiting
      our ability to obtain additional financing or financing at commercially
      competitive terms; and—
              placing
      us at a possible competitive disadvantage to less leveraged competitors
      and competitors with better access to capital
  resources.








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Upon the
occurrence of a fundamental change, holders of our Senior Subordinated
Convertible
Notes may force us to purchase their Convertible Notes at the full amount
owed,
including accrued but unpaid interest.





If we
undergo a fundamental change as defined in the documentation governing our $62.3
million of 3% Senior Subordinated Convertible Notes that may become due in 2011
(“Convertible Notes”), including, but not limited to, the acquisition by any
person of the beneficial ownership of 50% of our common stock, our consolidation
or merger with or into any other person, our liquidation, or our common stock
being removed from listing on the NASDAQ Global Market, the holders of the
Convertible Notes may, at their option, require us to purchase their Convertible
Notes for the full amount owed including accrued but unpaid interest. This
amount may be greater than the market value of the Convertible Notes at the time
of repurchase. As a result, the possibility of a repurchase requirement may
inhibit the consummation of certain transactions such as consolidations or
mergers that may be beneficial to our stockholders.





Upon the
occurrence of certain events, the initial conversion rate of our
Convertible Notes will be
adjusted, which could result in an increased number of shares being issued upon
conversion.





The
initial conversion rate of our Convertible Notes will be adjusted upon the
occurrence of certain events, including, among others, the issuance to our
stockholders of certain rights to purchase our common stock at less than the
current market price of our common stock or the issuance of cash dividends to
substantially all of our stockholders. If the conversion rate is adjusted,
holders of our Convertible Notes will receive a greater number of shares of our
common stock per Convertible Note, resulting in increased percentage ownership
of our common stock by the noteholders and increased dilution of the interests
held by current holders of our common stock.





We may not be
able to access sufficient additional capital sources or to access capital on terms
which are acceptable to us.





Our
capital requirements will depend on many factors, including market acceptance of
our product and clinical and strategic development opportunities. A large
portion of our expenses is currently fixed, including expenses related to our
facilities, equipment and personnel, and we may need to spend significant
amounts to conduct our post-marketing clinical studies or for product
improvement and development.  If we are unable to generate sufficient
profits to fund our capital requirements internally, then we will be forced to
turn to outside sources of capital.  We may be unable to access
sufficient sources of capital or to access capital on terms that are acceptable
to us.  Additionally, recent unfavorable disclosures by international
financial institutions concerning the sub-prime mortgage market may lead to a
contraction in credit availability, thereby further impacting our ability to
fund our capital requirements.  If additional capital sources are
unavailable, we may be forced to abandon our efforts with respect to clinical
studies or product improvement and development.




We
may fail to maintain the current regulatory approvals for our depression
indication and our ability to minimize our required investment for this
indication.





In
February 2008, we announced a plan to transfer our depression business to a
separate entity, in which we expected to maintain at least a minority interest.
This process did not result in the receipt of an offer that provides sufficient
value to our stockholders.  Accordingly, we continue evaluating
alternative actions intended to maintain the current regulatory approval, while
minimizing our required investment, as well as ensuring that VNS Therapy
continues to be available to patients in the United States and certain
international markets. If we are unable to find an alternative strategy with
respect to our depression indication, we may lose our regulatory approval which
could have a material adverse effect on shareholder value, or be forced to
increase our investment substantially, which could have a material adverse
effect on our consolidated results of operations, financial condition and cash
flows.





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We
may not be successful in implementing our open market share repurchase
program.





In
February 2008, we announced our intention to conduct an open market share
repurchase program for the repurchase of up to one million shares of our
outstanding common stock. The number of shares actually repurchased and the
timing of any repurchases will depend on factors such as the stock price,
economic and market conditions, and corporate and regulatory
requirements.  The program may be also suspended or discontinued at
any time. As of April 24, 2009, we have purchased 514,725 shares of our
outstanding common stock under the program.  We may be unable to
complete the program as planned.  There can be no assurance that any
repurchases will have a positive impact on our stock price.  Failure
to complete the program may negatively impact investor confidence in us and
negatively impact our stock price.





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





We have
conducted or supported animal studies or small human pilot studies for the
treatment of a number of therapeutic indications beyond refractory epilepsy and
depression. Regulatory approval for any new indications would require us to
conduct one or more larger scale pivotal trials. We have not conducted such
pivotal trials for any indication beyond refractory epilepsy and depression, nor
do we have any immediate plans to do so. In the event that we do invest in
future studies for new indications, we cannot assure you that our study results
will be positive. If we elect not to conduct research with regard to new
indications, our study results are not positive, we do not receive additional
regulatory approvals, or alternative indications do not prove to be commercially
viable, our revenue growth, if any, would be limited to revenue from our
existing approved indications in refractory epilepsy and
depression.





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





Market
acceptance of the VNS Therapy System depends on our ability to convince the
medical community and third-party payers of the clinical efficacy and safety of
vagus nerve stimulation and the VNS Therapy System. While the VNS Therapy System
has been implanted in an estimated 58,000 patients, many physicians are
still unfamiliar with this form of therapy. We believe that existing
pharmacological therapies, surgery (for refractory epilepsy) and ECT (for
depression) are the only other approved and currently available therapies
competitive with the VNS Therapy System. Medtronic, Inc., however, has conducted
studies concerning the effectiveness of its DBS device system for the treatment
of depression and announced that it intends to seek FDA approval for a DBS
device system for the treatment of epilepsy. These other therapies may be more
attractive to patients or their physicians than the VNS Therapy System in terms
of efficacy, cost or reimbursement availability. Furthermore, we have not funded
significant post-market clinical research that could change physicians’ opinions
or use of our product for refractory epilepsy. We cannot assure you that we will
ever receive broad reimbursement coverage for depression or that our sales will
increase for epilepsy or depression. Additionally, we cannot assure you that the
VNS Therapy System will achieve expanded market acceptance for the treatment of
epilepsy, depression or for any other indication. Failure of the VNS Therapy
System to gain additional market acceptance could severely harm our business,
our consolidated financial position and results of operations.





We
have not been successful in our marketing and sales effort in VNS Therapy for
depression.





We
launched VNS Therapy for depression in August 2005 following an expansion of our
sales and case management organization to support anticipated sales demand in
the depression market. In May 2007, CMS issued a national non-coverage
determination with respect to VNS Therapy for depression. Because the national
non-coverage determination is binding on all local Medicare contractors,
patients cannot obtain Medicare coverage for depression. In addition, CMS’s
non-coverage determination had a detrimental effect on coverage decisions by
other payers, including Medicaid and private payers. Accordingly our depression
sales have decreased markedly since fiscal year 2006. In addition, the absence
of broad regional or national insurance coverage has had a negative effect on
psychiatrists’ prescribing habits, resulting in substantially decreased sales of
VNS Therapy Systems for depression. Accordingly, during fiscal year 2009, we
curtailed active marketing efforts with respect to depression.





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We do not
anticipate any meaningful sales growth in depression unless and until we obtain
favorable coverage policies for VNS Therapy in depression.





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





The
Health Insurance Portability and Accountability Act of 1996 (“HIPAA”)
establishes federal rules protecting the privacy and security of personal health
information. The privacy and security rules address the use and disclosure of
individual health care information and the rights of patients to understand and
control how such information is used and disclosed. HIPAA provides both criminal
and civil fines and penalties for covered entities that fail to comply with
HIPAA. We intend to comply with applicable privacy and security standards.
However, if we fail to comply with the applicable regulations, we could suffer
civil penalties up to $25,000 per calendar year for each violation and criminal
penalties with fines up to $250,000 and potential imprisonment. In addition to
HIPAA, virtually every state has enacted one or more laws to safeguard privacy,
and these laws vary significantly from state to state and change frequently.
Even if our business model is compliant with the HIPAA Privacy and Security Rule
and the Texas privacy laws, it may not be compliant with the privacy laws of all
states. Because the operation of our business involves the collection and use of
substantial amounts of “protected health information,” we endeavor to conduct
our business as a “covered entity” under the HIPAA Privacy and Security Rule and
consistent with the Texas privacy laws, obtaining HIPAA-compliant patient
authorizations where required to support the collection and use of patient
information. We also sometimes act as a “business associate” for a covered
entity. Despite extensive efforts to conduct our business as a covered entity
under the HIPAA Privacy and Security Rules, the Office for Civil Rights of the
Department of Health and Human Services or another government enforcement agency
may determine that our business model or operations are not in compliance with
the HIPAA Privacy and Security Rules, which could subject us to penalties, could
severely limit our ability to market and sell VNS Therapy under our existing
business model and could harm our business growth and consolidated financial
position.





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





Our
ability to commercialize the VNS Therapy System successfully depends, in large
part, on whether third-party payers, including private healthcare insurers,
managed care plans, Medicare and Medicaid programs and others, agree to cover
the VNS Therapy System and associated procedures and services and to reimburse
at adequate levels for the costs of the VNS Therapy System and the related
services in the U.S. or internationally. While we currently have
reimbursement approval for epilepsy, we do not have substantial reimbursement
coverage for the treatment of depression. In May 2007, CMS issued a national
non-coverage determination with respect to VNS Therapy for depression. This
non-coverage determination means that Medicare will not cover VNS Therapy for
depression. Since the national non-coverage determination is binding on all
local Medicare contractors, patients are not able to obtain Medicare coverage
for depression. In addition, the CMS non-coverage determination also had a
detrimental effect on coverage by Medicaid and private payers. In addition,
periodic changes to reimbursement methodology for medical devices under the
Medicare and Medicaid programs occur and may reduce the rate of increase in
federal expenditures for health care costs. Such changes, as well as any future
regulatory changes and the failure of the VNS Therapy System to continue to
qualify for reimbursement under these programs, may have an adverse impact on
our business.





Healthcare,
as one of the largest industries in the U.S., continues to attract substantial
legislative interest and public attention. Congress and state legislatures are
constantly reassessing the propriety of coverage for various health services and
the payment level for such services. Certain reform proposals and other policy
shifts, if enacted, could limit coverage for VNS Therapy or the reimbursement
available for VNS Therapy from governmental agencies or third-party payers.
Changes in Medicare, Medicaid and other programs, cost-containment initiatives
by public and private payers, a failure to obtain substantial regional and
national coverage policies for VNS Therapy in depression, and proposals to limit
payments and health care spending could have a significant negative impact on
our future operating results.





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





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





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





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





We
may not be able to meet regulatory quality standards applicable to our
manufacturing process.




We are
required to register with the FDA as a device manufacturer and as a result, we
are subject to periodic inspection by the FDA for compliance with the FDA’s QSR
requirements, which require manufacturers of medical devices to adhere to
certain regulations, including testing, quality control and documentation
procedures.  In addition, the federal Medical Device Reporting
regulations require us to provide information to the FDA whenever there is
evidence that reasonably suggests that a device may have caused or contributed
to a death or serious injury, or may contain an anomaly which, if a malfunction
were to occur, could cause or contribute to a death or serious
injury.  Compliance with applicable regulatory requirements is subject
to continual review and is rigorously monitored through periodic inspections by
the FDA.  In the European Community, we are required to maintain
certain ISO certifications in order to sell products, and we undergo periodic
inspections by notified bodies to obtain and maintain these
certifications.  If we fail to adhere to QSR or ISO requirements, this
could delay production of our products and lead to fines, difficulties in
obtaining regulatory clearances, recalls or other consequences, which could in
turn have a material adverse effect on our consolidated financial condition and
results of operations.




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





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





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





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





We
may be subject to competition outside the U.S., reducing our sales and
earnings.





Our
patent protection outside the U.S. for the epilepsy and depression indications
has expired.  As a result, we are subject to competition in some
countries without legal recourse to challenge our competitors based on patent
infringement.  For example, we are aware of an entity in Turkey
manufacturing and selling implantable devices for delivering VNS Therapy in that
market.  In the future, we may be subject to other competition in
other countries, reducing our sales and earnings or limiting our
growth.





Additionally,
certain countries, including China, do not enforce compliance with laws that
protect IP rights with the same degree of vigor as is available under the U.S.
patent system. For this reason, there is a risk that our IP may be subject to
misappropriation in such countries. This may permit others to produce copies of
our products that are not covered by currently valid patent registrations. There
is also a risk that such products may be exported from such countries to other
countries.





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





There has
been substantial litigation regarding patent and other IP rights in the medical
device industry. Litigation, which could result in substantial cost to and
diversion of effort by us, may be necessary to enforce patents issued or
licensed to us, to protect trade secrets or know-how owned by us or to defend
ourselves against claimed infringement of the rights of others and to determine
the scope and validity of the proprietary rights of others. Adverse
determinations in litigation could subject us to significant liabilities to
third parties, could require us to seek licenses from third parties and could
prevent us from manufacturing, selling or using the VNS Therapy System, any of
which could severely harm our business.





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Intense
competition and rapid technological changes could reduce our ability to
market our
products successfully and achieve sales.





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





We are subject to
claims of product liability, and we may not have the resources or insurance to
cover the cost for losses under these claims.





The
manufacture and sale of the VNS Therapy System entails the risk of product
liability claims, which arise from time to time in the ordinary course of
business. We may be responsible for large self-insured retentions for each
claim, and our product liability coverage limit may not be adequate to pay
defense costs and judgments that may result from these claims. Product liability
insurance is expensive and in the future may only be available at significantly
higher premiums or may not be available on acceptable terms, if at all. A
successful claim brought against us in excess of our insurance coverage could
significantly harm our business and consolidated financial
position.





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





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





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The
process of obtaining FDA and other required regulatory approvals is lengthy,
expensive and uncertain. Moreover, regulatory approvals may include regulatory
restrictions on the indicated uses for which a product may be marketed. Failure
to comply with applicable regulatory requirements can result in, among other
things, fines, suspension or withdrawal of approvals, confiscations or recalls
of products, operating restrictions and criminal prosecution. Adverse results in
post-approval studies may result in limitations on or withdrawal of previously
granted approvals. Furthermore, changes in existing regulations or adoption of
new regulations could prevent us from obtaining, or affect the timing of, future
regulatory approvals. We may not be able to obtain additional future regulatory
approvals on a timely basis or at all. Delays in receipt of or failure to
receive such future approvals, suspension or withdrawal of previously received
approvals or recalls of the VNS Therapy System could severely harm our ability
to market and sell our current and future products and improvements. As a
condition of approval for the depression indication, the FDA has required us to
conduct a post-approval 460-patient dosing study and a 1,000-patient registry of
which 500 will be treated with VNS Therapy. The results of these studies may be
included in our product labeling. If we fail to conduct or complete these
studies in a timely manner, we may be subject to regulatory action, including
withdrawal of our depression indication approval.  Also, any adverse
regulatory action, depending on its breadth, may be detrimental to our
business.





We are subject to
governmental laws addressing our sales and marketing practices, and failure to
adhere to these laws could result in substantial fines and other penalties.





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





In
January 2006, we adopted revisions to our Business Practice Standards that we
believe more thoroughly address our compliance risks with respect to healthcare
laws. Additionally, in October 2008, we adopted International Business Practice
Standards that we believe address our compliance risks with respect to
international laws and rules. We endeavor to conduct our business in compliance
with our Business Practice Standards and International Business Practice
Standards and to ensure continued compliance through regular education of our
employees, audits of employee activities, and appropriate responses to
violations of the Business Practice Standards and International Business
Practice Standards. Although we believe that these efforts have been successful
and that we are in substantial compliance with our policies and the healthcare
laws, given the complexity of our business model, including extensive
interactions with patients and healthcare professionals, and the large number of
field personnel employed by us, violations of our policy and the law could
occur. We could be subject to investigation by the OIG or the DOJ or a
comparable state or international agency. If investigated, we could be forced to
incur substantial expense responding to the investigation and defending our
actions. If unsuccessful in our defense, we could be found to be in violation of
the healthcare laws and be subject to substantial fines and penalties, including
exclusion of the VNS Therapy System from Medicare and Medicaid
reimbursement.





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





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





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





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





Our
international business is subject to foreign currency fluctuations.





The
majority of our international sales are invoiced in Euros, U.S. dollars and
British pounds. The strengthening of the U.S. dollar generally has an
unfavorable impact on our sales. The weakening of the U.S. dollar generally has
a favorable impact on our sales.  The impact of foreign currency
fluctuations on sales is not indicative of the impact on our operations due to
the offsetting foreign currency impact on operating costs and
expenses.  Additionally, if currencies weaken against the U.S. dollar,
foreign distributors whose payables are denominated in U.S. dollars may not be
able to meet their obligations in a timely manner.





We sell our
products in certain emerging
economies.





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





In
many of the international markets in which we do business, including certain
parts of Europe, Russia and Asia, our employees, agents or distributors sell our
products to various governmental agencies.





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





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





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





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Since
November 2006, we have experienced significant turnover in our
management.  These changes in key management positions may strain our
existing resources, creating a risk of loss of other key employees. As a result,
our business could be adversely affected.





We are the
subject of governmental investigations related to our stock option granting
practices and procedures and other matters, the outcome of which could
adversely
affect our business.





In June
2006, the SEC staff advised us that it had commenced an informal inquiry of our
stock option grants and related practices, procedures and accounting. In June
2006, we also received a subpoena from the U.S. Attorney requesting
documents related to the same matters. In October 2006, the SEC staff made an
additional request for certain documents and information related to our revised
guidance on February 8, 2006 and our financial results announced on
May 1, 2006, our sales for the quarter ended April 28, 2006, coverage
or potential coverage of our VNS Therapy System by Alabama BlueCross BlueShield
and Aetna and the aging of our accounts receivable since January 1,
2003.





We are
cooperating with this governmental investigation. A more detailed discussion of
this matter is contained in “Note 14. Litigation — Governmental
Investigations of Options Granting Practices.” Although it is not
possible  to predict the likely outcome of these inquiries, an adverse
result could have a material adverse effect on us, our consolidated financial
position, results of operations and cash flows. Even if the result of such
inquiries is not adverse, the cost of defending against such inquiries has been
and may continue to be expensive and could have a material adverse effect on our
consolidated financial position.





We
have an obligation to advance legal fees for our current and former
officers and directors in certain situations, and that obligation could be
costly to us.





We and
certain former officers are the subject of an informal inquiry by the SEC. 
For details on the inquiry, see  “Note 14. Litigation —
Governmental Investigations of Options Granting Practices.” Pursuant to our
bylaws, we have an obligation to advance reasonable legal fees and expenses
incurred by our former officers in connection with their defense of
the inquiry.  The amount of legal fees and expenses we are required to
advance could be substantial and could have a material adverse effect on our
consolidated financial position.





Disruption
in the global financial markets may adversely impact the availability and cost
of credit, customer spending patterns and our suppliers’ ability to provide us
with necessary materials.





In the
U.S., recent market and economic conditions have been unprecedented and
challenging, with tighter credit conditions and slower growth. During fiscal
year ending April 24, 2009, continued concerns about the systemic impact of
inflation, energy costs, geopolitical issues, the availability and cost of
credit, the insurance industry, the U.S. mortgage market and a declining real
estate market in the U.S. have contributed to increased market volatility and
diminished expectations for the U.S. economy.  Added concerns fueled
by the federal government conservatorship of the Federal Home Loan Mortgage
Corporation and the Federal National Mortgage Association, the declared
bankruptcy of Lehman Brothers Holdings Inc., the U.S. government-provided loan
to American International Group Inc. and other federal government interventions
in the U.S. credit markets led to increased market uncertainty and instability
in both U.S. and international capital and credit markets. These conditions,
combined with volatile oil prices, declining business and consumer confidence
and increased unemployment have contributed to unprecedented market
volatility.





As a
result of these conditions, the cost and availability of credit has been and may
continue to be adversely affected by illiquid credit markets and wider credit
spreads. Concern about the stability of the markets generally and the strength
of counterparties specifically has led many lenders and institutional investors
to reduce, and in some cases, cease to provide funding to borrowers. Continued
turbulence in the U.S. and international markets and economies may adversely
affect our liquidity and financial condition, and the liquidity and financial
condition of our customers and suppliers. If these market conditions continue,
they may limit our ability to access the capital markets to meet liquidity needs
and timely replace maturing liabilities, resulting in an adverse effect on our
consolidated financial condition and results of operations.





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We have
exposure to the credit risks of some of our customers and suppliers and such
risks could be exacerbated by these volatile economic conditions. Although we
have programs in place that are designed to monitor and mitigate the associated
risk, there can be no assurance that such programs will be effective in reducing
our credit risks adequately. If there is a significant deterioration of customer
creditworthiness or actual defaults are higher than expected, future resulting
losses, if incurred, could harm our business and have a material adverse effect
on our operating results. In addition, the recent economic crisis could also
adversely impact our suppliers’ ability to provide us with materials and
components, which may negatively impact our business.





Given the
ramifications of the recent financial crisis, we also have exposure to any
instability in the insurance industry.  This unprecedented volatility
may impact an insurer’s ability to honor coverage of losses incurred under a
policy.  If we have losses that our insurers are unable to cover, this
could negatively impact our business and have a material adverse effect on our
operating results.





Our
manufacturing facility is located at a single site, and the occurrence of a
catastrophic disaster or other similar event could cause damage to our facility
and equipment, which would require us to cease or curtail
operations.





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





Item 1B.Unresolved Staff
Comments





Currently,
there are no outstanding, unresolved written comments by the SEC regarding any
of our periodic or current reports filed under the Exchange Act.  We
have, however, previously disclosed that we are subject to an inquiry by the SEC
relating to our accounting for stock option grants. We are cooperating with the
SEC in such inquiry.





Item 2.Properties





In
December 2007, we re-negotiated the lease on 114,000 square feet of office and
manufacturing space at 100 Cyberonics Blvd in Houston, Texas, extending the term
for 86 months, commencing on November 1, 2007 and ending on December 31, 2014,
and agreeing to surrender the use of 19,376 square feet of the
premises.  In January 2008, we completed the abandonment of the
portion of the leased space that we had agreed to surrender.  In March
2008 we agreed to surrender an additional 294 square feet.  We have
also agreed to lease approximately 8,800 square feet of warehouse and office
facilities at 11275 West Sam Houston Tollway South in Houston,
Texas.





As part
of our international operations, we have leased approximately 17,000 square
feet for administrative and sales offices in Brussels, Belgium and elsewhere in
Europe with terms ending in October 2009 through January 2011. All leased
properties include the appropriate space to accommodate expected growth in our
respective domestic and international businesses.





Item 3.Legal
Proceedings





For a
description of our material pending legal and regulatory proceedings and
settlements, see “Note 14. Litigation.”





Item 4.Submission of Matters to
a Vote of Security Holders





None.





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PART II





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




Our common stock is quoted on the NASDAQ Global Market under the symbol “CYBX.”
The high and low sale prices for our common stock during fiscal years 2008 and
2009 are set forth below. Price data reflect actual transactions, but do not
reflect mark-ups, mark-downs or commissions.





High
              
              
              LowFiscal
      Year Ended April 25, 2008First
      Quarter
              
              $
              22.38
              
              
              $
              14.58Second
      Quarter
              
              
              18.12
              
              
              
              12.95Third
      Quarter
              
              
              14.92
              
              
              
              11.51Fourth
      Quarter
              
              
              15.98
              
              
              
              9.59Fiscal
      Year Ended April 24, 2009First
      Quarter
              
              
              28.12
              
              
              
              15.27Second
      Quarter
              
              
              28.95
              
              
              
              9.85Third
      Quarter
              
              
              18.27
              
              
              
              9.84Fourth
      Quarter
              
              
              16.45
              
              
              
              12.31




As of June 12, 2009, according to data provided by our transfer agent, there
were 371 stockholders of record.




During fiscal year 2008 and 2009, we did not pay any cash dividends to our
stockholders. We currently intend to retain future earnings to fund the
development and growth of our business and, therefore, do not anticipate paying
cash dividends within the foreseeable future. Any future payment of dividends
will be determined by our Board of Directors and will depend on our consolidated
financial position and results of operations and other factors deemed relevant
by our Board of Directors.





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The table below presents purchase of equity securities by the issuer and
affiliated purchasers:





Period
            
            Total
      Number of Shares (or Units) Purchased
            
            
            Average
      Price Paid per Share (or Unit) (1)
            
            
            Total
      number of Shares (or Units) Purchased as Part of Publicly Announced Plans
      or Programs
            
            
            Maximum
      Number (or Approximate Dollar Value) of Shares (or Units) that may yet be
      Purchased under the Plans or Programs (2)January
      26 – February 29, 2008
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            1,000,000March
      1 – March 28, 2008
            
            
            348,300
            
            
            $
            12.3051
            
            
            
            348,300
            
            
            
            651,700March
      29 – April 25, 2008
            
            
            130,725
            
            
            $
            14.5685
            
            
            
            130,725
            
            
            
            520,975April
      26 – May 30, 2008
            
            
            7,000
            
            
            $
            15.0157
            
            
            
            7,000
            
            
            
            513,975May
      31 – June 27, 2008
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            513,975June
      28 – July 25, 2008
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            513,975July
      26 – August 29, 2008
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            513,975August
      30 – September 26, 2008
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            513,975September
      27 – October 24, 2008
            
            
            28,700
            
            
            $
            14.8844
            
            
            
            28,700
            
            
            
            485,275October
      25  – November 28, 2008
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            485,275November
      29 – December 27, 2008
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            485,275December
      28  – January 23, 2009
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            485,275January
      24  – February 27, 2009
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            485,275February
      28  – March 27, 2009
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            485,275March
      28  – April 24, 2009
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            485,275Total
            
            
            514,725
            
            
            $
            13.0606
            
            
            
            514,725
            
            
            
            485,275


____________________________





(1)
            Shares
      are purchased at market price.(2)
            In
      February 2008, we announced an open market share repurchase program for
      the repurchase of up to 1.0 million shares of our outstanding common
      stock.





Item 6.  Selected Financial
Data




The following table summarizes certain selected financial data and is qualified
by reference to, and should be read in conjunction with the Consolidated
Financial Statements and related Notes and with “Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations”
included in this Form 10-K. The selected financial data and the related
Notes for the 52 weeks ended April 24, 2009, April 25, 2008 and
April 27, 2007 are derived from consolidated financial statements that are
included in this Form 10-K. The selected financial data for the 52 weeks ended
April 29, 2006 and April 30, 2005 are derived from audited
consolidated financial statements that are not included in this
Form 10-K.





