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

Q3 2007 Earnings Call

October 18, 2007 9:00 am ET

Executives

Dan Starks - Chairman, President, and CEO

John Heinmiller - EVP and CFO

Eric Fain, President, Cardiac Rhythm Management Division

Mike Rousseau - President, U.S. Division

Joe McCullough - President, International Division

Analysts

Bob Hopkins - Lehman Brothers

Glenn Novarro - Banc America Securities

Glenn Reicin - Morgan Stanley

Rick Wise - Bear Stearns

Charles Han - Goldman Sachs

Joanne Wuensch - BMO Capital Market

Operator

Welcome to St. Jude Medical's Third Quarter 2007 Earnings Conference Call. Hosting the call today is Mr. Dan Starks, Chairman, President and Chief Executive Officer of St. Jude Medical.

This news release contains forward-looking statements within the meanings 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, 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 of other cautionary statements described in the company's filings with the SEC, including those described in the company's annual report on Form 10-K, filed on February 28, 2007. See pages 13 to 20 and the quarterly report on Form 10-Q filed on August 9, 2007, see pages 26 to 29. The company does not intend to update these statements and undertakes no duty to any person to provide any such update under any circumstance.

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

Dan Starks

Thank you, Melissa and good morning everyone. Welcome to our third quarter 2007 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, President of our U.S. Division, Joe McCullough, President of our International Division, and Angie Craig, Vice President of Corporate Relations.

I want to first ask John Heinmiller to conduct his normal review of our third quarter results, along with his typical update for the entire St. Jude Medical business. I will then make a few comments and open it up for your questions.

As you listen to the guidance we provided for the fourth quarter of 2007, please keep in mind that this guidance does not take into account the impact of Medtronic's recall of its Sprint Fidelis family of leads earlier this week. We know this event will impact our fourth quarter, but there are too many unknowns for us to factor this late-breaking event into our guidance at this time in a meaningful way.

And with that, let me turn it over to John Heinmiller. Go ahead, John.

John Heinmiller

Thank you, Dan. Sales for the quarter totaled $927 million, up approximately 13% over the $821 million reported in the third quarter of last year. Favorable currency translations versus last year's third quarter increased this quarter's sales by about $20 million.

Earnings per share were $0.46 for the third quarter of 2007, a 21% increase over EPS of $0.38 in the third quarter of 2006.

Before we discuss our third quarter 2007 sales results by product category, with guidance for the remainder of 2007, let me comment on the currency exchange rates we are currently using in our outlook for the remainder of 2007. The two main currencies influencing St. Jude's Medical's operations are the Euro and the Yen. For the Euro, we are assuming each Euro will translate into about $1.37 to $1.44. And for the Yen, we are assuming each 114 yen to 118 yen will translate into $1.

Now, for the discussion of sales by product. For the third quarter, total cardiac rhythm management sales, which include revenue from both our ICD and pacemaker product lines, were $588 million, up 13% from last year's third quarter. For the fourth quarter of 2007, we expect total cardiac rhythm management product sales to be in the range of $570 million to $610 million.

For the full year 2007, we expect total CRM product sales to be in the range of $2.300 billion to $2.340 billion, up approximately 12% to 14% versus 2006. For the third quarter, ICD sales were $318 million, up 17% from last year's third quarter, and consistent with our previous guidance that ICD sales would be in the range of $305 million to $335 million this quarter.

US ICD sales were $222 million, up 13% from last year's third quarter. International ICD sales were $96 million, a 28% increase over the third quarter of 2006, with $6 million of the increase due to favorable foreign currency translations.

For the fourth quarter of 2007, we expect St. Jude Medical ICD sales to be in the range of $310 million to $340 million. Given our fourth quarter ICD sales guidance, we now expect our full year 2007 ICD sales to be approximately $1.257 billion to $1.287 billion.

For low-voltage device sales, for the third quarter totaled $270 million, up 9% from last year's third quarter, and at the high end of our previous guidance that pacemaker sales would be $255 million to $270 million this quarter.

In the United States pacemaker sales were $131 million, a 7% increase compared with last year's third quarter. In our international markets, pacemaker sales were approximately $139 million, up 11% from the third quarter of 2006, including a $7 million increase due to favorable foreign currency translations.

For the fourth quarter of 2007, we expect total pacemaker sales to be in the range of $260 million to $275 million, and we now expect our full year 2007 worldwide pacemaker sales to be in the range of $1.45 billion to $1.60 billion.

Atrial Fibrillation or AF product sales for the third quarter totaled $100 million, up 23% over the third quarter of last year, and consistent with our guidance that AF product sales this quarter would be in the range of $93 million to $103 million.

For the fourth quarter of 2007, we expect AF product sales to be in the range of $100 million to $110 million, and we expect full year 2007 AF product sales to be in the range of $393 million to $403 million.

Total sales of cardiovascular products for the third quarter 2007 were $188 million, up 6% over the third quarter of 2006. As a reminder, products in the Cardiovascular division include mechanical and tissue heart valves, Angio-Seal Vascular Closure, embolic protection, PFO closure and other cardiovascular devices.

