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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 April 2, 2005 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
    
    94-2340464incorporation or organization)
    
    (I.R.S. Employer Identification No.)6035 Stoneridge Drive, Pleasanton, California
    
    94588(Address of principal executive offices)
    
    (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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act):Yes þ No o As of April 28, 2005 registrant had 48,266,917 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)Condensed Consolidated Balance Sheets as of April 2, 2005 and January 1, 2005
    
    
    3Condensed Consolidated Statements of Operations for the Three Months Ended April 2, 2005 and April 3, 2004
    
    
    4Condensed Consolidated Statements of Cash Flows for the Three Months Ended April 2, 2005 and April 3, 2004
    
    
    5Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended April 2, 2005 and April 3, 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
    
    
    33Item 4. Controls and Procedures
    
    
    33Part II. Other InformationItem 1. Legal Proceedings
    
    
    35Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    35Item 6. Exhibits
    
    
    35SignaturesExhibitsEXHIBIT 10.30EXHIBIT 10.31EXHIBIT 10.32EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) THORATEC CORPORATION AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(in thousands) April 2,
    
    
    January 1,2005
    
    
    2005AssetsCurrent assets:Cash and cash equivalents
    
    $
    19,499
    
    
    $
    16,017Short-term available-for-sale investments
    
    
    132,936
    
    
    
    129,842Restricted short-term investments
    
    
    3,379
    
    
    
    3,362Receivables, net of allowances of $780 and $708 respectively
    
    
    31,293
    
    
    
    33,051Inventories
    
    
    37,389
    
    
    
    39,141Deferred tax asset
    
    
    6,470
    
    
    
    6,470Prepaid expenses and other assets
    
    
    4,563
    
    
    
    3,873Total current assets
    
    
    235,529
    
    
    
    231,756Property, plant and equipment, net
    
    
    27,517
    
    
    
    27,584Goodwill
    
    
    94,097
    
    
    
    94,097Purchased intangible assets, net
    
    
    150,337
    
    
    
    153,141Restricted long-term investments
    
    
    4,836
    
    
    
    4,845Long-term deferred tax asset
    
    
    6,489
    
    
    
    6,381Other assets
    
    
    6,437
    
    
    
    6,611Total Assets
    
    $
    525,242
    
    
    $
    524,415Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    
    6,176
    
    
    
    7,699Accrued compensation
    
    
    8,060
    
    
    
    9,507Accrued income tax
    
    
    4,502
    
    
    
    2,299Other accrued expenses
    
    
    6,952
    
    
    
    6,001Total current liabilities
    
    
    25,690
    
    
    
    25,506Senior subordinated convertible notes
    
    
    143,750
    
    
    
    143,750Long-term deferred tax liability and other liabilities
    
    
    62,129
    
    
    
    63,051Total liabilities
    
    
    231,569
    
    
    
    232,307Shareholders Equity:Common shares; 100,000 authorized; issued and outstanding 48,207 and 48,375,
respectively
    
    
    363,674
    
    
    
    364,775Deferred compensation
    
    
    (1,380
    )
    
    
    (1,586
    )Accumulated deficit
    
    
    (68,864
    )
    
    
    (71,514
    )Accumulated other comprehensive income:Unrealized loss on investments
    
    
    (382
    )
    
    
    (325
    )Cumulative translation adjustments
    
    
    625
    
    
    
    758Total accumulated other comprehensive income
    
    
    243
    
    
    
    433Total shareholders equity
    
    
    293,673
    
    
    
    292,108Total Liabilities and Shareholders Equity
    
    $
    525,242
    
    
    $
    524,415
 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 EndedApril 2,
    
    
    April 3,2005
    
    
    2004Product sales
    
    $
    50,488
    
    
    $
    42,792Cost of product sales
    
    
    20,048
    
    
    
    17,721Gross profit
    
    
    30,440
    
    
    
    25,071Operating expenses:Selling, general and administrative
    
    
    14,817
    
    
    
    13,013Research and development
    
    
    7,719
    
    
    
    7,338Amortization of purchased intangible assets
    
    
    2,804
    
    
    
    2,931Litigation and other costs
    
    
    178
    
    
    
    133Total operating expenses
    
    
    25,518
    
    
    
    23,415Income from operations
    
    
    4,922
    
    
    
    1,656Other income and (expense):Interest expense
    
    
    (1,008
    )
    
    
    Interest income and other
    
    
    836
    
    
    
    465Income before income tax expense
    
    
    4,750
    
    
    
    2,121Income tax expense
    
    
    (1,615
    )
    
    
    (827
    )Net income
    
    $
    3,135
    
    
    $
    1,294Net income per share, basic
    
    $
    0.07
    
    
    $
    0.02Net income per share, diluted
    
    $
    0.06
    
    
    $
    0.02Shares used to compute net income per
share:Basic
    
    
    48,202
    
    
    
    56,106Diluted
    
    
    49,009
    
    
    
    57,458
 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) Three Months EndedApril 2,
    
    
    April 3,2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    3,135
    
    
    $
    1,294Adjustments to reconcile net income to net cash provided by (used in)
operating activities:Depreciation and amortization
    
    
    4,453
    
    
    
    4,641Investment premium amortization
    
    
    132
    
    
    
    56Non-cash interest and other expenses
    
    
    1,008
    
    
    
    Tax benefit related to stock options
    
    
    90
    
    
    
    131Amortization of deferred compensation
    
    
    232
    
    
    
    227Change in net deferred tax liability
    
    
    (1,183
    )
    
    
    (68
    )Changes in assets and liabilities:Receivables
    
    
    1,757
    
    
    
    (882
    )Inventories
    
    
    1,250
    
    
    
    (541
    )Prepaid expenses and other assets
    
    
    (690
    )
    
    
    (1,602
    )Accounts payable and other liabilities
    
    
    (512
    )
    
    
    (3,899
    )Other
    
    
    119
    
    
    
    (119
    )Net cash provided by (used in) operating activities
    
    
    9,791
    
    
    
    (762
    )Cash flows from investing activities:Purchases of available-for-sale investments
    
    
    (15,370
    )
    
    
    (19,100
    )Sales of available-for-sale investments
    
    
    8,900
    
    
    
    26,750Maturities of available-for-sale investments
    
    
    3,070
    
    
    
    5,844Purchases of property, plant and equipment, net
    
    
    (1,104
    )
    
    
    (2,036
    )Net cash provided by (used in) investing activities
    
    
    (4,504
    )
    
    
    11,458Cash flows from financing activities:Proceeds from stock option exercises, net
    
    
    541
    
    
    
    715Repurchase of common stock
    
    
    (2,238
    )
    
    
    (6,730
    )Net cash provided by (used in) financing activities
    
    
    (1,697
    )
    
    
    (6,015
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (108
    )
    
    
    71Net increase in cash and cash equivalents
    
    
    3,482
    
    
    
