##### 



U.S. SECURITIES AND EXCHANGE COMMISSION  WASHINGTON, D.C. 20549
 FORM 10-Q (Mark one) [X]
    
    Quarterly report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
 For the quarterly period ended July 3, 2004 or [  ]
    
    Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
 for the transition period from            to COMMISSION FILE NUMBER: 1-8145 THORATEC CORPORATION (Exact name of registrant as specified in its charter)
 California
(State or other jurisdiction of
incorporation or organization)
    
    94-2340464

(I.R.S. Employer Identification No.)6035 Stoneridge Drive, Pleasanton, California
(Address of principal executive offices)
    
    94588
(Zip Code)
 Registrants telephone number, including area code: (925) 847-8600 Indicate by check mark whether the registrant:(1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act):Yes [X] No [  ] As of August 5, 2004 registrant had 50,143,386 shares of common stock
outstanding.




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##### 



THORATEC CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS Part I. Financial Information
    
    
    3Item 1. Condensed Consolidated Financial Statements (unaudited)
    
    
    3Condensed Consolidated Balance Sheets as of July 3, 2004 and January 3, 2004
    
    
    3Condensed Consolidated Statements of Operations for the Three and Six Months Ended July 3, 2004 and June 28, 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the Six Months Ended July 3, 2004 and June 28, 2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosure of Market Risk
    
    
    34Item 4. Controls and Procedures
    
    
    35Part II. Other Information
    
    
    36Item 1. Litigation
    
    
    36Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    36Item 4. Submission of Matters to a Vote of Security Shareholders
    
    
    37Item 6. Exhibits and Reports on Form 8-K
    
    
    38Signatures
    
    
    39Exhibits
    
    
    40
 2




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##### 



PART I. FINANCIAL INFORMATION 
 ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THORATEC CORPORATION AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(in thousands) July 3,
    
    January 3,2004
    
    2004AssetsCurrent Assets:Cash and cash equivalents
    
    $
    125,910
    
    
    $
    62,020Short-term available-for-sale investments
    
    
    42,566
    
    
    
    Restricted short-term investments
    
    
    3,306
    
    
    
    Receivables, net of allowances of $541 and $486, respectively
    
    
    27,694
    
    
    
    27,969Inventories
    
    
    39,466
    
    
    
    36,417Deferred tax asset and other prepaid assets
    
    
    12,287
    
    
    
    12,796Total Current Assets
    
    
    251,229
    
    
    
    139,202Property, plant and equipment, net
    
    
    28,861
    
    
    
    28,492Goodwill
    
    
    94,535
    
    
    
    96,065Purchased intangible assets, net
    
    
    159,004
    
    
    
    164,865Long-term available-for-sale investments
    
    
    
    
    
    
    41,179Restricted long-term investments
    
    
    6,463
    
    
    
    Long-term deferred tax asset and other assets
    
    
    12,032
    
    
    
    6,328Total Assets
    
    $
    552,124
    
    
    $
    476,131Liabilities and Shareholders EquityCurrent Liabilities:Accounts payable and accrued expenses
    
    $
    24,038
    
    
    $
    22,772Total Current Liabilities
    
    
    24,038
    
    
    
    22,772Senior subordinated convertible notes
    
    
    143,750
    
    
    
    Long-term deferred tax liability and other liabilities
    
    
    64,789
    
    
    
    67,123Total Liabilities
    
    
    232,577
    
    
    
    89,895Shareholders Equity:Common shares; 100,000 authorized; issued and outstanding
51,381 and 56,242, respectively
    
    
    387,511
    
    
    
    423,045Deferred compensation
    
    
    (2,175
    )
    
    
    (2,630
    )Accumulated deficit
    
    
    (66,073
    )
    
    
    (34,594
    )Accumulated other comprehensive income:Unrealized gain (loss) on investments
    
    
    (140
    )
    
    
    51Cumulative translation adjustments
    
    
    424
    
    
    
    364Total accumulated other comprehensive income
    
    
    284
    
    
    
    415Total Shareholders Equity
    
    
    319,547
    
    
    
    386,236Total Liabilities and Shareholders Equity
    
    $
    552,124
    
    
    $
    476,131
 See notes to condensed consolidated financial statements. 3




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##### 



THORATEC CORPORATION AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(in thousands, except per share data) Three Months Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003Product sales
    
    $
    40,603
    
    
    $
    36,156
    
    
    $
    83,395
    
    
    $
    72,218Cost of product sales
    
    
    16,314
    
    
    
    14,651
    
    
    
    34,035
    
    
    
    29,542Gross profit
    
    
    24,289
    
    
    
    21,505
    
    
    
    49,360
    
    
    
    42,676Operating expenses:Selling, general and administrative
    
    
    13,774
    
    
    
    11,169
    
    
    
    26,787
    
    
    
    21,229Research and development
    
    
    7,380
    
    
    
    6,279
    
    
    
    14,718
    
    
    
    12,539Amortization of purchased intangible assets
    
    
    2,931
    
    
    
    3,096
    
    
    
    5,862
    
    
    
    6,192Legal settlement, restructuring and other costs
    
    
    
    
    
    
    (67
    )
    
    
    133
    
    
    
    (124
    )Total operating expenses
    
    
    24,085
    
    
    
    20,477
    
    
    
    47,500
    
    
    
    39,836Income from operations
    
    
    204
    
    
    
    1,028
    
    
    
    1,860
    
    
    
    2,840Interest and other income  net
    
    
    57
    
    
    
    649
    
    
    
    521
    
    
    
    1,160Income before income tax expense
    
    
    261
    
    
    
    1,677
    
    
    
    2,381
    
    
    
    4,000Income tax expense
    
    
    54
    
    
    
    654
    
    
    
    881
    
    
    
    1,560Net income
    
    $
    207
    
    
    $
    1,023
    
    
    $
    1,500
    
    
    $
    2,440Net income per share, basic and diluted
    
    $
    0.00
    
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.04Shares used to compute net income per share:Basic
    
    
    53,722
    
    
    
    55,394
    
    
    
    54,907
    
    
    
    55,226Diluted
    
    
    55,175
    
    
    
    56,891
    
    
    
    56,315
    
    
    
    56,240
 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) Six Months EndedJuly 3,
    
    June 28,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    1,500
    
    
    $
    2,440Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    9,393
    
    
    
    8,701Investment premium amortization
    
    
    495
    
    
    
    521Amortization of deferred compensation
    
    
    455
    
    
    
    599Loss on disposal of asset
    
    
    1
    
    
    
    25Income tax expense
    
    
    881
    
    
    
    1,560Non-cash compensation
    
    
    
    
    
    
    4Changes in assets and liabilities:Receivables
    
    
    275
    
    
    
    1,225Inventories
    
    
    (3,048
    )
    
    
    1,499Prepaid expenses and other assets
    
    
    119
    
    
    
    (274
    )Accounts payable and other liabilities
    
    
    772
    
    
    
    (4,582
    )Other
    
    
    (993
    )
    
    
    1,127Net cash provided by operating activities
    
    
    9,850
    
    
    
    12,845Cash flows from investing activities:Purchases of available-for-sale and other investments
    
    
    (29,084
    )
    
    
    (4,439
    )Maturities of available-for-sale investments
    
    
    16,620
    
    
    
    5,709Purchases of property, plant and equipment
    
    
    (3,836
    )
    
    
    (2,831
    )Net cash used in investing activities
    
    
    (16,300
    )
    
    
    (1,561
    )Cash flows from financing activities:Net proceeds from issuance of convertible notes
    
    
    139,181
    
    
    
    Proceeds from stock issued under employee stock purchase plan
    
    
    788
    
    
    
    578Proceeds from stock option exercises
    
    
    2,070
    
    
    
    3,571Repurchase of common stock
    
    
    (71,759
    )
    
    
    Net cash provided by financing activities
    
    
    70,280
    
    
    
    4,149Effect of exchange rate changes on cash
    
    
    60
    
    
    
    68Net increase in cash and cash equivalents
    
    
    63,890
    
    
    
    15,501Cash and cash equivalents at beginning of period
    
    
    62,020
    
    
    
    42,044Cash and cash equivalents at end of period
    
    $
    125,910
    
    
    $
    57,545Supplemental Cash Flow Disclosure:Cash paid for taxes
    
    $
    465
    
    
    $
    722Cash paid for interest
    
    $
    
    
    
    $
    Supplemental Disclosure of Non-cash Investing and Financing Activities:Tax benefit related to stock option exercises
    
    $
    387
    
    
    $
    911
 See notes to condensed consolidated financial statements. 5




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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 as herein we, our, Thoratec, or the Company,
have been prepared and presented in accordance with accounting principles
generally accepted in the United States of America and the rules and
regulations of the Securities and Exchange Commission, referred to as the SEC,
without audit and reflect all adjustments necessary (consisting only of normal
recurring adjustments) to present fairly our financial position, results of
operations and cash flows. Certain information and footnote disclosures
normally included in our annual financial statements, prepared in accordance
with accounting principles generally accepted in the United States of America,
have been condensed or omitted. The accompanying financial statements should be
read in conjunction with our fiscal 2003 consolidated financial statements
filed with the SEC in our Annual Report on Form 10-K. The operating results for
any interim period are not necessarily indicative of the results that may be
expected for any future period. The preparation of our condensed consolidated financial statements
necessarily requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the consolidated balance sheet dates and the reported
amounts of revenues and expenses for the periods presented. We have made certain reclassifications of 2003 amounts to conform to the
current presentation. Debt Offering On May 24, 2004 the Company completed the sale of senior subordinated
convertible notes due 2034, referred to as the convertible notes. We received
net proceeds from the sale, after underwriting discounts and other costs
totaling $4.6 million, of $139.2 million. See note 9. 2. Stock Based Compensation We account for stock-based compensation to employees using the intrinsic
value method in accordance with 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 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: 6




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##### 



Three Months Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003(in thousands, except per share data)Net income:As reported
    
    $
    207
    
    
    $
    1,023
    
    
    $
    1,500
    
    
    $
    2,440Add: Stock-based compensation
expense included in reported net
income, net of related tax
effects
    
    
    148
    
    
    
    183
    
    
    
    287
    
    
    
    368Deduct: Total stock-based
employee compensation expense
determined under fair value based
method for all awards, net of
related tax effects
    
    
    (3,354
    )
    
    
    (1,849
    )
    
    
    (5,397
    )
    
    
    (3,878
    )Pro forma
    
    $
    (2,999
    )
    
    $
    (643
    )
    
    $
    (3,610
    )
    
    $
    (1,070
    )Basic earnings (loss) per share:As reported
    
    $
    0.00
    
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.04Pro forma loss
    
    $
    (0.06
    )
    
    $
    (0.01
    )
    
    $
    (0.07
    )
    
    $
    (0.07
    )Diluted earnings (loss) per share:As reported
    
    $
    0.00
    
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.04Pro forma loss
    
    $
    (0.05
    )
    
