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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   (Mark one) þ
    
    ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended January 1, 2005
 o
    
    TRANSITION REPORT UNDER 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 Securities registered pursuant to Section 12(b) of the Exchange Act: None Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock Indicate by a check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes þ No o Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ Indicate by a check mark whether the registrant is an accelerated filer (as defined in
Exchange Act Rule 12(b)-2)Yes þ No o The aggregate market value of the voting stock held by non-affiliates computed by reference to
the last sale reported of such stock on July 2, 2004, the last business day of the Registrants
second fiscal quarter, as listed on The Nasdaq National Stock Market was $517,972,797. As of March 14, 2005, registrant had 48,198,480 shares of common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Designated portion of Thoratecs definitive proxy statement for its 2005 annual meeting of
shareholders are incorporated by reference into Part III of this Form 10-K.




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FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K, including the documents incorporated by reference in this
Annual Report, includes forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements can
be identified by the words expects, projects, hopes, believes, intends, should,
estimate, will, would, may, anticipates, plans, could and other similar words. Actual
results could differ materially from these forward-looking statements based on a variety of
factors, many of which are beyond our control. Therefore, readers are cautioned not to put undue
reliance on these statements. Investors are cautioned that all such statements involve risks and
uncertainties, including risks related to the development of new markets such as Destination
Therapy, the growth of existing markets for our products, customer and physician acceptance of our
products, changes in the mix of our product sales and the related gross margin for such product
sales, the results of clinical trials including the HeartMate II, the ability to improve financial
performance, regulatory approval processes, the effect of healthcare reimbursement and coverage
policies, the effects of seasonality in our product sales, the effects of price competition from
any of our competitors and the effects of any merger and acquisition related activities. Factors
that could cause actual results or conditions to differ from those anticipated by these and other
forward-looking statements include those more fully described in the Factors That May Affect
Future Results section and in other documents we file with the Securities and Exchange Commission.
Actual results, events or performance may differ materially. These forward-looking statements speak
only as of the date hereof. We undertake no obligation to publicly release the results of any
revisions to these forward-looking statements that may be made to reflect events or circumstances
after the date hereof, or to reflect the occurrence of unanticipated events. Thoratec, the Thoratec logo, Thoralon, TLC-II, HeartMate, HeartPak and Vectraare registered
trademarks, and Aria, Heart Hope and IVAD are trademarks of Thoratec Corporation. HEMOCHRON, ProTime, Surgicutt, Tenderlett, tenderfoot and IRMA are registered trademarks of
International Technidyne Corporation, or ITC, our wholly-owned subsidiary. 2




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TABLE OF CONTENTS PagePART IItem 1.
    
    Business.
    
    
    4Item 2.
    
    Properties.
    
    
    30Item 3.
    
    Litigation.
    
    
    30Item 4.
    
    Submission of Matters to a Vote of Security Holders.
    
    
    31PART IIItem 5.
    
    Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities.
    
    
    32Item 6.
    
    Selected Consolidated Financial Data.
    
    
    32Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    33Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk.
    
    
    42Item 8.
    
    Financial Statements and Supplementary Data.
    
    
    43Item 9.
    
    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
    
    
    70Item 9A.
    
    Controls and Procedures.
    
    
    70Item 9B.
    
    Other Information.
    
    
    71PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant and Code of Ethics.
    
    
    72Item 11.
    
    Executive Compensation.
    
    
    72Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management.
    
    
    72Item 13.
    
    Certain Relationships and Related Transactions.
    
    
    72Item 14.
    
    Principal Accountant Fees and Services.
    
    
    72PART IVItem 15.
    
    Exhibits and Financial Statement Schedules.
    
    
    73Exhibit Index
    
    
    75
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PART I 
 Item 1.Business OVERVIEW We are a leading manufacturer of circulatory support products for use by patients with
congestive heart failure, or CHF. We are a leading provider of circulatory support products
worldwide. We sell Ventricular Assist Devices, or VADs, to virtually every leading heart transplant
center in the world; marketing three out of the four VADs approved by the United States Food and
Drug Administration, or FDA, as a bridge to heart transplant for adults. We are also a leading
provider of point-of-care blood diagnostic test systems. Our business is comprised of two segments; Cardiovascular and ITC. The major product lines
within the Cardiovascular market are:  
    Circulatory Support Products.Our circulatory support products include VADs for the
short-term and long-term treatment of congestive heart failure.
    Vascular Graft Products.We have developed small diameter grafts using our proprietary
materials to address the vascular access market. Our grafts are sold in the United States
and internationally for use in hemodialysis. The major product line of our ITC segment is:  
    Point-of-Care Diagnostics. We are a leading supplier of point-of-care blood diagnostics
test systems that provide fast, accurate blood test results to improve patient management,
reduce healthcare costs and improve patient outcomes. 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 FDA to commercially market a VAD 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 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. We currently market VADs that may be implanted or worn outside the body and that are suitable
for treatments for different durations for patients of varying sizes and ages. We estimate that
doctors have implanted over 9,000 of our devices in patients suffering from heart failure. Our
devices are currently used primarily for patients awaiting a heart transplant or Destination
Therapy implants. On November 6, 2002, the FDA approved the HeartMate VAD as the first heart assist
device for Destination Therapy, or permanent support for patients suffering from end-stage heart
failure who are not eligible for heart transplantation. On April 7, 2003, the FDA approved the
HeartMate XVE, an enhanced version of the HeartMate VAD, for Destination Therapy. Thoratec is the
only company to have a ventricular assist device approved for Destination Therapy in the United
States. Destination Therapy The FDA approval of the HeartMate VAD for Destination Therapy marks the first time a VAD has
been approved as a long-term, permanent treatment for end-stage congestive heart failure patients
who do not qualify for heart transplantation due to age or extenuating health circumstances and who
otherwise have a life expectancy of less than two years. The FDAs decision to approve the HeartMate VAD for Destination Therapy was based on data from
a clinical trial called REMATCH, or Randomized Evaluation of Mechanical Assistance for the
Treatment of Congestive Heart 4




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Failure, which showed our HeartMate device nearly doubled and tripled survival over the drug
therapy group at one and two years, respectively. The Centers for Medicare & Medicaid Services, or CMS, issued a National Coverage Decision
Memorandum for the use of Left Ventricular Assist System, or LVAS, for Destination Therapy,
effective October 1, 2003. CMS has subsequently adjusted the relative weight and base level of
reimbursement it will provide under DRG (diagnosis-related group) 103 Heart Transplant or Implant
of Implantable Heart Assist Systems to raise the average payment for CMS DT-certified Centers
under DRG 103 to approximately $136,000; the same reimbursement given for heart transplants. In
many cases the actual payments to hospitals under DRG 103 could be higher or lower, based on
geographical location and other factors. Since December 2002, the majority of national insurance carriers, such as Aetna, Cigna,
Humana, United Healthcare and UNICARE, have issued positive coverage policies to cover the use of
ventricular assist devices for FDA-approved indications of our VADs, including Destination Therapy. OUR MARKETS Circulatory Support Products The primary markets for our VAD products are those patients suffering from heart failure, and
in particular, from CHF. CHF is a chronic disease that occurs when degeneration of the heart muscle
reduces the pumping power of the heart, causing the heart to become too weak to pump blood at a
level sufficient to meet the bodys demands. CHF can be caused by artery or valve diseases or a
general weakening of the heart muscle itself. In addition, other conditions, such as high blood
pressure or diabetes, can also lead to CHF. According to the American Heart Association, or the AHA, there are 4.9 million CHF patients in
the United States and approximately 550,000 new cases are diagnosed each year. The AHA also
estimates that approximately 70% of CHF patients under age 65 will die within eight years of
diagnosis. We believe that the number of patients suffering from end-stage CHF who could benefit
from some form of cardiac assist could be over 100,000 annually. While the number of treatment
options for earlier stage CHF has increased in recent years, the use of medication remains the most
widely used approach for treatment of the disease. These drug therapies include ACE inhibitors,
anti-coagulants and beta-blockers, which facilitate blood flow, thin the blood or help the heart
work in a more efficient manner. Other procedures include angioplasty, biventricular pacing, valve
replacement, bypass and left ventricular reduction surgery. Despite attempts to manage CHF through drug therapy, there is currently only one curative
treatment for the disease  a heart transplant. Unfortunately, the number of hearts available for
transplant each year can meet the needs of only a small number of the patients requiring a heart
transplant. The United Network for Organ Sharing reported that there were only 2,085 hearts
available for transplant in the United States in 2003. At any given time, there are approximately
4,000 patients on the U.S. national transplant waiting list and we believe a comparable number of
patients are waiting in Europe. The median wait for a donor heart by patients on a heart transplant
waiting list is approximately nine months, and many patients have to wait as long as two years
before receiving one of the few donor hearts available. In 2001, approximately 15% of these
patients died while waiting for a donor heart. In the United States, there are currently two FDA-approved indications for the use of VADs in
patients with CHF  as a bridge to heart transplant and as Destination Therapy. We are currently
pursuing one additional indication for our Thoratec VAD products  for therapeutic recovery of the
heart. Beyond the CHF markets, VADs are also approved for use during recovery following cardiac
surgery. All four indications are summarized below. Bridge to Transplant Ventricular assist devices provide additional cardiac support for patients
who are in late-stage heart failure waiting for a donor heart. Of the approximately 4,000 patients
on the waiting list for a heart transplant in the United States, we estimate that approximately 25%
receive a VAD. We believe that the percentage of patients bridged to transplant continues to increase with
surgeons level of comfort with the technology, particularly for longer-term support cases. There
are currently five devices approved in the United States as a bridge to transplant in adults, four
of which are manufactured by us. We estimate that the bridge to transplant indication represents a
worldwide market opportunity of up to 8,000 patients annually. 5




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Destination Therapy On November 6, 2002, we received approval to market the HeartMate VAD for
Destination Therapy patients with late-stage CHF who are not candidates for heart transplantation
due to other degenerative illnesses or advanced age. The National Institutes for Health (NIH)
estimated that the Destination Therapy application represents a long-term market opportunity of up
to 100,000 additional patients annually in the United States. For these end-stage CHF patients,
drug therapy is currently the only other treatment available and, even with drug therapy, the
12-month mortality rate for these patients is approximately 75%. We believe that the HeartMate will
provide a significant survival benefit for this patient population. We believe that the success in
transitioning this market from maximum drug therapy to VADs is dependent on the development of
VADs, like our HeartMate, with substantial longevities and proof of clinical efficacy. Therapeutic Recovery We believe that, for most patients, recovery of their own heart is a better
alternative than either heart transplantation or permanent implantation of a blood pumping device.
Based on recently reported cases of recovery in heart failure patients, we believe that our VAD
system, in combination with other agents such as cell or drug therapies, has the potential to
reverse the complications of late-stage heart failure in certain patients. While this therapeutic recovery indication is not yet approved for our devices, we are
actively investigating the worldwide experience with our VAD systems as a means of therapeutic
recovery and the requirements for pursuing regulatory approval for this indication. Although it is
not certain how many patients with CHF could benefit from this indication, based upon our estimate
of the percentage of patients with late-stage CHF, we believe that the patient population could be
substantial. We are continuing with our strategy to add this indication to our labeling. It will
require FDA approval and we will continue working with the FDA towards this goal in 2005. We are
also formulating a regulatory and clinical strategy for non-U.S. markets. Recovery Following Cardiac Surgery In addition to CHF, our devices are also used for patients who
suffer from acute cardiac failure and undergo cardiac surgery. Following cardiac surgery, some
patients have difficulty being weaned off heart/lung machines, a complication that arises in
approximately one percent of the more than 900,000 open-heart procedures performed each year. Many
of these patients ultimately die from heart failure when the heart, weakened by disease and the
additional trauma of surgery, fails to maintain adequate blood circulation. We believe that only a
small portion of this market is currently being treated with VADs and this patient population could
benefit substantially from further awareness and use of our VADs in this market. Point-of-Care Diagnostics Products Our point-of-care, or POC, blood diagnostic test systems provide fast, accurate blood test
results to improve patient management, reduce healthcare costs and improve patient outcomes. These
products are sold into the Hospital POC market, and the Alternate Site POC market comprising
physicians offices, long-term care facilities, clinics, visiting nurse associations, and home
healthcare companies. We believe that the market growth for POC diagnostic products is fueled by convenience and
ease of use to the patients and physicians, and the clinical benefits from the more frequent
monitoring that Alternate Site POC products allow patients. Vascular Graft Products In addition to the circulatory support market, we sell a device that addresses the vascular
access graft market, which we market as the VectraVascular Access Graft, or Vectra,for patients
undergoing renal hemodialysis. 6




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OUR STRATEGY Our key strategies to maintain and expand our leadership position are to: Offer a broad range of products.We believe that our broad and diverse product offering is an
important competitive advantage because it allows us to address the various preferences of surgeons
and the clinical needs of a wide variety of patients, as well as the economic needs and concerns of
third party payers. An important part of our strategy is to further broaden our product line to
meet customer needs by improving and developing new products internally or acquiring or licensing
new products. Increase Cost Effectiveness of our Products. While a recent study indicates that the cost of
implanting a VAD for Destination Therapy is comparable with that of a heart, liver or other major
organ transplant, cost remains a significant concern for our customers. In October 2003, CMS issued
a favorable National Coverage decision for the use of left ventricular assist systems that are
approved by the FDA for treating Destination Therapy in end-stage heart failure patients. We work
very closely with the approximately 69 centers approved by CMS in developing the Destination
Therapy market, which we believe will ultimately improve the cost effectiveness of Destination
Therapy. Additionally, we are expanding our market education and training programs and we continue
to implement improvements that enhance the performance and cost effectiveness of our products. Increase penetration of existing markets. We plan to treat a greater number and variety of
patients within our current customer base. To accomplish this, we are leveraging our existing
relationships with leading cardiac surgeons and hospitals and utilizing our existing sales channels
to gain acceptance and adoption of our products.  
    Bridge-to-Transplant Market.On July 28, 2003, Thoratec received CE mark certification,
providing approval to market the Thoratec Implantable Ventricular Assist Device, or IVAD,
in countries in the European Union. In August 2004, we received FDA approval in the U.S. to
market the IVAD for use in bridge-to-transplantation and post-cardiotomy recovery patients
who are unable to be weaned from cardiopulmonary bypass. This makes the IVAD the only
currently approved implantable cardiac assist device that can provide left, right or
biventricular support.
    Destination Therapy Market. In November 2002, we received approval for the HeartMate
VAD for Destination Therapy in the treatment of late-stage CHF patients who are not
candidates for heart transplants. While the initial CMS reimbursement approval was limited
to approximately 69 centers in 2004, we estimate the market penetration for this indication
could eventually be a meaningful portion of the 100,000 patients annually mentioned above,
as we introduce new technologies that increase the life of our VAD and improve the outcome
of procedures.
    Home Discharge for our TLC-II portable driver. On December 1, 2003, the FDA approved
the TLC-II portable driver for home use. The TLC-II was already approved for in-hospital
use in the United States, and has been approved for home therapy in Europe for several
years. This approval will enable patients supported by the device to be discharged from the
hospital to their home while awaiting heart transplantation or recovery of their existing
heart. The TLC-II driver is the first portable driver approved for home discharge to
support biventricular patients. Obtain approval for new indications or uses of our products.  
    Therapeutic recovery. We believe that the use of VADs may lead to recovery of the
existing heart in certain patients. While our Premarket Approval, or PMA, submission for
our Thoratec VAD for this indication has not yet received FDA approval, we continue to
investigate this market, and believe that the patient population that could benefit from
this use could be substantial.
    Use of HeartMate II in U.S. clinical trial. We recently completed a Phase I clinical
trial of 25 patients at 10 study sites for our HeartMate II VAD and on February 18, 2005
received FDA approval to begin the Phase II pivotal trial. We anticipate enrollment will
begin before the end of the first quarter of 2005. The pivotal trial will evaluate the
safety and effectiveness of the HeartMate II for use as a Bridge to Cardiac Transplantation
and for Destination Therapy in patients who are ineligible for cardiac transplant due to
age, malignancy or other reasons. The HeartMate II is an implantable Left Ventricular
Assist Device System, or LVAS, 7




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consisting of a miniature rotary blood pump that is designed to provide long-term support.
Its design is intended to be not only smaller but also simpler, quieter, and longer lasting
than current generation assist devices. Focus on and partner with leading heart centers. We have developed extremely strong,
long-standing relationships with leading cardiovascular surgeons and heart centers worldwide. We
believe that no other cardiac assist company enjoys the same depth of relationship and access to
these customers. Maintaining and expanding these relationships is an important part of our growth
strategy, particularly for the development and introduction of new products and the pursuit of
additional indications for our existing products. Our Heart Hope program, designed to partner with
some CMS approved Destination Therapy centers, to build the market for this new indication, and, in
the process, address important issues such as reimbursement, clinical outcomes, and the building of
a strong referral program for Destination Therapy patients was launched in 2004. Heart Hope is a
collaboration between Thoratec and leading heart centers to advance clinical, educational and
economic outcomes associated with the treatment of end-stage heart failure. Underlying the Heart
Hope initiative is an educational program designed to increase acceptance of Destination Therapy
among heart failure cardiologists, generate physician referrals and broaden patient awareness of
this new therapy. An important element of this effort is the programs use of marketing materials
such as newsletters, direct mail pieces, education symposia, web presence, print and radio
advertising and public relations materials. Increase our presence in the heart failure and cardiovascular disease markets. In addition to
increasing our presence in the heart failure and cardiovascular disease markets through internal
growth, we will also be evaluating strategic alliances, joint ventures, acquisitions and related
business development opportunities. OUR PRODUCTS We offer a broad product portfolio of implantable and external circulatory support product
devices:  
    The Thoratec Ventricular Assist Device System is an external device for short to
mid-term cardiac support, which is sold worldwide. The device is approved to assist the
left and the right ventricle and is worn outside of the body. The Thoratec VAD is approved
for use in BTT.
    The Thoratec IVAD is the only implantable blood pump approved for
bridge-to-transplantation and post-cardiotomy recovery. It can be used for left, right, or
biventricular support. The IVAD utilizes the same internal working components as the
Thoratec VAD System blood pump, but has an outer housing made of a titanium alloy that
makes it more suitable for implantation.
    The HeartMate Left Ventricular Assist System, also called the HeartMate XVE, is an
implantable device for longer-term cardiac support and the only device approved in the
United States, Europe and Canada for permanent support for those patients ineligible for
heart transplantation.
    The HeartMate II is an implantable LVAS consisting of a miniature rotary blood pump
that is designed to provide long-term support. Its design is intended to be not only
smaller, but also simpler, quieter, and longer lasting than current generation assist
devices. In addition to our cardiac assist products, we sell vascular access grafts, used in
hemodialysis for patients with end-stage renal disease, and point-of-care blood diagnostics test
systems and services that provide fast, accurate blood test results to improve patient management,
reduce healthcare costs and improve patient outcomes. Our cardiac assist products represented 58%, 60%, and 62% of our product sales in 2004, 2003,
and 2002, respectively. Our point-of-care blood diagnostics test systems and services amounted to
40%, 37% and 35% or our net product sales in 2004, 2003, and 2002, respectively. Sales of our
vascular access grafts accounted for the remainder of our net product sales in those years. Circulatory Support Products Ventricular assist devices perform some or most of the pumping function of the heart in
patients with severe heart failure. In most cases, a cannula connects the left ventricle of the
heart to a blood pump. Blood flows from the 8




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left ventricle to the pump chamber, via the cannula, powered by an electric or air driven
mechanism which drives the blood through another cannula into the aorta. From the aorta, the blood
then circulates throughout the body. Mechanical or tissue valves enable unidirectional flow.
Currently the power source remains outside the body for all FDA-approved VADs. Certain VADs are implanted internally, while others are placed outside the body. Some external
devices are placed immediately adjacent to the body (paracorporeal), while other external VADs are
positioned at a distance from the body (extracorporeal). We estimate that between 20% and 35% of
assist patients require biventricular support and therefore require a second pump for the right
ventricle. The Thoratec VAD The Thoratec VAD has been FDA approved since 1995 and has treated over 2,500 patients
worldwide. The Thoratec VAD is a paracorporeal device that is less invasive than implantable VADs
since only the cannula must be implanted. The paracorporeal nature of the Thoratec VAD has several
positive consequences including relatively shorter and less invasive implantation times
(approximately two hours) and the ability to use the device in smaller patients. A pneumatic power source drives the Thoratec VAD. It is designed for intermediate duration use
of a few weeks to several months, though this device has supported numerous patients for six to
eighteen months. Offering left, right or biventricular support, the Thoratec VAD is the only
biventricular support system approved for use as a bridge to transplant. This characteristic is
significant since approximately 50% of bridge to transplant patients treated with the Thoratec VAD
require right-sided ventricular assist. The Thoratec VAD is also the only device approved for both
bridge to transplant and recovery following cardiac surgery. We are working with the FDA to gain
approval for a therapeutic recovery indication for the Thoratec VAD. The Thoratec VAD is made with
our proprietary biomaterial, Thoralon, which may reduce clotting. While it is possible for most patients with paracorporeal VADs to walk or otherwise move
about, the large size of the typical drive console renders movement difficult. In order to improve
patient mobility, we developed the TLC-II, a small portable driver, which increases portability and
ambulation options. The portable driver was approved in the United States in June 2001 for use in
off-site excursions and was approved December 1, 2003 for home discharge use. The TLC-II has been
approved for use in Europe since 1998. The HeartMate VAD The HeartMate VE initially received FDA approval in September 1998 and the enhanced version of
the product, called the HeartMate XVE, received FDA approval in December 2001 for bridge to
transplantation. In April 2003, the HeartMate XVE version received FDA approval for Destination
Therapy. The HeartMate XVE is designed for use for a duration from several months to up to two or
three years. The HeartMate XVE offers only left ventricular support. Patients with a HeartMate XVE do not require anti-coagulation drugs, because the device
utilizes proprietary textured surfaces and tissue valves. As a result, we believe this device has
the lowest rate of stroke incidence for patients using ventricular support. The implantable nature
of this device enables patient mobility and home discharge. Implantable VAD We received CE Mark certification to market the Thoratec IVAD in Europe in July 2003 and FDA
approval for the North American Bridge to Transplant market in August 2004. The IVAD was approved
in Canada in November 2004. This makes the IVAD the only currently approved implantable cardiac
assist device that can provide left, right or biventricular support. The IVAD maintains the same
blood flow path, valves and blood pump as the paracorporeal (Thoratec VAD) device and is better
suited for longer-term support compared to the Thoratec VAD. The outer covering of the IVAD is made
of a titanium alloy, which facilitates implantation. The device weighs less than one pound and can
be implanted in patients ranging in weight from 40 kg to over 100 kg. The small blood pump is
implanted in the body. The IVAD is designed as a bridge to transplant and possibly for therapeutic
recovery, but is not currently considered for Destination Therapy. 9




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HeartMate II The HeartMate II is a next generation device intended for long-term cardiac support (5-7
years) for patients who are in end-stage heart failure. The HeartMate II is a small, implantable,
electrically powered device that weighs approximately 12 ounces and is approximately 1.7 inches in
diameter and 3.2 inches long. In addition to being significantly smaller than the HeartMate XVE,
with only one moving part, the HeartMate II is simpler and designed to operate more quietly than
pulsatile devices. As an axial flow device, the HeartMate II is designed to provide blood flow
through the circulatory system on a continual basis and is smaller and easier to implant than
pulsatile devices. We have enrolled thirty-six patients in our European study and U.S. Phase I clinical trial of the
HeartMate II device as of the end of 2004. Our Investigational Device Exemption, or IDE,
supplement to the FDA seeking approval to begin a pivotal trial in the U.S. for both Bridge to
Transplant and Destination Therapy was granted conditional approval in February 2005. We hope to
begin enrollment in this trial in the first quarter of 2005. We also intend to seek CE Mark
approval to begin commercial sales in Europe in 2005. HeartMate III We are also developing our third generation device, the HeartMate III, which is a centrifugal,
continuous flow pump that employs a magnetically levitated rotor that eliminates wear from touching
parts. The device is designed for long-term implantation (10 years or more) in patients with
end-stage heart failure, including Destination Therapy, bridge-to-transplantation and therapeutic
recovery. The product design is being finalized and pre-clinical studies are being performed to
ready the device for clinical evaluation. Vascular Graft Products The Vectravascular access graft was approved for sale in the United States in December 2000
and in Europe in January 1998. It is designed for use as a shunt between an artery and a vein,
primarily to provide access to the bloodstream for renal hemodialysis patients requiring frequent
needle punctures during treatment. Other currently available vascular access grafts are commonly
made out of ePTFE, which can lose integrity after repeated punctures and require a three to six
week healing period between implantation and the initiation of dialysis treatment. We believe that
the Vectraprovides significant advantages over existing synthetic vascular access grafts that may
encourage its use by surgeons who are currently using natural vessels for vascular access. Point-of-Care Diagnostics Through our subsidiary ITC, we design, develop, manufacture and market point-of-care
diagnostic test systems that provide fast and accurate blood test results to improve patient
management, reduce healthcare costs and improve patient outcomes. Our major product lines are the
following:  
    Hemochron POC coagulation system;
    Immediate Response Mobile Analysis (IRMA) POC blood gas/electrolyte and chemistry system;
    ProTime coagulation monitoring system;
    Hemoglobin Pro system; and
    Tenderfoot, Tenderlett and Surgicutt incision products. The Hemochron and IRMA products are primarily sold into the Hospital POC segment of the
market, and represent about 50% of ITCs total annual product sales.  
    Hemochron is used to monitor a patients coagulation while being administered
anticoagulants in various settings, including in the cardiovascular operating room to
monitor the drug Heparin and in an anticoagulation clinic to monitor the drug Coumadin.
Hemochron is considered a moderately complex device 10