    4,752Cash and cash equivalents at beginning of period
    
    
    16,017
    
    
    
    18,270Cash and cash equivalents at end of period
    
    $
    19,499
    
    
    $
    23,022Supplemental disclosure of cash flow information:Cash paid for taxes
    
    $
    427
    
    
    $
    217Cash paid for interest
    
    $
    
    
    
    $
    Supplemental disclosure of Non-cash investing and financing activities:Transfers of equipment from inventory
    
    $
    502
    
    
    $
    128
 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 EndedApril 2,
    
    
    April 3,2005
    
    
    2004Net income
    
    $
    3,135
    
    
    $
    1,294Other net comprehensive income :Unrealized loss on investments
(net of taxes
of $(108) and
$(20) for the three months
ended April 2, 2005 and April
3, 2004, respectively)
    
    
    (382
    )
    
    
    (31
    )Foreign currency translation
adjustments (net of taxes of
$33 and $0 for the three
months ended April 2, 2005 and
April 3, 2004, respectively)
    
    
    625
    
    
    
    71Comprehensive income
    
    $
    3,378
    
    
    $
    1,334
 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
2004 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 2004 amounts to conform to the current presentation. In prior years, auction rate securities were classified as cash and cash equivalents. These
securities have been reclassified for all periods presented from cash and cash equivalents to
short term available-for-sale investments. These auction rate securities have an underlying
component of a long-term debt or equity instrument; however, they are traded or mature on a shorter
term based on an auction bid that resets the interest rate over time intervals of 28 to 49 days.
These resets allow for a much higher level of liquidity than typical long term investments. As of
January 1, 2005, we reclassified $43.8 million of these securities to short-term available-for-sale
investments from cash and cash equivalents based on the period from purchase date to the reset
date and as they are not intended to be held to the maturity date. 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: 7




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Three Months EndedApril 2,
    
    
    April 3,2005
    
    
    2004(in thousands, except per sharedata)(Restated)Net income (loss):As reported
    
    $
    3,135
    
    
    $
    1,294Add: Stock-based compensation expense
included in reported net income, net of related
tax effects
    
    
    47
    
    
    
    139Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects
    
    
    (1,917
    )
    
    
    (1,896
    )Pro forma income (loss)
    
    $
    1,265
    
    
    $
    (463
    )Basic earnings (loss) per share:As reported
    
    $
    0.07
    
    
    $
    0.02Pro forma income (loss)
    
    $
    0.03
    
    
    $
    (0.01
    )Diluted earnings (loss) per share:As reported
    
    $
    0.06
    
    
    $
    0.02Pro forma income (loss)
    
    $
    0.03
    
    
    $
    (0.01
    )
 Subsequent to the issuance of our condensed consolidated financial statements for the quarter
ended October 2, 2004, management determined that total stock based employee compensation expense
determined under the fair value based method, net of related tax effects, for the first three
quarters of 2004 had been calculated incorrectly. Accordingly, such pro forma amounts presented
above have been restated. The effect was to decrease pro forma stock-based compensation expense,
net of tax and pro forma net loss by $0.1 million for the first quarter of 2004. Pro forma earnings
per share had no effect on the same quarter. This correction did not impact the Companys
consolidated financial position, results of operations, or cash flows for any of the periods
presented. 3. New Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued statement 123R
Share-Based Payment. This statement requires 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. Our adoption of this statement, which we expect to occur in the first
quarter of 2006, will have a material, although non-cash, impact on our consolidated statements of
operations. 4. Cash and cash equivalents We consider highly liquid investments with original maturities of three months or less to be
cash and cash equivalents. 5. Investments Our investments are primarily held in auction rate securities, corporate and municipal bonds
and U.S. government obligations and are classified as available-for-sale and are reported at fair
value based upon quoted market price. All investments mature within two years or less from the date
of purchase, except for some investments in U.S. Treasuries held as restricted investments as
collateral for future interest payments related to our convertible debt, which mature within three
years from the date of purchase. Investments with maturities beyond one year may be classified as
short-term, if they are intended for use in operations, based on their highly liquid nature or due
to the frequency in which the interest rate is reset such as with auction rate securities. In
addition these securities represent the investment of cash that is available and intended for
current operations. Investments that are not intended for use in current operations are classified
as long-term investments. Securities classified as restricted are investments held in U.S. Treasuries as collateral for
future interest payments related to our convertible debt and are reported at fair value based upon
quoted market price. The investments that 8




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relate to interest payments due within one year have been classified as restricted short-term
investments and the investments that relate to interest payments due after one year have been
classified as restricted long-term investments. We determined that these investments had no
impairments that were other-than temporary. For all investments, temporary differences between cost and fair value is presented as a
separate component of accumulated other comprehensive income. The specific identification method is
used to determine realized gains and losses on investments. 6. Financial Instruments We have a foreign currency exchange risk management program principally designed to mitigate
the change in value of assets and liabilities (primarily assets and liabilities on our UK
subsidiarys consolidated balance sheet that are denominated in UK pounds). Forward exchange
contracts that generally have terms of three months or less are used to hedge these 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 April 2, 2005
and January 1, 2005, respectively, the Company had forward foreign currency contracts to exchange
Pounds Sterling and Euros for U.S. Dollars with a notional value of $6.9 million and negligible
fair value for the same periods. Net foreign currency exchange loss was $0.2 million and $0.1 as
of April 2, 2005 and April 3, 2004, respectively. 7. Inventories Inventories consist of the following: As ofApril 2,
    
    
    January 1,2005
    
    
    2005(in thousands)Finished goods
    
    $
    15,744
    
    
    $
    18,562Work in process
    
    
    7,432
    
    
    
    4,582Raw materials
    
    
    14,213
    
    
    
    15,997Total
    
    $
    37,389
    
    
    $
    39,141
 8. Property, Plant and Equipment Property, plant and equipment consist of the following: As ofApril 2,
    
    
    January 1,2005
    
    
    2005(in thousands)Property, plant and equipment, at cost
    
    $
    62,991
    
    
    $
    61,670Less accumulated depreciation
    
    
    (35,474
    )
    
    
    (34,086
    )Total
    
    $
    27,517
    
    
    $
    27,584
 9. Goodwill and Purchased Intangible Assets The change in the carrying amount of goodwill, which is attributable to our Cardiovascular
business segment, for the three and twelve month periods ended April 2, 2005 and January 1, 2005
was as follows: 9




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As ofApril 2,
    
    
    January 1,2005
    
    
    2005(in thousands)Beginning balance
    
    $
    94,097
    
    
    $
    96,065Realization of acquired deferred tax asset
    
    
    
    
    
    
    (1,153
    )Reversal of accrual for securities registration costs
    
    
    
    
    
