Thoratec Corporation Q4 2007 Earnings Call Transcript

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 |  About: Thoratec Corporation (THOR)
by: SA Transcripts

Thoratec Corp. (NASDAQ:THOR)

Q4 2007 Earnings Call

February 5, 2008 11:00 am ET

Executives

David Smith - EVP and CFO

Gary Burbach - President and CEO

Larry Cohen - President of ITC

Analysts

Taylor Harris - JPMorgan

Bob Hopkins - Lehman Brothers

Jason Mills - Canaccord Adams

Suraj Kalia - Piper Jaffray

Jayson Bedford - Raymond James

Tim Lee - Caris & Company

Keay Nakae - Collins Stewart

Operator

Welcome to the ThoratecCorporation Earnings Call. Today's conference is being recorded.

Now, at this time, it's mypleasure to turn the conference over to David Smith, Executive Vice Presidentand Chief Financial Officer. Mr. Smith, please go ahead.

David Smith

Thank you and good morning,everyone. Thanks for joining us today. With me are Gary Burbach, President andChief Executive Officer; and Larry Cohen, President of our ITC division.

This was the quarter in which weachieved progress in a number of areas with our successful panel meeting, solidrevenue growth and a continued release of increasingly favorable data from the HeartMate II bridge to transplantation trial. Gary will outline key events during thequarter, and provide our operating perspectives on 2008. And I'll follow with areview of our financial performance, as well as our thinking about guidance for2008, before opening the call to your questions.

Before we begin, during thecourse of today's conference call and the question-and-answer session thatfollows, we may make projections or other forward-looking statements that aresubject to the Safe Harbor provisions of thesecurities laws regarding future events or the financial performance of the company.We caution you that these statements are only predictions, and that actualresults may differ materially. We also alert you to the risks contained in thedocuments we file with the Securities and Exchange Commission, such as ourannual and quarterly reports on Form 10-K and 10-Q. We do not undertake anyobligations to update or correct any forward-looking statements.

Gary?

Gary Burbach

Thank you, David. And goodmorning, everyone.

As David indicated, Thoratec ended the year with a great deal ofpositive momentum with a very favorable outcome in our FDA Panel Meeting at theend of November, which I will speak to in more detail shortly, and recordednearly 10% increase in revenues year-over-year as revenue were $235 millionversus $214 million a year ago. Revenues for the fourth quarter were $64.1million, our strongest quarter in the company's history and a 9% increase overrevenues of $58.8 million in the fourth quarter a year ago.

I will first discuss the eventsin our cardiovascular division where quarterly revenues increased 11% versusthe prior year. There were several contributing factors to our financialperformance, including continued adoption of the HeartMate II, both in Europeand through our USclinical program. In Europe, our HeartMateproduct line sales in 2007 were up nearly 80% over the prior year, a result ofbroader adoption of the HeartMate II in favorable foreign currency exchangerates.

In addition, we saw an increasein USbridge to transplantation activity in the fourth quarter. We also increasedtraction with our CentriMag distribution, as we continued to add new centers.Excluding CentriMag, we sold 470 pumps during the quarter versus 460 in thefourth quarter a year ago. For the year, our total pump sales were 1,712 versus1,728 in 2006.

As you might expect, we were delightedwith the unanimous recommendation for approval of the HeartMate II for bridgeto transplantation at the FDA Circulatory Devices Advisory Panel Meeting onNovember 30. This was based on their belief that the data demonstrated thesafety and efficacy of the device. We felt the discussion that day was highlyencouraging, and we want to acknowledge the contributions of the panel membersas well as the clinicians, patients and others who provided testimony andinformation to the panel.

We believe the conditionsoutlined in the panel's recommendations will not limit our ability to increaseadoption of the device and, in fact, their proposed labeling would eliminatespecific patient size restriction and rely instead on physician assessment ofbody habitats. We agree this is more appropriate than specifying a body surfacearea, and the labeling could increase the universal patients eligible for thedevice.

The other panel conditions focusedon two key areas; limiting the use of the HeartMate II for patients unable totolerate anticoagulation, as we'd expected, and developing an appropriate post-marketstudy protocol. To address the latter recommendation, Thoratec plans toleverage the INTERMACS registry already in place in the market for gatheringexperience of all commercially approved mechanical circulatory support devices.We see this registry is now set to helping grow the market for mechanicalcirculatory support.

Our subsequent discussions withthe staff at the FDA over the past two months have been very productive, andfocus primarily on updating our PMA data for the final device labeling, and, asI mentioned earlier, gaining consensus on an appropriate post-approval studydesign. We view their questions and comments today as part of a normal dialoguefor this type of submission. We expect to provide the FDA with all informationneeded to complete the PMA by the end of this week, and believe that we are ontrack for our first quarter approval and launch.

In the meantime, as I mentionedearlier, our clinical trial enrollment activity continues to be strong. Wecontinue to enroll patients under the Continued Access Protocol for DestinationTherapy that we received at the end of the third quarter. In addition, we havereceived two 20-patient CAPs for the bridge arm, one in the fourth quarter andone more recently at the end of January. This brings the total allowed CAPpatients in our bridge study to 320.

As of January 25, enrollment inthe Destination Therapy arm was 479 patients, an increase of 53 patients overthe 426 patients three months ago. Enrollment in the randomized portion was 291patients. Enrollment in the bridge arm of the trial was 439 versus 390 patientsthree months ago. Total enrollment in the trials of January 25 was 918 patientsversus 816 three months ago.

