SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

Commission File Number 1-13388

GUIDANT CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

317.971.2000

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None.

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in the definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     þ

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes þ          No o

      The aggregate market value of the registrant’s common shares (the only outstanding equity shares) as of June 30, 2004 (the last trading day of the second fiscal quarter), less shares held by officers and directors of the registrant, was approximately $17.5 billion.

      The number of shares of Common Stock outstanding as of February 10, 2005: 322,599,255

PART I

Overview

Guidant Corporation provides innovative, therapeutic medical solutions of distinctive value for customers, patients and healthcare systems around the world. Guidant’s lifesaving medical technologies are designed to extend the lives and improve the quality of life of millions of patients suffering from life-threatening cardiovascular disease. Approximately 12,000 employees develop, manufacture and market the Company’s medical devices in nearly 100 countries, with key operations in the US, Europe and Asia. As used herein, the terms “the Company” and “Guidant” mean Guidant Corporation and its consolidated subsidiaries.

Cardiovascular disease is the leading cause of death for both men and women in the US today and claims more lives each year than the next five leading causes of death combined. Within cardiovascular disease, Guidant develops, manufactures and markets products that focus on the treatment of cardiac arrhythmias, heart failure and coronary and peripheral disease including:

On December 15, 2004, the Company entered into an agreement and plan of merger with Johnson & Johnson (J&J) pursuant to which J&J will acquire the Company for approximately $25.4 billion in fully diluted equity value. Under the terms of the agreement, each Company common share will be exchanged for $30.40 in cash and $45.60 in J&J stock, provided that the average J&J common stock price is between $55.45 and $67.09 during the fifteen-day trading period ending three days prior to the transaction closing. Accordingly, each Guidant share will be converted into not more than .8224 and not less than .6797 of a J&J common share, plus $30.40 in cash. The boards of directors of the Company and J&J have approved the transaction, which remains subject to the approval of the Company’s shareholders, clearance under the Hart-Scott-Rodino Antitrust Improvements Act, the European Union merger control regulation, and other customary closing conditions.

      The graph below depicts the contributions of the Company’s products to its overall revenues:

Products

Guidant’s primary medical devices treat the heart, managing its rhythms, clearing its arteries, and permitting less-invasive surgeries. Less-invasive therapies have also been extended beyond the heart to clear and treat non-coronary vessels and biliary strictures. The following sections further describe Guidant’s products.

Cardiac Rhythm Management

Natural electrical impulses stimulate the heart’s chambers to pump blood. In healthy individuals, the electrical current causes the heart to beat at an appropriate rate and in synchrony. Guidant makes a variety of implantable devices that can monitor the heart and deliver electricity to treat cardiac abnormalities, including the following:

Tachycardia (abnormally fast or chaotic heart rhythms) can prevent the heart from pumping blood efficiently and can lead to SCD, sudden cardiac death. Implantable cardioverter defibrillator systems (defibrillators, leads, programmers and accessories) monitor the heart and can deliver electrical energy, restoring a normal rhythm. Guidant’s defibrillators can deliver tiered therapy — a staged progression from lower intensity pacing pulses designed to correct the abnormal rhythm to more aggressive shocks to restore a heartbeat. The Company’s products, including the VITALITY® family of defibrillators, provide a broad range of atrial (upper chambers of the heart) and ventricular (lower chambers) therapies to serve patients’ various needs.

The Guidant-funded MADIT II study demonstrated the benefit of Guidant defibrillators in reducing mortality in heart attack survivors with compromised heart function and is further described in Item 7. MADIT II enhances physicians’ ability to identify and treat an expanded at risk patient population.

Heart failure (the heart’s inability to pump effectively) is a debilitating, progressive condition, with symptoms including shortness of breath and extreme fatigue. Mortality for diagnosed patients is estimated to be 50% after five years. The condition is pervasive, with nearly five million Americans affected. Cardiac resynchronization therapy (CRT) devices, like certain devices in the Company’s CONTAK RENEWAL® family of devices, can help reduce mortality and hospitalization.

Recent clinical trials continue to support positive market trends in this area. For example, the results of the National Heart, Lung and Blood Institute’s Sudden Cardiac Death in Heart Failure Trial (SCD-HeFT) demonstrated positive benefits of implantable defibrillators in patients with heart failure. Similarly, investiga-

tors in the COMPANION clinical trial reported that for advanced heart failure patients with desynchronized heart contractions, the addition of resynchronization therapy to optimal drug treatment reduced the combination of death and hospitalization when compared with optimal drug treatment alone. SCD-HeFT and COMPANION are further described in Item 7.

Sales of CRT devices are included in the sales of defibrillators and pacemaker systems.

Bradycardia (slow or irregular heart rhythms) often results in an insufficient heart rate to provide adequate blood flow, creating symptoms such as fatigue, dizziness and fainting. Cardiac pacemaker systems (pulse generators, leads, programmers, and accessories) deliver electrical energy to stimulate the heart to beat more frequently. Pacemakers range from conventional single-chamber devices to more sophisticated adaptive-rate, dual-chamber devices. Company pacemakers, including the INSIGNIA® family, offer proprietary blended sensor technology designed to measure patient workload through respiration and motion, providing rate response based on the patient’s activity.

Vascular Intervention

The coronary arteries, which supply blood to the heart, are susceptible to buildups of plaque, which can inhibit essential blood flow. Historically, these obstructions were treated with coronary artery bypass grafting (CABG) — an open surgery using a portion of another vessel to route around the blockage. As described below, angioplasty and stenting have provided less-invasive alternatives, while drug eluting stents have further advanced this therapy.

Angioplasty systems and accessories can open clogged arteries. In a percutaneous transluminal coronary angioplasty (PTCA) procedure, a local anesthetic is administered and a small incision is made in the patient’s groin area to access the femoral artery. The physician inserts a guiding catheter through the femoral artery, up through the aorta and into the entrance of the coronary blood vessel and then advances a small guidewire through the inside of the guiding catheter into the blood vessel and across the site of the blockage. Then a dilatation catheter — such as a Guidant VOYAGER^tm Catheter — is delivered over the guidewire through the inside of the guiding catheter into the blood vessel and across the site of the blockage. The dilatation catheter is then inflated to compress the plaque against the artery wall, enlarging the opening of the vessel and increasing blood flow to the heart. At the end of the PTCA procedure, all of the devices are withdrawn. These systems can also be used as components of a stent system.

Coronary stents help overcome a major clinical challenge to PTCA — restenosis, the renarrowing of the blood vessel at the site of the initial treatment. Coronary stents are metal tubes or coils that are mounted on coronary dilatation catheters. Coronary stents, such as the Company’s MULTI-LINK® family, are permanently deployed at a blockage by inflating the coronary dilatation catheter to expand the stent in the artery. When the coronary dilatation catheter is removed from the artery, the stent stays in place, providing scaffolding to keep the artery open.

Drug eluting stents are coated with compounds designed to prevent excessive cell re-growth within the stent — in-stent restenosis. Their development represents a revolutionary advance in cardiovascular treatment, increasing the value of the therapy substantially. Competitive drug eluting stents were available in the US and Europe throughout 2004 and in Japan during the second half of 2004. These introductions have reduced Guidant’s sales of metallic coronary stents, particularly in the US. While the Company has not launched a drug eluting stent, drug eluting stents present a compelling opportunity for the Company, subject to completion of appropriate clinical work and receipt of necessary regulatory approvals for the Company’s products. Guidant currently co-promotes with Cordis Corporation (Cordis), a subsidiary of J&J, the Cordis CYPHER® Sirolimus-eluting Coronary Stent in the US, under an agreement entered into in February 2004.

