Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
Form 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2017
 
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _______________ to _______________
Commission file number: 001-37599
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=11567593&doc=15
LivaNova PLC
(Exact name of registrant as specified in its charter)
England and Wales
98-1268150
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
20 Eastbourne Terrace
London, United Kingdom
W2 6LG
(Address of principal executive offices)

(Zip Code)

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

 
_____________________________________________________________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Ordinary Shares — £1.00 par value per share
The NASDAQ Stock Market LLC
Title of Each Class of Stock
Name of Each Exchange on Which Registered
_____________________________________________________________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☑     No 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☑    No
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐ (Do not check if a smaller reporting company)
Smaller reporting company
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act

 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes ☐     No 
Class
Outstanding at April 28, 2017
Ordinary Shares - £1.00 par value per share
48,185,995

1



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

 
 
 
 

 
 
 
In this Quarterly Report on Form 10-Q, “LivaNova,” “the Company,” “we,” “us” and “our” refer to LivaNova PLC and its consolidated subsidiaries.
This report may contain references to our proprietary intellectual property, including among others:
Trademarks for our VNS therapy systems, the VNS Therapy® System, the VITARIA®™ System and our proprietary Pulse generators products: Model 102 (Pulse™), Model 102R (Pulse Duo™), Model 103 (Demipulse®), Model 104 (Demipulse Duo®), Model 105 (AspireHC®), Model 106 (AspireSR®) and our newest model in development, Sentiva™.
Trademarks for our Oxygenators product systems: Inspire™, Heartlink™ and Connect™.
Trademarks for our line of surgical tissue and mechanical valve replacements and repair products: MitroflowTM, Crown PRTTM, Solo SmartTM, PercevalTM, Top HatTM, Reduced Series Aortic ValvesTM, Carbomedics Carbo-SealTM, Carbo-Seal ValsalvaTM, Carbomedics StandardTM, OrbisTM and OptiformTM, and Mitral valve repair products: Memo 3DTM, Memo 3D ReChordTM, AnnuloFloTM and AnnuloFlexTM.
Trademarks for our implantable cardiac pacemakers and associated services: REPLY 200TM, ESPRITTM, KORA 100TM, KORA 250TM, SafeRTM, the REPLY CRT-PTM, the remedé® System.
Trademarks for our Implantable Cardioverter Defibrillators and associated technologies: the INTENSIATM, PLATINIUMTM, and PARADYM® product families.
Trademarks for our cardiac resynchronization therapy devices, technologies services: SonR®, SonRtipTM, SonR CRTTM, the INTENSIATM, PARADYM RFTM, PARADYM 2TM and PLATINIUMTM product families and the Respond CRTTM clinical trial.
Trademarks for heart failure treatment product: Equilia®™.
Trademarks for our bradycardia leads: BEFLEX™ (active fixation) and XFINE™ (passive fixation).
These trademarks and tradenames are the property of LivaNova or the property of our consolidated subsidiaries and are protected under applicable intellectual property laws. Solely for convenience, our trademarks and tradenames referred to in this Report on Form 10-Q may appear without the ® or ™ symbols, but such references are not intended to indicate in any way that we will not assert, to the fullest extent under applicable law, our rights to these trademarks and tradenames.

________________________________________

2



“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995
Certain statements in this Quarterly Report on Form 10-Q, other than purely historical information, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements include, but are not limited to, statements about the benefits of the business combination of Sorin and Cyberonics, LivaNova’s plans, objectives, strategies, financial performance and outlook, trends, the amount and timing of future cash distributions, prospects or future events and involve known and unknown risks that are difficult to predict. As a result, our actual financial results, performance, achievements or prospects may differ materially from those expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by the use of words such as “may,” “could,” “seek,” “guidance,” “predict,” “potential,” “likely,” “believe,” “will,” “should,” “expect,” “anticipate,” “estimate,” “plan,” “intend,” “forecast,” “foresee” or variations of these terms and similar expressions, or the negative of these terms or similar expressions. Such forward-looking statements are necessarily based on estimates and assumptions that, while considered reasonable by LivaNova and its management based on their knowledge and understanding of the business and industry, are inherently uncertain. These statements are not guarantees of future performance, and stockholders should not place undue reliance on forward-looking statements. There are a number of risks, uncertainties and other important factors, many of which are beyond our control, that could cause our actual results to differ materially from the forward-looking statements contained in this Quarterly Report on Form 10-Q, and include but are not limited to the risks and uncertainties summarized below:
Risks related to the Mergers:
failure to effectively integrate and/or manage newly acquired businesses, and the cost, time and effort required to integrate newly acquired businesses, all of which may be greater than anticipated;
operating costs, customer loss or business disruption (including, without limitation, difficulties in maintaining relationships with employees, customers, distributors or suppliers) being greater than expected following the Mergers;
failure to retain certain key legacy employees of the Cyberonics or Sorin businesses; and
changes in tax laws or interpretations that could increase our consolidated tax liabilities following the Mergers, including the risk that we could be treated as a domestic corporation for United States federal tax purposes.
Risks related to our business:
changes in our common stock price;
changes in our profitability;
regulatory activities and announcements, including the failure to obtain regulatory approvals for our new products;
effectiveness of our internal controls over financial reporting;
fluctuations in future quarterly operating results;
failure to comply with, or changes in, laws, regulations or administrative practices affecting government regulation of our products, including, but not limited to, U.S. Food and Drug Administration (“FDA”) laws and regulations;
failure to establish, expand or maintain market acceptance of our products for the treatment of our approved indications;
any legislative or administrative reform to the healthcare system, including the U.S. Medicare or Medicaid systems or international reimbursement systems, that significantly reduces reimbursement for our products or procedures or denies coverage for such procedures, as well as adverse decisions by administrators of such systems on coverage or reimbursement issues relating to our products;
failure to maintain the current regulatory approvals for our products’ approved indications;
failure to obtain or maintain insurance coverage and reimbursement for our products’ approved indications;
unfavorable results from clinical studies;
variations in sales and operating expenses relative to estimates;
our dependence on certain suppliers and manufacturers to provide certain materials, components and contract services necessary for the production of our products;
product liability, intellectual property disputes, shareholder related matters, environmental proceedings, income tax disputes, and other related losses and costs;

3



protection, expiration and validity of our intellectual property;
changes in technology, including the development of superior or alternative technology or devices by competitors;
failure to comply with applicable U.S. domestic laws and regulations, including federal and state privacy and security laws and regulations;
failure to comply with non-U.S. law and regulations;
non-U.S. operational and economic risks and concerns;
failure to attract or retain key personnel;
losses or costs from pending or future lawsuits and governmental investigations;
changes in accounting rules that adversely affect the characterization of our consolidated financial position, results of operations or cash flows;
changes in customer spending patterns;
continued volatility in the global market and worldwide economic conditions, in particular the implementation of Brexit will likely cause increased economic volatility;
changes in tax laws, including changes due to Brexit, or exposure to additional income tax liabilities;
harsh weather or natural disasters that interrupt our business operations or the business operations of our hospital-customers; and
the adoption of new therapies by the market requires significant time and expense and cannot be guaranteed.
Other factors that could cause our actual results to differ from our projected results are described in (1) “Part II, Item 1A. Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q, (2) our 2016 Form 10-K, (3) our reports and registration statements filed and furnished from time to time with the SEC and (4) other announcements we make from time to time.
Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no obligation to update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise. You should read the following discussion and analysis in conjunction with our unaudited consolidated financial statements and related notes included elsewhere in this report. Operating results for the quarter ended March 31, 2017 are not necessarily indicative of future results, including the full fiscal year. You should also refer to our “Annual Consolidated Financial Statements,” “Notes” thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” contained in our 2016 Form 10-K.
Financial Information and Currency of Financial Statements
All of the financial information included in this quarterly report has been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The reporting currency of our consolidated financial statements is U.S. dollars.


4



PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
LIVANOVA PLC AND SUBSIDIARIES’
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(UNAUDITED)
(In thousands, except per share amounts)
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net sales
 
$
285,105

 
$
286,969

Cost of sales
 
101,463

 
123,567

Product remediation
 
(792
)
 
706

Gross profit
 
184,434

 
162,696

Operating expenses:
 
 
 
 
Selling, general and administrative
 
112,397

 
115,866

Research and development
 
29,651

 
31,690

Merger and integration expenses
 
2,208

 
6,761

Restructuring expenses
 
10,150

 
28,592

Amortization of intangibles
 
11,414

 
15,892

Total operating expenses
 
165,820

 
198,801

Income (loss) from operations
 
18,614

 
(36,105
)
Interest income
 
273

 
213

Interest expense
 
(2,315
)
 
(1,192
)
Foreign exchange and other gains (losses)
 
3,439

 
(1,835
)
Income (loss) before income taxes
 
20,011

 
(38,919
)
Income tax expense (benefit)
 
5,655

 
(1,258
)
Losses from equity method investments
 
(3,085
)
 
(2,717
)
Net income (loss)
 
$
11,271

 
$
(40,378
)
 
 
 
 
 
Basic income (loss) per share
 
$
0.23

 
$
(0.83
)
Diluted income (loss) per share
 
$
0.23

 
$
(0.83
)
Shares used in computing basic income (loss) per share
 
48,067

 
48,918

Shares used in computing diluted income (loss) per share
 
48,178

 
48,918


See accompanying notes to the condensed consolidated financial statements
5



LIVANOVA PLC AND SUBSIDIARIES’
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(In thousands)
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net income (loss)
 
$
11,271

 
$
(40,378
)
Other comprehensive income (loss):
 
 
 
 
Net change in unrealized loss on derivatives
 
(2,633
)
 
(3,765
)
Tax effect
 
724

 
386

Net of tax
 
(1,909
)
 
(3,379
)
Foreign currency translation adjustment, net of tax
 
15,430

 
48,501

Total other comprehensive income
 
13,521

 
45,122

Total comprehensive income
 
$
24,792

 
$
4,744



See accompanying notes to the condensed consolidated financial statements
6



LIVANOVA PLC AND SUBSIDIARIES’
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
 
 
March 31, 2017
 
December 31, 2016
 
 
(Unaudited)
 
 
ASSETS
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
62,719

 
$
39,789

Accounts receivable, net
 
271,534

 
275,730

Inventories
 
192,388

 
183,489

Prepaid and refundable income taxes
 
60,367

 
60,615

Assets held for sale
 
17,622

 
4,477

Prepaid expenses and other current assets
 
56,047

 
55,973

Total Current Assets
 
660,677

 
620,073

Property, plant and equipment, net
 
205,121

 
223,842

Goodwill
 
698,276

 
691,712

Intangible assets, net
 
605,780

 
609,197

Investments
 
58,728

 
61,092

Deferred tax assets, net
 
9,401

 
6,017

Other assets
 
132,664

 
130,698

Total Assets
 
$
2,370,647

 
$
2,342,631

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current Liabilities:
 
 
 
 
Current debt obligations
 
$
45,456

 
$
47,650

Accounts payable
 
101,954

 
92,952

Accrued liabilities
 
68,416

 
75,567

Income taxes payable
 
26,682

 
22,340

Accrued employee compensation and related benefits liability
 
81,320

 
78,302

Total Current Liabilities
 
323,828

 
316,811

Long-term debt obligations
 
76,068

 
75,215

Deferred income taxes liability
 
166,960

 
172,541

Long-term employee compensation and related benefits liability
 
31,104

 
31,668

Other long-term liabilities
 
37,759

 
39,487

Total Liabilities
 
635,719

 
635,722

Commitments and contingencies (Note 8)
 

 

Stockholders’ Equity:
 
 
 
 
Ordinary Shares, £1.00 par value: unlimited shares authorized; 48,184,737 shares issued and 48,124,731shares outstanding at March 31, 2017; 48,156,690 shares issued and 48,028,413 shares outstanding at December 31, 2016
 
74,612

 
74,578

Additional paid-in capital
 
1,721,238

 
1,719,893

Accumulated other comprehensive loss
 
(54,966
)
 
(68,487
)
Retained deficit
 
(3,304
)
 
(14,575
)
Treasury stock at cost, 60,006 shares at March 31, 2017 and 128,277 shares at December 31, 2016
 
(2,652
)
 
(4,500
)
Total Stockholders’ Equity
 
1,734,928

 
1,706,909

Total Liabilities and Stockholders’ Equity
 
$
2,370,647

 
$
2,342,631


See accompanying notes to the condensed consolidated financial statements
7



LIVANOVA PLC AND SUBSIDIARIES’
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Cash Flows From Operating Activities:
 
 

 
 

Net income (loss)
 
$
11,271

 
$
(40,378
)
Non-cash items included in net income (loss):
 
 
 
 
Depreciation
 
8,778

 
10,915

Amortization
 
11,414

 
12,653

Stock-based compensation
 
3,844

 
6,116

Deferred income tax (benefit) expense
 
(5,518
)
 
1,282

Losses from equity method investments
 
3,085

 
2,717

Impairment of property, plant and equipment
 
4,650

 

Amortization of income taxes payable on intercompany transfers
 
6,513

 
3,502

Other
 
(1,915
)
 
2,745

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable, net
 
6,573

 
(8,442
)
Inventories
 
(4,436
)
 
10,800

Other current and non-current assets
 
(9,308
)
 
(13,714
)
Restructuring reserve
 
(6,697
)
 
