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STJ > SEC Filings for STJ > Form 10-Q on 7-Nov-2016All Recent SEC Filings

Show all filings for ST JUDE MEDICAL INC

Form 10-Q for ST JUDE MEDICAL INC


7-Nov-2016

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 interventional pain therapy and neurostimulation devices for the management of chronic pain and movement disorders. In the first quarter of 2016, we changed our sales reporting to closely align with how we manage the business in five key product categories:
1) Traditional Cardiac Rhythm Management (single and dual chamber tachycardia implantable cardioverter defibrillator (ICD) and bradycardia pacemaker (pacemaker) devices);
2) Heart Failure (HF) (cardiac resynchronization therapy (CRT) defibrillator (CRT-D) and pacemaker (CRT-P) devices, ventricular assist devices and heart failure monitoring devices);
3) Atrial Fibrillation (AF) (electrophysiology (EP) introducers and catheters, advanced cardiac mapping, navigation and recording systems, ablation systems and left atrial appendage occlusion);
4) Cardiovascular (vascular closure products, heart valve replacement and repair products, pressure measurement guidewires, optical coherence tomography (OCT) imaging products and fractional flow reserve (FFR) technology, structural heart defect devices, vascular plugs and percutaneous heart pumps); and
5) Neuromodulation (spinal cord stimulation and radiofrequency ablation to treat chronic pain and deep brain stimulation to treat movement disorders). Prior period amounts have been reclassified to conform to the current period's presentation. References to "St. Jude Medical," "St. Jude," "the Company," "we," "us" and "our" are to St. Jude Medical, Inc. and its subsidiaries.
This Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) should be read in conjunction with the MD&A included in our Current Report on Form 8-K filed with the SEC on June 7, 2016 for the fiscal year ended January 2, 2016 for important background including industry-wide and general economic factors affecting our business and our key business drivers. Recent Developments
Net sales for the third quarter and first nine months of 2016 increased 12% and 10%, respectively, compared to the same prior year periods. Foreign currency translation favorably impacted our third quarter 2016 net sales by $5 million and unfavorably impacted the first nine months 2016 net sales by $43 million compared to the same periods in 2015. Our increase in net sales during the third quarter and first nine months of 2016 compared to the same prior year periods was driven by the following key areas:

• We benefited from incremental net sales associated with our HF ventricular assist devices, acquired through our acquisition of Thoratec Corporation (Thoratec) during the fourth quarter of 2015.

• We experienced incremental net sales from our launch of the Proclaim™ Elite Spinal Cord Stimulation System (U.S. Food and Drug Administration (FDA) approval in November 2015).

• We continued to benefit from increased EP catheter ablation procedures, led by incremental net sales associated with our FlexAbility™ ablation catheter (FDA approval in January 2015) and our TactiCath® irrigated ablation catheter. Additionally, we benefited from increased net sales related to our AF diagnostic devices, our intracardiac echocardiography imaging (ICE) product offerings, our AF introducers and our advanced cardiac mapping systems.

• We continued to experience net sales benefits from increased transcatheter aortic valve replacement (TAVR) procedures and net sales increases related to our OCT imaging products and FFR technology, particularly in Europe.

• We also benefited from incremental net sales associated with our April 2016 U.S. launch of the Axium™ Neurostimulator System for dorsal root ganglion (DRG) stimulation.

We have also experienced partially offsetting net sales declines during the third quarter and first nine months of 2016 compared to the same prior year periods in our traditional pacemaker and ICD devices, our CRT-D devices,


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our CardioMEMS™ HF System and our mechanical heart valves. Refer to the Results of Operations section for a more detailed discussion on our net sales.

Diluted net earnings per share attributable to St. Jude Medical, Inc. for the third quarter and first nine months of 2016 were $0.73 and $1.89, respectively, driven by the revenue impacts described above and the following key items which resulted in net after-tax charges of $0.14 and $0.74 per diluted share during the third quarter and first nine months of 2016, respectively:

• We recognized after-tax acquisition-related costs, including contingent consideration fair value adjustments, of $0.04 and $0.25 per diluted share during the third quarter and first nine months of 2016, respectively.

• We recognized after-tax restructuring charges of $0.01 and $0.11 per diluted share during the third quarter and first nine months of 2016, respectively.

• We recognized unfavorable income tax adjustments of $0.01 and $0.21 per diluted share during the third quarter and first nine months, respectively.

