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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 Thoratec Corporation Earnings Call. Today's conference is being recorded.

Now, at this time, it's my pleasure to turn the conference over to David Smith, Executive Vice President and 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 and Chief Executive Officer; and Larry Cohen, President of our ITC division.

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

Before we begin, 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 file with the Securities and Exchange Commission, such as our annual and quarterly reports on Form 10-K and 10-Q. We do not undertake any obligations to update or correct any forward-looking statements.

Gary?

Gary Burbach

Thank you, David. And good morning, everyone.

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

I will first discuss the events in our cardiovascular division where quarterly revenues increased 11% versus the prior year. There were several contributing factors to our financial performance, including continued adoption of the HeartMate II, both in Europe and through our US clinical program. In Europe, our HeartMate product line sales in 2007 were up nearly 80% over the prior year, a result of broader adoption of the HeartMate II in favorable foreign currency exchange rates.

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

As you might expect, we were delighted with the unanimous recommendation for approval of the HeartMate II for bridge to transplantation at the FDA Circulatory Devices Advisory Panel Meeting on November 30. This was based on their belief that the data demonstrated the safety and efficacy of the device. We felt the discussion that day was highly encouraging, and we want to acknowledge the contributions of the panel members as well as the clinicians, patients and others who provided testimony and information to the panel.

We believe the conditions outlined in the panel's recommendations will not limit our ability to increase adoption of the device and, in fact, their proposed labeling would eliminate specific patient size restriction and rely instead on physician assessment of body habitats. We agree this is more appropriate than specifying a body surface area, and the labeling could increase the universal patients eligible for the device.

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

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

In the meantime, as I mentioned earlier, our clinical trial enrollment activity continues to be strong. We continue to enroll patients under the Continued Access Protocol for Destination Therapy that we received at the end of the third quarter. In addition, we have received two 20-patient CAPs for the bridge arm, one in the fourth quarter and one more recently at the end of January. This brings the total allowed CAP patients in our bridge study to 320.

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

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

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

Data presented by Dr. Andy Boyle from the University of Minnesota focused on the experience of 144 patients who were discharged from the hospital with the HeartMate II. The results show that the incidence of thromboembolism and pump thrombosis is quite low, and there is an opportunity to lower the recommended INR with the HeartMate II.

And Dr. Roberta Bogaev from Texas Heart looked at the experience of women on the HeartMate II. She noted that the outcomes for women implanted with the device were comparable to those of men implanted with the HeartMate II. As you know, this patient population has previously been underserved due to previous device size, and this data clearly supported the expanded use of this therapy with the HeartMate II.

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

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

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

Additionally, there will be a couple of noteworthy presentations on the Thoratec VAD product line, including UCLA single-centre experience with Thoratec PVAD BiVAD patients and the Papworth single-centre IVAD experience. We will be participating in both of these meetings; we invite you to visit our booth.

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

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

We believe that the size and durability of the HeartMate II ,combined with very favorable clinical outcomes and lower adverse event rates, will help clinicians feel more comfortable implanting the device even when longer wait times are anticipated. To support this effort, we will be making investments in our sales and market development teams, the latter of which is at the forefront of our referral program to expand adoption at our current size.

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

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

We've developed new collateral and marketing materials and data presentations, and will support them with clinician education program, such as grand round, general meetings, seminar sponsorships and similar events. We're focused on developing strong relationships with the referral community to build a successful program. This model has been developed in conjunction with our top tier centers and is based on many years of VAD implant experience.

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

With respect to HeartMate II launch, our goal is to place the system in about 14 new transplant centers during the year, which would put us in about 80% of the transplant centers in the 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 a comprehensive clinical support plan.

This plan includes center attendants at the training program conducted at one of several current HeartMate II centers, on-site clinical support by our team of clinical consultants and a comprehensive suite of support materials based on clinical best practices ranging from patient selection to device implantation and patient discharge and follow-up.

In addition, as we look forward to HeartMate II approval for Destination Therapy, it's clear that developing additional implant centers and clinicians will be needed to provide broader access to MCS therapy. We're laying the foundation for that strategy beginning this year. Efforts in this area will focus on funding for heart failure cardiology and cardiothoracic surgery fellowship programs, CMS and joint commission Destination Therapy certification programs, and training and educational programs for the clinical community.

