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Executives

David Smith – EVP and CFO

Gary Burbach – President and CEO

Analysts

Mimi Pham – JMP Securities

Eric Schneider – UBS

Taylor Harris – JP Morgan

Bob Hopkins – Banc of America

Tim Lee – Piper Jaffray

Jason Mills – Canaccord Adams

Keay Nakae – Collins Stewart

Greg Simpson – Stifel Nicolaus

Suraj Kalia – SMH Capital

Spencer Nam – Summer Street

Duane Nash – Wedbush Morgan

Jayson Bedford – Raymond James

Thoratec Corporation (THOR) Q1 2009 Earnings Call Transcript May 7, 2009 1:30 PM ET

Operator

Good day and welcome to the Thoratec Corporation earnings conference call. Today's call is being recorded. At this time, I would like to turn the conference over to Mr. David Smith. Please go ahead, sir.

David Smith

Thank you. Good afternoon and thank you for joining us today. With me are Gary Burbach, President and Chief Executive Officer; and Larry Cohen, President of our ITC Division. Thoratec started off 2009 strongly, generating a nearly 40% increase in revenues, filing our PMA supplement for destination therapy, and obtaining FDA approval for our new HeartMate external peripherals.

In addition of course was the announcement of our proposed acquisition of HeartWare International. Gary will discuss these and other key events of the quarter and I will follow with a review of our financial results. We will then open the call to your questions.

As a reminder during the course of today’s conference call and question and answer session that follows, we may make projections or other forward-looking statements that are subject to the Safe Harbor provisions of the securities laws regarding future events or the financial performance of the Company.

We caution you that these statements are only predictions and the actual results may differ materially. We also alert you the risks contained in the documents we filed with the Securities and Exchange Commission such as our annual and quarterly reports on Forms 10-K and 10-Q. We do not undertake any obligation to update or correct any forward looking statements. Gary?

Gary Burbach

Thank you, David, and good afternoon everyone. As David indicated we had a very productive quarter, not only with respect to our ability to grow revenues, but also in hitting the critical milestone that are laying the groundwork for longer-term growth.

Revenues for the quarter were $89.5 million, 39% increase over revenues of $64.4 million in the first quarter a year ago. As a reminder, we did not receive bridge to transplantation approval for the HeartMate II until April 2008. So the ensuing quarters 2009 will face more different comparables versus last year.

Cardiovascular division revenues in the quarter were $64.6 million versus $40.2 million a year ago. Excluding CentriMag, we sold 659 pumps versus 453 pumps in the first quarter a year ago. Our growth in the cardiovascular division was driven by strong reorder activity from our trial centers, continued study implants from new centers we brought on last year, and strong enrollment in the destination therapy trial.

In addition, the patient experience with the HeartMate II for bridge to transplantation in the commercial setting, which has just now surpassed a year, continues to be highly positive, demonstrating the value of our launch, training, and clinical support strategies. As our result suggest, we had not seen a meaningful impact from the economic environment on our VAD business.

However, we believe that the environment is having some negative impact on our ITC business, which we will discuss later. During the quarter, we added four new HeartMate II centers in North America. As we had indicated in our last call, we expected the pace of new center additions to slow versus that of the recent quarters.

We still expect to add 10 to 15 new HeartMate II centers during 2009, building upon the 101 in place in North America at the end of 2008. We also achieved two key regulatory milestones since our last call, including the filing of our PMA supplement seeking destination therapy approval for the HeartMate II an FDA approval of our new external peripherals for the HeartMate II an XVE.

Before I speak to those, I wanted to briefly update you on our definitive agreement to acquire HeartWare international that was announced on February 12. As you know, the closing of the HeartWare acquisition is subject to various conditions, including approval by the FTC and HeartWare shareholders. Both we and HeartWare are working diligently to comply with the request for additional information that we received from the FTC as we announced on March 27.

These reviews can take between four and six months to complete, so we continue to expect that the transaction will close in the second half of this year. With respect to our PMA supplement for destination therapy, as we announced on April 20, it includes data on a pivotal study cohort of 200 randomized patients, including two-year data on the first 167 patients enrolled.

Also included in this analysis is similar data on 24 small body surface area patients. This filing also provides data on adjunctive cohorts totaling an additional 409 patients. Including those who had originally been supported by an XVE who were elected to receive a HeartMate II based on the need for device replacement and patients involved under continued access protocols or CAPs.

In our last call, we had indicated that we were planning to make this filing in late May as a result of communication with the FDA, indicating that they expected our submission to include the full two-year follow-up on the primary cohort. However, following subsequent discussions with the agency and given the strong data in the interim analysis conducted at the end of 2008, we mutually agreed that it was appropriate to make this filing in April.

Less as we indicated in our press release, we will file an amendment with complete two-year data on all 200 randomized patients at the end of June. We believe that the trial data demonstrate that the HeartMate II is superior to the XVE, based on the device performance and the primary patient endpoint of two-year survival free from stroke and re-operation for device replacement.

The data also showed that key adverse events such as infections, sepsis, and right heart failure were significantly lower in patients implanted with the HeartMate II versus those treated with the XVE. As a result of this submission three weeks ago, we believe we are on track for an approval by early 2010. With respect to our plans for the presentation of the data from the destination therapy trial, we plan to file for a late breaking presentation at the American Heart Association meeting in Orlando on November 14 to 18.

This strategy is based on feedback from our clinicians that the AHA represents the optimum form for the initial release of the data. In doing so, we believe this will maximize the data value in supporting the launch of the HeartMate II for destination therapy. We're also working simultaneously on submitting the data for publication in a top-tier medical journal as part of our destination therapy launch strategy.

With respect to the trial itself enrollment at April 24 was 733 patients including 468 patients enrolled in the randomized portion of the trial. 85 patients were enrolled in the trial during the three month reported period. This is double the patient enrollment in the prior reporting period and roughly 60% greater than the reported period a year ago.