• We recognized after-tax strategic investment impairment charges of $0.11 per diluted share during the first nine months of 2016.

• We recognized after-tax product field action costs and litigation costs of $0.08 and $0.10 per diluted share during the third quarter and first nine months of 2016, respectively.

• We recognized after-tax net benefits related to litigation matters of $0.04 per diluted share during the first nine months of 2016.

Significant cash flow activity during the first nine months of 2016 included the following key items:

• We generated $905 million of cash flows from operating activities.

• We repaid $500 million principal amount of our 5-year, 2.500% unsecured senior notes (2016 Senior Notes), made net commercial paper payments of $408 million and drew the remaining $500 million of our 5-year, $2.6 billion unsecured term loan due 2020 (Term Loan Due 2020). We also made payments of $259 million on our Term Loan Due 2020.

• We returned $258 million to shareholders in the form of dividends.

• We paid $125 million to settle the contingent consideration liability associated with the Spinal Modulation regulatory-based milestone.

On April 27, 2016, St. Jude Medical and Abbott Laboratories (Abbott) entered into an agreement and plan of merger (the Merger Agreement) (see Note 11 to the Condensed Consolidated Financial Statements).

RESULTS OF OPERATIONS
Net sales
While we manage our operations globally and believe our product category sales
are the most relevant measure of revenue performance, we also utilize geographic
area revenue data as a secondary performance measure.
The following table presents net sales to external customers for our five key
product categories (in millions):
                                        Three Months Ended                                     Nine Months Ended
                                                                            %                                                     %
                               October 1, 2016       October 3, 2015      Change     October 1, 2016       October 3, 2015      Change
Traditional Cardiac Rhythm
Management                   $         378         $             408      (7.4 )%   $       1,139        $           1,246      (8.6 )%
Heart Failure                          351                       242      45.6  %           1,109                      753      47.3  %
Atrial Fibrillation                    316                       278      13.9  %             931                      840      10.8  %
Cardiovascular                         313                       290       7.6  %             933                      908       2.7  %
Neuromodulation                        141                       121      16.6  %             397                      347      14.6  %
  Net sales                  $       1,499         $           1,339      12.0  %   $       4,509        $           4,094      10.1  %


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The following table presents net sales by significant geographic area based on customer location (in millions):

                                  Three Months Ended                              Nine Months Ended
                                                October 3,        %                             October 3,        %
                            October 1, 2016        2015         Change     October 1, 2016         2015         Change
United States              $       783         $       705       11.1 %   $       2,354        $     2,098       12.2 %
Europe                             342                 306       12.0 %           1,099              1,001        9.9 %
Japan                              135                 111       20.9 %             385                344       11.8 %
Other foreign countries            239                 217       10.0 %             671                651        3.0 %
  Net sales                $     1,499         $     1,339       12.0 %   $       4,509        $     4,094       10.1 %

Our net sales are impacted by multiple factors, the most significant of which are often impacts of acquisitions and foreign currency translation. Operational sales changes include organic volume and selling price impacts. These impacts for the third quarter and first nine months of 2016 compared to the same prior year periods were as follows:

                                             Three Months Ended    Nine Months Ended
                                              October 1, 2016       October 1, 2016
                                                  % Change             % Change
Operational                                               1.4 %                0.7  %
Acquisitions                                             10.2 %               10.5  %
Translation                                               0.4 %               (1.1 )%
   Net sales change                                      12.0 %               10.1  %

During the third quarter and first nine months of 2016, incremental net sales of our ventricular assist devices, acquired through our acquisition of Thoratec in October 2015, favorably impacted all geographies. Additionally, the U.S. continued to benefit from incremental net sales associated with our launch of the Proclaim™ Elite Spinal Cord Stimulation System (FDA approval in November 2015) and our April 2016 launch of Axium™ Neurostimulator System as well as increased EP catheter ablation procedures and net sales volume increases associated with our AF introducers, ICE product offerings and AF diagnostic devices. During the third quarter and first nine months of 2016, Europe's net sales also benefited from increased TAVR procedures and net sales volume increases associated with our OCT imaging products and FFR technology, AF introducers and our recent launch of the Proclaim™ Elite Spinal Cord Stimulation System. Partially offsetting the first nine months of 2016 net sales benefits, we experienced unfavorable foreign currency translation impacts primarily due to the U.S. Dollar strengthening against certain currencies in South America and the Euro compared to the same prior year period. Additionally, we have continued to experience a net sales decline, predominately in the U.S, in our traditional ICD and pacemaker devices as well as our CRT-D devices driven by competitive pressures from third party magnetic resonance imaging (MRI) compatible devices during the third quarter and first nine months of 2016 compared to the same prior year periods. Our CardioMEMS™ HF System also experienced net sales declines, primarily in the U.S., during the third quarter and first nine months of 2016 compared to the same periods in 2015 due to the reimbursement challenges faced by our customers. We continue to work through the national coverage determination process to expand access for patients currently not covered.

