10-Q 1 stj-2012929x10qq3.htm FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 29, 2012 STJ-2012.9.29-10Q Q3
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 29, 2012 OR
 
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______.
Commission File Number: 1-12441
ST. JUDE MEDICAL, INC.
(Exact name of registrant as specified in its charter)
Minnesota
 
41-1276891
(State or other jurisdiction
 
(I.R.S. Employer
of incorporation or organization)
 
Identification No.)
One St. Jude Medical Drive, St. Paul, Minnesota 55117
(Address of principal executive offices, including zip code)
(651) 756-2000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x
 
Accelerated filer ¨
 
 
 
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
 
Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
¨ Yes x No

The number of shares of common stock, par value $.10 per share, outstanding on November 6, 2012 was 308,177,250.
 



TABLE OF CONTENTS

ITEM
 
DESCRIPTION
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




PART I - FINANCIAL INFORMATION
Item 1.
FINANCIAL STATEMENTS
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(In millions, except per share amounts)
(Unaudited)

 
Three Months Ended
 
Nine Months Ended
 
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
Net sales
$
1,326

 
$
1,383

 
$
4,131

 
$
4,205

Cost of sales:
 

 
 

 


 


Cost of sales before special charges
348

 
363

 
1,073

 
1,112

Special charges
7

 
7

 
46

 
18

Total cost of sales
355

 
370

 
1,119

 
1,130

Gross profit
971

 
1,013

 
3,012

 
3,075

Selling, general and administrative expense
456

 
505

 
1,440

 
1,532

Research and development expense
170

 
176

 
518

 
528

Purchased in-process research and development charges

 

 

 
4

Special charges
110

 
21

 
179

 
53

Operating profit
235

 
311

 
875

 
958

Other income (expense), net
(19
)
 
(20
)
 
(67
)
 
(72
)
Earnings before income taxes
216

 
291

 
808

 
886

Income tax expense
40

 
64

 
176

 
185

Net earnings
$
176

 
$
227

 
$
632

 
$
701

Net earnings per share:
 

 
 

 
 
 
 
Basic
$
0.56

 
$
0.70

 
$
2.01

 
$
2.15

Diluted
$
0.56

 
$
0.69

 
$
2.00

 
$
2.13

Cash dividends declared per share:
$
0.23

 
$
0.21

 
$
0.69

 
$
0.63

Weighted average shares outstanding:
 

 
 

 
 
 
 
Basic
314.7

 
324.2

 
314.8

 
326.0

Diluted
316.3

 
326.8

 
316.4

 
329.4

See notes to the condensed consolidated financial statements.


1


ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions)
(Unaudited)

 
Three Months Ended
 
Nine Months Ended
 
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
Net earnings
$
176

 
$
227

 
$
632

 
$
701

Other comprehensive income (loss), net of tax:
 

 
 

 
 
 
 
Unrealized gain on available-for-sale securities, net of taxes
4

 
2

 
10

 
3

Reclassification of realized gain on available-for-sale securities, net of taxes
(3
)
 

 
(8
)
 

Foreign currency translation adjustment, net of taxes
44

 
(127
)
 
(2
)
 
(18
)
Other comprehensive income (loss)
45

 
(125
)
 

 
(15
)
Total comprehensive income
$
221

 
$
102

 
$
632

 
$
686

See notes to the condensed consolidated financial statements.


2


ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions, except par value and share amounts)
 
September 29, 2012
 
 
 
(Unaudited)
 
December 31, 2011
ASSETS
 

 
 

Current Assets
 

 
 

Cash and cash equivalents
$
1,051

 
$
986

Accounts receivable, less allowance for doubtful accounts of $101 at both September 29, 2012 and December 31, 2011
1,350

 
1,367

Inventories
648

 
624

Deferred income taxes, net
232

 
232

Other current assets
156

 
182

Total current assets
3,437

 
3,391

Property, plant and equipment, at cost
2,597

 
2,454

Less accumulated depreciation
(1,188
)
 
(1,066
)
Net property, plant and equipment
1,409

 
1,388

Goodwill
2,967

 
2,953

Intangible assets, net
780

 
856

Other assets
426

 
417

TOTAL ASSETS
$
9,019

 
$
9,005

LIABILITIES AND SHAREHOLDERS’ EQUITY
 

 
 

Current Liabilities
 

 
 

Current debt obligations
$
540

 
$
83

Accounts payable
157

 
202

Dividends payable
73

 
67

Income taxes payable
29

 
1

Employee compensation and related benefits
282

 
305

Other current liabilities
437

 
403

Total current liabilities
1,518

 
1,061

Long-term debt
1,983

 
2,713

Deferred income taxes, net
246

 
279

Other liabilities
525

 
477

Total liabilities
4,272

 
4,530

Commitments and Contingencies (Note 6)

 

Shareholders’ Equity
 

 
 

Preferred stock ($1.00 par value; 25,000,000 shares authorized; none outstanding)

 

Common stock ($0.10 par value; 500,000,000 shares authorized; 315,554,553 and 319,615,965 shares issued and outstanding at September 29, 2012 and December 31, 2011, respectively)
32

 
32

Additional paid-in capital
126

 
43

Retained earnings
4,573

 
4,384

Accumulated other comprehensive income (loss):
 

 
 

Cumulative translation adjustment
(4
)
 
(2
)
Unrealized gain on available-for-sale securities
20

 
18

Total shareholders’ equity
4,747

 
4,475

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
9,019

 
$
9,005


See notes to the condensed consolidated financial statements.

3


ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)

Nine Months Ended
September 29, 2012
 
October 1, 2011
OPERATING ACTIVITIES
 

 
 

Net earnings
$
632

 
$
701

Adjustments to reconcile net earnings to net cash from operating activities:
 

 
 

Depreciation and amortization
212

 
225

Amortization of debt premium, net
(8
)
 
(4
)
Inventory step-up amortization

 
30

Stock-based compensation
54

 
58

Excess tax benefits from stock-based compensation
(1
)
 
(9
)
Purchased in-process research and development charges

 
4

Gain on sale of investment
(14
)
 

Deferred income taxes
(34
)
 
(24
)
Other, net
74

 
20

Changes in operating assets and liabilities, net of business acquisitions:
 

 
 

Accounts receivable
13

 
(53
)
Inventories
(26
)
 
(19
)
Other current assets
29

 
58

Accounts payable and accrued expenses
(16
)
 
(68
)
Income taxes payable
24

 
22

Net cash provided by operating activities
939

 
941

INVESTING ACTIVITIES
 

 
 

Purchases of property, plant and equipment
(188
)
 
(236
)
Proceeds from sale of investments
19

 

Other investing activities, net
(28
)
 
(32
)
Net cash used in investing activities
(197
)
 
(268
)
FINANCING ACTIVITIES
 

 
 

Proceeds from exercise of stock options and stock issued
106

 
286

Excess tax benefits from stock-based compensation
1

 
9

Common stock repurchased, including related costs
(300
)
 
(809
)
Dividends paid
(212
)
 
(138
)
Issuances of commercial paper borrowings, net
(272
)
 
445

Borrowings under debt facilities

 
78

Payments under debt facilities

 
(78
)
Net cash used in financing activities
(677
)
 
(207
)
Effect of currency exchange rate changes on cash and cash equivalents

 
(6
)
Net increase in cash and cash equivalents
65

 
460

Cash and cash equivalents at beginning of period
986

 
500

Cash and cash equivalents at end of period
$
1,051

 
$
960

See notes to the condensed consolidated financial statements.


4


ST. JUDE MEDICAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of St. Jude Medical, Inc. (St. Jude Medical or the Company) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States (U.S. generally accepted accounting principles) for complete financial statements. In the opinion of management, these statements include all adjustments (consisting of normal recurring adjustments) considered necessary to present a fair statement of the Company’s consolidated results of operations, financial position and cash flows. Operating results for any interim period are not necessarily indicative of the results that may be expected for the full year. Preparation of the Company’s financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts in the financial statements and footnotes. Actual results could differ from those estimates. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s consolidated financial statements and footnotes included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (2011 Annual Report on Form 10-K).

NOTE 2 – NEW ACCOUNTING PRONOUNCEMENTS
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-05, Comprehensive Income (Accounting Standards Codification (ASC) Topic 220): Presentation of Comprehensive Income, which eliminates the option to report other comprehensive income and its components in the consolidated statements of shareholders’ equity. ASU 2011-05, as amended, requires an entity to present items of net income and other comprehensive income in one continuous statement – referred to as the statement of comprehensive income – or in two separate, but consecutive, statements. Each component of net income and each component of other comprehensive income is required to be presented with subtotals for each and a grand total for total comprehensive income. The updated guidance does not change the calculation of earnings per share. The Company adopted ASU 2011-05 and ASU 2011-12, as amended, Presentation of Comprehensive Income: Reclassifications of Items of Other Comprehensive Income, in the first quarter of fiscal year 2012.

NOTE 3 – GOODWILL AND OTHER INTANGIBLE ASSETS
The changes in the carrying amount of goodwill for each of the Company’s reportable segments (see Note 13) for the nine months ended September 29, 2012 were as follows (in millions):
 
 
CRM/NMD
 
CV/AF
 
Total
Balance at December 31, 2011
$
1,235

 
$
1,718

 
$
2,953

Foreign currency translation and other
3

 
11

 
14

Balance at September 29, 2012
$
1,238

 
$
1,729

 
$
2,967



5


The following table provides the gross carrying amount of other intangible assets and related accumulated amortization (in millions):
 
September 29, 2012
 
December 31, 2011
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Definite-lived intangible assets:
 

 
 

 
 

 
 

Purchased technology and patents
$
934

 
$
350

 
$
922

 
$
276

Customer lists and relationships
61

 
38

 
48

 
25

Trademarks and tradenames
24

 
11

 
24

 
8

Licenses, distribution agreements and other
6

 
4

 
6

 
4

 
$
1,025

 
$
403

 
$
1,000

 
$
313

Indefinite-lived intangible assets:
 

 
 

 
 

 
 

Acquired IPR&D
$
109

 
 

 
$
120

 
 

Trademarks and tradenames
49

 
 

 
49

 
 

 
$
158

 
 

 
$
169

 
 

 
During the second quarter of 2012, the Company received U.S. Food and Drug Administration (FDA) clearance to market its AMPLATZER™ Vascular Plug 4 technology acquired in connection with its AGA Medical, Inc. acquisition in November 2010. As a result of the approval, the Company reclassified $11 million of acquired in-process research and development (IPR&D) from an indefinite-lived intangible asset to a purchased technology definite-lived intangible asset.

