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Johnson & Johnson's Management Discusses Q3 2013 Results - Earnings Call Transcript

Johnson & Johnson (JNJ) Q3 2013 Earnings Call October 15, 2013 8:30 AM ET


Louise Mehrotra - Vice President of Investor Relations

Dominic Caruso - Chief Financial Officer, Vice President - Finance

Michel Orsinger - Worldwide Chairman of DePuy Synthes Companies


Matthew Dodds - Citicorp

Mike Weinstein - JPMorgan

Kristen Stewart - Deutsche Bank

Larry Biegelsen - Wells Fargo

Tony Butler - Barclays Capital

Bruce Nudell - Credit Suisse

Jami Rubin - Goldman Sachs

Rick Wise - Stifel

Derrick Sung - Sanford Bernstein

Danielle Antalffy - Leerink Swann

Glenn Novarro - RBC Capital Markets

Bob Hopkins - Bank of America


Good morning, and welcome to the Johnson & Johnson third quarter 2013 earnings conference call. All participants will be able to listen-only until the question-and-answer session of the conference. This call is being recorded. If anyone has any objections you may disconnect at this time. (Operator Instructions).

I would now like to turn the call over to Johnson & Johnson, you may begin.

Louise Mehrotra

Good morning, and welcome. I am Louise Mehrotra, Vice President of Investor Relations for Johnson & Johnson and it is my pleasure this morning to review our business results for the third quarter of 2013. Joining me on the call today are Dominic Caruso, Vice President, Finance and Chief Financial Officer and Michel Orsinger, Worldwide Chairman of DePuy Synthes Companies.

A few logistics before we get into the details. This review is being made available to a broader audience via webcast accessible through the Investor Relations section of the Johnson & Johnson website. I will begin by briefly reviewing highlights of the third quarter for the corporation and highlights for our three business segments.

Following my remarks, Michel will provide an update on our DePuy Synthes business and the progress made on our near-term priorities in successfully integrating Synthes. Please note the presentations that accompanies Michel's remarks is available on our website.

Next Dominic will provide some additional commentary on the financial results and guidance for 2013. We will then open the call to your questions. We expect the call to last approximately 90 minutes. Included with the press release that was issued earlier this morning is a schedule of sales for key products and/or businesses to facilitate updating your models. These schedules are available on the Johnson & Johnson website as is the press release.

Before I get into the results, let me remind you that some of the statements made during this review may be considered forward-looking statements. The 10-K for the fiscal year 2012 identifies certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made today. The company does not undertake to update any forward-looking statements as a result of new information or future events or developments. The 10-K is available through the company and online.

During the review, non-GAAP financial measures are used to provide information pertinent to ongoing business performance. These non-GAAP financial measures should not be considered replacements for GAAP results. Tables reconciling these measures to the most comparable GAAP measures are available in the press release and on the Investor Relations section of the Johnson & Johnson website at investor.jnj.com.

Now, I would like to review our results for the third quarter of 2013. If you would refer to your copy of the press release, let's begin with the schedule titled, supplementary sales data by geographic area.

Worldwide sales to customers were $17.6 billion for the third quarter of 2013, up 3.1% as compared to the third quarter of 2012. On an operational basis, sales were up 4.7% and currency had a negative impact of 1.6%. In the U.S., sales were up 1.7%. In regions outside the U.S., our operational growth was 7.1%, while the effect of currency exchange rates negatively impacted our reported results by 2.9 points. Europe grew 8.4% on an operational basis while the western hemisphere, excluding the U.S., grew by 8% operationally. Asia-Pacific/Africa region grew 5.1% operationally. The success of new product launches made strong contributions to the results in all regions.

If you now turn to the consolidated statements of earnings, net earnings were $3 billion consistent with the 2012 results. Earnings per share were $1.04 versus $1.05 a year ago.

Please direct your attention to the box section of the schedule where we have provided earnings adjusted to exclude special items. As referenced in the accompanying table reconciling non-GAAP measures, 2013 third quarter net earnings were adjusted to exclude the after-tax special items of $937 million, primarily related to an increase in the accrual for litigation expenses, in-process research and development and integration costs associated with the acquisition of Synthes.

