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THOR > SEC Filings for THOR > Form 10-Q on 31-Oct-2013All Recent SEC Filings

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Form 10-Q for THORATEC CORP


31-Oct-2013

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 2012 Annual Report on Form 10-K (the "2012 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 mechanical circulatory support ("MCS") for the treatment of heart failure ("HF") patients. For chronic circulatory support for HF patients, our primary product lines are our ventricular assist devices ("VADs"): HeartMate II Left Ventricular Assist System ("HeartMate II"), Thoratec Paracorporeal Ventricular Assist Device ("PVAD"), and Thoratec Implantable Ventricular Assist Device ("IVAD"). We refer to HeartMate II as the "HeartMate product line" and PVAD and IVAD collectively as the "Thoratec product line." For acute circulatory support, our product lines are CentriMag Acute Circulatory System ("CentriMag") and for pediatric patients PediMag/PediVAS Acute Circulatory System ("PediMag/PediVAS"). HeartMate II, PVAD, IVAD, CentriMag and PediMag/PediVAS are approved by the U.S. Food and Drug Administration ("FDA"), and have received Conformité Européene ("CE") Mark approval 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. Some of our devices can also provide support for the right side of the heart.

On June 30, 2013, we acquired certain assets from Terumo Corporation ("Terumo") related to the DuraHeart II Left Ventricular Assist product line (DuraHeart II) previously under development by Terumo. Under the terms of the acquisition, we made an upfront cash payment of $13.0 million, and we will be obligated to make potential future milestone payments, based on regulatory approvals and product sales, of up to $43.5 million.

HeartMate II

HeartMate II is an implantable, electrically powered, continuous flow, left ventricular assist device ("LVAD") consisting of a rotary blood pump designed to provide intermediate and long-term MCS. 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, HeartMate II received CE Mark approval. The HeartMate II is the most widely used LVAD.


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CentriMag

CentriMag is an extracorporeal full-flow acute surgical support platform incorporating a polycarbonate pump, based on magnetically levitated bearingless motor technology. CentriMag is 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 ("HDE") 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. We have an ongoing study to evaluate the effectiveness of the CentriMag for periods of support for up to 30 days. CentriMag has CE Mark approval to provide support for up to 30 days for both cardiac and respiratory failure.

PediMag/PediVAS

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. PediMag is cleared by the FDA for use in conjunction with the CentriMag console and motor, for support periods of up to six hours. Outside the U.S., the device is branded as PediVAS. This device has CE Mark approval to provide support for up to 30 days for both cardiac and respiratory failure.

PVAD

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

A pneumatic power source drives PVAD. It is designed for short-to-intermediate duration for post-cardiotomy myocardial recovery following cardiac surgery and BTT. PVAD and IVAD, described below, offer left, right or biventricular support for use for BTT. This characteristic is significant because the vast majority of BTT patients treated with PVAD and IVAD require right as well as left-side ventricular assistance. PVAD and IVAD are also the only devices approved for both BTT and recovery following cardiac surgery. PVAD incorporates our proprietary biomaterial, Thoralon, which has excellent tissue and blood compatibility and is resistant to blood clots.

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

IVAD

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

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.

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 29, 2012, 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 28, 2013.


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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 28,       September 29,       September 28,       September 29,
                        2013                2012                2013                2012
                                   (in thousands, except for percentage data)

Product sales     $ 126,444   100.0 % $ 117,768   100.0 % $ 374,648   100.0 % $ 363,196   100.0 %
Cost of product
sales                40,958    32.4      36,162    30.7     117,031    31.2     111,071    30.6
Gross profit         85,486    67.6      81,606    69.3     257,617    68.8     252,125    69.4
Operating
expenses:
Selling,
general and
administrative       37,679    29.8      28,478    24.2     107,348    28.7      91,692    25.2
Research and
development          25,469    20.1      20,382    17.3      71,488    19.1      59,886    16.5
Total operating
expenses             63,148    49.9      48,860    41.5     178,836    47.8     151,578    41.7
Income from
operations           22,338    17.7      32,746    27.8      78,781    21.0     100,547    27.7
Other income
and (expense):
Interest
expense and
other                     -       -           -       -          (4 )     -          (3 )     -
Interest income
and other               569     0.5         579     0.5       1,899     0.5       1,401     0.4
Income before
income taxes         22,907    18.2      33,325    28.3      80,676    21.5     101,945    28.1
Income tax
expense               4,003     3.2       9,070     7.7      20,413     5.4      31,396     8.6
Net income        $  18,904    15.0   $  24,255    20.6   $  60,263    16.1   $  70,549    19.5

Three and nine months ended September 28, 2013 and September 29, 2012

Product Sales



Product sales consisted of the following:



                                         Three Months Ended                               Nine Months Ended
                             September 28,     September 29,                 September 28,     September 29,
                                 2013              2012         % Change         2013              2012         % Change
                                     (in thousands)                                  (in thousands)
Total product sales         $       126,444   $       117,768         7.4 % $       374,648   $       363,196         3.2 %

