Johnson & Johnson (NYSE:JNJ)
Q3 2010 Earnings Call
October 19, 2010 8:30 a.m. ET
Louise Mehrotra – Vice President, Investor Relations
Sheri McCoy - Worldwide Chairman, Pharmaceuticals Group
Dominic Caruso – Vice President, Finance and Chief Financial Officer
Christine [No other identification.]
Michael Weinstein – JP Morgan Chase & Co.
Sara Michelmore - Cowen & Co.
Rick Wise - Leerink Swann
Matt Dodds – Citigroup
Jami Rubin – Goldman Sachs
Derrick Sung – Sanford Bernstein
Bob Hopkins – Bank of America
Bruce Nudell – UBS
Matt Miksic – Piper Jaffray
Larry Biegelsen – Wells Fargo
Glenn Novarro – RBC Capital
Eddie Han-Burgess - Raymond James
Good morning and welcome. I'm 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 2010. Joining me on the podium today are Sheri McCoy, worldwide chairman of our pharmaceuticals group, and Dominic Caruso, vice president of finance and chief financial officer.
A few logistics before we get into the details. The audio and visuals from this presentation are being made available to a broader audience via a webcast, accessible through the Investor Relations section of the Johnson & Johnson website. I'll begin by briefly reviewing highlights of the third quarter for the corporation and highlights for our three business segments.
Following my remarks, Dominic will provide some additional commentary on the third quarter financial results and guidance for the full year of 2010. Sheri will then provide an update on our pharmaceuticals business. We will then open the floor to your questions. We will conclude our formal presentation at approximately 9:30 and following Q&A with some final remarks by Dominic, we will conclude the meeting around 10:00 a.m.
Distributed with the copy of the press release that you just received is a schedule with actual revenues for major products and/or business franchises. For the listening audience, these are available on the Johnson & Johnson website, as is a copy of the press release.
Before I get into the results, let me remind you that some of the statements made during this meeting may be considered forward-looking statements. The 10-K for the fiscal year 2009 identifies certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning. 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 or online.
Last item. During the call, non-GAAP financial measures may be used to provide information pertinent to ongoing business performance. These measures are reconciled to the GAAP measures and are available in the press release or on the Johnson & Johnson website.
Now I would like to review our results for the third quarter of 2010. If you 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 $15 billion for the third quarter of 2010, down 0.7% as compared to the third quarter of 2009. On an operational basis, sales were up slightly, and currency had a negative impact of 0.8%.
In the U.S., sales declined 2.5%. In regions outside the U.S., our operational growth was 2.6%, while the effect of currency exchange rates negatively impacted our reported sales by 1.5 points. Our strongest performing region was the Asia-Pacific Africa region, which grew 4.1% on an operational basis. Europe grew 1.8% operationally, while the western hemisphere, excluding the U.S., grew by 1.7% operationally.
If you'll now turn to the consolidated statement of earnings, net earnings were $3.4 billion compared to $3.3 billion in the same period in 2009, an increase of 2.2%. Earnings per share were $1.23 versus $1.20 a year ago.
I would now like to make some additional comments relative to the components leading to earnings before we move on to the segment highlights. Cost of goods sold, at 30.7% of sales, was 130 basis points higher than the same period in 2009, primarily due to the cost associated with the impact of the recalls and related remediation efforts in the consumer business and the impact of price reductions in our pharmaceuticals business and certain MD&D businesses.
Selling, marketing, and administrative expenses, at 31.4% of sales, were down 20 basis points versus last year due to cost-containment initiatives. Our investment in research and development as a percent of sales was 11.1%, 40 basis points higher than the third quarter of 2009 due to timing of spending on projects.
Interest expense net of interest income of $95 million is $19 million less than the third quarter of 2009 with lower interest expense on lower average debt. Other income net of other expense of $292 million was $196 million greater than the same period in 2009.
Taxes were 19% in the third quarter of 2010 versus 21.2% in the third quarter of 2009. Dominic will discuss other income and taxes in his commentary.
Now turning to the consolidated statement of earnings for the first nine months of 2010, consolidated sales to customers for the first nine months of 2010 were $45.9 billion, an increase of 1.3% as compared to the same period a year ago. On a year-to-date basis, sales were flat operationally and currency had a positive impact of 1.3 points.
On the consolidated statement of year-to-date earnings, I'd first like to draw your attention to the boxed section. Adjusted net earnings of $10.4 billion in 2010 compares to net earnings of $10.1 billion in 2009. Adjusted earnings per share, at $3.73, were 3.3% versus the 2009 results.
Turning now to business segment highlights, please refer to the supplementary sales schedule highlighting major products or business franchises. I'll begin with the consumer segment.
Worldwide consumer segment sales for the third quarter of 2010 of $3.6 billion decreased 10.6% as compared to the same period last year. On an operational basis, sales declined 10.2%, while the impact of currency was negative 0.4 points.
U.S. sales were down 24.5%, while international sales were up 0.4% on an operational basis. The consumer sales growth in the quarter was impacted by the OTC recalls, currency devaluation in Venezuela, and certain divestitures. The OTC recall impacted operational growth by approximately 6 points, while the devaluation and divestitures impacted operational growth by just over 1 point each.
For the third quarter of 2010, sales for the over-the-counter or OTC pharmaceuticals and nutritionals decreased 19.4% on an operational basis, compared to the same period in 2009, with U.S. sales down 40.2% and sales outside the U.S. up 3.5% on an operational basis.
Sales were impacted by the voluntary recalls announced earlier this year and suspension of production at the McNeil Fort Washington, Pennsylvania facility. As an update on the products included in the January recall that are produced at our McNeil Las Piedras, Puerto Rico facility, we are at normal levels of production. Restocking commenced in the second quarter and continues to ramp up to normal trade inventory levels for key products.
Regarding the Fort Washington facility, operations at this plant were suspended in connection with the recall of infants and children's liquid OTC products manufactured there. The suspension of manufacturing also impacted adult solid OTC products manufactured at the facility.
We remain on track with our plans for ultimate supply of these products from within the Johnson & Johnson manufacturing network. We began shipping a small amount of product and beginning in the first quarter of 2011, shipments will ramp up and continue to expand throughout the year.
McNeil submitted its remediation plan to the FDA on July 15. The plan applies to all manufacturing facilities McNeil operates to supply the U.S. market and addresses governance and management controls, training programs, process assessments, and process improvements. We are committed to regular and detailed communications with the FDA as we implement this plan.
Now moving on to the other businesses, skincare business declined on an operational basis by 4.9%, with the U.S. down 15.9% and sales outside the U.S. up 3.7% on an operational basis. In the third quarter we began implementing enhancements to equipment that will continue into the fourth quarter. This has resulted in a temporary reduction of shipments for certain products.
Baby care products achieved operational growth of 3.3%, with the U.S. growing 2% and sales outside the U.S. growing 3.6% on an operational basis when compared to the third quarter of 2009. Powders and cleansers were the major contributors to the sales growth outside the U.S., while babycenter.com contributed to the growth in the U.S.
Women's health declined operationally by 7.9%. Sales in the U.S. were down 14.8%, while sales outside the U.S. were down on an operational basis by 5.1% due to increased competitive pressure.
Sales in the oral care franchise were down 6.8%. In the U.S., sales were down 12.3% while sales outside the U.S. were down 2.2% operationally. Sales were impacted by the divestiture in the U.S. of the Efferdent and Effergrip brands, as well as lower sales of toothbrushes and slower category growth in mouth rinses.
That completes our review of the consumer segment, and I'll now review highlights for the pharmaceutical segment.
Worldwide net sales for the third quarter of $5.5 billion were up 4.7% versus the same period last year, with operational growth of 5.9% and a negative impact of currency of 1.2%. Sales in the U.S. increased 6.9%, while sales outside the U.S. increased on an operational basis by 4.6%.
The third-quarter sales were negatively impacted by U.S. health care reform as well as European austerity measures estimated to be approximately $150 million.
Now reviewing the products. Contributing to the results were a number of the core products, which I'll discuss in a moment, and importantly the new products recently introduced: Stelara, Simponi, Invega Sustenna, and Nucynta. With the successful launches of Stelara and Simponi, we achieved U.S. market leadership in immunology in 2010.
