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THOR > SEC Filings for THOR > Form 10-Q on 2-Nov-2012All Recent SEC Filings

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Form 10-Q for THORATEC CORP


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These statements can be identified by the words "expects," "projects," "hopes," "believes," "intends," "should," "estimate," "will," "would," "may," "anticipates," "plans," "could" and other similar words. Actual results, events or performance could differ materially from these forward-looking statements based on a variety of factors, many of which are beyond our control. Therefore, readers are cautioned not to put undue reliance on these statements. Factors that could cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described in the "Risk Factors" section of our 2011 Annual Report on Form 10-K (the "2011 Annual Report") and in other documents we file with the Securities and Exchange Commission ("SEC"). These forward-looking statements speak only as of the date hereof. We are not under any obligation, and we expressly disclaim any obligation, to publicly release any revisions or updates to these forward-looking statements that may be made to reflect events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.

The following presentation of management's discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

OVERVIEW

Continuing Operations-Cardiovascular Business

Thoratec Corporation ("we," "our," "us" or the "Company") is the world leader in mechanical circulatory support with a product portfolio to treat the full range of clinical needs for advanced heart failure patients. We develop, manufacture and market proprietary medical devices used for circulatory support.

For the treatment of heart failure ("HF") patients, we develop, manufacture and market proprietary medical devices used for mechanical circulatory support ("MCS"). For advanced HF, our primary product lines are our ventricular assist devices ("VADs"): the Thoratec Paracorporeal Ventricular Assist Device ("PVAD"), the Thoratec Implantable Ventricular Assist Device ("IVAD"), and the HeartMate II Left Ventricular Assist System ("HeartMate II"). We refer to the PVAD and the IVAD collectively as the "Thoratec product line" and we refer to the HeartMate II as the "HeartMate product line." For acute HF, our product lines are the CentriMag Acute Circulatory System ("CentriMag") and, for pediatric patients, the PediMag/PediVAS Acute Circulatory System ("PediMag/PediVAS"). The PVAD, IVAD, HeartMate II, CentriMag and PediMag/PediVAS are approved by the U.S. Food and Drug Administration ("FDA") and Conformité Européene ("CE") Mark approved in Europe.

MCS devices supplement the pumping function of the heart in patients with HF. In most cases, a cannula connects the left ventricle of the heart to a blood pump. Blood flows from the left ventricle to the pump chamber via the cannula, powered by an electric or air driven mechanism that drives the blood through another cannula into the aorta. From the aorta, the blood then circulates throughout the body. Mechanical or tissue valves enable unidirectional flow in some devices. Currently, the power source remains outside the body for all FDA-approved MCS devices.

Certain MCS devices are implanted internally, while others are placed outside the body. Some external devices are placed immediately adjacent to the body (paracorporeal), while other external MCS devices are positioned at a distance from the body (extracorporeal).

On August 3, 2011, we announced that we acquired the medical business of Levitronix LLC ("Levitronix Medical") for an upfront cash payment of $110 million, as well as potential future cash earn-out payments of up to $40 million. This acquisition follows a successful strategic relationship between the two companies. Prior to the acquisition, we provided distribution and clinical support to Levitronix Medical in the U.S. for the CentriMag under an agreement that would have expired at the end of 2011. We have also collaborated on the development of the fully magnetically levitated motor technology employed in the HeartMate III left ventricular assist system, which is currently in preclinical testing.

Our product portfolio of implantable and external MCS devices is described below.


Table of Contents

The HeartMate II

The HeartMate II is an implantable, electrically powered, continuous flow, left ventricular assist device consisting of a rotary blood pump designed to provide intermediate and long-term MCS. The HeartMate II is designed to improve survival and quality of life for a broad range of advanced HF patients. Significantly smaller than previous ventricular assist devices and with only one moving part, the HeartMate II is simpler and designed to operate more quietly than pulsatile devices.

