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On Jul 23, 2013, we downgraded our long-term recommendation on Cyberonics Inc. (CYBX - Analyst Report) to Neutral following continued revenue shortfalls in Japan and the setback for the treatment-resistant depression (TRD) indication. In our opinion, these headwinds dwarf the company’s consistent strong results and avid expectations for fiscal 2014. The stock carries a Zacks Rank #3 (Hold).

Why the Downgrade?

On Jun 5, Cyberonics reported solid fourth-quarter fiscal 2013 results. Fourth-quarter EPS rose 21.1% to 46 cents, beating the Zacks Consensus Estimate of 43 cents. Revenues shot up 19% to $68.3 million, well ahead of the Zacks Consensus Estimate of $64 million. Fiscal 2013 adjusted EPS and revenues of $1.74 and $254 million, respectively, also sailed past the year-ago mark, Zacks Consensus Estimate as well as the company guidance.

In light of the strong growth trend over the last few quarters, impressive overseas growth and solid demand for its VNS Therapy in an underpenetrated epilepsy market, Cyberonics issued an avid outlook for fiscal 2014. While we derive comfort from the advantages of VNS therapy and the strong untapped potential of the epilepsy market, we are wary about competitive pressures from larger players in the neuromodulation space.

We are also wary about lower-than-expected contributions from the high focus Japanese market, where Cyberonics continues to witness a sluggish sales market. Moreover, the ongoing margin pressure remains an overhang, as gross margin and operating margin posted downside of 153 basis points (bps) and 130 bps, respectively. To add to Cyberonics’ woes, gross margin is expected to decline 200 bps in fiscal 2014, ruling out any near-term improvement.

Meanwhile, the stand taken by CMS failed to soothe fears regarding another unsuccessful attempt at gaining national reimbursement coverage for the depression indication. Cyberonics also faces pricing pressure due to overall global macroeconomic uncertainty.

Other Stocks to Consider

While we remain on the sidelines for Cyberonics, other stocks such as IDEXX Laboratories Inc. (IDXX - Analyst Report), Globus Medical Inc. (GMED - Snapshot Report) and Thoratec Corp. (THOR - Analyst Report) are likely to do well. These stocks carry a Zacks Rank #2 (Buy).

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