Third quarter 2012, net earnings included after-tax special items of approximately $553 million as shown in the reconciliation of non-GAAP financial measures, excluding these special items for both periods, net earnings for the current quarter were $3.9 billion and diluted earnings per share were $1.36, representing increases of 11.3% and 8.8%, respectively as compared to the same period in 2012.

I would now like to make some additional comments relative to the components leading to earnings before we move onto the segment highlights. For the third quarter of 2013, cost of goods sold at 30.4%, was down 240 basis points from the same period last year. In the third quarter of 2012, we recorded an inventory step up charge related to the Synthes acquisition. Excluding the inventory step up charge, which was treated as a special item, cost of goods sold decreased 150 basis points versus the same period last year. Positive mix, strong volume growth in our Pharmaceutical business and cost improvement initiatives across many of the businesses was partially offset by the impact of the medical device excise tax.

Third quarter selling, marketing and administrative expenses, were 30.2% of sales, or 40 basis points lower than our 2012 results due to cost containment initiatives across many of the businesses. Our investment in research and development as a percent of sales was 11.6%, up 30 basis points due to increased spending in the Pharmaceuticals business. Interest expense, net of interest income of $87 million was down $33 million versus the third quarter of 2012, due to a lower average debt level.

Other expense net of other income of $943 million in the third quarter of 2013, compared to other income net of other expense of $19 million in the same period last year. Excluding special items, other income net of other expense of $43 million was $132 million less than 2012, due primarily to the impact of 2012 gains on divestitures. Excluding special items, the effective tax rate was 18.9% in the third quarter of 2013 compared to 22.2% in the same period last year. Dominic will provide commentary on taxes in his remarks.

Turning now to business segment highlights, please refer to the supplementary sales schedule highlighting key products or businesses for the third quarter of 2013. I will begin with the consumer segment.

Worldwide consumer segment sales for the third quarter of 2013 of $3.6 billion, increased 0.8% as compared to the same period last year. On an operational basis, sales increased 2%, while the impact of currency was negative 1.2%. U.S. sales were up 0.9%, while international sales grew 2.6% on an operational basis.

Excluding the impact of divestitures net of acquisitions, operational growth was approximately 2.5%. Baby care products increased on an operational basis by 2.6% when compared to the third quarter of 2012, due primarily to the impact of the health care products acquired earlier this year.

Sales in the Oral Care business decreased 3% operationally. Excluding the impact of the divestiture of manual toothbrushes in North America, operational sales were essentially flat.

For the third quarter of 2013, sales for OTC Pharmaceuticals increased 6.5% on an operational basis compared to the same period in 2012. U.S. sales were up 17.9%, driven by strong growth in analgesics and other key brands as we continue to make progress in returning a reliable supply of products to the marketplace.

International sales were up 2% operationally. Our skin care business grew 2.7% on an operational basis in the third quarter of 2013. Strong results for AVEENO were partially offset by the impact of divestitures. Excluding divestitures, operational growth was approximately 4%. Women's health grew 2.5% on an operational basis due to growth in international women's sanitary protection products. Wound care other sales decreased 6.9% on an operational basis impacted by competitive pressures as well as divestitures.

That completes our review of the consumer segment and I will now review highlights for the pharmaceutical segment. Worldwide net sales for the third quarter of $7 billion increased 9.9% versus the same period last year. On an operational basis, sales increased 10.9% with a negative currency impact of one point. Sales in the U.S. increased 7.9%, while sales outside the U.S. increased on an operational basis by 14%.

Now reviewing sales for major therapeutic areas. Immunology products grew 13.4% operationally, with sales in the U.S. up 3% and sales outside the U.S. up 47.7% operationally. Earlier this year, the company made certain supply chain changes for REMICADE resulting in sales to distributors previously recorded as U.S. export sales now being recorded as international sales. Adjusting for this impact the U.S. immunology growth was approximately 8% and operational growth outside the U.S. was approximately 28%.

In the U.S., REMICADE excluding export sales was up 7.8%, SIMPONI was up 19.4% and STELARA are was up 23.9%. Results were driven by market growth across the major products complemented by increased market share for both STELARA and SIMPONI. With the strength of our portfolio, we continue to be the U.S. market leader in immunology. REMICADE outside the U.S., adjusted for the supply chain change just mentioned, was up approximately 15% operationally due to strong growth in Canada and the emerging markets. STELARA made significant contributions to growth outside the U.S. due to market share gains and market growth across the major regions while SIMPONI's strong growth was due to increased shipments to our distribution partner, complemented by additional country launches and strong growth in other markets.

