**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

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**FORM 10-KSB**

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**ANNUALREPORT UNDER SECTION 13 OR 15(D) OFTHE SECURITIES EXCHANGE ACT OF 1934**

**Forthe fiscal year ended December 31, 2005Commission File No. 0-28882**

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**WORLD HEART CORPORATION**

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| **Canada**                               |   | **52-2247240**       |
|------------------------------------------|--------|----------------------|
| (State or other  Jurisdiction of         |   | (I.R.S. Employer     |
| Incorporation or  Organization)          |   | Identification  No.) |
|                                     |   |                 |
| **7799 Pardee  Lane**               |   | ** **           |
| **Oakland,  California, USA**            |   | **94621**            |
| (Address of  Principal Executive Office) |   | (Zip Code)      |

 

**(510) 563-5000**(Issuer’sTelephone Number)

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**Securitiesregistered under Section 12(b) of the Exchange Act:**

| **Title of each class**                                                  |   | **Name of  each exchange on which registered** |
|--------------------------------------------------------------------------|--------|------------------------------------------------|
| None                                                                     |   | None                                           |
|                                                                     |   |                                           |
| **Securities  registered under Section 12(g) of the Exchange Act:** |
| ** **                                                               |   | ** **                                     |
| **Title of  each class**                                                 |
| Common Shares, no  par value                                             |

 

Check whether the issuer is not required to filereports pursuant to Section 13 or 15(d) of the Exchange Act. o

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Actduring the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

| Yes x | Noo |
|------------|-----|

 

Check if there is no disclosure of delinquent filers inresponse to Item 405 of Regulation S-B contained in this form, and nodisclosure will be contained, to the best of the registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-KSB or any amendment to this Form 10-KSB. o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

| Yes o | No x |
|------------|-----------|

 

The issuer’s revenues for its most recent fiscal yearended December 31, 2005 were $11,645,954.

The aggregate market value of the voting and non-votingcommon equity held by non-affiliates computed by reference to the price atwhich the common equity was sold, or the average bid and asked price of suchcommon equity, as of March 15, 2006 was $24,677,138.

The number of common shares outstanding as of March 15,2006 was 55,479,549.

**DOCUMENTSINCORPORATED BY REFERENCE**

**Designated portionsof registrant’s Definitive Proxy Statement for its 2006 Annual Meeting ofShareholders are incorporated by reference into Part III of this Form 10-KSB.**

TransitionalSmall Business Disclosure Format (Check one): Yes o      No x

 

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**TABLE OF CONTENTS**

| **PART I**       |   |                                                                                                                        |
|-----------------------|--------|-----------------------------------------------------------------------------------------------------------------------------|
| Item 1.               |   | Description of Business.                                                                                                    |   | 1 |
| Item 2.               |   | Description of Property.                                                                                                    |   | 19 |
| Item  3.              |   | Legal  Proceedings.                                                                                                         |   | 20 |
| Item 4.               |   | Submission of Matters to a Vote of Security Holders.                                                                        |   | 20 |
| **PART II**      |   |                                                                                                                        |
| Item 5.               |   | Market for Common Equity, Related Stockholder Matters  and Small Business Issuer Purchases of Equity Securities.            |   | 21 |
| Item 6.               |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations.                                |   | 23 |
| Item  7.              |   | Financial  Statements.                                                                                                      |   | 39 |
| Item 8.               |   | Change In and Disagreements with Accountants on  Accounting and  Financial Disclosure.                                      |   | 39 |
| Item 8A.              |   | Controls and Procedures.                                                                                                    |   | 39 |
| Item  8B.             |   | Other  Information.                                                                                                         |   | 39 |
| **PART III**     |   |                                                                                                                        |
| Item 9.               |   | Directors, Executive Officers, Promoters and Control  Persons; Compliance With Section 16(a) of the Exchange Act. |   | 40 |
| Item 10.              |   | Executive Compensation.                                                                                                     |   | 40 |
| Item 11.              |   | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters.                            |   | 40 |
| Item 12.              |   | Certain Relationships and Related Transactions.                                                                             |   | 40 |
| Item 13.              |   | Exhibits.                                                                                                                   |   | 40 |
| Item 14.              |   | Principal Accountant Fees and Services.                                                                                     |   | 42 |
| SIGNATURES            |   | 43                                                                                                                          |
| EXHIBIT INDEX         |   | 44                                                                                                                          |
| FINANCIAL  STATEMENTS |   | F-1                                                                                                                         |

 

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**PART I**

**Item 1.**                        Descriptionof Business.

**SPECIALNOTE REGARDING FORWARD-LOOKING STATEMENTS**

This Annual Reporton Form 10-KSB includes “forward-looking statements” within themeaning of Section 27A of the United States Securities Act of 1933, asamended (the Securities Act) and Section 21E of the United StatesSecurities Exchange Act of 1934, as amended (the Exchange Act). Theforward-looking statements contain information that is generally stated to beanticipated, expected or projected by World Heart Corporation (WorldHeart), andinvolves known and unknown risks, uncertainties and other factors that maycause the actual results and performance of WorldHeart to be materiallydifferent from any future results and performance expressed or implied by suchforward-looking information. Potential risks and uncertainties include, withoutlimitation, the uncertainties inherent in the development of a new product foruse in the human body, our potential need for significant additional funding,our need for acceptance from third-party payers, extensive governmentregulation of our products, and rapid developments in technology, includingdevelopments by competitors. Important factors that could cause our actualresults to differ materially from those expressed or implied by suchforward-looking statements include:

·       ourability to successfully complete on a timely basis pre-clinical and clinicaldevelopment of our products;

·       ourability to grow our revenue and expand acceptance of our products by medicalcenters and hospitals in the United States and worldwide;

·       thecontinued availability of capital to finance our activities in the event thatwe do not achieve profitability;

·       decisions,and the timing of decisions, made by health regulatory agencies regardingapproval of our products;

·       ourability to successfully integrate technologies or companies that we may acquirefrom time to time.

·       ourability to obtain and enforce in a timely manner patent and other intellectualproperty protection for our technology and products;

·       ourability to avoid, either by product design, licensing arrangement or otherwise,infringement of third parties’ intellectual property;

·       ourability to complete and maintain corporate alliances relating to thedevelopment and commercialization of our technology and products;

·       thecompetitive environment and impact of technological change; and

·       otherfactors we discuss under the heading “Risk Factors.”

We undertake no obligationto update publicly or revise any forward-looking statements, whether as aresult of new information, future events or otherwise, except as may berequired under applicable securities laws.

**CORPORATE STRUCTURE**

**Name, Address and Incorporation**

WorldHeart was incorporated by articles ofincorporation under the laws of the Province of Ontario on April 1, 1996. OnDecember 14, 2005, WorldHeart filed articles of continuance and continuedunder 

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the laws of Canada. Ourhead office is located at 7799 Pardee Lane, Oakland, California, USA, 94621 andour head office telephone number is 510-563-5000. We have an officeat Cereslaan 34, 5384 VT, Heesch, Netherlands and a research facility at 4750Wiley Post Way, Suite 120, Salt Lake City, Utah, USA, 84116. Ourregistered office is located at 40 Elgin St, Suite 1400, Ottawa, Ontario,Canada, K1P 5K6 and our telephone number is (613) 238-2000.

Our articles ofincorporation were amended on June 22, 2000 to create a first series of1,374,750 preferred shares designated as Cumulative Redeemable ConvertiblePreferred Shares, Series A (the Series A Shares), in connection withthe acquisition by WorldHeart of the Novacor division (Novacor) of EdwardsLifesciences LLC (Edwards). On November 26, 2003, our articles wereamended to amend the rights and privileges of the Series A Shares inconnection with the conversion by Edwards Lifesciences (U.S.) Inc. of its Series AShares as part of our financing transaction completed in September 2003. Ourarticles were amended again on December 1, 2003, to effect a one commonshare for seven common shares share consolidation. WorldHeart filed articles ofcontinuance on December 14, 2005, associated with the reincorporationunder the laws of Canada from the Province of Ontario. In conjunction with thecontinuance, a new by-law was adopted by our directors. The shareholders ofWorldHeart will be asked to confirm the by-law at the next annual meeting ofshareholders.

**Intercorporate Relationships**

World Heart Inc. is our wholly-owned subsidiary,incorporated under the laws of the State of Delaware on May 22, 2000. WorldHeart Inc. acquired the assets and liabilities of the Novacor division ofEdwards in June 2000 and is responsible for the manufacturing and primarysales, marketing and support of the Novacor left ventricular assist system(Novacor® LVAS) as well as next-generation product development.

World Heart B.V. isour wholly-owned subsidiary, incorporated under the laws of the Netherlands on March 5,2004, through which we carry on sales, sales support and distribution inEurope.

2007262 Ontario Inc.(2007262), was an associated research and development company of WorldHeart,incorporated under the laws of the Province of Ontario on November 29,2001 to carry out specified research and development for us. WorldHeart and NewGeneration Biotech (Equity) Fund Inc. (NewGen), an Ontario labour-sponsoredventure capital corporation, each held 100 common shares of 2007262. On January 1,2006, WorldHeart purchased the 100 common shares of NewGen and became the soleshareholder of 2007262. WorldHeart is in the process of a voluntary dissolutionof 2007262 as there are no active operations in 2007262.

**BUSINESS OF WORLDHEART**

**The Company**

WorldHeart’s business is focused on the development,production, sales and support of ventricular assist devices (VADs). VADs aremechanical assist devices that supplement the circulatory function of the heartby re-routing blood flow through a mechanical pump allowing for the restorationof normal blood circulation. WorldHeart believes that it has the broadestnext-generation product platform under development for long-term circulatorysupport and that both pulsatile and rotary pumps are required to treat the fullspectrum of clinical needs of end and late-stage heart failure patients. TheCorporation believes that pulsatile devices are best suited for end-stagepatients with poor ventricular contractility, who require full support orfunctional replacement. Alternatively, rotary devices are best suited tolate-stage patients, with some contractility, who require only partial supportor an assist.

VADs are used for treatment of patients with severeheart failure including primarily patients whose hearts are irreversiblydamaged and cannot be treated effectively by medical or surgical means otherthan transplant. Bridge-to-transplant therapy involves implanting a VAD in atransplant-eligible patient to 

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maintain or improve thepatient’s health until a donor heart becomes available. Destination Therapy isthe implanting of a VAD to provide long-term support for a patient notcurrently eligible for a natural heart transplant.

The Novacor LVAS represents WorldHeart’s currentgeneration implantable pulsatile VAD. WorldHeart’s next-generation implantablepulsatile VAD, Novacor II, is currently under development. The firstanimal implant of the Novacor II was completed in July 2005 and weintend to continue pre-clinical testing in animals in 2006. The Novacor IIis being designed to be an implantable heart assist device to provide long-termpulsatile blood flow to patients suffering from heart failure and to permit therecipient to return to near normal activities. The WorldHeart rotary VAD, whichwe acquired as part of our acquisition of the assets of MedQuest Products, Inc.(MedQuest) in July 2005, is WorldHeart’s smallest device. It uses amagnetically-levitated rotor resulting in a pump with no moving parts subjectto wear, which is expected to provide multi-year support. The WorldHeart rotaryVAD is in an advanced development stage with an initial human feasibilityclinical trial, which began in early March 2006 in Europe.

The Novacor LVAS iscommercially available as a bridge-to-transplantation in Europe, Japan, theUnited States and Canada. In Europe, it is also available as analternative-to-transplantation and as a bridge-to-recovery to support patientswho may be able to recover the use of their natural heart. In Japan, theNovacor LVAS is approved for use by cardiac patients at risk of imminent deathfrom non-reversible left ventricular failure for which there is no alternativetherapy other than heart transplantation. The Novacor LVAS has been implantedin over 1,600 patients worldwide. In July 2004, we received unconditionalapproval of our Investigational Device Exemption Supplement for the RELIANT (*R*andomized *E*valuation ofthe Novacor® *L*VAS *I*n*A**N*on-*T*ransplant Population) clinical trial from the United StatesFood and Drug Administration (FDA). The data from the RELIANT Trial is intendedto support a Pre-market Approval Supplement (PMA Supplement) that willrequest a revision to the indication for use of the Novacor LVAS to includeend-stage heart failure patients that are ineligible for cardiactransplantation. At March 15, 2006, there are 21 centers and 32 patientsenrolled in the RELIANT Trial.

**ThreeYear History and Development of WorldHeart**

Since early 2003, a numberof important events have occurred indicating the increasing acceptance by themedical community of VAD-based therapy for treatment of end-stage heart failurethat we expect will continue to positively impact WorldHeart’s business as wellas the businesses of our competitors. Important industry developments includetwo increases in reimbursement for VADs in the United States (October 2003and October 2004) which significantly increased average reimbursements forVAD implantation to between $130,000 and $140,000.

*RegulatoryDevelopments*

A number ofsignificant regulatory developments related specifically to WorldHeart’sNovacor LVAS products have also occurred over the last few years:

·       Approvalwas given by the FDA in January 2003, and by Health Canada in March 2003,of our expanded polytetrafluoroethylene (ePTFE) inflow conduit as a componentof the Novacor LVAS product, which has been shown to reduce stroke rate.

·       Approvalwas given by the FDA in January 2004, and Health Canada in September 2003,of product enhancements to the Novacor LVAS aimed at improving the recipient’squality of life—quieter pump operation, new battery packs that are 40% lighterand operate for 60% longer, and a smaller, quieter battery charging system. Theseenhancements have been commercially available in Europe since June 2002.

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·       Approvalof the Novacor LVAS was given in Japan for use in August 2001, importationin January 2002 and reimbursement effective during April 2004.

·       Approvalwas given by the FDA in July 2004 of a PMA Supplement application for arevision to the labeling of the Novacor LVAS to reflect the current devicereliability data available to patients and physicians. The revised labelingindicates the demonstrated performance longevity of the Novacor LVAS, whichencompasses implant duration from zero to more than 36 months. The revisedlabeling, which is based upon statistical analysis of 1,077 device implants,shows the chance for reoperation to either fix or replace the Novacor LVAS is1.6% between zero and 6 months; 2.1% between 6 and 12 months; 11% between 12and 24 months; and 16% between 24 and 36 months.

·       Unconditional approval wasgiven by the FDA in July 2004 of our Investigational Device ExemptionSupplement for the RELIANT Trial. The RELIANT Trial will be conducted in up to40 clinical centers and is expected to enroll up to 390 patients. The data fromthe RELIANT Trial will support a PMA Supplement that will request a revision tothe indication for use of the Novacor LVAS to include end-stage heart failurepatients that are ineligible for heart transplantation. The RELIANT Trialrandomizes patients who enter the RELIANT Trial to receive either a NovacorLVAS or a Thoratec Corporation (Thoratec) HeartMate ® XVE LVAS, (the HeartMateXVE), on a 2:1 ratio. Costs of implants, including device costs, for both theNovacor LVAS and HeartMate XVE are eligible for reimbursement by Centers ofMedicare and Medicaid Services (CMS) on the same basis as is available forreimbursement of HeartMate XVE when used for Destination Therapy treatmentoutside the RELIANT Trial.

*Other Developments*

In 2003, we rationalized and reallocated our workforceto focus on sales, production and support of the Novacor LVAS, on a basisconsistent with the development plans and strategy for WorldHeart’snext-generation PulsatileVAD.

In September 2003,we completed a significant equity financing and restructuring. In summary, thefinancing and restructuring included:

·       ACdn$63,500,000 private placement of equity through the issuance of units, eachunit was comprised of one common share and one warrant exercisable for onecommon share at an exercise price of Cdn$7.42. The warrants are callable byWorldHeart for cash should our common shares trade at or above Cdn$17.50 for 20consecutive trading days. However, no more than 20% of the total warrantsissued may be called in any three month period;

·       Anexchange of the preferred shares of World Heart Inc. held by Edwards in theamount of $58 million plus accrued dividends for 711,589 common shares ofWorldHeart;

·       Theconversion of the Series A Shares of WorldHeart held by EdwardsLifesciences (U.S.) Inc. at a value of $20 million plus accrued dividendsinto 500,000 common shares of WorldHeart and 1,000,000 warrants, with eachwarrant exercisable for one common share of WorldHeart at an exercise price ofCdn$7.49 per common share; and

·       Aconsolidation of WorldHeart’s common shares on the basis of onepost-consolidation common share for seven pre-consolidation common shares.

Effective January 1, 2004, we assumed full salesand support responsibility for the Novacor LVAS worldwide with the exception ofJapan. Edwards was previously our exclusive distributor for the Novacor LVAS inall countries other than the United States. We continue to distribute theNovacor LVAS through Edwards in Japan and through other distributors inselected markets.

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On March 18, 2004, our common shares, which hadbeen delisted from the Nasdaq Global Market (Nasdaq) on October 15, 2002,were re-listed on Nasdaq under the symbol WHRT.

On April 22, 2004, with the announcement of ourfirst quarter results, we commenced reporting our results in United Statesdollars.

On July 12, 2004, we announced that our firstquarter results would be restated, and on August 12, 2004, we released ourrestated quarterly results. Restated revenues for the first quarter decreasedby $1.3 million to $2.2 million, as a result of a decrease in kitshipments recognized as revenue by 25 kits to a total of 26 kits, which alsoincreased the net loss for the period.

In July 2004, we announced certain managementchanges including the appointment of Jal S. Jassawalla as Presidentand Chief Executive Officer replacing Roderick M. Bryden who resigned fromthose positions and from the board of directors of WorldHeart. In August 2004,Mark Goudie, Vice President, Finance and Chief Financial Officer was appointedto the board of directors to fill the vacancy created by the resignation of Mr. Bryden.

In August 2004, we announced the consolidation ofour operations from Ottawa, Ontario to Oakland, California. The consolidationwas substantially completed by June 30, 2005.

On September 16, 2004, we completed the sale of$13,318,750 aggregate principal amount of convertible debentures and warrants. Thedebentures were convertible, at the option of the holder, into common shares ata conversion rate of $1.25 per common share until September 15, 2009. Thepurchasers of the convertible debentures were also issued a total of10,655,000 warrants to purchase common shares at an exercise price of$1.55 per common share exercisable until September 15, 2009.

On January 31, 2005 we entered into an assetpurchase agreement with MedQuest, as amended by amendment no. 1 dated March 22,2005, under which we agreed to purchase all of the assets of MedQuest for atotal purchase price of approximately $16.0 million plus the assumption of certainliabilities of approximately $3.5 million, subject to certain conditions,including shareholder approval (the MedQuest Acquisition).

Also, on January 31, 2005, we entered into apurchase agreement, as amended by amendment no. 1 dated March 22, 2005with Maverick Venture Management, LLC (Maverick) pursuant to which Maverickagreed to purchase in a private placement approximately 8.9 million commonshares of WorldHeart at $1.35 per common share for an aggregate purchase priceof $12 million. The closing of the private placement was contingent on theclosing of the transactions contemplated in the MedQuest Acquisition and otherclosing conditions.

On March 22, 2005, WorldHeart announced that ithad ceased to be a “foreign private issuer” as defined under the Exchange Actas a result of the consolidation and relocation of its headquarter operationsto Oakland, California.

On June 2, 2005, Richard Juelis was appointedVice-President, Finance and Chief Financial Officer, replacing Mark Goudie, andon June 9, 2005, John Vajda was appointed Vice President, Manufacturing.

On July 18, 2005, WorldHeart held its annual andspecial meeting of shareholders and received approval from its shareholders forthe issuance of common shares of WorldHeart to MedQuest in connection with theMedQuest Acquisition, the issuance of common shares of WorldHeart to Maverickin connection with the private placement, and a reduction of the exercise pricefrom $1.55 to $1.00 of certain warrants of WorldHeart in connection with theconversion of all of the convertible debentures and exercise of all of thewarrants issued in September 2004. Matters related to the WorldHeart employeestock option plan were also approved as well as the continuance of WorldHeartunder the Canada Business Corporations Act.

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Upon approval by shareholder vote, and unanimoustendering of the debentures and warrants, WorldHeart successfully completed, onJuly 29, 2005, the acquisition of all assets of MedQuest, raisedapproximately $22.7 million in gross financing proceeds from the privateplacement with Maverick and the exercise of all the outstanding warrants andconverted all of its convertible debentures. At the closing of thetransactions, Maverick and the shareholders of MedQuest held approximately 33%of the common shares of WorldHeart. Maverick was given the right to nominate upto two designees to WorldHeart’s Board of Directors so long as it holds orcontrols at least 25% of our issued and outstanding common shares.

Upon completion of the acquisition, WorldHeartretained most of MedQuest’s employees at its facility in Salt Lake City, Utah,which continues to serve as the development site for our WorldHeart rotary VADproduct. We also named Pratap Khanwilkar as Vice President, Rotary Systems andBusiness Development.

On December 15, 2005, we reincorporated in Canadafrom the Province of Ontario and subsequently intend to reincorporate fromCanada to the United States, likely in Delaware, during 2006. In conjunctionwith our reincorporation in Canada, Jal S. Jassawalla, President and ChiefExecutive Officer, was appointed to the Board of Directors and Mark Goudieresigned from the Board.

On December 21, 2005, the Board of Directors ofWorldHeart approved the accelerated vesting of all outstanding stock optionsheld by current employees or consultants, except for the options held by thenon-employee members of the Board of Directors.

On March 8, 2006,WorldHeart announced the first in human implant of its next-generationWorldHeart rotary VAD. The procedure, performed at St. Lukes’s Hospital inThessaloniki, Greece, was the beginning of the rotary VAD feasibility trial.

**Our Products**

Our currentbusiness is based on two generations of implantable VADs. The currentgeneration, commercially available product is our Novacor LVAS. Ourdevelopment-stage, next-generation VADs include the Novacor II andWorldHeart rotary VAD product candidates. Specifically:

·       theNovacor LVAS is currently commercially available as a bridge-to-transplant inthe United States, Canada, Europe and Japan. In Europe, it is also commerciallyavailable for Destination Therapy and as a bridge-to-recovery. In the UnitedStates, it is under evaluation in a pivotal study, the RELIANT Trial, forDestination Therapy;

·       theNovacor II is a small, bearingless, next-generation, pulsatile VADcurrently under development. A successful animal experiment was conducted in July 2005with additional studies planned for 2006 and 2007; and

·       the WorldHeart rotary VADis a small, next-generation, magnetically levitated, centrifugal, rotary,non-pulsatile VAD, which is now at an advanced stage of development. An initialhuman feasibility clinical trial began in March 2006 in  Europe.

*The Novacor LVAS*

The Novacor LVAS is our commercially available,implantable, pulsatile VAD, which has been in clinical use for more than 20years and has been implanted in more than 1,600 patients worldwide. The NovacorLVAS is an electromagnetically-driven pump, about the size of a human heart,that provides circulatory support for patients with life-threatening heartfailure by taking over part or all of the workload of the left ventricle of theheart. It is implanted within the abdominal wall and mimics the natural heartby creating a pulsing flow of blood. The natural heart continues to deliverwhat it can, and may recover 

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partially while assistedby the Novacor LVAS. The Novacor LVAS is self-regulating, respondinginstantaneously to the recipient’s changing heartbeat and circulatory demands.

The Novacor LVAS is currently approved for abridge-to-transplant in Europe, the United States and Canada. In Europe, it isalso available with an unrestricted indication for Destination Therapy. InJapan, the Novacor LVAS is the only approved implantable VAD for use by cardiacpatients at risk of imminent death from non-reversible left ventricular failurefor which there is no alternative except for a heart transplant.

WorldHeart commenced an equivalency clinical trial inthe second quarter of 2004 in the United States, called the RELIANT Trial, inwhich patients are randomized to receive either the Novacor LVAS or theThoratec HeartMate® XVE. It is expected that data from this clinical trial willsupport a PMA Supplement, which will be submitted to the FDA, for the long-termuse of the Novacor LVAS by non-transplant eligible patients, alsoreferred to as Destination Therapy. Implants under this trial are eligible forreimbursement by the CMS and certain private insurers. We believe that approvalof the Novacor LVAS for Destination Therapy use in the United States wouldincrease the market for the Novacor LVAS substantially.

Sales of the Novacor LVAScontribute to overhead and other indirect costs of producing the Novacor LVASproduct. To date, however, at current volumes the Novacor sales havecontributed only modestly to gross margins. We expect to continue to increasegross margin through increased sales and reduction of manufacturing costs,however, to the extent that we are unable to do so, our financial conditioncould be adversely affected and the Novacor operations would continue toconsume cash resources.

*Next-Generation VADPlatform*

*Pulsatile VAD*

Our next-generationpulsatile VAD, Novacor II, is currently under development and is expectedto result in an  implantable, pulsatileVAD designed specifically for Destination Therapy patients. Novacor II isbeing developed to be approximately 50% of the size of the Novacor LVAS, withno mechanical bearings. For the fully implantable configuration, its dualchamber design eliminates the need for volume compensation and the need forexternal venting, and incorporates remote power and monitoring (i.e.across-the-skin power and data transfer) and an implanted controller/battery. Thesefeatures are expected to provide recipients with an enhanced quality of life byallowing freedom of movement and minimal limitations to their regularactivities. It is magnetically-driven, allowing for simple operation with nowearing elements or precision components. Initially, the Novacor II willbe available with a percutaneous lead to provide clinicians and patients withthe simplest possible implant configuration. A first animal implant of theNovacor II took place in July 2005 with further pre-clinical and animaltesting planned for 2006, and we intend to begin human feasibility testing in2007. If clinical testing is successfully completed and regulatory approvalsare obtained, we would expect commercial approvals by approximately 2008 inEurope and in the United States by approximately 2009 or 2010.

*WorldHeart RotaryVAD*

Through the acquisition of MedQuest in July of2005, we obtained the WorldHeart rotary VAD, an advanced, next-generation,rotary blood pump intended for Destination Therapy. Unlike the initialgeneration of rotary pumps with blood-lubricated bearings, the WorldHeartrotary VAD is a compact, bearingless, magnetically-levitated, centrifugal pumpwith an impeller that is completely magnetically levitated. Full magneticlevitation eliminates wear mechanisms within the pump and provides for greaterclearances for more optimized blood flow around the impeller, while eliminatingdependence on the patient’s blood for suspension. The WorldHeart rotary VAD’slevitation technology employs a unique combination of passive and single-axisactive control, resulting in a system of optimal simplicity.

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The WorldHeart rotary VADis now at an advanced stage of development and has begun an initial humanfeasibility clinical trial in Europe in early March 2006. We expect tocomplete feasibility testing in 2006 and begin more advanced clinical trials in2007. If clinical testing is successfully completed and regulatory approvalsare obtained, we would expect commercial approvals by approximately 2007 or2008 in Europe and in the United States by approximately 2009 or 2010.

*Research andDevelopment Expenditures*

WorldHeart’s research anddevelopment expenditures were $7,388,385, $5,838,754 and $9,604,080 in 2005,2004, and 2003, respectively. Research and development spending isexpected to increase in 2006 with the addition of our Salt Lake City operationsand the WorldHeart rotary VAD development program.

**Third-party Reimbursement for VADs**

The United States currently provides for publicreimbursement of VADs used as a bridge-to-transplant. In addition, certainprivate insurance carriers in the United States provide reimbursement for VADuse. In October 2003, a National Coverage Decision by the CMS in theUnited States extended reimbursement to VADs approved by the FDA forDestination Therapy. In October 2004, CMS implemented a previouslyannounced increase in reimbursements for centers implanting VADs resulting inaverage domestic reimbursement rates of $130,000 to $140,000. In October 2005,CMS updated Healthcare Common Procedural Coding System (HCPCS) codes to includecoverage of VADs.

Several countries inEurope provide reimbursement for VADs. Reimbursements, however, vary betweencountries. Also, effective April 1, 2004, reimbursement in Japan forimplantable VADs was approved.

**Application of VADs in Patient Care**

*Current TreatmentMethods for End-Stage Heart Failure*

Research ison-going for an effective treatment for end-stage heart failure. Whileproviding some benefit,  therapies suchas medication and transplantation have significant limitations, and alternativeemerging technologies, such as xenografts (animal organs or tissue transplantedinto humans, with rejection being an even greater challenge), cardiomyoplasty(the use of another muscle wrapped around the heart and electrically stimulatedto augment heart function), genetic tissue engineering, multiple site pacing(pacing wires placed on two to three separate ventricular sites), passiveconstraint devices and implantable artificial hearts (total artificial heartsand ventricular assist devices, pulsatile and non-pulsatile), are beinginvestigated. The following are treatment methods currently being employed foradvanced heart failure:

·       *Medication*.   Pharmaceutical drugs are the first line ofdefense against heart failure; however, in spite of many advances, drugtherapies continue to be able to provide only limited benefit particularly inadvanced heart failure patients. Drug therapies usually do not treat theunderlying disorder and, thus, can only slow the disease’s progression. Moreover,a significant number of heart failure patients may be resistant to treatmentwith drug therapies and often such therapies have adverse side-effects.

