10-K 1 stj20150102201610-k.htm 10-K 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended January 2, 2016
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 of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
 
 
 
One St. Jude Medical Drive
 
(651) 756-2000
St. Paul, Minnesota 55117
 
(Registrant’s telephone number,
(Address of principal executive
 
including area code)
offices, including zip code)
 
 
 
 
 
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
Common Stock ($.10 par value)
 
New York Stock Exchange
(Title of class)
 
(Name of exchange on which registered)
 
Securities registered pursuant to Section 12(g) of the Act: None
 
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý           No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o           No ý
 
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. Yes ý           No o
 
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). Yes ý           No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
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 o
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o           No ý
The aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant was $20.6 billion at July 2, 2015 (the last business day of the registrant’s most recently completed second fiscal quarter), when the closing sale price of such stock, as reported on the New York Stock Exchange, was $73.03 per share.
The registrant had 283,616,926 shares of its $0.10 par value Common Stock outstanding as of February 19, 2016.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company’s Proxy Statement for its 2016 Annual Meeting of Shareholders are incorporated by reference into Part III.


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TABLE OF CONTENTS
ITEM
DESCRIPTION
PAGE
 
 
 
 
PART I
 
 
 
 
1.
1A.
1B.
2.
3.
4.
 
 
 
 
PART II
 
 
 
 
5.
6.
7.
7A.
8.
9.
9A.
9B.
 
 
 
 
PART III
 
 
 
 
10.
11.
12.
13.
14.
 
 
 
 
PART IV
 
 
 
 
15.
 
 
 
 


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PART I

Item 1.
BUSINESS

St. Jude Medical was incorporated in Minnesota in 1976. The Company's ticker symbol is STJ. References to “St. Jude Medical, Inc.,” “St. Jude,” “the Company,” “we,” “us” and “our” are to St. Jude Medical, Inc. and its subsidiaries.
Availability of SEC Reports
We make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act) as soon as reasonably practical after they are filed or furnished to the U.S. Securities and Exchange Commission (SEC). Such reports are available on our website (http://www.sjm.com) under Investors – Reports & Filings – SEC Filings. Information included on our website is not deemed to be incorporated into this Form 10-K. The SEC also maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public can obtain any documents that the Company files with the SEC at http://www.sec.gov.
General
St. Jude Medical, Inc., together with its subsidiaries is focused on the development, manufacture and distribution of cardiovascular medical devices for the global cardiac rhythm management, cardiovascular and atrial fibrillation therapy areas, and interventional pain therapy and neurostimulation devices for the management of chronic pain and movement disorders. We operate as a single operating segment and derive our revenues from seven principal product categories. Our seven principal product categories are as follows: tachycardia implantable cardioverter defibrillator (ICD) systems; atrial fibrillation (AF) products (electrophysiology (EP) introducers and catheters, advanced cardiac mapping, navigation and recording systems and ablation systems); bradycardia pacemaker (pacemaker) systems; vascular products (vascular closure products, pressure measurement guidewires, optical coherence tomography (OCT) imaging products, vascular plugs, heart failure monitoring devices and other vascular accessories); structural heart products (heart valve replacement and repair products and structural heart defect devices); neuromodulation products (spinal cord stimulation and radiofrequency ablation to treat chronic pain and deep brain stimulation to treat movement disorders); and Thoratec products (ventricular assist devices and percutaneous heart pumps). We market and sell our products world-wide primarily through a direct sales force.
On January 13, 2016, we announced that we would change our sales reporting starting in 2016 to closely align with how we will manage the business in five key areas: Heart Failure (HF), Atrial Fibrillation, Neuromodulation, Cardiovascular Disease and Traditional Cardiac Rhythm Management. Our sales results were managed on the basis of our existing product categories through 2015, with the intention that sales reporting be managed under the new classification once it is fully effective in the first quarter of 2016.
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 2010, significant U.S. healthcare reform legislation, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act (collectively PPACA), was enacted into law. As a U.S.-headquartered company with significant sales in the United States, this healthcare reform law has had, and is expected to continue to have, a material impact on us and on the U.S. healthcare system, more generally. Beginning in 2013, the law levied an annual 2.3% excise tax on the majority of our U.S. medical device sales, reduced the annual rate of inflation for Medicare payments to hospitals and called for the establishment of the Independent Payment Advisory Board to recommend strategies for reducing growth in Medicare spending. The law also focused on a number of Medicare provisions aimed at improving quality and decreasing costs, such as 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). The Consolidated Appropriations Act, 2016 (H.R. 2029), however, was signed into law in December 2015 and placed a

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moratorium on the 2.3% tax in both 2016 and 2017. We cannot predict what future healthcare legislation will be implemented at the federal or state level, nor 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.
Principal Products
The following table presents net sales to external customers for our seven major product categories (in millions):
Net Sales
2015
 
2014
 
2013
ICD Systems
$
1,582

 
$
1,746

 
$
1,741

Atrial Fibrillation Products
1,096

 
1,044

 
957

Pacemaker Systems
941

 
1,047

 
1,042

Vascular Products
716

 
709

 
704

Structural Heart Products
595

 
639

 
631

Neuromodulation Products
475

 
437

 
426

Thoratec Products
136

 

 

   Net sales
$
5,541

 
$
5,622

 
$
5,501


ICD Systems: Tachycardia implantable cardioverter defibrillator (ICD) systems and cardiac resynchronization therapy defibrillator (CRT-D) devices treat patients with tachycardia. ICDs and CRT-Ds are typically implanted underneath the collarbone and are connected to the heart by leads (wires) that carry electrical impulses to the heart. An ICD monitors the heartbeat and delivers high-energy electrical impulses, or “shocks,” to regulate the heart's rhythm and treat ventricular tachycardia (VT) and ventricular fibrillation (VF) -- which often lead to sudden cardiac death (SCD). A CRT-D device resynchronizes the beating of the ventricles and provides backup treatment for SCD. Physicians and healthcare professionals also use programmers and remote monitoring equipment to analyze device data from ICDs and CRT-devices.

Our primary ICD Systems' competitors include Medtronic plc. (Medtronic), Boston Scientific, Inc. (Boston Scientific), Biotronik International (Biotronik) and LivaNova plc. (LivaNova).

Atrial Fibrillation Products: Atrial fibrillation products provide access, diagnostic, visualization and ablation products to assist physicians in diagnosing and treating various irregular heart rhythms. Ablation technologies are primarily designed to be used in the electrophysiology (EP) lab to guide and facilitate the percutaneous delivery of catheters to areas of the heart where arrhythmias occur. Access products enable clinicians to facilitate the percutaneous delivery of diagnostic and ablation catheters to areas of the heart where arrhythmias occur. Diagnostic products gather electrical information from the heart to help determine the cause of an arrhythmia, the location of its source and allow clinicians to move the catheter tip in precise movements to diagnose the more anatomically challenging areas within the heart. Visualization products enable the physician to check for electrical isolation of the pulmonary vein openings during an AF ablation procedure and are designed to create high-density heart chamber models, including three-dimensional cardiac models and detailed electrical maps. Ablation products focus on disabling abnormal tissue that cause or perpetuate arrhythmias.

Our primary Atrial Fibrillation Products' competitors include Johnson & Johnson, Inc (J&J), Medtronic and Boston Scientific.

Pacemaker Systems: Pacemakers treat patients with bradycardia. Similar to ICDs and CRT-Ds, pacemakers are typically implanted underneath the collarbone and connected to the heart by leads, although some do not require the need to surgically create a pocket or use leads. Pacemakers monitor the patient's heart rate and, when necessary, deliver low-voltage electrical impulses to stimulate an appropriate heartbeat. Single-chamber pacemakers sense and stimulate only one chamber of the heart (atrium or ventricle), while dual-chamber devices can sense and pace both the upper atrium and lower ventricle chambers. Biventricular pacemakers can sense and pace in three chambers (atrium and both ventricle chambers) of the heart and are referred to as cardiac resynchronization therapy pacemaker (CRT-P) devices. Similar to ICDs and CRT-Ds, physicians and healthcare professionals use programmers and remote monitoring equipment to analyze device data and adjust patient treatment, as necessary.
 

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Our primary Pacemaker Systems' competitors include Medtronic, Boston Scientific, Biotronik and LivaNova.

Vascular Products: Vascular products include active vascular closure devices, compression assist devices, pressure measurement guidewires, diagnostic coronary imaging technology, percutaneous catheter introducers, diagnostic guidewires, heart failure monitoring devices, renal denervation technology and vascular plugs. Vascular closure devices close femoral and radial artery puncture sites following percutaneous coronary interventions, diagnostic procedures and certain peripheral procedures. Compression assist devices close puncture sites of the radial and other arteries. Pressure measurement guidewires provide measurements of intravascular pressure during a cardiovascular procedure and aid physicians in determining which lesions need treatment. Diagnostic coronary imaging technology provides interventional cardiologists with supplemental information on the physiologic and anatomical characteristics of a target vessel. Percutaneous catheter introducers create passageways for cardiovascular catheters from outside the human body through the skin into a vein, artery or other location inside the body. Diagnostic guidewires aid in the introduction of intravascular catheters. HF monitoring devices, include devices with wireless sensors that provide non-invasive hemodynamic data to physicians via the internet in the physician’s office, clinic, hospital or most often, in the patient’s home. Renal denervation technology is a multi-electrode ablation technology used to reduce blood pressure. Vascular plugs are expandable, cylindrical devices that reduce, redirect or eliminate blood flow to unwanted blood vessels.

Our primary Vascular Products' competitors include Abbott Laboratories, J&J, Cardinal Health, Inc., Koninklijke Philips N.V. and Boston Scientific.

Structural Heart Products: Structural Heart Products include heart valve replacement and repair products and structural heart defect devices, all of which are used to facilitate blood flow from the chambers of the heart throughout the entire body. Heart valve replacement and repair products include mechanical heart and tissue heart valves. Structural heart defect devices include closure devices that treat congenital heart defects, including atrial septal defects and patent ductus arteriosus defects, seal holes in the septum between the right and left sides of the heart and reduce the risk of ischemic stroke in patients with AF.

Our primary Structural Heart Products' competitors include Edwards Lifesciences Corporation, Medtronic and Boston Scientific.

Neuromodulation Products: Neuromodulation products provide neurostimulation therapy to treat chronic pain and movement disorders. Neurostimulation therapies include spinal cord stimulation (SCS) and radiofrequency ablation for the treatment of chronic pain and deep brain stimulation (DBS) for treating the symptoms of Parkinson's disease, primary and secondary dystonia and tremor. Similar to ICDs and pacemakers, a neurostimulation system includes an implantable device called an implantable pulse generator (IPG) that is typically implanted underneath the skin in the abdomen or upper buttock and produces an electrical current that is carried by leads to the targeted anatomical structure. Additionally, an external patient remote control is used to enable the patient to control his or her therapy within prescribed ranges, and an external clinician programmer is used to access all programming options of the implanted device to tailor therapy to the patient. In addition to SCS, radiofrequency ablation (RFA) is used to treat chronic spinal pain along with several peripheral areas that are not well treated with a neurostimulation system. Radiofrequency (RF) nerve ablation employs heat to disable pain-transmitting nerves and is used to treat a variety of chronic pain syndromes.

Our primary Neuromodulation Products' competitors include Medtronic, Boston Scientific, Nevro Corp. and Stryker Corporation.

Thoratec Products: Thoratec Products include ventricular assist devices and percutaneous heart pumps, both of which facilitate blood flow from the chambers of the heart throughout the entire body. Specifically, ventricular assist devices provide mechanical circulatory support for the treatment of HF patients by supplementing the pumping function of the heart. Percutaneous heart pumps continuously generate average blood flow through a percutaneous insertion during complex revascularization procedures.

Our primary Thoratec Products' competitors include AbioMed, Inc. and HeartWare International, Inc.
 

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Competition

The medical device market is intensely competitive and is characterized by extensive research and development and rapid technological change. Our customers consider many factors when choosing suppliers, including product reliability, clinical outcomes, product enhancements, breadth of product portfolio, pricing and product services provided by the manufacturer and product availability. As a result, market share can shift as a result of technological innovation and other business factors. Major shifts in industry market share have also occurred in connection with product problems, physician advisories and safety alerts, reflecting the importance of product quality in the medical device industry, and any quality problems with our processes, goods and services could harm our reputation for producing high-quality products and erode our competitive advantage, sales and market share. Our competitors range from small start-up companies to larger companies that have significantly greater resources and broader product offerings than us, and we anticipate that in the coming years, other small and large companies will enter certain markets in which we currently hold a strong position. Furthermore, our industry has experienced significant consolidation in recent years. Certain of our competitors have been able to expand their portfolio of products and services through this consolidation process, and they are able to offer customers a broader array of products and services than we can thereby, in some instances, providing them a competitive advantage in the market. In addition, we expect that competition will continue to intensify and we have seen increasing price competition as a result of managed care, consolidation among healthcare providers, increased competition and declining reimbursement rates. Product introductions or enhancements by competitors that have advanced technology, better features and/or lower pricing may make our products or proposed products obsolete or less competitive. Some of our product categories, such as the neurostimulation therapies and structural heart defect devices, have higher barriers to entry due to the long and expensive product development and/or regulatory approval process as well as certain existing intellectual property and patent positions. Other companies, however, may be able to enter these markets by leveraging their existing medical device capabilities, thereby decreasing the time and resources required to enter a certain market.
Government Regulation
The development, manufacturing and marketing of our products is subject to extensive and rigorous regulation by government agencies, both within and outside the United States, including but not limited to the Food and Drug Administration (FDA) and the relevant authorities in the member states of the European Union (EU Member States). In the United States, the Federal Food, Drug and Cosmetic Act (FDCA) and FDA regulations govern the composition, labeling, testing, clinical study, manufacturing, packaging, marketing and distribution of medical devices.
Unless exempt, all medical devices must receive FDA clearance or approval before they can be commercially marketed in the United States. Class III devices, such as life-sustaining, life-supporting or implantable devices, require the submission and approval of a pre-market approval (PMA) application demonstrating that the new medical device is safe and effective for its intended use. For certain class I and class II devices that pose less risk, manufacturers must submit a pre-market notification to the FDA. The notification process, which is generally known as 510(k) clearance, requires manufacturers to demonstrate that the medical device is substantially equivalent to a legally marketed medical device. Premarket notification is also required if a manufacturer makes certain modifications to an already marketed 510(k) device. Human clinical data submitted to the FDA in a 510(k) or PMA must be gathered in compliance with the FDA Good Clinical Practice regulations. Our vascular closure devices, mechanical and tissue heart valves, ICDs, pacemakers and certain leads, neurostimulation devices and EP catheter applications require a PMA application or supplement to a PMA. Other leads and lead delivery tools, annuloplasty ring products, other neurostimulation devices and other EP and cardiology products are currently marketed under the less rigorous 510(k) pre-market notification procedure.

Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations. These include, but are not limited to:

Establishment registration and product listing requirements;
Quality System Regulation (QSR) requires manufacturers, including third-party manufacturers, to follow stringent design, testing, documentation and other quality assurance procedures during product design and throughout the manufacturing process;
Labeling regulations and FDA prohibitions against the promotion of products for uncleared, unapproved or off-label uses and against making false and misleading product claims; and

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Medical device reporting regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur.

The FDA has broad post-market and regulatory enforcement powers. We are subject to unannounced inspections by the FDA to determine our compliance with the QSR and other regulations. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following sanctions:

Fines, injunctions, consent decrees and civil penalties;
Recall or seizure of our products;
Operating restrictions, partial suspension or total shutdown of production;
Refusing our requests for 510(k) clearance or PMA of new products or new intended uses;
Refusing to provide documents needed to export products;
Withdrawing 510(k) clearance or PMAs that are already granted; and
Criminal prosecution.

The FDA also has the authority to require us to repair, replace or refund the cost of any medical device that we have manufactured or distributed.

Our international business is subject to foreign medical device laws. Most major markets for medical devices outside the United States require clearance, approval or compliance with certain standards before a product can be commercially marketed. The applicable laws range from extensive device approval requirements in some countries for all or some of our products, to requests for data or certifications in other countries. In the European Union, all medical devices must be CE-marked. The CE-mark represents a declaration by the manufacturer of the product that the product conforms to all relevant European regulatory requirements, including those relating to safety and performance. For devices categorized as medium- or high-risk devices, European legislation requires the use of a notified body to carry out a compliance assessment before manufacturers can place their products on the market. A “notified body” is an independent certification body that uses a series of independent criteria to evaluate a manufacturer’s compliance with the technical requirements of the relevant legislation. Each notified body is appointed and supervised by a national governmental authority in the European Union (a “competent authority”). The regulatory systems of the EU Member States have been harmonized so that a medical device that is CE-marked can be sold anywhere within the European Union. However, any national health authority can raise public health concerns and take appropriate measures to protect public health. Increasingly, notified bodies and competent authorities in EU Member States coordinate supervision and enforcement of medical device regulations. In the European Union, we are also required to maintain certain International Organization for Standardization (ISO) certifications in order to sell products, and we undergo periodic inspections by notified bodies to obtain and maintain these certifications.

Our products are purchased principally by healthcare providers that typically bill various third-party payors, such as governmental programs, private insurance plans and managed care plans for the healthcare services provided to their patients. Reimbursement varies from country to country and can significantly impact the acceptance of new technology. In the United States, Medicare payment to providers is based on prospective rates set by the Centers for Medicare and Medicaid Services (CMS). CMS uses separate Prospective Payment Systems for reimbursement to acute inpatient hospitals, hospital outpatient departments, and ambulatory surgery centers (ASCs). Diagnosis-related group (DRG) and Ambulatory Payment Classification (APC) reimbursement schedules dictate the amount that CMS will reimburse hospitals for care of persons covered by Medicare. In response to rising Medicare and Medicaid costs, from time to time Congress and state legislatures consider legislation to restrict funding for these programs and reduce federal payments to hospitals and other providers. For example, federal healthcare reform legislation enacted in 2010 mandated reductions in reimbursement to hospitals and ASCs, including a cut in the annual inflation increase in reimbursement rates. Reduced funding to Medicare and other federal healthcare programs could have an adverse effect on market demand and our domestic pricing flexibility.

More generally, major third-party payors for hospital services in the United States and abroad continue to work to contain healthcare costs. The introduction of cost containment incentives, combined with closer scrutiny of healthcare expenditures by both private health insurers and employers, has resulted in increased discounts and contractual adjustments to hospital charges for services performed and in the shifting of services from the inpatient to the outpatient setting. From time to time, initiatives to limit the growth of healthcare costs, including price

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regulation, are implemented in countries in which we do business. Implementation of healthcare reform in the United States and in significant overseas markets may limit the reimbursement for our products.

As a medical device company, St. Jude Medical’s operations and interactions with providers such as hospitals and healthcare professionals are subject to extensive regulation by various federal, state, and local government entities. For example, the federal False Claims Act provides, in part, that the federal government may bring a lawsuit against any person or entity that it believes has knowingly presented, or caused to be presented, a false or fraudulent request for payment to the government, or has made or used, or caused to be made or used, a false statement or false record material to a false claim. A violation of the False Claims Act could result in fines up to $11,000 (as adjusted for inflation) for each false claim, plus up to three times the amount of damages sustained by the government. A False Claims Act violation may also provide the basis for the imposition of administrative penalties and exclusion from participation in federal healthcare programs. Most states have enacted false claims acts that are similar to the federal False Claims Act.

The federal Anti-Kickback Statute (AKS) prohibits an entity such as St. Jude Medical from knowingly and willfully offering or paying remuneration, directly or indirectly, to induce any other person or entity (such as a hospital, physician, or other purchasers of medical products) to purchase, prescribe, arrange for or recommend products such as ours that are covered by federal healthcare programs. A violation of the AKS constitutes a felony offense punishable by imprisonment and civil and criminal fines. A violation also can result in exclusion from federal healthcare programs. Many states and foreign countries have enacted similar anti-kickback laws, some of which may apply regardless of the patient’s payor source.