Within this category of products, sales of vascular closure products in the third quarter of 2007 were $85 million, a 1% increase over the third quarter of 2006. Sales of heart valve products in the third quarter of 2007 were $68 million, a 6% increase over the third quarter of 2006. For the fourth quarter of 2007, we expect cardiovascular product sales to be in the range of $185 million to $200 million. And we expect full year 2007 cardiovascular product sales to be in the range of $770 million to $785 million.

Total sales of neuromodulation products in the third quarter of 2007 were $51 million, up 16% from the third quarter of 2006. For the fourth quarter of 2007, we expect sales of neuromodulation products to be in the range of $47 million to $52 million. And we expect full year 2007 neuromodulation sales up $198 million to $203 million.

The geographic breakdown of St. Jude Medical sales in the third quarter of 2007 was 57% in the United States versus 43% outside the United States or OUS. And this compares to 58% US and 42% OUS in the third quarter of 2006.

A detailed geographic breakdown of this quarter's sales by product shows high voltage at $222 million US, $96 million OUS, low voltage at $131 million US, $139 million OUS, atrial fibrillation products at $46 million US and $54 million OUS, cardiovascular products at $83 million US and $105 million OUS, and finally neuromodulation product sales at $44 million US and $7 million OUS.

The gross profit margin in this quarter was 73.6%, representing a full percentage point of improvement over the third quarter of 2006 and up three-tenths of a percentage point sequentially from the second quarter of 2007. For the full year 2007, we continue to expect gross profit margins to be in the range of 73% to 73.5%.

Our third quarter SG&A expenses were 36.4% of net sales compared to 35.4% in last year's third quarter, primarily reflecting the investments made in our U.S. field sales and sales support organizations and market development programs that began in the second quarter of 2006.

In the second quarter of 2007, SG&A expenses as a percentage of net sales were 36.8%. We expect SG&A as a percentage of net sales to continue to drop slowly, as we leverage the expanded investments we made in our sales and marketing programs in 2006 and in the first quarter of 2007.

Research and development expenses in the third quarter of 2007 were 12.6% of net sales, compared to 13.2% in the third quarter of 2006. For the full year 2007, we expect R&D expenses to be in the range of 12.5% to 13.0% of net sales, as we continue to balance delivering short-term results with the right investments in long-term growth drivers.

Other expense was $8 million in the third quarter, and for the fourth quarter of 2007 we expect the other income and expense line item will be a net expense of approximately $3 million to $5 million. For the full year 2007, we expect the other income and expense line item will result in a net expense totaling approximately $26 million to $28 million.

Year-to-date, our effective income tax rate was 27%, which we anticipate will approximate the effective rate for the full year of 2007.

Moving on to the balance sheet, at the end of September 2007, we had $90 million in cash and cash equivalents, and $1.414 billion in total debt. The outstanding debt on our balance sheet includes $1.2 billion of 1.2% senior convertible debentures are issued during the second quarter of 2007, $28 million of outstanding commercial paper borrowings, and $181 million of notes issued in Japan, which are due in 2010 and bear interest at a fixed rate of 1%.

Next, I want to offer some comments regarding our EPS outlook for the fourth quarter and the full year 2007. In preparing our EPS guidance we have assumed that in the fourth quarter of 2007 the share count used in our fully diluted EPS calculation will be about $352 million to $354 million shares, with the weighted average outstanding shares for the full year 2007 also at $352 million to $354 million range.

The company expects consolidated EPS for the fourth quarter to be in the range of $0.47 to $0.48, and for the full 2007 we now expect the consolidated EPS to be in the range of $1.78 to $1.79.

Now, I'd like to turn it back to Dan Starks.

Dan Starks

Thank you, John. As we mentioned in our press release this morning, our third quarter results reinforce our confidence that we will enter 2008 well positioned to deliver earnings per share growth of at least 15%. Although, we will not be in a position to offer our guidance for 2008 until next quarter in accordance with a normal schedule, I would like to expand on the reasons for our confidence.

First, we expect to continue to take share in the ICD market during 2008 due to new people, new products and new customers. With respect to new people, the initiative we completed earlier this year to expand our U.S. field sales and support organization by approximately 450 people will fully impact our market share in 2008 for the first time due to the lapse of non-compete restrictions, the completion of training programs and the start-up lag time inherent in normal selling cycles.

With respect to new products, we are on track with the US and European launch of our current RF and Promote RF families of ICDs beginning at the upcoming AHA Scientific Sessions later this quarter and we expect another strong flow of new ICD and pacemaker products throughout 2008.

With respect to new customers we continue to expand our customer base in 2007 with first implants in new ICD accounts, growth of our pacemaker market share and success in our ICD and pacemaker customer contract and program. Taking together, we expect these new people, new products, and new customers to make 2008 the eight year in a row which St. Jude Medical gains ICD market share and put us that much closer to our multi-year goal of achieving about a one-third share of the global ICD and pacemaker markets.

