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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549****Form 10-K** **(Mark one)**   þ **ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   **For the fiscal year ended December 31, 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** **94-2340464***(State or Other Jurisdiction of* *(I.R.S. Employer**Incorporation or Organization)* *Identification No.)*   **6035 Stoneridge Drive, Pleasanton, California** **94588***(Address of Principal Executive Offices)* *(Zip Code)***Registrant’s telephone number, including area code: (925) 847-8600****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 if the registrant is a well-known seasoned issuer, as defined in Rule405 of the Securities Act. Yes þ No o     Indicate by a check mark if the registrant is not required to file reports pursuant to Section13 or Section 15(d) of the Exchange Act. Yes o No þ     Indicate by a check mark whether the registrant: (1) has filed all reports required to befiled 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) hasbeen 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 RegulationS-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. þ     Indicate by a check mark whether the registrant is a large accelerated filer, an acceleratedfiler, or a non-accelerated filer. See definition of “accelerated filer and large acceleratedfiler” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer þAccelerated filer o Non-accelerated filer o     Indicate by a check mark whether the registrant is a shell company (as defined in Exchange ActRule 12(b)-2)Yes o No þ     The aggregate market value of the voting stock held by non-affiliates computed by reference tothe last sale reported of such stock on July 2, 2005, the last business day of the Registrant’ssecond fiscal quarter, as listed on The Nasdaq National Stock Market was $739,742,359.     As of March 10, 2006, registrant had 52,319,017 shares of common stock outstanding.**DOCUMENTS INCORPORATED BY REFERENCE**     Designated portions of Thoratec’s definitive proxy statement for its 2006 annual meeting ofshareholders are incorporated by reference into Part III of this Form 10-K.     Thoratec, the Thoratec logo, Thoralon, TLC-II, HeartMate and *Vectra*are registered trademarksof Thoratec Corporation, and Heart Hope, HeartMate II and IVAD are trademarks of ThoratecCorporation.     HEMOCHRON, ProTime, Surgicutt, Tenderlett, Tenderfoot and IRMA are registered trademarks ofInternational Technidyne Corporation, or ITC, our wholly-owned subsidiary.  
 

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**TABLE OF CONTENTS**     **Page****PARTI**3Item 1. Business  3Item 1A. Risk Factors  16Item 1B. Unresolved Staff Comments  25Item 2. Properties  25Item 3. Legal Proceedings  26Item 4. Submission of Matters to a Vote of Security Holders  26**PART II**27Item 5. Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities  27Item 6. Selected Consolidated Financial Data  28Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 28Item 7A. Quantitative and Qualitative Disclosures About Market Risk  37Item 8. Financial Statements and Supplementary Data  39Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure  64Item 9A. Controls and Procedures  64Item 9B. Other Information  65**PART III**65Item 10. Directors and Executive Officers of the Registrant  65Item 11. Executive Compensation  65Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters  65Item 13. Certain Relationships and Related Transactions  65Item 14. Principal Accountant Fees and Services  65**PART IV**66Item 15. Exhibits and Financial Statement Schedules  66Exhibit Index 68 EXHIBIT 10.28 EXHIBIT 23.1 EXHIBIT 31.1 EXHIBIT 31.2 EXHIBIT 32.1 EXHIBIT 32.2
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**PART I****FORWARD-LOOKING STATEMENTS**     This Annual Report on Form 10-K, including the documents incorporated by reference in thisAnnual Report, includes forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended. Thesestatements can be identified by the words “expects,” “projects,” “hopes,” “believes,” “intends,”“should,” “estimate,” “will,” “would,” “may,” “anticipates,” “plans,” “could” and other similarwords. Actual results, events or performance could differ materially from these forward-lookingstatements based on a variety of factors, many of which are beyond our control. Therefore, readersare cautioned not to put undue reliance on these statements. Factors that could cause actualresults or conditions to differ from those anticipated by these and other forward-lookingstatements include those more fully described in the “Risk Factors” section of this Annual Reportand in other documents we file with the Securities and Exchange Commission. These forward-lookingstatements speak only as of the date hereof. We undertake no obligation to publicly release theresults of any revisions to these forward-looking statements that may be made to reflect events orcircumstances after the date hereof, or to reflect the occurrence of unanticipated events.**Item 1.*****Business*****OVERVIEW**     Thoratec Corporation (“we,” “our,” “us,” “the Company”) is a leading manufacturer ofcirculatory support products for the treatment of heart failure, or HF. We sell Ventricular AssistDevices, or VADs, our primary product, to leading heart transplant centers throughout the world andaccount for three out of the four VADs approved by the U.S. Food and Drug Administration, or FDA, asa bridge to heart transplant for adults and are commercially marketed. These devices are used for the temporary support of adultpatients awaiting a heart transplant and as the only FDA-approved ventricular assist deviceapproved for permanent implant, or Destination Therapy. We also are a leading provider ofpoint-of-care and incision blood diagnostic test systems.     Incorporated in the state of California in 1976, Thoratec Corporation trades on the NASDAQunder the ticker symbol THOR and is headquartered in Pleasanton, California.     Our business is comprised of two operating divisions: Cardiovascular and InternationalTechnidyne Corporation, or ITC, a wholly owned subsidiary.     The product line within the Cardiovascular segment is: **•** *Circulatory Support Products.*Our circulatory support products include VADs for theshort, intermediate, and long-term treatment of advanced HF. In addition, we havedeveloped small diameter grafts using our proprietary materials to address the vascularaccess market. Our grafts are sold in the U.S. and internationally for use inhemodialysis.     The product lines within the ITC segment are: **•** *Point-of-Care Diagnostics*. Our point-of-care products, or POC, include coagulationdiagnostic test systems that monitor a patient in a variety of clinical settings during theadministration of certain anticoagulants, and blood gas/electrolyte/chemistry products thatmonitor patients in a variety of clinical settings.  **•** *Incision*. Our incision products include devices to obtain patients’ blood samples fordiagnostic testing and screening for platelet function.     Heart failure is a disorder in which the heart loses its ability to pump blood efficiently.This condition may affect the right side, the left side or both sides of the heart, depriving manyorgans, including the kidneys and liver, of adequate oxygen and nutrients. This damages theseorgans and reduces their ability to function properly. Approximately 23 million people worldwidesuffer from HF, with two million new cases of HF diagnosed each year worldwide. In the U.S.,according to the American Heart Association, or AHA, nearly five million patients suffer from HFand an additional 550,000 patients are diagnosed with the condition annually. In contrast to othercardiovascular disorders, many of which have actually declined in the past few decades, theincidence of heart failure ranks as the most rapidly growing cardiovascular disorder in the U.S.Our VADs provide hemodynamic restoration therapy, which supports the performance of the heart andrestores blood flow to adequately meet the needs of vital organs.     Our VADs have been clinically proven to improve patient survival and quality of life. Wecurrently offer the widest range of products to serve this market, including VADs for short,intermediate and long-term support, as well as devices that are FDA-
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approved as a bridge-to-transplantation, for Destination Therapy and/or postcardiotomymyocardial recovery. We believe that our long-standing reputation for quality and innovation andour excellent relationships with leading cardiovascular surgeons worldwide position us to capturegrowth opportunities in the expanding heart failure market.     We currently market VADs that may be implanted or worn outside the body, can be used for left,right or biventricular support and that are suitable for treatments for different durations forpatients of varying sizes and ages. We estimate that doctors have implanted more than 10,000 of ourdevices, primarily for patients awaiting a heart transplant or those who require permanent support.On November 6, 2002, the FDA approved the HeartMate VE as the first heart assist device forDestination Therapy, or permanent support for patients suffering from late-stage heart failure whoare not eligible for heart transplantation. On April 7, 2003, the FDA approved the HeartMate XVE,an enhanced version of the HeartMate VE, for Destination Therapy. Thoratec is the only company tooffer a VAD approved by the FDA for Destination Therapy and marks the first time a VAD has beenapproved as a permanent treatment for late-stage heart failure patients who do not qualify forheart transplants because of age or extenuating health circumstances, and who otherwise have a lifeexpectancy of less than two years. The FDA’s decision to approve the HeartMate VAD for DestinationTherapy was based on data from a clinical trial called REMATCH, or Randomized Evaluation ofMechanical Assistance for the Treatment of Congestive Heart Failure, which showed our HeartMatedevice 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 DecisionMemorandum covering reimbursement for the use of a Left Ventricular Assist System for DestinationTherapy, effective October 1, 2003. CMS has subsequently adjusted the relative weight and baselevel of reimbursement it will provide under DRG (diagnosis-related group) 103 “Heart Transplant orImplant of Implantable Heart Assist Systems”, or DRG 103, to raise the average payment for CMSDestination Therapy-certified Centers to approximately $136,000, the same reimbursement given forheart transplants. In many cases the actual payments to hospitals under DRG 103 could be higher orlower, based on geographical location and other factors.     Several private payors have also issued positive coverage decisions. The majority of localBlue Cross and Blue Shield plans have created positive medical policy for bothbridge-to-transplantation and long-term therapy indications. Since December 2002, the majority ofnational insurance carriers, including Aetna, Cigna, Humana, United Health Group and UNICARE, haveissued positive coverage policies to cover the use of ventricular assist devices for FDA-approvedindications, including Destination Therapy.**OUR MARKETS****CARDIOVASCULAR SEGMENT*****Circulatory Support and Graft Products***     The primary markets for our VAD products serve those patients suffering from late stage HF.Late-stage HF is a chronic disease that occurs when degeneration of the heart muscle reduces thepumping power of the heart, causing the heart to become too weak to pump blood at a levelsufficient to meet the body’s demands. The condition can be caused by artery or valve diseases or ageneral weakening of the heart muscle itself. Other conditions, such as high blood pressure ordiabetes, also can lead to HF.     According to estimates by the AHA, 5 million patients suffer from HF in the U.S. andapproximately 550,000 new cases are diagnosed each year. The AHA also estimates that approximately80% of men and 70% of women HF patients under age 65 will die within eight years of diagnosis.While the number of treatment options for earlier stage HF has increased in recent years,medication remains the most widely used approach for treatment of the disease. These drug therapiesinclude ACE inhibitors, anti-coagulants and beta-blockers, which facilitate blood flow, thin theblood 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 HF through drug therapy, the only curative treatment for thedisease is a heart transplant. Unfortunately, the number of hearts available for transplant eachyear can meet the needs of only a small number of the patients requiring one. The United Networkfor Organ Sharing reported that there were only 2,096 hearts available for transplant in the U.S.in 2004. At any given time, approximately 4,000 patients are on the U.S. national transplantwaiting list, and we believe a comparable number of patients are waiting in Europe. The median waitfor a donor heart is approximately nine months; many patients have to wait as long as two years. In2002, approximately 15% of these patients died while waiting for a donor heart.     In the U.S., there are currently two FDA-approved indications for the long-term use of VADs inpatients with HF: as a bridge to heart transplant and as Destination Therapy. We are currentlypursuing an additional indication for our Thoratec VAD products: therapeutic recovery of the heart.Beyond the HF markets, VADs are also approved for use during recovery following cardiac surgery.All four indications are summarized below.
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     ***Bridge-to-Transplantation —***Ventricular assist devices provide additional cardiac support forpatients in late-stage heart failure waiting for a donor heart. Of the approximately 4,000 patientson the waiting list for a heart transplant in the U.S., we estimate that approximately 25% receivea VAD. We believe that the percentage of patients bridged to transplant will continue to increasewith surgeons’ level of comfort with the technology, particularly for longer-term support cases.There are currently five devices approved in the U.S. as a bridge–to-transplant in adults, four ofwhich are Thoratec devices.     ***Destination Therapy —***On November 6, 2002, we received approval to market the HeartMate VADfor Destination Therapy patients with late-stage HF who are not candidates for hearttransplantation due to other degenerative illnesses or advanced age. The National Institutes forHealth (NIH) estimated that the Destination Therapy application represents a long-term marketopportunity of up to 100,000 additional patients annually in the U.S. For these late-stage HFpatients, drug therapy is currently the only other treatment available. Even with drug therapy,the 12-month mortality rate for these patients is approximately 80%. We believe that the HeartMateprovides a significant survival benefit for this patient population. We believe that the success intransitioning this market from maximum drug therapy to VADs is dependent on the development ofproducts such as our HeartMate that deliver substantial longevity and proof of clinical efficacy.     ***Therapeutic Recovery —***We believe that for most patients the recovery of their own heart is abetter alternative than either heart transplantation or permanent implantation of a blood pumpingdevice. Based on recently reported cases of recovery in heart failure patients, we believe that ourVAD system, in combination with other agents such as cell or drug therapies, has the potential toreverse the complications of late-stage HF in certain patients. While this therapeutic recoveryindication is not yet approved for our devices, we are actively investigating the worldwideexperience with our VAD systems as a means of therapeutic recovery and the requirements forpursuing regulatory approval for this indication. Although it is not certain how many patients withHF could benefit from this indication, based upon our estimate of the percentage of patients withlate-stage HF, we believe that the patient population could be substantial. We are pursuing abridge to myocardial recovery indication to add to our labeling that is approved by the FDA whichwould allow the Thoratec VAD to be used to treat patients diagnosed with acute cardiac disorderssuch as fulminate myocarditis. We will continue working with the FDA toward this goal in 2006. Weare also formulating a regulatory and clinical strategy for non-U.S. markets.     ***Post-cardiotomy Myocardial Recovery Following Cardiac Surgery —***In addition to chronic HF, ourdevices are also used for patients who suffer from acute cardiac failure and undergo cardiacsurgery. Following cardiac surgery, some patients have difficulty being weaned off heart/lungmachines, a complication that arises in open-heart procedures. Many of these patients ultimately die from heart failurewhen the heart, weakened by disease and the additional trauma of surgery, fails to maintainadequate blood circulation. We believe that only a small portion of this market is currently beingtreated with VADs and that this patient population could benefit substantially from the use of ourFDA approved Thoratec VAD and IVAD products in this market.     ***Vascular Graft Products —***In addition to the circulatory support market, we sell a device thataddresses the vascular access graft market, which we market as the *Vectra*Vascular Access Graft, or*Vectra,*for patients undergoing renal hemodialysis.**ITC SEGMENT**     ***Point-of-Care Diagnostics Products —***Our point-of-care blood diagnostic test systems providefast, accurate blood test results to improve patient management, reduce healthcare costs andimprove patient outcomes. These products are sold into the hospital point-of-care market, into thealternate site point-of-care market including physicians’ offices, long-term care facilities,clinics, visiting nurse associations, home healthcare companies, and directly to patients. Webelieve that the market growth for point-of-care diagnostic products is fueled by convenience, easeof use, the clinical benefits that more frequent monitoring at alternate site point-of-care allowsand availability of time sensitive test results where the patient is being treated.     ***Incision Products —***Our incision products are used by professionals to obtain a patient’s bloodsample for diagnostic testing. Our incision products are sold into both the hospital point-of-careand the alternate site point-of-care markets. All products feature permanently retracting bladesfor a safe, less painful incision.**OUR STRATEGY**     Our strategy to maintain and expand our leadership position is comprised of the following:
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     *Offer a broad range of products.*Our VADs provide hemodynamic restoration therapy for theheart and have been clinically proven to improve patient survival and quality of life. Wecurrently offer the widest range of VADs to cover indications for use ranging from acute tolong-term support. We believe that our broad and diverse product offering represents an importantcompetitive advantage because it allows us to address the various preferences of surgeons, theclinical needs of a wide variety of patients, and the economic requirements of third party payors.We intend to further broaden our product line through internal development, acquisition andlicensing.     *Focus on and partner with leading heart centers*. We have developed long-standing relationshipswith leading cardiovascular surgeons and heart centers worldwide. We believe that no other cardiacassist company enjoys the same depth of relationships and access to these customers. Theserelationships are an important part of our growth strategy, particularly for the development andintroduction of new products and the pursuit of additional indications for our existing products.In 2005, we continued our investment in building these relationships by hiring five heart failuretherapy specialists as part of our program to generate referrals to our leading VAD centers,including those in our Heart Hope Program that we began in 2004. These specialists work inpartnership with our VAD centers to increase the awareness of hemodynamic restoration therapy andVADs in the cardiology community.     *Increase penetration of existing markets*. We plan to treat a greater number and variety ofpatients within our current customer base. To accomplish this, we are building upon our existingrelationships with leading cardiac surgeons, cardiac catheterization labs and hospitals, and usingour existing sales channels to gain acceptance and adoption of our products. **•** *Bridge-to-Transplantation Market.*On July 28, 2003, Thoratec received CE markcertification, providing approval to market the Thoratec Implantable Ventricular AssistDevice, or IVAD, within European Union countries. In August 2004, we received FDA approvalin the U.S. to market the IVAD for use in bridge-to-transplantation and post-cardiotomyrecovery patients who are unable to be weaned from cardiopulmonary bypass. This makes theIVAD 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 VADfor Destination Therapy in the treatment of late-stage HF patients who are not candidatesfor heart transplants. While the initial CMS reimbursement approval was limited to 69centers in 2004, we estimate the market penetration for this indication could eventually bea meaningful portion of the 100,000 patients annually diagnosed with late-stage HF mentionedabove, as we introduce new technologies that increase the useful life of our VAD and improvethe outcome of procedures.  **•** *Home Discharge for our TLC-II portable driver*. On December 1, 2003, the FDA approved theTLC-II portable driver (the unit providing power, monitoring and operational control of aVAD) for home use. The TLC-II was already approved for in-hospital use in the U.S., and hadbeen approved for home therapy in Europe for several years. This approval enables patientssupported by the device to be discharged from the hospital to their home while awaitingheart transplantation or recovery of their existing heart. The TLC-II driver is the firstportable driver approved for home discharge to support biventricular patients.  **•** *Point-of-Care Market*. In late 2003, we acquired the IRMA product line of bloodgas/electrolyte and chemistry tests from Diametrics Medical, Inc. This has significantlyincreased our test menu offering, and also provides us with the opportunity to develop thenext generation system which combines coagulation and blood gas tests into one platform. Inthe interim, the IDMS data management and connectivity system, acquired as part of the IRMAacquisition, will allow the stand-alone Hemochron and IRMA systems to interface with ahospital’s laboratory or hospital information system. We also currently sell the ProTimefor monitoring anticoagulation therapy to physician offices, nursing homes and otherClinical Laboratory Improvement Act, or CLIA, waived settings (facilities that performsimple types of tests and have lower level training for performing these tests).     *Obtain approval for new products.*We completed a U.S. Phase I clinical trial of 25 patients at10 study sites for our HeartMate II VAD and began our U.S. Phase II pivotal trial in the firstquarter of 2005. The Phase II study includes both a BTT and DT arm, the first time the FDA hasapproved a clinical trial with both indications in one protocol. The BTT arm will involve 133patients in total, with the primary endpoint being the rate of survival to either transplantationor 180 days of support. The DT arm of the study will involve 200 total patients, randomizing theHeartMate II to the company’s HeartMate XVE on a 2-1 basis, respectively. The DT arm provides for atwo-year composite endpoint, which includes patient survival, rate of neurological events anddevice reliability. We had more than 180 patients enrolled in the clinical trial as of the end of2005. The pivotal trial will evaluate the safety and effectiveness of the HeartMate II for use as abridge–to-transplantation and Destination Therapy. The HeartMate II is an implantable LeftVentricular Assist Device System consisting of a miniature rotary blood pump designed to providelong-term support. Its design is intended to be not only smaller but also simpler, quieter, andlonger lasting than current generation assist devices.