Sales of Remicade, a biologic approved for the treatment of a number of immune-mediated inflammatory diseases, were up 18.6% when compared to the third quarter of 2009. Sales growth in the U.S. was 4.3% due to strong market growth partially offset by lower market share in an increasingly competitive marketplace.
Strong market growth and an increase in inventory levels contributed to an increase in export sales of 75.5%. The international market growth is estimated to be over 20% in the quarter.
As an update on the arbitration with Merck, the evidentiary portion of the arbitration has been completed and oral argument is scheduled for late this year. It is possible we could have a decision in the first half of 2011.
Procrit and Eprex declined operationally by 22.9% during the quarter as compared to the same quarter last year, with Procrit down 31.8% due to a decline in the market and the impact of the recall announced in September. Eprex sales were lower by 11.9% operationally due to increased competition and a slow-down in certain European markets.
Risperdal Consta, a long-acting injectable antipsychotic, achieved third-quarter sales growth of 11% on an operational basis. Sales in the U.S. were down 16.3%; however solid growth was achieved in the combined market share of our long-acting injectables, including Invega Sustenna. Sales of Risperdal Consta outside the U.S. were up 26.6% operationally with very strong growth in Japan.
Sales of Levaquin, our anti-infective, were down 8.1% on an operational basis when compared with the same period a year ago, due to the decline in the market and increased penetration of generics. The U.S. anti-infective market is estimated to be down approximately 4% in the quarter due to a lower instance of respiratory illness and flu.
Concerta, a product for attention deficit hyperactivity disorder, was up 5.8% operationally in the third quarter as compared to the same period last year. Sales in the U.S. were up 4.4% due to double-digit market growth offset by the impact of health care reform. Sales outside the U.S. were up 9.3% operationally, with strong growth seen in most major regions.
Velcade is a treatment for multiple myeloma for which we have commercialization rights in Europe and the rest of the world outside the U.S. Operational sales growth was 10.1%. Timing of shipments related to tenders impacted the rate of growth in the quarter.
Aciphex, as it is known in the U.S. market, and Pariet outside the U.S., is a proton-pump inhibitor or PPI, that we co-market with Eisai. On an operational basis, sales were down 5.3% with U.S. sales down 11.5% and sales outside the U.S. up 0.8% operationally. Script share in the U.S. was down 1% due to increased competition from generics in the category.
Prezista, a protease inhibitor for the treatment of HIV, grew operationally 55.9% with the U.S. growing 30.8% and sales outside the U.S. growing 82.7% due to very strong momentum in share.
Invega, an atypical antipsychotic, grew operationally 2.7% with gross in the U.S. of 3.3%. As an update to our pharmaceutical pipeline, during the quarter CHMP adopted a positive opinion for Invega for the treatment of psychotic or manic symptoms of schizoaffective disorder. Additionally, in October we submitted to the FDA the pediatric supplemental NDA for Invega for the treatment of schizophrenia in adolescents ages 12-17 years of age.
I'll now review the medical devices and diagnostic segment results. Worldwide medical devices and diagnostic segment sales of $5.9 billion grew 1.9% operationally as compared to the same period in 2009. Currency had a negative impact of 0.6 points, resulting in a total sales increase of 1.3%. Sales in the U.S. were up 1.2%, while sales outside the U.S. increased on an operational basis by 2.6%.
Now turning to the franchises, starting with Cordis. Cordis sales were down 6.6% operationally with the U.S. up 5.6% and sales outside the U.S. down 13.5% operationally. Cordis results were impacted by lower sales of Cypher, our sirolimus-eluting stent, partially offset by strong growth in our Biosense Webster business.
Cypher sales were approximately $135 million, down 36% on an operational basis versus the prior year. Sales in the U.S. of approximately $45 million were down 12%. Estimated share in the U.S. of 13% was up one point from a year ago and flat on a sequential basis. Sales outside the U.S. of approximately $90 million declined 45% operationally.
The estimated market share in the quarter of 14% was down one point on a sequential basis, and down 11 points from the third quarter of 2009. Increased competition has impacted the share outside the U.S. Cypher estimated worldwide share for the quarter was 15%, flat sequentially and down 6 points from the third quarter of 2009.
Biosense Webster, our electrophysiology business, achieved strong double-digit operational growth in the quarter, due to increased market share. The successful launch and the continued expansion of the installed base of Carto 3 made a strong contribution to the results.
As an update on the clinical development of our Nevo stent, we submitted Nevo for CE mark at the end of the first quarter using the data from the RES-1 trial, which has demonstrated Nevo's superiority to Taxus Liberte at both 6 and 12 months.
In August we began limited patient enrollment in Nevo 2. While the stent itself is performing extremely well, we have decided to suspend enrollment so that we can improve the performance of the balloon catheter. We will restart Nevo 2 once these improvements have been made.
We are currently evaluating the impact that this delay will cause in our European launch, which is subject to CE marking, and our U.S. submission, which requires data from Nevo 2. We will not launch in any market prior to the restart of Nevo 2.
Moving on to our DePuy franchise. DePuy had operational growth up 2.6% when compared to the same period in 2009, with the U.S. growing 1.1% and the business outside the U.S. growing by 4.8% operationally. Pressure on pricing continued as a result of the economic trends. However, positive mix, due to continuing product innovation, has mitigated some of the impact.
Operational hip growth on a worldwide basis was approximately 2%. U.S. sales declined 1% due to lower volume in the metal-on-metal bearing business and intensified pressure on price net of mix. The growth outside the U.S., at 7% operational, was driven by the success of the acetabular and cementless systems. As of the second quarter, DePuy had maintained its worldwide market share leadership position in hip.
On an operational basis, worldwide knee growth was approximately 3%, with U.S. growth for the quarter at 2% and outside the U.S. growth at 4% operational.
Spine was flat on an operational basis, with the U.S. down approximately 3%, and sales outside the U.S. up 7% operationally. Pricing pressure in the category and softness in procedural volume impacted the growth in the U.S.
The diabetes franchise was up 1% operationally in the third quarter of 2010, with the U.S. business up 1.8% and the business outside the U.S. up 0.2% operationally. Macroeconomic pressures, such as increasing co-pays and out of pocket expense, continued to pressure volume growth in the category. Animus sales outside the U.S. continued to grow double digits due to continued development of the international market.
Ethicon worldwide sales grew operationally by 6%, with the U.S. up 9.3% and sales outside the U.S. up 3.4% operationally. The acquisition of Acclarent this year contributed to growth in the quarter. Growth was also driven by bio-surgicals and Mentor products, as well as increased penetration of antibacterial sutures outside the U.S.
Ethicon Endo-Surgery achieved operational growth of 3.3% in the third quarter of 2010 with the U.S. sales down 3% and sales outside the U.S. up on an operational basis by 8.4%. Growth was impacted by the divestiture of the breast care business. Excluding this impact, worldwide sales grew operationally by approximately 6%. Growth was driven by advanced sterilization, endo, harmonic, and SurgRX products.
Ortho-Clinical Diagnostics was down 0.4% in the third quarter, with the U.S. down 7.7% while sales outside the U.S. were up 9.2% on an operational basis. Growth of Vitros 5600 and 3600 was offset by lower sales in donor screening, with the move to selective testing for certain diseases.
Rounding out the review of the medical devices and diagnostics segment, our vision care franchise achieved operational sales growth of 1% in the third quarter compared to the same period last year. Sales in the U.S. increased 1.3%, while sales outside the U.S. increased 4% on an operational basis. Growth in both astigmatism and daily lenses were driven by the strength of the underlying platforms and new product launches partially offset by lower sales of reusable lenses.
That completes highlights for the medical devices and diagnostics segments, and concludes the segment highlights for Johnson & Johnson's third quarter of 2010.
I'll now turn the podium over to Dominic Caruso. Dominic?
Thank you Louise. I'd like to add my own welcome to members of the investment community who have joined us here today, and also to those who are listening in via webcast and conference call. I will keep my remarks brief to allow ample time for the update on our pharmaceutical business and for your questions.
I would like to provide a few comments about our third quarter results, update you on some positive developments in the quarter, and then wrap up with our guidance for the remainder of the year.