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and must be used by professionally trained personnel. The system consists of a small,
portable analytical instrument and disposable test cuvettes.
    IRMA is used to monitor a patients blood gas/electrolyte and chemistry status. It is
considered moderately complex and its use requires supervision by professionally trained
personnel. The system consists of a small, portable analytical instrument and disposable
test cartridges. The ProTime and Hemoglobin Pro products are sold into the Alternate Site POC market comprising
physicians offices, long-term care facilities, clinics, visiting nurse associations, and home
healthcare companies. Historically, this segment has represented about 20% of the ITCs total
annual product sales.  
    ProTime is used to monitor a patients coagulation while they are taking oral
anticoagulants such as Coumadin, and can be prescribed to be used by the patient at home or
can be used in the physicians office or clinic. The system consists of a small, portable
analytical instrument and disposable test cuvettes.
    Hemoglobin Pro (Hgb Pro) is used by professionals, mainly in the doctors office to
test for anemia; providing quick results on a very small blood sample. The system consists
of a small, hand held test meter and disposable test strips. Growth in the Alternate Site POC market is being fueled by convenience and ease of use to the
patients and physicians. In addition, in the case of the ProTime monitoring of oral anticoagulants,
clinical studies have shown that more frequent monitoring results in patients that stay in their
therapeutic range more often. More frequent monitoring is made possible by patients testing
themselves at home in addition to being tested in a doctors office when appropriate. Approximately 30% of our Hospital POC and the Alternate Site POC product sales are generated
by sales of equipment, with 70% relating to consumable products (cuvettes, cassettes, etc.) used in
the testing process. In late 2003, we acquired the IRMA product line of blood gas/electrolyte and chemistry tests
from Diametrics Medical, Inc. This has significantly increased our test menu offering, and also
provides us with the opportunity to develop the next generation system, combining the coagulation
and blood gas tests into one platform, which we anticipate will take 3-5 years to complete. In the
interim period, the idms data management and connectivity system, acquired as part of the IRMA
acquisition, will allow the stand-alone Hemochron and IRMA systems to interface with a hospitals
laboratory or hospital information system. This project was completed in the fourth quarter of
2004. Our Incision products, historically representing about 30% of ITCs total annual product
sales, are used to obtain a patients blood sample for diagnostic testing. These products are sold
to both the Hospital POC market and the Alternate Site POC market. Our products offer certain
advantages and command a price premium over the competition, but they only capture the higher end
of the market. Our most successful Incision product is the Tenderfoot, which is a heel stick used for
infant testing. We market this product based on its high-end features. Long-term, however, we
believe that customers will increasingly make purchasing decisions on these types of products based
on price. Therefore, we expect a gradual erosion of market share over time. The drivers for continued growth in this business assume increased patient testing, better
patient outcomes, and increased decentralization of testing from central laboratories to
point-of-care. Our international sales have increased to approximately 26% of ITCs total sales.
We expect international sales to increase from 26% currently to approximately 30% of ITCs total
sales by 2007. SALES AND MARKETING Circulatory Support Products The potential customers for our circulatory support products are hospitals that perform open
heart surgery and heart transplants. We estimate that 130 of the approximately 1,000 hospitals in
the United States that perform open- 11




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heart surgery also perform heart transplants. We actively market to these 130 heart transplant
hospitals and large cardiac surgery centers in addition to approximately 100 heart transplant
hospitals in Europe. We have recruited and trained a direct sales force that, as of January 1, 2005, comprised 21
experienced cardiovascular sales specialists to sell our circulatory support systems in the United
States, Canada, France, Germany, Spain, United Kingdom, Austria, Switzerland, Netherlands, Portugal
and South Africa. The sales effort is complemented by 16 direct clinical specialists, who conduct clinical
educational seminars, assist with a new open-heart centers first VAD implant and resolve clinical
questions or issues. We also partner with universities, experienced clinicians and opinion leaders
to assist with expanding clinical educational needs. The sales team focuses on cardiac surgeons
that perform heart transplantation, perfusionists and the transplant nursing staff. In addition to our direct selling efforts, we have a network of international distributors who
cover those markets that represent the majority of the remaining VAD potential. We employ sales and
marketing tactics commonly found within the cardiovascular device market such as direct mail,
clinical education seminars, symposia, equipment purchase and lease programs and journal
advertisement. Hospitals or other medical institutions that acquire a VAD system generally purchase VAD
pumps, related disposables and training materials, and purchase or rent two of the associated pump
drivers (to ensure that a backup driver is available). The time from the initial contact with the
cardiac surgeon until purchase is generally between nine and eighteen months, due to the expense of
the product and common hospital capital equipment acquisition procedures. Upon receipt of a
purchase order, we usually ship the products within thirty days. We do not typically carry a
backlog of orders pending shipment. The introduction of a VAD system in a new hospital or other medical institution requires that
the surgical and clinical support personnel possess certain expertise to use our products. For our
customers that do not already have this expertise, we provide initial training for the surgical and
clinical support teams. As many of our customers already possess sufficient experience and
expertise to use our products, training is provided as a best practice to optimize the use and
success of our products. In addition, a variety of training materials accompany the initial
delivery of our VAD products including instructions for use, patient management manuals and
assorted videos. As a follow-up to the initial training, we provide clinical support during the
first implant whenever possible. We also provide 24-hour access to clinically trained personnel.
Our sales force also helps customers understand and manage reimbursement from third-party payors. Vascular Graft Products We market the Vectrathrough C.R. Bard Corporation in the United States, and selected
countries in Europe, the Middle East and Northern Africa and through Goodman Co. Ltd. in Japan. Point-of-Care Diagnostics ITC currently maintains a direct sales staff of 46 in the United States, who sell to hospitals
as well as to third party dealers and distributors. Outside the United States, ITC has four
salespeople selling principally to third party distributors. Substantially all of ITCs product
sales have historically come through our distributor channels with Cardinal Healthcare as our
largest distributor generating 21% of ITCs annual product sales in 2004. As we have integrated the IRMA product line of blood gas analyzers into our business, an
increasing portion of our revenue in the United States market has been generated by direct sales
rather than through distributors. This shift has required expanding the sales, technical service,
customer service and shipping headcount at ITC in order to provide our customers with the support
and service that they historically obtained from our distributors. COMPETITION Competition from medical device companies and medical device subsidiaries of health care and
pharmaceutical companies is intense and is expected to increase. We believe our principal
competitors for the VAD system include WorldHeart Corporation, MicroMed Technology, Inc., AbioMed,
Inc., and Berlin Heart in Europe. Principal 12




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competitors in the vascular graft market include W.L. Gore, Inc., C.R. Bard and Boston
Scientific Corporation. Principal competitors in the hospital coagulation and blood gas monitoring
equipment market include the Cardiac Surgery Division of Medtronic, Inc., iSTAT, Radiometer, Abbott
Diagnostics, and Instrument Laboratories. Our primary competitor in the skin incision device market
is Becton, Dickson and Company. Competitors in the alternate site (non-hospital) point-of-care
diagnostics market include Roche Diagnostics and HemoSense. We believe the key competitive factors include the relative speed with which we can:  
    develop products;
    complete clinical testing;
    receive regulatory approvals; and
    manufacture and sell commercial quantities of products. We estimate we have a majority of the VAD market domestically and more than 50%
internationally. We believe that potential competitors are a few years away from completion of DT
clinical trials required before those products will become commercially available and compete with
our products in the United States. In addition, unless our competitors products result in
significantly better outcomes than our products, we believe that absent any compelling reasons,
cardiac centers will not generally change suppliers. Large medical device companies dominate the markets in which our ITC business competes and we
estimate our products hold anywhere from 2% to 20% market share. We expect that our growth in this
market will be generated by gaining market share and from a shift of testing from the central
laboratory to the point-of-care. However, this market segment is very competitive, and includes the
following potential drivers:  
    New drug therapies under development may not require the intense monitoring of a
patients coagulation that the current anti-coagulation drug of choice, Heparin, requires.
To try to mitigate this risk, we participate in clinical trials with key pharmaceutical
companies so as to provide the hemostasis monitoring that will ultimately be required for
new therapies.
    New competitors that might enter the market with broader test menus. To address this
risk, in late 2003 we acquired the IRMA product line of blood gas/electrolyte and chemistry
tests, which has significantly increased our test menu offering, and also offers us the
opportunity to develop the next generation system that combines blood gas and electrolyte
testing in one machine. PATENTS AND PROPRIETARY RIGHTS We seek to patent certain aspects of our technology. We hold, or have exclusive rights to,
several U.S. and foreign patents. Except for the patents mentioned below and one patent pertaining
to the TLC-II, the Thoratec VAD system is not protected by any other patents. We do not believe
that this lack of patent protection will have a material adverse effect on our ability to sell our
VAD system because of the lengthy regulatory period required to obtain approval of a VAD. Several
patents cover aspects of our HeartMate line of products. Our patents relating to blood coagulation, blood gas, blood electrolytes, blood chemistry, and
skin incision devices include patents transferred to ITC as part of our acquisition of the IRMA
blood analysis system business from Diametrics Medical. We own or hold rights in the remainder of
the U.S. patents by virtue of the merger between Thoratec and TCA, which resulted in the transfer
of the ownership of the TCA patents to Thoratec. Several patents cover aspects of our proprietary biomaterials technology, some of which were
sold to TH Goldschmidt AG, a German chemical manufacturer, in 1989, but as to which we have
retained worldwide, royalty-free, exclusive rights for most medical applications. The patent
license from Goldschmidt will remain in effect for the duration of the patents sold to Goldschmidt
and includes medical uses that we expect are necessary for our business as now conducted or as
proposed to be conducted in the future. For example, the medical applications include blood pumps,
artificial hearts and cardiac assist devices of all kinds, cardiovascular products, including heart
valves and prosthetic blood vessels and cannulae and blood tubing of all kinds. Aspects of our blood 13




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coagulation, blood gas, blood electrolytes, blood chemistry, and skin incision device products are covered
by patents directed to tube-and micro-coagulation whole blood analysis, including test methods,
reagents and integral (on-board) controls, thick film electrochemical analysis of blood gases,
blood electrolytes, and blood chemistry, and low trauma skin incision devices for capillary blood
sampling, and methods of manufacturing such devices. The duration remaining of some of our
biomaterials patents ranges from 5 to 10 years, on our grafts up to 16 years and on our blood
coagulation, blood gas, blood electrolytes, blood chemistry, and skin incision device products from
2 to 16 years. During the term of our patents, we have the right to prevent third parties from
manufacturing, marketing or distributing products that infringe upon our patents. In addition, we hold several patents on the HeartMate II axial blood flow pump and
transcutaneous energy transmission technology, the remaining duration of which ranges from 10 to 17
years. In August 1998, we obtained a license to incorporate technology developed by Sulzer
Electronics Ltd. and Lust Antriebstechnik GmbH into the HeartMate III. HeartMate III is a miniature
centrifugal pump featuring a magnetically levitated rotor with a bearingless motor that has been
developed by Levitronix GmbH. The license from Sulzer and Lust gives us the exclusive right to use
in our HeartMate products technology protected by several U.S. and foreign patents covering
implantable bearingless motors for the duration of those patents, subject to our payment of
royalties. In December 2000, we were informed by Sulzer Electronics that Sulzer had sold all of its
business in the bearingless motor and magnetic bearing fields to Levitronix and had assigned its
portion of the agreements between Sulzer and us to Levitronix. We believe that the license remains
in full force and effect. The validity of any of our patents may be challenged by others, and we could encounter legal
and financial difficulties in enforcing our patent rights against alleged infringements. In
addition, others could develop technologies that avoid infringement of our patents or obtain
patents, which would render our patents obsolete. Although we do not believe patents are the sole
determinant in the commercial success of our products, the loss of a significant percentage of our
patents or the patents relating to our products could seriously harm our business. We hold, or have exclusive rights to, several international patents, including several
biomaterial patents licensed from Goldschmidt referred to above. We have developed technical knowledge which, although non-patentable, we consider to be
significant in enabling us to compete. However, the proprietary nature of such knowledge may be
difficult to protect. It is our policy to enter into confidentiality agreements with each of our
employees prohibiting such employee from disclosing any confidential information or trade secrets.
In addition, these agreements provide that any inventions or discoveries relating to our business
by these individuals will be assigned to us and become our sole property. However, we cannot
guarantee that every person who obtains access to our confidential information or trade secrets
will have signed such an agreement, or that every person who has signed such an agreement will
abide by it. If they do not, or if our confidential information or trade secrets are otherwise
disclosed, there is no guarantee that any legal remedies will prevent the harmful disclosure or use
of our confidential information or trade secrets. Claims by competitors and other third parties that our products allegedly infringe the patent
rights of others could seriously harm our business. The medical device industry is characterized by
frequent and substantial intellectual property litigation. The cardiovascular and diagnostic device
markets are characterized by extensive patent and other intellectual property claims. Intellectual
property litigation is complex and expensive and the outcome of this litigation is difficult to
predict. Any future litigation, regardless of outcome, could result in substantial expense and
significant diversion of the efforts of our technical and management personnel. An adverse
determination in any such proceeding could subject us to significant liabilities or require us to
seek licenses from third parties or pay royalties that may be substantial. Furthermore, we cannot
assure you that necessary licenses would be available on satisfactory terms, or at all.
Accordingly, an adverse determination in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent us from manufacturing or selling certain of our products,
some of which could seriously harm our business. For example, in October 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 we settled the claim and recorded a charge of $2.3 million
in the fourth quarter of 2003 and $133,000 in the first six months of 2004 for the settlement and
related legal costs. At this time, we are not a party to any other material legal proceedings that relate to patents or
proprietary rights. 14




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GOVERNMENT REGULATIONS Regulation by governmental authorities in the United States and foreign countries is a
significant factor in the manufacture and marketing of our current and future products and in our
ongoing product research and development activities. All of our proposed products will require
regulatory approval prior to commercialization. In particular, medical devices are subject to
rigorous pre-clinical testing as a condition of approval by the FDA and by similar authorities in
foreign countries. U.S. Regulations In the United States, the FDA regulates the design, manufacture, distribution and promotion of
medical devices pursuant to the Federal Food, Drug, and Cosmetic Act and the regulations
promulgated thereunder, or the FDA Act and Regulations. Our VAD systems, blood coagulation testing
devices, skin incision devices, and Vectragraft products are regulated as medical devices. To
obtain FDA approval to market VADs similar to those under development, the FDA requires proof of
safety and efficacy in human clinical trials performed under an IDE. An IDE application must
contain pre-clinical test data supporting the safety of the product for human investigational use,
information on manufacturing processes and procedures, proposed clinical protocols and other
information. If the IDE application is accepted, human clinical trials may begin. The trials must
be conducted in compliance with FDA regulations and with the approval of one or more institutional
review boards. The results obtained from these trials, if satisfactory, are accumulated and
submitted to the FDA in support of either a Pre-Market approval, or PMA application or a 510(k)
premarket notification. There are substantial user fees that must be paid at the time of PMA or
510(k) submission to the FDA to help offset the cost of scientific data review that is required
before FDA can determine if the device is approvable. Premarket approval from the FDA is required
before commercial distribution of devices similar to those under development by us is permitted in
the United States. A PMA Supplement is required to make modifications to a device or application approved by a
PMA. A PMA Supplement must be supported by extensive data, including pre-clinical and human
clinical data, to prove the safety and efficacy of the device with respect to the modifications
disclosed in the supplement. By regulation, the FDA has 180 days to review a PMA application and
during that time an advisory committee may evaluate the application and provide recommendations to
the FDA. While the FDA has approved PMA applications within the allotted time period, reviews more
often occur over a significantly protracted period, usually 18 to 36 months, and a number of
devices have never been cleared for marketing. This is a lengthy and expensive process and there
can be no assurance that such FDA approval will be obtained. Under the FDAs requirements, if a manufacturer can establish that a newly developed device is
substantially equivalent to a legally marketed predicate device, the manufacturer may seek
marketing clearance from the FDA to market the device by filing a 510(k) premarket notification
with the FDA. This is the process that is used to gain FDA market clearance for most of ITCs
products. The 510(k) premarket notification must be supported by data establishing the claim of
substantial equivalence to the satisfaction of the FDA. The process of obtaining a 510(k) clearance
typically can take several months to a year or longer. If substantial equivalence cannot be
established, or if the FDA determines that the device requires a more rigorous review, the FDA will
require that the manufacturer submit a PMA application that must be approved by the FDA prior to
marketing the device in the United States. Both a 510(k) and a PMA, if approved, may include significant limitations on the indicated
uses for which a product may be marketed. FDA enforcement policy prohibits the promotion of
approved medical devices for unapproved uses. In addition, product approvals can be withdrawn for
failure to comply with regulatory requirements or the occurrence of unforeseen problems following
initial marketing. The approval process for each of our products is expensive and time consuming and we cannot
assure that any regulatory agency will grant its approval. Our inability to obtain, or delays in
obtaining, such approval would adversely affect our ability to commence marketing our products. We
cannot assure you that we will have sufficient resources to complete the required testing and
regulatory review processes. Furthermore, we are unable to predict the extent of adverse
governmental regulations, which might arise from future U.S. or foreign legislative or
administrative action. On October 26, 2002, the FDA signed into law The Medical Device User Fee and
Modernization Act of 2002 (MDUFMA). This law amends the FDA Act and Regulations to provide, among
other things, the ability for the FDA to impose user fees for medical device reviews. Our
activities require that we make 15




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many filings with the FDA that will now be subject to this new fee structure. Although the
precise amount of fees that we will incur each year will be dependent upon the specific quantity
and nature of our filings, these fees could amount to hundreds of thousands of dollars per year. In addition, any products distributed pursuant to the above authorizations are subject to
thorough and continuing regulation by the FDA. Products must be manufactured in registered
establishments and must be manufactured in accordance with Quality System Regulations and adverse
events must be reported to the FDA. Labeling and promotional activities are subject to scrutiny by
the FDA and, in certain instances, by the Federal Trade Commission. The FDA often requires post
market surveillance, or PMS, requirements for significant risk devices, such as VADs, that require
ongoing collection of clinical data during commercialization that must be gathered, analyzed and
submitted to the FDA periodically for up to several years. These PMS data collection requirements
are often burdensome and expensive and have an effect on the PMA approval status. The failure to
comply with the FDAs regulations can result in enforcement action, including seizure, injunction,
prosecution, civil penalties, recall and suspension of FDA approval. The export of devices is also
subject to regulation in certain instances. We are also subject to regulation by various state authorities, which may inspect us and
enforce state regulations. Failure to comply with applicable state regulations may result in
seizures, injunctions or other types of enforcement actions. International Regulations We are also subject to regulation in each of the foreign countries in which we sell products
with regard to product standards, packaging and labeling requirements, import restrictions, tariff
regulations, duties and tax requirements. Many of the regulations applicable to our products in
these countries are similar to those of the FDA. The national health or social security
organizations of certain countries require our products to be qualified before they can be marketed
in those countries. In order to be positioned for access to European and other international markets, we sought
and obtained certification under the ISO 13485 Series of Standards. ISO 13485 is a set of
integrated requirements, which when implemented, form the foundation and framework for an effective
quality management system. These standards were developed and published by the ISO, a worldwide
federation of national bodies, founded in Geneva, Switzerland in 1947. ISO has over 90 member
countries and ISO certification is widely regarded as essential to enter Western European markets.
We obtained EN ISO 13485:2000 Certification in March 2003. Commencing in mid-1998, all companies
are required to obtain CE Marks for medical devices sold or distributed in the European Union. The
CE Mark is an international symbol of quality. With it, medical devices can be distributed within
the European Union. A prerequisite for obtaining authority to CE Mark products is to achieve full
quality system certification in accordance with ISO 13485 and European Directives, such as the
Medical Device Directive (MDD), In-Vitro Device Directive (IVDD) and the Active Implantable Medical
Device Directive (AIMD). These are quality standards that cover design, production, installation
and servicing of medical devices manufactured by us. We have the ISO 13485 and appropriate MDD,
IVDD or AIMD certification and authority to CE Mark all our devices in commercial distribution
including our skin incision, blood coagulation testing devices, Vectragraft and VAD systems such
as the Thoratec VAD, IVAD and HeartMate Systems. We are also certified to be in compliance with the
requirements of the Canadian Medical Device Regulations (CMDRs) at all Thoratec manufacturing
sites, which is required effective January 1, 2003, to sell medical devices in Canada. Other Regulations We are also subject to various federal, state and local laws and regulations relating to such
matters as safe working conditions, laboratory and manufacturing practices and the use, handling
and disposal of hazardous or potentially hazardous substances used in connection with our research
and development work. Specifically, the manufacture of our biomaterials is subject to compliance
with federal environmental regulations and by various state and local agencies. Although we believe
we are in compliance with these laws and regulations in all material respects, we cannot assure
that we will not be required to incur significant costs to comply with environmental laws or
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THIRD PARTY REIMBURSEMENT AND COST CONTAINMENT Our products are purchased primarily by hospitals and other users, which then bill various
third party payors for the services provided to the patients. These payors, which include CMS,
private health insurance companies and managed care organizations, reimburse part or all of the
reasonable costs and fees associated with these devices and the procedures performed with these
devices. To date, CMS and a majority of private insurers with whom we have dealt have determined to
reimburse for our VADs and our diagnostic and vascular graft products. Effective October 1, 2003,
CMS issued a National Coverage Decision Memorandum for the use of LVAS that are approved by the FDA
for treating Destination Therapy in end-stage heart failure patients. Sixty-nine centers are now
recognized by CMS as Medicare LVAD centers. Effective October 1, 2004, Medicare reimbursement
payment increased with CMS LVAD centers receiving an average payment of approximately $136,000. The change of DRG category for implantable heart assist devices from DRG 525 to 103 has raised
the average payment under DRG 103 by more than 30% from approximately $90,000 to approximately
$136,000. Since FDA approval of the HeartMate LVAS for Destination Therapy, several private payors
have issued positive coverage decisions as well. In December 2002, Blue Cross/Blue Shield (BC/BS)
Technology Evaluation Center issued a positive decision on the use of LVADs for Destination
Therapy. Since December 2002, the majority of national insurance carriers, such as Aetna, Cigna,
Humana, United Healthcare and UNICARE, have issued positive coverage policies to cover the use of
ventricular assist devices for FDA-approved indications, including Destination Therapy. The reimbursement policies and practices of third party payors are subject to changes that
might be unfavorable to our VAD systems and such unfavorable changes could seriously harm sales of
our products. MANUFACTURING We manufacture our cardiovascular products at our facility in Pleasanton, California. This
facility has been inspected, approved and licensed by the FDA and the State of California
Department of Health Services, Food and Drug Section for the manufacture of medical devices and has
received the International Standards Organization (ISO) 9001 certification. Our manufacturing
processes consist of the assembly of standard and custom component parts, and the testing of
completed products. We rely on single sources of supply for several components of our VADs. We are
aware of alternative suppliers for all single-sourced items. Our blood coagulation testing and skin incision devices are manufactured in Edison, New
Jersey, with the exception of the ProTime instrument and the hemoglobin monitor, which are
manufactured through single source third party contract manufacturers in China and Germany. Our
blood gas analyzer devices are manufactured in Roseville, Minnesota. The New Jersey and Minnesota
facilities have been inspected, approved and licensed by the FDA and applicable state regulators.
In addition, these facilities maintain ISO9001, ISO 13485 and Canadian (CMDCAS) ISO certifications.
A significant amount of our manufacturing at these facilities is vertically integrated, with only
limited reliance on third parties to manufacture printed circuit boards, to sterilize and to test
products etc. We rely on single sources of supply for some components manufactured at our New
Jersey and Minnesota facilities, and use safety stocks where there might be risk in qualifying a
second supplier in a timely manner. We typically are able to fill orders from inventory and do not have significant order
backlogs. At the end of 2003 and during 2004, we experienced higher than normal backlog for
disposable test cuvettes due to higher demand. We have expanded capacity during 2004 to
accommodate the increased demand. Total backlog as of the end of fiscal 2004 and 2003 were
approximately $1.3 million and $1.6 million, respectively. RESEARCH AND DEVELOPMENT Thoratecs research and development expenses in 2004, 2003 and 2002 were $28.7 million, $26.1
million, and $25.3 million, 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. Projects typically include efforts to develop new products, such as the
HeartMate II and HeartMate III, efforts to improve the operation and performance of current
products, such as efforts to improve the life of various components of the HeartMate and the
Thoratec 17




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VAD products. Research and development costs also include regulatory and clinical costs
associated with our compliance with FDA regulations. MAJOR CUSTOMERS AND FOREIGN SALES We primarily sell our products to large hospitals and distributors. No customer accounted for
more than 10% of product sales in fiscal year 2004 or 2003. For fiscal year 2002, one distributor
customer accounted for 11% of total product sales. No other customer accounted for more than 10% of
total product sales in 2002. Sales originating outside the United States and U.S. export sales accounted for approximately
21%, 19% and 18% for the years ended 2004, 2003 and 2002, respectively, of our total product
sales. No individual foreign country accounted for a material portion of our net sales in any of
the last three fiscal years. EMPLOYEES As of January 1, 2005, we had a total of 914 employees, consisting of 905 full-time employees
and 9 part-time employees, 421 of whom worked in manufacturing, 130 in engineering, 102 in quality
control and regulatory affairs, 138 in marketing and sales support, 38 in administration and
finance and 85 in other support functions, including human resources, management information
systems, purchasing and facilities. Out of our total employees, 894 are employed in the United
States and 20 are employed in the United Kingdom and other European countries. None of our
employees are covered by a collective bargaining agreement. We consider relations with our
employees to be good. ADDITIONAL INFORMATION You can find additional information about Thoratec on our website at http://www.thoratec.com
(although non of this information is, or should be deemed to be, incorporated by reference into
this Annual Report on Form 10-K). We make filings of our periodic reports to the Securities and
Exchange Commission (SEC), including annual reports on Form 10-K, quarterly reports on Form 10-Q
and current reports on Form 8-K, as well as amendments to those reports, available free of charge
on our website as soon as reasonably practicable following electronic filing of those reports with
the SEC. 18




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FACTORS THAT MAY AFFECT FUTURE RESULTS Our business faces many risks. These risks include those related to the development of new
products and markets including Destination Therapy, the growth of existing markets for our
products, customer and physician acceptance of our products, changes in the mix of our product
sales, and the related gross margin for such product sales, the results of clinical trials,
including those for the HeartMate II, the ability to improve financial performance, regulatory
approval processes, the effect of healthcare reimbursement and coverage policies, our product
sales, the effects of price competition from any of our competitors and the effects of any merger
and acquisition related activities. The risks described below are what we believe to be the
material risks facing our company. However, the risks described below may not be the only risks we
face. Additional risks that we do not yet know of or that we currently believe are immaterial may
also impair our business operations. If any of the events or circumstances described in the
following risk factors actually occurs, our business, financial condition or results of operations
could suffer, and the trading price of our common stock could decline significantly. Investors
should consider the following risks, as well as the other information included in this Annual
Report onForm 10-K, and other documents we file from time to time with the SEC, such as our
quarterly reports onForm 10-Q, our current reports onForm 8-Kand any public announcements we
make from time to time. We have a history of net losses. We were founded in 1976 and we have a history of incurring losses from operations. As of
January 1, 2005, our accumulated deficit was approximately $71.5 million. We anticipate that our
expenses will increase as a result of increased pre-clinical and clinical testing, research and
development and selling, general and administrative expenses. We could also incur significant
additional costs in connection with our business development activities and the development and
marketing of new products and indicated uses for our existing products as well as litigation and
equity based compensation costs. Such costs could prevent us from achieving or maintaining
profitability in future periods. Since our physician and hospital customers depend on third party reimbursement, if third party
payors fail to provide appropriate levels of reimbursement for our products, our results of
operations will be harmed. Significant uncertainty exists as to the reimbursement status of newly approved health care
products such as VADs and vascular grafts, which 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 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 PMA
application. If the FDA concludes that any of our products does not meet the requirements to obtain
clearance under Section 510(k) of the Federal Food, Drug, and Cosmetic Act, then we would be
required to file a PMA application. The process for a PMA application is lengthy, expensive and
typically requires extensive pre-clinical and clinical trial data. We may not obtain clearance of a 510(k) notification or approval of a PMA application with
respect to any of 19