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     *Increase cost effectiveness of the therapies that employ our products*. While a recent studyindicates that the cost of implanting a VAD for Destination Therapy is comparable with that of aheart, 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 ventricularassist systems that are approved by the FDA for treating Destination Therapy in late-stage heartfailure patients. We work closely with the 69 CMS-approved centers to develop the DestinationTherapy market, which we believe will ultimately improve the cost effectiveness of this solution.We also are expanding our market education and training programs, and continue to make improvementsthat enhance the performance and cost effectiveness of our products.     *Increase our presence in Cardiovascular and ITC market segments*. In addition to increasing ourpresence in the heart failure, cardiovascular disease, point-of-care and incision markets throughinternal growth, we continue to evaluate strategic alliances, joint ventures, acquisitions andrelated business development opportunities.**OUR PRODUCTS****Cardiovascular Segment**     Our Cardiovascular segment offers the following broad product portfolio of implantable andexternal circulatory support product devices: **•** The Thoratec Ventricular Assist Device System is an external device for short to mid-termcardiac support. The device, which is sold worldwide, is approved to assist left, right andbiventricular support and is worn outside of the body. The Thoratec VAD is approved by theFDA for use as a bridge to transplantation and for post-cardiotomy myocardial recovery.  **•** The Thoratec IVAD is the only implantable blood pump approved for bothbridge-to-transplantation and post-cardiotomy myocardial recovery that can be used for left,right, or biventricular support. The IVAD utilizes the same internal working components asthe Thoratec VAD System, but has an outer housing made of a titanium alloy that makes itmore suitable for implantation.  **•** The HeartMate XVE Left Ventricular Assist System, or LVAS, is an implantable device formid to longer-term cardiac support and is the only device approved in the U.S., Europe andCanada for permanent support for those patients ineligible for heart transplantation. This device is designed to assist the pumping function of theleft ventricle of the natural heart and feature a unique textured blood-contacting surfacethat eliminates the need for systemic anticoagulation.  **•** The HeartMate II is an implantable LVAS consisting of a miniature rotary blood pumpdesigned to provide long-term support. Its design is intended to be not only smaller, butalso simpler, quieter, and longer lasting than the current generation of ventricular assistdevice. The HeartMate II is CE Marked and approved for distribution in Europe, but iscurrently only approved in the U.S. for investigational use.     In addition to our cardiac assist products, we sell vascular access graft products used inhemodialysis for patients with late-stage renal disease.***Circulatory Support and Graft Products***     Ventricular assist devices perform some or most of the pumping function of the heart inpatients with severe heart failure. In most cases, a cannula connects the left ventricle of theheart to a blood pump. Blood flows from the left ventricle to the pump chamber via the cannula,powered by an electric or air driven mechanism that drives the blood through another cannula intothe aorta. From the aorta, the blood then circulates throughout the body. Mechanical or tissuevalves enable unidirectional flow in some devices. Currently the power source remains outside thebody for all FDA-approved VADs.     Certain VADs are implanted internally, while others are placed outside the body. Some externaldevices are placed immediately adjacent to the body (paracorporeal), while other external VADs arepositioned at a distance from the body (extracorporeal).     We estimate that between 20% and 35% of assist patients require biventricular support andtherefore require a second pump for the right ventricle.
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*The Thoratec VAD*     The Thoratec VAD has been FDA approved since 1995 and has treated over 2,900 patientsworldwide. The Thoratec VAD is a paracorporeal device that is less invasive than implantable VADssince only the cannula must be implanted. The paracorporeal nature of the Thoratec VAD has severalpositive 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 useof a few weeks to several months, though this device has supported numerous patients for six to 18months. Offering left, right or biventricular support, the Thoratec VAD is the only biventricularsupport system approved for use as a bridge-to-transplant. This characteristic is significant sinceapproximately 50% of bridge-to-transplant patients treated with the Thoratec VAD require right aswell as left-sided ventricular assist. The Thoratec VAD is also the only device approved for bothbridge-to-transplantation and recovery following cardiac surgery. We are working with the FDA togain approval for a therapeutic recovery indication for the Thoratec VAD. The Thoratec VADincorporates our proprietary biomaterial, Thoralon, which has excellent tissue and bloodcompatibility and is resistant against blood clots.     The Thoratec VAD uses our TLC-II driver, which is a small portable driver that increasesportability and ambulation options compared to the typical drive console. The TLC-II portabledriver was approved in the U.S. in June 2001 for use in off-site excursions and in December 2003for home discharge use. The TLC-II has been approved for use in Europe since 1998.*The Thoratec IVAD*     We received CE Mark certification to market the Thoratec IVAD in Europe in July 2003 and FDAapproval for the U.S. market in August 2004. The IVAD was approved in Canada in November 2004. TheIVAD is the only currently approved implantable cardiac assist device that can provide left, rightor biventricular support. The IVAD maintains the same blood flow path, valves and blood pump as theparacorporeal (Thoratec VAD) device and is better suited for longer-term support compared to theThoratec VAD. The outer covering of the IVAD is made of a titanium alloy, which facilitatesimplantation. The device weighs less than one pound and can be implanted in patients ranging inweight from 90 lbs to more than 220 lbs. The IVAD is designed as a bridge-to-transplantation andpotentially for therapeutic recovery, but is not currently considered for Destination Therapy.*The HeartMate XVE LVAS*     The HeartMate VE initially received FDA approval in September 1998. The enhanced version ofthe product, called the HeartMate XVE, received FDA approval in December 2001 forbridge-to-transplantation. In April 2003, the HeartMate XVE received FDA approval for DestinationTherapy. The HeartMate XVE is designed for use for a duration from several months to up to two orthree years. The HeartMate XVE offers only left ventricular support. Patients with a HeartMate XVEdo not require anti-coagulation drugs, other then aspirin, because of the product’s incorporationof proprietary textured surfaces and tissue valves. As a result, we believe this device has thelowest rate of stroke incidence for patients using ventricular support. The implantable nature ofthis device enables patient mobility and home discharge.*The HeartMate II*     The HeartMate II is a next generation device intended for long-term cardiac support (5-7years) for patients who are in late-stage heart failure. The HeartMate II is a small, implantable,electrically powered device that weighs about 12 ounces and is approximately 1.7 inches in diameterand 3.2 inches long. In addition to being significantly smaller than the HeartMate XVE, with onlyone moving part the HeartMate II is simpler and designed to operate more quietly than pulsatiledevices. As an axial flow device, the HeartMate II is designed to provide blood flow through thecirculatory system on a continual basis and is smaller and easier to implant than pulsatiledevices. More than 180 patients have been enrolled in the clinical trials of the HeartMate IIdevice as of the end of 2005. The Investigational Device Exemption (IDE) for the pivotal trial inthe U.S. for both bridge-to-transplantation and Destination Therapy indications for use was fullyapproved by the FDA in May 2005. Approval to apply the CE Mark for commercial distribution inEurope was obtained in November 2005.*VAD Products Under Development*     We are also developing the HeartMate III, which is a centrifugal, continuous flow pump thatincorporates a magnetically levitated rotor in order to eliminate the potential for bearing-inducedwear. The device is designed for implantation of 10 years or more in patients with late-stage HF,including Destination Therapy, bridge-to-transplantation and therapeutic recovery. The productdesign is being finalized and pre-clinical studies are being performed to ready the device forclinical evaluation.
