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U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (Mark one) þ
    
    Quarterly report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
 For the quarterly period ended October 2, 2004 or o
    
    Transition report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
 for the transition period from            to COMMISSION FILE NUMBER: 1-8145 THORATEC CORPORATION (Exact name of registrant as specified in its charter)
 California
(State or other jurisdiction of
incorporation or organization)
    
    94-2340464(I.R.S.
Employer Identification No.)
 6035 Stoneridge Drive, Pleasanton, California
(Address of principal executive offices)
    
    94588
(Zip Code)
 Registrants telephone number, including area code: (925) 847-8600 Indicate by check mark whether the registrant:(1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act):Yes [X] No [ ] As of November 8, 2004 registrant had 48,752,878 shares of common stock
outstanding.




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THORATEC CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS Part I. Financial InformationItem 1. Condensed Consolidated Financial Statements (unaudited)
    
    
    3Condensed
Consolidated Balance Sheets as of October 2, 2004 and
January 3, 2004
    
    
    3Condensed Consolidated Statements of Operations for the Three and Nine Months Ended
October 2, 2004 and September 27, 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the Nine Months Ended October 2, 2004
and September 27, 2003
    
    
    5Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months
Ended October 2, 2204 and September 27, 2004
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosure of Market Risk
    
    
    35Item 4. Controls and Procedures
    
    
    36Part II. Other Information
    
    
    37Item 1. Litigation
    
    
    37Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    37Item 6. Exhibits
    
    
    39Signatures
    
    
    40Exhibits
    
    
    41EXHIBIT 31.1EXHIBIT 32.1
 2




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THORATEC CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS(unaudited)  October 2,
    
    January 3,2004
    
    2004AssetsCurrent Assets:Cash and cash equivalents
    
    $
    76,920
    
    
    $
    62,020Short-term available-for-sale investments
    
    
    69,959
    
    
    
    Restricted short-term investments
    
    
    3,318
    
    
    
    Receivables, net of allowances of $527 and $486 respectively
    
    
    29,934
    
    
    
    27,969Inventories
    
    
    41,386
    
    
    
    36,417Deferred tax asset and other prepaid assets
    
    
    12,315
    
    
    
    12,796Total Current Assets
    
    
    233,832
    
    
    
    139,202Property, plant and equipment, net
    
    
    28,193
    
    
    
    28,492Goodwill
    
    
    94,219
    
    
    
    96,065Purchased intangible assets, net
    
    
    156,072
    
    
    
    164,865Long-term available-for-sale investments
    
    
    
    
    
    
    41,179Restricted long-term investments
    
    
    6,509
    
    
    
    Long-term deferred tax asset and other assets
    
    
    11,598
    
    
    
    6,328Total Assets
    
    $
    530,423
    
    
    $
    476,131Liabilities and Shareholders EquityCurrent Liabilities:Accounts payable and accrued expenses
    
    $
    21,689
    
    
    $
    22,772Total Current Liabilities
    
    
    21,689
    
    
    
    22,772Senior subordinated convertible notes
    
    
    143,750
    
    
    
    Long-term deferred tax liability and other liabilities
    
    
    63,734
    
    
    
    67,123Total Liabilities
    
    
    229,173
    
    
    
    89,895Shareholders Equity:Common shares; 100,000 authorized; issued and outstanding
49,663 and 56,242, respectively
    
    
    374,567
    
    
    
    423,045Deferred compensation
    
    
    (1,947
    )
    
    
    (2,630
    )Accumulated deficit
    
    
    (71,644
    )
    
    
    (34,594
    )Accumulated other comprehensive income:Unrealized gain (loss) on investments
    
    
    (137
    )
    
    
    51Cumulative translation adjustments
    
    
    411
    
    
    
    364Total accumulated other comprehensive income
    
    
    274
    
    
    
    415Total Shareholders Equity
    
    
    301,250
    
    
    
    386,236Total Liabilities and Shareholders Equity
    
    $
    530,423
    
    
    $
    476,131
 See notes to condensed consolidated financial statements. 3




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THORATEC CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(in thousands, except per share data) Three Months Ended
    
    Nine Months EndedOctober 2,
    
    September 27,
    
    October 2,
    
    September 27,2004
    
    2003
    
    2004
    
    2003Product sales
    
    $
    40,661
    
    
    $
    35,250
    
    
    $
    124,055
    
    
    $
    107,469Cost of product sales
    
    
    17,646
    
    
    
    14,256
    
    
    
    51,680
    
    
    
    43,799Gross profit
    
    
    23,015
    
    
    
    20,994
    
    
    
    72,375
    
    
    
    63,670Operating expenses:Selling, general and administrative
    
    
    13,168
    
    
    
    10,562
    
    
    
    39,954
    
    
    
    31,791Research and development
    
    
    6,970
    
    
    
    6,100
    
    
    
    21,689
    
    
    
    18,640Amortization of purchased intangible assets
    
    
    2,931
    
    
    
    3,096
    
    
    
    8,793
    
    
    
    9,288Litigation, restructuring and other costs
    
    
    310
    
    
    
    
    
    
    
    443
    
    
    
    (124
    )Total operating expenses
    
    
    23,379
    
    
    
    19,758
    
    
    
    70,879
    
    
    
    59,595Income (loss) from operations
    
    
    (364
    )
    
    
    1,236
    
    
    
    1,496
    
    
    
    4,075Other income and (expense):Interest expense
    
    
    (1,015
    )
    
    
    
    
    
    
    (1,433
    )
    
    
    Interest income and other
    
    
    693
    
    
    
    218
    
    
    
    1,633
    
    
    
    1,379Income (loss) before income tax expense
    
    
    (686
    )
    
    
    1,454
    
    
    
    1,696
    
    
    
    5,454Income tax benefit (expense)
    
    
    288
    
    
    
    (567
    )
    
    
    (594
    )
    
    
    (2,127
    )Net income (loss)
    
    $
    (398
    )
    
    $
    887
    
    
    $
    1,102
    
    
    $
    3,327Net income (loss) per share, basic and diluted
    
    $
    (0.01
    )
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    0.06Shares used to compute net income (loss) per share:Basic
    
    
    50,114
    
    
    
    55,704
    
    
    
    53,304
    
    
    
    55,386Diluted
    
    
    50,114
    
    
    
    57,705
    
    
    
    54,422
    
    
    
    56,761
 See notes to condensed consolidated financial statements. 4




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THORATEC CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands) Nine Months EndedOctober 2,
    
    September 27,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    1,102
    
    
    $
    3,327Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    14,245
    
    
    
    13,144Investment premium amortization
    
    
    667
    
    
    
    796Amortization of deferred compensation
    
    
    682
    
    
    
    903Tax benefit related to stock option exercises
    
    
    404
    
    
    
    1,948Loss on disposal of asset
    
    
    57
    
    
    
    25Change in net deferred tax liability
    
    
    (1,022
    )
    
    
    1,424Changes in assets and liabilities:Receivables
    
    
    (1,965
    )
    
    
    4,925Inventories
    
    
    (4,969
    )
    
    
    2,356Prepaid expenses and other assets
    
    
    91
    
    
    
    (1,720
    )Accounts payable and other liabilities
    
    
    (1,676
    )
    
    
    (2,988
    )Other
    
    
    (145
    )
    
    
    16Net cash provided by operating activities
    
    
    7,471
    
    
    
    24,156Cash flows from investing activities:Purchases of available-for-sale and other investments
    
    
    (66,712
    )
    
    
    (14,138
    )Maturities of available-for-sale investments
    
    
    26,640
    
    
    
    6,708Purchases of property, plant and equipment
    
    
    (4,968
    )
    
    
    (4,169
    )Net cash used in investing activities
    
    
    (45,040
    )
    
    
    (11,599
    )Cash flows from financing activities:Net proceeds from issuance of convertible notes
    
    
    139,453
    
    
    
    Proceeds from stock issued under employee stock purchase plan
    
    
    775
    
    
    
    578Proceeds from stock option exercises
    
    
    2,201
    
    
    
    7,266Repurchase of common stock
    
    
    (90,008
    )
    
    
    Net cash provided by financing activities
    
    
    52,421
    
    
    
    7,844Effect of exchange rate changes on cash
    
    
    48
    
    
    
    50Net increase in cash and cash equivalents
    
    
    14,900
    
    
    
    20,451Cash and cash equivalents at beginning of period
    
    
    62,020
    
    
    
    42,044Cash and cash equivalents at end of period
    
    $
    76,920
    
    
    $
    62,495Supplemental Cash Flow Disclosure:Cash paid for taxes
    
    $
    511
    
    
    $
    726Cash paid for interest
    
    $
    
    
    
    $
    
 See notes to condensed consolidated financial statements. 5




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THORATEC CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(unaudited)
(in thousands) Three Months Ended
    
    Nine Months EndedOctober 2,
    
    September 27,
    
    October 2,
    
    September 27,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    (398
    )
    
    $
    887
    
    
    $
    1,102
    
    
    $
    3,327Other net comprehensive income (loss):Unrealized gain (loss) on
investments (net of taxes of
$9 and $(28) for the three months
ended and $(113) and $(15) for the
nine months ended October 2, 2004
and September 27, 2003,
respectively)
    
    
    3
    
    
    
    (37
    )
    
    
    (188
    )
    
    
    (18
    )Foreign currency translation
adjustments
    
    
    (  13
    )
    
    
    29
    
    
    
    48
    
    
    
    85Comprehensive income (loss)
    
    $
    (408
    )
    
    $
    879
    
    
    $
    962
    
    
    $
    3,394
 See notes to condensed consolidated financial statements. 6




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THORATEC CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands, unless otherwise stated) 1. Basis of Presentation The interim condensed consolidated financial statements of Thoratec
Corporation, referred to herein as we, our, Thoratec, or the Company,
have been prepared and presented in accordance with accounting principles
generally accepted in the United States of America and the rules and
regulations of the Securities and Exchange Commission, referred to as the SEC,
without audit, and reflect all adjustments necessary (consisting only of normal
recurring adjustments) to present fairly our financial position, results of
operations and cash flows. Certain information and footnote disclosures
normally included in our annual financial statements, prepared in accordance
with accounting principles generally accepted in the United States of America,
have been condensed or omitted. The accompanying financial statements should be
read in conjunction with our fiscal 2003 consolidated financial statements
filed with the SEC in our Annual Report on Form 10-K. The operating results for
any interim period are not necessarily indicative of the results that may be
expected for any future period. The preparation of our condensed consolidated financial statements
necessarily requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the consolidated balance sheet dates and the reported
amounts of revenues and expenses for the periods presented. We have made certain reclassifications of 2003 amounts to conform to the
current presentation. 2. Stock Based Compensation We account for stock-based compensation to employees using the intrinsic
value method in accordance with Accounting Principals Board Opinion (APB) No.
25, Accounting for Stock Issued to Employees. Accordingly, no accounting
recognition is given to stock options granted at fair market value until they
are exercised. Upon exercise, net proceeds, including tax benefits realized,
are recorded in shareholders equity. Similarly, no accounting recognition is
given to our employee stock purchase plan until a purchase occurs. Upon
purchase, net proceeds are recorded in common stock. Under the fair value
recognition provisions of Statement of Financial Accounting Standard (SFAS)
No. 123, the fair value of each option granted as a stock option or as an
option to purchase shares under the employee stock purchase plan is estimated
using the Black-Scholes option-pricing model. If compensation cost for our
stock-based plans had been determined based on the fair value at the grant
dates for awards under those plans, consistent with the method of SFAS No. 123,
our reported net income would have been adversely affected, as shown in the
following table: Three Months Ended
    
    Nine Months EndedOctober 2,
    
    September 27,
    
    October 2,
    
    September 27,2004
    
    2003
    
    2004
    
    2003(in thousands, except per share data)Net income (loss):As reported
    
    $
    (398
    )
    
    $
    887
    
    
    $
    1,102
    
    
    $
    3,327Add: Stock-based compensation expense included in
reported net income, net of related tax effects
    
    
    132
    
    
    
    183
    
    
    
    443
    
    
    
    551Deduct: Total stock-based employee compensation
expense determined under fair value based
method for
all awards, net of related tax effects
    
    
    (3,010
    )
    
    
    (2,163
    )
    
    
    (9,006
    )
    
    
    (6,040
    )Pro forma
    
    $
    (3,276
    )
    
    $
    (1,093
    )
    
    $
    (7,461
    )
    
    $
    (2,162
    )Basic earnings (loss) per share:As reported
    
    $
    (0.01
    )
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    0.06Pro forma loss
    
    $
    (0.07
    )
    
    $
    (0.02
    )
    
    $
    (0.14
    )
    
    $
    (0.04
    )Diluted earnings (loss) per share:As reported
    
    $
    (0.01
    )
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    0.06Pro forma loss
    
    $
    (0.07
    )
    
    $
    (0.02
    )
    
    $
    (0.14
    )
    
