Johnson & Johnson (JNJ) Q3 2016 Results - Earnings Call Transcript

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Johnson & Johnson (NYSE:JNJ) Q3 2016 Earnings Conference Call October 18, 2016 8:30 AM ET


Joseph Wolk - VP, IR

Joaquin Duato - EVP, Worldwide Chairman, Pharmaceuticals

William Hait - Global Head, Janssen Research & Development

Dominic J. Caruso - EVP and CFO


Larry Biegelsen - Wells Fargo

Kristen Stewart - Deutsche Bank

Michael Weinstein - J.P. Morgan

David Lewis - Morgan Stanley

Glenn Novarro - RBC Capital Markets

Jami Rubin - Goldman Sachs

Matthew Miksic - UBS


Good morning and welcome to the Johnson & Johnson Third Quarter 2016 Earnings Conference Call. All participants will be in a listen-only mode 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 conference call over to Johnson & Johnson. You may begin.

Joseph Wolk

Good morning. I'm Joe Wolk, Vice President of Investor Relations for Johnson & Johnson, and it is my pleasure to welcome you to the review of our business results for the third quarter of 2016. Joining me on the call today are, Dominic Caruso, Chief Financial Officer; Joaquin Duato, Worldwide Chairman, Pharmaceuticals; and Dr. Bill Hait, Global Head of Pharmaceutical Research & Development.

A few logistics before we discuss the results. This review is being made available via Webcast accessible through the Investor Relations section of the Johnson & Johnson Web-site at I will begin today's presentation by briefly reviewing the third quarter sales and earnings results for the corporation and sales results for each of our three business segments. Next, Joaquin and Bill will provide an update on our Pharmaceutical business, specifically highlighting how our focus on innovation to address unmet medical needs translates to current and future strong performance. Dominic will then provide some additional commentary on the results, review the income statement, and discuss guidance for 2016. Lastly, we will open the call to your questions.

We expect today's call to last approximately 90 minutes. Included with the press release issued earlier this morning is the schedule of sales for key products and businesses to facilitate updating your models. These schedules are available on the Johnson & Johnson Web-site, as is the press release. Please note we will be using a presentation to complement today's commentary. The presentation is also available on our Web-site.

I'd like to remind you that some of the statements made during this review are or may be considered forward-looking statements. The 10-K for fiscal year 2015 and the Company's subsequent filings identify certain factors that could cause the Company's actual results to differ materially from those projected in any forward-looking statements made here today. The Company does not undertake to update any forward-looking statements as a result of new information or future events or developments.

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 and should be read together with GAAP results. Tables reconciling these measures to the most comparable GAAP measures are available in the schedules accompanying the press release and on the Investor Relations section of the Johnson & Johnson Web-site.

During the course of today's presentation, we will discuss a number of products and compounds developed in collaboration with strategic partners or licensed from other companies. This slide is an acknowledgement of those relationships.

I would now like to review our results. Worldwide sales to customers were $17.8 billion for the third quarter of 2016, up 4.2% versus the third quarter of 2015. On an operational basis, sales were up 4.3% and currency had a negative impact of 0.1%. In the U.S., sales were up 6.7%, while regions outside the U.S. were up 1.5% comprised of 1.7% operational growth partially offset by a negative impact of currency exchange rate of 0.2%.

On an operational basis, the Western Hemisphere excluding the U.S. declined 1.3%. You may recall that we highlighted growth in the second quarter of 2016 being favorably impacted by an inventory build, which did reversed in the third quarter. Europe grew by 3.2%, while the Asia-Pacific, Africa region grew 1.4%.

Excluding the net impact of acquisitions and divestitures and hepatitis C, underlying operational sales growth was 5.9% worldwide, 7.3% in the U.S. and 4.2% outside the U.S. Additionally, operations in Venezuela reduced reported sales growth. Worldwide, this impact was a reduction of 30 basis points, and outside the U.S. 70 basis points.

Turning now to earnings, net earnings were $4.3 billion and earnings per share were $1.53, versus $1.20 a year ago. As referenced in the table reconciling non-GAAP measures, 2016 third quarter net earnings were adjusted to exclude after-tax amortization expense of $236 million and a charge of $175 million for after-tax special items. Dominic will discuss special items in his remarks.

Excluding amortization expense and special items for both periods, adjusted net earnings for the current quarter were $4.7 billion and adjusted diluted earnings per share were $1.68, representing increases of 12.2% and 12.8% respectively as compared to the same period in 2015. On an operational basis, adjusted diluted earnings per share also grew 12.8%.

Beginning with Consumer, let's now turn to segment highlights for the quarter. Please note that the percentage this quarter for all segments represent operational sales change in comparison to the third quarter of 2015 unless otherwise stated and therefore exclude the impact of currency translation.

Worldwide Consumer segment sales totaled $3.3 billion, increasing 0.1% from the third quarter of 2015. U.S. sales were up 1.1% while sales outside the U.S. declined 0.6%. Excluding the net impact of acquisitions and divestitures, underlying sales fell 0.4% worldwide with a decline of 1.5% in the U.S. and growth of 0.3% outside the U.S. In addition, operations in Venezuela negatively impacted growth worldwide and outside the U.S. by 110 basis points and 180 basis points respectively, with the most pronounced impact occurring in women's health.

Growth was driven by worldwide Skin Care and OTC sales outside the U.S. Baby Care experienced declines over the third quarter of 2015. Performance in the Consumer segment was negatively impacted by slower market growth and reductions of customer inventory levels. Overall, the impact of inventory reduction was approximately 3 points on worldwide Consumer sales growth for the quarter, with the most pronounced effect on OTC and Skin Care results. Dominic will discuss these factors in further detail later in the call.

OTC sales grew 1.8% worldwide. Results were driven by strong consumption in smoking cessation products across Europe and new product launches in Europe and Asia. U.S. sales growth due to share gains was partially offset by trade inventory levels impacting growth in the U.S. by approximately 10 points, where, as highlighted for the third quarter of 2015, the business experienced launch build in pain, allergy and digestive health. Also, a weak allergy season in the U.S. during 2016 negatively impacted inventory levels in the third quarter of 2016. In the U.S., adult analgesic market share was approximately 14%, up from 13% a year ago, while U.S. pediatric share was approximately 49%, up from 44% a year ago.

Skin Care grew 12.2% worldwide and 18.9% in the U.S. These results include the sales from the recent Vogue and NeoStrata acquisitions, which are captured in the U.S. OUS results were driven by stocking of DABAO products in China and share gains in Latin America. Inventory levels negatively impacted worldwide sales growth by 3 points. Successful marketing campaigns and new products continued to drive the results for LISTERINE in Oral Care. Divestitures impacted sales growth in Wound Care/Other and Women's Health categories.

Moving now to our Pharmaceutical segment, worldwide sales of $8.4 billion increased 9.0%, with U.S. sales up 11.8% and sales outside the U.S. up 5.0%, driven by strong performance of new products as well as growth from our core products. Excluding sales of hepatitis C products, OLYSIO and INCIVO, as well as the impact of acquisitions and divestitures, underlying worldwide sales growth was 10.7% as sales in the U.S. were up 13.0% and outside the U.S. up 7.0%.

Contributors to growth included; immunology products, REMICADE, SIMPONI and STELARA; oncology products, IMBRUVICA and DARZALEX; as well as INVEGA SUSTENNA/XEPLION/TRINZA and XARELTO. In immunology, REMICADE, STELARA and SIMPONI/SIMPONI ARIA achieved strong growth in the U.S. due to market growth and increasing share for STELARA. The results reported for REMICADE export sales was driven entirely by a change in inventory levels, accounting for approximately 90 points of growth. Specifically, there was an inventory build of approximately $55 million in the current period and $110 million impact from lower level inventories that we noted in the third quarter of 2015 results. Biosimilar competition continues to negatively impact performance of the export sales.

In neuroscience, INVEGA SUSTENNA/XEPLION/TRINZA achieved strong results with worldwide sales growth of 21%, due primarily to increased market share. As expected, during the quarter we saw the impact from generic entries for INVEGA tablets in the U.S.

