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THOR > SEC Filings for THOR > Form 10-Q on 7-Aug-2014All Recent SEC Filings

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Form 10-Q for THORATEC CORP


7-Aug-2014

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," "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 Annual Report on Form 10-K (the "2013 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

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 "PVAD and IVAD 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 and assumed certain liabilities 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 up-front 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. No milestone payments have been made to Terumo since the date of the acquisition.

On July 2, 2014, our wholly owned subsidiary, Thoratec Switzerland GmbH, acquired all of the outstanding equity interests of Apica Cardiovascular Limited ("Apica") and certain related subsidiaries from the former stockholders of Apica. In the second quarter of 2014 (prior to the acquisition of Apica on July 2, 2014), we provided Apica with a loan in the amount of $2.0 million. The upfront purchase price for the Acquisition was $35.0 million (prior to certain adjustments, including the repayment of the loan to Thoratec). In addition, milestone payments up to an aggregate maximum amount of $40.0 million will be payable in the future, contingent upon the achievement of certain clinical and regulatory events in both Europe and the U.S. and a certain minimum number of sales of related products.

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 our predecessor long-term LVAD and with only one moving part, HeartMate II is simpler and designed to operate more quietly than pulsatile devices.


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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, we completed the required conformity assessment procedure and design dossier reviews to be given authority from our Notified Body to affix the CE Mark to the HeartMate II for marketing in Europe. We believe HeartMate II is the most widely used LVAD.

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 thirty 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 up to thirty days. We completed the required conformity assessment procedure to affix the CE Mark to the CentriMag for marketing in Europe, and the device is marketed in Europe to provide support for up to thirty 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 been CE Marked for marketing in Europe 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, we completed the required conformity assessment procedure and design dossier reviews to be given authority from our Notified Body to affix the CE Mark to the PVAD, 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, we completed the required conformity assessment procedure and design dossier reviews to be given authority from our Notified Body to affix the CE Mark to the IVAD, 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 2013 Annual Report, 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 six months ended June 28, 2014.


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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                       Six Months Ended
                     June 28, 2014       June 29, 2013       June 28, 2014       June 29, 2013
                                    (in thousands, except for percentage data)
Product sales      $ 118,063   100.0 % $ 130,479   100.0 % $ 243,760   100.0 % $ 248,204   100.0 %
Cost of product
sales                 34,307    29.1      41,000    31.4      74,333    30.5      76,073    30.6
Gross profit          83,756    70.9      89,479    68.6     169,427    69.5     172,131    69.4
Operating
expenses:
Selling, general
and
administrative        35,477    30.1      34,924    26.8      70,978    29.1      69,669    28.1
Research and
development           23,048    19.5      21,506    16.5      46,387    19.0      46,019    18.5
Total operating
expenses              58,525    49.6      56,430    43.3     117,365    48.1     115,688    46.6
Income from
operations            25,231    21.3      33,049    25.3      52,062    21.4      56,443    22.8
Other income and
(expense):
Interest expense
and other                 (2 )     -           -       -          (2 )     -          (4 )     -
Interest income
and other                559     0.5         213     0.2         806     0.3       1,330     0.5
Income before
income taxes          25,788    21.8      33,262    25.5      52,866    21.7      57,769    23.3
Income tax
expense               (8,375 )  (7.1 )   (10,073 )  (7.7 )   (17,214 )  (7.1 )   (16,410 )  (6.6 )
Net income         $  17,413    14.7   $  23,189    17.8   $  35,652    14.6   $  41,359    16.7

Three and six months ended June 28, 2014 and June 29, 2013

Product Sales



Product sales consisted of the following:



                             Three Months Ended                   Six Months Ended
                      June 28,    June 29,                June 28,    June 29,
                        2014        2013      % Change      2014        2013      % Change
                         (in thousands)                      (in thousands)
Total product sales   $ 118,063   $ 130,479       (9.5 )% $ 243,760   $ 248,204       (1.8 )%

In the second quarter of 2014 as compared to the second quarter of 2013, product sales decreased by $12.4 million or 9.5%, driven by decreased sales volume of our HeartMate II, which was partially offset by an increase in sales volume of our CentriMag products. HeartMate II contributed $13.7 million to the decrease due primarily to reduced market growth relative to prior periods in conjunction with market share loss to a competitive device, dynamics that may continue to affect our results. The decrease was partially offset by an increase in the CentriMag and PediMag product line of $1.6 million. Additionally, the decrease was driven by a decline of $0.3 million in sales of other products. From a regional perspective, the U.S. sales decreased by $4.6 million, while international sales decreased by $7.8 million due to declines in both Europe and Japan.

