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Thoratec Corp. (NASDAQ:THOR)

Q2 2009 Earnings Call

August 05, 2009 4:30 pm ET

Executives

David Smith - EVP and CFO

Gary Burbach - President and CEO

Larry Cohen - President of our ITC Division

Analysts

Suraj Kalia - SMH Capital

Taylor Harris - JPMorgan

Jason Mills - Canaccord Adams

Mimi Pham - JMP Securities

Tim Lee - Piper Jaffray

Rick Wise - Leerink Swann

Bob Hopkins - Bank of America

Joshua Zable - Natixis

Duane Nash - Wedbush

Jayson Bedford - Raymond James

Keay Nakae - Collins Stewart

Sean Lavin - Lazard

Greg Simpson - Stifel Nicolaus

Operator

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

David Smith

Thank you operator. 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 continued a strong performance in the second quarter of 2009 reflecting growing adoption of the HeartMate II both domestically and in the international markets. In addition, we continue to add new HeartMate II centers, made progress with our PMA for Destination Therapy for HeartMate II, and had a successful controlled launch of our new HeartMate external peripherals.

Also last week we announced the termination of the proposed acquisition of HeartWare, which we will discuss today. Following Gary's review of these and other key operational events during the quarter, I'll discuss the financial results for the quarter, as well as our updated guidance for 2009. We'll then open your call for questions.

As a reminder during the course of today's conference call and the 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 that actual results may differ materially. We also alert you to 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 Burbach

Thank you, David, and good afternoon. To echo David's opening remarks, Thoratec had a very successful and productive second quarter with respect to product sales and the key elements of our growth strategy. During my comments today, I'll provide some color on our revenue growth, update you on our PMA submission for Destination Therapy, discuss some of the recent data publications and our market education programs and outline our perspectives on the HeartWare transaction.

Revenues for the quarter were $92.1 million, an 11% increase over revenues of $82.6 million in the second quarter a year ago. Our performance in the quarter brought total revenues for the first half of 2009 to $181.5 million, versus $147.1 million in the first half of 2008 or an increase of 23%. Cardiovascular division revenues in the second quarter of 2009 were $69.2 million versus $57.5 million a year ago or an increase of 20%. As a reminder, this quarter marks the first quarter in which we have comparables with respect to commercial sales of the HeartMate II for Bridge-to-Transplantation, as that launch began in April last year.

Excluding CentriMag, we sold 673 pumps in the quarter versus 599 pumps in the second quarter a year ago. As David mentioned, we experience strong growth in HeartMate II adoption in both the United States and Europe. I should also note that during the quarter, we surpass 3000 patients implanted with the HeartMate II. An important milestone that demonstrates the positive clinical impact and strong pace of adoption of the device.

For the first six months of 2009, cardiovascular division revenues were $133.9 million versus $97.7 million a year ago. Continuing the practice we started last year, we will provide six month revenues byproduct line. For the first half of 2009, HeartMate II and XVE product sales were $108.9 million, an increase of 58% over $69 million a year ago.

The year-over-year comparables reflect in part the fact that the commercial launch of the HeartMate II for Bridge-to-Transplantation did not occur until the second quarter of last year. At the same time, I can tell you that in the second quarter of 2009 our HeartMate product line sales growth was very strong. PVAD and IVAD product sales were $17.9 million versus $22 million a year ago, reflecting the continued cannibalization impact from the HeartMate II, particularly on the IVAD.

CentriMag sales were $5.7 million compared with sales of $5.4 million in the first half of 2008, while a graft sales of $1.4 million were consistent with those in the first half of 2008. For the first six months of 2009, revenues from pump sales were $104.2 million versus $74.7 million a year ago. While revenues from equipment and accessories were $28.3 million versus $21.7 million a year ago.

From a geographic breakout, North American cardiovascular division revenues were $112.2 million versus $76.4 million a year ago, while international revenues were $21.7 million versus $21.3 million a year ago. For the period, the impact of foreign exchange on revenues was an unfavorable $2.3 million versus the first six months of 2008.

One other thing to note about these results is that the cannibalization of the XVE by the HeartMate II following the end of randomization in the destination therapy trial has been even more dramatic than expected. In Q2 of this year, XVE sales were down by over 80% compared to the average for all of 2008.

As a result, we recorded a $4.3 million reserve for excess XVE inventory during the quarter. During our recent calls, we've spoken to the effect of the capital equipment environment and we continue to see no material impact on our core VAD business. However, as was the case in the first quarter, we do believe it is impacting our ITC equipment business, which we'll discuss in more detail shortly.

There were five new HeartMate II centers added during the quarter, which brings to nine the total added in North America to date. We continue to believe that we'll add several additional HeartMate II centers during the balance of the year, meeting or slightly exceeding the high end of our expectation to add 10 to 15 HeartMate II centers in North America during 2009.

Before discussing other operational highlights of the quarter, I want to take a couple of minutes and discuss the decision by Thoratec and HeartWare International to terminate our proposed acquisition of HeartWare given the FTC's decision to challenge the transaction. As you might expect both parties are disappointed at the outcome of this process, a number of people at Thoratec worked diligently to make this transaction happen, and we were looking forward to joining forces with our counterparts at HeartWare for whom we have a great deal of respect.

More importantly, we believe that if the combined entity, we would have been able to broaden the availability of life saving mechanical circulatory support therapies to the many advanced stage heart failure patient's who have no other viable treatment options, while accelerating the development and commercialization of new technologies.

Nevertheless since the FTCs decisions can only be challenged through litigation with the government, both companies believe that it was in the best long-term interests of our respective shareholders not to pursue what would have likely proven to be a protracted and costly process. As we've communicated with you since announcing this proposed transaction, we view the acquisition of HeartWare as an opportunistic situation.