In the third quarter, our business performance was solid despite a general softening in the global healthcare markets. We maintained or grew many of our market share positions. Our broad base of healthcare businesses continues to be a core strength that enables us to manage through the challenges that sometimes arise in markets where we compete. In the third quarter, we saw a deceleration of growth trends in overall healthcare spending related to the economy, which I will discuss in a few minutes.
Our third quarter reported results of $1.23 per share include approximately a $0.06 per share benefit from a lower effective tax rate, resulting from changes in the mix of our business as well as favorable tax adjustments in various jurisdictions.
Excluding this impact, our adjusted earnings per share still exceeded the mean of the analysts' estimates as published by First Call. Additionally, we had a lower level of pre-tax operating margin as compared to the prior year, due mainly to lower gross profit.
This was the result of pricing pressure across both our pharmaceutical and medical devices and diagnostics businesses as well as the impact of not shipping the OTC products from our McNeil Fort Washington, Pennsylvania facility and the ongoing cost of remediation at that facility.
During the third quarter we also increased our level of spending in R&D and although SG&A expenses were leveraged as part of our ongoing cost reduction efforts, these costs were not as low as you might have expected, as they also reflect some increased spending as we continue to invest in new growth platforms and product launches.
These higher costs were essentially offset by an increase in other income and expense that reflects some gains from divestitures, principally from the previously announced divestiture of our breast care business. As is our practice, when we make decisions to reshape our portfolio with divestitures, we typically use any gains to make additional investments or enable other business decisions that would enhance our long-term growth. That was certainly the case in the third quarter, and we expect that a higher level of investment spending would continue into the fourth quarter.
In our pharmaceutical business, we continued to see the impact from the European pricing pressures we mentioned on our second quarter call, and the impact of U.S. healthcare reform measures that were implemented earlier this year. Despite these impacts, our pharmaceutical business produced solid sales from its core products and successful new launches.
We continue to invest in the areas that we believe have significant growth potential and as you know, two weeks ago we announced an agreement to acquire Crucell. We expect that deal to close in 2011 and be dilutive to earnings per share in 2011 by approximately $0.03 to $0.05 per share. We want to make Crucell the center for vaccines in our pharmaceutical business.
Sheri will be covering several positive developments in our pharmaceutical business in just a few minutes.
Our medical devices and diagnostics business continued to show growth in five of seven franchises on an operational basis. In this quarter, however, that growth was tempered by a slowdown in the pace of surgical procedures, particularly in orthopedics.
This is consistent with observations that many in the analyst community have recently shared. There appear to be several factors contributing to this slowdown in the markets. We believe the effects of the weaker economy and the uncertainty that some patients face about their ability to take on additional medical expenses are prompting some patients to postpone elective procedures.
One factor making this more pronounced in this quarter is the recent discontinuation of extensions for COBRA health care benefits that are available to the unemployed in the United States. However, based on the latest data that we have, we believe we have maintained or improved market share in most areas of our MD&D businesses.
In the face of this lower level of healthcare spending across the markets where we compete, our view is that in the long-term demographic trends, emerging market expansion, and advances in technology that can make a significant difference to patient outcomes will provide strong tailwinds for continued growth in the global MD&D market.
We also continue to work through the DePuy/ASR hip implant recall, assisting patients and healthcare providers by providing information as well as paying for the cost for any follow up, monitoring, and treatment associated with the recall. We are still defining the extent of this program, after which we will assess the financial impact and provide you with additional information once that assessment is complete.
This quarter we also completed the acquisition of Micrus Endovascular, which strengthens our neuro device business for the treatment of hemorrhagic and ischemic stroke.
Regarding our consumer business, the third quarter results reflect an approximately $240 million negative impact to sales and an approximately $0.05 per share negative impact to EPS from the McNeil consumer healthcare recalls and shutdown of the Fort Washington, Pennsylvania facility.
I am pleased to report we have begun shipping one of the McNeil children's medicine products to our customers. Although they will be available only in limited quantities at first, we have been able to achieve this step by working closely with the FDA and our Canadian affiliate. Nearly 1 million bottles have been released, and we expect to distribute a total of 4 million bottles in the United States by the end of this year.
Meanwhile, in the remainder of our consumer business we saw solid results in emerging markets and continue to build on our iconic brands with new products. For example, Tylenol Precise is a new pain product launched in the third quarter which offers new insights on the science of touch and how it can relieve muscle and joint pain. And Listerine Zero, a less-intensive alcohol-free mouthwash that uses the same proven ingredients found in regular Listerine antiseptic, was launched this quarter.
I'd like to now provide some guidance for you to consider as you refine your models for 2010. Let me begin with a discussion of cash and interest income and expense. As you know, we raised $1.1 billion of cash through a debt offering in August. We saw a market opportunity to increase our financial flexibility with favorable terms and achieve the lowest rates on record for 10- and 30-year corporate bonds as one of the few AAA rated companies.
At the end of the third quarter, we had over $10 billion of net cash. This consists of approximately $22 billion of cash and investments, and approximately $12 billion of debt. This is an improvement of nearly $3 billion in our overall net cash position from the second quarter of 2010.
This past quarter we also continued our share repurchase program. To date we have purchased $9.6 billion of our stock under our $10 billion share repurchase program. We expect to complete the balance of the repurchase program by the end of this year. For purposes of your models, assuming no additional major acquisitions during 2010, I suggest you consider modeling net interest expense of between $300 million and $400 million, consistent with our previous guidance.
Turning to other income and expense, as a reminder, this is the account where we record royalty income as well as one-time gains and losses arising from such items as litigation, investments by our development [corp.] or asset sales and write-offs.
This account is difficult to forecast, but assuming no major one-time gains or losses, I would recommend that you consider modeling other income and expense for 2010 as a net gain ranging from approximately $450 million to $550 million, which is higher than our previous guidance, reflecting the recent divestiture gains. This excludes the impact of net litigation matters, which we have treated as special items, such as our settlement with Boston Scientific earlier this year.
And now a word on taxes. For the first nine months of 2010 the company's effective tax rate, excluding special items, was 22.2%. This does not yet reflect the benefit of the R&D tax credit, because that legislation has not been enacted.
We suggest that you model our effective tax rate for 2010 in the range of 21.5% to 22.5%, which is lower than our previous guidance, reflecting the impact of the favorable tax adjustments we recorded in this third quarter. And while it is not yet enacted, it is our expectation that the R&D tax credit legislation will be enacted later this year and made retroactive for 2010. And as always, we will continue to pursue opportunities in this area to improve upon the rate throughout the remainder of the year.
Now turning to sales and earnings guidance, our guidance continues to be based first on a constant currency basis, reflecting our results from operations assuming that average currency rates for 2010 will be the same as they were for 2009. This is the way we manage our business and we believe this operational review provides a good understanding of the underlying performance of our business. We will also continue to provide an estimate of our sales and EPS results for 2010 with the impact that current exchange rates could have and will use the euro as an example.
Turning to sales, given the factors that we outlined earlier this year, and reflecting the impact of the lower trends in spending across many of the healthcare markets in which we compete, we would be comfortable with your models reflecting flat operational sales - that is on a constant currency basis - as compared to the prior year.
This would result in estimated sales for 2010, on a constant currency basis, of approximately $62 billion. And while we are not predicting the impact of currency movements, to give you an idea of the potential impact, if currency exchange rates for the remainder of 2010 were to stay where they were as of last week, then our sales growth rate would be positively impacted by currency for the year, due principally to the recent strengthening of the euro from $1.29 in July to nearly $1.40 as of last week. This would result in a minor positive impact on the average rate for the full year as compared to the prior year so that the expected level of reported sales would also be approximately $62 billion.
And now turning to earnings, given the lower effective tax rate that we now estimate for the year, we believe that we will be able to offset the impact on earnings from the trends we are seeing in a lower level of spending across healthcare markets and the resulting change in our estimated sales for the year that I just outlined. Also, as I noted earlier, we expect increased investment spending for the year, which would be offset by higher gains in other income.
With that as context, I suggest that you continue to consider full-year 2010 EPS estimates, excluding the impact of special items, of between $4.70 and $4.80 per share on an operational basis, which assumes the same average exchange rates for 2010 as we saw in 2009.
