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

Q2 2009 Earnings Call

July 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

Robert Hopkins - Bank of America

Frederick Wise - Leerink Swann

Michael Weinstein - J.P. Morgan

Ben Andrew – William Blair

Kristen Stewart - Credit Suisse

Larry Biegelsen – Wells Fargo

Tim Lee – Piper Jaffray

Operator

Welcome to St. Jude Medical’s second 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 contain 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 successes, anticipated regulatory approvals, and future product launches and projected 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 quarterly report on Form 10-Q for the fiscal quarter ended April 4, 2009. The company does not intend to update these statements and undertakes no duty to any person to provide any such updates under any circumstance.

At this time, all participants have been placed on a listen-only mode, and 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 the St. Jude Medical second quarter 2009 earnings conference call. With me on the call today 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 review of our second quarter results along with his typical update for the entire St. Jude Medical business. I will then made additional comments and open it up for your questions.

John C. Heinmiller

Sales for the quarter totaled $1.184 billion, up approximately 4% over the $1.136 billion reported in the second quarter of last year. On a constant currency basis, second quarter sales increased 10% versus last year. Unfavorable currency translations versus last year’s second quarter decreased this quarter’s sales by about $69 million. Earnings per share were $0.63 for the second quarter of 2009, a 9% increase over adjusted EPS of $0.58 in the second quarter of 2008. On a currency neutral basis, our earnings per growth this quarter was higher than 20%.

As a reference point, adjusted EPS in last year’s second 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. On a GAAP basis, earnings per share growth this quarter was 15%.

Before we discuss our first quarter 2009 sales results by product category with guidance for the third quarter and the remainder of 2009, let me comment on foreign currency. The two main currencies influencing St. Jude Medical’s results are the euro and the yen. In our April conference call, we provided sales and earnings guidance for the second quarter and the full year 2009, using exchange rates which assumed that each euro would translate into about $1.27 to $1.32 and that each 97 to 102 yen would translate into $1.

For the second quarter the actual exchange rates for the euro and the yen versus the assumptions we used in April did not result in a material difference in reported net sales. Keep in mind that in connection with managing our global accounting records, the currency rates are established only once per fiscal month.

In preparing our sales and earnings guidance for the third quarter and the second half of 2009, we have updated the currency exchange rates used in our model. We are now assuming that each euro will translate into about $1.35 to $1.40 and that each 97 to 98 yen will translate into $1. This adjustment in our exchange rates is expected to positively impact our reported sales in the remaining two quarters of 2009 by approximately $20-$30 million.

The second quarter was an unusual fiscal quarter for us, since it included the first week of July due to our 52-53 week fiscal year convention. This brought both an extra holiday and an extra week of summer seasonality into our second quarter. We expect the negative impact of the unusual fiscal quarter timing for Q2 to reverse itself in the third quarter which obviously will have one less holiday than usual and one more week of stronger fall seasonality than normal. All of this is another example of why investors should be careful about reacting to comparative sales results for a single quarter, and it is usually more helpful to combine the results of at least two quarters when making comparisons that will provide the best insight into trends affecting our business.

Now for the discussion of sales by product category for the second quarter: For the second quarter, total cardiac rhythm management or CRM sales which include revenue from both our ICD and pacemaker product lines were $704 million, a decrease of 1% from last year’s second quarter including $42 million of unfavorable foreign currency translations. On a constant currency basis, second quarter CRM sales increased 5% versus last year.

For the second quarter, ICD sales were $400 million, down 1% from last year’s second quarter. On a constant currency basis, second quarter ICD sales increased 4% versus last year. US ICD sales were $255 million, up 1% from last year’s second quarter. International ICD sales were $145 million, a 5% decrease compared with the second quarter of 2008, including $23 million of unfavorable foreign currency translations.

For low-voltage devices, sales for the second quarter totaled $304 million, down 1% from last year’s second quarter. On a constant currency basis, second quarter low-voltage device sales increased 6% versus last year. In the United States, pacemaker sales were $132 million, a 1% decrease compared with last year’s second quarter. In our international markets, pacemaker sales were approximately $172 million, flat with last year’s second quarter including $19 million of unfavorable foreign currency translations.

For the third quarter of 2009, we expect total CRM product sales to be in the range of $700 million to $730 million. As we’ve reached the halfway point in the year, we’ve adjusted our guidance range for the full year 2009, and we now expect total CRM sales to be in the range of $2.820 billion to $2.880 billion.

Atrial fibrillation or AF product sales for the second quarter totaled $156 million, up 16% over the second quarter of last year including $10 million of unfavorable foreign currency translations. On a constant currency basis, second quarter AF product sales increased 23% versus last year. For the third quarter of 2009, we expect AF product sales to be in the range of $150 million to $165 million, and we now expect our full year 2009 AF product sales to be in the range of $630 million to $660 million.

Total sales of cardiovascular products for the second quarter of 2009 were $243 million, up 7% over the second quarter of 2008 including $15 million of unfavorable foreign currency translations. On a constant currency basis, second quarter cardiovascular product sales increased 13% 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 second quarter of 2009 were $99 million, including $7 million of unfavorable foreign currency translations. Sales of heart valve products in the second quarter of 2009 were $84 million, impacted by $6 million of unfavorable foreign currency translations.