    $
    (0.04
    )
 7




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3. New Accounting Pronouncements In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure which amends FASB Statement
No. 123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements of the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. We adopted the disclosure provisions of SFAS No. 148
at the beginning of fiscal 2002. On March 31, 2004, the FASB issued an exposure
draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95.
This proposed statement would require that stock-based compensation be
recognized as a cost in the financial statements and that such cost be measured
based on the fair value of the stock-based compensation. If issued in final
form as proposed by the FASB, our adoption of this proposed statement would
have a material, although non-cash, impact on our condensed consolidated
statements of operations. In March 2004, the Emerging Issues Task Force (EITF) reached a final
consensus on Issue 03-1, The Meaning of Other-Than-Temporary Impairment and
its Application to Certain Investments, to provide additional guidance in
determining whether investment securities have an impairment which should be
considered other-than-temporary. On September 15, 2004 the FASB issued proposed
FSP EITF Issue 03-1-a to address the application of the EITF Issue 03-1 to debt
securities that are affected by interest rate and/or sector-spread changes
only. On September 30, 2004, the FASB issued FSP EITF Issue 03-1-1, which
delayed the effective date of certain paragraphs of the EITF until EITF 03-1-a
is issued. Management is still evaluating the potential effect that the
adoption of EITF 03-1 and the related FASB Staff Positions (FSP)will have on
the Companys operating results or financial condition. In April 2004, the FASB issued FSP FASB Statement of Accounting Standards
(FAS) No. 129-1, Disclosure of Information about Capital Structure, Relating
to Contingently Convertible Securities to provide disclosure guidance for
contingently convertible securities. We adopted the disclosure provisions in
the second quarter of 2004 as they apply to the convertible notes. The 7.3
million shares underlying our convertible notes are reportable under this new
disclosure are antidilutive and, therefore, have been excluded from the
calculation of diluted net income per share. In October 2004, EITF Issue No. 04-8, Accounting Issues Related to
Certain Features of Contingently Convertible Debt and the Effect on Diluted
Earnings per Share was issued. Issue No. 04-8 states that shares available
under contingently convertible debt should be included in diluted earnings per
share, or EPS, in all periods, since the notes were issued, except when
inclusion is anti-dilutive, regardless of whether the contingency is met and
regardless of whether the market price contingency is substantial. Our adoption
of this proposed interpretation, which we expect to occur in the fourth quarter
of 2004,would not have a material impact on our most recent consolidated
results as the effect of the 7.3 million shares would be anti-dilutive. If in
future periods the shares would be dilutive, then 7.3 million shares will be
added to our share count used to calculate diluted earnings per share, and this
inclusion could result in lower diluted EPS than if the existing guidance had
not been changed by EITF 04-8. 4. Cash and Investments We consider highly liquid investments with maturities of three months or
less at the date of purchase to be cash equivalents. Short-term investments
consist of available-for-sale debt securities that are carried at fair value
and generally mature between three months and two years from the purchase date.
Investments with maturities beyond one year may be classified as short-term
based on their highly liquid nature. We include any unrealized gains and losses
on short-term investments, net of tax, in shareholders equity as a component
of other comprehensive income. As required by the terms of the convertible notes during the second
quarter of 2004 (See Note 9) we purchased an aggregate of $9.8 million in U.S.
government securities that were pledged to the trustee under the indenture.
These funds are for the exclusive benefit of the holders of the convertible
notes to provide for the payment, in full, of the first six semi-annual
interest payments. The investments that relate to interest payments due in the
first year have been classified as restricted short-term investments and the
investments that relate to interest payments due after the first year have been
classified as restricted long-term investments. 8




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5. Financial Instruments We have a foreign currency exchange risk management program principally
designed to mitigate the change in value of assets and liabilities that are
denominated in non-functional currencies. Forward exchange contracts that
generally have terms of three months or less are used to hedge these
non-functional currency exposures on our books. The derivatives used in the
foreign currency exchange risk management program are not designated as cash
flow or fair value hedges under SFAS 133. These contracts are recorded on the
condensed consolidated balance sheets at fair value in Deferred Tax Asset and
Other Prepaid Assets current assets. Changes in the fair value of the
contracts and the underlying exposures being hedged are included concurrently
in Interest income and other . At October 2, 2004, the notional value of
outstanding contracts approximated $7.0 million with negligible fair value. 6. Inventories Inventories consist of the following: As ofOctober 2,
    
    January 3,2004
    
    2004(in thousands)Finished goods
    
    $
    21,133
    
    
    $
    15,504Work in process
    
    
    5,354
    
    
    
    9,089Raw materials
    
    
    14,899
    
    
    
    11,824Total
    
    $
    41,386
    
    
    $
    36,417
 7. Property, Plant and Equipment Property, plant and equipment consist of the following: As ofOctober 2,
    
    January 3,2004
    
    2004(in thousands)Property, plant and equipment, at cost
    
    $
    61,131
    
    
    $
    58,023Less accumulated depreciation
    
    
    (32,938
    )
    
    
    (29,531
    )Total
    
    $
    28,193
    
    
    $
    28,492
 8. Goodwill and Purchased Intangible Assets The change in the carrying amount of goodwill, which is attributable to
our Cardiovascular business segment, for the nine month periods ended October
2, 2004 and September 27, 2003 was as follows: Nine Months EndedOctober 2,
    
    September 27,2004
    
    2003(in thousands)Beginning balance
    
    $
    96,065
    
    
    $
    96,492Realization of acquired deferred tax asset
    
    
    (1,031
    )
    
    
    Reversal of accrual for securities registration costs
    
    
    (815
    )
    
    
    Ending balance
    
    $
    94,219
    
    
    $
    96,492
 In the first nine months of 2004, goodwill related to the 2001 merger of
Thoratec and Thermo Cardiosystems, Inc. (TCA) was adjusted to reflect the
utilization of tax net operating loss benefits. At the time of the merger, a
deferred tax asset related to these tax benefits was established with a
corresponding valuation allowance for the full amount. A portion of the
original valuation allowance has been reversed against goodwill as we
recognized benefits related to these tax assets. 9




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Goodwill was also adjusted in the first quarter of 2004 to reflect the
reversal of an accrual, established at the time of the merger with TCA, for
securities registration costs. Under the terms of the merger agreement, the
Company committed to pay for securities registration related costs should
Thermo Electron Corporation (TCI) (the majority shareholder in TCA prior to
the merger) decide to sell its shares of the Companys common stock in a public
offering. This commitment was enforceable until TCIs holdings in Thoratec fell
below 10%, which occurred in the first quarter of 2004. The components of identifiable intangible assets are as follows: As of October 2, 2004Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Net Carrying Amount(in thousands)Patents and Trademarks
    
    $
    37,815
    
    
    $
    (13,141
    )
    
    $
    24,674Core Technology
    
    
    37,485
    
    
    
    (6,769
    )
    
    
    30,716Developed Technology
    
    
    122,782
    
    
    
    (22,177
    )
    
    
    100,605Non-compete Agreement
    
    
    90
    
    
    
    (13
    )
    
    
    77Total Purchased Intangible Assets
    
    $
    198,172
    
    
    $
    (42,100
    )
    
    $
    156,072
 As of January 3, 2004Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Net Carrying Amount(in thousands)Patents and Trademarks
    
    $
    37,815
    
    
    $
    (10,416
    )
    
    $
    27,399Core Technology
    
    
    37,485
    
    
    
    (5,353
    )
    
    
    32,132Developed Technology
    
    
    122,782
    
    
    
    (17,535
    )
    
    
    105,247Non-compete Agreement
    
    
    90
    
    
    
    (3
    )
    
    
    87Total Purchased Intangible Assets
    
    $
    198,172
    
    
    $
    (33,307
    )
    
    $
    164,865
 After fiscal 2003 year-end, the Company completed its assessment of the
final results from its feasibility clinical trial for the Aria CABG graft which
was ongoing through fiscal 2003. Based on the clinical trial results, the
Company determined that it would not devote additional resources to the
development of the Aria graft. Upon the decision to discontinue product
development, the Company recorded an impairment charge of $9.0 million in the
fourth quarter of 2003 to write off purchased intangible assets related to the
Aria graft which had been recorded as a result of the merger with TCA in 2001. On September 30, 2003, we completed an asset purchase of the Immediate
Response Mobile Analysis, or IRMA, point-of-care blood analysis system product
line from Diametrics Medical, Inc. (Diametrics). We paid approximately $5.2
million in cash and assumed trade payables. Approximately $1.8 million of the
total purchase price was allocated to purchased intangible assets. Amortization expense related to identifiable intangible assets was $2.9
million for the three months ended October 2, 2004 and $8.8 million for the
nine months ended October 2, 2004. Amortization expense related to identifiable
intangible assets was $3.1 million for the three months ended September 27,
2003 and $9.3 million for the nine months ended September 27, 2003.
Amortization expense is expected to be approximately $11.7 million for each of
the next five years. The purchased intangible assets have estimated useful
lives of seven to twenty years. 10




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9. Long-Term Debt In the second quarter of 2004, we completed the sale of $143.8 million
initial principal amount of senior subordinated convertible notes due 2034. The
convertible notes were sold to Qualified Institutional Buyers pursuant to the
exemption from the registration requirements of the Securities Act of 1933, as
amended, provided by Rule 144A thereunder. We used $9.8 million of the net
proceeds to purchase and pledge to the trustee under the indenture for the
exclusive benefit of the holders of the convertible notes, U.S. government
securities to provide for the payment, in full, of the first six scheduled
interest payments. Additional net proceeds were used to repurchase 4.2 million
shares of our outstanding common stock for $60 million. The remaining net
proceeds will be used for general corporate purposes, which may include
additional stock repurchases, strategic investments or acquisitions. Total net
proceeds to the Company from the sale were $139.4 million, after debt issuance
costs of $4.3 million. The convertible notes were issued at an issue price of $580.98 per note,
which is 58.098% of the principal amount at maturity of the notes. The
convertible notes bear interest at a rate of 1.3798% per year on the principal
amount at maturity, payable semi-annually in arrears in cash on May 16 and
November 16 of each year, from November 16, 2004 until May 16, 2011. Beginning
on May 16, 2011, the original issue discount will accrue daily at a rate of
2.375% per year on a semi-annual bond equivalent basis and, on the maturity
date, a holder will receive $1,000 per note. As a result, the aggregate
principal amount of the notes at maturity will be $247.4 million. The deferred debt issuance costs of $4.3 million are included in other
assets on the condensed consolidated balance sheet. The deferred debt issuance
costs are amortized on a straight line basis until May 2011 at which point the
Company can redeem the debt. These charges are included in Interest expense
on the consolidated statement of operations. October 2,2004Long Term Debt Offering Proceeds:
    
    (in thousands)Principal amount of convertible notes at maturity
    
    $
    247.4Original issue discount
    
    
    (103.7
    )Debt issuance costs
    
    
    (4.3
    )Net proceeds
    
    $
    139.4
 Holders of the convertible notes may convert their convertible notes into
shares of our common stock at a conversion rate of 29.4652 shares per $1,000
principal amount of convertible notes, which represents a conversion price of
$19.72 per share, subject to adjustments upon the occurrence of certain events.
Holders were able to convert their convertible notes at any point after the
close of business on September 30, 2004 if, as of the last day preceding the
calendar quarter, the closing price of our common stock for at least 20 trading
days in a period of 30 consecutive trading days ending on the last trading day
of such preceding calendar quarter is more then 120% of the accreted conversion
price per share of our common stock. Holders may surrender their convertible
notes on or prior to May 16, 2029 during the five business day period after any
five consecutive trading day period in which the trading price per note for
each day of that period was less than 98% of the product of the closing sale
price of our common stock and the conversion rate on each such day; provided
that if on the day prior to any conversion the closing sale price of our common
stock is greater than the accreted conversion price but less than or equal to
120% of the accreted conversion price, then holders will receive upon
conversion, in lieu of shares of common stock based on the conversion rate,
cash or common stock, or a combination of cash and common stock, at our option,
with a value equal to the accreted principal amount of the notes plus accrued
but unpaid interest as of the conversion date. Additionally, holders may
convert their convertible notes if we call them for redemption or if specified
corporate transactions or significant distributions to holders of our stock
have occurred. Holders may require us to repurchase all or a portion of their convertible
notes on each of May 16, 2011, 2014, 2019, 2024 and 2029 at a repurchase price
equal to 100% of the issue price, plus accrued original issue discount, if any.
In addition, if we experience a change in control or a termination of trading
each holder may require us to purchase all or a portion of such holders notes
at the same price, plus, in certain circumstances, a make whole premium. The
fair value of the make whole premium at October 2, 2004 was zero. We may redeem
any of the convertible notes at any time beginning May 16, 2011, by giving the
holders at least 30 days notice, either in whole or in part at a redemption
price equal to the sum of the issue price and the accrued original issue
discount, plus accrued and unpaid interest and liquidation damages, if any. 11




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The convertible notes are subordinated to all of our senior indebtedness
and structurally subordinated to all indebtedness of our subsidiaries.
Therefore, in the event of a bankruptcy, liquidation or dissolution of us or
one or more of our subsidiaries and acceleration of or payment default on our
senior indebtedness, holders of the convertible notes will not receive any
payment until holders of any senior indebtedness we may have outstanding have
been paid in full. 10. Common Stock In February 2004 and again in July 2004, the Board of Directors authorized
stock repurchase programs under which up to $50 million of our common stock
could be acquired in the open market or in privately negotiated transactions.
The number of shares to be purchased and the timing of purchases were based on
several conditions, including the price of our stock, general market conditions
and other factors. In May 2004, in conjunction with our convertible notes
offering, the Board of Directors authorized the repurchase of an additional $60
million of our common stock. As of October 2, 2004, we had repurchased and
retired 6.9 million shares with an aggregate purchase price of $90 million
under these combined programs. 11. Litigation, Restructuring and Other Costs Litigation, restructuring and other costs are comprised of: Three Months Ended
    