22,011

Accounts payable and accrued current and non-current liabilities
 
4,953

 
(607
)
Net cash provided by operating activities
 
33,207

 
9,600

Cash Flow From Investing Activities:
 
 

 
 

Purchases of property, plant and equipment
 
(7,566
)
 
(8,137
)
Proceeds from sale of cost method investment
 
3,192

 

Purchases of short-term investments
 

 
(6,991
)
Maturities of short-term investments
 

 
7,000

Other
 
(361
)
 
(820
)
Net cash used in investing activities
 
(4,735
)
 
(8,948
)
Cash Flows From Financing Activities:
 
 
 
 
Loans to equity method investments
 
(5,336
)
 
(2,846
)
Short-term borrowing (repayment), net
 
253

 
(10,342
)
Proceeds from exercise of stock options and SARs
 
876

 
2,541

Repayment of trade receivable advances
 

 
(16,076
)
Other
 
(1,819
)
 
(346
)
Net cash used in financing activities
 
(6,026
)
 
(27,069
)
Effect of exchange rate changes on cash and cash equivalents
 
484

 
1,272

Net increase (decrease) in cash and cash equivalents
 
22,930

 
(25,145
)
Cash and cash equivalents at beginning of period
 
39,789

 
112,613

Cash and cash equivalents at end of period
 
$
62,719

 
$
87,468


See accompanying notes to the condensed consolidated financial statements
8



LIVANOVA PLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1.  Unaudited Condensed Consolidated Financial Statements
Basis of Presentation
The accompanying condensed consolidated financial statements of LivaNova as of and for the three months ended March 31, 2017 and March 31, 2016 have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S.” and such principles, “U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of regulation S-X. The accompanying condensed consolidated balance sheet of LivaNova at December 31, 2016 has been derived from audited financial statements contained in our annual report on form 10-K for the year ended December 31, 2016, but do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the operating results of LivaNova and its subsidiaries, for the three months ended March 31, 2017 and are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. The financial information presented herein should be read in conjunction with the audited consolidated financial statements and notes thereto accompanying our Annual Report on Form 10-K for the year ended December 31, 2016.
Description of the Mergers
On October 19, 2015 LivaNova became the holding company of the combined businesses of Cyberonics and Sorin (the “Mergers”). Based on the structure of the Mergers, management determined that Cyberonics was considered to be the accounting acquirer and predecessor for accounting purposes.
Reclassification of Prior Year Comparative Period Presentation
To conform the condensed consolidated statement of income (loss) for the three months ended March 31, 2016 to the current period presentation, we reclassified $0.7 million previously presented on the Litigation Related Expenses line to Cost of Goods Sold - Product Remediation and $0.3 million to Selling, General and Administrative Expenses. Litigation Related Expenses was presented on a separate line within operating expenses in the condensed consolidated statement of income (loss) for the three months ended March 31, 2016.
To conform the condensed consolidated balance sheet as of December 31, 2016 to the current period presentation, we classified $4.5 million of Assets Held for Sale, relating to our plan to exit the Costa Rica manufacturing operation, to a separate line item in the condensed consolidated balance sheet from Prepaid Expenses and Other Current Assets.
To conform the condensed consolidated statement of cash flow for the three months ended March 31, 2016 to the current period presentation, certain amounts were reclassified within Cash Flows from Operating Activities.
Note 2. Restructuring
Our 2015 and 2016 Reorganization Plans (the “Plans”) were initiated October 2015 and March 2016, respectively, in conjunction with the completion of the Mergers. We initiated these plans to leverage economies of scale, streamline distribution and logistics and strengthen operational and administrative effectiveness in order to reduce overall costs. Costs associated with these plans were reported as ‘Restructuring expenses’ in our operating results in the condensed consolidated statements of income (loss). We estimate that the Plans will result in a net reduction of approximately 341 personnel of which 228 have occurred as of March 31, 2017.
In March 2017, we committed to a plan to sell our Suzhou Industrial Park facility in Shanghai, China. As a result of this exit plan we recorded an impairment of the building and equipment of $4.6 million, and accrued $0.5 million of additional costs, primarily related to employee severance, during the three months ended March 31, 2017. In addition, the remaining $13.1 million carrying value of the land, building and equipment was reclassified to Assets Held for Sale on the condensed consolidated balance sheet, as of March 31, 2017.

9



The restructuring expense accrual detail (in thousands):
 
 
Employee severance and other termination costs
 
Other
 
Total
Balance as of December 31, 2016
 
$
21,092

 
$
3,056

 
$
24,148

Charges
 
4,758

 
5,392

 
10,150

Cash payments, impairment and adjustments
 
(15,868
)
 
(5,166
)
 
(21,034
)
Balance as of March 31, 2017
 
$
9,982

 
$
3,282

 
$
13,264

The following table presents restructuring expense by reportable segment (in thousands):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Cardiac Surgery
 
$
6,002

 
$
4,210

Cardiac Rhythm Management
 
120

 
15,166

Neuromodulation
 
684

 
2,163

Other
 
3,344

 
7,053

Total
 
$
10,150

 
$
28,592

Note 3. Product Remediation Liability
At December 31, 2016, we recognized a liability for a product remediation plan related to our 3T Heater Cooler device. The remediation plan we developed consists primarily of a modification of the 3T design to include internal sealing and addition of a vacuum system to new and existing devices. These changes are intended to address regulatory actions and further reduce the risk of possible dispersion of aerosols from the 3T Heater Cooler devices in the operating room. The deployment of this solution for commercially distributed devices will occur upon final validation and verification of the design changes and approval or clearance by regulatory authorities worldwide, including FDA clearance in the U.S. In April 2017, we obtained CE Mark in Europe for the design change of the 3T device. As part of this plan, we also intend to perform a no-charge deep disinfection service for 3T users who have reported confirmed M. chimaera mycobacterium contamination. Although the deep disinfection service is not yet available in the U.S., it is currently offered in many countries around the world and will be expanded to additional geographies as regulatory approvals are received. Finally, in the fourth quarter of 2016 we initiated a program to provide existing 3T users with a new loaner 3T device at no charge pending regulatory approval and implementation of the vacuum system addition and deep disinfection service worldwide. This loaner program began in the U.S. and is being progressively made available on a global basis, prioritizing and allocating devices to 3T users based on pre-established criteria.
Changes in the carrying amount of the product remediation liability are as follows (in thousands):
Balance at December 31, 2016
 
$
33,487

Adjustments
 
(986
)
Remediation activity
 
(1,182
)
Effect of changes in currency exchange rates
 
412

Balance at March 31, 2017
 
$
31,731

As a result of the above adjustments to the product remediation liability and remediation activity during the three months ended March 31, 2017, there was a reduction in costs related to the product remediation program of $0.8 million included in Product Remediation line in the condensed consolidated statement of income (loss). It is reasonably possible that our estimate of the remediation liability could materially change in future periods due to the various significant assumptions involved such as customer behavior, market reaction and the timing of approvals or clearance by regulatory authorities worldwide. We recognize changes in estimates on a prospective basis. For further information, please refer to “Note 8. Commitments and Contingencies - 3T Heater Cooler.” At this stage, no liability has been recognized with respect to any lawsuits involving the Company related to the 3T Heater Cooler, while related legal costs are expensed as incurred.

10



Note 4. Investments
Cost-Method Investments
Our cost-method investments of $34.2 million and $33.8 million as of March 31, 2017 and December 31, 2016, respectively, consisted primarily of our equity investments in Respicardia, Inc. and ImThera Medical, Inc. Respicardia is a privately funded U.S. company developing an implantable device designed to restore a more natural breathing pattern during sleep in patients with central sleep apnea ("CSA") by transvenously stimulating the phrenic nerve. ImThera is a privately funded U.S. company developing a neurostimulation device system for the treatment of obstructive sleep apnea. During the three months ended March 31, 2017, we loaned ImThera $1.0 million, which is included in Other Assets on the condensed consolidated balance sheet. In addition, during the three months ended March 31, 2017, we sold our investment in Istituto Europeo di Oncologia S.R.L, for a gain of $3.2 million. This gain is included in Foreign exchange and other gains (losses) in the condensed consolidated statement of income (loss).
Equity Method Investments
Our equity-method investments consist of our equity position in the following entities (in thousands, except for percent ownership):
 
 
% Ownership (1)
 
March 31, 2017
 
December 31, 2016
Caisson Interventional LLC (2)
 
49.1
%
 
$
14,963

 
$
16,423

Highlife S.A.S. (3)
 
38.0
%
 
5,588

 
6,009

MicroPort Sorin CRM (Shanghai) Co. Ltd.
 
49.0
%
 
3,912

 
4,867

Other
 
 
 
18

 
16

Total (4)
 
 
 
$
24,481

 
$
27,315

(1)
Ownership percentages as of March 31, 2017.
(2)
Caisson Interventional LLC is a privately held clinical-stage medical device company located in the U.S., and is focused on the design, development, and clinical evaluation of a novel percutaneous mitral valve replacement system. During the quarter ended March 31, 2017, we loaned Caisson $3.0 million, which is included in Other Assets on the condensed consolidated balance sheet.
(3)
Highlife S.A.S is a privately held clinical-stage medical device company located in France, and is focused on the development of a unique transcatheter mitral valve replacement system to treat patients with mitral regurgitation. We loaned Highlife $1.3 million during the three months ended March 31, 2017, which is included in Other Assets on the condensed consolidated balance sheet.
(4)
We have loans outstanding to Caisson and Highlife amounting to $13.2 million, in total, at March 31, 2017.
Note 5. Fair Value Measurements
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table provides information by level for assets and liabilities that are measured at fair value on a recurring basis (in thousands):
 
 
Fair Value
as of
 
Fair Value Measurements Using Inputs Considered as:
 
 
March 31, 2017
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Derivative assets - designated as cash flow hedges (FX)
 
$
2,569

 
$

 
$
2,569

 
$

Derivative assets - freestanding hedges (FX)
 
1,620

 

 
1,620

 


 
$
4,189

 
$

 
$
4,189

 
$

Liabilities:
 
 
 
 
 
 
 
 
Derivative liabilities - designated as cash flow hedges (interest rate swaps)
 
$
2,053

 
$

 
$
2,053

 
$

Earnout for contingent payments (1)
 
3,913

 

 

 
3,913


 
$
5,966

 
$

 
$
2,053

 
$
3,913


11




 
 
Fair Value
as of
 
Fair Value Measurements Using Inputs Considered as:
 
 
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Derivative assets - designated as cash flow hedges (FX)
 
$
4,911

 
$

 
$
4,911

 
$

Derivative assets - freestanding hedges (FX)
 
3,358

 

 
3,358

 


 
$
8,269

 
$

 
$
8,269

 
$

 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Derivative liabilities - designated as cash flow hedges (FX)
 
$
942

 
$

 
$
942

 
$

Derivative Liabilities - designated as cash flow hedges (interest rate swaps)
 
1,392

 

 
1,392

 

Earnout for contingent payments (1)
 
3,890

 

 

 
3,890


 
$
6,224

 
$

 
$
2,334

 
$
3,890

(1)
This contingent payment arose as a result of acquisitions, see “Note 13. Supplemental Financial Information - Other Long-Term Liabilities” for further information.
Note 6. Financing Arrangements
The outstanding principal amount of long-term debt (in thousands, except interest rates):
 
 
March 31, 2017
 
December 31, 2016
 
Maturity
 
Interest Rate
European Investment Bank (1)
 
$
80,069

 
$
78,987

 
June 2021
 
0.95
%
Banca del Mezzogiorno (2)
 
6,859

 
6,747

 
December 2019
 
0.50% - 3.15%

Mediocredito Italiano (3)
 
7,397

 
7,276

 
December 2023
 
0.50% - 3.07%

Bpifrance (ex-Oséo)
 
1,775

 
1,909

 
October 2019
 
2.58
%
Region Wallonne
 
809

 
798

 
December 2023 and June 2033
 
0.00% - 2.42%

Mediocredito Italiano - mortgages
 
751

 
799

 
September 2021 and September 2026
 
0.40% - 0.65%

Total long-term facilities
 
97,660

 
96,516

 
 
 
 
Less current portion of long-term debt
 
21,592

 
21,301

 
 
 
 
Total long-term debt
 
$
76,068

 
$
75,215

 
 
 
 
(1)
The European Investment Bank (“EIB”) loan was obtained in July 2014 to support product development projects. The interest rate for the EIB loan is reset by the lender each quarter based on the Euribor. Interest payments are quarterly and principal payments are semi-annually.
(2)
The Banca del Mezzogiorno loan was obtained in January 2015 to support R&D projects as a part of the Large Strategic Project program of the Italian Ministry of Education.
(3)
We obtained the Mediocredito Italiano Bank loan in July 2016 as part of the Fondo Innovazione Teconologica program implemented by the Italian Ministry of Education.
Revolving Credit
The outstanding principal amount of our short-term unsecured revolving credit agreements and other agreements with various banks and governmental entities was $23.9 million and $26.4 million, at March 31, 2017 and December 31, 2016, respectively, with interest rates ranging from 0.0% to 15.3%.