This represents an operational EPS growth rate of 2% to 4%, and while we are not predicting the impact of currency movements, to give you an idea of the potential impact on EPS, if currency exchange rates for the balance of 2010 were to remain where they were as of last week, as an example with the euro nearly at $1.40, the impact of average currency movements for the year, primarily the euro, would be very minimal. And therefore, our reported EPS, excluding special items, would also be between $4.70 and $4.80 per share, an increase from our previous guidance reflecting changes in foreign currency exchange rates. We would be comfortable at the mid-point of this range.
That concludes my comments on our operating performance this quarter and on our guidance with respect to your models. Now let's move on to the next portion of our program today. As you know, we regularly communicate with the investment community about our long-term strategy and prospects for growth. Many of you joined us in June last year for a comprehensive review of our pharmaceuticals business, and today we're going to bring you an update on the exciting progress and new developments we have made since that time.
Sheri McCoy, worldwide chairman of our pharmaceuticals segment, has been leading an important transition of our pharmaceuticals business since she took that position nearly two years ago. She has helped lead that business through a period of major patent expirations and change and they have been launching important new, life-changing medicines and making important new pipeline investments to ensure we can continue to meet the needs of patients and healthcare providers.
It is my pleasure to introduce my friend and colleague on our executive committee, Sheri McCoy. Sheri?
[Applause.] Thank you Dominic, and good morning. I'm delighted to provide you with an update on our pharmaceuticals business.
What I'm going to talk to you about today is I'm going to provide you with an overview, and I'm going to start with perspective on the pharmaceutical industry. And what you'll hear is that we consider the pharmaceuticals industry a very attractive segment, recognizing it's undergoing historic change. With that said, there's terrific opportunity to innovate and reach patients with meaningful solutions.
We will talk about our pharmaceuticals business and what I'll provide you with is perspective on our business. We're building momentum, driving growth, and importantly, advancing our pipeline and revitalizing our portfolio. We're executing well against our strategic priorities and it's really driven through our strong talent and capabilities throughout our organization.
So some comments on the pharmaceutical landscape. Certainly it's a very large and growing business. EvaluatePharma estimates that it's a $650 billion market projected to grow between 3% and 4% over the next several years, with modest growth in the developed markets and double-digit growth in the emerging markets.
The 3% to 4% is lower than what we've seen historically, and this really takes into account the pricing pressures, loss of patent exclusivity, and the various healthcare reform initiatives going on around the globe. With that said, there's still tremendous opportunity with large therapeutic areas and unmet needs and opportunities to serve patients given the demographics and the change in the environment. So there's an opportunity to continue to make sure that we innovate and focus on this market.
Taking a look at our business, we characterize 2010 as the year of our pipeline advancement. We're building momentum, revitalizing our portfolio, moving away from some of our older products to a new generation of products. We're executing against our strategic priorities, focused on accelerating the growth of our launch products - those products we launched in 2009, and I'll spend some time talking about those.
We'll have a number of key filings the second half of this year, and we could be in a position to have five compounds in registration by the end of this year. We're focused on critical geographies, and I'll provide you with a brief update on some of the initiatives in these areas. And we've been focusing on our organizational effectiveness and efficiencies, both on the R&D side of our business as well as our commercial and supply chain - focusing on how we can get products to patients more rapidly.
I talk about revitalizing our portfolio, and I think this chart depicts it well. If you take a look at the right-hand side of this chart, you see the red bars, and that really looks to the loss of sales due to patent exclusivity - so the Risperdals and the Topamax - as well as the impact of healthcare reform.
On the other side of the chart, what you see are the green bars. This is reflecting the growth of our new products as well as some of our key prioritized products. And if we look at the growth of those products, that represents a growth rate of 26%. So for the first nine months of this year, we've added $1.4 billion in sales, essentially offsetting the loss due to loss of patent exclusivity and healthcare reform.
Importantly, as we move forward, we want less red and a lot more green, and bigger green. So that's our focus as we look to revitalize our portfolio.
We have four strategic priorities, and I'll walk you through each of them. In the area of innovative products, we'll talk first about our launch products. We're very pleased with the success of our four key launched products.
Stelara, a product for moderate to severe psoriasis with a novel mechanism of action, opportunity for three-month dosing, off to a very very good start. For the first nine months of this year our share is up 7.6 points in the dermatology market in the U.S. We also see very very strong performance in markets around the world. It has very high patient satisfaction, very good awareness with derms, particularly given the New England Journal of Medicine article, which talked to the superiority versus Ambril, and very very pleased with the performance of Stelara.
Simponi is a product that we entered into the sub-cu area in immunology. What we see there is that we're making good progress in terms of getting access. It's a very competitive market, and one of the things we see is about 25% to 28% of the patients are biologically naive patients. What we're seeing is the other 75% or so are people that have switched from either Ambril or Humira and tend to, in many cases have failed other anti-TNFs, so a more difficult patient population. We're continuing to work through that. We've also just filed a structural damage claim in the area of rheumatoid arthritis and we will be filing later this year for psoriatic arthritis.
Sustenna off to, also, a very good start in the long-acting injectable arena. Good patient satisfaction and clinician satisfaction and we're making progress from a formulary status perspective. This is an area where we have the opportunity to really increase the market penetration for long-acting injectibles, and that's where we're focusing our efforts.
Nucynta, for acute pain, we introduced the IR version in June of last year into a very competitive market with a lot of generics. We have an 8.1% share, up over three points for the past nine months. This is an area where we continue to get good progress and we're making inroads both in the PCP area as well as with pain specialists. We just recently received the Nucynta ER complete response letter from the FDA. We're in the process of working with them on that. There's no additional clinical data that is required. It's really questions about the bio-equivalence of that compound.
If we now look at our robust pipeline, just a couple of words on pipeline. If we look at the market that we're in today, it's a changing landscape. We recognize the cost to get new drugs to market is increasing, a lot more risk. And it's important that we focus our approach from a pipeline standpoint.
So we've identified five therapeutic areas. We have one individual that manages that therapeutic area and they have responsibility for end-to-end, going from discovery all the way to commercialization, looking at both large molecules and small molecules. They also have opportunity to do internal development as well as look at opportunities to build the pipeline through external partnerships or external acquisition.
Importantly, these areas are also trying to understand the stakeholder insights, looking at what is going to be happening in the next five to ten years, to make sure that we're building our development programs with that insight and understanding the importance of bio-markers and personalized medicine as we develop these different therapeutic areas.
We also take a look at our pipeline from a total perspective to understand the risk profile, and that's an area that we continue to focus on as we make investments in the various therapeutic areas. What's absolutely critical for our pipeline is to have very strong scientific expertise and commercial insight, and this is an area that we continue to focus on.
We have five therapeutic areas, all large, with significant unmet medical needs, and we've looked at these both from an internal development standpoint as well as an external. And just to give you some perspective as we think about this in terms of bolstering our pipeline, we have looked at external opportunities in the area of oncology.
We acquired Cougar Biotechnology for abiraterone acetate. In the area of Alzheimer's disease, entered a collaboration with Elan and Pfizer to look at how we can take bapineuzumab to the market. In the area of HIV, recognizing there was a broader opportunity if we had to fix those combinations, we partnered with Gilead. And in the area of vaccines, it was really the identification of the opportunity to get into prevention, to strengthen our emerging market capabilities, and also strengthening our infectious disease, we entered into a collaboration last year with Crucell and then recently this year we just announced the intent to acquire the additional 82% of the shares in that and we hope to close that acquisition in 2011.
I think this gives you a perspective on the flexibility in how we're thinking about building our pipeline and whether it would be an acquisition, or a partnership, or internal development. We look at our pipeline as a very robust pipeline. We have a lot going on in the various therapeutic areas.
If we take a look at line extensions in other areas to build our pipeline, what you can see is that we also have some very meaningful line extensions for our pipeline. We have a very very aggressive fourth quarter if you see the list of planned fillings, so we have a lot going on this second half of this year.
Now what I'd like to do is spend a few minutes talking about some of the key assets. First of all, abiraterone acetate. This is a product that we acquired through the Cougar Biotechnology acquisition. It has a tremendous opportunity to make a difference for people with prostate cancer.
We have actually two clinical trials. The first was chemo-refractory patients, people who had failed chemo for the advanced metastatic prostate cancer. We had the review of interim data by an independent advisory committee. The trial was stopped because the overall survival was significant, so what we're seeing is that in the case with the treatment arm with abiraterone, significant improvement in overall survival versus the placebo arm.
