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STJ > SEC Filings for STJ > Form 10-Q on 6-Nov-2013All Recent SEC Filings

Show all filings for ST JUDE MEDICAL INC

Form 10-Q for ST JUDE MEDICAL INC


6-Nov-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW
Our business is focused on the development, manufacture and distribution of cardiovascular medical devices for the global cardiac rhythm management, cardiovascular and atrial fibrillation therapy areas and implantable neurostimulation medical devices for the management of chronic pain. We sell our products in more than 100 countries around the world. Our largest geographic markets are the United States, Europe, Japan and Asia Pacific. On August 30, 2012, we announced the realignment of our product divisions into two new business units (or divisions): the Implantable Electronic Systems Division (combining our legacy Cardiac Rhythm Management and Neuromodulation product divisions) and the Cardiovascular and Ablation Technologies Division (combining our legacy Cardiovascular and Atrial Fibrillation product divisions). In addition, we centralized certain support functions, including information technology, human resources, legal, business development and certain marketing functions. The organizational changes were part of a comprehensive plan to accelerate our growth, reduce costs, leverage economies of scale and increase investment in product development. We began reporting under the new organizational structure as of the beginning of fiscal year 2013. Our principal products in each business unit are as follows: Implantable Electronic Systems Division (IESD) - tachycardia implantable cardioverter defibrillator systems (ICDs), bradycardia pacemaker systems (pacemakers) and neurostimulation products (spinal cord and deep brain stimulation devices); and Cardiovascular and Ablation Technologies Division (CATD) - vascular products (vascular closure products, pressure measurement guidewires, optical coherence tomography (OCT) imaging products, vascular plugs and other vascular accessories), structural heart products (heart valve replacement and repair products and structural heart defect devices) and atrial fibrillation (AF) products (electrophysiology (EP) introducers and catheters, advanced cardiac mapping, navigation and recording systems and ablation systems). References to "St. Jude Medical," "St. Jude," "the Company," "we," "us" and "our" are to St. Jude Medical, Inc. and its subsidiaries.
Our industry has undergone significant consolidation in the last decade and is highly competitive. Our strategy requires significant investment in research and development in order to introduce new products. We are focused on improving our operating margins through a variety of techniques, including the production of high quality products, the development of leading edge technology, the enhancement of our existing products and continuous improvement of our manufacturing processes. We expect competitive pressures in the industry, global economic conditions, cost containment pressure on healthcare systems and the implementation of U.S. healthcare reform legislation to continue to place downward pressure on prices for our products, impact reimbursement for our products and potentially reduce medical procedure volumes.
In March 2010, significant U.S. healthcare reform legislation, the Patient Protection and Affordable Care Act (PPACA) along with the Health Care and Education Reconciliation Act of 2010, was enacted into law. As a U.S. headquartered company with significant sales in the United States, this health care reform law will materially impact us. Certain provisions of this health care reform law are not yet effective and there are many programs and requirements for which the details have not yet been fully established or consequences not fully understood, and it is unclear what the full impact will be from the legislation. The law levies a 2.3% excise tax on all U.S. medical device sales, which we began paying effective January 1, 2013. The law also focuses on a number of Medicare provisions aimed at improving quality and decreasing costs. It is uncertain at this point what impact these provisions will have on patient access to new technologies. The Medicare provisions also include value-based payment programs, increased funding of comparative effectiveness research, reduced hospital payments for avoidable readmissions and hospital acquired conditions, and pilot programs to evaluate alternative payment methodologies that promote care coordination (such as bundled physician and hospital payments). Additionally, the law includes a reduction in the annual rate of inflation for hospitals that began in 2011 and the establishment of an independent payment advisory board to recommend ways of reducing the rate of growth in Medicare spending beginning in 2014. We cannot predict what healthcare programs and regulations will be ultimately implemented at the federal or state level, or the effect of any future legislation or regulation. However, any changes that lower reimbursement for our products or reduce medical procedure volumes could adversely affect our business and results of operations. We participate in several different medical device markets, each of which has its own expected growth rate. A significant portion of our consolidated net sales are comprised of cardiac rhythm management devices - ICDs and pacemakers. During 2011, the ICD market in the United States was negatively impacted by a decline in implant volumes and pricing resulting from the publication of an ICD utilization article in January 2011 in the Journal of the American Medical Association (JAMA) and subsequent hospital investigation by the U.S. Department of Justice (DOJ). The U.S. ICD market continued to experience some of the negative impacts, and from the end of 2010 through the end of 2012 we estimated the U.S. ICD market contracted at a mid single-digit percentage rate each year. Recently, however, the U.S. ICD market appears to be stabilizing, with contraction in the first nine months of 2013 in the low single-digit percentage rates. Management remains focused on increasing our worldwide market share, as we are one of three principal manufacturers and suppliers in the global cardiac rhythm management