However, we have always been clear, failure to consummate this transaction would not affect our ability to achieve our near and long-term growth strategies. We remain a leader in driving innovative force and mechanical circulatory support, not only with the broadest offering of products, but also with the robust product pipeline, improvement product development, regulatory, clinical, manufacturing, reimbursement, sales, and market development organizations.

As you've seen over the past 15 months with the commercial experience for Bridge-to-Transplantation, the HeartMate II has established a new standard of care for addressing the needs of an underserved heart failure population. Not only the launch been a success in terms of growing adoption, but also with respect to positive patient outcomes and new center growth, which demonstrate the efficacy of our training, education, and clinical support initiatives.

We believe the success of the HeartMate II represents an inflection point for the VAD sector and the growing appreciation of it's effectiveness in treating heart failure patients will drive broader adoption of mechanical circulatory support. With respect to our PMA supplement for Destination Therapy for the HeartMate II, we received a list of questions from the FDA in early July.

We view these questions as being routine and we are in the process of providing our responses, which we expect to complete within the next few days. We continue to expect that we'll receive approval by early 2010. Updating you on the destination therapy trial enrollment, we enrolled 795 patients as of July 24th, including 529 patients in the randomized portion of the trial.

This represents an increase of 62 patients over the 733 enrolled at April 24th. Earlier this week, we received approval for another 30 patient Cap after a two week gap following the completion of the prior Cap. We've also submitted the data from the Destination Therapy trial for a late breaking presentation at the American Heart Association, which takes place in Orlando in mid-November.

In addition, we have submitted the data to a major medical journal for publication to support our launch. In the meantime, I want to remind you that Dr. Randall Starling from the Cleveland clinic will present 180 day survival and other key data from the HeartMate to Bridge-To-Transplantation InnerMax post approval registry at the Heart Failure Society of America meeting in Boston next month.

We believe that this data will portray results that are similar or better than those of the trial, which speaks to the role that our training and quality programs have played in achieving positive patient outcomes in commercial utilization of the pump at both trial and new centers. On the publication front, the update from Dr. Pagani and Miller examining outcomes at 18 months for 281 HeartMate II Bridge-To-Transplantation patients appeared in the July 21st edition of the Journal of the American College of cardiology.

Key findings included 79% of these patients achieved transplantation, recovery of the natural heart or ongoing device support at 18 months. [Kathleen Mayer] estimated survival at 18 months of 72% and a 92% freedom from major device malfunction resulting in death or pump replacement for all causes at 18 months. Additionally, at six months, 83% of patients had approved from NYHA Class IV to NYHA Class I or II.

A second paper outlining data regarding the neurocognitive performance of HeartMate II patients by Dr. Ralph Petrucci of Drexel University, appeared in the Journal of Heart and Lung Transplantation. The data showed significant improvements in four cognitive domains including visual, memory executive functions during a one to six month period with no declines in any domain.

In our last call, we discussed the FDA approval for our new HeartMate external peripherals, including new batteries, charger, and power module, which were designed to provide an enhanced quality of life for HeartMate patient's by providing them more freedom and mobility and the ability to more easily resume many aspects of a normal lifestyle.

As we indicated at that time, we implemented a controlled launch of these offerings to a few high volume centers in April while we began the sale up production and finished goods inventories for a full rollout this quarter. The experience with the new system components has been overwhelmingly positive as patients have reported significantly improved battery run times.

In most cases, in excess of 10 hours per set along with notable improvements in battery weight, and component portability. We continue to invest aggressively in technological innovation to make VAD therapy increasingly appealing to both clinicians and patients. We have a wide range of initiatives focused on advancing the HeartMate II platform, which will also be applicable to future pumps such as the HeartMate III.

In the near-term, these efforts include the completion and launch of the aforementioned enhanced external peripherals. A more durable and modular percutaneous lead, [Seal graft], and a next generation system controller, which will include a backup battery to eliminate the risk of patients accidentally disconnecting all power sources.

Further reaching innovations to drive improvements in clinical outcomes include tools to facilitate an easier and less invasive implantation, technologies to reduce the risk of infection, integrated pressure sensors to facilitate true physiologic response and a fully implantable VAD system. We believe all of these advances will have a significant impact on continuing to advance the HeartMate II and enable us to address the broadening population of advanced stage heart failure patients in the coming years.

Relative to the HeartMate III, we are continuing to advance the development of that system as an exciting platform combining the benefits of full magnetic levitation in a smaller pump capable of being implanted less invasively, which we believe will have important clinical benefits including reduced rates of adverse events and enable the continued expansion of the addressable patient population for VADs.

We are currently working on our second iteration of the smaller HeartMate III platform and expect to implant this system in animals in the first quarter of 2010. And we'll provide you additional insight over the coming quarters. With respect to CMS certification for Destination Therapy reimbursement, a total of 70 centers have now received joint commission certification.

This includes 56 centers that have received re-certification, nine new transplant centers, and five open heart centers. We continue to believe we're on track to end the year with a total of approximately 75 centers certified for destination therapy reimbursement, which is key to an effective launch of the HeartMate II for this indication.

With respect to reimbursement, the updates to DRGs which will take effect in October have been finalized. Our two primary DRGs, one and 215 received a proposed increase of approximately 5% with DRG 2 subjected to a decrease of approximately 8%, although less than 20% of the VAD cases fall within this DRG.

During the quarter, we also held several successful market education and development programs. These included the first of our formalized VAD coordinator training sessions, which took place at the University of Louisville. We had 23 participants, including several attendees from non-transplant centers. It went very well and we're planning on our second session for the end of this year.