Reporting the presentation andpublication of data from HeartMate II trial experience continued to be an areaof strong focus for us. During the quarter, there were three key presentationsof HeartMate II data at the American Heart Association Scientific Sessions.

There were updated data on 279patients from the bridge trial presented by Dr. Frank Pagani from the University of Michigan. The results compared 133patients in the original trial cohort and 146 CAP patients, and showed thefavorable outcomes in the original patients for being mirrored in the CAPpatients at both 6 and 12 months. Additionally, Dr. Pagani reported a trendtoward reduction in serious adverse events in the CAP cohort as compared to theprimary cohort.

Data presented by Dr. Andy Boylefrom the University of Minnesota focused onthe experience of 144 patients who were discharged from the hospital with theHeartMate II. The results show that the incidence of thromboembolism and pumpthrombosis is quite low, and there is an opportunity to lower the recommendedINR with the HeartMate II.

And Dr. Roberta Bogaev from TexasHeart looked at the experience of women on the HeartMate II. She noted that theoutcomes for women implanted with the device were comparable to those of menimplanted with the HeartMate II. As you know, this patient population has previouslybeen underserved due to previous device size, and this data clearly supportedthe expanded use of this therapy with the HeartMate II.

Additionally, at last week'sAnnual Meeting of The Society of Thoracic Surgeons in Fort Lauderdale, Dr. Ranjit John from the University of Minnesotapresented their HeartMate II single-center bridge results in a plenary sessionattended by most of the STS attendees. He reported outcomes on their 32 bridgetreated patients with outstanding result, including a 30-day mortality rate ofless than 5% and a survival rate of nearly 94% at both 6 and 12 months.

While I'm on this subject ofpresentations, we have a very active spring ahead of us. There will be two keypresentations at the American College of Cardiology Meetingin March. Dr. Joe Rogers of Duke will be presenting an update of the HeartMateII bridge data, including one year follow-up for 279 patients. Additionally,Dr. Andy Boyle of Minnesotawill be presenting a comparison of functional capacity between NYHA class IVpatients implanted with the HeartMate II versus CRT.

Lastly, a number of abstractswill be presented at the ISA [Chelsea] meeting in April. Specific to HeartMateII, topics will include neurocognitive function improvement, the experience oflarge patients implanted with the HeartMate II, a review of right ventricularfailure, auto regulatory capability during exercise, and hemocompatibility inpulsatal devices versus continuous flow LVADs.

Additionally, there will be acouple of noteworthy presentations on the Thoratec VAD product line, includingUCLA single-centre experience with Thoratec PVAD BiVAD patients and the Papworthsingle-centre IVAD experience. We will be participating in both of thesemeetings; we invite you to visit our booth.

The determination of this kind ofdata is the key element of our strategy post-approval to drive broader adoptionand utilization of the HeartMate II, and mechanical circulatory support as thefrontline therapy for advanced stage heart failure patients irrespective of theduration of support required.

I want to take a few minutes tooutline the key elements of our market development strategy for 2008 andbeyond. The key objectives of this strategy include faster and broader adoptionof mechanical circulatory support therapy in the referring community, drivinggreater utilization among existing implant centers, and expanding the universeof implanting centers involved with the HeartMate II and VAD therapy generally.

We believe that the size anddurability of the HeartMate II ,combined with very favorable clinical outcomesand lower adverse event rates, will help clinicians feel more comfortableimplanting the device even when longer wait times are anticipated. To supportthis effort, we will be making investments in our sales and market developmentteams, the latter of which is at the forefront of our referral program toexpand adoption at our current size.

In addition to expanding ourmarket development team, we will be rolling out a program called"Partnership for Success," which we've successfully piloted at 12centers during 2007. The concept is to work with implanting centers to helpfoster relationships with key cardiology practices in their respective regions,to educate and build awareness of mechanical circulatory support therapy.

Commercial approval of theHeartMate II will enable us to broaden our efforts in determination of thetrial data, and is a very positive message for the many patients who can nowbenefit from HeartMate II and the cardiologists who care for them.

We've developed new collateraland marketing materials and data presentations, and will support them withclinician education program, such as grand round, general meetings, seminarsponsorships and similar events. We're focused on developing strongrelationships with the referral community to build a successful program. Thismodel has been developed in conjunction with our top tier centers and is basedon many years of VAD implant experience.

In addition, we will be expandingour public relations efforts to increase visibility around HeartMate II, andhow it has positively impacted the lives of our patients, similar to thestories that aired recently on ABC nightly news with Charles Gibson. The storywas about Celina Gonzalez, an elementary school teacher and mother, who wasimplanted with a HeartMate II at the end of 2006. She has done so well that herdoctors are evaluating her for possible recovery over the coming months. Youmay remember Celina from a prior a CBS Evening News story, as well as hercomments at the FDA Panel Meeting.

With respect to HeartMate IIlaunch, our goal is to place the system in about 14 new transplant centersduring the year, which would put us in about 80% of the transplant centers inthe US.A key launch objective is to ensure positive outcome in these new centers,which will be confirmed via the post-market study through the deployment of acomprehensive clinical support plan.

This plan includes centerattendants at the training program conducted at one of several currentHeartMate II centers, on-site clinical support by our team of clinicalconsultants and a comprehensive suite of support materials based on clinicalbest practices ranging from patient selection to device implantation andpatient discharge and follow-up.