In the third quarter of 2013 as compared to the third quarter of 2012, product sales increased by $8.7 million or 7.4%, driven by strong sales volume of our HeartMate II and CentriMag products. HeartMate II contributed approximately $7.0 million to the increase, due primarily to the introduction of our HeartMate II Pocket Controller in 2013 and the continued expansion of our international business. The CentriMag and PediMag product line contributed approximately $2.9 million to the increase. The increase was partially offset by a decline of approximately $1.2 million in sales of the Thoratec product line. From a regional perspective, the U.S. sales contributed approximately $2.1 million to the increase, while international sales contributed approximately $6.6 million.

In the first nine months of 2013 as compared to the first nine months of 2012, product sales increased by $11.5 million or 3.2%, driven by strong sales volume of our CentriMag products. HeartMate II contributed approximately $7.6 million to the increase, while the CentriMag and PediMag product line contributed approximately $8.1 million to the increase. The increase was partially offset by a decline of approximately $4.3 million in sales of the Thoratec product line. From a regional perspective, U.S. sales declined by approximately $7.8 million, while international sales increased by approximately $19.3 million. HeartMate II growth in the United States through the nine months ended September 28, 2013 remained pressured by the recent launch of a competitive device, a dynamic which we anticipate will continue to affect our results.

In the U.S., we added two HeartMate II centers during the third quarter of 2013, bringing the U.S. total to 169. Outside of the U.S., we added eight centers during the third quarter of 2013, bringing the international total to 183 centers.

Sales originating outside of the U.S. and U.S. export sales collectively accounted for approximately 21% and 17% of our total product sales for each of the third quarter of 2013 and the third quarter of 2012, respectively, and approximately 22% and 18% of our total product sales for each of the nine months ended September 28, 2013 and September 29, 2012, respectively.


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Gross Profit



Gross profit and gross margin were as follows:



                            Three Months Ended                   Nine Months Ended
                      September 28,     September 29,     September 28,     September 29,
                          2013              2012              2013              2012
                                      (in thousands, except percentages)
Total gross profit   $        85,486   $        81,606   $       257,617   $       252,125
Total gross margin              67.6 %            69.3 %            68.8 %            69.4 %

In the third quarter of 2013 as compared to the third quarter of 2012, gross margin decreased by 1.7 percentage points, while during the first nine months of 2013 as compared to the first nine months of 2012, gross margin decreased by 0.6 percentage point. This decrease was primarily due to warranty and product mix in connection with the introduction of the Pocket Controller in 2013 and the impact of the U.S. medical device excise tax, which we recorded for the first time in 2013.

Selling, General and Administrative Expenses



Selling, general and administrative expenses were as follows:



                                   Three Months Ended                               Nine Months Ended
                             September 28,     September 29,                 September 28,     September 29,
                                 2013              2012         % Change         2013              2012         % Change
                                     (in thousands)                                  (in thousands)

Total selling, general
and administrative
expenses                    $        37,679   $        28,478        32.3 % $       107,348   $        91,692        17.1 %

In the third quarter of 2013 as compared to the third quarter of 2012, selling, general and administrative expenses increased by $9.2 million, while in the first nine months of 2013 as compared to the first nine months of 2012, selling, general and administrative expenses increased by $15.7 million. The increases were primarily due to additional personnel supporting our market development initiatives, the remeasurement of our estimated contingent consideration associated with our acquisitions, and transaction costs in connection with the DuraHeart II acquisition.

Research and Development Expenses



Research and development expenses were as follows:



                                  Three Months Ended                                 Nine Months Ended
                           September 28,      September 29,                   September 28,      September 29,
                               2013               2012          % Change          2013               2012          % Change
                                    (in thousands)                                     (in thousands)
Total research and
development               $        25,469    $        20,382         25.0 %  $        71,488    $        59,886         19.4 %

Research and development (R&D) expenses are largely project driven, and fluctuate based on the level of project activity planned and subsequently approved and conducted.

In the third quarter of 2013 as compared to the third quarter of 2012, R&D expenses increased by $5.1 million, while in the first nine months of 2013 as compared to the first nine months of 2012, R&D expenses increased by $11.6 million. The increases were due to incremental personnel supporting our next generation product development programs, primarily related to HeartMate III, PHP, the fully implantable system, personnel added from our acquisition of DuraHeart II, and the impairment of certain fixed assets in the third quarter of 2013.