    
    (815
    )Ending balance
    
    $
    94,097
    
    
    $
    94,097
 There were no adjustments to Goodwill in the first three months of 2005. In 2004, goodwill
related to the merger of Thoratec with Thermo Cardiosystems, Inc. (TCA) was adjusted by $1.2
million to reflect the utilization of tax net operating loss (NOL) benefits related to our
subsidiary in the United Kingdom (UK). At the time of the merger, a deferred tax asset related to
these NOL tax benefits was established with a corresponding valuation allowance for the full
amount. As our UK subsidiary more likely than not will begin utilizing a portion of this NOL
benefit, a portion of the original valuation allowance has been reversed against goodwill . In addition, goodwill was also adjusted by $0.8 million 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 agreement, we agreed to pay these costs should Thermo
Electron Corporation (TCI) (the majority shareholder of 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 purchased intangible assets, net are as follows: As of April 2, 2005Gross Carrying
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    Net Carrying Amount(in thousands)Patents and Trademarks
    
    $
    37,815
    
    
    $
    (14,963
    )
    
    $
    22,852Core Technology
    
    
    37,485
    
    
    
    (7,622
    )
    
    
    29,863Developed Technology
    
    
    122,782
    
    
    
    (25,229
    )
    
    
    97,553Non-compete Agreement
    
    
    90
    
    
    
    (21
    )
    
    
    69Total Purchased Intangible Assets, net
    
    $
    198,172
    
    
    $
    (47,835
    )
    
    $
    150,337
 As of January 1, 2005Gross Carrying
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    Net Carrying Amount(in thousands)Patents and Trademarks
    
    $
    37,815
    
    
    $
    (14,051
    )
    
    $
    23,764Core Technology
    
    
    37,485
    
    
    
    (7,242
    )
    
    
    30,243Developed Technology
    
    
    122,782
    
    
    
    (23,721
    )
    
    
    99,061Non-compete Agreement
    
    
    90
    
    
    
    (17
    )
    
    
    73Total Purchased Intangible Assets, net
    
    $
    198,172
    
    
    $
    (45,031
    )
    
    $
    153,141
 Effective January 1, 2005, the Company revised its estimate for the remaining useful lives for
certain of its core and developed technology intangible assets. The effect of the change was to
decrease amortization expense by $0.1 million during the three months ended April 2, 2005 and is
expected to decrease amortization by $0.5 million during each of the next five years. Amortization
expense related to purchased intangible assets, net was $2.8 million and $2.9 million for the three
months ended April 2, 2005 and April 3, 2004, respectively. Amortization expense is expected to be
approximately $11.2 million for each of the next five years. Patents and trademarks have useful
lives of eight to twenty years, core and developed technology assets have useful lives ranging from
nine to twenty four years and the useful life of the non-compete agreement is approximately six
years. 10




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10. 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. Treasury securities to provide for the payment, in full,
of the first six scheduled interest payments. These securities are reflected on our condensed
consolidated balance sheets as restricted short-term and long-term investments. 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 of these convertible notes 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 $3.8 million, net of $0.5 million in amortization, 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 condensed consolidated statement
of operations. Long Term Debt Offering Proceeds (in millions):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 for conversion 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. As of the quarter ended April 2,
2005, no notes have been converted or called. 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 April 2, 2005 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 11




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accrued and unpaid interest and liquidated damages, if any for our failure to comply with our
registration obligations regarding the convertible notes. 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. The aggregate fair value of the convertible notes at April 2, 2005, based on market quotes,
was $129.3 million. 11. Common Stock In February 2004 and again in July 2004, the Board of Directors authorized stock repurchase
programs under which up to $50 million in the aggregate 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 are 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 April 2, 2005, we had repurchased and retired 8.5 million shares with an
aggregate purchase price of $104.9 million under these combined programs. 12. Litigation and Other Costs Litigation and other costs are comprised of: Three Months EndedApril 2,
    
    
    April 3,2005
    
    
    2004(in thousands)Litigation
    
    $
    178
    
    
    $
    133
 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. We have successfully defended ourselves
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. Subsequent to the filing of the Johnson complaint, additional
complaints were filed in the same court alleging substantially similar claims. On November 24,
2004, the Court entered an order consolidating the various putative class action complaints into a
single action entitled In re Thoratec Corp. Securities Litigation and thereafter entered an order
appointing Craig Toby as Lead Plaintiff pursuant to the Private Securities Litigation Reform Act
of 1995. On January 18, 2005, Lead Plaintiff filed a Consolidated Complaint. The Consolidated
Complaint generally alleges violations of the Securities Exchange Act of 1934 by the Company, its
chief executive officer, cardiovascular division president and 12




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former chief financial officer based upon, among other things, alleged false statements about
the Companys expected sales and the market for HeartMate as a Destination Therapy treatment. The
Consolidated Complaint seeks to recover unspecified damages on behalf of all purchasers of the
Companys publicly traded securities during the putative class period. On March 4, 2005, defendants
moved to dismiss the Consolidated Complaint and that motion currently is pending. On or about September 1, 2004, a shareholder derivative action entitled Wong v. Grossmanwas filed
in the California Superior Court for Alameda County based upon essentially the same facts as the
Federal securities class action suits referred to above. This action names the individual members
of the Companys Board of Directors, including the Chief Executive Officer and our former 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. We believe that the claims asserted in both the Federal securities law putative class action
and the state shareholder derivative actions are without merit. We have moved to dismiss the
Federal action and will file a similar motion in the Wong action if necessary. We are unable to
predict at this time the final outcome of these actions. We carry sufficient insurance to cover what management believes to be any reasonable exposure
on these actions; however, we cannot give assurance that our insurance will cover all costs or
other exposures we may incur with respect to these actions. 13. Income Taxes Our effective income tax expense rates were 34% and 39%, respectively, for the first quarters
of 2005 and 2004. The reduction in our effective tax expense rate is due primarily to additional
interest income from tax favorable investments and increased research tax credits. In addition, we
have reserved amounts for anticipated tax audit adjustments in the U.S., state and other foreign
tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and
interest may be due. At April 2, 2005 and January 1, 2005, we reported a net deferred tax liability of
approximately $48.0 million and $49.2 million, respectively, comprised principally of temporary
differences between the financial statement and income tax bases of intangible assets. 14. Net Income Per Share Basic and diluted net income per share were calculated as follows: Three Months EndedApril 2,
    
    
    April 3,2005
    
    
    2004(in thousands, except per share data)Net income
    
    $
    3,135
    
    
    $
    1,294Weighted average number of common shares-basic
    
    
    48,202
    
    
    
    56,106Dilutive effect of stock options & ESPP Shares
    
    
    807
    
    
    
    1,352Weighted average number of common
shares-diluted
    
    
    49,009
    
    
    
