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St. Jude Medical, Inc. (NYSE:STJ)

Q1 2009 Earnings Call

April 22, 2009 8:00 am ET

Executives

Daniel J. Starks - Chairman, President, and Chief Executive Officer

John C. Heinmiller - Chief Financial Officer

Eric S. Fain - President, Cardiac Rhythm Management Division

Michael T. Rousseau - Group President

Joseph H. McCullough - Group President

Angela D. Craig - Vice President, Corporate Relations

Analysts

Frederick Wise - Leerink Swann

Robert Hopkins - Bank of America

Bruce Nudell - UBS

Michael Weinstein - J.P. Morgan

Kristen Stewart - Credit Suisse

David Lewis - Morgan Stanley

Larry Biegelsen - Wachovia Capital Markets

Operator

Welcome to St. Jude Medical’s first quarter 2009 earnings conference call. Hosting the call today is Dan Starks, Chairman, President, and Chief Executive Officer of St. Jude Medical.

The remarks made during this conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Such forward-looking statements include the expectations, plans and prospects for the company, including potential clinical success, anticipated regulatory approvals, and future product launches and project revenues, margins, earnings, and market shares.

The statements made by the company are based upon management’s current expectations and are subject to certain risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. These risks and uncertainties include market conditions and other factors beyond the company’s control, and the risk factors and other cautionary statements described in the company’s filings with the SEC including those described in the risk factors and cautionary statement sections of the company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2009. The company does not intend to update these statements and undertakes no duty to any persons to provide any such updates under any circumstance.

At this time all participants have been placed on a listen-only mode. The floor will be opened for questions following the presentation. It is now my pleasure to turn the floor over to Dan Starks.

Daniel J. Starks

Welcome to St. Jude Medical’s first quarter 2009 earnings conference call. With me on the call today as usual are John Heinmiller, Executive Vice President and Chief Financial Officer; Eric Fain, President of our Cardiac Rhythm Management Division, Mike Rousseau, Group President; Joe McCullough, Group President; and Angie Craig, Vice President of Corporate Relations.

I want to first ask John Heinmiller to conduct his normal review of our first quarter results along with his typical update for the entire St. Jude Medical business. I will then address several topics and open it up for your questions.

John C. Heinmiller

Sales for the quarter totaled $1.134 billion, up approximately 12% over the $1.11 billion reported in the first quarter of last year. Unfavorable foreign currency translations versus last year’s first quarter decreased this quarter’s sales by about $51 million. On a constant currency basis first quarter increased 17.2% versus last year. Earnings per share were $0.58 for the first quarter of 2009, a 12% increase over adjusted EPS of $0.52 in the first quarter of 2008.

As we mentioned in our January conference call, we estimate that for 2009 generally between 45% and 55% of the revenue impact from foreign currency translations flows through to our operating profits. Given this dynamic on a currency neutral basis, our adjusted earnings per share growth this quarter would approximate 20%.

As a reference point adjusted EPS in last year’s first quarter now includes the impact of retroactively adjusting our historical financial statements as required by GAAP to reflect the change in accounting related to convertible debentures which had the effect of increasing our non-cash interest expense.

Before we discuss our first quarter 2009 sales results by product category with guidance for the second quarter and the remainder of 2009, let me comment on foreign currency. Specifically the two main currencies influencing St. Jude Medical’s operations are the euro and the yen. In our January conference call we explained that in preparing our sales and earnings guidance for the first quarter and the full year 2009, we used exchange rates which assumed that each euro would translate into about $1.27 to $1.32 and for the yen each 87 to 92 yen would translate into $1. For the first quarter the actual exchange rates for the euro and the yen were generally consistent with these ranges.

Now, turning to our assumptions for the second quarter and the remainder of 2009, we note that while the euro did demonstrate some volatility during the first quarter, we generally comfortable continuing to use the assumption that each euro will translate into about $1.27 to $1.32. However, the US dollar has strengthened relative to the yen and we are now assuming that each 97 to 102 yen will translate into $1. This adjustment in the yen exchange rate assumption is expected to negatively impact our reported sales in the remaining three quarters of 2009 by approximately $40 million.

Now for the sales by product category discussion. For the first quarter, total cardiac rhythm management sales which includes revenue from both our ICD and pacemaker product lines were $676 million, up 7% from last year’s first quarter including $31 million of unfavorable foreign currency translation. On a constant currency basis, first quarter CRM sale increased 12% versus last year. For the first quarter ICD sales were $394 million, up 9% from last year’s first quarter. On a constant currency basis, first quarter ICD sales increased 14% versus last year. US ICD sales were $258 million, up 9% from last year’s first quarter. International ICD sales were $136 million, a 9% increase over the first quarter of 2008 including $18 million in unfavorable foreign currency translations.

For low-voltage devices, sales for the first quarter totaled $282 million, up 4% from last year’s first quarter. On a constant currency basis, first quarter low-voltage device sales increased 9% versus last year. In the United States, pacemaker sales were $129 million, up 6% from last year’s first quarter. In our international markets, pacemaker sales were approximately $153 million, up 3% from last year’s first quarter including $13 million of unfavorable foreign currency translations.

For the second quarter of 2009, we expect total CRM product sales to be in the range of $690 million to $720 million and for the full year 2009 we expect total CRM sales to be in the range of $2.820 billion to $2.900 billion.