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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 sales. 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. The FDA also requires us to adhere to Quality System Regulations, which include production
design controls, testing, quality control, storage and documentation procedures. The FDA may at any
time inspect our facilities to determine whether we have adequate compliance. Compliance with
Quality System Regulations for medical devices is difficult and costly. In addition, we may not be
found to be compliant as a result of future changes in, or interpretations of, regulations by the
FDA or other regulatory agencies. If we do not achieve compliance, the FDA may withdraw marketing
clearance, require product recall or take other enforcement action, which in each case would harm
our business. Any change or modification to a device is required to be made in compliance with
Quality System Regulations, which compliance may cause interruptions or delays in the marketing and
sale of our products. The FDA also requires device manufacturers to submit reports regarding
deaths, serious injuries and certain malfunctions relating to use of their products. Sales of our products outside the United States are subject to foreign regulatory requirements
that vary from country to country. The time required to obtain approvals from foreign countries may
be longer or shorter than that required for FDA approval, and requirements for foreign licensing
may differ from FDA requirements. The federal, state and foreign laws and regulations regarding the manufacture and sale of our
products are subject to future changes, as are administrative interpretations and policies of
regulatory agencies. If we fail to comply with applicable federal, state or foreign laws or
regulations, we could be subject to enforcement actions. Enforcement actions could include product
seizures, recalls, withdrawal of clearances or approvals, and civil and criminal penalties, which
in each case would harm our business. Certain lawsuits have been filed against us Commencing on or about August 3, 2004, several Federal securities law putative class action
suits were filed in the United States District Court for the Northern District of California on
behalf of purchasers of the publicly traded securities of the Company between April 28, 2004 and
June 29, 2004. These suits were consolidated in a consolidated complaint filed on or about January
18, 2005. The complaint seeks to recover unspecified damages on behalf of all purchasers of our
publicly traded securities during the class period. On or about September 1, 2004, a shareholder derivative action entitled Wong v. Grossmanwas
filed in the California Superior Court for Alameda County based upon essentially the same facts as
the Federal securities suit. This action names the individual members of our Board of Directors,
our Chief Executive Officer and our former Chief Financial Officer as defendants. In June of 2004, MicroMed Technology, Inc., a potential competitor of ours, sued us in Texas.
MicroMed sought injunctive relief against us in connection with our HeartMate II Phase I clinical
trial on the grounds that we had provided the HeartMate II VAD to clinical sites without charge and
that doing so was a violation of Texas anti-trust law. In addition to injunctive relief, the
plaintiff is seeking unspecified damages and fees, including those arising from potential sales of
its VAD products which plaintiff alleges it lost due to our HeartMate II clinical trial. We have
successfully defended ourselves against MicroMeds requests for injunctive relief and will continue
to vigorously defend any and all of the claims made by MicroMed in this action. We believe that the claims asserted in the MicroMed action, and both the Federal securities
law putative class action and the state shareholder derivative action are without merit. We have
filed a motion to dismiss in the Federal securities law putative class action and the shareholder
suit currently is stayed through to at least early July 2005. We are unable to predict at this time the final outcome of these actions. We carry sufficient insurance to cover what management believes to be any reasonable exposure
on these actions, however we cannot give assurance that our insurance will cover all costs or other
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with respect to these actions. 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 January 1, 2005, 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 convertible notes. The level of our
indebtedness, among other things, could:  
    make it difficult for us to make payments on our debt;
    make it difficult for us to obtain any necessary financing in the future for working
capital, capital expenditures, debt service, acquisitions or general corporate purposes;
    limit our flexibility in planning for or reacting to changes in our business;
    reduce funds available for use in our operations;
    impair our ability to incur additional debt because of financial and other restrictive
covenants proposed for any such additional debt;
    make us more vulnerable in the event of a downturn in our business or an increase in
interest rates; or
    place us at a possible competitive disadvantage relative to less leveraged competitors
and competitors that have better access to capital resources. If we experience a decline in product sales due to any of the factors described in this
section or otherwise, we could have difficulty paying interest or principal amounts due on our
indebtedness. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary
to make required payments, or if we fail to comply with the various requirements of our
indebtedness, including the convertible notes, we would be in default, which would permit the
holders of our indebtedness to accelerate the maturity of the indebtedness and could cause defaults
under our other indebtedness. Any default under our indebtedness could have a material adverse
effect on our business, operating results and financial condition. If hospitals do not conduct Destination Therapy procedures using our VAD, our product sales will be
diminished. The use of our VADs as long-term therapy in patients who are not candidates for heart
transplantation (i.e. they are Destination Therapy patients) was approved by the FDA in 2002, and
was approved for reimbursement by the CMS in late 2003. The number of Destination Therapy procedures actually performed depends on many factors, most
of which are out of our direct control, including:  
    the number of CMS sites approved for Destination Therapy;
    the clinical outcomes of Destination Therapy procedures;
    cardiologists and referring physicians education, and their commitment to Destination Therapy;
    the economics of the Destination Therapy procedure for individual hospitals, which
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 21




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costs and related reimbursements of long-term hospitalization. The different outcomes of these and other factors, and their timing, will have a significant
impact on our future operating results. Sales of our VADs for Destination Therapy have proved
slower than we had originally anticipated, and we are unable to predict when, if ever, these sales
will generate significant revenue for us. The long and variable sales and deployment cycles for our VAD systems may cause our product sales
and operating results to vary significantly, which increases the risk of an operating loss for any
given fiscal period. Our VAD systems have lengthy sales cycles and we may incur substantial sales and marketing
expenses and expend significant effort without making a sale. Even after making the decision to
purchase our VAD systems, our customers often deploy our products slowly. For example, the length
of time between initial contact with cardiac surgeons and the purchase of our VAD systems is
generally between nine and eighteen months. In addition, the cardiac centers that buy the majority
of our products are usually led by cardiac surgeons who are heavily recruited by competing centers
or by centers looking to increase their profiles. When one of these surgeons moves between centers
we sometimes experience a temporary but significant reduction in purchases by the departed center
while it replaces its lead surgeon. As a result, it is difficult for us to predict the quarter in
which customers may purchase our VAD systems and our product sales and operating results may vary
significantly from quarter to quarter, which increases the risk of an operating loss for us for any
given quarter. In particular, sales of our VADs for Destination Therapy have been lower than we had
originally anticipated, and we cannot predict when, if ever, sales of our VADs for this indication
will generate the level of revenues we expect. Physicians may not accept or continue to accept our current products and products under
development. The success of our current and future products will require acceptance or continued acceptance
by cardiovascular and vascular surgeons, and other medical professionals. Such acceptance will
depend on clinical results and the conclusion by these professionals that our products are safe,
cost-effective and acceptable methods of treatment. Even if the safety and efficacy of our future
products are established, physicians may elect not to use them for a number of reasons. These
reasons could include the high cost of our VAD systems, restrictions on coverage, unfavorable
reimbursement from health care payors, or use of alternative therapies. Also, economic,
psychological, ethical and other concerns may limit general acceptance of our ventricular assist,
graft and other products. Our future product sales will be affected by the number of heart transplants conducted. A significant amount of our current product sales is generated by our VADs implanted
temporarily in patients awaiting heart transplants. The number of heart transplants conducted
worldwide depends on the number of hearts available to transplant, which number in turn depends on
the death rate of otherwise healthy people from events such as automobile accidents. We have experienced rapid growth and changes in our business, and our failure to manage this and
any future growth could harm our business. The number of our employees increased from 183 on December 30, 2000 to 914 on January 1, 2005.
We expect to continue increasing the number of our employees, and our business may suffer if we do
not manage and train our new employees effectively. Our product sales may not continue to grow at a
rate sufficient to support the costs associated with an increasing number of employees. Any future
periods of rapid growth may place significant strains on our managerial, financial and other
resources. The rate of any future expansion, in combination with our complex technologies and
products, may demand an unusually high level of managerial effectiveness in anticipating, planning,
coordinating and meeting our operational needs as well as the needs of our customers. If we fail to successfully introduce new products, our future growth may suffer. As part of our growth strategy, we intend to develop and introduce a number of new products
and product improvements. We also intend to develop new indications for our existing products. For
example, we are currently developing updated versions of our HeartMate products. If we fail to
commercialize these new products, product improvements and new indications on a timely basis, or if
they are not well accepted by the market, our future growth may suffer. 22




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Amortization of our intangible assets, which represent a significant portion of our total assets,
will adversely affect our net income and we may never realize the full value of our intangible
assets. As of January 1, 2005, we had $247.2 million of net intangible assets, representing 47% of our
total assets and 85% of our shareholders equity. Amortization expense relating to these intangible
assets for the year ended 2004 was $11.7 million. Ongoing amortization of purchased intangibles
will reduce our net income or increase our net loss. We may not receive the recorded value for our intangible assets if we sell or liquidate our
business or assets. The material concentration of intangible assets increases the risk of a large
charge to earnings if the revenue from, and recoverability of, these intangible assets is impaired.
We completed an assessment of the current values of our intangible assets at the year ended 2004
and determined that no impairment exists, however the lives have been modified on several
components of these identified assets. In the event, however, of such a charge to net income, the
market price of our common stock could be adversely affected. For example, in the first quarter of
2004, we completed an assessment of the final results from the feasibility clinical trial for the
Aria CABG graft, which was ongoing through fiscal 2003. Based on the clinical trial results, we
determined not to devote additional resources to development of the Aria graft. Upon the decision
to discontinue product development, we recorded an impairment charge of approximately $9 million as
of January 3, 2004 to write off purchased intangible assets related to the Aria graft, recorded as
a result of our merger with TCA. We rely on specialized suppliers for certain components and materials in our products and
alternative suppliers may not be available. We depend on a number of custom-designed components and materials supplied by other companies
including, in some cases, single source suppliers for components, instruments and materials used in
our VAD products and blood testing products. For example, single sources currently manufacture and
supply our ProTime and Hemoglobin instruments and the heart valves used in our HeartMate products.
The suppliers of our ProTime and Hemoglobin products are located in China and Germany,
respectively. We do not have long-term written agreements with most of our other vendors and from
these vendors receive components on a purchase order basis only. If we need alternative sources for
key raw materials or component parts for any reason, such alternative sources may not be available
and our inventory may not be sufficient to fill orders before we find alternative suppliers or
begin manufacturing these components or materials ourselves. Cessation or interruption of sales of
circulatory support products and or our point-of-care products would seriously harm our business,
financial condition and results of operations. Alternative suppliers, if available, may not agree to supply us. In addition, we may require
FDA approval before using new suppliers or manufacturing our own components or materials. Existing
suppliers could also subject to an FDA enforcement action, which could also disrupt our supplies.
If alternative suppliers are not available, we may not have the expertise or resources necessary to
produce these materials or component parts internally. Because of the long product development cycle in our business, suppliers may discontinue
components upon which we rely before the end of life of our products. In addition, the timing of
the discontinuation may not allow us time to develop and obtain FDA approval for a replacement
component before we exhaust our inventory of the legacy component. If suppliers discontinue components on which we rely, we may have to:  
    pay premium prices to our suppliers to keep their production lines open or to obtain
alternative suppliers;
    buy substantial inventory to last through the scheduled end of life of our product, or
through such time that we will have a replacement product developed and approved by the
FDA; or
    stop shipping the product in which the legacy component is used once our inventory of
the discontinued component is exhausted. 23




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Any of these interruptions in the supply of our materials could result in substantial
reductions in product sales 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. Principal competitors for the VAD
system include WorldHeart Corporation, MicroMed Technology, Inc., Abiomed, Inc., and Berlin Heart
in Europe. Principal competitors in the vascular graft market include W.L. Gore, Inc., C.R. Bard
Corporation, whom is also a distributor of our Vectraproduct line, and Boston Scientific
Corporation. Principal competitors in the hospital coagulation and blood gas monitoring equipment
market include the Cardiac Surgery Division of Medtronic, Inc., iSTAT, Radiometer, Abbott
Diagnostics, and Instrument Laboratories. Our primary competitor in the skin incision device market
is Becton, Dickson and Company. Competitors in the alternate site (non-hospital) point-of-care
diagnostics market include Roche Diagnostics and HemoSense. Many of our competitors have substantially greater financial, technical, distribution,
marketing and manufacturing resources than we have. Accordingly, our competitors may be able to
develop, manufacture and market products more efficiently and at a lower cost than we can. We
expect that the key competitive factors will include the relative speed with which we can:  
    develop products;
    complete clinical testing;
    receive regulatory approvals; and
    manufacture and sell commercial quantities of products. Large medical device companies dominate the markets in which our ITC business competes and we
estimate our products hold anywhere from 2% to 20% market share. We expect that any growth in this
market will come from expanding our market share at the expense of other companies, and from
testing being shifted away from the central laboratory to the point-of-care. However, this market
segment is very competitive, and includes the following potential drivers:  
    New drug therapies under development may not require the intense monitoring of a
patients coagulation that the current anti-coagulation drug of choice (Heparin) requires.
    New competitors that might enter the market with broader test menus. Any of the devices of our competitors in clinical trials and in development could prove to be
clinically superior, easier to implant, and/or less expensive than current commercialized devices,
thereby impacting Thoratecs marketshare. The price of our common stock may fluctuate significantly. The price of our common stock has been, and is likely to continue to be, highly volatile,
which means that it could decline substantially within a short period of time. For example our
stock price has ranged from $8.46 to $15.95 in the 12 months ended January 1, 2005. The price of
our common stock could fluctuate significantly for many reasons, including the following:  
    future announcements concerning us or our competitors;
    timing and reaction to the publication of clinical trial results;
    quarterly variations in operating results, which we have experienced in the past and
expect to experience in the 24




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future;
    charges, amortization and other financial effects relating to our merger with TCA;
    introduction of new products or changes in product pricing policies by us or our competitors;
    acquisition or loss of significant customers, distributors or suppliers;
    business acquisitions or divestitures;
    changes in earnings estimates by analysts;
    changes in third party reimbursement practices;
    regulatory developments, enforcement actions bearing on advertising, marketing or
sales, and disclosure regarding completed ongoing or future clinical trials; and
    fluctuations in the economy, world political events or general market conditions. In addition, stock markets in general, and the market for shares of health care stocks in
particular, have experienced extreme price and volume fluctuations in recent years, which
fluctuations have frequently been unrelated to the operating performance of the affected companies.
These broad market fluctuations may adversely affect the market price of our common stock. The
market price of our common stock could decline below its current price and the market price of our
stock may fluctuate significantly in the future. These fluctuations may be unrelated to our
performance. Shareholders have often instituted securities class action litigation after periods of
volatility in the market price of a companys securities. Several securities class action suits
have been filed against us, and if other such suits are filed against us in the future, we may
incur substantial legal fees and our managements attention and resources would be diverted from
operating our business in order to respond to the litigation. See Certain lawsuits have been filed
against us above. We may encounter problems manufacturing our products. We may encounter difficulties manufacturing our products. We do not have experience in
manufacturing some of our products in the commercial quantities that might be required if we
receive FDA approval of several or all of the products and indications currently under development,
including the HeartMate II VAD. If we have difficulty manufacturing any of our products, our
business will be harmed. Since we depend upon distributors, if we lose a distributor or a distributor fails to perform, our
operations will be harmed. With the exception of Canada and the larger countries in Europe, we sell our Thoratec VAD and
HeartMate systems in foreign markets through distributors. In addition, we sell our vascular access
graft products through the Bard Peripheral Vascular division of C.R. Bard Corporation (which is
also a competitor of ours) in the United States, and selected countries in Europe, the Middle East
and Northern Africa and through Goodman Co. Ltd. in Japan. Substantially all of the international
operations and a large portion of the Alternate Site domestic operations of ITC are conducted
through distributors. For the year ended January 1, 2005, 21% of ITCs total product sales were
through Cardinal Healthcare, a distributor of our blood coagulation testing equipment and skin
incision devices. To the extent we rely on distributors, our success will depend upon the efforts of others,
over which we may have little or no control. If we lose a distributor or a distributor fails to
perform to our expectations, our product sales may be harmed. 25




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Changes we make to our
method of distributing and selling our products could hurt our
relationship with distributors and their customers. In March 2004, we began
changing our manner of distributing our Hemochron product line to our
hospital pont-of-care customers in the United States from a
distributor model to a direct sales model. Sales of these products represented approximately $16.1 million of our total sales for the year ended January 1,
2005. This transition to a direct sales model necessitated expanding the sales, technical service,
customer service and shipping headcount at ITC in order to provide our customers with the support
and service that they historically obtained from our distributors, resulting in an increase in our
sales and general and administrative costs. We expect the transition process to conclude in early
2005 when the last distributor will have been converted and the United States hospital
point-of-care market will be served exclusively by ITC on a direct basis. This transition and its
execution involve significant risks, including:  
    the alienation of distributors when they are informed of our plans;
    the promotion by our former distributors of products from competitors rather than our products;
    the potential loss of customers who prefer to deal with a particular distributor; and
    the challenges and costs associated with building an effective direct sales force. If we fail to build an effective direct sales force for our hospital point-of-care product
lines, our revenues may fail to increase as expected or could decrease, which could adversely
affect our results of operations and financial condition. Our inability to protect our proprietary technologies or an infringement of others patents could
harm our competitive position. We rely on patents, trade secrets, copyrights, know-how, trademarks, license agreements and
contractual provisions to establish our intellectual property rights and protect our products.
These legal means, however, afford only limited protection and may not adequately protect our
rights. In addition, we cannot assure you that any of our pending patent applications will issue.
The Patent and Trademark Office, or PTO, may deny or significantly narrow claims made under patent
applications and the issued patents, if any, may not provide us with commercial protection. We
could incur substantial costs in proceedings before the PTO or in any future litigation to enforce
our patents in court. These proceedings could result in adverse decisions as to the validity and/or
enforceability of our patents. In addition, the laws of some of the countries in which our products
are or may be sold may not protect our products and intellectual property to the same extent as
U.S. laws, if at all. We may be unable to protect our rights in trade secrets and unpatented
proprietary technology in these countries. Our commercially available VAD products, which account for a majority of our sales, generally
are not protected by any patents. We rely principally on trade secret protection and, to a lesser
extent, patents to protect our rights to our HeartMate product line. We rely principally on patents
to protect our coagulation testing equipment, skin incision devices, Hemochron disposable cuvettes,
IRMA analyzer, IRMA disposable cartridges, and Hgb Pro disposable test strips. We seek to protect our trade secrets and unpatented proprietary technology, in part, with
confidentiality agreements with our employees and consultants. Although it is our policy to require
that all employees and consultants sign such agreements, we cannot assure you that every person who
gains or has gained access to such information has done so. Moreover, these agreements may be
breached and we may not have an adequate remedy. Our products may be found to infringe prior or future patents owned by others. We may need to
acquire licenses under patents belonging to others for technology potentially useful or necessary,
and such licenses may not be available to us. We could incur substantial costs in defending suits
brought against us on such patents or in bringing suits to protect our patents or patents licensed
by us against infringement. For example, in 2003, a patent infringement claim was filed against us by Bodycote Materials
Testing Canada, 26




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Inc. and David C. MacGregor, M.D. related to materials used in the HeartMate LVAS.
On February 3, 2004, we settled the claim and recorded a charge of $2.3 million in the fourth
quarter of 2003 for the settlement and related legal costs. Product liability claims could damage our reputation and hurt our financial results. Our business exposes us to an inherent risk of potential product liability claims related to
the manufacturing, marketing and sale of human medical devices. We maintain a limited amount of
product liability insurance. Our insurance policies generally must be renewed on an annual basis.
We may not be able to maintain or increase such insurance on acceptable terms or at reasonable
costs, and such insurance may not provide us with adequate coverage 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 acceptance of our
products or expand our business. Identified quality problems can result in substantial costs and write-downs. FDA regulations require us to track materials used in the manufacture of our products, so that
any problems identified in a finished product can easily be traced back to other finished products
containing the defective materials. In some instances, identified quality issues require scrapping
or expensive rework of the affected lot(s), not just the tested defective product, and could also
require us to stop shipments. In addition, since some of our products are used in situations where a malfunction can be life
threatening, identified quality issues can result in the recall and replacement, generally free of
charge, of substantial amounts of product already implanted or otherwise in the marketplace. Any quality issue identified can therefore result in substantial costs and write-offs, which
could materially harm our financial results. If we make acquisitions or divestitures, we could encounter difficulties that harm our business. We may acquire companies, products or technologies that we believe to be complementary to our
business. If we do so, we may have difficulty integrating the acquired personnel, operations,
products or technologies and we may not realize the expected benefits of any such acquisition. In
addition, acquisitions may dilute our earnings per share, disrupt our ongoing business, distract
our management and employees and increase our expenses, which could harm our business. We may also
sell businesses or assets as part of our strategy or if we receive offers from third parties. If we
do so, we may sell an asset or business for less than its full value. Our non-U.S. sales present special risks. During fiscal 2004 and 2003, sales originating outside the United States and U.S. export sales
accounted for approximately 21% and 18%, respectively, of our total product sales. We anticipate
that sales outside the United States and U.S. export sales will continue to account for a
significant percentage of our product sales and we intend to continue to expand our presence in
international markets. Non-U.S. sales are subject to a number of special risks. For example:  
    we generally sell many of our products at a lower price outside the United States;
    sales agreements may be difficult to enforce;
    receivables may be difficult to collect through a foreign countrys legal system;
    foreign customers may have longer payment cycles;
    foreign countries may impose additional withholding taxes or otherwise tax our foreign
income, impose tariffs or adopt other restrictions on foreign trade; 27




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
    U.S. export licenses may be difficult to obtain;
    intellectual property rights may be more difficult to enforce in foreign countries;
    terrorist activity or war may interrupt distribution channels or adversely impact our
customers or employees; and
    fluctuations in exchange rates may affect product demand and adversely affect the
profitability, in U.S. dollars, of products sold in foreign markets where payments are made in local currencies. Any of these events could harm our operations or operating results. Any claims relating to improper handling, storage or disposal of hazardous chemicals and
biomaterials could be time consuming and costly. Producing our products requires the use of hazardous materials, including chemicals and
biomaterials. We cannot eliminate the risk of accidental contamination or discharge and any
resultant injury from these materials. We could be subject to both criminal liability and civil damages in the event of an improper
or unauthorized release of, or exposure of individuals to, hazardous materials. In addition,
claimants may sue us for injury or contamination that results from our use or the use by third
parties of these materials, and our liability may exceed our total assets. Compliance with
environmental laws and regulations is expensive, and current or future environmental regulations
may impair our research, development or production efforts or harm our operating results. The occurrence of a catastrophic disaster or other similar events could cause damage to our
facilities and equipment, which would require us to cease or curtail operations. We are vulnerable to damage from various types of disasters, including earthquake, fire,
terrorist acts, flood, power loss, communications failures and similar events. For example, in
October 1989, a major earthquake that caused significant property damage and a number of fatalities
struck near the area in which our Pleasanton, California facility is located. If any such disaster
were to occur, we may not be able to operate our business at our facilities, in particular because
our premises require FDA approval, which could result in significant delays before we can
manufacture product from a replacement facility. The insurance we maintain may not be adequate to
cover our losses resulting from disasters or other business interruptions. Therefore, any such
catastrophe could seriously harm our business and results of operations. If we are unable to favorably assess the effectiveness of our internal control over financial
reporting, or if our independent auditors are unable to provide an unqualified attestation report
on our assessment, our stock price could be adversely affected. Under the Sarbanes-Oxley Act of 2002, we are required to assess the effectiveness of our
internal controls for financial reporting and assert that such internal controls are effective. Our
independent auditors must evaluate managements assessment of the effectiveness of our internal
controls over financial reporting and render an opinion on managements assessment and the
effectiveness of our internal controls over financial reporting. The Act has resulted in and is
likely to continue to result in increased expenses, and have required and are likely to continue to
require significant efforts by management and other employees. Although we believe that our
efforts will enable us to remain compliant under the Act, we can give no assurance that in the
future such efforts will be successful. Our business is complex and involves significant judgments
and estimates as described in our Critical Accounting Estimates. If we have material weaknesses
in internal controls, we will not be able to assert that our internal controls over financial
reporting are effective, which could adversely effect investor confidence in us and the market
price of our common stock. Fluctuations in foreign currency exchange rates could result in declines in our reported sales and
earnings. Because some of our international sales are denominated in local currencies and not in U.S.
dollars, our reported sales and earnings are subject to fluctuations in foreign exchange rates. At
present, we use forward foreign currency contracts to hedge the gains and losses created by the
remeasurement of non-functional currency denominated assets 28




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and liabilities. However, we do not
engage in hedge exposures that will arise from future sales. As a result, sales occurring in the
future that are denominated in foreign currencies may be translated into U.S. dollars at a less
favorable rate than our current exchange rate environment resulting in reduced revenues and
earnings. The competition for qualified personnel is particularly intense in our industry. If we are unable
to retain or hire key personnel, we may not be able to sustain or grow our business. Our ability to operate successfully and manage our potential future growth depends
significantly upon retaining key research, technical, sales, marketing, managerial and financial
personnel, and attracting and retaining additional highly qualified personnel in these areas. We
face intense competition for such personnel, and we may not be able to attract and retain these
individuals. We compete for talent with numerous companies, as well as universities and nonprofit
research organizations, throughout all our locations. The loss of key personnel for any reason or
our inability to hire and retain additional qualified personnel in the future could prevent us from
sustaining or growing our business. Our success will depend in large part on the continued services
of our research, managerial and manufacturing personnel. We cannot assure you that we will continue
to be able to attract and retain sufficient qualified personnel. We may be unable to repay or repurchase our convertible notes or our other indebtedness. At maturity, the entire outstanding principal amount of our convertible notes will become due
and payable. Holders of the convertible notes may also require us to repurchase the convertible
notes on May 16 in each of 2011, 2014, 2019, 2024 and 2029. In addition, if certain fundamental
changes to our company occur, the holders of the convertible notes may require us to repurchase all
or a portion of their convertible notes. We may not have sufficient funds or may be unable to
arrange for additional financing to pay the principal amount due at maturity or the repurchase
price of the convertible notes. Any such failure would constitute an event of default under the
indenture, which could, in turn, constitute a default under the terms of 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. Our adoption of ETIF Issue No. 04-8 in the fourth quarter of 2004, which requires the
inclusion of all shares available upon conversion of our convertible notes in our diluted earnings
per share, or EPS, regardless of whether the notes are then convertible, did not have a material
impact on our consolidated results for the periods in which the notes were outstanding as the
effect of the 7.3 million shares was anti-dilutive. However, if in future periods the shares are
dilutive, then 7.3 million shares will be added to our share count used to calculate diluted
earnings per share, and this inclusion could result in significantly lower diluted EPS than if the
existing guidance had not been changed by EITF 04-8. Anti-takeover defenses in our governing documents could prevent an acquisition of our company or
limit the price that investors might be willing to pay for our common stock. Our governing documents could make it difficult for another company to acquire control of our
company. For example:  
    Our Articles of Incorporation allow our Board of Directors to issue, at any time and
without shareholder approval, preferred stock with such terms as it may determine. No shares
of preferred stock are currently outstanding. However, the rights of holders of any of our
preferred stock that may be issued in the future may be superior to the rights of holders of
our common stock. 29