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***Vascular Graft Products***     The *Vectra*vascular access graft was approved for sale in the U.S. in December 2000 and inEurope in January 1998. It is designed for use as a shunt between an artery and a vein, primarilyto provide access to the bloodstream for renal hemodialysis patients requiring frequent needlepunctures during treatment.**ITC Segment**     Our ITC segment offers a broad portfolio of point-of-care diagnostic test systems and incisionproducts.***Point-of-Care Diagnostics***     Our ITC point-of-care product lines consist of the following: **•** Hemochron point-of-care coagulation system;  **•** Immediate Response Mobile Analysis, or IRMA, point-of-care blood gas/electrolyte and chemistry system;  **•** ProTime coagulation monitoring system; and  **•** Hemoglobin Pro system.*Hospital point-of-care*     The Hemochron and IRMA products are primarily sold into the hospital point-of-care segment ofthe market.  Hemochron is used to monitor a patient’s coagulation while being administered anticoagulants invarious settings, including in the cardiovascular operating room to monitor the drug Heparin andin an anticoagulation clinic to monitor the drug Coumadin. Hemochron is considered a moderatelycomplex device and must be used by professionally trained personnel. The system consists of asmall, portable analytical instrument and disposable test cuvettes.   IRMA is used to monitor a patient’s blood gas/electrolyte and chemistry status. It is consideredmoderately complex and its use requires supervision by professionally trained personnel. Thesystem consists of a small, portable analytical instrument and disposable test cartridges.*Alternate site point-of-care*     The ProTime and Hemoglobin Pro products are sold into the alternate site point-of-care marketcomprising physicians’ offices, long-term care facilities, clinics, visiting nurse associations,and home healthcare companies.  ProTime is used to monitor a patient’s coagulation while taking oral anticoagulants such asCoumadin, and can be prescribed to be used by the patient at home or in the physician’s office orclinic. The system consists of a small, portable analytical instrument and disposable testcuvettes.   Hemoglobin Pro, or Hgb Pro, is used by professionals, mainly in doctor’s offices to test foranemia; it provides quick results from a very small blood sample. The system consists of a small,hand-held test meter and disposable test strips.     Growth in this market is being fueled by convenience and ease of use for patients andphysicians. In addition, in the case of the ProTime monitoring of oral anticoagulants, clinicalstudies have shown that more frequent monitoring results in patients that stay in their therapeuticrange 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.***Incision Products***     Our ITC incision product lines consist of the following: **•** Tenderfoot incision;
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 **•** Tenderlett incision; and,  **•** Surgicutt Bleeding Time Devices.     Our incision products are used to obtain a patient’s blood sample for diagnostic testing.These products are sold to both the hospital and alternate site point-of-care markets. Our productsoffer certain advantages and command a premium over the competition, and are sold in the higher endof the market.  Tenderfoot is used by professionals as a “heel stick” for infant testing, allowing blood to flowmore freely to reduce the need to squeeze the foot. The Tenderfoot is our most successfulincision product and is available in four incision depths. We market this product based on itshigh-end features. Long-term, however, we believe that price will increasingly drive purchasingdecisions.   Tenderlett is used by professionals as a finger incision device that contains a surgicalstainless steel blade that incises to a controlled, standardized depth. The Tenderlett creates asmall, shallow incision in the finger and is available in three incision depths.   Surgicutt is used to perform screening tests to determine platelet function. This product isalso engineered to perfect the bleeding time test and better control many of the variables thathave previously hindered test standardization. The Surgicutt contains a stainless steel bladethat incises to a standardized depth and length for more reproducible results. It is sold inthree sizes to meet the needs of specific patient populations from infants to adults.     The growth in this segment will require increased patient testing, better patient outcomesreflecting the importance of timely and accurate results for health care professionals andincreased decentralization of testing from central laboratories to point-of-care.     Our cardiac assist and vascular graft products represented 62%, 60%, and 63% of our productsales in 2005, 2004, and 2003, respectively. Our point-of-care blood diagnostics test systems andservices and incision products amounted to 38%, 40% and 37% of our total product sales in 2005,2004, and 2003, respectively. For financial information related to our segments for each of thepast three years, please see Item 8, Note 11 to our Consolidated Financial Statements.**SALES AND MARKETING*****Circulatory Support Products***     Hospitals that perform open heart surgery and heart transplants are the potential customersfor our circulatory support products. We estimate that 136 of the approximately 1,000 hospitals inthe U.S. that perform open-heart surgery also perform heart transplants. We actively market toheart transplant hospitals and large cardiac surgery centers as well as to the approximately 100heart transplant hospitals in Europe.     We have recruited and trained a direct sales force that, as of December 31, 2005, comprised 19experienced cardiovascular sales specialists to sell our circulatory support systems in the U.S.,Canada, France, Germany, Spain, United Kingdom, Austria, Switzerland, Netherlands, Portugal andSouth Africa.     Thoratec’s sales effort is complemented by 13 direct clinical specialists and five heartfailure therapy specialists. The clinical specialists conduct clinical educational seminars,assist with a new open-heart center’s first VAD implant and resolve clinical questions or issues.Our heart failure therapy specialists work with lour leading VAD centers to generate referrals andincrease awareness in the cardiology community regarding hemodynamic restoration therapy and VADs.We partner with universities, experienced clinicians and opinion leaders to assist with expandingclinical educational needs. The sales team focuses on cardiac surgeons that perform hearttransplantation, perfusionists and the transplant nursing staff.     In addition to our direct selling efforts, we have a network of international distributors whocover those markets representing the majority of our remaining VAD sales potential. Our sales andmarketing tactics include direct mail, education seminars, symposia, equipment purchase and leaseprograms and journal advertisements, all common in the cardiovascular device market.     Hospitals or other medical institutions that acquire a VAD system generally purchase VADpumps, related disposables and training materials, and purchase or rent two of the associated pumpdrivers (to ensure that a backup driver is available). The time from the initial contact with thecardiac surgeon until purchase is generally between nine and 18 months, due to the expense of theproduct
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and common hospital capital equipment acquisition procedures. Upon receipt of a purchaseorder, we usually ship the products within thirty days.     The introduction of a VAD system in a hospital or other medical facility requires that thesurgical and clinical support personnel possess certain product expertise. We provide initialtraining and “best practice” instruction for these personnel, along with a variety of trainingmaterials that accompany the initial delivery of our VAD products, including instructions for use,patient management manuals and assorted videos. We provide clinical support during implants andprovide 24-hour access to clinically trained personnel. In addition, our sales force helpscustomers understand and manage reimbursement from third-party payors.***Vascular Graft Products***     We market the *Vectra*through C.R. Bard Corp. (a competitor of ours) in the U.S., and selectedcountries in Europe, the Middle East and Northern Africa and through Goodman Co. Ltd. in Japan. OnDecember 5, 2005 we modified our distributor agreement to continue exclusive distribution untilDecember 31, 2006.***Point-of-Care Diagnostics***     In 2005, ITC completed the process of establishing a direct sales force in the U.S. to sellour hospital point-of-care coagulation and IRMA products. We currently maintain a direct salesstaff of 46 people in the U.S. that sell directly to hospitals and to distributors in the alternatesite market. Outside the U.S., ITC has four salespeople selling principally to third partydistributors. ITC’s product sales prior to 2005, came through our distributor channels, withQuality Assured Services as our largest distributor.     As we have integrated the IRMA product line of blood gas analyzers into our business, anincreasing portion of our revenue in the U.S. market has been generated by direct sales rather thanthrough distributors. This shift has required expanding the sales, technical service, customerservice and shipping headcount at ITC to provide our customers with the support and servicehistorically provided by our distributors.***Incision Products***     Our incision products are sold by distributors worldwide. Our largest incision distributor inthe U.S. market is Cardinal Healthcare, which generated 71% of ITC’s annual incision product salesin 2005. In October of 2005, we appointed a second distributor, Surgilance, for our Tenderfootincision product in the U.S. market. Both Cardinal and Surgilance will distribute the Tenderfoot ona co-exclusive basis in the U.S.**COMPETITION**     Competition from medical device companies and medical device divisions of health care andpharmaceutical companies is intense and is expected to increase. Our principal competitors for theVAD system include WorldHeart Corporation, MicroMed Technology, Inc., AbioMed, Inc., and SynCardiaSystems, Inc. in the U.S. and Berlin Heart AG in Europe. Principal competitors in the vasculargraft market include W.L. Gore, Inc., C.R. Bard and Boston Scientific Corporation. Principalcompetitors in the hospital coagulation and blood gas monitoring equipment market include theCardiac Surgery Division of Medtronic, Inc., Radiometer A/S, Abbott Diagnostics, and InstrumentLaboratories. Our primary competitor in the skin incision device market is Becton, Dickson andCompany. Competitors in the alternate site point-of-care diagnostics market include RocheDiagnostics and HemoSense, Inc.     We believe that key competitive factors include the relative speed with which we can developproducts, complete clinical testing, receive regulatory approvals, achieve market acceptance andmanufacture and sell commercial quantities of our products.     We estimate that we have a majority of the VAD market domestically and more than 50%internationally. We believe that potential competitors are several years away from completion ofclinical trials required before those products will become commercially available and compete withour products in the U.S. In addition, unless our competitors’ products result in significantlybetter outcomes than our products, we believe that absent any compelling reason, cardiac centerswill not generally change suppliers.     Large medical device companies dominate the markets in which our ITC business competes and weestimate that we hold anywhere from a 2% to 20% market share, depending on the product. We expectthat our growth in this market will be generated by gaining market share and from a shift oftesting from the central laboratory to the point-of-care. However, this market segment is verycompetitive, and includes the following potential drivers:
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 **•** New competitors might enter the market with broader test menus. To address this risk, inlate 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 opportunityto develop the next generation system that combines blood gas and electrolyte testing in onemachine.  **•** New drug therapies under development may not require the intense monitoring of apatient’s coagulation necessary with the current anti-coagulation drug of choice, Heparin.To try to mitigate this risk, we participate in clinical trials with key pharmaceuticalcompanies to provide the hemostasis monitoring that will ultimately be required for new drugtherapies.**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 pertainingto the TLC-II, the Thoratec VAD system is not protected by any other patents. We do not believethat this lack of patent protection will have a material adverse effect on our ability to sell ourVAD system because of the lengthy regulatory period required to obtain approval of a VAD. Severalpatents cover aspects of our HeartMate line of products.     Our patents relating to blood coagulation, blood gas, blood electrolytes, and blood chemistrydevices include patents transferred to ITC as part of our acquisition of the IRMA blood analysissystem business from Diametrics Medical. We own or hold rights in the remainder of the U.S. patentsby virtue of the merger between Thoratec and TCA, which resulted in the transfer of the ownershipof the TCA patents to Thoratec.     Several patents cover aspects of our proprietary biomaterials technology. Aspects of our bloodcoagulation, blood gas, blood electrolytes, blood chemistry, and skin incision device products arecovered by patents directed to tube-and micro-coagulation whole blood analysis, including testmethods, reagents and integral (on-board) controls, thick film electrochemical analysis of bloodgases, blood electrolytes, and blood chemistry, and low trauma skin incision devices for capillaryblood sampling, and methods of manufacturing such devices. The duration remaining of some of ourbiomaterials patents ranges from four to nine years, on our grafts from two to 15 years and on our bloodcoagulation, blood gas, blood electrolytes, blood chemistry, and skin incision device products fromtwo to 16 years. During the term of our patents, we have the right to prevent third parties frommanufacturing, marketing or distributing products that infringe upon our patents.     In addition, we hold several patents on the HeartMate II axial blood flow pump andtranscutaneous energy transmission technology, the remaining duration of which ranges from nine to16 years. In August 1998, we obtained a license to incorporate technology developed by SulzerElectronics Ltd. and Lust Antriebstechnik GmbH into the HeartMate III. HeartMate III is a miniaturecentrifugal pump featuring a magnetically levitated rotor with a bearingless motor that has beendeveloped by Levitronix GmbH. The license from Sulzer and Lust gives us the exclusive right to usein our HeartMate products technology protected by several U.S. and foreign patents coveringimplantable bearingless motors for the duration of those patents, subject to our payment ofroyalties. In December 2000, we were informed by Sulzer Electronics that Sulzer had sold all of itsbusiness in the bearingless motor and magnetic bearing fields to Levitronix and had assigned itsportion of the agreements between Sulzer and us to Levitronix. We believe that the license remainsin full force and effect.     We also hold, or have exclusive rights to, several international patents.     We have developed technical knowledge which, although non-patentable, we consider to besignificant in enabling us to compete. It is our policy to enter into confidentiality agreementswith each of our employees prohibiting the disclosure of any confidential information or tradesecrets. In addition, these agreements provide that any inventions or discoveries by employeesrelating to our business will be assigned to us and become our sole property.     Despite our patent rights and policies with regard to confidential information, trade secretsand inventions, we may be subject to challenges to the validity of our patents, claims that ourproducts allegedly infringe the patent rights of others and the disclosure of our confidentialinformation or trade secrets. These and other related risks are described more fully under theheading “*Our inability to protect our proprietary technologies or an infringement of others’patents could harm our competitive positions*” in the “Risk Factors” section of this Annual Report.     At this time, we are not a party to any material legal proceedings that relate to patents orproprietary rights.
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**GOVERNMENT REGULATIONS**     Regulation by governmental authorities in the United States and foreign countries is asignificant factor in the manufacture and marketing of our current and future products and in ourongoing product research and development activities. All of our proposed products will requireregulatory approval prior to commercialization. In particular, medical devices are subject torigorous pre-clinical testing as a condition of approval by the FDA and by similar authorities inforeign countries.***U.S. Regulations***     In the U.S., the FDA regulates the design, manufacture, distribution and promotion of medicaldevices pursuant to the Federal Food, Drug, and Cosmetic Act and its regulations. Our VAD systems,blood coagulation testing devices, skin incision devices, and *Vectra*graft products are regulatedas medical devices. To obtain FDA approval to market VADs similar to those under development, theFDA requires proof of safety and efficacy in human clinical trials performed under anInvestigational Device Exemption (IDE). An IDE application must contain pre-clinical test datasupporting the safety of the product for human investigational use, information on manufacturingprocesses and procedures, proposed clinical protocols and other information. If the IDE applicationis accepted, human clinical trials may begin. The trials must be conducted in compliance with FDAregulations and with the approval of one or more institutional review boards. The results obtainedfrom these trials, if satisfactory, are accumulated and submitted to the FDA in support of either aPre-Market approval, or PMA application, or a 510(k) premarket notification. There are substantialuser fees that must be paid at the time of PMA, PMA Supplement or 510(k) submission to the FDA tohelp offset the cost of scientific data review that is required before the FDA can determine if thedevice is approvable. Premarket approval from the FDA is required before commercial distribution ofdevices similar to those under development by us is permitted in the U.S.     A PMA Supplement is required to make modifications to a device or application approved by aPMA. A PMA Supplement must be supported by extensive preclinical data, and sometimes human clinicaldata, to prove the safety and efficacy of the device with respect to the modifications disclosed inthe supplement. By regulation, the FDA has 180 days to review a PMA application, during which timean advisory committee may evaluate the application and provide recommendations to the FDA. Whilethe FDA has approved PMA applications within the allotted time period, reviews can occur over asignificantly protracted period, usually 18 to 36 months, and a number of devices have never beencleared for marketing. This is a lengthy and expensive process and there can be no assurance thatFDA 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 seekmarketing clearance from the FDA to market the device by filing a 510(k) premarket notificationwith the FDA. This is the process that is used to gain FDA market clearance for most of ITC’sproducts. The 510(k) premarket notification must be supported by data establishing the claim ofsubstantial equivalence to the satisfaction of the FDA. The process of obtaining a 510(k) clearancetypically can take several months to a year or longer. If substantial equivalence cannot beestablished, or if the FDA determines that the device requires a more rigorous review, the FDA willrequire that the manufacturer submit a PMA application that must be approved by the FDA prior tomarketing the device in the U.S.     Both a 510(k) and a PMA, if approved, may include significant limitations on the indicateduses for which a product may be marketed. FDA enforcement policy prohibits the promotion ofapproved medical devices for unapproved uses. In addition, product approvals can be withdrawn forfailure to comply with regulatory requirements or the occurrence of unforeseen problems followinginitial marketing.     The approval process for each of our products is expensive and time consuming and we cannot besure that any regulatory agency will grant its approval. Our inability to obtain, or delays inobtaining, such approval would adversely affect our ability to begin marketing our products. Wecannot assure you that we will have sufficient resources to complete the required testing andregulatory review processes. Furthermore, we are unable to predict the extent of adversegovernmental regulations, which might arise from future U.S. or foreign legislative oradministrative action. On October 26, 2002, the FDA signed into law The Medical Device User Fee andModernization Act of 2002. This law amends the FDA Act and regulations to provide, among otherthings, the ability for the FDA to impose user fees for medical device reviews. Our activitiesrequire that we make many filings with the FDA that are subject to this fee structure. Although theprecise amount of fees that we will incur each year will be dependent upon the specific quantityand nature of our filings, these fees could be a significant amount per year.     In addition, any products distributed pursuant to the above authorizations are subject tocontinuing regulation by the FDA. Products must be manufactured in registered establishments andmust be manufactured in accordance with Quality System Regulations. Adverse events must be reportedto the FDA. Labeling and promotional activities are subject to scrutiny by the FDA and, in certaininstances, by the Federal Trade Commission. The FDA often requires post market surveillance, orPMS, for significant risk devices, such as VADs, that require ongoing collection of clinical dataduring commercialization that must be gathered, analyzed and