    $
    (0.01
    )
    
    $
    (0.06
    )
    
    $
    (0.07
    )
 3. New Accounting Pronouncements In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure which amends FASB Statement
No. 123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements of the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. We adopted the disclosure provisions of SFAS No. 148
at the beginning of fiscal 2002. On March 31, 2004, the FASB issued an exposure
draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95.
This proposed statement would require that stock-based compensation be
recognized as a cost in the financial statements and that such cost be measured
based on the fair value of the stock-based compensation. If issued in final
form as proposed by the FASB, our adoption of this proposed statement would
have a material, although non-cash, impact on our consolidated statement of
operations. In March 2004, the EITF reached a final consensus on Issue 03-1, The
Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments, to provide additional guidance in determining whether investment
securities have an impairment which should be considered other-than-temporary.
Management expects that the adoption of this Issue will not have a significant effect on
the Companys operating results or financial condition. In April 2004, the FASB issued FSP FAS No. 129-1, Disclosure of
Information about Capital Structure, Relating to Contingently Convertible
Securities to provide disclosure guidance for contingently convertible
securities. We adopted the disclosure provisions in the second quarter of 2004
as they apply to the convertible notes. The 7.3 million shares underlying our
convertible notes are reportable under this new disclosure are antidilutive
and, therefore, have been excluded from the calculation of diluted net income
per share. See note 13. In the most recent Emerging Issues Task Force (EITF) meeting Issue No.
04-8, Accounting Issues Related to Certain Features of Contingently
Convertible Debt and the Effect on Diluted Earnings per Share was discussed.
The tentative conclusion was that shares available under contingently
convertible debt should be included in diluted earnings per share, or EPS, in
all periods, except when inclusion is anti-dilutive, regardless of whether the
contingency is met and regardless of whether the market price contingency is
substantial. If issued in final form as proposed by the EITF, adoption of this
proposed interpretation would not have a material impact on our most recent
consolidated results as the effect of the 7.3 million shares would be
anti-dilutive. If Issue No. 04-8 is adopted in final form, in periods when the
shares would be dilutive, 7.3 million shares will be added to our share count
used to calculate diluted earnings per share, and this inclusion could result
in significantly lower diluted EPS than if the existing guidance was not
changed as proposed by EITF 04-8. 7




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4. Cash and Investments We consider highly liquid investments with maturities of three months or
less at the date of purchase to be cash equivalents. Short-term investments
consist of available-for-sale debt securities that are carried at fair value
and generally mature between three months and two years from the purchase date.
Investments with maturities beyond one year may be classified as short-term
based on their highly liquid nature and to reflect managements
intent that these investments be considered available for current
operations. As a result of its reassessment during the quarter ended
April 3, 2004, the Company has classified its investments
as short-term at July 3, 2004. We
include any unrealized gains and losses on short-term investments, net of tax,
in shareholders equity as a component of other comprehensive income. As required by the terms of the convertible notes, we purchased an
aggregate of $9.8 million in U.S. government securities that were pledged to
the trustee under the indenture. These funds are for the exclusive benefit of
the holders of the convertible notes to provide for the payment, in full, of
the first six semi-annual interest payments. The investments that relate to
interest payments due in the first year have been classified as restricted
short-term investments and the investments that relate to interest payments due
after the first year have been classified as restricted long-term investments. 5. Financial Instruments We have a foreign currency exchange risk management program principally
designed to mitigate the change in value of assets and liabilities that are
denominated in non-functional currencies. Forward exchange contracts that
generally have terms of three months or less are used to hedge these
non-functional currency exposures on our books. The derivatives used in the
foreign currency exchange risk management program are not designated as cash
flow or fair value hedges under SFAS 133. These contracts are recorded on the
balance sheet at fair value in Deferred Tax Asset and Other current assets.
Changes in the fair value of the contracts and the underlying exposures being
hedged are included concurrently in Interest and Other Income  Net. At July
3, 2004, the notional value of outstanding contracts approximated $9.6 million
with negligible fair value. 6. Inventories Inventories consist of the following: As ofJuly 3,
    
    January 3,2004
    
    2004(in thousands)Finished goods
    
    $
    20,080
    
    
    $
    15,504Work in process
    
    
    5,862
    
    
    
    9,089Raw materials
    
    
    13,524
    
    
    
    11,824Total
    
    $
    39,466
    
    
    $
    36,417
 7. Property, Plant and Equipment Property, plant and equipment consist of the following: As ofJuly 3,
    
    January 3,2004
    
    2004(in thousands)Property, plant and equipment, at cost
    
    $
    61,820
    
    
    $
    58,023Less accumulated depreciation
    
    
    (32,959
    )
    
    
    (29,531
    )Total
    
    $
    28,861
    
    
    $
    28,492
 8




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8. Goodwill and Other Intangible Assets The change in the carrying amount of goodwill, which is attributable to
our Cardiovascular business segment, for the six-month periods ended July 3,
2004 and June 28, 2003 was as follows: Six Months EndedJuly 3,
    
    June 28,2004
    
    2003(in thousands)Beginning balance
    
    $
    96,065
    
    
    $
    96,492Realization of acquired deferred tax asset
    
    
    (715
    )
    
    
    Reversal of accrual for securities registration costs
    
    
    (815
    )
    
    
    Ending balance
    
    $
    94,535
    
    
    $
    96,492
 In the first half of 2004, goodwill related to the 2001 merger of Thoratec
and Thermo Cardiosystems, Inc. (TCA) was adjusted to reflect the utilization
of tax net operating loss benefits. At the time of the merger, a deferred tax
asset related to these tax benefits was established with a corresponding
valuation allowance for the full amount. A portion of the original valuation
allowance has been reversed against goodwill as we recognized benefits related
to these tax assets. Goodwill was also adjusted in the first quarter of 2004 to reflect the
reversal of an accrual, established at the time of the merger with TCA, for
securities registration costs. Under the terms of the merger agreement, the
Company committed to pay for securities registration related costs should
Thermo Electron Corporation (TCI) (the majority shareholder in TCA prior to
the merger) decide to sell its shares of the Companys common stock in a public
offering. This commitment was enforceable until TCIs holdings in Thoratec fell
below 10%, which occurred in the first quarter of 2004. The components of identifiable intangible assets are as follows: As of July 3, 2004Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Net Carrying Amount(in thousands)Patents and Trademarks
    
    $
    37,815
    
    
    $
    (12,236
    )
    
    $
    25,579Core Technology
    
    
    37,485
    
    
    
    (6,299
    )
    
    
    31,186Developed Technology
    
    
    122,782
    
    
    
    (20,623
    )
    
    
    102,159Non-compete Agreement
    
    
    90
    
    
    
    (10
    )
    
    
    80Total Purchased Intangible Assets
    
    $
    198,172
    
    
    $
    (39,168
    )
    
    $
    159,004
 As of January 3, 2004Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Net Carrying Amount(in thousands)Patents and Trademarks
    
    $
    37,815
    
    
    $
    (10,416
    )
    
    $
    27,399Core Technology
    
    
    37,485
    
    
    
    (5,353
    )
    
    
    32,132Developed Technology
    
    
    122,782
    
    
    
    (17,535
    )
    
    
    105,247Non-compete Agreement
    
    
    90
    
    
    
    (3
    )
    
    
    87Total Purchased Intangible Assets
    
    $
    198,172
    
    
    $
    (33,307
    )
    
    $
    164,865
 After fiscal 2003 year-end, the Company completed its assessment of the
final results from its feasibility clinical trial for the Aria CABG graft which
was ongoing through fiscal 2003. Based on the clinical trial results, the
Company determined that it would not devote additional resources to the
development of the Aria graft. Upon the decision to discontinue product
development, the Company recorded an impairment charge of $9.0 million in the
fourth quarter of 2003 to write off purchased intangible assets related to the
Aria graft, recorded as a result of the merger with TCA in 2001. On September 30, 2003, we completed an asset purchase of the Immediate
Response Mobile Analysis, or IRMA, point-of-care blood analysis system product
line from Diametrics Medical, Inc. (Diametrics). We paid 9




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##### 



approximately $5.2 million in cash and assumed trade payables.
Approximately $1.8 million of the total purchase price was allocated to
purchased intangible assets. Amortization expense related to identifiable intangible assets was $2.9
million for the three months ended July 3, 2004 and $4.9 million for the six
months ended July 3, 2004. Amortization expense related to identifiable
intangible assets was $3.1 million for the three months ended June 28, 2003 and
$6.2 million for the six months ended June 28, 2003. Amortization expense is
expected to be approximately $11.7 million for each of the next five years. The
purchased intangible assets have estimated useful lives of seven to twenty
years. 9. Long-term Debt On May 24, 2004 we completed the sale of $143.8 million initial principal
amount of senior subordinated convertible notes due 2034. The convertible
notes were sold to Qualified Institutional Buyers pursuant to the exemption
from the registration requirements of the Securities Act of 1933, as amended,
provided by Rule 144A thereunder. We used $9.8 million of the net proceeds to
purchase and pledge to the trustee under the indenture for the exclusive
benefit of the holders of the convertible notes, U.S. government securities to
provide for the payment, in full, of the first six scheduled interest payments.
Additional net proceeds were used to repurchase 4.2 million shares of our
outstanding common stock for $60 million. The remaining net proceeds will be
used for general corporate purposes. Total net proceeds to the Company from
the sale were $139.2 million, after debt issuance costs of $4.6 million. The convertible notes were issued at an issue price of $580.98 per note,
which is 58.098% of the principal amount at maturity of the notes. The
convertible notes bear interest at a rate of 1.3798% per year on the principal
amount at maturity, payable semi-annually in arrears in cash on May 16 and
November 16 of each year, from November 16, 2004 until May 16, 2011. Beginning
on May 16, 2011, the original issue discount will accrue daily at a rate of
2.375% per year on a semi-annual bond equivalent basis and, on the maturity
date, a holder will receive $1,000 per note. As a result, the aggregate
principal amount of the notes at maturity will be $247.4 million. The deferred debt issuance costs of $4.6 million are included in other
assets on the balance sheet. These 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 and Other Income  Net on the Consolidated
Statement of Operations. July 3,2004Long Term Debt Offering Proceeds:
    
    (in thousands)Principal amount of convertible notes at
maturity
    
    $
    247.4Original issue discount
    
    
    (103.7
    )Debt issuance costs
    
    
    (4.6
    )Net proceeds
    
    $
    139.2
 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 may convert their convertible notes at any point after the close of
business on September 30, 2004 if, as of the last day preceding the calendar
quarter, the closing price of our common stock for at least 20 trading days in
a period of 30 consecutive trading days ending on the last trading day of such
preceding calendar quarter is more then 120% of the accreted conversion price
per share of our common stock. Holders may surrender their convertible notes
on or prior to May 16, 2029 during the five business day period after any five
consecutive trading day period in which the trading price per note for each day
of that period was less than 98% of the product of the closing sale price of
our common stock and the conversion rate on each such day; provided that if on
the day prior to any conversion the closing sale price of our common stock is
greater than the accreted conversion price but less than or equal to 120% of
the accreted conversion price, then holders will receive upon conversion, in
lieu of shares of common stock based on the conversion rate, cash or common
stock, or a combination of cash and common stock, at our option, with a value
equal to the accreted principal amount of the notes plus accrued but unpaid
interest as of the conversion date. Additionally, holders may convert their
convertible notes if we call them for redemption or if specified corporate
transactions or significant distributions to holders of our stock have
occurred. 10