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market. We are also investing in our other therapy areas - cardiovascular, atrial fibrillation and neuromodulation - to increase our market share and grow sales through continued market penetration. In August 2013, we acquired Endosense S.A. (Endosense) for net cash consideration of $171 million plus an additional consideration payment upon U.S. Food and Drug Administration (FDA) approval. This acquisition expands the product offerings under our AF therapy area to include the TactiCath® irrigated ablation catheter, which has force-sensing technology that is CE Mark approved for AF and supra ventricular tachycardia ablation.
Net sales in the third quarter of 2013 increased 1% to $1,338 million compared to the third quarter of 2012. During the first nine months of 2013, net sales decreased 1% to $4,079 million over the first nine months of 2012. Foreign currency translation comparisons unfavorably decreased our third quarter and first nine months 2013 net sales by $26 million (2 percentage points) and $74 million (2 percentage points), respectively, compared to the same prior year periods. Although our net sales have been impacted by unfavorable foreign currency translation, overall ICD market contraction and average selling price declines in the cardiac rhythm management market, we have experienced net sales benefits in our AF business due to the continued increase in EP catheter ablation procedures, further market penetration of our EnSite® Velocity System and related connectivity tools as well as our intracardiac echocardiography imaging product offerings. Additionally, we have begun to experience a net sales benefit from our recent 2013 product launches including our next-generation Ellipse™ and Assura™ devices FDA approved in June 2013 and CE Mark approved in May 2013), our Accent MRI™ Pacemaker and the Tendril MRI™ lead (Japan regulatory approved in June 2013) and our Allure Quadra™ Cardiac Resynchronization Therapy Pacemaker (CRT-P), (CE Mark approved in April 2013). We have also experienced incremental net sales in the third quarter of 2013 due to our consolidation of Spinal Modulation Inc. (Spinal Modulation) in June 2013 as we are the primary beneficiary, contributing net sales from distribution of its Axium™ Neurostimulator System, a targeted therapy for chronic pain, and we continue to experience a full nine month benefit from our deep brain stimulation business, as we continue to penetrate the international market during 2013. Refer to the Segment Performance section for a more detailed discussion of the results of our reportable segments.

Our third quarter 2013 net earnings of $262 million and diluted net earnings per share of $0.90 increased 49% and 61%, respectively, compared to our third quarter 2012 net earnings of $176 million and diluted net earnings per share of $0.56. Third quarter 2013 net earnings were negatively impacted by after-tax charges of $15 million, or $0.05 per diluted share, associated with additional charges related to our previously announced 2012 business realignment and 2011 restructuring plans and acquisition-related costs. Third quarter 2012 net earnings were negatively impacted by after-tax special charges of $80 million, or $0.25 per diluted share, related primarily to the 2012 business realignment plan announced in August 2012 as well as ongoing restructuring charges related to the 2011 restructuring plan. Net earnings and diluted net earnings per share for the first nine months of 2013 were $600 million and $2.08, respectively, a 5% decrease and 4% increase, respectively, compared to net earnings of $632 million and diluted net earnings per share of $2.00 for the first nine months of 2012. The decrease in net earnings for the first nine months of 2013 over the same prior year period was due to after-tax charges totaling $236 million, or $0.81 per diluted share, which included after-tax charges of $101 million related to make-whole redemption charges and after-tax charges of $106 million associated with our previously discussed business realignment and restructuring plans, a license dispute settlement charge, an intangible asset impairment charge and other acquisition-related charges. Additionally, we recognized after-tax charges of $29 million to adjust the carrying value of our pre-existing CardioMEMS, Inc. (CardioMEMS)equity investment and fixed price purchase option to fair value during the first quarter of 2013. These charges were partially offset by a $21 million income tax benefit related to the 2012 federal research and development tax credit extended in the first quarter of 2013, retroactive to the beginning of our 2012 tax year, and a $15 million tax benefit related to the settlement and resolution of domestic tax audits with the U.S. Internal Revenue Service (IRS) during the third quarter of 2013. During the first nine months of 2012, net earnings were negatively impacted by after-tax charges of $161 million, or $0.51 per diluted share, primarily associated with business realignment and restructuring charges and a license dispute settlement charge. Refer to the Results of Operations section for a more detailed discussion of these charges.