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submitted to the FDA periodically for up to several years. These PMS data collectionrequirements are often burdensome and expensive and have an effect on the PMA approval status. Thefailure to comply with the FDA’s regulations can result in enforcement action, including seizure,injunction, prosecution, civil penalties, recall and/or suspension of FDA approval. The export ofdevices such as ours is also subject to regulation in certain instances.     We are also subject to regulation by various state authorities, which may inspect ourfacilities and manufacturing processes and enforce state regulations. Failure to comply withapplicable state regulations may result in seizures, injunctions or other types of enforcementactions.***International Regulations***     We are also subject to regulation in each of the foreign countries in which we sell products.These regulations relate to product standards, packaging and labeling requirements, importrestrictions, tariff regulations, duties and tax requirements. Many of the regulations applicableto our products in these countries are similar to those of the FDA. The national health or socialsecurity organizations of certain countries require our products to be qualified before they can bemarketed in those countries.     In order to be positioned for access to European and other international markets, we soughtand obtained certification under the ISO 13485 Series of Standards. ISO 13485 is a set ofintegrated requirements, which when implemented form the foundation and framework for an effectivequality management system. These standards were developed and published by the ISO, a worldwidefederation of national bodies, founded in Geneva, Switzerland in 1947. ISO has more than 90 membercountries and ISO certification is widely regarded as essential to enter Western European markets.We obtained EN ISO 13485:2003 Certification in February 2006. Since 1998, all companies arerequired to obtain CE Marks for medical devices sold or distributed in the European Union. The CEMark is an international symbol of quality. With it, medical devices can be distributed within theEuropean Union. A prerequisite for obtaining authority to CE Mark products is to achieve fullquality system certification in accordance with ISO 13485 and European Directives, such as theMedical Device Directive (MDD), In-Vitro Device Directive (IVDD) and the Active Implantable MedicalDevice Directive (AIMD). These are quality standards that cover design, production, installationand 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 devices, blood coagulation testing devices, *Vectra*graft and VADsystems such as the Thoratec VAD, IVAD and HeartMate Systems. We are also certified to be incompliance with the requirements of the Canadian Medical Device Regulations (CMDRs) at all Thoratecmanufacturing sites, which certification is required to sell medical devices in Canada.***Other Regulations***     We are also subject to various federal, state and local laws and regulations relating to suchmatters as safe working conditions, laboratory and manufacturing practices and the use, handlingand disposal of hazardous or potentially hazardous substances used in connection with our researchand development work. Specifically, the manufacture of our biomaterials is subject to compliancewith federal environmental regulations and by various state and local agencies. Although we believewe are in compliance with these laws and regulations in all material respects, we cannot provideassurance that we will not be required to incur significant costs to comply with environmental lawsor regulations in the future.**THIRD PARTY REIMBURSEMENT AND COST CONTAINMENT**     Our products are purchased primarily by hospitals and other users, which then bill variousthird 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 thereasonable costs and fees associated with these devices and the procedures performed with thesedevices.     To date, CMS and a majority of private insurers with whom we have dealt approved reimbursementfor our VADs and our diagnostic and vascular graft products. Effective October 1, 2003, CMS issueda National Coverage Decision Memorandum for the use of LVAS that are approved by the FDA fortreating Destination Therapy in late-stage HF patients. Sixty-nine centers are now recognized byCMS as Medicare LVAD centers.     Effective October 1, 2004, Medicare reimbursement payment increased for heart assist deviceswith CMS LVAD centers receiving an average payment of approximately $90,000 to approximately$136,000. This change of DRG category for implantable heart assist devices to DRG 103 from 525 hasraised the average payment under DRG 103 by more than 30%. Twenty-six new Healthcare CommonProcedure Coding System codes also have been created by CMS to provide reimbursement for outpatientequipment and supplies. Since FDA approval of the HeartMate LVAS for Destination Therapy, severalprivate payors also have issued positive coverage decisions. In December 2002, Blue Cross/BlueShield Technology Evaluation Center issued a positive decision on the use of
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LVADs for Destination Therapy. The majority of local Blue Cross Blue Shield plans now havecreated positive medical policy for both bridge-to-transplantation and Destination Therapyindications. Since December 2002, the majority of national private insurance carriers, such asAetna, Cigna, Humana, United Health Group and UNICARE, have issued positive coverage policies tocover the use of ventricular assist devices for FDA-approved indications, including DestinationTherapy.     The reimbursement policies and practices of third party payors are subject to changes thatmight be unfavorable to our VAD systems and such unfavorable changes could seriously harm sales ofour products.**MANUFACTURING**     Our Cardiovascular segment products are manufactured at our facility in Pleasanton,California. This facility has been inspected, approved and licensed by the FDA and the State ofCalifornia Department of Health Services, Food and Drug Section for the manufacture of medicaldevices and has received the International Standards Organization (ISO) 9001 certification. Ourmanufacturing processes consist of the assembly of standard and custom component parts, and thetesting of completed products. We rely on single sources of supply for several components of ourVADs. We are aware of alternative suppliers for a majority, but not all, of our single-sourceditems.     Our ITC segment blood coagulation testing and skin incision devices are manufactured inEdison, New Jersey, with the exception of the ProTime instrument and the hemoglobin monitor, whichare manufactured through single source third party contract manufacturers in China and Germany,respectively. Our blood gas analyzer devices are manufactured in Roseville, Minnesota. The NewJersey and Minnesota facilities have been inspected, approved and licensed by the FDA andapplicable state regulators. In addition, these facilities maintain ISO9001, ISO 13485 and Canadian(CMDCAS) ISO certifications.     A significant amount of our ITC segment manufacturing at these facilities is verticallyintegrated, with only limited reliance on third parties, such as for the manufacture of printedcircuit boards and the sterilization and testing of products. We rely on single sources of supplyfor some components manufactured at our New Jersey and Minnesota facilities, and use safety stockswhere there might be risk in qualifying a second supplier in a timely manner.     Both segments have typically been able to fill orders from inventory and historically have nothad significant order backlogs. At the end of 2004 and during 2005, we experienced backlog due tohigher demand. We have expanded capacity during 2005 and plan to continue expansion efforts in 2006to accommodate the increased demand for both the Cardiovascular and ITC manufacturing locations.Total backlog as of the end of fiscal 2005 and 2004 were approximately $1.2 million and $0.6million for our Cardiovascular segment and $0.5 million and $0.7 million for our ITC segment,respectively.**RESEARCH AND DEVELOPMENT**     Thoratec’s research and development expenses in 2005, 2004 and 2003 totaled $32.3 million,$28.7 million, and $26.1 million, respectively. Research and development costs are largely projectdriven, and the level of spending depends on the level of project activity planned and subsequentlyapproved and conducted. The primary component of our research and development costs is employeesalaries and benefits. Projects related to our Cardiovascular segment typically include clinicaltrials, such as our HeartMate II pivotal trial, efforts to develop new products, such as theHeartMate II and HeartMate III, and efforts to improve the operation and performance of currentproducts, such as efforts to improve the life of various components of the HeartMate and ThoratecVAD products. ITC research and development projects are typically involved with developinginstruments and disposable test cuvettes or cartridges that will be used at the point-of-care. Onesuch system is the Hemochron Signature Elite which was introduced in September of 2005. Inaddition, ITC devotes research and development efforts to maintain and improve current productsbased on customer feedback. Research and development costs for both segments also includeregulatory and clinical costs associated with our compliance with FDA regulations and clinicaltrials such as the Phase II HeartMate II pivotal trial.**MAJOR CUSTOMERS AND FOREIGN SALES**     We primarily sell our products to large hospitals and distributors. No customer accounted formore than 10% of total product sales in fiscal year 2005.     Sales originating outside the U.S. and U.S. export sales accounted for approximately 23%, 23%and 19% for the years ended 2005, 2004 and 2003, respectively, of our total product sales. Noindividual foreign country accounted for a material portion of our net sales in any of the lastthree fiscal years.
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**EMPLOYEES**     As of December 31, 2005, we had a total of 963 employees, consisting of 955 full-timeemployees and eight part-time employees, 526 of whom worked in manufacturing, 99 in engineering,127 in quality control and regulatory affairs, 137 in marketing and sales support, 33 inadministration and finance and 41 in other support functions, including human resources, managementinformation systems, purchasing and facilities. Of our total employees, 938 are employed in theU.S. and 25 are employed in the United Kingdom and other European countries. None of our employeesare covered by a collective bargaining agreement. We consider relations with our employees to begood.**ADDITIONAL INFORMATION**     Additional information about Thoratec is available on our website at http://www.thoratec.com(although none of this information is, or should be deemed to be, incorporated by reference intothis Annual Report on Form 10-K). We make filings of our periodic reports to the Securities andExchange Commission (“SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Qand current reports on Form 8-K, as well as amendments to those reports, available free of chargeon our website as soon as reasonably practicable following electronic filing of those reports withthe SEC.**Item 1A.*****Risk Factors***     *Our business faces many risks. These risks include those related to the development of newproducts and markets including Destination Therapy, the growth of existing markets for ourproducts, customer and physician acceptance of our products, changes in the mix of our productsales, 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, regulatoryapproval processes, the effect of healthcare reimbursement and coverage policies, our productsales, the effects of price competition from any of our competitors and the effects of any mergerand acquisition related activities. The risks described below are what we believe to be thematerial risks facing our company. However, the risks described below may not be the only risks weface. Additional risks that we do not yet know of or that we currently believe are immaterial mayalso impair our business operations. If any of the events or circumstances described in thefollowing risk factors actually occur, our business, financial condition or results of operationscould suffer, and the trading price of our common stock could decline significantly. Investorsshould consider the following risks, as well as the other information included in this AnnualReport on**Form 10-K**, and other documents we file from time to time with the SEC, such as ourquarterly reports on**Form 10-Q**, our current reports on**Form 8-K**and any public announcements wemake from time to time.****If we fail to obtain approval from the FDA and from foreign regulatory authorities, we cannotmarket and sell our products under development in the U.S. and in other countries, and if we failto adhere to ongoing FDA Quality System Regulations, the FDA may withdraw our market clearance ortake other action.***     Before we can market new products in the U.S., we must obtain PMA approval or 510(k) clearancefrom the FDA. This process is lengthy and uncertain. In the U.S., one must obtain clearance fromthe FDA of a 510(k) pre-market notification or approval of a more extensive submission known as aPMA application. If the FDA concludes that any of our products do not meet the requirements toobtain clearance under Section 510(k) of the Federal Food, Drug, and Cosmetic Act, then we will berequired to file a PMA application. The process for a PMA application is lengthy, expensive andtypically requires extensive pre-clinical and clinical trial data.     We may not obtain clearance of a 510(k) notification or approval of a PMA application withrespect to any of our products on a timely basis, if at all. If we fail to obtain timely clearanceor approval for our products, we will not be able to market and sell them, thereby harming ourability to generate sales. The FDA also may limit the claims that we can make about our products.We also may be required to obtain clearance of a 510(k) notification or a PMA Supplement from theFDA before we can market products that have been cleared, that have since been modified or that wesubsequently wish to market for new disease indications.     The FDA also requires us to adhere to Quality System Regulations, which include productiondesign controls, testing, quality control, storage and documentation procedures. The FDA may at anytime inspect our facilities to determine whether we have adequate compliance. Compliance withQuality System Regulations for medical devices is difficult and costly. In addition, we may not befound to be compliant as a result of future changes in, or interpretations of, regulations by theFDA or other regulatory agencies. If we do not achieve compliance, the FDA may withdraw marketingclearance, require product recall or take other enforcement action, which in each case would harmour business. Any change or modification to a device is required to be made in compliance withQuality System Regulations, which compliance may cause interruptions or delays in the marketing andsale of our products. The FDA also requires device manufacturers to submit reports regardingdeaths, serious injuries and certain malfunctions relating to use of their products.
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     Sales of our products outside the U.S. are subject to foreign regulatory requirements thatvary from country to country. The time required to obtain approvals from foreign countries may belonger or shorter than that required for FDA approval, and requirements for foreign licensing maydiffer from FDA requirements. In any event, if we fail to obtain the necessary approvals to sellany of our products in a foreign country, or if any obtained approval is revoked or suspended, wewill not be able to sell those products there.     The federal, state and foreign laws and regulations regarding the manufacture and sale of ourproducts are subject to future changes, as are administrative interpretations and policies ofregulatory agencies. If we fail to comply with applicable federal, state or foreign laws orregulations, we could be subject to enforcement actions. Enforcement actions could include productseizures, recalls, withdrawal of clearances or approvals, and civil and criminal penalties, whichin each case would harm our business.***If hospitals do not conduct Destination Therapy procedures using our VADs, market opportunities forour product will be diminished.***     The use of our VADs as long-term therapy in patients who are not candidates for hearttransplantation (i.e., Destination Therapy patients) was approved by the FDA in 2002, and wasapproved for reimbursement by CMS in late 2003.     The number of Destination Therapy procedures actually performed depends on many factors, manyof 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, whichinclude the costs of the VAD and related pre- and post-operative procedures and theirreimbursement;  **•** the impact of changes in reimbursement rates on the timing of purchases of VADs forDestination Therapy; and  **•** the economics for individual hospitals of not conducting a Destination Therapy procedure,including the costs and related reimbursements of long-term hospitalization.     The different outcomes of these and other factors, and their timing, will have a significantimpact on our future Cardiovascular product sales.***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 acceptanceby cardiovascular and vascular surgeons, and other medical professionals. Such acceptance willdepend 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 futureproducts are established, physicians may elect not to use them for a number of reasons. Thesereasons could include the high cost of our VAD systems, restrictions on insurance 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.***We rely on specialized suppliers for certain components and materials in our products andalternative suppliers may not be available.***     We depend on a number of custom-designed components and materials supplied by other companiesincluding, in some cases, single source suppliers for components, instruments and materials used inour VAD products and blood testing products. For example, single sources currently manufacture andsupply our ProTime and Hemoglobin instruments and the heart valves used in our HeartMate products.The suppliers of our ProTime and Hemoglobin products are located in China and Germany,respectively. We do not have long-term written agreements with most of our vendors and receivecomponents from these vendors on a purchase order basis only. If we need alternative sources forkey raw materials or component parts for any reason, such alternative sources may not be availableand our inventory may not be sufficient to fill orders before we find alternative suppliers orbegin manufacturing these components or materials ourselves. Cessation or interruption of sales ofcirculatory support products 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 requireFDA approval before using new
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suppliers or manufacturing our own components or materials. Existing suppliers could alsobecome subject to an FDA enforcement action, which could also disrupt our supplies. If alternativesuppliers are not available, we may not have the expertise or resources necessary to produce thesematerials or component parts internally.     Because of the long product development cycle in our business, suppliers may discontinuecomponents upon which we rely before the end of life of our products. In addition, the timing ofthe discontinuation may not allow us time to develop and obtain FDA approval for a replacementcomponent 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 obtainalternative suppliers;  **•** buy substantial inventory to last through the scheduled end of life of our product, orthrough 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 thediscontinued component is exhausted.     Any of these interruptions in the supply of our materials could result in substantialreductions in product sales and increases in our production costs.***We may encounter problems manufacturing our products.***     We may encounter difficulties manufacturing products in quantaties sufficient to meet demandin the quantities required. We do not have experience in manufacturing some of our products in thecommercial quantities that might be required if we receive FDA approval of those products andindications currently under development, including the HeartMate II VAD. If we have difficultymanufacturing any of our products, our sales may prove lower than would otherwise be the case andour reputation could be harmed.***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 thatany problems identified in a finished product can easily be traced back to other finished productscontaining the defective materials. In some instances, identified quality issues require scrappingor expensive rework of the affected lot(s), not just the tested defective product, and could alsorequire us to stop shipments.     In addition, since some of our products are used in situations where a malfunction can be lifethreatening, identified quality issues can result in the recall and replacement, generally free ofcharge, of substantial amounts of product already implanted or otherwise in the marketplace.     Any identified quality issue can therefore both harm our business reputation and result insubstantial costs and write-offs, which in either case could materially harm our business andfinancial results.***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 productsand product improvements. We also intend to develop new indications for our existing products. Forexample, we are currently developing updated versions of our HeartMate and Point-of-Care blooddiagnostics products. If we fail to commercialize these new products, product improvements and newindications on a timely basis, or if they are not well accepted by the market, our future growthmay suffer.***Our inability to protect our proprietary technologies or an infringement of others’ patents couldharm our competitive position.***     We rely on patents, trade secrets, copyrights, know-how, trademarks, license agreements andcontractual provisions to establish our intellectual property rights and protect our products.These legal means, however, afford only limited protection and may not adequately protect ourrights. In addition, we cannot assure you that any of our pending patent applications will issue.The U.S. Patent and Trademark Office may deny or significantly narrow claims made under patentapplications and the issued patents, if any, may not provide us with commercial protection. Wecould incur substantial costs in proceedings before the U.S. Patent and Trademark Office or in anyfuture litigation to enforce our patents in court. These proceedings could result in adversedecisions as to the validity and/or enforceability of our patents. In addition, the laws of some ofthe countries in which our products are or may be sold may not protect our products andintellectual property to the same extent as U.S. laws, if at all. We may be unable to protect ourrights in trade secrets and unpatented proprietary technology in these countries.