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##### 



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 July 3, 2004 was zero. We may redeem any of the convertible notes at any time beginning May 16, 2011,
by giving the holders at least 30 days notice, either in whole or in part at a
redemption price equal to the sum of the issue price and the accrued original
issue discount, plus accrued and unpaid interest and liquidation damages, if
any. The convertible notes are subordinated, therefore, in the event of our
bankruptcy, liquidation or dissolution and acceleration of or payment default
on our senior indebtedness, holders of the convertible notes will not receive
any payment until holders of any senior indebtedness we may have outstanding
have been paid in full. 10. Common Stock In February 2004, the Board of Directors authorized a stock repurchase
program under which up to $25 million of our common stock could be acquired in
the open market or in privately negotiated transactions. The number of shares
to be purchased and the timing of purchases were based on several conditions,
including the price of our stock, general market conditions and other factors.
In May 2004, in conjunction with our convertible notes offering, the Board of
Directors authorized the repurchase of an additional $60 million of our common
stock. As of July 3, 2004, we had repurchased and retired 5.1 million shares
with an aggregate purchase price of $71.8 million under these combined
programs. In July 2004, the Board of Directors authorized a stock repurchase program
under which Thoratec common stock with a market value of up to $25 million may
be acquired in the open market or in privately negotiated transactions. The
number of shares to be purchased and the timing of such activity will be
dependant on several conditions, including the price of Thoratec stock, general
market conditions and other factors. 11. Legal Settlement, Restructuring and Other Costs Legal settlement, restructuring and other costs are comprised of: Three Months Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003(in thousands)Legal Settlement
    
    $
    
    
    
    $
    
    
    
    $
    133
    
    
    $
    Restructuring
    
    
    
    
    
    
    (61
    )
    
    
    
    
    
    
    (118
    )Other
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    (6
    )Total
    
    $
    
    
    
    $
    ( 67
    )
    
    $
    133
    
    
    $
    (124
    )
 Legal Settlement 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 composed of additional legal
expenses related to the settlement. 11




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##### 



Restructuring Costs We completed consolidation of our VAD manufacturing operations in the
second quarter of 2003. Total costs related to this consolidation were $1.5
million. Following is a summary of restructuring cost activity relating to
the consolidation: Three Months Ended
    
    Six Months EndedJune 28,
    
    June 28,2003
    
    2003Accrued Restructuring Costs:
    
    (in thousands)Beginning balance
    
    $
    97
    
    
    $
    679Reduction of severance accrual
    
    
    (61
    )
    
    
    (122
    )Payments of employee severance
    
    
    (36
    )
    
    
    (557
    )Ending balance
    
    $
    
    
    
    $
    
 12. Income Taxes Our effective tax rates were 21% and 39%, respectively, for the three
months ended July 3, 2004 and June 28, 2003. The effective rate was 37% for the
six months ended July 3, 2004 and 39% for the six months ended June 28, 2003.
The reduction in our effective tax rate is due primarily to: (1) increased
statutory research credits (both in dollars as well as a percentage of income
before income taxes) and (2) additional interest income from tax favorable
investments. The effective income tax rate for both quarters differed from the
statutory federal income tax rate primarily due to the impact of state taxes. At July 3, 2004 and January 3, 2004, we reported a net deferred tax
liability of approximately $ 49.6 million and $51.3 million, respectively,
comprised principally of temporary differences between the financial statement
and income tax bases of intangible assets. 13. Net Income Per Share Basic and diluted net income per share were calculated as follows: Three Months Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003(in thousands)Net income
    
    $
    207
    
    
    $
    1,023
    
    
    $
    1,500
    
    
    $
    2,440Weighted average number of common shares-basic
    
    
    53,722
    
    
    
    55,394
    
    
    
    54,907
    
    
    
    55,226Dilutive effect of stock options
    
    
    1,453
    
    
    
    1,497
    
    
    
    1,408
    
    
    
    1,014Weighted average number of common shares-diluted
    
    
    55,175
    
    
    
    56,891
    
    
    
    56,315
    
    
    
    56,240Net income per common share-basic and diluted
    
    $
    0.00
    
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.04
 Basic income per share is computed by dividing net income by the weighted
average number of common shares outstanding during the period. Diluted income
per share reflects the potential dilution that could occur if securities or
other contracts to issue common stock were exercised or converted into common
stock. Of the options to purchase shares of our common stock outstanding as of
July 3, 2004, options covering 3.8 million shares and 4.9 million shares of our
common stock were excluded from the computation of the diluted income per share
for the three-month and six-month periods ending July 3, 2004, respectively, as
their inclusion would be antidilutive. Of the options to purchase shares of
common stock outstanding as of June 28, 2003, those covering 3.5 million shares
and 4.0 million shares of common stock were excluded from the computation of
diluted income per share for the three and six months ended June 28, 2003,
respectively, as their inclusion would be antidilutive. If EITF Issue No. 04-8 is issued in final form as proposed by the EITF,
our adoption of this proposed interpretation would not have a material impact
on our most recent consolidated results as the effect of the convertible notes
covering 7.3 million shares would be anti-dilutive. If Issue No. 04-8 is
adopted in final form, in periods when the shares would be dilutive, 7.3
million shares will be added to our outstanding shares used to 12




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##### 



calculate diluted earnings per share, and this inclusion could result in
significantly lower diluted EPS than if the existing guidance was not changed
as proposed. Although we adopted the disclosure provisions of FASB FSP FAS No. 129-1 in
the second quarter of 2004, the 7.3 million shares underlying our convertible
notes were anitdilutive. Therefore these shares were excluded from the
calculation of diluted net income per share. 14. Business Segment and Geographical Data We organize and manage our business by functional operating entities. Our
functional entities operate in two segments: (1) Cardiovascular and (2) ITC.
The Cardiovascular segment develops, manufactures and markets proprietary
medical devices used for circulatory support and vascular graft applications.
The ITC segment develops, manufactures and markets point-of-care diagnostic
test systems. Business Segments: Three Months Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003(in thousands)Product sales:Cardiovascular
    
    $
    23,072
    
    
    $
    23,559
    
    
    $
    49,625
    
    
    $
    47,467ITC
    
    
    17,531
    
    
    
    12,597
    
    
    
    33,770
    
    
    
    24,751Total product sales
    
    $
    40,603
    
    
    $
    36,156
    
    
    $
    83,395
    
    
    $
    72,218Income before income taxes:Cardiovascular
    
    $
    2,000
    
    
    $
    3,453
    
    
    $
    6,283
    
    
    $
    7,242ITC
    
    
    2,388
    
    
    
    2,138
    
    
    
    4,720
    
    
    
    4,487Corporate (a)
    
    
    (1,253
    )
    
    
    (1,534
    )
    
    
    (3,147
    )
    
    
    (2,821
    )Amortization of purchased intangibles
    
    
    (2,931
    )
    
    
    (3,096
    )
    
    
    (5,862
    )
    
    
    (6,192
    )Legal settlement, restructuring and other costs (b)
    
    
    
    
    
    
    67
    
    
    
    (133
    )
    
    
    124Total income from operations
    
    
    204
    
    
    
    1,028
    
    
    
    1,860
    
    
    
    2,840Interest and other income, net
    
    
    57
    
    
    
    649
    
    
    
    521
    
    
    
    1,160Income before income taxes
    
    $
    261
    
    
    $
    1,677
    
    
    $
    2,381
    
    
    $
    4,000
   (a)
    
    Represents primarily general and administrative expenses not specifically
identified to any particular business segment.(b)
    
    Related solely to the Cardiovascular segment. Geographic Areas: The geographic composition of our product sales were as follows: Three Months Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003(in thousands)Domestic
    
    $
    31,392
    
    
    $
    30,247
    
    
    $
    65,173
    
    
    $
    60,251International
    
    
    9,211
    
    
    
    5,909
    
    
    
    18,222
    
    
    
    11,967Total
    
    $
    40,603
    
    
    $
    36,156
    
    
    $
    83,395
    
    
    $
    72,218
 13




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##### 



15. Litigation and Claims In 2003, a patent infringement claim was filed against the Company by
Bodycote Materials Testing Canada, Inc. and David C. MacGregor, M.D. related to
materials used in the HeartMate LVAS. On February 3, 2004, the Company settled
the claim and recorded a charge of $2.3 million in the fourth quarter of 2003
for the settlement and related legal costs. In June of 2004, MicroMed Technology, Inc., a potential competitor of the
Company, sued the Company in Texas. MicroMed sued for 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 provides the HeartMate II VAD to
clinical sites without charge. MicroMed has asked the court to prevent
Thoratec from providing the HeartMate II to the clinical sites without charge
by claiming that such practices violate Texas anti-trust law. In addition to a
temporary restraining order, the plaintiff is seeking unspecified damages and
fees, including those resulting from lost sales of its VAD products (which are
in clinical trials in the U.S. only and not yet commercially approved) due to
the Companys HeartMate II clinical trial. The Company defeated MicroMeds motion for a temporary restraining order
and intends to mount a vigorous defense to all of the claims made by MicroMed. 16. Subsequent Events On July 29, 2004 the company announced that the board of directors
authorized a stock repurchase program under which Thoratec common stock with a
market value of up to $25 million may be acquired in the open market or in
privately negotiated transactions. The number of shares to be purchased and
the timing of such activity will be dependant on several conditions, including
the price of Thoratec stock, general market conditions and other factors. On August 3, 2004, a putative class action entitled Johnson v. Thoratec
Corporation, et al.was filed in the United States District Court for the
Northern District of California on behalf of purchasers of the publicly traded
securities of the Company between April 28, 2004 and June 29, 2004. The
Johnsoncomplaint generally alleges violations of the Securities Exchange Act
of 1934 by the Company, its chief executive officer and chief financial
officer. Based upon, inter alia,alleged false statements about the Companys
expected sales and the market for HeartMate as a Destination Therapy treatment.
The complaint seeks to recover unspecified damages on behalf of all purchasers
of the Companys publicly traded securities during the class period. Subsequent to the filing of the Johnsoncomplaint, additional plaintiffs law
firms issued press releases indicating that additional similar complaints have
been filed in the same court, alleging essentially the same claims, on behalf
of the same putative class of purchasers of Thoratec securities. The Company
has not been served with any of those complaints. Based on the facts known to
date, Thoratec believes that the claims asserted in this action and the related
actions are without merit and intends to vigorously defend this suit. However,
we are unable to predict at this time the final outcome of the various
shareholder actions, or whether the resolution of the actions could
materially affect our results of operations, cash flows or financial position.
No amount in respect of this matter has been accrued in our consolidated
financial statements. 14