    Nine Months EndedOctober 2,
    
    September 27,
    
    October 2,
    
    September 27,2004
    
    2003
    
    2004
    
    2003(in thousands)Litigation
    
    $
    310
    
    
    $
    
    
    
    $
    443
    
    
    $
    Restructuring/Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (124
    )Total
    
    $
    310
    
    
    $
    
    
    
    $
    443
    
    
    $
    (124
    )
 Litigation In April 2003, a patent infringement claim was filed against the Company
by Bodycote Materials Testing Canada, Inc. and David C. MacGregor, M.D. This
claim related to materials used in our HeartMate LVAS. On February 3, 2004, the
Company settled the claim and recorded a charge of $2.3 million in the fourth
quarter of 2003 for the settlement and related legal costs. The expense
recorded in the first quarter of 2004 is primarily comprised of additional
legal expenses related to the settlement. In June of 2004, MicroMed Technology, Inc., a potential competitor of the
Company, sued the Company in Texas. MicroMed sought a temporary restraining
order against the Company in connection with the Companys HeartMate II phase I
clinical trial on the grounds that the Company had provided the HeartMate II
VAD to clinical sites without charge and that doing so was a violation of Texas
anti-trust law. In addition to injunctive relief, the plaintiff is seeking
unspecified damages and fees, including those arising from potential sales of
its VAD products which plaintiff alleges it lost due to the Companys HeartMate
II clinical trial. The Company has successfully defended itself against MicroMeds requests
for injunctive relief and will continue to vigorously defend any and all of the
claims made by MicroMed in this action. On August 3, 2004, a putative Federal securities law class action entitled
Johnson v. Thoratec Corporation, et al. was filed in the United States District
Court for the Northern District of California on behalf of purchasers of the
publicly traded securities of the Company between April 28, 2004 and June 29,
2004. The Johnson complaint generally alleges violations of the Securities
Exchange Act of 1934 by the Company, its chief executive officer and chief
financial officer based upon, inter alia, alleged false statements about the
Companys expected sales and the market for HeartMate as a Destination Therapy
treatment. The complaint seeks to recover unspecified damages on behalf of all
purchasers of the Companys publicly traded securities during the class period.
Subsequent to the filing of the Johnson complaint, additional complaints were
filed in the same court alleging substantially similar claims. On October 4,
2004, a putative class member, Craig Toby, filed a motion to be appointed lead
plaintiff pursuant to the Private Securities Litigation Reform Act of 1995 and
to consolidate all of the pending class action litigations against Thoratec
into a single proceeding. The Court has not yet ruled on those motions. 12




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On or about September 1, 2004, a shareholder derivative action entitled
Wong v. Grossman was filed in the California Superior Court for Alameda County
based upon essentially the same facts as the Federal securities class action
suits. This action names the individual members of the Companys Board of
Directors, including the Chief Executive Officer and our Chief Financial
Officer as defendants and alleges that the defendants breached their fiduciary
duties and wasted corporate assets, and that certain of the defendants traded
in the Companys securities while in possession of material nonpublic
information. The Company believes that the claims asserted in both the Federal
securities law putative class action and the state shareholder derivative
action are without merit and the Company intends to move to dismiss both suits.
However, we are unable to predict at this time the final outcome of these
actions, or whether the resolution of the actions could materially affect our
results of operations, cash flows or financial position. Restructuring Costs We completed consolidation of our VAD manufacturing operations in the
second quarter of 2003. Total costs related to this consolidation were $1.5
million. Following is a summary of restructuring cost activity relating to the
consolidation: Nine Months EndedSeptember 27,2003Accrued Restructuring Costs:
    
    (in thousands)Beginning balance
    
    $
    679Reduction of severance accrual
    
    
    (122
    )Payments of employee severance
    
    
    (557
    )Ending balance
    
    $
    
 12. Income Taxes Our effective tax rates were 42% and 39% for the three months ended
October 2, 2004 and September 27, 2003, respectively. The effective rate was
35% for the nine months ended October 2, 2004 and 39% for the nine months ended
September 27, 2003. The reduction in our effective tax rate is due primarily
to: (1) a reduction of our projected annual profit before tax; (2) additional
interest income from tax favorable investments; and (3) a lower effective state
tax rate due to increased statutory tax credits. The effective income tax rate
for both quarters differed from the statutory federal income tax rate primarily
due to the impact of state taxes. At October 2, 2004 and January 3, 2004, we reported a net deferred tax
liability of approximately $ 48.6 million and $51.3 million, respectively,
comprised principally of temporary differences between the financial statement
and income tax bases of intangible assets. 13. Net Income (Loss) Per Share Basic and diluted net income (loss) per share were calculated as follows: Three Months Ended
    
    Nine Months EndedOctober 2,
    
    September 27,
    
    October 2,
    
    September 27,2004
    
    2003
    
    2004
    
    2003(in thousands, except per share data)Net income (loss)
    
    $
    (398
    )
    
    $
    887
    
    
    $
    1,102
    
    
    $
    3,327Weighted average
number of common
shares-basic
    
    
    50,114
    
    
    
    55,704
    
    
    
    53,304
    
    
    
    55,386Dilutive effect of
stock options
    
    
    
    
    
    
    2,001
    
    
    
    1,118
    
    
    
    1,375Weighted average
number of common
shares-diluted
    
    
    50,114
    
    
    
    57,705
    
    
    
    54,422
    
    
    
    56,761Net income (loss)
per common
share-basic and
diluted
    
    $
    (0.01
    )
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    0.06
 13




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Basic net income (loss) per share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted net income (loss) per share reflects the potential dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. Of the options to purchase shares of
our common stock outstanding as of October 2, 2004, options covering 10.5
million shares and 4.7 million shares of our common stock were excluded from
the computation of the diluted net income (loss) per share for the three month
and nine month periods ending October 2, 2004, respectively, as their inclusion
would be antidilutive. Of the options to purchase shares of common stock
outstanding as of September 27, 2003, those covering 0.2 million shares and 3.2
million shares of common stock were excluded from the computation of diluted
net income (loss) per share for the three and nine months ended September 27,
2003, respectively, as their inclusion would be antidilutive. 14. Business Segment and Geographical Data We organize and manage our business by functional operating entities. Our
functional entities operate in two segments: (1) Cardiovascular and (2) ITC.
The Cardiovascular segment develops, manufactures and markets proprietary
medical devices used for circulatory support and vascular graft applications.
The ITC segment develops, manufactures and markets point-of-care diagnostic
test systems. Business Segments: Three Months Ended
    
    Nine Months EndedOctober 2,
    
    September 27,
    
    October 2,
    
    September 27,2004
    
    2003
    
    2004
    
    2003(in thousands)Product sales:Cardiovascular
    
    $
    22,919
    
    
    $
    21,331
    
    
    $
    72,544
    
    
    $
    68,799ITC
    
    
    17,742
    
    
    
    13,919
    
    
    
    51,511
    
    
    
    38,670Total product sales
    
    $
    40,661
    
    
    $
    35,250
    
    
    $
    124,055
    
    
    $
    107,469Income before income taxes:Cardiovascular
    
    $
    2,330
    
    
    $
    2,920
    
    
    $
    8,649
    
    
    $
    10,161ITC
    
    
    2,058
    
    
    
    2,967
    
    
    
    6,778
    
    
    
    7,454Corporate (a)
    
    
    (1,511
    )
    
    
    (1,555
    )
    
    
    (4,695
    )
    
    
    (4,376
    )Amortization of purchased intangibles
    
    
    (2,931
    )
    
    
    (3,096
    )
    
    
    (8,793
    )
    
    
    (9,288
    )Litigation, restructuring and other costs (b)
    
    
    (310
    )
    
    
    
    
    
    
    (443
    )
    
    
    124Total income (loss) from operations
    
    
    (364
    )
    
    
    1,236
    
    
    
    1,496
    
    
    
    4,075Other income and (expense):Interest expense
    
    
    (1,015
    )
    
    
    
    
    
    
    (1,433
    )
    
    
    Interest income and other
    
    
    693
    
    
    
    218
    
    
    
    1,633
    
    
    
    1,379Income (loss) before income taxes
    
    $
    (686
    )
    
    $
    1,454
    
    
    $
    1,696
    
    
    $
    5,454
  (a)
    
    Represents primarily general and administrative expenses not specifically
identified to any particular business segment.(b)
    
    In 2004, relates to expenses not specifically identified to any
particular business segment. In 2003, this amount related solely to the
Cardiovascular segment. Geographic Areas: The geographic composition of our product sales were as follows: Three Months Ended
    
    Nine Months EndedOctober 2,
    
    September 27,
    
    October 2,
    
    September 27,2004
    
    2003
    
    2004
    
    2003(in thousands)Domestic
    
    $
    30,774
    
    
    $
    28,662
    
    
    $
    95,946
    
    
    $
    88,913International
    
    
    9,887
    
    
    
    6,588
    
    
    
    28,109
    
    
    
    18,556Total
    
    $
    40,661
    
    
    $
    35,250
    
    
    $
    124,055
    
    
    $
    107,469
 14




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements With the exception of historical facts, the statements contained in this
Form 10-Q are forward-looking statements, within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. These forward-looking statements generally can be identified by use of
statements that include words such as believe, expect, anticipate,
intend, plan, foresee, may, hope, will, estimates, potential,
continue or other similar words or phrases. Similarly, statements that
describe our objectives, plans or goals also are forward-looking statements.
All of these forward-looking statements are subject to risks and uncertainties
that could cause our actual results to differ materially from those
contemplated by the relevant forward-looking statement. See Factors Affecting
Future Results for the principal risk factors that could cause our actual
performance and future actions to differ materially from the forward-looking
statements. Readers are urged to consider these factors carefully in evaluating
the forward-looking statements. The forward-looking statements included in this
Form 10-Q are made only as of the date of this report and we undertake no
obligation to publicly update these forward-looking statements to reflect
subsequent events or circumstances. In addition, quantitative projections of
2004 revenue and gross margins, as well as projections regarding our market
share and the status of our competition, clinical trials and product acceptance
set forth in our Annual Report onForm 10-Kfor fiscal 2003 and our Quarterly
Report onForm 10-Qfor the first quarter of fiscal 2004, and any amendments
thereto, should no longer be relied upon. See our Interim Report on Form 8-K
furnished on June 29, 2004, which describes changes to our revenue projections
for fiscal 2004. The following presentation of managements discussion and analysis of our
financial condition and results of operations should be read together with our
consolidated financial statements included in thisForm 10-Q, and our Annual
Report onForm 10-Kfor 2003 filed with the SEC. 15




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Overview We are a leading manufacturer of circulatory support products for use by
patients with congestive heart failure, or CHF. According to the American Heart
Association, 4.9 million patients in the United States suffer from CHF and an
additional 550,000 patients are diagnosed with this disease annually. We were
the first company to receive approval from the United States Food and Drug
Administration, or FDA, to commercially market a ventricular assist device,
referred to as VADs, to treat patients with late-stage heart failure, which
comprises approximately 5% to 10% of the CHF patient population. Our VADs are
used primarily by these CHF patients to perform some or all of the pumping
function of the heart and we currently offer the widest range of products to
serve this market. We believe that our long-standing reputation for quality and
innovation and our excellent relationships with leading cardiovascular surgeons
worldwide position us to capture growth opportunities in the expanding
congestive heart failure market. Through our ITC subsidiary we design, develop,
manufacture and market point-of-care diagnostic test systems that provide fast,
accurate blood test results to improve patient management, reduce healthcare
costs and improve patient outcomes. Our Business Model The two product lines that represent the majority of our revenues are VADs
and point-of-care diagnostic test systems and services. Historical annual
revenue mix has been as follows: VAD pumps including associated products and services
    
    
    60-62
    %Point-of-care diagnostic test systems
    
    
    34-38
    %Grafts/Other
    
    
    2-4
    %
 Acquisitions and Strategic Developments On September 30, 2003, we completed an asset purchase of the Immediate
Response Mobile Analysis, or IRMA, point-of-care blood analysis system product
line from Diametrics Medical, Inc. (Diametrics). We paid approximately $5.2
million in cash and assumed trade payables. The purchase price was allocated
based on the fair value of assets acquired as determined by an independent
valuation firm. There was no goodwill recorded with the transaction. As a
result of the acquisition, $0.2 million relating to in-process research and
development was expensed in the fourth quarter of 2003. On March 30, 2004, we made an investment in BioCardia, Inc. Under the
terms of the investment documents, we (i) will assist BioCardia in exploring
opportunities for developing devices for the surgical delivery of
biotherapeutics, (ii) have limited exclusive rights to negotiate the
distribution, licensing or purchase of surgical delivery technology developed
by BioCardia and (iii) through an observational board seat, will be able to
review relevant clinical data accumulated by BioCardia through its multiple
trials. We have accounted for this investment on the cost basis as we do not
have the ability to exercise significant influence over BioCardias operating
and financial policies. This investment is included on our condensed
consolidated balance sheet in other long-term assets. Restructuring Plan In June 2001, following the merger with Thermo Cardiosystems, Inc., we
initiated a restructuring plan to consolidate all of our VAD manufacturing
operations to our facilities in Pleasanton, California. Through April 2003, the
completion date of the restructuring plan, we recorded a total of $1.5 million
in restructuring charges. These charges represent estimated employee severance
costs and stock option acceleration charges. Critical Accounting Policies and Estimates We have identified certain accounting policies as critical to our business
operations and the understanding of our results of operations. This section
should be read in conjunction with the section entitled Critical Accounting
Policies in our annual report on Form 10-K for fiscal 2003. We have identified the policies below as critical to our business
operations and the understanding of our results of operations. The impact and
any associated risks related to these policies on our business operations are
discussed 16