·       *Heart Transplantation*.   Hearttransplantation is currently the intervention of choice for some patients withend-stage heart failure. According to data from the American Heart Association(AHA), patients receiving heart transplants have a 71% five-year survival rate.However, the availability of donor organs as well as other major limitations,described below, has limited the number of transplants worldwide to about 4,000per year. In the United States, the number of heart transplants has averagedjust over 2,000 annually over the last several years, according to the AHA, 

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despite the fact that theAHA estimates that each year at least 40,000 Americans under age 65 wouldbenefit from heart transplants. Limited availability of and waiting times forsuitable donor hearts, as well as, high costs have limited the utility of hearttransplantation.

·       *Artificial Heart Technology*.   Both VADs and totalartificial hearts (each a form of mechanical circulatory support) have beenshown to be viable treatments for end-stage heart failure. These devices havesaved thousands of lives during temporary use as a bridge-to-transplant andhave selectively been used for bridge-to-recovery or as an alternative totransplantation. Adoption rates for long-term use are continuing to increase,although at a slower rate than anticipated.

*Advantages of VADs*

VADs that are either externally placed or abdominallyimplanted have been demonstrated as being effective in supporting bloodcirculation in patients with a failing heart. To date, more than 10,000patients have been supported by pulsatile VADs.

The followingadvantages over other treatments generally apply to VADs that are currentlyapproved and in use, including the Novacor LVAS. Although certain advantagesmay not apply in every situation or for all patients, we expect that thesepotential advantages will also apply to our Novacor II and the WorldHeartrotary VAD:

·       *Unlimited Supply*.   As a manufactureddevice, VADs are available as and when needed, including on an emergency basis,to treat advanced heart failure patients.

·       *Reduced Hospitalization*.   Unliketransplant patients, VAD patients go to surgery without a protracted wait for adonor organ, and in the case of implantable VADs, patients are generally ableto leave the hospital after a relatively shorter recovery period, thuspotentially reducing health care costs.

·       *Improved Patient Health*.   After VADimplantation, blood circulation is improved throughout the body and mostpatients experience improved levels of health as shown in a number of clinicalstudies, including those for the Novacor LVAS.

·       *Reduction in Medication Use*.   Unliketransplants, VADs typically do not cause rejection responses and, as a result,VAD patients typically do not need the administration of immuno-suppressivemedication. Patients are accordingly not subject to the risks and costsassociated with long-term administration of these medications.

·       *Natural Heart Recovery*.   Unlike total artificial heartsystems, VADs leave the natural heart intact and assist it when it is unable toprovide sufficient cardiac function to maintain blood circulation. Severalpatients have been weaned from the Novacor LVAS in Europe and the firstdomestic patient was weaned from the Novacor LVAS in August 2005 at theYale-New Haven Hospital in Connecticut after regaining sufficient natural heartfunctionality.

**Marketing,Manufacturing and Distribution Strategy**

Since the acquisition of the Novacor division ofEdwards in 2000, WorldHeart has had access to most key medical centers involvedin cardiac transplantation in North America, Europe and Japan. We currentlysell directly within the United States through a dedicated sales force. Before2004, the Novacor LVAS was represented by Edwards outside the United States. InJanuary 2004, we assumed full sales and support responsibility for theNovacor LVAS primarily in Europe but excluding Japan. WorldHeart continues todistribute its products through Edwards in Japan and through other distributorsin selected markets. Approximately 77% of WorldHeart’s 2005 revenue came fromthe United States.

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The United States and European-based operations of ourNovacor business have experienced clinical and technical personnel who actuallysupport key medical centers, as well as their leading clinicians and medicalstaff.

WorldHeart manufactures,distributes and services its commercial and clinical-stage products at itsOakland, California facility. Manufacturing is highly specialized, requiringqualified personnel and a facility that is compliant with the provisions of theUnited States Quality System Regulations and ISO Standards that pertain to themanufacture, inspection, and distribution of medical devices.

**Intellectual Property**

We have been granted 11 active United States patentsfor the Novacor LVAS and its associated subsystems. A subset of these patentshas also been filed and granted in the major European countries, in Canada andin Japan.

To date, we have been granted one United States patentand a second patent application is pending for the Novacor II, andcorresponding applications are also pending in Europe, Japan and Canada. TheTranscutaneous Energy Transfer technology licensed to WorldHeart from theOttawa Heart Institute intended to be incorporated in Novacor II has beenpatented in the United States, Canada and the United Kingdom.

As part of the MedQuest acquisition, WorldHeart nowholds various patents and licenses to patents related to the WorldHeart rotaryVAD and other potential future products. These licenses are through universityresearch foundations and other organizations. WorldHeart has ownership and/orexclusive licenses to 11 patents related to the MedQuest implantable blood pumptechnology. In addition, two patents are non-exclusively licensed related tocontrol of rotary blood pumps. Additional patents are pending.

We have a number of trademarks, and we have federallyregistered several, including the WORLDHEART logo mark and the NOVACOR mark. Aspart of the MedQuest acquisition, we also now own a number of additional marks,most of which are also federally registered, including the MEDQUEST mark, theHEARTQUEST mark and the AUTOME mark. Pending applications for registration ofother marks include the MAGLEV mark.

We generally enter intoconfidentiality and invention agreements with our employees and consultants,and control access to and distribution of information related to our technologyand products, documentation and other proprietary information.

**License Agreements**

Licenses related to the WorldHeart rotary VAD includean exclusive license with the University of Utah on four issued patents and onwhich WorldHeart has no future obligations. The University of Virginiaagreement is an exclusive royalty-based license on four patents. The agreementwith Magnetic Moments, Inc. (d.b.a. LaunchPoint Technologies) is anexclusive royalty-based license on four issued and pending patents.

In addition to the WorldHeart rotary VAD product, wehold a fully paid and royalty-based license from the University of Pittsburghon patents related to a right ventricular assist device (RVAD), and a pediatricventricular assist device (PVAD). There is also a royalty-based agreement withThe Heart Lung Institute, LLC, which funded early research of the WorldHeartrotary VAD.

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**Competition**

*Overview*

In addition to competing with other less-invasivetherapies for heart failure, the Novacor LVAS and our next-generation VADs willcompete with existing VADs and VADs under development, sold by a number ofexisting and emerging companies. Competition from medical device companies andmedical device subsidiaries of healthcare companies is intense and may increase.Many of our competitors may have substantially greater financial, technical,manufacturing, distribution and marketing resources.

At present, only two companies in North America havedeveloped implantable, electric VADs approved for commercial sale in the UnitedStates:  WorldHeart and Thoratec. Thoratechas two pulsatile left ventricular assist device models of its HeartMate thathave been approved in the United States for commercial sale. One ispneumatically driven (Heartmate IP LVAS), and the other is electrically driven(HeartMate XVE). The HeartMate XVE and the Novacor LVAS have been approved forcommercial sale for bridge-to-transplant indications in the United States andwithout restriction for use for heart-failure patients in Europe. The HeartMateXVE has maintained a dominant market share having also received regulatoryapproval for Destination Therapy in the United States in April 2003.

WorldHeart commenced the RELIANT Trial in 2004, inwhich study subjects are being randomized to be implanted with either theNovacor LVAS (Study Arm) or to the HeartMate XVE (Control Arm). It is expectedthat data from this trial, if successfully completed, will support a PMASupplement which will be submitted to the FDA for the use of the Novacor LVASfor Destination Therapy.

Thoratec, and other companies such as Abiomed, Inc.(Abiomed) have VADs that are designed for temporary use but are not typicallyimplanted in the body. Their pumps are external and are attached to the naturalheart via connecting tubes running through the recipient’s skin and tissue. Abiomed’sVAD is approved by the FDA for in-hospital use only. In 2001, Thoratec receivedapproval from the FDA for a portable console driver for its VAD that can enablerecipients to leave the hospital.

In Europe and certainother countries outside North America, Berlin Heart Institute and MedosMedizentechnik AG provide external VADs comparable to those manufactured anddistributed by Thoratec.

*Future ProductCompetition*

*Pulsatile versusRotary Flow (Non-Pulsatile) VADs*

Currently, most heart assist devices intended for usein end stage heart failure patients are pulsatile, mimicking the natural heart’spumping action. Non-pulsatile, or continuous blood flow VADs, are underdevelopment and have been tested in animals and in human trials as abridge-to-transplant or bridge-to-recovery. Continuous flow VADs are expectedto be smaller, less complex and valveless, to have lower energy needs and to bepotentially less costly. There is a lack of long-term clinical data onnon-pulsatile pump reliability and on human physiological and haematologicalresponses, including the determination of the human body’s requirement for apulsatile blood flow for long-term health.

We believe that effectivetreatment of advanced heart failure will require both pulsatile and rotarypumps to treat the full spectrum of clinical needs of end and late-stage heartfailure patients. We believe that pulsatile devices are best suited forend-stage patients with poor ventricular contractility, who require fullsupport (or, functional replacement); while rotary devices are better suitedfor late-stage patients, with some left ventricular contractility, who requireonly partial support (or, assist). We believe the only fully implantable,bearingless, pulsatile VAD under development is our next-generation VAD,Novacor II.

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*Rotary Flow VADs*

There is a large number of non-pulsatile, or rotaryflow, VADs in varying stages of development. One such device, which has beenundergoing United States clinical trials (as a bridge-to-transplant and forDestination Therapy) and which is approved for use in Europe, is the MicroMedDeBakey® VAD being developed by MicroMed Technology, Inc. This deviceprovides continuous left ventricular assist via a small rotary pump that isimplanted in the abdomen and is powered via wires that perforate the skin,connected to an external controller and rechargeable battery pack. The Jarvik2000 Flowmaker®, developed by Jarvik Heart, Inc., is a similar device at acomparable state of development. The Incor rotary pump from Berlin Heart isalso approved for use in Europe.

We believe that the WorldHeart rotary VAD underdevelopment is a unique, technologically advanced, next generation, rotary pump.This bearingless, centrifugal, magnetically-levitated rotor results in a pumpwith no moving parts subject to wear, in a small device expected to providemulti-year support over a wide range of flows.

Combining the WorldHeartrotary VAD with our clinical and commercialization infrastructure and ourcurrent and next-generation, long-term use, pulsatile Novacor systems will becritical in expanding our activities in the Destination Therapy market. WorldHeartis currently the only company that has small, silent, next-generation pulsatileand rotary systems under development, as well as a current-generation,pulsatile device in the market today.

**Government Regulations**

*Overview*

Most countries, includingthe United States, Canada and countries that comprise the European Community(EC), require regulatory approval prior to the commercial distribution ofmedical devices. In particular, active implantable medical devices generally aresubject to rigorous clinical testing as a condition of approval by the FDA andby similar authorities in Canada, in the EC and in other countries. Theapproval process for our Novacor II and WorldHeart’s rotary VAD will beexpensive and time consuming.

*United StatesRegulation*

In the United States, the FDA regulates themanufacture, distribution, labeling and promotion of medical devices pursuantto the United States Federal Food, Drug and Cosmetic Act (FDC Act) andregulations under the FDC Act. The Novacor LVAS, Novacor II and WorldHeart’srotary VAD devices are regulated as Class III medical devices. Humanclinical trials are conducted pursuant to an Investigational Design Exemption(IDE) in the United States, the results of which must demonstrate, to thesatisfaction of the FDA, the safety and efficacy of the medical device.

Before commercial distribution of our devices ispermitted in the United States, an application for Premarket Approval must beapproved by the FDA.

In addition, any medicaldevice distributed in the United States is subject to continuing regulation bythe FDA. Products must be manufactured in registered establishments and must bemanufactured in accordance with the Quality System Regulation. Labeling andpromotional activities are subject to scrutiny by the FDA and, in certaininstances, by the Federal Trade Commission. Failure to comply with theserequirements could result in enforcement action, including seizure, injunction,prosecution, civil penalties, recall and suspension of FDA approval.

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*Canadian Regulation*

The sale and advertising of medical devices in Canadaare governed by the Food and Drugs Act (Canada) through the Medical DevicesRegulations, administered by the Medical Devices Bureau of Health Canada (MDB).The current Medical Devices Regulations are undergoing revisions that may alignthe Canadian regulatory process with those of Canada’s international tradingpartners. We believe that international harmonization of the regulatory processwill be more likely to accelerate, rather than slow, the approval process as itrelates to WorldHeart’s next-generation VAD, Novacor II, and theWorldHeart rotary VAD.

Our Novacor II andthe WorldHeart rotary VADs are expected to be classified as Class IVmedical devices under the Medical Devices Regulations, requiring WorldHeart toapply for authorization from the MDB to conduct investigational testing onhuman subjects in Canada. At the conclusion of the human clinical trials, weplan to apply for a medical device license that will allow for generalmarketing of the device.

*RegulatoryRequirements in Other Countries*

It is also our intention to market the Novacor IIand the WorldHeart rotary VADs in the EC and other countries. We will berequired to meet the applicable medical devices standards in each such countryor region. Although harmonization has been under negotiation for some timeamong various countries, the approval process varies from country to countryand approval in one country does not necessarily result in approval in another.

We intend to apply for “CE”marking, an international symbol of quality and compliance, for the Novacor IIand the WorldHeart rotary VADs. The International Standards Organization (ISO)is a worldwide federation of national bodies, founded in Geneva, Switzerland in1946. ISO has over 92 member countries, including the United States and Canada.ISO standards are integrated requirements which, when implemented, form thefoundation and framework for an effective quality management system. Thesestandards were developed and published by the ISO. ISO certification is widelyregarded as essential to enter Western European markets. All companies arerequired to obtain ISO certification and the “CE” mark, in order to marketmedical devices in Europe. ISO 13485:2003 certification is the most current andmost stringent standard in the ISO series and covers design, production,installation and servicing of products. WorldHeart received ISO 13485:2003certification in September 2005. WorldHeart received the “CE” mark for theNovacor LVAS in 1993.

*Other RegulatoryRequirements*

We are also subject tovarious Canadian and United States federal, provincial, state and local lawsand regulations relating to such matters as safe working conditions, laboratoryand manufacturing practices, and the use, handling and disposal of hazardous orpotentially hazardous substances used in connection with WorldHeart’s research,development and production work. The manufacture of biomaterials is alsosubject to compliance with various federal environmental regulations and thoseof various provincial, state and local agencies. Although we believe that weare in compliance with these laws and regulations in all material respects,there can be no assurance that we will not be required to incur significantcost to comply with environmental and health and safety regulations in thefuture.

**Our Employees**

At March 15, 2006, we had 117 full time employees.Of these employees, 85 are located in Oakland, California, 25 in Salt LakeCity, Utah, 5 in Heesch, Netherlands and 2 in Canada. Approximately 64% of ouremployees are involved with research, development, manufacturing, quality,clinical affairs and regulatory, 17% are in sales and clinical support, and 19%are in finance and administration.

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We currently maintaincompensation, benefits, equity participation and work environment policiesintended to assist in attracting and retaining qualified personnel. We believethat the success of our business will depend, to a significant extent, on ourability to attract and retain such personnel. We have access to skilled laborresources in Oakland and Salt Lake City where there are well-developedtechnology industries. None of our employees are subject to a collectivebargaining agreement nor have we experienced any work stoppages.

**RISK FACTORS**

You should carefullyconsider the following risk factors in evaluating WorldHeart. Additional risksand uncertainties not presently known to us or that we currently consider notmaterial may also impair our business, financial condition and results ofoperations. If any of the events described below actually occurs, our business,financial condition and results of operations could be materially adverselyaffected.

**RiskFactors Relating to our Business**

*We have hadsubstantial losses since incorporation and expect to continue to operate at aloss while our products are under development, and we may never becomeprofitable.*

Since its inception in 1996, WorldHeart has incurredcumulative losses of approximately $252 million a significant portion of whichrelates to the costs of internally developed and acquired technologies. Researchand development expenses have been reduced in the past two years but areexpected to increase in relation to the completion and regulatory approval ofproducts currently under development.

MedQuest, acquired by WorldHeart in 2005, has alsogenerated losses from operations and did not have a commercially availablerevenue-generating product. We are committed to making significant additionalexpenditures for development of the Novacor II and WorldHeart rotary VAD in2006 and subsequent fiscal years, which will likely result in additional lossesfrom these activities in future periods. These expenditures include costsassociated with performing pre-clinical and clinical trials for our nextgeneration products, continuing research and development, seeking regulatoryapprovals and, if we receive these approvals, commencing commercialmanufacturing, sales and marketing of our products.

*We will requiresignificant capital investment to bring future products and productenhancements to market, and if adequate funding is not available, our financialcondition will be adversely affected and we may have to curtail or eliminateour development programs and significantly reduce our expenses.*

Our investment of capital has been and will continueto be significant. Developing our technology, future products and continuedproduct enhancements, including those of the Novacor II and WorldHeart rotaryVAD technologies, require a commitment of substantial funds to conduct thecostly and time-consuming research and clinical trials necessary for suchdevelopment and regulatory approval. If adequate funds are not available whenneeded, we may be required to delay, reduce the scope of, or eliminate one ormore of our research or development programs or obtain funds througharrangements with collaborative partners or others that may require us torelinquish rights to certain of our technologies, potential products orproducts that we would otherwise seek to develop or commercialize ourselves. Inaddition, we may be required to reduce our operating expenses, including butnot limited to, reductions in salaries and/or elimination of employees andconsultants. The inability to obtain additional financing when needed will havea material adverse effect on our business, financial condition and results ofoperations.

*We may be unable toobtain regulatory approvals, which will prevent us from selling our productsand generating revenue.*

Most countries, including the United States, Canadaand countries in Europe, require regulatory approval prior to the commercialdistribution of medical devices. In particular, implanted medical devicesgenerally are subject to rigorous clinical testing as a condition of approvalby the FDA and by similar 

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authorities in Canada(e.g., Health Canada), and in European and other countries. The approvalprocess is expensive and time consuming. Non-compliance with applicableregulatory requirements can result in, among other things, fines, injunctions,civil penalties, recall or seizure of products, total or partial suspension ofproduction, government refusal to grant marketing approval for devices,withdrawal of marketing approvals and criminal prosecution. The inability toobtain the appropriate regulatory approvals for our products in the UnitedStates, Canada and the rest of the world will prevent us from selling ourproducts which would have a material adverse effect on our business, financialcondition and results of operations.

In the United States, WorldHeart commenced its RELIANTTrial in the second quarter of 2004. It is expected that data from this trialwill support a PMA Supplement, which will be submitted to the FDA for the useof the Novacor LVAS for Destination Therapy. Although we are pursuingopportunities to change the trial inclusion criteria and to reduce the numberof patients required for approvability, there can be no assurances based oncurrent, slower than anticipated, enrolment in the RELIANT Trial that we willcomplete the trial on a timely basis. In addition, there can be no assurancethat even if the trial is completed that the FDA will act quickly or favorablyin the review of this application to market.

The Novacor II’s first animal implant occurred inJuly 2005, and we intend to progress pre-clinical testing in animalsin 2006. The WorldHeart rotary VAD began an initial human feasibility clinicaltrial in March 2006 in Europe.

There can be no assurance that the FDA, Health Canadaor any other regulatory authority will act favorably or quickly in its reviewof our applications, if and when made, and we may face significant difficultiesand costs obtaining such approvals that could delay or preclude us from sellingour next-generation products in the United States, Europe, Canada and elsewhere.Failure to receive, or delays in receiving, such approvals, including the needfor extended clinical trials or additional data as a prerequisite to approval,limitations on the intended use of our next-generation products, therestriction, suspension or revocation of any approvals obtained or any failureto comply with approvals obtained could have a material adverse effect on ourbusiness, financial condition and results of operations.

*We are dependent ona limited number of products.*

To date, all of our revenues have resulted from salesof the Novacor LVAS and related technologies. Our future financial performancedepends on the successful sales and marketing of the Novacor LVAS and thedevelopment, regulatory approval, introduction, customer acceptance andsuccessful sales and marketing of Novacor II and the WorldHeart rotaryVAD  We currently have no clinical datarelating to our products under development. Prior to any commercial use, ourproducts currently under development will require significant additionalcapital for research and development efforts, extensive pre-clinical andclinical testing and regulatory approval.

New product development is highly uncertain andunanticipated developments, clinical and regulatory delays, adverse orunexpected side effects or inadequate therapeutic efficacy could delay orprevent the successful commercialization of the Novacor II and of theWorldHeart rotary VAD. Any significant delays in, or premature termination of,clinical trials of our products under development could have a material adverseeffect on our business, financial condition and results of operations.

*Market acceptanceof our technologies and products is uncertain and our selling and distributioncapability is limited.*

The Novacor LVAS and our next-generationNovacor II and WorldHeart rotary VAD represent ventricular assisttechnologies that must compete with other products as well as with othertherapies for heart failure, such as medication, transplants, cardiomyoplastyand total artificial heart devices. In addition, although WorldHeart believesthat the Destination Therapy market opportunity for VADs is significant,adoption rates have continued to be slower than anticipated.

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We have a limited number of sales and technicalsupport personnel compared with other medical device companies in our industrysegment, which may put us at a competitive disadvantage in the marketplace. Ourlimited staffing may result in longer lead times to train new hospitalpersonnel before they are capable of using our device. Failure of our productsto achieve significant market acceptance due to competitive therapies orlimited selling and distribution could have a material adverse effect on ourbusiness, financial condition and results of operations.

*We face significantcompetition and technological obsolescence of our products.*

In addition to competing with other less-invasivetherapies for heart failure, including medications and pacing technology, ourproducts will compete with ventricular assist technology being developed andsold by a number of other companies. Competition from medical device companiesand medical device subsidiaries of healthcare and pharmaceutical companies isintense and expected to increase.

Some of our competitors have financial, technical,manufacturing, distribution and marketing resources substantially greater thanours. Third parties may succeed in developing or marketing technologies andproducts which are more effective and more timely than those developed ormarketed by us which could render our technology and products non-competitiveor obsolete, or we may not be able to keep pace with technological developmentsor our competitors’ time frames, all of which could have a material adverseeffect on our business, financial condition and results of operations.

*There arelimitations on third-party reimbursement for the cost of implanting ourdevices.*

Individual patients will seldom be able to paydirectly for the costs of implanting our devices. Successful commercializationof our products will depend in large part upon the availability of adequatereimbursement for the treatment and medical costs from third-party payers,including governmental and private health insurers and managed careorganizations. Consequently, we expect that our products will typically bepurchased by healthcare providers, clinics, hospitals and other users who willbill various third-party payers, such as government programs and privateinsurance plans, for the healthcare services provided to their patients.

The coverage and the level of payment provided bythird-party payers in the United States and other countries vary according to anumber of factors, including the medical procedure, third-party payer, locationand cost. In the United States, many private payers follow the recommendationsof the CMS, which establishes guidelines for the governmental coverage ofprocedures, services and medical equipment.

There can be no assurance with respect to any marketsin which we seek to distribute our products that third-party coverage andreimbursement will be adequate, that current levels of reimbursement will notbe decreased in the future or that future legislation, regulation orreimbursement policies of third-party payers will not otherwise adverselyaffect the demand for our products or our ability to sell our products on aprofitable basis, particularly if the installed cost of our systems and devicesshould be more expensive than competing products or procedures. Theunavailability of third-party payer coverage or the inadequacy of reimbursementwould have a material adverse effect on our business, financial condition andresults of operations.

*If we cannotprotect our intellectual property, our business could be adversely affected.*

Our intellectual property rights, including thoserecently acquired from MedQuest, are and will continue to be a criticalcomponent of our success. The loss of critical licenses, patents or tradesecret protection for technologies or know-how relating to our current productand our products in development could adversely affect our business prospects. Ourbusiness will also depend in part on our ability to defend our existing andfuture intellectual property rights and conduct our business activities free ofinfringement claims by third parties. We intend to seek additional patents, butour pending and future patent 

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applications may not beapproved, may not give us a competitive advantage and could be challenged byothers. Patent proceedings in the United States and in other countries may beexpensive and time consuming. In addition, patents issued by foreign countriesmay afford less protection than is available under United States intellectualproperty law, and may not adequately protect our proprietary information.

Our competitors may independently develop proprietarynon-infringing technologies and processes that are substantially similar toours, or design around our patents. In addition, others could developtechnologies or obtain patents, which would render our patents and patentrights obsolete. Claims by competitors and other third parties that ourproducts allegedly infringe the patent rights of others could have a materialadverse effect on our business. We could encounter legal and financialdifficulties in enforcing our licenses and patent rights against allegedinfringers. The medical device industry and cardiovascular device market, inparticular, is characterized by frequent and substantial intellectual propertylitigation. Intellectual property litigation is complex and expensive and theoutcome of this litigation is difficult to predict. Any future litigation,regardless of outcome, could result in substantial expense and significantdiversion for WorldHeart’s technical and management personnel. An adversedetermination in any such proceeding could subject us to significantliabilities or require us to seek additional licenses from third parties, paydamages and/or royalties that may be substantial or force us to redesign therelated product. These alternatives may be uneconomical or impossible. Furthermore,we cannot assure you that if additional licenses are necessary that they wouldbe available on satisfactory terms or at all. Accordingly, an adversedetermination in a judicial or administrative proceeding or failure to obtainnecessary licenses could prevent us from manufacturing or selling certain ofour products, any of which could have a material adverse effect on ourbusiness, financial condition and results of operations.

*We are exposed toproduct liability claims.*

Our business exposes us to an inherent risk ofpotential product liability claims related to the manufacturing, marketing andsale of the Novacor LVAS, and if and when regulatory approvals are received,the Novacor II and the WorldHeart rotary VAD, by device recipients in whomthe devices are implanted or by their families. Claims of this nature, ifsuccessful, could result in substantial damage awards to the claimants, whichmay exceed the limits of any applicable insurance coverage held by WorldHeart. Asuccessful claim brought against us in excess of, or outside of, our insurancecoverage could have a material adverse effect on our financial condition. Claimsagainst WorldHeart, regardless of their merit or potential outcome, could alsohave a material adverse effect on our ability to obtain physician endorsementof our products, to expand our business or obtain insurance in the future whichcould have a material adverse effect on our business and results of operations.

*We face risksassociated with our manufacturing operations, risks resulting from dependenceon third-party manufacturers, and risks related to dependence on solesuppliers.*

The manufacture of our products is a complex operationinvolving a number of separate processes and components. Material costs arehigh and certain of the manufacturing processes involved are labor-intensive. Achievingcontinued cost reductions will depend upon our ability to reduce material costsand reduce the time required to complete certain manufacturing processes. Theconduct of manufacturing operations is subject to numerous risks, includingreliance on third-party manufacturers, unanticipated technological problems anddelays. WorldHeart, or any entity manufacturing products or components on ourbehalf, may not be able to comply with applicable governmental regulations orsatisfy regulatory inspections in connection with the manufacture of ourproducts, which would have a material adverse effect on our business, financialcondition and results of operations.

We are currently dependent on single-sourcethird-party manufacturers for several of the components used in the NovacorLVAS. We do not have agreements with many of such single-source manufacturersand purchase these components pursuant to purchase orders placed from time totime in the ordinary course of business. We are substantially dependent on theability of these manufacturers to provide 

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adequate inventories ofthese components on a timely basis and on favorable terms. These manufacturersalso produce components for certain of our competitors, as well as other largecustomers, and there can be no assurance that such manufacturers will havesufficient production capacity to satisfy our inventory or schedulingrequirements during any period of sustained demand, or that we will not besubject to the risk of price fluctuations and periodic delays. Although webelieve that our relationships with our manufacturers are satisfactory and thatalternative sources for the components we currently purchase from single-sourcesuppliers are currently available, the loss of the services of suchmanufacturers or substantial price increases imposed by such manufacturers, inthe absence of readily available alternative sources of supply, would have amaterial adverse effect on us. Failure or delay by such manufacturers insupplying components to us on favorable terms could also adversely affect ouroperating margins and our ability to develop and deliver our products on a timelyand competitive basis which could have a material adverse effect on ourbusiness, financial condition and results of operations.

*We are dependent onkey personnel.*

As a result of the specialized scientific nature ofour business, we are dependent on our ability to attract and retain qualifiedscientific, technical and key management personnel. We face intense competitionfor such persons and we may not be able to attract or retain such individuals. Currently,WorldHeart does not have key man insurance for the Chief Executive Officer ofWorldHeart or any other executive officers.

In the past, MedQuest depended heavily on thecontributions of several principal members of its technical, regulatory andclinical, operating management and staff. Although most of the key MedQuestemployees became employees of WorldHeart upon completion of the MedQuestAcquisition, there is no assurance that we will be able to retain theseindividuals.