A second reason we are confident about our growth prospects for 2008 is that we expect the global ICD market to continue to grow at an upper single-digit rate. Now, that all of the numbers are in for last quarter, we can confirm that the global ICD market grew about 7% on a year-over-year basis during the second quarter of this year.

For our internal planning purposes as we look forward to next year, we assume that the global ICD market will continue to grow at about the same rate, combining single-digit growth in the US ICD market with double-digit growth in the international ICD market.

A third reason, we are optimistic about our growth goals for 2008 is that we expect strong contribution to earnings per share growth from productivity gains. As we outlined in our Annual Investors' Conference earlier this year, we expect to improve our net profit margin approximately five points over the five years beginning in the second half of 2007.

Our third quarter result show that we already are off to a good start with an 80 basis point improvement in net earnings as a percent of sales over sequential quarters. Although, this clearly represents meaningful improvement, we caution that just as with revenue and market share metrics, productivity gains will not be linear and that it would be more meaningful to measure productivity over periods longer than a single quarter.

A fourth reason, we are excited about our growth opportunity looking forward to 2008 and beyond is that our growth programs in atrial fibrillation, neuromodulation and stented tissue valves all are on track for 2008. We expect revenue in each of these programs to continue growing at encouraging double-digit rates and become increasingly important to our growth profile longer-term.

Before we open it up for questions, let me make two additional points. First, the guidance we've offered this morning for the remainder of this year, reflects the strength we are seeing across all our businesses, including Cardiac Rhythm Management, Atrial Fibrillation, Neuromodulation and portions of our Cardiovascular business. As I mentioned previously, we formulated this guidance before Medtronic issued an advisory toward primary family of high voltage leads earlier this week.

Second, St. Jude Medical is being asked whether we think Medtronic's advisory will impact long-term ICD market growth or create a meaningful shift of ICD market share. We think it is too soon to answer these questions. Experience has taught us how hard it is to predict what the consequences will be when another company issues a product advisory. We therefore are staying focused on executing St. Jude Medical's long-term growth program across all of our product platforms and fully leveraging our fundamental competitive advantages. We think it will take several quarters for the long-term implications of Medtronic's product advisory to become clear.

With that, I would like to turn the call back to our moderator and open it up for questions. Melissa will you please post the questions?

Question-and-Answer Session

Operator

Certainly. (Operator Instructions). The floor is now open for questions. Thank you. Our first question is coming from Bob Hopkins with Lehman Brothers. Please go ahead.

Bob Hopkins - Lehman Brothers

Hi, and thank you for taking the question. First one is I came a little late here, but just doing the math, it looks like you are lowering your full year ICD guidance by about $20 million to $30 million. And I was wondering if you could just comment on the reason why.

Dan Starks

We expect sequential quarter increase in our ICD sales on a core business basis, Bob. We see the core growth in the ICD market a little bit slower in the second half of this year than we previously anticipated. More importantly, however, I think when we look forward to what is going to happen now in the fourth quarter of this year, we do expect really a very meaningful impact from the recall earlier this week of a competitive high voltage lead. And so, I think that all of us are going to need to recalibrate what do we think is going to happen in Q4 now. We need to do that. Everybody else, clearly, is going to need to do that. We thought the most helpful thing we could do this morning is show people the condition of our core business in normal circumstances, and then let everybody else figure out what adjustments make sense in the same way that we're now going to do that on an internal basis here at St. Jude Medical.

Bob Hopkins - Lehman Brothers

But in essence is it the right read that you're being a little more cautious in your guidance for Q4 on the ICD line because of the recall?

Dan Starks

No.

Bob Hopkins - Lehman Brothers

So that $30 million that's coming out of your guidance is due to something else, just a broader slowdown that you are seeing away from the Medtronic issue?

Dan Starks

That's right.

Bob Hopkins - Lehman Brothers

Okay. And then have you seen anything in terms of your conversations with doctors over the last couple of days that would indicate anything relative to the market?

Dan Starks

Well, we have. Bob, we are going adhere to our normal communications discipline and not talk about intra-quarter events. This morning, even though, I appreciate that there is strong appetite for that, and I appreciate its all for very good reasons. But, we think that this is a volatile situation. It's only just risen here on Monday. Our primary concern is to behave responsibly, take the high role, stand back, let physicians take care of their patient’s, it’s not the right time for St. Jude Medical to be running in front of customers who really appropriately are paying attention to patients and answering patient’s questions now that this recall has been announced.

And so it will take some time for us really to sort through this. And you know, as I am sure others appreciate, the last time we had this kind of circumstance with meaningful recall from a competitive organization, it really did create poor visibility in the short-term, and it did create a lot of volatility in the short-term. So, we expect less visibility, more volatility in the short-term here in the fourth quarter, in the first quarter of next year. So, we'll work to make adjustments starting with the core business case that we've communicated this morning. But, we again think it be a little less visible and little more volatile.

Bob Hopkins - Lehman Brothers

Last question, I have is just on the sub 7 press release that you offer into the market place, one what percentage of your release are sub-7 French of the Riata that are sold today? And secondly, how confident are you are that with your thinner lead that you don't have any fracture rates that are higher than what you see with your normal leads?