    57,458Net income per common share-basic
    
    $
    0.07
    
    
    $
    0.02Net income per common share-diluted
    
    $
    0.06
    
    
    $
    0.02
 Basic earnings per share are computed by dividing net income by the weighted average number of
common shares outstanding during the period. Diluted earnings per share reflect the potential
dilution that could occur if securities or other contracts to issue common stock were exercised or
converted into common stock. Options to purchase 5.9 million and 3.7 million shares of common stock
were not included in the computation of diluted earnings and losses per share for the three months
ended April 2, 2005 and April 3, 2004, respectively, as their inclusion would be antidilutive. In
addition, the computation of diluted earnings per share excludes the effect of assuming the
conversion of our convertible notes, which are convertible at $19.72 per share into 7.3 million
shares of common stock, because their effect would have been antidilutive for the three months
ended April 2, 2005. The 13




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convertible notes were not issued as of April 3, 2004 therefore there was no effect on the
computation for diluted earnings per share for the three months then ended. 15. Business Segment and Geographical Data We organize and manage our business by functional operating entities. Our functional entities
operate in two segments: Cardiovascular and ITC. The Cardiovascular segment develops, manufactures
and markets proprietary medical devices used for circulatory support and vascular graft
applications. The ITC segment designs, develops, manufactures and markets point-of-care diagnostic
test systems and incision devices. Business Segments: Three Months EndedApril 2,
    
    
    April 3,2005
    
    
    2004(in thousands)Product sales:Cardiovascular
    
    $
    32,066
    
    
    $
    26,553ITC
    
    
    18,422
    
    
    
    16,239Total product sales
    
    $
    50,488
    
    
    $
    42,792Income before income taxes:Cardiovascular(a)
    
    $
    6,128
    
    
    $
    2,894ITC(a)
    
    
    3,151
    
    
    
    2,292Corporate (b)
    
    
    (4,179
    )
    
    
    (3,397
    )Litigation and other costs (c)
    
    
    (178
    )
    
    
    (133
    )Income from operations
    
    
    4,922
    
    
    
    1,656Other income and (expense):Interest expense
    
    
    (1,008
    )
    
    
    Interest income and other
    
    
    836
    
    
    
    465Income before income tax expense
    
    $
    4,750
    
    
    $
    2,121
   (a)
    
    Amortization expense of $2.8 million and $2.9 million for the three months ended
April 2, 2005 and April 3, 2004, respectively, related to the Cardiovascular segment. The ITC
segment had amortization expense of $40,000 and $39,000 for the same three month periods.(b)
    
    Represents primarily general and administrative items not specifically identified to a
particular business segment.(c)
    
    Relates to expenses not specifically identified to a particular business segment. Geographic Areas: The geographic composition of our product sales were as follows: Three Months EndedApril 2,
    
    
    April 3,2005
    
    
    2004(in thousands)Domestic
    
    $
    39,204
    
    
    $
    33,781International
    
    
    11,284
    
    
    
    9,011Total
    
    $
    50,488
    
    
    $
    42,792
 14




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements This
Quarterly Report onForm 10-Qincludes 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
statements can be identified by the words expects, projects, hopes, believes, intends,
should, estimate, will, would, may, anticipates, plans, could, and words of similar
import and the negatives thereof. Actual results could differ materially from these forward-looking
statements based on a variety of factors, many of which are beyond our control. Therefore, readers
are cautioned not to put undue reliance on these statements. Investors are cautioned that all such
statements involve risks and uncertainties, including risks related to the development of new
markets such as Destination Therapy, the growth of existing markets for our products, customer and
physician acceptance of our products, changes in the mix of our product sales and the related gross
margin for such product sales, 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 our product sales, the effects
of price competition from any of our competitors and the effects of any merger and acquisition
related activities. Factors that could cause actual results or conditions to differ from those
anticipated by these and other forward-looking statements include those more fully described in the
Factors That May Affect Future Results section and in other documents we file with the Securities
and Exchange Commission, or SEC. Actual results, events or performance may differ materially. These
forward-looking statements speak only as of the date hereof. We undertake no obligation to publicly
release the results of any revisions to these forward-looking statements that may be made to
reflect events or circumstances after the date hereof, or to reflect the occurrence of
unanticipated events. The following presentation of managements discussion and analysis of our financial condition
and results of operations should be read together with our consolidated financial statements
included in thisForm 10-Q, and our Annual Report onForm 10-Kfor 2004 filed with the SEC. Overview We are a leading manufacturer of circulatory support products for use by patients with
congestive heart failure, or CHF. Our Ventricular Assist Devices, or VADs, are used primarily by
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 wholly-owned subsidiary, ITC, we design, develop, manufacture and market
point-of-care diagnostic test systems and incision products that provide for fast, accurate blood
test results to improve patient management, reduce healthcare costs and improve patient outcomes. Our Business Model Our business is comprised of two segments; Cardiovascular and ITC. The major product lines within the Cardiovascular segment are:  
    Circulatory Support Products.Our circulatory support products include VADs for the
short-term and long-term treatment of congestive heart failure.
    Vascular Graft Products.We have developed small diameter grafts using our proprietary
materials to address the vascular access market. Our grafts are sold in the United States
and internationally for use in hemodialysis. The major product lines of our ITC segment are: 15