In oncology, strong patient uptake with new indications, approvals and demonstrated efficacy drove results for IMBRUVICA in the U.S. Sales increased 92% worldwide and IMBRUVICA remains the leader in both new and total patient regimen share in second line CLL and MCL. Outside the U.S., IMBRUVICA continues to experience a strong adoption in Canada and the G5 and has recently launched in Japan, Hong Kong and Korea. ZYTIGA sales grew 5.3% worldwide. In the U.S., market growth was essentially flat while market share was up almost 2 points sequentially. Sales outside the U.S. were tied to share gains in Japan and adoption in China since the launch in January of this year. DARZALEX continues to gain strong acceptance as a treatment for multiple myeloma and contributed approximately 2 points of worldwide pharmaceutical sales growth.

Turning to cardiovascular and metabolics, XARELTO continued strong share performance with TRx market share up 1.7 points versus Q3 of 2015 to 17.5%. Warfarin represents approximately 55% of the total market, down from 62% in the third quarter of 2015. XARELTO continues to be broadly reimbursed with over 95% of commercial and Medicare Part D patients covered at the lowest branded product co-pay. INVOKANA/INVOKAMET sales declined 3%, with the U.S. down 8.7% due to an increase in price discounts. Some of the increase in discounts is attributable to higher co-pay program costs in the quarter. While the defined market of Type 2 diabetes excluding insulin and metformin was up approximately 5%, TRx share was essentially flat to the third quarter of 2015. TRx share with endocrinologists was approximately 11% and approximately 6% with the primary care.

I'll now review the results of the Medical Devices segment. Worldwide Medical Devices segment sales of $6.2 billion increased 0.7%, with U.S. sales increasing 1.4% and sales outside the U.S. decreasing 0.2%. As a reminder, Cordis was divested in the fourth quarter of 2015. Excluding the net impact of acquisitions and divestitures, underlying growth was 3.1% worldwide, with the U.S. up 2.3% and growth of 3.9% outside the U.S. Additionally, the devaluation in Venezuela impacted growth worldwide by 10 basis points and outside the U.S. by 30 basis points.

Growth was driven by Electrophysiology, Advanced Surgery, Vision Care and Orthopaedics, slightly offset by General Surgery and Diabetes Care. Electrophysiology within Cardiovascular grew 16% worldwide, driven by continued share gains in the U.S. and Europe as the atrial fibrillation procedure market increases. Orthopaedics sales growth was driven by joint reconstruction and U.S. trauma. Pricing pressure continued across all major categories but was partially offset by positive mix in trauma and spine. Continued success of the TFNA nailing system in trauma, the ATTUNE platform in knees and the CORAIL primary stem in hips contributed to the sales results.

Within Advanced Surgery, endocutters grew 14%, energy was up 10% and biosurgicals up 7%. The acquisition of NeuWave Medical, closed in the second quarter of this year, also contributed modestly to growth. Vision Care sales were higher by 5.5% worldwide as new products launched late last year continued on an upward trajectory across all regions. Worldwide General Surgery declined by approximately 2% due to discontinuing certain products in women's health and hernia, partially offset by both market growth and share gains in sutures. Competitive pressures and price erosion continued to impact Diabetes Care.

That concludes the segment highlights for Johnson & Johnson's third quarter of 2016. To assist with your models, this slide provides you with a summary of important developments that occurred during the quarter. It is now my pleasure to turn the discussion over to Joaquin Duato, Worldwide Chairman, Pharmaceuticals, to inform you about the state of the Pharmaceutical business and the progress made since our May 2015 Business Review Day. Joaquin?

Joaquin Duato

Thanks, Joe, and good morning everyone. I'm very pleased to share an update on our Pharmaceutical sector. Since May 2015, when we last met, our Pharmaceuticals business has continued to flourish and remains the primary growth engine of Johnson & Johnson. Our market-leading innovative medicines are the foundation of our strong performance, with a vast majority of their growth coming from volume gains.

We continue to pursue significant growth opportunities in terms of both penetration within existing indications and planned line extensions. Additionally, we have launched DARZALEX, the first of our 10 potential $1 billion-plus NMEs. As a result, we remain confident that we'll continue to deliver a strong growth through 2019 despite biosimilar competition and market dynamics.

Our success is a result of our strong track record of execution. Our industry-leading pipeline has delivered 12 NMEs since 2011 and eight breakthrough therapy designations since 2013. And for the fourth year, we are proud to have been named the #1 company in R&D and commercial productive innovation.

Our focused execution has delivered 11 in-market $1 billion-plus brands. 10 of these brands are growing and six of them are growing double-digits. Cumulatively, sales from our medicines launched since 2011 are the second highest of any pharmaceutical company. Our R&D and commercial capabilities are a proven strong foundation for future growth.

First, we will continue to focus on driving volume growth across our current market-leading brands through clinical differentiation. Second, we will accelerate the growth of these in-market brands through approximately 40 potential line extensions. Critically, 10 of these line extensions have more than $0.5 billion potential. Third, as we shared last year, we have a [indiscernible] pipeline investing in 10 potential $1 billion-plus NMEs, planned to be filed through 2019. Of these, we anticipate five to deliver significant growth opportunities in the near term. Since 2015, our expectations on these near-term opportunities have crystallized. Our latest information provides higher certainty that these products will succeed, delivering higher value than originally anticipated.

DARZALEX, launched last year, is significantly outperforming expectations. According to your own models, it is well on its way to becoming a multibillion-dollar brand. Sirukumab has just been filed in the U.S. and Europe. Guselkumab has just had very positive data versus Humira presented at the EADV and we anticipate filing for psoriasis before year-end. Apalutamide has a broad clinical development program in both pre-metastatic and metastatic prostate cancer. We're also investigating it in combination with ZYTIGA and with our newly licensed PARP inhibitor, Niraparib. Finally, Esketamine is already in Phase 3 and recently received a second breakthrough therapy designation. Bill will provide additional clinical details on these near-term opportunities shortly.

Finally, it is important to note that these three strategies will prepare us to deliver robust growth beyond 2019, paving the way for more than 25 potential next-generation NMEs in the 2020 to 2024 timeframe. The strength of our in-market portfolio, complemented by our near term line extensions and NME launches will more than offset upcoming headwinds including those anticipated for REMICADE.

We are fully prepared to execute our focused biosimilar readiness plan. Yesterday, the launch of our U.S. biosimilar to REMICADE was announced for later this year. However, the appeals process is still ongoing and we believe any commercial launch of our biosimilar remains at risk.

Biosimilars are very different from generics. For example, in Canada, Australia and Brazil, where there is already biosimilar competition to REMICADE, we have maintained more than 90% volume share. Our U.S. commercial team is ready for a potential biosimilar launch.

I am confident in our strategy for three reasons. First, with no biosimilar approved for interchangeability, REMICADE's significant long-term safety data, a strong advocacy from patients and clear physician preference means that the 70% of patients who are stable on REMICADE are highly unlikely to switch. Second, our patient assistance programs provide a leading market differentiator. Third, we are confident that we can continue to provide a cost-effective option in all channels. The current market is extremely competitive and REMICADE's ASP is already significantly lower than the list price. Additionally, in developing innovative contracts, we can utilize the full breadth of our portfolio.

Our immunology franchise remains poised to grow through 2019. We have a strong market position and a deep near-term pipeline. Let me give you some examples. Already in rheumatoid arthritis, SIMPONI ARIA is the fastest growing IV product in the U.S. and has higher new-to-brand share than REMICADE. Outside of the U.S., we continue to gain share with SIMPONI too. Additionally, we plan to file two line extensions for SIMPONI ARIA in psoriatic arthritis and ankylosing spondylitis. Together, with the recent submissions of sirukumab for approval in the U.S. and Europe, we will further strengthen our leading position in rheumatology.

Turning to psoriasis, STELARA continues to be the #1 biologic in new-to-brand share in the U.S. and maintains clear share leadership in key markets internationally. One of our 10 potential $1 billion plus brands, guselkumab, is expected to provide a significant boost to our leadership in psoriasis and Bill will share more on this important upcoming filing.

Finally, moving to gastroenterology, the most exciting news is the recent launch of STELARA for Crohn's disease in the U.S. and its anticipated launch in Europe. There is tremendous unmet need in this debilitating disease. For example, 70% to 80% of Crohn's patients on anti-TNFs are not in remission at one year, and the patient population is expected to grow 50% over the next decade. This is the first in a series of line extensions, including UC, which will drive more than 35% of STELARA performance by 2019.