In addition, we're developing best practices for centers interested in VAD therapy that provides a comprehensive guide to building a successful program. Elements will include optimal clinical strategies to drive superior clinical outcomes, as well as economic and reimbursement considerations. This will clearly be a longer term process, but hopefully, during the year we can add at least a few centers that are not doing implants today, and set the stage for accelerated growth in the years ahead.

We believe that supporting this strategy will be our ability to leverage the relationships that we've developed through CentriMag program. Ultimately, we believe that we can show that there is not only a huge unmet need in this market, 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 and broaden center penetration are working very well. We're noticing a significant trend in the LVAD market, with a shift toward increased adoption of the HeartMate II. We've realized a clear competitive advantage in Europe and would expect that trend to continue during 2008.

In addition, we are working very closely with the regulatory organizations there to foster a more conducive reimbursement environment to expand the potential market of VADs. We've made significant headway in this regard recently with the French Ministry of Health informing us that the HeartMate II and XVE as well as Thoratec PVAD will be reimbursed under the T-2 list, which is for advanced technologies that are reimbursed directly by the Ministry. In addition both Belgium and the Netherlands have expanded reimbursement for VAD.

We are also making good progress in our program to further strengthen the HeartMate II platform. Working closely with patients and clinicians, we are developing the next generation external peripheral systems that we plan to introduce later this year. The new system features longer lasting battery technology, is lighter and more portable and in conjunction with the new line of accessory transport options, is designed to further improve our patients experience while on the device.

In addition, we are working on a more 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 unmet needs of the market, as it relates to the HeartMate III. Key areas of focus include reduced anticoagulation, a less invasive implant, the potential for induced pulse [fertility], as well as further improvements in clinical outcomes.

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

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

Second, while we are making good progress with the voluntary recall of certain ProTime units that was initiated towards the end of last year, we are expecting that it will contribute to a somewhat lower growth rate from ProTime in 2008. However, we anticipate introducing our new ProTime platform by the end of 2008 and reaccelerating growth in this area.

A recent development that could provide a meaningful impact to our ProTime business over the next few years is the proposal from CMS to expand coverage for home testing to include patients with atrial fibrillation and deep vein thrombosis. If approved, this would expand coverage to approximately 70% of patients requiring chronic warfarin therapy.

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

I would also like to acknowledge our newest Board Member, Steven Collis, who recently joined the Board. Steven is Executive Vice President of the AmerisourceBergen and President of a specialty group that provides specialty pharmaceuticals and related services such as reimbursement consulting to physicians. Steven has significant experience shepherding this group through an extensive growth period, and we are delighted to have some of his experience and expertise as a member of the Board.

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

David Smith

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

Total revenues for 2007 were $235 million versus $214 million at 2006 or an increase of nearly 10%. For all of 2007 Cardiovascular division revenues were $144 million, an 8% increase over revenues of $134 million in 2006, while at ITC total year revenues were $91 million 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 revenues in the fourth quarter were $40.5 million versus $36.5 million a year ago. Sales at ITC were $23.6 million versus $22.4 million in the fourth quarter a year ago. Going forward, to provide greater visibility to the core VAD business, we planned to provide an annual historical breakout of the revenue mix between the HeartMate and Thor VAD, which includes the PVAD and IVAD product lines.

For 2007, the split between these lines were 68% for the HeartMate product lines and 32% for the Thoratec product lines, reflecting the increasing migration to the HeartMate line that we discussed with you in the past. We expect this migration towards the HeartMate II to continue with bridge approval. But for the Thoratec VAD, they continue to serve an important patient segment particularly for bridge patients requiring BiVAD support.

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

The year-over-year increase in operating expense is due primarily to product development expense, market development initiatives, the stock compensation review completed in the first quarter of 2007 and corporate activities such as Sarbanes-Oxley consulting. On a 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 dilutive in 2007 and as a result, our weighted average shares outstanding were approximately $62 million. The debt is considered dilutive when EPS is higher than the interest income per share that the bondholder would receive. Accounting literature requires that the shares to be considered, and the shares outstanding count, and the interest expense recorded in other income and expense net of tax will be added back to net income providing some offset. The dilution in 2007, and in 2006 related to the convertible debt was approximately $0.01.