NOTE 4 – INVENTORIES
The Company’s inventories consisted of the following (in millions):

 
September 29, 2012
 
December 31, 2011
Finished goods
$
444

 
$
438

Work in process
59

 
54

Raw materials
145

 
132

 
$
648

 
$
624


NOTE 5 – DEBT
The Company’s debt consisted of the following (in millions):
 
September 29, 2012
 
December 31, 2011
2.20% senior notes due 2013
$
456

 
$
461

3.75% senior notes due 2014
700

 
699

2.50% senior notes due 2016
519

 
518

4.875% senior notes due 2019
495

 
495

1.58% Yen-denominated senior notes due 2017
105

 
104

2.04% Yen-denominated senior notes due 2020
164

 
164

Yen-denominated credit facilities
84

 
83

Commercial paper borrowings

 
272

Total debt
2,523

 
2,796

Less: current debt obligations
540

 
83

Long-term debt
$
1,983

 
$
2,713

Expected future minimum principal payments under the Company’s debt obligations are as follows: $540 million in 2013; $700 million in 2014; $500 million in 2016; $105 million in 2017; and $664 million in years thereafter.
Senior Notes Due 2013: On March 10, 2010, the Company issued $450 million principal amount of 3-year, 2.20% unsecured senior notes (2013 Senior Notes) that mature in September 2013. The majority of the net proceeds from the issuance of the 2013 Senior Notes was used to retire outstanding debt obligations. Interest payments are required on a semi-annual basis. The

6


2013 Senior Notes were issued at a discount, yielding an effective interest rate of 2.23% at issuance. The Company may redeem the 2013 Senior Notes at any time at the applicable redemption price. The debt discount is being amortized as interest expense through maturity.
Concurrent with the issuance of the 2013 Senior Notes, the Company entered into a 3-year, $450 million notional amount interest rate swap designated as a fair value hedge of the changes in fair value of the Company’s fixed-rate 2013 Senior Notes. On November 8, 2010, the Company terminated the interest rate swap and received a cash payment of $19 million. The gain from terminating the interest rate swap agreement has been reflected as an increase to the carrying value of the debt and is being amortized as a reduction of interest expense resulting in a net average interest rate of 0.8% that will be recognized over the remaining term of the 2013 Senior Notes.
Senior Notes Due 2014: On July 28, 2009, the Company issued $700 million principal amount of 5-year, 3.75% unsecured senior notes (2014 Senior Notes) that mature in July 2014. Interest payments are required on a semi-annual basis. The 2014 Senior Notes were issued at a discount, yielding an effective interest rate of 3.78% at issuance. The debt discount is being amortized as interest expense through maturity. The Company may redeem the 2014 Senior Notes at any time at the applicable redemption price.
Senior Notes Due 2016: On December 1, 2010, the Company issued $500 million principal amount of 5-year, 2.50% unsecured senior notes (2016 Senior Notes) that mature in January 2016. The majority of the net proceeds from the issuance of the 2016 Senior Notes was used for general corporate purposes including the repurchase of the Company’s common stock. Interest payments are required on a semi-annual basis. The 2016 Senior Notes were issued at a discount, yielding an effective interest rate of 2.54% at issuance. The debt discount is being amortized as interest expense through maturity. The Company may redeem the 2016 Senior Notes at any time at the applicable redemption price.
Concurrent with the issuance of the 2016 Senior Notes, the Company entered into a 5-year, $500 million notional amount interest rate swap designated as a fair value hedge of the changes in fair value of the Company’s fixed-rate 2016 Senior Notes. On June 7, 2012, the Company terminated the interest rate swap and received a cash payment of $24 million. The gain from terminating the interest rate swap agreement has been reflected as an increase to the carrying value of the debt and is being amortized as a reduction of interest expense resulting in a net average interest rate of 1.3% that will be recognized over the remaining term of the 2016 Senior Notes.
Senior Notes Due 2019: On July 28, 2009, the Company issued $500 million principal amount of 10-year, 4.875% unsecured senior notes (2019 Senior Notes) that mature in July 2019. Interest payments are required on a semi-annual basis. The 2019 Senior Notes were issued at a discount, yielding an effective interest rate of 5.04% at issuance. The debt discount is being amortized as interest expense through maturity. The Company may redeem the 2019 Senior Notes at any time at the applicable redemption price.
1.58% Yen-Denominated Senior Notes Due 2017: On April 28, 2010, the Company issued 7-year, 1.58% unsecured senior notes in Japan (1.58% Yen Notes) totaling 8.1 billion Japanese Yen (the equivalent of $105 million at September 29, 2012 and $104 million at December 31, 2011). The principal amount of the 1.58% Yen Notes recorded on the balance sheet fluctuates based on the effects of foreign currency translation. Interest payments are required on a semi-annual basis and the entire principal balance is due on April 28, 2017.
2.04% Yen-Denominated Senior Notes Due 2020: On April 28, 2010, the Company issued 10-year, 2.04% unsecured senior notes in Japan (2.04% Yen Notes) totaling 12.8 billion Japanese Yen (the equivalent of $164 million at both September 29, 2012 and December 31, 2011). The principal amount of the 2.04% Yen Notes recorded on the balance sheet fluctuates based on the effects of foreign currency translation. Interest payments are required on a semi-annual basis and the entire principal balance is due on April 28, 2020.
Yen–Denominated Credit Facilities: In March 2011, the Company borrowed 6.5 billion Japanese Yen (the equivalent of $84 million at both September 29, 2012 and December 31, 2011) under uncommitted credit facilities with two commercial Japanese banks that provide for borrowings up to a maximum of 11.25 billion Japanese Yen. The principal amount reflected on the balance sheet fluctuates based on the effects of foreign currency translation. Half of the borrowings bear interest at Yen LIBOR plus 0.275% and mature in June 2013 and the other half of the borrowings bear interest at Yen LIBOR plus 0.25% and mature in March 2013. The maturity dates of each credit facility automatically extend for a one-year period, unless the Company elects to terminate the credit facility.
Other Available Borrowings: In December 2010, the Company entered into a $1.5 billion unsecured committed credit facility (Credit Facility) that it may draw on for general corporate purposes and to support its commercial paper program. The Credit Facility expires in February 2015. Borrowings under the Credit Facility bear interest initially at LIBOR plus 0.875%, subject to adjustment in the event of a change in the Company’s credit ratings. As of September 29, 2012 and December 31, 2011, the Company had no outstanding borrowings under the Credit Facility.

7


The Company’s commercial paper program provides for the issuance of short-term, unsecured commercial paper with maturities up to 270 days. As of September 29, 2012, no commercial paper borrowings were outstanding. During the first nine months of 2012, the Company’s weighted average effective interest rate on its commercial paper borrowings was approximately 0.23%. Any future commercial paper borrowings would bear interest at the applicable then-current market rates. The Company classifies all of its commercial paper borrowings as long-term debt, as the Company has the ability to repay any short-term maturity with available cash from its existing long-term, committed Credit Facility.
NOTE 6 – COMMITMENTS AND CONTINGENCIES
Litigation
Silzone® Litigation and Insurance Receivables: The Company has been sued in various jurisdictions beginning in March 2000 by some patients who received a heart valve product with Silzone® coating, which the Company stopped selling in January 2000. The Company has vigorously defended against the claims that have been asserted and will continue to do so with respect to any remaining claims.
The Company's outstanding Silzone cases consist of one class action in Ontario, one individual case in Ontario and one proposed class action in British Columbia by the provincial health insurer. In Ontario, a trial on common issues commenced in February 2010 in a class action case involving Silzone patients. In June 2012, the Court ruled in the Company's favor on all nine common class issues and the Court ruled the case should be dismissed. An order dismissing that action has been signed by the trial judge. On September 14, 2012, counsel for the class filed an appeal with the Court of Appeal for the Province of Ontario.  No briefing scheduling has yet been set for this appeal. The proposed class action lawsuit by the British Columbia provincial health insurer seeks to recover the cost of insured services furnished or to be furnished to patients who were also class members in a British Columbia class action that was resolved in 2010. Although the British Columbia provincial health insurer's lawsuit remains pending in the British Columbia court, there has not been any activity since 2010. The individual case in Ontario requests damages in excess of $1 million (claiming unspecified special damages, health care costs and interest). Based on the Company’s historical experience, the amount ultimately paid, if any, often does not bear any relationship to the amount claimed.
The Company has recorded an accrual for probable legal costs, settlements and judgments for Silzone related litigation. The Company is not aware of any unasserted claims related to Silzone-coated products. For all Silzone legal costs incurred, the Company records insurance receivables for the amounts that it expects to recover based on its assessment of the specific insurance policies, the nature of the claim and the Company’s experience with similar claims. The Company’s current and final insurance layer for Silzone claims consists of $13 million of remaining coverage with two insurance carriers. To the extent that the Company’s future Silzone costs (the material components of which are settlements, judgments, legal fees and other related defense costs) exceed its remaining insurance coverage, the Company would be responsible for such costs. The Company has not recognized an expense related to any potential future damages as they are not probable or reasonably estimable at this time.
The following table summarizes the Company’s Silzone legal accrual and related insurance receivable at September 29, 2012 and December 31, 2011 (in millions):
 
September 29, 2012
 
December 31, 2011
Silzone legal accrual
$
4

 
$
22

Silzone insurance receivable
$
3

 
$
15

Volcano Corporation & LightLab Imaging Litigation: The Company's subsidiary, LightLab Imaging, has pending litigation with Volcano Corporation (Volcano) and Axsun Technologies, Inc. (Axsun), a subsidiary of Volcano, in the Superior Court of Massachusetts and in state court in Delaware. LightLab Imaging makes and sells optical coherence tomography (OCT) imaging systems. Volcano is a LightLab Imaging competitor in medical imaging. Axsun makes and sells lasers and is a supplier of lasers to LightLab Imaging for use in OCT imaging systems. The lawsuits arise out of Volcano's acquisition of Axsun in December 2008. Before Volcano acquired Axsun, LightLab Imaging and Axsun had worked together to develop a tunable laser for use in OCT imaging systems. While the laser was in development, LightLab Imaging and Axsun entered into an agreement pursuant to which Axsun agreed to sell its tunable lasers exclusively to LightLab in the field of human coronary artery imaging for a certain period of time.
After Volcano acquired Axsun in December 2008, LightLab Imaging sued Axsun and Volcano in Massachusetts, asserting a number of claims arising out of Volcano's acquisition of Axsun. In January 2011, the Court ruled that Axsun's and Volcano's conduct constituted knowing and willful violations of a statute that prohibits unfair or deceptive acts or practices or acts of unfair competition, entitling LightLab Imaging to double damages, and furthermore, that LightLab Imaging was entitled to recover attorneys' fees. In February 2011, Volcano and Axsun were ordered to pay the Company for reimbursement of