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Interest Income and Other



Interest income and other consisted of the following:



                                  Three Months Ended                                 Nine Months Ended
                           September 28,      September 29,                   September 28,      September 29,
                               2013               2012          % Change          2013               2012          % Change
                                    (in thousands)                                     (in thousands)
Interest income           $           223    $           286       (22.0 )%  $           691    $           908       (23.9 )%
Foreign currency, net                 168                156         7.7 %               464                178       160.7 %
Other                                 178                137        29.9 %               744                315       136.2 %
Total interest income
and other                 $           569    $           579                 $         1,899    $         1,401

The changes in interest income and foreign currency (net) were not significant. The change in other items was due to the mark-to-market value of our deferred compensation plan assets during the current period.

Income Taxes

On January 2, 2013, the U.S. President signed into law The American Taxpayer Relief Act of 2012. This Act extends the research tax credit for two years to December 31, 2013. The extension of the research tax credit is retroactive and includes amounts paid or incurred after December 29, 2011. As a result of the enactment after the Company's 2012 year end, we recognized, in the first quarter of 2013, a benefit of approximately $1.3 million for qualifying amounts incurred in 2012.

Our effective income tax rates for the third quarters of 2013 and 2012 were 17.5% and 27.2%, respectively. Our effective income tax rates for the first nine months of 2013 and 2012 were 25.3% and 30.8%, respectively. The decrease is primarily attributable to the recognition of Federal tax benefits due to the expiration of statutes of limitations in the third quarter of 2013 and the 2012 federal research tax credits, which we recognized in the first quarter of 2013 (in the period of enactment), as well as the 2013 federal research tax credits.

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 earnings for 2013 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 municipal bonds, corporate bonds, variable demand notes, commercial paper and certificate of deposit. 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 28,     December 29,
                                                    2013              2012
                                                        (in thousands)
Cash and cash equivalents                      $       102,843   $      101,322
Short-term investments                                 176,005          148,426
Long-term investments                                    4,160           10,607
Total cash, cash equivalents and investments   $       283,008   $      260,355

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.


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Cash Flow Activities



                                                    September 28, 2013      September 29, 2012
                                                                  (in thousands)
Net cash provided by operating activities          $             86,451    $            109,203
Net cash used in investing activities                           (44,248 )                (1,172 )
Net cash used in financing activities                           (40,388 )                (2,560 )
Effect of exchange rate changes on cash and
cash equivalents                                                   (294 )                   (94 )
Net increase in cash and cash equivalents          $              1,521    $            105,377

Cash Provided by Operating Activities

Cash provided by operating activities in the first nine months of 2013 was $86.5 million and consisted of net income of $60.3 million, adjustments for non-cash items of $41.5 million, and cash used in working capital of $15.3 million. Adjustments for non-cash items primarily consisted of $20.2 million of stock-based compensation expense, $13.8 million of depreciation and amortization expense, and the remeasurement of the contingent consideration of $3.9 million, offset in part by $1.8 million for excess tax benefits from stock-based compensation. The decrease in cash from the changes in working capital activities primarily consisted of an increase in inventory of $20.6 million (due in part to the launch of our Pocket Controller this year), offset in part by a decrease in accounts receivable of $4.0 million from higher collections in the nine months of 2013. Decreases to accounts payable and other liabilities totaling $1.5 million also contributed to cash provided by operating activities.

Cash provided by operating activities in the first nine months of 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 inventory levels, offset by an increase in accounts receivable of $2.0 million from higher sales in the nine months of 2012. Increases to accounts payable and other liabilities totaling $11.7 million also contributed to cash provided by operating activities.

Cash Used in Investing Activities

Cash used in investing activities in the first nine months of 2013 of $44.2 million was primarily attributable to purchases of available for sale investments of $132.4 million, $13.0 million cash paid to acquire DuraHeart II, as well as capital expenditures of $6.9 million to support our manufacturing facilities and administration growth, which was offset by the maturities and sales of available for sale investments of $108.0 million.

Cash used in investing activities in the first nine months of 2012 of $1.2 million was primarily attributable to purchases of available for sale investments of $128.1 million and capital expenditures of $7.3 million to support our manufacturing facilities and administration growth. This was partially offset by maturities and sales of available for sale investments of $134.2 million.

Cash Used in Financing Activities

Cash used in financing activities in the first nine months of 2013 of $40.4 million was primarily comprised of $40.0 million used for repurchases of 820,120 shares of our common stock under the stock repurchase programs authorized, $7.1 million used to repurchase vested restricted stock units and awards for settlement of income tax withholding liabilities and $4.2 million paid in contingent consideration. This amount was offset in part by $6.6 million of proceeds related to stock option exercises, $2.5 million of proceeds from stock issued under the employee stock purchase plan, and $1.8 million from excess tax benefits for share-based compensation.

Cash used in financing activities in the first nine months of 2012 of $2.6 million was primarily comprised of $10.4 million used for repurchases of shares of our common stock under our stock repurchase programs and the payment of contingent consideration of $1.5 million. This was partially offset by proceeds of $5.2 million related to stock option exercises, $1.9 million of proceeds from stock issued under the employee stock purchase plan, and $2.2 million from excess tax benefits for share-based compensation.

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