As a manufacturer of FDA-approved devices reimbursable by federal healthcare programs, we are subject to the Physician Payments Sunshine Act, which requires us to report annually to CMS certain payments and other transfers of value we make to U.S.-licensed physicians or U.S. teaching hospitals. Failure to comply with the Physician Payments Sunshine Act can result in a maximum annual penalty up to $150,000, or $1 million for knowing failures to report.

In addition, federal and state laws have also been enacted to protect the confidentiality of certain patient health information, including patient records, and restrict the unauthorized use and disclosure of this information. In particular, the Health Insurance Portability and Accountability Act of 1996 (HIPAA), as amended by the Health Information Technology for Economic and Clinical Health Act (HITECH), and their implementing regulations (collectively, HIPAA Standards), govern the use and disclosure of protected health information by “covered entities,” which are healthcare providers that submit electronic claims, health plans and healthcare clearinghouses, as well as their "business associates" and their subcontractors. Our employee health benefit plans are considered “covered entities” and, therefore, are subject to the HIPAA Standards.

Additionally, we may function as a “business associate” in our commercial arrangements with healthcare providers using our Merlin.net™ Patient Care Network System or using the CardioMEMS™ product and, in this capacity, may be subject to the HIPAA Standards. Violations of the HIPAA Standards are punishable by civil penalties up to an annual limit of $1.5 million for all identical violations and criminal penalties up to an annual limit of $250,000 and ten years’ imprisonment for certain knowing violations. Failure to comply with any state or foreign laws regarding personal data protection may also result in significant fines or penalties, lawsuits, costs associated with mitigating any privacy or security breach, and/or negative publicity.

In some jurisdictions, there are laws, regulations and guidance that regulate the use of certain animal material in medical devices because of concerns about Transmissible Spongiform Encephalopathy (TSE), such as Bovine Spongiform Encephalopathy, which is sometimes referred to as “mad cow disease”, a disease which has sometimes been transmitted to humans through the consumption of beef. We are not aware of any reported cases of transmission of TSE through medical products. Nonetheless, some medical device regulatory agencies have considered and are considering whether to continue to permit the sale of medical devices that incorporate certain animal material. Some of our products such as Angio-Seal™ use bovine collagen. In addition, some of the tissue heart valves we market incorporate bovine and porcine pericardial material.

International Operations
The principal geographic markets for our products are the United States, Europe and Japan. Refer to the Results of Operations section in Item 7. "Management's Discussion and Analysis Results of Operations" for a detail of our net

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sales by region and a discussion of their related results. No individual international-based country has a significant amount of long-lived assets.
Our international business is subject to special risks such as: foreign currency exchange controls and fluctuations; the imposition of or increase in import or export duties, surtaxes, tariffs or customs duties; the imposition of import or export quotas or other trade restrictions; foreign tax laws and increased costs associated with overlapping tax structures; longer accounts receivable cycles; and other international regulatory, economic, legal and political problems. These risks are further described in Item 1A., "Risk Factors." Currency exchange rate fluctuations relative to the U.S. Dollar can affect our reported consolidated results of operations and financial position. See Item 7A., "Qualitative and Quantitative Disclosures About Market Risk" for further information, including a discussion of our hedging program, that helps mitigate some of these foreign currency exchange rate risks.
Business Combinations and Investments
In addition to generating growth internally through our own research and development (R&D) and sales activities, we also make strategic acquisitions and investments from time to time to access new technologies, therapy areas and geographies. We expect to continue to make acquisitions and investments in future periods to strengthen our business. Refer to Note 2 to the Consolidated Financial Statements within Item 8. “Financial Statement and Supplementary Data” for additional information relating to acquisitions made in recent periods.
Seasonality
Our quarterly net sales are influenced by many factors, including new product introductions, acquisitions, regulatory approvals, patient and physician holiday schedules and other factors. Net sales in the third quarter are typically lower than other quarters of the year as a result of patient tendencies to defer, if possible, procedures during the summer months and from the seasonality of the U.S. and European markets, where summer vacation schedules normally result in fewer procedures.
Marketing and Distribution
Our products are sold in more than 100 countries throughout the world. No distributor organization or single customer accounted for more than 10% of our 2015, 2014 or 2013 consolidated net sales.
In the United States and Canada, we sell directly to healthcare providers primarily through a direct sales force. In Europe, we have direct sales organizations in 21 different countries, selling throughout Europe, the Middle East and Africa. In Japan, we sell directly to healthcare providers through a direct sales force, and we continue to use longstanding independent distributor relationships. In Asia Pacific, we have direct sales organizations in 10 different countries. In Latin America, we have direct sales organizations in five different countries. Some of our direct sales in Asia Pacific and Latin America also include sales to independent distributors. Throughout the rest of the world, we use a combination of direct sales forces and independent distributors.
Group purchasing organizations (GPO), independent delivery networks (IDN) and large single accounts such as the Veterans Administration in the United States continue to consolidate purchasing decisions for some of our healthcare provider customers. We have contracts in place with many of these organizations. In some circumstances, our inability to obtain a contract with a GPO or IDN could adversely affect our efforts to sell products to a particular healthcare provider.
Research and Development
Our R&D expenses were $676 million in 2015, $692 million in 2014 and $691 million in 2013. Our investment in R&D reflects our commitment to fund long-term growth opportunities while balancing short-term results. The markets in which we participate are dynamic and competitive. Our ongoing commitment to R&D investments is intended to provide patients with positive outcomes and innovation that will shape the markets in which we participate. Our R&D activities primarily include research, development, clinical and regulatory efforts. These efforts are primarily focused on product innovation that we anticipate will ultimately improve patient outcomes, reduce overall healthcare costs and provide economic value to our customers while providing the best possible technology available. Our most significant clinical trials as of January 2, 2016 are summarized as follows:

Portico Re-sheathable Transcatheter Aortic Valve System US IDE Trial: The objective of this clinical trial is to evaluate the safety and effectiveness of the Portico Transcatheter Heart Valve and Delivery Systems (Portico) via transfemoral and alternative delivery methods. The clinical study will analyze the high risk

9


cohort and extreme risk cohort together against a commercially available control for the primary safety and effectiveness endpoints.
Thoratec Corporation MOMENTUM 3, Multi-center Study of MagLev Technology in Patients Undergoing MCS Therapy With HeartMate 3™ (HM3) IDE Clinical Study Protocol: The objective of this clinical study is to evaluate the safety and effectiveness of the HM3 Left Ventricular Assist System (LVAS) by demonstrating non-inferiority to the HeartMate 2 (HMII) LVAS when used for the treatment of advanced, refractory, left ventricular HF. The HM3 LVAS is intended to provide hemodynamic support in patients with advanced, refractory left ventricular HF; either for short term support, such as a bridge to cardiac transplantation or myocardial recovery, or as long term support, such as destination therapy. The HM3 is intended for use inside or outside the hospital.
Thoratec Corporation HeartMate PHP™ Coronary InterventionS in HIgh-Risk PatiEnts Using a Novel Percutaneous Left Ventricular Support Device (SHIELD II) study protocol: The HeartMate PHP™ System is a temporary (less than 6 hour procedure) ventricular assist device indicated for use during high risk percutaneous coronary interventions (PCI) performed in elective or urgent, hemodynamically stable patients with severe coronary artery disease and depressed left ventricular ejection fraction. The trial objective is to assess the safety and efficacy of the HeartMate PHP™ in supporting patients with severe symptomatic coronary artery disease with diminished but stable cardiovascular function, who are undergoing elective or urgent high risk percutaneous coronary interventions (PCI) but are not candidates for coronary artery bypass graft (CABG) surgery. The trial is designed as a prospective, randomized, multi-center, open-label non-inferiority trial in the U.S. comparing HeartMate PHP™ to Abiomed® Impella® 2.5 percutaneous cardiac support system.
Patents, Licenses and Trademarks
Our policy is to protect our intellectual property rights related to our medical devices. Where appropriate, we apply for U.S. and foreign patents. We own or hold licenses to numerous U.S. and foreign patents. U.S. patents are typically granted for a term of twenty years from the date a patent application is filed. The actual protection afforded by a foreign patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country. In those instances where we have acquired technology from third parties, we have sought to obtain rights of ownership to the technology through the acquisition of underlying patents or licenses.
We also have obtained certain trademarks and tradenames for our products to distinguish our products from our competitors’ products. U.S. trademark registrations are for a term of ten years and are renewable every ten years as long as the trademarks are used in the regular course of trade. We register our trademarks in the U.S. and in a number of countries where we do business.
While we believe design, development, clinical and regulatory aspects of the medical device business represent the principal barriers to entry, we also rely on our patents, trade secrets, exclusive and non-exclusive license rights and non-disclosure and non-competition agreements to make it more difficult for competitors to market products similar to those we produce. Therefore, we also believe our patents and other intellectual property provide an important competitive advantage to our business.
We can give no assurance that any of our patent rights, whether issued, subject to license or in process, will not be circumvented or invalidated. Furthermore, there are numerous existing and pending patents on medical products and biomaterials. There can be no assurance that our existing or planned products do not or will not infringe such rights or that others will not claim such infringement. Our industry has extensive ongoing patent litigation which can lead to significant legal costs for indeterminate periods of time, injunctions against the manufacture or sale of infringing products and significant royalty payments. At any given time, we may be a plaintiff or defendant in such an action. No assurance can be given that we will be able to prevent competitors from challenging our patents or entering markets we currently serve.
Suppliers
We purchase raw materials and other products from numerous suppliers. Our manufacturing requirements comply with the rules and regulations of the FDA and comparable agencies in foreign countries, which mandate validation of materials prior to use in our products. We purchase certain supplies used in our manufacturing processes from single sources due to quality considerations, costs or constraints resulting from regulatory requirements. Agreements with certain suppliers are terminable by either party upon short notice, and we have been advised periodically by some suppliers that, in an effort to reduce their potential product liability exposure, they may terminate sales of products to customers that manufacture implantable medical devices. While some of these

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suppliers have modified their positions and have indicated a willingness to continue to provide a product temporarily until an alternative vendor or product can be qualified (or even to reconsider the supply relationship), where a particular single-source supply relationship is terminated, we may not be able to establish additional or replacement suppliers for certain components or materials quickly. A reduction or interruption by a sole-source supplier of the supply of materials or key components used in the manufacturing of our products or an increase in the price of those materials or components could adversely affect our business, financial condition and results of operations.
Product Liability
The design, manufacture and sale of our medical devices entail an inherent risk of product liability claims. Our products are often used in intensive care settings with seriously ill patients, and many of the medical devices we manufacture and sell are designed to be implanted in the human body for long periods of time or indefinitely. There are a number of factors that could result in an unsafe condition or injury to, or death of, a patient with respect to these or other products which we manufacture or sell, including component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information. Product liability claims may be brought by individuals or by groups seeking to represent a class.
Insurance
Consistent with industry practice, we do not currently maintain or intend to maintain any insurance policies with respect to product liability in the future. We believe that our self-insurance program, which is based on historical loss trends, will be adequate to cover future losses, although we can provide no assurances that this will remain true as historical trends may not be indicative of future losses. These losses could have a material adverse impact on our consolidated earnings, financial condition or cash flows.
Our facilities could be materially damaged by earthquakes, hurricanes and other natural disasters or catastrophic circumstances. Earthquake insurance is currently difficult to obtain, extremely costly, and restrictive with respect to scope of coverage. We do not currently maintain or intend to maintain earthquake insurance. Consequently, we could incur uninsured losses and liabilities arising from an earthquake near our California, Puerto Rico or Costa Rica facilities as a result of various factors, including the severity and location of the earthquake, the extent of any damage to our facilities, the impact of an earthquake on our workforce and on the infrastructure of the surrounding communities and the extent of damage to our inventory and work in process. These losses could have a material adverse effect on our business for an indeterminate period. Furthermore, our manufacturing facilities in Puerto Rico and Malaysia may suffer damage as a result of hurricanes and could result in lost production and additional expenses to us to the extent any such damage is not fully covered by our hurricane and business interruption insurance.
Employees
As of January 2, 2016, we had approximately 18,000 employees worldwide. Our employees are not represented by any labor organizations, with the exception of a limited number of employees in Europe and Brazil. We have never experienced a work stoppage as a result of labor disputes. We believe that our relationship with our employees is generally good.
Executive Officers of the Registrant
The following is a list of our executive officers as of February 19, 2016. For the present position, the date in parentheses indicates the year during which each executive officer began serving in such capacity.
Name
 
Age
 
Present Position
Other Positions Held 2011-2015
Michael T. Rousseau
 
60
 
President and Chief Executive Officer (2016)
Chief Operating Officer (2014-2015)
 
 
 
 
 
Group President, Cardiovascular and Ablation Technologies Division, Implantable Electronic Systems Division and U.S. Division (2012-2014)
 
 
 
 
 
Group President, Cardiac Rhythm Management Division, Neuromodulation Division, Atrial Fibrillation Division, Cardiovascular Division and U.S. Division (2009-2012)

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Daniel J. Starks
 
61
 
Executive Chairman of the Board (2016)
Chairman (2004-2015), President (2001-2015) and Chief Executive Officer (2004-2015)
John C. Heinmiller
 
61
 
Executive Vice President (2004)
Chief Financial Officer (1998-2012)
Lisa M. Andrade
 
44
 
Vice President, Chief Marketing Officer (2014)
Senior Vice President, Global Strategy and Market Development (2013-2014)
 
 
 
 
 
Senior Vice President, Marketing, U.S. Division (2011-2013)
 
 
 
 
 
Vice President, Education and Market Development, U.S. Division (2011)
 
 
 
 
 
Vice President, Connectivity, U.S. Division (2010-2011)
I. Paul Bae
 
51
 
Vice President, Global Human Resources (2015) and Chief Compliance Officer (2012)
Deputy General Counsel, Labor and Employment (2012-2015)
 
 
 
 
 
Senior Vice President, Administration and General Counsel, Americas Division (2009-2012)
Joel D. Becker
 
48
 
President, Americas Division (2014)
President, U.S. Division (2011-2014)
 
 
 
 
 
Senior Vice President, Marketing, U.S. Division (2011)
 
 
 
 
 
Vice President, Program Management & Business Development, Atrial Fibrillation Division (2004-2011)
Mark D. Carlson, M.D.
 
60
 
Vice President, Global Clinical Affairs and Chief Medical Officer (2013)
Chief Medical Officer and Senior Vice President, Research and Clinical Affairs, Implantable Electronic Systems Division (2012-2013)
 
 
 
 
 
Chief Medical Officer and Senior Vice President, Research and Clinical Affairs, Cardiac Rhythm Management Division (2007-2012)
Jeffrey A. Dallager
 
41
 
Vice President and Corporate Controller (2014)
Senior Vice President, Finance and Supply Chain, International Division (2012-2014)
 
 
 
 
 
Senior Vice President, Finance, U.S. Division (2009-2012)
Philip J. Ebeling
 
45
 
Vice President, Chief Technology Officer (2016)
Senior Vice President, Research and Development (2014-2015)
 
 
 
 
 
Senior Vice President, Research and Development, Cardiovascular and Ablation Technologies Division (2012-2014)
 
 
 
 
 
Vice President, Research and Development, Cardiovascular Division (2011-2012)
Rachel H. Ellingson
 
46
 
Vice President, Corporate Strategy (2016)
Vice President, Global Communications (2014-2015)
 
 
 
 
 
Vice President, Corporate Relations (2012-2014)
 
 
 
 
 
Vice President, Corporate Communications and Investor Relations (2011-2012)
Eric S. Fain, M.D.
 
55
 
Group President (2014)
President, Implantable Electronic Systems Division (2012-2014)
 
 
 
 
 
President, Cardiac Rhythm Management Division (2007-2012)
Jeff A. Fecho
 
55
 
Vice President, Global Quality (2012)
Vice President, Quality, Cardiovascular Division (2008-2012)
Denis M. Gestin
 
52
 
President, International Division (2008)
 

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Mark W. Murphy
 
47
 
Vice President, Information Technology and Chief Information Officer (2013)
Senior Director, Enterprise Applications (2009-2013)
Scott P. Thome
 
53
 
Vice President, Global Operations and Supply Chain (2014)
Senior Vice President, Cardiovascular and Ablation Technologies Division (2012-2014)
 
 
 
 
 
Senior Vice President, Cardiovascular Division (2010-2012)
Jason A. Zellers
 
50
 
Vice President, General Counsel and Corporate Secretary (2011)
Vice President, General Counsel, International Division (2006-2011)
Donald J. Zurbay
 
48
 
Vice President, Finance (2006) and Chief Financial Officer (2012)
Corporate Controller (2006-2012)



Item 1A.
RISK FACTORS
Our business faces many risks. Any of the risks discussed below, or elsewhere in this Form 10-K or our other SEC filings, could have a material impact on our business, financial condition or results of operations.
We face intense competition and may not be able to keep pace with the rapid technological changes in the medical devices industry.
The medical device market is intensely competitive and is characterized by extensive research and development and rapid technological change. Our customers consider many factors when choosing suppliers, including product reliability, clinical outcomes, breadth of product portfolio, price and product services provided by the manufacturer, product availability and market share can shift as a result of technological innovation and other business factors. Major shifts in industry market share have occurred in connection with product problems, physician advisories and safety alerts, reflecting the importance of product quality in the medical device industry, and any quality problems with our processes, goods and services could harm our reputation for producing high-quality products and erode our competitive advantage, sales and market share. Our competitors range from small start-up companies to larger companies which have significantly greater resources and broader product offerings than us, and we anticipate that in the coming years, other large companies will enter certain markets in which we currently hold a strong position. Furthermore, our industry has experienced significant consolidation in recent years. Certain of our competitors have been able to expand their portfolio of products and services through this consolidation process, and they are able to offer customers a broader array of products and services than we can, thereby, in some instances, providing them a competitive advantage in the market. In addition, we expect that competition will continue to intensify with increasing price competition as a result of managed care, consolidation among healthcare providers, increased competition and declining reimbursement rates. Product introductions or enhancements by competitors which have advanced technology, better features or lower pricing may make our products or proposed products obsolete or less competitive. As a result, we will be required to devote continued efforts and financial resources to bring our products under development to market, enhance our existing products and develop new products for the medical marketplace. If we fail to develop new products, enhance existing products or compete effectively, our business, financial condition and results of operations will be adversely affected.
Consolidation in the healthcare industry could lead to demands for price concessions or limit or eliminate our ability to sell to certain of our significant market segments.
The cost of healthcare has risen significantly over the past decade and numerous initiatives and reforms initiated by legislators, regulators and third-party payors to curb these costs have resulted in a consolidation trend in the medical device industry, as well as among our customers, including healthcare providers. This, in turn, has resulted in greater pricing pressures and limitations on our ability to sell to important market segments, as group purchasing organizations, independent delivery networks and large single accounts, such as the Veterans Administration in the United States, continue to consolidate purchasing decisions for some of our healthcare provider customers. We expect that market demand, government regulation, third-party reimbursement policies and societal pressures will continue to change the worldwide healthcare industry, resulting in further business consolidations and alliances that may exert further downward pressure on our product prices and adversely impact our business, financial condition and results of operations.


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We are subject to stringent domestic and foreign medical device regulation and any adverse regulatory action may materially adversely affect our financial condition and business operations.

We are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. To varying degrees, each of these authorities monitors and enforces our compliance with laws and regulations governing the development, testing, clinical study, manufacturing, labeling, packaging, marketing and distribution of our medical devices. These laws and regulations are subject to change and to evolving interpretations which could increase costs, prevent or delay future device clearance or approvals, or otherwise adversely affect our ability to market currently cleared or approved devices. The process of obtaining marketing approval or clearance from the FDA and comparable foreign bodies for new products, or for enhancements or modifications to existing products, could:

take a significant amount of time,
require the expenditure of substantial resources,
involve rigorous pre-clinical and clinical testing, as well as increased post-market surveillance,
involve modifications, repairs or replacements of our products, and
result in limitations on the indicated uses of our products.