8


attorneys' fees and double damages, which Volcano paid to the Company in July 2011. The Court also issued certain injunctions against Volcano and Axsun when it entered its final judgment.
In Delaware, Axsun and Volcano commenced an action in February 2010 against LightLab Imaging, seeking a declaration as to whether Axsun may supply a certain light source for use in OCT imaging systems to Volcano. Axsun's and Volcano's position is that this light source is not a tunable laser and hence falls outside Axsun's exclusivity obligations to Volcano. LightLab Imaging's position, among other things, is that this light source is a tunable laser. Though the trial of this matter was expected to occur in early 2011, in a March 2011 ruling, the Delaware Court postponed the trial of this case because Axsun and Volcano did not yet have a finalized light source product to present to the Court.
In May 2011, LightLab Imaging initiated a lawsuit against Volcano and Axsun in the Delaware state court. The suit seeks to enforce LightLab Imaging's exclusive contract with Axsun, to prevent Volcano from interfering with that contract, to bar Axsun and Volcano from using LightLab Imaging confidential information and trade secrets, and to prevent Volcano and Axsun from violating a Massachusetts statute prohibiting unfair methods of competition and unfair or deceptive acts or practices relating to LightLab Imaging's tunable laser technology. In October 2011, LightLab Imaging filed an amended and supplemental complaint in this action, and in early November 2011, the Company received Volcano and Axsun's response, including motions to dismiss some of the claims and stay the prosecution of other claims. In May 2012, the Court granted Volcano's motion to stay the proceedings until Volcano provides notice of its intent to begin clinical trials or engage in other public activities with an OCT imaging system that uses a type of light source that is in dispute in the lawsuit. Volcano is under an order to provide such a notice at least 45 days before beginning such trials or engaging in such activities.
Volcano Corporation & St. Jude Medical Patent Litigation: In July 2010, the Company filed a lawsuit in federal district court in Delaware against Volcano for patent infringement. In the suit, the Company asserted certain patents against Volcano and seeks injunctive relief and monetary damages. The infringed patents are part of the St. Jude Medical PressureWire® technology platform, which was acquired as part of St. Jude Medical's purchase of Radi Medical Systems in December 2008. Volcano filed counterclaims against the Company in this case, alleging certain St. Jude Medical patent claims are unenforceable and that certain St. Jude Medical products infringe certain Volcano patents. The Company believes the assertions and claims made by Volcano are without merit. Jury trials on liability issues in this matter occurred in October 2012. On October 19, 2012 the jury ruled in favor of Volcano finding that certain Volcano patents do not infringe the Company's patents and that certain St. Jude Medical patents were invalid. Before the trial involving the patents Volcano asserted against the Company, Volcano advised the Company it would not proceed on one patent, and, as part of this decision, Volcano agreed to not to assert a patent infringement claim against the Company involving that patent for any product, manufactured, marketed or sold by St. Jude prior to October 20, 2012. On October 22, 2012, Volcano proceeded to trial on its three remaining patents, and on October 25, 2012, the jury ruled that the Company did not infringe these three patents. Through post-trial motions, as well as, if necessary, an appeal to the appellate court, the Company plans to challenge various issues related to the trial that resulted in the October 19, 2012 jury decision.
AorTech Biomaterial PTY Limited, AorTech International PLC and AorTech Medical Devices USA, Inc. & St. Jude Medical License & Supply Agreement Litigation: On October 16, 2012, the Company filed a lawsuit against AorTech Biomaterial PTY Limited, AorTech International PLC and AorTech Medical Devices USA, Inc. (collectively, AorTech), in Federal District Court for the Central District of California. The lawsuit seeks declaratory and injunctive relief from AorTech's publicly announced intention to terminate the parties' License & Supply Agreement for Elast-Eon, the raw material used in St. Jude Medical's Optim® insulation for certain leads. On October 18, 2012, the Company filed an Application for a Temporary Restraining Order (TRO), and on November 1, 2012, the Court granted the Company's TRO application, preventing AorTech from terminating or breaching the License & Supply Agreement. The Company intends to seek final resolution of this matter as quickly and expeditiously as possible and remains confident in the strength of its legal position. 

March 2010 Securities Class Action Litigation: In March 2010, a securities lawsuit seeking class action status was filed in federal district court in Minnesota against the Company and certain officers on behalf of purchasers of St. Jude Medical common stock between April 22, 2009 and October 6, 2009. The lawsuit relates to the Company's earnings announcements for the first, second and third quarters of 2009, as well as a preliminary earnings release dated October 6, 2009. The complaint, which seeks unspecified damages and other relief as well as attorneys' fees, alleges that the Company failed to disclose that it was experiencing a slowdown in demand for its products and was not receiving anticipated orders for CRM (Cardiac Rhythm Management) devices. Class members allege that the Company's failure to disclose the above information resulted in the class purchasing St. Jude Medical stock at an artificially inflated price. In December 2011, the Court issued a decision denying a motion to dismiss filed by the defendants in October 2010. On October 25, 2012, the Court granted plaintiffs' motion to certify the case as a class action, which defendants did not oppose. The discovery phase of the case is ongoing, and the Company intends to continue to vigorously defend against the claims asserted in this lawsuit.
   

9


June 2012 Securities Class Action Litigation: On June 14, 2012, a securities class action lawsuit was filed in federal district court in Minnesota against the Company and a company officer for alleged violations of the federal securities laws on behalf of all purchasers of the publicly traded securities of the Company between December 15, 2010 and April 4, 2012 who were damaged thereby. The complaint, which sought unspecified damages and other relief as well as attorneys' fees, alleged that the Company failed to disclose information concerning its Riata, QuickFlex and QuickSite leads. Class members alleged that the Company's failure to disclose this information resulted in the class purchasing St. Jude Medical stock at an artificially inflated price. On August 20, 2012, the plaintiff voluntarily dismissed his complaint against the Company.
Other than disclosed above, the Company has not recorded an expense related to any potential damages in connection with these litigation matters because any potential loss is not probable or reasonably estimable. Additionally, other than disclosed above, the Company cannot reasonably estimate a loss or range of loss, if any, that may result from these litigation matters.
Regulatory Matters
In late September 2012, the FDA commenced an inspection of the Company's Sylmar, California facility, and, following such inspection, issued eleven observations on a Form 483. In early November 2012, the Company's CRM division provided written responses to the FDA detailing proposed corrective actions and immediately initiated efforts to address FDA's observations of nonconformity. None of the FDA observations identified a specific issue regarding the clinical or field performance of any particular device. The Sylmar, California facility will continue to manufacture CRM devices while the Company works with the FDA to address these observations.

The FDA inspected the Company's Plano, Texas manufacturing facility at various times between March 5 and April 6, 2009. On April 6, 2009, the FDA issued a Form 483 identifying certain observed nonconformities with current Good Manufacturing Practice (cGMP). Following the receipt of the Form 483, the Company's Neuromodulation division (NMD) provided written responses to the FDA detailing proposed corrective actions and immediately initiated efforts to address FDA's observations of nonconformity. The Company subsequently received a warning letter dated June 26, 2009 from the FDA relating to these non-conformities with respect to its Neuromodulation division's Plano, Texas and Hackettstown, New Jersey facilities.
With respect to this warning letter, the FDA notes that it will not grant requests for exportation certificates to foreign governments or approve pre-market approval applications for Class III devices to which the quality system regulation deviations are reasonably related until the violations have been corrected. The Company is working cooperatively with the FDA to resolve all of its concerns.
Customer orders have not been and are not expected to be impacted while the Company works to resolve the FDA's concerns. The Company is working diligently to respond timely and fully to the FDA's requests. While the Company believes the issues raised by the FDA can be resolved without a material impact on the Company's financial results, the FDA has recently been increasing its scrutiny of the medical device industry and raising the threshold for compliance. The government is expected to continue to scrutinize the industry closely with inspections, and possibly enforcement actions, by the FDA or other agencies. The Company is regularly monitoring, assessing and improving its internal compliance systems and procedures to ensure that its activities are consistent with applicable laws, regulations and requirements, including those of the FDA.
Governmental Investigations
In March 2010, the Company received a Civil Investigative Demand (CID) from the Civil Division of the U.S. Department of Justice (DOJ). The CID requests documents and sets forth interrogatories related to communications by and within the Company on various indications for tachycardia implantable cardioverter defibrillator systems (ICDs) and a National Coverage Decision issued by Centers for Medicare and Medicaid Services. Similar requests were made of the Company's major competitors. In addition, on August 31, 2012 the Company received a CID from the Civil Division of the DOJ requesting documents related to St. Jude Medical's Riata® and Riata ST® silicone-insulated products.  The CID appears to relate to a review of whether circumstances surrounding the Company's Riata® and Riata ST® defibrillator lead products caused the submission of false claims to federal healthcare programs.  Finally, on September 20, 2012, the Office of Inspector General for the Department of Health and Human Services (OIG) issued a subpoena requiring the Company to produce certain documents related to payments made by the Company to healthcare professionals practicing in California, Florida, and Arizona, as well as policies and procedures related to payments made by the Company to non-employee healthcare professionals. 
The Company is cooperating with these investigations and is responding to these requests. However, the Company cannot predict when these investigations will be resolved, the outcome of these investigations or their impact on the Company. The Company has not recorded an expense related to any potential damages in connection with these governmental matters because any potential loss is not probable or reasonably estimable. The Company cannot reasonably estimate a loss or range of loss, if any, that may result from these matters.