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below. Preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets, liabilities, revenue and
expenses and the disclosure of contingent assets and liabilities. There can be
no assurance that actual results will not differ from those estimates. Evaluation of Goodwill and Purchased Intangibles for Impairment In accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, we periodically evaluate the carrying value of
long-lived assets to be held and used including intangible assets, when events
or circumstances warrant such a review. The carrying value of a long-lived
asset to be held and used is considered impaired when the anticipated
separately identifiable undiscounted cash flows from such an asset are less
than the carrying value of the asset. In that event, a loss is recognized based
on the amount by which the carrying value exceeds the fair value of the
long-lived asset. Fair value is determined primarily using the anticipated cash
flows discounted at a rate commensurate with the risk involved. Management must
make estimates of these future cash flows and the approximate discount rate,
and if these estimates prove incorrect, the carrying value of these assets on
our condensed consolidated balance sheet could significantly misstate their
true value. As of the beginning of fiscal year 2002, we adopted SFAS No. 142,
Goodwill and Other Intangible Assets, and ceased the amortization of
purchased goodwill. In addition, we reevaluated the useful lives of our
identifiable intangible assets and determined that the remaining useful lives
were appropriate. Each year we complete an impairment test of goodwill as
required by SFAS No. 142. Upon completion of our impairment tests as of the end
of fiscal 2003, we determined that our goodwill was not impaired. Revenue Recognition We recognize revenue from product sales when evidence of an arrangement
exists, title has passed (generally upon shipment) or services have been
rendered, the selling price is fixed or determinable and collectibility is
reasonably assured. Sales to distributors are recorded when title transfers
upon shipment. One of our distributors has certain limited product return
rights. A limited number of our other distributors have certain rights of
return upon termination of their distribution agreement. A reserve for sales
returns is recorded for these customers applying reasonable estimates of
product returns based upon significant historical experience. No other direct
sales customers or distributors have return rights or price protection. Sales of certain Cardiovascular segment products to first-time customers
are recognized when it has been determined that the customer has the ability to
use such products. These sales frequently include the sale of products and
training services under multiple element arrangements. For most customers,
training is not essential to the functionality of the products as the customers
already possess sufficient expertise and experience to use the products. In
these situations, training is provided as a best practice to optimize the use
and success of the products. The amount of revenue under these arrangements
allocated to training is based upon fair market value of the training, which is
performed principally by third party providers. The amount of product sales
allocated to the Cardiovascular segment products is done on a residual method
basis. Under this method, the total value of the arrangement is allocated first
to the undelivered training element based on the fair market value, with the
remainder being allocated to the Cardiovascular segment products. The amount of
product sales allocated to training is recorded as deferred revenue and is
recognized when the training is completed. As of the nine months ended October
2, 2004, all products that had been delivered and recorded as product sales
were delivered to customers for which training had been completed. There was no
amount of product sales deferred related to this training not yet completed at
the nine months ended October 2, 2004; however, $20,000 of such product sales
were deferred at the end of 2003 and $100,000 at the end of 2002. We also rent certain medical devices to customers on a month-to-month or
as-used basis. Rental income is based on utilization and is included in product
sales as earned. Included in product sales for the nine months ended October 2,
2004, the years ended 2003, and 2002 are $4.4 million, $4.6 million, and $3.8
million, respectively, of income earned from the rental of these medical
devices. The majority of our products are covered by up to a two-year limited
manufacturers warranty from the date of installation. Estimated contractual
warranty obligations are recorded when related sales are recognized and any
additional amounts are recorded when such costs are probable and can be
reasonably estimated. 17




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Reserves We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make payments owed to us for
product sales. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required. In June 2001, following the merger with Thermo Cardiosystems, Inc., we
initiated a restructuring plan to consolidate all of our VAD manufacturing
operations. Through April 2003, the completion date of the restructuring plan,
we recorded a total of $1.5 million in restructuring charges. These charges
represent estimated employee severance costs and stock option acceleration
charges Accounting Pronouncements In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure which amends FASB Statement
No. 123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements of the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. We adopted the disclosure provisions of SFAS No. 148
at the beginning of fiscal 2002. On March 31, 2004, the FASB issued an exposure
draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95.
This proposed statement would require that stock-based compensation be
recognized as a cost in the financial statements and that such cost be measured
based on the fair value of the stock-based compensation. If issued in final
form as proposed by the FASB, our adoption of this proposed statement would
have a material, although non-cash, impact on our condensed consolidated
statements of operations. In March 2004, the Emerging Issues Task Force (EITF) reached a final
consensus on Issue 03-1, The Meaning of Other-Than-Temporary Impairment and
its Application to Certain Investments, to provide additional guidance in
determining whether investment securities have an impairment which should be
considered other-than-temporary. On September 15, 2004 the FASB issued proposed
FSP EITF Issue 03-1-a to address the application of the EITF Issue 03-1 to debt
securities that are affected by interest rate and/or sector-spread changes
only. On September 30, 2004, the FASB issued FSP EITF Issue 03-1-1, which
delayed the effective date of certain paragraphs of the EITF until EITF 03-1-a
is issued. Management expects that the adoption of this Issue and the related
FSPs will not have a significant effect on the Companys operating results or
financial condition. In April 2004, the FASB issued FSP FAS No. 129-1, Disclosure of
Information about Capital Structure, Relating to Contingently Convertible
Securities to provide disclosure guidance for contingently convertible
securities. We adopted the disclosure provisions in the second quarter of 2004
as they apply to the convertible notes. The 7.3 million shares underlying our
convertible notes are reportable under this new disclosure are antidilutive
and, therefore, have been excluded from the calculation of diluted net income
per share. See note 13. In October 2004, EITF Issue No. 04-8, Accounting Issues Related to
Certain Features of Contingently Convertible Debt and the Effect on Diluted
Earnings per Share was issued. Issue No. 04-8 states that shares available
under contingently convertible debt should be included in diluted earnings per
share, or EPS, in all periods, since the notes were issued, except when
inclusion is anti-dilutive, regardless of whether the contingency is met and
regardless of whether the market price contingency is substantial. Our adoption
of this proposed interpretation, which we expect to occur in the fourth quarter
of 2004, would not have a material impact on our most recent consolidated
results as the effect of the 7.3 million shares would be anti-dilutive. If in
future periods the shares would be dilutive, then 7.3 million shares will be
added to our share count used to calculate diluted earnings per share, and this
inclusion could result in lower diluted EPS than if the existing guidance had
not been changed by EITF 04-8. 18




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Results of Operations The following table sets forth selected condensed consolidated statements
of operations data for the periods indicated as a percentage of total product
sales: Three Months Ended
    
    Nine Months EndedOctober 2,
    
    September 27,
    
    October 2,
    
    September 27,2004
    
    2003
    
    2004
    
    2003Product sales
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of sales
    
    
    43
    
    
    
    40
    
    
    
    42
    
    
    
    41Gross profit
    
    
    57
    
    
    
    60
    
    
    
    58
    
    
    
    59Operating expenses:Selling, general & administrative
    
    
    33
    
    
    
    30
    
    
    
    32
    
    
    
    30Research & development
    
    
    17
    
    
    
    17
    
    
    
    18
    
    
    
    17Amortization of purchased intangible assets
    
    
    7
    
    
    
    9
    
    
    
    7
    
    
    
    8Litigation, restructuring and other costs
    
    
    1
    
    
    
    0
    
    
    
    0
    
    
    
    0Total operating expenses
    
    
    58
    
    
    
    56
    
    
    
    57
    
    
    
    55Income (loss) from operations
    
    
    (1
    )
    
    
    4
    
    
    
    1
    
    
    
    4Other income and (expense):Interest expense
    
    
    (3
    )
    
    
    0
    
    
    
    (1
    )
    
    
    0Interest income and other
    
    
    2
    
    
    
    1
    
    
    
    1
    
    
    
    1Income (loss) before income taxes
    
    
    (2
    )
    
    
    5
    
    
    
    1
    
    
    
    5Income tax benefit (expense)
    
    
    1
    
    
    
    2
    
    
    
    0
    
    
    
    2Net income (loss)
    
    
    (1
    )%
    
    
    3
    %
    
    
    1
    %
    
    
    3
    %
 See Note 14 to our unaudited condensed consolidated interim financial
statements in this report for data presented by business segment. Three months ended October 2, 2004 and September 27, 2003 Product Sales Product sales in the third quarter of 2004 were $40.7 million compared to
$35.3 million in the third quarter of 2003. The primary components of the $5.4
million increase in product sales were the following:  
    
    Point-of-care diagnostic sales increased $2.8 million, including $1.4
million in revenue from the IRMA product line acquired in the fourth
quarter of 2003.
    
    Alternate site sales of the Protime product line increased $0.9
million.
    
    Other sales, (drivers, cannulae, service, rentals and spares)
increased $1.5 million, including an increase in TLC II driver revenue
principally from Home Discharge, which was approved by the FDA toward
the end if the second quarter 2004. Our sales of Destination Therapy implants were lower year to date than we
had originally anticipated, and we expect product sales to increase more slowly
than we had originally projected. Gross Profit Gross profit in the third quarter of 2004 was 57% compared to 60% in the
third quarter of 2003. The change in margins were due to the following
fluctuations:  
    
    A higher margin resulting from higher average sales prices on IVAD
and PVAD products internationally, offset by
    
    A lower margin on point-of-care products, primarily related to the
IRMA product line, plus higher distribution costs associated with the
shift in mix from distributor to direct channels. 19




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Selling, General and Administrative Selling, general and administrative expenses in the third quarter of 2004
were $13.2 million, or 33% of product sales, compared to $10.6 million, or 30%
of product sales, in the third quarter of 2003. Underlying the $2.6 million
increase in spending were the following:  
    
    Increased headcount from 164 at the end of the third quarter of 2003
to 203 at the end of the third quarter of 2004, together with annual
salary.
    
    Higher spending on marketing and related activities, primarily
associated with our HeartHope Center Program, Destination Therapy, and
costs associated with the IRMA product line. We anticipate that selling, general and administrative costs will
generally increase each year as our business grows, with some quarterly and
annual significant increases in spending in connection with particular events
such as product development or enhancements. Spending as a percentage of
revenue is expected to decrease assuming revenue from current products
increases, particularly if we realize increasing revenue generated by
Destination Therapy implants. Research and Development Research and development expenses in the third quarter of 2004 were $7.0
million compared to $6.1 million in the third quarter of 2003, representing 17%
of product sales for both periods. Research and development costs are largely
project driven, and the level of spending depends on the level of project
activity planned and subsequently approved and conducted. The primary component
of our research and development costs is employee salaries and benefits.
Research and development costs also include regulatory and clinical costs
associated with our compliance with FDA regulations. We anticipate that research and development costs will generally increase
each year assuming our business grows, with some quarterly and annual
significant increases in spending in connection with particular events such as
product introductions and regulatory approvals. We expect research and
development spending as a percentage of revenue to trend downward as revenue
from current products increase, in particular if we realize increasing revenue
related to sales of Destination Therapy implants. Amortization of Purchased Intangible Assets Amortization of purchased intangible assets in the third quarter of 2004
was $2.9 million compared to $3.1 million in the third quarter of 2003. The
decrease of $0.2 million is primarily due to the write-off of purchased
intangible assets related to the Aria CABG graft in the fourth quarter of 2003. Income Taxes Our effective tax rates were 42% and 39% for the third quarters of 2004
and 2003, respectively. The change in our effective tax rate over these
quarters was due primarily to a reduction of our projected annual profit before
tax and additional interest income from tax favorable investments. The
effective income tax rate for both quarters differed from the statutory federal
income tax rate primarily due to the impact of state taxes, research and
experimental tax credits and tax favorable investments. Nine months ended October 2, 2004 and September 27, 2003 Product Sales Product sales in the first nine months of 2004 were $124.1 million
compared to $107.5 million in the first nine months of 2003. The primary
components of the $16.6 million increase in product sales were as follows:  
    
    $8.1 million higher revenue from sales of point-of-care diagnostic
test systems, including $4.7 million generated by the IRMA product line; 20




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##### Table of Contents




    
    $4.7 million higher revenue from sales of alternate site and incision
products, including a $3.5 million increase in the ProTime product line;
    
    $5.2 million higher VAD revenue; partially offset by
    
    $1.4 million lower graft revenue. Gross Profit Gross profit as a percentage of sales in the first nine months of 2004 and
2003 was 58% and 59%, respectively. Within these essentially flat margins were
the following fluctuations:  
    
    A 3% higher margin on cardiovascular products resulting from a
shift in mix from lower to higher margin products, partially offset by
higher manufacturing costs.
    
