Note: All New Material Since the Last Report Is Highlighted

Research Digest April 6, 2006 Research Associate: Rangan Bagchi, MBA Editor: Nelson Bishop, CFA

Sr. Ed. : Ian Madsen, CFA : [email protected] 1-800-767-3771,x417 www.zackspro.com 155 North Wacker Drive Chicago, IL 60606

Guidant Corporation (GDT-NYSE) $77.85 Note: All new material since the last report is highlighted.

Reason for Report: Pre-earnings Update Prev. Ed.: March 9, 2006

Overview

Guidant Corp. (GDT) is one of the world’s leading medical device companies in cardiac rhythm management, interventional cardiology, and cardiac and vascular surgery markets. GDT consists of four divisions: Cardiac Rhythm Management (CRM), Vascular Intervention, Cardiac Surgery, and Endovascular. The company is based in Indianapolis, Indiana, and has approximately 12,000 employees. On January 25, 2006, BSX and Guidant Corporation announced that the Board of Directors of Guidant has unanimously approved and entered into the merger agreement provided to Guidant by Boston Scientific on January 17, 2006. Under that agreement, Boston Scientific will acquire all the outstanding shares of Guidant for a combination of cash and stock worth $80 per Guidant share, or approximately $27B in aggregate. Prior to entering into this agreement with Boston Scientific, Guidant terminated its merger agreement with Johnson & Johnson. Additional information is available online at http://www.guidant.com/.

Key Positive Arguments Key Negative Arguments . Implantable Cardiac Defibrillators (ICDs), one . Analysts have been concerned over a slowdown in of the most promising areas of medical the ICD market. In addition, a more competitive STJ devices, is an area where GDT operates and is has rolled out two heart failure products that are a leading player. taking some share from GDT. . GDT received Investigational Device . GDT’s stent business is facing difficulties as it will Exemption (IDE) conditional approval from the take time for GDT to convert from bare metal stent to FDA to begin the U.S. portion of its SPIRIT III drug eluting stent (DES). clinical trial. It will allow GDT to initiate the . GDT is far behind competitors such as BSX, JNJ, pivotal trial to evaluate the safety and efficacy and MDT in the drug-eluting stent market. of XIENCE V. . Analysts believe that it will be difficult for GDT to . SCD-HeFT reimbursement (January 27 by regain the lost ICD and pacemaker market share due CMS) has not as yet begun to favorably impact to a series of product recalls. procedure volumes.

GDT’s fiscal year ends on December 31; all fiscal references are to the calendar year.

Revenue

Provided below is a summary of revenues:

© Copyright 2006, Zacks Investment Research. All Rights Reserved. Revenue 2004A 1Q05A 2Q05A 3Q05A 4Q05A 2005A 2006E 2007E Total Revenue $3,765.4 $953.3 $974.1 $795.0 $828.2 $3,550.6 $3789.9↑ $4,384.0↑ Digest High $3,765.4 $953.3 $974.1 $795.0 $828.2 $3,550.6 $3,917.0 $4,849.0 Digest Low $3,765.4 $953.3 $974.1 $795.0 $828.2 $3,550.6 $3,587.0 $3,906.9 Y oY Growth 1.2% 2.1% 3.8% -14.0% -14.4% -5.7% 6.7% 15.7% Quarterly Growth -1.5% 2.2% -18.4% 4.2%

On April 5, 2006, Guidant Corporation announced preliminary, unaudited 1Q06 sales of approximately $894M, reflecting a decline of approximately 6% versus 1Q05, and growth of 8% versus 4Q05. Preliminary, unaudited U.S. and worldwide implantable defibrillator sales in the quarter were approximately $308M and $419M, respectively, representing declines of 16 percent and 12 percent, respectively, compared to the first quarter of 2005, and growth of 13 percent each compared to the fourth quarter of 2005.

GDT reported 4Q05 sales of $828M, representing a sales decline of $140M or 14 percent versus the prior year, primarily due to the impact of the 2005 product recalls and field actions. Foreign currency translations negatively impacted revenue by $27M or 3 percent compared to the prior year, and by $6M or 1 percent compared to the third quarter of 2005.

The company also reported full year 2005 sales of $3.55B, representing a sales decline of $215M or 6 percent versus 2004. Foreign currency translations negatively impacted revenue by $5 million compared to the prior year.

GDT derives its revenue from four main divisions: Cardiac Rhythm Management, Vascular Intervention, Cardiac Surgery, and Endovascular.

Cardiac Rhythm Management:

This division includes implantable cardioverter defibrillator (ICDs) used to detect and treat potentially fatal, abnormally fast heart rhythms. Its product line includes the Vitality family of implantable defibrillators. GDT also has devices for slow and irregular heart rhythms in the Pulsar Max and Insignia product lines. This division is under increased competition from STJ with its EPIC HF and ATLAS HF products, and the analysts are concerned that the worldwide rate of growth of ICDs is slowing to 20% or less annually.