Atrial fibrillation or AF product sales for the first quarter totaled $145 million, up 22% over the first quarter of last year including $6 million of unfavorable foreign currency translations. On a constant currency basis, first quarter AF product sales increased 27% versus last year. For the second quarter of 2009, we expect AF product sales to be in the range of $145 million to $160 million, and we now expect our full year 2008 AF product sales to be in the range of $640 million to $670 million. This 2009 outlook range is slightly less than the full year 2009 guidance range we provided last quarter which primarily reflects the stronger US dollar versus the yen.

Total sales of cardiovascular products for the first quarter of 2009 were $240 million, up 15% over the first quarter of 2008 including $12 million of unfavorable foreign currency translations. On a constant currency basis, first quarter cardiovascular product sales increased 21% versus last year. This product category includes sales of products that St. Jude Medical acquired from Radi Medical Systems in December 2008. Within this category of products sales of vascular closure products in the first quarter of 2009 were $98 million, up 9% over the first quarter of 2008. Sales of heart valve products in the first quarter of 2009 were $81 million, a 4% increase over the first quarter of 2008.

For the second quarter of 2009, we expect cardiovascular product sales to be in the range of $235 million to $250 million. We now expect full year 2009 cardiovascular product sales to be in the range of $955 million to $985 million. This 2009 outlook range is slightly less than the full year 2009 guidance range we provided last quarter which primarily reflects the stronger US dollar versus the yen.

Total sales of neuromodulation products in the first quarter of 2009 were $73 million, up 40% from the first quarter of 2008 including $2 million of unfavorable foreign currency translation. For the second quarter of 2009, we expect sales of neuromodulation products to be in the range of $70 million to $75 million and we now expect full year 2009 neuromodulation sales in the range of $295 million to $315 million.

The geographic breakdown of St. Jude medical sales in the first quarter of 2009 was 55% in the United States versus 45% outside the United States or OUS. This compares to 53% US and 47% OUS in the first quarter of 2008. A detailed geographic breakdown of this quarter’s sales by product shows high-voltage at $258 million US and $136 million OUS, low-voltage at $129 million US and $153 million OUS, atrial fibrillation products at $69 million US and $76 million OUS, cardiovascular product sales at $103 million US and $137 million OUS, and finally neuromodulation product sales at $62 million US and $11 million OUS.

The gross profit margin this quarter was 74.0% representing a 20 basis point decline over the first quarter of 2008 as the negative impact of foreign currency was partially offset by productivity improvement. For the full year 2009, we continue to expect gross profit margins to be in the range of 73.5% to 74.5%.

Our first quarter SG&A expenses were 36.8% of net sales consistent with the fourth quarter of 2008 and for the full year 2009 we forecast SG&A as a percentage of net sales to be in the range of 36.0% to 36.5%. Research and development expenses in the first quarter of 2009 were 12.3% of net sales compared to 12.2% in the first quarter of 2008. For the full year 2009, we continue to expect R&D expense to be in the range of 12% to 13% of net sales as we continue to balance delivering short-term results with the right investment in long-term growth drivers.

Net other expense was $7 million in the first quarter. For the second quarter of 2009, we expect the other income and expense line items will again be a net expense of approximately $7 million. For the full year 2009, we expect other expense of approximately $20 million to $25 million.

For the first quarter the company’s effective income tax rate was 26.8% and for 2009 we continue to expect the tax rate to be in the range of 26.5% to 27.0%.

Moving on to the balance sheet, at the end of the first quarter of 2009, we had $325 million in cash and cash equivalents and $1.305 billion in total debt. The outstanding debt on our balance sheet includes $1.013 billion of borrowings under our domestic credit facilities which mature in 2011 and $292 million of notes issues in Japan which mature in 2010 and 2011. The weighted average interest rate on our borrowings at the end of the first quarter was approximately 1.6%.

Next I want to offer some comments regarding our EPS outlook for the second quarter and the full year 2009. In preparing our EPS guidance we have assumed that in the second quarter of 2009 the share count used in our fully diluted EPS calculation will be about 349 million to 351 million shares with the weighted average outstanding shares for the full year 2009 at 351 million to 353 million. The company expects consolidated earnings per share for the second quarter to be in the range of $0.62 to $0.64. For the full year 2009 we continue to expect consolidated EPS to be in the range of $2.48 to $2.54. Our 2009 full year earnings per share guidance reflects the change in the US dollar versus the yen which is expected to be offset by the overall strength and continued growth of our business.

I would now like to turn it back to Dan Starks.

Daniel J. Starks

The strength of our first quarter results reinforces the messages we delivered at our annual investor conference on February 6, 2009. One core message was that St. Jude Medical is well positioned to deliver sustained double-digit sales growth. Total St. Jude Medical’s sales during the first quarter increased over 17% on a constant currency basis compared with the first quarter one year ago. If we adjust for the sales benefit we received from acquiring Radi Medical Systems in December 2008, St. Jude Medical’s organic sales still increased over 15% on a constant currency basis during the first quarter compared with the same quarter one year ago.