Additional Therapies

Cardiac surgery devices are used to perform EVH, cardiac surgical ablation and less-invasive CABG procedures. Surgical cardiac ablation systems include the FLEX® Microwave Systems, which allow physi-

cians to perform cardiac surgical ablation procedures both in an open setting concomitant to a valve or bypass procedure, and in a stand-alone minimally invasive procedure.

EVH through the VASOVIEW® Endoscopic Vessel Harvesting System allows physicians to harvest the saphenous vein, the most common bypass conduit used in CABG procedures, in a less-invasive manner through one or two small incisions in a patient’s leg, or the radial artery through small incisions in a patient’s arm. Guidant also provides devices to enable a complete less-invasive CABG procedure — a bypass performed while a patient’s heart remains beating. This eliminates the need to stop the patient’s heart and place the patient on a heart-lung machine that circulates the patient’s blood during the CABG procedure. Devices such as Guidant’s ACROBAT^tm Systems help stabilize and manipulate the heart during beating-heart surgery. Guidant estimates that approximately 30% of all CABG procedures in the US use the beating-heart approach and in excess of 60% use minimally invasive vessel harvesting.

Biliary, peripheral and carotid systems are used to treat artery and biliary stricture disease. Guidant products include the ABSOLUTE^tm Self-Expanding Stent, AGILTRAC^tm Peripheral Dilatation Catheter and RX ACCULINK^tm Carotid Stent System, including the RX ACCUNET^tm Embolic Protection System.

Sales and Marketing

Guidant relies on a direct sales force and independent distributors to best serve its global customers. Sales personnel work closely with the primary decision makers who purchase products, including physicians, material managers, biomedical staff, hospital administrators and purchasing managers. As further described below, third-party payors and group purchasers have become increasingly important.

The primary physician users of Guidant’s largest-selling products are as follows:

In the US, Guidant sells substantially all of its products through a direct sales force. In 2004, 67% of consolidated net sales was derived from sales to customers in the US.

In 2004, 33% of consolidated net sales was derived from operations outside the US through a direct sales force and independent distributors. Guidant sells products in nearly 100 countries. Major markets include Europe and Japan, with 23% and 7% of worldwide net sales in 2004. (Revenues are attributed to countries based on the location of the customer.) Guidant is not dependent on any single customer, and no single customer accounted for more than 10% of consolidated net sales in 2004. The sales and marketing approach outside the US varies depending on country size and stage of development.

Competition and Customers

The medical technology industry is highly competitive and is characterized by rapid product development and technological change. In order to remain competitive with other developers of medical devices and other therapies, Guidant must continue to develop and acquire cost-effective new products and technologies. Similarly, significant shifts in market share have occurred in connection with production, regulatory, safety, and other concerns, reflecting the importance of product quality.

Guidant’s primary competitors for implantable cardiac rhythm management devices are Medtronic, Inc. (Medtronic) and St. Jude Medical, Inc. (St. Jude). Guidant’s primary competitors for vascular disease

products include Abbott Laboratories, Boston Scientific Corporation (Boston Scientific), CR Bard, Inc., J&J, Medtronic, Sorin Biomedica and Terumo Medical Corporation. Guidant faces a number of additional competitors with respect to Guidant’s other products. Guidant also faces competition from providers of alternative medical therapies, such as pharmaceutical companies. Guidant competes primarily on the basis of therapy effectiveness, product features, product quality, customer support, price, field services and cost effectiveness.

Research and Development

Innovation is essential to Guidant’s success. It is one of the primary bases of competition in Guidant’s markets. The Company works to introduce new products, enhance the effectiveness and ease of use of existing products and expand the applications for its existing products.

Guidant’s research and development staff focuses on product design and development, quality, clinical research and regulatory compliance. The Company’s research and development facilities are described in Item 2. Item 7 further describes the Company’s recent development efforts, including drug eluting stent research and research concerning advanced patient management features for cardiac rhythm management devices.

To pursue primary research efforts, Guidant has developed alliances with several leading research institutions and universities. Guidant also works with leading clinicians around the world in conducting scientific studies on the Company’s products. These studies include clinical trials that provide data for use in regulatory submissions and post-market approval studies involving applications of products.

Guidant evaluates developing technologies in areas where the Company may have technological or marketing expertise for possible investment or acquisition. Guidant also has invested in several development-stage companies.

In each of the past three years, Guidant has invested 13-14% of net sales in research and development (excluding purchased in-process research and development).

Manufacturing and Raw Materials

Guidant vertically integrates operations where integration provides significant cost, supply or quality benefits. In some areas, Guidant is highly vertically integrated. In other cases, the Company purchases raw materials and components. In all cases, Guidant attempts to work closely with suppliers to ensure the cost-effective delivery of high quality materials and components. Major considerations used in the selection and retention of suppliers are supplier technology, quality, reliability, consistent on-time delivery, services to be provided and cost.

In general, production activities occur in a controlled environment setting or “clean room.” Manufacturing employees are trained in the necessary production operations and quality system standards applicable to the production process. Guidant’s facilities are further described in Item 2.

The Company purchases many of the materials and components used in manufacturing products, some of which are custom made. Certain supplies are purchased from single sources due to quality considerations, costs or constraints resulting from regulatory requirements. Agreements with certain suppliers can be terminated upon short notice. The Company cannot quickly establish additional or replacement suppliers for certain components or materials, largely due to the US Food and Drug Administration (FDA) and other approval systems, and the complex nature of the manufacturing processes employed by many suppliers. Production issues, including capacity constraints, affecting facilities or those of suppliers can affect the Company’s ability to bring new or existing products to market.

Patents, Trademarks, Proprietary Rights and Licenses

Patents and other proprietary rights are essential to Guidant’s business. Guidant also relies upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop, maintain and strengthen the Company’s competitive position. The Company reviews third-party patents and patent applications, as publicly available, in an effort to develop an effective patent strategy, avoid infringement of third-party patents, identify licensing opportunities and monitor the patent claims of others.

The Company owns numerous patents and has numerous patent applications pending in the US and in foreign countries designed to protect the inventions contained in many products, as well as surgical methods in which products are used. The Company is a party to numerous license agreements pursuant to which patent rights have been obtained or granted in consideration for cash, cross-licensing rights or royalty payments.

Guidant’s policy is to seek patent protection in the US and elsewhere where it is commercially advantageous to do so. However, the standards for protection of intellectual property vary widely.

The Company cannot assure that pending patent applications will result in issued patents, that patents issued or licensed will not be challenged or circumvented by competitors, that Company patents will not be found to be invalid or that the intellectual property rights of others will not prevent the Company from selling certain products or including key features in the Company’s products.

The Company operates in an industry susceptible to significant patent litigation. At any given time, Guidant generally is involved as both a plaintiff and defendant in a number of patent infringement and other intellectual-property related actions. Such litigation can result in significant royalty or other payments or result in injunctions that can prevent the sale of products. (See Item 8, Note 16 to the consolidated financial statements.)

Healthcare Cost Containment and Third-Party Reimbursement

The ability of customers to obtain appropriate reimbursement for products and services from government and third-party payors is essential to the success of medical technology companies. The availability of reimbursement affects which products customers purchase and the prices they are willing to pay. Reimbursement varies from country to country and can significantly impact the acceptance of new technology.