In addition, as we look forwardto HeartMate II approval for Destination Therapy, it's clear that developingadditional implant centers and clinicians will be needed to provide broaderaccess to MCS therapy. We're laying the foundation for that strategy beginningthis year. Efforts in this area will focus on funding for heart failurecardiology and cardiothoracic surgery fellowship programs, CMS and joint commissionDestination Therapy certification programs, and training and educational programsfor the clinical community.

In addition, we're developingbest practices for centers interested in VAD therapy that provides acomprehensive guide to building a successful program. Elements will includeoptimal clinical strategies to drive superior clinical outcomes, as well aseconomic and reimbursement considerations. This will clearly be a longer termprocess, but hopefully, during the year we can add at least a few centers thatare not doing implants today, and set the stage for accelerated growth in theyears ahead.

We believe that supporting thisstrategy will be our ability to leverage the relationships that we've developedthrough CentriMag program. Ultimately,we believe that we can show that there is not only a huge unmet need in thismarket, but that it also comes with favorable economics for the centers.

Another important trend in our VAD business is our continued growth in Europe, where our programs to increase adoption andbroaden center penetration are working very well. We're noticing a significanttrend in the LVAD market, with a shift toward increased adoption of the HeartMateII. We've realized a clear competitive advantage in Europeand would expect that trend to continue during 2008.

In addition, we are working veryclosely with the regulatory organizations there to foster a more conducivereimbursement environment to expand the potential market of VADs. We've madesignificant headway in this regard recently with the French Ministry of Healthinforming us that the HeartMate II and XVE as well as Thoratec PVAD will bereimbursed under the T-2 list, which is for advanced technologies that arereimbursed directly by the Ministry. In addition both Belgium and the Netherlands have expandedreimbursement for VAD.

We are also making good progressin our program to further strengthen the HeartMate II platform. Working closelywith patients and clinicians, we are developing the next generation externalperipheral systems that we plan to introduce later this year. The new systemfeatures longer lasting battery technology, is lighter and more portable and inconjunction with the new line of accessory transport options, is designed tofurther improve our patients experience while on the device.

In addition, we are working on amore durable percutaneous lead, a next generation controller, field graphs,tools to support consistent and potentially less invasive surgical implants,and a fully implantable system. Further, we continue to assess the key unmetneeds of the market, as it relates to the HeartMate III. Key areas of focusinclude reduced anticoagulation, a less invasive implant, the potential forinduced pulse [fertility], as well as further improvements in clinicaloutcomes.

I also want to note that duringthe fourth quarter we made a small investment in Acorn Cardiovascular, which isthe private company addressing the advanced stage heart failure market with theproprietary mesh wrap that is placed around the heart to prevent theprogression of heart failure by improving the heart structure and function.This transaction furthers our strategy to be the leader in advanced stage heartfailure therapies and will provide us further in sight into treatment andpatient management therapies. We do not expect this transaction to have anynear-term financial impact.

ITC had a solid year withparticular growth in the international market. Overall in 2007, ProTime didvery well, up about 26% year-over-year, and hospital point-of-care productscontinue to experience meaningful growth. In fact, our growth in coagulation isoutpacing that of the overall market. While, we expect to see a number of thesame revenue drivers in 2008, we believe sales at ITC will be somewhat dampenedin two areas; first, our skin incision business will be more challenging in 2008with increased low cost competition. You may recall that we benefited from acompetitive recall in 2007.

Second, while we are making goodprogress with the voluntary recall of certain ProTime units that was initiatedtowards the end of last year, we are expecting that it will contribute to asomewhat lower growth rate from ProTime in 2008. However, we anticipateintroducing our new ProTime platform by the end of 2008 and reacceleratinggrowth in this area.

A recent development that couldprovide a meaningful impact to our ProTime business over the next few years isthe proposal from CMS to expand coverage for home testing to include patientswith atrial fibrillation and deep vein thrombosis. If approved, this wouldexpand coverage to approximately 70% of patients requiring chronic warfarintherapy.

We've been very active in thiseffort, and we expect that CMS will issue a final decision memorandum on thisproposal by the end of March. I should point out that while we don't expect tosee a meaningful impact from this expanded coverage until 2009, our review showsit is a very positive development.

I would also like to acknowledgeour newest Board Member, Steven Collis, who recently joined the Board. Stevenis Executive Vice President of the AmerisourceBergen and President of a specialtygroup that provides specialty pharmaceuticals and related services such asreimbursement consulting to physicians. Steven has significant experience shepherdingthis group through an extensive growth period, and we are delighted to havesome of his experience and expertise as a member of the Board.

For review of our financialresults and our guidance for 2008, I'll now turn the call over to David.

David Smith

Thank you, Gary. Before reviewing our results, as areminder, non-GAAP net income excludes amortization of intangibles, certainlitigation, CEO transition expense and in-process and research and developmentexpenses from our acquisition of Avox as well as share based compensationexpenses under FAS 123(NYSE:R) and changes to the makeover business from ourconvertible notes. Non-GAAP net income also takes into account that tax effectof these adjustments. You can find the reconciliation between our GAAP andnon-GAAP results in our earnings news release at thoratec.com.