10



The Company is also involved in various other lawsuits, claims and proceedings that arise in the ordinary course of business.
Product Warranties
The Company offers a warranty on various products, the most significant of which relates to its ICDs and pacemakers systems. The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such costs at the time the product is sold. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
Changes in the Company’s product warranty liability during the three and nine months ended September 29, 2012 and October 1, 2011 were as follows (in millions):
 
Three Months Ended
 
Nine Months Ended

September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
Balance at beginning of period
$
38

 
$
29

 
$
36

 
$
25

Warranty expense recognized
2

 
2

 
5

 
8

Warranty credits issued
(1
)
 
(1
)
 
(2
)
 
(3
)
Balance at end of period
$
39

 
$
30

 
$
39

 
$
30

Other Commitments
The Company has certain contingent commitments to acquire various businesses involved in the distribution of the Company’s products and to pay other contingent acquisition consideration payments. While it is not certain if and/or when these payments will be made, as of September 29, 2012, the Company estimates it could be required to pay approximately $10 million in future periods to satisfy such commitments. Refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance Sheet Arrangements and Contractual Obligations of the Company’s 2011 Annual Report on Form 10-K for additional information.

NOTE 7 – PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT (IPR&D) AND SPECIAL CHARGES
IPR&D Charges
During the second quarter of 2011, the Company recorded IPR&D charges of $4 million in conjunction with the purchase of intellectual property in its CRM segment since the related technological feasibility had not yet been reached and such technology had no future alternative use.
Special Charges
The Company recognizes certain transactions and events as special charges in its consolidated financial statements. These charges (such as restructuring charges, impairment charges and certain settlement or litigation charges) result from facts and circumstances that vary in frequency and impact on the Company's results of operations. In order to enhance segment comparability and reflect management's focus on the ongoing operations of the Company, special charges are not reflected in the individual reportable segments operating results.
2012 Business Realignment Plan
During the third quarter of 2012, the Company incurred charges of $74 million resulting from the realignment of its product divisions into two new operating units: the Cardiovascular and Ablation Technologies Division (combining its Cardiovascular Division and Atrial Fibrillation Division) and the Implantable Electronic Systems Division (combining its Cardiac Rhythm Management Division and Neuromodulation Division). In addition, the Company is centralizing certain support functions, including information technology, human resources, legal, business development and certain marketing functions. The organizational changes are part of a comprehensive plan to accelerate the Company's growth, reduce costs, leverage economies of scale and increase investment in product development. Of the $74 million recorded as special charges, the Company recognized $52 million of severance costs and other termination benefits after management determined that such severance and benefits were probable and estimable, in accordance with ASC Topic 712, Nonretirement Postemployment Benefits. The Company also recognized $22 million of accelerated depreciation charges and other costs primarily associated with information technology assets no longer expected to be utilized or with a limited remaining useful life. The 2012 business realignment plan

11


is expected to reduce the Company's global workforce by approximately 5% and result in total charges of $150 million to $200 million.
A summary of the activity related to the 2012 business realignment plan accrual is as follows (in millions):

 
Employee
Termination
Costs
 
Inventory
Charges
 
Fixed
Asset
Charges
 
Other Restructuring Costs
 
Total
Balance at June 30, 2011
$

 
$

 
$

 
$

 
$

Cost of sales special charges
1

 
2

 

 

 
3

Special charges
51

 

 
18

 
2

 
71

Non-cash charges used

 
(2
)
 
(18
)
 

 
(20
)
Cash payments
(16
)
 

 

 
(1
)
 
(17
)
Foreign exchange rate impact
1

 

 

 

 
1

Balance at September 29, 2012
$
37

 
$

 
$

 
$
1

 
$
38

2011 Restructuring Plan
During 2011, the Company incurred charges totaling $163 million related to restructuring actions to realign certain activities in the Company's CRM business and sales and selling support organizations. Of the $163 million in special charges, $48 million was recognized in cost of sales. The restructuring actions included phasing out CRM manufacturing and R&D operations in Sweden, reductions in the Company's workforce and rationalizing product lines. In connection with the staged phase-out of CRM manufacturing and R&D operations in Sweden, the Company began recognizing severance costs and other termination benefits during 2011 for over 650 employees in accordance with ASC Topic 420, Exit or Disposal Cost Obligations whereby certain employee termination costs are recognized over the employees’ remaining future service period. Additionally, during 2011, the Company recognized certain severance costs for 550 employees after management determined that such severance and benefits were probable and estimable, in accordance with ASC Topic 712, Nonretirement Postemployment Benefits. The total charge for employee termination costs recognized during 2011 was $82 million. Additionally, the Company recognized $20 million of inventory obsolescence charges primarily associated with the rationalization of product lines across our business. The Company also recorded $26 million of impairment and accelerated depreciation charges, of which $12 million related to an impairment charge to write-down the Company's CRM manufacturing facility in Sweden to its fair value. Additionally, the Company recognized $35 million of other restructuring charges primarily associated with CRM restructuring actions ($13 million of pension settlement charges associated with the termination of Sweden's defined benefit pension plan and $4 million of idle facility costs related to transitioning manufacturing operations out of Sweden) as well as $7 million of contract termination costs and $11 million of other costs.

During the first nine months of 2012, the Company incurred additional charges totaling $95 million related to the restructuring actions initiated during 2011. Of the $95 million in special charges, $42 million was recognized in cost of sales. The Company recognized severance costs and other termination benefits of $36 million during the first nine months of 2012 for an additional 100 employees after management determined that such severance and benefits were probable and estimable, in accordance with ASC Topic 712, Nonretirement Postemployment Benefits. Of the $36 million recognized, $7 million was recognized during the third quarter of 2012. The Company also recognized $12 million of inventory obsolescence charges during the first half of 2012 primarily related with the rationalization of product lines in our CRM and NMD businesses. Additionally, the Company recognized $47 million of other restructuring charges which included $33 million of restructuring related charges associated with the Company's CRM business and sales and selling support organizations (of which $11 million related to idle facility costs in Sweden). The remaining charges included $8 million of contract termination costs and $6 million of other costs. Of the $47 million in other restructuring charges, $13 million was recognized in the third quarter of 2012 (of which $4 million related to idle facility costs in Sweden).

12


A summary of the activity related to the 2011 restructuring plan accrual is as follows (in millions):
 
Employee
Termination
Costs
 
Inventory
Charges
 
Fixed
Asset
Charges
 
Other Restructuring Costs
 
Total
Balance at January 1, 2011
$

 
$

 
$

 
$

 
$

Cost of sales special charges
9

 
20

 
9

 
10

 
48

Special charges
73

 

 
17

 
25

 
115

Non-cash charges used

 
(20
)
 
(26
)
 
(1
)
 
(47
)
Cash payments
(27
)
 

 

 
(15
)
 
(42
)
Foreign exchange rate impact
(1
)
 

 

 

 
(1
)
Balance at December 31, 2011
$
54

 
$

 
$

 
$
19

 
$
73

Cost of sales special charges
5

 
9

 

 
9

 
23

Special charges
11

 

 

 
8

 
19

Non-cash charges used

 
(9
)
 

 

 
(9
)
Cash payments
(20
)
 

 

 
(15
)
 
(35
)
Foreign exchange rate impact
1

 

 

 

 
1

Balance at March 31, 2012
51

 

 

 
21

 
72

Cost of sales special charges
5

 
3

 

 
7

 
15

Special charges
8

 

 

 
10

 
18

Non-cash charges used

 
(3
)
 

 
(4
)
 
(7
)
Cash payments
(14
)
 

 

 
(14
)
 
(28
)
Foreign exchange rate impact
(2
)
 

 

 
(1
)
 
(3
)
Balance at June 30, 2012
48

 

 

 
19

 
67

Cost of sales special charges

 

 

 
4

 
4

Special charges
7

 

 

 
9

 
16

Non-cash charges used

 

 

 

 

Cash payments
(15
)
 

 

 
(9
)
 
(24
)
Foreign exchange rate impact
2

 

 

 

 
2

Balance at September 29, 2012
$
42

 
$

 
$

 
$
23

 
$
65


Other Special Charges
Intangible asset impairment charges: During the first nine months of 2012, the Company recognized a $23 million impairment charge for certain developed technology intangible assets in its NMD division as the Company's updated expectations for the future undiscounted cash flows did not exceed the carrying value of the related assets. Additionally, during the second quarter of 2012, the Company determined that certain intangible assets in the Company's Atrial Fibrillation (AF) and Cardiovascular (CV) businesses were considered impaired as their future expected undiscounted cash flows did not exceed the carrying value of the related assets. As a result, the Company recognized a $5 million impairment charge to write-down the intangible assets to their fair value.
Settlement charge: During the first nine months of 2012, the Company agreed to settle a dispute on licensed technology for the Company's Angio-Seal™ vascular closure devices. In connection with this settlement, which resolved all disputed claims and included a fully-paid perpetual license, the Company recognized a $28 million settlement expense which it classified as a special charge and also recognized a $12 million licensed technology intangible asset to be amortized over the technology's remaining patent life.





13


NOTE 8 – NET EARNINGS PER SHARE
The table below sets forth the computation of basic and diluted net earnings per share (in millions, except per share amounts):

 
Three Months Ended
 
Nine Months Ended
 
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
Numerator:
 
 
 
 
 

 
 

Net earnings
$
176

 
$
227

 
$
632

 
$
701

Denominator:
 
 
 
 
 

 
 

Basic weighted average shares outstanding
314.7

 
324.2

 
314.8

 
326.0

Effect of dilutive securities:
 
 
 
 
 

 
 

Employee stock options
1.3

 
2.4

 
1.4

 
3.3

Restricted stock units
0.3

 
0.2

 
0.2

 
0.1

Diluted weighted average shares outstanding
316.3

 
326.8

 
316.4

 
329.4

Basic net earnings per share
$
0.56

 
$
0.70

 
$
2.01

 
$
2.15

Diluted net earnings per share
$
0.56

 
$
0.69

 
$
2.00

 
$
2.13

Approximately 16.1 million and 7.8 million shares of common stock subject to stock options and restricted stock units were excluded from the diluted net earnings per share computation for the three months ended September 29, 2012 and October 1, 2011, respectively, because they were not dilutive. Additionally, approximately 16.7 million and 7.3 million shares of common stock subject to stock options and restricted stock units were excluded from the diluted net earnings per share computation for the nine months ended September 29, 2012 and October 1, 2011, respectively, because they were not dilutive.
NOTE 9 – OTHER INCOME (EXPENSE), NET
The Company’s other income (expense) consisted of the following (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
Interest income
$
1

 
$
1

 
$
3

 
$
3

Interest expense
(18
)
 