After the Company develops a promising new product, the Company may find limited demand for the product unless reimbursement approval is obtained from private and governmental third-party payors. Reimbursement decisions for products such as defibrillators, including new or expanded indications, can materially affect results. The Company is actively engaged in the policy dialogue concerning healthcare cost containment and reimbursement and works to demonstrate the value of Company products.

Major third-party payors for hospital services in the US (Medicare, Medicaid, private healthcare insurance and managed care plans) and abroad continue to work to contain healthcare costs. The introduction of cost containment incentives, combined with closer scrutiny of healthcare expenditures by both private health insurers and employers, has resulted in increased discounts and contractual adjustments to hospital charges for services performed and in the shifting of services between inpatient and outpatient settings. Initiatives to limit the growth of healthcare costs, including price regulation, are also underway in other countries in which Guidant does business. Implementation of healthcare reforms in significant markets and other countries may limit the price of, or the level at which reimbursement is provided for Company products.

Government Regulation

Medical devices are subject to regulation by numerous regulatory bodies, including the FDA and comparable agencies in other countries. The Company must comply with laws and regulations governing the development, testing, manufacturing, labeling, marketing and distribution of medical devices.

Devices are subject to varying levels of regulatory control, the most comprehensive of which requires that a clinical evaluation be conducted before a device receives approval for commercial distribution. In the US, the Company generally can obtain permission to distribute a new device in two ways. The first applies to any new device that is substantially equivalent to a device first marketed prior to May 1976. In this case, to obtain FDA permission to distribute the device, the Company generally must submit a pre-market notification application (a 510(k) submission), and receive an FDA order finding substantial equivalence to a predicate device (pre-May 1976) and permitting commercial distribution of that device for its intended use. A 510(k) submission must provide information supporting its claim of substantial equivalence to the predicate device. If clinical data from human experience is required to support the 510(k) submission, this data must be gathered in compliance with investigational device exemption (IDE) regulations for investigations performed in the US.

The second, more comprehensive, approval process applies to a new device that is not substantially equivalent to a pre-1976 product. In this case, two steps of FDA approval generally are required before the Company can market the product in the US. First, the Company must comply with IDE regulations in connection with any human clinical investigation of the device. Second, the FDA must review the Company’s pre-market approval (PMA) application, which contains, among other things, clinical information acquired under the IDE. The FDA will approve the PMA application if it finds there is reasonable assurance the device is safe and effective for its intended use.

Certain changes to existing devices that do not significantly affect safety or effectiveness can be made with in vitro testing under reduced regulatory procedures, generally without human clinical trials and by filing a PMA supplement to a prior PMA.

Exported devices are subject to the regulatory requirements of each country to which the device is exported, as well as certain FDA export requirements. Frequently, regulatory approval may first be obtained in a foreign country prior to application in the US. For example, the Company often completes Conformité Européene (CE) Mark registrations for Company products under various medical device directives in the European Union.

After approval or clearance to market is given, the FDA and foreign regulatory agencies, upon the occurrence of certain events, have the power to withdraw the clearance or require changes to a device, its manufacturing process, or its labeling or additional proof that regulatory requirements have been met.

The Company is also required to register with the FDA as a device manufacturer. As a result, the Company is subject to periodic inspection by the FDA for compliance with the FDA’s Quality System Regulation requirements and other regulations. In the European Community, the Company is required to maintain certain International Organization for Standardization (ISO) certifications in order to sell product and it undergoes periodic inspections by notified bodies to obtain and maintain these certifications. These regulations require the Company to manufacture products and maintain documents in a prescribed manner with respect to design, manufacturing, testing and control activities. Further, the Company is required to comply with various FDA and other agency requirements for labeling and promotion. The Medical Device Reporting regulations require that the Company provide information to the FDA whenever there is evidence to reasonably suggest that a device may have caused or contributed to a death or serious injury or, if a malfunction were to occur, could cause or contribute to a death or serious injury. In addition, the FDA prohibits the Company from promoting a medical device for unapproved indications.

The delivery of the Company’s devices is also regulated by the US Department of Health and Human Services (HHS) and comparable state and foreign agencies responsible for reimbursement and regulation of health care. US federal health care laws apply when the Company submits a claim on behalf of a federal health care program beneficiary, or when a customer submits a claim reimbursed under Medicare, Medicaid or most other federally funded health care programs. The principal federal laws prohibit the filing of false or improper claims for federal payment and unlawful inducements for the referral of business. They also prohibit health care service providers from providing certain services to a patient if that patient was referred by a physician who has certain types of direct or indirect financial relationships with the service provider. These laws are subject to interpretations.

If the FDA believes that a company is not in compliance with applicable regulations, it can issue a warning letter, issue a recall order, institute proceedings to detain or seize products, impose operating restrictions, enjoin future violations and assess civil penalties against the company, its officers or its employees and can recommend criminal prosecution to the Department of Justice. Other foreign and domestic regulatory agencies may have similar powers. HHS also can impose severe criminal and civil penalties including, for example, exclusion from participation as a supplier of product to beneficiaries covered by Medicare or Medicaid. In June 2003, in connection with the resolution of the ANCURE® matter further described in Item 8, Note 16 to the consolidated financial statements, Guidant and its EndoVascular Technologies, Inc. (EVT) subsidiary entered into a Corporate Integrity Agreement with the Office of Inspector General of HHS. The agreement has a five-year term.

Guidant cannot assure that all necessary regulatory approvals, including approvals for new products or product improvements, will be granted on a timely basis, if at all. Delays in or failures to receive approval, product recalls or warnings and other regulatory actions and penalties can materially affect operating results.

Environmental Regulation

The Company uses substances regulated under environmental laws, primarily in manufacturing and sterilization processes. While it is difficult to quantify, the Company believes the ongoing impact of compliance with environmental protection laws and regulations will not have a material impact on the Company’s financial position or results of operations.

Product Liability and Insurance

The design, manufacture and marketing of medical devices of the types the Company produces entail an inherent risk of product liability claims. Company products are often used in intensive care settings with seriously ill patients. In addition, many of the medical devices the Company manufactures and sells are designed to be implanted in the human body for long periods of time or indefinitely. A problem with a product can result in product liability claims or a recall of, or safety alert or advisory notice relating to, the product. Product liability insurance remains available to the Company on terms consistent with those available in prior periods. However, like many of its industry peers, the Company has elected to increase substantially the degree to which it self-insures for product liability exposures. The decision does not affect coverage with respect to claims made under previous policies. Guidant cannot assure that insurance will be available or adequate to satisfy future claims. (See Item 8, Note 16 to the consolidated financial statements.)

Corporate History

Guidant incorporated in Indiana in September 1994 to be the parent of several of the medical device and diagnostics businesses of Eli Lilly and Company (Lilly). In December 1994, Guidant consummated an initial public offering of a portion of outstanding common shares. In September 1995, Lilly, by means of a split-off, disposed of all of its remaining interests in Guidant. Biographical information for executive officers is provided in Item 10 and includes positions held with the Company and Lilly.

Employees

As of December 31, 2004, Guidant had approximately 12,000 full-time employees, including approximately 3,400 employees outside the US. The Company maintains compensation, benefits, equity participation and work environment policies intended to assist in attracting and retaining qualified personnel. Guidant’s success depends, in significant part, on the ability to attract and retain such personnel. In addition, the Company contracts for services where appropriate. Contract labor provides management with flexibility, including dealing with fluctuations in demand and new product transfers to manufacturing.