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##### Table of Contents




    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. 
 Item 2.Properties We are headquartered in Pleasanton, California, where we lease approximately 72,000 square
feet of office, manufacturing and research facilities and 4,000 square feet of warehouse space. Our
leases for these facilities expire through 2012. Additionally, we lease the following facilities:  
    Approximately 11,000 square feet of office and research facilities in Rancho Cordova,
California expiring in 2007.
    Approximately 45,000 square feet of office, manufacturing, warehouse and research
facilities in Edison, New Jersey expiring through 2017.
    Approximately 35,000 square feet of office, manufacturing and research facilities in
Roseville, Minnesota, expiring in 2008.
    Approximately 39,000 square feet of office and research facilities in Burlington,
Massachusetts, expiring in 2011.
    Approximately 3,000 square feet of office facilities in the United Kingdom expiring in
2008. We also own approximately 66,000 square feet of office, manufacturing and research facilities
in Edison, New Jersey. Each of our manufacturing areas has been inspected, approved and licensed for the manufacture
of medical devices by the FDA. Additionally, the Pleasanton facility is subject to inspections,
approvals and licensing by the State of California Department of Health Services (Food and Drug
Section). The Edison facility is subject to inspections, approvals and licensing by State of New
Jersey Department of Health. We believe our facilities will be sufficient for at least the next year and that additional
space will be available at a reasonable price to satisfy space needs thereafter.] 
 Item 3.Litigation In June of 2004, MicroMed Technology, Inc., a competitor of ours, sued us in Texas. MicroMed
sought injunctive relief against us in connection with our HeartMate II Phase I clinical trial on
the grounds that we had provided the HeartMate II VAD to clinical sites without charge and that
doing so was a violation of Texas anti-trust law. In addition to injunctive relief, the plaintiff
is seeking unspecified damages and fees, including those arising from potential sales of its VAD
products which plaintiff alleges it lost due to our HeartMate II clinical trial. We have
successfully defended ourselves against MicroMeds requests for injunctive relief and will continue
to vigorously defend any and all of the claims made by MicroMed in this action. Commencing on or about August 3, 2004, several Federal securities law putative class action
suits were filed in the United States District Court for the Northern District of California on
behalf of purchasers of the publicly traded securities of the Company between April 28, 2004 and
June 29, 2004. These suits were consolidated in a consolidated complaint filed on or about January
18, 2005. The complaint generally alleges violations of the Securities Exchange Act of 1934 by us,
our Chief Executive Officer and our former Chief Financial Officer and the President of our
cardiovascular division based upon, among other things, alleged false statements about the
Companys expected sales and the market for HeartMate as a Destination Therapy treatment. The
complaint seeks to recover unspecified damages on behalf of all purchasers of our publicly traded
securities during the class period. 30




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##### Table of Contents



On or about September 1, 2004, a shareholder derivative action entitled Wong v. Grossmanwas
filed in the California Superior Court for Alameda County based upon essentially the same facts as
the Federal securities suit
This action names the individual members of our Board of Directors,
our Chief Executive Officer and our former Chief Financial Officer as defendants and alleges that
the defendants breached their fiduciary duties and wasted corporate assets, and that certain of the
defendants traded in our securities while in possession of material nonpublic information. We believe that the claims asserted in the MicroMed action, and both the Federal securities
law putative class action and the state shareholder derivative action are without merit. We have
filed a motion to dismiss in the Federal securities law putative class action and the shareholder
suit currently is stayed through at least early July 2005. We are unable to predict at this time the final outcome of these actions. We carry sufficient insurance to cover what management believes to be any reasonable exposure
on these actions; however, we cannot give assurance that our insurance will cover all costs or
other exposures we may incur with respect to these actions. 
 Item 4.Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the quarter ended January 1,
2005. Our Executive Officers D. Keith Grossman, President, Chief Executive Officer and Director,joined our company as
President and Chief Executive Officer in January 1996. He was elected to the Board of Directors in
February 1996. Prior to joining us, Mr. Grossman was a Division President of Major Pharmaceuticals,
Inc., from June 1992 to September 1995, at which time it was sold. From July 1988 to June 1992, Mr.
Grossman served as the Vice President of Sales and Marketing for Calcitek, Inc., a manufacturer of
implantable medical devices, and division of SulzerMedica formerly Intermedics, Inc. Prior to 1988,
Mr. Grossman held various other sales and marketing management positions within the McGaw
Laboratories Division of American Hospital Supply Corporation. Lawrence Cohen, President of ITC,joined our company in May 2001 as President of ITC. Prior to
joining ITC, Mr. Cohen served as CEO of HemoSense, Inc., a developer of medical diagnostic
products, from August 1998 to April 2001. From October 1989 to March 1998, Mr. Cohen held the
positions of Vice President Marketing and Sales, Vice President International and Worldwide
Executive Vice President at Ortho-Clinical Diagnostics, a Johnson & Johnson company. From 1980 to
1989, Mr. Cohen also held executive management positions at Instrumentation Laboratory and Beckman
Coulter Corporation. He is a past president of the Biomedical Marketing Association and was on the
Board of Trustees of the National Blood Foundation from 1998 to 2004. Jeffrey W. Nelson, President  Cardiovascular Division,joined our company as President -
Cardiovascular Division in August 2002. Prior to joining us, Mr. Nelson was at Philips Medical
Systems (formerly ADAC Laboratories) where he spent eight years, most recently as general manager
of the companys nuclear medicine division. He also served as a senior vice president of North
American sales and general manager of ADAC Radiology Solutions and held business unit and regional
sales and marketing positions at the company. Before that, he was a marketing manager for Syncor
International Corporation, an associate at Cerulean Venture Fund and was in sales with Baxter
Healthcare International. 31




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##### Table of Contents



PART II 
 Item 5.Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities Our common stock is traded on the NASDAQ National Market under the symbol THOR. The
following table sets forth, for the periods indicated, the high and low closing sales price per
share of our common stock, as reported by the NASDAQ National Market. As of March 14, 2005, there
were 48,198,480 shares of our common stock outstanding with approximately 775 holders of record,
including multiple beneficial holders at depositories, banks, and brokerages listed as a single
holder in the street name of each respective depository, bank, or broker. High
    
    
    LowFiscal Year 2003First Quarter
    
    $
    12.21
    
    
    $
    7.63Second Quarter
    
    
    14.44
    
    
    
    11.45Third Quarter
    
    
    19.23
    
    
    
    13.74Fourth Quarter
    
    $
    16.99
    
    
    $
    12.35Fiscal Year 2004First Quarter
    
    $
    15.95
    
    
    $
    11.75Second Quarter
    
    
    14.99
    
    
    
    10.49Third Quarter
    
    
    11.01
    
    
    
    9.40Fourth Quarter
    
    $
    10.88
    
    
    $
    8.46
 We have not declared or paid any dividends on our common stock and we do not anticipate doing
so in the foreseeable future. Issuer Purchases of Equity Securities Our stock repurchase programs, which authorized us to repurchase up to $110 million of shares
of the companys common stock, were announced on February 11, 2004 as a $25 million of shares
program, on May 12, 2004 as a $60 million shares program, and on July 29, 2004 as an additional $25
million share program. These programs do not have an expiration date. The table below sets forth
the information with respect to repurchases made under these stock repurchase programs during each
month in the fourth quarter of our fiscal year ended January 1, 2005. Maximum Dollar ValueOf Shares That MayTotal Number of
    
    
    YetTotal Number
    
    
    Average
    
    
    Shares Purchased as
    
    
    Be Purchased UnderOf Shares
    
    
    Price Paid
    
    
    Part Of Publicly
    
    
    The ProgramPurchased
    
    
    Per Share
    
    
    Announced Program
    
    
    (in millions)October 3, 2004 to October 30, 2004
    
    
    557,000
    
    
    $
    8.93
    
    
    
    557,000
    
    
    $
    15.0October 31, 2004 to November 27, 2004
    
    
    537,500
    
    
    $
    9.30
    
    
    
    537,500
    
    
    $
    10.0November 28, 2004 to January 1, 2005
    
    
    277,500
    
    
    $
    9.72
    
    
    
    277,500
    
    
    $
    7.3Total
    
    
    1,372,000
    
    
    $
    9.24
    
    
    
    1,372,000
 
 Item 6.Selected Consolidated Financial Data The selected consolidated financial data presented below for the five fiscal years ended
January 1, 2005 is derived from our audited financial statements. The data set forth below should
be read in conjunction with Managements Discussion and Analysis of Financial Condition and
Results of Operations below and our audited consolidated financial statements and notes thereto
appearing elsewhere in this Annual Report, the consolidated financial statements of TCA filed with
the SEC on Form 8-K/A on March 30, 2001 and on Form 10-K on March 17, 2000. Certain
reclassifications have been made to the financial statements previously filed with the SEC to
conform to current practice. In the merger of Thoratec with TCA that was completed on February 14, 2001, we issued new
shares of our common stock to the shareholders of TCA in exchange for all the outstanding common
stock of TCA at an exchange
ratio of 0.835 shares of Thoratec stock for each share of TCA. The
merger was accounted for as a reverse acquisition because former shareholders of TCA owned a
majority of our outstanding stock subsequent to the 32




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##### Table of Contents



merger. For accounting purposes, TCA is deemed
to have acquired Thoratec and therefore for fiscal year 2000 all financial information presented
herein represents the results of operations of TCA. Our 2001 consolidated financial information
presented herein includes the financial results of TCA for the full fiscal year and Thoratecs
financial
results for the post-merger period from February 14, 2001 through December 29, 2001. The
weighted average number of common shares previously reported by TCA has been adjusted for all
periods presented to reflect the exchange ratio of 0.835 to 1. Our fiscal year ends on the Saturday closest to December 31. Accordingly, our fiscal year will
periodically contain more or less than 365 days. For example, fiscal 2000 ended on December 30,
2000, fiscal 2001 ended on December 29, 2001, fiscal 2002 ended December 28, 2002, fiscal 2003
ended January 3, 2004 and fiscal 2004 ended January 1, 2005. Fiscal Year2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000 (a)(In thousands, except per share data)Statement of Operations:Product sales
    
    $
    172,341
    
    
    $
    149,916
    
    
    $
    130,844
    
    
    $
    113,384
    
    
    $
    83,396Gross profit
    
    
    100,222
    
    
    
    88,748
    
    
    
    75,720
    
    
    
    60,544
    
    
    
    48,566Amortization of goodwill and purchased
intangible assets
    
    
    11,724
    
    
    
    12,333
    
    
    
    12,384
    
    
    
    15,674
    
    
    
    In-process research and development
    
    
    
    
    
    
    220
    
    
    
    
    
    
    
    76,858
    
    
    
    Impairment of intangible asset
    
    
    
    
    
    
    8,987
    
    
    
    
    
    
    
    
    
    
    
    Litigation, merger, restructuring and other costs
    
    
    733
    
    
    
    2,132
    
    
    
    1,409
    
    
    
    7,134
    
    
    
    1,831Net income (loss)
    
    
    4,974
    
    
    
    (2,182
    )
    
    
    511
    
    
    
    (87,866
    )
    
    
    7,524Basic and diluted earnings (loss) per share
    
    $
    0.07
    
    
    $
    (0.04
    )
    
    $
    0.01
    
    
    $
    (1.68
    )
    
    $
    0.23Balance Sheet Data:Cash and cash equivalents and short term
available-for-sale investments
    
    $
    145,859
    
    
    $
    62,020
    
    
    $
    45,483
    
    
    $
    91,726
    
    
    $
    129,008Working capital
    
    
    206,250
    
    
    
    116,430
    
    
    
    107,972
    
    
    
    135,924
    
    
    
    149,207Total assets
    
    
    524,415
    
    
    
    476,131
    
    
    
    468,432
    
    
    
    530,241
    
    
    
    176,685Subordinated convertible debentures
    
    
    143,750
    
    
    
    
    
    
    
    
    
    
    
    54,838
    
    
    
    54,838Long-term deferred tax liability and other
    
    
    63,052
    
    
    
    67,123
    
    
    
    75,454
    
    
    
    81,020
    
    
    
    Total shareholders equity
    
    $
    292,108
    
    
    $
    386,236
    
    
    $
    374,340
    
    
    $
    373,343
    
    
    $
    105,869
  (a)
    Our financial statements for 2000 were audited by Arthur Andersen LLP, who have ceased
operations. 
 Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations With the exception of historical facts, the statements contained in thisForm 10-Kare
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, project, should, would, clear,
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 That May Affect Future Results above for what we believe to be the principal factors
that could cause our actual performance and future actions to differ materially from the
forward-looking statements. Readers are urged to consider these factors carefully in evaluating the
forward-looking statements. The forward-looking statements included in thisForm 10-Kare 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. 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-K. Overview We are a leading manufacturer of circulatory support products for use by patients with
congestive heart failure, or CHF. Our VADs are used primarily by these CHF patients to perform some
or all of the pumping function of the 33




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##### Table of Contents



heart and we currently offer the widest range of products to
serve this market. We believe that our long-standing reputation for quality and innovation and our
excellent relationships with leading cardiovascular surgeons worldwide position us to capture
growth opportunities in the expanding congestive heart failure market. Through our wholly-owned
subsidiary, ITC, we design, develop, manufacture and market point-of-care diagnostic test systems
that provide fast, accurate blood test results to improve patient management, reduce healthcare
costs and improve patient outcomes. Our business is comprised of two segments; Cardiovascular and ITC. The major product lines
within the Cardiovascular segment are:  
    Circulatory Support Products.Our circulatory support products include VADs for the
short-term and long-term treatment of congestive heart failure.
    Vascular Graft Products.We have developed small diameter grafts using our proprietary
materials to address the vascular access market. Our grafts are sold in the United States
and internationally for use in hemodialysis. The major product line of our ITC segment is:  
    Point-of-Care Diagnostics. We are a leading supplier of point-of-care blood diagnostics
test systems that provide fast, accurate blood test results to improve patient management,
reduce healthcare costs and improve patient outcomes. Growth in out ITC segment assumes increased patient testing, better patient outcomes, and
increased decentralization of testing from central laboratories to point-of-care. Our Business Model The two product lines that represent the majority of our product sales are VAD and
point-of-care diagnostic test systems and services. Historical product sales mix has been as
follows: 2004
    
    
    2003
    
    
    2002Cardiovasular:VAD pumps including associated products and services
    
    
    58
    %
    
    
    60
    %
    
    
    62
    %Grafts
    
    
    2
    %
    
    
    3
    %
    
    
    3
    %Point-of-care diagnostic test systems
    
    
    40
    %
    
    
    37
    %
    
    
    35
    %Product Sales
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 Acquisitions and Strategic
Investments 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, subject to BioCardias authorization will be able to
review relevant clinical data accumulated by BioCardia through its multiple trials. We have
accounted for this investment on the cost basis as we do not have the ability to exercise
significant influence over BioCardias operating and financial policies. This investment is
included on our consolidated balance sheet in other long-term assets. 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.
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,
$220,000 relating to in-process research and development was expensed in the fourth quarter of
2003. 34




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##### Table of Contents



Restructuring Plan In June 2001, following the merger with TCA, 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 the policies below as critical to our business operations and the
understanding of our results of operations. The impact and any associated risks related to these
policies on our business operations are discussed below. For a more detailed discussion on the
application of these and other accounting policies, see the notes to the consolidated financial
statements included in this Annual Report on Form 10-K. Preparation of financial statements in
accordance with generally accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets, liabilities, revenue and expenses and the
disclosure of contingent assets and liabilities. There can be no assurance that actual results will
not differ from those estimates. Evaluation of Purchased Intangibles and Goodwill for Impairment In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, we periodically evaluate the carrying value of long-lived assets to be held and used,
including intangible assets subject to amortization, when events or circumstances warrant such a
review. The carrying value of a long-lived asset to be held and used is considered impaired when
the anticipated separately identifiable undiscounted cash flows from such an asset are less than
the carrying value of the asset. In that event, a loss is recognized based on the amount by which
the carrying value exceeds the fair value of the long-lived asset. Fair value is determined
primarily using the anticipated cash flows discounted at a rate commensurate with the risk
involved. Management must make estimates of these future cash flows and the approximate discount
rate, and if any of these estimates proves incorrect, the carrying value of these assets on our
consolidated balance sheet could become significantly impaired. As of the beginning of fiscal year 2002, we adopted SFAS No. 142, Goodwill and Other
Intangible Assets, and ceased amortizing purchased goodwill. We complete an impairment test of
goodwill and other intangible assets subject to amortization as required by SFAS No. 142 and SFAS
No. 144. Upon completion of our impairment tests as of the end of the year 2004, we determined that
neither goodwill nor intangible assets were impaired. Revenue Recognition We recognize revenue from product sales for our Cardiovascular and ITC business segments when
evidence of an arrangement exists, title has passed (generally upon shipment) or services have been
rendered, the selling price is fixed or determinable and collectibility is reasonably assured.
Sales to distributors are recorded when title transfers upon shipment. One of our distributors has
certain limited product return rights. One other distributor has certain rights of return upon
termination of its distribution agreement. A reserve for sales returns is recorded for these
customers applying reasonable estimates of product returns based upon significant historical
experience. No other direct sales customers or distributors have return rights or price
protection. Sales of certain Cardiovascular segment products to first-time customers are recognized when
it has been determined that the customer has the ability to use such products. These sales
frequently include the sale of products and training services under multiple element arrangements.
For most customers, training is not essential to the functionality of the products as the customers
already possess sufficient expertise and experience to use the products. In these situations,
training is provided as a best practice to optimize the use and success of the products. The amount
of revenue under these arrangements allocated to training is based upon fair market value of the
training, which is performed principally by third party providers. The amount of product sales
allocated to the Cardiovascular segment products is done on a fair
value basis. Under this basis, the total value of the arrangement is
allocated to the training and the Cardiovascular segment products
based on the relative fair market value of the training and products.
The amount of product sales allocated to training is recorded as deferred revenue and is recognized
when the training is completed. As of the end of fiscal 2004, all products that had been delivered
and recorded as product sales were delivered to customers for which training had been 35




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completed. There was no amount of product sales deferred related to this training not yet completed at the end
of 2004; however, $20,000 of such product sales were deferred at the end of 2003 and $0.1 million
at the end of 2002. The majority of our products are covered by up to a two-year limited manufacturers warranty
from the date of installation. Estimated contractual warranty obligations are recorded when related
sales are recognized and any additional amounts are recorded when such costs are probable and can
be reasonably estimated Management makes decisions on such things as credit worthiness and warranty reserves. If these
decisions prove incorrect, the carrying value of these assets and liabilities on our consolidated
balance sheet could be significantly different. Reserves We maintain allowances for doubtful accounts for estimated losses resulting from the inability
of our customers to make payments owed to us for product sales. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. Management must make judgments to determine the amount of reserves to accrue, if management
estimates prove incorrect, our financial statements could be adversely affected. Results of Operations The following table sets forth selected consolidated statements of operations data for the
years indicated as a percentage of total product sales: Fiscal Year2004
    
    
    2003
    
    
    2002Product sales
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of product sales
    
    
    42
    
    
    
    41
    
    
    
    42Gross profit
    
    
    58
    
    
    
    59
    
    
    
    58Operating expenses:Selling, general & administrative
    
    
    31
    
    
    
    30
    
    
    
    29Research and development
    
    
    17
    
    
    
    17
    
    
    
    19Amortization of purchased intangible assets
    
    
    7
    
    
    
    8
    
    
    
    10Loss on impairment of intangible asset
    
    
    
    
    
    
    6
    
    
    
    Litigation, merger, restructuring and other costs
    
    
    
    
    
    
    1
    
    
    
    1Total operating expenses
    
    
    55
    
    
    
    62
    
    
    
    59Income (loss) from operations
    
    
    3
    
    
    
    (4
    )
    
    
    (1
    )Other income and (expense):Interest expense
    
    
    (1
    )
    
    
    
    
    
    
    Interest income and other
    
    
    1
    
    
    
    1
    
    
    
    2Income (loss) before taxes
    
    
    3
    
    
    
    (3
    )
    
    
    1Income tax expense (benefit)
    
    
    (1
    )
    
    
    (1
    )
    
    
    Net income (loss)
    
    
    2
    %
    
    
    (2
    )%
    
    
    1
    %
 Fiscal Years 2004 and 2003 Product Sales Product sales in 2004 were $172.3 million compared to $149.9 million in 2003. The primary
components of the $22.4 million, or 15%, increase in product sales were the following:  
    Point-of-care diagnostic sales increased $9 million, including $4.5 million in revenue
from the IRMA product line acquired in the fourth quarter of 2003.
    Alternate site sales increased $4.7 million, primarily due to increased sales of the
ProTime product line.
    Higher VAD sales of $4.5 million. The majority of this increase came from higher sales
of the HeartMate VAD. 36




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##### Table of Contents




    Other ancillary product sales, (drivers, cannulae, service, rentals and spares)
increased $5.9 million, including an increase in TLC II driver revenue principally from
Home Discharge, which was approved by the FDA toward the end of the second quarter of
2004; partially offset by
    $1.7 million in lower graft revenue. Our sales of Destination Therapy implants were lower in 2004 than we had originally
anticipated, and we expect product sales for this indication to increase more slowly than we had
originally projected. Gross Profit Gross profit as a percentage of sales for 2004 and 2003 was 58% and 59%, respectively. Within
these essentially flat margins were the following significant fluctuations:  
    A 1% higher margin on cardiovascular products resulting from a shift in sales mix from
lower to higher margin products, partially offset by higher manufacturing costs.
    A 3% lower margin on point-of-care revenue, primarily related to the IRMA product line,
plus higher manufacturing and shipping costs associated in part with the shift in sales
from distributor to direct channels. Selling, General and Administrative Selling, general and administrative expenses in 2004 were $54.1 million, or 31% of product
sales, compared to $44.4 million, or 30% of product sales, in 2003. The $9.7 million increase in
spending was primarily attributable to the following:  
    Increased headcount from 139 employees at the end of 2002 to 174 at the end of 2003 to
207 at the end of 2004, together with annual salary, fringe benefit and other cost
increases of $4.7 million.
    Higher spending on marketing and related activities, primarily associated with our
HeartHope Center Program, Destination Therapy, and costs associated with the IRMA product
line of $3.9 million.
    Higher professional fees, including legal, audit and financial consulting services
relating primarily to our compliance with the Sarbanes-Oxley Act of 2002 of an additional
$0.9 million.
    Higher insurance premiums for 2004 compared to 2003 of $0.2 million. Research and Development Research and development expenses in 2004 were $28.7 million, or 17% of product sales,
compared to $26.1 million, or 17% of product sales, in 2003. Research and development costs are
largely project driven, and the level of spending depends on the level of project activity planned
and subsequently approved and conducted. The primary component of our research and development
costs is employee salaries and benefits. Research and development costs also include regulatory and
clinical costs associated with our compliance with FDA regulations. Amortization of Purchased Intangible Assets Amortization of purchased intangible assets in 2004 was $11.7 million compared to $12.3
million in 2003 as there were no new acquisitions coupled with the $9.0 million write-off of the
Aria assets at the end of fiscal year 2003. In-process Research and Development Costs We had no in-process research and development charges in 2004. In-process research and
development expense in 2003 was $0.2 million related to our acquisition of the IRMA product line. 37




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Litigation, Merger, Restructuring and Other Costs Litigation, merger, restructuring and other charges in 2004 were $0.7 million compared to $2.1
million in 2003. The 2004 expense is primarily comprised of costs associated with a putative
Federal securities law class action, and a shareholder derivative action entitled Wong v. Grossman
that were filed in the third quarter of 2004. The 2003 expense is primarily comprised of $2.3
million to settle a patent infringement claim. Interest Expense Interest expense in 2004 was $2.5 million compared to none in 2003. This expense in 2004
includes $2.1 million in interest payments and $0.4 million in amortization of the debt issuance
costs related to our convertible notes. We did not have these notes or any other debt instrument
in 2003. Interest Income and Other Interest income and other in 2004 was $2.2 million compared to $1.8 million in 2003. This
increase was primarily due to higher interest income earned on our portfolio based on increased
cash balances in 2004 compared 2003. Income Taxes Our effective tax rate was 24% in 2004 compared to 39% in 2003. The reduction in our effective
tax on a comparative basis was due primarily to a combination of reduced tax basis profitability in
the current year; increased interest income from tax favorable investments; increased research and
development credits; offset in part by increased expenditures for non-deductible expenses. Fiscal Years 2003 and 2002 Product Sales Product sales in 2003 were $149.9 million compared to $130.8 million in 2002. The primary
components of the $19.1 million, or 15%, increase in product sales were as follows:  
    Higher VAD sales of $7.1 million. The majority of this increase came from higher sales
of the HeartMate VAD.
    Higher graft sales of $1.0 million.
    Higher revenue from sales of ancillary products of $1.8 million.
    Higher revenue from ITC sales of point-of-care diagnostic test systems of $7.4 million
    Revenue of $1.7 million from IRMA product line acquired by ITC in the fourth quarter of 2003 Gross Profit Gross profit as a percentage of sales increased from 58% in 2002 to 59% in 2003 due to the
following:  
    Higher VAD average selling prices resulted in a 2.2% increase in margin, largely as a
result of sales in 2003 of our HeartMate VAD representing a higher percentage of our
revenue when compared to the lower priced
Thoratec VAD. The HeartMate VAD typically had an
average selling price of between $60,000 and $70,000, while the Thoratec VAD typically sold
for between $30,000 and $40,000.
    Lower margins on our ITC products resulted in a 0.8% decline in our overall margins.
This includes the impact of the IRMA product line we acquired in the fourth quarter of 2003
which operated with margins in the 30% range, compared to the margins on other products
sold by ITC which were typically in the 50% range, and the impact of higher scrap, higher
freight, and lower ASPs in our Incision product line. 38