The foreign currency translation impacts to net sales are not necessarily indicative of the net earnings impact of foreign currency translation due to partially offsetting foreign currency translation impacts on cost of sales, operating expenses and our hedging program.

The net sales fluctuations for the third quarter and first nine months of 2016 compared to the same prior year periods are further discussed by our five key product categories.

Traditional Cardiac Rhythm Management: We continued to experience net sales declines in our ICD and pacemaker devices during the third quarter and first nine months of 2016 compared to the same prior year periods, primarily driven by competitive pressures from third party MRI compatible devices, predominately in the U.S, including overall average selling price declines due to a market preference for such devices. Foreign currency translation impacting net sales was flat during the third quarter of 2016 compared to the third quarter of 2015 and unfavorably impacted the first nine months 2016 Traditional Cardiac Rhythm Management net sales by $18 million (1.4 percentage points) compared to the same period in 2015.


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Heart Failure: The increase in HF net sales during the third quarter and first nine months of 2016 compared to the same prior year periods is primarily due to incremental net sales associated with our ventricular assist devices, acquired through our Thoratec acquisition. Partially offsetting the net sales increases, we continued to experience net sales declines in our CRT-D devices primarily driven by competitive pressures from third party MRI compatible devices, predominately in the U.S, including overall average selling price declines due to a market preference for such devices. We also experienced net sales declines in our CardioMEMS™ HF System during the third quarter and first nine months of 2016 compared to the same prior year periods due to the reimbursement challenges faced by our customers. Foreign currency translation unfavorably impacted third quarter and the first nine months 2016 Heart Failure net sales by $2 million (0.6 percentage points) and $8 million (1.3 percentage points), respectively, compared to the same prior year periods.

Cardiovascular: During the third quarter and first nine months of 2016, we experienced net sales volume increases associated with our TAVR products and OCT imaging products and FFR technology. Partially offsetting these increases, we continued to experience a net sales decline in our mechanical heart valves due to a market preference for tissue valves during the third quarter and first nine months of 2016 compared to the same prior year periods. Foreign currency translation favorably impacted third quarter 2016 Cardiovascular net sales by $2 million (0.6 percentage points) compared to the same prior year period and unfavorably impacted our first nine months 2016 Cardiovascular net sales by $10 million (1.2 percentage points) compared to the same period in 2015.

Atrial Fibrillation: AF continued to benefit from increased EP catheter ablation procedures and increased net sales volumes related to our AF diagnostic, ICE product offerings, AF introducers and advanced cardiac mapping systems during the third quarter and first nine months of 2016 compared to the same prior year periods. Our EP catheter ablation net sales continued to benefit from incremental net sales associated with our FlexAbility™ ablation catheter (FDA approval in January 2015) and our TactiCath® irrigated ablation catheter during the third quarter and first nine months of 2016 compared to the same prior year periods. We also experienced increased net sales volumes associated with our ICE catheters, Ensite NavX™ navigation and visualization technology, steerable diagnostic catheters and Agilis™ NxT steerable introducer during the third quarter and first nine months of 2016 compared to the same periods in 2015. Foreign currency translation favorably impacted third quarter 2016 AF net sales by $5 million (2.0 percentage points) compared to the third quarter of 2015 and unfavorably impacted the first nine months 2016 AF net sales by $3 million (0.3 percentage points) compared to the same prior year period.