Moving now to cardiovascular and metabolics, INVOKANA continues to be a standout performer. Globally, it is the leading SGLT2 inhibitor and the third-largest non-insulin Diabetes medicine. Put into perspective, in the U.S., there have been more prescriptions filled for INVOKANA and INVOKAMET than all other SGLT2 inhibitors combined. A total of more than 1.3 million patients are treated in the U.S. alone.

As Joe mentioned earlier, INVOKANA's performance dipped this quarter due to temporary increased costs to administer co-pay patient access programs. However, I want to emphasize that this was a transitory event. Our return to growth will be driven by INVOKANA's strong access position across U.S. commercial plans and Medicare Part D and the recent approval of INVOKAMET XR. We are expecting our cardiovascular outcomes data to readout in mid-2017.

XARELTO is another market leader in our cardiovascular and metabolics portfolio, delivering double-digit growth every year since its launch in 2011. To date, XARELTO has already treated more than 3.8 million patients in the U.S. and is supported by an extremely robust published real-world data set, including evidence from more than 91,000 patients demonstrating consistency with our clinical trials. As a result, it is broadly reimbursed with more than 95% Medicare and commercial patients on formulary at the lowest branded co-pay.

These considerable achievements are just the start. Approximately 54% of potential patients are still utilizing Warfarin, presenting significant growth opportunities in current indications. Additionally, there are eight new indications seeking clinical studies underway as part of EXPLORER, the largest clinical development program within the anticoagulant space. If successful, the potential patient pool could increase more than five-fold.

Turning to neuroscience, INVEGA TRINZA is a growth catalyst for the entire long-acting therapy franchise. Not only is INVEGA TRINZA the fastest growing LAT in the U.S., it has also contributed to growing INVEGA SUSTENNA scripts 26% in the 13 months since launch. Significant opportunities for growth remain as only 11% of patients are treated with LATs in the U.S.

Celebrating 10 years of innovation this year, our HIV portfolio has achieved approximately 20% growth annually and cumulative sales of more than $15 billion. Today, 25% of patients in developed markets are treated with a J&J HIV medicine. Our class-leading portfolio has benefited more than 1 million patients and this legacy will continue with upcoming line extensions.

When Prezista first launched, it was part of a six-tablet regimen. The first upcoming line extension, Darunavir Single Tablet Regimen, will reduce this number to one, improving adherence and safety. Also, we expect two Rilpivirine fixed-dose combinations, one with Gilead’s TAF and another one with ViiV's dolutegravir, that will drive additional growth post 2019.

Finally, let's move to our fastest growing therapeutic area, oncology. IMBRUVICA has led the recent growth of our oncology franchise, accelerating from a record breaking global launch to clear market share leadership in total patients in the first-line chronic lymphocytic leukemia. Today, IMBRUVICA is reimbursing 41 countries with world-class market access. Since launch, an additional six indications have been approved and we anticipate an additional seven new registrations ahead, four of which have $500 million plus potential. Together with a number of promising combination therapies in development, these new indications will ascertain a very exciting future for IMBRUVICA.

IMBRUVICA's leadership in oncology is mirrored by our recently launched asset, DARZALEX. Only three months after its launch, DARZALEX became the number one prescribed therapy in fourth line or later multiple myeloma. From a launch aligned sales perspective, DARZALEX has continued to far outpace its competitors. This first-in-class medicine has since been approved in the EU and Canada and is driving positive share trends in earlier therapy lines in the U.S. We are confident DARZALEX can become the standard of care in multiple myeloma and help even more than the 10,000 patients who have benefited already worldwide.

Growth will continue to accelerate with the anticipated approval in second-line patient populations and the impressive data from the recently published CASTOR and POLLUX studies. An additional five Phase 3 trials are currently underway as well as development of a subcutaneous formulation. As Bill will detail, we have also seen some positive data that DARZALEX may be effective outside of multiple myeloma.

What should be clear today is that all of our current market-leading medicines have significant potential for continued volume growth. Additionally, we have a multitude of promising potential line extensions across every therapeutic area, approximately 40 in total, by 2019. Of these, 10 have more than $0.5 billion potential. The remaining 30 potential line extensions are not insignificant. Cumulatively, the line extensions for XARELTO and INVOKANA have the potential to drive $3 billion to $5 billion in incremental sales for the cardiovascular franchise. We believe these new indications will be a key driver of our growth through 2019, even in the context of biosimilars and market dynamics.

In my six years leading our pharmaceutical sector, I have never been more excited and more positive about our future as I am today. We have significant growth potential throughout our portfolio with market-leading brands, 40 anticipated line extensions, 10 of which have more than $0.5 billion potential, and 10 NMEs with more than $1 billion potential to be filed by 2019. Combined, these factors will ensure that we continue to outpace the industry growth through 2019.

It is now my privilege to turn the call over to Dr. William Hait, who heads up our R&D organization. Bill will provide additional detail about our pipeline that is set to deliver these groundbreaking treatments. Bill?

William Hait

Thank you, Joaquin. Good morning, everyone. My name is Bill Hait and I am the Global Head of Research & Development for the Janssen Pharmaceutical Companies of Johnson & Johnson. As Joaquin indicated, at Janssen we believe that by continuing to execute our current strategy, we will consistently deliver valuable products to patients with serious unmet medical needs and that this will sustain our leadership in the pharmaceutical industry.

Our strength is built on a blend of deep internal scientific expertise with industry-leading collaborations through the work of Johnson & Johnson Innovation. We continue to find efficiencies that produce savings that we invest in our pipeline and our strategic focus creates an enviable track record. We are delivering against our anticipated 2015 to 2019 NME and LE results that will produce a cadence of significant clinical data, regulatory filings and approvals. For these reasons and the results I will describe today, Janssen has become one of the most productive and most respected pharmaceutical companies.

Before I share with you the details of our pipeline progress, let me explain how and why we have been able to sustain industry leading results. Our five end-to-end therapeutic areas span basic drug discovery through launch and lifecycle management. This structure produces a focused seamless R&D organization, promotes efficient phase transitions and ensures dedication to major unmet medical needs where there is compelling translatable science. These five therapeutic areas concentrate on 11 high priority disease areas through our disease area strongholds, nimble and efficient biotech like teams embedded in the broader context of the therapeutic areas.

Each disease area stronghold undergoes rigorous triennial review by our external Scientific Advisory Board, receives a priority score and proportional funding of discovery and early development. Our therapeutic areas are supported by substantial research capabilities through our Centers of Excellence, including biotechnology, medicinal chemistry, diagnostics, clinical operations and most recently oligonucleotide and nucleic acid chemistry expertise garnered through the acquisition of Alios.

Assets that transition into late development are prioritized into three categories to ensure that our investment of resources align with our most promising targets. Currently, our top two categories, which represent 40% of our assets and 80% of our overall late development value, receives 60% of our investment. It is through this approach that we remain at the top of the industry in successful phase transitions and speed to market.

Janssen has achieved considerable success and we are poised to continuously deliver near and long-term growth. Our balanced investment across all aspects of our pipeline allows us to enjoy a constant flow of important new data. We launched 12 new products since 2011. We received the most FDA approvals from 2011 to 2016 as well as eight breakthrough therapy designations. For four consecutive years, we have been named the Innovation Leader by IDEA Pharma and became the partner of choice to the work of J&J innovation. And for the third consecutive year, Fortune Magazine ranked Janssen Pharmaceutical Companies of Johnson & Johnson #1 in the pharmaceutical category on its annual World's Most Admired Companies list.

Our unwavering commitment to global public health is demonstrated by SIRTURO, the first new drug for the treatment of tuberculosis in over 40 years, as well as the work on new convenient HIV combinations, the first prime-boost Ebola vaccine using Crucell's adenoviral vector and Bavarian Nordic's MVA vector as well as new chewable forms of Mebendazole for children with worm infestations.