We generated $671 million of operating cash flows during the first nine months of 2013, compared to $939 million of operating cash flows during the first nine months of 2012, with higher tax payments from the settlement of tax audits accounting for much of the decrease. We ended the third quarter with $1,245 million of cash and cash equivalents and $3,469 million of total debt. We issued $900 million principal amount of 10-year, 3.25% unsecured senior notes (2023 Senior Notes) and $700 million principal amount of 30-year, 4.75% unsecured senior notes (2043 Senior Notes) that mature on April 15, 2023 and April 15, 2043, respectively. We used a portion of the proceeds to redeem both our $700 million principal amount of 5-year, 3.75% unsecured senior notes due in 2014 (2014 Senior Notes) and our $500 million principal amount of 10-year, 4.875% unsecured senior notes due in 2019 (2019 Senior Notes). We also repaid our $450 million principal amount of 3-year, 2.20% unsecured senior notes (2013 Senior Notes) that matured on September 15, 2013.

We also repurchased 13.9 million shares of our common stock for $542 million at an average repurchase price of $38.83 per share during the first quarter of 2013. Additionally, on February 23, 2013, May 1, 2013 and July 30, 2013 our Board of


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Directors authorized quarterly cash dividends of $0.25 per share payable on April 30, 2013, July 31, 2013 and October 31, 2013, respectively, to shareholders of record as of March 29, 2013, June 28, 2013 and September 30, 2013, respectively. Our dividends represent a 9% per share increase over the same periods in 2012.

NEW ACCOUNTING PRONOUNCEMENTS
Information regarding new accounting pronouncements that impacted 2013 or our historical consolidated financial statements and related disclosures is included in Note 1 to the Condensed Consolidated Financial Statements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have adopted various accounting policies in preparing the consolidated financial statements in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are disclosed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended December 29, 2012 (2012 Annual Report on Form 10-K). Preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires us to adopt various accounting policies and to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates and assumptions, including those related to accounts receivable allowance for doubtful accounts; inventory reserves; goodwill and intangible assets; income taxes; litigation reserves and insurance receivables; and stock-based compensation. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. Actual results may differ from these estimates. There have been no material changes to our critical accounting policies and estimates from the information provided in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations included in our 2012 Annual Report on Form 10-K.

SEGMENT PERFORMANCE
Our reportable segments consist of our Implantable Electronic Systems Division (IESD) and our Cardiovascular and Ablation Technologies Division (CATD). Our principal products in each segment are as follows: IESD - tachycardia implantable cardioverter defibrillator systems (ICDs), bradycardia pacemaker systems (pacemakers) and neurostimulation products (spinal cord and deep brain stimulation devices); and CATD - vascular products (vascular closure products, pressure measurement guidewires, optical coherence tomography (OCT) imaging products, vascular plugs and other vascular accessories), structural heart products (heart valve replacement and repair products and structural heart defect devices) and AF products (EP introducers and catheters, advanced cardiac mapping, navigation and recording systems and ablation systems).
Net sales of our reportable segments include end-customer revenues from the sale of products they each develop and manufacture or distribute. The costs included in each of the reportable segments' operating results include the direct costs of the products sold to customers and operating expenses managed by each of the reportable segments. Certain expenses managed by our selling and corporate functions, including all stock-based compensation expense, impairment charges, certain acquisition-related expenses, in-process research and development (IPR&D) charges, excise tax expense, special charges and centralized support groups' operating expenses are not recorded in the IESD and CATD reportable segments. As a result, reportable segment operating profit is not representative of the operating profit of the products in these reportable segments.