Sales of infectious disease products increased 2.4% on an operational basis. INCIVO, a treatment for Hepatitis C, grew 5.3% on an operational basis, reflecting launches in additional countries partially offset by lower sales in Europe impacted by a combination of patient warehousing, patients enrollment in clinical trials and seasonality in treatment patterns impacting new patient starts in the summer months. Continued momentum in market share growth in the major markets for PREZISTA made notable contributions to the results. Results outside the U.S. were impacted by the timing of tender business. Strong growth for the combined sales of COMPLERA and EDURANT also contributed to the results.

Neuroscience product sales declined 1.9% operationally with U.S. sales down 11.4% impacted by generic competition primarily for CONCERTA. The long-acting injectable antipsychotics, RISPERDAL CONSTA and INVEGA SUSTENA or XEPLION achieved operational growth of over 15% due to an increase in combined market share. Sales of oncology products increased 57% on an operational basis due to the strong results for ZYTIGA and VELCADE. ZYTIGA is approved to treat both chemo refractory and chemo naïve metastatic castration resistant prostate cancer.

In the quarter, ZYTIGA achieved operational sales growth of over 70%, with U.S. sales growing 50% due to very strong market growth of nearly 25% and increased market share in the combined metastatic castrate resistant prostate cancer market. ZYTIGA has captured 33% of that market and is up approximately 2.5 points sequentially. ZYTIGA sales outside the U.S. nearly doubled on an operational basis versus third quarter of 2012 and on a sequential basis, sales were up over 15%. Additional country rollouts and the expansion of the label to chemo naïve patients drove the strong results. ZYTIGA is approved in more than 80 countries.

VELCADE is a treatment for multiple myeloma. Sales increased 26.3% on an operational basis. Strong performance in patient share in the frontline setting and the launch of the subcutaneous version continue to drive sales growth. Other oncology increased primarily due to DOXIL/CAELYX. Regarding DOXIL/CAELYX, ensuring a efficient supply for physicians and their patients remained our urgent priority. We have begun to encounter supply outages of DOXIL in the U.S. due to issues at our third-party manufacturer. We continue to take the steps needed for the long-term transition to suppliers, which we are accelerating wherever possible. The FDA has approved the generic doxorubicin hydrochloride liposome injection, which is currently available for patients.

In Europe, the Committee for Medicinal Products for Human Use, or CHMP has approved manufacturing at CAELYX from an alternate supplier. We anticipate receiving CAELYX from this manufacturer by the end of the year.

Other pharmaceutical products increased 5.9% on an operational basis with strong results for XARELTO and INVOKANA partially offset by lower sales for EPREX and PARIET, primarily related to generic competition.

XARELTO more than tripled compared with the same quarter last year and grew nearly 30% on a sequential basis, reaching nearly 40% of the new two brand scripts in cardiology in September, surpassing warfarin by over eight points and widening the lead by three points versus the last quarter.

Total prescription exit share in the broader anticoagulant market grew approximately 1.5 points on a sequential basis to nearly 10%.

In the U.S., INVOKANA achieved 17% new to brand share with endocrinologists within the defined market of type-2 diabetes excluding insulin and metformin. At 17%, INVOKANA is the number one branded non-insulin product NBRx in that market. In addition to the number of approvals and filings that Dominic will highlight in his remarks, during the quarter, ibrutinib was granted priority review by the FDA for the use in the treatment of previously treated patients with chronic lymphocytic leukemia or CLL, and small lymphocytic lymphoma or SLL and for its use in the treatment of previously treated patients with mantle cell lymphoma, or MCL. In late February, PDUFA date has been assigned.

We announced the simultaneous submissions of a biologic license application to FDA and a marketing authorization application to the European Medicines Agency or EMA for siltuximab, an experimental product for the treatment of patients with multicentric Castleman disease. The resubmission to the FDA complete response for the use of XARELTO to reduce the risk of secondary cardiovascular events and [Centrum] in patients with acute coronary syndrome was filed with a PDUFA date of mid-February, next year.

In October, a marketing authorization application was submitted to the EMA, seeking approval for a once-daily single tablet fixed dose antiretroviral combination product containing darunavir, a protease inhibitor developed by Johnson with cobicistat, a pharmacokinetic enhancer developed by Gilead Sciences for use in combination with other HIV-1 medicines.