A second key message we delivered during our February 6th conference was that we will continue to gain market share in our cardiac rhythm management or CRM business consisting of our pacemaker and ICD product line. First quarter results confirm that we have continued to gain share in our CRM business as reflected in constant currency sales growth of 12% for our global CRM business and sequential quarter growth for our global ICD business.

We expect the competitive position of our CRM business to continue to strengthen during the remainder of 2009 as we leveraged the benefit of our AnalyST and AnalyST Accel ICD launches in Europe, the upcoming launch of our Accent and Anthem pacemakers with wireless RF telemetry, and all of the other CRM new product launches we outlined during our February 6th conference. This includes our Promote Plus and Current Plus ICDs in the United States, our Promote Accel and Current Accel ICDs in Europe, and in Japan our Zephyr and Frontier II pacemakers together with our Current RF and Promote RF ICDs. These new device launches are supported in all markets by the only 7-French high-voltage lead, new leads, new lead delivery tools, and expanded remote follow up capabilities. These new device launches also are supported by the strongest contracting program in the largest and most competitive global field sales and support organizations that St. Jude Medical has ever had in place.

A third key message we delivered at our February 6th investor conference was that we have revitalized our cardiovascular franchise and that going forward we expect our cardiovascular business to deliver double-digit sales growth on a sustainable basis. During the first quarter our cardiovascular business grew over 21% on a constant currency basis including strong double-digit organic growth in our vascular closure, tissue valve, and PressureWire product lines. We continue to foresee sustained double-digit sales growth in our cardiovascular franchise on the strength of our Angio-Seal Evolution technology, our new PressureWire Aeris technology, a continuous flow of new heart value repair products, the anticipated launch of our Trifecta pericardial tissue valve product line in Europe by the end of 2010 and in the United States by the end of 2011, and ultimately our transcatheter aortic heart valve replacement programs.

A fourth key message at our annual investor conference was that neuromodulation is one of the best growth opportunities in the medical device space and that we expect to continue delivering accelerated growth from this portion of our business. Neuromodulation revenue exceeded our expectations by growing 44% on a constant currency basis during the first quarter. This reflects the value customers place on our new Eon Mini product line together with the capabilities of our global field sales and support organizations. Demand for our Eon Mini product line continued to exceed supply during the first quarter. We expect to resolve these constraints during the current quarter.

Looking forward to the remainder of 2009 we expect continued robust growth in our neuromodulation business as we fully leverage the value of our Eon Mini product line and continue to enter the deep brain stimulation market in Europe with our Libra product line. In addition, we are on track to complete enrolment within the next few weeks in our two US pivotal trials focused on gaining indications for patients suffering from Parkinson’s disease and from migraine headaches.

A fifth key message at our annual investor conference focused on the success of our atrial fibrillation or AF business. We pointed out that the depth and breadth of our AF program including our strong product development pipeline leaves us well positioned to maintain our leadership in AF. Global revenue for AF related products increased 27% on a constant currency basis during the first quarter without the benefit of significant new products. This compares to constant currency sales growth of AF related products for full year 2008 of 29%. We look forward to strengthening the growth of our AF program the remainder of 2009 with the launch of our next-generation EnSite Velocity product line, initial integration of EnSite with our EP-WorkMate recording system, and longer term, the integration of our MediGuide navigation technology into our catheter and EnSite product development program.

A sixth key message at our February investor conference was that we are on track to improve our operating margin to approximately 29% by 2012 with a variety of specific continuous improvement initiatives. On April 9th we dedicated our new hybrid manufacturing facility in Liberty, South Carolina. This will simultaneously create at least 300 new jobs in the United States and help us reduce our pacemaker and ICD manufacturing costs. We continue to expand pacemaker and ICD manufacturing at our new Arecibo facility in Puerto Rico. We are on schedule with our programs to establish new manufacturing facilities in Brazil, Costa Rica, and in Malaysia, which ultimately will help reduce our average cost of goods sold for virtually all products.

We continue to implement our SAP Enterprise software system together with our entire program to improve SG&A to a series of specific productivity improvement initiatives by 2012.

In conclusion, St. Jude Medical’s first quarter results fully met or exceeded the expectations we created at our annual investor conference on February 6, 2009. We look forward to the remainder of the year with strong confidence that our growth expectations are realistic and that St. Jude Medical’s growth program is on track now and for the long term.

That concludes our prepared remarks. I’d like to now turn the call back to Celes and ask Celes to moderate the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will come from the line of Frederick Wise - Leerink Swann.

Frederick Wise - Leerink Swann

A couple of questions; first, just the integral question about the ICD market, your perspective on current market trends Dan, and particularly as it relates to pricing; if you could give us some perspective on the pricing impact in the quarter and the outlook for the year as a lot of doctors we’re talking to seem to be ever more focused on driving prices down; would appreciate your perspective.