Total revenues for 2007 were $235million versus $214 million at 2006 or an increase of nearly 10%. For all of2007 Cardiovascular division revenues were $144 million, an 8% increase overrevenues of $134 million in 2006, while at ITC total year revenues were $91million or a 13% increase over revenues of $80 million in 2006.

As Gary mentioned, revenues for the quarter were$64.1 million versus $58.8 million a year ago. Cardiovascular division revenuesin the fourth quarter were $40.5 million versus $36.5 million a year ago. Salesat ITC were $23.6 million versus $22.4 million in the fourth quarter a yearago. Going forward, to provide greater visibility to the core VAD business, weplanned to provide an annual historical breakout of the revenue mix between theHeartMate and Thor VAD, which includes the PVAD and IVAD product lines.

For 2007, the split between theselines were 68% for the HeartMate product lines and 32% for the Thoratec productlines, reflecting the increasing migration to the HeartMate line that wediscussed with you in the past. We expect this migration towards the HeartMateII to continue with bridge approval. But for the Thoratec VAD, they continue toserve an important patient segment particularly for bridge patients requiringBiVAD support.

Non-GAAP gross margin for 2007was 58.7% versus 59.1% a year ago. The year-over-year decrease in gross marginsis due primarily to the impact with the ProTime recall reserve, and unfavorablenon-pump product mix, partially by favorable foreign exchange. Non-GAAPoperating expenses for 2007 were $116.1 million versus $104.1 million.

The year-over-year increase inoperating expense is due primarily to product development expense, marketdevelopment initiatives, the stock compensation review completed in the firstquarter of 2007 and corporate activities such as Sarbanes-Oxley consulting. Ona non-GAAP basis, the company's effective tax rate for 2007 was 29% versus 23%in 2006. For all of 2007, non-GAAP earnings per share were $0.33 compared to$0.37 in 2006.

Our convertible debt was dilutivein 2007 and as a result, our weighted average shares outstanding wereapproximately $62 million. The debt is considered dilutive when EPS is higherthan the interest income per share that the bondholder would receive.Accounting literature requires that the shares to be considered, and the sharesoutstanding count, and the interest expense recorded in other income andexpense net of tax will be added back to net income providing some offset. Thedilution in 2007, and in 2006 related to the convertible debt was approximately$0.01.

In terms of our balance sheet, weended 2007 with $218 million in cash and short-term investments for sale versus$194 million at the end of 2006. Cash flow for the year was strong with our cashbalances increasing $24 million. This increase was a result of both operationsand stock option exercises offset by capital expenditures. We are excited aboutthe prospects for the company going forward.

Growth drivers that will drivevalue creation include the launch of HeartMate II for the bridge indication,Destination Therapy data from our pivotal trial for HeartMate II in 2009, theexpectation of a launch of HeartMate II for DT in 2010, and continuedinvestment in the space as we continue to enhance our leadership position andbroaden the use of mechanical circulatory support for advanced stage heartfailure patients in a market, we believe has a greater than $5 billionpotential. We expect the solid topline growth will translate to increasing operatingleverage, even while we invest in driving market expansion.

With respect to 2008, we expectsales in the range of $255 million to $265 million with an expectation thatHeartMate II will launch at the end of the first quarter. CV division growth isexpected to be from the low to mid teens, and would grow primarily based uponthe launch of HeartMate II in the United States, including itsintroduction to a broader set of transplant centers, growth in implant volumesat existing centers and an increase in the HeartMate II average selling price.We also expect continued growth in Europe.

We expect that ITC will grow inthe mid single digits, with growth coming from our hospital point-of-care andalternate side products. As Garymentioned earlier, 2008 will be a transition year for ITC, and we expectstronger growth in 2009, with the launch of a new ProTime system and the impactof new reimbursement for at-home testing.

Gross margins are expected to bebetween 59% and 60% on a non-GAAP basis. We expect margin improvement for theCV division, with the launch of HeartMate II offset by geographic mix relatedto the Thoratec product line, growth in international distributor markets,along with non-pump product mix, and increased cost associated with manufacturingtransfer and incremental capacity expansion.

Gross margins are an area wherewe expect to see significant improvement in the coming years. In addition,gross margins at ITC will be flat over the prior year, as a result of anincrease in the level of international sales as a percentage of total sales,and a reduction in our incision sales.

We expect significant improvementat the operating income line over 2007 with the launch of HeartMate II. Incomefrom operations is expected to increase between 15% and 30% over 2007 on anon-GAAP basis, underscoring the leverage potential of our business model. Wewill be doing this while we continue to invest in product development, alongwith the market development initiatives and launch activities for HeartMate II.

Our weighted average sharesoutstanding are expected to be between 63 million and 64 million shares,reflecting the expectation that the current debt will be dilutive in 2008. Theeffect of this dilution is approximately $0.01. Non-GAAP earnings per sharewill be in the range of $0.36 to $0.40. Some offset to the gains and incomefrom operations include lower interest rates, interest income as a result ofchanging market conditions, our higher expected tax rate in 2008 and increasedshares outstanding.

Thank you again for joining ustoday, and we'll now open it up to your questions. As a reminder, we ask thatyou limit yourselves to one question and a follow-up, so we can address as manyquestions as possible. Operator?

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question will come fromTaylor Harris with JPMorgan.

