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

Q2 FY08 Earnings Call

July 16, 2008, 08:00 AM ET

Executives

Daniel J. Starks - Chairman, President and CEO

John C. Heinmiller - EVP and CFO

Analysts

Frederick Wise - Leerink Swann Llc

Tao Levy - Deutsche Banc Securities

Michael Weinstein - JPMorgan

Larry Biegelsen - Wachovia

Vivian Cervantes - Rodman & Renshaw

Kristen Stewart - Credit Suisse

Joanne Wuensch - BMO Capital Markets

Operator

Welcome to St. Jude's Medical Second Quarter 2008 Earnings Conference Call. Hosting the call today is Dan Starks, Chairman, President and Chief Executive Officer of St. Jude Medical.

The remarks made during this conference call include forward-looking statements within the 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 St. Jude Medical.

The statements made on this conference call are based upon 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.

Such statements involve potential risks and uncertainties, such as market conditions and other factors beyond St. Jude Medical's control and the risk factors and other cautionary statements described in St. Jude Medical's filings with the SEC, including those described in the risk factors and cautionary statement sections of the St. Jude Medical's Annual Report on Form 10-K, filed on February 27, 2008.

St. Jude Medical 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 your questions following the presentation. It is now my pleasure to turn the floor over to Mr. Dan Starks.

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

Thank you, Jackie. Welcome to the St. Jude Medical second quarter 2008 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 normal review of our second quarter results along with his cyclical update for the entire St. Jude Medical business. I will then make a few comments and open it up for your questions. Go ahead, John.

John C. Heinmiller - Executive Vice President and Chief Financial Officer

Thank you, Dan. Sales for the quarter totaled $1.136 billion, up approximately 20% over the $947 million reported in the second quarter of last year.

Favorable currency translations versus last year's second quarter increased this quarter sales by about $64 million, which was consistent with our expectations at the time we gave guidance on foreign currency exchange rates and sales at the end of the first quarter.

The federal research and development tax credit expired at the end of 2007 and has not yet been extended for 2008. In this circumstance GAAP requires us to estimate and report our F'08 income tax rate assuming that the research and development credit is not extended.

For purposes of this conference call and our calculation of adjusted net earnings however, we are assuming that the tax credit will be extended for 2008, as in past years. As a result, comments referencing second quarter results and our guidance for 2008, including earnings per share amounts, are presented based on the effective income tax rate that contemplate the extension of the federal research and development credit for 2008, virtual [ph] acted to January 1, 2008. To the extent if the federal research and development credit is not renewed, our effective income tax rate for 2008 would be higher, than what has been presented during this call.

Earnings per share was $0.60 for the second quarter of 2008, a 33% increase over EPS of $0.45, in the second quarter of 2007. Before we discuss our second quarter 2008 sales result by product category, with guidance for the remainder of 2008, let me comment on the currency exchange rates we're currently using in our outlook.

The two main currencies influencing St. Jude Medical's operations are the Euro and the Yen. For the euro we are assuming that each euro will translate into about $1.54 to $1.58 and for the yen we are assuming that each 105 to 110 yen will translate into $1.

In addition, as we move into the second half of 2008, we would point out that due to our 52, 53 weeks fiscal year convention, our fourth quarter this year will have 64 selling days versus 61 selling days in the fourth quarter of 2007.

Now for the discussion of sales by product category; For the second quarter, total Cardiac Rhythm Management sales or CRM sales which include revenue from both ICD and pacemaker product lines were $712 million, up 20% from last year's second quarter and above our previous guidance that total CRM sales would be in the range of $650 million to $680 million this quarter.

For the second quarter, ICD sales were at $406 million, up 24% from last year's second quarter. U.S. ICD sales were $253 million, up 14% from last year's second quarter. International ICD sales were $153 million, a 46% increase over the second quarter of 2007 with $18 million of the increase being favorable foreign currency translations.

For low-voltage devices, sales for the second quarter totaled $306 million, up 14% from last year's second quarter. In the United States, pace maker sales were $134 million, a 6% increase compared with last year's second quarter.

In our international markets, pacemaker sales were approximately $172 million, up 22% from the second quarter of 2007, including a $20 million increase due to favorable foreign currency translations.

For the third quarter of 2008, we expect total CRM product sales to be in the range of $660 million to $690 million, reflecting the seasonality we normally experience in our business during the third quarter.

For the full year 2008, we are raising our guidance today. And now expect total CRM sales to be in the range of $2.725 billion to $2.775 billion, up approximately 15% to 17% versus 2007.

Our previous guidance was $2.625 billion to $2.700 billion. Atrial Fibrillation or AF product sales for the second quarter totaled $135 million, up 35% over the second quarter of last year, and above our previous guidance that AF product sales this quarter would be in range of $115 million to $125 million. For the third quarter of 2008, we expect AF product sales to be in the range of a $125 million to a $135 million.

We are raising our full year 2008 AF product sales guidance to be in the range of $515 million to $545 million, up from our prior guidance of $495 million to $525 million. This includes the expected contribution towards EP [ph] net systems revenue in the second half of the year.

Total sales of cardiovascular products for the second quarter of 2008, were $228 million, up 14% over the second quarter of 2007. Within this category of product sales our vascular closure products in the second quarter of 2008 were $97 million, a 9% increase over the second quarter of 2007.