Thoratec also hosted symposiums at the recent meeting of the American Association of Heart Failure Nurses and at the European Society of Cardiology heart failure meeting. Both of them well attended and notably at the European Meeting VAD data presentations were included in the main program for the first time.

I should also note that in October, we will be conducting our second annual program for heart failure cardiology and cardiovascular surgery fellows and expect approximately two dozen attendees.

Finally, in Japan, our market introduction effort for the HeartMate II continues to go well. We'd a very positive meeting with the regulatory agency late last month and believe we are on track to launch a small confirmatory trial in early 2010. Turning to ITC, revenues in the quarter were $22.8 million versus $25.1 million in the second quarter a year ago.

For the first six months of 2009, revenues were 47.7 million versus 49.3 million in the same period a year ago. The revenue breakout for six months was hospital point of care revenues, which include HEMOCHRON, A-VOX, and IRMA of $24.9 million versus $27.2 million a year ago. Alternate site revenues, which are primarily ProTime were $16.4 million versus $13.8 million last year, while skin incision revenues were $6.4 million versus $8.3 million a year ago.

North American revenues at ITC for the first six months of 2009 were $29 million versus $32.2 million a year ago, while international revenues were $18.7 million versus $17.1 million in the first six months of 2008. Several factors impacted our second quarter performance at ITC, particularly in North America.

They included delays in capital equipment purchases in the hospital and physicians office environments that have affected HEMOCHRON, AVOXimeter, and ProTime instrument sales, as well as sales to the veterinary market through IDEX. And while our patients self testing in pharmaceutical clinical trial ProTime businesses continue to grow nicely, we're facing strong competitive pressure in the US physician office market, both from a pricing perspective, as well as the fact that our current offering is late in its life cycle.

At the same time we are starting to see some stabilization in the incision business, but has been subject to increased competitive pressure in the past and hope that this business will continue to normalize over the next several quarters. In terms of the 483 notice of observation report, which we've discussed with you in the past, we met with the FDA in mid June to review our corrective and preventive action progress and plans to address observations noted by the agency in January following their last inspection of our ITC manufacturing operations.

We view this meeting is a positive step and continue to aggressively manage the work according to the schedule we outlined and submitted to the agency shortly after this inspection. Our overall plan includes the submission of bimonthly updates to the FDA on our progress, and we've provided two to date. There is another main component of this plan, we have recently added two new Vice President in the areas of manufacturing and quality, who bring significant experience to ITC and we believe will strengthen our efforts in these areas.

With respect to our new ProTime offering, we'd indicated previously that we expected to file the 510-K during the second quarter. That time line has slipped a bit, although we expect to make that submission this quarter. Based on this timing, we would hope to have approval and be ready to launch the device during the first half of 2010.

In the meantime, data from our new ProTime offering was presented in several abstracts at the Anticoagulation Forum that took place in San Diego in early May. There were three poster presentations that demonstrated excellent results including superior performance when compared with our current ProTime, very good agreement with several reference methods and little or no influence on the PTI in our results from common interfering substances such as unfractionated Heparin, amylases, bilirubin, cholesterol, and triglycerides.

In closing, despite our disappointment over the outcome of the proposed HeartWare transaction, we're pleased with Thoratec's performance in the first half of the year, and believe we are positioned to finish 2009 strongly and build value over the long-term. We've demonstrated the ability to realize commercial success for leading edge technology and implement programs that achieve positive patient outcomes and rapid center adoption.

We're excited about the many near-term milestones ahead of us, including receiving Destination Therapy approval for the HeartMate II, on going technological innovation and broad distribution of data, all of which will drive greater utilization of VAD therapy to treat advanced stage heart failure patients. Thank you, again, for joining us today and I'll now turn the call over to David.

David Smith

Thanks Gary. Before reviewing our results, I want to remind you that non-GAAP net income excludes amortization of intangibles, share based compensation expense under FAS 123R, the effect of FSP 14-1 related to convertible instruments, and HeartWare transaction costs. Non-GAAP net income also takes into account the tax effects of these adjustments.

You can find a reconciliation between our GAAP and non-GAAP results in our earnings press release at thoratec.com. Revenues for the second quarter of 2009 were $92.1 million, an 11% increase over $82.6 million in the second quarter of last year. As Gary mentioned, we had a very strong performance in our cardiovascular division with revenues up 20% over the prior year.

The net impact of stocking orders year-over-year was a negative $3.5 million, while FX was an unfavorable $1.4 million versus the second quarter a year ago. Non-GAAP gross margin for the quarter was 55.7% versus 62.1% a year ago. The decrease in gross margin in the quarter reflected the $4.3 million excess inventory reserve related to the XVE that Gary mentioned earlier.

The impact of foreign exchange, lower ITC volumes, and unfavorable manufacturing variances offset in part by higher ASPs for the HeartMate II and overall worldwide HeartMate II volume. Non-GAAP operating expenses were relatively consistent at $33.9 million versus $34.5 million a year ago. We do expect that spending will be higher in the second half of the year as we prepare for the Destination Therapy launch and due to timing of spending in our research and development programs.

In addition, we encourage $7.4million in HeartWare transaction expenses, which have been excluded from non-GAAP operating expenses. Through the first six months of 2009, we've recorded 11.3 million in HeartWare transaction related expenses. There will be some expenses related to the in transaction in the third quarter, but we expect them to be relatively modest.

On a non-GAAP basis, other income was $500,000 versus other income of $1.1 million in the second quarter of 2008. This reflects lower interest rates and shortened maturities on our cash and investment portfolio. As we've noted previously, we expect yields to remain low to the balance of the year.