None of the Company’s employees is represented by a labor union. The Company has never experienced an organized work stoppage or strike and considers relations with employees to be good. In five of the past seven years, Guidant has been named by Fortune magazine as one of the “100 Best Companies to Work For.”

Guidant has adopted a Code of Business Conduct (available on Guidant’s website, www.guidant.com) that applies to the Company’s Board of Directors and all employees.

Financial Information Relating to Classes of Products

Financial information relating to classes of products is provided in Item 8, Note 12 to the consolidated financial statements.

Financial Information Relating to Foreign and Domestic Operations

Financial information relating to foreign and domestic operations is provided in Item 8, Note 12 to the consolidated financial statements. Additional information concerning foreign exchange risks is provided in Item 7A, “Quantitative and Qualitative Disclosures about Market Risk”, and Item 8, Note 13 to the consolidated financial statements.

Local restrictions on the transfer of funds from abroad (including the availability of dollar exchange) have not to date been a significant deterrent to the Company’s overall operations abroad. A substantial portion of cash and cash equivalents is held by the Company’s non-US subsidiaries. Additional information concerning the planned repatriation of cash from a foreign affiliate is discussed in Item 8, Note 10 to the consolidated financial statements.

Available Information

Guidant’s web address is www.guidant.com. Guidant’s electronic filings with the SEC (including all Forms 10-K, 10-Q, and 8-K and any amendments to these reports) are available free of charge on the website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC.

Guidant has also posted the Board of Director’s Corporate Governance Guidelines, the charters of the board’s audit, nominating (governance) and compensation committees, and the Company’s Code of Business Conduct covering directors and all employees on the website. These materials also are available free of charge in print to shareholders who request them in writing.

As of December 31, 2004, the Company owned or leased the following principal operating facilities:

Guidant maintains executive offices at 111 Monument Circle, 29th Floor, Indianapolis, Indiana. Subject to normal expansion, the Company believes that Company facilities are adequate to meet present and reasonably foreseeable needs.

The Company is subject to various legal proceedings, many involving routine litigation incidental to the business. Other matters contain allegations that are not routine and involve compensatory, punitive, or treble damage claims, or claims for injunctive relief related to alleged infringement of third parties’ rights, or seek declarations affecting the validity of Company patents. (See Item 8, Note 16 to the consolidated financial statements.)

During the fourth quarter of 2004, no matters were submitted to a vote of security holders.

PART II

Guidant’s common shares (the Company’s only outstanding equity shares) are traded on the New York Stock Exchange (NYSE). The Company’s annual CEO certification to the NYSE for the previous year was submitted as of June 3, 2004.

In millions, except per share and other data

All financial information reflects the GALILEO and AAA product lines and Brazil operations as discontinued operations.

Income from continuing operations and earnings per share (EPS) include:

(1) 2004

(2) 2003

(3) 2002

(4) 2001

(5) 2000

See Notes to Consolidated Financial Statements for further description of these items.

2004 OPERATING RESULTS

SALES SUMMARY

Sales

Guidant reported $3,765.6 million worldwide net sales for the year ended December 31, 2004, representing 3% growth compared to 2003. Growth in unit volume favorably impacted sales by 2%, which was partially offset by a 1% decrease in pricing. The impact of fluctuations in foreign currency exchange rates increased sales by $88.0 million or 2%. Sales of products other than worldwide coronary stents grew $426.4 million, an increase of 15% compared to 2003. Sales growth was driven by 18% growth in implantable defibrillator system sales, which accounted for 47% of Guidant’s 2004 worldwide sales. This growth was partially offset by a 36% decrease in coronary stent system sales primarily due to competitive drug eluting stents and increased competition from metallic coronary stent competitors in Japan. Coronary stents comprised 14% of Company sales in 2004, compared to 23% in the prior year.

Sales:

Sales of implantable defibrillator systems include both sales of implantable cardioverter defibrillator (ICD) and CRT-D systems. Worldwide sales of implantable defibrillator systems for 2004 were $1,763.5 million, up $274.8 million or 18% over 2003. Growth was driven primarily by increased volume and a shift toward higher-value CRT-D systems. US implantable defibrillator system sales climbed 15% to $1,395.1 million,

while international sales of $368.4 million were up 33% over the prior year. Sales of implantable defibrillator systems increased due to the following:

Worldwide pacemaker system sales were $719.5 million in 2004 compared to $683.5 million in 2003, representing 5% growth. Sales in the US totaled $426.0 million, a decrease of 1% compared to 2003. International pacemaker system sales grew 17% to $293.5 million, primarily due to volume and fluctuations in foreign currency exchange rates. Pacemaker system sales primarily include:

Sales:

Worldwide coronary stent system sales in 2004 were $538.1 million, a decrease of 36% compared to 2003 sales of $843.7 million. Modest quarterly sequential declines in coronary stent system sales are expected until Guidant introduces its own drug eluting stent. Coronary stent system sales comprise 14% of sales in 2004, compared to 23% of sales in 2003. US coronary stent system sales were $259.6 million ($161.9 million to US end-users) in 2004 compared to $463.2 million ($402.2 million to US end-users) in 2003. Increasing penetration of competitive drug eluting stents in the US primarily drove the decline compared to 2003.

In February 2004, Guidant entered into an agreement with J&J to co-promote Cordis’ CYPHER Sirolimus-eluting Coronary Stent (CYPHER). This agreement also allows for co-promotion of future drug eluting stents sold by J&J. Co-promotion commissions earned by Guidant under this agreement, along with sales of stent delivery technology to J&J, are included in US coronary stent system sales. Revenues from J&J were $97.7 million in 2004 compared to $61.0 million in 2003.

International coronary stent system sales for 2004 and 2003 were $278.5 million and $380.5 million. This decrease was primarily due to declining stent sales in Japan as a result of competitive metallic coronary stent launches since late 2003 and the launch of CYPHER in the third quarter of 2004. Coronary stent system sales in 2004 primarily include:

Angioplasty system sales totaled $452.5 million in 2004 compared to $423.6 million in 2003, representing 7% growth primarily due to volume. During the second and third quarter of 2004, Guidant announced FDA approval and launched the over-the-wire VOYAGER (OTW) and the rapid exchange VOYAGER (RX) Coronary Dilatation Catheters. (See Item 7A, “Quantitative and Qualitative Disclosures about Market Risk”, for information regarding a field action involving the VOYAGER (RX) Coronary Dilatation Catheter.)

Sales:

Worldwide sales of cardiac surgery, biliary, peripheral and carotid systems totaled $292.0 million in 2004 compared to $205.3 million in 2003, representing 42% growth. Sales were driven by:

Cost of Products Sold

Cost of products sold was $921.6 million in 2004 compared to $877.4 million in 2003. Gross profit percentage was 75.5% in 2004 compared to 75.9% in 2003. The decrease in gross profit percentages was primarily driven by the decrease in sales of stents in the US and Japan, partially offset by a continued sales mix shift toward higher value implantable defibrillator systems, including CRT-D systems. Guidant has implemented a lean manufacturing initiative across the cardiac rhythm management product lines. This initiative is improving responsiveness of the supply chain and helping to offset the Company’s decreasing gross profit percentage due to decreasing stent sales.