*The price of ourshares is highly volatile.*

As a small capitalization medical device company, theprice of our common shares has been, and is likely to continue to be, highlyvolatile. Future announcements concerning us or our competitors, quarterlyvariations in operating results, introduction of new products, delays in theintroduction of new products or changes in product pricing policies by us orour competitors, acquisition or loss of significant customers, partners,distributors and suppliers, changes in earnings estimates or our ratings byanalysts, regulatory developments, or fluctuations in the economy or generalmarket conditions, among other factors, could cause the market price of ourcommon shares to fluctuate substantially. There can be no assurance that themarket price of our common shares will not decline below its current price orthat it will not experience significant fluctuations in the future, includingfluctuations that are unrelated to our performance.

Currently WorldHeart’s common shares are quoted on theNasdaq Global Market and listed on the Toronto Stock Exchange. We must satisfycertain minimum listing maintenance requirements to maintain the Nasdaqquotation, including a series of financial tests relating to shareholdersequity or net income or market value, public float, number or market makers andshareholders, market capitalization, and maintaining a minimum bid price of$1.00 per share.

On November 29, 2005, we received notificationfrom Nasdaq stating that, because our stock price had traded below $1.00 pershare for 30 consecutive trading days, we would be subject to delisting if ourclosing stock does not trade above $1.00 per share for, at least, 10consecutive trading days before May 30, 2006. If compliance with theminimum trading price requirement cannot be demonstrated by May 30, 2006and, except for the bid price requirement, we meet the Nasdaq Capital Marketinitial listing criteria, then we could request a transfer to the NasdaqCapital Market which will provide us with an additional 180 calendar daycompliance period in which to demonstrate compliance with the minimum bid pricerequirement. If we do not regain compliance or are not eligible for theadditional compliance period, then our common shares will be delisted. Delistingfrom Nasdaq will result in our common shares trading on the 

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Over-the-Counter BulletinBoard, which is viewed by most investors as a less desirable and less liquidmarket place. This could make trading more difficult for our investors, leadingto lower trading volumes and declines in share price, which would also make itmore difficult and expensive for us to raise additional capital.

*The sales of commonshares by our shareholders could depress the price of our common shares.*

If our shareholders sell substantial amounts of ourcommon shares in the public market, the market price of our common shares couldfall. These sales might also make it more difficult for us to sell equity orequity related securities at a time and price that we would deem appropriate. Allof the common shares of WorldHeart issued to MedQuest pursuant to the MedQuestAcquisition and to Maverick pursuant to the private placement have been  registered pursuant to a re-sale registrationstatement, and MedQuest recently effected a partial distribution of our sharesto its former shareholders who are now free to sell the shares in the market. Salesby these shareholders and by the former holders of our convertible debenturesand warrants who received the common shares in connection with the conversionand exercise of the respective debentures and warrants in July 2005 couldhave an adverse impact on the trading price of our common shares.

*Industryconsolidation may affect our ability to compete successfully.*

Companies in similar businesses are entering intobusiness combinations with one another which may create more powerful oraggressive competitors. There is a risk that we will not be able to competesuccessfully as future markets evolve and that we may have to pursue additionalacquisitions or other business combinations. Increased competitive pressurecould lead to lower sales and prices of our products, and this could harm ourbusiness, results of operations and financial condition.

*The integration ofthe WorldHeart and MedQuest operations could be costly in the future and we mayfail to continue to  successfully effectthe integration.*

Our ability to realize some of the additionalanticipated benefits of the MedQuest Acquisition will depend in part on ourability to continue to integrate MedQuest’s operations into our currentoperations. The integration process has and will continue to requiresignificant efforts from management. The WorldHeart rotary VAD developmentcontinues to be conducted from the facilities at our Salt Lake City operations,with significant technical manufacturing and administrative support fromOakland personnel. If we are unable to continue to successfully integrate theoperations of MedQuest or if the costs of integration are higher than expected,our business, operating results and financial condition may be negativelyimpacted.

*The concentrationof our capital stock ownership following the completion of the MedQuestAcquisition and the private placement to Maverick may limit your ability toinfluence corporate matters.*

As of December 31,2005, Maverick, directly and indirectly, controls over 30% of our issued commonshares. Maverick is a limited liability company controlled by Kevin Compton. Assuch, Maverick may exercise significant influence over all matters requiringshareholder approval, including elections of directors and significantcorporate transactions, such as a merger or other sale of our company or itsassets for the foreseeable future. This concentrated control may limit yourability to influence corporate matters, and, as a result, we may take actionsthat our shareholders do not view as beneficial.

**Item 2.**                        Descriptionof Property.

**Our Facilities**

Our headquarters office is located in Oakland,California. As part of the consolidation of our operations, which commenced in August 2004,we have moved our head office to Oakland, California from Ottawa, Ontario. Ourfacilities in Oakland include two buildings and approximately 40,000 squarefeet of 

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manufacturing and officespace. This space was obtained as part of the Novacor acquisition and continuesto be the sole manufacturing facility for the Novacor LVAS. The Oakland leaseexpires on April 30, 2007. Our facility in Salt Lake City, Utah iscomprised of 24,044 square feet of research and office space with a lease thatexpires on January 31, 2008. Our office in Heesch, Netherlands consists ofapproximately 2,500 square feet under a lease expiring December 31, 2007.Our registered office is in Ottawa, Ontario.

We are not aware of anyenvironmental issues that may affect the use of our properties. We currentlyhave no investments in real estate, real estate mortgages or real estatesecurities, and do not anticipate making any such investments. However, ourpolicy with respect to investments in real estate assets may change in thefuture without a vote of shareholders.

**Item 3.**                        LegalProceedings.

In the normal course ofbusiness, we may be a party to legal proceedings. We are not currently a partyto any material legal proceedings.

**Item 4.**                        Submissionof Matters to a Vote of Security Holders.

None.

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**PART II**

**Item 5.**                        Marketfor Common Equity and Related Stockholder Matters and Small Business IssuerPurchases of Equity Securities.

Our common shares are quoted on the Nasdaq GlobalMarket under the symbol WHRT and are listed on the Toronto Stock Exchange (TSX)under the symbol WHT. Our common shares began trading on the Nasdaq commencingin August 1998 but were delisted on October 15, 2002 and were quotedon the Nasdaq OTC Bulletin Board from October 15, 2002 until March 17,2004. Our common shares were readmitted to trading on Nasdaq on March 18,2004. On December 1, 2003, WorldHeart amended its articles to effect a onecommon share for seven common shares consolidation and began trading on apost-consolidated basis on December 4, 2003.

Thefollowing table sets forth the high and low bid prices for our common shares asreported on the Nasdaq for the periods indicated below:

| ** **     | ** ** | **Common Shares** | ** ** |
|----------------|------------|------------------------|------------|
| **2004**       | ** ** | **High**               | ** ** | **Low** | ** ** |
| First Quarter  |       | $                      | 9.00       |   | $ | 7.68 |   |
| Second Quarter |       | $                      | 8.50       |   | $ | 3.70 |   |
| Third Quarter  |       | $                      | 5.10       |   | $ | 1.05 |   |
| Fourth Quarter |       | $                      | 2.68       |   | $ | 0.97 |   |

 

| ** **     | ** ** | **Common Shares** | ** ** |
|----------------|------------|------------------------|------------|
| **2005**       | ** ** | **High**               | ** ** | **Low** | ** ** |
| First Quarter  |       | $                      | 2.62       |   | $ | 1.12 |   |
| Second Quarter |       | $                      | 1.60       |   | $ | 0.90 |   |
| Third Quarter  |       | $                      | 1.50       |   | $ | 0.98 |   |
| Fourth Quarter |       | $                      | 1.09       |   | $ | 0.44 |   |

 

| ** **           | ** ** | **Common Shares** | ** ** |
|----------------------|------------|------------------------|------------|
| **2006**             | ** ** | **High**               | ** ** | **Low** | ** ** |
| January              |       | $                      | 0.60       |   | $ | 0.51 |   |
| February             |       | $                      | 0.78       |   | $ | 0.52 |   |
| March 15,  2006 |       | $                      | 1.09       |   | $ | 0.99 |   |

 

Thefollowing table sets forth the high and low sales prices in Canadian dollarsfor our common shares as reported on the TSX for the periods indicated:

| ** **     | ** ** | **Common Shares** | ** ** |
|----------------|------------|------------------------|------------|
| **2004**       | ** ** | **High**               | ** ** | **Low** | ** ** |
| First Quarter  |       | Cdn $11.40             |       | Cdn $8.40 |   |
| Second Quarter |       | Cdn $10.85             |       | Cdn $5.06 |   |
| Third Quarter  |       | Cdn $6.48              |       | Cdn $1.33 |   |
| Fourth Quarter |       | Cdn $3.20              |       | Cdn $1.16 |   |

 

| ** **     | ** ** | **Common Shares** | ** ** |
|----------------|------------|------------------------|------------|
| **2005**       | ** ** | **High**               | ** ** | **Low** | ** ** |
| First Quarter  |       | Cdn $2.36              |       | Cdn $1.33 |   |
| Second Quarter |       | Cdn $1.99              |       | Cdn $1.18 |   |
| Third Quarter  |       | Cdn $1.78              |       | Cdn $1.15 |   |
| Fourth Quarter |       | Cdn $1.30              |       | Cdn $0.51 |   |

 

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| ** **           | ** ** | **Common Shares** | ** ** |
|----------------------|------------|------------------------|------------|
| **2006**             | ** ** | **High**               | ** ** | **Low** | ** ** |
| January              |       | Cdn $0.73              |       | Cdn $0.56 |   |
| February             |       | Cdn $0.90              |       | Cdn $0.58 |   |
| March 15,  2006 |       | Cdn $1.25              |       | Cdn $1.11 |   |

 

As of March 15, 2006,the approximate number of holders of record of our common shares was 250 andthe approximate number of beneficial holders of our common shares was 9,500.

**CERTAIN INCOME TAX CONSIDERATIONS**

*Canadian FederalIncome Tax Considerations*

This summary is applicable to a holder or prospectivepurchaser of common shares who is not (and is not deemed to be) resident inCanada, does not (and is not deemed to) use or hold the common shares in, or inthe course of, carrying on a business in Canada, and is not an insurer thatcarries on an insurance business in Canada and elsewhere.

This summary is based on the current provisions of the*Income Tax Act* (Canada), the regulationsthereunder, all specific proposals to amend such Act and regulations publicly announcedby or on behalf of the Minister of Finance (Canada) prior to the date hereofand WorldHeart’s understanding of the published administrative and assessingpractices and policies of the Canada Revenue Agency. This summary does nototherwise take into account any change in law or administrative practice,whether by judicial, governmental, legislative or administrative action, nordoes it take into account provincial, territorial or foreign income taxconsequences, which may vary from the Canadian federal income taxconsiderations described herein.

This summary is of ageneral nature only and it is not intended to be, nor should it be construed tobe, legal or tax advice to any holder of the common shares and norepresentation with respect to Canadian federal income tax consequences to anyholder of common shares is made herein. Accordingly, prospective purchasers andholders of the common shares should consult their own tax advisers with respectto their individual circumstances.

*Dividends on CommonShares*

Canadian withholding taxat a rate of 25.0% (subject to reduction under the provisions of any relevanttax treaty) will be payable on dividends paid or credited to a holder of commonshares. Under the Canada-U.S. income tax treaty, the withholding tax rate isgenerally reduced to 15.0% for a holder entitled to the benefits of the treaty(or 5.0% if the holder is a corporation that owns at least 10.0% of the commonshares).

*Capital Gains andLosses*

Subject to the provisions of a relevant tax treaty,capital gains realized by a holder on the disposition or deemed disposition ofcommon shares held as capital property will not be subject to Canadian taxunless the common shares are taxable Canadian property (as defined in the *Income Tax Act* (Canada)), in which case the capital gainswill be subject to Canadian tax at rates which will approximate those payableby a Canadian resident. Common shares will not be taxable Canadian property toa holder provided that, at the time of the disposition or deemed disposition,the common shares are listed on a prescribed stock exchange (which currentlyincludes the TSX) unless such holder, persons with whom such holder did notdeal at arms length or such holder together with all such persons, owned 25.0%or more of the issued 

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shares of any class orseries of shares of WorldHeart at any time within the 60 month periodimmediately preceding such time.

Under the Canada-U.S.income tax treaty, a holder entitled to the benefits of the treaty and to whomthe common shares are taxable Canadian property will not be subject to Canadiantax on the disposition or deemed disposition of the common shares unless at thetime of disposition or deemed disposition, the value of the common shares isderived principally from real property situated in Canada.

**EQUITYCOMPENSATION PLAN INFORMATION**

The discussion under the above heading in ourdefinitive proxy statement for the 2006 Annual Meeting of Shareholders isincorporated herein by reference to such proxy.

In December 2005, WorldHeart repurchased for$2,000 a total of 720,870 warrants from one of its warrant holders.

As of December 31,2005, WorldHeart has not engaged in any share repurchases and does not have anypublicly announced repurchase programs.

**Item 6.**                        MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

**INTRODUCTION**

World Heart Corporation and its subsidiaries arecollectively referred to as WorldHeart. The following Management Discussion andAnalysis of Financial Condition and Results of Operations was prepared bymanagement and discusses material changes in WorldHeart’s financial conditionand results of operations and cash flows for the years ended December 31,2005, 2004 and 2003. Such discussion and comments on the liquidity and capital resourcesshould be read in conjunction with the information contained in theaccompanying audited consolidated financial statements prepared in accordancewith U.S. GAAP. In this discussion, all amounts are in United States dollars(U.S. dollars) unless otherwise stated.

The discussion andcomments contained hereunder include both historical information andforward-looking information. The forward-looking information, which generallyis information stated to be anticipated, expected, or projected by management,involves known and unknown risks, uncertainties and other factors that maycause the actual results and performance to be materially different from anyfuture results and performance expressed or implied by such forward-lookinginformation. Potential risks and uncertainties include, withoutlimitation:  numerous uncertainties andtime delays inherent in the development of products for use in the human body;WorldHeart’s need to establish reimbursement mechanisms and product acceptancefrom third-party payers; extensive government regulation of our products; rapiddevelopments in technology by competitors some of whom have significantlygreater financial, production and marketing resources; slower than anticipatedgrowth in the Destination Therapy market and our ability to raise significantadditional funding, as well as other risks and uncertainties set forth underthe heading “Risk Factors” and elsewhere in this Annual Report on Form 10-KSB.

**OVERVIEW**

WorldHeart is a global technology leader in mechanicalcirculatory support systems currently developing and commercializingimplantable ventricular assist devices (VADs), which are mechanical pumps thatallow for the restoration of normal blood circulation to patients sufferingfrom advanced heart failure. WorldHeart believes that it has the broadest nextgeneration product platform under development for long-term circulatory supportand that both pulsatile and rotary pumps are required to treat the fullspectrum of clinical needs of end and late-stage heart failure patients. TheCorporation believes that 

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pulsatile devices are bestsuited for end-stage patients with poor ventricular contractility, who requirefull support or functional replacement. Alternatively, rotary devices are bestsuited to late-stage patients, with some contractility, who require onlypartial support or an assist. The Corporation has facilities in Oakland,California, Salt Lake City, Utah and Heesch, Netherlands. During the secondquarter 2005, we consolidated our Ottawa operations into the Oakland facility. WorldHeartcurrently derives substantially all of its revenue from its Novacor LVAS andrelated peripheral equipment which it manufactures in Oakland and sellsdirectly to medical clinics and hospitals in the United States, most of Europeand Canada and through a distributor in certain other countries.

The Novacor LVAS is commercially approved as a bridgeto transplantation device in the United States and Canada. In Europe, theNovacor LVAS has unrestricted approval for use as an alternative totransplantation, a bridge-to-transplantation, and to support patients who maybe able to recover the use of their natural heart. In Japan, the device iscommercially approved for use in cardiac patients at risk of imminent deathfrom non-reversible left ventricular failure for which there is no alternativeexcept heart transplantation.

WorldHeart is conducting a long-term use pivotal trialin the United States called RELIANT (*R*andomized *E*valuation of the Novacor *L*VAS*i*n *a**N*on-*T*ransplantPopulation). Data from the RELIANT Trial is expected to support a Pre-marketApproval Supplement that will request approval for the use of the Novacor LVASby non-transplant eligible, or Destination Therapy, patients in theUnited States. At year end December 31, 2005, 20 medical centers and 24patients were enrolled in the RELIANT Trial. As of March 15, 2006, 21medical centers and 32 patients were enrolled in this trial.

WorldHeart is developing a next-generation smallimplantable pulsatile VAD (the Novacor II) and during the third quarter of2005 acquired MedQuest’s technology and development programs associated with amagnetically levitated centrifugal rotary VAD (the WorldHeart rotary VAD). Developmentwork on the Novacor II achieved an important milestone with a successfulinitial animal implant completed in July 2005 and further animal trialsplanned for 2006 to be followed by human trials. Pre-clinical testing ofthe WorldHeart rotary VAD is underway and an initial human feasibility clinicalstudy began in early March 2006 in Europe.

Research and development by WorldHeart’s competitorsis proceeding for several next-generation non-pulsatile continuous flow assistdevices. Certain of these devices have received the CE Mark in Europe and areadvancing through clinical trials in the United States and Europe. It has notbeen determined whether these non-pulsatile devices will be suitable forlong-term use.

Although the DestinationTherapy patient population continues to be largely untreated by cardiac assistdevices, we believe that the Destination Therapy market will evolve morerapidly when devices are accepted as reliable and durable. A wider adoption ofVADs for long term patient use will likely occur with the next-generation VADsand we believe that late-stage and end-stage heart failure will be best treatedby a combination of rotary and pulsatile flow VADs.

**MEDQUEST ACQUISITION**

On January 31, 2005, WorldHeart announced adefinitive agreement to concurrently: acquire all the assets of MedQuest for9,300,000 common shares plus the assumption of $3,500,000 in debt; issue8,888,889 common shares through a private placement to Maverick, for grossproceeds of $12,000,000; issue 10,655,000 common shares upon the exercise of10,655,000 warrants for gross proceeds of $10,655,000 and convert 10,655,000 ofWorldHeart’s outstanding convertible debentures.

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Upon approval by shareholder vote on July 18,2005, and unanimous tendering of the debentures and warrants, WorldHeartsuccessfully completed, on July 29, 2005, the acquisition of all assetsand assumption of certain liabilities of MedQuest, raised approximately $22.7million in gross financing proceeds from the private placement with Maverickand the exercise of all the outstanding warrants and also converted all of itsremaining convertible debentures. In addition, pursuant to the purchaseagreement, WorldHeart repaid $3.5 million owed by MedQuest to Maverick uponclosing of the MedQuest Acquisition. As a result, WorldHeart received netproceeds of approximately $8.5 million from the private placement.

The acquisition resultedin a one-time charge to earnings for the value of the acquired in-processresearch and development of approximately $18.1 million in the period endedSeptember 30, 2005.

**SELECTED FINANCIAL INFORMATION**

| ** **                                  | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Net revenue                                 |       | $                                          | 11,645,954 |   | $ | 9,575,761 |   |
| Net loss for the  year                      |       | (52,833,775                                | )          | (26,141,798 | ) |
| Net loss  applicable to common shareholders |       | (58,694,025                                | )          | (26,141,798 | ) |
| Basic and diluted  loss per share           |       | (1.76                                      | )          | (1.70 | ) |
| Total assets                                |       | 26,821,693                                 |       | 42,258,430 |   |
| Long-term liabilities                       |       | $                                          | —     |   | $ | 8,193,508 |   |

 

**SUMMARY OF QUARTERLY RESULTS**

| ** **                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **December 31,**

**2005**  | ** ** | **September 30,  2005** | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** |
| Net revenue                                 |       | $                                | 3,630,037  |   | $ | 2,149,751 |   | $ | 2,449,178 |   | $ | 3,416,988 |   |
| Net loss for the  period                    |       | (21,997,530                      | )          | (22,251,108 | ) | (4,642,741 | ) | (3,942,396 | ) |
| Net loss  applicable to common shareholders |       | (21,997,530                      | )          | (28,111,358 | ) | (4,642,741 | ) | (3,942,396 | ) |
| Basic and diluted loss  per share           |       | $                                | (0.40      | ) | $ | (0.64 | ) | $ | (0.27 | ) | $ | (0.24 | ) |

 

| ** **                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **December 31,  2004**      | ** ** | **September 30,  2004** | ** ** | **June 30,  2004** | ** ** | **March 31,  2004** | ** ** |
| Net revenue                                 |       | $                                | 2,986,980  |   | $ | 2,250,050 |   | $ | 2,146,388 |   | $ | 2,192,343 |   |
| Net loss for the  period                    |       | (6,293,510                       | )          | (10,935,893 | ) | (5,402,792 | ) | (3,509,603 | ) |
| Net loss  applicable to common shareholders |       | (6,293,510                       | )          | (10,935,895 | ) | (5,402,792 | ) | (3,509,603 | ) |
| Basic and diluted loss  per share           |       | $                                | (0.41      | ) | $ | (0.71 | ) | $ | (0.35 | ) | $ | (0.23 | ) |

 

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**RESULTSOF OPERATIONS FOR THE YEAR ENDED DECEMBER** 31, 2005COMPARED WITH THE YEAR ENDED DECEMBER 31,2004

| ** **                                      | ** ** | **Year Ended December 31,** | ** **  |
|-------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                      | ** ** | **2005**                                   | ** **  | **2004** | ** ** |
| **Revenue**                                     |       | $                                          | 11,645,954  |   | $ | 9,575,761 |   |
| **Cost of  goods sold**                         |       | (8,478,855                                 | )           | (7,680,384 | ) |
| **Gross  margin**                               |       | 3,167,099                                  |        | 1,895,377 |   |
| % of Revenue                                    |       | 27                                         | %           | 20 | % |
| **Operating expenses**                          |       |                                       |        |   |   |
| Selling, general  and administrative            |       | 12,041,345                                 |        | 13,363,796 |   |
| Research and development                        |       | 7,388,385                                  |        | 5,838,754 |   |
| Restructuring  costs                            |       | 333,030                                    |        | 1,787,129 |   |
| Amortization of  intangibles                    |       | 338,507                                    |        | 515,012 |   |
| Acquired  in-process research and development   |       | 18,147,341                                 |        | — |   |
| Goodwill  impairment                            |       | 17,179,643                                 |        | — |   |
| Total operating expenses                        |       | 55,428,252                                 |        | 21,504,691 |   |
| **Operating  loss before the undernoted**       |       | (52,261,152                                | )           | (19,609,314 | ) |
| **Other income (expense)**                      |       |                                       |        |   |   |
| Foreign exchange  loss                          |       | (144,268                                   | )           | (308,338 | ) |
| Investment income                               |       | 369,671                                    |        | 99,427 |   |
| Loss on disposal  of assets                     |       | (959                                       | )           | (46,431 | ) |
| Interest and  financing expenses                |       | (797,067                                   | )           | (6,277,142 | ) |
| **Net  loss for the year**                      |       | (52,833,775                                | )           | (26,141,798 | ) |
| **Effect  of warrant exchange**                 |       | (5,860,250                                 | )           | — |   |
| **Net loss applicable to common  shareholders** |       | $                                          | (58,694,025 | ) | $ | (26,141,798 | ) |

*** ***

***Revenue.***   The saleof Novacor LVAS implant kits and related peripheral equipment and servicesaccounts for substantially all of WorldHeart’s revenues. WorldHeart primarilysells its products directly, except for a few countries where we sell throughdistributors. Prior to January 1, 2004, WorldHeart sold its productsdirectly in the United States and through our distributor, Edwards, outside theUnited States.

Thecomposition of revenue is as follows:

| ** **             | ** ** | **Year Ended December 31,** | ** ** |
|------------------------|------------|--------------------------------------------|------------|
| ** **             | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **             | ** ** | **$**                                      | ** ** | **Units** | ** ** | **$** | ** ** | **Units** | ** ** |
| Implant kits           |       | $                                          | 7,600,064  |   |   | 118 |   |   | $ | 7,055,643 |   |   | 113 |   |   |
| Peripherals and  other |       | 4,045,890                                  |       |   |   |   |   | 2,520,118 |   |   |   |   |   |
| Revenue                |       | $                                          | 11,645,954 |   |   |   |   |   | $ | 9,575,761 |   |   |   |   |   |

 

Net revenue for the year ended December 31, 2005increased by  $2.1 million representingan increase of 22% over the year ended December 31, 2004. Implant kitrevenue in 2005 increased by  $544,000,representing a 8% increase compared with 2004. During 2005, the averageprice per kit was $64,400, compared with $62,400 during 2004 reflectingprimarily a reduction in discounted sales in 2005.

Peripherals and other revenues, including Novacor LVAShardware and peripheral sales, services and other revenue for the year ended December 31,2005, were  $4.0 million, whichrepresents an increase of about 60% over peripherals and other revenue of  $2.5 million recorded in the year ended December 31,2004.

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Implant kits recognized as revenue in the year ended December 31,2005 were 118 compared with 113 in the year ended December 31, 2004. WorldHeartrecognized revenue on 87 implant kits in the United States in 2005 comparedwith 59 implant kits in 2004. In Europe, Canada and the rest-of-world,WorldHeart recognized revenue on 31 implant kits in 2005 compared with 54 in2004.

At December 31, 2004, 17 implant kits had beenshipped and invoiced, however, the revenue was deferred as the transactions didnot meet our revenue recognition criteria. Revenue was recognized on 14 ofthese kits during 2005 and revenue from 8 additional kits was deferredresulting in 11 implant kits remaining in deferred revenue at December 31,2005. These kits, plus some undelivered components of multiple elementtransactions, resulted in deferred revenue at year end 2005 of  $1.2 million. During the first quarter of2006, we anticipate several implant kits previously shipped to one of our medicalcenters, and on which revenue recognition was deferred, will meet our revenuerecognition criteria, resulting in a further reduction in our deferred revenuebalance.

During 2004, WorldHeart announced that its RELIANTTrial had commenced. The RELIANT Trial is a randomized 40 centerequivalency trial where patients will receive a Novacor LVAS or Thoratec’sHeartMate® XVE on a 2:1 ratio and where HeartMate is the control arm. At December 31,2005, enrollment grew to 20 centers and 24 patient were enrolled inthe RELIANT trial. At March 15, 2006, center and patient enrollment grewto 21 and 32, respectively.

In future periods, we expect implant kit andperipherals revenue to increase. We anticipate that the average revenue perimplant kit will continue at current levels resulting from fewer discountedsale transactions. This assumes new centers become enabled with the requiredperipheral equipment and implant volume increases at our medical centers.

***Cost of goods sold:*********For the year ended December 31,2005, the cost of goods sold as a percent of revenue was  73%, compared with 80% at  December 31, 2004. We were able to improve margins in 2005 bycontinuing to implement cost improvement programs and improve our product salesmix to include higher margin peripheral products. We expect our cost per unitto remain at current levels, at least through 2006 or until we reachsustainable increased production volumes.

***Selling, general and administrative.***   Selling,general and administrative expenses consist primarily of payroll and relatedexpenses for executives, sales, marketing, accounting and administrativepersonnel, professional fees, communication expenses, promotional activities,costs associated with meeting multi-jurisdictional regulatory requirements,insurance premiums, and occupancy and other general corporate expenses.

The composition of selling, general and administrativeexpenses is as follows:

| ** **                  | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Selling                     |       | $                                          | 5,776,283  |   | $ | 5,994,238 |   |
| General and  administrative |       | 6,265,062                                  |       | 7,369,558 |   |
| Total                       |       | $                                          | 12,041,345 |   | $ | 13,363,796 |   |

 

Selling, general and administrative expense for theyear ended December 31, 2005 decreased by $1.3 million, or 10%, versus thesame period in 2004. Selling expenses for the year ended December 31, 2005decreased by $0.2 million, or 4%, compared with the same period in 2004.Selling expenses decreased due to lower promotional costs, as well as lowersalaries and selling commissions.

General and administrative expenses decreased by $1.1million, or 15%, for the year ended 2005 compared with 2004. These reductionsare primarily due to cost savings associated with the consolidation of ourNorth American Novacor operations, offset somewhat by $382,000 in non-cashcompensation expense related to the vesting of stock options in December 2005.Administrative expenses are expected to 

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decrease in the nextseveral quarters resulting from previously implemented cost reduction programsoffset somewhat by costs associated with the implementation of informationsystems upgrades and internal controls, as well as, administrative support ofour product development programs.

***Research anddevelopment:*********Research and development expenses consistprincipally of salaries and related expenses for research personnel, prototypemanufacturing, testing, clinical trial expenses, factory costs and regulatoryaffairs expenses incurred at our Oakland and Salt Lake City facilities.

Research and development expenses for the year endedDecember 31, 2005 increased by $1.5 million, or 27%, compared with theyear ended December 31, 2004. The MedQuest Acquisition in July 2005resulted in $2.1million of additional research and development expenses in the second half of2005. Other research and development costs decreased by $0.6 million, or 10%,during 2005, compared with the same period in 2004, reflecting the reduction inexpenses due to the consolidation of the North American Novacor operations. This$600,000 decrease includes, $498,000 in non-cash compensation expenserelating to the vesting of stock options in December 2005 and $147,000 in otherresearch and development costs. Development work and related expenses on thenext-generation Novacor II and WorldHeart rotary VAD are expected to increasein preparation for continuing animal and initial human clinical trials.

