Basis of Presentation, Use of Accounting Estimates and Significant Accounting Policies

The Mergers

On October 19, 2015, as further described herein, LivaNova became the holding company of the combined businesses of Cyberonics and Sorin. Based on the structure of the Mergers, management determined that Cyberonics was considered to be the accounting acquirer and predecessor for accounting purposes.

Sale of our Cardiac Rhythm Management Business Franchise

On November 20, 2017, we entered into a letter of intent (“LOI”) to sell the CRM Business Franchise to MicroPort Scientific Corporation for $190.0 million in cash. We expect to enter into the definitive acquisition agreement contemplated by the LOI in the second quarter of 2018. As a result of the commitment to undertake the proposed transaction, we recognized an impairment of $78.3 million, net of a $15.3 million tax benefit, related to the intangible and tangible assets of the CRM Business Franchise. The impairment is included in impairment of discontinued operations, net of tax within the consolidated statements of (loss) income. We concluded that the sale of the CRM Business Franchise represents a strategic shift in our business that will have a major effect on future operations and financial results and therefore qualifies as a discontinued operation under U.S. GAAP. The results of operations of the CRM Business Franchise are reflected as discontinued operations for all periods presented in the Annual Report on Form 10-K and the assets and liabilities of the CRM Business Franchise are classified as held for sale and presented as assets and liabilities of discontinued operations on the consolidated balance sheets dated December 31, 2017 and December 31, 2016.

Basis of Presentation

The accompanying consolidated financial statements of LivaNova at December 31, 2017 have been prepared in accordance with generally accepted accounting principles in the United States (“U.S.” and such principles, “U.S. GAAP”) and the instructions to Form 10-K and Article 3 and Article 5 of Regulation S-X.

Reporting Periods

In this Annual Report on Form 10-K, LivaNova, as the successor company to Cyberonics, is reporting the results for:


•	LivaNova and its consolidated subsidiaries for the years ended December 31, 2017 and December 31, 2016.

•

A transitional period, April 25, 2015 to December 31, 2015, filed on Form 10-K/T. This transitional report is the result of the change from Cyberonics’ fiscal year ending the last Friday in April before the Mergers to a calendar year ending December 31st after the Mergers. The transitional period included the business activities of Cyberonics and its consolidated subsidiaries for the period April 25, 2015 to October 18, 2015, and the consolidated results of the combined businesses of LivaNova (Cyberonics and Sorin) for the period October 19, 2015 through December 31, 2015.


•	LivaNova is also reporting the historical results of Cyberonics and its consolidated subsidiaries, our predecessor, for the fiscal year ended April 24, 2015.

Consolidation

The accompanying consolidated financial statements for LivaNova include LivaNova’s wholly owned subsidiaries and the LivaNova PLC Employee Benefit Trust (“the Trust”). The accompanying consolidated financial statements for Cyberonics include Cyberonics’ wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of our consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in such financial statements and accompanying notes. These estimates are based on management’s best knowledge of current events and actions we may undertake in the future. Estimates are used in accounting for, among other items, valuation and amortization of intangible assets, goodwill, measurement of deferred tax assets and liabilities, uncertain income tax positions, stock-based compensation, obsolete and slow-moving inventories, models, such as an impairment analysis, and in general, allocations to provisions and the fair value of assets and liabilities recorded in a business combination. Actual results could differ materially from those estimates.

Reclassifications

The following reclassifications have been made to conform the prior year consolidated statements of (loss) income, consolidated balance sheets and consolidated statements of cash flows with current year presentation:

•

Having entered into a letter of intent (“LOI”) to sell our CRM Business Franchise to MicroPort Scientific Corporation on November 20, 2017, we have classified CRM’s assets and liabilities as held for sale in the consolidated balance sheets as assets and liabilities of discontinued operations and CRM’s operating results in the consolidated statement of net (loss) income into discontinued operations for all prior periods presented. In addition, to conform the consolidated statement of net (loss) income and “Note 18. Geographic and Segment Information” for the year ended December 31, 2016 to the current period presentation, we reclassified operating expense of $6.0 million from the CRM segment to the Neuromodulation segment. In addition, we reclassified operating expense of $1.0 million from the CRM segment to the Neuromodulation segment for the transitional period ended December 31, 2015.

•

To conform the consolidated balance sheet as of December 31, 2016 to the current period presentation, we reclassified $4.5 million of assets held for sale, related to our plan to exit the Costa Rica manufacturing operation, to a separate line item in the consolidated balance sheet from ‘Prepaid expenses and other current assets’. We received $4.9 million in proceeds from the sale of our Costa Rica manufacturing operation during the year ended December 31, 2017.