Research and Development

Innovation is essential to Guidant’s success. It is one of the primary bases of competition in Guidant’s markets. The Company works to introduce new products, enhance the effectiveness and ease of use of existing products and expand the applications for its products. The Company’s investment in R&D, as a percentage of sales, remained at historical percentages. Research and development expense was $516.0 million in 2004, or 13.7% of net sales, compared to $515.0 million in 2003, or 14.1% of net sales. Significant investments in research and development in 2004 included:

In addition to funding internal research and development efforts, Guidant also invests in early-stage technologies through equity investments, acquisitions and other collaborative vehicles.

Purchased In-Process Research and Development (IPRD)

Guidant recorded IPRD charges of $99.8 million and $83.7 million in 2004 and 2003 for acquisitions and subsequent milestones. Guidant records IPRD for the portion of the purchase price representing the value of technologies relating to products that have not received FDA approval and have no alternative future use, excluding the value of core and developed technologies. (See further information on business combinations in Item 8, Note 4 to the consolidated financial statements.) IPRD charges for 2004 included:

IPRD charges in 2003 totaled $83.7 million and primarily included:

The assets gained through Novartis, MediVas and Biosensors were acquired to be key components of Guidant’s drug eluting stent program. If the SPIRIT family of clinical trials is successful, Guidant expects to enter the US market in the next 2-3 years. It is estimated that this project will incur research and development expenses of approximately $150.0 million to $200.0 million from 2005 through completion to achieve commercial viability in the US.

Sales, Marketing and Administrative (SM&A)

SM&A expenses were $1,191.0 million in 2004, virtually unchanged compared to 2003. SM&A expenses as a percentage of sales decreased to 31.6% in 2004 compared to 32.6% in 2003 driven primarily by the reduction of expenses in the second half of 2004 associated with the restructuring (See further discussion below). A portion of this reduction is due to changes in employee benefits that are not expected to recur in 2005. SM&A expenses as a percentage of sales in 2005 are expected to be more in line with the first half of 2004.

Total expenses included $30.9 million and $53.5 million in 2004 and 2003 associated with restricted stock awards. The expense was higher in 2003 primarily due to the share price performance measures achieved in 2003 and early 2004, which accelerated the expense. (See Item 8, Note 5 to the consolidated financial statements.) These expenses were classified in the income statement consistent with the functional area of related employees.

Interest

      The components of interest, net are as follows:

Royalties

Royalty expense is incurred for sales of certain implantable defibrillator systems, pacemaker systems, coronary stent systems and angioplasty systems. Net royalty expense totaled $50.0 million in 2004 compared to $59.7 million in 2003. Net royalty expense included royalty income of less than $1.0 million in both years presented. The decrease in royalty expense was primarily due to the December 2003 expiration of a Mirowski patent covering certain implantable defibrillator products. At December 31, 2004, the Company had accrued $60.1 million, which represents all royalties and interest potentially payable under the license agreement pertaining to that patent. The ultimate payment by Guidant will depend on a final ruling regarding the patent. (See Item 8, Note 16 to the consolidated financial statements.)

Amortization

Amortization expense was $30.7 million in 2004 compared to $20.6 million in 2003. The increase of $10.1 million was attributable to the intangibles recorded in conjunction with the February 2004 acquisition of AFx, inc. and the June 2003 acquisition of X Technologies, Inc.

Other, net

Other, net expense was $21.1 million in 2004 compared to $7.7 million in 2003. The additional expense in 2004 compared to 2003 is primarily due to equity investments ($14.1 million in 2004 compared to $5.1 million in 2003) that were considered permanently impaired in 2004 and an increase in losses on disposal of fixed assets ($8.7 million in 2004 compared to $0.7 million in 2003).

Litigation and Foundation Contribution

In 2004 the Company recorded a $20.0 million litigation benefit from a settlement with Medtronic related to atrial fibrillation technology. Concurrently, this litigation benefit was contributed to the Guidant Foundation. The Company recorded a $422.8 million net litigation expense in the second quarter of 2003 related to the decision of an arbitration panel in a matter involving Cordis. That decision became final in the third quarter of 2003, with payment made in the fourth quarter of 2003. (See Item 8, Note 15 to the consolidated financial statements.)

Restructuring

On July 21, 2004, Guidant’s Board of Directors approved a corporate-wide restructuring and realignment that included work force reductions, cessation of certain capital projects and contract terminations, resulting primarily from the weakness in the metallic coronary stent market. The expense associated with this plan was $66.0 million and includes severance and benefits packages for affected employees of $42.7 million, expense associated with the accelerated vesting of stock-based compensation (stock options and restricted stock) for affected employees of $7.1 million, impairment of property, plant and equipment of $6.5 million, relocation expenses of $4.4 million, contract termination costs of $3.9 million and other related costs of $1.4 million. The restructuring allowed the Company to redirect investment to its strategic imperatives of heart failure therapy, drug eluting stent development and distribution.

Income Tax

Income tax expense for 2004 and 2003 was $304.8 million and $55.9 million, resulting in effective income tax rates of 34.7% and 11.8%. The effective income tax rate in 2004 is comparable to the US statutory rates because the benefit from overseas operations was offset by the tax recorded in conjunction with the American Jobs Creation Act of 2004 (the Act). The effective tax rate in 2003 is lower than the US statutory rates primarily due to the litigation settlement in 2003 that was deductible at the US statutory tax rates, the benefit from overseas operations and the agreement reached with the US and foreign tax authorities with respect to various issues in the examination of tax years 1996-2000, resulting in a decrease in accrued taxes by $30.0 million.

The Act was signed into law on October 22, 2004 and provides a one-time elective incentive to repatriate foreign earnings by providing an 85% dividends received deduction (DRD) reducing the effective federal income tax rate on such earnings from 35% to 5.25%. The repatriation incentive requires CEO approval of a domestic reinvestment plan, and is subject to numerous restrictions. In the fourth quarter, the Company’s CEO approved a domestic reinvestment plan to repatriate approximately $1.5 billion of cash held outside the US, via an extraordinary dividend during 2005. Pursuant to the approved domestic reinvestment plan, Guidant expects to use the repatriated cash to fund growth opportunities through investment in research and development and capacity expansion. The Company’s evaluation of specific provisions of the Act will continue as guidance from the US Treasury and US Internal Revenue Service (IRS) is issued. The Company recorded a tax liability of $104.2 million in the fourth quarter of 2004 in connection with the planned repatriation, as prior to that time, deferred income taxes had not been provided for undistributed earnings because they were intended to be indefinitely reinvested in operations outside the US. This tax liability includes a provision of $29.4 million related to the gross-up on the portion of the dividend subject to the 85% DRD. As enacted, the Act does not expressly provide for the reduction of the gross-up by the 85% DRD. In November 2004, technical corrections legislation was introduced in both chambers of Congress to permit reducing the gross-up by the 85% DRD. If the legislation is enacted as introduced, the Company will reverse the provision of $29.4 million in the quarter the legislation is enacted.

The Act also provides a deduction for qualified domestic production activities such as manufacturing. The Company is evaluating these provisions of the Act. The Company’s preliminary assessment is that the deduction will not have a material impact on the Company’s effective income tax rate.

During 2003, the Company reached agreement with US and foreign tax authorities with respect to various issues in the examination of tax years 1996-2000. The Company decreased its previous estimate for accrued taxes by $30.0 million in the fourth quarter of 2003 to reflect the resolution of these audits. In December 2003, the IRS proposed adjustments to certain previously filed tax returns. The Company believes it has meritorious defenses of its tax filings and will vigorously defend them at the IRS appellate level or through litigation in the courts. While no assurance can be provided as to the ultimate resolution of outstanding tax issues, the positions taken by the IRS are not expected to have a significant impact on the effective tax rate in future periods. The Company has accrued for probable liabilities resulting from tax assessments by tax authorities.