Sales of heart valve products in the second quarter of 2008 were $87 million, a 14% increase over the second quarter of 2007.

For the third quarter of 2008, we expect cardiovascular product sales to be in the range of $195 million to $210 million. And we expect full year 2008 cardiovascular product sales to be in the range of $845 million to $870 million.

Total sales of neuromodulation products in the second quarter 2008 was $61 million, up 17% from the second quarter of 2007, and above our previous guidance of $51 million to $56 million. For the third quarter of 2008, we expect sales of neuromodulation products to be in the range of $55 million to $60 million. We expect full year 2008 neuromodulation sales of $225 million to $240 million, up from our previous guidance of $216 million to $231 million.

Total revenue guidance for 2008 therefore, for St. Jude Medical is now $4.310 billion to $4.430 billion, a $124 million increase, compared to the high end of our prior guidance. The geographic breakdown of St. Jude Medical sales in the second quarter of 2008 was 51% in the United States with U.S. versus 49% outside the United States or OUS. This compares to 56% U.S. and 44% OUS in the second quarter of 2007.

A detailed geographic breakdown of this quarter sales by product shows high voltage at $253 million U.S., $153 million OUS, low voltage at $134 million U.S., $172 million OUS, atrial fibrillation products at $57 million U.S. and $78 million OUS, cardiovascular products at $89 million U.S. and $139 million OUS and finally, neuromodulation product sales at $50 million U.S. and $11 million OUS.

The gross profit margin this quarter was 74.7%, representing a 140 basis point improvement over the second quarter of 2007, and up 50 basis points sequentially from the first quarter of 2008.

For the full year 2008, we expect gross profit margins to be in the range of 74.2% to 74.7%. Our second quarter SG&A expenses were 36.7% of net sales and for the full year 2008, we continue to forecast SG&A as a percentage of net sales in the range of 36% to 36.5%.

Research and Development expenses in the second quarter of 2008 were 12.2% of net sales with expense up 16% from the second quarter of 2007. For the full year 2008, we continue to expect R&D expense to be in the range of 12% to 13% of net sales as we continue to balance delivering short-term results with the right investments in long-term growth drivers.

Other expense was $5 million in the second quarter. And for the third quarter of 2008, we expect the other income and expense line item will be a net expense of approximately $1 million to $4 million.

And for the full year 2008, we expect the other income and expense line item will result in net expense totaling approximately $5 million to $10 million. Year-to-date, our effective income tax rate was 27.5%, which we anticipate will approximate the effective rate for the full year of 2008. And as reminder, this effective income tax-rate contemplates the extension of the federal research and development credit in 2008, retroactive to the beginning of the year. To the extent this is not extended our effective income tax rate will increase. We have also assumed extension of the federal research and development credit in the earnings per share guidance for 2008.

Moving onto the balance sheet, at the end of 2008 we had $397 million in cash and cash equivalents and $1.399 billion in total debt. The outstanding debt on our balance sheet primarily represents $1.2 billion or 1.2% Senior Convertible Debentures issued during the second quarter of 2007, and $194 million of notes issued in Japan, which are due in 2010 and their interest data fluctuated at 1%.

Next, I have to offer some comments regarding our earnings per share outlook for the third quarter and the full year 2008.

In preparing our EPS guidance, we've assumed that in third quarter of 2008, the share count used in our full diluted EPS calculation, will be about $249 million to $351 million shares with diluted average shares outstanding for the full year 2008 of $350 million to $353 million.

This guidance for weighted average shares outstanding reflects the repurchase of 6.7 million shares of our common stock, which we have completed in May 2008.

The company's expects consolidated earnings per share for the third quarter, to be in the range of $0.56 to $0.58. And for the full year 2008, we're raising our consolidated EPS guidance by $0.13, and now expect earnings per share for 2008, to be in the range of $2.28 to $2.33. I would now turn it back to the Dan Starks.

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

Thank you, John. I would like to focus my comments to be on briefly reviewing several of the key themes we presented in our annual Investors conference in February of this year.

One key theme was that we are well positioned to continue to gain ICD market share. The first two quarters of 2008 have shown that we were correct. We will have to wait for our competitors to report to finalize our market model, but we estimate that during the first half of 2008, we gained between 2 and 3 full points of global ICD market share versus the first half of 2007. This compares with a 2 point gain of global ICD market share during the first half of 2007 versus the first half of 2006.

We attribute this rate of gain to the cumulative impact of numerous competitive advantages, we put in place during the last two years. This includes our launch of over 40 new ICD and pacemaker products in a 24 month period, the expansion of our global field sales and support organizations, including the addition of over 450 new people in the United States alone.

Our success came first ICD implants in order of hundreds of new accounts, and our progress gaining new customer contracts. The same competitive dynamics with the strength and our gain of ICD market share have strengthened our gain of pacemaker market share.

We again will point to you that we need to wait for our competitors to report their quarterly results to finalize our analysis, but we estimate that we gained between one and 1.5 points in global pacemaker market share during the first half of 2008, versus the first half of 2007. This compares with a gain of one full point of pacemaker market share, during the first half of 2007 versus the prior year.