HeartMate II received FDA approval in April 2008 for bridge-to-transplantation ("BTT") and received FDA approval for use in HF patients who are not eligible for heart transplantation ("Destination Therapy" or "DT") in January 2010. In November 2005, the HeartMate II received CE Mark approval, allowing for its commercial sale in Europe. In May 2009, the HeartMate II was approved in Canada.

The Paracorporeal Ventricular Assist Device

The PVAD is an external, pulsatile, ventricular assist device, FDA approved for BTT, including home discharge, and post-cardiotomy myocardial recovery that provides left, right and biventricular MCS. The PVAD is a paracorporeal device that is less invasive than implantable VADs as only the cannula is implanted. The paracorporeal nature of the PVAD has several benefits including shorter implantation times (approximately two hours) and the ability to use the device in smaller patients.

A pneumatic power source drives the PVAD. It is designed for short-to-intermediate duration use of a few weeks to several months, although this device has supported certain patients for up to eighteen months. Offering left, right or biventricular support, the PVAD and the IVAD, described below, are the only biventricular support systems approved for use for BTT. This characteristic is significant because approximately 65% of BTT patients treated with the PVAD and the IVAD require right- as well as left-sided ventricular assistance. The PVAD and the IVAD are also the only devices approved for both BTT and recovery following cardiac surgery. The PVAD incorporates our proprietary biomaterial, Thoralon, which has excellent tissue and blood compatibility and is resistant to blood clots.

The PVAD received FDA approval for BTT in December 1995 and for recovery (post-cardiotomy) in May 1998. In June 1998, the PVAD received CE Mark approval, allowing for its commercial sale in Europe. In November 1994, the PVAD was approved in Canada.

The Implantable Ventricular Assist Device

The IVAD is an implantable, pulsatile, ventricular assist device FDA approved for BTT, including home discharge, and post-cardiotomy myocardial recovery that provides left, right or biventricular MCS. The IVAD maintains the same blood flow path, valves and blood pumping mechanism as the PVAD, but has an outer housing made of a titanium alloy that makes it suitable for implantation.

The IVAD received FDA approval for BTT and recovery (post-cardiotomy) in August 2004. In June 2003, the IVAD received CE Mark approval, allowing for its commercial sale in Europe. In November 2004, the IVAD was approved in Canada.

The CentriMag

The CentriMag is an extracorporeal full-flow acute surgical support platform incorporating a polycarbonate pump, based on magnetically levitated bearingless motor technology. The CentriMag is 510(k) cleared by the FDA for use up to six hours in patients requiring short-term extracorporeal circulatory support during cardiac surgery. Additionally, CentriMag is approved under an FDA humanitarian device exemption to be used as a right ventricular assist device for periods of support up to 30 days in patients in cardiogenic shock due to acute right ventricular failure. In May 2008, Levitronix received approval to commence a U.S. pivotal trial to demonstrate safety and effectiveness of the CentriMag for periods of support up to 30 days. The CentriMag has CE Mark approval in Europe to provide support for up to 30 days for both cardiac and respiratory failure. In Canada, the CentriMag is approved for short-term cardiopulmonary support.

The PediMag/PediVAS

The PediMag and PediVAS are identical, extracorporeal full-flow acute surgical support platforms incorporating a polycarbonate pump, based on magnetically levitated bearingless motor technology, designed to provide acute surgical support to pediatric patients. The brand names differ according to indication for use, duration of support, and regulatory approval. The PediMag is 510(k) cleared by the FDA for use, in conjunction with the CentriMag console and motor, for support periods of up to six hours. An Investigational Device Exemption (IDE) has been submitted to the FDA in order to begin a U.S. clinical trial examining the safety and probable benefit of the device for use up to 30 days to support pediatric patients. Outside the U.S., the device is branded as PediVAS and has CE Mark approval for support durations of up to 30 days for both cardiac and respiratory failure. In Canada, PediVAS is approved for short cardiopulmonary support or extracorporeal life support.