We cannot be certain that new medical devices or new uses for existing medical devices will be cleared or approved by the FDA or foreign regulatory agencies in a timely or cost-effective manner, if cleared or approved at all. In addition, the FDA may require post-market testing and surveillance and may, depending on the results, prevent or limit further marketing of products. The failure to receive approval or clearance for significant new products or modifications to existing products or the receipt of an approval of limited or reduced scope could have a material adverse effect on our financial condition and results of operations.

Both before and after a product is commercially released, we have ongoing responsibilities under the FDCA and FDA regulations, which govern virtually all aspects of a medical device’s design, development, testing, manufacturing, labeling, storage, record keeping, adverse event reporting, sale, promotion, distribution and shipping. Compliance with applicable statutory and regulatory requirements is subject to continual review and is monitored rigorously through periodic inspections by the FDA, which may result in observations on Form 483, and in some cases warning letters, that require corrective action. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could:

require us to notify health professionals and others that the devices present unreasonable risk of substantial harm to public health;
order us to recall, repair, replace or refund the cost of any medical device that we manufactured or distributed;
detain, seize or ban adulterated or misbranded medical devices;
refuse to provide us with documents necessary to export our products;
refuse requests for 510(k) clearance or PMA of new products or new intended uses;
withdraw 510(k) clearances or PMAs that are already granted;
impose operating restrictions, including requiring a partial or total shutdown of production;
enjoin or restrain conduct resulting in violations of applicable law pertaining to medical devices; and/or
assess criminal or civil penalties against us or our officers and employees.

Any adverse regulatory action, depending on its magnitude, may restrict us from effectively manufacturing, marketing and selling our products. In addition, negative publicity and product liability claims resulting from any adverse regulatory action could have a material adverse effect on our financial condition and results of operations.

In addition, the FDCA permits device manufacturers to promote products solely for the uses and indications set forth in the approved product labeling. The U.S. Department of Justice has initiated a number of enforcement actions against manufacturers that promote products for “off-label” uses, alleging, among other things, that “off-label” promotion caused the submission of false and fraudulent claims for reimbursement to federal health care programs in violation of the Federal False Claims Act. Government enforcement action can result in substantial fines, penalties, and/or administrative remedies, including exclusion from government reimbursement programs and entry into Corporate Integrity Agreements (CIAs) with governmental agencies entailing significant additional obligations and costs.


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Foreign governmental regulations have become increasingly stringent and more common, and we may become subject to even more rigorous regulation by foreign governmental authorities in the future. Changes in clearance, approvals or standards that must be complied with prior to commercial marketing or the enactment of additional laws or regulations may cause delays in or prevent the marketing of a product. Penalties for a company's noncompliance with foreign governmental regulation could be severe, including revocation or suspension of a company's business license and criminal sanctions. Any domestic or foreign governmental medical device law or regulation imposed in the future may have a material adverse effect on our financial condition and business operations.

Our business, financial condition, results of operations and cash flows could be significantly and adversely affected by recent healthcare reform legislation and other administration and legislative proposals.

The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act (collectively PPACA), was enacted into law in 2010. As a U.S.-headquartered company with significant sales in the United States, this healthcare reform law has had, and is expected to continue to have, a material impact on us and on the U.S. healthcare system, more generally. Beginning in 2013, the law levied a 2.3% excise tax on the majority of our U.S. medical device sales, which has materially impacted our cash flows and results of operations, although H.R. 2029, signed into law in December 2015, placed a moratorium on this tax in 2016 and 2017. Additionally, the law reduced the annual rate of inflation for Medicare payments to hospitals and called for the establishment of the Independent Payment Advisory Board to recommend strategies for reducing growth in Medicare spending. The law also focused on a number of Medicare provisions aimed at improving quality and decreasing costs, such as 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). It is uncertain at this point what consequences these provisions may have on potentially limiting patient access to new technologies. We cannot predict what future healthcare legislation will be implemented at the federal or state level, nor 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.

In addition, general instability in the federal budget may also lead to legislation that could result in cuts in Medicare and Medicaid reimbursement. In recent years, the government has enacted a variety of appropriations legislation to temporarily suspend the debt ceiling and continue government operations. While Congress has been taking temporary spending measures, many members of Congress have made public statements indicating that budget-related deadlines should be used as leverage to negotiate additional cuts in federal spending, and the Medicare program is frequently mentioned as a target for spending cuts.

Our failure to comply with requirements and/or restrictions relating to reimbursement and regulation of healthcare goods and services may subject us to penalties and adversely affect our financial condition and results of operations.

As a medical device company, our operations and interactions with healthcare providers such as hospitals and healthcare professionals are subject to extensive regulation by various federal, state and local government entities. Failure to comply with such laws and regulations could result in substantial penalties and adversely affect our financial condition and results of operations. For example, in the United States, federal laws and regulations prohibit the filing of false or improper claims for payment by federal healthcare programs (the federal False Claims Act) and unlawful inducements for the referral of business reimbursable by federal healthcare programs (the federal AKS), require disclosure of payments or other transfers of value made to U.S.-licensed physicians and teaching hospitals (the federal Physician Payments Sunshine Act), and regulate the use and disclosure of protected health information (the federal HIPAA Standards). Additionally, many states have enacted similar laws that may impose more stringent requirements. Foreign governments also impose regulations in connection with their healthcare reimbursement programs and the delivery of healthcare goods and services. If a governmental authority were to conclude that we are not in compliance with applicable laws and regulations, we and our officers and employees could be subject to severe criminal and civil penalties, including, for example, exclusion from participation in federal healthcare programs, including Medicare and Medicaid. Such fines and potential exclusion could adversely affect our financial condition and results of operations.


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The medical device industry and its customers are often the subject of governmental investigations into marketing and other business practices.

We are subject to extensive and stringent regulation by the FDA, the Office of Inspector General for the Department of Health and Human Services, the Department of Justice and other federal, state and foreign governmental authorities, who have been increasing their scrutiny of the medical device industry in recent years. Much of the regulatory scrutiny concerns medical device companies' promotional practices and relationships and financial arrangements with health care providers. Investigations against us could result in the commencement of civil and/or criminal proceedings, substantial fines, penalties and/or administrative remedies, the imposition of additional and costly compliance obligations and the diversion of management's attention from the day-to-day operations of the business, any of which could have an adverse effect on our financial condition and results of operations. In addition, investigations of our customers may adversely affect the size of our markets.

Changes in tax laws or exposure to additional income tax liabilities could have a material impact on our financial condition and results of operations.

We are subject to income taxes as well as non-income based taxes, in both the United States and various foreign jurisdictions. We are subject to ongoing tax audits in various jurisdictions. Tax authorities may disagree with certain positions we have taken, such as interpretations as to the legality of tax advantages granted under the European Union state aid rules, and assess additional taxes. The outcomes of these audits could have a material impact on our results of operations and financial condition. Our operations in Puerto Rico, Costa Rica and Malaysia presently benefit from various tax incentive grants. Unless these grants are extended, they will expire between 2018 and 2026. If we are unable to renew, extend, or obtain new tax incentive grants, the expiration of existing tax incentive grants could have a material impact on our financial results in future periods. Additionally, changes in tax laws or tax rulings could materially impact our effective tax rate. For example, proposals for fundamental U.S. international tax reform, such as past or current proposals by the Obama administration, if enacted, could have a significant adverse impact on our future results of operations. In addition, the enactment of the PPACA levied a 2.3% excise tax on the majority of our U.S. medical device sales, although H.R. 2029, signed into law in December 2015, placed a moratorium on this tax in 2016 and 2017.
Instability in international markets or foreign currency fluctuations could adversely affect our results of operations.
We generate a significant amount of revenue from outside the United States. Our products are currently marketed in more than 100 countries around the world, with our largest geographic markets outside of the United States being Europe and Japan. As a result, we face currency and other risks associated with our international sales. We are exposed to foreign currency exchange rate fluctuations due to transactions denominated primarily in Euros, Japanese Yen and other foreign currencies, which may potentially reduce the U.S. Dollars we receive for sales denominated in any of these foreign currencies and/or increase the U.S. Dollars we report as expenses in these currencies, thereby affecting our consolidated results of operations. Fluctuations between the currencies in which we do business have caused and will continue to cause foreign currency transaction gains and losses. We cannot predict the effects of currency exchange rate fluctuations upon our future operating results because of the number of currencies involved, the variability of currency exposures and the volatility of currency exchange rates. The hedging strategy we initiated in 2015 in an effort to mitigate the effects of currency exchange rate volatility may not be effective.
In addition to foreign currency exchange rate fluctuations, there are a number of additional risks associated with our international operations, including those related to:
the imposition of or increase in import or export duties, surtaxes, tariffs or customs duties;
the imposition of import or export quotas or other trade restrictions;
foreign tax laws and potential increased costs associated with overlapping tax structures;
compliance with various U.S. and foreign laws, including the Foreign Corrupt Practices Act, the UK Anti-Bribery Act and import/export laws;
longer accounts receivable cycles in certain foreign countries, whether due to cultural, economic or other factors;
changes in medical reimbursement programs and regulatory requirements in international markets in which we operate; and

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economic and political instability in international markets, including concerns over excessive levels of sovereign debt and budget deficits in countries where we market our products that could result in an inability to pay or timely pay outstanding payables.

Economic conditions could adversely affect our results of operations.

Instability in the global economy and financial markets can affect our business through its effects on general levels of economic activity, employment and customer behavior. The rate of recovery from the recent recession in the United States and other markets has been slower than historical economic recovery periods. Central Banks around the world may move to tighten monetary conditions in an attempt to control inflation. Reductions in federal spending in the United States over the next decade (e.g. sequestration) could result in cuts to, and restructuring of, entitlement programs such as Medicare and aid to states for Medicaid programs. Our hospital customers rely heavily on Medicare and Medicaid programs to fund their operations. Any cuts to these programs could negatively affect the business of our customers and our business. As a result of poor economic conditions, our customers may experience financial difficulties or be unable to borrow money to fund their operations, which may adversely impact their ability or decision to purchase our products or to pay for products they purchase on a timely basis, if at all. While the economic environment has begun to show signs of improvement, the strength and timing of any economic recovery remains uncertain, and we cannot predict to what extent the global economic slowdown may negatively impact our net sales, average selling prices, profit margins, procedural volumes and reimbursement rates from third party payors. In addition, adverse economic conditions may affect our suppliers, leading them to experience financial difficulties or to be unable to borrow money to fund their operations, which could cause disruptions in our ability to produce our products.

We continue to experience longer collection cycles for trade receivables in certain European member states, particularly in Southern Europe. Additional negative economic disruptions and slowdowns in Europe may result in us not fully collecting these receivables, adversely affecting our cash flows, financial position and results of operations. Additional prolongation of the economic disruptions in Europe may negatively impact reimbursement rates and procedural volumes and adversely affect our business and results of operations.

We may not realize the expected benefits from our restructuring initiatives and continuous improvement efforts, and they may result in unintended adverse impacts to our business.

We have made changes to our organizational structure to better position us for the evolving competitive, regulatory and economic environments in which we operate. These changes have included, among others, combining our several operating divisions into a single division, resulting in an integrated research and development organization and a consolidation of manufacturing and supply chain operations worldwide; centralization of certain support functions, including information technology, human resources, legal, business development and certain marketing functions; streamlining distribution methods; rationalizing plant utilization levels; and consolidating vendor relationships. We also have made decisions regarding the programs and initiatives we will prioritize to strengthen our strategic focus.

While these changes were part of a comprehensive plan to, among other things, accelerate our growth, leverage economies of scale, drive process improvements through global synergies, balance plant utilization levels, centralize certain vendor relationships, reduce overall costs and streamline distribution methods, we may not realize the expected benefits of our restructuring initiatives and continuous improvement efforts. In addition, these actions and potential future restructuring actions could yield unintended consequences, such as distraction of management and employees, business disruption, reduced employee morale and productivity and unexpected additional employee attrition, including the inability to attract or retain key personnel. These consequences could negatively affect our business, financial condition and results of operations. In addition, these restructuring measures and potential future restructuring measures may not result in the expected cost savings and additional operating efficiency we hope to achieve.

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We are increasingly dependent on sophisticated information technology and, if we fail to properly maintain the integrity of our data systems or if our products do not operate as intended, our business could be materially affected.
We are increasingly dependent on sophisticated information technology for our products and infrastructure. We have been consolidating and integrating the number of systems we operate and have upgraded and expanded our information systems capabilities, including the conversion to a new enterprise resource planning system. Our information and manufacturing systems, as well as our products that incorporate information technology, require an ongoing commitment of significant resources to maintain, protect and enhance existing systems and products and develop new systems and products to keep pace with continuing changes in information processing technology, mobile device technology, evolving systems and regulatory standards and the need to protect patient and customer information. In addition, third parties may attempt to hack into our systems or products in order to, among other things, compromise the integrity of those systems or products. If we fail to maintain or protect the integrity of our information and manufacturing systems and our products that incorporate information technology, we could lose existing customers, have difficulty attracting new customers, have difficulty manufacturing product, have problems with product functionality that could pose a risk to patients, have difficulty preventing, detecting and controlling fraud, become subject to product recalls, regulatory sanctions or penalties, experience increases in operating expenses, incur expenses or lose revenues as a result of a breach or suffer other adverse consequences. Our process of consolidating the number of systems we operate, upgrading and expanding the information capabilities of our systems and products, protecting and enhancing the integrity of our systems and products and developing new systems and products to keep pace with continuing changes in information processing technology may not be successful and additional systems or product issues may arise in the future. Any significant breakdown, intrusion, interruption, corruption or destruction of our systems or products could have a material adverse effect on our business.

If our efforts to maintain the privacy and security of our customer, patient, third-party payor, employee, supplier or Company information are not successful, we could incur substantial additional costs and become subject to litigation, enforcement actions and reputational damage.

Our business, like that of most medical device manufacturers, involves the receipt, storage and transmission of patient information and payment and reimbursement information, as well as confidential information about third-party payors, our employees, our suppliers and our Company. Our information systems are vulnerable to an increasing threat of continually evolving cybersecurity risks. Unauthorized parties may attempt to gain access to our systems or information through fraud or other means of deceiving our employees or third-party service providers. Hardware, software or applications we develop or obtain from third parties may contain defects in design or manufacture or other problems that could unexpectedly compromise information security. The methods used to obtain unauthorized access, disable or degrade service or sabotage systems are also constantly changing and evolving, and may be difficult to anticipate or detect for long periods of time. We have implemented and regularly review and update processes and procedures to protect against unauthorized access to or use of secured data and to prevent data loss. However, the ever-evolving threats mean we must continually evaluate and adapt our systems and processes, and our efforts may not be adequate to safeguard against all data security breaches, misuse of data or sabotage of our systems. Any future significant compromise or breach of our data security, whether external or internal, or misuse of customer, third-party payor, employee, supplier or Company data, could result in additional significant costs, lost sales, fines, lawsuits and damage to our reputation. In addition, as the regulatory environment related to information security, data collection and use, and privacy becomes increasingly rigorous, with new and constantly changing requirements applicable to our business, compliance with those requirements could also result in additional costs.

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Failure to integrate acquired businesses into our operations successfully could adversely affect our business.
As part of our strategy to develop and identify new products and technologies, we have made several acquisitions in recent years and may make additional acquisitions in the future. In October 2015, we completed the acquisition of Thoratec Corporation (Thoratec), which represented our largest acquisition to date. Our integration of the operations of Thoratec as well as the other businesses we have acquired in recent years requires significant efforts, including the coordination of information technologies, research and development, manufacturing, operations and sales and marketing. These efforts result in additional expenses and involve significant amounts of management's time that cannot then be dedicated to other projects. Our failure to manage successfully and coordinate the growth of the combined company could also have an adverse impact on our business. In addition, the businesses we acquired may not become profitable or remain so. If our acquisitions are not successful, we may record unexpected impairment charges. Factors that will affect the success of our acquisitions include:

the presence or absence of adequate internal controls and/or significant fraud in the financial systems of acquired companies;
adverse developments arising out of investigations by governmental entities of the business practices of acquired companies;
any decrease in customer loyalty and product orders caused by dissatisfaction with the combined companies' product lines and sales and marketing practices, including price increases;
our ability to retain key employees; and
the ability of the combined company to achieve synergies among its constituent companies, such as increasing sales of the combined company's products, achieving cost savings and effectively combining technologies to develop new products.

We incurred additional indebtedness to finance the acquisition of Thoratec, which may decrease our business flexibility and increase our borrowing costs.

As a result of the Thoratec acquisition, our consolidated indebtedness has increased substantially. The increased indebtedness and higher debt-to-equity and debt-to-income ratios of our Company, as compared to that which has existed on a historical basis, may have the effect, among other things, of reducing our flexibility to respond to changing business and economic conditions and increasing borrowing costs. In addition, since the completion of the acquisition, the rating on our debt has been downgraded by certain credit rating agencies.

Cost containment pressures and domestic and foreign legislative or administrative reforms resulting in restrictive reimbursement practices of third-party payors or preferences for alternate therapies could decrease the demand for products purchased by our customers, the prices which they are willing to pay for those products and the number of procedures using our devices.

Our products are purchased principally by healthcare providers that typically bill various third-party payors, such as governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed care plans, for the healthcare services provided to their patients. The ability of customers to obtain appropriate reimbursement for their services and the products they provide from government and third-party payors is critical to the success of medical technology companies. The availability of reimbursement affects which products customers purchase and the prices they are willing to pay. Reimbursement varies from country to country and can significantly impact the acceptance of new technology. After we develop a promising new product, we may find limited demand for the product unless reimbursement approval is obtained from governmental and private third-party payors.

For example, Medicare covers items and services that are reasonable and necessary for the diagnosis or treatment of an illness or injury. The Center for Medicare and Medicaid Services (CMS) may issue a national coverage determination (NCD), which sets forth a Medicare coverage limitation for a specific item or service, and in the absence of a NCD, a local Medicare Administrative Contractor (MAC) may issue a local coverage determination (LCD), which sets forth a coverage limitation for that specific Medicare jurisdiction. To date, one MAC has finalized and one MAC has proposed a restrictive LCD for our CardioMEMS™ product. It is possible that other MACs may release similarly restrictive LCDs, which could have an adverse effect on sales of our CardioMEMS™ product. CardioMEMS™ was also the subject of a report by the Institute for Clinical and Economic Research (ICER) - an organization that examines the cost-effectiveness of various products. ICER’s report stated that the evidence

19


surrounding CardioMEMS™ is “promising but inconclusive.” Some private payors have limited or not provided coverage for CardioMEMS™, and ICER’s report could be used by third-party payors to continue or adopt restrictive coverage or reimbursement of the product.

In addition to Medicare, many other major third-party payors for healthcare provider services in the United States and abroad continue to work to contain healthcare costs. The introduction of cost containment incentives, combined with closer scrutiny of healthcare expenditures by both private and public health insurers and employers, has resulted in increased discounts and contractual adjustments to healthcare provider charges for services performed and in the shifting of services from the inpatient to the outpatient setting. Initiatives to limit the growth of healthcare costs, including price regulation, are also underway in several countries in which we do business. Implementation of healthcare reforms in the United States and in significant overseas markets such as Germany, Japan and other countries may limit the price or the level at which reimbursement is provided for our products and adversely affect both our pricing flexibility and the demand for our products.