Looking forward to the remainder of 2008 and beyond, our confidence remains high that we will continue to gain ICD and pacemaker market share. Our confidence is based on a long list of factors that includes all the following. First; we will continue to leverage our sales force expansion. Keep in mind that many of the one year non-compete agreements that were in place for people we hired from competitors, expired during the second half of 2007. We are still in the early phase of selling cycles for a number of new sales reps.

Second; a number of our new customer contracts have only recently been finalized. Most of the benefits of these contracts are still ahead of us.

Third; our Current and Promote RF, ICD products have only been on the market two full quarters. Together with the Merlin.net version 3.0, remote monitoring system we launched during the second quarter, these new products still are gaining traction and have not yet reached their full market share potential.

Fourth; is the competitive advantage we gained from having the only two product lines with 7 French high voltage leads on the market. Approximately 90% of the high voltage leads being sold during the second quarter in the United States were 7 French.

Fifth is the value of our Quickopt Timing Optimization technology. This is another example of technology that is available only from St. Jude's Medical.

Our QuickOpt technology permits physicians to improve V to V and A to V timing in an ICD within minutes using our Merlin Patient care system during routine follow up without the need for a separate echocardiography procedure.

A sixth factor is that we have continued to strengthen our competitive advantage in Japan and in China. During the second quarter, we launched the first and only Japanese language program on the market in Japan.

During the second quarter, we also were the first and only company to launch a full feature programmer in China, using the Mandarin language. To put this in context 39% of our total company revenue during the second quarter was from global markets outside the United States. This indicates we're best in class versus our closest competitors, with respect to relative effectiveness in international market.

Our leadership in national language programmers is only tip of the iceberg with respect to this effectiveness, and the implications it has for our continued gain of CRM market share. We've a number of additional reasons to the optimistic that we will continue to gain CRM market shares the remainder of this year and beyond. This includes our anticipated launch in selective markets, of the first and only ICD product lines with ST segment monitoring diagnostics.

Our Current, XL and Promote XL lines of ICDs, our Accident and Anthem lines of pacemakers and our Merlin@home technology. We also will continue to boast of a competitive advantage, we already enjoy with our after sense, our quick size in our quick flex leads [ph] by launching additional leads and lead delivery tools.

Overall it should be clear that we are well positioned to continue gaining CRM market share, moving forward as always, we cautioned that these gains will not be linear and that it is more meaningful to calculate CRM market share by combining the results of two sequential quarters, given that our fiscal quarters include different months than the fiscal quarters of our largest competitor. This is especially true in the case of ICD's where unit volumes are relatively low, average selling prices are relatively high and smaller variations in market dynamics or timing of customer orders can have a more visible impact on competitive results.

During the remainder of 2008, we also look forward to additional progress in our clinical trials evaluating our unique six factor impedance pulmonary edema diagnostic technology, and our potential breakthrough technology with left atrial pressure trenching diagnostics. It should be increasingly apparent that we are becoming the technology leader in Cardiac Rhythm Management.

With respect to CRM market growth, we estimate that the global CRM market grew between 7% to 9% during the first half of 2008. We expect the globalize ICD and pacemaker market to maintain upper single digit growth for the full year 2008.

With that, let me move away from reviewing the highlights of our ICD and pacemaker business to talk about our atrial fibrillation or AF business.

A second key theme at our annual investor's conference earlier this year is that our AF business is on track to become an increasingly important long term growth driver. First, let me address the size of the current market. Although our AF business is focused on helping physicians to optimize short term approaches to atrial fibrillation. Our AF business addresses the entire spectrum of electrophysiology procedures. We estimate that the relevant market will be over $1.5 billion in size by the end of this year and that it can continue to grow at a mid to upper teens rate.

This implies that over the next five to seven years the market for AF related products will be as large as for those pacemaker market. It therefore is especially significant that either [ph] our sustained focus on this market since the early 1990s, St. Jude Medical today has the leading program in AF.

This leadership is reflected in our 32% growth in AF revenue during the first half of 2008 versus the first half of the prior year. It also is especially significant in this context, if we had not closed our acquisition of EP MedSystems, this acquisition immediately expands our AF program into two new segments of the market totaling approximately $100 million and will help us accelerate our development of next generation technologies designed to simplify AF invasion procedures.

We will enter into another new segment of the market for AF related products with our confirmed implantable cardiac monitor during the second half of this year.

Both, by gaining share with current products and by entering into new market segments, we are continuing to expand the footprint of St. Jude medical in the electrophysiology lab increasing their return to St. Jude Medical from our ongoing AF market development activities and reinforcing the significance of our AF technology platform as an additional long-term growth driver.

Next; I would like to comment on our neuromodulation business. A third piece... theme we presented at our annual investors conference earlier this year, was that, although it is at an earlier stage of development than our atrial fibrillation business, our neuromodulation business is on track to become another major growth driver for St. Jude Medical.

This theme continues to resonate, revenue growth of 17% on a year-over-year basis during the second quarter without the benefit of our Iamin [ph] product line. It's a testament to the quality of our technology, the breadth of our product line, the strength of our customer relationships and the capabilities of our global field sales and report organizations.

We look forward to launching our next generation Iamin's spinal cord stimulator before the end of this quarter. Iamin will give St. Jude's Medical, the smallest spinal cord stimulator on the market, while maintaining our existing device longevity and bearing over our competitors.

We look forward to receiving CE mark towards the end of this year or early 2009 with our next generation deep brain stimulation systems for patients in Europe who suffer from Parkinson's disease.