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##### 



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




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##### 



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




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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. Preparation of financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amount of assets, liabilities, revenue
and expenses and the disclosure of contingent assets and liabilities. There can
be no assurance that actual results will not differ from those estimates. Evaluation of Goodwill and Purchased Intangibles for Impairment In accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which we adopted as of the beginning of fiscal
year 2002, we periodically evaluate the carrying value of long-lived assets to
be held and used including intangible assets, when events or circumstances
warrant such a review. The carrying value of a long-lived asset to be held and
used is considered impaired when the anticipated separately identifiable
undiscounted cash flows from such an asset are less than the carrying value of
the asset. In that event, a loss is recognized based on the amount by which the
carrying value exceeds the fair value of the long-lived asset. Fair value is
determined primarily using the anticipated cash flows discounted at a rate
commensurate with the risk involved. Management must make estimates of these
future cash flows and the approximate discount rate, and if these estimates
prove incorrect, the carrying value of these assets on our balance sheet could
significantly overstate their true value. As of the beginning of fiscal year 2002, we adopted SFAS No. 142,
Goodwill and Other Intangible Assets, and ceased the amortization of
purchased goodwill. In addition, we reevaluated the useful lives of our
identifiable intangible assets and determined that the remaining useful lives
were appropriate. Each year we complete an impairment test of goodwill as
required by SFAS No. 142. Upon completion of our impairment tests as of the end
of fiscal 2003, we determined that our goodwill was not impaired. Revenue Recognition We recognize revenue from product sales when evidence of an arrangement
exists, title has passed (generally upon shipment) or services have been
rendered, the selling price is fixed or determinable and collectibility is
reasonably assured. Sales to distributors are recorded when title transfers
upon shipment. One distributor has certain limited product return rights. A
limited number of other distributors have certain rights of return upon
termination of their distribution agreement. A reserve for sales returns is
recorded for these customers applying reasonable estimates of product returns
based upon significant historical experience in accordance with SFAS No. 48,
Revenue Recognition when Right of Return Exists. No other direct sales
customers or distributors have return rights or price protection. Sales of certain Cardiovascular segment products to first-time customers
are recognized when it has been determined that the customer has the ability to
use such products. These sales frequently include the sale of products and
training services under multiple element arrangements. For most customers,
training is not essential to the functionality of the products as the customers
already possess sufficient expertise and experience to use the products. In
these situations, training is provided as a best practice to optimize the use
and success of the products. The amount of revenues under these arrangements
allocated to training is based upon fair market value of the training,
performed principally by third party providers. The amount of product sales
allocated to the Cardiovascular segment products is done on a residual method
basis. Under this method, the total value of the arrangement is allocated first
to the undelivered training element based on the fair market value, with the
remainder being allocated to the Cardiovascular segment products. The amount of
product sales allocated to training is recorded as deferred revenue and is
recognized when the training is completed. As of the six months ended July 3,
2004 all products that had been delivered and recorded as product sales were
delivered to customers for which training had been completed. There were no
amount of product sales deferred related to this training not yet completed at
the six months ended July 3, 2004, however, there were $20,000 at the end of
2003 and $100,000 at the end of 2002. We also rent certain medical devices to customers on a month-to-month or
as-used basis. Rental income is based on utilization and is included in product
sales as earned. Included in product sales for the six months ended July 3,
2004, the years ended 2003, and 2002 are $3.1 million, $4.6 million, and $3.8
million, respectively, of income earned from the rental of these medical
devices. 17




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##### 



The majority of our products are covered by a one-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. Reserves We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make payments owed to us for
product sales. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required. In June 2001, we approved a Restructuring Plan to consolidate all of our
VAD manufacturing operations to our manufacturing facilities and headquarters
in Pleasanton, California. Through the completion date of the Restructuring
Plan in April 2003, we recorded $1.5 million of restructuring charges in
accordance with Emerging Issues Task Force 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity and
Staff Accounting Bulletin 100, Restructuring and Impairment Charges. These
charges represent estimated employee severance costs and stock option
acceleration charges. We completed the relocation of the Woburn, Massachusetts
manufacturing operations to our Pleasanton facility in the first quarter of
2003 and in February 2003 the FDA inspected the Pleasanton facility related to
this transfer. We received FDA approval in April 2003. As of the completion
date of the Restructuring Plan, we had paid approximately $1.3 million in
severance payments to 78 employees. Accounting Pronouncements In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure which amends FASB Statement
No. 123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements of the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. We adopted the disclosure provisions of SFAS No. 148
at the beginning of fiscal 2002. On March 31, 2004, the FASB issued an exposure
draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95.
This proposed statement would require that stock-based compensation be
recognized as a cost in the financial statements and that such cost be measured
based on the fair value of the stock-based compensation. If issued in final
form as proposed by the FASB, our adoption of this proposed statement would
have a material, although non-cash, impact on our consolidated statement of
operations. In March 2004, the EITF reached a final consensus on Issue 03-1, The
Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments, to provide additional guidance in determining whether investment
securities have an impairment which should be considered other-than-temporary.
Management expects that the adoption of this Issue will not have a significant effect on
the Companys operating results or financial condition. In April 2004, the FASB issued FSP FAS No. 129-1, Disclosure of
Information about Capital Structure, Relating to Contingently Convertible
Securities to provide disclosure guidance for contingently convertible
securities. We adopted the disclosure provisions in the second quarter of 2004
as they apply to the convertible debt we issued on May 24, 2004. The 7.3
million shares underlying our convertible notes that are reportable under this
new disclosure are antidilutive. Therefore, these shares have been excluded
from the calculation of diluted net income per share. In the most recent Emerging Issues Task Force (EITF) meeting Issue No.
04-8, Accounting Issues Related to Certain Features of Contingently
Convertible Debt and the Effect on Diluted Earnings per Share was discussed.
The tentative conclusion was that shares available under contingently
convertible debts should be included in diluted earnings per share in all
periods, except when inclusion is anti-dilutive, regardless of whether the
contingency is met and regardless of whether the market price contingency is
substantive. If issued in final form as proposed by the EITF, adoption of this
proposed interpretation would not have had a material impact on our
consolidated results as the effect of the 7.3 million shares would be
anti-dilutive. In periods when the shares would be dilutive 7.3 million shares
will be added to our share count used to calculate diluted earnings per share. 18




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##### 



Results of Operations The following table sets forth selected consolidated statements of
operations data for the periods indicated as a percentage of total product
sales: Three Months Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003Product sales
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of sales
    
    
    40
    
    
    
    41
    
    
    
    41
    
    
    
    41Gross profit
    
    
    60
    
    
    
    59
    
    
    
    59
    
    
    
    59Operating expenses:Selling, general & administrative
    
    
    34
    
    
    
    31
    
    
    
    32
    
    
    
    29Research & development
    
    
    18
    
    
    
    17
    
    
    
    18
    
    
    
    17Amortization of purchased intangible assets
    
    
    7
    
    
    
    9
    
    
    
    7
    
    
    
    8Legal settlement, merger, restructuring and other costs
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Total operating expenses
    
    
    59
    
    
    
    57
    
    
    
    57
    
    
    
    54Income from operations
    
    
    1
    
    
    
    3
    
    
    
    2
    
    
    
    4Interest and other income  net
    
    
    0
    
    
    
    2
    
    
    
    1
    
    
    
    1Income before income taxes
    
    
    1
    
    
    
    5
    
    
    
    3
    
    
    
    5Income tax expense
    
    
    0
    
    
    
    2
    
    
    
    1
    
    
    
    2Net income
    
    
    1
    %
    
    
    3
    %
    
    
    2
    %
    
    
    3
    %
 Three months ended July 3, 2004 and June 28, 2003 Product Sales Product sales in the second quarter of 2004 were $40.6 million compared to
$36.2 million in the second quarter of 2003. The primary components of the
$4.4 million increase in product sales were the following:  
    
    Point-of-care diagnostic sales increased $4.9 million, including
$1.6 million in revenue from the IRMA product line acquired in the
fourth quarter of 2003.  
    
    This increase in point-of-care diagnostics was offset by lower
sales of grafts, with VAD sales essentially flat. Our sales of Destination Therapy implants were lower in the second quarter
than we originally anticipated, and we expect product sales to increase more
slowly than we originally projected, partly because we believe customers
delayed purchasing Destination Therapy implants until the proposed increase in
the Medicare reimbursement rate becomes effective on October 1, 2004. Gross Profit Gross profit in the second quarter of 2004 was 60% compared to 59% in
2003. Within these essentially flat margins were the following fluctuations:  
    
    A 4% higher margin on VAD products resulting from a shift in mix to
higher margin lines, offset by  
    
    A 3% lower margin on point-of-care products, primarily related to
the lower margin IRMA product line acquired in the fourth quarter of
2003, plus higher distribution costs associated with the shift in mix
from distributor to direct channels. 19




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##### 



If we recognize higher revenue for our current Destination Therapy
initiatives, we anticipate that margins will increase as the higher margin VAD
products represent a larger portion of our overall revenues. Selling, General and Administrative Selling, general and administrative expenses in the second quarter of 2004
were $13.8 million, or 34% of product sales, compared to $11.2 million, or 31%
of product sales, in the second quarter of 2003. Underlying the $2.6 million
increase in spending were the following:  
    
    Increased SG&A headcount from 138 at the end of the second quarter
of 2003 to 198 at the end of the second quarter of 2004, together with
annual salary increases aggregating approximately 4.5% effective
January 2004.  
    