Dan Starks

We are very confident about them. The question that you have asked is exactly the first question that we always ask anytime another company issues are recalled. That absolutely the first thing we say, okay, is this something that could be problem for us. What do we know about the payer mechanism? What do we know about the design? How does that compare to any of our products? Is there something here to that we have overlooked, that we need to be more alert to? And here also we've certainly done that in the case of the Fidelis recall from Medtronic.

One thing here with respect to Fidelis is that, although we only have known of the recall itself since Monday, we have been aware of the concerned surrounding of the Fidelis rate of facture for some time, both because of Medtronic's own letter in March of 2007, and also because of Dr. Hauser letter in Heart Rhythm Journal in July of 2007. So, just as Medtronic has and just as other stakeholders have, we have been very focused on working to understand what the vulnerabilities of the Medtronic design are, what their failure mechanism is, is that something and whether that's something that potentially be a problem for our Riata line of products, and we are confident that it is not.

And to elaborate on that little bit, let me just go back to the way that we even started to think about Riata family of leads when we designed it right on the first day. Part of our design process is to evaluate the top causes of failure in our current generation devices, and then work the design improvements to get at and reduce the level of failure that we have identified in any current product families.

And so we did that with Riata in the same way that we have done that with each of our ICD families, and each of our pacer family. The predecessor to our Riata family of high-voltage leads was our SPL family of high-voltage leads, and before that it was our TDL family of high-voltage leads. You will see in the data that our SPL family of high-voltage leads showed improved reliability over a prior generation. And our goal then was to look at, even though the SPL family of high-voltage leads has very good reliability, what are the most frequent failures in that product line, and what can we do to reduce those failures in our next generation of Riata family of leads.

The most frequent failure in that SPL family of leads, although, it was a low a level of failure, was occasional facture. So, as we look at the Riata family of leads, one of our primary design goals was to make improvement in the Riata family of leads that would reduce the opportunity for occasional lead fractures. And so, we have a very high confidence that we've accomplished that here with our Riata family.

If you compare a cross-section of our Riata lead with the cross-section of the Fidelis lead, you'll see that they are very fundamentally different design concepts. You'll see in Medtronic's own letter here and previously before they announced their recall they were busy telling customers that our design was really very different from their design, and clearly it is. Our conductor coil is centered; it is surrounded by six protective cables. We designed in redundant pacing and sensing, cable conductors. We maintained clear compression lumens. We have a different coil design. When you look at a cross-section of the Fidelis lead you'll see that center conductor is off center, it's out toward the edge of the lead. You'll see that it's surrounded by no protective cables. It doesn’t have the redundancy in pacing and sensing cable conductors that we have. You'll noticed that as you compared to their Quattro they took two compression lumens out that are really very clearly visible in the Quattro cross-section.

And then probably most importantly, we have a very different connection technology with our conduction cables that to the electrodes and at the proximal end of the lead we use a crimp and weld technique, which is a long-standing, proven reliable technology and absolutely mandatory component of our design criteria, the informed observers will determine that in the Fidelis design Medtronic for some reason departed from what they had done previously with a crimp and weld technique, and went to a bare spot weld right against the filers of the conductor cable. So, there are profound differences that give us a very high confidence that we are Riata family of leads is very reliable, very different from Fidelis, and not susceptible to the same mechanism of that has underlay the problems that Medtronic has experience.

And the proof that only as a person would compare what happened in the initial design of the devices, and then what was the thinking behind the initial design of the devices? What were their priorities, as always development groups have to make trade-offs when they choose this element of design versus that element of design. Our trade-offs were focus especially on lead reliability and especially on reducing the opportunity for lead fracture. One of the consequences of that is that we have had physicians in the past they were Fidelis lead is more flexible and they would like the fact that it is more flexible. But, what we thought was that reliability was more important than that degree of flexibility, and with hindsight now we'll be tremendously vindicated.

As we look at with our clinical experiences with our Riata family of leads, we are again very encouraged as we look at our internal data as of September 30, 2007 our documents reflect registered as implanted in the United States 121,220 Riata leads. Out of that cohort of registered implants in the US, we see on a returned, analyzed and confirmed basis total of 13 factures from all causes are about 20 times lower incidents are facture than Medtronic reports in their physician advisory earlier this week.

If you look at only the 7 French version of that same database, our documents reflect 34,937, 7 French Riata leads with only a total of two factors from all causes in that experience. So, that is consistent with what we would expect to see and then I would further look at, we are going to update our lead performance report here. A week from tomorrow we will publish our updated performance report that will show on the Riata family the 8 French versions at 30 months viability at 99.3% out of approximately 82,000 leads, and that compares to at 30 months 99.1% viability reported by Quattro. And as you would compare that to their Fidelis data at 30 months it compares to their 97.7%, so all of this is consistent.