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
    Point-of-Care Diagnostics. Our point-of-care products include coagulation diagnostic
test systems that monitor a patient while being administered certain anticoagulants, blood
gas/electrolyte and chemistry status, or anemia.  
    Incision. Our incision products include devices used to obtain a patients blood sample
for diagnostic testing and screening for platelet function. Cardiovascular segment We offer a broad product portfolio of implantable and external circulatory support product
devices comprised of:  
    The Thoratec Ventricular Assist Device System is an external device for short to
mid-term cardiac support, which is sold worldwide. The device is approved to assist the
left and the right ventricle and is worn outside of the body. The Thoratec VAD is approved
for use in bridge-to-transplant, or BTT.
    The Thoratec Implantable Ventricular Assist Device, or IVAD, is the only
bi-ventricular implantable blood            pump approved for BTT and post-cardiotomy recovery.
It can be used for left, right, or biventricular support. The IVAD utilizes the same
internal working components as the Thoratec VAD System blood pump, but has an outer housing
made of a titanium alloy that makes it more suitable for implantation.
    The HeartMate Left Ventricular Assist System, also called the HeartMate XVE, is an
implantable device for mid to long-term cardiac support and the only device approved in the
United States, Europe and Canada for permanent support of those patients ineligible for
heart transplantation. The HeartMate XVE is approved for use in both BTT and Destination
Therapy, or permanent support for patients suffering from end-stage heart failure who are
not eligible for heart transplantation.
    The HeartMate II, which is currently in clinical trials for BTT and Destination
Therapy, is an implantable LVAS consisting of a miniature rotary blood pump that is
designed to provide long-term support. Its design is intended to be not only smaller, but
also simpler, quieter, and longer lasting than current generation assist devices.
    The Vectravascular access graft is designed for use as a shunt between an artery and a
vein, primarily to provide access to the bloodstream for renal hemodialysis patients
requiring frequent needle punctures during treatment. The primary markets for our VAD products are those patients suffering from heart failure and,
in particular, from CHF. CHF is a chronic disease that occurs when degeneration of the heart muscle
reduces the pumping power of the heart, causing the heart to become too weak to pump blood at a
level sufficient to meet the bodys demands. CHF can be caused by artery or valve diseases or a
general weakening of the heart muscle itself. Other conditions, such as high blood pressure or
diabetes, can also lead to CHF. In the United States, there are currently two FDA-approved indications for the use of VADs in
patients with CHF  as a bridge to heart transplant and as Destination Therapy. We are currently
pursuing one additional indication for our Thoratec VAD products  for therapeutic recovery of the
heart. Beyond the CHF markets, VADs are also approved for use during recovery following cardiac
surgery. We currently market VADs that may be implanted or worn outside the body and that are suitable
for treatments for different durations for patients of varying sizes and ages. We estimate that
doctors have implanted over 9,500 of our devices in patients suffering from heart failure. Our
devices are currently used primarily for patients awaiting a heart transplant or Destination
Therapy implants. On November 6, 2002, the United States Food and Drug Administration, or FDA,
approved the HeartMate VAD as the first heart assist device for Destination Therapy. On April 7,
2003, the FDA approved the HeartMate XVE, an enhanced version of the HeartMate VAD, for Destination
Therapy. Thoratec is the only company to have a ventricular assist device approved for Destination
Therapy in the United States. In August 2004, we received FDA approval in the U.S. to market the
IVAD for use in bridge-to-transplantation and post-cardiotomy recovery patients who are unable to
be weaned from cardiopulmonary bypass. This makes the IVAD the only currently approved implantable
cardiac assist device that can provide left, right or biventricular support. 16




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ITC Segment The major product lines of diagnostic test systems and incision device products are:  
    The Hemochron Point of Care, or POC, coagulation system is used to monitor a patients
coagulation while being administered anticoagulants in various settings, including in the
cardiovascular operating room to monitor the drug Heparin and in an anticoagulation clinic
to monitor the drug Coumadin. Hemochron is considered a moderately complex device and must
be used by professionally trained personnel. The system consists of a small, portable
analytical instrument and disposable test cuvettes.
    The Immediate Response Mobile Analysis, or IRMA, POC blood gas/electrolyte and
chemistry system is used to monitor a patients blood gas/electrolyte and chemistry status.
It is considered moderately complex and its use requires supervision by professionally
trained personnel. The system consists of a small, portable analytical instrument and
disposable test cartridges.
    The ProTime coagulation monitoring system is used to monitor a patients coagulation
while they are taking oral anticoagulants such as Coumadin, and can be prescribed to be
used by patients at home or can be used in the physicians office or clinic. The system
consists of a small, portable analytical instrument and disposable test cuvettes.
    The Hemoglobin Pro System (Hgb Pro) is used by professionals, mainly in the doctors
office to test for anemia; providing quick results on a very small blood sample. The system
consists of a small, hand held test meter and disposable test strips.
    Tenderfoot, Tenderlett and Surgicutt incision products are used by professionals to
obtain a patients blood sample for diagnostic testing. The tenderfoot is a heel stick
used for infant testing, Tenderlett is used for finger incisions and the Surgicutt is used
to perform screening tests to determine platelet function. All products feature
permanently retracting blades for safe, virtually pain-free incision. The Hemochron and IRMA products are primarily sold into the Hospital POC segment of the
market. The ProTime and Hemoglobin Pro products are sold into the Alternate Site POC market
comprising physicians offices, long-term care facilities, clinics, visiting nurse associations,
and home healthcare companies. Our incision products are sold to both the Hospital POC market and the Alternate Site POC.
Our most successful incision product is the Tenderfoot. Although we market this product based on
its high-end features, we believe that, in the long-term, customers will increasingly make
purchasing decisions on these types of products based on price. Therefore, we expect a gradual
erosion of market share over time. Critical Accounting Policies and Estimates 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 below. For a more detailed discussion on the
application of these and other accounting policies, see the notes to the condensed consolidated
financial statements included in this Quarterly Report on Form 10-Q and our Annual Report on Form
10-K for fiscal 2004 filed with the SEC. 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 Purchased Intangibles and Goodwill 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 subject to amortization, 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 17




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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 any of these estimates proves incorrect, the carrying value of these assets on our
consolidated balance sheet could become significantly impaired. As of the beginning of fiscal year 2002, we adopted SFAS No. 142, Goodwill and Other
Intangible Assets, and ceased amortizing purchased goodwill. Since then, we complete an annual
impairment test of goodwill and other intangible assets subject to amortization as required by SFAS
No. 142 and SFAS No. 144. Upon completion of our impairment tests as of the end of the year 2004,
we determined that neither goodwill nor intangible assets were impaired. Based on changes in
business conditions, we did modify the economic useful lives of certain components of our core and
developed technology assets which had an immaterial impact on our results of operations for the
three months ended April 2, 2005. Revenue Recognition We recognize revenue from product sales for our Cardiovascular and ITC business segments 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. One other distributor has certain rights of return upon
termination of its distribution agreement. A reserve for sales returns is recorded for these
customers applying reasonable estimates of product returns based upon 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.
Training is not considered essential to the functionality of our products. The amount of revenue
under these arrangements allocated to training is based upon the fair market value of the training,
which is typically performed on behalf of the Company by third party providers. The amount of
product sales allocated to the Cardiovascular segment products is done on a fair value basis. Under
this basis, the total value of the arrangement is allocated to the training and the Cardiovascular
segment products based on the relative fair market value of the training and the 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 end of the fiscal quarter ended April 2, 2005, 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 end of the three months ended April 2, 2005 and none at the 2004
fiscal year end. 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. In determining when to recognize revenue, management makes decisions on such matters as the
relative fair values of the product and training elements when sold together, customer credit
worthiness and warranty reserves. If these decisions prove incorrect, the carrying value of these
assets and liabilities on our consolidated balance sheet could be significantly different. 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. Management must make judgments to determine the amount of reserves to accrue. If management
estimates prove incorrect, our financial statements could be adversely affected. 18




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Accounting Pronouncements In December 2004, the FASB issued statement 123® Share-Based Payment. This statement
requires 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. Our adoption of this
statement, which we expect to occur in the first quarter of 2006, will have a material, although
non-cash, impact on our consolidated statements of operations. 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 EndedApril 2,
    
    
    April 3,2005
    
    
    2004Product sales
    
    
    100
    %
    
    
    100
    %Cost of sales
    
    
    40
    
    
    
    41Gross profit
    
    
    60
    
    
    