In terms of our balance sheet, we ended 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 cash balances increasing $24 million. This increase was a result of both operations and stock option exercises offset by capital expenditures. We are excited about the prospects for the company going forward.

Growth drivers that will drive value creation include the launch of HeartMate II for the bridge indication, Destination Therapy data from our pivotal trial for HeartMate II in 2009, the expectation of a launch of HeartMate II for DT in 2010, and continued investment in the space as we continue to enhance our leadership position and broaden the use of mechanical circulatory support for advanced stage heart failure patients in a market, we believe has a greater than $5 billion potential. We expect the solid topline growth will translate to increasing operating leverage, even while we invest in driving market expansion.

With respect to 2008, we expect sales in the range of $255 million to $265 million with an expectation that HeartMate II will launch at the end of the first quarter. CV division growth is expected to be from the low to mid teens, and would grow primarily based upon the launch of HeartMate II in the United States, including its introduction to a broader set of transplant centers, growth in implant volumes at 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 in the mid single digits, with growth coming from our hospital point-of-care and alternate side products. As Gary mentioned earlier, 2008 will be a transition year for ITC, and we expect stronger growth in 2009, with the launch of a new ProTime system and the impact of new reimbursement for at-home testing.

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

Gross margins are an area where we 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 an increase in the level of international sales as a percentage of total sales, and a reduction in our incision sales.

We expect significant improvement at the operating income line over 2007 with the launch of HeartMate II. Income from operations is expected to increase between 15% and 30% over 2007 on a non-GAAP basis, underscoring the leverage potential of our business model. We will be doing this while we continue to invest in product development, along with the market development initiatives and launch activities for HeartMate II.

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

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

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question will come from Taylor Harris with JPMorgan.

Taylor Harris - JPMorgan

Thanks a lot for taking the question. 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's going to be contributing to that growth rate between the pricing increase that you're going to be getting from the mix of HeartMate II, utilization increases at existing centers, and then the rollout to additional centers.

Gary Burbach

Yes, they are all pretty significant contributors to the growth, Taylor. Relative to the new centers, we mentioned that we're targeting about 40 new centers in the US for HeartMate II this year. Each of those centers would typically stock two units. So you can infer pretty clearly the contribution that would come from that.

In terms of implant volumes, we do expect to see a reasonable increase in implant volumes from the existing centers, in particular, that have been participating in the trial. And in terms of pricing, our expectation is that the ASP for the HeartMate II will be in the neighborhood 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 new centers, two implants per center, and if we just assume no restocking, that would be about 80 units on a 1,700 unit base. So that's about 5 points of growth rate there. Is that reasonable? And then, it sounds like maybe you’ve got a third contribution from those three factors. Is that reasonable?

Gary Burbach

That sounds roughly reasonable.

Taylor Harris - JPMorgan

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

David Smith

Yeah. I guess there are a few items relative to Q4. As you mentioned the ProTime recall was a fairly significant factor in Q4. We also had some unfavorable manufacturing variances. You may recall that we release those six months after they are realized, and in Q2 we had some lower production rates of HeartMate II in particular, as the timetable to launch was extended. So that resulted in some unfavorable manufacturing variance that hit in Q4.

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

We are also seeing those used at a higher rate because we have higher discharge rates with the HeartMate patient, and so that was a negative impact in Q4 as well. So, those were the major 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 move through 2008 and on beyond 2008. This problem around the HeartMate II accessories, as we move out into 2009 and beyond, we expect to see an opportunity to improve there. We will be launching the external peripherals, which should provide an opportunity for us to make some improvements on that front 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 the business as well as the hospital side of the business that we anticipate being lower cost than the current product in improving the gross margins in the ITC business 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 improving gross margins.

Taylor Harris - JPMorgan

Okay. And if I could just get one more 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 Bob Hopkins, Lehman Brothers

Bob Hopkins - Lehman Brothers

Thanks. Let me start bigger picture and work my way down. Just following up on Taylor's question and on your comments about 2008 being something of a transition, you've already launched this product and ITC issues worked their way through. Just curious, if you're willing to give any kind of top line growth thoughts for 2009, when you got the training done and ITC is teed up and everything is sort of falling in place, and any sort of rough thoughts on '09 top line growth or bottom line growth that you'll be willing to share with us today?