As Joaquin mentioned and as we highlighted at our 2015 Pharmaceutical Business Review Day, between 2015 and 2019 we plan on filing approximately 10 new drugs, each with the potential for greater than $1 billion in peak year sales and 40 line extensions. This slide highlights 10 LEs anticipated to be filed in the 2015 to 2019 time period with peak year sales potential greater than $0.5 billion. In addition, our early pipeline is rich in important assets that have the potential to file between 2020 and 2024.

We are on track to deliver our anticipated NME and LE results through a cadence of significant clinical data, regulatory filings and approvals. Since May 2015, we garnered three new product approvals and filings with a fourth, Guselkumab, anticipated this year, and we achieved 16 significant line extensions.

Now, let me use our time together to describe in greater detail some of the progress we have made since our May 2015 Pharmaceutical Business Review. Oncology is the newest of our five therapeutic areas and achieved industry-leading growth based on our development of several first-in-class drugs, including ZYTIGA, IMBRUVICA and DARZALEX.

Our hem-malignancies disease area is anchored by IMBRUVICA and DARZALEX. IMBRUVICA, the first BTK inhibitor for the treatment of certain B-cell malignancies, received four FDA breakthrough therapy designations. IMBRUVICA was recently approved for front-line use based on the unprecedented results in previously untreated CLL patients reported in the RESONATE-2 Study published in the December 15th issue of The New England Journal. As shown in this slide, treatment with ibrutinib decreased progression or death from CLL by 84% compared to chlorambucil and demonstrated a similar improvement in overall survival.

DARZALEX, the first monoclonal antibody for the treatment of multiple myeloma, received two FDA breakthrough therapy designations and was approved almost four months ahead of its PDUFA date in double refractory myeloma. As shown on this slide, combination therapy with DARZALEX delivered impressive results in treatment of relapsed or refractory multiple myeloma patients. The CASTOR and POLLUX studies demonstrated that the addition of DARZALEX to Velcade and dexamethasone or Revlimid and dexamethasone respectively produced a greater than 60% decrease in risk of progression or death as compared to that of VelDex or RevDex alone. Both of these studies were published in The New England Journal. This month, the FDA granted priority review for Daratumumab in combination with Lenalidomide and Dexamethasone or Bortezomib and Dexamethasone for relapsed multiple myeloma with a PDUFA date in February 2017.

Our prostate cancer disease area is anchored by ZYTIGA, the first CYP17 inhibitor for the treatment of men with metastatic castrate-resistant prostate cancer, and is approved for both pre and post chemotherapy indications. Furthermore, we are developing ARN-509, now known as apalutamide, a more potent next-generation androgen receptor antagonist that shows a high degree of safety and efficacy in castrate-resistant prostate cancer. As seen in these figures, apalutamide decreased PSA by a median of 85% in patients with non-metastatic castrate-resistant prostate cancer every 12 weeks of treatment. The maximal PSA response, shown in the right-hand figure, was achieved in 94% of patients.

Earlier this year, we licensed Niraparib from TESARO to obtain a highly potent and selective PARP inhibitor for the treatment of prostate cancer patients with DNA repair defects, for use in combination with ZYTIGA or apalutamide. Niraparib is in Phase 2 clinical trials and currently planned to be filed by 2019. This portfolio of assets gives us confidence that we will continue to bring great results to patients with prostate cancer for many years to come.

While we did not explicitly address immuno-oncology during our 2015 Pharmaceutical Business Review, we continue to make significant progress in this area. Over the last five years, we invested in four critical areas, including vaccines, T-cell checkpoint inhibitors, T-cell redirection and myeloid mechanisms of action. We currently have 15 immuno-oncology assets in development, including eight that are in the clinic.

Recently, we uncovered an important additional mechanism of action of DARZALEX to be immune-mediated through the depletion of immunosuppressive myeloid and lymphoid populations including a previously unrecognized super-suppressor CD38 positive T-reg population as well as activation of CD8 and CD4 positive effect to T-cells. These results provide the impetus for exploring DARZALEX in indications beyond hem-malignancies and solid tumors.

Our immunology therapeutic area continues to deliver extraordinary products for patients with psoriasis, inflammatory bowel disease and rheumatoid arthritis. STELARA was the first IL-12, IL-23 monoclonal antibody introduced for moderate to severe plaque psoriasis and active psoriatic arthritis. It was recently approved in moderately to severely active Crohn's disease in the U.S., received a positive opinion from the Committee for Medicinal Products for Human Use of the European Medicines Agency, and offers new options for adult patients with IBD.

Guselkumab is a first-in-class selective anti-IL-23 monoclonal antibody that demonstrated significant efficacy versus placebo and superiority compared with the anti-tumor necrosis factor, adalimumab, in moderate to severe plaque psoriasis. The VOYAGE study, whose results are shown in this slide, randomly assigned 750 patients to receive Guselkumab, adalimumab or a placebo followed by Guselkumab in a 2-2-1 ratio. Patients treated with Guselkumab achieved a significantly greater chance of attaining a PASI 90 score compared to that of patients treated with adalimumab or placebo at week 16, and the advantage over adalimumab was sustained through week 48.

The high degree of efficacy of Guselkumab, the less intensive dosing regimen and the potential for a STELARA-like safety profile makes Guselkumab highly competitive with newly launched anti-IL-17 antibodies. We plan to file for psoriasis this year and advance Guselkumab into Phase 3 for patients with psoriatic arthritis.

Neuroscience is a historically strong area for Janssen since Dr. Paul Janssen and colleagues developed haloperidol, the first medication for schizophrenia. We have built on Dr. Paul's legacy with the development of next generation antipsychotics and pioneered the development of long-acting injectables that help improve compliance with this difficult to treat patient population, most recently with the approval of INVEGA TRINZA in every three-month injectable formulation.

Today, we focus on neuroscience investment in drugs that treat serious mood disorders, including depression, suicidality and Alzheimer's disease. Esketamine, an intranasally delivered enantiomer of ketamine, produced groundbreaking results in major depressive disorder, with onset of action measured in hours to days rather than weeks to months.

There is an alarming increase in suicides, both in the U.S. and globally, more than 41,000 each year in the U.S. alone. It's a tragic issue that's emerging as a major health priority. As shown in this slide, Esketamine ameliorated suicidal ideation within four hours and sustained this effect for over three weeks, leading to its second FDA breakthrough therapy designation.

Infectious diseases is one of our most exciting and important area of investment for future growth where we focus on respiratory infections and hepatitis. We are pursuing an aggressive strategy for the cure of hepatitis C. We recently reported a 100% SVR12 in patients with genotype 1 with both an eight and six-week duration of treatment using a 3DAA combination of OLYSIO, AL-335 and odalasvir. Based on these exceptional data, we are moving to 3DAA regimen into late development studies.

Our cardiovascular and metabolism therapeutic area developed both INVOKANA and XARELTO in partnership with Mitsubishi Tanabe and Bayer respectively. New line extensions are designed to continue to bring value to these two first-in-class drugs.

With XARELTO, we are pursuing studies in congestive heart failure, embolic stroke of undetermined source, VTE prevention in medically ill patients, infrainguinal peripheral artery disease, VTE prevention in cancer patients and in acute coronary syndrome. We anticipate readouts from two INVOKANA cardiovascular outcome studies by mid-2017, which we believe will further strengthen the importance of the SGLT2 inhibitor class in the treatment of patients with diabetes. We are also studying the role of INVOKANA in diabetic kidney disease and plan to address obesity and pre-diabetes.

In summary, at the Janssen Pharmaceutical Companies of Johnson & Johnson, we are executing a clearly defined innovation strategy that drives value to patients around the world. We are on track to meeting our anticipated results described in 2015. We are producing a cadence of transformational innovations that are leading to exceptional results. We are a leader in productivity, approvals and FDA breakthrough therapy designations, and we are one of the fastest growing top 10 pharmaceutical companies.

We have had the most U.S. FDA approvals in the last five years, 2011 to 2016, and eight breakthrough therapy designations. We anticipate filing approximately 10 NMEs between 2015 and 2019, each with greater than $1 billion peak year sales potential. We have approximately 40 planned line-extension filings anticipated between 2015 and 2019, several with greater than $500 million in peak year sales potential, supported by a steady flow of clinical data that drive better patient results. Finally, we take pride in delivering years of life saved and better quality of life for our first Credo responsibility to the doctors, nurses and patients who use our products.