In 4Q05, worldwide implantable defibrillator (ICD) sales of $372M decreased 19 percent versus the prior year and increased 13 percent versus the third quarter; U.S. implantable defibrillator sales of $272 million declined 23 percent versus the prior year and increased 11 percent versus the third quarter. In 4Q05, total CRM sales were $506M, down 20% Y/Y. In 2005, worldwide implantable defibrillator sales decreased 6 percent to $1.65B; U.S. implantable defibrillator sales declined 12 percent to $1.23B.

Vascular Intervention:

This division includes coronary stents and related delivery systems, and angioplasty systems and accessories, including catheters and guidewires. A stent is a wire mesh tube used to prop open an artery during angioplasty. The stent stays in the artery permanently, holds it open, improves blood flow to the heart muscle and relieves symptoms (usually chest pain). Stenting is a fairly common procedure; in fact, it now represents 70-90 percent of procedures. The Vascular Intervention division is in a state of transition as the marketplace and technology change from bare metal stents to drug eluting stents (DES). DES appears to be a superior device to a bare metal stent in a large number of cases. In fact, it has been estimated that stent procedures have converted to DES in over 80% of the cases. DES is priced approximately 2-3X more than a bare metal stent. GDT not only lacks an approved drug eluting compound for its DES program but is also far behind its competitors in the DES market. Most analysts

Zacks Investment Research Page 2 www.zackspro.com and management now estimate that GDT will enter the U.S. market in 2007, instead of 2006 due to product quality issues. Guidant announced that it has received Investigational Device Exemption (IDE) conditional approval from the FDA to begin the U.S. portion of its SPIRIT III clinical trial. Guidant is pleased with the FDA conditional approval as it will allow the company to initiate the pivotal trial to evaluate the safety and efficacy of XIENCE V. Results of the SPIRIT III trial may be used to obtain FDA approval for XIENCE V for the treatment of coronary artery disease. On December 13, 2005, GDT announced that it has begun enrollment in the Japan arm of its SPIRIT III drug eluting stent trial.

In 4Q05, worldwide pacemaker sales of $134M declined 24 percent versus the prior year and 12 percent versus the third quarter; U.S. pacemaker sales of $70M declined 29 percent versus the prior year and 19 percent versus the third quarter. Worldwide coronary stent sales of $117M declined 6 percent versus the prior year; U.S. stent sales increased 3 percent to $64M. Worldwide angioplasty system sales decreased 6 percent to $113M. In 2005, worldwide pacemaker sales declined 13 percent to $629M; U.S. pacemaker sales declined 19 percent to $346M. Worldwide coronary stent sales of $462M declined 14 percent; U.S. stent sales decreased 5 percent to $247M. Worldwide angioplasty system sales decreased 4 percent to $436M.

The analysts’ quarterly projections for the Vascular Intervention division are included in the accompanying spreadsheet.

Cardiac Surgery & Endovascular:

Cardiac Surgery devices include emerging therapies for Coronary Artery Bypass Grafting (CABG), which are less invasive than traditional procedures. Endovascular products include biliary, perpheral, and carotid systems used in treating artery and biliary stricture diseases. In 4Q05, worldwide sales of cardiac surgery and peripheral, including carotid and biliary systems increased 2 percent to $92M. For the full year, worldwide sales of cardiac surgery and peripheral, including carotid and biliary systems, increased 28 percent to $373M. The analysts believe that carotid stent penetration will gradually increase over time. The analysts’ quarterly projections for the Cardiac Surgery and Endovascular division are included in the accompanying spreadsheet.

Margins

In 4Q05, gross margin was 77.3% compared to 76.0% in the fourth quarter of 2004. The improvement was primarily due to positive manufacturing variances from inventory builds supporting the re-launch of certain implantable defibrillators. For the full year 2005, gross margin was 73.8 percent compared to 75.5 percent in 2004. The margin decline was primarily due to the impact of net charges resulting from the 2005 product recalls and field actions. In 4Q05, pro forma operating income decreased 65%Y/Y to $114M, representing an operating margin of 13.8%. The declines were driven by higher R&D and SG&A.

SG&A as a percentage of sales increased 20% Y/Y to 42.8%. R&D increased 47% year over year to $172M. On a percentage of sales basis, R&D represented 20.7% compared with 12.1% a year ago. Management attributed the increased R&D to spending on clinical trials, notably the SPIRIT drug eluting stent program and the MADIT-CRT trial. The high spending on SPIRIT makes the Vascular business less profitable.

Provided below is a summary of margins:

Zacks Investment Research Page 3 www.zackspro.com Margins 2003A 2004A 2005A 2006E 2007E Gross 75.5% 75.5% 73.8% 76.0% 77.8% Operating 26.5% 28.8% 22.8% 18.5% 24.5% Net 20.5% 21.1% 17.0% 13.9% 19.9%

Earnings per Share

Provided below is a summary of EPS:

EPS 2004A 1Q05A 2Q05A 3Q05A 4Q05A 2005A 2006E 2007E Digest High $2.47 $0.65 $0.29 $0.32 $0.25 $1.91 $1.90↑ $2.76↓ Digest Low $2.47 $0.65 $0.29 $0.32 $0.25 $1.91 $1.30 $1.93 Digest Avg. $2.47 $0.65 $0.29 $0.32 $0.25 $1.91 $1.60 $2.36 Digest YoY growth 1.2% 16.1% -50.0% -49.2% -64.3% -22.7% -16.2% 47.6%

GDT posted 4Q05 EPS of $0.25, down 64% Y/Y. This was below the consensus estimate of $0.34. The downside was primarily due to sales decline, continued investment in DES and ICD development and distribution capabilities, as well as product recalls. The full year 2005 EPS declined 23% Y/Y to $1.91. The company reaffirmed 2006 EPS guidance of $1.48-$1.58.