Gary Burbach

Yeah. Not specific thoughts, I guess, more broadly though, Bob, I'd comment, we are continuing to make significant investments in the business because we view that there really is a dramatic growth opportunity as you look not just at '09, but as you look a little more broadly at the opportunity here, and our belief that the HeartMate II has the potential to really significantly penetrate this under-penetrated Destination Therapy market in particular.

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

Bob Hopkins - Lehman Brothers

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

Gary Burbach

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

Bob Hopkins - Lehman Brothers

Okay. And then the last question is 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 outlined where the money is going, but just any other detail on how much incremental money you're spending? I suppose we could back into it from the guidance, but just what percentage of that spend is sort of ongoing versus one-time in nature?

Gary Burbach

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

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

In terms of launch, there is a lot of investment around training. That is probably a little bit more one-time in nature as you get those new centers on board. And then, finally, we mentioned that there is kind of an emphasis that we're starting to put on, trying to 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 be something that starts to pay off in an increasing way as you go into '09 and beyond.

So kind of a fronted loaded investment, continuing to have to spend there, but probably with increasing returns as you go forward.

Bob Hopkins - Lehman Brothers

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

Gary Burbach

I guess you could characterize it that way is, essentially, the phase that they're in is they reviewed the result. It appeared that there was a subset, a pretty significant subset of patients where there are actually some quite positive outcomes. And so the funding, 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 of patients and success in that group. And then, secondly, to bring a second generation, a much less invasive generation, of the device to the clinical trial.

Bob Hopkins - Lehman Brothers

Thank you.

Gary Burbach

Thanks

Operator

Our next question is from Jason Mills, Canaccord Adams.

Jason Mills - Canaccord Adams

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

Gary Burbach

Thank you.

Jason Mills - Canaccord Adams

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

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

Gary Burbach

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

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

And as you know, we've talked about that there is not a sharp bright line here between Bridge and Destination Therapy. There is a fair bit of grey zone. So, I think the expectation would be in the near term, that clinicians would push into that grey zone, and really expand the view as to what's an appropriate bridge-to-transplantation patient to implant with the device, really, in terms of the certainty of transplant within a shorter time period not being as high. So, having kind of more uncertainty around that, but having a better device and therefore being comfortable implanting it in this broader range of patients.

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

Jason Mills - Canaccord Adams

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

So, if you are going to back into the 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 within your guidance. So, I understand the desire to be conservative, given the history of sort of aggressive expectations previously, three or fours year ago, before you got here. So, could you talk to that and was your guidance reflecting 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 the existing trail centers, that we will see some growth in usage from those centers that they have already experience with the device. They've got comfort and confidence, and where they commercially available, that we'll see some broader usage by those centers.

Our expectations are lower for the new centers that we are going to be bringing on board in terms of -- we are not expecting them to start aggressively using the device right out of the gate this year, but to really have a more gradual process of getting trained.

Jason Mills - Canaccord Adams

Great.

Gary Burbach

They are starting to use the device, and we view that there is a little bit of ramp up that's center specific.

Jason Mills - Canaccord Adams

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

Gary Burbach

Yeah. We did not see -- as you mentioned, we saw a very robust activity in Q4. We were quite encouraged by that, even as one of our competitors was actively ramping their trial up. Our plan is based on an expectation that our competitors will have some reasonable success in driving their trials forward. But really, there is only one of the newer competitors that is really actively on pivotal trial where there is the potential for a greater level of enrollment. The others really will just be in earlier pilot trial activity, where we wouldn't expect a lot of competitive activity.

Jason Mills - Canaccord Adams

Thank you very much.

Gary Burbach

Thank you.

Operator

Our next question is from Suraj Kalia 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 the so-called next improvements in HeartMate II at some centers. Can you understand some of these features you mentioned [pulsatility] and one of the things we've heard is possible elimination of a pump pocket. What are the key things in the field that are driving the R&D enhancements in HeartMate II?