***Restructuringcosts:*******OnAugust 25, 2004, we approved a plan to consolidate the Ottawa, Ontariooperations into our facilities in Oakland, California where the Novacor LVAS ismanufactured. The consolidation of the North American Novacor operations intoone location and reduced ongoing business expenses in 2004 and 2005 and willcontinue to benefit operational efficiency and effectiveness.

The restructuring was completed by the end ofJune 2005. For the year ended December 31, 2005, restructuring costsof $333,000 were recorded, compared with $1.8 million for the year ended December 31, 2004.

Thefollowing were restructuring costs for 2005 and 2004:

| ** **                                                | ** ** | **Employee  Severance** | ** ** | **Contract  Settlement** | ** ** | **Write down** | ** ** | **Other** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------|------------|-----------|------------|------------|------------|
| Costs accrued  during 2004                                |       | $                       | 1,396,037  |                     | $          | 57,653              |       | $         | 338,595    | ** ** | $          | 22,509 |   | $ | 1,814,794 |   |
| Costs paid or  settled in 2004                            |       | (795,923                | )          | —                   |       | (338,595            | )          | (8,624    | )          | (1,143,142 | )          |
| Balance in  accrued liabilities at December 31, 2004 |       | $                       | 600,114    |                     | $          | 57,653              |       | $         | —     |       | $          | 13,885 |   | $ | 671,652 |   |
| Costs accrued  during 2005                                |       | 122,352                 |       | 192,012                  |       | (6,801              | )          | 25,467    |       | 333,030    |       |
| Costs paid or  settled in 2005                            |       | (722,466                | )          | (249,665                 | )          | 6,801               |       | (39,352   | )          | (1,004,682 | )          |
| Balance in accrued  liabilities at December 31, 2005 |       | $                       | —     |                     | $          | —              |       | $         | —     |       | $          | — |   | $ | — |   |

 

Employee severance costs represent the amountemployees earned. Contract settlement costs were recorded when notice wasprovided that the contract was being terminated and WorldHeart ceased using therights conveyed under the contract. The capital assets were written down totheir net realizable value when the decision was made to consolidate the NorthAmerican operations and it was determined that the carrying value of thecapital assets was impaired. Other restructuring costs were recognized when theservices were actually received.

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***Acquired in-processresearch and development.******  ***During thethird quarter of 2005, we recorded a one-time, non-cash charge of $18.1 millionto expense the in-process research and development acquired in the MedQuestAcquisition. We had estimated the value of the WorldHeart rotary VAD projectusing an income approach and applied risk-adjusted discount rates to theestimated future revenue and expenses attributable to this technology and theMagLev Plus at the time of the acquisition. We determined at the time of theacquisition that these projects had no alternative future use and therefore, asrequired under SFAS 142, we expensed the amounts immediately. There was noacquired in-process research and development expense recorded in 2004.

***Amortization ofintangibles.******  ***Amortization of intangibles for theyear ended December 31, 2005 was $338,000 compared with $515,000 for thesame period in 2004. In the first two quarters of 2005, we recordedamortization of $255,000 related to the intangible assets purchased with theNovacor business. At the end of the second quarter of 2005, these assets hadbeen fully amortized. In the second half of 2005, we recorded $83,000 inamortization expense which related entirely to the $766,000 value assigned tothe workforce acquired in the MedQuest Acquisition. These intangibles are beingamortized over a four year period.

***Goodwill impairment.******  ***The purchaseof Novacor from Edwards in 2000 resulted in the recording of goodwill of $17.2million. Since then, management has performed an annual impairment assessmenton our goodwill in accordance with SFAS 142.  At December 31, 2005, we determined thatthe fair value of our goodwill was impaired and, accordingly, we recorded agoodwill impairment charge of $17.2 million in the fourth quarter of 2005. Theimpairment is largely a result of slower than anticipated adoption of theNovacor LVAS product.

***Foreign exchangelosses.***   During the year ended December 31,2005, a foreign exchange loss of approximately $144,000 was recorded comparedwith a loss of $308,000 for the year ended December 31, 2004. The decreasein foreign exchange loss in 2005 compared with the previous year relates tofluctuations in the relative value of the U.S. dollar compared with theCanadian dollar and the Euro, and reductions in certain Canadian dollardenominated assets throughout the first half of 2005. We anticipate thatforeign exchange gains and losses will diminish in 2006 with the winding downof our Canadian operations in the first half of 2005.

***Investment andother income.***   Investment income resultsprimarily from interest earned on cash equivalents and short-term investments. Investmentand other income was $370,000 and $99,000 for 2005 and 2004, respectively. For2005, investment income was $245,000 and other income, consisting of the writeoff of long term liabilities at two medical centers which, as determined duringthe period, were no longer payable, was $125,000. The increase in investmentincome in 2005 was due to higher average balances invested at higher averageinterest rates, compared with 2004.

***Interest expenseand financing costs:*** Interest expense and financingcosts during the year ended December 31, 2005 were $797,000, compared with$6,277,000 during the year ended December 31, 2004. Interest expense andfinancing costs consisted primarily of non-cash interest and accretion relatedto the convertible debentures. During 2005 interest expenses related to theconvertible debentures were $797,000. All outstanding debentures were convertedin July 2005 resulting in a significant expense reduction for theremainder of 2005. During the year ended December 31, 2004, interest andfinancing costs were $6.3 million, consisting of a $5.8 million non-cash chargerelated to the beneficial conversion feature of the convertible debenturesissued on September 15, 2004, plus the corresponding accrued interestrelated to these convertible debentures.

***Effect of warrantexchange:*** We recorded a one-time charge of $5.9million in the third quarter of 2005 resulting from a reduction in the exerciseprice of about 10.7 million warrants originally issued, with convertibledebentures, in a private placement in September 2004 and subsequentlyexercised during July 2005. The exercise price of these warrants wasreduced by $0.55 from $1.55 to $1.00.

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***Stock option acceleration:***InDecember, 2005, the Board of Directors of WorldHeart approved the acceleratedvesting of all outstanding stock options held by current employees orconsultants, except for the options held by the non-employee members of theBoard of Directors. The purpose of the acceleration of vesting was to improveemployee morale and to minimize the amount of compensation expense in futureperiods following the adoption by WorldHeart of SFAS 123(R). This program willresult in a reduction of future pre-tax charges under SFAS 123(R) of $3.4million, of which $2.0 million and $1.4 million would have been recognized infiscal 2006 and 2007, respectively. The accelerated vesting of stock options in2005 results in a proforma charge of $4.9 million, reflected in the footnotedisclosure in the notes to the consolidated financial statements.

RESULTSOF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2004 COMPARED WITH THE YEAR ENDEDDECEMBER 31,2003

| ** **                                            | ** ** | **Year Ended December 31,** | ** **  |
|-------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                            | ** ** | **2004**                                   | ** **  | **2003** | ** ** |
| Revenue                                               | ** ** | ** **                                 | ** **  | ** ** | ** ** |
| Gross revenues                                        |       | $                                          | 9,575,761   |   | $ | 7,883,203 |   |
| Less: returns                                         |       | —                                     |        | (1,107,396 | ) |
| Net revenue                                           |       | 9,575,761                                  |        | 6,775,807 |   |
| Cost of goods sold                                    |       | (7,680,384                                 | )           | (4,968,898 | ) |
| Gross margin                                          |       | 1,895,377                                  |        | 1,806,909 |   |
| % of Revenue                                          |       | 20                                         | %           | 27 | % |
| **Operating  Expenses**                               |       |                                       |        |   |   |
| Selling, general  and administrative                  |       | 13,363,796                                 |        | 7,263,759 |   |
| Research and  development                             |       | 5,838,754                                  |        | 9,604,080 |   |
| Restructuring  costs                                  |       | 1,787,129                                  |        | 3,356,487 |   |
| Amortization of  intangibles                          |       | 515,012                                    |        | 1,938,595 |   |
| Total operating expenses                              |       | 21,504,691                                 |        | 22,162,921 |   |
| **Operating loss before the undernoted**              |       | (19,609,314                                | )           | (20,356,012 | ) |
| **Other  Income (expense)**                           |       |                                       |        |   |   |
| Foreign exchange  loss                                |       | (308,338                                   | )           | 10,055,129 |   |
| Investment income                                     |       | 99,427                                     |        | 105,596 |   |
| Loss on disposal  of assets                           |       | (46,431                                    | )           | (27,147 | ) |
| Interest and  financing expenses                      |       | (6,277,142                                 | )           | (4,406,620 | ) |
| Net loss for the  year                                |       | (26,141,798                                | )           | (14,629,054 | ) |
| Accretion on  preferred shares                        |       | —                                     |        | (1,614,855 | ) |
| Inducement  related to conversion of preferred shares |       | —                                     |        | (1,924,395 | ) |
| **Net  loss applicable to common shareholders**       |       | $                                          | (26,141,798 | ) | $ | (18,168,304 | ) |

 

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***Revenue.***   The saleof Novacor LVAS implant kits and related peripheral equipment and servicesaccounted for substantially all of WorldHeart’s revenues.

Thecomposition of revenue was as follows:

| ** **                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| ** **                                 | ** ** | **$**                                      | ** ** | **Units** | ** ** | **$** | ** ** | **Units** | ** ** |
| Implant kits                               |       | $                                          | 7,055,643  |   | 113 |   | $ | 5,996,738 |   | 118 |   |
| Re-purchased Edwards implant kits          |       | —                                     |       |   |   | (602,339 | ) | (20 | ) |
|                                       |       |                                       |       | 113 |   |   |   | 98 |   |
| Peripherals and  other                     |       | 2,520,118                                  |       |   |   | 1,886,465 |   |   |   |
| Re-purchased Edwards peripherals and other |       | —                                     |       |   |   | (505,057 | ) |   |   |
| Gross revenue                              |       | $                                          | 9,575,761  |   |   |   | $ | 6,775,807 |   |   |   |

 

Net revenue for the yearended December 31, 2004 increased to $9.6 million representing anincrease of 41% over the year ended December 31, 2003. Implant kit netrevenue in 2003 includes the return of 20 units, which WorldHeart re-acquiredin connection with the amendments to the distribution agreement with Edwards inDecember 2003. Net implant kits recognized as revenue in 2004 increased by15% compared to 2003.

Peripherals and otherrevenues, including Novacor LVAS hardware and peripheral sales and services forthe year ended December 31, 2004, were $2.5 million, which represents an increase of 82% over other revenueof  $1.4 million (gross revenueof  $1.9 million less returnsof  $505,000) recorded in the year ended December 31,2003.

Gross revenue increasedto  $9.6 million representing anincrease of 21% over the year ended December 31, 2003. Novacor LVAS implantkit gross revenue increased to $7.1 million for the year ended December 31, 2004 comparedto  $6.0 million for the year ended December 31,2003 representing an increase of 18%. The gross number of implant kitsrecognized as revenue in the year ended December 31, 2004 was 113 comparedto 118 in the year ended December 31, 2003. The revenue per kit increasedsubstantially for sales outside of the United States and Japan due primarily tothe shift to selling direct to medical centers rather than through adistributor.

An additional 17 implantkits were shipped and invoiced in the year ended December 31, 2004,however, these kits were deferred as revenue at the time of shipment as thetransactions did not meet our revenue recognition criteria. These kits remainin deferred revenue at December 31, 2004 representing  $1,020,000.

WorldHeart recognizedrevenue on 59 implant kits in the United States in 2004 compared to 51 implantkits in 2003. In Europe, Canada and the rest-of-world, excluding Japan,WorldHeart recognized revenue on 44 implant kits in 2004 compared to 44 in 2003(64 kits less the return of 20 kits). Revenues were recognized on 10 implantkits in Japan in 2004 compared to three in 2003.

During the second quarterof 2004, WorldHeart announced its RELIANT Trial and implantation commencedunder the RELIANT Trial in the third quarter of 2004. At December 31,2004, WorldHeart had enrolled nine centers under the RELIANT Trial with fiveimplants.

***Cost of goods sold.***   Forthe year ended December 31, 2004, the overall cost of goods sold increasedto 80% of revenue as compared to 73% for the year ended December 31, 2003.

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Despitecontinued efforts to improve per unit manufacturing costs, we experiencedsignificant production inefficiencies during 2004 caused by supply shortagesdue to quality control and production volumes well below capacity. Thisresulted in higher Novacor LVAS per unit production costs.

***Selling, general and administrative.***   Selling,general and administrative expenses consist primarily of payroll and relatedexpenses for executives, sales, marketing, accounting and administrativepersonnel, professional fees, communication expenses, promotional activities,costs associated with meeting multi-jurisdictional regulatory requirements,insurance premiums, and occupancy and other general corporate expenses.

Thecomposition of selling, general and administrative expenses was as follows:

| ** **                  | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------|------------|
| ** **                  | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| Selling                     |       | $                                          | 5,994,238  |   | $ | 4,518,270 |   |
| General and  administrative |       | 7,369,558                                  |       | 2,745,489 |   |
| Total                       |       | $                                          | 13,363,796 |   | $ | 7,263,759 |   |

 

Selling, general andadministrative expenses for the year ended December 31, 2004 increased by$6.1 million or 84% from the same period in 2003. Selling expensesincreased during 2004, as compared to 2003, as WorldHeart assumedresponsibility for its direct sales in Europe and increased sales and marketingprogram expenditures in the United States. General and administrative expensesincreased with the expanded infrastructure required to support a broadenedsales responsibility and due to increases in communication expenses,professional fees, insurance costs and multi-jurisdictional regulatory costs. Costsrelated to the European distribution operations and the related support arefully reflected in the results for the year ended December 31, 2004. Inthe third quarter of 2004, WorldHeart commenced the consolidation of its NorthAmerican operations.

***Research and development.***   Researchand development expenses consist principally of payroll and related expensesfor development staff, prototype manufacturing, testing, and configuration ofequipment expenses, trial expenses, and regulatory affairs expenses.

Researchand development expenses for the year ended December 31, 2004 decreased by$3.8 million or 39% compared to year ended December 31, 2003. Grossresearch and development expenditures excluding the impact of governmentprograms decreased by 42% to $6.0 million in 2004 compared to $10.3 millionin 2003.

| ** **                               | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------|------------|--------------------------------------------|------------|
| ** **                               | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| Gross research  and development expenses |       | $                                          | 5,975,344  |   | $ | 10,299,324 |   |
| Investment tax  credits                  |       | (136,590                                   | )          | (695,244 | ) |
| Net research and  development expenses   |       | $                                          | 5,838,754  |   | $ | 9,604,080 |   |

 

Lower research anddevelopment costs for year ended December 31, 2004 compared to the sameperiod in 2003 reflect expense reductions associated with the mergednext-generation VAD development program and reduced pre-clinical and clinicaltrial expenses. The cost reduction programs were completed in fiscal year 2003and the expense reductions were realized in 2004.

Investment tax credits forthe year ended December 31, 2004 totaled $137,000 and relate to a Canadian provincial government investment taxcredit program. A credit of $2.3 million was recorded against research and development expensefor the year ended December 31, 2003 relating to a Canadian federal taxcredit program. However, in the same period a provision of  $1.7 million was recorded against researchand development expense relating to a provincial tax credit program claim thatwas recorded in a prior period.

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***Restructuring costs.***   OnAugust 25, 2004, we approved a plan to consolidate the Ottawa, Ontariooperations into our facilities in Oakland, California where the Novacor LVAS ismanufactured. The consolidation of the North American operations into onelocation reduced ongoing business expenses in 2004 and 2005. The restructuringwas completed by June 2005.

Thefollowing were restructuring costs incurred in 2004:

| ** **                                                | ** ** | **Employee  Severance** | ** ** | **Contract  Settlement** | ** ** | **Write down** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------|------------|-----------|------------|-----------|------------|
| Costs accrued  during 2004                                |       | $                       | 1,396,037  |                     |       | $                   | 57,653     |      |       | $         | 338,595    |   | $ | 22,509 |   | $ | 1,814,794 |   |
| Costs paid or  settled in 2004                            |       | (795,923                | )          |                     | —     |                |       | (338,595  | )          | (8,624    | )          | (1,143,142 | ) |
| Balance in accrued  liabilities at December 31, 2004 |       | $                       | 600,114    |                     |       | $                   | 57,653     |      |       | $         | —     |   | $ | 13,885 |   | $ | 671,652 |   |

 

During the year ended December 31,2004, actual restructuring costs of $1.8 million were recorded. Employee severance costs represent theamount employees earned to December 31, 2004. Contract settlement costswere recorded when notice was provided that the contract was being terminatedand WorldHeart ceased using the rights conveyed under the contract. The capitalassets were written down to their net realizable value when the decision wasmade to consolidate the North American operations and it was determined thatthe carrying value of the capital assets was impaired. Other restructuringcosts are recognized when the services are actually received.

During the year ended December 31,2003, WorldHeart realigned its business operations to focus on Novacor LVAScommercial operations and to reduce research and development costs by mergingour VAD development programs. Total restructuring costs for the year ended December 31,2003 amounted to  $3.4 million. Therestructuring costs related to employee severance and termination costswere  $1.6 million; costs related to thebuyout of a Novacor LVAS royalty agreement were $1.0 million; costs related to the excess of inventory purchase costover the carrying value of the inventory re-purchased from Edwards were  $770,000; and other miscellaneous costswere  $13,000. The royalty buy-outeliminated royalty payment obligations going forward of 4% of Novacor LVASsales.  $2.2 million of the 2003restructuring costs were paid in 2003 with $1.2 million being paid in 2004. The difference of  $28,000 was adjusted in 2004 to reflectrevised estimates for employee severance and termination costs.

***Amortization of intangibles.***   Amortizationof intangibles for the year ended December 31, 2004 was  $515,000 compared with  $1.9 million for the same period in 2003. Themajority of the intangible assets arose from the purchase of the Novacorbusiness in June 2000. Most of these assets have now reached the end oftheir original estimated useful life and have been fully amortized. As at December 31,2004, intangible assets totaling $255,000 remain unamortized.

***Foreign exchange gains and losses.***   Duringthe year ended December 31, 2004, a foreign exchange loss of  $308,000 was recorded compared to a gainof  $10.0 million for the year endedDecember 31, 2003. The 2004 foreign exchange loss relates to the effect ofa strengthening U.S. dollar compared to the Canadian dollar during the firsthalf of the year on net monetary assets, predominately cash and cashequivalents and short-term investments, less current liabilities, denominatedin Canadian dollars. The majority of the 2003 foreign exchange gain can beattributed to the preferred shares.

***Interest expense and financing costs.***   Duringthe year ended December 31, 2004, interest and financing costs of  $6.3 million were recorded compared withcosts of  $4.4 million during the yearended December 31, 2003. Interest expense and financing costs in 2004consisted mainly of the non-cash charge of the beneficial conversion feature ofthe convertible debentures. These non-cash interest charges continued toaccrete ratably on the convertible debentures until their conversion. Alloutstanding debentures were converted in July 2005, in conjunction withthe terms of the MedQuest Acquisition. Interest expense and financing costs forthe year ended December 31, 2003 consisted of interest on loan 

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obligations thatwere outstanding during the year as well as the costs of entering into the loanobligations. In September 2003, the loans were repaid in full.

**LIQUIDITYAND CAPITAL RESOURCES**

Historically, WorldHearthas funded operations through the sale of equity and issuance of debtinstruments. Combined with revenues, these funds have provided us with theresources to operate our business, attract and retain key personnel, fund ourresearch and development program and clinical trials, apply and obtain thenecessary regulatory approvals and develop our technology and products.

***Liquidity.***   At December 31,2005, WorldHeart had cash, cash equivalents and short-term investments of$10.7 million, compared with $8.8 million at December 31, 2004,an increase during 2005 of $1.9 million. This increase was primarily dueto financing activities offset by cash outflows from operations. In July 2005,we received net cash of $19.1 million, resulting from the Maverick privateplacement of $12.0 million and proceeds from warrant exercises of  $10.7 million, offset by a repayment of theMaverick bridge loan of $3.5 million.

During2005, cash used to fund operating activities was  $15.7 million, consisting primarily of thenet loss for the period of  $52.8 millionadjusted for:

·       anon-cash in-process research and development charge of $18.1 million related tothe MedQuest Acquisition;

·       anon-cash goodwill impairment charge of $17.2 million related to Novacor; and

·       workingcapital changes that required cash of $1.2 million, consisting primarily of adecrease of $1.3 million in accounts payable and accrued compensation,partially offset by a decrease of  $0.3million in accounts receivable and other receivables, and an increase of$0.2 million in prepaid expenses.

Investing activities for2005 used cash of $0.1 million consisting primarily of $5.0 million inredemption of short-term investments, offset by $3.5 million repayment of thebridge loan related to the MedQuest Acquisition, $1.3 million in transactioncosts related to the MedQuest Acquisition and capital asset purchases of $0.3million.

With the completion of theMedQuest Acquisition and related financing transactions and through costreduction programs to re-align our cost structure in light of slower thananticipated Destination Therapy adoption rates, we ended the third and fourthquarters of 2005 with cash and cash equivalents of $14.9 million and $10.7million, respectively. Based on our current operating expenses and commercialsales, we believe we currently have sufficient cash to fund operations intomid-year 2006. The current financial condition among other factors indicatesthat there is significant doubt about the corporation’s ability to continue asa going concern.

We are actively exploringvarious financing alternatives, including equity financing transactions, aswell as corporate collaborations. Equity financings could include, but are notlimited to, private investments in public equity (PIPE) transactions, as wellas public offerings. Corporate collaborations could include licensing of one ormore of our products for upfront and milestone payments, or co-development andco-funding of our products. We have initiated cost reduction programs and willcontinue to control and reduce expenses until sufficient funding is in place. Wehave re-aligned our spending from administration and manufacturing to maintainkey development programs while carefully managing our overall cash usage.WorldHeart intends to engage an investment banker to assist the Corporation inthe evaluation and completion of financing and implementation of strategicalternatives. While the Corporation is exploring all opportunities to improveits financial condition within the next several months, there is no assurancethat these programs will be successful. This would result in a significantdelay in the completion,  reduction inscope, or termination of our development programs and raise further doubt aboutour ability to continue to do business.

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Our long-term workingcapital and capital requirements will depend upon numerous factors, includingthe following: our continued focus on improving commercial operations; expandedNovacor LVAS kit sales and enrolment in the RELIANT Trial; decreasingproduction costs through a manufacturing cost reduction program; the rate ofinvestment in our next-generation technologies, including our Novacor II andWorldHeart rotary VAD; the clinical trials costs and the approval process forthe next-generation products; our general efforts to improve operationalefficiency and conserve cash, including continued synergies from the MedQuestAcquisition and other cost improvement programs.

***ContractualObligations***

Thefollowing table sets forth WorldHeart’s contractual obligations as ofDecember 31, 2005.

| ** **                   | ** ** | **Total** | ** ** | **Less than   1 year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **Thereafter** | ** ** |
|------------------------------|------------|-----------|------------|---------------------------------------|------------|--------------------|------------|--------------------|------------|----------------|------------|
| Operating lease  obligations |       | $         | 1,703,575  |                                  | $          | 1,065,315          |       | $                  | 636,340    |           |       | $ | 1,919 |   |   |   | $ | — |   |   |
| Other long term  obligations |       | 203,000   |       | 51,000                                |       | 152,000            |       |               | —     |           |       |   | — |   |   |
| Total                        |       | $         | 1,906,575  |                                  | $          | 1,116,315          |       | $                  | 788,340    |           |       | $ | 1,919 |   |   |   | $ | — |   |   |

 

Other long termobligations primarily include payments due under a license agreement.

*Operating Leases*

During 2003, $222,003 wasdrawn against the cash amount pledged as collateral for obligations under afacility lease for the Oakland, California operations. In 2004, the balance wasrestored to the original pledged amount of $750,000. The cash remains pledgedagainst a letter of credit issued by WorldHeart in support of its obligationsand is not available for general operations**.**TheSalt Lake City facility lease has a security deposit of $9,200. The ContractualObligations table shows a reduction in operating lease obligations in futureyears. This reduction is mainly due to the expiration of the current operatingleases for the Oakland facility in April 2007 and expiration of the SaltLake City facility lease in 2009. We expect to renew these leases onapproximately the same terms.

*Novacor LVAS Royalties*

WorldHeart is committed,under the Novacor LVAS royalty agreement, to provide royalty payments tocertain employees. Royalties are payable on annual consolidated gross revenuesat a rate of 0.808% up to a maximum of $3,232,000. Cumulative royalty paymentsto December 31, 2005 total $1,121,226 (2004—$1,027,184). Royalty paymentscharged to cost of goods sold for the year ended December 31, 2005 were$94,042 (2004—$80,432).

*Technology Partnerships Canada Contribution Agreement*

During 2002, WorldHeartentered into a shared funding program with Technology Partnerships Canada (TPC)under which the Canadian government shares costs of certain research anddevelopment activities. Funding in the amount of  $6.6 million was claimed. Effective January 1,2004, repayment is in the form of royalties on annual consolidated grossrevenues at a rate of 0.65% for a nine year period ending December 31,2012. If during this period royalty payments reach the maximum of  $20.3 million, no further repayments will berequired. If the royalty payments do not exceed $20.3 million during this period, they will continue until 2015 or untilthe maximum is reached**,**whichevercomes first. In connection with the agreement, we also granted TPC 92,857warrants to purchase an equivalent number of our common shares exercisableuntil December 4, 2006, at an exercise price of $29.05 per share.

During 2005, theGovernment of Canada reassessed the TPC program and delayed a final closingmeeting required to disburse $209,543 in remaining payments to WorldHeart. Asthere is uncertainty as to whether these amounts will be received, theCorporation has provided for the full amount of this receivable.

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**CAPITALEXPENDITURES**

| ** **            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|----------|------------|
| Capital  Expenditures |       | $        | 306,296    |     | $          | 363,224  |       | $ | 150,135 |   |
|                       |            |          |            |          |            |          |            |  |  |  |

 

Capital expenditures for2005 were reduced from 2004 as part of WorldHeart’s cost reduction program. WorldHeartanticipates that capital expenditures for 2006 will be similar to 2005, withsufficient manufacturing capacity and office space to accommodate itsoperations.

At December 31, 2005,WorldHeart occupied three facilities. WorldHeart’s Oakland, Californiaheadquarters facility consists of approximately 40,000 square feet ofmanufacturing, research and office space. The Oakland leases were renewed in2002 for a five-year term expiring on April 30, 2007. The Salt Lake Cityfacility consists of 24,044 square feet of research and office space with alease that expires on January 31, 2008. WorldHeart’s European location isin Heesch, Netherlands consists of approximately 2,500 square feet of warehouseand office space. The Heesch lease was signed in 2004 for a three-year termexpiring on December 31, 2007. The former Ottawa, Canada facilityoriginally comprised 22,755 square feet of manufacturing and office space witha lease that originally expired on December 31, 2006. The Ottawa locationwas shut down and the building lease was terminated as part of therestructuring plan in August 2004.

**MARKET RISK**

WorldHeart is subject toinvestment risk on investments that it makes with excess cash.

Investment risk ismitigated by close adherence to an established investment policy, which hasbeen approved by the Board of Directors. The policy sets liquidity criteria,and counter party risk diversification criteria and restricts investments toinvestment grade quality instruments of AA or better or R1 medium or better inthe case of commercial paper. Income exposure resulting from a decline ininterest rates is not significant due to the short term maturity ofinvestments, all of which were in money market funds during 2005.

WorldHeart has assets andliabilities denominated in foreign currencies, including primarily the Euro.WorldHeart’s current foreign currency exposure is small. However, it may, inthe future, enter into foreign exchange contracts in order to mitigate itsforeign exchange risks. WorldHeart did not enter into foreign exchange forwardcontracts or hedging transactions in 2005.

**CRITICALACCOUNTING ESTIMATES AND POLICIES**

WorldHeart’s managementmakes certain assumptions and estimates that impact the reported amounts ofassets, liabilities and stockholders’ equity, and revenues and expenses. Theseassumptions and estimates are inherently uncertain. Management judgements thatare currently the most critical are related to revenue recognition, inventoryvaluation, valuation of goodwill and long-lived assets, restructuring and stockbased compensation. Below we describe these policies as well as the estimatesinvolved. For a more detailed discussion on accounting policies, see the notesto the audited consolidated financial statements.

*Revenue recognition*

Revenue from product andservice sales is recognized when all of the following criteria are met:  persuasive evidence of an agreement exists;delivery has occurred or services have been rendered; the price is fixed anddeterminable; and collection is reasonably assured. WorldHeart occasionallyrents certain in-hospital equipment to customers. Rental income is included inrevenue when earned. WorldHeart provides for returns based on prior experience.

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For multiple element offerings, WorldHeart allocatesthe proceeds to the elements based on their relative fair values. Revenue fromeach element is recognized when the product is delivered or services are deemedto have been completed.