That completes the review of the Pharmaceutical segment. I will now review the Medical Devices and Diagnostics segment results. Worldwide medical devices and diagnostic segment sales of $6.9 billion, declined 2% versus for the same period last year. On an operational basis, sales increased 0.3% with a negative currency impact of 2.3 points. Sales in the U.S. declined 4.2%, while sales outside the U.S. increased on an operational basis by 4.2%. Adjusted for divestitures and exits from certain businesses, underlying growth was approximately 1% reflecting continued market and pricing pressure.

I will provide more commentary on these factors in the franchise reviews. Starting with cardiovascular care, sales were up 4.2% operationally with U.S. up 0.5%, and sales outside the U.S. up 6.6% operationally, driven by Biosense Webster, our Electrophysiology business, with worldwide operational growth of over 11% in the quarter. The success of a number of capital launches made strong contributions to the results.

Diabetes care sales declined 11.3% on an operational basis in the third quarter of 2013 with the U.S. business down 27.7% due to the impact of lower price primarily related to competitive bidding. The business outside the U.S. was up 6.5% operationally with strong sales in the emerging markets partially offset by lower sales in some of the developed markets. The success of the launch of Animas Vibe in certain international countries has contributed to growth in the quarter.

The diagnostics business declined 8% on an operational basis. Excluding the impact of the divestiture of the Virco's business, operational sales were down approximately 2.5% due to the exit from certain donor screening contracts and lower capital placements. Infection prevention decreased 0.5% on an operational basis with sales in the U.S. down 7.1% due to the soft capital equipment sales reflecting a lower level of trade-ins. Outside the U.S., operational growth of 4.3% was driven by both consumables and capital item sales.

Orthopedic sales were up 1.1% on an operational basis when compared to the same period in 2012 with the U.S. down 0.8% and sales outside the U.S. up 3.4%. Operationally, hips were up 6% worldwide driven by 7% growth in U.S. due to strong results on primary stent platforms sales partially offset by continued pricing pressure. Hips outside the U.S. were up 4% on the operational basis driven mainly by heads and acetabular products. Knees worldwide increased 3% on an operational basis with similar results both in and outside the U.S. Growth in the U.S. was due to the successful launch of ATTUNE Fixed Bearing Knee as well as strong sales of Revision platforms partially offset by lower sales of rotating platforms and pricing pressure. The launch of ATTUNE drove the results outside the U.S.

Trauma was up 1% on an operational basis with the U.S. flat and outside the U.S., up 2% operationally. Low cost competition impacted to the results in the U.S. while the timing of tender business negatively impacted the results outside the U.S. Worldwide spine was down 2% on an operational basis with the U.S. down approximately 10% impacted by pricing pressures, the continued softness in the market as well as the disruption in the commercial sales organization as we integrate the businesses. Outside the U.S., sales were up approximately 9% operationally, with strong growth in Latin America and Asia-Pacific.

Specialty surgery operational growth was 6.7% in the third quarter of 2013. U.S. sales were up 4.2% and sales outside the U.S. up 9.2% on an operational basis. Strong sales of biosurgical products and international sales of energy products were the major contributors to growth, complemented by sales growth from new products for both MENTOR and ACCLARENT. These gains were partially offset by lower sales of HARMONIC products in the U.S. due to competitive pressures.

Surgical care worldwide sales were up 1.4% on an operational basis, with U.S. down 2.5% and sales outside the U.S. up 3.9% operationally. U.S. sales were impacted by lower sales of women's health and urology products. Outside the U.S., future sales and strong demand for endocutter products with the ECHELON FLEX powered ENDOPATH Stapler were the important drivers of growth.

Rounding up the review of the medical devices and diagnostic segment. Our vision care business achieved operational sales growth of 3.9% in the third quarter with U.S. up 1.9% and sales outside the U.S. up 4.9% operationally. Growth was driven by daily lenses and ASTIGMATISM lenses. That completes highlights for the medical devices and diagnostics segment and concludes the segment highlights for Johnson & Johnson's third quarter of 2013.

It is now my pleasure to turn the call over to Michel Orsinger. Michel?