Taylor Harris - JPMorgan

Thanks a lot for taking thequestion. My first question is on the cardiovascular division growth rate for'08. I was wondering if you could just give us a sense of the ranges of what'sgoing to be contributing to that growth rate between the pricing increase thatyou're going to be getting from the mix of HeartMate II, utilization increasesat existing centers, and then the rollout to additional centers.

Gary Burbach

Yes, they are all prettysignificant contributors to the growth, Taylor.Relative to the new centers, we mentioned that we're targeting about 40 newcenters in the USfor HeartMate II this year. Each of those centers would typically stock twounits. So you can infer pretty clearly the contribution that would come fromthat.

In terms of implant volumes, wedo expect to see a reasonable increase in implant volumes from the existingcenters, in particular, that have been participating in the trial. And in termsof pricing, our expectation is that the ASP for the HeartMate II will be in theneighborhood of $80,000, and that compares to a price during the trial of about$65,000 in the US.

Taylor Harris - JPMorgan

Okay. If you're saying 40 newcenters, two implants per center, and if we just assume no restocking, thatwould be about 80 units on a 1,700 unit base. So that's about 5 points ofgrowth rate there. Is that reasonable? And then, it sounds like maybe you’vegot a third contribution from those three factors. Is that reasonable?

Gary Burbach

That sounds roughly reasonable.

Taylor Harris - JPMorgan

Okay. And then my follow-upquestion is on gross margin. So, I know, there were some gross margin pressuresthrough '07, just in ITC division, but we saw it step down in the fourthquarter, and I was wondering if you could comment on that in particular and atwhat point of scale does HeartMate II become accretive to gross margins?

David Smith

Yeah. I guess there are a fewitems relative to Q4. As you mentioned the ProTime recall was a fairlysignificant factor in Q4. We also had some unfavorable manufacturing variances.You may recall that we release those six months after they are realized, and inQ2 we had some lower production rates of HeartMate II in particular, as thetimetable to launch was extended. So that resulted in some unfavorablemanufacturing variance that hit in Q4.

We are expecting some relativelysignificant cannibalization of XVE and so we had some additional E&Oreserve related to the HeartMate XVE. And then lastly, in looking at the mix ofthe various products, the Thor line has a relatively higher gross marginparticularly around the non-pump element, the various peripheral accessoriesthat are utilized by the patients post-discharge. And so, the HeartMateproducts have a lower gross margin around those peripheral items.

We are also seeing those used ata higher rate because we have higher discharge rates with the HeartMatepatient, and so that was a negative impact in Q4 as well. So, those were themajor items that you saw kind of impacting the Q4 gross margin.

As we look forward to the future,certainly HeartMate II will scale up to be a positive contributor as you movethrough 2008 and on beyond 2008. This problem around the HeartMate IIaccessories, as we move out into 2009 and beyond, we expect to see anopportunity to improve there. We will be launching the external peripherals,which should provide an opportunity for us to make some improvements on thatfront and enhance the gross margins.

And then also relative to ITC,we've future products, which we've mentioned both in the ProTime side of thebusiness as well as the hospital side of the business that we anticipate beinglower cost than the current product in improving the gross margins in the ITCbusiness with the ProTime product being launched towards the end of this year.So again, as you look towards 2009, that should be a contributor to improvinggross margins.

Taylor Harris - JPMorgan

Okay. And if I could just get onemore in. So, following up on that is HeartMate II, as you cannibalize XTE in'08, does that help gross margin or not?

David Smith

Yes.

Taylor Harris - JPMorgan

It does, okay. Thanks a lot.

Operator

Our next question is from BobHopkins, Lehman Brothers

Bob Hopkins - Lehman Brothers

Thanks. Let me start biggerpicture and work my way down. Just following up on Taylor's question and on your comments about2008 being something of a transition, you've already launched this product andITC issues worked their way through. Just curious, if you're willing to giveany kind of top line growth thoughts for 2009, when you got the training doneand ITC is teed up and everything is sort of falling in place, and any sort ofrough thoughts on '09 top line growth or bottom line growth that you'll bewilling to share with us today?

Gary Burbach

Yeah. Not specific thoughts, Iguess, more broadly though, Bob, I'd comment, we are continuing to makesignificant investments in the business because we view that there really is adramatic growth opportunity as you look not just at '09, but as you look alittle more broadly at the opportunity here, and our belief that the HeartMateII has the potential to really significantly penetrate this under-penetratedDestination Therapy market in particular.

And so, there is significantinvestment not just around the launch, but also in terms of continuing R&Dinvestments, which I touched upon and also market development investments thatI touched upon. And then similarly, David mentioned that we view that there issignificant potential for improvement in gross margin and that's really drivenalong, remember, the lines that I mentioned previously with Taylor in terms ofHeartMate II scale up, addressing some of these lower margins that we see onthe accessory side of the HeartMate II or the HeartMate product line. And thenalso ITC, really, I think there’s some significant opportunity to improve grossmargins there in the coming years.

Bob Hopkins - Lehman Brothers

Okay. Now, I'll focus on '08, theguidance that you provided for 2008, could you just let me know what percentageof total LVAD sales in 2008 you expect to be HeartMate II?

Gary Burbach

Yeah. We are not providing kindof product by product specific guidance. We did try to provide some moreclarity here with the information that the HeartMate product line in '07accounted for 68% of the VAD sales. I guess, two things. One, we expect thatmix to continue to move towards HeartMate during 2008. And within the HeartMateproduct line, we expect there also to be increase in cannibalization of the XVEby the HeartMate II. So, kind of two factors that continue to drive HeartMateII to be an increasing proportion of the sales.