In terms of the status of CAPs, we received approval from the FDA for new 30 patient CAP two weeks ago. As I mentioned a moment ago, the other important regulatory milestone was the recent FDA approval for our new HeartMate external peripherals. These include new batteries, charger, and power module. The overall objective of these enhancements is to provide an even better quality of life for HeartMate patients by offering them more freedom and mobility and the ability to resume many aspects of a normal life.

The new batteries are lighter and longer lasting roughly double the 3 to 5 hours of support provided by the prior battery. In addition, the new batteries include onboard diagnostics that display a variety of information including the remaining battery life. The new charger weighs about 8 pounds versus 30 pounds for the prior version making it more mobile and portable along with providing optimal battery charging and conditioning to extend battery life.

The power module and the AC unit, which weighs about 10 pounds or one-third of the prior version this is used primarily when the patient is sleeping or going to be in one location for an extended period of time and include the card adaptor [ph]. We're introducing these new offerings via control launch to a few high-volume centers, as we scale up production and build inventory for a full rollout in the third quarter.

We are excited about these new offerings not only because of what they mean to our patients, but also that they further HeartMate II’s technology leadership and provide features that are import to our future launch for destination therapy. Other programs to enhance the HeartMate II system remain on track, including improvements to both the external and implanted portions of the percutaneous lead, a new controller, and field inflow and outflow grafts all of which are scheduled for introduction in 2010.

With respect to some other brief updates in the VAD area, we continue to see encouraging progress with respect to CMS certification for destination therapy reimbursement. As you may know the deadline for the recertification of existing centers was the last week in March.

A total of 64 centers have received certification as of that time including 55 centers that received recertification. In addition, nine centers have received new CMS certification including eight transplant centers, and one non-transplant center. As we indicated in our last call, we expect that 10 to 20 new centers will receive certification this year with a total of approximately 75 centers certified for destination therapy reimbursement by the end of the year.

Having centered the chief certification from CMS for destination therapy reimbursement it is key to an effective launch of HeartMate II for destination therapy. With respect to reimbursement the proposed updates to DRGs, which will take effect in October, were issued by CMS at the end of last week. Our two primary DRGs one and 215 have received about a 5% increase in the base rate for VAD implantation.

Secondary codes such as DRG 2 received a 5% decrease although less than 20% of the VAD cases fall within this DRG. It is important to note that these are proposed and not final at this point. We are monitoring the reimbursement process and we will update you as appropriate.

In addition, we continue to make progress with our program to introduce the HeartMate II in Japan. We are having fruitful discussions with both the regulatory agency and potential distributors and are on track to initiate a small confirmatory trial there later this year.

We held a major clinician education event during the quarter, a highly successful users meeting in March. We had 220 attendees representing a large number of our North American customers, as well as several perspective centers. Attendees included surgeons, heart failure cardiologist, and VAD coordinators.

There was a very productive exchange of information on clinical and economical best practices for advanced heart failure therapy and mechanical circulatory support, particularly related to the growing utilization of the HeartMate II. Over the next several months, we will launch two new initiatives related to ensuring positive patient outcomes and building clinical infrastructure capacity.

The first is a formalized VAD coordinator training session next month at the University of Louisville that is focused on providing less experienced VAD coordinators, a strong foundation in program management, patient selection, and techniques to improve patient outcomes.

In addition, we are launching a series of mentoring programs for VAD coordinators in which we team up coordinators from experienced centers with those at centers that are just starting their VAD programs. Of course an important element of our market education and development efforts continue to be presentations at major medical meetings and publications in leading medical journals.

The discussion of VAD therapy had a significant presence at the two most recent meeting, the American College of Cardiology or ACC in March and the International Society for Heart and Lung Transplantation or ISHLT, which took place two weeks ago. There are more than 125 VAD related data presentations at the ISH LT and I will take a couple of minutes to highlight several of them.

A study led by Dr. Ranjit John from the University of Minnesota reviewed post-transplant survival in 469 patients implanted in the HeartMate II bridge to transplantation trial. Of the 250 patients who were transplanted, he reported post-transplant survival at 30 days with 97% and 87% at one year. This conclusion was that post-transplant survival rates for patients implanted with a continuous slow VAD were at least comparable to those who underwent a conventional transplant.

This is despite the fact the patient's were UNOS status 1A or 1B at study entry compared to the conventional cohort, which includes UNOS Class II patients who by definition are less sick. Dr. Nader Moazami from Washington University in St. Louis looked at pump durability and replacement among 484 patients in the HeartMate II bridge trial.

The median and mean durations of support were 194 and 291 days respectively with the longest supported for 3.7 years. He reported that 151 patients were supported for longer than one year with 45 more supported for longer than two years. 18 of the patients underwent device replacement and they were no failures of the mechanical pumping mechanisms.

He founded that 12 and 18 month breaks of freedom from device replacement or failure including patient related events where 94% and 92% respectively. He concluded that the use of the HeartMate II is associated with a low incidence of major device malfunction or major device infection resulting in pump exchange or death and that the data demonstrate the reliability and durability of the pumps design and provide encouraging evidence supporting its use for long-term circulatory support.

A third study out of Sharp Memorial Hospital in San Diego looked at outcomes of 22 LVAD patients over the age of 70 with a mean age of 75. Half were implanted with the HeartMate II end half with the HeartMate XVE. The average duration of support was 410 days although it ranged up to 1,577 days or roughly four and one-third years. The survival rate was 95% at 30 days, 83% in 90 days, and 75% at one year.

These are incredibly positive results in an older patient population that can benefit significantly from VAD therapy, particularly as we approach destination therapy approval for the HeartMate II.