For the third quarter of 2009, we expect cardiovascular product sales to be in the range of $230 million to $245 million. We expect full year 2009 cardiovascular product sales to be in the range of $960 million to $990 million.

Total sales of neuromodulation products in the second quarter of 2009 were $81 million, up 33% from the second quarter of 2008 including $2 million of unfavorable foreign currency translations. For the third quarter of 2009, we expect sales of neuromodulation products to be in the range of $77 million to $82 million, and we expect full year 2009 neuromodulation sales of $305 million to $320 million.

Let me pause at this point and recap our full year 2009 sales guidance. For cardiac rhythm management devices, we expect sales for 2009 in the range of $2.820 billion to $2.880 billion. Sales of our AF products for 2009 are expected to reach $630 million to $660 million. We expect sales of cardiovascular products to be $960 million to $990 million, and for neuromodulation products, we expect 2009 sales to be in the range of $305 million to $320 million.

If you add up the sales across all growth platforms, total sales in 2009 are expected to be $4.715 billion to $4.850 billion. The midpoint of this range represents approximately 13% constant currency growth for full year 2009 compared with 2008. The geographic breakdown of St. Jude Medical sales in the second quarter of 2009 was 53% US versus 47% outside the US or OUS. This compares to 51% and 49% OUS in the second quarter of 2008. A detailed geographic breakdown of this quarter’s sales by product shows high voltage at $255 million US, $145 million OUS, low voltage at $132 million US, $172 million OUS, atrial fibrillation products at $74 million US and $82 million OUS, cardiovascular products at $101 million and 142 million OUS, and finally neuromodulation products at $69 million US and $12 million OUS.

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 74.2%, representing a 50 basis point decline compared with the second quarter of 2008 as the negative impact of foreign currency was partially offset by productivity improvements. For the full year 2009, we expect gross profit margins to stay in the range of 73.9% to 74.4%.

Our second quarter SG&A expenses were 36.4% of net sales, compared to 36.7% in the second quarter of 2008. For the full year 2009, we continue to forecast SG&A as a percentage of net sales in the range of 36.0% to 36.5%.

Research and development expenses in the second quarter of 2009 were 12.1% of net sales compared with 12.2% in the second quarter of 2008. For the full year 2009, we continue to expect R&D expense to be in the range of 12.0% to 12.5% of net sales as we continue to balance delivering short-term results with the right investments in long-term growth drivers.

Net other expense was $5 million in the second quarter. For the third quarter of 2009, we expect the other income and expense line item will again be a net expense of approximately $6 million. For the full year 2009, we expect the other expense to be approximately $22 million to $27 million.

For the second quarter the company’s effective income tax rate was 26.8%. 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 second quarter of 2009, we had $487 million in cash and cash equivalents and $1.286 billion in total debt. The outstanding debt on our balance sheet primarily represents $986 million of borrowings under our domestic credit facilities which mature in 2011 and $300 million of notes issued in Japan which mature in 2010 and 2011.

As you have seen, we filed a registration statement on Form S3 with the SEC this morning. Subject to market conditions, we are planning to potentially access the debt capital markets and raise proceeds in the range of $1 billion. Given the attractive interest rate environment and St. Jude Medical’s financial strength, we feel it is an opportune time to diversify our capital structure by adding a component of longer term fixed rate debt. Separately, we also announced today that our Board of Directors has authorized a $500 million share repurchase program. This repurchase authorization reflects our continued confidence in St. Jude Medical’s growth and financial position. We have not included either of these transactions in the guidance we are providing today for the third quarter and the remainder of 2009; however, if we were to complete both transactions, we do not believe that it would result in any change to our earnings per share guidance.

Next, I want to offer some comments regarding our earnings per share outlook for the third quarter and full year 2009. In preparing our EPS guidance, we have assumed that in the third quarter of 2009, the share count used in our fully diluted EPS calculation will be about 350 million to 352 million with the weighted average shares for the full year of 2009 at 351 million to 353 million.

The company consolidated earnings per share for the third quarter to be in the range of $0.61 to $0.63, and for the full year 2009, we expect consolidated EPS to be in the range of $2.48 to $2.54.

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

Daniel J. Starks

I would like to devote the next few minutes to reviewing five of St. Jude Medical’s major growth drivers starting with our cardiac rhythm management or CRM business. We have indicated in that past that we expect the global market for ICDs and pacemakers to grow at a mid single digit rate measured in constant currency. Events during the second quarter reinforced our confidence that this growth expectation is reasonable. Growth dynamics in international markets remain favorable due to the proven value of ICD therapy and its underpenetration in most major international markets. In the US, continued growth in the replacement segment of the ICD market is being supplemented by encouraging growth of de novo implant. We need to see more complete data from the MADIT CRT clinical trial results later this year to help us update our market model more completely, but the announcement that this major landmark clinical trial met its primary endpoint is encouraging.