We are very aggressively working to file by the year end. We have a second trial for chemo-naive patients and what we're planning there is potentially filing in 2012, based on an interim review by an independent panel of the overall survival data in 2012.
Bapineuzumab is for the treatment of Alzheimer's. Probably has the greatest potential for disease modification. It would be the first in class. This is an area that we have tremendous opportunity to make a difference for patients. If you look at the cost associated with Alzheimer's disease it's estimated in the U.S. to be about $150 billion. So tremendous opportunity.
We have four trials underway in partnership with Pfizer. We are running the U.S. trials. We essentially have completed the enrollment in the main study and we're continuing to enroll in the bio-marker sub-studies. And we anticipate filing in 2012-2013.
Rivaroxaban - we're very excited about this compound, has an opportunity to make a huge difference in people's lives. This is an area where we've invested significantly in partnership with Bayer. We have about 60,000-plus patients enrolled in clinical studies. We're focusing on five indications and I'll briefly talk about the first three.
The first one is VTE prevention. This is for hip or knee replacement surgery, and we had data last year where we showed superiority versus enoxaparin. We had a complete response letter, and we are right now in the process of responding back to the FDA for the complete response and we'll have that filed by year-end.
VTE treatment - we have three Phase III trials underway, or in the process of either being completed or underway. We just recently announced the DVT trial where we showed non-inferiority versus standard of care, which was enoxaparin followed by vitamin K antagonist. So very good results and we're in the process of completing the Einstein-PE study and we'll file in 2012 once we have all Phase III trials complete.
Stroke prevention is a very large trial. We have 14,000 patients enrolled. We plan to present the results of this in November - November 15 at the AHA meeting - and very excited about this opportunity and plan to file later this year. This is a double-blinded product test versus orphan, so we're excited about this opportunity and again, we'll hope to present the results in November at the AHA meeting. And we have two other indications for medically ill and ACS both on track.
Canagliflozin is an opportunity in the area of treatment of Type II diabetes. It's an SGL T2 inhibitor. We presented phase 2b data at the ADA meeting earlier this year. We have nine ongoing Phase III studies and we have over 10,000 patients enrolled at this point. And we'll be planning to file in 2012, both in the U.S. and Europe.
Telaprevir is a terrific opportunity in the treatment of hepatitis C. We're partnering this asset with Vertex. It's a potential first in class protease inhibitor. We have all Phase III studies completed at this point, all have met their primary objectives, importantly, both for treatment naive patients as well as treatment failure patients. They've all showed significantly higher SVR rate. We also had a very low rate of discontinuation and we're seeing that there's a significant reduction in treatment time, particularly for the naive patients. We'll be filing in Europe in the end of 2010, this year.
435 is also a product in the treatment of Hepatitis C. This is one that we think is next-generation protease inhibitors that has the potential for increased patient satisfaction and potentially better adherence. We've completed three Phase II-B studies. We've got two that were enrolled for naive patients and we showed very very strong viral load reduction as well as a good safety profile and we're in the process of completing the treatment failure segment of this study.
TMC278 is for the treatment of HIV. This is an oral combination. It's an NNRTI once-daily. We also are working with Gilead on this for a fixed-dose combination. We've had two Phase III trials with treatment-naive patients, and both trials have met study objectives, which is non-inferiority versus efavirenz, and we're also seeing very strong tolerability versus efavirenz. We've filed the single agent in Europe and the U.S. in third quarter. Gilead has filed the fixed-dose combination in Europe and plans to file the fixed-dose combination in the U.S. in the fourth quarter of this year.
So as we think about our portfolio, one of the things - I've talked a lot about compounds, so it's really important as we look at our portfolio is to understand the pipeline from a therapeutic area perspective. So as we look at infectious disease it's a matter of going from HIV - we've built it based on [Inaudible] and our understanding, broadening into 27A and then going beyond that into hepatitis C and going even more broadly into infectious disease, whether it be tuberculosis or in the area of vaccines. And so that's how we're thinking about our pipeline and making sure that we're continuing to have the scientific capability and the commercial expertise to broaden.
In the area of immunology platform, another good example where we've gone from Remicade, where we've built out indications. We've gone to new targets, as in the case of Stelara, with new mechanism of action. And continuing to look at other areas of unmet needs in immune-mediated diseases.
So if you think about our pipeline, and look at it from this perspective, we go across the five different therapeutic areas, it's making sure that we continue to build our capabilities in all of these individual areas.
Now, talking about geographic presence. Just a couple comments. I'm going to focus on emerging markets and also talk briefly about Japan. Emerging markets - our key focus is on China. We're focused on developing market-appropriate products, whether we do that internally or through partnerships. We're also working closely with government and other key stakeholders to ensure that we're working through the major healthcare reform initiatives in getting our products to patients.
In the area of emerging markets, we're also looking at partnerships in places like India and [inaudible], where we're working with branded generic manufacturers to actually increase our local product portfolio. So we're bringing in our existing global products, but also working with other partners to have local product needs - local products that address key needs.
In the area of Japan, very very large market. You can see, a $128 billion market, strong growth rates. If we look at our pipeline there, we have an unprecedented number of new products in 2011. We have a very strong pipeline and we're working both on our own as well as in partnership with people like Takeda, where we're working in collaboration on Velcade as well as galantamine. And this just gives you a snapshot of our pipeline in Japan.
One of the key points is not only are we looking at products that are specific to the market, we're also in our global clinical programs as we're developing new products, making sure that we have Japan in early, so we're developing global clinical programs to ensure that there's not a lag between our launches in the Western world and Japan.
So if you look at our pipeline and think about the areas of focus, one of the key takeaways is that our pharmaceuticals business is an attractive business. We're building momentum and revitalizing our portfolio, executing well against our strategies, both driving share and growth of our launched products, accelerating growth in key areas for emerging markets, and importantly spending time focused on building our pipeline. And all of this is achievable through our foundation, which is the strong people that we have throughout our organization, throughout Johnson & Johnson.
Thank you. [Applause.]
So we'll now begin the Q&A session. If you could wait for a mic before you ask your question because we are webcasting this meeting. So we have Catherine over here.
Thanks very much. I wanted to just ask a question for next year in regards to healthcare reform impact, and I'm including with that the European dynamics on pricing. If you could give any kind of relative remarks versus the impact you experienced this year, and comments on the doughnut hole and what that might mean. And then on the product side, if I could ask - your nerve-growth factor program, [inaudible], have you had any interruptions to that program given what Pfizer's had with Tanezumab? And then also one last question, which is on Sustenna. I'm wondering what your source of business is there. Are these patients patients that were on the oral Invega, and so your future for that program is pegged to what you can achieve on the oral side? Or are you seeing patients turn from the other atypicals. Thanks for your patience on those three.
Okay, Catherine, thanks. Let me take the first question and then I'll turn over the other two to Sheri. On healthcare reform, what we're seeing this year is around the same level of impact that we announced early in the year. So we said we would see somewhere in the neighborhood of $400 million to $500 million of an impact this year. It probably will be a little bit at the lower end of that as opposed to the higher end, so that's good, you know, as we were trying to estimate that.
And of course not all of the provisions are implemented yet. And most of them will then be implemented next year. Consistent with what we said earlier, for 2011 the way we think about it, if I could just give you an industry perspective, remember this is about a $100 billion impact to the pharmaceutical industry over a 10-year period, but it varies by year. The impact to the industry in 2010 we estimate at about $4 billion. The impact to the industry in 2011 we estimate at $11 billion, and we expect that we will incur our relative market share percent of that.
One thing about the $11 billion, just to clarify, the $11 billion includes bout $2.5 billion that is related to the healthcare reform fee, which will not be included in sales. The industry has concluded, with the accounting experts, that it should be included in a place other than sales on the income statement, so in "other income" or "sales and marketing expenses" but in total that is the impact. And so on a sales, top line level, that $11 billion, take away the $2.5 billion, is about $8.5 billion, and that's roughly around 5% of the overall U.S. market, and we would expect a similar impact in our business as everyone participating in the market will see.
I'll just follow up on the two questions you had. First of all, on the anti-nerve-growth factor, we have not had any impact to our clinical study. We have been in contact with the FDA but we're continuing with that and are very optimistic about that compound.