•

For the year ended December 31, 2017, Loans to Equity and Cost Method Investees of $7.4 million was presented as an Investing Activities and to conform the presentation for the prior year ended December 31, 2016, Loans to Equity and Cost Method Investees of $6.3 million was reclassified to Investing Activities from Financing Activities. For the year ended December 31, 2017 ‘Intangible asset purchases’ were reported as ‘Purchases of property, plant and equipment and other’ and we conformed the presentation for the prior year and the transitional period ended December 31, 2016 and December 31, 2015, respectively. Certain financing activities were reported as Other for the year ended December 31, 2017 and we conformed the presentation for the prior year and the transitional period ended December 31, 2016 and December 31, 2015, respectively.

Merger, Integration and Restructuring Charges

As a result of the Mergers and acquisitions, we incurred merger, integration and restructuring charges and reported them separately as operating expenses in the consolidated statements of (loss) income.


•	Merger expenses consisted of expenses directly related to the Mergers, such as professional fees for legal services, accounting services, due diligence, a fairness opinion and the preparation of registration and regulatory filings in the United States and Europe, as well as investment banking fees.


•	Integration expenses consisted of consultancy fees with regard to: our systems integration, organization structure integration, finance, synergy and tax planning, the transition to U.S. GAAP for Sorin, our London Stock Exchange listing and certain re-branding efforts.

•

After the consummation of the Mergers between Cyberonics and Sorin in October 2015, we initiated several restructuring plans (the “Restructuring Plans”) to combine our business operations. We identified costs incurred and liabilities assumed for the Restructuring Plans. The Restructuring Plans are intended to leverage economies of scale, eliminate duplicate corporate expenses, streamline distributions and logistics and office functions in order to reduce overall costs.

Cash and Cash Equivalents

We consider all highly liquid investments with an original maturity of three months or less, consisting of demand deposit accounts and money market mutual funds, to be cash equivalents and are carried in the balance sheet at cost, which approximated their fair value.

Accounts Receivable

Our accounts receivable consisted of trade receivables from direct customers and distributors. We maintain an allowance for doubtful accounts for potential credit losses based on our estimates of the ability of customers to make required payments, historical credit experience, existing economic conditions and expected future trends. We write off uncollectible accounts against the allowance when all reasonable collection efforts have been exhausted.

Inventories

We state our inventories at the lower of cost, using the first-in first-out (“FIFO”) method, or market. Our calculation of cost includes the acquisition cost of raw materials and components, direct labor and overhead. We reduce the carrying value of inventories for those items that are potentially excess, obsolete or slow moving based on changes in customer demand, technology developments or other economic factors.

Property, Plant and Equipment (“PP&E”)

Assets held and used

PP&E is carried at cost, less accumulated depreciation. Maintenance, repairs and minor replacements are charged to expense as incurred, while significant renewals and improvements are capitalized. We compute depreciation using the straight-line method over estimated useful lives. Leasehold improvements are depreciated over the shorter of the following terms: the useful life of the asset or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date the leasehold improvements are purchased. Capital improvements to the building are added as building components and depreciated over the useful life of the improvement or the building, whichever is less.

Assets held for sale

We classify long-lived assets as held for sale in the period in which we commit to a plan to sell the asset, the asset is available for immediate sale, the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value and the sale of the asset is probable within the next twelve months and when actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. A long-lived asset classified as held for sale is measured at the lower of its carrying amount or fair value less cost to sell and depreciation is discontinued. We recognize a loss for any excess of carrying value over the fair value less cost to sell.

Business Combinations and Goodwill

We allocate the amounts we pay for an acquisition to the assets we acquire and liabilities we assume based on their fair values at the date of acquisition, including property, plant and equipment, inventories, accounts receivable, long-term debt, and identifiable intangible assets which either arise from a contractual or legal right or are separable from goodwill. We base the fair value of identifiable intangible assets acquired in a business combination, including in-process research and development, on valuations that use information and assumptions provided by management, which consider management’s best estimates of inputs and assumptions that a market participant would use. We allocate any excess purchase price over the fair value of the net tangible and identifiable intangible assets acquired to goodwill. Transaction costs associated with these acquisitions are expensed as incurred and are reported as operating expenses. We recognize adjustments to the provisional amounts identified during the measurement period with a corresponding adjustment to goodwill in the reporting period in which the adjustment amounts are determined. The effect on earnings of changes in depreciation, amortization or other income effects, if any, as a result of the change to the provisional amounts are recorded in the same period’s financial statements, calculated as if the accounting had been completed at the acquisition date.