Daniel J. Starks

It would not surprise me Rick that physicians you are talking to would be increasingly focused on driving prices down and the hospital administration has always been intensively focused on driving prices down; so I think the world looks a little bit different from different individual perspectives, but from a global perspective for St. Jude Medical what strikes us the most about ICD market dynamics is the stability of them. So, we see stable trends in average selling prices which include ongoing significant price pressure which is really business as normal for us and has been for a number of years. We’ve seen no change in continued pressure on average selling prices. We see stable dynamics on procedure volumes and we see stable dynamics on customer inventory levels. We are encouraged that we continue to anticipate that as data becomes clearer that we have some continued growth in de novo implants in the United States as well as continued strong growth in the replacement market, and on a total global basis for ICDs, we clearly see growth in the de novo segment as well as strong growth in the replacement segment. Looking forward to the remainder of this year, there is nothing in particular that leads us to expect a change in these stable dynamics. A couple of things that are on our radar screen are the upcoming results of the MADIT-CRT clinical trial. Like you and like everybody else we’re waiting to get confirmation whether these data will be presented at the late-breaking clinical trials of HRS; we don’t know if they will be or not, but we hope that they are, and it seems that the clinical majority view is that the MADIT-CRT is likely to have some good news for positive change to ICD market dynamics.

The other thing that we look at going forward through the remainder of the year is the impact of new technology that we’re bringing to the market and the most significant one is in Europe with our AnalyST and our AnalyST Accel ICD technology, the ST segment monitoring capability, and we’re optimistic that as that technology becomes well known as more key opinion leaders work with it and help us define the value and limits of that technology that we’re right on that path of adding more capability to devices that get implanted so that when referring physicians or patients or implanting physicians might be on the fence about whether to implant a device in a particular patient there is more technology and more benefit to that implant to help aid that decision. So, those are our comments and I’d be happy to take it over.

Frederick Wise - Leerink Swann

A different follow up just touching on the warning letter you announced last night; I appreciate this is a small product line, can you give any perspective on any larger issues, did this impact the facility, the time you had hoped to resolve it, and does this affect any of the product rollouts that you highlighted at the analysts’ meeting or today, Dan?

Daniel J. Starks

No, it doesn’t affect any product rollouts that we have mentioned previously. This warning letter relates to a documentation issue. First and foremost there is never an excuse for incomplete documentation and the process that we went through here was first we had a very extensive inspection from FDA in December followed by a Form 43 and observations of incomplete documentation. We shouldn’t need an inspection from FDA to point out to us that we have incomplete documentation. So this was a very appropriate warning letter and from an objective perspective really will help make us a better company. It’s embarrassing to me, it’s embarrassing to all of us that we put ourselves in a position where we deserved this warning letter. We already have remediated most of the observations, we’re in the process of remediating the remainder of the observations, we want to get it behind us as quickly as we can. I don’t want to say that we have somewhat of an organizational expertise in responding to warning letters on the one hand. On the other hand we do have prior experience; in 2005, we received a warning letter as I know you’d recall and some others would as well, on our Angio-Seal product line and so we’ve been through this process just like with that Angio-Seal related warning letter, we want to get the conditions that led to the warning letter fully remediated and get this issue behind us and would take it as a lesson learned to help us increase the robustness of our internal audit processes and make sure that we keep ourselves in a position where we don’t deserve another warning letter.

I think again from an objective perspective I think all of this really does show that we have effective medical device regulatory system here in the United States; that the system is working in the way that it’s supposed to; quality is clearly important enough; that it’s good to have another set of eyes conducting audits in addition to everything that we do on an internal basis. So, from that perspective as people on the public policy front and others from outside the industry look at medical devices and look at what is working well and what isn’t working, I think that this is an indication that the US regulatory system is robust and on guard and doing what it’s supposed to do.

Frederick Wise - Leerink Swann

Again, no impact on PMAs or 510(k) approvals in the next 12 to 24 months?

Daniel J. Starks

We don’t expect any.

Operator

Our next question comes from the line of Robert Hopkins - Bank of America.

Robert Hopkins - Bank of America

Dan, just following up on the warning letter on the cost side; do you anticipate any incremental cost to fix the issues?

Daniel J. Starks

None other than what we’ve already included dating back to the last quarterly conference call. This is not a new topic for us. This topic was flagged to us in December as a result of the routine inspection of this particular manufacturing site. So, we’ve been fully focused on remediating these documentation issues and it’s not a severe thing in expenses, it’s not about money, it’s just about making sure that we keep ourselves out of this position going forward in the future. So, there’s nothing here that would be different for any of our spending expectations or any of our guidance or any of our revenue expectations in any respect.

Robert Hopkins - Bank of America

Two other ones; one for you and one for John. On the ICD side, your business has remained resilient despite a seasonally tougher quarter given that it’s Medtronic’s fiscal fourth quarter, and I was just wondering in the past you’ve talked about de novo implant business at St. Jude, that as a business it’s growing, and I was wondering if that’s still the case, has it accelerated of late, and also in the past you’ve said that the percentage of your total ICD revenues that comes from replacements is still materially below the levels of your competitors which they have disclosed is in the 30% range, and I was just wondering if there’s been any change on either one of those fronts; and then just quickly for John lastly, that $40 million incremental FX headwind, does that accrete to about $0.04 and so you’re obviously saying here that the underlying strength in the business can make up that $0.04; just wanted to make sure my math is right.

John C. Heinmiller

The answer to that is yes.