    A 4% lower margin on point-of-care revenue, primarily related to
the IRMA product line, plus higher distribution costs associated with
the shift in mix from distributor to direct channels. Selling, General and Administrative Selling, general and administrative expenses in the first nine months of
2004 were $40.0 million, or 32% of product sales, compared to $31.8 million, or
30% of product sales, in the first nine months of 2003. Underlying the $8.2
million increase in these expenses were the following drivers:  
    
    Increased headcount from 164 at the end of the first nine months of
2003 to 203 at the end of the first nine months of 2004, together with
annual salary increases.
    
    Higher spending on marketing and related activities, primarily
associated with our HeartHope Center Program, Destination Therapy, and
costs associated with the IRMA product line.
    
    Higher professional fees, including legal, audit and financial
consulting services relating primarily to our compliance with the
Sarbanes-Oxley Act of 2002. Research and Development Research and development expenses in the first nine months of 2004 were
$21.7 million compared to $18.6 million in the first nine months of 2003,
representing 18% and 17% of product sales, respectively. The primary component
of our research and development costs is employee salaries and benefits.
Research and development costs also include regulatory and clinical costs
associated with our compliance with FDA regulations Amortization of Purchased Intangible Assets Amortization of purchased intangible assets in the first nine months of
2004 was $8.8 million compared to $9.3 million in the first nine months of
2003. The decrease of $0.5 million is primarily due to the write-off of
purchased intangible assets related to the Aria CABG graft in the fourth
quarter of 2003. Income Taxes Our effective tax rates were 35% and 39% for the nine month periods ended
October 2, 2004 and September 27, 2003, respectively. The reduction in our
effective tax on a comparative basis was due primarily to a reduction of our
projected annual profit before tax and additional interest income from tax
favorable investments. The effective income tax rate for both quarters differed
from the statutory federal income tax rate primarily due to the impact of state
taxes, research and experimental tax credits and tax favorable investments. Liquidity and Capital Resources At October 2, 2004, we had working capital of $212.1 million compared with
$116.4 million at January 3, 2004. Cash and cash equivalents and short-term
available-for-sale investments at October 2, 2004 were $146.9 million 21




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compared to $62 million at January 3, 2004. The increase is due primarily
to proceeds from our convertible debt offering in the second quarter of 2004. Cash provided by operating activities for the nine months ended October 2,
2004 was $7.5 million, after payments for litigation and annual bonuses accrued
at January 3, 2004 totaling $5.2 million. In addition, investing activities
used $45 million, with $40.1 million net purchases of investments and $5.0
million to acquire property, plant and equipment. Of the net investment
activity, $9.8 million was used to purchase U.S. Government securities that
were pledged in relation to the issuance of our convertible notes. The
purchases of property, plant and equipment were comprised of $4.3 million for
equipment and $0.7 million for leasehold improvements. Cash provided by
financing activities for the first nine months of 2004 was $52.4 million,
including $139.4 million net proceeds from the issuance of our convertible
notes and an additional $3.0 million from proceeds related to stock option
exercises and our Employee Stock Purchase Plan, partially offset by $90.0
million paid to repurchase 6.9 million shares of stock under our stock
repurchase programs. A portion of the debt offering proceeds were used to purchase and pledge
$9.8 million to the trustee under the indenture for the exclusive benefit of
the holders of the convertible notes, U.S. government securities to provide for
the payment, in full, of the first six scheduled interest payments. Additional
net proceeds were used to repurchase 4.2 million shares of our outstanding
common stock for $60 million. The remaining net proceeds will be used for
general corporate purposes, which may include additional stock repurchases,
strategic investments or acquisitions. The convertible notes were issued at an
issue price of $580.98 per note, which is 58.098% of the principal amount at
maturity of the notes. The convertible notes bear interest at a rate of 1.3798%
per year on the principal amount at maturity, payable semi-annually in arrears
in cash on May 16 and November 16 of each year, from November 16, 2004 until
May 16, 2011. Beginning on May 16, 2011, the original issue discount will
accrue daily at a rate of 2.375% per year on a semi-annual bond equivalent
basis and, on the maturity date, a holder will receive $1,000 per note. As a
result, the aggregate principal amount of the notes at maturity will be $247.4
million. In February 2004 and July 2004, the Board of Directors authorized stock
repurchase programs under which up to an aggregate of $50 million of our common
stock could be acquired in the open market or in privately negotiated
transactions. The number of shares to be purchased and the timing of purchases
were based on several conditions, including the price of our stock, general
market conditions and other factors. In May 2004, in conjunction with our
convertible notes offering, the Board of Directors authorized the repurchase of
an additional $60 million of our common stock. As of October 2, 2004, we had
repurchased and retired 6.9 million shares with an aggregate purchase price of
$90.0 million under these combined programs. 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 stock repurchase programs for
at least the next twelve months. The impact of inflation on our financial position and the results of
operations was not significant during any of the periods presented. Contractual Obligations As of October 2, 2004, we had the following contractual obligations (in
millions): Total
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    ThereafterLong-Term Debt Obligations
(includes interest)(a)
    
    $
    167.6
    
    
    
    2.1
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    151.9Operating Lease Obligations
    
    
    20.3
    
    
    
    .6
    
    
    
    2.5
    
    
    
    2.5
    
    
    
    2.4
    
    
    
    2.1
    
    
    
    10.2Purchase Obligations
    
    
    15.4
    
    
    
    .2
    
    
    
    2.0
    
    
    
    2.0
    
    
    
    2.0
    
    
    
    2.0
    
    
    
    7.2Total
    
    $
    203.3
    
    
    
    2.9
    
    
    
    7.9
    
    
    
    7.9
    
    
    
    7.8
    
    
    
    7.5
    
    
    
    169.3
 Our purchase obligations of $15.4 million were comprised of supply agreements
in effect at October 2, 2004. (a) See Note 9 to our unaudited consolidated interim financial statements in
this report for data on interest related to long-term debt. 22




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Off-Balance Sheet Items In the third quarter of 2004 we obtained an Irrevocable Standby Letter of
Credit for $390,000 as part of our workers compensation insurance program.
The Letter of Credit is not collateralized. The Letter of Credit expires on
June 30, 2005 and is scheduled to automatically renew each year on June 30. 23




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##### Table of Contents



FACTORS THAT MAY AFFECT FUTURE RESULTS Our business faces many risks. Such risks include those related to the development of new
markets including Destination Therapy, the growth of existing markets for our products, customer
and physician acceptance of Thoratec products, changes in the mix of Thoratec product sales, and
the related gross margin for such product sale, the results of clinical trials including the
HeartMate II, the ability to improve financial performance, regulatory approval processes, the
effect of healthcare reimbursement and coverage policies, the effects of seasonality in Thoratec
products sales, the effects of price competition from any Thoratec competitors and the effects of
any merger and acquisition related activities. The risks described below are what we believe to be
the material risks facing our company. However, the risks described below may not be the only risks
we face. Additional risks that we do not yet know of or that we currently believe are immaterial
may also impair our business operations. If any of the events or circumstances described in the
following risk factors actually occurs, our business, financial condition or results of operations
could suffer, and the trading price of our common stock could decline significantly. Investors
should consider the following risks, as well as the other information included in this Quarterly
Report and our Annual Report on Form 10-K for fiscal 2003, before deciding to invest in our
company. We have a history of net losses. We were founded in 1976 and we have a history of incurring losses from operations. As of
October 2, 2004, our accumulated deficit was approximately $71.6 million. We anticipate that our
expenses will increase as a result of increased pre-clinical and clinical testing, research and
development and selling, general and administrative expenses. We could also incur significant
additional costs in connection with our business development activities and the development and
marketing of new products and indicated uses for our existing products as well as litigation costs.
Such costs could prevent us from achieving or maintaining profitability in future periods. Since our physician and hospital customers depend on third party reimbursement, if third party
payors fail to provide appropriate levels of reimbursement for our products, our results of
operations will be harmed. Significant uncertainty exists as to the reimbursement status of newly approved health care
products such as VADs and vascular grafts, which can delay or prevent adoption in volume by
hospitals. Government and other third party payors are increasingly attempting to contain health
care costs. Payors are attempting to contain costs by, for example, limiting coverage and the level
of reimbursement of new therapeutic products. Payors are also attempting to contain costs by
refusing, in some cases, to provide any coverage for uses of approved products for disease
indications other than those for which the FDA has granted marketing approval. To date, a majority of private insurers with whom we have been involved and the Centers for
Medicare and Medicaid, referred to as CMS, have determined to reimburse some portion of the cost of
our VADs and our diagnostic and vascular graft products, but we cannot estimate what portion of
such costs will be reimbursed and our products may not continue to be approved for reimbursement.
In addition, changes in the health care system may affect the reimbursability of future products.
If coverage is not expanded or if the reimbursement levels are not increased or are partially or
completely reduced, our revenues would be reduced. If we fail to obtain approval from the FDA and from foreign regulatory authorities, we cannot
market and sell our products under development in the United States and in other countries, and if
we fail to adhere to ongoing FDA Quality System Regulations, the FDA may withdraw our market
clearance or take other action. Before we can market new products in the United States, we must obtain clearance from the FDA.
This process is lengthy and uncertain. In the United States, one must obtain clearance from the FDA
of a 510(k) premarket notification or approval of a more extensive submission known as a pre-market
approval, or PMA, application. If the FDA concludes that any of our products does not meet the
requirements to obtain clearance under Section 510(k) of the Federal Food, Drug, and Cosmetic Act,
then we would be required to file a PMA application. The process for a PMA application is lengthy,
expensive and typically requires extensive pre-clinical and clinical trial data. We may not obtain clearance of a 510(k) notification or approval of a PMA application with
respect to any of our products on a timely basis, if at all. If we fail to obtain timely clearance
or approval for our products, we will not be able to market and sell our products, harming our
ability to generate revenue. The FDA may also limit the claims that we can make about our products.
We may also be required to obtain clearance of a 510(k) notification or PMA 24




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##### Table of Contents



Supplement from the FDA before we can market products that have been cleared, but we have
since modified or that we subsequently wish to market for new disease indications. The FDA also requires us to adhere to Quality System Regulations, which include production
design controls, testing, quality control, storage and documentation procedures. The FDA may at any
time inspect our facilities to determine whether we have adequate compliance. Compliance with
Quality System Regulations for medical devices is difficult and costly. In addition, we may not be
found to be compliant as a result of future changes in, or interpretations of, regulations by the
FDA or other regulatory agencies. If we do not achieve compliance, the FDA may withdraw marketing
clearance, require product recall or take other enforcement action, which in each case would harm
our business. Any change or modification to a device is required to be made in compliance with
Quality System Regulations, which compliance may cause interruptions or delays in the marketing and
sale of our products. The FDA also requires device manufacturers to submit reports regarding
deaths, serious injuries and certain malfunctions relating to use of their products. Sales of our products outside the United States are subject to foreign regulatory requirements
that vary from country to country. The time required to obtain approvals from foreign countries may
be longer or shorter than that required for FDA approval, and requirements for foreign licensing
may differ from FDA requirements. The federal, state and foreign laws and regulations regarding the manufacture and sale of our
products are subject to future changes, as are administrative interpretations and policies of
regulatory agencies. If we fail to comply with applicable federal, state or foreign laws or
regulations, we could be subject to enforcement actions. Enforcement actions could include product
seizures, recalls, withdrawal of clearances or approvals, and civil and criminal penalties, which
in each case would harm our business. Certain lawsuits have been filed against us On August 3, 2004, a putative Federal securities law class action entitled Johnson v. Thoratec
Corporation, et al. was filed in the United States District Court for the Northern District of
California on behalf of purchasers of the publicly traded securities of the Company between April
28, 2004 and June 29, 2004. The complaint seeks to recover unspecified damages on behalf of all
purchasers of the Companys publicly traded securities during the class period. Subsequent to the
filing of the Johnson complaint, additional complaints were filed in the same court alleging
substantially similar claims. On or about September 1, 2004, a shareholder derivative action entitled Wong v. Grossman was
filed in the California Superior Court for Alameda County based upon essentially the same facts as
the Federal securities class action suits. This action names the individual members of the
Companys Board of Directors, including our Chief Executive Officer, and our Chief Financial
Officer as defendants. We intend to move to dismiss both suits. However, we are unable to predict at this time the
final outcome of these actions, or whether the resolution of the actions could materially affect
our results of operations, cash flows or financial position. In June of 2004, MicroMed Technology, Inc., a potential competitor of the Company, sued the
Company in Texas. MicroMed sought a temporary restraining order against the Company in connection
with the Companys HeartMate II phase I clinical trial on the grounds that the Company had provided
the HeartMate II VAD to clinical sites without charge and that doing so was a violation of Texas
anti-trust law. In addition to injunctive relief, the plaintiff is seeking unspecified damages and
fees, including those arising from potential sales of its VAD products which plaintiff alleges it
lost due to the Companys HeartMate II clinical trial. The Company has successfully defended itself against MicroMeds requests for injunctive relief
and will continue to vigorously defend any and all of the claims made by MicroMed in this action. Our debt obligations expose us to risks that could adversely affect our business, operating results
and financial condition. We have a substantial level of debt. As of October 2, 2004, we had $143.8 million of
outstanding indebtedness. The terms of our convertible notes do not restrict our ability to incur
additional indebtedness, including indebtedness senior to the notes. The level of our indebtedness,
among other things, could: 25