Finally Prof. Crobach [ph] from the Berlin Heart Institute presented a retrospective comparison of the incident of thromboembolic cerebral events in 64 patients implanted with the HeartMate II versus its 260 other rotary pump patients. Of note, in the HeartMate II patients were older and there was a higher proportion of destination therapy patients in the HeartMate II cohorts.

Overall, the HeartMate II patients exhibited a lower rate of thromboembolism versus the control group with a reported rate of 97% freedom from stroke at one year and HeartMate II patient survival rates of 84% at one year and 81% at two years. In addition, we have three papers reporting data from the HeartMate II bridge trial completed and accepted for publication, which we expect to see later this year.

These include an update from Doctors Pagani and Miller on the original 133 bridge trial patients published in the New England Journal of Medicine. The updated data examines competing outcomes on 281 patients at 18 months, including positive primary outcomes, transplantations ongoing or recovery of 79%.

The other papers look at neural cognitive experience of patients written by Dr. Ralph Petrucci of Drexel and positive data on low thromboembolism rates and lower anti-coagulation requirements from Dr. Andy Boyle of the University of Minnesota. Several more papers detailing data from the trial have also been submitted. I also want to mention that we expect an abstract on the HeartMate II post market InterMax registry will be presented at the Heart Failure Society of America meeting in mid-September.

Turning to ITC, revenues in the quarter were $24.9 million versus $24.2 million in the first quarter a year ago. As I mentioned earlier, we believe the capital equipment environment is having an impact on ITC, particularly with respect to device purchasing activity at hospitals and physicians offices.

We experienced some growth in our international markets with US revenues essentially flat year-over-year. Our alternative side business generated solid revenues as our pro-time business continues to benefit from the growing patient self testing market and increased activity in the pharmaceutical clinical trial sector.

This growth was offset by a couple of factors including lower revenues in our physician office, professional, or pro time business resulting from increasing competitive pressure and the impact of economic conditions on capital equipment purchases, which also affected our Hospital point of care business.

In addition, we saw continued softness in our incision business to the lower price competition we have discussed previously. The timeline for the five 10-K filing for our new pro-time offering has slipped a bit from our prior guidance as we now expect to make that submission late this quarter.

This delay is due to some additional testing that was needed as part of a five 10-K filing. Positive data from the trial is being presented in four abstracts at the anti-coagulation forum in San Diego this week. We expect to have approval and launch the new device in late 2009 or early 2010.

Also in mid-March, we submitted our response to the 483 notice of observation report issued by the FDA that we discussed in our last call. We expect to meet with the agency to discuss our plan in the near future. In addition, we continue working aggressively to implement the preventive and corrective actions to address the observations raised in its report.

In closing, Thoratec had a very promising start to 2009 as we continue to drive our growth strategies and realizing both continued adoption of the HeartMate II and successful patient outcomes with the device. In addition, we have achieved two important regulatory milestones with the filing of our PMA for destination therapy and FDA approval of our new HeartMate external peripherals, and we continue to drive our HeartMate product enhancement efforts that will support our destination therapy launch.

We also continued the facility of broad range of data at leading professional meetings and in top-tier medical journals. Our market development programs are fostering adoption as well as laying groundwork for our destination therapy approval in the US by early 2010.

Thank you again for joining us today and I will now turn the call over to David for a review of our financial results. David.

David Smith

Thank you, Gary. Before reviewing our results I want to remind you that non-GAAP net income excludes amortization of intangibles share-based compensation expenses under FAS 123R. The effect of FSP 14-1 one related to convertible instruments and HeartWare transaction costs.

Non-gap net income also takes into effect – takes into account the tax effects of these adjustments. You can find a reconciliation between our GAAP and non-GAAP results in our earnings news release at Thoratec.com. As Gary mentioned revenues for the first quarter were – for 2009 were $89.5 million at 39% increase over revenues of $64.4 million in the first quarter of 2008.

The impact from foreign exchange was an unfavorable $900,000 versus the first quarter a year ago. Non-GAAP gross margin for the quarter was 61% versus 56.3% a year ago. The increase in gross margin reflects higher ASP's for the HeartMate II and world wide HeartMate II volume offset in part by lower margins at ITC, related primarily to geographic mix, competitive pricing pressure and unfavorable manufacturing variances. Non-GAAP operating expenses in the quarter were $34.1 million versus $30.7 million a year ago.

The year-over-year increase is due primarily to product and market development initiatives, HeartMate II commercialization programs, and higher compensation expense. We also incurred $3.9 million in HeartWare related transaction expenses during the first quarter. As a reminder, these have been excluded from non-GAAP operating expenses.

On a non-GAAP basis, other income and expense was a minor loss in the quarter versus other income of $1.3 million in the first quarter of 2008. This is a result of lower interest rates and shortened maturities on our cash and investment portfolio along with the strengthening of the US dollar versus the British pound.

We expect that we will continue to see the effect of lower interest rates and shortened maturities through the balance of the year. On a non-GAAP basis, the company's effective tax rate for the quarter was 32.6% versus 33.5% a year ago, reflecting new state apportionment rates. Non-GAAP earnings per diluted share for the quarter were $0.22 versus $0.08 in the first quarter a year ago.

Our earnings per share in the first quarter of 2009 reflect a $0.01 negative impact related to foreign exchange. Weighted average diluted shares outstanding at the end of the quarter were $65 million versus $62.2 million a year ago. Our convertible debt continues to be dilutive increasing diluted shares outstanding by approximately $7.3 million.

Turning to the balance sheet, we ended the quarter with $275 million in cash and investments versus $279 million at the end of fiscal 2008. This balance includes $20 million in restricted cash, related to the note we made available to HeartWare and net auction rate securities of $30 million.

Our cash balances declined in the first quarter, due to expenditures related to the HeartWare transaction, increases in inventory levels, capital expenditures associated with our manufacturing capacity expansion, and increased performance based compensation paid in the first quarter.