12



Note 7. Derivatives and Risk Management
Due to the global nature of our operations, we are exposed to foreign currency exchange rate fluctuations. In addition, due to certain loans with floating interest rates, we are also subject to the impact of changes in interest rates on our interest payments. We enter into foreign currency exchange rate (“FX”) derivative contracts and interest rate swap contracts to reduce the impact of foreign currency rate and interest rate fluctuations on earnings and cash flow. We measure all outstanding derivatives each period end at fair value and report the fair value as either financial assets or liabilities in the consolidated balance sheets. We do not enter into derivative contracts for speculative purposes. If the derivative qualifies for hedge accounting, depending on the nature of the hedge and hedge effectiveness, changes in the fair value of the derivative will either be recognized immediately in earnings or recorded in other Accumulated Other Comprehensive Income (loss) (“AOCI”) until the hedged item is recognized in earnings upon settlement/termination. FX amounts in AOCI are reclassified to the consolidated statement of income (loss)as shown in the tables below and interest rate swaps gains and losses in AOCI are reclassified to interest expense in the consolidated statement of income (loss). We evaluate hedge effectiveness at inception and on an ongoing basis. If a derivative is no longer expected to be highly effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is recorded in earnings. Cash flows from derivative contracts are reported as operating activities in the consolidated statements of cash flows.
Derivatives that are not designated as hedging instruments are referred to as freestanding derivatives with changes in fair value included in earnings. We use currency exchange rate derivative contracts and interest rate derivative instruments, to manage the impact of currency exchange and interest rate changes on earnings and cash flows. In order to minimize earnings and cash flow volatility resulting from currency exchange rate changes, we enter into derivative instruments, principally forward currency exchange rate contracts. These contracts are designed to hedge anticipated foreign currency transactions and changes in the value of specific assets and liabilities. At inception of the forward contract, the derivative is designated as either a freestanding derivative or a cash flow hedge.
Freestanding Derivative FX Contracts
The gross notional amount of derivative FX forward contracts, not designated as hedging instruments (freestanding derivatives), outstanding at March 31, 2017 and December 31, 2016 was $210.0 million and $489.1 million, respectively. These derivative contracts are designed to offset the FX effects in earnings of various intercompany loans, our European Investment Bank loan, and receivables denominated in JPY and GBP. We recorded net losses for these freestanding derivatives of $1.8 million and $3.8 million, for the three months ended March 31, 2017 and March 31, 2016, respectively. These losses are included in Foreign exchange and other gains (losses) in the condensed consolidated statement of income (loss).
Cash Flow Hedges
Notional amounts of open derivative contracts designated as cash flow hedges (in thousands):
Description of contract:
 
March 31, 2017
 
December 31, 2016
FX derivative contracts to be exchanged for British Pounds
 
$
8,277

 
$
6,663

FX derivative contracts to be exchanged for Japanese Yen
 
52,498

 
57,840

Interest rate swap contracts
 
64,107

 
63,246

 
 
$
124,882

 
$
127,749

After-tax net gain associated with derivatives designated as cash flow hedges recorded in the ending balance of Accumulated Other Comprehensive Loss and the amount expected to be reclassified to earnings in the next 12 months (in thousands):
Description of contract:
 
March 31, 2017
 
Net amount expected to be reclassed to earnings in next 12 months
FX derivative contracts
 
$
1,195

 
$
1,195

Interest rate swap contracts
 
515

 
121

 
 
$
1,710

 
$
1,316


13



Pre-tax gains (losses) for derivative contracts designated as cash flow hedges recognized in Other Comprehensive Income (“OCI”) and the amount reclassified to earnings from Accumulated Other Comprehensive Income (“AOCI”) (in thousands):
 
 
 
Three Months Ended March 31,
 
 
 
2017
 
2016
Description of derivative contract
 
Location in earnings of reclassified gain or loss
Losses Recognized in OCI
 
(Losses) Gains Reclassified from AOCI to Earnings:
 
Losses Recognized in OCI
 
Gains (Losses)Reclassified from AOCI to Earnings:
FX derivative contracts
 
Foreign Exchange and Other
$
(6,832
)
 
$
(4,678
)
 
$
(3,580
)
 
$
190

FX derivative contracts
 
SG&A

 
810

 

 
(291
)
Interest rate swap contracts
 
Interest expense

 
(331
)
 
(319
)
 
(33
)
 
 
 
$
(6,832
)
 
$
(4,199
)
 
$
(3,899
)
 
$
(134
)

14



The following tables present the fair value on a gross basis, and the location of, derivative contracts reported in the consolidated balance sheets (in thousands):
March 31, 2017
 
Asset Derivatives
 
Liability Derivatives
Derivatives designated as hedging instruments
 
Balance Sheet Location
 
Fair Value (1)
 
Balance Sheet Location
 
Fair Value (1)
Interest rate contracts
 
Prepaid expenses and other current assets
 
$

 
Accrued liabilities
 
$
901

Interest rate contracts
 
Other assets
 

 
Other long-term liabilities
 
1,152

Foreign currency exchange rate contracts
 
Prepaid expenses and other current assets
 
2,569

 
Accrued liabilities
 

Total derivatives designated as hedging instruments
 

 
2,569

 

 
2,053

Derivatives not designated as hedging instruments
 

 

 

 

Foreign currency exchange rate contracts
 
Prepaid expenses and other current assets
 
1,620

 
Accrued liabilities
 

Total derivatives not designated as hedging instruments
 

 
1,620

 

 

 
 

 
$
4,189

 

 
$
2,053

December 31, 2016
 
Asset Derivatives
 
Liability Derivatives
Derivatives designated as hedging instruments
 
Balance Sheet Location
 
Fair Value (1)
 
Balance Sheet Location
 
Fair Value (1)
Interest rate contracts
 
Prepaid expenses and other current assets
 
$

 
Accrued liabilities
 
$
942

Interest rate contracts
 
Other assets
 

 
Other long-term liabilities
 
1,392

Foreign currency exchange rate contracts
 
Prepaid expenses and other current assets
 
4,911

 
Accrued liabilities
 

Total derivatives designated as hedging instruments
 
 
 
4,911

 
 
 
2,334

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
Foreign currency exchange rate contracts
 
Prepaid expenses and other current assets
 
3,358

 
Accrued liabilities
 

Total derivatives not designated as hedging instruments
 
 
 
3,358

 
 
 

 
 
 
 
$
8,269

 
 
 
$
2,334

(1)
For the classification of input used to evaluate the fair value of our derivatives, refer to “Note 5. Fair Value Measurements.”
Note 8.  Commitments and Contingencies
3T Heater Cooler
FDA Warning Letter.
On December 31, 2015, LivaNova received a Warning Letter (the “Warning Letter”) dated December 29, 2015 from the U.S. Food and Drug Administration (“FDA”) alleging certain violations of FDA regulations applicable to medical device manufacturers at the Company’s Munich, Germany and Arvada, Colorado facilities.

15



The FDA inspected the Munich facility from August 24, 2015 to August 27, 2015 and the Arvada facility from August 24, 2015 to September 1, 2015. On August 27, 2015, the FDA issued a Form 483 identifying two observed non-conformities with certain regulatory requirements at the Munich facility. We did not receive a Form 483 in connection with the FDA’s inspection of the Arvada facility. Following the receipt of the Form 483, we provided written responses to the FDA describing corrective and preventive actions that were underway or to be taken to address the FDA’s observations at the Munich facility. The Warning Letter responded in part to our responses and identified other alleged violations not previously included in the Form 483.
The Warning Letter further stated that our 3T Heater Cooler devices and other devices we manufactured at our Munich facility are subject to refusal of admission into the United States until resolution of the issues set forth by the FDA in the Warning Letter. The FDA has informed us that the import alert is limited to the 3T Heater Cooler devices, but that the agency reserves the right to expand the scope of the import alert if future circumstances warrant such action. The Warning Letter did not request that existing users cease using the 3T Heater Cooler device, and manufacturing and shipment of all of our products other than the 3T Heater Cooler remain unaffected by the import limitation. To help clarify these issues for current customers, we issued an informational Customer Letter in January 2016, and that same month agreed with the FDA on a process for shipping 3T Heater Cooler devices to existing U.S. users pursuant to a certificate of medical necessity program.
Lastly, the Warning Letter stated that premarket approval applications for Class III devices to which certain Quality System regulation deviations identified in the Warning Letter are reasonably related will not be approved until the violations have been corrected. However, the Warning Letter only specifically names the Munich and Arvada facilities in this restriction, which do not manufacture or design devices subject to premarket approval.
We are continuing to work diligently to remediate the FDA’s inspectional observations for the Munich facility as well as the additional issues identified in the Warning Letter. We take these matters seriously and intend to respond timely and fully to the FDA’s requests.
CDC and FDA Safety Communications and Company Field Safety Notice Update
On October 13, 2016 the Centers for Disease Control and Prevention (“CDC”) and FDA separately released safety notifications regarding the 3T Heater Cooler devices. The CDC’s Morbidity and Mortality Weekly Report (“MMWR”) and Health Advisory Notice (“HAN”) reported that tests conducted by CDC and its affiliates indicate that there appears to be genetic similarity between both patient and heater cooler strains of the non-tuberculous mycobacterium (“NTM”) bacteria M. chimaera isolated in hospitals in Iowa and Pennsylvania. Citing the geographic separation between the two hospitals referenced in the investigation, the report asserts that 3T Heater Cooler devices manufactured prior to August 18, 2014 could have been contaminated during the manufacturing process. The CDC’s HAN and FDA’s Safety Communication, issued contemporaneously with the MMWR report, each assess certain risks associated with heater cooler devices and provide guidance for providers and patients. The CDC notification states that the decision to use the 3T Heater Cooler during a surgical operation is to be taken by the surgeon based on a risk approach and on patient need. Both the CDC’s and FDA’s communications confirm that heater cooler devices are critical medical devices and enable doctors to perform life-saving cardiac surgery procedures.
Also on October 13, 2016, the Company issued a Field Safety Notice Update for U.S. users of 3T Heater Cooler devices to proactively and voluntarily contact facilities to facilitate implementation of the CDC and FDA recommendations. In the fourth quarter of 2016, we initiated a program to provide existing 3T users with a new loaner 3T device at no charge pending regulatory approval and implementation of additional risk mitigation strategies worldwide. This loaner program began in the U.S. and is being progressively made available on a global basis, prioritizing and allocating devices to 3T users based on pre-established criteria. We anticipate that this program will continue until we are able to address customer needs through a broader solution that includes implementation of one or more of the risk mitigation strategies currently under review with regulatory agencies.
At December 31, 2016, we recognized a liability for our product remediation plan related to our 3T Heater Cooler device. We concluded that it was probable that a liability had been incurred upon management’s approval of the plan and the commitments made by management to various regulatory authorities globally in November and December 2016, and furthermore, the cost associated with the plan was reasonably estimable. At March 31, 2017, the product remediation liability was $31.7 million. Refer to “Note 3. Product Remediation Liability” for additional information.

16



Baker, Miller et al v. LivaNova PLC
On February 12, 2016, LivaNova was alerted that a class action complaint had been filed in the U.S. District Court for the Middle District of Pennsylvania with respect to the Company’s 3T Heater Cooler devices, naming as evidence, in part, the Warning Letter issued by the FDA in December 2015. The named plaintiffs to the complaint are two individuals who underwent open heart surgeries at WellSpan York Hospital and Penn State Milton S. Hershey Medical Center in 2015, and the complaint alleges that: (i) patients were exposed to a harmful form of bacteria, known as nontuberculous mycobacterium (“NTM”), from LivaNova’s 3T Heater Cooler devices; and (ii) LivaNova knew or should have known that design or manufacturing defects in 3T Heater Cooler devices can lead to NTM bacterial colonization, regardless of the cleaning and disinfection procedures used (and recommended by the Company). Named plaintiffs seek to certify a class of plaintiffs consisting of all Pennsylvania residents who underwent open heart surgery at WellSpan York Hospital and Penn State Milton S. Hershey Medical Center between 2011 and 2015 and who are currently asymptomatic for NTM infection (approximately 3,600 patients).
The putative class action, which has not been certified, seeks: (i) declaratory relief finding the 3T Heater Cooler devices are defective and unsafe for intended uses; (ii) medical monitoring; (iii) general damages; and (iv) attorneys’ fees. On March 21, 2016, the plaintiffs filed a First Amended Complaint adding Sorin Group Deutschland GmbH and Sorin Group USA, Inc. as defendants. On September 29, 2016 the Court dismissed LivaNova PLC from the case, and on October 11, 2016, the Court denied the Company’s motion to dismiss Sorin Group Deutschland GmbH and Sorin Group USA, Inc. from the lawsuit.
In addition to the Baker case addressed in the preceding section, the Company has received additional lawsuits from around the U.S. related to surgical cases in which a 3T Heater Cooler device was allegedly used. Thirty-six lawsuits have been filed against the Company in state and Federal courts in Pennsylvania, South Carolina, North Carolina, Iowa, South Dakota, California, Texas, Massachusetts, Illinois and Alabama and one case has been filed in Montreal, Canada. Two of the cases noted above are brought by plaintiffs seeking class action status: the case filed against the Company in Canada, which relates to surgical cases at the Montreal Heart Institute, and a single case relating to surgical cases performed at two hospitals in South Carolina.
We intend to vigorously defend each of these claims. Given the relatively early stage of each of these matters, we cannot, however, give any assurances that additional legal proceedings making the same or similar allegations will not be filed against LivaNova PLC or one of its subsidiaries, nor that the resolution of these complaints or other related litigation in connection therewith will not have a material adverse effect on our business, results of operations, financial condition and/or liquidity.
Other Matters
SNIA Litigation
Sorin S.p.A. was created as a result of a spin-off (the “Sorin spin-off”) from SNIA S.p.A. (“SNIA”). The Sorin spin-off, which spun off SNIA’s medical technology division, became effective on January 2, 2004. Pursuant to the Italian Civil Code, in a spin-off transaction, the parent and the spun-off company can be held jointly liable up to the actual value of the shareholders’ equity conveyed or received (we estimate that the value of the shareholders’ equity received was approximately €573 million (or $612 million) for certain indebtedness or liabilities of the pre-spin-off company:
for “debt” (debiti) of the pre-spin-off company that existed at the time of the spin-off (this joint liability is secondary in nature and, consequently, arises only when such indebtedness is not satisfied by the company owing such indebtedness);
for “liabilities” (elementi del passivo) whose allocation between the parties to the spin-off cannot be determined based on the spin-off plan.