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Selling, General and Administrative Selling, general and administrative expenses in 2003 were $44.4 million, or 30% of product
sales, compared to $37.4 million, or 29% of product sales, in 2002. The $7.0 million increase in
spending was primarily attributable to the following:  
    Increased headcount from 125 employees at the end of 2001 to 139 at the end of 2002 to
174 at the end of 2003, together with annual salary increases aggregating 4% effective
January 2003.
    Higher spending on Medicare reimbursement activities and market research and related
activities, primarily associated with Destination Therapy, and costs associated with the
IRMA product line acquired in the fourth quarter of 2003.
    Higher insurance premiums
    Higher facilities costs related to higher headcount. These higher costs were offset in part by lower legal costs in 2003 due to our filing with the
SEC a registration statement in 2002 that did not recur in 2003, and lower meeting expenses related
to a customer event in 2002 that did not recur in 2003. Research and Development Research and development expenses in 2003 were $26.1 million, or 17% of product sales,
compared to $25.3 million, or 19% of product sales, in 2002. 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 are 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 2003 was $12.3 million compared to $12.4
million in 2002. The expense was flat year over year as there were no acquisitions or changes in
amortization values through the year ended 2003. Amortization of Goodwill Beginning in 2002, we stopped amortizing goodwill in accordance with SFAS No. 142. Impairment of Intangible Asset Subsequent to the year ended 2003, we completed an assessment of the final results from our
feasibility clinical trial for the Aria CABG graft, which was ongoing through fiscal 2003. Based on
the clinical trial results, we determined that it would not devote additional resources to the
development of the Aria graft. Upon the decision to discontinue product development, we recorded an
impairment charge of $9.0 million as of January 3, 2004 to write off purchased intangible assets
related to the Aria graft, which were recorded as a result of the merger with TCA. In-process Research and Development Costs In-process research and development expense in 2003 was $0.2 million related to our
acquisition of the IRMA product line. There were no in-process research and development expenses
in 2002. Legal Settlement, Merger, Restructuring and Other Costs Legal settlement, merger, restructuring and other charges in 2003 were $2.1 million compared
to $1.4 million in 2002. The 2003 expense is primarily comprised of $2.3 million to settle a patent
infringement claim filed against us 39




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by Bodycote Materials Testing Canada, Inc. and David C.
MacGregor, M.D related to materials used in the Companys HeartMate® LVAS, partially
offset by a reversal of a restructuring reserve. Interest Expense There was no interest expense in 2003 and $1.1 million in 2002. This decrease was due to less
interest paid due to the redemption of our debentures in March 2002. We had no debt in 2003. Interest Income and Other Interest income and other in 2003 was $1.8 million compared to $2.7 million in 2002. This
decrease was primarily due to the impact of lower interest rates on invested cash in 2003, which
resulted in a decrease in interest income, and the impact of our foreign exchange hedging program
commenced in 2003. Income Taxes Our effective tax rate was 39% in 2003 compared to an effective tax rate of 42% in 2002. This
reduction reflects the relatively larger impact of various tax incentives, nondeductible expenses
and tax credits in 2002 when net income subject to tax was less than $1.0 million. Based on a
pre-tax loss in 2003 of $3.6 million, the impact of these tax differences was proportionately
lower. Liquidity and Capital Resources At January 1, 2005, we had working capital of $206.3 million compared with $116.4 million at
January 3, 2004. Cash and cash equivalents and short-term available-for-sale investments at January
1, 2005 were $145.9 million compared to $62.0 million at January 3, 2004. The increase is due
primarily to unexpended proceeds from our convertible debt offering in the second quarter of 2004. Cash provided by operating activities for the year ended January 1, 2005 was $18.2 million,
after payments of litigation expenses for a settled litigation matter and annual bonuses accrued
at January 3, 2004 totaling $5.2 million. In addition, investing activities used $61.4 million,
with $55.6 million net purchases of investments and $5.8 million to acquire property, plant and
equipment. The purchases of property, plant and equipment consisted of $5.0 million for equipment
and $0.8 million for leasehold improvements. Cash provided by financing activities for the year was
$40.5 million, including $139.4 million net proceeds from the issuance of our convertible notes and
an additional $3.8 million from proceeds related to stock option exercises and our Employee Stock
Purchase Plan, partially offset by $102.7 million paid to repurchase 8.3 million shares of stock
under our stock repurchase programs. A portion of the debt offering proceeds were used to purchase and pledge $9.8 million to the
trustee under the indenture for the exclusive benefit of the holders of the convertible notes, U.S.
government securities to provide for the payment, in full, of the first six scheduled interest
payments. Additional net proceeds were used to repurchase 4.2 million shares of our outstanding
common stock for $60.0 million. The remaining net proceeds will be used for general corporate
purposes, which may include additional stock repurchases, strategic investments or acquisitions.
The convertible notes were issued at an issue price of $580.98 per note, which is 58.098% of the
principal amount at maturity of the notes. The convertible notes bear interest at a rate of 1.3798%
per year on the principal amount at maturity, payable semi-annually in arrears in cash on May 16
and November 16 of each year, from November 16, 2004 until May 16, 2011. Beginning on May 16, 2011,
the original issue discount will accrue daily at a rate of 2.375% per year on a semi-annual bond
equivalent basis and, on the maturity date, a holder will receive $1,000 per note. As a result, the
aggregate principal amount of the notes at maturity will be $247.4 million. In February 2004 and July 2004, the Board of Directors authorized stock repurchase programs
under which up to an aggregate of $50.0 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 $60.0 million of our common stock. As
of January 1, 2005, we had repurchased and retired 8.3 million shares with an aggregate purchase
price of $102.7 million under these combined programs. 40




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We believe that cash and cash equivalents, short-term available-for-sale investments on hand
and expected cash flows from operations, will be sufficient to fund our operations, capital
requirements and stock repurchase programs for at least the next twelve months. The impact of inflation on our financial position and the results of operations was not
significant during any of the periods presented. Contractual Obligations As of January 1, 2005, we had the following contractual obligations (in millions): Total
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    ThereafterLong-Term Debt Obligations (a)
    
    $
    269.1
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    3.4
    
    
    
    252.1Operating Lease Obligations
    
    
    19.5
    
    
    
    2.5
    
    
    
    2.5
    
    
    
    2.4
    
    
    
    2.3
    
    
    
    1.8
    
    
    
    8.0Purchase Obligations
    
    
    19.8
    
    
    
    2.2
    
    
    
    2.2
    
    
    
    2.2
    
    
    
    2.2
    
    
    
    1.8
    
    
    
    9.2Total
    
    $
    308.4
    
    
    
    8.1
    
    
    
    8.1
    
    
    
    8.0
    
    
    
    7.9
    
    
    
    7.0
    
    
    
    269.3
 Our operating lease obligations of $19.5 million were comprised of our various leased
facilities and office equipment. Our purchase obligations of $19.8 million were comprised of
supply agreements in effect at January 1, 2005. (a) Includes interest of $21.8 million and original issue discount of $103.7 million. See note 8
to our audited consolidated financial statements in this report for data related to long-term debt. Letter of Credit In the third quarter of 2004 we obtained an Irrevocable Standby Letter of Credit for $390,000
as part of our workers compensation insurance program. The Letter of Credit is not
collateralized. The Letter of Credit expires on June 30, 2005 and is scheduled to automatically
renew each year on June 30th. Accounting Pronouncements In December 2004, the FASB issued statement 123® Share-Based Payment This statement
requires that stock-based compensation be recognized as a cost in the financial statements and that
such cost be measured based on the fair value of the stock-based compensation. Our adoption of this
statement, which we expect to occur in the third quarter of 2005, will have a material, although
non-cash, impact on our consolidated statements of operations. In March 2004, the Emerging Issues Task Force (EITF) reached a final consensus on Issue
03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,
to provide additional guidance in determining whether investment securities have an impairment
which should be considered other-than-temporary. On September 15, 2004 the FASB issued proposed FSP
EITF Issue 03-1-a to address the application of the EITF Issue 03-1 to debt securities that are
affected by interest rate and/or sector-spread changes only. On September 30, 2004, the FASB
issued FSP EITF Issue 03-1-1, which delayed the effective date of certain paragraphs of the EITF
until EITF 03-1-a is issued. We did however, adopt the disclosure provisions in the fourth
quarter of 2004, the adoption had no effect on our operating results or financial condition.
Management expects that the adoption of the delayed portions of this Issue and the related FSPs
will not have a significant effect on our operating results or financial condition once adopted. 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 15. In October 2004, EITF Issue No. 04-8, Accounting Issues Related to Certain Features of
Contingently Convertible Debt and the Effect on Diluted Earnings per Share was issued. Issue No.
04-8 states that shares 41




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available under contingently convertible debt should be included in diluted
earnings per share, or EPS, in all periods, since the notes were issued, except when inclusion is
anti-dilutive, regardless of whether the contingency is met and regardless of whether the market
price contingency is substantial. Our adoption of this proposed interpretation, in the fourth
quarter of 2004, did not have a material impact on our most recent consolidated results as the
effect of the 7.3 million shares issuable upon conversion of the notes was anti-dilutive. If in
future periods the shares would be dilutive, then 7.3 million shares will be added to our share
count used to calculate diluted earnings per share, and this inclusion could result in lower
diluted EPS than if the existing guidance had not been changed by EITF 04-8. 
 Item 7A.Quantitative and Qualitative Disclosures About Market Risk Interest Rate Risk Our investment portfolio is made up of cash equivalent and marketable investments in auction
rate securities, money market funds, debt instruments of government agencies, U.S. Treasuries,
local municipalities, and high quality corporate issuers. All investments are carried at market
value and are treated as available-for-sale. All investments mature within two years or less from
the date of purchase, except for some investments in U.S. Treasuries held as restricted investments
as collateral for future interest payments related to our convertible debt, which mature within
three years from the date of purchase. Our holdings of the securities of any one issuer, except
government agencies, do not exceed 10% of the portfolio. If interest rates rise, the market value
of our investments may decline which could result in a loss if we are forced to sell an investment
before the scheduled maturity. If interest rates were to rise or fall from current levels by 25
basis points the change in our net unrealized loss on investments would be nominal. We do not
utilize derivative financial instruments to manage interest rate risks. Our convertible notes do not bear interest rate risk as the notes were issued at a fixed rate
of interest. Foreign Currency Rate Fluctuations We conduct business in foreign countries. Our international operations consist primarily of
sales and service personnel for our ventricular assist products, who report to our U.S. sales and
marketing group and are internally reported as part of that group. All assets and liabilities of
our non-U.S. operations are translated into U.S. dollars at the period-end exchange rates and the
resulting translation adjustments are included in comprehensive income. The period-end translation
of the non-functional currency assets and liabilities (primarily assets and liabilities on our UK
subsidiary consolidated balance sheet that are not denominated in UK Pounds) at the period-end
exchange rates result in foreign currency gains and losses, which are included in Interest Income
and Other. We use forward foreign currency contracts to hedge the gains and losses generated by the
revaluation of these non-functional currency assets and liabilities. These derivatives are not
designated as cash flow or fair value hedges under SFAS No. 133. As a result, changes in the fair
value of the forward foreign currency contracts are included as Interest Income and Other. The
change in the fair value of the forward foreign currency contracts typically offsets the change in
value from revaluation of the non-functional currency assets and liabilities. These contracts
typically have maturities of three months or less. At January 1, 2005 and January 3, 2004, we had
forward foreign currency contracts in Pounds Sterling and Euros with a notional value of $6.9
million and $4.3 million, respectively. These contracts had an average exchange rate of Euros to
Pounds Sterling of .6939 and Pounds Sterling to the U.S. dollar of .4763 as of January 1, 2005.
The impact of foreign currency revaluation, net of forward foreign currency contracts, was $0.2
million for the year ended January 1, 2005 and was negligible for the year ended January 3, 2004. 42




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Item 8.Financial Statements and Supplementary Data THORATEC CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS  
 PageFinancial Statements:Management Report on Internal Control Over Financial Reporting
    
    
    44Reports of Independent Registered Public Accounting Firm.
    
    
    45Consolidated Balance Sheets.
    
    
    47Consolidated Statements of Operations.
    
    
    48Consolidated Statements of Comprehensive Income (Loss).
    
    
    49Consolidated Statements of Shareholders Equity.
    
    
    50Consolidated Statements of Cash Flows.
    
    
    51Notes to Consolidated Financial Statements.
    
    
    52EXHIBIT 10.20EXHIBIT 10.29EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 43




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MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over
financial reporting to provide reasonable assurance regarding the reliability of our financial
reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. Management assessed our internal control over financial reporting as of January 1, 2005, the
end of our fiscal year. Management based its assessment on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Managements assessment included evaluation of such elements as the design and
operating effectiveness of key financial reporting controls, process documentation, accounting
policies, our overall control environment and took into consideration the situation which resulted
in the restatement of the pro forma stock compensation fair value disclosures for the years ended
January 3, 2004 and December 28, 2002 . This assessment is supported by testing and monitoring
performed by our internal accounting and finance organization. Based on our assessment, management has concluded that our internal control over financial
reporting was effective as of January 1, 2005 to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external
reporting purposes in accordance with generally accepted accounting principles. The results of
managements assessment were reviewed with the Audit Committee. Our independent registered public accounting firm, Deloitte & Touche LLP, has issued an
attestation report on managements assessment of our internal control over financial reporting,
which is included in this Item 8 of this Annual Report on Form 10-K. 44




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Directors of Thoratec Corporation: We have audited managements assessment, included in the accompanying Managements Report on
Internal Control Over Financial Reporting, that Thoratec Corporation and subsidiaries (the
Company) maintained effective internal control over financial reporting as of January 1, 2005,
based on the criteria established in Internal ControlIntegrated Frameworkissued by the Committee
of Sponsoring Organizations of the Treadway Commission. The Companys management is responsible
for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to express an
opinion on managements assessment and an opinion on the effectiveness of the Companys internal
control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions. A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including
the possibility of collusion or improper management override of controls, material misstatements
due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that the Company maintained effective internal control
over financial reporting as of January 1, 2005, is fairly stated, in all material respects, based
on the criteria established in Internal ControlIntegrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of January 1,
2005, based on the criteria established in Internal ControlIntegrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements and financial statement
schedules as of and for the year ended January 1, 2005 of the Company and our report dated March
16, 2004 expressed an unqualified opinion on those financial statements and financial statement
schedules and included an explanatory paragraph concerning the restatement of the pro forma stock
compensation fair value disclosures for the years ended January 3, 2004 and December 28, 2002. /s/ DELOITTE & TOUCHE LLP San Francisco, California
March 16, 2005 45




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Thoratec Corporation: We have audited the accompanying consolidated balance sheets of Thoratec Corporation and
subsidiaries (the Company) as of January 1, 2005 and January 3, 2004, and the related
consolidated statements of operations,
comprehensive income (loss), stockholders equity, and cash flows for the years ended January 1,
2005, January 3, 2004, and December 28, 2002. Our audits also included the financial statement
schedules listed in the Index to this Annual Report of Form 10-K at Part VI Item 15 (a) 2. These
financial statements and financial statement schedules are the responsibility of the Companys
management. Our responsibility is to express an opinion on the financial statements and financial
statement schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion. In our opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of Thoratec Corporation and subsidiaries as of January 1, 2005 and
January 30, 2004, and the results of their operations and their cash flows for the years ended
January 1, 2005, January 2, 2004 and December 28, 2002, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, such financial statement
schedules, when considered in relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set forth therein. As discussed in Note 1 to the consolidated financial statements, the pro forma stock
compensation fair value disclosures for the years ended January 3, 2004 and December 28, 2002 have
been restated. We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Companys internal control over financial
reporting as of January 1, 2005, based on the criteria established in Internal ControlIntegrated
Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated March 16, 2005 expressed an unqualified opinion on managements assessment of the
effectiveness of the Companys internal control over financial reporting and an unqualified opinion
on the effectiveness of the Companys internal control over financial reporting. /s/DELOITTE & TOUCHE LLP San Francisco, California
March 16, 2005 46




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THORATEC CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS For the Fiscal Year Ended2004
    
    
    2003(In thousands)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    16,017
    
    
    $
    18,270Short-term available-for-sale investments
    
    
    129,842
    
    
    
    43,750Restricted short-term investments
    
    
    3,362
    
    
    
    Receivables, net of allowances of $708 in 2004 and $486 in 2003
    
    
    33,051
    
    
    
    27,969Inventories
    
    
    39,141
    
    
    
    36,417Deferred tax asset
    
    
    6,470
    
    
    
    9,717Prepaid expenses and other assets
    
    
    3,873
    
    
    
    3,079Total current assets
    
    
    231,756
    
    
    
    139,202Property,
plant and equipment, net
    
    
    27,584
    
    
    
    28,492Long-term available-for-sale investments
    
    
    
    
    
    
    41,179Restricted long-term investments
    
    
    4,845
    
    
    
    Goodwill
    
    
    94,097
    
    
    
    96,065Purchased intangible assets, net
    
    
    153,141
    
    
    
    164,865Long-term deferred tax asset
    
    
    6,381
    
    
    
    4,796Other assets
    
    
    6,611
    
    
    
    1,532Total Assets
    
    
    524,415
    
    
    $
    476,131LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    7,699
    
    
    $
    6,952Accrued compensation
    
    
    9,507
    
    
    
    8,851Accrued liabilities for legal, audit and warranty
    
    
    1,610
    
    
    
    1,463Accrued legal settlement
    
    
    
    
    
    
    2,000Accrued income taxes
    
    
    2,299
    
    
    
    1,637Other accrued liabilities
    
    
    4,391
    
    
    
    1,869Total current liabilities
    
    
    25,506
    
    
    
    22,772Senior subordinated convertible notes
    
    
    143,750
    
    
    
    Long-term deferred tax liability and other
    
    
    63,051
    
    
    
    67,123Total Liabilities
    
    
    232,307
    
    
    
    89,895CommitmentsShareholders equity:Common shares: authorized 100,000; issued and outstanding
48,375 in 2004 and 56,242 in 2003
    
    
    364,775
    
    
    
    423,045Deferred compensation
    
    
    (1,586
    )
    
    
    (2,630
    )Accumulated deficit
    
    
    (71,514
    )
    
    
    (34,594
    )Accumulated other comprehensive income:Unrealized gain (loss) on investments
    
    
    (325
    )
    
    
    51Cumulative translation adjustments
    
    
    758
    
    
    
    364Total accumulated other comprehensive income
    
    
    433
    
    
    
    415Total Shareholders Equity
    
    
    292,108
    
    
    
    386,236Total Liabilities and Shareholders Equity
    
    $
    524,415
    
    
    $
    476,131
 See notes to consolidated financial statements. 47




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THORATEC CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS For the Fiscal Years Ended2004
    
    
    2003
    
    
    2002(In thousands, except per share data)Product sales
    
    $
    172,341
    
    
    $
    149,916
    
    
    $
    130,844Cost of product sales
    
    
    72,119
    
    
    
    61,168
    
    
    
    55,124Gross profit
    
    
    100,222
    
    
    
    88,748
    
    
    
    75,720Operating expenses:Selling, general and administrative
    
    
    54,134
    
    
    
    44,437
    
    
    
    37,413Research and development
    
    
    28,657
    
    
    
    26,052
    
    
    
    25,251Amortization of purchased intangible assets
    
    
    11,724
    
    
    
    12,333
    
    
    
    12,384Impairment of intangible asset
    
    
    
    
    
    
    8,987
    
    
    
    In-process research and development
    
    
    
    
    
    
    220
    
    
    
    Litigation, merger, restructuring and other costs
    
    
    733
    
    
    
    2,132
    
    
    
    1,409Total operating expenses
    
    
    95,248
    
    
    
    94,161
    
    
    
    76,457Income (loss) from operations
    
    
    4,974
    
    
    
    (5,413
    )
    
    
    (737
    )Other income and (expense):Interest expense
    
    
    (2,460
    )
    
    
    
    
    
    
    (544
    )Interest income and other
    
    
    2,176
    
    
    
    1,837
    
    
    
    2,175Income (loss) before taxes
    
    
    4,690
    
    
    
    (3,576
    )
    
    
    894Income tax expense (benefit)
    
    
    1,126
    
    
    
    (1,394
    )
    
    
    383Net income (loss)
    
    $
    3,564
    
    
    $
    (2,182
    )
    
    $
    511Basic and diluted earnings (loss) per share
    
    $
    0.07
    
    
    $
    (0.04
    )
    
    $
    0.01Shares used to compute earnings (loss) per share:Basic
    
    
    52,187
    
    
    
    55,583
    
    
    
    56,184Diluted
    
    
    53,160
    
    
    
    55,583
    
    
    
    56,762
 See notes to consolidated financial statements. 48




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THORATEC CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) For the Fiscal Years Ended2004
    
    
    2003
    
    
    2002(In thousands)Net income (loss)
    
    $
    3,564
    
    
    $
    (2,182
    )
    
    $
    511Other net comprehensive income (loss):Unrealized gain (loss) on
available-for-sale investments (net of
taxes of $(130), $(54), and $87 in
2004, 2003, and 2002, respectively)
    
    
    (376
    )
    
    
    (79
    )
    
    
    130Foreign currency translation adjustments
    
    
    394
    
    
    
    273
    
    
    
    108Comprehensive income (loss)
    
    $
    3,582
    
    
    $
    (1,988
    )
    
    $
    749
 See notes to consolidated financial statements. 49




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##### Table of Contents



THORATEC CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY Retained
    
    
    
    
    
    
    AccumulatedEarnings
    
    
    
    
    
    
    Other
    
    
    TotalCommon
    
    
    Stock
    
    
    (Accumulated
    
    
    Deferred
    
    
    Comprehensive
    
    
    ShareholdersShares
    
    
    $
    
    
    Deficit)
    
    
    Compensation
    
    
    Income (Loss)
    
    
    Equity(In thousands)BALANCE, DECEMBER 29, 2001
    
    
    56,114
    
    
    $
    409,081
    
    
    $
    (31,166
    )
    
    $
    (4,555
    )
    
    $
    (17
    )
    
    $
    373,343Issuance of common shares, net of costs
    
    
    1,055
    
    
    
    16,120
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,120Non-cash compensation for services
    
    
    
    
    
    
    100
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100Exercise of common stock options for cash
    
    
    93
    
    
    
    829
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    829Tax benefit related to employees and
directors stock plans
    
    
    
    
    
    
    334
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    334Common stock issued under restricted
common stock award
    
    
    50
    
    
    
    328
    
    
    
    
    
    
    
    (328
    )
    
    
    
    
    
    
    Repurchase of common stock
    
    
    (2,275
    )
    
    
    (16,526
    )
    
    
    (1,757
    )
    
    
    
    
    
    
    
    
    
    
    (18,283
    )Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,148
    
    
    
    
    
    
    
    1,148Other comprehensive income:Unrealized gain on available-for-sale
investments (net of taxes of $87)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    130
    
    
    
    130Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    108
    
    
    
    108Net Income
    
    
    
    
    
    
    
    
    
    
    511
    
    
    
    
    
    
    
    
    
    
    
    511BALANCE, DECEMBER 28, 2002
    
    
    55,037
    
    
    $
    410,266
    
    
    $
    (32,412
    )
    
    $
    (3,735
    )
    
    $
    221
    
    
    $
    374,340Non-cash compensation for services
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30Exercise of common stock options for cash
    
    
    1,082
    
    
    
    9,494
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,494Issuance of common shares under Employee
Stock Purchase Plan
    
    
    123
    
    
    
    1,107
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,107Tax benefit related to employees and
directors stock plans
    
    
    
    
    
    
    2,148
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,148Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,105
    
    
    
    
    
    
    
    1,105Other comprehensive income:Unrealized loss on available-for-sale
investments (net of taxes of $(54))
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (79
    )
    
    
    (79
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    273
    
    
    
    273Net Loss
    
    
    
    
    
    
    
    
    
    
    (2,182
    )
    
    
    
    
    
    
    
    
    
    
    (2,182
    )BALANCE, JANUARY 3, 2004
    
    
    56,242
    
    
    $
    423,045
    
    
    $
    (34,594
    )
    
    $
    (2,630
    )
    
    $
    415
    
    
    $
    386,236Exercise of common stock options for cash
    
    
    266
    
    
    
    2,432
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,432Issuance of common shares under Employee
Stock Purchase Plan
    
    
    147
    
    
    
    1,341
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,341Tax benefit related to employees and
directors stock plans
    
    
    
    
    
    
    485
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    485Repurchase of common stock
    
    
    (8,255
    )
    
    
    (62,200
    )
    
    
    (40,484
    )
    
    
    
    
    
    
    
    
    
    
    (102,684
    )Restricted Stock Forfeiture
    
    
    (25
    )
    
    
    (328
    )
    
    
    
    
    
    
    134
    
    
    
    
    
    
    
    (194
    )Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    910
    
    
    
    
    
    
    
    910Other comprehensive income:Unrealized loss on available-for-sale
investments (net of taxes of $(130)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (376
    )
    
    
    (376
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    394
    
    
    
    394Net Income
    
    
    
    
    
    
    
    
    
    
    3,564
    
    
    
    
    
    
    
    
    
    
    
    3,564BALANCE, JANUARY 1, 2005
    
    
    48,375
    
    
    $
    364,775
    
    
    $
    (71,514
    )
    
    $
    (1,586
    )
    
    $
    433
    
    
    $
    292,108
 See notes to consolidated financial statements. 50




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##### Table of Contents



THORATEC CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS For the Fiscal Years Ended2004
    
    
    2003
    
    
    2002(In thousands)Cash flows from operating activities:Net income (loss)
    
    $
    3,564
    
    
    $
    (2,182
    )
    
    $
    511Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:Depreciation and amortization
    
    
    18,782
    
    
    
    18,785
    
    
    
    17,076Investment premium amortization
    
    
    948
    
    
    
    18
    
    
    
    77Unrealized (gain)/loss on available-for-sale investments
    
    
    130
    
    
    
    54
    
    
    
    130Impairment of intangible asset
    
    
    
    
    
    
    8,987
    
    
    
    In-process research and development
    
    
    
    
    
    
    220
    
    
    
    Non-cash interest and other expenses
    
    
    778
    
    
    
    32
    
    
    
    409Tax benefit related to stock options
    
    
    485
    
    
    
    2,148
    
    
    
    334Amortization of deferred compensation
    
    
    715
    
    
    
    1,105
    
    
    
    1,148Loss on disposal of asset
    
    
    122
    
    
    
    55
    
    
    
    2Change in net deferred tax liability
    
    
    (2,178
    )
    
    
    (4,756
    )
    
    
    (836
    )Changes in assets and liabilities:Receivables
    
    
    (5,082
    )
    
    
    565
    
    
    
    (420
    )Inventories
    
    
    (3,116
    )
    
    
    3,525
    
    
    
    (13,026
    )Prepaid expenses and other assets
    
    
    (30
    )
    