In the first six months of 2014 as compared to the first six months of 2013, product sales decreased by $4.4 million or 1.8%, driven by decrease in sales volume of our HeartMate II products due primarily to the same reasons discussed above. HeartMate II contributed $6.6 million to the decrease which was partially offset by an increase in the CentriMag and PediMag product line of $4.2 million. Additionally, the decrease was driven by a decline of $2.0 million in sales of the other products. From a regional perspective, U.S. sales decreased by $1.3 million and international sales decreased by $3.2 million.

Sales originating outside of the U.S. and U.S. export sales collectively accounted for approximately 20% and 24% of our total product sales for each of the second quarter of 2014 and the second quarter of 2013, respectively, and approximately 22% and 23% of our total product sales for each of the first six months of 2014 and the first six months of 2013, respectively.


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Gross Profit



Gross profit and gross margin were as follows:



                       Three Months Ended        Six Months Ended
                      June 28,     June 29,    June 28,    June 29,
                        2014         2013        2014        2013
                           (in thousands, except percentages)
Total gross profit   $    83,756   $  89,479   $ 169,427   $ 172,131
Total gross margin          70.9 %      68.6 %      69.5 %      69.4 %

In the second quarter of 2014 as compared to the second quarter of 2013, gross margin increased by approximately two percentage points, while during the first six months of 2014 as compared to the first six months of 2013, gross margin percentage did not significantly change. The increase in the second quarter of 2014 as compared to the second quarter of 2013 was primarily due to favorable manufacturing absorption variances and underlying efficiencies and lower intangible amortization expense related to PVAD and IVAD intangible assets, offset in part by unfavorable warranty expense and inventory reserves.

Selling, General and Administrative Expenses



Selling, general and administrative expenses were as follows:



                             Three Months Ended                       Six Months Ended
                           June 28,      June 29,                  June 28,      June 29,
                             2014          2013       % Change       2014          2013       % Change
                               (in thousands)                          (in thousands)
Total selling, general
and administrative
expenses                  $    35,477   $    34,924        1.6 %  $    70,978   $    69,669        1.9 %

In the second quarter of 2014 as compared to the second quarter of 2013, selling, general and administrative expenses increased by $0.5 million, while in the first six months of 2014 as compared to the first six months of 2013, selling, general and administrative expenses increased by $1.3 million. The increases were primarily due to market development initiatives, offset by lower incentive compensation in 2014 and the remeasurement of the estimated contingent consideration associated with our acquisitions.

Research and Development Expenses



Research and development expenses were as follows:



                             Three Months Ended                       Six Months Ended
                           June 28,      June 29,                  June 28,      June 29,
                             2014          2013       % Change       2014          2013       % Change
                               (in thousands)                          (in thousands)
Total research and
development expenses      $    23,048   $    21,506        7.2 %  $    46,387   $    46,019        0.8 %

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 second quarter of 2014 as compared to the second quarter of 2013, R&D expenses increased by $1.5 million, while in the first six months of 2014 as compared to the first six months of 2013, R&D expenses increased by $0.4 million. The increase in the second quarter of 2014 as compared to the second quarter of 2013 was primarily due to expenses associated with the DuraHeart II program, which we acquired in 2013, a continued investment in the PHP program, in part offset by the remeasurement of the estimated contingent consideration associated with the DuraHeart II acquisition.

Interest Income and Other



Interest income and other consisted of the following:



                        Three Months Ended                      Six Months Ended
                      June 28,     June 29,                  June 28,      June 29,
                        2014         2013      % Change        2014          2013      % Change
                          (in thousands)                         (in thousands)
Interest income       $     201    $     222       (9.5 )%  $      425    $      468       (9.2 )%
Foreign currency,
net                        (130 )        (40 )    225.0 %         (187 )         296     (163.2 )%
Other                       488           31    1,474.2 %          568           566        0.4 %
Total interest
income and other      $     559    $     213                $      806    $    1,330

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.