On a non-GAAP basis the company's effective tax rate for the quarter was 36.1% versus 32.4% a year ago, reflecting higher pretax earnings and lower tax exempt interest. Non-GAAP earnings per diluted share for the quarter were $0.18 versus $0.20 a year ago. Results for the second quarter of this year reflect a negative impact of $0.04 per share related to stocking orders in FX.

In addition, the effect of the XVE inventory write down was approximately $0.04 per share in the quarter. Weighted average diluted shares outstanding at the end of quarter were $65.1 million versus $62.6 million a year ago. Our convertible debt continue to be dilutive, increasing diluted shares outstanding by approximately $7.3 million.

With respect to the balance sheet, we ended the quarter with $295 million in cash and investments versus $279 at the end of fiscal 2008 underscoring the financial strength of the company. This balance includes $20 million in restricted cash related to the and net we have made available to HeartWare and net auction rate securities of $24.7 million.

We have received notice from HeartWare regarding their intention to begin drawing on the loan facility. The initial amount drawn was $4 million-dollar. Finally in terms of guidance for fiscal 2009, revenues for the year are now projected to be in the range of $355 to $365 million. We expect our strong performance in the cardiovascular division to continue through the balance of the year.

Growth is expected to be in the high teens to low 20s for the cardiovascular division driven by the HeartMate product line. As we've noted previously, we have seen weakness in the ITC business through the first half of the year, and we expect it to be a challenging environment through the balance of the year.

ITC revenues in 2009 are now projected to be roughly flat with those of 2008. We expect non-GAAP gross margins to be consistent with those in fiscal 2008 upside related to HeartMate II activity is being offset by the XVE write down and weakness at ITC. In terms of non-GAAP earnings per share, we now expect that they will be in the range of $0.76 to $0.81 with weighted average shares outstanding between $0.65 and $0.66 million shares. Thanks again for joining us today and we'll open the questions now. As a reminder, we ask that you limit yourselves to one question and a follow-up. Operator.

Question-and-Answer Session

Operator

(Operator Instructions). And we'll go first to Suraj Kalia SMH Capital.

Suraj Kalia - SMH Capital

Good evening gentlemen. Congrats on a nice quarter. Gary, too many questions. Let me see where should I start? What are the lessons learned from the HeartMate II launch, and even current magnetically levitated pumps, and which of these lessons Gary do you all envision being applied to HeartMate III. Can the development timeline be squeezed?

Gary Burbach

I'm not sure if I followed your question, Suraj. If you maybe restate it to make sure I'm answering your question.

Suraj Kalia - SMH Capital

Gary, you all obviously know the current landscape for magnetically levitated pumps. You all have obviously done a huge trial for HeartMate II. You all have learned various lessons from that dealing with the FDA, and do you think whatever you all have learned from the current landscape could be translated to HeartMate III and potentially squeeze the development timeline for HeartMate III?

Gary Burbach

Well, certainly one of the things that we learned from the HeartMate II trial is, around the clinical results and the importance of exceeding the clinical results that we have seen with the HeartMate II for any next generation pump, so it has to have a variety of attributes that are going to enable that.

Size was the issue with the previous HeartMate III. And why we decided to go back, take that foundation technology and downsize it to make it a size that is much more easily implantable. But at the same time, we have high expectations for a fully magnetically levitated system.

Some of the benefits that provides from having larger gaps for the blood flow. So we're quite enthusiastic about that technology and the potential to advance even further beyond the HeartMate II and the results that we are seeing there. I think we'll also be able to leverage off of the work that we are doing with the HeartMate II program on a variety of fronts that I mentioned earlier, ranging from some of the near-term things durable percutaneous lead, better external peripherals to further reaching initiatives like a fully implantable system, pressure sensing to facilitate physiologic response.

And so that should benefit the HeartMate III platform quite dramatically in terms of not having these things come out serially and in a longer time horizon from the pump initially coming out as we have seen with the HeartMate II. But having those additional enhancements and capabilities earlier on in the life cycle of that pump. And certainly, I expect that the experience with HeartMate II, the trial, the R&D development provides us a tremendous amount of experience and capability to drive that program as expeditiously as possible.

Suraj Kalia - SMH Capital

Given the 300 million or close thereof you'll have on the balance sheet, would other areas be areas where you'll be looking for acquisitions? Maybe acute failure or do you think a share repurchase is appropriate at this stage?

Gary Burbach

I think we definitely are interested in considering other business development opportunities as I've mentioned before. We believe that they have to be in arenas that make sense, that we have capabilities and a belief that we can be successful. Heart failure is certainly one of those areas, mechanical circulatory support. So I think you can expect that we'll certainly take a hard look at those kinds of possibilities.

Suraj Kalia - SMH Capital

Final one, Gary. Remind me again. Japan, what's the market size for BTT and DT and you might have said this, forgive me if I missed that.

Gary Burbach

No. We haven’t. So today there're very, very few transplants that occur in Japan annually, so there's a very small bridge to transplant market. So it creates we believe a very – so you have a patient population that’s even more dramatically underserved in Japan than you do in the United States and Europe. So the opportunity for a Destination Therapy application with a pump like the HeartMate II, we think is quite traumatic.

Operator

And we'll go next to Taylor Harris with JPMorgan.

Taylor Harris - JPMorgan

Thanks a lot. On the destination trial enrollment, it was a little bit down from the first quarter, but obviously up from what you were doing before that. Gary, did you have some pressures from the Cap program during the second quarter and may be just talk to us about what you're seeing in terms of enrollment trends there.

Gary Burbach

I think the FDA, while so far enabling us to maintain access via the Cap program has done so at a metered pace. So providing these relatively small additional Caps that each time require the institutions to go back to their IRBs to get approval. For many of the institutions their IRB cycles are such that they can't get through it in the time that a 30 patient Cap is subscribed. So, we've definitely seen that process create a challenge for a number of centers and that’s I think really keep a limit on that enrollment.