Now, before I turn it over to Dominic, for your reference let me leave you with the current overview of our pipeline across our five therapeutic areas. Dominic will now continue with an update of the Company's financial results.

Dominic J. Caruso

Thank you, Bill and Joaquin, and good morning everyone. As you just heard, our Pharmaceutical business is well positioned for continued above-industry growth as we made good progress against the pipeline expectations we communicated at our 2015 Pharmaceutical Business Review. With great leaders like Joaquin and Bill, our strong end market performance driven by excellent commercial capabilities and our robust R&D pipeline, you can see why we remain confident that our Pharmaceuticals business will continue to be a major driver of growth moving forward.

I will now turn our discussion back to the quarter. We're pleased with our overall results. As you know, we had a strong start to the year, and as a result, last quarter we increased our sales and earnings guidance. I'm happy to say we're tracking with those higher expectations while continuing to invest in our business. As you've heard, our Pharmaceutical business delivered strong results this quarter with underlying operational growth of 10.7%. Let me now provide some comments on our other businesses.

In our Consumer business, we continued to gain share this quarter. However, as reported by Nielsen, the industry saw slowdown in many markets with category growth rates in 2016 about half of the category growth rates we saw in Q3 of 2015. As Joe noted, our sales growth for the quarter was also impacted by lower trade inventory levels. These lower levels are the result of inventory builds in Q3 2015, as we discussed at that time, due to re-launches of certain products as well as inventory reduction programs being implemented at some of the larger retailers this past quarter. When excluding the impact of acquisitions and divestitures and the impact of the devaluation that occurred in Venezuela last year, and this overall impact with trade inventory reductions, overall Consumer growth was nearly 4%. Based on increasing share trends of our brands, we expect trade levels to align with consumption going forward.

In Medical Devices, consistent with some recent analyst reports about the market, we believe the industry experienced lower hospital admissions and procedure rates during the mid summer months. Late in the quarter, several reports showed higher levels of activity, and in fact the data that we recently saw published for September looked encouraging. Additionally, we are very pleased to see our priority platforms continue to deliver robust growth of nearly 9%, with some at double-digits as Joe mentioned earlier. Overall, Hospital Medical Devices operational growth, excluding acquisitions and divestitures, was approximately 4% this quarter. In the Consumer Medical Device businesses, we saw continued price erosion in our Diabetes business. However, in our Vision Care business, we saw good operational growth of 5.5%.

So in summary, as we previously discussed, in 2015 our underlying operational growth, which excludes the impact of acquisitions and divestitures as well as hepatitis C sales and the few extra shipping days that we saw in 2015, was about 5.5%. On this same basis, we continued to accelerate our growth and we delivered strong underlying operational sales growth of approximately 5.9% for the third quarter of 2016. Our sales were above analyst estimates, as were earnings, due to significantly higher pre-tax operating margins.

As you may remember, our guidance from January included a more than 200 basis point increase in our 2016 pre-tax operating margin on an adjusted basis. We have attained that level year-to-date while continuing to invest in our business and we remain comfortable with that forecast for the full year as we continue to execute on the restructuring activities in our Medical Devices businesses while also investing in growth.

As you know, in September we announced a definitive agreement to acquire Abbott Medical Optics. We expect this transaction to close in Q1 of 2017. So, for 2016, the transaction is expected to have no impact to our adjusted earnings and is not expected to impact our guidance. For 2017, again assuming a Q1 close, the transaction is expected to be positive to sales growth and immediately accretive to adjusted EPS. We are excited about Abbott Medical Optics' strong and differentiated surgical ophthalmic portfolio, particularly in cataract surgery. That, coupled with our world-leading ACUVUE contact lens business, will help us become a broad-based leader in vision care.

Now, I'll take the next few minutes to highlight some key points regarding our results for the quarter, and then I'll provide some updates to our guidance for you to consider in refining your models for the remainder of 2016. So I'll now turn to our consolidated statement of earnings for the third quarter of 2016.

Our operational sales growth this quarter was 4.3%, and when we exclude the impact of acquisitions, divestitures, the impact of hep C sales and the overall impact the Venezuela had, it was strong at more than 6%. If you direct your attention to the boxed section of the schedule, you will see we have provided our earnings adjusted to exclude intangible amortization expense and special items.

As referenced in the table of non-GAAP measures, the 2016 third quarter net earnings were adjusted to exclude intangible amortization expense and special items of approximately $400 million on an after-tax basis, which consisted primarily of the intangible amortization expense of about $250 million and the anticipated special charges as we continue to execute on the Medical Devices restructuring plan. Our adjusted earnings per share is therefore $1.68, which exceeded the mean of the analyst estimates as published by first call. This is an increase in adjusted EPS of 12.8% versus the prior year. Adjusted EPS on a constant currency basis was the same, as the impact of currency was flat year-over-year.

Now let's take a few moments to talk about other items of the statement of earnings. Cost of goods sold increased by 30 basis points, mostly due to unfavorable transaction currency impacts, partly offset by a favorable mix and manufacturing efficiencies. Selling, marketing and administrative expenses were 26.8% of sales or 290 basis points lower, as compared to the third quarter of 2015, due to overall good cost management. Our investment in research and development as a percent of sales was 12.2%, lower by 40 basis points, due primarily to lower milestone payments, partly offset by increased project spending as we advance our promising product pipeline.

Our pre-tax operating margin, when excluding special items and intangible amortization expense, was 32% or 310 basis points higher than the third quarter of the prior year. As a reminder, our pre-tax operating margin is defined as gross profit, less selling, marketing and administrative expenses, and less R&D expenses. As we anticipated, we are seeing improvement as we progress throughout the year, and through nine months we have achieved a 220 basis point improvement in this measure of profitability, consistent with the expectations we communicated to you throughout the year.

Interest expense, net of interest income, was similar to last year. Other income and expense was a net gain of approximately $50 million in the quarter, compared to a net expense of approximately $400 million in the same period last year. Excluding the special items that are reflected in this line, other income and expense was a net gain of approximately $200 million, compared to a net gain of approximately $400 million in the prior year period which included a higher level of gains from divestitures.

Excluding special items, the effective tax rate in the quarter was 19.7%, compared to 20% in the same period last year. This year's effective rate reflects the R&D tax credit which was passed by Congress late last year and it reflects the current mix of our businesses and the impact from a new accounting standard relating to the tax benefit on share-based compensation which we discussed in our call in July.

Turning to the next slide, I will now review adjusted income before tax by segment. In the third quarter of 2016, our adjusted income before tax margin for the enterprise improved by 220 basis points versus the third quarter of 2015. You will note a significant improvement in margins for the Medical Devices and Pharmaceutical businesses. Last year, our Consumer business benefited from a gain on the sale of SPLENDA and you're seeing that reflected in their lower margin this quarter, although still at very healthy rates.

As you can see on the next slide, on a year-to-date basis, we are pleased to see solid improvement in our Consumer margin and we remain confident it will show an improved adjusted income before tax margin for full-year 2016 as compared to 2015. Overall, we expect adjusted income before tax margins for the enterprise to show an improvement over the prior year for all of 2016 as our increase in pre-tax operating profit margin which I noted earlier more than offsets the lower level of divestiture gains in 2016 as compared to 2015.

Now, I'd like to provide some guidance for you to consider as you refine your models for 2016. I'd like to start with some of the items that we know you find difficult to forecast. Let's start with cash and interest income and expense. At the end of the quarter, we had approximately $13 billion of net cash, which consist of approximately $40 billion of cash and marketable securities and approximately $27 billion of debt.

Through the end of the third quarter, we completed nearly 60% of our $10 billion share repurchase program and we expect to complete approximately 75% of the program by the end of this year. For purposes of your models and assuming no major acquisitions or other major uses of cash, I suggest you consider modeling net interest expense of between $400 million and $450 million. This is a slight tightening of the range.

Regarding other income and expense, as a reminder, this is the account where we record royalty income as well as gains or losses arising from such items as litigation, investments by our Development Corp., divestitures, asset sales and write-offs. We would be comfortable with your models for 2016 reflecting net other income and expense, excluding special items, as a gain ranging from approximately $750 million to $850 million, a lower range than our previous guidance related to the underlying activity. This impact will be offset by a lower tax rate.