Daniel J. Starks

To your first question on replacement and de novo, the dynamics that we spelled out about two months ago at our February 6th investors’ conference remain intact and these dynamics really do have quite a bit of lead time to them with respect to replacements and so we think these are stable dynamics and very transparent dynamics in the way that our replacement business is a smaller percent of our total revenue due to our market share five years ago than is the case with at least two other participants in the market. So, the observation that a number of people have made that our de novo market share really is higher than is apparent in our reported sales than in our mathematical calculated market share remains true and the fact that we’re actually selling against this replacement headwind and as we already have gained the market share we’ve gained and as we continue to gain market share this headwind will convert into a tailwind and have significant implications for our opportunity to continue to gain reported market share all remains very true. It also remains true then that as we look at de novo implants versus other companies looking at de novo implants, it’s understandable that our observations would be different. We’re taking business in the de novo market where we’re seeing more de novo implants. We recognize that as an increase in the de novo segment to the extent that that’s a less of an increase in the de novo segment and instead reflects our continued market share gain, it’s something that’s hard for us to sort through, but clearly that’s the strength of our business; the de novo portion of the total market.

Even more so another part of our strong competitive advantage in ICDs is our high-voltage lead line and that really only becomes a factor with respect to de novo implants. So, you’re exactly right about all of those dynamics. Those dynamics are stable dynamics. We expect to continue to see the benefit of them over the next years to come and we have not seen any change during this last quarter.

Robert Hopkins - Bank of America

Dan, will you disclose the percentage of your ICD revenues that comes from replacements?

Daniel J. Starks

It’s less than 30%.

Operator

Our next question comes from the line of Bruce Nudell - UBS.

Bruce Nudell - UBS

I had a question for you Dan just to put a finer point on Bob’s question. We did an analysis that really suggested that your passive reported market share gains just by virtue of your ramp of de novo implants could be around a 100 basis points per year for three to five years; is that in the ballpark?

Daniel J. Starks

You got me between a rock and a hard place, Bruce; on the one hand, I don’t want to offer any multi-year guidance, on the other hand, I would note that you have good insights.

Bruce Nudell - UBS

Okay, thank you; and another thing, Dan, is just on ICDs and I have one followup; the US market has really remained insulated to outside competitors and this really is reflective of a question posed to me by a client; Biotronik has been a vendor that’s been around a long time, obviously, builds high quality implants; do you ever see another player entering the US CRM market in a significant way?

Daniel J. Starks

If anybody in this space says no, then one ought to think that people are getting a little bit cocky; so I think long term, we think of emerging markets, we think of growing economies, we think of manufacturers that don’t exist today potentially originating in up and coming economies, and we operate as though we are at risk of a new competitor coming into the space at any time, and what that does is it just keeps us absolutely sharp, absolutely focused, urgent in all of our continued expansion of technology, and the idea is that as long as we keep moving as fast as we are and as fast as we have to come up from where we were, last into the market, third into the market and had to fill in a lot of product line hose, we did it with fewer resources, look at all the progress we’ve made over 10-1/2 years, look at the consistent gain of market share, look at the way that we now really are in so many meaningful ways the leading innovator in this space, why couldn’t somebody else do that over a prolonged period of time with a strong focus; really the only protection we have against that is to keep moving forward faster than anybody else could move to catch us; so whether you’re asking with respect to somebody who’s name might be on your radar screen already which really there isn’t anyone we take as a credible set that way or if you would be thinking about somebody completely new working to come into this space, our organizational habit and our leadership focus is to conduct ourselves in a way that would best mitigate against that risk.

Bruce Nudell - UBS

And I guess my only other question is I think last year at the analyst day meeting you presented data that basically said you’re about 70,000 US ablations, there’re clearly at least a million people in the US for highly symptomatic and drug refractory, what’s required and when will we see a real inflection point in the rate of growth of procedures?

Daniel J. Starks

The best think I could say, Bruce, is first of all, I’ll start off by saying that I certainly don’t have a special crystal ball; the way that we think about it though is we analogize to the ICD market, and the way that the ICD market developed with the first implants as I recall in 1983, it took some 15 to 20 years to get to the very strongest part of that growth curve; first catheter based ablations of chronic atrial fibrillation were in 1993, so from that very less perspective, we’re about 10 years behind the market development of ICDs, I think part of it got the ICD market really accelerating its growth as the denominator got larger with landmark clinical trials; that’s what we look to for the atrial fibrillation ablation market though we think that the market really needs the kind of landmark clinical trials with all of the characteristics that would make the clinical trial landmark to us and that’s the CABANA trial. I think we need the CABANA trial or an equivalent to the CABANA trial, and then other additional supporting trials, a number of which are already in the works to create the consensus in the referring community, to create the consensus in the reimbursement community that atrial fibrillation ablation procedures not only are best for patients but that these procedures also reduce the cost of healthcare, and so, really check both of those boxes very very positively.

So, I think that’s what we need, and along the way besides an accumulating database of positive clinical results and positive cost effectiveness results, besides that, along the way we’ll continue to do what we need to do and will do and I really don’t think it’s a risk factor, I think it’s something that we’re all making a lot of progress getting at. We need to keep making these procedures simpler and quicker, and we need to keep working to reduce the risk of any complication from the procedure. So, we’ve made a lot of progress since 1993 on all of those fronts, and we have strong pipeline of technologies and programs to continue to make progress on all of those fronts out to the limits of our planning horizon, I’m confident we’ll do it and I don’t doubt that other organizations will contribute to that too.

So, I think all those things will come together here over the next 5 years or so to keep the already robust growth dynamics going strongly even as the developed market itself gets larger.