Certain products arecovered by a limited warranty. Warranty costs are based on historicalexperience and estimated and recorded when the related sales are recognized. Anyadditional costs are recorded when incurred or when they can reasonably beestimated.

*Inventory valuation*

WorldHeart may write-downcertain inventory when, based on physical inventory or analysis of its records,it determines the inventory is obsolete or excess compared to its expecteddemand. To the extent inventory movement or product demand is not as anticipated,the write-down may be higher or lower than the usage that is ultimatelyexperienced. Once written down, the inventory is not written back up.

*Valuation ofgoodwill and long-lived assets*

In accordance with SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets,” WorldHeart reviews thecarrying value of long-lived assets whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. Suchevents or circumstances might include a significant decline in market share, asignificant decline in revenue and/or profits, changes in technology,significant litigation or other items.

In accordance with SFAS No. 142, “Goodwilland Other Intangible Assets,” WorldHeart completes on an annual basis animpairment test of goodwill.  Inevaluating whether there is an impairment of goodwill, management compares thecarrying amounts of such assets with the related enterprise value. Enterprisevalue is used to measure the value of the goodwill. Estimates of the enterprisevalue at December 31, 2005 are determined in part by a discounted cashflow valuation using estimates of revenue and net income, a 30% discount rateand an eight year period. The fair value method and the revenue multiplesmethod were also factored into the estimate of enterprise value.

Upon completion of itsgoodwill impairment test at December 31, 2005, WorldHeart determined thatthe entire amount of the Novacor goodwill was impaired resulting in a goodwillimpairment charge of $17,179,643.

*Stock BasedCompensation*

The Corporation accounts for its stock option plan inaccordance with the Financial Accounting Standards Board’s (FASB) Statement ofFinancial Accounting Standards (SFAS) No. 123, “Accounting for StockBased Compensation,” and Accounting Principles Board (APB) Opinion No. 25,“Accounting for Stock Issued to Employees.” No compensation expense is recognized when shares are issued atprevailing market prices or options are issued to employees with exerciseprices at the grant date equal to prevailing market prices. Any considerationpaid by employees on the exercise of stock options or purchase of capital stockis credited to share capital. The pro-forma fair value expense of optionsissued by the Corporation is disclosed in Note 13.

Stock options issued in lieu of cash to non-employeesfor services performed are recorded at the fair value of the options at thetime they are issued and are expensed as service is provided.

The fair value of optionsgranted are determined using the Black-Scholes model. Use of this modelrequires management estimates and assumptions regarding: expected option life(estimated at six years), volatility (based on historical average daily stockprices), risk free interest rate (estimated based on United States Treasuryrates), and dividend yields (nil). Option forfeitures are estimated at 25%based on our historical forfeiture rates.

37

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**CANADIAN GAAP**

Significant differencesbetween Canadian GAAP and U.S. GAAP are presented in the notes to the auditedconsolidated financial statements.

**OUTSTANDING SHARE DATA**

Theoutstanding share data as at December 31, 2005 and December 31, 2004,is a follows:

| ** **                                     | ** ** | **Number of shares outstanding** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Common shares                                  |       | 55,479,549                       |       | 15,744,522 |   |
| Options to  purchase common shares             |       | 6,803,803                        |       | 3,172,771 |   |
| Warrants to  purchase common shares            |       | 13,048,363                       |       | 24,424,233 |   |
| Debentures  convertible to common shares       |       | —                           |       | 10,655,000 |   |
| Accrued interest  convertible to common shares |       | —                           |       | 1,997,813 |   |

 

In 2004, a conversion rateof $1.25 per common share was assumed for the interest on the convertibledebentures. Interest accrued on the face value of the convertible debentures atan annual non-compounding rate of 3%. In conjunction with the MedQuestAcquisition in July 2005, 10,655,000 warrants were exercised and10,891,097 debentures were converted into common shares.

**NEW ACCOUNTING PRONOUNCEMENTS**

On June 1, 2005, the FASB issued SFAS 154, *“Accounting Changes and Error Corrections,”*(“SFAS 154”) which replaces APB 20, *“AccountingChanges,”* (“APB 20”) and SFAS 3, *“ReportingAccounting Changes in Interim Financial Statements.”*  SFAS 154 applies to all voluntary changes inaccounting principle and changes the requirements for accounting for andreporting of a change in accounting principle. SFAS 154 requires retrospectiveapplication to prior periods financial statements of a voluntary change inaccounting principle unless it is impracticable. APB 20 previously requiredthat most voluntary changes in accounting principles be recognized by includingin net income of the period of the change the cumulative effect of changing tothe new accounting principle. SFAS 154 carries forward many other provisions ofAPB 20 without change, including the provisions related to the reporting of achange in accounting estimate, a change in the reporting entity and thecorrection of an error. The Corporation will adopt this standard effective January 1,2006.

On December 16, 2004, the FASB issued SFAS123(R), “Share-Based Payment,” which is a revision of SFAS 123, “Accounting forStock-Based Compensation.” SFAS 123(R) supersedes APB Opinion No. 25,“Accounting for Stock Issued to Employees,” and amends SFAS 95, “Statement ofCash Flows.” SFAS 123(R) requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the income statementbased on their fair values at the date of grant. Pro forma disclosure in thefootnotes to financial statements is no longer an alternative.

SFAS 123(R) permits public companies to adopt itsrequirements using one of two methods. The “modified prospective” methodrecognizes compensation cost based on the requirements of SFAS 123(R) forall share-based payments granted after the effective date, and based on therequirements of SFAS 123 for all awards granted to employees prior to theeffective date of SFAS 123(R) that remain unvested on the effective date.The “modified retrospective” method includes the requirements of the modifiedprospective method described above, but also permits entities to restate theirhistorical financial statements based on the amounts previously recognizedunder SFAS 123 for purposes of pro forma disclosures either for all priorperiods presented, or for prior interim periods of the year of adoption. WorldHeartintends to adopt the “modified prospective” method beginning in the firstquarter of 2006.

38

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In December 2005,WorldHeart implemented a plan to accelerate vesting of all of its employee andconsultant stock options, other that those held by non-employee directors, andtook other actions to improve employee morale and minimize the impact of theadoption of FAS 123(R).

**Item 7.**                        FinancialStatements

The financial statementsrequired to be filed pursuant to this Item 7 are included in this AnnualReport on Form 10-KSB on pages F-1 to F-30.

**Item 8.**                        ChangeIn and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

**Item 8A.**                Controlsand Procedures.

*Evaluationof disclosure controls and procedures.*   Based ontheir evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act) as of a date within 90 days of thefiling date of this Annual Report on Form 10-KSB, our president andchief executive officer (principal executive officer) and our chief financialofficer (principal accounting and financial officer) have concluded that ourdisclosure controls and procedures are designed to ensure that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules andforms and are operating in an effective manner at the reasonable assuranceslevel.

*Changes in internalcontrols over financial reporting:* There was no changein our internal controls over financial reporting that occurred during thequarter ended December 31, 2005, that has materially affected, or isreasonably likely to materially affect, our internal controls over financialreporting.

**Item 8B.**               OtherInformation.

None.

39

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**PART III**

**Item 9.**                        Directors,Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) ofthe Exchange Act.

The information relating to our directors, nomineesfor election as directors, and executive officers under the headings “Electionof Directors” and “Executive Officers” in our definitive proxy statement forthe 2006 Annual Meeting of Shareholders is incorporated herein by reference tosuch proxy statement.

We have adopted a writtencode of business conduct and ethics that applies to our principal executiveofficer and principal financial and accounting officer, or persons performingsimilar functions. We intend to disclose any amendments to, or waivers from,our code of business conduct and ethics that are required to be publiclydisclosed pursuant to rules of the Securities and Exchange Commission andNasdaq by filing such amendment or waiver with the Securities and ExchangeCommission.

**Item 10.**                 ExecutiveCompensation.

The discussion under theheading “Executive Compensation” in our definitive proxy statement for the 2006Annual Meeting of Shareholders is incorporated herein by reference to suchproxy statement.

**Item 11.**                 SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters.

The discussion under theheading “Voting Shares, Record Date and Principal Holders” in our definitiveproxy statement for the 2006 Annual Meeting of Shareholders is incorporatedherein by reference to such proxy statement.

**Item 12.**                 CertainRelationships and Related Transactions.

The discussion under theheading U.S. “Certain Relationships and Related Transactions” in our definitiveproxy statement for the 2006 Annual Meeting of Shareholders is incorporatedherein by reference to such proxy statement.

**Item 13.**                 Exhibits.

| Exhibit 2.1 | Asset Purchase Agreement between World Heart Corporation and  MedQuest, dated as of January 31, 2005 (incorporated by reference to the  Corporation’s Report on Form 6-K, Dated February 1, 2005).                                                                  |
|------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 3.1 | Article of Continuance, dated December 14,  2005 (incorporated by reference to the Corporation’s report on Form 8-K  dated December 14, 2005 (Commission File No. 000-28882)).                                                                            |
| Exhibit 3.2 | By-laws of the Corporation (incorporated by  reference to the Corporation’s Registration Statement on Form F-1,  dated October 8, 1996).                                                                                                                                 |
| Exhibit 3.3 | Amendment to the By-Laws of the Corporation  (incorporated by reference to Amendment No. 2 to the Corporation’s  Registration Statement on Form F-1, dated December 6, 1996.                                                                              |
| Exhibit 3.4 | By-laws of the Corporation (incorporated by  reference to the Corporation’s report on Form 8-K dated December 21,  2005 (Commission File No. 000-28882)).                                                                                                           |
| Exhibit 4.1 | Form of Common Share Certificate.*                                                                                                                                                                                                                                                 |
| Exhibit 4.2 | Registration Rights Agreement, dated September 22,  2003, between the Corporation and the purchasers named therein (incorporated  by reference to Exhibit 4.2 to the Corporation’s Registration  Statement on Form F-3 (Commission File No. 333-111512)). |

40

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| Exhibit 4.3  | Warrant Indenture, dated September 22, 2003,  between the Corporation and CIBC Mellon Trust Company (incorporated by  reference to Exhibit 4.3 to the Corporation’s Registration  Statement on Form F-3 (Commission File No. 333-111512)).                                                  |
|-------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 4.4  | U.S. Purchase Agreement for Units, dated September 22,  2003 (incorporated by reference to Exhibit 4.4 to the Corporation’s  Registration Statement on Form F-3 (Commission File No. 333-111512)).                                                                                               |
| Exhibit 4.5  | Agency Agreement, dated September 22, 2003,  between the Corporation and Research Capital Corporation (incorporated by  reference to Exhibit 4.5 to the Corporation’s Registration  Statement on Form F-3 (Commission File No. 333-111512)).                                                     |
| Exhibit 4.7  | Registration Rights Agreement, dated September 15,  2004, between the Corporation and the purchasers named therein (incorporated  by reference to Exhibit 4.2 to the Corporation’s Registration  Statement on Form F-3 (Commission File No. 333-119750)).                                        |
| Exhibit 4.9  | Purchase Agreement, dated as of January 31,  2005, between the Corporation and Maverick Venture Management, LLC  (incorporated by reference to the Corporation’s Report on Form 6-K,  Dated February 1, 2005)                                                                                         |
| Exhibit 4.10 | Registration Rights Agreement dated as of July 29,  2005 between the Corporation, MedQuest Products, Inc. and Maverick  Venture Management, LLC. (incorporated by reference to Exhibit 4.1 to  the Corporation’s Form 10-QSB for the period ended June 30,  2005 (Commission File No.000-28882)) |
| Exhibit 10.1 | Restated and Amended Distribution Agreement, dated December 31,  2003, between the Corporation and Edwards Lifesciences LLC (incorporated by  reference to Exhibit 99.1 to Amendment No. 1 the Corporation’s  Registration Statement on Form F-3 (Commission File No. 333-111512)).** **    |
| Exhibit 10.2 | Consulting Agreement, dated July 13, 2004,  between the Corporation and Synergistic Business Solutions. (incorporated by  reference to Exhibit 10.2 to the Corporation’s Form 10-KSB/A  for the year ended December 31, 2004 (Commission File No. 000-28882))                                    |
| Exhibit 10.3 | Letter Agreement, dated June 23, 2000, as  amended on October 12, 2004, between the Corporation and Phillip J.  Miller. (incorporated by reference to Exhibit 10.7 to the Corporation’s Form 10-KSB/A  for the year ended December 31, 2004 (Commission File No. 000-28882))                |
| Exhibit 10.4 | Letter Agreement, dated October 6, 2003, as  amended on October 12, 2004, between the Corporation and John Marinchak.  (incorporated by reference to Exhibit 10.6 to the Corporation’s Form 10-KSB/A  for the year ended December 31, 2004 (Commission File No. 000-28882))                 |
| Exhibit 10.5 | Letter Agreement, dated December 9, 2003, as  amended on October 12, 2004, between the Corporation and Piet Jansen.  (incorporated by reference to Exhibit 10.5 to the Corporation’s Form 10-KSB/A  for the year ended December 31, 2004 (Commission File No. 000-28882))                   |
| Exhibit 10.6 | Letter Agreement dated June 23, 2000, as  amended on October 28, 2004, between the Corporation and Jal S.  Jassawalla. (incorporated by reference to Exhibit 10.1 to the  Corporation’s Form 10-QSB for the period ended March 31, 2005  (Commission File No. 000-28882))                   |
| Exhibit 10.7 | Letter Agreement dated January 24, 2005 between  the Corporation and Pratap Khanwilkar. (incorporated by reference to Exhibit 10.3  to the Corporation’s Form 10-QSB for the period ended June 30,  2005 (Commission File No. 000-28882)).                                                       |

41

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| Exhibit 10.8  | Letter Agreement, dated May 19, 2005 between  the Corporation and John Vajda. (incorporated by reference to Exhibit 10.1  to the Corporation’s Form 10-QSB for the year ended June 30,  2005 (Commission File No. 000-28882))                  |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 10.9  | Letter Agreement dated May 27, 2005 between the  Corporation and A. Richard Juelis. (incorporated by reference to Exhibit 10.1  to the Corporation’s Form 10-QSB for the period ended June 30,  2005 (Commission File No. 000-28882)).         |
| Exhibit 10.10 | Form of indemnification agreement (incorporated  by reference to the Corporation’s report on Form 8-K dated December 21,  2005 (Commission File No. 000-28882)).                                                                                    |
| Exhibit 10.11 | License Agreement dated March 31, 1999, as  amended on June 8, 2005, between the Corporation and the University of  Utah Research Foundation*                                                                                                                      |
| Exhibit 10.12 | License Agreement dated March 31, 1999 between  the Corporation and the University of Virginia Patent Foundation*                                                                                                                                                       |
| Exhibit 10.13 | License Agreement dated February 13, 2002  between the Corporation and University of Pittsburgh*                                                                                                                                                                        |
| Exhibit 10.14 | Operating Agreement of Heart Lung Institute, LLC  dated October 13,1998 as amended July 15, 2005, between the  Corporation and the Heart and Lung Research foundation.*                                                                                            |
| Exhibit 10.15 | World Heart Corporation Employee Stock Option Plan  (incorporated by reference to the Corporation’s Registration Statement on  Amendment No. 1 to form F-1, dated November 18, 1996)                                                                          |
| Exhibit 14.1  | Amended and Restated Code of Conduct of the  Corporation, adopted on October 26, 2004. (incorporated by reference  to Exhibit 99.1 to the Corporation’s Form 10-KSB for the year  ended December 31, 2004 (Commission File No 000-28882)) |
| Exhibit 21.1  | List of All Subsidiaries of World Heart Corporation.*                                                                                                                                                                                                                        |
| Exhibit 23.1  | Consent of Independent Accountants*                                                                                                                                                                                                                                          |
| Exhibit 24.1  | Power of Attorney (reference is made to the  signature page to this Form 10-KSB)                                                                                                                                                                                   |
| Exhibit 31.1  | Certification of Principal Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                |
| Exhibit 31.2  | Certification of Principal Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                |
| Exhibit 32.1  | Certification of Principal Executive Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.  1350.                                                                                                                                               |
| Exhibit 32.2  | Certification of Principal Financial Officer pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. 1350.                                                                                                                                           |

----

* Filed herewith

**Item 14.**                 PrincipalAccountant Fees and Services.

The discussion under the heading “Appointment ofAuditors” in our definitive proxy statement for the 2006 Annual Meeting ofShareholders in incorporated herein by reference to such proxy statement.

42

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**SIGNATURES**

Inaccordance with Section 13 or 15(d) of the Exchange Act, theregistrant caused this report to be signed on its behalf by the undersigned,duly authorized.

|        | WORLD HEART  CORPORATION                                          |
|--------|-------------------------------------------------------------------|
|   | (Registrant)                                                      |
|   | By  /s/ JAL S. JASSAWALLA,  President and Chief Executive Officer |
|   | (Signature and Title)                                             |
|   | Date March 27, 2006                                          |

 

We, the undersigned, directors and officers of WorldHeart Corporation do hereby severally constitute and appoint JAL S. JASSAWALLAand A. RICHARD JUELIS and each or any of them, our true and lawful attorneysand agents, with full power of substitution and resubstitution, for him or herand in his or her name, place and stead, in any and all capacities, to sign anyand all amendments to the Registrant’s Annual Report on Form 10-KSBfor the fiscal year ended December 31, 2005, and to file the same with allexhibits thereto, and all other documents in connection therewith, with theSecurities and Exchange Commission, granting unto said attorneys and agents,and each or any of them, full power and authority to do and perform each andevery act and thing requisite and necessary to be done, as fully to all intentsand purposes as he or she might or could do in person, hereby ratifying andconfirming all that said attorneys and agents, and each of them, or substituteor substitutes, may lawfully do or cause to be done by virtue hereof.

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and datesindicated.

|                               | **Name** | ** **                                           | ** ** |                      | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|-------------------------------|----------|------------------------------------------------------|------------|----------------------|-----------|------------|------------|--|----------|------------|
| /s/ JAL  S. JASSAWALLA   |     | President, Chief  Executive Officer and Director     |       | March 27,  2006 |
| Jal  S. Jassawalla            |     | (principal executive officer)                        |       |                 |
| /s/ A. RICHARD  JUELIS   |     | Vice President,  Finance and Chief Financial Officer |       | March 27,  2006 |
| A.  Richard Juelis            |     | (principal financial and accounting officer)         |       |                 |
| /s/ JOHN  F. CARLSON     |     | Director                                             |       | March 27,  2006 |
| John  F. Carlson              |     |                                                 |       |                 |
| /s/ WILLIAM  C. GARRIOCK |     | Director                                             |       | March 27,  2006 |
| William  C. Garriock          |     |                                                 |       |                 |
| /s/ ROBERT  J. MAJTELES  |     | Director                                             |       | March 27,  2006 |
| Robert  J. Majteles           |     |                                                 |       |                 |
| /s/ C. IAN  ROSS         |     | Chairman of the  Board and Director                  |       | March 27,  2006 |
| C. Ian Ross                   |     |                                                 |       |                 |

 

43

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**EXHIBIT INDEX **

| Exhibit 2.1  |   | Asset Purchase Agreement between World Heart  Corporation and MedQuest, dated as of January 31, 2005 (incorporated by  reference to the Corporation’s Report on Form 6-K, Dated  February 1, 2005).                                                                                                        |
|-------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 3.1  |   | Article of  Continuance, dated December 14, 2005 (incorporated by reference to the  Corporation’s report on Form 8-K dated December 14, 2005  (Commission File No. 000-28882)).                                                                                                                  |
| Exhibit 3.2  |   | By-laws of the  Corporation (incorporated by reference to the Corporation’s Registration  Statement on Form F-1, dated October 8, 1996).                                                                                                                                                                        |
| Exhibit 3.3  |   | Amendment to the  By-Laws of the Corporation (incorporated by reference to Amendment No. 2  to the Corporation’s Registration Statement on Form F-1,  dated December 6, 1996.                                                                                                                    |
| Exhibit 3.4  |   | By-laws of the  Corporation (incorporated by reference to the Corporation’s report on  Form 8-K dated December 21, 2005 (Commission File  No. 000-28882)).                                                                                                                                                 |
| Exhibit 4.1  |   | Form of Common  Share Certificate.                                                                                                                                                                                                                                                                                        |
| Exhibit 4.2  |   | Registration Rights  Agreement, dated September 22, 2003, between the Corporation and the  purchasers named therein (incorporated by reference to Exhibit 4.2  to the Corporation’s Registration Statement on Form F-3  (Commission File No. 333-111512)).                                       |
| Exhibit 4.3  |   | Warrant Indenture, dated  September 22, 2003, between the Corporation and CIBC Mellon Trust  Company (incorporated by reference to Exhibit 4.3 to the  Corporation’s Registration Statement on Form F-3 (Commission File  No. 333-111512)).                                                 |
| Exhibit 4.4  |   | U.S. Purchase Agreement  for Units, dated September 22, 2003 (incorporated by reference to  Exhibit 4.4 to the Corporation’s Registration Statement on  Form F-3 (Commission File No. 333-111512)).                                                                                              |
| Exhibit 4.5  |   | Agency Agreement, dated  September 22, 2003, between the Corporation and Research Capital  Corporation (incorporated by reference to Exhibit 4.5 to the  Corporation’s Registration Statement on Form F-3 (Commission File  No. 333-111512)).                                                    |
| Exhibit 4.7  |   | Registration Rights  Agreement, dated September 15, 2004, between the Corporation and the purchasers  named therein (incorporated by reference to Exhibit 4.2 to the  Corporation’s Registration Statement on Form F-3 (Commission File  No. 333-119750)).                                       |
| Exhibit 4.9  |   | Purchase Agreement,  dated as of January 31, 2005, between the Corporation and Maverick  Venture Management, LLC (incorporated by reference to the Corporation’s  Report on Form 6-K, Dated February 1, 2005)                                                                                         |
| Exhibit 4.10 |   | Registration Rights  Agreement dated as of July 29, 2005 between the Corporation, MedQuest  Products, Inc. and Maverick Venture Management, LLC. (incorporated by  reference to Exhibit 4.1 to the Corporation’s Form 10-QSB for  the period ended June 30, 2005 (Commission File No.000-28882)) |
| Exhibit 10.1 |   | Restated and Amended  Distribution Agreement, dated December 31, 2003, between the Corporation  and Edwards Lifesciences LLC (incorporated by reference to Exhibit 99.1  to Amendment No. 1 the Corporation’s Registration Statement on  Form F-3 (Commission File No. 333-111512)).             |

44

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| Exhibit 10.2  |   | Consulting Agreement, dated July 13, 2004, between  the Corporation and Synergistic Business Solutions. (incorporated by  reference to Exhibit 10.2 to the Corporation’s Form 10-KSB/A  for the year ended December 31, 2004 (Commission File No. 000-28882))                      |
|--------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 10.3  |   | Letter Agreement, dated  June 23, 2000, as amended on October 12, 2004, between the  Corporation and Phillip J. Miller. (incorporated by reference to  Exhibit 10.7 to the Corporation’s Form 10-KSB/A for the year  ended December 31, 2004 (Commission File No. 000-28882)) |
| Exhibit 10.4  |   | Letter Agreement, dated  October 6, 2003, as amended on October 12, 2004, between the  Corporation and John Marinchak. (incorporated by reference to  Exhibit 10.6 to the Corporation’s Form 10-KSB/A for the year  ended December 31, 2004 (Commission File No. 000-28882))  |
| Exhibit 10.5  |   | Letter Agreement, dated  December 9, 2003, as amended on October 12, 2004, between the  Corporation and Piet Jansen. (incorporated by reference to Exhibit 10.5  to the Corporation’s Form 10-KSB/A for the year ended  December 31, 2004 (Commission File No. 000-28882))    |
| Exhibit 10.6  |   | Letter Agreement dated  June 23, 2000, as amended on October 28, 2004, between the  Corporation and Jal S. Jassawalla. (incorporated by reference to  Exhibit 10.1 to the Corporation’s Form 10-QSB for the period  ended March 31, 2005 (Commission File No. 000-28882))     |
| Exhibit 10.7  |   | Letter Agreement dated  January 24, 2005 between the Corporation and Pratap Khanwilkar.  (incorporated by reference to Exhibit 10.3 to the Corporation’s  Form 10-QSB for the period ended June 30, 2005 (Commission  File No. 000-28882)).                                        |
| Exhibit 10.8  |   | Letter Agreement, dated  May 19, 2005 between the Corporation and John Vajda. (incorporated by  reference to Exhibit 10.1 to the Corporation’s Form 10-QSB  for the year ended June 30, 2005 (Commission File No. 000-28882))                                                      |
| Exhibit 10.9  |   | Letter Agreement dated  May 27, 2005 between the Corporation and A. Richard Juelis.  (incorporated by reference to Exhibit 10.1 to the Corporation’s  Form 10-QSB for the period ended June 30, 2005 (Commission  File No. 000-28882)).                                            |
| Exhibit 10.10 |   | Form of  indemnification agreement (incorporated by reference to the Corporation’s  report on Form 8-K dated December 21, 2005 (Commission File  No. 000-28882)).                                                                                                                       |
| Exhibit 10.11 |   | License Agreement dated  March 31, 1999, as amended on June 8, 2005, between the Corporation  and the University of Utah Research Foundation                                                                                                                                                           |
| Exhibit 10.12 |   | License Agreement dated  March 31, 1999 between the Corporation and the University of Virginia  Patent Foundation                                                                                                                                                                                           |
| Exhibit 10.13 |   | License Agreement dated  February 13, 2002 between the Corporation and University of Pittsburgh                                                                                                                                                                                                             |
| Exhibit 10.14 |   | Operating Agreement of  Heart Lung Institute, LLC dated October 13,1998 as amended July 15,  2005, between the Corporation and the Heart and Lung Research foundation.                                                                                                                                 |
| Exhibit 10.15 |   | World Heart Corporation  Employee Stock Option Plan (incorporated by reference to the Corporation’s  Registration Statement on Amendment No. 1 to form F-1, dated  November 18, 1996)                                                                                                             |

45

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| Exhibit 14.1 |   | Amended  and Restated Code of Conduct of the Corporation, adopted on  October 26, 2004. (incorporated by reference to Exhibit 99.1  to the Corporation’s Form 10-KSB for the year ended  December 31, 2004 (Commission File No 000-28882)) |
|-------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 21.1 |   | List of All Subsidiaries  of World Heart Corporation.                                                                                                                                                                                                                         |
| Exhibit 23.1      |   | Consent of Independent  Accountants                                                                                                                                                                                                                                           |
| Exhibit 24.1 |   | Power of Attorney  (reference is made to the signature page to this Form 10-KSB)                                                                                                                                                                                    |
| Exhibit 31.1 |   | Certification of  Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                |
| Exhibit 31.2 |   | Certification of  Principal Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                |
| Exhibit 32.1 |   | Certification of  Principal Executive Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, 18 U.S.C. 1350.                                                                                                                                                |
| Exhibit 32.2 |   | Certification of  Principal Financial Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, 18 U.S.C. 1350.                                                                                                                                           |

 

46

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**WORLD HEARTCORPORATION**

|                                                                                                                      | ** ** | **Page** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Management’s Statement of Responsibility                                                                        |       |     | F-2        |   |   |
| Auditors’ Report to the Shareholders of World Heart  Corporation                                                |       |     | F-3        |   |   |
| AUDITED CONSOLIDATED  FINANCIAL STATEMENTS:                                                                          |       |     |       |   |   |
| Consolidated  Balance Sheets as of December 31, 2005 and 2004                                                   |       |     | F-4        |   |   |
| Consolidated Statements of Operations for the years  ended December 31, 2005, 2004 and 2003                |       |     | F-5        |   |   |
| Consolidated Statements of Shareholders’ Equity for  the years ended December 31, 2005, 2004 and 2003 |       |     | F-6        |   |   |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2005, 2004 and 2003                |       |     | F-7        |   |   |
| Notes  to Consolidated Financial Statements                                                                          |       |     | F-8        |   |   |

 

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**MANAGEMENT’S STATEMENT OF RESPONSIBILITY**

Management is responsible for the preparation of theconsolidated financial statements and all other information in the annualreport. The financial statements have been prepared in accordance withgenerally accepted accounting principles in the United States (“U.S. GAAP”) andreflect management’s best estimates and judgments. The financial informationpresented elsewhere in the annual report is consistent with the consolidatedfinancial statements.

Management has developed and maintains a system ofinternal controls to provide reasonable assurance that all assets aresafeguarded and to facilitate the preparation of relevant, reliable and timelyfinancial information. Consistent with the concept of reasonable assurance, theCorporation recognizes that the relative cost of maintaining these controlsshould not exceed their expected benefits.

The Audit Committee, which is comprised of independentdirectors, reviews the consolidated financial statements, considers the reportof the external auditors, assesses the adequacy of the Corporation’s internalcontrols, and recommends to the Board of Directors the independent auditors forappointment by the shareholders. The consolidated financial statements werereviewed by the Audit Committee and approved by the Board of Directors.