17



The Company believes and has argued before the relevant fora that Sorin is not jointly liable with SNIA for its alleged SNIA debts and liabilities. Specifically, between 1906 and 2010, SNIA’s subsidiaries Caffaro Chimica S.r.l. and Caffaro S.r.l. and their predecessors (the “SNIA Subsidiaries”), conducted certain chemical operations (the “Caffaro Chemical Operations”), at sites in Torviscosa, Brescia and Colleferro, Italy (the “Caffaro Chemical Sites”). These activities allegedly resulted in substantial and widely dispersed contamination of soil, water and ground water caused by a variety of hazardous substances released at the Caffaro Chemical Sites. In 2009 and 2010, SNIA and the SNIA Subsidiaries filed for insolvency. In connection with SNIA’s Italian insolvency proceedings, the Italian Ministry of the Environment and the Protection of Land and Sea (the “Italian Ministry of the Environment”), sought compensation from SNIA in an aggregate amount of €3.4 billion (or $3.6 billion) for remediation costs relating to the environmental damage at the Caffaro Chemical Sites allegedly caused by the Caffaro Chemical Operations. The amount was based on certain clean-up activities and precautionary measures set forth in three technical reports prepared by ISPRA, the technical agency of the Ministry of the Environment. In addition to disputing liability, the Company also disputes the amount being claimed and the basis for its estimation by Italian authorities, and that issue also remains in dispute. No final remediation plan has been approved at any time by the Italian authorities.
In September 2011, the Bankruptcy Court of Udine, and in July 2014, the Bankruptcy Court of Milan each held (in proceedings to which our Company is not part) that the Italian Ministry of the Environment and other Italian government agencies (the “Public Administrations”) were not creditors of either SNIA Subsidiaries or SNIA in connection with their claims in the context of their Italian insolvency proceedings. LivaNova (as the successor to Sorin in the litigation) believes these findings are and will be influential (although not formally binding) upon other Italian courts, including civil courts. Public Administrations have appealed both decisions in those insolvency proceedings: in January 2016 the Court of Udine rejected the appeal brought by the Italian Public Administrations. The Public Administrations have appealed that second loss in pending proceedings before the Italian Supreme Court. The appeal by the Public Administrations before the Court of Milan remains pending.
In January 2012, SNIA filed a civil action against Sorin in the Civil Court of Milan asserting provisions of the Italian Civil Code relating to potential joint liability of a parent and a spun-off company in the context of a spin-off, as described above. Those proceedings seek to determine Sorin’s joint liability with SNIA for damages allegedly related to the Caffaro Chemical Operations (as described below). SNIA’s civil action against Sorin also named the Public Administrations Italian Ministry of the Environment and other Italian government agencies, as defendants, in order to have them bound to the final ruling. The Public Administrations that had also sought compensation from SNIA for alleged environmental damage subsequently counterclaimed against Sorin, seeking to have Sorin declared jointly liable towards those Public Administrations alongside SNIA, and on the same legal basis. SNIA and the Public Administrations also requested the court to declare inapplicable to the Sorin spin-off the cap on potential joint liability of parties to a spin-off otherwise provided for by the Italian Civil Code. The cap, if applied, would limit any joint liability to the actual value of the shareholders’ equity received. The Public Administrations have argued before the court that the Sorin spin-off was planned prior to the date such caps were enacted under the Italian Civil Code (although executed after such caps were introduced into Italian law) and should therefore not be applied to the Sorin spin-off.
We have vigorously contested all of SNIA’s claims against Sorin as well as those claims brought by the Public Administrations. A favorable decision pertaining to the case was delivered in Judgment No. 4101/2016 on April 1, 2016 (the “Decision”). In its Decision, the Court of Milan dismissed all legal actions of SNIA and of the Public Administrations against Sorin, further requiring the Public Administrations to pay Sorin €300 thousand (or $321 thousand), as legal fees (of which €50,000 jointly with SNIA).
On June 21, 2016, the Public Administrations filed an appeal against the above decision before the Court of Appeal of Milan. The first hearing of the appeal proceedings was held on December 20, 2016 and the Court scheduled the final hearing for May 16, 2017. After such hearing the parties will file their final briefs and the Court is expected to render its decision in November 2017. SNIA appeared before the Court but did not file an appeal.
LivaNova (as successor to Sorin in the litigation) continues to believe that the risk of material loss relating to the SNIA litigation is not probable as a result of the reasoning contained in, and legal conclusions reached in, the recent court decisions described above. We also believe that the amount of potential losses relating to the SNIA litigation is, in any event, not estimable given that the underlying damages, related remediation costs, allocation and apportionment of any such responsibility, which party is responsible for which time period, all remain issues in dispute and that no final decision on a remediation plan has been approved. As a result, LivaNova has not made any accrual in connection with the SNIA litigation.
Pursuant to European Union, United Kingdom and Italian cross-border merger regulations applicable to the Mergers, legacy Sorin liabilities, including any potential liabilities arising from the claims against Sorin relating to the SNIA litigation, are assumed by LivaNova as successor to Sorin. Although LivaNova believes the claims against Sorin in connection with the SNIA

18



litigation are without merit and continues to contest them vigorously, there can be no assurance as to the outcome. A finding during any appeal or novel proceedings that Sorin or LivaNova is liable for relating to the environmental damage at the Caffaro Chemical Sites or its alleged cause(s) could have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Environmental Remediation Order
On July 28, 2015, Sorin and other direct and indirect shareholders of SNIA received an administrative order from the Italian Ministry of the Environment (the “Environmental Remediation Order”), directing them to promptly commence environmental remediation efforts at the Caffaro Chemical Sites (as described above). LivaNova believes that the Environmental Remediation Order is without merit. LivaNova (as successor to Sorin) believes that it should not be liable for damages relating to the Caffaro Chemical Operations pursuant to the Italian statute on which the Environmental Remediation Order relies because, inter alia, the statute does not apply to activities occurring prior to 2006, the date on which the statute was enacted (Sorin was spun off from SNIA in 2004). Additionally, LivaNova believes that Sorin should not be subject to the Environmental Remediation Order because Italian environmental regulations only permit such an order to be imposed on an “operator” of a remediation site, and Sorin has never operated any activity of whatsoever nature at any of the industrial sites concerned and, further, has never been identified in any legal proceeding as an operator at any of these Caffaro Chemical Sites, and could not and in fact did not cause any environmental damage at any of the Caffaro Chemical Sites.
Accordingly, LivaNova (as successor to Sorin) alongside other parties, challenged the Environmental Remediation Order before the Administrative Court of Lazio in Rome (the “TAR”). A hearing was held on February 3, 2016.
On March 21, 2016 the TAR issued several judgments, annulling the Environmental Remediation Order, one for each of the addressees of the Environmental Remediation Order, including LivaNova. Those judgments were based on the fact that (i) the Environmental Remediation Order lacks any detailed analysis of the causal link between the alleged damage and the activities of the Company, which is a pre-condition to imposition of the measures proposed in the Environmental Remediation Order, (ii) the situation of the Caffaro site does not require urgent safety measures, because no new pollution events have occurred and no additional information/evidence of a situation of contamination exists and (iii) the Environmental Remediation Order was not enacted using the correct legal basis, and in any event the Ministry failed to verify the legal elements that could have led to a conclusion of legal responsibility of the addressees of the Environmental Remediation Order.
LivaNova has welcomed the decisions. The TAR decisions described above have nonetheless been appealed by the Ministry before the Council of State. No information on the timing of the first hearing of this appeal is presently available.
Opposition to Merger Proceedings
On July 28, 2015, the Public Administrations filed an opposition proceeding to the proposed merger between Sorin and Cyberonics (the “Merger”), before the Commercial Courts of Milan, asking the Court to prohibit the execution of the Merger. In its initial decision on August 20, 2015 the Court authorized the Merger. Public Administrations did not appeal such decision. The proceeding then continued as a civil case, with the Public Administration seeking damages against LivaNova. The Commercial Court of Milan delivered a first instance decision on October 6, 2016 fully rejecting the Public Administrations’ request and condemning the same to pay LivaNova €200 thousand in damages for frivolous litigation plus  €200 thousand  in legal fees. LivaNova has welcomed the decision, which has nonetheless been appealed by the Public Administrations before the Court of Appeal of Milan. The first hearing was held on April 4, 2017 and the Court scheduled a final hearing on January 17, 2018. The Court of Appeal is likely to take a decision around June 2018. 
Andrew Hagerty v. Cyberonics, Inc.
On December 5, 2013, the United States District Court for the District of Massachusetts (“District Court”) unsealed a qui tam action filed by former employee Andrew Hagerty against Cyberonics under the False Claims Act (the “False Claims Act”) and the false claims statutes of 28 different states and the District of Columbia (United States of America et al ex rel. Andrew Hagerty v. Cyberonics, Inc. Civil Action No. 1:13-cv-10214-FDS). The False Claims Act prohibits the submission of a false claim or the making of a false record or statement to secure reimbursement from, or limit reimbursement to, a government-sponsored program. A “qui tam” action is a lawsuit brought by a private individual, known as a relator, purporting to act on behalf of the government. The action is filed under seal, and the government, after reviewing and investigating the allegations, may elect to participate, or intervene, in the lawsuit. Typically, following the government’s election, the qui tam action is unsealed.

19



Previously, in August 2012, Mr. Hagerty filed a related lawsuit in the same court and then voluntarily dismissed that lawsuit immediately prior to filing this qui tam action. In addition to his claims for wrongful and retaliatory discharge stated in the first lawsuit, the qui tam lawsuit alleges that Cyberonics violated the False Claims Act and various state false claims statutes while marketing its VNS Therapy System, and seeks an unspecified amount consisting of treble damages, civil penalties, and attorneys’ fees and expenses.
In October 2013, the United States Department of Justice declined to intervene in the qui tam action, but reserved the right to do so in the future. In December 2013, the District Court unsealed the action. In April 2014, Cyberonics filed a motion to dismiss the qui tam complaint, alleging a number of deficiencies in the lawsuit. In May 2014, the relator filed a First Amended Complaint. Cyberonics filed another motion to dismiss in June 2014, and the parties completed their briefing on the motion in July 2014. On April 6, 2015, the District Court dismissed all claims filed by Andrew Hagerty under the False Claims Act, but did not dismiss the claims for wrongful and retaliatory discharge. On July 28, 2015, Cyberonics filed its answer to the surviving claims in Mr. Hagerty’s first Amended Complaint and asserted its demand for arbitration pursuant to Mr. Hagerty’s employment documents.
In August 2015, Mr. Hagerty filed a Motion Seeking Leave to file a Second Amended Complaint responding to certain deficiencies noted by the District Court when dismissing claims in his First Amended Complaint alleging that Cyberonics submitted, or caused the submission of false claims under the False Claims Act. On September 4, 2015, Cyberonics filed our Brief in Opposition to Hagerty’s Motion for Leave to file a Second Amended Complaint.  Mr. Hagerty filed a Reply Brief in support of his Motion for Leave to file a Second Amended Complaint on September 11, 2015.  On September 16, 2015, the District Court heard oral arguments on (a) Mr. Hagerty’s motion seeking to amend his complaint, and (b) Cyberonics’ pending motion demanding arbitration on the claims relating to wrongful and retaliatory discharge.  On November 17, 2015, the District Court (1) denied Mr. Hagerty’s Motion for Leave to File a Second Amended Complaint (accordingly, the previously dismissed claims remain dismissed); (2) granted Cyberonics’ Motion to Compel Arbitration of the two remaining claims (for retaliatory discharge under the False Claims Act (“FCA”) and for wrongful termination/retaliation under Massachusetts law); and (3) stayed the pending case (in order to consolidate all issues for appeal pending resolution of the arbitration). On or about February 22, 2016, Mr. Hagerty dismissed, without prejudice, his individual claims that were ordered to arbitration. Subsequently, on or about March 21, 2016, Mr. Hagerty filed an appeal of the previously dismissed FCA claims with the U.S. First Circuit Court of Appeals (“Appeals Court”). Both Mr. Hagerty and the Company filed written briefs with the Appeals Court and on November 8, 2016, the First Circuit Court of Appeals held oral arguments before the Court. On or about December 16, 2016, the Court issued its opinion in the matter, upholding the district court’s dismissal of the FCA claims. Mr. Hagerty did not seek panel rehearing or en banc reconsideration of that opinion on or before January 9, 2017 and the First Circuit issued a mandate sending the case back to the district court for final disposition. Mr. Hagerty did not file a petition for Writ of Certiorari with the U.S. Supreme Court before March 16, 2017, and accordingly, the matter is concluded.
Tax Litigation
In a tax audit report notified on October 30, 2009, the Regional Internal Revenue Office of Lombardy (the “Internal Revenue Office”) informed Sorin Group Italia S.r.l. that, among several issues, it was disallowing in part (for a total of €102.6 million or $109.6 million, related to tax years 2002 through 2006) a tax-deductible write down of the investment in the U.S. company, Cobe Cardiovascular Inc., which Sorin Group Italia S.r.l. recognized in 2002 and deducted in five equal installments, beginning in 2002. In December 2009, the Internal Revenue Office issued notices of assessment for 2002, 2003 and 2004. The assessments for 2002 and 2003 were automatically voided for lack of merit. In December 2010 and October 2011, the Internal Revenue Office issued notices of assessment for 2005 and 2006 respectively. The Company challenged all three notices of assessment (for 2004, 2005 and 2006) before the relevant Provincial Tax Courts.
The preliminary challenges filed for 2004, 2005 and 2006 were denied at the first jurisdictional level. These decisions were appealed by the Company. The appeal submitted against the first-level decision for 2004 was accepted. The second-level decision relating to the 2004 notice of assessment was appealed to the Italian Supreme Court (Corte di Cassazione) by the Internal Revenue Office on February 3, 2017. The Supreme Court’s decision is pending. The appeal submitted against the first-level decision for 2005 was rejected. The second-level decision (relating to the 2005 notice of assessment) has been appealed to the Italian Supreme Court (Corte di Cassazione), where LivaNova will argue that the assessment should be deemed null, void and illegitimate because of inappropriate interpretation and application of regulations. This litigation is still pending before the Italian Supreme Court. The appeal filed against the second-level decision for 2006 was rejected; LivaNova filed an appeal to the Italian Supreme Court on April 28, 2017. In November 2012, the Internal Revenue Office served a notice of assessment for 2007 and, in July 2013, served a notice of assessment for 2008. In that matter the Internal Revenue Office claims an increase in taxable income due to a reduction (similar to the previous notices of assessment for 2004, 2005 and 2006) of the losses reported by Sorin Group Italia S.r.l. for the 2002, 2003 and 2004 tax periods, and subsequently utilized in 2007 and 2008. Both notices of assessment were challenged within the statutory deadline. The Provincial Tax Court of Milano has stayed its decision for