Bob Hopkins - Lehman Brothers

Okay. And then the last questionis on the incremental spending for 2008 to make sure that the launch goes well.Could you quantify what the incremental spend is in 2008? You kind of outlinedwhere the money is going, but just any other detail on how much incrementalmoney you're spending? I suppose we could back into it from the guidance, butjust what percentage of that spend is sort of ongoing versus one-time innature?

Gary Burbach

Yeah. I mean I think that thereis good information there for you to back into a reasonable estimate. In termsof the major elements, we are looking to add a handful of additional people tothe market development team that's focused on that whole referral process. Sothat's a kind of significant part of the growth. I do think that that's an areathat, as we go forward, that there will continue to be some incrementalinvestments. So that's probably not a one-time investment, but something thatwill continue as we go forward.

R&D investment, there's anumber of programs that we're investing in and I think we'll continue to investin, although the need to increase that level of investment will probablydiminish with time as we've made pretty substantial incremental investments todrive programs on a number of different fronts.

In terms of launch, there is alot of investment around training. That is probably a little bit more one-timein nature as you get those new centers on board. And then, finally, wementioned that there is kind of an emphasis that we're starting to put on, tryingto broaden the number of centers that are involved in the therapy. And so,we're really kind of at the front end of that this year and expect that to besomething that starts to pay off in an increasing way as you go into '09 andbeyond.

So kind of a fronted loadedinvestment, continuing to have to spend there, but probably with increasingreturns as you go forward.

Bob Hopkins - Lehman Brothers

Okay. Thank you. And just onelittle quick one on Acorn, I know it's not a big deal, but I thought theirpivotal trials failed. Am I remembering correctly, and so is that more of an IPinvestment, just some clarification there, and then I'll hop.

Gary Burbach

I guess you could characterize itthat way is, essentially, the phase that they're in is they reviewed theresult. It appeared that there was a subset, a pretty significant subset ofpatients where there are actually some quite positive outcomes. And so thefunding, which we’re a kind of minor participant in, is focused on two things.One, a small confirmatory trial to prove out that kind of focused group ofpatients and success in that group. And then, secondly, to bring a secondgeneration, a much less invasive generation, of the device to the clinicaltrial.

Bob Hopkins - Lehman Brothers

Thank you.

Gary Burbach

Thanks

Operator

Our next question is from JasonMills, Canaccord Adams.

Jason Mills - Canaccord Adams

Thanks, Gary and David, fortaking my question. Congrats on a good quarter.

Gary Burbach

Thank you.

Jason Mills - Canaccord Adams

Obviously, my first question’salso around HeartMate II. Obviously, the Destination Therapy sort of patientpopulation theoretically defined is 25,000 plus, give or take, versus ourbridge to transplant, which we can all define as the size of the transplant wascurrently three to four. And couple that with looking at your deviceenhancements you're planning for this year and next, improved per client,better battery, those are obviously things that are designed for short term VADuse, those are for longer term VAD use.

And so, with those two thingssaid, could you talk about an understanding that you can't market it for DTuntil you receive approval, regardless of whether or not we think that it’sridiculous to have two indications or not. Could you talk about yourconversations with the new centers broadly, and existing centers broadly,because even your current guidance seems to be conservative on the topline, andseems to suggest you're going to have to see an expanding bridge to transplantpatient population? Could you talk about what you are hearing in the field andhow we might see that sort of theoretical bridge to transplant population growin the near term; i.e., the next 12 to 18 months?

Gary Burbach

Okay. First, I guess there is atremendous amount of enthusiasm in the field for the device. The currentcenters that have the device in the trial are anxious to get the deviceavailable in a less restrictive commercial basis. And then, similarly, thecenters that have not been in the trial are very eager to bring the device onboard, and hence, our pretty aggressive expectation to have the device in placein 80% of the transplant centers by the end of the year. So, there’s a lot ofenthusiasm on that front. I think in terms of the evolution of the use of thedevice, we'll be presenting additional longer-term data here at the ACC fromthe Bridge trial, where clinicians will be able to see the results out at oneyear.

So, they will start to be able togain increasing confidence about the use of the device, beyond whattraditionally would be a more limited bridge to transplantation time period,and patients now that are pushing into a longer bridge time period, or maybemore uncertainty around exactly what their clinician course is going to be.

And as you know, we've talkedabout that there is not a sharp bright line here between Bridge and DestinationTherapy. There is a fair bit of grey zone. So, I think the expectation would bein the near term, that clinicians would push into that grey zone, and reallyexpand the view as to what's an appropriate bridge-to-transplantation patientto implant with the device, really, in terms of the certainty of transplantwithin a shorter time period not being as high. So, having kind of moreuncertainty around that, but having a better device and therefore beingcomfortable implanting it in this broader range of patients.

And then, our expectation is thatthat gets substantially reinforced as we move into 2009, and we have therelease of Destination Therapy data after we get to the two year follow-uptimeframe in May of next year. That, I think substantially enhances andcontinues to drive that process, followed by DT approval based on the currenttimelines in 2010.

