STJ ST. Jude Medical, Inc.

Medical technology giant St. Jude Medical’s (STJ) second-quarter 2011 adjusted earnings per share of 85 cents beat the Zacks Consensus Estimate by a penny and surpassed the year-ago earnings of 79 cents.

This represents the Minnesota-based company’s ninth consecutive quarter of outperformance.

The adjusted earnings exclude charges (of $10 million) associated with the AGA Medical acquisition as well as costs (of $32 million) related to the restructuring of certain activities at the company’s Cardiac Rhythm Management (“CRM”) division. Profit, as reported, slipped 5.2% year over year to $241 million (or 72 cents a share) on account of these charges.

Revenues

Revenues soared 10% year over year (up 4% in constant currency) to $1,447 million, mostly in line with the Zacks Consensus Estimate. Revenue growth was fueled by healthy double-digit growth across the company’s Cardiovascular and Atrial Fibrillation franchises coupled with solid contribution from overseas operations, partly masked by a soft CRM business. Foreign currency swings contributed roughly $75 million to the top line.

Segment Analysis

Revenues from the CRM division, St. Jude’s mainstay, grew by a mere 1% year over year to $793 million given softness across the ICD and Pacemaker businesses. ICD sales inched up 1% to $477 million while pacemaker revenues remained stable year over year at $316 million.

Sluggish ICD market growth is affecting the company’s CRM results. Moreover, absence of a one-time benefit, realized in the prior-year quarter stemming from rival Boston Scientific’s (BSX) temporary suspension of ICD product sales in the U.S., impacted ICD as well as CRM revenues in the quarter. Barring this impact, CRM and ICD sales increased 3% and 5%, respectively.

Nevertheless, St. Jude’s Fortify and Unify devices are gaining notable traction. Moreover, launch of the highly-anticipated quadripolar CRT systems should boost the company’s ICD market share.

Atrial Fibrillation revenues surged 18% year over year to $208 million while Neuromodulation revenues rose 9% to $104 million. The cardiovascular business had a solid quarter with revenues zooming 35% year over year to $342 million, buoyed by the contributions from AGA Medical.

Within Cardiovascular, revenues from vascular products climbed 14% to $189 million. Structural heart product sales rocketed 74% to $153 million benefiting from the addition of the AGA Medical product lines.

Margins

Gross margin fell to 72.7% from 73.7% a year ago as higher cost of sales (up 14.4%), largely due to the inventory step-up costs associated with AGA Medical acquisition, more than offset the top line growth.

Selling, general and administrative expenses, as a percentage of sales, rose to 35.5% from 34.1% a year-ago. Research and development expenses (as a percentage of sales) increased to 12.2% from 11.8%. Operating margins declined to 22.5% from 27.8% a year ago, mainly hit by the restructuring charges.

Financial Health

St. Jude ended the quarter with cash and cash equivalents of $833 million, a roughly 25% year over year increase. However, long-term debt increased nearly 27% year over year to $2,486 million.

Outlook and Recommendation

St. Jude has slashed its earnings forecast for fiscal 2011. The company now expects adjusted earnings per share of $3.25-$3.30 for the full year, down from its earlier projection of $3.28-$3.33. For third-quarter fiscal 2011, St. Jude expects adjusted earnings per share in the band of 74 cents to 76 cents. The current Zacks Consensus Estimates for third quarter and fiscal 2011 are 80 cents and $3.30, respectively.

St. Jude and its rivals Medtronic (MDT) and Boston Scientific are tussling for market share in the CRM market. Nevertheless, the company is well placed to grow its CRM share (especially in ICDs) on the back of new product launches.

While we are impressed by St. Jude’s solid fundamentals, strong product mix, healthy growth trajectory and operating leverage, we remain wary by competition-driven pricing pressure and a soft CRM market. Our long-term Neutral recommendation on the stock is supported by a short-term Zacks #3 Rank (Hold).

 
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