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Critical Accounting Policies and Estimates

Our unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these statements requires management to make judgments and estimates. Some accounting policies have a significant impact on amounts reported in these financial statements. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, in the Notes to the Consolidated Financial Statements (Note
1) and the Critical Accounting Policies and Estimates section in Management's Discussion and Analysis of Financial Condition and Results of Operations. There have been no changes in these significant accounting policies during the nine months ended September 29, 2012.

Results of Operations



The following table sets forth selected unaudited condensed consolidated
statements of operations data for the periods indicated and as a percentage of
total product sales:



                              Three Months Ended                       Nine Months Ended
                       September 29,        October 1,         September 29,        October 1,
                           2012                2011                2012                2011
                                      (in thousands, except for percentage data)

Product sales        $ 117,768   100.0 % $ 102,584   100.0 % $ 363,196   100.0 % $ 313,335   100.0 %
Cost of product
sales                   36,162    30.7      32,937    32.1     111,071    30.6      99,051    31.6
Gross profit            81,606    69.3      69,647    67.9     252,125    69.4     214,284    68.4
Operating
expenses:
Selling, general
and administrative      28,478    24.2      25,632    24.9      91,692    25.2      77,375    24.7
Research and
development             20,382    17.3      16,273    15.9      59,886    16.5      47,826    15.3
Total operating
expenses                48,860    41.5      41,905    40.8     151,578    41.7     125,201    40.0
Income from
operations              32,746    27.8      27,742    27.1     100,547    27.7      89,083    28.4
Other income and
(expense):
Interest expense
and other                    -       -          (3 )     -          (3 )     -      (4,650 )  (1.5 )
Interest income
and other                  579     0.5         283     0.2       1,401     0.4       1,526     0.5
Income before
income taxes            33,325    28.3      28,022    27.3     101,945    28.1      85,959    27.4
Income tax expense      (9,070 )  (7.7 )    (9,033 )  (8.8 )   (31,396 )  (8.6 )   (28,729 )  (9.2 )
Income from
continuing
operations              24,255    20.6      18,989    18.5      70,549    19.4      57,230    18.2
Loss from
discontinued
operations, net of
tax                          -       -      (1,031 )  (1.0 )         -       -      (1,031 )  (0.3 )
Net income           $  24,255    20.6   $  17,958    17.5   $  70,549    19.4   $  56,199    17.9

Three and nine months ended September 29, 2012 and October 1, 2011

Product Sales



Product sales consisted of the following:



                                  Three Months Ended                           Nine Months Ended
                        September 29,     October 1,                September 29,     October 1,
                            2012             2011       % Change        2012             2011       % Change
                               (in thousands)                              (in thousands)
Total product sales    $       117,768   $    102,584       14.8 % $       363,196   $    313,335       15.9 %

During the three months ended September 29, 2012 as compared to the three months ended October 1, 2011, product sales increased by $15.2 million or 14.8% driven by strong sales volume of our HeartMate II and CentriMag products. HeartMate II units grew 27% contributing $18.3 million to the increase, while the CentriMag and PediMag product lines increase was attributable to the incremental revenues of $0.9 million related to the Levitronix Medical acquisition. The increase was partially offset by a decline of $3.4 million in sales of the Thoratec product line. From a regional perspective, U.S. sales contributed $13.6 million to the increase, while international sales contributed $1.6 million.


Table of Contents

During the nine months ended September 29, 2012 as compared to the nine months ended October 1, 2011, product sales increased by $49.9 million or 15.9% driven by strong sales volume of our HeartMate II and CentriMag products. HeartMate II units grew 23% contributing $51.3 million to the increase, while the CentriMag and PediMag product lines contributed $7.3 million to the increase, primarily attributable to the incremental revenues of $6.1 million related to the Levitronix Medical acquisition. This was partially offset by a decline of $8.7 million in sales of the Thoratec product line. From a regional perspective, U.S. sales contributed $39.2 million to the increase, while international sales contributed $10.7 million.

Sales originating outside of the U.S. and U.S. export sales accounted for approximately 17% and 18% of our total product sales for each of the three months ended September 29, 2012 and October 1, 2011, respectively, and approximately 18% and 17% of our total product sales for each of the nine months ended September 29, 2012 and October 1, 2011, respectively.