(17
)
 
(55
)
 
(52
)
Other
(2
)
 
(4
)
 
(15
)
 
(23
)
Total other income (expense), net
$
(19
)
 
$
(20
)
 
$
(67
)
 
$
(72
)

NOTE 10 – INCOME TAXES
As of September 29, 2012, the Company had $227 million accrued for unrecognized tax benefits, all of which would affect the Company’s effective tax rate if recognized. Additionally, the Company had $39 million accrued for interest and penalties as of September 29, 2012. At December 31, 2011, the liability for unrecognized tax benefits was $206 million and the accrual for interest and penalties was $35 million. The Company recognizes interest and penalties related to income tax matters in income tax expense.
The Company is subject to U.S. federal income tax as well as income tax of multiple state and foreign jurisdictions. The Company has substantially concluded all U.S. federal income tax matters for all tax years through 2001. Additionally, substantially all material foreign, state and local income tax matters have been concluded for all tax years through 2004. The U.S. Internal Revenue Service (IRS) completed an audit of the Company’s 2002 through 2005 tax returns and proposed adjustments in its audit report issued in November 2008. The IRS completed an audit of the Company’s 2006 and 2007 tax returns and proposed adjustments in its audit report issued in March 2011. The Company is vigorously defending its positions and initiated its defense at the IRS appellate level in January 2009 for the 2002 through 2005 adjustments and in May 2011 for the 2006 through 2007 adjustments. An unfavorable outcome could have a material negative impact on the Company’s effective income tax rate in future periods. It is reasonably possible that the amount of unrecognized tax benefits will significantly change in the next 12 months from both cash payments and/or adjustments to previously recorded income tax reserves primarily due to potential resolution of ongoing income tax authority examinations. As the final outcome of these matters is inherently uncertain, the Company is not able to reasonably estimate the amount by which the liability for unrecognized tax

14


benefits will increase or decrease during the next 12 months.

NOTE 11 – FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS
The fair value measurement accounting standard, codified in ASC Topic 820, Fair Value Measurement (ASC Topic 820), provides a framework for measuring fair value and defines fair value as the price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that should be determined using assumptions that market participants would use in pricing an asset or liability. The standard establishes a valuation hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability developed based on independent market data sources. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability developed based upon the best information available. The valuation hierarchy is composed of three categories. The categorization within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The categories within the valuation hierarchy are described as follows:
Level 1 – Inputs to the fair value measurement are quoted prices in active markets for identical assets or liabilities.
Level 2 – Inputs to the fair value measurement include quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly.
Level 3 – Inputs to the fair value measurement are unobservable inputs or valuation techniques.
Assets and Liabilities that are Measured at Fair Value on a Recurring Basis
The fair value measurement standard applies to certain financial assets and liabilities that are measured at fair value on a recurring basis (each reporting period). These financial assets and liabilities include money-market securities, trading marketable securities, available-for-sale marketable securities and derivative instruments. The Company continues to record these items at fair value on a recurring basis and the fair value measurements are applied using ASC Topic 820. The Company does not have any material nonfinancial assets or liabilities that are measured at fair value on a recurring basis. A summary of the valuation methodologies used for the respective financial assets and liabilities measured at fair value on a recurring basis is as follows:
Money-Market Securities: The Company’s money-market securities include funds that are traded in active markets and are recorded at fair value based upon the quoted market prices. The Company classifies these securities as level 1.
Trading Securities: The Company’s trading securities include publicly-traded mutual funds that are traded in active markets and are recorded at fair value based upon quoted market prices of the net asset values of the funds. The Company classifies these securities as level 1.
Available-For-Sale Securities: The Company’s available-for-sale securities include publicly-traded equity securities that are traded in active markets and are recorded at fair value based upon the closing stock prices. The Company classifies these securities as level 1. The following table summarizes the components of the balance of the Company’s available-for-sale securities at September 29, 2012 and December 31, 2011 (in millions):
 
September 29, 2012
 
December 31, 2011
Adjusted cost
$
9

 
$
9

Gross unrealized gains
33

 
30

Fair value
$
42

 
$
39

Derivative Instruments: The Company’s derivative instruments consist of foreign currency exchange contracts and interest rate swap contracts. The Company classifies these instruments as level 2 as the fair value is determined using inputs other than observable quoted market prices. These inputs include spot and forward foreign currency exchange rates and interest rates that the Company obtains from standard market data providers. The fair value of the Company’s outstanding foreign currency exchange contracts was not material at September 29, 2012 or December 31, 2011.

15


A summary of financial assets measured at fair value on a recurring basis at September 29, 2012 and December 31, 2011 is as follows (in millions):
 
Balance Sheet
Classification
September 29, 2012
 
Quoted Prices
In Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 

 
 

 
 

 
 

Money-market securities
Cash and cash equivalents
$
866

 
$
866

 
$

 
$

Available-for-sale securities
Other current assets
42

 
42

 

 

Trading securities
Other assets
228

 
228

 

 

Total assets
 
$
1,136

 
$
1,136

 
$

 
$


 
Balance Sheet
Classification
December 31, 2011
 
Quoted Prices
In Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 

 
 

 
 

 
 

Money-market securities
Cash and cash equivalents
$
745

 
$
745

 
$

 
$

Available-for-sale securities
Other current assets
39

 
39

 

 

Trading securities
Other assets
205

 
205

 

 

Interest rate swap
Other assets
18

 

 
18

 

Total assets
 
$
1,007

 
$
989

 
$
18

 
$

Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis
The fair value measurement standard also applies to certain nonfinancial assets and liabilities that are measured at fair value on a nonrecurring basis. A summary of the valuation methodologies used for the respective nonfinancial assets and liabilities measured at fair value on a nonrecurring basis is as follows:
Long-Lived Assets: The Company reviews the carrying amount of its long-lived assets other than goodwill and indefinite-lived intangible assets for potential impairment whenever events or changes in circumstance include a significant decrease in market price, a significant adverse change in the extent or manner in which an asset is being used or a significant adverse change in the legal or business climate. The Company measures the fair value of its long-lived assets, such as its definite-lived intangible assets and property, plant and equipment using independent appraisals, market models and discounted cash flow models. A discounted cash flow model requires inputs to a present value cash flow calculation such as a risk-adjusted discount rate, terminal values, operating budgets, long-term strategic plans and remaining useful lives of the asset or asset group. If the carrying value of the Company’s long-lived assets (excluding goodwill and indefinite-lived intangible assets) exceeds the related undiscounted future cash flows, the carrying value is written down to the fair value in the period identified.
During the third quarter of 2012, the Company determined that certain purchased technology intangible assets in the Company's NMD business were considered impaired as their future expected undiscounted cash flows did not exceed the carrying value of the related assets. As a result, the Company recognized a $23 million impairment charge to write-down the intangible assets to their estimated fair value of $3 million as of September 29, 2012. The fair value measurements of these intangible assets are considered Level 3 in the fair value hierarchy due to the use of unobservable inputs, specifically the discounted cash flows income approach method, to measure fair value.
During the second quarter of 2012, the Company determined that certain purchased technology intangible assets in the Company's AF and CV businesses were considered impaired as their future expected undiscounted cash flows did not exceed the carrying value of the related assets. As a result, the Company recognized a $5 million impairment charge to write-down the intangible assets to their estimated fair value of $4 million as of June 30, 2012. The fair value measurements of these intangible assets are considered Level 3 in the fair value hierarchy due to the use of unobservable inputs, specifically the discounted cash flows income approach method, to measure fair value.
During the second quarter of 2011, the Company initiated restructuring actions resulting in the planned future closure of its CRM manufacturing facility in Sweden, resulting in the recognition of a $12 million impairment charge to write-down the

16


facility to its estimated fair value of $13 million. The fair value measurement of the facility is considered Level 2 in the fair value hierarchy due to the use of observable inputs, specifically comparable third party sale prices for similar facilities. During the fourth quarter of 2011, the Company recognized $52 million of intangible asset impairments primarily associated with customer relationship intangible assets. Due to the changing dynamics of the U.S. healthcare market, these intangible assets were determined to have no future discrete cash flows and were fully impaired.
Cost Method Investments: The Company also holds investments in equity securities that are accounted for as cost method investments, which are classified as other assets and measured at fair value on a nonrecurring basis. The carrying value of these investments approximated $144 million and $128 million at September 29, 2012 and December 31, 2011, respectively. The fair value of the Company’s cost method investments is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of these investments. When measured on a nonrecurring basis, the Company’s cost method investments are considered Level 3 in the fair value hierarchy due to the use of unobservable inputs to measure fair value.
Fair Value Measurements of Other Financial Instruments
The aggregate fair value of the Company’s fixed-rate senior notes at September 29, 2012 (measured using quoted prices in active markets) was $2,563 million compared to the aggregate carrying value of $2,439 million (inclusive of the terminated interest rate swaps). The fair value of the Company’s variable-rate debt obligations at September 29, 2012 approximated their aggregate $84 million carrying value due to the variable interest rate and short-term nature of these instruments.