Jason Mills - Canaccord Adams

That's helpful. And then just asa follow-up to that, when you are looking at 40 new centers, and you areexpecting that each one of those centers could stock two VADs per center, itseems to imply that your guidance doesn't expect much reorder from those newcenters, understanding that you are not going to have all 40 as of the firstday after approval. But it would seem to be conservatively implied that youwould expect some reorder, given the enthusiasm you just mentioned. Couple thatwith the restrictions being lifted on the existing centers, if we are thinkingabout just a growth of 2 to 3 pumps per existing 40 centers, you start to thinkabout well over 200 incremental HeartMate II VAD growth in 2008 versus 2007.

So, if you are going to back intothe numbers, and I won't bore you with them because I'm sure you've done them,it implies significant cannibalization to try to bring the numbers back withinyour guidance. So, I understand the desire to be conservative, given thehistory of sort of aggressive expectations previously, three or fours year ago,before you got here. So, could you talk to that and was your guidancereflecting some of the conservatism that I just went over?

Gary Burbach

Yeah. I guess, qualitatively,Jason, our expectation for the year in terms of implant activity are that theexisting trail centers, that we will see some growth in usage from thosecenters that they have already experience with the device. They've got comfortand confidence, and where they commercially available, that we'll see some broaderusage by those centers.

Our expectations are lower forthe new centers that we are going to be bringing on board in terms of -- we arenot expecting them to start aggressively using the device right out of the gatethis year, but to really have a more gradual process of getting trained.

Jason Mills - Canaccord Adams

Great.

Gary Burbach

They are starting to use thedevice, and we view that there is a little bit of ramp up that's centerspecific.

Jason Mills - Canaccord Adams

That makes sense. I'll slip onemore, and I'll get back in queue. What levels of impact do you factor inqualitatively from competitor trials, and I will note that on your Q3 call yousaid your 4Q guidance incorporated some competitive trial activity, and youended up beating consensus by just shy of 10%. So, I wonder if that's saidanything about the progress in some of these competitive trials.

Gary Burbach

Yeah. We did not see -- as youmentioned, we saw a very robust activity in Q4. We were quite encouraged bythat, even as one of our competitors was actively ramping their trial up. Ourplan is based on an expectation that our competitors will have some reasonablesuccess in driving their trials forward. But really, there is only one of thenewer competitors that is really actively on pivotal trial where there is thepotential for a greater level of enrollment. The others really will just be inearlier pilot trial activity, where we wouldn't expect a lot of competitiveactivity.

Jason Mills - Canaccord Adams

Thank you very much.

Gary Burbach

Thank you.

Operator

Our next question is from SurajKalia with Piper Jaffray.

Suraj Kalia - Piper Jaffray

Good Morning, Gary, David.Congratulations on the quarter.

Gary Burbach

Thanks, Suraj.

David Smith

Hi.

Suraj Kalia - Piper Jaffray

Gary, we've heard chatter regarding theso-called next improvements in HeartMate II at some centers. Can you understandsome of these features you mentioned [pulsatility] and one of the things we'veheard is possible elimination of a pump pocket. What are the key things in thefield that are driving the R&D enhancements in HeartMate II?

Gary Burbach

Yeah. The two items you justmentioned, Suraj, are really more HeartMate III potential opportunities. WithHeartMate II, I think the key focus areas here in the near term are theexternal peripherals, and providing a really more streamlined, patient-friendlyset of external peripherals in terms of the battery, the battery charger, thepower base unit, all of those elements that the patient interacts with on adaily basis.

Now that we have a pump that hasa very strong profile in terms of durability, the percutaneous lead becomes theweakest link in the chain in terms of the implanted components, in terms ofdurability. And so, really, as Jason just mentioned, as you look to longer termuse, and particularly Destination Therapy, it becomes critically important tohave a very robust durable percutaneous lead.

Similarly, the controller. Havinga truly next generation controller that's patient-friendly and alsophysician-friendly, in terms of the interface with those users of the system.Sealed grafts, which make the implantation easier, other tools that make theimplantation easier and less invasive. And then, also in a little bit longerterm basis, a sealed system, a fully implanted system where we get rid of thepercutaneous lead and the various issues that are associated with that,including potential infection.

Suraj Kalia - Piper Jaffray

Okay. And Gary, based on theexperience with HeartMate II in the BTT arm and the acute safety profile we sawat some centers, how should we look upon the DT arm being matched by Thoratec,or the experience as best as you can share it currently?

Gary Burbach

Yeah, well I think certainly anumber of parameters from the Bridge trial likely are things that we will seein the DT trial. Lots of the adverse event elements of the trial, particularlythe kind of clinical outcomes. You'd expect to see similar kinds of performanceas you look at the DT trail.

And then, now that we are givinglonger-term follow-up data out, we will see one year data for 279 patients hereat the ACC. I think they were starting to see a lot of data points that shouldprovide-- it starts to provide some visibility towards expectations for DT.

Suraj Kalia - Piper Jaffray

And last question, Gary. I will hop back inthe queue. In terms of Europe, you mentioned you are all seeing an uptake inHeartMate II placements given from when HeartMate II was approved in Europe into the current date. What do you think are thekey elements driving growth out there? Is it just enhanced clinical experience?Is that looking at the USdata, what are the underlying factors that are contributing to your growththere now?

Gary Burbach

Yeah, I think first and foremostit’s the very positive clinical experience that they are having in Europe on acenter-by-center basis and collectively that's really substantially improvedfrom the experiences they've had with devices that have been availablepreviously, and it is supported by the US clinical data. We did see inparticular the publication of the New England Journal material that was verywell received in the European community, and helped to enhance that acceptanceand adoption of the device.