In the area of Invega Sustenna, what we're seeing is the most severe patients are the ones that are being put onto Invega Sustenna. We are seeing some switching from Risperdal Consta but we're also seeing people coming from other therapies where they've failed that therapy.
Michael Weinstein – JP Morgan
I'm going to try to sneak in a couple of questions here, but I'll start with Sheri. Can you give us your updated thoughts on potential competition from a generic for Concerta and whether we should be expecting one in our models for 2011? Second, related to the comments made earlier, in the commentary on DePuy there was a couple of times you talked about intensified competition [inaudible] [predominate] here - intensifying competition, intensified pressure on price, net of mix - those are the words you used. And I was hoping you could just give us a little bit more on that and tell us where is pricing in your U.S. DePuy business today for hips and knees on a year-over-year basis? And then maybe if I have time, one follow up.
On Concerta, at this point we don't have any indication of any generic approval. As you know, we have not heard back from the FDA after our citizen's petition many years ago. We're still watching and waiting, but we have not seen anything additional.
On DePuy, the orthopedics - well, pricing in general in medical devices has been under pressure and the DePuy business or orthopedics overall our latest estimates are that price, inclusive of mix, is down about 1.5% as compared to last year.
So that's price offset by some benefit from mix?
Yeah, that's the net.
And Sheri, just to make clear the question I was asking on Concerta, when we get around to January - and maybe this is Dominic, you're going to want to chime in here but - do you think we should be assuming in our 2011 estimates a generic competitor to Concerta?
I think the best way to answer that Mike, is when we give guidance in January we'll let you know what we assume. [Laughter.]
Sara Michelmore - Cowen & Co.
I guess just two questions on margins and it's obvious to us that the pricing outlook here has diminished somewhat in the U.S., just across the businesses. Dominic, as you look out and think about strategically how you offset some of these costs, A) how are you kind of tracking this stuff and how are you guys dealing with it real time, and B) what are the potential offsets you have in terms of just dealing with this new normal in terms of price pressure?
One thing to clarify, in the quarter, of course, we have two impacts to gross margin, which I alluded to. One is pricing pressure, and the second is the lack of sales of the OTC business compared to prior year -
Sara Michelmore -
And that was actually the second part of my question, not to interrupt, but when does that get back to some sort of normalized level? What's the shipment?
Okay. So with respect to pricing overall, both in medical devices both in U.S. and Europe, and in healthcare reform impacting price essentially in pharmaceuticals, we had talked about the fact that we were beginning and are now implementing an enterprise-wide supply chain initiative. That will help us in terms of being able to control better the price of production, the cost of production, and therefore try to mitigate any of the pricing impacts that impact gross margin. So that program is underway.
Of course, it's not a one-year program. It takes time, it involves rationalization of plans, and efficiencies in the production arena. We believe that's a good place to go in the business. We think we have opportunities there. We would rather not reduce our investment in R&D spending and we'd rather not cut back on the investment necessary to launch the products successfully in the market. So that's how we're addressing gross margin through the operations initiative.
In terms of the supply of the McNeil products and the ramp-up of the Fort Washington plant, the plant is shut down as you know. The plant will not be operational until late 2011. However, we've already begun transferring the products to other manufacturing locations within Johnson & Johnson as I stated earlier.
We began shipping already some products at a smaller, limited quantity. It will ramp up again through the end of the year and then throughout 2011. In the first half of the year we'll ramp up to normal levels. It probably won't reach normal levels until mid-way through the year.
Sara Michelmore -
And just a quick followup on the diabetes business. Louise, it just seems like the trends are really tough there and I'm surprised that it's bad internationally as well, excluding Animas. What's going on in that business? Is it pricing? Is it volume? Can you give the full detail? Thanks.
So we are seeing some volume reduction in it because of increasing co-pays as well as out-of-pocket expenses, so we are seeing volumes being depressed.
I think that's true. I think pricing also has been an impact in that business as well, but Louise is right. Overall, out-of-pocket spending by consumers is under pressure, and that particular business, of course with diabetes test strips there is some out-of-pocket spending that impacts consumers' behavior.
Rick Wise- Leerink Swann
First a question for Dominic and then a couple for Sheri. Dominic, obviously you touched on the U.S. procedure - volume still down - you talked about the economy and out of COBRA and everything - to the extent that you can specific to ortho or Ethicon, did you see any improvement in the quarter? Have you seen any stabilization or improvement? I'm talking about ex of price now, just any kind of procedure rebound or stabilization in September, October versus the fall off the cliff in June?
Well, we don't have great data yet for September or October. Procedures did slow down across the board. We do think it's as I said earlier, this manifestation of all of a sudden in the U.S. those who are unemployed and had the extension of COBRA benefits. And many of you may remember this. There's a 65% subsidy to individuals that were unemployed to help them cover their COBRA costs, and that went away in May. So obviously that had an impact in individuals deciding whether or not to go in for elective procedures. We did see a slowdown overall in hospital admissions and also in elective procedures and in overall lab tests, and [inaudible] was also a slowdown. Aesthetic medicine seems to be recovering, which is an unusual phenomenon I guess given everything else that we're seeing, and overall we do believe that this is a factor that's absolutely tied to unemployment, and I think it was broad-based in what we saw. Louise, I don't know if you had any other observations in the data.
No, I think that pretty much covers it. Future volumes in the U.S. are flat.
And now for Sheri, just a couple of specific points, Sheri. I really wish you'd tell us what you think about the Merck litigation [laughter] but let me try to ask you a question that you will answer. In the event that J&J would win full rights to Remicade from Merck, if that would happen, what's your ability to ramp production? How quickly, and what kind of investment? Are there incremental regulatory steps you'd have to take? Basically, how quickly could you make all that happen?
We're prepared. [Laughter.]
Okay. I'll take that as a sign of optimism. And then turning to the ROCKET-AF trial, just curious your press release strategy there if you wouldn't mind. Will there be a press release via either J&J or Bayer before, or are they embargoed, do we have to wait for the release at AHA. Can you release any top line data stating what you achieved, the primary end points, etc.?
We're in discussion right now with Bayer on that point, because obviously it's material for them. So we're in discussions with them on what we can and cannot release.
Matt Dodds – Citigroup
So Sheri, for you, on the drugs today it looks like Procrit, Aciphex, and Levaquin are the three that are either seeing share pressure, price pressure. Is it your take those are the primary three and that if you look at the rest of the portfolio it's in decent shape on those front? Or is there any other drugs we should be thinking about that could fall under that category?
We feel very good. If you looked at those growth products that I identified, the 26% growth, a lot of that, you know the Prezistas, the Concertas, etc. are doing very well. So you're right that Levaquin is one that will be coming off patent in 2011. We're seeing some decline there and some generic impact, but we feel very good about the products and are investing - if we have a choice from a marketing and sales spend we're investing behind the growth products. And so those are areas that we're not focusing on. Aciphex we continue to invest behind as well, but we do see some challenges in that space, PPI space
And on that point, I would assume some of these drugs still have the potential for price, at least in the U.S. Not these, but some of the other drugs that are doing better.
Obviously we always look at pricing and what's appropriate relative to the market dynamics.
And then Dominic, one for you. When you talk about the gross margin, and I don't want any specifics for next year, but right now pricing's impacting it, but I also wonder with the lower volumes you've been running, you've probably been running because the trends have been lower. Is it possible we'll see an impact due to higher overhead allocation as that inventory starts showing up, whether it's fourth quarter or next year? Or do you have the efficiencies to offset the lower volumes you're probably running in some of these plants. And that's not consumer, that's MD&D and non-McNeil consumer.
Right. Well, as I said earlier this enterprise supply chain initiative that we've embarked on will help us address that issue and we'll do everything we can to keep margins reasonable in the face of these pretty severe pricing pressures. But this is not a one-year project, right? This takes some time to get the plants rationalized and volumes moved around in the right place. So we'll do our best. We don't manage each line of the P&L that way, Matt. We look at overall - what's the overall performance of the business and what's the best place to invest versus reduce costs. So we'll do what we can with the gross margin line, but it's not a one-year project.
Is it logical at these lower volume rates you're probably running that there will be some impact from that?
We would expect volumes to go up, of course, as sales grow, so -
No, I'm saying for what you're running now.