20



years 2007 and 2008 pending resolution of the litigation regarding years 2004, 2005, and 2006. The total amount of losses in dispute is €62.6 million (or $66.9 million). LivaNova has continuously reassessed its potential exposure in this matter - taking into account also the recent, and generally adverse, trend to taxpayers in this type of litigation. Although LivaNova’s defensive arguments are strong, the negative Court decisions experienced so far (four negative judgments versus one positive judgment received to date) has led us to leave unchanged the previously recognized liability of €16.9 million (or $18.1 million).
Other Litigation
Additionally, we are the subject of various pending or threatened legal actions and proceedings that arise in the ordinary course of our business. These matters are subject to many uncertainties and outcomes that are not predictable and that may not be known for extended periods of time. Since the outcome of these matters cannot be predicted with certainty, the costs associated with them could have a material adverse effect on our consolidated net income, financial position or cash flows.
Note 9.  Stockholders’ Equity
Comprehensive income
The table below presents the change in each component of accumulated other comprehensive income (loss) (“AOCI”), net of tax, and the reclassifications out of AOCI into net earnings for the three months ended March 31, 2017 and March 31, 2016 (in thousands):
 
 
Change in Unrealized Gain (Loss) on Cash Flow Hedging Derivatives
 
Foreign Currency Translation Adjustments Gain (Loss) (1)
 
Total
As of December 31, 2016
 
$
3,619

 
$
(72,106
)
 
$
(68,487
)
Other comprehensive (loss) income before reclassifications, before tax
 
(6,832
)
 
15,430

 
8,598

Tax benefit
 
1,934

 

 
1,934

Other comprehensive (loss) income before reclassifications, net of tax
 
(4,898
)
 
15,430

 
10,532

Reclassification of loss from accumulated other comprehensive income, before tax
 
4,199

 

 
4,199

Tax benefit
 
(1,210
)
 

 
(1,210
)
Reclassification of loss from accumulated other comprehensive income, after tax
 
2,989

 

 
2,989

Net current-period other comprehensive (loss) income, net of tax
 
(1,909
)
 
15,430

 
13,521

As of March 31, 2017
 
$
1,710

 
$
(56,676
)
 
$
(54,966
)
 
 
 
 
 
 
 
As of December 31, 2015
 
$
888

 
$
(55,116
)
 
$
(54,228
)
Other comprehensive (loss) income before reclassifications, before tax
 
(3,899
)
 
48,501

 
44,602

Tax benefit
 
405

 

 
405

Other comprehensive (loss) income before reclassifications, net of tax
 
(3,494
)
 
48,501

 
45,007

Reclassification of loss from accumulated other comprehensive income, before tax
 
134

 

 
134

Tax benefit
 
(19
)
 

 
(19
)
Reclassification of loss from accumulated other comprehensive income, after tax
 
115

 

 
115

Net current-period other comprehensive (loss) income, net of tax
 
(3,379
)
 
48,501

 
45,122

As of March 31, 2016
 
$
(2,491
)
 
$
(6,615
)
 
$
(9,106
)
(1)
Taxes are not provided for foreign currency translation adjustments as translation adjustment are related to earnings that are intended to be reinvested in the countries where earned.

21



Note 10.  Income Taxes
During the three months ended March 31, 2017 and March 31, 2016, we recorded income tax expense of $5.7 million and income tax benefit of $1.3 million, respectively, with effective income tax rates of 28.3% and 3.2%, respectively.
Our consolidated effective income tax rate for the three months ended March 31, 2017, includes the continued impact of various discrete items, including the recognition of a $3.0 million deferred tax asset related to a reserve for an uncertain tax position recognized in a prior year. Excluding the impact of discrete tax items, our consolidated effective income tax rate for the three months ended March 31, 2017 and March 31, 2016 was 41.6% and 3.2%, respectively.
Our consolidated effective tax rate, excluding discrete tax items for the three months ended March 31, 2017, includes the full year impact in 2017 of the consolidation of our intangible assets into an entity organized under the laws of England and Wales, which was not effective until the end of the second quarter of 2016. Our consolidated effective income tax rate, excluding discrete tax items, for the three months ended March 31, 2016, was impacted by $32.0 million of unbenefited net operating losses in certain tax jurisdictions.
Note 11.  Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income (loss) per share, (in thousands, except per share data):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Numerator:
 
 
 
 
Net income (loss)
 
$
11,271

 
$
(40,378
)
 
 
 
 
 
Denominator:
 
 
 
 
Basic weighted average shares outstanding
 
48,067

 
48,918

Add effects of share based compensation instruments (1)
 
111

 

Diluted weighted average shares outstanding
 
48,178

 
48,918

Basic income (loss) per share
 
$
0.23

 
$
(0.83
)
Diluted income (loss) per share
 
$
0.23

 
$
(0.83
)
(1)
Excluded from the computation of diluted earnings per share during the quarter ended March 31, 2017 were average outstanding dilutive instruments (primarily stock options and stock appreciation rights) to purchase approximately 607,000 ordinary shares of LivaNova because to include them would be anti-dilutive, primarily due to an exercise price exceeding the average price of our stock during the period. Excluded from the computation of diluted earnings per share for the quarter ended March 31, 2016, were average outstanding dilutive instruments to purchase 157,000 ordinary shares of LivaNova because to include them would be anti-dilutive due to the net loss during the period.
Note 12.  Geographic and Segment Information
Segment Information
We identify operating segments based on the way we manage, evaluate and internally report our business activities for purposes of allocating resources and assessing performance.
We are transitioning the organization to a regional focus with regional leaders in the U.S., Europe, and the rest of world. Supporting the regions will be our three product franchises: Neuromodulation, Cardiac Surgery, and Cardiac Rhythm Management. The product franchise leaders will be responsible for product R&D and marketing on a global basis. We believe a regional focus will allow a number of tangible benefits, namely the ability to share resources, faster decision-making, improved market access capabilities, and greater focus on the needs of physicians, hospitals, and patients. Our new operating structure, and the introduction of new talent into the leadership team, will facilitate an evolution of our goals and decision making processes; accordingly, we will continue to monitor the way we manage, evaluate and internally report our business activities and the corresponding impact this could have on our segment reporting.
The Cardiac Surgery segment generates its revenue from the development, production and sale of cardiovascular surgery products. Cardiac Surgery products include oxygenators, heart-lung machines, autotransfusion, mechanical heart valves and tissue heart valves. The Cardiac Rhythm Management segment generates its revenue from the development, manufacturing

22



and marketing of products for the diagnosis, treatment, and management of heart rhythm disorders and heart failure. Cardiac Rhythm Management products include high-voltage defibrillators, cardiac resynchronization therapy devices (“CRT-D”) and low-voltage pacemakers. The Neuromodulation segment generates its revenue from the design, development and marketing of neuromodulation therapy for the treatment of drug-resistant epilepsy and treatment resistant depression. Neuromodulation products include the VNS Therapy System, which consists of an implantable pulse generator, a lead that connects the generator to the vagus nerve, surgical equipment to assist with the implant procedure, equipment to enable the treating physician to set the pulse generator stimulation parameters for the patient, instruction manuals and magnets to suspend or induce stimulation manually.
“Other” includes Corporate shared services expenses for finance, legal, human resources and information technology and Corporate business development (“New Ventures”). New Ventures is focused on new growth platforms and identification of other opportunities for expansion.
Net sales of our reportable segments include end-customer revenues from the sale of products they each develop and manufacture or distribute. We define segment income as operating income before merger and integration, restructuring, amortization and litigation settlement.
Net sales and operating income (loss) by segment (in thousands):
 
 
Three Months Ended March 31,
Net Sales:
 
2017
 
2016
Cardiac Surgery
 
$
139,204

 
$
143,443

Neuromodulation
 
87,159

 
81,358

Cardiac Rhythm Management
 
58,280

 
61,731

Other
 
462

 
437

Total Net Sales
 
$
285,105

 
$
286,969

 
 
Three Months Ended March 31,
Income (Loss) from Operations:
 
2017
 
2016
Cardiac Surgery
 
$
16,018

 
$
2,122

Neuromodulation
 
41,678

 
40,582

Cardiac Rhythm Management
 
2,492

 
(9,491
)
Other
 
(17,802
)
 
(18,073
)
Total Reportable Segments’ Income from Operations
 
42,386

 
15,140

Merger and integration expenses
 
2,208

 
6,761

Restructuring expenses
 
10,150

 
28,592

Amortization of intangibles
 
11,414

 
15,892

Operating Income (Loss)
 
$
18,614

 
$
(36,105
)
The following tables present our assets and capital expenditures by segment (in thousands):
Assets:
 
March 31, 2017
 
December 31, 2016
Cardiac Surgery
 
$
1,270,946

 
$
1,277,799

Neuromodulation
 
608,728

 
611,085

Cardiac Rhythm Management
 
345,940

 
341,998

Other
 
145,033

 
111,749

Total Assets
 
$
2,370,647

 
$
2,342,631


23



 
 
Three Months Ended March 31,
Capital expenditures:
 
2017
 
2016
Cardiac Surgery
 
$
3,794

 
$
5,489

Neuromodulation
 
1,461

 
1,915

Cardiac Rhythm Management
 
1,658

 
480

Other
 
1,203

 
253

Total
 
$
8,116

 
$
8,137

Geographic Information
We operate under three geographic regions: United States, Europe, and Rest of World. Net sales to external customers by geography are determined based on the country the products are shipped to and are as follows (in thousands):
 
 
Three Months Ended March 31,
Net Sales
 
2017
 
2016
United States
 
$
114,349

 
$
114,128

Europe (1) (2)
 
96,346

 
99,307

Rest of World
 
74,410

 
73,534

Total (3)
 
$
285,105

 
$
286,969

(1)
Net sales to external customers include $8.0 million and $8.8 million in the United Kingdom for the three months ended March 31, 2017 and March 31, 2016, respectively.
(2)
Includes those countries in Europe where LivaNova has a direct sales presence.  Countries where sales are made through distributors are included in Rest of World.
(3)
No single customer represented over 10% of our consolidated net sales. Except for the U.S. and France, no country’s net sales exceeded 10% of our consolidated net sales. French sales were $32.8 million for the three months ended March 31, 2017.
Property, plant and equipment, net by geography are as follows (in thousands):
PP&E
 
March 31, 2017
 
December 31, 2016
United States
 
$
61,730

 
$
61,279

Europe (1)
 
128,482

 
130,777

Rest of World
 
14,909

 
31,786

Total
 
$
205,121

 
$
223,842

(1)
Property, plant and equipment, net included with Europe includes $3.1 million and $3.0 million in the United Kingdom at March 31, 2017 and December 31, 2016, respectively.
Note 13. Supplemental Financial Information
Accounts receivable, net, consisted of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Trade receivables from third parties
 
$
282,078

 
$
285,336

Allowance for bad debt
 
(10,544
)
 
(9,606
)
 
 
$
271,534

 
$
275,730


24



Inventories consisted of the following (in thousands):

 
March 31, 2017
 
December 31, 2016
Raw materials
 
$
48,212

 
$
47,704

Work-in-process
 
36,347

 
32,316

Finished goods
 
107,829

 
103,469

 
 
$
192,388

 
$
183,489

Inventories are reported net of the provision for obsolescence, which totaled $9.7 million and $9.8 million at March 31, 2017 and December 31, 2016, respectively.
Prepaid expenses and other current assets consisted of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Income taxes payable on inter-company transfers of property
 
$
19,445

 
$
19,445

Current loans and notes receivable
 
9,168

 
7,093

Deposits and advances to suppliers
 
5,297

 
5,417

Earthquake grant receivable
 
4,515

 
4,748

Derivative contract assets
 
4,189

 
8,269

Other prepaid expenses
 
13,433

 
11,001

 
 
$
56,047

 
$
55,973

Other long-term assets consisted of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Income taxes payable on inter-company transfers of property
 
$
120,721

 
$
124,551

Loans and notes receivable
 
7,424

 
2,029

Investments (1)
 
2,865

 
2,537

Guaranteed deposits
 
858

 
940

Other
 
796

 
641

 
 
$
132,664

 
$
130,698

(1)
Primarily cash surrender value of company owned life insurance policies.
Accrued liabilities consisted of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Product remediation liability (1)
 
$
23,987

 
$
23,464

Restructuring related liabilities
 
10,326

 
16,859

Provisions for agents, returns and other
 
5,879

 
7,271

Product warranty obligations
 
2,611

 
2,736

Royalty costs
 
2,093

 
2,503

Deferred income
 
1,844

 
1,708

Clinical study costs
 
1,322

 
839

Derivative contract liabilities
 
901

 
942

Insurance
 
111

 
118

Other
 
19,342

 
19,127

 
 
$
68,416

 
$
75,567

(1)
Refer to “Note 3. Product Remediation Liability.”