Michel Orsinger

Thank you, Louise, and good morning, everyone. I look forward to providing you with an update on the integration of the DePuy and Synthes, the value we are seeing in the combination of these two companies and our strategy for leading and shaping the industry. Having now worked with Johnson & Johnson prior to the Synthes acquisition, and now as a J&J leader, I have had ample opportunity to get to know the enterprise and discover its richness, breadth, resources and capabilities.

I am very impressed by the values expressed in our credo and the ability of a large global organization to nourish and live by such values in an increasingly complex world. I now have a lot of respect for the people in Johnson & Johnson.

Before I start my presentation, I would like to give my perspective on the DePuy Synthes third quarter results that Louise presented. While I am not entirely satisfied with our results, we have had some important wins. Joint reconstruction, especially in the U.S., is performing very well and we believe we grew market share in hips. Furthermore we generated double-digit growth in emerging markets with the best results coming from China, Russia and Brazil.

Our performance in trauma and U.S. spine was lower than expected. Trauma results were due mostly to a biannual tender that did not repeat this year and pressure from lower price competition which we are managing by leveraging sales force coverage, segmenting the market and introducing new product configurations. U.S. spine results were due to integration disruptions which we are addressing.

Overall, we are pleased to maintain our strong market leadership positions. I am very confident about the future. DePuy and Synthes, two of the most successful and respected companies in orthopedics and neuro, joined together at the right time to actively participate in and shape the changing healthcare environment. I am convinced that we are all well positioned to expand our leadership in the industry and I am excited by the opportunities in front of us.

As a combined organization, we are better suited to optimize our offerings. For patients and surgeons, there is the potential for exciting medical innovations that leverage the product development capabilities from both organizations as well as from the larger J&J enterprise. For providers, our scaled and unparalleled product portfolio which spans many platforms opens new possibilities to consolidate suppliers. In emerging markets, the same benefit will enable us to continue accelerating growth. In addition, our larger experienced sales force, leadership and professional education, and collaboration with the AO, and the values driven, combined talent from both organizations offer competitive differentiation in the industry.

DePuy Synthes participates in a market that has very strong fundamentals. At $44 billion the market is large and diverse. There is plenty of opportunity to address unmet orthopedic and neuro needs. We believe that as the global population ages, demand for the types of products we offer will increase and many emerging markets are investing in the healthcare systems to provide more and better care for their citizens.

As you look over our planning horizon, emerging market growth is projected to increase roughly four times the rate of developed markets. As healthcare systems around the world face the reality of cost containment and provide us participate more in decision making with clinicians, DePuy Synthes as part of J&J is primed to offer new value-added solutions and help transform healthcare delivery.

Against the backdrop of these market dynamics, we are expecting the worldwide ortho and neuro market to grow between 2% and 4% compounded annually by 2017. Our first year at DePuy Synthes has been exciting and rewarding. As you can imagine combining two organizations of this size and complexity is a significant undertaking. Our employees are doing a great job and I am pleased to say the integration is on track.

Our primary goal during the integration was to minimize customer disruption. Based on feedback from customers, we believe we have achieved this in all, but one platform. As we combine two different sales forces with two different sales models in U.S. spine, we have experienced some disruptions in that business and we continue to take corrective measures.

In other parts of the business, I am particularly encouraged to see synergies being realized by cross-selling initiatives we envisioned from the onset, as well as revenue and cost synergies. Initially having very much focused on commercial integration, we are now spending more time on internal systems and processes, including IT, HR, supply chain and quality. This work remains a priority as the successful integration is one of the foundational elements of our future.

We have combined terrific talent from both organizations and supplemented our team with new capabilities to help address the changes in our markets. We achieved a high retention rate of our global DePuy Synthes staff during integration and we are engaging in a new innovation agenda.

Our strategy is focused on four growth drivers. We have continued to transform our business and drive growth through continuous innovation, focus on emerging markets, excellent execution and cultivation of talent and an engaged organization. For the rest of today's discussion, I will focus on our approach to innovation and our emerging market strategy.

In today's dynamic healthcare environment, our customers are looking for new solutions that improve clinical outcomes, increased patient satisfaction and do this at reduced cost, specifically to address patient satisfaction and to unmet patient needs, improving the instability some patients experience with existing knew replacements.