Suraj Kalia - Piper Jaffray

Okay, gentlemen. Congratulationsagain.

Gary Burbach

Thank you.

Operator

Our next question is from JaysonBedford of Raymond James.

Jayson Bedford - Raymond James

Hi, good morning, and thanks fortaking the question. First, how quickly will it take a new center to get up tospeed and start implanting the HeartMate II?

Gary Burbach

It shouldn't take too much time,Jayson. We've seven centers that are training centers for HeartMate II, thatare current participants in the trial. So, every month there will be trainingoccurring that centers can go and participate in. So, really once they make thedecision to bring the device in, we've product that's available, so there isnot a product availability issue, there is training availability. We've rampedup our clinical support team, so that team will have availability to supportcases, because we want to be there and support the first few cases in a prettyextensive way. So, the ramp up really shouldn't take much time in terms of acenter being able to implant their first patient, once they make that decision.

Jayson Bedford - Raymond James

Okay. And the training involved,is it just scheduling a procedure, or is it all didactic training?

Gary Burbach

Well, the training at one of theimplanting centers is didactic, and also animal lab training. And then afterthat, once they have their first patient, then we've our clinical team that'son site and supporting the center in their first few implants.

Jayson Bedford - Raymond James

Okay, that's fair. And then justas a follow-up. I appreciate the detail on the percentage break-up between thetwo product lines. I'm just wondering, from an absolute dollar basis, would youexpect the Thor line to grow next year?

Gary Burbach

No, I don't. The Thor line this year,we mentioned that we saw some challenges there. We've talked about that interms of some of the short-term devices, some of the changing treatmentpatters, as patients are intervened earlier, where they would only need an LVADand especially with HeartMate II available now commercially in the U.S in thenear term. We expect that trend to continue to where the Thor product wouldbegin to be more and more focused on BiVAD patients, and we are seeing agradually diminishing universe of BiVAD patient, as I mentioned, as they areintervened on a little bit earlier and they only require an LVAD.

Jayson Bedford - Raymond James

Okay. Is it fair to say kind of0% to 10% decline in the Thor line?

Gary Burbach

Yeah, it's a gradual decline.

Jayson Bedford - Raymond James

Okay, thanks. I'll get back inqueue.

Gary Burbach

Okay, thanks.

Operator

Our next question is from Tim Leeof Caris & Company.

Tim Lee - Caris & Company

Hi, good morning and thanks fortaking the question here. Just a couple of quick ones here. How should we thinkabout how the 40 new centers get added? I mean, just given your modest revenueexpectations from that cohort, I mean, are most of those backend loaded towardsthe latter part of '08?

Gary Burbach

Yeah, the majority of them wouldcome in the second half of the year. We've essentially an expectation, that weindicated, of a launch right at the end of this quarter, let's call it thebeginning of Q2. So, we've really got three quarters of launch activity. So,we'd expect that the majority of that would occur in the second half of theyear.

Tim Lee - Caris & Company

Now, given the positive panelthat you've had, have any centers approached you to get in line to get trainedbetter?

Gary Burbach

Well, there is clearly asignificant amount of interest. We obviously can't promote the product yetuntil we do get commercial approval. But there are definitely a number ofcenters that have a lot of enthusiasm to be able to get the device in-house.

Tim Lee - Caris & Company

Just one last one, if I may. Ithink, during your comments you talked about Belgiumand Netherlandsincreasing the reimbursement rates for VAD. I mean, as we look at Europe, are reimbursement rates sufficient to cover thecosts associated with the higher ASPs with HeartMate II, or just anyqualitative comments on that front, please?

Gary Burbach

Yeah. I'd say we're moving in theright direction. If you look at the US, that process really took a number ofyears to get that reimbursement to where it need to be, to make it aneconomically positive event. I feel like we are there now here in the US,with the most recent increases that occurred last October. On Europe,we are still earlier in the process. But we were certainly very encouraged bythe progress that we saw last year, particularly in France.

Tim Lee - Caris & Company

Okay, thank you.

Gary Burbach

Thank you.

Operator

And our last question will befrom Keay Nakae with Collins Stewart.

Keay Nakae - Collins Stewart

Yes. Hello, Gary.

Gary Burbach

Hello, Keay.

Keay Nakae - Collins Stewart

The 40 centers, can you help usunderstand how experienced they are with either your products or others,thinking in terms of what kind of volume do these centers generally do withLVADs per year. And how specifically experienced are they with the HeartMateXVE?

Gary Burbach

Yeah, the large majority of thesecenters are very experienced, and willhave experience with other Thoratec products including the XVE. So, they shouldbe able to come online quite readily in terms of being active experiencecenters.

Keay Nakae - Collins Stewart

And as far as your assumed taxrate for next year. What are you assuming?

David Smith

We are assuming that the ratewill be up slightly. We didn't provide specific point guidance on it.

Keay Nakae - Collins Stewart

Can you ballpark it?

David Smith

No, actually, it will be upslightly.

Keay Nakae - Collins Stewart

All right, thanks.

Operator

And with that, I'll turn the callto Garry Burbach for closing.

Garry Burbach

Okay. Well, we just like to thankyou for joining in this morning. We are obviously quite pleased with the waythat we closed our 2007, and we look forward to a very positive 2008 andcontinuing to update you on our progress. Thanks.

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