    Higher spending on marketing and related activities, primarily
associated with Destination Therapy, and costs associated with the IRMA
product line acquired in the fourth quarter of 2003. We anticipate that selling, general and administrative costs will
generally increase each year as our business grows, with some quarterly and
annual significant increases in spending in connection with particular events
such as product development or enhancements. Spending as a percentage of
revenue is expected to decrease assuming revenue from current products
increase, particularly if we realize increasing revenue generated by
Destination Therapy implants. Research and Development Research and development expenses in the second quarter of 2004 were $7.4
million compared to $6.3 million in the second quarter of 2003, representing
18% and 17% of product sales, respectively. Research and development costs are
largely project driven, and the level of spending depends on the level of
project activity planned and subsequently approved and conducted. The primary
component of our research and development costs is employee salaries and
benefits. Research and development costs also include regulatory and clinical
costs associated with our compliance with FDA regulations. We anticipate that research and development costs will generally increase
each year as our business grows, with some quarterly and annual significant
increases in spending in connection with particular events such as product
introductions and regulatory approvals. We expect research and development
spending as a percentage of revenue to trend downward as revenue from current
products increase, in particular if we realize increasing revenue related to
sales of Destination Therapy implants. Amortization of Purchased Intangible Assets Amortization of purchased intangible assets in the second quarter of 2004
was $2.9 million compared to $3.1 million in the second quarter of 2003. The
decrease of $0.2 million is primarily due to the write-off of purchased
intangible assets related to the Aria CABG graft in the fourth quarter of 2003. Income Taxes Our effective tax rates were 21% and 39%, respectively, for the second
quarters of 2004 and 2003. The reduction in our effective tax rate over the two
quarters was due primarily to a reduction of our projected annual profit before
tax and additional interest income from tax favorable investments. The
effective income tax rate for both quarters differed from the statutory federal
income tax rate primarily due to the impact of state taxes, research and
experimental tax credits and tax favorable investments. 20




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##### 



Six months ended July 3, 2004 and June 28, 2003 Product Sales Product sales in the first six months of 2004 were $83.4 million compared
to $72.2 million in the first six months of 2003. The primary components of the
$11.2 million increase in product sales were as follows:  
    
    $9.0 million higher revenue from sales of point-of-care diagnostic
test systems, including $3.3 million generated by the IRMA product line
acquired in the fourth quarter of 2003;  
    
    $3.0 million higher VAD sales; and  
    
    $0.8 million lower graft sales. Gross Profit Gross profit as a percentage of sales in the first six months of 2004 and
2003 was 59%. Within these flat margins were the following fluctuations:  
    
    A 4% higher margin on cardiovascular products resulting from a
shift in mix from lower to higher margin products, offset by higher
manufacturing costs.  
    
    A 4% lower margin on point-of-care revenues, primarily related to
the lower margin IRMA product line acquired in the fourth quarter of
2003, plus higher distribution costs associated with the shift in mix
from distributor to direct channels. Selling, General and Administrative Selling, general and administrative expenses in the first six months of
2004 were $26.8 million, or 32% of product sales, compared to $21.2 million, or
29% of product sales, in the first six months of 2003. Underlying the $5.6
million increase in these expenses were the following drivers:  
    
    Increased SG&A headcount from 138 at the end of the first six
months of 2003 to 198 at the end of the first six months of 2004,
together with annual salary increases aggregating 4.5% effective
January 2004.  
    
    Higher spending on marketing and related activities, primarily
associated with Destination Therapy, and costs associated with the IRMA
product line acquired in the fourth quarter of 2003.  
    
    Higher professional fees, including legal, audit and financial
consulting services relating primarily to our compliance with the
Sarbanes-Oxley Act of 2002. Research and Development Research and development expenses in the first six months of 2004 were
$14.7 million compared to $12.5 million in the first six months of 2003,
representing 18% and 17% of product sales, respectively. The primary component
of our research and development costs is employee salaries and benefits.
Research and development costs also include regulatory and clinical costs
associated with our compliance with FDA regulations Amortization of Purchased Intangible Assets Amortization of purchased intangible assets in the first six months of
2004 was $5.9 million compared to $6.2 million in the first six months of 2003.
The decrease of $0.3 million is primarily due to the write-off of purchased
intangible assets related to the Aria CABG graft in the fourth quarter of 2003. 21




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##### 



Income Taxes Our effective rates were 37% for the six months ended July 3, 2004 and 39%
for the six months ended June 28, 2003. The reduction in our effective tax on
a comparative basis was due primarily to a reduction of our projected annual
profit before tax and additional interest income from tax favorable
investments. The effective income tax rate for both quarters differed from the
statutory federal income tax rate primarily due to the impact of state taxes,
research and experimental tax credits and tax favorable investments. Liquidity and Capital Resources At July 3, 2004, we had working capital of $227.2 million compared with
$116.4 million at January 3, 2004. Cash and cash equivalents and short-term

available-for-sale investments at July 3, 2004 were $168.5 million compared to
$62 million at January 3, 2004. Cash provided by operating activities was $ 9.9 million, after payments
for legal settlement and annual bonuses accrued at January 3, 2004 totaling
$5.2 million. In addition, investing activities used $16.3 million, with $12.5
million used for investments and $3.8 million to acquire property, plant and
equipment. Of the net investment activity, $9.8 million was used to purchase
U.S. Government securities that were pledged in relation to the issuance of our
convertible notes. The purchases of property, plant and equipment were
comprised of $3.2 million for equipment and $0.6 million for leasehold
improvements. Cash provided by financing activities was $70.3 million, as we
received $139.2 million net proceeds from the issuance of our convertible notes
and an additional $2.1 million from proceeds related to stock option exercises,
offset by $71.8 million paid during the first and second quarters of 2004 to
repurchase 5.1 million shares of stock under our stock repurchase programs. The debt offering proceeds were used to purchase and pledge $9.8 million
to the trustee under the indenture for the exclusive benefit of the holders of
the convertible notes, U.S. government securities to provide for the payment,
in full, of the first six scheduled interest payments. Additional net proceeds
were used to repurchase 4.2 million shares of our outstanding common stock for
$60 million. The remaining net proceeds will be used for general corporate
purposes, which may include additional stock repurchases, strategic investments
or acquisitions.
The convertible notes were issued at an issue price of $580.98 per note, which
is 58.098% of the principal amount at maturity of the notes. The convertible
notes bear interest at a rate of 1.3798% per year on the principal amount at
maturity, payable semi-annually in arrears in cash on May 16 and November 16 of
each year, from November 16, 2004 until May 16, 2011. Beginning on May 16,
2011, the original issue discount will accrue daily at a rate of 2.375% per
year on a semi-annual bond equivalent basis and, on the maturity date, a holder
will receive $1,000 per note. As a result, the aggregate principal amount of
the notes at maturity will be $247.4 million. On February 11, 2004, the Board of Directors authorized a stock repurchase
program under which up to $25 million of our common stock could be acquired in
the open market or in privately negotiated transactions. The number of shares
to be purchased and the timing of purchases 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 July 3, 2004, we had repurchased and retired 5.1 million shares
with an aggregate of $71.8 million under these combined programs. On July 28,
2004, the Board of Directors authorized up to an additional $25 million for the
repurchase of our common stock on the open market or in privately negotiated
transactions. We believe that cash and cash equivalents and 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 program for at least the next twelve months. The impact of inflation on our financial position and the results of
operations was not significant during any of the periods presented. 22




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##### 



Contractual Obligations As of July 3, 2004, we had the following contractual obligations (in
millions): Total
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    ThereafterLong-Term Debt Obligations
(includes interest)
    
    $
    167.6
    
    
    
    2.1
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    151.9Operating Lease Obligations
    
    
    21.0
    
    
    
    1.3
    
    
    
    2.5
    
    
    
    2.5
    
    
    
    2.4
    
    
    
    2.1
    
    
    
    10.2Purchase Obligations
    
    
    15.8
    
    
    
    .6
    
    
    
    2.0
    
    
    
    2.0
    
    
    
    2.0
    
    
    
    2.0
    
    
    
    7.2Total
    
    $
    204.4
    
    
    
    4.0
    
    
    
    7.9
    
    
    
    7.9
    
    
    
    7.8
    
    
    
    7.5
    
    
    
    169.3
 Our purchase obligations of $15.8 million were comprised of supply agreements
in effect at July 3, 2004. 23




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##### 



FACTORS THAT MAY AFFECT FUTURE RESULTS Our business faces many risks. 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-Kfor fiscal 2003 before deciding to invest in our company. We have a history of net losses. We were founded in 1976 and we have a history of incurring losses from
operations. As of July 3, 2004, our accumulated deficit was approximately $66.1
million. We anticipate that our expenses will increase as a result of increased
pre-clinical and clinical testing, research and development and selling,
general and administrative expenses. We could also incur significant additional
costs in connection with our business development activities and the
development and marketing of new products and indicated uses for our existing
products. 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 in turn
can delay or prevent adoption in volume by hospitals. Government and other
third party payors are increasingly attempting to contain health care costs.
Payors are attempting to contain costs by, for example, limiting coverage and
the level of reimbursement of new therapeutic products. Payors are also
attempting to contain costs by refusing, in some cases, to provide any coverage
for uses of approved products for disease indications other than those for
which the FDA has granted marketing approval. To date, a majority of private insurers with whom we have been involved
and the Centers for Medicare and Medicaid, referred to as CMS, have determined
to reimburse some portion of the cost of our VADs and our diagnostic and
vascular graft products, but we cannot estimate what portion of such costs will
be reimbursed and our products may not continue to be approved for
reimbursement. In addition, changes in the health care system may affect the
reimbursability of future products. If coverage is not expanded or if the
reimbursement levels are not increased or are partially or completely reduced,
our revenues would be reduced. If we fail to obtain approval from the FDA and from foreign regulatory
authorities, we cannot market and sell our products under development in the
United States and in other countries, and if we fail to adhere to ongoing FDA
Quality System Regulations, the FDA may withdraw our market clearance or take
other action. Before we can market new products in the United States, we must obtain
clearance from the FDA. This process is lengthy and uncertain. In the United
States, one must obtain clearance from the FDA of a 510(k) premarket
notification or approval of a more extensive submission known as a pre-market
approval, or PMA, application. If the FDA concludes that any of our products
does not meet the requirements to obtain clearance under Section 510(k) of the
Federal Food, Drug, and Cosmetic Act, then we would be required to file a PMA
application. The process for a PMA application is lengthy, expensive and
typically requires extensive pre-clinical and clinical trial data. Pre-clinical
data may need to be obtained in accordance with FDA good laboratory practices. We may not obtain clearance of a 510(k) notification or approval of a PMA
application with respect to any of our products on a timely basis, if at all.
If we fail to obtain timely clearance or approval for our products, we will not
be able to market and sell our products, harming our ability to generate
revenue. The FDA may also limit the claims that we can make about our products.
We may also be required to obtain clearance of a 510(k) notification or PMA
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. 24




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##### 



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. Our debt obligations expose us to risks that could adversely affect our
business, operating results and financial condition. We have a substantial level of debt. As of July 3, 2004, we had $143.8
million of outstanding indebtedness. The terms of our convertible notes do not
restrict our ability to incur additional indebtedness, including indebtedness
senior to the notes. The level of our indebtedness, among other things, could:  
    
    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; and 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 25