ATTUNE also was developed to address provider interest in outcomes and efficiency of healthcare delivery. To-date, 27 publications document the science behind the design thereby addressing our stakeholders' need for evidence. The ATTUNE knee system launch is off to a very successful start with positive feedback from patients, surgeons and physical therapists. Following commercialization in North America, launches are underway in 13 European and Asia-Pacific countries.

In addition to developing new products, we have started to complement our product offering with value-added programs and services. Let me describe one such program we are piloting, DePuy partnered with CAELYX [ph] and Janssen to create a program to help hospital reduce the length of stay for joint replacement patients while enhancing quality of care and patient satisfaction. The result is a patient care pathway program called Care4Today Orthopedic Solutions that integrates patient education, a change management program for hospitals and home recovery support. The first impressive results from the pilot show reduced patient length of stay and excellent patient and staff feedback.

The third pillar of innovation is new business models. We are piloting many different cross-selling arrangements across DePuy Synthes and J&J that leverage our considerable product portfolio. For example, in the U.S., joint recon distributors are selling power tools and they are in community and they are rural community and rural hospitals selling trauma. Trauma is selling joint week on as sports medicine products in academic centers. Sports medicine is selling trauma products in community and rural hospitals and ambulatory research centers. Across Johnson & Johnson, Ethicon is selling and marketing CMS tissue metrics product as part of its hernia portfolio.

We formed a strategic account management group that is leveraging our broader offerings to become one point of contact for all of our customers' orthopedic and neuro needs. As providers seek to reduce vendors, the team is steadily gaining traction in identifying and winning accounts that would benefit most from our comprehensive portfolio.

Taking collaboration one step further we are in active discussions with large institutions to jointly define value, based on their specific needs, set new standards and pilot entirely new approaches to delivering healthcare. The combination of the DePuy and Synthes and even the broader efforts across MD&D and J&J, place us in a very unique position to accomplish these goals.

Now, I would like to move to another significant source of future growth, emerging markets. These countries represent a small part of our revenue at this point, yet we anticipate close to 40% of our projected growth in years to come from these countries. Today, I will focus on China where DePuy Synthes has a strong foundation.

Our three pronged strategy there is based on helping patients gain access to care. First the premium segments remains vital to our business and it will continue to provide innovations for the urban customer segments. While doing so we will continue to refine core products to match different anatomical and search and preferences.

Our second strategy is to develop value segment products which are simple, easy to ease and more affordable options for underserved patients in more rural areas. We are adapting existing premium products that still maintain our high quality standards. One example is our rich knee instruments, a simplified instrument set for the Sigma Fixed Bearing Knee. We are planning the launch of this affordable option in China and India this year.

Our other differentiating approach to the fast growing value segment is to become a local supplier in China for trauma. Products that are manufactured and have undergone clinical trials in China are considered local and give us access to a whole new market segment with attractive reimbursements.

A few years ago, we took the strategic decision to build a plant in Suzhou, which helps us to maintain our manufacturing standards and also invested in clinical trials for trauma products. In fact, we have breaking news on this front. Just this past Saturday, we received our product license for domestic manufacturer for four classes of trauma products. We will launch these locally manufactured and approved products next year, giving us a significant advantage in addressing the value segments.

Finally, as the demand for healthcare in the region grows, more surgeons need training. Considering our broad-based product portfolio, we are exploring expansion of our collaboration with the AO Foundation into new clinical areas beyond trauma in Asia-Pacific.

With DePuy Synthes support, the AO offered its first ever neuro trauma course in Beijing and Shanghai. In November, the AO will offer its first ever joint reconstruction course in China. In conclusion, we are making tremendous progress, positioning our business for long-term profitable growth. We recognize the unique opportunity to address the needs of our customers and form strategic alliances.

We are redefining innovation, accelerating growth in emerging markets and developing new capabilities and leadership skills in our organization. I look forward to sharing our progress as our transformation continues. We have only just begun to realize the power of this great combination.

Thank you. Now it is my pleasure to turn the call over to Dominic Caruso.

Dominic Caruso

Thank you, Michel, and good morning everyone. I must say, we are very fortunate to have Michel leading our DePuy Synthes business with his level of energy, strong leadership and clear vision for the world's largest orthopedics business and I very much enjoy working with Michel as a member of our management committee.

Now, I would like to turn to our third quarter results, review some achievements during the quarter and provide an update on our guidance for 2013. I will begin with a brief comment about what we are seeing in the overall healthcare market.