Another positive indicator for ongoing growth in the ICD market is the 8-year followup data from the MADIT-2 clinical trial that was presented at the annual HRS Scientific sessions during the second quarter. These data showed both that the survival benefit in ICD treated patients persist over time and perhaps more importantly that the difference in survival between ICD and non-ICD treated patients continues to increase over 8 years to the level where one life is saved for every six ICDs implanted, compared with the previous data that one life is saved with every 17 ICDs implanted.

All of these factors together reinforce our confidence that it is realistic to expect the global CRM market to continue growing on a constant currency basis at least at a mid single rate for the foreseeable future.

With respect to the topic of global CRM market share, we’re waiting for all companies to report their current quarter results before we refine our market model, but we estimate that during the first half of 2009, we gained between 50 and 100 basis points of share in the global CRM market on a year over year basis. We expect to gain additional share in the global CRM market during the second half of 2009 due to a number of new products I will touch on briefly.

First, initial experience with our limited market release of AnalyST ICDs in Europe has been encouraging. During the second quarter, we began to build on this experience with a limited launch in Europe of our second generation AnalyST XL line of ICDs. We expect full launch of our AnalyST XL line of ICDs in Europe during the second half of 2009.

Also during the second quarter, we began to launch in Japan our Current and Promote lines of ICDs, our Zephyr and Frontier 2 lines of low-voltage devices, and our QuickSite and QuickFlex lines of low-voltage pacing leads. Keeping in mind that Japan is the largest medical device market in the world outside the US, we expect all of these new product launches in Japan to help us gain share in the global CRM market during the second half of 2009 and throughout 2010.

With respect to our share of the US CRM market, during the second quarter we began to launch Current Plus and Promote Plus lines of ICDs and expect more impact from these new products during the second half of the year. During second half of this year, we also are launching our Current Plus ICD and Promote Plus CRTP devices and Durata lead with the in-line SJ4 connector, resulting in less lead volume in the device pocket, fewer set screws, and simpler lead to can connection.

As we announced just yesterday, we have received regulatory approval for our Accent and Anthem lines of pacemakers with RF telemetry here in the US during this last week and look forward to the benefit we expect this new technology to have on our market share in the second half of 2009 and throughout 2010. Together with market launch of version 4.0 of our supporting Merlin.net patient care network, this system makes St. Jude Medical the first and only CRM company to offer completely wireless remote followup sessions for pacemakers and CRTP devices. This also allows us for the first time to offer remote monitoring capability for all of our CRM product lines.

Let me move on to offer an update about our atrial fibrillation or AF business. One significant development in our AF business during the second quarter was the approval of NIH funding for the CABANA trial. As a reminder, the CABANA trial will enroll up to 3000 patients at 140 centers to compare the clinical effectiveness of catheter ablation versus medical management for patients who suffer from atrial fibrillation. This is exactly the kind of independent comparative effectiveness trial envisioned in current public policy initiatives for enlightened and cost-effective healthcare reform and is important for proper development of the AF market. We look forward to presentation of the CABANA feasibility data as well as to the milestone of first patient enrolment in the pivotal trial during the second half of 2009.

Toward the end of the second quarter, we were pleased to received FDA clearance to launch our next generation EnSite Velocity platform. In addition to improvement in software technology, EnSite Velocity represents the first significant platform change to our advanced mapping technology since the introduction of EnSite NavX in 2003. We will also introduce the first integration of our EnSite Velocity system with our EP Workmate recording system later this year. This will be followed by first integration of our EnSite and Velocity and EP Workmate systems with our new Mediguide technology toward the end of next year. All of this together represents meaningful steps forward in the ways we can support catheter procedures in the electrophysiology cath lab with products from our atrial fibrillation division.

In spite of our strong lineup of new products from our AF division to support sales growth during the second half of 2009 and beyond, you will notice that we have slightly reduced our full year guidance for sales of AF products. We have done this in response to what we believe is a modest slowdown in the capital equipment side of the market for AF products due to macroeconomic conditions. We are encouraged, however, that even with this capital equipment slowdown, revenue for our AF business grew 23% on a constant currency basis during the second quarter.

I would next like to comment on our neuromodulation business. Q2 represents the first quarter of sales results where our supply of Eon Mini devices was unconstrained. As a result of strong customer acceptance of this product line, sales for the quarter exceeded the high end of our guidance leading us to raise our guidance for full year sales of neuromodulation products.

Also in the second quarter, we completed enrolment in our US pivotal trial evaluating the benefit of our Libra and Libra XP deep brain stimulation or DBS systems for patients who suffer from Parkinson’s disease. This trial requires one year followup after last implant which implies the opportunity for FDA regulatory approval of the Libra system in 2011. Nearer time, launch of our Libra and Libra XP DBS systems in Europe is ongoing, laying the foundation for stronger sales contribution from our DBS business in Europe in 2010. We expect to launch our next generation DBS system in Europe in the first half of 2010 as well.