    
    (1,043
    )
    
    
    (1,521
    )Accounts payable and other liabilities
    
    
    3,372
    
    
    
    3,004
    
    
    
    (1,836
    )Other
    
    
    (255
    )
    
    
    
    
    
    
    Net cash provided by operating activities
    
    
    18,235
    
    
    
    30,517
    
    
    
    2,048Cash flows from investing activities:Purchases of available-for-sale investments
    
    
    (197,015
    )
    
    
    (33,897
    )
    
    
    (84,267
    )Sales of available-for-sale investments
    
    
    119,782
    
    
    
    1,200
    
    
    
    89,850Maturities of available-for-sale investments
    
    
    21,620
    
    
    
    15,891
    
    
    
    700Reclassification from (to) restricted cash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    45,884Capitalized transaction costs
    
    
    
    
    
    
    (395
    )
    
    
    Purchases of property, plant and equipment, net
    
    
    (5,812
    )
    
    
    (6,785
    )
    
    
    (7,144
    )Acquisition of product line
    
    
    
    
    
    
    (5,200
    )
    
    
    Net cash provided by (used in) investing activities
    
    
    (61,425
    )
    
    
    (29,186
    )
    
    
    45,023Cash flows from financing activities:Net proceeds from issuance of convertible notes
    
    
    139,454
    
    
    
    
    
    
    
    Proceeds from stock option exercises, net
    
    
    2,432
    
    
    
    9,494
    
    
    
    829Proceeds from common stock offering
    
    
    
    
    
    
    
    
    
    
    15,335Proceeds from stock issued under employee stock purchase plan
    
    
    1,341
    
    
    
    1,107
    
    
    
    Repurchase of common stock
    
    
    (102,684
    )
    
    
    
    
    
    
    (18,283
    )Repurchase of convertible debentures
    
    
    
    
    
    
    
    
    
    
    (54,838
    )Net cash provided by (used in) financing activities
    
    
    40,543
    
    
    
    10,601
    
    
    
    (56,957
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    394
    
    
    
    194
    
    
    
    54Net increase (decrease) in cash and cash equivalents
    
    
    (2,253
    )
    
    
    12,126
    
    
    
    (9,832
    )Cash and cash equivalents at beginning of period
    
    
    18,270
    
    
    
    6,144
    
    
    
    15,976Cash and cash equivalents at end of period
    
    $
    16,017
    
    
    $
    18,270
    
    
    $
    6,144Supplemental disclosure of cash flow information:Cash paid for taxes
    
    $
    1,114
    
    
    $
    889
    
    
    $
    347Cash paid for interest
    
    $
    1,631
    
    
    $
    
    
    
    $
    839Supplemental disclosure of Non-cash investing and financing
activities:Purchases of equipment from Inventory
    
    $
    392
    
    
    $
    142
    
    
    $
    386Issuance of restricted stock
    
    $
    
    
    
    $
    
    
    
    $
    328Cancellation of restricted stock
    
    $
    (328
    )
    
    $
    
    
    
    $
    Reclassification of acquired workforce, net of taxes
    
    $
    
    
    
    $
    
    
    
    $
    1,334
 See notes to consolidated financial statements. 51




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##### Table of Contents



THORATEC CORPORATION AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Operations and Significant Accounting Policies Operations- Thoratec Corporation, referred to in these Notes as we, our, us, Thoratec
or the Company, is headquartered in Pleasanton, California and is a manufacturer of circulatory
support products for use by patients with congestive heart failure. We develop, manufacture and
market products that are used by physicians and hospitals for cardiac assist, vascular and
diagnostic applications. We organize and manage our business by functional operating entities,
which operate in two business segments: Cardiovascular and ITC. Our Cardiovascular segment
develops, manufactures and markets proprietary medical devices used for circulatory support and
vascular graft applications. Our ITC segment designs, develops, manufactures and markets
point-of-care diagnostic test systems. We conduct business both domestically and internationally.
In February 2001, we merged with Thermo Cardiosystems, Inc. (TCA). Prior to the merger with TCA
(the Merger), TCA was a subsidiary of Thermo Electron Corporation (Thermo Electron). In
September 2003, ITC acquired the Immediate Response Mobile Analysis, (IRMA), point-of-care blood
analysis system product line from Diametrics Medical, Inc., (Diametrics), in an asset purchase. Fiscal Year- We report on a 52-53 week fiscal year, which ends on the Saturday closest to
December 31. The fiscal years ended December 28, 2002, (2002) included 52 weeks and the fiscal
years ended January 3, 2004, (2003) and January 1, 2005 (2004) included 53 weeks. Principles of Consolidation- The consolidated financial statements include the accounts of
our Company and our wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation. Use of Estimates- The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires our management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates. Major Customers and Concentration of Credit Risk- We primarily sell our products to large
hospitals and distributors. No customer accounted for more than 10% of product sales in fiscal year
2004 or 2003. For fiscal year 2002, one distributor customer accounted for 11% of total product
sales. Accounts receivable for this same distributor customer accounted for 11% and 10% of total
accounts receivable as of the end of 2003 and 2002, respectively. No other customer accounted for
more than 10% of total product sales in 2004, 2003, or 2002 or had an accounts receivable balance
greater than 10% of total accounts receivable at the end of 2004 or 2003. Credit is extended based on an evaluation of a customers financial condition and generally
collateral is not required. To date, credit losses have not been significant; however, we maintain
allowances for potential credit losses. Additionally, we are potentially subject to concentrations of credit risk in our investments.
To mitigate this credit risk, we invest in high-grade instruments and limit our exposure to any one
issuer. Certain Risks and Uncertainties- We are subject to certain risks and uncertainties and
believe that changes in any of the following areas could have a material adverse effect on our
future financial position or results of operations: the ability to achieve and maintain
profitability; the ability of third party payors to cover and provide appropriate levels of
reimbursement for our products; the ability to receive Food and Drug Administration, or FDA, and
foreign regulatory authorities approval to manufacture, market and sell our products; the ability
to direct and manage current and future growth, including the growth of the number of Destination
Therapy, or DT, procedures performed and the integration of any current and future acquisitions of
companies or technologies; new product development and introduction, including FDA approval and
market receptiveness; the ability to realize the full value of our intangible assets; our reliance
on specialized suppliers; competition from other products; the ability to manufacture products on
an efficient and timely basis and at a reasonable cost and in sufficient volume, including the
ability to obtain timely deliveries of parts from suppliers; our dependence upon distributors and
any changes made to our method of distribution; the ability to protect our proprietary technologies
or an infringement of others patents; product liability or other claims; our ability to identify
and correct quality issues in a timely manner and at a 52




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reasonable cost; the ability to maintain
compliance with changing federal and state regulations; the long and variable
sales and deployment cycle of our ventricular assist device (VAD) products; worldwide demand
for circulatory support and graft products and blood coagulation testing and skin incision devices
and the management of risks inherent in selling in foreign countries; claims relating to the
handling, storage or disposal of hazardous chemicals and biomaterials; stock price volatility due
to general economic conditions or future issuances and sales of our stock; the occurrence of
natural catastrophic disasters; foreign currency fluctuations; and the ability to attract and
retain talented employees. Cash and Cash Equivalents- Cash and cash equivalents are defined as short-term highly liquid
investments with original maturities of 90 days or less. Short-Term and Long-Term Available-For-Sale Investments- Our investments are primarily held
in auction rate securities, corporate and municipal bonds and U.S. government obligations and are
classified as available-for-sale and are reported at fair value based upon quoted market price. Any
temporary difference between cost and fair value of an investment is presented as a separate
component of accumulated other comprehensive income. The specific identification method is used to
determine realized gains and losses on investments. Short-term investments 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 or due to the frequency in
which the interest rate is reset such as with auction rate securities, in addition these securities
represent the investment of cash that is available and intended for current operations.
Investments that are not intended for use in current operations are classified as long-term
investments. Restricted Short-Term and Long-Term Investments- Our investments are primarily held in U.S.
Treasuries as collateral for future interest payments related to our convertible debt. These
securities are classified as restricted and are reported at fair value based upon quoted market
price. In the fourth quarter of 2004 we adopted the disclosure provisions of EITF 03-01, which
provides additional guidance in determining whether investment securities have an impairment which
should be considered other-that-temporary. Under this new guidance we determined that we had no
impairments that were other-than temporary. Any temporary difference between cost and fair value
of an investment is presented as a separate component of accumulated other comprehensive income.
The specific identification method is used to determine realized gains and losses on investments. Inventories- Inventories are stated at the lower cost or market. Cost is based on the first
in, first out method. Property, Plant and Equipment- Property, plant and equipment are stated at cost. Depreciation
is computed using the straight-line method based on estimated useful lives of 2 to 30 years.
Leasehold improvements are amortized over the lesser of the useful life or the remaining term of
the lease. Property, plant and equipment include certain medical devices rented to customers.
Amortization expense of all rental equipment included in our rental program is recognized ratably
over 2 to 3 years and is recorded in cost of product sales. The Company leases certain facilities for administration, manufacturing and warehousing under
long term operating leases. Any scheduled rent increases, rent holidays and other related
incentives are recognized on a straight-line basis over the term of the lease. Capitalized Software Costs- We capitalize the costs of computer software developed or
obtained for internal use in accordance with Statement of Position 98-1, Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use. Capitalized computer software costs
consist of purchased software licenses, implementation costs and consulting for certain projects
that qualify for capitalization. We expense costs related to preliminary project assessment,
research and development, re-engineering, training and application maintenance as incurred. Through
fiscal year 2003, costs capitalized for a new enterprise resource planning software system (ERP
System) were $3.7 million. No additional costs were capitalized in 2004 related to this ERP
System. Depreciation expense related to this ERP System of $0.5 million was recorded in each 2004
and 2003 and an additional $0.4 million was recorded in 2002. All capitalized software costs are
depreciated on a straight-line method over a period of eight years upon being placed in service. Valuation of Long-Lived Assets 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 53




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the long-lived asset. Fair value is determined primarily using the anticipated
cash flows discounted at a rate commensurate with the risk involved. Purchased Intangible Assets and Goodwill- 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. We complete an impairment test of goodwill and other intangible assets subject to
amortization as required by SFAS No. 142 and SFAS No. 144. Upon completion of our impairment tests
as of the end of fiscal 2004, we determined that neither goodwill nor intangible assets were
impaired. Fair Value of Financial Instruments- Financial instruments include cash and cash equivalents,
short-term and long-term available-for-sale investments, restricted short-term and long-term
investments, customer receivables, accounts payable, convertible notes and certain other accrued
liabilities. The fair values of short-term and long-term investments are assessed using current
market quotations from major investment brokers. The carrying amounts of these investments are
adjusted to market value monthly. The carrying amounts of all other financial investments are
reasonable estimates of their fair values. Debt Issuance Costs Costs incurred in connection with the issuance of our senior
subordinated convertible notes have been capitalized and are included in other assets on the
consolidated balance sheet. These costs are amortized on a straight line basis until May 2011, the
point at which we can redeem the debt, and such amortization expense is reflected in Interest
expense on the consolidated statement of operations. Foreign Currency Translation We conduct business in foreign countries. All assets and
liabilities of our non-United States operations are translated into United States dollars at
period-end exchange rates, and the resulting translation adjustments are included in other
comprehensive income. Income and expense items are translated at actual or average monthly rates of
exchange. Exchange rate fluctuations resulting from the period-end translation of the current
portion of the intercompany obligation of our wholly-owned U.K. subsidiary into United States
dollars are recorded in the statements of operations as foreign currency transaction gains or
losses and are included in Interest Income and Other. In September 2003, the Company began using forward foreign currency contracts to hedge the
gains and losses generated by the remeasurement of non-functional currency assets and liabilities
(primarily assets and liabilities on our UK subsidiarys consolidated balance sheet that are not
denominated in UK pounds). Changes in the fair value of the forward currency contracts are included
in Interest Income and Other, and typically offset the foreign currency exchange gains and losses
described above. These derivatives are not designated as cash flow or fair value hedges under SFAS
No. 133 and typically have maturities of three months or less. At January 1, 2005, the Company had
forward foreign currency contracts to exchange Pounds Sterling and Euros for U.S. Dollars with a
notional value of $6.9 million and negligible fair value. Net foreign currency exchange loss was
$0.2 million in 2004 and negligible in 2003. Net foreign currency exchange gain was approximately
$0.5 million on 2002. Repurchases of Common Stock- In February 2004, the Board of Directors authorized a stock
repurchase program under which up to $25.0 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 market price of our stock,
general market conditions and other factors. The Board of Directors subsequently authorized the
repurchase of an additional $60.0 million in May 2004 and an additional $25.0 million in July 2004.
Through December 2004, we repurchased 8.3 million shares of our common stock for $102.7 million
under these three combined programs. For each share repurchased, we reduced the common stock
account by the average value per share reflected in the account prior to the repurchase with the
excess allocated to retained earnings. All repurchased shares have been retired. Revenue Recognition and Product Warranty- We recognize revenue from product sales of our
Cardiovascular and ITC segments when evidence of an arrangement exists, title has passed (generally
upon shipment) or services have been rendered, the selling price is fixed or determinable and
collectibility is reasonably assured. Sales to distributors are recorded when title transfers upon
shipment. One distributor has certain limited product return rights. One other distributor has
certain rights of return upon termination of its distribution agreement. A reserve for sales
returns is recorded for these customers applying reasonable estimates of product returns based upon
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 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 54




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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 revenues allocated to the
Cardiovascular segment products is done on a fair value basis. Under this basis, the total value of the arrangement is
allocated to the training and the Cardiovascular segment products
based on the relative fair market value of the training and products. The amount of
revenues allocated to training is recorded as deferred revenue and is recognized when the training
is completed. As of the end of 2004, all products that had been delivered and recorded as product
sales were delivered to customers for which training had been completed. There was no amount of
product sales deferred related to this training not yet completed for the year ended 2004; however,
$20,000 of such product sales were deferred at the end of 2003 and $0.1 million at the end of
2002. On December 29, 2004 we modified our distributor agreement with BARD Medical to continue the
exclusive distribution of our Vectraproduct line until December 31, 2005. We received a payment
of $1.8 million which will be recognized over the remaining term of the agreement. 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 2004, 2003, and 2002 are $5.8 million, $4.7 million, and $3.9 million, respectively, of
income earned from the rental of these medical devices. The majority of our products are covered by up to a two-year limited manufacturers warranty.
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 and
are included in Cost of Product Sales. The change in accrued warranty expense in 2004, 2003 and
2002 is summarized in the following table (in thousands): Balance
    
    
    Charges to
    
    
    
    
    
    
    BalanceBeginning
    
    
    Costs and
    
    
    Warranty
    
    
    Endof Year
    
    
    Expenses
    
    
    Expenditures
    
    
    of YearFiscal year ended 2004
    
    $
    829
    
    
    $
    173
    
    
    $
    (384
    )
    
    $
    618Fiscal year ended 2003
    
    $
    695
    
    
    $
    193
    
    
    $
    (59
    )
    
    $
    829Fiscal year ended 2002
    
    $
    910
    
    
    $
    45
    
    
    $
    (260
    )
    
    $
    695
 Stock-Based Compensation- We account for stock-based awards to employees using the intrinsic
value method in accordance with Accounting Principals Board Opinion 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 credited to equity. The fair value of each option granted 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 FASB Statement No. 123®, our reported net income (loss) would have been adversely
affected, as shown in the following table (in thousands, except per share data): For Fiscal Year Ended2004
    
    
    2003
    
    
    2002(Restated)
    
    (Restated)Net income (loss):As reported
    
    $
    3,564
    
    
    $
    (2,182
    )
    
    $
    511Add: Stock-based compensation expense
included in reported net income, net of
related tax effects
    
    
    793
    
    
    
    693
    
    
    
    726Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects
    
    
    (12,524
    )
    
    
    (7,363
    )
    
    
    (7,883
    )Pro forma
    
    $
    (8,167
    )
    
    $
    (8,852
    )
    
    $
    (6,646
    )Basic and diluted earnings (loss) per share:As reported
    
    $
    0.07
    
    
    $
    (0.04
    )
    
    $
    0.01Pro forma
    
    $
    (0.16
    )
    
    $
    (0.16
    )
    
    $
    (0.12
    )
 Subsequent to the issuance of our 2003 consolidated financial statements,
management determined that total stock based employee compensation expense determined under the
fair value based method, net of related tax effects, for 2003 and 2002 had been calculated
incorrectly. Accordingly, such pro forma amounts presented above have been restated. The effect was
to decrease pro forma stock-based compensation expense, net of tax and pro 55




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forma net loss by $1.1
million for 2003 and by $1.9 million for 2002. Pro forma earnings per share increased $0.02 per
share for 2003 and $0.03 per share in 2002. This correction did not impact the Companys
consolidated financial position, results of operations, or cash flows for any of the periods
presented. The increase in stock-based employee compensation expense, net of tax effects, in 2004 was
primarily due to the decreased effective tax rates offset by an increase in the number of options
granted in 2004. The fair value of each option granted is estimated at the date of grant using the
Black-Scholes option pricing model with the following assumptions used for grants made: Stock Option PlansFor Fiscal Year Ended2004
    
    
    2003
    
    
    2002Risk-free interest rate
    
    
    4.36
    %
    
    
    3.69
    %
    
    
    4.79
    %Expected volatility
    
    
    62
    %
    
    
    67
    %
    
    
    69
    %Expected option life
    
    3.36 years
    
    3.88 years
    
    3.85 yearsDividends
    
    None
    
    None
    
    None
 Employee Stock Purchase PlanFor Fiscal Year Ended2004
    
    
    2003
    

    

2002Risk-free interest rate
    
    
    1.32
    %
    
    
    1.16
    %
    
    
    1.39
    %Expected volatility
    
    
    61
    %
    
    
    67
    %
    
    
    69
    %Expected option life
    
    0.50 years
    
    0.50 years
    
    0.50 yearsDividends
    
    None
    
    None
    
    None
 Earnings (Loss) Per Share- Basic earnings (loss) per share were computed using the weighted
average number of common shares outstanding for each respective year. Diluted earnings (loss) per
share amounts reflect the weighted average impact from the date of issuance of all potentially
dilutive securities during the years presented unless the inclusion would have had an antidilutive
effect. Other Comprehensive Income (Loss)- Comprehensive income (loss) includes net income (loss) and
is defined as the change in net assets during the period from non-owner sources, including
unrealized gains and losses on available-for-sale investments and foreign currency translation
adjustments. Recently Issued Accounting Standards- In December 2004, the FASB issued statement 123®
Share-Based Payment This statement requires that stock-based compensation be recognized as a cost
in the financial statements and that such cost be measured based on the fair value of the
stock-based compensation. Our adoption of this statement, which we expect to occur in the third
quarter of 2005, will have a material, although non-cash, impact on our consolidated statements of
operations. In March 2004, the Emerging Issues Task Force (EITF) reached a final consensus on Issue
03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,
to provide additional guidance in determining whether investment securities have an impairment
which should be considered other-than-temporary. On September 15, 2004, the FASB issued proposed
FSP EITF Issue 03-1-a to address the application of the EITF Issue 03-1 to debt securities that are
affected by interest rate and/or sector-spread changes only. On September 30, 2004, the FASB
issued FSP EITF Issue 03-1-1, which delayed the effective date of certain paragraphs of the EITF
until EITF 03-1-a is issued. We did however, adopt the disclosure provisions in the fourth
quarter of 2004, the adoption had no effect on our operating results or financial condition.
Management expects that the adoption of the delayed portions of this Issue and the related FSPs
will not have a significant effect on our 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 that are reportable under this new disclosure are antidilutive and, therefore, have been
excluded from the calculation of diluted net income per share. See note 15. In October 2004, EITF Issue No. 04-8, Accounting Issues Related to Certain Features of
Contingently Convertible Debt and the Effect on Diluted Earnings per Share was issued. Issue No.
04-8 states that shares available under contingently convertible debt should be included in diluted
earnings per share, or EPS, in all periods, 56




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since the notes were issued, except when inclusion is
anti-dilutive, regardless of whether the contingency is met and regardless of whether the market
price contingency is substantial. Our adoption of this proposed interpretation, in the fourth
quarter of 2004, did not have a material impact on our most recent consolidated results as the
effect of the 7.3 million shares was anti-dilutive. If in future periods the shares would be
dilutive, then 7.3 million shares will be added to our share count used to calculate diluted
earnings per share, and this inclusion could result in lower diluted EPS than if the existing
guidance had not been changed by EITF 04-8. Presentation Certain 2003 and 2002 amounts have been reclassified to conform to the
presentation in the 2004 financial statements. In prior years, auction rate securities were classified in Cash and cash equivalents. These
securities have been reclassified for all periods presented from Cash and cash equivalents to
Short term available-for-sale investments. These auction rate securities have an underlying
component of a long-term debt or equity instrument; however, these are traded or mature on a
shorter term based on an auction bid that resets the interest rate over time intervals of 28 to 49
days. These resets allow for a much higher level of liquidity than typical long term investments.
We have reclassified these securities to short-term available-for-sale investments based on the
period from purchase date to the reset date and as they are not intended to be held to the maturity
date. The tables below summarize the effect of this reclassification: Short-termCash and cash
    
    
    available-for-saleequivalents
    
    
    investmentsYear Ended 2003:As previously reported
    
    $
    62,020
    
    
    $
    Auction rate securities
    
    
    (43,750
    )
    
    
    43,750As adjusted
    
    $
    18,270
    
    
    $
    43,750
 2. Acquisition and Strategic Investment On September 30, 2003, we completed an asset purchase of the IRMA point-of-care blood analysis
system product line from 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 as follows: LifeWorking capital
    
    $
    1,034Property, plant and equipment
    
    
    2,492
    
    
    3-10 yearsCore technology
    
    
    331
    
    
    10 yearsExisting developed technology
    
    
    1,058
    
    
    10 yearsPatents
    
    
    317
    
    
    17 yearsOther intangibles
    
    
    143
    
    
    7-17 yearsIn-process research and development
    
    
    220
    
    
    Expensed in 2003Acquisition costs
    
    
    (395
    )Consideration paid
    
    $
    5,200
 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 a pro-forma basis, consolidating historical financial information of Thoratec and the IRMA
product line and making pro forma consolidation adjustments, as if the acquisition had occurred on
December 30, 2001, unaudited pro forma revenue for 2002 and 2003 would have been $143.2 million and
$154.8 million respectively. On the same basis, 2002 net loss and loss per share would have been
$0.4 million $0.01 respectively, and 2003 net loss and loss per share would have been approximately
$2.7 million and $0.05 respectively. 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, subject to BioCardias authorization will be able to
review relevant clinical data accumulated by BioCardia through its multiple trials. We
have accounted for this investment on the cost basis as we do not have the ability to exercise
significant influence over BioCardias operating and financial policies. This investment is
included on our consolidated balance sheet in other long-term assets. 57




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3. Investments Short-term investments consist of available-for-sale securities that are carried at fair value
and generally mature or reset interest rates 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 because such marketable securities represent the investment of cash that
is available for current operations. Investments that are not intended for use in current
operations are classified as long-term investments. We include any unrealized gains and losses on
short-term investments, net of tax, in shareholders equity as a component of other comprehensive
income. As required by the terms of the convertible notes during the second quarter of 2004 (See Note
8) 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 within one year have been classified
as restricted short-term investments and the investments that relate to interest payments due after
one year have been classified as restricted long-term investments. Individual securities with a fair value below the costs basis at January 1, 2005 were
evaluated to determine if they were other-than-temporarily impaired. These securities were
determined to be only temporarily impaired because the decline in value was related entirely to
changes in market interest rates. No securities have been in a continuous loss position for 12
months or longer. The aggregate market value, cost basis and gross unrealized gains and losses of short-term and
long-term available-for-sale investments and restricted short-term and long-term investments for
2004 and 2003 by major security type are as follows (in thousands): Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    ValueAs of Fiscal Year 2004
Short-term investments:Corporate bonds
    
    $
    24,435
    
    
    $
    
    
    
    $
    (118
    )
    
    $
    24,317Municipal bonds and auction rate securities
    
    
    92,300
    
    
    
    1
    
    
    
    (149
    )
    
    
    92,152U.S. government obligations
    
    
    13,500
    
    
    
    
    
    
    
    (126
    )
    
    
    13,374Restricted investments in U.S. Government obligations
    
    
    3,375
    
    
    
    
    
    
    
    (13
    )
    
    
    3,362133,610
    
    
    
    1
    

    
    
    (406
    )
    
    
    133,205Long-term investments:Restricted Investments in U.S. Government obligations
    
    
    4,862
    
    
    
    
    
    
    
    (17
    )
    
    
    4,845$
    138,472
    
    
    $
    1
    
    
    $
    (423
    )
    
    $
    138,050As of Fiscal Year 2003
Short-term investments:Municipal bonds and auction rate securities
    
    $
    43,750
    
    
    $
    
    
    
    $
    
    
    
    $
    43,75043,750
    
    
    
    
    
    
    
    
    
    
    $
    43,750Long-term investments:Corporate bonds
    
    $
    37,095
    
    
    $
    105
    
    
    $
    (19
    )
    
    $
    37,181US government obligations
    
    
    4,000
    
    
    
    
    
    
    
    (2
    )
    
    
    3,998$
    84,845
    
    
    $
    105
    
    
    $
    (21
    )
    
    $
    84,929
 The contractual maturities of available-for-sale investments and restricted investments as of
January 1, 2005 and January 3, 2004, regardless of the consolidated balance sheet classifications,
are as follows (in thousands): Amortized
    
    
    FairCost
    
    
    ValueAs of Fiscal Year 2004:Due within one year
    
    $
    91,301
    
    
    $
    91,126Due after one year through two years
    
    
    45,583
    
    
    
    45,337Due after two years through three years
    
    
    1,588
    
    
    
    1,587$
    138,472
    
    
    $
    138,050As of Fiscal Year 2003:Due within one year
    
    $
    67,540
    
    
    $
    67,626Due after one year through two years
    
    
    17,305
    
    
    
    17,303$
    84,845
    
    
    $
    84,929
 58




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The cost of available-for-sale investments and restricted investments that are sold is based
on specific identification in determining recorded realized gains and losses. In 2004 and 2003
there were no significant gains or losses recorded. 4. Inventories Inventories consist of the following (in thousands): As of Fiscal Year2004
    
    
    2003Finished goods
    
    $
    18,562
    
    
    $
    15,504Work-in-process
    
    
    4,582
    
    
    
    9,089Raw materials
    
    
    15,997
    
    
    
    11,824Total
    
    $
    39,141
    
    
    $
    36,417
 5. Purchased Intangible Assets and Goodwill The change in the carrying amount of goodwill, which is only attributable to our
Cardiovascular business segment, for fiscal years 2004 and 2003 was as follows (in thousands): As of Fiscal Years2004
    
