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 25, 2008oro
              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 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.  þ
 
 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 26, 2007, 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 $254.3 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 19, 2008, 26,942,170 shares of common stock were
outstanding.
 
 DOCUMENTS
INCORPORATED BY REFERENCE
 
 Portions
of the definitive proxy statement of Cyberonics, Inc. for the 2008 Annual
Meeting of Stockholders, which will be filed within 120 days of
April 25, 2008, are incorporated by reference into Part III of this
Annual Report on Form 10-K.
 
  
  TABLE OF CONTENTS
 
 
 
 PART IItem 1.
              Business
              2Item 1A.
              Risk Factors
              15Item 1B.
              Unresolved Staff Comments
              26Item 2.
              Properties
              26Item 3.
              Legal Proceedings
              26Item 4.
              Submission of Matters to a Vote of Security
      Holders
              26PART IIItem 5.
              Market for Registrant’s Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities
              26Item 6.
              Selected Financial Data
              28Item 7.
              Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
              29Item 7A.
              Quantitative and Qualitative Disclosures About
      Market Risk
              39Item 8.
              Financial Statements and Supplementary
      Data
              40Item 9.
              Changes in and Disagreements With Accountants on
      Accounting and Financial Disclosure
              40Item 9A.
              Controls and Procedures
              40Item 9B.
              Other Information
              43PART IIIItem 10.
              Directors, Executive Officers and Corporate
      Governance
              43Item 11.
              Executive Compensation
              43Item 12.
              Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters
              43Item 13.
              Certain Relationships and Related Transactions, and
      Director Independence
              43Item 14.
              Principal Accounting Fees and
      Services
              43PART IVItem 15.
              Exhibits, Financial Statement
    Schedules
              44
 
 
 In this
Annual Report on Form 10-K, “Cyberonics,” “we,” “us” and “our” refer to
Cyberonics, Inc. and
 its
consolidated subsidiary (Cyberonics Europe NV).
 _______________
  1
 Table of Contents  CAUTIONARY
STATEMENT ABOUT FORWARD-LOOKING STATEMENTS
 
 This
Annual Report on Form 10-K (this “Form 10-K”) contains forward-looking
statements. These statements relate to future events or our future financial
performance. We have attempted to identify forward-looking statements by
terminology such as “expect,” “may,” “will,” “intend,” “anticipate,” “believe,”
“estimate,” “could,” “possible,” “plan,” “project,” “forecast” and similar
expressions. Our forward-looking statements generally relate to our growth
strategies, financial results, reimbursement programs, product acceptance
programs, product development programs, clinical and new indication development
programs, regulatory approval programs, manufacturing processes and sales and
marketing programs. Forward-looking statements should be carefully considered as
involving a variety of risks and uncertainties including, but not limited to,
those 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 (“VNS Therapy System”) includes the
following:
 
 —
              A
      generator to provide the appropriate stimulation to the vagus
      nerve;—
              A
      lead that is attached to both the generator and the vagus
      nerve;—
              Associated
      equipment to assist with necessary implantation
surgery;—
              Equipment
      to assist with setting the stimulation parameters particular to the
      patient;—
              Appropriate
      instruction manuals; and—
              Magnets
      to suspend or induce stimulation
manually.
 
 The
implantation of the generator and lead into patients is generally performed on
an outpatient basis. The battery contained in this 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.
 
 The
United States (“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
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 and Canada 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.
  2
 Table of Contents  
 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. Because there are
currently no favorable national coverage policies and only a few regional
coverage policies for VNS Therapy for depression, we have assisted physicians
and patients with obtaining case-by-case approvals since FDA approval in July
2005. Any long-term growth in sales for the treatment of depression is dependent
on obtaining favorable national and regional coverage policies for VNS Therapy
for depression.  In May 2007, the Centers for Medicare and Medicaid
Services (“CMS”) (formerly, the Healthcare Financing Administration) issued
a final determination of non-coverage with respect to reimbursement of VNS
Therapy for depression.
 
 In
February 2008, we announced that, after consulting with clinical and
reimbursement experts, we have developed a plan, including the conduct of an
additional randomized clinical trial, or possibly more than one such clinical
trial, to obtain reimbursement coverage for our depression
indication.  We also announced a plan to transfer our depression
business to a separate entity, in which we expect to maintain at least a
minority interest.  We have engaged an investment bank to assist us in
identifying a financial partner to provide the funding necessary to execute this
plan.
 
 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 of
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 and, therefore, are an important component of our
clinical research activities.
 
 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 rights
to third parties in order to optimize our portfolio. This includes the
assessment and determination of which of our intellectual property 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 intellectual property rights of third parties in order to
determine whether we should attempt to acquire those rights through a license.
We recently granted rights to Ethicon Endo-Surgery, Inc. to use our technology
to treat obesity.
 
 Since
inception, we have incurred substantial expenses, primarily for research and
development activities that include product and process development and clinical
trials and related regulatory activities, sales and marketing activities,
manufacturing start-up costs and systems infrastructure. We have also made
significant investments in recent periods in connection with sales and marketing
activities in the U.S. and clinical research costs associated with new
indications development, most notably depression. As of April 25, 2008, we had
incurred an accumulated deficit of approximately
$269.2 million.  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 clinical
trials.
  3
 Table of Contents  
 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. It is estimated that approximately 2.7 million
individuals in the U.S. have epilepsy, with approximately 125,000 new cases
diagnosed each year, and we estimate 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: anti-epileptic 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
distribution.
 
 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. 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, over 48,000 patients
worldwide have been treated with the VNS Therapy System for
epilepsy.
  4
 Table of Contents  
 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. According to the World Health Organization,
based on years lived with disability, depression is the leading cause of
disability for the general population. Depression interferes with a person’s
ability to function, feel pleasure or maintain interest in everyday living. It
is associated with increased mortality due to suicide and other co-morbid
general medical conditions or general medical conditions that co-exist with the
depressive disorder. Total annual costs for depression in the U.S. are
estimated to exceed $80 billion, including $26 billion in annual
direct treatment costs. 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 under development for the treatment of depression,
including repetitive transcranial
 magnetic
stimulation (“rTMS”) and DBS, but these treatments are not currently approved
for commercial distribution.
 
 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. The FDA approved the depression
indication for the VNS Therapy System based on (a) a long-term uncontrolled
trial (the “Pivotal Trial”) of adjunctive VNS Therapy that showed significant,
sustained improvement of depressive symptoms over one and two years, and (b) a
comparison of the 12-month outcomes in the Pivotal Trial with the 12-month
outcomes among a non-randomized, but well-matched, group of patients who
received only standard treatments for their depression. After one year of
adjunctive VNS Therapy in the Pivotal Trial, response to treatment ranged from
22% to 37% (depending on which outcome was measured). Moreover, 60% of the
patients who responded after three months of adjunctive VNS Therapy were still
responders at one year and 70% of the three-month responders were responders at
the two-year evaluation. For those patients who were responders at the one-year
evaluation, 69% were still responders at the two-year evaluation. 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.
 
 FDA
Post-Approval Study Commitments and Other Clinical Research Studies
 
 As a
condition of approval for the VNS Therapy System’s depression indication, the
FDA requires us to conduct two post-approval clinical studies. One is a
460-patient randomized, controlled study that compares outcomes for different
levels of vagus nerve stimulation. The other is a patient registry that will
include 500 patients experiencing “treatment as usual” (as defined in the
study) plus adjunctive VNS Therapy and 500 patients experiencing only treatment
as usual. Both studies are actively enrolling patients. To maintain timely
progress in the 460-patient 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.
  5
 Table of Contents 
 We are
also sponsoring post-marketing studies in refractory epilepsy and supporting a
variety of studies to improve the fundamental understanding of how VNS Therapy
works. The E-06 Study is an open randomized post-marketing study being conducted
in Europe to assess the efficacy and safety of adjunctive VNS versus adjunctive
new anti-epileptic drug AED treatment in children with refractory seizures. The
European Indication for Use allows children under the age of 12 to be implanted
with VNS Therapy. The PuLsE Study is an open prospective randomized long-term
effectiveness post-marketing study being conducted in Europe and Canada
comparing best medical practice with or without adjunctive VNS Therapy in
patients 16 years or older with pharmaco-resistant partial epilepsy. Both
studies are actively enrolling patients. 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 both medically refractory
epilepsy and 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 and in commercial use in over
52,000 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.
 
 The VNS
Therapy System delivers stimulation 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 and 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 DemiPulseTM Duo 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.
  6
 Table of Contents 
 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 device 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.
 
 Product
Development
 
 Our
product development efforts 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.
 
 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 the next generation
single-connector VNS Therapy System generator, and the DemiPulse Duo generator
is the next generation 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 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
Perennia Lead to be more robust than its predecessor.
 
 We are
conducting ongoing product development programs to enhance the VNS Therapy
System pulse generator, the bipolar lead and programming software. We will be
required to file for the appropriate U.S. and international regulatory
approvals, and some projects may require clinical trials, in connection with the
introduction of new and improved products.
  7
 Table of Contents  
 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.
 
 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 regulation also
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.
 
 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/CEE relating to Active Implantable Medical Devices (“AIMD”). KEMA is an
entity that confirms that a company’s products and quality systems are
compliant, and serves as our notified body within the scope and framework of the
European Council Directive 90/385/CEE relating to AIMD, audits us on an annual
basis for such compliance.
 
 Marketing
and Sales
 
 U.S.
 
 We market
and sell our products for refractory epilepsy and depression through separate
direct sales and marketing forces.
 
 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.
  8
 Table of Contents  
 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—
              reimbursement
      specialists 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, in part, as a
result of the May 2007 negative coverage determination by CMS. As previously
announced, we have a plan to obtain favorable coverage policies.  This
plan includes an additional clinical trial or trials and the intention to
transfer our depression business to another entity, in which we plan to retain
at least a minority interest.
 
 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 additional clinical trial(s),
and submitted further evidence of the efficacy of VNS Therapy for
depression.  This evidence is not expected to be available until at
least 2011.
 
 International
 
 We market
and sell our products in approximately 71 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.
 
 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, and parts of Central and South
America, Asia, 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. Under the terms of the distributor agreements, no product return
rights are granted to the distributor, and no additional product performance
issues exist for us after shipment to the distributor. 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 a
reduction of net sales in the same period net sales are
recognized.
  9
 Table of Contents 
 Third-Party
Reimbursement in the U.S. Market
 
 We sell
the VNS Therapy System to hospitals and ambulatory surgery centers (“ASCs”) on
payment terms that are generally 30 days from 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 get paid by
third party payers for the costs of purchasing the VNS Therapy System and the
associated surgery and patient care. Reimbursement or payment rates were largely
unchanged over the past year, with a slight increase in the Medicare allowable
amount. 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.
 
 Coverage
for VNS Therapy in depression has been difficult to obtain.  As a
result, we have announced our plan to transfer our depression business to a
separate entity and to seek a financial partner to fund one or more new clinical
trials.
 
 We employ
case managers, available through our reimbursement hotline, to help with
coverage, coding and reimbursement issues on a case-by-case basis and/or policy
level.
 
 The
implant procedure, including the cost of the device (approximately $21,000 for a
DemiPulsemodel
VNS Therapy System), hospital charges and physician fees, generally costs
between $23,000 and $38,000.
 
 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. However, in May 2007, 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, 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
2008, coverage for VNS Therapy for depression is still very limited. Only a few
plans have issued favorable coverage policies for VNS Therapy in depression, and
approximately 300 plans have approved one or more case-by-case requests. Most
plans have either no policy or a non-coverage policy with respect to coverage
for depression. Following the May 2007 CMS national non-coverage determination
for depression, we have had difficulty expanding or even maintaining coverage
among private payers.
  10
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 As stated
above, we believe it will be necessary to undertake at least one additional
clinical trial to provide further evidence  to support coverage for
VNS Therapy for depression. This trial will take several years to complete, and
we cannot give any assurances that, if we undertake an additional trial, private
payers will provide, expand or maintain coverage for VNS Therapy in depression
once such additional clinical trial work is completed.
 
 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;—
              the
      product’s safety and efficacy;—
              the
      number of studies performed and peer-reviewed articles published with
      respect to the product; and—
              how
      the product and therapy compare to alternative
  therapies.
 
 Payment
for VNS Therapy Outside the US
 
 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 price to be paid, which is generally lower than
the price paid to the company in the U.S. market. In fiscal year 2008, our
international net sales accounted for 22% of total net sales, and the three
largest individual country markets were France, Great Britain and Germany. In
those countries, we sell directly to hospitals, and the amount received may vary
in each market 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 do not anticipate significant sales volumes until reimbursement approvals are
achieved in these countries for this indication. We are continuing to pursue
appropriate reimbursement approvals for these countries.
  11
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 Competition
 
 We
believe that in the fields of refractory epilepsy and depression, existing and
future drug therapies are and will continue to be the primary competition for
the VNS Therapy System. We may also face competition from other medical device
companies for the treatment of partial seizures and depression. Medtronic, Inc.,
for example, continues to conduct clinical studies involving an implantable
signal generator used with an invasive deep brain probe for the treatment of
neurological disorders including epilepsy and depression, and has received FDA
approval for the device for the treatment of essential tremor and Parkinson’s
Disease. St. Jude Medical, Inc. has also announced that it will conduct a trial
of a similar device for the treatment of depression. 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, 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 and depression
treatment markets are the efficacy and safety 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.
 
 While no
other device therapies have been specifically approved for depression, 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 refractory patients. For severe
patients or those at acute risk for suicide, ECT 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 depression patients. As other
forms of neurostimulation are investigated and developed for epilepsy or
depression, these may emerge as competition for VNS patient candidates. Less
invasive procedures like rTMS and magnetic seizure therapy (“MST”) may compete
for a similar place in the depression treatment market. 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.
 
 We face
similar competition with respect to the development and sale of VNS Therapy as a
treatment for the other disorders we are evaluating, including, but not limited
to fibromyalgia, multiple sclerosis, Alzheimer’s disease, anxiety,
obsessive-compulsive disorders and bulimia.
 
 Patents,
Licenses and Proprietary Rights
 
 Including
the patents referred to in the agreements described above, as of April 25,
2008, we owned or licensed 40 U.S. patents and 78 pending U.S. patent
applications, covering various aspects of the VNS Therapy System, potential
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 25 patents issued by the European Patent Office or
other international authorities and 97 patent applications pending in the
European Patent Office or before other national or international
authorities.
  12
 Table of Contents  
 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
five 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. We believe that these patents give us an advantage by limiting
competition in VNS to treat refractory epilepsy and depression globally. The
license agreement will give us coverage until expiration of the licensed patents
in July 2011 for movement disorders and May 2011 for neuropsychiatric disorders.
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 royalties will
be reduced to 1.0% for the duration of any remaining patents covering licensed
products.
 
 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.
 
 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.
 
 We
believe that the patents we own and license provide us with protection in the
U.S. in the field of cranial nerve stimulation, including VNS for the
control of epilepsy, neuropsychiatric disorders (including clinical depression),
eating disorders (including obesity and bulimia), anxiety disorders, dementia
(including Alzheimer’s Disease), traumatic brain injury and additional
indications for which method patents have been issued. The protection provided
by our international patents is not as strong as that provided by our
U.S. patents due to differences in patent laws. In particular, European and
other countries prohibit patents covering methods for treatment of the human
body by surgery or therapy.
 
 There has
been substantial litigation regarding patent and other intellectual property
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.
 
 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. EES has also been
granted a right of first refusal to negotiate any license under any patent
rights acquired by us within the specified field of use and offered for
licensing.
  13
 Table of Contents  
 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 three product
liability lawsuits alleging liability on the basis of negligence and negligent
misrepresentation. 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 the VNS Therapy Systems involved in existing lawsuits are
defective or that VNS Therapy Systems involved in future lawsuits are likely to
be defective or otherwise have caused or are likely to cause injury to patients
who are or may be involved in these lawsuits; 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. We establish a liability reserve
on our balance sheet in an amount less than our self-insured retention for all
matters that we believe are probable of payment as a result of a judgment or
settlement. 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 approved our decision to address it by
means of a technical bulletin/safety alert letter. A related claim with material
adverse consequences to our business could be asserted.
 
 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.
 
 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.
 
 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 approved our decision to address
this situation by means of a 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.
 
 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.
  14
 Table of Contents  
 Employees
 
 As of May
30, 2008, we had approximately 438 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, although we have had to undertake significant
reductions in personnel over the last two fiscal years. 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 indications for VNS Therapy covered by our method
patents 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.
 
 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.
 
 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 25, 2008, our stock traded from a high
of $22.38 to a low of $9.59 per share. Our stock price may be affected by a
number of factors, some of which are beyond our control, including, without
limitation:
  15
 Table of Contents  
 —
              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 find a partner to develop VNS Therapy for depression and the
      terms of any agreement with that partner;—
              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. These broad market fluctuations have also adversely affected, and
may continue to adversely affect, the market price of our common
stock.
 
 We were not
profitable in fiscal year 2008, and we have been profitable for only eight
fiscal quarters since our
inception in 1987.
 
 Through
April 25, 2008, we incurred an accumulated deficit of approximately
$269.2 million. We continue to incur substantial expenses,
including:
 
 —
              clinical
      expenses related to our commitment for post-market studies in the
      depression indication;—
              regulatory
      expenses related to our post-market surveillance and other regulatory
      obligations and manufacturing expenses; and—
              general
      legal and audit expenses, including expenses resulting from internal and
      governmental investigations of our stock option granting practices and
      procedures.
 
 Although
our financial results improved on a quarterly basis through fiscal year 2008, we
can provide no assurance that our net sales will grow or that our expenses will
decline sufficiently to enable us to become consistently profitable or to remain
profitable in the future.
  16
 Table of Contents  
 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
      expense associated with and the timing of obtaining marketing approvals
      for the VNS Therapy System for other indications, if
  any;—
              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; and—
              litigation,
      including product liability, securities class action, stockholder
      derivative, general commercial and other
  lawsuits.
 
 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 25, 2008, we had $125.0 million in convertible debt with
aggregate annual debt service obligations, excluding full repayment of
principal, of approximately $3.8 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.
 
  17
 Table of Contents  
 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
$125.0 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 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 not be able to transfer our depression business to a separate entity or to
secure the resources necessary to implement our clinical plan for the
development of the depression indication.
 
 We have
announced our intention to search for a financial partner with whom we can
operate the depression indication as a separate business.  We have
also engaged an investment bank to assist us in identifying a financial partner
to provide the funding necessary to execute the clinical plan in support of the
use of VNS Therapy for the treatment of depression.  We expect to
transfer rights to VNS Therapy for depression into a separate entity and retain
a minority interest in such entity.  We are currently entering into
preliminary discussions with persons who may be interested in developing VNS
Therapy for depression.  However, we may be unable to secure a
financial partner for the implementation of the clinical plan or transfer the
depression business to a separate entity on favorable commercial
terms.  If we are unable to successfully complete our plan, we may be
unable to conduct any additional clinical trials and the future profitability of
our depression business, if any, may be severely harmed.
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 We
may not be successful in implementing our open market share repurchase
program.
 
 We have 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.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 be
successful in our efforts to directly or indirectly 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 of the use of the VNS Therapy System to
treat epilepsy or depression, which could cause our sales to be lower than
expectations.
 
 Regulatory
approval for the VNS Therapy System is limited to two indications: refractory
epilepsy and depression. Market acceptance of the VNS Therapy System for these
indications 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. On May 4, 2007, CMS issued a
national non-coverage determination with respect to VNS Therapy for depression.
Prior to the non-coverage determination, some patients were able to obtain
coverage on a case-by-case basis through their local Medicare contractor or
fiscal intermediary. Since the national non-coverage determination is binding on
all local Medicare contractors, patients will no longer be able to obtain
Medicare coverage on a case-by-case basis. In addition, CMS’s non-coverage
determination has had a detrimental effect on coverage decisions by other
payers, including Medicaid and private payers.
 
