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Medical devices major, St. Jude Medical, Inc.’s (STJ - Analyst Report) third quarter 2012 adjusted earnings of 83 cents per share beat the Zacks Consensus Estimate of 81 cents per share and surpassed the year-ago earnings of 78 cents per share. Adjusted earnings exceeded the upper-end of the company’s previously announced guidance by a penny.

Adjusted earnings exclude extraordinary and one-time charges totaling 27 cents, such as restructuring expenses associated with realignment of the product division and support functions as well as expenses to modernize manufacturing at the Cardiac Rhythm Management (CRM) segment, impairment expenses and an income tax benefit.

In the reported quarter, profits dropped 22.5% to $176 million (or 56 cents a share) on account of weak revenue generation and a contraction in operating margin.

Revenues

St. Jude reported net revenues of $1,326 million, down 4% year over year. Revenues missed the Zacks Consensus Estimate of $1,342 million. However, net sales grew less than 1% on constant currency basis. All segments reported disappointing results, especially Cardiac Rhythm Management (CRM) and Cardiovascular units, except the Atrial Fibrillation (AF) business.

On a geographic basis, revenues from the domestic and international markets were $639 million (down 2.7%) and $687 million (down 5.4%), respectively.

Segment Analysis

Revenues from the core CRM business declined 8% year over year (down 4% in terms of constant currency) to $691 million.

Within CRM, revenues from Implantable Cardioverter Defibrillator (ICD) dropped 7% (down 4% in constant currency) to $412 million. Sales from the pacemaker division fell 9% (down 4% in constant currency) to $279 million.  

Neuromodulation sales inched down 1%, (up 2% in constant currency) year over year to $101 million. However, AF sales climbed 9% (up 13% in constant currency) to $220 million in the quarter.

Revenues from St. Jude’s Cardiovascular segment declined 4% (up 1% in constant currency) to $314 million. Within Cardiovascular segment, structural heart devices sales decreased 4% to $145 million and revenues from vascular offerings dipped 5% year over year to $169 million.
 
Margins

Gross margin remained flat year over year at 73.2%. Selling, general and administrative expenses, as a percentage of sales, edged down to 34.4% from 36.5% a year ago. Research and development expenses (as a percentage of sales) were 12.8%, roughly flat year over year. Operating margins decreased to 17.7% from 22.5% a year ago.

Balance Sheet

St. Jude exited the third quarter of 2012 with cash and cash equivalents of $1,051 million, 9.5% higher than the previous year. Long-term debt decreased 32% year over year to $1,983 million.

The company authorized a share repurchase program of up to $300 million as a measure to offset dilution related to stock compensation programs in 2013 and achieve earnings power.

Guidance

For full-year 2012, St. Jude revised its adjusted earnings forecast to the range of $3.42–$3.44 per share from the earlier band of $3.40–$3.45. On a reported basis, the company lowered its expected earnings to be in the range of $2.70–$2.72 per share from the earlier range of $3.00–$3.05 per share.

For the fourth quarter, the company expects adjusted earnings in the band of 86 cents–88 cents a share. On a reported basis, the company expects earnings to be between 70 cents and 72 cents for the fourth quarter.

With a market cap of $13.48 billion, St. Jude is a leading medical device manufacturer maintaining a solid rate of growth over the past decade. We believe that new product development and penetration into emerging markets will drive long-term growth for the company.

St. Jude is aggressively realigning its operating segments in order to lower operating expenses as well as to hedge against the upcoming MedTech tax from 2013. Moreover, we are impressed by the company’s efforts to deliver incremental returns to investors leveraging its solid balance sheet, healthy free cash flow and earnings power.

However, weak foreign exchange, competitive pressures and a sluggish CRM market, given the ongoing difficult macroeconomic conditions continue to be a drag on the company’s results. St. Jude and its peers Medtronic Inc. (MDT - Analyst Report) and Boston Scientific Corporation (BSX - Analyst Report) are contending in a soft CRM market. Our long-term Neutral recommendation on St. Jude is in agreement with a short-term Zacks #3 Rank (Hold).

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