    
    2003Balance at the beginning of year
    
    $
    96,065
    
    
    $
    96,492Adjustment to reflect realization of acquired deferred tax asset
    
    
    (1,153
    )
    
    
    (427
    )Reversal of accrual for securities registration costs
    
    
    (815
    )
    
    
    Balance as of January 1, 2005
    
    $
    94,097
    
    
    $
    96,065
 In 2003 and again in 2004, goodwill related to the merger of Thoratec with TCA was adjusted to
reflect the utilization of tax net operating loss (NOL) benefits related to our subsidiary in the
United Kingdom (UK). At the time of the merger, a deferred tax asset related to these NOL tax
benefits was established with a corresponding valuation allowance for the full amount. As our UK
subsidiary more likely than not will begin utilizing a portion of this NOL benefit, a portion of
the original valuation allowance has been reversed against goodwill. 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, we 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, consisting primarily of patents and
trademarks, core technology and developed technology, which are included in purchased intangible
assets on the consolidated balance sheets, are as follows (in thousands): Fiscal Year 2004Gross Carrying
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    Net Carrying AmountPatents and Trademarks
    
    $
    37,815
    
    
    $
    (14,051
    )
    
    $
    23,764CoreTechnology
    
    
    37,485
    
    
    
    (7,242
    )
    
    
    30,243Developed Technology
    
    
    122,782
    
    
    
    (23,721
    )
    
    
    99,061Non-compete Agreement
    
    
    90
    
    
    
    (17
    )
    
    
    73Total Purchased Intangible Assets
    
    $
    198,172
    
    
    $
    (45,031
    )
    
    $
    153,141
 Fiscal Year 2003Gross Carrying
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    Net Carrying AmountPatents 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
 59




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Subsequent to year-end 2003, 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 as of January 3, 2004 to write off purchased
intangible assets related to the Aria graft, which were recorded as a result of the merger. On September 30, 2003, we completed our previously announced asset purchase agreement to
acquire the Immediate Response Mobile Analysis, or IRMA, point-of-care blood analysis system
product line from Diametrics. We paid approximately $5.2 million in cash and assumed trade
payables. Approximately $1.8 million of the total purchase price was allocated to purchased
intangible assets. Amortization expense related to identifiable intangible assets for fiscal 2004, 2003, and 2002
was $11.7 million, $12.3 million and $12.4 million, respectively. Patents and trademarks have
useful lives of eight to twenty years, core technology assets have useful lives ranging from nine
to twenty years, developed technology have a useful life range of nine to twenty years and the
useful life of the non-compete agreement is approximately six years. 6. Property, Plant and Equipment Property, plant and equipment consist of the following (in thousands): As of Fiscal Year2004
    
    
    2003Land
    
    $
    341
    
    
    $
    341Building
    
    
    2,445
    
    
    
    2,445Building lease
    
    
    2,285
    
    
    
    2,285Equipment
    
    
    38,728
    
    
    
    34,606Rental equipment
    
    
    6,810
    
    
    
    6,493Leasehold improvements
    
    
    11,061
    
    
    
    11,853Total
    
    
    61,670
    
    
    
    58,023Accumulated depreciation and amortization
    
    
    (34,086
    )
    
    
    (29,531
    )$
    27,584
    
    
    $
    28,492
 Depreciation expense in 2004, 2003, and 2002 was $7.1 million, $5.7 million and $5.2 million,
respectively. 7. Commitments and Contingencies Leases We lease manufacturing, office, research facilities and equipment under various operating
lease agreements. Future minimum lease payments as of the end of 2004 are noted below (in
thousands): Fiscal year:2005
    
    $
    2,4632006
    
    
    2,4532007
    
    
    2,4322008
    
    
    2,2572009
    
    
    1,849Thereafter
    
    
    8,032Total
    
    $
    19,486
 Rent expense for all operating leases was $2.5 million in 2004, $2.1 million in 2003 and $1.8
million in 2002. Commitments We had various purchase order commitments, which were comprised of supply agreements, totaling
approximately $19.8 million and $10.2 million as of the end of fiscal years 2004 and 2003,
respectively. Contingencies We are involved in various litigation matters (See Note 14). 60




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8. Long-Term Debt In the second quarter of 2004, we completed the sale of $143.8 million initial principal
amount of senior subordinated convertible notes due 2034. The convertible notes were sold to
Qualified Institutional Buyers pursuant to the exemption from the registration requirements of the
Securities Act of 1933, as amended, provided by Rule 144A thereunder. We used $9.8 million of the
net proceeds to purchase and pledge to the trustee under the indenture for the exclusive benefit of
the holders of the convertible notes, U.S. Treasury securities to provide for the payment, in full,
of the first six scheduled interest payments. These securities are reflected as restricted
investments. Additional net proceeds were used to repurchase 4.2 million shares of our outstanding
common stock for $60 million. The remaining net proceeds will be used for general corporate
purposes, which may include additional stock repurchases, strategic investments or acquisitions.
Total net proceeds to the Company from the sale were $139.4 million, after debt issuance costs of
$4.3 million. The convertible notes were issued at an issue price of $580.98 per note, which is 58.098% of
the principal amount at maturity of the notes. The convertible notes bear interest at a rate of
1.3798% per year on the principal amount at maturity, payable semi-annually in arrears in cash on
May 16 and November 16 of each year, from November 16, 2004 until May 16, 2011. Beginning on May
16, 2011, the original issue discount will accrue daily at a rate of 2.375% per year on a
semi-annual bond equivalent basis and, on the maturity date, a holder will receive $1,000 per note.
As a result, the aggregate principal amount of the notes at maturity will be $247.4 million. The deferred debt issuance costs of $4.3 million are included in other assets on the
consolidated balance sheet. The deferred debt issuance costs are amortized on a straight line basis
until May 2011 at which point the Company can redeem the debt. These charges are included in
Interest expense on our consolidated statements of operations. Fiscal Year2004(in millions)Long Term Debt Offering Proceeds:Principal amount of convertible notes at maturity
    
    $
    247.4Original issue discount
    
    
    (103.7
    )Debt issuance costs
    
    
    (4.3
    )Net proceeds
    
    $
    139.4
 Holders of the convertible notes may convert their convertible notes into shares of our common
stock at a conversion rate of 29.4652 shares per $1,000 principal amount of convertible notes,
which represents a conversion price of $19.72 per share, subject to adjustments upon the occurrence
of certain events. Holders were able to convert their convertible notes at any point after the
close of business on September 30, 2004 if, as of the last day preceding the calendar quarter, the
closing price of our common stock for at least 20 trading days in a period of 30 consecutive
trading days ending on the last trading day of such preceding calendar quarter is more then 120% of
the accreted conversion price per share of our common stock. Holders may surrender their
convertible notes on or prior to May 16, 2029 during the five business day period after any five
consecutive trading day period in which the trading price per note for each day of that period was
less than 98% of the product of the closing sale price of our common stock and the conversion rate
on each such day; provided that if on the day prior to any conversion the closing sale price of our
common stock is greater than the accreted conversion price but less than or equal to 120% of the
accreted conversion price, then holders will receive upon conversion, in lieu of shares of common
stock based on the conversion rate, cash or common stock, or a combination of cash and common
stock, at our option, with a value equal to the accreted principal amount of the notes plus accrued
but unpaid interest as of the conversion date. Additionally, holders may convert their convertible
notes if we call them for redemption or if specified corporate transactions or significant
distributions to holders of our stock have occurred. As of the year ended January 1, 2005 no notes
have been converted or called. Holders may require us to repurchase all or a portion of their convertible notes on each of
May 16, 2011, 2014, 2019, 2024 and 2029 at a repurchase price equal to 100% of the issue price,
plus accrued original issue discount, if any. In addition, if we experience a change in control or
a termination of trading each holder may require us to purchase all or a portion of such holders
notes at the same price, plus, in certain circumstances, a make whole premium. The fair value of
the make whole premium at January 1, 2005 was zero. We may redeem any of the convertible notes at
any time beginning May 16, 2011, by giving the holders at least 30 days notice, either in whole or
in part at a redemption price equal to the sum of the issue price and the accrued original issue
discount, plus accrued and unpaid interest and liquidation damages, if any. 61




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The convertible notes are subordinated to all of our senior indebtedness and structurally
subordinated to all indebtedness of our subsidiaries. Therefore, in the event of a bankruptcy,
liquidation or dissolution of us or one or more of our subsidiaries and acceleration of or payment
default on our senior indebtedness, holders of the convertible notes will not receive any payment
until holders of any senior indebtedness we may have outstanding have been paid in full. The aggregate fair value of the convertible notes at January 1, 2005, based on market quotes,
was $126.0 million. On March 11, 2002, we completed the redemption of then outstanding subordinated convertible
debentures using restricted cash, cash and cash equivalents of approximately $54.8 million. A loss
in the amount of $0.5 million and a tax benefit of $0.2 million was recorded on the date of the
redemption related to the write-off of the capitalized debt issuance costs. Restricted cash had
been pledged as collateral for a letter of credit guarantee to Thermo Electron related to Thermo
Electrons guarantee of our subordinated debentures. As a result of the redemption, the letter of
credit guarantee to Thermo Electron was extinguished. 9. Common and Preferred Stock We have authorized 100 million no par common shares, and 2.5 million shares of preferred
stock, of which 540,541 shares have been designated Series A and 500,000 shares designated Series
B. The Series A preferred stock is entitled to cumulative annual dividends of $1.30 per share and
has a liquidation preference of $9.25 per share plus cumulative unpaid dividends. We may redeem the
Series A preferred stock at any time for our liquidation preference. Each share of preferred stock
is convertible into one-third of a share of common stock, after adjusting for earned but unpaid
dividends. At January 1, 2005, no shares of Series A preferred stock were outstanding. The Series B preferred stock is senior to the Series A in all preferences. Series B is
entitled to cumulative annual dividends of $0.96 per share and has a liquidation preference of
$8.00 per share plus cumulative unpaid dividends. The Series B preferred stock is redeemable by us
five years after its issuance for $8.00 per share plus cumulative unpaid dividends. Each share of
Series B preferred stock is convertible at any time into three and one-third shares of common stock
and has certain anti-dilution provisions. Series B preferred vote on an as-converted basis. At
January 1, 2005, no shares of Series B preferred stock were outstanding. On May 2, 2002, we adopted a shareholder rights plan, which we call the Rights Plan. Under the
Rights Plan, we distributed one purchase right for each share of common stock outstanding at the
close of business on May 17, 2002.
If a person or group acquires 15% or more of our common stock in
a transaction not pre-approved by our Board of Directors, each right will entitle its holder, other
than the acquirer, to buy our common stock at 50% of its market value for the rights then current
exercise price (initially $70.00). In addition, if an unapproved party acquires more than 15% of
our common stock, and our Company or our business is later acquired by the unapproved party or in a
transaction in which all shareholders are not treated alike, shareholders with unexercised rights,
other than the unapproved party, will be entitled to purchase common stock of the merger party or
asset buyer with a value of twice the exercise price of the rights. Each right also becomes
exercisable for one one-thousandth of a share of our Series RP preferred stock at the rights then
current exercise price ten days after an unapproved third party makes, or announces an intention to
make, a tender offer or exchange offer that, if completed, would result in the unapproved party
acquiring 15% or more of our common stock. Our Board of Directors may redeem the rights for a
nominal amount before an event that causes the rights to become exercisable. The rights will expire
on May 2, 2012. In connection with the Rights Plan, we designated 100,000 no par shares of Series RP preferred
stock. These shares, if issued, will be entitled to receive quarterly dividends and liquidation
preferences. There are no shares of Series RP preferred stock issued and outstanding and we do not
anticipate issuing any shares of Series RP preferred stock except as may be required under the
Rights Plan. In 2002, we sold 1.1 million newly issued shares of our common stock for $15.3 million, net of
underwriting discounts, fees and other expenses of the offering. 62




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10. Stock-Based Compensation Restricted Common Stock In 2001, an award of 250,000 shares of restricted common stock was made to one of our
executive officers under our 1997 Stock Option Plan. This award was valued at $4.1 million,
recorded as deferred compensation and is being amortized over the restriction lapse period. In
2002, a similar award of 50,000 shares was made to another of our executive officers. This award
was valued at $0.3 million, was recorded as deferred compensation and was being amortized over the
restriction lapse period. The second award was forfeited in December 2004 upon the resignation of
the executive officer and the previously recognized amortization of deferred compensation of $0.2
million was reversed. In addition 25,000 shares were granted as a consultant award in December
2004. This award was valued at $0.2 million and amortizes over the restriction lapse period of
three years. As of the end of fiscal 2004, none of the restrictions on the remaining shares have
lapsed. Stock Option Plans Pursuant to the terms of the Thoratec and TCA merger agreement, all TCA stock-based
compensation plans were assumed by Thoratec effective February 14, 2001. There were no grants under
any of TCAs plans during 2004, 2003, or 2002. Moreover, all outstanding options and restrictions
on past TCA grants were accelerated and became fully vested as of the Merger date of February 14,
2001 and were converted to 971,222 of our common stock options at the Merger conversion ratio of
0.835 to 1. Although assumed by Thoratec, the TCA stock options remain exercisable upon the same
terms and conditions as under the TCA stock option plan pursuant to which it was granted and the
applicable option agreement. In 1993, our Board of Directors approved the 1993 Stock Option Plan (1993 SOP), which
permits us to grant options to purchase up to 666,667 shares of common stock. No options were
granted under this plan in 2004 or 2003. In 1996, the Board of Directors adopted the 1996 Stock Option Plan (1996 SOP) and the 1996
Non-employee Directors Stock Option Plan (Directors Option Plan). The 1996 SOP consists of two
parts. Part One permits us to grant options to purchase up to 500,000 shares of common stock.
During both 2004 and 2003 no options were granted at fair market value under Part One of the 1996
SOP. Part Two related to the Chief Executive Officer (CEO) and permitted us to grant
non-qualified options to the CEO to purchase up to 333,333 shares of common stock, which were
granted in 1996. The Directors Option Plan, as amended, permits us to grant up to 550,000 shares
and provides for an initial grant to a Director to purchase 15,000 shares upon appointment to the
Board, and annual grants thereafter to purchase 7,500 shares (granted in four equal installments).
Provisions also include immediate vesting of both initial and annual grants and a five year life on
the options. In addition, the plan administrator has been provided with the discretion to impose
any repurchase rights in our favor on any optionee. We currently have seven non-employee directors,
each of whom is eligible to participate in the Directors Option Plan. There were
52,500 and 61,875 options granted in 2004 and 2003, respectively, at fair market value under the Directors Option
Plan. In 1997, the Board of Directors adopted the 1997 Stock Option Plan (1997 SOP). The 1997 SOP
was amended by approval of a vote of our shareholders in February 2001, amended by the Board of
Directors in December 2001, and amended again by approval of a vote of our shareholders in May
2003. The 1997 SOP allows us to grant up to 13.7 million shares of stock in the form of stock
options, restricted stock awards, and stock bonuses. During 2004 and 2003, 3.1 million and 2.2
million options, respectively, were granted at fair market value under this plan. During 2004 and
2003, 25,000 shares and no shares, respectively, were granted as restricted stock awards, noted
above, under this plan. We have four common stock option plans with options still outstanding at January 1, 2005.
Options may be granted by the Board of Directors at the fair market value on the date of grant and
generally become exercisable within five years of grant and expire between five and ten years from
the date of grant. At the end of 2004, options to purchase 1.8 million common shares remain
available for grant under all the plans. 63




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##### Table of Contents



Stock option activity is summarized as follows (in thousands, except per share data): WeightedNumber of
    
    
    AverageOptions
    
    
    Exercise PriceOutstanding at fiscal year end 2001 (2,615
exercisable at $9.99 weighted average price per
share)
    
    
    5,585
    
    
    $
    10.51Granted ($7.19 weighted average fair value per share)
    
    
    2,825
    
    
    
    13.31Cancelled and expired
    
    
    (582
    )
    
    
    13.19Exercised
    
    
    (93
    )
    
    
    8.90Outstanding at fiscal year end 2002 (3,392
exercisable at $9.94 weighted average price per
share)
    
    
    7,735
    
    
    
    11.36Granted ($6.57 weighted average fair value per share)
    
    
    2,302
    
    
    
    12.74Cancelled and expired
    
    
    (801
    )
    
    
    13.51Exercised
    
    
    (1,082
    )
    
    
    8.74Outstanding at fiscal year end 2003 (3,566
exercisable at $10.76 weighted average price per
share)
    
    
    8,154
    
    
    
    11.88Granted ($5.72 weighted average fair value per share)
    
    
    3,140
    
    
    
    12.33Cancelled and expired
    
    
    (752
    )
    
    
    13.53Exercised
    
    
    (266
    )
    
    
    8.99Outstanding at fiscal year end 2004 (5,111
exercisable at $11.38 weighted average price per
share)
    
    
    10,276
    
    
    $
    11.97
 Options outstanding as of the end of 2004 are summarized as follows: Options OutstandingWeighted
    
    
    
    
    
    
    Options ExercisableAverage
    
    
    Weighted
    
    
    
    
    
    
    WeightedExercise
    
    
    
    
    
    Remaining
    
    
    Average
    
    
    
    
    
    
    AveragePrice
    
    Number
    
    
    Contractual Life
    
    
    Exercise
    
    
    Number
    
    
    ExerciseRange
    
    Outstanding
    
    
    (In Years)
    
    
    Price
    
    
    Outstanding
    
    
    Price$4.38    $5.60
    
    
    344,286
    
    
    
    3.69
    
    
    
    5.23
    
    
    
    316,540
    
    
    
    5.195.75    6.38
    
    
    526,559
    
    
    
    5.65
    
    
    
    5.99
    
    
    
    405,749
    
    
    
    6.056.40    9.25
    
    
    1,187,542
    
    
    
    6.25
    
    
    
    8.39
    
    
    
    749,617
    
    
    
    8.309.25    11.80
    
    
    1,979,107
    
    
    
    6.29
    
    
    
    9.89
    
    
    
    1,391,547
    
    
    
    9.8811.85 - 14.40
    
    
    3,736,476
    
    
    
    8.86
    
    
    
    12.88
    
    
    
    793,954
    
    
    
    13.0214.42 - 17.60
    
    
    2,322,554
    
    
    
    6.99
    
    
    
    15.73
    
    
    
    1,310,800
    
    
    
    15.6817.63 - 20.85
    
    
    141,216
    
    
    
    5.57
    
    
    
    18.78
    
    
    
    103,968
    
    
    
    18.8429.92 - 33.05
    
    
    38,389
    
    
    
    3.29
    
    
    
    31.98
    
    
    
    38,389
    
    
    
    31.98$4.38 - $33.05
    
    
    10,276,129
    
    
    
    7.24
    
    
    
    11.97
    
    
    
    5,110,564
    
    
    
    11.38
 Employee Stock Purchase Plan In May 2002, our shareholders approved the Companys Employee Stock Purchase Plan (ESPP)
under which 500,000 shares of common stock had been reserved for issuance. In addition, the ESPP
provides for an annual increase of up to 250,000 shares in the total number of shares available for
issuance under the ESPP on March 1 of
each year. No increase in shares available for issuance under
the ESPP was made during 2004. Eligible employees may purchase a limited number of shares of the
Companys stock at 85% of the lower of the market value at the offering date or market value on the
purchase date. Approximately 147,000 shares of common stock were issued in 2004 for $1.4 million.
Approximately 123,000 shares of common stock were issued in 2003 for $1.1 million. As of the end of
fiscal year 2004, approximately 230,000 shares are available for issuance under this plan. 11. Taxes on Income The provisions for income tax expenses (benefits) are as follows (in thousands): For Fiscal Year Ended2004
    
    
    2003
    
    
    2002Current:Federal
    
    $
    401
    
    
    $
    232
    
    
    $
    661State
    
    
    529
    
    
    
    873
    
    
    
    1,103Foreign
    
    
    1,126
    
    
    
    13
    
    
    
    142,056
    
    
    
    1,118
    
    
    
    1,778
 64




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##### Table of Contents



For Fiscal Year Ended2004
    
    
    2003
    
    
    2002Deferred:Federal
    
    
    (112
    )
    
    
    (2,175
    )
    
    
    (930
    )State
    
    
    (818
    )
    
    
    (764
    )
    
    
    (465
    )Foreign
    
    
    
    
    
    
    427
    
    
    
    (930
    )
    
    
    (2,512
    )
    
    
    (1,395
    )Total income tax provision (benefit)
    
    $
    1,126
    
    
    $
    (1,394
    )
    
    $
    383
 The domestic and foreign components of income (loss) before income taxes are as follows (in
thousands): For the Fiscal Years ended2004
    
    
    2003
    
    
    2002Domestic
    
    $
    1,470
    
    
    $
    (5,123
    )
    
    $
    576Foreign
    
    
    3,220
    
    
    
    1,547
    
    
    
    318Income (loss) before income taxes
    
    $
    4,690
    
    
    $
    (3,576
    )
    
    $
    894
 The provision for income taxes in the accompanying statements of operations differs from the
provision calculated by applying the U.S. federal statutory income tax rate of 35% to income (loss)
before taxes due to the following (in thousands): For Fiscal Year Ended2004
    
    
    2003
    
    
    2002U.S. federal statutory income tax expense (benefit)
    
    $
    1,641
    
    
    
    35.0
    %
    
    $
    (1,251
    )
    
    
    35.0
    %
    
    $
    313
    
    
    
    35.0
    %State income tax expense (benefit), net of federal tax
expense (benefit)
    
    
    (5
    )
    
    
    (.1
    )
    
    
    (126
    )
    
    
    3.5
    
    
    
    177
    
    
    
    19.8Non-deductible expenses
    
    
    547
    
    
    
    11.5
    
    
    
    398
    
    
    
    (11.0
    )
    
    
    191
    
    
    
    21.3Research and development and other credits
    
    
    (798
    )
    
    
    (16.9
    )
    
    
    (343
    )
    
    
    9.5
    
    
    
    (452
    )
    
    
    (50.5
    )Expiration of net operating losses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    154
    
    
    
    17.2Foreign earnings permanently reinvested
    
    
    
    
    
    
    
    
    
    
    (72
    )
    
    
    2.0
    
    
    
    
    
    
    
    Tax advantaged investment income
    
    
    (259
    )
    
    
    (5.5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1,126
    
    
    
    24.0
    %
    
    $
    (1,394
    )
    
    
    39.0
    %
    
    $
    383
    
    
    
    42.8
    %
 Deferred income taxes reflect the net tax effects of: (a) temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes, and (b) operating loss and tax credits carryforwards. Significant components of our net deferred taxes are as follows (in thousands): As of Fiscal Year2004
    
    
    2003Deferred tax assets:Write-off of acquired technology
    
    $
    913
    
    
    $
    1,043Reserves and accruals
    
    
    2,463
    
    
    
    2,265Depreciation and amortization
    
    
    842
    
    
    
    368Inventory basis difference
    
    
    2,627
    
    
    
    2,621Research and development credit carryforwards
    
    
    3,830
    
    
    
    2,324Net operating loss carryovers
    
    
    2,107
    
    
    
    5,570Other, net
    
    
    69
    
    
    
    322Total deferred tax assets
    
    
    12,851
    
    
    
    14,513Deferred tax liabilities:Purchased intangibles
    
    
    (60,971
    )
    
    
    (65,845
    )Depreciation and amortization
    
    
    (1,046
    )
    
    
    Net deferred tax liabilities
    
    $
    (49,154
    )
    
    $
    (51,332
    )
 Foreign
earnings were considered to be permanently invested in operations outside the United
States through 2004, except for those earnings required to be allocated to Subpart F income. At the end of 2004, we had federal and state net operating loss (NOL) carryforwards of
approximately $6.0 million and $2.0 million, respectively. If not utilized, the federal NOL will
expire in 2021. Acquired
foreign NOLS, were fully utilized in 2004 and treated as a post acquisition purchase
price adjustment. 65




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At the end of 2004, we had available carryforward research and experimentation tax credits for
federal and state income tax purposes of approximately $2.8 million and $1.4 million, respectively.
Federal tax credit carryforwards expire from 2007 through 2024. State tax credits carry forward
indefinitely. The federal and state provisions do not reflect the tax savings resulting from reductions
associated with our various stock option plans. These savings were $.5 million, $2.1 million and
$0.3 million in 2004, 2003 and 2002, respectively. We are currently under examination by the State of New Jersey for the years 1997 through 2000.
Although the ultimate outcome of this examination is unknown, we believe that adequate amounts have
been provided for any adjustments that may result from the current examination and that the final
outcomes will not have a material adverse affect on companys results of operations. We have provided adequate amounts for anticipated tax audit adjustments in the U.S., state and
other foreign tax jurisdictions based on our estimate of whether, and the extent to which,
additional taxes and interest may be due. If events occur which indicate payment of these amounts
are unnecessary, the reversal of the liabilities would result in tax benefits being recognized in
the period when we determine the liabilities are no longer necessary. If our estimate of tax
liabilities proves to be less than the ultimate assessment, a further charge to expense would
result. 12. Enterprise and Related Geographic Information 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 designs, develops, manufactures and markets point-of-care
diagnostic test systems. Business segments (in thousands): For the Fiscal Years Ended2004
    
    
    2003
    
    
    2002Product sales:Cardiovascular
    
    $
    103,002
    
    
    $
    94,382
    
    
    $
    84,442ITC
    
    
    69,339
    
    
    
    55,534
    
    
    
    46,402Total product sales
    
    $
    172,341
    
    
    $
    149,916
    
    
    $
    130,844Income (loss) before taxes:Cardiovascular(a)
    
    $
    2,129
    
    
    $
    1,315
    
    
    $
    (3,992
    )ITC(a)
    
    
    9,940
    
    
    
    10,542
    
    
    
    9,680Corporate (b)
    
    
    (6,362
    )
    
    
    (5,931
    )
    
    
    (5,016
    )In-process research and development
    
    
    
    
    
    
    (220
    )
    
    
    Impairment of intangible asset
    
    
    
    
    
    
    (8,987
    )
    
    
    Litigation, merger, restructuring and other costs (c)
    
    
    (733
    )
    
    
    (2,132
    )
    
    
    (1,409
    )Total operating loss
    
    
    4,974
    
    
    
    (5,413
    )
    
    
    (737
    )Other income and (expense):Interest expense
    
    
    (2,460
    )
    
    
    
    
    
    
    (544
    )Interest income and other
    
    
    2,176
    
    
    
    1,837
    
    
    
    2,175Total income (loss) before taxes
    
    $
    4,690
    
    
    $
    (3,576
    )
    
    $
    894Total assets:Cardiovascular
    
    $
    314,636
    
    
    $
    326,872
    
    
    $
    352,008ITC
    
    
    38,437
    
    
    
    31,546
    
    
    
    23,464Corporate (b)
    