We have no change to the overall guidance for 2009 that we provided in our fourth quarter conference call. However, we do expect that ITC's revenues will be flat to an increase in the low single digits in 2009 versus previous expectations of mid-single-digit growth. This is due to increased pressure on hospital and physician office capital purchases and competition.

Thanks for joining us today and we will now open the call to your questions. As a reminder we ask that you limit yourselves to one question and a follow-up. Operator.

Question-and-Answer Session

Operator

(Operator instructions) We will take the first question from Mimi Pham with JMP Securities.

Mimi Pham – JMP Securities

Hi good morning, good afternoon.

Gary Burbach

Hi, Mimi.

Mimi Pham – JMP Securities

Can you just clarify your CAP with 30 patients, are you through the end of that now that, you know since you had rolled I guess 85 patients in the three-month period?

Gary Burbach

So the 30 patient CAP that I mentioned is a new CAP that we just received two weeks ago. So the previous CAP we had enrolled that CAP, yes.

Mimi Pham – JMP Securities

So you still have 30 patients, I mean 30 people left on this new 30 patient CAP.

Gary Burbach

Close to. Yes.

Mimi Pham – JMP Securities

Do you have a sense from the FDA, like in terms of, you know last quarter you talked about just potential restrictions on the CAP, is that somewhat related to them allowing you to file earlier or do you have any more clarity or color on that that you can provide in terms of future potential restrictions?

Gary Burbach

Yes. I mean at this point there are restrictions other than that it's only 30 patients. You can see from the pace that we enrolled in the trial in the last quarter that centers are enrolling patients quickly relative to that size. So, it necessitates us going back fairly frequently and the side is going through their IRB process, which for this kind of a change is quick, but nevertheless it does make for a bit of a cumbersome process.

It also maintains uncertainty as to will they continue to provide CAPs in that kind of an approach. So our focus is certainly to try to maintain access to our trial centers through the review and approval process. So, at this point, we certainly are pleased that the FDA gave us another CAP and you know we will look to continue that process going forward.

Mimi Pham – JMP Securities

Okay. And just one last question, in terms of the questions received from the FTC regarding the HeartWare transaction would you say that you're more confident or less confident about the transaction closing in the second half of this year based on your review of the questions?

Gary Burbach

Yes. We are not going to discuss the specifics of the second request, you know we are, as we mentioned, we are actively working to respond to those questions and continue to expect to close in the second half of the year.

Mimi Pham – JMP Securities

Okay thank you very much.

Gary Burbach

Thank you.

Operator

Our next question comes from Eric Schneider with UBS.

Eric Schneider – UBS

Hi good evening.

Gary Burbach

Hi.

Eric Schneider – UBS

With your plan now to release the data at late break at the AHA, what sort of push back are you confronting from potential new centers that you're trying to get up and running into events to make, you know upfront investments and what is obviously a hospital capital constrained environment.

Gary Burbach

Yes. Certainly, the economic environment isn't favorable in terms of that kind of, the new center initiative that we have. We are encouraged by the interest of the clinicians, you know the recent CMS proposed increase in reimbursement, I think gives us another positive economic data point. We have a significant amount of additional positive trial data coming out of the bridge trials here at the ACC and ISHLT meetings. So, we feel like we have all the ingredients that we need to make a very compelling case, I think the economic environment, you know extends the time process some that we are continuing to push forward on that. We continue, as I mentioned we continue to expect 10 to 15 additional HeartMate II centers during the course of 2009. We had four in Q1. So, we certainly feel like we are on track to that element of our plan.

Eric Schneider – UBS

And are there any new centers still potentially available in Europe and with respect to the one's you are in what you are seeing competitively from recent market entrants there?

Gary Burbach

Yes, you know we have been commercial for three years in Europe. So, we've had a much longer time period, you know bringing sides on board with HeartMate II we did add one more new center in Europe during Q1 and we expect that we will add a few more during the course of the year. So Europe continues to be very positive environment in terms of the success that the centers are having, the enthusiasm that they have for HeartMate II. So we continue to view Europe as a growth opportunity as well.

Eric Schneider – UBS

And you're not seeing share losses or strengths that people testing out newer devices that have come on the market in that window.

Gary Burbach

Well, you know that’s always the case, you know in our field it is a field that is dominated by academic medical centers that are always interested in trying out new devices, you know we saw that as Ventracor came onto the market here over the last couple of years, Thermo, you know HeartWare we expect they will see a similar kind of a dynamic.

Eric Schneider – UBS

Thank you.

Operator

Our next question comes from Taylor Harris of JP Morgan.

Taylor Harris – JP Morgan

Thanks a lot. My first question is on the DT trial as well, so, I think you said that the randomized portion was up and I just wanted to make sure that we understood that because I thought you had stopped randomizing, so is that just an issue of semantics and did the enrollment spike I guess because of the lack of randomization in your view?

Gary Burbach

Right. So just to restate the data, Taylor. So, in total 733 patients have been enrolled in the trial, that covers all the arms, the historical randomized now non-randomized, but you know the pivotal arm, as well as the small patients and the XVE exchanges of the 733, 468 are in, what I referred to as the randomized portion of the trial, your question is a good one in terms of you are correct and that’s not randomized anymore. So, the more recent entrants into that portion of the trial are actually non-randomized. So, the 468 is a combination of up until December, you know the randomized patients and now this year non-randomized patients. And so, we had 85 patients that were enrolled in total across all of those from late January to late April and that is roughly double the rate that we saw in the previous three-month period leading up to late January and I think certainly that increase enrollment was based on the elimination of randomization, we talked numerous times about one of the challenges that we've been rolling in that BT trial was a lack of enthusiasm around the HeartMate XVE for destination therapy and so with that barrier gone, you know there was substantial greater enthusiasm to enroll patients into the trial.