Operator

Our next question comes from line of Michael Weinstein - J.P. Morgan.

Michael Weinstein - J.P. Morgan

Dan, let me start with just one ICD question; do you think your share gains on the lead side are still outpacing your gains on the IPG side, do these only come with the 7-French lead?

Daniel J. Starks

Yes.

Michael Weinstein - J.P. Morgan

Then, let me ask you a neuromodulation question or a couple of question; it would look from our math that you gained year-over-year about 4-point mark of share in the neurostim market; I was wondering if you could give us your thoughts on market growth and help us think about the constraints you have right now in the Eon Mini?

Daniel J. Starks

My recollection, and please take this as an approximate number rather than one where I have the documentation at my fingertips and the calculation and know that I’m exactly right, but my recollection is that the spinal cord stimulation market in 2008 grew about 17%; so, we’ve said in the past that we expect the part of the neuromodulation market St. Jude Medical participates in to grow on a sustainable basis at about 15%; so, I believe that the market in fact is growing at least 15%, even a little bit better than that, we expect the market to continue to grow in the range of about 15% and then would also be enthusiastic that besides the spinal cord stimulation market growth, we have such as verdant territory to get into with deep brain stimulation that even if the deep brain stimulation market wasn’t growing, we’d have a huge new growth opportunity for St. Jude Medical and that market itself is continuing to growth as well; so, we’ve got really three very strong market dynamics that we’re working to capture with our neuromodulation business program and with all of the products that we’ve got in our neuromodulation product pipeline.

On the Eon Mini side, we’ve prioritized increasing the supply of Eon Mini; we’ve done it at the expense of some gross margin; so, we’ve really just said that we’re going to worry about the gross margin, second, we will focus on product supply first, that’s what we’ve done. What you’ll see during the second quarter, you’ll see us resolve, we expect to be unconstrained coming out of the second quarter, so as you look at our full year guidance for Eon Mini versus first quarter results and second quarter guidance, we expect an elevated level of sales in the second half of the year to benefit from that lack of constraints on product supply, and then, although you didn’t ask, over the second half of the year, we’d also expect to see some benefit to the gross margin with really more of a normalized manufacturing process on neuromodulation.

Michael Weinstein - J.P. Morgan

Two quick followups for John, one, could you just give us the contribution if you could estimate what the contribution from acquisitions were in the quarter; Dan gave a rough reference; and then two, is there any update on your hedging strategy?

John C. Heinmiller

The only thing I can think of is we’re not going to start to reports separately legacy sales for Radi, and that’s really the factor that would be on the radar screen outside of organic sales growth; in round numbers, the Radi contribution was about $20 million, but that does not mark the start of reporting legacy sales tied formally Radi products in future conference calls, but it was that order of magnitude; so, the difference between the actual constant currency sales growth of 17% and the organic number was about 15.2% at a constant currency rate, so you could kind of back out of that the difference between that 17% and the 15.2%. The organic sales growth in the first quarter was very balanced. It came from really every part of the business.

I think what’s most striking to us from our first quarter results is the level of balance that we have in our growth drivers and really we’ve got good contribution from both the mechanical and tissue valve portion of our business, from the vascular closure side of the business, from spinal cord stimulation, we have a slowly expanding contribution from deep brain stimulation, we’ve got so many different product lines in the atrial fibrillation portion of our business, all of which are contributing to growth, and then on top of that, not only did we get good growth contribution from our ICD business but we got it from our pacemaker business, and in both cases, we got it both from the United States and from international market; so, really just very very balanced contributions to 15% organic growth across the board.

Daniel J. Starks

On the hedging question, Mike, there’s really no change in our hedging strategy; we continue to have specific transaction hedges in place to assist in settling inter-company accounts in foreign denominated amounts similar to the way a lot of companies do, that’s the only hedging program that we’ve had and that we continue to have.

Operator

Our next question comes from the line of Kristen Stewart - Credit Suisse.

Kristen Stewart - Credit Suisse

I was just wondering if you guys could comment, just kind of looking out on whether or not we should expect any additional acquisitions and just kind of how the integration of Radi and all the other acquisitions have been going; I think the zero constant currency growth number also includes the acquisition of the electrophysiology business as well?

Daniel J. Starks

To the latter point, yes, Kristen, but that’s a small number; I’m thinking of it as more of a rounding number, but yes, that is in there; I forget exactly what that level of sales was at the point of acquisition but that’s turned into organic sales growth for us; my recollection is that it wasn’t growing in its prior structure, and in the St. Jude Medical structure, it is growing; so, the acquired part of that really I think would be immaterial.

On the topic of integration of our acquisitions, these have been just very gratifying acquisitions and the integration processes to-date are again gratifying. What we do differently than some companies is we really prioritize what we’re acquiring when we announce an acquisition is we’re really acquiring the talent of the people more than we’re acquiring kind of the physical assets and physical products and physical manufacturing line, and so, what we focus on is, the do-diligence process always is under a high degree of confidentiality, so once we announce the acquisition, we’ve got to have people in our organization, people in the new part of our organization establish working relationships, we don’t go in with the idea that we’re going to financially rationalize the acquisition, we go in with the idea that first, we a little bit like the Hippocratic, first we’ve got to do no harm, we want to make sure that business we acquired continues to perform in the way that it did that we expected in the first place to make us interested in making the acquisition, that means we’ve got to keep those people in place, we’ve got to establish relationships, we’ve got to get them engaged, we need to come to understand what the dynamics in that business are, and then over time, to the extent that there are synergies, we will, in an orderly way, work to get at them.