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##### 



(Destination Therapy) was approved by the FDA in 2002, and was approved
for reimbursement by the CMS in late 2003. The number of Destination Therapy procedures actually performed is
dependent on many factors, most of which are out of our direct control,
including:  
    
    the number of CMS sites approved for Destination Therapy;  
    
    the clinical outcomes of Destination Therapy procedures;  
    
    cardiology and referring physician education, and their commitment to Destination Therapy;  
    
    the economics of the Destination Therapy procedure for
individual hospitals, which includes the costs of the VAD and
related pre- and post- operative procedures and their reimbursement;  
    
    the impact of changes in reimbursement rates on the timing of purchases of VADs for Destination Therapy; and  
    
    the economics for individual hospitals of not conducting a
Destination Therapy procedure, including the costs and related
reimbursements of long-term hospitalization. The different outcomes of these and other factors, and their timing, will
have a significant impact on our future 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 revenue and operating results to vary significantly, which increases the
risk of an operating loss for any given fiscal quarter. Our VAD systems have lengthy sales cycles and we may incur substantial
sales and marketing expenses and expend significant effort without making a
sale. Even after making the decision to purchase our VAD systems, our customers
often deploy our products slowly. For example, the length of time between
initial contact with cardiac surgeons and the purchase of our VAD systems is
generally between nine and eighteen months. In addition, the cardiac centers
that buy the majority of our products are usually led by cardiac surgeons who
are heavily recruited by competing centers or by centers looking to increase
their profiles. When one of these surgeons moves between centers we sometimes
experience a temporary but significant reduction in purchases by the departed
center while it replaces its lead surgeon. As a result, it is difficult for us
to predict the quarter in which our customers may purchase our VAD systems and
our revenue and operating results may vary significantly from quarter to
quarter, which increases the risk of an operating loss for us for any given
quarter. In particular, sales of our VADs for Destination Therapy have been
lower than we had originally anticipated, and we cannot predict when, if ever,
sales of our VADs for this indication will generate significant revenue. Physicians may not accept or continue to accept our products and products under
development. The success of our current and future products will require acceptance or
continued acceptance by cardiovascular and vascular surgeons and other medical
professionals. Such acceptance will depend on clinical results and the
conclusion by these professionals that our products are safe, cost-effective
and acceptable methods of treatment. Even if the safety and efficacy of our
future products are established, physicians may elect not to use them for a
number of reasons. These reasons could include the high cost of our VAD
systems, restrictions on coverage or unfavorable reimbursement from health care
payors. Also, economic, psychological, ethical and other concerns may limit
general acceptance of our ventricular assist, graft and other products. Our future products sales will be affected by the number of heart transplants
conducted. A significant amount of our current products sales is generated by our
VADs implanted temporarily in patients awaiting heart transplants. The number
of heart transplants conducted worldwide depends on the number of hearts
available to transplant, which number in turn depends on the death rate of
otherwise healthy people from events such as automobile accidents. To the
extent that public safety measures and technological improvements, such as
automobile air bags and anti-lock brakes, are successfully implemented, the
availability of these hearts to transplant may not grow significantly, and may
trend downward. 26




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##### 



We have experienced rapid growth and changes in our business, and our failure
to manage this and any future growth could harm our business. As a result of the Merger, the number of our employees increased
significantly, and has continued to grow. The number of our employees increased
from 183 on December 30, 2000 to 899 on July 3, 2004. We expect to continue
increasing the number of our employees, and we may suffer if we do not manage
and train our new employees effectively. Our product sales may not continue to
grow at a rate sufficient to support the costs associated with an increasing
number of employees. Any future periods of rapid growth may place significant
strains on our managerial, financial and other resources. The rate of any
future expansion, in combination with our complex technologies and products,
may demand an unusually high level of managerial effectiveness in anticipating,
planning, coordinating and meeting our operational needs as well as the needs
of our customers. If we fail to successfully introduce new products, our future growth may
suffer. As part of our growth strategy, we intend to develop and introduce a
number of new products and product improvements. We also intend to develop new
indications for our existing products. For example, we are currently developing
updated versions of our HeartMate products. If we do not introduce these new
products, product improvements and new indications on a timely basis, or if
they are not well accepted by the market, our future growth may suffer. Amortization of our intangible assets, which represent a significant portion of
our total assets, will adversely affect our net income and we may never realize
the full value of our intangible assets. As of July 3, 2004, we had $253.5 million of net intangible assets,
representing 45.9% of our total assets and 79.3% of our shareholders equity.
These intangible assets consist primarily of goodwill and other intangible
assets arising from the Merger and our trademarks and patented technology.
Amortization expense relating to these intangible assets for the first half and
second quarter of 2004 were $5.9 million and $2.9 million, respectively.
Ongoing amortization of purchased intangibles will reduce our net income or
increase our net loss. We may not receive the recorded value for our intangible assets if we sell
or liquidate our business or assets. The material concentration of intangible
assets increases the risk of a large charge to earnings in the event that the
revenue from, and recoverability of, these intangible assets is impaired. In
the event of such a charge to net income, the market price of our common stock
could be adversely affected. For example, in the first quarter of 2004, we
completed an assessment of the final results from the feasibility clinical
trial for the Aria CABG graft, which was ongoing through fiscal 2003. Based on
the clinical trial results, we determined not to devote additional resources to
development of the Aria graft. Upon the decision to discontinue product
development, we recorded an impairment charge of approximately $9 million as of
January 3, 2004 to write off purchased intangible assets related to the Aria
graft, recorded as a result of the Merger. We rely on specialized suppliers for certain components and materials in our
products and alternative suppliers may not be available. We depend on a number of custom-designed components and materials supplied
by other companies including, in some cases, single source suppliers for
components and materials used in our VAD products and blood testing products.
For example, a single source currently manufactures and supplies the heart
valves used in our HeartMate products. We do not have long-term written
agreements with most of our vendors and receive components on a purchase order
basis only. If we need alternative sources for key raw materials or component
parts for any reason, such alternative sources may not be available and our
inventory may not be sufficient to fill orders before we find alternative
suppliers or begin manufacturing these components or materials ourselves.
Cessation or interruption of sales of circulatory support products would
seriously harm our business, financial condition and results of operations. Alternative suppliers, if available, may not agree to supply us. In
addition, we may need to obtain FDA approval before using new suppliers or
manufacturing our own components or materials. Existing suppliers could also be
subject to an FDA enforcement action, which could also disrupt our supplies. If
alternative suppliers are not available, we may not have the expertise or
resources necessary to produce these materials or component parts internally. 27




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##### 



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 use up
inventory of the legacy component. If suppliers discontinue components on which we rely, we may have to:  
    
    pay premium prices to our suppliers to keep their production lines open or to alternative suppliers;  
    
    buy substantial inventory to take us through the scheduled end of
life of our product, or through such time that we will have a
replacement product developed and approved by the FDA; or  
    
    stop shipping the product in which the legacy component is used
once our inventory of the discontinued component is exhausted. Any of these interruptions in the supply of our materials could result in
substantial reductions in revenue and increases in our production costs. If we fail to compete successfully against our existing or potential
competitors, our product sales or operating results may be harmed. Competition from medical device companies and medical device subsidiaries
of health care and pharmaceutical companies is intense and is expected to
increase. Competitors for the VAD system include World Heart Corporation and
ABIOMED, Inc. Principal competitors in the vascular graft market include W.L.
Gore, Inc., C.R. Bard and Boston Scientific Corporation. Principal competitors
in the hospital coagulation and blood gas monitoring equipment market include
the Cardiac Surgery Division of Metronic, Inc., iSTAT, Radiometer, Bayer, Inc.,
and Instrument Labratories. 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 Holding AG and
Hemo-Sense. Many of our competitors have substantially greater financial, technical,
distribution, marketing and manufacturing resources than we have. Accordingly,
our competitors may be able to develop, manufacture and market products more
efficiently and at a lower cost than we can. We expect that the key competitive
factors will include the relative speed with which we can:  
    
    develop products;  
    
    complete clinical testing;  
    
    receive regulatory approvals; and  
    
    manufacture and sell commercial quantities of products. Additionally, our competitors may succeed in developing and marketing
technologies and products that are more effective than ours. Any such products
may render our technology and products obsolete or noncompetitive. In addition,
new surgical procedures and medications could be developed that replace or
reduce the importance of current procedures that use our products. The price of our common stock may fluctuate significantly, which may make it
difficult for holders to resell our common stock issuable upon conversion of
the convertible notes when desired or at attractive prices. 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. The price of our common stock could fluctuate significantly for
many reasons, including the following: 28




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
    
    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 the Merger;  
    
    introduction of new products or changes in product pricing policies by us or our competitors;  
    
    acquisition or loss of significant customers, distributors or suppliers;  
    
    business acquisitions or divestitures;  
    
    changes in earnings estimates by analysts;  
    
    changes in third party reimbursement practices;  
    
    regulatory developments, enforcement actions bearing on
advertising, marketing or sales, and disclosure regarding completed
ongoing or future clinical trials; and  
    
    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. In the past, shareholders have often instituted securities class action
litigation after periods of volatility in the market price of a companys
securities. If a shareholder or convertible note holder files a securities
class action suit against us, we would 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. 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. We transferred the
manufacturing operations for the HeartMate from Woburn, Massachusetts to
Pleasanton, California and, in the first half of 2003, received clearance from
the FDA to begin manufacturing the HeartMate in this new location. If we have
difficulties manufacturing our products, our business will be harmed. Since we depend upon distributors, if we lose a distributor or a distributor
fails to perform, our operations will be harmed. With the exception of Canada and the larger countries in Europe, we sell
our VAD and HeartMate systems in foreign markets through distributors. In
addition, we sell our vascular access graft products through the Bard
Peripheral Vascular division of C.R. Bard Corporation in the United States,
Europe and selected countries in Scandinavia, the Middle East and Northern
Africa and through Goodman Co. Ltd. in Japan. Substantially all of the
international operations and a large amount of the domestic operations of our
ITC subsidiary are conducted through distributors. For the six months ended
July 3, 2004, 19% of our total product sales were through Cardinal Healthcare,
a distributor of our blood coagulation testing equipment and skin incision
devices. 29




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To the extent we rely on distributors, our success will depend upon the
efforts of others, over which we may have little control. If we lose a
distributor or a distributor fails to perform to our expectations, our revenues
will be harmed. Changes we make to our method of distributing and selling our products could
hurt our relationship with distributors and their customers. Following our recent acquisition of the IRMA product line of blood gas
analyzers, commencing in March 2004, we changed our manner of distributing our
Hemochron and IRMA product lines to our hospital point-of-care customers in the
United States from a distributor model to a direct sales model. Sales of these
products represented approximately $3.9 million of our sales in the second
quarter of 2004. This transition will include expanding the sales, technical service,
customer service and shipping headcount at our ITC subsidiary in order to
provide our customers with the support and service that they historically
obtained from our distributors. We expect our sales, general and administrative
costs to increase. We expect the transition process to conclude in early 2005
when the last distributor will have been converted and the United States will
be served exclusively by ITC on a direct basis. This transition and its
execution involve significant risks, including:  
    
    the alienation of distributors when they are informed of our plans;  
    
    the promotion by our former distributors of products from competitors rather than our products;  
    
    the potential loss of customers who prefer to deal with a particular distributor; and  
    
    the challenges and costs associated with building an effective direct sales force. If we fail to build an effective direct sales force for our Hemochron and
IRMA 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 significant
portion of our sales, generally are not protected by any patents. We rely
principally on trade secret protection and, to a lesser extent, patents to
protect our rights to the HeartMate. We rely principally on patents to protect
our coagulation testing equipment, skin incision devices, Hemochron disposable
cuvettes, IRMA analyzer, IRMA disposable cartridges, and Hgb Pro disposable
test strips. We seek to protect our trade secrets and unpatented proprietary
technology, in part, with confidentiality agreements with our employees and
consultants. Although it is our policy to require that all employees and
consultants sign such agreements, we cannot assure you that every person who
gains or has gained access to such information has done so. Moreover, these
agreements may be breached and we may not have an adequate remedy. Our products may be found to infringe prior or future patents owned by
others. We may need to acquire licenses under patents belonging to others for
technology potentially useful or necessary, and such licenses may not 30