Taylor Harris – JP Morgan

Okay great. And then second question is just on guidance, the rest of the year outlook, which implies about $85 million to $88 million of revenue a quarter. So below the first quarter level and I just wanted to make sure is there any reason or set of reasons that the first quarter would have been peak revenue for the year?

Gary Burbach

I say the greatest uncertainty as we look at the balance of the year given what we are just talking about in terms of the DT trial being a significant element of revenue generation in the first quarter is whether the FDA continues to provide, you know kind of consistent CapEx as we go through the review and approval process. So, that would be kind of the one element of uncertainty other than that there is not reason to expect that Q1 would represent a peak in the year.

Taylor Harris – JP Morgan

Okay great thanks a lot.

Gary Burbach

Thank you.

Operator

We will now hear from Bob Hopkins with Banc of America.

Bob Hopkins – Banc of America

Hi thanks, can you hear me okay?

Gary Burbach

Yes, thanks Bob.

Bob Hopkins – Banc of America

Yeah, great story because I am in an airport here. I want to follow up on Taylor's question on enrollment, especially enrollment under the – the latest enrollment under the CAP, so can you tell us, like the last CAP, which I think was also 30 patients, how quickly was that enrolled?

Gary Burbach

At the pace that we were enrolling that was enrolled in probably about six weeks or so.

Bob Hopkins – Banc of America

So you had the last 30 patients enrolling in roughly six weeks.

Gary Burbach

That’s correct.

Bob Hopkins – Banc of America

Okay. And then I apologize, I didn’t see the press release but was there any stocking that went on this quarter? And is there any pushback on inventories as it relates to HeartMate II? And roughly what kind of inventory does the hospital carry? Is it one device, two devices?

Gary Burbach

Yes, so in terms of stocking, it's really the four new centers and as we’ve mentioned it’s typically two devices. So, you're talking about something on the order of $600,000 in stocking activities, so fairly minimal.

Bob Hopkins – Banc of America

Okay.

Gary Burbach

And most of the hospitals stock two devices, so for one for an implant and one is a backup in case there is an issue. So that's the vast majority of the centers that stock two, there's a small number of centers that might stock three or only one, but we didn’t really see any substantive change in behavior in terms of inventory stocking levels other than over probably the course of the last year, we have seen some reduction in stocking levels with the XVE as centers have got ramped up with HeartMate II, ramped down their XVE utilization and so they are not looking – they are more inclined to only have one XVE on the shelf than two as they historically have.

Bob Hopkins – Banc of America

Okay. And then just real quickly, has your opinion changed on the need for a panel for Destination Therapy? And then also as you look at – – look forward to 2010, it sounds like you have 75 Destination Therapy centers approved for reimbursement, you will have the data out and you get the approval sometime in early 2010. Are there any other – as we start to think about a longer-term model, is there any other hurdles that we should know about that would kind of limit the rollout of the device on 2010 upon approval or should be all systems go? Thanks.

Gary Burbach

Let's see, the first part of the question, I'm sorry, Bob – what's that? Oh yes, right, panel. So in terms of panel at this point, we don’t know but we believe that we will have visibility to that in the kind of 100 day review time period from the FDA. So hopefully we'll have some greater insight and ability to communicate on that front with you in the not too distant future. And relative to kind of other obstacles, there really aren't other significant obstacles. I'd say there is an opportunity with we are pursuing which is to try to pursue IIIB reimbursement with CMS, so today for DT that reimbursement is for Class IV patients in the commercial setting. So I view that as more of an opportunity versus on obstacle.

Bob Hopkins – Banc of America

Thank you.

Gary Burbach

Thanks, Bob.

Operator

Our next question comes from Tim Lee with Piper Jaffray.

Tim Lee – Piper Jaffray

Good afternoon and thanks for taking the question. Just following upon on Bob’s question on the panel, I mean hypothetically if you have to go to panel could we see the data coming out before the AHA if the panel gets scheduled early enough?

Gary Burbach

I guess, yes, that is a possibility.

Tim Lee – Piper Jaffray

Okay. And then just in terms of the CAP, how restrictive is it to renew the CAP? I mean how in terms of the kind of the logistics involved? Is it a one week process or one month process? Any type of framework you could provide on that please?

Gary Burbach

Yes, typically it’s a 30 day review by the FDA. They may respond slightly quicker than that, but usually it’s pretty close to 30 days or 30 days on the dot that they respond to those requests. And then once we receive the response, the approval as we did two weeks ago with the size it is generally a very quick process, so they are generally within a matter of days able to turn around their IRB to enroll patients.

Tim Lee – Piper Jaffray

And then just one last one on the ITC side, in terms of the 43, what is the next step that’s involved and has all the deliverables been given to the FDA? Is it the next meeting that is coming up for the agency? If you could just provide us some more specificity on that front please?

Gary Burbach

Yes, so we have provided them with a full set of plans in terms of our responses to those observations. We will be providing them with regular update reports to report on our progress against those committed plans and we expect to meet with them likely later sometime this quarter to review that plan and get any feedback.

Tim Lee – Piper Jaffray

Okay. Thank you.

Gary Burbach

Thank you.

Operator

Our next question comes from Jason Mills with Canaccord Adams.

Jason Mills – Canaccord Adams

Hi gentlemen, congrats on a good quarter.

Gary Burbach

Thanks, Jason.

David Smith

Yes.

Jason Mills – Canaccord Adams

Gary, you mentioned the greatest uncertainty as it relates to the quarterly progression revenue going forward is, whether or not you would be able to continue to roll in additional CAPs. I am wondering if that is the – if that is truly something that is an uncertainty in light of what seems to be continued penetration into this transplant eligible patient population. That is sort of hard to put your finger on how big it is, but certainly it's this huge gray area sort of between Bridge-to-Transplantation and Destination Therapy as you talked about in the past. Perhaps you could provide us some color in light of your comment about the uncertainty around CAP with respect to what you are seeing in this transplant eligible patient population?