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     Our commercially available VAD products, which account for a majority of our sales, generallyare not protected by any patents. We rely principally on trade secret protection and, to a lesserextent, patents to protect our rights to our HeartMate product line. We rely principally on patentsto 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, withconfidentiality agreements with our employees and consultants. Although it is our policy to requirethat all employees and consultants sign such agreements, we cannot assure you that every person whogains or has gained access to such information has done or will do so. Moreover, these agreementsmay 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 toacquire 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 suitsbrought against us on such patents or in bringing suits to protect our patents or patents licensedby us against infringement.     For example, in 2003, a patent infringement claim was filed against us by Bodycote MaterialsTesting 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 fourthquarter of 2003 for the settlement and related legal costs.***Our future product sales in our Cardiovascular segment will be affected by the number of hearttransplants conducted.***     A significant amount of our product sales are generated by our VADs implanted temporarily inpatients awaiting heart transplants. The number of heart transplants conducted worldwide depends onthe number of hearts available to transplant.***Our future disposable cuvette test product sales in our ITC segment could be affected by changes inmonitoring requirements for medical procedures.***     ITC product sales are generated by medical procedures that require monitoring of coagulationand blood gas parameters done in cardiovascular operating rooms and cardiac catheterization labs.The sales of our disposable test products could decline if there were a significant reduction inthose medical procedures.***Since we depend upon distributors, if we lose a distributor or a distributor fails to perform, ouroperations may be harmed.***     With the exception of Canada and the larger countries in Europe, we sell our Thoratec VAD andHeartMate systems in foreign markets through distributors. In addition, we sell our vascular accessgraft products through the Bard Peripheral Vascular division of C.R. Bard Corporation (which isalso a competitor of ours) in the U.S. and selected countries in Europe, the Middle East andAfrica, and through Goodman Co. Ltd. in Japan. Substantially all of the international operationsand a large portion of the alternate site domestic operations of ITC are conducted throughdistributors. For the year ended December 31, 2005, 22% of ITC’s total product sales were throughdistributors.     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 toperform to our expectations, our product sales may be harmed.***If we fail to compete successfully against our existing or potential competitors, our product salesor operating results may be harmed.***     Competition from medical device companies and medical device subsidiaries of health care andpharmaceutical companies is intense and is expected to increase. In the European market,competitors include SynCardia Systems, Inc., Berlin Heart AG and Abiomed, Inc. We will also competewith other, smaller companies that have similar products in trials. Principal competitors in thevascular graft market include W.L. Gore, Inc., C.R. Bard Corporation, which is also a distributorof our *Vectra*product line, and Boston Scientific Corporation. Principal competitors in thehospital coagulation and blood gas monitoring equipment market include the Cardiac Surgery Divisionof Medtronic, Inc., Radiometer A/S, Abbott Diagnostics, and Instrument Laboratories. Our primarycompetitor in the skin incision device market is Becton, Dickson and Company. Competitors in thealternate site point-of-care diagnostics market include Roche Diagnostics and HemoSense, Inc.     Some of our competitors, especially those of our ITC segment, have substantially greaterfinancial, technical, distribution, marketing and manufacturing resources, while other competitorshave different technologies that may achieve broader customer
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acceptance or better cost structures than our products. Accordingly, our competitors may beable to develop, manufacture and market products more efficiently, at a lower cost and with moremarket acceptance than we can. In addition, new drugs or other devices may reduce the need forVADs. We expect that the key competitive factors will include the relative speed with which we can: **•** develop products;  **•** complete clinical testing;  **•** receive regulatory approvals; and  **•** manufacture and sell commercial quantities of products.     Large medical device companies dominate the markets in which ITC competes. We expect that anygrowth in this market will come from expanding our market share at the expense of other companiesand from testing being shifted away from central laboratories to the hospital and alternate sitepoint-of-care. However, this market segment is very competitive and includes the followingpotential drivers: **•** New drug therapies under development may not require the intense monitoring of apatient’s coagulation that the current anti-coagulation drug of choice (Heparin) requires.  **•** New competitors might enter the market with broader test menus.     Any of the devices of our competitors in clinical trials and in development could prove to beclinically superior, easier to implant, and/or less expensive than current commercialized devices,thereby impacting Thoratec’s market share.***Our non-U.S. sales present special risks.***     A substantial portion of our total sales occurs outside the U.S. We anticipate that salesoutside the U.S. and U.S. export sales will continue to account for a significant percentage of ourproduct 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 U.S.;  **•** 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 foreignincome, impose tariffs or adopt other restrictions on foreign trade;  **•** U.S. export licenses may be difficult to obtain;  **•** intellectual property rights may be (and often are) 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 theprofitability, in U.S. dollars, of products sold in foreign markets where payments are madein local currencies.     Any of these events could harm our operations or financial results.***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 currency exchangerates. At present, we use forward foreign currency contracts to hedge the gains and losses createdby the re-measurement of non-functional currency denominated assets and liabilities. However, we donot engage in
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hedge exposures that will arise from future sales. As a result, sales occurring in the futurethat are denominated in foreign currencies may be translated into U.S. dollars at a less favorablerate than our current exchange rate environment resulting in reduced revenues and earnings.***Certain lawsuits have been filed against us.***     On August 3, 2004, a Federal securities law putative class action suits entitled *Johnson v.Thoratec Corporation, et al.*was filed in the U.S. District Court for the Northern District ofCalifornia on behalf of purchasers of our publicly traded securities of the Company between April28, 2004, and June 29, 2004. Subsequent to the filing of the *Johnson*complaint, additionalcomplaints were filed in the same court alleging substantially similar claims. On November 24,2004, the Court entered an order consolidating the various putative class action complaints into asingle action entitled *“In re Thoratec Corp. Securities Litigation”*and thereafter entered an orderappointing Craig Toby as “Lead Plaintiff” pursuant to the Private Securities Litigation Reform Actof 1995. On or about January 18, 2005, Lead Plaintiff filed a Consolidated Complaint. TheConsolidated Complaint generally alleges violations of the Securities Exchange Act of 1934 byThoratec, its former Chief Executive Officer, its former Chief Financial Officer, and itsCardiovascular Division President based upon, among other things, alleged false statements aboutthe Company’s expected sales and the market for HeartMate as a Destination Therapy treatment. TheConsolidated Complaint seeks to recover unspecified damages on behalf of all purchasers of theCompany’s publicly traded securities during the putative class period. On March 4, 2005,defendants moved to dismiss the Consolidated Complaint and that motion currently is pending.     On or about September 1, 2004, a shareholder derivative action entitled *Wong v. Grossman*wasfiled in the California Superior Court for Alameda County based upon essentially the same facts asthe Federal securities class action suit referred to above. This action names the individualmembers of our Board of Directors, including the former Chief Executive Officer and certain othercurrent and former executive officers, as defendants and alleges that the defendants breached theirfiduciary duties and wasted corporate assets, and that certain of the defendants traded in Thoratecsecurities while in possession of material nonpublic information. Proceedings in *Wong v. Grossman*are currently stayed until at least April 2006.     We believe that the claims asserted in both the Federal securities law putative class action andthe state shareholder derivative action are without merit. We have moved to dismiss the Federalaction and will file a similar motion in the *Wong*action if necessary. We are unable to predict atthis time the outcome of these actions.     We carry sufficient insurance to cover what management believes to be any reasonable exposureon these actions; however, we cannot give assurance that our insurance will cover all costs orother exposures we may incur with respect to these actions.***The long and variable sales and deployment cycles for our VAD systems may cause our product salesand operating results to vary significantly, which increases the risk of an operating loss for anygiven fiscal period.***     Our VAD systems have lengthy sales cycles and we may incur substantial sales and marketingexpenses and expend significant effort without making a sale. Even after making the decision topurchase our VAD systems, our customers often deploy our products slowly. For example, the lengthof time between initial contact with cardiac surgeons and the purchase of our VAD systems isgenerally between nine and eighteen months. In addition, the cardiac centers that buy the majorityof our products are usually led by cardiac surgeons who are heavily recruited by competing centersor by centers looking to increase their profiles. When one of these surgeons moves to a new centerwe sometimes experience a temporary but significant reduction in purchases by the departed centerwhile it replaces its lead surgeon. As a result, it is difficult for us to predict the quarter inwhich customers may purchase our VAD systems and our product sales and operating results may varysignificantly from quarter to quarter, which increases the risk of an operating loss for us for anygiven quarter. In particular, sales of our VADs for Destination Therapy have been lower than we hadoriginally anticipated, and we cannot predict when, if ever, sales of our VADs for this indicationwill generate the level of revenues we expect.***Since our physician and hospital customers depend on third party reimbursement, if third partypayors fail to provide appropriate levels of reimbursement for our products, our results ofoperations will be harmed.***     Significant uncertainty exists as to the reimbursement status of newly approved health careproducts such as VADs and vascular grafts. Such uncertainty could delay or prevent adoption ofthese products in volume by hospitals. Government and other third party payors are increasinglyattempting 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 alsoattempting to contain costs by refusing, in some cases, to provide any coverage for uses ofapproved products for disease indications other than those for which the FDA has granted marketingapproval.     To date, a majority of private insurers with whom we have been involved and the Centers forMedicine & Medicaid Services, or
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CMS, have determined to reimburse some portion of the cost of our VADs and our diagnostic andvascular graft products, but we cannot estimate what portion of such costs will be reimbursed, andour products may not continue to be approved for reimbursement. In addition, changes in the healthcare system may affect the reimbursability of future products. If coverage is partially orcompletely reduced, our revenues would be reduced.***Our debt obligations expose us to risks that could adversely affect our business, operating resultsand financial condition.***     We have a substantial level of debt. The terms of our convertible notes do not restrict ourability 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 workingcapital, 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 restrictivecovenants proposed for any such additional debt;  **•** make us more vulnerable in the event of a downturn in our business or an increase ininterest rates; or  **•** place us at a possible competitive disadvantage relative to less leveraged competitorsand competitors that have better access to capital resources.     If we experience a decline in product sales due to any of the factors described in thissection or otherwise, we could have difficulty paying interest or principal amounts due on ourindebtedness. If we are unable to generate sufficient cash flow or otherwise obtain funds necessaryto make required payments, or if we fail to comply with the various requirements of ourindebtedness, including the convertible notes, we would be in default, which would permit theholders of our indebtedness to accelerate the maturity of the indebtedness and could cause defaultsunder our other indebtedness. Any default under our indebtedness could have a material adverseeffect on our business, operating results and financial condition.***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 dueand payable. Holders of the convertible notes may also require us to repurchase the convertiblenotes on May 16 in each of 2011, 2014, 2019, 2024 and 2029. In addition, if certain fundamentalchanges to our company occur, the holders of the convertible notes may require us to repurchase allor any portion of their convertible notes. We may not have sufficient funds or may be unable toarrange for additional financing to pay the principal amount due at maturity or the repurchaseprice of the convertible notes. Any such failure would constitute an event of default under theindenture, which could, in turn, constitute a default under the terms of any other indebtedness wemay have incurred. Any default under our indebtedness could have a material adverse effect on ourbusiness, operating results and financial condition.***Conversion of the convertible notes or other future issuances of our stock will dilute theownership interests of existing shareholders.***     The conversion of some or all of the convertible notes will dilute the ownership interest ofour existing shareholders. Any sales in the public market of the common stock issuable upon suchconversion could adversely affect prevailing market prices of our common stock. Further, theexistence of the convertible notes may encourage short selling of our common stock by marketparticipants because the conversion of the convertible notes could depress the price of our commonstock. In addition, future sales of substantial amounts of our stock in the public market, or theperception that such sales could occur, could adversely affect the market price of our stock. Salesof our shares and the potential for such sales could cause our stock price to decline.     Our adoption of Emerging Issues Task Force (“EITF”) Issue No. 04-8 in the fourth quarter of2004, which requires the inclusion of all shares available upon conversion of our convertible notesin 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 wereoutstanding as
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the effect of the 7.3 million shares was anti-dilutive as of the years ended 2005, 2004 and2003. However, if in future periods the shares are dilutive, then 7.3 million shares will be addedto our share count used to calculate diluted earnings per share, and this inclusion could result insignificantly lower diluted EPS than if we had not adopted EITF 04-8, as they were in the fourthquarter of 2005.***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 intangibleassets.***     A substantial portion of our assets is comprised of goodwill and purchased intangible assets,recorded as a result of our merger with TCA completed in September 2001. We may not receive therecorded value for our intangible assets if we sell or liquidate our business or assets. Thematerial concentration of intangible assets increases the risk of a large charge to earnings if therevenue or recoverability of these intangible assets is impaired. For example, in the firstquarter of 2004, we completed an assessment of the final results from the feasibility clinicaltrial for the Aria CABG graft, which was ongoing through fiscal 2003. Based on the clinical trialresults, we decided not to devote additional resources to development of the Aria graft. Upon thedecision to discontinue product development, we recorded an impairment charge of approximately $9million as of January 3, 2004 to write off purchased intangible assets related to the Aria graft.In the event of another such charge to net income, the market price of our common stock could beadversely affected.***Any claims relating to improper handling, storage or disposal of hazardous chemicals andbiomaterials could be time consuming and costly.***     Producing our products requires the use of hazardous materials, including chemicals andbiomaterials. We cannot eliminate the risk of accidental contamination or discharge and anyresultant injury from these materials.     We could be subject to both criminal liability and civil damages in the event of an improperor 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 thirdparties of these materials, and our liability may exceed our total assets. Compliance withenvironmental laws and regulations is expensive, and current or future environmental regulationsmay impair our research, development or production efforts or harm our operating results.***The competition for qualified personnel is particularly intense in our industry. If we are unableto 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 dependssignificantly upon retaining key research, technical, clinical, regulatory, sales, marketing,managerial and financial personnel, and attracting and retaining additional highly qualifiedpersonnel in these areas. We face intense competition for such personnel, and we may not be able toattract and retain these individuals. We compete for talent with numerous companies, as well asuniversities and nonprofit research organizations, throughout all our locations. The loss of keypersonnel for any reason or our inability to hire and retain additional qualified personnel in thefuture could prevent us from sustaining or growing our business. Our success will depend in largepart on the continued services of our research, managerial and manufacturing personnel. We cannotassure you that we will continue to be able to attract and retain sufficient qualified personnel.***The price of our common stock may fluctuate significantly.***     The price of our common stock has been, and is likely to continue to be, volatile, which meansthat it could decline substantially within a short period of time. For example our closing stockprice has ranged from $9.39 to $22.36 in the 12 months ended December 31, 2005. The price of ourcommon stock could fluctuate significantly for many reasons, including the following: **•** future announcements concerning us or our competitors;  **•** regulatory developments, enforcement actions bearing on advertising, marketing or sales,and disclosure regarding completed/ ongoing or future clinical trials;  **•** quarterly variations in operating results, which we have experienced in the past and expect to experience in the future;  **•** introduction of new products or changes in product pricing policies by us or our competitors;  **•** acquisition or loss of significant customers, distributors or suppliers;
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 **•** reaction to Company guidance;  **•** business acquisitions or divestitures;  **•** changes in earnings estimates by analysts;  **•** changes in third party reimbursement practices;  **•** charges, amortization and other financial effects relating to our merger with TCA; 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 inparticular, have experienced extreme price and volume fluctuations in recent years, fluctuationsthat frequently have been unrelated to the operating performance of the affected companies. Thesebroad market fluctuations may adversely affect the market price of our common stock. The marketprice of our common stock could decline below its current price and the market price of our stockmay fluctuate significantly in the future. These fluctuations may be unrelated to our performance.     Shareholders often have instituted securities class action litigation after periods ofvolatility in the market price of a company’s securities. Several securities class action suitshave been filed against us, and if other such suits are filed against us in the future we may incursubstantial legal fees and our management’s attention and resources would be diverted fromoperating our business in order to respond to the litigation. See *“Certain lawsuits have been filedagainst us”*above.***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 tothe manufacturing, marketing and sale of human medical devices. We maintain a limited amount ofproduct 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 reasonablecosts, and such insurance may not provide us with adequate coverage against potential liabilities.A successful claim brought against us in excess, or outside, of our insurance coverage couldseriously harm our financial condition and results of operations. Claims against us, regardless oftheir merit or potential outcome, may also reduce our ability to obtain physician acceptance of ourproducts or expand our business.***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 ourbusiness. 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. Inaddition, acquisitions may dilute our earnings per share, disrupt our ongoing business, distractour management and employees and increase our expenses, any of which could harm our business. Wemay also sell businesses or assets as part of our strategy or if we receive offers from thirdparties. If we do so, we may sell an asset or business for less than its carrying value.***The occurrence of a catastrophic disaster or other similar events could cause damage to ourfacilities 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, inOctober 1989, a major earthquake that caused significant property damage and a number of fatalitiesstruck near the area in which our Pleasanton, California facility is located. If any such disasterwere to occur, we may not be able to operate our business at our facilities, in particular becauseour premises require FDA approval, which could result in significant delays before we canmanufacture products from a replacement facility. The insurance we maintain may not be adequate tocover our losses resulting from disasters or other business interruptions. Therefore, any suchcatastrophe could seriously harm our business and results of operations.***We have a history of net losses***     We were founded in 1976 and we have a history of incurring losses from operations. Weanticipate that our expenses will increase as a result of increased pre-clinical and clinicaltesting, research and development and selling, general and administrative expenses. We could alsoincur significant additional costs in connection with our business development activities and thedevelopment and marketing of new products and indicated uses for our existing products as well aslitigation and equity based compensation costs. Such
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costs could prevent us from maintaining profitability in future periods.***We have experienced rapid growth and changes in our business, and our failure to manage this andany future growth could harm our business.***     The number of our employees has substantially increased during the past several years. Weexpect to continue to increase the number of our employees, and our business may suffer if we donot manage and train our new employees effectively. Our product sales may not continue to grow at arate sufficient to support the costs associated with an increasing number of employees. Any futureperiods of rapid growth may place significant strains on our managerial, financial and otherresources. The rate of any future expansion, in combination with our complex technologies andproducts, 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.***Anti-takeover defenses in our governing documents could prevent an acquisition of our company orlimit 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 ourcompany. For example: **•** Our Articles of Incorporation allow our Board of Directors to issue, at any time andwithout shareholder approval, preferred stock with such terms as it may determine. No sharesof preferred stock are currently outstanding. However, the rights of holders of any of ourpreferred stock that may be issued in the future may be superior to the rights of holders ofour common stock.  **•** We have a rights plan, commonly known as a “poison pill,” which would make it difficultfor someone to acquire us without the approval of our Board of Directors.     All or any one of these factors could limit the price that certain investors would be willingto pay for shares of our common stock and could delay, prevent or allow our Board of Directors toresist an acquisition of our company, even if the proposed transaction was favored by a majority ofour independent shareholders.**Item 1B.*****Unresolved Staff Comments*****None.****Item 2.*****Properties***     We are headquartered in Pleasanton, California, where we lease approximately 72,000 squarefeet of office, manufacturing and research facilities and 4,000 square feet of warehouse space. Ourleases 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 researchfacilities in Edison, New Jersey, expiring through 2017.  **•** Approximately 37,000 square feet of office and research facilities in Piscataway, NewJersey, expiring in 2010.  **•** Approximately 35,000 square feet of office, manufacturing and research facilities inRoseville, 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 facilitiesin Edison, New Jersey.     In January 2006, Thoratec purchased a 66,000 square foot building in Pleasanton, California,that will become Thoratec’s corporate office building. We expect to complete improvements onapproximately 36,000 square feet of this building in 2006. We plan to occupy this space on orabout May 2006. The remaining building square footage is currently leased from us by a third partyand we expect to improve and occupy this portion of the building upon the expiration of the thirdparty lease on March 31, 2007.