25



Other long-term liabilities consisted of the following (in thousands):

 
March 31, 2017
 
December 31, 2016
Uncertain tax positions
 
$
17,182

 
$
16,857

Product remediation liability (1)
 
7,744

 
10,023

Earnout for contingent payments (2)
 
3,913

 
3,890

Government grant deferred revenue
 
3,855

 
3,803

Unfavorable operating leases (3)
 
1,566

 
1,672

Derivative contract liabilities (4)
 
1,152

 
1,392

Other
 
2,347

 
1,850

 
 
$
37,759

 
$
39,487

(1)
Refer to “Note 3. Product Remediation Liability.”
(2)
The earnout for contingent payments represents contingent payments due related to two acquisitions: the first acquisition, in September 2015, was of Cellplex PTY Ltd. in Australia and the second acquisition was the commercial activities of a local distributor in Colombia. The contingent payments for the first acquisition are based on achievement of sales targets by the acquiree through June 30, 2018 and the contingent payments for the second acquisition are based on sales of cardiopulmonary disposable products and heart lung machines of the acquiree through December 2019. Refer to “Note 5. Fair Value Measurements.”
(3)
Unfavorable operating leases represents the adjustment to recognize future lease obligations at their estimated fair value in conjunction with the Mergers in October 2015 between Cyberonics and Sorin.
(4)
Financial derivatives represent forward interest rate swap contracts, which hedge our long-term European Investment Bank debt. Refer to “Note 7. Derivatives and Risk Management.”
Note 14. New Accounting Pronouncements
In May 2014, the FASB issued ASC Update No. 2014-09, Revenue from Contracts with Customers (Topic 606): Update No. 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers and will replace most existing revenue recognition guidance when it becomes effective. This new standard is effective for annual reporting periods beginning after December 15, 2017, and interim periods within that reporting period. Early application is not permitted, and the standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect this standard will have on our financial statements and related disclosures.
In January 2016, the FASB issued ASC Update No. 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. Update 2016-01 requires equity investments that do not result in consolidation and are not accounted for under the equity method to be measured at fair value with changes recognized in net income. However, an entity may elect to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The amendments, in addition, reduce complexity of the impairment assessment of equity investments without readily determinable fair values with regard to the other-than-temporary impairment guidance. The amendments also require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset and liability. This guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early application of certain provisions is permitted. We are currently evaluating the effect this standard will have on our consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASC Update No. 2016-02, Leases (new Topic 842, superseded Topic 840): This guidance requires lessees to recognize most leases on their balance sheets as lease liabilities with corresponding right-of-use assets. While many aspects of lessor accounting remain the same, the new standard makes some changes, such as eliminating today’s real estate-specific guidance. The new standard requires lessees and lessors to classify most leases using a principle generally consistent with that of “IAS 17 - Leases,” which is similar to U.S. GAAP but without the use of bright lines. The standard also changes what is considered initial direct costs. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. The standard is effective for annual periods beginning after December 15, 2018 and interim periods within that year. Early adoption is permitted. We are currently evaluating the effect this standard will have on our consolidated financial statements and related disclosures.

26



In March 2016, the FASB issued ASC Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which simplified the accounting for certain aspects of share-based payment transactions including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. We adopted the amendments of ASU 2016-09 effective January 1, 2017, using the following methods:
We adopted the Amendment that requires all of the tax effects related to the settlement of share based compensation awards to be recorded through the income statement on a prospective basis. The adoption of this Amendment did not have a material effect on income tax expense for the three months ended March 31, 2017.
We adopted the Amendment related to cash flow presentation of tax-related cash flows resulting from share based payments on a prospective basis. The Amendment stipulates that all tax-related cash flows resulting from share based payments are to be reported as operating activities in the statement of cash flows, rather than, under past requirements, to present gross windfall tax benefits as an inflow from financing activities and an outflow from operating activities.
Under the Amendment related to forfeitures, entities are permitted to make a company wide accounting policy election to either estimate forfeitures each period, as required prior to this Amendment’s effective date, or to account for forfeitures as they occur. We elected to continue to account for forfeitures using the estimation method.
We adopted the Amendment related to the timing of when excess tax benefits are recognized, which requires that all windfalls and shortfalls be recognized when they arise. There were no unrecognized excess tax benefits prior to the adoption of the Amendment.
In August 2016, the FASB issued ASC Update No. 2016-15, Classification of Certain Cash Receipts and Cash Payments (Topic 230 -Statement of Cash Flows): The amendments provide guidance in the presentation and classification of certain cash receipts and cash payments in the statement of cash flows including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, and distributions received from equity method investees. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The amendments should be applied using a retrospective transition method to each period presented. We are currently evaluating the impact of adopting these provisions on our consolidated financial statements.
In October 2016, the FASB issued ASC Update No. 2016-16, Income Taxes - Intra-Entity Transfers of Assets Other Than Inventory (Topic 740): This update simplifies the accounting for the income tax consequences of transfers of assets from one unit of a corporation to another unit or subsidiary by eliminating an accounting exception that prevents the recognition of current and deferred income tax consequences for such “intra-entity transfers” until the assets have been sold to an outside party. The amendment should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment directly to retained earnings as of the beginning of the period in which the guidance is adopted. The rule takes effect for annual periods after December 15, 2017, including interim periods within those annual reporting periods. We are currently evaluating the impact of adopting this update; however, based on preliminary analysis, it is possible that this update could adversely impact our effective tax rate by several percentage points in future periods commencing in the first quarter of year 2018.
In March 2017, the FASB issued ASC Update No. 2017-01, Business Combinations (Topic 805)—Clarifying the Definition of a Business. This update clarifies when a set of assets and activities is a business. The amendments provide a screen to determine when a set is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. If the screen is not met, the amendments in this Update (1) require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) remove the evaluation of whether a market participant could replace missing elements. This update is effective for annual periods after December 15, 2017, including interim periods within those annual reporting periods. We are currently evaluating the impact of adopting this update on our consolidated financial statements.

27



In March 2017, the FASB issued ASC Update No. 2017-07, Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post Retirement Benefit Cost. This update requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are used to present the other components of net benefit cost, that line item or items must be appropriately described. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. The amendments in this Update also allow only the service cost component to be eligible for capitalization when applicable. This update takes effect for annual periods after December 15, 2017, including interim periods within those annual reporting periods. We are currently evaluating the impact of adopting this update on our consolidated financial statements.
Note 15. Subsequent Events
We announced on February 23, 2017 our voluntary cancellation of our standard listing of ordinary shares with the London Stock Exchange (“LSE”). We have taken this action due to the low volume of our ordinary share trading on the LSE. Trading ceased at the close of business on April 4, 2017. We will continue to serve our shareholders through our listing on the NASDAQ Stock Market, where the vast majority of trading of our ordinary shares occurs. This decision has no bearing on our status as a UK company and our commitment to invest in the European market.
On May 2, 2017, we acquired the remaining outstanding interests in Caisson Interventional, LLC (“Caisson”), in support of our strategic growth initiatives. Based in Maple Grove, Minn., Caisson is a privately held clinical-stage medical device company focused on the design, development and clinical evaluation of a novel transcatheter mitral valve replacement (“TMVR”) implant with a fully transvenous delivery system. We have been an investor in Caisson since 2012 and have agreed to pay up to $72 million, net of $6 million of debt forgiveness, to acquire the remaining 51 percent of the company. The first payment of $18 million was made at closing with the balance paid on a schedule driven primarily by regulatory approvals and sales earn outs. As a result of the acquisition, LivaNova expects to recognize a pre-tax non-cash gain during the three months ended June 30, 2017 on the $15.0 million book value of its existing investment in Caisson.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and related notes which appear elsewhere in this document and with our annual report on Form 10-K for the year ended December 31, 2016. Our discussion and analysis may contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Risk Factors” in Item 1A of our Annual Report on Form 10-K and elsewhere in this quarterly report.
The capitalized terms used below have been defined in the notes to our condensed consolidated financial statements. In the following text, the terms “we,” “our,” “our company” and “us” may refer, as the context requires, to LivaNova PLC or collectively to LivaNova PLC and its subsidiaries.
Business Overview
LivaNova PLC and its subsidiaries (collectively, the “Company”, “LivaNova”, “we” or “our”) is a public limited company organized under the laws of England and Wales. Headquartered in London, United Kingdom (“U.K.”). LivaNova is a global medical device company focused on the development and delivery of important therapeutic solutions for the benefit of patients, healthcare professionals and healthcare systems throughout the world. Working closely with medical professionals in the fields of Cardiac Surgery, Neuromodulation and Cardiac Rhythm Management, we design, develop, manufacture and sell innovative therapeutic solutions that are consistent with our mission to improve our patients’ quality of life, increase the skills and capabilities of healthcare professionals and minimize healthcare costs.
Business Franchises
We operate our business through three segments: Neuromodulation, Cardiac Surgery and Cardiac Rhythm Management. Our three reportable segments correspond to our Business Franchises and each Business Franchise corresponds to one of our three main therapeutic areas aligned to best serve our customers. Corporate activities include corporate business development and New Ventures. New Ventures is focused on new growth platforms and identification of other opportunities for expansion and investment.

28



For further information regarding our business segments, historical financial information and our methodology for the presentation of financial results, please refer to the condensed consolidated financial statements and accompanying notes of this Quarterly Report on Form 10-Q.
Cardiac Surgery (“CS”) Update
On October 5, 2015, we announced the initiation of PERSIST-AVR, the first international, prospective post-market randomized multi-center trial evaluating the Perceval sutureless aortic valve compared to standard sutured bioprostheses in patients with aortic valve disease. The trial is expected to enroll 1,234 patients within a two-year enrollment period and patients will be followed until five years post procedure. In January 2017, the independent study, “Aortic Valve Replacement With Sutureless Perceval Bioprosthesis: Single-Center Experience With 617 Implants,” was presented to The Society of Thoracic Surgeons. The study found that AVR procedures conducted with Perceval resulted in low mortality and excellent hemodynamic performance for patients.
In January 2016, we announced FDA approval of the Perceval sutureless valve. Perceval is the only sutureless biological aortic replacement valve on the market today with a unique self-anchoring frame that enables the surgeon to replace the diseased valve without suturing it into place. While we have been selling Perceval in other parts of the world, we began commercial distribution of the device in the United States with the first implant announced on March 8, 2016. Perceval has been implanted in more than 20,000 patients in over 310 hospitals in 34 countries across the world.
In addition, in early February 2016, we announced that we had received FDA approval of CROWN PRT valve for the treatment of aortic valve disease. The CROWN PRT is a stented aortic bioprosthesis technology and features a surgeon-friendly design, with optimized hemodynamics with patented PRT, designed to enhance valve durability. We anticipate launching CROWN PRT in the U.S. later this year.
In March 2017, we committed to a plan to sell our Suzhou Industrial Park facility in Shanghai, China, an emerging market greenfield project for the local manufacture of Cardiopulmonary disposable products in Suzhou Industrial Park in China. As a result of this exit plan we recorded an impairment of the building and equipment of $4.6 million and accrued $0.5 million of additional costs, primarily related to employee severance, during the three months ended March 31, 2017, included in Restructuring Expenses line in the condensed consolidated statement of income (loss). In addition, the remaining $13.1 million carrying value of the land, building and equipment were reclassified to Assets Held for Sale on the condensed consolidated balance sheet, as of March 31, 2017.
FDA Warning Letter. In December 2015, we received an FDA Warning Letter (the “Warning Letter”) alleging certain violations of FDA regulations applicable to medical device manufacturing at our Munich, Germany and Arvada, Colorado facilities. On October 13, 2016 the Centers for Disease Control and Prevention (“CDC”) and FDA separately released safety notifications regarding the 3T Heater Cooler devices in response to which the Company issued a Field Safety Notice Update for U.S. users of 3T Heater Cooler devices to proactively and voluntarily contact facilities to facilitate implementation of the CDC and FDA recommendations.
At December 31, 2016, we recognized a liability for a product remediation plan related to our 3T Heater Cooler device. The remediation plan developed by the Company consists primarily of a modification of the 3T design to include internal sealing and addition of a vacuum system to new and existing devices. These changes are intended to address regulatory actions and further reduce the risk of possible dispersion of aerosols from the 3T Heater Cooler device in the operating room. The deployment of this solution for commercially distributed devices will occur upon final validation and verification of the design changes and approval or clearance by regulatory authorities worldwide, including FDA clearance in the U.S. In April 2017, we obtained CE Mark in Europe for the design change of the 3T device. As part of this plan, we also intend to perform a no-charge deep disinfection service for 3T users who have reported confirmed M. chimaera mycobacterium contamination. Although the deep disinfection service is not yet available in the U.S., it is currently offered in many countries around the world and will be expanded to additional geographies as regulatory approvals are received. In the fourth quarter of 2016 we initiated a program to provide existing 3T users with a new loaner 3T device at no charge pending regulatory approval and implementation of the vacuum system addition and deep disinfection service worldwide. This loaner program began in the U.S. and is being progressively made available on a global basis, prioritizing and allocating devices to 3T users based on pre-established criteria. It is estimated that by the end of 2018, a majority of the 3T devices in use globally will be upgraded and returned to operation. It is reasonably possible that our estimate of the remediation liability could materially change in future periods due to the various significant assumptions involved such as customer behavior, market reaction and the timing of approvals or clearance by regulatory authorities worldwide. At March 31, 2017 the product remediation liability was $31.7 million. Refer to “Note 3. Product Remediation Liability” in our consolidated financial statements included in this Report on Form 10-Q for additional information.