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52
      Weeks EndedApril 24,
                2009
              
              April 25,
                2008
              
              April 27,
                2007
              
              April 28,
                2006
              
              April 29,
                2005Consolidated
      Statement of Operations Data:Net
      sales
              
              $
              143,600,979
              
              
              $
              121,229,742
              
              
              $
              130,968,437
              
              
              $
              123,441,575
              
              
              $
              103,442,570Cost
      of sales
              
              
              20,040,636
              
              
              
              21,092,374
              
              
              
              18,258,374
              
              
              
              15,822,045
              
              
              
              15,674,040Gross
      profit
              
              
              123,560,343
              
              
              
              100,137,368
              
              
              
              112,710,063
              
              
              
              107,619,530
              
              
              
              87,768,530Operating
      expenses:Selling,
      general and administrative
              
              
              84,837,694
              
              
              
              85,944,866
              
              
              
              134,144,315
              
              
              
              137,310,196
              
              
              
              86,972,068Research
      and development
              
              
              19,732,941
              
              
              
              22,421,199
              
              
              
              28,092,243
              
              
              
              29,541,707
              
              
              
              20,092,810Total
      operating expenses
              
              
              104,570,635
              
              
              
              108,366,065
              
              
              
              162,236,558
              
              
              
              166,851,903
              
              
              
              107,064,878Income
      (loss) from operations
              
              
              18,989,708
              
              
              
              (8,228,697
              )
              
              
              (49,526,495
              )
              
              
              (59,232,373
              )
              
              
              (19,296,348
              )Interest
      income
              
              
              1,235,757
              
              
              
              3,844,508
              
              
              
              4,649,394
              
              
              
              3,211,956
              
              
              
              1,072,488Interest
      expense
              
              
              (3,394,837
              )
              
              
              (5,818,272
              )
              
              
              (5,913,119
              )
              
              
              (3,018,969
              )
              
              
              (444,270
              )Gain
      on early extinguishment of debt
              
              
              11,000,698
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Other
      income (expense), net
              
              
              (381,265
              )
              
              
              (397,141
              )
              
              
              (311,112
              )
              
              
              69,460
              
              
              
              84,736Income
      (loss) before income taxes
              
              
              27,450,061
              
              
              
              (10,599,602
              )
              
              
              (51,101,332
              )
              
              
              (58,969,926
              )
              
              
              (18,583,394
              )Income
      tax expense (benefit)
              
              
              729,441
              
              
              
              (264,837
              )
              
              
              78,775
              
              
              
              99,266
              
              
              
              26,113Net
      income (loss)
              
              $
              26,720,620
              
              
              $
              (10,334,765
              )
              
              $
              (51,180,107
              )
              
              $
              (59,069,192
              )
              
              $
              (18,609,507
              )Basic
      income (loss) per share
              
              $
              1.00
              
              
              $
              (0.39
              )
              
              $
              (2.01
              )
              
              $
              (2.37
              )
              
              $
              (0.77
              )Diluted
      income (loss) per share
              
              $
              0.61
              
              
              $
              (0.39
              )
              
              $
              (2.01
              )
              
              $
              (2.37
              )
              
              $
              (0.77
              )Shares
      used in computing basic income (loss) per share
              
              
              26,632,115
              
              
              
              26,568,746
              
              
              
              25,514,232
              
              
              
              24,916,938
              
              
              
              24,036,736Shares
      used in computing diluted income (loss) per share
              
              
              27,542,198
              
              
              
              26,568,746
              
              
              
              25,514,232
              
              
              
              24,916,938
              
              
              
              24,036,736Consolidated
      Balance Sheet Data (as of Year End):Cash,
      cash equivalents and marketable securities
              
              $
              66,225,479
              
              
              $
              91,058,692
              
              
              $
              84,804,876
              
              
              $
              92,355,071
              
              
              $
              61,475,892Total
      assets
              
              
              112,043,628
              
              
              
              136,231,087
              
              
              
              137,644,883
              
              
              
              152,300,284
              
              
              
              98,855,397Convertible notes(1)
              
              
              62,339,000
              
              
              
              125,000,000
              
              
              
              125,000,000
              
              
              
              125,000,000
              
              
              
              —Line
      of credit
              
              
              —
              
              
              
              —
              
              
              
              7,500,000
              
              
              
              2,500,000
              
              
              
              3,000,000Other long-term obligations(2)
              
              
              7,647,544
              
              
              
              9,166,440
              
              
              
              295,184
              
              
              
              1,148,457
              
              
              
              209,928Accumulated
      deficit
              
              
              (242,520,817
              )
              
              
              (269,241,437
              )
              
              
              (258,646,256
              )
              
              
              (207,466,149
              )
              
              
              (148,396,957
              )Stockholders’
      equity (deficit)
              
              
              24,411,844
              
              
              
              (15,223,305
              )
              
              
              (16,062,229
              )
              
              
              4,629,866
              
              
              
              75,595,841





(1)Convertible notes were presented in our balance sheet as current
      liabilities prior to fiscal year 2008 due to the Default Notice from the
      Trustee.  The Convertible notes are presented as long-term
      liabilities as of April 24, 2009 and April 25, 2008 after agreement was
      reached with the Trustee.  See “Debt Instruments and Related
      Covenants.”


(2)Other long-term
      obligations as of April 24, 2009 and April 25, 2008 include deferred
      license revenue in the approximate amount of $7.5 and $9.0 million,
      respectively.





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





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





This item
provides material historical and prospective disclosures enabling investors and
other users to assess our consolidated financial position and results of
operations. The Consolidated Financial Statements include the consolidated
balance sheets, consolidated statements of operations, consolidated statements
of stockholders’ equity (deficit) and comprehensive income (loss) and
consolidated statements of cash flows. The Notes are an integral part of the
Consolidated Financial Statements and provide additional information required to
fully understand the nature of amounts included in the Consolidated Financial
Statements.





Overview





We are a
neuromodulation company founded to design, develop and bring to market medical
devices that provide a unique therapy, VNS Therapy, for the treatment of
epilepsy, depression and other disorders as approved by the applicable
regulatory bodies.





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Our
ability to successfully expand the commercialization of the VNS Therapy System
depends on obtaining and maintaining favorable insurance coverage, coding and
reimbursement for the device, the implant procedure and follow-up care.
Currently, we have broad coverage, coding and reimbursement for VNS Therapy for
the treatment of refractory epilepsy. The Centers for Medicare and Medicaid
Services, (“CMS”), which we estimate pays for approximately 25% of the VNS
Therapy implants, issues an annual update to the reimbursement amounts received
by our customers.  Recently, Medicare made significant changes to the
amounts that are reimbursed to hospitals for the generator and the lead,
effective on January 1, 2009. These changes include an increase from $11,877 to
$12,545 in the amount paid for generator, and a decrease from $14,061 to $7,234
in the amount paid for a lead and the insertion procedure. The reimbursement
rates will vary depending on geographic area. We continue to work with the CMS
to insure favorable and appropriate reimbursement for our products and related
procedures; however, these changes and other potential changes in the future
could have a long-term adverse impact on our ability to procure sales to
hospitals, as well as an adverse impact on our business and our future operating
results.





Our
clinical development program has included pilot and pivotal studies in using VNS
Therapy (a) as an adjunctive therapy for reducing the frequency of seizures
in patients over 12 years of age with partial onset seizures that are
refractory to antiepileptic drugs and (b) as an adjunctive treatment for
patients 18 years of age and older with chronic or recurrent depression who
are in a major depressive episode. We have also conducted or provided support
for small pilot studies for the use of VNS Therapy in the treatment of
Alzheimer’s Disease, anxiety, bulimia, fibromyalgia, obesity,
obsessive-compulsive disorder, multiple sclerosis and other indications. These
studies have been conducted to determine the safety and effectiveness of VNS
Therapy in these new indications and to determine which new indications might be
considered for pivotal studies.





Since
inception, we have incurred substantial expenses, primarily for research and
development activities that include product and process development, clinical
studies and related regulatory activities, sales and marketing activities,
manufacturing start-up costs and systems infrastructure. As of April 24, 2009,
we incurred an accumulated deficit of approximately
$242.5 million.





The
primary exchange rate movements that impact our consolidated net sales growth
include the U.S. dollar as compared to the Euro and the British pound. The
strengthening of the U.S. dollar generally has an unfavorable impact on our
sales for the year. The impact of foreign currency fluctuations on net sales is
not indicative of the impact on our operations due to the offsetting foreign
currency impact on operating costs and expenses.





Proceedings
Related to Stock Option Grants and Practices





Regulatory
Proceedings.  In June 2006, the staff of the SEC advised us
that it had commenced an informal inquiry of some of our stock option grants,
and we received a subpoena from the Office of the U.S. Attorney for the Southern
District of New York requesting documents related to our stock option grants,
practices and procedures. In October 2006, the SEC staff made an additional
request for certain documents and information related to our revised guidance on
February 8, 2006 and our financial results announced on May 1, 2006,
our sales for the quarter ended April 28, 2006, coverage or potential
coverage of our VNS Therapy System by BlueCross BlueShield of Alabama and Aetna
and the aging of our accounts receivable since January 1, 2003. We are
cooperating with the SEC staff and the U.S. Attorney’s Office.





At the
direction of our Board, our Audit Committee, with the assistance of its
independent counsel and counsel’s forensic accountants, completed a review of
our stock option grants, practices and procedures, including compliance with
U.S. GAAP and all applicable statutes, rules and regulations. Our Audit
Committee concluded that incorrect measurement dates were used for certain stock
option grants made principally during the period from 1998 through 2003. Based
on our Audit Committee’s investigation, subsequent internal analysis and
discussions with our independent registered public accountants, our Board
concluded on November 18, 2006, that we needed to restate certain of our
historical consolidated financial statements to record non-cash charges for
compensation expense relating to past stock option grants. The effects of these
restatements are reflected in the consolidated financial statements, including
unaudited quarterly data. None of the restatements have any impact on net cash
provided by (used in) operating activities.





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We had
been under a limited scope audit by the Internal Revenue Service (“IRS”) in
connection with our stock option activity.  In October 2008 we
received a final close out notice from the IRS regarding the examination which
stated that no changes to the tax we reported were made.





Significant
Accounting Policies and Critical Accounting Estimates





We have
adopted various accounting policies to prepare the Consolidated Financial
Statements in accordance with accounting principles generally accepted in the
U.S. (“GAAP”). Our most significant accounting policies are disclosed in
“Note 1. Summary of Significant Accounting Policies and Related Data” in
the Notes to the Consolidated Financial Statements.





The
preparation of the Consolidated Financial Statements, in conformity with GAAP,
requires us to make estimates and assumptions that affect the amounts reported
in the Consolidated Financial Statements and the related Notes. Our estimates
and assumptions are updated as appropriate, which in most cases is at least
quarterly. We base our estimates on historical experience or various assumptions
that are believed to be reasonable under the circumstances, and the results form
the basis for making judgments about the reported values of assets, liabilities,
revenues and expenses. Actual results may materially differ from these
estimates.





We
consider the following accounting policies as the most significant because, in
management’s view, they are most important to the portrayal of our consolidated
financial position and results of operations and most demanding in terms of
requiring estimates and other exercises of judgment.





Accounts
Receivable.  We provide an allowance for doubtful accounts
based upon specific customer risks and general historical trends. An increase in
losses beyond that expected by management or what we have historically
experienced would reduce earnings when they become known.





Inventories.  We
state our inventories at the lower of cost, the first-in, first-out (“FIFO”)
method, or market. Our calculation of cost includes the acquisition cost of raw
materials and components, direct labor and overhead. Management considers
potential obsolescence at each balance sheet date. An acceleration of
obsolescence could occur if consumer demand differs from
expectations.





Property and
Equipment.  Property and equipment are carried at cost, less
accumulated depreciation. Maintenance, repairs and minor replacements are
charged to expense as incurred; significant renewals, improvements and
expansions are capitalized. For financial reporting purposes, we compute
depreciation using the straight-line method over useful lives ranging from two
to nine years. An unanticipated change in the utilization or expected useful
life of property and equipment could result in acceleration in the timing of the
expenses.





Leases.  Financial
Accounting Standards Board (“FASB”) Statement No. 13,“Accounting for Leases”(“FAS
13”)establishes
standards of financial accounting and reporting for leases by lessees and
lessors. We are a party to the contract of leased facilities and other lease
obligations recorded in compliance with FAS 13. The lease terms provide for
tenant improvement allowances that are recorded as deferred rent and amortized,
using the straight-line method, as reduction to rent expense over the term of
the lease. Scheduled rent increases and rent holidays are recognized on a
straight-line basis over the term of the lease. During fiscal year 2008 we
surrendered a portion of our leased facilities at 100 Cyberonics Boulevard in
Houston Texas.  We record the net present value of our future lease
obligations related to the space surrendered, offset by the net present value of
estimated proceeds from the sub-lease of the space surrendered.





Revenue
Recognition.   We recognize revenue when title to the goods and
risk of loss transfer to customers, providing there are no remaining performance
obligations required of us or any matters requiring customer acceptance. We
record estimated sales returns and discounts as a reduction of net sales in the
same period revenue is recognized. Our net sales are dependent upon sales to new
and existing customers pursuant to our current policies. Changes in these
policies or sales terms could impact the amount and timing of revenue
recognized.





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Table of Contents





Licensing
Revenue.  We evaluate our license agreements and recognize
licensing revenue considering the guidance provided by Staff Accounting Bulletin
(“SAB”) Topic 13, “Revenue
Recognition,” EITF 00-21“Revenue Arrangements with Multiple
Deliverables,” Regulation S-X Rule 5-03(b)(1)“Sales and Revenue,” EITF
01-14 “Income Statement
Characterization of Reimbursement of Out-of-pocket Expenses” and other
regulations as applicable.





Licensing
Expense.  We have executed license agreements under which we
have secured the rights provided under certain patents. Royalties payable under
the terms of these agreements are expensed as incurred.





Research and
Development.  All research and development costs are expensed
as incurred. We have entered into contractual obligations for the conduct of
clinical studies. Costs are incurred over the duration of the studies and paid
under the terms of the contracts. Research and development expenses could vary
significantly due to possible changes in the timing of clinical
activity.





Stock Options.  We
account for our employee stock-based compensation plans under FASB Statement No.
123 (revised 2004), “Share-Based Payment” (“FAS
123(R)”).  Under FAS 123(R) the fair value of compensatory stock
options is determined using the Black-Scholes option valuation model, which is
affected by assumptions regarding a number of complex and subjective variables.
Total compensation cost for the 52 weeks ended April 24, 2009 for stock options
was approximately $5.4 million. As of April 24, 2009, there was approximately
$6.0 million of unrecognized compensation cost related to unvested stock options
that are expected to be amortized over a weighted average period of 3.65
years.





Restricted Stock, Restricted Stock
Units and Other Share-Based Awards.  We may grant restricted
stock, restricted stock units or stock awards to directors, officers and key
employees which have no purchase cost to the grantee. Nonvested restricted stock
entitles the grantees to dividends, if any, and voting rights for their
respective shares. Sale or transfer of the shares is restricted until they are
vested.  Typically, grants are service based and vest ratably over the
service period of four to five years, or cliff vest after three years, as
required under the agreement establishing the grant. Compensation cost is
expensed ratably over the service period. Generally, the fair value of
restricted stock is determined for accounting purposes using the market closing
price on the grant date. We also grant restricted stock subject to performance
or market conditions that can vest based on the satisfaction of the conditions
of the grant. The fair market value and derived service period of market
condition-based grants is determined using the Monte Carlo simulation method.
The derived service period for performance-based grants is estimated based on
our judgment of likely future performance. The Monte Carlo simulation method is
subject to variability as several factors utilized must be estimated, including
the derived service period, which is estimated based on our judgment of likely
future performance, and our stock price volatility. We issue new shares for the
granting of restricted stock. Total compensation cost for the 52 weeks ended
April 24, 2009 related to grants of restricted stock was approximately $4.2
million. As of April 24, 2009, there was approximately $5.6 million of
unrecognized compensation cost related to grants of restricted stock that is
expected to be amortized over a weighted average period of 2.18
years.





Foreign Currency
Translation.  The assets and liabilities of our subsidiary,
Cyberonics Europe, SA, are generally translated into U.S. dollars at
exchange rates in effect on reporting dates, while capital accounts are
translated at historical rates. Statements of Operations items are translated at
average exchange rates in effect during the financial statement period. The
gains and losses that result from this process are shown in the accumulated
other comprehensive income (loss) section of Stockholders’ Equity (Deficit) and
Comprehensive Income (Loss) and are not included in the determination of the
results of operations. Gains and losses resulting from foreign currency
transactions denominated in currency other than the functional currency are
included in other income and expense.





34


Table of Contents





Income Taxes.  We
account for income taxes under FASB Statement No. 109, “Accounting for Income Taxes”
(“FAS 109”).  Under this method, deferred income taxes reflect the
impact of temporary differences between financial accounting and tax basis of
assets and liabilities. Such differences relate primarily to the deductibility
of certain accruals and reserves and the effect of tax loss and tax credit
carryforwards not yet utilized. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in operations in the period that includes the
enactment date.





FAS 109
requires that deferred tax assets are to be reduced by a valuation allowance if
the weight of available evidence indicates that it is more-likely-than-not that
some portion of the deferred tax assets will not be realized. Therefore, we
maintained a valuation allowance for most of our deferred tax assets for the 52
weeks ended April 24, 2009 because historically we have experienced significant
operating losses and operate in an industry subject to rapid technological
change.  We have achieved profitability in the current year and expect
to continue to be profitable in the next fiscal year. We continue to evaluate
the future realization of our deferred tax assets based on expectations of
future taxable income. Depending on our continued ability to achieve expected
levels of profitability, we may have sufficient evidence in future quarters of
fiscal year 2010 to conclude that it is more-likely-than-not that we will
recognize the value of our deferred tax assets, in whole or in part, in fiscal
year 2010.  To the extent the valuation allowance is reversed a
benefit will be recorded in our consolidated results of operations.





Effective
April 28, 2007, we adopted FASB Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes" ("FIN 48").  This interpretation clarifies the
criteria for recognizing income tax benefits under FASB Statement No. 109, "Accounting for Income
Taxes," and requires additional disclosures about uncertain tax
positions.  Under FIN 48, the financial statement recognition of the
benefit for a tax position is dependent upon the benefit being
more-likely-than-not to be sustainable upon audit by the applicable taxing
authority.  If this threshold is met, the tax benefit is then measured
and recognized at the largest amount that is greater than 50 percent likely of
being realized upon ultimate settlement.





Results
of Operations





Net
Sales





We sell
VNS Therapy Systems to hospitals and ambulatory surgical centers (“ASCs”) for
both epilepsy and depression indications, but we often do not know the intended
use for a specific VNS Therapy System at the time of its sale.  As a
result, we use information available from two separate internal databases to
estimate our sales by indication for use.





The FDA
has designated our VNS Therapy System, which is a Class III implantable medical
device, as a “tracked” device under the FDA’s Medical Device Tracking
regulation.  Consistent with the tracking regulation, we urge each
implanting hospital or ASC to complete and return to us an implant card that
provides information from which we can identify the corresponding indication for
use.  We maintain the returned information in an implant card
database.  Separately, we accumulate information relating to
prospective and actual patients, prescribing and implanting physicians, and
hospitals and ASCs in a sales-related database.





We do not
receive an implant card for each device we sell, and we sometimes sell devices
that are not the subject of data included in our sales-related
database.  In addition, the delay between the date of a sale and the
date of receipt of the corresponding implant card may result in an implant card
being received in a fiscal quarter subsequent to the fiscal quarter
corresponding to the date of the sale.  We assume that any delay,
however, will affect each fiscal quarter by approximately the same
extent.  By combining information derived from both the tracking and
sales-related databases, we form an estimate of the split between units and net
sales for the epilepsy and depression indications.  The accuracy of
our estimates of sales by indication for use, however, may vary from one fiscal
quarter to the next, and investors should exercise caution in relying on these
estimates.





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Table of Contents





Net sales
for fiscal year 2009 were approximately $143.6 million, which consisted of U.S.
net product sales of $114.9 million, international net product sales of $27.2
million and licensing revenue of $1.5 million.  Net sales for fiscal
year 2008 were approximately $121.2 million, which consisted of U.S. net product
sales of $94.4 million, international net sales of $26.3 million and licensing
revenue of $0.5 million.  Net sales for fiscal year 2007 were
approximately $131.0 million, which consisted of U.S. net product sales of
$111.1 million, and  international net sales of $19.9
million.





In fiscal
year 2009 U.S. net product sales increased by $20.5 million, or 21.7%,
compared to fiscal year 2008 due to a volume increase of 8.2% and increased
average selling prices of 13.5%.  The average selling price has
increased, in part, due to the market penetration of our new models, the
Demipulse generator (single pin) and the Demipulse Duo generator (dual pin).
International net sales increased by $0.9 million, or 3.4%, in fiscal year
2009 compared to fiscal year 2008, due primarily to an increase in the average
selling price.  The increase in international pricing was due to
increased average selling prices of 10.5% offset by an average unfavorable
foreign currency exchange impact of 6.2%.  Average selling prices have
increased, in part, due to the market penetration of our new
models.





In fiscal
year 2008 U.S. net product sales decreased by $16.7 million, or 15.0%,
compared to fiscal year 2007 due to the continued reduction in the number of VNS
Therapy Systems attributable to the depression indication, following both the
preliminary and final non-coverage determinations by the CMS in February 2007
and May 2007, respectively.  International net sales increased by
$6.4 million, or 32.4%, in fiscal year 2008 compared to fiscal year 2007,
due primarily to unit growth and the impact of foreign currency
movements.





U.S. net
sales attributable to the depression indication have continued to decline
significantly since the CMS’s May 2007 issuance of a national non-coverage
determination with respect to VNS Therapy for depression. Using the methodology
disclosed above, we estimate that our net domestic sales attributable to
depression for fiscal year 2009 were approximately $1.5 million compared to $4.7
million for the same period last year, a decrease of approximately
68%.  For fiscal year 2008, U.S. sales attributable to depression were
$4.7 million compared to $29.6 million for the fiscal year 2007, a decrease of
approximately 84%.





In
December 2007, we received a $9.5 million up-front payment relating to the
licensing of certain of our patent rights pertaining to weight reduction,
hypertension and diabetes.  We are amortizing this up-front payment on
a straight-line basis until April 2014, the estimated end of our obligation to
prosecute the related licensed patent applications.  During fiscal
year 2009 and 2008 we recognized licensing revenue in the amount of
approximately $1.5 and $0.5 million, respectively. There was no licensing
revenue recognized during fiscal year 2007.





Gross
Profit





The gross
profit for product sales for fiscal year 2009 was 85.9% of net sales, compared
to 82.6% for fiscal year 2008 and 86.1% for fiscal year 2007.  The
increase in gross profit margin for fiscal year 2009 as compared to fiscal year
2008 was primarily a result of increased production volume resulting in
increased manufacturing efficiency and  higher average selling
prices.  The decrease in gross profit margin for fiscal year 2008 as
compared to fiscal year 2007 was primarily a result of a decreased production
volume resulting in decreased manufacturing efficiency.





Cost of
products sold consists primarily of direct labor, allocated manufacturing
overhead, third-party contractor costs, royalties and the acquisition cost of
raw materials and components. We are obligated to pay royalties at a rate of
approximately 3% of net sales. Based upon the mix between U.S. and international
sales, direct and distributor sales, the VNS Therapy System selling price,
applicable royalty rates and the levels of production volume, gross profit may
fluctuate in future periods.





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Table of Contents





Operating
Expenses





Selling, General and Administrative
(“SG&A”) Expenses.  SG&A expenses are comprised of
sales, marketing, development, general and administrative activities. SG&A
expenses were approximately $84.8 million for the fiscal year 2009, a decrease
in expenses of approximately $1.1 million, or 1.3%, compared to fiscal year
2008.  The decrease in SG&A expenses is primarily due to reduced
marketing and selling expenses related to depression, offset by an increase in
compensation expenses.  SG&A expenses were approximately $85.9
million for the fiscal year 2008, a decrease in expenses of approximately $48.2
million, or 35.9%, compared to fiscal year 2007. The decrease was primarily due
to cost-saving strategies implemented throughout fiscal year 2008, including an
ongoing reduction in selling and marketing expenses of $25.6 million primarily
associated with the depression indication. Further, fiscal year 2007 included
expenses of $5.4 million primarily associated with the resignations of our
Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), proxy
costs of approximately $1.6 million associated with a director election
contest, and significant legal and other expenses primarily due to costs
associated with the investigation into our stock options granting and accounting
practices. Legal expenses decreased by $10.0 million in fiscal year 2008,
including the receipt of approximately $1.5 million in insurance recoveries.
Stock-based compensation expenses of $7.6 million were lower by $1.1 million in
fiscal year 2009 as compared to fiscal year 2008. Stock-based compensation
charges of $8.7 million were lower by $6.7 million in fiscal year 2008 than
in fiscal year 2007.





Research and Development (“R&D”)
Expenses.  R&D expenses are comprised of expenses related
to our product and process development, product design efforts, clinical trial
programs and regulatory activities. R&D expenses were approximately $19.7
million for fiscal year 2009, a decrease in expenses of approximately $2.7
million, or 12.0%, as compared to fiscal year 2008.  This decrease is
primarily due to decreased clinical expenses relating to depression
post-approval studies and decreased international clinical expenses partially
offset by increased engineering expenses for product development. R&D
expenses were approximately $22.4 million for fiscal year 2008, a decrease in
expenses of approximately $5.7 million, or 20.2%, as compared to fiscal year
2007.  This decrease was primarily due to the implementation of
cost-saving strategies throughout the year and a reduction of $1.6 million in
stock-based compensation charges.





Early
Extinguishment of Debt





During
fiscal year 2009 we repurchased approximately $62.7 million of aggregate
principal amount of our convertible notes (the “Convertible Notes”) in
privately-negotiated transactions at a purchase price of approximately $50.4
million.  As a result of the purchases, we wrote off approximately
$1.3 million in unamortized bond issue costs resulting in a gain on early
extinguishment of debt of approximately $11.0 million.  We did not
retire any Convertible Notes during fiscal years 2008 or 2007. After our fiscal
year end, we repurchased $15.6 million additional aggregate principal amount of
Convertible Notes resulting in a gain on early extinguishment of debt of
approximately $1.5 million.  For further discussion see “Note
6.  Convertible Notes”.