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     Each of our manufacturing areas has been inspected, approved and licensed for the manufactureof 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 DrugSection). The Edison facility is subject to inspections, approvals and licensing by State of NewJersey Department of Health.     The Cardiovascular segment utilizes all of the facilities in California, Massachusetts and inthe United Kingdom. The ITC segment utilizes all of the facilities in New Jersey and Minnesota.**Item 3.*****Legal Proceedings***     On August 3, 2004, a putative Federal securities law class action suit entitled *Johnson v.Thoratec Corporation, et al.*was filed in the U.S. District Court for the Northern District ofCalifornia on behalf of purchasers of our publicly traded securities between April 28, 2004 andJune 29, 2004. Subsequent to the filing of the *Johnson*complaint, additional complaints were filedin the same court alleging substantially similar claims. On November 24, 2004, the Court enteredan order consolidating the various putative class action complaints into a single action entitled*“In re Thoratec Corp. Securities Litigation”*and thereafter entered an order appointing Craig Tobyas “Lead Plaintiff” pursuant to the Private Securities Litigation Reform Act of 1995. On or aboutJanuary 18, 2005, Lead Plaintiff filed a Consolidated Complaint. The Consolidated Complaintgenerally alleges violations of the Securities Exchange Act of 1934 by Thoratec, its former ChiefExecutive Officer, its former Chief Financial Officer and its Cardiovascular Division Presidentbased upon, among other things, alleged false statements about the Company’s expected sales and themarket for HeartMate as a Destination Therapy treatment. The Consolidated Complaint seeks torecover unspecified damages on behalf of all purchasers of the Company’s publicly traded securitiesduring the putative class period. On March 4, 2005, defendants moved to dismiss the ConsolidatedComplaint and that motion currently is pending.     On or about September 1, 2004, a shareholder derivative action entitled *Wong v. Grossman*wasfiled in the California Superior Court for Alameda County based upon essentially the same facts asthe Federal securities class action suit referred to above. This action names the individualmembers of our Board of Directors, including the former Chief Executive Officer and certain othercurrent and former executive officers as defendants, and alleges that the defendants breached theirfiduciary duties and wasted corporate assets, and that certain of the defendants traded in Thoratecsecurities while in possession of material nonpublic information. Proceedings in *Wong v. Grossman*are currently stayed until at least April 2006.     We believe that the claims asserted in both the Federal securities law putative class actionand the state shareholder derivative action are without merit. We have moved to dismiss the Federalaction and will file a similar motion in the *Wong*action if necessary. We are unable to predict atthis time the outcome of these actions.     We carry sufficient insurance to cover what management believes to be any reasonable exposureon these actions; however, we cannot give assurance that our insurance will cover all costs orother 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 December 31,2005.**Our Executive Officers**     *Gerhard F. Burbach, President, Chief Executive Officer and Director,*joined our company asPresident, Chief Executive Officer and a director, in January 2006. Prior to joining us, Mr.Burbach served as the president and chief executive officer of Digirad Corporation, a leadingprovider of solid-stage imaging products and services to cardiologist offices, hospitals andimaging centers. He continues to serve on the Digirad board of directors. Before that he servedfor two years as president and chief executive officer of Bacchus Vascular Inc, a developer ofinterventional cardiovascular devices. Previously, he served for three years as chief executiveofficer of Philips Nuclear Medicine. Until its acquisition by Philips Electronics, he spent fouryears at ADAC Laboratories where he became president and general manager of the nuclear medicinedivision. He also spent six years with the consulting firm of McKinsey & Company, primarily withinthe firm’s healthcare practice.     *Lawrence Cohen, President of ITC,*joined our company in May 2001 as President of ITC. Prior tojoining ITC, Mr. Cohen served as CEO of HemoSense, Inc., a developer of medical diagnosticproducts, from August 1998 to April 2001. From October 1989 to March 1998, Mr. Cohen held thepositions of Vice President Marketing and Sales, Vice President International and WorldwideExecutive Vice President at Ortho-Clinical Diagnostics, a Johnson & Johnson company. From 1980 to1989, Mr. Cohen held
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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 ofthe 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 MedicalSystems (formerly ADAC Laboratories) where he spent eight years, most recently as general managerof the company’s nuclear medicine division. He also served as a senior vice president of NorthAmerican sales and general manager of ADAC Radiology Solutions and held business unit and regionalsales and marketing positions at the company. Before that, he was a marketing manager for SyncorInternational Corporation, an associate at Cerulean Venture Fund and was in sales with BaxterHealthcare International.     *Cynthia L. Lucchese, Senior Vice President and Chief Financial Officer,*joined our company inSeptember 2005 as Senior Vice President and Chief Financial Officer. Prior to joining us, Ms.Lucchese spent 10 years working for Guidant Corporation, most recently as Vice President andTreasurer. She also served as Vice President, Finance & Administration, Guidant Sales Corporationand Vice President, Controller and Chief Accounting Officer. Prior to that, she spent eight yearsworking for Eli Lilly & Company in a variety of financial roles. She also spent three yearsworking in public accounting for Ernst & Young LLP.     *David A. Lehman, Vice President, General Counsel and Secretary*, joined our company as Vice President andGeneral Counsel in May 2003. Mr. Lehman was appointed as Secretary in December 2004. Prior to joining us, Mr. Lehman served as Vice President and GeneralCounsel of Brigade Corporation, a provider of business process outsourcing services, from June 2000to May 2003. From November 1997 to June 2000, Mr. Lehman was Assistant General Counsel at Bio-RadLaboratories, Inc., a diagnostic and life science products company. Prior to November 1997, Mr.Lehman was in the legal department of Mitsubishi International Corporation, in New York and Tokyofor more than seven years. Mr. Lehman started his career as an associate attorney at the law firmof Hall, Dickler, Kent, Friedman and Wood.     *Beth A. Taylor, Vice President, Administration*, joined our company as Director of HumanResources in November 1999 and was promoted to Vice President of Human Resources in February 2001.In October 2005, Ms. Taylor was promoted to Vice President, Administration. Prior to joining us,Ms. Taylor served as Director of Human Resources for CCI/Triad, a supplier of informationtechnology solutions to the automotive aftermarket, hardware retailers and the lumber industry,from March 1998 to November 1999. Prior to March 1998, Ms. Taylor held various other humanresource positions such as Corporate Employee Development Manager with Valent U.S.A. Corporation,and Director of Human Resources with ADP.**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.” Thefollowing table sets forth, for the periods indicated, the high and low closing sales price pershare of our common stock, as reported by the NASDAQ National Market. As of March 10, 2006, therewere 52,319,017 shares of our common stock outstanding with approximately 720 holders of record,including multiple beneficial holders at depositories, banks, and brokerages listed as a singleholder in the “street” name of each respective depository, bank, or broker.           **High** **Low**Fiscal Year 2004        First Quarter $15.95  $11.75 Second Quarter  14.99   10.49 Third Quarter  11.01   9.40 Fourth Quarter $10.88  $8.46 Fiscal Year 2005        First Quarter $12.49  $9.39 Second Quarter  15.60   11.45 Third Quarter  17.82   15.20 Fourth Quarter $22.36  $16.38      We have not declared or paid any dividends on our common stock and we do not anticipate doingso in the foreseeable future.*Issuer Purchases of Equity Securities*     Our stock repurchase programs, which authorized us to repurchase up to a total of $130 millionof shares of the company’s common stock, were announced on February 11, 2004 as a $25 millionprogram, on May 12, 2004 as a $60 million program, on July
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29, 2004 as a $25 million program, and on February 6, 2006 as an additional $20 millionprogram. These programs do not have an expiration date. Through December 2005, we repurchased 8.5million shares of our common stock for $104.9 million under these combined programs.**Item 6.*****Selected Consolidated Financial Data***     The selected consolidated financial data presented below for the five fiscal years endedDecember 31, 2005 are derived from our audited financial statements. The data set forth belowshould be read in conjunction with “Management’s Discussion and Analysis of Financial Condition andResults of Operations” below and our audited consolidated financial statements and notes theretoappearing elsewhere in this Annual Report. We have reclassified our long-term deferred tax assetsagainst our long-term deferred tax liabilities in the financial statements previously filed withthe SEC in order to conform to the current year’s presentation of a single net long-term deferredtax balance.     In the merger of Thoratec with TCA that was completed on February 14, 2001, we issued newshares of our common stock to the shareholders of TCA in exchange for all the outstanding commonstock of TCA at an exchange ratio of 0.835 shares of Thoratec stock for each share of TCA. Themerger was accounted for as a reverse acquisition because former shareholders of TCA owned amajority of our outstanding stock subsequent to the merger. For accounting purposes, our 2001consolidated financial information presented herein includes the financial results of TCA for thefull fiscal year and Thoratec’s financial results for the post-merger period from February 14, 2001through December 29, 2001. The weighted average number of common shares previously reported by TCAhas 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 willperiodically contain more or less than 365 days. For example, fiscal 2001 ended on December 29,2001, fiscal 2002 ended December 28, 2002, fiscal 2003 ended January 3, 2004, fiscal 2004 endedJanuary 1, 2005 and fiscal 2005 ended December 31, 2005. Fiscal 2006 will end on December 30,2006.                       **Fiscal Year**  **2005** **2004** **2003** **2002** **2001**  **(In thousands, except per share data)****Statement of Operations:**                    Product sales $201,712  $172,341  $149,916  $130,844  $113,384 Gross profit  123,340   100,222   88,748   75,720   60,544 Amortization of goodwill and purchased intangible assets  11,204   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  95   733   2,132   1,409   7,134 Net income (loss)  13,198   3,564   (2,182)  511   (87,866)Basic earnings (loss) per share $0.27  $0.07  $(0.04) $0.01  $(1.68)Diluted earnings (loss) per share $0.26  $0.07  $(0.04) $0.01  $(1.68)**Balance Sheet Data:**                    Cash and cash equivalents and short term available-for-sale investments $210,936  $145,859  $62,020  $45,483  $91,726 Working capital  269,293   206,250   116,430   107,972   135,924 Total assets  573,918   518,034   471,335   463,188   520,928 Subordinated convertible debentures  143,750   143,750   —   —   54,838 Long-term deferred tax liability and other  50,430   56,670   62,327   69,210   71,707 Total shareholders’ equity $348,147  $292,108  $386,236  $374,340  $373,343 **Item 7.*****Management’s Discussion and Analysis of Financial Condition and Results of Operations***     This Annual Report on Form 10-K, including the documents incorporated by reference in thisAnnual Report, includes forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended. Thesestatements can be identified by the words “expects,” “projects,” “hopes,” “believes,” “intends,”“should,” “estimate,” “will,” “would,” “may,” “anticipates,” “plans,” “could” and other similarwords. Actual results, events or performance could differ materially from these forward-lookingstatements based on a variety of factors, many of which are beyond our control. Therefore, readersare cautioned not to put undue reliance on these statements. Factors that could cause actualresults or conditions to differ from those anticipated by these and other forward-lookingstatements include those more fully described in the “Risk Factors” section of this Annual Reportand in other documents we file with the Securities and Exchange Commission. These forward-looking
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statements speak only as of the date hereof. We undertake no obligation to publicly releasethe results of any revisions to these forward-looking statements that may be made to reflect eventsor circumstances after the date hereof, or to reflect the occurrence of unanticipated events.     *The following presentation of management’s discussion and analysis of our financial conditionand results of operations should be read together with our consolidated financial statementsincluded in this**Form 10-K**.***Overview**     We are a leading manufacturer of circulatory support products for use by patients with heartfailure, or HF. Our Ventricular Assist Devices, or VADs, are used primarily by HF patients toperform some or all of the pumping function of the heart. We currently offer the widest range ofproducts to serve this market. We believe that our long-standing reputation for quality andinnovation and our excellent relationships with leading cardiovascular surgeons worldwide positionus to capture growth opportunities in the expanding HF market. Through our wholly-owned subsidiary,ITC, we design, develop, manufacture and market point-of-care diagnostic test systems and incisionproducts that provide for fast, accurate blood test results to improve patient management, reducehealthcare costs and improve patient outcomes.**Our Business Model**     Our business is comprised of two segments: Cardiovascular and ITC.     The product line of our Cardiovascular segment is: **•** *Circulatory Support Products.*Our circulatory support products include VADs for theshort, intermediate and long-term treatment of advanced heart failure. In addition*,*we havedeveloped small diameter grafts using our proprietary materials to address the vascularaccess market. Our grafts are used for hemodialysis.     The product lines of our ITC segment are: **•** *Point-of-Care Diagnostics*. Our point-of-care products include coagulation diagnostic testsystems that monitor a patient while being administered certain anticoagulants, bloodgas/electrolyte and chemistry status, or anemia.  **•** *Incision*. Our incision products include devices used to obtain a patient’s blood samplefor diagnostic testing and screening for platelet function.**Cardiovascular segment**     We offer the following broad product portfolio of implantable and external circulatory supportdevices: **•** The Thoratec Ventricular Assist Device System is an external device for short to mid-termcardiac support, which is sold worldwide. The device is approved to assist left, right andbiventricle support and is worn outside of the body. The Thoratec VAD is approved for use inbridge-to-transplantation, or BTT and for post-cardiotomy myocardial recovery.  **•** The Thoratec IVAD is the only implantable blood pump approved for both BTT andpost-cardiotomy myocardial recovery. It can be used for left, right, or biventricularsupport. The IVAD utilizes the same internal working components as the Thoratec VAD System,but has an outer housing made of a titanium alloy that makes it more suitable forimplantation.  **•** The HeartMate XVE Left Ventricular Assist System, or LVAS, is an implantable device formid to long-term cardiac support and the only device approved in the U.S., Europe and Canadafor permanent support for those patients ineligible for heart transplantation. The HeartMateXVE is also approved for use in BTT.  **•** The HeartMate II, which is currently in clinical trials for BTT and Destination Therapy,is an implantable device consisting of a miniature rotary blood pump designed to providelong-term cardiac support. Its design is intended to be not only smaller, but also simpler,quieter, and longer lasting than the current generation of ventricular assist devices.     In addition to our cardiac assist products, we sell vascular access grafts, used inhemodialysis for patients with late-stage renal disease.     The primary markets for our VAD products are those patients suffering from heart failure and,in particular, from late-stage HF. HF is a chronic disease that occurs when degeneration of theheart muscle reduces the pumping power of the heart, causing the heart