Intangible Assets, Other than Goodwill

Intangible assets shown on the consolidated balance sheets consist of finite-lived and indefinite-lived assets. Developed technology rights consist primarily of existing technology and technical capabilities acquired from Sorin in the Mergers that were recorded at their respective fair values as of the acquisition date which includes patents, related know-how and licensed patent rights that represent assets expected to generate future economic benefits. Trademarks and trade names include the Sorin trade name acquired as part of the Mergers. In-process R&D was recognized as part of the acquisition of Caisson Interventional, LLC (“Caisson”). Customer relationships consist of relationships with hospitals and cardiac surgeons in the countries where we operate. Other intangible assets consist of favorable leases acquired from Sorin in the Mergers. We amortize our finite-lived intangible assets over their useful lives using the straight-line method.

Amortization expense is disclosed separately in the consolidated statement of net (loss) income. We evaluate our intangible assets each reporting period to determine whether events and circumstances indicate either a different useful life or impairment. If we change our estimate of the useful life of an asset, we amortize the carrying amount over the revised remaining useful life.

Impairments of Long-Lived Assets, Investments and Goodwill

PP&E, intangible assets and investments

We evaluate the carrying value of our long-lived assets and investments when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Such changes in circumstance may include, among other items, (i) an expectation of a sale or disposal of a long-lived asset or asset group, (ii) adverse changes in market or competitive conditions, (iii) an adverse change in legal factors or business climate in the markets in which we operate and (iv) operating or cash flow losses.

For PP&E and intangible assets used in our operations, recoverability generally is determined by comparing the carrying value of an asset, or group of assets to their expected undiscounted future cash flows. If the carrying value of an asset (asset group) is not recoverable, the amount of impairment loss is measured as the difference between the carrying value of the asset (asset group) and its estimated fair value. The asset grouping as well as the determination of expected undiscounted cash flow amounts requires significant judgments, estimates, and assumptions, including cash flows generated upon disposition. We generally measure fair value by considering sale prices for similar assets. Assets to be disposed of are carried at the lower of their financial statement carrying amount or fair value less costs to sell.

Goodwill

We conduct impairment testing of our goodwill on October 1st each year. We test goodwill for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

Testing is performed at the reporting unit level, which is defined as an operating segment or a component of an operating segment that constitutes a business for which financial information is available and is regularly viewed by management. Neuromodulation and Cardiac Surgery are deemed to be our reporting units for purposes of goodwill impairment testing.

If we determine that goodwill is more-likely-than-not impaired we perform the first step of a two-step goodwill impairment test. We first identify potential impairment by comparing the fair value of the reporting unit to its carrying amount, including goodwill. Fair value refers to the price that would be received if we were to sell the unit as a whole in an orderly transaction. If the carrying amount of our reporting unit is greater than zero and its fair value exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the impairment test is unnecessary. If the carrying value of the reporting unit exceeds its fair value, we perform step 2 of the goodwill impairment test and determine if the carrying amount of the reporting unit exceeds the implied fair value of the goodwill. An impairment loss is recognized, when the carrying amount of the reporting unit’s net assets exceeds the implied fair value of the reporting unit, up to and including the carrying amount of the goodwill.

If the aggregate fair value of our reporting units exceeds our market capitalization, we evaluate the reasonableness of the implied control premium which includes a comparison to implied control premiums from recent market transactions within our industry or other relevant benchmark data.

Goodwill impairment evaluations are highly subjective. In most instances, they involve expectations of future cash flows that reflect our judgments and assumptions regarding future industry conditions and operations. The estimates, judgments and assumptions used in the application of our goodwill impairment policies reflect both historical experience and an assessment of current operational, industry, market, economic and political environments. The use of different estimates, judgments, assumptions and expectations regarding future industry and market conditions and operations would likely result in materially different asset carrying values and operating results.

Quantitative factors used to determine the fair value of the reporting units reflect our best estimates, and we believe they are reasonable. Future declines in the reporting unit's operating performance or our anticipated business outlook may reduce the estimated fair value of our reporting unit and result in additional impairments. Factors that could have a negative impact on the fair value of the reporting units include, but are not limited to:

•Decreases in revenue as a result of the inability of our sales force to effectively market and promote our products;

•Increased competition, patent expirations or new technologies or treatments;

•Declines in anticipated growth rates;

•The outcome of litigation, legal proceedings, investigations or other claims resulting in significant cash outflows;

•Increases in the market-participant risk-adjusted Weighted Average Cost of Capital (“WACC”).