Interest
Income





Interest
income of approximately $1.2 million for the fiscal year 2009 represented a
decrease of 67.9% as compared to fiscal year 2008.  The decrease in
interest income is due to lower cash balances and lower interest rates. Interest
income of approximately $3.8 million for fiscal year 2008 represented a decrease
of 17.3% as compared to interest income of $4.6 million for fiscal year 2007.
The decrease in interest income was due to decreased interest rates, partially
offset by higher cash balances.





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Table of Contents





Interest
Expense





Interest
expense of approximately $3.4 million for fiscal year 2009 decreased by
approximately $2.4 million, or 41.7%, as compared to fiscal year
2008.  The decrease in interest expense is primarily due to our
repurchase and retirement of approximately $62.7 million principal value of our
Convertible Notes. Interest expense of approximately $5.8 million for fiscal
year 2008 decreased by $0.1 million, or 1.6%, compared to $5.9 million for
fiscal year 2007. The decrease was primarily due to savings from the
termination, in January 2008, of the line of credit under the revolving line of
credit with Merrill Lynch Capital, a division of Merrill Lynch Business
Financial Services, Inc. (“the Credit Agreement”) and reduced liquidated damages
on the Convertible Notes, offset by termination fees and the write off of
origination fees associated with the termination of the Credit
Agreement.





Other
Expense, Net





For the
fiscal year 2009, other expense, net was approximately $381,000, a decrease of
approximately $16,000, or 4.0%, as compared to fiscal year 2008.  The
decrease is primarily due to the reduction of leasehold abandonment expenses of
approximately $109,000, offset by increased transaction losses associated with
changes in foreign currency exchange rates.  For the fiscal year 2008,
other expense, net was approximately $397,000, an increase of approximately
$86,000, or 27.7%, as compared to fiscal year 2007. The increase was primarily
due to the impact of approximately $109,000 in leasehold abandonment expense
associated with the re-negotiation of the leased facilities at our corporate
headquarters.





Income
Taxes





At
April 24, 2009, we had net operating loss carryforwards for federal income
tax purposes of approximately $234.2 million. The following is a
reconciliation of statutory federal income tax rates to our effective income tax
rate expressed as a percentage of income (loss) before income
taxes:





For
      the 52 Weeks EndedApril 24,
      2009
              
              April 25,
      2008
              
              April 27,
      2007Income
      tax expense (benefit)
              
              $
              729,441
              
              
              $
              (264,837
              )
              
              $
              78,775U.S. statutory
      rate
              
              
              34.0
              %
              
              
              (34.0
              )%
              
              
              (34.0
              )%Change
      in deferred tax valuation allowance excluding impact of
      shortfall
              
              
              (34.1
              )
              
              
              29.1
              
              
              
              30.2Shortfall
      on settlement of options and restricted stock
              
              
              2.4
              
              
              
              30.8
              
              
              
              1.8Reduction
      in valuation allowance due to shortfall
              
              
              (2.4
              )
              
              
              (30.8
              )
              
              
              (1.8
              )Federal
      income tax provision (1)
              
              
              1.4
              
              
              
              0.6
              
              
              
              —Foreign
      taxes
              
              
              0.3
              
              
              
              0.3
              
              
              
              0.1State
      and local tax provision
              
              
              1.0
              
              
              
              (3.4
              )
              
              
              0.1Other,
      net
              
              
              0.1
              
              
              
              4.9
              
              
              
              3.8Effective
      tax rate
              
              
              2.7
              %
              
              
              (2.5
              )%
              
              
              0.2
              %





(1)
            The
      federal income tax provision for fiscal years 2009 and 2008 consists of
      federal alternative minimum income
tax.








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Table of Contents





Liquidity
and Capital Resources





Overview





Net cash
decreased by $24.8 million during fiscal year 2009 primarily due to cash used to
repurchase approximately $62.7 million principal value of our Convertible Notes
at a purchase price of approximately $50.4 million offset by increases in cash
provided by operations of $24.6 million and stock option exercises of $4.3
million. Net cash increased by $6.3 million during fiscal year 2008 due
primarily to the increase in cash provided by operations of  $14.5
million, which included a $9.5 million up-front payment relating to the
licensing of certain of our patent rights pertaining to weight reduction,
hypertension and diabetes, the increase in cash provided by stock option
exercises of $6.4 million, offset by cash used to purchase treasury shares and
retire the outstanding balance of the Credit Agreement for $13.8
million.





We
believe our current financial and capital resources, including cash, cash
equivalents and cash flow from operations, will be adequate to fund anticipated
business activities, including increased investing activities, through fiscal
year 2010, although there can be no assurance of this, as this estimate is based
upon a number of assumptions that may not hold true. Our liquidity could be
adversely affected by the factors affecting future operating results that are
discussed in “Item 1A. Risk Factors.”





Cash
Flows





Net cash provided by (used in) operating, investing and financing activities
were as follows:





52
      Weeks EndedApril 24,
      2009
              
              April 25,
      2008
              
              April 27,
      2007Operating
      activities
              
              $
              24,589,950
              
              
              $
              14,455,207
              
              
              $
              (20,688,856
              )Investing
      activities
              
              
              (2,918,266
              )
              
              
              (817,064
              )
              
              
              (1,425,349
              )Financing
      activities
              
              
              (46,627,016
              )
              
              
              (7,429,200
              )
              
              
              14,434,408





Operating
Activities





Net cash
provided by operating activities during fiscal year 2009 is approximately $24.6
million, an increase of $10.1 million compared to fiscal year
2008.  The increase is primarily due to an increase in sales and gross
margin improvement resulting in overall profitable operations.  Net
cash provided by operating activities during fiscal year 2008 was approximately
$14.5 million, an increase of $35.1 million compared to fiscal year 2007. The
increase was primarily due to a $40.8 million decrease in net losses in fiscal
year 2008 compared to fiscal year 2007, as well as $9.5 million in proceeds in
fiscal year 2008 from the licensing of certain of our patent rights pertaining
to weight reduction, hypertension and diabetes.





Investing
Activities





Net cash
used by investing activities during fiscal year 2009 is approximately
$2.9 million, an increase of approximately $2.1 million compared to fiscal
year 2008. The increase in investment is primarily to enhance business
infrastructure such as information technology and manufacturing
capabilities.  We expect to further increase our investments in these
areas in fiscal year 2010 to $8.5 million. Net cash used by investing activities
during fiscal year 2008 was approximately $0.8 million, a decrease of
approximately $0.6 million compared to fiscal year 2007, representing a decrease
in investments in business infrastructure and facilities.





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Table of Contents





Financing
Activities





Net cash
used in financing activities during fiscal year 2009 was approximately $46.6
million, an increase in net cash used of $39.2 million, compared to fiscal year
2008, due primarily to the repurchase of approximately $62.7 million principal
value of our Convertible Notes at a purchase price of approximately $50.4
million during fiscal year 2009, offset by cash received on the exercise of
stock options of $4.3 million and a reduction in cash used of $5.8 million for
the purchase of treasury stock.  Net cash used in financing activities
during fiscal year 2008 was approximately $7.4 million, a decrease in cash flow
from financing activities of $21.9 million as compared to net cash provided of
$14.4 million in fiscal year 2007.  This decrease in cash flow was
primarily due to the termination of the Credit Agreement and the purchase of
treasury shares in fiscal year 2008.





Debt
Instruments and Related Covenants





Convertible
Notes





In
September 2005, we issued the Convertible Notes. Interest on the Convertible
Notes at the rate of 3% per year on the principal amount is payable
semi-annually, in arrears, in cash on March 27 and September 27 of each year,
beginning March 27, 2006. The Convertible Notes are unsecured and subordinated
to all of our existing and future senior debt and equal in right of payment with
our existing and future senior subordinated debt. Holders may convert their
Convertible Notes, which were issued in the form of $1,000 bonds, into 24.0964
shares of our common stock per bond, which equal a conversion price of
approximately $41.50 per share, subject to adjustments, at any time prior to
maturity.





In April
2008, we settled litigation in connection with the Convertible Notes and, as a
result, we may be forced to repurchase the Convertible Notes at par if tendered
to us on December 27, 2011 nine months prior to the original
maturity.  For additional information, see “Note
6.  Convertible Notes.” in the Notes to the Consolidated Financial
Statements.  As a result of the settlement and the associated
documents, we are able to reflect the Convertible Notes as a long-term liability
as of April 24, 2009 and April 25, 2008.





Contractual
Obligations





We are
party to a number of contracts pursuant to which we are obligated to pay for
clinical studies totaling $1.0 million as of April 24, 2009, which is
included with accrued liabilities, see “Note 5.  Accrued Liabilities”.
Although we have no firm commitments, we expect to make capital expenditures of
approximately $8.5 million during fiscal year 2010, primarily to maintain
organizational capacity and business infrastructure such as information
technology and manufacturing capabilities.





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Table of Contents





The chart
below reflects our obligations under our material contractual obligations as of
April 24, 2009:





Notes
                Issuance
      (1)
              
              
              Operating
                Leases
      (2)
              
              
              Other
      (3)
              
              
              Total
                Contractual
                ObligationsContractual
      Obligations:Less
      Than One Year
              
              $
              1,870,170
              
              
              $
              3,294,195
              
              
              $
              363,861
              
              
              $
              5,528,2261-3 Years
              
              
              65,497,616
              
              
              
              5,787,535
              
              
              
              250,525
              
              
              
              71,535,6764-5 Years
              
              
              —
              
              
              
              5,626,997
              
              
              
              20,095
              
              
              
              5,647,092Over
      5 Years
              
              
              —
              
              
              
              1,907,950
              
              
              
              21,114
              
              
              
              1,929,064Total
      Contractual Obligations
              
              $
              67,367,786
              
              
              $
              16,616,677
              
              
              $
              655,595
              
              
              $
              84,640,058








(1)
            Consists
      of principal and interest obligations related to the Convertible Notes
      issuance presented as if the Convertible Notes were to become due and
      payable on December 27, 2011, in accordance with the Supplemental
      Indenture. After our year end we repurchased $15.6 million additional
      aggregate principal amount of the Convertible Notes.  This
      repurchase will result in the total Contractual Obligations for Notes
      Issuance, including interest, to be reduced by approximately $16.9 million
      to approximately $50.5 million.(2)
            Consists
      of operating lease obligations related to facilities, office and
      transportation equipment.(3)
            Reflects
      amounts we are contractually obligated to spend in connection with sales,
      marketing and training events and licensing
  agreements.





Factors
Affecting Future Operating Results and Common Stock Price





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





Item 7A.Quantitative and
Qualitative Disclosures About Market Risk





We are
exposed to market risk on interest rates, foreign currency exchange rate risk,
and our Convertible Notes risk.





Interest
Rate Risk





Our
exposure to market risk for changes in interest rates relates primarily to our
short-term investments. We do not hedge our interest rate exposure or invest in
derivative securities. Based upon the average outstanding balances in cash, cash
equivalents and our line of credit, a 100-basis point change in interest rates
would not have a material impact on our consolidated financial
results.





Foreign
Currency Exchange Rate Risk





Due to
the global reach of our business, we are also exposed to market risk from
changes in foreign currency exchange rates, particularly with respect to the
U.S. dollar versus the Euro and the British pound. Our wholly owned foreign
subsidiary is consolidated into our financial results and is subject to risks
typical of an international business, including, but not limited to, differing
economic conditions, changes in political climate, differing tax structures,
other regulations and restrictions and foreign exchange rate volatility.
Accordingly, our future results could be materially impacted by changes in these
or other factors. At this time, we have not deemed it to be cost effective to
engage in a program of hedging the effect of foreign currency fluctuations on
our operating results using derivative financial instruments. A sensitivity
analysis indicates that, if the U.S. dollar uniformly weakened 20% against
the Euro, the effect upon net income recorded during fiscal year 2009 would be
favorable by approximately $1.3 million, or 4.9%. Conversely, if the
U.S. dollar uniformly strengthened 20% against the Euro, the impact on our
operations would be unfavorable by approximately $0.9 million, or 3.3%. The
fluctuations in foreign currency exchange rates for the fiscal year 2009
represented an unfavorable impact of 6.2% in our international sales as compared
to fiscal year 2008.





41


Table of Contents








Convertible
Notes Risk





The
estimated fair value of our Convertible Notes was approximately
$50.5 million, based on the outstanding liability of approximately $62.3
million as of April 24, 2009.  Because we pay fixed interest coupons
on the Convertible Notes, market interest rate fluctuations do not impact our
debt interest payments.  However, the fair value of our Convertible
Notes will fluctuate as a result of changes in the price of our common stock,
changes in market interest rates, changes in our credit worthiness, and changes
in the overall credit market.  Generally, the fair market value of our
Convertible Notes will increase as interest rates fall and decrease as interest
rates rise. The fair market value of our Convertible Notes may also increase as
the market price of our common stock rises and decrease as the market price of
our common stock falls. At April 24, 2009, a 10% decrease in the price of our
common stock would have resulted in a decrease of approximately $211,000 on the
fair value of our Convertible Notes, and a 10% increase in the price of our
common stock would have resulted in an increase of approximately $210,000 on the
fair value of our Convertible Notes. To increase consistency and comparability
in fair value measurements, FASB Statement No. 157, "Fair Value Measurements,"
requires that the inputs used to measure fair value be categorized into levels.
There are three levels in the hierarchy. The highest level, or level 1, is an
unadjusted market quote from an active market for identical assets or
liabilities, level 2 are inputs to the fair value measurement that are
observable for the asset or liability, either directly or indirectly, and level
3 are inputs that are unobservable. Assessing the significance of a particular
input to the fair value measurement in its entirety requires judgment,
considering factors specific to the asset or liability. We believe that the fair
value measurement of our Convertible Notes fall into Level 2.





Item 8.Financial Statements and
Supplementary Data





The
information required by this Item is incorporated by reference to the
Consolidated Financial Statements beginning on page F-1.





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





None.





Item 9A.Controls and
Procedures





Disclosure
Controls and Procedures





(a)  Evaluation of Disclosure
Controls and Procedures





We
maintain a system of disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports filed under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms. Such information is also
accumulated and communicated to management, including our CEO and CFO, as
appropriate, to allow timely decisions regarding required disclosure. Our
management, under the supervision and with the participation of our CEO and CFO,
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Exchange Act) as of the end of the period covered by this Form 10-K. Based
on that evaluation, our CEO and CFO concluded that our disclosure controls and
procedures were effective as of April 24, 2009.





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





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





42


Table of Contents




In
connection with the preparation of our annual consolidated financial statements,
our management, under the supervision and with the participation of our CEO and
CFO, assessed the effectiveness of our internal control over financial reporting
based on criteria established in Internal Control — Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this assessment, our management has concluded that
our internal control over financial reporting was effective as of April 24,
2009.





KPMG LLP,
the independent registered public accounting firm who audited the consolidated
financial statements included in this Form 10-K, has issued a report on our
internal control over financial reporting as of April 24,
2009.





(c)  Changes in Internal Control
Over Financial Reporting





There was
no change in our internal control over the current financial reporting period
that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.





43


Table of Contents







Report
of Independent Registered Public Accounting Firm




The Board
of Directors and Stockholders


Cyberonics,
Inc.:




We have
audited Cyberonics, Inc.’s internal control over financial reporting as of April
24, 2009, based oncriteria established
inInternal Control –
Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO). Cyberonics, Inc.’s management is responsible
for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Management’s Report on Internal
Control Over Financial Reporting (Item 9A(b)). Our responsibility is to
express an opinion on the Company’s internal control over financial reporting
based on our audit.




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




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




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




In our
opinion, Cyberonics, Inc. maintained, in all material respects, effective
internal control over financial reporting as of April 24, 2009, based on
criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).




We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Cyberonics,
Inc. and subsidiary as of April 24, 2009 and April 25, 2008, and the related
consolidated statements of operations, stockholders’ equity (deficit) and
comprehensive income (loss), and cash flows for the 52 weeks ended April 24,
2009, April 25, 2008, and April 27, 2007, and our report dated June 18, 2009
expressed an unqualified opinion on those consolidated financial
statements.







/s/  KPMG
LLP





Houston,
Texas


June 18,
2009





44


Table of Contents





Item 9B.Other
Information





None.





PART III





Item 10.Directors, Executive
Officers and Corporate Governance





Pursuant
to general instruction G to Form 10-K, we incorporate by reference
into this item the information to be disclosed in our definitive proxy statement
for our 2009 Annual Meeting of Stockholders.





Financial
Code of Ethics





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





Item 11.Executive
Compensation





Pursuant
to general instruction G to Form 10-K, we incorporate by reference
into this Item the information to be disclosed in our definitive proxy statement
for our 2009 Annual Meeting of Stockholders.





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





Pursuant
to general instruction G to Form 10-K, we incorporate by reference
into this Item the information to be disclosed in our definitive proxy statement
for our 2009 Annual Meeting of Stockholders.





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





Pursuant
to general instruction G to Form 10-K, we incorporate by reference
into this Item the information to be disclosed in our definitive proxy statement
for our 2009 Annual Meeting of Stockholders.





Item 14.Principal Accounting
Fees and Services





Pursuant
to general instruction G to Form 10-K, we incorporate by reference
into this Item the information to be disclosed in our definitive proxy statement
for our 2009 Annual Meeting of Stockholders.





45


Table of Contents





PART IV





Item 15.Exhibits, Financial
Statement Schedules





(1) Financial
Statements





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





Description
              Page
      No.Report
      of Independent Registered Public Accounting Firm
              F-2Consolidated
      Balance Sheets
              F-3Consolidated
      Statements of Operations
              F-4Consolidated
      Statements of Stockholders’ Equity (Deficit) and Comprehensive Income
      (Loss)
              F-5Consolidated
      Statements of Cash Flows
              F-6Notes
      to Consolidated Financial Statements
              F-7





(2) Financial Statement
Schedules





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





(3) Index to
Exhibits





The
exhibits marked with the asterisk symbol (*) are filed or furnished (in the case
of Exhibit 32.1) with this Form 10-K. The exhibits marked with the cross
symbol (†) are management contracts or compensatory plans or arrangements filed
pursuant to Item 601(b)(10)(iii) of Regulation S-K.  The
exhibits marked with the pound symbol (#) have been redacted and are the subject
of an application for confidential treatment filed with the SEC pursuant to Rule
24b-2 of the general rules and regulations promulgated under the Exchange
Act.





Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference3.1
              Amended
      and Restated Certificate of Incorporation of Cyberonics,
    Inc.
              
              Cyberonics,
      Inc.’s Registration Statement on Form S-3 filed on February 21,
      2001
              333-56022
              3.13.2
              Amended
      and Restated Bylaws of Cyberonics, Inc.
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 26,
2007
              000-19806
              3.2(i)4.1
              Second
      Amended and Restated Preferred Shares Rights Agreement dated August 21,
      2000 between Cyberonics, Inc. and BankBoston, N.A. (formerly known as The
      First National Bank of Boston), including the Form of First Amended
      Certificate of Designation of Rights, Preferences and Privileges of Series
      A Participating Preferred Stock of Cyberonics, Inc., Form of Rights
      Certificate and Stockholder Rights Plan attached thereto as Exhibits A, B
      and C, respectively
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on September 12,
    2000
              000-19806
              4.14.2
              Amendment
      No. 1 to Second Amended and Restated Preferred Share Rights Agreement
      dated April 26, 2001
              
              Cyberonics,
      Inc.’s Annual Report and Transition Report on Form 10-K for the fiscal
      period ended April 27, 2001 and the transition period from July 1, 2000 to
      April 27, 2001
              000-19806
              4.24.3
              Amendment
      No. 2 to Second Amended and Restated Preferred Share Rights Agreement
      dated October 31, 2001
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 30, 2004
              000-19806
              4.34.4
              Amendment
      No. 3 to Second Amended and Restated Preferred Share Rights Agreement
      dated December 9, 2003
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 12,
    2003
              000-19806
              99.2








46


Table of Contents





Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference4.5
              Amendment
      No. 4 to Second Amended and Restated Preferred Share Rights Agreement
      dated January 9, 2004
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on January 13,
2004
              000-19806
              99.24.6
              Amendment
      No. 5 to Second Amended and Restated Preferred Share Rights
      Agreement
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on February 1,
2007
              000-19806
              4.14.7
              Indenture
      dated September 27, 2005 between Cyberonics, Inc. and Wells Fargo Bank,
      National Association, as Trustee
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 3, 2005
              000-19806
              10.14.8
              Supplemental
      Indenture dated April 18, 2008 to the Indenture dated September 27, 2005
      between Cyberonics, Inc. and Wells Fargo Bank, National Association, as
      Trustee
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on April 24, 2008
              000-19806
              10.24.9
              Registration
      Rights Agreement dated September 27, 2005 between Cyberonics, Inc. and
      Merrill Lynch, Pierce, Fenner & Smith Incorporated, as the Initial
      Purchaser
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 3, 2005
              000-19806
              10.24.10
              Form
      of Confirmation of OTC Convertible Note Hedge executed September 21, 2005
      to be effective September 27, 2005
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 3, 2005
              000-19806
              10.34.11
              Form
      of Confirmation of OTC Warrant Transaction executed September 21, 2005 to
      be effective September 27, 2005
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 3, 2005
              000-19806
              10.410.1
              License
      Agreement dated March 15, 1988 between Cyberonics, Inc. and Dr. Jacob
      Zabara
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.110.2
              License
      Agreement dated August 22, 2000 between Cyberonics, Inc. and Dr. Mitchell
      S. Roslin
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.210.3#
              Exclusive
      Patent License Agreement dated December 17, 2007, by and between
      Cyberonics, Inc. and Ethicon Endo-Surgery, Inc.
              
              Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended January 25,
      2008
              000-19806
              10.110.4
              Lease
      Agreement dated December 5, 2002 between Cyberonics, Inc., as Lessee, and
      Space Center Operating Associates, LP, as Lessor, commencing on December
      8, 2002 for Space “A” and January 1, 2004 for Space “B,” as amended March
      3, 2003 (First Amendment), October 2, 2003 (Second Amendment), March 11,
      2004 (Third Amendment), March 17, 2004 (Subordination, Non-Disturbance and
      Attornment), March 19, 2004 (Transfer of Ownership to Triple Net
      Properties, LLC), March 23, 2005 (Fourth Amendment), May 5, 2005 (Fifth
      Amendment) and July 13, 2005 (Sixth Amendment)
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.310.5
              Seventh
      Amendment, dated December 28, 2007, to that certain Lease Agreement dated
      December 5, 2002 between Cyberonics, Inc., as Lessee, and Space Center
      Operating Associates, LP, as Lessor
              
              Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
              000-19806
              10.510.6
              Eighth
      Amendment, dated March 31, 2008, to that certain Lease Agreement dated
      December 5, 2002 between Cyberonics, Inc., as Lessee, and Space Center
      Operating Associates, LP, as Lessor
              
              Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
              000-19806
              10.6





47


Table
of Contents
 Exhibit
                  Number
                Document
      Description
                
                Report
      or Registration Statement
                SEC
      File or
                  Registration
                  Number
                Exhibit
                  Reference10.7†
                Cyberonics,
      Inc. Amended and Restated 1996 Stock Option Plan
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on April 29,
      1999
                333-77361
                4.110.8†
                First
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated October 2, 2000
                
                Cyberonics,
      Inc.’s Quarterly Report on
                  Form
      10-Q for the quarter ended September 30, 2000
                000-19806
                10.210.9†
                Second
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated March 21, 2001
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 30, 2004
                000-19806
                10.1210.10†
                Third
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated July 27, 2001
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on January 22,
      2002
                333-81158
                4.410.11†
                Fourth
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated January 2002
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on January 22,
      2002
                333-81158
                4.510.12†
                Fifth
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated July 19, 2002
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on July 25,
      2002
                333-97095
                4.110.13†
                Form
      of Stock Option Agreement under the Cyberonics, Inc. Amended and Restated
      1996 Stock Option Plan between Cyberonics, Inc. and the executive officers
      listed on the schedule attached thereto
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.6910.14†
                Cyberonics,
      Inc. Amended and Restated 1997 Stock Plan
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on March 8,
      2001
                333-56694
                4.510.15†
                First
      Amendment to the Cyberonics, Inc. Amended and Restated 1997 Stock Plan
      dated March 21, 2001
                
                Cyberonics,
      Inc.’s Quarterly Report on
                  Form
      10-Q for the quarter ended July 26, 2002
                000-19806
                10.110.16†
                Second
      Amendment to the Cyberonics, Inc. Amended and Restated 1997 Stock Plan
      dated November 21, 2002
                
                Cyberonics,
      Inc.’s Proxy Statement for the Annual Meeting of Stockholders filed on
      October 15, 2002
                000-19806
                Annex B10.17†
                Third
      Amendment to the Cyberonics, Inc. Amended and Restated 1997 Stock Plan
      dated August 19, 2008
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 24,
      2008
                000-19806
                10.110.18†
                Form
      of Executive Restricted Stock Agreement under the Cyberonics, Inc. Amended
      and Restated 1997 Stock Plan between Cyberonics, Inc. and the executive
      officers listed on the schedule attached thereto
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended July 27,
      2007
                000-19806
                10.510.19†
                Form
      of Director Restricted Stock Agreement under the Cyberonics, Inc. Amended
      and Restated 1997 Stock Plan between Cyberonics, Inc. and the directors
      listed on the schedule attached thereto (three-year
    vesting)
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended July 27,
      2007
                000-19806
                10.610.20†
                Form
      of Director Restricted Stock Agreement under the Cyberonics, Inc. Amended
      and Restated 1997 Stock Plan between Cyberonics, Inc. and the directors
      listed on the schedule attached thereto (four-year
vesting)
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended July 27,
      2007
                000-19806
                10.710.21†
                Form
      of Employee Restricted Stock Agreement under the Cyberonics, Inc. Amended
      and Restated 1997 Stock Plan
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended July 27,
      2007
                000-19806
                10.810.22†
                Cyberonics,
      Inc. 1998 Stock Option Plan
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on November 3,
      1998
                333-66691
                4.1




48
 Table of Contents  Exhibit
                  Number
                Document
      Description
                
                Report
      or Registration Statement
                SEC
      File or
                  Registration
                  Number
                Exhibit
                  Reference10.23†
                First
      Amendment to the Cyberonics, Inc. 1998 Stock Option Plan dated March 21,
      2001
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 30, 2004
                000-19806
                10.2310.24†
                Cyberonics,
      Inc. New Employee Equity Inducement Plan
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on August 27,
      2003
                333-108281
                4.310.25†
                Amended
      and Restated Cyberonics, Inc. New Employee Equity Inducement
      Plan
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on June 18,
      2007
                333-143821
                4.110.26†
                First
      Amendment to the Amended and Restated Cyberonics, Inc. New Employee Equity
      Inducement Plan dated August 19, 2008
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 24,
      2008
                000-19806
                10.310.27†
                Form
      of Executive Restricted Stock Agreement under the Cyberonics, Inc. New
      Employee Equity Inducement Plan between Cyberonics, Inc. and the executive
      officers listed on the schedule attached thereto dated as of the dates so
      indicated.
                
                Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                000-19806
                10.3010.28†
                Form
      of Executive Restricted Stock Agreement dated September 10, 2007 under the
      Cyberonics, Inc. New Employee Equity Inducement Plan between Cyberonics,
      Inc. and the executive officers listed on the schedule attached thereto
      relating to Cyberonics’ Common Stock Price
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                000-19806
                10.110.29†
                Form
      of Executive Restricted Stock Agreement dated September 10, 2007 under the
      Cyberonics, Inc. New Employee Equity Inducement Plan between Cyberonics,
      Inc. and the executive officers listed on the schedule attached thereto
      relating to Cyberonics’ Net Income
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                000-19806
                10.210.30†
                Form
      of Executive Restricted Stock Agreement dated September 10, 2007 under the
      Cyberonics, Inc. New Employee Equity Inducement Plan between Cyberonics,
      Inc. and the executive officers listed on the schedule attached thereto
      relating to Cyberonics’ Net Sales
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                000-19806
                10.310.31†
                Form
      of Executive Restricted Stock Agreement dated September 10, 2007 under the
      Cyberonics, Inc. New Employee Equity Inducement Plan between Cyberonics,
      Inc. and the executive officers listed on the schedule attached thereto
      relating to Cyberonics’ Net Sales and Earnings
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                000-19806
                10.410.32†
                Cyberonics,
      Inc. 2005 Stock Plan
                
                Cyberonics,
      Inc.’s Proxy Statement for the Special Meeting of Stockholders filed on
      April 14, 2005
                000-19806
                Annex A10.33†
                First
      Amendment to the Cyberonics, Inc. 2005 Stock Plan dated August 19,
      2008
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 24,
      2008
                000-19806
                10.210.34†
                Form
      of Director Restricted Stock Agreement effective June 1,
    2005
                
                Cyberonics,
      Inc.’s Quarterly Form 10-Q for the quarter ended July 29,
    2005
                000-19806
                10.110.35†
                Form
      of Amendment to Director Stock Option Agreement dated December 2006
      between Cyberonics, Inc. and the directors listed on the schedule attached
      thereto
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.6810.36†
                Form
      of Stock Option Agreement under the Cyberonics, Inc. 2005 Stock Plan
      between Cyberonics, Inc. and the executive officers listed on the schedule
      attached thereto
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.7010.37†
                Form
      of Employee Restricted Stock Agreement under the Cyberonics, Inc. 2005
      Stock Plan (one-year vesting)
                
                Cyberonics,
      Inc.’s Quarterly Form 10-Q for the quarter ended July 29,
    2005
                000-19806
                10.2
 
 49
 Table of Contents  Exhibit
                    Number
                  Document
      Description
                  
                  Report
      or Registration Statement
                  SEC
      File or
                    Registration
                    Number
                  Exhibit
                    Reference10.38†
                  Form
      of Employee Restricted Stock Agreement under the Cyberonics, Inc. 2005
      Stock Plan (five-year vesting) and the executive officers listed on the
      schedule attached thereto
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 28, 2006
                  000-19806
                  10.7210.39†
                  Form
      of Indemnification Agreement for directors of Cyberonics,
    Inc.
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 28, 2006
                  000-19806
                  10.6610.40†
                  Summary
      of Non-Equity Incentive Compensation Plans
                  
                  Cyberonics,
      Inc.’s Annual Report on Form 10-K for the year ended April 27,
      2007
                  000-19806
                  10.6410.41†
                  Employment
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and Gregory
      H. Browne
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on July 13, 2007
                  000-19806
                  10.110.42†
                  Severance
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and Gregory
      H. Browne
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on July 13, 2007
                  000-19806
                  10.210.43†
                  Letter
      Agreement dated August 1, 2007 between Cyberonics, Inc. and Michael A.
      Cheney
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on August 7, 2007
                  000-19806
                  10.110.44†
                  Executive
      Restricted Stock Agreement between Cyberonics, Inc. and Daniel J. Moore
      dated June 18, 2007
                  
                  Cyberonics,
      Inc.’s Annual Report on Form 10-K for the year ended April 27,
      2007
                  000-19806
                  10.6610.45†
                  Employment
      Agreement dated April 26, 2007 by and between Cyberonics, Inc. and Daniel
      J. Moore
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on May 1, 2007
                  000-19806
                  10.110.46†
                  First
      Amendment to Employment Agreement dated April 26, 2007 by and between
      Cyberonics, Inc. and Daniel J. Moore
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on July 19, 2007
                  000-19806
                  10.110.47†
                  Second
      Amendment to Employment Agreement dated December 19, 2008 between
      Cyberonics, Inc. and Daniel J. Moore
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                  000-19806
                  10.110.48†
                  Indemnification
      Agreement effective June 28, 1999 between Cyberonics, Inc. and Alan J.
      Olsen
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 28, 2006
                  000-19806
                  10.4410.49†
                  Severance
      Agreement effective July 14, 2003 between Cyberonics, Inc. and George E.
      Parker
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 30, 2004
                  000-19806
                  10.4010.50†
                  Officer
      Stock Option Plan Agreement dated July 14, 2003 between Cyberonics, Inc.
      and George E. Parker
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 28, 2006
                  000-19806
                  10.4610.51†
                  Employment
      Agreement effective July 14, 2003 between Cyberonics, Inc. and George E.
      Parker
                  
                  Cyberonics,
      Inc.’s Quarterly Report on
                    Form
      10-Q for the quarter ended October 24, 2003
                  000-19806
                  10.110.52†
                  First
      Amendment to Employment Agreement effective June 15, 2006 between
      Cyberonics, Inc. and George E. Parker
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 28, 2006
                  000-19806
                  10.4810.53†
                  Employment
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and James A.
      Reinstein
                  
                  Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                  000-19806
                  10.6110.54†
                  Severance
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and James A.
      Reinstein
                  
                  Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                  000-19806
                  10.6210.55†*
                  Release
      Agreement effective May 4, 2007 between Cyberonics, Inc. and John A.
      Riccardi10.56†*
                  Letter
      Agreement dated February 1, 2008 between Cyberonics, Inc. and Dr. Richard
      L. Rudolph10.57†
                  Stock
      Option Amendment and Cash Bonus Agreement dated October 22, 2007 between
      Cyberonics, Inc. and Randal L. Simpson
                  
                  Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                  000-19806
                  10.5
 
  50
 Table
of Contents
 Exhibit
                    Number
                  Document
      Description
                  
                  Report
      or Registration Statement
                  SEC
      File or
                    Registration
                    Number
                  Exhibit
                    Reference10.58†
                  Cyberonics
      1998 Stock Option Notice of Stock Option Grant and Stock Options Agreement
      dated October 22, 2007 between Cyberonics, Inc. and Randal L.
      Simpson
                  
                  Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                  000-19806
                  10.610.59
                  Consulting
      Agreement dated November 19, 2006 between Cyberonics, Inc. and Pamela B.
      Westbrook
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on November 20,
    2006
                  000-19806
                  10.310.60†
                  Indemnification
      Agreement effective August 1, 2003 between Cyberonics, Inc. and David S.
      Wise
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 28, 2006
                  000-19806
                  10.6110.61†
                  Severance
      Agreement effective September 17, 2003 between Cyberonics, Inc. and David
      S. Wise
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 30, 2004
                  000-19806
                  10.4210.62†
                  Employment
      Agreement effective September 17, 2003 between Cyberonics, Inc. and David
      S. Wise
                  
                  Cyberonics,
      Inc.’s Quarterly Report on
                    Form
      10-Q for the quarter ended October 24, 2003
                  000-19806
                  10.210.63†
                  First
      Amendment to Employment Agreement effective June 15, 2006 between
      Cyberonics, Inc. and David S. Wise
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 28, 2006
                  000-19806
                  10.6410.64†
                  New
      Employee Equity Inducement Plan Agreement dated September 17, 2003 between
      Cyberonics, Inc. and David S. Wise
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 28, 2006
                  000-19806
                  10.6510.65†
                  Form
      of Amendment of Employment Agreement (Messrs. Parker, Simpson and
      Wise)
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                  000-19806
                  10.210.66†
                  Form
      of Amendment of Employment Agreement (Messrs. Browne and
      Reinstein)
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                  000-19806
                  10.310.67†
                  Form
      of Amendment of Severance Agreement (Messrs. Browne, Parker, Reinstein,
      Simpson and Wise)
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                  000-19806
                  10.410.68†
                  Form
      of Amendment of Restricted Stock Agreement (Messrs. Browne and
      Reinstein)
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                  000-19806
                  10.510.69
                  Settlement
      Agreement and Release, dated April 18, 2008, by and between Cyberonics,
      Inc. and Wells Fargo Bank, National Association, as
Trustee
                  
                  Cyberonics,
      Inc.’s Current Report on Form 8-K filed on April 24, 2008
                  000-19806
                  10.110.70†
                  Summary
      of Non-Employee Director Compensation as of June 24, 2008
                  
                  Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                  000-19806
                  10.8310.71†
                  Summary
      of Fiscal Year 2008 Executive Bonus Program
                  
                  Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                  000-19806
                  10.8410.72*#
                  International
      Distributor Agreement effective April 24, 2009 between and Cyberonics,
      Inc. and Nihon Kohden Corporation21.1
                  List
      of Subsidiaries of Cyberonics, Inc.
                  
                  Cyberonics,
      Inc.’s Annual Report on
                    Form
      10-K for the fiscal period ended April 28, 2006
                  000-19806
                  21.123.1*
                  Consent
      of Independent Registered Public Accounting Firm, KPMG LLP24.1*
                  Powers
      of Attorney (included on the Signature Page to this Annual Report on Form
      10-K)31.1*
                  Certification
      of the Chief Executive Officer of Cyberonics, Inc. pursuant to Section 302
      of the Sarbanes-Oxley Act of 200231.2*
                  Certification
      of the Chief Financial Officer of Cyberonics, Inc. pursuant to Section 302
      of the Sarbanes-Oxley Act of 200232.1*
                  Certification
      of the Chief Executive Officer and Chief Financial Officer of Cyberonics,
      Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002
  51
 Table of
Contents





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.





CYBERONICS,
      INC.By:
            /s/
      GREGORY H. BROWNEGregory
      H. BrowneVice
      President, Finance and Chief Financial Officer(Principal
      Financial Officer and Principal Accounting
  Officer)





Date:
June 18, 2009





POWER
OF ATTORNEY





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





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








Signature
                Title
                Date/s/HUGH M.
      MORRISON
                  Hugh
      M. Morrison
                Chairman
      of the Board of Directors
                June
      18, 2009/s/DANIEL J.
      MOORE
                  Daniel
      J. Moore
                Director,
      President and Chief Executive Officer
                  (Principal
      Executive Officer)
                June
      18, 2009/s/GREGORY H.
      BROWNE
                  Gregory
      H. Browne
                Vice
      President, Finance and Chief Financial Officer (Principal Financial Officer
      and
                  Principal
      Accounting Officer)
                June
      18, 2009/s/GUY C.
      JACKSON
                  Guy
      C. Jackson
                Director
                June
      18, 2009/s/  JOSEPH E.LAPTEWICZ
                  Joseph
      E. Laptewicz
                Director
                June
      18, 2009/s/ALFRED J.
      NOVAK
                  Alfred
      J. Novak
                Director
                June
      18, 2009/s/ALAN J.
      OLSEN
                  Alan
      J. Olsen
                Director
                June
      18, 2009/s/ARTHUR L. ROSENTHAL
      PH.D.
                  Arthur
      L. Rosenthal, Ph.D.
                Director
                June
      18, 2009/s/MICHAEL J.
      STRAUSS, M.D., M.P.H.
                  Michael
      J. Strauss, M.D., M.P.H.
                Director
                June
      18, 2009/s/REESE S.
      TERRY, JR.
                  Reese
      S. Terry, Jr.
                Director
                June
      18, 2009








52


Table of Contents















































CONSOLIDATED
FINANCIAL STATEMENTS


April
24, 2009, April 25, 2008 and April 27, 2007


TOGETHER
WITH INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM’S REPORT


















































F-1


Table of Contents





Report
of Independent Registered Public Accounting Firm








The Board
of Directors and Stockholders


Cyberonics,
Inc.:




We have
audited the accompanying consolidated balance sheets of Cyberonics, Inc.
and subsidiary as of April 24, 2009 and April 25, 2008, and the related
consolidated statements of operations, stockholders’ equity (deficit) and
comprehensive income (loss), and cash flows for the 52 weeks ended April 24,
2009, April 25, 2008, and April 27, 2007. These consolidated financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Cyberonics, Inc. and
subsidiary as of April 24, 2009 and April 25, 2008, and the results of their
operations and their cash flows for the 52 weeks ended April 24, 2009, April 25,
2008, and April 27, 2007, in conformity with U.S. generally accepted
accounting principles.




We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Cyberonics, Inc.’s internal control over
financial reporting as of April 24, 2009, based on criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated June 18, 2009 expressed an
unqualified opinion on the effectiveness of the Company’s internal control over
financial reporting.







/s/  KPMG
      LLP





Houston,
Texas


June 18,
2009








F-2


Table of Contents


CYBERONICS,
INC. AND SUBSIDIARY





CONSOLIDATED
BALANCE SHEETS








April
      24, 2009
              
              
              April
      25, 2008ASSETSCurrent
      Assets:Cash
      and cash equivalents
              
              $
              66,225,479
              
              
              $
              91,058,692Restricted
      cash
              
              
              1,000,000
              
              
              
              1,000,000Accounts
      receivable, net of allowances of $361,740 and $240,925,
      respectively
              
              
              22,250,653
              
              
              
              20,039,832Inventories
              
              
              12,841,064
              
              
              
              12,829,710Other
      current assets
              
              
              2,216,706
              
              
              
              2,108,185Total
      Current Assets
              
              
              104,533,902
              
              
              
              127,036,419Property
      and equipment, net
              
              
              5,612,791
              
              
              
              5,503,139Other
      assets
              
              
              1,896,935
              
              
              
              3,691,529Total
      Assets
              
              $
              112,043,628
              
              
              $
              136,231,087LIABILITIES
      AND STOCKHOLDERS' EQUITY (DEFICIT)Current
      Liabilities:Accounts
      payable
              
              $
              3,046,736
              
              
              $
              2,740,075Accrued
      liabilities
              
              
              14,598,504
              
              
              
              14,547,877Total
      Current Liabilities
              
              
              17,645,240
              
              
              
              17,287,952Long-Term
      Liabilities:Convertible
      notes
              
              
              62,339,000
              
              
              
              125,000,000Deferred
      license revenue and other
              
              
              7,647,544
              
              
              
              9,166,440Total
      Long-Term Liabilities
              
              
              69,986,544
              
              
              
              134,166,440Total
      Liabilities
              
              
              87,631,784
              
              
              
              151,454,392Commitments
      and ContingenciesStockholders’
      Equity (Deficit):Preferred
      Stock, $.01 par value per share; 2,500,000 shares authorized; no
      shares issued and outstanding
              
              
              —
              
              
              
              —Common
      Stock, $.01 par value per share; 50,000,000 shares authorized;
      28,175,552 shares issued and 27,353,215 shares outstanding at April 24,
      2009; and 27,712,248 shares issued and 26,925,611 outstanding at April 25,
      2008
              
              
              281,755
              
              
              
              277,122Additional
      paid-in capital
              
              
              258,519,876
              
              
              
              282,788,451Common
      stock warrants
              
              
              25,200,000
              
              
              
              25,200,000Hedges
      on convertible notes
              
              
              —
              
              
              
              (38,200,000
              )Treasury
      stock, 822,337 and 786,637 common shares at April 24, 2009 and April 25,
      2008, respectively, at cost
              
              
              (16,831,128
              )
              
              
              (16,298,835
              )Accumulated
      other comprehensive income (loss)
              
              
              (237,842
              )
              
              
              251,394Accumulated
      deficit
              
              
              (242,520,817
              )
              
              
              (269,241,437
              )Total
      Stockholders’ Equity (Deficit)
              
              
              24,411,844
              
              
              
              (15,223,305
              )Total
      Liabilities and Stockholders’ Equity (Deficit)
              
              $
              112,043,628
              
              
              $
              136,231,087








See
accompanying Notes to Consolidated Financial Statements
 F-3


Table of Contents





CYBERONICS,
INC. AND SUBSIDIARY





CONSOLIDATED
STATEMENTS OF OPERATIONS








52
      Weeks EndedApril
      24, 2009
              
              April
      25, 2008
              
              April 27,
      2007Net
      sales
              
              $
              143,600,979
              
              
              $
              121,229,742
              
              
              $
              130,968,437Cost
      of sales
              
              
              20,040,636
              
              
              
              21,092,374
              
              
              
              18,258,374Gross
      profit
              
              
              123,560,343
              
              
              
              100,137,368
              
              
              
              112,710,063Operating
      expenses:Selling,
      general and administrative
              
              
              84,837,694
              
              
              
              85,944,866
              
              
              
              134,144,315Research
      and development
              
              
              19,732,941
              
              
              
              22,421,199
              
              
              
              28,092,243Total
      operating expenses
              
              
              104,570,635
              
              
              
              108,366,065
              
              
              
              162,236,558Income
      (loss) from operations
              
              
              18,989,708
              
              
              
              (8,228,697
              )
              
              
              (49,526,495
              )Interest
      income
              
              
              1,235,757
              
              
              
              3,844,508
              
              
              
              4,649,394Interest
      expense
              
              
              (3,394,837
              )
              
              
              (5,818,272
              )
              
              
              (5,913,119
              )Gain
      on early extinguishment of debt
              
              
              11,000,698
              
              
              
              —
              
              
              
              —Other
      expense, net
              
              
              (381,265
              )
              
              
              (397,141
              )
              
              
              (311,112
              )Income
      (loss) before income taxes
              
              
              27,450,061
              
              
              
              (10,599,602
              )
              
              
              (51,101,332
              )Income
      tax expense (benefit)
              
              
              729,441
              
              
              
              (264,837
              )
              
              
              78,775Net
      income (loss)
              
              $
              26,720,620
              
              
              $
              (10,334,765
              )
              
              $
              (51,180,107
              )Basic
      income (loss) per share
              
              $
              1.00
              
              
              $
              (0.39
              )
              
              $
              (2.01
              )Diluted
      income (loss) per share
              
              $
              0.61
              
              
              $
              (0.39
              )
              
              $
              (2.01
              )Shares
      used in computing basic income (loss) per share
              
              
              26,632,115
              
              
              
              26,568,746
              
              
              
              25,514,232Shares
      used in computing diluted income (loss) per share
              
              
              27,542,198
              
              
              
              26,568,746
              
              
              
              25,514,232











See
accompanying Notes to Consolidated Financial Statements
 F-4


Table of Contents


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) AND


COMPREHENSIVE
INCOME (LOSS)





AccumulatedAdditional
              
              
              Common
              
              
              Hedges
      on
              
              
              
              
              
              
              
              
              Other
              
              
              
              
              
              TotalCommon
      Stock
              
              
              Paid-In
              
              
              Stock
              
              
              Convertible
              
              
              Deferred
              
              
              Treasury
              
              
              Comprehensive
              
              
              Accumulated
              
              
              Stockholders’Shares
              
              
              Amount
              
              
              Capital
              
              
              Warrants
              
              
              Notes
              
              
              Compensation
              
              
              Stock
              
              
              Income
      (Loss)
              
              
              Deficit
              
              
              EquityBalance
      at April 28, 2006
              
              
              25,781,349
              
              
              $
              257,813
              
              
              $
              244,648,193
              
              
              $
              25,200,000
              
              
              $
              (38,200,000
              )
              
              $
              (9,167,093
              )
              
              $
              (9,993,200
              )
              
              $
              (649,698
              )
              
              $
              (207,466,149
              )
              
              $
              4,629,866Stock
      options exercised
              
              
              798,074
              
              
              
              7,981
              
              
              
              9,924,390
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              9,932,371Unregistered
      shares issued
              
              
              75,000
              
              
              
              750
              
              
              
              1,940,250
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,941,000Issuance
      of Common Stock under Employee Stock Purchase Plan
              
              
              6,283
              
              
              
              63
              
              
              
              148,030
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              148,093Issuance
      of Restricted Stock
              
              
              52,500
              
              
              
              525
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              525Cancellation
      of Restricted Stock
              
              
              (12,152
              )
              
              
              (121
              )
              
              
              121
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Transfer
      of Deferred Compensation Balance (123R adoption)
              
              
              —
              
              
              
              —
              
              
              
              (9,167,093
              )
              
              
              —
              
              
              
              —
              
              
              
              9,167,093
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Non-cash
      Compensation Expense
              
              
              —
              
              
              
              —
              
              
              
              18,594,246
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              18,594,246Modification
      of Non-employee Stock Options
              
              
              —
              
              
              
              —
              
              
              
              (258,262
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (258,262
              )Excise
      Tax Remediation
              
              
              —
              
              
              
              —
              
              
              
              (221,071
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (221,071
              )Net
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (51,180,107
              )
              
              
              (51,180,107
              )Translation
      adjustment
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              351,110
              
              
              
              —
              
              
              
              351,110Comprehensive
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (50,828,997
              )Balance
      at April 27, 2007
              
              
              26,701,054
              
              
              
              267,011
              
              
              
              265,608,804
              
              
              
              25,200,000
              
              
              
              (38,200,000
              )
              
              
              —
              
              
              
              (9,993,200
              )
              
              
              (298,588
              )
              
              
              (258,646,256
              )
              
              
              (16,062,229
              )Cumulative
      Effect of Change in Accounting Principle
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (260,416
              )
              
              
              (260,416
              )Balance
      at April 27, 2007
              
              
              26,701,054
              
              
              
              267,011
              
              
              
              265,608,804
              
              
              
              25,200,000
              
              
              
              (38,200,000
              )
              
              
              
              
              
              
              (9,993,200
              )
              
              
              (298,588
              )
              
              
              (258,906,672
              )
              
              
              (16,322,645
              )Stock
      options exercised
              
              
              491,064
              
              
              
              4,910
              
              
              
              6,388,226
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              6,393,136Issuance
      of Common Stock under Employee Stock Purchase Plan
              
              
              2,735
              
              
              
              27
              
              
              
              42,415
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              42,442Issuance
      of Restricted Stock
              
              
              575,100
              
              
              
              5,751
              
              
              
              (5,751
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Cancellation
      of Restricted Stock
              
              
              (57,705
              )
              
              
              (577
              )
              
              
              577
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Purchase
      of Treasury Stock
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (6,305,635
              )
              
              
              —
              
              
              
              —
              
              
              
              (6,305,635
              )Non-Cash
      Compensation Expense
              
              
              —
              
              
              
              —
              
              
              
              11,063,306
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              11,063,306Excise
      Tax Remediation
              
              
              —
              
              
              
              —
              
              
              
              (309,126
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (309,126
              )Net
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (10,334,765
              )
              
              
              (10,334,765
              )Translation
      adjustment
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              549,982
              
              
              
              —
              
              
              
              549,982Comprehensive
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (9,784,783
              )Balance
      at April 25, 2008
              
              
              27,712,248
              
              
              
              277,122
              
              
              
              282,788,451
              
              
              
              25,200,000
              
              
              
              (38,200,000
              )
              
              
              —
              
              
              
              (16,298,835
              )
              
              
              251,394
              
              
              
              (269,241,437
              )
              
              
              (15,223,305
              )Stock
      options exercised
              
              
              303,210
              
              
              
              3,032
              
              
              
              4,279,469
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              4,282,501Issuance
      of Common Stock under Employee Stock Purchase Plan
              
              
              1,720
              
              
              
              17
              
              
              
              25,176
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              25,193Issuance
      of Restricted Stock
              
              
              184,431
              
              
              
              1,844
              
              
              
              (1,844
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Cancellation
      of Restricted Stock
              
              
              (26,057
              )
              
              
              (260
              )
              
              
              260
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Purchase
      of Treasury Stock
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (532,293
              )
              
              
              —
              
              
              
              —
              
              
              
              (532,293
              )Non-Cash
      Compensation Expense
              
              
              —
              
              
              
              —
              
              
              
              9,628,364
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              9,628,364Termination
      of Convertible Note Hedge
              
              
              —
              
              
              
              —
              
              
              
              (38,200,000
              )
              
              
              —
              
              
              
              38,200,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Net
      income
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              26,720,620
              
              
              
              26,720,620Translation
      adjustment
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (489,236
              )
              
              
              —
              
              
              
              (489,236
              )Comprehensive
      income
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              26,231,384Balance
      at April 24, 2009
              
              
              28,175,552
              
              
              $
              281,755
              
              
              $
              258,519,876
              
              
              $
              25,200,000
              
              
              $
              —
              
              
              $
              —
              
              
              $
              (16,831,128
              )
              
              $
              (237,842
              )
              
              $
              (242,520,817
              )
              
              $
              24,411,844








See
accompanying Notes to Consolidated Financial Statements
 F-5


Table of Contents


CYBERONICS,
INC. AND SUBSIDIARY





CONSOLIDATED
STATEMENTS OF CASH FLOWS


52
      Weeks EndedApril
      24, 2009
                
                April
      25, 2008
                
                April
      27, 2007Cash
      Flows From Operating Activities:Net
      income (loss)
                