Taylor Harris - JPMorgan

Okay. So do you think a 60 type range is the right one to think about going forward?

Gary Burbach

Well, I guess that depends on whether the FDA continues to provide Cap availability. I can't say definitively that they will, they have to-date. I think it's certainly reasonable that they would given the strong outcomes that they've seen. But, I think that will really depend on what position does the FDA take. The good news is this week we got another Cap for 30 patients. So hopefully, we'll be able to maintain that pace.

Taylor Harris - JPMorgan

Okay, great. And then just looking at the business aside from the clinical trial. You had a good sequential increase from the first quarter. Was most of that in the US with just increased utilization? Or I'm curious about the international markets as well. Have you seen any sort of a meaningful pickup there in particular because of Ventracor leaving the market?

Gary Burbach

The bulk of the growth was really based in the US. So we did see continued progress outside the US with HeartMate II. But, really the much more significant driver of the growth was based in North America.

Operator

And we'll go next to Jason Mills with Canaccord Adams.

Jason Mills - Canaccord Adams

Congrats on another great quarter. Let's start with the DT trial again just circling back to that. Gary, perhaps more color on the timeline. You say you submitted the publication. Within what time frame should we reasonably expect the journal to whom you submitted it to, to get around to publishing that and could there be a possibility that if a panel is necessary, you may have either the panel occur or the publication occur before the presentation at AHA November. Just wondering what sort of the variances in time could be.

Gary Burbach

Yes. So if a panel is convened, which we don't have an answer from the FDA yet on that question, then certainly there's the possibility that the data would be presented at a panel prior to the AHA meeting. In terms of a publication, I don't think that it's likely that that would be in advance of the AHA presentation. I think we would look to have that publication come out shortly after the AHA. So that it kind of comes right on the heels of that if we can manage that and have it kind of available for launch when we get DT approval.

Jason Mills - Canaccord Adams

Great. And to the business that's driving the performance, obviously HeartMate II. One, if you could you provide some sort of dichotomy in your results in terms of what you're seeing from the centers that you had on board at the time you launched HeartMate II?

In other words same-store sales growth and trends there as well as utilization for quarter trends at some of the new centers that you've added, I believe it's now over 60 since the launch of HeartMate II, and just remind us how many total HeartMate II centers you have. And if I missed it, I'm sorry.

Gary Burbach

Okay, yes. In North America, we have 110 total HeartMate II centers as of the end of Q2. So, we've added nine since the beginning of this year. And I think the very good news to that question, Jason, is that the growth has been very broad based in terms of both continued strong growth in the original trial centers, as well as in the new centers that have come on since the launch. So very strong, broad based increase in utilization across the full range of centers.

Jason Mills - Canaccord Adams

Okay. Last question and I'll get back in queue. Related to [JCO] certification. In the past you've worked pretty diligently to try to streamline that process, and so far as you have the ability to do that wondering if you could update us on the initiatives there and still suggest that you're going to be at around 75 certified centers by the end of the year. Wondering what that process looks like in 2010 after the data is presented. Do you expect to see an acceleration in those filing for certification and how can you help there?

Gary Burbach

Yeah. So, as we mentioned, we expect to be at 75 at the end of this year. I'd say that that's going very well in terms of getting the original centers which were, I think that is kind of in the high 50s that are ongoing previous DT centers. And then the balance over 15 are centers that are going to be new to DT certification, either transplant centers or open heart centers that weren’t really involved with VADs previously.

We do expect to see continued progress in 2010, although I wouldn't expect an acceleration versus the progress that we're seeing this year in terms of centers being certified. We expect next year to be able to accelerate the rate of new open heart centers, bringing HeartMate II into their institution. But they then have to go through the process of having a surgeon who has 10 implants, which maybe they hire someone, maybe they do it organically, which will take some time and then they have to go through the application and review an approval process.

So there is a reasonably substantial timeline, even once they decide, okay we're going to acquire HeartMate II and start to move down this path to actually get to certification.

Operator

And we'll go next to Mimi Pham with JMP Securities.

Mimi Pham - JMP Securities

Hi. Good afternoon. Can you just clarify exactly what discussions you've had with the FDA regarding the need for a panel? Have they thrown out the September 24 date that’s presently scheduled for the circulatory device panel?

Gary Burbach

No. They haven't told us anything, Mimi, relative to whether or not we're likely to have a panel.

Mimi Pham - JMP Securities

Okay. So there's no discussion. Regarding HeartMate II centers, are they right now planning to add VAD coordinators and other resources in preparation for what should be increased DT referrals and implants in 2010 when HeartMate II is approved or hospital administrations on board with their plans to add resources?

Gary Burbach

We're seeing that even today centers have been ramping up. If you look at the last year since we launched HeartMate II; the rate of VAD utilization in the US is up quite substantially. And that's based on a wide range of these centers implanting many more patients than they did previously, discharging many more patients than they have in the past. So the level of support that’s going on today already is much higher and we're seeing the addition of VAD coordinators at many centers.

I mentioned the session that we had at Louisville last quarter. We have another one planned towards the end of this year to provide a training forum for these new VAD coordinators. So we are seeing administration willingness to expand those resources. And we're certainly looking at what are the different things that we can do, both in the near term and the longer term, to make the management of these patients more efficient to reduce that burden on these centers and reduce the level of additions that they're going to have to make to continue to expand their programs.

Mimi Pham - JMP Securities

How many CentriMag centers are you in?

Gary Burbach

I believe it's about 80.

Operator

And we will go next to Tim Lee with Piper Jaffray.