What we're running now? Sure, there's volume pressure in overall gross margin. That's reflected in the overall gross margin. That's correct.
Jami Rubin – Goldman Sachs
Dominic, can you bring us up to date on your latest thinking on the company's M&A strategy? It just seems from some of the recent deals you've done, Cougar, Elan, Crucell, that your risk appetite has grown. In the case of Cougar it's paid off, congratulations. In the case of Elan you're buying an asset for a lot of money before the key critical data is released. Crucell seems like a lot of money to pay - a billion more than what Wyeth's offered just a little over a year ago. So I'm wondering if you could, again, refresh us on your M&A strategy. Has your risk appetite grown?
And secondly, your cash position. Like many large healthcare/pharma companies, most of your cash is growing overseas relative to the U.S., and I'm just wondering if you could share your thoughts on how you're going to put that cash to work given the requirements to repatriate to the U.S.
Right, well just an overall comment on the M&A strategy. Of course it's part of a growth strategy, which begins with investing in organic development first and foremost. It is the most capital efficient way for us to grow. Then Jami, as you know, we partner and license products quite a bit, so there's a second-tier strategy, partnering and licensing. And then thirdly, selectively acquiring companies and assets where we think the returns are appropriate given the risk profile.
So I'm not sure the risk appetite changes as much as we learn more about the relative compounds we're able to better assess the outlook for those compounds and therefore hopefully work a deal where the price we pay gives our shareholders an appropriate return given the risk of putting shareholders' capital to work. So in the case of [inaudible], obviously we worked closely with that team in our due diligence efforts and we're pleased with what we saw, which enabled us to go forward. And with Crucell, as Sheri mentioned, we already had a collaboration with Crucell last year, obviously learned a lot about the great capabilities that that organization has. So we're able to better assess the risk involved and therefore take the actions that we took.
And then second part of your question about utilization of cash and many companies in our industry in particular have cash overseas and as you know greater than 50% of our business is overseas, so it's natural that we would accumulate some cash overseas. We'll intend to invest that appropriately. Crucell is a good example of that. We're going to use our ex-U.S. cash to invest in the Crucell transaction and we'll always look for opportunities to use that cash. But having a little bit of cash is not such a bad thing these days.
Derrick Sung – Sanford Bernstein
I wanted to go back to the pricing pressures and environment that we're seeing in Europe. I was wondering if you could give us, either Sheri or Dominic, some details first on what you're seeing now in terms of the austerity measures, and I think you quantified $150 million in pricing pressure. Where is that coming from? Which specific countries? Are there specific categories that are being impact? And then how do you foresee that playing out next year? Is that going to spread to other countries, or is it going to be the same countries that are having those today? And then just a follow on to that, if you could comment on the medical device environment in Europe as well, and with budgets rolling around what do you expect to see next year in terms of budgets and pricing from Europe there?
Derrick, can I just clarify one thing, the $150 million includes U.S. healthcare reform as well as European austerity measures. It's about two-thirds U.S. healthcare reform, one-third austerity measures.
And just to further clarify that $150 million Louise was talking about was in the quarter, so $100 million of U.S. healthcare reform and $50 million of European austerity. We have previously discussed in the previous quarter review that we expected the impact of European pricing pressure for 2010 to be about $200 million, and that we didn't see much of it early in the year. We saw it ramping up through the latter part of the year. We are seeing what we expected we would see, so our estimate was about $200 million for this year.
Obviously since it's just ramped up towards the latter part of this year we would expect that this would continue into next year. The pricing pressures appear to be somewhere in the neighborhood of mid-single-digits in terms of incremental price in the European markets that we compete in. So that's what this $200 million refers to for the second half of the year, and obviously you can consider what the full-year impact might be in 2011.
It's not any particular country, per se. It's all the countries that have announced various austerity measures. That's our estimate of how those will roll into next year. So we can't single out any one particular country.
And then in medical devices, we haven't seen much of a pricing impact per se in the European market, but rather a slowdown in volume, or a procedure slowdown.
Bob Hopkins – Bank of America
I just wanted to see if I could get you to clarify the comment earlier about orthopedic pricing trends, that down 1.5%, which is a net of price and mix. First of all, is that a global number for global hips and knees? And how does that compare to what you saw the last couple of quarters, where I think you've commented at [inaudible] like these that there had been no change. Now I think you're saying maybe there is a little change. Just wanted to get a sense for what that is sequentially.
So hips and knees, together in the U.S., is down about 1% to 2%. That's pretty consistent in total versus the prior quarter. OUS is down about 1%. And then spine is - previously I had said it was down mid-single digits. We did see, actually, some positive on the spine pricing, so it's still down, but it's down less than the last quarter.
So did anything get worse sequentially, hips, knees, spine from a pricing perspective?
In total if you look at hips and knees together it's similar, but we did see a little bit more in the hip in the quarter versus the knees in the U.S.
Okay, so if there's any change sequentially it was really just spine getting a little better.
Spine got a little better, and we did see hips get a little tougher, but we saw knees offset that. So in total we're very similar.
And then two other really quick ones. I was wondering if you could talk to volume, specifically to the general surgery business as [inaudible]. You made comments broadly about medical devices, but I was wondering if there was anything from the divisional level that was mentioned on procedure volume in Ethicon or Ethicon Endo, particularly. And then finally, on gross margins, I was wondering, can you quantify the impact specifically of the recall and remediation on gross margin this quarter?
On the first question, with respect to procedural volumes, we did see overall hospital admission rates go down and elective procedure volumes slow down in the quarter. That was present in both the Ethicon and Ethicon Endo businesses. As Louise mentioned, the Ethicon business had about a significant impact in the U.S. from the acquisition of Acclarent, and without that business it grew at lower rates than we've seen in prior quarters. And the same with Endo, a little bit different situation there. That was impacted by the divestiture of the breast care business, but without that divestiture the growth rate was still below the rates which we've seen in prior quarters. So it's pretty clear that surgical procedures as evidenced by hospital admissions, etc. have declined in the quarter and we're one of the first companies that report, as you know Bob, so we'll have to see what others report in this regard.
And the second part of your question was what?
Just on the gross margin, if you could quantify the impact of the recall and remediation on gross margin this particular quarter? You mentioned a bunch of things impacting, including price, and I was wondering if you could -
I'd rather not get that specific on the specific cost of the remediation.
Bruce Nudell – UBS
Question for Sheri and then for Dominic. Sheri, could you scale what you think the U.S. market opportunity is for novel anticoagulants and given the profile of Xarelto to date, which is kind of superior efficacy, comparable bleeding. Is there a sweet spot in secondary prevention for VTE or high-risk AF patients? And for Dominic, we've come to the conclusion that the step up in pricing pressures is ascribable to the profit squeeze that hospitals are experiencing. Declining elective procedures worsens that. Looking forward, when things get better, which they hopefully will, will things get better on the pricing front? Or have hospitals found religion and have there been secular changes that just make it a really tough environment going forward?
On the U.S. thrombosis market, if you look at the size of the market today it's about a $3.8 billion, $3.9 billion market, projected to grow to about an $8 billion market. Importantly, if you look at people who are using warfarin or Coumadin today the issue is around monitoring and what we see is if you have an oral anticoagulant we think there's an opportunity not only to reach those patients but potentially to even grow the market, because it's much more convenient. People will stay on the medications, etc. And in the studies that we're doing, obviously we haven't seen the data yet on the a-fib, but we will see that in the next few weeks and be able to present that. Certainly we think that will be an opportunity, because we'll be testing versus standard of care, which is warfarin. So we believe that there will be broad usage and penetration based on those results, assuming a very positive result.
I think there is. I think that it is going to be an oral factor 10A. It will be different than [inaudible] and we think that it will depend on the data that we get, but assuming very positive data we think there will be a sweet spot.
Bruce, you're absolutely right that hospitals are under some profit pressure, and you also mentioned that elective procedures slowing down compound that, but we think they're obviously related. One of the reasons why they're under some profit pressure is there are less volumes in the hospitals, and many of the volumes are down because of this uncertainty in terms of can someone who's unemployed afford, or should they incur the out-of-pocket cost. I think obviously as that improves volumes would improve and elective procedures would improve and hospitals would be under less pressure. Whether or not price returns to where it was before, I don't want to speculate now. I think it's too early to speculate. But I do think that these two phenomena are related. The profit pressure of hospitals is primarily related to the volume pressures that they're facing today.