During the second quarter, we also completed enrollment in our US pivotal trial for back of the head or occipital nerve stimulation for patients who suffer from certain forms of migraine. This trial also requires one year followup after last implant. Until the clinical efficacy data are unblinded, after appropriate followup for this portion of the trial has been completed, it is premature for us to discuss the likelihood and timing of product approval.

The third clinical trial I would like to touch on in our neuromodulation business is our US pivotal trial evaluating the benefit of deep brain stimulation targeting Brodmann area 25 for patients who suffer from some forms of treatment-resistant depression. We are on track to complete enrolment this quarter of our 30th patient in this pivotal trial. Following achievement of this milestone, we will submit the data for our first 30 patients to FDA and request permission to expand the trial. Due to the early stage of this clinical program, it is premature to discuss the likely timeframe for regulatory approval.

Before I move on to talk about our cardiovascular business, I would like to acknowledge that on July 1, 2009, we filed an 8-K reporting that we received a warning letter from FDA as a result of inspectional observations made regarding certain aspect of our neuromodulation business. St. Jude Medical takes very seriously both these inspectional observations and the subsequent warning letter. Both at a corporate level and a divisional level, we are fully remediating all appropriate aspects of our neuromodulation quality system. As we indicated in our July 1st 8-K filing, we do not expect this warning letter to have a material impact on St. Jude Medical’s business and have taken all implications of the warning letter into account in formulating the guidance we have issued as part of this earning release.

The fourth growth driver that I would like to update you on is the status of our cardiovascular division or CVD business. CVD revenue came in toward the high end of our guidance during the second quarter and indicates that our CVD growth program is on track. We estimate that during the second quarter, we gained market share on our global business with our pressure wire fractional flow reserve product line and with our tissue valve franchise. We are on track to bring our Trifecta line of pericardial stented tissue valve to the market in Europe toward the end of 2010 and in the US toward the end of 2011. As we indicated at our annual investors’ conference on February 6th of this year, our CVD franchise has been reinvigorated and is well positioned to deliver constant currency double digit sales growth on a sustainable basis.

Productivity improvements are also an important driver of our earnings growth, so I’d like to address those initiatives as well. As you may remember from our analysts day, our goal is to achieve approximately a 29% operating profit margin by 2012. We’re on track with expansion of our manufacturing operations in cost-advantage locations both in the US and in other regions around the world. This is expected to have increasingly visible impact on our profitability in 2010 and beyond. We expect these and other continuous improvement initiatives to strengthen our flexibility to respond successfully to any new market dynamics that may arise from macroeconomic conditions, from healthcare reform, from the evolving regulatory and legal climate, or from ongoing pressure on average selling prices.

Before I open it up for questions, I would like to comment on the Form S3 registration statement we filed with the SEC this morning as previously mentioned by John Heinmiller. Assuming market conditions remain favorable, the proposed debt issuance in the range of $1 billion will allow us to reduce our reliance on bank financing, extend our debt maturities, take advantage of historically attractive interest rates, and increase our liquidity, all while maintaining an improved credit rating status. Our primary motivation is tied to the prudent management of our capital structure.

With that, let me conclude by saying that both Q2 and first half 2009 results reinforce our confidence that St. Jude Medical growth program is balanced and realistic. We continue to target a minimum 15% compound annual growth rate in earnings per share measured on a constant currency basis. We continue to focus on delivering this level of EPS growth through a combination of sustained double-digit sales growth by improving our profit margin to best competitive benchmarks and by using our strong cash flow to repurchase stock and fund disciplined acquisitions as appropriate.

With that, we have completed our prepared remarks and are ready to open the line for questions.

Question and Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Rick Wise with Leerink Swann.

Frederick Wise - Leerink Swann

Turing back to this year in growth, obviously you had a tough comp in the Q2 of 2008; you knew that going in. OUS was sequentially higher despite the higher effects. Can you talk a little bit more about the US number? Appreciating the comment about the weeks, did you expect going in that the US business would sequentially decline and maybe yet, I’d be curious if you have a thought in your mind, how would you have us adjust for that holiday week in terms of a more normalized number?

Daniel J. Starks

The question of precise adjustment for fiscal quarters under these circumstances is a challenge for us. We only have this kind of fiscal year mismatch year over year once every 5 years, so we really don’t have a good organizational expertise in exactly how to account for it. I think what you’ll see is you’ll see the impact of the short quarter in Q2 reverse itself with the impact of a long quarter in Q3, so think the best perspective would be to appreciate that normally we have a sequential quarter reduction in sales of almost all product classes including our CRM sales in Q3 versus Q2 due to seasonality including the impact of holidays and vacations in the summer season, and you see from the CRM guidance that we gave here for Q3, you can infer that we expect a sequential quarter increase in CRM sales in Q3 versus Q2, and so that would be the best way to give you some color or commentary about our expectations of the impact of a short quarter in Q2 and a long quarter in Q3.

I think another way to get at it would be to look at our sequential quarter increase Q2 versus Q1, and this would really apply to all of our product classes. You would see that all of our major product categories’ revenue increased sequentially, Q2 versus Q1. Even though Q2 was a short quarter, we actually delivered about 4.4% increase on sequential quarter basis Q2 versus Q1. FX accounted for some of that, but less than half of that 4.4% sequential quarter increase, so that would give you an additional indication of the ongoing strength of our CRM sales growth.