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to become too weak to pump blood at a level adequate to meet the body’s demands. HF can becaused by artery or valve diseases or a general weakening of the heart muscle itself. Otherconditions, such as high blood pressure or diabetes, can also lead to HF.     In the United States, we currently have two FDA-approved indications for the use of VADs inpatients with HF: as a bridge to heart transplant and as Destination Therapy. We are currentlypursuing an additional indication for our Thoratec VAD products: therapeutic recovery of the heart.Beyond the HF markets, VADs are also approved for use during recovery following cardiac surgery.     We currently market VADs that may be implanted or worn outside the body and that are suitablefor treatments for different durations for patients of varying sizes and ages. We estimate thatdoctors have implanted nearly 10,000 of our devices in patients suffering from heart failure. Ourdevices are currently used primarily for patients awaiting a heart transplant or as DestinationTherapy implants. On November 6, 2002, the United States Food and Drug Administration, or FDA,approved the HeartMate VAD as the first heart assist device for Destination Therapy. On April 7,2003, the FDA approved the HeartMate XVE, an enhanced version of the HeartMate VAD, for DestinationTherapy. Thoratec is the only company to have a ventricular assist device approved for DestinationTherapy in the United States. In August 2004, we received FDA approval in the U.S. to market theIVAD for use in bridge-to-transplantation and post-cardiotomy recovery patients who are unable tobe weaned from cardiopulmonary bypass. This makes the IVAD the only currently approved implantablecardiac assist device that can provide left, right or biventricular support.**ITC Segment**     The major product lines of point-of-care, or POC, diagnostic test systems and incision deviceproducts are: **•** The Hemochron POC coagulation system, which is used to monitor a patient’s coagulationwhile being administered anticoagulants in various settings, including in the cardiovascularoperating room to monitor the drug Heparin and in an anticoagulation clinic to monitor thedrug Coumadin. Hemochron is considered a moderately complex device and must be used byprofessionally trained personnel. The system consists of a small, portable analyticalinstrument and disposable test cuvettes.  **•** The IRMA POC blood gas/electrolyte and chemistry system, which is used to monitor apatient’s blood gas/electrolyte and chemistry status. It is considered moderately complexand its use requires supervision by professionally trained personnel. The system consists ofa small, portable analytical instrument and disposable test cartridges.  **•** The ProTime coagulation monitoring system, which is used to monitor patients’ coagulationwhile they are taking oral anticoagulants such as Coumadin, and can be prescribed for use bypatients at home or can be used in the physician’s office or clinic. The system consists ofa small, portable, analytical instrument and disposable test cuvettes.  **•** The Hemoglobin Pro, or Hgb Pro, is used by professionals, mainly in the doctor’s officeto test for anemia; it provides quick results from a very small blood sample. The systemconsists of a small, hand held test meter and disposable test strips.  **•** Tenderfoot, Tenderlett and Surgicutt incision products, which are used by professionalsto obtain a patient’s blood sample for diagnostic testing. The Tenderfoot is a “heel stick”used for infant testing, the Tenderlett is used for finger incisions and the Surgicutt isused to perform screening tests to determine platelet function. All products featurepermanently retracting blades for safe, virtually pain-free incision.     The Hemochron and IRMA products are primarily sold into the hospital POC segment of themarket. The ProTime and Hemoglobin Pro products are sold into the alternate site (non-hospital) POCmarket comprising physicians’ offices, long-term care facilities, clinics, visiting nurseassociations, and home healthcare companies.     Our incision products are sold to both the hospital POC and the alternate site POC markets.Our most successful incision product is the Tenderfoot. Although we market this product based onits high-end features, we believe that customers are increasingly making purchasing decisions onthese types of products based on price. We have seen a gradual erosion of market share in thecurrent year.**Acquisitions**     On September 30, 2003, we completed an asset purchase of the Immediate Response MobileAnalysis, 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 wasallocated based on the fair value of assets acquired as determined by an independent valuationfirm. There was no goodwill recorded with the transaction. As a result of the acquisition, $220,000relating to in-process research and development was expensed in the fourth quarter of 2003.
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**Critical Accounting Policies and Estimates**     We have identified the policies below as critical to our business operations and theunderstanding of our results of operations. The impact of, and any associated risks related tothese policies on our business operations are discussed below. For a more detailed discussion onthe application of these and other accounting policies, see the notes to the consolidated financialstatements included in this Annual Report on Form 10-K. Preparation of financial statements inaccordance with generally accepted accounting principles requires management to make estimates andassumptions that affect the reported amount of assets, liabilities, revenue and expenses and thedisclosure of contingent assets and liabilities. There can be no assurance that actual results willnot differ from those estimates.***Make-Whole Premium***     Under the terms of our senior subordinated convertible notes issued in 2004, if we experiencea change in control or a termination of trading of our common stock, each note holder may requireus to purchase all or a portion of their notes at a price equal to the issue price plus anyoriginal issue discount. In addition, if the consideration for the change in control is all cash,the company will pay a make-whole premium to the note holders. This premium is considered anembedded derivative under SFAS 133 and has been bifurcated from the convertible notes and recordedat its estimated fair value, $0.2 million and none at December 31, 2005 and January 1, 2005,respectively.     There are significant variables and assumptions used in valuing the make-whole provisionincluding, but not limited to, the company’s stock price, volatility of the company’s stock, theprobability of acquisition and the probability of the type of consideration used by a potentialacquirer. If any of these variables move significantly or if management’s assumptions proveincorrect, our financial statements could be materially and adversely affected.***Revenue Recognition***     We recognize revenue from product sales for our Cardiovascular and ITC business segments whenevidence of an arrangement exists, title has passed (generally upon shipment) or services have beenrendered, 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 hascertain limited product return rights. Other distributors have certain rights of return upontermination of their distribution agreement. A reserve for sales returns is recorded for thesecustomers applying reasonable estimates of product returns based upon historical experience. Noother direct sales customers or distributors have return rights or price protection.     We recognize sales of certain Cardiovascular segment products to first-time customers when wehave determined that the customer has the ability to use such products. These sales frequentlyinclude the sale of products and training services under multiple element arrangements. Training isnot considered essential to the functionality of the products. The amount of revenue under thesearrangements allocated to training is based upon fair market value of the training, which istypically performed on behalf of the Company by third party providers. The amount of product salesallocated 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 segmentproducts based on the relative fair market value of the training and products.     The majority of our products are covered by up to a two-year limited manufacturer’s warrantyfrom the date of shipment or installation. Estimated contractual warranty obligations are recordedwhen related sales are recognized and any additional amounts are recorded when such costs areprobable and can be reasonably estimated.     In determining when to recognize revenue, management makes decisions on such matters as thefair values of the product and training elements when sold together, customer credit worthiness andwarranty reserves. If these decisions prove incorrect, the carrying value of these assets andliabilities on our condensed consolidated balance sheets could be significantly different and itcould have a material adverse effect on our results of operations for any fiscal period.***Reserves***     We maintain allowances for doubtful accounts for estimated losses resulting from the inabilityof our customers to make payments owed to us for product sales. When the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability to make payments,additional allowances may be required.     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 anyadditional amounts are recorded when such costs are probable and can be reasonably estimated andare included in “Cost of Product Sales”.
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     We have provided adequate amounts for anticipated tax audit adjustments in the U.S., state andother 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 amountsare unnecessary, the reversal of the liabilities would result in tax benefits being recognized inthe period when we determine the liabilities are no longer necessary. If our estimate of taxliabilities proves to be less than the ultimate assessment, a further charge to expense wouldresult.     Management must make judgments to determine the amount of reserves to accrue. If managementestimates prove incorrect, our financial statements could be materially and adversely affected.***Evaluation of Purchased Intangibles and Goodwill for Impairment***     In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” 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 areview. The carrying value of a long-lived asset to be held and used is considered impaired whenthe anticipated separately identifiable undiscounted cash flows from such an asset are less thanthe carrying value of the asset. In that event, a loss is recognized based on the amount by whichthe carrying value exceeds the fair value of the long-lived asset. Fair value is determinedprimarily using the anticipated cash flows discounted at a rate commensurate with the riskinvolved. Management must make estimates of these future cash flows and the approximate discountrate, and if any of these estimates proves incorrect, the carrying value of these assets on ourconsolidated balance sheet could become significantly impaired.     In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” we no longer amortizegoodwill. We complete an impairment test of goodwill and other intangible assets subject toamortization as required by SFAS No. 142 and SFAS No. 144. Upon completion of our impairment testsas of the end of the year 2005, we determined that neither goodwill nor intangible assets wereimpaired.**Results of Operations**     The following table sets forth selected consolidated statements of operations data for theyears indicated as a percentage of total product sales:               **Fiscal Year**  **2005** **2004** **2003**Product sales  100%  100%  100%Cost of product sales  39   42   41              Gross profit  61   58   59              Operating expenses:            Selling, general & administrative  30   31   30 Research and development  16   17   17 Amortization of purchased intangible assets  6   7   8 Impairment of intangible asset  —   —   6 Litigation, restructuring and other costs  —   —   1              Total operating expenses  52   55   62 Income (loss) from operations  9   3   (4)Other income and (expense):            Interest expense  (2)  (1)  — Interest income and other  2   1   1              Income (loss) before taxes  9   3   (3)Income tax expense (benefit)  2   1   (1)             Net income (loss)  7%  2%  (2)%             **Fiscal Years 2005 and 2004*****Product Sales***     Product sales in 2005 were $201.7 million compared to $172.3 million in 2004. TheCardiovascular segment increased sales by $22.2 million and the ITC segment increased sales by $7.2million. Product sales increases are due to an increase in volume unless otherwise noted. Theprimary components of the total $29.4 million increase in product sales were the following:
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 **•** VAD product sales increased $16.7 million. The increase came from higher sales of ourHeartMate II and IVAD products, partially offset by a reduction in sales of our PVAD and XVEproduct lines.  **•** Other ancillary revenue (drivers, cannulae, service, rentals and spares) increased $2.6million, including increases in driver rental revenue and cannulae sales associated with theIVAD product line.  **•** Graft product sales increased by $2.9 million, principally due to the recognition of apayment related to the modification of our distribution agreement with C.R. Bard Corporationin December 2004 as well as a higher average selling price.  **•** Point-of-care diagnostic product sales increased $8.5 million, due primarily to increasesin our sales of Protime, IRMA, and Hemochron products partially offset by a modest decreasein sales of our Hgb Pro products year over year.  **•** Incision product sales were down $1.3 million year over year.Sales originating outside of the United States and U.S. export sales accounted for approximately23% of our total product sales in 2005 and 2004.***Gross Profit***     Gross profit as a percentage of product sales for 2005 and 2004 was 61% and 58%, respectively.The 3% increase in gross profit was due to the proportionate sales of ITC versus Cardiovascularproducts in conjunction with the following: **•** The Cardiovascular segment increased gross profit by 4% due to increased sales of highermargin VAD products, coupled with a decrease in manufacturing costs; and  **•** The ITC segment increased gross profit by 1%, due to higher margin sales in thepoint-of-care product line and reduced manufacturing costs.***Selling, General and Administrative***     Selling, general and administrative expenses in 2005 were $61.8 million, or 30% of productsales, compared to $54.1 million, or 31% of product sales, in 2004. The $7.7 million increase inspending was primarily attributable to the following: **•** Increased personnel costs of $3.7 million associated with CEO transition, CFOrecruitment, and other bonus and retention programs not specifically identified to anyparticular business segment.  **•** Increased personnel costs associated with higher product sales and overall headcountincreases in the Cardiovascular segment of $2.5 million partially offset by a $0.3 milliondecrease in personnel costs for the ITC segment.  **•** Higher spending on marketing and related activities primarily associated with DestinationTherapy and costs associated with training efforts in the Cardiovascular segment totaling$1.2 million, in addition to a $0.8 million increase in spending by the ITC segment relatedto increased Group Purchasing Organization and consulting fees partially offset by adecrease of $0.2 million related to travel and supplies.***Research and Development***     Research and development expenses in 2005 were $32.3 million, or 16% of product sales,compared to $28.7 million, or 17% of product sales, in 2004. Of the $3.6 million increase, ourCardiovascular and ITC segments incurred $3.3 million and $0.3 million, in additional expenses,respectively, year over year. Research and development costs are largely project driven, and thelevel of spending depends on the level of project activity planned and subsequently approved andconducted. The primary component of our research and development costs is employee salaries andbenefits. Research and development costs also include regulatory and clinical costs associated withour compliance with FDA regulations and clinical trials such as the Phase II HeartMate II pivotaltrial.***Amortization of Purchased Intangible Assets***     Amortization of purchased intangible assets in 2005 was $11.2 million compared to $11.7million in 2004. The $0.5 million decrease is the result of changes in certain asset lives inJanuary 2005 as a result of our 2004 SFAS No. 144 impairment test.