Moving on to the topic of clinical trials in neuromodulation, enrolment continues in our pivotal clinical trials for patients who suffer from treatment for existing depression, based on the breakthrough clinical research of Dr. Mayberg and Dr. Lozano and their colleagues with respect to deep brain stimulation of Brodmann Area 25.

St. Jude Medical now has a total of four pivotal clinical trials under way in the United States evaluating the benefit of neuromodulation therapy for patients suffering from Parkinson's disease, essential tremor, migraines and treatment for resistant depression. Our neuromodulation business is making steady progress towards becoming a major lead growth driver for St. Jude Medical.

Our fourth key theme we presented at our annual investors conference earlier this year is that St. Jude Medical is implementing a comprehensive program to improve net operating margins by many as 5 points over the five year period that began in the second half of 2007. Four quarters into this program, we are off to a good start and have met or exceeding our interim goals.

Our net operating margins for the first half of 2008 reflects meaningful improvements compared with the first half of 2007. It is especially significant that our growth margins improved 130 basis points during the first half of 2008 compared with the first half of the prior year. This improvement was without the benefit of our long term initiatives to expand manufacturing activities and lower cost environment.

These new manufacturing initiatives will begin to impact our income statement modestly in 2009, with more significant benefit in later years. With respect to our initiatives to improve our net operating margin by as many as 5 points over the five year period that began in the second half of 2007. I would like to repeat an earlier caution that we do not expect productivity gains to be linear.

I also would to reiterate that our five year horizon for productivity gains establishes only a base line case. We will not hesitate to modify our timeline for productivity gains if we think it is appropriate to expand our investments in new long term growth drivers to our physicians or to move internal initiatives. We continue to do our best to reconcile these competing considerations for you, to our ongoing quarterly and annual guidance.

From my closing comments I would like to express, how pleased St. Jude Medical's management team is, that we were successful on so many fronts during the second quarter.

Revenues for every division, we had a double digit growth. We gained market share in almost all major product categories. Our revenue growth rate accelerated on a currency mutual basis. We made good progress leveraging the middle of our income statement. We both exceed our short term profit goal and extended our investments in long term growth rather. We are well position for a strong second half of 2008 and for sustained success, further into the future.

With that, I would like to turn the call back to our moderator Jackie and open it up for questions. I would like to ask that as a courtesy everybody please there limit yourself to two questions so that we can get to as many people as possible, in the time remaining.

Jackie, please go ahead.

Question And Answer

Operator

Thank you. [Operator Instructions]. Your first question is from Bob Hopkins [ph] with Banc of America. Please go ahead.

Unidentified Analyst

Thanks [ph] and good morning and congrats on the results.

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

Good morning Bob.

Unidentified Analyst

I have two questions. First question is since some talk in the market about your new marketing relationship you guys have with Abbot, I was wondering if you could talk a little bit about that and just more details and how it compares with what you previously had with J&J.

And then my second question is just to get it our there, I realize that don't have the benefit of [indiscernible] when you talk a lot about your previous share gains but I was just curious what did you learn in the quarter about the speed in the market what's your opinion about the speed of the overall market that has sort of suffered CapEx from market share?

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

Bob let me take your second question first. On the state of the market, we were encouraged by the state of the market during the second quarter. If we would talk about Japan for example, we saw market growth in Japan recover a little bit over the prior two quarters. And we expect the market growth for ICDs in Japan to continue to recover modestly during the remainder of this year.

The overall dynamics were good. Our growth continued really across the Board and in all major geographies and with all major product lines So, we were encouraged that we see a healthy dynamics in the... modest but healthy dynamics in the CRM market consistent with our expectations here at the beginning of the year.

We... as we started the year suggesting that the global pace maker and ICD market will... was expected to be about 5% to 7%, we increased that expectation now to say that we think that for the full year, the growth maybe closer to something in the range of 7% to 9%. So, I would say that our experience during the second quarter was positive across the board with respect to the market dynamics.

With respect to your first question, we do have an agreement with Abbot, I would characterize it as a limited agreement. Its really something that just facilitates the discussion of St. Jude's Medical and Abbot with customers where customer want stock of both companies at the same time, about contracts covering our ICD and pacemaker products and Abbots Xience stent and angioplasty related products.

And really I would just call that more business as usual than anything in the sense that speaking just for St. Jude Medical we are always be happy to accommodate the customers and do what we can to meet their needs and to the extent they would like to talk to us about a broader bundle we are prepared to do that.

Unidentified Analyst

Good my other question. [Indiscernible]

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

I'm sorry, say again.

Unidentified Analyst

It is much different than the previous relationship we had with J&J?

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

I'm not closed enough to all of the details to compare exactly but I would call it directionally similar.

Unidentified Analyst

Thanks very much.

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

You're welcome.

Operator

Thank you. Your next question is from Rick Wise with Leerink Swann. Please go ahead.

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

Good morning, Rick.

Operator

Your line is live sir, please un-mute your line and proceed with your question.

Frederick Wise - Leerink Swann Llc

Okay, can you hear clearly now?

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

Yeah.

Frederick Wise - Leerink Swann Llc

I guess I have finally questions will focus on some things there. First, maybe you could give us a little more color on international growth outlook, I mean, your OUS ICDs were exceptionally strong and there have been some concern about the OUS growth rates. Maybe tell us the extent why we might see this kind of growth In P&L and to accelerate a few, can you comment the technology if it fails, I mean what are the drivers there and then I will ask the second question.