Neuromodulation: The primary increase in Neuromodulation net sales during the third quarter and first nine months of 2016 was the result of incremental net sales associated with our launch of the Proclaim™ Elite Spinal Cord Stimulation System (FDA approval in November 2015) and April 2016 U.S. launch of our Axium™ Neurostimulator System for DRG stimulation compared to the same prior year periods. Foreign currency translation impacting net sales was flat during the third quarter of 2016 compared to the third quarter of 2015 and unfavorably impacted the first nine months 2016 Neuromodulation net sales by $4 million (1.3 percentage points) compared to the same prior year period.

Gross profit
                                  Three Months Ended                                      Nine Months Ended
(in millions)            October 1, 2016      October 3, 2015     Change         October 1, 2016     October 3, 2015     Change
Gross profit            $        1,004       $         914          9.8  %      $         3,031     $         2,850        6.4  %
Percentage of net sales           67.0 %              68.3 %       (1.3 )  pts.            67.2 %              69.6 %     (2.4 )  pts.

Our gross profit percentage (or gross margin) was unfavorably impacted by foreign currency translation during the third quarter and first nine months of 2016 by approximately 1.0 percentage points and 1.1 percentage points, respectively, compared to the same periods in 2015. In 2015, we began to enter into foreign exchange forward contracts to hedge against the effect of exchange rate fluctuations on cash flows denominated in foreign currencies. Our hedging program has moderately mitigated periodic fluctuations. Additionally, inventory acquired in our Thoratec acquisition was recorded at fair value, which closely approximates normal selling prices. This resulted in higher cost of sales for Thoratec products sold in the first nine months of 2016, which negatively impacted our first nine months 2016 gross margin by approximately 0.9 percentage points. We also experienced additional negative gross margin impact during the third quarter and first nine months of 2016 compared to the same prior year periods as a result of unfavorable average selling price impacts and geographic sales mix, primarily driven by competitive pressures from third party MRI compatible pacemaker, CRT-D and ICD devices.


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Special charges negatively impacted our gross margins during the third quarter and first nine months of 2016 by 1.7 percentage points and 0.8 percentage points, respectively. Special charges negatively impacted our gross margins during the third quarter and first nine months of 2015 by approximately 1.3 percentage points and 0.6 percentage points, respectively.

Our gross margins for the third quarter and first nine months of 2016 were also negatively impacted by 0.6 percentage points and 0.9 percentage points, respectively, of excise taxes assessed on the sale of our products. During the third quarter and first nine months of 2015, our gross margins were negatively impacted by 1.6 percentage points and 1.5 percentage points, respectively, of excise taxes assessed on the sale of our products. We expect the unfavorable impact of excise taxes on our gross margins to be lower in 2016 and 2017 compared to 2015 due to the H.R. 2029 law passed in December 2015 which temporarily suspends the U.S. medical device excise tax. The temporary suspension has no impact on the Puerto Rico excise tax. Selling, general and administrative (SG&A) expense

                                 Three Months Ended                                     Nine Months Ended
(in millions)           October 1, 2016      October 3, 2015     Change        October 1, 2016     October 3, 2015    Change
Selling, general and
administrative expense $          481       $           413       16.5 %      $         1,474     $         1,290      14.3 %
Percentage of net
sales                            32.1 %                30.8 %      1.3   pts.            32.7 %              31.5 %     1.2   pts.

The increase in our SG&A expense during the third quarter and first nine months of 2016 was primarily driven by net acquisition-related costs, including stock-based compensation expense for Thoratec-related replacement equity awards, transaction and integration costs, and contingent consideration fair value adjustments, of $17 million (1.1 percentage points) and $65 million (1.5 percentage points), respectively. Our third quarter and first nine months of 2015 SG&A expense was favorably impacted by net acquisition-related benefits of $8 million (0.6 percentage points) and $40 million (1.0 percentage points), respectively, primarily due to a decrease in the fair value of the Nanostim, Inc. contingent consideration liability to reflect a change in the expected timing and probability of future revenue milestone achievements. The partially offsetting benefit during the third quarter and first nine months of 2016 was primarily the result of our cost savings initiatives, including benefits associated with our restructuring activities. Research and development (R&D) expense

                                 Three Months Ended                                      Nine Months Ended
(in millions)           October 1, 2016      October 3, 2015     Change        October 1, 2016      October 3, 2015     Change
Research and
development expense    $          183       $           161       13.7 %      $          563       $          499        12.8 %
Percentage of net
sales                            12.2 %                12.0 %      0.2   pts.           12.5 %               12.2 %       0.3   pts.