 While the
VNS Therapy System has been implanted in more than 52,000 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. These 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
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.
  19
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 We
may not be successful in finding a partner to develop VNS Therapy for treatment
of depression, or the terms of such partnership may not provide substantial
returns to us.
  We are
currently entering into preliminary discussions with persons who may be
interested in developing VNS Therapy for depression.  We expect to
transfer rights to VNS Therapy for depression into a separate entity and retain
a minority interest in such entity.  We may not be able to find a
partner willing to develop VNS Therapy, and the terms of any agreement with that
partner and/or the interest we retain in the separate entity may not provide us
with a significant return.
  We
may not be successful in our marketing and sales effort in VNS Therapy for
depression, which could severely harm our business.
 
 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. Although patient demand in depression has been strong,
our depression sales have decreased markedly since fiscal year 2006. At the
present time, we do not expect sales of the VNS Therapy System for depression to
result in any consistent revenue growth until the product receives broader
regional or national coverage by insurers and other third-party payers. In
addition, the absence of broad regional or national insurance coverage has had a
negative effect on psychiatrists’ prescribing habits, resulting in decreasing
sales of VNS Therapy Systems for 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.
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 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 have not yet received substantial
reimbursement coverage approval 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. Prior to the non-coverage determination, some
patients were able to obtain coverage on a case-by-case basis through their
local Medicare contractor or Fiscal Intermediary. Since the national
non-coverage determination is binding on all local Medicare contractors,
patients are no longer able to obtain Medicare coverage on a case-by-case basis.
In addition, the CMS non-coverage determination also has had a detrimental
effect on potential and existing 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.
 
 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.
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 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 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 product liability litigation, with liabilities well in excess of
our product liability insurance coverage limits, any or all of which could
severely harm our business and our consolidated financial position and results
of operations.
 
 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
intellectual property 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 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 intellectual property
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
successfullymarket our
products 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 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 and the HIPAA Privacy Rule, 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
based on certain marketing and sales practices and compensation arrangements
with referral sources. 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, 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. We endeavor to conduct our business in compliance with our 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. 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 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.
 
 Our failure to
attract and retain qualified personnel and any changes in our key personnel
including officers, could adversely affect
our operations.
 
 In
connection with the commercialization of and the lack of consistent
reimbursement for the VNS Therapy System in the U.S. for depression, we
made significant changes to our organization, including an initial scale up in
personnel from February 2005 through July 2005 of approximately 50% and
subsequent reductions in personnel of 11% in fiscal year 2006, 15% in fiscal
year 2007 and a further 15% in fiscal year 2008. These activities have placed,
and may continue to place a significant strain on our resources and 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.
 
 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 involved
in an investigation conducted by the staff of the
Senate Finance that may result in adverse publicity, expenditure of substantial
resources and diversion of management attention, all with an adverse
effect on
our business.
 
 We
received a letter in November 2006 and a second letter in March 2007 from
Senator Charles Grassley on behalf of the United States Senate Committee on
Finance (“SFC”) requesting our cooperation in providing certain documents and
information relating to (a) our employees, agents and consultants regarding
their meetings and communications with the CMS regarding coverage of the VNS
Therapy System for depression and (b) our agents’ and consultants’
participation in presentations, preparation of publications and advice to
government agencies on VNS Therapy for depression. A discussion of the SFC
investigation is contained in “Note 14. Litigation — Senate Finance
Committee Investigation.” We are unable to provide assurance at this time as to
any further action that may be taken by the SFC or its staff in regard to this
matter. Any further action taken by the SFC or its staff could have a material
adverse effect on our business, including but not limited to increased expense
to comply with requests and diversion of management attention from the conduct
of our business.
 
 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.
 
 In
November 2007, we also received an Internal Revenue Service (“IRS”) request for
a remote examination and associated information document requests seeking
information related to our stock option practices.  In February 2008,
the IRS made an additional information document request also related to our
stock option practices.
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 We are
cooperating with these governmental investigations. A more detailed discussion
of these matters is contained in “Note 14. Litigation — Governmental
Investigations of Options Granting Practices.” Although it is not possible at
this early stage 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 will 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.
 
 Item 1B.UnresolvedStaff 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 Parkway South in Houston,
Texas.
 
 As part
of our international operations, we have also agreed to lease approximately
17,000 square feet in sales offices in Europe through April 2010. All
leased properties include the appropriate space to accommodate expected growth
in our respective domestic and international businesses.
 
 Item 3.LegalProceedings
 
 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.
 
 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 2007 and 2008
are set forth below. Price data reflect actual transactions, but do not reflect
mark-ups, mark-downs or commissions.
  26
 Table of Contents 
 
 High
              
              
              LowFiscal
      Year Ended April 27, 2007First
      Quarter
              
              
              27.16
              
              
              
              19.74Second
      Quarter
              
              
              21.64
              
              
              
              14.70Third
      Quarter
              
              
              27.55
              
              
              
              17.30Fourth
      Quarter
              
              
              23.02
              
              
              
              17.62Fiscal
      Year Ended April 25, 2008First
      Quarter
              
              
              22.38
              
              
              
              14.58Second
      Quarter
              
              
              18.12
              
              
              
              12.95Third
      Quarter
              
              
              14.92
              
              
              
              11.51Fourth
      Quarter
              
              
              15.98
              
              
              
              9.59
 
 As of
June 19, 2008, according to data provided by our transfer agent, there were
377 stockholders of record.
 
 During
fiscal year 2007 and 2008, 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.
 
 For a
discussion of the securities authorized under our equity compensation plans, see
“Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters,” which incorporates by reference the
information to be disclosed in our definitive proxy statement for our 2008
Annual Meeting of Stockholders.
 
 In
February 2008, we announced the rescission of the open market share repurchase
program previously announced in May 2006 and the authorization of a new open
market share repurchase program for the repurchase of up to 1.0 million shares
of our outstanding common stock. The actual 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. This program has resulted in our aggregate repurchasing of
approximately 479,000 shares of common stock for approximately $6.3 million
through April 25, 2008.
  27
 Table of Contents  
 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) (2)
              
              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 (3)(4)April
      28 – June 1, 2007
              —
              
              $
              —
              
              —
              
              3,000,000June
      2 – June 29, 2007 (1)
              6,612
              
              $
              17.4400
              
              —
              
              3,000,000January
      26, 2008 – 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
              
              520,975Total
              485,637
              
              $
              12.9843
              
              479,025
              
              520,975
 
 
 (1)
              The
      shares were purchased from our CEO in connection with the grant of
      restricted shares and were made in connection with satisfying tax
      withholding obligations related to those shares.(2)
              The
      price paid for the shares connected with the CEO’s restricted stock was
      the closing price of our stock on the day before issuance per our equity
      incentive plans.  All other shares purchased during the fiscal
      year were purchased at market price.(3)
              In
      May 2006, our Board of Directors approved a program to purchase up to
      3,000,000 common shares on the open market.  No shares were
      purchased under the plan.(4)
              On
      February 20, 2008, our Board of Directors authorized and we announced a
      new plan to purchase up to 1,000,000 shares of our outstanding common
      stock, which supersedes the previous plan to purchase 3,000,000 shares of
      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 25, 2008, April 27, 2007 and April 28, 2006
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,
2005 and the 53 weeks ended April 30, 2004 are derived from audited
financial statements that are not included in this
Form 10-K.
  28
 Table of Contents  
 52
      Weeks Ended
              
              
              53
      Weeks EndedApril 25,
                2008
              
              
              April 27,
                2007
              
              
              April 28,
                2006
              
              
              April 29,
                2005
              
              
              April 30,
                2004Consolidated
      Statement of Operations Data:Net
      sales
              
              $
              121,229,742
              
              
              $
              130,968,437
              
              
              $
              123,441,575
              
              
              $
              103,442,570
              
              
              $
              110,721,499Cost
      of sales
              
              
              21,092,374
              
              
              
              18,258,374
              
              
              
              15,822,045
              
              
              
              15,674,040
              
              
              
              16,386,487Gross
      profit
              
              
              100,137,368
              
              
              
              112,710,063
              
              
              
              107,619,530
              
              
              
              87,768,530
              
              
              
              94,335,012Operating
      expenses:Selling,
      general and administrative
              
              
              85,944,866
              
              
              
              134,144,315
              
              
              
              137,310,196
              
              
              
              86,972,068
              
              
              
              72,198,977Research
      and development
              
              
              22,421,199
              
              
              
              28,092,243
              
              
              
              29,541,707
              
              
              
              20,092,810
              
              
              
              17,582,527Total
      operating expenses
              
              
              108,366,065
              
              
              
              162,236,558
              
              
              
              166,851,903
              
              
              
              107,064,878
              
              
              
              89,781,504Earnings
      (loss) from operations
              
              
              (8,228,697
              )
              
              
              (49,526,495
              )
              
              
              (59,232,373
              )
              
              
              (19,296,348
              )
              
              
              4,553,508Interest
      income
              
              
              3,844,508
              
              
              
              4,649,394
              
              
              
              3,211,956
              
              
              
              1,072,488
              
              
              
              469,924Interest
      expense
              
              
              (5,818,272
              )
              
              
              (5,913,119
              )
              
              
              (3,018,969
              )
              
              
              (444,270
              )
              
              
              (565,702
              )Other
      income (expense), net
              
              
              (397,141
              )
              
              
              (311,112
              )
              
              
              69,460
              
              
              
              84,736
              
              
              
              390,997Earnings
      (loss) before income taxes
              
              
              (10,599,602
              )
              
              
              (51,101,332
              )
              
              
              (58,969,926
              )
              
              
              (18,583,394
              )
              
              
              4,848,727Income
      tax expense (credit)
              
              
              (264,837
              )
              
              
              78,775
              
              
              
              99,266
              
              
              
              26,113
              
              
              
              230,789Net
      earnings (loss)
              
              $
              (10,334,765
              )
              
              $
              (51,180,107
              )
              
              $
              (59,069,192
              )
              
              $
              (18,609,507
              )
              
              $
              4,617,938Basic
      earnings (loss) per share
              
              $
              (0.39
              )
              
              $
              (2.01
              )
              
              $
              (2.37
              )
              
              $
              (0.77
              )
              
              $
              0.20Diluted
      earnings (loss) per share
              
              $
              (0.39
              )
              
              $
              (2.01
              )
              
              $
              (2.37
              )
              
              $
              (0.77
              )
              
              $
              0.18Shares
      used in computing basic earnings (loss) per share
              
              
              26,568,746
              
              
              
              25,514,232
              
              
              
              24,916,938
              
              
              
              24,036,736
              
              
              
              22,921,031Shares
      used in computing diluted earnings (loss) per share
              
              
              26,568,746
              
              
              
              25,514,232
              
              
              
              24,916,938
              
              
              
              24,036,736
              
              
              
              25,954,640Consolidated
      Balance Sheet Data (as of Year End):Cash,
      cash equivalents and marketable securities
              
              $
              91,058,692
              
              
              $
              84,804,876
              
              
              $
              92,355,071
              
              
              $
              61,475,892
              
              
              $
              58,363,731Total
      assets
              
              
              136,231,087
              
              
              
              137,644,883
              
              
              
              152,300,284
              
              
              
              98,855,397
              
              
              
              94,296,524Convertible Notes(1)
              
              
              125,000,000
              
              
              
              125,000,000
              
              
              
              125,000,000
              
              
              
              —
              
              
              
              —Line
      of credit
              
              
              —
              
              
              
              7,500,000
              
              
              
              2,500,000
              
              
              
              3,000,000
              
              
              
              10,031,000Other long-term obligations(2)
              
              
              9,166,440
              
              
              
              295,184
              
              
              
              1,148,457
              
              
              
              209,928
              
              
              
              —Accumulated
      deficit
              
              
              (269,241,437
              )
              
              
              (258,646,256
              )
              
              
              (207,466,149
              )
              
              
              (148,396,957
              )
              
              
              (129,787,450
              )Common
      stockholders’ equity (deficit)
              
              
              (15,223,305
              )
              
              
              (16,062,229
              )
              
              
              4,629,866
              
              
              
              75,595,841
              
              
              
              68,980,479
 
 (1)Convertible Notes were presented in our balance sheet as current
      liabilities prior to fiscal year 2008.  The Convertible Notes
      are presented as long term liabilities as of April 25,
    2008.
 (2)Other long-term
      obligations in 2008 include deferred license revenue in the approximate
      amount of $9.0 million.
 
 As
discussed in “Note 9. Stock Incentive and Purchase Plans” in the Notes to
the Financial Statements, we adopted Statement of Financial Accounting Standards
Board (“SFAS”) 123 (revised 2004) ”Share-Based Payment”(“SFAS 123(R)”)
effective April 29, 2006. As a result, we recognized compensation expenses
during fiscal years 2008 and 2007 in the amount of $11.6 million
and  $19.4 million, respectively. See “Note 9. Stock
Incentive and Purchase Plans” in the Notes to the Consolidated Financial
Statements for additional information.
 
 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 “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, excluding the related Notes,
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.
 29
 Table of Contents  
 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.
 
 Our
ability to expand successfully the commercialization of the VNS Therapy System
depends on obtaining and maintaining favorable coverage, coding and
reimbursement for the implant procedure and follow-up care. Currently, we have
broad coverage, coding and reimbursement for VNS Therapy for the treatment of
epilepsy. Absent favorable national and regional coverage policies, we have been
obtaining certain case-by-case approvals for depression since FDA approval in
July 2005, although case-by-case coverage is very limited at present. We believe
that long-term growth in depression is dependent on identifying and entering
into an agreement with a third party for the development of VNS Therapy for
depression and obtaining favorable national and regional coverage policies in
depression.
 
 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 of
patients 18 years of age and older with chronic or recurrent depression in
a major depressive episode. We have also conducted or provided support for small
pilot studies for the treatment of Alzheimer’s Disease, anxiety, chronic
migraine headache, bulimia and other disorders. These studies have been
conducted to determine the safety and effectiveness of VNS Therapy for the
treatment of these disorders and, in the case of pilot studies, to determine
which new indications might be considered for pivotal studies and, therefore,
these studies are an important component of our clinical research
activities.
 
 Since
inception, we have incurred substantial expenses, primarily for research and
development activities that include product and process development and clinical
trials and related regulatory activities, sales and marketing activities,
manufacturing start-up costs and systems infrastructure. We have also made
significant investments in recent periods in connection with sales and marketing
activities in the U.S. and clinical research costs associated with VNS Therapy.
As of April 25, 2008, we incurred an accumulated deficit of approximately
$269.2 million. We anticipate increasing investments in post-approval
clinical studies.
 
 The
primary exchange rate movements that impact our consolidated net sales growth
include the U.S. dollar as compared to the Euro. The weakening of the
U.S. dollar generally has a favorable 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 SEC staff advised us that it
had commenced an informal inquiry of our stock option grants and related
practices, procedures and accounting. 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.
In addition, we received a subpoena from the U.S. Attorney requesting
documents related to the same matters. We are cooperating with both of these
governmental investigations. For additional information, see “Note 14.
Litigation – Governmental Investigation of Options Granting Practices” in the
Notes to the Consolidated Financial Statements.
 
 In
November 2007, we received an IRS request for a remote limited scope examination
and associated information document requests seeking information related to our
stock option practices.  In February 2008, the IRS made an additional
information document request also related to our stock option
practices.  We are endeavoring to cooperate with the IRS in this
examination by providing documents and information in response to its
examination requests.  The examination is ongoing.
  30
 Table of Contents  
 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.   SFAS
No. 13“Accounting for
Leases”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
SFAS 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. At April 25,
2008 and April 27, 2007, we had approximately $0.0 and $152,000 in deferred
rent, respectively. Scheduled rent increases and paid 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.  The net present value of our future lease obligations
related to the space surrendered as of April 25, 2008, is approximately
$563,000, partially offset by the net present value of estimated proceeds from
the sub-lease of the space surrendered of approximately $480,000. A net expense
and accrued liability of approximately $83,000 were recorded as of April 25,
2008.
 
 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.
  31
 Table of Contents 
 Licensing
Revenue.  We evaluate our licensing 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.  See “Note 13.  Licensing
Agreement” for additional information.
 
 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.  Prior to April 29, 2006, we adopted the
disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based
Compensation”and SFAS No. 148, “Accounting for Stock-Based Compensation —
Transition and Disclosure,”which disclosures are presented in
“Note 1. Summary of Significant Accounting Policies and Related Data” in
the Notes to the Consolidated Financial Statements. Because of this election, we
accounted for our employee stock-based compensation plans under Accounting
Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued
to Employees”and the
related interpretations.
 
 We
adopted SFAS 123(R) on April 29, 2006 using the Black-Scholes option
pricing model and the Modified Prospective Method, which require the
compensation cost to be recognized under SFAS 123(R) for grants issued
after the adoption date and the unvested portion of grants issued prior to the
adoption date. As a result of the adoption of SFAS 123(R), we recognized
share-based compensation expense of approximately $11.6 million and
$19.4 million during fiscal years 2008 and 2007, respectively, including
the impact associated with the resignation of certain officers and employees
during fiscal year 2007. We anticipate recognizing approximately
$9.6 million in non-cash compensation expense during fiscal year 2009.
Stock-based compensation cost is affected by assumptions regarding a number of
complex and subjective variables.
 
 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 certain
key employees. Nonvested restricted stock grantees are entitled to dividends, if
any, and voting rights for their respective shares. Sale or transfer of the
shares is restricted until they are vested.  Share grants have no
purchase cost to the grantee. Typically, grants vest ratably and compensation
costs are amortized over the requisite service period of one to five years. We
also grant restricted stock subject to performance or market conditions that can
vest over derived service periods. The fair value of restricted stock is
determined for accounting purposes, on the grant date using the grant date fair
market value of our stock. We utilize the Monte Carlo simulation method to
establish the fair value, the expected vesting date and the derived service
period of the market conditions based grants. The Monte Carlo simulation method
is subject to variability, as several factors utilized must be estimated,
including stock price volatility.
 
 Foreign Exchange. The primary
exchange rate movement that impacts our consolidated net sales growth is the
U.S. dollar as compared to the Euro. The weakening of the U.S. dollar
generally has a favorable impact on our sales. 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.
 
 Income Taxes.  We
account for income taxes under the asset and liability method. Under this
method, deferred income taxes reflect the impact of temporary differences
between financial accounting and tax bases 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 are evaluated for realization based on a
more-likely-than-not criteria in determining if a valuation allowance should be
provided.
  32
 Table of Contents  
 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.
 
 U.S. net
sales attributable to the depression indication have declined 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 2008 were approximately $4.7 million compared to $29.6 million
for the same period last year, a decrease of approximately 84%.  For
fiscal year 2007, U.S. sales attributable to depression were $29.6 million
compared to $16.6 million for the fiscal year 2006, an increase of approximately
78%.
 
 In fiscal
year 2008 U.S. net product sales decreased by $16.7 million, or 15%,
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 CMS in February 2007 and
May 2007, respectively.  International net sales increased by
$6.4 million, or 32%, 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 increased by $3.2 million, or 3%, in fiscal year 2007 compared to
fiscal year 2006 primarily due to higher average selling prices. International
net sales increased by $4.3 million, or 28%, in fiscal year 2007 compared
to fiscal year 2006, due to a 22% increase in new patient sales and a 9% higher
average selling price, which in turn was largely due to favorable currency
impact and changes in country mix.
 