Theconsolidated financial statements were audited by PricewaterhouseCoopers LLP,the external auditors, on behalf of the shareholders. 
| Original signed by:      |   | Original signed  by:     |
|--------------------------|--------|--------------------------|
| Jal. S.  Jassawalla      |   | A. Richard Juelis        |
| Chief Executive  Officer |   | Chief Financial  Officer |

 

F-2

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**AUDITORS’ REPORT TO THE BOARD OF DIRECTORS ANDSHAREHOLDERSOF WORLD HEART CORPORATION**

We have audited the accompanying consolidated balancesheets of World Heart Corporation and its subsidiaries as of December 31,2005 and 2004, and the related consolidated statements of operations,shareholders’ equity and cash flow for the years ended December 31, 2005,2004 and 2003. These financial statements are the responsibility of theCorporation’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe our audits provide a reasonable basis for our audit opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of World Heart Corporation and its subsidiaries at December 31,2005 and 2004 and the results of their operations and their cash flows for theyears ended December 31, 2005, 2004 and 2003 in conformity with accountingprinciples generally accepted in the United States.

Theaccompanying financial statements have been prepared assuming that theCorporation will continue as a going concern. As discussed in Note 1 to thefinancial statements, the Corporation has suffered recurring losses that raisesubstantial doubt about its ability to continue as a going concern. Management’splans in regard to these matters are also described in Note 1. The financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.
| Ottawa, Canada     |   | PRICEWATERHOUSECOOPERS  LLP |
|--------------------|--------|-----------------------------|
| March 3, 2006 |   | Chartered Accountants       |

 

F-3

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**WORLD HEART CORPORATIONCONSOLIDATED BALANCE SHEETS(United States Dollars)**

| ** **                                                                                                   | ** ** | **December 31, 2005** | ** **   | **December 31, 2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|---------------------------------|--------------|---------------------------------|------------|
| **ASSETS**                                                                                                   | ** ** |                            | ** **   | ** **                      |       |   | ** ** | ** ** |   |
| **Current assets**                                                                                           |       |                            |         |                            |       |   |   |   |   |
| Cash and cash  equivalents (Note 5)                                                                          |       |                            | $            | 10,661,682                      |       |   |   | $ | 3,818,767 |   |   |
| Short-term investments                                                                                       |       |                            | —       |                            |       |   | 4,999,034 |   |   |
| Trade and other  receivables                                                                                 |       |                            | 3,896,281    |                            |       |   | 4,238,049 |   |   |
| Prepaid expenses                                                                                             |       |                            | 778,007      |                            |       |   | 575,261 |   |   |
| Inventory (Note 6)                                                                                           |       |                            | 8,215,995    |                            |       |   | 8,112,525 |   |   |
|                                                                                                         |       |                            | 23,551,965   |                            |       |   | 21,743,636 |   |   |
| **Long-term assets**                                                                                         |       |                            |         |                            |       |   |   |   |   |
| Long-term receivable                                                                                         |       |                            | —       |                            |       |   | 318,553 |   |   |
| Cash pledged as  collateral for lease (Note 18)                                                              |       |                            | 750,000      |                            |       |   | 750,000 |   |   |
| Capital assets (Note 7)                                                                                      |       |                            | 1,837,540    |                            |       |   | 2,011,586 |   |   |
| Intangible assets (Note  8)                                                                                  |       |                            | 682,188      |                            |       |   | 255,012 |   |   |
| Goodwill (Note 9)                                                                                            |       |                            | —       |                            |       |   | 17,179,643 |   |   |
|                                                                                                         |       |                            | 3,269,728    |                            |       |   | 20,514,794 |   |   |
| **Total assets**                                                                                             | ** ** |                            | **$**        | **26,821,693**                  | ** ** |   |   | **$** | **42,258,430** | ** ** |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                |       |                            |         |                            |       |   |   |   |   |
| **Current liabilities**                                                                                      |       |                            |         |                            |       |   |   |   |   |
| Accounts payable and  accrued liabilities                                                                    |       |                            | $            | 3,754,620                       |       |   |   | $ | 3,854,833 |   |   |
| Indirect taxes payable  (Note 10)                                                                            |       |                            | 343,082      |                            |       |   | 832,000 |   |   |
| Accrued compensation                                                                                         |       |                            | 806,367      |                            |       |   | 1,343,364 |   |   |
| Deferred revenue                                                                                             |       |                            | 1,205,107    |                            |       |   | 1,607,622 |   |   |
|                                                                                                         |       |                            | 6,109,176    |                            |       |   | 7,637,819 |   |   |
| **Long-term liabilities**                                                                                    |       |                            |         |                            |       |   |   |   |   |
| Convertible debentures  (Note 11)                                                                            |       |                            | —       |                            |       |   | 8,177,140 |   |   |
| Long-term obligation                                                                                         |       |                            | —       |                            |       |   | 16,368 |   |   |
|                                                                                                         |       |                            | —       |                            |       |   | 8,193,508 |   |   |
| **Total liabilities**                                                                                        | ** ** |                            | **$**        | **6,109,176**                   | ** ** |   |   | **$** | **15,831,327** | ** ** |   |
| **Commitment and Contingency (Note 18)**                                                                     | ** ** |                            | ** **   | ** **                      |       |   | ** ** | ** ** |   |
| **Shareholders’ equity (Note 13)**                                                                      |       |                            |         |                            |       |   |   |   |   |
| Share capital:                                                                                               |       |                            |         |                            |       |   |   |   |   |
| Issued and outstanding—55,479,549  common shares (December 31, 2004—15,744,522 common shares) |       |                            | 276,908,002  |                            |       |   | 214,616,061 |   |   |
| Additional  paid-in-capital                                                                                  |       |                            | 2,138,765    |                            |       |   | 11,451,267 |   |   |
| Cumulative other  comprehensive income                                                                       |       |                            | (6,285,577   | )                               |       |   | (6,285,577 | ) |   |
| Accumulated deficit                                                                                          |       |                            | (252,048,673 | )                               |       |   | (193,354,648 | ) |   |
| Total shareholders’  equity                                                                             |       |                            | 20,712,517   |                            |       |   | 26,427,103 |   |   |
| **Total liabilities and shareholders’ equity**                                                          | ** ** |                            | **$**        | **26,821,693**                  | ** ** |   |   | **$** | **42,258,430** | ** ** |   |

 

(The accompanying notes are an integral part of theseconsolidated financial statements.)
| Signed on behalf of the  Board of Directors  Original signed by C. Ian Ross and Jal Jassawalla |
|------------------------------------------------------------------------------------------------|
| ** **                                                                                     | ** ** | ** ** |
| **Director**                                                                                   | ** ** | **Director** |

 

F-4

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**WORLD HEART CORPORATIONCONSOLIDATED STATEMENTSOF OPERATIONS(United States Dollars)**

| ** **                                                | ** ** | **Year Ended  December 31,** | ** **  | **Year Ended  December 31,** | ** ** | **Year Ended  December 31,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------|-------------|----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                | ** ** | **2005**                               | ** **  | **2004**                               | ** ** | **2003**                               | ** ** |
| **Revenue**                                               |       | $                                      | 11,645,954  |                                   | $          | 9,575,761                              |       | $ | 6,775,807 |   |
| **Cost of  goods sold**                                   |       | (8,478,855                             | )           | (7,680,384                             | )          | (4,968,898                             | )          |
| **Gross  margin**                                         |       | 3,167,099                              |        | 1,895,377                              |       | 1,806,909                              |       |
| **Operating  expenses**                                   |       |                                   |        |                                   |       |                                   |       |
| Selling, general and administrative                       |       | 12,041,345                             |        | 13,363,796                             |       | 7,263,759                              |       |
| Research and development                                  |       | 7,388,385                              |        | 5,838,754                              |       | 9,604,080                              |       |
| Restructuring costs (Note 14)                             |       | 333,030                                |        | 1,787,129                              |       | 3,356,487                              |       |
| Amortization of intangibles                               |       | 338,507                                |        | 515,012                                |       | 1,938,595                              |       |
| Acquired in-process research and development  (Note 4)    |       | 18,147,341                             |        | —                                 |       | —                                 |       |
| Goodwill impairment (Note 9)                              |       | 17,179,643                             |        | —                                 |       | —                                 |       |
| **Total operating expenses**                              |       | 55,428,251                             |        | 21,504,691                             |       | 22,162,921                             |       |
| **Operating loss**                                        |       | (52,261,152                            | )           | (19,609,314                            | )          | (20,356,012                            | )          |
| **Other  income (expenses)**                              |       |                                   |        |                                   |       |                                   |       |
| Foreign exchange gain (loss)                              |       | (144,268                               | )           | (308,338                               | )          | 10,055,129                             |       |
| Investment and other income                               |       | 369,671                                |        | 99,427                                 |       | 105,596                                |       |
| Loss on disposal of capital assets                        |       | (959                                   | )           | (46,431                                | )          | (27,147                                | )          |
| Interest expense and financing costs                      |       | (797,067                               | )           | (6,277,142                             | )          | (4,406,620                             | )          |
| **Net  loss for the year**                                |       | (52,833,775                            | )           | (26,141,798                            | )          | (14,629,054                            | )          |
| **Accretion on preferred shares**                         |       | —                                 |        | —                                 |       | (1,614,855                             | )          |
| **Inducement  related to conversion of preferred shares** |       | —                                 |        | —                                 |       | (1,924,395                             | )          |
| **Effect  of warrant exchange**                           |       | (5,860,250                             | )           | —                                 |       | —                                 |       |
| **Net  loss applicable to common shareholders**           |       | $                                      | (58,694,025 | )                                      | $          | (26,141,798                            | )          | $ | (18,168,304 | ) |
| **Weighted average number of common shares  outstanding** |       | 33,369,318                             |        | 15,373,689                             |       | 6,259,757                              |       |
| **Basic  and diluted loss per common share**              |       | $                                      | (1.76       | )                                      | $          | (1.70                                  | )          | $ | (2.90 | ) |

 

(The accompanying notes are an integral part of these consolidated financial statements.)

F-5

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**WORLD HEART CORPORATIONCONSOLIDATED STATEMENTSOF SHAREHOLDERS’ EQUITY (United States Dollars)**

| ** **                                                                     | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** **  | **Cumulative  Other  Comprehensive** | ** ** | **Accumulated** | ** ** | **Shareholders’  Equity** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|-------------|--------------------------------------|------------|-----------------|------------|--------------------------------|------------|
| ** **                                                                     | ** ** | **Number**            | ** ** | **Amount**              | ** **  | **Capital**                          | ** ** | **Income**      | ** ** | **Deficit**                    | ** ** | **(Deficiency)** | ** ** |
| **Balance  as at December 31,  2002**                                     |       | 2,567,084             |       | $                       | 93,501,762  |                                 | $          | —          |       |                           | $          | (578,717 | ) |   | $ | (150,510,388 | ) |   | $ | (57,587,343 | ) |   |
| Common shares  issued through private placement and public offering            |       | 11,006,159            |       | 43,692,929              |        | —                               |       |            | —     |                           |       | — |   |   | 43,692,929 |   |   |
| Common shares and  warrants granted upon the conversion of warrants and rights |       | 238,857               |       | 3,211,698               |        | —                               |       |            | —     |                           |       | — |   |   | 3,211,698 |   |   |
| Warrants issued in  connection with debentures and loans                       |       | —                |       | —                  |        | 2,354,370                            |       |            | —     |                           |       | — |   |   | 2,354,370 |   |   |
| Common shares and  warrants issued upon conversion of preferred shares         |       | 1,211,589             |       | 72,051,103              |        | —                               |       |            | —     |                           |       | (1,924,395 | ) |   | 70,126,708 |   |   |
| Options issued for  services                                                   |       | —                |       | —                  |        | 193,449                              |       |            | —     |                           |       | — |   |   | 193,449 |   |   |
| Accretion on  preferred shares                                                 |       | —                |       | —                  |        | —                               |       |            | —     |                           |       | (1,614,855 | ) |   | (1,614,855 | ) |   |
| Reduction in APIC  due to accretion of preferred shares                        |       | —                |       | —                  |        | (1,465,842                           | )          |            | —     |                           |       | 1,465,842 |   |   | — |   |   |
| Cumulative  translation adjustment (note 3)                               |       | —                |       | —                  |        | —                               |       |            | (5,706,860 | )                              |       | — |   |   | (5,706,860 | ) |   |
| Net loss for the  year ended December 31, 2003                            |       | —                |       | —                  |        | —                               |       |            | —     |                           |       | (14,629,054 | ) |   | (14,629,054 | ) |   |
| **Balance  as at December 31,  2003**                                     |       | 15,023,689            |       | 212,457,492             |        | 1,081,977                            |       |            | (6,285,577 | )                              |       | (167,212,850 | ) |   | 40,041,042 |   |   |
| Common shares and  warrants issued in connection with convertible debentures   |       | 470,874               |       | 659,166                 |        | 4,548,920                            |       |            | —     |                           |       | — |   |   | 5,208,086 |   |   |
| Value of  debentures’ beneficial conversion feature                       |       | —                |       | —                  |        | 5,821,370                            |       |            | —     |                           |       | — |   |   | 5,821,370 |   |   |
| Common shares  issued upon exercise of warrants                                |       | 250,000               |       | 1,499,403               |        | —                               |       |            | —     |                           |       | — |   |   | 1,499,403 |   |   |
| Warrants  repurchased                                                          |       | —                |       | —                  |        | (1,000                               | )          |            | —     |                           |       | — |   |   | (1,000 | ) |   |
| Net loss for the  year ended December 31, 2004                            |       | —                |       | —                  |        | —                               |       |            | —     |                           |       | (26,141,798 | ) |   | (26,141,798 | ) |   |
| **Balance  as at December 31,  2004**                                     |       | 15,744,563            |       | 214,616,061             |        | 11,451,267                           |       |            | (6,285,577 | )                              |       | (193,354,648 | ) |   | 26,427,103 |   |   |
| Common shares  issued upon exercise of warrants                                |       | 10,655,000            |       | 20,884,420              |        | (10,229,420                          | )          |            | —     |                           |       | — |   |   | 10,655,000 |   |   |
| Common shares  issued in private placement                                     |       | 8,888,889             |       | 12,000,000              |        | —                               |       |            | —     |                           |       | — |   |   | 12,000,000 |   |   |
| Common shares  issued upon conversion of convertible debentures and interest   |       | 10,891,097            |       | 14,769,475              |        | (5,821,370                           | )          |            | —     |                           |       | — |   |   | 8,948,105 |   |   |
| Common shares  issued to purchase MedQuest assets                              |       | 9,300,000             |       | 14,694,000              |        | —                               |       |            | —     |                           |       | — |   |   | 14,694,000 |   |   |
| Effect of warrant  exchange                                                    |       | —                |       | —                  |        | 5,860,250                            |       |            | —     |                           |       | (5,860,250 | ) |   | — |   |   |
| Non-cash stock  compensation                                                   |       | —                |       | —                  |        | 880,038                              |       |            | —     |                           |       | — |   |   | 880,038 |   |   |
| Registration fees                                                              |       | —                |       | (55,954                 | )           | —                               |       |            | —     |                           |       | — |   |   | (55,954 | ) |   |
| Warrants repurchased                                                           |       | —                |       | —                  |        | (2,000                               | )          |            | —     |                           |       | — |   |   | (2,000 | ) |   |
| Net loss for the  year ended December 31, 2005                            |       | —                |       | —                  |        | —                               |       |            | —     |                           |       | (52,833,775 | ) |   | (52,833,775 | ) |   |
| **Balance  as at December 31,  2005**                                     |       | 55,479,549            |       | $                       | 276,908,002 |                                 | 2,138,765  |            |       | $                              | (6,285,577 | ) |   | $ | (252,048,673 | ) |   | $ | 20,712,517 |   |   |
|                                                                                |            |                       |            |                         |             |                                      |            |                 |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |

 

 

(The accompanying notes are an integral part of these consolidated financial statements.)

F-6

----

**WORLD HEART CORPORATIONCONSOLIDATED STATEMENTSOF CASH FLOW(United States Dollars)**

| ** **                                                                                                      | ** ** | **Year Ended December 31,** | ** **     |
|-----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|----------------|
| ** **                                                                                                      | ** ** | **2005**                                   | ** **     | **2004** | ** ** | **2003** | ** ** |
| **CASH FLOWS FROM (USED IN)**                                                                                   | ** ** | ** **                                 | ** **     | ** ** | ** ** | ** ** | ** ** |
| **Operating activities**                                                                                        |       |                                       |           |   |   |   |   |
| Net loss for the  period                                                                                        |       | $                                          | (52,833,775    | ) | $ | (26,141,798 | ) | $ | (14,629,054 | ) |
| Items not involving cash—                                                                                  |       |                                       |           |   |   |   |   |
| Amortization and  depreciation                                                                                  |       | 1,033,441                                  |           | 1,390,508 |   | 3,302,044 |   |
| Loss on disposal of  capital assets                                                                             |       | 959                                        |           | 46,431 |   | 27,147 |   |
| Acquired in-process  research and development                                                                   |       | 18,147,341                                 |           | — |   | — |   |
| Goodwill impairment                                                                                             |       | 17,179,643                                 |           | — |   | — |   |
| Write down of capital and  intangible assets                                                                    |       | —                                     |           | 547,366 |   | — |   |
| Non-cash expense on stock  options                                                                              |       | 880,038                                    |           | 81,466 |   | 2,704,247 |   |
| Non-cash interest on debt                                                                                       |       | 778,603                                    |           | 6,266,027 |   | — |   |
| Long-term receivable                                                                                            |       | 318,553                                    |           | — |   | — |   |
| Gain on settlement of  obligation                                                                               |       | —                                     |           | — |   | (1,694,300 | ) |
| Unrealized foreign  exchange loss (gain)                                                                        |       | 65,168                                     |           | 7,956 |   | (9,728,237 | ) |
| Change in  operating components of working capital (Note 19)                                               |       | (1,236,970                                 | )              | (5,132,726 | ) | (4,939,234 | ) |
| **Cash  used in operating activities**                                                                          | ** ** | **(15,666,999**                            | **)**          | **(22,934,770** | **)** | **(24,957,387** | **)** |
| **Investing activities**                                                                                        |       |                                       |           |   |   |   |   |
| Redemption  (purchase) of short-term investments                                                                |       | 4,999,035                                  |           | 6,504,997 |   | (10,847,245 | ) |
| Purchase of  capital assets                                                                                     |       | (306,296                                   | )              | (363,224 | ) | (150,135 | ) |
| Repayment of  bridge loan in connection with MedQuest Acquisition                                               |       | (3,500,000                                 | )              | — |   | — |   |
| Transaction costs  paid in connection with MedQuest Acquisition                                                 |       | (1,255,696                                 | )              | — |   | — |   |
| Cash pledged as  collateral for lease                                                                           |       | —                                     |           | (222,003 | ) | 217,178 |   |
| **Cash  used investing activities**                                                                             | ** ** | **(62,957**                                | **)**          | **5,919,770** | ** ** | **(10,780,202** | **)** |
| **Financing activities**                                                                                        |       |                                       |           |   |   |   |   |
| Capital lease  repayments                                                                                       |       | —                                     |           | — |   | (40,460 | ) |
| Convertible  debenture proceeds                                                                                 |       | —                                     |           | 13,318,750 |   | 856,837 |   |
| Repayment of  convertible debenture and accumulated interest                                                    |       | —                                     |           | — |   | (884,108 | ) |
| Bridge loan  proceeds                                                                                           |       | —                                     |           | — |   | 767,771 |   |
| Repayment of  bridge loan and accumulated interest                                                              |       | —                                     |           | — |   | (775,068 | ) |
| Repayment of  short-term loan and accmulated interest                                                           |       | —                                     |           | — |   | (1,308,558 | ) |
| Senior and  subordinated loan and accumulated interest                                                          |       | —                                     |           | — |   | 6,542,790 |   |
| Repayment of  senior and subordinated loan and accumulated interest                                             |       | —                                     |           | — |   | (7,367,568 | ) |
| Common shares  issued through private placement                                                                 |       | 12,000,000                                 |           | — |   | 48,453,282 |   |
| Common shares  issued through exercise of warrants                                                              |       | 10,655,000                                 |           | 1,498,403 |   | 1,120,555 |   |
| Repurchase of  warrants                                                                                         |       | (2,000                                     | )              | — |   | — |   |
| Payment of  expenses related to convertible debentures, financing, exercise of warrants  and issuance of shares |       | (55,955                                    | )              | (378,162 | ) | (5,173,616 | ) |
| **Cash  provided by financing activities**                                                                      | ** ** | **22,597,045**                             | ** **     | **14,438,991** | ** ** | **42,191,857** | ** ** |
| **Effect  of exchange rates on cash and cash equivalents**                                                      | ** ** | **(24,175**                                | **)**          | **57,099** | ** ** | **(273,905** | **)** |
| **Change  in cash and cash equivalents for the period**                                                         | ** ** | **6,842,915**                              | ** **     | **(2,518,910** | **)** | **6,180,363** | ** ** |
| **Cash and  cash equivalents, beginning of the period**                                                         | ** ** | **3,818,767**                              | ** **     | **6,337,677** | ** ** | **157,314** | ** ** |
| **Cash and  cash equivalents, end of the period**                                                               | ** ** | **$**                                      | **10,661,682** | ** ** | **$** | **3,818,767** | ** ** | **$** | **6,337,677** | ** ** |
| **Supplementary Cash Flow Information**                                                                         |       |                                       |           |   |   |   |   |
| Convertible  debentures settled with the issuance of common shares                                              |       | $                                          | 8,627,117      |   | $ | — |   | $ | — |   |
| Accrued interest  on convertible debentures settled with the issuance of common shares                          |       | 320,988                                    |           | — |   | — |   |
| Purchase of  MedQuest assets with issuance of common shares                                                     |       | 14,694,000                                 |           |   |   |   |   |

 

(The accompanying notes are an integral part of these consolidated financial statements.)

F-7

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS**

**1.**                 GOING CONCERNASSUMPTION

These consolidated financial statements have beenprepared on the basis of accounting principles applicable to a going concern,which assume that WorldHeart will continue in operation for the foreseeablefuture and will be able to realize its assets and discharge its liabilities inthe normal course of operations.

The use of these principles may not be appropriatebecause, at December 31, 2005, there was substantial doubt that theCorporation would be able to continue as a going concern. The Corporation’sability to continue as a going concern is primarily dependent upon its abilityto obtain additional financing, reduce expenses or enter into corporatecollaborations.

As shown in the consolidated financial statements, theCorporation incurred a significant net loss of $52.8 million and used cash inits operations of $15.7 million during the year ended December 31, 2005.The Corporation had cash and cash equivalents of $10.7 million at December 31,2005, which it believes is sufficient to fund operations through mid-year 2006.The current financial condition, among other factors, indicates that there issignificant doubt about the Corporation’s ability to continue as a goingconcern. The consolidated financial statements do not include any adjustmentsrelating to the recoverability of assets that might be necessary should theCorporation be unable to continue as a going concern.

The Corporation’scontinuation as a going concern is dependent upon its ability to obtainadditional cash to allow for the satisfaction of its obligations on a timelybasis. WorldHeart is actively exploring various financing alternatives,including equity financing transactions, as well as, corporate collaborations.Equity financings could include, but are not limited to, private investments inpublic equity (PIPE) transactions, as well as public offerings. Corporatecollaborations could include licensing of one or more of our products forupfront and milestone payments, or co-development and co-funding of our products.Management has initiated cost reduction programs and will continue to controland reduce expenses until sufficient funding is in place. WorldHeart intends toengage an investment banker to assist the Corporation in the evaluation andcompletion of financing and implementation of strategic alternatives. While theCorporation is exploring all opportunities to improve its financial conditionwithin the next several months, there is no assurance that these programs willbe successful. This would result in a significant delay in the completion, reductionin scope, or termination of our development programs and raise further doubtabout our ability to do business.

**2.**                 NATURE OFOPERATIONS

WorldHeart is a globaltechnology leader in mechanical circulatory support systems currentlydeveloping and commercializing implantable ventricular assist devices (VADs),which are mechanical pumps that allow for the restoration of normal bloodcirculation to patients suffering from advanced heart failure. WorldHeart hasfacilities in Oakland, California, Salt Lake City, Utah and Heesch, Netherlands.During the second quarter 2005, the Corporation consolidated the Ottawaoperations into its Oakland facility. WorldHeart currently derivessubstantially all of its revenue from its Novacor® LVAS (left ventricular assist system) andrelated peripheral equipment which it manufactures in Oakland and sellsdirectly to medical clinics and hospitals in the United States, most of Europeand Canada and through a distributor in other countries.

F-8

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**3.**                 SIGNIFICANTACCOUNTING POLICIES

**(a)**         Basisof presentation

These consolidatedfinancial statements have been prepared by management in accordance withaccounting principles generally accepted in the United States (U.S. GAAP), andinclude all assets, liabilities, revenues and expenses of the Corporation andits wholly owned subsidiaries; World Heart Inc. and World Heart B.V. Allmaterial intercompany transactions and balances have been eliminated. These principlesalso conform in all material respects with Canadian generally acceptedaccounting principles (Canadian GAAP) except as described in Note 22. Theconsolidated financial statements are expressed in U.S. dollars.

**(b)**         Useof estimates

The preparation of theseconsolidated financial statements in conformity with U.S. GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the dates of the financial statements and the reported amounts of revenuesand expenses during the reporting periods. Actual results could differ fromthese estimates.

**(c)**          Cashequivalents and short-term investments

Cash equivalents andshort-term investments include money market funds, debt instruments ofcommercial enterprises, financial institutions and government entities. TheCorporation has established guidelines relative to credit ratings,diversification and maturities that are intended to mitigate risk and provide liquidity.Cash equivalents include highly liquid and highly rated investments withmaturity periods of three months or less when purchased. Short-term investmentsinclude those investments with maturities in excess of three months but lessthan one year.

**(d)**         Inventory

Inventory of raw materialsis valued at the lower of average cost and replacement cost. Work in progressand finished goods are valued at the lower of average cost and net realizablevalue.

**(e)**          Capitalassets

Capitalassets are recorded at cost. Amortization is calculated using the followingrates and bases: 

| Furniture and fixtures                |   | 20% declining balance             |
|---------------------------------------|--------|-----------------------------------|
| Computer equipment and  software      |   | 30% declining balance             |
| Manufacturing and  research equipment |   | 30% declining balance             |
| Leasehold improvements                |   | Straight-line over the lease term |

 

The carrying value ofcapital assets is assessed when factors indicating a possible impairment arepresent. The Corporation records an impairment loss in the period when it is determinedthat the carrying amounts may not be recoverable. The impairment loss would becalculated as the amount by which the carrying amount exceeds the discountedcash flows from the asset.

F-9

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(f)**            Goodwilland other intangible assets

Goodwill and intangible assets with an indefinite lifeare not amortized but are tested for impairment on at least an annual basis asrequired under Statement of Financial Accounting Standard No. 142 (SFAS 142).Intangible assets with a definite life are amortized over their legal orestimated useful lives, whichever is shorter.

The Corporation reviews the carrying amounts ofintangible assets with a definite life whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Such events or circumstances might include a significant declinein market share, a significant decline in profits, changes in technology,significant litigation or other items.

The impairment test forgoodwill is a two-step process. Step one consists of a comparison of the fairvalue of a reporting unit with its carrying amount, including the goodwillallocated to the reporting unit. Measurement of the fair value of a reportingunit is based on one or more fair value measures including the Corporation’smarket capitalization, present value techniques of estimated future cash flowsand estimated amounts at which the unit as a whole could be bought or sold in acurrent transaction between willing parties. If the carrying amount of thereporting unit exceeds the fair value, step two requires the fair value of thereporting unit to be allocated to the underlying assets and liabilities of thatreporting unit, resulting in an implied fair value of goodwill. If the carryingamount of the reporting unit goodwill exceeds the implied fair value of thatgoodwill, an impairment loss equal to the excess is recorded in net earnings(loss). This test is performed on the last business day of December ineach year.

**(g)**          Incometaxes

Income taxes are providedfor using the asset and liability method whereby deferred tax assets andliabilities are recognized using current tax rates on the difference betweenthe financial statement carrying amounts and the respective tax basis of theassets and liabilities. The Corporation provides a valuation allowance ondeferred tax assets when it is more likely than not that such assets will notbe realized.

**(h)**         Commonshares

Common shares are recordedas the net proceeds received on issuance after deducting all share issue costs.

**(i)**            Revenuerecognition

Revenue from product and service sales is recognizedwhen all of the following criteria are met: persuasive evidence of an agreement exists; delivery has occurred orservices have been rendered; the price is fixed and determinable; andcollection is reasonably assured.