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The following table presents net sales and operating profit by reportable segment (in millions):

                                         IESD       CATD       Other      Total
Three Months ended September 28, 2013:
Net sales                              $   786    $   552    $     -     $ 1,338
Operating profit                           534        321       (542 )       313
Three Months ended September 29, 2012:
Net sales                              $   792    $   534    $     -     $ 1,326
Operating profit                           547        319       (631 )       235

Nine Months ended September 28, 2013:
Net sales                              $ 2,389    $ 1,690    $     -     $ 4,079
Operating profit                         1,630        995     (1,722 )       903
Nine Months ended September 29, 2012:
Net sales                              $ 2,482    $ 1,649    $     -     $ 4,131
Operating profit                         1,720        980     (1,825 )       875

The following discussion of the changes in our net sales is provided by class of similar products within our reportable segments. Implantable Electronic Systems Division

                                     Three Months Ended                                          Nine Months Ended
                           September 28,                                  %                                                             %
(in millions)                  2013            September 29, 2012       Change       September 28, 2013      September 29, 2012       Change
ICD systems              $           418     $                412         1.5  %   $         1,299          $             1,321        (1.7 )%
Pacemaker systems                    264                      279        (5.4 )%               779                          851        (8.5 )%
Neuromodulation products             104                      101         3.0  %               311                          310         0.3  %
                         $           786     $                792        (0.8 )%   $         2,389          $             2,482        (3.7 )%

IESD's net sales decreased 1% and 4% during the third quarter and first nine months of 2013 compared to the same prior year periods. During the third quarter and first nine months of 2013, foreign currency translation had a $9 million (1 percentage point) and $27 million (1 percentage point), respectively, unfavorable impact on net sales compared to the same prior year periods. ICD net sales increased 2% during the third quarter of 2013 and decreased 2% during the first nine months of 2013 compared to the same prior year periods. Our U.S. 2013 third quarter ICD net sales of $253 million increased 2% compared to the same prior year period, and our U.S. ICD net sales during the first nine months of 2013 of $778 million were flat compared to the same period in 2012. Although the ICD market has been experiencing low to mid-single digit percentage rate declines in average selling prices, we have begun to experience a sales volume benefit from our June 2013 FDA approval of our next-generation Ellipse™ and Assura™ devices featuring DynamicTx™ Over-Current Detection Algorithm, which automatically adjusts shock configurations and utilizes a new low friction coating on the device can to reduce the risk for lead-to-can abrasion, the most common type of lead insulation failure in the industry. Internationally, our third quarter and first nine months of 2013 ICD net sales of $165 million and $521 million, respectively, were flat and decreased 4%, respectively, compared to the same prior year periods. Foreign currency translation had a $3 million (1 percentage point) and $13 million (1 percentage point) unfavorable impact on international ICD net sales in the third quarter and first nine months of 2013, respectively, compared to the same periods in 2012 primarily as a result of the strengthening U.S. Dollar against the Japanese Yen. Going forward, we expect to benefit from our next-generation Ellipse™ and Assura™ devices featuring DynamicTx™ Over-Current Detection Algorithm, which received CE mark approval in May 2013.
Pacemaker systems net sales decreased 5% and 9% during the third quarter and first nine months of 2013, respectively, compared to the same prior year periods primarily driven by overall market declines in average selling prices and unfavorable foreign currency translation. In the United States, our third quarter 2013 pacemaker systems net sales of $107 million decreased


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6% compared to the same prior year period. During the first nine months of 2013, U.S. pacemaker systems net sales of $324 million decreased 7% compared to the same period in 2012. Internationally, our 2013 net sales during the third quarter of $157 million and first nine months net sales of $455 million decreased 5% and 10%, respectively, compared to the same prior year periods. Foreign currency translation had a $6 million (2 percentage points) and $14 million (2 percentage points) unfavorable impact on international pacemaker systems net sales during the third quarter and first nine months of 2013 compared to the same prior year periods. International pacemaker sales began to benefit from our July 2013 launch of our Accent MRI™ Pacemaker and the Tendril MRI™ lead, which received regulatory approval from the Japanese Ministry of Health, Labor and Welfare in June 2013, partially offsetting the impact of average selling price declines and unfavorable foreign currency translation. We also benefited from sales of our Allure Quadra™ CRT-P, which received CE Mark approval in April 2013.