Our design is robust; it was intended to be robust. We aired on the side of reliability and the lead design. We have factored in redundancy and the design; we have done that in our Promote and Current family of ICDs. We have done that across our Unity family of the devices that we are so much looking forward to getting out into the field here over these next few years. It's really what we expect to have become the trademark of St. Jude Medical, our focus on safety and reliability of our devices.

Bob Hopkins - Lehman Brothers

Dan, thank you very much for the details.

Dan Starks

Welcome.

Operator

Thank you. Your next question is coming from Glenn Novarro with Banc of America Securities. Please go ahead.

Glenn Novarro - Banc America Securities

Thanks. Good morning, Dan. I am wondering if we can just touch briefly on the Japan market, because there is an incidence where Medtronic is going to be off the market for let's call it several quarters. So, can you talk about what position you are in Japan to fill that void left behind by Medtronic? And what products you have available, sales force? Do you have the ability from a capacity point of view to even fill that market in Japan that's behind? Thanks.

Dan Starks

Our answers are all positive, Glenn, to each component of what you think about with respect to Japan. We have plenty of inventory, we are fully on the market. We now have several quarters of experience in our field organization, and we are prepared to step in and support customers to the fullest. As a person thinks about just the production and capacity and supply, you'll notice that our inventory is really very nicely built for growth. We've increased our inventory gradually here over this last number of quarters. We produce high-voltage leads at multiple sites. We have had our site set on substantive gain of market share and a growing ICD market. We've again placed a high priority on being sure that we did not hold ourselves back from being as successful as possible, so we're very nicely positioned to step in wherever we can be most helpful to customers in Japan, as well as in any other markets with good product supply already out in the field with good production capacity of that we put in place anticipating our continued growth, and so we are good to go.

With respect to Japan in particular, let me ask President of our International Division, Joe McCullough to comment further, what would you like to add with respect to Japan, maybe just starting with our view of the size of the Japan ICD market in around numbers?

Joe McCullough

Sure. As we've said before we expect the total high voltage market in Japan to be around $200 million. I would like to just go back a little bit, and go over a little bit of history first, and that would answer why we are fully prepare to be extremely competitive in the marketplace no matter what presents. As everybody knows, we bought Getz Brothers a number of years ago. And with Getz Brothers they have been selling our complete portfolio, our CRM portfolio for sometime. We have a very nice large market share in Japan on our low voltage technology, and we have a very broad and confident and well trained CRM sales force in Japan that stretches and covers every part of Japan completely, and it has been historically for a number of years, and since we have acquired debts and have our own direct St. Jude Medical, Japan organization. We have continued to build and improve on that very competitive sales force.

A number of quarters ago, I think it was last year, we introduced our high voltage technology with the well trained sales force and they are very competitive, and we have continued to gradually gain market share in our high voltage program, because physicians continue to increased their support of our rhythm management program. And as you know, we just introduced the CRT-D technology in Japan, and this launch will occur over a number of quarters going forward. And what I mean by that, as you well know we as well as the other manufacturers have been asked by the Japanese regulatory authorities to conduct post-market surveillance studies, which we are doing. And we have a quite a few, and I won't go into the details of the number of accounts that have IRB approval to participate in that clinical studies, and the number of centers continue to add and starting next quarter and multiple quarters after that we'll continue to introduce new technology into the Japanese market.

So, we are very confident that we will continue gain CRT-D and traditional high voltage in Japan. What physicians have already told us and I was there just a moth or so ago, about our CRT-D technology is they appreciate the high voltage technology or the high output technology. They appreciate the Quick Site lead, because it's positioning capability and its proven long-term stability. And over the quarters physicians have appreciated the value of our high voltage lead technology. So, we continue to receive very positive remarks from our customer about our technology, and the level of service we are able to provide. Simultaneously, though, we've been continuing as others to train physicians on left-heart lead procedures and continue to train the sales force. So, we are fully prepared to continue to gain market share in the high voltage arena.

Glenn Novarro - Banc America Securities

Okay. Great, thanks guys.

Operator

Thank you. Your next question is coming from Glenn Reicin with Morgan Stanley. Please go ahead.

Glenn Reicin - Morgan Stanley

Good morning folks.

Dan Starks

Good morning.

Glenn Reicin - Morgan Stanley

Two questions; just really follow-ups here. Can you just remind if exactly whether you are abiding by the [Meyer Burke] recommendations with respect to third-party review when you talk about quality? And just can you give us little bit more assurance on Riata?

And then second, Dan, if you can talk a little bit about the sales force? Is there anyway to help quantify sort of where you are at in terms of the productivity of the new reps. Maybe talk a little bit about new accounts opened or if you can tell us what percentage of the reps are not productive, if you can give us any sort of color there as to what the impact was in the third quarter versus the second, and sort of what the step-up is in the fourth quarter or first quarter in next year?

Dan Starks

Sure. On the first part of your question, Glenn, let me refer your question to President of our Cardiac Rhythm Management Division, Eric Fain and ask Eric, if you would like to comment on that?