Gary Burbach

Yes, I think that certainly been a very positive aspect of the progression of the business since we received the approval and launched HeartMate II for Bridge-to-Transplant last – April of 2008. And we’ve seen centers come on board very rapidly and we’ve seen a broad cross-section of centers, both those in the trial as well as those that have bought the device since it became available commercially, expand their utilization of that with HeartMate II and utilize them in a broader population of patients than they have historically. So that’s something that we have now a year under our belt of that experience, that’s been a positive progression throughout that year. So we feel good about that continuing to take place as we go forward through the balance of 2009. So I don’t view that one so much as an uncertainty because we have a year of track record and feel good about that progress continuing with. The CAP and the DT patients, there obviously we rely on the FDA. We certainly had a good experience during the Bridge review and approval process where they continued to provide CapEx, but we do just one highlight that we don’t have control over that.

Jason Mills – Canaccord Adams

Right. I guess I am sort of getting at is at the end of the day it's up to the centers that are screening these patients and using their judgment as to which patients fall under the current labeling. And insofar as that is true, it would seem to me that the CAP and whether you get continued extenuation of the CAP is perhaps less important than what’s going on in terms of the individual centers screening and their practice with respect to implanting patients, as you mentioned, that are a broader patient cohort of sort of Bridge patients than you've ever seen before. Am I thinking about that right? And the second part of that question is, what are you seeing in your channel feedback with respect to how cardiologists that are working at these transplant centers, what their rate of screening has done over the last let's say 12 months? Because in our checks, cardiologists are in some cases triple booking each hour, in other words ramping the number of patients that they're screening that could be potential LVAD patients. Thank you.

Gary Burbach

Yes, I think that to your first part of your question, both are certainly important dynamics. There is a kind of general positive progression kind of regardless of the CAP, but I do believe that there are set of patients that many of the clinician would not implant under the commercial Bridge approval. A 75-year-old patient that is clearly not a transplant candidate even under a kind of aggressive view of things. Those – again, we saw that in Q1, where we’ve seen this positive progression with Bridge through 2008, but that in Q1 we saw – that continued and then we saw on top of that this bump related specifically to the DT trial.

Jason Mills – Canaccord Adams

Right, right. Last question, how can you guys affect the rate at which centers get certified under Jaka [ph]? What initiatives do you have in place or will you put in place perhaps starting now as you anticipate a potential DT approval and you anticipate perhaps a bottleneck because obviously the certification process doesn’t happen overnight.

Gary Burbach

Yes, we have very substantial efforts that are focused on that, Jason. So we have essentially a cook book that we go into the centers, really help them make it a much easier process so that each center isn't kind of reinventing the wheel here in terms of how they get through this certification process. And then for new centers, working with them to help them get their required number of implants generally by getting them partnered up with existing centers to help get through that process more expeditiously to get to Jaka certification.

Jason Mills – Canaccord Adams

Thanks guys.

Gary Burbach

Thanks, Jason.

Operator

Now, we will hear from Keay Nakae with Collins Stewart.

Keay Nakae – Collins Stewart

Yes, good afternoon. Gary, with respect to the change of mind by the FDA to allow you to file the PMA earlier, can you give us a little more insight there, what it – what that a function of the agency familiarity with the HeartMate II? Is it the same team reviewing the device who reviewed it for Bridge or what other factors went into the decision to do something that frankly we rarely see them do?

Gary Burbach

Yes, certainly the lead reviewer is the same as during the Bridge trial and a number of the other parties are the same is doing the Bridge trial. So I think that’s certainly a very significant benefit that familiarity with what they saw during the Bridge process and the continued data they have seen on that front. And I think also as they had an opportunity to review the interim analysis data that we provided to them at the end of last year and really understand that and get comfortable with it, gave them the confidence to take a more aggressive posture in terms of our submission of the data.

Keay Nakae – Collins Stewart

Okay, very good. And then with respect to, just following up on Jason’s question on the transplant eligible population, can you characterize who we surgeons are feeling more comfortable in implanting today than they were before, I mean clearly as you mentioned there was a hard CAP on age who they probably won’t classify as a grey area patient, but compared to the more traditional Bridge candidates, who are they being more aggressive with specifically?

Gary Burbach

Yes, I think its – if you think about it in terms of kind of probabilistic view of these patients, historically clinicians implanted patients for Bridge-to-Transplant with XVE or PVAD or whatever devices, pulsatile devices that they felt had a very, very high probability of getting to a transplant. And I think that with the HeartMate II, they have the confidence that they have seen with the performance of the device, durability, clinical results, that they are willing to take on patients that have maybe a somewhat lower probability because obesity and will they lose weight, kind of social situations, which is often a knock out factor for transplants and HeartMate II can provide kind of more time and opportunity for those patients to address those kinds of issues. So I think it’s a lot of those kinds of situations where there's the benefit of time, there's less concern about risks, complications etcetera that they are willing to expand that view of the appropriate patient.

Keay Nakae – Collins Stewart

So, just a follow-up on that, qualitatively what’s the risk that you are pulling forward a lot of the traditional DT patients and when you actually get the label? The impact initially may not be as great as what people might expect?

Gary Burbach

Yes, I don’t think based on what we saw with the DT trial in Q1, I think that’s a good indicator that that’s not a significant risk. We saw with the elimination of randomization on top that they have kind of expanded transplant view. We saw this very significant increase in enrollment in the DT trial. That enrollment in that trial doubled based on the elimination of randomization. So I think that’s a strong indicator that there is this very significant additional population that we haven’t really tapped into yet.

Keay Nakae – Collins Stewart

Okay, very good. Thanks.

Gary Burbach

Thank you.

Operator

Our next question comes from Greg Simpson with Stifel Nicolaus.

Greg Simpson – Stifel Nicolaus

All right. Thanks and good afternoon guys, and congratulations on heck of a quarter.