The synergies we’re always most focused on is sales synergies, and so, the integration process almost always requires an increase in our SG&A as we train the expanded global organization that St. Jude Medical brings to the discussion where appropriate on the technology that now is part of our total portfolio, and then over time, as we find ways to particularly to get cost synergies especially through growth and in a way that is good to the people, that’s how we think about it. So, that’s what we did with our acquisition of ANS and that’s the way we think about all of our acquisitions. What we’re doing with Radi is what we’re doing with MediGuide and it has worked well for us.

Kristen Stewart - Credit Suisse

And those acquisitions are proceeding as planned?

Daniel J. Starks

Absolutely.

Kristen Stewart - Credit Suisse

And then, just in terms of sales force, are you guys planning to add any additional sales people within cardiac rhythm management this year or any other areas within the organization in a meaningful way?

Daniel J. Starks

In a meaningful way, no; I think a good way to think about it is that we will add people as our business grows; so, I think that that is kind of normal organic growth, not an unusual new initiative that would be worth talking about separately.

Kristen Stewart - Credit Suisse

And then lastly, the FFR technology, what do you think it will take to really bring that to be more of a standard of care and how has that been integrated into the franchise?

Daniel J. Starks

We’re still in the early stage of integrating into the franchise in the sense that it starts out as a technology that the majority of our cardiology global sales organization has not had a prior experience with, we’re training on it, and reaching out to key opinion leaders is what we’ve done to-date, and then, creating the market development plan and marketing plan is what we’re right in the middle of. So, I think a good way to think about it would be that we really ought not to expect anything significantly different on the FFR and our pressure wire; on the one hand we have just announced the launch of wireless version of the pressure wire, the PressureWire Aeris, that’s something that adds to the mixture; but we think of 2009 as a year where we’re getting quite a bit smarter about how to best leverage this technology both in our key opinion leader working relationships and in our internal organization, bringing up our knowledge level; so, I would look to 2010 and beyond for more specifics and this year would be more of a training and planning year.

Operator

Our next question comes from the line of David Lewis - Morgan Stanley.

David Lewis - Morgan Stanley

Dan, just a strategic question here, maybe it’s the environment, but we increasingly talked to hospital purchasing managers lately; your comments of ICD/CRM commoditization seem to be running rampant and even comparisons that hip and knee implants are increasingly more common; I wonder if you could just give us your perspective on ICD/CRM commoditization, and if you disagree, sort of where do you think that differentiation lies?

Daniel J. Starks

It all depends on who one talks to; again, certainly on the hospital administration material management side, I was going to make a little bit of a smart remark which I won’t, but I think the monitor there is to tend to think of products as more commodities, and as part of a discussion of why prices are to be lower; a person gets very different comments from physicians that are particularly focused on the practice; there’s so much that really makes the different; one thing that is clearly not a commodity is the level of service and technical support; so, it’s a commodity if everybody’s is top state of the art, on the other hand, in the real world, that’s really not how it is, so the service is a significant differentiating factor.

The device reliability is a non-trivial issue; that’s an area where St. Jude Medical really has excelled here on a consistent basis. The 7-French high voltage lead is really not a commodity as reflected in clinical preference for it when it was available from another company to be over 90% of that company’s mix, and now in the case of St. Jude Medical, here it’s over 90% of our mix, so that clearly is not a commodity kind of product to merit that kind of market preference. The wireless RF telemetry on the low voltage platform that we’re about to put out into market is clearly not a commodity, it has a real impact on expediting procedures, improving procedure times, letting physicians sew up the pacer pocket at the same time that they’re continuing to interact with the device, and we saw that on the ICD front, we fully expect to see that on the pacemaker front.

The ST segment monitoring is not a commodity kind of product. We’ve got patients who can offer testimonials to the impact it’s had on them, that they just happened to be lucky enough to have this kind of additional diagnostic in their device at the time when in the clinical trial it alarmed and sent them to the emergency room and helped them find that they had this incidence; I’m thinking of a 95% blockage in the left main coronary artery, that clearly is not a commodity kind of event if it’s you or if it’s a member of your family, so, I think the less one knows about it, the more it’s a commodity; the more expert one is, the more differentiation there is in the technology that St. Jude Medical has; I won’t defend anybody else’s technology, but we wouldn’t be spending 12.3% of sales on R&D if all it gave us was the same as everybody else.

David Lewis - Morgan Stanley

Okay, just a couple of quick ones here, Dan, is there any assumptions built into AF guidance in the back half of the year for positive results out of CABANA pilot study on the first half?

Daniel J. Starks

No, we don’t expect an inflection to market growth as a result of the CABANA feasibility data being published. We think that the current robust growth will continue; we haven’t seen the CABANA feasibility, but we just expect the CABANA feasibility data to be one more factored, we don’t expect it to have an impact like the favorable outcome that a pivotal trial would.