Tim Lee - Piper Jaffray

In terms of your full-year sales growth goals for the cardiovascular division, your strong results year-to-date, it looks like you are targeting second half sales to kind of average in that division $60 million to $65 million. Is that math right and two, if that is the case, what are the dynamics that could result in the second half sales being less than what you are seeing here in the first half of the year?

Gary Burbach

Well I think if your look at our range of guidance, it certainly incorporates the second half being as strong as the first half. So, as David mentioned, we expect the cardiovascular division progress to continue to be strong in the second half as we've seen in the first half. Certainly, we're mindful of the DT trial side of this.

And the need to continue to gain Cap access and we saw a little bit of a reduction in Q2 versus Q1 because of that whole Cap application and approval process. Certainly, as you look at the quarters, Q3 is typically been our weakest quarter just based on your kind of summer activity being a little bit lower than other quarters. I'd say we're quite bullish on the second half continuing to be strong in the cardiovascular division.

Tim Lee - Piper Jaffray

Have you had your 100-day meeting with the FDA and in terms of HeartMate III, has the design been finalized or are we still waiting on that process?

Gary Burbach

We haven't had the 100-day meeting with the FDA yet. As I mentioned in the next few days, we'll complete our responses to the questions they provided us back in early July. My expectation would be that sometime in the reasonably near future, hopefully in the next few weeks after they have a chance to review the responses to those questions that we would have that 100-day meeting or 100-day or so meeting.

Hopefully, we'll get visibility as to whether or not there would be a panel at that point and obviously, we will communicate that information once it becomes available.

HeartMate III design, as I mentioned this is the second iteration of the smaller version of HeartMate III. My expectation based on current progress is that this will be a final version of the design, but I can't say that definitively until we get further into the process.

Operator

And we'll go next to Rick Wise with Leerink Swann.

Rick Wise - Leerink Swann

Turning back to gross margin, first half gross margins were a shade under 58%. You're saying full year roughly equal to 2008, which is 59.3% so that would suggest the second half would have to be over 60% in total. You said, Gary, third quarter a little seasonally weaker, has been mostly fourth quarter. Can you discuss, is that logical? Maybe help us understand some of the factors that are going to get you back over 60%, probably in the fourth quarter?

Gary Burbach

Well, certainly the biggest item that stands out is this XVE, excess inventory reserve. So that was over $4 million in Q2. So that alone really would have brought the first half gross margins well in the line with our expectations for the year. So that item alone really addresses that gap.

Rick Wise - Leerink Swann

I think you mentioned some unexpected negative manufacturing variances. How significant was that? Was that all bad? Is that resolved now if I heard you correctly?

David Smith

You get manufacturing variances in any given quarter. We happen to have more manufacturing variances in the ITC side in the second quarter this year than in the prior year. So, we had some scrap-based variances and then some absorption-based variances. And we think that we're making some good progress there.

The good news is back with the gross margins. If you look at the mix between the businesses, our mix has gone from a 70-30 to a 75-25 CV to ITC, so that itself is going to pull up the margin potential going forward anyway.

Rick Wise - Leerink Swann

What do you expect for stocking from each of the certified DT centers? Is it fair to assume that stocking would be highest in the theoretically DT therapy would be conducted in more patients or if you end year with 75 centers, how much incremental might there be from that stocking?

Gary Burbach

I don't expect any incremental stocking from those centers. We keep a pretty close track on that. The centers pretty consistently are stocking two pumps, whether they're a Bridge center, a DT center or both, we haven't seen that behavior change here over the last year. We have seen some centers with the XVE and the IVAD begin to reduce their stocking levels, moving from two pumps to one pump many times. But that's really the only change in the stocking dynamic that we've seen.

Rick Wise - Leerink Swann

Gary, obviously, you were excited about the HeartWare deal that you wanted to do it. I assume you wanted to do it in large part the technology, you've talked a little bit about the iterations of HeartMate II and the prospects for HeartMate III. Do you feel at all that Thoratec's future has been limited or diminished in any kind of way because the HeartWare deal is going away?

Gary Burbach

No, the answer to that would be no. I think our prospects are still incredibly positive. As we've talked about on a number of occasions, the addressable patient population here we think is huge. We think we've only really begun to address it. I think what we're seeing with the HeatMate II here over the last year is tremendous validation that the potential for expansion and use of that therapy is really quite dramatic.

And so between our technology programs, be that the variety of programs on the HeartMate II in the near term or then into the HeartMate III into the further term market development programs, clinical programs to drive clinical best practices, clinical data, we just have a wide range of initiatives to drive that therapy forward, drive that that market forward over the coming years. So, I'm extremely optimistic about our prospects, both in the near term as well as the long term.

Operator

And we'll go next to Bob Hopkins from Bank of America.

Bob Hopkins - Bank of America

I just want to follow-up on Taylor's question on the DT trial enrollment in the Cap program and kind of those Q2 numbers versus the Q1 numbers, that 85 versus 62? So first of all, are we still talking about the same number of centers, 40 versus 40?

Gary Burbach

Yes.

Bob Hopkins - Bank of America

You mentioned a couple of things about this quarter's Cap program that it was maybe a little bit more restrictive, but is there any other color that you can add to that? Is there an apples-to-oranges way to look at Q1 versus Q2?

Gary Burbach

When we say it's the same number of centers, that's true on an absolute basis. Maybe it's not totally apples-to-apples is because we have these limits of 30 patients per Cap. Centers that have longer [IRB] cycles I think have become less inclined to kind of remain engaged in the process. So, I think we've seen as that dynamic has gone on now over the course of a handful of Caps, these kind of centers that are actively driving that process have probably come down a bit.

Bob Hopkins - Bank of America

Do you have a rough sense if there were no Cap restrictions, what kind of number you think would represent true demand? You did 85 in the first quarter. I assume it would be a number north of that. Is that a fair way to think about it if you were kind of free from Cap restrictions?