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##### Table of Contents




    
    make it difficult for us to make payments on our debt;  
    
    make it difficult for us to obtain any necessary financing in the future for working
capital, capital expenditures, debt service, acquisitions or general corporate purposes;  
    
    limit our flexibility in planning for or reacting to changes in our business;  
    
    reduce funds available for use in our operations;  
    
    impair our ability to incur additional debt because of financial and other restrictive
covenants proposed for any such additional debt;  
    
    make us more vulnerable in the event of a downturn in our business or an increase in
interest rates; or  
    
    place us at a possible competitive disadvantage relative to less leveraged competitors
and competitors that have better access to capital resources. If we experience a decline in product sales due to any of the factors described in this
section or otherwise, we could have difficulty paying interest or principal amounts due on our
indebtedness. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary
to make required payments, or if we fail to comply with the various requirements of our
indebtedness, including the convertible notes, we would be in default, which would permit the
holders of our indebtedness to accelerate the maturity of the indebtedness and could cause defaults
under our other indebtedness. Any default under our indebtedness could have a material adverse
effect on our business, operating results and financial condition. If hospitals do not conduct Destination Therapy procedures using our VAD, our product sales will be
diminished. The use of our VADs as long-term therapy in patients who are not candidates for heart
transplantation (Destination Therapy) was approved by the FDA in 2002, and was approved for
reimbursement by the CMS in late 2003. The number of Destination Therapy procedures actually performed is dependent on many factors,
most of which are out of our direct control, including:  
    
    the number of CMS sites approved for Destination Therapy;  
    
    the clinical outcomes of Destination Therapy procedures;  
    
    cardiology and referring physician education, and their commitment to Destination Therapy;  
    
    the economics of the Destination Therapy procedure for individual hospitals, which
includes the costs of the VAD and related pre- and post- operative procedures and their
reimbursement;  
    
    the impact of changes in reimbursement rates on the timing of purchases of VADs for
Destination Therapy; and  
    
    the economics for individual hospitals of not conducting a Destination Therapy
procedure, including the costs and related reimbursements of long-term hospitalization. The different outcomes of these and other factors, and their timing, will have a significant
impact on our future operating results. Sales of our VADs for Destination Therapy have proved
slower than we had originally anticipated, and we are unable to predict when, if ever, these sales
will generate significant revenue for us. 26




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The long and variable sales and deployment cycles for our VAD systems may cause our revenue and
operating results to vary significantly, which increases the risk of an operating loss for any
given fiscal quarter. Our VAD systems have lengthy sales cycles and we may incur substantial sales and marketing
expenses and expend significant effort without making a sale. Even after making the decision to
purchase our VAD systems, our customers often deploy our products slowly. For example, the length
of time between initial contact with cardiac surgeons and the purchase of our VAD systems is
generally between nine and eighteen months. In addition, the cardiac centers that buy the majority
of our products are usually led by cardiac surgeons who are heavily recruited by competing centers
or by centers looking to increase their profiles. When one of these surgeons moves between centers
we sometimes experience a temporary but significant reduction in purchases by the departed center
while it replaces its lead surgeon. As a result, it is difficult for us to predict the quarter in
which our customers may purchase our VAD systems and our revenue and operating results may vary
significantly from quarter to quarter, which increases the risk of an operating loss for us for any
given quarter. In particular, sales of our VADs for Destination Therapy have been lower than we had
originally anticipated, and we cannot predict when, if ever, sales of our VADs for this indication
will generate significant revenue. Physicians may not accept or continue to accept our products and products under development. The success of our current and future products will require acceptance or continued acceptance
by cardiovascular and vascular surgeons and other medical professionals. Such acceptance will
depend on clinical results and the conclusion by these professionals that our products are safe,
cost-effective and acceptable methods of treatment. Even if the safety and efficacy of our future
products are established, physicians may elect not to use them for a number of reasons. These
reasons could include the high cost of our VAD systems, restrictions on coverage, unfavorable
reimbursement from health care payors, or use of alternative therapies. Also, economic,
psychological, ethical and other concerns may limit general acceptance of our ventricular assist,
graft and other products. Our future product sales will be affected by the number of heart transplants conducted. A significant amount of our current product sales is generated by our VADs implanted
temporarily in patients awaiting heart transplants. The number of heart transplants conducted
worldwide depends on the number of hearts available to transplant, which number in turn depends on
the death rate of otherwise healthy people from events such as automobile accidents. To the extent
that public safety measures and technological improvements, such as automobile air bags and
anti-lock brakes, are successfully implemented, the availability of these hearts to transplant may
not grow significantly, and may trend downward. We have experienced rapid growth and changes in our business, and our failure to manage this and
any future growth could harm our business. The number of our employees increased from 183 on December 30, 2000 to 905 on October 2, 2004.
We expect to continue increasing the number of our employees, and we may suffer if we do not manage
and train our new employees effectively. Our product sales may not continue to grow at a rate
sufficient to support the costs associated with an increasing number of employees. Any future
periods of rapid growth may place significant strains on our managerial, financial and other
resources. The rate of any future expansion, in combination with our complex technologies and
products, may demand an unusually high level of managerial effectiveness in anticipating, planning,
coordinating and meeting our operational needs as well as the needs of our customers. If we fail to successfully introduce new products, our future growth may suffer. As part of our growth strategy, we intend to develop and introduce a number of new products
and product improvements. We also intend to develop new indications for our existing products. For
example, we are currently developing updated versions of our HeartMate products. If we do not
introduce these new products, product improvements and new indications on a timely basis, or if
they are not well accepted by the market, our future growth may suffer. 27




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Amortization of our intangible assets, which represent a significant portion of our total assets,
will adversely affect our net income and we may never realize the full value of our intangible
assets. As of October 2, 2004, we had $250.3 million of net intangible assets, representing 47% of our
total assets and 83% of our shareholders equity. Amortization expense relating to these
intangible assets for the first nine months and third quarter of 2004 were $8.8 million and $2.9
million, respectively. Ongoing amortization of purchased intangibles will reduce our net income or
increase our net loss. We may not receive the recorded value for our intangible assets if we sell or liquidate our
business or assets. The material concentration of intangible assets increases the risk of a large
charge to earnings if that the revenue from, and recoverability of, these intangible assets is
impaired. In the event of such a charge to net income, the market price of our common stock could
be adversely affected. For example, in the first quarter of 2004, we completed an assessment of the
final results from the feasibility clinical trial for the Aria CABG graft, which was ongoing
through fiscal 2003. Based on the clinical trial results, we determined not to devote additional
resources to development of the Aria graft. Upon the decision to discontinue product development,
we recorded an impairment charge of approximately $9 million as of January 3, 2004 to write off
purchased intangible assets related to the Aria graft, recorded as a result of our merger with TCA. We rely on specialized suppliers for certain components and materials in our products and
alternative suppliers may not be available. We depend on a number of custom-designed components and materials supplied by other companies
including, in some cases, single source suppliers for components and materials used in our VAD
products and blood testing products. For example, a single source currently manufactures and
supplies the heart valves used in our HeartMate products. We do not have long-term written
agreements with most of our vendors and from these vendors receive components on a purchase order
basis only. If we need alternative sources for key raw materials or component parts for any reason,
such alternative sources may not be available and our inventory may not be sufficient to fill
orders before we find alternative suppliers or begin manufacturing these components or materials
ourselves. Cessation or interruption of sales of circulatory support products would seriously harm
our business, financial condition and results of operations. Alternative suppliers, if available, may not agree to supply us. In addition, we may need to
obtain FDA approval before using new suppliers or manufacturing our own components or materials.
Existing suppliers could also be subject to an FDA enforcement action, which could also disrupt our
supplies. If alternative suppliers are not available, we may not have the expertise or resources
necessary to produce these materials or component parts internally. Because of the long product development cycle in our business, suppliers may discontinue
components upon which we rely before the end of life of our products. In addition, the timing of
the discontinuation may not allow us time to develop and obtain FDA approval for a replacement
component before we exhaust our inventory of the legacy component. If suppliers discontinue components on which we rely, we may have to:  
    
    pay premium prices to our suppliers to keep their production lines open or to
alternative suppliers;  
    
    buy substantial inventory to take us through the scheduled end of life of our product,
or through such time that we will have a replacement product developed and approved by the
FDA; or  
    
    stop shipping the product in which the legacy component is used once our inventory of
the discontinued component is exhausted. Any of these interruptions in the supply of our materials could result in substantial
reductions in revenue and increases in our production costs. 28




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If we fail to compete successfully against our existing or potential competitors, our product sales
or operating results may be harmed. Competition from medical device companies and medical device subsidiaries of health care and
pharmaceutical companies is intense and is expected to increase. Competitors for the VAD system
include World Heart Corporation and ABIOMED, Inc. Principal competitors in the vascular graft
market include W.L. Gore, Inc., C.R. Bard and Boston Scientific Corporation. Principal competitors
in the hospital coagulation and blood gas monitoring equipment market include the Cardiac Surgery
Division of Medtronic, Inc., iSTAT, Radiometer, Abbott Diagnostics, and Instrument Laboratories.
Our primary competitor in the skin incision device market is Becton, Dickson and Company.
Competitors in the alternate site (non-hospital) point-of-care diagnostics market include Roche
Diagnostics and HemoSense. Many of our competitors have substantially greater financial, technical, distribution,
marketing and manufacturing resources than we have. Accordingly, our competitors may be able to
develop, manufacture and market products more efficiently and at a lower cost than we can. We
expect that the key competitive factors will include the relative speed with which we can:  
    
    develop products;  
    
    complete clinical testing;  
    
    receive regulatory approvals; and  
    
    manufacture and sell commercial quantities of products. Additionally, our competitors may succeed in developing and marketing technologies and
products that are more effective than ours. Any such products may render our technology and
products obsolete or noncompetitive. In addition, new surgical procedures and medications could be
developed that replace or reduce the importance of current procedures that use our products. The price of our common stock may fluctuate significantly. The price of our common stock has been, and is likely to continue to be, highly volatile,
which means that it could decline substantially within a short period of time. For example our
stock price has ranged from $8.46 to $15.95 in the ten months ended October 30, 2004. The price of
our common stock could fluctuate significantly for many reasons, including the following:  
    
    future announcements concerning us or our competitors;  
    
    timing and reaction to the publication of clinical trial results;  
    
    quarterly variations in operating results, which we have experienced in the past and
expect to experience in the future;  
    
    charges, amortization and other financial effects relating to our merger with TCA;  
    
    introduction of new products or changes in product pricing policies by us or our competitors;  
    
    acquisition or loss of significant customers, distributors or suppliers;  
    
    business acquisitions or divestitures;  
    
    changes in earnings estimates by analysts;  
    
    changes in third party reimbursement practices;  
    
    regulatory developments, enforcement actions bearing on advertising, marketing or
sales, and disclosure regarding completed ongoing or future clinical trials; and 29




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
    
    fluctuations in the economy, world political events or general market conditions. In addition, stock markets in general, and the market for shares of health care stocks in
particular, have experienced extreme price and volume fluctuations in recent years, which
fluctuations have frequently been unrelated to the operating performance of the affected companies.
These broad market fluctuations may adversely affect the market price of our common stock. The
market price of our common stock could decline below its current price and the market price of our
stock may fluctuate significantly in the future. These fluctuations may be unrelated to our
performance. Shareholders have often instituted securities class action litigation after periods of
volatility in the market price of a companys securities. Some securities class action suits have
been filed against us, and if other such suits are filed against us in the future, we may incur
substantial legal fees and our managements attention and resources would be diverted from
operating our business in order to respond to the litigation. See Certain lawsuits have been filed
against us. above. We may encounter problems manufacturing our products. We may encounter difficulties manufacturing our products. We do not have experience in
manufacturing some of our products in the commercial quantities that might be required if we
receive FDA approval of several or all of the products and indications currently under development,
including the HeartMate II VAD currently commencing. If we have difficulties manufacturing our
products, our business will be harmed. Since we depend upon distributors, if we lose a distributor or a distributor fails to perform, our
operations will be harmed. With the exception of Canada and the larger countries in Europe, we sell our VAD and HeartMate
systems in foreign markets through distributors. In addition, we sell our vascular access graft
products through the Bard Peripheral Vascular division of C.R. Bard Corporation in the United
States, Europe and selected countries in Scandinavia, the Middle East and Northern Africa and
through Goodman Co. Ltd. in Japan. Substantially all of the international operations and a large
portion of the Alternate Site domestic operations of our ITC subsidiary are conducted through
distributors. For the nine months ended October 2, 2004, 21% of our total product sales were
through Cardinal Healthcare, a distributor of our blood coagulation testing equipment and skin
incision devices. To the extent we rely on distributors, our success will depend upon the efforts of others,
over which we may have little control. If we lose a distributor or a distributor fails to perform
to our expectations, our revenues will be harmed. Changes we make to our method of distributing and selling our products could hurt our relationship
with distributors and their customers. Following our acquisition of the IRMA product line of blood gas analyzers, commencing in March
2004, we changed our manner of distributing our Hemochron and IRMA product lines to our hospital
point-of-care customers in the United States from a distributor model to a direct sales model.
Sales of these products represented approximately $4.7 million of our sales in the first nine
months of 2004. This transition includes expanding the sales, technical service, customer service and shipping
headcount at our ITC subsidiary in order to provide our customers with the support and service that
they historically obtained from our distributors, resulting in an increase in our sales and general
and administrative costs. We expect the transition process to conclude in early 2005 when the last
distributor will have been converted and the United States hospital point-of-care market will be
served exclusively by ITC on a direct basis. This transition and its execution involve significant
risks, including:  
    
    the alienation of distributors when they are informed of our plans;  
    
    the promotion by our former distributors of products from competitors rather than
our products;  
    
    the potential loss of customers who prefer to deal with a particular distributor;
and 30