Gross Profit



Gross profit and gross margin were as follows:



                               Three Months Ended               Nine Months Ended
                          September 29,     October 1,     September 29,     October 1,
                              2012             2011            2012             2011
                                       (in thousands, except percentages)
Total gross profit (A)   $        81,606   $     69,647   $       252,125   $    214,284
Total gross margin                  69.3 %         67.9 %            69.4 %         68.4 %


(A) Includes the effect of adjustments to cost of product sales for intangible amortization expense of $2.0 million and $6.0 million for the three and nine months ended October 1, 2011, respectively, previously presented within operating expense. Refer to Note 1 in the unaudited condensed consolidated financial statements for details.

During the three months ended September 29, 2012 as compared to the three months ended October 1, 2011, gross margin percentage increased by 1.4%. This increase was primarily due to higher fair value inventory adjustment related to the Levitronix acquisition recorded in third quarter of 2011.

During the nine months ended September 29, 2012 as compared to the nine months ended October 1, 2011, gross margin percentage increased by 1.0%. This increase was primarily due to volume based efficiencies, partially offset by unfavorable foreign currency exchange movements.

Selling, General and Administrative Expenses



Selling, general and administrative expenses were as follows:



                              Three Months Ended                           Nine Months Ended
                         September 29,     October 1,                 September 29,     October 1,
                             2012             2011       % Change         2012             2011       % Change
                                (in thousands)                               (in thousands)

Total selling,
general and
administrative
expenses (B)            $        28,478   $     25,632        11.1 % $        91,692   $     77,375        18.5 %


(B) Includes intangible amortization expense related to patents and trademarks of $0.6 million and $1.1 million reclassified to selling, general and administrative expense for the three and nine months ended October 1, 2011, respectively.

During the three months ended September 29, 2012, as compared to the three months ended October 1, 2011, selling, general and administrative costs increased by $2.9 million primarily due to costs related to market development initiatives.

During the nine months ended September 29, 2012 as compared to the nine months ended October 1, 2011, selling, general and administrative costs increased by $26.4 million primarily due to costs related to market development initiatives.


Table of Contents

Research and Development Expenses



Research and development expenses were as follows:



                                 Three Months Ended                          Nine Months Ended
                            September 29,     October 1,                September 29,     October 1,
                                2012             2011       % Change        2012             2011       % Change
                                   (in thousands)                              (in thousands)
Total research and
development                $        20,382   $     16,273       25.3 % $        59,886   $     47,826       25.2 %

Research and development costs are largely project-driven and fluctuate based on the level of project activity planned and subsequently approved and conducted.

During the three months ended September 29, 2012 as compared to the three months ended October 1, 2011, research and development costs increased by $4.1 million, while during the nine months ended September 29, 2012 as compared to the nine months ended October 1, 2011, research and development costs increased by $12.1 million. The increases were due to research and development headcount, costs associated with the development of HeartMate III, HeartMate PHP, and HeartMate II peripheral enhancements.

Interest Expense and Other



Interest expense primarily relates to interest on the senior subordinated
convertible notes as follows:



                                 Three Months Ended                             Nine Months Ended
                           September 29,        October 1,                September 29,      October 1,
                               2012                2011       % Change        2012              2011        % Change
                                   (in thousands)                                 (in thousands)
Interest expense         $               -     $         (3 )        - % $            (3 )  $      (4,499 )   (100.0 )%
Amortization of debt
issuance costs related
to senior subordinated
convertible notes                        -                -          -                 -             (151 )        -
Total interest expense
and other                $               -     $         (3 )            $            (3 )  $      (4,650 )

Interest expense in 2011 pertained primarily to the senior subordinated convertible notes that were extinguished in May 2011.