Gary Burbach

Thanks, Greg.

Greg Simpson – Stifel Nicolaus

Just two real quick easy ones for you, just to follow-up on the guidance question let me talk about the bottom line with the result in the first quarter, any additional cost or expenses you might maybe push into ’09 from 2010 given the strength of the business? Or is the earnings guidance just consistent with the current caution on the revenue side.

Gary Burbach

Yes, I think there is few things to think about in terms of the balance of the year versus Q1 relative to drop through to the bottom line. First in terms of gross margin, we had a benefit in terms of absorption because of a build up of inventory which you will see an increase in inventory on the balance sheet around HeartMate II and trying to build up a little bit of safety stock for HeartMate II and increase the finished goods level there. And then also building up inventory of our external peripherals which we will be launching here in the near future, so that was a benefit in Q1 that won’t recur in the following quarters.

And then in terms of operating expenses, there will be some greater level of spending in the Q2 to Q4 timeframe around R&D programs and just kind of around the timing of when those programs incur greater expenses, we will see some more of that in Q2 to four. The EP, external peripherals, launch which will happen here full force in Q3. Destination Therapy launch preparation, so some of the sales and marketing initiatives particularly to prepare ourselves for very effective launch there. And then on the ITC side, we talk briefly about addressing the 483 observations. We got those plans in place. There's a lot of execution in the balance of the year where we'll see some incremental spending.

Greg Simpson – Stifel Nicolaus

Okay, perfect. Thanks for the color. And then final question, you mentioned HeartMate II ASPs increased in the quarter, can you give us the relative – the relevant data points?

Gary Burbach

Yes, that’s not an increase relative to the end of last year. That’s an increase relative to Q1 of 2008. So during the trial, we were in the kind of mid $60,000 range for HeartMate II ASP in the commercial setting beginning last April. That was increased to the mid $80,000 range, so that’s consistent with that experience.

Greg Simpson – Stifel Nicolaus

Okay, perfect. Thanks guys.

Gary Burbach

Thank you.

Operator

We will now hear from Suraj Kalia with SMH Capital.

Suraj Kalia – SMH Capital

Hi guys, congrats on the quarter.

Gary Burbach

Thanks, Suraj.

Suraj Kalia – SMH Capital

Gary, what is the specific evidence that you all are seeing in terms of profitability per procedure for the hospital due to HeartMate II or maybe what is the feedback you all are currently getting from hospital administrators?

Gary Burbach

Yes, as we go in and – we have the team, the helps with the whole DT certification process, also it’s focused on helping hospitals with their reimbursement practices kind of assessing their economics. And consistently as we go in and work with hospitals, review their records and billing, the hospitals are consistently profitable if they are billing properly for these procedures.

Suraj Kalia – SMH Capital

Okay. And Gary in terms of the peripherals, are the older HeartMate II's retrofitable with the new peripherals that you eventually launched them in Q3 and do you all expect a bump in sales either due to demand pull or cost push specifically related to these peripherals?

Gary Burbach

So the pump is compatible, so it’s essentially everything outside the body that gets replaced, the controller, the battery, the battery charger, power base unit, those components are replaced. And we would expect that there would be some revenue opportunity associated with the roll out of those external peripherals. Obviously the non-pump revenue is a much smaller component of the overall revenue, so it’s a more modest opportunity also comes at a lower gross margin than the pumps.

Suraj Kalia – SMH Capital

And finally, Gary, in terms of the low volume centers from your launch let’s say Q2, Q3 of last year to now, how would you characterize the change in the rate of implants you have seen in the low volume centers versus the high volume centers?

Gary Burbach

Yes, as we mentioned last year, we saw an increase across really all the centers that had brought HeartMate II in both the trial centers that had it previously as well as the commercial centers that we’re bringing in during the balance of the year. In Q1, we continue to see those kinds of positive results with the broad range of centers, but in Q1 in particular, the trial centers saw the most significant growth based on the growth in the DT trial.

Suraj Kalia – SMH Capital

Okay. And Gary, pardon me if I may just squeeze in one. Just want to reconcile your earlier statement where you said your investigators had said AHA would be the best time to maximize the launch of HeartMate II in DT, which theoretically could be after a panel. On the other hand, if we do go to panel then the data will be available. Can you help me reconcile those two? Part of me reads that either the assumption is that there will be no panel or at least the hope is that there will be no panel. And can you connect that to what your investigators are saying? Would it affect anything if you do release all the data, the panel, if you have to?

Gary Burbach

Yes, so certainly I think in the scenario where there is not a panel which we obviously hope with the path that we will be on. In that case, I think very clearly you are presenting the data for the first time hopefully in a late breaking session at the AHA, a very significant forum, close to hopefully the approval and launch of the device for a definition therapy, so kind of the perfect launching platform. In the case where the FDA does decide to call a panel, obviously a lot of that is out of our control. So if that’s the case, first we will understand what the time table that they are looking to work under and does it impact our plan as currently described in terms of the release of the data at the AHA.

Suraj Kalia – SMH Capital

Thanks guys.

Gary Burbach

Thank you.

Operator

Our next question comes from Spencer Nam with Summer Street.

Spencer Nam – Summer Street

Thanks very much. I have just a couple of quick questions. First question is, based on this panel and I am assuming this review cycle is 100 to 80 days cycle, is that right?

Gary Burbach

Yes.

Spencer Nam – Summer Street

So based on this panel situation and data release and that you have already applied for PMA, it sounds like we are going to see the data before November AHA meeting because if there is a panel, data is going to come out. If there isn’t a panel, then they will approve this device before November.

Gary Burbach

No, that’s a target timeline and if they – generally kind of a mid 100 day or so time period, they are likely to give us some questions back what potentially stops the clock for some time period while we respond to those questions. So I wouldn’t draw a straight kind of six months line from mid-April and say in that scenario you can have an approval. So there is definitely – I view that as a rough time table for a significant submission like this.