For multiple element offerings the Corporationallocates the proceeds to the elements based on their relative fair values. Revenuefrom each element is recognized when the product is delivered or servicesrendered. The Corporation provides for returns based on prior experience. Thecost of implant kits and equipment is charged to costs of sales upon delivery. TheCorporation also rents certain in-hospital equipment to customers. Rentalincome is included in revenue when earned.

The Corporation has provided certain customers withdeferred payment terms. The Corporation has, in certain instances, transferredfuture payments under these contracts to third-party financing institutions ona non-recourse basis. In situations where the Corporation assumedresponsibility for interest payments, 

F-10

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

revenue was recorded netof the present value of the committed future interest cost. The transfer of therelated accounts receivable was recorded when control of the receivable wassurrendered.

Certain products arecovered by a limited warranty. Warranty costs are based on historicalexperience and estimated and recorded when the related sales are recognized. Anyadditional costs are recorded when incurred or when they can reasonably beestimated.

**(j)**            Stock-basedcompensation

The Corporation has a stock option plan as describedin Note 13. The Corporation accounts for its stock option plan inaccordance with the Financial Accounting Standards Board’s (FASB) Statement ofFinancial Accounting Standards (SFAS) No. 123, “Accounting for Stock BasedCompensation,” and Accounting Principles Board (APB) Opinion No. 25, “Accountingfor Stock Issued to Employees.”  Nocompensation expense is recognized when shares are issued at prevailing marketprices or options are issued to employees with exercise prices at the grantdate equal to prevailing market prices. Any consideration paid by employees onthe exercise of stock options or purchase of capital stock is credited to sharecapital. The pro-forma fair value expense of options issued by theCorporation is disclosed in Note 13.

Stock options that are re-priced by the Corporationare accounted for using variable accounting under FASB Interpretation (FIN) No. 44,“Accounting for Certain Transactions Involving Stock Compensation,” whereby anypositive difference between the prevailing market price and the exercise priceis recognized as an expense over the vesting period of the option.

Stock options issued in lieu of cash to non-employeesfor services performed are recorded at the fair value of the options at thetime they are issued and are expensed as service is provided.

In December 2002, the FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation Transition and Disclosure—an Amendmentof FASB Statement No. 123” (SFAS 148), which amended the transitionalprovisions of SFAS No. 123, “Accounting for Stock-based Compensation”(SFAS 123), for companies electing to recognize employee stock-basedcompensation using the fair value based method.

During fiscal 2003, 2004and 2005, WorldHeart elected to continue to account for its stock-basedcompensation in accordance with the provisions of APB 25, as interpreted byFIN No. 44, “Accounting for Certain Transactions Involving StockCompensation, an Interpretation of APB Opinion No. 25,” and present thepro forma footnote disclosures required by SFAS 123, as amended by SFAS 148.

**(k)**         Researchand development costs

Research and developmentcosts, including research performed under contract by third parties, areexpensed as incurred.

**(l)**            Governmentassistance

Government assistance isrecognized when the expenditures that qualify for assistance are made and theCorporation has complied with the conditions for the receipt of governmentassistance. Government assistance is applied to reduce the carrying value ofany assets acquired or to reduce eligible expenses incurred. A liability torepay government assistance, if any, is recorded in the period when theconditions arise that cause the assistance to become repayable.

F-11

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(m)**     Foreigncurrency translation

The consolidated financialstatements of the Corporation are presented in U.S. dollars. The financialstatements of the Corporation’s subsidiaries are translated into U.S. dollar asfollows:  monetary assets and liabilitiesare translated at exchange rates prevailing at the balance sheet date; non-monetaryitems and any related amortization of such items are translated at the rates ofexchange in effect when the assets were acquired or obligations incurred; andall other income and expense items are translated at average exchange ratesprevailing during the year. Exchange gains and losses are included in net lossfor the year.

**(n)**         Changein functional and reporting currency 

Effective January 1, 2004, the functional currency ofthe Corporation changed from the Canadian dollar to the U.S. dollar. Ingeneral, this change resulted from the Corporation's restructuring and issuanceof common shares and warrants during the year ended December 31, 2003 alongwith a gradual increase in the overall proportion of business activitiesconducted in U.S. dollars. Concurrent with this change in functional currency,the Corporation adopted the U.S. dollar as its reporting currency. 

The change was effected for prior periods as follows:assets and liabilities have been translated at the spot rate on that date;income and expense items for those periods have been translated at the averagerate for each period; and equity transactions have been translated at historicrates. The resulting net translation adjustment has been posted to thecumulative other comprehensive income account.

**4.**                 MEDQUESTACQUISITION

On July 29, 2005, the Corporation completed itsacquisition (MedQuest Acquisition) of MedQuest Products, Inc. (MedQuest),the developer of the WorldHeart rotary VAD (previously called the HeartQuestRotary VAD), a small rotary pump, for an aggregate consideration of 9.3 millioncommon shares plus the assumption of $3.5 million in debt and the payment oftransaction costs of WorldHeart. The acquisition was accounted for as anacquisition of assets as the operations of MedQuest did not meet the definitionof a business as defined in Emerging Issues Task Force Issue (EITF) Abstract No. 98-3“Determining Whether a Non-monetary Transaction Involves Receipt of ProductiveAssets or of a Business”. Assets acquired and liabilities assumed were recordedat their estimated fair values. The value of the acquisition consideration,including certain acquisition and closing costs, exceeded the fair value of thenet assets acquired by approximately $3.8 million. The excess was allocated tothe relative fair values of the non-monetary assets acquired. Amounts allocatedto identifiable intangible assets are being amortized over their estimateduseful lives. Amounts allocated to purchased in-process research anddevelopment were expensed immediately.

Thevalue of the acquisition consideration is as follows:

| Issuance of  WorldHeart common shares |   | $         | 14,694,000 |   |
|---------------------------------------|--------|-----------|------------|--------|
| Bridge loan  repayment                |   | 3,500,000 |       |
| Transaction costs                     |   | 1,255,696 |       |
| Total purchase  price                 |   | $         | 19,449,696 |   |

 

F-12

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Theallocation of the purchase price, based on the estimated fair values of theassets acquired, at the acquisition date of July 29, 2005 is as follows:

| Net current  assets                            |   | $          | 272,488    |   |
|------------------------------------------------|--------|------------|------------|--------|
| Property and  equipment                        |   | 264,183    |       |
| Acquired  workforce                            |   | 765,684    |       |
| Purchased  in-process research and development |   | 18,147,341 |       |
| Net assets acquired                            |   | $          | 19,449,696 |   |

 

An aggregate amount of $14.6 million was originallyallocated to purchased in-process research and development. We used an incomeapproach and applied risk-adjusted discount rates to the estimated futurerevenues and expenses attributable to IPR&D programs at MedQuest. The mostsignificant in-process program relates primarily to the development ofthe WorldHeart rotary VAD, an advanced, next generation, rotary blood pumpintended for the Destination Therapy market. The WorldHeart rotary VAD had anestimated fair value at the time of purchase of approximately $9.6 million. Theother major development program called MagLev Plus had an estimated fair valueof approximately $5.0 million.

The estimated fair value of the IPR&D wasincreased by approximately$3.6 million related to the excess of the purchase price over the estimatedfair value of the net assets acquired. Therefore, the IPR&D was valued atapproximately $18.1 million.

The Corporation recorded anon-cash charge to operations in the third quarter of 2005 of approximately $18.1 millionto immediately expense the purchased IPR&D as required under SFAS No. 141where such purchased IPR&D is determined to have no alternative future use.

*Private Placement*

In connection with theMedQuest Acquisition on July 29, 2005, WorldHeart entered into a privateplacement agreement with Maverick Venture Management, LLC (Maverick) who wasalso the majority shareholder of MedQuest. Maverick purchased 8,888,889 commonshares of WorldHeart at a purchase price of $1.35 per share for total grossproceeds of approximately$12.0 million. Pursuant to the asset purchase agreement between MedQuest andWorldHeart, WorldHeart assumed certain liabilities of MedQuest, including approximately $3.5 million owed toMaverick in connection with the ongoing operations of the MedQuest business andrepaid that amount to Maverick upon closing of the MedQuest Acquisition.

F-13

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**5.**                 CASH,CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

At December 31,2005, substantially all of WorldHeart’s cash was invested in money marketfunds. The corporate securities held at December 31, 2004 were purchasedon December 21, 2004 and earned interest at rates ranging from 2.36% to4.5%. These securities were sold or reached their maturity dates during 2005.The securities in the following table at December 31, 2004 and 2005 areclassified as available for sale.

| ** **                          | ** ** | **December 31,**                    | ** ** |
|-------------------------------------|------------|------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **                          | ** ** | **Cash and Cash  Equivalents** | ** ** | **Short-Term  Investments** | ** ** | **Cash and Cash  Equivalents** | ** ** | **Short-Term  Investments** | ** ** |
| Cash                                |       |                                     | $          | 1,609,892 |   |   |   | $ | — |   |   |   | $ | 1,518,767 |   |   | $ | — |   |
| Money market                        |       |                                     | 9,051,790  |   |   |   | — |   |   |   | — |   |   | — |   |
| Guaranteed  investment certificates |       |                                     | —     |   |   |   | — |   |   |   | 2,300,000 |   |   | — |   |
| Corporate  securities               |       |                                     | —     |   |   |   | — |   |   |   | — |   |   | 4,999,034 |   |
|                                |       |                                     | $          | 10,661,682 |   |   |   | $ | — |   |   |   | $ | 3,818,767 |   |   | $ | 4,999,034 |   |

 

**6.**                 INVENTORY

| ** **       | ** ** | **December 31,** | ** ** |
|------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Raw Materials    |       | $                     | 2,464,825  |   | $ | 2,337,702 |   |
| Work in progress |       | 3,440,131             |       | 3,014,302 |   |
| Finished goods   |       | 2,311,039             |       | 2,760,521 |   |
|             |       | $8,215,995            |       | $ | 8,112,525 |   |
|                  |            |                       |            |  |  |  |  |

 

Consigned sales includedin inventory at December 31, 2005 and 2004 were  $401,889 and $409,360, respectively.

**7.**                 CAPITALASSETS

| ** **                            | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **Cost**                        | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** |
| Furniture and  fixtures               |       | $                               | 304,745    |   | $ | (187,967 | ) | $ | 116,778 |   |
| Computer  equipment and software      |       | 930,973                         |       | (564,839 | ) | 366,134 |   |
| Manufacturing and  research equipment |       | 5,339,951                       |       | (4,045,907 | ) | 1,294,044 |   |
| Leasehold  improvements               |       | 579,031                         |       | (518,447 | ) | 60,584 |   |
|                                  |       | $                               | 7,154,700  |   | $ | (5,317,160 | ) | $ | 1,837,540 |   |

 

| ** **                            | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **Cost**                        | ** ** | **Accumulated   Amortization** | ** ** | **Net Book  Value** | ** ** |
| Furniture and  fixtures               |       | $                               | 443,349    |   | $ | (334,184 | ) | $ | 109,165 |   |
| Computer  equipment and software      |       | 1,465,906                       |       | (1,061,608 | ) | 404,298 |   |
| Manufacturing and  research equipment |       | 4,996,274                       |       | (3,498,150 | ) | 1,498,124 |   |
| Leasehold  improvements               |       | 507,755                         |       | (507,755 | ) | **—** |   |
|                                  |       | $                               | 7,413,284  |   | $ | (5,401,697 | ) | $ | 2,011,586 |   |

 

F-14

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**8.**                 INTANGIBLEASSETS

Thecost and accumulated amortization of the Corporation’s intangible assets as of December 31,2005 and December 31, 2004 are as follows:

| ** **               | ** ** | **December 31, 2005** | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **Cost**                        | ** ** | **Accumulated  Amortization** | ** ** | **Net Book Value** | ** ** |
| Purchased  technology    |       | $                               | 6,191,698  |   | $ | 6,191,698 |   |   | $ | — |   |   |
| Other intangible  assets |       | 5,137,242                       |       | 4,455,054 |   |   | 682,188 |   |   |
|                     |       | $                               | 11,328,940 |   | $ | 10,646,752 |   |   | $ | 682,188 |   |   |

 

| ** **               | ** ** | **December 31, 2004** | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **Cost**                        | ** ** | **Accumulated  Amortization** | ** ** | **Net Book Value** | ** ** |
| Purchased  technology    |       | $                               | 6,191,698  |   | $ | 5,936,686 |   |   | $ | 255,012 |   |   |
| Other intangible  assets |       | 4,371,573                       |       | 4,371,573 |   |   | — |   |   |
|                     |       | $                               | 10,563,271 |   | $ | 10,308,259 |   |   | $ | 255,012 |   |   |

 

At December 31, 2005,other intangible assets of $682,188 relates to the value of the MedQuestworkforce acquired in July 2005, and are net of  $83,481 in amortization expense recognized in2005.

**9.**                 GOODWILL

WorldHeart’s goodwillbalance of $17.2 million was related entirely to the Novacor LVAS product. On December 31,2005, the Corporation completed its annual goodwill impairment test inaccordance with SFAS 142. In evaluating whether there was an impairment ofgoodwill, management compared the fair value of the reporting unit against itscarrying amount, including the goodwill. Measurement of the fair value wasbased on the reporting unit’s market capitalization, discounted cash flows, anda multiple of revenues. As the carrying amount exceeded the estimated fairvalue, the fair value was allocated to the reporting unit’s assets andliabilities and management then determined that the carrying value of thegoodwill exceeded the implied fair value of the goodwill. Accordingly, agoodwill impairment charge of $17,179,643 was recorded in fiscal 2005. Managementbelieves this impairment arose primarily as a result of slower than anticipatedadoption of the Novacor LVAS product.

**10.**          INDIRECTTAXES PAYABLE

The Corporation accrued$832,000 at December 31, 2004 related to a sales tax assessment receivedfrom the Province of Ontario during the year. The amount is included inresearch and development expenses in 2004 as the assessment relates to taxesassessed on certain of those expenses incurred in the prior years. TheCorporation paid $488,918 during 2005, leaving a balance at December 31,2005 of $343,082 in the accrual account. Until the assessment has been paid,the Ministry of Finance for Ontario has placed a lien for the value of theassessed amount on the assets of the Corporation.

**11.**          CONVERTIBLEDEBENTURES AND WARRANTS

As part of the MedQuest Acquisition, WorldHeart issuedtender offers to the holders of its unsecured convertible debentures(Debentures) and the holders of its common share purchase warrants issued toinvestors on September 15, 2004 (Warrants). The holders of theDebentures unanimously agreed to 

F-15

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

convert all of theoutstanding Debentures at the stated conversion price of $1.25 per common share.On July 18, 2005, the shareholders approved a reduction in the Warrantexercise price from $1.55 to $1.00 per share on the condition that the Warrantholders exercise the Warrants immediately. The holders of the Warrantsunanimously agreed to exercise the 10,655,000 Warrants into 10,655,000 commonshares. During the last two weeks of July 2005, all of the Warrants wereexercised into common shares and the outstanding Debentures were converted tocommon shares. In addition, the accrued interest on the Debentures wasconverted into an additional 236,097 common shares at a conversion price equalto the volume weighted average stock price at the date of conversion.

The Debentures, which would have become due on September 15,2009, were convertible at any time at the holder’s option into common shares ofthe Corporation at a price of $1.25 per share, and accumulated non-compoundinginterest at an annual rate of 3%. The interest was convertible at any time intocommon shares of WorldHeart at a price equal to the volume weighted averagestock price at the date of conversion.

The Corporation could have redeemed the Debentureswhen the trading price of the common shares was greater than $3.00 for 20consecutive days, subject to a maximum of 20% of the initially issuedDebentures in any 90-day period. The Warrants allowed the holders topurchase 10,655,000 common shares of WorldHeart at an exercise price of $1.55per share and were exercisable for a period of five years. WorldHeart couldhave called the Warrants when the trading price of the common shares wasgreater than $4.50 for 20 consecutive trading days, subject to a maximum of 20%of the initially issued Warrants in any 90-day period.

The Corporation issued to its agents 470,833 commonshares of the Corporation with a value of $659,166 and granted agent’s warrantsexercisable for 193,800 common shares of the Corporation with a value of$179,759 having the same terms as the warrants.

As a result of the changein fair value attributed to the decrease in the exercise price of the Warrantsfrom $1.55 to $1.00, $5,860,250 was recorded in the third quarter of 2005 as anincrease in net loss applicable to common shareholders and an increase in thecarrying value of the Warrants included in additional paid-in capital.

**12.**          PREFERREDSHARES

**(a)**         Authorized

Authorized preferredshares of the Corporation consist of an unlimited number of shares issuable inseries.

**(b)**         Issued

On September 22, 2003, Edwards exchanged all ofits Series A redeemable, cumulative, participating preferred shares ofWorld Heart Inc. for 711,589 common shares by the Corporation.

On November 27, 2003, Edwards Lifesciences (U.S.)Inc. converted all of its Series A cumulative, redeemable, convertiblepreferred shares into 500,000 common shares and warrants to acquire 1,000,000common shares at $5.93 per share, expiring November 27, 2008. A fair valueof $6,015,680 was attributed to the additional common shares and warrants ofwhich $4,091,285 was applied to reduce the outstanding liability for accrueddividends and the remaining $1,924,395 was charged to accumulated deficit.

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**13.**          SHAREHOLDERS’EQUITY

**Common shares**

**(a)**         Authorized

Authorized common sharesof the Corporation consist of an unlimited number of shares with no par value. OnNovember 25, 2003, the Corporation’s shareholders approved a one-for-sevenconsolidation of the Corporation’s common shares and common share equivalents,and on December 1, 2003 WorldHeart filed Articles of Amendment effectingthe share consolidation. All references to common share, option, warrant andper common share amounts for all periods presented have been retroactivelyrestated to reflect the share consolidation.

**Employee StockOption Plan**

The Corporation has an employee stock option plan(ESOP). The maximum number of shares reserved and set aside under options toeligible persons pursuant to the ESOP could not exceed 1,501,857 common shares.At December 31, 2004, options for 789,046 common shares were granted. Inaddition, on September 23, 2004, the Corporation granted, subject toshareholder approval of an increase in the number of options available underthe plan, options for 2,383,725 common shares to employees, officers, directorsand consultants. This grant was conditional on the forfeiture by the employees,officers, directors and consultants of 251,685 options for common sharesalready issued and outstanding under the ESOP. The maximum number of common sharesat any time available for issuance under the ESOP, or pursuant to otheroutstanding options, to any one person was 5% of the common shares then issuedand outstanding. The Compensation Committee appointed by the Board of Directorsadministers the ESOP. The exercise price for all options issued under the ESOPis based on the fair market value of the common share price which is theclosing price quoted on the Toronto Stock Exchange on the last trading daybefore the date of grant. The options generally vest annually in equal portionsover either a five-year period or a three-year period and must be exercisedwithin a four-year to a six-year period from each date of vesting.

On July 18, 2005 shareholders approved tworesolutions amending the ESOP. The first resolution increased the number ofcommon shares of the Corporation reserved for issuance from 1,501,857 commonshares to 9,772,505 common shares. Shareholders also approved  the second resolution to remove therestriction providing that the aggregate number of options reserved forissuance to any one person shall not exceed five percent (5%) of the issued andoutstanding common shares.

On December 21, 2005, the Board of Directors ofWorldHeart approved the accelerated vesting of all outstanding stock optionsheld by current employees or consultants, except for the options held by thenon-employee members of the Board of Directors. The accelerated options haveexercise prices ranging from $0.98 to $59.95 per share and a weighted averageexercise price of $1.77 per share. The purpose of the acceleration of vesting was to improve employee moraleand to minimize the amount of compensation expense in future periods followingthe adoption by WorldHeart of SFAS 123(R).

Without the acceleration of vesting of stock options,the pre-tax charges under SFAS 123 relating to these options would have been$2.0 million in 2006 and $1.4 million in 2007. The adjustment for stock basedcompensation under the fair value method is $4.9 million consisting of$3.4 million due to option acceleration vesting and $1.5 million dueto options vesting during 2005, reflected in the proforma table at the end of this note.

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Of the 6.8 million optionsto purchase shares of the Corporation’s common stock, 6.3 million optionsbecame immediately exercisable on December 21, 2005 as a result of theacceleration. Vesting was not accelerated for 520,000 options previouslygranted to non-employee directors. No changes were made to the exercise priceof any outstanding options.

**Stock Option andWarrant Activity**

Thefollowing table summarizes the number of options and warrants outstanding andthe weighted average exercise prices:

| ** **                             | ** ** | **Employees** | ** ** | **Non-Employees**                      | ** ** | ** **  | ** ** | ** **                             | ** ** | ** **   | ** ** |
|----------------------------------------|------------|---------------|------------|----------------------------------------|------------|-------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                             | ** ** | **Options**   | ** ** | **Weighted  average  exercise  price** | ** ** | **Options** | ** ** | **Weighted  average  exercise  price** | ** ** | **Warrants** | ** ** | **Weighted  average  exercise  price** | ** ** | **Total** | ** ** |
| ** **                             | ** ** | **#**         | ** ** | **$**                                  | ** ** | **#**       | ** ** | **$**                                  | ** ** | **#**        | ** ** | **$** | ** ** | **#** | ** ** |
| Outstanding at  December 31, 2002 |       | 261,297       |       |                                   | 45.09      |        |       | 9,683                                  |       |         | 42.49      |   |   | 607,065 |   |   | 26.18 |   |   | 878,045 |   |
| Granted                                |       | 1,079,538     |       |                                   | 8.07       |        |       | 34,350                                 |       |         | 8.25       |   |   | 14,138,457 |   |   | 6.18 |   |   | 15,252,345 |   |
| Exercised                              |       | —        |       |                                   | —     |        |       | —                                 |       |         | —     |   |   | (147,857 | ) |   | 7.12 |   |   | (147,857 | ) |
| Cancelled                              |       | (118,108      | )          |                                   | 53.77      |        |       | (3,110                                 | )          |         | 46.99      |   |   | — |   |   | — |   |   | (121,218 | ) |
| Expired                                |       | (2,758        | )          |                                   | 39.51      |        |       | —                                 |       |         | —     |   |   | (5,000 | ) |   | 57.75 |   |   | (7,758 | ) |
| Forfeited                              |       | (75,621       | )          |                                   | 19.36      |        |       | (1,258                                 | )          |         | 9.41       |   |   | — |   |   | — |   |   | (76,879 | ) |
| Outstanding at December 31, 2003  |       | 1,144,348     |       |                                   | 10.98      |        |       | 39,665                                 |       |         | 13.54      |   |   | 14,592,665 |   |   | 6.99 |   |   | 15,776,678 |   |
| Granted                                |       | 127,852       |       |                                   | 6.46       |        |       | 3,095                                  |       |         | 7.77       |   |   | 10,923,566 |   |   | 1.58 |   |   | 11,054,513 |   |
| Exercised                              |       | —        |       |                                   | —     |        |       | —                                 |       |         | —     |   |   | (250,000 | ) |   | 5.93 |   |   | (250,000 | ) |
| Repurchased                            |       | —        |       |                                   | —     |        |       | —                                 |       |         | —     |   |   | (300,000 | ) |   | 5.93 |   |   | (300,000 | ) |
| Expired                                |       | (7,166        | )          |                                   | 52.46      |        |       | —                                 |       |         | —     |   |   | (541,998 | ) |   | 26.84 |   |   | (549,164 | ) |
| Forfeited                              |       | (514,165      | )          |                                   | 8.01       |        |       | (4,583                                 | )          |         | 8.48       |   |   | — |   |   | — |   |   | (518,748 | ) |
| Outstanding at December 31, 2004  |       | 750,869       |       |                                   | 11.85      |        |       | 38,177                                 |       |         | 13.68      |   |   | 24,424,233 |   |   | 4.15 |   |   | 25,213,279 |   |
| Granted                                |       | 5,799,141     |       |                                   | 1.27       |        |       | 588,000                                |       |         | 1.33       |   |   | — |   |   | — |   |   | 6,387,141 |   |
| Exercised                              |       | —        |       |                                   | —     |        |       | —                                 |       |         | —     |   |   | (10,655,000 | ) |   | 1.55 |   |   | (10,655,000 | ) |
| Repurchased                            |       | —        |       |                                   | —     |        |       | —                                 |       |         | —     |   |   | (720,870 | ) |   | 5.93 |   |   | (720,870 | ) |
| Cancelled                              |       | (367,689      | )          |                                   | 15.74      |        |       | (4,695                                 | )          |         | 8.19       |   |   | — |   |   | — |   |   | (372,384 | ) |
| Outstanding at  December 31, 2005 |       | 6,182,321     |       |                                   | 1.69       |        |       | 621,482                                |       |         | 2.03       |   |   | 13,048,363 |   |   | 6.18 |   |   | 19,852,166 |   |

 

F-18

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

| ** **                                                                       | ** ** | **Options**              | ** ** | ** **               | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                                                       | ** ** | **Employees**            | ** ** | **Non-Employees**        | ** ** | **Warrants** | ** ** |
| Weighted average  exercise price of exercisable options and warrants:            |       |                     |       |                     |       |   |   |
| December 31, 2003                                                           |       | $                        | 45.67      |                     | $          | 50.55 |   | $ | 7.03 |   |
| December 31, 2004                                                           |       | 18.09                    |       | 18.34                    |       | 4.15 |   |
| December 31, 2005                                                           |       | 1.69                     |       | 2.03                     |       | 6.18 |   |
| Number of exercisable  options and warrants:                                     |       |                     |       |                     |       |   |   |
| December 31, 2003                                                           |       | 66,283                   |       | 4,036                    |       | 14,592,665 |   |
| December 31, 2004                                                           |       | 287,102                  |       | 17,867                   |       | 24,424,233 |   |
| December 31, 2005                                                           |       | 5,662,223                |       | 621,482                  |       | 13,048,363 |   |
| Range of exercise prices  of all options and warrants at December 31, 2005: |       |                     |       |                     |       |   |   |
| From                                                                             |       | $                        | 0.98       |                     | $          | 1.34 |   | $ | 1.55 |   |
| To                                                                               |       | $                        | 49.34      |                     | $          | 59.95 |   | $ | 28.63 |   |
| Range of expiry dates of  all options and warrants at December 31, 2005:    |       |                     |       |                     |       |   |   |
| From                                                                             |       | Jan. 1, 2006   |       | Jan. 22, 2006  |       | Feb. 11, 2006 |   |
| To                                                                               |       | Oct. 16,  2012 |       | Sept. 23, 2013 |       | Sep. 14, 2009 |   |

 

The followingtable summarizes information about the outstanding options and warrants as atDecember 31, 2005:

| **Range of exercise price** | ** ** | ** ** | ** ** | **Number  outstanding** | ** ** | **Weighted  average  exercise price** | ** ** | **Weighted  average  remaining life  in years** | ** ** |
|--------------------------------------------|------------|------------|------------|-------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------------|------------|
| $ .98 to  2.50                   |       | 6,599,404  |       |                    | $          | 1.28                                       |       |                                                      |       | 6.41 |   |   |
|    2.51 to  5.00            |       | 1,484      |       |                    | $          | 4.08                                       |       |                                                      |       | 4.53 |   |   |
|    5.01 to  7.50            |       | 12,511,881 |       |                    | $          | 6.01                                       |       |                                                      |       | 2.66 |   |   |
|    7.51 to  10.00           |       | 601,033    |       |                    | $          | 7.93                                       |       |                                                      |       | 3.16 |   |   |
|  10.01 to  20.00                 |       | 7,838      |       |                    | $          | 14.68                                      |       |                                                      |       | 0.33 |   |   |
|  20.01 to  40.00                 |       | 127,209    |       |                    | $          | 28.50                                      |       |                                                      |       | 0.86 |   |   |
|  40.01 to  59.95                 |       | 3,317      |       |                    | $          | 52.28                                      |       |                                                      |       | 0.90 |   |   |
|                                       |       | 19,852,166 |       |                    | $          | 4.65                                       |       |                                                      |       | 3.91 |   |   |

 

The Corporation accounts for its stock option plan inaccordance with the provisions of SFAS No. 123, which requires companiesto recognize as expense, over the vesting period, the fair value of all stockbased awards on the date of grant or to continue to apply the provisions of APBOpinion No. 25 and provide pro forma net income and pro formaincome per share disclosures as if the fair value based method defined in SFAS No. 123had been applied to stock-based awards. The Corporation follows thisalternative method. The pro forma net loss and net loss per share in the tablebelow reflects for fiscal 2005 approximately $5.8 million of compensationexpense taking into effect WorldHeart’s acceleration of unvested,out-of-the-money options in December 2005 discussed above.