Maybe another way to look at and triangulate the strength of our CRM sales in Q2 in spite of the short quarter would be to look at the percentage increase growth for CRM sales that we’ve reported this morning versus what Boston reported yesterday. In Q1, it was clear to everybody I think that St. Jude Medical continued to gain share with robust results in both on the pacing and on ICD side in the CRM segment of our business. With that strong Q1 on a sequential quarter basis, our CRM sales grew 4.1% Q2 versus Q1, again even though Q2 was a short quarter. Boston’s sequential quarter sales growth was lower than that, Q1 to Q2. On the total CRM sales growth, our trend was on a comparative basis favorable, sequential quarter on the pacing side. There was even a stronger favorable comparison on the ICD side. It was more of a wash on our ICD sales; on a sequential quarter basis, it increased about 1.8% versus Boston’s on a sequential quarter basis increased about 2.3%, and exactly how much of that reflects short quarter versus other dynamic is something that would really very visible with comparative Q3 results.

I think another way to think about it is, you see the additional strength of our ICD sales results in international markets. That is probably a leading indicator for what you will see in our US ICD sales results as the new products get into the European segment of the international market a little bit quicker than they do here in the US. So, the impact of Current Plus and Promote Plus ion Europe was earlier than in the United States. We got the benefit of the AnalyST and now the limited launch impact of AnalyST XL in European markets. Obviously, we don’t have that benefit yet in the US, so I appreciate that it is a challenge to figure out exactly how to value our short quarter in Q2, but there are a number of perspectives I have given you to help you triangulate.

Frederick Wise - Leerink Swann

So you clearly don’t feel like you’ve lost share on an account by account basis?

Daniel J. Starks

I am sure that that is a mixed bag with some account by account share loss and some account by account share gain, but I think that probably another way to triangulate all of this is as you would work to evaluate how to assess our sales results in Q2 with it being an anomalous fiscal quarter. Another way to look at it would be to just look at full year results in 2008, first half results in 2009, and look at our full year guidance for 2009, and just as a reminder that our constant currency sales growth for all product categories in 2008 was 12%. The midpoint of our guidance for constant currency sales growth for all product categories here in 2009, as you’ve heard this morning, is 13%. I appreciate we’ve got the benefit of the Radi acquisition there and a half-year of EP Med Systems, but that is probably about a 1.5-point impact on that 13% constant currency guidance at the midpoint. The first half of 2009, we delivered, on a constant currency basis, sales growth of 14%, so I wouldn’t rule out the possibility that we might be able to deliver sales above the midpoint of our full year guidance in 2009. That is another way to just look at what’s the underlying strength even though we’ve got a short quarter here in Q2, what’s underlying strength and what’s the core message in our sales guidance. If you just combine that sale guidance for full year 2009 with the midpoint of 13% constant currency growth, and then add to it the flow of new products to support current growth drivers that we highlighted a little bit in our prepared remarks, and you look at the way that the key markets and key growth drivers are continuing to expand in the area of AF and area of spinal cord stimulation and area of CRT segment of the ICD market, and then again, I think if you look at the range of new growth drivers that we’ve been working to develop here for a number of years that are starting to become more visible—our entry into Parkinson’s disease, our potential entry here into migraine, and further out the work we are doing to get into the depression business and to develop a transcatheter valve business; nearer-term, our upcoming entry into the pericardial stented tissue valve portion of the heart valve business and our recent entry here into the fractional flow reserve segment of the interventional cardiology market—all of those growth drivers that I’ve just I mentioned are really either not yet contributing, but becoming more visible or just barely beginning to contribute to what already is a best in class among our peer group in constant currency sustained sales growth.

Operator

Your next question comes from the line of Bob Hopkins - Bank of America.

Robert Hopkins - Bank of America

John, what were the selling days in this second quarter versus last year, and then also did you have also roughly about 2 points of contribution from M&A in the quarter like you did in the first?

Daniel J. Starks

I don’t have the data point on a note right front of me, Bob. Just on counting the calendar, I think it was about 2 or 3 selling days less.

John C. Heinmiller

Yes, two or three days less, but how many holidays do you count in different geographies. If you just take the US, I think it’s 2 selling days of difference.

Daniel J. Starks

And then the compounding factor as you would appreciate, Bob. Besides the topic of selling days, we’ve got the topic of seasonality and the first week of July with the number of vacations that we’d typically get in the Fourth of July weekend week, so there were a couple of dynamics that you’d factor in.

John C. Heinmiller

I think Dan mentioned the impact of Radi and EP Med Systems is probably in that range of 1.5 to 2 points.

Robert Hopkins - Bank of America

Dan, just going back to the cardiac rhythm management area and AF, you lowered guidance a little bit. You explained AF. Could you comment what percentage of your AF business is exposed to capital, and then more importantly on the CRM side, you lowered the top end of the guidance a little bit. I assume most of that’s a function of what’s going on with ICD sales, so my question is relative to your previous guidance, what’s changed? Is it a little bit less changed, a little bit less confidence on the market, or both?