For example, in 2010, PPACA was enacted into law in the United States and included a number of provisions aimed at improving the quality and decreasing the costs of healthcare. The healthcare reform statutes have already resulted in significant reimbursement cuts in Medicare payments to hospitals and other healthcare providers, although it is uncertain what consequences these provisions may have on new technologies. Additionally, the Budget Control Act of 2011 (BCA) called for the establishment of a Joint Select Committee on Deficit Reduction, tasked with reducing the federal debt level. However, because the Committee did not draft a proposal by the BCA’s deadline, automatic cuts (sequestration) in various federal programs began on March 1, 2013. Under the Bipartisan Budget Act of 2013 and a bill signed by the President on February 15, 2014, sequestration has been extended through fiscal year 2024. Medicare payments to providers are subject to such cuts, although the BCA generally limited the Medicare cuts to two percent. For fiscal year 2024, however, Medicare sequestration amounts will be realigned such that there will be a four percent sequester for the first six months and no sequester for the second six months.

Legislative or administrative reforms to the U.S. or international reimbursement systems that significantly reduce reimbursement for procedures using our medical devices or deny coverage for such procedures, or adverse decisions relating to our products by administrators of such systems on coverage or reimbursement issues, would have an adverse impact on the products purchased by our customers and the prices our customers are willing to pay for them. Healthcare providers may respond to such cost-containment pressures by substituting lower cost products or other therapies for our products. This, in turn, would have an adverse effect on our financial condition and results of operations.

Failure to maintain strong working relationships with physicians and other healthcare professionals could adversely impact our product development and sales and marketing efforts.
 
If we fail to maintain our working relationships with physicians and other healthcare professionals, many of our products may not be developed and marketed in line with the needs and expectations of the professionals who use and support our products. The research, development, marketing and sales of many of our new and improved products is dependent upon our maintaining working relationships with physicians as well as other healthcare professionals, including hospital purchasing agents, who are becoming increasingly instrumental in making purchasing decisions for our products. We rely on these professionals to provide us with considerable knowledge and experience regarding our products and the marketing and sale of our products. Physicians also assist us as researchers, consultants, advisory board members, inventors and as public speakers. If we are unable to maintain our strong relationships with these professionals and continue to receive their advice and input, the development and marketing and sales of our products could suffer, which could have a material adverse effect on our financial condition and results of operations. Our relationships with physicians and other healthcare professionals and other providers that use our products are regulated under the U.S. federal AKS and similar state and foreign laws. Failure to comply with the federal AKS or similar state or foreign law could result in criminal or civil penalties, exclusion from federal healthcare programs, or the imposition of corporate integrity agreements that result in significant administrative obligations and costs.

In addition, in February 2013, CMS finalized regulations to implement the Physician Payments Sunshine Act, enacted as part of the U.S. healthcare reform legislation in 2010. This rule requires us to report annually to CMS certain payments and other transfers of value we make to U.S.-licensed physicians and teaching hospitals. These annual reports are publicly available, which could impact the number of physicians and other healthcare providers who are willing to work with us on the research and development of our products. In addition, several states have

20


implemented, and a number of foreign regulatory bodies are in the process of developing, similar transparency and disclosure laws applicable to medical device manufacturers, some of which require reporting of transfers of value made not only to physicians, but to a wider variety of healthcare professionals and institutions as well.

Our products are continually the subject of clinical trials conducted by us, our competitors or other third parties, the results of which may be unfavorable, or perceived as unfavorable by the market, and could have a material adverse effect on our business, financial condition and results of operations.

As a part of the regulatory process of obtaining marketing clearance for new products and new indications for existing products, we conduct and participate in numerous clinical trials with a variety of study designs, patient populations and trial endpoints. Unfavorable or inconsistent clinical data from existing or future clinical trials conducted by us, by our competitors or by third parties, or the market's or FDA's perception of this clinical data, may adversely impact our ability to obtain product approvals, the size of the markets in which we participate, our position in, and share of, the markets in which we participate and our business, financial condition and results of operations.

If we are unable to protect our intellectual property effectively, our financial condition and results of operations could be adversely affected.

Patents and other proprietary rights are essential to our business and our ability to compete effectively with other companies is dependent upon the proprietary nature of our technologies. We also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop, maintain and strengthen our competitive position. We seek to protect these, in part, through confidentiality agreements with certain employees, consultants and other parties. We pursue a policy of generally obtaining patent protection in both the United States and in key foreign countries for patentable subject matter in our proprietary devices and also attempt to review third-party patents and patent applications to the extent publicly available to develop an effective patent strategy, avoid infringement of third-party patents, identify licensing opportunities and monitor the patent claims of others. We currently own numerous United States and foreign patents and have numerous patent applications pending. We are also a party to various license agreements pursuant to which patent rights have been obtained or granted in consideration for cash, cross-licensing rights or royalty payments. Pending or future patent applications may not result in issued patents and current or future patents issued to or licensed by us may be challenged, invalidated or circumvented. Additionally, the rights granted thereunder may not provide a competitive advantage to us or prevent competitors from entering markets which we currently serve. Any required license may not be available to us on acceptable terms, if at all. In addition, some licenses may be non-exclusive, and therefore our competitors may have access to the same technologies as us. In addition, we may have to take legal action in the future to protect our trade secrets or know-how or to defend them against claimed infringement of the rights of others. Any legal action of that type could be costly and time consuming to us and we cannot be certain of the outcome. The invalidation of key patents or proprietary rights which we own or an unsuccessful outcome in lawsuits to protect our intellectual property could have a material adverse effect on our financial condition and results of operations.
Our intellectual property, other proprietary technology and other sensitive Company data are also potentially vulnerable to loss, damage or misappropriation from information technology system malfunction, computer viruses, unauthorized access or misappropriation or misuse thereof by those with permitted access, as well as other events. The steps we have taken and will continue to take to protect our intellectual property, other proprietary technology and other sensitive Company data from these risks may not prevent breakdowns, breaches, cyber-attacks or other events. Such events could have a material adverse effect on our reputation, financial condition or results of operations.

Patent litigation could be costly and disruptive to us and may have an adverse effect on our financial condition and results of operations.

We operate in an industry that is susceptible to significant patent litigation and, in recent years, it has been common for companies in the medical device field to aggressively challenge the rights of other companies to prevent the introduction and sale of new devices. Companies that obtain patents for products or processes that are necessary for or useful to the development of our products may bring legal actions against us claiming infringement and at any given time, we generally are involved as both a plaintiff and a defendant in a number of patent infringement and other intellectual property-related actions. Defending intellectual property litigation is expensive and complex and outcomes are difficult to predict. Patent litigation may result in significant royalty or other payments or injunctions that can prevent the sale of products and may cause a significant diversion of the efforts of our technical and management personnel. In the event that our right to market any of our products is successfully challenged or if we

21


fail to obtain a required license or are unable to design around a patent, our financial condition and results of operations could be materially adversely affected.

Product liability claims and other litigation, including private securities litigation, shareholder derivative suits and contract litigation, may adversely affect our financial condition and results of operations.

The design, manufacture and sale of the medical devices we produce entail an inherent risk of product liability claims. Our products are often used in intensive care settings with seriously ill patients, and many of the medical devices we manufacture and sell are designed to be implanted in the human body for long periods of time or indefinitely. There are a number of factors that could result in an unsafe condition or injury to, or death of, a patient with respect to these or other products which we manufacture or sell, including component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information. Product liability claims may be brought by individuals or by groups seeking to represent a class.
The outcome of product liability litigation, particularly class action lawsuits, is difficult to assess or quantify. Plaintiffs in these types of lawsuits often seek recovery of very large or indeterminate monetary amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for substantial periods of time. The final resolution of these types of litigation matters may take a number of years and it is difficult to reasonably estimate the time frame in which any potential settlements or judgments would be paid out or the amounts of any such settlements or judgments. In addition, the cost to defend product liability claims may be significant. Product liability claims, securities and commercial litigation and other current or future litigation, including any costs (the material components of which are settlements, judgments, legal fees and other related defense costs) not covered under our previously-issued product liability insurance policies and existing litigation reserves, could have a material adverse effect on our results of operations, financial position and cash flows.
The loss of any of our sole-source or single source suppliers or an increase in the price of inventory supplied to us could have an adverse effect on our business, financial condition and results of operations.
We purchase certain supplies used in our manufacturing processes from single sources due to quality considerations, costs or constraints resulting from regulatory requirements. Agreements with certain suppliers are terminable by either party upon short notice, and we have been advised periodically by some suppliers that in an effort to reduce their potential product liability exposure, they may terminate sales of products to customers that manufacture implantable medical devices. While some of these suppliers have modified their positions and have indicated a willingness to continue to provide a product temporarily until an alternative vendor or product can be qualified (or even to reconsider the supply relationship), where a particular single-source supply relationship is terminated, we may not be able to establish additional or replacement suppliers for certain components or materials quickly. This is largely due to the FDA approval system, which mandates validation of materials prior to use in our products, and the complex nature of manufacturing processes employed by many suppliers. In addition, we may lose a sole-source supplier due to, among other things, the acquisition of such a supplier by a competitor (which may cause the supplier to stop selling its products to us) or the bankruptcy of such a supplier, which may cause the supplier to cease operations. A reduction or interruption by a sole-source supplier of the supply of materials or key components used in the manufacturing of our products or an increase in the price of those materials or components could adversely affect our business, financial condition and results of operations.

22


Regulatory actions arising from the concern over Bovine Spongiform Encephalopathy may limit our ability to market products containing bovine material.
Our Angio-Seal™ vascular closure device, as well as our vascular graft products, contain bovine collagen. In addition, some of the tissue heart valves we market, such as our Biocor®, Epic™, Trifecta™ and Portico™ tissue heart valves, incorporate bovine pericardial material. In some jurisdictions, there are laws, regulations and guidance that regulate the use of certain animal material in medical devices because of concerns about Transmissible Spongiform Encephalopathy (TSE), such as Bovine Spongiform Encephalopathy, which is sometimes referred to as “mad cow disease,” a disease which has sometimes been transmitted to humans through the consumption of beef. Some medical device regulatory agencies have considered and are considering whether to continue to permit the sale of medical devices that incorporate certain animal material. While we are not aware of any reported cases of transmission of TSE through medical products and are cooperating with regulatory agencies considering these issues, the suspension or revocation of authority to manufacture, market or distribute products containing bovine material, or the imposition of a regulatory requirement that we procure material for these products from alternate sources, could result in lost market opportunities, harm the continued commercialization and distribution of such products and impose additional costs on us. Any of these consequences could in turn have a material adverse effect on our financial condition and results of operations.
Our operations are subject to environmental, health and safety laws and regulations that could require us to incur material costs.
Our operations are subject to environmental, health and safety laws and regulations concerning, among other things, the generation, handling, transportation and disposal of hazardous substances or wastes, particularly ethylene oxide, the cleanup of hazardous substance releases, and emissions or discharges into the air or water. We have incurred and expect to incur expenditures in the future in connection with compliance with environmental, health and safety laws and regulations. New laws and regulations, violations of these laws or regulations, stricter enforcement of existing requirements, or the discovery of previously unknown contamination could require us to incur costs or become the basis for new or increased liabilities that could be material.

Our product liability self-insurance program may not be adequate to cover future losses.
Consistent with the predominant practice in our industry, we do not currently maintain or intend to maintain in the future any insurance policies with respect to product liability. Our self-insurance program, which is based on historical loss trends, may not be adequate to cover future losses, as historical trends may not be indicative of future losses. These losses could have a material adverse impact on our results of operations, financial condition and cash flows.
Natural disasters or other catastrophes could adversely affect our business, financial condition and results of operations.
The occurrence of one or more natural disasters, such as hurricanes, cyclones, typhoons, tropical storms, floods, earthquakes and tsunamis, severe changes in climate and geo-political events, such as acts of war, civil unrest or terrorist attacks, or the occurrence of epidemic diseases in a country in which we operate or in which our suppliers are located could adversely affect our operations and financial performance. For example, we have significant facilities located in Sylmar, Pleasanton and Sunnyvale, California, Puerto Rico, Malaysia and Costa Rica. Earthquake insurance is currently difficult to obtain, extremely costly and restrictive with respect to scope of coverage. We do not currently maintain or intend to maintain earthquake insurance. Consequently, we could incur uninsured losses and liabilities arising from an earthquake near our California, Puerto Rico or Costa Rica facilities as a result of various factors, including the severity and location of the earthquake, the extent of any damage to our facilities, the impact of an earthquake on our workforce and on the infrastructure of the surrounding communities and the extent of damage to our inventory and work in process. These losses could have a material adverse effect on our business for an indeterminate period. Furthermore, our manufacturing facilities in Puerto Rico or Malaysia may suffer damage as a result of hurricanes and could result in lost production and additional expenses to us to the extent any such damage is not fully covered by our hurricane and business interruption insurance. Even with insurance coverage, natural disasters or other catastrophic events, including acts of war or terrorism, could cause us to suffer substantial losses in our operational capacity and could also lead to a loss of opportunity and to a potential adverse impact on our relationships with our existing customers resulting from our inability to produce products for them, for which we would not be compensated by existing insurance. This in turn could have a material adverse effect on our financial condition and results of operations.

23


Further, when natural disasters result in wide-spread destruction, or certain regions experience acts of war or terrorism, the adverse impact on the operations of our customers in those affected locations could result in a material adverse effect on our results of operations in that region or on the consolidated operations of our business.



 
 
Item 1B.
UNRESOLVED STAFF COMMENTS
None.
 
 
Item 2.
PROPERTIES
We own our principal executive offices, which are located in St. Paul, Minnesota. As of January 2, 2016, our manufacturing and research and development facilities are located in California, Michigan, Minnesota, Arizona, South Carolina, Texas, New Jersey, Oregon, Massachusetts, Georgia, Brazil, Puerto Rico, Costa Rica, Israel, Switzerland and Malaysia. We own approximately 70% (800,000 square feet) of our total manufacturing space. We also maintain over 100 sales and administrative offices world-wide. With the exception of 17 locations, all of our sales and administrative offices are leased. We believe that all buildings, machinery and equipment are in good condition, suitable for their purposes and are maintained on a basis consistent with sound operations. Additionally, we believe that we have sufficient space for our current operations and for foreseeable expansion in the next few years.

 
 
Item 3.
LEGAL PROCEEDINGS
Discussion of legal proceedings is incorporated by reference from Part II, Item 8. "Financial Statements and Supplementary Data" of this document, and should be considered an integral part of Part I, Item 3, "Legal Proceedings."

 
 
Item 4.
MINE SAFETY DISCLOSURES
No matters require disclosure.


24


PART II
 
 
Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

There were no sales of unregistered securities during the three months ended January 2, 2016. As of February 19, 2016, St. Jude Medical, Inc. had 1,765 shareholders of record. St. Jude Medical, Inc.'s stock is listed on the New York Stock Exchange, Inc. (NYSE) as "STJ."

Cash dividends declared totaled $0.29 per share for each quarter in fiscal year 2015 and $0.27 per share for each quarter in fiscal year 2014. The Company expects to continue to pay quarterly cash dividends in the foreseeable future, subject to Board approval. The following prices are the high and low market sales quotations per share of the Company’s common stock for the quarters indicated:
 
 
Fiscal Year
 
 
2015
 
2014
Quarter
 
High
 
Low
 
High
 
Low
First
 
$
68.99

 
$
63.93

 
$
68.79

 
$
59.16

Second
 
$
76.33

 
$
64.96

 
$
70.59

 
$
59.85

Third
 
$
80.84

 
$
61.01

 
$
71.90

 
$
61.00

Fourth
 
$
68.97

 
$
59.88

 
$
70.24

 
$
54.80


Stock Performance Graph
The following graph compares the cumulative total shareholder returns for St. Jude Medical common stock for the last five fiscal years with the Standard & Poor’s 500 Health Care Equipment Index and the Standard & Poor’s 500 Index weighted by market value at each measurement point. The comparison assumes that $100 was invested on December 31, 2010, in St. Jude Medical common stock and in each of these Standard & Poor’s indexes and assumes the reinvestment of any dividends.


25


 
 
Item 6.
SELECTED FINANCIAL DATA

Five-Year Summary Financial Data
(in millions, except per share amounts)
 
 
2015
 
2014
 
2013
 
2012
 
2011
Summary of Operations for the Fiscal Year:
Net sales
 
$
5,541

 
$
5,622

 
$
5,501

 
$
5,503

 
$
5,612

Net earnings attributable to St. Jude Medical, Inc.
 
$
880

 
$
1,002

 
$
723

 
$
752

 
$
826

Diluted net earnings per share attributable to St. Jude Medical, Inc.
 
$
3.07

(a)
$
3.46

(b)
$
2.49

(c)
$
2.39

(d)
$
2.52

Cash dividends declared per share
 
$
1.16

 
$
1.08

 
$
1.00

 
$
0.92

 
$
0.84

Financial Position at Year End:
Total assets (e)
 
$
13,064

 
$
10,193

 
$
10,232

 
$
9,265

 
$
9,109

Long-term debt (e)
 
$
5,229

 
$
2,259

 
$
3,502

 
$
2,544

 
$
2,704


Fiscal year 2014 consisted of 53 weeks. All other fiscal years noted above consisted of 52 weeks.

(a)
2015 diluted net earnings per share attributable to St. Jude Medical, Inc. included after-tax charges of $172 million, or $0.59 per diluted net earnings per share attributable to St. Jude Medical, Inc., related to acquisition-related charges, restructuring activities associated with our 2016 Initiatives, our Manufacturing and Supply Chain Optimization Plan, our 2012 Business Realignment Plan and 2011 Restructuring Plan, product field action costs and litigation costs, legal settlement expenses and intangible asset impairment charges, partially offset by an income tax benefit for discrete income tax adjustments and a net benefit related to insurance recoveries associated with a litigation case. See the Notes to the Consolidated Financial Statements in Item 8. "Financial Statements and Supplementary Data" for further detail.
(b)
2014 diluted net earnings per share attributable to St. Jude Medical, Inc. included after-tax charges of $150 million, or $0.52 per diluted net earnings per share attributable to St. Jude Medical, Inc., related to restructuring activities associated with our Manufacturing and Supply Chain Optimization Plan and our 2012 Business Realignment Plan, acquisition-related charges, intangible asset impairment charges, product field action costs and litigation costs and legal settlement expenses, partially offset by a favorable legal settlement and an income tax benefit for discrete income tax adjustments. See the Notes to the Consolidated Financial Statements in Item 8. "Financial Statements and Supplementary Data" for further detail.
(c)
2013 diluted net earnings per share attributable to St. Jude Medical, Inc. included after-tax charges of $371 million, or $1.27 per diluted net earnings per share attributable to St. Jude Medical, Inc., related to restructuring activities associated with our 2012 Business Realignment Plan and 2011 Restructuring Plan, debt retirement costs primarily associated with make-whole redemption payments and the write-off of unamortized debt issuance costs, acquisition-related charges, intangible asset impairment charges, product field action costs and litigation costs and a legal settlement charge, partially offset by an income tax benefit from the enactment of a tax law and the settlement of domestic tax audits. See the Notes to the Consolidated Financial Statements in Item 8. "Financial Statements and Supplementary Data" for further detail.
(d)
2012 diluted net earnings per share attributable to St. Jude Medical, Inc. included after-tax charges of $321 million, or $1.02 per diluted net earnings per share attributable to St. Jude Medical, Inc., related to restructuring activities associated with our 2012 Business Realignment Plan and 2011 Restructuring Plan, product field action and litigation charges, a legal settlement charge, intangible asset impairment charges, inventory write-offs and an additional income tax charge related to a settlement reserve for certain prior year tax positions.
(e)
Effective in 2015, we adopted Accounting Standards Update (ASU) No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs and used the retrospective application method to adjust the total assets and total debt balances. Prior period balances have been retrospectively adjusted to conform to the current year's presentation.