Eric Fain

Sure. We are following the HRS recommendations. One of the big things that came out of that was on the topic of having medical Advisory Board Review of our data. We do that systematically ahead of our product performance reports being published. We've recently had both on the device, so we've established separate MABs for devices and leads. We have had meetings recently for both of those and they reviewed our data and will be reflected in our product performance report that will be published in the end next week.

Glenn Reicin - Morgan Stanley

Excellent.

Dan Starks

And then, on the question of sales force productivity, I'm sure we won't give you the granularity that you'd like Glenn. But, let me refer your question to President of our U.S. Division, Mike Rousseau. Mike, how much insight are you prepared to offer on the topic of productivity of our expanded sales organization?

Mike Rousseau

Well, Glenn, as you know, we will anniversary the '06 hires here as we conclude Q4. They were now fully trained. We will be through the vast majority of the non-compete period. The reps are going back into accounts, and entering what I would call a new selling cycle, where they are introducing our technology looking to get it into the rotation. So, we have high confidence that we'll start to see productivity increase as we work away into '08 and beyond. So, I would characterize it as being on track.

Glenn Reicin - Morgan Stanley

And so Mike, let me just push you a little bit. I think last quarter you are unwilling to give us a number on the percent of reps that had non-competes. If I am wrong you are welcome to offer it up as to what that number was in the second quarter and compare that with the third? If you are unwilling to do that, if we take the number of reps that were under non-compete in the second quarter, what percent of those have been freed up in the third quarter? And what percent it will be freed up in the fourth?

Dan Starks

Let me jump in. And I don't remember exact numbers, but directionally we can be pretty responsive. So, and again, I know that you have good data on this and kind of good documents reflecting our prior communications. Not everybody in the call does, so bare with me just to give everybody just a reminder on how we ramped up the expansion of our field.

We started the initiative in the second quarter of 2006, and so that was small contribution in expanding our numbers there in the second quarter of 2006. The biggest number, the biggest addition of headcount in a single quarter in that initiative was in the third quarter of 2006. Then, we had another good number, but smaller expansion of headcount in the fourth quarter of 2006. And then, smaller again tapered off in the first quarter of 2007. So, it was really a bell curve with the third and fourth quarters being where we added majority of our people.

As I recall out of that total 450, as I recall in round numbers it seems like something in the ballpark of about 180 of them were experienced reps. So, when you take out the ones that were not experienced reps, and then appreciate that, that a number of those had to be involved in training programs and they would be like new employees, some of them would have some interesting clinical experience, others would be, we even hired people fresh out of by medical engineering school. And so the ramp up on productivity of those people would be across the board depending on what the specialty was, depending what the background was.

But if you come into the 180 or so experienced reps, most of them had non-competes, they didn't all, but most of them had non-competes. And then typically it was a probably almost always a one year. So, there wasn't much, there weren't many, I won't give you the exact numbers, I don't actually have in front of me. But, there weren't that many people who came off non-competes in the second quarter. The biggest numbers came off non-competes in the third quarter here of 2007. And so, remember now that just gives them the ability to reengage, and thus now they need to start on the working through a normal selling cycle process. And then in lot of cases there are contracts that are in place they are part of that normal selling cycle process. So, that really makes it a far more of 2008 impact. You do get the one-offs that are really the exception where somebody is immediately productive.

We've got some of that last year with people who did not have non-competes and we will get some of we have got and some of that this year as people have reengaged in the field. But, for the most part you would expect to see, not now in the fourth quarter a number of people starting to reengage and in the first quarter of next year another second largest number of people starting to reengage. And then during 2008 really seeing the impact of those people back in front of their customers with the full product line, working through contract issues, working to get people acquainted with the technology that they, some of them have never used before and get comfortable with a small volume at the front end and then work to expand that into increasing volume. So, I didn't answer your question exactly, but directionally it's that kind of a slope for growth and for return on investment in the expansion of our field organization.

Glenn Reicin - Morgan Stanley

That's very helpful. And just anecdotally, have you been hearing anything about the impact of having a year-off on these reps?

Dan Starks

Well, I mean, there is a typical experience, which is again incorporated into the comments that I've made to you. So, we took advantage of the year with experienced people to provide training were appropriate, and so it wasn't total lag times, sometimes there were other things that people could do productively that were permitted on to the non-competent and thinner business circumstances. But for the most part that year-off means that once they reengage, its not a question of how sharper they are in their expertise, its really a question of, okay, they're really now starting the selling cycle. There is a relationship in place to support the kind of process of that selling cycle, but its still starting a selling cycle and so it's just a typical experience. I don't think we've seen anything unusual with this cohort and don't expect to see anything unusual with this cohort versus our experience over the last 10 and 20 years with similar kinds of processes.

Glenn Reicin - Morgan Stanley

Thank you very much.

Dan Starks

Welcome.

Operator

Thank you. Your next question is coming from Rick Wise with Bear Stearns. Please go ahead.

Rick Wise - Bear Stearns

Good morning.

Dan Starks

Good morning.