Spencer Nam – Summer Street

I appreciate that, that’s helpful. And the second question I have, I really appreciated you going through some of this data that have been presented by some of your principal investigators and others who worked with HeartMate II, but lot of times do you sort of the small set data usually come out after pivotal data in other experience that I have with devices, so I kind of wonder since you guys are throwing all these data points out, whether you guys have lot of confidence in your the pivotal data that is going to actually come out after we've reviewed all these data points. Because if I'm thinking that if the pivotal data is not as good as the small sample data, it could be actually a little bit disappointing. I was wondering what your sort of intention of providing these data points to us early on ahead of the pivotal data?

Gary Burbach

Well, so to be clear the major data that I mentioned both came out of the Bridge trial and those were not small data points. Those were well over 400 patients, so that’s really kind of the continuing progression of the Bridge trial. So I think that’s a very useful data, we’ve indicated consistently that we are going to continue to update that data as it continues to grow in terms of the number of patients as well as in the duration of support. In terms of the other two data points that are individual center experiences, they're specific items. One is around older patients which Sharp has had a unique experience to date in terms of really implanting a substantially older set of patients. And there they had a positive experience with both the HeartMate II and the HeartMate XVE, so we're not using that data to try to infer anything about the DT data. But really just they're demonstrating that with a practice that knows how to implant these patients, manage these patients, they can have extremely successful outcomes. So I think it's a very encouraging data point in that sense.

And then the last one from Berlin was a very specific item around thromboembolic events which is, in terms of adverse events the most significant item that people get concerned within this space. There was a presentation at the ACC from another center that was a less positive experience on that particular item, and so we wanted to kind of communicate an experience from a very experienced center that knows how to utilize these devices to show kind of very positive experience relative to that particular characteristic of the system. So none of it is looking to try to foreshadow the DT trial, but is very much focused on the current indication for use and the positive experience that we are seeing there.

Spencer Nam – Summer Street

Okay. Thanks very much for the detailed answer. Thank you.

Gary Burbach

Thank you.

Operator

Our next question comes from Duane Nash with Wedbush Morgan.

Duane Nash – Wedbush Morgan

Hi, good afternoon.

Gary Burbach

Good afternoon.

Duane Nash – Wedbush Morgan

First quick question is, can you comment at all on what contribution HeartMate XVE revenues in Destination Therapy might have contributed to the last quarter? And the reason why I ask is simply because the potential downside to future quarter revenues as we get closer to potential approval of the HeartMate II and whether or not centers will stop implanting awaiting decision from the FDA on what looks like a better device.

Gary Burbach

Yes, XVE continues to go down and in Q1 we saw a continued downward progression in terms of XVE. We haven’t broken those numbers out specifically, but I can tell you that I wouldn’t be concerned that that's a material risk. What we're seeing is HeartMate II certainly cannibalizing XVE, but also growing the market substantially.

Duane Nash – Wedbush Morgan

Great, thanks. And second question is, as we start to go into 2010 and onwards, as we expect the HeartMate II to enter the Destination Therapy market, can you comment at all on what might be the rate limiting step in adoption whether it's available centers, whether it's surgeons who are experienced, whether it's device supply, whether it’s referrals, any color you can give on that?

Gary Burbach

Yes, I think that referrals are the kind of initial rate limiting step. That’s why we have a lot of focus on market development, clinical education out into the referring physician community, so we’ve been focused on that now for a couple of years. I think that’s serving us very well in everything that we have learned, the investments that we’ve made I think are really going to pay dividends as we get to DT launch. Behind that is center capacity, which tend to be less about the surgeons than the VAD coordinators. That’s why we are highlighting a fair bit of energy around VAD coordinators helping to develop them, I mentioned a couple of initiatives during my discussion around building more VAD coordinator capability in the community.

Duane Nash – Wedbush Morgan

Great. Well, thank you.

Gary Burbach

Thank you.

Operator

And our last question will come from Jayson Bedford with Raymond James.

Jayson Bedford – Raymond James

Hi, good afternoon. Most of my questions have been answered, so just a couple quickies. On the sales infrastructure, can you just remind us how many reps you have and if you plan to add onto that at the end of this year in advance to the DT launch?

Gary Burbach

Sure. Currently in the United States, we have three groups Jayson, the territory managers which is kind of the classic salesperson, clinical support specialists, and what we refer to it as market development managers who are the people that do the outreach education to the referring physician community. Roughly equal size amongst the group, they generally tend to operate in teams of three and in certain geographies. And we have about 15 of each of those, so about 45 in total in terms of frontline field teams. We do it expect to add by a handful of additional people to that team here over the course of the balance of this year and then I would next year with DT launch that we would have a little more substantial growth in that group, maybe kind of on the order of 10 or so additional individuals.

Jayson Bedford – Raymond James

Okay. So it doesn’t sound like there's a big build necessary?

Gary Burbach

No, it’s not something dramatic. No.

Jayson Bedford – Raymond James

Okay. And lastly, on the guidance, it seems pretty conservative given the strength in the first quarter, but you didn’t mention the potential variability because of the CAP and I am just wondering does the guidance you put out there, does it assume that you are not granted anymore CAPs?

Gary Burbach

No, it assumes that we do continue to have access to CAP patients, but potentially not quite at the maximum rate that we could potentially utilize.

Jayson Bedford – Raymond James

Okay. Thank you.

Gary Burbach

Thank you.

Operator

And we have no further questions at this time.

Gary Burbach

Okay, operator. Thank you and I just like to thank everyone for joining us this afternoon. We look forward to keeping you updated over the balance of the year. Thanks.

Operator

Ladies and gentlemen, that does conclude today’s conference. We thank you for your participation.

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Source: Thoratec Corporation Q1 2009 Earnings Call Transcript
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