NOTE 12 – DERIVATIVE FINANCIAL INSTRUMENTS
The Company follows the provisions of ASC Topic 815 in accounting for and disclosing derivative instruments and hedging activities. All derivative financial instruments are recognized on the balance sheet at fair value. Changes in the fair value of derivatives are recognized in net earnings or other comprehensive income depending on whether the derivative is designated as part of a qualifying hedge transaction. Derivative assets and derivative liabilities are classified as other current assets, other assets, other current liabilities or other liabilities, as appropriate.
Foreign Currency Forward Contracts
The Company hedges a portion of its foreign currency exchange rate risk through the use of forward exchange contracts. The Company uses forward exchange contracts to manage foreign currency exposures related to intercompany receivables and payables arising from intercompany purchases of manufactured products. These forward contracts are not designated as qualifying hedging relationships under ASC Topic 815. The Company measures its foreign currency exchange contracts at fair value on a recurring basis. The fair value of outstanding contracts was immaterial as of September 29, 2012 and December 31, 2011. During the third quarter of 2012 and 2011, the net amount of gains (losses) the Company recorded to other income (expense) for its forward currency exchange contracts not designated as hedging instruments under ASC Topic 815 was a net loss of $4 million and a net gain of $2 million, respectively. During the first nine months of 2012 and 2011, the net amount of gains (losses) the Company recorded to other income (expense) for its forward currency exchange contracts not designated as hedging instruments under ASC Topic 815 was a net gain of $1 million and a net loss of $6 million, respectively. These net gains/(losses) were almost entirely offset by corresponding net (losses)/gains on the foreign currency exposures being managed. The Company does not enter into contracts for trading or speculative purposes. The Company’s policy is to enter into hedging contracts with major financial institutions that have at least an “A” (or equivalent) credit rating.
Interest Rate Swap
In prior periods, the Company has chosen to hedge the fair value of certain debt obligations through the use of interest rate swap contracts. For interest rate swap contracts that are designated and qualify as fair value hedges, changes in the value of the fair value hedge are recognized as an asset or liability, as applicable, offsetting the changes in the fair value of the hedged debt instrument. When outstanding, the Company’s swap contracts are recorded on the consolidated balance sheets as a component of other current assets, other assets, other accrued expenses or other liabilities based on the gain or loss position of the contract and the contract maturity date. Additionally, any payments made or received under the swap contracts are accrued and recognized as interest expense. On June 7, 2012, the Company terminated the interest rate swap it had entered into concurrent with the March 2010 issuance of the 2016 Senior Notes and received a cash payment of $24 million. The gain from terminating the interest rate swap agreement has been reflected as an increase to the carrying value of the debt and is being amortized as a reduction of interest expense resulting in a net average interest rate of 1.3% that will be recognized over the remaining term of the 2016 Senior Notes. At December 31, 2011, the fair value of the interest rate swap was an $18 million unrealized gain which was classified in other assets.


17


NOTE 13 – SEGMENT AND GEOGRAPHIC INFORMATION
Segment Information
The Company’s four operating segments are Cardiac Rhythm Management (CRM), Cardiovascular (CV), Atrial Fibrillation (AF) and Neuromodulation (NMD). The primary products produced by each operating segment are: CRM – tachycardia implantable cardioverter defibrillator systems (ICDs) and bradycardia pacemaker systems (pacemakers); CV – vascular products, which include vascular closure products, pressure measurement guidewires, optical coherence tomography (OCT) imaging products, vascular plugs and other vascular accessories, and structural heart products, which include heart valve replacement and repair products and structural heart defect devices; AF – electrophysiology (EP) introducers and catheters, advanced cardiac mapping, navigation and recording systems and ablation systems; and NMD – neurostimulation products, which include spinal cord and deep brain stimulation devices.
As discussed in Note 7, during the third quarter of 2012, the Company announced the realignment of its product divisions into two new operating units: the Cardiovascular and Ablation Technologies Division (combining CV and AF) and the Implantable Electronic Systems Division (combining CRM and NMD). In addition, the Company is centralizing certain support functions, including information technology, human resources, legal, business development and certain marketing functions. While this divisional realignment was effective August 30, 2012, the Company will continue to report under its legacy operating segment structure for internal management financial forecasting and reporting purposes through the end of fiscal year 2012. The Company will report under the new organizational structure effective the beginning of fiscal year 2013.
The Company has aggregated the four operating segments into two reportable segments based upon their similar operational and economic characteristics: CRM/NMD and CV/AF. Net sales of the Company’s reportable segments include end-customer revenues from the sale of products they each develop and manufacture or distribute. The costs included in each of the reportable segments’ operating results include the direct costs of the products sold to customers and operating expenses managed by each of the reportable segments. Certain expenses managed by the Company’s selling and corporate functions, including all stock-based compensation expense, impairment charges, certain acquisition-related charges, in-process research and development (IPR&D) charges, excise tax expense and special charges have not been recorded in the individual reportable segments. As a result, reportable segment operating profit is not representative of the operating profit of the products in these reportable segments. Additionally, certain assets are managed by the Company’s selling and corporate functions, principally including trade receivables, inventory, cash and cash equivalents, certain marketable securities and deferred income taxes. For management reporting purposes, the Company does not compile capital expenditures by reportable segment; therefore, this information has not been presented, as it is impracticable to do so.
The following table presents net sales and operating profit by reportable segment (in millions):
 
CRM/NMD
 
CV/AF
 
Other
 
Total
Three Months ended September 29, 2012:
 

 
 

 
 

 
 

Net sales
$
792

 
$
534

 
$

 
$
1,326

Operating profit
526

 
298

 
(589
)
 
235

Three Months ended October 1, 2011:
 

 
 

 
 

 
 

Net sales
$
853

 
$
530

 
$

 
$
1,383

Operating profit
523

 
281

 
(493
)
 
311

 
 
 
 
 
 
 
 
Nine Months ended September 29, 2012:
 
 
 
 
 
 
 
Net sales
$
2,482

 
$
1,649

 
$

 
$
4,131

Operating profit
1,650

 
915

 
(1,690
)
 
875

Nine Months ended October 1, 2011:
 

 
 

 
 

 
 

Net sales
$
2,603

 
$
1,602

 
$

 
$
4,205

Operating profit
1,624

 
834

 
(1,500
)
 
958



18


The following table presents the Company’s total assets by reportable segment (in millions):
Total Assets
September 29, 2012
 
December 31, 2011
CRM/NMD
$
2,330

 
$
2,412

CV/AF
2,986

 
3,093

Other
3,703

 
3,500

 
$
9,019

 
$
9,005

Geographic Information
The following table presents net sales by geographic location of the customer (in millions):
 
Three Months Ended
 
Nine Months Ended
Net Sales
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
United States
$
640

 
$
658

 
$
1,969

 
$
2,012

International
 
 
 
 
 
 
 
Europe
311

 
359

 
1,059

 
1,139

Japan
172

 
162

 
500

 
466

Asia Pacific
118

 
111

 
339

 
310

Other
85

 
93

 
264

 
278

 
686

 
725

 
2,162

 
2,193

 
$
1,326

 
$
1,383

 
$
4,131

 
$
4,205

The amounts for long-lived assets by significant geographic market include net property, plant and equipment by physical location of the asset as follows (in millions):
Long-Lived Assets
September 29, 2012
 
December 31, 2011
United States
$
1,026

 
$
1,007

International
 

 
 

Europe
79

 
84

Japan
35

 
31

Asia Pacific
83

 
81

Other
186

 
185

 
383

 
381

 
$
1,409

 
$
1,388



19


Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW
Our business is focused on the development, manufacture and distribution of cardiovascular medical devices for the global cardiac rhythm management, cardiology, cardiac surgery and atrial fibrillation therapy areas and implantable neurostimulation medical devices for the management of chronic pain. We sell our products in more than 100 countries around the world. Our largest geographic markets are the United States, Europe, Japan and Asia Pacific. Our four operating segments are Cardiac Rhythm Management (CRM), Cardiovascular (CV), Atrial Fibrillation (AF), and Neuromodulation (NMD). Our principal products in each operating segment are as follows: CRM – tachycardia implantable cardioverter defibrillator systems (ICDs) and bradycardia pacemaker systems (pacemakers); CV – vascular products, which include vascular closure products, pressure measurement guidewires, optical coherence tomography (OCT) imaging products, vascular plugs and other vascular accessories, and structural heart products, which include heart valve replacement and repair products and structural heart defect devices; AF – electrophysiology (EP) introducers and catheters, advanced cardiac mapping, navigation and recording systems and ablation systems; and NMD – neurostimulation products, which include spinal cord and deep brain stimulation devices. References to “St. Jude Medical,” “St. Jude,” “the Company,” “we,” “us” and “our” are to St. Jude Medical, Inc. and its subsidiaries.
On August 30, 2012, we announced the realignment of our product divisions into two new operating units: the Cardiovascular and Ablation Technologies Division (combining CV and AF) and the Implantable Electronic Systems Division (combining CRM and NMD). In addition, we are centralizing certain support functions, including information technology, human resources, legal, business development and certain marketing functions. The organizational changes are part of a comprehensive plan to accelerate our growth, reduce costs, leverage economies of scale and increase investment in product development. While this divisional realignment was effective August 30, 2012, we will continue to report under our legacy operating segment structure for internal management financial forecasting and reporting purposes through the end of fiscal year 2012. We will report under the new organizational structure effective the beginning of fiscal year 2013.
Our industry has undergone significant consolidation in the last decade and is highly competitive. Our strategy requires significant investment in research and development in order to introduce new products. We are focused on improving our operating margins through a variety of techniques, including the production of high quality products, the development of leading edge technology, the enhancement of our existing products and continuous improvement of our manufacturing processes. We expect competitive pressures in the industry, global economic conditions, cost containment pressure on healthcare systems and the implementation of U.S. healthcare reform legislation to continue to place downward pressure on prices for our products, impact reimbursement for our products and potentially reduce medical procedure volumes.
In March 2010, significant U.S. healthcare reform legislation, the Patient Protection and Affordable Care Act (PPACA) along with the Health Care and Education Reconciliation Act of 2010, was enacted into law. As a U.S. headquartered company with significant sales in the United States, this health care reform law will materially impact us. Certain provisions of the health care reform are not effective for a number of years and there are many programs and requirements for which the details have not yet been fully established or consequences not fully understood, and it is unclear what the full impact will be from the legislation. The law does levy a 2.3% excise tax on all U.S. medical device sales beginning in 2013. Our U.S. net sales represented approximately 47% of our worldwide consolidated net sales in 2011 and we expect the new tax will materially and adversely affect our business, cash flows and results of operations. The law also focuses on a number of Medicare provisions aimed at improving quality and decreasing costs. It is uncertain at this point what impact these provisions will have on patient access to new technologies. The Medicare provisions also include value-based payment programs, increased funding of comparative effectiveness research, reduced hospital payments for avoidable readmissions and hospital acquired conditions, and pilot programs to evaluate alternative payment methodologies that promote care coordination (such as bundled physician and hospital payments). Additionally, the law includes a reduction in the annual rate of inflation for hospitals that began in 2011 and the establishment of an independent payment advisory board to recommend ways of reducing the rate of growth in Medicare spending beginning in 2014. We cannot predict what healthcare programs and regulations will be ultimately implemented at the federal or state level, or the effect of any future legislation or regulation. However, any changes that lower reimbursement for our products or reduce medical procedure volumes could adversely affect our business and results of operations.
We participate in several different medical device markets, each of which has its own expected growth rate. A significant portion of our net sales relate to CRM devices – ICDs and pacemakers. The 2011 ICD market in the United States was negatively impacted by a decline in implant volumes and pricing resulting from the publication of an ICD utilization article in January 2011 in the Journal of the American Medical Association and subsequent hospital investigation by the U.S. Department of Justice. During the current year, the U.S. ICD market has continued to experience these negative impacts and we estimate the 2012 U.S. ICD market has contracted at a mid single-digit percentage rate from the 2011 comparable period. While the

20


long-term impact on the CRM market is uncertain, management remains focused on increasing our worldwide CRM market share, as we are one of three principal manufacturers and suppliers in the global CRM market. We are also investing in our other three major operating segments – cardiovascular, atrial fibrillation and neuromodulation – to increase our market share in these markets.
Net sales in the third quarter and first nine months of 2012 were $1,326 million and $4,131 million, respectively, decreases of 4% and 2% over the third quarter and first nine months of 2011, respectively. During the third quarter and first nine months of 2012 unfavorable foreign currency translation impacted our net sales by $60 million and $114 million, respectively, compared to the same prior year periods. Refer to the Segment Performance section for a more detailed discussion of the results for the respective segments.