Gary Burbach

Yes, I think so.

Bob Hopkins - Bank of America

And have you guys looked at that specifically in terms of what you think that the demand is in those 40 centers, and for a specific number on it or not that detailed yet?

Gary Burbach

No, we haven't taken that detailed look yet, Bob.

Operator

And we'll go next to Joshua Zable with Natixis.

Joshua Zable - Natixis

Just a couple of quick ones here. Just getting back to the DT Cap here. I know in the first quarter obviously you had a strong quarter and specifically one of the reasons you didn't take up your guidance was because you didn't have certainty related to that DT Cap.

Obviously, you got another 30 patients. But, when you think about your outlook for the rest of the year, does that assume that you are going to get another one? Does it assume that would be upside to the guidance?

Gary Burbach

Our assumption is that we would continue to see Cap access as we have seen here over the course of the last few months. So this kind of 30 patient Cap, with potentially little bit of a pause like we had here recently where we had a couple of week gap, so we certainly expect to have ongoing access to Caps in the trial.

Joshua Zable - Natixis

And then just related to the HeartWare deal here. A couple of different sort of questions, but all related. With the termination of the deal, it sounds like you still obviously giving them access to capital.

I know there were some clauses about they might actually have to pay you something if the deal got closed, can you just comment. I know that was sort of a general clause. It said under certain circumstances, so but it didn't specify, that's two.

Three would be related to the intellectual property now that you two obviously have sat down probably not only across the table, but have kind of looked under the skirt here for lack of a better word. What kind of IP issues are there if any in other words with HeartMate III, could your potentially have a similar way of implant or size or anything like that?

And then four, again related to the termination of the deal, they're out there in Europe, I'm just wondering I'm sure if I were a Thoratec salesperson, I'd be very thrilled about both products. Is there any pushback now or questions you guys are getting in terms of where they are competing against each other as to why maybe the HeartMate II is better so to speak given that you guy try to acquire it. I know that’s a lot of questions, I can repeat them.

Gary Burbach

So first, there is no breakup fee that either party has to pay to the other. So the only remaining element of that transaction is this $20 million facility that they can draw down on, which David mentioned that they had drawn $4 million from that facility. In terms of IP, I don't expect that there are any IP issues, as we continue forward with our range of product development programs on the HeartMate II platform with the HeartMate III.

So I don't see any issues there. And then in terms of Europe and kind of competitive activity, I believe that we're quite well positioned based on the very positive experience with the HeartMate II. The base of clinical data and clinical experience, we have over 3000 patients.

The HVAD we thought was an interesting technology with promise, but we recognize it still has a long way to go, lot of uncertainty associated with it. So I think our team feels quite confident about their ability to continue to execute.

Joshua Zable - Natixis

Just to follow-up related to the HeartMate III and I know it's far off so to speak, but one of the interesting things about the HVAD was the ease of implant, which is little bit different. Forget the device for a second, is that something when you guys think of HeartMate III or IV or whatever maybe a different type of implantation or should we see similar to what we've been doing with HeartMate II?

Gary Burbach

No. You should see an easier implantation with HeartMate III than with HeartMate II.

Operator

And we'll go next to Duane Nash with Wedbush.

Duane Nash - Wedbush

Gary, you mentioned that there was a two week delay in the Cap, and I was uncertain whether that was actually in Q2 or that happened later in July?

Gary Burbach

That happened in July.

Duane Nash - Wedbush

Okay. And then also in many surgical devices, we often see a little bit of a slowdown during the summer before a ramp back up in the last quarter. Is that something we should expect here?

Gary Burbach

That's typically been the case with our business. Last year was a little unusual and that we were in the midst of the HeartMate II launch activities. But, if you look over a longer time period over the last five years, you'll see that Q3 typically is a bit of a slower quarter.

Duane Nash - Wedbush

Okay. And then one last question about the HeartWare transaction. You just mentioned that they had drawn down $4 million, do they have the opportunity to draw down any more or is that capped at the moment?

Gary Burbach

They can draw down up to $20 million.

David Smith

They can do that at any time.

Operator

We'll go next to Jayson Bedford with Raymond James.

Jayson Bedford - Raymond James

Good afternoon, guys, thanks for fitting me in here. Just a couple of quickies. First, on the difference between on the VAD side, the difference between unit growth and dollar growth in the quarter. Did you raise prices on HeartMate II or any of that?

Gary Burbach

No. But you do have to recall Jason that Q2 of last year, we did still have the early part of the quarter that was pre HeartMate II launch. So there was I think it was like April 21st that we launched HeartMate II and we changed to the commercial pricing, which was higher. And then the other factor is that in Q2 of last year, there were many more XVE sales as I mentioned. The XVE sales have dropped very dramatically and the HeartMate II has a premium price to the XVE. So you have those two factors that create a higher average ASP in Q2 of this year than Q2 of last year.

Jayson Bedford - Raymond James

Okay so but there's been no change from the first quarter either in terms of pricing?

Gary Burbach

No.

Jayson Bedford - Raymond James

Okay. And then just in terms of the and I may have missed this, but the timing of the new accessories I guess specifically, the more durable modular lead. When do you expect to have that approved?

Gary Burbach

So, the approval of some of those modular lead enhancements, we'd expect the first two of those to occur early next year. So there were three different initiatives there. There was a wire repair kit for the external portion of the lead if there is damage. And then for the pump end connection of the lead there was also a program for that. Those are essentially ready to go into the FDA. And then the modular kind of completely new generation lead. I'd expect to come a bit later than that probably towards the end of next year.