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

Rick, let me offer some comments and then I will ask Group President, Joe McCullough if he has additional comments. The primary driver of growth in international markets of the... ICD market growth in particular, from my perspective is the comparison of clinical data on the one hand and how strong the clinical data is, how strong the medical consensus is that ICD therapy is indicated for a broad group of patients on one hand. And on the other hand, how small the current ICD practice is and so major market opportunities and the extreme would be data that you have operated in the past that just to use as one example on the marketing... of China's I recall that the data is that there is less than one implants, one ICD implant per million in that population as compared with something in excess of 600 implants per million here in United States.

Using the example of the market of Japan as I recall, the data we presented earlier this year at our annual investors' conference was implants for million were in range of about 37 implants per million, something like that. As we look at the major markets in Europe, we see a range of penetration levels of the range is lower closer to 100 to 200 implants per million than they are to the current U.S. practice and we think the current U.S. practice has a very incredible opportunity to increase as well.

So, I think its the lack of the penetration, compared with the state of clinical consensus that the therapy is both indicated and then are also cost effective is the primary basis for our optimism that our international market growth rate will be sustainable for quite some time in the near future. I talked you through the highlights...

Unidentified Analyst

Can you --

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

Go ahead, Rick.

Unidentified Analyst

Now so you think... and so you see OUS market growth in the low teens, mid teens, upper teens as we look over the next 6, 12, 18 months whatever time frame it locked in?

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

Yes, right in that range.

Frederick Wise - Leerink Swann Llc

Rich, I am ready to use the data.

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

I can't be more precise for every year. I think in an effort to be as helpful as possible. I think that I can offer, that I think its most meaningful, is not in a tighter range on international ICD growth rate itself, I think what I can offer it really is most meaningful is the... and this isn't what you are asking me, I appreciate but I am just pushing back to say I think its more meaningful to look at the combined global pacemaker and ICD market growth rates.

That average is out a lot of anecdotal events and its there is an interplay between pacemaker market growth rate and ICD market growth rates and I think we are far more precise, we are far more accurate and therefore to me its significantly more meaningful to think in terms of global CRM market growth rate and we think that that would be in the range of in upper single digits here for this full year and that we haven't given guidance yet for future years but something directionally there similar for future years.

Frederick Wise - Leerink Swann Llc

And just a quick follow-up. Gross margins were at a record high, I think this quarter at 74.7%, it's on your guidance for the year sort of a range that I think that's the upper end. I am trying to understand the factors here in this mixed volume cost reduction. If you could just help us understand what's that and thanks so much.

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

John Heinmiller's the Chief Financial Officer and Executive Vice President maybe you'd like to answer that.

John C. Heinmiller - Executive Vice President and Chief Financial Officer

Certainly, You are right, certainly that growth in our ICD sales is reflected in the growth profit margins. There is a modest amount of currency benefit reflected there. Our... we increased our full year guidance, but we were steady that there is nothing unusual going on here and at the same point we will really are not yet ready to have that... have some of our longer term growth initiatives in our overall program.

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

All right, Jackie would you like to take the next question.

Operator

Thank you. Your next question is from Tao Levy with Deutsche Banc. Please go ahead.

Tao Levy - Deutsche Banc Securities

Hi, good morning.

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

Good morning.

Tao Levy - Deutsche Banc Securities

So, regarding my main question, I guess is throughout the 7% and 9% in CRM market growth that you guys are now talking about in first half versus when you saw you were doing many quarter or the last few... couple of quarters ago. One, if you could summarize I know you provide a lot of commentary on it, but if you can summarize in couple substance points as to why there is been changes, the demographic trends haven't changed over the last couple of quarters. The technology, maybe I missed part of your introduction. Is it... is the investment changes, is there more Medicare stuff. I am just trying to get a better sense as to... one quarter bliss or we are seeing when we go aggressive in the market.

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

A little about it, Tao is our FX benefit. So that would be... we're talking about revenue growth rate as compared to the cumulative growth rate and so to the expense that FX translations have changed as they have during this year and seems to be at a bit of a sustained level for the remainder of the year. That factor is in, I wouldn't say that there has been any with what the cardiac regarding FX translations, I don't think there has been dynamics in the market different from what we anticipated.

We anticipated single digit growth, in the U.S. market, we anticipated low double digit growth in the combined international markets and that really is exactly what we have seen with a bit of a tail wind supplied by FX calculations.

Tao Levy - Deutsche Banc Securities

Okay, great and on the ICD front... any changes in new patients coming in versus replacements of the implants.

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

We can only speak for our own experience and in our data in our own implant practice, we gained significant share in the de novo implants as well as continue to maintain our expected level of replacement implants. So I think you would see our shared gains really would reflect our gain of additional de novo implants. We really don't have that level of insight to comment with respect to competitive experiences.

Tao Levy - Deutsche Banc Securities

I guess going in on there on Angio-Seal, the growth in this quarter, does it do anything about the PTI volumes or at all this EBITDA, you are starting to see and little bit of a comeback at least from the probable extent companies, any comments there?