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
    
    the challenges and costs associated with building an effective direct sales force. If we fail to build an effective direct sales force for our hospital point-of-care product
lines, our revenues may fail to increase as expected or could decrease, which could adversely
affect our results of operations and financial condition. As we end the third quarter of 2004,
over 95% of our U.S. hospital point-of-care business has been converted to the direct sales model
with no material adverse event. Our inability to protect our proprietary technologies or an infringement of others patents could
harm our competitive position. We rely on patents, trade secrets, copyrights, know-how, trademarks, license agreements and
contractual provisions to establish our intellectual property rights and protect our products.
These legal means, however, afford only limited protection and may not adequately protect our
rights. In addition, we cannot assure you that any of our pending patent applications will issue.
The Patent and Trademark Office, or PTO, may deny or significantly narrow claims made under patent
applications and the issued patents, if any, may not provide us with commercial protection. We
could incur substantial costs in proceedings before the PTO or in any future litigation to enforce
our patents in court. These proceedings could result in adverse decisions as to the validity and/or
enforceability of our patents. In addition, the laws of some of the countries in which our products
are or may be sold may not protect our products and intellectual property to the same extent as
U.S. laws, if at all. We may be unable to protect our rights in trade secrets and unpatented
proprietary technology in these countries. Our commercially available VAD products, which account for a significant portion of our sales,
generally are not protected by any patents. We rely principally on trade secret protection and, to
a lesser extent, patents to protect our rights to the HeartMate. We rely principally on patents to
protect our coagulation testing equipment, skin incision devices, Hemochron disposable cuvettes,
IRMA analyzer, IRMA disposable cartridges, and Hgb Pro disposable test strips. We seek to protect our trade secrets and unpatented proprietary technology, in part, with
confidentiality agreements with our employees and consultants. Although it is our policy to require
that all employees and consultants sign such agreements, we cannot assure you that every person who
gains or has gained access to such information has done so. Moreover, these agreements may be
breached and we may not have an adequate remedy. Our products may be found to infringe prior or future patents owned by others. We may need to
acquire licenses under patents belonging to others for technology potentially useful or necessary,
and such licenses may not be available to us. We could incur substantial costs in defending suits
brought against us on such patents or in bringing suits to protect our patents or patents licensed
by us against infringement. For example, in 2003, a patent infringement claim was filed against the Company by Bodycote
Materials Testing Canada, Inc. and David C. MacGregor, M.D. related to materials used in the
HeartMate LVAS. On February 3, 2004, the Company settled the claim and recorded a charge of $2.3
million in the fourth quarter of 2003 for the settlement and related legal costs. Product liability claims could damage our reputation and hurt our financial results. Our business exposes us to an inherent risk of potential product liability claims related to
the manufacturing, marketing and sale of human medical devices. We maintain only a limited amount
of product liability insurance. Our insurance policies generally must be renewed on an annual
basis. We may not be able to maintain or increase such insurance on acceptable terms or at
reasonable costs, and such insurance may not provide us with adequate coverage against potential
liabilities. A successful claim brought against us in excess of, or outside of, our insurance
coverage could seriously harm our financial condition and results of operations. Claims against us,
regardless of their merit or potential outcome, may also reduce our ability to obtain physician
endorsement of our products or expand our business. Identified quality problems can result in substantial costs and write-downs. FDA regulations require us to track materials used in the manufacture of our products, so that
any problems identified in a finished product can easily be traced back to other finished products
containing the defective 31




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materials. In some instances, identified quality issues require scrapping or expensive rework
of the affected lot(s), not just the tested defective product and could also require us to stop
shipments. In addition, since some of our products are used in situations where a malfunction can be life
threatening, identified quality issues can result in the recall and replacement, generally free of
charge, of substantial amounts of product already implanted or otherwise in the marketplace. Any quality issue identified can therefore result in substantial costs and write offs, which
could materially harm our financial results. If we make acquisitions or divestitures, we could encounter difficulties that harm our business. We may acquire companies, products or technologies that we believe to be complementary to our
business. If we do so, we may have difficulty integrating the acquired personnel, operations,
products or technologies and we may not realize the expected benefits of any such acquisition. In
addition, acquisitions may dilute our earnings per share, disrupt our ongoing business, distract
our management and employees and increase our expenses, which could harm our business. We may also
sell businesses or assets as part of our strategy or if we receive offers from third parties. If we
do so, we may sell an asset or business for less than its full value. Our non-U.S. sales present special risks. During the nine months ended October 2, 2004 and the year ended 2003, sales originating
outside the United States and U.S. export sales accounted for approximately 23% and 19%,
respectively, of our total product sales. We anticipate that sales outside the United States and
U.S. export sales will continue to account for a significant percentage of our product sales and we
intend to continue to expand our presence in international markets. Non-U.S. sales are subject to a
number of special risks. For example:  
    
    we generally sell many of our products at a lower price outside the United States;  
    
    sales agreements may be difficult to enforce;  
    
    receivables may be difficult to collect through a foreign countrys legal system;  
    
    foreign customers may have longer payment cycles;  
    
    foreign countries may impose additional withholding taxes or otherwise tax our foreign
income, impose tariffs or adopt other restrictions on foreign trade;  
    
    U.S. export licenses may be difficult to obtain;  
    
    intellectual property rights may be more difficult to enforce in foreign countries;  
    
    terrorist activity or war may interrupt distribution channels or adversely impact our
customers or employees; and  
    
    fluctuations in exchange rates may affect product demand and adversely affect the
profitability, in U.S. dollars, of products sold in foreign markets where payments are made
in local currencies. Any of these events could harm our operations or operating results. Any claims relating to improper handling, storage or disposal of hazardous chemicals and
biomaterials could be time consuming and costly. Producing our products requires the use of hazardous materials, including chemicals and
biomaterials. We cannot eliminate the risk of accidental contamination or discharge and any
resultant injury from these materials. We could be subject to both criminal liability and civil damages in the event of an improper
or unauthorized release of, or exposure of individuals to, hazardous materials. In addition,
claimants may sue us for injury or 32




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contamination that results from our use or the use by third parties of these materials, and
our liability may exceed our total assets. Compliance with environmental laws and regulations is
expensive, and current or future environmental regulations may impair our research, development or
production efforts or harm our operating results. The occurrence of a catastrophic disaster or other similar events could cause damage to our
facilities and equipment, which would require us to cease or curtail operations. We are vulnerable to damage from various types of disasters, including earthquake, fire,
terrorist acts, flood, power loss, communications failures and similar events. For example, in
October 1989, a major earthquake that caused significant property damage and a number of fatalities
struck near the area in which our Pleasanton, California facility is located. If any such disaster
were to occur, we may not be able to operate our business at our facilities, in particular because
our premises require FDA approval, which could result in significant delays before we can
manufacture product from a replacement facility. The insurance we maintain may not be adequate to
cover our losses resulting from disasters or other business interruptions. Therefore, any such
catastrophe could seriously harm our business and results of operations. If we are unable to favorably assess the effectiveness of our internal control over financial
reporting, or if our independent auditors are unable to provide an unqualified attestation report
on our assessment, our stock price could be adversely affected. Under the Sarbanes-Oxley Act of 2002, we are required to assess the effectiveness of our
internal controls for financial reporting and assert that such internal controls are effective. Our
independent auditors must evaluate managements assessment of the effectiveness of our internal
controls over financial reporting and render an opinion on managements assessment and the
effectiveness of our internal controls over financial reporting. To prepare for compliance with
this requirement of the Sarbanes-Oxley Act, we have undertaken certain actions including the
adoption of an internal plan which includes a timeline and schedule of activities for the
evaluation, testing and remediation, if necessary, of internal controls. These actions have
resulted in and are likely to continue to result in increased expenses, and have required and are
likely to continue to require significant efforts by management and other employees. Although we
believe that our efforts will enable us to provide the required report and enable our independent
auditors to provide the required attestation as of our fiscal year end, we can give no assurance
that such efforts will be completed in a timely manner and on a successful basis. If this were to
occur, we may be unable to assert that the internal controls over financial reporting are
effective, or our independent auditors may not be able to render the required attestation
concerning our assessment and the effectiveness of the internal controls over financial reporting,
which in either event could adversely effect investor confidence and the market price of our common
stock. Fluctuations in foreign currency exchange rates could result in declines in our reported sales and
earnings. Because some of our international sales are denominated in local currencies and not in U.S.
dollars, our reported sales and earnings are subject to fluctuations in foreign exchange rates. At
present, we use forward foreign currency contracts to hedge the gains and losses created by the
remeasurement of non-functional currency denominated assets and liabilities. However, we do not
engage in hedge exposures that will arise from future sales. As a result, sales occurring in the
future that are denominated in foreign currencies may be translated into U.S. dollars at a less
favorable rate than our current exchange rate environment resulting in reduced revenues and
earnings. The competition for qualified personnel is particularly intense in our industry. If we are unable
to retain or hire key personnel, we may not be able to sustain or grow our business. Our ability to operate successfully and manage our potential future growth depends
significantly upon retaining key research, technical, sales, marketing, managerial and financial
personnel, and attracting and retaining additional highly qualified personnel in these areas. We
face intense competition for such personnel, and we may not be able to attract and retain these
individuals. We compete with numerous companies, as well as universities and nonprofit research
organizations, throughout all our locations. The loss of key personnel for any reason or our
inability to hire and retain additional qualified personnel in the future could prevent us from
sustaining or growing our business. Our success will depend in large part on the continued services
of our research, managerial and manufacturing personnel. We cannot assure you that we will continue
to be able to attract and retain sufficient qualified personnel. 33




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We may be unable to repay or repurchase our convertible notes or our other indebtedness. At maturity, the entire outstanding principal amount of our convertible notes will become due
and payable. Holders of the convertible notes may also require us to repurchase the convertible
notes on May 16 in each of 2011, 2014, 2019, 2024 and 2029. In addition, if certain fundamental
changes to our company occur, the holders of the convertible notes may require us to repurchase all
or a portion of their convertible notes. We may not have sufficient funds or may be unable to
arrange for additional financing to pay the principal amount due at maturity or the repurchase
price of the convertible notes. Any such failure would constitute an event of default under the
indenture, which could, in turn, constitute a default under the terms of our other indebtedness.
Any default under our indebtedness could have a material adverse effect on our business, operating
results and financial condition. Conversion of the convertible notes or other future issuances of our stock will dilute the
ownership interests of existing shareholders. The conversion of some or all of the convertible notes will dilute the ownership interest of
our existing shareholders. Any sales in the public market of the common stock issuable upon such
conversion could adversely affect prevailing market prices of our common stock. Further, the
existence of the convertible notes may encourage short selling by market participants because the
conversion of the convertible notes could depress the price of our common stock. In addition,
future sales of substantial amounts of our stock in the public market, or the perception that such
sales could occur, could adversely affect the market price of our stock. Sales of our shares and
the potential for such sales could cause our stock price to decline. In addition, our adoption of ETIF Issue No. 04-8, expected to occur in the fourth quarter of
2004, which requires the inclusion of all shares available upon conversion of our convertible notes
in our diluted EPS regardless of whether the notes are then convertible, would not have a material
impact on our consolidated results for the periods in which the notes were outstanding as the
effect of the 7.3 million shares would be anti-dilutive. If in future periods the shares would be
dilutive, then 7.3 million shares will be added to our share count used to calculate diluted
earnings per share, and this inclusion could result in significantly lower diluted EPS than if the
existing guidance had not been changed by EITF 04-8. Anti-takeover defenses in our governing documents could prevent an acquisition of our company or
limit the price that investors might be willing to pay for our common stock. Our governing documents could make it difficult for another company to acquire control of our
company. For example:  
    
    Our Articles of Incorporation allow our Board of Directors to issue, at any time and
without shareholder approval, preferred stock with such terms as it may determine. No
shares of preferred stock are currently outstanding. However, the rights of holders of any
of our preferred stock that may be issued in the future may be superior to the rights of
holders of our common stock.  
    