Jayson Bedford - Raymond James

Okay. And pardon my ignorance on this. Is it specific to the device or when you get approved, it's for both the bridge and the destination indications?

Gary Burbach

What's that?

Jayson Bedford - Raymond James

The modular leads.

Gary Burbach

No, it's for both indications.

Jayson Bedford - Raymond James

Okay. That's what I thought. Okay, thank you.

Operator

And we'll go next to Keay Nakae with Collins Stewart.

Keay Nakae - Collins Stewart

Gary, a couple of strategic questions for you with the way ITC is performing now, in the past it provided a valuable addition in terms of its cash flow, but how important is that now and how strategic is that asset?

Gary Burbach

I think that that dynamic has certainly changed given what we are seeing with the HeartMate II. And ITC, we certainly want to see performance turnaround and improve as we look forward here to 2010. We're excited about the launch of the new ProTime in 2010.

But, it certainly is not strategically linked to the CV division. So our view at this point is to continue to make the appropriate investments to move that franchise forward, to continue to build value in it. But in terms of a long-term vision, there's not a connection there that says this is kind of inextricably linked for the long-term.

Keay Nakae - Collins Stewart

Then just following upon your earlier comments in terms of other business development initiatives you might consider, with the decision by the FTC with respect to HeartWare, how much do you think this limits you in terms of going after other mechanical support devices that aren't VAD or other passive systems that are addressing heart failure?

Gary Burbach

I don't think that it should limit us in terms of those types of acquisition opportunities. The FTC looked at the HeartWare acquisition through a very narrow lens, that being the LVAD market and essentially said that we were the number one player in that space in their press releases. Their assertion was that HeartWare was the only viable competition in the foreseeable future in that LVAD, that specific narrow domain.

So, once you move outside of that narrow domain to broader mechanical circulatory, support possibilities, be that partial support devices or acute devices or other heart failure technologies. I don't think that analysis hold for those types of technologies.

Operator

And we'll go next to Sean Lavin with Lazard.

Sean Lavin - Lazard

I have one question on the upgraded peripherals, how we should think about reimbursement, and will insurance companies that had previously paid for a pump cover a peripheral upgrade?

Gary Burbach

Generally you should think about the peripherals as coming into play for new patients that are being implanted. And so it becomes a part of that sale similar to the sales of the current peripherals with pumps. We certainly expect that there will be some portion of ongoing patients that over time will be upgraded to these new peripherals.

We believe a dramatic improvement over the current peripherals which does provide an opportunity and I think a very reasonable case to the insurance companies or to CMS to upgrade those patients. Typically, we expect that the patient would have to be supported for some time period, a year or more to become eligible for that kind of an upgrade. But, we will certainly be working with centers to facilitate those opportunities.

Operator

We'll go next to Greg Simpson with Stifel Nicolaus.

Greg Simpson - Stifel Nicolaus

Any thoughts on maybe ramping up the level of R&D spending dedicated to HeartMate III now that the HeartWare deal is up the table?

Gary Burbach

As I mentioned in my comments, we're investing aggressively not just in HeartMate III, but also in a very wide range of technology and innovation. It's not just about the pump. I think sometimes it's easy for investors in particular to get overly focused on the pump and forget that it's really one component of a broad based set of technologies that are involved in these systems.

There's aggressive investment across a broad spectrum of technology innovation. As David mentioned, we do expect our R&D program spending to be up in the second half for this year and I'd certainly expect that that would continue to be the case into 2010.

Greg Simpson - Stifel Nicolaus

Okay. And then just one other Gary, if I could. You mentioned animal trials starting on HeartMate III in Q1 of 2010. Can I push here and may be speculate on when we might see first human?

Gary Burbach

It'd be premature at this point. Certainly as we continue forward with the program, we'll provide you that kind of additional visibility.

Operator

And we'll take our final question from Jason Mills with Canaccord Adams.

Jason Mills - Canaccord Adams

Thanks, guys for taking the follow-up. I didn't expect to get back in. Gary a question about what you're seeing at the senior level in terms of screening and cardiologists. Not just that coordinator adds but cardiologists being brought into the fold. Obviously, these guys are the guys that are screening these patients, screening more patients obviously leads to more implants. It seems like that could be occurring, but perhaps an update there anecdotally what you're seeing from the field.

Gary Burbach

Yeah anecdotally, we're definitely seeing an increased level of engagement and enthusiasm from cardiologists, not just at these VAD implanting centers, but community cardiologists. Some of that is certainly tremendous amount of the success of HeartMate II and the positive clinical outcomes there. I think our whole MDM program is also having a substantial impact there.

We have actually this Friday a half dozen cardiologists that are community cardiologists that are coming here to spend the day, focused on that therapy. So they're taking a couple of days out of their practice to come and spend time here and get further engaged in the therapy. And we've had a number of those sessions this year and that's something that we are putting more and more energy behind, so I'm certainly very enthused by what I'm seeing from engagement in terms of the cardiology community.

Jason Mills - Canaccord Adams

Great to hear. Last question, you guys both have had quite a broad experience in medical devices and dealing with the FDA. I'm just wondering, logistically the 100-day time point has passed, while you haven't had the 100-day meeting. Is it logistically true or false that if you are going to hear about a panel, the FDA has to notify you that within the 100 days, let alone when the meeting happens, or is that not a stipulation?

Gary Burbach

No, I don't believe that's a stipulation. The hundred days is a target that they have. So there's no kind of hard requirement there.

All right. Thank you. I think that wraps it up. I'd just like to thank everyone for joining us today. And we'll look forward to keeping you updated on our progress. Thanks again.

Operator

And that concludes today's conference. Thank you for your participation.

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Source: Thoratec Corp. Q2 2009 Earnings Call Transcript
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