Interest Income and Other



Interest income and other consisted of the following:



                             Three Months Ended                             Nine Months Ended
                        September 29,      October 1,                 September 29,      October 1,
                            2012              2011       % Change         2012              2011       % Change
                               (in thousands)                                (in thousands)
Interest income        $           286    $        350        (18 )% $           908    $      2,165        (58 )%
Foreign currency,
net                                156             299        (48 )%             178            (420 )     (142 )%
Other                              137            (366 )     (137 )%             315            (219 )     (244 )%
Total interest
income and other       $           579    $        283               $         1,401    $      1,526

Interest income during the three months ended September 29, 2012 primarily due to the decline in interest rates and lower short-term investment balances as a result of the extinguishment of the senior subordinated convertible notes and shares repurchased in the first quarter of 2011 and cash utilized for the Levitronix Medical acquisition.

Interest income during the nine months ended September 29, 2012 primarily due to the decline in interest rates and lower short-term investment balances as a result of the extinguishment of the senior subordinated convertible notes and shares repurchased in the first and fourth quarters of 2011. Foreign currency losses increased by $0.6 million due to fluctuations in foreign exchange rates.


Table of Contents

Income Taxes

Our effective income tax rates from continuing operations for the three months ended September 29, 2012 and October 1, 2011 were 27.2% and 32.2%, respectively. Our effective income tax rates from continuing operations for the nine months ended September 29, 2012 and October 1, 2011 were 30.8% and 33.4%, respectively. The decrease is primarily attributable to a greater percentage of earnings generated in lower-tax jurisdictions, a function of the acquisition of Levitronix Medical. This rate benefit was partially offset by the lack of federal R&D credits in the absence of enacted legislation.

Our effective tax rate is calculated based on the statutory tax rates imposed on projected annual pre-tax income or loss in various jurisdictions. Because changes in our forecasted profitability for 2012 can significantly affect our projected annual effective tax rate, our quarterly tax rate could fluctuate significantly depending on our profitability.

Liquidity and Capital Resources

Cash, Cash Equivalents and Investments

Cash and cash equivalents include highly liquid financial instruments that are readily convertible to cash and have maturities of 90 days or less from the date of purchase.

Investments classified as short-term consist of various financial instruments such as money market funds, bank deposits, municipal and corporate bonds, commercial paper, and variable demand notes. Bonds with high credit quality with maturities of greater than 90 days when purchased are classified as short-term available-for-sale investments. Investments classified as long-term consist of our investments in auction rate securities.

Following is a summary of our cash, cash equivalents and investments:

                                                September 29,     December 31,
                                                    2012              2011
                                                        (in thousands)
Cash and cash equivalents                      $       148,038   $       42,661
Short-term investments                                 148,740          150,753
Long-term investments                                   11,102           16,090
Total cash, cash equivalents and investments   $       307,880   $      209,504

We believe that cash and cash equivalents, short-term available-for-sale investments on hand and expected cash flows from operations will be sufficient to fund our operations, capital requirements, and share repurchase programs for at least the next 12 months.

Cash Flow Activities



                                                 September 29,      October 1,
                                                     2012              2011        % Change
                                                        (in thousands)
Net cash provided by operating activities       $       109,203    $     86,948          26 %
Net cash provided by (used in) investing
activities                                               (1,172 )       124,167        (101 )%
Net cash provided by (used in) financing
activities                                               (2,560 )      (204,659 )       (99 )%
Effect of exchange rate changes on cash and
cash equivalents                                            (94 )          (568 )       (83 )%
Net increase in cash and cash equivalents       $       105,377    $      5,888

Cash Provided by Operating Activities

Cash provided by operating activities in the nine months ended September 29, 2012 was $109.2 million and consisted of net income of $70.5 million, adjustments for non-cash items of $26.6 million, and cash provided by working capital of $12.1 million. Adjustments for non-cash items primarily consisted of $16.0 million of stock-based compensation expense, $14.6 million of depreciation and amortization expense, offset by $4.2 million related to deferred income taxes and $2.2 million for excess tax benefits from stock-based compensation. The increase in cash from changes in working capital activities primarily consisted of a decrease in inventory of $5.2 million resulting from lower . . .

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