Derivatives and Risk Management

U.S. GAAP requires companies to recognize all derivatives as assets and liabilities on the balance sheet and to measure the instruments at fair value through earnings unless the derivative qualifies for hedge accounting. 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 comprehensive income (loss) until the hedged item is recognized in earnings upon settlement/termination. The changes in the fair value of the derivative are intended to offset the change in fair value of the hedged asset, liability or probable commitment. 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.

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. We do not enter into currency exchange rate derivative contracts for speculative purposes. All derivative instruments that qualify for hedge accounting are recorded at fair value on the consolidated balance sheets, as financial assets or liabilities (current or non-current) depending upon the gain or loss position of the contract and contract maturity date.

Forward contracts designated as cash flow hedges are designed to hedge the variability of cash flows associated with forecasted transactions denominated in a foreign currency that will take place in the future. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income (loss) and reclassified into earnings to offset exchange differences originated by the hedged item or to adjust the value of operating income (expense). We use freestanding derivative forward contracts to offset exposure to the variability of the value associated with assets and liabilities denominated in a foreign currency. These derivatives are not designated as hedges, and therefore changes in the value of these forward contracts are recognized in earnings, thereby offsetting the current earnings effect of the related change in value of foreign currency denominated assets and liabilities.

We use interest rate derivative instruments designated as cash flow hedges to manage the exposure to interest rate movements and to reduce the risk of increased borrowing costs by converting floating-rate debt into fixed-rate debt. Under these agreements, we agree to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to agreed-upon notional principal amounts. The interest rate swaps are structured to mirror the payment terms of the underlying loan. The fair value of the interest rate swaps is reported in the consolidated balance sheets as financial assets or liabilities (current or non-current) depending upon the gain or loss position of the contract and the maturity of the future cash flows of the fair value of each contract. The effective portion of the gain or loss on these derivatives is reported as a component of accumulated other comprehensive income. The non-effective portion is reported in interest expense in consolidated statements of income (loss).

Fair Value Measurements

We follow the authoritative guidance on fair value measurements and disclosures with respect to assets and liabilities that are measured at fair value on both a recurring and nonrecurring basis. Under this guidance, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. The authoritative guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability, based on market data obtained from sources independent of us. Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or liability developed based upon the best information available in the circumstances. The categorization of financial assets and financial liabilities within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The hierarchy is broken down into three levels defined as follows:


•	Level 1 - Inputs are quoted prices in active markets for identical assets or liabilities.


•	Level 2 - Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly.


•	Level 3 - Inputs are unobservable for the asset or liability.

Financial assets and liabilities that are classified as Level 2 include derivative instruments, primarily forward and option currency contracts and interest rate swaps contracts, which are valued using standard calculations and models that use readily observable market data as their basis.

Financial liabilities that are classified as Level 3 include contingent consideration arrangements resulting from acquisitions that involve potential future payment of consideration that is contingent upon the achievement of performance milestones. Contingent consideration is recognized at the acquisition date based on the consideration expected to be transferred and estimated as the probability of future cash flows discounted to present value in accordance with accepted valuation methodologies. Contingent consideration is remeasured each reporting period with the change in fair value, including accretion for the passage of time, recorded in earnings.

Investments

Cost and Equity Method Investments

Our investments in equity instruments, and related loans, are strategic investments in companies that are in varied stages of development and not publicly traded. Our equity investments are reported under Investments, and related loans under Prepaid Expenses and Other Current Assets and Other Assets, on the consolidated balance sheets. We account for our equity investments and related loans under the cost or the equity method, as appropriate, depending on our level of control over the investee. We use the equity method if we exercise significant influence over the investee but do not control the investee, and we use the cost method if we exercise less than significant influence, which is generally under 20% ownership.

Cost Method Investments

We initially record the amount of our cost method investments at cost and regularly review our investments for changes in circumstance or the occurrence of events that suggest our investment may not be recoverable. This evaluation considers all available financial information related to the investee, including valuations based on recent third-party equity investments in the investees. If an impairment is considered to be other-than-temporary, the loss is recognized in the consolidated statements of income in the period the determination is made. Impairments are reported as Impairment of cost-method investments in the consolidated statement of (loss) income.