F-19

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Theestimated share-based compensation costs based on stock options granted todirectors and employees, and the pro-forma net loss and loss per shareare as follows:

| ** **                                                    | ** ** | **2005**   | ** **  | **2004**   | ** ** | **2003**    | ** ** |
|---------------------------------------------------------------|------------|------------|-------------|------------|------------|-------------|------------|
| Net loss  applicable to common shareholders                   |       | $          | (58,694,025 | )          | $          | (26,141,798 | )          | $ | (18,168,304 | ) |
| Adjustment for stock-based  costs under the fair value method |       | (4,970,236 | )           | (2,134,707 | )          | (1,579,378  | )          |
| Adjusted pro forma net loss                              |       | $          | (63,664,261 | )          | $          | (28,276,505 | )          | $ | (19,747,682 | ) |
| Reported basic  and diluted loss per share                    |       | $          | (1.76       | )          | $          | (1.70       | )          | $ | (2.90 | ) |
| Pro forma  basic loss per share                          |       | $          | (1.91       | )          | $          | (1.84       | )          | $ | (3.15 | ) |

 

Theweighted average fair value of the options issued during the year ended December 31,2005 was $0.94 (2004—$4.39; 2003—$5.48). The fair values of options granted aredetermined using the Black-Scholes model. For 2005, 2004 and 2003, thefollowing weighted average assumptions were utilized:

| ** **                      | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected option  life, in years |       | 6        |       | 6        |       | 6        |       |
| Volatility                      |       | 83       | %          | 73       | %          | 75       | %          |
| Risk free  interest rate        |       | 4.17     | %          | 4.00     | %          | 3.65     | %          |
| Dividend yield                  |       | Nil      |       | Nil      |       | Nil      |       |

 

**14.**          2007262ONTARIO, INC.

On December 19, 2001, the Corporationincorporated 2007262 Ontario Inc. (2007262) to carry out specified research anddevelopment.

2007262 has been accountedfor as a research and development arrangement, recording amounts expended by2007262 as research and development expenses in the period that they occurred. Expensesincurred by 2007262 in 2005, 2004 and 2003 were $18,723 , $230,071 and$608,970, respectively. On January 1, 2006, WorldHeart purchased the 100common shares of NewGen and became the sole shareholder of 2007262. WorldHeartis in the process of a voluntary dissolution of 2007262 as there are no activeoperations in 2007262.

F-20

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**15.**          RESTRUCTURING

On August 25,2004, the Corporation approved a plan to consolidate its Ottawa, Ontariooperations into its facilities in Oakland, California where the Novacor LVAS ismanufactured. The consolidation of the Novacor North American operations intoone location has reduced ongoing business expenses and management expects thatit will continue to improve the Corporation’s operational efficiency andeffectiveness. The consolidation was completed by June 30, 2005.

| ** **                                                | ** ** | **Employee  Severnace** | ** ** | **Contract  Settlement** | ** ** | **Write down** | ** ** | **Other** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------|------------|-----------|------------|------------|------------|
| Costs accrued  during 2004                                |       | $                       | 1,396,037  |                     | $          | 57,653              |       | $         | 338,595    |       | $          | 22,509 |   | $ | 1,814,794 |   |
| Costs paid or  settled in 2004                            |       | (795,923                | )          | —                   |       | (338,595            | )          | (8,624    | )          | (1,143,142 | )          |
| Balance in  accrued liabilities at December 31, 2004 |       | $                       | 600,114    |                     | $          | 57,653              |       | $         | —     |       | $          | 13,885 |   | $ | 671,652 |   |
| Costs accrued during 2005                                 |       | 122,352                 |       | 192,012                  |       | (6,801              | )          | 25,467    |       | 333,030    |       |
| Costs paid or  settled in 2005                            |       | (722,466                | )          | (249,665                 | )          | 6,801               |       | (39,352   | )          | (1,004,682 | )          |
| Balance in accrued  liabilities at December 31, 2005 |       | $                       | —     |                     | $          | —              |       | $         | —     |       | $          | — |   | $ | — |   |

 

**16.**          LOSSPER COMMON SHARE

Forall of the years presented, diluted loss per share equals basic loss per sharedue to the anti-dilutive effect of convertible debentures, options and warrants.

| ** **                                     | ** ** | **Number of common shares to be issued  on exercise or conversion** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Employee and  non-employee stock options       |       | 6,803,803                                                                                                        |       | 789,046 |   | 1,184,013 |   |
| Warrants                                       |       | 13,048,363                                                                                                       |       | 24,424,233 |   | 14,592,665 |   |
| Convertible  debentures                        |       | —                                                                                                           |       | 10,655,000 |   | — |   |
| Stock options  subject to shareholder approval |       | —                                                                                                           |       | 2,383,725 |   | — |   |
| Total potentially  dilutive instruments        |       | 19,852,166                                                                                                       |       | 38,252,004 |   | 15,776,678 |   |

 

F-21

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**17.**          INCOMETAXES

TheCorporation operates in several tax jurisdictions. Its income is subject tovarying rates of tax and losses incurred in one jurisdiction cannot be used tooffset income taxes payable in another. A reconciliation of the combinedCanadian federal and provincial income tax rate with the Corporation’seffective tax rate is as follows:

| ** **                                     | ** ** | **December 31,** | ** **  |
|------------------------------------------------|------------|-----------------------|-------------|
| ** **                                     | ** ** | **2005**              | ** **  | **2004** | ** ** | **2003** | ** ** |
| Canadian loss                                  |       | $                     | (26,813,000 | ) | $ | (15,790,000 | ) | $ | (10,115,000 | ) |
| United States’  loss                      |       | (24,169,000           | )           | (9,053,000 | ) | (4,185,000 | ) |
| European loss                                  |       | (1,852,000            | )           | (1,300,000 | ) | (329,000 | ) |
| Loss before  income taxes                      |       | (52,834,000           | )           | (26,142,000 | ) | (14,629,000 | ) |
| Expected statutory rate                        |       | 36.12                 | %           | 36.12 | % | 36.62 | % |
| Expected recovery  of income tax               |       | (19,084,000           | )           | (9,440,000 | ) | (5,360,000 | ) |
| Effect of foreign  tax rate differences        |       | (1,281,000            | )           | (510,000 | ) | (350,000 | ) |
| Permanent  differences                         |       | 6,354,000             |        | 2,316,000 |   | (1,860,000 | ) |
| Change in  valuation allowance                 |       | 15,240,000            |        | 7,930,000 |   | 12,360,000 |   |
| Effect of changes  in SR&ED carry forwards |       | 371,000               |        | 2,256,000 |   | 760,000 |   |
| Effect of tax  rate changes                    |       | —                |        | 268,000 |   | 270,000 |   |
| Effect of  exchange rate differences           |       | (1,600,000            | )           | (2,820,000 | ) | (5,820,000 | ) |
| Recovery of income taxes                       |       | $                     | —      |   | $ | — |   | $ | — |   |

 

TheCanadian statutory income tax rate of 36.12% is comprised of federal income taxat approximately 22.12% and provincial income tax at approximately 14.00%. Forthe years ended December 31, 2003, the permanent differences relateprimarily to imputed interest expense on the Preferred Shares and goodwillamortization.

| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **Deferred  tax assets:**              |       |                  |       |   |   |
| SR&ED expenditures                 |       | $                     | 10,410,000 |   | $ | 10,280,000 |   |
| Net operating losses                   |       | 45,810,000            |       | 37,750,000 |   |
| Investment tax credits                 |       | 5,610,000             |       | 5,540,000 |   |
| Share issue costs                      |       | 5,240,000             |       | 4,790,000 |   |
| Asset basis differences                |       | 7,740,000             |       | 1,500,000 |   |
|                                   |       | 74,810,000            |       | 59,860,000 |   |
| Less: valuation allowance              |       | (74,810,000           | )          | (59,570,000 | ) |
|                                   |       | —                |       | 290,000 |   |
| **Deferred  tax liabilities:**         |       |                  |       |   |   |
| Asset basis differences                |       | —                |       | (290,000 | ) |
| **Net  deferred income tax liability** |       | $                     | —     |   | $ | — |   |

 

F-22

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

The primary temporary differences affecting deferredtaxes and their approximate effects are as follows:

As at December 31,2005, the Corporation has unclaimed Scientific Research and ExperimentalDevelopment (SR&ED) expenditures, income tax loss carryforwards andinvestment tax credits. The unclaimed amounts and their expiry dates are asfollows:

| ** **                                                  | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| SR&ED  expenditures—carried forward without expiry |       | $                     | 28,816,205 |   | $ | 28,500,000 |   | $ | 25,610,000 |   |
| Income tax loss  carryforwards:                             |       |                  |       |   |   |   |   |
| Federal (Canada) (expire 2003-2009)                         |       | 61,484,493            |       | 57,054,000 |   | 49,210,000 |   |
| Provincial (expire 2003-2009)                               |       | 62,568,187            |       | 55,900,000 |   | 52,290,000 |   |
| United States (expire 2010-2017)                            |       | 62,400,000            |       | 49,100,000 |   | 46,430,000 |   |
| Europe                                                      |       | 3,103,820             |       | 1,400,000 |   | 140,000 |   |
| Investment tax credits  (expire 2006-2012)                  |       | 7,203,480             |       | 7,100,000 |   | 6,170,000 |   |
|                                                             |            |                       |            |  |  |  |  |  |  |  |

 

**18.**          COMMITMENTSAND CONTINGENCIES

**(a)**         OperatingLeases

TheCorporation is committed to minimum lease payments for office facilities andequipment and licenses as follows:

| **Year** | ** ** | ** ** | ** ** | **Lease  payments** | ** ** | **Licenses and  other** | ** ** |
|----------|------------|------------|------------|---------------------|------------|------------------------------|------------|
| 2006     |       | $          | 1,065,315  |                |       | $                            | 51,000     |   |   |
| 2007     |       | 473,172    |       |                | 76,000     |                         |       |
| 2008     |       | 163,168    |       |                | 76,000     |                         |       |
| 2009     |       | 1,919      |       |                | —     |                         |       |
| 2010     |       | —     |       |                | —     |                         |       |
|          |            |            |            |                     |            |                              |            |  |  |  |  |

 

Total rent expense for theyears ended December 31, 2005, 2004, and 2003 was $1,084,866, $1,026,315,and $1,114,717, respectively. During 2002, the Corporation pledged cash in theamount of $750,000 as collateral for obligations under a premises lease for itsOakland operation. During 2003, $222,003 was drawn against the cash amountpledged to cover certain rent obligations and in 2004 the Corporation restoredthe balance to the original pledged amount of $750,000. The balance of pledgedcash used as collateral remains at $750,000 at December 31, 2005. Inaddition, WorldHeart has paid a $150,000 security deposit associated with theOakland lease.

**(b)**         NovacorLVAS Royalties

The Corporation iscommitted, under the Novacor LVAS royalty agreement to royalty payments tocertain employees. Royalties are payable on annual consolidated gross revenuesat a rate of 0.808% up to a cumulative maximum of $3,232,000. Cumulativeroyalty payments to December 31, 2005 total $1,121,225 (2004 -$1,027,184).

F-23

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(c)**          TechnologyPartnerships Canada Contribution Agreement

During 2002, the Corporation entered into a sharedfunding program with Technology Partnerships Canada (TPC) under which theCanadian government shares costs of certain research and development activities.Through December 31, 2005, the Corporation claimed funding in the amountof approximately $6.6 million. Effective January 1, 2004, repayment wouldbe in the form of royalties payable on annual consolidated gross revenues at arate of 0.65% for a nine-year period ending December 31, 2012. If duringthis period royalty payments reach the maximum of $20.3 million no furtherrepayments will be required. If the royalty payments do not exceed $20.3million during this period they will continue until 2015 or until the maximumis reached, whichever is earlier. In connection with the agreement, theCorporation also granted TPC 92,857 warrants to purchase an equivalent numberof common shares of the Corporation, exercisable until December 4, 2006,at an exercise price of $29.05 per share.

During 2005, theGovernment of Canada  reassessed the TPCprogram and delayed a final closing meeting required to disburse $209,543 inremaining payments to WorldHeart. As there is uncertainty as to whether theseamounts will be received, the Corporation has provided for the full amount ofthis receivable.

**(d)**         ResearchAgreement

Effective April 1, 1996, the Corporation enteredinto a research agreement with the Cardiovascular Devices Division (CVD) of theOttawa Heart Institute Research Corporation (Research Agreement) under whichthe Corporation agreed to fund a substantial portion of CVD’s remainingresearch efforts relating to artificial heart technology. The Corporationacquired joint ownership with CVD of the technology arising from CVD’s researchunder the Research Agreement and an exclusive twenty-five year license tomarket the product and certain other related technologies for an initiallicense fee of $147,544 and royalties of 7%. The Corporation is no longerfocused on developing or commercializing this technology and as a result is notexpected to make any royalty payments to CVD.

The Corporation’s research funding to CVD under theResearch Agreement was $13,400,000 for the period from April 1, 1996 to December 31,2004. No payments were made during 2005 and the Corporation does not anticipateany future payments under the Research Agreement, as it is not pursuingdevelopment of the CVD artificial heart technology.

The Corporation has been in discussions with theOttawa Heart Institute to resolve certain payments which both parties believeare owed to the other. In addition, a former officer of WorldHeart currentlyemployed at CVD has made additional claims for certain payments. WorldHeartbelieves that most of these claims are unsubstantiated and without merit. At December 31,2005, World Heart has accrued liabilities of approximately $770,000 andrecorded accounts receivable of $615,000 related to CVD and the former officer.

Under the terms of anexclusive license agreement with the University of Utah, which was assigned toWorldHeart as part of the MedQuest Acquisition, WorldHeart has accrued aliability at December 31, 2005 of $125,000 payable to the University inthe first quarter of 2006.

F-24

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**19.**          NETCHANGE IN OPERATING COMPONENTS OF WORKING CAPITAL AND SUPPLEMENTAL CASH FLOWDISCLOSURE

Thenet change in operating components of working capital is comprised of:

| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Accounts and  other receivables           |       | $                     | 341,768    |   | $ | (475,399 | ) | $ | (334,286 | ) |
| Prepaid expenses                          |       | (184,180              | )          | 52,000 |   | (275,978 | ) |
| Inventory                                 |       | (103,470              | )          | (2,176,785 | ) | (1,812,506 | ) |
| Accounts payable  and accrued liabilities |       | (754,091              | )          | (2,172,728 | ) | (2,502,353 | ) |
| Accrued  compensation                     |       | (536,997              | )          | (359,814 | ) | (14,111 | ) |
|                                      |       | $                     | (1,236,970 | ) | $ | (5,132,726 | ) | $ | (4,939,234 | ) |

 

Interest and financingcosts paid in the year ended December 31, 2005 totaled $305,000 (2004—nil).

**20.**          SEGMENTEDINFORMATION

Operating segments are defined as components of anenterprise about which separate financial information is available that isevaluated regularly by the Corporation’s chief decision maker in deciding howto allocate resources and assess performance. The Corporation’s chief decisionmaker is the Chief Executive Officer.

The Corporation has oneoperating segment for the purpose of making operating decisions and assessingperformance and operates in several geographic locations.

*GeographicLocations*

Thefollowing geographic data includes revenue based on product shipmentdestination and long-lived assets based on physical location. The Corporationhas locations in the United States and Europe:

| ** **    | ** ** | **2005**    | ** **     | **2004**                   | ** ** |
|---------------|------------|-------------|----------------|----------------------------|------------|
| ** **    | ** ** | **Revenue** | ** **     | **Long-lived Assets** | ** ** | **Revenue** | ** ** | **Long-lived Assets** | ** ** |
| United States |       | $           | 8,978,882      |                       |       | $ | 2,265,834 |   |   | $ | 5,343,725 |   |   | $ | 16,038,366 |   |   |
| Europe        |       | 1,698,957   |           |                       | 253,894    |   |   | 3,033,294 |   |   | 515,011 |   |   |
| Canada        |       | 685,959     |           |                       | —     |   |   | 510,672 |   |   | 2,892,864 |   |   |
| Japan         |       | 282,156     |           |                       | —     |   |   | 688,070 |   |   | — |   |   |
| **Total**     | ** ** | **$**       | **11,645,954** | ** **                 | ** ** | **$** | **2,519,728** |   | ** ** | **$** | **9,575,761** | ** ** | ** ** | **$** | **19,446,241** |   |   |

 

At December 31, 2005,2004 and 2003 accounts receivable from Edwards comprised 6%, 8% and 24%,respectively, of accounts receivable. One other account receivable in 2003amounted to greater than 10% of the total accounts receivable balance. During2005, Edwards accounted for 5% of revenue and no other customer accounted formore than 10% of revenue. During 2004, Edwards accounted for 7% of revenueand   no other customer accounted formore than 10% of revenue. In 2003, Edwards accounted for 38% of revenue and twoother customers accounted for 23% of revenue.

F-25

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**21.**          FINANCIALINSTRUMENTS

Financial instruments recognized in the balance sheetat December 31, 2005 consist of cash and cash equivalents, trade and otherreceivables, accounts payable and certain accrued  liabilities. The Corporation does not hold orissue financial instruments for trading purposes.

The Corporation investsthe majority of its excess cash in high-grade instruments and diversifies theconcentration of cash among different financial institutions.

**(a)**         Fair value

The Corporation believes thatthe carrying values of its financial instruments approximate their fair valuesbecause of their short terms to maturity, except for the long-term receivableat December 31, 2004. The long-term receivable is valued at the presentvalue of future cash flows at a rate of 4%.

**(b)**         Interest rate risk

The Corporation is subjectto interest rate risks from time to time because of the term to maturity of itscash equivalents and short-term investments. During 2005, all of WorldHeart’sinvestments were in money market funds.

**(c)**          Foreign exchange risk

WorldHeart has assets andliabilities denominated in foreign currencies, including primarily the Euro. WorldHeart’scurrent foreign currency exposure is small, but if its’ exposure changes in thefuture it may enter into foreign exchange contracts in order to match itsforeign exchange requirements.

**(d)**         Credit risk

Financial instruments thatpotentially subject the Corporation to a concentration of credit risk consistof cash, cash equivalents, short-term investments and accounts receivable. TheCorporation has established guidelines for cash, cash equivalents andshort-term investments relative to credit ratings, diversification andmaturities that are intended to maintain safety and liquidity. The Corporationhas a limited number of customers, all of which operate in the health-careindustry.   The Corporation performsongoing credit evaluations of its customers’ financial condition and generallyrequires no collateral from its customers. The Corporation maintains anallowance for doubtful accounts receivable based upon the expectedcollectibility of accounts receivable.

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**22.**          CANADIANACCOUNTING PRINCIPLES

Theconsolidated financial statements have been prepared in accordance with U.S.GAAP. These principles differ, as they affect the Corporation, for the yearsended December 31, 2005 and 2004 in the following material respects fromCanadian GAAP. There are no differences in reported cash flows for the yearspresented.

| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **BALANCE SHEETS—Canadian GAAP** |       |                  |       |   |   |
| **ASSETS**                                      |       |                  |       |   |   |
| Current assets                                  |       | $                     | 23,546,784 |   | $ | 21,743,636 |   |
| Long-term  receivable                           |       | —                |       | 318,553 |   |
| Cash pledged as  collateral for lease           |       | 750,000               |       | 750,000 |   |
| Capital assets                                  |       | 1,837,540             |       | 2,011,586 |   |
| Intangible assets                               |       | 17,317,249            |       | 255,012 |   |
| Goodwill                                        |       | —                |       | 17,179,643 |   |
|                                            |       | $                     | 43,451,573 |   | $ | 42,258,430 |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**  |       |                  |       |   |   |
| Current  liabilities                            |       | $                     | 6,100,347  |   | $ | 7,637,819 |   |
| Convertible  debentures(1)                      |       | 10,172                |       | 2,530,659 |   |
| Long-term  obligation                           |       | 8,830                 |       | 16,368 |   |
|                                            |       | 6,119,349             |       | 10,184,846 |   |
| **Shareholders’ equity  (deficiency)**     |       |                  |       |   |   |
| Common  shares(2)(3)                            |       | 250,131,052           |       | 187,027,058 |   |
| Contributed  surplus(1)(3)                      |       | 12,682,731            |       | 22,871,780 |   |
| Cumulative  translation adjustment              |       | (6,490,184            | )          | (6,490,184 | ) |
| Accumulated  deficit(1)(2)(3)(4)                |       | (218,991,375          | )          | (171,335,070 | ) |
|                                            |       | 37,332,224            |       | 32,073,584 |   |
|                                            |       | $                     | 43,451,573 |   | $ | 42,258,430 |   |

 

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

| ** **                                                                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Net  loss in accordance with U.S. GAAP**                                      |       | $(52,833,775                               | )          | $(26,141,798 | ) | (14,629,054 | ) |
| Adjustments to  reconcile to Canadian GAAP:                                     |       |                                       |       |   |   |   |   |
| Non-cash share based compensation costs(6)(3)                                   |       | (4,970,236                                 | )          | (2,134,707 | ) | — |   |
| Interest and accretion on convertible debentures(1)                             |       | (608,910                                   | )          | 5,469,700 |   | — |   |
| Amortization of purchased in-process research and  development(5)               |       | (1,512,280                                 | )          | — |   | (916,180 | ) |
| Interest on preferred shares(3)                                                 |       | —                                     |       | — |   | (4,322,110 | ) |
| Foreign exchange translation on shares(3)                                       |       | —                                     |       | — |   | (1,985,669 | ) |
| In-process research and development(5)                                          |       | 18,147,341                                 |       | — |   | — |   |
| Gain on settlement of obligation under research and  development arrangement(4) |       | —                                     |       | — |   | (1,694,300 | ) |
| **Net  loss in accordance with Canadian GAAP**                                  |       | (41,777,860                                | )          | (22,806,805 | ) | (23,547,313 | ) |
| **Weighted average number of common shares  outstanding**                       |       | 33,369,318                                 |       | 15,373,689 |   | 6,259,757 |   |
| **Basic and diluted loss per  common share**                                    |       | $                                          | (1.25      | ) | $ | (1.48 | ) | $ | (3.76 | ) |
|                                                                                 |            |                                            |            |  |  |  |  |  |  |  |

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**Footnotes**

(1)          UnderU.S. GAAP the proceeds of the issue on the convertible debentures were splitbetween the convertible debentures and the related warrants for common sharesbased on their relative fair values. As a result of allocating some of theproceeds to the warrants, the convertible debentures contain a beneficialconversion feature equal to the intrinsic value of the convertible debentureson the date of issuance. The value of the warrants and the beneficialconversion feature were recorded in additional paid-in capital. OnSeptember 16, 2004, the earliest possible exercise date, the full value ofthe beneficial conversion feature was charged to interest expense. UnderCanadian GAAP the proceeds of the issue were allocated based on the relativefair values of the debentures, the warrants and the conversion option. The netproceeds were allocated as follows:

| ** **              | ** ** | **September 15,  2004** | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |   |
|-------------------------|------------|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|--------|
| Convertible  debentures |       | $                            | 1,734,350  |                        | $          | 2,530,659                   |       |   | $ | — |   |   |
| Warrants                |       | 4,504,127                    |       | 4,504,127                   |       |                        | —     |   |   |
| Conversion  feature     |       | 5,863,191                    |       | 5,863,191                   |       |                        | —     |   |   |
|                    |       | $                            | 12,101,668 |                        | $          | 12,897,977                  |       |   | $ | — |   |   |
|                         |            |                              |            |                             |            |                             |            |        |  |  |  |  |  |  |

 

The value allocated to the debentures will accrete tothe cash value at maturity at the effective interest rate. All of thedebentures were converted and certain warrants were exercised in July 2005.

(2)          Under U.S. GAAP, thedifference between the issue price and initial public offering (IPO) price ofshares issued within a one-year period prior to the IPO is generally accountedfor as an expense and charged against earnings for the period with acorresponding and equal amount recorded as paid-in capital. There is nocorresponding requirement under Canadian GAAP. The difference of $32,867,182related to the Corporation’s IPO in 1996, increases the common shares andaccumulated deficit reported under U.S. GAAP, with no difference reported intotal shareholders’ equity.

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

(3)          Under U.S. GAAP,mandatorily redeemable convertible preferred shares are recorded as mezzaninefinancing at their fair value on the date of issue and excluded from bothshareholders’ equity and long-term debt. Dividends are accumulated on theseshares at the average dividend rate and this amount, together with the amountnecessary to accrete the fair value to the redemption price on maturity, arecharged first to retained earnings; if no retained earnings, then toaccumulated paid-in capital; if no accumulated paid-in capital, then toaccumulated deficit. Under Canadian GAAP these shares are treated as compoundinstruments and divided into their debt and equity components based on therelative fair values at the time of issue and the effective interest related tothe debt component is charged to earnings. The different presentation on thebalance sheets also results in a difference in the treatment of exchangebecause, under Canadian GAAP the amount in shareholders’ equity is translated athistorical rates and the amount in long-term debt is translated at currentrates. Under U.S. GAAP, the full value of the preferred shares is translated atcurrent rates.

(4)          Under U.S. GAAP, theobligation under the research and development arrangement is classified as aliability. Under Canadian GAAP, this amount is reflected as equity as NewGeneration Biotech (Equity) Fund Inc. (NewGen) was to receive equity securitiesof the Corporation upon completion of the R&D arrangement. On January 31,2003, the Corporation exchanged the 637,000 Series 1 preferred shares heldby NewGen for 637,000 common shares of WorldHeart and 637,000 common sharepurchase warrants exerciseable into one common share of WorldHeart at a priceof $27.71 per share at any time up to January 24, 2004. As a result of thetransaction the Corporation has recorded a gain on the settlement of theobligation and increased share capital by $1,694,300 under U.S. GAAP.

(5)          Under U.S. GAAP,acquired in-process research and development is required to be expensed if therelated technology has not reached technological feasibility and does not havean alternative future use. Under Canadian GAAP, this amount is capitalized andamortized over its useful life. As a result of the MedQuest acquisition in-processresearch and development that was written off for U.S. GAAP is amortized underCanadian GAAP, in 2005. The 2003 amortization relates to an acquisition in2000.

(6)          UnderU.S. GAAP, the Corporation accounts for its stock option plan in accordancewith APB Opinion No. 25 and provides pro forma net income andpro forma income per share disclosure as if the fair value based method asdefined in SFAS No. 123 had been applied to stock-based awards. UnderCanadian GAAP, the Corporation accounts for its stock option plan in accordancewith CICA 3870 which requires entities to account for employee stockoptions using the fair value based method, where compensation cost is measuredat fair value at the date of grant and is expensed over the stock-based awardsvesting period.

**23.**          NEWACCOUNTING PRONOUNCEMENTS

On June 1, 2005, the FASB issued SFAS 154, “AccountingChanges and Error Corrections,” (“SFAS 154”) which replaces APB 20, “AccountingChanges,” (“APB 20”) and SFAS 3, “Reporting Accounting Changes in InterimFinancial Statements.”  SFAS 154 appliesto all voluntary changes in accounting principle and changes the requirementsfor accounting for and reporting of a change in accounting principle. SFAS 154requires retrospective application to prior periods financial statements of avoluntary change in accounting principle unless it is impracticable. APB 20previously required that most voluntary changes in accounting principles berecognized by including in net income of the period of the change thecumulative effect of changing to the new accounting principle. SFAS 154 carriesforward many other provisions of APB 20 without change, including theprovisions related to the reporting of a change in 

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**WORLD HEART CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

accounting estimate, achange in the reporting entity and the correction of an error. The Corporationwill adopt this standard effective January 1, 2006.

In June 2001, the FASB issued SFAS No. 148,whichamended the transitional provisions of SFAS No. 123 for companies electingto recognize employee stock-based compensation using the fair value basedmethod. The provisions of FASB No. 148 will be effective for yearsbeginning on or after January 1, 2006.

On December 16, 2004, the FASB issued SFAS123(R), “Share-Based Payment,” which is a revision of SFAS 123, “Accounting forStock-Based Compensation.” SFAS 123(R) supersedes APB Opinion No. 25,“Accounting for Stock Issued to Employees,” and amends SFAS 95, “Statement ofCash Flows.” SFAS 123(R) requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values at the date of grant. Pro forma disclosurein the footnotes to financial statements is no longer an alternative.WorldHeart is required to adopt SFAS 123(R) effective at the beginning ofthe first quarter of fiscal 2006.

SFAS 123(R) permits public companies to adopt itsrequirements using one of two methods. The “modified prospective” methodrecognizes compensation cost based on the requirements of SFAS 123(R) forall share-based payments granted after the effective date, and based on therequirements of SFAS 123 for all awards granted to employees prior to theeffective date of SFAS 123(R) that remain unvested on the effective date.The “modified retrospective” method includes the requirements of the modifiedprospective method described above, but also permits entities to restate theirhistorical financial statements based on the amounts previously recognizedunder SFAS 123 for purposes of pro forma disclosures either for all priorperiods presented, or for prior interim periods of the year of adoption. TheCorporation will adopt the “modified prospective” method  beginning in the first quarter of 2006.

In December 2005, WorldHeart implemented a planto accelerate vesting of all of its employee and consultant stock options,other than those held by non-employee directors, and took other actions toimprove employee morale and minimize the impact of the adoption of FAS 123(R).

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