29



As of March 31, 2017, no liability has been recognized with respect to any lawsuits involving the Company related to the 3T Heater Cooler. For further information, please refer to “Note 8. Commitments and Contingencies” in our consolidated financial statements included in this Report on Form 10-Q.
Neuromodulation Update
Epilepsy
Our product development efforts are directed toward improving the VNS Therapy System and developing new products that provide additional features and functionality. We are conducting ongoing product development activities to enhance the VNS Therapy System pulse generator, lead and programming software. We will be required to obtain appropriate U.S. and international regulatory approvals, and clinical studies may be a prerequisite to regulatory approvals for some products. We recently submitted our application to the FDA for Sentiva. Sentiva will be our newest VNS Therapy device and will incorporate the same technology as AspireSR, but will be smaller in size - more akin to the Demi Pulse. We anticipate approval of the device in the latter part of 2017.
Depression
In March 2017, The American Journal of Psychiatry published the results of the longest and largest naturalistic study on effective treatments for patients experiencing chronic and severe depression. The findings showed that the addition of VNS Therapy to traditional treatment methods is effective in reducing symptoms in patients with treatment-resistant depression.
Cardiac Rhythm Management (“CRM”) Update
In January 2016, we announced that we received regulatory approval to market the KORA 250TM in Japan. The KORA 250 is a full body MRI conditional pacemaker and is equipped with our proprietary Automatic MRI mode. In addition, the device is designed to proactively manage comorbidities, including SafeR and the ability to monitor patients for severe sleep apnea using Sleep Apnea Monitoring (“SAM”).
Corporate Activities and New Ventures Update
Heart failure
New Ventures is primarily focused on the development and clinical testing of the VITARIA®™ System for treating heart failure through vagus nerve stimulation.
We received CE Mark approval of the VITARIA®™ System in February 2015 for patients who have moderate to severe heart failure (New York Heart Association Class II/III) with left ventricular dysfunction (ejection fraction < 40%) and who remain symptomatic despite stable, optimal heart failure drug therapy. The VITARIA®™ System provides a specific method of VNS called autonomic regulation therapy (“ART”), and it includes the same elements as the VNS Therapy System - pulse generator, lead, programming wand and software, programming computer, tunneling tool and accessory pack - without the patient kit with magnets. We conducted a pilot study, ANTHEM-HF, outside the United States, which concluded during 2014. The study results support the safety and efficacy of ART delivered by the VITARIA®™ System. We submitted the results to our European Notified Body, DEKRA, and on February 20, 2015, we received CE Mark approval. The VITARIA®™ System is not available in the U.S. During 2014, we also initiated a second pilot study, ANTHEM-HFpEF, to study ART in patients experiencing symptomatic heart failure with preserved ejection fraction. This pilot study is currently underway outside the United States.
Sleep Apnea
ImThera Medical, Inc. (“ImThera”) is a privately held, emerging-growth, company developing an implantable neurostimulation device system for the treatment of obstructive sleep apnea. We have an investment of $12.0 million in ImThera, and during the three months ended March 31, 2017, we loaned ImThera $1.0 million to fund operating expenses.
Mitral valve regurgitation
Mitral regurgitation occurs when the heart’s mitral valve does not close tightly, which allows blood to flow backwards in the heart. This reduces the amount of blood that flows to the rest of the body, making the patient feel tired or out of breath. Treatment depends on the nature and the severity of mitral regurgitation. In certain cases, heart surgery may be needed to repair or replace the valve. Left untreated, severe mitral valve regurgitation can cause heart failure or heart rhythm problems (arrhythmias). We are invested in three mitral valve startups. Cardiosolutions Inc., a startup headquartered in the U.S. in which we have held an interest since 2012, is developing an innovative Spacer technology for treating mitral regurgitation. In addition, Highlife S.A.S. (“Highlife”), headquartered in France, and Caisson Interventional LLC (“Caisson”), headquartered in the U.S., are two companies focused on developing devices for treating mitral regurgitation through percutaneous replacement

30



of the native mitral valve. Although both companies are focused on mitral valve replacement, their devices differ significantly in both the delivery system (transapical versus transfemoral) and the anchoring system. In 2016, both Caisson and Highlife completed their first human implants in feasibility clinical studies. We invested $8.5 million in Caisson and $5.3 million in Highlife in 2016 to fund product development and clinical studies.
Significant Accounting Policies and Critical Accounting Estimates 
There have been no material changes to our critical accounting policies from the information provided in “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2016 Form 10-K. The accompanying unaudited condensed consolidated financial statements of LivaNova and its consolidated subsidiaries have been prepared in accordance with U.S. GAAP on an interim basis.
New accounting pronouncements are disclosed in “Note 14. New Accounting Pronouncements” contained in the condensed consolidated financial statements in this Quarterly Report on Form 10-Q.
Other
On June 23, 2016, the United Kingdom (the “U.K.”) held a referendum in which voters approved an exit from the European Union (the “EU”), commonly referred to as “Brexit.” On March 29, 2017, the U.K. Government gave formal notice of its intention to leave the EU, formally commencing the negotiations regarding the terms of withdrawal between the U.K. and the EU. The withdrawal must occur within two years, unless the deadline is extended. The negotiation process will determine the future terms of the U.K.’s relationship with the EU. The notification does not change the application of existing tax laws, and does not establish a clear framework for what the ultimate outcome of the negotiations and legislative process will be.
Various tax reliefs and exemptions that apply to transactions between EU Member States under existing tax laws may cease to apply to transactions between the U.K. and EU Member States when the U.K. ultimately withdraws from the EU. It is unclear at this stage if or when any new tax treaties between the U.K. and the EU or individual EU Member States will replace those reliefs and exemptions. It is also unclear at this stage what financial, trade and legal implications will ensue from Brexit and how Brexit may affect us, our customers, suppliers, vendors, or our industry.
Several of our wholly owned subsidiaries that are domiciled either in the U.K., various EU Member States, or in the United Sates, and our parent company, LivaNova PLC, are party to intercompany transactions and agreements under which we receive various tax reliefs and exemptions in accordance with applicable international tax laws, treaties and regulations. If certain treaties applicable to our transactions and agreements are not renegotiated or replaced with new treaties containing terms, conditions and attributes similar to those of the existing treaties, Brexit may have a material adverse impact on our future financial results and results of operations. During the two-year negotiation period, we will monitor and assess the potential impact of this event and explore possible tax planning strategies that may mitigate or eliminate any such potential adverse impact. We will not account for the impact of Brexit in our income tax provisions until changes in tax laws or treaties between the U.K. and the EU or individual EU Member States are enacted or the withdrawal becomes effective.
The Trump Administration has included as part of its agenda a potential reform of U.S. tax laws. In addition, the “Tax Reform Blueprint” published by the House of Representatives includes a framework of various issues that may affect our future tax position including, but not limited to, a reduction in the corporate tax rate, elimination of the interest deduction and border adjustability. The content of any final legislation, the timing for enactment, and the reporting periods that would be impacted cannot be determined at this time.

31



Results of Operations
We are reporting, in this Quarterly Report on Form 10-Q, the results for LivaNova and its consolidated subsidiaries for the three months ended March 31, 2017, as compared to the three months ended March 31, 2016.
The following table summarizes our condensed consolidated results of operations for the three months ended March 31, 2017 and March 31, 2016 (in thousands):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net sales
 
$
285,105

 
$
286,969

Cost of sales
 
101,463

 
123,567

Product remediation
 
(792
)
 
706

Gross profit
 
184,434

 
162,696

Operating expenses:
 
 
 
 
Selling, general and administrative
 
112,397

 
115,866

Research and development
 
29,651

 
31,690

Merger and integration expenses
 
2,208

 
6,761

Restructuring expenses
 
10,150

 
28,592

Amortization of intangibles
 
11,414

 
15,892

Total operating expenses
 
165,820

 
198,801

Income (loss) from operations
 
18,614

 
(36,105
)
Interest income
 
273

 
213

Interest expense
 
(2,315
)
 
(1,192
)
Foreign exchange and other gains (losses)
 
3,439

 
(1,835
)
Income (loss) before income taxes
 
20,011

 
(38,919
)
Income tax expense (benefit)
 
5,655

 
(1,258
)
Losses from equity method investments
 
(3,085
)
 
(2,717
)
Net income (loss)
 
$
11,271

 
$
(40,378
)
Net Sales
The table below illustrates net sales by operating segment (in thousands, except for percentages):
 
 
Three Months Ended March 31,
 
 
 
 
2017
 
2016
 
% Change
Cardiac Surgery
 
$
139,204

 
$
143,443

 
(3.0
)%
Neuromodulation
 
87,159

 
81,358

 
7.1
 %
Cardiac Rhythm Management
 
58,280

 
61,731

 
(5.6
)%
Other
 
462

 
437

 
5.7
 %
 
 
$
285,105

 
$
286,969

 
(0.6
)%

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The table below illustrates net sales by market geography (in thousands):
 
 
Three Months Ended March 31,
 
 
 
 
2017
 
2016
 
% Change
Cardiac Surgery
 
 
 
 
 
 
United States
 
$
38,245

 
$
40,920

 
(6.5)%
Europe (1)
 
40,956

 
42,864

 
(4.5)%
Rest of World
 
60,003

 
59,659

 
0.6%
 
 
139,204

 
143,443

 
(3.0)%
Neuromodulation
 
 
 
 
 
 
United States
 
73,659

 
70,242

 
4.9%
Europe (1)
 
7,929

 
6,355

 
24.8%
Rest of World
 
5,571

 
4,761

 
17.0%
 
 
87,159

 
81,358

 
7.1%
Cardiac Rhythm Management
 
 
 
 
 
 
United States
 
2,444

 
2,966

 
(17.6)%
Europe (1)
 
47,461

 
50,018

 
(5.1)%
Rest of World
 
8,375

 
8,747

 
(4.3)%
 
 
58,280

 
61,731

 
(5.6)%
Other
 
462

 
437

 
5.7%
 
 
$
285,105

 
$
286,969

 
(0.6)%
(1)
Includes those countries in Europe where LivaNova has a direct sales presence. Countries where sales are made through distributors are included in Rest of World.
Analysis of sales for the three months ended March 31, 2017, as compared to the three months ended March 31, 2016:
Cardiac Surgery sales decreased by 3.0% due to increased sales of the INSPIRE family of oxygenators, increased sales in Perceval, our new sutureless valve, offset by lower heart lung machine sales in all geographies and decreased sales in traditional mechanical heart valves
Sales for Neuromodulation increased by 7.1%. U.S. sales increased by 4.9% and Europe sales increased by 24.8% due to increased demand and improved pricing for the Aspire SR. Rest of World sales increase by 17.0% due primarily due to a change in our sales distribution model from indirect to direct, in Canada and Australia, during the second and third quarters of fiscal year 2016, respectively.
Cardiac Rhythm Management sales decreased by 5.6% primarily due to pricing pressure in the U.S. and Europe. Sales remained relatively flat in Rest of World, as increased sales of cardiac resynchronization therapy devices (“CRT-D”), due to the SonR study positive outcome and IS-4 approval, and increased sales in Japan, due to the KORA 250 launch, were offset by declines in other areas.