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

Tao, we keep in mind that with respect to the interventional cardiology market, our Angio-Seal business is a little bit like the tail on the dog. So, I would defer to the other companies that are... which have better visibility and are more completely in that business.

But, and then keep in mind that we are the only one type... We are the only ones that we break on our Angio-Seal results separately and not everybody does so, the extent of which we are gaining shares versus the extent to which procedures are picking up is something that is a little bit difficult for us too dissect, but I suspect that there is some rebound of procedure volume reflected in our growth rate.

Tao Levy - Deutsche Banc Securities

Thank you very much and great quarter.

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

Thank you.

Operator

Thank you. Your next question is from Mike Weinstein with JPMorgan. Please go ahead.

Michael Weinstein - JPMorgan

Hi guys, good morning. And nice quarter gentlemen. Again just to clarify that 79% now with 40 [indiscernible] given currency that probably 2% to 4% constant currency?

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

Michael you just a little bit garbled, I'm not sure if you are on a cellphone but I'm sorry would you say that again.

Michael Weinstein - JPMorgan

Yeah sure the 79% that you guys are talking about for reported CRM for the first half of the year for market which currency how are you saying that's probably 2% to 4% constant currency?

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

I think it's probably higher than that but I don't have that data in front of me to be more precise.

Michael Weinstein - JPMorgan

Okay, let me ask we have a number from reported for that at your labs, if they are in the first quarter more than the second quarter that exact pricing from various competitors have got more close to your defibrillators within the what I would say is cumulative check for pricing down year-over-year, you would like to be somewhere in that 3% to 5% range is that wide, is that implying [ph], what would be your commentary on that?

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

We will offer precise comment on our average selling prices and changes in our average selling prices, I would refer back to the expectation we have expressed previously that we think that on average its probably an expectation to apples- to- apples 2% to 3% drop in average selling prices for the same products and same markets but the more important point maybe the changes in product mix, the ASP premiums on the new product launches, the... and there's the changes in geographic mix all of its there on ASP. When you net all of that together and talk about our experience, with ASPs during the second quarter and during the first quarter, we saw nothing unusual.

Michael Weinstein - JPMorgan

Okay, so that you the sales and you are starting back of the year opportunities So the U.S. ICD market the comment my question is that, pricing being down 3% to 5% year-over-year, not sure of your pace, not sure of that order comment.

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

I could not confirm that for you.

Michael Weinstein - JPMorgan

Okay, and last I just want to clarify with John, just to make sure that all of the businesses has ended above that average this quarter, was there any difference in selling there between Q2 and Q1 and into Q2 08 then Q2 '07?

John C. Heinmiller - Executive Vice President and Chief Financial Officer

If we were not lagging any difference in selling base with our first quarter results. I've seen the commentary about the difference that Easter makes in one quarter versus another... there may be some difference with respect to the global Easter Holiday sale in some market. I think you will reflect, it really get comes back to the point that we have been making a bit, overloaded like voice in the wilderness saying it's a lot more meaningful to look at a couple of quarters in a row. When you look at our first half result versus first half results a year ago we have shown, market share gains, we have shown strong sales growth, we have shown strong constant currency revenue growth and all other good things and so I think that's its more meaningful to look at a longer period of time rather than try to pull out some of the peculiarities in a roughly 90 day period.

Michael Weinstein - JPMorgan

Okay, great. Thanks there.

John C. Heinmiller - Executive Vice President and Chief Financial Officer

You are welcome.

Operator

Thank you. Your next question is from Paul Choi with Merrill Lynch. Please go ahead.

Unidentified Analyst

Actually it's Mike [indiscernible] calling, I was just having some dialing problems. I have two questions. Can you hear me?

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

Yes we've got bad connection this call... everybody is sounding a little bit garbled, but we can hear you. Go ahead.

Unidentified Analyst

Okay, great. I'll speak slowly. I have two questions. Firstly on the gross margin again, could you please break out the 1.4 first point improvements in the second quarter by increased volume, the benefit from the Unity platform and FX transaction benefits? So maybe still between... of the 1.4% and then secondly a question on the accounting. Can you give us some indication what is happening over the last six months for the provision for warranties, the provision for doubtful debts and also the provision for inventory obsolescence. Thank you.

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

I'm going to answer for John Heinmiller, with respect to the latter question. There was nothing remarkable in any of the accounting measures that you've mentioned and with respect to the first question on the bisecting the 1.4 in your asset [ph] we could break it out industry category, the answer is no.

Unidentified Analyst

Okay. And Dan, if I can ask a quick question on the convertible. Can you give us some indication what the EPS impact would be on the 2008 year, under FAS B141 if it was implemented. And also if the accounting change will influence your decisions of using convertibles going forward, thank you.

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

Let me refer that question to John Heinmiller, John, is there any information you could offer about that.

John C. Heinmiller - Executive Vice President and Chief Financial Officer

No. It really doesn't apply to us and our debt will mature before that accounting principle becomes effective. And so we haven't really studied it that way.

Unidentified Analyst

So, will it impact your... will it change your view on using convertibles for share buybacks et cetera, going forward?

John C. Heinmiller - Executive Vice President and Chief Financial Officer

I wouldn't say, we would consider all kind of debt financing going forward, and it would be based upon the circumstances in the markets and our business at the time. So, we really don't make any comments about influences right now on what we do in the future.

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

Let's move onto the next question, Jackie, please.