Discontinued Operations

In March 2004, Guidant’s Board of Directors approved a plan to discontinue the GALILEO® Intravascular Radiotherapy System (GALILEO System) product line for the treatment of in-stent restenosis due to the significant competitive impact of drug eluting stents. On April 21, 2004, Guidant signed a definitive agreement with Novoste Corporation (Novoste) to cooperate in assisting existing US and Canadian customers of the GALILEO System who wish to transition to Novoste products. Guidant received $2.5 million upon signing and the agreement provides for earn-out payments up to a maximum of $4.0 million based on Novoste sales in the US and Canada. The disposal plan consists primarily of the termination of normal activity, abandonment of property and equipment, product returns, collection of accounts receivable and settlement of liabilities.

In December 2003, Guidant’s Board of Directors ratified a plan to discontinue Guidant’s operations in Brazil due to unfavorable business conditions and poor operating performance.

In June 2003, Guidant’s Board of Directors approved a plan to dispose of the ANCURE ENDOGRAFT® System (ANCURE) product line to treat abdominal aortic aneurysms (AAA) due to continuing financial losses, limited prospects for the Company’s AAA product line and the impact of the US Department of Justice investigation. (See Item 8, Note 16 to the consolidated financial statements.)

In accordance with Statement of Financial Accounting Standards (SFAS) 144, Accounting for the Impairment or Disposal of Long-Lived Assets, these disposals represent discontinued operations. Accordingly, the accompanying consolidated financial statements and notes reflect the results of operations and financial position of the GALILEO and AAA product lines and the Brazil operations as discontinued operations for all periods presented.

Loss from discontinued operations before income taxes for the year ended December 31, 2004 primarily includes charges of $37.9 million for estimated ANCURE-related settlements, write down of long-lived assets to fair value, severance related charges and recording inventory and accounts receivable at net realizable value. Loss from discontinued operations before income taxes for the year ended December 31, 2003, includes a $62.4 million charge for the agreement with the US Department of Justice surrounding the ANCURE product line for the treatment of AAA (See Item 8, Note 16 to the consolidated financial statements), a charge of $37.9 million, primarily related to the write down of long-lived assets to fair value, severance-related charges and recording inventory and accounts receivable at net realizable value and a gain of $20.0 million for a payment made from Cook in exchange for granting a covenant not to sue related to Cook’s manufacture and distribution of Cook’s endovascular graft products. The Company does not expect any significant activity associated with the exit of these three businesses during 2005, except for potential litigation charges.

The following summarizes the financial information for discontinued operations:

2003 OPERATING RESULTS

SALES SUMMARY

Sales

Guidant reported $3,644.8 million worldwide net sales for the year ended December 31, 2003, representing 17% sales growth compared to 2002. Growth in unit volume and price increases favorably impacted sales by 12% and 1%. The impact of fluctuations in foreign currency exchange rates increased sales by $131.2 million or 4%. Sales growth was driven by 48% growth in implantable defibrillator system sales, which accounted for 41% of Guidant’s 2003 worldwide sales. This growth was partially offset by an 8% decrease in coronary stent system sales primarily due to the launch of competitive drug eluting stents in Europe and the US in 2003.

Worldwide sales of implantable defibrillator systems for 2003 were $1,488.7 million, up $481.9 million or 48% over 2002. US implantable defibrillator system sales climbed 47% to $1,210.7 million, while international sales of $278.0 million were up 50% over the prior year. Implantable defibrillator system sales were driven by:

Worldwide pacemaker system sales were $683.5 million in 2003 compared to $636.6 million in 2002, representing 7% growth. Sales in the US totaled $431.7 million, an increase of 4% over 2002. International pacemaker system sales grew 13% to $251.8 million, primarily due to fluctuations in foreign currency exchange rates. Pacemaker system sales include sales of CRT-P systems and were driven by:

Worldwide coronary stent system sales in 2003 were $843.7 million, a decrease of 8% compared to 2002 sales of $920.9 million. US coronary stent system sales were $463.2 million ($402.2 million to US end-users) in 2003 compared to $628.5 million ($575.5 million to US end-users) in 2002. The decline of US coronary stent system sales was primarily driven by increasing penetration of competitive drug eluting stents in the US. US end-user coronary stent system sales (which exclude the sales to Cordis) in 2003 accounted for 11% of Guidant’s worldwide revenues compared to 18% in 2002. International sales of coronary stent systems in 2003 grew 30% to $380.5 million compared to $292.4 million in 2002, primarily attributable to unit volume growth in Japan.

Angioplasty system sales totaled $423.6 million in 2003 compared to $390.8 million in 2002, representing 8% growth. Key product sales were driven by the Rapid-Exchange (RX) CROSSSAIL® and Over-The-Wire (OTW) OPENSAIL® Coronary Dilatation Catheters.

Worldwide sales of cardiac surgery, biliary, peripheral and carotid systems totaled $205.3 million in 2003 compared to $165.8 million in 2002, representing 24% growth.

Cost of Products Sold

Cost of products sold was $877.4 million in 2003 compared to $742.0 million in 2002, representing gross profit percentages of 75.9% compared to 76.2% in 2002. The gross profit percentage decreased in 2003 compared to 2002 due to previously discussed changes in product sales mix and the impact of foreign currency hedge losses, partially offset by increased manufacturing efficiencies. The foreign currency hedge losses recorded in cost of products sold partially offset the increase in sales caused by the weakening US dollar and served to mitigate the net impact of foreign currency fluctuations on net earnings. Additionally, in the fourth quarter of 2003, the Company recorded $11.0 million of expense related primarily to scrap of work-in-process and finished goods inventory containing a specific third-party-supplied component.

Research and Development

Research and development expense was $515.0 million in 2003, or 14.1% of net sales, compared to $410.5 million in 2002, or 13.2% of net sales. Significant investments in research and development in 2003 included:

Purchased In-Process Research and Development (IPRD)

Guidant recorded IPRD charges of $83.7 million (described in detail earlier) and $54.9 million in 2003 and 2002 for acquisitions and subsequent milestone payments. (See further information on business combinations in Item 8, Note 4 to the consolidated financial statements.) IPRD charges in 2002 totaled $54.9 million and included:

Sales, Marketing and Administrative

SM&A expenses were $1,189.0 million in 2003, an increase of $250.6 million or 26.7% compared to 2002. SM&A expenses as a percentage of sales increased to 32.6% in 2003 compared to 30.1% in 2002 driven primarily by sales growth, resulting in increased sales commissions and continued expansion of the US sales force, including field clinical personnel in the US who support clinicians.

Total expenses increased by $53.5 million as a result of restricted stock grants made under the 2003 performance-based equity compensation program, including accelerated vesting based upon the attainment of Company share price appreciation targets. These expenses were classified in the income statement consistent with the functional area of related employees. Approximately two-thirds of the share price appreciation targets were achieved and expensed in 2003. The final share price appreciation target was achieved in January 2004.

Interest

The components of interest, net are as follows:

Royalties

Net royalty expense totaled $59.7 million in 2003 compared to $50.9 million in 2002. Net royalty expense included royalty income of less than $1.0 million in both years. Royalty expense is incurred for sales of certain implantable defibrillator systems, pacemaker systems, coronary stent systems and angioplasty systems. The $8.8 million increase in 2003 was primarily due to increased sales of implantable defibrillator systems.