    59Operating expenses:Selling, general and administrative
    
    
    30
    
    
    
    31Research and development
    
    
    15
    
    
    
    17Amortization of purchased intangible assets
    
    
    6
    
    
    
    7Litigation and other costs
    
    
    
    
    
    
    Total operating expenses
    
    
    51
    
    
    
    55Income from operations
    
    
    9
    
    
    
    4Other income and (expense):Interest expense
    
    
    (2
    )
    
    
    Interest income and other
    
    
    2
    
    
    
    1Income before income tax expense
    
    
    9
    
    
    
    5Income tax expense
    
    
    3
    
    
    
    2Net income
    
    
    6
    %
    
    
    3
    %
 See Note 15 to our unaudited condensed consolidated interim financial statements in this report for
data presented by business segment. Three months ended April 2, 2005 and April 3, 2004 Product Sales Product sales in the first quarter of 2005 were $50.5 million compared to $42.8 million in the
first quarter of 2004. The Cardiovascular segment increased sales by $5.5 million and the ITC
segment increased sales by $2.2 million. Product sales increases are due to an increase in volume
unless otherwise noted. The primary components of the total $7.7 million increase in product sales
were the following:  
    VAD product sales increased $4.4 million. The majority of this increase came from
higher sales of the IVAD product line of $4.1 million.
    Other ancillary product sales, (drivers, cannulae, service, rentals and spares)
increased $0.9 million, including an increase in TLC II driver revenue principally from
Home Discharge, which was approved by the FDA toward the end of the second quarter of
2004.
    Graft product sales increased by $0.2 million due to a higher average selling price.
    Point-of-care diagnostic product sales increased $2.7 million, due primarily to a $1.1
million increase in sales in our Hemochron product line coupled with modest increases in
sales of our IRMA, ProTime and Hemoglobin products quarter over quarter. 19




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
    Incision product sales decreased by $0.5 million due in part to lower volume offset by
higher average selling prices. For the three months ended April 2, 2005 and April 3, 2005, sales originating ourside of the United
Staes and U.S. export sales accounted for approximately 22% and 23%,
respectively, of our total
product sales. Gross Profit Gross profit in the first quarter of 2005 was 60% compared to 59% in the first quarter of
2004. The change in gross profit was due to the following fluctuations:  
    The Cardiovascular segment increased gross profit by 1% due to higher incremental
revenue in conjunction with higher margin VAD product sales offset by an increase in
manufacturing costs;  
    The ITC segment increased gross profit by 3%, due to higher incremental revenue in
higher margin products and increased margins in the point-of-care market related to the
shift in mix from distributor to direct channels sales. Selling, General and Administrative Selling, general and administrative expenses in the first quarter of 2005 were $14.8 million,
or 30% of product sales, compared to $13.0 million, or 31% of product sales, in the first quarter
of 2004. The $1.8 million increase in spending resulted from:  
    Increased personnel costs associated with higher product sales in both the
Cardiovascular and ITC segments totaling $0.7 million.  
    Higher spending on marketing and related activities, primarily associated with our
HeartHope Center Program, Destination Therapy, and costs associated with the IRMA product
line totaling $0.3 million.  
    Higher professional fees, including legal, audit and financial consulting services
relating to our compliance with the Sarbanes-Oxley Act of 2002 and project related business
development activities of an additional $0.8 million. Research and Development Research and development expenses in the first quarter of 2005 were $7.7 million compared to
$7.3 million in the first quarter of 2004, representing 15% and 17% of product sales for the
respective periods. Our Cardiovascular and ITC segment each incurred $0.2 million of the increase
in expenses quarter over quarter. 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 . Amortization of Purchased Intangible Assets Amortization of purchased intangible assets in the first quarter of 2005 was $2.8 million
compared to $2.9 million in the first quarter of 2004. The decrease of $0.1 million is the result
of changes in business conditions which caused us to modify the remaining economic useful lives of
certain of our core and developed technology assets. These changes were made in accordance with
our periodic valuation of the useful lives of our identifiable intangible assets under FAS 144 as
of January 1, 2005. Interest Expense Interest expense for the first quarter 2005 was $1.0 million compared to none in the first
quarter of 2004. This expense in first quarter of 2005 includes $0.8 million in interest payments
and $0.2 million in amortization of the 20




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debt issuance costs related to our convertible notes issued in May 2004. We did not have
these notes or any other debt instrument in the first quarter of 2004. Interest Income and Other Interest income and other for the three months ended April 2, 2005 was $0.8 million compared
to $0.5 million in the three months ended April 3, 2004. This increase was primarily due to higher
interest income earned on our portfolio based on increased cash balances, as a result of the
convertible notes issuance, in the first quarter of 2005 compared to the first quarter of 2004,
before the notes were issued. Income Taxes Our effective income tax expense rates were 34% and 39%, respectively, for the first quarters
of 2005 and 2004. The reduction in our effective tax expense rate is due primarily to additional
interest income from tax favorable investments and increased research tax credits. In addition, we
have provided adequate amounts for anticipated tax audit adjustments in the U.S., state and other
foreign tax jurisdictions based on our estimate of whether, and the extent to which, additional
taxes and interest may be due. If events occur which indicate payment of these amounts are
unnecessary or the liability proves to be more than anticipated, the reversal of the liabilities
would result in tax benefits being recognized or a further charge to expense would result in the
period the event occurs. Our effective tax rate is calculated based on the statutory tax rate imposed on projected
annual pre-tax income or loss in various jurisdictions. Since relatively small changes in our
forecasted profitability for 2005 can significantly affect our projected annual effective tax rate,
we believe our quarterly tax expense rate of 34% is the most reliable estimate of our effective tax
expense rate. Accordingly, our quarterly tax rate for the second quarter and the remainder of 2005
will be largely dependent on our profitability and could fluctuate significantly. Liquidity and Capital Resources At April 2, 2005, we had working capital of $209.8 million compared with $206.3 million at
January 1, 2005. Cash and cash equivalents and short-term available-for-sale investments at April
2, 2005 were $152.4 million compared to $145.9 million at January 1, 2005. The increase is due
primarily to cash generated from operations, offset in part by net purchases of property, plant and
equipment and repurchases of our common stock. Cash provided by operating activities for the three months ended April 2, 2005 was $9.8
million. Investing activities used $4.5 million, with $3.4 million net purchases of investments
and $1.1 million to acquire property, plant and equipment, net of $0.5 million in inventory
transfers of product for demonstration purposes. The purchases of property, plant and equipment
consisted of equipment purchases of $1.6 million, of which $1.0 million of the purchases relates to
the Cardiovascular segment and $0.6 million relates to the ITC segment. Cash used in financing
activities for the quarter was $1.7 million, including $2.2 million paid to repurchase 0.2 million
shares of stock under our stock repurchase programs, partially offset by $0.5 million from proceeds
related to stock option exercises and our Employee Stock Purchase Plan. In March 2005, we agreed to purchase a new enterprise resource planning software system (ERP
system) for our ITC segment. The estimated cost of the purchased software licenses,
hardware, implementation costs and consulting for the ERP system is approximately $0.8 million over the 2005
fiscal year. 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. 21