26


 
 
Item 7.
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, cardiovascular and atrial fibrillation therapy areas, and interventional pain therapy and neurostimulation devices for the management of chronic pain and movement disorders. We operate as a single operating segment and derive our revenues from seven principal product categories. Our seven principal product categories are as follows: tachycardia implantable cardioverter defibrillator (ICD) systems; atrial fibrillation (AF) products (electrophysiology (EP) introducers and catheters, advanced cardiac mapping, navigation and recording systems and ablation systems); bradycardia pacemaker (pacemaker) systems; vascular products (vascular closure products, pressure measurement guidewires, optical coherence tomography (OCT) imaging products, vascular plugs, heart failure monitoring devices and other vascular accessories); structural heart products (heart valve replacement and repair products and structural heart defect devices); neuromodulation products (spinal cord stimulation and radiofrequency ablation to treat chronic pain and deep brain stimulation to treat movement disorders); and Thoratec products (ventricular assist devices and percutaneous heart pumps). We market and sell our products world-wide primarily through a direct sales force.
On January 13, 2016, we announced that we would change our sales reporting starting in 2016 to closely align with how we will manage the business in five key areas: Heart Failure (HF), Atrial Fibrillation, Neuromodulation, Cardiovascular Disease and Traditional Cardiac Rhythm Management. Our sales results were managed on the basis of our existing product categories through 2015, with the intention that sales reporting be managed under the new classification once it is fully effective in the first quarter of 2016.
We utilize a 52/53-week fiscal year ending on the Saturday nearest December 31st. Fiscal years 2015 and 2013 consisted of 52 weeks and ended on January 2, 2016 and December 28, 2013, respectively. Fiscal year 2014 consisted of 53 weeks and ended on January 3, 2015, with the additional week reflected in our fourth quarter 2014 results.
In 2010, significant U.S. healthcare reform legislation, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act (collectively PPACA), was enacted into law. As a U.S.-headquartered company with significant sales in the United States, this healthcare reform law has had, and is expected to continue to have, a material impact on us and on the U.S. healthcare system, more generally. Beginning in 2013, the law levied an annual 2.3% excise tax on the majority of our U.S. medical device sales, although the Consolidated Appropriations Act, 2016 (H.R. 2029), signed into law in December 2015, placed a moratorium on this tax in 2016 and 2017.
Net sales in 2015 decreased 1% compared to 2014. Foreign currency translation unfavorably decreased our 2015 net sales by 7% compared to 2014. Partially offsetting the unfavorable foreign currency translation impact, our net sales increased during 2015 compared to 2014 in the following key areas:
We benefited from incremental net sales associated with our ventricular assist devices, acquired through our acquisition of Thoratec Corporation (Thoratec) during the fourth quarter of 2015.
Our AF Products continued to benefit from increased EP catheter ablation procedures, led by increased net sales from our TactiCath® irrigated ablation catheter that received U.S. Food and Drug Administration (FDA) approval in October 2014 and incremental net sales from our FlexAbility™ ablation catheter that received FDA approval in January 2015.
Our CardioMEMS™ HF System has continued to penetrate the market resulting in increased net sales since receiving FDA approval in May 2014.
We also continued to benefit from incremental net sales from our radiofrequency ablation products and related consumable items, acquired as part of our NeuroTherm acquisition in August 2014.
Finally, we continued to experience incremental net sales from our Quadra Allure MP™ cardiac resynchronization therapy pacemaker (CRT-P) device that received CE Mark approval in December 2014.

In addition to unfavorable foreign currency translation, we also experienced net sales declines during 2015 compared to 2014 in our traditional pacemaker and ICD devices, our cardiac resynchronization therapy defibrillator (CRT-D) devices, the third party vascular products we distribute in Japan and our mechanical heart valves as the market continues to shift toward a preference for tissue valves. Refer to the Results of Operations section for a more detailed discussion of our net sales.

27



Net sales in 2014 increased 2% compared to 2013. Foreign currency translation unfavorably decreased our 2014 net sales by 1% compared to 2013. The increase in our 2014 net sales compared to 2013 was primarily driven by the following key areas:

Our AF Products benefited from increased EP catheter ablation procedures and increased sales volumes associated with our intracardiac echocardiography imaging product offerings.
We also benefited from incremental net sales associated with our NeuroTherm acquisition and FDA approval of the CardioMEMS™ HF System.
We continued to experience incremental net sales benefits from our 2013 acquisitions of Endosense and Nanostim, and sales volume increases associated with Spinal Modulation's Axium™ Neurostimulator System, a targeted therapy for chronic pain, for which, prior to exercising our purchase option in May 2015, we had been the exclusive distributor.
Finally, our increased sales volumes associated with our Fractional Flow Reserve (FFR) technology products and OCT imaging products, Trifecta™ pericardial stented tissue valve, transcatheter aortic heart valves and AMPLATZER™ occluder products also continued to benefit our 2014 net sales compared to 2013.

Partially offsetting these net sales increases, we experienced a 2014 net sales decline in our other neuromodulation chronic pain products, our third party vascular products we distribute in Japan and our mechanical heart valves, due to a market preference for tissue valves, compared to 2013. Refer to the Results of Operations section for a more detailed discussion of our net sales.

Diluted net earnings per share attributable to St. Jude Medical, Inc. during 2015 was $3.07 compared to $3.46 during 2014 driven by the revenue impacts described previously and the following key items which resulted in net after-tax charges of $0.59 per diluted share during 2015:

We recognized net after-tax charges of $0.35 per diluted share during 2015 for acquisition-related costs primarily associated with our acquisition of Thoratec, partially offset by contingent consideration fair value adjustments.
We recognized after-tax special charges of $0.30 per diluted share related to restructuring activities during 2015.
We recognized an after-tax income tax benefit of $0.07 per diluted share related to discrete income tax adjustments during 2015.
We recognized net after-tax special charges of $0.02 per diluted share related to product field action costs and litigation costs during 2015.
We recognized a net after-tax special benefit of $0.01 per diluted share associated with favorable legal settlements including insurance recoveries, partially offset by two unrelated unfavorable legal settlements and one unfavorable legal judgment associated with a product liability claim.

Diluted net earnings per share attributable to St. Jude Medical, Inc. during 2014 was $3.46 compared to $2.49 during 2013 driven by the revenue impacts described previously, partially offset by the following key items which resulted in after-tax charges of $0.52 per diluted share during 2014:

We recognized after-tax special charges of $0.34 per diluted share related to restructuring activities during 2014.
We recognized after-tax special charges of $0.13 per diluted share associated with intangible asset impairment charges during 2014.
We recognized after-tax special charges of $0.13 per diluted share related to product field action costs and litigation costs during 2014.
We recognized after-tax special charges of $0.12 per diluted share associated with acquisition-related charges during 2014, primarily associated with our acquisitions of Endosense, CardioMEMS, NeuroTherm and Nanostim.
We recognized an after-tax income tax benefit of $0.17 per diluted share related to discrete income tax adjustments.
Additionally, we also recognized a net after-tax special benefit of $0.03 per diluted share associated with a legal settlement gain related to a favorable judgment and resolution in a patent infringement case, partially offset by legal settlement expenses associated with three unrelated legal cases.


28


Refer to the Results of Operations section for a more detailed discussion of these charges. In addition to the impact of these after-tax charges, both our 2015 and 2014 diluted net earnings per share attributable to St. Jude Medical, Inc. also increased compared to the same respective prior year period as a result of share repurchases in both 2015 and 2014, resulting in lower outstanding shares compared to the same respective prior year comparable period.

Significant cash flow activity included the following key items:

We generated $1,039 million of operating cash flows during 2015, compared to $1,304 million of operating cash flows during 2014 and $961 million of operating cash flows during 2013.
We acquired Thoratec for $3.3 billion in net cash consideration during 2015, compared to our business combination payments of $147 million in 2014 and $292 million in 2013.
We utilized proceeds of $2.1 billion from a 5-year, $2.6 billion term loan due 2020 (Term Loan Due 2020), together with $1.5 billion of proceeds from unsecured senior notes issued during 2015 to finance a portion of our Thoratec acquisition, and repaid term loans totaling $925 million. During 2014 and 2013, we had net debt issuances of $275 million and $554 million, respectively.
We also returned $822 million to shareholders in the form of common stock repurchases and dividends during 2015 compared to $779 million during 2014 and $1,115 million during 2013.

Refer to the Liquidity section for a more detailed discussion.

RESULTS OF OPERATIONS
Net sales
While we manage our operations globally and believe our product category sales are the most relevant measure of revenue performance, we also utilize geographic area revenue data as a secondary performance measure.
The following table presents net sales to external customers for our seven major product categories (in millions):
 
 
 
 
 
 
 
% Change
 
% Change
 
2015
 
2014
 
2013
 
2015 vs. 2014
 
2014 vs. 2013
ICD Systems
$
1,582

 
$
1,746

 
$
1,741

 
(9.4
)%
 
0.3
%
Atrial Fibrillation Products
1,096

 
1,044

 
957

 
5.0

 
9.1

Pacemaker Systems
941

 
1,047

 
1,042

 
(10.0
)
 
0.5

Vascular Products
716

 
709

 
704

 
0.9

 
0.7

Structural Heart Products
595

 
639

 
631

 
(6.7
)
 
1.3

Neuromodulation Products
475

 
437

 
426

 
8.6

 
2.6

Thoratec Products
136

 

 

 
N/A
 
N/A
    Net sales
$
5,541

 
$
5,622

 
$
5,501

 
(1.4
)%
 
2.2
%
The following table presents net sales by significant geographic area based on customer location (in millions):
 
 
 
 
 
 
 
% Change
 
% Change
 
2015
 
2014
 
2013
 
2015 vs. 2014
 
2014 vs. 2013
United States
$
2,838

 
$
2,657

 
$
2,596

 
6.8
 %
 
2.4
 %
Europe
1,384

 
1,531

 
1,458

 
(9.6
)
 
5.0

Japan
456

 
526

 
567

 
(13.2
)
 
(7.2
)
Other foreign countries
863

 
908

 
880

 
(5.0
)
 
3.2

     Net sales
$
5,541

 
$
5,622

 
$
5,501

 
(1.4
)%
 
2.2
 %

29


Our net sales changes are impacted by multiple factors, the most significant of which are often impacts of acquisitions and foreign currency translation. Operational sales changes include organic volume and selling price impacts. These impacts for 2015 and 2014 were as follows:
 
2015
 
2014
Operational
2.9
 %
 
2.8
 %
Acquisitions
3.0

 
0.7

Translation
(7.3
)
 
(1.3
)
     Net sales change
(1.4
)%
 
2.2
 %

Overall, net sales decreased during 2015 compared to 2014. Geographically, we experienced unfavorable foreign currency translation impacts of $413 million primarily due to the U.S. Dollar strengthening against the Euro and Japanese Yen compared to 2014. Additionally, we have continued to experience a net sales decline in the third party vascular products we distribute in Japan as a result of discontinuing certain distribution relationships and we have experienced net sales declines in our traditional ICD and pacemaker devices in Japan compared to 2014. The decrease in our 2015 net sales was partially offset by incremental net sales associated with our Thoratec and NeuroTherm business combinations and continued benefits in the U.S. from our CardioMEMS™ HF System net sales.

Overall, net sales increased during 2014 compared to 2013 primarily as a result of incremental net sales from our NeuroTherm, Spinal Modulation, Endosense and CardioMEMS business combinations. Geographically, we experienced unfavorable foreign currency translation impacts of $74 million compared to 2013 primarily due to the U.S. Dollar strengthening against the Japanese Yen and Latin American and Asia Pacific currencies, partially offset by the U.S. Dollar weakening against the Euro.

The foreign currency translation impacts to net sales are not necessarily indicative of the net earnings impact of foreign currency translation due to partially offsetting foreign currency translation impacts on cost of sales, operating expenses and our hedging program.

Our 2015 net sales compared to 2014 net sales, and our 2014 net sales compared to our 2013 net sales are discussed by our seven major product categories as follows:

ICD Systems: Our 2015 ICD Systems net sales decreased compared to 2014 ICD Systems net sales due to unfavorable foreign currency translation impacting our 2015 ICD Systems net sales by $103 million (5 percentage points) compared to 2014. Additionally, we experienced net sales declines in both our CRT-D devices and traditional ICD devices, driven by competitive pressures from magnetic resonance imaging (MRI) ICDs, which most significantly impacted our U.S. CRT-D devices causing overall average selling price declines during 2015 compared to 2014.

Our 2014 ICD Systems net sales increased compared to 2013 ICD Systems net sales driven by our Quadra Assura™ for quadripolar CRT-D and our Unify Assura™ CRT-D, launched in 2013. These increases were partially offset by declines in our other ICD categories as well as ICD and CRT-D net sales declines in Japan. Foreign currency translation unfavorably decreased our 2014 ICD Systems net sales by $15 million (1 percentage point) compared to the prior year.

Atrial Fibrillation Products: Our 2015 AF Products net sales continued to benefit from increased EP catheter ablation procedures and our intracardiac echocardiography imaging product offerings compared to our 2014 AF Products net sales. Incremental net sales associated with our TactiCath® irrigated ablation catheter (FDA approval in October 2014) and our FlexAbility™ ablation catheter (FDA approval in January 2015) benefited our net sales during 2015 compared to the prior year. Our net sales also benefited from our Agilis™ NxT steerable introducer and our advanced cardiac mapping systems as a result of increased sales volumes. Foreign currency translation had an $87 million (8 percentage points) unfavorable impact on 2015 AF Products net sales compared to 2014.

Our 2014 AF Products net sales increased over our 2013 AF Products net sales primarily driven by our continued increase in EP catheter ablation procedures and our intracardiac echocardiography imaging product offerings. We also experienced a net sales benefit from our European launch of our TactiCath® irrigated ablation catheter,

30


acquired through our Endosense acquisition in August 2013, including incremental net sales from our U.S. TactiCath® irrigated ablation catheter product launch after receiving FDA approval in October 2014. Foreign currency translation had a $17 million (2 percentage points) unfavorable impact on our 2014 AF Products net sales compared to 2013.

Pacemaker Systems: Our 2015 Pacemaker Systems net sales were unfavorably impacted by foreign currency translation of $82 million (8 percentage points) compared to our 2014 Pacemaker Systems net sales. Additionally, we experienced net sales declines in our traditional pacemaker devices primarily driven by competitive pressures from MRI pacemakers in the U.S. causing average selling price declines during 2015 compared to 2014. Partially offsetting these net sales decreases, we continued to experience incremental net sales from our Quadra Allure MP™ CRT-P device during 2015 compared to 2014.

Our 2014 Pacemaker Systems net sales increased compared to 2013 Pacemaker Systems net sales primarily due to continued net sales benefits from our July 2013 Accent MRI™ Pacemaker and Tendril MRI™ lead launch in Japan and our Allure Quadra™ CRT-P launch in Europe (CE Mark approval in April 2013). Foreign currency translation unfavorably impacted our 2014 Pacemaker Systems net sales by $17 million (2 percentage points) compared to 2013. Additionally, our U.S. 2014 Pacemaker Systems net sales decreased compared to 2013 primarily due to overall market declines in average selling prices.

Vascular Products: Our 2015 Vascular Products net sales continued to benefit from incremental net sales related to the FDA approval of our CardioMEMS™ HF System in May 2014 compared to 2014 Vascular Products net sales. Unfavorable foreign currency translation impacted our 2015 Vascular Product net sales by $61 million (8 percentage points) compared to 2014 Vascular Products net sales. Additionally, we have continued to experience a 2015 net sales decline in the third party vascular products we distribute in Japan as a result of discontinuing certain distribution relationships compared to 2014. Partially offsetting these net sales decreases we experienced net sales volume increases associated with our FFR technology and OCT imaging products during 2015 compared to 2014.

Our 2014 Vascular Products net sales continued to benefit from incremental net sales related to receiving FDA approval of the CardioMEMS™ HF System in May 2014 and sales volume increases related to our FFR technology and OCT imaging products compared to our 2013 Vascular Products net sales. Partially offsetting these net sales increases, we experienced a 2014 net sales decline in our third party vascular products we distribute in Japan compared to 2013. Foreign currency translation also unfavorably decreased our 2014 Vascular Products net sales by $12 million (2 percentage points) compared to 2013. Additionally, although Angio-Seal™ sales volumes increased during 2014, we experienced an overall net sales decrease as a result of average selling price declines due to competitive pressures compared to 2013. We also continued to experience lower 2014 net sales of our EnligHTN™ Renal Denervation System compared to 2013 driven by expected overall market declines in the treatment of drug-resistant, uncontrolled hypertension.

Structural Heart Products: Our 2015 Structural Heart Products net sales were unfavorably impacted by foreign currency translation of $55 million (9 percentage points) compared to our 2014 Structural Heart Products net sales. We also experienced a 2015 net sales decline in our mechanical heart valves compared to 2014 due to a market preference for tissue valves. Partially offsetting these net sales decreases, we experienced net sales volume increases associated with our left atrial appendage AMPLATZER™ occluder products.

Our 2014 Structural Heart Product net sales increased over our 2013 Structural Heart Product net sales primarily due to increased sales volumes associated with our Trifecta™ pericardial stented tissue valve, our transcatheter aortic heart valves and our AMPLATZER™ occluder products. Our 2014 net sales volumes of our Trifecta™ pericardial stented tissue valve were partially offset by a net sales volume decrease in our mechanical heart valves due to a market preference for tissue valves. Additionally, foreign currency translation had an $11 million (2 percentage points) unfavorable impact on our 2014 Structural Heart Products net sales compared to 2013.

Neuromodulation Products: Our 2015 Neuromodulation Products net sales increased over our 2014 Neuromodulation Products net sales as a result of our August 2014 acquisition of NeuroTherm. Additionally, we benefited from the launch of Protégé MRI™ spinal cord stimulation system (FDA approval in April 2015), Prodigy MRI™ with burst stimulation (CE Mark approval in August 2015) and Proclaim™ Elite Spinal Cord Stimulation System (FDA approval in November 2015) during 2015 compared to 2014. Partially offsetting these net sales increases, foreign currency translation unfavorably decreased our 2015 net sales by $25 million (5 percentage points) compared to 2014.


31


Our 2014 Neuromodulation Products net sales increased over our 2013 Neuromodulation Products net sales primarily as a result of our incremental NeuroTherm net sales and our sales volume increases associated with Spinal Modulation's Axium™ Neurostimulator System, a targeted therapy for chronic pain, for which, we had been the exclusive distributor prior to exercising our purchase option in May 2015. Partially offsetting these net sales increases, we experienced a 2014 net sales decline in our other neuromodulation chronic pain products and unfavorable foreign currency translation impacts of $2 million (1 percentage point) on our 2014 Neuromodulation net sales compared to the prior year.

Thoratec Products: Our 2015 Thoratec Products net sales increase was a result of our acquisition of Thoratec in October 2015.
Gross profit
 

 
 

 
 
 
2015 vs. 2014 Change
 
2014 vs. 2013
Change
 
(in millions)
2015
 
2014
 
2013
 
 
 
Gross profit
$
3,796

 
$
3,969

 
$
3,927

 
(4.4
)%
 
1.1
 %
 
Percentage of net sales
68.5
%
 
70.6
%
 
71.4
%
 
(2.1
)
pts.
(0.8
)
pts.

Our 2015 gross profit percentage (or gross margin) was unfavorably impacted by foreign currency translation impacts of 1.2 percentage points compared to 2014. In 2015, we began to enter into foreign exchange forward contracts to hedge against the effect of exchange rate fluctuations on cash flows denominated in foreign currencies. We expect our hedging program will help mitigate these fluctuations. Additionally, inventory acquired in our Thoratec acquisition was recorded at fair value, which closely approximates normal selling prices. This resulted in higher cost of sales for Thoratec products sold in 2015, which negatively impacted our 2015 gross profit by approximately 0.5 percentage points. A similar impact is expected to continue in early 2016 as the remaining acquired inventory is sold. Additional negative gross margin impact during 2015 compared to 2014 was primarily the result of unfavorable average selling price impacts and geographic sales mix, primarily driven by competitive MRI pacemaker and ICD pressures, which most significantly impacted our U.S. CRT-D and traditional pacemaker devices during 2015 compared to 2014.