33



Cost of Sales and Expenses
The table below illustrates our comparative cost of sales and major expenses as a percentage of sales:
 
 
Three Months Ended March 31, 2017
 
Three Months Ended March 31, 2016
 
% Change
Cost of sales
 
35.6
 %
 
43.1
%
 
(7.5
)%
Product remediation
 
(0.3
)%
 
0.2
%
 
(0.5
)%
Gross profit
 
64.7
 %
 
56.7
%
 
8.0
 %
Selling, general and administrative
 
39.4
 %
 
40.4
%
 
(1.0
)%
Research and development
 
10.4
 %
 
11.0
%
 
(0.6
)%
Merger and integration expenses
 
0.8
 %
 
2.4
%
 
(1.6
)%
Restructuring expenses
 
3.6
 %
 
10.0
%
 
(6.4
)%
Amortization of intangibles
 
4.0
 %
 
5.5
%
 
(1.5
)%
Total operating expenses
 
58.2
 %
 
69.3
%
 
(11.1
)%
Cost of Sales
Cost of sales consisted primarily of direct labor, allocated manufacturing overhead, the acquisition cost of raw materials and components. Our cost of sales as a percentage of net sales decreased by 7.5% to 35.6% for the three months ended March 31, 2017 as compared to the prior year period. This decrease was primarily due to the amortization of the step-up in inventory basis at the Mergers of $21.3 million that accounted for 7.4% of our cost of sales as a percent of net sales for the three months ended March 31, 2016. The amortization of the step-up in inventory basis was fully amortized in 2016.
Merger and Integration Expenses
Merger and integration expenses consisted primarily of consulting costs associated with: computer systems integration efforts, organization structure integration, synergy and tax planning, as well as the integration of internal controls for the two legacy organizations. In addition, integration expenses include retention bonuses, branding and renaming efforts and lease cancellation penalties in Milan and Brussels.
Merger and integration expenses as a percentage of net sales decreased by 1.6% to 0.8% of net sales for the three months ended March 31, 2017 as compared to the prior year period as a result of a decrease in merger related activities, partially offset by an increase in integration expenses.
Restructuring Expenses
Restructuring expenses were primarily due to our efforts under our 2015 and 2016 Reorganization Plans to leverage economies of scale, eliminate duplicate corporate expenses and streamline distributions, logistics and office functions in order to reduce overall costs. Restructuring expenses as a percentage of net sales decreased by 6.4% to 3.6% of net sales for the three months ended March 31, 2017 as compared to the prior year period, due to a decrease in restructuring activities.
Restructuring expenses for the three months ended March 31, 2017 included $5.1 million in expenses related to our plan to sell our Suzhou, China facility.
Interest Expense
We incurred interest expense of $2.3 million for the three months ended March 31, 2017, primarily related to our bank debt and income tax related interest expense for our inter-company sale of intellectual property, as compared to $1.2 million of interest expense for the prior year period, primarily related to bank debt.
Foreign Exchange and Other Gains (Losses)
Foreign exchange and other gains (losses) for the three months ended March 31, 2017 included a $3.2 million gain on a sale of a cost-method investment. During the three months ended March 31, 2016, we incurred net FX losses of $1.8 million, primarily related to losses from freestanding FX forward currency contracts and FX losses on commercial transactions, partially offset by net FX gains on intercompany loans and third party assets and liabilities.

34



Income Taxes
LivaNova PLC is domiciled and resident in the U.K. Our subsidiaries conduct operations and earn income in numerous countries and are subject to the laws of taxing jurisdictions within those countries, and the income tax rates imposed in the tax jurisdictions in which our subsidiaries conduct operations vary. As a result of the changes in the overall level of our income, the deployment of various tax strategies and the changes in tax laws, our consolidated effective income tax rate may vary from one reporting period to another.
During the three months ended March 31, 2017 and March 31, 2016, we recorded income tax expense of $5.7 million and income tax benefit of $1.3 million, respectively, with effective income tax rates of 28.3% and 3.2%, respectively.
Our consolidated effective income tax rate for the three months ended March 31, 2017, includes the impact of various discrete tax items, including the recognition of a $3.0 million deferred tax asset related to a reserve for an uncertain tax position recognized in a prior year. Excluding the impact of discrete tax items, our consolidated effective income tax rate for the three months ended March 31, 2017 and March 31, 2016 was 41.6% and 3.2%, respectively.
Our consolidated effective tax rate, excluding discrete tax items, for the three months ended March 31, 2017, includes the full year impact in 2017 of the consolidation of our intangible assets into an entity organized under the laws of England and Wales, which was not effective until the end of the second quarter of 2016. Our consolidated effective income tax rate, excluding discrete tax items, for the three months ended March 31, 2016 was impacted by $32.0 million of unbenefited net operating losses in certain tax jurisdictions.
On October 13, 2016, the U.S. IRS and U.S. Treasury Department released final and temporary regulations under section 385. In response to comments, the final regulations significantly narrow the scope of the proposed regulations previously issued on April 4, 2016. Like the proposed regulations, the final regulations establish extensive documentation requirements that must be satisfied for a debt instrument to constitute debt for U.S. federal tax purposes and re-characterizes a debt instrument as stock if the instrument is issued in one of a number of specified transactions. Moreover, while these new rules are not retroactive, they will impact our future intercompany transactions and our ability to engage in future restructuring.
Losses from Equity Method Investments
We recognized losses of $3.1 million during the three months ended March 31, 2017 from our share of investee losses at Highlife, Caisson and MicroPort and $2.7 million during the three months ended March 31, 2016 due to losses from the same private medical start-up companies as well as Respicardia. We accounted for Respicardia as an equity method investment through November 2016, and then due to a loss of our significant influence over Respicardia, we began accounting for our investment in Respicardia as a cost method investment.
Liquidity and Capital Resources
Based on our current business plan, we believe that our existing cash and cash equivalents and future cash generated from operations will be sufficient to fund our expected operating needs, working capital requirements, R&D opportunities, capital expenditures and debt service requirements over the next 12 months. We regularly review our capital needs and consider various investing and financing alternatives to support our requirements. Refer to “Note 6. Financing Arrangements” in the condensed consolidated financial statements in this Quarterly Report on Form 10-Q for additional information regarding our debt. Our liquidity could be adversely affected by the factors affecting future operating results, including those referred to in “Part II - Item 1A. Risk Factors” in this Quarterly Report on Form 10-Q.
No provision has been made for income taxes on unremitted earnings of our foreign controlled subsidiaries (non-U.K. locations) as of March 31, 2017. In the event of the distribution of those earnings in the form of dividends, a sale of the subsidiaries or certain other transactions, we may be liable for income taxes. However, the tax liability on future distributions should not be significant as most jurisdictions with unremitted earnings have various participation exemptions or no withholding tax.

35



Cash Flows
Net cash and cash equivalents provided by (used in) operating, investing and financing activities and the net increase (decrease) in the balance of cash and cash equivalents were as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Operating activities
 
$
33,207

 
$
9,600

Investing activities
 
(4,735
)
 
(8,948
)
Financing activities
 
(6,026
)
 
(27,069
)
Effect of exchange rate changes on cash and cash equivalents
 
484

 
1,272

Net increase (decrease)
 
$
22,930

 
$
(25,145
)
Operating Activities
The increase in cash provided by operating activities, during the three months ended March 31, 2017 as compared to the same prior year period, is primarily the result of an increase in net income partially offset by cash payments for prior period restructuring activities during the three months ended March 31, 2017.
Investing Activities
The decrease in cash used in investing activities during the the three months ended March 31, 2017, as compared to the same prior year period, is primarily the result of proceeds of $3.2 million received from the sale of a cost method investment during the quarter.
Financing Activities
The decrease in cash used in financing activities during the three months ended March 31, 2017 as compared to the same prior year period is primarily the result of the repayment of trade receivable advances and the net repayment of short-term borrowings during the same prior year period.
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOURES ABOUT MARKET RISK
We are exposed to certain market risks as part of our ongoing business operations, including risks from foreign currency exchange rates, interest rate risks and concentration of procurement suppliers that could adversely affect our consolidated financial position, results of operations or cash flows. We manage these risks through regular operating and financing activities and, at certain times, derivative financial instruments. Quantitative and qualitative disclosures about these risks are included in our 2016 Form 10-K in “Part II, Item 7A Management’s Discussion and Analysis of Financial Condition and Results of Operations.” There have been no material changes from the information provided therein.

ITEM 4.  CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
(a)  Evaluation of Disclosure Controls and Procedures
We maintain a system of disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act, 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. This information is also accumulated and communicated to management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“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 of the end of the most recent fiscal quarter reported herein. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of March 31, 2017.
(b)  Changes in Internal Control Over Financial Reporting
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-5(f) under the Exchange Act) occurred during the quarter ended March 31, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

36



PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a description of our material pending legal and regulatory proceedings and settlements, refer to “Note 8. Commitments and Contingencies – Litigation and Regulatory Proceedings” in our condensed consolidated financial statements included in this Report on Form 10-Q. 
ITEM 1A.  RISK FACTORS
Our business faces many risks. Any of the risks referenced below or elsewhere in this Report on Form 10-Q or our other SEC filings could have a material impact on our business and consolidated financial position or results of operations. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also impair our business operations.
For additional detailed discussion of risk factors that should be understood by any investor contemplating investment in our stock, please refer to “Part I. Item 1A. Risk Factors” in our 2016 Form 10-K and elsewhere as described in this Report on Form 10-Q.
The results of the United Kingdom’s referendum on withdrawal from the European Union may have a negative effect on global economic conditions, financial markets and our business, which could reduce the price of our ordinary shares.
On June 23, 2016, the United Kingdom (the “UK”) held a referendum in which voters approved an exit from the European Union (the “EU”), commonly referred to as “Brexit.” On March 29, 2017, the UK Government gave formal notice of its intention to leave the EU, formally commencing the negotiations regarding the terms of withdrawal between the UK and the EU. The withdrawal must occur within two years, unless the deadline is extended or a withdrawal agreement is negotiated sooner. The negotiation process will determine the future terms of the UK’s relationship with the EU. The notification does not change the application of existing tax laws, and does not establish a clear framework for what the ultimate outcome of the negotiations and legislative process will be.
Various tax reliefs and exemptions that apply to transactions between EU Member States under existing tax laws may cease to apply to transactions between the UK and EU Member States when the UK ultimately withdraws from the EU. It is unclear at this stage if or when any new tax treaties between the UK and the EU or individual EU Member States will replace those reliefs and exemptions. It is also unclear at this stage what financial, trade and legal implications the withdrawal of the U.K. from the EU will have and how Brexit may affect us, our customers, suppliers, vendors, or our industry.
Several of our wholly owned subsidiaries that are domiciled either in the UK, various EU Member States, or in the United Sates, and our holding company, LivaNova PLC, are party to intercompany transactions and agreements under which LivaNova receives various tax reliefs and exemptions. If certain treaties applicable to our transactions and agreements are not renegotiated or replaced with new treaties containing terms, conditions and attributes similar to those of the existing treaties, the departure of the UK from the EU may have a material adverse impact on our future financial results and results of operations. During the two-year negotiation period, LivaNova will monitor and assess the potential impact of this event and explore possible tax planning strategies that may mitigate or eliminate any such potential adverse impact. LivaNova will not account for the impact of Brexit in our income tax provisions until changes in tax laws or treaties between the UK and the EU or individual EU Member States are enacted or the withdrawal becomes effective.
Our failure to attract and retain qualified personnel and any changes in our key personnel, including officers, could adversely affect our operations.
Our employees are vital to our success and our ability to grow in the future will depend upon our ability to attract, hire and retain highly qualified employees. On March 31, 2017, we announced the resignation of Vivid Sehgal, our Chief Financial Officer, effective May 31, 2017. We are currently engaged in an ongoing effort to identify and hire a successor. We believe that we have thus far been successful in attracting and retaining qualified personnel in a highly-competitive labor market due, in large part, to our competitive compensation and benefits and our rewarding work environment, fostering employee professional training and development and providing employees with opportunities to contribute to our continued growth and success. However, our failure to attract and retain qualified personnel and any changes in our key personnel, including officers, could adversely affect our operations.

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ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.

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ITEM 6. EXHIBITS
The exhibits marked with the asterisk symbol (*) are filed or furnished (in the case of Exhibit 32.1) with this Report on Form 10-Q. 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.  
Exhibit
Number
 
Document Description
 
 Report or Registration Statement
SEC File or
Registration
Number
Exhibit
Reference
2.1
Transaction Agreement, dated March 23, 2015, by and among LivaNova PLC (f/k/a Sand Holdco Limited), Cyberonics, Inc., Sorin S.p.A. and Cypher Merger Sub, Inc.
 
LivaNova PLC Registration Statement on Form S-4, filed on April 20, 2015, as amended
333-203510
2.1
3.1
Articles of Association of LivaNova PLC
 
LivaNova PLC Current Report on Form 8-K, filed on October 19, 2015
001-37599
3.1
10.62†
CEO Employment Agreement effective January 1, 2017 between LivaNova Plc and Mr. Damien McDonald
 
LivaNova Plc Currrent Report on Form 8-K filed on February 28, 2017
001-37599
10.2
10.63†
Side Letter dated January 1, 2017 between LivaNova Plc and Mr. Damien Mc