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FACTORS THAT MAY AFFECT FUTURE RESULTS Our business faces many risks. These risks include those related to the development of new
products and markets including Destination Therapy, the growth of existing markets for our
products, customer and physician acceptance of our products, changes in the mix of our product
sales, and the related gross margin for such product sales, the results of clinical trials,
including those for the HeartMate II, the ability to improve financial performance, regulatory
approval processes, the effect of healthcare reimbursement and coverage policies, our product
sales, the effects of price competition from any of our 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 onForm 10-K, and other documents we file from time to time with the
SEC, such as our current reports onForm 8-Kand any public announcements we make from time to
time. We have a history of net losses. We were founded in 1976 and we have a history of incurring losses from operations. 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 and equity based compensation 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 uncertainty 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
Medicine & Medicaid Services, or the 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) pre-market notification or approval of a more extensive submission known as a 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, thereby harming
our ability to generate sales. The FDA may also limit the 22




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claims that we can make about our products. We may also be required to obtain clearance of a
510(k) notification or PMA 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. Commencing on or about August 3, 2004, several Federal securities law putative class action
suits were 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. These suits were consolidated in a consolidated complaint filed on or about January
18, 2005. The complaint seeks to recover unspecified damages on behalf of all purchasers of our
publicly traded securities during the class period. On or about September 1, 2004, a shareholder derivative action entitled Wong v. Grossmanwas
filed in the California Superior Court for Alameda County based upon essentially the same facts as
the Federal securities suit. This action names the individual members of our Board of Directors,
our Chief Executive Officer and our former Chief Financial Officer as defendants. In June of 2004, MicroMed Technology, Inc., a potential competitor of ours, sued us in Texas.
MicroMed sought injunctive relief against us in connection with our HeartMate II Phase I clinical
trial on the grounds that we 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 our HeartMate II clinical trial. We have
successfully defended ourselves 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. We believe that the claims asserted in the MicroMed action, and both the Federal securities
law putative class action and the state shareholder derivative action are without merit. We have
filed a motion to dismiss in the Federal securities law putative class action and the shareholder
suit currently is stayed through to at least early July 2005. We are unable to predict at this time the final outcome of these actions. We carry sufficient insurance to cover what management believes to be any reasonable exposure
on these actions; however, we cannot give assurance that our insurance will cover all costs or
other exposures we may incur with respect to these actions. 23




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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. The terms of our convertible notes do not restrict our
ability to incur additional indebtedness, including indebtedness senior to the convertible notes.
The level of our indebtedness, among other things, could:  
    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 (i.e., they are Destination Therapy patients) 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 depends 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;
    cardiologists and referring physicians education, and their commitment to Destination Therapy;
    the economics of the Destination Therapy procedure for individual hospitals, which
include 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 24




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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. The long and variable sales and deployment cycles for our VAD systems may cause our product sales
and operating results to vary significantly, which increases the risk of an operating loss for any
given fiscal period. 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 customers may purchase our VAD systems and our product sales 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 the level of revenues we expect. Physicians may not accept or continue to accept our current 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. 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 has substantially increased during the past several years. We
expect to continue increasing the number of our employees, and our business 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 fail to
commercialize 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. 25




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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. A substantial portion of our assets are comprised of goodwill and purchased intangible assets.
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 the revenue from, and recoverability of, these intangible assets is impaired.
We completed an assessment of the current values of our intangible assets at the year ended 2004
and determined that no impairment exists, however the lives have been modified on several
components of these identified assets. In the event, however, 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, instruments and materials used in
our VAD products and blood testing products. For example, single sources currently manufacture and
supply our ProTime and Hemoglobin instruments and the heart valves used in our HeartMate products.
The suppliers of our ProTime and Hemoglobin products are located in China and Germany,
respectively. 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 and or our point-of-care 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 require
FDA approval before using new suppliers or manufacturing our own components or materials. Existing
suppliers could also become 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 obtain
alternative suppliers;
    buy substantial inventory to last 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 product sales and increases in our production costs. 26




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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. Principal competitors for the VAD
system include WorldHeart Corporation, MicroMed Technology, Inc., Abiomed, Inc., and Berlin Heart
in Europe. Principal competitors in the vascular graft market include W.L. Gore, Inc., C.R. Bard
Corporation, which is also a distributor of our Vectraproduct line, 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. Large medical device companies dominate the markets in which ITC competes. We expect that any
growth in this market will come from expanding our market share at the expense of other companies,
and from testing being shifted away from central laboratories to the point-of-care. However, this
market segment is very competitive, and includes the following potential drivers:  
    New drug therapies under development may not require the intense monitoring of a
patients coagulation that the current anti-coagulation drug of choice (Heparin) requires.  
    New competitors might enter the market with broader test menus. Any of the devices of our competitors in clinical trials and in development could prove to be
clinically superior, easier to implant, and/or less expensive than current commercialized devices,
thereby impacting Thoratecs marketshare. 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 $14.99 in the 12 months ended April 2, 2005. 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; 27




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
    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
    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. Several 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. If we have difficulty manufacturing any of 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 may be harmed. With the exception of Canada and the larger countries in Europe, we sell our Thoratec 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 (which is
also a competitor of ours) in the United States, and selected countries in Europe, 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 ITC are conducted
through distributors. For the quarter ended April 2, 2005, 16% of ITCs 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 or no control. If we lose a distributor or a distributor fails to
perform to our expectations, our product sales may be harmed. Changes we make to our method of distributing and selling our products could hurt our relationship
with distributors and their customers. In March 2004, we began changing our manner of distributing our Hemochron product line to our
hospital point-of-care customers in the United States from a distributor model to a direct sales
model. This transition to a direct sales model necessitated expanding the sales, technical service,
customer service and 28




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shipping headcount at ITC 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. This transition process concluded in the first quarter of 2005, which
resulted in the United States hospital point-of-care market now being served directly and
exclusively by ITC. This transition and its execution involve significant risks, including:  
    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  
    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. 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 majority 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 our HeartMate product line. 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 us by Bodycote Materials
Testing Canada, Inc. and David C. MacGregor, M.D. related to materials used in the HeartMate LVAS.
On February 3, 2004, we 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 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 29




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against potential liabilities. A successful claim brought against us in excess 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 acceptance 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 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. A substaintial portion of our total sales occurs outside the United States. 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. 30