Rick Wise - Bear Stearns

Let me start with just a follow-up to your comments on the sounding, it sounds like quite profound design differences and performance of the Riata lead. Dan, a lot of people are confused by the MOD database which seemingly has a lot of reports on Riata. Can you help people understand how to relate those numbers in MOD to the numbers you are giving us just conceptually? Thanks.

Dan Starks

Sure, I will ask Eric Fain to do it actually. But just let me kick it off a little bit before I defer to the expert on it. Keep in mind Rick, as I know you would keep in mind, but everyone also keep in mind when they look at the MOD database, that's a whole hodgepodge, all kinds of events. There is a lot of redundancy there. I'll see someone as Eric Fain as he is regularly keeping me informed on these kinds on things. But, it includes an initial reports, follow-up reports, manufacturer reports, user reports all on a same event. It's a statement of claims too. You are airing the side of, if there is possibility that something not be recorded and then you go ahead and record it. So, a number of those claims and reports that would be reflected in the MOD database would be benign. So, there is just a whole a lot of different things that are captured in the MOD database. It's really very non-specific.

The best source of data, I think for an observer would be the product performance reports. Again this product performance reports are precise, they are rigorous, they eliminate the kind of the noise, and they are reviewed by our independent physician panel. So, I think the MON can be more of distraction than anything. It's useful to raise a question. It's not useful to answer the question. So, one ought to answer the question using by production performance report data that is completely documented with all the engineering quality, regulatory support appropriate and with the oversight of independent physician panel as well. So, I've stepped on Eric's toes a little bit, same things I know he would say. But, let me ask Eric if you would add more to people that look at the MOD database and are working to understand what it means and what it doesn't mean.

Eric Fain

Sure, I think Dan summed it up nicely. The other comments I'd make Rick are also that, remember that the coding of these things is done at different times in the process and when the complaint comes in things are not as known, obviously, as they are at with the final analysis and then you are also reliant on what people choose to put in for reasons with the initial complaints and so no. But, I can tell you that we obviously have gone back and done a rigorous review of our experience with the Riata lead, the data that Dan mentioned previously is supported by that review. And we are comfortable with that data is reflected accurately in our product performance report, and again, there will be an update on that at the end of the next week.

Rick Wise - Bear Stearns

Thanks Eric. Couple of follow-ups, Dan I've heard from several physicians I have spoken to post the Medtronic issue that there is likely to be more emphasis going forward, even more emphasis going forward on remote access and patient monitoring. I know you've lost your wireless ICD. Can you update us on how that's likely to impact St. Jude? And are you relatively disadvantaged from what at least some doctors are saying just that with Medtronic and Boston a little further ahead of you from our product point of view? Thanks.

Dan Starks

Let me, rather than giving my own comments, let me ask the people that are closer to the customers to comment. Let me ask President of our U.S. Division, Mike Rousseau to comment first as this is a set of issues that Mike and his leadership team focus on, on a regular basis. What would you say to answer Rick's question?

Mike Rousseau

Rick, as you know, we launched Merlin.net that allowed us to get and position ourselves in the market relative to remote follow-up and that was coming off with House call, which was the original remote follow-up for ICDs for us to market actually. As we move forward with Current and Promote, we will enter the RX space and be compatible sometime in the first half of '08, I mean, not wanting to make an estimate of when the FDA will give us certain software approvals. But, we are confident in the first half as criteria. Once there, and remember there is lag between implant and when a physician will begin to use the follow-up, we will, I think at that point actually move into a leadership position based on the fact that we are a open platform and we are the easiest platform to move to the EMR space. And that will be the next critical factor in how we are going to follow patients and that's being able to be seamlessly visible in electronic medical record. So, that's the product layout, and all products moving forward will be supported by that system.

Rick Wise - Bear Stearns

And so, you don't expect it to be relatively disadvantage in '08 if there is some sort of more aggressive push in that direction?

Mike Rousseau

I think our timing would end up being, I would characterize it is just in time.

Rick Wise - Bear Stearns

Thanks so much.

Operator

Thank you. Your next question is coming from Charles Holland with Goldman Sachs. Please go ahead.

Charles Holland - Goldman Sachs

Good morning. Thanks for taking the question. Just two questions, first one is a quick follow-up on the question on Japan. And I am sorry if I miss this before, but what is the word on being able to mix and match Bes and cans out there. Are there any legal considerations that we should take into account?

Dan Starks

Now, let me just kind of say, I actually whenever I get to ask the question or whenever we get to ask to question on legal considerations, I am always careful to differ. So, I don't want to have any of us walk you through a legal opinion on Japan Law, and so I will duck that little bit. But, let me ask President of our International Division Joe McCullough to talk about what our experiences in the field with mix and matching in Japan on the ICD side in? What we think the environment is there?

Joe McCullough

Normally physicians have not wanted to mix and match the leads with the devices, and I can't tell you what to expect in the future, because historically it happen somewhat to be very small percentage of the time. So, I can't tell you what to expect in the future, that's just been their cultural bias for many, many years.