Our third quarter 2012 net earnings of $176 million and diluted net earnings per share of $0.56 both decreased 22% and 19%, respectively, compared to our third quarter 2011 net earnings of $227 million and diluted net earnings per share of $0.69. Third quarter 2012 net earnings were negatively impacted by after-tax special charges of $80 million primarily related to our 2012 realignment plan announced in August 2012 to realign our product divisions and to centralize certain support functions, as well as ongoing restructuring charges related to the 2011 restructuring plan. Third quarter 2011 net earnings were negatively impacted by after-tax special charges of $21 million primarily related to our 2011 restructuring plan. Additionally, during the third quarter of 2011 we recognized an $8 million accounts receivable write-down associated with one customer in Europe. Net earnings and diluted net earnings per share for the first nine months of 2012 were $632 million and $2.00 per diluted share, a decrease of 10% and 6%, respectively, compared to the first nine months of 2011. During the first nine months of 2012 and 2011, net earnings were negatively impacted by after-tax charges of $161 million and $88 million, respectively, associated with the 2012 realignment and 2011 restructuring charges discussed previously, as well as 2011 post-acquisition expenses for the AGA Medical Holdings, Inc. (AGA Medical) acquisition that consummated in November 2010. Refer to the Results of Operations section for a more detailed discussion of these charges.

We generated $939 million of operating cash flows during the first nine months of 2012, compared to $941 million of operating cash flows during the first nine months of 2011. We ended the third quarter with $1,051 million of cash and cash equivalents and $2,523 million of total debt. We also repurchased 7.1 million shares of our common stock for $300 million at an average repurchase price of $42.14 per share and our Board of Directors authorized quarterly cash dividend payments of $0.23 per share paid on April 30, 2012, July 31, 2012 and October 31, 2012. Our 2012 dividends represent a 10% per share increase over the same periods in 2011. During the first nine months of 2011, we repurchased 11.7 million shares of our common stock for $500 million at an average repurchase price of $42.79 per share.

NEW ACCOUNTING PRONOUNCEMENTS
In July 2012, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-lived Intangible Assets for Impairment, an update to ASU 2011-08, Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2012-02 enables an entity to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with Subtopic 350-30, Intangibles - Goodwill and Other - General Intangibles Other than Goodwill. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Previous guidance in Subtopic 350-30 required an entity to test an indefinite-lived intangible asset for impairment by comparing the fair value of the asset with its carrying amount, utilizing only a quantitative impairment test. ASU 2012-02 is effective for interim and annual reporting periods for fiscal years beginning after September 15, 2012, with early adoption permitted. We expect to early adopt this new accounting pronouncement during our fourth quarter of 2012 and do not expect a material impact on our financial condition or results of operations.
Information regarding the new accounting pronouncement that impacted our 2012 financial statements and disclosures is included in Note 2 to the Condensed Consolidated Financial Statements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have adopted various accounting policies in preparing the consolidated financial statements in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are disclosed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (2011 Annual Report on Form 10-K).
Preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires us to adopt various accounting policies and to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates and assumptions, including those related

21


to accounts receivable allowance for doubtful accounts; inventory reserves; valuation of in-process research and development (IPR&D), other intangible assets and goodwill; income taxes; litigation reserves and insurance receivables; and stock-based compensation. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. Actual results may differ from these estimates. There have been no material changes to our critical accounting policies and estimates from the information provided in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2011 Annual Report on Form 10-K.

SEGMENT PERFORMANCE
Our four operating segments are Cardiac Rhythm Management (CRM), Cardiovascular (CV), Atrial Fibrillation (AF), and Neuromodulation (NMD). The primary products produced by each operating segment are: CRM – tachycardia implantable cardioverter defibrillator systems (ICDs) and bradycardia pacemaker systems (pacemakers); CV – vascular products, which include vascular closure products, pressure measurement guidewires, optical coherence tomography (OCT) imaging products, vascular plugs and other vascular accessories, and structural heart products, which include heart valve replacement and repair products and structural heart defect devices; AF – electrophysiology (EP) introducers and catheters, advanced cardiac mapping, navigation and recording systems and ablation systems; and NMD – neurostimulation products, which include spinal cord and deep brain stimulation devices.
The Company currently aggregates the four operating segments into two reportable segments based upon their similar operational and economic characteristics: CRM/NMD and CV/AF. As discussed in the overview section, we will report under our new organizational structure effective the beginning of fiscal year 2013. Net sales of the Company’s reportable segments include end-customer revenues from the sale of products they each develop and manufacture or distribute. The costs included in each of the reportable segments’ operating results include the direct costs of the products sold to customers and operating expenses managed by each of the reportable segments. Certain expenses managed by our selling and corporate functions, including all stock-based compensation expense, impairment charges, certain acquisition-related expenses, IPR&D charges, excise tax expense and special charges have not been recorded in the individual reportable segments. As a result, reportable segment operating profit is not representative of the operating profit of the products in these reportable segments.
The following table presents net sales and operating profit by reportable segment (in millions):
 
CRM/NMD
 
CV/AF
 
Other
 
Total
Three Months ended September 29, 2012:
 

 
 

 
 

 
 

Net sales
$
792

 
$
534

 
$

 
$
1,326

Operating profit
526

 
298

 
(589
)
 
235

Three Months ended October 1, 2011:
 

 
 

 
 

 
 

Net sales
$
853

 
$
530

 
$

 
$
1,383

Operating profit
523

 
281

 
(493
)
 
311

 
 
 
 
 
 
 
 
Nine Months ended September 29, 2012:
 
 
 
 
 
 
 
Net sales
$
2,482

 
$
1,649

 
$

 
$
4,131

Operating profit
1,650

 
915

 
(1,690
)
 
875

Nine Months ended October 1, 2011:
 

 
 

 
 

 
 

Net sales
$
2,603

 
$
1,602

 
$

 
$
4,205

Operating profit
1,624

 
834

 
(1,500
)
 
958

The following discussion of the changes in our net sales is provided by class of similar products within our four operating segments, which is the primary focus of our sales activities.

22


Cardiac Rhythm Management
 
Three Months Ended
 
 
 
Nine Months Ended
 
 
(in millions)
September 29, 2012
 
October 1, 2011
 
%
Change
 
September 29, 2012
 
October 1, 2011
 
%
Change
ICD systems
$
412

 
$
445

 
(7.4
)%
 
$
1,321

 
$
1,387

 
(4.8
)%
Pacemaker systems
279

 
306

 
(8.8
)%
 
851

 
918

 
(7.3
)%
 
$
691

 
$
751

 
(8.0
)%
 
$
2,172

 
$
2,305

 
(5.8
)%
Cardiac Rhythm Management’s net sales decreased 8% and 6% during the third quarter and first nine months of 2012, respectively, compared to the same prior year periods. During the third quarter and first nine months of 2012, foreign currency translation had a $32 million and $63 million unfavorable impact, respectively, compared to the same periods last year.
ICD net sales decreased 7% and 5% during the third quarter and first nine months of 2012, respectively, compared to the same prior year periods primarily driven by unfavorable foreign currency and a decline in the U.S. market which continues to contract at a mid single-digit percentage rate from the 2011 comparable periods. The U.S. ICD market continues to be negatively impacted by a decline in implant volumes and pricing resulting from the publication of an ICD utilization article in January 2011 in the Journal of the American Medical Association, subsequent hospital investigation by the U.S. Department of Justice and a significant increase in hospital ownership of physician practices. Facing this market contraction, our U.S. 2012 third quarter and first nine month ICD net sales of $247 million and $780 million, respectively, both decreased 4% compared to the same prior year periods. Partially offsetting the U.S. ICD market contraction, we experienced a benefit from sales of our Unify Quadra® Cardiac Resynchronization Therapy Defibrillator (CRT-D) and Quartet® Left Ventricular Quadripolar Pacing Lead, which was approved by the U.S. Food and Drug Administration (FDA) in November 2011 and is the industry's first quadripolar pacing system. Sales of our Assuraportfolio of ICDs and CRT-Ds as well as our Ellipse ICD, which were approved by the FDA in May 2012, also provided a benefit to our 2012 net sales. Internationally, third quarter and first nine month 2012 ICD net sales of $165 million and $541 million decreased 12% and 6%, respectively, compared to the same prior year periods. Foreign currency translation had a $17 million (9 percentage point) and $35 million (6 percentage point) unfavorable impact on international ICD net sales in the third quarter and first nine months of 2012 compared to the same prior year periods as a result of the strengthening U.S. Dollar against the Euro.
Pacemaker net sales decreased 9% and 7% during the third quarter and first nine months of 2012 compared to the same prior year periods. In the United States, our third quarter 2012 pacemaker net sales of $114 million and first nine month pacemaker net sales of $348 million both decreased 10% compared to the same prior year periods. Internationally, our 2012 net sales during the third quarter of $165 million and first nine months of $503 million decreased 8% and 6%, respectively, compared to the same prior year periods. Foreign currency translation had a $15 million (8 percentage point) and $28 million (5 percentage point) unfavorable impact during the third quarter and first nine months of 2012, respectively, compared to the same prior year periods.
Cardiovascular
 
Three Months Ended
 
 
 
Nine Months Ended
 
 
(in millions)
September 29, 2012
 
October 1, 2011
 
%
Change
 
September 29, 2012
 
October 1, 2011
 
%
Change
Vascular products
$
169

 
$
177

 
(4.5
)%
 
$
530

 
$
550

 
(3.6
)%
Structural heart products
145

 
151

 
(4.0
)%
 
460

 
447

 
2.9
 %
 
$
314

 
$
328

 
(4.3
)%
 
$
990

 
$
997

 
(0.7
)%

Cardiovascular net sales decreased 4% and 1% during the third quarter and first nine months of 2012, respectively, compared to the same periods one year ago. Foreign currency translation unfavorably impacted CV net sales by $16 million and $29 million during the third quarter and first nine months of 2012, respectively, compared to the same prior year periods. We experienced a negative impact on CV net sales during the third quarter of 2012 as a result of an overall slowdown in cardiovascular procedures, particularly in Europe with its economic disruptions negatively impacting procedural volumes.