And now for taxes, we're very comfortable with your models reflecting an effective tax rate for 2016, excluding special items, of approximately 18% to 18.5%, which is lower than our previous guidance primarily due to a higher level of income in lower tax jurisdictions.

Now turning to sales and earnings, our sales and earnings guidance for 2016 takes into account several assumptions and key factors that I would like to highlight. Our sales range for 2016 continues to remain the same, whether or not a biosimilar REMICADE launches this year in the U.S. Additionally, we do not anticipate biosimilar or generic competition this year for PROCRIT, ZYTIGA, RISPERDAL CONSTA and INVEGA SUSTENNA, but as expected, there are generic entrants for INVEGA and ORTHO TRI-CYCLEN Lo.

As we've done for several years, our guidance will be first based on a constant currency basis, reflecting our results from operations. This is the way we manage our business and we believe this provides a good understanding of the underlying performance of our business. We will also provide an estimate of our sales and adjusted EPS results for 2016 with the impact that current exchange rates could have on the translation of those results.

We continue to be comfortable with the sales guidance we provided last quarter, reflecting an operational sales increase on a constant currency basis of between 3% and 4% for the year. This would result in sales for 2016 on a constant currency basis of between approximately $72.2 billion to $72.9 billion. Additionally, by way of comparison to how we described our sales results in 2015, our operational sales growth for 2016, excluding the impact of all acquisition, divestitures and hepatitis C, would be approximately 6%, a higher level of growth than we saw last year even after adjusting for the shipping days in 2015 which we mentioned earlier.

Although we are not predicting the impact of currency movements, using the euro as of last week at $1.11, the negative impact of foreign currency translation would be approximately 1% on sales growth. This is consistent with our previous guidance as major currencies had not significantly fluctuated since our last update. So, after impacts of currency, we would expect reported sales to reflect the change in the range of positive 2% to 3% or a total expected level of reported sales of approximately $71.5 billion to $72.2 billion, consistent with our previous guidance.

And now turning to earnings, as a reminder, we expect transaction currency impacts to be negative to our gross margin by approximately 60 to 80 basis points in 2016 as compared to 2015. We would be comfortable with adjusted operational EPS guidance in the range of between $6.71 and $6.76 per share on a constant currency basis, reflecting an operational or constant currency growth rate of 8% to 9%, and this is a narrowing of the range.

If currency exchange rates for all of 2016 were to remain where they were as of last week, the negative impact to EPS would be approximately $0.03, consistent with our previous guidance. Therefore, we would be comfortable with our reported adjusted EPS ranging from $6.68 to $6.73 per share, which again is a narrowing of our previous guidance with a midpoint that is $0.03 higher than our previous guidance range.

Finally, just a reminder of some dynamics you will see in our fourth quarter results this year in comparison to the fourth quarter of 2015. In 2015, we had additional shipping days based on when our year-end closed, and that contributed approximately 4 points of sales growth in the fourth quarter of last year. Additionally, in the fourth quarter last year, we closed on the Cordis divestiture, and based on our latest guidance for 2016, we will have significantly lower level of other income from divestitures as compared to the prior year.

In closing, we are very pleased with our performance so far this year and we remain confident and optimistic about our future full-year growth for 2016. Specifically, we are expecting operational sales growth of 3% to 4% and underlying operational sales growth of 6%, a higher level than we experienced last year on a comparable basis. Our adjusted pre-tax operating margin improvements are on track to meet the expectations we laid out in our guidance of more than a 200 basis point improvement over the prior year. We narrowed our guidance and increased the midpoint for adjusted operational EPS growth, which remained strong in the range of $6.71 to $6.76 per share, with a growth rate of 8% to 9%, and we are very well-positioned to seize the opportunities in our strong pipelines to continue fueling our future growth.

Now I'd like to turn things back to Joe for the Q&A portion of the call. Joe?

Joseph Wolk

Thank you, Dominic. Michelle, can you please provide instructions for those on the line wishing to participate in the Q&A?

Question-and-Answer Session


[Operator Instructions] Your first question comes from Larry Biegelsen with Wells Fargo.

Larry Biegelsen

So Dominic, I wanted to focus on the 2017 puts and takes. Dominic, in our Healthcare Conference in September, you said the only real delta from 2016 to 2017 is the rate at which biosimilar REMICADE could penetrate the market, assuming Pfizer launches at risk and you don't think the penetration will be dramatic. I took that to mean that you feel that you can grow sales in 2017 at a similar rate to 2016 minus the impact from biosimilar REMICADE. So my questions are, is that the right interpretation and what gives you the confidence that this level of growth will continue? And second, the biosimilar for Neupogen captured about 7% of the market in year one. Would you expect Inflectra penetration to be less than that? Any color that you can give on the expected penetration would be helpful, and I did have one follow-up on Pharma. Thank you.

Dominic J. Caruso

Sure, Larry. Thanks for the question. I think the way you characterized it is accurate, that excluding the impact of any biosimilar launch, we would expect the business to grow at a rate similar to what we saw this year in the Pharma business overall, as well as I think we will see improved performance in the Medical Devices business and we're seeing continued share gains in the Consumer business. So I think that is a good way to characterize it. We'll provide more color on that when we talk about the 2017 guidance in our discussion in January.

We do think that the rate of penetration for a biosimilar will be modest. I know several reasons for that. As we talked about before, 70% of the patients are treated well with REMICADE. There is no interchangeability available, that's another factor. And we're already in a highly competitive environment with respect to biologics, anti-TNF therapies, as you know. Before any comments on Neupogen, Joaquin, anything else you want to add to overall penetration of biosimilars?

Joaquin Duato

We are confident that we have our readiness plan for our biosimilar launch in the U.S. What we have seen internationally in markets like Australia, Brazil where we market REMICADE is that our volume share has been in excess of 90%. So that is consistent with what you described. We are confident that we have a strong plan based on what Dominic described before, there's been 2.6 million patients treated with REMICADE worldwide, there is no interchangeability and there is a clear patient and physician preference. So it's highly unlikely that you're going to be seeing patients that are stable in REMICADE to switch it. So that is 70% of the patients.

At the same time, we have a strong patient assistance program which will prove to be a market differentiator and we are ready to compete in every channel trying to bring patients the most affordable option in every situation. So we feel well-prepared to face the biosimilar, and as Dominic said, we are convinced that we will continue to grow our business in the face of biosimilar competition.

Dominic J. Caruso

And Larry, I'm not sure whether Neupogen is a good analog or not. I mean, who knows, right. Obviously, we have Europe, we have a biosimilar in Europe that Merck is responsible for marketing I think there over about a two-year period. Merck has retained about 75% share. So that's one analog. You had a follow-up question you said on Pharma.

Larry Biegelsen

Yes, maybe for Joaquin. So on INVOKANA, I saw in the presentation that you expect to present the CANVAS and the CANVAS-R data in mid-2017. So my questions are, are you going to present CANVAS and CANVAS-R separately before mid-2017 and did you have any plan to issue a press release with top line results before the presentation? And lastly, what's your confidence that we'll see a similar cardiovascular benefit as we did with EMPA-REG OUTCOME as well as the lack of significant amputation risk? Thanks for taking the questions.

Joaquin Duato

INVOKANA remains the leading SGLT2, as I have described in the conference call, and to talk about CANVAS and CANVAS-R and the cardiovascular benefit, I'm going to pass the question to Bill.

William Hait

This is Bill Hait. So we plan to evaluate CANVAS and CANVAS-R together as one net analysis. We're in discussions right now on the degrees of statistical confidence with the FDA. We have very strong reason to suspect based on CANVAS that the combination will give data very similar to what was reported with EMPA.


The next question comes from Kristen Stewart with Deutsche Bank.

Kristen Stewart

I was just going back to I guess REMICADE and just again through the pipeline I guess, what are some of the things that you feel confident on to the extent that the biosimilar could take I guess greater share than what you are expecting that could start to fill-in I guess some of the gaps from that perspective?