Daniel J. Starks

On the AF side of our business, as you know, we don’t break out the segment inside our AF number. The capital component is a significant part of it. I don’t actually have the exact statistic in mind as I’m formulating my comments back to you, Bob, and if I had them, I guess I wouldn’t give you the exact anyway, but it’s a very meaningful part. I’m thinking it’s somewhere in the ballpark of 40-50%, but my number may be wrong, but directionally it’s somewhere like that, for percentage of AF business that relates to capital equipment. On the topic of the CRM market, what you see in our guidance is more our being cautious with respect to second half of the year market growth, and it’s hard for us to fully factor in the impact of the economy and unemployment level and the general slowdown in procedures in hospitals. We get quite a bit of comment from customers on an anecdotal basis of changes in procedure volumes, but it’s not consistent feedback from customers, and I think to the extent there is economic impact on hospital procedure volumes as it relates to our business and in particular our CRM business, we think that that would be minimal. If any thing, it would just be more a question of timing than anything else, but we’re just concerned about softness in the market due to just the continued impact of more people losing jobs and more focus on inventory at hospitals, more focus on management capital at hospitals, but nothing that would deserve to draw a lot of attention, but it’s at a level where when we’re updating our guidance, we would rather error on the side of being a little bit cautious, and we again would rather underpromise and overdeliver than the reverse, so we’re just being very cautious in our outlook.

Robert Hopkins - Bank of America

So, it’s a comment on market and not market share?

Daniel J. Starks

That’s right.

John C. Heinmiller

I would just offer a little more comments on the capital equipment side. It’s a little bit less on a percentage basis, but I think just on the dynamic of where do we see the incremental growth and wanting to just have the impact on that guidance is where it came into play.

Robert Hopkins - Bank of America

So around 10-20% maybe, is that a decent number or is it really higher?

John C. Heinmiller

Yes, I think it’s probably closer to that range, but again it’s not something that we’d give out on a specific basis.

Operator

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

Michael Weinstein - J.P. Morgan

Dan and John, I would assume that the capital equipment piece is probably more than that 10% range. Is that fair, John?

John C. Heinmiller

Yes.

Michael Weinstein - J.P. Morgan

As you guys always say going back last several years, it’s always tough to draw too much from one quarter. You had blowout fourth and first quarters and this quarter is in line and in some cases, weaker particularly in some of the US businesses. Dan, do you have the visibility to say whether or not the economy is impacting in different pieces? I think it would be pretty fair to assume it’s impacting your capital equipment piece of AF. Can you make a conclusion that hospitals are holding less inventory of certain products? Can you make the conclusion that there is some push-off on some procedures, like prophylactic ICD implants? Can you see that at all?

Daniel J. Starks

We get anecdotal comments to that effect on the field, Mike, but it’s hard to qualify the anecdotal data and hard to draw a conclusion from it.

Michael Weinstein - J.P. Morgan

If I look at your guidance for the year, you’re still guiding organically, if I backed out the acquisitions and adjust for currency, you’re still guiding for the back half of the year to 10% or better topline growth. Is my math right there, John?

John C. Heinmiller

Yes.

Michael Weinstein - J.P. Morgan

If I think about the pluses and minuses on that, you’ve obviously got a lot of momentum in neuromodulation. You actually just got approval for what should be an important product from the pacemaker business, so the momentum on the competitiveness at least a few businesses right now looks very good. Is your principal concern just the unknown of the economy and overall market growth rates?

Daniel J. Starks

That’s in the middle of our radar screen.

Michael Weinstein - J.P. Morgan

Dan, let me ask you a Washington question. With a lot stuff that’s been on and off the table over the last couple of weeks, is there anything in your view or are you close enough to say anything that you view as being particularly concerning to the industry overall as well as St. Jude in particular?

Daniel J. Starks

We are working with our colleagues through AdvaMed, so I wouldn’t offer any comments outside of the public statements the device industry has made through the AdvaMed oracle. We’re all concerned about healthcare reform. We expect it to have some meaningful impact on our business. I think the meaningful impact will be a mixed bag. The way that we think about it is we focus on keeping ourselves in the best condition to respond to whatever the details of healthcare reform ultimately turn out to be, so continuing to improve our cost structure is really the strongest focus that we have to make sure that when healthcare reform details are clarified, we’re well positioned to be successful in whatever the new environment is.

Operator

Your next question comes from the line of Ben Andrew – William Blair

Ben Andrew – William Blair

Can, you talk a little bit about the international dynamics and if you’re seeing any significant changes there in trajectory, particularly Japan? You talked about a lot of the new product opportunities there. How significant are your share opportunities in some of those product areas?