    We have a rights plan, commonly known as a poison pill, which would make it difficult
for someone to acquire our company without the approval of our Board of Directors. All or any one of these factors could limit the price that certain investors would be willing
to pay for shares of our common stock and could delay, prevent or allow our Board of Directors to
resist an acquisition of our company, even if the proposed transaction was favored by a majority of
our independent shareholders. 34




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK Interest Rate Risk Our investment portfolio is made up of cash equivalent and marketable investments in money
market funds and debt instruments of government agencies and high quality corporate issuers. All
investments are carried at market value and are treated as available-for-sale. All investments
mature within two years or less from the date of purchase. The holdings of any one issuer, except
government agencies, do not exceed 10% of the portfolio. If interest rates rise, the market value
of our investments may decline which could result in a loss if we are forced to sell an investment
before the scheduled maturity. We do not utilize derivative financial instruments to manage
interest rate risks. Our convertible notes do not bear interest rate risk as the notes were issued at a fixed rate
of interest. Foreign Currency Rate Fluctuations We conduct business in foreign countries. Our international operations consist primarily of
sales and service personnel for our ventricular assist products, who report into our U.S. sales and
marketing group and are internally reported as part of that group. All assets and liabilities of
our non-U.S. operations are translated into U.S. dollars at the period-end exchange rates and the
resulting translation adjustments are included in comprehensive income. The period-end translation
of the non-functional currency assets and liabilities (primarily assets and liabilities on our UK
subsidiary consolidated balance sheet that are not denominated in UK Pounds) at the period-end
exchange rates result in foreign currency gains and losses, which are included in Interest and
Other Income-Net. We use forward foreign currency contracts to hedge the gains and losses generated by the
revaluation of these non-functional currency assets and liabilities. These derivatives are not
designated as cash flow or fair value hedges under SFAS No. 133. As a result, changes in the fair
value of the forward foreign currency contracts are included as incurred in Interest and Other
IncomeNet. The change in the fair value of the forward foreign currency contracts typically
offsets the change in value from revaluation of the non-functional currency assets and liabilities.
These contracts typically have maturities of three months or less. At October 2, 2004 and September
27, 2003, the Company had forward foreign currency contracts in Pounds Sterling and Euros with a
notional value of $7.0 million and $4.6 million, respectively. The impact of foreign currency
revaluation, net of forward foreign currency contracts, was negligible for the quarter ending
October 2, 2004 and a loss of $0.2 million for the quarter ending September 27, 2003. 35




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ITEM 4. CONTROLS AND PROCEDURES An evaluation was performed under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of our disclosure controls and procedures as of October 2, 2004. Disclosure controls and procedures are designed to reasonably assure that the information
required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly
Report, is recorded, processed, summarized and reported within the time periods specified in the
SECs rules and forms. Disclosure controls and procedures are also designed to reasonably assure
that such information is accumulated and communicated to our management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. Our disclosure controls and procedures include components of our internal
control over our financial reporting, which consists of control processes designed to provide
reasonable assurance regarding the reliability of financial reporting and permitting the
preparation of our financial statements in conformity with generally accepted accounting
principles. To the extent that components of our internal control over our financial reporting are
included within our disclosure controls and procedures, they are included in the scope of our
quarterly controls evaluation. The evaluation of our disclosure controls and procedures included a review of our processes
and implementation and the effect on the information generated for use in this Quarterly Report. In
the course of this evaluation, we sought to identify any significant deficiencies or material
weaknesses in our controls, to determine whether we had identified any acts of fraud involving
personnel who have significant roles in internal controls and to confirm that any necessary
corrective action, including process improvements, were being undertaken. This type of evaluation
is performed every fiscal quarter so that our conclusions concerning the effectiveness of these
controls can be reported in our periodic reports filed with the SEC. The overall goals of these
evaluations activities are to monitor our disclosure controls and procedures and to make
modifications as necessary. Based on the evaluation, subject to the limitations described below, our management, including
the Chief Executive Officer and Chief Financial Officer, concluded that as of October 2, 2004 the
Companys disclosure controls and procedures were effective in providing reasonable assurance that
information required to be disclosed by the Company in the reports that it files or submits under
the Exchange Act is recorded, processed, summarized and reported within the time periods specified
in the SECs rules and forms. There have been no changes in our internal controls during the fiscal
quarter ended October 2, 2004 that have materially affected or are reasonably likely to materially
affect the Companys internal control over financial reporting. Our management, including the Chief Executive Officer and the Chief Financial Officer, do not
expect that the disclosure controls and procedures or internal controls will prevent all error and
all fraud. A control system, no matter how well conceived and operated, can only provide
reasonable, not absolute, assurances that the objectives of the control system are met. The design
of a control system reflects resource constraints; the benefits of controls must be considered
relative to their costs. Because there are inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues and instances of
error or fraud, if any, within the Company have been or will be detected. These inherent
limitations include the realities that judgments in decision-making can be faulty and that
breakdowns occur because of simple error or mistake. Controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management override of the control.
The design of any system of controls is based in part upon certain assumptions about the likelihood
of future events. There can be no assurance that any design will succeed in achieving its stated
goals under all future conditions; over time, controls may become inadequate because of changes in
conditions or deterioration in the degree of compliance with the policies or procedures. Because of
the inherent limitations in a cost-effective control system, misstatements due to error or fraud
may occur and not be detected. We intend to continuously review and evaluate the design and effectiveness of our disclosure
controls and procedures and to improve our controls and procedures over time and to correct any
deficiencies that we may discover in the future. Our senior management has timely access to all
material financial and non-financial information concerning our business. While we believe the
present design of our disclosure controls and procedures is effective, future events affecting our
business may cause us to significantly modify our disclosure controls and procedures. 36




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PART II. OTHER INFORMATION 
 ITEM 1. LITIGATION In June of 2004, MicroMed Technology, Inc., a potential competitor of the Company, sued the
Company in Texas. MicroMed sought a temporary restraining order against the Company in connection
with the Companys HeartMate II phase I clinical trial on the grounds that the Company had provided
the HeartMate II VAD to clinical sites without charge and that doing so was a violation of Texas
anti-trust law. In addition to an injunctive relief, the plaintiff is seeking unspecified damages
and fees, including those arising from potential sales of its VAD products which plaintiff alleges
it lost due to the Companys HeartMate II clinical trial. The Company has successfully defended itself against MicroMeds requests for injunctive relief
and will continue to vigorously defend any and all of the claims made by MicroMed in this action. On August 3, 2004, a putative Federal securities law class action entitled Johnson v. Thoratec
Corporation, et al. was filed in the United States District Court for the Northern District of
California on behalf of purchasers of the publicly traded securities of the Company between April
28, 2004 and June 29, 2004. The Johnson complaint generally alleges violations of the Securities
Exchange Act of 1934 by the Company, its chief executive officer and chief financial officer based
upon, inter alia, alleged false statements about the Companys expected sales and the market for
HeartMate as a Destination Therapy treatment. The complaint seeks to recover unspecified damages on
behalf of all purchasers of the Companys publicly traded securities during the class period.
Subsequent to the filing of the Johnson complaint, additional complaints were filed in the same
court alleging substantially similar claims. On October 4, 2004, a putative class member, Craig
Toby, filed a motion to be appointed lead plaintiff pursuant to the Private Securities Litigation
Reform Act of 1995 and to consolidate all of the pending class action litigations against Thoratec
into a single proceeding. The Court has not yet ruled on those motions. On or about September 1, 2004, a shareholder derivative action entitled Wong v. Grossman was
filed in the California Superior Court for Alameda County based upon essentially the same facts as
the Federal securities class action suits. This action names the individual members of the
Companys Board of Directors, including our Chief Executive Officer and our Chief Financial Officer
as defendants and alleges that the defendants breached their fiduciary duties and wasted corporate
assets, and that certain of the defendants traded in the Companys securities while in possession
of material nonpublic information. The Company believes that the claims asserted in both the Federal securities law putative
class action and the state shareholder derivative action are without merit and the Company intends
to move to dismiss both suits. However, we are unable to predict at this time the final outcome of
these actions, or whether the resolution of the actions could materially affect our results of
operations, cash flows or financial position. While we believe we carry sufficient insurance to cover what management believes to be any
reasonable exposure on these actions, we cannot give you any assurance that our insurance will
cover any costs or other exposures we may have with respect to these actions. 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES (c) Recent Unregistered Sales of Equity Securities. In the second quarter of 2004 we completed the sale of $143.8 million initial principal amount
of senior subordinated convertible notes due 2034. The convertible notes were sold in a private
placement to Qualified Institutional Buyers pursuant to the exemption from the registration
requirements of the Securities Act of 1933, as amended, provided by Rule 144A thereunder. Total
proceeds to the Company from the sale were $139.4 million, after debt issuance costs of $4.3
million. The convertible notes were issued at an issue price of $580.98 per note, which is 58.098% of
the principal amount at maturity of the notes. The convertible notes bear interest at a rate of
1.3798% per year on the principal amount at maturity, payable semi-annually in arrears in cash on
May 16 and November 16 of each year, from November 16, 2004 until May 16, 2011. Beginning on May
16, 2011, the original issue discount will accrue daily at 37




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a rate of 2.375% per year on a semi-annual bond equivalent basis and, on the maturity date, a
holder will receive $1,000 per note. As a result, the aggregate principal amount of the notes at
maturity will be $247.4 million. Holders of the convertible notes may convert their convertible notes into shares of our common
stock at a conversion rate of 29.4652 shares per $1,000 principal amount of convertible notes,
which represents a conversion price of $19.72 per share, subject to adjustments upon the occurrence
of certain events. Holders were able to convert their convertible notes at any point after the
close of business on September 30, 2004 if, as of the last day preceding the calendar quarter, the
closing price of our common stock for at least 20 trading days in a period of 30 consecutive
trading days ending on the last trading day of such preceding calendar quarter is more then 120% of
the accreted conversion price per share of our common stock. Holders may surrender their
convertible notes on or prior to May 16, 2029 during the five business day period after any five
consecutive trading day period in which the trading price per note for each day of that period was
less than 98% of the product of the closing sale price of our common stock and the conversion rate
on each such day; provided that if on the day prior to any conversion the closing sale price of our
common stock is greater than the accreted conversion price but less than or equal to 120% of the
accreted conversion price, then holders will receive upon conversion, in lieu of shares of common
stock based on the conversion rate, cash or common stock, or a combination of cash and common
stock, at our option, with a value equal to the accreted principal amount of the notes plus accrued
but unpaid interest as of the conversion date. Additionally, holders may convert their convertible
notes if we call them for redemption or if specified corporate transactions or significant
distributions to holders of our stock have occurred. The debt offering proceeds were used to purchase and pledge $9.8 million to the trustee under
the indenture for the exclusive benefit of the holders of the convertible notes, U.S. government
securities to provide for the payment, in full, of the first six scheduled interest payments.
Additional net proceeds were used to repurchase 4.2 million shares of our outstanding common stock
for $60 million. The remaining net proceeds will be used for general corporate purposes, which may
include additional stock repurchases, strategic investments or acquisitions. (e) Purchases of Equity Securities by the Issuer. Maximum Dollar ValueOf Shares That MayTotal Number of
    
    YetTotal Number
    
    Average
    
    Shares Purchased as
    
    Be Purchased UnderOf Shares
    
    Price Paid
    
    Part Of Publicly
    
    The ProgramPurchased
    
    Per Share
    
    Announced Program
    
    (in millions)January 4, 2004 to January 31, 2004
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    25.0February 1, 2004 to February 28, 2004
    
    
    185,000
    
    
    $
    13.59
    
    
    
    185,000
    
    
    $
    22.5February 29, 2004 to April 3, 2004
    
    
    325,000
    (2)
    
    $
    12.97
    
    
    
    325,000
    
    
    $
    18.3April 4, 2004 to May 1, 2004
    
    
    0
    
    
    $
    0
    
    
    
    0
    
    
    $
    18.3May 2, 2004 to May 29, 2004
    
    
    4,234,100
    
    
    $
    14.33
    
    
    
    4,234,100
    
    
    $
    17.6May 30, 2004 to July 3, 2004
    
    
    405,000
    
    
    $
    10.76
    
    
    
    405,000
    
    
    $
    13.2July 4, 2004 to July 31, 2004
    
    
    1,240,000
    
    
    $
    10.67
    
    
    
    1,240,000
    
    
    $
    25.0August 1, 2004 to August 28, 2004
    
    
    162,000
    
    
    $
    10.10
    
    
    
    162,000
    
    
    $
    23.4August 29, 2004 to October 2, 2004
    
    
    332,000
    
    
    $
    10.21
    
    
    
    332,000
    
    
    $
    20.0Total
    
    
    6,883,100
    
    
    $
    13.08
    
    
    
    6,883,100
  (1)
    
    Our stock repurchase programs, which authorizes the Company to repurchase up to $110 million
of shares, was announced on February 11, 2004 as a $25 million of shares program and increased
on May 12, 2004 to an $85 million shares program, and again was increased to $110 million of
shares on July 29, 2004. These programs do not have an expiration date.  (2)
    
    Includes 250,000 shares purchased from Thermo Electron Corporation in a privately arranged
transaction executed through a third party broker at the then current market price. 38




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ITEM 6. EXHIBITS (a) Exhibits: 31.1 Section 302 Certifications of Chief Executive Officer and Chief Financial Officer. 32.1 Section 906 Certifications of Chief Executive Officer and Chief Financial Officer. 39




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SIGNATURES In accordance with the requirements of the Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THORATEC CORPORATIONDate: November 12, 2004
    /s/ D. Keith GrossmanD. Keith Grossman,Chief Executive OfficerDate: November 12, 2004
    /s/ M. Wayne BoylstonM. Wayne Boylston,Senior Vice President, Chief
Financial Officer and Secretary
(Principal Financial and Accounting
Officer)