Equity Method Investments

The cost of our investments accounted for under the equity method may give rise to a difference between the cost of the investment and our share of the investee’s net book value, or a basis difference. A basis difference is assigned to assets and liabilities of the investee with remaining unassigned basis assigned to goodwill. We amortize finite lived basis differences over the life of the asset or liability. We adjust our investment carrying value each period for our share of the investee’s income or loss. We report our share of the investee’s losses and the amortization of basis differences in the consolidated statements of income (loss) as Income (Loss) from Equity Method Investments. We regularly review our investments for changes in circumstance or the occurrence of events that suggest our investment may not be recoverable, and if an impairment is considered to be other-than-temporary, the loss is recognized in the consolidated statements of income in the period the determination is made and reported as Losses from Equity Method Investments.

Warranty Obligation

We offer a warranty on various products. We estimate the costs that may be incurred under warranties and record a liability in the amount of such costs at the time the product is sold. The amount of the reserve recorded is equal to the net costs to repair or otherwise satisfy the claim. We include the warranty obligation in accrued liabilities and other on the consolidated balance sheets. Warranty expense is recorded to cost of goods sold in our consolidated statements of income (loss).

Retirement Benefit Plan Assumptions

We sponsor various retirement benefit plans, including defined benefit pension plans (pension benefits), defined contribution savings plans and termination indemnity plans, covering substantially all U.S. employees and employees outside the United States. Pension benefit costs include assumptions for the discount rate, retirement age, compensation rate increases and the expected return on plan assets.

Revenue Recognition

Product Revenue

We sell our products through a direct sales force and independent distributors. We recognize revenue when persuasive evidence of a sales arrangement exists, title to the goods and risk of loss transfers to customers or to independent distributors, the selling price is fixed or determinable and collectability is reasonably assured. We estimate expected sales returns based on historical data and record a reduction of sales with a return reserve. We record state and local sales taxes net; that is, we exclude sales tax from revenue.

Service Revenue

Services largely consist of technical assistance services provided to hospitals for the installation, maintenance and support in the operation of heart-lung machines and autotransfusion systems. Service related revenue is recognized on the basis of progress of the services, when services are rendered, when collectability is reasonably assured and when the amount is fixed and determinable.

Research and Development (“R&D”)

All R&D costs are expensed as incurred. R&D includes costs of basic research activities as well as engineering and technical effort required to develop a new product or make significant improvement to an existing product or manufacturing process. R&D costs also include regulatory and clinical study expenses, including post-market clinical studies.

Leases

We account for leases that transfer substantially all benefits and risks incidental to the ownership of property as an acquisition of an asset and the incurrence of an obligation, and we account for all other leases as operating leases. Certain of our leases provide for tenant improvement allowances that have been recorded as deferred rent and amortized, using the straight-line method, over the life of the lease as a reduction to rent expense. In addition, scheduled rent increases and rent holidays are recognized on a straight-line basis over the term of the lease.

Stock-Based Compensation

Stock-Based Incentive Awards

We may grant stock-based incentive awards to directors, officers, key employees and consultants. We measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair market value of the award. We recognize equity-based compensation expense ratably over the period that an employee is required to provide service in exchange for the entire award (all vesting periods). We issue new shares upon stock option exercises, otherwise issuance of stock for vesting of restricted stock, restricted stock units or stock appreciation rights are issued from treasury shares. We have the right to elect to pay the cash value of vested restricted stock units in lieu of the issuance of new shares.

Stock Appreciation Rights

A stock appreciation right (“SAR”) confers upon an employee the contractual right to receive an amount of cash, stock, or a combination of both that equals the appreciation in the company’s stock from an award’s grant date to the exercise date. SARs may be exercised at the employee’s discretion during the exercise period and do not give the employee an ownership right in the underlying stock. SARs do not involve payment of an exercise price. We use the Black-Scholes option pricing methodology to calculate the grant date fair market value of SARs. We determine the expected volatility of the awards based on historical volatility. Calculation of compensation for stock awards requires estimation of employee turnover and forfeiture rates.

Restricted Stock and Restricted Stock Units

We may grant restricted stock and restricted stock units at no purchase cost to the grantee. The grantees of unvested restricted stock units have no voting rights nor rights to dividends. Sale or transfer of the stock and stock units are restricted until they are vested. The fair market value of service-based restricted stock and restricted stock units are determined using the market closing price on the grant date, and compensation is expensed ratably over the vesting period. Calculation of compensation for stock awards requires estimation of employee turnover and forfeiture rates.