Special charges negatively impacted our gross margins during 2015, 2014 and 2013 by $39 million (0.7 percentage points), $56 million (1.0 percentage points) and $45 million (0.8 percentage points), respectively.

Our 2015, 2014 and 2013 gross margins were also negatively impacted by 1.6 percentage points, 1.4 percentage points and 0.9 percentage points, respectively, as a result of excise taxes assessed on the sale of our products. We expect the unfavorable impact of excise taxes on our gross margins to be lower in 2016 and 2017 due to the H.R. 2029 law passed in December 2015, which temporarily suspends the U.S. medical device excise tax. The temporary suspension has no impact on the Puerto Rico excise tax.

Refer to the “Special Charges” section that follows for a more detailed discussion of our special charges.
Selling, general and administrative (SG&A) expense
 

 
 

 
 
 
2015 vs. 2014 Change
 
2014 vs. 2013
Change
 
(in millions)
2015
 
2014
 
2013
 
 
 
Selling, general and administrative expense
$
1,878

 
$
1,856

 
$
1,805

 
1.2
%
 
2.8
%
 
Percentage of net sales
33.9
%
 
33.0
%
 
32.8
%
 
0.9

pts.
0.2

pts.

The increase in our SG&A expense as a percent of net sales in 2015, 2014 and 2013 was primarily driven by net acquisition-related costs, including contingent consideration fair value adjustments, of $112 million (2.0 percentage points), $56 million (1.0 percentage points) and $21 million (0.4 percentage points), respectively (see Note 11 to the Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data"). The partially offsetting benefit in our SG&A expense as a percent of net sales was driven by our cost savings initiatives, including benefits associated with our restructuring activities.



32


Research and development (R&D) expense
 

 
 

 
 
 
2015 vs. 2014 Change
 
2014 vs. 2013
Change
 
(in millions)
2015
 
2014
 
2013
 
 
 
Research and development expense
$
676

 
$
692

 
$
691

 
(2.3
)%
 
0.1
 %
 
Percentage of net sales
12.2
%
 
12.3
%
 
12.6
%
 
(0.1
)
pts.
(0.3
)
pts.

Our R&D expense as a percent of net sales has remained relatively consistent over the last few years, reflecting our commitment to fund growth through cost effective innovation. Our investment in R&D reflects our commitment to fund long-term growth opportunities while balancing short-term results. Our global R&D activities primarily include research, development, clinical and regulatory efforts. These efforts are primarily focused on product innovation that we anticipate will ultimately improve patient outcomes, reduce overall healthcare costs and provide economic value to our customers while providing the best possible technology available. We will continue to assess our R&D programs in future periods as we focus on the development of new products and the improvement to existing products.

Amortization of intangible assets
 
 
 
 
 
 
2015 vs. 2014 Change
 
2014 vs. 2013
Change
(in millions)
2015
 
2014
 
2013
 
Amortization of intangible assets
$
116

 
$
89

 
$
79

 
30.3
%
 
12.7
%

The increase in our 2015 intangible asset amortization expense compared to 2014 was driven by an increase in our definite-lived intangible assets as a result of our business combinations during 2015 and 2014. In October 2015, we acquired Thoratec and recognized $683 million of purchased technology and patent intangible assets that have an estimated weighted average useful life of 9.8 years and a $93 million trademark definite-lived intangible asset that has an estimated useful life of 16.0 years. Additionally, our 2015 intangible asset amortization expense reflects a full year of amortizing assets we acquired through prior business combinations compared to a partial year in 2014, discussed further in the following paragraph.

The increase in our 2014 intangible asset amortization expense compared to 2013 was driven by an increase in our definite-lived intangible assets as a result of our 2014 and 2013 business combinations. In August 2014, we acquired NeuroTherm and recognized $87 million of developed technology intangible assets that have estimated useful lives ranging from 11 to 12 years and a $2 million other intangible asset that has an estimated useful life of five years. Additionally, after receiving FDA approval of our CardioMEMS™ HF System in May 2014, we reclassified $63 million of acquired in-process research and development (IPR&D) from an indefinite-lived intangible asset to a purchased technology definite-lived intangible asset, and began amortizing the asset over its estimated useful life of 11 years. In October 2014, we also received FDA approval of our TactiCath® irrigated ablation catheter and reclassified $33 million of acquired IPR&D from an indefinite-lived intangible asset to a purchased technology definite-lived intangible asset, and began amortizing the asset over its estimated useful life of seven years. Additionally, our 2014 intangible asset amortization expense reflects a full year of amortizing assets acquired from our 2013 business combinations. During the second half of 2013, we acquired Nanostim and Endosense and recognized a total of $54 million in developed technology assets with estimated useful lives ranging between seven and 10 years.
Special charges
 

 
 

 
 
(in millions)
2015
 
2014
 
2013
Cost of sales special charges
$
39

 
$
56

 
$
45

Special charges
96

 
181

 
301

    Total special charges
$
135

 
$
237

 
$
346

We recognize certain transactions and events as special charges in our Consolidated Financial Statements. These charges (such as restructuring charges, impairment charges, certain legal settlements or product field action costs and litigation costs) result from facts and circumstances that vary in frequency and impact on our results of operations. Generally, special charges are reflected in the Consolidated Statements of Earnings within our operating expenses in a separate line item, special charges. However, based on the nature of the charge, when certain special charges impact the calculation of gross profit, they are reflected in the line item cost of sales special charges within the Consolidated Statements of Earnings. The most common special charges impacting the cost of

33


sales special charge line item relate to manufacturing activities. Refer to Note 8 to the Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data" for a detailed discussion of our special charges.
The following table provides additional detail about our special charges and related income statement classification within our Consolidated Statements of Earnings (in millions):
 
 
For the Fiscal Year Ended
 
 
2015
 
2014
 
2013
Type of Special Charge
 
Cost of Sales Special Charges
Special Charges
Total Special Charges
 
Cost of Sales Special Charges
Special Charges
Total Special Charges
 
Cost of Sales Special Charges
Special Charges
Total Special Charges
Restructuring activities
 
 
 
 
 
 
 
 
 
 
 
 
2016 Initiatives
 
$
12

$
22

$
34

 
$

$

$

 
$

$

$

Manufacturing and Supply Chain Optimization Plan
 
29

49

78

 
7

25

32

 



2012 Business Realignment Plan
 
5

9

14

 
30

78

108

 
35

185

220

2011 Restructuring Plan
 

(1
)
(1
)
 



 

24

24

Other restructuring related charges
 

2

2

 



 



Intangible asset impairment charges
 

2

2

 

58

58

 

42

42

Legal settlements
 

(6
)
(6
)
 

10

10

 

22

22

Product field action costs and litigation costs
 
(7
)
19

12

 
19

10

29

 
10

28

38

Total special charges
 
$
39

$
96

$
135

 
$
56

$
181

$
237

 
$
45

$
301

$
346


The 2012 Business Realignment Plan was precipitated by our strategic decision to begin merging four product divisions (legacy Cardiac Rhythm Management, Neuromodulation, Cardiovascular and Atrial Fibrillation divisions) into one integrated operating segment. Upon changing our internal reporting structures in the third quarter of 2014 to align with the new global organization, we initiated the Manufacturing and Supply Chain Optimization Plan. The objectives of this plan were driven by opportunities we identified as a result of the enhanced visibility we had into our newly consolidated manufacturing and supply chain operations. As a net result of these related plans, we have closed certain of our facilities and consolidated their activities into other facilities, we have made changes to our product distribution methods in certain geographies and we now manage our operations with a single, global focus that is tailored, where necessary, for local requirements.
 
As we refined our long-term forecasts, including the integration of Thoratec into our business, we began to make decisions regarding the programs and initiatives we will prioritize to strengthen our strategic focus (2016 Initiatives). These decisions are being made in alignment with how we will manage the business in five key areas: Heart Failure, Atrial Fibrillation, Neuromodulation, Cardiovascular Disease and Traditional Cardiac Rhythm Management.

34



We plan to use some of the cost savings from the actions to reinvest in our growth drivers.
Other expense, net
 
 
 
 
 
(in millions)
2015
 
2014
 
2013
Interest income
$
(3
)
 
$
(5
)
 
$
(5
)
Interest expense
103

 
85

 
81

Other (income) expense
2

 
3

 
191

Other expense, net
$
102

 
$
83

 
$
267


Interest income: Our interest income is dependent on our outstanding cash balances and applicable interest rates.

Interest expense: Our interest expense has increased over the last two years as a result of higher average debt balances primarily issued to finance our business combinations. Our interest expense is expected to increase in future periods based on our average outstanding debt balance, given our recent debt issuances to fund our October 2015 acquisition of Thoratec. See Note 4 of our Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data" for further information on our debt.

Other (income) expense: Generally, our other (income) expense includes foreign currency transaction gains and losses, realized available-for-sale security gains and losses and gains and losses on derivative instruments not designated as hedging instruments. During 2015, we recognized $13 million of commitment fees associated with an unused bridge facility in other (income) expense. During 2013, we redeemed the full $700 million principal amount of 5-year, 3.75% unsecured senior notes originally due in 2014 (2014 Senior Notes) and the full $500 million principal amount of 10-year, 4.875% unsecured senior notes originally due in 2019 (2019 Senior Notes). In connection with the redemption of these notes prior to their scheduled maturities, we recognized a $161 million debt retirement charge to other (income) expense associated primarily with make-whole redemption payments and the write-off of unamortized debt issuance costs. Additionally, in connection with the initial February 2013 consolidation of CardioMEMS, we recognized a $29 million loss to other (income) expense related to a fair value remeasurement adjustment during 2013 to adjust the carrying value of our CardioMEMS equity investment and fixed price purchase option. Partially offsetting these expenses, we recognized $22 million, $3 million and $13 million of realized gains associated with the sales of available-for-sale securities in 2015, 2014 and 2013, respectively. The remaining increase in other (income) expense during 2015, 2014 and 2013 was substantially related to our foreign currency transaction losses.

Income taxes
(as a percent of earnings before income taxes and noncontrolling interest)
2015
 
2014
 
2013
Effective tax rate
6.7
%
 
10.6
%
 
11.7
%

Our effective tax rate differs from our U.S. federal statutory 35% tax rate due to our international operations that are subject to foreign tax rates that are lower than the U.S. federal statutory rate, state and local taxes and domestic tax incentives. Our effective tax rate is also impacted by discrete factors or events such as special charges, non-deductible charges, tax law changes or the resolution of audits by tax authorities.

Special charges, acquisition-related costs and discrete items favorably impacted the 2015 effective income tax rate by 9.9 percentage points. Special charges and discrete items recognized during 2014 favorably impacted the effective tax rate by 7.4 percentage points. Debt redemption charges and special charges favorably impacted our 2013 effective tax rate by 7.7 percentage points. Additionally, our 2013 effective tax rate includes the full year 2012 benefit of the R&D tax credit, which was extended for 2012 in January 2013. As a result of the late extension, our effective tax rate for 2013 was favorably impacted by 1.6 percentage points. Our effective tax rate, except for those items noted above, has been favorably impacted largely by changes in the mix of income before income taxes between the U.S. and foreign countries.

35


Net loss attributable to noncontrolling interest
(in millions)
2015
 
2014
 
2013
Net loss attributable to noncontrolling interest
$
(14
)
 
$
(47
)
 
$
(31
)

Net loss attributable to noncontrolling interest represents the elimination of the losses attributable to non-St. Jude Medical, Inc. ownership interests in St. Jude Medical, Inc. consolidated entities. The changes in the net loss attributable to noncontrolling interest are largely related to the differing periods during which there were non-St. Jude Medical, Inc. ownership interests in CardioMEMS and Spinal Modulation. Refer to Note 2 of the Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data" for additional information.

LIQUIDITY AND CAPITAL RESOURCES
We believe that our existing cash balances, future cash generated from operations and available borrowing capacity under our 5-year, $1.5 billion revolving, unsecured committed credit facility (Credit Facility Expiring 2020) and our commercial paper program will be sufficient to fund our operating needs, working capital requirements, R&D opportunities, capital expenditures, debt service requirements, share repurchases and shareholder dividends over the next 12 months and in the foreseeable future thereafter. Also, see the Off-Balance Sheet Arrangements and Contractual Obligation section that follows.
We believe that our earnings, cash flows and balance sheet position will permit us to obtain additional debt financing or equity capital should suitable investment and growth opportunities arise. We monitor capital markets regularly and may raise additional capital when market conditions or interest rate environments are favorable.
As of January 2, 2016, most of our cash and cash equivalents were held by our non-U.S. subsidiaries. A portion of these foreign cash balances are associated with earnings that are permanently reinvested and which we plan to use to support our continued growth plans outside the United States through funding of operations and other investment and growth opportunities. The majority of these funds are only available for use by our U.S. operations if they are repatriated into the United States. The funds repatriated would be subject to additional U.S. taxes upon repatriation; however, it is not practicable to estimate the amount of additional U.S. tax liabilities we would incur. We currently have no plans to repatriate these funds held by our non-U.S. subsidiaries.
Total debt increased to $6,392 million at January 2, 2016 from $3,852 million at January 3, 2015. During 2015, we issued $1.5 billion of unsecured senior notes and utilized proceeds of $2.1 billion from our 5-year, $2.6 billion Term Loan Due 2020 to finance a portion of our Thoratec acquisition. Additionally, we entered into a 365-day, $175 million Term Loan due 2016 (Term Loan due 2016) that was used to acquire the remaining ownership interest in Spinal Modulation. We also entered into the Credit Facility Expiring 2020 that we may draw upon to refinance existing indebtedness and for general corporate purposes. The Credit Facility Expiring 2020 amended and restated our previous $1.5 billion unsecured committed credit facility that was scheduled to expire in May 2018. As of January 2, 2016 and January 3, 2015, we had no outstanding borrowings under either facility. Partially offsetting our debt issuances, we repaid term loans totaling $925 million, including the Term Loan Due 2016, and made $285 million in net commercial paper payments. On January 15, 2016, we drew the remaining $500 million of the $2.6 billion Term Loan Due 2020 to refinance existing indebtedness and for general corporate purposes.
As expected from our debt issuances, rating agencies took the following actions:

On September 14, 2015, in connection with our $1.5 billion unsecured senior notes issuance, Fitch Ratings downgraded our long term ratings to A- and downgraded our short term rating to F2 with stable outlook and assigned an A- rating to the $1.5 billion unsecured senior notes.
On October 8, 2015, after completing our acquisition of Thoratec, Moody’s Investors Service downgraded our senior unsecured ratings to Baa2 with negative outlook and affirmed our Prime-2 short term rating;
Standard and Poor’s Ratings Services downgraded our corporate credit rating to A- with negative outlook and lowered our short term and commercial paper rating to A2.

As a result of the downgrade in our credit ratings, our interest rate on our Credit Facility Expiring 2020 changed from a rate of London InterBank Offered Rate (LIBOR) plus 0.680% to LIBOR plus 0.900%.

These announcements were a reflection of the increase in our debt used to support our acquisition of Thoratec. We do not expect the actions by the ratings agencies to have a significant impact on our liquidity or future flexibility to access additional funding.

36



Agency ratings are subject to change, and there can be no assurance that a ratings agency will continue to provide ratings and/or maintain its current ratings. A security rating is not a recommendation to buy, sell or hold securities, and may be subject to revision or withdrawal at any time by the rating agency, and each rating should be evaluated independently of any other rating. Agency ratings are based on a number of factors, which include financial strength, business and financial risk, as well as transparency with rating agencies and timeliness of financial reporting.
Certain of our debt outstanding and available borrowings contain operating and financial covenants. Specifically, the Credit Facility Expiring 2020 and the Term Loan Due 2020 require that we have a leverage ratio (defined as the ratio of indebtedness to EBITDA (net earnings before interest expense, income taxes, depreciation, amortization and certain income and expenses)) not exceeding 4.25 to 1.0 through the fiscal year ending January 2, 2016, 4.0 to 1.0 for the fiscal quarters of 2016, and 3.5 to 1.0 thereafter. In February 2016, we amended the Credit Facility Expiring 2020 and the Term Loan Due 2020 to clarify the leverage ratio calculation to exclude certain expenses relating to the Thoratec acquisition incurred in the fourth quarter of 2015 and include EBITDA from Thoratec for periods prior to completion of the business combination. Additionally, during the third quarter of 2015, we amended a debt covenant related to our 1.580% Yen Denominated Senior Notes Due 2017 and our 2.040% Yen Denominated Senior Notes Due 2020 (Yen Notes) to require a ratio of total debt to total capitalization not exceeding 65% through the second fiscal quarter of 2016 and reducing to 60% thereafter. Under the Credit Facility Expiring 2020, Term Loan Due 2020, senior notes and Yen Notes, we also have certain limitations on how we conduct our business, including limitations on dividends, additional liens or indebtedness and limitations on certain acquisitions, mergers, investments and dispositions of assets. We were in compliance with all of our debt covenants as of January 2, 2016. For further information on our debt obligations outstanding at January 2, 2016, refer to Note 4 of the Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data."
A summary of our cash flows from operating, investing and financing activities is provided in the following table (in millions):
 
2015
 
2014
 
2013
Net cash provided by (used in):
 
 
 
 
 
Operating activities
$
1,039

 
$
1,304

 
$
961

Investing activities
(3,445
)
 
(339
)
 
(522
)
Financing activities
1,692

 
(827
)
 
(257
)
Effect of currency exchange rate changes on cash and cash equivalents
(61
)
 
(69
)
 
(3
)
Net (decrease) increase in cash and cash equivalents
$
(775
)
 
$
69

 
$
179

Operating Cash Flows
Operating cash flows can fluctuate significantly from period to period due to payment timing differences of working capital accounts such as accounts receivable, inventories, accounts payable, accrued liabilities and income taxes payable. During 2015, our operating cash flows were negatively impacted due to Thoratec acquisition-related costs. During 2013, our operating cash flows were negatively impacted due to higher tax payments made as a result of a tax audit settlement associated with certain tax audits related to our 2002 through 2009 tax years.
We use two primary measures that focus on accounts receivable and inventory – days sales outstanding (DSO) and days inventory on hand (DIOH). We use DSO as a measure that places emphasis on how quickly we collect our accounts receivable balances from customers. We use DIOH, which can also be expressed as a measure of the estimated number of days of cost of sales on hand, as a measure that places emphasis on how efficiently we are managing our inventory levels. These measures may not be computed the same as similarly titled measures used by other companies. Our DSO (ending net accounts receivable divided by average daily sales for the most recently completed quarter) was 78 days at January 2, 2016 compared to 77 days at January 3, 2015 and 91 days at December 28, 2013. The overall decrease in our DSO over the last two years compared to December 28, 2013 is primarily a result of our increased receivable collection efforts as well as foreign currency translation impacts reducing our accounts receivable balance compared to the balance at December 28, 2013. Our DIOH (ending net inventory divided by average daily cost of sales for the most recently completed six months) was 179 days at January 2, 2016 compared to 170 days at January 3, 2015 and 158 days at December 28, 2013. Inventory acquired through our acquisition of Thoratec and related inventory step charges recognized in cost of sales in the last half of

37


2015 increased our DIOH by 10 days. The increase was primarily a result of additional Thoratec inventory acquired with only 13 weeks of Thoratec cost of sales activity based on our October 8, 2015 acquisition date. Special charges recognized in cost of sales in the last half of 2015 partially offset the Thoratec inventory impacts to our DIOH, reducing our January 2, 2016 DIOH by 6 days. Special charges recognized in cost of sales in the second half of 2014 reduced our January 3, 2015 DIOH by 7 days, and special charges recognized in cost of sales in the second half of 2013 reduced our December 28, 2013 DIOH by 5 days. The overall increase in our DIOH at January 2, 2016 and January 3, 2015 compared to our DIOH at December 28, 2013 is the result of higher inventory levels due to our business combinations and more inventory on hand to support our product launches.
Investing Cash Flows
We acquired Thoratec for $3.3 billion in net cash consideration during 2015, NeuroTherm for $147 million in net cash consideration during 2014, and Endosense and Nanostim for $171 million and $121 million in net cash consideration, respectively, during 2013, which have all contributed to our recent growth. We expect to continue to benefit from our recent business combinations in future periods. Additionally, our purchases of property, plant and equipment totaled $186 million, $190 million and $222 million in 2015, 2014 and 2013, respectively, primarily reflecting our continued investment in our product growth platforms currently in place.
Financing Cash Flows
Our financing cash flows can fluctuate significantly depending upon our liquidity needs, the extent of our common stock repurchases and the amount of stock option exercises. A summary of our financing cash flows is provided in the following table (in millions):
 
2015
 
2014
 
2013
Stock issued under employee stock plans, including tax benefit
$
163

 
$
156

 
$
458

Common stock repurchases
(500
)
 
(476
)
 
(833
)
Dividends paid
(322
)
 
(303
)
 
(282
)
Debt borrowings, net
2,562

 
275

 
554

Purchase of shares from noncontrolling ownership interest
(173
)
 
(344
)
 

Payment of contingent consideration

 
(128
)
 

Other, net
(38
)
 
(7
)
 
(154
)
Net cash provided by (used in) financing activities
$
1,692

 
$
(827
)
 
$
(257
)

During 2015, we entered into a $175 million Term Loan Due 2016 that was used to acquire the remaining ownership interest in Spinal Modulation and issued $1.5 billion of unsecured senior notes together with proceeds of $2.1 billion from our 5-year, $2.6 billion Term Loan Due 2020 issuance to finance a portion of our Thoratec acquisition. Partially offsetting our 2015 debt issuances, we repaid our 2-year, $500 million unsecured term loan due June 2015, our 364-day, $250 million unsecured term loan due August 2015, our $175 million Term Loan Due 2016 and made net commercial paper payments of $285 million. We exercised our exclusive option and paid $173 million to Spinal Modulation’s shareholders to obtain the remaining 81% ownership interest in the company that we did not previously own. Both of our yen-denominated credit facilities that expired in June 2015 and March 2015 for 3.25 billion Japanese Yen each (the combined equivalent of $54 million as of January 2, 2016) were automatically extended for a one-year period bearing interest at Yen LIBOR plus 0.270% and Yen LIBOR plus 0.250%, respectively. Refer to Notes 4 and 6 to the Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data" for further information.