Charles Holland - Goldman Sachs

Okay. Thanks a lot of Joe. And actually just to continue on the international front. ICD sales outside the US saw some moderation in growth on what seems to be the easiest year-over-year comparison in 2007. Is there anything to read into there? Could you just talk to what the trends are outside the US and if there is in back something that we are not seeing?

Dan Starks

Charles, I don't think that one ought to read too much into any of the third quarter data. We have always cautioned people that whether the quarter data, regardless of what the view of the quarter data is that it's an awfully short period time and that there is so much that goes on timing wise with respect to the both just the number of procedures and the way that days fall and the way the orders fall that it really means a lot more to combine the results of sequential quarters.

I think a six month period of time really is lot more meaningful than our 90 day period of time. And we've just seen that again and again. Over this last three years in particular that's become our mantra, is when we have a really strong quarter don't go nuts, when you have a weak quarter don't lose any sleep. That you really look at the trends across two quarters in a row, there is lumpiness across different companies, the lumpiness doesn't match quarters. There is so much that it will happen in the volume, in some of these high volume centers that will change the procedure of volume that they have it falling to one quarter versus another quarter. There are so many different things that happen. Nobody would look at daily sales, so I think we got something interesting and I appreciate, I am exaggerating to make the point. But, with a quarter sales it's a little bit more of the same than one would appreciate.

So, I ought to say don't read too much in other quarter. The main thing I think in Q3 on the year-over-year basis it matched for seasonality, but the main thing in Q3 is the seasonality just across the board all product lines, procedures seemed to be a little bit light everywhere. But, we expect to see, I think more importantly as you see, yeah, but going forward now what do we extrapolate. We expect healthy ICD market growth in international markets in 2008. Everything seems lined up nicely. The increase, the expansion of physicians that are trained in the business of providing ICD therapy to people continues to build in all of these are emerging international markets that are increasingly important. Reimbursement continues. We don't see major differences in 2008 on the reimbursement side. So, I think you'll see everything just continue to go on pretty nicely in international markets with respect to ICDs, that's our expectation. We expect encouraging double-digit growth in international ICD markets for 2008.

Charles Holland - Goldman Sachs

Okay. Fair enough. I just wanted to make sure there was nothing fundamental out there. Thank you.

Dan Starks

You're welcome. Melissa, maybe I would take one last question.

Operator

Thank you. Your last question is coming from Joanne Wuensch with BMO Capital Market. Please go ahead.

Joanne Wuensch - BMO Capital Market

Thank you very much. To add some difference, can we please talk about what's happening in your Brady sales line? Its growing faster than I would have expected and I'm curios what do you think the sustainability is of high single-digit worldwide growth rate is? What do you think the market is growing at and who you think are taking your share from?

Dan Starks

All good question, Joanne. I will confess in advance that we won't answer them precisely, but we'll do our best to partly respond to it. You raised a great point here on pacing side and it really juxtapose with the ICD dynamics. So, if we back to a year ago or somewhere earlier this year, we began to provide our guidance really emphasizing the expectations of pacing and ICDs combined. And if we appreciate that's not the convention, we didn't start down this path attending to annoy anybody. We started down the path, because we wanted to start to provide the thinking that the rate of growth in the ICD market and the rate of growth in the pacing market interrelate and also that share trends interrelates. That's been our experience for fundamental reasons, it make sense to us and it's our experience.

So, we provide our guidance, we still give the differentiation, but we really think that the more meaningful guidance is, what do we think combined pacing and ICD sales are going to be? And what about the kind of combined market opportunity, blending growth rates on pacemakers with growth rates on ICD. And so, this quarter is a perfect example. We are up at the high-end of the pacing guidance, we are not at the high-end of the ICD guidance, and that's not coincidence. The pacing market was a little bit stronger. There are patients that could have got an ICDs, they have got pacers instead. You'll see our presence on the pacing side and the way we were capturing those sales reflects, they does reflects the productivity and reflects to the effectiveness of our field organizations that we're, so many times these are exactly the same physicians, exactly the same implant centers, exactly the same field organization. We are in there for whichever procedures they are going to do, and if it's ICD procedures you are going to see may be a little weaker pacing sales from us and stronger ICD sales. If it's pacing producers you are going to see stronger pacing sales over what weaker ICD sales, which is what you saw now this quarter. So, that you are right that that's the flip side of what could we see on the ICD side. That will we expect strength in pacing trends when we see a little bit weakness in ICD trends, but big picture over time we expect the share trend to go along somewhat together and pacing and ICD. But what do we expect specifically for 2008, we will give our guidance next quarter and we are not yet prepare to do it today.

Joanne Wuensch - BMO Capital Market

Okay, thank you very much.

Dan Starks

You're welcome and we’ve gone for over hour and now I'd like to thank everybody for participating and joining us this morning and turn it over to our moderator Melissa for concluding comments.

Operator

Thank you. Today's call is being recorded and will be available for a replay beginning at 12 pm Eastern Standard Time. The dial-in numbers are for US 877-519-4471 and International 973-341-3080, and enter the pin number 9218664. Thank you, this does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.

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Source: St. Jude Medical Q3 2007 Earnings Call Transcript
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