Daniel J. Starks

Let me offer a couple of comments, and then I’m going to ask Joe McCullough, Group President, to comment as well. In Japan, we have significant opportunity to gain share and in other international markets very significant opportunity not only to gain share but the idea of relative underpenetration of Japan in particular and then even more so once we get to a market like China or India. The opportunity for market growth and the current level market growth is something that is particularly a helpful dynamic to our future growth outlook, so it’s a combination or rate of share growth and our ability to continue to capture share in these markets. As you know we have a strong direct program in Japan, a strong direct program in China, and in other key international markets, compared to our peer group we are relatively stronger in many of these key international markets as you see from our international sales as a percent of total versus our peer group. Depending on FX rates, we range between about 46-49% of our sales coming from global markets outside of the US. When you look at our most direct peer group comparison, you see that we’re meaningfully more visible and effective in these international markets as a percent of our business than the competition is. I’ve stolen a lot of Joe’s thunder here, leaving him wondering now what’s he going to say since I took some of the words out of his mouth, but with respect to Japan in particular, Joe, maybe that’s something that you could offer an update on what we see for growth dynamics in the CRM space in particular in Japan.

Joseph H. McCullough

On both the high-voltage and low-voltage parts of the business, we’re seeing very nice growth in the market place. Specifically, in high voltage, I think it’s estimated now to be back up to the growth of the mid double digit with higher growth in CRTD segment of the business, and so great opportunity for continued growth as physicians adopt the broader indications for ICD therapy, and we’re still hopeful that the government in the future will increase their reimbursement for some of those indications. As it relates to St. Jude Medical, our salesforce is very well prepared, very well trained, and very focused on launching our new products. The Current and Promote RF technology, the Zephyr pacemaker, and our left heart lead technology we’re in the process of launching those products now, and very excited about what we hear from our customers on what they think of our technology. Of course, we have the only Japanese language programmer in the industry, so we’re very optimistic about our future growth potential.

Ben Andrew – William Blair

Coming back to the US and the competitive dynamic within ICDs, was there any material change in the behavior patters, whether pricing or aggressiveness or whatever, between Q1 and Q2, Dan, that you noticed or that you anticipate in the back half?

Daniel J. Starks

No. To give you a little more flavor, we see pricing pressure as a meaningful competitive dynamic. It has been, and we expect it to continue to be, but not in a different way Q2 versus Q1. There are a number of dynamics that are meaningful in our competitive outlook, but not different in any meaningful way from Q2 versus Q1.

Operator

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

Kristen Stewart - Credit Suisse

I just wanted to delve maybe a little bit deeper just in terms of the pricing that you just had mentioned. What are you seeing specifically on price for ICDs, and what level competition are you seeing out there from Boston and Medtronic? Were you seeing any increased levels of competition this quarter? Did Medtronic’s extra selling week have any sort of influence on your business? Anything in that regard?

Daniel J. Starks

You catch me here on Medtronic’s extra selling week. I’m not so tuned into what their fiscal quarter peculiarities are, so I’m sorry that I can’t comment on that. With respect to competitive pressure on average selling prices, we see significant competitive pressure on average selling prices. I would be reluctant to say that it was a different dynamic in Q2 versus prior periods.

Kristen Stewart - Credit Suisse

Is it down two to three percentage points? I think that’s how it’s been characterized or is it down more?

Daniel J. Starks

We characterize the average selling price pressure with respect to global ASPs to say that there’s the geographic mix, there’s the product mix, there’s the impact of new products and ASP premiums tied to new products versus more mature products, and probably ASP reduction with more mature products. When you blend all that together, our experience in the second quarter was in the range of 2-3% decrease in average selling price, just as it has been in prior periods.

Kristen Stewart - Credit Suisse

And that’s globally?

Daniel J. Starks

Yes.

Kristen Stewart - Credit Suisse

Is the US more or less than that figure?

Daniel J. Starks

I couldn’t really comment. We just don’t get more microscopic on our ASP commentary, so I just don’t want to say anything differentially than total global ASP pressures and impact on total global CRM market growth and margin and all those kinds of things. It’s continues to be in the 2-3% range.

Kristen Stewart - Credit Suisse

With respect to the MADIT CRT trial, yesterday Boston seemed reasonably upbeat about the trial and the prospect, and Medtronic has also been pretty positive. What is it that you’re looking at coming out of the study that you are really looking closely at before updating your model? Why are you not more positive given what you’ve seen on the topline side?

Daniel J. Starks

We’re positive, Kristen. We haven’t seen the subset analysis. We just haven’t seen the actual results to let us fine tune our assessment of the exact impact, but we’re very positive. Let me refer your question to Eric S. Fain, President of our Cardiac Rhythm Management Division, for more sophisticated comments than I could offer on the topic. Eric, what’s your observation about what we know so far from what’s been published with respect to MADIT CRT results, and what are you looking for moving forward as the results are more fully circulated?

Eric S. Fain

We’re positive on the outcome of the trial and see it as a significant event and really look at it as a landmark clinical trial result. I think as has been spoken about before, it’s not only gong to have impact on the mix of CRT and traditional ICD devices, but we also think that along with the results of the extending MADIT-2 followup data will have a positive impact on the referrals, and I think as we’ve seen with other landmark trials, the actual impact in the market place will come as the trial gets fully presented and papers come out and that gets the commentary going and the pushdown into the actual referral markets and the impact around the world, so we’re waiting for the results. I understand they’re going to be presented in detail on September 1st at the ESE meeting, and we do not expect any surprises coming out of that that would temper anybody’s enthusiasm, but we expect that it will take the presentation of the actual data to start to get significant momentum.