Amortization

Amortization expense was $20.6 million in 2003 compared to $12.3 million in 2002. The increase of $8.3 million was primarily driven by Guidant’s acquisition of X Technologies, Inc. in June 2003. A portion of the purchase price was allocated to the intangible assets related to the FDA-approved FX miniRAIL® Dilatation Catheter.

Other, net

Net other expenses were $7.7 million in 2003 and were comprised primarily of equity investment write-offs and losses on foreign exchange contracts. Net other expenses were $12.6 million in 2002, comprised primarily

of fixed asset and equity investment write-offs and losses on foreign exchange contracts. Other, net includes the following:

Litigation and Foundation Contribution

The Company recorded $422.8 million in net litigation expense in the second quarter of 2003. The Company accrued $425.0 million in that quarter based on the decision of an arbitration panel in a matter involving Cordis. That decision became final in the third quarter of 2003, with payment made in the fourth quarter of 2003. In 2002, Guidant recorded a net legal benefit of $137.1 million resulting from a $158.2 million award against Medtronic, partially offset by other minor settlements. (See Item 8, Note 15 to the consolidated financial statements.) Concurrently, $40.0 million of this litigation benefit was contributed to the Guidant Foundation.

Income Tax

Income tax expense for 2003 and 2002 was $55.9 million and $251.2 million, resulting in effective income tax rates of 11.8% and 27.3%. The effective tax rate in 2003 is lower than the US statutory rates primarily due to the litigation settlement in 2003 that was deductible at the US statutory tax rates, the benefit from overseas operations and the agreement reached with the US and foreign tax authorities with respect to various issues in the examination of tax years 1996-2000, resulting in a decrease in accrued taxes by $30.0 million. The effective tax rate in 2002 was lower than the US statutory tax rates, primarily due to the benefit for overseas operations.

Liquidity and Capital Resources

Summary of Cash Flows

2004/2003

Net cash provided by operating activities was $1,135.6 million in 2004, an increase of $728.8 million primarily due to:

Net cash used for investment activities was $672.7 million in 2004, an increase of $280.2 million compared to prior year primarily due to $320.1 net purchases of short-term investments. The majority of these short-term investments are interest-bearing investments with maturities between three and six months.

Net cash used for financing activities was $66.8 million in 2004, a change of $447.4 million primarily due to:

partially offset by:

2003/2002

Net cash provided by operating activities decreased by $637.4 million in 2003 compared to 2002 primarily due to the following payments made in 2003:

Net cash used in investing activities increased by $172.9 million in 2003 primarily due to:

Net cash provided by financing activities was $380.6 million in 2003, compared to net cash used of $353.2 million in 2002, a change of $733.8 million due to:

partially offset by:

The effect of exchange rate changes on cash decreased $47.1 million in 2003 compared to 2002, primarily due to decreasing Euro cash holdings in 2003 compared to 2002.

Cash Commitments

Scheduled payments at December 31, 2004 include the following:

Other items that are material to understanding the Company’s cash requirements and are not in the table above, have either been previously discussed, are contingent on future revenue streams or are purchases in the normal course of business. Such items are typically not enforceable or legally binding or are subject to change based on management business decisions.

At December 31, 2004, the Company had outstanding borrowings of $659.2 million at a weighted average interest rate of 3.41%, including bank borrowings, commercial paper, $350.0 million principal balance in long-term notes due in 2006 and interest rate swap agreements valued at $2.7 million. Bank borrowings represent short-term uncommitted credit facilities with commercial banks. The commercial paper borrowings are supported by two credit facilities aggregating $900.0 million. There are currently no outstanding borrowings under these facilities. The Company classified $302.0 million as short-term debt at December 31, 2004. The Company believes that cash and cash equivalent balances will be adequate to fund maturities of short-term borrowings, obligations to make interest payments on its debt and other anticipated operating cash needs for 2005, including planned capital expenditures of approximately $425.0 million in 2005. The planned repatriation of $1.5 billion of cash, currently held outside the US, during 2005 will help fund this expansion. The expected increase in capital expenditures is primarily due to planned investments in manufacturing equipment and facilities in Ireland and California to support Guidant’s drug eluting stent initiatives and to support continued cardiac rhythm management sales growth.

Certain of Guidant’s acquisitions involve contingent consideration. Contingent consideration will be recorded when the amount is determinable and will be allocated to the fair value of the intangibles or IPRD, with any amounts paid above fair value of identifiable assets recorded as goodwill. In addition to contingent consideration, certain equity investments made by Guidant in other entities may involve contingent payments, which would provide additional ownership to Guidant (both collectively referred to as “milestone payments”). These milestone payments are generally contingent upon reaching performance-related milestones, including specified revenue levels, product development targets or regulatory approvals or filings. At December 31, 2004, Guidant’s accrual for milestone obligations totaled $33.3 million, which is expected to be paid during the next

two years. In addition, future undiscounted performance-related milestone payments of up to $243.0 million could be paid through 2010, depending on when and if milestones are attained. Potential milestone payments under existing agreements during the next 12 months range from $25.0 million to $71.0 million, of which management currently estimates $33.0 million could result in IPRD charges if paid. The Company continues to evaluate business development opportunities, which may generate additional payments.

New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board issued SFAS 123(R), Share-Based Payment. This Statement is a revision to SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires the measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do not render service. The Company will adopt SFAS 123(R) on July 1, 2005, requiring compensation cost to be recorded as expense for the portion of outstanding unvested awards, based on the grant-date fair value of those awards calculated using Black-Scholes option pricing model under SFAS 123 for pro forma disclosures. Based on unvested stock options currently outstanding and the expense that will be associated with the Employee Stock Purchase Plan, the effect of adopting SFAS 123(R), absent the effect of the pending J&J merger, will reduce the Company’s net income by approximately $14.4 million in the second half of 2005. Upon Company shareholder approval of the merger with J&J, the majority of the equity outstanding immediately vests and becomes exercisable.

Critical Accounting Estimates

It is important to understand Guidant’s accounting policies and estimates in order to understand its financial statements. In preparing the consolidated financial statements in accordance with US generally accepted accounting principles, management must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex. Consequently, actual results could differ from those estimates. Management considers an accounting estimate to be critical if:

Guidant continually evaluates the accounting policies and estimates it uses to prepare the consolidated financial statements. In cases where management estimates are used, they are based on historical experience, information from third-party professionals and various other assumptions believed to be reasonable. Management has discussed the development and selection of these critical accounting estimates with Guidant’s Audit Committee and the Audit Committee has reviewed the foregoing disclosure. In addition, there are other items within Guidant’s financial statements that require estimation, but are not deemed critical as based on the criteria above. Changes in estimates used in these and other items could have a material impact on Guidant’s financial statements in any one period.

The accounting policies that are most subject to important estimates or assumptions include those described below. See Item 8, Note 2 to the consolidated financial statements for further description of these items.

Inventory Reserves — The Company values its inventory at the lower of cost (first-in, first-out method) or market. Reserves are estimated for excess, slow moving and obsolete inventory as well as inventory with a carrying value in excess of its net realizable value. Write-offs are recorded when product is destroyed. The Company reviews inventory on hand at least quarterly and records provisions for excess and obsolete inventory based on several factors including current assessment of future product demand, anticipated release of new

products into the market, historical experience and product expiration. The Company’s industry is characterized by rapid product development and frequent new product introductions. Uncertain timing of product approvals, variability in product launch strategies, product recalls and variation in product utilization all impact the estimates related to excess and obsolete inventory.