                $
                26,720,620
                
                
                $
                (10,334,765
                )
                
                $
                (51,180,107
                )Non-cash
      items included in net income (loss):Depreciation
                
                
                2,179,900
                
                
                
                3,063,710
                
                
                
                3,708,710(Gain)
      loss on disposal or write-off of assets
                
                
                230,221
                
                
                
                185,585
                
                
                
                (8,189
                )Gain
      on early extinguishment of debt
                
                
                (11,000,698
                )
                
                
                —
                
                
                
                —Stock-based
      compensation
                
                
                9,681,593
                
                
                
                11,263,127
                
                
                
                19,421,391Deferred
      license revenue amortization
                
                
                (1,493,968
                )
                
                
                (533,560
                )
                
                
                —Amortization
      of financing costs and other items
                
                
                906,356
                
                
                
                932,204
                
                
                
                818,070Deferred
      income taxes
                
                
                9,804
                
                
                
                (425,945
                )
                
                
                —Unrealized
      loss in foreign currency transactions
                
                
                4,361
                
                
                
                114,303
                
                
                
                10,968Changes
      in operating assets and liabilities:Accounts
      receivable, net
                
                
                (3,312,205
                )
                
                
                (287,036
                )
                
                
                2,809,389Inventories
                
                
                (37,949
                )
                
                
                4,517,214
                
                
                
                90,620Other
      current assets
                
                
                32,588
                
                
                
                856,882
                
                
                
                2,051,878Other
      assets, net
                
                
                (302,671
                )
                
                
                297,044
                
                
                
                55,641Accounts
      payable and accrued liabilities
                
                
                1,057,638
                
                
                
                (4,703,658
                )
                
                
                1,703,008Deferred
      license revenue
                
                
                —
                
                
                
                9,500,000
                
                
                
                —Other
                
                
                (85,640
                )
                
                
                10,102
                
                
                
                (170,235
                )Net
      cash provided by (used in) operating activities
                
                
                24,589,950
                
                
                
                14,455,207
                
                
                
                (20,688,856
                )Cash
      Flow From Investing Activities:Purchases
      of property and equipment
                
                
                (2,668,266
                )
                
                
                (817,064
                )
                
                
                (1,425,349
                )Convertible
      promissory note
                
                
                (250,000
                )
                
                
                —
                
                
                
                —Net
      cash used in investing activities
                
                
                (2,918,266
                )
                
                
                (817,064
                )
                
                
                (1,425,349
                )Cash
      Flows From Financing Activities:Repurchase
      of Convertible Notes
                
                
                (50,402,417
                )
                
                
                —
                
                
                
                —Proceeds
      from exercise of options for common stock
                
                
                4,307,694
                
                
                
                6,435,055
                
                
                
                9,684,666Purchase
      of treasury stock
                
                
                (532,293
                )
                
                
                (6,305,635
                )
                
                
                —Increase
      (decrease) in borrowing against line of credit
                
                
                —
                
                
                
                (7,500,000
                )
                
                
                5,000,000Payments
      on financing obligations
                
                
                —
                
                
                
                (58,620
                )
                
                
                (246,701
                )Additional
      costs related to Convertible Notes
                
                
                —
                
                
                
                —
                
                
                
                (3,557
                )Net
      cash provided by (used in) financing activities
                
                
                (46,627,016
                )
                
                
                (7,429,200
                )
                
                
                14,434,408Effect
      of exchange rate changes on cash and cash equivalents
                
                
                122,119
                
                
                
                44,873
                
                
                
                129,602Net
      increase (decrease) in cash and cash equivalents
                
                
                (24,833,213
                )
                
                
                6,253,816
                
                
                
                (7,550,195
                )Cash
      and cash equivalents at beginning of year
                
                
                91,058,692
                
                
                
                84,804,876
                
                
                
                92,355,071Cash
      and cash equivalents at end of year
                
                $
                66,225,479
                
                
                $
                91,058,692
                
                
                $
                84,804,876Supplementary
      Disclosures of Cash Flow Information:Cash
      paid for interest
                
                $
                3,019,498
                
                
                $
                5,247,501
                
                
                $
                4,979,462Cash
      paid (refunded) for income taxes
                
                $
                686,634
                
                
                $
                (103,447
                )
                
                $
                65,609











See
accompanying Notes to Consolidated Financial Statements
 F-6


Table of Contents





CYBERONICS,
INC. AND SUBSIDIARY





NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





Note 1.  Summary
of Significant Accounting Policies and Related Data





Nature of
Operations.  We are headquartered in Houston, Texas and design,
develop, manufacture and market the Cyberonics VNS TherapyTM System (“VNS Therapy
System”), an implantable medical device that delivers a unique therapy, vagus
nerve stimulation (“VNS”) therapy (“VNS Therapy”), for the treatment of
refractory epilepsy and treatment-resistant depression. We have regulatory
approval to market and sell the VNS Therapy System for refractory epilepsy in
the United States (“U.S.”), Canada, Europe, Australia and other markets. In
2001, we obtained regulatory approval for commercial distribution of the VNS
Therapy System for the treatment of depression in the European market and in
Canada. In July 2005, the U.S. Food and Drug Administration (“FDA”) approved the
VNS Therapy System as an adjunctive long-term treatment of chronic or recurrent
depression for patients 18 years of age or older who are experiencing a
major depressive episode and have not had an adequate response to four or more
adequate antidepressant treatments.





We are a
neurostimulation business focused on creating new markets, improving our
products, developing new medical devices for patients suffering from epilepsy
and expanding our business into other neuromodulation
opportunities.  We operate our business as a single segment operation,
meaning substantially all of our operations are impacted by the same
considerations, including, but not limited to, economic characteristics,
technology, manufacturing processes, customers, distribution and marketing
strategies, regulatory environments and shared infrastructures.





Consolidation.  The
accompanying consolidated financial statements include Cyberonics, Inc. and our
wholly-owned subsidiary, Cyberonics Europe, SA. All significant intercompany
accounts and transactions have been eliminated.





Use of
Estimates.  The preparation of consolidated financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect
the amounts reported in the consolidated financial statements and these
accompanying Notes. Actual results could differ from those estimates. Critical
estimates that require management’s judgment relate to the allowance for
doubtful accounts, estimates of any obsolete inventory, useful lives for
property and equipment, impairment of any long-lived assets, sales returns and
allowances, recognition of licensing revenue, product warranties, stock option
expenses and income tax valuation allowances.





Foreign Currency
Translation.  The assets and liabilities of our subsidiary,
Cyberonics Europe, SA are generally translated into U.S. dollars at
exchange rates in effect on reporting dates, while capital accounts and certain
obligations of a long-term nature payable to Cyberonics, Inc., the parent
company, are translated at historical rates. Statement of Operations items are
translated at average exchange rates in effect during the financial statement
period. The gains and losses that result from this process are shown in the
Accumulated Other Comprehensive Income (Loss) section of Stockholders’ Equity
(Deficit) and Comprehensive Income (Loss), and are not included in the
determination of the results of operations. Gains and losses resulting from
foreign currency transactions denominated in a currency other than the
functional currency are included in other income and expense.





Cash and Cash
Equivalents.  We consider all highly liquid investments with a
maturity of three months or less at the time of purchase to be cash
equivalents.





Restricted
Cash.  We classify as restricted cash highly liquid investments
that otherwise would qualify as cash equivalents, but that have been set aside
as collateral and are unavailable for withdrawal for up to one year due
to  certain conditions that must be met.





F-7


Table of Contents





Fair Value of
Financial Instruments.  The carrying amounts reported in the
Consolidated Balance Sheets for cash and cash equivalents, accounts receivable,
accounts payable and accrued liabilities approximate their fair values due to
the short-term maturity of these financial instruments. The fair value of our
Convertible Notes is discussed in “Note 6. Convertible Notes.”




Accounts
Receivable.  Activity in our allowance for doubtful accounts
consists of the following:





52
      Weeks EndedApril
      24, 2009
              
              April
      25, 2008
              
              April
      27, 2007Balance
      at beginning of year
              
              $
              240,925
              
              
              $
              308,083
              
              
              $
              234,478Increase
      in allowance
              
              
              120,815
              
              
              
              34,054
              
              
              
              161,652Reductions
      for write-offs
              
              
              —
              
              
              
              (101,212
              )
              
              
              (88,047
              )Balance
      at end of year
              
              $
              361,740
              
              
              $
              240,925
              
              
              $
              308,083





Inventories.  We
state our inventories at the lower of cost, the first-in first-out (“FIFO”)
method or market. Our calculation of cost includes the acquisition cost of raw
materials and components, direct labor and overhead net of obsolescence
provisions.





Property and
Equipment.  Property and equipment are carried at cost, less
accumulated depreciation. Maintenance, repairs and minor replacements are
charged to expense as incurred; significant renewals and betterments are
capitalized. We compute depreciation using the straight-line method over useful
lives ranging from two to nine years. Property and equipment under capital
leases are stated at the lower of the present value of minimum lease payments at
the beginning of the lease term or fair value at the inception of the lease.
Property and equipment under capital leases are depreciated using the
straight-line method over the shorter of the lease term or the estimated useful
life of the property.





Leases.  Financial
Accounting Standards Board (“FASB”) Statement No. 13, “Accounting for Leases” (“FAS
13”),establishes
standards of financial accounting and reporting for leases by lessees and
lessors. We are a party to the contract of leased facilities and other lease
obligations recorded in compliance with FAS No. 13. The lease terms
provide for tenant improvement allowances that are recorded as deferred rent and
amortized, using the straight-line method, as reduction to rent expense over the
term of the lease. Scheduled rent increases and rent holidays are recognized on
a straight-line basis over the term of the lease. During fiscal year 2008 we
completed the abandonment of a portion of our leased facilities at 100
Cyberonics Boulevard in Houston, Texas. We record the net present value of our
future lease obligations related to the space surrendered, offset by the net
present value of estimated proceeds from the sub-lease of the space surrendered.
We review our estimate of the net present value of the proceeds from the
sub-lease of the space surrendered on a quarterly basis.





Long-Lived
Assets.  FASB Statement No. 144, “Accounting for the Impairment
or Disposals of
Long-Lived Assets” (“FAS 144”),provides a single
accounting model for long-lived assets to be disposed.  FAS 144
also establishes the criteria for classifying an asset as held for sale and sets
the scope of business to be disposed of that qualifies for reporting as
discontinued operations as well as changes the timing of recognizing losses on
such operations.





Other Current Assets and Other
Assets.  Other current assets and other assets include prepaid
expenses and convertible notes origination costs, which are expensed in the
normal course of business over the periods these expenses benefit.





F-8


Table of Contents





Share Based
Compensation.  We account for our employee stock-based
compensation plans under FASB Statement No. 123 (revised 2004), “Share-Based Payment” (“FAS
123(R)”).





Stock Options.  We
may grant options to directors, officers and key employees.  Options
we grant generally vest ratably over the period ending with the fourth or fifth
anniversary of the grant date and have a maximum life of 10
years.  Stock option grant prices are set according to the applicable
stock option plan and are equal to either the closing price of our common stock
on the last trading day prior to the grant date, for grants made prior to
amendment of the plans on August 19, 2008, or the closing price of our
common stock on the day of the grant, for grants made after the
amendment.  There are no post-vesting restrictions on the shares
issued.  We issue new shares upon share option exercise. We use the
Black-Scholes option pricing methodology to calculate the grant date fair market
value of stock option grants.





Restricted Stock, Restricted Stock
Units and Other Stock-Based Awards.  We may grant restricted
stock, restricted stock units or stock awards to directors, officers and key
employees which have no purchase cost to the grantee. Nonvested restricted stock
entitles the grantees to dividends, if any, and voting rights for their
respective shares. Sale or transfer of the shares is restricted until they are
vested. Typically, grants are service based and vest ratably over the service
period of four to five years, or cliff vest after three years, as required under
the agreement establishing the grant.  Compensation cost is expensed
ratably over the service period. Generally, the fair value of restricted stock
is determined for accounting purposes using the market closing price on the
grant date. We may also grant restricted stock subject to performance or market
conditions that can vest based on the satisfaction of the conditions of the
grant. The fair market value and derived service period of market
condition-based grants is determined using the Monte Carlo simulation method.
The derived service period for performance-based grants is estimated based on
our judgment of likely future performance. The Monte Carlo simulation method is
subject to variability as several factors utilized must be estimated, including
the derived service period, which is estimated based on our judgment of likely
future performance, and our stock price volatility. We issue new shares for the
granting of restricted stock.





Revenue
Recognition.   We recognize revenue when title to the goods and
risk of loss transfers to customers, providing there are no remaining
performance obligations required of us or any matters requiring customer
acceptance. We record estimated sales returns and discounts as a reduction of
net sales in the same period revenue is recognized. Our revenues are dependent
upon sales to new and existing customers pursuant to our current policies.
Changes in these policies or sales terms could impact the amount and timing of
revenue recognized.





Licensing
Revenue.  We evaluate our license agreements and recognize
licensing revenue considering the guidance provided by Staff Accounting Bulletin
(“SAB”) Topic 13, “Revenue
Recognition,” EITF 00-21“Revenue Arrangements with Multiple
Deliverables,” Regulation S-X Rule 5-03(b)(1)“Sales and Revenue,” EITF
01-14 “Income Statement
Characterization of Reimbursement of Out-of-pocket Expenses” and other
regulations as applicable.





Licensing
Expense.  We have executed license agreements under which we
have secured the rights provided under certain patents. Royalties payable under
the terms of these agreements are expensed as incurred.





Research and
Development.  All research and development costs are expensed
as incurred.




Product
Warranty.  We offer warranties on our leads and generators for
one to two years from the date of implant, depending on the product in question.
We provide, at the time of shipment, for costs estimated to be incurred under
our product warranties. Provisions for warranty expenses are made based upon
projected product warranty claims.





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Table of Contents





Changes
in our liability for product warranties during the 52 weeks ended April 24,
2009, April 25, 2008 and April 27, 2007 are as follows:





Year
              
              Balance
      at the Beginning of the Year
              
              Warranty
      Expense Recognized
              
              Warranties
      Settled
              
              Balance
      at the
                End
      of the Year2009
              
              $
              79,055
              
              
              $
              46,492
              
              
              $
              (3,888
              )
              
              $
              121,6592008
              
              
              68,822
              
              
              
              10,883
              
              
              
              (650
              )
              
              
              79,0552007
              
              
              46,991
              
              
              
              27,037
              
              
              
              (5,206
              )
              
              
              68,822





Income Taxes.  We
account for income taxes under the FASB Statement No. 109, “Accounting for Income Taxes”
(“FAS 109”).  Under this method, deferred income taxes reflect the
impact of temporary differences between financial accounting and tax basis of
assets and liabilities.  Such differences relate primarily to the
deductibility of certain accruals and reserves and the effect of tax loss and
tax credit carryforward not yet utilized.  Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.  The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in operations in the period
that includes the enactment date.  Deferred tax assets are evaluated
for realization based on a more-likely-than-not criterion in determining if a
valuation allowance should be provided.





Effective
April 28, 2007, we adopted FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (“FIN 48”).  This interpretation clarifies the
criteria for recognizing income tax benefits under FASB 109 and requires
additional disclosures about uncertain tax positions.  Under FIN 48,
the financial statement recognition of the benefit for a tax position is
dependent upon the benefit being more-likely-than-not to be sustainable upon
audit by the applicable taxing authority.  If this threshold is met,
the tax benefit is then measured and recognized at the largest amount that is
greater than 50 percent likely of being realized upon ultimate
settlement.





Net Earnings (Loss) Per
Share.  FASB Statement No. 128, “Earnings Per Share” (“FAS
128”), requires dual presentation of earnings per share (“EPS”): basic EPS and
diluted EPS. Basic EPS is computed by dividing net earnings or loss applicable
to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS includes dilutive stock options and
unvested restricted stock that are considered common stock equivalents using the
treasury stock method.





The
following table sets forth the computation of basic and diluted net income
(loss) per share of common stock:





For
      the 52 Weeks EndedApril
      24, 2009
              
              April
      25, 2008
              
              April
      27, 2007Numerator:Net
      income (loss)
              
              $
              26,720,620
              
              
              $
              (10,334,765
              )
              
              $
              (51,180,107
              )Deduct
      effect of Convertible Notes
              
              
              (9,895,370
              )
              
              
              —
              
              
              
              —Diluted
      income (loss)
              
              $
              16,825,250
              
              
              $
              (10,334,765
              )
              
              $
              (51,180,107
              )Denominator:Basic
      weighted average shares outstanding
              
              
              26,632,115
              
              
              
              26,568,746
              
              
              
              25,514,232Add
      effect of:Stock
      Options and restricted stock
              
              
              190,331
              
              
              
              —
              
              
              
              —Convertible
      Notes
              
              
              719,752
              
              
              
              —
              
              
              
              —Diluted
      weighted average shares outstanding
              
              
              27,542,198
              
              
              
              26,568,746
              
              
              
              25,514,232Basic
      income (loss) per share
              
              $
              1.00
              
              
              $
              (0.39
              )
              
              $
              (2.01
              )Diluted
      income (loss) per share
              
              $
              0.61
              
              
              $
              (0.39
              )
              
              $
              (2.01
              )





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Table of Contents





Excluded
from the computation of diluted EPS for the 52 weeks ended April 24, 2009
were outstanding options to purchase approximately 1.7 million common shares,
because to include them would have been anti-dilutive as a result of the
exercise price of the options exceeding their current fair market
value.  Excluded from the computation of diluted EPS for the 52 weeks
ended April 25, 2008 and April 27, 2007 were outstanding options and
unvested restricted stock to purchase approximately 3.3 million
and  5.6 million common shares, respectively, because to include
them would have been anti-dilutive due to the net loss.





We issued
$125.0 million of Senior Subordinated Convertible Notes due in 2012
(“Convertible Notes”) during fiscal year 2006.  Approximately $62.3
million of the Convertible Notes are outstanding as of April 24, 2009, and are
convertible into approximately 2.6 million shares of our common stock but are
not included in dilutive shares because under the “if-converted” method of FAS
128, which assumes conversion of the Convertible Notes to shares and adjusts net
income (loss) for interest expense net of tax, they are
anti-dilutive.  Additionally, the Convertible Notes are anti-dilutive
in fiscal years 2008 and 2007 due to net losses.





During
fiscal year 2009 we purchased approximately $62.7 million of aggregate principal
amount of our Convertible Notes in privately-negotiated transactions. Under
FASB’s Emerging Issues Task Force ("EITF") D-53, "Computation of Earnings per Share
for a Period That Includes a Redemption or an Induced Conversion of a Portion of
a Class of Preferred Stock", ("EITF D-53"), we are required to determine
the dilutive effect of the repurchased Convertible Notes separately from the
Convertible Notes outstanding at April 24, 2009.  Under the “if-converted” method of FAS
128, Convertible Notes repurchased during fiscal year 2009 are treated as having
been converted to common stock equivalents at the start of the
period.  Adjustments to dilutive net income related to the repurchased
Convertible Notes consist primarily of removing the gain related to the
repurchases and similarly removing the effects of interest expense and other
items.





In
conjunction with the Convertible Notes, we purchased call options to buy
3,000,000 shares of our common stock at an exercise price of $41.50 per share
(the “Note Hedge”).  Purchased call options are anti-dilutive and are
not included in the computation of diluted EPS.  The  Note
Hedge was terminated effective May 6, 2008 in accordance with its terms; see
“Note 7.  Convertible Note Hedge and Warrants.” Also, in
conjunction with the Convertible Notes, we sold common stock warrants (the
“Warrants”) to sell 3,000,000 shares of our common stock at an exercise
price of $50.00 per share. In accordance with the treasury stock method of
FAS No. 128, “Earnings Per Share,”the
Warrants are not included in the computation of diluted EPS because the
Warrants’ exercise price is greater than the average market price of the common
stock.





Comprehensive Income
(Loss).  Comprehensive income (loss) is the total of net income
(loss) and all other non-owner changes in equity.





Note 2.  Inventories





Inventories
consist of the following:





April 24,
      2009
              
              
              April 25,
      2008Raw
      materials
              
              $
              5,381,272
              
              
              $
              7,220,830Finished
      goods
              
              
              5,241,600
              
              
              
              4,391,711Work-in-process
              
              
              2,218,192
              
              
              
              1,217,169$
              12,841,064
              
              
              $
              12,829,710








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Note 3.  Property
and Equipment





Property
and equipment consist of the following:





April
      24, 2009
              
              April
      25, 2008Computer
      equipment
              
              $
              8,867,061
              
              
              $
              8,560,562Manufacturing
      equipment
              
              
              9,810,334
              
              
              
              8,905,857Leasehold
      improvements
              
              
              3,925,286
              
              
              
              3,994,759Furniture
      and fixtures
              
              
              2,880,409
              
              
              
              3,033,167Office
      equipment
              
              
              745,883
              
              
              
              1,398,684Capital
      investment programs in process
              
              
              1,311,148
              
              
              
              545,89827,540,121
              
              
              
              26,438,927Accumulated
      depreciation
              
              
              (21,927,330
              )
              
              
              (20,935,788
              )$
              5,612,791
              
              
              $
              5,503,139





Note 4.  Line
of Credit





On
January 13, 2006, we established the $40.0 million revolving line of
credit under the Credit Agreement.   The Credit Agreement had a
three-year term ending January 13, 2009 and was collateralized by accounts
receivable, inventory, subsidiary stock, general intangibles, equipment and
other collateral with normal terms and conditions.





Effective
January 14, 2008, we voluntarily terminated the Credit Agreement in accordance
with its terms. Early termination of the Credit Agreement triggered an
obligation on the part of the Company to pay a Deferred Commitment Fee (as
defined in the Credit Agreement) in the amount of $0.4 million in addition to
obligations to repay the $10.0 million outstanding loan balance and to pay the
accrued interest as of the effective date of termination. We satisfied these
obligations on January 14, 2008.  We also wrote off unamortized
origination fees of approximately $0.2 million.





Note 5.  Accrued
Liabilities





Accrued
liabilities consist of the following:




April
      24, 2009
                                                                                          
                                                                                          April
      25, 2008Payroll
      and other compensation
                                                                                          
                                                                                          $
                                                                                          9,872,631
                                                                                          
                                                                                          $
                                                                                          7,987,219Royalties
                                                                                          
                                                                                          
                                                                                          1,133,225
                                                                                          
                                                                                          
                                                                                          994,398Clinical
      costs
                                                                                          
                                                                                          
                                                                                          956,383
                                                                                          
                                                                                          
                                                                                          1,978,942Property
      tax and other tax accruals
                                                                                          
                                                                                          
                                                                                          849,503
                                                                                          
                                                                                          
                                                                                          849,680Professional
      services
                                                                                          
                                                                                          
                                                                                          481,675
                                                                                          
                                                                                          
                                                                                          907,097Other
                                                                                          
                                                                                          
                                                                                          1,305,087
                                                                                          
                                                                                          
                                                                                          1,830,541$
                                                                                          14,598,504
                                                                                          
                                                                                          
                                                                                          14,547,877





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Note 6.  Convertible
Notes





On
September 27, 2005, we issued $125 million of Convertible Notes,
originally due on September 27, 2012. Interest on the Convertible Notes at the
rate of 3% per year on the principal amount is payable semi-annually in arrears
in cash on March 27 and September 27 of each year beginning March 27, 2006.
The Convertible Notes are unsecured and subordinated to all of our existing and
future senior debt and equal in right of payment with our existing and future
senior subordinated debt. Holders may convert their Convertible Notes, which
were issued in the form of $1,000 bonds, into 24.0964 shares of our common
stock per bond, which equals a conversion price of approximately $41.50 per
share, subject to adjustments, at any time prior to maturity. Holders who
convert their Convertible Notes in connection with certain fundamental changes
may be entitled to a make-whole premium in the form of an increase in the
conversion rate. A fundamental change will be deemed to have occurred upon a
change of control, liquidation or a termination of trading. The make-whole
premium, depending on the price of the stock and the date of the fundamental
change, may range from 6.0241 to 0.1881 shares per bond, when the stock
price ranges from $33.20 to $150.00, respectively. If a fundamental change of
our company occurs, the holder may require us to purchase all or a part of their
Convertible Notes at a price equal to 100% of the principal amount of the
Convertible Notes to be purchased, plus accrued and unpaid interest, if any. We
may, at our option, instead of paying the fundamental change purchase price in
cash, pay it in our common stock valued at a 5% discount from the market price
of our common stock for the 20 trading days immediately preceding and including
the third day prior to the date we are required to purchase the Convertible
Notes, or in any combination of cash and shares of our common stock. This
offering provided net proceeds of approximately $121 million. We used the
proceeds for (1) a simultaneous share buyback of 301,000 shares at
$33.20 for a total of $10.0 million and (2) the net cost of
$13.0 million related to the Note Hedge and Warrants, which transactions
were designed to limit our exposure to potential dilution from conversion of the
Convertible Notes. These transactions resulted in net cash proceeds of
approximately $98.3 million.





On
September 27, 2005, we entered into a registration rights agreement (the
“Registration Rights Agreement”) in connection with our issuance of the
Convertible Notes. Under the Registration Rights Agreement, we were required to
file a registration statement for the Convertible Notes and the shares into
which the Convertible Notes are convertible on or before July 14, 2006 and
to use reasonable best efforts to cause the registration statement to become
effective on or before October 12, 2006. Due to delays in completing our
consolidated financial statements for the fiscal year ended April 28, 2006,
we did not file the required registration statement. As a result of failing to
file the registration statement on a timely basis, we were obligated by the
terms of the Registration Rights Agreement to pay specified liquidated damages
to the holders of the Convertible Notes for the period during which the failure
continued. The liquidated damages per year equal 0.25% of the principal amount
of the outstanding Convertible Notes during the first 90-day period (a total of
$78,125 for the first 90 days) and 0.50% of the principal amount of the
outstanding Convertible Notes for the period commencing 91 days following
the failure to file the registration statement (an additional $156,250 for each
90-day period during which the failure to obtain the effectiveness of the
registration statement continued).





In
compliance with the requirements of the FASB staff position (“FSP”) applicable
to the Emerging Issues Task Force (“EITF”) FSP EITF 00-19-2 “Accounting for Registration Payment
Arrangements,” (“FSP EITF 00-19-2”), during the period ended July 27,
2007, we recognized the cost of these liquidated damages that were due up to
September 27, 2007, the date when our obligations under the Registration Rights
Agreement expired. We adopted FSP EITF 00-19-2 on April 28, 2007 resulting
in an adjustment in the amount of approximately $0.3 million to the beginning
balance in accumulated deficit and accrued liabilities in the Consolidated
Balance Sheet as of July 27, 2007.  The total liquidated damages
accrued were paid on September 27, 2007. Our obligation to procure the
effectiveness of the registration statement expired on September 27,
2007.  On that date, the Convertible Notes became tradable under Rule
144 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) by
persons who are not our affiliates.





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Table of Contents





During
the fiscal year ended April 24, 2009 we repurchased approximately $62.7 million
of aggregate principal amount of our Convertible Notes in privately-negotiated
transactions at a purchase price of approximately $50.4 million.  As a
result of the purchases, we wrote off approximately $1.3 million in unamortized
bond issue costs resulting in a gain on early extinguishment of debt of
approximately $11.0 million. After our year end we repurchased $15.6 million
additional aggregate principal amount of Convertible Notes resulting in a gain
on early extinguishment of debt of approximately $1.5 million.





Fair
Value of Convertible Notes


To
increase consistency and comparability in fair value measurements, FASB
Statement No. 157, "Fair Value
Measurements," requires that the inputs used to measure fair value be
categorized into levels. There are three levels in the hierarchy. The highest
level, or level 1, is an unadjusted market quote from an active markets for
identical assets or liabilities, level 2 are inputs to the fair value
measurement that are observable for the asset or liability, either directly or
indirectly and level 3 are inputs that are unobservable. Assessing the
significance of a particular input to the fair value measurement in its entirety
requires judgment, considering factors specific to the asset or liability. We
believe that the fair value measurement of our Convertible Notes fall into Level
2. Adjusted market quotes obtained from brokers were used to estimate the fair
value of this debt. The estimated fair value of the Convertible Notes was
approximately $50.5 million, based on the outstanding liability of
approximately $62.3 million, as of April 24, 2009. The estimated fair value of
the Convertible Notes as of April 25, 2008 and April 27, 2007, based
on the outstanding liability of $125.0 million, was $105.8 million and
$115.0 million, respectively.





Convertible
Notes Indenture Default Notice





Pursuant
to the Indenture dated September 27, 2005 (the “Indenture”), between us, as
issuer, and Wells Fargo Bank, National Association (the “Trustee”), we are
required to deliver to the Trustee “within 15 days after we file them” with
the SEC copies of all Annual Reports on Form 10-K and other information,
documents and other reports that we are required to file with the SEC pursuant
to Section 13 or 15(d) of the Exchange Act. In July 2006, we received the
Notice of Default from the Trustee, pursuant to which the Trustee asserted that
we are in default under the Indenture as a result of our failure (1) to
file with the SEC our 2006 Form 10-K by July 12, 2006 and (2) to
deliver a copy of the 2006 Form 10-K to the Trustee by July 27, 2006.
In October 2006, we received the Notice of Acceleration from the Trustee
informing us that, pursuant to the Indenture, the Trustee had declared the
Convertible Notes due and payable at their principal amount, together with
accrued and unpaid interest, and fees and expenses, and demanding that all such
principal, interest, fees and expenses under the Convertible Notes be paid to
the Trustee immediately.  We classified this liability as short term
in our balance sheet as of April 27, 2007.





In
October 2006, we filed an action seeking a declaration that no event of default
had occurred.  In April 2008, we reached an agreement with the Trustee
to settle the proceedings and executed a Settlement Agreement and Supplemental
Indenture. As part of the settlement, the parties released all claims, and the
parties executed a supplemental indenture agreement (the “Supplemental
Indenture”). The Supplemental Indenture obligates us to repurchase for par value
any of the Convertible Notes tendered to Cyberonics on December 27, 2011, nine
months prior to the maturity date under the Indenture. The Supplemental
Indenture otherwise makes no additional changes to the terms of the
Indenture.  As a result of the settlement and the associated
documents, we reflected the Convertible Notes as a long-term liability as of
April 24, 2009 and April 25, 2008.




Note 7.  Convertible
Note Hedge and Warrants





On
September 27, 2005, in conjunction with the issuance of $125 million
of Convertible Notes, we purchased the Note Hedge and sold Warrants. The Note
Hedge and the Warrants were recorded in stockholders’ equity (deficit) on the
consolidated balance sheet.  On May 5, 2008 we received from Merrill
Lynch International (“MLI”) a notice that the Note Hedge was terminated
effective May 6, 2008 in accordance with its terms.  According to the
notice, the Supplemental Indenture constituted an “Amendment Event” (as such
term is defined in the Note Hedge confirmation) that resulted in the occurrence
of an “Additional Termination Event” (as such term is defined in the Note Hedge
confirmation) and gave rise to a right to termination.  As a
consequence of that action, we have reflected the termination of the Note Hedge
as a $38.2 million reduction of paid-in capital in fiscal 2009. The termination
had no effect on our consolidated statements of operations.  The
Warrants remain outstanding and could be exercised if our stock price exceeds
$50.00 per share.





F-14


Table of Contents





Note 8.  Stockholders’
Equity (Deficit)





Preferred
Stock.  We have 2,500,000 shares of undesignated Preferred
Stock authorized and available for future issuance, of which none have been
issued through April 24, 2009. With respect to the shares authorized, our
Board of Directors, at its sole discretion, may determine, fix and alter
dividend rights, dividend rates, conversion rights, voting rights, terms of
redemption, redemption prices, liquidation preferences and the number of shares
constituting any such series and may determine the designation, terms and
conditions of the issuance of any such shares.





Preferred Share Purchase
Rights.  In January 1997, our Board of Directors declared a
dividend of one Preferred Share Purchase Right (“Right”) on each outstanding
share of our common stock to stockholders of record on March 10, 1997. We
amended and restated the Preferred Share Rights (“Plan”) on August 21,
2000. The Rights will become exercisable following the tenth day after a person
or group of affiliated persons (an “Acquiring Person”), acquires beneficial
ownership of 15% or more of our common stock or announces commencement of a
tender offer, the consummation of which would result in such person or group of
persons becoming an Acquiring Person (a “Triggering Event”). Each Right entitles
the holder thereof to buy 1/1000 of a share of our Series A Participating
Preferred Stock at an exercise price of $150 (the “Exercise Price”). We will be
entitled to redeem the Rights at $.01 per Right at any time prior to a
Triggering Event. If, prior to redemption of the Rights, a person becomes an
Acquiring Person, each Right (except for Rights owned by the Acquiring Person,
which will thereafter be void) will entitle the holder thereof to purchase, at
the Right’s then current exchange price, that number of shares of our common
stock, or, in certain circumstances as determined by our Board, cash, other
property or other securities having a market value at that time of twice the
Right’s exercise price. In the event a person becomes an Acquiring Person and we
sell more than 50% of our assets or earning power or we are acquired in a merger
or other business combination, proper provision must be made so that a holder of
a Right which has not theretofore been exercised (except for Rights owned by the
Acquiring Person, which will thereafter be void), will thereafter have the right
to receive, upon exercise of a Right, shares of common stock of the acquiring
company having a value equal to two times the then current Exercise Price. At
any time after a Triggering Event and prior to acquisition by such Acquiring
Person of 50% or more of the outstanding common stock, our Board of Directors
may exchange the Rights (other than Rights owned by the Acquiring Person or its
affiliates) for our common stock at an exchange ratio of one share of common
stock per Right. In April 2001, we amended the Plan to designate the State of
Wisconsin Investment Board (“SWIB”) as an Exempt Person under the terms of the
Plan as long as SWIB is the Beneficial Owner of less than 20%. In January 2007,
we amended the Plan to extend the final expiration date of the Plan to
January 29, 2010.





Note 9.  Stock
Incentive and Purchase Plans





We
account for our employee stock-based compensation plans under FAS 123(R), “Share-Based
Payment”.





Amounts
recognized in the consolidated financial statements for share-based compensation
are as follows:





For
      the 52 Weeks EndedApril
      24, 2009
              
              
              April
      25, 2008
              
              
              April
      27, 2007Total
      cost of share-based payment plans during the year
              
              $
              9,628,364
              
              
              $
              11,427,518
              
              
              $
              19,796,954Amounts
      capitalized in inventory and fixed assets during the year
              
              
              (867,834
              )
              
              
              (1,013,187
              )
              
              
              (915,111
              )Amounts
      recognized in operations for amounts previously capitalized in inventory
      and fixed assets
              
              
              921,063
              
              
              
              1,212,483
              
              
              
              539,548Amounts
      charged against operations, before income tax benefit
              
              $
              9,681,593
              
              
              $
              11,626,814
              
              
              $
              19,421,391Amount
      of related income tax benefit recognized in operations
              
              
              —
              
              
              
              —
              
              
              
              —








F-15


Table of Contents





The
charges applicable to stock-based compensation increased our cost of goods sold
by $0.8 million, sales, general and administrative (“SG&A”) expenses by
$7.6 million and research and development (“R&D”) expenses by
$1.2 million during the 52 weeks ended April 24, 2009 and
increased our cost of goods sold by $1.2 million, SG&A expenses by
$8.7 million and R&D expenses by $1.7 million during the
52 weeks ended April 25, 2008. The charges applicable to stock-based
compensation increased our cost of goods sold by $0.3 million, SG&A
expenses by $15.4 million, which includes $3.7 million applicable to
the resignations of the Chief Executive Officer (“CEO”) and Chief Financial
Officer (“CFO”) in the third quarter of fiscal year 2007, and R&D expenses
by $3.3 million during the 52 weeks ended April 27,
2007.





Stock Incentive
Plans.  As of April 24, 2009, we have authorized an
aggregate of 15,250,000 shares of common stock for issuance pursuant to our
1988 Incentive Stock Plan, 1996 Stock Option Plan, 1997 Stock Plan, 1998 Stock
Option Plan, New Employee Equity Inducement Plan, the 2005 Stock Plan, our
officer plans and subsequent amended versions of such plans (the “Stock Plans”).
Shares can no longer be issued pursuant to the 1988 Incentive Stock Plan, 1996
Stock Option Plan, 1998 Stock Option Plan and certain officer
plans.  These plans account for 10,200,000 of the originally
authorized shares. The Amended and Restated 1997 Stock Plan, Amended and
Restated New Employee Equity Inducement Plan and the 2005 Stock Plan allow
issuance of either nonstatutory or incentive stock options and restricted
stock.





Stock
Options.   We may grant options to directors, officers and
key employees.   Options granted under the Stock Plans generally
vest ratably, monthly or annually, over four or five years following their date
of grant and have maximum terms of 10 years.  Stock option grant
prices are set according to the applicable stock option plan and are equal to
either the closing price of our common stock on the last trading day prior to
the grant date, for grants made prior to amendment of the plans on August 19,
2008, or the closing price of our common stock on the day of the grant, for
grants made after the amendment. There are no post-vesting restrictions on the
shares issued.  We use the Black-Scholes option pricing methodology to
calculate the grant date fair market value of stock option grants. This
methodology takes into account variables such as implied volatility, dividend
yield rate, expected option term and risk-free interest rate. The expected term
is based upon observation of actual time elapsed between the date of grant and
the exercise of options per group of employees. We issue new shares upon share
option exercise.





For the
52 weeks ended April 24, 2009, we granted 379,791 stock options at a weighted
average exercise price of $18.85 per share. For the 52 weeks ended April 25,
2008, we granted no stock options. For the 52 weeks ended April 27,
2007, we granted 156,250 options at a weighted average exercise price of $22.78
per share. Stock options to purchase approximately 2.6 million shares at a
weighted average of $22.52 per share were outstanding as of April 24, 2009,
approximately 2.7 million shares at a weighted average of $22.27 per share were
outstanding as of April 25, 2008 and approximately 5.5 million shares at a
weighted average exercise price of $20.62 per share were outstanding as of
April 27, 2007.








F-16


Table of Contents





The
following table summarizes information regarding total stock option activity for
the 52 weeks ended April 24, 2009, April 25, 2008 and April 27,
2007:





For
      the 52 Weeks EndedApril 24,
      2009
                  
                  
                  April 25,
      2008Options
                  
                  Number
      of Shares
                  
                  
                  Wtd.
      Avg. Exercise Price
                  
                  
                  Wtd.
      Avg. Fair Market Value
                  
                  
                  Wtd.
      Avg. Remaining Contractual Term
                  
                  
                  Aggregate
      Intrinsic Value
                  
                  
                  Number
      of Shares
                  
                  
                  Wtd.
      Avg Exercise Price
                  
                  
                  Wtd.
      Avg. Fair Market Value
                  
                  
                  Wtd.
      Avg. Remaining Contractual Term
                  
                  
                  Aggregate
      Intrinsic ValueOutstanding —
      beginning of year
                  
                  
                  2,682,561
                  
                  
                  $
                  22.27
                  
                  
                  $
                  17.26
                  
                  
                  4.96
                  
                  
                  $
                  —
                  
                  
                  
                  5,469,363
                  
                  
                  $
                  20.62
                  
                  
                  $
                  15.72
                  
                  
                  4.47
                  
                  
                  $
                  —Granted
                  
                  
                  379,791
                  
                  
                  
                  18.85
                  
                  
                  
                  10.95
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  —
                  
                  
                  
                  —Exercised
                  
                  
                  303,210
                  
                  
                  
                  14.12
                  
                  
                  
                  11.94
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  491,064
                  
                  
                  
                  13.02
                  
                  
                  
                  10.99
                  
                  
                  —
                  
                  
                  
                  2,070,419Forfeited
                  
                  
                  136,872
                  
                  
                  
                  24.40
                  
                  
                  
                  19.02
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  337,596
                  
                  
                  
                  28.35
                  
                  
                  
                  20.31
                  
                  
                  —
                  
                  
                  
                  —Expired
                  
                  
                  47,276
                  
                  
                  
                  27.56
                  
                  
                  
                  19.28
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1,958,142
                  
                  
                  
                  19.25
                  
                  
                  
                  14.00
                  
                  
                  —
                  
                  
                  
                  —Outstanding —
      end of year
                  
                  
                  2,574,994
                  
                  
                  
                  22.52
                  
                  
                  
                  16.83
                  
                  
                  
                  4.88
                  
                  
                  
                  —
                  
                  
                  
                  2,682,561
                  
                  
                  
                  22.27
                  
                  
                  
                  17.26
                  
                  
                  
                  4.96
                  
                  
                  
                  —Fully
      vested and exercisable — end of year
                  
                  
                  2,057,158
                  
                  
                  
                  22.54
                  
                  
                  
                  17.45
                  
                  
                  
                  4.00
                  
                  
                  
                  205,926
                  
                  
                  
                  2,263,301
                  
                  
                  
                  21.03
                  
                  
                  
                  16.49
                  
                  
                  
                  4.61
                  
                  
                  
                  1,980,053Expected
      to vest — end of year
                  
                  
                  434,467
                  
                  
                  
                  21.88
                  
                  
                  
                  13.71
                  
                  
                  
                  8.65
                  
                  
                  
                  —
                  
                  
                  
                  301,717
                  
                  
                  
                  30.06
                  
                  
                  
                  21.81
                  
                  
                  
                  7.05
                  
                  
                  
                  89,189






For
      the 52 Weeks EndedApril 27,
      2007Options
                  
                  Number
      of Shares
                  
                  
                  Wtd.
      Avg.
                    Exercise
      Price
                  
                  
                  Wtd.
      Avg. Fair Market Value
                  
                  
                  Wtd.
      Avg. Remaining Contractual Term
                  
                  
                  Aggregate
      Intrinsic ValueOutstanding —
      beginning of year
                  
                  
                  6,839,578
                  
                  
                  $
                  20.18
                  
                  
                  $
                  15.54
                  
                  
                  4.39
                  
                  
                  $
                  —Granted
                  
                  
                  156,250
                  
                  
                  
                  22.78
                  
                  
                  
                  11.36
                  
                  
                  —
                  
                  
                  
                  173,443Exercised
                  
                  
                  798,074
                  
                  
                  
                  11.95
                  
                  
                  
                  9.53
                  
                  
                  —
                  
                  
                  
                  7,221,524Forfeited
                  
                  
                  497,481
                  
                  
                  
                  25.72
                  
                  
                  
                  19.34
                  
                  
                  —
                  
                  
                  
                  —Expired
                  
                  
                  230,910
                  
                  
                  
                  27.91
                  
                  
                  
                  21.20
                  
                  
                  —
                  
                  
                  
                  —Outstanding —
      end of year
                  
                  
                  5,469,363
                  
                  
                  
                  20.62
                  
                  
                  
                  15.72
                  
                  
                  
                  4.47
                  
                  
                  
                  —Fully
      vested and exercisable — end of year
                  
                  
                  4,329,499
                  
                  
                  
                  18.72
                  
                  
                  
                  14.45
                  
                  
                  
                  3.61
                  
                  
                  
                  21,610,813Expected
      to vest — end of year
                  
                  
                  979,820
                  
                  
                  
                  28.25
                  
                  
                  
                  20.74
                  
                  
                  
                  7.81
                  
                  
                  
                  1,480,270





The
following table lists the assumptions used to estimate the grant date fair
market value of our stock option grants for the 52 weeks ended April 24,
2009, April 25, 2008 and April 27, 2007:





Per FAS
      123(R)For
      the 52 Weeks EndedApril 24,
      2009
                
                April 25,
      2008
                
                April 27,
      2007Dividend
      Yield
                —
                
                —
                
                —Risk-free
      interest rate — based on grant date
                1.49%
      - 4.52%
                
                N/A
                
                4.51%
      - 5.23%Expected
      option term — in years per group of employees
                4.10
      - 6.66
                
                N/A
                
                4.98
      - 6.96Implied
      volatility at grant date
                50.88%
      - 55.89%
                
                N/A
                
                32.10%
      - 54.47%Discount
      for post-vesting restrictions
                N/A
                
                N/A
                
                N/AOption
      price
                Closing
      price on last trading day prior to date of grant through August 18, 2008,
      after that, closing price on date of grant
                
                N/A
                
                Closing
      price on last trading day prior to date of grantGrant
      price
                Closing
      price on date of grant
                
                N/A
                
                Closing
      price on date of grant








F-17


Table of Contents








Total
compensation cost for the 52 weeks ended April 24, 2009 for the stock
options was approximately $5.4 million. As of April 24, 2009, there
was approximately $6.0 million of unrecognized compensation cost related to
unvested stock options that are expected to vest over a weighted-average period
of 3.65 years.  Total compensation cost for the 52 weeks
ended April 25, 2008 for the stock options was approximately
$7.5 million. As of April 25, 2008, there was approximately
$6.6 million of unrecognized compensation cost related to unvested stock
options that was expected to vest over a weighted-average period of
2.06 years. Total compensation cost for the 52 weeks ended
April 27, 2007 for the stock options was approximately $15.6 million.
As of April 27, 2007, there was approximately $20.3 million of
unrecognized compensation cost related to unvested stock options which was
expected to vest over a weighted-average period of 2.81 years.





During
the 52 weeks ended April 24, 2009, April 25, 2008 and April 27, 2007,
stock options with a fair market value of $5.3 million, $7.6 million and
$19.7 million vested, respectively.





Cash
received from option exercises under all stock-based payment arrangements for
the 52 weeks ended April 24, 2009, April 25, 2008 and April 27, 2007
was approximately $4.3 million, $6.4 million and $9.5 million,
respectively. Cash received from Employees’ Stock Purchase Plan for the
52 weeks ended April 24, 2009, April 25, 2008 and April 27, 2007 was
approximately $25,000, $42,000 and $0.2 million, respectively. We did not
settle any equity instruments granted under stock-based payment arrangements for
cash for any of the periods presented herein.





Restricted Stock, Restricted Stock
Units and Other Stock-Based Awards.  We may grant restricted
stock, restricted stock units or stock awards to directors, officers and key
employees which have no purchase cost to the grantee. Nonvested stock entitles
the grantees to dividends, if any, and voting rights for their respective
shares. Sale or transfer of the shares is restricted until they are vested.
Typically, grants are service-based and vest ratably over four or five years or
cliff vest in three years, as required under the agreement establishing the
grant. Compensation cost is expensed ratably over the service period. Generally,
the fair market value of restricted stock is determined for accounting purposes
using the market closing price on the grant date. We may also grant restricted
stock subject to performance or market conditions that can vest based on the
satisfaction of the conditions of the grant.  The fair market value
and derived service period of market condition-based grants is determined using
the Monte Carlo simulation method. The derived service period for
performance-based grants is estimated based on our judgment of likely future
performance. The Monte Carlo simulation method is subject to variability as
several factors utilized must be estimated, including the derived service
period, which is estimated based on our judgment of likely future performance,
and our stock price volatility. We issue new shares for the granting of
restricted stock. As of
June 8, 2009, we could be obligated to repurchase from our executive officers as
many as approximately 195,000 shares of our common stock within the period
ending September 10, 2012 to permit the executive officers to meet their minimum
statutory tax withholding requirements on vesting of their restricted
stock.




During
fiscal year 2008, we executed restricted stock agreements with Daniel J. Moore
as President and CEO, Gregory H. Browne as Vice President, Finance and CFO and
James A. Reinstein as Vice President, Sales and Marketing and General Manager,
International. Under the terms of their employment agreements, Messrs. Moore,
Browne and Reinstein received 125,000, 30,000 and 50,000 performance-based
shares, respectively, with the performance conditions agreed upon by the
respective individuals and the Compensation Committee of our Board of
Directors.  The restricted stock agreements provide that the shares
are subject to forfeiture unless, within the five-year period commencing on the
date of the grant, the following conditions (the "Forfeiture Conditions") are
met:





F-18


Table of Contents








—
              As
      to 25% of the shares, the following two conditions were met and the shares
      issued during the third quarter of fiscal year 2009: (a) our cumulative
      net earnings in accordance with U.S. Generally Accepted Accounting
      Principles ("GAAP") and before extraordinary items ("Net Income") for four
      consecutive fiscal quarters exceeds a specified target amount, and (b) our
      Net Income for the fourth of such four consecutive fiscal quarters exceeds
      a specified target amount;—
              As
      to 25% of the shares, the following condition was met and the shares are
      expected to be issued during the first quarter of fiscal year 2010: the
      sum of four consecutive fiscal quarters of our net sales exceeds the sum
      of the previous four consecutive fiscal quarters of net sales, commencing
      after fiscal 2007, by a specified target percentage;—
              As
      to 25% of the shares, for a fiscal year after fiscal 2008, the following
      three conditions are to be met: (a) our net sales amount grows by not less
      than a specified target percentage over the net sales amount for the prior
      fiscal year, (b) our earnings per share amount on a fully diluted basis,
      in accordance with GAAP and before extraordinary items ("Earnings Per
      Share"), grows by not less than a specified target percentage, which must
      be higher on a percentage basis than our net sales amount growth for the
      same period, over the Earnings Per Share for the prior fiscal year, and
      (c) the sum of the percentages for net sales amount growth and Earnings
      Per Share growth is equal to or greater than a specified target
      percentage; provided that, for the prior fiscal year against which
      performance of conditions (a), (b), and (c) are measured, we report
      Earnings Per Share in excess of a specified target amount;
    and—
              As
      to 25% of the shares, the following condition is to be met: the 65-day
      moving average of the closing price of our common stock, as adjusted for
      any splits and as reported by NASDAQ or another exchange acceptable to the
      Compensation Committee, exceeds a specified target
  price.





Calculation
of the associated non-cash compensation expense requires judgment as to several
factors, including timing and likelihood of achieving both profitability and
revenue growth. With respect to those shares issued with vesting dependent on
achievement of a certain stock price, we utilize a Monte Carlo simulation for
establishing the appropriate fair value and derived service period. The
calculation of grant date fair market value and derived service period is
subject to variability, as several of the factors used must be estimated,
including stock price volatility of approximately 53% and risk free rate of
approximately 4%.





As of
April 24, 2009, April 25, 2008 and April 27, 2007, our unamortized
compensation expense for grants of restricted stock totaled approximately $5.6
million, $6.7 million and $3.0 million, respectively, which is expected to
be amortized over a weighted average period of 2.18 years, 2.61 years and
4.04 years, respectively. We recognized approximately $4.2 million, $3.6
million and $3.0 million of compensation expense related to grants of
restricted stock during the 52 weeks ended April 24, 2009, April 25, 2008
and April 27, 2007, respectively.








F-19


Table of Contents





The
following table details the activity in the nonvested restricted stock awards
for the 52 weeks ended April 24, 2009, April 25, 2008 and April 27,
2007:





For
      the 52 Weeks EndedApril 24,
      2009
              
              
              April 25,
      2008Number
      of Shares
              
              
              Wtd.Avg.Grant
      Date Fair Value
              
              
              Aggregate
      Intrinsic Value
              
              
              Number
      of Shares
              
              
              Wtd.Avg.
      Grant Date Fair Value
              
              
              Aggregate
      Intrinsic ValueOutstanding —
      beginning of period
              
              
              620,632
              
              
              $
              17.68
              
              
              $
              9,897,294
              
              
              
              144,860
              
              
              $
              29.03
              
              
              $
              3,214,443Granted
              
              
              184,431
              
              
              
              19.73
              
              
              
              2,493,507
              
              
              
              575,100
              
              
              
              16.14
              
              
              
              9,172,845Vested
              
              
              158,710
              
              
              
              18.40
              
              
              
              2,646,668
              
              
              
              60,623
              
              
              
              25.39
              
              
              
              967,830Forfeited
              
              
              27,057
              
              
              
              18.53
              
              
              
              365,811
              
              
              
              38,705
              
              
              
              24.97
              
              
              
              617,345Outstanding —
      end of period
              
              
              619,296
              
              
              
              18.07
              
              
              
              8,372,882
              
              
              
              620,632
              
              
              
              17.68
              
              
              
              9,897,294





For
      the 52 Weeks EndedApril 27,
      2007Number
      of Shares
              
              
              Wtd.Avg.Grant
      Date Fair Value
              
              
              Aggregate
      Intrinsic ValueOutstanding —
      beginning of period
              
              
              270,889
              
              
              $
              36.10
              
              
              $
              6,011,027Granted
              
              
              52,500
              
              
              
              20.89
              
              
              
              1,164,975Vested
              
              
              150,220
              
              
              
              37.75
              
              
              
              3,333,382Forfeited
              
              
              28,309
              
              
              
              35.29
              
              
              
              628,177Outstanding —
      end of period
              
              
              144,860
              
              
              
              29.03
              
              
              
              3,214,443





Employee Stock Purchase
Plan.  Under the 1991 Employee Stock Purchase Plan (“Stock
Purchase Plan”), 950,000 shares of our common stock have been reserved for
issuance. Subject to certain limits, the Stock Purchase Plan allows eligible
employees to purchase shares of our common stock through payroll deductions of
up to 15% of their respective current compensation at a price equaling 95% of
the fair market value of our common stock on the last business day of the
purchase period. Purchase periods are six months in length and begin on the
first business days of June and December. At April 24, 2009, 409,419 shares
remain available for future issuances under the Stock Purchase Plan. No
compensation expense is recorded for the Stock Purchase Plan.





Modifications.   In
fiscal year 2007, the Audit Committee of our Board of Directors concluded that
certain stock options were issued at prices that were not consistent with the
fair market value applicable on the date of grant. Section 409A of the Internal
Revenue Code (“IRC”) imposes an excise tax and interest penalties on a grantee’s
gain from the exercise of a stock option granted with an exercise price less
than the fair market value of the common stock on the date of the grant. The
excise tax applies only to that portion of a grant that vests after December 31,
2004; however, any grants that vested after December 31, 2004 and were exercised
on or before December 31, 2005 are exempt from the excise tax.  The
regulations under Section 409A of the IRC permitted a grantee to avoid the
excise tax by adjusting the exercise price for an affected grant up to the fair
market value on the date of the grant. In July 2007, we closed a tender offer to
the employees who had stock options that were subject to the excise tax and
interest penalties under Section 409A of the IRC.  As a result of the
tender offer, we replaced or amended 225 grants of approximately 133 employees
impacting options to purchase approximately 370,000 shares at a total cost of
approximately $570,000, of which approximately $288,000 represented additional
expense that was recorded during fiscal year 2008. All commitments related to
the tender offer have been paid, and we had no outstanding liabilities as of
April 24, 2009 or April 25, 2008.





Stock Recognition
Program.  In May 1992, our Board of Directors established the
Cyberonics Employee Stock Recognition Program. Since its inception, a total of
8,200 shares of our common stock have been reserved for issuance as special
recognition grants. The shares are granted to employees for special performances
and/or contributions at the discretion of our President, based on nominations
made by fellow employees. At April 24, 2009, 2,230 shares remain
available for future issuances under the program.





F-20


Table of Contents





Note 10.  New
Accounting Pronouncements





In
September 2006, the FASB issued FAS No. 157, “Fair Value Measurements”
(“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring
fair value in U.S. GAAP and expands disclosures about fair value measurements.
FAS 157 applies under other accounting pronouncements that require or permit
fair value measurements, the FASB having previously concluded in those
accounting pronouncements that fair value is the relevant measurement attribute.
Accordingly, FAS 157 does not require any new fair value measurements. However,
for some entities, the application of FAS 157 will change current practice.
FAS 157 is effective with fiscal years beginning after November 15,
2007. In February 2008, the FASB issued Staff Position,“FSP FAS 157-2 – Effective date of
FAS No. 157” (“FAS 157-2”).  FAS 157-2 defers the effective
date of FAS 157 to fiscal years beginning after November 15, 2008, and interim
periods within those fiscal years for nonfinancial assets and nonfinancial
liabilities, except for items that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually). In October
2008, the FASB issued Staff Position, “FSP FAS 157-3 to clarify the application
of FAS 157 in an inactive market. Our implementation of FAS 157 as of April 26,
2008 did not have an impact in our consolidated results of operations and
financial position for the fiscal year 2009.





In
December 2007, the FASB issued FAS No. 160“Noncontrolling Interests in
Consolidated Financial Statements (as amended)” (“FAS 160”). FAS 160 will
require noncontrolling interests (previously referred to as minority interests)
to be treated as a separate component of equity, rather than as a liability or
other item outside of permanent equity. FAS 160 applies to the accounting for
noncontrolling interests and transactions with noncontrolling interest holders
in consolidated financial statements. FAS 160 is effective for fiscal years, and
interim periods within those fiscal years beginning on or after December 15,
2008. The adoption of this Statement is not expected to have a material impact
on our consolidated results of operations and financial position.





In
December 2007, the FASB issued FAS No. 141(R)“Business Combinations”
(“FAS 141(R)”). FAS 141(R) required most identifiable assets, liabilities,
noncontrolling interests, and goodwill acquired in a business combination to be
recorded at “full fair value.” FAS 141(R) applies to all business combinations,
including combinations among mutual entities and combinations by contract alone.
Under FAS 141(R), all business combinations will be accounted for by applying
the acquisition method. FAS 141(R) applies prospectively to business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008. The
adoption of FAS 141(R) is expected to have a significant impact on our
accounting for future business combinations after April 24, 2009.





In March
2008, the FASB issued FAS No. 161 “Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No. 133”(“FAS 161”). FAS 161 amends FAS 133, “Accounting for Derivative
Instruments and Hedging Activities” (“FAS 133”), and requires companies
with derivative instruments to disclose information about how and why a company
uses derivative instruments, how derivative instruments and related hedged items
are accounted for under FAS 133, and how derivative instruments and related
hedged items affect a company’s financial positions, financial performance and
cash flows. The required disclosures include the fair value of derivative
instruments and their gains or losses in tabular format, information about
credit-risk-related contingent features in derivative agreements, counterparty
credit risk, and the company’s strategies and objectives for using derivative
instruments. FAS 161 expands the current disclosure framework in FAS 133. FAS
161 is effective prospectively for fiscal years and interim periods beginning
after November 15, 2008. Our adoption of FAS 161 on January 25, 2009 had no
affect on our consolidated results of operations and financial
position.





In May
2008, the FASB issued Financial Staff Position (“FSP”) APB 14-1,“Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement)” (“FSP APB 14-1”). The FSP requires issuers of convertible
debt that may be settled wholly or partly in cash to account for the debt and
equity components separately.  The FSP is effective for financial
statements issued for fiscal years beginning after December 15, 2008 and interim
periods within those years, and must be applied retrospectively to all periods
presented.  The adoption of FSP APB 14-1 is not expected to have a
material impact on our consolidated results of operations and financial
position.





F-21


Table of Contents





In June
2008, the FASB issued EITF No. 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities”
(“EITF 03-6-1”). EITF 03-6-1 requires unvested share-based payment awards that
contain non-forfeitable rights to dividends to be treated as participating
securities for purposes of determining basic earnings per share (“EPS”) as
defined in EITF Issue No. 03-6, “Participating Securities and the Two-Class
Method under FASB Statement No. 128”. EITF 03-6-1 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those years.  Upon adoption, all previously
reported EPS data, including interim financial statements, summaries of
earnings, and selected financial data should be adjusted retrospectively to be
in conformance with the requirements of the FSP.  We are currently
evaluating the impact that the implementation of EITF 03-6-1 may have on our
consolidated results of operations and financial position for fiscal year
2010.





In June
2009, the FASB issued FAS No. 165 “Subsequent Events”(“FAS 165”). FAS 165
requires companies to recognize in the financial statements the effects of
subsequent events that provide additional evidence about conditions that existed
at the date of the balance sheet, including the estimates inherent in the
process of preparing financial statements. An entity shall disclose the date
through which subsequent events have been evaluated, as well as whether that
date is the date the financial statements were issued.  Companies are
not permitted to recognize subsequent events that provide evidence about
conditions that did not exist at the date of the balance sheet but arose after
the balance sheet date and before financial statements are issued. Some
nonrecognized subsequent events must be disclosed to keep the financial
statements from being misleading.  For such events a company must
disclose the nature of the event, an estimate of its financial effect, or a
statement that such an estimate cannot be made. This Statement applies
prospectively for interim or annual financial periods ending after June 15,
2009. The adoption of FAS 165 is not expected to have a material impact on our
consolidated results of operations and financial position.





Note 11.  Income
Taxes





The
U.S. and foreign components of income (loss) before income taxes and the
provision for income taxes are presented in this table:





52
      Weeks EndedApril 24,
      2009
              
              April 25,
      2008
              
              April 27,
      2007Income
      (loss) before income taxes:Domestic
              
              $
              29,190,583
              
              
              $
              (8,627,510
              )
              
              $
              (48,172,762
              )Foreign
              
              
              (1,740,522
              )
              
              
              (1,972,092
              )
              
              
              (2,928,570
              )$
              27,450,061
              
              
              $
              (10,599,602
              )
              
              $
              (51,101,332
              )Provision
      for current income tax expense:Federal
              
              $
              384,005
              
              
              $
              64,721
              
              
              $
              —State
      and local
              
              
              254,785
              
              
              
              68,440
              
              
              
              27,790Foreign
              
              
              80,847
              
              
              
              27,947
              
              
              
              50,985$
              719,637
              
              
              $
              161,108
              
              
              $
              78,775Provision
      for deferred income tax expense (benefit):Federal
              
              $
              —
              
              
              $
              —
              
              
              $
              —State
      and local
              
              
              9,804
              
              
              
              (425,945
              )
              
              
              —Foreign
              
              
              —
              
              
              
              —
              
              
              
              —$
              9,804
              
              
              $
              (425,945
              )
              
              $
              —Total
      tax provision
              
              $
              729,441
              
              
              $
              (264,837
              )
              
              $
              78,775








F-22


Table of Contents





The
following is a reconciliation of the statutory federal income tax rate to our
effective income tax rate expressed as a percentage of income (loss) before
income taxes:





For
      the 52 Weeks EndedApril 24,
      2009
              
              April 25,
      2008
              
              April 27,
      2007U.S. statutory
      rate
              
              
              34.0
              %
              
              
              (34.0
              )%
              
              
              (34.0
              )%Change
      in deferred tax valuation allowance excluding impact of
      shortfall
              
              
              (34.1
              )
              
              
              29.1
              
              
              
              30.2Federal
      income tax provision (1)
              
              
              1.4
              
              
              
              0.6
              
              
              
              —Shortfall
      on settlement of options and restricted stock
              
              
              2.4
              
              
              
              30.8
              
              
              
              1.8Reduction
      in valuation allowance due to shortfall
              
              
              (2.4
              )
              
              
              (30.8
              )
              
              
              (1.8
              )Foreign
      taxes
              
              
              0.3
              
              
              
              0.3
              
              
              
              0.1State
      and local tax provision
              
              
              1.0
              
              
              
              (3.4
              )
              
              
              0.1Other,
      net
              
              
              0.1
              
              
              
              4.9
              
              
              
              3.8Effective
      tax rate
              
              
              2.7
              %
              
              
              (2.5
              )%
              
              
              0.2
              %





(1)
            Federal
      income tax provision for fiscal years 2009 and 2008 consist of federal
      alternative minimum income tax.





Significant
components of our deferred tax assets are as follows:





April
      24, 2009
              
              April
      25, 2008Deferred
      tax assetsFederal
      net operating loss carryforwards
              
              $
              71,237,626
              
              
              $
              79,255,912State
      net operating loss carryforwards and other
              
              
              9,088,757
              
              
              
              9,577,159Deferred
      compensation expense
              
              
              9,269,588
              
              
              
              8,028,569Convertible
      Notes
              
              
              1,965,551
              
              
              
              —Foreign
      net operating loss carryforwards
              
              
              8,512,810
              
              
              
              7,920,487Licensing
      income
              
              
              2,430,857
              
              
              
              2,916,924Charitable
      contribution carryforwards
              
              
              1,928,277
              
              
              
              1,698,856Accrued
      expenses
              
              
              837,935
              
              
              
              640,963Property
      and equipment
              
              
              652,735
              
              
              
              604,458Inventory
      costs capitalized
              
              
              597,062
              
              
              
              537,162Reserves
              
              
              318,775
              
              
              
              192,304Federal
      alternative minimum tax credit carryforward
              
              
              577,750
              
              
              
              95,650Total
      deferred tax assets
              
              
              107,417,723
              
              
              
              111,468,444Deferred
      tax liabilities, net
              
              
              —
              
              
              
              —Deferred
      tax valuation allowance
              
              
              (107,001,582
              )
              
              
              (111,042,499
              )Net
      deferred tax assets
              
              $
              416,141
              
              
              $
              425,945





At
April 24, 2009, we have net operating loss carryforwards of approximately
$234.2 million for federal income tax purposes, expiring during fiscal
years 2011 through 2027, and tax credit carryforwards of approximately
$4.3 million for federal income tax purposes, of which $3.7 million is
unrecognized tax benefit, expiring during fiscal years 2010 through 2017. At
April 24, 2009, we have net operating loss carryforwards of approximately
$90.5 million for state and local income tax purposes, expiring at various
dates beginning in fiscal year 2010.  In the past we have experienced
ownership changes as defined in Section 382 of the Internal Revenue Code
(“IRC”), and most recently we experienced an ownership change in August 2006. As
a result, our ability to utilize certain net operating losses to offset future
taxable income may be limited. Due to our operating loss history and the
possible limitations pursuant to Section 382 of the IRC, we have established a
valuation allowance that fully offsets our net federal deferred tax assets,
including those related to the tax loss credit carryforwards, resulting in no
regular U.S. federal income tax expense or benefit for financial
reporting  purposes.








F-23


Table of Contents





A
valuation allowance is established if it is more likely than not that all or a
portion of the deferred tax assets will not be realized. We have historically
experienced significant operating losses and operate in an industry subject to
rapid technological changes. We believe there is sufficient uncertainty
regarding future taxable income and realizability of deferred tax assets such
that a valuation allowance is required to fully offset deferred tax assets for
the 52 weeks ended April 24, 2009, except for the Texas Temporary
Credit for Business Loss Carryforwards discussed below. We continually review
the adequacy and necessity of the valuation allowance in accordance with the
provision of SFAS No. 109 “Accounting for Income Taxes.”Of the total
valuation allowance at April 24, 2009, approximately $20.8 million
relates to stock option compensation deductions and $10.9 million relates
to amortization of the Note Hedge prior to termination of the Convertible Notes
and Note Hedge synthetic debt instrument on May 6, 2008. The tax benefit
associated with stock option compensation deductions and the Note Hedge
amortization will be credited to equity when realized. The valuation allowance
decreased by approximately $4.0 million for the 52 weeks ended April 24, 2009,
due primarily to the utilization of federal net operating loss carryforward. The
valuation allowance decreased approximately $3.1 million for the 52 weeks ended
April 25, 2008, due primarily to the utilization of federal net operating loss
carryforward and the increase in deferred tax benefit for licensing income. In
fiscal years 2009, 2008 and 2007, the effect of tax shortfall on settlement of
options and restricted stock is reflected in the rate reconciliation with the
concurrent and offsetting reduction in the valuation allowance.





In
connection with the issuance of our Convertible Notes as disclosed in “Note 6.
Convertible Notes,” for tax purposes the Convertible Note and the Note Hedge are
considered a synthetic debt instrument under the rules of Treas. Reg. Section
1.1275-6. Tax benefits derived from amortization of the cost of the Note Hedge
are recorded in equity.  In April 2008, the parties to the Indenture
executed the Supplemental Indenture under which we agreed to repurchase for cash
at par value any note tendered in December 2011, nine months ahead of the
maturity date under the Indenture.  On May 5, 2008, MLI delivered to
us a notice asserting that the Note Hedge was terminated effective May 6, 2008
in accordance with the terms of the original Hedge Agreement. According to the
notice the Supplemental Indenture gave rise to a right of
termination.  The termination of the Note Hedge has been treated as a
termination of the Convertible Notes and Note Hedge as a synthetic debt
instrument pursuant to Treas. Reg. Section 1.1275-6(d)(2).





Effective
April 28, 2007, we adopted FASB Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes" ("FIN 48").  This interpretation clarifies the
criteria for recognizing income tax benefits under FASB Statement No. 109, "Accounting for Income
Taxes," and requires additional disclosures about uncertain tax
positions.  Under FIN 48, the financial statement recognition of the
benefit for a tax position is dependent upon the benefit being
more-likely-than-not to be sustainable upon audit by the applicable taxing
authority.  If this threshold is met, the tax benefit is then measured
and recognized at the largest amount that is greater than 50 percent likely of
being realized upon ultimate settlement.





The
following is a roll forward of our total gross unrecognized tax benefit for
fiscal year 2009 (in thousands):





52
      Weeks EndedApril
      24, 2009
                    
                    April
      25, 2008Balance
      at beginning of year
                    
                    $
                    (5,244
                    )
                    
                    $
                    (5,562
                    )Tax
      positions related to current year
                    
                    
                    —
                    
                    
                    
                    —Tax
      positions related to prior years:Reductions
      for tax positions related to lapses of statute of
    limitations:Credits
                    
                    
                    198
                    
                    
                    
                    198Imputed
      interest on overseas payments
                    
                    
                    —
                    
                    
                    
                    109Change
      in effective tax rate (federal and state)
                    
                    
                    38
                    
                    
                    
                    11Balance
      at end of year
                    
                    $
                    (5,008
                    )
                    
                    $
                    (5,244
                    )





The
unrecognized tax benefit of $5.6 million, at adoption, includes no uncertain tax
positions that would impact our effective tax rate, if
recognized.  The application of FIN 48 would have resulted in a
decrease in retained earnings of $5.6 million; however, the decrease was fully
offset by a decrease in the related valuation allowance.





F-24


Table of Contents





We expect
that the amount of unrecognized tax benefits will decrease by approximately $0.2
million in the next 12 months due to expiring credit carryforwards; however, we
do not expect the change to have any impact on our consolidated results of
operations or financial position because of the existence of the valuation
allowance.





Our
policy is to recognize interest and penalties accrued on unrecognized tax
benefits as a component of administrative expense. For the 52 weeks ended April
24, 2009, we did not have any accrued interest or penalties associated with
unrecognized tax benefits.





We had
been under a limited scope audit by the Internal Revenue Service (“IRS”) in
connection with our stock option activity. In October 2008 we received a final
close-out notice from the IRS regarding the examination stating that no changes
to the tax we reported were made. We are subject to income tax examinations for
our U.S. federal income taxes, non-U.S. income taxes and state and local income
taxes for fiscal year 1992 and subsequent years, with certain
exceptions.





In fiscal
year 2008 we recognized a deferred state income tax benefit of approximately
$426,000 for the Texas Temporary Credit for Business Loss Carryforwards. Under
the Texas Margin Tax law, we have the right to claim this credit against the
Texas margin tax liability on an annual basis over a twenty-year
period.  As a result, we have recorded a deferred tax asset of
approximately $416,000 and $426,000, included in Other Assets on our Balance
Sheet as of April 24, 2009 and April 25, 2008, respectively.  This
deferred tax asset is recorded because we believe it is more likely than not
that the asset will be realized based on projections of our future Texas margin
tax liability as this tax is assessed on taxable gross margin and not pretax
income (loss) .





Note 12.  Employee
Retirement Savings Plan





We
sponsor the Cyberonics, Inc. Employee Retirement Savings Plan (the “Savings
Plan”) which qualifies under Section 401(k) of the IRC. The Savings Plan is
designed to provide eligible employees with an opportunity to make regular
contributions into a long-term investment and savings program. Substantially all
U.S. employees are eligible to participate in the Savings Plan beginning
with the first quarterly open enrollment date following the start of their
employment. We match 50% of employees’ contributions up to 6% of eligible
earnings, subject to a five-year vesting period. We incurred expenses applicable
to these contributions of approximately $0.9 million, $0.8 million and
$1.2 million for the fiscal years 2009, 2008 and 2007,
respectively.





Note 13.  Commitments
and Contingencies





Post-market Clinical
Surveillance.  Pursuant to the post-market surveillance
conditions specified as part of our FDA marketing approval, we are required to
conduct two clinical studies on treatment-resistant depression (“TRD”) patients.
One study of 460 patients, the dosing study, is a randomized controlled
study assessing three different stimulation paradigms. The other study, the TRD
registry, is a longitudinal registry that will follow 500 VNS patients and 500
non-VNS patients for up to five years. We expense the costs related to these
long-term follow-up activities as they are incurred and establish accruals for
such costs incurred but not paid as of the respective balance sheet
dates.  Since fiscal year 2006 when the studies were initiated to the
end of fiscal year 2009, we have incurred direct expenses of approximately $7.5
million for the dosing study and $2.6 million for the TRD registry. In November
2008, we submitted an amendment to the protocol of the TRD patient dosing study
to the FDA.  We are requesting a reduction in the number of study
subjects from 460 to 330, a level that was reached in February
2009.  We have suspended further patient enrollment while we wait for
the FDA’s decision. Based on a reassessment of the study power and size, we
believe that this proposal maintains appropriate study power.  In
April 2009, the FDA requested additional information on the proposed change in
sample size which we submitted in May 2009.  We do not know when to
expect a decision from the FDA.





F-25


Table of Contents





License
Agreements.  We have executed a license agreement that provides
us with worldwide exclusive rights under five U.S. patents (and their
international counterparts) covering the method and devices of the VNS Therapy
System for vagus nerve and other cranial nerve stimulation for the control of
epilepsy and other movement disorders, as well as a number of other conditions
and disorders. The license agreement provides that we will pay a royalty equal
to the greater of $36,000 per year or 3% of net sales of licensed products
during fiscal years 2004 through 2011, after which the royalty rate will decline
to one percent for the remaining term of the licensed patents. These patents
expire between 2011 and 2022. The license agreement runs for successive
three-year terms, renewable at our election. The license agreement, and its
periods of extension, may not be terminated by the licensor without cause. Our
royalty payments pursuant to this agreement are expensed as incurred. Effective
December 17, 2007, we entered into a license agreement granting an exclusive
license to a third party under certain patents and patent applications
pertaining to weight reduction, hypertension or diabetes in exchange for an
up-front, non-refundable payment of $9.5 million, plus a royalty on future
commercial sales of any product covered by the licensed patents.  We
retained the responsibility to prosecute the licensed patent applications and to
maintain the licensed patents, including the obligation to pay related expenses
for U.S. patents and applications.  We estimate that our obligation to
prosecute the licensed patent applications will be satisfied by the end of April
2014.  Accordingly, we are recognizing the $9.5 million up-front
payment on a straight-line basis from the date of execution of the agreement to
April 2014. The unrecognized portion of the $9.5 million up-front payment
is included in other long-term liabilities on the consolidated balance sheet as
of April 24, 2009.





Royalty
expenses for the 52 weeks ended April 24, 2009, April 25, 2008 and
April 27, 2007 were $4.2 million, $3.6 million and $3.8 million,
respectively.





Lease
Agreements.  We lease facilities in Houston, Texas and several
sales offices in Europe, as well as transportation and office equipment, under
noncancelable operating leases. In the third quarter of fiscal year 2008, we
abandoned a portion of our leased facilities in Houston and recorded a liability
of approximately $248,000 representing the net present value of the minimum
lease payments applicable to the surrendered square footage, offset by the net
present value of the estimated proceeds from the sub-lease of the space
surrendered.  During the thirteen weeks ended October 24, 2008, we
reduced our estimate of the net present value of the proceeds from sub-leasing
by approximately $70,000 and charged operating expenses for the change in
estimate.  The net present value of our future lease obligations
related to the space surrendered as of April 24, 2009 is approximately $427,000,
partially offset by the net present value of the estimated proceeds from the
sublease of the space surrendered of approximately $357,000.   We
recorded a net expense related to the surrendered space of $82,000 and $ 83,000
for fiscal years 2009 and 2008, respectively.





At April
24, 2009 and April 25, 2008 we had no deferred rent; at April 27, 2007
we had approximately $152,000 of deferred rent. Scheduled rent increases and
rent holidays are recognized on a straight-line basis over the term of the
lease.





Future
minimum payments relating to these agreements at April 24, 2009 are as
follows:





52/53
      Weeks Ending on the last Friday of April:2010
                
                $
                3,294,1952011
                
                
                2,942,0212012
                
                
                2,845,5142013
                
                
                2,789,5492014
                
                
                2,837,448Thereafter
                
                
                1,907,950





Our
rental expense for the 52 weeks ended April 24, 2009, April 25, 2008
and April 27, 2007 amounted to approximately $3.3 million,
$3.0 million and $3.2 million, respectively.





F-26


Table of Contents





Distribution
Agreements.At April 24, 2009, we had 52 distribution
agreements with independent distributors that grant the distributor the right to
distribute our products in designated territories located in Canada, Mexico,
Central and South America, Asia, Japan, Australia, the Middle East and parts of
Europe. The distribution agreements generally grant the distributor exclusive
rights for the designated territory for a specified period of time, generally
one to three years. Under the terms of the agreement, we may be required to
compensate the distributor in the event that the agreement is terminated by us
or is not renewed upon expiration.





Other
Commitments.  We have agreements whereby we indemnify our
officers and directors for certain events or occurrences while the officer or
director is, or was, serving at our request in such a capacity. The term of the
indemnification period is for the officer’s or director’s lifetime. The maximum
potential amount of future payments we could be required to make under these
indemnification agreements is unlimited; however, we believe the fair value of
these indemnification agreements is not estimable.





At
April 24, 2009, we had approximately $0.2 million in noncancelable
commitments related to domestic marketing programs planned for our VNS Therapy
System and royalty agreements during fiscal year 2009.





Note 14.  Litigation





We are
named as a defendant in lawsuits or are the subject of governmental inquires
from time to time arising in the ordinary course of business. The outcome of
such lawsuits or other proceedings cannot be predicted with certainty and may
have a material adverse effect on our consolidated financial position or results
of operations.





Securities
Class Action Lawsuit





As
previously disclosed in our 2008 Form 10-K, the consolidated securities
litigation styled In re
Cyberonics, Inc. Securities Litigation, Civil Action No. H-05-2121, was
dismissed with prejudice by the federal district court in Houston, Texas in
October 2007. The U.S. Court of Appeals for the Fifth Circuit affirmed the
district court's dismissal with prejudice in September 2008. The plaintiffs
elected not to petition the U.S. Supreme Court for a writ of certiorari and,
accordingly, the matter is concluded.