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Income Taxes

Our effective income tax rates for the three months ended June 28, 2014 and June 29, 2013 were 32.5% and 30.3%, respectively. Our effective income tax rates for the six months ended June 28, 2014 and June 29, 2013 were 32.6% and 28.4%, respectively. The increase is primarily due to the lack of federal R&D credits in the absence of enacted legislation in 2014. For the three months ended June 29, 2013, we recognized a tax benefit of approximately $0.4 million related to these credits. In the first six months of 2013, we recognized a benefit of approximately $2.0 million for these credits, of which $1.3 million relates to the 2012 credits recognized as a result of the timing of 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 earnings for 2014 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, certificates of deposit, and asset-backed securities. 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:

                                               June 28,     December 28,
                                                 2014           2013
                                                     (in thousands)
Cash and cash equivalents                      $ 134,729   $      139,099
Short-term investments                           156,472          166,691
Long-term investments                              4,270            4,234
Total cash, cash equivalents and investments   $ 295,471   $      310,024

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



                                                          June 28, 2014      June 29, 2013
                                                                   (in thousands)
Net cash provided by operating activities                $        40,834    $        36,097
Net cash (used in) provided by investing activities                    6            (22,599 )
Net cash used in financing activities                            (45,481 )           (4,256 )
Effect of exchange rate changes on cash and cash
equivalents                                                          271               (370 )
Net increase (decrease) in cash and cash equivalents              (4,370 )            8,872

Cash Provided by Operating Activities

Cash provided by operating activities in the first six months of 2014 was $40.8 million and consisted of net income of $35.7 million, adjustments for non-cash items of $23.1 million, and cash used in working capital of $17.9 million. Adjustments for non-cash items primarily consisted of $14.6 million of stock-based compensation expense and $8.2 million of depreciation and amortization expense, offset in part by $1.0 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 $8.1 million primarily from higher HeartMate product line inventory, offset in part by a decrease in accounts receivable of $3.7 million from higher collections in the first six months of 2014. Decreases to accounts payable and other liabilities totaling $14.0 million also contributed to cash provided by operating activities.


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Cash provided by operating activities in the first six months of 2013 was $36.1 million and consisted of net income of $41.4 million, adjustments for non-cash items of $24.1 million, and cash used in working capital of $29.4 million. Adjustments for non-cash items primarily consisted of $13.4 million of stock-based compensation expense and $9.2 million of depreciation and amortization expense, offset in part by $1.4 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 $19.1 million in part due to the launch of our Pocket Controller in 2013, offset in part by a decrease in accounts receivable of $2.1 million from higher collections in the first six months of 2013. Decreases to accounts payable and other liabilities totaling $13.3 million also contributed to cash used in operating activities.

Cash Provided by (Used in) Investing Activities

Cash provided by investing activities in the first six months of 2014 was primarily attributable to sales and maturities of available for sale investments of $94.2 million, which was offset by purchases of available for sale investments of $86.9 million, capital expenditures of $5.3 million to support our manufacturing facilities and administration growth, and a note receivable from Apica of $2.0 million.

Cash used in investing activities in the first six months of 2013 of $22.6 million was primarily attributable to purchases of available for sale investments of $71.5 million, restricted cash of $13.0 million held in escrow for the anticipated acquisition of the DuraHeart II, as well as capital expenditures of $5.7 million to support our manufacturing facilities and administration growth, which was offset by the maturities and sales of available for sale investments of $67.6 million.

Cash Used in Financing Activities

Cash used in financing activities in the first six months of 2014 of $45.5 million was primarily comprised of $39.1 million used for repurchases of 1.1 million shares of our common stock under the stock repurchase programs authorized, $6.9 million used to repurchase vested restricted stock units for settlement of income tax withholding liabilities and $6.1 million paid in contingent consideration. This amount was offset in part by $2.9 million of proceeds related to stock option exercises, $2.8 million of proceeds from stock issued under the employee stock purchase plan, and $1.0 million from excess tax benefits for share-based compensation.

Cash used in financing activities in the first six months of 2013 of $4.3 million was primarily comprised of $6.9 million to repurchase vested restricted stock units for settlement of income tax withholding liabilities and $4.2 million paid in contingent consideration. This amount was offset in part by $2.9 million of proceeds related to stock option exercises, $2.5 million of proceeds from stock issued under the employee stock purchase plan, and $1.4 million from excess tax benefits for share-based compensation.

Stock Repurchase Program

. . .

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