During 2014, we exercised our exclusive option and paid $344 million to CardioMEMS' shareholders to obtain the remaining 81% ownership interest in the company that we did not previously own. Additionally, we received FDA approval of the TactiCath® irrigated ablation catheter and settled the contingent consideration liability. Refer to Notes 6 and 11 to the Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data" for further information regarding both of these transactions. Additionally, during 2014, we entered into a 364-day, $250 million unsecured term loan and used the proceeds for general corporate purposes, including the acquisition of NeuroTherm.

During 2013, we issued $900 million principal amount of 10-year, 3.25% unsecured senior notes (2023 Senior Notes) and $700 million principal amount of 30-year, 4.75% unsecured senior notes (2043 Senior Notes). We used

38


the majority of the proceeds to redeem both our $700 million principal amount 2014 Senior Notes and our $500 million principal amount 2019 Senior Notes. We used the remaining proceeds from the issuance of our 2023 Senior Notes and 2043 Senior Notes for general corporate purposes. We also entered into a 2-year, $500 million unsecured term loan during 2013 and used the proceeds for general corporate purposes.

Generally, our common stock repurchases are funded from cash generated from operations and issuances of commercial paper. Changes in our common stock repurchases can vary from year to year based on our Board of Director authorization limits.

We have increased our dividends every year since 2011. On February 19, 2016 our Board of Directors authorized a cash dividend of $0.31 per share payable on April 30, 2016 to shareholders of record as of March 31, 2016. We expect to continue to pay quarterly cash dividends in the foreseeable future, subject to Board approval.

OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
We believe that our off-balance sheet arrangements do not have a material current or anticipated future effect on our consolidated earnings, financial position or cash flows. Our off-balance sheet arrangements principally consist of operating leases for various facilities and equipment and purchase commitments.
In the normal course of business, we periodically enter into agreements that require us to indemnify customers or suppliers for specific risks, such as claims for injury or property damage arising out of our products or the negligence of our personnel or claims alleging that our products infringe third-party patents or other intellectual property. In addition, under our bylaws and indemnification agreements we have entered into with our executive officers and directors, we may be required to indemnify our executive officers and directors for losses arising from their conduct in an official capacity on behalf of St. Jude Medical. We may also be required to indemnify officers and directors of certain companies that we have acquired for losses arising from their conduct on behalf of their companies prior to the closing of our acquisition. Our maximum exposure under these indemnification obligations cannot be estimated, and we have not accrued any liabilities within our Consolidated Financial Statements or included any indemnification provisions in our commitments table. Historically, we have not experienced significant losses on these types of indemnification obligations.
A summary of contractual obligations and other minimum commercial commitments as of January 2, 2016 is as follows (in millions):
 
Payments Due by Period
 
 
Less than
1-3
3-5
More than
 
Total
1 Year
Years
Years
5 Years
Contractual obligations related to
 
 
 
 
 
off-balance sheet arrangements:
 
 
 
 
 
 Operating lease obligations
$
190

$
53

$
62

$
43

$
32

 Purchase obligations (a)
429

373

37

19


   Total
$
619

$
426

$
99

$
62

$
32

 
 
 
 
 
 
Contractual obligations reflected
 
 
 
 
 
in the balance sheet:
 
 
 
 
 
 Long-term debt obligations (b)
$
7,463

$
750

$
1,025

$
2,550

$
3,138

 Contingent consideration (c)
151

118

25

8


 Uncertain tax positions (d)
150

150




   Total
$
7,764

$
1,018

$
1,050

$
2,558

$
3,138

 
 
 
 
 
 
Grand Total (e)
$
8,383

$
1,444

$
1,149

$
2,620

$
3,170

 
(a)
 
These amounts include commitments for inventory purchases and capital expenditures that do not exceed our projected requirements and are in the normal course of business. The purchase commitment amounts do not represent the entire anticipated purchases and capital expenditures in the future, but only those for which we are contractually obligated (enforceable and legally binding with all significant terms).

39


 
(b)
 
Includes scheduled maturities of long-term debt and scheduled interest payments. See Note 4 to the Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data" for additional information on our debt obligations. Based on our anticipated future liquidity, we may make payments on our long-term debt in advance of our scheduled maturities.
 
(c)
 
Generally, these amounts include our contingent consideration payments related to certain of our acquisitions. In connection with these acquisitions, we may have agreed, or companies that we acquired may have previously agreed, to provide additional consideration payments upon the achievement of certain product development milestones, which may include but are not limited to successful levels of achievement in clinical trials and certain product regulatory approvals. We may also provide for additional consideration payments to be made upon the achievement of certain levels of future product sales. While it is not certain if and/or when these payments will be made, we have included the current fair values of payments in the table based on our best estimates of the dates when we expect the milestones and/or contingencies will be met.
 
(d)
 
The table includes the current portion of the liability for uncertain tax positions, which is expected to be paid in the next 12 months. The table does not include our noncurrent liability for uncertain tax positions of $208 million or our related accrual for gross interest and penalties of $38 million as of January 2, 2016, as we are uncertain as to if or when such amounts may be paid.
 
 
 
 
 
(e)
 
The table does not include other liabilities of $302 million pertaining to non-qualified deferred compensation because the timing of the future cash payments is uncertain.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Preparation of our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States (U.S. GAAP) 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. Our significant accounting policies are disclosed in Note 1 to the Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data."
On an ongoing basis, we evaluate our estimates and assumptions, including those related to our acquisition-related measurements, income taxes and legal proceedings. 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 and expenses. Actual results may differ from these estimates. Senior management has discussed the development, selection and disclosure of its critical accounting policies and estimates with the Audit Committee and the Board of Directors. We believe that the following represent our most critical accounting estimates because (1) they are most important to the portrayal of our financial conditions and results and (2) they require our most difficult, subjective or complex judgments:
Acquisition-related Measurements
We make significant estimates in performing the initial measurements required by the acquisition method of accounting. Certain related items, such as intangible assets, contingent consideration and goodwill are subsequently measured as described below. The inputs and assumptions for the various estimates are often interrelated. As a result, a change to an assumption for a single acquired technology, for example, may affect several of the measurements and may simultaneously have favorable and unfavorable impacts on our Consolidated Statements of Earnings.
Business Combinations: We applied the acquisition method of accounting to one transaction in 2015, one transaction in 2014 and four transactions in 2013. When we apply the acquisition method of accounting, the total purchase consideration is allocated to identifiable assets acquired, liabilities assumed and noncontrolling interests (“net assets”). Any residual purchase consideration is recorded as goodwill. Identifying net assets requires significant judgment, especially with respect to intangible assets, including IPR&D activities, of the acquired entity. Specific acquired IPR&D projects that are to be used in our R&D activities are separately identified as one or more units of account (generally based on jurisdiction) in purchase accounting when the projects have substance and are incomplete at the business combination date.
Determining the total purchase consideration utilizes significant estimates when we previously hold an equity interest in the acquired entity and/or when the terms of the agreements contain contingent consideration payments. The allocation of the purchase price among the net assets utilizes significant estimates in determining the fair values of the respective net assets, especially with respect to intangible assets (including IPR&D assets). We

40


typically engage independent third-party appraisal firms to assist in the estimation process. Examples of the significant estimates and assumptions inherent in the initial measurements include, but are not limited to:
timing and amount of revenue and future cash flows, which often depend on estimates of relevant market sizes, expected market growth rates, trends in technology (including the impacts of anticipated product introductions by competitors, legal agreements and patent litigation), the expected useful lives of acquired technologies and the expected completion date of IPR&D projects;
expected costs to develop the IPR&D projects into commercially viable products, which include the stage of completion, the complexity of the work to complete, the contribution of core technologies and other acquired assets and the required clinical investment to obtain regulatory approval;
the discount rate reflecting the risk inherent in future cash flows; and
perpetual growth rate used to calculate the terminal value, where applicable.

While we use our best estimates and assumptions to accurately value the net assets at the acquisition date as well as contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the net assets with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of the net assets, whichever comes first, any subsequent adjustments are recorded to our Consolidated Statements of Earnings.
Intangible Assets: We make estimates and assumptions in accounting for intangible assets subsequent to acquisition for which results will emerge over long periods of time. These estimates and assumptions are closely monitored by management and periodically adjusted as circumstances warrant.
The carrying values of our definite-lived intangible assets were $1,370 million and $708 million at January 2, 2016 and January 3, 2015, respectively, and consisted primarily of purchased technology and patents. We establish the estimated useful lives of these intangible assets at the acquisition date by considering our expected uses of the assets, provisions that may limit the useful lives, the effects of obsolescence and other factors. If reliably determinable, we amortize these assets in a pattern reflecting consumption of their economic benefits; otherwise we utilize the straight-line amortization method. We test these assets for recoverability whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Examples of indicators we monitor include, but are not limited to, significant adverse changes in the manner in which the asset is being used, legal and regulatory factors, business climate (including impacts of competing technologies) and forecasted cash flows. If we determine that the carrying amounts for the assets are not recoverable, we impair the carrying amounts to the assets’ fair values using the income approach and updated estimates and assumptions. During 2015 and 2013 we recognized impairment charges of $2 million and $13 million, respectively. There were no impairments of definite-lived intangible assets in 2014.
The carrying values of our indefinite-lived intangible assets were $856 million and $143 million at January 2, 2016 and January 3, 2015, respectively, and consisted primarily of IPR&D projects. We test these assets for impairment annually or more frequently if events or changes in circumstances (including completion or abandonment of the IPR&D projects) indicate that the fair value of the asset is more likely than not below its carrying amount. In evaluating whether a quantitative test is necessary, we consider the totality of all relevant events or circumstances that could affect the significant inputs used to determine the fair values of these assets. This assessment includes consideration of qualitative factors such as macroeconomic conditions, industry and market considerations, cost factors, financial performance, entity-specific events and regulatory or other factors. If we determine that an indefinite-lived intangible asset is more likely than not impaired, we impair the carrying amount to the asset’s fair value using the income approach and updated estimates and assumptions. When an IPR&D project is completed (generally upon receipt of regulatory approval), the asset is then accounted for as a definite-lived intangible asset. During 2014, we reclassified $96 million of IPR&D to definite-lived intangible assets. During 2014 and 2013, we recognized impairment charges of $58 million and $29 million, respectively. There were no impairments of indefinite-lived intangible assets in 2015.
Contingent Consideration: The fair value of our contingent consideration was $151 million and $50 million at January 2, 2016 and January 3, 2015, respectively. The fair value of contingent consideration is remeasured to the estimated fair value each reporting period with the change in fair value recognized in selling, general and administrative expense in our Consolidated Statements of Earnings. Changes in the fair value of the contingent consideration liability can result from changes in discount rates and periods as well as changes in the timing and amounts of revenue estimates or in the timing or likelihood of achieving the milestones that trigger payment. These

41


changes resulted in (benefits) or charges of ($87 million), $22 million and $1 million during 2015, 2014 and 2013, respectively.
Income Taxes
We estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax expense as well as assessing temporary differences in the treatment of items for tax and financial accounting purposes. These timing differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheets. We assess the likelihood that our deferred tax assets will be realized from future taxable income after consideration of all positive and negative evidence. Evidence we consider varies for different tax jurisdictions. In situations in which we have been able to conclude that our deferred tax assets will be realized, we have generally relied on future reversals of taxable temporary differences, expected future taxable income where such estimates have historically been reliable and other factors. Certain of our subsidiaries in international tax jurisdictions, however, are in cumulative loss positions and have experienced cumulative losses in recent periods. Experiencing cumulative losses in recent periods is considered significant negative evidence that is difficult to overcome with other positive evidence. In these situations, we reduce the carrying value of deferred tax assets that arose primarily from net operating losses and tax credit carryforwards by recording valuation allowances because we do not believe it is more-likely-than-not that these assets will be realized. Gross deferred tax assets were $1,012 million and $1,066 million at January 2, 2016 and January 3, 2015, respectively. We have established valuation allowances of $337 million and $400 million at January 2, 2016 and January 3, 2015, respectively.
We have not provided U.S. income taxes on certain of our non-U.S. subsidiaries' undistributed earnings, as such amounts are intended to be reinvested outside the United States indefinitely based on our specific business plans and tax strategies. Our business plans and tax strategies consider: (i) short-term and long-term forecasts and budgets of the U.S. parent and non-U.S. subsidiaries; (ii) working capital and other needs in locations where earnings are generated; (iii) our past practices regarding non-U.S. subsidiary dividends; (iv) sources of financing by the U.S. parent, such as issuing debt; and (v) uses of cash by the U.S. parent that are more discretionary in nature, such as business combinations and share repurchase programs. However, should we change our business plans and tax strategies in the future and decide to repatriate a portion of these earnings to one of our U.S. subsidiaries, including cash maintained by these non-U.S. subsidiaries, we would recognize additional U.S. tax liabilities. It is not practicable to estimate the amount of additional U.S. tax liabilities we would incur.

We record our income tax provisions based on our knowledge of all relevant facts and circumstances, including the existing tax laws, our experience with previous settlement agreements, the status of current tax audits and examinations and our understanding of how the tax authorities view certain relevant industry and commercial matters. We recognize liabilities for anticipated income tax audit issues in the United States and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. Our estimate of whether additional taxes will be due is based on analyses of whether we believe that it is more-likely-than-not that our tax position is sustainable based solely on its technical merits and consideration of the taxing authorities’ widely understood administrative practices and precedents. Our estimate of the extent to which additional taxes will be due is based on analyses of the portion that is greater than 50 percent likely to be realized upon settlement with taxing authorities that have full knowledge of all relevant information.

Although we recognize income tax liabilities related to our uncertain tax positions, our accruals represent accounting estimates that are subject to the inherent uncertainties associated with the tax audit process, and therefore include certain contingencies. The finalization of the tax audit process across the various tax authorities, including federal, state and foreign, often takes many years. We adjust our income tax liabilities in light of changing facts and circumstances as new information becomes available; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current tax liabilities estimate. If our estimate of tax liabilities proves to be less than the ultimate assessment, an additional income tax expense would result. As of January 2, 2016, our liability for uncertain tax positions was $338 million and our accrual for gross interest and penalties was $58 million. As of January 3, 2015, our liability for uncertain tax positions was $328 million and our accrual for gross interest and penalties was $44 million.

42


Legal Proceedings 
We operate in an industry that is susceptible to significant product liability and intellectual property claims. Additionally, we have been subject to legal actions involving shareholder derivative actions, securities class actions and other class actions. The outcomes of our legal proceedings are not in our complete control due to inherent uncertainties, including unfavorable rulings or developments, and may not be known for extended periods of time. We record a liability in our Consolidated Financial Statements for costs related to claims, including future legal costs, settlements and judgments where we have assessed that a loss is probable and an amount can be reasonably estimated. Where the reasonable estimate of the probable loss is a range, we record the most likely estimate of the loss, or the low end of the range if there is no one best estimate. Product liability claims may be brought by individuals seeking relief for themselves or, increasingly, by groups seeking to represent a class. In situations in which we believe that a loss is at least reasonably possible, we are often not able to estimate an amount or range of potential loss often because the amounts claimed typically bear no relation to the extent of the plaintiff’s alleged injury. Estimates of probable losses resulting from our litigation, claims and assessments are inherently difficult to predict, particularly when the matters are in early procedural stages, have incomplete scientific facts or are in legal discovery, involve unsubstantiated or indeterminate claims for damages, potentially involve penalties, fines or punitive damages, or could result in a change in our business practice. Additionally, claims may be asserted against us in the future related to events that are not presently known to us. While it is not possible to predict the outcome for most of our legal proceedings and litigation is subject to inherent uncertainties, there can be no certainty that we may not ultimately incur charges in excess of our presently recorded liabilities. A future adverse ruling, settlement or unfavorable development could have a material adverse effect on our consolidated earnings, financial position or cash flows. Based on our experience and any new developments, we reexamine our estimated probable liabilities and associated expenses each period and where appropriate we adjust our estimated liabilities. As a result, our current estimates are subject to change in future periods.

NEW ACCOUNTING PRONOUNCEMENTS
Certain new accounting standards may become effective for us in fiscal year 2016 and future periods upon finalization. Information regarding new accounting pronouncements that impacted 2015 or our historical Consolidated Financial Statements and related disclosures is included in Note 1 to the Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data."

CAUTIONARY STATEMENTS
In this discussion and in other written or oral statements made from time to time, we have included and may include statements that constitute “forward-looking statements” with respect to the financial condition, results of operations, plans, objectives, new products, future performance and business of St. Jude Medical, Inc. and its subsidiaries. Statements preceded by, followed by or that include words such as “may,” “will,” “expect,” “anticipate,” “continue,” “estimate,” “forecast,” “project,” “believe” or similar expressions are intended to identify some of the forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are included, along with this statement, for purposes of complying with the safe harbor provisions of that Act. These forward-looking statements involve risks and uncertainties. By identifying these statements for you in this manner, we are alerting you to the possibility that actual results may differ, possibly materially, from the results indicated by these forward-looking statements. We undertake no obligation to update any forward-looking statements. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the risks and uncertainties discussed in the previous section entitled Off-Balance Sheet Arrangements and Contractual Obligations, in Part I, Item 1A, "Risk Factors" including the various factors described below and in Part I, Item 7A. "Qualitative and Quantitative Disclosures About Market Risk." Since it is not possible to foresee all such factors, you should not consider these factors to be a complete list of all risks or uncertainties. We believe the most significant factors that could affect our future operations and results are set forth in the following list.
1.
 
Competition, including product introductions by competitors that have advanced technology, better features or lower pricing.
2.
 
Consolidation and other healthcare industry changes leading to demands for price concessions and/or limitations on, or the elimination of, our ability to sell in significant market segments.
3.
 
Changes in laws, regulations or administrative practices affecting government regulation of our products, such as FDA regulations, including those that decrease the probability or increase the time and/or expense of obtaining approval for products or impose additional burdens on the manufacture and sale of medical devices.

43


4.
 
Governmental legislation, including the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act, and/or regulation that significantly impacts the healthcare system in the United States or in international markets and that results in lower reimbursement for procedures using our products or denies coverage for such procedures, reduces medical procedure volumes or otherwise adversely affects our business and results of operations, including the imposition of any medical device excise tax.
5.
 
Any changes to the U.S. Medicare or Medicaid systems or international reimbursement systems that significantly reduces reimbursement for procedures using our medical devices or denies coverage for such procedures, as well as adverse decisions relating to our products by administrators of such systems on coverage or reimbursement issues.
6.
 
Adverse developments in investigations and governmental proceedings.
7.
 
Changes in accounting rules or tax laws that adversely affect our results of operations, financial position or cash flows.
8.
 
Risks associated with our substantial international operations, including economic and political instability, currency fluctuations, changes in customs, tariffs and other trade restrictions and compliance with foreign laws.
9.
 
Disruptions in the financial markets or changes in economic conditions, including interest rates, inflation rates and exchange rates, that adversely impact the availability and cost of credit and customer purchasing and payment patterns, including the collectability of customer accounts receivable.
10.
 
Our inability to realize the expected benefits from our restructuring initiatives and continuous improvement efforts and the negative unintended consequences such activity could have.
11.
 
Our inability to maintain, protect and enhance our information and manufacturing systems and our products that incorporate information technology or to develop new systems and products as well as risks to the privacy and security of customer, patient, third-party payor, employee, supplier or company information from continually evolving cybersecurity threats.
12.
 
Inability to successfully integrate the businesses that we have acquired in recent years, including our recent acquisition of Thoratec, and that we plan to acquire.
13.
 
The substantial additional indebtedness we incurred to finance the Thoratec acquisition, which may decrease our business flexibility and increase our borrowing costs.
14.
 
A reduction in the number of procedures using our devices caused by cost-containment pressures, publication of adverse study results, initiation of investigations of our customers related to our devices or the development of or preferences for alternative technologies or therapies.
15.
 
Safety, performance or efficacy concerns about our products, many of which are expected to be implanted for many years, some of which may lead to recalls and/or advisories with the attendant expenses and declining sales.
16.
 
Failure to successfully complete, or unfavorable data from, clinical trials for our products or new indications for our products and/or failure to successfully develop markets for such new indications.
17.
 
Assertion, acquisition or grant of key patents by or to others that have the effect of excluding us from market segments or requiring us to pay royalties.
18.
 
Declining industry-wide sales caused by product quality issues or recalls or advisories by us or our competitors that result in loss of physician and/or patient confidence in the safety, performance or efficacy of sophisticated medical devices in general and/or the types of medical devices recalled in particular.
19.
 
Adverse developments in litigation, including product liability litigation, patent or other intellectual property litigation, qui tam litigation or shareholder litigation.
20.
 
The loss of, or price increases by, suppliers of key components, some of which are sole-sourced.
21.
 
Regulatory actions arising from concern over Bovine Spongiform Encephalopathy, sometimes referred to as “mad cow disease,” that have the effect of limiting our ability to market products using bovine collagen, such as Angio-Seal™, or products using bovine pericardial material, such as our Biocor®, Epic™, Trifecta™ and Portico™ tissue heart valves or that impose added costs on the procurement of bovine collagen or bovine pericardial material.
22.
 
Conditions imposed in resolving, or any inability to timely resolve, any regulatory issues raised by the FDA, including Form 483 observations or warning letters, as well as risks generally associated with our health, safety and environmental regulatory compliance and quality systems.
23.
 
Our ability to fund future product liability losses related to claims made subsequent to becoming self-insured.

44


24.
 
Severe weather or other natural disasters that can adversely impact customer purchasing patterns and/or patient implant procedures or cause damage to the facilities of our critical suppliers or one or more of our facilities, such as an earthquake affecting our facilities in California, Puerto Rico and Costa Rica or a hurricane affecting our facilities in Puerto Rico and Malaysia.



45


 
 
Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MARKET RISK

In the normal course of business, we are exposed to market risk primarily due to changes in foreign currency exchange rates and interest rates. Changes in these rates could result in fluctuations in our earnings and cash flows. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, we do not expect any material losses from these risks.

We are also exposed to credit risk in the event of nonperformance by our counterparties involved in our derivative financial instruments. Our risk, however, is limited to the fair value of the instrument. Additionally, we limit our counterparties to major financial institutions. We perform periodic evaluations of the relative credit standings of these financial institutions and also limit the amount of credit exposure with any one financial institution. We do not anticipate nonperformance by any of our counterparties.

We perform sensitivity analyses to determine the effects that market risk exposures may have on our financial position and results of operations. The financial instruments included in the sensitivity analyses include our senior notes, short-term and long-term variable-rate debt and our derivative financial instruments. Our derivative financial instruments generally include interest rate swaps and foreign exchange forward contracts.

Interest Rate Risk

Interest rate volatility may cause fluctuations in our income statement and cash flows with respect to existing debt and future debt issuances. We manage interest expense using a mix of fixed and floating rate debt. To help manage borrowing costs, we may enter into interest rate swaps that are designated and qualify as fair value hedges. Under these arrangements, we agree to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed upon notional principal amount (see Note 4 of our Consolidated Financial Statements within Item 8. "Financial Statements and Supplementary Data" for further information on our debt and references to its related derivatives and/or hedging instruments in prior periods).

To perform the interest rate sensitivity analyses, we assess the change in the fair value of our senior notes and the change in our interest expense on our variable-rate debt assuming a hypothetical change of one percentage point in interest rates. The estimated change in the fair value of our senior notes was measured by recalculating the yield and corresponding fair value impact and comparing the recalculated fair values to the current fair value of our senior notes at January 2, 2016. The change in our estimated 2016 interest expense on our variable-rate debt was recalculated assuming a hypothetical change of one percentage point in interest rates based on our estimated variable-rate debt outstanding during 2016. The interest rates used are based on rates in effect at January 2, 2016. The differences in these comparisons are the hypothetical gains or losses associated with our interest rate risk.

Based on our January 2, 2016 debt obligations and contractual payments due during 2016, we estimate a hypothetical one-percentage point change in our interest rates would have the following impacts (in millions):
 
Hypothetical
Hypothetical
Change in:
+1 percentage point
-1 percentage point
Estimated fair value of debt obligations as of January 2, 2016
$
(230
)
$
260

Estimated 2016 interest expense
26

(24
)










46


Foreign Exchange Rate Risk

Foreign currency exchange rates and fluctuations in those rates may cause fluctuations in cash flows related to foreign denominated transactions. We enter into foreign currency forward contracts to hedge against the effect of exchange rate fluctuations on cash flows denominated in Euros and Japanese Yen. These transactions are designated as cash flow hedges. We may dedesignate these cash flow hedge relationships in advance of the occurrence of the forecasted transaction. Additionally, we enter into foreign currency forward contracts that are not designated in hedging relationships to offset, in part, the impacts of certain intercompany receivables and payables arising from intercompany purchases of manufactured products. We are also exposed to foreign currency exchange rate fluctuations due to transactions denominated primarily in Euros and the Japanese Yen. When the U.S. Dollar weakens against foreign currencies, the dollar value of sales denominated in foreign currencies increases and vice versa. A hypothetical 10% change in the value of the U.S. Dollar in relation to our foreign currency denominated sales would have an impact of approximately $245 million on our 2015 net sales. This amount is not necessarily indicative of the hypothetical net earnings impact due to partially offsetting impacts on the related cost of sales, operating expenses and cash flow hedges in place in the applicable foreign currencies.

To perform the foreign exchange rate sensitivity analysis for our derivative financial instruments, market values are computed based on the present value of future cash flows as affected by a hypothetical 10% change in the U.S. Dollar against the Euro and Japanese Yen. The foreign currency exchange rates used are based on rates in effect at January 2, 2016. The differences in these comparisons are the hypothetical gains or losses associated with our foreign exchange rate risk. Information provided by this sensitivity analysis does not necessarily represent the actual changes in fair value that we would incur under normal market conditions due to practical limitations as all variables, other than the specific market risk factor, are held constant. In addition, the results of the models are constrained by the fact that forecasted foreign currency cash flows are excluded from the analysis, while the financial instruments relating to the hedged item are included. As a result, reported changes in the values of certain derivative financial instruments impacting the results of the sensitivity analysis are not matched with the offsetting changes in the values of the items being hedged.

At January 2, 2016, a hypothetical 10% weaker U.S. Dollar against hedged currencies, with all other variables held constant, would result in an estimated increase in the fair value of our derivative financial instruments of approximately $94 million as of January 2, 2016. Conversely, a hypothetical 10% stronger U.S. Dollar against hedged currencies, with all other variables held constant, would result in an estimated decrease in the fair value of our financial instruments of approximately $103 million as of January 2, 2016.



47


 
 
Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Management
Management's Report on the Financial Statements
We are responsible for the preparation, integrity and objectivity of the accompanying financial statements. The financial statements were prepared in accordance with accounting principles generally accepted in the United States and include amounts which reflect management's best estimates based on its informed judgment and consideration given to materiality. We are also responsible for the accuracy of the related data in the annual report and its consistency with the financial statements.
Audit Committee Oversight
The adequacy of our internal accounting controls, the accounting principles employed in our financial reporting and the scope of independent and internal audits are reviewed by the Audit Committee of the Board of Directors, consisting solely of independent directors. The independent registered public accounting firm meets with, and has unrestricted access to, the Audit Committee to discuss the results of its audit work.
Management's Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of the Company's management, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework established by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Based on this evaluation, we concluded that our internal control over financial reporting was effective as of January 2, 2016. Management's assessment of the effectiveness of the Company's internal control over financial reporting as of January 2, 2016 excluded Thoratec Corporation, which was acquired by the Company in October 2015 in a purchase business combination. Thoratec Corporation is a wholly-owned subsidiary of the Company whose total assets and total net sales represented less than 35% of consolidated total assets and less than 3% of consolidated net sales, respectively, of the Company as of and for the year ended January 2, 2016. As permitted by guidelines established by the Securities and Exchange Commission, companies are allowed to exclude certain acquisitions from their assessments of internal control over financial reporting during the first year of an acquisition while integrating the acquired companies. Our internal control over financial reporting as of January 2, 2016, has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report, which is included herein, which expresses an unqualified opinion on the effectiveness of the Company's internal control over financial reporting as of January 2, 2016.

/s/   Michael T. Rousseau
Michael T. Rousseau
President and Chief Executive Officer

/s/   Donald J. Zurbay
Donald J. Zurbay
Vice President, Finance and Chief Financial Officer


48


Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
of St. Jude Medical, Inc.

We have audited St. Jude Medical, Inc.’s internal control over financial reporting as of January 2, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). St. Jude Medical, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As indicated in the accompanying Management’s Annual Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Thoratec Corporation, which is included in the consolidated financial statements of St. Jude Medical, Inc. and constituted less than 35% of consolidated total assets as of January 2, 2016 and less than 3% of consolidated net sales for the year then ended. Our audit of internal control over financial reporting of St. Jude Medical, Inc. also did not include an evaluation of the internal control over financial reporting of Thoratec Corporation.

In our opinion, St. Jude Medical, Inc. maintained, in all material respects, effective internal control over financial reporting as of January 2, 2016, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of St. Jude Medical, Inc. as of January 2, 2016 and January 3, 2015, and the related consolidated statements of earnings, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended January 2, 2016, and our report dated February 23, 2016 expressed an unqualified opinion thereon.


/s/ Ernst & Young LLP

Minneapolis, Minnesota
February 23, 2016

49


Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
of St. Jude Medical, Inc.
 
We have audited the accompanying consolidated balance sheets of St. Jude Medical, Inc. as of January 2, 2016 and January 3, 2015, and the related consolidated statements of earnings, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended January 2, 2016. Our audit also included the financial statement schedule listed in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of St. Jude Medical, Inc. at January 2, 2016 and January 3, 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 2, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), St. Jude Medical, Inc.’s internal control over financial reporting as of January 2, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 23, 2016 expressed an unqualified opinion thereon.


/s/ Ernst & Young LLP
 
Minneapolis, Minnesota
February 23, 2016


50



CONSOLIDATED STATEMENTS OF EARNINGS
(in millions, except per share amounts)

Fiscal Year Ended
January 2, 2016
 
January 3, 2015
 
December 28, 2013
Net sales
$
5,541

 
$
5,622

 
$
5,501

Cost of sales:
 

 
 

 
 
Cost of sales before special charges
1,706

 
1,597

 
1,529

Special charges
39

 
56

 
45

Total cost of sales
1,745

 
1,653

 
1,574

Gross profit
3,796

 
3,969

 
3,927

Selling, general and administrative expense
1,878

 
1,856

 
1,805

Research and development expense
676

 
692

 
691

Amortization of intangible assets
116

 
89

 
79

Special charges
96

 
181

 
301

Operating profit
1,030

 
1,151

 
1,051

Interest income
(3
)
 
(5
)
 
(5
)
Interest expense
103

 
85

 
81

Other (income) expense
2

 
3

 
191

     Other expense, net
102

 
83

 
267

Earnings before income taxes and noncontrolling interest
928

 
1,068

 
784

Income tax expense
62

 
113

 
92

Net earnings before noncontrolling interest
866

 
955

 
692

Less: Net loss attributable to noncontrolling interest
(14
)
 
(47
)
 
(31
)
Net earnings attributable to St. Jude Medical, Inc.
$
880

 
$
1,002

 
$
723

Net earnings per share attributable to St. Jude Medical, Inc.:
 
 

 
 
Basic
$
3.11

 
$
3.52

 
$
2.52

Diluted
$
3.07

 
$
3.46

 
$
2.49

Cash dividends declared per share:
$
1.16

 
$
1.08

 
$
1.00

Weighted average shares outstanding:
 

 
 

 
 
Basic
282.2

 
285.0

 
287.0

Diluted
286.3

 
289.7

 
290.6

The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.


51



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)

Fiscal Year Ended
January 2, 2016
 
January 3, 2015
 
December 28, 2013
Net earnings before noncontrolling interest
$
866

 
$
955

 
$
692

Other comprehensive income (loss), net of tax:
 

 
 

 
 
Unrealized gain (loss) on available-for-sale securities, net of tax (expense) benefit of $7 million, $4 million and $3 million, respectively
(12
)
 
(2
)
 
(3
)
Unrealized gain (loss) on derivative financial instruments, net of tax (expense) benefit of ($6 million), $0 million and $0 million, respectively
8

 

 
3

Foreign currency translation adjustment
(168
)
 
(217
)
 

Other comprehensive income (loss)
(172
)
 
(219
)
 

Total comprehensive income before noncontrolling interest
694

 
736

 
692

Total comprehensive loss attributable to noncontrolling interest
(14
)
 
(47
)
 
(31
)
Total comprehensive income attributable to St. Jude Medical, Inc.
$
708

 
$
783

 
$
723

The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.


52


CONSOLIDATED BALANCE SHEETS
(in millions, except par value and share amounts)
 
January 2, 2016
 
January 3, 2015
ASSETS
 

 
 

Current Assets
 

 
 

Cash and cash equivalents
$
667

 
$
1,442

Accounts receivable, less allowance for doubtful accounts of $46 million and $53 million, respectively
1,237

 
1,215

Inventories
909

 
784

Deferred income taxes
264

 
291

Other current assets
188

 
168

Total current assets
3,265

 
3,900

Property, Plant and Equipment
 
 
 
Land, building and improvements
729

 
709

Machinery and equipment
1,597

 
1,616

Diagnostic equipment
441

 
450

Property, plant and equipment, at cost
2,767

 
2,775

Less: Accumulated depreciation
(1,447
)
 
(1,432
)
Net property, plant and equipment
1,320

 
1,343

Goodwill
5,651

 
3,532

Intangible assets, net
2,226

 
851

Deferred income taxes
132

 
113

Other assets
470

 
454

TOTAL ASSETS
$
13,064

 
$
10,193

LIABILITIES AND SHAREHOLDERS’ EQUITY
 

 
 

Current Liabilities
 

 
 

Current debt obligations
$
1,163

 
$
1,593

Accounts payable
201

 
151

Dividends payable
82

 
77

Income taxes payable
201

 
60

Employee compensation and related benefits
309

 
292

Other current liabilities
517

 
493

Total current liabilities
2,473

 
2,666

Long-term debt
5,229

 
2,259

Deferred income taxes
738

 
240

Other liabilities
582

 
784

Total liabilities
9,022

 
5,949

Commitments and Contingencies (Note 5)

 

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; 283,450,374 and 286,659,901 shares issued and outstanding, respectively)
28

 
29

Additional paid-in capital
148

 
118

Retained earnings
4,211

 
4,225

Accumulated other comprehensive income (loss)
(345
)
 
(173
)
Total shareholders' equity before noncontrolling interest
4,042

 
4,199

Noncontrolling interest

 
45

Total shareholders' equity
4,042

 
4,244

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
13,064

 
$
10,193

The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.

53


CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in millions, except share amounts)
 
 
 
 
Accumulated
 
 
 
Common Stock
Additional
 
Other
Non-
Total
 
Number of
 
Paid-In
Retained
Comprehensive
controlling
Shareholders'
 
Shares
Amount
Capital
Earnings
Income (Loss)
Interest
Equity
Balance as of
December 29, 2012
295,648,327

$
30

$

$
4,018

$
46

$

$
4,094

Net earnings
 
 
 
723

 
(31
)
692

Other comprehensive income (loss)
 
 
 
 



Cash dividends declared
 
 
 
(286
)
 
 
(286
)
Repurchases of common stock
(18,385,436
)
(2
)
(287
)
(519
)
 
 
(808
)
Stock-based compensation
 
 
65

 
 
 
65

Common stock issued under employee stock plans and other, net
11,854,461

1

442

 
 
 
443

Additions in noncontrolling ownership interests
 
 

 
 
204

204

Balance as of
December 28, 2013
289,117,352

29

220

3,936

46

173

4,404

Net earnings
 
 
 
1,002

 
(47
)
955

Other comprehensive income (loss)
 
 
 
 
(219
)

(219
)
Cash dividends declared
 
 
 
(309
)
 
 
(309
)
Repurchases of common stock
(6,670,817
)
(1
)
(247
)
(186
)
 
 
(434
)
Stock-based compensation
 
 
69

 
 
2

71

Common stock issued under employee stock plans and other, net
4,213,366

1

134

 
 
 
135

Tax benefit from stock plans
 
 
21

 
 
 
21

Measurement period fair value adjustment to noncontrolling interest
 
 
 
 
 
(36
)
(36
)
Purchase of shares from noncontrolling ownership interest
 
 
(79
)
(218
)
 
(47
)
(344
)
Balance as of
January 3, 2015
286,659,901

29

118

4,225

(173
)
45

4,244

Net earnings
 
 
 
880

 
(14
)
866

Other comprehensive income (loss)
 
 
 
 
(172
)

(172
)
Cash dividends declared
 
 
 
(328
)
 
 
(328
)
Repurchases of common stock
(7,467,660
)
(1
)
(168
)
(331
)
 
 
(500
)
Stock-based compensation
 
 
84

 
 
2

86

Common stock issued under employee stock plans and other, net
4,258,133


139

 
 
 
139

Fair value of replacement equity awards exchanged in business combination
 
 
17
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