    
    171,342
    
    
    
    117,713
    
    
    
    92,960Total assets
    
    $
    524,415
    
    
    $
    476,131
    
    
    $
    468,432Depreciation and amortization:Cardiovascular
    
    $
    16,854
    
    
    $
    18,797
    
    
    $
    17,150ITC
    
    
    1,928
    
    
    
    1,222
    
    
    
    1,074Total depreciation and amortization
    
    $
    18,782
    
    
    $
    20,019
    
    
    $
    18,224Capital expenditures:Cardiovascular
    
    $
    3,734
    
    
    $
    4,785
    
    
    $
    6,321ITC(d)
    
    
    2,477
    
    
    
    4,634
    
    
    
    1,207Total capital expenditures
    
    $
    6,211
    
    
    $
    9,419
    
    
    $
    7,528
   (a)
    
    Amortization expense of $11.6 million, $12.3 million and $12.4 million for the fiscal years
ended 2004, 2003 and 2002 respectively, related to the Cardiovascular segment. The ITC
segment had amortization expense of 66




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$0.2 million, $44,000, and none for the fiscal years ended
2004, 2003 and 2002 respectively.(b)
    
    Represents primarily general and administrative items not specifically identified to any
particular business segment.(c)
    
    In 2004, relates to expenses not specifically identified to any particular business segment.
In 2003 and 2002, this amount related solely to the Cardiovascular segment.(d)
    
    ITC capital expenditures in 2003 include $2.5 million of property, plant and equipment acquired
through our acquisition of the IRMA product line. Geographic Areas (in thousands): For the Fiscal Years Ended2004
    
    
    2003
    
    
    2002Product Sales:Domestic
    
    $
    133,081
    
    
    $
    121,831
    
    
    $
    106,983International
    
    
    39,260
    
    
    
    28,085
    
    
    
    23,861Total
    
    $
    172,341
    
    
    $
    149,916
    
    
    $
    130,844
 13. Retirement Savings Plan Substantially all of our full-time employees are eligible to participate in a 401(k)
retirement savings plan (the Retirement Plan). Under the Retirement Plan, employees may elect to
contribute up to 25% of their eligible compensation to the Retirement Plan with Thoratec making
discretionary matching contributions, subject to certain IRS limitations. In 2004, 2003 and 2002,
our matching contribution was 50%, up to the first 6% of eligible employee plan compensation.
Employees vest under the Retirement Plan at the rate of 25% per year, with full vesting after four
years of service with us. For 2004, 2003 and 2002, we made contributions to the Retirement Plan of
approximately $0.9 million, $0.8 million and $0.8 million, respectively. In 2004, we established a non-qualified, unfunded compensation plan for certain management
employees and our Board of Directors. Amounts deferred and contributed under the deferred
compensation plan (DCP) are credited or charged with the performance of investment options
offered under the plan and elected by the participants. The liability for compensation deferred
under this plan was $0.3 million and none at January 1, 2005 and January 3, 2004, respectively and
is included in Long-term deferred tax liability and Other. We manage the risk of changes in the
fair value of the liability for deferred compensation by electing to match our liability under the
plan with an investment vehicle that offsets a substantial portion of the companys exposure. The
cash value of the investment vehicle, which includes funding for future deferrals, was $1.0 million
and $0.4 million at January 1, 2005 and January 3, 2004, respectively and is included in Other
Assets. 14. Litigation, Merger, Restructuring and Other Costs Litigation, merger, restructuring and other costs are comprised of (in thousands): For the Fiscal Years Ended2004
    
    
    2003
    
    
    2002Litigation
    
    $
    733
    
    
    $
    2,256
    
    
    $
    Merger
    
    
    
    
    
    
    
    
    
    
    356Restructuring and other
    
    
    
    
    
    
    (124
    )
    
    
    1,053Total
    
    $
    733
    
    
    $
    2,132
    
    
    $
    1,409
 Litigation In April 2003, a patent infringement claim was filed against the Company by Bodycote Materials
Testing Canada, Inc. and David C. MacGregor, M.D. This claim related to materials used in our
HeartMate LVAS. On February 3, 2004, the Company settled the claim and recorded a charge of $2.3
million in the fourth quarter of 2003 for the settlement and related legal costs. In June of 2004, MicroMed Technology, Inc., a competitor, sued us in Texas. MicroMed sought
injunctive relief against us in connection with our HeartMate II Phase I clinical trial on the
grounds that we had provided the HeartMate II VAD to clinical sites without charge and that doing
so was a violation of Texas anti-trust law. In 67




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addition to injunctive relief, the plaintiff is
seeking unspecified damages and fees, including those arising from potential sales of its VAD
products which plaintiff alleges it lost due to our HeartMate II clinical trial. We have
successfully defended ourselves against MicroMeds requests for injunctive relief, believe
MicroMeds claims are without merit, and will continue to vigorously defend any and all of the
claims made by MicroMed in this action. Commencing on or about August 3, 2004, several putative securities law class action suits were
filed in the
United States District Court for the Northern District of California on behalf of purchasers
of the publicly traded securities of the Company between April 28, 2004 and June 29, 2004. These
suits were consolidated in a consolidated complaint filed on or about January 18, 2005. The
complaint generally alleges violations of the Securities Exchange Act of 1934 by us, our Chief
Executive Officer, our former Chief Financial Officer and the President of our cardiovascular
division based upon, among other things, alleged false statements about the Companys expected
sales and the market for HeartMate as a Destination Therapy treatment. The complaint seeks to
recover unspecified damages on behalf of all purchasers of our publicly traded securities during
the class period. On or about September 1, 2004, a shareholder derivative action entitled Wong v. Grossman was
filed in the California Superior Court for Alameda County based upon essentially the same facts as
the Federal securities suit. This action names the individual members of our Board of Directors,
our Chief Executive Officer and our former Chief Financial Officer as defendants and alleges that
the defendants breached their fiduciary duties and wasted corporate assets, and that certain of the
defendants traded in our securities while in possession of material nonpublic information. We believe that the claims asserted in both the Federal securities law putative class action
and the state shareholder derivative actions are without merit. We have filed a motion to dismiss
in the Federal securities law putative class action and the shareholder derivative suit currently
is stayed through at least early July 2005. We are unable to predict at this time the final outcome of these actions. We carry sufficient insurance to cover what management believes to be any reasonable exposure
on these actions, however, we cannot give assurance that our insurance will cover all costs or
other exposures we may incur with respect to these actions. Merger Costs Merger costs recorded during 2002 consisted principally of employee severance, pre-merger
employee retention costs, and outside consulting, accounting and legal expenses associated with the
TCA merger. Restructuring Costs and Other 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 for 2003 (in thousands): Fiscal Year2003
    
    
    2002Accrued Restructuring Costs:Beginning balance
    
    $
    679
    
    
    $
    863Employee severance accrual
    
    
    
    
    
    
    425Reduction of severance accrual
    
    
    (122
    )
    
    
    Payments of employee severance
    
    
    (557
    )
    
    
    (609
    )Ending balance
    
    $
    
    
    
    $
    679
 Other costs of $529,000 were incurred in the fourth quarter of 2002 related to the termination
of a European distribution agreement. In the first quarter of 2003, $523,000 of this amount was
paid. The remaining $6,000 of the original accrual was reversed from expense in the second quarter
of 2003 as an adjustment to estimated settlement costs. 15. Earnings (Loss) Per Share Basic earnings (loss) per share are computed by dividing net income (loss) by the weighted
average number of common shares outstanding during the period. Diluted earnings per share reflect
the potential dilution that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. 68




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Options to purchase 6.2 million, 3.3 million and 4.2
million shares of common stock were not included in the computation of diluted earnings and losses
per share for 2004, 2003 and 2002, respectively, as their inclusion would be antidilutive. In
addition, the computation of diluted earnings per share for 2004 excludes the effect of assuming
the conversion of our convertible notes, which are convertible at $19.72 per share, because their
effect would have been antidilutive. Basic and diluted earnings (loss) per share were calculated as follows (in thousands, except
per share data): 2004
    
    
    2003
    
    
    2002Net income (loss)
    
    $
    3,564
    
    
    $
    (2,182
    )
    
    $
    511Weighted average number of common shares-Basic
    
    
    52,187
    
    
    
    55,583
    
    
    
    56,184Dilutive effect of stock-based compensation plans
    
    
    973
    
    
    
    
    
    
    
    578Weighted average number of common shares-Diluted
    
    
    53,160
    
    
    
    55,583
    
    
    
    56,762Basic and diluted earnings (loss) per common share
    
    $
    0.07
    
    
    $
    (0.04
    )
    
    $
    0.01
 16. Quarterly Results of Operations (Unaudited) The following is a summary of our unaudited quarterly results of operations for fiscal years
2004 and 2003: First
    
    
    Second
    
    
    Third
    
    
    Fourth(In thousands, except per share data)Fiscal Year 2004
Product sales
    
    $
    42,792
    
    
    $
    40,603
    
    
    $
    40,661
    
    
    $
    48,285Gross profit
    
    
    25,071
    
    
    
    24,289
    
    
    
    23,015
    
    
    
    27,847Net income (loss)
    
    
    1,294
    
    
    
    207
    
    
    
    (398
    )
    
    
    2,461Basic and diluted earnings (loss) per share
    
    $
    0.02
    
    
    $
    0.00
    
    
    $
    (0.01
    )
    
    $
    0.05Fiscal Year 2003
Product sales
    
    $
    36,062
    
    
    $
    36,156
    
    
    $
    35,250
    
    
    $
    42,448Gross profit
    
    
    21,171
    
    
    
    21,505
    
    
    
    20,994
    
    
    
    25,078Net income (loss)
    
    
    1,418
    
    
    
    1,023
    
    
    
    887
    
    
    
    (5,510
    )Basic and diluted earnings (loss) per share
    
    $
    0.03
    
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    (0.10
    )
 The fourth quarter of 2003 included charges of $2.3 million relating to a settlement of a
patent infringement claim and $9.0 million to write off purchased intangibles. 69




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Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 
 Item 9A.Controls and Procedures Attached as exhibits to this Form 10-K are certifications of our Chief Executive Officer and
principal financial officer, which are required in accordance with Rule 13a-14 of the Securities
Exchange Act of 1934, as amended. This Controls and Procedures section includes information
concerning the controls and controls evaluation referred to in the certifications. Item 8 of this
Form 10-K sets forth the report of Deloitte & Touche LLP, our independent registered public
accounting firm, regarding its audit of our internal control over financial reporting and of
managements assessment of internal control over financial reporting. This section should be read in conjunction with the certifications and the Deloitte &
Touche LLP report for a more complete understanding of the topics presented . Disclosure Controls and Procedures An evaluation was performed under the supervision and with the participation of our
management, including our Chief Executive Officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure controls and procedures as of January
1, 2005. 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 Annual
Report on Form 10-K. In the course of this evaluation, we sought to identify any significant
deficiencies or material weaknesses in our disclosure controls and procedures, to determine whether
we had identified any acts of fraud involving personnel who have a significant role in our
disclosure controls and procedures, and to confirm that any necessary corrective action, including
process improvements, was taken. This type of evaluation is done quarterly so that our conclusions
concerning the effectiveness of these controls can be reported in our periodic reports filed with
the SEC. The overall goals of these evaluation activities are to monitor our disclosure controls
and procedures and to make modifications as necessary. We intend to maintain these disclosure
controls and procedures, modifying them as circumstances warrant. Based on that evaluation, our management, including the Chief Executive Officer and principal
financial officer, concluded that as of January 1, 2005 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. Changes to Internal Controls Prior
to year end 2004, as part of the implementation of the
Section 404 of the Sarbanes Oxley Act, the Company instituted internal controls which were designed to and
did detect the situation which resulted in the restatement of the pro forma stock compensation fair
value disclosures for the years ended January 3, 2004 and
December 28, 2002. Management concluded that the control
deficiency which resulted in the restatement was not indicative of a
material weakness in internal controls as of January 1, 2005. There have been no
other changes in our internal controls over financial reporting during the fiscal year ended
January 1, 2005 that have materially affected or are reasonably likely to materially affect our
internal control over financial reporting. Inherent Limitations on Controls and Procedures Our management, including the Chief Executive Officer and the principal financial officer,
does not expect that internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can only provide reasonable assurances that the objectives
of the control system are met. The design of a control system reflects resource constraints; the
benefits of controls must be considered relative to their costs. Because there are inherent
limitations in all control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been or will be
detected. As these inherent limitations are known features of the financial reporting process it is
possible to design into the process safeguards to reduce, though not eliminate, these risks. These
inherent limitations include the realities that judgments in decision-making can be faulty and that
breakdowns occur because of simple error or mistake. Controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management override of the control.
The design of any system of controls is based in part upon certain assumptions about the likelihood
of future events. There can be no assurance that any design will succeed in achieving its stated
goals 70




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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. 
 Item 9B. Other Information None. 71




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PART III 
 Item 10.Directors and Executive Officers of the Registrant and Code of Ethics The information regarding directors and executive officers required by Item 10 is incorporated
herein by reference from the information under the captions Election of Directors, Section 16(a)
Beneficial Ownership Reporting Compliance, Code of Ethics, and in other applicable sections in
the definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A for our 2005 annual meeting of stockholders. 
 Item 11.Executive Compensation The information required by Item 11 is incorporated herein by reference from the information
under the caption Executive Compensation in the definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A for our 2005 annual meeting of
stockholders. 
 Item 12.Security Ownership of Certain Beneficial Owners and Management The information required by Item 12 is incorporated herein by reference from the information
under the caption Security Ownership of Certain Beneficial Owners and Management in the
definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A for our 2005 annual meeting of stockholders. 
 Item 13.Certain Relationships and Related Transactions The information required by Item 13 is incorporated herein by reference from the information
under the caption Certain Transactions in the definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A for our 2005 annual meeting of
stockholders. 
 Item 14.Principal Accountant Fees and Services The information required by Item 14 is incorporated herein by reference from the information
under the caption Independent Public Accountants in the definitive proxy statement to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A for our 2005 annual meeting
of stockholders. 72




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##### Table of Contents



PART IV 
 Item 15.Exhibit and Financial Statement Schedules (a) List of documents filed as part of this report:  1.
    Financial Statements and Reports of Independent Registered Public Accounting Firm.Reference is made to the Index to Financial Statements under Item 8 of Part II of this Annual
Report on Form 10-K, where these documents are included.2.
    Financial Statement SchedulesSchedule II  Valuation and Qualifying Accounts and Reserves for each of the three fiscal years
ended January 1, 2005, January 3, 2004 and December 28, 2002.Other financial statement schedules are not included either because they are not required or the
information is otherwise shown in our audited consolidated financial statements or the notes
thereto.3.
    ExhibitsReference is made to the Exhibit Index on page 75 of this Annual Report, where these documents
are included. 73




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THORATEC CORPORATION AND SUBSIDIARIES SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For Each of the Three Fiscal Years for the Period Ended January 1, 2005 Balance
    
    
    Additions
    
    
    
    
    
    
    BalanceBeginning
    
    
    (charges
    
    
    
    
    
    
    End ofof Year
    
    
    to expense)
    
    
    Deductions
    
    
    Year(In thousands)Year Ended January 1, 2005:Allowance for doubtful accounts
    
    $
    486
    
    
    $
    417
    
    
    $
    (195
    )(1)
    
    $
    708Accrued product warranty
    
    $
    829
    
    
    $
    173
    
    
    $
    (384
    )(2)
    
    $
    618Year Ended January 3, 2004:Allowance for doubtful accounts
    
    $
    238
    
    
    $
    361
    
    
    $
    (113
    )(1)
    
    $
    486Accrued product warranty
    
    $
    695
    
    
    $
    193
    
    
    $
    (59
    )(2)
    
    $
    829Year Ended December 28, 2002:Allowance for doubtful accounts
    
    $
    551
    
    
    $
    154
    
    
    $
    (467
    )(1)
    
    $
    238Accrued product warranty
    
    $
    910
    
    
    $
    45
    
    
    $
    (260
    )(2)
    
    $
    695
   (1)
    
    Accounts written off, net of recoveries.(2)
    
    Warranty expenditures incurred. 74




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##### Table of Contents



EXHIBIT INDEX ExhibitNumber
    
    Exhibit3.1
    
    Thoratecs Articles of Incorporation, as amended.(1)3.2
    
    Thoratecs By-Laws, as amended February 25, 2005. (2)4.1
    
    Rights Agreement between Thoratec Corporation and Computershare Trust Company, Inc. as Rights
Agent dated as of May 2, 2002.(3)4.2
    
    Indenture, dated as of May 24, 2004, by and between Thoratec Corporation and U.S. Bank, National
Association, as Trustee. (4)4.3
    
    Form of Senior Subordinated Convertible Note due 2034. (5)4.4
    
    Pledge Agreement, dated as of May 24, 2004, between Thoratec Corporation and U.S. Bank, National
Association, and Pledge Agreement Supplement, dated as of June 7, 2004. (4)4.5
    
    Control Agreement, dated as of May 24, 2004, between Thoratec Corporation and U.S. Bank, National
Association, and Control Agreement Amendment, dated as of June 7, 2004.(4)4.6
    
    Registration Rights Agreement, dated May 24, 2004, by and among Thoratec Corporation and Merrill
Lynch Pierce Fenner & Smith Incorporated as Initial Purchaser of the Senior Subordinated
Convertible Notes due 2034. (4)10.1
    
    Thoratecs 1984 Incentive Stock Option Plan, as amended.(6)10.2
    
    Intellectual Property Cross-license Agreement between Thermedics and the Thoratec Cardiosystems
dated August 19, 1988.(7)10.3
    
    Form of Indemnification Agreement between Thoratec Cardiosystems and its officers and directors.(7)10.4
    
    Thoratecs 1993 Stock Option Plan.(8)10.5
    
    Agreement dated May 26, 1993, between The Polymer Technology Group Incorporated and the Thoratec
Cardiosystems.(9)10.6
    
    Thoratecs 1996 Stock Option Plan.(10)10.7
    
    Thoratecs 1996 Nonemployee Directors Stock Option Plan, as amended. (11)10.8
    
    Lease Agreement dated July 25, 1996, between Main Street Associates and Thoratec, as amended.(12)10.9
    
    First Amendment to Lease Agreement originally between Main Street Associates and Thoratec dated
July 25, 1996.(13)10.10
    
    Second Amendment to Lease Agreement originally between Main Street Associates and Thoratec dated
July 25, 1996.(14)10.11
    
    Thoratecs 1997 Stock Option Plan, as amended.(15)10.12
    
    Amended and Restated Directors Stock Option Plan of Thoratec Cardiosystems.(16)10.13
    
    Amended and Restated Nonqualified Stock Option Plan of Thoratec Cardiosystems.(16)10.14
    
    Agreement and Plan of Merger by and among Thoratec, Lightning Acquisition Corporation, Thermo
Cardiosystems Inc, and Thermo Electron Corporation dated October 3, 2000.(17)10.15
    
    Registration Rights Agreement by and between Thoratec and Thermo Electron dated October 3,
2000.(17)10.16
    
    Shareholder Agreement by and between Thoratec and Thermo Electron dated October 3, 2000.(17)10.17
    
    Lease agreement dated August 16, 1995, between International Technidyne Corporation and BHBMC, as
amended.(18)10.18
    
    Employment Agreement by and between Thoratec and D. Keith Grossman, amended as of December 6,
2001.(18)10.19
    
    Thoratecs 2002 Employee Stock Purchase Plan.(19)10.20
    
    Form of Separation Benefits Agreement between Thoratec and its executive officers.10.21
    
    Thoratecs Deferred Compensation Plan effective as of January 1, 2004. (11)10.22
    
    Grantor Trust Agreement between Thoratec and Wachovia Bank, National Association effective as of
November 21, 2003.(11)
 75




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ExhibitNumber
    
    Exhibit10.24
    
    Commercial Lease between International Technidyne Corporation and Roseville Properties Management
Company dated September 26, 2003. (11)10.25
    
    Lease Agreement between International Technidyne Corporation and NJ Mortgage Association dated
February 21, 2003. (20)10.26
    
    Separation Agreement and Release between M. Wayne Boylston and Thoratec, entered into on December
17, 2004. (21)10.27
    
    Consulting Services Agreement between M. Wayne Boylston and Thoratec, entered into on December 17,
2004. (21)10.28
    
    Amended and Restated Thoratec Corporation Restricted Stock Grant Agreement between M. Wayne
Boylston and Thoratec, entered into on December 17, 2004. (21)10.29
    
    Description of the Executive Disability Income Protection Program.21
    
    Subsidiaries of Thoratec.(18)23.1
    
    Consent of Independent Registered Public Accounting Firm  Deloitte & Touche LLP.24
    
    Power of Attorney  Reference is made to page 79 hereof.31.1
    
    Section 302 Certification of Chief Executive Officer31.2
    
    Section 302 Certification of principal financial officer32.1
    
    Section 906 Certification of Chief Executive Officer32.2
    
    Section 906 Certification of principal financial officer
   (1)
    
    Filed as an Exhibit to Thoratecs Annual Report on Form 10-K for the fiscal year ended
December 28, 2002 filed with the SEC on March 20, 2003 and incorporated herein by reference.(2)
    
    Filed as an Exhibit to Thoratecs Form 8-K filed with the SEC on March 3, 2005.(3)
    
    Filed as an Exhibit to Thoratecs Form 8-A12G filed with the SEC on May 3, 2002 (Registration
No. 000-49798), and incorporated herein by reference.(4)
    
    Filed as an Exhibit to Thoratecs Quarterly Report on Form 10-Q for the fiscal quarter ended
July 3, 2004 filed with the SEC on August 12, 2004, and incorporated herein by reference.(5)
    
    Included as an exhibit to Exhibit 4.2.(6)
    
    Filed as an Exhibit to Thoratecs Annual Report on Form 10-K for the fiscal year ended
December 29, 1990 filed with the SEC on March 28, 1991, and incorporated herein by reference.(7)
    
    Filed as an Exhibit to Thoratec Cardiosystems Registration Statement on Form S-1
(Registration No. 33-25144) and incorporated herein by reference.(8)
    
    Filed as an Exhibit to Thoratecs Annual Report on Form 10-K for the fiscal year ended
January 1, 1994 filed with the SEC on March 22, 1994, and incorporated herein by reference.(9)
    
    Filed as an Exhibit to Thoratec Cardiosystems Quarterly Report on Form 10-Q for the fiscal
quarter ended July 3, 1993 and incorporated herein by reference.(10)
    
    Filed as an Exhibit to Thoratecs Registration Statement on Form S-8 filed with the SEC on
September 12, 1996, (Registration No. 333-11883) and incorporated herein by reference.(11)
    
    Filed as an Exhibit to Thoratecs Annual Report on Form 10-K for the fiscal year ended
January 3, 2004 filed with the SEC on March 17, 2004 and incorporated herein by reference. 76




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(12)
    
    Filed as an Exhibit to Thoratecs Quarterly Report on Form 10-Q for the fiscal quarter ended
June 29, 1996, filed with the SEC on August 13, 1996, and incorporated herein by reference.(13)
    
    Filed as an Exhibit to Thoratecs Quarterly Report on Form 10-Q for the fiscal quarter ended
June 28, 1997, filed with the SEC on July 30, 1997, and incorporated herein by reference.(14)
    
    Filed as an Exhibit to Thoratecs Quarterly Report on Form 10-Q for the fiscal quarter ended
September 27, 1997 filed with the SEC on November 12, 1997, and incorporated herein by
reference.(15)
    
    Filed as an Exhibit to Thoratecs Registration Statement on Form S-8 filed with the SEC on
June 18, 2003 (Registration No. 333-106238), and incorporated herein by reference.(16)
    
    Filed as an Exhibit to Thoratec Cardiosystems Quarterly Report on Form 10-Q for the fiscal
quarter ended July 3, 1999 filed with the SEC on August 5, 1999, and incorporated herein by
reference.(17)
    
    Filed as an Annex to Thoratecs Registration Statement on Form S-4/A, filed with the SEC on
December 29, 2000 (Registration No. 333-72128), and incorporated herein by reference.(18)
    
    Filed as an Exhibit to Thoratecs Form 10-K405 filed with the SEC on March 15, 2002
(Registration No. 033-72502), and incorporated herein by reference.(19)
    
    Filed as an Exhibit to Thoratecs Form S-8 POS filed with the SEC on July 1, 2002
(Registration No. 333-90768), and incorporated herein by reference.(20)
    
    Filed as an Exhibit to Thoratecs Quarterly Report on Form 10-Q for the fiscal quarter ended
March 29, 2003 filed with the SEC on May 13, 2003, and incorporated herein by reference.(21)
    
    Filed as an Exhibit to Thoratecs Form 8-K filed with the SEC on December 20, 2004. 77




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SIGNATURES In accordance with Section 13 or Section 15(d) of the Exchange Act, as amended, the Registrant
has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized on this 16th day of March 2005. THORATEC CORPORATIONBy:
    
    /s/ D. KEITH GROSSMAND. Keith GrossmanChief Executive OfficerDate: March 16, 2005
 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS that each person whose signature appears below constitutes
and appoints D. Keith Grossman and David Lehman, and each of them, his true and lawful
attorney-in-fact, with full power of substitution and resubstitution, to act for him and in his
name, place and stead, in any and all capacities to sign any and all amendments to this annual
report on Form 10-K and to file the same, with all exhibits thereto, and all documents in
connection therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and
every act and thing which they, or any of them, may deem necessary or advisable to be done in
connection with this annual report as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them,
or any substitute or substitutes for any or all of them, may lawfully do or cause to be done by
virtue hereof. In accordance with the Exchange Act, this report has been signed below by the following
persons on behalf of the Thoratec Corporation and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ D. KEITH GROSSMAN
    
    Chief Executive Officer,D. Keith Grossman
    
    President and Director
    
    March 16, 2005/s/ JEFFREY M. McCORMICK
    
    Corporate Controller,Jeffrey M. McCormick
    
    (principal financial and accounting officer)
    
    March 16, 2005/s/ J. DONALD HILL
    
    Director and Chairman of theJ. Donald Hill
    
    Board of Directors
    
    March 16, 2005/s/ HOWARD E. CHASEHoward E. Chase
    
    Director
    
    March 16, 2005/s/ J. DANIEL COLEJ. Daniel Cole
    
    Director
    
    March 16, 2005/s/ NEIL F. DIMICKNeil F. Dimick
    
    Director
    
    March 16, 2005/s/ WILLIAM M. HITCHCOCKWilliam M. Hitchcock
    
    Director
    
    March 16, 2005/s/ GEORGE W. HOLBROOK, JR.George W. Holbrook, Jr.
    
    Director
    
    March 16, 2005/s/ DANIEL M. MULVENADaniel M. Mulvena
    
    Director
    
    March 16, 2005
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