Vascular products' net sales decreased 5% and 4% during the third quarter and first nine months of 2012, respectively, compared to the same periods in 2011 primarily due to the termination of a distribution contract in Japan, negatively impacting our third quarter and first nine months of 2012 vascular product net sales by 4% and 6%, respectively, compared to the same

23


periods in 2011. Foreign currency translation also unfavorably impacted net sales by $8 million and $13 million in our third quarter and first nine months of 2012, respectively, compared to the same periods in 2011. These decreases were partially offset by increases in sales of our OCT products, led by our Ilumien™ hardware platform, which combines both OCT and fractional flow reserve (FFR) capabilities into a single system, as well as sales volume increases in our FFR technology products as we continue to penetrate the market.
 
Structural heart products' net sales decreased 4% and increased 3% during the third quarter and first nine months of 2012, respectively. The decrease in 2012 third quarter net sales was impacted by a reduction in cardiovascular procedures in Europe, driven by the previously discussed economic challenges. The increase in net sales during the first nine months of 2012 was driven by an increase in our tissue heart valve sales volumes, led by our Trifecta product line of pericardial stented tissue valves. Overall tissue heart valve sales volumes increased 22% during the first nine months of 2012 compared to the same prior year period. Foreign currency translation unfavorably impacted structural heart products' net sales by $8 million and $16 million during the third quarter and first nine months of 2012, respectively, compared to the same periods in 2011.
Atrial Fibrillation
 
Three Months Ended
 
 
 
Nine Months Ended
 
 
(in millions)
September 29, 2012
 
October 1, 2011
 
%
Change
 
September 29, 2012
 
October 1, 2011
 
%
Change
     Atrial fibrillation products
$
220

 
$
202

 
8.9
%
 
$
659

 
$
605

 
8.9
%

In our Atrial Fibrillation division, our access, diagnosis, visualization, recording and ablation products assist physicians in diagnosing and treating atrial fibrillation and other irregular heart rhythms. AF net sales increased 9% during both the third quarter and first nine months of 2012 compared to the same prior year periods due to the continued increase in EP catheter ablation procedures and the continued market penetration of our EnSite® Velocity System and related connectivity tools (EnSite Connect™, EnSite Courier™ and EnSite Derexi™ modules). Foreign currency translation had an unfavorable impact on AF net sales of $9 million and $16 million in the third quarter and first nine months of 2012, respectively, compared to the same periods in 2011.
Neuromodulation
 
Three Months Ended
 
 
 
Nine Months Ended
 
 
(in millions)
September 29, 2012
 
October 1, 2011
 
%
Change
 
September 29, 2012
 
October 1, 2011
 
%
Change
     Neuromodulation products
$
101

 
$
102

 
(1.0
)%
 
$
310

 
$
298

 
4.0
%

Neuromodulation net sales decreased 1% during the third quarter of 2012 due to unfavorable foreign currency translation of $3 million (3 percentage points). Net sales during the first nine months of 2012 increased 4% compared to the same period in 2011 as a result of continued market acceptance of our products and sales growth in our neurostimulation devices that help manage chronic pain primarily associated with the Eon Mini™ platform and growing market acceptance of the Epiducer™ Lead Delivery system which gives physicians the ability to place multiple neurostimulation leads through a single entry point. Foreign currency translation had a $6 million (2 percentage point) unfavorable impact on NMD net sales during the first nine months of 2012 compared to the same prior year periods.

RESULTS OF OPERATIONS
Net sales
 
Three Months Ended
 
 
 
Nine Months Ended
 
 
(in millions)
September 29, 2012
 
October 1, 2011
 
%
Change
 
September 29, 2012
 
October 1, 2011
 
%
Change
     Net sales
$
1,326

 
$
1,383

 
(4.1
)%
 
$
4,131

 
$
4,205

 
(1.8
)%

Overall, net sales decreased 4% and 2% during the third quarter and first nine months of 2012 compared to the same prior year periods. Foreign currency translation had an unfavorable impact of $60 million and $114 million on the third quarter and first nine months of 2012 net sales, respectively, due primarily to the strengthening of the U.S. Dollar against the Euro. This amount is not indicative of the net earnings impact of foreign currency translation for the third quarter and first nine months of 2012

24


due to partially offsetting foreign currency translation impacts on cost of sales and operating expenses.
Net sales by geographic location of the customer were as follows (in millions):
 
Three Months Ended
 
Nine Months Ended
Net Sales
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
United States
$
640

 
$
658

 
$
1,969

 
$
2,012

International
 
 
 
 
 
 
 
Europe
311

 
359

 
1,059

 
1,139

Japan
172

 
162

 
500

 
466

Asia Pacific
118

 
111

 
339

 
310

Other
85

 
93

 
264

 
278

 
686

 
725

 
2,162

 
2,193

 
$
1,326

 
$
1,383

 
$
4,131

 
$
4,205



Gross profit
 

 
 

 
 
 
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
Gross profit
$
971

 
$
1,013

 
$
3,012

 
$
3,075

Percentage of net sales
73.2
%
 
72.7
%
 
72.9
%
 
73.1
%

Gross profit for the third quarter of 2012 totaled $971 million, or 73.2% of net sales, compared to $1,013 million, or 72.7% of net sales for the third quarter of 2011. Gross profit for the first nine months of 2012 totaled $3,012 million, or 72.9% of net sales, compared to $3,075 million, or 73.1% of net sales for the first nine months of 2011. Our gross profit percentage for the third quarter and first nine months of 2012 was negatively impacted by restructuring special charges of $7 million (0.6 percentage points) and $46 million (1.1 percentage points), respectively, due to realigning our product divisions, centralizing certain support functions as well as ongoing restructuring charges related to our 2011 restructuring plan. Our gross profit percentage for the first nine months of 2011 was also negatively impacted by $29 million (or 0.7 percentage points) from inventory step-up amortization costs associated with our AGA Medical acquisition, and special charges of $7 million and $18 million (or 1.1 and 0.5 percentage points, respectively) during the third quarter and first nine months of 2011, respectively. Refer to “Special Charges” within the Results of Operations section for a more detailed discussion of these charges.

Selling, general and administrative (SG&A) expense
 

 
 

 
 
 
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
Selling, general and administrative
$
456

 
$
505

 
$
1,440

 
$
1,532

Percentage of net sales
34.4
%
 
35.5
%
 
34.9
%
 
36.4
%

SG&A expense for the third quarter of 2012 totaled $456 million, or 34.4% of net sales, compared to $505 million, or 35.5% of net sales, for the third quarter of 2011. SG&A expense for the first nine months of 2012 totaled $1,440 million, or 34.9% of net sales, compared to $1,532 million, or 36.4% of net sales, for the first nine months of 2011. The decrease in our SG&A expense as a percent of net sales during the third quarter and first nine months of 2012 was primarily driven by cost savings initiatives including the integration of the AGA Medial business into our CV division and the integration of our Neuromodulation domestic sales organization into our United States selling organization. Additionally, contract termination and international integration charges related to our AGA Medical acquisition negatively impacted SG&A expenses as a percent of net sales by 0.5 percentage points during both the third quarter and first nine months of 2011.


25


Research and development (R&D) expense
 

 
 

 
 
 
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
Research and development expense
$
170

 
$
176

 
$
518

 
$
528

Percentage of net sales
12.8
%
 
12.2
%
 
12.5
%
 
12.5
%

R&D expense in the third quarter of 2012 totaled $170 million, or 12.8% of net sales, compared to $176 million, or 12.2% of net sales, for the third quarter of 2011. R&D expense in the first nine months of 2012 totaled $518 million, or 12.5% of net sales, compared to $528 million, or 12.5% of net sales, for the first nine months of 2011. R&D expense as a percent of net sales remains consistent with prior periods, reflecting our continuing commitment to fund future long-term growth opportunities. We will continue to balance delivering short-term results with our investments in long-term growth drivers.

Purchased in-process research and development charges
During the second quarter of 2011, we recorded IPR&D charges of $4 million in conjunction with the purchase of intellectual property in our CRM segment since the related technological feasibility had not yet been reached and such technology had no future alternative use.
Special charges
 

 
 

 
 
 
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
September 29, 2012
 
October 1, 2011
 
September 29, 2012
 
October 1, 2011
Cost of sales special charges
$
7

 
$
7

 
$
46

 
$
18

Special charges
110

 
21

 
179

 
53

 
$
117

 
$
28

 
$
225

 
$
71

We recognize certain transactions and events as special charges in our consolidated financial statements. These charges (such as restructuring charges, impairment charges and certain settlement or litigation charges) result from facts and circumstances that vary in frequency and impact on our results of operations. In order to enhance segment comparability and reflect management’s focus on the ongoing operations, special charges are not reflected in the individual reportable segments operating results.
2012 Business Realignment Plan: During the third quarter of 2012, we incurred charges of $74 million from the realignment of our product divisions into two new operating units: the Cardiovascular and Ablation Technologies Division (combining our Cardiovascular Division and Atrial Fibrillation Division) and the Implantable Electronic Systems Division (combining our Cardiac Rhythm Management Division and Neuromodulation Division). In addition, we are centralizing certain support functions, including information technology, human resources, legal, business development and certain marketing functions. The organizational changes are part of a comprehensive plan to accelerate our growth, reduce costs, leverage economies of scale and increase investment in product development. Of the $74 million recorded as special charges, we recognized $52 million of severance costs and other termination benefits; additionally, we recorded $22 million of accelerated depreciation charges and other costs primarily associated with information technology assets no longer expected to be utilized or with a limited remaining useful life. The 2012 business realignment plan is expected to reduce our global workforce by approximately 5% and result in total charges of $150 million to $200 million.