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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 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, or the Act, beginning in 2004 we are required to assess
the effectiveness of our internal controls for financial reporting annually 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.
The Act has resulted in and is likely to continue to result in increased expenses, and has required
and is likely to continue to require significant efforts by management and other employees.
Although we believe that our efforts will enable us to remain compliant under the Act, we can give
no assurance that in the future such efforts will be successful. Our business is complex and
involves significant judgments and estimates as described in our Critical Accounting Estimates.
If we have material weaknesses in internal controls, we will not be able to assert that our
internal controls over financial reporting are effective, which could adversely effect investor
confidence in us 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. 31




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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 for talent 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. 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 any 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. Our adoption of Emerging Issues Task Force (EITF) Issue No. 04-8 in the fourth quarter of
2004, which requires the inclusion of all shares available upon conversion of our convertible notes
in our diluted earnings per share, or EPS, regardless of whether the notes are then convertible,
did 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 was anti-dilutive. However, if in future
periods the shares are 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 we had not adopted 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. 32




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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. 
 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 auction
rate securities, money market funds, debt instruments of government agencies, U.S. Treasuries,
local municipalities, 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, except for some investments in U.S. Treasuries held as restricted investments
as collateral for future interest payments related to our convertible debt, which mature within
three years from the date of purchase. Our holdings of the securities 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. If interest rates were to rise or fall from current levels by 25
basis points the change in our net unrealized loss on investments would be nominal. 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 to 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 Income
and Other. 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 Interest Income and Other. 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 April 2, 2005 and April 3, 2004, we had
forward foreign currency contracts in Pounds Sterling and Euros with a notional value of $7.0
million and $10.3 million, respectively. These contracts had an average exchange rate of Euros to
Pounds Sterling of .6929 and Pounds Sterling to the U.S. dollar of .5346 as of April 2, 2005. The
impact of fluctuations in foreign currency exchange rates, net of forward foreign currency
contracts, was negligible for the periods ended April 2, 2005 and April 3, 2004. 
 ITEM 4. CONTROLS AND PROCEDURES Attached as exhibits to this Form 10-Q are certifications of our Chief Executive Officer and
principal financial officer, which are required in accordance with Rule 13a-14 of the Securities
Exchange Act of 1934, as amended (the Exchange Act). This Controls and Procedures section
includes information concerning the controls and controls evaluation referred to in the
certifications. Item 8 of our 2004 Annual Report on Form 10-K sets forth the report of Deloitte &
Touche LLP, our independent registered public accounting firm, regarding its audit of our internal
control over financial reporting and of managements assessment of internal control over financial
reporting. Disclosure Controls and Procedures An evaluation was performed under the supervision and with the participation of our
management, including our Chief Executive Officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure controls and procedures, as defined in
Rule 13a-15(e) under the Exchange Act, as of April 2, 2005. The 33




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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 on Form
10-Q. In the course of this evaluation, we sought to identify any significant deficiencies or
material weaknesses in our disclosure controls and procedures, to determine whether we had
identified any acts of fraud involving personnel who have a significant role in our disclosure
controls and procedures, and to confirm that any necessary corrective action, including process
improvements, was taken. This type of evaluation is done quarterly 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 evaluation activities are to monitor our disclosure controls
and procedures and to make modifications as necessary. We intend to maintain these disclosure
controls and procedures, modifying them as circumstances warrant. Based on that evaluation, our management, including the Chief Executive Officer and principal
financial officer, concluded that as of April 2, 2005 the Companys disclosure controls and
procedures, as defined in Rule 13a-15(e) under the Exchange Act, were effective. Changes to Internal Controls As part of the implementation of section 404 of the Sarbanes Oxley Act, the Company instituted
internal controls that were designed to and did detect the situation which resulted in the
restatement of the pro forma stock compensation fair value disclosures for the years ended January
3, 2004 and December 28, 2002. Management concluded that the control deficiency which resulted in
the restatement was not indicative of a material weakness in internal controls as of January 1,
2005. There have been no changes in our internal controls over financial reporting during the
first quarter 2005 that have materially affected or are reasonably likely to materially affect our
internal control over financial reporting. Inherent Limitations on Controls and Procedures Our management, including the Chief Executive Officer and the principal financial officer,
does not expect that internal controls will prevent all error and all fraud. A control system, no
matter how well designed and operated, can only provide reasonable 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 fraud, if any, within the company have been or will be
detected. As these inherent limitations are known features of the financial reporting process, it
is possible to design into the process safeguards to reduce, though not eliminate, these risks.
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. While our disclosure controls and procedures are designed to
provide reasonable assurance of achieving their objectives, 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 review and evaluate the design and effectiveness of our disclosure controls and
procedures on an ongoing basis and to improve our controls and procedures over time and to correct
any deficiencies that we may discover in the future. While our Chief Executive Officer and
principal financial officer have concluded that, as of April 2, 2005, the design of our disclosure
controls and procedures, as defined in Rule 13a-15(e) under the Exchange Act, was effective, future
events affecting our business may cause us to significantly modify our disclosure controls and
procedures. 34




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PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS See Note 12 to our unaudited condensed consolidated interim financial statements in this Quarterly
Report on Form 10Q. 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS (a) Recent Unregistered Sales of Equity Securities. None (c) Purchases of Equity Securities by the Issuer. Our stock repurchase programs, which authorized us to repurchase up to $110 million of shares
of the Companys common stock, were announced on February 11, 2004 as a $25 million of shares
program, on May 12, 2004 as a $60 million shares program, and on July 29, 2004 as an additional $25
million share program. These programs do not have an expiration date. The table below sets forth
the information with respect to repurchases made under these stock repurchase programs during each
month in the first quarter of 2005. 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 2, 2005 to January 29, 2005
    
    
    232,500
    
    
    $
    9.63
    
    
    
    232,500
    
    
    $
    5.1January 30, 2005 to February 26, 2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    5.1February 27, 2005 to April 2, 2005
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    5.1Total
    
    
    232,500
    
    
    $
    9.63
    
    
    
    232,500
 
 ITEM 6. EXHIBITS (a) Exhibits:  10.30
    Thoratec Corporation Corporate Executive Incentive Plan FY2005, effective for
certain executive officers of the Company.10.31
    Thoratec Corporation Cardiovascular Business Executive Incentive Plan FY2005,
effective for certain executive officers of the Company.10.32
    International Technidyne Corporation Executive Incentive Plan FY2005, effective
for certain executive officers of the Company.31.1
    Section 302 Certification of Chief Executive Officer31.2
    Section 302 Certification of principal financial officer.32.1
    Section 906 Certification of Chief Executive Officer32.2
    Section 906 of principal financial officer. 35




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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: May 11, 2005
    
    /s/ D. Keith GrossmanD. Keith Grossman,Chief Executive OfficerDate: May 11, 2005
    
    /s/ Jeffrey M. McCormickJeffrey M. McCormick,Corporate Controller,(principal financial and accounting officer)
 36