GUIDANT CORPORATION
Notes to Consolidated Financial Statements
(In millions, except per share data)
(unaudited)

Note 1 — Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair presentation of results of operations, financial position and cash flows in conformity with generally accepted accounting principles. Operating results from interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. In the opinion of management, the consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company’s results for the periods presented. The preparation of financial statements in conformity with generally accepted accounting principles requires management to 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. Actual results could differ from these estimates. A discussion of the Company’s significant accounting policies is described in the “Significant Accounting Policies” section of “Management’s Discussion and Analysis of Results of Operations and Financial Condition.”

For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. As used herein, the terms “the Company” and “Guidant” mean Guidant Corporation and its consolidated subsidiaries.

Note 2 – Stock-Based Compensation

The Company has adopted the disclosure-only provisions of SFAS 123, Accounting for Stock-Based Compensation, as amended by SFAS 148, Accounting for Stock-Based Compensation—Transition and Disclosure. Accordingly, the Company accounts for stock-based compensation under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, using the intrinsic value method. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to all stock-based employee compensation. The pro forma impact on net income assumes a forfeiture rate of approximately 10%. These pro forma amounts may not be representative of the effects on reported net income for future years due to the uncertainty of stock option grant volume and potential changes in assumptions driven by market factors.

In February 2003, Guidant’s Board of Directors authorized the issuance of approximately 2.3 million restricted shares of common stock (U.S.) and restricted stock units (outside the U.S.) to over 2,000 employees. Restricted stock awards granted to certain executive officers vest over six years. Awards granted to other employees vest over three years. Grants may vest earlier upon a qualifying disability, death, retirement or change in control. This grant includes a performance element that allows vesting to accelerate if certain Guidant share price performance measures are met. Specifically, 1/3 of the general grant will vest immediately upon achievement of 25%, 50% and 75% appreciation of the 60-day moving average stock price from the date of grant ($34.37 on February 18, 2003). Portions of the executive officer grant may accelerate from 6 years to 3 years under this same performance measure. Guidant recorded $79.0 million of unearned compensation in conjunction with this grant, representing the fair value of the restricted stock awards on the date of grant. The unearned compensation will be recognized as compensation expense ratably over the vesting period or earlier based on the performance element. The related expense totaled $2.8 million in the first quarter of 2003. The Company expects to record approximately $21.0 million of compensation expense during 2003 related to this award, absent the achievement of a performance measure.