Valuation of Purchased In-Process Research and Development (IPRD), Goodwill and Other Intangible Assets — When a business combination occurs, the purchase price is allocated based upon the fair value of tangible assets, IPRD, goodwill and intangible assets. The Company recognizes IPRD in business combinations for the portion of the purchase price allocated to the appraised value of in-process technologies, defined as those technologies relating to products that have not received FDA approval and have no alternative future use. The portion assigned to in-process technologies excludes the value of core and developed technologies, which are recognized as intangible assets when purchased. Valuations require the use of significant estimates. The amount of the purchase price allocated to IPRD is determined by estimating future cash flows of the technology and discounting net cash flows back to present values. The Company considers, among other things, the project’s stage of completion, complexity of the work completed as of the acquisition date, costs already incurred, projected costs to complete, contribution of core technologies and other acquired assets, expected introduction date and the estimated useful life of the technology. The discount rate used to arrive at a present value as of the date of acquisition is based on the time value of money and medical technology investment risk. Goodwill represents the excess of cost over fair value of identifiable net assets of the business acquired and the amount allocated to IPRD. The methodologies used in arriving at these estimates are in accordance with accepted valuation methods.

Income Taxes — All income tax amounts reflect the use of the liability method. Under this method, deferred tax assets and liabilities are determined based on the expected future tax consequences of temporary differences between the carrying amounts of assets and liabilities for financial and income tax reporting purposes.

Guidant operates in multiple tax jurisdictions with different tax rates and must determine the allocation of income to each of these jurisdictions based on estimates and assumptions. In the normal course of business, the Company will undergo scheduled reviews by taxing authorities regarding the amount of taxes due. These reviews include questions regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions. Tax reviews often require an extended period of time to resolve and may result in income tax adjustments if changes to the allocation are required between jurisdictions with different tax rates.

Guidant records its tax provisions based on the existing laws, experience with previous settlement agreements, the status of current IRS (and other taxing authorities) examinations and management’s understanding of how the tax authorities view certain relevant industry and commercial matters. Although the Company has recorded all probable income tax accruals in accordance with SFAS 5, Accounting for Contingencies, and SFAS 109, Accounting for Income Taxes, these accruals represent accounting estimates that are subject to inherent uncertainties associated with the tax audit process and, therefore, include certain contingencies. The Company adjusts these accruals in light of changing facts and circumstances, such as the progress of a tax audit. The Company believes that any potential tax conclusion will not have a material adverse impact on Guidant’s consolidated financial position or liquidity. However, it may be material to Guidant’s consolidated results of operations of a future period.

Legal Proceedings and Other Loss Contingencies — The Company is subject to various legal proceedings, many involving routine litigation incidental to the business. Other matters contain allegations that are not routine and involve compensatory, punitive or treble damage claims, or claims for injunctive relief related to alleged infringement of a third party’s patents, or seek declarations affecting the validity of the Company’s patents. Litigation outcomes are not within the Company’s complete control, are often very difficult to predict and often are resolved over long periods of time. Estimating probable losses requires the analysis of multiple possible outcomes that often depends on judgments about potential actions by third parties. Contingencies are recorded in the consolidated financial statements, or otherwise disclosed, in accordance with SFAS 5, Accounting for Contingencies.

The overall objective of Guidant’s financial risk management policy is to reduce the potential negative earnings effect from the impact of fluctuating foreign currencies and interest rates. The primary feature of Guidant’s risk management philosophy is that all hedging activity must be designed to reduce financial risks associated with commercial and financial transactions that arise in the ordinary course of business. Guidant utilizes foreign exchange forward contracts and interest rate swap agreements to minimize the impact of fluctuating foreign currencies and interest rates. The contracts are initiated within the guidelines of documented corporate risk management policies. Guidant does not use financial instruments for speculative or trading activities.

Foreign Exchange Risk

Due to Guidant’s commitment to a global presence and customer support, the Company conducts a portion of its business in various foreign currencies (primarily the currencies of Europe and Asia) and, as a result, a portion of revenues and earnings is exposed to changes in foreign exchange rates. Such exposures arise from transactions denominated in foreign currencies, primarily intercompany loans and cross-border sales of inventory, as well as from the translation of results of operations from outside the US. The Company seeks to manage its foreign exchange risk in part through operational means, including managing local currency assets in relation to local currency liabilities.

Foreign exchange risk is also managed through the use of foreign exchange contracts. The fair value of all foreign exchange contracts outstanding was ($33.4) million and ($46.8) million at December 31, 2004 and 2003. An analysis was prepared to estimate the sensitivity of the fair value of all foreign exchange contracts to hypothetical 10% favorable and unfavorable changes in exchange rates at December 31, 2004 and 2003. The results of the estimation, which may vary from actual results, are as follows:

Fair Value of Foreign Exchange Contracts

Any gains and losses in fair value of foreign exchange contracts would be largely offset by losses and gains on underlying transactions or anticipated transactions. These offsetting gains and losses are not reflected in the above table.

Interest Rate Risk

The Company’s financial instruments are exposed to interest rate risk. During 2004, Guidant had two interest rate swap agreements to modify the interest characteristic of the principal amount of its long-term notes so that the interest payable on long-term notes effectively becomes variable and thus matches the variable interest rate received from its cash. Accordingly, interest rate fluctuations impact the Company’s long-term notes outstanding, which are offset by corresponding changes in the fair value of the interest rate swap agreements. Since the Company is in a net cash position, the interest rate swap agreements reduce exposure to floating rate risk. An analysis of the impact on the Company’s interest rate sensitive financial instruments to a hypothetical 10% change in short-term interest rates compared to interest rates at year-end showed no significant impact on earnings or cash. The fair value of the interest rate swap agreements was $2.7 million at December 31, 2004.

Regulatory and Other Matters

See Item 1, “Healthcare Cost Containment and Third-Party Reimbursement and Government Regulation”.

Field Actions

The Company continually collects and analyzes information about product performance through field observations and other quality metrics to determine if a field action is necessary. Following this process, from time to time, the Company initiates field actions with respect to market-released products. These actions may include product recalls or communications with a significant number of physicians about a product or labeling issue. The scope of such actions can range from very minor issues affecting a small number of units to more significant actions. Since the Company’s last filing on Form 10-Q, the Company conducted the following field action:

In late January 2005, Guidant voluntarily withdrew VOYAGER (RX) Coronary Dilatation Catheters of sizes 1.5 mm to 3.5 mm to address the potential for a leak at the guidewire exit notch. While the probability of a leak is low, the Company is pursuing root cause analysis and corrective actions. FDA and affected international regulatory agencies have been notified.

Cautionary Factors

Certain statements included in this filing are forward-looking, including accounting estimates, expectations with respect to announced transactions, statements concerning pricing and sales trends, drug eluting stent development, recovery of tax assets and the outcome of other tax matters, capital expenditures, cash flows, costs of research programs, the timing of discontinued operations and the timing of product developments. The statements are based on assumptions about many important factors, including assumptions concerning:

Actual results may differ materially. The Company does not undertake to update its forward-looking statements.

Index to Consolidated Financial Statements

GUIDANT CORPORATION

Consolidated Statements of Income

(In millions, except per share data)

See Notes to Consolidated Financial Statements

GUIDANT CORPORATION

Consolidated Balance Sheets

(In millions, except share data)

See Notes to Consolidated Financial Statements

GUIDANT CORPORATION

Consolidated Statements of Shareholders’ Equity

(In millions, except share data)