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be available to us. We could incur substantial costs in defending suits
brought against us on such patents or in bringing suits to protect our patents
or patents licensed by us against infringement. For example, in 2003, a patent infringement claim was filed against the
Company by Bodycote Materials Testing Canada, Inc. and David C. MacGregor, M.D.
related to materials used in the HeartMate LVAS. On February 3, 2004, the
Company settled the claim and recorded a charge of $2.3 million in the fourth
quarter of 2003 for the settlement and related legal costs. Product liability claims could damage our reputation and hurt our financial
results. Our business exposes us to an inherent risk of potential product liability
claims related to the manufacturing, marketing and sale of human medical
devices. We maintain only a limited amount of product liability insurance. Our
insurance policies generally must be renewed on an annual basis. We may not be
able to maintain or increase such insurance on acceptable terms or at
reasonable costs, and such insurance may not provide us with adequate coverage
against potential liabilities. A successful claim brought against us in excess
of, or outside of, our insurance coverage could seriously harm our financial
condition and results of operations. Claims against us, regardless of their
merit or potential outcome, may also reduce our ability to obtain physician
endorsement of our products or expand our business. Identified quality problems can result in substantial costs and write-downs. FDA regulations require us to track materials used in the manufacture of
our products, so that any problems identified in a finished product can easily
be traced back to other finished products containing the defective 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. In addition,
acquisitions may dilute our earnings per share, disrupt our ongoing business,
distract our management and employees and increase our expenses, which could
harm our business. We may also sell businesses or assets as part of our
strategy or if we receive offers from third parties. If we do so, we may sell
an asset or business for less than its full value. Our non-U.S. sales present special risks. During the six months ended July 3, 2004 and the year ended 2003, sales
originating outside the United States and U.S. export sales accounted for
approximately 21% and 19%, respectively, of our total product sales. We
anticipate that sales outside the United States and U.S. export sales will
continue to account for a significant percentage of our product sales and we
intend to continue to expand our presence in international markets. Non-U.S.
sales are subject to a number of special risks. For example:  
    
    we generally sell many of our products at a lower price outside the United States;  
    
    sales agreements may be difficult to enforce;  
    
    receivables may be difficult to collect through a foreign countrys legal system; 31




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
    
    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 may interrupt distribution channels or
adversely impact our customers or employees; and  
    
    fluctuations in exchange rates may affect product demand and
adversely affect the profitability, in U.S. dollars, of products
sold in foreign markets where payments are made in local currencies. Any of these events could harm our operations or operating results. Any claims relating to improper handling, storage or disposal of hazardous
chemicals and biomaterials could be time consuming and costly. Producing our products requires the use of hazardous materials, including
chemicals and biomaterials. We cannot eliminate the risk of accidental
contamination or discharge and any resultant injury from these materials. We could be subject to both criminal liability and civil damages in the
event of an improper or unauthorized release of, or exposure of individuals to,
hazardous materials. In addition, claimants may sue us for injury or
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, which could seriously harm our business and operations, 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. Fluctuations in foreign currency exchange rates could result in declines in our
reported sales and earnings. Because some of our international sales are denominated in local
currencies and not in U.S. dollars, our reported sales and earnings are subject
to fluctuations in foreign exchange rates. At present, we use forward foreign
currency contracts to hedge the gains and losses created by the remeasurement
of non-functional currency denominated assets and liabilities. However, we do
not engage in hedge exposures that will arise from future sales. As a result,
sales occurring in the future that are denominated in foreign currencies may be
translated into U.S. dollars at a less favorable rate than our current exchange
rate environment resulting in reduced revenues and earnings. The competition for qualified personnel is particularly intense in our
industry. If we are unable to retain or hire key personnel, we may not be able
to sustain or grow our business. Our ability to operate successfully and manage our potential future growth
depends significantly upon retaining key research, technical, sales, marketing,
managerial and financial personnel, and attracting and retaining 32




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additional highly qualified personnel in these areas. We face intense
competition for such personnel, and we may not be able to attract and retain
these individuals. We compete with numerous companies, as well as universities
and nonprofit research organizations throughout all our locations. The loss of
key personnel for any reason or our inability to hire and retain additional
qualified personnel in the future could prevent us from sustaining or growing
our business. Our success will depend in large part on the continued services
of our research, managerial and manufacturing personnel. We cannot assure you
that we will continue to be able to attract and retain sufficient qualified
personnel. We may be unable to repay or repurchase our convertible notes or our other
indebtedness. At maturity, the entire outstanding principal amount of our convertible
notes will become due and payable. Holders of the convertible notes may also
require us to repurchase the convertible notes on May 16 in each of 2011, 2014,
2019, 2024 and 2029. In addition, if certain fundamental changes to our company
occur, the holders of the convertible notes may require us to repurchase all or
a portion of their convertible notes. We may not have sufficient funds or may
be unable to arrange for additional financing to pay the principal amount due
at maturity or the repurchase price of the convertible notes. Any such failure
would constitute an event of default under the indenture, which could, in turn,
constitute a default under the terms of our other indebtedness. Any default
under our indebtedness could have a material adverse effect on our business,
operating results and financial condition. Conversion of the convertible notes or other future issuances of our stock will
dilute the ownership interests of existing shareholders. The conversion of some or all of the convertible notes will dilute the
ownership interest of our existing shareholders. Any sales in the public market
of the common stock issuable upon such conversion could adversely affect
prevailing market prices of our common stock. Further, the existence of the
convertible notes may encourage short selling by market participants because
the conversion of the convertible notes could depress the price of our common
stock. In addition, future sales of substantial amounts of our stock in the
public market, or the perception that such sales could occur, could adversely
affect the market price of our stock. Sales of our shares and the potential for
such sales could cause our stock price to decline. If the ETIF adopts Issue No. 04-8 as proposed, we would be required to
include all shares available upon conversion of our convertible notes in our
diluted EPS if the effect would be dilutive, regardless of whether the notes
are then convertible. This inclusion could result in a significantly lower
diluted EPS number than would otherwise have been the case. Anti-takeover defenses in our governing documents could prevent an acquisition
of our company or limit the price that investors might be willing to pay for
our common stock. Our governing documents could make it difficult for another company to
acquire control of our company. For example:  
    
    Our Articles of Incorporation allow our Board of Directors to
issue, at any time and without shareholder approval, preferred stock
with such terms as it may determine. No shares of preferred stock
are currently outstanding. However, the rights of holders of any of
our preferred stock that may be issued in the future may be superior
to the rights of holders of our common stock.  
    
    We have a rights plan, commonly known as a poison pill,
which would make it difficult for someone to acquire our company
without the approval of our Board of Directors. All or any one of these factors could limit the price that certain
investors would be willing to pay for shares of our common stock and could
delay, prevent or allow our Board of Directors to resist an acquisition of our
company, even if the proposed transaction was favored by a majority of our
independent shareholders. 33




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK Interest Rate Risk Our investment portfolio is made up of cash equivalent and marketable
security investments in money market funds and debt instruments of government
agencies and high quality corporate issuers. All investments are carried at
market value and are treated as available-for-sale. All investments mature
within two years or less from the date of purchase. The holdings of any one
issuer, except government agencies, do not exceed 10% of the portfolio. If
interest rates rise, the market value of our investments may decline which
could result in a loss if we are forced to sell an investment before the
scheduled maturity. We do not utilize derivative financial instruments to
manage interest rate risks. Our debt issuance however, does not have interest rate risk associated as
the notes were issued at a fixed rate of interest. Foreign Currency Rate Fluctuations We conduct business in foreign countries. Our international operations
consist primarily of sales and service personnel for our ventricular assist
products, who report into our U.S. sales and marketing group and are internally
reported as part of that group. All assets and liabilities of our non-U.S.
operations are translated into U.S. dollars at the period-end exchange rates
and the resulting translation adjustments are included in comprehensive income.
The period-end translation of the non-functional currency assets and
liabilities (primarily assets and liabilities on our UK subsidiary consolidated
balance sheet that are not denominated in UK Pounds) at the period-end exchange
rates result in foreign currency gains and losses, which are included in
Interest and Other Income-Net. We use forward foreign currency contracts to hedge the gains and losses
generated by the revaluation of these non-functional currency assets and
liabilities. These derivatives are not designated as cash flow or fair value
hedges under SFAS No. 133. As a result, changes in the fair value of the
forward foreign currency contracts are included as incurred in Interest and
Other IncomeNet. The change in the fair value of the forward foreign currency
contracts typically offsets the change in value from revaluation of the
non-functional currency assets and liabilities. These contracts typically have
maturities of three months or less. At July 3, 2004, the Company had forward
foreign currency contracts in Pounds Sterling and Euros with a notional value
of $9.6 million and with a negligible fair value. There were no such contracts
outstanding at June 28, 2003. The impact of foreign currency revaluation, net
of forward foreign currency contracts, was a loss of $0.1 million for the
quarter ending July 3, 2004 and a gain of $0.2 million for the quarter ending
June 28, 2003. 34




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ITEM 4. CONTROLS AND PROCEDURES An evaluation was performed under the supervision and with the
participation of our management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures as of July 3, 2004. Disclosure controls and procedures are designed to reasonably assure that
the information required to be disclosed in our reports filed under the
Exchange Act, such as this Quarterly Report, is recorded, processed, summarized
and reported within the time periods specified in the SECs rules and forms.
Disclosure controls and procedures are also designed to reasonably assure that
such information is accumulated and communicated to our management, including
the Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. Our disclosure controls
and procedures include components of our internal control over our financial
reporting, which consists of control processes designed to provide reasonable
assurance regarding the reliability of financial reporting and permitting the
preparation of our financial statements in conformity with generally accepted
accounting principles. To the extent that components of our internal control
over our financial reporting are included within our disclosure controls and
procedures, they are included in the scope of our quarterly controls
evaluation. The evaluation of our disclosure controls and procedures included a review
of our processes and implementation and the effect on the information generated
for use in this Quarterly Report. In the course of this evaluation, we sought
to identify any significant deficiencies or material weaknesses in our
controls, to determine whether we had identified any acts of fraud involving
personnel who have significant roles in internal controls and to confirm that
any necessary corrective action, including process improvements, were being
undertaken. This type of evaluation is done every fiscal quarter so that our
conclusions concerning the effectiveness of these controls can be reported in
our periodic reports filed with the SEC. The overall goals of these
evaluations activities are to monitor our disclosure controls and procedures
and to make modifications as necessary. Based on the evaluation, subject to the limitations described below, our
management, including the Chief Executive Officer and Chief Financial Officer,
concluded that as of July 3, 2004 the Companys disclosure controls and
procedures were effective in providing reasonable assurance that information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SECs rules and forms. There have been no
changes in our internal controls during the fiscal quarter ended July 3, 2004
that have materially affected or are reasonably likely to materially affect the
Companys internal control over financial reporting. Our management, including the Chief Executive Officer and the Chief
Financial Officer, do not expect that the disclosure controls and procedures or
internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can only provide reasonable, not
absolute, assurances that the objectives of the control system are met. The
design of a control system reflects resource constraints; the benefits of
controls must be considered relative to their costs. Because there are inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of error or fraud, if
any, within the Company have been or will be detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty and that breakdowns occur because of simple error or mistake. Controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls is based in part upon certain assumptions about the
likelihood of future events. There can be no assurance that any design will
succeed in achieving its stated goals under all future conditions; over time,
controls may become inadequate because of changes in conditions or
deterioration in the degree of compliance with the policies or procedures.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected. We intend to 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. Our senior management has timely access to all material
financial and non-financial information concerning our business. While we
believe the present design of our disclosure controls and procedures is
effective, future events affecting our business may cause us to significantly
modify our disclosure controls and procedures. 35