At this time, we are still seeing utilization rates that are essentially flat year-over-year supporting a continued stable environment which is similar to what we saw in the second quarter. At Johnson & Johnson, the level of consistently solid and sustainable performance we deliver is due to the breadth of our business and the extraordinary achievements and dedication of our people around the world.

Our third quarter results reflect the progress we are making in achieving our near-term priorities of delivering strong business results, returning a reliable supply of OTC products for the marketplace, successfully integrating Synthes and building on a strong momentum in the pharmaceutical segment. Our innovative products are clearly making a meaningful difference in the treatment of patients.

We have also continued to make advancements in the implementation of our longer-term strategic growth drivers of creating value for innovation as evidence by the productivity of our pipeline and success for our nearly launched products, focusing on excellence and execution, leading with purpose and by increasing our global reach with greater local focus, which is reflected by our double-digit operational growth this year in the BRIC countries.

Let's now review some of the highlights of the Q3 results. We are pleased to report strong third quarter results with sales of $17.6 billion, representing an increase of nearly 5% on an operational basis versus the third quarter of 2012, and earnings per share excluding special items of $1.36, or a nearly 9% increase over the prior year. As you can see, we recorded special items in the quarter of approximately $900 million on an after-tax basis that consisted largely of charges related to an increase in our accrual for various litigation matters, charges for in-process for search and development and continued integration and transaction cost associated with the Synthes acquisition.

Together these special items negatively impacted our third quarter results by $0.32 per share. We have consistently treated these types of matters as special items. Excluding these special items, our adjusted earnings per share was $1.36, which exceeded the mean of the analyst estimates as reported by first call of $1.32.

Now, let's look at sales performance and some important business developments by segment.

In pharmaceuticals, we reported operational sales growth in the quarter of approximately 11%. Fueled by sales of INVEGA SUSTENNA, REMICADE, SIMPONI, STELARA, VELCADE and PREZISTA and new products including XARELTO, INVOKANA and ZYTIGA which has well exceeded $1 billion in global sales this year also recorded very strong sales in the quarter contributing to that segment's continued growth.

Other developments off note in the pharmaceutical segment included the successful completion of the acquisition of Aragon Pharmaceuticals which we initially announced in June. This acquisition increases our leadership position in the field of prostate cancer and strengthens our pipeline with a potentially best-in-class compound that has just advanced in the Phase 3 development that, if approved, would complement ZYTIGA and broaden the range of patients that could potentially be treated.

Several important positive regulatory decisions were also made on some of our key products including the FDA's approval of SIMPONI ARIA, the IV version of SIMPONI for the treatment of moderately to severely active rheumatoid arthritis and STELARA for the treatment of psoriatic arthritis. In Japan, the Ministry of Health approved simeprevir which will be marketed as SOVRIAD for the treatment of genotype-1 chronic hepatitis C virus infection and XEPLION, the first once-monthly atypical antipsychotic for the treatment of schizophrenia approved in that country.

In Europe, the European Commission approved VELCADE as the first therapeutic option in a combination approach for adults with previously untreated multiple myeloma who are deemed eligible for high dose chemotherapy with hematological stem cell transplantation, STELARA for the treatment of active psoriatic arthritis in adult patients with response to previous non-biological drug therapy when that has been inadequate and also SIMPONI for the treatment of adult patients with moderately to severely active ulcerative colitis who have had inadequate response to conventional therapy or who are intolerant to such therapies. Also in Europe, the CHMP granted a positive opinion on INVOKANA for the treatment of adults with Type 2 diabetes.

We also increased our leadership presence in the hepatitis C market just last week with the acquisition of a Phase 2 compound for the treatment of chronic hepatitis C from an affiliate of GlaxoSmithKline. Under the terms of the deal, we acquired all rights to develop and commercialize that product.

In our MD&D segment, sales were essentially flat versus the prior year on an operational basis reflecting the continued market and pricing pressures as well as divestitures already described by Louise. Of note, however, was double-digit operational growth that we saw in the BRIC markets. Biosense Webster's electrophysiology products and our cardiovascular care business continues to deliver strong growth as did joint reconstruction products in the orthopaedics business, international sales in the surgical care business and continued group performance in the specialty surgery business.