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***Litigation, Restructuring and Other Costs***     Litigation, restructuring and other charges in 2005 were $0.1 million compared to $0.7 millionin 2004. The expense in both years is primarily comprised of costs associated with a Federalsecurities law putative class action, and a shareholder derivative action entitled *Wong v.Grossman,*that were filed in the third quarter of 2004.***Interest Expense***     Interest expense in 2005 was $4.1 million compared to $2.5 million in 2004. The expensesinclude $3.5 million and $2.1 million in interest payments and $0.6 million and $0.4 million inamortization of the debt issuance costs, related to our convertible notes for 2005 and 2004,respectively.***Interest Income and Other***     Interest income and other in 2005 was $4.2 million compared to $2.2 million in 2004. Thisincrease was primarily due to higher interest income earned on our portfolio based on increasedaverage cash balances and higher interest rates in 2005 compared with 2004.***Income Taxes***     Our effective tax rate was 26.9% in 2005 compared to 24.0% in 2004. The increase in oureffective tax rate on a comparative basis was due primarily to a combination of a significantincrease in current profitability and increased nondeductible executive compensation, offset inpart by increased interest income from tax favorable investments and increased research anddevelopment credits.**Fiscal Years 2004 and 2003*****Product Sales***     Product sales in 2004 were $172.3 million compared to $149.9 million in 2003. The primarycomponents of the $22.4 million, or 15%, increase in product sales were the following: **•** Point-of-care diagnostic sales increased $9.0 million, including $4.5 million in revenuefrom 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.  **•** Other ancillary product sales, (drivers, cannulae, service, rentals and spares) increased$5.9 million, including an increase in TLC II driver revenue principally from “HomeDischarge”, which was approved by the FDA in the second quarter of 2004; partially offset by  **•** $1.7 million in lower graft product sales.***Gross Profit***     Gross profit as a percentage of product 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 fromlower 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 fromdistributor to direct channels.
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***Selling, General and Administrative***     Selling, general and administrative expenses in 2004 were $54.1 million, or 31% of productsales, compared to $44.4 million, or 30% of product sales, in 2003. The $9.7 million increase inspending was primarily attributable to the following: **•** Increased headcount from 174 employees 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 ourHeartHope Center Program, Destination Therapy, and costs associated with the IRMA productline of $3.9 million.  **•** Higher professional fees, including legal, audit and financial consulting servicesrelating 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. Of the $2.6 million increase, ourCardiovascular and ITC segments incurred $0.8 million and $1.8 million, in additional expenses,respectively, year over year. Research and development costs are largely project driven, and thelevel of spending depends on the level of project activity planned and subsequently approved andconducted. The primary component of our research and development costs is employee salaries andbenefits. Research and development costs also include regulatory and clinical costs associated withour compliance with FDA regulations and clinical trials.***Amortization of Purchased Intangible Assets***     Amortization of purchased intangible assets in 2004 was $11.7 million compared to $12.3million in 2003 as there were no new acquisitions in 2004 coupled with the $9.0 million write-offof the Aria assets at the end of 2003.***In-process Research and Development Costs***     We had no in-process research and development charges in 2004. In-process research anddevelopment expense in 2003 was $0.2 million related to our acquisition of the IRMA product line.***Litigation, Restructuring and Other Costs***     Litigation, restructuring and other charges in 2004 were $0.7 million compared to $2.1 millionin 2003. The 2004 expense is primarily comprised of costs associated with a putative Federalsecurities law class action, and a shareholder derivative action entitled *Wong v. Grossman*thatwere filed in the third quarter of 2004. The 2003 expense is primarily comprised of $2.3 million tosettle a patent infringement claim.***Interest Expense***     Interest expense in 2004 was $2.5 million compared to none in 2003. This expense in 2004includes $2.1 million in interest payments and $0.4 million in amortization of the debt issuancecosts related to our convertible notes. We did not have these notes or any other outstanding debtinstrument in 2003.***Interest Income and Other***     Interest income and other in 2004 was $2.2 million compared to $1.8 million in 2003. Thisincrease was primarily due to higher interest income earned on our portfolio based on increasedcash balances in 2004 compared 2003.***Income Taxes***     Our effective tax rate was 24% in 2004 compared to 39% in 2003. The reduction in our effectivetax on a comparative basis was due primarily to a combination of reduced tax basis profitability in2004, increased interest income from tax favorable investments and increased research anddevelopment credits, which were offset in part by increased expenditures for non-deductibleexpenses.
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**Liquidity and Capital Resources**     At December 31, 2005, we had working capital of $269.3 million compared with $206.3 million atJanuary 1, 2005. Cash and cash equivalents and short-term available-for-sale investments atDecember 31, 2005 were $210.9 million compared to $145.9 million at January 1, 2005. The increaseis due primarily to cash generated from operations and proceeds from stock option exercises, offsetin part by net purchases of property, plant and equipment and purchases of investment securities.     Cash provided by operating activities for the year ended December 31, 2005 was $36.7 million.This amount included net income of $13.2 million and non-cash adjustments to net income of $23.4million primarily made up of $18.9 million for depreciation and amortization, $7.3 million relatedto tax benefits on stock options, $1.9 million related to amortization of deferred compensationexpenses principally related to CEO transition costs, and $1.2 million for unrealized costs relatedto investments and interest and other, partially offset by a $5.9 million change in the deferredtax liability. Additionally, $6.8 million was provided by accounts payable and other liabilities,driven by increased accruals for income taxes and compensation related costs, partially offset byan increase in cash used for inventory of $3.8 million and an increase in accounts receivable of$2.9 million due primarily to increased sales at the end of the year.     Investing activities used $51.1 million, with $43.1 million net purchases of investmentsecurities and $8.0 million to acquire property, plant and equipment, net of $1.3 million intransfers of product inventory of drivers and demonstration equipment into fixed assets. Thepurchases of property, plant and equipment consisted of equipment purchases of $9.4 million, ofwhich $5.7 million relates to the Cardiovascular segment and $3.7 million relates to the ITCsegment.     Cash provided by financing activities for year ended December 31, 2005 was $34.4 million,including $37.9 million from proceeds related to stock option exercises and purchases under ourEmployee Stock Purchase Plan partially offset by $2.2 million paid to repurchase 0.2 million sharesof stock under our stock repurchase programs in the first quarter of 2005 and $1.3 million relatedto restricted stock forfeiture.     In March 2005, we agreed to purchase a new enterprise resource planning software system, orERP system, for our ITC segment. The cost of the purchased software licenses, hardware,implementation costs and consulting for the ERP system for the year ended December 31, 2005 was$1.2 million, with $1.1 million capitalized.     In September 2005, we agreed to purchase a 67,000-square foot office building in Pleasanton,California for approximately $13.4 million, subject to certain adjustments and other expenses atclosing. During the third quarter of 2005 we paid a deposit of $1.0 million. The remaining amountdue, $12.4 million, was paid at the close of escrow, which occurred in January 2006 and was paidfor with existing cash.     We believe that cash and cash equivalents, short-term available-for-sale investments on handand expected cash flows from operations, will be sufficient to fund our operations, capitalrequirements 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 notsignificant during any of the periods presented.**Off Balance Sheet Arrangements**     *Letter of Credit —*In the third quarter of 2004 we obtained an Irrevocable Standby Letter ofCredit for $460,000 as part of our workers’ compensation insurance program. The Letter of Credit isnot collateralized. The Letter of Credit expires on June 30, 2006 and is scheduled to automaticallyrenew each year on June 30th.**Contractual Obligations**     As of December 31, 2005, we had the following contractual obligations (in millions):                              **Total**  **2006**  **2007**  **2008**  **2009**  **2010**  **Thereafter**Long-Term Debt Obligations (a) $265.8  $3.4  $3.4  $3.4  $3.4  $3.4  $248.8Real Estate Purchase Obligation  12.4   12.4   —   —   —   —   —Operating Lease Obligations  19.4   2.9   2.9   2.5   2.2   2.2   6.7Purchase Obligations  18.2   2.8   2.2   2.2   1.8   1.9   7.3                     Total $315.8  $21.5   8.5   8.1   7.4   7.5   262.8                     
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     Our operating lease obligations of $19.4 million were comprised of our various leasedfacilities and office equipment. Our purchase obligations of $18.2 million were comprised of supplyagreements in effect at December 31, 2005. The real estate obligation relates to the balance dueat December 31, 2005 for the purchase of a 67,000-square foot office building in Pleasanton,California, which closed in January 2006.     (a) Includes interest of $18.3 million and original issue discount of $103.7 million. See note7 to our audited consolidated financial statements in this Annual Report for data related tolong-term debt.***Accounting Pronouncements***     In December 2004, the Financial Accounting Standards Board (“FASB”) issued statement 123(R)“Share-Based Payment, an amendment of FASB statements Nos. 123 and 95.” This statement requiresthat stock-based compensation be recognized as a cost in the financial statements and that suchcost be measured based on the fair value of the stock-based compensation. In April 2005, theSecurities and Exchange Commission adopted a rule amendment that delayed the compliance dates forSFAS 123(R), and as such, we have adopted this statement on January 1, 2006.     We have elected to adopt the modified prospective application transition approach forimplementing the provisions of SFAS 123(R). Under this method, stock compensation expense will beincluded in our financial statements as of January 1, 2006, on a prospective basis, without anyrestatement of prior period expense. In addition, we will continue to use the Black-Scholes modelfor the valuation of our stock-based awards consistent with our previously reported pro formaresults under the original SFAS 123. The option life and forfeiture assumptions that we use underSFAS 123(R) will change as underlying stock option data is refined. The valuation assumptions,given stock option data refinements, may differ in material respects from those disclosed in thepro forma results under the original SFAS 123 disclosed previously in footnote #1 to theconsolidated financial statements.     The effects of the adoption of SFAS 123(R) will result in significant, although non-cash,stock-based compensation expense which we estimate to be $13.5 to $14.5 million for our 2006 fiscalyear.     In November 2005, the Financial Accounting Standards Board (“FASB”) issues FASB Staff Position(FSP) 115-1/124-1, “The Meaning of Other-Than-Temporary Impairment and its Application to CertainInvestments.” This FSP provides additional guidance on when an investment in a debt or equitysecurity should be considered impaired and when that impairment is deemed other-than-temporary,even if a decision to sell has not been made. The FSP also requires certain disclosures aboutunrealized losses that have not been recognized as other-than-temporary impairments. Companies arerequired to apply the guidance in this FSP to reporting periods beginning after December 15, 2005.We adopted this FSP in 2005.**Item 7A.*****Quantitative and Qualitative Disclosures About Market Risk*****Interest Rate Risk**     Our investment portfolio is made up of marketable investments in money market funds, auctionrate securities, U.S. Treasury securities and debt instruments of government agencies, localmunicipalities, and high quality corporate issuers. All investments are carried at market value andare treated as available-for-sale. All investments mature within two years or less from the date ofpurchase, except some of the investments in U.S. Treasuries that are held as restricted investmentsas collateral for future interest payments related to our convertible debt, which mature withinthree years from the original 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 marketvalue of our investments may decline, which could result in a loss if we are forced to sell aninvestment before its scheduled maturity. If interest rates were to rise or fall from currentlevels 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 rateof interest.**Foreign Currency Rate Fluctuations**     We conduct business in foreign countries. Our international operations consist primarily ofsales and service personnel for our ventricular assist products who report to our U.S. sales andmarketing group and are internally reported as part of that group. All assets and liabilities ofour non-U.S. operations are translated into U.S. dollars at the period-end exchange rates and theresulting translation adjustments are included in comprehensive income. The period-end translationof the non-functional currency assets and liabilities
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(primarily assets and liabilities on our U.K. subsidiary’s consolidated balance sheet that arenot denominated in U.K. Pounds Sterling) at the period-end exchange rates result in foreigncurrency 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 therevaluation of these non-functional currency assets and liabilities. These derivatives are notdesignated as cash flow or fair value hedges under SFAS No. 133. As a result, changes in the fairvalue of the forward foreign currency contracts are included in “Interest Income and Other.” Thechange in the fair value of the forward foreign currency contracts typically offsets the change invalue from revaluation of the non-functional currency assets and liabilities. These contractstypically have maturities of three months or less. At December 31, 2005, we had forward foreigncurrency contracts in Euros with a notional value of $4.4 million, and at January 1, 2005, we hadforward foreign currency contracts in Pounds Sterling and Euros with a notional value at $6.9million. These contracts had an average exchange rate of Euros to U.S. dollars of 0.8358 as ofDecember 31, 2005. The impact of foreign currency revaluation, net of forward foreign currencycontracts, was a gain of $0.1 million for the year ended December 31, 2005 and a loss of $0.2million for the year ended January 1, 2005.
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**Item 8.*****Financial Statements and Supplementary Data*****THORATEC CORPORATION AND SUBSIDIARIES****INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**       **Page** **Financial Statements:**    Management Report on Internal Control Over Financial Reporting 40  Reports of Independent Registered Public Accounting Firm  41  Consolidated Balance Sheets  43  Consolidated Statements of Operations  44  Consolidated Statements of Comprehensive Income (Loss)  45  Consolidated Statements of Shareholders’ Equity  46  Consolidated Statements of Cash Flows  47  Notes to Consolidated Financial Statements  48  
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MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING     Our management is responsible for establishing and maintaining adequate internal control overfinancial reporting to provide reasonable assurance regarding the reliability of our financialreporting and the preparation of financial statements for external purposes in accordance withgenerally accepted accounting principles.     Management assessed our internal control over financial reporting as of December 31, 2005, theend of our fiscal year. Management based its assessment on criteria established in *“*InternalControl–Integrated Framework” issued by the Committee of Sponsoring Organizations of the TreadwayCommission. Management’s assessment included evaluation of such elements as the design andoperating effectiveness of key financial reporting controls, process documentation, accountingpolicies, and our overall control environment. This assessment is supported by testing andmonitoring performed by our internal accounting and finance organization.     Based on our assessment, management has concluded that our internal control over financialreporting was effective as of December 31, 2005 to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statements for externalreporting purposes in accordance with generally accepted accounting principles. The results ofmanagement’s assessment were reviewed with the Audit Committee.     Our independent registered public accounting firm, Deloitte & Touche LLP, has issued a reporton management’s assessment of our internal control over financial reporting, which is included inthis Item 8 of this Annual Report on Form 10-K.
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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 onInternal Control Over Financial Reporting, that Thoratec Corporation and subsidiaries (the“Company”) maintained effective internal control over financial reporting as of December 31, 2005,based on the criteria established in *Internal Control—Integrated Framework*issued by the Committeeof Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible formaintaining effective internal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.     We conducted our audit in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides a reasonable basisfor our opinions.     A company’s internal control over financial reporting is a process designed by, or under thesupervision of, the company’s principal executive and principal financial officers, or personsperforming similar functions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financial reporting includesthose policies and procedures that (1) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accounting principles,and that receipts and expenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.     Because of the inherent limitations of internal control over financial reporting, includingthe possibility of collusion or improper management override of controls, material misstatementsdue to error or fraud may not be prevented or detected on a timely basis. Also, projections of anyevaluation of the effectiveness of the internal control over financial reporting to future periodsare 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 controlover financial reporting as of December 31, 2005, is fairly stated, in all material respects, basedon the criteria established in *Internal Control—Integrated Framework*issued by the Committee ofSponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained,in all material respects, effective internal control over financial reporting as of December 31,2005, based on the criteria established in *Internal Control—Integrated Framework*issued by theCommittee of Sponsoring Organizations of the Treadway Commission.     We have also audited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated financial statements and financial statementschedule as of and for the year ended December 31, 2005 of the Company and our report dated March15, 2006 expressed an unqualified opinion on those financial statements and financial statementschedule.DELOITTE & TOUCHE LLPSan Francisco, California