Joaquin Duato

I described part of the reasons for optimism during my conversation before. We not only feel that we are going to be able to grow in the face of biosimilars in the pharmaceutical business overall, but we also are confident that we're going to be able to grow our immunology franchise in the face of biosimilars. Let me give you some examples of why going into the three segments, rheumatology, psoriasis and gastroenterology.

In rheumatology, SIMPONI and SIMPONI ARIA are doing very well. As a matter of fact, SIMPONI ARIA is already leading in new-to-brand share in rheumatology in the U.S., and SIMPONI is gaining share in all international markets. We plan to file two line extensions of SIMPONI ARIA in ankylosing spondylitis and in psoriatic arthritis by 2017, and also we just filed sirukumab with EMEA and we plan to file it here in the U.S. before the end of the year. So that gives us a strong confidence that we're going to continue to grow in rheumatology.

Then moving into psoriasis, STELARA continues to be the leading in new-to-brand share in the U.S. and it's leading in most markets internationally. Together with that, we plan to file Guselkumab that we have presented very impressive data at the last EADV. We plan to file Guselkumab before the end of the year. So that's another reason why we feel real confident that we will continue to grow in psoriasis.

And finally gastroenterology, which by the way for us is the largest and fastest-growing segment, we just had the approval of STELARA in Crohn's disease and we are now launching it in the U.S. and we anticipate to be launching it in Europe pretty soon. So that is another reason which we believe that we are going to be able to continue to grow in immunology.

So overall, we have line extensions, we have continuous penetration and also we have the filing of sirukumab and Guselkumab in the second half of the year.


The next question comes from Mike Weinstein with J.P. Morgan.

Michael Weinstein

So Dominic, I wanted to just follow up on all the discussion on the Pharmaceutical business. You made some comments at an investor conference in September that caught my attention. You talked about the five major therapeutic categories the Company is in today, and you opened up I think for the first time that the potential of the Company would consider adding a new therapeutic category. Just want to get a sense of your interest in doing that, and maybe the rest of the team wants to chime in as well.

Dominic J. Caruso

Sure, Mike. I remember that discussion pretty well. I just want to put it in the context for everyone. So this was a discussion about the success of our Pharmaceutical business, which has largely been driven by collaboration, licensing, co-development, et cetera, and not at all by any major acquisition, right. And the question that I got posed to me was, well, that's been very successful, why would you ever change that or is there any reason to consider a change in that strategy?

And my comment was, to the extent we have five major therapeutic areas today, if we decided that another major therapeutic area was of importance to us and we wanted to get into that therapeutic area and we felt we could add a lot to it based on our overall scientific knowledge more broadly, that I would see that perhaps being done not by necessarily a licensing strategy but more of an acquisition type strategy. So it would enhance the overall portfolio of Johnson & Johnson's Pharmaceutical business beyond the current therapeutic areas that we currently are in, and by doing that, that might require a more significant acquisition than we've been doing in the Pharma business. So that's the context for that.

Joaquin Duato

What is important to remember is that our focus is in medical innovation, and therefore our areas in which we'll operate will depend on where science is going and our own internal capabilities on the development on the commercial side. So, from that perspective, we are constantly evaluating in which therapeutic areas we are in and its affluent situation. The focus is in transformational medical innovation and the actual therapeutic areas can change over time.

Michael Weinstein

And so, is that – I mean, Dominic, that comment, is that just an indicator of that there is an open-end sort of interest in new therapeutic areas more so today than maybe in the last five years?

Dominic J. Caruso

I think there's always an interest in new therapeutic areas where there is medical innovation where we think we can make a difference to patients in the health care system. So I'm not sure that that's changed dramatically, although over the last several years, we've built these very prominent disease strongholds within the therapeutic areas that we have today and obviously they take some time to build. Bill, any other comments on that?

William Hait

In fact, to get to where we are today, we had to focus down from approximately 33 different diseases we were investing broadly but thinly to 11 diseases where we developed extremely deep expertise internally, from basic discovery right through launching, commercialization and market understanding, to where we are always considering first, is there a room for further massive innovation because of the development of transformational science or new knowledge that we can go after. And number two is, we become very familiar with adjacencies to the areas we are in, and if they look attractive, they are often the ones we take the hardest look at. So we are always looking to see if there's still massive innovation left to go in our disease areas and therapeutic areas and we're always looking closely at adjacencies.


The next question comes from David Lewis with Morgan Stanley.

David Lewis

Two questions, first for Joaquin and then Dominic, some commentary on Medical Devices utilization. So Joaquin, I found your commentary on the strategy to defend REMICADE pretty compelling. So, should we take from your comments that your existing strategy is sufficient or should we expect more proactive pricing strategies to emerge in 2017 and beyond?

Joaquin Duato

Our strategy is three-pronged, as I described. The first one is the fact that we believe based on the track record of REMICADE and the lack of interchangeability, it's unlikely that patients are going to switch if they are stable. So that's a very important component for us. The second element is that we plan to compete in all channels, and in planning to compete in all channels, we are going to be utilizing innovative contracting and utilizing the full breadth of our portfolio. And then finally, we plan to utilize market differentiators such as patient assistance programs that are going to enable affordability. So with these three components, we feel confident that we are going to be able to have a very strong plan to face the biosimilar.

The second element of that overall is what I just described before, what are the elements that lead us to believe that we'll continue to grow in immunology too, and I described the different line extensions and NMEs that we have in the three areas, rheumatology, gastroenterology and psoriasis. So combined, we feel strongly that we'll be able to continue to grow in immunology and overall the Pharmaceutical business will grow in the face of the biosimilars.

David Lewis

Okay. So if you had to use price next year more aggressively, Joaquin, that would be an incremental surprise to you?

Joaquin Duato

This is already a very competitive market as it is today. As you can imagine, there is already significant competition in the market today, both in the subcu area and in the IV area. So we believe that the level of discounting that is today makes it already a high bar for any new entrant.

David Lewis

Thank you, very clear. And then Dominic, you made a series of comments on utilization. I just want to clarify both the near-term and kind of longer-term environment. So if I heard you correctly, it seems like there was some softening potentially in the Medical Devices business in the summer but that got better in September. I wonder if you could just help us out in terms of how you would characterize the environment here in September and entering into October. Is it stable with what you saw in the first half of the year or different? And then the second part of that question is, you also said, in 2017 you actually expect some improvement in the Medical Devices business, and maybe you could share with us your confidence level and the areas that you would expect to improve in 2017?

Dominic J. Caruso

Sure. So what we saw, David, is that through published sources, many of which are from firms such as yours and many of the sell-side that publish, we saw actually utilization rates as depicted in hospital admissions and hospital surgical procedures with the first quarter of this year being the highest by far and then a slowdown in the second quarter, a slowdown even below the level at which most estimates were depicting or forecasting. And then the third quarter was even slower than the second quarter overall but with a very marked difference in September.

So once September hit, the data showed quite a rebound from the summer months, and the rate of growth in September was actually faster than what we saw in the first quarter, which was the highest growth quarter year-over-year in terms of penetration. Now whether that remains at that level or whether it's a rebound effect from the summer, we'll have to see. But I think this is all well-chronicled in the multiple reports that many of you I'm sure have seen. So overall, I'd say we're now in a stable environment in hospital procedures.

Going into 2017, I expressed confidence in our Medical Devices business growing faster, and quite frankly, you know we have a plan for that business to return to growth at above market for the Medical Devices sector and it's continuing to improve. What gives me confidence there is that the area that we focused the most on, the growth platforms and priority platforms, just this quarter they grew at 9%, and within those, three of those in particular, electrophysiology, energy and endocutters, each grew at double-digit growth. So we obviously have very robust growth coming in the priority platforms, which we expect to continue and drive us to above market growth in 2017.


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

Glenn Novarro

Just a follow-up on REMICADE, because Dominic, you said REMICADE, where the biosimilars would be a launch risk, so can you remind us what's next in the legal process? And then you also did a good job of discussing the impact you thought for the top line. Can you talk about the profitability of REMICADE today? Is this a drug that is still heavily marketed? I can't imagine there is a lot of R&D behind REMICADE.