David Lewis - Morgan Stanley

Okay, John, one last question here on currency obviously affecting gross margins or may change your GM guidance, can you walk us through sort of the principal drivers that are sort of offsetting that currency impact on the GM line and it’s kind of difficult to understand on the SG&A percentage going up just with currency but are there any other areas of spending that you’re increasing now that were not sort of in the forecast 3 months ago?

John C. Heinmiller

Well, I think that we have said in the past that we expected currency to have about a 60 basis point drag on the gross profit margin and then what’s offsetting that are just a number of productivity gains that we’re getting in the product category, and then within that, as Dan mentioned, we had a negative impact on gross margin to the extent that we’re focused on getting the manufacturing caught up on Eon Mini; when you look at SG&A, again as Dan eluded to in his remarks, the way we go about integration, we tend to make an investment in that SG&A line as we’re doing training and as we’re just beginning to ramp up what we believe are the growth opportunities with that acquisition which we have in this quarter with the Radi transaction. So, there really isn’t an simple bridge schedule that I can walk you through that gives you a, here’s the two or three things to think about, it’s just a number of dynamics and then we factor all those into our thinking as we continue to provide guidance. We think that gross profit margin will continue about in this range for the rest of the year.

David Lewis - Morgan Stanley

Okay, Dan, one more quick one; there’s a lot of talk about competitive changes obviously in the last 6 to 9 months, is it safe to assume given what looks like on a constant currency basis a slight acceleration in your business, do you think that those competitive pressures specifically in the US are waning?

Daniel J. Starks

I’m not sure that I am exactly on track with you, David, on what you’re eluding to, so my answer may not really satisfy you, but particularly with respect to the all parts of our business, it’s a tough market, we have tough competitors, it’s an extremely competitive market, we expect it to continue to be extremely competitive, so we don’t think the competitive nature of any part of our business’ market is going to wane here going forward into the second half of this year. We expect to have to fight really hard for every single little bit of gain that we get.

Operator

Our next question comes from the line of Larry Biegelsen - Wachovia Capital Markets

Larry Biegelsen - Wachovia Capital Markets

Dan, a question on A-Fib, a multi-part question; I think you said that you think the market can grow 15% this year, do you think it will grow 15% until we have the CABANA study which is probably 5 to 7 years away according to Dr. Packer? Second, can you give us some comfort that you can continue to grow faster than the market beyond 2009 where we have a lot of new competitors coming in? And lastly, your thoughts on the left atrial appendage opportunity given the data we saw at ACC.

Daniel J. Starks

All good questions, Larry, a little bit unfortunate to start on the topic when we really already exhausted our time, so I won’t do justice to your questions, I won’t comment on anybody else’s business and acquisition opportunities, etc., so, I just won’t comment on the left atrial appendage side of things; I can’t give you a good answer here in a short period of time about the depth and breadth of St. Jude Medical’s atrial fibrillation program, and that’s really the answer to your question of what would lead us to think that we can continue to gain market share, there’s just too many pieces to it; we work to give an overview of it in the course of about an hour at the February 6 investor conference, so I would refer everybody back to those slides as really the template for an answer. We obviously can talk about the basis of our confidence for continued growth in our atrial fibrillation for a full day and we can spend multiple days on it and it will all be good discussion, so it’s a strong part of what we’ve been focused on for 16 years, it includes all of the different components of our technology, it includes a lot of our product development pipeline that we have kept confidential for proprietary reasons that will become visible in future years. We’ve provided some good information about what we’ve got coming in the product line in 2009 in a little bit in the first half of 2010, but our product map and current product development activities go far beyond that, so the undisclosed technology and products are a strong part of what we’ve got coming to keep our growth above the growth of the market in the atrial fibrillation part of our business. So, it’s really all those things and I apologize that’s not a crisp answer, but there’s plenty there that we work to provide good continuity in talking about what the full scope of our AF program is, and I can’t really reiterate it here on the conference call, but we will regularly re-visit it at investor’s conferences, people will see a lot about this part of the our business at the HRS conference, so that’s about the best I could say.

With respect to the CABANA trial, the timeframe of the CABANA trial is one that really nobody can predict. One of the questions is going to be whether the trial goes to maturity or whether the data safety monitoring board along the way finds it appropriate to terminate the trial early; so, there’s really a lot of variables that could bear on when the data from that trial becomes visible.

Larry Biegelsen - Wachovia Capital Markets

But Dan, the 15% growth until then is that about the right way to think about it?

Daniel J. Starks

That’s how we think about it; we deserve the right to think about it differently at any point, but with today’s info, that’s how we think about it; we think of it as about 15% growth market on a sustainable basis.

Larry Biegelsen - Wachovia Capital Markets

Thanks, Dan.

Daniel J. Starks

I apologize, I know there are people in the queue. I apologize we’ve exhausted our time. Thank you everybody for joining participating in our call this morning and hope to get to others of you next time. So, with that let me turn it back to you, Celeste, to indicate your closing comments.

Operator

Today's call is being recorded and will be available for replay beginning at 12 pm Eastern standard time. The dial-in numbers are US 1-800-642-1687 and international 706-645-9291 and enter pin number 88814949. Thank you, this does conclude today’s teleconference. Please disconnect your lines at this time.

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Source: St. Jude Medical, Inc. Q1 2009 Earnings Call Transcript
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