Our consumer business saw an operational sales increase of 2%. Positive contributors to the operational results were analgesic brands MOTRIN and TYLENOL, AVEENO skincare products and international sales of baby care products.

I want to comment that as we continued to return a liable supply of high quality OTC product for the shelves, we are seeing strong uptick in the market, and as you can see, our U.S. OTC business posted strong nearly 18% growth in the quarter.

Now let me provide some guidance for you to consider as you refine your models for 2013. Let me begin with a discussion of cash and interest income and expense. At the end of the third quarter we had approximately $10 billion of net cash. This consists of approximately $25 billion of cash and marketable securities and $15 billion of debt.

We continued to generate strong cash flows from operations which in this quarter were essentially offset by the finalization and related cash settlement of the accelerated share repurchase program that was initiated in conjunction with the acquisition of Synthes. With that program now completed, we have resumed our normal share repurchases related to employee compensation programs. For purposes of your models, assuming no major acquisitions, I would suggest you consider modeling net interest expense of between $350 million and $400 million slightly lower than our previous guidance.

Turning to other income and expense. As a reminder, this is the account where we record royalty income as well as gains and losses arising from such items of litigation, investments by our development corporation and divestitures, asset sales or write-offs. This account is difficult to forecast but at this late stage of the year, we would be comfortable with your models for 2013 reflecting other income and expense as a net gain, excluding any special items ranging from approximately $500 million to $600 million, which is lower than our previous guidance.

Now a word on taxes. For the third quarter of 2013, the company's effective tax rate excluding special items was 19.3%. We suggest that you model our effective tax rate for the full year 2013 at approximately between 19% and 19.5%, which is a tightening of the previous range. As always, we will continue to pursue opportunities in this area to improve upon this rate during the remainder of the year.

Now turning to sales and earnings. We would be comfortable with your models reflecting operational sales growth on a constant currency basis of between approximately 6% and 7% for the year which is consistent with our previous guidance. This would result in estimated sales for 2013 on a constant currency basis of approximately $71.3 billion to $71.9 billion.

While we are not predicting the impact of currency movements, to give an idea of the potential impact of currency exchange rates for the remainder of 2013, were to stay where they were as of last week, but our sales growth rate will be negatively impacted by approximately 1.5% for the year. Thus under this scenario, we would expect reported sales growth to be between approximately 4.5% and 5.5% for the year for an expected level of reported sales of approximately between $70.3 billion and $70.9 billion which is higher than our prior guidance mostly due to the strengthening of the euro versus the U.S.


Turning now to earnings, considering the strength we see in our operating results, which will more than offset the expected lower level of other income guidance I mentioned earlier, we suggest that you consider full year 2013 EPS estimates, excluding the impact of special items of between $5.44 and $5.49 per share at constant currency rates. We are not predicting the impact of currency movements. However, to give you an idea of the potential impact on EPS if currency exchange rates for the balance of 2013, were to remain where they were as of the end of last week, then our reported earnings per share excluding special items would see no impact related to currency fluctuations, therefore we suggest that you model our reported earnings per share excluding special items in the range of between $5.44 and $5.49 per share or a growth of between 7% and 8% which at the mid-point is higher than our previous guidance.

Overall, as you update you models for the guidance I just provided, you should see pre-tax operating margins will continue to show improvement over the prior year and we now expect that improvement will be greater than 100 basis points. This will more than offset the expected level of other income as for our updated guidance. We feel confident we can achieve an even better improvement than we expected at the beginning of the year given the strength of our operating performance while we continue to invest in growth for the future.

Finally, a word on the impact of foreign currency transactions related to the devaluation of the yen, which may be helpful for you as you update your models. As you know, the yen devalued by approximately 25% versus the U.S. dollar and the euro this year. The impact of the yen devaluation on 2013 results has not been significant, because of our policy of advanced hedging of foreign currency transactions in a matter that provides certainty in our planning related to currency swings during the year. However, we expect the impact of devaluation of the yen to be a significant headwind in 2014. We estimate this headwind to negatively impact gross margin in 2014 by approximately 60 basis points. Of course, as we complete our planning for 2014, we will look for ways to mitigate this impact as much as possible.

Now back to you Louise for the question-and-answer session.

Louise Mehrotra

Thank you, Dominic. Felicia, could you please give the instructions for the Q&A session?

Earnings Call Part 2: