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Johnson & Johnson (NYSE:JNJ)

Q3 2013 Earnings Call

October 15, 2013, 8:30 am ET

Executives

Louise Mehrotra - Vice President of Investor Relations

Dominic Caruso - Chief Financial Officer, Vice President - Finance

Michel Orsinger - Worldwide Chairman of DePuy Synthes Companies

Analysts

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

Operator

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.

dollar.

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?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Matthew Dodds with Citicorp.

Matthew Dodds - Citicorp

Dominic, first for you. If you look at the geographic results, Europe has grown a lot faster than the U.S. I assume pharma is a big part of it, but do you think you are also gaining share in Europe and MD&D? Then broadly for Europe, what do you think about the environment for Europe in Q3 versus Q2? That's for you Dominic.

Then Michel for you, in U.S. spine, I thought the integration started in the fourth quarter of last quarter. So why is the hit seem like again it's getting worse as we are moving through 2013 and when do you think that all sorts out?

Dominic Caruso

Right. Hi, Matt. Good morning. Well, you are right. We do see strong growth in Europe. It is primarily driven by the pharmaceutical business, as obviously we have launched some exciting new products in the pharma business. In MD&D, we continue to see government austerity pressures and, quite frankly, a reduction of overall volumes in those businesses. However we seem to making pretty good progress in the Ethicon Surgical Care business and even in our diabetics and the DePuy legacy business in Europe as well.

Michel Orsinger

Good morning, Matt. Indeed related to our U.S. spine performance, we have and continue to go through some disruptions, while we are very excited about our international business growing at plus 9%. Now related to the U.S. changes, as you can imagine, combining two sales forces from two different companies is a major task. We are combining different selling models, distributor base versus a direct setting model. Two sales people are calling on the same accounts on the same hospitals requiring realignment of territories.

The sales force having to deal short-term with the complexity of two different systems, processes, it all takes time. Just as one example, sales consulting, as consultants ordering products need to do this from two different legacy ordering systems which need to be harmonized through IT and that obviously can lead to some frustrations by the sales force. But having said so, we are taking clear measures, ongoing measures, at very different levels, related primarily to ensure we can provide better support to the sales force, make their job easier but at the same time also provide enhanced and harmonized compensation and benefit packages.

We are in the final stage of realigning our territories and I think people, customers but also our sales people do recognize that we, having the opportunity to combine two product bags, have one of the most attractive product offering, specially leveraging the strength of legacy Synthes in the cervical area, leveraging the strength of legacy DePuy in the lumber area. So time will help to stabilize the sales force and to create the stronger spine company also in the U.S.

Matthew Dodds - Citigroup

Thanks Michel. Thanks, Dominic

Louise Mehrotra

Next question, please.

Operator

Your next question comes from the line of Mike Weinstein of JPMorgan.

Mike Weinstein - JPMorgan

Hi, thank you for that. Thanks for taking the questions this morning. Since we have Michel, Michel, with this one comment you made, the step that you made, you talked about lower price competition in trauma and it wasn't clear if you were talking in the U.S., if you were talking emerging market. So could you explain on that? Thanks.

Michel Orsinger

The lower price competition we have been observing is primarily located in the U.S. We have seen some smaller companies trying to offer very specific product segments in specific institutions. So we are clearly taking corrective measures by working on major initiatives related to segmentation, customer segmentation, channel segmentation and products.

We are going to counteract by also cross selling and certainly elevating our agenda with our customers leveraging our breadth and size of our portfolio through contracts and also establishing more strategic relationships. We see our sales clearly as a total solution provider which includes products and services primarily supported and provided by our well educated salesforce.

Louise Mehrotra

Okay. Thank you, Michel.

Mike Weinstein - JPMorgan

Then maybe if I could just follow up with maybe one item here. Dominic, if I look at the breadth of J&J, everybody looks at it right now and says the pharma business looks fantastic. You have got some product launches that are driving very strong growth and you are lapping up more that are coming shortly, so I think everybody is very comfortable with performance of pharma business and the outlook of the next, say, let's call it two or three years at a minimum.

The challenges on the other side of the business within MD&D consumers, let me spend just a minute on consumer. If we stripped out and looked at the rest of the portfolio, the rest of the portfolio is growing 0% to 1% for last several quarters, but it doesn't seems like it has really picked up even as the economy has got in little bit better, so can you just talk a little bit about the strategy for the balance of the consumer business and is there any potential for growth to be accelerated for the broader portfolio?

Dominic Caruso

Sure, Mike. Well, let say the consumer business has had as you know some challenges related to the overall economic slowdown, and yes you did comment and we do see some pickup in overall economic activity, but certainly not to the level that we all hope it would be at, so there are still some carryover elements of trading down, if you will, store brands and the like and what's incumbent upon our business then is to create the innovations that consumers will want and purchase and remain loyal to.

You see that in certain pockets of our business more than others quite frankly. For example in skin care, AVEENO products are doing extremely well. You see new advertising campaigns et cetera and AVEENO alone is up 16% year-over-year. In other elements of the business, we have proved our portfolio quite frankly, we have had the impact of divestitures that have shown - made the difficulty in comparing the progress year-over-year, but we are poised to continue to capture market share through innovation which has been our stronghold in the consumer business in addition obviously to focusing on the return of OTC business.

Just to mention one other thing about consumer, our emerging markets in the consumer business continue to do well despite some slowdown in some of these emerging markets we were confident that that consumer business will continue to do well and show growth as those consumers begin to purchase more personal care products in the future, so we are happy with the progress to-date. I think, we still have little bit ways to go with some innovation, but we have been very fortunate with the level of innovation we have been able to deliver thus far and I am confident we will see more coming in the near-term.

Louise Mehrotra

Next question please?

Operator

Your next question comes from the line of Kristen Stewart with Deutsche Bank.

Kristen Stewart - Deutsche Bank

Thanks for taking my question. Dominic, I know you had mentioned with the completion of the ASR program that you are going to be resuming your normal share repurchases to offset the employee stock issuance. I was just wondering if you could take a step back and maybe give us some of your broader thoughts on just capital allocation at this point. I guess why not doing more significant stock purchases given your net cash balance?

Michel Orsinger

Kristen thanks for the question. Well, we have consistently addressed this question in a way that I think investors have come to understand our approach to capital allocation which is first and foremost we are going to generate strong cash flows. After that, we are very proud of having a 51-year history of increasing our dividend and so we have a priority towards allocating capital to our dividend which has proven to be the most enduring return to capital that we have looked at over long periods of time compared to other companies in the industry. Then we would like to continue to increase our presence in the global healthcare market by doing smart acquisitions at the right time with the right value for shareholders, which in the end continues to give us the ability to generate even stronger cash flows for the long-term.

Then finally in order of priority, we look at share repurchases primarily as an offset to any dilution we might incur. For example, in the Synthes transaction, we completely offset that dilution of the employee stock purchases. We also obviously continue to offset that dilution, so that's the order in which we think of capital allocation to the extent we are opportunistic at times to buy back stock. We will always entertain that possibility, but that's been our approach and we think it has served us well and will continue to serve us well and our shareholder for the long-term.

Kristen Stewart - Deutsche Bank

Okay, and then just thinking about Synthes and some of the assumptions that you guys had at the time of acquisition. I know the growth forecast is a little bit softer now relative to back then. I think trauma and spine were expected to grow somewhere between 5% and 7%. I think today on the slides you guys have showed now globally orthopedic, closer to 2% to 4%. How do you guys just think about, I guess some of the cost synergies that you had originally targeted? How are those tracking? And are there greater opportunities on the cost side to maybe offset maybe at little bit lower sales growth contribution from the acquisition?

Dominic Caruso

Right. Thanks, Kris. Let me just address that and then ask Michel if he would like to add anything. You are absolutely right. The major difference between the time of the acquisition and now is the growth rate primarily in trauma. Trauma as you know, was growing at that point 6%, 7% and you saw from Michel's discussion what we expect the growth rate to be going forward. So that's a major change in assumptions.

We think that in order to answer that challenge we will have to do two things. Michel talked about the first being making sure that we have a comprehensive offering with the breadth of our portfolio et cetera. Secondly we will have to look at cost. However, you will remember that the major purpose of this acquisition was not to drive our cost synergies. It was to, as Michel mentioned, number one, preserve and then enhance the experience with our customers. But given the realities of the marketplace, we will look at, in fact, at what's an appropriate level of cost structure should be lower level of market growth remain for extended periods of time.

But Michel, anything else you would add to that?

Michel Orsinger

Indeed, Dominic. The emphasis we have is on growth but considering the new market environment over the last two years, it's a relative growth to the market which our people feel accountable to. Related to cost synergies we see nevertheless attractive opportunities to further realize and within our integration efforts, I must say, that at least the internally defined growth and cost synergies are on target.

Louise Mehrotra

Thank you. Next question, please?

Operator

Your next question comes from the line of Larry Biegelsen with Wells Fargo.

Louise Mehrotra

Good morning.

Larry Biegelsen - Wells Fargo

Good morning. Thanks for taking the question. One for Dominic and one for Michel. Starting with Dominic, you gave some color on the call on your BRIC market growth, but I don't think you gave for overall J&J. I think it was 19% in the second quarter. Can you give us that number for the third quarter and just the near-term outlook, Dominic there, given the issues in China? And if you could just talk about any impact in China across the three segments from the recent years? Thanks.

Dominic Caruso

Right. Well, we did see an overall slower level of market growth in China most recently but let me just give you an idea of year-to-date through the nine months if you exclude Synthes from the numbers because obviously they impact the comparison for last year. We have double-digit growth across the BRIC markets, over 10%. Somewhere near 11%, 12% combined in the BRIC markets.

So I think that's pretty healthy growth considering the relative slowdown that we have most recently are seen. We still believe the BRIC markets will be a major contributor of our growth going forward across all three of our major segments, MD&D, consumer and pharma as well.

Larry Biegelsen - Wells Fargo

Thanks for that. And then Michel, I am sure people would love to hear you your reaction to the Stryker-MAKO deal? And just lastly, it seems like the large joint market improved in the third quarter based on the two companies as reported so far in the U.S. Would you agree with that? If so why? Thanks.

Michel Orsinger

Thank you for the question. First of all related to robotics. I think it's important to put it the question in to context of enabling technologies. There are many ways to improve the surgical processes and such enables our computer data territory, patient specific instrumentation, sensors and enabling technology in today's environment, in my opinion, must consider in a balanced way outcomes, efficiency and costs.

So robotics, in its current stage, based on my information has not yet been proven that it is the best solution to address all of these criteria in a holistic way. It has theoretical incremental improvement in surgical accuracy but with increased significant surgical time and capital cost. Longer-term, robotic technology could have a role in facilitating less invasive patient customized implants and to proceeded solutions, so we continue to monitor this technology with great interest. Our focus is currently on procedure and episode of care efficiency. For example through our TruMatch and Care4Today where we think there are much more fundamental advantages to be gained.

Related to your second question, I can confirm your statement. We also believe that joint in the third quarter has at least maintained momentum if not picked up. We see an overall very attractive performance from DePuy Synthes recon with plus 7%. I am confident although we still have to wait until other major players report their quarterly results, I am confident that that DePuy Synthes has gained share in the third quarter and that would mean that we have done so in its fifth consecutive quarter.

Louise Mehrotra

Next question please?

Operator

Your next question comes from the line of Tony Butler with Barclays Capital.

Tony Butler - Barclays Capital

Good morning, Louise, and thank you very much for your time. Two questions, Dominic, the first or may be both of you. One is around free cash flow or cash flow from operations, however you wish to address it. Correct me if am wrong, I believe in the second quarter as you mentioned that the second half of this year, cash flow from operations would be greater. If am incorrect, I apologize for that, but the most important question is, regardless of how you view it. Do you have a view at which point cash flow growth can actually be something similar to the net income growth that you have actually been demonstrating quarter-in quarter-out just based upon at least pharma and to some degree the turnaround in consumer?

The second, more product-specific question, is around abiraterone, and clearly very strong sequential growth is all that growth coming from the pre-chemo market or can you comment, or are you able to providing the split about whether the growth is ex or pre-chemo and why is it post-chemo? Thanks very much.

Michel Orsinger

Sure, Tony. Well, let's see. Let's talk about free cash flow and just for purposes of definition that's cash flow from operation less capital expenditures. That's the way we look at free cash flow and that has consistently been very strong at Johnson & Johnson and this year is no exception to that. Last year, we reported free cash flow in excess of $12 billion. We expect that this year's free cash flow will be greater than that.

With respect to the relationship of free cash flow, the earnings, many of the special charges that we have talked about are in fact non-cash special charges right now. If you look at our earnings in comparison to free cash flow, what you will find is that generally speaking Johnson & Johnson has always delivered free cash flow in the aggregate that's somewhere in the neighborhood of 95% to 105% or just about equal to the net earnings that the company generates on an annual basis, so that has to do with our ability to manage receivables, inventory and appropriately invest in capital, so a very strong cash flow indeed and that's a credit to all the men and women that operate and run our businesses throughout the world where they do pay attention for the level of free cash flow that's generated, because that of course is the fuel for us to invest further in our business.

With respect to abiraterone or ZYTIGA pre-chemo versus chemo, Louise was able to look that up for us, so let me just turn it over to Louise for that answer.

Louise Mehrotra

Okay. Tony, the split of sales in the U.S. is roughly 55% naive and 45% refractory in the quarter. If you look at the market growth, the market growth in the quarter was 24.5% for that total market, refractory grew about 26.5% and naive about 23.5%. We actually grew share also in a total market going to 33% up from 30.6% and the refractory market you see a slight dip at that 55% from 55.4%, because of the new competition but you see nice growth in the naive market 24.6%, up from 21%.

Tony Butler - Barclays Capital

Thank you, Louise.

Louise Mehrotra

Next question, please?

Operator

Your next question comes from the line of Bruce Nudell with Credit Suisse.

Bruce Nudell - Credit Suisse

Good morning. Thanks for taking my question. I have a couple of questions for Dominic. First, Dominic, one of the areas that J&J is not currently participating in is structural heart. There is a lot of interest in it. Just broadly speaking, do you guys feel that expectations are overhyped that they are assets to be had that are of interest or what's the general level of interest on the part of J&J in that space?

Michel Orsinger

Well, Tony, the structural heart ware or cardiovascular devices in general are of interest to Johnson & Johnson with the exception of the stent market which, Bruce, we have exited. So we do view structural heart as an attractive market. It is true, however, that whenever we look at acquisitions we look to acquire assets at a price that we believe will generate value for our shareholders. So to the extent that valuations are a bit inflated, we would rather wait and approach that market when valuations come, in our view, better in line, Bruce. So that's the way we look at it. So of interest to us but we will watch valuations carefully before acting.

Bruce Nudell - Credit Suisse

And my follow-on is about XARELTO. What's your view of the prospects for maintaining leadership in that category in the U.S.? Secondly how do you scale the ACS opportunity within the overall opportunity in the U.S.? Thanks so much.

Michel Orsinger

Well, Bruce, the main strategy with XARELTO has been and continues to work well for us and that is that the breadth of clinical indications and support for the product is really unparalleled in the marketplace, in addition to the convenience of the once-daily dosage. So we have see steady growth in XARELTO, new to brand share in particular with cardiologist and even with primary care physicians, primarily because of the breadth of the clinical data despite the fact that there has been much competition entering the marketplace but that competition just doesn't have the breadth of clinical data that we have with XARELTO. So that's been our strategy. I credit our cardiovascular therapeutic area team for developing that strategy and it's working really well. So I expect we will continue to be leaders in this marketplace.

ACS just adds to the total package of clinical data which our experience is that that gives physicians, cardiologists, et cetera just more confidence in the utilization of that compound given the fact that it's been extensively studied. We look forward to see what the FDA responses with respect to our new submission for ACS. But we think that will add to the breadth of good clinical data which has been, I think, the main driver of the growth of the product.

Bruce Nudell - Credit Suisse

Thank you.

Louise Mehrotra

Next question please.

Operator

Your next question comes from the line of Jami Rubin with Goldman Sachs.

Louise Mehrotra

Good morning, Jami.

Jami Rubin - Goldman Sachs

Thank you. Good morning. Just two questions for you, Dominic. The first is in Simeprevir. I know that goes before a panel, I believe next week. I am just wondering how we should think it will be used? Do you expect it to be used as part of an all oral regimen beginning in 2014 with Gilead's Sofo or do you expect it's use to be limited to peg riba? My second question is more of a strategy question and, I think, dovetails with some of the earlier questions on this call and that is, clearly pharma has been the key driver of growth for the past couple of years now. I am just wondering what your plans are to unleashed that value which, clearly I think, has been hidden by the continued under performance of MD&D and consumer. Clearly the market is paying up for independent asset showing the type of growth that we are seeing in your pharma business. I am just wondering how you are thinking about that now. I know we have discussed this repeatedly in the past but I think this continues to be the case? Thanks.

Dominic Caruso

Sure, Jami. Well, with simeprevir, it would be premature to comment too much before the panel meeting because obviously the utilization of the compound will be somewhat dependent on the label that eventually is granted by the FDA. We do think it's a very potent protease inhibitor and as you know, we have studied the compound in addition to the single indication that we are now in waiting for FDA approval on. We have studied it in combination with other compounds including Gilead's compound and others, both NS5As and nukes.

Our strategy has been to develop the most potent protease inhibitor and combine it with other compounds in the marketplace and now I am please to remind you that we have just acquired our own NS5A with our acquisition of the compound from GlaxoSmithKline, so obviously we will now develop a combination of our own, but to comment any further about the actual utilization would be premature for the label and the outcome.

With respect to unlocking value, you are right. We have talked about this many times. You have also heard us describe our approach to healthcare as a comprehensive approach having a broad base in healthcare. We believe that that is the best strategy for the long-term to deliver both, innovation and breadth of business and solutions for the healthcare marketplace. We believe we are best positioned by having a combined set of businesses that we currently have and we think that investors and others that follow us very closely understand the composition of our business and can certainly do a very fair some of the parts analysis by looking at the combination of each of the businesses and the appropriate growth rates and above market quite frankly multiples that we think businesses like our Pharma business deserve, so it's all readily available and easily done and we think the long-term strategy is one that's sound and we continue to subscribe to having a broad base of healthcare businesses to be most competitive in the marketplace for the long-term.

Louise Mehrotra

Next question please?

Operator

Your next question comes from the line of Rick Wise with Stifel.

Rick Wise - Stifel

Good morning, everybody. Dominic just a few gross margins, you know we are almost back of the 70% gross margin what we saw throughout much of changes last decade and I assume that the third quarter gross margin performance was driven by the excellent pharma results, which seemed pretty sustainable. Knowing how focused you are personally on driving efficiencies throughout the organization broadly, Dominic can we assume that that kind of gross margin performances we saw that for closer to that 70%, level of sustainable basis that's closer hand that maybe we would appreciate it and maybe you could expand on your comments on the positive mixed cost improvement in the third quarter specifically?

Dominic Caruso

Sure. Well, the comparison to last year's third quarter just to be clear, last year's third quarter included the step up in inventory values from the acquisition of Synthes, so you see it 2.5 or 250 basis points improvement year-over-year and about 100 basis points is due to the non-repeat of the step-up in inventory values as that's now flushed out of the system, but the rest of it a 150 basis points is primarily due to the mix of the business, with pharma driving most of the growth. Pharma is in fact the highest gross margin business for us, but in addition to that we have seen good cost containment and cost efficiencies in our MD&D business. Of course as we continue to remediate under consent decree, we will obviously over time show improvements in gross margin from current levels to future in our consumer business.

Now having said that, our supply chain strategy is a long term strategy. We have been added now for a couple of years and it includes reciting and redistributing where the products are manufactured. That takes time, Rick, to implement, but we are obviously off to a good start and we expect we will continue to generate cost efficiencies within the supply chain over an appropriate level of time given the regulatory requirement et cetera for reciting products, so we are off to a good start. We are very proud of it and thanks for pointing it out.

Rick Wise - Stifel

Great. Just a thought, but quick one for you and Michel. I was at (Inaudible) last week and several CEOs suggested that maybe they were seeing some stronger procedure growth in the second half as folks do more procedures ahead of 2014 January 01 that's what we said and constantly changing insurance coverage. Do you think you are seeing any benefits, Michel? Dominic, feel free to chime in and maybe talk a little bit, Michel, about the ATTUNE impact. I assume, as a result of these kinds of launches, it takes off gradually. Are you where you hope to be? Just where are we in the ATTUNE launch?

Michel Orsinger

Okay, first of all related to spine. My takeaway from that was, in general, stakeholders are expecting more and more evidence. We might see some uplift in the fourth quarter from a market point of view, people who have been delaying and may use that co-payment earlier year might finally decide to go for surgeries.

ATTUNE. We are on track related to ATTUNE. Very important to us. All the clinical outcomes, which are very good. Surgeon's acceptance to try the product are also very good. So we are in the midst of launching not only now in the U.S., but expanding into Europe and eventually Asia-Pacific.

The key question, in my opinion, will be how much of our volume goes into current customers versus how much we give to new customers to convert and this is a balance our sales force needs to tackle. But so far, we are very confident that ATTUNE will have a good impact worldwide within the next two to three years.

Rick Wise - Stifel

Thank you.

Louise Mehrotra

Next question, please.

Operator

Your next question comes from line of Derrick Sung with Sanford Bernstein.

Louise Mehrotra

Good morning.

Derrick Sung - Sanford Bernstein

Good morning. Thanks for taking my question. One for Michel and then one for Dominic. First, Michel. One of the longer term concerns that investors have had about the ortho market has been the potential for a generic or value segment offering to really penetrate and destroy pricing in the marketplace. The kind of the comments that you made on trauma are the first that I think we have really heard that. Maybe this is having some sort of a near term impact now and I just wanted to get your comments on your view of whether or not you can, the value segment offering is something that's here to stay in the U.S. and if there is potential that it might spread from trauma to hips to knees to spine and what the impact of that might be on the markets long-term?

Michel Orsinger

Thank you. Certainly the healthcare landscape is changing big time. And as mentioned before, all stakeholders are looking forward continuing to improve patient outcome but also to increase patient satisfaction and do that at reduced cost. While the landscape is changing, we see emerging decision makers like the providers, either CEOs of the hospital of groups and having had the opportunity to meet many of them over the last few months, there is a demand for value creation, there is a demand for transforming the healthcare delivery system and there is a demand to collaborate with larger companies.

Scale, in the sense of DePuy Synthes, but also leveraging other opportunities within MD&D and within even other Johnson & Johnson portfolios will give us the opportunity to work at a much higher strategic level with providers and, yes, provide more cost effective procedures, products but also services to ensure that this more total oriented solution and not just focused on products, will provide a relevant add on solution to every single stakeholder. So we are confident that, now, being part of J&J but combining those two companies, we can leverage breadth of the portfolio, scale and this is what matters more than ever before to the healthcare providers and payers, by the way.

Derrick Sung - Sanford Bernstein

But do you, Michel, feel that the value segment in the U.S. is here to stay in ortho and continue to grow from here?

Michel Orsinger

It depends how you define value segment. We define it as providing healthcare in a more effective way and this is not just focused on the product. This is not just focused on the price. You have to look at the whole continuum. The patient goes through a process. We are developing new programs and services to educate the patient, working with providers and clinicians to have protocols with standardized procedures but eventually also a company there the patients and the families in the rehab post operatively. And this is what we see as a better value offering, a more relevant offering and not just focused on pricing and discounting.

The discussions will continue obviously to deal on pricing, but we have now being part of a larger company DePuy Synthes and J&J, the unique opportunity to again leverage size and scale and create beyond product innovation service and program innovation which will create value, so in that sense the Value segment is becoming more holistic, more complex, but representing a great opportunity for us.

Derrick Sung - Sanford Bernstein

Okay. Thank you, Michel, understood. Dominic, just quickly, I was wondering if you could comment on the progress of the Ortho Clinical Diagnostics divestiture and where you are there in and I appreciate that you may not be able to give us direct answer on the actual status, but more importantly when you think about the proceeds that might be generated from that transaction in the future, do those come back to shareholders, do they get reinvested? Can you give us a sense for what you might do there? Thank you.

Dominic Caruso

Sure, Derrick. Well, with respect to the strategic the evaluation of strategic options for Ortho-Clinical Diagnostics, we said it would take a 12-month to 24-month period. We announced that in January. We are progressing well, it's on track. We are moving through the process. Things are moving along well, so we are progressing as planned. It's premature to give you any more insight in to that. Then obviously, whenever we do finally complete the analysis and make a decision, but I think it would be premature to comment, part of that what we do with the proceeds, but when we are talk about obviously we will update investors at that time.

Louise Mehrotra

Okay. Thank you. Next question please?

Operator

Your next question comes from the line of Danielle Antalffy with Leerink Swann.

Danielle Antalffy - Leerink Swann

Good morning, everybody. Thanks so much for taking the question. Dominic, I wanted to ask about understanding that you can't provide specific 2014 guidance, but over the last few quarters pharma has been a big driver of the top line and I suspect bottom line outperformance. You know, as we come up on anniversarying that strong performance, potential competition for our recent new product launches our ramping competition there, how do we think about where the next leg of growth is going to come for J&J overall in the near to medium-term?

Dominic Caruso

Sure. Well. Each of the businesses have a substantial innovations that they are launching plans for 2014 and beyond to launch substantial innovations across every one of our businesses. Pharma, you are right, has experienced substantial growth as a result of new product launches, but those product launches are just beginning. They have taken hold now and we think they will continue to do well. Then new products, as you have seen us develop our strategy of continuing to in-license new products and launching those into the marketplace successfully, I think you will continue to see us do that, so I think each one of our businesses has a set of innovation that we plan to launch and each of the businesses should contribute to the growth going forward.

Danielle Antalffy - Leerink Swann

Okay. Great. Thanks. Then within the Medical Devices business in particular, one of your competitors has recently talked more about sort of viewing the device business more holistically providing full solutions to the hospital. Do you have any perspectives on that and how you think the healthcare environment will change as it relates to that and where J&J stands with that any perspective there would be helpful? Thanks so much.

Dominic Caruso

Sure, Danielle. Well, Michel talked a great length about that with respect to the orthopedics business and I would like to ask Michel to comment further, because he's involved across the broad spectrum of Johnson & Johnson's Medical Devices businesses as well, but we see it as an important characteristic in the marketplace and one in which scale and breadth and the power of Johnson & Johnson should serve us well. Certainly, there is very few companies that can match our scale and breadth in dealing with the comprehensive offering to the hospitals.

Michel has been there on the frontlines with hospital CEOs and talking about the breadth and scale of Johnson & Johnson even beyond orthopedic, so I am sure Michel you could add a few comments as well.

Michel Orsinger

Yes. Indeed, the key goal in our discussions with key partners is, how we could provide value in form of more holistic solutions. So far the industry has been very much focused on surgeons and patients, obviously, delivering good clinical outcomes. Now the healthcare delivery system needs to find new ways to do so in a more cost effective way. Hence we are driving now not only a strong R&D pipeline but a pipeline of new programs and services, collaborating together with the partners. We don't have all the answers today. But we understand more and more of their needs.

So elevating our relationship to more a strategic partnership with the providers in providing more holistic solutions. And maybe one more word, a key advantage we have, beside our already really relevant critical size within DePuy and Synthes, talking about MD&D, more and more we find new ways to collaborate, for example, with Global Surgery,

who offer complementary products for one and the same procedure. So a procedure based approach give us as also opportunity to combine co-solutions from different pockets of the industry.

Louise Mehrotra

We will take two more questions.

Operator

Your next question comes from the line of Glenn Novarro with RBC Capital Markets.

Glenn Novarro - RBC Capital Markets

Hi. Good morning. Two questions. First, Dominic, the number of selling days. Any changes in the number of selling days this quarter? Then I wanted to just follow up quickly on a pricing question.

Dominic Caruso

Glenn, good morning. I don't think the number of selling days is very significant this quarter versus last. I wouldn't attribute any of the change to selling days.

Glenn Novarro - RBC Capital Markets

Okay, and then second on pricing. You called out pricing several times on the device side particularly knees and hips as well as spine. So one, can you tell me has pricing got worse or is it just the same type of pressure? Then Louise, some times you give us pricing in knees, hips and spines. I wondered if you can do that for us?

Dominic Caruso

So let me just give you overall. We expected at the beginning of the year that pricing would be a headwind for us this year of about 50 basis points in operating margin. We still think that's the case now that we are nine months through the year. Pricing is in fact an overall headwind for the business in total. And Louise, specifically for these orthopedics.

Louise Mehrotra

So this is U.S. only. So price in hips is down about 3% in the quarter. We have a positive mix about 1.5%. So a net of negative 1.5% price mix for the hips in U.S. And as far as knees, price is down about 1.5%, mix up about 1%.

Glenn Novarro - RBC Capital Markets

And do you have that for spine as well?

Louise Mehrotra

I do. So price for spine down about 4% in the quarter with a negative mix of about 0.5%. So close to about 4.5% negative in terms of price mix for spine, U.S. U.S. only, again.

Glenn Novarro - RBC Capital Markets

Okay. Thank you, Louise.

Louise Mehrotra

Last question.

Operator

And your last question comes from the line of Bob Hopkins with Bank of America.

Dominic Caruso

Hi, Bob.

Bob Hopkins - Bank of America

Hi, good morning. Thanks for squeezing me in. Just two quick questions. One, Dominic, I just wanted to confirm something I heard earlier. I think you said in Q2 that BRIC growth for J&J was 19% and I think you said in Q3 it was 11%, 12%. Is that correct?

Dominic Caruso

Well, no, Bob. I didn't say that. I think the person asking the question was stating comments about the growth in the second quarter. I commented on year-to-date through nine months, the BRIC growth excluding Synthes, because that's very important to exclude Synthes in the analysis, is 11% to 12% overall for Johnson & Johnson in the BRIC markets excluding Synthes.

Bob Hopkins - Bank of America

Okay, and then so it sounds like things are a little slower in Q3 which is, I guess, not surprising. Was there any one division where that was more pronounced than another?

Dominic Caruso

Well a little slower overall but I don't know that I would point any one particular division versus another. I mean there's dynamics in the China marketplace each and every quarter. So I would just say on an overall basis greater than 10% growth is, we are pretty happy with that growth and I think it will do. It will continue to be a major driver of growth for us but what we are seeing is double-digit growth in the BRIC marketplaces but a little lower than what everyone else has previously commented on as an expectation for BRIC growth of maybe mid-teens. We see it's a little bit slower than that now.

Bob Hopkins - Bank of America

Okay, and then lastly, for Michel. Any of the comments on the hip market, in your comments do you feel like you are taking share and have been taking share over the last couple of quarters. I was just wondering is that a general comment, because especially around Q3, because you don't see the rest of the market growing at the same rate as you are, or was there something specific about a specific competitor that you are referring to in terms of your commentary around Q3 market share?

Michel Orsinger

I attribute our Q3 performance primarily to good portfolio mix in the U.S. primarily driven by Corail/TRI-LOCK and Pinnacle Acetabular Cup System. I attribute it to a very focused strategy, by the way well executed by the sales force and last but not least by a solid leadership. No major changes in my opinion related to competition. Good execution by DePuy Synthes.

Louise Mehrotra

Thank you. We will have some final comments from Dominic.

Dominic Caruso

Okay. Thanks Michel for joining us today and thanks Louise. Well, we are very pleased with our quarterly results and our progress this year in advancing our near-term priorities of returning to a reliable supply of OTC products to the market, successfully integrating Synthes and building on the momentum of our newly launched pharmaceutical products. We are doing all of this while continuing to deliver strong financial results and developing longer term strategies to drive growth in this dynamic global healthcare market, where we are focused on addressing the critical unmet healthcare needs of patients and consumers.

I would like to, again, thank the people of Johnson & Johnson for their dedication and commitment, and I look forward to updating you on our full year results, our outlook for 2014 and our strategic priorities along with our CEO, Alex Gorsky, when we meet in January. Thanks again for your time this morning and have a great day, everyone.

Operator

Thank you. This concludes today's Johnson & Johnson third quarter 2013 earnings conference call. You may now disconnect.

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