Matt Miksic – Piper Jaffray
Dominic, one follow up for you on the P&L. Earlier in the year you started creating some flexibility to help push behind these new product launches. We've seen some underperformance in some of the med device markets and consumer markets. Just wondering is this forcing you to prioritize, push some things into 2011. What are some of those things if that's true?
As I said in my comments, we did see some pressure on gross margin as you can see from the results, but we decided that it was important for us to continue to invest in R&D in particular, so you'll see R&D went up a little bit as a percent of sales and SG&A not as far down as you might have expected, because we're going to launch these products successfully. We're fortunate enough to be able to have some other offsetting gains when we readjust our portfolio and divest some assets as you'd expect us to. We'd redeploy those gains to other pieces of the business. So we're going to continue to invest in the business, and I've tried to highlight for you how we intend to cover that in the current estimate.
One question on just what you're seeing in terms of hospitals. We've talked about how patients are acting, we've talked about pricing. In terms of some of the businesses you have with exposure to capital and equipment, either in diagnostics or elsewhere, maybe in cardio, what are you seeing hospitals do in terms of investing in their own facilities? How do you expect that to continue?
Well, we don't have a significant part of our business that is impacted by capital purchases, but in both diagnostics and in some of the Biosense Webster business obviously we do see hospital pressure in terms of capital budgets. Although the launches of the OCD products are doing well, the Vitros launches, and as Louise mentioned the Carto system in Biosense Webster seems to be doing well. So where there's innovation and improvements in the throughput of a hospital, we see less pressure on capital spending there.
And just one last one on some color around DePuy if you wouldn't mind for [trauma] and Mitek. If you could give us some color on U.S., OUS growth it would be helpful.
Sure. So operational growth on trauma was 1% in the U.S. and minus 3% OUS, so total is flat. And Mitek, about 11% in the U.S., OUS about 3%. In total it's about 7%.
Larry Biegelsen – Wells Fargo
First, for Sheri, can you talk about the 5.9% operational growth we saw in pharma? Very strong, just the sustainability of that? And then for Dominic, the med tech market, you presented in June, I think, 5% K growth through 2014. What do you think the market's growing at right now? How do recent trends affect that K [growth]. What kind of lag do you think there's going to be between unemployment and a rebound that you talked about earlier?
As we talked about revitalizing our portfolio our focus has been on driving those growth products. What we saw in third quarter was strong growth from those key products. We did have some benefit of some one-time differences, specifically the Remicade international shipments and some year-on-year comparisons in our oral contraceptive business. So we do expect to continue to grow, but I think we did see a specific benefit in third quarter based on those one-time items.
Larry, you're right. In the June MD&D review we estimated that the MD&D market through 2014 would grow at about 5%. It's obviously not growing at that level now. We do think that that phenomenon we saw in the U.S. of the termination of these COBRA benefits has a significant impact in patients deciding whether to go in for these elective procedures. So I'm not sure that that's a long-term phenomenon. It's hard to say, but I would say that the 5% over time might be under a little pressure if unemployment stays at these relatively high rates for an extended period of time. I can't give you a new estimate as of now.
Glenn Novarro – RBC Capital
Two questions for Dominic. One, on pricing in Europe, I'm surprised you said pricing was pretty flat in Europe for medical devices, but I guess that's mainly because Europe's a tender system and a contract-based system and most of the contracts in place were started at the beginning of the year. But we are in a period now where tenders and contracts are going to start getting re-upped and all our research tells us that pricing's going to get worse in Europe next year. So I'm just wondering, have you checked in with a lot of your divisions recently? Do you have any feel for how contracts and tenders are coming up in the most recent period in the last month or so? And what should we assume for pricing in Europe next year? And then just on the share repurchase, you picked up the share repurchase you said. Is that because of the debt financing or is there another reason why all of a sudden you're starting to pick up the repurchase again?
I think you're right that we will see some pricing pressure in medical devices in Europe in 2011 and we certainly didn't see much of it so far in 2010. The other phenomenon in addition to the tender system is of course many of the countries have a DRG system, so there's not a direct specific price for the product issue as there is in pharmaceuticals, where governments pay the hospitals a fixed cost for the procedure. So that tends to buffer the pricing impact a little bit in medical devices. But I do think as tenders - and our folks have told us that as tenders are coming up they're sensing some pricing pressure will manifest itself in 2011, but I can't give you an estimate as of now. We increased our share repurchase program for a couple of reasons. It has nothing to do with the debt financing. That was just opportunistic that we were able to get long-term debt at extremely attractive rates. We typically look at the overall cash utilization of the company and when we're evaluating various opportunities in the business we may pause and take a look at other things. So as you know we completed Micrus. We have now announced the acquisition of Crucell. Unfortunately our stock did take a bit of a hit early in the quarter at what we thought was an unusually low level. So I think, you know, alignment of where we're spending our cash and also that short period of time that we saw the stock take a hit we took advantage of that opportunity.
And Glenn, I just want to clarify a little bit. The pricing in Europe in medical devices, we always have pricing pressure in that market. What Dominic was referring to was additional because of European austerity. We've seen very limited impact because of European austerity.
And we'll take one last question from Eddie.
Eddie Han-Burgess - Raymond James
Dominic, one question for you and a set for Sheri. Dominic, you indicated twice that the SG&A leverage in the quarter was tracking below what the Street expects. When would the pronounced leverage show up? And Sheri, I'm surprised to see that Yondellis is still on, given the complete response letter last year about this time - data were less than compelling. What is the future of Yondellis? Can you elaborate on the FDA's response letter on Nucynta ER. How big of a push out does it entail, and the commercial strategy. Are you waiting for the ER approval to fully commercialize IR?
On the SG&A line, and as you've heard us say before, we don't typically manage every single line in a certain formula base. We decide to invest where we think it's appropriate to invest. Remember that we've implemented a restructuring program, which was partially implemented this year and then expands in 2011. So obviously that will have some impact on the SG&A line. But as I said earlier, and as we said when we announced the restructuring program, that we'll look to reinvest as much of the savings as we can when launching new products. So as these products that Sheri's business and Alex's business are beginning to come out of the FDA and into the marketplace we're going to take every opportunity to invest behind them. I think you'll see us manage the overall P&L and not necessarily just one line of the P&L. So I can't comment on exactly what will happen to that line in the long-term. But you've seen us manage on an overall pre-tax operating margin and when we don't we try to describe exactly what we're doing instead of improving pre-tax operating margins. But I think in this marketplace, with slower markets in particular, I think it's wise to continue to invest in the business and not retract from the markets, because we still see great opportunities in these markets and we want to be there once the markets return.
On Yondellis, we're optimistic about that product. We received a complete response because they wanted to see overall survival data. And so we're continuing the study to - and it's based on number of events, but we do have that product approved in many markets around the world, so we're optimistic on Yondellis and certainly we'll focus on getting the overall survival data to go back with a complete response letter. For Nucynta ER, the question from the FDA was around bioequivalence of what we did the safety and clinical testing on relative to another formulation that we're planning to launch from a tamper-resistance perspective. We will be in discussions with the FDA and we'll get more clarity around what's required for this bioequivalence. I think the important thing is that they're not asking for additional clinical data. As it relates to Nucynta IR we have been aggressively selling that product. We are focused on primary care physicians as well as pain specialists and orthopedics, and so we are not doing anything to slow down IR in waiting for ER.
Okay, well thanks. Thanks everyone and thank you Sheri for a terrific review of the pharmaceutical pipeline. In closing let me just say we remain positive about the underlying growth opportunities for our business as our new products, robust pipelines, and core businesses position us well for continued growth. Going forward, we see the global economy recovering, albeit slowly, and we continue to invest in some of the fastest growing segments of the healthcare industry as the economy recovers. We are confident we will continue to manage our businesses effectively based on our broad base in healthcare, our financial discipline, and most importantly thanks to the dedication, focus, and integrity of the people of Johnson & Johnson. I look forward to continuing to update you on our progress and seeing you in January along with our chairman, Bill Weldon, when we discuss our fourth quarter and year end results and provide guidance for 2011. Thanks for your time this morning, and have a wonderful day.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!