Target Price/Valuation

Target price for GDT ranges from $42 (Smith Barney) to $78 (Prudential). The analyst (Smith Barney) with the lowest target price has valued it by applying an average of 1)22x P/E multiple of forward 12- month EPS estimate of $1.30; 2) a 16x TEV/2005 EBITDA multiple; and 3) a DCF valuation. The Digest average target price is $62.67 (↑ from previous report; approximately 19% downside from current price).

Rating Distribution Positive 0% Neutral 80% Negative 20% Average Target Price $62.67↑

Long-Term Growth

The Digest average long-term growth rate is 13.3%. The analysts are unanimous that GDT will need to compete in the DES market, be successful with its clinical DES trials, and eventually receive FDA and international approvals to market its DES products in order to achieve better long-term growth. As a standalone company, GDT will need to rely on its CRM business to carry the company for a few years. The recent CMS decision on incremental SCDHeFT reimbursement is a significant positive outcome for the major CRM players like GDT.

Zacks Investment Research Page 4 www.zackspro.com Capital Structure/Solvency/Cash Flow/Governance/Other

On March 29, 2006, GDT announced that approximately 1% of its current XIENCE V inventory was not manufactured with strict adherence to quality standards. The company is not releasing any existing XIENCE V inventory and has stopped enrolling patients in the ongoing 4.0mm and Japan arm of its non- randomized SPIRIT III clinical trial registry. This will delay the E.U. launch of XIENCE V until 3Q06, which will in turn have an impact on ABT as it is taking over GDT’s vascular segment.

On March 17, 2006, Guidant Corporation announced that the first patient has been enrolled in a new post-approval study of carotid artery stenting in high surgical risk patients, called CAPTURE 2 (Carotid ACCULINK/ACCUNET Post Approval Trial to Uncover Rare Events). A key objective of CAPTURE 2 is to gather additional and more extensive clinical data to extend Medicare coverage of carotid stenting to a broader group of patients.

On March 9, 2006, GDT announced that the company has launched the RX Herculink Elite Biliary Stent System in the U.S., following FDA 510(k) clearance. The company also received Conformité Européene (CE) Mark approval, and has begun marketing the stent system in the European Union.

On February 23, 2006, GDT announced that the FDA has completed an inspection of Guidant's Cardiac Rhythm Management facilities in St. Paul, Minnesota, and has provided Guidant a Form FDA-483, noting one inspection observation.

On February 21, 2006, GDT announced that its Board of Directors declared a first quarter dividend of $0.10 per share on outstanding common stock.

On January 30, 2006, GDT announced that the company has received Conformité Européene (CE) Mark approval for the XIENCE V Everolimus Eluting Coronary Stent System. This regulatory certification allows Guidant to begin marketing the drug eluting stent in the 25 countries of the European Union. In addition, the CE Mark approval is used to support market registrations in other regulated countries including those within Asia, Latin America and Eastern Europe.

On December 27, 2005, GDT announced that it has received a warning letter from the FDA related to FDA’s inspection of GDT’s Cardiac Rhythm Management facility in St. Paul, Minnesota. The warning letter indicated that the FDA will not approve any new ICD until the warning letter has been lifted

On December 12, 2005, GDT announced the CE Mark approval of its ACUITY Steerable heart failure lead.

The company repatriated approximately $1.5B in 1H05 under the American Jobs Creation Act 2004. GDT ended the third quarter with cash of $1995M and short-term investment of $727M. Total debt in the quarter was $355.1M.

Individual Analyst Opinions

POSITIVE RATINGS

NEUTRAL RATINGS

Zacks Investment Research Page 5 www.zackspro.com AG Edwards – Hold: Report Date: February 21, 2006: The firm maintains a Hold rating based on the belief that the 4Q05 results will not impact the BSX/GDT merger.

Prudential - Neutral weight ($78): Report Date: January 29, 2006: The firm has raised the target price from $70 to $78. The firm maintains a Neutral weight rating on GDT.

NEGATIVE RATINGS

Smith Barney – Sell ($42): Report Date: January 29, 2006: The firm has lowered the target price from $48 to $42. The firm believes that GDT has entered into a period that includes several quarters of muted financial performance.

NOT EXPLICITLY RATED

CIBC - Report Date: April 5, 2006: The firm continues to think that the Street is ignoring the potential factors that could slow the ICD market and is focusing only on the positives.

Goldman: Report Date: April 5, 2006: The firm maintains a Not Rated stance on GDT.

MorganStanley: Report Date: April 5, 2006: The firm’s rating on GDT remains suspended.

Copy Editor: Pushpanjali B

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