 The
increase in average system price in the U.S. market over the prior year is
primarily attributable to an increase in the average price for generators of 7%,
partially offset by an increase in the number of generators assumed to be sold
for the purpose of replacing implanted generators having a battery at or near
the end of its useful life. A replacement generator may be sold without a lead,
and therefore the total system price is lower than if a lead was included in the
sale. In the most recent year in the U.S. market, the number of generators sold
without leads increased from 1,167 to 2,135.
  33
 Table of Contents  
 Effective
December 17, 2007, we entered into the EES License Agreement, which grants EES
an exclusive license to certain patents and patent applications pertaining to
weight reduction, hypertension or diabetes.  Under the terms of the
EES License Agreement, EES paid an up-front, non-refundable payment of $9.5
million in December 2007.  In addition, the EES License Agreement
requires EES to pay a royalty on future commercial sales of any product covered
by the licensed patents.  The EES License Agreement also requires us
to retain the responsibility to prosecute the licensed patent applications and
maintain the licensed patents subject to reimbursement by EES.  We are
recognizing the $9.5 million payment on a straight-line basis from the date of
execution of the EES License Agreement to April 2014, which represents the
estimated time frame to fulfill our obligation to prosecute the licensed patent
applications.  During fiscal year 2008, we recognized revenue in the
amount of approximately $0.5 million applicable to the EES License Agreement,
and recorded a related cost of $47,500 in cost of goods sold applicable to the
transfer of certain patent rights under the EES License Agreement. There was no
licensing revenue recognized during fiscal years 2007 or 2006.
 
 Gross
Profit
 
 Gross
profit on products sold decreased by $13.1 million, or 12% in fiscal year
2008, compared to fiscal year 2007 primarily due to lower volume of overall
sales in the U.S. and a higher volume of sales in international
markets.  While the average selling prices were higher in both the
U.S. and international markets, the consolidated average selling price was lower
due to the mix between domestic and international sales. Gross profit margin
decreased by 350 basis points to 82.6% compared to fiscal year 2007 due to
(a) lower production volumes affecting operational efficiencies, which had an
adverse impact of 237 basis points, (b) stock-based compensation expense of
$1.2 million, which had an adverse impact of 48 basis points and (c) higher
average selling prices in generators offset by lower volume of complete systems,
which had an unfavorable impact of 65 basis points.
 
 Gross
profit on products sold increased by $5.1 million, or 5% in fiscal year
2007, compared to fiscal year 2006 primarily due to higher average selling
prices and increased sales volumes. Gross profit margin decreased by
112 basis points to 86.1% compared to fiscal year 2006 due to (a) lower
production volumes affecting operational efficiencies, which had an adverse
impact of 233 basis points, (b) stock-based compensation expense of $0.8
million, which had an adverse impact of 60 basis points, and offset by (c)
higher average selling prices, which had a favorable impact of 181 basis
points.
 
 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. Gross profit margins can be expected to fluctuate
in future periods 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 in licensing revenue for fiscal year 2008 was approximately $0.5 million,
or 91.1% of licensing revenue. The cost of licensing revenue represents
royalties paid applicable to the assignment of certain patents. We had no
licensing revenue or related costs during fiscal year 2007 or
2006.
  34
 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 for the fiscal year 2008 decreased by $48.2 million, or 35.9%, as
compared to fiscal year 2007. The decrease is 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 expenses
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 2008, including the receipt of approximately $1.5 million in
insurance recoveries. Stock-based compensation charges of $8.7 million were
lower by $6.7 million than in fiscal year 2007.  SG&A expenses for
fiscal year 2007 decreased by $3.2 million, or 2.3%, as compared to fiscal
year 2006.  The decrease was primarily due to a decrease of $37.9
million in sales, marketing, and related expenses that had been associated with
the depression launch during fiscal year 2006, partially offset by higher
finance and administration expenses of $5.4 million primarily associated
with the resignations of our CEO and our CFO, proxy cost of approximately
$1.6 million associated with a director election contest, an increase of
$10.9 million in legal and other expenses primarily due to costs associated
with the investigation into our stock options granting and accounting practices,
and an increase in non-cash stock-based compensation charges of
$17.7 million applicable to our adoption of SFAS 123(R).
 
 Research and Development (“R&D”)
Expenses.  R&D expenses are comprised of expenses related
to our product and process development, product design efforts, clinical trials
programs and regulatory activities. R&D expenses decreased by
$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. R&D expenses decreased by $1.4 million in fiscal year 2007, or
4.9%, as compared to fiscal year 2006. The decrease in fiscal year 2007 was
primarily due to a reduction in engineering and regulatory expenses of
$4.9 million, partially offset by an increase of $2.4 million in
international clinical expenses and $2.5 million in higher non-cash
stock-based charges.
 
 Interest
Income
 
 Interest
income of $3.8 million during fiscal year 2008 decreased by 17.3% as
compared to interest income of $4.6 million for fiscal year 2007, due to
decreased interest rates, partially offset by higher cash balances. Interest
income of $4.6 million during fiscal year 2007 increased by 45% as compared
to interest income of $3.2 million for fiscal year 2006, due to increased
interest rates.
 
 Interest
Expense
 
 Interest
expense of $5.8 million for fiscal year 2008 decreased by $0.1 million, or 1.6%,
compared to $5.9 million during fiscal year 2007. The change is primarily due to
interest and other savings from the voluntary termination of our Credit
Agreement in January 2008, and reduced liquidated damages on the Convertible
Notes, offset by $0.4 million in termination fees and write off of origination
fees of approximately $0.2 million also associated with the termination of the
Credit Agreement. Interest expense of $5.9 million for fiscal year 2007
increased 96% from $3.0 million in fiscal year 2006 primarily due to higher
loan balances and interest and fees applicable to the Convertible Notes,
including $0.4 million of liquidated damages.
  35
 Table of Contents  
 Other
Income (Expense), Net
 
 Other
expense, net of $0.4 million for fiscal year 2008 represented an increase of
$86,000, or 27.7%, as compared to fiscal year 2007. The increase is primarily
due to the impact of foreign currency exchange rates and an approximately $0.1
million loss in disposal of assets associated with the re-negotiation of the
leased facilities at our corporate headquarters. Other expense, net of
$0.3 million for fiscal year 2007, represented a decrease of
$0.4 million, or 548% as compared to other income of $0.1 million for
the same period during the previous fiscal year. These expenses, primarily
include income related to the transaction gains and losses associated with the
impact of changes in foreign currency exchange rates offset by derivative
expense associated with the extension of certain stock option grants to former
employees whose grants would have expired unexercised due to our inability to
issue stock under our stock option plans as a consequence of our delinquent SEC
reports during our fiscal year 2007.
 
 Income
Taxes
 
 At
April 25, 2008, we had net operating loss carryforwards for federal income
tax purposes of approximately $254.5 million. The following is a
reconciliation of statutory federal income tax rates to our effective income tax
rate expressed as a percentage of loss before income taxes:
 
 For
      the 52 Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006Income
      Tax Expense (benefit)
              
              $
              (264,837
              )
              
              $
              78,775
              
              
              $
              99,266U.S. statutory
      rate
              
              
              (34.0
              )%
              
              
              (34.0
              )%
              
              
              (34.0
              )%Change
      in deferred tax valuation allowance excluding impact of
      shortfall
              
              
              29.1
              
              
              
              30.2
              
              
              
              31.6Shortfall
      on settlement of options and restricted stock
              
              
              30.8
              
              
              
              1.8
              
              
              
              0.0Reduction
      in valuation allowance due to shortfall
              
              
              (30.8
              )
              
              
              (1.8
              )
              
              
              0.0Federal
      income tax provision
              
              
              0.6
              
              
              
              0.0
              
              
              
              0.0Foreign
      taxes
              
              
              0.3
              
              
              
              0.1
              
              
              
              0.1State
      and local tax provision
              
              
              (3.4
              )
              
              
              0.1
              
              
              
              0.1Other,
      net
              
              
              4.9
              
              
              
              3.8
              
              
              
              2.4(2.5
              )%
              
              
              0.2
              %
              
              
              0.2
              %
 
 Liquidity
and Capital Resources
 
 Overview
 
 We
generated a net loss of $10.3 million for the year ended April 25, 2008 compared
to a net loss of $51.2 million for the year ended April 27, 2007 and a
net loss of $59.1 million for the year ended April 28,
2006.  During fiscal year 2008, we generated $14.5 million in cash
from operating activities, which includes $9.5 million in proceeds from the EES
License Agreement. This revenue is being recognized on a straight-line basis
during the estimated time of approximately six and one half years to fulfill our
obligations under the EES License Agreement, and the balance of $9.0 million
remains in deferred revenue as of April 25, 2008.  Cash used in
operations was $20.7 million for the year ended April 27, 2007, as
compared to $70.9 million used in operations for the year ended
April 28, 2006.
 
 On
January 13, 2006, we established the $40.0 million revolving line of
credit (“Credit Agreement”) with Merrill Lynch Capital, a division of
Merrill Lynch Business Financial Services Inc. (“Administrative Agent”) and the
lenders who were party to the Credit Agreement (“Lenders”). During fiscal year
2008, we voluntarily terminated the Credit Agreement, requiring us to pay off an
outstanding balance of $10.0 million and pay a termination fee of $0.4
million.  The termination of the Credit Agreement also required us to
recognize $0.2 million in expenses relating to unamortized origination costs. We
incurred $5.0 million in additional indebtedness in fiscal year 2007
through additional borrowings under the Credit Agreement.
  36
 Table of Contents 
 In
February 2008, we announced a plan to purchase 1.0 million shares of our
outstanding common stock under the open market share repurchase program. Through
April 25, 2008 we have purchased approximately 479,000 shares pursuant to this
plan at an average cost of $12.92, resulting in a total investment of
approximately $6.3 million. The completion of this program is subject to certain
conditions which may or may not be met.
 
 We
believe our current financial and capital resources will be adequate to fund
anticipated business activities through fiscal year 2009, 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 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006Operating
      Activities
              
              $
              14,455,207
              
              
              $
              (20,688,856
              )
              
              $
              (70,876,209
              )Investing
      activities
              
              
              (817,064
              )
              
              
              (1,425,349
              )
              
              
              17,501,141Financing
      activities
              
              
              (7,429,200
              )
              
              
              14,434,408
              
              
              
              106,994,787
 
 Operating
Activities
 
 Net cash
provided by operating activities during fiscal year 2008 was approximately $14.5
million compared to $20.7 million used in operating activities during fiscal
year 2007. The increase in cash provided by operating activities is primarily
due to a lower net loss that includes $11.3 million of non-cash charges as well
as $9.5 million in proceeds from the EES License Agreement.  Net cash
provided by operating activities improved by approximately $35.1 million during
fiscal year 2008, primarily due to a decrease of approximately $40.8 million in
net loss and $9.3 million in favorable changes in assets and liabilities,
partially offset by an $8.2 million decrease in non-cash
expenses.  Net cash used in operating activities during fiscal year
2007 was approximately $20.7 million, as compared to net cash used in
operating activities of approximately $70.9 million in fiscal year 2006.
Net cash provided by operating activities improved by approximately
$50.2 million during fiscal year 2007, primarily due to a decrease of
approximately $7.9 million in net loss and favorable changes in non-cash
expenses of approximately $19.9 million and in operating assets and
liabilities of approximately $22.4 million.
 
 Investing
Activities
 
 Net cash
used by investing activities during fiscal year 2008 was approximately
$0.8 million compared to net cash used in investing activities in fiscal
year 2007 of approximately $1.4 million. Net cash used in investing
activities during fiscal year 2008 was invested in the purchase of property and
equipment. Net cash used by investing activities during fiscal year 2007 was
approximately $1.4 million compared to cash provided by investing
activities in fiscal year 2006 of approximately $17.5 million. Cash used
during fiscal year 2007 was invested in the purchase of property and equipment.
Net proceeds during fiscal year 2006 of approximately $22.8 million from
the sale of short-term marketable securities were offset by purchases of
property and equipment of approximately $4.3 million and the investment of
approximately $1.0 million in restricted cash.
  37
 Table of Contents  
 Financing
Activities
 
 Net cash
used in financing activities during fiscal year 2008 was approximately $7.4
million, compared to proceeds of $14.4 million during fiscal year 2007. Net cash
provided by financing activities during fiscal year 2007 was approximately
$14.4 million compared to net proceeds of approximately $107.0 million
in fiscal year 2006. The net cash used in financing activities during fiscal
year 2008 includes $7.5 million in payment of all amounts due on termination of
the Credit Agreement, $0.1 million in payment of financing obligations, $6.3
million in acquisition of treasury stock, partially offset by $6.4 million in
proceeds from stock option exercises.  The net proceeds during fiscal
year 2007 include approximately $5.0 million in borrowings under the Credit
Agreement and approximately $9.7 million in proceeds from issuance of
common stock, partially offset by approximately $0.3 million in payments on
financing obligations.
 
 Debt
Instruments and Related Covenants
 
 Line
of Credit
 
 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 our part 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 $7.5 million outstanding at the beginning of fiscal year 2008, plus
additional borrowings during the fiscal year, for a total of $10.0 million
outstanding loan balance and 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.
 
 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
14.  Litigation – Indenture Default Litigation” 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 25, 2008.
 
 Contractual
Obligations
 
 We are
party to a number of contracts pursuant to which we are paying for clinical
studies for current operating obligations payable totaling $2.0 million as
of April 25, 2008. Although we have no firm commitments, we expect to make
capital expenditures of approximately $3.0 million during fiscal year 2009,
primarily to maintain organizational capacity, business infrastructure and
facilities.
  38
 Table of Contents  
 The chart
below reflects our obligations under our material contractual obligations as of
April 25, 2008.
 
 Notes
                Issuance
      (1)
              
              
              Operating
                Leases
      (2)
              
              
              Other
      (3)
              
              
              Total
                Contractual
                ObligationsContractual
      Obligations:Less
      Than One Year
              
              $
              3,750,000
              
              
              $
              3,401,187
              
              
              $
              310,227
              
              
              $
              7,461,4141-3 Years
              
              
              7,500,000
              
              
              
              6,022,580
              
              
              
              20,068
              
              
              
              13,542,6483-5 Years
              
              
              127,541,667
              
              
              
              5,494,851
              
              
              
              20,095
              
              
              
              133,056,613Over
      5 Years
              
              
              —
              
              
              
              4,731,716
              
              
              
              31,119
              
              
              
              4,762,835Total
      Contractual Obligations
              
              $
              138,791,667
              
              
              $
              19,650,334
              
              
              $
              381,509
              
              
              $
              158,823,510
 
 
 (1)
              Consists
      of principal and interest obligations related to the
  Notes(2)
              Consists
      of operating lease obligations related to facilities and office
      equipment.(3)
              Reflects
      amounts we expect to spend in connection with sales, marketing and
      training events and royalty
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 limited market risk on interest rates and foreign currency exchange
rates.
 
 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.
 
 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 over the Euro. 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 10% against the Euro, the
effect upon the net loss recorded during fiscal year 2008 would be favorable by
approximately $0.3 million, or 2.7%. Conversely, if the U.S. dollar
uniformly strengthened 10% against the Euro, the impact on our operations would
be unfavorable by approximately $0.2 million, or 2.2%.
 
 Our
Convertible Notes are sensitive to fluctuations in the price of our common stock
into which the debt is convertible. Changes in equity prices may result in
changes in the fair value of the convertible subordinated debt due to the
difference between the current market price of the debt and the market price at
the date of issuance of the debt. At April 25, 2008, a 10% decrease in the
price of our common stock could have resulted in a decrease of approximately
$2.2 million on the net fair value of our Convertible Notes, while a 10%
increase in the price of our common stock could have resulted in an increase of
approximately $1.3 million on the fair value of our Convertible
Notes.
  39
 Table of Contents  
 In
conjunction with the Convertible Notes, we purchased call options to buy
approximately 3,000,000 shares of our common stock at an exercise price of
$41.50 per share (the “Note Hedge”).  On May 5, 2008 we received from
Merrill Lynch International (“MLI”) a notice pursuant to which MLI asserted that
the Note Hedge was terminated effective May 6, 2008 in accordance with its
terms.  MLI asserted that our execution of the supplemental indenture
agreement dated April 18, 2008 (the “Supplemental Indenture”) in connection with
the settlement of the litigation related to the Convertible Notes 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.  We are reviewing MLI’s assertion that the Note Hedge has
been terminated and the consequences of that action. For a detailed description
of the lawsuit, refer to “Note 14. Litigation – Indenture Default
Litigation.”
 
 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.Changesin 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 25, 2008.
 
 (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.
 
 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 (“COSO”). Based on this assessment, our management has
concluded that our internal control over financial reporting was effective as of
April 25, 2008.
 
 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 25,
2008.
  40
 Table of Contents  
 
 (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.
  41
 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
25, 2008, 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 25, 2008, 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 25, 2008 and April 27, 2007, and the related
consolidated statements of operations, stockholders’ equity (deficit) and
comprehensive income (loss), and cash flows for the 52 weeks ended April 25,
2008, April 27, 2007, and April 28, 2006, and our report dated June 24, 2008
expressed an unqualified opinion on those consolidated financial
statements.
  
 /s/  KPMG
LLP
 
 Houston,
Texas
 June 24,
2008
  42
 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 2008 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 2008 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 2008 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 2008 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 2008 Annual Meeting of Stockholders.
  43
 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
      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 onForm
      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
 
  44
 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 onForm
      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 onForm
      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 onForm
      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 Lessor10.6*
              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 Lessor10.7
              Purchase
      Agreement dated September 21, 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 September 27,
    2005
              000-19806
              10.110.8
              Credit
      Agreement between Cyberonics, Inc. and Merrill Lynch Capital, a division
      of Merrill Lynch Business Financial Services Inc., as Administrative Agent
      and as Lender and as Sole Bookrunner and Sole Lead Arranger, and the
      additional Lenders thereto dated January 13, 2006
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on January 19,
2006
              000-19806
              10.1
 
  45
 Table of Contents 
 Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference10.9
              Consent
      and Amendment Agreement effective July 27, 2006 to the Credit Agreement
      between Cyberonics, Inc. and Merrill Lynch Capital, a division of Merrill
      Lynch Business Financial Services Inc., individually as Lender,
      Administrative Agent, Sole Bookrunner and Sole Lead Arranger, and the
      additional Lenders thereto
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on July 27, 2006
              000-19806
              10.110.10
              Consent
      and Amendment Agreement effective October 31, 2006 to the Credit Agreement
      between Cyberonics, Inc. and Merrill Lynch Capital, a division of Merrill
      Lynch Business Financial Services Inc., individually as Lender,
      Administrative Agent, Sole Bookrunner and Sole Lead Arranger, and the
      additional Lenders thereto
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on November 6,
2006
              000-19806
              10.110.11†
              Consent
      and Amendment Agreement, dated December 29, 2006, by and among Cyberonics,
      Inc., Merrill Lynch Capital, and the Lenders party to the Credit Agreement
      (as defined therein)
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on January 5, 2007
              000-19806
              10.110.12†
              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
              4.110.13†
              First
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated October 2, 2000
              
              Cyberonics,
      Inc.’s Quarterly Report onForm
      10-Q for the quarter ended September 30, 2000
              000-19806
              10.210.14†
              Second
      Amendment to the Cyberonics, Inc. Amended and Restated 1996 Stock Option
      Plan dated March 21, 2001
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 30, 2004
              000-19806
              10.1210.15†
              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
              4.410.16†
              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
              4.510.17†
              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
              4.110.18†
              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 onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.6910.19†
              Cyberonics,
      Inc. Amended and Restated 1997 Stock Plan
              
              Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on March 8,
      2001
              333-56694
              4.510.20†
              First
      Amendment to the Cyberonics, Inc. Amended and Restated 1997 Stock Plan
      dated March 21, 2001
              
              Cyberonics,
      Inc.’s Quarterly Report onForm
      10-Q for the quarter ended July 26, 2002
              000-19806
              10.110.21†
              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 B10.22†
              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
              10.510.23†
              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
              10.610.24†
              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
              10.710.25†
              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
              10.810.26†
              Cyberonics,
      Inc. 1998 Stock Option Plan
              
              Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on November 3,
      1998
              333-66691
              4.110.27†
              First
      Amendment to the Cyberonics, Inc. 1998 Stock Option Plan dated March 21,
      2001
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 30, 2004
              000-19806
              10.23
 
  46
 Table of Contents 
 Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference10.28†
              Cyberonics,
      Inc. New Employee Equity Inducement Plan
              
              Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on August 27,
      2003
              333-108281
              4.310.29†
              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
              4.110.30†*
              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.10.31†
              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’ Common Stock Price
              
              Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
              000-19806
              10.110.32†
              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
              10.210.33†
              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
              10.310.34†
              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
              10.410.35†
              Cyberonics,
      Inc. 2005 Stock Plan
              
              Cyberonics,
      Inc.’s Proxy Statement for the Special Meeting of Stockholders filed on
      April 14, 2005
              000-19806
              Annex A10.36†
              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
              10.5210.37†
              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 onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.6810.38†
              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 onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.7010.39†
              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
              10.210.40†
              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 onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.7210.41†
              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
              10.6610.42†*
              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
              10.6410.43†
              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
              10.110.44†
              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
              10.210.45†
              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
              10.1
 
  47
 Table of Contents 
 Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference10.46†
              Indemnification
      Agreement effective August 1, 2003 between Cyberonics, Inc. and Robert P.
      Cummins
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.3210.47†
              Employment
      Agreement effective August 5, 2005 between Cyberonics, Inc. and Robert P.
      Cummins
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on August 9, 2005
              000-19806
              99.110.48†
              Letter
      Agreement Regarding Advancement of Attorney’s Fees effective September 28,
      2006 between Cyberonics, Inc. and Robert P. Cummins
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.3410.49†
              Resignation
      Agreement effective November 17, 2006 between Cyberonics, Inc. and Robert
      P. Cummins
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on November 20,
    2006
              000-19806
              10.110.50†
              Description
      of Non-Equity Incentive Compensation under the Employment Agreement of
      Robert P. Cummins
              
              Cyberonics,
      Inc.’s Annual Report on Form 10-K for the year ended April 27,
      2007
              000-19806
              10.6710.51†
              Employment
      Agreement effective June 15, 2006 between Cyberonics, Inc. and William
      Steven Jennings
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.3810.52†
              Separation
      Agreement between Steve Jennings and Cyberonics, Inc., dated January 31,
      2007
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on February 6,
2007
              000-19806
              10.110.53†
              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
              10.6610.54†
              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
              10.110.55†
              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
              10.110.56†
              Indemnification
      Agreement effective June 28, 1999 between Cyberonics, Inc. and Alan J.
      Olsen
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.4410.57†
              Severance
      Agreement effective July 14, 2003 between Cyberonics, Inc. and George E.
      Parker
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 30, 2004
              000-19806
              10.4010.58†
              Officer
      Stock Option Plan Agreement dated July 14, 2003 between Cyberonics, Inc.
      and George E. Parker
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.4610.59†
              Employment
      Agreement effective July 14, 2003 between Cyberonics, Inc. and George E.
      Parker
              
              Cyberonics,
      Inc.’s Quarterly Report onForm
      10-Q for the quarter ended October 24, 2003
              000-19806
              10.110.60†
              First
      Amendment to Employment Agreement effective June 15, 2006 between
      Cyberonics, Inc. and George E. Parker
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.4810.61†*
              Employment
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and James A.
      Reinstein10.62†*
              Severance
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and James A.
      Reinstein10.63†
              Release
      Agreement effective May 4, 2007 between Cyberonics, Inc. and John A.
      Riccardi
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on May 10, 2007
              000-19806
              10.110.64†
              Employee
      Restricted Stock Agreement dated July 22, 2005 between Cyberonics, Inc.
      and Richard L. Rudolph, M.D.
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.5110.65†
              Stock
      Option Agreement Amendment and Bonus Agreement dated December 28, 2006
      between Cyberonics, Inc. and Richard L. Rudolph, M.D.
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.5310.66†*
              Letter
      Agreement dated February 1, 2008 between Cyberonics, Inc. and Dr. Richard
      L. Rudolph10.67†
              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
              10.510.68†
              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
              10.610.69
              Consulting
      Agreement between Cyberonics, Inc. and BK Consulting, an assumed name used
      by Reese S. Terry, Jr., a founder and member of the Board of Directors of
      Cyberonics, Inc., dated August 25, 2005
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on August 30, 2005
              000-19806
              99.1
 
  48
 Table of Contents  
 Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference10.70
              Amendment
      to Consulting Agreement between Cyberonics, Inc. and BK Consulting dated
      August 23, 2006
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on August 25, 2006
              000-19806
              10.110.71†
              Consulting
      Agreement between Cyberonics, Inc. and BK Consulting, an assumed name used
      by Reese S. Terry, Jr., a founder and member of the Board of Directors of
      Cyberonics, Inc., dated May 16, 2007
              
              Cyberonics,
      Inc.’s Annual Report on Form 10-K for the year ended April 27,
      2007
              000-19806
              10.6510.72
              Termination
      of Consulting Agreement between Cyberonics, Inc. and BK Consulting
      effective November 19, 2006
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 13,
    2006
              000-19806
              10.110.73†
              Employment
      Agreement effective June 15, 2006 between Cyberonics, Inc. and Pamela B.
      Westbrook
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.5810.74†
              Letter
      Agreement Regarding Advancement of Attorney’s Fees effective October 12,
      2006 between Cyberonics, Inc. and Pamela B. Westbrook
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.5910.75†
              Resignation
      Agreement effective 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
              10.4510.76
              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
              10.310.77†
              Indemnification
      Agreement effective August 1, 2003 between Cyberonics, Inc. and David S.
      Wise
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.6110.78†
              Severance
      Agreement effective September 17, 2003 between Cyberonics, Inc. and David
      S. Wise
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 30, 2004
              000-19806
              10.4210.79†
              Employment
      Agreement effective September 17, 2003 between Cyberonics, Inc. and David
      S. Wise
              
              Cyberonics,
      Inc.’s Quarterly Report onForm
      10-Q for the quarter ended October 24, 2003
              000-19806
              10.210.80†
              First
      Amendment to Employment Agreement effective June 15, 2006 between
      Cyberonics, Inc. and David S. Wise
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.6410.81†
              New
      Employee Equity Inducement Plan Agreement dated September 17, 2003 between
      Cyberonics, Inc. and David S. Wise
              
              Cyberonics,
      Inc.’s Annual Report onForm
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.6510.82†
              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
              10.110.83†*
              Summary
      of Non-Employee Director Compensation as of June 24,
    200810.84†*
              Summary
      of Fiscal Year 2008 Executive Bonus Program21.1
              List
      of Subsidiaries of Cyberonics, Inc.
              
              Cyberonics,
      Inc.’s Annual Report onForm
      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
 
  49
 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 24, 2008
 
 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
      24, 2008/s/DANIEL J.
      MOORE
                Daniel
      J. Moore
              Director,
      President and Chief Executive Officer
                (Principal
      Executive Officer)
              June
      24, 2008/s/GREGORY H.
      BROWNE
                Gregory
      H. Browne
              Vice
      President, Finance and Chief Financial Officer (Principal Financial Officer
      and
                Principal
      Accounting Officer)
              June
      24, 2008/s/GUY C.
      JACKSON
                Guy
      C. Jackson
              Director
              June
      24, 2008/s/ALFRED J.
      NOVAK
                Alfred
      J. Novak
              Director
              June
      24, 2008/s/ALAN J.
      OLSEN
                Alan
      J. Olsen
              Director
              June
      24, 2008/s/ARTHUR L. ROSENTHAL
      PH.D.
                Arthur
      L. Rosenthal, Ph.D.
              Director
              June
      24, 2008/s/JEFFREY E.
      SCHWARZ
                Jeffrey
      E. Schwarz
              Director
              June
      24, 2008/s/MICHAEL J.
      STRAUSS, M.D., M.P.H.
                Michael
      J. Strauss, M.D., M.P.H.
              Director
              June
      24, 2008/s/REESE S.
      TERRY, JR.
                Reese
      S. Terry, Jr.
              Director
              June
      24, 2008
 
  50
 Table of Contents  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 CONSOLIDATED
FINANCIAL STATEMENTS
 April
25, 2008, April 27, 2007 and April 28, 2006
 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 25, 2008 and April 27, 2007, and the related
consolidated statements of operations, stockholders’ equity (deficit) and
comprehensive income (loss), and cash flows for the 52 weeks ended April 25,
2008, April 27, 2007, and April 28, 2006. 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 25, 2008 and April 27, 2007, and the results of their
operations and their cash flows for the 52 weeks ended April 25, 2008, April 27,
2007, and April 28, 2006, in conformity with U.S. generally accepted
accounting principles.
  As
discussed in Note 1 to the consolidated financial statements, effective April
29, 2006, the Company changed its method of accounting for share-based
payments.
  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 25, 2008, 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 24, 2008 expressed an
unqualified opinion on the effectiveness of the Company’s internal control over
financial reporting.
  
 /s/  KPMG
      LLP
 
 Houston,
Texas
 June 24,
2008
 
  F-2
 Table of Contents  CYBERONICS,
INC. AND SUBSIDIARY
 
 CONSOLIDATED
BALANCE SHEETS
 
 April 25,
      2008
              
              
              April 27,
      2007ASSETSCurrent
      Assets:Cash
      and cash equivalents
              
              $
              91,058,692
              
              
              $
              84,804,876Restricted
      cash
              
              
              1,000,000
              
              
              
              1,000,000Accounts
      receivable, net of allowances of $240,925 and $308,083,
      respectively
              
              
              20,039,832
              
              
              
              18,914,206Inventories
              
              
              12,829,710
              
              
              
              17,580,830Other
      current assets
              
              
              2,108,185
              
              
              
              3,127,345Total
      Current Assets
              
              
              127,036,419
              
              
              
              125,427,257Property
      and equipment, net of accumulated depreciation of $20,935,788 and
      $19,606,513, respectively
              
              
              5,503,139
              
              
              
              8,028,037Other
      assets
              
              
              3,691,529
              
              
              
              4,189,589Total
      Assets
              
              $
              136,231,087
              
              
              $
              137,644,883LIABILITIES
      AND STOCKHOLDERS’ EQUITY (DEFICIT)Current
      Liabilities:Line
      of credit
              
              $
              —
              
              
              $
              7,500,000Accounts
      payable
              
              
              2,740,075
              
              
              
              5,951,931Accrued
      liabilities
              
              
              14,547,877
              
              
              
              14,844,266Convertible
      Notes
              
              
              —
              
              
              
              125,000,000Other
              
              
              —
              
              
              
              115,731Total
      Current Liabilities
              
              
              17,287,952
              
              
              
              153,411,928Long
      Term Liabilities:Convertible
      Notes
              
              
              125,000,000
              
              
              
              —Deferred
      License Revenue and Other
              
              
              9,166,440
              
              
              
              295,184Total
      Long Term Liabilities
              
              
              134,166,440
              
              
              
              295,184Total
      Liabilities
              
              
              151,454,392
              
              
              
              153,707,112Commitments
      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;
      27,712,248 shares issued and 26,925,611 shares outstanding at April 25,
      2008; and 26,701,054 shares issued and 26,400,054 outstanding at April 27,
      2007
              
              
              277,122
              
              
              
              267,011Additional
      paid-in capital
              
              
              282,788,451
              
              
              
              265,608,804Common
      stock warrants
              
              
              25,200,000
              
              
              
              25,200,000Hedges
      on Convertible Notes
              
              
              (38,200,000
              )
              
              
              (38,200,000
              )Treasury
      stock, 786,637 common shares at April 25, 2008 and 301,000 common shares
      at April 27, 2007, at cost
              
              
              (16,298,835
              )
              
              
              (9,993,200
              )Accumulated
      other comprehensive income (loss)
              
              
              251,394
              
              
              
              (298,588
              )Accumulated
      deficit
              
              
              (269,241,437
              )
              
              
              (258,646,256
              )Total
      Stockholders’ Equity (Deficit)
              
              
              (15,223,305
              )
              
              
              (16,062,229
              )Total
      Liabilities and Stockholders’ Equity (Deficit)
              
              $
              136,231,087
              
              
              $
              137,644,883
 
  See
accompanying Notes to Consolidated Financial Statements
 F-3
 Table of Contents CYBERONICS,
INC. AND SUBSIDIARY
 
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 
 
 52
      Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006Net
      sales
              
              $
              121,229,742
              
              
              $
              130,968,437
              
              
              $
              123,441,575Cost
      of sales
              
              
              21,092,374
              
              
              
              18,258,374
              
              
              
              15,822,045Gross
      Profit
              
              
              100,137,368
              
              
              
              112,710,063
              
              
              
              107,619,530Operating
      Expenses:Selling,
      general and administrative
              
              
              85,944,866
              
              
              
              134,144,315
              
              
              
              137,310,196Research
      and development
              
              
              22,421,199
              
              
              
              28,092,243
              
              
              
              29,541,707Total
      Operating Expenses
              
              
              108,366,065
              
              
              
              162,236,558
              
              
              
              166,851,903Loss
      From Operations
              
              
              (8,228,697
              )
              
              
              (49,526,495
              )
              
              
              (59,232,373
              )Interest
      income
              
              
              3,844,508
              
              
              
              4,649,394
              
              
              
              3,211,956Interest
      expense
              
              
              (5,818,272
              )
              
              
              (5,913,119
              )
              
              
              (3,018,969
              )Other
      income (expense), net
              
              
              (397,141
              )
              
              
              (311,112
              )
              
              
              69,460Loss
      before income taxes
              
              
              (10,599,602
              )
              
              
              (51,101,332
              )
              
              
              (58,969,926
              )Income
      tax (benefit) expense
              
              
              (264,837
              )
              
              
              78,775
              
              
              
              99,266Net
      Loss
              
              $
              (10,334,765
              )
              
              $
              (51,180,107
              )
              
              $
              (59,069,192
              )Basic
      loss per share
              
              $
              (0.39
              )
              
              $
              (2.01
              )
              
              $
              (2.37
              )Diluted
      loss per share
              
              $
              (0.39
              )
              
              $
              (2.01
              )
              
              $
              (2.37
              )Shares
      used in computing basic loss per share
              
              
              26,568,746
              
              
              
              25,514,232
              
              
              
              24,916,938Shares
      used in computing diluted loss per share
              
              
              26,568,746
              
              
              
              25,514,232
              
              
              
              24,916,938
  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 29, 2005
              
              
              24,781,456
              
              
              $
              247,815
              
              
              $
              227,190,470
              
              
              $
              —
              
              
              $
              —
              
              
              $
              (2,896,798
              )
              
              $
              —
              
              
              $
              (548,689
              )
              
              $
              (148,396,957
              )
              
              $
              75,595,841Stock
      options exercised
              
              
              637,191
              
              
              
              6,371
              
              
              
              8,694,565
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              8,700,936Issuance
      of Common Stock under Employee Stock Purchase Plan
              
              
              88,970
              
              
              
              890
              
              
              
              1,777,939
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,778,829Issuance
      of Restricted Stock
              
              
              278,732
              
              
              
              2,787
              
              
              
              9,651,358
              
              
              
              —
              
              
              
              —
              
              
              
              (9,654,145
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Cancellation
      of Restricted Stock
              
              
              (5,000
              )
              
              
              (50
              )
              
              
              (174,662
              )
              
              
              —
              
              
              
              —
              
              
              
              174,712
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Deferred
      compensation relating to stock options
              
              
              —
              
              
              
              —
              
              
              
              (2,491,477
              )
              
              
              —
              
              
              
              —
              
              
              
              2,491,477
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Amortization
      of deferred compensation and expense of certain stock
    options
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              717,661
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              717,661Purchase
      of Treasury Stock
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (9,993,200
              )
              
              
              —
              
              
              
              —
              
              
              
              (9,993,200
              )Sale
      of common stock warrants
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              25,200,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              25,200,000Purchase
      of convertible note hedge
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (38,200,000
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (38,200,000
              )Net
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (59,069,192
              )
              
              
              (59,069,192
              )Translation
      adjustment
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (101,009
              )
              
              
              —
              
              
              
              (101,009
              )Comprehensive
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (59,170,201
              )Balance
      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
              )
 
  See
accompanying Notes to Consolidated Financial Statements
 F-5
 Table of Contents CYBERONICS,
INC. AND SUBSIDIARY
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 52
      Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006Cash
      Flows From Operating Activities:Net
      loss
              
              $
              (10,334,765
              )
              
              $
              (51,180,107
              )
              
              $
              (59,069,192
              )Non-cash
      items included in net loss:Depreciation
              
              
              3,063,710
              
              
              
              3,708,710
              
              
              
              3,350,988(Gain)
      loss on disposal of assets
              
              
              185,585
              
              
              
              (8,189
              )
              
              
              (81,433
              )Unrealized
      (gain) loss in foreign currency transactions
              
              
              114,303
              
              
              
              10,968
              
              
              
              (104,542
              )Stock-based
      compensation
              
              
              11,263,127
              
              
              
              19,421,391
              
              
              
              717,661Amortization
      of financing costs
              
              
              895,650
              
              
              
              781,638
              
              
              
              419,497Other
      non-cash items
              
              
              36,554
              
              
              
              36,432
              
              
              
              (232,752
              )Changes
      in operating assets and liabilities:Accounts
      receivable, net
              
              
              (287,036)
              
              
              
              2,809,389
              
              
              
              (4,995,947
              )Inventories
              
              
              4,517,214
              
              
              
              90,620
              
              
              
              (8,767,305
              )Other
      current assets
              
              
              856,882
              
              
              
              2,051,878
              
              
              
              (1,488,869
              )Other
      assets, net
              
              
              297,044
              
              
              
              55,641
              
              
              
              (84,653
              )Accounts
      payable and accrued liabilities
              
              
              (4,703,658
              )
              
              
              1,703,008
              
              
              
              (250,778
              )Deferred
      license revenue
              
              
              8,966,440
              
              
              
              —
              
              
              
              —Deferred
      income taxes
              
              
              (425,944
              )
              
              
              —
              
              
              
              —Other
              
              
              10,101
              
              
              
              (170,235
              )
              
              
              (288,884
              )Net
      Cash Provided By (Used In) Operating Activities
              
              
              14,455,207
              
              
              
              (20,688,856
              )
              
              
              (70,876,209
              )Cash
      Flow From Investing Activities:Proceeds
      from sale of short-term marketable securities
              
              
              —
              
              
              
              —
              
              
              
              22,800,000Restricted
      cash
              
              
              —
              
              
              
              —
              
              
              
              (1,000,000
              )Purchases
      of property and equipment
              
              
              (817,064
              )
              
              
              (1,425,349
              )
              
              
              (4,298,859
              )Net
      Cash Provided By (Used In) Investing Activities
              
              
              (817,064
              )
              
              
              (1,425,349
              )
              
              
              17,501,141Cash
      Flows From Financing Activities:Increase
      (decrease) in borrowing against line of credit
              
              
              (7,500,000
              )
              
              
              5,000,000
              
              
              
              (500,000
              )Payment
      related to line of credit origination costs
              
              
              —
              
              
              
              —
              
              
              
              (499,814
              )Payments
      on financing obligations
              
              
              (58,620
              )
              
              
              (246,701
              )
              
              
              (192,378
              )Proceeds
      from issuance of Convertible Notes, net of issuance costs
              
              
              —
              
              
              
              —
              
              
              
              120,700,414Additional
      costs related to Convertible Notes
              
              
              —
              
              
              
              (3,557
              )
              
              
              —Sale
      of Common Stock Warrants
              
              
              —
              
              
              
              —
              
              
              
              25,200,000Purchase
      of Convertible Note Hedge
              
              
              —
              
              
              
              —
              
              
              
              (38,200,000
              )Proceeds
      from issuance of Common Stock
              
              
              6,435,055
              
              
              
              9,684,666
              
              
              
              10,479,765Purchase
      of treasury stock
              
              
              (6,305,635
              )
              
              
              —
              
              
              
              (9,993,200
              )Net
      Cash Provided By (Used In) Financing Activities
              
              
              (7,429,200
              )
              
              
              14,434,408
              
              
              
              106,994,787Effect
      of exchange rate changes on cash and cash equivalents
              
              
              44,873
              
              
              
              129,602
              
              
              
              59,460Net
      Increase (Decrease) in Cash and Cash Equivalents
              
              
              6,253,816
              
              
              
              (7,550,195
              )
              
              
              53,679,179Cash
      and cash equivalents at beginning of year
              
              
              84,804,876
              
              
              
              92,355,071
              
              
              
              38,675,892Cash
      and cash equivalents at end of year
              
              $
              91,058,692
              
              
              $
              84,804,876
              
              
              $
              92,355,071Supplementary
      Disclosures of Cash Flow Information:Cash
      paid for interest
              
              $
              5,247,501
              
              
              $
              4,979,462
              
              
              $
              2,213,594Cash
      (refunded) paid for income taxes
              
              $
              (103,447
              )
              
              $
              65,609
              
              
              $
              98,414Supplemental
      Disclosure of Non-cash Activity:Purchases
      of capital assets with notes payable
              
              $
              —
              
              
              $
              —
              
              
              $
              497,698
 
  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 Therapy SystemTM (“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 other indications for VNS Therapy covered by our method
patents 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, NV. 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, NV 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 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 immediate withdrawal until certain
conditions are 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, accrued liabilities and line of credit 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 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006Balance
      at beginning of year
              
              $
              308,083
              
              
              $
              234,478
              
              
              $
              275,457Increase
      in allowance
              
              
              34,054
              
              
              
              161,652
              
              
              
              51,245Reductions
      for write-offs
              
              
              (101,212
              )
              
              
              (88,047
              )
              
              
              (92,224
              )Balance
      at end of year
              
              $
              240,925
              
              
              $
              308,083
              
              
              $
              234,478
 
 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.  Statement
of Financial Accounting Standards Board (“SFAS”) No. 13 “Accounting for Leases”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 SFAS 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. At April 25, 2008 and April 27,
2007, we had approximately $0.0 and $152,000 in deferred rent, respectively.
Scheduled rent increases and paid 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 that we had agreed to surrender. The net present value of the
minimum lease payments applicable to the surrendered square footage is
approximately $563,000, partially offset by the net present value of the
estimated proceeds from the sublease of the space surrendered of approximately
$480,000.  As a result of the abandonment of the space, a net expense
and accrued liability of approximately $83,000 were recorded as of April 25,
2008.
 
 Long-Lived
Assets.  SFAS No. 144, “Accounting for the Impairment
or Disposals of
Long-Lived Assets”provides a single accounting model for long-lived
assets to be disposed of. SFAS No. 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  
 Stock
Options.  Prior to April 29, 2006, we adopted the
disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based
Compensation” (“SFAS No. 123”) and SFAS No. 148,
“Accounting for
Stock-Based Compensation — Transition and
Disclosure”(“SFAS No. 148”). Because of this election, we
accounted for our employee stock-based compensation plans under Accounting
Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued
to Employees”(“APB
No. 25”) and the related interpretations.
 
 We
adopted SFAS No. 123 (revised 2004) ”Share-Based Payment”
(“SFAS 123(R)”) on April 29, 2006 using the Black-Scholes option
pricing model and the Modified Prospective Method, which requires the
compensation cost to be recognized under SFAS 123(R) for grants issued
after the adoption date and the unvested portion of grants issued prior to the
adoption date. As a result of the adoption of SFAS 123(R), we recognized
share-based compensation expense of approximately $11.6 million during fiscal
year 2008 and $19.4 million during fiscal year 2007 including the impact
associated with the resignations of certain officers and employees. The deferred
compensation expense is recorded on a straight line basis over the attribution
period of each unit of stock-based compensation.
 
 The
following table illustrates the effect on net loss and loss per share if we had
applied the fair value recognition provisions of SFAS No. 123 and
SFAS No. 148, instead of APB 25, to stock-based employee compensation
for the 52 weeks ended April 28, 2006:
 
 Net
      loss as reported
              $
              (59,069,192
              )Add:
      Stock-based employee compensation expense included in reported net loss,
      net of related tax effects(1)
              
              717,661Deduct:
      Total stock-based employee compensation expense determined under the fair
      value method for all awards, net of related tax effects(1)
              
              (26,384,997
              )Pro
      forma net loss
              $
              (84,736,528
              )Loss
      per share:Basic —
      as reported
              $
              (2.37
              )Basic —
      pro forma
              $
              (3.40
              )Diluted —
      as reported
              $
              (2.37
              )Diluted —
      pro forma
              $
              (3.40
              )
 
 __________
 
 (1)
              There
      was no tax effect included in these amounts due to our deferred tax
      valuation allowance.
 
 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 certain
key employees. Nonvested restricted stock grantees are entitled to dividends, if
any, and voting rights for their respective shares. Sale or transfer of the
shares is restricted until they are vested.  Share grants have no
purchase cost to the grantee. Typically grants vest ratably and compensation
costs are amortized over the requisite service period of one to five years. We
also grant restricted stock subject to performance or market conditions that can
vest over derived service periods. The fair value of restricted stock is
determined for accounting purposes, on grant date using the grant date fair
market value of our stock. We utilize the Monte Carlo simulation method to
establish the fair value, the expected vesting date and derived service period
of the market conditions based grants. The Monte Carlo simulation method is
subject to variability as several factors utilized must be estimated, including
stock price volatility.
 
 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 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.
  F-9
 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.  See “Note 13.  Commitments and
Contingencies – License Agreement”for additional
information.
 
 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.
 
 Changes
in our liability for product warranties during the 52 weeks ended April 25,
2008, April 27, 2007 and April 28, 2006 are as follows:
 
 Year
              
              Balance
      at the
                Beginning
      of the Year
              
              
              Warranty
      Expense
                Recognized
              
              
              Warranties
                Settled
              
              
              Balance
      at the
                End
      of the Year2008
              
              $
              68,822
              
              
              $
              10,883
              
              
              $
              (650
              )
              
              $
              79,0552007
              
              
              46,991
              
              
              
              27,037
              
              
              
              (5,206
              )
              
              
              68,8222006
              
              
              46,991
              
              
              
              10,312
              
              
              
              (10,312
              )
              
              
              46,991
 
 Income Taxes.  We
account for income taxes under the Financial Accounting Standard Board (“FASB”)
Statement No. 109, “Accounting
for Income Taxes” (“FAS109”).  Under this method, deferred
income taxes reflect the impact of temporary differences between financial
accounting and tax bases 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.  SFAS No. 128, “Earnings Per Share” 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.
  F-10
 Table of Contents 
 The
following table sets forth the computation of basic and diluted net loss per
share of common stock:
 
 For
      the 52 Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006Numerator:Net
      loss
              
              $
              (10,334,765
              )
              
              $
              (51,180,107
              )
              
              $
              (59,069,192
              )Denominator:Basic
      weighted average shares outstanding
              
              
              26,568,746
              
              
              
              25,514,232
              
              
              
              24,916,938Effect
      of dilutive securities
              
              
              —
              
              
              
              —
              
              
              
              —Diluted
      weighted average shares outstanding
              
              
              26,568,746
              
              
              
              25,514,232
              
              
              
              24,916,938Basic
      loss per share
              
              $
              (0.39
              )
              
              $
              (2.01
              )
              
              $
              (2.37
              )Diluted
      loss per share
              
              $
              (0.39
              )
              
              $
              (2.01
              )
              
              $
              (2.37
              )
 
 Excluded
from the computation of diluted EPS for the 52 weeks ended April 25,
2008, April 27, 2007 and April 28, 2006 were outstanding options and
unvested restricted stock to purchase approximately 3.3
million,  5.6 million and 7.3 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 and, in conjunction with the
Convertible Notes, 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”) and sold
common stock warrants (“Warrants”). The Convertible Notes are convertible into
approximately 3,000,000 shares of our common stock. Dilution is measured in
accordance with the “if converted” method of SFAS No. 128, “Earnings Per Share,”which
assumes conversion of the Convertible Notes and adjusts net earnings (loss) for
interest expense net of tax; however, due to net losses, the Convertible Notes
are anti-dilutive and are not included in the computation of diluted EPS.
Purchased call options are anti-dilutive and are not included in the computation
of diluted EPS. We issued 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 SFAS No. 128, “Earnings Per Share,”the
Warrants are not included in the computation of diluted EPS because the
Warrants’ exercise price was greater than the average market price of the common
stock.
 
 Comprehensive Income
(Loss).  Comprehensive income (loss) is the total of net loss
and all other non-owner changes in equity.
 
 Note 2.  Inventories
 
 Inventories
consist of the following:
 
 April 25,
      2008
              
              
              April 27,
      2007Raw
      materials
              
              $
              7,220,830
              
              
              $
              9,205,449Finished
      goods
              
              
              4,391,711
              
              
              
              6,702,196Work-in-process
              
              
              1,217,169
              
              
              
              1,673,185$
              12,829,710
              
              
              $
              17,580,830
 
  F-11
 Table of Contents  
 Note 3.  Property
and Equipment
 
 Property
and equipment consist of the following:
 
 April 25,
      2008
              
              
              April 27,
      2007Computer
      equipment
              
              $
              8,560,562
              
              
              $
              9,164,999Manufacturing
      equipment
              
              
              8,905,857
              
              
              
              8,788,850Leasehold
      improvements
              
              
              3,994,759
              
              
              
              4,218,858Furniture
      and fixtures
              
              
              3,033,167
              
              
              
              3,518,179Office
      equipment
              
              
              1,398,684
              
              
              
              1,415,515Construction
      in progress
              
              
              545,898
              
              
              
              528,14926,438,927
              
              
              
              27,634,550Accumulated
      depreciation
              
              
              (20,935,788
              )
              
              
              (19,606,513
              )$
              5,503,139
              
              
              $
              8,028,037
 
 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. The collateral does not include our intellectual property and
provides the lender with limited rights and remedies relative to the funds
raised in our September 2005 Convertible Notes offering. Pursuant to the terms
of the Credit Agreement, we agreed to maintain a minimum liquidity of
$25.0 million, which was defined as the sum of the revolving loan limit
minus the revolving loan outstanding plus the unrestricted cash and cash
equivalent balances, and to provide periodic certifications of compliance in
connection with the Credit Agreement. The amount available under the Credit
Agreement was limited to 85% of the eligible accounts receivable and a portion
of eligible inventory.
 
 Interest
was payable at a base rate offered for loans in U.S. dollars for the period of
one month under the British Bankers Association LIBOR rates, plus a base margin
rate of 1.75% on the greater of the outstanding loan balance or the minimum
agreed-upon loan balance. The minimum loan balance was $10.0 million
through January 13, 2009. The fees associated with the line of credit under
the Credit Agreement included a one-time commitment fee of $400,000, a
collateral fee ranging from 0.25% to 1% of the outstanding loan balance and
other usual and customary fees associated with this type of line of
credit.
 
 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.  As of April 27, 2007,
our available borrowing capacity was $19.8 million with a loan balance of $7.5
million.
  F-12
 Table of Contents  
 Note 5.  Accrued
Liabilities
 
 Accrued
liabilities consist of the following:
 
 April
      25, 2008
              
              
              
              April
      27, 2007Payroll
      and other compensation
              
              $
              7,987,219
              
              
              $
              7,279,726Clinical
      costs
              
              
              1,978,942
              
              
              
              2,746,677Royalties
              
              
              994,398
              
              
              
              922,221Professional
      services
              
              
              907,097
              
              
              
              1,214,821Property
      tax and other tax accruals
              
              
              849,680
              
              
              
              807,909Other
              
              
              1,830,541
              
              
              
              1,872,912$
              14,547,877
              
              
              $
              14,844,266
 
 In April
2007, the Board of Directors approved a reduction in force with an approximate
accrued cost of $1.5 million.  As of April 25, 2008 and April 27,
2007, $0.0 and $0.7 million remained unpaid, respectively.
 
 Note 6.  Convertible
Notes
 
 On
September 27, 2005, we issued $125 million of 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 to 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. The estimated fair
value of the Convertible Notes as of April 25, 2008 and April 27, 2007
was $105.8 million and $115.0 million, respectively. Market quotes
obtained from brokers were used to estimate the fair value of this
debt.
  F-13
 Table of Contents  
 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. Approximately $56,000 was recorded in accrued
liabilities in the Consolidated Balance Sheet as of April 27, 2007 and $0 as of
April  25, 2008.  The total liquidated damages accrued were
paid on September 27, 2007 in compliance with our obligations under the
Indenture. Liquidated damages were not applicable in fiscal year
2006.  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.
 
 Convertible
Notes Indenture Default Notice
 
 Pursuant
to the Indenture, 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. The Trustee removed the case to federal court and filed a
counterclaim for breach of the Indenture. After summary judgment briefing by
both parties to the dispute, the federal district court granted summary judgment
in our favor in June 2007 and declared that no default had occurred under the
Indenture. For a detailed description of the lawsuit, refer to
“Note 14. — Litigation — Indenture Default Litigation.” The
Trustee appealed the district court’s decision to the U.S. Court of Appeals for
the Fifth Circuit. On April 18, 2008, the Trustee and Cyberonics reached an
agreement to settle the proceedings and have executed a Settlement Agreement and
Supplemental Indenture. As part of the settlement, the appeal was dismissed with
prejudice, 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 original maturity date under the original 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 25, 2008.
   F-14
 Table of Contents 
  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
Convertible Notes are convertible into approximately 3,000,000 shares of
our common stock. We purchased the Note Hedge to enable the purchase of
approximately 3,000,000 shares of our common stock at an exercise price of
$41.50 per share. We issued the Warrants to sell approximately
3,000,000 shares of our common stock at an exercise price of $50.00 per
share. The purpose of the purchase of the Note Hedge and the sale of the
Warrants was to limit our exposure to potential dilution from conversion of the
Convertible Notes subject to the Note offering. The Note Hedge and the Warrants
are recorded in stockholders’ equity (deficit) on the consolidated balance
sheet.  On May 5, 2008 we received from Merrill Lynch International
(“MLI”) a notice pursuant to which MLI asserted that the Note Hedge was
terminated effective May 6, 2008 in accordance with its terms.  MLI
asserted that our execution of the Supplemental Indenture dated April 18, 2008
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.  We are reviewing MLI’s assertion that the
Note Hedge has been terminated and the consequences of that action. We believe
that if effective, this termination will not have a material impact on our
Consolidated Financial Statements.
 
 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 25, 2008. 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.
  F-15
 Table of Contents  
 Note 9.  Stock
Incentive and Purchase Plans
 
 We
adopted SFAS 123(R) effective April 29, 2006 using the Black-Scholes
option pricing model and the Modified Prospective Method which requires the
compensation cost to be recognized under SFAS 123(R) for grants issued
after the adoption date and the unvested portion of grants issued prior to the
adoption date. Prior to April 29, 2006, we adopted the disclosure-only
provisions of SFAS No. 123 and SFAS No. 148. Because of this
election, we accounted for our employee stock-based compensation plans under APB
25 and the related interpretations. The calculation of grant date fair market
value requires judgment, as several of the factors used must be estimated,
including stock price volatility and employee stock option exercise
behavior.
 
 Amounts
recognized in the consolidated financial statements for share-based compensation
are as follows:
 
 For
      the 52 Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006Total
      cost of share-based payment plans during the year
              
              $
              11,427,518
              
              
              $
              19,796,954
              
              
              $
              717,661Amounts
      capitalized in inventory and fixed assets during the year
              
              
              (1,013,187
              )
              
              
              (915,111
              )
              
              
              —Amounts
      recognized in operations for amounts previously capitalized in inventory
      and fixed assets
              
              
              1,212,483
              
              
              
              539,548
              
              
              
              —Amounts
      charged against operations, before income tax benefit
              
              $
              11,626,814
              
              
              $
              19,421,391
              
              
              $
              717,661Amount
      of related income tax benefit recognized in operations
              
              
              —
              
              
              
              —
              
              
              
              —
 
 Because
of our net operating losses, our deferred tax benefits related to our
stock-based compensation expense are offset with a valuation
allowance.  In addition, because of our net operating losses, our
current tax benefits related to all of our stock-based compensation arrangements
are unrealized and unrecognized. The charges applicable to stock-based
compensation increased our cost of goods sold by $1.2 million, sales,
general and administrative expenses by $8.7 million and research and
development 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, sales, general and
administrative 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 research
and development expenses by $3.3 million during the 52 weeks ended
April 27, 2007.
 
 Stock Options.  As
of April 25, 2008, we have reserved an aggregate of 15,250,000 shares
of common stock for issuance pursuant to our 1988 Stock Option Plan, 1996 Stock
Option Plan, 1997 Stock Option Plan, 1998 Stock Option Plan, Amended and
Restated New Employee Equity Inducement Plan and the 2005 Stock Option Plan
(collectively, the “Stock Option Plans”). Options granted under the Stock Option
Plans generally vest monthly over four or five years following their date of
grant. Options granted under the Stock Option Plans have maximum terms of
10 years. The 1997 Stock Option Plan, the Amended and Restated New Employee
Equity Inducement Plan and the 2005 Stock Option Plan allow issuance of either
nonstatutory or incentive stock options and restricted stock, while the 1996 and
the 1998 Stock Option Plans provide for issuance of nonstatutory stock options
exclusively. 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 approximately $22.78 per share. In compliance
with the provisions of our stock option plans, stock option grant prices are
equal to the closing price of our common stock on the last trading day prior to
the grant date. Stock option fair values for accounting purposes are calculated
using the closing stock price on the day of grant. Stock options to purchase
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 25, 2008, April 27, 2007 and April 28,
2006:
 
 For
      the 52 Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007Options
              
              Number
      of Shares
              
              
              Wtd.
      Avg. Exercise Price
              
              
              Wtd.
      Avg. FairMarket Value
              
              
              Wtd.
      Avg. Remaining Contractual Term
              
              
              Aggregate
      Intrinsic Value
              
              
              Number
      of Shares
              
              
              Wtd.
      Avg Exercise Price
              
              
              Wtd.
      Avg. FairMarket Value
              
              
              Wtd.
      Avg. Remaining Contractual Term
              
              
              Aggregate
      Intrinsic ValueOutstanding —
      beginning of year
              
              
              5,469,363
              
              
              $
              20.62
              
              
              $
              15.72
              
              
              —
              
              
              $
              —
              
              
              
              6,839,578
              
              
              $
              20.18
              
              
              $
              15.54
              
              
              —
              
              
              $
              —Granted
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              —
              
              
              
              —
              
              
              
              156,250
              
              
              
              22.78
              
              
              
              11.36
              
              
              —
              
              
              
              173,443Exercised
              
              
              491,064
              
              
              
              13.02
              
              
              
              10.99
              
              
              —
              
              
              
              2,070,419
              
              
              
              798,074
              
              
              
              11.95
              
              
              
              9.53
              
              
              —
              
              
              
              7,221,524Forfeited
              
              
              337,596
              
              
              
              28.35
              
              
              
              20.31
              
              
              —
              
              
              
              —
              
              
              
              497,481
              
              
              
              25.72
              
              
              
              19.34
              
              
              —
              
              
              
              —Expired
              
              
              1,958,142
              
              
              
              19.25
              
              
              
              14.00
              
              
              —
              
              
              
              —
              
              
              
              230,910
              
              
              
              27.91
              
              
              
              21.20
              
              
              —
              
              
              
              —Outstanding —
      end of year
              
              
              2,682,561
              
              
              
              22.27
              
              
              
              17.26
              
              
              
              4.96
              
              
              
              —
              
              
              
              5,469,363
              
              
              
              20.62
              
              
              
              15.72
              
              
              
              4.47
              
              
              
              —Fully
      Vested and Exercisable — end of year
              
              
              2,263,301
              
              
              
              21.03
              
              
              
              16.49
              
              
              
              4.61
              
              
              
              1,980,053
              
              
              
              4,329,499
              
              
              
              18.72
              
              
              
              14.45
              
              
              
              3.61
              
              
              
              21,610,813Expected
      to vest — end of year
              
              
              301,717
              
              
              
              30.06
              
              
              
              21.81
              
              
              
              7.05
              
              
              
              89,189
              
              
              
              979,820
              
              
              
              28.25
              
              
              
              20.74
              
              
              
              7.81
              
              
              
              1,480,270
 
 For
      the 52 Weeks EndedApril 28,
      2006Options
              
              Number
      of Shares
              
              
              Wtd.
      Avg. Exercise Price
              
              
              Wtd.
      Avg. FairMarket Value
              
              
              Wtd.
      Avg. Remaining Contractual Term
              
              
              Aggregate
      Intrinsic ValueOutstanding —
      beginning of year
              
              
              6,923,046
              
              
              $
              17.93
              
              
              $
              13.98
              
              
              —
              
              
              $
              —Granted
              
              
              1,120,513
              
              
              
              35.65
              
              
              
              26.48
              
              
              —
              
              
              
              —Exercised
              
              
              637,090
              
              
              
              13.66
              
              
              
              11.02
              
              
              —
              
              
              
              12,360,044Forfeited
              
              
              557,208
              
              
              
              30.49
              
              
              
              22.99
              
              
              —
              
              
              
              —Expired
              
              
              9,683
              
              
              
              39.01
              
              
              
              29.11
              
              
              —
              
              
              
              —Outstanding —
      end of year
              
              
              6,839,578
              
              
              
              20.18
              
              
              
              15.54
              
              
              
              4.39
              
              
              
              —Fully
      Vested and Exercisable — end of year
              
              
              4,302,595
              
              
              
              17.18
              
              
              
              13.35
              
              
              
              3.57
              
              
              
              28,344,613Expected
      to vest — end of year
              
              
              2,174,605
              
              
              
              25.95
              
              
              
              19.72
              
              
              
              8.24
              
              
              
              5,856,553
 
 We use
the Black-Scholes option pricing methodology to calculate the grant date fair
market value of stock option grants and nonvested share grants. There are no
post-vesting restrictions on the shares issued. 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.
  F-17
 Table of Contents 
 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 27, 2007 and April 28, 2006:
 
 Per
      FAS 123(R)
              
              Per
      APB 25 and Pro Forma Disclosure Requirements of SFAS 123 and SFAS
      148For
      the 52 Weeks Ended
              
              For
      the 52 Weeks EndedApril 25,
                2008
              
              April 27,
                2007
              
              
              
              April 28,
                2006Dividend
      Yield
              —
              
              
              —
              
              Dividend
      Yield
              
              
              —Risk-free
      interest rate — per grant date
              N/A
              
              4.51%
      - 5.23%
              
              Risk-free
      interest rate — rolling 12 months
              
              3.85%Expected
      option term — in years per group of employees
              N/A
              
              4.98
      - 6.96
              
              Expected
      option term — in years for the company as a whole
              
              6.24Implied
      volatility at grant date
              N/A
              
              32.10%
      - 54.47%
              
              Historic
      Volatility at the end of each reporting period
              
              84.58%Discount
      for post-vesting restrictions
              N/A
              
              N/A
              
              Discount
      for post-vesting restrictions
              
              N/AOption
      price
              N/A
              
              Closing
      price on last trading day prior to date of grant
              
              Option
      price
              
              Closing
      price on last trading day prior to date of grantGrant
      price
              N/A
              
              Closing
      price on date of grant
              
              Grant
      Price
              
              Closing
      price on last trading day prior to date of grant
 
 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 are 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 is
expected to vest over a weighted-average period of 2.81 years.
 
 During
the 52 weeks ended April 25, 2008, April 27, 2007 and April 28,
2006, stock options with a fair market value of $7.6 million, $19.7 million
and $20.7 million vested, respectively.
 
 Cash
received from option exercises under all stock-based payment arrangements for
the 52 weeks ended April 25, 2008, April 27, 2007 and April 28,
2006 was approximately $6.4 million, $9.5 million and $8.7 million
respectively. Cash received from Employees’ Stock Purchase Plan for the
52 weeks ended April 25, 2008, April 27, 2007 and April 28, 2006
was approximately $42,000, $0.2 million and $1.8 million,
respectively. We did not realize any tax benefit for the tax deductions from
option exercise of share-based payment arrangements. We did not settle any
equity instruments granted under stock-based payment arrangements for cash for
any of the periods presented herein.
 
 We have
not repurchased common shares for the purpose of satisfying stock-based
compensation obligations. We issued new shares upon exercise of stock option
grants.
  F-18
 Table of Contents  
 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 certain
key employees. Nonvested restricted stock grantees are entitled to dividends, if
any, and voting rights for their respective shares. Sale or transfer of the
shares is restricted until they are vested.  Share grants have no
purchase cost to the grantee. Typically grants vest ratably and compensation
costs are amortized over the requisite service period of one to five years. We
also grant restricted stock subject to performance or market conditions that can
vest over derived service periods. The fair value of restricted stock is
determined for accounting purposes, on grant date using the grant date fair
market value of our stock. We utilize the Monte Carlo simulation method to
establish the fair value, the expected vesting date and derived service period
of the market conditions based grants. The Monte Carlo simulation method is
subject to variability as several factors utilized must be estimated, including
stock price volatility.
 
 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:
 
 —
              As
      to 25% of the shares, the following two conditions are met: (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 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 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 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 25, 2008 and April 27, 2007, our unamortized compensation expense for
grants of restricted stock totaled $6.7 million and $3.0 million which is
expected to be amortized over a weighted average period of 2.61 years and
4.04 years, respectively. We recognized $3.6 million and $3.0 million
and $2.3 million of compensation expense related to grants of restricted stock
during the 52 weeks ended April 25, 2008, April 27, 2007 and April 28,
2006, respectively.
  F-19
 Table of Contents 
 In August
2005, we executed an employment agreement with Robert P. Cummins, our former
CEO, President and Chairman of the Board.  This employment agreement
provided that we would use our best efforts to issue an additional 75,000 shares
of restricted stock on the first and second anniversaries of its
execution.  This was a liability classified award due to the
provisions of his employment agreement.  Mr. Cummins’ employment
agreement terminated with his resignation on November 17, 2006, resulting in the
reversal of a $1.0 million liability that had been previously recognized for the
above restricted stock.
 
 The
following table details the activity in the nonvested restricted stock awards
for the 52 weeks ended April 25, 2008, April 27, 2007 and April 28,
2006:
 
 For
      the 52 Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007Number
      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
              
              
              144,860
              
              
              $
              29.00
              
              
              $
              2,309,624
              
              
              
              270,889
              
              
              $
              36.10
              
              
              $
              6,011,027Granted
              
              
              575,100
              
              
              
              16.14
              
              
              
              9,172,845
              
              
              
              52,500
              
              
              
              20.89
              
              
              
              1,164,975Vested
              
              
              60,623
              
              
              
              25.39
              
              
              
              967,830
              
              
              
              150,220
              
              
              
              37.75
              
              
              
              3,333,382Forfeited
              
              
              38,705
              
              
              
              24.97
              
              
              
              617,345
              
              
              
              28,309
              
              
              
              35.29
              
              
              
              628,177Outstanding —
      end of period
              
              
              620,520
              
              
              
              17.68
              
              
              
              9,897,294
              
              
              
              144,860
              
              
              
              29.03
              
              
              
              3,214,443
 
 For
      the 52 Weeks EndedApril 28,
      2006Number
      of Shares
              
              
              Wtd.Avg.Grant
      Date Fair Value
              
              
              Aggregate
      Intrinsic ValueOutstanding —
      beginning of period
              
              
              —
              
              
              $
              —
              
              
              $
              —Granted
              
              
              278,732
              
              
              
              36.16
              
              
              
              6,327,216Vested
              
              
              —
              
              
              
              —
              
              
              
              —Forfeited
              
              
              7,843
              
              
              
              38.30
              
              
              
              178,036Outstanding —
      end of period
              
              
              270,889
              
              
              
              36.10
              
              
              
              6,149,180
 
 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 25,
2008,  411,139 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 have no outstanding liabilities as of
April 25, 2008.
  F-20
 Table of Contents 
 We
erroneously omitted four stock option grants that were made to employees who
were not Section 16 officers at the time of the grant. In October 2007, we
implemented the adjustments for the grants omitted from the tender offer. As a
result of these adjustments, we replaced or amended four grants of two employees
impacting options to purchase approximately 11,000 shares at a total cost of
approximately $46,000 of which approximately $18,000 represented additional
expense which was recorded during fiscal year 2008, and approximately $28,000
was recorded against additional paid in capital.
 
 We also
erroneously omitted one stock option grant made to Richard L. Rudolph, M.D.,
Vice President, Clinical and Medical Affairs and Regulatory, and Chief Medical
Officer, a Section 16 officer at the time of the grant.  Section 409A
required that the adjustments to stock option grants to Section 16 officers be
implemented prior to December 31, 2006, and with the exception of one stock
option grant issued to Dr. Rudolph, we implemented the adjustments for all
affected grants to Section 16 officers in December 2006. In August 2007, the
Compensation Committee of the Board of Directors authorized us to address Dr.
Rudolph’s omitted stock option grant by paying him on an annual basis an amount
representing the federal excise tax and interest liability, if any, due under
Section 409A for the unadjusted stock option grant, all on a grossed-up
basis.   The payment is due on April 1 of the calendar year
following the end of the tax year in which the Section 409A tax liability is
incurred.  During the 52 weeks ended April 25, 2008, we recorded
accrued liabilities and additional expenses of approximately $62,000 related to
this grant.
 
 Effective
as of August 1, 2007, Mr. Michael A. Cheney resigned his position as Vice
President, Marketing. On August 3, 2007, the Compensation Committee of the Board
of Directors resolved to amend Mr. Cheney’s stock option grants authorizing an
extension of the period allowed for exercising his vested stock options
applicable to four grants from 90 days from the date of his resignation to 130
days.  The modification affected four options to purchase
approximately 108,000 shares and resulted in additional expense of approximately
$19,000, which was recorded during the 52 weeks ended April 25,
2008.
 
 After we
failed to file our 2006 Form 10-K by July 27, 2006, our registration statements
on Form S-8 for the Stock Purchase Plan and our Stock Option Plans became
ineffective, and between July 27, 2006 and February 9, 2007, we were unable to
issue stock under either plan.  As a result of our inability to issue
stock under the Stock Option Plans, we amended the stock option agreements for
certain grants that would otherwise have expired to extend the exercise or
expiration period during fiscal year 2007. This modification impacted
approximately 142,000 options that were issued to 18 ex-employees and
approximately 45,000 options issued to five active employees and resulted in
compensation expense of approximately $120,000 for the 52 weeks ended April 27,
2007 and derivative expense of approximately $147,000.  With the
filing of our Form 10-Q for the period ended October 27, 2006 on February 9,
2007, we became current in our filings and were again able to issue stock under
the plans.
 
 On
November 17, 2006, Mr. Robert Cummins resigned his position as Chairman of the
Board, President and CEO.  His resignation agreement provided for the
acceleration of all outstanding nonvested restricted stock and stock
options.  Due to these provisions, we accelerated the vesting of
80,000 nonvested shares and approximately 172,000 stock options and recognized
additional expenses in the amount of approximately $2.7 million during the 52
weeks ended April 27, 2007.  In addition, we recognized expenses in
the amount of $1.9 million applicable to the issuance of 75,000 unregistered
shares that vested immediately.
 
 On
November 19, 2006, Ms. Pamela Westbrook resigned her position as
CFO.  Her resignation agreement provided for the acceleration of stock
options and nonvested shares that would have vested within the 12 months
following her date of resignation.  Due to these provisions, we
accelerated the vesting of 1,000 nonvested shares and approximately 11,000 stock
options and recognized additional expenses in the amount of approximately $0.1
million for the 52 weeks ended April 27, 2007.
  F-21
 Table of Contents  
 In
December 2006, we entered into agreements with four current and former Section
16 officers, not including members of our Board, Mr. Cummins or Ms. Westbrook,
agreeing to make payments commencing in January 2008 in consideration of the
officers’ agreement to amend their affected stock option agreements to adjust
the exercise price to the fair market value on the date of the
grant.  At the same time, we also entered into agreements with Ms.
Westbrook and five current and former members of our Board amending their
affected stock option agreements, without any payment from us, to adjust the
exercise price to the fair market value on the date of the grant.  The
agreements to correct the exercise price on options represented approximately
182,000 shares impacted by Section 409A of the IRC.  The cost
associated with the remediation applicable to the officer grants impacted by
Section 409A was approximately $0.4 million, of which we recognized the vested
portion that represents approximately $37,000 and $0.3 million during the 52
weeks ended April 25, 2008 and April 27, 2007, respectively.  These
grants are subject to vesting conditions that require active employment in order
to vest.  According to the agreements, payments are made on a
quarterly basis with the first payroll of the following
quarter.  Liabilities in the amount of approximately $9,000 and $0
were outstanding as of April 25, 2008, and April 27, 2007,
respectively.
 
 The
adoption of SFAS 123(R) on April 29, 2006 had the following effects on
our operations and cash flows for the fiscal year ended April 27,
2007:
 
 52
      Weeks Ended April 27, 2007Without
                SFAS
      123(R)
              
              
              Effect
      of
                SFAS
      123(R)
              
              
              As
      reportedLoss
      from continuing operations
              
              
              $
              (35,154,136
              )
              
              $
              (14,372,359
              )
              
              $
              (49,526,495
              )Loss
      before income taxes
              
              
              
              (36,728,973
              )
              
              
              (14,372,359
              )
              
              
              (51,101,332
              )Net
      loss
              
              
              
              (36,807,748
              )
              
              
              (14,372,359
              )
              
              
              (51,180,107
              )Cash
      flow used in operations
              
              
              
              (20,688,856
              )
              
              
              —
              
              
              
              (20,688,856
              )Cash
      flow provided by financing activities
              
              
              
              14,434,408
              
              
              
              —
              
              
              
              14,434,408Basic
      loss per share
              
              
              
              (1.45
              )
              
              
              (0.56
              )
              
              
              (2.01
              )Diluted
      loss per share
              
              
              
              (1.45
              )
              
              
              (0.56
              )
              
              
              (2.01
              )
 
 For the
52 weeks ended April 27, 2007, the $14.4 million effect of the adoption of
SFAS 123(R) is net of $0.7 million, that would have been recorded
under the intrinsic value method had we continued to apply APB No. 25 for
stock-based compensation expenses, $4.2 million for restricted stock and
$0.1 million for stock option grants modifications.
 
 The
following table illustrates the effect on net loss and loss per share if we had
applied the fair market value recognition provisions of SFAS 123(R) for the
52 weeks ended April 28, 2006.
 
 For
      the 52 Weeks EndedApril 28,
      2006Net
      loss as reported
              $
              (59,069,192
              )(1)
      Add: Stock-based employee compensation expense included in net loss, net
      of tax effects
              
              717,661(1)
      Deduct: Total stock-based employee compensation expenses determined under
      the fair value method for all awards, net of related tax
      effects
              
              (26,384,997
              )Pro-forma
      net loss
              $
              (84,736,528
              )Loss
      per share:Basic —
      as reported
              
              (2.37
              )Basic —
      pro-forma
              
              (3.40
              )Diluted —
      as reported
              
              (2.37
              )Diluted —
      pro-forma
              
              (3.40
              )
 __________
 
 (1)
              There
      was no tax effect included in these amounts due to the valuation
      allowance.
 
  F-22
 Table of Contents  
 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 25, 2008, 2,230 shares remain
available for future issuances under the program.
 
 Note 10.  New
Accounting Pronouncements
 
 In June
2006, the FASB issued FIN 48. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprise’s financial statements
in accordance with FASB Statement No. 109, “Accounting for Income Taxes.”FIN 48 prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. The adoption of FIN 48 is required for
fiscal years beginning after December 15, 2006.  As a result of
the implementation of FIN 48 on April 28, 2007, we reduced our deferred tax
assets and the associated valuation allowance for gross unrecognized tax
affected benefits by approximately $5.6 million. There was no adjustment to our
accumulated deficit as a result of unrecognized tax benefits because of the full
valuation allowance against the related deferred tax assets.  The
amount of unrecognized tax benefits did not change materially during fiscal
year 2008.  If the unrecognized tax benefits are ultimately
recognized, they would have no impact on the effective tax rate due to the
existence of the valuation allowance.
 
 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 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 “FSP FAS 157-2 – Effective date of
FAS No. 157.” This FSP 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). Our implementation of FAS 157 as of April
26, 2008 will not have an impact in our consolidated results of operations and
financial position.
 
 In
December 2006, the FASB issued FSP EITF 00-19-2 (“FSP”). The FSP addresses
an issuer’s accounting for registration payment arrangements. The FSP specifies
that the contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement, whether issued as a
separate agreement or included as a provision of a financial instrument or other
agreement, should be separately recognized and measured in accordance with FASB
Statement No. 5 “Accounting for
Contingencies.”The guidance in the FSP amends FASB Statements No. 133, “Accounting for Derivative
Instruments and Hedging Activities,”and No. 150, “Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity,”as well
as FASB Interpretation No. 45, “Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others”to include scope exceptions for registration
payment arrangements. The FSP is effective immediately for registration payment
arrangements and the financial instruments subject to those arrangements that
are entered into or modified subsequent to the date of issuance of the FSP. For
registration payment arrangements and financial instruments subject to those
arrangements that were entered into prior to the issuance of the FSP, it is
effective for financial statements issued for fiscal years beginning after
December 15, 2006, and interim periods within those fiscal years. We
adopted the FSP on April 28, 2007. The implementation of the FSP resulted in an
adjustment to the beginning balance in accumulated deficit in the amount of
approximately $0.3 million recorded during the 52 weeks ended April 25,
2008.
  F-23
 Table of Contents 
 In
February 2007, the FASB issued FAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities — Including an amendment of FASB Statement
No. 115”(“FAS 159”). FAS 159 permits entities to choose to
measure many financial instruments and certain other items at fair value. The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions. FAS 159 is expected to expand the use of fair value
measurement, which is consistent with our Board’s long-term measurement
objectives for accounting for financial instruments. FAS 159 is effective as of
the beginning of an entity’s first fiscal year that begins after
November 15, 2007, which for us would be fiscal year 2009. Early adoption
is permitted as of the beginning of a fiscal year that begins on or before
November 15, 2007, provided the entity also elects to apply the provisions
of FAS 157.Our
implementation of FAS 159 as of April 26, 2008 will not have an impact in our
consolidated results of operations and financial position.
 
 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. The Statement applies to the accounting
for noncontrolling interests and transactions with noncontrolling interest
holders in consolidated financial statements. FAS 160 is effective for the
periods beginning on or after December 15, 2008. Earlier application is
prohibited. We are currently evaluating the impact that the implementation of
FAS 160 as of April 25, 2009 may have 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) is effective for periods beginning on or
after December 15, 2008. We are currently evaluating the impact that the
implementation of FAS 141(R) as of April 25, 2009 may have on our
consolidated results of operations and financial position.
 
 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”). It 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 periods beginning on or after November 15,
2008, or April 25, 2009 for us. We are currently evaluating the impact that the
implementation of FAS 161 may have in our consolidated results of operations and
financial position.
  F-24
 Table of Contents  
 Note 11.  Income
Taxes
 
 The
U.S. and foreign components of loss before income taxes and the provision
for income taxes are presented in this table:
 
 52
      Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006Loss
      before income taxes:Domestic
              
              $
              (8,627,510
              )
              
              $
              (48,172,762
              )
              
              $
              (57,271,372
              )Foreign
              
              
              (1,972,092
              )
              
              
              (2,928,570
              )
              
              
              (1,698,554
              )$
              (10,599,602
              )
              
              $
              (51,101,332
              )
              
              $
              (58,969,926
              )Provision
      for current income tax expense:Federal
              
              $
              64,721
              
              
              $
              —
              
              
              $
              —State
      and local
              
              
              68,440
              
              
              
              27,790
              
              
              
              39,730Foreign
              
              
              27,947
              
              
              
              50,985
              
              
              
              59,536$
              161,108
              
              
              $
              78,775
              
              
              $
              99,266Provision
      for deferred income tax expense (benefit):Federal
              
              $
              —
              
              
              $
              —
              
              
              $
              —State
      and local
              
              
              (425,945
              )
              
              
              —
              
              
              
              —Foreign
              
              
              —
              
              
              
              —
              
              
              
              —$
              (425,945
              )
              
              $
              —
              
              
              $
              —Total
      Provision
              
              $
              (264,837
              )
              
              $
              78,775
              
              
              $
              99,266
 
 The
following is a reconciliation of the statutory federal income tax rate to our
effective income tax rate expressed as a percentage of loss before income
taxes:
 
 For
      the 52 Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006U.S. statutory
      rate
              
              
              (34.0
              )%
              
              
              (34.0
              )%
              
              
              (34.0
              )%Change
      in deferred tax valuation allowance excluding impact of
      shortfall
              
              
              29.1
              
              
              
              30.2
              
              
              
              31.6Federal
      income tax provision
              
              
              0.6
              
              
              
              0.0
              
              
              
              0.0Shortfall
      on settlement of options and restricted stock
              
              
              30.8
              
              
              
              1.8
              
              
              
              0.0Reduction
      in valuation allowance due to shortfall
              
              
              (30.8
              )
              
              
              (1.8
              )
              
              
              0.0Foreign
      taxes
              
              
              0.3
              
              
              
              0.1
              
              
              
              0.1State
      and local tax provision
              
              
              (3.4
              )
              
              
              0.1
              
              
              
              0.1Other,
      net
              
              
              4.9
              
              
              
              3.8
              
              
              
              2.4(2.5
              )%
              
              
              0.2
              %
              
              
              0.2
              %
 
  F-25
 Table of Contents  
 Significant
components of our deferred tax assets are as follows:
 
 April 25,
      2008
              
              
              April 27,
      2007Deferred
      tax assets:Federal
      net operating loss carryforwards
              
              $
              79,255,912
              
              
              $
              82,344,559State
      net operating loss carryforwards and other
              
              
              9,577,159
              
              
              
              9,337,842Deferred
      compensation expense
              
              
              8,028,569
              
              
              
              8,238,132Foreign
      net operating loss carryforwards
              
              
              7,920,487
              
              
              
              7,305,790Licensing
      income
              
              
              2,916,924
              
              
              
              —Charitable
      contribution carryforwards
              
              
              1,698,856
              
              
              
              877,286Accrued
      expenses
              
              
              640,963
              
              
              
              710,119Property
      and equipment
              
              
              604,458
              
              
              
              467,325Inventory
      costs capitalized
              
              
              537,162
              
              
              
              400,011Reserves
              
              
              192,304
              
              
              
              258,237Federal
      tax credit carryforwards
              
              
              95,650
              
              
              
              4,207,517Total
      deferred tax assets
              
              
              111,468,444
              
              
              
              114,146,818Deferred
      tax liabilities, net
              
              
              —
              
              
              
              —Deferred
      tax valuation allowance
              
              
              (111,042,498
              )
              
              
              (114,146,818
              )Net
      deferred tax assets
              
              $
              425,946
              
              
              $
              —
 
 At
April 25, 2008, we have net operating loss carryforwards of approximately
$254.4 million for federal income tax purposes, which expire during the
years 2009 through 2027, and tax credit carryforwards of approximately
$4.0 million for federal income tax purposes, which expire during the years
2009 through 2021. At April 25, 2008, we have net operating loss
carryforwards of approximately $95.7 million for state and local income tax
purposes, which expire at various dates beginning in 2009. In August 2006, we
experienced an ownership change as defined in Section 382 of the IRC. Our
ability to utilize credit carryforwards to offset future tax liabilities and to
utilize certain net operating losses to offset future taxable income may be
limited pursuant to IRC Section 382.
  In
connection with the issuance of our Convertible Notes as disclosed in “Note 6.
Convertible Notes” we purchased the Note Hedge from MLI for approximately three
million shares of our common stock at an exercise price of $41.50 per share
during the quarter ended October 28, 2005. The Convertible Note and the Note
Hedge are considered a synthetic debt instrument under the rules of Treasury
Regulation 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 original 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. We are reviewing MLI’s assertion that the Note Hedge has been
terminated and the tax consequences of that action.
  F-26
 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 that 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 25, 2008 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 25, 2008, approximately $20.8 million
relates to stock option compensation deductions and $4.0 million relates to
amortization of the Note Hedge. The tax benefit associated with stock option
compensation deductions and the Note Hedge will be credited to equity when
realized. The valuation allowance decreased approximately $3.1 million for the
52 weeks ended April 25, 2008 due primarily to changes in valuation allowance
related to the utilization of federal net operating loss carryforward, the
reduction of deferred tax benefits for uncertain tax positions under FIN 48, and
the increase in deferred tax benefits for licensing income.  The
valuation allowance increased approximately $16.3 million for the 52 weeks ended
April 27, 2007 due primarily to an increase in the federal net operating loss
carryforwards.  In fiscal years 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.
 
 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 rollforward of our total gross unrecognized tax benefit for
fiscal year 2008 (in thousands):
 
 Balance
      as of April 28, 2007
              
              $
              (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
              
              
              198Imputed
      interest on overseas payments
              
              
              109Change
      in effective tax rate (federal and state)
              
              
              11Balance
      as of April 25, 2008
              
              $
              (5,244
              )
 
 The
unrecognized tax benefits of $5.6 million, at adoption, include 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.
 
 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 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
25, 2008 we did not have any accrued interest or penalties associated with
unrecognized tax benefits.
  F-27
 Table of Contents  
 We are
currently under limited scope audit by the Internal Revenue Service (“IRS”) and
the state of California in connection with our stock option activity. In
November 2007, we received an IRS request for a remote examination and
associated information document requests seeking information related to our
stock option practices.  In February 2008, the IRS made an additional
information document request also related to our stock option
practices.  We are endeavoring to cooperate with the IRS in this
examination by providing documents and information in response to its
examination requests. The examination is ongoing. 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 1994 and subsequent years, with certain
exceptions.
 
 In May
2006, Texas enacted the Texas Margin Tax law which restructures the state
business tax by replacing the taxable capital components of the current
franchise tax with a new "taxable margin" component for taxable years ended on
or after January 1, 2007.  As a result of the Texas Margin Tax law we
recognized in fiscal year 2008, current state income tax expense of $38,000 for
the state of Texas and 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 in fiscal year 2008 of approximately $426,000, included in Other Assets on
our Balance Sheet.  This deferred tax asset was 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 liabilities.
 
 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. We incurred expenses applicable to these contributions of
approximately $0.8 million, $1.2 million and $1.5 million for the
fiscal years 2008, 2007 and 2006, 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 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. Enrollment in both studies is ongoing. 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 2008, we have incurred direct
expenses of approximately $4.2 million for the dosing study and $2.0 million for
the TRD registry.
 
 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.
  F-28
 Table of Contents 
 Effective
December 17, 2007, we entered into a license agreement (the “EES License
Agreement”) with Ethicon Endo-Surgery, Inc. (“EES”), granting EES an exclusive
license to 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 retain the responsibility to
prosecute the licensed patent applications and maintain the licensed patents,
including the obligation to pay related expenses for U.S. patents and
applications.  EES has the obligation to pay or reimburse us for
expenses related to patents issued and applications pending outside the
U.S.  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. During the fiscal year ended
April 25, 2008, we recognized revenue in the amount of approximately $0.5
million applicable to the EES License Agreement, and recorded a related cost of
$47,500 applicable to the transfer of certain patent rights.  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 25,
2008.
 
 Royalty
expenses for the 52 weeks ended April 25, 2008, April 27, 2007
and April 28, 2006 were $3.6 million, $3.8 million and
$3.6 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. The lease terms provide for tenant improvement
allowances that are recorded as deferred rent and amortized, straight-line, as
reductions to rent expense over the term of the lease. At April 25, 2008
and April 27, 2007, we had zero and approximately $152,000 of deferred
rent, respectively. 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.  The net present value of our
future lease obligations related to the space surrendered as of April 25, 2008
is approximately $563,000, partially offset by the net present value of the
estimated proceeds from the sublease of the space surrendered of approximately
$480,000.  A net expense and accrued liability of approximately
$83,000 were recorded as of April 25, 2008.
 
 Future
minimum payments relating to these agreements at April 25, 2008 are as
follows:
 
 52/53
      Weeks Ending on the last Friday of April:2009
              
              $
              3,401,1872010
              
              
              3,228,7522011
              
              
              2,793,8272012
              
              
              2,726,1322013
              
              
              2,768,719Thereafter
              
              
              4,731,716
 
 Our
rental expense for the 52 weeks ended April 25, 2008, April 27,
2007 and April 28, 2006 amounted to approximately $3.0 million,
$3.2 million and $3.0 million, respectively.
 
 Distribution
Agreements.At April 25, 2008, we had approximately 42
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, 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.
  F-29
 Table of Contents 
 At
April 25, 2008, we had approximately $0.3 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.
 
 Indenture
Default Litigation
 
 In July
2006, we received the Notice of Default from the Trustee, pursuant to which the
Trustee asserted that we were in default of our obligations under the Indenture
with respect to our Convertible Notes, 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 declared the
Convertible Notes due and payable at their principal amount, together with
accrued and unpaid interest, fees and expenses, and demanding that all such
principal, interest, fees and expenses under the Convertible Notes be paid to
the Trustee immediately. To clarify our rights and responsibilities under the
Indenture, we filed a declaratory judgment action in October 2006 in Texas
state court seeking a declaration that no event of default has occurred under
the Indenture and requesting attorney fees under the Declaratory Judgment Act.
In January 2007, the Trustee removed the lawsuit to the U.S. District Court
for the Southern District of Texas, Cyberonics, Inc. v.
Wells Fargo Bank, N.A. as the
Trustee under Indenture, Civil Action No. A:07-CV-121, and filed an
answer and counterclaim seeking damages for the alleged default. After both
parties filed motions for summary judgment, the district court granted our
motion and denied the Trustee’s motion, declaring that “Cyberonics satisfied its
contractual obligations and has not breached the Agreement.” As a result of the
pending litigation, the Convertible Notes were classified as short term
liabilities in our balance sheet as of April 27, 2007.
 
 The
Trustee appealed the district court’s decision to the U.S. Court of Appeals for
the Fifth Circuit.  With the appeal still pending, we reached an
agreement with the Trustee to settle the proceedings and executed a Settlement
Agreement and Supplemental Indenture on April 17, 2008.  Pursuant to
the terms of the settlement, the appeal was dismissed with prejudice, the
parties released all claims, and the parties executed the Supplemental
Indenture.  The Supplemental Indenture obligates us to repurchase for
par value any of the Convertible Notes tendered to us on December 27, 2011, nine
months prior to the original maturity date of the Convertible
Notes.  The settlement and the associated documents allow us to
reflect the Convertible Notes as a long-term liability at April 25,
2008.
 
 Securities
Class Action Lawsuit
 
 In June
2005, a putative class action lawsuit was filed against us and certain of our
officers and Robert P. Cummins, then Chairman and CEO, in the United
States District Court for the Southern District of Texas. The lawsuit is styled
Richard Darquea v.
Cyberonics Inc., et al., Civil Action No. H:05-cv-02121. A second
lawsuit with similar allegations, styled Stanley Sved v. Cyberonics,
Inc., et al.,Civil Action No. H:05-cv-2414 was filed in
July 2005. In July 2005, the court consolidated the two cases under
Civil Action No. H-05-2121, styled In re Cyberonics, Inc. Securities
Litigation,and entered a scheduling order. In September 2005, the
court appointed EFCAT, Inc., John E. and Cecelia Catogas, Blanca Rodriguez, and
Mohamed Bakry as lead plaintiffs and also appointed lead plaintiffs’
counsel.
  F-30
 Table of Contents  
 The lead
plaintiffs filed a consolidated amended complaint in November 2005. The
complaint generally alleged, among other things, that the defendants violated
Sections 10(b) and 20(a) of the Exchange Act by making false and misleading
statements regarding our VNS Therapy System as a therapy for depression. In
January 2006, the defendants filed a motion to dismiss the consolidated
complaint on the basis that the complaint fails to allege facts that state any
claim for securities fraud. In July 2006, the District Court granted our
motion to dismiss the consolidated complaint, allowing the plaintiffs
30 days to file an amended complaint. The court found that the plaintiffs
failed to meet their burden to plead a securities fraud claim with
particularity, including failures to allege with particularity a material
misstatement or omission, to allege facts sufficient to raise a strong inference
of intent or severe recklessness, and to allege sufficiently the causal
connection between the plaintiffs’ loss and the defendants’ actions. The court
noted that “the deficiencies in Plaintiffs’ complaint might well extend beyond
the point of cure,” but nonetheless granted plaintiffs the right to amend their
complaint in light of the strong presumption of law favoring a right to
amend.
 
 In
August 2006, the lead plaintiffs filed a First Amended Complaint for
Violation of the Securities Laws. The complaint generally alleges, among other
things, that the defendants violated Sections 10(b) and 20(a) of the
Exchange Act by making false and misleading statements regarding the VNS Therapy
System as a therapy for treatment-resistant depression. The lead plaintiffs
allege that the defendants failed to disclose that certain individuals
associated with the FDA had safety and efficacy concerns about the use of the
VNS Therapy System for the treatment of depression and questioned the adequacy
of evidence of safety and effectiveness we presented to the FDA, that the
defendants misrepresented the prospect for payer reimbursement for the VNS
Therapy System, that the defendants concealed executive compensation and
governance issues, and that the defendants falsely stated that an analyst’s
statements about options granted in June 2004 were inaccurate and without merit.
The lead plaintiffs seek to represent a class of all persons and entities,
except those named as defendants, who purchased or otherwise acquired our
securities during the period February 5, 2004 through August 1, 2006.
The amended complaint seeks unspecified monetary damages and equitable or
injunctive relief, if available.
 
 In
October 2006, the defendants filed a motion to dismiss the amended
complaint on the basis that the complaint fails to allege facts that state any
claim for securities fraud. The lead plaintiffs filed an opposition to the
motion to dismiss that same month, and the defendants filed a reply to the
opposition in November 2006. Also in October 2006, a week before the
defendants filed their reply in connection with the motion to dismiss the
amended complaint, the Los Angeles County Employees Retirement Association filed
a motion seeking to intervene and asking the court to require the lead
plaintiffs to republish notice of the amended class action claims. In
November 2006, the court issued an order compelling republication of notice
and staying the proceeding pending determination of the lead plaintiff pursuant
to the Private Securities Litigation Reform Act. In December 2006, the lead
plaintiffs published notice of the filing of the first amended complaint,
stating that investors who purchased our securities during the expanded class
period (February 5, 2004 through August 1, 2006, inclusive) may move
the court for consideration to be appointed as lead plaintiff within
60 days. In February 2007, the court lifted the stay, and in March 2007,
the lead plaintiffs filed a motion seeking leave to file an amended complaint.
In April 2007, the court denied the plaintiff’s motion to amend without
prejudice and stayed the litigation in light of issues raised in a case that was
pending before the U.S. Supreme Court, but had not yet reached a
resolution. In June 2007, the court lifted the stay and granted plaintiffs leave
to “supplement — not amend” their first amended complaint and granted us
leave to “supplement — not amend” our motion to dismiss the first amended
complaint. In October 2007, the court issued an order dismissing the plaintiffs’
supplemented first amended complaint with prejudice, and the plaintiffs filed a
notice of appeal to the United States Court of Appeals for the Fifth
Circuit.  The plaintiffs filed their Brief of Appellants in January
2008.  We filed our Brief of Appellee in February 2008, and the
plaintiffs filed their Reply Brief later that same month.  The Court
of Appeals has scheduled oral argument in July 2008.  Our brief to the
appellate court seeks the affirmance of the district court’s favorable judgment;
however, an adverse result in this lawsuit could have a material adverse effect
on us, our consolidated financial position, results of operations and cash
flows.
  F-31
 Table of Contents 
 Stockholder
Derivative Litigation
 
 We were
named as a nominal defendant in a stockholder derivative lawsuit brought on
behalf of the company styled Rudolph v. Cummins, et alpending in the U.S. District Court for the Southern District of Texas,
Houston Division, naming several of our current and former officers and
directors as defendants, alleging purported improprieties in our issuance of
stock options and the accounting related to issuances. The operative Amended
Complaint also purported to state a putative class action claim against the
individual defendants for violation of Section 14(a) of the Exchange Act,
as well as claims against the individual defendants for breach of fiduciary
duty, gross mismanagement and corporate waste, against the officer defendants
for unjust enrichment, and against certain individual defendants for insider
trading.
 
 We were
also named as a nominal defendant in five stockholder derivative lawsuits
brought on behalf of the company in the District Court of Harris County, Texas,
alleging purported improprieties in our issuance of stock options and the
accounting related to such issuances. These cases were consolidated into a
single case, In re Cyberonics,
Inc. Derivative Litigation, in the 189th Judicial District Court of
Harris County, Texas in January 2007 (together with Rudolph v. Cummins, the
“Derivative Lawsuits”).
 
 In
November 2006, our Board formed a Special Litigation Committee (“SLC”) to
investigate, analyze and evaluate the claims raised in the Derivative Lawsuits
and to determine the actions, if any, we should take with respect to the
derivative claims, including whether to pursue, to seek to dismiss or to attempt
to resolve the derivative claims in the best interests of us and our
stockholders.
 
 In
October 2007, we and the individual defendants reached an agreement in
principle, set forth in a memorandum of understanding (“MOU”), with the
plaintiffs, to settle claims alleged in the Derivative Lawsuits.  The
settlement, which was subject to a stipulation of settlement to be approved by
the parties, the SLC of our Board, and our insurer, provided in pertinent part
as follows:
 
 —
              All
      claims in the Derivative Lawsuits will be dismissed with
      prejudice.—
              There
      will be no admission of liability by any defendant.—
              All
      claims that were or could have been asserted in the Derivative Lawsuits
      against us, all individual defendants, and KPMG LLP will be released,
      excluding any claim we may have under the resignation agreements of Robert
      P. Cummins and Pamela B. Westbrook with respect to their ongoing
      obligations under those agreements.—
              The
      plaintiffs will seek court approval for an award of attorneys fees and
      reimbursement of expenses in an amount not to exceed $650,000 to be paid
      solely by us or our insurer, which approval the settling defendants will
      not oppose;—
              The
      settlement will become effective and any award of fees and expenses to the
      plaintiffs’ counsel will become payable only if and when the following
      conditions are satisfied:ú
              the
      SLC and our insurer approve the settlement
  documentation;ú
              the
      plaintiffs complete confirmatory discovery demonstrating to the reasonable
      satisfaction of plaintiffs’ counsel that the settlement is fair and
      reasonable;ú
              the
      court in In re
      Cyberonics, Inc. Derivative Litigation enters a judgment, after
      notice and opportunity for a final hearing, approving the settlement and
      dismissing with prejudice the claims against all
    defendants;ú
              the
      court in Rudolph v.
      Cummins enters a judgment dismissing with prejudice the claims
      against all defendants without costs; andú
              the
      foregoing judgments become final judgments no longer subject to
      review.—
              The
      MOU is null and void if any of the foregoing conditions is not
      satisfied.
 
 In
December 2007, as contemplated in the MOU, we, along with the individual
defendants, entered into a Stipulation of Settlement (“Stipulation”) with the
plaintiffs pursuant to which the parties agreed, consistent with the terms and
conditions in the MOU, to settle the claims alleged in the Derivative
Lawsuits.  On January 2, 2008, the 189th
Judicial District Court of Harris County, Texas entered a Preliminary Approval
Order setting a hearing for March 7, 2008 on final approval of the settlement,
approving the forms of notice to shareholders of the settlement, and setting a
deadline on February 26, 2008 for the filing of objections to the
settlement.  In January 2008, we published notices of the settlement
to shareholders.
  F-32
 Table of Contents  
 On March
7, 2008, the 189th
Judicial District Court of Harris County, Texas entered a final judgment
approving the settlement and dismissing the case.  On March 17, 2008,
the United States District Court for the Southern District of Texas entered a
final judgment dismissing Rudolph v.
Cummins.  Also on March 17, 2008, our insurer paid $650,000
into escrow pending finality of the judgments in the Derivative
Lawsuits.  On April 22, 2008, the period for appealing the judgments
in the Derivative Lawsuits expired without an appeal.  Thereafter, the
escrowed funds were paid to the plaintiffs’ attorneys.
 
 Governmental
Investigation of Options Granting Practices
 
 On
June 9, 2006, the staff of the SEC advised us that it had commenced an
informal inquiry of some of our stock option grants. On June 26, 2006, we
received a subpoena from the Office of the United States Attorney for the
Southern District of New York requesting documents related to our stock option
grants practices and procedures. On October 23, 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 Blue Cross and Blue Shield 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.
Our Board directed the Audit Committee to conduct an independent investigation
of our stock option grants, practices and procedures, including compliance with
Generally Accepted Accounting Principles and all applicable statutes, rules and
regulations, and the Audit Committee retained independent counsel to assist it
in completing that review.
 
 The Audit
Committee, with the assistance of its independent counsel and counsel’s forensic
accountants, completed its review of our stock option grants, practices and
procedures. The 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 the 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.
 
 In
November 2007, the Internal Revenue Service (“IRS”) initiated a limited scope
remote examination and tendered a document request seeking information related
to our stock option practices.  In February 2008, the IRS tendered a
second document request seeking additional information related to our stock
option practices.  We are endeavoring to cooperate with the IRS in
this examination by providing documents and information in response to its
requests.  The examination is ongoing.
  F-33
 Table of Contents  
 Senate
Finance Committee Investigation
 
 In May
2005, we received a letter from the Senate Finance Committee (“SFC”) advising us
that it is examining FDA’s handling of our PMA-Supplement for the use of VNS
Therapy to address depression. Following our responses to the May letter, we
received a second letter from the SFC in July 2005, to which we responded by
providing the requested documents and information. In February 2006, the SFC
published a Committee Staff Report entitled, “Review of FDA’s Approval Process
for the Vagus Nerve Stimulation System for Treatment-Resistant Depression.” The
report states that a senior FDA official approved our VNS Therapy System for
depression despite the conclusion of more than 20 FDA scientists, medical
officers and management staff who reviewed our application and that the
application did not demonstrate reasonable assurance of safety and effectiveness
sufficient for approval in depression. The report concludes that the FDA did not
disclose to the public the scientific dissent within the FDA regarding the
effectiveness of the VNS Therapy System for depression and that the FDA has not
ensured that the public has all of the accurate, scientific information
regarding the VNS Therapy System for depression it needs. The report does not
accuse us of any misconduct and does not conclude that FDA violated any law,
regulation or procedure by approving VNS Therapy for depression; however, the
report states that the SFC staff received a range of allegations regarding FDA
and us and that allegations other than those addressed in the report may be
addressed at a later date. The report follows a year-long investigation
conducted by the staff of the SFC, including letters we received in May 2005 and
July 2005 requesting documents and information. We cooperated with the SFC staff
and provided the requested documents and information.
 
 We
received a letter in November 2006 and a second letter in March 2007 from
Senator Charles Grassley on behalf of the SFC requesting our cooperation in
providing certain documents and information relating to (1) our employees,
agents, and consultants regarding their meetings and communications with the
Centers for Medicare and Medicaid Services (“CMS”) regarding coverage of the VNS
Therapy System for depression and (2) our agents’ and consultants’
participation in presentations, preparation of publications, and advice to
government agencies on VNS Therapy for depression. We believe that we have
responded fully to Senator Grassley’s requests.
 
 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 25, 2008, 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.
  F-34
 Table of Contents  
 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.  In March 2008, we agreed to surrender an additional 294
square feet and further modify our minimum lease obligations.  The net
present value of our future lease obligations related to the space surrendered
as of April 25, 2008, is approximately $563,000, partially offset by the net
present value of the estimated proceeds from the sublease of the space
surrendered of approximately $480,000. A net expense and accrued liability of
approximately $83,000 were recorded as of April 25, 2008.
 
 Note 17.  Geographic
Information
 
 Net
      Sales52
      Weeks EndedApril 25,
      2008
              
              
              April 27,
      2007
              
              
              April 28,
      2006United
      States
              
              $
              94,902,720
              
              
              $
              111,077,666
              
              
              $
              107,906,412International
              
              
              26,327,022
              
              
              
              19,890,771
              
              
              
              15,535,163Total
              
              $
              121,229,742
              
              
              $
              130,968,437
              
              
              $
              123,441,575Long-Lived
      AssetsApril 25,
      2008
              
              
              
              April 27,
      2007
              
              
              
              April 28,
      2006United
      States
              
              $
              8,467,363
              
              
              
              11,475,519
              
              
              $
              14,502,293International
              
              
              727,305
              
              
              
              742,107
              
              
              
              522,051Total
              
              $
              9,194,668
              
              
              
              12,217,626
              
              
              $
              15,024,344
 
 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 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
      earnings (loss)
              
              
              (8,163,463
              )
              
              
              (4,077,340
              )
              
              
              (997,316
              )
              
              
              2,903,354
              
              
              
              (10,334,765
              )Basic
      and diluted earnings (loss) per share
              
              
              (0.31
              )
              
              
              (0.15
              )
              
              
              (0.04
              )
              
              
              0.11
              
              
              
              (0.39
              )52 weeks
      ended April 27, 2007Net
      sales
              
              $
              33,731,520
              
              
              $
              34,140,796
              
              
              $
              31,664,282
              
              
              $
              31,431,839
              
              
              $
              130,968,437Gross
      profit
              
              
              29,930,192
              
              
              
              30,336,850
              
              
              
              26,736,914
              
              
              
              25,706,107
              
              
              
              112,710,063Net
      loss
              
              
              (8,533,387
              )
              
              
              (12,493,703
              )
              
              
              (19,385,300
              )
              
              
              (10,767,717
              )
              
              
              (51,180,107
              )Basic
      and diluted loss per share
              
              
              (0.34
              )
              
              
              (0.49
              )
              
              
              (0.76
              )
              
              
              (0.42
              )
              
              
              (2.01
              )
 __________
 
 (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-35
 Table of Contents  
 Note 19.  Supplementary
Information to Form 10-K for the Fiscal Year Ended April 28, 2006
 
 As noted
in our financial statements and footnotes included in the 2006 Form 10-K, which
was filed with the SEC on January 5, 2007, we restated our financial results for
the fiscal years prior to 2006 for non-cash stock-based compensation expense
relating to stock option grants.
 
 We
described in the Notes to the Consolidated Financial Statements in the 2006 Form
10-K that we had conducted an internal investigation regarding our stock option
grants and related practices, procedures and accounting during the periods from
1993 through the conclusion of the investigation. As a result of the internal
investigation, we restated prior fiscal periods to reflect additional
stock-based compensation expense relating to stock option grants made during the
period from fiscal years 1994 through 2006.
 
 We, in
consultation with our independent auditors and legal counsel, used our best
efforts to provide disclosure in our 2006 Form 10-K, which incorporated all
guidance available at the time of filing.
 
 As
disclosed in our 2006 Form 10-K, the errors and the types of errors identified
during the review process were as follows:
 
 (1)
              Incorrect
      measurement dates were used for certain stock option grants made
      principally during the period from 1998 to 2003;(2)
              The
      existence of multiple documents with different dates evidencing approval
      for the same grants resulted in a scenario that is considered re-pricing
      under GAAP;(3)
              The
      cancellation of certain stock option grants that were subsequently
      re-issued at a lower price than the original grant constituted re-pricing
      that rendered the grants subject to variable accounting
      treatment;(4)
              Stock
      option grants issued to non-employees were either not recorded or were
      recorded incorrectly; and(5)
              Other
      miscellaneous errors related to stock
options.
 
 On
January 16, 2007, subsequent to the filing of our 2006 Form 10-K, the Chief
Accountant in the Division of Corporation Finance of the SEC published an
illustrative letter to provide guidance concerning information registrants
should consider in reports filed with the SEC to correct errors in accounting
for stock option grants (the “Illustrative Letter”). In addition to the
information and disclosures incorporated in our 2006 Form 10-K, the Illustrative
Letter provided guidance to incorporate the following additional
disclosures:
 
 (a)
              The
      amount of each material type of error, as disclosed above, that is
      included in the cumulative adjustment to opening retained earnings for the
      fiscal year ended April 30, 2004
is:
 
 Cumulative
      Adjustment to Retained EarningsType
      of Error
              
              
              (1)
              
              
              
              (2)
              
              
              
              (3)
              
              
              
              (4)
              
              
              
              (5)
              
              
              TotalCumulative
      Adjustment
              
              $
              4,091,457
              
              
              $
              3,964,500
              
              
              $
              836,293
              
              
              $
              842,403
              
              
              $
              105,518
              
              
              $
              9,840,171
 
 (b)
              Information
      in accordance with paragraph 45.c.2 of FASB Statement No. 123, which
      requires a tabular presentation of the stock-based employee compensation
      cost, net of related tax effects, included in the determination of net
      income as reported and as restated, for the fiscal years 2001 through 2003
      is as follows:
 
 Stock-Based
      Compensation ExpenseYear
              
              As
      Reported
              
              
              As
      Restated2001
              
              $
              393,750
              
              
              $
              1,330,1292002
              
              
              472,500
              
              
              
              2,565,7142003
              
              
              472,500
              
              
              
              5,749,286
 
 We
      recorded no APB 25 expense on an as reported basis prior to fiscal year
      2001.
  F-36
 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 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
              10.34.11
              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
              10.1
 
  
 Table of Contents 
 Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference10.2
              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 Lessor10.6*
              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 Lessor10.7
              Purchase
      Agreement dated September 21, 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 September 27,
    2005
              000-19806
              10.110.8
              Credit
      Agreement between Cyberonics, Inc. and Merrill Lynch Capital, a division
      of Merrill Lynch Business Financial Services Inc., as Administrative Agent
      and as Lender and as Sole Bookrunner and Sole Lead Arranger, and the
      additional Lenders thereto dated January 13, 2006
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on January 19,
2006
              000-19806
              10.110.9
              Consent
      and Amendment Agreement effective July 27, 2006 to the Credit Agreement
      between Cyberonics, Inc. and Merrill Lynch Capital, a division of Merrill
      Lynch Business Financial Services Inc., individually as Lender,
      Administrative Agent, Sole Bookrunner and Sole Lead Arranger, and the
      additional Lenders thereto
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on July 27, 2006
              000-19806
              10.110.10
              Consent
      and Amendment Agreement effective October 31, 2006 to the Credit Agreement
      between Cyberonics, Inc. and Merrill Lynch Capital, a division of Merrill
      Lynch Business Financial Services Inc., individually as Lender,
      Administrative Agent, Sole Bookrunner and Sole Lead Arranger, and the
      additional Lenders thereto
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on November 6,
2006
              000-19806
              10.110.11†
              Consent
      and Amendment Agreement, dated December 29, 2006, by and among Cyberonics,
      Inc., Merrill Lynch Capital, and the Lenders party to the Credit Agreement
      (as defined therein)
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on January 5, 2007
              000-19806
              10.110.12†
              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
              4.110.13†
              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
              10.210.14†
              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
              10.1210.15†
              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
              4.4
 
  
 Table of Contents 
 Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference10.16†
              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
              4.510.17†
              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
              4.110.18†
              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
              10.6910.19†
              Cyberonics,
      Inc. Amended and Restated 1997 Stock Plan
              
              Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on March 8,
      2001
              333-56694
              4.510.20†
              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
              10.110.21†
              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 B10.22†
              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
              10.510.23†
              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
              10.610.24†
              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
              10.710.25†
              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
              10.810.26†
              Cyberonics,
      Inc. 1998 Stock Option Plan
              
              Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on November 3,
      1998
              333-66691
              4.110.27†
              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
              10.2310.28†
              Cyberonics,
      Inc. New Employee Equity Inducement Plan
              
              Cyberonics,
      Inc.’s Registration Statement on Form S-8 filed on August 27,
      2003
              333-108281
              4.310.29†
              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
              4.110.30†*
              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.10.31†
              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’ Common Stock Price
              
              Cyberonics,
      Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 26,
      2007
              000-19806
              10.1
 
  
 Table of Contents  
 Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference10.32†
              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
              10.210.33†
              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
              10.310.34†
              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
              10.410.35†
              Cyberonics,
      Inc. 2005 Stock Plan
              
              Cyberonics,
      Inc.’s Proxy Statement for the Special Meeting of Stockholders filed on
      April 14, 2005
              000-19806
              Annex A10.36†
              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
              10.5210.37†
              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
              10.6810.38†
              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
              10.7010.39†
              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
              10.210.40†
              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
              10.7210.41†
              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
              10.6610.42†*
              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
              10.6410.43†
              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
              10.110.44†
              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
              10.210.45†
              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
              10.110.46†
              Indemnification
      Agreement effective August 1, 2003 between Cyberonics, Inc. and Robert P.
      Cummins
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.3210.47†
              Employment
      Agreement effective August 5, 2005 between Cyberonics, Inc. and Robert P.
      Cummins
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on August 9, 2005
              000-19806
              99.110.48†
              Letter
      Agreement Regarding Advancement of Attorney’s Fees effective September 28,
      2006 between Cyberonics, Inc. and Robert P. Cummins
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.3410.49†
              Resignation
      Agreement effective November 17, 2006 between Cyberonics, Inc. and Robert
      P. Cummins
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on November 20,
    2006
              000-19806
              10.110.50†
              Description
      of Non-Equity Incentive Compensation under the Employment Agreement of
      Robert P. Cummins
              
              Cyberonics,
      Inc.’s Annual Report on Form 10-K for the year ended April 27,
      2007
              000-19806
              10.6710.51†
              Employment
      Agreement effective June 15, 2006 between Cyberonics, Inc. and William
      Steven Jennings
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.3810.52†
              Separation
      Agreement between Steve Jennings and Cyberonics, Inc., dated January 31,
      2007
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on February 6,
2007
              000-19806
              10.110.53†
              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
              10.66
 
  
 Table of Contents 
 Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference10.54†
              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
              10.110.55†
              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
              10.110.56†
              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
              10.4410.57†
              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
              10.4010.58†
              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
              10.4610.59†
              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
              10.110.60†
              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
              10.4810.61†*
              Employment
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and James A.
      Reinstein10.62†*
              Severance
      Agreement dated July 9, 2007 by and between Cyberonics, Inc. and James A.
      Reinstein10.63†
              Release
      Agreement effective May 4, 2007 between Cyberonics, Inc. and John A.
      Riccardi
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on May 10, 2007
              000-19806
              10.110.64†
              Employee
      Restricted Stock Agreement dated July 22, 2005 between Cyberonics, Inc.
      and Richard L. Rudolph, M.D.
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.5110.65†
              Stock
      Option Agreement Amendment and Bonus Agreement dated December 28, 2006
      between Cyberonics, Inc. and Richard L. Rudolph, M.D.
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.5310.66†*
              Letter
      Agreement dated February 1, 2008 between Cyberonics, Inc. and Dr. Richard
      L. Rudolph10.67†
              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
              10.510.68†
              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
              10.610.69
              Consulting
      Agreement between Cyberonics, Inc. and BK Consulting, an assumed name used
      by Reese S. Terry, Jr., a founder and member of the Board of Directors of
      Cyberonics, Inc., dated August 25, 2005
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on August 30, 2005
              000-19806
              99.110.70
              Amendment
      to Consulting Agreement between Cyberonics, Inc. and BK Consulting dated
      August 23, 2006
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on August 25, 2006
              000-19806
              10.110.71†
              Consulting
      Agreement between Cyberonics, Inc. and BK Consulting, an assumed name used
      by Reese S. Terry, Jr., a founder and member of the Board of Directors of
      Cyberonics, Inc., dated May 16, 2007
              
              Cyberonics,
      Inc.’s Annual Report on Form 10-K for the year ended April 27,
      2007
              000-19806
              10.6510.72
              Termination
      of Consulting Agreement between Cyberonics, Inc. and BK Consulting
      effective November 19, 2006
              
              Cyberonics,
      Inc.’s Current Report on Form 8-K filed on December 13,
    2006
              000-19806
              10.110.73†
              Employment
      Agreement effective June 15, 2006 between Cyberonics, Inc. and Pamela B.
      Westbrook
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.5810.74†
              Letter
      Agreement Regarding Advancement of Attorney’s Fees effective October 12,
      2006 between Cyberonics, Inc. and Pamela B. Westbrook
              
              Cyberonics,
      Inc.’s Annual Report on
                Form
      10-K for the fiscal period ended April 28, 2006
              000-19806
              10.5910.75†
              Resignation
      Agreement effective 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
              10.45
 
  
 Table of Contents  
 Exhibit
                Number
              Document
      Description
              
              Report
      or Registration Statement
              SEC
      File or
                Registration
                Number
              Exhibit
                Reference10.76
              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
              10.310.77†
              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
              10.6110.78†
              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
              10.4210.79†
              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
              10.210.80†
              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
              10.6410.81†
              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
              10.6510.82†
              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
              10.110.83†*
              Summary
      of Non-Employee Director Compensation as of June 24, 200810.84†*
              Summary
      of Fiscal Year 2008 Executive Bonus Program21.1
              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