Operator

Your next question is from Larry Biegelsen with Wachovia. Please go ahead.

Larry Biegelsen - Wachovia

Hi. Can you hear me, okay.

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

Yes.

Larry Biegelsen - Wachovia

Okay, great. Two questions, first again on the 7% to 9% could you breakout both through CRM, both in the first half, could you break out US and OUS please?

And second Tom, are actually... it's a valve question which came in strong this quarter, and was there any stocking in valves sales in the quarter for FA. And maybe... Dan, we haven't heard from you I think a while on your plans in St Jude tranche capital, I was curious if there was anything helpful. Thanks.

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

Maybe again I'll take this in reverse order and Larry you have actually have three questions if I miss something, remind me please on that. Your question on trans catheter valves, we've mentioned generally in the past that we have a internal program relating to trans catheter valve practice but we haven't offered any significant information on it in the past and we won't do it today either.

With respect to as stocking of valves I am not aware of stocking of valves and on looking at couple of people on the table who are indicating their experience is the same. So we think that the valve growth that we reported reflected the combination of our participation in the tissue valves and little bit of growth in the tissue valve market number one. And then number two was really we got a competitive product line, we've got good customer relationships and we've got well trained global sales organization that are presenting at technology exhibitions and we were very cost... we are increasing our participation in valve replacement proceedings during the second quarter and that we took some market share.

On the topic of the U.S. and OUS... I don't mean to... I'm not deliberately being unhelpful on the one hand, on the other hand, we have indicated that the we will... we are willing to talk about market growth is in the general terms and that we expect lower growth in the U.S., stronger growth internationally. We haven't put precise data to it. And we and I won't do it now. A person works to put a little finer point on market growth, we are all really going to have to wait together for the other companies in this space to report. We are making best estimates on the direction of growth based on our data and though we'll be more complicated to be more precise.

Larry Biegelsen - Wachovia

Thank You.

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

Jackie, would you take the next question.

Operator

Your next question is from Vivian Cervantes with Rodman & Renshaw.

Vivian Cervantes - Rodman & Renshaw

Hi, good morning. Thank you for taking the question. I just wanted to talk on a little bit on the manufacturing on comments you made... you are looking to increase share, any color you can provide, is there is an increased shift to manufacturing OUS, maybe, another penetration that's limited, any commentaries you have there? Thank you.

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

Vivian on the expansion of manufacturing in lower costs environment, I got that part of your question, I'm sorry I missed your reference to unity would you just say that again?

She may have gone of the line, With respect to manufacturing, expanding our manufacturing in cost advantaged environment. So, it's a... we have the luxury with our growth profile of maintaining manufacturing in current locations number one. So, we're not talking about loss of jobs, we're not talking about taking manufacturing in current sites and terminating it and moving it to new sites. We're talking about putting more of our growth in cost advantaged locations. In the past we've done that especially in Puerto Rico, we've previously announced our expansion of facilities in Puerto Rico. We've announced that we're working to begin manufacturing pacemakers and ICD's in Puerto Rico. And over the next couple of years, a good part of our manufacturing growth will be located in Puerto Rico.

We also are establishing manufacturing in Malaysia. We will then be able to locate a meaningful portion of our manufacturing expansion in Malaysia, similarly in Costa Rica so we actually have a very specific complete program for where to locate manufacturing growth over the next five years and our program is to especially focus on expansion in cost advantaged environments. So, that will start out, as I said, that will start out having very modest impact on the income statement in 2009 and one appreciates once we begin the manufacturing we better work through the inventory currents and help buy and buildup the stock with really a small volume to make sure we have good training program, good control, maintain quality and it will be a gradual ramp up, it will in the out years that really our manufacturing strategy will have a meaningful impact on the income statement.

So in extent that we're showing good gains already, it bodes well for our opportunity to sustain those gains even in the face of tough competitive conditions going forward number one; and then to further improve on those gains again even in the face of strong price pressure, apex changes and continued tough competitive conditions.

I'm sorry that I didn't get the detail of your reference to the Unity platforms but as we have indicated previously, we have a strong focus on design for quality, design for manufacturability, the Unity platform was five years in the making and probably someone in the companies will tell it is longer, longer than that, but part of the vision of Unity platform was that it established a common hardware platform for low-voltage and high-voltage feature sets as there is... it eliminated redundancy, eliminated some significant costs, it can be... that was inherent in the manufacturing process from the separate origins of our high-voltage business and our low-voltage business are now unified here in a single hardware set in common test strategy, test platforms, common software development and firmware development program.

So, we expect to see to be able to leverages this not only in our quality speed to market but also in our manufacturing efficiencies where there are simplicity and cost effectiveness as well as high quality of our manufacturing cost of fees going forward.

And Jackie, maybe you can take the next question.

Operator

Thank you. Your next question is from Catherine Hu with Credit Suisse. Please go ahead.

Kristen Stewart - Credit Suisse

Hi, its actually Kristen Stewart, I was just wondering if you would be willing to comment on your R&D, early you have had a lot of products in the pipeline and you are running a little bit higher then industry peers. I was wondering if you can give us a sense on how that breaks down in terms of basic research, clinical trial and whether there is a significant amount of consultant payments in there?