Governmental
Investigation of Options Granting Practices





In
June 2006, the staff of the SEC advised us that it had commenced an
informal inquiry of some of our stock option grants, and we received a subpoena
from the Office of the U.S. Attorney for the Southern District of New York
requesting documents related to our stock option grants practices and
procedures. In October 2006, the SEC staff made an additional request for
certain documents and information related to our revised guidance on
February 8, 2006 and our financial results announced on May 1, 2006,
our sales for the quarter ended April 28, 2006, coverage or potential
coverage of our VNS Therapy System by BlueCross BlueShield of Alabama and Aetna
and aging of our accounts receivable since January 1, 2003. We are
cooperating with the SEC staff and the U.S. Attorney’s Office.





At the
direction of our Board, our Audit Committee, with the assistance of its
independent counsel and counsel’s forensic accountants, completed a review of
our stock option grants, practices and procedures, including compliance with
U.S. GAAP and all applicable statutes, rules and regulations. Our Audit
Committee concluded that incorrect measurement dates were used for certain stock
option grants made principally during the period from 1998 through 2003. Based
on our Audit Committee’s investigation, subsequent internal analysis and
discussions with our independent registered public accountants, our Board
concluded on November 18, 2006, that we needed to restate certain of our
historical consolidated financial statements to record non-cash charges for
compensation expense relating to past stock option grants. The effects of these
restatements are reflected in the consolidated financial statements, including
unaudited quarterly data. None of the restatements had any impact on net cash
provided by (used in) operating activities.





F-27


Table of Contents





Note 15.  Concentrations





Our cash
equivalents and trade accounts receivable represent potential concentrations of
credit risk.





We
minimize potential concentrations of credit risk in cash equivalents by placing
investments in high quality financial instruments and, as required by our
corporate investment policy, limiting the amount of investment in any one
issuing party. At April 24, 2009, management believes that we have no
significant concentrations of credit risk related to these assets and have
incurred no material impairments in the carrying values of our cash
equivalents.





Concentrations
of credit risk with respect to trade accounts receivable are limited due to the
large number of customers and their dispersion across a number of geographic
areas. However, essentially all trade receivables are concentrated in the
hospital and healthcare sectors in the U.S. and several other countries
and, accordingly, are exposed to their respective business, economic and
country-specific variables. Although we do not currently foresee a concentrated
credit risk associated with these receivables, repayment is dependent upon the
financial stability of these industry sectors and the respective countries’
national economies and healthcare systems.





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





We rely
upon favorable reimbursement, coverage and coding for VNS Therapy. Essentially
all patients implanted with VNS Therapy for the treatment of epilepsy are
covered by private payers, Medicare or Medicaid. VNS Therapy for epilepsy has
specifically approved codes for physicians, surgeons and hospitals.





Note 16. Re-Negotiation of Leased
Facilities





In
December 2007, we re-negotiated the lease on our premises located at 100
Cyberonics Blvd., Houston Texas, extending the term for 86 months, commencing on
November 1, 2007 and ending on December 31, 2014, and agreeing to surrender the
use of 19,376 square feet of the premises.  In January 2008, we
completed the abandonment of the portion of the leased space that we had agreed
to surrender.  The net present value of our future lease obligations
related to the space surrendered as of April 24, 2009 was approximately
$427,000, partially offset by the net present value of the estimated proceeds
from the sublease of the space surrendered of approximately $357,000. For
surrendered space, an expense for fiscal year 2009, and an accrued liability, as
of April 24, 2009, of approximately $70,000 was recorded.





F-28


Table of Contents





Note 17.  Geographic
Information





Net
      Sales52
      Weeks EndedApril 24,
      2009
                      
                      
                      April 25,
      2008
                      
                      
                      April 27,
      2007United
      States
                      
                      $
                      116,385,898
                      
                      
                      $
                      94,902,720
                      
                      
                      $
                      111,077,666International
                      
                      
                      27,215,081
                      
                      
                      
                      26,327,022
                      
                      
                      
                      19,890,771Total
                      
                      $
                      143,600,979
                      
                      
                      $
                      121,229,742
                      
                      
                      $
                      130,968,437Long-Lived
      AssetsApril 24,
      2009
                      
                      
                      
                      April 25,
      2008
                      
                      
                      
                      April 27,
      2007United
      States
                      
                      $
                      5,398,021
                      
                      
                      
                      5,111,059
                      
                      
                      $
                      7,584,850International
                      
                      
                      214,770
                      
                      
                      
                      392,080
                      
                      
                      
                      443,187Total
                      
                      $
                      5,612,791
                      
                      
                      
                      5,503,139
                      
                      
                      $
                      8,028,037





Sales are
classified according to the country of destination, regardless of the shipping
point.





All
assets located outside of the U.S. are classified as
“International.”





Note 18.  Quarterly
Financial Information — Unaudited





First
                Quarter
              
              
              Second
      Quarter
              
              
              Third
                Quarter
              
              
              Fourth
      Quarter
              
              
              Totals(1)52 weeks
      ended April 24, 2009Net
      sales
              
              $
              33,731,858
              
              
              $
              36,031,971
              
              
              $
              35,259,969
              
              
              $
              38,577,181
              
              
              $
              143,600,979Gross
      profit
              
              
              28,915,096
              
              
              
              30,854,171
              
              
              
              30,325,530
              
              
              
              33,465,546
              
              
              
              123,560,343Net
      income
              
              
              2,052,801
              
              
              
              8,350,202
              
              
              
              9,794,602
              
              
              
              6,523,015
              
              
              
              26,720,620Diluted
      income per share
              
              
              0.08
              
              
              
              0.14
              
              
              
              0.15
              
              
              
              0.22
              
              
              
              0.6152 weeks
      ended April 25, 2008Net
      sales
              
              $
              29,075,469
              
              
              $
              28,946,696
              
              
              $
              29,315,933
              
              
              $
              33,891,644
              
              
              $
              121,229,742Gross
      profit
              
              
              23,523,702
              
              
              
              24,370,592
              
              
              
              24,245,263
              
              
              
              27,997,811
              
              
              
              100,137,368Net
      income (loss)
              
              
              (8,163,463
              )
              
              
              (4,077,340
              )
              
              
              (997,316
              )
              
              
              2,903,354
              
              
              
              (10,334,765
              )Basic
      and diluted income (loss) per share
              
              
              (0.31
              )
              
              
              (0.15
              )
              
              
              (0.04
              )
              
              
              0.11
              
              
              
              (0.39
              )


__________





(1)
            EPS
      in each quarter is computed using the weighted-average number of shares
      outstanding during that quarter while EPS for the full year is computed
      using the weighted-average number of shares outstanding during the year.
      Thus, the sum for the four quarters’ EPS does not necessarily equal the
      full year EPS.





F-29


Table of Contents





INDEX
to EXHIBITS





The
exhibits marked with the asterisk symbol (*) are filed or furnished (in the case
of Exhibit 32.1) with this Form 10-K. The exhibits marked with the cross
symbol (†) are management contracts or compensatory plans or arrangements filed
pursuant to Item 601(b)(10)(iii) of Regulation S-K.  The
exhibits marked with the pound symbol (#) have been redacted and are the subject
of an application for confidential treatment filed with the SEC pursuant to Rule
24b-2 of the general rules and regulations promulgated under the Exchange
Act.





Exhibit
                  Number
                Document
      Description
                
                Report
      or Registration Statement
                SEC
      File or
                  Registration
                  Number
                Exhibit
                  Reference3.1
                Amended
      and Restated Certificate of Incorporation of Cyberonics,
    Inc.
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-3 filed on February 21,
      2001
                333-56022
                3.13.2
                Amended
      and Restated Bylaws of Cyberonics, Inc.
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 26,
2007
                000-19806
                3.2(i)4.1
                Second
      Amended and Restated Preferred Shares Rights Agreement dated August 21,
      2000 between Cyberonics, Inc. and BankBoston, N.A. (formerly known as The
      First National Bank of Boston), including the Form of First Amended
      Certificate of Designation of Rights, Preferences and Privileges of Series
      A Participating Preferred Stock of Cyberonics, Inc., Form of Rights
      Certificate and Stockholder Rights Plan attached thereto as Exhibits A, B
      and C, respectively
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on September 12,
    2000
                000-19806
                4.14.2
                Amendment
      No. 1 to Second Amended and Restated Preferred Share Rights Agreement
      dated April 26, 2001
                
                Cyberonics,
      Inc.’s Annual Report and Transition Report on Form 10-K for the fiscal
      period ended April 27, 2001 and the transition period from July 1, 2000 to
      April 27, 2001
                000-19806
                4.24.3
                Amendment
      No. 2 to Second Amended and Restated Preferred Share Rights Agreement
      dated October 31, 2001
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 30, 2004
                000-19806
                4.34.4
                Amendment
      No. 3 to Second Amended and Restated Preferred Share Rights Agreement
      dated December 9, 2003
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 12,
    2003
                000-19806
                99.24.5
                Amendment
      No. 4 to Second Amended and Restated Preferred Share Rights Agreement
      dated January 9, 2004
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on January 13,
2004
                000-19806
                99.24.6
                Amendment
      No. 5 to Second Amended and Restated Preferred Share Rights
      Agreement
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on February 1,
2007
                000-19806
                4.14.7
                Indenture
      dated September 27, 2005 between Cyberonics, Inc. and Wells Fargo Bank,
      National Association, as Trustee
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 3, 2005
                000-19806
                10.14.8
                Supplemental
      Indenture dated April 18, 2008 to the Indenture dated September 27, 2005
      between Cyberonics, Inc. and Wells Fargo Bank, National Association, as
      Trustee
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on April 24, 2008
                000-19806
                10.24.9
                Registration
      Rights Agreement dated September 27, 2005 between Cyberonics, Inc. and
      Merrill Lynch, Pierce, Fenner & Smith Incorporated, as the Initial
      Purchaser
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 3, 2005
                000-19806
                10.24.10
                Form
      of Confirmation of OTC Convertible Note Hedge executed September 21, 2005
      to be effective September 27, 2005
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 3, 2005
                000-19806
                10.3
 
  
 Table of Contents  
 Exhibit
                  Number
                Document
      Description
                
                Report
      or Registration Statement
                SEC
      File or
                  Registration
                  Number
                Exhibit
                  Reference4.11
                Form
      of Confirmation of OTC Warrant Transaction executed September 21, 2005 to
      be effective September 27, 2005
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on October 3, 2005
                000-19806
                10.410.1
                License
      Agreement dated March 15, 1988 between Cyberonics, Inc. and Dr. Jacob
      Zabara
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.110.2
                License
      Agreement dated August 22, 2000 between Cyberonics, Inc. and Dr. Mitchell
      S. Roslin
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.210.3#
                Exclusive
      Patent License Agreement dated December 17, 2007, by and between
      Cyberonics, Inc. and Ethicon Endo-Surgery, Inc.
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended January 25,
      2008
                000-19806
                10.110.4
                Lease
      Agreement dated December 5, 2002 between Cyberonics, Inc., as Lessee, and
      Space Center Operating Associates, LP, as Lessor, commencing on December
      8, 2002 for Space “A” and January 1, 2004 for Space “B,” as amended March
      3, 2003 (First Amendment), October 2, 2003 (Second Amendment), March 11,
      2004 (Third Amendment), March 17, 2004 (Subordination, Non-Disturbance and
      Attornment), March 19, 2004 (Transfer of Ownership to Triple Net
      Properties, LLC), March 23, 2005 (Fourth Amendment), May 5, 2005 (Fifth
      Amendment) and July 13, 2005 (Sixth Amendment)
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.310.5
                Seventh
      Amendment, dated December 28, 2007, to that certain Lease Agreement dated
      December 5, 2002 between Cyberonics, Inc., as Lessee, and Space Center
      Operating Associates, LP, as Lessor
                
                Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                000-19806
                10.510.6
                Eighth
      Amendment, dated March 31, 2008, to that certain Lease Agreement dated
      December 5, 2002 between Cyberonics, Inc., as Lessee, and Space Center
      Operating Associates, LP, as Lessor
                
                Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                000-19806
                10.610.7†
                Cyberonics,
      Inc. Amended and Restated 1996 Stock Option Plan
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on April 29,
      1999
                333-77361
                4.110.8†
                First
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated October 2, 2000
                
                Cyberonics,
      Inc.’s Quarterly Report on
                  Form
      10-Q for the quarter ended September 30, 2000
                000-19806
                10.210.9†
                Second
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated March 21, 2001
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 30, 2004
                000-19806
                10.1210.10†
                Third
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated July 27, 2001
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on January 22,
      2002
                333-81158
                4.410.11†
                Fourth
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated January 2002
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on January 22,
      2002
                333-81158
                4.510.12†
                Fifth
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated July 19, 2002
                
                Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on July 25,
      2002
                333-97095
                4.110.13†
                Form
      of Stock Option Agreement under the Cyberonics, Inc. Amended and Restated
      1996 Stock Option Plan between Cyberonics, Inc. and the executive officers
      listed on the schedule attached thereto
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.69
 
  
 Table of Contents  
 Exhibit
                      Number
                    Document
      Description
                    
                    Report
      or Registration Statement
                    SEC
      File or
                      Registration
                      Number
                    Exhibit
      Reference10.14†
                    Cyberonics,
      Inc. Amended and Restated 1997 Stock Plan
                    
                    Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on March 8,
      2001
                    333-56694
                    4.510.15†
                    First
      Amendment to the Cyberonics, Inc. Amended and Restated 1997 Stock Plan
      dated March 21, 2001
                    
                    Cyberonics,
      Inc.’s Quarterly Report on
                      Form
      10-Q for the quarter ended July 26, 2002
                    000-19806
                    10.110.16†
                    Second
      Amendment to the Cyberonics, Inc. Amended and Restated 1997 Stock Plan
      dated November 21, 2002
                    
                    Cyberonics,
      Inc.’s Proxy Statement for the Annual Meeting of
      Stockholders filed on October 15, 2002
                    000-19806
                    Annex
      B10.17†
                    Third
      Amendment to the Cyberonics, Inc. Amended and Restated 1997 Stock Plan
      dated August 19, 2008
                    
                    Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 24,
      2008
                    000-19806
                    10.110.18†
                    Form
      of Executive Restricted Stock Agreement under the Cyberonics, Inc. Amended
      and Restated 1997 Stock Plan between Cyberonics, Inc. and the executive
      officers listed on the schedule attached thereto
                    
                    Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended July 27,
      2007
                    000-19806
                    10.510.19†
                    Form
      of Director Restricted Stock Agreement under the Cyberonics, Inc. Amended
      and Restated 1997 Stock Plan between Cyberonics, Inc. and the directors
      listed on the schedule attached thereto (three-year
    vesting)
                    
                    Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended July 27,
      2007
                    000-19806
                    10.610.20†
                    Form
      of Director Restricted Stock Agreement under the Cyberonics, Inc. Amended
      and Restated 1997 Stock Plan between Cyberonics, Inc. and the directors
      listed on the schedule attached thereto (four-year
vesting)
                    
                    Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended July 27,
      2007
                    000-19806
                    10.710.21†
                    Form
      of Employee Restricted Stock Agreement under the Cyberonics, Inc. Amended
      and Restated 1997 Stock Plan
                    
                    Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended July 27,
      2007
                    000-19806
                    10.810.22†
                    Cyberonics,
      Inc. 1998 Stock Option Plan
                    
                    Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on November 3,
      1998
                    333-66691
                    4.110.23†
                    First
      Amendment to the Cyberonics, Inc. 1998 Stock Option Plan dated March 21,
      2001
                    
                    Cyberonics,
      Inc.’s Annual Report on
                      Form
      10-K for the fiscal period ended April 30, 2004
                    000-19806
                    10.2310.24†
                    Cyberonics,
      Inc. New Employee Equity Inducement Plan
                    
                    Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on August 27,
      2003
                    333-108281
                    4.310.25†
                    Amended
      and Restated Cyberonics, Inc. New Employee Equity Inducement
      Plan
                    
                    Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on June 18,
      2007
                    333-143821
                    4.110.26†
                    First
      Amendment to the Amended and Restated Cyberonics, Inc. New Employee Equity
      Inducement Plan dated August 19, 2008
                    
                    Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 24,
      2008
                    000-19806
                    10.310.27†
                    Form
      of Executive Restricted Stock Agreement under the Cyberonics, Inc. New
      Employee Equity Inducement Plan between Cyberonics, Inc. and the executive
      officers listed on the schedule attached thereto dated as of the dates so
      indicated.
                    
                    Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                    000-19806
                    10.3010.28†
                    Form
      of Executive Restricted Stock Agreement dated September 10, 2007 under the
      Cyberonics, Inc. New Employee Equity Inducement Plan between Cyberonics,
      Inc. and the executive officers listed on the schedule attached thereto
      relating to Cyberonics’ Common Stock Price
                    
                    Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                    000-19806
                    10.110.29†
                    Form
      of Executive Restricted Stock Agreement dated September 10, 2007 under the
      Cyberonics, Inc. New Employee Equity Inducement Plan between Cyberonics,
      Inc. and the executive officers listed on the schedule attached thereto
      relating to Cyberonics’ Net Income
                    
                    Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                    000-19806
                    10.2
 
  
 Table of Contents  
 Exhibit
                  Number
                Document
      Description
                
                Report
      or Registration Statement
                SEC
      File or
                  Registration
                  Number
                Exhibit
                  Reference10.30†
                Form
      of Executive Restricted Stock Agreement dated September 10, 2007 under the
      Cyberonics, Inc. New Employee Equity Inducement Plan between Cyberonics,
      Inc. and the executive officers listed on the schedule attached thereto
      relating to Cyberonics’ Net Sales
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                000-19806
                10.310.31†
                Form
      of Executive Restricted Stock Agreement dated September 10, 2007 under the
      Cyberonics, Inc. New Employee Equity Inducement Plan between Cyberonics,
      Inc. and the executive officers listed on the schedule attached thereto
      relating to Cyberonics’ Net Sales and Earnings
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                000-19806
                10.410.32†
                Cyberonics,
      Inc. 2005 Stock Plan
                
                Cyberonics,
      Inc.’s Proxy Statement for the Special Meeting of Stockholders filed on
      April 14, 2005
                000-19806
                Annex A10.33†
                First
      Amendment to the Cyberonics, Inc. 2005 Stock Plan dated August 19,
      2008
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 24,
      2008
                000-19806
                10.210.34†
                Form
      of Director Restricted Stock Agreement effective June 1,
    2005
                
                Cyberonics,
      Inc.’s Quarterly Form 10-Q for the quarter ended July 29,
    2005
                000-19806
                10.110.35†
                Form
      of Amendment to Director Stock Option Agreement dated December 2006
      between Cyberonics, Inc. and the directors listed on the schedule attached
      thereto
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.6810.36†
                Form
      of Stock Option Agreement under the Cyberonics, Inc. 2005 Stock Plan
      between Cyberonics, Inc. and the executive officers listed on the schedule
      attached thereto
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.7010.37†
                Form
      of Employee Restricted Stock Agreement under the Cyberonics, Inc. 2005
      Stock Plan (one-year vesting)
                
                Cyberonics,
      Inc.’s Quarterly Form 10-Q for the quarter ended July 29,
    2005
                000-19806
                10.210.38†
                Form
      of Employee Restricted Stock Agreement under the Cyberonics, Inc. 2005
      Stock Plan (five-year vesting) and the executive officers listed on the
      schedule attached thereto
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.7210.39†
                Form
      of Indemnification Agreement for directors of Cyberonics,
    Inc.
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.6610.40†
                Summary
      of Non-Equity Incentive Compensation Plans
                
                Cyberonics,
      Inc.’s Annual Report on Form 10-K for the year ended April 27,
      2007
                000-19806
                10.6410.41†
                Employment
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and Gregory
      H. Browne
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on July 13, 2007
                000-19806
                10.110.42†
                Severance
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and Gregory
      H. Browne
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on July 13, 2007
                000-19806
                10.210.43†
                Letter
      Agreement dated August 1, 2007 between Cyberonics, Inc. and Michael A.
      Cheney
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on August 7, 2007
                000-19806
                10.110.44†
                Executive
      Restricted Stock Agreement between Cyberonics, Inc. and Daniel J. Moore
      dated June 18, 2007
                
                Cyberonics,
      Inc.’s Annual Report on Form 10-K for the year ended April 27,
      2007
                000-19806
                10.6610.45†
                Employment
      Agreement dated April 26, 2007 by and between Cyberonics, Inc. and Daniel
      J. Moore
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on May 1, 2007
                000-19806
                10.110.46†
                First
      Amendment to Employment Agreement dated April 26, 2007 by and between
      Cyberonics, Inc. and Daniel J. Moore
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on July 19, 2007
                000-19806
                10.110.47†
                Second
      Amendment to Employment Agreement dated December 19, 2008 between
      Cyberonics, Inc. and Daniel J. Moore
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                000-19806
                10.1
 
  
 Table of Contents 
 Exhibit
                  Number
                Document
      Description
                
                Report
      or Registration Statement
                SEC
      File or
                  Registration
                  Number
                Exhibit
                  Reference10.48†
                Indemnification
      Agreement effective June 28, 1999 between Cyberonics, Inc. and Alan J.
      Olsen
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.4410.49†
                Severance
      Agreement effective July 14, 2003 between Cyberonics, Inc. and George E.
      Parker
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 30, 2004
                000-19806
                10.4010.50†
                Officer
      Stock Option Plan Agreement dated July 14, 2003 between Cyberonics, Inc.
      and George E. Parker
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.4610.51†
                Employment
      Agreement effective July 14, 2003 between Cyberonics, Inc. and George E.
      Parker
                
                Cyberonics,
      Inc.’s Quarterly Report on
                  Form
      10-Q for the quarter ended October 24, 2003
                000-19806
                10.110.52†
                First
      Amendment to Employment Agreement effective June 15, 2006 between
      Cyberonics, Inc. and George E. Parker
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.4810.53†
                Employment
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and James A.
      Reinstein
                
                Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                000-19806
                10.6110.54†
                Severance
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and James A.
      Reinstein
                
                Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                000-19806
                10.6210.55†*
                Release
      Agreement effective May 4, 2007 between Cyberonics, Inc. and John A.
      Riccardi10.56†*
                Letter
      Agreement dated February 1, 2008 between Cyberonics, Inc. and Dr. Richard
      L. Rudolph10.57†
                Stock
      Option Amendment and Cash Bonus Agreement dated October 22, 2007 between
      Cyberonics, Inc. and Randal L. Simpson
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                000-19806
                10.510.58†
                Cyberonics
      1998 Stock Option Notice of Stock Option Grant and Stock Options Agreement
      dated October 22, 2007 between Cyberonics, Inc. and Randal L.
      Simpson
                
                Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
                000-19806
                10.610.59
                Consulting
      Agreement dated November 19, 2006 between Cyberonics, Inc. and Pamela B.
      Westbrook
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on November 20,
    2006
                000-19806
                10.310.60†
                Indemnification
      Agreement effective August 1, 2003 between Cyberonics, Inc. and David S.
      Wise
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.6110.61†
                Severance
      Agreement effective September 17, 2003 between Cyberonics, Inc. and David
      S. Wise
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 30, 2004
                000-19806
                10.4210.62†
                Employment
      Agreement effective September 17, 2003 between Cyberonics, Inc. and David
      S. Wise
                
                Cyberonics,
      Inc.’s Quarterly Report on
                  Form
      10-Q for the quarter ended October 24, 2003
                000-19806
                10.210.63†
                First
      Amendment to Employment Agreement effective June 15, 2006 between
      Cyberonics, Inc. and David S. Wise
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.6410.64†
                New
      Employee Equity Inducement Plan Agreement dated September 17, 2003 between
      Cyberonics, Inc. and David S. Wise
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                10.6510.65†
                Form
      of Amendment of Employment Agreement (Messrs. Parker, Simpson and
      Wise)
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                000-19806
                10.2
 
  
 Table of Contents 
 Exhibit
                  Number
                Document
      Description
                
                Report
      or Registration Statement
                SEC
      File or
                  Registration
                  Number
                Exhibit
                  Reference10.66†
                Form
      of Amendment of Employment Agreement (Messrs. Browne and
      Reinstein)
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                000-19806
                10.310.67†
                Form
      of Amendment of Severance Agreement (Messrs. Browne, Parker, Reinstein,
      Simpson and Wise)
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                000-19806
                10.410.68†
                Form
      of Amendment of Restricted Stock Agreement (Messrs. Browne and
      Reinstein)
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 29,
    2008
                000-19806
                10.510.69
                Settlement
      Agreement and Release, dated April 18, 2008, by and between Cyberonics,
      Inc. and Wells Fargo Bank, National Association, as
Trustee
                
                Cyberonics,
      Inc.’s Current Report on Form 8-K filed on April 24, 2008
                000-19806
                10.110.70†
                Summary
      of Non-Employee Director Compensation as of June 24, 2008
                
                Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                000-19806
                10.8310.71†
                Summary
      of Fiscal Year 2008 Executive Bonus Program
                
                Cyberonics,
      Inc.’s Annual Report on Form 10-K for the fiscal year ended April 25,
      2008
                000-19806
                10.8410.72*#
                International
      Distributor Agreement effective April 24, 2009 between and Cyberonics,
      Inc. and Nihon Kohden Corporation21.1
                List
      of Subsidiaries of Cyberonics, Inc.
                
                Cyberonics,
      Inc.’s Annual Report on
                  Form
      10-K for the fiscal period ended April 28, 2006
                000-19806
                21.123.1*
                Consent
      of Independent Registered Public Accounting Firm, KPMG LLP24.1*
                Powers
      of Attorney (included on the Signature Page to this Annual Report on Form
      10-K)31.1*
                Certification
      of the Chief Executive Officer of Cyberonics, Inc. pursuant to Section 302
      of the Sarbanes-Oxley Act of 200231.2*
                Certification
      of the Chief Financial Officer of Cyberonics, Inc. pursuant to Section 302
      of the Sarbanes-Oxley Act of 200232.1*
                Certification
      of the Chief Executive Officer and Chief Financial Officer of Cyberonics,
      Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002