Income Taxes

We are a U.K. corporation, and we operate through our various subsidiaries in a number of countries throughout the world. Our provision for income taxes is based on the tax laws and rates applicable in the jurisdictions in which we operate and earn income. We use significant judgment and estimates in accounting for our income taxes. We recognize deferred tax assets and liabilities for the anticipated future tax effects of temporary differences between the financial statements basis and the tax basis of our assets and liabilities, which are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Income tax expense compared to pre-tax income yields an effective tax rate.

We file federal and local tax returns in many jurisdictions throughout the world and are subject to income tax examinations for our fiscal year 1992 and subsequent years, with certain exceptions. While we believe that our tax return positions are fully supported, tax authorities may disagree with certain positions we have taken and assess additional taxes. Therefore, we regularly assess our tax positions in previously filed tax returns and positions we expect to take in future tax returns. Out tax positions are evaluated for recognition using a more-likely-than-not threshold. Those tax positions requiring recognition are measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon effective settlement with a taxing authority that has full knowledge of all relevant information. We regularly monitor our tax positions and tax liabilities, and we reevaluate the technical merits of our tax positions. Some of the reasons a reserve for an uncertain tax benefit may be reversed are: (i) completion of a tax audit, (ii) a change in applicable tax law including a tax case or legislative guidance, or (iii) an expiration of the statute of limitations. We recognize interest and penalties associated with unrecognized tax benefits and record interest in interest expense, and penalties in selling, general and administrative expense, in the consolidated statements of income (loss).

We periodically assess the recoverability of our deferred tax assets by considering whether it is more likely than not that some or all of the actual benefit of those assets will be realized. To the extent that realization does not meet the “more-likely-than-not” criterion, we establish a valuation allowance. We periodically review the adequacy and necessity of the valuation allowance by considering significant positive and negative evidence relative to our ability to recover deferred tax assets and to determine the timing and amount of valuation allowance that should be released. This evidence includes: (i) profitability in the most recent quarters, (ii) internal forecasts for the current and next two future years, (iii) size of deferred tax asset relative to estimated profitability, (iv) the potential effects on future profitability from increasing competition, healthcare reforms and overall economic conditions, (v) limitations and potential limitations on the use of our net operating losses due to ownership changes, pursuant to IRC Section 382, and (vi) the implementation of prudent and feasible tax planning strategies, if any.

Foreign Currency

Our functional currency is the U.S. dollar, however, a portion of the revenues earned and expenses incurred by certain of our subsidiaries are denominated in currencies other than the U.S. dollar. We determine the functional currency of our subsidiaries that exist and operate in different economic and currency environments based on the primary economic environment in which the subsidiary operates, that is, the currency of the environment in which an entity primarily generates and expends cash. Our significant foreign subsidiaries are located in Europe and the U.S. The functional currency of our significant European subsidiaries is the Euro and the functional currency of our significant U.S. subsidiaries is the U.S. dollar.

Assets and liabilities for subsidiaries whose functional currency is not the U.S. dollar are translated into U.S. dollars based on a combination of both current and historical exchange rates, while their revenues earned and expenses incurred are translated into U.S. dollars at average period exchange rates. Translation adjustments are included as ‘Accumulated other comprehensive income (loss)’ (“AOCI”) in the consolidated balance sheets. Gains and losses arising from transactions denominated in a currency different from an entity’s functional currency are included in Foreign exchange and other gains (losses) in our consolidated statements of income (loss). Taxes are not provided on cumulative translation adjustments, as substantially all translation adjustments are related to earnings which are intended to be indefinitely reinvested in the countries where earned.

Segments

Prior to the Mergers we had one operating and reportable segment. Upon completion of the Mergers, we reorganized our reporting structure and aligned the segments of Sorin and Cyberonics and the underlying divisions and businesses. We currently have two operating and reportable segments, Neuromodulation and Cardiac Surgery. Refer to “Note 18. Geographic and Segment Information” for additional information.

Contingencies

The Company is subject to product liability claims, government investigations and other legal proceedings in the ordinary course of business. Legal fees and other expenses related to litigation are expensed as incurred and included in Selling, general and administrative expenses in the Consolidated Statements of Income. Contingent accruals are recorded when the Company determines that a loss is both probable and reasonably estimable. Due to the fact that legal proceedings and other contingencies are inherently unpredictable, our assessments involve significant judgment regarding future events.