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

Kristen with respect to the third part on a significant amount of consultant payments, the answer would be no. Then on the topic of basic research, I think you would find basic research to be very small part of our total R&D spend. By far most of it is well here we have got, it has been a part of development as compared with the basic research. On the clinical... some of our clinical trial expenses are captured in R&D depends on what kind of clinical trials they are, but its really lot of more the need than it's engineering expense, its really what you would think of that as core, product development of existing technology. There is technology development in addition in there, different then the basic research. It's kind of the mid zone between the basic research and the application of existing technology. I... it's a far more meaningful amount of technology development than there is basic research. But you got the buckets right, and I think you would not find anything unusual in our mix.

The idea that we are above many of our peers in our total R&D spend, I think really does reflect the focus that we have on striking the right balance between sustaining our growth longer-term and continuing to diversify our growth pipelines versus deliver short-term results. So, we've never been a management team or a Board to over emphasize short-term results. Here as you can see from our behavior in the past... none of us expect to change that set of values moving forward.

Kristen Stewart - Credit Suisse

Okay and then just going back to your comments with respect to the hospital bundling and your arrangements with Abbot? And your prior one with J&J, to what degree do you believe you have had success with the arrangements with J&J in the past? Are you seeing any increase in CRM in vascular bundling from any of your competitors? Kind of looking at a bigger picture standpoint, the benefit of the hospital here is really price. Is this a sign that the basis for competition in CRM is changing, you historically past decisions on technology and therapist [ph] that is this a sign that differentiation is woven in and price is becoming more important factor?

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

Good question Kristen I think first to start with generally our past experience with product bundles, I think it is fair to think of this as a dynamic that surfaces from time to time in hospital efforts to be as cost effective as possible I think though that historically bundling had not been a successful cost management strategy for hospitals. I think that historically at least I am talking about our kinds of devices, the specialty physicians preferred devices there is a limited number of competitors, we are all very focused on meeting customers needs, market share is the topic of a lot of attention between all of us.

I think we have always been operating in an end environment that has... where cost is an element... it's only... it really is only one of a number of dynamics, I don't think that it has changed; its weight in the formula has changed. The... I think what hospitals tend to find is if they can get optimum prices without a bundle and its simpler and that as you look at our bundle you end up talking about what kinds of compromises you are going to make on device choice without really getting a price benefit for it, I think that's the experience that most customers have had in past times when the topic of bundling across a greater angio products has come to the fore.

Our experience in this in the past has been that bundled arrangements have... its nice to have your bundled arrangement available, yet customers want to talk about it I think that when you get right down to giving the best devices and the best service at the best price the hospital I think bundles are not really all that significant of a factor.

Kristen Stewart - Credit Suisse

Are your competitors bundling at the present time?

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

In comes off from time to time the... but again it just, it doesn't seem to really get a lot of traction, when here I think the most important thing is if a competitor comes up with a bundle as long as we can say well if that's what you want to do we can do it too, it tends to then go away, when you get back to business talking about the what's most helpful to the to physician and to the patients and again we are all extremely competitive and none of us can really have that in our prices anyway, I think we all have to be very cost effective and price sensitive.

Kristen Stewart - Credit Suisse

Thanks very much.

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

You are welcome. We will just take one more question, Jackie, would you go to the last question, please.

Operator

Your final question is from Joanne Wuensch with BMO Capital Markets

Joanne Wuensch - BMO Capital Markets

Thank you for taking my question.

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

You are welcome.

Joanne Wuensch - BMO Capital Markets

You gave us what the OUS ICD growth was ex FX in the quarter.

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

No, we didn't get that and again we're really not going to... we don't know what the market growth was until we really need to see the other companies report for the final detail to our own internal analysis.

Joanne Wuensch - BMO Capital Markets

I'm sorry. I am not asking about market. I am asking OUS ICD growth.

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

Well we...missed the act, we indicated FX impact on the... they've actually... yeah so, that data go out there. Joanne I'm sorry, I don't have the exact number and pardon me ... it was in FC call, was in that high 20%.

Joanne Wuensch - BMO Capital Markets

Okay. Thank you. And second question in the... the quarter was very good. Your turnaround for the future is very good. If you had to sort of summarize what change this quarter versus last quarter, what would you say? Thank You.

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

More data. We have more data.

Joanne Wuensch - BMO Capital Markets

That's it.

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

Yeah. So, last quarter we were always... we work to be balance, if anything we want to err on the side of being a little bit conservative. We have never been punished for under promising and over delivering. We don't want expectations to get out ahead of us. And to the extent that we were responding to 90 days of data and air [ph] driving the rest of the year, based on the 90 days of data. We now have another roughly 90 days of data. We have got... we have got increased confidence in the... in the... our continued rate of shift, that market share. The more data would be my short version.

Joanne Wuensch - BMO Capital Markets

Perfect. Thank you very much.

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

You are welcome. And with that we have reach the top in the hour and a little bit past and I would like to thank everybody for participating in the call today. And Jackie, I will turn it back to you to read your concluding statement. Thank you very much. Bye.

Operator

Today's call is being recorded and will be available for replay beginning at 12 PM Eastern Time. The dial in numbers are for U.S. 800-642-1687 and for international 706-645-9291 and enter pin number 52207814. Thank you, this does conclude today's teleconference. Please disconnect your lines at this time.

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Source: St. Jude Medical, Inc. Q2 2008 Earnings Call Transcript
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