Gary Burbach

Yeah. The two items you just mentioned, Suraj, are really more HeartMate III potential opportunities. With HeartMate II, I think the key focus areas here in the near term are the external peripherals, and providing a really more streamlined, patient-friendly set of external peripherals in terms of the battery, the battery charger, the power base unit, all of those elements that the patient interacts with on a daily basis.

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

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

Suraj Kalia - Piper Jaffray

Okay. And Gary, based on the experience with HeartMate II in the BTT arm and the acute safety profile we saw at 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 a number of parameters from the Bridge trial likely are things that we will see in the DT trial. Lots of the adverse event elements of the trial, particularly the kind of clinical outcomes. You'd expect to see similar kinds of performance as you look at the DT trail.

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

Suraj Kalia - Piper Jaffray

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

Gary Burbach

Yeah, I think first and foremost it’s the very positive clinical experience that they are having in Europe on a center-by-center basis and collectively that's really substantially improved from the experiences they've had with devices that have been available previously, and it is supported by the US clinical data. We did see in particular the publication of the New England Journal material that was very well received in the European community, and helped to enhance that acceptance and adoption of the device.

Suraj Kalia - Piper Jaffray

Okay, gentlemen. Congratulations again.

Gary Burbach

Thank you.

Operator

Our next question is from Jayson Bedford of Raymond James.

Jayson Bedford - Raymond James

Hi, good morning, and thanks for taking the question. First, how quickly will it take a new center to get up to speed 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, that are current participants in the trial. So, every month there will be training occurring that centers can go and participate in. So, really once they make the decision to bring the device in, we've product that's available, so there is not a product availability issue, there is training availability. We've ramped up our clinical support team, so that team will have availability to support cases, because we want to be there and support the first few cases in a pretty extensive way. So, the ramp up really shouldn't take much time in terms of a center 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 the implanting centers is didactic, and also animal lab training. And then after that, once they have their first patient, then we've our clinical team that's on site and supporting the center in their first few implants.

Jayson Bedford - Raymond James

Okay, that's fair. And then just as a follow-up. I appreciate the detail on the percentage break-up between the two product lines. I'm just wondering, from an absolute dollar basis, would you expect 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 in terms of some of the short-term devices, some of the changing treatment patters, as patients are intervened earlier, where they would only need an LVAD and especially with HeartMate II available now commercially in the U.S in the near term. We expect that trend to continue to where the Thor product would begin to be more and more focused on BiVAD patients, and we are seeing a gradually diminishing universe of BiVAD patient, as I mentioned, as they are intervened on a little bit earlier and they only require an LVAD.

Jayson Bedford - Raymond James

Okay. Is it fair to say kind of 0% 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 in queue.

Gary Burbach

Okay, thanks.

Operator

Our next question is from Tim Lee of Caris & Company.

Tim Lee - Caris & Company

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

Gary Burbach

Yeah, the majority of them would come in the second half of the year. We've essentially an expectation, that we indicated, of a launch right at the end of this quarter, let's call it the beginning 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 the year.

Tim Lee - Caris & Company

Now, given the positive panel that you've had, have any centers approached you to get in line to get trained better?

Gary Burbach

Well, there is clearly a significant amount of interest. We obviously can't promote the product yet until we do get commercial approval. But there are definitely a number of centers 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. I think, during your comments you talked about Belgium and Netherlands increasing the reimbursement rates for VAD. I mean, as we look at Europe, are reimbursement rates sufficient to cover the costs associated with the higher ASPs with HeartMate II, or just any qualitative comments on that front, please?

Gary Burbach

Yeah. I'd say we're moving in the right direction. If you look at the US, that process really took a number of years to get that reimbursement to where it need to be, to make it an economically 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 by the 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 be from 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 us understand how experienced they are with either your products or others, thinking in terms of what kind of volume do these centers generally do with LVADs per year. And how specifically experienced are they with the HeartMate XVE?

Gary Burbach

Yeah, the large majority of these centers are very experienced, and will have experience with other Thoratec products including the XVE. So, they should be able to come online quite readily in terms of being active experience centers.

Keay Nakae - Collins Stewart

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

David Smith

We are assuming that the rate will 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 up slightly.

Keay Nakae - Collins Stewart

All right, thanks.

Operator

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

Garry Burbach

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

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Source: Thoratec Corporation Q4 2007 Earnings Call Transcript
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