Neuromodulation products net sales increased 3% during the third quarter of 2013 and were flat during the first nine months of 2013 compared to the same prior year periods. The increase in net sales during the third quarter of 2013 compared to the same prior year period was driven by our investment in Spinal Modulation and the net sales benefit from their Axium™ Neurostimulator System, for which we are the exclusive distributor. The Axium™ Neurostimulator System provides a more targeted therapy for patients suffering with chronic pain and is available for sale in Europe and Australia. Additionally, we continued to benefit from our deep brain stimulation business for patients suffering from Parkinson's disease, essential tremor or dystonia, as we continue to penetrate the international market. Foreign currency translation did not have a significant impact during the third quarter and the first nine months of 2013 compared to the same prior year periods. Cardiovascular and Ablation Technologies Division

                                   Three Months Ended                                        Nine Months Ended
                         September 28,                                 %                                                           %
(in millions)                2013            September 29, 2012      Change      September 28, 2013      September 29, 2012      Change
Atrial fibrillation
(AF) products          $           235     $                220       6.8  %   $           705          $               659       7.0  %
Vascular products                  168                      169      (0.6 )%               521                          530      (1.7 )%
Structural heart
products                           149                      145       2.8  %               464                          460       0.9  %
                       $           552     $                534       3.4  %   $         1,690          $             1,649       2.5  %

CATD net sales increased 3% during both the third quarter and first nine months of 2013, respectively, compared to the same prior year periods. Foreign currency translation unfavorably impacted CATD net sales by $17 million (3 percentage points) and $47 million (3 percentage points) during the third quarter and first nine months of 2013 compared to the same periods in 2012.

AF products net sales increased 7% during both the third quarter and first nine months of 2013, respectively, compared to the same prior year periods primarily due to the continued increase in EP catheter ablation procedures, the continued market penetration of our EnSite® Velocity System and related connectivity tools (EnSite Connect™, EnSite Courier™ and EnSite Derexi™ modules) and our intracardiac echocardiography imaging product offerings, which provide physicians a clear picture of the inner workings of the heart through an ultrasound probe. Foreign currency translation had a $7 million (3 percentage points) and $19 million (3 percentage points) unfavorable impact on AF products net sales during the third quarter and first nine months of 2013 compared to the same periods in 2012. Going forward we expect to benefit from our recent European launch of our TactiCath® irrigated ablation catheter, acquired through our Endosense acquisition in August 2013. The TactiCath® irrigated ablation catheter provides physicians a real-time, objective measure of the force to apply to the heart wall during a catheter ablation procedure.

Vascular products net sales decreased 1% and 2% during the third quarter and first nine months of 2013, respectively, compared to the same prior year periods primarily due to unfavorable foreign currency translation of $7 million (4 percentage points) and $18 million (3 percentage points) during the third quarter and first nine months of 2013, respectively, and net sales declines related to our third party products we distribute in Japan compared to the same periods last year. As a result of the economic pressures and average selling price declines in the Japan market, many third party manufacturers have migrated to a direct selling model with end customers, which resulted in a revenue decrease during the third quarter and first nine months of 2013 compared to the same prior year periods. These decreases were partially offset by increased revenues in our Fractional Flow Reserve FFR technology products and OCT imaging products during the third quarter and first nine months of 2013 compared to the same prior year periods. Going forward we expect to benefit from our recent European launch of our next-generation EnligHTN™ Renal Denervation System for treating patients with drug-resistant, uncontrolled hypertension, which received CE Mark approval in late August 2013.


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Structural heart products net sales increased 3% and 1% during the third quarter and first nine months of 2013, respectively, compared to the same periods in 2012. The increases were primarily driven by sales of our Trifecta™ pericardial stented tissue valve and our AMPLATZER™ occluder products, partially offset by a net sales decrease in our mechanical valves due to market preference for tissue valves. Additionally, foreign currency translation had a $3 million (2 percentage points) and $10 million (2 percentage points) unfavorable impact on structural heart products net sales during the third quarter and first nine months of 2013, respectively, compared to the same periods in 2012.

RESULTS OF OPERATIONS
Net sales
                                Three Months Ended                                        Nine Months Ended
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