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PART II. OTHER INFORMATION 
 ITEM 1. LITIGATION In June of 2004, MicroMed Technology, Inc., a potential competitor of the
Company, sued the Company in Texas. MicroMed sued for 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 provides the HeartMate II VAD to
clinical sites without charge. MicroMed has asked the court to prevent
Thoratec from providing the HeartMate II to the clinical sites without charge
by claiming that such practices violate Texas anti-trust law. In addition to a
temporary restraining order, the plaintiff is seeking unspecified damages and
fees, including those resulting from lost sales of its VAD products (which are
in clinical trials in the U.S. only and not yet commercially approved) due to
the Companys HeartMate II clinical trial. The Company defeated MicroMeds motion for a temporary restraining order
and intends to mount a vigorous defense to all of the claims made by MicroMed. On August 3, 2004, a putative class action entitled Johnson v. Thoratec
Corporation, et al.was filed in the United States District Court for the
Northern District of California on behalf of purchasers of the publicly traded
securities of the Company between April 28, 2004 and June 29, 2004. The
Johnsoncomplaint generally alleges violations of the Securities Exchange Act
of 1934 by the Company, its chief executive officer and chief financial
officer. Based upon, inter alia,alleged false statements about the Companys
expected sales and the market for HeartMate as a Destination Therapy treatment.
The complaint seeks to recover unspecified damages on behalf of all purchasers
of the Companys publicly traded securities during the class period. Subsequent to the filing of the Johnsoncomplaint, additional plaintiffs law
firms issued press releases indicating that additional similar complaints have
been filed in the same court, alleging essentially the same claims, on behalf
of the same putative class of purchasers of Thoratec securities. The Company
has not been served with any of those complaints. Based on the facts known to
date, Thoratec believes that the claims asserted in this action and the related
actions are without merit and intends to vigorously defend this suit. However,
we are unable to predict at this time the final outcome of the various
shareholder actions, or whether the resolution of the actions could
materially affect our results of operations, cash flows or financial position.
No amount in respect of this matter has been accrued in our consolidated
financial statements. 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES (c) Recent Unregistered Sales of Equity Securities. On May 24, 2004 we completed the sale of $143.8 million initial principal
amount of senior subordinated convertible notes due 2034. The convertible
notes were sold in a private placement to Qualified Institutional Buyers
pursuant to the exemption from the registration requirements of the Securities
Act of 1933, as amended, provided by Rule 144A thereunder. Total proceeds to
the Company from the sale were $139.2 million, after debt issuance costs of
$4.6 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. 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 may convert their convertible notes at any point after the close of
business on September 30, 2004 if, as of the last day preceding the calendar
quarter, the closing price of our common stock for at least 20 trading days in
a period of 30 consecutive trading days ending on the last trading day of such
preceding calendar quarter is more then 120% of the accreted conversion price
per share of our common stock. Holders may surrender their convertible notes
on or prior to May 16, 2029 during the five business day period after any five
consecutive trading day period in which the trading price per note for each day
of that period was less than 98% of the product of the closing sale price of
our common stock 36




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and the conversion rate on each such day; provided that if on the day prior to
any conversion the closing sale price of our common stock is greater than the
accreted conversion price but less than or equal to 120% of the accreted
conversion price, then holders will receive upon conversion, in lieu of shares
of common stock based on the conversion rate, cash or common stock, or a
combination of cash and common stock, at our option, with a value equal to the
accreted principal amount of the notes plus accrued but unpaid interest as of
the conversion date. Additionally, holders may convert their convertible notes
if we call them for redemption or if specified corporate transactions or
significant distributions to holders of our stock have occurred. The debt offering proceeds were used to purchase and pledge $9.8 million
to the trustee under the indenture for the exclusive benefit of the holders of
the convertible notes, U.S. government securities to provide for the payment,
in full, of the first six scheduled interest payments. Additional net proceeds
were used to repurchase 4.2 million shares of our outstanding common stock for
$60 million. The remaining net proceeds will be used for general corporate
purposes, which may include additional stock repurchases, strategic investments
or acquisitions. (e) Purchases of Equity Securities by the Issuer. Maximum Dollar ValueOf Shares That MayTotal Number of
    
    YetTotal Number
    
    Average
    
    Shares Purchased as
    
    Be Purchased UnderOf Shares
    
    Price Paid
    
    Part Of Publicly
    
    The ProgramPurchased
    
    Per Share
    
    Announced Program
    
    (in millions)January 4, 2004 to January 31, 2004
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    25.0February 1, 2004 to February 28, 2004
    
    
    185,000
    
    
    $
    13.59
    
    
    
    185,000
    
    
    $
    25.0February 29, 2004 to April 3, 2004
    
    
    325,000
    (2)
    
    $
    12.97
    
    
    
    325,000
    
    
    $
    18.3April 4, 2004 to May 1, 2004
    
    
    0
    
    
    $
    0
    
    
    
    0
    
    
    $
    18.3May 2, 2004 to May 29, 2004
    
    
    4,234,100
    
    
    $
    14.33
    
    
    
    4,234,100
    
    
    $
    17.6May 30, 2004 to July 3, 2004
    
    
    405,000
    
    
    $
    10.76
    
    
    
    405,000
    
    
    $
    13.2Total
    
    
    5,149,100
    
    
    $
    13.94
    
    
    
    5,149,100
  (1)
    
    Our stock repurchase program, which authorizes the Company to repurchase
up to $85 million of shares, was announced on February 11, 2004 as a $25
million of shares program and increased on May 12, 2004 to an $85 million shares program. On July 29, 2004 we announced that the Board of Directors
authorized the Company to repurchase up to an additional $25 million shares. These programs do not have an expiration date.  (2)
    
    Includes 250,000 shares which were purchased from Thermo Electron
Corporation in a privately arranged transaction executed through a third
party broker at the then current market price. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The annual meeting of shareholders was held on May 21, 2004. The
following item was voted upon and approved at the meeting: To elect directors to serve for the ensuing year until their successors
are elected, Number of VotesFor
    
    WithheldHoward E. Chase
    
    
    52,924,625
    
    
    
    1,001,777J. Daniel Cole
    
    
    52,663,177
    
    
    
    1,263,225Neil F. Dimick
    
    
    52,065,580
    
    
    
    1,860,822D. Keith Grossman
    
    
    52,562,093
    
    
    
    1,364,309J. Donald Hill
    
    
    52,093,268
    
    
    
    1,833,134William M. Hitchcock
    
    
    52,625,153
    
    
    
    1,301,249George W. Holbrook, Jr.
    
    
    52,241,999
    
    
    
    1,684,403Daniel M. Mulvena
    
    
    52,243,119
    
    
    
    1,683,283
 37




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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 4.1     Indenture, dated as of May 24, 2004, by and between the Registrant and U.S.
Bank, National Association, as Trustee. 4.2     Pledge Agreement, dated as of May 24, 2004, between the Registrant and U.S.
Bank, National Association, and Pledge Agreement Supplement, dated as of June
7, 2004. 4.3     Control Agreement, dated as of May 24, 2004, between the Registrant and
U.S. Bank, National Association, and Control Agreement Amendment, dated as of
June 7, 2004. 4.4     Registration Rights Agreement, dated May 24, 2004, by and among the
Registrant and Merrill Lynch Pierce Fenner & Smith Incorporated as Initial
Purchaser of the Senior Subordinated Convertible Notes due 2034. 31.1    Section 302 Certifications of Chief Executive Officer and Chief Financial
Officer. 32.1    Section 906 Certifications of Chief Executive Officer and Chief Financial
Officer.  (b)
    
    Reports on Form 8-K: On June 29, 2004, the Company furnished a Current Report on Form 8-K,
reporting under item 12, providing an update on our business activities and
outlook for the remainder of 2004. On June 8, 2004, the Company furnished a Current Report on Form 8-K,
reporting under item 9, announcing that the initial purchaser for our
initial offering of $125 million initial principal amount of senior
convertible notes due 2023, exercised its option to purchase an additional
$18.7 million initial principal amount of such senior subordinated
convertible notes. On May 20, 2004, the Company furnished a Current Report on Form 8-K,
reporting under item 9, announcing our intention to commence an offering of
$125 million in aggregate initial principal amount of senior convertible
notes as well as the pricing of the note offering. On April 27, 2004, the Company furnished a Current Report on Form 8-K,
reporting under item 12, announcing our fiscal 2004 first quarter results. 38




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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: August 12, 2004
    /s/ D. Keith GrossmanD. Keith Grossman,Chief Executive Officer Date: August 12, 2004
    /s/ M. Wayne BoylstonM. Wayne Boylston,Senior Vice President,
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer) 39




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##### 



EXHIBIT INDEX ExhibitNo.
    
    Description4.1
    
    Indenture, dated as of May 24, 2004, by and between the Registrant and U.S.
Bank, National Association, as Trustee.4.2
    
    Pledge Agreement, dated as of May 24, 2004, between the Registrant and U.S.
Bank, National Association, and Pledge Agreement Supplement, dated as of June
7, 2004.4.3
    
    Control Agreement, dated as of May 24, 2004, between the Registrant and
U.S. Bank, National Association, and Control Agreement Amendment, dated as of
June 7, 2004.4.4
    
    Registration Rights Agreement, dated May 24, 2004, by and among the
Registrant and Merrill Lynch Pierce Fenner & Smith Incorporated as Initial
Purchaser of the Senior Subordinated Convertible Notes due 2034.31.1
    
    Section 302 Certifications of Chief Executive Officer and Chief Financial Officer.32.1
    
    Section 906 Certifications of Chief Executive Officer and Chief Financial Officer.