Operator

Your next question comes from the line of Larry Biegelsen – Wells Fargo.

Larry Biegelsen – Wells Fargo

Dan, could you help us reconcile your comments on the encouraging signs you talked about for de novo implants and your cautiousness going forward on CRM, and you’ve also asked us to look at the ICD or the CRM market in two quarters. In the first half of ’09 in the US, your growth rate was about 5%, which is the slowest in a while. Is that a fair run rate?

Daniel J. Starks

I think for a run rate, Larry, we would not say more than that results that have been published over the last couple of quarters of course speak to themselves. As far as a run rate going forward, I’ll stick with our guidance for combining pacer and ICD numbers together in our expectations, so I don’t want to segment that out differently and I know you asked me several questions.

Larry Biegelsen – Wells Fargo

Dan, earlier in your prepared remarks, you talked about encouraging signs for de novo implants, but also sounded more cautious in the Q&A based on what you are seeing in the economy, and I’m just trying to understand how those two fit together because your initial comments were encouraging and your latter comments have been more cautious.

Daniel J. Starks

I think if you are taking some sound bites out of context and piecing them together, they’ll lead to confusion. The point that I made was that we have guided in the past to our expectations that the global CRM market will grow at a mid single digit rate, and so with that starting point, my additional comments were that our experience during the second quarter of 2009 reinforces our confidence that the global CRM market will continue to grow at a mid single digit rate for the foreseeable future, and that includes then the dynamics affecting the pacer side of the market, it includes the dynamics affecting on the US side the continued high growth rate in replacement devices accompanied by an encouraging increase in de novo implants. As you know in the past there were prior periods where none of us saw an increase in de novo implants in the United States. We see an increase in de novo implants in the United States, so I was characterizing that increase as therefore encouraging, and all in the context as we update our view now with another quarter’s experience behind us, do we continue to see the same level of growth in the global CRM market or not. The purpose of my commentary was to give you a little bit of flavor on why we continue to be encouraged that the global CRM market will continue to grow at least at a mid single digit rate.

Larry Biegelsen – Wells Fargo

On gross margins, John, last quarter you talked about how increasing the supply of the Eon Mini negatively impacted your gross margin, but this would normalize in the second half of year. Can you talk about how much it negatively impacted your gross margin in the first half, and do you continue to expect this to normalize in the second half of the year, and do you expect FX to negatively impact your gross margin still by 60 basis points for full year 2009?

John Heinmiller

I think that the idea last quarter was that we were working to build our inventory of Eon Mini, and it was first experience with that manufacturing, so we saw a little bit of an impact there. That’s obviously improved now that we are in more of an unrestrained availability of supply, and we would expect now to have leverage going forward as we gain more experience with that product, and it has obviously exceeded the high end of our expectations with this quarter, and then we did mention at the beginning of the year as we delivered comments on what our full year guidance was going to be that when you took in to account the FX impact that it would be about 60 basis points of negative impact, and I think that kind of an estimate still holds true. The FX has moved around a little bit but not enough to impact that component of the gross profit margin, and so where we see that our gross profit margin has not suffered completely from that impact, there is an underlying productivity improvement that we continue to experience.

Operator

The last question comes from the line of Tim Lee with Piper Jaffray.

Tim Lee – Piper Jaffray

I just want to follow up on some of your comments on the AnalyST ICD in Europe. Just in terms of the initial usage by physicians, how are they using the feature for the changes in ST segment elevation? Are they using it for patient monitoring or are they using it for the detection of MI, or are they not using that feature at all?

Joe McCullough

We are in the middle of registry right now, and physicians are very encouraged about this feature. As you know, the ST segment monitor continuously monitors for the presence or absence of shifts in the ST segment. In the presence of shifts, it does point the physician towards doing additional diagnostic work and in so doing they will determine if the patient is ischemic or not, and so we are encouraged by what the physicians are saying and how they are using the technology at this stage.

Tim Lee – Piper Jaffray

I think in your prepared comments you had said the lessening FX impact is helping topline by $20 to $30 million for the year. What does that translate from a bottom line impact?

John C. Heinmiller

I think we’ve offered in the past that about 50% as the midpoint. We gave a range historically that there is 40-60% depending upon the geography and the mix that flows through to the operating profit line.

Daniel J. Starks

With that, I would like to thank everybody for joining us. I apologize to those that are in the queue that we have not been able to get to. I would like to turn it over to Regina to read the concluding remarks.

Operator

Today's call is being recorded and will be available for replay beginning at 12 p.m. Eastern Standard Time. The dial-in numbers are for the US 1-800-642-1687 and for international 706-645-9291 and enter pin number 15311313. This does conclude today’s teleconference.

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Source: St. Jude Medical, Inc. Q2 2009 Earnings Call Transcript
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