Dominic J. Caruso

A couple of things where we stand on the legal front, as you know we have an upcoming trial on the media related to the production of the biosimilar and that trial is scheduled for mid-February of 2017, and we're also appealing the ruling recently in the Massachusetts Court regarding the patent being invalid, and that will proceed. But we're also separately, and we had been involved in this process for quite some time, we're continuing the appeals process within the U.S. Patent Office and that process has several more steps to go. Joe, anything else you want to add to that?

Joseph Wolk

Yes, just with some specific dates, Glenn. So the oral arguments in front of the PTO was heard on September 28. We expect that decision to be rendered anywhere from one to three months. In the courts, on the 471 patent, the final judgment just came from the bench on September 27. So that triggers the time in which we have to appeal, and we are going through that process now.

Dominic J. Caruso

Okay, and with regard to profitability, obviously the product like REMICADE is an important product that obviously delivers significant profitability to the Company, but of course we have a number of new launches. We have some that are already launched and are progressing and rapidly growing and their relative cost does not grow at the rate of their sales growth, and overall we have to manage through this period of time when eventually when a biosimilar launches and a patent expires, we'll have to prepare ourselves for that in any event.

So we are very well prepared to adjust accordingly, and as you know, our major focus always is to grow our sales at a rate faster than the rate in which our markets grow, so gain share, and then grow our earnings at a rate faster than sales. So that's the level at which we plan for each and every year.

Glenn Novarro

So is there some restructuring that may come out over the next, announcements that may come out that could serve as an offset to REMICADE and any potential lost profitability?

Dominic J. Caruso

We don't see any major restructuring related to the REMICADE situation on the horizon, Glenn, not at all.

Glenn Novarro

Okay, great. Thank you.


Your next question comes from Jami Rubin with Goldman Sachs.

Jami Rubin

Dominic, just a couple of questions for you. With the upcoming election, obviously it's been a major area of focus for healthcare investors. I'm just curious to your thoughts on Proposition 61, and as you know, I think that polls are showing that that actually might pass in the state of California, and just curious to know what you think the industry's response will be to that. And then secondly, I'm interested in your thoughts on the potential for an international tax reform as part of an infrastructure bill. Obviously, you would be huge beneficiaries of such a bill because of repatriation. Can you give us your thoughts on the likelihood of that happening? We had multiple discussions over the years about tax reforms, which never happens, maybe it will happen this time, just curious to know what your Washington folks are saying. And are we correct in assuming that if you were to do a large mega transaction adding that sixth tool to your Pharmaceutical division, are you more likely to wait until we get visibility on that or is your decision irrespective of potential legislation? Thanks.

Dominic J. Caruso

Okay, Jami, let me take a minute and reverse a little. So whether or not we do a major transaction, we'll not be dependent on waiting for international tax reform. Obviously we have plenty of borrowing capacity and obviously any transaction that's done outside the U.S. would be an effective use of that OUS cash. And as you know, we've had the benefit of being able to structure transactions and effectively use our OUS cash in a tax efficient manner and we did that [indiscernible] transaction, we've done that recently with the two transactions that we recently announced.

With respect to international tax reform and what we're hearing, I can tell you that I visit in Washington often and speak with members of the House Ways and Means Committee and the Senate Finance Committee and the tax staffs are busily working and working very collaboratively with U.S. multinationals on an appropriate tax reform package. We think there is more [by-parts] [ph] to support now than there has been in the past. We think that often we hear, as you mentioned, the benefit of investing in U.S. infrastructure as a result of those repatriated earnings coming back into the U.S. So that would be a positive. And we think that overall the climate for international tax reform post the election, quite frankly, is more positive than it's been in the last year or so.

And then with respect to Proposition 61, there are several opponents to that proposition and we would prefer to have pricing that is more related to outcomes. Evidence-based medicine is something that we are advocates of, and therefore, outcome-based pricing is a logical consequence of that. But Joaquin, any other thoughts on Prop 61?

Joaquin Duato

Thank you. I mean as you were saying, Dominic, despite of the rhetoric about pharmaceutical pricing, it's always good to take some perspective on that. Pharmaceuticals represent 14% of total expenditures and we understand that we need to work with different stakeholders in order to try to manage our healthcare cost and we have advanced different ideas in that area as you were describing, Dominic, such as value-based contracting, and we need to work there in order to try to eliminate the regulatory barriers that do not help in that area.

As far as Proposition 61, as an example of that rhetoric, as Dominic said, there are different groups that oppose that measure that includes even veteran groups and seniors and unions, the reason being it's unclear what the effects of Proposition 61 would be. It is clear that it would be difficult to operationalize and also would create some access barriers to patients. So overall, we don't see Proposition 61 as the right way to try to work on pharmaceutical pricing. We think it's a misguided action.

Joseph Wolk

Being respectful of everyone's time, we'll take one more question, Michelle.


Our final question comes from Matt Miksic with UBS.

Matthew Miksic

I have one just quick clarification here on REMICADE, and then I have one on sort of capital allocation. So Dominic and Joaquin, if I could just make sure I'm understanding your comment on pricing and expected biosimilar competition. As you've gone through a number of times here on the call, the perception is that REMICADE pricing will face some kind of new downward pressure or abrupt pressure here as a result of this launch. It sounds like what you're saying is, the net price for the drug is already quite competitive. There will be obviously penetration but it doesn't sound like you're expecting to see any kind of significant or abrupt changes in pricing because of the competitive launch. Is that a fair characterization of what you're saying?

Joaquin Duato

I think you got it right. All drugs, all medicines face price pressure. This is a particularly competitive market as it is today and we think that the price level is already quite competitive. So I think you characterized the situation quite right. I think the competition is going to move into other discussions such as other market differentiators, but the market is already quite competitive as it is.

Matthew Miksic

Got it. Thank you. And then on capital allocation, just broadly speaking, Dominic, as we get this question quite often, you've made a number of comments throughout September about the kinds of things that you would be interested in strategically. You of course have said previously you'd be interested in ophthalmology and you are now pursuing that. If you wouldn't mind just for the record kind of ticking through your major divisions, and just I think you've touched on Pharma already, your preference there, but maybe on Consumer and Devices, just remind us the kinds of things that you are still interested in, their size and maybe area?

Dominic J. Caruso

Matt, as a broadly-based company in human healthcare, we have an equal amount of interest across each of the businesses, and the way we compensate for that is basically looking at an appropriate risk-adjusted return for the particular assets that we're interested in, and that is the same even regardless of size. I mean, obviously size matters for a couple of reasons. One is that the asset may be well understood, the business may be well-penetrated, the premium required for the asset may be excessive, and therefore to generate value for our shareholders would be a challenge, but it doesn't mean we wouldn't try to do that or we wouldn't look for areas where that may in fact be available for us. So that would be across any of the businesses.

Within Consumer and Medical Devices in particular, Consumer, just like we have in Pharma, we have specific areas of focus. We have 11 need states. The primary focus for us is growing internationally in emerging markets, so strong brands in emerging markets. A focus on over-the-counter medications and the beauty space particularly in Asia are of interest to us. We just did a recent transaction with Dr.Ci:Labo in Japan where we have an interest in that Asian marketplace and utilizing that brand throughout broader, throughout Asia beyond Japan where it's currently marketed, just as an example of one.

In the Medical Devices, as you know we have a very strong presence in orthopaedics and in general surgery. We keep looking for additional bolt-on acquisitions there and we have a very strong electrophysiology business in cardiovascular but there are other areas within cardiovascular that seem attractive in structural heart and other areas, but the valuation would be something we'd always consider. So we'd also be very disciplined about doing a transaction where the valuation seem pretty high, which is what they are today.

Joseph Wolk

Thank you for the questions, Matt. That concludes the Q&A. I will now turn the discussion back over to Dominic for some closing remarks.

Dominic J. Caruso

Okay. Thanks Joe. As I noted earlier, we're very pleased with our overall performance this quarter and we are tracking well through the second half of the year. I would like to thank Joaquin and Bill for their outstanding leadership and for the great presentation they gave this morning about the continued progress we are making in our pharmaceutical business. I would also like to thank all of our colleagues around the world for their extraordinary achievements and dedication to the success of Johnson & Johnson. Thank you for your time today and I look forward to updating you on our full-year results in January. Have a great day.


Thank you. This concludes today's Johnson & Johnson's third quarter 2016 earnings conference call. You may now disconnect.

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