Our R&D expense as a percent of net sales has remained relatively consistent, reflecting our commitment to fund growth through cost effective innovation. Our investment in R&D reflects our commitment to fund long-term growth opportunities while balancing short-term results. Our global R&D activities primarily include research, development, clinical and regulatory efforts. These efforts are primarily focused on product innovation that we anticipate will ultimately improve patient outcomes, reduce overall healthcare costs and provide economic value to our customers while providing the best possible technology available. We will continue to assess our R&D programs in future periods as we focus on the development of new products and the improvement to existing products. Our most significant clinical trials as of October 1, 2016 are summarized as follows:

• Portico Re-sheathable Transcatheter Aortic Valve System U.S. Investigational Device Exemption (IDE) Trial: The objective of this clinical trial is to evaluate the safety and effectiveness of the Portico Transcatheter Heart Valve and Delivery Systems (Portico) via transfemoral and alternative delivery methods. The clinical study will analyze the high risk cohort and extreme risk cohort together against a commercially available control for the primary safety and effectiveness endpoints.

• Thoratec Corporation MOMENTUM 3, Multi-center Study of MagLev Technology in Patients Undergoing mechanical circulatory support (MCS) Therapy with HeartMate 3™ (HM3) IDE Clinical Study Protocol: The objective of this clinical study is to evaluate the safety and effectiveness of the HM3 Left Ventricular Assist


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System (LVAS) by demonstrating non-inferiority to the HeartMate 2™ LVAS when used for the treatment of advanced, refractory, left ventricular HF. The HM3 LVAS is intended to provide hemodynamic support in patients with advanced, refractory left ventricular HF, either for short term support, such as a bridge to cardiac transplantation or myocardial recovery, or as long term support, such as destination therapy. The HM3 is intended for use inside or outside the hospital.
• Thoratec Corporation HeartMate PHP™ Coronary InterventionS in HIgh-Risk PatiEnts Using a Novel Percutaneous Left Ventricular Support Device (SHIELD II) study protocol: The HeartMate PHP™ System is a temporary (less than 6 hour procedure) ventricular assist device indicated for use during high risk percutaneous coronary interventions (PCI) performed in elective or urgent, hemodynamically stable patients with severe coronary artery disease and depressed left ventricular ejection fraction. The trial objective is to assess the safety and efficacy of the HeartMate PHP™ in supporting patients with severe symptomatic coronary artery disease with diminished but stable cardiovascular function, who are undergoing elective or urgent high risk PCI but are not candidates for coronary artery bypass graft surgery. The trial is designed as a prospective, randomized, multi-center, open-label non-inferiority trial in the U.S. comparing HeartMate PHP™ to Abiomed® Impella® 2.5 percutaneous cardiac support system.

• AMPLATZER™ Amulet™ LAA Occluder Trial (Amulet IDE): The objective of this clinical trial is to evaluate the safety and efficacy by demonstrating its performance is non-inferior to the commercially available WATCHMAN® left atrial appendage closure device in patients with non-valvular atrial fibrillation. Patients who are eligible for the trial will be randomized to receive either the Amulet device or the WATCHMAN device and will be followed for 5 years after device implant.

Amortization of intangible assets

                               Three Months Ended                                Nine Months Ended
                         October 1,                                       October 1,
(in millions)               2016         October 3, 2015       Change        2016         October 3, 2015         Change
Amortization of
intangible assets      $         47     $             23        104.3 % $        139     $             71           95.8 %

The primary increase in our intangible asset amortization expense during the third quarter and first nine months of 2016 compared to the same prior year periods was driven by our acquisition of Thoratec in October 2015. Additionally, we received FDA approval of the Axium™ Neurostimulator System in February 2016 and reclassified the related acquired in-process research and development from an indefinite-lived intangible asset to a purchased technology definite-lived intangible asset and began amortization. Special charges
We recognize certain transactions and events as special charges in our Condensed Consolidated Financial Statements. These charges (such as restructuring charges, impairment charges, certain legal settlements or product field action costs and litigation costs) result from facts and circumstances that vary in frequency and impact on our results of operations. Generally, special charges are reflected in the Condensed Consolidated Statements of Earnings within our operating expenses in a separate line item, special charges. However, based on the nature of the charge, when certain special charges impact the calculation of gross profit, they are reflected in the line item cost of sales special charges within the . . .

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